The Medicare Competitive Bidding ProgramOutcomes and Improvements

Shivaani Prakash11.17.10Market Design

Background•Center for Medicare and Medicaid Services

(CMS) administers Medicare program▫Health insurance coverage for individuals 65

and older▫Fee-for-service program with reimbursement

structure for health care services▫Growing body of literature providing

evidence of inefficient pricing structure within Medicare system for provider reimbursement, medical services, Advantage health plans etc.

Background• Newly instituted competitive bidding system to

supply Medicare beneficiaries with medical equipment▫Products: Prosthetics, orthotics, durable medical

equipment and medical supplies ▫Account for $220 Billion in Medicare expenditures

• Benefits to competitive bidding system▫Expect competitive bidding to result in lower

reimbursement prices due to increased competition▫Give CMS a role in determining firm eligibility to

ensure quality and prevent collusion

Background ctd.• Balanced Budget Act of 1997: Congress mandated

that Demonstration Projects be created to explore the use of auctions to set competitive prices for medical supplies▫ Based on GAO review that found very high Medicare

mark-ups compared to retail prices and payments made by other insurers

• Medicare pays suppliers of medical equipment based on indexed administrative prices from 25 years ago▫ Prices do not reflect today’s market (esp. decreases)▫ Divergence in prices distorts market for medical

supplies

Goal for CMS Bidding Process

•“The appropriate bidding mechanism would arise from a collaboration of government officials, industry representatives, and auction experts and it would emphasize transparency, good price and assignment discovery, and strategic simplicity. The result would be sustainable long-term competition among suppliers that reduces costs while maintaining high quality.”

Three-Stage Auction Process• Stage 1: A pre-screening stage determines each firm’s

ability to supply quality service to Medicare beneficiaries within different categories of goods (e.g., surgical supplies, oxygen equipment).

• Stage 2: eligible firms submit bids on each and every individual good within the categories on which they are bidding, and winners are determined

• Stage 3: ▫ Winner determined by taking a weighted average of their

bids on individual goods (composite bid), and those with lowest composite bid are official Medicare providers

▫ The price of an individual good is determined using the median of the winning bids on that good

Current Bidding Process Rules•Eligibility Requirements

•Nonbinding commitments for bids

•Winner pays un-weighted median bid value

•Composite bids for variety of products

•Rationale?

Eligibility Requirements

•CMS’s goal was to choose firms that would provide reliable, quality service to Medicare beneficiaries.

•Firms had to comply with all state and federal regulatory requirements, all Medicare and Medicaid statutes and regulations, all billing guidelines pertaining to Medicare, and all National Supplier Clearinghouse standards.

Nonbinding Commitments for Bids•Any auction winner can decline to sign a

supply contract following the auction

• Undermines the credibility of bids

•Encourages low-ball bids in which the supplier acquires at no cost the option to sign a supply contract

Paying Un-Weighted Median Bid Value

•The current system sets reimbursement prices using the median of the winning bids rather than using the clearing price

• Further encourages low-ball bids, since a low bid guarantees winning, does not affect the price and gives the supplier a free option to sign a supply contract.

Paying Un-Weighted Median Bid Value

•Even if suppliers bid their true costs, up to one-half of the winning suppliers would reject the supply contract and the government would be left with insufficient supply.

• Others may accept the contract and cross-subsidize public patients with the revenue from private patients, or just take a loss. ▫Does not develop a sustainable supplier pool or

competitive bidding process

Composite Bids•Takes an average of a bidder’s bids across many

products weighted by government estimated demand. ▫Provides strong incentives to distort bids away

from costs—known as bid skewing.

• Bidders bid low on products where the government overestimated demand and high on products where the government underestimated demand. As a result, prices for individual products are not closely related to costs

Composite Bids

• Divergence between costs and prices likely will result in selective fulfillment of customer orders.▫Orders for low-priced products are apt to

go unfilled.

Rationale• Unclear• “We suspect the problem is that CMS initially did not

realize that auction expertise was required, and once they spent millions of dollars developing the failed approach, they stuck with it rather than admit that mistakes were made. This bureaucratic inertia is seen not just in government but in all organizational decision making.”

• “Misconception that the properties of single-unit auctions translate to multi-unit auctions”▫Majority of multi-unit auctions are inefficient and do not

deliver expected outcomes

Competitive Bidding Model• Standard in multi-unit procurement auctions: bids are sorted

from lowest to highest, and winners are selected, lowest bid first, until the cumulative supply quantity equals the estimated demand.

• CMS model does not encourage truthful bidding of the lowest price at which a firm is willing to supply each good

• Main problem: the composite bid, not individual component bids, determines whether a firm becomes a designated Medicare supplier▫ Avails the firm of a number of ways of achieving target

composite bid regardless of cost of each individual good▫ Creates uncertainty about price of goods, allows for gaming

Competitive Bidding Model ctd.• The main prediction from the model is that while the CMS

format will achieve price reductions on some goods, this will most likely occur at the expense of increased prices on other goods.

• It is possible that equilibrium bids will result in low cost providers being shut out of the market and relatively inefficient firms becoming Medicare providers.

• The fact that when a firm bids high on one good it must correspondingly bid low on another good in order to reach its targeted composite bid introduces additional, less quantifiable ramifications as well.▫ Specifically, if the price of a good is bid too low, firms may tacitly

avoid supplying it, thereby increasing consumer search costs and decreasing quality of service

Competitive Bidding Model ctd.

•“This collection of problems suggests that the program over time may degenerate into a “race to the bottom” in which suppliers become increasingly unreliable, product and service quality deteriorates, and supply shortages become common. Contract enforcement would become increasingly difficult and fraud and abuse would grow.” ▫–Peter Crampton, Testimony to Health

Subcommittee, House Ways and Means

Supplier Strategy• If a firm believes that CMS has underestimated

relative demand for a good, it can increase its bid on that good while lowering its bid on a good for which it believes relative demand forecasts are too high, all while simultaneously maintaining its targeted composite bid.

• In doing so, it will be able to increase the price of the good that it believes will have relatively high demand by simply lowering its bid on the good for which it forecasts relatively low demand. This is clearly a profitable strategy that has adverse pricing repercussions.

Supplier Strategy ctd.• By lowering its bid on good 1, the firm can

increase its bid on good 2, all the while maintaining the optimal composite bid. While this means that it will be accepting a lower price for good 1, it expects that the reduction in profits will be more than offset by the increase in profits caused by the increase in the price of good 2.

• Depends on what the firm estimates demand for good 1 and good 2 to be relative to CMS’ demand estimate

Theoretical Outcomes from Bidding Process• Median pricing rule combined with

withdrawable bidding can result in:▫“Low-ball” bids▫Unsustainable supplier pool▫Skewed bids distorted away from true cost of

providing each good• Benefits/costs to:

▫Suppliers▫CMS▫Medicare beneficiaries▫Taxpayers

Other Problematic Outcomes

•Costs to Medicare due to distorted prices•Lack of transparency

▫Quantities are set in a non-transparent way in advance of the auction.

▫Bids from last auction were taken in Nov. 2009, winners are still unknown

•Effect on quality of products •Performance measurement

Demonstration Project Implementation• CMS conducted three auction tests in Polk County,

FL and San Antonio, TX▫Despite major flaws, few changes made to system▫Auction experts not engaged in design of system

• Round 1 of program: 2008▫9 Metropolitan areas▫Congress cancelled outcomes due to bidder

complaints about unsustainably low prices and unfair qualification procedures

▫Round 1 rebid in Nov. 2009, prices to be announced in 2011

▫Round 2 to being in 2011 (expand to 100 total MSAs)

Evidence• Preliminary evidence shows that prices of several goods

increased (50 out of 162), less than 7% showed a decrease

• Fifty-percent of the winning bidders are offered a contract price less than their bids for some goods▫ Some suppliers have refused to sign contracts because prices

were less than the production costs

• Increase in winners’ profits for some goods

• Gains in competitive bidding to CMS not as large as hoped

• As a result: possible reimbursement cuts and decreases in supply to Medicare beneficiaries, some consumers will face higher prices, ultimately pass on higher costs to taxpayers

Evidence ctd.•U.S. timber auctions and electricity auctions

use similar composite bidding systems▫Documented instances of gaming the system

•Problems with evidence:▫No way to retrieve the individual marginal

costs from individual bids.▫CMS has not made composite or individual

bid information available—cannot estimate underlying distribution of costs

Proposed Solutions to Bidding Process

•Suggested: descending variant of Ausubel, Cramton, and Milgrom’s (2006) clock-proxy auction▫A first stage of open bidding allows for simple

transparent price discovery, while a second round of proxy bidding ensures efficiency.

▫Eliminates the exposure problem, eliminates the incentives for demand reduction, and mitigates collusion, all without distorting bidder incentives, thus increasing the expectation of reduced Medicare prices.

Future Policy Directions?

•“A federal program that pays more than $220 billion a year to close to one million suppliers in every congressional district in the United States is going to end up with administered prices, whether that is a theoretically elegant phenomenon or not.”▫Cooper and Vladeck, Health Affairs, 2o00

Next Steps for Research Paper• Merits of other alternatives to the process and

expected outcomes from alternatives• Policy Implications

▫CMS testimony on bidding process now available▫Role of Healthcare Reform (section on DME suppliers)

PPACA identified durable medical equipment (DME) and home health services as items or services that pose a high risk of waste and abuse.

Mainly restrict who can order DME, but allows Secretary of HHS to set specific standards for quality

• Suppliers’ reactions to the bidding process and further proof of their strategies

• More evidence from timber and electricity markets

Sources• Ausubel, L., and Peter Cramton. 2002. Demand reduction and inefficiency in multi-unit

auctions. Working Paper, University of Maryland.• Cramton, P. Comments on Medicare Competitive Bidding Program. Submitted to Chairman

Stark, Health Subcommittee, Ways and Means, House of Representatives. September 23, 2010.

• Cramton, P. and Katzman, B. Reducing Healthcare Costs Requires Good Market Design. Issues Brief. September 20, 2010.

• Cooper and Vladeck (2000). Bringing Competitive Pricing to Medicare. Health Affairs 19:5, p. 49-54.

• Dor, Avi. 2004. Optimal price rules, administered prices and suboptimal prevention: Evidence from a Medicare program. Journal of Regulatory Economics 25:81–104.

• Doud, Column and Feldman (2000). A Tale of Four Cities: Medicare Reform and Competitive Pricing. Health Affairs 19:5, p. 9-29.

• Federal Register (2007) “Medicare Program; Competitive Acquisition for Certain Durable Medical Equipment, Prosthetics, Orthotics, and Supplies (DMEPOS) and Other Issues; Final Rule,” 72:68.

• House Committee on Energy and Commerce, Subcommittee of Health (2010) Hearing on “Medicare’s Competitive Bidding Program for Durable Medical Equipment: Implications for Quality, Cost and Access,” 15 September 2010.

• Katzman, Brett and Kerry Anne McGeary (2008) “Will Competitive Bidding Decrease Medicare Prices?” Southern Economic Journal, 74:3, 839–856.

• Milgrom, Paul (2004) Putting Auction Theory to Work, Cambridge, England: Cambridge University Press.

• Center for Medicare and Medicaid Services. Durable Medical Equipment, Prosthetics, Orthotics, and Supplies Quality Standards. October 2008.