The impact of contracting out on Medicare and Medicaid.

• Author: Duggan, Mark

More than 120 million Americans currently receive their health insurance through the Medicare or Medicaid programs. Total government spending on the two programs in 2016 is projected to exceed $1.2 trillion. (1)

Medicare is a federal program that covers approximately 48 million Americans aged 65 or older, as well as nine million younger adults receiving Social Security Disability Insurance (SSDI) benefits. Medicaid is a means-tested program that, in 2016, provided coverage to more than 74 million low-income individuals. It is financed jointly by the federal government and state governments. More than 10 million "dually eligible" individuals receive health insurance coverage from both programs. Both programs provide coverage for most health care services, with Medicare requiring enrollees to cover a greater share of their costs and Medicaid generally reimbursing health care providers less generously.

During the 1960s, 1970s, and for much of the 1980s, both programs tended to reimburse hospitals, physicians, and other health care providers directly for the cost of each service. One concern with this fee-for-service (FFS) method of reimbursement was that it could give care providers a financial incentive to perform unnecessary or low-value services. Similarly, providers had little incentive to coordinate with one another to optimize services. These concerns and rapid growth in spending for both programs led Medicare in the early 1980s and many state Medicaid programs soon thereafter to test alternative payment models known as managed care. These included health maintenance organizations (HMOs) and others, with the managed care organization typically receiving a fixed amount per member per month to coordinate and finance health care for the enrollee.

In the years since, a large body of evidence has demonstrated that Medicare managed care recipients utilize significantly less health care than their counterparts in traditional FFS Medicare. However, it is unclear whether this reflects an effect of managed care or instead a difference in the characteristics of those choosing to enroll in Medicare managed care plans, which since 2003 have been referred to as Medicare Advantage (MA). This is especially true because all Medicare recipients have the option to enroll in MA plans, and thus MA enrollees may differ in unobserved ways from those in FFS Medicare. Medicare Advantage has become more important over time. Today, nearly one in three (31 percent) of the nation's 57 million Medicare recipients is enrolled in a MA plan, compared with just one in eight (13 percent) in 2005 [Figure 1, next page.]

Jonathan Gruber, Boris Vabson, and I investigated the differences between MA enrollees and all other Medicare beneficiaries for the period 1998 through 2003 in the state of New York. (2) We focused on this time period and on a single state for two reasons: First, we were able to link individual-level hospital discharge data from New York with month-by-month Medicare enrollment data, allowing us to measure health care utilization for the same individual as he or she transitioned from FFS Medicare to MA or vice versa. Second, at the end of 2000, several counties experienced an abrupt reduction in their MA enrollment as certain health...