Can Medicare be saved?

Medicare, the federal health insurance program for the elderly, turns 46 this year. How much longer it survives depends on whether Congress decides to mend it or end it.

The existential threat to Medicare comes from the rapidly rising cost of the medical treatments it covers. The program will cost the federal government nearly half a trillion dollars this year, and the price is expected to rise 62% over the coming decade.

House Budget Committee Chairman Rep. Paul Ryan (R-Wis.) has a straightforward solution to the problem: Get the federal government out of the health insurance business, not just for the elderly (through Medicare) but also for the poor (through Medicaid). The budget he proposed for fiscal 2012, which the House passed Friday on a party-line vote, recommends that the government start replacing Medicare in 10 years with subsidies for private insurance policies that seniors buy for themselves. It also calls on Congress to immediately convert direct federal support for Medicaid into block grants to states to help them provide coverage for low-income residents.

The changes would eventually work out well for the federal government, if not necessarily for the programs’ beneficiaries. Yet Ryan’s ideas about Medicare address a fundamental problem that last year’s healthcare reform bill largely ignored: Consumers don’t pay attention to the cost of many of the procedures they demand because someone else pays for them. That’s an inherent problem with insurance, which is designed to shield people from costs. The issue for policymakers is how to bring the power of market forces to Medicare without leaving elderly Americans unable to afford the care they need.

Ryan’s proposal would put Medicare and Medicaid on a budget, at least where federal dollars were concerned. Under his plan, after Medicare started the transition from providing insurance to subsidizing premiums in 2022, the increase in subsidies would be tied primarily to the consumer price index, which has been rising at roughly half the rate of healthcare costs. Increases in the Medicaid block grants would similarly be held well below the rate that treatment costs have been growing.

The assumption is that the new limits would put pressure on the healthcare system to adapt, because money that isn’t available can’t be spent. Supporters of this approach argue that requiring seniors to cover more of their own costs would reduce the demand for nonessential healthcare services and make insurers and providers compete harder for their dollars. Easing federal control over Medicaid would let states pursue innovative approaches to insuring the poor rather than forcing them to spend a growing amount of their budgets on healthcare every year.

If that pressure doesn’t bring about the desired changes, however, Ryan’s plan would leave seniors, states and the poor more exposed to ever-higher costs. And regrettably, the plan treats the symptoms of the healthcare spending problem, not the sources. Those include an aging population and an endless stream of expensive new treatments that can extend lives, two factors that no reform effort could or would try to change. But there is much that can be done to eliminate the perverse incentives in the healthcare system that deliver the biggest financial rewards to those who perform the most treatments on the sickest patients.

Ryan doesn’t address that issue, at least not directly. But the healthcare reform law Congress enacted last year, which Ryan wants to repeal, tries to fix the system’s warped incentives by trying out new ways to deliver and pay for care that emphasize coordination, quality and value. The law calls for the lessons from successful trials to be applied more broadly across Medicare, in the hope that they will filter into private insurance plans as well.

Another drawback to Ryan’s plan is that private insurers have higher operating costs than Medicare — witness how much more the privately operated Medicare Advantage plans cost the government than conventional Medicare — and don’t have the leverage to negotiate reimbursement rates for doctors and hospitals that are as low as Medicare pays. As a consequence, the switch from Medicare to subsidies for private insurance is likely to increase the total amount spent on healthcare and drive seniors’ healthcare costs through the roof.

By the Congressional Budget Office’s estimate, Americans turning 65 in 2022 would have to spend more than $12,500 on healthcare out of their own pockets under Ryan’s plan, while older citizens still in the traditional Medicare program would spend less than half that amount for the same coverage. That gap would widen each year, the CBO projected.

Ryan’s proposal for Medicaid runs into similar difficulties, but with states feeling the squeeze, not seniors. The likely result is that states would cover fewer people, leaving more Americans uninsured. That would be bad for everyone in the system. People with no insurance and low incomes tend to obtain care in the least efficient, most expensive ways, with doctors and hospitals passing the costs on as best they can to those with insurance.

Nevertheless, some of Ryan’s ideas are promising. For example, he would reduce premium subsidies after 2022 to the wealthiest 8% of seniors to help poor recipients cover their out-of-pocket costs. By putting the money into medical savings accounts, it would encourage the recipients to spend the money carefully, which should in turn encourage more competition among providers.

Once the flawed incentives in the system have been addressed through better ways to pay for and deliver care, premium subsidies could be a welcome alternative to traditional Medicare — as long as insurers were required to provide at least a standard, federally defined set of benefits, and that they offer coverage to everyone, not just the healthiest seniors. Ryan includes both of these requirements in his proposal. His plan also borrows a key provision from the healthcare reform law: It would set up insurance exchanges to help seniors shop for subsidized coverage.

Despite the ideological gulf between Republicans and Democrats, the right path for Congress would be to incorporate into last year’s law the elements of Ryan’s plan that promote more cost-sensitive consuming and more competitive markets without ending the commitment to affordable healthcare to seniors and the poor. The result may not curb federal costs as dramatically, but it would do considerably more to slow the growth of healthcare spending as a whole.