A Note on the Federal Employee Health Benefits Program – A Model for Medicare?

Often the Federal Employee Health Benefits Program ("FEHBP") is pointed to as a model for how health care insurance should be provided to everyone. In fact, Paul Ryan's plan claims to be modeled on the FEHBP, though as many commenters have noted, the federal government's portion of the payment would be less generous over time than that provided by the FEHBP. The FEHBP, it should be noted, is not only provided to members of Congress, but to all federal employees and to federal retirees who opted to be covered by FEHBP when they were working for the federal government.

I am not going to dissect the Ryan proposal here, and I am not a health care expert. I will, though, make some comments about the FEHBP as someone who has participated in it for many years. While I am happy to be covered by it, the plan has had some problems, which I believe are instructive as consideration is given to modification of Medicare and the U.S. health care system generally.

FEHBP has an open season once a year when all who are covered or are eligible to be covered can choose the particular insurance company plan they want for the coming year. Free market proponents like this feature, since it makes for competition among plans. However, it also can serve to divide the large population covered by the FEHBP into separate risk pools, with different characteristics.

Open season causes the problem of adverse selection. For example, those who are older or tend to have higher medical expenses because of existing conditions will opt for more expensive plans that provide better benefits. Also, people who know that they will have a particular medical procedure in the coming year will gravitate to the plan that covers that procedure the best.

In the 1980s, Blue Cross offered a high and low option plan under the FEHBP. Over time, the risk profile of the group covered by the high option plan became much worse than those in the low option plan. Blue Cross had to increase the premiums for the high option plan rather dramatically at times because of this. The increase in premiums caused a further migration from the high to the low option plan, thus exacerbating the difference in the risk characteristics of the two populations. Eventually, the risk profile of the high option plan became so bad and costs escalated so much that Blue Cross dropped it and renamed the low option plan its standard option.

Also, there have been instances were a significant number of employees with a particular medical need all went to a particular plan that provided the best coverage. This often resulted in the sponsor of the plan to modify its coverage the following year in order to fend off the adverse selection problem

In addition, the particular market structure created by the FEHBP provides an incentive to the companies to be somehow as attractive as possible to relatively health government workers so that they have to pay less in benefits. They do this by providing add-on features to their plans that are not mandated by the Office of Personnel Management.

My impression is that these problems are not currently as bad as they have been in the past, but that is only an impression. The main competition currently appears to be between HMOs and more traditional plans. The majority of people who are covered by traditional plans are covered by Blue Cross, though there are some other significant players such as GEHA, and Cigna offers a plan sponsored by a federal union that is open to all.

The main problem currently with the FEHBP and, I believe, health insurance plans provided to private employees, is that many primary care doctors are dropping out of the insurance networks, thus increasing health costs to the patients who opt to stay with them nevertheless. In Washington, DC, this problem appears particularly acute. It is difficult to find a primary care physician with a downtown office who is willing to accept new patients covered by Blue Cross. Primary care physicians do not believe they are adequately compensated by Blue Cross, and, in general, they hate the associated paperwork.

Another issue is that costs have escalated. When I first began working for the federal government, the premiums were quite modest, even to someone at the bottom of the professional ranks. The premiums are no longer negligible to any but independently wealthy government employees, though still a very good deal given the alternatives. Escalating costs going forward, though, will probably be a problem.

FEHBP does provide good coverage, and OPM's oversight and regulations has generally been effective. But the FEHBP experience shows there are limits to "the magic of the marketplace" when it comes to providing health insurance. The point of insurance is to pool the risks. Creating dramatically different risk pools goes counter to this, as Blue Cross learned. The adverse selection problem also means that over time different plans will provide similar, though not necessarily identical, benefits. Having different plans with somewhat different benefit structures though adds to administrative costs as it makes billing and claim review complex.

These points should be kept in mind as we further restructure our health care system and perhaps make changes to Medicare, which covers a group more likely to have expensive health care needs. As has often been pointed out, the U.S. devotes more of its GDP to health care than other industrial countries, while not, at least not yet, providing universal coverage nor achieving better health care results.

(For those interested in a comparative study of health care systems, I recommend T.R. Reid's book, The Healing of America: A Global Quest for Better, Cheaper, and Fairer Health Care.)

Rating Agencies and Treasury Debt

Today, there was a bit of silliness concerning the rating of U.S. government debt. S&P said it affirmed the AAA rating of U.S. government debt, but also said that there was a one in three chance that it would lower that rating on U.S. long-term debt within two years. The Treasury countered with a press release put out under the name of Assistant Secretary for Financial Markets Mary Miller with the caption: "Treasury Welcomes S&P Affirmation of AAA Rating, Moody's View of Recent Fiscal Announcements by Both Parties as a Positive 'Turning Point' for US; Stresses Need for Action on Debt and Deficits."

In the first place, the debt of a sovereign issuer in its own currency cannot be evaluated in the same manner as corporate debt or the debt of a country borrowing in a foreign currency. Secondly, the Treasury press release is inconsequential spin. As I mentioned in a recent post, it is hard to see how there will be long-term fiscal reform in the near term, though Treasury says it is optimistic about it.

One wonders why the rating agencies waste their time trying to rate U.S. Treasury debt. They should put their effort into restoring their credibility from the disaster of their profit-motivated AAA ratings of CDOs. While S&P is right to be skeptical of the ability of the Congress and the Administration to agree on long-term fiscal changes, I do not think S&P has any particular expertise that would justify its implying that they may arrive at a rating downgrade for the U.S. government that could be read as suggesting that the Treasury is more likely to default than some AAA corporate issuers.

The stock market apparently fell in reaction to the S&P announcement, but I don't think this one-day move means much.

Joe Nocera Disappoints

As readers of this blog know, I reviewed very favorably All the Devils Are Here: The Hidden History of the Financial Crisis, which Joe Nocera coauthored with Bethany McLean. Consequently, I was disappointed to read two columns Mr. Nocera has written recently in his new position as an op-ed columnist for The New York Times with which I disagreed. They concern natural gas.

Mr. Nocera, who discloses he is a friend of T. Boone Pickens, argued in his first column on this subject, "Pass the Boone Pickens Bill," that tax incentives should be passed to the tune of a billion dollars a year for five years to encourage the use of natural gas. He writes: "Natural gas is cheaper than oil. It's cleaner. And it's ours. If Congress can't pass this thing, there's really no hope." This column generated a torrent of comments concerning the environmental problems associated with natural gas, especially the extraction method known as "fracking" which has resulted in polluted and sometimes flammable tap water. One commenter wrote: "We can survive without natural gas but we won't survive without clean water. Here in PA we've learned the hard way that current technologies for mining natural gas are a huge risk to our water tables."

In reaction to the criticism, Mr. Nocera penned a second column on this subject a few days later, "About My Support for Natural Gas." The article begins, "Oh, puh-leeze!" It then proceeds by making an unconvincing case that the environmental issues associated with natural gas are vastly exaggerated and that "every problem associated with drilling for natural gas is solvable," though it does not say at what price. This column too has received a torrent of mostly negative comments.

Many of the comments are well written and well argued, unlike those one sees at many other sites, both conservative and liberal. Mr. Nocera should have admitted that there were environmental concerns in his first column. Inexplicably, he has yet to mention the 2010 Oscar nominated film for best documentary – Gasland – on this subject. (Incidentally, Inside Job won, a documentary certainly more to Mr. Nocera's liking.)

For those interested, Gasland makes a powerful case against fracking. It is readily available for sale or rent on DVD.

More on “the Wall” Between Social Security and the General Fund

In a recent post, I expressed some skepticism concerning Charles Blahous' argument that breaching the wall between the Social Security trust funds and the General fund would mean "the end of Social Security as we know it." Since I wrote that post, it occurred to me that the wall is currently being breached.

For 2011, the Social Security tax on employees has been reduced from 6.2% to 4.2%. (Self-employed individuals also benefit from this reduction.) The General Fund is making the Social Security Trust funds whole. While this last fact has been kept relatively quiet, it is interesting that there has been no hue and cry that this is the end of Social Security as we know it.

To be fair though, Charles Blahous has been consistent on this issue. He points me to an article he wrote last December criticizing this fund transfer. In that piece, he concludes: "These gimmicks embody a huge gamble with the future of Social Security. Millions of baby boomers will eventually be expecting benefits that they will believe they paid for via their payroll tax contributions. Increasingly, we are laying a foundation for future taxpayers to say – and rightly – "No, you didn't." He is right that this argument will be made by those who want to cut Social Security benefits if there are continued accounting gimmicks. On this issue, though, I just see the politics as playing out differently, especially since baby boomers vote and older voters have higher participation rates.

What the temporary reduction in the FICA tax does show is that legislators know that it is a bad tax. It is a direct tax on employment, and, as many like to say, if you tax something you will get less of it. It is also a regressive tax. I do, though, have some doubt that a temporary reduction in the FICA tax will have much effect.

Starving the Beast

The strategy of cutting taxes in order to force spending reductions has been called "starving the beast." It did not really work in the Reagan Administration, as the budget deficit went up from about $50 billion at the end of the Carter Administration to the $200 billion range. Domestic programs were, in general, not cut, but defense spending was increased. Those who believe the government should be smaller can at least argue that, during the Reagan Administration, no major new domestic spending programs were initiated. During the George W. Bush Administration, starving the beast by tax cuts also did not result in lower government spending. Indeed, spending went up as military action was initiated and a prescription drug benefit was added to Medicare, among other factors.

Currently, in face of the large short-term and projected long-term budget deficits, the starving the beast strategy appears to be bearing fruit. While the actual expenditure cuts for the current fiscal year seem to be much smaller than initially advertised when the deal averting a government shutdown was announced, the House Republicans will keep pushing and the Obama Administration now takes the position that government spending should be cut, along with some tax increases that most Republicans oppose, in order to reduce the deficit.

Of course, the current budget deficit over which there is much hand wringing is not only the result of the Bush tax cuts, but also the recession and subsequent sluggish economy and the waging of two, perhaps now three, wars. There is also a long-term budget deficit outlook which is in large measure the result of an aging population and escalating medical costs.

Initially the tax cuts were argued to be well-timed, because they countered a recession that was developing when Bush took office. But once taxes are cut, it seems there is never a good time to raise them, even if the economy recovers. At least one former Bush official indicated pleasure publicly that the Obama Administration had to forego letting the tax cuts expire for even on the wealthiest in the compromise last year. (The estate tax was reinstated for amounts over $5 million for 2011 and 2012, but the effect of this differs among large estates, since in 2010, when there was no estate tax, some heirs are subject to capital gains taxes.)

I suspect that the Republicans are in danger of overplaying their hand. They claim that the voters gave them a clear mandate to reduce spending in the 2010 election. I am not so sure. I am reminded in this connection of the "townhall" style debate between Bill Clinton and George H.W. Bush. A member of the audience asked a question related to the deficit. I don't remember exactly what it was, but literally taken, it did not make much sense. President Bush appeared flummoxed about how to answer it, because he took the question literally. Clinton decided that the question was really about the recession and made it clear he was concerned about that. His answer appeared to satisfy the questioner. Most observers believe that Clinton won that debate.

In other words, during periods of economic distress, the budget deficit can serve as a stand-in for what ails us. That does not really mean that voters want spending cut, because many of those spending programs have constituencies that benefit from them. They also don't want taxes raised, unless it is on the "man behind the tree," as the saying goes. What voters really want is for economic prosperity to return.

The Republicans argue that the "road to prosperity" runs through keeping taxes low and reducing government spending. They argue that the stimulus program failed. What they seem to be saying is that government spending can never jumpstart the economy, only tax cuts can do that. Many economists, though, would disagree with the relative efficacy of spending increases and tax cuts during a recession.

The argument that the stimulus failed is similar to the argument I have heard repeated many times that the New Deal did not get us out of the Depression; it was World War II that did that. Old-fashioned liberals counter, though, that the Roosevelt Administration was not aggressive enough in its spending programs and that World War II, though entered into for other reasons, economically served as an enormous stimulus program financed by the issuance of government securities. Currently, Paul Krugman and others argue that the reason the results from the stimulus program were not more dramatic is that it was not big enough, not that it was undertaken, as some would argue.

The Administration, which seems resigned to accepting budget cuts, is betting that the current recovery proves to have traction, and that the economy improves over the next two years even as the government contracts somewhat. They cannot be confident of that; in fact, no one knows, but that is the bet they are forced to take. In fact, the Administration will want to take credit for any deficit reduction initiatives that are undertaken. The Administration, though, will resist the type of overhaul of the Medicare program that Paul Ryan has proposed. President Obama's recent speech on budget issues made this clear. It was in part an unapologetic defense of the New Deal and the Great Society.

While the Obama Administration is attempting to make a virtue out of political necessity, the message the Republicans are sending to the electorate is more muddled. During the Bush Administration, they expanded Medicare without much seeming concern with how to finance this expansion. During the health care debate they argued that Medicare was being cut and that this was a bad thing. Now, they are arguing that it should be effectively privatized for those under 55 and made much less generous. It is certainly possible that whoever the Republican nominee is in 2012 will want to distance himself from the House Republicans in the general election.

I am somewhat surprised that Ryan took on Medicare while not addressing Social Security. He could have proposed some changes to Social Security that at least would have pushed out the date of projected insolvency of the trust fund as a first step. The Medicare issue is more difficult, because it cannot really be addressed without considering the entire health care system in the U.S., not just programs related to those over 65. It is also extremely emotional, since it eventually involves end-of-life issues.

Ryan has to know that his proposal for Medicare is not going to be enacted. As the saying goes, "politics is the art of the possible." He has succeeded in getting the issue a lot of attention, but I am not sure where he goes from here.

What seems to have happened is that for the short-term, the starving the beast strategy will serve to cut some government spending. The outlook for dealing with the long-term deficit outlook is not as clear. While there seems to be a political consensus developing that this should be addressed, there is no consensus on how to do it. If something is done, there will have to be proposals other than the Ryan plan. Ryan himself may well have marginalized himself in this debate, at least when it begins to matter, by proposing something that he is unlikely ever to garner anything approaching majority support.

Debt Limit Follies

The debt limit showdown will soon be before us. It will be riveting theater for those interested in politics and has the potential to be unnerving to financial market participants. We will likely see irresponsible statements and political posturing. Politicians threatening that they are prepared for the government to default on its debt unless they get their way are being reckless with the country's financial reputation.

Almost all political appointees I worked for at the Treasury believe that the debt limit exercise is a total waste of time, that default would be catastrophic, and that it would be preferable, if Congress insists on debt limit legislation, for necessary increases in the limit to be accomplished by legislation unencumbered with other matters and enacted in a timely matter. I say almost all, because there is one former senior Treasury official who, once he had left office, appeared to me to downplay the consequences of default. I hope he has changed his mind. In any case, arguing that default is no big deal if it is corrected a few days later is wrong. Just think about what would happen to the trading of Treasury securities after a default and the task of getting interest payments to the right holders after the fact. Also, of course, there are the little matters of a foreign exchange crisis and a global financial panic. Imagine the damage to the financial reputation of the U.S. and the long-term impacts to U.S. world financial leadership.

There is always the danger that some might be tempted to mislead themselves about the severity of default because it gets in the way of their political goals. But if people are serious about fiscal responsibility, they should not threaten default.

Of course, default is exceedingly unlikely. As I wrote in a previous post:

"Once Treasury has used a particular maneuver to remain solvent during a debt limit crisis, Congress knows about it and expects Treasury to use it again. Meanwhile, Treasury starts sending increasingly frantic letters to the Hill asking for an increase.   

"While this is all theater, and everyone knows that Congress will eventually do the right thing and pass debt limit legislation, it is not costless. There are market effects as Treasury cancels auctions and takes other actions such as suspending sales of special securities to state and local governments. Also, top Treasury officials, including the Secretary, have to spend an inordinate amount of time monitoring the level of the debt, the Treasury's cash balance, and the daily projections of cash inflows and outflows. They also have to consider how to deal with the political problem. This time drain diverts them from dealing with real issues, because of the requirement to handle this artificial crisis."

I also wrote: "The fear during a debt limit crisis is that Congress or the Administration may carry the charade too far, and the Treasury will not have enough cash to make an interest payment or to make payments, such as the large Social Security payments at the beginning of each month. This has never happened." As former Treasury Secretary Rubin stated in a masterpiece of ambiguity (whether or not the ambiguity was intentional), default is "unthinkable."

Some members of Congress will again threaten what has never happened in order to pressure the Administration. It will be a real political test for the President and Secretary Geithner. It is a test that they should not have to undergo.

With respect to the members of Congress doing the threatening, it is hard to know whether they really believe in what they are saying. Some might; many probably just think it is a useful way to try to score political points, since they believe that at the end of the day default will be avoided.

While it is legitimate to have a full debate on the role of government going forward, and specifically on tax and spending policies, the debt limit is not the appropriate legislative vehicle for this debate. The public and the rest of the world will be aghast as default is threatened. But it seems there is no way for this to be avoided in the coming months.

A Comment on Charles Blahous’ Social Security Article

Charles Blahous, who serves as a public trustee for Social Security and Medicare, wrote an article about Social Security ("Social Security's possible fate: Done in by its friends") for the Washington Post, which was posted on that newspaper's website on the evening of March 24, 2011. The article is interesting in that it does not resort to the usual argument that at some point the trust fund will have to cut benefits because of insufficient funds if nothing is done. Blahous takes a more realistic view. If nothing is done to shore up the system, around 2031, Blahous states, there will be a funding crisis. He then goes on to say: "Faced with a choice between wrenching benefit cuts and/or payroll tax increases vs. tearing down the wall between Social Security and the rest of the budget, legislators will tear it down."

Blahous argues that this would be a terrible result for the program – "the end of Social Security as we know it…No longer would benefit programs be shielded from the chopping block by the rationale that they were funded by separate payroll tax contributions. Social Security would be financed from the general revenue pool, and its benefits would thereafter have to compete with every other federal spending priority."

Of course, Blahous is right that Social Security benefits would not be suddenly cut because of a shortage of money in the trust funds. There are too many beneficiaries, who tend to vote in higher percentages than other groups, for that to happen. But his other proposition, that this would lead to "the end of Social Security as we know it," is a bit of a stretch. Social Security is currently one of the programs that is being discussed as needing fixing in order to reduce the long-term deficit. The Greenspan Commission proved that changes to the program can be made. In other words, Social Security currently competes with other spending programs. The degree to which it has been successful in this competition is due to political realities more than anything else.

Moreover, that there is a separate trust fund and a dedicated tax to fund it is a double-edged sword. Sure, it provides the argument to beneficiaries that they paid into the fund and hence their benefits should not be cut. But it also provides the argument that the benefits should be cut or payroll taxes raised because the fund is projected to run out of money. In fact, that is the argument that Blahous is making.

Part of the problem is that we do not want to admit what is going on here. Social Security is in reality a transfer program; it transfers income from the working population to retirees (and the disabled and surviving dependents). Dedicated taxes and trust funds do not change that economic reality. Before Social Security, this was effectively done privately; children would take care of their aging parents if they needed help. Chancellor Bismarck of Germany decided in the 19^th century that taking care of retirees should be socialized, and many countries, including the U.S. in the 1930s, decided to follow the German example.

In order to sell the program and to differentiate it from welfare, the program was designed with a special tax and trust fund. And from the point of view of the individual, Social Security can reasonably be viewed as a combination of a retirement savings and insurance program. But that does not change the economic reality when looking at the program as a whole, it is a transfer program.

Attempts to change Social Security dramatically, such as having it rely more on private investment accounts, have always floundered on a fundamental political reality. No generation wants to be the one that both funds an older generation's retirement and its own. On this point, while I have not been able to verify the quote, I remember reading that FDR once said that he had structured Social Security in such a way that "no damn future politician" could ever change it. And so far he has been right. The New Dealers have managed from the grave to win against proposals to alter the system fundamentally.

This is not to say that there are no demographic issues. One that will resolve itself over time is the baby boomers' retirement, already underway. The longer life expectancy of retirees and a diminished fertility rate, though, are likely to be continuing problems. There will have to be adjustments in light of this, especially if the U.S. is not more open to legal immigration than it currently is.

However, in my view, the adjustments to Social Security are nowhere near as pressing nor as fundamental than what is necessary for Medicare and health care generally. More than other countries, the administrative costs of our overly complex health care system are a burden, as anyone who has tried to figure out medical bills and health insurance reimbursements surely knows. And our aging population needs more health care. The recently passed health care legislation, now under attack, does not address the growing costs of health care to the economy as a whole nearly enough. The politics of this are discouraging, and I hope that Blahous and others devote their energies to figuring a way to come up with workable solution that can be sold in the current fractious political environment.

(Disclosure: I have met Mr. Blahous when we both served briefly on an advisory committee to a private firm, though I do not know him well.)