Thursday, April 13, 2017

Of index investing and traditional Medicare

For some time, a kind of inverted analogy between index fund investing and Traditional Medicare has been flickering round the edges of my mind, so let's see where it leads.

I was very impressed by a forecast I heard almost exactly eight years ago (Suzanne Duncan of the IBM Institute for Business Value)  that within 20 years, 85-90% of assets under management would be invested in passive vehicles -- that is, index funds or institutional equivalents. And in fact, in 2015, passive funds accounted for a third of U.S. mutual fund assets, up from a quarter three years prior.

For individual investors, and for most institutional investors, the shift to passive investment makes excellent sense. It's almost impossible for a portfolio of actively managed funds to beat an index portfolio over time. Just today, the Wall Street Journal reports, "Over the 15 years ended in December 2016, 82% of all U.S. funds trailed their respective benchmarks, according to the latest S&P Indices Versus Active funds scorecard."  And of course, index funds retain a huge fee advantage, since they don't have to pay managers for their acumen -- the funds change their investments automatically to mirror a predetermined basket of equities or bonds.

Someone has to make active decisions that determine prices, however, thereby creating the indexes that passive investors rely on. That means investing in research, complex mathematical analysis, and, sometimes at least, intuition born of lived experience.  What happens when the indexed values are produced by managers investing, say, just 5% of all assets under management? Isn't that a rather small brain moving a dinosaur? Is a smaller herd of decision-makers likelier to stampede in destructive directions?

Conversely, Medicare Advantage -- what you might call actively managed healthcare for seniors -- is grabbing a growing share of the Medicare market, now up to 32% of the whole, up from 22% in 2008.

Like index funds, Medicare Advantage works for a growing (and coincidentally, nearly identical) share of the market -- and works well for many people, especially those who can't readily afford Medigap insurance, which allows enrollees to retain access to almost of all healthcare providers with very limited out-of-pocket costs. The commonest Medicare Advantage is tradeoff is to accept a limited provider network in exchange for more limited out-of-pocket exposure. Most MA plans cap out-of-pocket costs, which are open-ended in traditional Medicare. MA premiums vary widely, but many plans have lower premiums than traditional Medicare, with drug coverage included.

Just as passive investors depend on active investors to set prices, Medicare Advantage enrollees (and taxpayers) rely on traditional Medicare to maintain price control -- that is, to keep costs low enough that the government can continue to subsidize coverage at current levels, which amount to about 85% of the combined premiums for parts A, B and D for 95% of enrollees (high income enrollees pay higher percentages).

At present, government payments to Medicare Advantage plans are tightly tied to traditional Medicare payment rates. For each county (or region, for regional plans) Medicare sets a per-enrollee price target, or “benchmark” for MA plans to bid against, determined by traditional Medicare payment rates. If an insurer's bid comes in below benchmark, they are paid at the benchmark rate and must use the surplus either to offer additional services or to lower premiums. If they bid above the benchmark, they charge a premium for the difference over and above the standard premium for traditional Medicare Part B (physician services),

The benchmark system effectively keeps MA plans paying providers rates within a couple of percentage points of those paid by traditional Medicare. CMS sets those rates, working with a panel of doctors to determine how much labor is involved in each medical procedure, but ultimately determining the rates at which those estimated hours should be reimbursed. Those rates are much lower than those paid by private insurers in employer-sponsored plans.

Paul Ryan famously wants to untether MA rates from traditional Medicare rates by changing the benchmark basis, for example by making the second lowest bid or the average bid in each market the benchmark (as in the ACA marketplace). That could lower premiums in some cases, with traditional Medicare remaining as a control, as it would be a bidder in each market.

If, however, traditional Medicare continues to lose market share -- with or without a shove from a switch to  premium support -- it could lose its pricing power. Premium support proposals generally call for the traditional Medicare option in each market to be paid on a capitated basis (per enrollee), as MA plans are. A Kaiser Family Foundation brief warns that if the sickest patients gravitate to traditional Medicare, because of its unlimited access to providers, its premiums could rise, and it could enter a death spiral.

Even if that scenario does not play out, if traditional Medicare enrollment falls below a critical mass, and if providers who contract with private Medicare plans are not obligated to accept traditional Medicare, the government will lose its pricing power.  Provider payment rates would float, and might rise toward the higher rates paid in the commercial market -- in which case the government would inevitably cut the share of the premium it subsidizes.

In both cases (investing and senior health insurance), what works best for a growing share of consumers may put the stability of the whole system at risk if taken to its logical conclusion.

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