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.

Posted at http://healthaffairs.org/blog/2012/02/15/medicare-and-commercial-health-insurance-the-fundamental-difference/.

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