Following the close of the National Bipartisan Commission on the Future of Medicare, discussion on overall Medicare reform has begun to take a back seat to the debate over prescription drugs. But the need for Medicare reform is as great as ever.
This Backgrounder discusses the proposal for Medicare reform that was developed by a bipartisan and bicameral group of members on the Medicare Commission. The core of the commission's proposal is embodied in the Medicare Preservation and Improvement Act of 1999 (S.1895), introduced last November by Sens. John Breaux (D-La.), Bill Frist (R-Tenn.), Bob Kerrey (D-Neb.) and Chuck Hagel (R-Neb.), and cosponsored by Sens. Judd Gregg (R-N.H.) and Kit Bond (R-Mo.).
[page]"The Balanced Budget Act of 1997 created a commission to propose fundamental reform of Medicare"
In the spring of 1997, Medicare trustees warned that the Hospital Insurance (HI) Trust Fund – the trust fund for Medicare Part A, which pays for hospital care – would be exhausted in 2001. Congress responded with the Balanced Budget Act of 1997. This extended the predicted life of the Part A trust fund to 2008 by lowering the amounts paid hospitals, other providers and managed care plans and by shifting some expenses (particularly a portion of home health care costs) from Part A to Part B. Part B is the Supplementary Medical Insurance (SMI) portion of Medicare; it pays for physician and outpatient hospital services, diagnostic tests and certain other services. Part A is funded by a specifically dedicated payroll tax. Part B is funded through general income tax revenues (75 percent) and beneficiary premiums (25 percent). The amount available under Part B, therefore, is not limited to a finite sum.
Congress recognized that the financial health of the Part A trust fund was only one of the many issues confronting Medicare and that the Balanced Budget Act was only a short-term reprieve from the overall financial woes facing the program. Accordingly, the act also created the National Bipartisan Commission on the Future of Medicare, directing it to analyze the long-term financial condition of the program, identify its financial problems and recommend solutions. After a full year of in-depth analysis of the Medicare program by all 17 members, the commission produced a proposal supported by 10 of the 17 members.
"However, President Clinton did not support the Medicare reform proposal developed by the very commission he created."
However, ultimately President Clinton did not support the Medicare reform proposal developed by the very commission he created. Instead, the president told the American people that dedicating a portion of future government budget surpluses to the Part A trust fund could resolve Medicare's financial problems and permit the expansion of benefits. In January 1999, while the commission was deliberating, the president proposed transferring 15 percent of projected federal budget surpluses over the next 15 years to the Part A trust fund. He also proposed expanding Medicare to include a prescription drug benefit. And he proposed extending Medicare to 55-to-64-year olds – supposedly on a "budget neutral basis," meaning they would pay premiums to cover the cost of the coverage.
As the work of the commission was concluding, the Medicare trustees issued their 1999 report on the status of the Part A trust fund. Because of the Balanced Budget Act and the strong economy, the trustees pushed the estimated date of the depletion of the Part A trust fund from 2008 to 2015.
The effective message was that the budget "surplus" would solve Medicare's financial problems, enhance benefits and extend coverage without increased taxes. Medicare thus moved out of public debate, except where the debate focused on a new drug benefit. Yet the underlying problems remain. Medicare reform is essential and inevitable.
Beneficiaries, taxpayers, policy experts, Medicare administrators and providers all agree that Medicare needs to be reformed, but "Medicare reform" means entirely different things to different people.
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While the threat of imminent bankruptcy of the Part A trust fund drew attention in 1997, that is only a small part of the problem.
The Medicare trust funds are a government accounting device, unlike private trust funds that can invest money to pay future liabilities. The Part A trust fund merely shows the extent to which payroll taxes are available to pay for hospital and other care covered under that part. When there is no balance in that trust fund, Medicare cannot spend money for Part A services. For most of the 1990s, the Part A trust fund spent more each year than it took in, drawing down the balance of the fund. While 1998 and 1999 were better than expected, the trust fund will run out of money; it is only a question of when.
"Medicare is a pay-as-you-go program; increased future spending will require higher and higher taxes."
The Part B trust fund is even more of a fiction; it represents an estimate of the amount of general revenues needed (on top of the 25 percent paid by beneficiaries through their premiums) to cover medical expenses in the upcoming year.
The payroll taxes that fund Part A continue to contribute an increasingly smaller portion of the total tax revenues needed to sustain Medicare.
- Part A payroll taxes accounted for 54 percent of all Medicare spending in 1997. [See Figure I.]
- The commission estimated that by 2025 payroll taxes will fund only 21 to 25 percent of total Medicare expenditures.1 [See Figure II.]
"Payroll taxes have been shrinking as a source of Medicare funding."
Government expenditures for Part B services are not funded by a dedicated payroll tax, nor are they limited to a predetermined amount of money. A Medicare beneficiary who enrolls in Part B pays a premium ($45.50 per month in 1999 and 2000) to cover 25 percent of Part B, and the remainder is financed by a mandatory appropriation; Congress must appropriate whatever is necessary to pay for Part B services.
In one sense, Medicare Part B does not pose the same problem that Part A does. The money is there, funded automatically. In another sense, however, this is the problem. Part B has a first and automatic call on general tax revenues with no limit as to how much can be spent. Spending decisions are made by default without consideration of other governmental needs for the money (except as expenditures are limited by the effect of specific programmatic changes in covered services).
The dedicated funding source for Part A provides a mechanism to alert Congress of the financial needs as evidenced when trust fund dollars are low. However, President Clinton's proposal to precommit money from future general tax revenues for Part A is based on the assumption that projected surpluses will materialize. Most importantly, precommitting future general revenues eliminates the current mechanisms in place that are necessary to gauge the fiscal soundness of Medicare, predetermines future budget priorities (which is impossible) and undercuts the need to make the program more efficient. In essence, it lets Medicare run out of control.
The real economic issue relates not to the future exhaustion of the Part A trust fund, but to the total amount of Medicare spending and the funds necessary to sustain this overall spending.
- When Part A costs exceed the balance in the trust fund, those costs will have to be paid, either by diverting general tax revenues to Part A, which leaves less money for other government programs, or by increasing the payroll tax.
- The rise in Part B costs will automatically consume a larger percentage of general revenues, forcing relative cutbacks in other government programs or requiring an increase in income taxes.
"Although Medicare takes 12 percent of the federal budget today, it will take up to 38 percent in 2030."
Whether funded through payroll taxes, income taxes or some new taxes, total Medicare spending increasingly will burden the federal budget and the general economy. As Figure III shows:
- Medicare now accounts for 12 percent of the federal budget.
- The commission projected that this would grow to 28 to 38 percent (depending on assumptions) in 2030.
The financing problem consequently is not only a question of when the Part A trust fund will be depleted but also of the mechanism by which the total amount spent on Medicare is determined.
[page]Even though the financing of current Medicare benefits is unstable and raises critical budgetary issues, some people are demanding additional benefits. Medicare only covers nursing home care for 100 days after a hospitalization, limits the number of covered hospital days and covers few outpatient prescription drugs. Medicare covers care for illness, not management of chronic conditions. To some people, reform means adding these benefits to Medicare coverage. In addition, the president proposes expanding Medicare to cover unemployed individuals as young as 55 on what he alleges would be a cost-neutral basis to Medicare.
Medicare in its current form not only is rife with waste and inefficiency, but also leaves beneficiaries exposed to thousands of dollars in out-of-pocket costs. As many as 360,000 Medicare beneficiaries faced annual costs in excess of $5,000 each in 1998.2
- To avoid the prospects of financial devastation, a majority of seniors acquire private insurance to fill the gaps in Medicare – either through a former employer (30 percent), private "Medigap" insurance (28 percent) or a combination of the two (4 percent).3
- However, economic studies show that seniors with supplemental insurance consume significantly more health care than those without the insurance.4
- In addition, most Medigap policies do not cover drugs and many employer plans have incomplete coverage.
"Some 16 percent of Medicare beneficiaries have joined managed care plans."
Medicare was formulated in the 1960s and modeled on the fee-for-service private insurance of that era. While the commercial market has since developed a variety of insurance and delivery arrangements, and medicine has advanced tremendously, Medicare has remained much the same. Approximately 84 percent of Medicare beneficiaries are in the fee-for-service system. Medicare pays providers for each service, so Medicare and its contractors must determine the reasonableness and necessity of millions of services each year. At the same time, Medicare permits patients to demand any service they hope may help them, regardless of its merit or cost, and physicians have an economic incentive and professional imperative to satisfy these demands. They are subject only to Medicare's finding a particular service unnecessary and refusing to pay.
Medicare has sought to counteract these incentives by setting the prices it pays hospitals, doctors and other providers. The result is a complex scheme that sets the amount Medicare pays for virtually every service provided to every Medicare beneficiary. Of course, no bureaucracy can determine the "right" price for every service. To the extent that the price is higher than it would be in a competitive market, Medicare money is wasted. To the extent that it is lower, providers must subsidize Medicare beneficiaries and thus find it more advantageous to concentrate on private pay or private sector patients.
Medicare controls beget additional controls, making the system's rules and restrictions even more incomprehensible and difficult to follow.
To keep patients and providers from circumventing the controls, the Health Care Financing Administration (HCFA), the agency that administers Medicare, has sought to prohibit beneficiaries from using their own money for care that Medicare does not cover or determines is not medically necessary. A recent court decision permits beneficiaries to obtain such care, but only if the doctor and patient engage in a bureaucratic process of red tape. Overall under Medicare, patients are prohibited from paying out of their own pocket to obtain care from a physician of their choice, unless the physician is willing to undergo severe penalties (i.e., exclusion from the Medicare program for two years).
"No one has an incentive to balance the cost of care against the expected benefit."
As a result of these controls, Medicare has changed from a program that helps beneficiaries pay for care they and their doctor choose to a government-run health care system that determines what care beneficiaries can get and what prices providers will be paid. Even with these controls and a complex administrative system to review the medical necessity of each specific service, Medicare can control only unit prices, not utilization. Neither patients nor doctors have an economic incentive to balance the cost of care against the expected benefit. And taxpayers, through Medicare, pay.
Some 16 percent of Medicare beneficiaries have joined managed care plans. These plans compete with the open-ended but regulated fee-for-service system and are paid an amount based on the cost of the fee-for-service system, with formulaic adjustments determined by Congress.
Currently, the small percentage of Medicare beneficiaries enrolled in private HMOs get more benefits at a lower cost. However, because the government's method of paying premiums to these private plans is highly imperfect, discrepancies exist. Many believe that the average HMO is overpaid.5 However, a number have been underpaid – and are leaving the market. The plans providing services under Medicare+Choice are subject to a complex and prescriptive regulatory structure, where reimbursements, eligibility and core benefits are all predetermined by the federal government.
[page]These problems and different perspectives on what reform means came to a head in the deliberations of the National Bipartisan Commission on the Future of Medicare. The commission's organizational statute required that 11 of its 17 members agree on any recommendation. No proposal received that supermajority support, and the commission did not issue a recommendation. However, Sens. Breaux and Frist developed legislation (S.1895) that incorporates the fundamental principles established in the commission's proposal. S.1895 addresses both benefit expansion and system reform in the same package, illustrates the types of change necessary and demonstrates the scope of the problems that Medicare faces even with reform.
"The core recommendation: restructure Medicare along the lines of the federal employees health plan."
The core recommendation of the commission, carried forward by S.1895, is to restructure Medicare, using as a model the Federal Employees Health Benefits Program (FEHBP). The FEHBP covers nine million federal employees, retirees and their families, including members of Congress. Under S.1895, beneficiaries would be subsidized by the federal government (as they are today) for participation in any of the competing private or government-sponsored plans offered under Medicare, including the current Medicare fee-for-service program. Depending on the plan chosen, beneficiaries could pay as little as nothing up to the current Part B premium ($45.50) for all Medicare benefits and would have the option to pay slightly higher premiums for drug coverage and/or additional benefits not offered by Medicare today.
The contribution amount would be based on the national average – weighted by plan enrollment and adjusted for risk and geography – of the premiums for standard benefits. The standard benefit package would be "all services guaranteed under the existing Medicare statute."6 Plans could offer additional benefits, but a Medicare Board would be required to approve variations to ensure that the "overall value of the package would be consistent with statutory objectives and would not lead to adverse or unfavorable risk selection problems."7
Breaux-Frist would peg the overall Medicare contribution to 88 percent of the national average of the cost of the standard benefit package. This is more than the government is forecast to provide in 2015 under current law (86 percent).
"Medicare would pay for a standard benefit package."
By contrast, under Breaux-Frist the amount of Medicare's contribution would be guaranteed. However, the contribution would be calculated based on the standard benefit package and would be calculated so that the subsidy decreases the more expensive the plan becomes. Beneficiaries would not pay more than they do today in Part B premiums for a plan that represented the national weighted average, but could receive 100 percent subsidy for a plan that is less than 85 percent of the national weighted average.
In rural areas, where managed care and competition among plans is unlikely, beneficiaries would be protected from paying premiums that are higher than the current Part B premiums (or 12 percent of total spending on Medicare).
Establishing a Medicare Board. The new Medicare Board proposed to administer the Competitive Premium System would oversee competition among private and government-sponsored (the continuing HCFA-run fee-for-service) plans. The board is viewed as the Medicare equivalent of the Office of Personnel Management, which manages the federal government's health insurance for its employees. It would, among other tasks, compute payments to plans, manage an open-enrollment period, provide comparative information, enforce financial and quality standards, review and approve benefit packages and service areas to preclude adverse selection and, most importantly, negotiate health plan premiums.
"The Medicare Board would have to be designed carefully so it could not become a new, expanded HCFA."
The board would have strong purchasing power as well as regulatory authority. It would exercise its authority by regulation and negotiation with plans rather than by regulating providers directly as HCFA now does. Because there is potential to structure a board based on increased regulation, the board would have to be designed carefully so it could not become a new, expanded HCFA.
Further, to preserve a private market, S.1895 lets plans decide what benefits, above the minimum, they would offer, and at what price. And it would have to leave the purchasing decision to the beneficiaries.
Providing a mechanism for outpatient drug coverage. Under the Breaux-Frist proposal, all health plans offering Medicare coverage, including HCFA, would have to offer a standard plan that includes all current Medicare benefits as well as a high-option plan that includes current benefits, prescription drug coverage and stop-loss protection. Thus, beneficiaries would have the option to choose a plan that best suits their individual health care needs. At the same time, S.1895 would provide prescription drug coverage at no premium cost to beneficiaries with incomes less than 135 percent of the federal poverty level. S.1895 would also subsidize the cost of drug coverage for all beneficiaries with a premium "discount" based on a sliding scale for those with incomes between 135 percent and 150 percent of poverty and a guaranteed 25 percent discount off premiums for beneficiaries with incomes above 150 percent of poverty.
Combining the Part A and B Trust Funds. With Part A and Part B combined into a single trust fund, the Medicare Board would report on the extent to which Medicare was funded through general revenues. If general revenue funding exceeded 40 percent, Medicare would be considered "programmatically insolvent." The automatic appropriation would not be effective for amounts above this level, but instead Congress would have to approve any additional expenditures from general revenues, thereby creating a responsible mechanism in which to determine the financial viability of the program.
[page]Overall, the Breaux-Frist proposal would provide Medicare beneficiaries with control over their health benefits as well as an updated benefit package reflecting advancements in medicine and prescription drug coverage. They could choose the plan they want, a choice that would benefit each beneficiary and make the system more efficient. Because beneficiaries would have a pre-determined amount of assistance, they would be more price sensitive and plans would be more competitive. Because beneficiaries would be able to choose, they would force plans to provide quality care in an efficient way. The savings would provide higher benefit levels or lower taxes.
The commission estimated that its proposal, including the added benefits and changes in eligibility to be consistent with eligibility for Social Security benefits, would reduce the growth rate in Medicare by 12 percent. Whether additional funding would be required can be considered after the changes make the system more efficient.
"Medicare beneficiaries will have more control over their health care, and the government less, if the board does what it is supposed to do."
If the Medicare Board is not so powerful it overwhelms individual choice, government control over the delivery of health care will lessen. Medicare beneficiaries will be able to choose how their health care is provided, and government will have less control of providers and beneficiaries. Health plans will exercise control, but beneficiaries will be able to decide which rules they are willing to accept, balancing the relative costs and benefits of the various plans.
Breaux-Frist thus takes a large step toward modernizing and improving the structure, as well as the benefits, of Medicare.
NOTE: Nothing written here should be construed as necessarily reflecting the views of the National Center for Policy Analysis or as an attempt to aid or hinder the passage of any bill before Congress.
[page]- The proposal and supporting data prepared by staff are available at http://medicare.commission.gov
- See Mark E. Litow, "Defined Contributions as an Option in Medicare," September 17, 1999, Milliman & Robertson, Inc., for the National Center for Policy Analysis. http://www.ncpathinktank.org/studies/mr020400.html
- Franklin J. Eppig and George S. Shulis, "Trends in Medicare Supplementary Insurance, 1992-96" Health Care Financing Review, Vol. 19, No. 1, Fall 1997. Another 17 percent of Medicare beneficiaries also have Medicaid coverage.
- For example, see Sandra Christensen and Judy Shinogle, "Effects of Supplemental Coverage on the Use of Services by Medicare Enrollees," Health Care Financing Review, Vol. 19, No. 1, Fall 1997.
- See Joseph P. Newhouse, Melinda Beeuwkes Buntin and John D. Chapman, "Risk Adjustment and Medicare," revised June 1999, Commonwealth Fund.
- "Building a Better Medicare for Today and Tomorrow," National Bipartisan Commission on the Future of Medicare, March 16, 1999, available on the commission's web site at http://medicare.commission.gov/medicare/bbmtt31599.html
- Ibid.