With Baby Boomers Aging, Medicare Financing System Must Be Restructured

ABSTRACT: The Medicare program needs to be restructured if it is to remain solvent for the generation of baby boomers now reaching age 60. Since many cancer patients are Medicare beneficiaries, the health of the program is vital to the oncology community. Cancer Care & Economics (CC&E) recently spoke to Thomas R. Saving, PhD, about Medicare economics. Dr. Saving has been renominated for a second term as one of two Presidential-appointed Public Trustees of the Social Security and Medicare Trust Funds. He is a University Distinguished Professor of Economics and holds the Jeff Montgomery Professorship in Economics at Texas A&M University, where is he also director of the Private Enterprise Research Center.

CC&E: In a nutshell, what is the Medicare Trust Fund?

DR. SAVING: Medicare is administered by the Centers for Medicare & Medicaid Services (CMS) through two trust funds, one for Hospital Insurance (HI) or Part A, and one for Supplementary Medical Insurance (SMI) or Part B. Unlike a private trust fund, the Medicare Trust Funds generate no income to the US Treasury. They were created as a means of accounting for program income (Medicare taxes and premiums) and disbursements (benefit payments and administrative costs).

Much like the Social Security system, the Part A program is intended to be self-supporting; that is, the benefits provided by the program should be funded almost entirely from payroll taxes. If the Medicare receipts in Part A are less than Medicare expenditures—as long as there is an accounting entry in the trust fund—the treasury is authorized to pay the deficits Medicare has accrued.

The second trust fund, Part B, is actually a combination of Part B and Part D, the prescription drug benefit. This fund is managed so that annual income (Federal general fund revenue transfers and beneficiary premiums) is always projected to cover the next year's cost. This is achieved by automatically adjusting the monthly premium and the amount the Treasury transfers to the fund. The Treasury is authorized to pay the benefits even if the projected costs were underestimated, so in effect, it's simply an authorization to spend.

CC&E: Will the generation transfer method of financing Medicare withstand the imminent swell in beneficiaries from the Baby Boom generation?

DR. SAVING: In its current form, it will not. At the current rate, within 35 years we will be transferring more than 50% of all federal income tax revenues to Medicare alone. In other words, by 2040, if we continue on our present course, we will have to cut federal spending by more than half or raise taxes to more than two and a half times today's level just to balance the budget. Since that scenario is untenable, Medicare needs to be restructured.

The primary problem in Medicare's fiscal crisis is the generation transfer methodology. It combines the worst incentives on the market side by financing a system that discourages saving for the future. The result is a lower capital stock for the nation. When coupled with the Baby Boom bulge, this method will ultimately cripple Medicare. So, first and foremost, the generational transfer method of financing must be abandoned.

CC&E: What do you propose to replace the generational transfer method?

DR. SAVING: We should move toward an age cohort system in which all individuals born within a certain year insure themselves against retirement and medical expenses. Then, if the population age distribution experiences a bulge—like the one we face with the Baby Boomer retirement—the contribution to retirement medical insurance will rise accordingly, maintaining the same per capita value as that for smaller cohorts. In this way, future retirees will pay for their own medical expenses instead of placing the burden of care on their children and grandchildren.

CC&E: First dollar coverage seems to discourage cost-effective spending of health care resources. Is this something Medicare might address in the future?

DR. SAVING: This so-called first dollar coverage protects beneficiaries from financial liability from the first dollar of expenditure beyond their premium. It also creates an artificial picture of their expenditures. This is a dilemma throughout the health care system. If consumers care about costs, then competition will result in producers caring about the costs of health care. For example, if we had a "Travelcare" system to pay airfare for travelers, how many do you think would choose coach over first class?

One challenge is to somehow make customers value their health care costs without negatively affecting their health status. How do we arrive at a point in which we begin selecting the least costly alternative in cancer treatment? For example, in certain cancer diagnoses, there are choices between very expensive treatments that only confer minimal survival and palliative care that is less costly but may produce better quality-of-life outcomes. But right now we're not having that dialogue, and consequently, there are no incentives for patients and their families to entertain an option that would be less financially draining on them and the health care system. We must create an environment in which both suppliers and demanders of health care are cost conscious. Other industries do, why not health care?

CC&E: Could universal health care vouchers be an alternative to Medicare?

DR. SAVING: A system of universal health care vouchers is intriguing in theory, since it would guarantee basic health care coverage for every American regardless of changes in employment, income, health status, or other unforeseen circumstances. Conceptually, vouchers would drive more competition among health care providers, and that could stimulate cost savings and better utilization of technologies and resources.

But a few questions need to be addressed. How do you deal with unexpected costs and the different health levels of people in the Medicare and non-Medicare market? How do you structure a benefits package contract? How do you determine the costs of services, deductibles, co-payments, catastrophic coverage, etc? And how do you define what is basic coverage as opposed to comprehensive coverage? So while I think that the concept of universal health care vouchers is attractive, there are still systemic problems with implementing such a program. Then there's the problem of finding the political will to make such a dramatic shift in the way we deliver and pay for health care services.

CC&E: The Congressional Budget Office (CBO) estimates that by 2015, Medicare Part D spending will represent approximately 23% of Medicare's total budget. Is this a good program?

DR. SAVING: Much of what Part D covers is out-of-pocket expenditures for Medicare beneficiaries. For cancer patients taking very expensive drugs, Part D can provide substantial financial relief. The prescription drug bill, however, is still a work in progress; to a large extent, the jury is out on its overall benefits vs costs. Further, we haven't had enough time yet to see what will happen on the demand side as individuals begin paying less of their prescription drug costs. Are they going to demand even more drugs? And if so, what effect will it have on the overall expansion of Medicare expenditures.

CC&E: Would less government regulation benefit the health care system?

DR. SAVING: More competition and less regulation would theoretically reduce the growth rate in costs, but the problem is how to accomplish this within the economic and political constraints of the current system. Further, if we are going to get the most out of our health care sector, policymakers must address the high cost of health care regulation, medical liability reform, and deregulation of the FDA.

CC&E: The Medicare Modernization Act created health savings accounts (HSAs). What is this instrument, and is it a good idea?

DR. SAVING: A health savings account is basically an alternative to traditional health insurance. HSAs combine a savings account with catastrophic insurance, and offer a different way for consumers to pay for their health care. The consumer owns and controls the money in his/her account. Decisions on how to spend the money are made by the consumer without relying on a third party or a health insurer. Giving consumers more control over their health care dollars is essentially a good idea. One problem I have with HSAs is that if at the end of the year, the consumer has money left over in the account that is not needed for health care expenses, any withdrawal of that money for other uses will be subject to both income tax and a 10% penalty. (The excess funds can, however, be carried over to the next year without penalty.)

I have argued about this penalty clause with members of Congress who are big proponents of health savings accounts. I think this instrument can be an important part of the overall restructuring of Medicare, but we've got to take away the penalty. It is counterproductive to penalize consumers for prudent utilization of their health care allotment. The excess money in a health saving account should be totally discretionary.

CC&E: So to summarize, what needs to be done in order to save Medicare?

DR. SAVING: It's a complex problem that has been evolving over decades, and the solutions are not easy to come by. But, as mentioned, we must change the generational transfer method of financing the program to one that isn't affected by birth rate variations and that requires individuals to save toward their retirement medical care during their working years—through a retirement medical insurance program—rather than depend on younger taxpayers to finance their care. That is essential. And we should move toward insurance with no first-dollar coverage so that both retirees and insurers will have a stake in the cost of medical care.