Testimony

Before the Committee on the Budget, House of

Representatives

United States General Accounting Office

GAO

For Release on Delivery

Expected at 10:00 a.m.

Wednesday, July 25, 2001 MEDICARE

New Spending Estimates

Underscore Need for

Reform

Statement of David M. Walker

Comptroller General of the United States

GAO-01-1010T
Page 1 GAO-01-1010T

Mr. Chairman and Members of the Committee:

I am pleased to be here today as you discuss the long-term financial

condition of the Medicare program. In previous congressional testimony

over the past several years, I have consistently stressed that without

meaningful reform, demographic and cost trends will drive Medicare

spending to unsustainable levels.1

 These trends highlight the need to act

now rather than later when needed changes will be increasingly more

painful and disruptive.

Although the short-term outlook of Medicare’s Hospital Insurance trust

fund improved somewhat in the last year, the long-term projections are

much worse due to a change in expectations about future health care

costs. Specifically, the Medicare Trustees’ latest projections released in

March incorporate more realistic—i.e., higher—assumptions about longterm health care spending. As a result, the long-term outlook for

Medicare’s financial future—both Hospital Insurance (HI) and

Supplementary Medical Insurance (SMI)—is considerably worse than

previously estimated. The Congressional Budget Office (CBO) also

increased its long-term estimates of Medicare spending. The slowdown in

Medicare spending growth that we have seen in recent years appears to

have come to an end. In the first 8 months of fiscal year 2001, Medicare

spending was 7.5 percent higher than the previous year. The fiscal

discipline imposed through the Balanced Budget Act of 1997 (BBA)

continues to be challenged, while interest in modernizing the Medicare

benefits package to include prescription drug coverage has increased.

Taken together, these developments mean higher, not lower health care

cost growth. They reinforce the need to begin taking steps to address the

challenges of meaningful Medicare reform. In pursuing such reform, it is

important to focus on the long-term sustainability of the combined

Medicare program, rather than the solvency of the HI trust fund alone.

Ultimately, any comprehensive Medicare reform must confront several

fundamental challenges. In summary:

 1 Medicare: Higher Expected Spending and Call for New Benefit Underscore Need for

Meaningful Reform (GAO-01-539T, March 22, 2001); Medicare Reform: Leading Proposals

Lay Groundwork, While Design Decisions Lie Ahead (GAO/T-HEHS-AIMD-00-103, Feb. 24,

2000); Medicare Reform: Ensuring Fiscal Sustainability While Modernizing the Program

Will Be Challenging (GAO/T-HEHS/AIMD-99-294, Sept. 22, 1999).
Page 2 GAO-01-1010T

• Medicare spending is likely to grow faster than previously estimated. The

Medicare Trustees are now projecting that, in the long- term, Medicare

costs will eventually grow at 1 percentage point above per-capita gross

domestic product (GDP) each year—about 1 percentage point faster per

year than the previous assumption. Accordingly, as estimated by the Office

of the Actuary at the Centers for Medicare and Medicaid Services (CMS)—

formerly known as the Health Care Financing Administration (HCFA), the

estimated net present value of future additional resources needed to fund

Part A HI benefits over the next 75 years increased from $2.6 trillion last

year to $4.6 trillion this year—an increase of more than 75 percent.

• Our long-term budget simulations show that demographics and health care

spending will drive us back into periods of escalating deficits and debt

absent meaningful entitlement reforms or other significant tax or spending

actions. Our March 2001 long-term simulations show that even if the oftenstated goal of saving all Social Security surpluses is realized, large and

persistent deficits will return in less than 20 years.

• Medicare’s sustainability can no longer be measured merely using the

traditional measure of HI trust fund solvency. The financial status of this

trust fund does not reflect the whole picture. In fact, focusing on solvency

can be misleading and give a false sense of security regarding the overall

condition of the Medicare program. Both Part A expenditures financed

through payroll taxes and Part B SMI expenditures financed through

general revenues and beneficiary premiums must be taken into

consideration. When viewed from this comprehensive perspective, total

Medicare spending is projected to double as a share of GDP by 2035.

Importantly, this estimate does not include the cost of any prescription

drug benefit.

• Since the cost of a drug benefit would boost these spending projections

even further, adding prescription drug coverage will require difficult policy

choices that will likely have significant effects on beneficiaries, taxpayers,

and the program. Recognition of who bears the cost of Medicare is critical.

Currently, there may not be full awareness that beneficiaries’ payroll tax

contributions and premiums generally finance considerably less than their

lifetime benefits.

• Properly structured reforms to promote competition among health plans

can help make beneficiaries more cost conscious. However, improvements

to traditional fee-for-service (FFS) Medicare are also critical, as it will

likely remain dominant for some time to come.

• Fiscal discipline is difficult, but the continued importance of traditional

Medicare underscores the need to base adjustments to provider payments

on hard evidence rather than anecdotal information and to carefully target

relief where it is both needed and deserved.
Page 3 GAO-01-1010T

• Similarly, reform of Medicare’s management, which is on the table as

discussions of Medicare program reforms proceed, will require carefully

targeted efforts to ensure that adequate resources are appropriately

coupled with improved performance and increased accountability.

• Ultimately, we will need to look at broader health care reforms to balance

health care spending with other societal priorities. In doing this, it is

important to look at the entire range of federal policy tools—tax policy,

spending, and regulation. It is also important to note the fundamental

differences between health care wants, which are virtually unlimited, from

needs, which should be defined and addressed, and overall affordability, of

which there is a limit. In the end, we will need to take a range of steps to

increase the transparency of health care costs and quality, target

assistance to those in need, re-examine incentives, and assure

accountability for desired outcomes.

The consensus that Medicare is likely to cost more than previously

estimated serves to reinforce the need to act soon. Realistically, reforms to

address the Medicare program’s huge long-range financial imbalance will

need to proceed incrementally. In addition, efforts to update the program’s

benefits package will need careful and cautious deliberation. As the

Congress considers Medicare reform, it will be important to adopt

effective cost containment reforms alongside potential benefit expansions.

Any benefit expansion efforts will need to be coupled with adequate

program reforms if Medicare’s long-range financial condition is not to be

worsened. This is especially important in connection with a potential

prescription drug benefit, as this coverage represents the fastest-growing

expenditure for many public and private health plans. Therefore, the time

to begin these difficult, but necessary, incremental steps is now.

As I have stated in other testimony, Medicare as currently structured is

fiscally unsustainable. While many people have focused on the

improvement in the HI trust fund’s shorter-range solvency status, the real

news is that we now have a more realistic view of Medicare’s long-term

financial condition and the outlook is much bleaker. A consensus has

emerged that previous program spending projections have been based on

overly optimistic assumptions and that actual spending will grow faster

than has been assumed.

Medicare’s Long-Term

Financial Future

Looks Worse
Page 4 GAO-01-1010T

First, let me talk about how we measure Medicare’s fiscal health. In the

past, Medicare’s financial status has generally been gauged by the

projected solvency of the HI trust fund, which covers primarily inpatient

hospital care and is financed by payroll taxes. Looked at this way,

Medicare—more precisely, Medicare’s Hospital Insurance trust fund—is

described as solvent through 2029.

However, even from the perspective of HI trust fund solvency, the

estimated exhaustion date of 2029 does not mean that we can or should

wait until then to take action. In fact, delay in addressing the HI trust fund

imbalance means that the actions needed will be larger and more

disruptive. Taking action today to restore solvency to the HI trust fund for

the next 75 years would require benefit cuts of 37 percent or tax increases

of 60 percent, or some combination of the two. While these actions would

not be easy or painless, postponing action until 2029 would require more

than doubling of the payroll tax or cutting benefits by more than half to

maintain solvency. (See fig. 1.) Given that in the long-term, Medicare cost

growth is now projected to grow at 1 percentage point faster than GDP,

HI’s financial condition is expected to continue to worsen after the 75-year

period. By 2075, HI’s annual financing shortfall—the difference between

program income and benefit costs—will reach 7.35 percent of taxable

payroll. This means that if no action is taken this year, shifting the 75-year

horizon out one year to 2076—a large deficit year—and dropping 2001—a

surplus year—would yield a higher actuarial deficit, all other things being

equal.

Traditional HI Trust Fund

Solvency Measure Is a

Poor Indicator of

Medicare’s Fiscal Health
Page 5 GAO-01-1010T

Figure 1: Estimated Benefit Reduction or Tax Increase Necessary to Restore HI

Trust Fund Solvency

Source: Office of the Actuary, CMS, 2001 intermediate assumptions.

Moreover, HI trust fund solvency does not mean the program is financially

healthy. Under the Trustees’ 2001 intermediate estimates, HI outlays are

projected to exceed HI tax revenues beginning in 2016, the same year in

which Social Security outlays are expected to exceed tax revenues. (See

fig. 2.) As the baby boom generation retires and the Medicare-eligible

population swells, the imbalance between outlays and revenues will

increase dramatically. Thus, in 15 years the HI trust fund will begin to

experience a growing annual cash deficit. At that point, the HI program

must redeem Treasury securities acquired during years of cash surplus.

Treasury, in turn, must obtain cash for those redeemed securities either

through increased taxes, spending cuts, increased borrowing, retiring less

debt, or some combination thereof.

37

44

54 60

80

119

0

25

50

75

100

125

150

2001-2075 2016-2075 2029-2075

Percent

Benefit Reduction

Tax Increase
Page 6 GAO-01-1010T

Figure 2: Medicare’s Hospital Insurance Trust Fund Faces Cash Deficits as Baby

Boomers Retire

Source: GAO analysis of data from the Office of the Actuary, CMS, 2001 intermediate assumptions.

Finally, HI trust fund solvency does not measure the growing cost of the

Part B SMI component of Medicare, which covers outpatient services and

is financed through general revenues and beneficiary premiums.2

 Part B

accounts for somewhat more than 40 percent of Medicare spending and is

expected to account for a growing share of total program dollars. As the

Trustees noted in this year’s report, a rapidly growing share of general

revenues and substantial increases in beneficiary premiums will be

required to cover part B expenditures.

 2

At Medicare’s inception, the law initially established a formula for Part B premiums that

set the rate to cover 50 percent of expected program costs for aged enrollees, with the

remaining 50 percent covered by general revenues. Legislation enacted in 1972 limited the

annual percentage increase in the premium to the same percentage by which Social

Security benefits were adjusted for changes in cost of living. As a result, from the mid1970s through the early 1980s, the portion of program costs covered by premium income

dropped from 50 percent to below 25 percent. Beginning in the early 1980s, Congress

regularly voted to set part B premiums at a level to cover 25 percent of expected program

costs, in effect overriding the cost-of-living adjustment limitation. In 1997 BBA permanently

set the rate at 25 percent.

-300

-200

-100

0

100

2000 2005 2010 2015 2020 2025 2030 2035 2040

HI cash surplus HI cash deficit

Medicare HI

cash deficit

2016

Billions of 2000 dollars
Page 7 GAO-01-1010T

Clearly, it is total program spending—both Part A and Part B—relative to

the entire federal budget and national economy that matters. This total

spending approach is a much more realistic way of looking at the

combined Medicare program’s sustainability. In contrast, the historical

measure of HI trust fund solvency cannot tell us whether the program is

sustainable over the long haul. Worse, it can serve to distort perceptions

about the timing, scope, and magnitude of our Medicare challenge.

These figures reflect a worsening of the long-term outlook. Last year a

technical panel advising the Medicare Trustees recommended assuming

that future per-beneficiary costs for both HI and SMI eventually will grow

at a rate 1 percentage point above GDP growth—about 1 percentage point

higher than had previously been assumed.3

 That recommendation—which

was consistent with a similar change CBO had made to its Medicare and

Medicaid long-term cost growth assumptions4

—was adopted by the

Trustees. In their new estimates published on March 19, 2001, the

Trustees adopted the technical panel’s long-term cost growth

recommendation.5

 The Trustees note in their report that this new

assumption substantially raises the long-term cost estimates for both HI

and SMI. In their view, incorporating the technical panel’s

recommendation yields program spending estimates that represent a more

realistic assessment of likely long-term program cost growth.

Under the old assumption (the Trustees’ 2000 best estimate intermediate

assumptions), total Medicare spending consumed 5 percent of GDP by

2063. Under the new assumption (the Trustees’ 2001 best estimate

intermediate assumptions), this occurs almost 30 years sooner in 2035—

and by 2075 Medicare consumes over 8 percent of GDP, compared with 5.3

percent under the old assumption. The difference clearly demonstrates the

 3

Technical Review Panel on the Medicare Trustees Reports, Review of Assumptions and

Methods of the Medicare Trustees’ Financial Projections (Dec. 2000). As the panel noted,

for many years the Medicare projections have been based on an assumption that in the long

run, average per-beneficiary costs would increase at about the same rate as program

underlying funding sources. For HI, this meant that expenditures were assumed to increase

at the same rate as average hourly earnings. For SMI, this meant that per-beneficiary costs

were assumed to grow at the same rate as per-capita GDP.

4

CBO, The Long-Term Budget Outlook (Oct. 2000).

5

See 2001 Annual Report of the Board of Trustees of the Federal Hospital Insurance Trust

Fund (March 2001) and 2001 Annual Report of the Board of Trustees of the Federal

Supplementary Medical Insurance Trust Fund (March 2001).

New Estimates Increase

Urgency of Reform Efforts
Page 8 GAO-01-1010T

dramatic implications of a 1-percentage point increase in annual Medicare

spending over time. (See fig. 3)

Figure 3: Medicare Spending as a Share of GDP Under Old and New Assumptions

Note: Data are gross outlays as projected under the Trustees’ intermediate assumptions.

Source: GAO analysis of data from the 2000 and 2001 HI and SMI Trustees Reports.

In part the progressive absorption of a greater share of the nation’s

resources for health care, as with Social Security, is a reflection of the

rising share of the population that is elderly. Both programs face

demographic conditions that require action now to avoid burdening future

generations with the program’s rising costs. Like Social Security,

Medicare’s financial condition is directly affected by the relative size of the

populations of covered workers and beneficiaries. Historically, this

relationship has been favorable. In the near future, however, the covered

worker-to-retiree ratio will change in ways that threaten the financial

solvency and sustainability of this important national program. In 1970

there were 4.6 workers per HI beneficiary. Today there are about 4, and in

2030, this ratio will decline to only 2.3 workers per HI beneficiary.6

 (See

fig. 4.)

 6

For Social Security, there were 3.7 covered workers per beneficiary in 1970. Today there

are 3.4, and the ratio is expected to decline to 2.1 in 2030.

0

2

4

6

8

10

2000 2010 2020 2030 2040 2050 2060 2070 2075

Percent of GDP

2000 Trustees 2001 Trustees
Page 9 GAO-01-1010T

Figure 4: Workers Per HI Beneficiary Expected to Decline

Source: GAO analysis of data from the Office of the Actuary, CMS.

Unlike Social Security, however, Medicare growth rates reflect not only a

burgeoning beneficiary population, but also 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.7

 Moreover, the actual costs of

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

insulate consumers from the cost of health care decisions. All of these

factors contribute to making Medicare a much greater and more complex

fiscal challenge than even Social Security.

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

the growth in health care spending will become increasingly unsustainable

over the longer term.8

 Figure 5 shows the sum of the future expected HI

 7

In arriving at their recommendation for Medicare long-term cost growth, the Medicare

Technical Panel observed that historically, the primary long-run determinant of real health

care spending has been the development and diffusion of new medical technology.

8

See Long-Term Budget Issues: Moving from Balancing the Budget to Balancing Fiscal Risk

(GAO-01-385T, Feb. 6, 2001).

0

1

2

3

4

5

1966 1975 1985 1995 2005 2015 2025 2035 2045 2055 2065 2075

Workers per HI Beneficiary
Page 10 GAO-01-1010T

cash deficit and the expected general fund contribution to SMI as a share

of federal income taxes under the Trustees 2001 intermediate estimates.

SMI has received contributions from the general fund since the inception

of the program. This general revenue contribution is projected to grow

from about 5 percent of federal personal and corporate income taxes in

2000 to 13 percent by 2030. Beginning in 2016, use of general fund

revenues will be required to pay benefits as the HI trust fund redeems its

Treasury securities. Assuming general fund revenues are used to pay

benefits after the trust fund is exhausted, by 2030 the HI program alone

would consume more than 6 percent of income tax revenue. On a

combined basis, Medicare’s draw on general revenues would grow from

5.4 percent of income taxes today to nearly 20 percent in 2030 and 45

percent by 2070.

Figure 5: SMI General Revenue Contribution and HI Cash Deficit as a Share of

Federal Corporate and Personal Income Taxes

Note: Estimates are based on the Trustees’ 2001 intermediate assumptions and assume that

personal and corporate federal income taxes remain at the same share of gross domestic product as

in 2000.

Source: GAO analysis of data from the Office of the Chief Actuary, CMS, 2001 intermediate

assumptions.

Figure 6 reinforces the need to look beyond the HI program. HI is only the

first layer in this figure. The middle layer adds the SMI program, which is

expected to grow faster than HI in the near future. By the end of the 75-

0

5

10

15

20

25

30

35

40

45

50

1970 1980 1990 2000 2010 2020 2030 2040 2050 2060 2070

SMI general revenue contribution HI cash deficit

Percent of federal income taxes
Page 11 GAO-01-1010T

year projection period, SMI will represent almost half of total estimated

Medicare costs.

To get a more complete picture of the future federal health care

entitlement burden, Medicaid is added. Medicare and the federal portion

of Medicaid together will grow to 14.5 percent of GDP from today’s 3.5

percent. Taken together, the two major government health programs—

Medicare and Medicaid—represent an unsustainable burden on future

generations. In addition, this figure does not reflect the taxpayer burden of

state and local Medicaid expenditures. A recent statement by the National

Governors Association argues that increased Medicaid spending has

already made it difficult for states to increase funding for other priorities.

Figure 6: Medicare and Medicaid Spending as a Share of GDP

Notes:

1. Medicare data are gross outlays as projected under the Trustees’ 2001 intermediate assumptions.

2. Federal Medicaid data based on CBO’s October 2000 long-term budget outlook.

Source: GAO analysis of data from the Congressional Budget Office and the March 2001 HI and SMI

Trustees Reports.

Our long-term simulations show that to move into the future with no

changes in federal health and retirement programs is to envision a very

different role for the federal government. Assuming, for example, that

Congress and the President adhere to the often-stated goal of saving the

Social Security surpluses, our long-term simulations show a world by 2030

in which Social Security, Medicare, and Medicaid absorb most of the

available revenues within the federal budget. Under this scenario, these

0

2

4

6

8

10

12

14

16

2000 2010 2020 2030 2040 2050 2060 2075

Percent of GDP

HI

SMI

Medicaid
Page 12 GAO-01-1010T

programs would require more than three-quarters of total federal revenue

even without adding a Medicare prescription drug benefit. (See fig. 7.)

Figure 7: Composition of Federal Spending as a Share of GDP Under the “Save the Social Security Surpluses” Simulation

Notes:

Revenue as a share of GDP declines from its 2000 level of 20.6 percent due to unspecified

permanent policy actions. In this display, policy changes are allocated equally between revenue

reductions and spending increases.

The “Save the Social Security Surpluses” simulation can only be run through 2056 due to the

elimination of the capital stock.

Source: GAO’s March 2001 analysis.

This scenario contemplates saving surpluses for 20 years—an

unprecedented period of surpluses in our history—and retiring publicly

held debt. Alone, however, even saving all Social Security surpluses would

not be enough to avoid encumbering the budget with unsustainable costs

from these entitlement programs. Little room would be left for other

federal spending priorities such as national defense, education, and law

enforcement. Absent changes in the structure of Medicare and Social

Security, sometime during the 2040s government would do nothing but

mail checks to the elderly and their health care providers. Accordingly,

substantive reform of the Medicare and Social Security programs remains

critical to recapturing our future fiscal flexibility.

0

10

20

30

40

50

2000 2030 2050

Percent of GDP

Net interest Social Security Medicare & Medicaid All other spending

Revenue
Page 13 GAO-01-1010T

Demographics argue for early action to address Medicare’s fiscal

imbalances. Ample time is required to phase in the reforms needed to put

this program on a more sustainable footing before the baby boomers

retire. In addition, timely action to bring costs down pays large fiscal

dividends for the program and the budget. The high projected growth of

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

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

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. Today’s decisions can have wide-ranging effects on our ability to

afford tomorrow’s commitments. As I have testified before, you can think

of the budget choices you face as a portfolio of fiscal options balancing

today’s unmet needs with tomorrow’s fiscal challenges. At the one end—

with the lowest risk to the long-range fiscal position—is reducing publicly

held debt. At the other end—offering the greatest risk—is increasing

entitlement spending without fundamental program reform.

Reducing publicly held debt helps lift future fiscal burdens by freeing up

budgetary resources encumbered for interest payments, which currently

represent about 12 cents of every federal dollar spent, and by enhancing

the pool of economic resources available for private investment and longterm economic growth. This is particularly crucial in view of the known

fiscal pressures that will begin bearing down on future budgets in about 10

years as the baby boomers start to retire. However, as noted above, debt

reduction is not enough. Our long-term simulations illustrate that, absent

entitlement reform, large and persistent deficits will return.

Despite common agreement that, without reform, future program costs

will consume growing shares of the federal budget, there is also a

mounting consensus that Medicare’s benefit package should be expanded

to cover prescription drugs, which will add billions to the program’s cost.

This places added pressure on policymakers to consider proposals that

could fundamentally reform Medicare. Our previous work provides, I

believe, some considerations that are relevant to deliberations regarding

the potential addition of a prescription drug benefit and Medicare reform

options that would inject competitive mechanisms to help control costs. In

addition, our reviews of HCFA offer lessons for improving Medicare’s

management. Implementing necessary reforms that address Medicare’s

financial imbalance and meet the needs of beneficiaries will not be easy.

Medicare’s Bleak

Financial Outlook

Drives Need for

Meaningful Program

and Management

Reform
Page 14 GAO-01-1010T

We must have a Medicare agency that is ready and able to meet these 21st

century challenges.

Among the major policy challenges facing the Congress today is how to

reconcile Medicare’s unsustainable long-range financial condition with the

growing demand for an expensive new benefit—namely, coverage for

prescription drugs. It is a given that prescription drugs play a far greater

role in health care now than when Medicare was created. Today, Medicare

beneficiaries tend to need and use more drugs than other Americans.

However, because adding a benefit of such potential magnitude could

further erode the program’s already unsustainable financial condition, you

face difficult choices about design and implementation options that will

have a significant impact on beneficiaries, the program, and the

marketplace.

Let’s examine the current status regarding Medicare beneficiaries and drug

coverage. About a third of Medicare beneficiaries have no coverage for

prescription drugs. Some beneficiaries with the lowest incomes receive

coverage through Medicaid. Some beneficiaries receive drug coverage

through former employers, some can join Medicare+Choice plans that

offer drug benefits, and some have supplemental Medigap coverage that

pays for drugs. However, significant gaps remain. For example,

Medicare+Choice plans offering drug benefits are not available

everywhere and generally do not provide catastrophic coverage. Medigap

plans are expensive and have caps that significantly constrain the

protection they offer. Thus, beneficiaries with modest incomes and high

drug expenditures are most vulnerable to these coverage gaps.

Overall, the nation’s spending on prescription drugs has been increasing

about twice as fast as spending on other health care services, and it is

expected to keep growing. Recent estimates show that national per-person

spending for prescription drugs will increase at an average annual rate

exceeding 10 percent until at least 2010. As the cost of drug coverage has

been increasing, employers and Medicare+Choice plans have been cutting

back on prescription drug benefits by raising enrollees’ cost-sharing,

charging higher copayments for more expensive drugs, or eliminating the

benefit altogether.

It is not news that adding a prescription drug benefit to Medicare will be

costly. However, the cost consequences of a Medicare drug benefit will

depend on choices made about its design—including the benefit’s scope

and financing mechanism. For instance, a Medicare prescription drug

Adding a Fiscally

Responsible Prescription

Drug Benefit Will Entail

Multiple Trade-Offs
Page 15 GAO-01-1010T

benefit could be designed to provide coverage for all beneficiaries,

coverage only for beneficiaries with extraordinary drug expenses,

coverage only for low-income beneficiaries. Policymakers would need to

determine how costs would be shared between taxpayers and

beneficiaries through premiums, deductibles, and copayments and

whether subsidies would be available to low-income, non-Medicaid eligible

individuals. Design decisions would also affect the extent to which a new

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

by Medicaid, Medigap, or employer plans covering prescription drugs for

retirees. Clearly, the details of a prescription drug benefit’s

implementation would have a significant impact on both beneficiaries and

program spending. Experience suggests that some combination of

enhanced access to discounted prices, targeted subsidies, and measures to

make beneficiaries more aware of costs may be needed. Any option would

need to balance concerns about Medicare sustainability with the need to

address what will likely be a growing hardship for some beneficiaries in

obtaining prescription drugs.

The financial prognosis for Medicare clearly calls for meaningful spending

reforms to help ensure that the program is sustainable over the long haul.

The importance of such reforms will be heightened if financial pressures

on Medicare are increased by the addition of new benefits, such as

coverage for prescription drugs. Some leading reform proposals envision

that Medicare could achieve savings by adapting some of the competitive

elements embodied in the Federal Employees Health Benefits Program.

Specifically, these proposals would move Medicare towards a model in

which health plans compete on the basis of benefits offered and costs to

the government and beneficiaries, making the price of health care more

transparent.

Currently, Medicare follows a complex formula to set payment rates for

Medicare+Choice plans, and plans compete primarily on the richness of

their benefit packages. Medicare permits plans to earn a reasonable profit,

equal to the amount they can earn from a commercial contract. Efficient

plans that keep costs below the fixed payment amount can use the

“savings” to enhance their benefit packages, thus attracting additional

members and gaining market share. Under this arrangement, competition

Reform Options Based on

Competition Offer

Advantages but Contain

Limitations
Page 16 GAO-01-1010T

among Medicare plans may produce advantages for beneficiaries, but the

government reaps no savings.9

In contrast, a competitive premium approach offers certain advantages.

Instead of having the government administratively set a payment amount

and letting plans decide—subject to some minimum requirements—the

benefits they will offer, plans would set their own premiums and offer at

least a required minimum Medicare benefit package. Under these

proposals, Medicare costs would be more transparent: beneficiaries could

better see what they and the government were paying for in connection

with health care expenditures. Beneficiaries would generally pay a portion

of the premium and Medicare would pay the rest. Plans operating at lower

cost could reduce premiums, attract beneficiaries, and increase market

share. Beneficiaries who joined these plans would enjoy lower out-ofpocket expenses. Unlike today’s Medicare+Choice program, the

competitive premium approach provides the potential for taxpayers to

benefit from the competitive forces. As beneficiaries migrated to lowercost plans, the average government payment would fall.

Experience with the Medicare+Choice program reminds us that

competition in Medicare has its limits. First, not all geographic areas are

able to support multiple health plans. Medicare health plans historically

have had difficulty operating efficiently in rural areas because of a

sparseness of both beneficiaries and providers. In 2000, 21 percent of rural

beneficiaries had access to a Medicare+Choice plan, compared to 97

percent of urban beneficiaries. Second, separating winners from losers is a

basic function of competition. Thus, under a competitive premium

approach, not all plans would thrive, requiring that provisions be made to

protect beneficiaries enrolled in less successful plans.

The extraordinary challenge of developing and implementing Medicare

reforms should not be underestimated. Our look at health care spending

projections shows that, with respect to Medicare reform, small

implementation problems can have huge consequences. To be effective, a

good program design will need to be coupled with competent program

 9

In fact, the government has been losing money on the Medicare+Choice program.

Medicare pays more, on average, for beneficiaries enrolled in managed care plans than if

these individuals had remained in traditional Medicare. See Medicare+Choice: Payments

Exceed Cost of Fee-for-Service Benefits, Adding Billions to Spending (GAO/HEHS-00-161,

Aug. 23, 2000).

Effective Program

Management Key to

Successful Reform Efforts
Page 17 GAO-01-1010T

management. Consistent with that view, questions are being raised about

the ability of CMS to administer the Medicare program effectively.

Our reviews of Medicare program activities confirm the legitimacy of these

concerns. In our companion statement today, we discuss not only the

Medicare agency’s performance record but also areas where constraints

have limited the agency’s achievements. We also identify challenges the

agency faces in seeking to meet expectations for the future.

As the Congress and the Administration focus on current Medicare

management issues, our review of HCFA suggests several lessons:

• Managing for results is fundamental to an agency’s ability to set

meaningful goals for performance, measure performance against those

goals, and hold managers accountable for their results. Our work shows

that HCFA has faltered in adopting a results-based approach to agency

management, leaving the agency in a weakened position for assuming

upcoming responsibilities. In some instances, the agency may not have the

tools it needs because it has not been given explicit statutory authority.

For example, the agency has sought explicit statutory authority to use full

and open competition to select claims administration contractors. The

agency believes that without such statutory authority it is at a

disadvantage in selecting the best performers to carry out Medicare claims

administration and customer service functions. To be effective, any agency

must be equipped with the full complement of management tools it needs

to get the job done.

• A high-performance organization demands a workforce with, among other

things, up-to-date skills to enhance the agency’s value to its customers and

ensure that it is equipped to achieve its mission. HCFA began workforce

planning efforts that continue today in an effort to identify areas in which

staff skills are not well matched to the agency’s evolving mission. In

addition, CMS recently reorganized its structure to be more responsive to

its customers. It is important that CMS continue to reevaluate its skill

needs and organizational structure as new demands are placed on the

agency.

• Data-driven information is essential to assess the budgetary impact of

policy changes and distinguish between desirable and undesirable

consequences. Ideally, the agency that runs Medicare should have the

ability to monitor the effects of Medicare reforms, if enacted—such as

adding a drug benefit or reshaping the program’s design. However, HCFA

was unable to make timely assessments, largely because its information

systems were not up to the task. The status of these systems remains the

same, leaving CMS unprepared to determine, within reasonable time
Page 18 GAO-01-1010T

frames, the appropriateness of services provided and program

expenditures. The need for timely, accurate, and useful information is

particularly important in a program where small rate changes developed

from faulty estimates can mean billions of dollars in overpayments or

underpayments.

• An agency’s capacity should be commensurate with its responsibilities. As

the Congress continues to modify Medicare, CMS’ responsibilities will

grow substantially. HCFA’s tasks increased enormously with the

enactment of landmark Medicare legislation in 1997 and the modifications

to that legislation in 1999 and 2000. In addition to the growth in Medicare

responsibilities, the agency that administers this program is also

responsible for other large health insurance programs and activities. As

the agency’s mission has grown, however, its administrative dollars have

been stretched thinner. Adequate resources are vital to support the kind of

oversight and stewardship activities that Americans have come to count

on—inspection of nursing homes and laboratories, certification of

Medicare providers, collection and analysis of critical health care data, to

name a few. Shortchanging this agency’s administrative budget will put the

agency’s ability to handle upcoming reforms at serious risk.

In short, because Medicare’s future will play such a significant role in the

future of the American economy, we cannot afford to settle for anything

less than a world-class organization to run the program. However,

achieving such a goal will require a clear recognition of the fundamental

importance of efficient and effective day-to-day operations.

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. I

feel that the greatest risk lies in doing nothing to improve the Medicare

program’s long-term sustainability. It is my hope that we will think about

the unprecedented challenge facing future generations in our aging

society. Engaging in a comprehensive effort to reform the Medicare

program and put it on a sustainable path for the future would help fulfill

this generation’s stewardship responsibility to succeeding generations. It

would also help to preserve some capacity for future generations to make

their own choices for what role they want the federal government to play.

Updating Medicare’s benefit package may be a necessary part of any

realistic reform program. Such changes, however, need to be considered in

the context of Medicare’s long-term fiscal outlook and the need to make

changes in ways that will promote the program’s longer-term

Conclusions
Page 19 GAO-01-1010T

sustainability. We must remember that benefit expansions are often

permanent, while the more belt-tightening payment reforms—vulnerable

to erosion—could be discarded altogether. The BBA experience reminds

us about the difficulty of undertaking reform.

Most importantly, any substantial benefit reform should be coupled with

other meaningful program reforms that will help to ensure the long-term

sustainability of the program. In the end, the Congress should consider

adopting a Hippocratic oath for Medicare reform proposals—namely,

“Don’t make the long-term outlook worse.” Ultimately, we will need to

engage in a much more fundamental health care reform debate to

differentiate wants, which are virtually unlimited, from needs, which

should be defined and addressed, and overall affordability, of which there

is a limit.

We at GAO look forward to continuing to work with this Committee and

the Congress in addressing this and other important issues facing our

nation. In doing so, we will be true to our core values of accountability,

integrity, and reliability.

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

answer any questions you or other Members of the Committee may have.

(290101)