By Erwin A. Blackstone and Joseph P. Fuhr Jr.
In January 2011, Medicare began a program that employed a competitive bidding auction in an attempt to constrain prices for durable medical equipment and supplies (DMEPOS). However, there are other factors besides price — such as quality and level of service — that need to be taken into account. Such equipment and supplies comprised about $10 billion of Medicare expenditures in 2009. Unfortunately, the design of this auction for the equipment and supplies is flawed and is likely to cause problems of access and quality for Medicare beneficiaries.
The newly implemented Medicare auction program for durable medical equipment and supplies is flawed in many ways and will lead to issues of access and quality for Medicare beneficiaries. An efficient auction would determine the competitive price by ranking the bids from the lowest to highest price until the desired quantity is obtained. All suppliers would receive the price of the last supplier required to meet the quantity that Medicare desired.
The auction system used by Medicare fails to meet the required conditions for an efficient auction. In particular, winning bidders are under no obligation to supply the market. If a winning bidder decides that the auction price is too low, the firm can simply choose not to supply. Such a system provides an incentive to offer unrealistically low bids.
Another major flaw is the use of median price. Instead of the price being the highest price necessary to elicit the required quantity (in market terms, the demand), the Medicare price is set at the median so that the price is set below 50 percent of the winning bids. This combined with the no obligation to supply for firms that bid below the median price will lead to even larger shortages. This auction system seems to be unique to Medicare.
The median price system further encourages unrealistically low bids since such bids could have little effect on the median, but will increase the likelihood of winning. Thus, firms have the incentive to bid low to be assured that they will be among the winners, knowing that if the median price is too low they have the option to not supply. However, if many bidders follow such a strategy, the median price itself could be biased downward and become unrealistically low, perhaps below most or even all of the bidding firms’ costs. Shortages and beneficiary access could then be threatened. For example, a survey conducted in August 2010 of 400 providers found that 80 percent of respondents thought bid prices were too low and would not supply.
Another problem arises from the utilization of a composite bid that involves a firm bidding for each of its products weighted by the government’s projected demand for each product. Bidders have an incentive to bid high on products that are weighted low because Medicare has underestimated demand and bid low on over-weighted products. The result is prices unrelated to costs. Also, a firm may be the lowest bidder for a given item but its composite price may be a non-winner. Thus, the price for an individual item could be higher under composite pricing. Under a composite system, firms that specialize in certain products will be foreclosed from the market even though they may be the lowest bidder for a specific product.
Adding to the problem is the 3-year interval between bids. Costs and demands are likely to change during such a period of fixed prices, threatening supplies and availability.
Probable Impacts: Evidence and Analysis
There is already evidence that the Medicare auction system has problems. Low and perhaps below cost prices of course will make availability and access to needed equipment and supplies more difficult. Especially noteworthy is the inability to control for quality. Indeed, in a report to Congress, Secretary of Health & Human Services Tommy Thompson concluded “that if prices did not cover costs, suppliers had an incentive to offer inferior products or pursue other strategies that could limit product selection.” An important component of this type of equipment is the service which is required for the best or even proper use of the equipment. Winning bidders reported that they would reduce service and provide cheaper and lower quality products. The decrease in services can be seen from results of the CMS’s pilot study. One area within the pilot study found “a 22 percentage point rise in urological supplies users reported receiving no training, and a 40 percentage point decrease in surgical dressings users reporting instruction in maintenance.” Also, “surgical dressings users reported a halving, on average, of the number of contacts with suppliers.”
To cut costs, winners could shift from delivering equipment to homes and instead employ mail order. Thompson concluded that mail delivery became more common under competitive bidding and resultant cost pressures. Thompson noted that some wheelchair suppliers tried to cut costs by reducing the accessories provided, charged for accessories previously included in the equipment price, and possibly employed less qualified personnel for fitting. In response to problems with wheelchairs “this category may need special monitoring and more explicit supplier standards in the future.” Also, “five of eighteen respondents began offering used instead of new mattresses.” In addition, it was found that patients had lower access to portable oxygen.
Prices that do not cover costs could also lead to shifting of costs and probably higher overall costs. For example, patients might be required to stay in the hospital longer if delays occur in delivery of equipment or supplies to the patients’ homes, and there is some early evidence that this is happening. Thus, decreases in service and quality could impose substantial costs on Medicare and patients. Emergency room visits might also increase if delays are encountered in obtaining equipment, training, repairs, supplies, or any other services required for successful use of equipment which could result in injuries to beneficiaries.
There are other consequences of too low prices. These include probable exit of firms from the industry with perhaps an increase in industry concentration, which could lead to reduced competition in the future. It was noted that two-thirds of the auctions saw the number of suppliers decrease by 50 percent or more. GAO reported the change in number of suppliers by product category and Competitive Bidding Areas from 2006-08. In many cases the changes are dramatic. In Miami the number of complex power wheelchairs and related accessories suppliers decreased from 101 in 2006 to 6 Competitive Bidding Program (CBP) contract suppliers in 2008. In Charlotte, the number of mail-order diabetic suppliers decreased from 118 in 2006 to 10 CBP contract suppliers in 2008. Further, long-standing relationships between patients and equipment suppliers could be imperiled, leading to greater errors and reduced quality of care. Consolidation gives the elderly fewer options where they live and increases further the risk of shortages.
Another consequence of too low prices would be a reduced incentive to engage in research and development which leads to innovations and better products and services in the long run. The emphasis on price cutting to obtain a winning bid could also reduce funds available for R&D. Unremunerative prices and the uncertainty that even an improved product could gain a winning bid would imperil R&D.
This inefficient Medicare auction system will harm many beneficiaries. The result will be lower quality of products, fewer services, less education provided to consumers and shortages, which will affect access to needed equipment. It is important to preserve incentives for high quality products and product innovation in such an important consumer market. This will lead to lower quality of life for the elderly through longer hospital stays, more emergency room visits, and loss of independence if the elderly can no longer stay at home and must go into long term care. An added consequence is higher cost of care as more beneficiaries are shifted from low cost home health care to higher cost facilities. The auction system as presently comprised will lead to government failure and decrease consumer welfare.
· Peter Crampton, “Auction Design for Medicare Durable Medical Equipment,” Nov. 23, 2010. See also Jan Ayres and Peter Crampton, “Fix Medicare’s Bizarre Auction Program,” New York Times, Sept. 30, 2010.
· Allen Dobson and Joan E. DaVanzo, “The Risks to Medicare Beneficiaries of DMEPOS Competitors Bidding – Considerations for the Round 1 Re-Bid and Beyond,” Report for American Association for Homecare, Sept. 10, 2010.
· Tommy G. Thompson, Secretary of Health and Human Services, “Final Report to Congress: Evaluation of Medicare’s Competitive Bidding Demonstrations for Durable Medical Equipment, Prosthetics, Orthotics, and Supplies,” 2004.
· U.S. Government Accountability Office, “Medicare: CMS Working to Address Problems from Round 1 of the Durable Medical Equipment Competitive Bidding Program”, November, 2009.
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 Erwin A. Blackstone is a professor of Economics at Temple University and a senior research fellow at The American Consumer Institute. Joseph P. Fuhr Jr. is a professor of Economics at Widener University and a senior research fellow at The American Consumer Institute. For more information about the institute, visit www.theamericanconsumer.org.
 Allen Dobson and Joan E. DaVanzo, “The Risks to Medicare Beneficiaries of DMEPOS Competitors Bidding – Considerations for the Round 1 Re-Bid and Beyond,” Report for American Association for Homecare,” Sept. 10, 2010.
 Dobson and DaVanzo, p. 8.
 Secretary of Health & Human Services, Tommy G. Thompson, “Final Report to Congress: Evaluation of Medicare’s Competitive Bidding Demonstrations for Durable Medical Equipment, Prosthetics, Orthotics, and Supplies,” 2004, p.16.
 Dobson and DaVanzo, p. 8.
 Thompson, p. 10.
 Thompson, p. 25.
 Thompson, p. 16.
 Thompson, p. 16.
 Thompson, p. 16.
 Thompson, p. 25.
 American Association for Homecare, “Medicare Patients Report Problems with Access to Medically Required Equipment and Services under Controversial Competitive Bidding System,” Feb. 2, 2011.
 GAO, p. 16.
 GAO, p. 47.