May 18 2006

They'd Sooner Fix Medicaid

Can market incentives save the system?

^OKLAHOMA CITY -- The state Legislature here is working to finalize an agreement for Medicaid reform legislation creating personal health accounts (PHAs) for Medicaid enrollees. This comes hard on the heels of similar innovations in South Carolina and Florida. Reform is in the air--much the way it was when Wisconsin revolutionized its welfare system in the early 1990s, forerunning a stunning national success. Are we on the verge of consumer revolution in health care?

It is of course too soon to tell, but the Oklahoma case study is auspicious. The state's antiquated Medicaid bureaucracy has fostered, by turns, a lack of patient choice, provider dissatisfaction, a 9.5% payment error rate, and an escalating price tag of some $3.5 billion. Against these discouraging trends, state leaders spent six months last year formulating stopgap measures with state agencies, policy innovators, providers and beneficiaries.^

Instead of assuming the indigent are incapable of decision-making, Oklahoma legislators proposed that Medicaid beneficiaries be given a risk-adjusted allowance to purchase private health insurance. A PHA would be established for annual out-of-pocket expenses without a "use it or lose it" penalty--that is, the unspent balance could be used for future health-care needs. They state would not mandate a homogenous set of benefits; instead, it would provide financial assistance and patient counseling.

The reform passed the Oklahoma State House in March and recently won Oklahoma State Senate approval. The bill's sponsors, Republican Rep. Kris Steele, and Democratic Sen. Tom Adelson, are working to craft a durable bill to send to the governor by the end of this year.

Oklahoma is simply coming to grips with reality--Medicaid needs fundamental change. Although the program subsidizes care for 52 million low-income people, Medicaid's price tag threatens the financial stability of many states. South Carolina's expenses, for instance, have virtually doubled in the past decade, and may consume nearly one-fourth of the state's budget in 2010. Nationwide, Medicaid spending grew 9.1% in 2004 alone, and is projected to be at nearly half a trillion dollars in less than a decade. Fiscally conscious governors and state legislatures have traditionally controlled Medicaid expenses through reductions in enrollment, benefits and provider reimbursement. Tennessee governor Phil Bredesen, for instance, culled 190,000 from the Medicaid rolls.

But Oklahoma, South Carolina and Florida have embarked on a path that is at once less draconian and yet more radical. All three states have taken the step of permitting Medicaid enrollees to choose health services and providers for themselves. South Carolina, for example, puts a set amount every year into each enrollee's PHA, to be spent as he or she sees fit. The benefits of this simple but revolutionary system will be enormous: Health costs remain low, government outlays stable and state finances healthy. Private accounts will introduce market incentives into the Medicaid system, lightening obligations all around.

Medicaid enrollees can shop for care and increase their chances of receiving the care they need. (Not surprisingly, current Medicaid enrollees have more unmet needs than similar adults with private health insurance.) Health-care providers, compelled to compete for Medicaid customers will likely offer more consumer-oriented services at competitive costs.

Critics of Medicaid choice argue that such plans have several intrinsic flaws. Some view the plan as wasteful, citing Medicaid's already low per-patient cost. But these "low costs" come at the participants' expense. Physicians, scared off by the drastically low level of state reimbursement for Medicaid providers, refuse to take them on as clients. In South Carolina, 30% of physicians refuse to accept any new Medicaid enrollees. With the new regime, physicians will have increased freedom to price competitively.

What about the common charges that Medicaid choice works only in states with numerous managed care providers? One need only look at Georgia and Ohio to refute this claim. Both states drew enthusiastic crowds of providers after they enacted Medicaid choice plans, including Goliaths of the business like Aetna, United Health and Anthem.

But these are side issues for the real opponents of Medicaid choice. They inevitably trot out a familiar, patronizing argument. Medicaid enrollees, they claim, are either not educated enough to be trusted with their own health, or lack access to necessary sources of information. Yet patients make intelligent decisions--when we let them do it. For instance, disabled people in government-run "cash and counseling" programs--monthly, need-based health allowances, spent at the discretion of the participants--consistently receive better care than those who lack discretion.

Even in the private sector, evidence favors consumer-driven plans. Definity Health and Cigna, both providers of consumer-driven insurance policies, have actually documented a reduction in flare-ups among their diabetic and asthmatic enrollees due to increased testing and drug compliance. McKinsey & Co. found that members of consumer-driven health plans were more likely to follow the complicated treatment routines necessary to hold chronic diseases at bay.

Conventional wisdom is usually posed against reform; and it seems even less trustworthy regarding Medicaid. We now stand at a crossroads, similar to the one 15 years ago regarding welfare. Strong-arming enrollees and providers with rationing tactics is not the only way, and surely not the best way, to control Medicaid costs.

We can move beyond the "Scrooge" option. Letting consumers drive the system is better both for the health of patients and the solvency of their home states. Oklahoma is the latest example of an encouraging trend.

Dr. Coburn is a Republican senator from Oklahoma. Ms. Herzlinger is the Nancy R. McPherson Professor of Business Administration at the Harvard Business School and a senior fellow at the Manhattan Institute.