Healthcare and the Budget Control Act of 2011

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Richard Evans / Scott Hinds

203.901.1631 /.1632

richard@ / hinds@ssrllc.com

August 3, 2011

Healthcare and the Budget Control Act of 2011

  • The Budget Control Act calls for $2.1T to $2.5T in cumulative deficit reduction for the period 2013 – 2021. $917B of this is in the form of ‘up-front’ cuts in discretionary spending, and has no appreciable effect on health spending
  • The Act establishes a joint committee that must propose (by 11/23/11) and pass (by 12/23/11) deficit reduction legislation that lowers the deficit by at least $1.2T, under special rules that more or less guarantee a straight up-or-down vote
  • If the committee fails outright, or falls short of its $1.2T target, automatic spending cuts would either replace (if no legislation passes) or supplement (if legislation passes with a deficit reduction < $1.2T) the committee’s legislation and guarantee a total deficit reduction of $1.2T
  • The automatic cuts are divided evenly between: 1) discretionary defense spending; and 2) non-defense discretionary spending and certain entitlements. Medicare is subject to automatic cuts, Medicaid is not. Automatic cuts to Medicare are capped at 2 percent, or roughly $139B. Automatic Medicare cuts would probably take the form of across the board cuts in provider payment rates
  • We believe the committee has better than even odds of succeeding with legislation that produces all, or nearly all, of the $1.2T target. The politics of the committee and the parliamentary mechanics of its special rules mean the makers of products used by Medicare beneficiaries are likely to be hit with de novo rebates and/or discounts. Rebates on drugs sold under Part D are possible, despite the exclusionary clause
  • After rebates and discounts on inputs to care, we believe that in the following order, further means-testing of Medicare premiums and a gradual increase in the Medicare eligibility age to 67 are reasonably likely
  • We view major changes to Medicaid (either payment rates or eligibility) as unlikely
  • If the committee fails, automatic cuts to Medicare payment rates mean the entire healthcare impact of the Act falls on providers, in which case Hospitals would be the most negatively affected of healthcare’s major sub-sectors. If the committee succeeds – and we believe there are better than even odds that it will – Hospitals are likely to get a reprieve vs. expectations as other sub-sectors bear some of the burden; but Major Pharmaceuticals, Specialty Pharmaceuticals, Medical Devices, and Biotech are likely to fare worse than expected

The mechanics of the Act as they relate to federal health spending

Step 1: The Act brings an immediate reduction of $917B in planned discretionary spending over the next ten years. Medicare and Medicaid constitute the vast majority of federal health spending (63 percent and 31 percent in 2009, respectively (Exhibit 1)), and both are entitlements, i.e. non-discretionary, thus neither program is affected by the ‘up-front’ $917B spending cuts

Step 2: The Act calls for the formation of a joint committee (12 members of Congress, 6 Republican and 6 Democrat), which is required to present, by November 23rd of this year, legislation that reduces the cumulative (2013 to 2021) deficit forecast by between $1.2T and $1.5T. Congress cannot modify, and must vote on, the legislation presented by the committee by December 23rd of this year. The legislation is subject to expedited rules preventing various parliamentary tactics intended to change or delay the measure

The committee can attempt to meet its deficit reduction target through either or a combination of spending cuts and new revenue. Importantly, the baseline for calculating the impact of the committee’s recommendations on the deficit is current law, i.e. the committee’s legislation only gets credited for revenue and/or spending cuts that otherwise would not have happened

If the committee proposes and Congress passes legislation that reduces the deficit by more than $1.2T, then the President receives a further increase in the debt ceiling equivalent to the amount by which the resulting deficit reductions exceed $1.2T, to a limit of $1.5T, after which any further (incredibly unlikely) deficit reductions would have no effect on the debt ceiling. If the committee fails to produce legislation or if Congress fails to pass the committee’s proposal, then the Act calls for a $1.2T automatic reduction in planned spending. Or, in the event any resulting legislation falls short of the $1.2T minimum, the Act calls for automatic reductions in planned spending sufficient to bring total deficit reductions to $1.2T

In the event of automatic spending reductions, any reductions are shared evenly between two broad budget categories: 1) discretionary defense spending; and, 2) non-defense discretionary spending and certain entitlements. In this instance ‘certain’ entitlements do include Medicare, but do not include Medicaid. Medicare cuts under the automatic reductions are limited to 2 percent of projected Medicare spending

First reaction to what the Act means for healthcare

The Act reduces the deficit by at least $2.1T and as much as $2.4T. However health spending cuts are not part of the up-front $917B reduction in discretionary spending, leaving a maximum of $1.2T to $1.5T[1] in deficit reductions that might affect health spending. If the committee delivers $1.2T in deficit reductions, any portion of this could come from health spending. Alternatively, if the committee and Congress fail completely, the automatic trigger can reduce federal health spending by no more than about $139B, an amount equal to 2 percent of currently projected[2] 2013 – 2021 Medicare[3] spending (Exhibit 2). If the automatic cuts are triggered, it is not entirely clear from our reading of the Act how the 2 percent reduction in projected Medicare spending would be achieved. However, in the absence of new authority, we presume HHS / CMS[4] would of course have to act within their existing authority, which infers the 2 percent reduction would come in the form of reductions to provider payment rates. We further presume that, in the absence of new authority, reductions would be spread somewhat evenly across providers. To put a 2 percent payment cut in historic context, the ratio of Medicare to commercial payment rates presently is about 0.74, versus a long-term (’93 – ’09) average of 0.78 (Exhibit 3). A 2 percent across the board reduction in payment rates would lower this ratio to 0.72, or the lowest it’s been since 1994. Despite a lower than normal level of the Medicare to commercial payment ratio, we would note that hospital margins are relatively healthy as compared to past periods (Exhibit 4), which we believe reflects hospitals’ recent real pricing gains with commercial payors

The first question on the road to predicting / analyzing federal health spending effects is to ask whether the committee succeeds. The tight timeframe and complexity of the issue work against the committee being successful; however, the nature of the automatic cuts and Republican majorities in the House generally work in favor. If the committee fails to produce legislation, or produces legislation that Congress does not pass, then the automatic cuts fall disproportionately on defense[5], which presumably is to say the cuts fall disproportionately on Republican interests. This apparent tipping of the ‘incentive balance’ should preferentially motivate Republicans to approve something other than the automatic cuts, and thus raises the odds of passing legislation – Republicans control[6] the House, and would need ‘only’ 4 Democrats to join Republicans in the Senate. We’re going to stop short of more closely estimating odds for the moment, but we generally believe the odds of the committee producing, and Congress passing, legislation that delivers a meaningful proportion of the $1.2T minimum savings target are better than 50:50

The second question, and by far the most complex, is what effect the committee’s proposed legislation would have on health spending. Attacking this in layers… if the committee produces legislation, healthcare almost certainly will be addressed directly, given the great relevance of Medicare and Medicaid to the deficit. Of the two programs, we think Medicare is more heavily affected, both because of its larger share of federal spending, and because of the general feeling that Medicaid payment rates already are too low (as evidenced by e.g. necessary providers not participating) and that expansion of eligibility already is hard-wired by the health reform law. Of the available options for reducing Medicare effects on the deficit, we would expect the following to be pursued in order of priority: 1) reduce input costs; 2) raise revenue; and 3) reduce scope of benefits

Option 1: Reducing input costs can be achieved in either or a combination of two ways: discounts and rebates on products used by Medicare beneficiaries, or reduced payment rates to providers. We recognize that manufacturers have just gone through a round of contributing to federal health cost reduction during the reform debate, but we doubt this fact does anything to protect manufacturers from discounts / rebates in any legislation produced by the committee. Specifically, we believe the committee-based process called for by the Act is more able to force new rebates and discounts than Congress would be under its normal legislative processes. The committee has far fewer members than the entire Congress, giving lobbyists fewer potential points at which to affect legislation as it is drafted. Once out of the committee the legislation cannot be changed, so the option of modifying legislation on the floor, or in conference, is lost. And, the timeframe for drafting (and passing) legislation is incredibly tight, meaning lobbyists simply have less time to affect the result. Once legislation passes to the floor, lobbyists plainly can try to influence the simple up or down vote in the broader Congress. However the nature of a member’s vote on the committee’s legislation is very different from a more ‘traditional’ vote, and this too works against the lobbyist. In a more traditional legislative process, a bill calling for a discount from industry X is, to a given legislator, a choice between savings from industry X on the one hand, or no savings (and presumably more deficit) on the other. In this traditional framing, the alternative to an industry X discount – no savings – has at best a very vague constituency. I.e. no one holds that member tightly accountable for the specific savings opportunity missed by not getting a discount from industry X. However in the present case, the alternative to the industry X discount is a large cut to another powerful constituency; i.e. the savings are coming, it’s now simply a matter of where the savings come from. Because the automatic spending cuts are things both parties (and particularly Republicans) care about, there is a constituency on each side of the legislator’s choice, and those constituencies will hold that legislator accountable for any impacts created by supporting, or not supporting, the committee’s legislation. Thus crudely, which way to vote becomes a matter of which constituency is more cherished and/or powerful, after adjusting for the available savings. The manufacturers (pharmaceuticals, medical devices, biotech, etc.) of products consumed by Medicare beneficiaries plainly are less cherished and less powerful than Medicare beneficiaries themselves, thus reducing input costs takes priority over narrowing benefits or raising beneficiaries’ costs. And, these manufacturers presumably are no more cherished or powerful than the constituencies affected by the alternative cuts (e.g. defense). Thus all in, we see de novo rebates and discounts from manufacturers (including prescription drug sales to Part D[7]) as a likely outcome of the Budget Control Act

In 2010 Medicare’s retail purchases of prescription drugs totaled $54.8B, and we estimate that hospitals purchased roughly $9B of prescription drugs used in the care of Medicare beneficiaries. We (very roughly) estimate that a 10 percent mandatory rebate on drugs (including biotech) purchased by or on behalf of Medicare beneficiaries would reduce the 2013e – 2021e deficit by $60B. We estimate that hospitals purchased roughly $15B of innovative / premium-priced devices for use in Medicare beneficiaries’ care in 2010, and further estimate that a 10 percent rebate on these sales would reduce the 2013e – 2021e deficit by approximately $14B. Exhibits 5 and 6 rank biotech and device companies, respectively, by the percentage of sales attributable to Medicare

We also see reasonable odds of the committee reducing Medicare payment rates, though not to the degree (as much as 2 percent) that would occur under the automatic cuts. Where the automatic cuts to provider payment rates presumably would be somewhat evenly spread across providers, the opportunity exists under the committee for payment cuts to be more selective. Here, providers (e.g. home health) or even suppliers (e.g. motorized wheelchairs) that are viewed less favorably are likely to face larger cuts to their payment rates. Beyond any selective cuts to payment rates, a general / systematic adjustment to payment rates also is somewhat likely, and there are as many frameworks for altering payment rates as there are variables in the calculation of these rates. We see one framework (productivity updates) as most logical and most (at least in relative terms) probable. Medicare payments are configured in such a way that providers cannot gain by competing with one another on costs, thus Medicare payments lack an essential free-market means of prompting gains in productivity[8]. And, the payment updates lack a well-defined adjustment for productivity gains that might (and in fact do) occur from means other than direct competition among providers. Thus payments for a given service tend to grow in real terms, and this tendency can be reduced or eliminated by making a productivity adjustment to payment rate calculations. CBO proposed and evaluated such a change in its December 2008 analysis of health spending options, and found that reducing annual growth in physician FFS payments by an amount equal to expected productivity gains would reduce 2010 – 2019 Medicare spending by more than $200B[9]

Option 2, raising revenue, might be approached by the committee in both general (raise taxes) and program-specific (raise Medicare premiums) fashions. Continuing on the theme of having less cherished and less powerful constituencies carry more of the deficit-reduction burden, we would expect at least a handful of populist modifications to the tax code, for example new taxes on corporate jets, though these are unlikely to raise significant revenue. More substantively, we believe it is reasonably likely that Medicare contributions will be further geared to means, i.e. wealthier beneficiaries are likely to pay a higher proportion of their Medicare coverage costs than they do now[10]

Option 3, reducing the scope of eligibility, would in practice likely mean raising the eligibility age for Medicare from 65 to 67. CBO ‘scored’ this option in its December 2008 study of health spending alternatives, and estimated that an increase in the eligibility age to 67 would reduce 2010 – 2019 spending by $85.6B[11]. Importantly, CBO assumed the increase in eligibility age would be two months per year beginning in 2014, which would reduce both the political and savings impacts of the change

Other options: The committee obviously operates under a very tight timeframe, meaning there is insufficient bandwidth for de novo policy options. Accordingly we would expect the committee to make use of (and take credit for) policy changes that might have otherwise been on Congress’ to-do list. Repeal of the CLASS[12] Act is a likely example: a product of the recently passed Affordable Care Act (ACA), CLASS has, for a variety of reasons, little support from either party. The Independent Payment Advisory Board (IPAB) also is generally unpopular; however restricting or even repealing IPAB is unlikely, as this would work against the committee’s ability to reach its deficit reduction target. Limiting the extent to which Medigap policies can offset Medicare beneficiaries’ out-of-pocket cost burdens is a possible option for the committee; however we think the committee would be more likely to rely on an increased gearing of premium contributions to means, as the impact of means-testing falls on a narrower group of beneficiaries than changes to Medigap

  1. For the record, we recognize Congress and the joint committee are free to reduce the deficit by more than $1.5T, but we see no reasonable prospect of this actually happening
  2. Again for the record – the ‘13e through ‘20e Medicare projections are official Office of the Actuary figures as of July 2011; no official estimate yet exists for ‘21e Medicare spending
  3. At this stage of the process we’re focused only on the bigger picture – i.e. Medicare and Medicaid. We recognize that Department of Defense (DoD) spending on health for active military families might be affected by the automatic spending cuts, and that Federal Employees Health Benefits Program (FEHBP) subsidy levels might also be affected. Department of Veterans Affairs (VA) spending would not be affected, as veterans’ benefits are exempt from the automatic spending cuts
  4. Health and Human Services (HHS); and within HHS, the Centers for Medicare & Medicaid Services (CMS)
  5. Defense dominates discretionary spending, and so gets hit in the up-front $917B reduction; and, if the automatic cuts are triggered, half of the triggered amount – on top of whatever portion defense ‘gave’ in the up-front $917B reduction – comes from defense
  6. Given the Tea Party rift in the Republican ranks, we admit ‘control’ is a generous word. However, bear in mind the committee’s legislation is not about whether to reduce the deficit, but how, and by how much
  7. We recognize that the Medicare drug benefit legislation contains language that precludes HHS from affecting the prices of drugs sold in Part D; however we’ve long felt that the clause can and eventually will be removed
  8. Please don’t read this free-market reference as our taking sides on the matter of whether healthcare should be market-based or government-controlled. We believe the free-market vs. government-control debate is, in the context of US healthcare, a tug-of-war over either of two wrong answers. For more, please see “Health and Capital” at www.healthandcapital.com
  9. Congressional Budget Office, “Budget Options Volume I: Health Care” December 2008
  10. Medicare premiums already are means-tested to a limited degree; we’re simply calling for further means testing
  11. Ibid. 9
  12. Community Living Assistance Services and Support
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