How To Heal Medicare

Dr. James A. Block's forehead creases with worry as he contemplates the future. His 1,702-bed Johns Hopkins Hospital is one of the top research and teaching centers in the country. And so far, Hopkins has managed to avoid the layoffs bedeviling so many other teaching centers. What's worrying the hospital's president and CEO is "this enormous experiment, this great risk we're about to undertake."

A new heart transplant technique? No. The hand-wringing is over the Medicare reforms that congressional Republicans want to enact. "I just wish Newt would call me and say, `Actually, I'm not going to gut your education and research programs or cut off your most vulnerable patients."'

Like thousands of other health professionals around the country, Block is watching the Washington policy debate with emotions that run from hope to horror. Fully half of Hopkins' revenues come from Washington and subsidize education and research. Even the smallest program changes would ripple throughout the entire health-care industry.

Welcome or not, change is on the way. Medicare, the $178 billion federal program serving 37 million elderly and disabled, is going under Congress' knife in the next few weeks. Cuts in Medicare spending are the key to GOP plans to balance the budget and provide $245 billion in tax breaks over seven years. To pay for this, Medicare would be cut by $270 billion, or 14%, over seven years. House Speaker Newt Gingrich (R-Ga.), the man in Dr. Block's nightmares, insists that cutting the program can be accomplished in the name of reform.

While the GOP hasn't yet settled on a plan, many health professionals agree the system needs an overhaul. "If we don't start making the changes now, it will be too late in the 21st century," says Dr. Douglas Henley, president-elect of the American Academy of Family Physicians. "Medicare has not been evolving with the market."

RUSHING CHANGE. But any reform worthy of the name will have to be carefully crafted and fully discussed. A clumsy revamping could easily jeopardize cancer research and postpone cures for AIDS, sickle-cell anemia, and a hundred other maladies. The GOP leadership would like to rush their changes into law this fall after a brief debate. But that's unlikely since lobbyists, Democrats, and many moderate Republicans have yet to weigh in on Gingrich's proposed changes. The battle is more likely to mirror the last protracted fight over health-care reform in 1994. Or Republicans could choose an easier route: a big cut in Medicare payments to doctors and hospitals without raising out-of-pocket costs for the vocal elderly.

As the political battle rages, BUSINESS WEEK culled some of the best prescriptions for fixing Medicare from doctors, administrators, managed-care organizations, economists, and other experts (table). Most don't want to see Medicare cut merely to balance the budget, but nearly all want to see the 30-year program brought up to date. The consensus: The most sensible solutions focus on market incentives to lower the cost of medical care through competition among insurers and providers.

WEALTHY SENIORS. The experts also agree that government can't stand back and let the private sector run the show alone. Regulators will have to step in to assure that cost-cutting doesn't mean seniors will be treated like second-class patients. The elderly will also have to be educated about the intricacies of picking among a bewildering array of managed-care plans, such as health maintenance organizations and preferred provider organizations. Further, government needs to encourage the tiny nursing home insurance industry. Whether or not to buy such insurance is often a senior's most import decision. Washington must also prod the teaching hospitals to modernize their mix of specialists to keep up with the nation's rapid switch to managed care. More family physicians, internists, and generalists will be needed as the call for such specialists as anesthesiologists fades.

With Medicare's expenses growing out of control, its financial underpinnings also have to be addressed. Because healthier seniors are living longer, the age of Medicare eligibility ought to be raised to at least 67 to keep pace with the gradual increase in Social Security retirement age. And a consumption tax should be substituted for the highly regressive payroll tax that hits young workers the hardest but doesn't touch even the wealthiest of seniors. Wealthier seniors--those with incomes over $45,000--should pay more for their coverage. And ultimately, the nation will have to engage in frank debate about the rationing of health care--limiting the use of advanced surgical techniques, life-sustaining machinery, and elective surgery for those unable to benefit substantially.

There is little disagreement on how American health care got to this point. Since Medicare and Medicaid were enacted in 1965, the industry has seen a tremendous boom in size, technology, and cost. The elderly benefited most. A flowering of technology helped push life expectancy from 70 to 76. The over-65 population rose from 9% of the total in 1965 to 12% today. Half as many Americans now die from heart attacks, a third as many from strokes. "We went through three decades of phenomenal growth, but we weren't paying attention to affordability and accessibility," admits Dr. John D. Stobo, vice-dean of Johns Hopkins' school of medicine.

Indeed, the advances came with a terrific price tag. Half of all health inflation over the past 20 years is due to technology improvements, says Congress' Office of Technology Assessment. Even the simplest devices got gold-plated. "Everything now is disposable, and all the instruments have digital readouts," complains Dr. Jeffrey P. Koplan, president of the Prudential Center for Health Care Research in Atlanta. "What was wrong with the old mercury thermometers?"

Congress added to the inflation by expanding Medicare benefits and keeping premiums and deductibles low. Kidney dialysis, for example, was added to the benefit mix along with care for the disabled. Naturally, Medicare's costs exploded. To keep pace, Congress repeatedly boosted Medicare's payroll tax (charts). Still, costs outstripped income. The Medicare trust fund that pays for hospitalizations is headed for bankruptcy in 2002.

Aside from Medicare's runaway cost and the payroll tax's drag on the economy, there's another problem: "The benefit package stinks," says Deborah L. Steelman, a former Reagan Administration budget official and now an expert on entitlements. Medicare doesn't pay for the first day of hospitalization or the 91st day, doesn't cover eyeglasses, dental care, hearing aids, or prescription medicine. Worse, it doesn't cover most nursing-home care, a growing burden on the elderly and their children.

Republicans hope they have an answer to Medicare's skimpy benefits. The GOP plan aims to expand coverage by relying on providers and insurance companies to compete for the elderly's business. The elderly would shop among dozens of new forms of insurance companies, alliances of doctors, HMOs, and other managed-care providers.

VOUCHER POWER. Here's how one such plan, using government vouchers, might work: Seniors would be given a voucher to shop among private insurance plans and providers. Adding in a little of their own money, retirees could buy basic insurance. Or they might choose to go with a company that offers higher levels of care for a higher premium--say, an HMO that offers some prescription coverage and vision care. The senior gets a choice of plans, the government puts a lid on its per capita spending, and market forces are brought to bear on runaway costs.

Or the voucher could be turned into cash and deposited in a tax-free Medical Savings Account similar to an Individual Retirement Account. Suppose, for example, the value of the Medicare voucher was for $4,800, the current average yearly beneficiary cost. The patient could buy a catastrophic-care insurance policy for $4,000 that carries a $2,000 deductible. The $800 remaining could be used to buy eyeglasses, medicine, or pay for doctor visits. Money left in the MSA at the end of the year could be rolled over into the next year's MSA or withdrawn after paying a tax. MSAs would cut administrative costs and encourage seniors to shop carefully. "The closer a patient gets to making his own decisions--and paying for routine medical services from his own pocket--the better off we will all be," says Dr. David N. Sundwall, president of the American Clinical Laboratory Assn.

This approach would be more difficult than the present system to manage. Regulators would need to guarantee that insurance companies delivered on their promises and provided quality--and not just cheap--health care. And the savings are likely to be smaller than the GOP hopes. The biggest expenditures by the elderly come in the final months of life and in hospitals. Just 5% of the sickest Medicare patients each year account for more than half the program's total costs, according to estimates.

In the past, Washington has tried to keep beneficiaries happy by expanding benefits and to keep Medicare solvent by dramatically raising taxes. But critics of the status quo say the tax remedy is neither wise nor fair. That's because the hospitalization portion of Medicare is paid for by a payroll tax. That puts more of the burden on young workers for the benefit of the retired elderly, whose incomes are generally higher but not subject to the tax.

The fair answer, say some economists, is higher premiums, co-payments, and deductibles for the top-earning 10% of seniors. A consumption tax could shift some of the burden onto wealthier retirees. "The fact is, Medicare is one of the government's most popular programs, but the financing has got to be fixed," says Robert D. Reischauer, former head of the Congressional Budget Office.

GROWING UP. The hardest issue is one nobody in the health industry likes to talk about: rationing, or what professionals sometimes refer to as "utilization reductions." In plain English: limiting medicine to those seniors who could truly benefit. Hence, no hip-replacement surgery for the 90-year-old nursing-home resident who doesn't walk anywhere anyway. "An efficient health-care system must employ wholesale rationing," says Princeton University health economist Uwe E. Reinhardt. "It is time for America to grow up and understand what will happen" as we turn much of the Medicare system over to the private sector.

Questions such as these--the most difficult kinds of choices for government and for families--will eventually have to be faced as technology continues to advance and push costs higher. In the meantime, most experts believe that cost inflation can be kept to a fairly tolerable level. But just as Dr. Block's researchers have helped make U.S. health care the best in the world, they have also made it the most expensive. It may now be time for Dr. Block's researchers to find ways to keep Americans healthy and not break the bank.

No Single Cure for Medicare

As Congress wrangles over ways to overhaul the massive health-care program for the elderly, Business Week picks a handful of prescriptions that, taken together, add up to effective reform:

VOUCHERS AND MEDICAL SAVINGS ACCOUNTS Encourage competition among health providers and insurers by giving seniors the money to pay for their chosen plans.

QUALITY CONTROL Educate consumers about trade-offs between quality and cost control. Set standards for managed-care providers.

MEANS TESTING Charge affluent seniors higher premiums, co-payments, and deductibles for Medicare.

DOCTOR GLUT Cut federal subsidies for foreign medical students and for medical schools that generate too many specialists in fields where they're already in oversupply.

NURSING HOMES Standardize current thicket of private insurance for long-term care, which Medicare doesn't cover but which the elderly desperately need.

CONSUMPTION TAX Ease Medicare's payroll-tax burden on young workers by substituting a sales tax.

RAISE ELIGIBILITY AGE Match Medicare to rising life-expectancy rates. Otherwise, financial problems will multiply and the burden on workers will grow.


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