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The Financial Outlook for Medicare
Testimony before the
Senate Finance Committee
March 22, 2001
by
Richard S. Foster, F.S.A.
Chief Actuary
Health Care Financing Administration
Chairman Grassley, Senator Baucus, distinguished Committee
members, thank you for inviting me to testify today about
the financial outlook for the Medicare program as shown
in the recently released 2001 annual reports of the Medicare
Board of Trustees. I welcome the opportunity to assist you
in your efforts to ensure the future financial viability
of the nation's second largest social insurance program-one
that is a critical factor in the income security of the
our aged and disabled populations.
The financial outlook for the Medicare program presents
a mixed picture. Over the next 10 years, the Hospital Insurance
(HI) and Supplementary Medical Insurance (SMI) trust funds
are adequately financed and meet the Trustees' formal tests
for short-range financial adequacy. The depletion of the
HI trust fund, which had been projected for 2025 in last
year's Trustees Report, has been postponed to 2029 in the
new estimates.
Over the long range, in contrast, HI and SMI expenditures
are projected to grow more rapidly than in previous reports
as a result of revised long-range Medicare cost growth assumptions.
The assumption change was recommended by the 2000 Medicare
Technical Review Panel, an independent, expert group of
actuaries and economists convened by the Board of Trustees
to review the Medicare financial projections. HI tax revenues
are projected after 2015 to fall increasingly short of program
expenditures, eventually covering only one-third of estimated
costs by the end of the Trustees' 75-year projection period.
For SMI, continuing rapid expenditure growth would place
growing financial burdens both on beneficiaries and on the
Federal budget. The SMI trust fund would remain in financial
balance indefinitely, however, due to the annual redetermination
of program financing.
Background
Roughly 39 million people were eligible for Medicare benefits
in 2000. HI, or "Part A" of Medicare, provides
partial protection against the costs of inpatient hospital
services, skilled nursing care, post-institutional home
health care, and hospice care. SMI covers most physician
services, outpatient hospital care, home health care not
covered by HI, and a variety of other medical services such
as diagnostic tests, durable medical equipment, and so forth.
Only about 22 percent of HI enrollees received some reimbursable
covered services during 2000, since hospital stays and related
care tend to be infrequent events even for the aged and
disabled. In contrast, the vast majority of enrollees incur
reimbursable SMI costs because the covered services are
more routine and the annual deductible for SMI is only $100.
The two parts of Medicare are financed on totally different
bases. HI costs are met primarily through a portion of the
FICA and SECA payroll taxes. Of the total FICA tax rate
of 7.65 percent of covered earnings, payable by employees
and employers, each, HI receives 1.45 percent. Self-employed
workers pay the combined total of 2.90 percent. Following
the Omnibus Budget Reconciliation Act of 1993, HI taxes
are paid on total earnings in covered employment, without
limit. Other HI income includes a portion of the income
taxes levied on Social Security benefits, interest income
on invested assets, and other minor sources.
SMI enrollees pay monthly premiums ($50.00 in 2001) that
cover about 25 percent of program costs. The balance is
paid by general revenue of the Federal government and a
small amount of interest income.
The HI tax rate is specified in the Social Security Act
and is not scheduled to change at any time in the future
under present law. Thus, program financing cannot be modified
to match variations in program costs except through new
legislation. In contrast, SMI premiums and general revenue
payments are reestablished each year to match estimated
program costs for the following year. As a result, SMI income
automatically matches expenditures without the need for
legislative adjustments.
Each part of Medicare has its own trust fund, with financial
oversight provided by the Board of Trustees. My discussion
of Medicare's financial status is based on the actuarial
projections contained in the Board's 2001 reports to Congress.
Such projections are made under three alternative sets of
economic and demographic assumptions, to illustrate the
uncertainty and possible range of variation of future costs,
and cover both a "short range" period (the next
10 years) and a "long range" (the next 75 years).
The projections are not intended as firm predictions of
future costs, since this is clearly impossible; rather,
they illustrate how the Medicare program would operate under
a range of conditions that can reasonably be expected to
occur. The projections shown in this testimony are based
on the Trustees' "intermediate" set of assumptions.
Short-range financial outlook for Hospital Insurance
Chart 1 shows HI expenditures versus income over the last
10 years and projections through 2010. For most of the program's
history, income and expenditures have been very close together,
illustrating the pay-as-you-go nature of HI financing. The
taxes collected each year are intended to be roughly sufficient
to cover that year's costs. Surplus revenues are invested
in special Treasury securities.
Chart 1-HI expenditures and income
(In billions)
During 1990-97, HI costs increased at a faster rate than
HI income. Expenditures exceeded income by a total of $17.2
billion in 1995-97. Prior to the Balanced Budget Act of
1997, this trend was expected to continue, with costs growing
at about 8 percent annually, against revenue growth of only
5 to 6 percent. The 1995-97 shortfalls were met by redeeming
trust fund assets, but in the absence of corrective legislation
assets would have been depleted in about 2001. The Medicare
provisions in the Balanced Budget Act were designed to help
address this situation. As indicated in chart 1, these changes-together
with subsequent low general and medical inflation and increased
efforts to address fraud and abuse in the Medicare program-resulted
in a decline in HI expenditures during 1998-2000 and trust
fund surpluses totaling $61.8 billion over this period.
The Board of Trustees has recommended maintaining HI assets
equal to at least one year's expenditures as a contingency
reserve. As indicated in chart 2, HI assets at the beginning
of 2001 represented about 125 percent of estimated expenditures
for the year. The HI trust fund is estimated to continue
to experience significant surpluses for about the next 15
years. After 2020, however, expenditures are projected to
again exceed income. As shown in chart 2, assets would initially
accumulate rapidly but then be drawn down to cover the resulting
shortfalls. The trust fund would be exhausted in 2029 under
the Trustees' intermediate assumptions.
The depletion date estimated in the 2001 Trustees Report
represents a significant improvement compared to the estimate
in last year's report (2025). The improvement arises from
higher payroll tax revenues and income taxes on Social Security
benefits in 2000 than had been estimated, together with
assumed faster economic growth over the next 10 years. In
addition, benefit expenditures in 2000 were lower than estimated,
and adjustments have been made to projected expenditure
growth for the future based on this experience. The higher
payroll taxes in 2000 resulted from robust economic growth,
particularly the rapid growth in productivity and wages.
Lower-than-expected HI expenditures reflected a reduction
in the utilization of skilled nursing facility services,
low increases in health care costs generally, and continuing
efforts to combat fraud and abuse in the Medicare program.
Chart 2-HI trust fund assets
(Assets at beginning of year as percentage of annual expenditures)
2000 Medicare Technical Review Panel
The projections in the new Trustees Reports also reflect
a number of recommendations made by the 2000 Medicare Technical
Review Panel. The impact of these recommendations on the
HI projections for the first 25 years were largely offsetting
and had a minimal impact on the estimated year of asset
depletion.
The Technical Panel was convened by the Board of Trustees
in 2000 to review the financial projections in the Medicare
Trustees Reports. It was made up of seven independent health
actuaries and health economists, who were nominated by the
prior public members of the Board of Trustees. The panel
met from June through November 2000 and issued its final
recommendations in December 2000.
The panel unanimously found that the projection work of
the Office of the Actuary at the Health Care Financing Administration
was of excellent quality and was performed in a highly competent
and completely professional manner. Overall, the members
concluded that the methods and assumptions used to project
the status of the Medicare program were reasonable, with
the exception of the long-range expenditure growth assumption,
which they believed to be too low. In addition to their
recommendation to increase this growth rate assumption,
the panel issued 37 other findings and recommendations.
For the 2001 Trustees Reports, the Medicare Board of Trustees
adopted all of the panel's recommendations that could realistically
be incorporated within the short time available following
the panel's report. These included the recommended long-range
growth assumptions, corresponding adjustments to short-range
"case-mix" growth assumptions, an improvement
in certain assumptions relating to the costs for beneficiaries
who switch from fee-for-service coverage to Medicare+Choice
plans, and several recommendations regarding the content
of the Trustees Reports. The Board will consider the panel's
remaining recommendations for possible inclusion in future
reports, as time and available health research knowledge
permit.
In past Trustees Reports, increases in the average HI cost
per unit of service were assumed to gradually decline after
the first 15 years and to equal growth in average hourly
earnings during the final 50 years of the projection. The
last expert review panel, in 1991, concluded that the assumption
was "not unreasonable" but recommended that it
be monitored carefully in subsequent years. The 2000 Technical
Panel recommended that average HI and SMI expenditures per
beneficiary be assumed to increase at the rate of per capita
GDP plus one percentage point. They based this recommendation
primarily on the historical impact of advances in medical
technology on health care cost increases, which they expected
to continue indefinitely. They also considered other factors
contributing to health care cost growth, the assumptions
of other forecasters, and the "sustainability"
of such cost increases in the very long range. Although
they acknowledged the remaining (and considerable) uncertainty
regarding health expenditure growth rates over very extended
periods, the panel concluded that there is substantially
greater evidence in favor of the faster growth assumption
than there is in support of the prior HI and SMI Trustees
Report assumptions. I concur with their conclusion, as does
the Board of Trustees.
Long-range financial outlook for Hospital Insurance
The interpretation of dollar amounts through time is very
difficult over extremely long periods like the 75-year projection
period used in the Trustees Reports. For this reason, long-range
tax income and expenditures are expressed as a percentage
of the total amount of wages and self-employment income
subject to the HI payroll tax (referred to as "taxable
payroll"). The results are termed the "income
rate" and "cost rate," respectively. Projected
long-range income and cost rates are shown in chart 3 for
the HI program.
Past income rates have generally followed program costs
closely, rising in a step-wise fashion as the payroll tax
rates were adjusted by Congress. Income rate growth in the
future is minimal, due to the fixed tax rates specified
in current law. Trust fund revenue from the taxation of
Social Security benefits increases gradually, because the
income thresholds specified in the Internal Revenue Code
are not indexed. Over time, an increasing proportion of
Social Security beneficiaries will incur income taxes on
their benefit payments.
Chart 3-Long-range HI income and costs under intermediate
assumptions
(as a percentage of taxable payroll)
Past HI cost rates have generally increased over time but
have periodically declined abruptly as the result of legislation
to expand HI coverage to additional categories of workers,
raise (or eliminate) the maximum taxable wage base, introduce
new payment systems such as the inpatient prospective payment
system, etc. Cost rates decreased significantly in 1998-2000
as a result of the Balanced Budget Act provisions together
with strong economic growth. After 2002, however, cost rates
are projected to increase steadily and accelerate significantly
with the retirement of the baby boom, beginning in about
2010. As a result of the revised long-range expenditure
growth assumption, projected cost rates after 2030 are substantially
greater than the corresponding estimates in last year's
Trustees Report. In particular, by the end of the 75-year
period, scheduled tax income would cover only one-third
of projected expenditures.
The average value of the financing shortfall over the next
75 years-known as the actuarial deficit-is 1.97 percent
of taxable payroll. This deficit could be closed by an immediate
increase of 1 percentage point in the HI payroll tax rate,
payable by employees and employers, each. (The projected
deficit could also be eliminated by many other revenue increases
and/or expenditure reductions.) Note, however, that such
a change would only correct the deficit "on average."
Initially, HI revenue would be significantly in excess of
expenditures, but by the end of the period, only about one-fourth
of the projected deficit would be eliminated.
The effect of the baby boom's retirement on Social Security
and Medicare is relatively well known, having been discussed
at length for more than 25 years. Basically, by the time
the baby boom cohorts have retired, there will be nearly
twice as many HI beneficiaries as there are today. When
the HI program began, there were 4.5 workers in covered
employment for every HI beneficiary. As shown in chart 5,
this ratio is currently 4.0 workers per beneficiary. With
the advent of the baby boom's retirement, the number of
beneficiaries will increase more rapidly than the labor
force, resulting in a decline in this ratio to 2.3 in 2030
and 2.0 in 2075 under the intermediate projections. Other
things being equal, there would be a corresponding increase
in HI costs as a percentage of taxable payroll.
Chart 4-Workers per HI beneficiary
There are other demographic effects beyond those attributable
to the varying number of births in past years. In particular,
life expectancy has improved substantially in the U.S. over
time and is projected to continue doing so. The average
remaining life expectancy for 65-year-olds increased from
12.4 years in 1935 to 17.4 years currently, with an estimated
further increase to about 21 years at the end of the long-range
projection period. Medicare costs are also sensitive to
the age distribution of beneficiaries. Older persons incur
substantially larger costs for medical care, on average,
than younger persons. Thus, as the beneficiary population
ages over time they will move into higher-utilization age
groups, thereby adding to the financial pressures on the
Medicare program.
Financial outlook for Supplementary Medical Insurance
Chart 5 presents estimates of the short-range outlook for
SMI and is generally similar to the information presented
in chart 1 for the HI program. Two key differences stand
out: First, the income and expenditure curves for SMI are
nearly indistinguishable in the future. As noted previously,
SMI premiums and general revenue income are reestablished
annually to match expected program costs for the following
year. Thus, the program will automatically be in financial
balance, regardless of future program cost trends. The second
difference is-in contrast to the decline in HI expenditures
during 1998-2000-SMI expenditures increased at an average
rate of 6.9 percent over this period.
Chart 5-SMI expenditures and income
(In billions)
Although the Balanced Budget Act contained a number of provisions
designed to reduce the rate of growth in SMI expenditures,
their impact was more than offset by other factors. First,
the Act specified that home health services not associated
with a prior stay in an institution were to be converted
to Part B benefits and paid for by the SMI trust fund (phased
in over several years). In addition, the Act provides for
several significant new preventive or "screening"
benefits, such as colorectal examinations, not previously
covered by Medicare, and it gradually corrects an excessive
level of beneficiary coinsurance for outpatient hospital
services. As a result, SMI costs are estimated to increase
somewhat as a result of the Balanced Budget Act. Further
cost increases have resulted under the Balanced Budget Refinement
Act of 1999 and the Benefit Improvement and Protection Act
of 2000.
Chart 6 shows projected long-range SMI expenditures and
premium income as a percentage of GDP. Under present law,
beneficiary premiums will continue to cover approximately
25 percent of total SMI costs, with the balance drawn from
general revenues. Expenditures are projected to increase
at a significantly faster rate than GDP, for largely the
same reasons underlying HI cost growth. After about 2030,
the SMI costs projected in the 2001 Trustees Report are
substantially higher than those in the 2000 report, again
primarily as a result of the revised long-range growth rate
assumption recommended by the Medicare Technical Review
Panel.
Although SMI is automatically in financial balance, the
program's continuing rapid growth in expenditures places
an increasing burden on beneficiaries and the Federal budget.
In 2000, for example, about 6 percent of a typical 65-year-old's
Social Security benefit was withheld to pay the monthly
SMI premium of $45.50, and another 8 percent was required
to cover average deductible and coinsurance expenditures
for the year. Twenty years later, under the intermediate
assumptions, the same beneficiary's premium and copayment
costs would average 21 percent of his or her benefit. Similarly,
SMI general revenues in fiscal year 2000 were equivalent
to 5.4 percent of the personal and corporate Federal income
taxes collected in that year. If such taxes remain at their
current level, relative to the national economy, then SMI
general revenue financing in 2075 would represent 22 percent
of total income taxes.
Chart 6-SMI expenditures and premiums as a percentage of
GDP
Combined HI and SMI expenditures
The financial status of the Medicare program is appropriately
evaluated for each trust fund separately, as summarized
in the preceding sections. By law, each fund is a distinct
financial entity, and the nature and sources of financing
are very different between the two funds. This distinction,
however, frequently causes greater attention to the HI trust
fund-its projected year of asset depletion in particular-and
less attention to SMI, which does not face the prospect
of depletion. It is important to consider the total cost
of the Medicare program and its overall sources of financing,
as shown in chart 7. Interest income is excluded since,
under present law, it would not be a significant part of
program financing in the long range.
Combined HI and SMI expenditures are projected to increase
from 2.2 percent of GDP to about 8.5 percent in 2075, based
on the Trustees' intermediate set of assumptions. In past
years, total income from HI payroll taxes, income taxes
on Social Security benefits, HI and SMI beneficiary premiums,
and SMI general revenues was very close to total expenditures.
Over the next 15 years, such Medicare revenues are estimated
to slightly exceed program expenditures, reflecting the
expected excess of HI tax income over expenditures. Thereafter,
however, overall expenditures are expected to exceed aggregate
revenues. Again, the growing difference arises from the
projected imbalance between HI tax income and expenditures-throughout
this period, SMI revenues would continue to approximately
match SMI expenditures.
Chart 7-Medicare expenditures and sources of income as
a percentage of GDP
Over time, SMI premiums and general revenues would continue
to grow rapidly, since they would keep pace with SMI expenditure
growth under present law. HI payroll taxes are not projected
to increase as a share of GDP, primarily because no further
increases in the tax rates are scheduled under present law.
Thus, as HI sources of revenue become increasingly inadequate
to cover HI costs, SMI premiums and general revenues would
represent a growing share of total Medicare income.
Conclusions
In their 2001 reports to Congress, the Board of Trustees
notes the significant improvement in the financial outlook
for Medicare that has come about as a result of legislation,
strong economic growth, relatively slow growth in health
costs generally, and efforts to combat fraud and abuse.
But they emphasize the continuing financial pressures facing
Medicare and urge the nation's policy makers to take further
steps to address these concerns. They also argue that consideration
of further reforms should occur in the relatively near future.
Today's relatively favorable conditions could change, accelerating
the expected return to deficits in the HI trust fund. Moreover,
the earlier solutions are enacted, the more flexible and
gradual they can be. Finally, the Trustees note that early
action increases the time available for affected individuals
and organizations-including health care providers, beneficiaries,
and taxpayers-to adjust their expectations.
I concur with the Trustees' assessment and pledge the Office
of the Actuary's continuing assistance to the joint effort
by the Administration and Congress to determine effective
solutions to the remaining financial problems facing the
Medicare program. I would be happy to answer any questions
you might have on Medicare's financial issues.