Nothing for something? Estimating cost and value for beneficiaries from recent medicare spending increases on HMO payments and drug benefits

  • Steven D. PizerEmail author
  • Austin B. Frakt
  • Roger Feldman


The Medicare Modernization Act of 2003 added a new outpatient prescription drug benefit to Medicare and increased payments to HMOs. We estimate a nested logit model of plan choice to quantify the welfare benefits from these two expansion paths. We find that the addition of stand-alone prescription drug plans was welfare improving and produced nine times as much value per government dollar as the increase in payments to HMOs. In light of these results, we suggest that HMO bidding procedures should be modified to reduce payments to HMOs by about $67 billion over the next 10 years.


Medicare HMO payment Choice models Welfare 

JEL Classifications

I 11 I 18 


  1. Atherly A. (2002) The effect of Medicare supplemental insurance on Medicare expenditures. International Journal of Health Care Finance and Economics 2: 137–162 doi: 10.1023/A:1019978531869 CrossRefGoogle Scholar
  2. Atherly A., Dowd B.E., Feldman R. (2004) The effect of benefits, premiums, and health risk on health plan choice in the Medicare program. Health Services Research 39(4, Part I): 847–864CrossRefGoogle Scholar
  3. Berenson R. (2004) Medicare disadvantaged and the search for the elusive ‘level playing field’ Health Affairs Web Exclusive 15: W4-572–585Google Scholar
  4. Berry S., Levinsohn J., Pakes A. (1995) Automobile Prices in Market Equilibrium. Econometrica 63(4): 841–890 doi: 10.2307/2171802 CrossRefGoogle Scholar
  5. Cawley J., Chernew M., McLaughlin C. (2005) HMO participation in Medicare managed care. Journal of Economics & Management Strategy 14(3): 543–574 doi: 10.1111/j.1530-9134.2005.00073.x CrossRefGoogle Scholar
  6. Cutler D., Sheiner L. (2000) Generational aspects of Medicare. The American Economic Review 90(2): 303–307Google Scholar
  7. Feldman R. (1994) The welfare economics of a health plan merger. Journal of Regulatory Economics 6(1): 67–86 doi: 10.1007/BF01065391 CrossRefGoogle Scholar
  8. Frakt A.B., Pizer S.D. (2006) A first look at the new Medicare prescription drug plans. Health Affairs Web Exclusive 25: w252–w261CrossRefGoogle Scholar
  9. Greene W.H. (2003) Econometric analysis. Prentice Hall, Upper Saddle River New JerseyGoogle Scholar
  10. H. J. Kaiser Family Foundation. (2004). Prescription drug coverage for Medicare beneficiaries: an overview of the Medicare prescription drug, improvement, and modernization act of 2003 (Public Law 108–173), 14 January 2004, (8 August 2005).
  11. H. J. Kaiser Family Foundation. (2005). Prospects for retiree health benefits as Medicare prescription drug coverage begins: Findings from the Kaiser/Hewitt 2005 survey on retiree health benefits, December 2005,
  12. Jack W., Sheiner L. (1997) Welfare-improving health expenditure subsidies. The American Economic Review 87(1): 206–221Google Scholar
  13. Jindal, B. P. (2002). Assistant Secretary for Planning and Evaluation, Department of Health and Human Services, Testimony before the Subcommittee on Health of the House Committee on Energy and Commerce, Hearing on Medicare Modernization: Examining the Federal Employees Health Benefit Program as a Model for Seniors, March 20, 2002.Google Scholar
  14. Maddala G.S. (1983) Limited dependent and qualitative variables in econometrics. Cambridge University Press, CambridgeGoogle Scholar
  15. McFadden, D. (1974). Conditional logit analysis of qualitative choice behavior. In P. Zarembka (Ed.), Frontiers in econometrics. New York: Academic Press (pp. 105–142).Google Scholar
  16. Medicare Payment Advisory Commission (MedPAC). (2007). Report to the Congress: Medicare Payment Policy, March 2007.Google Scholar
  17. Mello M.M. et al (2003) Understanding biased selection in Medicare HMOs. Health Services Research 38(3): 961–992CrossRefGoogle Scholar
  18. Nevo A. (2001) Measuring market power in the ready-to-eat cereal industry. Econometrica 69(2): 307–342CrossRefGoogle Scholar
  19. Pauly, M. V., & Zeng, Y. (2003). Adverse selection and the challenges to stand-alone prescription drug insurance, NBER Working Paper No. W9919.Google Scholar
  20. Pizer, S. D., Feldman, R., & Frakt, A. B. (2005). Defective design: Regional competition in Medicare. Health Affairs Web Exclusive, 24, W5-399-411.Google Scholar
  21. Pizer S.D., Frakt A.B. (2002) Payment policy and competition in the Medicare + Choice program. Health Care Financing Review 24(1): 83–94Google Scholar
  22. Pizer S.D., Frakt A.B., Feldman R. (2003) Payment policy and inefficient benefits in the Medicare + Choice program. International Journal of Healthcare Finance and Economics 3(2): 79–93CrossRefGoogle Scholar
  23. Pizer S.D., Frakt A. B., Feldman R. (2008) Predicting risk selection following major changes in Medicare. Health Economics 17(4): 453–468CrossRefGoogle Scholar
  24. Small K.A., Rosen H.S. (1981) Applied welfare economics with discrete choice models. Econometrica 49(1): 105–130CrossRefGoogle Scholar
  25. Town R., Liu S. (2003) The welfare impact of Medicare HMOs. Rand Journal of Economics 34(4): 719–736CrossRefGoogle Scholar
  26. Trajtenberg M. (1989) The welfare analysis of product innovations, with an application to computed tomography scanners. Journal of Political Economy 97(2): 444–479CrossRefGoogle Scholar

Copyright information

© Springer Science+Business Media, LLC 2008

Authors and Affiliations

  • Steven D. Pizer
    • 1
    • 2
    Email author
  • Austin B. Frakt
    • 1
  • Roger Feldman
    • 3
  1. 1.Department of Veterans’ AffairsHealth Care Financing & Economics, VA Boston Health Care SystemBostonUSA
  2. 2.Boston UniversityBostonUSA
  3. 3.University of MinnesotaMinneapolisUSA

Personalised recommendations