Does Managed Care Reduce Federal Spending? Evidence from Medicare

Although Medicare Managed Care (MMC) was introduced as a way to reduce costs, the effect of the program on total Medicare spending is unknown. Current literature has focused on three conflicting sets of findings including spillover effects from managed care which reduce total Medicare spending and positive selection into managed care and overpayments to managed care plans relative to Fee-for-Service (FFS) spending, which increase spending. This research reconciles these results by examining the effects of Medicare managed care penetration on total county-level Medicare spending for elderly beneficiaries from 1999 - 2004. Using an instrumental variables approach, I find that a one percentage point increase in Medicare managed care penetration increases total county Medicare spending by 1.1 percent, $2.6 billion in 2004 dollars. There is no evidence of cost-reducing spillovers from MMC penetration to FFS. Increases in FFS spending likely caused by positive selection into MMC account for 40 percent of the increase in costs, the remainder is built in by federal payment policy to MMC plans.