March 2005

Time for Change? The Outlook for Medicare and Social Security

Opening Address

Mark McClellan
Centers for Medicare and Medicaid Services

With major efforts underway to make Medicare and Social Security financially sustainable, today’s review of the Trustees Reports is appropriate and important. The trustees report a slightly improved outlook for Medicare, largely due to lower projected costs for Parts A (hospital insurance, or HI) and D (the prescription drug benefit). Costs for Part B (supplemental medical insurance, or SMI), on the other hand, are higher in the most recent projections even though physician payment increases were held this year to 1.5 percent and other areas have been cut. Since three-quarters of Parts B and D are funded by general revenues, higher spending for outpatient care imposes serious pressures on the overall federal budget.

Medicare’s unfunded liability over the next seventy-five years is about $30 trillion, a deficit driven by increased enrollment, rising prices, and greater utilization of innovative medical services. Small changes, however, can have big impacts on program finances. For instance, a 1-percent decrease in the rate of Part A spending growth would cut two-thirds of Part A’s actuarial deficit.

Until recently, Medicare’s benefits were out of date, and its focus was on health problems after they occurred. Ninety-five percent of the program’s health care dollars were spent on treatment, and only 5 percent on prevention. While the Medicare Modernization Act of 2003 (MMA) has received the most credit for adding a prescription drug benefit to the program, it has also broken ground in shifting the program’s focus toward preventive care. Cardiovascular and diabetes screenings are now free for Medicare patients, and new beneficiaries receive a “welcome to Medicare” physical upon enrollment. Engaging patients in their care promises to deliver both better outcomes and lower costs.

Another great innovation of MMA is the administration of the prescription drug benefit through private plans and the revitalization of the Medicare Advantage program (MA), which also delivers Medicare benefits through private plans. Competition is the most effective way to achieve higher quality and lower cost care. Actuarial analyses estimate that total spending on prescription drugs for seniors will not change when the benefit begins. Seniors’ utilization of medicines will increase dramatically, but the average prices they pay will fall, and this will be achieved in a way that continues to encourage medical innovation. Moreover, various studies confirm that government negotiation or explicit controls cannot yield greater savings.

Expanded benefits for Medicare enrollees must be coupled with better coordination and more efficient use. Enhanced MA plans are a core part of CMS’s drive for more efficient, higher quality care, especially for chronically ill beneficiaries. The average senior who enrolls in a MA plan stands to save $100 each month in out-of-pocket costs, relative to traditional Medicare. Seniors in fair to poor health could save much more from better management of their care.

CMS has received applications from more than 125 potential MA plans, fifty of which are completely new to Medicare. In 2005, forty-seven states and over 90 percent of beneficiaries will be served by MA plans. Three-quarters of seniors living in rural areas will have access to them. This is the broadest participation of private health plans in Medicare’s history.

Medicare’s modernization has not been limited to updated benefits. Reforms underway are also introducing a business pace to the program. Physicians with innovative approaches to delivering care have long been frustrated by Medicare’s payment system, which simply rewards more visits, procedures, hospitalizations, and tests. Moving toward a “pay for performance” system (P4P) will begin to tie Medicare reimbursement to quality of care and patient satisfaction. For instance, the Medicare Health Support pilot program enrolls chronically ill patients and pays physicians based on clinical outcomes, patient satisfaction, and overall costs. As a result of a payment incentive, CMS will next week begin to report ten quality of care measures for almost 99 percent of hospitals. The agency expects to expand this effort to additional measures and providers in the future. 

P4P systems encourage greater use of health information technology (IT), preventive care, and other measures that improve the efficiency and quality of health care. Beyond adopting P4P standards, CMS has committed extra support to small, rural, and other needy providers to facilitate their adoption of this new payment model.

The trustees report that more than 45 percent of Medicare funding could come from general revenues in just eight years, which would trigger a warning to Congress and the administration as soon as next year. Modernized benefits are critical to achieving financial sustainability. This is a historic opportunity to update Medicare’s benefits, make smarter use of our Medicare dollars, and ensure the program’s solvency.

AEI research assistant Ximena Pinell prepared this summary.

Keynote Address

Mark W. Warshawsky
Treasury Department

As evidenced by this conference, the Trustees Reports receive a great deal of attention and are very influential. Several factors contribute to their credibility and impartiality, including the oversight of two public trustees (two members from the private sector), periodic external review of the methods and assumptions underlying the projections, the actuaries’ opinions at the end of the reports, and the annual evaluation of the reports’ presentation and substance.   

Social Security’s current funding gap is often measured by the seventy-five-year shortfall, which is estimated at $4.3 trillion or 1.92 percent of taxable payroll. This estimate does not fully capture the financial status of the Social Security program because people pay taxes in advance of receiving benefits. No finite forecast period, then, can completely represent the financial outlook of the program. For example, the current seventy-five-year projections include almost all of the 2010 birth cohort’s taxes, but little of their benefits.

To understand Social Security’s permanent financial problem, income and costs must be calculated for the indefinite future, not just the next seventy-five years. In the 2005 Trustees Report, it is estimated that for the entire past and future of the program, the present value of scheduled benefits exceeds the present value of scheduled tax income by $11.1 trillion. This is the gap that reform must close. The Bush administration is committed to reform that makes Social Security permanently solvent.

Delaying reform only reduces the options for fairly distributing the benefits of Social Security across generations. If reform is deferred, fewer generations will be left to participate in the reformed system, and the changes will have to be more severe. Purely pay-as-you-go financing of Social Security would also unfairly burden future generations. For example, one option for achieving solvency would be to leave benefits unchanged and to raise payroll taxes each year starting when the trust fund is depleted in 2041. The payroll tax rate would reach 19 percent by the end of the seventy-five-year projection period, which most would agree is unfair. Any equitable reform would at least partially pre-fund Social Security benefits.

Fortunately, the current situation of Social Security is fixable. President Bush supports reform that increases the power of the individual, does not increase the tax burden, and provides economic opportunity for more Americans. The president’s guiding principles for reform include protecting the benefits of seniors at or near retirement, not increasing the payroll tax, offering personal retirement accounts (PRAs) to younger workers, and pursuing the goal of a permanently sustainable system.

PRAs provide individual control and ownership and allow individuals to invest in private-sector markets. The accounts will be voluntary; a worker can “opt-in” by choosing to put a portion of his or her payroll taxes into a PRA. Those who do not opt in will receive traditional Social Security benefits, with the system reformed so as to make it permanently solvent. An important benefit of PRAs is that they serve as private and effective “lock boxes.” Because the savings are in personal accounts, they do not appear on the government balance sheet as budget surpluses and therefore do not lead to increased government spending.

Some have questioned the policy focus on Social Security when Medicare is facing larger financial shortfalls. One reason is that much more analytical groundwork needs to be done before the options to reform Medicare are clear and well understood. Options for effective Social Security reform, on the other hand, have been thoroughly analyzed by the research and policy communities.

Still, the administration has already begun to lay the necessary policy groundwork to reform Medicare. Medicare finances are projected to rise substantially, primarily due to rapidly increasing health care costs. Because health care cost growth is an economy-wide problem, efforts to contain Medicare expenditures must be done in the context of greater health care system reform.

The administration has promoted policies to make health care choices better informed and more responsive to costs and benefits. The Medicare Modernization Act introduced health savings accounts to the commercial health insurance market, increased the role of private plans in Medicare, and increased price competition between those plans. The administration is also considering how to encourage the utilization of health care information technology, which is believed to reduce errors and waste.

AEI intern Meaghan Ryan prepared this summary.

Panel I: The Outlook for Medicare

Panel II: The Outlook for Social Security