Medicare 'bundle' payments are the right way forward in healthcare
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When it was introduced in 1965, Medicare’s payment structure inadvertently encouraged hospitals to inflate the cost of delivering medical care. Over the past few decades, various reforms have sought to fix this incentive by providing a single payment to cover the costs of treating individuals with specific medical conditions. The attempt to bundle reimbursement for joint replacements was one of the most promising steps in this direction, but on August 15, the Centers for Medicare and Medicaid Services (CMS) announced that it was scaling back this and other similar initiatives.

Having made this move, the Trump administration needs to demonstrate that its qualms about specific models do not represent an abandonment of attempts to improve the efficiency of the healthcare delivery system.

So that hospitals would support the launch of the Medicare program, Congress originally promised to pay them according to whatever they claimed it cost them to treat beneficiaries. This caused an enormous increase in their capital investments, greatly augmented the number of hospitals in the United States, provoked the widespread expansion of existing facilities, and led the program’s hospital costs to soar from $3 billion in 1967 to $37 billion in 1983. This incentive for hospitals to inflate the cost of providing care caused their expenditures to increase six times more than one would expect from an expansion of insurance coverage alone — driving up the cost of treatment for those who were not even enrolled in Medicare.

In 1982, Congress and the Reagan administration enacted a major reform, so that hospitals would be paid a fixed amount in return for treating hospital inpatients with specific medical diagnoses (“DRGs”)—essentially providing a voucher payment for Medicare beneficiaries to receive care. This proved very successful at controlling costs without adversely impacting quality or access to care, and slowed the increase of hospital spending from an average of 14 percent per year between 1965 and 1982 to an average of only six percent since then.


Yet, physician services, payments to anesthesiologists, and follow-up care were carved out of the DRG payments. As a result, although the growth of hospital costs slowed during the 1980s, spending on other services picked up speed. Fixed fees for these services were then instituted, but often as separate payments according to the volume of consultations, medical tests, and services used, rather than as a single payment for the treatment of a condition. While Medicare physician fees rose by only 4.5 percent from 2000 to 2005, spending on physician services rose by 45 percent per beneficiary.

In addition to encouraging providers to inflate the volume of services, the carve-out also makes it very difficult to shop for care. Even if you know how much the DRG payment for surgery at a specific hospital might cost, it is near-impossible to anticipate the various auxiliary services which providers may bill for.  When you purchase a flight, you’re not charged separately for the plane, the fuel, and the cabin crew—they’re all part of the package, regardless of how many flight attendants choose to stop by your seat. The same should be true with hospital care. 

It therefore makes sense to pay according to the conditions treated rather than in proportion to the volume of services used. The Affordable Care Act required CMS to develop bundled payments for Medicare, and allowed it to fully implement changes demonstrated to have reduced costs without adversely impacting the quality and access to care. Although this reform approach was reaffirmed in the bipartisan 2015 Medicare Access and CHIP Reauthorization Act, opposition from providers has caused pilot reforms for joint replacements and cancer care to be revised.

Providers have argued that bundled payments should not be mandatory, leaving them the option to bill under existing fee-for-service payment arrangements. But it is not possible to properly test the effectiveness of bundled payment when a skewed sample of providers selects into the program. Nor is the reform likely to save much money if providers who find the status quo more lucrative can opt for that instead.

A more reasonable criticism of Medicare’s bundle payment structures is that they may inhibit competition from cheaper sites of care, such as Ambulatory Surgery Centers, by requiring episodes to be based around hospitalizations. Further, many of the reforms deployed by CMS under the name of bundles are not true prospective payments, which constrain aggregate costs, but shared savings arrangements which may leave expensive providers happily claiming fee-for-service as before.

While it may be straightforward to bundle payment for services associated with discrete medical interventions, such as knee replacements, it is harder to do for many chronic conditions. A patient admitted to a hospital after a stroke may well also have diabetes, and the cost of complications will not always be clearly associated with one condition or the other.

That being the case, it makes most sense for Medicare to make a single payment per beneficiary to cover the totality of care costs, adjusted in proportion to likely medical needs. This is the objective of the Medicare Advantage program, which would also eliminate the need for inevitably-politicized micromanagement of payment for each of thousands of procedures.

But, while Medicare Advantage has grown rapidly over recent years, traditional fee-for-service payment rules still greatly influence the structure of the healthcare delivery system, and are therefore well worth getting right.

Chris Pope is a senior fellow at the Manhattan Institute.

The views expressed by contributors are their own and are not the views of The Hill.