A Warning from the Medicare Trustees

rice-logoby Charles Blahous:

My most recent article for e21 summarized the 2015 Social Security trustees’ report released last week. This companion piece does the same for the Medicare report. These are the last annual reports in which I participated as a public trustee based on my term that ended last autumn. The Medicare report shows that the program is on an unsustainable path. Following is some key information from the report about Medicare finances.

Understanding Medicare finances involves much more than just tracking the solvency status of a trust fund. Medicare has two trust funds, one for Hospital Insurance (HI), the other for Supplementary Medical Insurance (SMI). The HI trust fund operates in some ways analogous to Social Security. For example, it is financed primarily by a payroll tax on wages, it receives some income from taxing Social Security benefits, and each year the trustees estimate its actuarial status and projected duration of solvency.

The SMI trust fund (from which physician services and prescription drug benefits are financed) operates quite differently. It receives about three-quarters of its revenue from the general government fund, a good portion of the remainder from beneficiary premiums, and is always kept solvent by statutory design. Thus, when SMI cost growth produces financial strains, these are manifested not in the threat of trust fund depletion but in rising cost obligations facing the federal budget as well as program participants.

HI is the only part of Medicare for which the trustees produce solvency calculations, yet it is less than half of Medicare’s whole. In 2014 Medicare spent $269 billion from its HI trust fund but a larger $344 billion from its SMI trust fund. Any undue emphasis on the trustees’ estimates of actuarial balance will miss well more than half of Medicare’s larger financial picture.

Under current Medicare cost growth projections, the financing burdens facing the federal budget (in the form of general revenue obligations), as well as those facing Medicare participants, will grow dramatically in the years ahead. This can be seen in Figure 1.

Figure 1: Medicare Cost and Income by Source as a Percentage of GDP

 

Ns1XGpuAs with Social Security, Medicare’s current cost growth rate is unsustainable because it exceeds the rate of national economic growth. Change will be needed to limit Medicare cost growth to sustainable rates. Social Security is still more expensive than Medicare and faces the more immediate threat of insolvency. However, Medicare’s cost growth rate is somewhat worse than Social Security’s. Cost growth in both programs will be at its most severe over the next couple of decades, as Figure 2 shows.

Figure 2: Social Security (OASI + DI) and Medicare (HI + SMI) Cost Growth as a Percentage of GDP

Figure 2: Social Security (OASI + DI) and Medicare (HI + SMI) Cost Growth as a Percentage of GDP

As with Social Security, most Medicare cost growth is caused by population aging, which increases the number of beneficiaries relative to workers. By contrast, health care cost inflation — though a serious issue — is a lesser factor in the decades to come. Policy advocates tend to discuss health care cost growth more than population aging, yielding to the temptation to promise pain-free solutions via greater efficiency in service delivery. But the more important work of fixing Medicare cost growth will consist of making difficult decisions about the proportion of our lives that Americans should expect to receive federally-subsidized health care. Figure 3 shows that the ratio of workers to beneficiaries is declining rapidly.

Figure 3: Medicare's Worker/Beneficiary Ratio

Medicare HI Operations Are Already on Thin Ice, and the Near-Term Outlook is Somewhat Worse than Last Year’s Projections. Each year there is some over-emphasis of the projected Medicare HI trust fund depletion date, which at 2030 is unchanged from last year’s report to this one. That said, policy makers should understand that the near-term picture for HI has become a bit more tenuous.

Figure 4 shows HI’s projected “trust fund ratio” (TFR) in the next few years. The TFR is basically the ratio of assets in a trust fund to one year’s worth of benefits; in other words, a TFR of 100 means we could finance one year’s worth of benefits out of trust fund assets if incoming payroll tax revenue suddenly stopped. To meet the trustees’ test of financial adequacy, a fund’s TFR needs to reach 100 within five years and stay above that level.

Figure 4: Medicare HI's Trust Fund Ratio is Low and Falling

Not only does HI fail the trustees’ test of short-term financial adequacy, it is on shakier footing than projected in last year’s report. The current assets in the HI trust fund would finance less than nine months’ worth of benefit payments, and we project this ratio to decline in upcoming years. The main reason the depletion date hasn’t moved closer is because we slightly lowered our projections for general health care cost inflation over the decades ahead. But even as our medium-term assumptions are slightly more optimistic, our short-term reality is slightly worse than expected.

There is a substantial risk that costs will be higher than projected. Two laws passed in recent years – the Affordable Care Act (ACA) in 2010 and the Medicare Access and Chip Reauthorization Act (MACRA) in 2015 – each contain aggressive cost-containment measures with effects projected to compound in the future. We should hope that these measures prove successful and politically sustainable because without them projected Medicare costs would be much higher. Were they to be repealed or scaled back, they would need to be replaced by alternative measures generating as much or more savings. That said, both the ACA and MACRA reflect legislative gambits that have often proved unsuccessful in the past – specifically, increasing spending in the near term with the promise of cutting it later. Historically lawmakers have not always followed through with such promised spending reductions. In addition, the CMS Medicare Actuary has cautioned that both the ACA and MACRA would impose more aggressive payment reductions on various categories of health care providers than has proved politically sustainable in the past.

Because of these warnings, the trustees directed the CMS Medicare Actuary to produce an illustrative alternative projection scenario in which the ACA and MACRA payment constraints are assumed to be gradually phased out over time. In this illustrative alternative scenario, Medicare costs would rise from 3.5 percent of GDP today to 6.1 percent in 2040 and 9.1 percent in 2089. Under our primary projection, total program costs would be 5.6 percent of GDP in 2040 and 6.0 in 2089. Taken together, the trustees’ findings dramatize the need for reforms to slow Medicare cost growth and stabilize program finances.

 

Charles Blahous is a senior research fellow for the Mercatus Center, a research fellow for the Hoover Institution, a public trustee for Social Security and Medicare, and a contributor to e21.

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