Careening Towards the Wall: The Case for Medicare Reform

by Michael Lynch, Public Policy Fellow

Introduction

Established in 1966, Medicare currently pays for the health care for more than 33 million people over the age of 65 and 4 million disabled people. One out of seven Americans receive their health care through Medicare.

Structurally, Medicare is composed of two parts: Medicare Part A and Medicare Part B. Medicare Part A covers the first 60 days of inpatient hospital care after a $716 deductible. Medicare Part A expenditures come from a trust fund funded by a payroll tax, which is currently 2.9 percentof gross income. Medicare Part B, or Supplementary Medical Insurance, covers out-patient medical services, typically at a rate of 80 percent of approved prices. Medicare Part B relies on two sources of funding: enrollees pay 31 percent of the program's costs in premiums, currently set at $46.10 per month, while the other 69 percent of the program is paid for out of general revenues, or the federal budget.

Critical Condition: Medicare's Spiraling Costs

From the outset, Medicare's costs far outstripped its creators' most conservative estimates. In 1965, the House Ways and Means Committee estimated that Medicare would cost approximately $12 billion in 1990. In 1990, Medicare cost $109 billion, 900 percent over target. Medicare's expenditures have doubled in the last decade alone, increasing from $70 billion in 1985 to 162 billion in 1994. Figure I illustrates Medicare spending since 1980, which has increased at an average annual rate of approximately 10 percent.

Today, Medicare is the fastest growing program in the federal budget. Total Medicare spending is exceeded only by social security, defense, and interest on the national debt. Unfortunately, Medicare in its current form is fiscally insupportable. The Medicare Board of Trustees, including members of the Clinton cabinet Robert Reich, Secretary of Labor, and Donna Shalala, Secretary of Health and Human Services, project that Part A will be bankrupt in just seven years if left in its present state. In the summary of their 1995 annual reports, the Trustees caution, "the HI Trust Fund (Part A) continues to be severely out of balance and is projected to be exhausted in about 7 years. The SMI Trust Fund (Part B)...shows a rate of growth of costs which is clearly unsustainable." The Trustees were clear in their call on Congress for action. "[M]edicare reform needs to be addressed urgently as a distinct legislative initiative."¹

America's changing demographics are driving up Medicare costs. In 1970, one in ten Americans was over 65; today, one in eight is over 65 and by the year 2005 one in five Americans is projected to be over 65. Americans are also retiring earlier than ever. While roughly one out of three men over 65 worked in 1960, only one out of six men over 65 continued to work in 1994. These demographic changes have made Medicare insupportable in its current form. The Congressional Budget Office estimates that the average 65 year-old couple, both retiring this year, will take out $126,000 more from Medicare than they contributed.

Strengthening the System

Heeding the Trustees' call, the Congressional leadership has developed a comprehensive plan to strengthen Medicare, Part A and B. The plan is based on the idea that management techniques successful in the private sector and giving seniors the incentives to manage their own care will control costs without sacrificing quality of care.

The Congressional leadership plan leaves traditional Medicare Part A and B intact for those who are comfortable with their current arrangements. Seniors electing traditional Medicare will continue to pay Part B premiums set at 31 percent of program costs, which is the current rate. High-income seniors, individuals who earn more than $75,000 and couples who earn more than $125,000, will pay more if they choose to enroll in Part B. The subsidy for Part B will be eliminated for individual seniors who earn more than $100,000 a year and couples who earn more than $175,000 a year.

In addition, the Republican plan would create a Medicare Plus option, which would offer seniors two additional choices -- Managed Care and Medical Savings Accounts (MSA).

Under Medicare Plus, seniors could choose to organize their health care through a managed care company. This option is currently available in some states, including California, where one out of three seniors elect managed care. Seniors benefit from managed care's expansive benefits and lower deductibles and co-payments. Taxpayers stand to benefit because the government pays the managed care company 95 percent of the average annual per-capita Medicare expenditure, pocketing the 5 percent residual in savings.

Even more promising are MSAs, which will harness the power of the market to control costs while expanding service. MSAs combine a high deductible insurance policy with a tax free savings account. Seniors who choose MSAs will receive a voucher to purchase the insurance policy and deposit the remaining money in a savings account, from which routine medical bills will be paid. At the end of the year, any remaining money in the account can either be rolled into an account for the next year or funds in excess of 60 percent of the premium for the insurance policy could be withdrawn.

The actuarial firm Milliman and Robertson estimates that if half of those on Medicare choose MSAs, the average recipient will have nearly $3,000 left over each year after buying catastrophic insurance. Even if every Medicare recipient chooses the MSA option, according to Milliman and Robertson, the average Medicare recipients will have nearly $2,000 to fund their account. This means that total out-of-pocket expenses will be capped at $1,000, as MSAs obviate the need for expensive medi-gap insurance. Compare this to the average out-of-pocket expense of more than $2,000 that seniors face under the current system.

MSAs are a good deal for seniors -- poor or wealthy, sick or healthy. Since they are spending essentially their own money, they will be sure to get the best value for their health care buck and they won't have to trade off restricted doctor choice for expanded benefits. Finally, since the government will fund the account each year, should it run dry in any given year, seniors can rest assured that it will soon be replenished.

Conclusion

Although no plan is perfect, the Congressional leadership's Medicare plan makes significant strides in the right direction. It addresses the fact that Medicare needs serious structural reform if it is to be available for the next generation. Out of a "decent respect for the opinions of mankind," the plan leaves traditional Medicare intact for those who are comfortable with it but calls on high-income seniors to pay more of the program's cost. The structural reforms it proposes rely primarily on market mechanisms, not more bureaucratic decision making.

1. Social Security and Medicare Board of Trustees, "Status of the Social Security and Medicare Program: A Summary of the 1995 Annual Reports," Washington, D.C., April, 1995.

October 1995

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