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A Guide to the 2013 Medicare Trustees Report

Charles Blahous | 06/11/2013

[This is the second of two articles summarizing the findings of the 2013 Social Security and Medicare trustees’ reports. See part 1 here.]

As one of the programs’ two public trustees it has become my custom to publish such summaries soon after the annual publication of the reports. The first this year summarized the Social Security report, whereas this one will summarize the Medicare report. Following are some of the report’s key points:

The trustees’ projection for the depletion date of the Medicare Hospital Insurance (HI) Trust Fund is but one part of a much larger mosaic of Medicare finances. There is a tendency in press reporting to focus unduly on the trustees’ annual projection for the date of depletion of the Medicare HI trust fund. But Medicare is a large and complex program with different trust funds financed in different ways.

Medicare’s HI trust fund, which finances hospital, home health following hospital stays, skilled nursing facility and hospice care services, is only one piece of a larger Medicare program and indeed represents less than half of total program costs. Like Social Security, Medicare HI is financed primarily by a tax on worker wages and can theoretically become insolvent if its obligations exceed its financial resources. But Medicare’s Supplementary Medical Insurance (SMI) trust fund has even greater expenditures and includes Medicare Parts B (physician, outpatient hospital, and general home health services) and D (prescription drug coverage). SMI has no projected depletion date because by statutory construction it is automatically provided with whatever general fund revenues it needs (beyond tax and premium income) to remain solvent. Thus financial strains in SMI are manifested not in projected insolvency but as rising pressure on the general federal budget.

Click on Graph for underlying data.

In 2012, HI expenditures totaled roughly $267 billion and SMI expenditures $307 billion. In the future this gap is projected to widen, with SMI becoming a relatively larger share of total Medicare expenditures. So while the projected duration of solvency of the HI trust fund is certainly an important piece of information, it does not speak to the substantial majority of Medicare operations.

The trustees have issued a Medicare “funding warning” for a seventh straight year. Because of the general budget implications of rising Medicare costs, the trustees are required to report whenever there is “excess general revenue Medicare funding,” defined as whenever the difference between total costs and dedicated (mostly tax and premium) revenues exceeds 45 percent of total program costs. This year we found such an excess again in 2013 and issued our seventh consecutive Medicare funding warning.

As with Social Security, the principal driver of Medicare cost growth for the next two decades is its rising number of beneficiaries. There is also a tendency for public discussions of Medicare’s financing problems to focus on general health care cost inflation. But a far more important factor in the near term is the sheer number of beneficiaries coming onto the Medicare rolls as the baby boomers head into retirement. Under current law the swelling beneficiary population will cause Medicare expenditures to rise dramatically through the mid-2030s. Only after then does general health cost inflation become the relatively more important factor. Overall, the principal driver of most projected Medicare cost growth relative to GDP is demographic.

This is visible on the following graph from the summary of the trustees’ reports showing projected costs in both programs relative to GDP. The growth rate for total Medicare (HI + SMI) is slightly higher than for Social Security (OASI + DI) because Medicare is also affected by health cost inflation. In both programs the biggest factor is the pre-2035 surge in baby boomer beneficiaries. Accordingly, we will not get a handle on rising Medicare costs unless we are willing to address the growth in the number of beneficiaries drawing benefits from it. My companion piece on the Social Security report details how we have failed to adequately adjust these programs for the demographic realities of changing fertility patterns and rising longevity.

Click on Graph for underlying data.

Medicare costs are nearly certain to be higher than our current projections. Like other federal scorekeepers, the trustees are required to project program operations under current law regardless of whether most people assume that current law will be sustained. This is particularly important with respect to Medicare projections because current law specifies that physician payments will be cut by nearly 25 percent in early 2014 under the statutory Sustainable Growth Rate (SGR) formula. Lawmakers have overridden similar payment reductions in every year since 2003 and are widely expected to do so again.

If lawmakers continue to override the SGR physician payment formula, total Medicare costs will be substantially higher than what we now project – in the long run, more than 10% higher. The Medicare trustees’ report presents an illustrative alternative scenario that assumes a continuation of the historical pattern of SGR overrides; under this alternative scenario total Medicare costs will be 7.2% of GDP in 2087 as opposed to 6.5% under current law.

We also show an another alternative scenario in which, in addition to an SGR override, certain controversial elements of the 2010 Affordable Care Act (ACA) are either scaled back from 2020-2034 (e.g., the ACA’s aggressive annual reductions in most categories of provider payments) or eliminated altogether (e.g., implementation of the cost reduction recommendations of the ACA’s Independent Payment Advisory Board). There is great disagreement among analysts as to whether these features of the ACA will prove sustainable over the long term. We as trustees take no position on that controversy but we do estimate the financial consequences of their being overridden. In this second alternative scenario total Medicare costs climb to 9.8% of GDP by 2087.

Small changes in the projected HI depletion date are not statistically significant. Some reporting has overstated the financial improvement represented by the slight postponement in the projected date of HI trust fund depletion from 2024 in last year’s report to 2026 in this year’s. HI finances are basically balanced on a knife’s edge and even a slight change in cost growth assumptions can cause the projected depletion date to move by a few years.

At the start of this year HI’s “trust fund ratio” was 81, which means that there were only enough reserves in the trust fund to finance 0.81 years’ worth of benefit payments. HI finances over the next several years depend enormously on whether annual income will balance outgoing benefit expenditures almost exactly. Under our current projections HI’s trust fund ratio will hover at low levels throughout the next decade, declining steadily until depletion in 2026. In the accompanying graph I show how if our projected HI cost growth rates are understated just a little bit, its trust fund’s projected depletion date would move closer. If our projections are low by just half a percentage point per year, the HI fund would be depleted in 2024. If we’re low by one point per year, depletion would occur in 2022. Accordingly, no one should interpret small changes in the HI depletion date as signifying a substantial change in the Medicare financing outlook.

There is no reason to believe that the recent reported slowdown in health care cost growth will improve the long-term picture significantly relative to current projections. At our press conference announcing the release of the trustees’ report, I was surprised to hear questions asking in effect whether a recent slowdown in health care cost growth might have a significant effect on the outlook and debate surrounding the Medicare program. To my ear the questions reflected an incomplete understanding of the factors underlying current projections. It would be mistaken to conclude that the recent slowdown in health care cost growth (partially though not wholly attributable to the recent recession) should relax pressure for much-needed Medicare reforms.

It’s important to understand that our long-term projections already assumed a substantial slowdown in health care cost growth relative to historical rates. This is because the projections are based on demonstrated trends in the elasticity of health care cost growth – in layman’s terms, how much people’s health care consumption patterns change as a result of factors that include health care prices, income levels, and insurance coverage. To put it more crudely, we have never expected that historical rates of health care cost growth will continue to the point where health care services absorb our entire economy. We are not going to have a society in which we are all walking around homeless, naked and starving but with impeccable health care.

Thus even before the 2010 passage of the ACA, we were assuming that health care cost growth would eventually slow down. Adding the ACA’s aggressive Medicare cost restraints to that assumption means that we are in effect assuming over the long term that Medicare expenses will actually grow more slowly per capita than our general economy. This assumption is one reason why many have questioned whether the ACA’s cost restraints will be sustainable over the long term. At the very most, one might argue that the recent slowdown in health care costs renders current projections slightly more plausible, but no one should be assuming that things are going to look much better.

Summary: In sum, Medicare like Social Security faces substantial financing challenges and warrants significant legislative reforms. Whereas in Social Security the financing strains are manifested in projections of trust fund depletion, in Medicare some financing strains are manifested primarily in rising projected pressure on the general federal budget. As with Social Security, Medicare is being strained by the growing numbers of baby boomers moving onto its benefit rolls. Overall, Medicare financial projections are subject to greater uncertainty than Social Security’s due to the difficulty of projecting health cost inflation. For a variety of reasons including expected legislative actions, actual Medicare costs are likely to be higher than currently projected.

Charles Blahous is a research fellow with the Hoover Institution, a senior research fellow with the Mercatus Center, and the author of Social Security: The Unfinished Work.