In Brief: Cost Containment in Medicare: A Review of What Works and What Doesn't

“Cost Containment in Medicare: A Review of What Works and What Doesn't” examines the history of Medicare's cost control initiatives. The authors from The Urban Institute and Health Policy Alternatives Inc. — Robert Berenson, Michael Hash, Thomas Ault, Beth Fuchs, Stephanie Maxwell, Lisa Potetz and Stephen Zuckerman — wrote this report for the AARP Public Policy Institute.

Since 1965 when Medicare was signed into law, policy makers have been concerned about escalating costs and have examined various ways to contain costs without affecting beneficiaries' access to quality health care.

The authors identify and describe nine approaches to Medicare cost containment since the mid-1980s. Overall, they found that Medicare has a mixed record of managing costs. But there is considerable evidence that modest cost containment has been achieved, especially compared to growth in private health spending.

Key findings:

Prospective payment for hospitals and post-acute providers: Prospective payment rates for hospitals have been in place for over 20 years. Studies confirm that changing the incentives from a cost-based system to an episode payment has resulted in measurable, ongoing savings and given Medicare greater control over program spending. However, the cost savings have been reduced somewhat because some costs have been shifted to post-hospital care and outpatient services.

Prospective rates for skilled nursing facilities (SNFs) were introduced in 1998. The results have been mixed. In the first two years, expenditures fell by three percent but returned to double digit increases since year 2000. These increases suggest the prospective payment for SNFs hasn't been successful in controlling Medicare outlays.

On the home health side, Medicare spending for home health services grew at an annual rate of 30 percent between 1988 and 1996. Since prospective payments began in 2000, expenditure increases have been about seven percent. Home health agencies have responded to the payment system and together with other changes in eligibility have increased the efficiency of their operations.

Physician fee schedules: Studies and spending trends show that growth in Medicare physician expenditures were significantly lower through 2003 because of fee schedules and spending targets in place since 1992. There was a four percent savings in the 12-year period after 1991. However, for the years 1998 to 2005, total physician spending grew 7.4 percent annually, below the long term average of 8.9. One problem is that the fee-for-service payment system encourages increases in the volume of services. A second problem is that Congress has repeatedly over-ridden automatic reductions to the physician fee schedule that would otherwise have been imposed, allowing more rapid growth in expenditures above annual targets.