Social Insurance Required Supplementary Information

A higher real-wage differential immediately increases both HI expenditures for health care and wages for all workers.  There is a full effect on wages and payroll taxes, but the effect on benefits is only partial, since not all health care costs are wage-related.  In dollar terms (either nominal or present-value), expenditures, revenues, deficits, and taxable payroll all increase with faster real-wage growth.  In relative terms, however, faster wage growth increases taxable payroll, and thus tax revenues, more than it increases expenditures.  This scenario leads to an improved financial status, where a smaller increase in the HI payroll tax rate would be required to attain financial balance.  Similarly, slower real-wage growth worsens the financial outlook for the HI trust fund.  For these reasons, the dollar cashflow measures required by Federal accounting standards do not adequately describe the sensitivity of the HI financial status to changes in the real-wage assumptions and must be supplemented by other measures. 

For the Year Ended September 30, 2007

Medicare, the largest health insurance program in the country, has helped fund medical care for the nation’s aged and disabled for slightly over four decades.  The Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (known informally as the Medicare Modernization Act, or MMA) introduced the most sweeping changes to the program since its enactment in 1965.  The most significant change is that, beginning in 2004, the MMA established a prescription drug benefit.  A separate Part D account within the SMI trust fund handles the transactions for this coverage.  A brief description of the provisions of Medicare’s Hospital Insurance (HI, or Part A) trust fund and Supplementary Medical Insurance (SMI, or Parts B and D) trust fund is included in Note 1 of this Financial Report.

The required supplementary information (RSI) contained in this section is presented in accordance with the requirements of the Federal Accounting Standards Advisory Board (FASAB).  Included are a description of the long‑term sustainability and financial condition of the program and a discussion of trends revealed in the data.

The RSI material is generally drawn from the 2007 Annual Report of the Boards of Trustees of the Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust Funds, which represents the official government evaluation of the financial and actuarial status of the Medicare trust funds.  Unless otherwise noted, all data are for calendar years, and all projections are based on the Trustees’ intermediate set of assumptions.  The projections have been revised slightly since the preparation of the 2007 Trustees Report, to adjust for the impact of an accounting error that was discovered in August of this year.  Beginning in May of 2005, Part A hospice expenditures were inadvertently drawn from the Part B account of the SMI trust fund rather than from the HI trust fund.  Therefore, Part A expenditures in the 2007 Trustees Report were understated slightly and Part B expenditures were correspondingly overstated.

The Medicare Trustees emphasize that the SMI Part B expenditures projected under current law are significantly understated.  Congress is very likely to continue overriding certain statutory provisions that would otherwise require reductions in physician payment rates of about 10 percent in 2008 and another 5 percent per year in 2009 through at least 2016. 

Printed copies of the Trustees Report may be obtained from CMS Office of the Actuary (410‑786-6386) or can be downloaded from www.cms.hhs.gov/ReportsTrustFunds/.

Actuarial Projections

Cashflow in Nominal Dollars 

Using nominal dollars[1] for short‑term projections paints a reasonably clear picture of expected performance with particular attention on cashflow and trust fund balances.  Over longer periods, however, the changing value of the dollar can complicate efforts to compare dollar amounts in different periods and can create severe barriers to interpretation, since projections must be linked to something that can be reasonably comprehended in today’s experience.

For this reason, long‑range (75‑year) Medicare projections in nominal dollars are seldom used and are not presented here.  Instead, nominal‑dollar estimates for the HI trust fund are displayed only through the projected date of depletion, currently the year 2018[2].  Corresponding estimates for SMI Parts B and D are presented only for the next 10 years, primarily due to the fact that under present law, the SMI trust fund is automatically in financial balance every year.

HI

Chart 1 shows the actuarial estimates of HI income, expenditures, and assets for each of the years 2007 through 2018, in nominal dollars.  Income includes payroll taxes, income from the taxation of Social Security benefits, interest earned on the U.S. Treasury securities held by the HI trust fund, and other miscellaneous revenue.  Expenditures include benefit payments and administrative expenses.  The estimates are for the “open group” population—all persons who will participate during the period as either HI taxpayers or beneficiaries, or both—and consist of payments from, and on behalf of, employees now in the workforce, as well as those who will enter the workforce through 2018.  The estimates also include income and expenditures attributable to these current and future workers, in addition to current beneficiaries.

As chart 1 shows, HI expenditures are expected to exceed income excluding interest in 2007 and, under the intermediate assumptions, would begin to exceed income including interest in 2010.  This situation arises as a result of health cost increases that are expected to continue to grow faster than workers’ earnings.  Beginning in 2010, the HI trust fund would start redeeming its assets; by the end of 2018, the assets would be depleted.  For the fourth year in a row, the HI trust fund does not meet an explicit test of short-range financial adequacy, as assets are predicted to fall below expenditures within the next 10 years.

The projected year of depletion of the HI trust fund is very sensitive to assumed future economic and other trends.  Under less favorable conditions the cash flow could turn negative much earlier and thereby accelerate asset exhaustion.

SMI

Chart 2 shows the actuarial estimates of SMI income, expenditures, and assets, for Parts B and D combined, for each of the years 2007 through 2016, in nominal dollars.  Whereas HI estimates are displayed through 2018, SMI estimates cover only the years through 2016, as SMI differs fundamentally from HI in regard to the way it is financed.  In particular, financing for SMI Parts B and D is not based on payroll taxes but rather on a combination of monthly beneficiary premiums and income from the general fund of the U.S. Treasury—both of which are established annually to cover the following year’s expenditures.[3]  Estimates of SMI income and expenditures, therefore, are virtually the same, as illustrated in chart 2, and so are not shown in nominal dollars separately beyond 2016.[4]

Income includes monthly premiums paid by, or on behalf of, beneficiaries, transfers from the general fund of the U.S. Treasury, certain payments by the States to the Part D account, and interest earned on the U.S. Treasury securities held by the SMI trust fund.  Chart 2 displays only total income; it does not separately show income excluding interest.  The difference between the two depictions of income is not visible graphically since interest is not a significant source of income.[5]  Expenditures include benefit payments as well as administrative expenses.

As chart 2 indicates, SMI income is very close to expenditures.  As mentioned earlier, this is because of the financing mechanism for Parts B and D.  Under present law, both accounts are automatically in financial balance every year, regardless of future economic and other conditions.

HI Cashflow as a Percentage of Taxable Payroll

Each year, estimates of the financial and actuarial status of the HI trust fund are prepared for the next 75 years.  Because it is difficult to meaningfully compare dollar values for different periods without some type of relative scale, income and expenditure amounts are shown relative to the earnings in covered employment that are taxable under HI (referred to as “taxable payroll”).

Chart 3 illustrates income (excluding interest) and expenditures as a percentage of taxable payroll over the next 75 years.  Prior to last year’s Trustees Report, the long‑range increase in average expenditures per beneficiary was assumed to equal growth in per capita gross domestic product (GDP) plus 1 percentage point.  Beginning with the 2006 report, the Board of Trustees adopted a refinement of these long-range growth assumptions.  The refinement provides a smoother and more realistic transition from current Medicare cost growth rates, which have been significantly above the level of GDP growth, to the ultimate assumed level of GDP plus zero percent for the indefinite future.

Based on these projections, the Medicare Trustees apply a formal test of “long-range close actuarial balance.”  The HI trust fund fails this test by a wide margin, as it has in almost all previous years.

Since HI payroll tax rates are not scheduled to change in the future under present law, payroll tax income as a percentage of taxable payroll is estimated to remain constant at 2.90 percent.  Income from taxation of benefits will increase only gradually as a greater proportion of Social Security beneficiaries become subject to such taxation over time.  Thus, as chart 3 shows, the income rate is not expected to increase significantly over current levels.  On the other hand, expenditures as a percentage of taxable payroll sharply escalate—in part due to health care cost increases that exceed wage growth, but also due to the attainment of Medicare eligibility of those born during the 1946‑1964 baby boom.

HI and SMI Cashflow as a Percentage of GDP

Expressing Medicare incurred expenditures as a percentage of GDP gives a relative measure of the size of the Medicare program compared to the general economy.  The GDP represents the total value of goods and services produced in the United States.  This measure provides an idea of the relative financial resources that will be necessary to pay for Medicare services.

HI

Chart 4 shows HI income (excluding interest) and expenditures over the next 75 years expressed as a percentage of GDP.  In 2006, the expenditures were $191.9 billion, which was 1.4 percent of GDP.  This percentage is projected to increase steadily throughout the remainder of the 75-year period.

SMI

Because of the Part B and Part D financing mechanism in which income mirrors expenditures, it is not necessary to test for long‑range imbalances between income and expenditures.  Rather, it is more important to examine the projected rise in expenditures and the implications for beneficiary premiums and Federal general revenue payments.  Chart 5 shows projected total SMI (Part B and Part D) expenditures and premium income as a percentage of GDP.  As in the projections for HI, the assumed long‑range increase in average expenditures per beneficiary was refined in last year’s Trustees Report.  This refinement provides a more gradual transition from current health cost growth rates to the ultimate assumed level of GDP plus zero percent just after the 75^th year and for the indefinite future.  The growth rates are estimated year by year for the next 12 years, reflecting the impact of specific statutory provisions.  Expenditure growth for years 13 to 25 is assumed to grade smoothly into the long‑range assumption.

Under the intermediate assumptions, annual SMI expenditures were $216.4 billion, or about 1.6 percent of GDP, in 2006.  Then, in about 25 years, they would grow to almost 4 percent of GDP and to more than 6 percent by the end of the projection period.

To match the faster growth rates for SMI expenditures, beneficiary premiums, along with general revenue contributions, would increase more rapidly than GDP over time.  In fact, average per-beneficiary costs for Part B and Part D benefits are projected to increase in most years by at least 5 percent annually.  The associated beneficiary premiums—and general revenue financing—would increase by approximately the same rate.  The special State payments to the Part D account are set by law at a declining portion of the States’ forgone Medicaid expenditures attributable to the Medicare drug benefit.  The percentage was 90 percent in 2006, phasing down to 75 percent in 2015 and later.  Then, after 2015, the State payments are also expected to increase faster than GDP.

Worker-to-Beneficiary Ratio

HI

Another way to evaluate the long‑range outlook of the HI trust fund is to examine the projected number of workers per HI beneficiary.  Chart 6 illustrates this ratio over the next 75 years.  For the most part, current benefits are paid for by current workers.  The retirement of the baby boom generation will therefore be financed by the relatively smaller number of persons born after the baby boom.  In 2006, every beneficiary had 3.9 workers to pay for his or her benefit.  In 2030, however, after the last baby boomer turns 65, there will be only about 2.4 workers per beneficiary.  The projected ratio continues to decline until there are just 2.0 workers per beneficiary by 2081.

Sensitivity Analysis

In order to make projections regarding the future financial status of the HI and SMI trust funds, various assumptions have to be made.  First and foremost, the estimates presented here are based on the assumption that both trust funds will continue under present law.  In addition, the estimates depend on many economic and demographic assumptions.  Because of revisions to these assumptions, due to either changed conditions or more information, estimates sometimes change substantially compared to those made in prior years.  Furthermore, it is important to recognize that actual conditions are very likely to differ from the projections presented here, since the future cannot be anticipated with certainty.

In order to illustrate the sensitivity of the long‑range projections, six of the key assumptions were varied individually to determine the impact on the HI actuarial present values and net cashflows.[6]  The assumptions varied are the health care cost factors, fertility rate, net immigration, real‑wage differential, CPI, and real‑interest rate.[7]

For this analysis, the intermediate economic and demographic assumptions in the 2007 Annual Report of the Boards of Trustees of the Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust Funds are used as the reference point.  Each selected assumption is varied individually to produce three scenarios.  All present values are calculated as of January 1, 2007 and are based on estimates of income and expenditures during the 75‑year projection period.

Charts 7 through 12 show the net annual HI cashflow in nominal dollars and the present value of this net cashflow for each assumption varied.[8]  In most instances, the charts depicting the estimated net cashflow indicate that, after increasing in the early years, net cashflow decreases steadily through 2081 under all three scenarios displayed.  On the present value charts, the same pattern is evident, in most cases, until around 2060, when the present values begin to increase (or become less negative).  This occurs as a result of the discounting process used for computing present values, which is used to help interpret the net cashflow deficit in terms of today’s dollar.  In other words, the amount required today to cover this deficit begins to decrease at the end of the 75-year period.

Health Care Cost Factors

Table 1 shows the net present value of cashflow during the 75‑year projection period under three alternative assumptions for the annual growth rate in the aggregate cost of providing covered health care services to beneficiaries.  These assumptions are that the ultimate annual growth rate in such costs, relative to taxable payroll, will be 1 percent slower than the intermediate assumptions, the same as the intermediate assumptions, and 1 percent faster than the intermediate assumptions.  In each case, the taxable payroll will be the same as that which was assumed for the intermediate assumptions.

Table 1 demonstrates that if the ultimate growth rate assumption is 1 percentage point lower than the intermediate assumptions, the deficit decreases by $7,240 billion.  On the other hand, if the ultimate growth rate assumption is 1 percentage point higher than the intermediate assumptions, the deficit increases more substantially, by $11,758 billion.

Charts 7 and 7A show projections of the net cashflow under the three alternative annual growth rate assumptions presented in table 1.

This assumption has a dramatic impact on projected HI cashflow.  Several factors, such as the utilization of services by beneficiaries or the relative complexity of services provided, can affect costs without affecting tax income.  As charts 7 and 7A indicate, the financial status of the HI trust fund is extremely sensitive to the relative growth rates for health care service costs.

Fertility Rate

Table 2 shows the net present value of cashflow during the 75‑year projection period under three alternative ultimate fertility rate assumptions: 1.7, 2.0, and 2.3 children per woman.

As table 2 demonstrates, for an increase of 0.3 in the assumed ultimate fertility rate, the projected present value of the HI deficit decreases by approximately $205 billion.

Charts 8 and 8A show projections of the net cashflow under the three alternative fertility rate assumptions presented in table 2.

As charts 8 and 8A indicate, the fertility rate assumption has only a negligible impact on projected HI cashflows.  In fact, higher fertility in the first year does not affect the labor force until roughly 20 years have passed (increasing HI payroll taxes slightly) and has virtually no impact on the number of beneficiaries within this period.  Over the full 75‑year period, the impacts are expected to be somewhat greater, as illustrated by the present values in table 2.

Net Immigration

Table 3 shows the net present value of cashflow during the 75‑year projection period under three alternative net immigration assumptions: 672,500 persons, 900,000 persons, and 1,300,000 persons per year.

As shown in table 3, if the ultimate net immigration assumption is 672,500 persons, the deficit decreases by $144 billion.  Conversely, if the ultimate net immigration assumption is 1,300,000 persons, the deficit increases by $224 billion.

Charts 9 and 9A show projections of the net cashflow under the three alternative net immigration assumptions presented in table 3.

As charts 9 and 9A indicate, this assumption has an impact on projected HI cashflow starting almost immediately.  Because immigration tends to occur among those who work and pay taxes into the system, in the short term payroll taxes increase faster than benefits; in the long term, however, the opposite occurs, as those individuals age and become beneficiaries in a period with much greater health care costs per beneficiary.

Real-Wage Differential

Table 4 shows the net present value of cashflow during the 75‑year projection period under three alternative ultimate real‑wage differential[9] assumptions: 0.6, 1.1, and 1.6 percentage points.  In each case, the ultimate CPI-increase is assumed to be 2.8 percent, yielding ultimate percentage increases in average annual wages in covered employment of 3.4, 3.9, and 4.4 percent, respectively.

As indicated in table 4, for a half‑point increase in the ultimate real‑wage differential assumption, the deficit—expressed in present-value dollars—increases by approximately $980 billion.  In this instance, the results expressed in present-value dollars do not reveal the full implications of faster or slower growth in real wages.  While the dollar amount of the trust fund deficit is lower, for a smaller real-wage differential, table 4 also indicates that the deficit represents a higher percentage of taxable payroll.  In other words, with slower growth in real wages, a higher tax increase would be necessary to cover the corresponding HI trust fund deficit.  In practice, slow growth in real wages worsens the financial status of the HI trust fund, and, conversely, rapid growth in real wages improves the fund’s condition.  The reasons for the apparent inconsistency between the present-value and taxable-payroll measures are described below.

Charts 10 and 10A show projections of the net cashflow under the three alternative real‑wage differential assumptions presented in table 4.

As noted previously and illustrated in charts 10 and 10A, slower real-wage growth results in smaller HI cashflow deficits, when expressed in either nominal or present-value dollars.  While this result appears to suggest that the financial status of the HI trust fund improves with slower real-wage growth, in practice the opposite is true.  To better illustrate this result, chart 10B shows projected HI expenditures and tax revenues under the three scenarios, expressed as a percent of taxable payroll. 

As indicated in chart 10B, HI expenditures represent a significantly higher proportion of taxable payroll under conditions of slow real-wage growth (and vice versa).  HI tax revenues, however, as a percentage of taxable payroll, are largely unaffected.  As a result, the HI deficit as a percentage of taxable payroll increases substantially with slow wage growth, and faster real-wage growth leads to lower HI cost rates and deficits.

A higher real-wage differential immediately increases both HI expenditures for health care and wages for all workers.  There is a full effect on wages and payroll taxes, but the effect on benefits is only partial, since not all health care costs are wage-related.  In dollar terms (either nominal or present-value), expenditures, revenues, deficits, and taxable payroll all increase with faster real-wage growth.  In relative terms, however, faster wage growth increases taxable payroll, and thus tax revenues, more than it increases expenditures.  This scenario leads to an improved financial status, where a smaller increase in the HI payroll tax rate would be required to attain financial balance.  Similarly, slower real-wage growth worsens the financial outlook for the HI trust fund.  For these reasons, the dollar cashflow measures required by Federal accounting standards do not adequately describe the sensitivity of the HI financial status to changes in the real-wage assumptions and must be supplemented by other measures. 

Consumer Price Index

Table 5 shows the net present value of cashflow during the 75‑year projection period under three alternative ultimate CPI rate-of-increase assumptions: 1.8, 2.8, and 3.8 percent.  In each case, the ultimate real‑wage differential is assumed to be 1.1 percent, yielding ultimate percentage increases in average annual wages in covered employment of 2.9, 3.9, and 4.9 percent, respectively.

Table 5 demonstrates that if the ultimate CPI-increase assumption is 1.8 percent, the deficit decreases by $63 billion.  On the other hand, if the ultimate CPI-increase assumption is 3.8 percent, the deficit increases by only $6 billion.

Charts 11 and 11A show projections of the net cashflow under the three alternative CPI rate-of-increase assumptions presented in table 5.

As charts 11 and 11A indicate, this assumption has a large impact on projected HI cashflow in nominal dollars but only a negligible impact when the cashflow is expressed as present values.  The relative insensitivity of the projected present values of HI cashflow to different levels of general inflation occurs because inflation tends to affect both income and costs in a similar manner.  In nominal dollars, however, a given deficit “looks bigger” under high‑inflation conditions but is not significantly different when it is expressed as a present value or relative to taxable payroll.  This sensitivity test serves as a useful example of the limitations of nominal‑dollar projections over long periods.

Real-Interest Rate

Table 6 shows the net present value of cashflow during the 75‑year projection period under three alternative ultimate real‑interest assumptions: 2.1, 2.9, and 3.6 percent.  In each case, the ultimate annual increase in the CPI is assumed to be 2.8 percent, resulting in ultimate nominal annual yields of 4.9, 5.7, and 6.4 percent, respectively.

As illustrated in table 6, for every increase of 0.1 percentage point in the ultimate real‑interest rate, the deficit decreases by approximately $530 billion.

Charts 12 and 12A show projections of the net cashflow under the three alternative real‑interest assumptions presented in table 6.

As shown in charts 12 and 12A, the projected HI cashflow when expressed in present values is more sensitive to the interest assumption than when it is expressed in nominal dollars.  This is not an indication of the actual role that interest plays in HI financing.  In actuality, interest finances very little of the cost of the HI trust fund because, under the intermediate assumptions, the fund is projected to be relatively low and exhausted by 2018.  These results illustrate the substantial sensitivity of present value measures to different interest rate assumptions.  With higher assumed interest, the very large deficits in the more distant future are discounted more heavily (that is, are given less weight), resulting in a smaller overall net present value.

Trust Fund Finances and Sustainability

HI

Under the Medicare Trustees’ intermediate assumptions, the HI trust fund is projected to be exhausted in 2018, the same as was estimated in last year’s report.  Income from all sources is projected to exceed expenditures for only the next 4 years and to fall short by steadily increasing amounts in 2010 and later.  These shortfalls can be met with increasing reliance on interest payments on invested assets and the redemption of those assets, thereby adding to the draw on the Federal Budget.  In the absence of corrective legislation, a depleted HI trust fund would initially produce payment delays, but very quickly lead to a curtailment of health care services to beneficiaries.  In practice, Congress has never allowed a Medicare or Social Security trust fund to become fully depleted.

The HI trust fund is substantially out of financial balance in the long range.  Bringing the fund into actuarial balance over the next 75 years under the intermediate assumptions would require very substantial increases in revenues and/or reductions in benefits.  These changes are needed in part as a result of the impending retirement of the baby boom generation.

SMI

Under current law, the SMI trust fund will remain adequate, both in the near term and into the indefinite future, because of the automatic financing established for Parts B and D.  Because there is no authority to transfer assets between the Part D and Part B accounts, it is necessary to evaluate each account’s financial adequacy separately.

The financing established for the Part B account for calendar year 2007 is adequate to cover 2007 expected expenditures and to restore the financial status of the Part B account in 2007 to a satisfactory level.  Because the net trust fund ratio would still be at the lower end of the desirable range, the Part B financing rates for 2008 would have to be increased slightly above the estimated expenditure increase.

No financial imbalance is anticipated for the Part D account, since the general revenue subsidy for this benefit is expected to be drawn on a daily, as-needed basis.  The projected Part D costs shown in this section are significantly lower than previously estimated, reflecting the latest data on drug cost trends generally and Part D bid and enrollment levels.

For both the Part B and Part D accounts, beneficiary premiums and general revenue transfers will be set to meet expected costs each year.  However, a critical issue for the SMI trust fund is the impact of the past and expected rapid growth of SMI costs, which place steadily increasing demands on beneficiaries, the Federal Budget, and society at large.

Medicare Overall

The Medicare Modernization Act requires the Board of Trustees to determine whether the difference between Medicare outlays and “dedicated financing sources” is projected to exceed 45 percent of total Medicare outlays within the next 7 fiscal years (2007‑2013).[10]  This difference is projected to first exceed 45 percent of total expenditures in 2013, which is within the 7‑year test period.  Consequently, the Trustees issued a determination of projected “excess general revenue Medicare funding,” as required by law.  A similar determination was made in their 2006 annual report to Congress.  Under the MMA, these two consecutive determinations trigger a “Medicare funding warning,” indicating that the general revenues provided to Medicare under current law are becoming a substantial proportion of total program costs. This finding requires the President to submit to Congress, within 15 days after the release of the next budget, proposed legislation to respond to the warning.[11]  Congress is then required to consider this legislation on an expedited basis. This new requirement will help call attention to Medicare’s impact on the Federal Budget.