Additional spending reductions necessary to save Medicare

Healthcare Financial Management, August, 1997 by Rick Gundling

Healthcare financial managers bracing themselves for roughly $115 billion in Medicare spending reductions over the next five years should be aware that this is just the beginning. In April, the Medicare trust fund board of trustees issued a report that warns that without corrective legislation soon, the trust fund will be exhausted shortly after the turn of the century; payment delays and, finally, curtailment of healthcare services to beneficiaries are the likely results. The trustees assert, therefore, that even more dramatic cost-cutting measures are needed.

Medicare Part A Funding and Expenditures

The Hospital Insurance (HI) program pays for Medicare Part A services, and is financed primarily by worker and employer payroll taxes. Each year's taxes are mainly used to pay benefits for current beneficiaries. Income not needed to pay benefits and related expenses is held in the trust fund and invested in U.S. Treasury securities.

The total number of Medicare Part A beneficiaries increased by 1.4 percent in 1996, and by 22.4 percent over the past 10 years. Medicare Part A benefits cost $128.6 billion in 1996, a 10 percent increase over the previous year, and average expenditure per enrollee increased by nine percent to $3,400. Fee-for-service inpatient hospital care represented 67 percent of Part A expenditures; skilled nursing and home health care accounted for 22 percent of the total; payments to managed care plans represented another nine percent; and hospice benefits accounted for the final two percent. Payroll taxes, paid by 147 million workers, accounted for 89 percent of total HI trust fund income, while interest represented eight percent, and revenue from taxing Social Security income represented another three percent.

The trustees have been reporting since 1992 that the HI trust fund does not meet even the short-range test of financial adequacy. The financial condition of the HI trust fund is assessed based on an examination of three alternative Medicare cost assumptions: low, intermediate, and high cost. These alternatives are used to illustrate a range of possible outcomes, with the intermediate set of assumptions representing the best estimate of expected future economic and demographic trends.

The trustees estimate that under their intermediate assumptions, the HI trust fund will be depleted in the year 2001. It is projected that there will be 3.6 workers per Part A beneficiary when the baby-boom generation begins to reach age 65 in 2010. The worker-to-beneficiary ratio is expected to rapidly decline to 2.3 to 1 in 2030 as the last of the baby boomers reach age 65. The ratio is expected to continue to decline after 2030 as life expectancy continues to lengthen.

In comparison with workers' earnings, HI expenditures are projected to grow rapidly, from 3.5 percent in 1996 to about 11.5 percent in 2070. As a percentage of the gross domestic product, Part A expenditures would grow more slowly, from 1.7 percent in 1996 to about five percent in 2070. Nonetheless, projected HI tax contributions would cover a declining share of expenditures under present law. The trustees assert that tax income will equal 84 percent of expenditures in 1997 and 74 percent in 2001 and will cover less than one-third of Part A costs 75 years from now.

To address the immediate financial problems facing the HI trust fund, the trustees strongly recommend that legislation be enacted as soon as possible to reduce growth in HI program costs and extend the life of the HI trust fund. Short-term legislative measures recommended now would provide time to develop means of addressing the program's long-term financial imbalance.

The Long-term Outlook

The long-range outlook for the HI trust fund remains extremely unfavorable, as it fails by a wide margin to meet the trustees' long-range test of sufficiency using intermediate assumptions. (In fact, the trustees maintain that it would fail the long-term test even using the low-cost assumptions.) To bring the HI trust fund into balance over the next 25 years using the intermediate assumptions, spending would have to be reduced by 40 percent, income increased by 66 percent, or some combination of the two. The current Part A payroll tax of 1.45 percent for both employees and employers, therefore, would have to be raised to 2.46 percent immediately, or benefits reduced by a comparable amount.

Over the full 75-year projection period, greater changes in income or outlays, or both, are needed. To help bring about these changes, the trustees recommend establishing a national advisory group on Medicare reform that would provide critical information needed to develop legislative long-range solutions. Healthcare financial managers should be prepared for dramatic changes to the Medicare program.

Rick Gundling, FHFMA, CMA, is technical director, HFMA Washington, D.C., office group.