Medicare: Financial Outlook Poses Challenges for Sustaining Program and Adding Drug Coverage
Published: 2002-04-17T00:00:00

Fast Facts:

Highlights:
section_title: What GAO Found
paragraphs: The lack of outpatient prescription drug coverage may leave Medicare's most vulnerable beneficiaries with high out-of-pocket costs. Recent estimates suggest that, at any given time, more than a third of Medicare beneficiaries lack prescription drug coverage. The rest have some coverage through various sources--most commonly employer-sponsored health plans. Recent evidence indicates that this coverage is beginning to erode. The short- and long-term cost pressures facing Medicare will require substantial financing and programmatic reforms to put future Medicare on a sustainable footing. In the absence of a drug benefit, many Medicare beneficiaries obtain coverage through health plans, public programs, and the Medigap insurance market. The price, availability, and level of such coverage varies widely, leaving substantial gaps and exposure to high out-of-pocket costs for thousands. Despite pressures to adopt a prescription drug benefit, the rapidly rising cost of current obligations argues for careful deliberation and extreme caution in expanding benefits. GAO's long-term simulations show that the aging of the baby boomers and rising per capita health care spending will, absent meaningful reform, lead to massive fiscal challenges in future years.

section_title: Letter
paragraphs: I am pleased to be here today as you discuss options for increasing  Medicare beneficiaries’ access to prescription drugs. There are growing  concerns about gaps in the Medicare program, most notably the lack of  outpatient prescription drug coverage, which may leave Medicare’s most  vulnerable beneficiaries with high out-of-pocket costs. Recent estimates  suggest that, at any point in time, over a third of Medicare beneficiaries  lack prescription drug coverage. The rest have at least some drug coverage  through various sources—most commonly employer-sponsored health  plans—although recent evidence indicates that this coverage is beginning  to erode.
At the same time, however, the short-term and long-term cost pressures  facing the existing Medicare program are considerable. After a brief  slowdown in the late 1990s, Medicare spending growth has recently  accelerated. In the last fiscal year, growth in program spending reached  nearly 9 percent, with spending on certain services increasing much more  rapidly. For example, spending for home health grew about 30 percent and  spending for skilled nursing facility care grew slightly over 20 percent.
As I have noted previously, substantive financing and programmatic  reforms are necessary to put Medicare on a sustainable footing for the  future. These fundamental reforms are vital to reducing the program’s  growth, which threatens to absorb ever-increasing shares of the nation’s  budgetary and economic resources. Thus, any proposals to help seniors  with the costs of prescription drugs would need to be carefully crafted to  avoid further erosion of the projected financial condition of the Medicare  program, which is already unsustainable in its present form.
We must also remain mindful that the fiscal pressures created by the  retirement of the baby boom generation and rising health care costs are  just over the horizon. Between now and 2035, the number of people who  are 65 and older will double. Federal health and retirement spending are  expected to surge as people live longer and spend more time in retirement.  In addition, advances in medical technology are likely to keep pushing up  the cost of providing health care. Moreover, the baby boomers will have  left behind fewer workers to support them in retirement. Absent  substantive reform of the entitlement programs, a rapid escalation of  federal spending for Social Security, Medicare, and Medicaid beginning  less than 10 years from now is virtually certain to overwhelm the rest of  the federal budget.
As figure 1 shows, fiscal flexibility has already decreased as spending for  Social Security, Medicare, and Medicaid have absorbed an increasingly  large share of the federal budget. Reductions in defense spending have  helped accommodate the growth in these entitlement programs. However,  reductions in defense spending can no longer be used as a means to help  fund other claims on the budget; indeed, spending on defense and  homeland security will grow as we seek to combat threats to our nation.
Today my remarks will focus on (1) the access and affordability issues that  underlie the interest in a Medicare prescription drug benefit, (2) the  financial challenges Medicare faces to meet its current obligations, and (3)  key considerations in light of the tension between benefit expansions and  budgetary pressures.
In summary, intentions to add prescription drug coverage to Medicare’s  benefits come during a period of rapid growth in national spending for  pharmaceuticals. Between 1995 and 2000, spending for prescription drugs  rose more than 2 1/2 times faster than spending for health care overall, and  this dramatic growth is expected to continue in the coming years. In the  absence of a drug benefit in the Medicare program, many beneficiaries  obtain coverage from other sources, including health plans, public  programs, and the Medigap insurance market. But the price, availability,  and level of such coverage vary widely, leaving substantial gaps and  exposure to high out-of-pocket costs for hundreds of thousands of  beneficiaries.
Despite the various pressures to adopt a prescription drug benefit, the  rapidly escalating cost of meeting current obligations for present and  future beneficiaries argues for careful deliberation and extreme caution in  crafting any benefit expansion. Medicare’s trustees have indicated in  recent years that the Medicare program is already unsustainable in its  present form. GAO’s long-term budget simulations show that the aging of  the baby boom generation and rising per capita health care spending will,  absent meaningful reform, lead to massive fiscal challenges in future  years. Assuming, for example, that last year’s tax reductions are made  permanent and discretionary spending keeps pace with the economy, by  mid-century, spending for the current Medicare program—without the  addition of a drug benefit—is projected to account for more than one- quarter of all federal revenues. In fact, federal revenues may only be  adequate to pay Social Security and interest on the federal debt. As a  result, massive spending, tax increases, or some combination of the two  would be necessary to obtain balance. (See fig. 2.)
The huge budgetary pressures that we are sure to face in the coming years  require that we set priorities so that any benefit expansions are in line with  available resources. In this regard, the application of basic health  insurance principles to any proposed benefit could help moderate the cost  for both beneficiaries and taxpayers. Under these principles, beneficiaries  receive protections against the risk of catastrophic medical expenses  while remaining conscious of the cost of care. At the same time, it is  important that benefit expansion proposals include targeting mechanisms  to ensure that federal support is directed at the beneficiaries with the  greatest financial risk. Nevertheless, as I have stated previously, no matter  how well designed a new benefit may be, adding benefits without  fundamentally reforming the existing program will merely hasten the  exhaustion of Medicare’s Hospital Insurance (HI) trust fund and the  draining of general revenues. Any benefit expansion will also serve to  make our long-range fiscal challenge even greater. Ideally, Medicare  reforms should be designed to improve our long-range fiscal situation. At a  minimum, they should be designed so as not to make our long-range fiscal  challenge worse.
subsections: section_title: Rising Drug Spending Elevates Beneficiary Access Concerns
paragraphs: Extensive research and development have led to new and improved  prescription drug therapies that, in some instances, have replaced other  health care interventions. For example, new medications for the treatment  of ulcers have virtually eliminated the need for some surgical treatments.  As a result of these innovations, the importance of prescription drugs as  part of health care has grown. However, not all new drug therapies serve  to reduce the need for more invasive and expensive medical procedures.  Some new drug therapies are substitutes for already existing, less  expensive, ones and may not appreciably improve efficacy or reduce side  effects. Others may be used more for making lifestyle enhancements than  for extending life or treating a serious medical condition. Spending on the  new drug therapies, along with the mass media advertising of prescription  drugs, serves to significantly increase total drug spending as a component  of health care costs.
The Medicare benefit package, largely designed in 1965, provides virtually  no outpatient drug coverage. Beneficiaries may fill this coverage gap in  various ways. All beneficiaries have access to individually purchased  supplemental policies—Medigap—when they first become eligible for  Medicare at age 65. Those policies that include drug coverage tend to be  expensive and provide only limited benefits. Some beneficiaries have  access to coverage through employer-sponsored policies or Medicare  health maintenance organizations (HMO). In recent years, coverage  through these sources has become more expensive and less widely  available. Beneficiaries whose income falls below certain thresholds may  qualify for Medicaid or other public programs.
subsections: section_title: Prescription Drug Costs Continue to Rise Rapidly
paragraphs: In recent years, prescription drug expenditures have grown substantially,  both in total and as a share of all heath care outlays. Prescription drug  spending grew an average of almost 15 percent per year from 1995 to 2000,  well more than double the 5.6 percent average growth rate for health care  expenditures overall. (See table 1.) As a result, prescription drugs account  for a growing share of health care spending  rising from 6.1 percent in  1995 to 9.4 percent in 2000. By 2011, prescription drug expenditures are  expected to account for almost 15 percent of total health expenditures.
Total drug expenditures have been driven up by several factors. Drug  coverage by private insurance has likely contributed to the rise in  spending, because insured consumers are partially insulated from the  costs. In the years from 1993 to 2000, the share of prescription drug  expenditures paid by private health insurers rose from more than a fourth  to almost a half. (See fig. 3.) The development of new, more expensive  drug therapies—including new drugs that replace old drugs and new drugs  that treat disease more effectively—also contributed to the growth in drug  spending by boosting the volume of drugs used as well as the average  price for drugs used. Similarly, biotechnology advances and a growing  knowledge of the human immune system are significantly shaping the  discovery, design, and production of drugs. Advertising pitched to  consumers has also served to increase the demand for prescription drugs.  A recent study found that, in 2000, the 50 drugs most heavily advertised  directly to consumers were responsible for nearly half of the roughly $21- billion increase in retail spending on prescription drugs from 1999 to 2000.
section_title: Drug Coverage for Medicare Beneficiaries Is Becoming More Expensive and Less Available
paragraphs: In 2001, CBO estimated that the average Medicare beneficiary would use  $1,756 worth of prescription drugs. This is a substantial amount  considering that some beneficiaries lack any drug coverage and others  with coverage may have less than in previous years. Moreover, significant  numbers of beneficiaries have drug expenses much higher than those of  the average beneficiary. CBO also estimated that some 10 percent of  Medicare beneficiaries would have expenditures of $4,000 or more.
According to a recent survey, in the fall of 1999, nearly two-thirds of  Medicare beneficiaries had some form of drug coverage from a  supplemental insurance policy, health plan, or public program. More than  one-third reported that they lacked drug coverage altogether. (See fig. 4.)
Employer-sponsored health plans provide drug coverage to the largest  segment of the Medicare population with coverage. However, there are  signs that this coverage is eroding. Fewer employers are offering health  benefits to retirees eligible for Medicare, and those that continue to offer  coverage are requiring retirees to pay a larger share of costs. The  proportion of large employers offering health coverage to retirees eligible  for Medicare declined from 31 percent in 1997 to 23 percent in 2001. At the  same time, the proportion of large employers requiring Medicare-eligible  retirees to pay the full cost of their health coverage increased from 27  percent to 31 percent.
In March 2001, 10 percent of Medicare beneficiaries obtained prescription  drug coverage through a Medicare HMO, down from about 15 percent in  1999. Medicare HMOs have found drug coverage to be an attractive benefit  that beneficiaries consider when choosing to enroll. However, owing to  rising drug expenditures and their effect on plan costs, fewer Medicare  HMOs are offering a drug benefit. In 2002, 50 percent of Medicare  beneficiaries have access to a Medicare HMO with drug coverage, down  from 65 percent in 1999. The drug benefits the plans do offer have become  less generous, increasing enrollees’ out-of-pocket costs and limiting their  total drug coverage.
About 7 percent of beneficiaries purchase Medigap policies that provide  drug coverage. These policies have shortcomings: they tend to be  expensive, involve significant cost-sharing, and do not provide protection  against catastrophic out-of-pocket expenses. In 1999, average premiums  for standard Medigap policies that included drug coverage ranged from  about $1,400 per year to $1,700 per year. Beneficiaries remained  responsible for a $250 deductible for drugs and 50-percent coinsurance.  The drug benefit was capped at an annual limit of $1,250 or $3,000.  Furthermore, Medigap premiums have been increasing in recent years.  One recent study reported that, from 1999 to 2000, premiums for the  Medigap plans offering prescription drug coverage rose the most—by 17 to  34 percent—compared to 4 to 10 percent increases for Medigap plans  without prescription drug coverage.
All Medicare beneficiaries who qualify for full Medicaid benefits receive  drug coverage that may include some limits, such as restrictions on the  number of prescriptions that can be filled per month, depending on the  state’s Medicaid plan. Individuals with low incomes who are not eligible  for full Medicaid benefits may have access to some drug coverage through  a state pharmacy assistance program. As of April 2002, 26 states and the  District of Columbia had such a program in operation.
Access barriers to prescription drugs may be particularly acute for  Medicare beneficiaries who lack drug coverage and have substantial  health care needs. In 1998, among beneficiaries in poor health, those  without drug coverage had drug expenditures that were $910 lower than  those with drug coverage and they filled 14.5 fewer prescriptions. The  difference in expenditures and use between the two groups suggests that  the lack of drug coverage may impose barriers to health care.
section_title: Expanding Benefits Needs to Be Considered in Light of Larger Medicare Fiscal Concerns
paragraphs: The current Medicare program, without improvements, is ill suited to  serve future generations of seniors and eligible disabled Americans.  Although the need to modernize Medicare’s benefit package is compelling,  the program is already fiscally unsustainable in its present form, and the  disparity between program expenditures and program revenues is expected to widen dramatically in the coming years.
subsections: section_title: As Currently Structured, Medicare Is Fiscally Unsustainable
paragraphs: On March 26, 2002, the trustees of the Medicare trust funds reported on  the current and projected financial status of the program over the next 75  years. The report stated that, while the near-term financial condition has  improved slightly since last year’s report, Medicare continues to face  substantial financial challenges in the not-too-distant future that need to  be addressed soon.
Medicare’s fiscal health is often gauged by the projected solvency of the HI  trust fund, which pays for inpatient hospital stays, skilled nursing care,  hospice, and certain home health services and is financed by payroll taxes.  The gap between income and costs can best be expressed relative to  taxable payroll (the HI trust fund’s funding base). This year, under the  trustees’ 2002 intermediate estimates, the 75-year actuarial deficit is  projected to be 2.02 percent of taxable payroll—an increase from last  year’s projected deficit of 1.97 percent. This means that to bring the HI  trust fund into balance over the 75-year period, either program outlays  would have to be immediately reduced by 38 percent or payroll tax income  immediately increased by almost 70 percent, or some combination of the  two.
The trustees’ report also projected that the trust fund for Medicare’s HI  component would remain solvent until 2030. However, the projection that  the HI trust fund is not facing imminent insolvency does not mean that we  can or should wait until 2030 to take action. Although HI revenues  currently exceed HI outlays, the March 2002 trustees’ report projects that  cash deficits will reemerge in 2016 and grow larger with each passing year.  (See fig. 5.) Unlike private trust funds that can set aside money for the  future by investing in financial assets, the Medicare HI trust fund is  essentially an accounting device. It allows the government to track the  extent to which earmarked payroll taxes cover Medicare’s HI outlays.  While the U.S. Treasury securities in the HI trust fund are backed by the  full faith and credit of the U.S. government, they essentially represent an  unfunded promise to pay, which will require tough fiscal choices in future  years.
To finance its cash deficits, the HI trust fund will need to draw on the  special- issue Treasury securities acquired during the years when the  program generated cash surpluses. The negative cash flow will place  increased pressure on the federal budget. In essence, for HI to “redeem” its  securities, the government will need to obtain cash through some  combination of increased taxes, spending cuts, increased borrowing from  the public (or correspondingly less debt reduction than would have been  the case had cash flow remained positive).
A focus on HI solvency alone, however, does not provide a complete  picture of the Medicare program ‘s expected future fiscal claims. The  Supplementary Medical Insurance (SMI) portion of Medicare, which  covers physician and outpatient hospital services, diagnostic tests, and  certain other medical services, is not reflected in the HI solvency measure.  SMI is largely funded through general revenues and its outlays are  projected to grow even faster than HI outlays in the near future.
section_title: Bleak Outlook for Medicare’s Long-Term Sustainability Increases Urgency for Program Reform
paragraphs: 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 about 11 percent of federal revenues in  2001 to more than one-quarter by mid-century. Over the same time frame,  Medicare’s expenditures are expected to more than double as a share of  the nation’s economy, from 2.4 to 6.0 percent, as shown in figure 6.  Moreover, relatively fewer potential workers will be available to shoulder  Medicare’s financial burden. In 2000 there were 4.9 working-age persons  (18 to 64 years) per elderly person, but by 2030, this ratio is projected to  decline to 2.8.
For the HI portion of Medicare, in 2001 there were 4 covered workers per HI beneficiary.  Under their intermediate 2002 estimates, the trustees project that by 2030 there will be only  2.4 covered workers per HI beneficiary. about 12 percent of the total population; by 2030, they will comprise 20  percent. Medicare growth rates, however, reflect not only a rapidly  increasing beneficiary population, but also the escalation of health care  costs at rates well exceeding general rates of inflation.
When viewed from the perspective of the entire budget and the economy,  the growth in Medicare spending will become progressively unsustainable  over the longer term. Our updated budget simulations show that to move  into the future with no changes in federal health and retirement programs  is to envision a very different role for the federal government. Assuming,  for example, that last year’s tax reductions are made permanent and  discretionary spending keeps pace with the economy, spending for net  interest, Social Security, Medicare, and Medicaid consumes nearly 50  percent of federal revenue by 2015 and more than three-quarters of federal  revenue by 2030, leaving little room for other federal priorities including  defense and education. (See fig. 2.) By 2050, total federal revenue is  insufficient to fund entitlement spending and interest payments, resulting  in deficits that are escalating out of control.
Our long-term simulations illustrate the magnitude of the fiscal challenges  associated with an aging society and the significance of the related  challenges the government will be called upon to address. As I have stated  previously, early action to reform Medicare and other programs would  yield the highest fiscal dividends for the federal budget and would provide  a longer period for prospective beneficiaries to make adjustments in their  own planning. Waiting to build economic resources and reform future  claims entails significant risks. First, we lose an important window during  which today’s relatively large workforce can increase savings and enhance  productivity, two elements critical to growing the future economy.  Second, we lose the opportunity to reduce the interest burden on the  federal budget, thereby creating a legacy of higher debt. Third and most  critically, we risk losing the opportunity to phase in changes gradually so  that all affected parties can make the adjustments needed to adequately  plan for the future.
Unfortunately, our long-range challenge has become more difficult, and  the window of opportunity to address the entitlement challenge is  narrowing. It remains more important than ever to return to these issues  over the next several years. Ultimately, the critical question is not how  much a trust fund has in assets, but whether the government as a whole  can afford the promised benefits now and in the future and at what cost to  other claims on scarce resources.
section_title: Private Health Insurance Principles Should Guide Reform Efforts
paragraphs: Given the current federal fiscal environment, we cannot afford to ignore  the difficult policy choices that must be made to keep the Medicare  program on a sustainable footing. Adding prescription drug coverage to  the Medicare benefit package would require balancing competing  concerns about program sustainability, federal obligations, and the  hardship faced by some beneficiaries. The addition of a benefit that has  the potential to be massively expensive should be focused on meeting the  needs deemed to be of the highest priority. This focus would entail  targeting financial help to beneficiaries most in need and, to the extent  possible, avoiding the substitution of public for private coverage. I  continue to maintain, that, optimally, benefit expansions should be made  in the context of overall program reforms that are designed to make the  program more sustainable over the long term.
Several basic principles of health insurance provide a framework for  keeping any new prescription drug benefit more affordable for both  beneficiaries and the taxpayers. First, as health insurance is intended to  protect individuals against large, or catastrophic, expenses, a well- designed benefit should limit beneficiaries’ liability for out-of-pocket  expenses. Second, a benefit should be designed to include reasonable  cost-sharing to encourage the appropriate use of services. Third, the  benefit should include features to avoid adverse selection, that is, avoid  covering only beneficiaries who will use the benefit. Including the  individuals who may not currently need the benefit—but may need it in  the future—can spread the risk and help keep the cost down for everyone.
Leading proposals to integrate prescription drug coverage into the  Medicare program, to varying degrees, incorporate these principles. For  example, the proposals commonly limit a beneficiary’s financial liability  for prescription drug costs. They seek to restrain inappropriate spending,  in part by requiring cost-sharing in the form of a deductible and  coinsurance. To make drug coverage attractive to a broader spectrum of  beneficiaries, the proposals subsidize the beneficiary premium. To further  encourage beneficiaries to sign up for prescription drug coverage when  they are healthy, the proposals include provisions that discourage delayed  enrollment. Finally, because even modest cost-sharing amounts might  prove too burdensome for some individuals, the proposals include  targeting mechanisms to help prevent low income from becoming a barrier  to obtaining prescription drug coverage.
Although the leading prescription drug coverage proposals share certain  key design features, they differ in important details, such as the amount of  required cost sharing and the limit on beneficiary out-of-pocket costs.  These differences reflect trade-offs in cost-control mechanisms, benefit  generosity, and protections for beneficiaries with high needs. Careful  debate about the different trade-offs is important, because both the overall  design of a new benefit and the associated details determine the likely  impact on both beneficiaries and taxpayers. Frankly, we know that  incorporating a prescription drug benefit into the existing Medicare  program will add hundreds of billions of dollars to program spending over  the next 10 years. For this reason, I cannot overstate the importance of  adopting meaningful financial reforms to ensure that Medicare remains  viable for future generations.
section_title: Concluding Observations
paragraphs: Updating the Medicare benefit package may be an important step in  addressing an aging society’s legitimate expectations for health care.  Expanding access to prescription drugs could ease the significant financial  burden some Medicare beneficiaries face because of outpatient drug costs.  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. Care must be taken to ensure  that any potential expansion of the program be balanced with other  programmatic reforms so that we do not worsen Medicare’s existing  financial imbalances. The program needs to include adequate fiscal  incentives to control costs and should be carefully targeted to meet  genuine needs while remaining affordable.
This generation has a stewardship responsibility to future generations to  reduce the debt burden they will inherit, to provide a strong foundation for  future economic growth, and to ensure that future commitments are both  adequate and affordable. Changes need to be considered as part of a  broader initiative to address Medicare’s current fiscal imbalance and  promote the program’s longer-term sustainability. Balancing these  competing concerns may require the best from government-run programs  and private sector efforts to modernize Medicare for the future. Medicare  reform and modernization are best done with considerable lead-time to  phase in changes and take action before the changes that are needed  become dramatic and disruptive.