Saving Medicare
A Private Sector Solution
"An alternative to the pay-asyou-go approach is a system under which each generation pays its own way."
An alternative to Medicare's current pay-as-you-go approach is a system under which each generation prefunds its retirement health care expenditures and pays its own way. Prefunding Medicare could be accomplished by requiring each age cohort (all individuals born between January 1 and December 31 in any given year) to pool together, making deposits to private savings accounts and eventually paying premiums that would insure against postretirement medical expenses. What follows is a brief description of how the reform would work. [See Saving Medicare: A Ten-Point Plan.]
Private Savings (PRIME) Accounts. Each individual would be required to make annual deposits to a Personal Retirement Insurance for Medical Expenses (PRIME) account. These private savings accounts would grow until retirement and would accumulate sufficient funds to allow the purchase of basic health insurance during the years of retirement. The same dollar contribution to PRIME accounts would be made by all members of the same age group, and the required amount would be adjusted from year to year to insure sufficient funds for postretirement health care.12 For example:
- To replace Medicare, a 25-year-old would need to deposit about $668 a year, every year, until retirement - an amount equal to about 2.4 percent of the average person's wage over the next 40 years.
- A 35-year-old would have to contribute about $1,098 - a larger amount since he or she has only 30 years over which to accumulate the necessary funds.
- A 45-year-old would need to contribute about $2,008 each year for the next 20 years.
These deposits would be funded by dollar-for-dollar reductions in the workers' payroll tax liability. Roughly speaking, workers would put money aside in their own accounts rather than paying taxes to Medicare. A more complete discussion of the required contribution amounts and the assumptions behind them is provided below.
"Each individual would be required to make annual deposits to a Personal Retirement Insurance for Medical Expenses (PRIME) account."
Since participation in Medicare is compulsory, participation in any private-sector alternative also would be compulsory. Whether or not compulsion is justified, it solves two important problems. First, mandatory participation eliminates a potential "free rider" problem. As a society, we have decided that individual access to health care will not depend on ability to pay. Yet knowing that society will take care of them, individuals have an incentive to save less than they may need to fund their retirement medical care expenses. Mandatory participation also addresses the adverse selection problem that would result if individuals could opt into the system only when they expected to incur large medical expenses.
Accounts for Low-Income Workers. Those whose deposits fall short of the required amount because of low earnings would have their accounts topped up by the government. The required contributions of those who earn more than enough to fund their accounts would support the topping up. Taken as a whole, as each age group reaches retirement age there would be enough money to cover their retirement health care insurance premiums.
Accounts for Spouses. Married workers also would have to divert a portion of their Medicare payroll taxes to the PRIME accounts of nonworking spouses. These deposits would be accounted for separately so the nonworking spouses would be fully protected in cases of death, separation or divorce.
Investment of PRIME Accounts. Individuals would select a manager for their PRIME account from among competing financial institutions, which would be required to invest PRIME funds prudently and conservatively in a diversified portfolio.
"Those whose deposits fall short because of low earnings would have their accounts topped up by the government."
Postretirement Health Insurance. Sometime before their 65th birthday, individuals would have to use their PRIME account funds to purchase postretirement private health insurance. Such insurance could consist of an HMO, PPO, MSA or some other plan, but the chosen plan would include catastrophic coverage for basic medical care. The proposed insurance would be similar to today's Medicare in that it would pay no death benefit. Funds not used for third-party insurance could be placed in a Medical Savings Account to purchase medical care directly or to pay for long-term care.
Death Benefit. Unused MSA balances and other PRIME account funds not used to purchase catastrophic insurance could be transferred to an individual's heirs at death.
Medicare Buy-In Option. As an alternative to private insurance, individuals could use their PRIME account funds to buy back into Medicare during the transition period.
Funding the Transition. Throughout the transition period, Medicare taxes would be kept at their current level. Tax revenue not diverted to PRIME accounts would fund Medicare benefits for those already retired or near retirement and retire any debt incurred as a result of the transition.
The medical care risks of current and future retirees will exist regardless of who acts as the insurer. What medical care will encompass and what proportion of total resources will be dedicated to it in the future is unknown. Yet it does not follow that the government must be the insurer or that transfer payments must fund retirement medical expenses. The real question is whether future retirees will pay for their own retirement medical purchases or rely on their children and grandchildren to pay. Pay-as-you-go financing shifts the risks from medical care consumers to taxpayers. Prefunding links the consumers of medical care to its funding.