Prologue: Almost from the first day that Medicare began contracting with health maintenance organizations (HMOs) for the purpose of enrolling its elderly beneficiaries, policy analysts have criticized the payment methodology used by the Health Care Financing Administration (HCFA), but no ready solutions to correct the problem were available. The problem is that, without adequate payment adjustments for the medical risk posed by individual beneficiaries, health plans have a financial incentive to enroll the healthy and spurn the sick. Congress, as a part of its recent efforts to address Medicare's financial problems, did little to resolve this issue, but it did instruct HCFA to develop recommendations on how to reform the payment methodology. In this paper, Joe Newhouse and two of his colleagues propose that Medicare experiment with paying HMOs different amounts based on a patient's diagnosis. Newhouse is the John D. MacArthur Professor of Health Policy and Management at Harvard University and one of the nation's most respected health economists. He was the founding editor and continues to edit the Journal of Health Economics. He also currently chairs the Prospective Payment Assessment Commission. Newhouse's impeccable reputation as a health economist evolved from his early work as the principal investigator for the RAND Health Insurance Experiment, the most far-reaching health services research project ever conducted in the United States. Melinda Beeuwkes Buntin, a doctoral student in the Harvard health policy program, holds a bachelor's degree from Princeton University, where she graduated magna cum laude in 1993. John Chapman, who earned a doctorate in public policy from the Kennedy School of Government at Harvard last June, works as a private health care consultant. ABSTRACT: Medicare's method for reimbursing at-risk managed care plans causes potential problems with selection (when beneficiaries with higher-than-expected costs stay in traditional plans) and stinting (the tendency to under-provide health services). Adjusting payment by diagnosis offers substantial improvement. We favor large-scale demonstrations of diagnosis-based reimbursement. Reducing payment, a Clinton administration proposal, would recoup excess payments in the short run but not address the selection problem, which could ree\merge. Selection makes current payments vulnerable to upward spirals. We propose not using traditional Medicare to update reimbursement. Basing some payment on enrollees' actual use addresses selection and stinting. Rather than reinsurance, we propose blending traditional Medicare and risk-adjusted capitation. Ceding some cases to traditional Medicare in advance appears to be useful for terminally ill patients.
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