AAPS Proposal for Medicare Reform

In addition, Congress should study the effect of federal laws that tend to weight the scales in favor of one form of payment over another through artificial, government-conferred subsidies and other advantages or government-imposed burdens. Such laws should be repealed.


  1. To reduce incentives for fraud and abuse, all Medicare benefits should be paid to the beneficiary, by
    means of a dual-payee check. Beneficiaries might be given a 10% rebate on all overcharges
    that they discover (say charges for services not received or charges greater than published
  • Physicians’ office labs should be exempted from the Clinical Laboratory Improvement Act (H.R.
  • For persons under single-payer Medicare, copayments for laboratory tests and home-health
    services should be required.
  • Laws and regulations that increase costs without demonstrably improving safety (such as those set
    by OSHA, the EPA, and the FDA), should be repealed.
  • An increase in the retirement age should be phased in. Smoothly increasing the retirement age
    from the level of 67 (to take effect in the mid 2000s) to age 75 by 2075 would help today’s
    young people plan for the future, while reducing current costs. To demonstrate Congress’s
    genuine interest in the issue, the increases should begin immediately. The new retirement age
    should be set at 65 years and 3 months immediately and increased by 2.25 additional months
    each year thereafter, to get to a new age of 75 over the next 80 years.
  • Over the long-term, more Americans should own their own insurance, together with an MSA, so that
    it would become practical to keep the same policy into retirement and to provide for their
    increasing expenses. The great artificial divide at age 65 is a consequence of the system that
    ties medical insurance to employment.
  • The requirement for physicians to file all Medicare claims should be repealed. The deductible for
    Part A and Part B should be combined, and claims should not be processed by Medicare until
    an individual has met the deductible. Claims for amounts below a certain threshold amount,
    say $120, should not be processed; rather, beneficiaries should accumulate their statements
    and file a claim when the aggregate amount exceeds the threshold.


Overall Medicare costs:

Medicare expenditures total (Part A and Part B), projected for 1995: $180 billion

Part B premiums $19 billion

Approx. taxpayer subsidy to Medicare: $161 billion

Medicare expenditures per enrollee: $5000

FBI estimate of “fraud and abuse”: 10% or $18 billion

Immediate Cost Savings:

1. From private contracting: estimated $2 billion/yr
$14 billion over 7 yrs

In an AAPS survey of members, 60% of respondents said they were interested in private
contracting (providing service without filing a claim at a price agreed to by the patient) and would do
so if legal ambiguities were removed. If 10% of current Part B services were transferred outside the
Medicare system, the immediate savings would be $1.9 billion, plus the cost of processing a very large
number of relatively small claims. The cost would be borne voluntarily by physicians and patients.

2. From removing incentives and opportunities for fraud:
$9 billion/yr
$63 billion over 7 years

If 10% of Medicare payments (or $18 billion) are fraudulent, a 50% decrease would yield these

Waste, fraud, and abuse are rampant in programs based on third-party blank checks. A level
as low as the FBI estimate of 10% would be a tribute to the extraordinarily high moral character of
most physicians, who are major participants.

Past efforts at enforcement have been both ineffective and costly. Besides the monetary cost,
the erosion of constitutional rights has been severe. Some targeted physicians, whether innocent or
guilty, have undergone Kafkaesque ordeals over small amounts in alleged overpayments, while
perpetrators of multimillion dollar scams escape unpunished.

AAPS favors severe punishment of persons proved guilty of willfully defrauding government
programs, after the same due process of law accorded to bank robbers and other miscreants.
However, more intrusive audits of medical practices, along with networks of paid spies and informers,
will simply create injustices without solving the problem. In large part, this is because most abuse
probably complies with the letter of the law.

The key to minimizing fraud and abuse is to return to the traditional practice of making
insurance payments to the beneficiary, rather than to middlemen or providers. Making payments by
dual-payee check would address the concern that subscribers might pocket the insurance check rather
than paying their bills.

An additional effect, difficult to calculate, is an increased awareness of cost by

Voucher payments should also be made to subscribers or their fiduciary agent, for example, a
federally insured bank in the case of a beneficiary choosing the MSA/catastrophic insurance option.
(No fiduciary agent may bear risk related to the utilization of medical services by the beneficiary.)
There have been reports of Medicare patients (as many as 10% of those enrolling in one entity) signing
up for HMOs without awareness that they had done so. Few patients would be unaware of the
transaction if they had to sign a large check in order to complete it.

This mechanism would also stop the scheme under which providers give steep discounts to
insurers, who do not pass along savings to their beneficiaries.

3. Opting out of Medicare:
about $24,500 per individual

If 1% of about 35 million beneficiaries opted out, savings would be:
about $8.6 billion in 7 years

If 5% of the beneficiaries opted out, savings would be:
about $43.0 billion in 7 years

Today’s beneficiaries collect in benefits on the average far more than they have contributed. A
two-earner couple retiring in 1995 can expect to collect about $117,000 more, on the average. If they
instead paid this excess themselves with pretax dollars, given a tax burden of about 28%, the savings
to the Treasury would be about $85,000 net, or $24,500 each. (The savings could be more. The
Treasury is not realizing any revenue at all from assets that are held to avoid incurring capital gains

It is possible that few Americans would choose to turn down Medicare’s tremendous tax subsidy.
However, there are probably some Americans of means who do not wish to burden other people’s
grandchildren to provide for their medical care. Some persons might experience net financial gain if
they purchase high-deductible insurance (say for the price of a Medigap policy and Part B premiums)
and do not require much medical care. Every person would gain freedom by choosing this option.

According to a May, 1995, survey by DYG, Inc., 93 percent of Americans believe Medicare is
important to financial security. Thus, 7 percent think otherwise, and some of these might opt out.

It may be argued that some improvident senior citizens would cash out and spend the money
irresponsibly, planning to become a burden on others should they need medical care. There are various
methods of addressing this problem. For example: repealing laws that would force providers to care
for opted-out persons without establishing financial responsibility; requiring evidence of purchase of
catastrophic insurance; or disbursing the money in increments.

4. Copayments for laboratory tests and home health:
$6 billion and $20 billion, respectively

5. Repeal of counterproductive regulations:
$ billions

The regulatory burden is hard to calculate. It is estimated that the Clinical Laboratory
Improvement Act alone imposes perhaps $4 billion in extra costs, not all of which is paid for through
government programs.

6. Combining deductibles:
estimated 10% of Part B benefits ($6.5 billion/yr now)
$30 billion in 7 yrs

7. Changing claims filing procedures:
$1 billion/yr
$7 billion in 7 yrs

These estimates are difficult to make. But several facts are clear: Part B is the most rapidly
growing portion of Medicare, and many benefits have been shifted from Part A to Part B, as through
out-patient surgery. The deductible for Part B is very small. The presence of a significant deductible
has the effect of decreasing utilization significantly. The effectiveness of a Medicare deductible is
mostly cancelled by Medigap policies that cover the deductible; thus the effectiveness of restructuring
the deductible would partly depend upon the percentage of beneficiaries purchasing Medigap insurance,
and the type of insurance.

Medicare itself provides evidence of the effects of direct beneficiary responsibility for payment.
Medicare spending per beneficiary is from 131 to 173% higher in patients who have employer-provided
Medigap coverage, compared with those who do not. (The greatest difference is for patients whose
self-assessment of their health is “excellent.”)

Medicare claims to have a very low administrative overhead of 2 to 3%. This figure has been
challenged, and has been placed as high as 26%. Of this 26%, not all is related to claims processing;
we will assume that claims processing contributes 3% of the cost. Simply observing the exchanges of
correspondence, it looks as though the cost of processing many of the claims vastly exceeds the
amount paid in benefits on small claims. In any case, the administrative cost is more closely related
to the number of claims than to their dollar value. Let us assume that administrative overhead for
Part B is 3% (or $1.95 billion). About 51% of Medicare beneficiaries submit claims totalling less than
$1096 in a year (Part A and Part B combined), and most of these submit more than one claim for a
smaller amount. It seems reasonable to estimate a savings of $1 billion per year due to reducing the
number of claims to be processed.

All estimated savings under traditional Medicare may be offset by persons opting to take a
voucher instead, unless the voucher amount is reduced to account for the savings realized through
drastic reductions in claims processing.

The Effect of Vouchers

The savings to the taxpayer will depend upon the level at which the voucher is set and on how
many beneficiaries choose them. Vouchers for Medicare HMOs at 95% of the actuarial value probably
have not resulted in savings, due to risk selection. If vouchers save 10%, and 25% of beneficiaries
choose them, the taxpayers save $4 billion per year, or $28 billion over seven years.

Because utilization falls when patients are spending their own funds, 7-year savings of more
than $200 billion were estimated by the firm of Milliman and Robertson. One of their assumptions is
that 70% of beneficiaries would choose vouchers.

A decrease in utilization is not the only important effect of vouchers. Vouchers would also put
pressure on prices. There are two fundamentally different ways to exert this pressure: the stick of
coercion by managers, or the carrot of voluntary cooperation between physicians and patients who are
spending their own money. We believe the latter method is greatly to be preferred.

Vouchers would save no money at all unless beneficiaries choose them. What would be the
cost and benefits to individuals choosing the MSA/catastrophic insurance option?

The following presents a method of approaching that question. It is based on a large number
of assumptions. The numbers will vary with the individual. The most important assumption is that the
government will offer an actuarially fair voucher ($4000 is illustrative only; for an 80-year-old
the amount may be substantially more than for a 65-year-old).

Some state that the voucher should-for the vast majority of persons-at least cover the cost of
a catastrophic policy offered by a commercial insurer interested in competing in an honest and fair
marketplace, with a little left over to help fund the deductible through an MSA. (A draft proposal from
Milliman and Robertson calculates voucher amounts ranging from $2,600 to $4,100 for 1996; Medicare
risk-HMOs now receive $4,800 per beneficiary.)

Estimates of premiums for catastrophic insurance vary greatly. The lowest estimate we have
seen is $2,775 for a $2,000 deductible policy for a 70-year-old individual. A much higher estimate of
$7,236 annually for a 70 year old has been given for a policy with a $4,000 deductible and 20%
coinsurance to an out-of-pocket maximum of $7,000 with no coverage for prescription drugs. The
latter estimate assumes that standard non-Medicare billed charges would be reimbursed; in other
words, beneficiaries would be paying the full charge for their services and not shifting 50% to other
insured or sick persons. In fact, they would be paying for cost shifts from traditional Medicare and other
insurance plans that pay only discounted charges or “usual, customary and reasonable” prices.
(Medicare cost-shifting amounts to a non-legislated and unacknowledged tax that is at least as high
as the Medicare payroll tax.)

We consider all price estimates to be hypothetical unless they are quoted for a real product
available for purchase. However, these prices do have a factual basis in that they are extrapolated
from actual experience with younger individuals and actual expenditures under Medicare.

This is a static method. It cannot account for the dynamic forces that result from changing
the incentives; yet these forces are very powerful and demonstrably have large effects. Better methods
are needed to forecast the results. In the meantime, this approach should help individuals decide what
is best for them.

For the catastrophic insurance/MSA method to achieve cost savings, it is crucial that the
insurance products be developed in a free marketplace; that is, insurers must be allowed to compete on
the basis of both price and benefits. True insurance companies must not be driven from the
marketplace by laws and regulations benefiting companies that profit from managing transactions,
investments, and “health care delivery systems,” while transferring risk to “providers.” Insurance must
be distinguished from prepayment for managed consumption. Insurance means the voluntary sharing of
actuarially improbable but individually catastrophic financial loss.

It is also crucial to realize that Medical Savings Accounts are not insurance. There is no need
for overhead related to claims processing because there are no claims. The transaction costs should
be no higher than those for the use of credit cards.

Current expenditures under traditional Medicare:

by Medicare (for benefits and administration)$5000

by Medicare beneficiaries from personal funds:

Representative premium for Medigap insurance: $1100

Out-of-pocket expense (drugs, etc.) (AARP) avg $1500

Part B premium $553

Average case: On the average, Medicare beneficiaries
spend $3153 of their own funds on medical care each year.

Best case: If an individual chooses to buy a Medigap policy,
spending will be at least $1,653, even if no medical care is used at all. If he forgoes Medigap coverage,
he will spend just the $553 for Part B premiums.

Worst case: There is really no upper limit on
possible expenditures, because Medicare provides no catastrophic coverage. If an individual requires
prolonged intensive care, or could benefit from treatment unapproved by Medicare or unavailable at the
Medicare-dictated price, the patient must either pay out of pocket or do without. Many are now forced
to do without because of threats from HCFA that cause many physicians to refuse to treat Medicare
beneficiaries as private patients. About 1.5% of Medicare beneficiaries paid more than $5,000 out of
pocket in 1992; the average liability for these patients was $8,657.

Estimated expenditures for Medicare beneficiaries using MSA/catastrophic insurance option:

by Medicare:

Voucher (may be risk adjusted)
(expenditures/enrollee – part B premium – 10%): $4000

by Medicare beneficiary from personal funds:

premium for insurance: $2800 to 7200
deductible: $3000 to 4000
copayments under some plans: up to $3000

noncovered out-of-pocket avg $1500

less voucher – $4000

Average case: The average expenditure under this option,
given a $3500 premium for an insurance policy with a $4000 deductible, would be $480 (compared with
$3153 under Medicare). ($3500 premium + $1500 out-of-pocket – $4000 voucher.) Note that half
of all Medicare beneficiaries have Medicare-covered costs of $520 or less in any given year.)

Best case: In a year with minimum expenditures, a catastrophic
premium of $2800 only, the beneficiary would have a net savings of $1200, which could earn interest in
the MSA to help cover expenses in years involving more expenses.

Worst case: Catastrophic expenses would be covered, unlike
under Medicare. In the worst case, the patient will incur a lot of noncovered expenses, such as for
prescription drugs or alternative treatments. Such items are also not covered under Medicare.

If the cost of the catastrophic insurance is as assumed under “average case,” the person would
face an out-of-pocket cost of around $5,000 (compared with $3153 under Medicare). Note that about
19% of Medicare beneficiaries incur costs of $3,303 or more in a given year.

If the cost of catastrophic insurance is at the high end, the beneficiary would face a minimum
expenditure of $3200 in a year ($7200 – $4000), or $1547 more than a patient with traditional
Medicare plus Medigap. In the worst case of the worst case scenario, he could face a cost of more
than $11,700 ($7,200 premium, $7,000 deductible and copayments, $1,500 or more in noncovered
expenses, less $4,000 covered by voucher). If such persons are allowed to contribute sufficient funds
to an MSA, excluded from both state and federal taxes, and if they are in a 50% tax bracket (including
self-employment and federal and state income taxes), they risk a net expenditure of around $5,850 in
a catastrophically bad year. (This would give them the same tax advantage that younger persons enjoy
if they have employer-provided, low-deductible insurance.)

Many Americans might be willing to take this risk for moral and patriotic reasons, to avoid
burdening their fellow citizens with cost-shifting equivalent of taxation. There are also reasons of
enlightened self interest in that the beneficiary maintains maximal freedom of choice with access to
state-of-the-art technology that would be denied by Medicare or managed-care rationing.

We believe this worst-case scenario to be highly unlikely, for it assumes no decreased utilization
and no downward pressure on prices, both contradicting previous experience.

Estimated expenditures for Medicare beneficiaries using managed-care option:

by Medicare: $4000

by Medicare beneficiary from personal funds:
nominal copayments
noncovered treatment

Average case: The average patient will incur a few
copayments. Many plans cover prescription drugs, so out-of-pocket expenses may be less. (However,
this coverage may become unavailable if less generous vouchers are given. Furthermore, the drugs
that the patient actually needs may not be on the formulary, forcing him either to pay or to accept a
less satisfactory substitute.)

Best case: Under a managed-care plan, the beneficiary does
not stand to profit personally from staying healthy or prudent shopping. (Some suggest allowing him to
keep a portion of the savings if he chooses a plan that costs less than the value of the voucher.) The
best case is hardly different from the average case.

Worst case: The worst financial outcome under managed
care is that a patient will decide to have a treatment for which the plan does not pay. Having turned
all his Medicare benefits over to the plan, the patient’s access to care denied by the plan will be the
same as that of any other uninsured person (unless providers fear to offer treatment at all because of
ambiguities concerning private contracting).

At present, the rationing of medical care to the sick is probably more severe under many managed care plans than it is under Medicare. This situation could change in either direction, depending on which option has the more stringent price controls or the tighter constraints on providers.

A calculation for an indemnity plan (or other arrangement not yet developed) can be made in
the same manner.


All options involve both benefits and risks. The most important reason for choosing one option rather than another is probably not a dry financial calculation. The main issue is whether one feels more secure with the government or a managed-care entity in charge of one’s medical care (with utilization review committees, practice guidelines, outcomes measurements, etc.), or whether one feels capable of taking responsibility for one’s own medical decisions.

The savings to the taxpayer outlined in this draft total more than $300 billion in seven years, exceeding the Republican goals, without the imposition of new price controls or benefits cuts.

The risk adjustment factors shall be determined periodically by accepted actuarial methods. (For example, the
initial value of the voucher might be the average per capita expenditure by Medicare multiplied by 0.88 for individuals
aged 65-74; by 1.15 for individuals aged 75-84; and by 1.27 by individuals aged 85 and over. The value of the
voucher might also be adjusted by geographic area.)

From Medicare Trustees’ Report, rounded from “intermediate projections: for 1995, including benefits payments plus
administrative costs. Note that the administrative costs may be vastly understated, as many expenses are attributed to
other programs or shifted to providers.

Wall Street Journal, Aug 21, 1995.

BNA’s Medicare Report 7/14/95

BNA’s Health Care Policy Report 3/20/95

Mark Litow and Peter Hendee, “Restructuring Medicare: a Long-Term Plan to Save the Medicare Program,” Council
for Affordable Health Insurance, August, 1995.

Mark Litow and the Technical Committee, “Rhetoric vs. Reality: Comparing Public and Private Health Care
Administrative Costs,” Council for Affordable Health Insurance, March, 1994.

For example, J. Michael Brown, in “The Tortuous History of a Medicare Claim,” Wall St J 8/31/95, estimates the
cost of processing a single $30 claim to be $300.

Mark Litow and Peter Hendee, “Restructuring Medicare: a Long-Term Plan to Save the Medicare Program,” Council
for Affordable Health Insurance, August, 1995.

Stanley A. Roberts, personal correspondence to Michael Schlitt, M.D., 9/1/95.

Gary Robbins and Aldona Robbins, “Reforming Medicare with Medical Savings Accounts,” National Center for Policy
Analysis Report No. 95, July 1995.

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