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

Letter

Rising Drug Spending Elevates Beneficiary Access Concerns

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.

Prescription Drug Costs Continue to Rise Rapidly

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.

Drug Coverage for Medicare Beneficiaries Is Becoming More Expensive and Less Available

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.

Expanding Benefits Needs to Be Considered in Light of Larger Medicare Fiscal Concerns

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.

As Currently Structured, Medicare Is Fiscally Unsustainable

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.

Bleak Outlook for Medicare’s Long-Term Sustainability Increases Urgency for Program Reform

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.

Private Health Insurance Principles Should Guide Reform Efforts

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.

Concluding Observations

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.