Patient Zero

It was late 2002, and Tom Scully, administrator of the Centers for Medicare & Medicaid Services (CMS), was at a U.S. News and World Report forum , relating a tale of hospital skullduggery. Under CMS rules, Medicare reserved 5.1 percent of its budget to compensate hospitals that treated “outlier” high-cost patients. Scully, a youthful-looking man with a pile of slightly graying hair who talked a mile a minute, explained that Tenet and several other hospital systems, without the regulators knowing, had for years randomly jacked up prices on individual patients to access the set-aside. This deprived other hospitals that actually had sick patients from getting a higher share of the funds; the dishonest actors were costing the honest ones money.

Scully didn’t blame hospital deception, but the policy framework he was hired to manage. “I love Medicare, it’s a great program, but as an insurance model, it’s a

By David Dayen

joke,” he said, explaining that his regulators were outgunned and slow to react. The hospitals falsified patient costs and that was unethical, he conceded, but they were just responding to incentives. “People follow the money,” Scully said, “and they’ll find the little niches in the program and they’ll game it, and that’s what happened here.”

One reading of the history of health care over the past half-century, as the profit motive was gradually introduced into insurance and delivery systems, is that little niches have sprung up, and people with capital have taken advantage.

That would include Tom Scully.

At the Office of Management and Budget (OMB) in the first Bush administration and CMS under Bush II, Scully played a major role in many of the defining features of health care today, from Medicare Advantage and the privatized Part D prescription drug benefit to risk adjustment and the physician payment schedule. He wasn’t responsible for Obamacare, but the program closely follows his desire to solve problems through the private sector.

When Scully left CMS in late 2003, he joined Welsh, Carson, Anderson & Stowe, perhaps the leading health care–focused private equity firm, where he used his knowledge and contacts to invest in companies that were poised to capitalize on the incentives the government offered. Welsh Carson helped pave the way for what is now an investor gold rush into the medical system.

I’ve watched and listened to virtually every scrap of tape of Scully over the last 35 years, and I conducted a long interview with him in June. I think his beliefs are sincere. He thinks government price-setting doesn’t work, and that empowering private insurers that put their own money at risk leads to better and more efficient care. He believes poor people should be covered generously, but all other patients exposed to cost to reduce overutilization. And he wants the best hospitals and nursing homes and clinics to be paid more than the worst, to force advances in quality.

In practice, this set of philosophies has created the monster that is America’s health care system, where most of the money is public, but most of the entities dishing out and getting that money are private. Commercialization has crowded out what was a thriving nonprofit impulse; intensifying mergers and acquisitions have concentrated every aspect of the system; and a plague of middlemen each take their cut. Scully’s fear of big-government price-fixers has led to the triumph of big private profit-takers, at the cost of doctors, nurses, and patient care.

More than anything, the system has become maddeningly complex, with armies of functionaries working every angle, straddling every ethical line, to unlock a big safe full of money. Scully is America’s safecrackerin-chief. He designed so many aspects of this system, with its intricate nooks and crannies, that he’s practically the only person who understands it. That makes him an extremely valuable commodity. It’s almost as if he invented his career outside of government when he was transforming it on the inside.

Scully, 65, was born in Philadelphia. After graduating from the University of Virginia, he came to Washington, getting hired in 1981 as a staffer for Sen. Slade Gorton (R-WA) while earning his law degree at night from Catholic

University. He eventually moved on to BigLaw giant Akin Gump, working as a telecom lawyer. But he was friends with one of George Herbert Walker Bush’s sons, and that pulled him into the 1988 presidential campaign, where he ran the press operation (he worked briefly on Bush’s 1980 campaign as well).

“I didn’t know the difference between Medicare and Medicaid, even after the campaign,” Scully told me, in typical self-effacing style. But a position running legislative affairs at OMB came open, and Scully’s first two big projects there were health care–related: trying to save the Medicare Catastrophic Coverage Act of 1988, and devising a better method for Medicare to pay physicians, which had seen 14 percent annual inflation the previous year.

Both ended in failure. The catastrophic coverage law, which provided a limited prescription drug benefit, capped out-of-pocket costs, and allowed longer clinical stays, sparked outrage because it forced wealthier Medicare beneficiaries to pay higher premiums for other people’s benefits. After House Ways and Means Committee chair Dan Rostenkowski (D-IL) had his car surrounded by angry constituents after a town hall, Congress repealed the law. The Medicare physician payment reform, called the resource-based relative value scale (RBRVS), uses a complex process to pay doctors for each procedure. It failed to alter the cost trends.

Scully soon became associate director of OMB for health, education, and welfare, simul- taneously taking a health care policy role in the White House. Within a few years, Scully was writing the long-forgotten 1992 Bush health care proposal. “We think a marketdriven delivery mechanism is the best,” he said when presenting the plan at the conservative American Enterprise Institute (AEI).

A decade earlier, Arizona, the last state to adopt Medicaid, was the first to create a statewide Medicaid managed care system. Building on successes from Southern California’s Kaiser Permanente, whose insurance limited patients to Kaiser doctors and hospitals, Arizona paid private insurers a per capita rate approximating annual health expenditures, and the insurers used narrow networks and strong case management to keep within that budget. Health inflation in Arizona was lower than the national average. Scully drew the lesson that private insurers can eliminate waste, because it’s their money at stake. “If you say here’s $16,000 a year, call me next year, they’re going to work like crazy to put a 10 percent margin on that,” Scully told me.

The Bush health plan adopted the Arizona managed-care model for Medicare and Medicaid, and added a tax credit for uninsured Americans outside those programs to help purchase basic private health insurance. Rules were put in place so nobody could be denied for a pre-existing condition and everyone in a region would pay the same rate. A risk-adjustment mechanism would give companies with sicker patients in its risk pool payments from healthier pools, to guard against cherry-picking.

Being a Republican plan, there was malpractice reform in it. But in form, the 1992 Bush health plan at least rhymes with what passed 18 years later as Obamacare: premium support for basic coverage, and insurance market reforms to prevent adverse selection. The reliance on competition and case management to “bend the cost curve” was a selling point of the Affordable Care Act. While Scully ended up mildly opposing the ACA because he thought the subsidies were too high, he said at a 2018 policy forum that it resembled the Federal Employees Health Benefits Program, a private insurance exchange that has been his model reform for 30 years. “Exchanges are the right thing, what Obama did was the right thing,” Scully told me.

The Bush health care plan would not get adopted, as he lost the 1992 election. Scully decamped first to law/lobby shop Patton

Boggs—Sen. Jay Rockefeller (D-WV) teased him at a 1994 panel that “he is now very close to poverty … but was able to afford cab fare for this”—and then to run the Federation of American Hospitals, which represented around 1,700 private providers. He had now been an inside player in every major part of the health care system, public and private.

A dutiful partisan, Scully opposed the Clinton health care plan as packed with unfunded liabilities and fuzzy math. But as he was documenting the evils of out-ofcontrol health spending, he was representing hospitals, the biggest cost drivers in Medicare and Medicaid, and it’s doubtful he was lobbying for less money for them. In our call, Scully told me about his frustrations with match rates in Medicaid, and how states can use other pockets of funds to eliminate their share. “The Massachusetts miracle that Mitt Romney did? There wasn’t one penny of Massachusetts money in there, it was all a provider tax scam,” he said. “I actually coached the Massachusetts

Hospital Association a little bit on how to do it as a lawyer.” He quickly followed up with, “That doesn’t mean it’s right!”

When George W. Bush took office in 2001, Scully was recruited to run what was then called the Health Care Financing Administration; he and Health and Human Services (HHS) Secretary Tommy Thompson changed the name to the Centers for Medicare & Medicaid Services to emphasize a “new culture of responsiveness,” Thompson said . Rebranding was part of the agenda: Scully spent big to market a 1-800-Medicare customer service line, with silly commercials featuring Leslie Nielsen and even a blimp that flew over college football games.

When you hear that the government is nothing more than an insurance company with an army, CMS is that insurance company. (Well, sort of; since its inception, the government has contracted Medicare billing to private insurers, mostly Blue Cross plans, in exchange for a 1.4 percent fee.)

Today, CMS enforces the rules and manages approximately $1.4 trillion in payments for Medicare and Medicaid; in Scully’s day, it was around $560 billion. Even the Pentagon is smaller.

Scully didn’t love the system. He lamented how fee-for-service Medicare paid doctors the same whether the procedure was successful or not. He hated supplemental Medigap insurance policies, which wrapped around traditional Medicare to cover copayments, giving seniors first-dollar coverage and making them insensitive to price. He once claimed that seniors in Florida went to the doctor too much because they were bored, but usually he was more careful in saying that public insurance made it impossible to manage utilization.

At CMS, Scully started publishing objective quality information on nursing homes and home health agencies, and instituted a small pilot for paying select hospitals more based on their success rates. But Scully said repeatedly that he re-entered government to get a Medicare prescription drug benefit done, to avenge the ghosts of the catastrophic coverage defeat. His talking point was that seniors paid the highest prices in the drugstore, because without a prescription plan, they couldn’t negotiate group rates for medications.

Legislation dragged on for years. Supporters envisioned a separate drug benefit run entirely by private insurers, not CMS. The poorest seniors would have no premium and small copays, but above 135 percent of the poverty line—roughly two-thirds of seniors at the time—costs went up, with a $420 annual premium, a $250 initial deductible, and more if beneficiaries hit the “doughnut hole” at higher drug spending levels.