Medicare’s Financing Problems: Some Solutions

At a reader’s request I’ve been writing about the financing problems facing Medicare. The first post contrasted Medicare’s issues with those of Social Security. The second and third posts provided the bare basics and details of Medicare’s financing woes, respectively. This final post discusses some possible solutions. I will mostly assume readers are familiar with the content of those prior posts.

I’ll focus on Medicare’s Hospital Insurance (HI) solvency issue, though some of what I write applies to Medicare’s Supplementary Medical Insurance (SMI) arm as well. HI’s solvency problem is the fact that HI payroll taxes are insufficient to cover HI expenses. This is an immediate problem–already expenditures exceed HI payroll revenue–and one that must be addressed by about 2017 when the HI trust fund is depleted.

According to the American Academy of Acturaries’ (AAA) Public Policy Monograph titled Medicare Reform Options (June 2007), possible solutions to HI insolvency fall, rather obviously, into two main categories, though solution options may be combined: (1) increase revenue and (2) decrease spending.

Options to increase revenue include:

  • Increasing the HI payroll tax rate. An increase from the current 2.9% rate to 6.41% would be required to eliminate the HI deficit over the next 75 years. The rate could also be made progressive with higher income wage earners paying a higher rate than lower income wage earners.
  • Increase general revenue funding. The HI program does not currently draw on general revenue. A general revenue contribution growing from 0.4% to 3.4% of GDP by 2080 would be required for solvency. Such additional demands on the federal budget could be met through some form of increased taxation.
  • Increase beneficiary premiums. Currently there is no premium on HI benefits. Requiring beneficiaries to pay a premium, perhaps means tested, is a potential source of revenue.
  • Changes to trust fund investments. HI trust fund assets are held in non-marketable special-issue U.S. government securities. Instead they could be invested in a broader mix of instruments for greater return at greater risk.

I have not quantified all of the above options, nor does the AAA report upon which they’re based do so. But it is clear from the ones I did quantify that a major infusion of revenue is required. Options to decrease spending include:

  • Reduce payments to providers. Congress has a mechanism that is supposed to control provider payments, the Sustainable Growth Rate system. However, Congress routinely overrides the recommendations of that system causing physician payments to grow more quickly.
  • Reduce Medicare Advantage (MA) payments. As I’ve written about before, MA plans are paid at a much higher rate than is reflected in average FFS Medicare costs. Reducing MA payment rates down to average FFS Medicare costs is a major source of savings and one recommended by many policy analysts and being considered by Congress today. It has been estimated that over-payments to MA plans shorten the span of HI solvency by 18 months.
  • Reducing eligibility. Increasing the age of Medicare eligibility above 65 would decrease demands on the program, but only modestly. Even increasing age of eligibility to age 70 by 2040 would only save about 8%.
  • Increasing cost sharing or reducing benefits. Clearly these are ways to decrease costs with the effects varying by precisely how cost sharing is increased or which benefits are reduced.
  • Increasing efficiency. Much has been made of the geographic variation in Medicare spending. There is clearly room for increases in efficiency without reductions in health.

Again, I have not quantified all of the above options. However an AAA “Backgrounder” on Medicare suggests that to make HI solvent over a 75 year projection, benefits would need to be cut in half or payroll taxes doubled, or some combination of the two. So, this is a very big deal!

To maintain HI solvency Congress has made changes to Medicare in the past, as summarized in publications of the Congressional Research Service and The Henry J. Kaiser Family Foundation (KFF). These statutory adjustments are, in part, why the Medicare trustees’ prediction of insolvency date changes from year to year (changes in demographics and economic conditions also have an impact on the predicted insolvency date).

In closing it is worth noting that HI’s insolvency problem can be eliminated in an accounting sense by simply permitting HI to draw on general revenue as the Medicare’s SMI program does. That idea simply illustrates that HI’s solvency issue really isn’t different from the financial problems facing the rest of Medicare or health care financing in general. Health care expenses are growing at a much faster rate than the economy putting a strain on personal, business, and government budgets. Reasons for growth in Medicare spending in particular and health care spending in general are beyond the scope of this post  but are discussed at length in a KFF publication and briefly in other posts on this blog.

Clearly changes need to be made in Medicare’s financing and soon. This will be a challenging political issue in the next several years.

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