A. Characteristics of the Medicare System

1. The Medicare system comprises two separately financed trust funds: the Hospital Insurance (HI) trust fund, which reimburses health care providers for the costs of inpatient hospitalization, skilled nursing facilities, home health care, and hospice services; and the Supplementary Medical Insurance (SMI) trust fund, which covers services provided by physicians and hospital outpatient services. Persons age 65 and over and most disabled persons are eligible for HI coverage. Funding for HI benefits comes from a payroll tax, with employees and employers each currently paying 1.45 percent of earnings. SMI coverage is optional and available to all people eligible for HI benefits. In 1998, the HI program covered about 39 million individuals, of which approximately 22 percent received covered medical services. SMI is fully financed through federal government general revenues and enrollee premiums. As a result of the Balanced Budget Act of 1997 the monthly SMI premium is now adjusted yearly to maintain premium revenues at 25 percent of total program expenditures, with the remainder financed from general revenues.² In 1998, the SMI program covered about 37 million individuals, of which approximately 87 percent received covered medical services. Medicare beneficiaries incur other health care expenses reflecting deductibles and co-payments for some services, and payments for medical services not covered by HI or SMI, such as outpatient prescription drugs.

2. Medicare beneficiaries can choose between two kinds of coverage: fee-for-service, in which beneficiaries freely choose their health care providers, and managed-care plans, in which beneficiaries receive services from a network of providers. About 90 percent of current beneficiaries opt for the fee-for-service coverage. Fee-for-service providers are paid directly by Medicare according to an established fee schedule or reasonable costs. Managedcare plans are paid 95 percent of fee-for-service costs, with adjustments for demographic and other characteristics of each plan’s beneficiaries. While managed-care plans limit the choice of providers, they tend to cover a broader range of services and entail less out-of-pocket expenses for beneficiaries.

B. Medicare’s Financial Imbalance

3. Despite a recent slowdown owing largely to changes enacted in the Balanced Budget Act of 1997, Medicare spending has grown significantly as a share of GDP, rising from about 1½ percent in 1988 to 2½ percent in 1998. The rapid aging of the population beginning around 2010 will greatly accelerate this trend unless substantive changes are made. In particular, HI and SMI expenditures are expected (under the Trustees’ intermediate scenario) to continue to grow faster than the economy as a whole (Figure 1). Rapid growth in Medicare spending in relation to the economy is related to two factors. The first and most immediate factor is the growth in costsper beneficiary, which is expected to continue at a rapid pace under current policies. The second factor is the rate of growth in the number of beneficiaries, which is expected to rise beginning around 2010. Indeed, the United States is currently in a period of historically low growth in Medicare enrollment as the so-called “baby-bust” generation, born during the 1930s and 1940s, reaches age 65. Only after 2010, when the first wave of the baby-boom generation reaches age 65, will Medicare enrollment begin a period of exceptionally fast growth lasting approximately two decades. Between 2010 and 2030, the rate of growth in enrollment is expected to average nearly 2½ percent a year, compared with an average annual growth of about 1½ percent during the period 1995–2010. Medicare enrollment is expected to increase from about 14 percent of the population in 1996 to 22 percent in 2030.³

View Full Size

United States: Medicare Expenditures, 1966–2070

Citation: IMF Staff Country Reports 1999, 101; 10.5089/9781451839579.002.A008

Source: Medicare Trustee’s 1999 annual report.

• Download Figure
• Download figure as PowerPoint slide

4. Under the current funding rules, the SMI trust fund cannot experience a financial imbalance since beneficiary premiums and Federal general-revenue contributions are adjusted each year automatically to meet program costs. Thus, the concept of solvency as applied to Medicare applies only to the HI component. In 1998, HI income exceeded program expenditures by $4.8 billion, the first surplus since 1994. Income exceeded expectations as a result of higher-than-expected payroll-tax revenues due to high levels of employment. Expenditures also declined, reflecting the implementation of measures enacted in the Balanced Budget Act of 1997. By 2007, HI annual expenditures are projected to again exceed annual HI income. The assets of the HI trust fund, based on the Trustees’ intermediate cost assumptions, are now expected to be exhausted in 2015, somewhat later than envisaged in last year’s report. To bring the HI account into long-term actuarial balance,⁴ measures affecting either revenues or outlays equivalent to a 1.46 percentage point increase in the payroll tax would be required.

C. Approaches to Fixing the Financial Imbalance

5. Equity and efficiency considerations tend to argue against closing the financial imbalance entirely through a payroll tax increase, or through a transfer of general revenues, without also adopting measures to reduce outlays. This is because higher taxes generally impose a deadweight economic loss on the economy, and thus a purely tax-based fix, maximizes the associated distortion. In addition to this efficiency consideration, a purely tax-based fix places the full burden of the reform on current and future workers without imposing any cost on current Medicare beneficiaries, thereby raising intergenerational equity concerns. This suggests that a balanced approach that targets both revenues and outlays probably is warranted. Further efforts should be made to identify areas in which incentives to hold down costs might be strengthened. On the demand side, this might be achieved, for example, through an increase in co-payments and deductibles in order to enhance price sensitivity and induce a degree of “comparison shopping.” On the supply side, this might be achieved by identifying and eliminating any “excess” payments (Le,, beyond what is needed to induce supply at a given quality) for specific services and/or by taking steps to enhance price competition among service providers. This, of course, would be an extremely challenging undertaking in view of the complicated structure of health care markets. Finally, further efforts to improve transparency, enhance auditing procedures, and strengthen sanctions could make the system less open to fraud and abuse.⁵

6. The reforms adopted in the Balanced Budget Act of 1997 made a number of steps toward such a balanced approach.⁶ A major piece of the 1997 package was a general reduction in real prospective payments to physicians and hospitals. Although price ceilings in competitive markets would be expected to create shortages and/or queues, or to adversely affect quality, the U.S. health care market, particularly that element functioning under the Medicare system, is far from the competitive ideal. It remains unclear whether reducing real prospective payments for Medicare services has compromised quality or impaired access. The 1997 reforms also shifted most home health care benefits from HI to SMI, which essentially increased that portion of Medicare that is financed through a combination of general revenues and SMI insurance premiums. In addition, the 1997 measures allowed recipients to choose either the traditional fee-for-service program, certain private feeforservice plans, or so-called “coordinated care” plans (including health maintenance organizations, provider-sponsored organizations, and preferred provider organizations) under which a fixed amount per enrollee is paid by Medicare. The introduction of alternatives to the traditional fee-for-service approach was designed to achieve a degree of cost containment by establishing a foundation for greater competition in health care delivery,

7. The Administration’s FY 2000 budget contains proposals to reduce the growth in spending in the traditional fee-for-service segment of Medicare HI and to transfer general revenues to the HI trust fund.⁷ Together with a proposed extension of Medicare coverage, the measures to achieve spending restraint are estimated by the Congressional Budget Office (1999) to result in a net increase of $19 billion for the HI trust fund in FY 2009. From the perspective of improving the actuarial outlook, the only significant adjustment is the proposal to transfer $350 billion over the next decade from general revenues to the HI trust fund. Including interest earned, the Congressional Budget Office (CBO) estimates that this would increase the value of the HI trust fond in FY 2009 by $435 billion for a total of $595 billion and push back the date of insolvency of the HI trust fund by several years. The longer-term financial imbalance in the HI trust fund thus would be narrowed, but not significantly improved by this proposal.

8. In an effort to address this longer-term imbalance, the Bipartisan Commission on the Future of Medicare was created by Congress in the Balanced Budget Act of 1997 and was charged with making recommendations by March 1, 1999 to “strengthen and improve” the system in time for the retirement of the “Baby Boomers.” The 17-member commission failed to achieve the 11-member super majority needed for a single plan to win the Commission’s endorsement. Although the Breaux-Thomas Plan, named after Commission Chairman Senator John Breaux and Commission Administrative Chairman Congressman Bill Thomas, failed to win the necessary super majority, it was endorsed by a majority of Commission members and is expected to help frame the continuing debate on Medicare reform.

9. The Breaux-Thomas plan calls for a fundamental restructuring of the Medicare system. It consists of three parts: (i) a “premium support” system to take effect in 2003 under which private health insurance plans and a government-run fee-for-service plan would compete for subscriber’s subsidized premium payments; (ii) certain immediate improvements in the quality of Medicare services; and (iii) financing and solvency considerations.

10. Under the premium support proposal, a Medicare Board would oversee and negotiate with private health insurance plans, provide information to subscribers, enforce financial/prudential and quality-of-care standards, and review and approve benefit packages. All plans would have benefits and premiums approved by the Board, and benefits would be funded by actuarially sound premiums. The government fee-for-service plan would have to meet the same requirements as private plans. Plans would have to offer a standard benefits package, but they could also offer additional benefits and vary copayments and deductibles subject to Board approval. On average, beneficiaries would pay 12 percent of the total cost of the standard benefits package, with the remainder funded by the federal government. Low-income beneficiaries would pay nothing for most plans.⁸ Beneficiaries that select plans costing 85 percent of the national average plan, or less, would also face no beneficiary premium. Financing for the Breaux-Thomas premium support plan would come from a combination of general revenues, premiums, and payroll taxes. Under the plan, the age eligibility for Medicare would conform to the normal Social Security retirement age, and a nonsubsidized buy-in would be available at age 65 when that age restrictions rise.

11. Among the immediate “improvements” relative to the benefits package under the current Medicare system, the plan would introduce outpatient prescription drug coverage. The Breaux-Thomas plan would also consolidate and somewhat reduce the deductibles established under the current HI and SMI systems and index these to the growth in Medicare costs. In order to improve the incentives to economize on the use of outpatient services, a minimum 10 percent coinsurance/copay would be established for all services except hospitalization and preventive care. Those services with higher copayments under the current system would retain the higher levels.

12. By enhancing competition among medical-services providers and taking steps to improve efficiency (e.g., through higher copayments), the Breaux-Thomas proposal would appear to place Medicare on an improved financial foundation. According to Medicare Commission staff estimates, the plan would reduce the current annual growth rate in Medicare outlays by 1–1½ percentage points.⁹ In 2030, for example, Medicare spending is estimated to reach nearly 6 percent of GDP compared to 8½ percent under current law,

13. The Breaux-Thomas proposal argues that the concept of “solvency” as currently applied to Medicare is not a useful guide to policy making, and that a more meaningful test would be based on the amount of general revenues needed to fund outlays in each year. This would focus attention on the tradeoffs between Medicare and other programs financed from general revenues. The proposal would redefine the concept of solvency, which currently applies only to the HI component of Medicare. HI and SMI would be combined into a single trust fund, and the new concept of solvency (“programmatic solvency”) would require the Trustees to publish annual projections for the ratio of general-revenue financing to total Medicare financing. Whenever this ratio is projected to exceed 40 percent of annual Medicare outlays, the Trustees would notify Congress of the envisaged “programmatic insolvency.” This would then trigger Congressional deliberations on the appropriate mix between adjustments in the payroll tax, premiums, and/or the share of general revenues that should be devoted to Medicare versus other spending priorities. Under the revised solvency standard, the Medicare system would become “programmatically insolvent” around 2013–17.

15. Objections to the Breaux-Thomas plan included that the plan: (i) did not take into account the Administration’s plan; (ii) did not solve the longer-term insolvency problem of Medicare; (iii) did not adequately address the limited access to outpatient prescription drugs; (iv) would eventually raise the age of eligibility; and (v) inadequately protected low-income seniors.

16. On June 29, 1999, the Administration released a plan to reform and improve the longer-term financial outlook for Medicare. The main features include measures to increase price competition, extensions of prescription drug and preventive healthcare benefits, and transfers from general revenues to the Medicare HI Trust Fund.

17. The single most significant measure to extend the life of the HI Trust Fund by 25 years (through 2027) is the proposed transfer from general revenues beginning in 2000 of about 15 percent of projected budget surpluses over the next 15 years (totaling $794 billion). Budget enforcement rules would require that the reported on-budget federal budget surplus would be reduced by the full amount of the transfer, helping to ensure that these surpluses would materialize and not be used for other purposes.

18. The proposal also includes a number of measures to improve efficiency through greater price competition among services providers and incentives for beneficiaries to “comparison shop.” The traditional fee-for-service program would provide broader authority to service providers for competitive pricing, and would also create incentives for beneficiaries to select physicians based on both quality of care and costs. Beneficiaries electing the managed-care option would be encouraged to select a low-cost private managed care provider by providing them 75 cents of every dollar of cost savings. Direct cost-containment provisions like those in the Balanced Budget Act of 1997, which are set to expire in 2003, would be extended under the plan.

19. A new voluntary outpatient prescription drug benefit would be established. When fully phased-in in 2008, it would cover half of a beneficiaries’ outpatient drug outlays of up to $5,000 annually ($2,500 in Medicare payments) with no deductible. Like the Breaux-Thomas proposal, it would ensure that beneficiaries with incomes below 135 percent of the poverty level would pay no premiums and be free of cost sharing. Premium assistance would be available to those with incomes between 135 percent and 150 percent of the poverty level. Participant premiums would be around one-half to one-third of private premiums for plans currently including similar outpatient drug benefits.

20. Cost sharing (copayments and deductibles) for preventive-care benefits would be eliminated. At the same time, certain existing cost-sharing provisions would be increased, including a 20 percent copayment for clinical laboratory tests, and the SMI deductible would be indexed to inflation.