Government Created Markets, Competition and Welfare: The Case of Medicare HMOs

In this paper we estimate the welfare associated with the Medicare HMO program, now known as Medicare+Choice. We find that the Medicare HMO program contributed over $5.8 billion (1998 dollars) to consumer and producer surplus from 1993 to 1998. We estimate that the HMO program generates positive net societal welfare as long as the cost of treating HMO enrollees in the Medicare fee-for-service (FFS) plan is not less than 96% of the average Medicare payment to HMOs. Increases in the government payment subsidy to HMOs are estimated to result in a net welfare loss of approximately 10%. A $1 increase in government subsidy expenditure is expected to increase consumer welfare by 8 cents and increase HMO profits by 81 cents. This result is sensitive to assumptions on the cost of care of the marginal FFS enrollee. If there are no cost differentials between Medicare HMO and FFS enrollees, then increases in the payment rate are welfare neutral. ____________________________ We have received helpful comments from Mike Chernew, Bryan Dowd, Roger Feldman, Tom McGuire, Mark Rysman, and participants at the 5 Industrial Organization of Health Care Conference.