Reforming Medicare

Studies | Health

No. 261
Thursday, May 15, 2003
by Andrew J. Rettenmaier and Thomas R. Saving


Executive Summary

Medicare is in need of reform. In a few years, as medical costs escalate and baby boomers retire, Medicare and Social Security will place significant burdens on the federal budget:

  • By 2030, about the midpoint of the baby boomer retirement years, deficits in Social Security and Medicare will require 37 percent of federal income taxes.
  • This means that within three decades the federal government will either have to eliminate more than one-third of all the income-tax-funded services it currently provides or increase the income tax burden by more than one-third.

As the next generation of retirees replaces the baby boom generation, the financial picture for Social Security and Medicare will worsen, not improve. For example:

  • By 2050, when today's college students begin to retire, Medicare and Social Security will require 54 percent of all federal income tax revenues in addition to all dedicated taxes and premiums.
  • By 2070, the two programs combined will require almost 75 percent of all income tax revenues - leaving only one out of four dollars for all other federal government functions.

The Medicare and Social Security systems are committed to pay future benefits to retirees and workers. Currently, the cost of these future commitments are not reported as federal government debts. If they were, how much would the federal government owe - assuming we ended the two programs and paid only those benefits that have already been earned? The answer:

  • The present value of accrued Social Security obligations in 2001 was $12.9 trillion.
  • The present value of accrued Medicare obligations was $10.3 trillion for Medicare Part A benefits and $6.6 trillion for Part B benefits.
  • And in 2001, the unofficial debt of these entitlement programs combined was $29.8 trillion, more than10 times the official federal debt.

If Congress passes a Medicare prescription drug benefit similar to that proposed in 2002 by House Republicans, federal obligations will immediately increase by an amount equal to more than 80 percent of the outstanding national debt.

What can be done? For the short run, we recommend fundamental reform. Rather than spending more, we recommend better use of the dollars we are already spending. Specifically:

  • An integrated health insurance program should replace Medicare Part A, Medicare Part B and private medigap insurance.
  • The new program should be comprehensive, offering catastrophic coverage and prescription drug benefits.
  • Seniors should be able to enroll in any of a number of competing private health plans that offer these benefits, including HMOs and Medical Savings Account plans.
  • With catastrophic coverage eliminating the need for medigap insurance, greater cost sharing and competition below the deductible will ensue.

A number of reform proposals would allow seniors who enroll in private plans to reselect a plan every 12 months. A long-term contract would be better, allowing seniors to switch plans only if they are unhappy with the plan they are in; a beneficiary's movement would prompt a severance payment from one plan to the other to compensate for any losses created by the move.

The principal advantage of long-term contracts is that they can remove an insurer's incentive to avoid enrolling the sickest beneficiaries and then underserve them after enrollment.

  • Over a 12-month period, the most costly enrollees are the sickest (often those near death).
  • Over a longer period, say, for the remainder of the enrollees' lives, the most expensive enrollees are those who are healthiest at the time of enrollment.

In general, seniors of the same age cohort cost Medicare about the same near the end of their lives, regardless of the age at which they die. However, before their death, those who live the longest will tend to require the most Medicare dollars because they will have more years to consume benefits.

At the time a person enters a health plan, his or her future health costs are very difficult to predict. We arrayed seniors who were born in 1912 into quintiles (fifths) according to the amount they spent on health care at ages 65 to 69. The results:

  • One-third of those who were the lowest-cost beneficiaries from 65 to 69 years of age continued to cost the least for the rest of their lives; the other two-thirds rose to a higher-cost quintile.
  • Of those who were the highest-cost beneficiaries at ages 65 to 69, only 27 percent cost the most for the rest of their lives; the remaining 73 percent fell to a lower-cost quintile.
  • For each of the three middle quintiles, remaining lifetime spending was almost random, based on spending during the first five years.

An important part of this proposal is that movements of beneficiaries from one plan to another will necessitate compensation payment between the two plans. Plan X and Plan Y will agree to a beneficiary's move if the loser is compensated for its losses. The two plans would also have to agree on the amount of compensation.


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