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Medicare And Commercial Health Insurance: The Fundamental Difference



February 15th, 2012
 
by Diane Archer and Theodore Marmor

As the debate over Medicare continues in connection to America’s fiscal problems, it is critical to understand how Medicare differs from commercial health insurance for working people.  There is a fundamental difference between these two types of health insurance plans, one social and one commercial.

The basic difference between Medicare and commercial insurance is that Medicare is designed to absorb risk,  serving individuals who have or may have costly and complex medical needs as well as the relatively healthy, whereas commercial insurance is required to protect its business interests by avoiding those most likely to use medical care.  That’s why Medicare was first enacted. People over 65 were unable to buy commercial insurance because they use three times more medical services than working people; it was unaffordable or insurers simply refused to provide it. And now it’s simply unrealistic to imagine that commercial insurance companies will change their fundamental business model and work to protect the health and financial security of most Americans.

Medicare’s mandate: Medicare is a federally administered insurance program that Americans pay into throughout our working lives and enroll in after they retire or in case of a serious disability. It pools the resources of the entire nation to protect older and disabled Americans from the risk of an unforeseeable financial disaster in the event of an acute illness, an injury, or an expensive chronic condition. All American workers finance the program and all are covered by it once eligible: no one is excluded because of their age, health status, or their income. Meanwhile the program is obligated to pay for all necessary care for the eligible population, wherever they live in the country and whatever else may be true about their history, prospects, and preferences. Medicare only denies claims for medically unnecessary care.

Commercial insurance’s mandate: Commercial health insurance, even with regulations, has an entirely different mandate.  Its fundamental purpose is commercial.  Insurance corporations receive premiums that must fund the costs of their enrollees’ health care and administrative costs, as well as profit margins sufficient to allow borrowing in the capital markets.  To make that work, insurance firms avoid risk. They are rewarded for avoiding, within the rules of the day, those who are already sick, those likely to become sick, and those whose incomes are relatively low.

In short private insurers must limit the risks they take on in order to survive.  And that itself explains a good deal of the behavior that has made commercial health insurance firms unpopular: inclinations to make eligibility difficult for anyone who has or whom they believe is likely to have a costly condition, postpone the payment of claims, quibble about the scope of coverage, and many other behaviors that have filtered into the day to day vocabulary of Americans. The Affordable Care Act takes a good first step at moderating differences and limiting this behavior, but it cannot and does not encourage insurers to pool risk or design plans that attract people with costly conditions as Medicare does.

Commercial insurers will always seek to minimize their exposure to risk:  It’s simply unrealistic to expect commercial insurers to do the job Medicare is already doing. Before Medicare was created in 1965, many argued that the federal government should simply subsidize the purchase of commercial insurance for seniors. But it became clear — even to the industry — that commercial insurers could not find a way to profitably cover older Americans, even with a subsidy. Yet today, some in Congress are embracing the system that was rejected nearly 50 years ago.

The fundamental nature of commercial insurers will undermine any effort to use them to protect the most vulnerable Americans. No matter what regulations are instituted in an attempt to guarantee their good behavior, commercial insurers will still have an incentive to avoid risk, and they will do so insofar as it is possible.

In Massachusetts, where insurers must offer coverage to anyone, plans avoid offering adequate coverage for costly conditions and disguise what they are actually selling. Even heavily regulated Medicare Advantage commercial plans are designed to push people in poor health into traditional Medicare in order to avoid actually paying for care, and they have successfully overcome policies meant to halt this practice. They are also less likely than traditional Medicare to counteract the health care inequalities facing people of color, people with low incomes, the chronically ill, and the disabled.

Since commercial insurers are not publicly accountable, it is difficult to say exactly how commercial insurers perpetuate these inequalities; their data are proprietary, and they generally keep the payment policies that allow them to remain profitable secret.

Medicare is more cost-effective than commercial insurance: Commercial insurance is less effective than Medicare on any number of metrics. Because Medicare has such an enormous coverage pool, the program has bargaining power that no commercial insurance company can match. On average, Medicare manages to pay 22 percent less than what commercial plans pay for physician services, so the only way those plans could compete would be by offering 22 percent fewer services.

Unsurprisingly, Medicare’s per capita costs have risen more slowly than commercial insurers’ and are projected to continue doing so. Meanwhile, commercial insurers invest so many resources in avoiding paying for actual medical care that their administrative costs are much higher. Commercial insurance meets the health care needs of most working people because most workers most of the time do not need a lot of health care.

Only Medicare is designed to insulate Americans from risk: This essay has laid out the differences between two different ideal types of insurance. The realities of how plans actually work can be substantially more complicated. Medicare hospital insurance (Part A) most fully conforms to the social insurance model, since it is financed by proportional contributions from all citizens, whereas Part B uses general revenue and a yearly premium. Meanwhile regulations can moderate the difference between commercial and social insurance. But nothing can change the underlying reality that programs like Medicare are designed to absorb and broadly distribute risk, protecting everyone, while commercial insurers are designed to select and protect individuals with the fewest needs.

The belief that competition among private health insurance firms can produce cost savings or higher quality care represents the victory of illusion over evidence. We need to let the existing Medicare system do what it already does effectively: insulate Americans from risk, rather than shift risk to the most vulnerable citizens.

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10 Responses to “Medicare And Commercial Health Insurance: The Fundamental Difference”

  1. Thomas Cox Says:

    Insurers can, and should, avoid risk by increasing the numbers of policyholders they cover.

    Insurers minimize risk not by increasing profits at the expense of their policyholders, but by driving their actual future servicing costs to the average as they issue more and more policies.

    Anyone who does not understand that insurance is based on the Central Limit Theorem ought not be opining about how it works. The principles are simple to understand and the conclusions abundantly obvious:

    Large insurers are more efficient risk managers than small insurers.

    Large insurers can offer higher policyholder benefits than smaller insurers because their future costs are more predictable.

    Larger insurers require lower levels of idled assets as surplus for their insurance operations than smaller insurers.

    Larger insurers are less likely to fail than smaller insurer, unless managed extremely poorly by managers and executives who benefit from their mismanagement.

    A small number – say 20 – 30 extremely large insurers could be ALMOST AS EFFICIENT as a national health insurer, if they are required to offer identical benefits and if the benefits are known to all involved: attorneys, patients/policyholders, providers, and legislators. Less litigation, less uncertainty, lower waiting times for services, no fraudulent denials of care, and a much less complicated and more efficient health care (finance) system.

    This is all Insurance 101. Every underwriter, actuary, and claims manager knows how insurance really works – it is about time the public, our health care finance experts, policy analysts, and our legislators learn Insurance 101 basics.

  2. dennisbyron2 Says:

    @ annie

    I assume you are replying to my comment because no one else — regretfully — in the article or in the comments gets into the “nuts and bolts” of Medicare, to use your words.

    I must have been unclear however. Whatever you think the effect of “Wall Street” is on the health care insurance industry in general and nationwide, it is not a factor for Medicare for Massachusetts (or for the rest of the totally dysfunctional Massachusetts health care insurance market for that matter). A half dozen non-profit companies dominate the health care insurance market in general and the Medicare supplement and Medicare Advantage market in partiuclar in Massachusetts. In fact the only “Wall Street” company substantially involved in Medicare in Massachusetts is Hewlett Packard, which ironically is the Part A and Part B administrator.

    So much for that profit vs non-profit theory.

  3. Annie Kelleher Says:

    Excellent article and commentary. It is important to keep the overarching concept of a publicly funded program for universal health care coverage in mind as this dialogue continues. And yet, I am glad that one of the submitted comments includes some of the “devil-in-the-details” often avoided by analysts and the academy. The current structure of Medicare and Medicaid does indeed rely almost entirely on the private sector to implement the nuts & bolts of Medicare transactions. Medicare does actually cost money after one becomes eligible through ongoing SS monthly “paycheck”‘ deductions and supplemental insurance costs to fill the many gaps. On the other hand, Wall Street based “insurance” companies who are now tightly coupled with CMS have long been involved in slowly re-writing policy which has opened the door to profiteers who wish to cherry-pick from Medicare through offering their supplemental policies. Thus the comment submitted earlier lacks insight about this duplicitous relationship between Wall Street health insurance corporations and CMS.

    I ardently wish to see a Medicare For All sea-change in the USA. However i have found that the simple mantras of “everbody in,nobody out, Medicare for All, leaves those under 65 with a lot of fundamental misunderstandings about how Medicare actually works at every level along the chain of care-to-payment.
    This aversion to frank discussions regarding how a future Medicare for All system would be implemented and funded (in detail) is misleading to those who believe in this ideal of healthcare equity.

    We should not avoid discussion of the complexity inherent in Medicare administration. US citizens are quite familiar with the nightmarish complexity of Wall Street based health insurance corporations and can handle the details of Medicare administration if they are presented coherently.

    I loathe our current profit based health care funding morass with all its cruelty, and pray every day for an equitable streamlined Single Payer (Medicare for All) system. We just need to be clear (in detail) about how we can/will improve Medicare, how we will implement an efficient system, how it will be funded in a declining economy, and sustain the quality we have a right to be proud of.

    thank you,

  4. dennisbyron Says:

    Ms. Archer’s and Mr. Marmor’s political screed misses very key points about Medicare. Clearly neither author is on Medicare nor has either apparently ever talked to a person that is.

    Their ideological statement begins with the typical academic premise that Medicare (also fondly referred to by many academics and politicians as “Medicare as we know it”) is good insurance. The authors are totally wrong when they say “Medicare is designed to absorb risk.” Medicare is designed to do exactly the opposite; it is terrible insurance with lifetime limits that increase the risk to the senior, geographic restrictions, no drug/vision/dental/annual-physical-exam coverage, high co-pays, and high deductibles.

    This article suffers the usual academic misunderstanding about what us seniors really do to protect ourselves from high healthcare costs. We do not depend on the Medicare inaccurately described in the Archer/Marmor article. Medicare beneficiaries turn to private insurers — both for-profit and non-profit insurers, depending on locale — at a much higher rate than those not eligible for Medicare:

    Half of us depend on retiree insurance from private insurers rather than ” Medicare as we know it” (although that number is dwindling).

    25% of us luckily — because George Bush revised Part C in 2003 — depend on Medicare Part C (and that percentage has doubled in the last five years).

    15% of us or more get Medigap insurance from private insurance companies to make up for the all the weaknesses in Medicare noted above because Medicare specifically does not handle the “risk of an unforeseeable financial disaster in the event of an acute illness, an injury, or an expensive chronic condition.”

    A small percentage of us receive our care through the Veterans’ Administration or are dual eligible for both Medicare and Medicaid and depend on Medicaid-administered programs like the MSPs to cover costs.

    A very few percent of us are signed up only for Medicare Parts A and B. Presumably those in that relatively small group are the very rich or are people who for some reason have fallen through the cracks despite extensive efforts by CMS-certified State Healthcare Information Programs (SHIPs) to reach out to the needy and make sure every senior has good healthcare insurance from private insurers to make up for the shortcomings of “Medicare as we know it.”

    In fact it is not even accurate for Archer and Marmor to say “Medicare is a federally administered” program. While the U.S. federal government is the payer of Medicare claims, all Parts of Medicare are administered by private insurance companies. To be clear, it is not just the very-popular-with-seniors Parts C and D that are administered by private insurers (although not all are the for-profit companies demeaned without any evidence by the authors). The traditional Medicare Parts A and B programs are also all administered by private insurance companies.

    In addition, the statements about Massachusetts seem to be unsupported by the facts. The authors say:

    “In Massachusetts, where insurers must offer coverage to anyone, plans avoid offering adequate coverage for costly conditions and disguise what they are actually selling. Even heavily regulated Medicare Advantage commercial plans are designed to push people in poor health into traditional Medicare in order to avoid actually paying for care, and they have successfully overcome policies meant to halt this practice. .. Since commercial insurers are not publicly accountable, it is difficult to say exactly how commercial insurers perpetuate these inequalities ..”

    In Massachusetts, commercial insurers are “publicly accountable” and — only because it seem relevant to the authors for some reason — most of them are non profits. The authors link to a report as a proofpoint that seems to be heavily dependent on information from the Massachusetts Connector. But that has nothing to do with Medicare. Medicare-eligible people in Massachusetts cannot deal through the Connector.

    The authors unsubstantiated claims about Medicare effectiveness have been throughly disproven elsewhere. The simplistic answer is that any business would have lower administrative costs if it could have the federal government deduct its revenues from an income stream to a customer or client before the income is even distributed . That’s the way Medicare holds down administrative costs; Social Security takes Medicare’s premium from seniors before the monthly benefit is distributed.

  5. Richard N. Gottfried Says:

    Archer and Marmor are 100% on target. The principle of traditional Medicare is not only right for Medicare; it is right for all of us — single-payer universal public health coverage, funded by broad-based progressive taxes. The national political situation is pretty bleak, but individual states can lead. State single-payer legislation can help move the country. Richard N. Gottfried, chair, NY State Assembly Committee on Health

  6. Lee Goldberg Says:

    Great post!! It is important for everyone to recognize the fundamental difference between social insurance programs like Medicare and many commercial plans. I wonder where nonprofit providers fit in? Particularly if they are mission-driven? I assume they have many of the same demands on them (higher administrative costs, smaller pool, need to have revenues greater than costs, creditors) but not all (shareholders). That may not be a big enough difference, but worth thinking about. Also, we have to be careful not to confuse the financing of a program like Medicare and the social insurance nature of it. As scholars like Michael Graetz have pointed out, we shouldn’t conflate the two. Medicare could (and perhaps should) be funded wholly through income taxes and would still be a social insurance program, given the near universal eligibilty for benefits and the role it plays in providing coverage that most people ideally get from participating in the labor market.

  7. R Lande Says:

    Good article and good point by Vince K that risk-adjustment can be usefully used. In Germany, with a long history of universal coverage, they have private not-for-profit insurers which receive risk-adjusted payments to eliminate any incentive to avoid certain types of subscribers.

    Insurers in the US used to be not-for-profit, like the Blues, but that model has also been left behind, with problematic consequences.

  8. Don McCanne Says:

    Vince Kuraitis writes that the authors’ statement on incentives for commercial insurers needs to be challenged. It is Mr. Kuraitis’ challenge that needs to be challenged since the authors’ statement is quite correct.

    Commercial insurers do have incentives to avoid risk, and, if subjected to risk adjustment, they have incentives to game the system. This is not suggesting illegal activity. It merely represents “appropriate” commercial activity – activities that are rewarded on Wall Street.

    Risk adjustment already takes place in the Medicare Advantage program. An NBER study (Working Paper No. 16977, April 2011) revealed that the Medicare Advantage plans were able to further increase their own advantage and transfer more resources from the relatively sick in the traditional program to the relatively healthy within their plans.

    Quoting from the NBER report, “With social insurance programs, however, imperfect pricing can induce private firms to cream-skim, exacerbating the utility consequences of the underlying inequality the program was initially intended to mitigate. At least in the case of Medicare, we find little evidence that risk adjustment has solved this problem.”

    And from the NBER Digest, “Thus the authors conclude that the Medicare Advantage program both increased total Medicare spending and transferred Medicare resources from the relatively sick to the relatively healthy, and that risk-adjustment was not able to address either of these problems.”

    Archer and Marmor are precisely correct: “No matter what regulations are instituted in an attempt to guarantee their good behavior, commercial insurers will still have an incentive to avoid risk, and they will do so insofar as it is possible.” That is the nature of the commercial approach to insurance, which is in sharp contrast to the social function of the traditional Medicare program.

  9. Vince Kuraitis Says:

    You make a sweeping statement: No matter what regulations are instituted in an attempt to guarantee their good behavior, commercial insurers will still have an incentive to avoid risk, and they will do so insofar as it is possible.

    An equally sweeping rebuttal: this problem is entirely fixable by risk adjusting — paying higher premiums for members that are less healthy. Medicare has already started doing this with Medicare Advantage plans.

    Of course, the devil is in the details…and in a debate we’d probably come out in the middle somewhere. Risk adjustment is easier to conceptualize than to do accurately.

    …but I think your broad, blunt assertion needs to be challenged.

  10. Joanne Lynn Says:

    Thanks for the insightful review of important perspectives. One more thing differentiates Medicare – we own it together and it serves the public interest. For a long time, Medicare functioned as a public insurance agency with only a minimal regulatory and quality assurance role. In the past few years, CMS has acted toward being a substantial public health resource, with substantial investment in quality and now in costs as well. The possibilities for a commercial health insurance company to take on these roles is substantially more limited.

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