Executive Summary
The long-term solvency of Medicare is the most serious domestic policy problem this country faces in the 21st century. Despite the rosy forecasts from politicians, the Medicare Trustees confirm that health care spending will consume an increasing proportion of the economy. As this occurs, Medicare spending will crowd out other government services.
Perverse incentives for patients and providers to squander resources are enormous. Medicare is an entitlement that places few limits on the services seniors consume. Beneficiaries bear little of the cost if they are wasteful and benefit little when they consume care prudently. In addition, Medicare providers have few financial incentives to control costs and keep beneficiaries out of the hospital.
Historically, a fundamental problem with efforts to contain Medicare expenditures is that Medicare follows a top-down model. Policymakers have tried to hold down spending with price controls and caps on the fees doctors and hospital earn, rather than empowering seniors to police their own consumption. One of the top-down cost-control methods involves paying hospitals a fixed fee per patient diagnosis. Another one (now modified) required automatically scaling back physician fees by a similar percentage if spending on physicians exceeded a specified growth rate. These efforts were largely unsuccessful. In 2010, the Affordable Care Act created a 15-member Independent Payment Advisory Board (IPAB) that has the power to cut reimbursements when the rate of spending growth exceeds a predetermined threshold. The five-year-old program has no members and Congress is debating repealing it.
Spending per beneficiary has risen over time as medical technology — and perverse incentives — have raised Medicare’s costs. Per capita spending on Medicare beneficiaries has skyrocketed since its inception:
- In 1970, annual per capita Medicare spending was only $385.
- Today it is $12,430.
- It is projected to approach $19,000 a decade from now.
Medicare spending as a percentage of gross domestic product (GDP) was 1.3 percent in 1980, 2.2 percent in 2000 and now is about 3.5 percent. Spending is expected to surpass 4 percent by 2022, and under projections that are likely to occur, could reach 9.1 percent of GDP in 2089.
To affect consumer demand sufficiently to slow Medicare spending, policymakers must find ways to promote price sensitivity among beneficiaries long after they have met their deductibles. To reduce health expenditures from the supply side, policymakers have to find ways to promote competition among providers caring for seniors. In addition, health plans and providers must be rewarded when they come up with cost-saving programs that provide high-quality care at a lower cost.
With the appropriate reforms, an increase in payroll taxes could fund a health spending account seniors
themselves control — an idea known as prefunding. Putting seniors in charge of the funds in their account
would make them more prudent consumers of health care because any unused funds would roll-over and
accumulate for future health care expenses.
One way to prefund a portion of Medicare expenditures is to set up a Medicare Health Savings Account (HSA) for each worker. Working-age adults — and their employers — could jointly contribute a total 4 percent of payroll into a type of mutual fund that accumulates and grows at market rates. Upon reaching Medicare eligibility at age 65, the accumulated funds would be converted into an annuity that provides an annual payment into each senior’s Medicare HSA. Upon reaching Medicare eligibility, seniors would also be covered by a high-deductible plan with potentially little-to-no cost sharing above a $5,000 annual deductible.
An actuarial analysis for the NCPA conducted by Milliman Inc., a national consultancy, found that
prefunding personal accounts and coupling them with high-deductible plans would save Medicare an estimated $2.4 trillion annually by 2053 compared to the status quo. Of this amount:
- An estimated one-fifth ($434 billion) would come from better incentives that reduce the rate of health care inflation (that is, the medical trend rate).
- An estimated one-third of the savings ($787 billion) would come from reduced use of benefits by seniors.
- An estimated one-quarter ($651 billion) would come from increased cost-sharing by seniors.
A few health plans are experimenting with a concept that attempts to make enrollees care about the price of
costly services even after their deductibles are met using a concept known as reference pricing. Reference pricing is an arrangement where enrollees face unlimited costsharing for all costs of a treatment or a procedure above a stated reference price set by the health plan, and close to some price available in the market. Because enrollees are very sensitive to prices higher than the reference price, providers have an incentive to charge the reference price to avoid losing business. Thus, high-deductibles and reference pricing will encourage doctors and hospitals to compete for seniors’ business on the basis of price.
There are other methods Medicare plans could use to raise quality and reduce costs. Seniors’ cost-sharing could be reduced or bonus deposits made to their Medicare HSA in return for working closely with a Medicare Advantage plan’s care coordinator. Medicare Advantage plans are integrated health plans responsible for all medical care received. Copays could be reduced or possibly waived for seniors who first call their medical home to inquire about medical tests, prescription drugs or where to receive care in the event urgent care was needed.
Not long after Medicare was established in 1965, expenditures began to skyrocket. Rather than create
a sustainable program where seniors shared some of the responsibility for controlling spending, politicians’
preferred method to contain costs was to ratchet down reimbursements to Medicare providers. This was a
mistake. Increasingly, Medicare needs to encourage workers to prefund more of their retiree medical needs
and empower seniors to make more prudent spending decisions with the appropriate incentives. In addition,
Medicare should explore other cost-sharing tools that could make beneficiaries price-sensitive above their
deductibles.