Competitive Bidding in Medicare: Who Benefits From Competition?

Published Online: September 20, 2012
Zirui Song, PhD; Mary Beth Landrum, PhD; and Michael E. Chernew, PhD
Objectives: To conduct the first empirical study of competitive bidding in Medicare.

Study Design and Methods: We analyzed 2006-2010 Medicare Advantage data from the Centers for Medicare & Medicaid Services using longitudinal models adjusted for market and plan characteristics.

Results: A $1 increase in Medicare’s payment to health maintenance organization (HMO) plans led to a $0.49 (P <.001) increase in plan bids, with $0.34 (P <.001) going to beneficiaries in the form of extra benefits or lower cost sharing. With preferred provider organization and private fee-for-service plans included, higher Medicare
payments increased bids less ($0.33 per dollar), suggesting more competition among these latter plans.

Conclusions: As a market-based alternative to cost control through administrative pricing, competitive bidding relies on private insurance plans proposing prices they are willing to accept for insuring a beneficiary. However, competition is imperfect in the Medicare bidding market. As much as half of every dollar in increased plan payment went to higher bids rather than to beneficiaries. While having more insurers in a market lowered bids, the design of any bidding system for Medicare should recognize this shortcoming of competition.

(Am J Manag Care. 2012;18(9):546-552)
As a market-based alternative to administrative price setting, competitive bidding relies on private insurance plans proposing prices they are willing to accept. In a perfectly competitive market, plans should bid only as high as their cost of insuring beneficiaries.

  • Although higher Medicare payments to plans should translate into additional benefits to beneficiaries, this assertion has never been tested.

  • When we conducted the first empirical study of bidding in Medicare, we found that competition is imperfect in the Medicare Advantage market.

  • About half of every dollar in additional plan payments went to higher bids rather than to beneficiaries.
Medicare spending is the dominant driver of our nation’s projected long-term deficit.1 Increasingly, proposals to control Medicare spending center on competitive bidding as opposed to administratively imposed payment reductions, which some consider unlikely to be politically sustainable.2,3 In a bidding system, private health plans compete for beneficiaries who shop among plans varying in generosity, similar to today’s Medicare Advantage system. In fact, a crucial policy question surrounding cost containment in coming years is whether Medicare should use administratively set prices or market forces—including bidding—to pay health plans and perhaps even provider organizations such as accountable care organizations.

Bidding is the foundation of the Ryan-Wyden plan by Senator Ron Wyden (D-OR) and Representative Paul Ryan (R-WI),4 as well as the Domenici-Rivlin proposal.5 These proposals seek to end traditional Medicare and replace it with a bidding system based on the Medicare Advantage model. Proponents estimate that reforming Medicare into a bidding system would save $339 billion, or 9.5% of Medicare spending, through 2020—5.6 percentage points more than projected savings under the Patient Protection and Affordable Care Act (PPACA).6 Yet despite increasing attention and optimistic projections, bidding remains unstudied.

In the current Medicare Advantage program, plans submit a price (bid) that they are willing to accept for insuring a beneficiary. Plans must, at minimum, cover Medicare Part A (hospital) and Part B (physician) services, but they can also offer coverage for other services such as prescription drugs or reductions in cost sharing. The amount of additional benefit plans may offer depends on how their bid compares with a benchmark payment rate set by the Centers for Medicare & Medicaid Services (CMS). The lower the bid, the more plans are allowed to “rebate” back to beneficiaries through additional benefits, which can be used to attract potential enrollees (Figure 1). When markets are competitive, plans should bid only as high as the cost of insuring beneficiaries.7 In other words, when Medicare raises payments to plans in a competitive market, bids (adjusting for costs) should not change, and the increased Medicare payment should largely translate into extra benefits to enrollees.

To date, there is no evidence on how plans bid, as bidding data were not previously available. We used newly released Medicare Advantage data from CMS to conduct the first empirical study of the bidding system. Specifically, we investigated how bids respond to changes in CMS benchmark payments and whether higher benchmarks result in additional benefits to beneficiaries. Understanding how plans respond to benchmark changes is crucial for assessing how competitive markets may work in Medicare. We hypothesize that the market may not be sufficiently competitive, consequently diverting CMS payments into plan or provider profits and away from Medicare beneficiaries.



Medicare Advantage (formerly Medicare Part C and Medicare+Choice) has grown from 2.3 million beneficiaries in 1994 to 11.7 million (1 in 4 beneficiaries) in 2011.8 Over these years, the predominant plan type was health maintenance organization (HMO) plans, while preferred provider organization (PPO) and private fee-for-service (PFFS) plans have grown in the last decade.9 Each year, CMS publishes a benchmark payment rate for every county based on its history of traditional fee-for-service Medicare spending in that county. A plan may serve (compete in) multiple counties, but may submit only 1 bid.

If the bid exceeds the average benchmark faced by the plan (calculated using its projected enrollment across counties), the plan receives only the benchmark amount and must collect the difference by charging beneficiaries a premium. If, however, the bid is below the benchmark—almost always the case—CMS pays the plan its bid plus 75% of the difference between the bid and benchmark, which the plan must give back to beneficiaries as a rebate.10 Rebates may include additional benefits or lower Medicare Part B (or Part D) premiums. The other 25% of the difference is returned to the Medicare program (Figure 1).

While the county benchmark aims to reflect Medicare Advantage plan costs, there are several reasons why the benchmark may not accurately capture true plan costs (in which case plans may bid differently from the benchmark). First, the benchmark for paying Medicare Advantage plans is calculated from fee-for-service Medicare costs rather than Medicare Advantage costs. The fee-for-service program is different from managed care plans in many ways that affect spending. Additionally, the beneficiary populations may be different. Second, the benchmark for any year (t) is estimated using fee-for-service Medicare costs from a 5-year period spanning t-8 to t-3 prior to the benchmark year. Thus, spending in the 2 years prior to any benchmark year is not included in the estimate. Moreover, various nuances of the formula for calculating benchmarks may produce differences from actual plan costs.

Data and Variables

We analyzed county-level and plan-level Medicare Advantage payment data from CMS for 2006 through 2010. We also used county-level published benchmark rates and actual county-level fee-for-service costs. Since actual fee-for-service costs are only available through 2009, our baseline analysis uses 2006-2009 data. CMS calculates county benchmarks by using the fee-for-service Medicare spending in a county from a 5-year period (8 years ago to 3 years ago) and trending that amount forward using the growth rate in that 5-year period. This lag, as well as various special provisions of the rules determining benchmark rates,8,10 results in benchmark updates that are not highly correlated with actual changes in costs at the county level. In addition, we used public CMS data on plan location and enrollment by county in each year. We merged these public data sets to create a unique Medicare Advantage market centered on each county.

The county-level data contain average plan bids and rebates weighted by plan enrollment, as well as the averagecounty CMS Hierarchical Condition Categories (CMSHCC) risk scores of beneficiaries. CMS-HCC risk scores are calculated using beneficiary age, sex, and clinical diagnoses.11 The plan bid is standardized to a beneficiary of 1.0 risk, making all bids comparable. The plan-level data contain planspecific bids, rebates, and average CMS-HCC risk score of plan enrollees. County benchmark rates and actual fee-forservice costs are also standardized to a beneficiary of 1.0 risk. We restricted analysis to local plans, which bid against the same benchmark. We excluded regional plans, which use different benchmarks. We also excluded employer plans and special needs plans. Our baseline analysis included only HMO plans, the plan type with the longest history. In sensitivity analyses, we included local PPO and then PFFS plans, both  of which are less managed. PFFS plans most closely resemble traditional fee-for-service Medicare.

Study Design

Both county-level and plan-level analyses of the relationship between benchmark rates and bids are inherently limited. Because plans are required to submit a single bid covering all counties they serve, relating the county benchmark to the average bid in any given county ignores the effect of benchmarks in other (often adjacent) counties that may affect the plan’s bid. Alternatively, plan-level longitudinal models require plans to be stable over time. Yet insurers frequently consolidate or split their plans from one year to the next. For example, a “silver” plan’s enrollees in one year may be subsumed under a “gold” plan in the next year, retaining the gold plan’s identification number. Alternatively, the 2 plans may merge and assume a new identification number altogether. Subsequently, this consolidated plan may split again. Such plan dynamics complicate longitudinal models with plans as the unit of the observation.

To combat these limitations, we constructed, for each county, an effective “market” that takes into account the benchmarks in other counties that plans observe when making their bids. First, for each county, we identified all other counties served by plans in the target county. Next, we assigned the benchmarks in these other counties to the target county, weighted by the share of each target county plan’s enrollment in these other counties. We used the plan’s average share across the study period so that the weights were stable. This procedure was repeated for other variables. The resulting markets are a stable unit of analysis over time, allowing for longitudinal models.

Statistical Analysis

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