Experts on Bidding Say CMS System Will Fail

One hundred and sixty-six of the world’s authorities on auctions and competitive bidding systems sent a letter to Congress earlier this week outlining severe problems with the Medicare bidding program for durable medical equipment.

The experts don’t oppose the idea of using a bidding system to set prices but they point out that the CMS bidding program has four severe flaws:
• The bids are not binding.
• Median-bid pricing encourages low-ball bids.
• The use of composite bids distorts prices.
• Lack of transparency undermines the system.

The experts conclude, “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… We recommend that the government fix the flaws in the current auction program and develop a new design that emphasizes the key features of successful designs. Implementation of the current design will result in a failed government program.”

Please share the letter with your Representative and Senators and with your local and state chapters of AARP and other organizations that advocate for seniors or patient groups.

Tyler Wilson, AAHomecare president, said, “It’s one thing for us to predict that the bidding program will not fly. But when 166 respected experts – who can envision a well-designed competitive bidding program – independently warn the program will go down in flames, that should send up real warning signals there’s trouble ahead.”

Most of the experts who signed the letter are professors or staff at leading universities throughout the world including Yale, Harvard, Stanford, MIT, London School of Economics, University of Chicago, University of Pennsylvania, Duke, Columbia, California Institute of Technology, and Cornell, among others. (The letter states the signatories’ views are their own and do not represent the views of any organization.)

The economists’ letter was addressed to Rep. Pete Stark who chairs the House Ways and Means Subcommittee on Health. The subcommittee appears to be skeptical of CMS claims about the virtues of the bidding program. Stark forwarded the letter to CMS Administrator Donald Berwick yesterday with a cover letter that reiterates the experts’ concerns: “[I]f not addressed these flaws will ultimately reduce beneficiary access to necessary equipment, lead to lower quality items and services, and could increase fraud and abuse.”

Economists Peter Cramton of the University of Maryland and Brett E. Katzman of
Kennesaw State University led the effort to gather the signatures and draft the letter.

An excerpt follows:
Four main problems
The first problem is that the auction rules violate a basic principle of auction design: bids must be binding commitments. In the Medicare auction, bidders are not bound by their bids. Any auction winner can decline to sign a supply contract following the auction. This undermines the credibility of bids, and encourages low-ball bids in which the supplier acquires at no cost the option to sign a supply contract.

The second problem is a flawed pricing rule. As is 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. What is odd is that rather than paying winners the clearing price (the last-accepted bid), the auction pays winners the unweighted median among the winning bids. This is unique in our collective experience. The result is that fifty percent of the winning bidders are offered a contract price less than their bids. This median pricing rule further encourages low-ball bids, since a low bid guarantees winning, does not impact the price, and gives the supplier a free option to sign a supply contract. Even if suppliers bid their true costs, up to one-half of the winning suppliers would reject the supply contract and the government would be left with insufficient supply. Others may accept the contract and cross-subsidize public patients with the revenue from private patients, or just take a loss. This pricing rule does not develop a sustainable competitive bidding process or healthy supplier pool.

The third problem arises from the use of composite bids, an average of a bidder’s bids across many products weighted by government estimated demand. This provides strong incentives to distort bids away from costs—the problem of 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. Bid skewing is especially problematic in this setting, since the divergence between costs and prices likely will result in selective fulfillment of customer orders. Orders for low-priced products are apt to go unfilled.

The fourth problem is a lack of transparency. It is unclear how quantities associated with each bidder are determined. These quantities are set in a non-transparent way in advance of the auction. Bids from the last auction event were taken in November 2009, and now more than ten months later, we still do not know who won contracts. Both quality standards and performance obligations are unclear. This lack of transparency is unacceptable in a government auction and is in sharp contrast to well-run government auctions such as the Federal Communications Commission spectrum auctions.

Click here to view the full letter.