Issue Brief

April 2002

Medicare Modernization   

Over and over in conversations about health policy or the federal budget, politicians and analysts say, “We need to modernize Medicare”—or “We need to reform Medicare.” What do they mean when they use those terms?

This is an important question because, depending on the speaker’s and listener’s points of view, it is easy for people to be talking at cross-purposes about this subject. For all practical purposes the terms “modernization” and “reform” can be used interchangeably to describe any set of policy proposals to change Medicare.   Since different audiences react differently to the two words, they are used for effect by skillful “spinmeisters”.

The important question is, what set of policy changes are people talking about when they say they want to modernize or reform Medicare? For example, to some reform is adding a new benefit while to others it means restructuring the program as in combining Parts A, B, and C into one or prioritizing as in Medicare+Choice.

The audiences for reform consist of different groups of people. These groups don’t fit into neat classifications that can be measured against each other to negotiate a compromise. Important groups in the Medicare debate include:

• The beneficiaries.

• The people from doctors and nurses to hospitals and drug companies who provide professional services and products to those beneficiaries.

• The taxpayers who must foot a large portion of the bill for Medicare services.

• The political decision-makers who may have very different views on what should be done based on their political party or philosophy.

• The intellectuals and analysts who continually try to exert pressure on the political process

• The health services researchers whose business it is to demonstrate the best way to change the system.

One can see why there is room for miscommunication with such a varying mix of actors all pushing and prodding at the same time.

Today’s Medicare  
The Medicare program today, while it has many internal complexities, is based on a very simple premise: Medicare is basically a defined benefit health insurance program for all people over the age of 65 who have paid taxes into the program at one time or another over their working lives. 

Today that amounts to more than 40 million people. Being based on a simple premise, however, does not ensure a simple program and Medicare is anything but simple. Over the 37 years since it was first enacted, events and changes in technology have provided many challenges to the program. Because both benefit and payment systems are established by law and regulation, the program has been filled with complexity and controversy for many years. And now, as the baby boomer generation begins to enter the ranks of the elderly, financial pressures on the program are extremely challenging.

In the current fiscal year it is estimated that Medicare will cost more than $220 billion. Further the Congressional Budget Office (CBO) projects that ten years from now in 2012, the program will cost more than $420 billion if current laws remain unchanged. That is a staggering number considering that it cost only $7 billion thirty years ago. Given these numbers, it is easy to see why so many people are interested in “modernizing Medicare.”

Problems in Medicare  
In addition to its cost pressures, there are a few other things that people complain about frequently and loudly with regard Medicare. Today Medicare pays only a little more than half of enrollees’ medical expenses because so many expenses are paid from other insurance, private funds, or other government programs. For these reasons, many people want to change Medicare to improve its benefit structure. Although almost all seniors like the program in general, they complain that the benefit package hasn’t kept up with changes in current health care practice and is not as good as many insurance packages that working people have. In particular, this complaint is heard most vociferously with regard to outpatient prescription drug coverage that is generally not provided under Medicare.

Providers complain about the level of reimbursement they receive from the program. These complaints move around the community of providers. Some years it is the hospitals that seem to have the most trouble with Medicare’s reimbursement formulas while other years it is the doctors and other professionals who have problems. This year has been particularly acute for doctors as the new physician payment formula adopted in the Balanced Budget Act of 1997 (BBA) has backfired in a big way and physicians are scheduled to take a 5.4% reduction in reimbursements. In fact, according to a March 17 article in The New York Times, for the first time ever “...significant numbers of doctors are refusing to take new Medicare patients, saying the government now pays them too little to cover the costs of caring for the elderly.”

Given the fact that some providers are now acting on their complaints in ways that could reduce access to care for seniors, it is likely that Congress will take action on this problem. Whether it moves forward on any other front remains to be seen.

Proposals for Medicare Reform  
Proposals to reform or modernize Medicare run the gamut from minor tinkering to a dismantling of the program as it exists today. All approaches to Medicare modernization involve either increasing the cost of the program to the taxpayer or increasing the cost to beneficiaries with the most likely outcome being a combination of both. For purposes of understanding, the discussion about various proposals it is useful to think of them as falling into three categories: defined benefit systems, defined contribution systems, or premium support systems.

1. Defined Benefit System  
A defined benefit system is one in which a beneficiary is entitled to a specific benefit regardless of how much he or she has contributed. Traditional Medicare is a good example of a defined benefit program in that it doesn’t matter whether you paid Medicare payroll taxes on $10,000 of income or $1,000,000 of income you still qualify for Medicare coverage if you are over 65 and become ill. And that coverage is defined in law and regulation and does not vary based on the amount you paid into the system. It is only natural that beneficiaries and their advocates want any Medicare modernization to continue the defined benefit program. According to Max Richtman, Executive Vice President of the National Committee to Preserve Social Security and Medicare, they want any reform package to “...ensure seniors continued access to a defined benefit package, reasonable premiums and out of pocket expenses, and access to the physician of their choice.” These people are very sensitive to cost and argue that they already pay too much out of pocket expense because of their greater needs for health care and Medicare’s lack of coverage for many services especially outpatient prescription drugs.

 2. Defined Contribution System  
A defined contribution system is one in which a benefit will vary depending on the value of a contribution. In this structure a contribution level is set but the benefit will vary depending on how high the contribution is and how much of it is used. Under this structure a person could run out of benefits if the entire amount of his or her contribution was depleted.

Examples of this type of system include IRA’s and 401(k) retirement systems or Medical Savings Accounts. The amount of the benefit varies based on how much money was accumulated from the contributions and when the money is gone the benefit ends.

Proponents for a defined contribution system for Medicare would eliminate the current Medicare and Medicare + Choice programs altogether. In their place they would create a system in which the federal government would provide a set dollar amount or voucher for each senior to use to buy insurance and if the insurance doesn’t cover the cost of services, the beneficiary would be at risk for the remaining costs. The people who want this type of system argue that seniors would “shop around” and become more efficient users of medical services, thereby reducing the cost of the entire system. They also argue that it would greatly reduce the exposure of the taxpayer to price shocks and surprises and create more predictability for the federal budget. On the other hand, depending on the level set for the vouchers, it could greatly increase costs to many seniors and it puts all seniors at greater financial risk.

  3. Premium Support System  
This proposal is an intermediate option between the current system and a pure defined contribution approach. In this system the government and seniors would share in the risks of increased costs. It would not produce as much savings for the government as a defined contribution approach but it would be a less draconian change for beneficiaries.

The idea is that seniors would be able to participate in a variety of health insurance plans and their premiums would vary depending on the insurance package they chose. Under these proposals the government would pay a share of the insurance cost depending on some measure such as median cost. The beneficiary would pay a premium similar to the current Medicare Part B premiums most people pay now. The difference would be that the premium would vary depending on the coverage chosen by the beneficiary.

Advocates of this approach envision that it would function like the current system used for federal employees—Federal Employees Health Benefit Plan (FEHBP)—in which employees choose from a variety of plans and pay varying premiums depending on which plan they choose. In the FEHBP system there is one open season every year in which plan offerings can be altered and premiums changed. During open season employees are notified of the next year’s changes and they can choose to remain in their current plan or move to a competing plan. The government requires a “basic level of coverage” in all plans and it makes a basic contribution but beyond that the plans may vary and employees choose and pay accordingly.

The people who support using this approach for Medicare believe it would make seniors more careful consumers, insurers more eager to improve their benefits so they can compete, and ultimately result in lower costs as the entire system becomes more efficient. But, the main reason many support it is because they believe it will result in lower costs to the government. Until a few years ago their arguments were gaining strength because FEHBP’s cost growth was slower than Medicare’s but recently, FEHBP costs have grown at a higher rate than Medicare and now this argument has become a little muddled.

Arguments for Change  
There is almost universal agreement that the basic Medicare benefit package is too limited and needs to be updated to include prescription drugs and various preventive practices. There is also almost universal agreement that the program is becoming so expensive it will need more funds than are now available and may soon crowd out many other valuable federal programs. Given these two contradictory concerns how should the program be changed.

In today’s political climate there is very little support for a defined contribution program for this population. Therefore, most of the debate concerns changing the program from a defined benefit program to a premium support program or improving the defined benefit program but not changing its basic structure.

Generally speaking, seniors, their advocates, and many democrats favor keeping the program as a defined benefit program and updating its benefit package by adding an outpatient prescription drug benefit. Although these people recognize that you would have to add more government money to enhance the benefit package, they argue that doing this will provide better overall health care for seniors and the total cost of the system will go down. They argue that the Medicare entitlement represents a sacred pact between seniors and the federal government that was entered into 35 years ago. They believe if you restructure the program in a way that takes away the defined benefit you break that pact and undermine public support for the whole endeavor.

Opponents of the current structure argue that this will only make the program more costly and eventually it will go broke or drive everything else out of the budget because the taxpayer will not be able to sustain it. Generally speaking, political conservatives and most republicans argue for a premium support system similar to the FEHBP. These people believe that the Medicare insurance program for seniors is now too rigid because the government runs it. They believe restructuring the program into a program similar to the FEHBP will result in a more nimble system. They argue the benefit packages in such a system would automatically keep up with the times because of the insurers’ need to compete for enrollees. They also maintain the government will be able to control and predict costs better because it will only be paying a portion of the premiums not the cost of the service. Further they believe that if seniors shop around among these various packages the system will become more economically efficient and consequently cheaper.

Opponents of this change argue it breaks the trust between the government and seniors who have paid into the system most of their working lives. They also argue that Medicare + Choice, which was supposed to accomplish some of these objectives, has not worked very well and this type of change may not work with this population.

Conclusion
There is much debate about Medicare in the policy community but unfortunately most of it is focused on cost. Although the cost pressures in the program are enormous, it is not clear that focusing on them is going to lead to a good solution. The simple truth of the matter is that health care is expensive for everybody and it is particularly expensive for the elderly. It is the job of Congress to debate and decide just how much of the government’s resources they are willing to commit to this problem. It may be that the chances for success in managing costs and providing needed care would improve if the experts and policy makers who decide the nature of the program would start to focus on paying for quality. There is considerable evidence that higher quality health care is cheaper in thelong run and taking a quality approach to Medicare financing and management might hold the greatest promise in the long run. At the very least, it is worth a try.

Sources:
"Restructuring Medicare: Impacts on Beneficiaries" by Marilyn Moon, UrbanInstitute, Washington, DC, January 1999.

AEI Articles "Medicare, Social Security Overcrowding the Federal Budget",Norman J. Ornstein, American Enterprise Institute for Public Policy Research, Washington, DC, July 1999.

AEI Articles "A Look at...The New Retirement: Getting Old Ain’t What It Used to Be", Douglas J. Besharov and Keith W. Smith, American Enterprise Institute for Public Policy Research, Washington, DC, August 1999.

Testimony on Medicare Reform before Ways and Means Subcommittee on Health, United States House of Representatives, Washington DC, March 15, 2001.

"Overhauling Medicare: What It Will Take to Attract Private Providers", James Frogue, Richard Smith, Alissa Fox, Janet Stokes Trautwein, and Victoria Craig Bunce, Heritage Foundation Lecture, March 2001.

Testimony on Medicare Reform, Committee on the Budget, United States House of Representatives, July 25, 2001.

"Medicare: New Road?", Patricia Barry, AARP Bulletin ONLINE, October 2001.

Testimony on Medicare+Choice Program, Ways and Means Subcommittee on Health, United States House of Representatives, Washington DC, December 4, 2001.

Testimony on Medicare Payment Policy, Subcommittee on Health, Committee on Energy and Commerce, United States House of Representatives, February 14, 2002.

"Many Doctors Say They Are Refusing Medicare Patients", Robert Pear, New York Times, March 17, 2002.

Testimony on Medicare Modernization: Examining the Federal Employees Health Benefit Program as a Model for Seniors, Subcommittee on Health, Committee on Energy and Commerce, United States House of Representatives, March 20, 2002.

"A Comparison of the Senate and House Budget Plans", Richard Kogan and Robert Greenstein, Center on Budget and Policy Priorities, Washington, DC, March 2002.

"Costs of a Medicare Prescription Drug Benefit: A Comparison of Alternatives",  D.P. Goldman, G.F. Malkin, J. Malkin, Rand Health, The Rand Corporation, 2002.

NOTE: This Issue Brief was written by Eileen Baumgartner, NIHP Senior Researcher and former Democratic Staff Director of the House Budget Committee.