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Medicare Advantage – the commercial alternative to traditional Medicare – is drawing down federal health care funds, costing taxpayers an to the tune of .

Medicare Advantage, also known as Part C, was . The competition among private insurance companies, and with traditional Medicare, to manage patient care was meant to give insurance companies an incentive to find efficiencies. Instead, the program’s payment rules overpay insurance companies on the taxpayer’s dime.

We are who study Medicare, including how the structure of the Medicare payment system is, in the case of Medicare Advantage, working against taxpayers.

Medicare beneficiaries when they turn 65. Younger people can also become eligible for Medicare due to chronic conditions or disabilities. Beneficiaries have , including the traditional Medicare program administered by the U.S. government, Medigap supplements to that program administered by private companies, and all-in-one Medicare Advantage plans administered by private companies.

Commercial Medicare Advantage plans are increasingly popular – over in them, and this share continues to grow. People are attracted to these plans for their extra benefits and out-of-pocket spending limits. But due to a loophole in most states, enrolling in or switching to Medicare Advantage is . The Senate Finance Committee has also found that some plans have used deceptive, aggressive and potentially harmful sales and marketing tactics to .

Baked into the plan

Researchers have found that the overpayment to Medicare Advantage companies, which has grown over time, was, intentionally or not, baked into the Medicare Advantage payment system. Medicare Advantage plans are , because these people typically use more care and so would be more expensive to cover in traditional Medicare.

However, differences in by Medicare Advantage plans causes enrollees to seem sicker and costlier on paper than they are in real life. This issue, , leads to overpayment with taxpayer dollars to insurance companies.

Some of this extra money lower cost sharing, lower prescription drug premiums and increase supplemental benefits like vision and dental care. Though Medicare Advantage enrollees may like these benefits, funding them this way is expensive. For every extra dollar that taxpayers pay to Medicare Advantage companies, only roughly to goes to beneficiaries in the form of .

As Medicare Advantage becomes increasingly expensive, the Medicare program continues to face .

In our view, in order for Medicare to , Medicare Advantage . The way the government pays the private insurers who administer Medicare Advantage plans, which may seem like a black box, is key to why the government overpays Medicare Advantage plans relative to traditional Medicare.

Paying Medicare Advantage

Private plans have been a and have been paid through . They garnered only a very small share of enrollment until 2006.

The current Medicare Advantage payment system, and heavily reformed by the Affordable Care Act in 2010, had two policy goals. It was designed to encourage private plans to offer the same or better coverage than traditional Medicare at equal or lesser cost. And, to make sure beneficiaries would have multiple Medicare Advantage plans to choose from, the system was also designed to be profitable enough for insurers to entice them to offer multiple plans throughout the country.

To accomplish this, for each county. This benchmark calculation begins with an estimate of what the government-administered traditional Medicare plan would spend on the average county resident. This value is , including enrollee location and plan quality ratings, to give each plan its own benchmark.

Medicare Advantage plans then submit bids, or estimates, of what they expect their plans to spend on the average county enrollee. If a plan’s spending estimate is above the benchmark, enrollees pay the difference as a .

benchmark, however, meaning they project that the plans will provide coverage that is equivalent to traditional Medicare at a lower cost than the benchmark. These plans don’t charge patients a Part C premium. Instead, they receive a portion of the difference between their spending estimate and the benchmark as a rebate that they are supposed to pass on to their enrollees , like reductions in cost-sharing, lower prescription drug premiums and supplemental benefits.

Finally, in a process known as , Medicare payments to Medicare Advantage health plans are adjusted based on the health of their enrollees. The plans are .

Theory versus reality

In theory, this payment system should save the Medicare system money because the risk-adjusted benchmark that Medicare estimates for each plan should run, on average, equal to what Medicare would actually spend on a plan’s enrollees if they had enrolled in traditional Medicare instead.

In reality, the risk-adjusted benchmark estimates are . This causes Medicare – really, taxpayers – to spend more for each person who is enrolled in Medicare Advantage than if that person had enrolled in traditional Medicare.

Why are payment estimates so high? There are two main culprits: benchmark modifications designed to encourage Medicare Advantage plan availability, and risk adjustments that overestimate how sick Medicare Advantage enrollees are.

Benchmark modifications

Since the current Medicare Advantage , policymaker modifications have made Medicare’s benchmark estimates on each enrollee.

In 2012, as part of the Affordable Care Act, Medicare Advantage benchmark estimates received another layer: ” .” These made the benchmark estimates, and therefore payments to Medicare Advantage companies, higher in areas with low traditional Medicare spending and lower in areas with high traditional Medicare spending. This benchmark adjustment was meant to encourage to Medicare Advantage options.

In that same year, Medicare Advantage plans started receiving ” ” with plans that have higher “star ratings” based on quality factors such as enrollee health outcomes and care for chronic conditions receiving higher bonuses.

However, research shows that ratings and may .

Even before fully taking into account risk adjustment, recent estimates peg the benchmarks, on average, as . This means that a Medicare Advantage plan’s spending estimate could be below the benchmark and the plan would still get paid more for its enrollees than it would have cost the government to cover those same enrollees in traditional Medicare.

Overestimating enrollee sickness

The second major source of overpayment is health risk adjustment, which tends to overestimate how sick Medicare Advantage enrollees are.

Each year, Medicare studies traditional Medicare diagnoses, such as diabetes, depression and arthritis, to understand which have higher treatment costs. Medicare uses this information to adjust its payments for Medicare Advantage plans. Payments are lowered for plans with lower predicted costs based on diagnoses and raised for plans with higher predicted costs. This process is known as

But there is a critical bias baked into risk adjustment. Medicare Advantage companies know that they’re paid more if their enrollees seem more sick, so they diligently make sure each enrollee has .

This can include legal activities like to ensure that diagnoses are recorded accurately. It can also occasionally , where charts are “upcoded” to include diagnoses that patients don’t actually have.

In traditional Medicare, most providers – the exception being – are not paid more for recording diagnoses. This difference means that the same beneficiary is likely to have if they are enrolled in traditional Medicare rather than a private insurer’s Medicare Advantage plan. Policy experts refer to this phenomenon as a difference in ” ” between Medicare Advantage and traditional Medicare.

In addition, Medicare Advantage plans than their diagnoses would predict, such as someone with a very mild form of arthritis. This is known as “favorable selection.”

The differences in coding and favorable selection make beneficiaries look sicker when they enroll in Medicare Advantage instead of traditional Medicare. This makes cost estimates . Research shows that this mismatch – and resulting overpayment – is likely as Medicare Advantage grows.

Where the money goes

Some of the to Medicare Advantage are returned to enrollees through . Extra benefits include cost-sharing reductions for medical care and prescription drugs, lower Part B and D premiums, and extra “supplemental benefits” like and .

Medicare Advantage enrollees may enjoy these benefits, which could be considered a reward for enrolling in Medicare Advantage, which, unlike traditional Medicare, has .

However, according to some policy experts, the is .

It also makes it difficult for traditional Medicare to compete with Medicare Advantage.

Traditional Medicare, which tends to cost the Medicare program less per enrollee, is the standard Medicare benefits package. If its enrollees want dental coverage or hearing aids, they have to purchase these separately, alongside a and a Medigap plan to lower their deductibles and co-payments.

The system sets up Medicare Advantage plans to not only be overpaid but also be increasingly popular, all on the taxpayers’ dime. to prospective enrollees who, once enrolled in Medicare Advantage, will likely , even if they decide the extra benefits are not worth the prior authorization hassles and the limited provider networks. In contrast, traditional Medicare typically does not engage in as much direct advertising. The federal government only accounts for .

At the same time, some people who need more health care and are through their Medicare Advantage plan – to traditional Medicare – are doing so, . This leaves taxpayers to pick up care for these patients just as their needs rise.

Where do we go from here?

Many researchers have proposed ways to reduce excess government spending on Medicare Advantage, including expanding , or using Others have proposed even more fundamental reforms to the Medicare Advantage payment system, including so that Medicare Advantage plans will compete more with each other.

Reducing payments to plans may have to be traded off with reductions in plan benefits, though .

There is a long-running debate over what type of coverage should be required under both traditional Medicare and Medicare Advantage. Recently, policy experts have advocated for introducing an to traditional Medicare. There have also been multiple to make part of the standard Medicare benefits package.

Although all older people require regular dental care and many of them require hearing aids, providing these benefits to everyone enrolled in traditional Medicare would not be cheap. One approach to providing these important benefits without significantly raising costs is to make these benefits . This would allow people with lower incomes to purchase them at a lower price than higher-income people. However, .

There is also debate over how much Medicare Advantage plans should be allowed to vary. The average Medicare beneficiary has to choose from, . For instance, right now, the average person eligible for Medicare would have to sift through the fine print of dozens of different plans to compare important factors, such as out-of-pocket maximums for medical care, coverage for dental cleanings, cost-sharing for inpatient stays, and provider networks.

Although millions of people are in suboptimal plans , , let alone switch plans, during the annual enrollment period at the end of the year, likely because the process of comparing plans and switching is difficult, especially for older Americans.

MedPAC, a congressional advising committee, suggests that , like out-of-pocket maximums and dental, vision and hearing benefits, could help the plan selection process work better, while still allowing for flexibility in other benefits. The challenge is without unduly reducing consumers’ options.

The Medicare Advantage program . However, the $83-billion-per-year overpayment of plans, which amounts to more than 8% of , . We believe the Medicare Advantage payment system needs a broad reform that aligns insurers’ incentives with the needs of Medicare beneficiaries and American taxpayers.

This article is part of an occasional series examining the U.S. Medicare system.

Past articles in the series: