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Everything You Wanted to Know About Medicare But Were Too Confused to Ask

From the March/April 2007 Issue

It’s America’s largest and most endangered health insurance program. Changes that give consumers more say—like the new Part D drug benefit—are helpful, but we’ll have to make tough trade-offs in the years ahead.

1) What is Medicare?

Medicare helps pay the cost of healthcare for about 43 million people, including nearly everyone age 65 or older plus many disabled persons. The program covers inpatient services (such as a stay in the hospital or skilled nursing facility) under Part A, and outpatient services (such as a doctor’s visit) under Part B. Beneficiaries can choose the traditional Medicare program, which is run by the federal government, or private health plans under Medicare Advantage (Part C). Prescription drugs have been covered under Part D since the start of 2006. Launched in 1965, Medicare is the largest single health insurer in the country, this year spending over $440 billion, or about 20 cents out of every health dollar.

Don’t confuse Medicare with Medicaid, the program that pays for the healthcare of low-income families (mostly mothers and their children) as well as elderly and disabled persons with high health costs or limited means who receive benefits from both programs.

2) Can we count on Medicare for the future?

Not the way we’re going. On its current course, Medicare is headed for a fiscal breakdown. Spending is growing more rapidly than revenue, and those trends will only get worse after 2010, when baby boomers start reaching age 65. By 2018, Medicare will not be able to pay for all the hospital bills that come in. Well before that year, Medicare beneficiaries will find that it is increasingly difficult to make appointments with specialists and gain access to high-tech care because of a squeeze on payments to providers. If trends continue, federal health spending (including the rising cost of Medicaid) will crowd out funding for the environment, defense, and other priorities from the budget.

The crisis is larger than Medicare or Medicaid, and it is not just a problem of spending too much. Americans are paying a great deal of money—a projected $2.3 trillion in 2007—for healthcare, but there is growing concern that we’re not getting our money’s worth. Unabated increases in health costs place a growing strain on employers’ ability to offer coverage and force increasing numbers of workers onto the rolls of the uninsured.

Much of that money, which represents about one-sixth of gross domestic product, is not well spent. Financial incentives encourage health services to be used wastefully. After all, patients have little reason to economize when insurance typically pays most of the cost of treatment. Our ability to diagnose and treat diseases has grown impressively, but our understanding of how to ensure efficient care for patients is woefully inadequate.

Medicare Revenue and Spending as Percentage of GDP

3) Solutions later. For now, how does the traditional Medicare program work?

Traditional Medicare offers every beneficiary the same package of health benefits, which were greatly improved with the addition of drug coverage last year. However, beneficiaries face a bewildering schedule of premiums and payments for health services, and they are still exposed, under some circumstances, to potentially catastrophic costs.

Part A requires no premium for 99 percent of participants. It is funded out of payroll taxes. Participants do pay monthly premiums for Parts B, C, and D.

Like most other insurance, Medicare requires beneficiaries to pay part of the initial cost of their care each year, that is, the deductible. But, unlike most other insurance, Medicare beneficiaries pay separate deductibles for inpatient and outpatient services.

For inpatient services, beneficiaries who are admitted to the hospital pay, out of their own pockets, the national average cost of care for the first day, set at $992 this year. After that, Medicare pays all hospital costs for the first 60 days. But the few patients who remain longer are liable for charges starting at $248 per day, rising to $496 a day after 90 days. Medicare stops paying altogether after 150 days in the hospital.

Those who use physician and other outpatient services pay the first $131 in costs themselves. After that, they pay for 20 percent of physician and outpatient care plus a hodgepodge of charges for other services, such as in-home nursing.

4) Is there a limit on what a Medicare beneficiary has to shell out?

No. Some low-income or chronically ill patients are eligible for Medicaid, which covers most of the extra costs. Those with higher incomes often purchase private Medigap plans or participate in health plans as retirees of businesses. These plans offer coverage that picks up where Medicare leaves off, but the premiums can be high.

A 65-year-old in good health living in Washington, D.C., for example, would pay a Medigap premium ranging from $65 to $167 a month, depending on what her plan covers. That’s on top of Medicare’s Part B premium of $93.50 a month and a premium for prescription drug coverage that is at least $12.20 a month.

Sources of Supplemental Insurage Coverage

5) Do private plans perform better than traditional Medicare?

In general, yes. The Medicare Advantage (MA) program, started in 1997, gives private health plans an opportunity to compete for enrollees. These plans can offer benefits not covered by traditional Medicare (such as preventive dental care, hearing and vision benefits, or podiatry) or more generous coverage (including protection against catastrophic costs). Many MA plans charge lower premiums for drug coverage than traditional Medicare does, and some offer additional coverage in the infamous “doughnut hole” (explained below).

Some MA plans limit patients’ access to healthcare providers, but other plans allow patients to use any provider available under traditional Medicare. Preferred provider organizations (PPOs) have broad provider networks and allow members to use out-of-network providers if they pay more of the cost of care. That’s the same kind of coverage that most people under 65 receive through their employers. Private fee-for-service plans (PFFSs) go even further, allowing their members to use any willing Medicare provider without paying an extra fee. Eighty percent of Medicare beneficiaries have at least one PFFS option available to them.

The average 65-year-old resident of Washington, D.C., could save as much as $950 this year enrolling in a PFFS plan with a drug benefit and full access to Medicare providers instead of remaining in traditional Medicare without additional coverage. Savings would be even greater if that beneficiary were willing to enroll in a plan (such as a health maintenance organization, or HMO) with a more restricted provider network.

6) How does the new drug benefit work?

In recent years, prescription drugs have become an important tool for curing diseases and keeping people healthy, but, remarkably, it was not until last year that all Medicare beneficiaries had access to medicines taken on an outpatient basis. The new benefit is expensive, costing taxpayers more than $1 trillion over the next decade. But it will provide patients with therapies that can be more effective and less costly than non-drug treatments.

Private plans, either stand-alone drug plans for enrollees in traditional Medicare or broad MA plans, deliver Medicare prescription benefits and compete for a share of the market. Competition puts pressure on the plans to negotiate hard for low drug prices, encourage the use of more cost-effective pharmaceuticals, and offer affordable premiums.

The crisis is larger than Medicare or Medicaid, and it is not just a problem of spending too much.

The standard Part D benefit requires that enrollees in 2007 pay for their first $265 in drug expenses. (Dollar amounts are adjusted for inflation and rise over time.) After that, enrollees pay 25 percent and Medicare pays 75 percent of the cost of prescriptions until $2,400 has been spent. Enrollees pay all of their own drug expenses between $2,400 and $5,451, in what is known as the “doughnut hole,” but only 5 percent of all costs above $5,451. Enrollees pay on the basis of their plan’s discounted prices rather than higher retail prices, even in the “doughnut hole.” Part D plans may restructure the benefit, however, and many plans offer zero deductibles, fixed-dollar copayments, or some coverage in the “doughnut hole.”

The response of private insurers to Part D has been overwhelming. The average Medicare beneficiary has more than 50 different Part D plan choices. Thanks to competition, premiums averaged $24 a month in 2006, one-third lower than experts had predicted.

7) Wouldn’t a single drug plan have been less confusing?

Less confusing but not better. There was some confusion early in the process as everyone—beneficiaries, pharmacists, plan-makers, and the government—had much to learn. A massive grassroots education campaign was organized by a coalition of organizations including the National Council on Aging, AARP, patient groups, and national groups representing health plans and professionals.

Having one plan would have made enrollment easier, but remember what that plan would have been: the standard “doughnut hole” benefit designed by Congress. That plan was not popular with beneficiaries. Instead, nearly 90 percent of beneficiaries enrolled in other types of plans. Replacing consumer choice with a one-size-fits-all policy for Part D would make millions of beneficiaries worse off.

Despite difficulties at the start of the program, more than 22 million beneficiaries enrolled in Part D plans for 2006, a figure greatly exceeding expectations. Almost all Part D participants are happy with their choices. Another 16 million beneficiaries had coverage from employer plans or programs like the VA that was at least as good as Part D. In all, about 90 percent of Medicare beneficiaries have drug coverage this year.

8) So what about that doughnut hole?

The government-designed plan stops paying for prescription drugs after a Part D participant has spent $2,400 during the year. That person might have to pay as much as $3,051 for prescriptions before Part D kicks in again. While they pay a discounted price for these medicines, Medicare participants with significant drug needs are saddled with a major burden.

But there are ways to fill the hole. Some beneficiaries qualify for low-income subsidies—state pharmacy assistance programs or discounts from drug manufacturers or pharmacies. In addition, beneficiaries may choose a private Part D plan that partly fills in the gap, typically by covering generic (but not brand-name) drugs. But plans with extra coverage charge higher premiums.

9) Why can’t we use Medicare’s huge buying power to get a better deal, like the Veterans Administration does?

Many people argue that Part D drug prices are higher than they should be, resulting in higher costs for patients and taxpayers. They say that Medicare should follow the lead of the U.S. Department of Veterans Affairs, which negotiates dramatically lower prices directly with manufacturers. Medicare, with 43 million beneficiaries, can surely get a better deal than any of the private drug plans.

That’s a seductive argument, but it ignores some key facts. The VA system does not provide the access to pharmaceuticals or the shopping convenience offered by Part D. VA’s low prices are possible because it puts a tight limit on the number of drugs its physicians may prescribe. The VA drug formulary, the list of drugs the benefit covers, includes just 19 percent of medicines approved by the Food and Drug Administration since 2000. For some patients, that means less effective treatment with more side effects.

Veterans using the VA system cannot go to their neighborhood pharmacy. The VA requires them to see only VA-employed doctors at VA facilities, using VA pharmacies to acquire VA-approved drugs. It is unlikely that Medicare beneficiaries would accept such limits.

The average 65-year-old resident of Washington, D.C., could save as much as $950 this year by enrolling in a private fee-for-service plan with a drug benefit.

In fact, companies that sponsor Part D plans may have more clout with drug manufacturers than Medicare would have as the sole purchaser. Most Part D plans are operated by pharmacy benefits managers (PBMs) that specialize in administering drug benefits for insurers. Because they represent both Part D plans and private insurers (including big employers), the top three PBMs—Caremark Rx, Medco Health Solutions, and Express Scripts—each negotiate prices on behalf of more than 50 million people with drug coverage. That is at least double the government’s market share of 22 million enrollees if it acted as the single purchaser.

10) Back to the subject of funding…. Part of every paycheck is going into a personal account in the Medicare trust fund. What is happening to that money?

Workers and their employers each pay a 1.45 percent tax that is used to finance Medicare’s Part A coverage of inpatient services. Some people think that these tax dollars are saved until they turn 65 and then are used to pay for their Medicare benefits. The government encourages such thinking by referring to the Part A “trust fund.” In fact, no money is being accumulated on your behalf, and there is no trust fund in the conventional sense of the term.

Instead, Medicare is a pay-as-you-go system. It takes payroll-tax revenues from active workers and premiums paid by beneficiaries to cover expenses in the current year.

Up until 2006, Medicare spent less under Part A than it collected in taxes. Any surplus went back into other federal spending, and the Treasury Department kept track of this extra revenue by issuing special non-negotiable bonds to Medicare. In other words, the Treasury borrowed the money, used the funds to pay the government’s other bills, and wrote out an IOU to Medicare. Today, Medicare is no longer running a surplus in Part A, and according to the government’s actuaries, those IOUs will be used up in a little over ten years.

11) Couldn’t we find more revenue to maintain Medicare benefits in the future?

Medicare will need about $10 trillion in new revenue (measured in today’s dollars) just to keep paying bills that will come in over the next 75 years for hospital care and other services under Part A. We will need about $20 trillion in tax revenue to pay for outpatient services under Part B and prescription drugs under Part D. Even in an economy as large as America’s (our GDP in 2006 was about $13 trillion), the tax increases required to raise such amounts would be formidable. Economic growth would suffer from the drain on the private sector and jobs would be lost. Although seniors might pay part of the needed costs, most of the burden of such a tax hike would be borne by our children and grandchildren.

Even if we raised the funds, much of the new money would be wasted without a fundamental reform of Medicare. Trying to maintain the program as it is today would mean preserving incentives for excessive and inappropriate care. While we need to ensure continued access to healthcare for Medicare beneficiaries, we should focus our efforts on creating a new Medicare program that works.

12) What’s the final judgment? Can Medicare be saved?

Yes, but not by continuing business as usual. Medicare’s focus should shift from paying for services to paying for value. Medicare beneficiaries should be made more conscious of cost and quality. We must convert Medicare into a program that rewards the efficient and effective delivery of healthcare. That will require further reforms to make competition work for Medicare—reforms Congress has been reluctant to adopt. The question is, do we have the political will to save Medicare?

13) Are there any ways to fix Medicare?

Yes. Here are some sensible—and relatively painless—ways to narrow the gap between tax revenues and Medicare costs:

• Change payment incentives. Medicare should pay for better health outcomes, not just for services performed.

• Enhance competition. As the Part D experience has shown, the best way to lower costs is through more competition, not more government management. Traditional Medicare should be permitted to adjust its benefits, premiums, and other features in response to changing consumer demand and evolving medical practice, rather than waiting for Congress to act.

• Improve care delivery. Traditional Medicare is “à la carte” medicine, with a vast menu of treatments and health providers laid out before often-uncomprehending patients. By failing to coordinate the delivery of health services, we waste resources.

• Keep track of which treatments work best. A flood of medical innovations promise improvements in our ability to diagnose and treat disease. Choosing a treatment can be complicated, however, and the knowledge of what really works is often lacking. Patient-level data from Medicare should be used to analyze the effectiveness of treatments for diseases.

• Let beneficiaries be consumers. When people turn 65, they do not suddenly lose their ability to make decisions. Fears that Medicare beneficiaries would not be able to select a Part D plan proved unjustified. To the contrary, that experience illustrates the need for a consumer-oriented infrastructure in healthcare. Consumers need transparency plus clear financial incentives that promote prudent decision making.

• Promote personal responsibility. Medicare should promote responsibility, such as better patient compliance with drug therapies for hypertension. The result will be better care and lower costs. But, again, the problem doesn’t begin with Medicare. Good health habits are developed well before age 65.

Charts by MacNeill and MacIntosh; Source info for Chart 1: U.S. Social Security Administration, 2006; Source info for Chart 2: Kaiser Family Foundation analysis of the Medicare Current Beneficiary Survey 2002 Cost and Use file.

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