July 31, 1996

Sausalito, California

Medicare is looming as a huge election and public policy issue. The program is tremendously popular with the public; a new poll released today by the Kaiser Family Foundation and Harvard School of Public Health found that 77 percent of those questioned said it should not be cut to help balance the federal budget. Even spending cuts meant to preserve the system were rejected. Fifty-four percent said Congress "should not make major reductions in future spending to prevent the Medicare program from going bankrupt." Only 37% accepted cuts for that reason. Seven percent identified Medicare as one of the two most important election issues, comparable to the 6% identifying abortion as their high priority.

Certainly, the President has gotten the message, and is defining his message as "preserving and strengthening Medicare." He rejected deep cuts in growth of Medicare called for by Congressional Republicans last year, and now calls for moderate interim action while a bipartisan commission studies changes required for the long term. Even Newt Gingrich had to backpedal on his prediction that Medicare would wither on the vine.

Yet the problem is enormous and threatens to become larger very quickly. The Hospital Insurance Trust Fund, financed by a 1.45% payroll tax each on employers and employees, dipped into reserves this year to meet expenses incurred. Medicare trustees predict that reserves will be exhausted by the year 2001. The full actuarial deficit is projected to be $407.8 billion on expenses of nearly $2 trillion through 2005. Therefore, by the trustees best guess, nearly a 25% cut will be necessary to simply maintain the program through 2005. There is great uncertainty about costs, and the trustees have been all over the map with their predictions before, but costs are growing alarmingly, and demographic factors -- such as the retirement of the baby boom generation starting in 2010 -- make it clear that major shifts need to be made if we are to save Medicare at all.

First, why are costs rising so rapidly? In the 70s, 80s, and 90s growth was 17.5%, 12.1%, and 10.3% (projected), which is steep but still better than either national or private health care spending over the last decade. In the seventies, two new categories (the disabled and end stage renal disease) were added to medicare. In sum, the pool of beneficiaries has grown 2.5% per year since the programs inception. Benefits have also been expanded, with addition of hospice, mammography, pap smears, certain immunizations, and kidney dialysis and transplant. (Benefits are still relatively thin, with no prescription drug or catastrophic coverage, high deductibles, etc.). There also has been an explosion in the use of medical technology, further fueling high costs. Finally, Medicare's fee-for-service structure encourages overuse of medical resources.

One swift solution would be to raise taxes. Trustees estimate the actuarial balance deficit is 4.52% over the next 75 years, meaning the current payroll tax of 2.9% would have to be raised by 4.52% immediately to erase the deficit, a highly unlikely prospect. However, the tax has been stable for 10 years (although the ceiling on taxable income was removed in 1994), and some would argue it is time for an update. For the time being, however, there seems to be a concensus against raising taxes. Which leaves cutting expenditures as the main route to reform. (Leaving aside such budget gimmicks as moving some benefits from Part A to Part B and thus off of the trust fund and onto general revenues.)

Cost cutting implies squeezing the beneficiaries, providers or the system. Some would means-test the Medicare entitlement or raise deductibles or copayments. Elders already spend twice as much of their income as non-elders on health care, with only half the income. Means testing would erode the very idea of social insurance. Providers already get low reimbursements from Medicare; some would argue that there is still some fat to be trimmed, though others suggest that cutting any more would reduce access and quality by forcing some financially marginal hospitals into insolvency. And it is unclear how much or how quickly savings can be wrung from the system. Most reform proposals now on the table advocate different mechanisms of shifting more beneficiaries into capitated managed care, which theoretically has incentives to hold down costs.

Any reform proposal has to deal with the hybrid system currently in operation, with 65% of beneficiaries also covered by employer plans and/or Medigap policies, and another 16% on Medicaid, yielding 81% who face little or no coinsurance. This means that the typical disincentive to use excess resources when faced with copayments is not applicable to Medicare.

Medicare is also currently divided into Part A (hospital services) and Part B (physician outpatient services) (roughly). This distinction was made historically to appease congressional republicans who wanted a "voluntary" system in place (Part B) alongside the mandatory Part A. The financing and payment schemes of the two are completely distinct. Some would argue that the distinction is anachronistic and not easily integrated into managed care and other novel forms of service delivery: many services once provided only in the hospital are being provided to outpatients now, for example. Any thorough reform proposal should merge the two, for ease and clarity. Funding mechanisms would have to be worked out to integrate the fiscal discipline of Part A's trust fund with Part B's general revenue source.

One reform proposal would move Medicare from "service reimbursement" to "premium support". First, health plans in a given market area would bid on providing a package of defined comprehensive benefits to Medicare enrollees. Then beneficiaries would have their choice of plan. Medicare would contribute a defined sum towards any given plan. If the plan charges more than this amount, enrollees would pay the difference. Plans under the defined sum would be allowed to provide extra benefits. This would provide a strong incentive to choose cheaper, more efficient plans. Architects of this plan envision a period of transition during which the new payment system would be phased in. Regulatory agencies would be set up to handle enrollment and marketing in given areas.

Others envision a stripped down version of this based strictly on vouchers. Simply put, we would figure out how much we wanted to spend, then divide this into the total number of enrollees, adjust for some local variations in cost, and give this voucher amount to beneficiaries to put towards their choice of health plan during an open enrollment season. This would provide less protection for consumers from high costs of health plans than the previous reform proposal, since it might theoretically provide for even less than the low cost plan. This plan also doesn't mandate a defined benefit package, thus making comparison shopping somewhat harder, and increasing opportunity for selecting good risks by making the benefit package a bad deal for groups you want to exclude.

Critical issues to consider include 1) defining the benefit package; 2) amount of the voucher -- e.g. defined contribution from government vs. tying payment to bids received; 3) phasing in any new payment mechanism; 4) to what extent should competition be managed?....others

Anyone out there have any good ideas?