For Release on Delivery

Expected at 2:00 p.m.

Wednesday, September 22, 1999

GAO/T-HEHS/AIMD-99-294

MEDICARE REFORM

Ensuring Fiscal

Sustainability While

Modernizing the Program

Will Be Challenging

Statement of David M. Walker

Comptroller General of the United States

Testimony

Before the Subcommittee on Health, Committee on Ways

and Means, House of Representatives

United States General Accounting Office

GAO

Page 1 GAO/T-HEHS/AIMD-99-294

Mr. Chairman and Members of the Subcommittee:

I am pleased to be here today as you discuss efforts to reform the

administration, structure, and financing of Medicare–steps essential to

maintaining the program’s long-term solvency and to its modernization.

There appears to be an emerging consensus that substantive financing and

programmatic reforms are necessary to put Medicare on a sustainable

footing for the future. The long-term cost pressures facing this program

are considerable. Fundamental program reforms are vital to reducing the

program’s growth, which threatens to absorb ever-increasing shares of the

nation’s budgetary and economic resources.

Against this backdrop, I want to acknowledge your efforts, Mr. Chairman,

as well as the contributions of the other members of the Bipartisan

Commission on the Future of Medicare. The Breaux-Thomas proposal,

which grew out of the Commission’s deliberations, included a

comprehensive reform plan on a technically difficult issue that touches on

both the future health of beneficiaries and the fiscal health of the U.S.

economy.1 I also want to commend both this Subcommittee and the

Congress as a whole for remaining steadfast in the face of intense pressure

to roll back the Medicare payment reforms included in the Balanced

Budget Act of 1997 (BBA). It is in no sense hyperbole to note that the BBA

changes constituted a critical down payment for Medicare reform. I know

that the Subcommittee appreciates the vital importance of waiting for

strong evidence that demonstrates the need for any modifications before

acting.

You must be especially prudent during this period of prosperity as you

consider Medicare reform initiatives. Please remember that, even as recent

estimates have increased the size of budget surpluses, these are projected

budget surpluses, and we know that the business cycle has not been

repealed. Current projected surpluses could well prove to be fleeting, and

thus appropriate caution should be exercised when creating new

entitlements that establish permanent claims on future resources. While I

do not relish being the accountability cop at the surplus celebration party,

that is part of my job as Comptroller General of the United States.

Moreover, while the size of future surpluses could exceed or fall short of

projections, we know that demographic and cost trends will, in the

——————————————————

1The National Bipartisan Commission on the Future of Medicare held its last meeting on March 16,

1999. By a vote of 10 to 7, the Commission failed to achieve the 11-member super majority required by

law to report a recommendation to the Congress.

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Sustainability While Modernizing the

Program Will Be Challenging
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Sustainability While Modernizing the

Program Will Be Challenging

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absence of meaningful reform, drive Medicare spending to levels that will

prove unsustainable for future generations of taxpayers. Accordingly, we

need to view this period of projected prosperity as an opportunity to

address the structural imbalances in Medicare, Social Security, and other

entitlement programs before the approaching demographic tidal wave

makes the imbalances more dramatic and meaningful reform less feasible.

As the foregoing suggests, the stakes associated with Medicare reform are

high for the program itself and for the rest of the federal budget, both now

and for future generations. Current policy decisions can help us prepare

for the challenges of an aging society in several important ways: (1)

reducing public debt to increase national savings and investment, (2)

reforming entitlement programs to reduce future claims and free up

resources for other competing priorities, and (3) establishing a more

sustainable Medicare program that delivers effective and affordable health

care to our seniors.

In this context, I would like to make a few summary points before delving

into the specifics of Medicare’s financial health and a discussion of

potential reform.

• In March, the Bipartisan Commission on the Future of Medicare

completed its deliberations. Reform options emerged from these and other

discussions that touched on all aspects of the Medicare program, including

(1) modernization of the traditional Medicare fee-for-service program,

both to update the benefit package and enhance its potential for

containing program costs; (2) modernization of the Medicare+Choice

program to ensure that beneficiaries have health plan choices and allow

the program to more efficiently purchase plan services; and (3) adoption

of a program like the Federal Employees Health Benefits Program

(FEHBP) or a premium support model to foster quality and price based

competition among health plans and to elevate beneficiaries’

consciousness about and responsibility for program costs.

Given the size of Medicare’s unfunded liability, it is realistic to expect that

reforms intended to bring down future costs will have to proceed

incrementally. The time to begin the difficult but necessary steps to

reclaim our fiscal future is now, when we have budget surpluses and a

demographic “holiday” with retirees a far smaller proportion of the

population than they will be in the future.

Ideally, the unfunded promises associated with today’s program should be

addressed before or concurrent with proposals to make new ones, such as

adding prescription drug coverage. To do otherwise might be politically
Medicare Reform: Ensuring Fiscal

Sustainability While Modernizing the

Program Will Be Challenging

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attractive but not fiscally prudent. If benefits are added, policymakers

need to consider targeting strategies that fully offset the related costs.

They may also want to design a mechanism to monitor aggregate program

costs over time and to establish expenditure or funding thresholds that

would trigger a call for fiscal action. Our history shows that when benefits

are attractive, fiscal controls and constraints are difficult to maintain. In

addition, any potential program expansion should be accompanied by

meaningful reform of the current Medicare program to help ensure its

sustainability.

To qualify as meaningful reform, a proposal should make a significant

down payment toward ensuring Medicare’s long-range financial integrity

and sustainability–the most critical issue facing Medicare. The 1999 annual

reports of the Medicare trustees project that program costs will continue

to grow faster than the rest of the economy. Care must be taken to ensure

that any potential expansion of the program is balanced with other

programmatic reforms so that we do not worsen Medicare’s existing

financial imbalances. Proposals to reform Medicare should be assessed

against the following criteria: affordability, equity, adequacy, feasibility,

and acceptance. (See table 1.)

Table 1: Criteria for Assessing the Merits of Medicare Reform Proposals

Criterion What this means for a proposal

Affordability A proposal should be evaluated in terms of its effect on the long-term

sustainability of Medicare expenditures

Equity A proposal should be fair to providers and across groups of

beneficiaries

Adequacy A proposal should include resources that allow appropriate access and

provisions that foster cost-effective and clinically meaningful innovations

that address patients’ needs

Feasibility A proposal should incorporate elements that facilitate effective

implementation and adequate monitoring

Acceptance A proposal should be transparent and should educate provider and

beneficiary communities about its costs and the realities of tradeoffs

required by significant policy changes

People want unfettered access to health care, and some have needs that

are not being met. However, health care costs compete with other

legitimate priorities in the federal budget, and their projected future

growth threatens to crowd out future generations’ flexibility to decide

which of these competing priorities will be met. Thus, in making important

fiscal decisions for our nation, policymakers need to consider the

fundamental differences between wants, needs, and what both individuals
Medicare Reform: Ensuring Fiscal

Sustainability While Modernizing the

Program Will Be Challenging

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and our nation can afford. This concept applies to all major aspects of

government, from major weapons system acquisitions to issues affecting

domestic programs. It also points to the fiduciary and stewardship

responsibility that we all share to ensure the sustainability of Medicare for

current and future generations within a broader context of providing for

other important national needs and economic growth.

Let’s not kid ourselves—reforming Medicare is hard work. Health care

spending accounts for one-seventh of the nation’s economy, and Medicare

is the nation’s single largest health care payer. The program’s beneficiary

populations consist of roughly 35 million seniors and 4 million disabled

individuals under age 65. The Health Care Financing Administration

(HCFA) estimates that the program’s billers—physicians, hospitals,

equipment suppliers, and other providers of health services—number

about 1 million.

As the various reform options come under scrutiny, the importance of

design details should not be overlooked. Our work on efforts to implement

reforms mandated in the BBA is instructive regarding reform specifics.

Three principal lessons can be drawn from recent experience: (1) The

particulars of payment mechanisms largely determine the extent to which

a reform option can eliminate excess government spending while

protecting beneficiaries access’ to care. (2) Revisions to newly

implemented policies should be based on a thorough assessment of their

effects so that, at one extreme, they are not unduly affected by external

pressures and premature conclusions or, at the other extreme, they remain

static when change is clearly warranted. (3) For choice-based models to

function as intended–that is, to foster competition based on cost and

quality–consumers must have information that is sufficiently comparable.

At this time, I would like to discuss the competing concerns at the crux of

Medicare reform, in general, and to provide a conceptual framework for

considering the various possible combinations of reform options, in

particular.

The current Medicare program, without improvements, is ill suited to

serve future generations of seniors and eligible disabled Americans. On

the one hand, the program is fiscally unsustainable in its present form, as

the disparity between program expenditures and program revenues is

expected to widen dramatically in the coming years. On the other, the

program is outmoded in that it has not been able to adopt modern, marketbased management tools, and its benefit package contains gaps in desired

coverage compared to private employer coverage. Compounding the

Competing Concerns

Pose Challenges for

Medicare Reform
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Sustainability While Modernizing the

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difficulties of responding to these competing concerns is the sheer size of

the Medicare program—even modest program changes send ripples across

the program’s 39-million-strong beneficiary population and the

approximately 1 million health care providers that bill the program.

Balancing the needs of all these parties requires hard choices that have

been brought before this Subcommittee, the Congress, and the National

Bipartisan Commission on the Future of Medicare.

Unlike private trust funds that can set aside money for the future by

investing in financial assets, the Medicare Hospital Insurance (HI) Trust

Fund—which pays for inpatient hospital stays, skilled nursing care,

hospice, and certain home health services—is essentially an accounting

device. It allows the government to track the extent to which earmarked

payroll taxes cover Medicare’s HI outlays. In serving the tracking purpose,

annual trust fund reports show that Medicare’s HI component is, on a cash

basis, in the red and has been since 1992. (See fig. 1.) Currently,

earmarked payroll taxes cover only 89 percent of HI spending and,

including all earmarked revenue, the fund is projected to have a $7 billion

cash deficit for fiscal year 1999 alone. To finance this deficit, Medicare has

been drawing on its special issue Treasury securities acquired during the

years when the program generated a cash surplus. Consequently, Medicare

is already a net claimant on the Treasury—a threshold that Social Security

is not currently expected to reach until 2014. In essence, for Medicare to

“redeem” its securities, the government must raise taxes, cut spending for

other programs, or reduce the projected surplus. Outlays for Medicare

services covered under Supplementary Medical Insurance (SMI)–physician

and outpatient hospital services, diagnostic tests, and certain other

medical services and supplies–are already funded largely through general

revenues.

Medicare Is Already in the

Red
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Figure 1: Financial Outlook of the Hospital Insurance Trust Fund, 1990 to

2025

Without meaningful reform, the long-term financial outlook for Medicare

is bleak. Together, Medicare’s HI and SMI expenditures are expected to

increase dramatically, rising from 12 percent in 1999 to more than a

quarter of all federal revenues by mid century. Over the same time frame,

Medicare’s expenditures are expected to double as a share of the

economy, from 2.5 to 5.3 percent, as shown Fig. 2.

-200

-150

-100

-50

0

50

100

150

200

19901995200020052010

201520202025

Dollars in billions

Cash Surplus/Deficit Fund Balance

Cash Deficit 1992
Medicare Reform: Ensuring Fiscal

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Figure 2: Composition of Medicare Funding as a Percent of Gross

Domestic Product (GDP), 1999 to 2071

The progressive absorption of a greater share of the nation’s resources for

health care, like Social Security, is in part a reflection of the rising share of

elderly in the population. Medicare’s rolls are expanding and are projected

to increase rapidly with the retirement of the baby boom. Today’s elderly

make up about 13 percent of the total population; by 2030, they will

comprise 20 percent as the baby boom generation ages and the ratio of

workers to retirees declines from 3.4 to one today to roughly two to one.

However, Medicare growth rates also reflect the escalation of health care

costs at rates well exceeding general rates of inflation. Increases in the

number and quality of health care services have been fueled by the

explosive growth of medical technology. Moreover, the actual costs of

health care consumption are not transparent. Third-party payers generally

insulate consumers from the cost of care decisions. In traditional

Medicare, for example, the impact of the cost-sharing provisions designed

to curb the use of services is muted because about 80 percent of

beneficiaries have some form of supplemental health care coverage (such

as Medigap insurance) that pays these costs. For these reasons, among

others, Medicare represents a much greater and more complex fiscal

challenge than even Social Security over the longer term.

0%

1%

2%

3%

4%

5%

6%

1999200320072011201520192023202720312035203920432047205120552059206320672071

Percent of GDP

General Revenue or Other Payroll Tax Premiums
Medicare Reform: Ensuring Fiscal

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When viewed from the perspective of the entire budget and the economy,

the growth in Medicare spending will become progressively unsustainable

over the longer term. Our updated budget simulations show that to move

into the future without making changes in the Social Security, Medicare,

and Medicaid programs is to envision a very different role for the federal

government. Even assuming that all projected surpluses are saved and

existing discretionary budget caps are complied with, our long-term model

shows a world by 2030 in which Social Security, Medicare, and Medicaid

increasingly absorb available revenues within the federal budget. (See fig.

3.) If none of the surplus is saved, the long-term outlook is even more

daunting. (See fig. 4.) Budgetary flexibility declines drastically, and there

is little or no room for programs for national defense, the young,

infrastructure, and law enforcement. In short, there will be essentially no

discretionary programs at all.

Figure 3: Composition of Spending as a Share of GDP Under “Save the

Unified Surplus” Simulation

0 %

1 0 %

2 0 %

3 0 %

4 0 %

5 0 %

6 0 %

1998 2030* 2050 2070

Percent of GDP

Social Security Medicare & Medicaid N e t Interest All other spending

Revenue

*In 2030, all other spending includes offsetting interest receipts.
Medicare Reform: Ensuring Fiscal

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Figure 4: Composition of Spending as a Share of GDP Under “No Unified

Surplus” Simulation

When viewed together with Social Security, the financial burden of

Medicare on the future taxpayers becomes unsustainable. As figure 5

shows, the cost of these two programs combined would nearly double as a

share of the payroll tax base over the long term. Assuming no other

changes, these programs would constitute an unimaginable drain on the

earnings of our future workers.

0 %

1 0 %

2 0 %

3 0 %

4 0 %

5 0 %

6 0 %

1998 2030 2050

Percent of GDP

Soc ia l Security Medicare & Medicaid Net Interest All other spending

Revenue
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Figure 5: Social Security and Medicare HI as a Percent of Taxable Payroll,

1999 to 2074

While the problems facing the Social Security program are significant,

Medicare’s challenges are even more daunting. To close Social Security’s

deficit today would require a 17 percent increase in the payroll tax,

whereas the HI payroll tax would have to be raised 50 percent to restore

actuarial balance to the trust fund. This analysis, moreover, does not

incorporate the financing challenges associated with the SMI and Medicaid

programs.

Early action to address the structural imbalances in Medicare is critical.

First, ample time is required to phase in the reforms needed to put this

program on a more sustainable footing before the baby boomers retire.

Second, timely action to bring costs down pays large fiscal dividends for

the program and the budget. Our long-term budget simulations, as shown

in figure 6, illustrate how critical early action on Medicare reform is to our

long-term fiscal future. If the annual growth in per person Medicare

spending could be slowed to 4 percent over the 70-year period it would

yield the kind of savings needed to establish a truly sustainable budget

policy for the long term. This is not easy however. Although over 70 years

the projected average annual growth in per person spending is 4.5 percent,

over the next 10 years it is nearly 5 percent. The high projected growth of

Medicare in the coming years, means that the earlier the reform begins, the

greater the savings will be as a result of the effects of compounding.

Reforms fully phased in by 2005 would enable us to maintain surpluses

over the entire 70-year simulation period.

0

5

10

15

20

25

30

19992002200520082011201420172020202320262029203220352038204120442047205020532056205920622065206820712074

Percent of taxable payroll

Current Level
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Figure 6: Federal Deficits as a Share of GDP Under Alternative Medicare

Simulations, 1999 to 2069

The actions necessary to bring about a more sustainable program will no

doubt call for some hard choices. Some suggest that the size of the

imbalances between Medicare’s outlays and payroll tax revenues for the

HI program may well justify the need for additional resources. One

possible source could be general revenues. Although this may eventually

prove necessary, such additional financing should be considered as part of

a broader initiative to ensure the program’s long-range financial integrity

and sustainability.

What concerns me most is that devoting general funds to the HI may be

used to extend HI’s solvency without addressing the hard choices needed

to make the whole Medicare program more sustainable in economic or

budgetary terms. Increasing the HI trust fund balance alone, without

underlying program reform, does nothing to make the Medicare program

more sustainable—that is, it does not reduce the program’s projected

share of GDP or the federal budget. From a macro economic perspective,

the critical question is not how much a trust fund has in assets but

whether the government as a whole has the economic capacity to finance

all Medicare’s promised benefits—both now and in the future.

If more fundamental program reforms are not made, I fear that general

fund infusions would interfere with the vital signaling function that trust

fund mechanisms can serve for policymakers about underlying fiscal

imbalances in covered programs. The greatest risk is that dedicating

-5

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1999 2004 2009 2014 2019 2024 2029 2034 2039 2044 2049 2054 2059 2064 2069

Percent of GDP

Action taken in 2005

No action

Action taken in 2015
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general funds to the HI program will reduce the sense of urgency that

impending trust fund bankruptcy provides to policymakers by artificially

extending the solvency of the HI program. Furthermore, increasing the

trust fund’s paper solvency does not address cost growth in the SMI

portion of Medicare, which is projected to grow even faster than HI in

coming decades.

Beyond reforming the Medicare program itself, maintaining an overall

sustainable fiscal policy and strong economy is vital to enhancing our

nation’s future capacity to afford paying benefits in the face of an aging

society. Decisions on how we use today’s surpluses can have wide-ranging

impacts on our ability to afford tomorrow’s commitments.

As we know, there have been a variety of proposals to use the surpluses

for purposes other than debt reduction. Although these proposals have

various pros and cons, we need to be mindful of the risk associated with

using projected surpluses to finance permanent future claims on the

budget, whether they are on the spending or tax side.2 Commitments often

prove to be permanent while projected surpluses can be fleeting. For

instance, current projections assume full compliance with tight

discretionary spending caps. Moreover, relatively small changes in

economic assumptions can lead to very large changes in the fiscal outlook,

especially when carried out over a decade. In a recent report, the

Congressional Budget Office (CBO) compared the actual deficits or

surpluses for 1988 through 1998 with the first projection it had produced 5

years before the start of each fiscal year. Excluding the estimated impact

of legislation, CBO says that its errors averaged about 13 percent of actual

outlays. Such a shift in 2004 would mean a potential swing of about $250

billion in the projected surplus.

Although most would not argue for devoting 100 percent of the surplus to

debt reduction over the next 10 years, saving a good portion of our

surpluses would yield fiscal and economic dividends as the nation faces

the challenges of financing an aging society. Our work on the long-term

budget outlook illustrates the benefits of maintaining surpluses for debt

reduction. Reducing the publicly held debt reduces interest costs, freeing

up budgetary resources for other programmatic priorities. For the

economy, running surpluses and reducing debt increase national saving

and free up resources for private investment. These results, in turn, lead to

stronger economic growth and higher incomes over the long term.

——————————————————

2See Federal Budget: The President’s Midsession Review (GAO/OCG-99-29, July 21, 1999).

Long-Term Fiscal Policy

Choices
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Over the last several years, our simulations illustrate the long-term

economic consequences flowing from different fiscal policy paths.3 Our

models consistently show that saving all or a major share of projected

budget surpluses ultimately leads to demonstrable gains in GDP per

capita. Over a 50-year period, GDP per capita would more than double

from present levels by saving all or most of projected surpluses, while

incomes would eventually fall if we failed to sustain any of the surplus.

Although rising productivity and living standards are always important,

they are especially critical for the 21st century, for they will increase the

economic capacity of the projected smaller workforce to finance future

government programs along with the obligations and commitments for the

baby boomers’ retirement.

In addition to its significant financial imbalance, Medicare is outmoded

from a programmatic perspective. In its current form, the program lacks

the flexibility to readily adjust its administered prices and fees in line with

market rates and lacks the tools to exercise meaningful control over the

volume of services used. Nevertheless, BBA reforms enacted in 1997 have

begun to address certain programmatic shortcomings by modernizing the

program’s pricing and payment strategies and by moving toward qualitybased competition among health plans. The act’s combination of structural

reforms, constraints on provider fees, and increases in beneficiary

payments was expected to lower program spending by $386 billion over 10

years. Because certain key provisions have only recently or have not yet

been phased in, the full effects of the BBA on providers, beneficiaries, and

taxpayers will not be known for some time.

Of particular significance was BBA’s creation of the Medicare+Choice

program, which furthered the use of a choice-based model of providing

Medicare benefits. Medicare+Choice expanded Medicare’s managed care

options to include, in addition to health maintenance organizations

(HMO), health plans such as preferred provider organizations, providersponsored organizations, and private fee-for-service plans. In making this

expanded consumer choice program, BBA provisions placed a dramatic

new emphasis on the development and dissemination of comparative plan

information to consumers to foster quality-based plan competition. Other

BBA provisions were designed to pay health plans more appropriately

than Medicare had done under the previous HMO payment formula.

—————————————————— 3See Budget Issues: Long-Term Fiscal Outlook (GAO/T-AIMD/OCE-98-83, Feb. 25, 1998) and Budget

Issues: Analysis of Long-Term Fiscal Outlook (GAO/AIMD/OCE-98-19, Oct. 22, 1997).

BBA Made Medicare

Reform Down Payment
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BBA also made historic changes to traditional Medicare. It is gradually

eliminating, for the most part, cost-based reimbursement methods and

replacing them with prospective payment systems (PPS). The intent is to

foster the more efficient use of services and to lower growth rates in

spending for these providers, replicating the experience for acute care

hospitals following the implementation of Medicare’s PPS for hospitals,

which began in the mid-1980s. BBA mandated phasing in PPSs for skilled

nursing facilities, home health agencies (HHA), hospital outpatient

services, and certain hospitals not already paid under such arrangements.

Yet pressures mount to undo some of these changes. Affected providers

are currently seeking to repeal various BBA provisions, some relying on

anecdotal evidence rather than systematic analysis to make their case. An

illustration is the reporting of health plan withdrawals from the

Medicare+Choice program for 1999. Plans cite, and the press reports,

inadequate payment rates as the reason for dropping out of Medicare or

reducing enrollees’ benefits. We have another point of view based on our

fact-gathering and analyses.

BBA sought to moderate Medicare’s payments to managed care plans

because, ironically, Medicare managed care cost, not saved, the

government money. That is, the government was paying more to cover

beneficiaries in managed care than it would have if these individuals had

remained in the traditional fee-for-service program. In our report, we

noted that BBA has reduced, but not eliminated, excess payments.4 In fact,

Medicare’s payments to some plans are generous enough for plans to

make profits and to finance prescription drugs and other extras not

available to the majority of senior and disabled beneficiaries who remain

in traditional Medicare. We have also reported that factors additional to or

even exclusive of payment rates—including competition and other market

conditions—played a significant role in the 1999 plan dropouts.5 Our

ongoing analysis of the year 2000 plan dropouts reveals similar findings.

The question this raises for policymakers is the extent to which they

should be concerned about health plan dropouts from Medicare when plan

participation means that the government finances non-Medicare benefits

for a minority of beneficiaries while paying more for these beneficiaries

than for similar ones in traditional Medicare. Among other lessons,

however, the intensity of pressure to roll back BBA’s curbs on managed

—————————————————— 4See Medicare+Choice: Reforms Have Reduced, but Likely Not Eliminated, Excess Plan Payments

(GAO/HEHS-99-144, June 18, 1999).

5See Medicare Managed Care Plans: Many Factors Contribute to Recent Withdrawals; Plan Interest

Continues (GAO/HEHS-99-91, Apr. 27, 1999).
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care rate increases teaches us the difficulty that this Subcommittee and

the Congress as a whole face in making Medicare payment reforms.

Concern continues to be voiced about the obvious gaps in protections for

Medicare beneficiaries, in contrast to what is available for most

individuals with private employer-based coverage. At the same time,

competing concerns remain about the need to check Medicare’s cost

growth, even without adding new benefits. In response, the various reform

options, including those favored by a majority of the Bipartisan

Commission, have two major dimensions: (1) expansion of Medicare’s

benefit package and (2) cost containment through financing and other

structural transformations. Two commonly discussed benefit expansions

are the inclusion of a prescription drug benefit and coverage for

extraordinary out-of-pocket costs, known as catastrophic coverage. The

financing reforms are reflected in three models: fee-for-service

modernization, Medicare+Choice modernization, and a premium support

system fashioned after FEHBP. Each of these models is designed, to

different degrees, to alter program incentives currently in place to make

beneficiaries more cost conscious and providers more efficient (See

table 2).

Table 2: Major Dimensions of Medicare Reform, by Option

Updated benefit package options Financing and organizational change

options

Coverage for outpatient prescription drugs Fee-for-service modernization

Limit on beneficiary liability Medicare+Choice modernization

FEHBP-type premium support

Medicare’s basic benefit package largely reflects the offerings of the

commercial insurance market in 1965 when the program began. Although

commercial policies have evolved since then, Medicare’s package—for the

most part—has not.6 For example, unlike many current commercial

policies, Medicare does not cover outpatient prescription drugs or cap

beneficiaries’ annual out-of-pocket spending. Some beneficiaries can

augment their coverage by participating in the Medicaid program (if their

——————————————————

6Some Medicare benefits have changed. For example, BBA added or expanded coverage for screening

mammograms, prostate cancer screening tests, bone mass measurements, and several screening or

preventive services.

Dimensions of Reform

Include Benefit

Expansions and

Financing Changes

Benefit Expansion

Reforms
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incomes are low enough), obtaining a supplemental insurance policy

privately or through an employer, or enrolling in a Medicare+Choice plan.

However, these options are not available to or affordable for all

beneficiaries. Furthermore, to the extent that Medicaid and supplemental

policies provide first-dollar coverage of services, the beneficiary

population’s sensitivity to service costs is dulled, contributing to some

continued excess utilization. Consequently, many reform advocates

believe that Medicare’s basic benefit package should be brought into line

with current commercial norms for active workers.

 Two benefit reforms under discussion by policymakers are the inclusion

of prescription drugs and stop-loss coverage that caps beneficiary out-ofpocket spending. Each involves myriad options, and assessing the merit of

these reforms would depend on the specifics included. For instance, a

Medicare prescription drug benefit could be targeted to provide coverage

for all beneficiaries, coverage only for beneficiaries with extraordinary

drug expenses, coverage only for low-income beneficiaries, or coverage

for selected drugs, such as those deemed to be cost beneficial. Such

coverage decisions would hinge on understanding how a new

pharmaceutical benefit would shift to Medicare portions of the out-ofpocket costs borne by beneficiaries as well as those costs paid by

Medicaid, Medigap, or employer plans covering prescription drugs for

retirees. How would these new program costs be shared between

taxpayers and beneficiaries through premiums, deductibles, and

copayments? Would subsidies be provided to help low-income

beneficiaries not eligible for Medicaid with these costs? The

administration of the benefit raises other questions, such as “Who would

set and enforce drug coverage standards among the private health plans

participating in Medicare?” and, for traditional Medicare, “How would

reimbursable prices be set?” Price-setting options include using a formula

based on market prices, negotiating directly with manufacturers, or

contracting with pharmaceutical benefit management companies. The

Breaux-Thomas proposal favored targeting a drug benefit to low-income

beneficiaries while allowing those at higher incomes to buy into the

benefit. A catastrophic, or stop-loss, coverage benefit would similarly

entail its own design permutations and variables.

Many Medicare reforms are designed to slow spending growth to keep the

program viable for the nation’s growing aged population. Although the

various proposals, including those considered by the Bipartisan

Commission, differ from one another in concept, they generally include

mechanisms to make beneficiaries more cost conscious, and incorporate

provider incentives to improve the efficiency of health care delivery. The

Financing and Other

Structural Reforms
Medicare Reform: Ensuring Fiscal

Sustainability While Modernizing the

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various financing and structural reforms consist of components of three

general models: fee-for-service modernization, Medicare+Choice

modernization, and a premium support system fashioned after FEHBP

(See table 3).

Table 3: Three Medicare Financing and Structural Reforms

Fee-for-service

modernization

Medicare+Choice

modernization

FEHBP-type

premium support

Pending under

BBA

Prospective

payment systems

for HHAs, hospital

outpatient

departments, and

others

Health-based risk

adjustment of rates

Annual enrollment

and lock-in

Competitive pricing

demonstration

Potential under

current

proposals

Selective

purchasing

Negotiated pricing

Case management

for complex and

chronic conditions

Utilization

management

Medigap and

beneficiary costsharing reforms

Expanded use of

centers of

excellence

Plan savings shared

with program and/or

beneficiaries

Competitive

premium pricing

Premium based on

offered or

negotiated price

Beneficiary

contribution based

on plan cost

Traditional Medicare

incorporated

Enhanced flexibility

Self-financed

BBA improved the efficiency of Medicare’s traditional fee-for-service

program by substituting a variety of PPSs and other fee changes for its

cost-based reimbursement methods and outdated fees. Nevertheless,

Medicare is still not an efficient purchaser. Adjusting its systems of

administered prices and fees up or down to ensure beneficiary access or

to capture potential savings as the market changes poses an

overwhelming, if not impossible, challenge. Medicare largely remains a

passive bill payer, exercising little meaningful control over the volume of

services used. Proposals to modernize fee-for-service Medicare aim at

Fee-for-Service

Modernization
Medicare Reform: Ensuring Fiscal

Sustainability While Modernizing the

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Page 18 GAO/T-HEHS/AIMD-99-294

providing flexibility to take advantage of market prices and introducing

some management of service utilization. In proposing to make fee-forservice more fiscally accountable and to provide it with additional

flexibility to achieve these fiscal goals, the Bipartisan Commission also

discussed fee-for-service modernization as one of the critical elements of

reform.

Preferred provider arrangements, whereby insurers select certain

providers because of their willingness to accept lower fees and their

efficient style of practice, have become commonplace in the commercial

insurance market. By accepting negotiated or competitively bid fees that

fall below the usual levels, selected providers and the beneficiaries using

their services would be afforded certain advantages. The selected

providers with lower fees may experience increased demand, while

beneficiaries using their services could be subject to lower cost sharing.

Comparable arrangements have been proposed for fee-for-service

Medicare. Testing of this concept has been under way in the HCFA’s

Centers of Excellence demonstrations, where hospitals and physicians

agree to provide certain procedures for negotiated all-inclusive fees. BBA

also allowed for testing of competitive bidding for medical equipment and

supplies, with high bidders being excluded from serving Medicare

beneficiaries.

About 87 percent of beneficiaries in traditional Medicare face little cost

sharing in the form of deductibles or copayments for services by virtue of

their eligibility for Medicaid or their enrollment in a supplementary

insurance plan. While increases in cost sharing have been common in

private insurance to make beneficiaries sensitive to the value and cost of

services, it has been a cost-containment tool largely unavailable to

Medicare. Protecting low-income beneficiaries from financial barriers to

care remains a critical concern. One possible change in allowable

supplementary coverage would be to restructure cost sharing to heighten

beneficiary sensitivity to the cost of services while removing catastrophic

costs for those who have intensive health care needs.

Private indemnity insurers have moved to incorporate certain utilization

management techniques into their policies, such as prior authorization of

some expensive services and case management for persons with serious

chronic conditions. Although such techniques are increasingly common

among private insurers, their effectiveness on the population Medicare

covers is unknown.

Medicare+Choice signaled a new phase in efforts to transform Medicare.

Built on the program that allowed beneficiaries to enroll in participating

Medicare+Choice

Modernization
Medicare Reform: Ensuring Fiscal

Sustainability While Modernizing the

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managed care plans, Medicare+Choice expands options available to

beneficiaries and substantially changes plan payment methods. By raising

payments in certain areas and allowing additional types of entities to

contract with Medicare, Medicare+Choice is intended to boost plan

participation and beneficiary enrollment. Payment changes are designed to

adjust the per capita rates to more accurately reflect enrollees’ expected

resource use and slow the growth of spending over time.

Among other payment changes, BBA required HCFA to implement by

January 1, 2000, a methodology to adjust plan payments to reflect the

health status of plan members. Favorable selection—that is, the tendency

for healthier beneficiaries to enroll in managed care plans—has resulted in

payments that are higher than warranted. The new risk adjustment method

developed for Medicare will more closely align payments to the expected

health care costs of plans’ enrollees. This will help produce the savings

originally envisioned when managed care enrollment options were offered

to Medicare beneficiaries and will foster competition among plans on the

basis of benefits and quality rather than enrollment strategies.

The design of the Medicare+Choice program does not, however, allow

taxpayers to benefit from the current competition among health plans. If a

plan can provide the Medicare package of benefits for less than the

Medicare payment, it must cover additional benefits, reduce fees, or both.7

Plans that offer enriched benefit packages—such as including coverage for

outpatient prescription drugs or routine physical examinations—may

attract beneficiaries and gain market share. Medicare, however, pays the

predetermined price even in fiercely competitive markets.

The Medicare+Choice program could be modified, through new

legislation, to require that taxpayers and beneficiaries both benefit from

health plan competition. The Congress could require that when payments

exceed a plan’s cost of services (including reasonable profit), part of the

savings be returned to the program and the rest be used to fund additional

benefits. Another alternative would be to set plan payments through

competitive bidding. In fact, BBA mandates a competitive pricing

demonstration. However, setting the parameters of a competitive pricing

system is a formidable task. Furthermore, this payment-setting approach

may be best suited to urban areas with high concentrations of managed

care members.

——————————————————

7Alternatively, plans can contribute to a stabilization fund that would allow them to provide additional

benefits or lower fees in future years. Before BBA, health plans also had the option of accepting a

lower capitation payment. In practice, plans preferred to add benefits to attract beneficiaries.
Medicare Reform: Ensuring Fiscal

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Page 20 GAO/T-HEHS/AIMD-99-294

Although modernizing traditional Medicare and Medicare+Choice could

improve the control of program spending, several incentives would remain

unaltered. For example, beneficiaries would remain partially insulated

from the cost consequences of their choices. They would not benefit

directly from selecting plans capable of delivering Medicare-covered

benefits less expensively because the premiums they pay might well

remain constant. Program payments to plans would continue to be

established administratively. The Breaux-Thomas proposal recognized

beneficiary sensitivity to cost as the critical element missing from the

current Medicare program. To remedy this situation, the Breaux-Thomas

proposal and others have proposed the adoption of an FEHBP-type

premium support for Medicare—a mechanism that could, at the same

time, serve to increase beneficiary sensitivity to the cost consequences of

their choices and enhance quality/cost based competition.

The two defining elements of an FEHBP-type of premium support are (1)

the establishment of premium levels for plans through negotiations

between the program and plans and (2) the linking of beneficiaries’

contributions to the premiums of the plans they join. This system makes

transparent to beneficiaries which plans operate less expensively and can

therefore charge lower premiums. In principle, it encourages competition

because plans that can deliver services more efficiently can lower

premiums and attract more enrollees. In practice, some caveats remain.

Differences in premiums can reflect more than variation in efficiency. For

example, plans may achieve savings through narrower provider networks

that, while capable of providing Medicare-covered benefits, could cause

beneficiaries inconveniences and delays in accessing services. Providing

beneficiaries adequate comparative information on plans’ expected and

actual performance becomes even more critical.

Because most beneficiaries participate—and are expected to continue to

participate—in traditional fee-for-service Medicare, its incorporation into

the FEHBP-type system is seen as important. Under current arrangements,

the only premium for participating in the traditional program is the fixed

monthly amount that beneficiaries voluntarily pay to receive coverage for

SMI or to be eligible to enroll in a Medicare+Choice plan. Because the

premium amount represents only 25 percent of the program’s cost and is

deducted from beneficiaries’ monthly Social Security payments,

participants are not as aware of the cost of the traditional Medicare

program. The Breaux-Thomas proposal incorporates traditional Medicare

as another plan under an FEHBP-type premium support system.

Traditional Medicare would propose and negotiate premiums like any

other plan and be expected to be self-financing and self-sustaining.

Recognizing the challenge the latter requirement creates, the proposal

FEHBP-Type

Premium Support
Medicare Reform: Ensuring Fiscal

Sustainability While Modernizing the

Program Will Be Challenging

Page 21 GAO/T-HEHS/AIMD-99-294

would also provide traditional Medicare more flexibility to manage costs

using tools similar to proposals for fee-for-service modernization.

Incorporating traditional Medicare as another plan puts all plans on equal

footing and maximizes beneficiaries awareness of costs. However, the

sheer size of the traditional program creates questions. How much

flexibility can be granted to traditional Medicare, given its market power?

What will it mean for a public plan to be self-sustaining and self-financing?

Can it generate and retain reserves as a protection against future losses?

How will losses be managed? The insolvency of traditional Medicare,

which may continue to enroll the majority of beneficiaries and may be the

only plan serving many areas of the country, is not acceptable. The

dilemma of how to guarantee traditional Medicare’s solvency in the

context of an FEHBP-type premium support system needs to be

addressed.

An FEHBP-type premium support system would increase the importance

of effective program management and design. In particular, the ability to

risk-adjust premiums to reflect the variation in health status of

beneficiaries joining different plans would become paramount.

Participating plans that attract a disproportionate number of more

seriously ill and costly beneficiaries would be at a competitive

disadvantage if their premium revenues were not adjusted adequately. In

turn, enrollees in those plans might find services compromised by the

plans’ financial situation. Inadequate risk adjustment may be a particular

problem for the traditional Medicare plan, which may function as a refuge

for many chronically ill persons who find selecting among plans

challenging and opt for something familiar.

In determining how to reform the Medicare program, much is at stake—

not only the future of Medicare itself but also assuring the nation’s future

fiscal flexibility to pursue other important national goals and programs.

Mr. Chairman, I feel that the greatest risk lies in doing nothing to improve

the program’s long-term sustainability or, worse, in adopting changes that

may aggravate the long-term financial outlook for the program and the

budget.

It is my hope that we will think about the unprecedented challenge facing

future generations in our aging society. Relieving them of some of the

burden of today’s financing commitments would help fulfill this

generation’s fiduciary responsibility. It would also preserve some capacity

to make their own choices by strengthening both the budget and the

economy they inherit. While not ignoring today’s needs and demands, we

Concluding

Observations
Medicare Reform: Ensuring Fiscal

Sustainability While Modernizing the

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Page 22 GAO/T-HEHS/AIMD-99-294

should remember that surpluses can be used as an occasion to promote

the transition to a more sustainable future for our children and

grandchildren.

General fund infusions and expanded benefits may well be a necessary

part of any major reform initiative. Updating the benefit package may be a

necessary part of any realistic reform program to address the legitimate

expectations of an aging society for health care, both now and in the

future. Such changes, however, need to be considered as part of a broader

initiative to address Medicare’s current fiscal imbalance and promote the

program’s longer-term sustainability. In addition, the Congress should

consider adequate fiscal incentives to control costs and a targeting

strategy in connection with any proposal to provide any new benefit such

as prescription drugs.

I am under no illusions about how difficult Medicare reform will be. The

Breaux-Thomas proposal addresses the principal elements of reform, but

many of the details need to be worked out. Those details will determine

whether reforms will be both effective and acceptable—that is, seen as

guaranteeing the sustainability and preservation of the Medicare

entitlement, a key goal on which there appears to be consensus.

Experience shows that forecasts can be far off the mark. Benefit

expansions are often permanent, while the more belt-tightening payment

reforms—vulnerable to erosion—could be discarded altogether. Recent

experience implementing BBA reforms provides us some sobering lessons

about the difficulty of undertaking reform and the need for effectiveness,

flexibility, and steadfastness. Effectiveness involves collecting the data

necessary to assess impact—separating the transitory from the permanent

and the trivial from the important. Flexibility is critical to make changes

and refinements when conditions warrant and when actual outcomes

differ substantially from the expected ones. Steadfastness is needed when

particular interests pit the primacy of their needs against the more global

interest of making Medicare affordable, sustainable, and effective for

current and future generations of Americans. This makes it all the more

important that any new benefit expansion be carefully designed to balance

needs and affordability, both now and over the longer term.

The bottom line is that surpluses represent both an opportunity and an

obligation. We have an opportunity to use our unprecedented economic

wealth and fiscal good fortune to address today’s needs but an obligation

to do so in a way that improves the prospects for future generations. This

generation has a stewardship responsibility to future generations to

reduce the debt burden they inherit, to provide a strong foundation for

future economic growth, and to ensure that future commitments are both
Medicare Reform: Ensuring Fiscal

Sustainability While Modernizing the

Program Will Be Challenging

Page 23 GAO/T-HEHS/AIMD-99-294

adequate and affordable. Prudence requires making the tough choices

today while the economy is healthy and the workforce is relatively large.

National saving pays future dividends over the long term but only if

meaningful reform begins soon. Entitlement reform is best done with

considerable lead time to phase in changes and before the changes that

are needed become dramatic and disruptive. The prudent use of the

nation’s current and projected budget surpluses combined with

meaningful Medicare and Social Security program reforms can help

achieve both of these goals.

Mr. Chairman, this concludes my prepared statement. I will be happy to

answer any questions you or other Members of the Subcommittee may

have.

If you have any questions regarding this testimony, please call Paul L.

Posner, Director of Budget Issues, at (202) 512-9573 or William J. Scanlon,

Director of Health Financing and Public Health Issues at (202) 512-7114.

Other individuals who made key contributions include Linda F. Baker,

James Cosgrove, Hannah F. Fein, James R. McTigue, Walter Ochinko, and

Deborah Spielberg.

(101896/935333)

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