A Medicare Reform Proposal Everyone Can Love: Finding Common Ground among Medicare Reformers

Studies | Health

No. 306
Saturday, December 01, 2007
by Andrew J. Rettenmaier and Thomas R. Saving

Results under Alternate Rate of Return Assumptions

The HIRA annuity estimates thus far have been based on the assumption that the real rate of return earned on HIRA investments is 2.9 percent during both the accumulation and decumulation phases of the insurance.  The annuities as well as the effects on total Medicare spending were also calculated using a real return of 5.2 percent (the long-run average real return on a 60/40 stock/bond portfolio) for the accumulation phase and 2.9 percent for the decumulation phase.21

“The accounts of younger average-income workers will fund 29 percent to 59 percent of projected spending on Medicare-covered services at age 75.”

Deductibles as Percentages of Spending.  Table I summarizes the size of the base deductibles, HIRA annuities and their combination, relative to average spending at age 75 for the three birth years previously depicted and the two rates of return.  Because of the short time period that people can accumulate funds in their HIRAs, the effects of the two different rates of return on total deductibles for members of the 1950 birth year are similar.  However, workers born in 1970, who are 37 in 2007, have 28 years to accumulate funds in their HIRAs.  Those born in 1990 have their entire work lives to contribute.

The table's first panel indicates the base deductibles as shares of Medicare-covered services.22  Recall that the base deductible of $2,500 in 2007 is indexed to the growth in per capita Medicare spending.  As a result, its size relative to average spending at age 75 for each cohort is quite similar through time.  The base deductible is 16.2 percent of average spending at age 75 for workers born in 1950 and is 17.5 percent for retirees born in 1970 and 1990.

“Reformed Medicare will spend less than the current system beginning in 2048 (Method 1) or as soon as 2032 (Method 2).”

The next panel reports the HIRA annuities as a percentage of Medicare spending on covered services at age 75 for each birth year and for the two rate of return assumptions.  This panel illustrates how time to retirement age and rates of return affect the degree to which the HIRA annuities can replace projected spending.  Workers with medium earnings who were born in 1950, and who have less time remaining in the labor force before they retire will be able to fund annuities equal to 5.0 percent to 5.6 percent of their projected spending when they are 75 years old — depending on the rate of return assumption.  However, the HIRA annuities that today's medium earning young workers can fund through a lifetime of contributions are equal to 28.6 percent to 59.3 percent of projected spending when they are 75 years old.  As this panel also indicates, the HIRA annuities are less than the base deductible for older workers, about the same size as the base deductibles for workers born in 1970 and much higher for the youngest workers under the most conservative rate of return assumption.

“HIRAs could earn 5.2 percent, the average long-run return on a stock-and-bond portfolio during the accumulation period.”

The last panel reports the total deductibles.  The higher rate of return produces a total deductible equal to about 43 percent of average spending at age 75 for the 1970 birth year rather than the 35 percent deductible with the lower real rate of return.  Further, medium earners among today's 17 year olds will accumulate enough in their HIRAs to produce total deductibles equal to almost 77 percent of spending on Medicare-covered services when they are 75 years old if the higher rate of return assumption is used.  With the 2.9 percent return assumption, this group's total deductible will equal 46 percent of projected spending when they are 75.

Figures IIIa-IIIc summarize the total deductibles as percentages of Medicare-covered services for all ages for the three sample birth years using the alternative accumulation phase rate of return.

“High-wage workers would pay for 95 percent of their retirement health care costs.”

Aggregate Results under Alternate Rate-of-Return Assumptions. Table II compares the aggregate estimates under the two alternative rates of return.  The higher total deductibles resulting from the higher rate of return assumption will induce greater spending responses. Table II compares the alternative results in terms of the crossover year, and the relative costs in 2050 and 2080. The first two columns summarize the estimates underlying Figures IVa and IVb.  The last two columns summarize the estimates when the higher rate of return is used for the accumulation phase of the insurance. Figures IVa and IVb depict the annual cost estimates using the two methods for determining the deductibles' effects on total spending.

Using Method 1 to account for the effects of the total deductible, combined with the higher rate of return, produces 2043 as the estimated year when the cost of the reformed system falls below that of current Medicare.  The crossover year is 2049 when the 2.9 percent return is used.

Using Method 2 produces a crossover year of 2032 under both real return assumptions.  The long-run effects, however, show that the higher discount rate and resulting higher deductibles further reduce the projected total spending with the HIRA reform.  By 2080, reformed Medicare spending is 40 percent less than is currently projected.

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