Chairman Roth, Senator Moynihan, distinguished Committee members, thank you for
inviting me to testify today about the financial outlook for the Medicare program. 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 has improved dramatically since 1997 as
a result of the Balanced Budget Act of 1997, together with recent strong economic growth,
moderate increases in health costs generally, and continuing efforts to combat fraud and
abuse. Even so, there remains a serious imbalance between long-range income and
expenditures for the Hospital Insurance (HI) trust fund and growth rates for Supplementary
Medical Insurance (SMI) benefits are expected to continue to exceed growth in the nation's economy.
Background
Chart 1 summarizes the enrollment, covered services, and financing provisions of the
Medicare program. Information is shown separately for the HI and SMI programs, also known
as "Parts A and B,"respectively. As indicated,
roughly 39 million people were eligible for Medicare benefits in 1998. HI 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 1998, 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 ($45.50 in 1999) 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 thefont
Board of Trustees. My discussion of Medicare's financial status is based on the actuarial projections contained in the
Board's 1999 report
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 2 shows past income, expenditures, and trust fund assets for the HI program and
projections through 2015. 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. The Board of Trustees has recommended maintaining
assets equal to at least one year's expenditures as a contingency reserve.
During 1990-97, HI expenditures increased at a faster rate than HI income. Expenditures
exceeded income by $2.6 billion in 1995, $5.3 billion in 1996, and $9.3 billion in 1997.
Prior to the Balanced Budget Act, 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 and, as indicated in
chart 2, these changes significantly reduce the growth rate in HI expenditures during
1998-2002. In 1998, income exceeded expenditures for the first time in 4 years. The trust
fund is estimated to continue to experience modest surpluses through about 2006.
Thereafter, however, expenditures are projected to again exceed income. Assets would be
drawn down to cover the resulting shortfalls but would be exhausted by about 2015 under
the Trustees'
intermediate assumptions.
The depletion date estimated in the 1999 Trustees Report represents a significant
improvement compared to the estimate in last year's report (2008). The improvement arises from higher payroll tax revenues
in 1998 than had been estimated, together with lower benefit expenditures and adjustments
to projected income and expenditure growth for the future based on this experience. The
higher payroll taxes in 1998 resulted from robust economic growth, particularly the rapid
growth in employment. Lower HI expenditures reflected the implementation of the Balanced
Budget Act, low increases in health care costs generally, and continuing efforts to combat
fraud and abuse in the Medicare program.
The improvement in the HI depletion date also reflects a subtle but important shift in
the near-term operations of the trust fund. As shown in chart 3, the HI trust fund was
previously projected to experience small deficits during 1998-2002, and large and growing
deficits thereafter. The improvements described above, however, were sufficient to result
in modest surpluses during this period, instead of small deficits. As a result,
under the Trustees'
intermediate assumptions, the trust fund would not begin to draw down assets for another 7
or so years. Thus, the impact of the favorable experience in 1998 is magnified because the
transformation of small deficits to small surpluses significantly delays the onset of the
fund's depletion.
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 4 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.
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. Future cost rates are projected to
initially decrease as a result of the Balanced Budget Act provisions. After 2002, however,
cost rates would increase steadily and accelerate significantly with the retirement of the
baby boom, beginning in about 2010. Closing the HI deficit over the first 25 years would
require either an 11-percent reduction in benefits or a 12-percent increase in income, or
some combination, starting immediately. Over the full 75-year period, the adjustments
would have to be considerably greater. The good news is that, as a result of the Balanced
Budget Act and the favorable experience of recent years, the long-range actuarial deficit
is only one-third of the level projected prior to the BBA. The bad news is that, even so,
the remaining imbalance is considerable.
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 roughly 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. Currently, this ratio is 3.9 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 2050 under
the intermediate projections. Other things being equal, there would be a corresponding
increase in HI costs as a percentage of taxable payroll.
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 over 20 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.
The key factors underlying past and projected increases in HI expenditures are
summarized in chart 6. Aggregate cost increases have been factored into (i) growth in the
number of beneficiaries, (ii) increases in general inflation, as measured by the Consumer
Price Index, and (iii) all other factors, reflecting per capita increases in the
utilization of health services and in the "intensity" (or average complexity) of such services. Through the early 1980s,
general inflation was a major contributor to growth in HI costs. The "all other" category has seen major swings
in the past, from average annual increases of as much as 6 percent to as little as 0.7
percent.
Under the intermediate projections, the impact of the baby boom's retirement clearly shows up
in its effect on beneficiary growth rates. The Trustees project a fairly constant rate of
inflation at about 3.3 percent annually. Projected growth in the "all other" category varies significantly,
reflecting the net impact of several factors. Initially, residual growth rates are low due
to the impact of the Balanced Budget Act. After 2002, utilization is expected to
reaccelerate, although not as severely as in past years, due to the new prospective
payment systems mandated by the Act. Future demographics will also play a role: as an
influx of 65-year-old baby boomers arrives, average per capita utilization will actually
decrease temporarily, as the average age of beneficiaries declines. As the baby boom
generation ages, however, their utilization will increase and drive up residual HI growth
rates overall.
A final factor affecting the residual growth rates shown in chart 6 is an assumption
that health costs cannot continue to grow indefinitely at the high rates frequently
experienced in the past. A simple extrapolation of the past quickly leads to a situation
where Medicare alone would represent a substantial portion of total gross domestic product, an untenable and unrealistic
situation. For this reason, residual growth rates are purposely assumed to gradually
moderate toward the end of the first 25-year projection period. This assumption has been
used for many years and has been found appropriate in the past by independent panels of
expert actuaries and economists. More recently, however, it has received considerable
criticism. Accordingly, I have asked my staff to carefully review the long-range Medicare
growth assumptions. In addition, the Board of Trustees is convening a new expert panel for
the purpose of reviewing the Medicare trust fund projections. We will also ask this group
to review the long-range growth assumptions.
Financial outlook for Supplementary Medical Insurance
Chart 7 presents estimates of the short-range outlook for SMI and is generally similar
to the information presented in chart 2 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 the relative level of trust fund assets. Since financing is reset
frequently, a lower level of assets can suffice for contingency reserve purposes.
The primary concern for SMI is the rapid rate of growth in benefits. SMI costs grew by
41 percent over the last 5 years, exceeding the growth in the nation's gross domestic product (GDP)
by 9 percent. Similar growth is projected for the short-range future. Although the
Balanced Budget Act contained a number of provisions designed to reduce the rate of growth
in SMI expenditures, their impact is 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.
The increase in SMI costs is offset by additional premium revenue under a provision to
maintain the SMI premium at the level of 25 percent of expenditures. Prior to the Balanced
Budget Act, premium increases would have been limited to the Social Security
cost-of-living adjustment (COLA) and, over time, would have represented a declining share
of total costs. The Balanced Budget Act makes permanent the current relationship between
premium revenue and total costs.
The long-range cost of SMI (shown in chart 8 as a percentage of GDP) is expected to
follow the same general pattern seen previously for HI. In contrast to HI, these costs
will automatically be met through enrollee premiums and general revenues of the Federal
government. Policy makers remain concerned about continuing rapid growth in SMI
expenditures.
Conclusions
In their 1999 report to Congress, the Board of Trustees notes the substantial
improvements in the financial outlook for Medicare that have come about as a result of the
Balanced Budget Act of 1997, together with recent strong economic growth and relatively
slow growth in health costs generally. 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 wholeheartedly 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.
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