Medicare

When Medicare was established in 1965, many of its supporters believed that insuring persons age sixty-five and over was a precursor to a national system of health insurance. The Medicare program was thought to be just the first piece of legislation towards this end. But instead, Medicare has become the largest public program of health insurance, and universal health insurance is a reality only for older adults and some persons with disabilities.

Although in many ways Medicare has been one of the most successful public programs of the federal government, it has also faced criticism as a result of its rapid expansion. At $222 billion in spending in 2000, it represents about 12 percent of the federal budget. Since the 1980s, it has been a frequent target of efforts to reduce federal spending. Major legislation enacted in 1997 as part of the Balanced Budget Act set in motion the most recent set of changes aimed at slowing the growth of the program. (Legislation enacted in 1998 and 1999 mitigated some of these changes, however.) The implications of an aging society, moreover, are that Medicare will continue to come under scrutiny, and perhaps face major changes in the future.

A brief history and overview

The issue of national health insurance was debated periodically in the United States after World War II. Gradually, the focus shifted to a strategy to begin with older persons. President John F. Kennedy made this one of his major campaign issues in 1960. But it was not until 1965, during a period of considerable social activism, that the legislation was finally passed. Persons over the age of sixty-five were singled out because they had higher rates of poverty and lower rates of insurance than other groups. As a social insurance program, the goals of Medicare have been to provide equal access to care for those who are eligible, supported by taxpayers (who will later become beneficiaries). By most accounts, it has been extremely successful.

Initially, everyone over the age of sixty-five in 1965 was eligible to participate in Medicare when it began in July of 1966. After that, eligibility was limited to persons over the age of sixty-five who qualified for some type of Social Security benefit, usually as a worker or dependent. This still captures about 98 percent of all persons age sixty-five and older. In 1972, the program's scope was expanded to include persons who receive Social Security Disability Insurance, following a two-year waiting period. In addition, persons with end-stage renal disease—who face costly kidney dialysis treatments— were also added to the program. Over 39 million persons, nearly one in every eight Americans, were enrolled in Medicare in 2000, up from 19 million in 1966.

The benefits covered by Medicare have been altered little since 1965, although changes in the way care is delivered in the United States have affected the size of the various components of the benefit package. Part A of Medicare, also called Hospital Insurance, covers inpatient hospital services, up to one hundred days of care in a skilled nursing facility following a hospital stay, and hospice care. Part B of Medicare, referred to as Supplementary Medical Insurance, covers physician services, outpatient hospital care, laboratory testing, and ambulatory services. Home health care services—skilled care such as rehabilitation services provided to persons who are homebound— have been subject to a number of changes in recent years; presently these services are divided between the two parts of the program.

Part A of Medicare is financed by a payroll tax of 1.45 percent of all wages assessed on both employers and employees (when the program began, that tax rate was 0.35 percent, and has gradually increased over time). The rate of the tax has not changed since 1986, although the amount subject to tax has risen. In 1993, the upper limit on the tax was eliminated so that all wages are subject to the Medicare payroll tax. Part B is voluntary and financed by premiums on beneficiaries and by general revenues sufficient to make up the level of spending required. The premium initially paid 50 percent of the costs of Part B, but legislation reduced this share beginning in 1972 because Medicare's costs were growing substantially faster than incomes of beneficiaries. It was set at 25 percent of the costs of a beneficiary's benefits on a temporary basis starting in 1982, and it became a permanent requirement in 1997.

When Medicare began, it was dominated by inpatient hospital care, which accounted for about two-thirds of all spending. Indeed, most of the focus of debate before Medicare's passage was on Part A of the program. But as care has moved out of the inpatient setting, Part B has become a much larger share of the program. Care in hospital outpatient departments and in physicians' offices now replaces many surgeries and treatments formerly done only in inpatient settings. In addition, skilled nursing facility care and home health—referred to as post-acute care—have also increased in importance over time. When individuals leave a hospital after only a few days, post-acute care is often needed as a transition. But these benefits have also come under increased scrutiny for moving Medicare into the domain of long-term care services.

Another original principle of the program was that it would not interfere with the practice of medicine. Payments were designed to be as much like the standard insurance policies then in place as possible. But costs for the program rose rapidly almost from the beginning, and in the mid-1970s it became clear that the government needed to slow spending growth. This was done largely through application of new payment policies. Traditional Medicare has remained a fee-for-service program in which beneficiaries are free to see any hospitals or doctors they wish.

Changes in payment policies

Medicare is first and foremost an insurer for elderly and disabled persons, setting rates of payment and contracting with private firms to process and pay claims. Originally, Medicare approved payments with little oversight of charges that providers of care submitted. However, restrictions soon began to be added, and by the mid-1980s, most of the payment systems for various Medicare-covered services had been modified. The most recent broad changes were contained in the 1997 Balanced Budget Act (BBA), which placed a particular emphasis on the post-acute care area. New ways of paying for care, as well as lower rates of payment were legislated, although implementation has taken considerably longer than expected.

These changes were built on similar reforms that date to the 1980s, when new payment systems for hospitals and physicians were developed. Medicare served as a leader with these reforms, fundamentally changing the way that hospitals and doctors are paid. The hospital payment system for Medicare now pays a flat rate to a hospital, based on the patient's diagnosis. While hospitals with varying characteristics may be paid somewhat different rates, this was a major move away from a system in which the costs reported by the hospital were simply reimbursed by Medicare. This new system has encouraged hospitals to be more efficient, although it has also resulted in some premature discharges. Over time, however, this payment system has been judged to be relatively successful. It has helped to encourage movement away from long inpatient stays and to more care being delivered outside of hospitals. Medicare has been credited with contributing to an array of changes that affect the health care system in general.

Physician payment changes in Medicare sought to rebalance the level of payments between primary-care physicians and specialists. Payments for procedures by specialists have been reduced relative to office visits to primary-care physicians, for example, in order to elevate the importance of basic care. Again, this has been relatively successful, although the level of payments is often criticized by physicians. Many other health care insurers now use Medicare's resource-based relative value scale (RBRUS). Both hospital and physician payments require periodic updating, and Medicare is sometimes criticized for falling behind in making adjustments in response to new procedures, but the program has been a major player affecting the delivery of care.

It remains to be seen whether the payment changes in post-acute care and hospital outpatient services will be as successful. Again, the goal has been to move away from a cost-based system and toward one that will provide incentives for "appropriate" levels of care. It has taken much longer than anticipated to develop these new payment systems, however, because there is much less consensus about the amount of care needed in particular circumstances. Not surprisingly, efforts to implement these new systems have been controversial.

Consider the case of home health care—how many home health visits should someone who has had hip replacement surgery need? Little careful research has been done to help address such issues, and without standards or norms of care it is difficult to devise a fair system. However, spending on Medicare's home-health benefit grew from $3.3 billion in 1990 to $19.6 billion in 1997, so it is not surprising that it became a target for change. This included an effort to introduce a new payment system in stages and to demand greater accountability from agencies to reduce fraud and abuse. As a consequence, home health care spending actually declined in the late 1990s. Unfortunately, just as policy in 1997 was not developed with a full understanding of its ultimate consequences, changes in the new payment system are also likely to be undertaken with little guidance.

Other Medicare policies affecting health care delivery

In addition to the influence of Medicare's payment systems, the program has had other important effects on the delivery of health care. One of the most significant of these was the requirement that hospitals treating Medicare patients must treat all those eligible, leading to the desegregation in the 1960s of many hospitals that had formerly excluded black Americans. Medicare has also been a leader in the development of data systems that have allowed research into various issues, such as how care is delivered in different parts of the country, and the creation of various quality measurements. Medicare decisions about coverage of certain procedures are often used by private insurers for their decision-making processes as well. Finally, included in Medicare's payments to hospitals are subsidies for hospitals that provide medical education and for those that treat a disproportionate share of low-income individuals. Unlike many other payers of health care, Medicare contributes not just to the costs for its own beneficiaries, but for other activities that benefit all Americans.

Private plans serving Medicare beneficiaries

Beneficiaries have another option under the Medicare program: they can choose to enroll in a participating private plan and agree to get all of their Medicare-covered services from that plan. This plan—usually a health maintenance organization (HMO)—agrees to provide care to Medicare beneficiaries in a given geographical area for a fixed monthly payment. When this HMO option was established in 1983, it was intended to save money for Medicare by paying plans at a rate of 95 percent of the costs of average enrollees. The new Part C of Medicare, called Medicare+Choice, established by the BBA renamed and modified the managed-care option. The intent of this change was to move Medicare further away from its traditional role as insurer and expand its role as a purchaser of private insurance. Additional types of plans, such as private fee-for-service plans and physician- or hospital-led insurance, are now also allowed to participate in Medicare+Choice, although so far only a few such plans have been offered to Medicare beneficiaries.

Initially, when the HMO option began, private plans attracted only a very small share of Medicare beneficiaries, because HMOs require beneficiaries to use only plan-approved doctors and hospitals as a condition of coverage. Medicare has lagged behind the rest of the health care system in part because beneficiaries can choose to remain in traditional fee-for-service Medicare and use services at will with no penalties attached. To be more competitive with fee-for-service, many HMOs offer beneficiaries services in addition to those covered by Medicare, such as prescription drug coverage—a strategy that became more successful as the cost of supplemental insurance elsewhere in the system rose rapidly. Many of the HMOs offering further benefits do so in those parts of the country where Medicare's monthly contribution to HMOs is high. Plans are able to offer more benefits in part because beneficiaries agree to abide by a stricter set of rules for participation, such as using only doctors, hospitals, and other health care providers who are on a prescribed list. In exchange, beneficiaries usually face lower cost-sharing requirements, and they sometimes have access to benefits such as prescription drug coverage or dental care.

Most studies of the private-plan option have suggested that payments are more generous than what it actually costs to provide services, so that Medicare's monthly payments to plans effectively subsidize additional benefits for those in private plans—and the option therefore fails to save money for the government. Changes made under the BBA were intended to reduce these overpayments, but these changes have been controversial and have contributed to a number of plans withdrawing from the Medicare+Choice system. BBA clearly did not accelerate the move to more private coverage of Medicare beneficiaries. Some of the BBA changes were modified in 1999, but HMOs remain critical of the severity of the BBA cutbacks. Although plans may still be overpaid, both HMOs and their enrollees argue that they should not be subject to slower rates of growth in payments over time, as this restricts their ability to continue offering extra benefits. On the other hand, beneficiaries in fee-for-service Medicare do not receive subsidies for extra benefits, and higher payments to HMOs may increase the gap in funding levels between these two sources.

In early 2001, about 5.6 million beneficiaries participated in Medicare+Choice plans. While still representing only about 14 percent of all beneficiaries, this portion of Medicare has grown rapidly since the early 1990s, though growth slowed between 1998 and 2001. The viability of the Medicare+Choice plan remains one of the most important problems facing Medicare, and also raises concerns about some of the broader reform options now under consideration.

Costs to beneficiaries

Although Part B of Medicare is voluntary, because the premium required represents only 25 percent of the costs of the benefit, most who are eligible choose to enroll. In addition to the Part B premium, Medicare beneficiaries are required to pay an array of cost-sharing charges. That is, beneficiaries must pay for a share of much of the care they receive, either in up-front costs (deductibles) or each time they visit physicians (coinsurance). Both Parts A and B have a deductible, and most of the services are subject to some type of co-insurance. The Part A deductible ($776 in 2000) is particularly high. This requires cost-sharing, and the required exclusion of some benefits (such as prescription drugs) from coverage have resulted in a less comprehensive benefit package than what is available to many younger families. Consequently, a market for supplemental insurance has arisen, either supported by employers as part of a retirement package or purchased specifically by beneficiaries (and referred to as Medigap).

Persons covered by employer-subsidized retiree benefits have the best coverage. The extra coverage is usually quite comprehensive, and any premiums that retirees must pay are usually subsidized. This coverage usually fills in most of Medicare's required cost-sharing, as well as benefits such as prescription drugs. In contrast, Medigap plans are expensive and carry high administrative costs. Those who enroll in these plans get some protection from unusually high expenses, but also face substantially higher financial burdens from the premiums. Regulations on the Medigap market place controls on what can be offered but not on the costs of plans. These costs tend to be very high for the oldest beneficiaries and often are not available to beneficiaries under age sixty-five.

As noted above, beneficiaries also can obtain additional benefits to supplement Medicare's basic package by enrolling in Medicare+Choice. Cost sharing is lower, and some additional benefits are usually offered for less than the price of a Medigap plan. But these plans have also become more expensive and less comprehensive over time.

Gaps in coverage for low-income beneficiaries are made up through Medicaid, a joint federal/state program to which most Medicare beneficiaries can qualify if their financial resources are low enough. In addition, legislation enacted in 1988 established the Qualified Medicare Beneficiary Program, which allows Medicaid to further fill in the gaps. Later additions include the Specified Low-Income Medicare Beneficiary Program and the Qualified Individual Program. These programs help to fill in Medicare's cost-sharing or premium requirements for low-income persons who do not qualify for full Medicaid benefits, and each is targeted to a different income group. However, participation rates remain a problem, reducing the effectiveness of these programs. As a consequence, the comprehensiveness of coverage for older Americans and eligible disabled persons varies considerably via this complicated environment of patchwork supplemental benefits.

One important result of the absence of a comprehensive Medicare benefit is the financial burden that beneficiaries face in paying for their own care. When the premiums that they pay for Part B and supplemental insurance are added to the direct expenses for care not covered by any insurance, older Americans devote over 20 percent of their incomes to health care on average. This does not include the costs of long-term care for persons in institutions. Those enrolled in the Medicare+Choice program face smaller but not insignificant burdens. In 1965, when Medicare was instituted, the share of income that individuals paid for their care was about 19 percent. Medicare reduced that share, but it has gradually risen over time as the costs of health care have gone up faster than the incomes of older Americans. Even without further requirements on beneficiaries to pay more for their care, that share will likely rise over time as health costs continue to outpace retirement incomes.

The future of Medicare

The future of Medicare has become a controversial political issue, mainly because it is a large and popular public program that faces projections of rapid growth in the future. As a government program, either new revenues will have to be added to support Medicare, or its growth will have to be curtailed. Much of the problem is driven by the expected increase in the number of persons eligible for Medicare—from 39 million in 2000 to 78 million in 2030—as the baby-boom generation becomes eligible for benefits. While the numbers covered by Medicare have already doubled since 1966, this is likely to be a more significant change because the share of the population eligible for Medicare will also grow from one in every eight Americans to more than one in every five.

One option for savings often discussed is an increase in the age of eligibility, although this would have only a small impact on the numbers eligible if the age were to rise from sixty-five to sixty-seven, for example. About 5 percent of beneficiaries are in this age range, but they are considerably less costly to insure than the average Medicare beneficiary. Nonetheless, this option is likely to be seriously debated as one means for reducing Medicare's costs. Another approach is to limit eligibility to persons with low or moderate incomes, changing dramatically the nature of a program that has always been very inclusive. As yet there seems to be little political support for this latter option, although proposals to ask higher income beneficiaries to bear a greater share of Medicare's costs (e.g., through an income-related premium) is more often discussed. One of Medicare's strengths is its universality and resulting broad-based taxpayer acceptance, and making high-income persons ineligible could undermine that support.

Most of the political discussion in the late 1990s and early in this century continues to focus on ways to make the program more efficient, but there is little agreement on how to do this. The two major strains of debate center on whether extensive restructuring (relying on the private sector to achieve efficiencies) is necessary, or whether more incremental changes within the current program would be sufficient. The Medicare+Choice program, for example, was enacted in an effort to rely more upon the private sector to find ways to hold down the rate of spending growth. Supporters of using the private sector to foster competition among plans serving the Medicare population would put private plans center stage, with the traditional program offered as just one of many options. This approach has been termed premium support and would require that beneficiaries wishing to stay in the traditional plan or choose expensive options pay higher premiums to do so. An even more dramatic restructuring proposal would simply give those who are eligible the resources to buy private plans with very little oversight. Supporters of these approaches promote the likelihood of greater efficiency from relying on private plans as compared to the government. Thus, savings would likely come both from charging some beneficiaries more and from any benefits of competition.

On the other hand, a substantial slowdown in growth in 1998 and 1999 was achieved for Medicare using traditional methods of limiting payments and reforming the payment structure for benefits, lending support to those who would prefer to retain the current structure with its emphasis on a public program. Reforms would still be needed, but might instead concentrate on improving the Medicare+Choice payment mechanism and adding more active management to the fee-for-service piece of Medicare. Key issues in the debate between these approaches center on which will retain the highest quality of care and the greatest protections for the beneficiaries of the program.

Regardless of whether structural or incremental approaches to change are adopted, it is unlikely that the program can be maintained in its current form without more revenues. A further complicating policy issue arises over the comprehensiveness of the benefit package. It is difficult to imagine achieving greater efficiency in the delivery of health care if major pieces of that care, such as prescription drugs, are not included in the basic benefit package. Both sides of the debate generally agree that improvements in the benefit package should be made, but this adds to the complexity of any solution because new benefits inevitably mean higher costs, putting further pressure on the need for new revenues and/or reforms in the current system. The contentious debate on the prescription drug issue in 2000 and 2001 is illustrative of the difficulty in finding common ground for reforms.

Finally, another issue that may add to the costs of the Medicare program over time is reform of the protections for low-income beneficiaries. Low participation and state reluctance to improve upon these protections suggest that they might better be moved out of Medicaid and into Medicare, but again this would raise costs for the Medicare program.

The future of Medicare will inevitably bring changes: some will come from explicit policy and legislative initiatives, but others will reflect the rapidly changing nature of the health care system as a whole. Medicare cannot be understood or administered without an appreciation for its interrelationships with the American health care system, and an aging society will inevitably put pressures on the program that will require new approaches and new funding.