• Medicare’s Financing Problems: Some Details

    In response to a reader’s question, this is the third post pertaining to the solvency of Medicare (U.S., not Canada). The first post put the problem in the context of that facing Social Security. The second provided some of the basics of Medicare’s financing issues. This post goes a bit deeper into Medicare solvency. In the final post of the series I’ll discuss some possible solutions. I assume readers are familiar with the content of my prior posts so I don’t have to repeat definitions and explanations of basic concepts.

    Analysis of and news about Medicare’s financing issues can be confusing because there are really two fundamental issues and each can be measured and viewed in different ways. One fundamental issue is a genuine solvency issue with the Hospital Insurance (HI) arm of Medicare: its annual expenses already exceed its annual payroll tax based revenue.

    The other fundamental issue is a health care financing problem with the Supplementary Medical Insurance (SMI) arm of Medicare: its annual expenses, funded by general revenue and beneficiary premiums are growing at a rate that consumes a larger and larger portion of national income and the federal budget, as does health care overall. Since HI and SMI are parts of Medicare it is possible to say that Medicare as a whole has a solvency problem and Medicare as a whole has a health care financing problem.

    Because SMI’s financing problem is really a broader health care cost problem it isn’t unique to Medicare. A long-term solution to SMI’s problem will likely require reform to the nation’s health system in general. Therefore, I will not dwell on it except to point out one way in which it comes up in the media.

    A 2003 law defines a specific “Medicare funding warning” and compels the president to propose corrective legislation in response. The funding warning is triggered whenever two consecutive Medicare trustees’ reports predict that general revenue sources will account for more than 45% of total (HI+SMI) annual Medicare spending for any year within the next seven. Note that general revenue is only one of several sources of Medicare funding, including HI payroll taxes, beneficiary premiums, and a few others. Lately this funding warning has been triggered each year, and its announcement is an opportunity for the media to report on Medicare’s financial woes. Note, however, that this trigger reflects both Medicare’s solvency issue (because HI payroll tax revenue is too low) and its other health financing issue (because health care costs are too high, requiring a greater amount of general revenue for SMI payments).

    There are many ways to view HI’s solvency problem. I’ll discuss two. One is a short-range financial adequacy test that pertains to HI’s trust fund, held in the form of U.S. federal government bonds. HI’s trust fund increase when HI payroll taxes exceed HI expenses and decreases in the opposite case. Medicare trustees recommend that the trust fund’s value meet or exceed predicted annual expenses for each of the next ten years. This is akin to a personal emergency fund, a stash of cash or cash-equivalents to be used if there is an interruption in income. The HI trust fund fails to meet this short-range financial adequacy test: assets are predicted to fall below expenditures in 2012.

    A second way to view HI’s solvency problem is from a perspective of  long-range actuarial balance: can revenue support expenses over the long term? The answer is no. In every year since 2005 HI payroll tax revenue has been below expenses. So far, trust fund interest has made up the difference. But beginning in 2010 even that won’t suffice and the trust fund’s principal will be drawn down. HI expenses will be funded, in part, by redeeming U.S. government securities. Since the U.S. government will likely be in debt at that time (and for a long time afterwards), it will have to fund those redemptions with increases in taxes or public debt.

    By 2017 the HI trust fund is expected to be fully depleted. HI payroll tax revenues are projected to cover only 81% of costs. It is unlikely that Congress or the president would allow this to occur so something will be done to increase HI revenues or decrease expenses. I’ll discuss some of those options in the next post on this topic.

    Postscript: Because the Medicare trustees produce new forecasts every year their projections change year-by-year. The dates of certain milestones (depletion of HI trust fund, for example) move each year, due to changes in economic conditions and forecasts and changes to the Medicare program. The years I cite above may be slightly different than those reported in the media at the time of the most recent or the next trustees’ report.

    The following are my main sources for content of this post:

    See also the recent Health Affairs piece by Joseph White on the degree to which Medicare is able to control costs.

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