Medicare: Financial Challenges and Considerations for Reform
Published: 2003-04-10T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: We are pleased to be here today as Congress examines Medicare's financial health and consider the budgetary and economic challenges presented by an aging society. The Comptroller General has been particularly attentive to the sustainability challenges faced by the nation's two largest entitlement programs--Medicare and Social Security--for more than a decade since he served as a public trustee for these programs in the early 1990s. The recent publication of the 2003 Trustees' annual report reminds us, once again, that the status quo is not an option for Medicare. If the program stays on its present course, in 10 years Hospital Insurance (HI) Trust Fund outlays will begin to exceed tax receipts, and by 2026 the HI trust fund will be exhausted. It is important to note that trust fund insolvency does not mean the program will cease to exist; program tax revenues will continue to cover a portion of projected expenditures.1 However, Medicare is only part of the broader health care financing problem that confronts both public programs and private payers. The unrelenting growth in health care spending is producing a health care sector that continues to claim an increasing share of our gross domestic product (GDP).
section_title: What GAO Found
paragraphs: Despite the grim outlook for Medicare's financial future, fiscal discipline imposed on Medicare through the Balanced Budget Act of 1997 (BBA) continues to be challenged, and interest in modernizing the program's benefit package to include prescription drug coverage and catastrophic protection continues to grow. Such unabated pressures highlight the urgency for meaningful reform. As we deliberate on the situation, we must be mindful of several key points. The traditional measure of HI Trust Fund solvency is a misleading gauge of Medicare's financial health. Long before the HI Trust Fund is projected to be insolvent, pressures on the rest of the federal budget will grow as HI's projected cash inflows turn negative and grow as the years pass. Moreover, a focus on the financial status of HI ignores the increasing burden Supplemental Medical Insurance (SMI)--Medicare part B--will place on taxpayers and beneficiaries. GAO's most recent long-term budget simulations continue to show that demographic trends and rising health care spending will drive escalating federal deficits and debt, absent meaningful entitlement reforms or other significant tax or spending actions. To obtain budget balance, massive spending cuts, tax increases, or some combination of the two would be necessary. Neither slowing the growth of discretionary spending nor allowing the tax reductions to sunset will eliminate the imbalance. In addition, while additional economic growth will help ease our burden, the potential fiscal gap is too great to grow our way out of the problem. Since the cost of a drug benefit would boost spending projections even further, adding drug coverage when Medicare's financial future is already bleak will require difficult policy choices that will mean trade-offs for both beneficiaries and providers. Just as physicians take the Hippocratic oath to "do no harm," policymakers should avoid adopting reforms that will worsen Medicare's long-term financial health. Our experience with Medicare--both the traditional program and its private health plan alternative--provides valuable lessons that can guide consideration of reforms. For example, we know that proposals to enroll beneficiaries in private health plans must be designed to encourage beneficiaries to join efficient plans and ensure that Medicare shares in any efficiency gains. We also recognize that improvements to traditional Medicare are essential, as this program will likely remain significant for some time to come.

section_title: Letter
paragraphs: I am pleased to be here today as you examine Medicare’s financial health  and consider the budgetary and economic challenges presented by an  aging society. I have been particularly attentive to the sustainability  challenges faced by the nation’s two largest entitlement programs— Medicare and Social Security—for more than a decade since I served as a  public trustee for these programs in the early 1990s. The recent  publication of the 2003 Trustees’ annual report reminds us, once again,  that the status quo is not an option for Medicare. If the program stays on  its present course, in 10 years Hospital Insurance (HI) Trust Fund outlays  will begin to exceed tax receipts, and by 2026 the HI trust fund will be  exhausted. It is important to note that trust fund insolvency does not mean  the program will cease to exist; program tax revenues will continue to  cover a portion of projected expenditures. However, Medicare is only part  of the broader health care financing problem that confronts both public  programs and private payers. The unrelenting growth in health care  spending is producing a health care sector that continues to claim an  increasing share of our gross domestic product (GDP).
Despite the grim outlook for Medicare’s financial future, fiscal discipline  imposed on Medicare through the Balanced Budget Act of 1997 (BBA)  continues to be challenged, and interest in modernizing the program’s  benefit package to include prescription drug coverage and catastrophic  protection continues to grow. Such unabated pressures highlight the  urgency for meaningful reform. As we deliberate on the situation, we must  be mindful of several key points:    The traditional measure of HI Trust Fund solvency is a misleading gauge of  Medicare’s financial health. Long before the HI Trust Fund is projected to  be insolvent, pressures on the rest of the federal budget will grow as HI’s  projected cash inflows turn negative and grow as the years pass.  Moreover, a focus on the financial status of HI ignores the increasing  burden Supplemental Medical Insurance (SMI)—Medicare part B—will  place on taxpayers and beneficiaries.
GAO’s most recent long-term budget simulations continue to show that  demographic trends and rising health care spending will drive escalating  federal deficits and debt, absent meaningful entitlement reforms or other  significant tax or spending actions. To obtain budget balance, massive  spending cuts, tax increases, or some combination of the two would be  necessary. Neither slowing the growth of discretionary spending nor  allowing the tax reductions to sunset will eliminate the imbalance. In  addition, while additional economic growth will help ease our burden, the  potential fiscal gap is too great to grow our way out of the problem.
Since the cost of a drug benefit would boost spending projections even  further, adding drug coverage when Medicare’s financial future is already  bleak will require difficult policy choices that will mean trade-offs for both  beneficiaries and providers. Just as physicians take the Hippocratic oath  to “do no harm,” policymakers should avoid adopting reforms that will  worsen Medicare’s long-term financial health.
Our experience with Medicare—both the traditional program and its  private health plan alternative—provides valuable lessons that can guide  consideration of reforms. For example, we know that proposals to enroll  beneficiaries in private health plans must be designed to encourage  beneficiaries to join efficient plans and ensure that Medicare shares in any  efficiency gains. We also recognize that improvements to traditional  Medicare are essential, as this program will likely remain significant for  some time to come.
Ultimately, we will need to look at broader health care reforms, as  spending growth problems are not exclusive to Medicare. For both public  and private payers, containing growth in health expenditures will be an  abiding 21st century challenge. In today’s health care sector, there are few  incentives for providers and consumers to be prudent in their ordering and  use of health care services, too little transparency with regard to the value  and costs of care, and inadequate accountability to ensure that health care  plans and providers meet standards for appropriate use and quality.
These problems cannot be solved overnight. It will require committed,  long-term resolve and sustained attention to help policymakers and the  public understand the need to move beyond the status quo. The magnitude  of the challenge suggests that reforms will need to be phased in over time  to minimize any temporary disruptions that may result. However,  incremental reforms should build upon each other and continue to bring  us closer to our desired goals. This argues for having a systematic process  for setting common goals and assessing the potential for any proposed  reforms to meet these goals. At GAO, we are developing a framework— that is, a comprehensive set of criteria—for consideration by the Congress,  to help policymakers evaluate proposed health care reforms.
Now I would like to discuss overall trends in health care spending, the  financial challenges Medicare faces, and considerations for health care  reform efforts.
subsections: section_title: Trends in Health Care Spending Systemwide Pose Significant Challenges for 21st Century
paragraphs: To best understand Medicare’s fiscal plight, we should also understand the  broader health care context in which it operates. Total health care  spending from all sources—public and private—continues to increase at a  breathtaking pace. From 1990 through 2000, spending nearly doubled from  about $696 billion to about $1.3 trillion (see fig. 1). From 2000 through  2010, the rate of spending growth is expected to accelerate somewhat,  resulting in an estimated $2.7 trillion in total annual health care spending  by the end of the period. Increases in medical prices account for a little  more than half of the 20-year spending increase, while increases in the use  of services—owing to population growth and rise in the number of  services used per person—and more expensive services account for the  rest.
The rapid growth in health care spending means that an increasing share  of the nation’s output, as measured by GDP, will be devoted to the  production of health care services and goods. In 1970, spending on health  care represented about 7 percent of GDP (see fig. 2). By 2010, health care  spending’s share of GDP is expected to rise to about 17 percent.
At the same time that health care spending has increased, consumers have  become more insulated from these costs. In 1962, nearly half—46  percent—of health care spending was financed by individuals out of their  own pockets (see fig. 3). The remaining 54 percent was financed by a  combination of private health insurance and public programs. By 2002, the  amount of health care spending financed by individuals out of their own  pockets was estimated to have dropped to 14 percent.
Tax considerations encourage employers to offer health insurance to their  employees, as the value of the premium is excluded from the calculation  of employees’ taxable earnings. Moreover, the value of the insurance  coverage does not figure into the calculation of payroll taxes. These tax  exclusions represent a significant source of foregone federal revenue,  currently amounting to about 1 percent of GDP.
section_title: Outlook Worsening for Medicare’s Long- Term Sustainability
paragraphs: Today the Medicare program faces a long-range and fundamental financing  problem driven by known demographic trends and projected escalation of  health care spending beyond general inflation. The lack of an immediate  crisis in Medicare financing affects the nature of the challenge, but it does  not eliminate the need for change. Within the next 10 years, the first baby  boomers will begin to retire, putting increasing pressure on the federal  budget. From the perspectives of the program, the federal budget, and the  economy, Medicare in its present form is not sustainable. Acting sooner  rather than later would allow changes to be phased in so that the  individuals who are most likely to be affected, namely younger and future  workers, will have time to adjust their retirement planning while helping  to avoid related “expectation gaps.” Since there is considerable confusion  about Medicare’s current financing arrangements, I would like to begin by  describing the nature, timing, and extent of the financing problem.
subsections: section_title: Demographic Trends And Expected Rise in Health Care Costs Drive Medicare’s Long-Term Financing Problem
paragraphs: As you know, Medicare consists of two parts—HI and SMI. HI, which pays  for inpatient hospital stays, skilled nursing care, hospice, and certain home  health services, is financed by a payroll tax. Like Social Security, HI has  always been largely a pay-as-you-go system. SMI, which pays for physician  and outpatient hospital services, diagnostic tests, and certain other  medical services, is financed by a combination of general revenues and  beneficiary premiums. Beneficiary premiums pay for about one-fourth of  SMI benefits, with the remainder financed by general revenues. These  complex financing arrangements mean that current workers’ taxes  primarily pay for current retirees’ benefits except for those financed by  SMI premiums.
As a result, the relative numbers of workers and beneficiaries have a major  impact on Medicare’s financing. The ratio, however, is changing. In the  future, relatively fewer workers will be available to shoulder Medicare’s  financial burden. In 2002 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 2002 there were nearly 4 covered  workers per HI beneficiary. Under the Trustees’ intermediate 2003  estimates, the Medicare Trustees project that by 2030 there will be only 2.4  covered workers per HI beneficiary. (See fig. 4.)
The demographic challenge facing the system has several causes. People  are retiring early and living longer. As the baby boom generation ages, the  share of the population age 65 and over will escalate rapidly. A falling  fertility rate is the other principal factor underlying the growth in the  elderly’s share of the population. In the 1960s, the fertility rate was an  average of 3 children per woman. Today it is a little over 2, and by 2030 it  is expected to fall to 1.95—a rate that is below replacement. The  combination of the aging of the baby boom generation, increased  longevity, and a lower fertility rate will drive the elderly as a share of total  population from today’s 12 percent to almost 20 percent in 2030.
Taken together, these trends threaten both the financial solvency and  sustainability of this important program. Labor force growth will continue  to decline and by 2025 is expected to be less than a third of what it is  today. (See fig. 5.) Relatively fewer workers will be available to produce  the goods and services that all will consume. Without a major increase in  productivity, low labor force growth will lead to slower growth in the  economy and slower growth of federal revenues. This in turn will only  accentuate the overall pressure on the federal budget. This slowing labor  force growth is not always recognized as part of the Medicare debate, but  it is expected to affect the ability of the federal budget and the economy to  sustain Medicare’s projected spending in the coming years.
The demographic trends I have described will affect both Medicare and  Social Security, but Medicare presents a much greater, more complex, and  more urgent challenge. Unlike Social Security, Medicare spending 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. The growth of medical technology has contributed to increases  in the number and quality of health care services. Moreover, the actual  costs of health care consumption are not transparent. Third-party payers  largely insulate covered consumers from the cost of health care decisions.  These factors and others contribute to making Medicare a greater and  more complex fiscal challenge than even Social Security.
section_title: HI’s Trust Fund Faces Cash Flow Problems Long before the HI Trust Fund Is Projected to Be Insolvent
paragraphs: Current projections of future HI income and outlays illustrate the timing  and severity of Medicare’s fiscal challenge. Today, the HI Trust Fund takes  in more in taxes than it spends. Largely because of the known  demographic trends I have described, this situation will change. Under the  Trustees’ 2003 intermediate assumptions, program outlays are expected to  begin to exceed program tax revenues in 2013 (see fig. 6). To finance these  cash deficits, HI will need to draw on the special-issue Treasury securities  acquired during the years of cash surpluses. For HI to “redeem” its  securities, the government will need to obtain cash through some  combination of increased taxes, spending cuts, and/or increased  borrowing from the public (or, if the unified budget is in surplus, less debt  reduction than would otherwise have been the case). Neither the decline  in the cash surpluses nor the cash deficits will affect the payment of  benefits, but the negative cash flow will place increased pressure on the  federal budget to raise the resources necessary to meet the program’s  ongoing costs. This pressure will only increase when Social Security also  experiences negative cash flow and joins HI as a net claimant on the rest  of the budget.
The gap between HI income and costs shows the severity of HI’s financing  problem over the longer term. This gap can also be expressed relative to  taxable payroll (the HI Trust Fund’s funding base) over a 75-year period.  This year, under the Trustees 2003 intermediate estimates, the 75-year  actuarial deficit is projected to be 2.40 percent of taxable payroll—a  significant increase from last year’s projected deficit of 2.02 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  42 percent or program income immediately increased by 71 percent, or  some combination of the two. These estimates of what it would take to  achieve 75-year trust fund solvency understate the extent of the problem  because the program’s financial imbalance gets worse in the 76th and  subsequent years. Every year that passes we drop a positive year and add a  much bigger deficit year.
The projected exhaustion date of the HI Trust Fund is a commonly used  indicator of HI’s financial condition. Under the Trustees 2003 intermediate  estimates, the HI Trust Fund is projected to exhaust its assets in 2026. This  solvency indicator provides information about HI’s financial condition, but  it is not an adequate measure of Medicare’s sustainability for several  reasons. HI Trust Fund balances do not provide meaningful information on  the government’s fiscal capacity to pay benefits when program cash  inflows fall below program outlays. As I have described, the government  would need to come up with cash from other sources to pay for benefits  once outlays exceeded program tax income.
In addition, the HI Trust Fund measure provides no information on SMI.  SMI’s expenditures, which account for about 43 percent of total Medicare  spending, are projected to grow even faster than those of HI in the near  future. Moreover, Medicare’s complex structure and financing  arrangements mean that a shift of expenditures from HI to SMI can extend  the solvency of the HI Trust Fund, creating the appearance of an  improvement in program’s financial condition. For example, the Balanced  Budget Act of 1997 modified the home health benefit, which resulted in  shifting a portion of home health spending from the HI Trust Fund to SMI.  Although this shift extended HI Trust Fund solvency, it increased the draw  on general revenues and beneficiary SMI premiums while generating little  net savings.
Ultimately, the critical question is not how much a trust fund has in assets,  but whether the government as a whole and the economy can afford the  promised benefits now and in the future and at what cost to other claims  on scarce resources. To better monitor and communicate changes in  future total program spending, new measures of Medicare’s sustainability  are needed. As program changes are made, a continued need will exist for  measures of program sustainability that can signal potential future fiscal  imbalance. Such measures might include the percentage of program  funding provided by general revenues, the percentage of total federal  revenues or gross domestic product devoted to Medicare, or program  spending per enrollee. As such measures are developed, questions would  need to be asked about actions to be taken if projections showed that  program expenditures would exceed the chosen level.
section_title: Absent Reform of Medicare and Other Entitlements for the Elderly, Budgetary Flexibility Will Disappear
paragraphs: Taken together, Medicare’s HI and SMI expenditures are expected to  increase dramatically, rising from about 12 percent of federal revenues in  2002 to more than one-quarter by midcentury. The budgetary challenge  posed by the growth in Medicare becomes even more significant in  combination with the expected growth in Medicaid and Social Security  spending. This growth in spending on federal entitlements for retirees will  become increasingly unsustainable over the longer term, compounding an  ongoing decline in budgetary flexibility. Over the past few decades,  spending on mandatory programs has consumed an ever-increasing share  of the federal budget.  In 1962, prior to the creation of the Medicare and  Medicaid programs, spending for mandatory programs plus net interest  accounted for about 32 percent of total federal spending. By 2002, this  share had almost doubled to approximately 63 percent of the budget. (See  fig. 7.)
In much of the past decade, reductions in defense spending helped  accommodate the growth in these entitlement programs. Even before the  events of September 11, 2001, however, this ceased to be a viable option.  Indeed, spending on defense and homeland security will grow as we seek  to combat new threats to our nation’s security.
GAO prepares long-term budget simulations that seek to illustrate the  likely fiscal consequences of the coming demographic tidal wave and  rising health care costs. These simulations continue to show that to move  into the future with no changes in federal retirement and health programs  is to envision a very different role for the federal government. Assuming,  for example, that the tax reductions enacted in 2001 do not sunset and  discretionary spending keeps pace with the economy, by midcentury  federal revenues may be inadequate to pay Social Security and interest on  the federal debt. Spending for the current Medicare program—without any  additional new benefits—is projected to account for more than one- quarter of all federal revenues. To obtain budget balance, massive  spending cuts, tax increases, or some combination of the two would be  necessary. (See fig.8). Neither slowing the growth of discretionary  spending nor allowing the tax reductions to sunset eliminates the  imbalance. In addition, while additional economic growth would help ease  our burden, the projected fiscal gap is too great for us to grow our way out  of the problem.
Indeed, long-term budgetary flexibility is about more than Social Security  and Medicare. While these programs dominate the long-term outlook, they  are not the only federal programs or activities that bind the future. The  federal government undertakes a wide range of programs, responsibilities,  and activities that obligate it to future spending or create an expectation  for spending. Our recent report describes the range and measurement of  such fiscal exposures—from explicit liabilities such as environmental  cleanup requirements to the more implicit obligations presented by life- cycle costs of capital acquisition or disaster assistance. Making  government fit the challenges of the future will require not only dealing  with the drivers—entitlements for the elderly—but also looking at the  range of other federal activities. A fundamental review of what the federal  government does and how it does it will be needed.
section_title: Medicare Is Projected to Absorb Ever- Increasing Shares of the Economy
paragraphs: At the same time, it is important to look beyond the federal budget to the  economy as a whole. Figure 9 shows the total future draw on the economy  represented by Medicare, Medicaid, and Social Security. Under the 2003  Trustees’ intermediate estimates and the Congressional Budget Office’s  (CBO) most recent long-term Medicaid estimates, spending for these  entitlement programs combined will grow to 14 percent of GDP in 2030  from today’s 8.4 percent. Taken together, Social Security, Medicare, and  Medicaid represent an unsustainable burden on future generations.
Although real incomes are projected to continue to rise, they are expected  to grow more slowly than has historically been the case. At the same time,  the demographic trends and projected rates of growth in health care  spending I have described will mean rapid growth in entitlement spending.  Taken together, these projections raise serious questions about the  capacity of the relatively smaller number of future workers to absorb the  rapidly escalating costs of these programs.
As HI trust fund assets are redeemed to pay Medicare benefits and SMI  expenditures continue to grow, the program will constitute a claim on real  resources in the future. As a result, taking action now to increase the  future pool of resources is important. To echo Federal Reserve Chairman  Alan Greenspan, the crucial issue of saving in our economy relates to our  ability to build an adequate capital stock to produce enough goods and  services in the future to accommodate both retirees and workers in the  future. The most direct way the federal government can raise national  saving is by increasing government saving, that is, as the economy returns  to a higher growth path, a balanced fiscal policy that recognizes our long- term challenges can help provide a strong foundation for economic growth  and can enhance our future budgetary flexibility. It is my hope that we will  think about the unprecedented challenge facing future generations in our  aging society. Putting Medicare 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.
As with Social Security, both sustainability and solvency considerations  drive us to address Medicare’s fiscal challenges sooner rather than later.  HI Trust Fund exhaustion may be more than 20 years away, but the  squeeze on the federal budget will begin as the baby boom generation  begins to retire. This will begin as early as 2008, when the leading edge of  the baby boom generation becomes eligible for early retirement. CBO’s  current 10-year budget and economic outlook reflects this. CBO projects  that economic growth will slow from an average of 3.2 percent a year from  2005 through 2008 to 2.7 percent from 2009 through 2013 reflecting slower  labor force growth. At the same time, annual rates of growth in entitlement  spending will begin to rise. Annual growth in Social Security outlays is  projected to accelerate from 5.2 percent in 2007 to 6.6 percent in 2013.  Annual growth in Medicare enrollees is expected to accelerate from 1.1  percent today to 2.9 percent in 2013. Acting sooner rather than later is  essential to ease future fiscal pressures and also provide a more  reasonable planning horizon for future retirees. We are now at a critical  juncture. In less than a decade, the profound demographic shift that is a  certainty will have begun.
section_title: Pressure to Address Medicare Coverage Gaps Must Be Balanced against Program Sustainability Concerns
paragraphs: Despite a common awareness of Medicare’s current and future fiscal  plight, pressure has been building to address recognized gaps in Medicare  coverage, especially the lack of a prescription drug benefit and protection  against financially devastating medical costs. Filling these gaps could add  massive expenses to an already fiscally overburdened program. Under the  Trustees 2003 intermediate assumptions, the present value of HI’s  actuarial deficit is $6.2 trillion. This difficult situation argues for tackling  the greatest needs first and for making any benefit additions part of a  larger structural reform effort.
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 the option to purchase 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 private health plans that contract  to serve Medicare beneficiaries. 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. According to one survey, in the fall of  1999, more than one-third of beneficiaries reported that they lacked drug  coverage altogether.
Medicare also does not limit beneficiaries’ cost-sharing liability. The  average beneficiary who obtained services had a total liability for  Medicare-covered services of $1,700, consisting of $1,154 in Medicare  copayments and deductibles in addition to the $546 in annual part B  premiums in 1999, the most recent year for which data are available on the  distribution of these costs. The burden can, however, be much higher for  beneficiaries with extensive health care needs. In 1999, about 1 million  beneficiaries were liable for more than $5,000, and about 260,000 were  liable for more than $10,000 for covered services. In contrast, employer- sponsored health plans for active workers typically limited maximum  annual out-of-pocket costs for covered services to less than $2,000 per  year for single coverage.
Modernizing Medicare’s benefit package will require balancing competing  concerns about program sustainability, federal obligations, and the  hardship faced by some beneficiaries. In particular, the addition of a  benefit that has the potential to be extremely expensive—such as  prescription drug coverage—should be focused on meeting the needs  deemed to be of the highest priority. This would entail targeting financial  help to beneficiaries most in need—those with catastrophic drug costs or  low incomes—and, to the extent possible, avoiding the substitution of  public for private insurance coverage. As I continue to maintain, acting  prudently means making any benefit expansions in the context of overall  program reforms that are designed to make the program more sustainable  over the long term instead of worsening the program’s financial future.
One reform to help improve Medicare’s financial future would be to  modify Medicare’s cost-sharing rules and provide beneficiaries with better  incentives to use care appropriately. Health insurers today commonly  design cost-sharing requirements—in the form of deductibles,  coinsurance, and copayments—to ensure that enrollees are aware that  there is a cost associated with the provision of services and to use them  prudently. Ideally, cost-sharing should encourage beneficiaries to evaluate  the need for discretionary care but not discourage necessary care.  Coinsurance or copayments would be required generally for services  considered to be discretionary and potentially overused and would aim to  steer patients to lower cost or better treatment options. Care must be  taken, however, to avoid setting cost-sharing requirements so high as to  create financial barriers to care.
Medicare fee-for-service cost-sharing rules diverge from these common  insurance industry practices in important ways. For example, Medicare  imposes a relatively high deductible of $840 for hospital admissions, which  are rarely optional. In contrast, Medicare has not increased the part B  deductible since 1991. For the last 12 years, the deductible has remained  constant at $100 and has thus steadily declined as a proportion of  beneficiaries’ real incomes. Adjusted for inflation, the deductible has fallen  to $74.39 in 1991 dollars.
section_title: Medicare Reforms Should Realign Incentives, Improve Transparency, and Strengthen Accountability
paragraphs: In recent years, leading proposals have been made to restructure Medicare  that have included greater reliance on private health plans and reforms to  the traditional fee-for-service program. The weaknesses identified in these  two components of the current program suggest several lessons regarding  such restructuring. Experience with Medicare’s private health plan  alternative, called Medicare+Choice, suggests that details matter if  competition is to produce enhanced benefits for enrollees and savings for  the program. In addition, the traditional program must not be left  unattended because it will be an important part of Medicare for years to  come. The strategies needed to address either structural component must  incorporate sufficient incentives to achieve efficiency, adequate  transparency to reveal the cost of health care, and appropriate  accountability mechanisms to ensure that the promised care and level of  quality are actually delivered.
subsections: section_title: Reforms That Include Private Plans Should Incorporate Incentives Sufficient to Result in Program Savings
paragraphs: If the inclusion of private health plans is to produce savings for Medicare,  private incentives and public goals must be properly aligned. This means  designing a program that will encourage beneficiaries to select health plan  options most likely to generate program savings. This is not the case in the  current Medicare+Choice program. For example, incentives for health  plan efficiency exist, but any efficiency gains achieved do not produce  Medicare savings. Payments to private health plans that participate in  Medicare+Choice are not set through a competitive process. Instead, plans  receive a fixed payment from Medicare as prescribed by statute and in  return must provide all Medicare-covered services with the exception of  hospice. Efficient health plans are better able to afford to provide extra  benefits, such as outpatient prescription drug benefits; charge a lower  monthly premium; or both and may do so to attract beneficiaries and  increase market share. Until recently, however, these efficiency and  market share gains were advantageous to beneficiaries and health plans  but generated no savings for Medicare. Even today, the opportunity for the  program to realize savings from competition among Medicare+Choice  health plans remains extremely limited. This experience has shown that  savings are not automatic from simply enrolling beneficiaries in private  health plans.
The Medicare+Choice experience offers another lesson about private  plans and program savings. That is, as we recommended in 1998, payments  to health plans must be adequately risk-adjusted for the expected health  care costs of the beneficiaries they enroll. Otherwise, the government can  inadequately compensate health plans that enroll less healthy beneficiaries  with higher expected health care costs or will overpay health plans that  enroll relatively healthy beneficiaries with low expected health care costs.  Moreover, health plans will have an incentive to avoid enrolling less  healthy beneficiaries with higher expected health care costs. In 2000, we  reported that the failure to adequately adjust Medicare’s payments to  private health plans for beneficiaries’ expected health care costs  unnecessarily increased Medicare spending by $3.2 billion in 1998.
A third lesson is that the use of private plans to serve Medicare  beneficiaries may not be feasible in all locations nationwide. In  Medicare+Choice, it has been difficult and expensive to encourage private  health plans to serve rural areas. Payment rates have been substantially  raised in rural areas since 1997, yet by 2003 nearly 40 percent of  beneficiaries living in rural areas lack access to a private health plan; in  contrast, 15 percent of beneficiaries in urban areas lack access to a plan.  Finally, the Medicare+Choice experience underscores the importance of  beneficiaries having user-friendly, accurate information to compare their  health plan options and of holding private health plans appropriately  accountable for the services they have promised to deliver.
section_title: Fixing Flaws In Traditional Medicare Essential to Alter Program’s Fiscal Course
paragraphs: Leading Medicare reform proposals have included traditional Medicare as  a component in their design. Traditional Medicare is likely to have a  significant role for years to come, as any fundamental structural reforms  would take considerable time before plan and beneficiary participation  becomes extensive. Therefore, addressing flaws in the traditional program  should be part of any plan to steer Medicare away from insolvency and  improve its sustainability for future generations. The experience of other  health insurers’ use of cost-containment strategies, including some  incentives for beneficiaries to make value-based choices, suggests a  strategy for modernizing the program’s design. In the current program, the  lack of insurance-type protections and difficulty in setting payment rates  keep Medicare from achieving greater efficiencies and thus from  improving its balance sheet.
subsections: section_title: Supplemental Coverage Reduces Beneficiary Cost Sensitivity
paragraphs: Coverage through Medigap—policies that meet federally established  standards and are sold by private insurers—helps to fill in some of  Medicare’s gaps, but Medigap plans also have shortcomings. As required  by law, Medigap plans must conform to 1 of 10 standard benefit packages,  which vary in levels of coverage. Medigap offers beneficiaries stop-loss  protections that are lacking in traditional Medicare, but these policies  diminish important program protections by covering required deductibles  and coinsurance. The most popular Medigap plans are fundamentally  different from employer-sponsored health insurance policies for retirees in  that they do not require individuals to pay deductibles, coinsurance, and  copayments. Such cost-sharing requirements are intended to make  beneficiaries aware of the costs associated with the use of services and  encourage them to use these services prudently. In contrast, Medigap’s  first-dollar coverage—the elimination of deductibles or coinsurance  associated with the use of covered services—undermines this objective.  Although such coverage reduces financial barriers to health care, it  diminishes beneficiaries’ sensitivity to costs and likely increases  beneficiaries’ use of services, adding to total Medicare spending.
Traditional Medicare needs the tools that other insurers use to achieve  better value for the protection provided. Instead of working at cross- purposes to the traditional program, Medigap should be better coordinated  with it. Insurance-type reforms to Medicare and Medigap—namely, the  preservation of cost-sharing requirements in conjunction with stop-loss  provisions—could help improve beneficiaries’ sensitivity to the cost of  care while better protecting them against financially devastating medical  costs.
section_title: Difficulties in Setting Payment Rates
paragraphs: Medicare too often pays overly generous rates for certain services and  products, preventing the program from achieving a desirable degree of  efficiency. For example, for certain services, our work has shown  substantially higher Medicare payments relative to providers’ costs—35  percent higher for home health care in the first six months of 2001 and 19  percent higher for skilled nursing facility care in 2000. Similarly,  Medicare has overpaid for various medical products. Last year, we  reported that, in 2000, Medicare paid over $1 billion more than other  purchasers for certain outpatient drugs that the program covers. Earlier  findings that have since been addressed by the Congress following our  recommendations showed Medicare paying over $500 million more than  another public payer for home oxygen equipment. Excessive payments  hurt not only the taxpayers but also the program’s beneficiaries or their  supplemental insurers, as beneficiaries are liable for copayments equal to  20 percent of Medicare’s approved fee. For certain outpatient drugs,  Medicare’s payments to providers were so high that the beneficiaries’  copayments exceeded the price at which providers could buy the drugs. In  2001, we recommended that, for covered outpatient prescription drugs,  Medicare establish payment levels more closely related to actual market  transaction costs, using information available to other public programs  that pay at lower rates.
Over the past two decades, at the Congress’ direction, Medicare has  implemented a series of payment reforms designed to promote the  efficient delivery of services and control program spending. Some reforms  required establishing set fees for individual services; others required  paying a fixed amount for a bundle of services. The payment methods  introduced during this time were designed to include—in addition to  incentives for efficiencies—a means to calibrate payments to ensure  beneficiary access and fairness to providers.
A major challenge in administering these methods—whether based on fee  schedules or prospective payment systems using bundled payments— involves adjusting the payments to better account for differences in  patients’ needs and providers’ local markets to ensure that the program is  paying appropriately and adequately. Payment rates that are too low can  impair beneficiary access to services and products, while rates that are too  high add unnecessary financial burdens to the program. As a practical  matter, Medicare is often precluded from using market forces—that is,  competition—to determine appropriate rates. In many cases, Medicare’s  size and potential to distort market prices makes it necessary to use means  other than competition to set a price on services and products.
Most of Medicare’s rate-setting methods are based on formulas that use  historical data on providers’ costs and charges. Too often, these data are  not recent or comprehensive enough to measure the costs incurred by  efficient providers. At the same time, data reflecting beneficiaries’ access  to services are also lacking. When providers contend that payments are  not adequate, typically information is not readily available to provide the  analytical support needed to determine whether these claims are valid. I  have noted in the past the essential need to monitor the impact of program  policy changes so that distinguishing between desirable and undesirable  consequences can be done systematically and in a timely manner. To that  end, I have also noted the importance of investing adequate resources in  the agency that runs Medicare to ensure that the capacity exists to carry  out these policy-monitoring activities.
Under some circumstances, competition may be feasible and practical for  setting more appropriate rates. Medicare has pilot tested “competitive  bidding” in a few small markets. According to program officials, these test  projects have shown that, for selected medical products, Medicare has  saved money on items priced competitively. As part of these competitive  bidding tests, steps were taken to monitor beneficiary access and product  quality. To use competitive bidding on a broader scale, Medicare would  require not only new authority but would need to make substantial  administrative preparations, as competing with a larger number of  products nationally would entail bidding in multiple markets and  monitoring access and quality once prices had been set.
section_title: Concluding Observations
paragraphs: Medicare’s financial challenge is very real. The 21st century has arrived  and the demographic tidal wave is on the horizon. Within 5 years,  individuals in the vanguard of the baby boom generation will be eligible  for Social Security and 3 years after that they will be eligible for Medicare.  The future costs of serving the baby boomers are already becoming a  factor in CBO’s short-term cost projections.
Clearly the issue before us is not whether to reform Medicare but how. I  feel the greatest risk lies in doing nothing to improve Medicare’s long-term  sustainability. It is my hope that we will think about the unprecedented  challenge of facing future generations in our aging society. Engaging in a  comprehensive effort to reform the program and put it on a sustainable  path for the future would help fulfill this generation’s stewardship  responsibility to succeeding generations.
Medicare reform would be done best with considerable lead time to phase  in changes and before the changes that are needed become dramatic and  disruptive. Given the size of Medicare’s financial challenge, it is only  realistic to expect that reforms intended to bring down future costs will  have to proceed incrementally. We should begin this now, when retirees  are still a far smaller proportion of the population than they will be in the  future. The sooner we get started, the less difficult the task will be.
As we contemplate the forecast for Medicare’s fiscal condition and its  implications, we must also remember that the sources of some of its  problems—and its solutions—are outside the program and are universal to  all health care payers. Some tax preferences mask the full cost of  providing health benefits and can work at cross-purposes to the goal of  moderating health care spending. Therefore, it may be important to  reexamine the incentives contained in current tax policy and consider  potential reforms. Advances in medical technology are also likely to keep  raising the price tag of providing care, regardless of the payer. Although  technological advances unquestionably provide medical benefits, judging  the value of those benefits—and weighing them against the additional  costs—is more difficult. Consumers are not as informed about the cost of  health care and its quality as they may be about other goods and services.  Thus, while the greater use of market forces may help to control cost  growth, it will undoubtedly be necessary to employ other cost control  methods as well.
We must also be mindful that health care costs compete with other  legitimate priorities in the federal budget, and their projected growth  threatens to crowd out future generations’ flexibility to decide which  competing priorities will be met. 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 issues affecting domestic programs.  It also points to the fiduciary and stewardship responsibility that we all  share to ensure the sustainability of Medicare for current and future  generations within a broader context of providing for other important  national needs and economic growth.
A major challenge policymakers face in considering health care reforms is  the dearth of timely, accurate information with which to make decisions.  Medicare’s size and impact on the nation’s health care economy means  that its payment methods and rate adjustments, no matter how reasonable,  often produce opposition. Recent experience with the payment reforms  established in the BBA illustrates this point. In essence, these reforms  changed Medicare’s payment methods to establish incentives for providers  to deliver care efficiently. BBA’s changes were enacted in response to  continuing rapid growth in Medicare spending that was neither sustainable  nor readily linked to demonstrated changes in beneficiary needs.  Nonetheless, affected provider groups conducted a swift, intense  campaign to roll back the BBA changes. In the absence of solid, data- driven analyses, affected providers’ anecdotes were used to support  contentions that Medicare payment changes were extreme and threatened  their financial viability. This and similar reactions to mandated Medicare  payment reforms underscore how difficult it is, without prompt and  credible data, to defend against claims that payments changes have  resulted in insufficient compensation that could lead to access problems.
The public sector can play an important role in educating the nation about  the limits of public support. Currently, there is a wide gap between what  patients and providers expect and what public programs are able to  deliver. Moreover, there is insufficient understanding about the terms and  conditions under which health care coverage is actually provided by the  nation’s public and private payers. In this regard, GAO is preparing a  health care framework that includes a set of principles to help  policymakers in their efforts to assess various health financing reform  options. This framework will examine health care issues systemwide and  identify the interconnections between public programs that finance health  care and the private insurance market. The framework can serve as a tool  for defining policy goals and ensuring the use of consistent criteria for  evaluating changes. By facilitating debate, the framework can encourage  acceptance of changes necessary to put us on a path to fiscal  sustainability. I fear that if we do not make such changes and adopt  meaningful reforms, future generations will enjoy little flexibility to fund  discretionary programs or make other valuable policy choices.
Mr. Chairman, this concludes my prepared statement. I will be happy to  answer any questions you or other committee members may have.
section_title: Contacts and Acknowledgments
paragraphs: For future contacts regarding this testimony, please call William J.  Scanlon, Director, Health Care Issues, at (202) 512-7114. Other individuals  who made key contributions include Linda Baker, James Cosgrove, Jessica  Farb, Hannah Fein, James McTigue, Yorick F. Uzes, and Melissa Wolf.