United States General Accounting Office

GAO Testimony

Before the Committee on Finance, U.S. Senate

For Release on Delivery

Expected at 2:00 p.m.

Thursday, July 22, 1999

MEDICARE REFORM

Observations on the

President’s July 1999

Proposal

Statement of David M. Walker

Comptroller General of the United States

GAO/T-AIMD/HEHS-99-236

Medicare Reform: Observations on the

President’s July 1999 Proposal

Mr. Chairman and Members of the Committee:

I am pleased to be here today to discuss the President’s recent proposal to

reform Medicare. According to the President, his proposal is intended to

make Medicare more efficient, modernize the benefit package, and extend

the program’s long-term solvency.

When I last testified before you to discuss this topic in March,1

 there

appeared to be an emerging consensus that substantive financing and

programmatic reforms were necessary to put Medicare on a sustainable

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

remain today. 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. Modernizing and upgrading

Medicare’s benefit package may be important, but such initiatives need to

be considered in light of the broader financial challenges facing this

program and the nation.

Against this backdrop, I want to acknowledge this Committee’s efforts on

Medicare reform over the past several months. The Committee has been

diligent in exploring difficult issues pertaining to proposed options as well

as the impact of reforms included under the Balanced Budget Act of 1997

(BBA). To date, this Committee and the Congress as a whole have remained

steadfast in the face of intense pressure to roll back BBA’s payment reforms

and are waiting until strong evidence demonstrates the need for

modifications. The President also deserves credit for looking out over a

15-year period in formulating budget proposals and proposing an historic

reduction in publicly held debt that will help future generations better

afford future commitments.

These initiatives are important because we must be especially prudent

during this period of prosperity, even as recent estimates of budget

surpluses have been increased. At the same time, we must remember that

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has not been repealed.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 we should exercise appropriate caution when creating

new entitlements that establish permanent claims on future resources.

While I don’t relish being the accountability cop at the surplus celebration

party, that’s part of my job as Comptroller General of the United States.

1

See Medicare and Budget Surpluses: GAO’s Perspective on the President’s Proposal and the Need for

Reform (GAO/T-AIMD/HEHS-99-113, Mar. 10, 1999).

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

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

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’d like to make a few summary points before delving into

the specifics of Medicare’s financial health and the President’s July 1999

proposal.

• The President’s proposal contains programmatic reforms that reflect a

good faith effort to advance the reform debate. It provides a baseline for

further debate and consideration of reforming Medicare. As such, it is an

important step in the goal of reaching a national consensus about how we

are going to deal with the explosive cost of medical care for our elderly

population in the decades to come. We understand that several Members

of Congress, including Members of the Senate Finance Committee, plan to

introduce their own reform proposals later in this session.

• The Congress and the President may ultimately decide to include some

form of prescription drug coverage as part of Medicare. Given this

expectation and the future projected growth of the program, some

additional revenue sources may in fact be a necessary component of

Medicare reform. However, it is essential that we not take our eye off the

ball. The most critical issue facing Medicare is the need to ensure the

program’s long-range financial integrity and sustainability. 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 be balanced with

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

financial imbalances.

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

reforms to bring down future costs will have to proceed in an incremental

fashion. 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” where retirees are 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. To do

otherwise might be politically attractive but not fiscally prudent. If

additional benefits are added, policymakers need to consider targeting

strategies and fully offsetting the related costs. They may also want to

design a mechanism to monitor these and aggregate program costs over

time as well as establish expenditure or funding thresholds that would

trigger a call for fiscal action. Our history shows that while 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, and the President’s package of reforms provides a useful

starting point.

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

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

and sustainability. As we testified before this Committee in March and

again in June, 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

Affordability A proposal should be evaluated in terms of impact on the

long-term sustainability of program expenditures.

Equity A proposal should be fair across groups of beneficiaries

and to providers.

Adequacy A proposal should include the resources to allow

appropriate access as well as provisions to foster

cost-effective and clinically meaningful innovations that

address patient needs.

Feasibility A proposal should incorporate elements to facilitate

effective implementation and adequate monitoring.

Acceptance A proposal should be transparent and should educate

beneficiary and provider communities about its costs and

the realities of trade-offs required when significant policy

changes occur.

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• People want unfettered access to desired health care, and some have

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

other legitimate claims 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

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

government, from major weapons system acquisitions to domestic

program issues. 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.

• The President’s latest proposal is projected to virtually eliminate the

publicly held debt by 2015—this would be a significant accomplishment.

Such an initiative would provide a substantial fiscal dividend by reducing

interest costs, raising national savings, and contributing to future

economic growth. This initiative would help us better afford our future

commitments, but it would not alone be sufficient. Even if all future

surpluses were saved, we would nonetheless be saddled with a budget

over the longer term that at current tax rates could fund little else but

entitlement programs for the elderly population. Reforms reducing the

future growth of Medicare as well as Social Security and Medicaid are vital

under any fiscal and economic scenario to restoring fiscal flexibility for

future generations of taxpayers.

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

Medicare reform, in general, and issues to consider in assessing the

President’s proposal, in particular.

Competing Concerns

Pose Challenges for

Medicare Reform

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,

market-based management tools, and its benefit package contains gaps in

desired coverage. Compounding the 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

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health care providers that bill the program. Balancing the needs of these

interests requires hard choices that this Committee, the Congress, and the

National Bipartisan Commission on the Future of Medicare have had

brought before them in their deliberations.

Medicare Is Already in the

Red

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

investments 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, on a cash

basis, is 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, or SMI

(physician and outpatient hospital services, diagnostic tests, and certain

other medical services and supplies), are already funded largely through

general revenues.

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Figure 1: Financial Outlook of the Hospital Insurance Trust Fund

-200

-150

-100

-50

0

50

100

150

200

Cash Surplus/Deficit

Fund Balance

Cash Deficit 1992

Dollars in Billions

1990

1995

2000

2005

2010

2015

2020

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 in figure 2.

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Figure 2: Composition of Medicare Funding as a Percent of Gross Domestic Product (GDP)

0

1

2

3

4

5

6 Percent of GDP

General Revenue or Other 

Payroll Tax

Premiums

1999

2004

2009

2014

2019

2024

2029

2034

2039

2044

2049

2054

2059

2064

2069

2074

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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 will have declined from nearly 4 to 1 today to roughly 2

to 1.

However, Medicare growth rates also reflect the escalating growth of

health care costs at rates well exceeding general rates of inflation.

Increases in the number and quality of health 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.

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. GAO’s updated budget simulations shows that to

move into the future without changes in the Medicare, Social Security, 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—i.e., essentially no discretionary

programs at all.

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Figure 3: Composition of Spending as a Share of GDP Under “Save the Unified Surplus” Simulation

0

10

20

30

40

50

60

1998 2030 2050 2070

Percent of GDP

Social Security

Medicare and Medicaid

Net Interest

All Other Spending

Revenue

Note: In 2030, all other spending includes offsetting interest receipts.

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

0

10

20

30

40

50

60

1998 2030 2050

Percent of GDP

Social Security

Medicare and Medicaid

Net Interest

All Other Spending

Revenue

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. This analysis, moreover, does not

incorporate the financing challenges associated with the SMI and Medicaid

programs.

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Figure 5: Social Security and Medicare Part A as a Percent of Taxable Payroll

0

5

10

15

20

25

30 Percent of Taxable Payroll 

Current Level

1999

2004

2009

2014

2019

2024

2029

2034

2039

2044

2049

2054

2059

2064

2069

2074

Early action to address the structural imbalances in this program is

critical. First, ample time is needed to phase in the kinds of changes

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, illustrates how critical early action on

Medicare reform is to our long-term fiscal future. Any reforms slowing

Medicare’s per person growth rate from a projected average annual rate of

4.5 percent to 4 percent over a 70-year period would yield the kind of

savings needed to truly establish a sustainable budget policy for the long

term. Because of the high projected growth of Medicare in the coming

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years, the earlier the reform begins, the greater the savings due to the

effects of compounding. Reforms fully phased in by 2002 would enable us

to maintain surpluses over the entire 70-year simulation period.

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

-5

0

5

10

15

20

1998 2010 2030 2050 2070

Percent of GDP

No Action

Action Taken in 2002

Action Taken in 2012

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Medicare Out of Date

Relative to Other Health

Care Payers

In addition to its significant financial imbalance, Medicare is

unsatisfactory from a programmatic perspective. BBA reforms were

designed in part to modernize the program’s pricing and payment

strategies, but Medicare has not yet become a prudent purchaser. 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.

In addition, concerns continue to be voiced about the current coverage

gaps in protections for Medicare beneficiaries, which contrast with what is

available for younger Americans with private employer-based coverage.

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. For example, unlike many current commercial policies,

Medicare does not cover routine physical examinations or outpatient

prescription drugs or cap beneficiaries’ out-of-pocket spending.

Two-thirds of Medicare beneficiaries obtain prescription drug coverage by

participating in the Medicaid program (if they are eligible), obtaining a

supplemental insurance policy privately or through an employer, or

enrolling in a Medicare+Choice plan. However, in some cases, these

options do not provide adequate coverage, leaving high users with

significant out-of-pocket costs; for many of the remaining third of

beneficiaries, these options are inaccessible altogether, either because

they are not available—in the case of a Medicare+Choice plan—or are not

affordable. In short, many reform advocates believe that Medicare’s basic

benefit package should be brought into line with current commercial

norms.

The challenge facing the Congress today is to identify reform options that

satisfy the need to make Medicare’s costs more sustainable while

addressing certain gaps in coverage. With respect to prescription drug

coverage, striking this balance is particularly difficult. On the one hand,

financing a prescription drug benefit would be a costly proposition. From

1992 to 1997, prescription drug spending grew on average by 11 percent a

year, compared with a 5-percent average growth rate for health

expenditures overall. As a result, drug spending during that same period

consumed a larger share of total health care spending—rising from

5.6 percent to 7.2 percent. In addition, the elderly population, which

constitutes the majority of Medicare beneficiaries, consists of relatively

high users of prescription drugs. In 1995 (the most recent year for which

data are available), annual drug costs were $600 per elderly person,

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compared to just over $140 for a nonelderly individual. On the other hand,

the lack of a prescription drug benefit creates a significant burden for

those who have little or no supplemental coverage. In 1999, an estimated

20 percent of Medicare beneficiaries—some of whom lack any

supplemental coverage—will have total drug costs of $1,500 or more.

Number and Size of

Affected Parties Make

Medicare Reform

Exceptionally Difficult

The fact that changes to Medicare can create seismic reverberations is not

surprising. 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. HCFA estimates that the

program’s billers—physicians, hospitals, equipment suppliers, and other

providers of medical services—number about 1 million.

BBA payment reforms are the latest case example illustrating the intensity

of reactions from providers affected by legislative changes. BBA sought to

lower future payments to Medicare’s managed care plans and to providers

historically paid through cost reimbursement. Affected providers are

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

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

recent illustration is the reporting of health plan withdrawals from the

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

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

enrollees’ benefits. GAO has 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 recent

published work, we noted that BBA has reduced, but not eliminated, excess

payments.2

 In fact, Medicare’s payments to some plans are generous

enough to finance prescription drugs and other extras not available to the

majority of senior and disabled beneficiaries that remain in traditional

Medicare. We have also reported that factors additional to or even

exclusive of payment rates—including competition and other market

2

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

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

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conditions—played a significant role in plan dropouts.3 The question this

raises for policymakers is to what extent should they 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 those in

traditional Medicare. Among other lessons, however, the intensity of

pressure to roll back BBA’s curbs on managed care rate increases teaches

us the difficulty that this Committee and the Congress as a whole face in

making appropriate Medicare payment reforms.

President’s Medicare

Reform Proposal

The President’s proposal to reform Medicare is intended to function on

two levels: first, as a Medicare financing strategy and, second, as a

package of programmatic reforms. On the basis of GAO’s work on these

topics, I would like to discuss several key issues.

Financing Aspect of

President’s Proposal

The President proposes to use 13 percent of the projected budget

surpluses over the next 15 years to provide additional Treasury securities

to the HI Trust Fund and partially offset the cost of the proposed

prescription drug benefit.4

 This aspect of the proposal has important

implications for the budget as a whole as well as for Medicare financing in

particular.

With regard to its more general budgetary significance, the President’s

proposal is part of a broader initiative that would save a major share of the

surplus to reduce debt held by the public. Most of the surplus transferred

to Medicare would be invested in federal Treasuries and the President is

proposing budget enforcement mechanisms—“lockboxes”—that would

ensure that these transfers be used solely to reduce publicly held debt. As

the President himself has suggested, debt reduction plays a critical role in

enhancing our economic capacity to finance our burgeoning commitments

over the long run. The President’s June Midsession Review projects that

his proposals would reduce debt held by the public by $3.6 trillion over the

next 15 years, virtually eliminating publicly held debt by 2015.

Approximately two-thirds of total projected unified budget surpluses

3

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

Continues (GAO/HEHS-99-91, Apr. 27, 1999).

4

In the Midsession Review, the President proposes to transfer $794 billion of the projected 15-year

surpluses to Medicare—$723 would be used to acquire additional Treasury securities for the HI Trust

Fund and the remainder would help pay for the proposed drug benefit. Excluding financing costs

associated with the President’s proposed new spending, this amount represents 15 percent of

projected surpluses. However, when computed to include these costs, the transfer represents

13 percent of total projected surpluses.

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would be used to reduce the debt through lockbox provisions dedicating

all of Social Security’s surpluses, and about a quarter of the on-budget

surplus would be transferred to Medicare for debt reduction. However,

because of the transfers to Medicare, debt held by government accounts

would increase by about $1 trillion over the 15-year period.

The reduction in publicly held debt proposed by the President —although

less than the baseline, which assumes that all surpluses would be

saved—would confer significant short- and long-term benefits to the

budget and the economy. Our own work on long-term budget outlooks

illustrates the benefits of maintaining surpluses for debt reduction.

Interest on the debt represents today the third largest expenditure in the

federal budget. Reducing the publicly held debt reduces these costs,

freeing up budgetary resources for other programmatic priorities. Under

the President’s plan, interest expense would fall from $229 billion in 1999

to about $10 billion in 2014. For the economy, lowering debt increases

national saving and frees up resources for private investment. This in turn

leads to stronger economic growth and higher incomes over the long term.

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

economic consequences flowing from different fiscal policy paths.5

 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 most or all 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.

With regard to the Medicare program itself, the proposed “transfer” of

surpluses would extend the solvency of the HI Trust Fund on paper from

2015 to 2027. This initiative, however, represents a major departure in

financing for the HI program. Established as a payroll tax funded program,

HI would now receive an explicit grant of funds from general revenues not

supported by underlying payroll tax receipts. Treasury securities held by

the Trust Fund have always represented the value of the loan provided by

the HI program’s prior payroll tax surpluses to the Treasury. Under the

5

See 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).

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President’s proposal, the value of securities held by the HI Trust Fund

would exceed that supported by earlier payroll tax surpluses and this

grant would constitute a new claim on the general fund for the future. In

effect, the proposed transfer would make the HI Trust Fund financing look

more like that of the part B SMI Trust Fund, which obtains 75 percent of its

funding from the general fund.

As the foregoing suggests, this is a major change in the theoretical design

of the HI program that deserves full and open debate. The size of the

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

program may well justify the need for additional financing from general

revenues. The President argues that Medicare should be guaranteed a

share of the benefits resulting from the fiscal improvement that debt

reduction and lower interest costs would bring about. However, using

surpluses to finance Medicare entails significant risks.

The President’s proposal to grant Medicare additional Treasury securities

creates the risk of reducing transparency about the underlying financial

condition of the HI Trust Fund. Although arguably justified as a way to lock

in debt reduction, the transfers are not necessary to do this. What

concerns me is the transfers extend the solvency of the HI Trust Fund on

paper without making 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 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 of Medicare’s promised

benefits—both now and in the future.

In fact, the transfer 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 the proposed

transfer will reduce the sense of urgency that impending trust fund

bankruptcy provides to policymakers by artificially extending the solvency

of the HI program through 2027—well into the peak of the baby boomers’

retirement. 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.

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The President’s proposal to transfer funds to the HI Trust Fund would, in

effect, increase the general fund contribution to total Medicare funding.

Increasing the balances of Treasury securities owned by the HI Trust Fund

alone would increase the formal claim that the Trust Fund has on future

general revenues since the Trust Fund’s securities constitute a legal claim

against the Treasury. These are resources that will not be available for

competing priorities in either domestic or defense areas. When

considering both HI and SMI programs together, the share of general fund

financing would grow under the President’s proposal from its current level

of 34 percent to about 57 percent by 2027. Although the programs’ costs

are projected to grow to these levels in the absence of any changes, the

proposals would lock in general fund financing of these costs through the

transfer of additional Treasury securities. In effect, the proposal would

likely ensure that projected Trust Fund shortfalls through 2027 will be

financed through the general fund rather than through Medicare program

reforms.

Finally, any proposal to allocate surpluses is vulnerable to the risk that

those projected surpluses may not materialize. Commitments often prove

to be permanent while surpluses can be fleeting. Although recent budget

forecasts have proven to be too pessimistic, the history of budget forecasts

should remind us not to be complacent about the certainty of these large

projected surpluses. In its January 1999 report, the Congressional Budget

Office (CBO) compared the actual deficits or surpluses for 1988 through

1998 with the first projection it produced 5 years before the start of each

fiscal year. Excluding the estimated impact of legislation, CBO says its

errors averaged about 13 percent of actual outlays. Such a shift in 2004

would mean a swing of $250 billion and about $300 billion in 2009.

Accordingly, any permanent commitments that are dependent on the

realization of a long-term forecast should be considered carefully.

Programmatic Aspects of

President’s Proposal

The President’s reform plan also consists of several programmatic

changes—most notably, a proposal for health plans to compete on the

basis of price and the addition of a prescription drug benefit. The plan also

calls for measures intended to help Medicare operate more efficiently or

strengthen future financing, including the following: create a preferred

provider option in which beneficiaries would be rewarded with lower

cost-sharing requirements when choosing providers preferred by

Medicare; expand the use of centers of excellence, in which providers that

specialize in performing such procedures as coronary artery bypass

surgery receive a global fee for all services provided rather than a separate

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fee for each service; extend certain BBA provisions that reduce provider

payment rate increases, thus helping to slow future program spending;

impose a 20-percent copayment for clinical laboratory services; and index

the part B deductible for inflation.

Overall, the Office of Management and Budget estimates that the changes

in price competition and cost incentives would achieve savings of

$72 billion over 10 years. However, these savings would offset only 60

percent of the total projected $118 billion for the new prescription drug

benefit, with the remainder being financed through a portion of the

general fund transfers, as discussed earlier. CBO’s re-estimate of the

President’s proposal—projecting a higher cost for the drug benefit and

smaller savings—underscores the uncertainty and volatility inherent in

health care cost estimates. This argues for proceeding cautiously in

expanding the Medicare program to include new benefits.

Now I would like to elaborate on the competitive pricing of health plan

premiums and the addition of a prescription drug benefit.

Provisions for Proposed Health

Plan Competition

Under the President’s proposal, private health plans serving Medicare

beneficiaries would compete on the basis of cost and quality to provide

Medicare-covered benefits. Instead of administratively established

payment rates, plans would set their own premiums for a standard

package of benefits. The government’s contribution would be limited to

96 percent of the estimated fee-for-service costs of enrolled beneficiaries.

Beneficiaries choosing plans priced under the 96-percent level would pay

reduced part B premiums and could retain these savings or use them to

buy optional benefits. Beneficiaries choosing plans exceeding the

96-percent level would pay an amount additional to the standard part B

premium.

In principle, the competitive pricing of managed care plan premiums has

considerable merit and could help produce savings for both the program

and beneficiaries. Using market forces to set prices would constitute a

major advance. Price competition among plans is more likely to lead to

payments that appropriately compensate efficient plans rather than the

excessive payment levels that have resulted from administratively set

prices. Taxpayers would benefit in two ways: first, because the

government’s contribution would be lower than if beneficiaries remained

in traditional Medicare and, second, because the government would net

25 percent of the savings achieved through the enrollment of beneficiaries

in plans priced below the government contribution cap.

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However, the extent to which price competition among health plans would

produce savings depends on the design and implementation

particulars—which the Administration has not yet made available. Our

previous work demonstrates conclusively that health plan payments must

take into account the health status of enrolled beneficiaries—that is, be

risk adjusted—if savings are to be realized.6

 Also critical is how Medicare

will estimate average fee-for-service spending and calculate its

contribution to health plan premiums. Currently, average fee-for-service

spending varies dramatically across geographic areas, due primarily to

differences in beneficiaries’ use of medical services and, to a lesser extent,

differences in local prices. Some of the variation can reflect an area’s

inappropriate use of services—either too low or too high. Because such

inappropriate utilization is embedded in the fee-for-service expenditure

data, benchmarking plan payments against current fee-for-service

spending levels requires careful scrutiny. The Administration indicates it

will incorporate a geographic adjustment that will take into consideration

these local differences, but it has released few details on how this process

would work.

Provisions for Proposed

Prescription Drug Benefit

The second major programmatic element of the President’s proposal is the

addition of a prescription drug benefit. Essentially, the prescription drug

benefit would be voluntary, requiring a premium separate from the current

part B premium and 50-percent copayment from beneficiaries for each

prescription. Beneficiaries would be permitted to enroll for the benefit,

generally, only when they are first eligible. The benefit is designed to be

phased in. In 2002, the beneficiary’s premium would be about $24 per

month, with Medicare paying up to $1,000 per-beneficiary annually. By

2008, the premium would rise to about $44 per month, with Medicare

paying up to $2,500 per-beneficiary annually. The poorest beneficiaries

would not pay premiums or copayments, and other low-income

beneficiaries would receive premium assistance.

Enrollees in Medicare managed care plans would receive their

prescription drug benefit as they do currently. Beneficiaries in traditional

Medicare would get their benefit through private companies called

“pharmacy benefit managers” (PBM) or through entities that essentially

operate like a PBM. In the private sector today, PBMs under contract with

third-party payers administer and manage enrollees’ prescription drug

benefit. As proposed for Medicare, PBMs would be paid a fee for managing

6

See Medicare Managed Care: Better Risk Adjustment Expected to Reduce Excess Payments Overall

While Making Them Fairer to Individual Plans (GAO/T-HEHS-99-72, Feb. 25, 1999) and Medicare

HMOs: HCFA Can Promptly Eliminate Hundreds of Millions in Excess Payments (GAO/HEHS-97-16,

Apr. 25, 1997).

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the drug benefit and would competitively bid to manage the benefit for a

particular geographic area. They would negotiate prices with drug

manufacturers.

Several of the prescription drug benefit provisions contain elements of

fiscal discipline, transparency, and economy. For example, the separate

premium—for which the government’s share must be calculated each

year—serves as a mechanism to track the benefit’s aggregate costs. The

50-percent copayment and the annual cap are likely to help control

excessive utilization. The one-time enrollment opportunity encouraging

beneficiary participation would help spread risk across a larger pool of

individuals, not just among the high users. This provision would help

prevent a situation in which a greater contribution from the government

would be needed to finance the benefit if only frequent users chose to

enroll. Finally, premium and copayment subsidies would help relieve

low-income beneficiaries from some of the burden of high out-of-pocket

costs.

We note, however, the following design and implementation concerns

regarding the drug benefit as proposed.

• Cost of the benefit. This new benefit is not fully paid for by other offsetting

program changes. General funds from the projected surpluses make up the

difference; but as I said earlier, this would finance a permanent benefit

expansion with an uncertain revenue stream.

• Targeting of the benefit. A primary means of allocating limited resources is

to target them on the greatest needs. With the exception of greater federal

subsidies for certain near-poor Medicare beneficiaries, the proposed

coverage is not targeted to need. The proposal provides first-dollar

coverage rather than using a deductible that would make beneficiaries

more cost-sensitive and would reduce total program expenditures. In

addition, it would cap the benefit at $2,500, leaving some beneficiaries

incurring catastrophic drug expenses without coverage.

• Substitution for employer-provided. The proposed benefit could mean that

some costs borne by employers and retirees through retiree health benefit

plans would become the responsibility of the federal taxpayer. A partial

subsidy to employers—equaling two-thirds of what the program would pay

for Medicare drug coverage—aims at minimizing the number of employers

and retirees dropping employer-sponsored coverage. How effective the

subsidy works in preventing substitution remains to be seen. Some

employers may still find it advantageous to drop coverage. Retirees may

actually approve if they prefer to obtain the full drug benefit from

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Medicare and receive alternative benefits from their former employers,

including “wrap-around” drug coverage that fills some of the gaps in the

Medicare benefit.

• Uneven impact across states. In assisting low-income Medicare

beneficiaries with premiums and cost-sharing of the new drug benefit, the

President’s proposal would build on existing Medicare “buy-in” programs,

in which the federal government and the state together subsidize—through

Medicaid—some combination of Medicare premiums, deductibles, and

copayments. For individuals between 100 and 150 percent of the federal

poverty level, the President’s proposal provides for full federal funding of

the prescription drug benefit; for those below 100 percent, the proposal

calls for shared funding between the federal government and the state.7

States would experience varying levels of fiscal relief or additional burden,

depending on the extent to which they ensured that these individuals

receive their benefit.

More than 40 percent of low-income individuals eligible for the current

Medicare buy-in benefits are not enrolled, and enrollment is particularly

low among eligible individuals above the federal poverty level. The

inclusion of the drug benefit would create a greater incentive for these

beneficiaries to enroll in the Medicare buy-in program. Further, the full

federal funding of the drug benefit for those above the federal poverty

level could help reduce the disincentives that states face when considering

whether to actively encourage beneficiaries to enroll in a federally

mandated program that is not fully funded by the federal government. At

the same time, significantly greater enrollment in the Medicare buy-in

programs resulting from the new drug benefit and outreach efforts would

increase a state’s financial exposure for matching funds that subsidize

beneficiaries’ Medicare part B premiums. States with eligibility standards

for full Medicaid benefits that are well below the federal poverty level

would be more likely to incur additional obligations.

• Obstacles to realizing the savings potential of PBMs. In the private sector,

the negotiations between PBMs and drug manufacturers and PBMs and

pharmacies are determined privately, whereas Medicare—as a public

program—is required to have transparent policies that are determined

openly. If a PBM, as a Medicare contractor, has to conduct such

negotiations in public, achieving meaningful discounts for Medicare may

be difficult. Moreover, a PBM’s span of control, not specified in the

President’s proposal, could have mixed effects on the PBM’s ability to

7

Beneficiaries with income between 135 and 150 percent of the federal poverty level would pay a

partial, sliding-scale premium based on their income.

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control drug costs. On the one hand, the greater the number of

beneficiaries within that span, the greater the potential for moving market

share to take advantage of manufacturers’ discounts; on the other hand,

the greater the number of affected providers, the greater the pressure for

the PBM to include all willing providers, which would undermine its ability

to negotiate with selected manufacturers or providers offering the best

terms.

Finally, I would caution that the creation of a new and compelling benefit

for this program not exacerbate Medicare’s financial problems and should

include a way to monitor future costs to the government. Although the

President’s proposed 50-percent copayment could serve to control

excessive utilization, that copayment rate and other financial control

mechanisms are subject to erosion. As you know, the part B premium

originally was set at a level to finance 50 percent of the part B program

costs. However, less than 10 years later, the method for setting the part B

premium was tied to changes in cost of living, resulting in premiums

dropping below 25 percent of the program costs. Under current law, the

premium is set at 25 percent of premium costs, far from the original

cost-sharing arrangement, and the projected costs of the part B program

are expected to continue to escalate, with general Treasury revenues

paying 75 percent of those costs.

Given this history, it would be prudent to target the benefit to those most

in need and include additional safety valves to check excessive program

cost growth. If expenditure or funding thresholds were established, they

could be used to trigger periodic congressional reviews and could prompt

legislative action if spending projections showed that the thresholds were

likely to be exceeded.

Concluding

Observations

I would like to conclude by pointing to the historic opportunity presented

by the recently projected surpluses. Some advocate spending the

surpluses to address a host of pent-up demands on the spending and/or

revenue sides of the budget, built up from years of struggling with and

finally succeeding in eliminating deficits. Updating Medicare’s benefit

package is but one of a number of legitimate claims being made for the use

of these surpluses.

It is my hope that in considering all of these competing claims in the

present we also think about the unprecedented challenge facing future

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

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today’s financing commitments would help fulfill this generation’s

fiduciary responsibility: it would also serve to preserve some capacity to

make their own choices by both strengthening the budget and the

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

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

the transition to a more sustainable future for our children and

grandchildren.

In this regard, I think the President’s proposal has the advantage of putting

forth a long-term plan that would help promote future growth by paying

down the publicly held debt. Many in the Congress putting forth

constructive reform proposals for Social Security and Medicare also

deserve credit—a sustainable future involves both fiscal policies that

would improve national savings as well as real programmatic reforms to

reduce the burdens of obligations and commitments on future generations.

In determining how to finance the Medicare program, much is at

stake—not only the future of Medicare itself but also preserving the

nation’s future fiscal flexibility to pursue other important national goals

and programs. Mr. Chairman, I feel that the greatest risk lies in extending

the HI Trust Fund’s solvency while 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.

General fund infusions and expanded benefits may well be a necessary

part of any major reform initiative. Updating the benefit package is

probably a key part of any realistic reform program to address the

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

the future. The President’s proposal also includes a broader package of

reforms that provide a good point of departure for addressing Medicare’s

current fiscal imbalance. However, more needs to be done to ensure the

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

consider adequate fiscal incentives to control costs and an enhanced

targeting strategy in connection with any proposal to provide a

prescription drug benefit.

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

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,

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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

adequate and affordable. Prudence requires making the tough choices

today while the economy is healthy and the cohort of workers 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 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 Committee may have.

GAO Contacts and

Acknowledgments

For future contacts 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 at (202) 512-7114. Other individuals

who made key contributions include Linda F. Baker, Hannah F. Fein,

James R. McTigue, and Deborah Spielberg.

(935325/101871) Page 25 GAO/T-AIMD/HEHS-99-236 GAO/T-AIMD/HEHS-99-236
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