The Medicare Competitive
Bidding Program
Outcomes and Improvements
Shivaani Prakash
11.17.10
Market 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 markups 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 onehalf of the winning suppliers would reject the
supply contract and the government would be
left with insufficient supply.
• Others may accept the contract and crosssubsidize 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.