Charles Sauer: Medicare’s bad incentives are costing taxpayers billions

Costco, the multi-billion-dollar retailer, just partnered with health insurer SCAN Group to offer Medicare Advantage plans in select states.

This new offering of the popular alternative to Medicare, which lets beneficiaries choose among competing private plans, shows how mainstream these plans have become. They are incredibly popular: over 10 million Medicare-eligible patients have signed up for these plans since 2020, and over half of all eligible Americans are on Medicare Advantage plans in 2026.

But Medicare Advantage has flawed incentives that put the program at financial risk. Part of the program's funding is set to run dry by 2033, and some of this funding shortfall is due to the program's incentives to "over-diagnose" patients.

Under Medicare Advantage, contracted insurers get reimbursed more for sicker patients, encouraging insurers to fabricate patient diagnoses to reap larger government reimbursements. Last year, the Centers for Medicare & Medicaid Services estimated that it paid nearly $24 billion in improper payments to its contracted Medicare Advantage insurers.

Without reform, these incentives will continue to drive unnecessary Medicare spending, raising costs for taxpayers and beneficiaries while rewarding insurers for coding more diagnoses rather than delivering better care. Lawmakers have the opportunity to fix these incentives through bipartisan reforms like the No UPCODE Act.

The key issues with Medicare Advantage stem from the program's insurer reimbursement rates, which are calculated using patient risk scores. Risk scores estimate a beneficiary's expected healthcare costs based on factors including age and documented health conditions. The higher the risk score, the more Medicare reimburses insurers. This reimbursement structure creates a financial incentive for insurers to identify and document additional diagnoses that inflate patient risk scores.

Medicare Advantage insurers can conduct health risk assessments, including in-home visits by contracted health professionals, to identify and document beneficiaries' health conditions. During these assessments, insurance representatives often add diagnoses without the testing or treatment history needed to verify them. In 2023, roughly $7.5 billion in excess payments can be directly attributed to patient diagnoses given during these health risk assessments, according to an Inspector General's report.

Many insurers are also accused of "upcoding," or increasing the severity of existing diagnoses without patients receiving corresponding care. Recently, the Department of Justice reached a settlement against one home health company for alleged Medicare Advantage upcoding. The company allegedly submitted fraudulent patient diagnoses for ailments like malnutrition and substance use disorder that were either clinically inaccurate or "did not require or affect patient care."

The Medicare Payment Advisory Commission estimates coding differences alone will increase payments to Medicare Advantage plans by roughly $22 billion in 2026. Overall excess payments to Medicare Advantage plans are expected to increase Medicare Part B premiums by about $11 billion this year.

The payment system also rewards insurers most aggressive about documenting diagnoses, allowing plans to collect more taxpayer dollars without necessarily providing better care. That creates an uneven playing field in which financial success can depend as much on coding practices as on keeping patients healthy.

Medicare Advantage's incentives don't just fail patients – they also pass costs onto taxpayers. When introduced in the 1990s, Medicare Advantage was promised as a lower-cost alternative for Americans paying a large share of their tax dollars toward traditional Medicare. Now, partly because of high coding intensity and potential fraud, experts expect that Medicare Advantage to cost 14% more per enrollee than its traditional counterpart.

It's why bills like the No UPCODE Act are so necessary. Introduced by Senators Bill Cassidy (R-La.) and Jeff Merkley (D-Or.), the bill would rework Medicare Advantage's payment incentives to reduce the financial rewards for aggressive coding. It would limit the use of diagnoses gathered through health risk assessments, revise the risk-score formula to be less sensitive to upcoded diagnoses, and require two years of diagnostic data for risk-adjusted claims instead of just one year – directly addressing the problems plaguing Medicare Advantage.

These reforms are necessary to put Medicare Advantage back on course. By reworking the program's reimbursement incentives, Medicare can reward insurers for quality care and value rather than coding intensity, and policymakers can restore trust in a program that serves over 35 million people.

Medicare Advantage is attractive to patients for a reason, and beneficiaries should be free to choose these plans without paying the price for government inefficiency. Lawmakers sold Medicare Advantage as the best of both worlds: private-plan choice and high-quality Medicare coverage at a fair cost to taxpayers. It's time Congress made sure patients and taxpayers actually get what they were promised.

Charles Sauer is the president of the Market Institute and the author of "Profit Motive" Sauer can be reached at charles@marketinstitute.org.

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