The Medicare program, while quite popular with beneficiaries, has been groaning under the weight of an ever-increasing budgetary impact. Both the spending per beneficiary and the number of beneficiaries itself are rising well above the rate of growth of the overall population. 

From 2013 to 2023, total enrollment grew 27 percent, resulting in 65 million total beneficiaries and a total expenditure of $839 billion, according to the Center for Medicare and Medicaid Services. The Kaiser Family Foundation estimates Medicare spending grew 71 percent over the same decade, or 31 percent in real (inflation adjusted) terms. During that time period, the U.S. population has grown only 6 percent, and the number of workers to Medicare beneficiaries fell from 3.4 workers per beneficiary to 2.8 from 2010 to 2020. This concerning trend has resulted in many diverse efforts at cost containment, to little effect.

Medicare Advantage was first proposed in the Balanced Budget Amendment of 1997 and further incentivized in the Medicare Modernization Act of 2003. The basic structure involves private administration by for-profit insurance companies, paid by the Center for Medicare and Medicaid Services (CMS) with public funds. The early rationale for such a program was both to give beneficiaries more options and to serve as a cost control measure, with the discipline and competition of the private market constraining bloat, waste, fraud, and abuse. 

Traditional Medicare mainly paid for health care services on a fee-for-service (FFS) basis, meaning if a service was billed by a healthcare provider, CMS paid for it. Medicare Advantage was a novel attempt to change that payment structure. In its early years, Medicare Advantage remained a modest portion of overall Medicare enrollment, with 19 percent patient share in 2007, but this year 54 percent of all beneficiaries are enrolled in private Medicare plans. 

To those in favor of market-oriented solutions, this would seem like a success story. It would be, except one crucial piece of context: It is costing taxpayers a lot of money. The Medicare Advisory Payment Commission (MedPac), a nonpartisan congressional agency, estimates that the CMS has spent 23 percent more on Medicare Advantage patients than it would have if those patients were in traditional Medicare. As with any public-private partnership, the government is acting as an agent for the taxpayers, and in this particular case, Medicare beneficiaries. As is often the case, the government agency attempts to set a rule or series of rules that aim to achieve an agreed-upon goal: in this case, delivering high-value care while constraining costs. The privately administered Medicare Advantage plans, however, have a very strong interest in taking advantage of these rules, whether or not they are beneficial for patients or taxpayers. The structure of how CMS pays Medicare Advantage plans leads to some peculiar incentives that were not apparent to policymakers initially but have become increasingly obvious over time.

The private Medicare Advantage insurers—UnitedHealthCare, Humana, and BlueCross BlueShield together account for more than 60 percent of the program’s plans—are paid by CMS through two main mechanisms, a capitated rate and a risk adjustment. A capitated rate is a flat fee per Medicare beneficiary based on the average of what CMS thinks annual spending should be, based on historical data. If that was the only payment mechanism, however, there would be a problem that has bedeviled those designing insurance plans forever: beneficiary selection.  

While Medicare Advantage plans cannot explicitly turn away Medicare beneficiaries who apply, insurers can select for healthier patients, thereby creating a larger difference between the capitated rate and what they actually spend in caring for a particular patient in a given year. Medicare Advantage plans have been known to create “narrow networks” whereby it is difficult to access care that beneficiaries are nominally entitled to. A national study found that in 2019 only approximately 18 percent of mental and behavioral health professionals and 34 percent of cardiologists were in any Medicare Advantage network.The plans also offer benefits, such as gym memberships, that are more likely to attract healthier patients. This is where risk adjustment comes in. 

A patient’s “risk score” is based on some factors such as age and gender, but more importantly the patient’s diagnosed ailments from the prior year. These diagnoses are input by humans, often but not always physicians. Showing that a patient is as sick as possible results in a higher risk adjustment reimbursement and potentially more profit for a plan provider. As a result, what is known as “coding intensity” is much higher in Medicare Advantage as opposed to traditional Medicare. In other words, an incentive exists for medical professionals to put in as many codes as they can, and particularly the codes associated with the best reimbursement. 

The reimbursement rates, both capitated and risk adjustment, are based on patients in the traditional Medicare system, where there is less relative coding intensity incentivized by the reimbursement system, hence the term “upcoding.”

The growth to more than half of the Medicare patient pool is compelling evidence of Medicare Advantage’s popularity. Plan providers are savvy in how they market to potential beneficiaries: They often find ways to steer patients by partnering with or even owning physician practices. They offer no or low-cost premiums and add-on services such as dental and vision. They provide a “one stop shop” that is less fragmented than the separate parts A, B, and D found in traditional Medicare. 

However, in its current form Medicare Advantage is unsustainably expensive. Given this crossroads of the Medicare program in general and Medicare Advantage in particular, there are two mistakes that can be made on either side of the political aisle. Those who were suspicious of Medicare Advantage to begin with will use this relatively high spending as an excuse to dismantle or severely limit the program. I believe those who are more market-oriented, however, are in danger of making a complementary mistake —complacency. The program is in need of far-reaching reform if it is to fulfill its promise of cost containment and allow market-oriented solutions to flourish. 

Many proposed ideas would help mitigate the program’s unintended outcomes. The first is to base spending for Medicare Advantage patients on a pool of those patients, not traditional Medicare patients. This addresses the upcoding problem: If coding is the same for the group upon which you set reimbursement, there is no incentive to upcode, given a reliable way to link the diagnoses to the services performed. Another way to mitigate the upcoding problem would be to move away from diagnosis codes as the main way to adjust for risk and incorporate more “ungameable” characteristics. One way to lessen the selection problem would be to regulate narrow networks and ensure plans have a certain amount of services practically accessible within the network. These are just a few high-level ideas that will surely require detailed thought, but doing nothing has ceased to be an option.

Our federal government has a series of tough choices ahead of it in order to sustain its fiscal solvency—health care spending being prominent among them. Many prior attempts to rein in such spending have fallen short. It would be a mistake to both throw out the Medicare Advantage program and to ignore its problems. Reform is needed, and it is needed soon if the program is not to discredit itself entirely.