Medicare: Past, Present and Future

Studies | Health

No. 299
Sunday, July 01, 2007
by Andrew J. Rettenmaier and Thomas R. Saving


Letting Seniors Make Their Own Rationing Decisions

Letting Seniors Make Their Own Rationing Decisions

“With a $5,000 deductible, seniors would reduce their spending by as much as one-third.”

An alternative to having Medicare limit health options for the elderly is to redesign the insurance package and have retirees themselves choose between health care and other uses of money.  The Medicare projections made by the Trustees are based on a past that is greatly affected by the fact that Medicare beneficiaries have limited incentives to care what health care costs.  In particular, the prevalence of medigap (private supplemental) insurance among the Medicare population essentially removes all the deductibles and copays that are Medicare's primary cost-control mechanisms.  One simple reform, then, would be to replace first-dollar insurance coverage with Health Savings Accounts (HSAs) combined with catastrophic coverage. 

Redesigning Medicare.   A possible design would work like this:  Individuals would face a high deductible, applied to all Medicare-covered services.  They would have 100 percent third-party insurance coverage for all expenses above the deductible and they would pay for all expenses below the deductible from their own pockets or from an individually owned HSA.  Note: Although this is a conventional design for HSA products, it is not necessarily the best design (especially for the chronically ill).  It is used to identify a range of the effects a high-deductible policy might have on the health care spending of retirees using estimates from the RAND Health Insurance Experiment (see below). 

Estimated Effects of Health Insurance with High Deductibles.   The results of the RAND Health Insurance Experiment provide benchmarks for estimating the effect of replacing traditional, first-dollar coverage with an HSA coupled to a high-deductible policy.  To illustrate the effect of this reform, consider replacing current Medicare with a $5,000 deductible with no other copays.  The deductible could rise at the rate of per capita Medicare expenditures. 15  Estimating the effects of a high-deductible policy on Medicare spending in two ways provides a range of potential spending reductions. 

“There is an alternative way of reducing Medicare's unfunded liability by as much as 40 percent.”

As the range of estimates in Table III shows, a high-deductible policy can potentially reduce total spending on Medicare-covered services by 27 percent to 41 percent.  Specifically: 

  • Senior premiums for Part B and Part D coverage are reduced by 40 percent to 50 percent (in order to maintain the current cost-sharing percentages).
  • Senior medigap premiums are eliminated because beneficiaries would pay the deductible amount. 
  • In total, seniors spend $1,862 to $2,390 less on Medicare-covered services. 
  • Government Medicare spending can potentially be reduced by $2,785 to $4,427, or 25 percent to 40 percent below baseline projections. 

Impact on the Federal Government Finances .  Figure X depicts the range of effects resulting from high-deductible policies coupled with HSAs.  Assuming the full effect of the reform is immediate, the general revenue transfer is reduced by more than 60 percent with the lower-bound spending estimate and by almost 40 percent with the upper-bound spending estimate.  While the reduction over the entire 75-year Trustees projection period remains very significant, the percentage reduction is less impressive than the initial reduction in the transfer. 

Table 3

In the case of the lower-bound estimate, by 2010, a transfer of 5.5 percent of federal nonentitlement revenues to Medicare will be required; by 2030 it will rise to 18.9 percent of nonentitlement revenues, and by midcentury a transfer of more than 30 percent will be needed.  At the close of the 75-year projection period, the lower-bound spending estimate would require a transfer of more than 42 percent of all federal nonentitlement revenues to Medicare.  While this terminal year transfer is lower than the 68 percent transfer required under the current Medicare program, the funding burden is still significant. 

In the case of the upper-bound spending estimate, by 2010, a transfer of 8.5 percent of federal nonentitlement revenues to Medicare will be required; by 2030 it will rise to almost 25 percent of nonentitlement revenues, and by midcentury the transfer will need to be more than 40 percent.  At the close of the 75-year projection period, the transfer using the upper-bound spending estimate would be about 53 percent of all federal nonentitlement revenues. 

“Medicare could cover costs above a high deductible and seniors could use Health Savings Accounts for expenses below the deductible.”

Roth-Type HSAs.  Currently, people under age 65 have access to HSA plans through an employer or in the individual insurance market.  Deposits to HSAs are made with pretax dollars and accounts grow tax-free.  From their HSA, people can make tax-free purchases of health care (just as their employer third-party insurance payments are tax-free).  However, withdrawals for non-health purposes face ordinary income taxes and a 10 percent penalty as well if the withdrawal occurs before age 65. 

The proposal for Medicare beneficiaries is similar, but with important design differences.  Specifically, a Medicare beneficiary's deposits to an HSA account should be with after-tax dollars and withdrawals for nonhealth purposes would be tax-free.  Such an account would be similar to a Roth IRA in terms of taxation. 16

“With a Roth-type HSA, seniors could withdraw funds for any purpose tax free.”

A Roth-type account is attractive for three reasons.  First, most senior health spending is already made with after-tax dollars.  Out-of-pocket spending and medigap premiums not paid by an employer are clearly after-tax.  Payroll tax dollars for Part A coverage have already been subjected to the income tax.  And Part B premiums are deducted from Social Security benefits that are subjected to income taxation through the Social Security benefits tax.  Second, a Roth account allows the beneficiary to make unbiased choices between health care and other uses of money.  With a regular HSA, a dollar withdrawn for nonhealth purposes faces a 30 percent tax, say, for someone in a 30 percent tax bracket.  That means a dollar of health care must trade against 70 cents of other goods.  With a Roth account, by contrast, a dollar of health care trades against a dollar's worth of other goods and services.  As a result, people will not spend a dollar on health care unless they get a dollar's worth of value.  Finally, the RAND experimental results can be applied to a Roth-type account in straightforward way. 

As discussed below, deposits to the HSAs could be made by seniors themselves or, during a transition phase, by Medicare.  Unspent HSA monies would revert to the individual at the close of each year or could be rolled over to the next year. 

Figure 10

“A high-deductible policy would require lower general revenue transfers compared to current-system projections.”

A Phased-In Approach.  These results assume an immediate shift to high-deductible policies for all seniors receiving Medicare benefits. 17  Of course, a higher deductible could be phased in gradually in any number of ways, which would delay the projected spending reductions to later years.  One approach would make the federal government assume some of the cost below the deductible in order to at least initially make beneficiaries as well-off as under the current arrangement.  If the program were redesigned in this way, with an HSA and a $5,000 deductible, how much would the government have to deposit in HSAs to make beneficiaries indifferent to the change? 18  One way to address this question is to consider how government spending on behalf of beneficiaries (the net Medicare benefit) and spending by beneficiaries themselves change with the two estimates presented in Table III. 

In 2007, the average net Medicare benefit is $9,500, and seniors spend an average of $1,605 on Medicare premiums and $1,911 on medigap insurance. 19  With a $5,000 deductible, the calculated upper-bound estimate for total Medicare spending would save the government $2,144 per beneficiary and, at the lower-bound, save the government $3,635.

Seniors currently spend $3,500 out of pocket on medigap insurance on average. These funds could be deposited in HSAs, leaving approximately $1,500 up to the $5,000 deductible. During a phase-in of the reform, the government could deposit $1,500 on average in each beneficiary's HSA.

Of course, a $1,500 deposit to every senior's HSA would reduce the potential savings to the government.

Ultimately, the government contribution to the HSA must be phased out if the savings depicted in this study are to materialize.  And there are several ways to accomplish this.  The HSA deposits could, for example, be gradually reduced for all retirees or only reduced for new retirees.  By contrast, the HSA contributions could remain for people who are older, sicker or poorer, while falling for everyone else. 

“The government could initially deposit about $1,500 to each beneficiary's Health Savings Account.”

For example, currently, Medicaid implicitly provides the copays for Medicare Part B and Part D for the lowest earners. Thus, one option to phase in the reform is to make the government's HSA contribution inversely related to the beneficiary's Social Security benefit over time. Thus, beneficiaries with low Social Security benefits would receive an HSA contribution equal to the total deductible amount while those with higher Social Security benefits would receive reduced government contributions. This would gradually "means-test" the government contribution to the HSAs.  Alternatively, the size of the deductible could gradually be scaled to a worker's lifetime earnings. 20


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