Saving Medicare

For the past generation, ensuring access to health care and financial security for older Americans and their families under the Medicare program has been an important social commitment. The elderly are healthier now than before Medicare was enacted and they and their families are protected from financial ruin caused by high medical expenses. Medicare has also helped to narrow the gap in health status between the most and least well-off, and it has contributed to medical advances by supporting research and innovation that have led to increased health, vitality, and longevity among the elderly.

Now this remarkable social commitment to older persons may be weakening, largely because of Medicare’s faltering finances. As everyone knows, Medicare’s costs are rising rapidly, and members of the huge baby boom generation will soon begin to retire. Although the boomers are expected to be healthier in their older years than their parents and grandparents were, the surge in the number of people over 65 will probably mean much more chronic illness and disability in the population as a whole and will raise the demand for health services and long-term care. Thus, ensuring the continued commitment of health protection to the elderly will require bolstering the Medicare program.

Medicare spending topped $200 billion in 1996. Despite an overall slackening of medical price inflation over the past few years, Medicare spending has continued to outpace private health insurance spending. The possibility that Medicare outlays will continue to grow faster than overall federal spending is a major concern. Medicare’s share of the federal budget is expected to increase from under 12 percent in 1997 to 16 percent by 2008.

The solvency of the Medicare Part A trust fund depends on a simple relationship: income into the fund must exceed outlays. In 1995, for the first time since Medicare began, outlays exceeded income. In 1997, Part A expenditures were $139.5 billion, whereas income was $130.2 billion. The difference was made up from a reserve fund, which had $115.6 billion left in it at the end of 1997. By 2008, the reserves are expected to be depleted.

Because the first baby boomers become eligible for Medicare in 2011, action is needed now to solve the program’s long-term financial problems. The combination of increased federal outlays for millions of aging Americans and projected smaller worker-to-retiree ratios will most assuredly lead to the Medicare program’s inability to meet the health care needs of next century’s elderly population. This scenario is unavoidable without substantial reductions in the growth of Medicare spending, increased taxes to cover program costs, or both.

A 17-member national Bipartisan Commission on the Future of Medicare is now considering changes needed to shore up the program. The commission’s mandate is to review Medicare’s long-term financial condition, identify problems that threaten the trust fund’s financial integrity, analyze potential solutions, and recommend program changes. A final report is due to Congress by March 1, 1999. Two approaches the commission is considering are raising the Medicare eligibility age from age 65 to 67 and requiring beneficiaries to pay more of the program’s costs. Congress has already demonstrated its willingness to restructure the program. In 1997, with little public input or comment, the Senate voted to gradually raise the Medicare eligibility age to 67 years, an action that would have ended the entitlement to Medicare for persons age 65 and 66. Fortunately, the House refused to support this measure. But the Senate vote underscores how great the stakes are in the current debate.

Fixing Medicare’s fiscal problems will require difficult choices. Whatever changes are made will ultimately affect every American directly or indirectly. To assess the proposals now on the table, it is essential that people of all ages have a basic understanding of the Medicare program: how it is financed, what services it pays for, and its current limitations.

Medicare basics

The Medicare program, enacted in 1965, provides health insurance for persons 65 and older if they or their spouses are eligible for Social Security or Railroad Retirement benefits. Also eligible are disabled workers who have received Social Security payments for 24 months; persons with end-stage renal disease; and dependent children of contributors who have become disabled, retired, or died. When Medicare was enacted, only 44 percent of older Americans had any hospital insurance. Today, Medicare provides coverage to 98 percent of those 65 and older (more than 33 million people) as well as 5 million disabled persons.

Although Medicare is referred to as a single program, it has two distinct parts-one for hospital insurance and one for physician services- with separate sources of financing. Enrollment in Part A, the Medicare Hospital Insurance Trust Fund, is mandatory for those eligible and requires no premium payments from eligible persons. Persons not eligible can purchase Part A coverage; the cost of the premium depends on how much covered employment a person has. Persons with no covered employment must pay the full actuarial cost, which was $3,700 per year in 1997. Enrollment in the Supplementary Medical Insurance Trust (Part B) is voluntary and is limited to those who are entitled to Part A. Nearly all persons over 65 who are eligible for Part A also purchase Part B coverage. The current premium is $43.80 per month. (Those who choose not to enroll often have generous coverage as a retirement benefit.) Nearly 80 percent of Medicare beneficiaries also have supplemental insurance, either “Medigap” or a retirement plan.

About 90 percent of Part A income comes from a 2.9 percent payroll tax-half paid by employees and half by employers. Self-employed individuals pay the full 2.9 percent. The rest comes from interest earnings, income from taxation of some Social Security benefits, and premiums from voluntary enrollees. Part B of Medicare is financed primarily through beneficiary premiums (about 25 percent) and general revenues (about 75 percent). Part B does not face the prospect of insolvency because general revenues always pay any program expenditures not covered by premiums.

Should beneficiaries pay more?

One proposal to reduce federal outlays for Medicare would require beneficiaries to pay a larger share of the program’s costs. But the proposal fails to consider a compelling fact: Medicare currently pays only about 45 percent of the total health care costs of older Americans. Contrary to what many Americans assume, Medicare benefits are less generous than typical employer-provided health policies. Although Medicare covers most acute health care services, it does not cover significant items such as many diagnostic tests, eye examinations, eyeglasses, and hearing aids. Most important, it does not cover the cost of prescription drugs.

Many chronic conditions are now successfully controlled with medications. In 1998, Medicare beneficiaries with prescription drug expenses will spend an average of $500 per person on medications. Beneficiaries who need to take multiple drugs on a daily basis can easily pay twice that amount. Of the 10 standard Medigap policies, only the three most expensive ones include prescription drug coverage, and some of these are not sold to people with preexisting health conditions. In short, most seniors are simply out of luck when it comes to insurance protection for prescription drug expenses.

Another gap in protection is for long-term care, which includes health care, personal care (such as assistance with bathing), and social and other supportive services needed during a prolonged period by people who cannot care for themselves because of a chronic disease or condition. Long-term care services may be provided in homes, community settings, nursing homes, and other institutions. Medicare’s coverage of nursing home care and home health care is generally limited to care after an acute episode, and Medigap policies don’t cover long-term care. Private long-term care insurance is available, but very few people over 65 purchase it because of high premium costs. The average cost of a moderately priced policy at age 65 is about $1,800 per year; at age 79, about $4,500.

Part A and B services require considerable cost sharing in the form of deductibles and copayments, and unlike most private health insurance plans, Medicare does not have a catastrophic coverage cap that limits annual financial liability. Since the 1980s, several legislative changes have increased the amount of program costs for which Medicare beneficiaries are responsible through premium increases, higher deductibles, and increased copayments. In 1997, Medicare beneficiaries spent on average about $2,149 or nearly 20 percent of their income on out-of-pocket costs for acute health care. These costs include premiums for Part B and Medigap insurance, physician copayments, prescription drugs, dental services, and other uncovered expenses. These estimates do not include payments for home health care services or skilled nursing facility care not covered by Medicare. In 1995, Medicare beneficiaries who used skilled nursing facilities (less than three percent of all beneficiaries) had an average length of stay of about 40 days, which would have required a copayment of about $1,900. Some medicap policies will pay this. Compared to persons under 65 who have insurance, Medicare beneficiaries pay a significantly larger share of their health care costs through out-of-pocket payments.

Medicare’s home health benefit is a particular focus of proposals to increase cost sharing. The home health benefit covers intermittent skilled nursing visits and part-time intermittent home health aide visits to assist people with tasks such as bathing and dressing. Home health is the only Medicare benefit that does not require cost sharing. A congressional proposal last year would have required a $5 copayment per visit for many Medicare beneficiaries who receive home health care. Although this may appear to be a trivial amount, a closer look at the recipients of home care and the amount of services they receive indicates that the copayment could indeed prove to be unaffordable for a large proportion of home health beneficiaries. About a third of these beneficiaries have long-term needs and, compared with other home health users, are more impaired and poorer than the average Medicare beneficiary. This group of long-term home health users is also more likely to have incomes under $15,000 a year. Because they receive on average more than 80 home health visits a year, a $5 copayment would increase their costs by more than $400 a year. There are serious equity concerns about requiring the poorest and most infirm Medicare beneficiaries to pay such an amount.

Individually purchased Medigap insurance is often medically underwritten and is expensive. Annual premiums can range from $420 to more than $4,800, depending on the benefits offered and the age of the beneficiary. Annual premiums for a typical Medigap plan reached $1,300 in 1997. Despite their high cost, however, many standard Medigap policies offer little protection. Only 14 percent of beneficiaries have policies that cover prescription drugs. Rising Medigap premium costs, fueled in part by the growth of hospital outpatient services that require a 20 percent copayment, have become an issue of growing concern to many older Americans.

Employer-provided retiree health coverage is another important source of financial security for some older Americans. Retirees, especially those who have the least income or the poorest health, value this extra security as well as the comprehensiveness of the insurance as compared to Medigap plans. However, the number of firms that offer health benefits to Medicare-eligible retirees is declining. Fewer than one-third of all large firms now award retirement health benefits. Firms are also limiting their financial obligations to retirees by restricting health benefit options, tightening eligibility requirements (such as required length of employment), and increasing individual cost sharing. And more companies are replacing insurance with defined contribution plans in which retirees get a fixed dollar amount to purchase health benefits. Thus, the value of the employer contribution can diminish over time.

The relationship between Medicare and the supplemental insurance market is complex and will continue to change as the market changes in many areas of the country and as the nature of employer-sponsored retiree coverage evolves. These trends and their interrelationships must be thoroughly assessed when considering possible structural alterations in Medicare. It cannot be assumed that if Medicare raises deductibles and copayments, Medigap policies will cover the increased cost sharing, or if they do, that they will remain affordable.

Medicare beneficiaries, whatever their income, pay the same monthly Part B premiums. Some people believe that requiring people with higher income to pay a larger amount would be more equitable. In 1997, Congress considered but did not enact a proposal that would have made the Part B premium income-related: Medicare beneficiaries with higher incomes would have been required to pay more, and rates for those with low incomes would have remained unchanged. Concerns were raised that any approach to make people with higher incomes pay more would undermine the social insurance basis of the program and encourage higher-income elderly persons to opt out. However, the primary reason Congress dropped the proposal was because administering it would have been complex and costly and because it would not have produced significant new revenue. This is not surprising given that 50 percent of persons 65 and older have incomes less than $15,000 per year.

Age of eligibility

The Bipartisan Medicare Commission is specifically charged to make recommendations on raising the age-based eligibility for Medicare. Proponents argue that because the eligibility age for Social Security will gradually rise to age 67 in 2025, Medicare’s eligibility age should rise as well. This reasoning, however, is based on a misunderstanding of how Social Security works. It isn’t the eligibility age for Social Security that is being raised but rather the age at which a person is eligible to receive full benefits from the program. All persons eligible for Social Security will still have the option of retiring at age 62 with reduced benefits, and many do.

If Medicare eligibility were to truly parallel Social Security eligibility, then Medicare would offer reduced benefits to early retirees who would be required to pay a greater portion of the actuarial value of the Part B premium than current beneficiaries pay. Such a policy was recently proposed by the Clinton administration as a practical way of providing health insurance to people aged 55 to 64 who need to take early retirement. The proposal was criticized by those who questioned its budget neutrality and by those concerned about the affordability of premiums for low-income Medicare beneficiaries, particularly as they reach advanced ages.

Although reducing the number of people who are eligible for Medicare would appear to be a major source of program savings, closer analysis indicates that it is not. A recent study found that even if the eligibility age were raised immediately, no more than a year would be added to the life of the Part A trust fund, because a significant number of people aged 65 and 66 would still qualify for Medicare on the basis of disability. Also, per capita Medicare expenditures for persons 65 and 66 years old are less than two-thirds of the cost for the average beneficiary. It is estimated that raising the eligibility age to 67 would reduce total annual program costs by only 6.2 percent. For this small saving, the number of uninsured 65- and 66-year-olds could reach 1.75 million.

By any measure, the incidence of health problems increases with advanced age. The earlier the age of retirement, the greater the frequency that poor health or disability are cited as the primary reason for retiring. Health insurance and the access it provides to medical care become more important as people grow older because of the increasing risk of having major and multiple problems. In the current medically underwritten health insurance market, people who are older and who do not have employer-provided insurance are not likely to be covered. Either they are considered medically uninsurable because of preexisting conditions, or they are charged so much because of a preexisting condition that they can’t afford the policy. On the basis of data from the National Medical Expenditure Survey, a rough estimate of the cost of a private, individual insurance policy covering 80 percent of expenses for a 65-year-old person is about $6,000 per year.

It is tempting to assume that if the age for Medicare eligibility were increased, employers who provide health benefits to retirees would simply extend their coverage to fill the gap. In reality, the opposite is likely to happen. Economists at Rand found that between 1987 and 1992, the percentage of employers offering retiree health benefits to persons under 65 decreased from 64 percent to 52 percent. This is not surprising, because retiree coverage of those 65 and older is supplemental to Medicare and therefore costs much less than the coverage provided to those under 65. A recent study found that the average annual employer cost for employers offering coverage per early retiree under 65 was $4,224; for retirees 65 and older, it was $1,663. For at least a decade, U.S. employers have been cutting back on health insurance coverage for workers and retirees, and this trend is expected to continue indefinitely.

Recent court rulings have further contributed to the insecurity of retiree health benefits. In separate 1994 rulings, two federal appeals courts decided that under the Employment Retirement Income Security Act (ERISA), employers can modify or terminate welfare benefit plans, notwithstanding promises of lifetime benefits that were given to employees. In effect, the courts ruled that “informal” documents distributed to employees promising lifetime benefits are basically irrelevant if the actual contract specifies different provisions. In 1995, the U.S. Supreme Court refused to hear an appeal of an Eighth Circuit Court decision that allowed a company to modify its retirees’ health benefits. Also in 1995, the Supreme Court found that employers are generally free under ERISA, for any reason and at any time, to adopt, modify, or terminate welfare and health benefit plans.

Taken together, the high cost of health insurance, the decreasing number of companies offering retiree health benefits, and the unfavorable court rulings make it extremely unlikely that employers are going to step in and provide health care coverage for people aged 65 and 66. Thus, the Medicare Commission should not consider an increase in Medicare’s eligibility age without fully recognizing the limitations of the private health insurance market and the certain increase in the number of uninsured persons. Any reasonable proposal to increase the Medicare eligibility age must include provisions for people aged 65 and 66 to buy into the Medicare program. But this is not a straightforward solution, because it raises questions about the affordability of the actuarially based Medicare premium (about $3,000 in 1997) and the resulting need for subsidies for low-income persons.

Is managed care the savior?

One of the most significant recent developments within the Medicare program is the introduction of managed care. More than 5 million Medicare beneficiaries are enrolled in managed care plans, and the Congressional Budget Office has projected that within a decade, nearly 40 percent of beneficiaries will be enrolled in managed care. Some think that managed care could be the salvation of the Medicare program, because they believe that it can simultaneously reduce overall Medicare expenditure growth and provide better benefits and lower cost sharing for Medicare enrollees. There are valid reasons for thinking that this scenario is in fact too good to be true.

Managed care plans do tend to provide more generous benefits and require less cost sharing than the traditional Medicare program. By accepting limits on their choice of doctors and hospitals, Medicare beneficiaries may secure valued benefits such as prescription drugs, often without additional charges. Managed care plans receive a monthly payment per enrollee from the federal government that is about 95 percent of the average cost of treating Medicare patients in the fee-for-service sector. But because plans tend to attract healthier individuals, whose cost is less than this per capita rate, Medicare pays more than it otherwise would have for these beneficiaries under fee-for-service. One study by the Physician Payment Review Commission found that the cost of treating new Medicare managed care enrollees was only 65 percent of the cost of treating beneficiaries under the fee-for-service system. This overpayment problem is exacerbated by the fact that people can switch from managed care plans to fee-for-service once they become seriously ill, and managed care plans clearly have a strong financial incentive to adopt practices that will encourage them to do so.

How to deal with the distortion of financial incentives caused by people with high medical expenses remains a difficult problem. People with major chronic illnesses who need more extensive medical services than the average older person are not considered attractive enrollees because they pose a major financial liability for health plans. If statistical adjustments in Medicare plan payments based on the health status and diagnosis of enrollees could be developed, health plans would be less likely to avoid enrolling this population and less likely to skimp on their care. However, the development of predictive risk models powerful enough to offset risk selection practices by plans is still many years away.

Thus, achieving Medicare savings from an increase in managed care enrollments is not ensured. Health maintenance organizations (HMOs) may choose to enter the Medicare market if they believe that the per capita payments, relative to costs, will yield financial rewards. However, there may prove to be a fine line between setting federal payments high enough to attract HMOs into the Medicare program and setting plan payments at a level that yields any real program savings. Federal budget officials will need to keep their fingers crossed and hope that Medicare savings from managed care will grow over time as plans gain experience in controlling utilization and reducing lengths of hospital stays among the elderly.

One final proposal to revamp Medicare must be examined. For nearly 20 years, one school of economists has argued that we need to fundamentally alter the way we think about Medicare benefits. Their view is that instead of an entitlement to benefits, a Medicare beneficiary should receive a voucher to be used to purchase private health insurance. Supporters argue that this approach would offer beneficiaries the ability to select a health plan that best meets their health and financial needs, much as federal employees do through the Federal Employees Health Benefits Program. It would also give Congress better control of Medicare spending. But theoretical advantages are tempered by practical questions: how to prevent insurance companies from engaging in risk selection; how to prevent diminished quality of care, particularly in lower-cost plans; and most important, how to ensure that the amount of the voucher is sufficient to purchase at least the same amount of benefits and financial protection that Medicare currently provides. This last concern is particularly important for beneficiaries who have the least income and the greatest medical needs. When considering this approach, the Medicare Commission will need to carefully balance hypothesized cost savings with other societal goals such as affordability, access, and quality of care.

Will society choose to pay more?

Medicare’s structure and financing must evolve if it is to meet the health care needs of the retired baby boom cohort. The changes that will be required will entail difficult policy choices. Raising Medicare’s eligibility age to 67 will cut some costs, but at what price? Are the savings worth the cost of creating a new group of uninsured older Americans? Imposing additional cost-sharing requirements on Medicare beneficiaries would in theory provide a powerful incentive to limit their use of health services. In reality, the availability of supplemental insurance decreases this incentive, and there is evidence that increased cost sharing can decrease the utilization of medically necessary care. This would be a particularly negative and potentially costly outcome for older persons with chronic conditions who require periodic physician and outpatient care. In general, increasing cost sharing is a regressive approach because it shifts costs to those who are sickest and it imposes a greater burden on the poor

We must continue to reduce the rate of increase in Medicare’s costs. We also have to acknowledge the possibility that society will choose to pay more-in short, higher taxes-for Medicare’s continued protection. This option is often dismissed as not politically feasible, but when people understand the personal costs of the alternatives, they may change their minds.

Medicare has strong and enduring public support because it is a universal program. Although Medicare must be put on a sound financial basis, its universal nature must not be undermined, and reform must not come at the high price of increased numbers of uninsured, increased financial insecurity, and reduced care for those who need it the most. President Johnson perfectly captured the larger purpose of the Medicare program when he said “with the passage of this Act, the threat of financial doom is lifted from senior citizens and also from the sons and daughters who might otherwise be burdened with the responsibility for their parents’ care. [Medicare] will take its place beside Social Security and together they will form the twin pillars of protection upon which all our people can safely build their lives.” We need to ensure that this protection continues into the 21st century.