Medicare Reform: Ensuring Fiscal Sustainability While Modernizing the Program Will be Challenging

Published by the Government Accountability Office on 1999-09-22.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                                United States General Accounting Office

GAO                             Before the Subcommittee on Health, Committee on Ways
                                and Means, House of Representatives

For Release on Delivery
Expected at 2:00 p.m.
Wednesday, September 22, 1999   MEDICARE REFORM

                                Ensuring Fiscal
                                Sustainability While
                                Modernizing the Program
                                Will Be Challenging
                                Statement of David M. Walker
                                Comptroller General of the United States

Medicare Reform: Ensuring Fiscal
Sustainability While Modernizing the
Program Will Be Challenging
               Mr. Chairman and Members of the Subcommittee:

               I am pleased to be here today as you discuss efforts to reform the
               administration, structure, and financing of Medicare–steps essential to
               maintaining the program’s long-term solvency and to its modernization.
               There appears to be an emerging consensus that substantive financing and
               programmatic reforms are necessary to put Medicare on a sustainable
               footing for the future. The long-term cost pressures facing this program
               are considerable. Fundamental program reforms are vital to reducing the
               program’s growth, which threatens to absorb ever-increasing shares of the
               nation’s budgetary and economic resources.

               Against this backdrop, I want to acknowledge your efforts, Mr. Chairman,
               as well as the contributions of the other members of the Bipartisan
               Commission on the Future of Medicare. The Breaux-Thomas proposal,
               which grew out of the Commission’s deliberations, included a
               comprehensive reform plan on a technically difficult issue that touches on
               both the future health of beneficiaries and the fiscal health of the U.S.
               economy.1 I also want to commend both this Subcommittee and the
               Congress as a whole for remaining steadfast in the face of intense pressure
               to roll back the Medicare payment reforms included in the Balanced
               Budget Act of 1997 (BBA). It is in no sense hyperbole to note that the BBA
               changes constituted a critical down payment for Medicare reform. I know
               that the Subcommittee appreciates the vital importance of waiting for
               strong evidence that demonstrates the need for any modifications before

               You must be especially prudent during this period of prosperity as you
               consider Medicare reform initiatives. Please remember that, even as recent
               estimates have increased the size of budget surpluses, these are projected
               budget surpluses, and we know that the business cycle has not been
               repealed. Current projected surpluses could well prove to be fleeting, and
               thus appropriate caution should be exercised when creating new
               entitlements that establish permanent claims on future resources. While I
               do not relish being the accountability cop at the surplus celebration party,
               that is part of my job as Comptroller General of the United States.

               Moreover, while the size of future surpluses could exceed or fall short of
               projections, we know that demographic and cost trends will, in the

               1The National Bipartisan Commission on the Future of Medicare held its last meeting on March 16,
               1999. By a vote of 10 to 7, the Commission failed to achieve the 11-member super majority required by
               law to report a recommendation to the Congress.

               Page 1                                                                  GAO/T-HEHS/AIMD-99-294
    Medicare Reform: Ensuring Fiscal
    Sustainability While Modernizing the
    Program Will Be Challenging

    absence of meaningful reform, drive Medicare spending to levels that will
    prove unsustainable for future generations of taxpayers. Accordingly, we
    need to view this period of projected prosperity as an opportunity to
    address the structural imbalances in Medicare, Social Security, and other
    entitlement programs before the approaching demographic tidal wave
    makes the imbalances more dramatic and meaningful reform less feasible.

    As the foregoing suggests, the stakes associated with Medicare reform are
    high for the program itself and for the rest of the federal budget, both now
    and for future generations. Current policy decisions can help us prepare
    for the challenges of an aging society in several important ways: (1)
    reducing public debt to increase national savings and investment, (2)
    reforming entitlement programs to reduce future claims and free up
    resources for other competing priorities, and (3) establishing a more
    sustainable Medicare program that delivers effective and affordable health
    care to our seniors.

    In this context, I would like to make a few summary points before delving
    into the specifics of Medicare’s financial health and a discussion of
    potential reform.

•   In March, the Bipartisan Commission on the Future of Medicare
    completed its deliberations. Reform options emerged from these and other
    discussions that touched on all aspects of the Medicare program, including
    (1) modernization of the traditional Medicare fee-for-service program,
    both to update the benefit package and enhance its potential for
    containing program costs; (2) modernization of the Medicare+Choice
    program to ensure that beneficiaries have health plan choices and allow
    the program to more efficiently purchase plan services; and (3) adoption
    of a program like the Federal Employees Health Benefits Program
    (FEHBP) or a premium support model to foster quality and price based
    competition among health plans and to elevate beneficiaries’
    consciousness about and responsibility for program costs.

    Given the size of Medicare’s unfunded liability, it is realistic to expect that
    reforms intended to bring down future costs will have to proceed
    incrementally. The time to begin the difficult but necessary steps to
    reclaim our fiscal future is now, when we have budget surpluses and a
    demographic “holiday” with retirees a far smaller proportion of the
    population than they will be in the future.

    Ideally, the unfunded promises associated with today’s program should be
    addressed before or concurrent with proposals to make new ones, such as
    adding prescription drug coverage. To do otherwise might be politically

    Page 2                                                  GAO/T-HEHS/AIMD-99-294
Medicare Reform: Ensuring Fiscal
Sustainability While Modernizing the
Program Will Be Challenging

attractive but not fiscally prudent. If benefits are added, policymakers
need to consider targeting strategies that fully offset the related costs.
They may also want to design a mechanism to monitor aggregate program
costs over time and to establish expenditure or funding thresholds that
would trigger a call for fiscal action. Our history shows that when benefits
are attractive, fiscal controls and constraints are difficult to maintain. In
addition, any potential program expansion should be accompanied by
meaningful reform of the current Medicare program to help ensure its

To qualify as meaningful reform, a proposal should make a significant
down payment toward ensuring Medicare’s long-range financial integrity
and sustainability–the most critical issue facing Medicare. The 1999 annual
reports of the Medicare trustees project that program costs will continue
to grow faster than the rest of the economy. Care must be taken to ensure
that any potential expansion of the program is balanced with other
programmatic reforms so that we do not worsen Medicare’s existing
financial imbalances. Proposals to reform Medicare should be assessed
against the following criteria: affordability, equity, adequacy, feasibility,
and acceptance. (See table 1.)

Table 1: Criteria for Assessing the Merits of Medicare Reform Proposals

Criterion         What this means for a proposal
Affordability     A proposal should be evaluated in terms of its effect on the long-term
                  sustainability of Medicare expenditures
Equity            A proposal should be fair to providers and across groups of
Adequacy          A proposal should include resources that allow appropriate access and
                  provisions that foster cost-effective and clinically meaningful innovations
                  that address patients’ needs
Feasibility       A proposal should incorporate elements that facilitate effective
                  implementation and adequate monitoring
Acceptance        A proposal should be transparent and should educate provider and
                  beneficiary communities about its costs and the realities of tradeoffs
                  required by significant policy changes

People want unfettered access to health care, and some have needs that
are not being met. However, health care costs compete with other
legitimate priorities in the federal budget, and their projected future
growth threatens to crowd out future generations’ flexibility to decide
which of these competing priorities will be met. Thus, in making important
fiscal decisions for our nation, policymakers need to consider the
fundamental differences between wants, needs, and what both individuals

Page 3                                                           GAO/T-HEHS/AIMD-99-294
                      Medicare Reform: Ensuring Fiscal
                      Sustainability While Modernizing the
                      Program Will Be Challenging

                      and our nation can afford. This concept applies to all major aspects of
                      government, from major weapons system acquisitions to issues affecting
                      domestic programs. It also points to the fiduciary and stewardship
                      responsibility that we all share to ensure the sustainability of Medicare for
                      current and future generations within a broader context of providing for
                      other important national needs and economic growth.

                      Let’s not kid ourselves—reforming Medicare is hard work. Health care
                      spending accounts for one-seventh of the nation’s economy, and Medicare
                      is the nation’s single largest health care payer. The program’s beneficiary
                      populations consist of roughly 35 million seniors and 4 million disabled
                      individuals under age 65. The Health Care Financing Administration
                      (HCFA) estimates that the program’s billers—physicians, hospitals,
                      equipment suppliers, and other providers of health services—number
                      about 1 million.

                      As the various reform options come under scrutiny, the importance of
                      design details should not be overlooked. Our work on efforts to implement
                      reforms mandated in the BBA is instructive regarding reform specifics.
                      Three principal lessons can be drawn from recent experience: (1) The
                      particulars of payment mechanisms largely determine the extent to which
                      a reform option can eliminate excess government spending while
                      protecting beneficiaries access’ to care. (2) Revisions to newly
                      implemented policies should be based on a thorough assessment of their
                      effects so that, at one extreme, they are not unduly affected by external
                      pressures and premature conclusions or, at the other extreme, they remain
                      static when change is clearly warranted. (3) For choice-based models to
                      function as intended–that is, to foster competition based on cost and
                      quality–consumers must have information that is sufficiently comparable.

                      At this time, I would like to discuss the competing concerns at the crux of
                      Medicare reform, in general, and to provide a conceptual framework for
                      considering the various possible combinations of reform options, in

Competing Concerns    The current Medicare program, without improvements, is ill suited to
                      serve future generations of seniors and eligible disabled Americans. On
Pose Challenges for   the one hand, the program is fiscally unsustainable in its present form, as
Medicare Reform       the disparity between program expenditures and program revenues is
                      expected to widen dramatically in the coming years. On the other, the
                      program is outmoded in that it has not been able to adopt modern, market-
                      based management tools, and its benefit package contains gaps in desired
                      coverage compared to private employer coverage. Compounding the

                      Page 4                                                 GAO/T-HEHS/AIMD-99-294
                             Medicare Reform: Ensuring Fiscal
                             Sustainability While Modernizing the
                             Program Will Be Challenging

                             difficulties of responding to these competing concerns is the sheer size of
                             the Medicare program—even modest program changes send ripples across
                             the program’s 39-million-strong beneficiary population and the
                             approximately 1 million health care providers that bill the program.
                             Balancing the needs of all these parties requires hard choices that have
                             been brought before this Subcommittee, the Congress, and the National
                             Bipartisan Commission on the Future of Medicare.

Medicare Is Already in the   Unlike private trust funds that can set aside money for the future by
                             investing in financial assets, the Medicare Hospital Insurance (HI) Trust
Red                          Fund—which pays for inpatient hospital stays, skilled nursing care,
                             hospice, and certain home health services—is essentially an accounting
                             device. It allows the government to track the extent to which earmarked
                             payroll taxes cover Medicare’s HI outlays. In serving the tracking purpose,
                             annual trust fund reports show that Medicare’s HI component is, on a cash
                             basis, in the red and has been since 1992. (See fig. 1.) Currently,
                             earmarked payroll taxes cover only 89 percent of HI spending and,
                             including all earmarked revenue, the fund is projected to have a $7 billion
                             cash deficit for fiscal year 1999 alone. To finance this deficit, Medicare has
                             been drawing on its special issue Treasury securities acquired during the
                             years when the program generated a cash surplus. Consequently, Medicare
                             is already a net claimant on the Treasury—a threshold that Social Security
                             is not currently expected to reach until 2014. In essence, for Medicare to
                             “redeem” its securities, the government must raise taxes, cut spending for
                             other programs, or reduce the projected surplus. Outlays for Medicare
                             services covered under Supplementary Medical Insurance (SMI)–physician
                             and outpatient hospital services, diagnostic tests, and certain other
                             medical services and supplies–are already funded largely through general

                             Page 5                                                 GAO/T-HEHS/AIMD-99-294
Medicare Reform: Ensuring Fiscal
Sustainability While Modernizing the
Program Will Be Challenging

Figure 1: Financial Outlook of the Hospital Insurance Trust Fund, 1990 to



Dollars in billions

                              Cash Deficit 1992
















                                             Cash Surplus/Deficit     Fund Balance

Without meaningful reform, the long-term financial outlook for Medicare
is bleak. Together, Medicare’s HI and SMI expenditures are expected to
increase dramatically, rising from 12 percent in 1999 to more than a
quarter of all federal revenues by mid century. Over the same time frame,
Medicare’s expenditures are expected to double as a share of the
economy, from 2.5 to 5.3 percent, as shown Fig. 2.

Page 6                                                                       GAO/T-HEHS/AIMD-99-294
Medicare Reform: Ensuring Fiscal
Sustainability While Modernizing the
Program Will Be Challenging

Figure 2: Composition of Medicare Funding as a Percent of Gross
Domestic Product (GDP), 1999 to 2071



Percent of GDP








































                                               General Revenue or Other            Payroll Tax        Premiums

The progressive absorption of a greater share of the nation’s resources for
health care, like Social Security, is in part a reflection of the rising share of
elderly in the population. Medicare’s rolls are expanding and are projected
to increase rapidly with the retirement of the baby boom. Today’s elderly
make up about 13 percent of the total population; by 2030, they will
comprise 20 percent as the baby boom generation ages and the ratio of
workers to retirees declines from 3.4 to one today to roughly two to one.

However, Medicare growth rates also reflect the escalation of health care
costs at rates well exceeding general rates of inflation. Increases in the
number and quality of health care services have been fueled by the
explosive growth of medical technology. Moreover, the actual costs of
health care consumption are not transparent. Third-party payers generally
insulate consumers from the cost of care decisions. In traditional
Medicare, for example, the impact of the cost-sharing provisions designed
to curb the use of services is muted because about 80 percent of
beneficiaries have some form of supplemental health care coverage (such
as Medigap insurance) that pays these costs. For these reasons, among
others, Medicare represents a much greater and more complex fiscal
challenge than even Social Security over the longer term.

Page 7                                                                                                GAO/T-HEHS/AIMD-99-294
Medicare Reform: Ensuring Fiscal
Sustainability While Modernizing the
Program Will Be Challenging

When viewed from the perspective of the entire budget and the economy,
the growth in Medicare spending will become progressively unsustainable
over the longer term. Our updated budget simulations show that to move
into the future without making changes in the Social Security, Medicare,
and Medicaid programs is to envision a very different role for the federal
government. Even assuming that all projected surpluses are saved and
existing discretionary budget caps are complied with, our long-term model
shows a world by 2030 in which Social Security, Medicare, and Medicaid
increasingly absorb available revenues within the federal budget. (See fig.
3.) If none of the surplus is saved, the long-term outlook is even more
daunting. (See fig. 4.) Budgetary flexibility declines drastically, and there
is little or no room for programs for national defense, the young,
infrastructure, and law enforcement. In short, there will be essentially no
discretionary programs at all.

Figure 3: Composition of Spending as a Share of GDP Under “Save the
Unified Surplus” Simulation



 Percent of GDP

                  30%               Revenue



                                    1998                       2030*                        2050                     2070

                                  Social Security        Medicare & Medicaid             N e t Interest    All other spending

                   *In 2030, all other spending includes offsetting interest receipts.

Page 8                                                                                                    GAO/T-HEHS/AIMD-99-294
Medicare Reform: Ensuring Fiscal
Sustainability While Modernizing the
Program Will Be Challenging

Figure 4: Composition of Spending as a Share of GDP Under “No Unified
Surplus” Simulation



  Percent of GDP




                           1998                           2030                 2050

                         S o c ia l S e c u r i t y   Medicare & Medicaid   Net Interest     All other spending

When viewed together with Social Security, the financial burden of
Medicare on the future taxpayers becomes unsustainable. As figure 5
shows, the cost of these two programs combined would nearly double as a
share of the payroll tax base over the long term. Assuming no other
changes, these programs would constitute an unimaginable drain on the
earnings of our future workers.

Page 9                                                                                     GAO/T-HEHS/AIMD-99-294
Medicare Reform: Ensuring Fiscal
Sustainability While Modernizing the
Program Will Be Challenging

Figure 5: Social Security and Medicare HI as a Percent of Taxable Payroll,
1999 to 2074


Percent of taxable payroll



                                                                                                    Current Level




















































While the problems facing the Social Security program are significant,
Medicare’s challenges are even more daunting. To close Social Security’s
deficit today would require a 17 percent increase in the payroll tax,
whereas the HI payroll tax would have to be raised 50 percent to restore
actuarial balance to the trust fund. This analysis, moreover, does not
incorporate the financing challenges associated with the SMI and Medicaid

Early action to address the structural imbalances in Medicare is critical.
First, ample time is required to phase in the reforms needed to put this
program on a more sustainable footing before the baby boomers retire.
Second, timely action to bring costs down pays large fiscal dividends for
the program and the budget. Our long-term budget simulations, as shown
in figure 6, illustrate how critical early action on Medicare reform is to our
long-term fiscal future. If the annual growth in per person Medicare
spending could be slowed to 4 percent over the 70-year period it would
yield the kind of savings needed to establish a truly sustainable budget
policy for the long term. This is not easy however. Although over 70 years
the projected average annual growth in per person spending is 4.5 percent,
over the next 10 years it is nearly 5 percent. The high projected growth of
Medicare in the coming years, means that the earlier the reform begins, the
greater the savings will be as a result of the effects of compounding.
Reforms fully phased in by 2005 would enable us to maintain surpluses
over the entire 70-year simulation period.

Page 10                                                                                                                                              GAO/T-HEHS/AIMD-99-294
Medicare Reform: Ensuring Fiscal
Sustainability While Modernizing the
Program Will Be Challenging

Figure 6: Federal Deficits as a Share of GDP Under Alternative Medicare
Simulations, 1999 to 2069



 Percent of GDP

                                                                                                              No action

                                                                                                            Action taken in 2015


                                                                                                       Action taken in 2005

                       1999   2004   2009   2014   2019   2024   2029   2034   2039   2044   2049    2054    2059   2064   2069

The actions necessary to bring about a more sustainable program will no
doubt call for some hard choices. Some suggest that the size of the
imbalances between Medicare’s outlays and payroll tax revenues for the
HI program may well justify the need for additional resources. One
possible source could be general revenues. Although this may eventually
prove necessary, such additional financing should be considered as part of
a broader initiative to ensure the program’s long-range financial integrity
and sustainability.

What concerns me most is that devoting general funds to the HI may be
used to extend HI’s solvency without addressing the hard choices needed
to make the whole Medicare program more sustainable in economic or
budgetary terms. Increasing the HI trust fund balance alone, without
underlying program reform, does nothing to make the Medicare program
more sustainable—that is, it does not reduce the program’s projected
share of GDP or the federal budget. From a macro economic perspective,
the critical question is not how much a trust fund has in assets but
whether the government as a whole has the economic capacity to finance
all Medicare’s promised benefits—both now and in the future.

If more fundamental program reforms are not made, I fear that general
fund infusions would interfere with the vital signaling function that trust
fund mechanisms can serve for policymakers about underlying fiscal
imbalances in covered programs. The greatest risk is that dedicating

Page 11                                                                                             GAO/T-HEHS/AIMD-99-294
                          Medicare Reform: Ensuring Fiscal
                          Sustainability While Modernizing the
                          Program Will Be Challenging

                          general funds to the HI program will reduce the sense of urgency that
                          impending trust fund bankruptcy provides to policymakers by artificially
                          extending the solvency of the HI program. Furthermore, increasing the
                          trust fund’s paper solvency does not address cost growth in the SMI
                          portion of Medicare, which is projected to grow even faster than HI in
                          coming decades.

Long-Term Fiscal Policy   Beyond reforming the Medicare program itself, maintaining an overall
                          sustainable fiscal policy and strong economy is vital to enhancing our
Choices                   nation’s future capacity to afford paying benefits in the face of an aging
                          society. Decisions on how we use today’s surpluses can have wide-ranging
                          impacts on our ability to afford tomorrow’s commitments.

                          As we know, there have been a variety of proposals to use the surpluses
                          for purposes other than debt reduction. Although these proposals have
                          various pros and cons, we need to be mindful of the risk associated with
                          using projected surpluses to finance permanent future claims on the
                          budget, whether they are on the spending or tax side.2 Commitments often
                          prove to be permanent while projected surpluses can be fleeting. For
                          instance, current projections assume full compliance with tight
                          discretionary spending caps. Moreover, relatively small changes in
                          economic assumptions can lead to very large changes in the fiscal outlook,
                          especially when carried out over a decade. In a recent report, the
                          Congressional Budget Office (CBO) compared the actual deficits or
                          surpluses for 1988 through 1998 with the first projection it had produced 5
                          years before the start of each fiscal year. Excluding the estimated impact
                          of legislation, CBO says that its errors averaged about 13 percent of actual
                          outlays. Such a shift in 2004 would mean a potential swing of about $250
                          billion in the projected surplus.

                          Although most would not argue for devoting 100 percent of the surplus to
                          debt reduction over the next 10 years, saving a good portion of our
                          surpluses would yield fiscal and economic dividends as the nation faces
                          the challenges of financing an aging society. Our work on the long-term
                          budget outlook illustrates the benefits of maintaining surpluses for debt
                          reduction. Reducing the publicly held debt reduces interest costs, freeing
                          up budgetary resources for other programmatic priorities. For the
                          economy, running surpluses and reducing debt increase national saving
                          and free up resources for private investment. These results, in turn, lead to
                          stronger economic growth and higher incomes over the long term.

                          2See Federal Budget: The President’s Midsession Review (GAO/OCG-99-29, July 21, 1999).

                          Page 12                                                              GAO/T-HEHS/AIMD-99-294
                      Medicare Reform: Ensuring Fiscal
                      Sustainability While Modernizing the
                      Program Will Be Challenging

                      Over the last several years, our simulations illustrate the long-term
                      economic consequences flowing from different fiscal policy paths.3 Our
                      models consistently show that saving all or a major share of projected
                      budget surpluses ultimately leads to demonstrable gains in GDP per
                      capita. Over a 50-year period, GDP per capita would more than double
                      from present levels by saving all or most of projected surpluses, while
                      incomes would eventually fall if we failed to sustain any of the surplus.
                      Although rising productivity and living standards are always important,
                      they are especially critical for the 21st century, for they will increase the
                      economic capacity of the projected smaller workforce to finance future
                      government programs along with the obligations and commitments for the
                      baby boomers’ retirement.

BBA Made Medicare     In addition to its significant financial imbalance, Medicare is outmoded
                      from a programmatic perspective. In its current form, the program lacks
Reform Down Payment   the flexibility to readily adjust its administered prices and fees in line with
                      market rates and lacks the tools to exercise meaningful control over the
                      volume of services used. Nevertheless, BBA reforms enacted in 1997 have
                      begun to address certain programmatic shortcomings by modernizing the
                      program’s pricing and payment strategies and by moving toward quality-
                      based competition among health plans. The act’s combination of structural
                      reforms, constraints on provider fees, and increases in beneficiary
                      payments was expected to lower program spending by $386 billion over 10
                      years. Because certain key provisions have only recently or have not yet
                      been phased in, the full effects of the BBA on providers, beneficiaries, and
                      taxpayers will not be known for some time.

                      Of particular significance was BBA’s creation of the Medicare+Choice
                      program, which furthered the use of a choice-based model of providing
                      Medicare benefits. Medicare+Choice expanded Medicare’s managed care
                      options to include, in addition to health maintenance organizations
                      (HMO), health plans such as preferred provider organizations, provider-
                      sponsored organizations, and private fee-for-service plans. In making this
                      expanded consumer choice program, BBA provisions placed a dramatic
                      new emphasis on the development and dissemination of comparative plan
                      information to consumers to foster quality-based plan competition. Other
                      BBA provisions were designed to pay health plans more appropriately
                      than Medicare had done under the previous HMO payment formula.

                      3See Budget Issues: Long-Term Fiscal Outlook (GAO/T-AIMD/OCE-98-83, Feb. 25, 1998) and Budget
                      Issues: Analysis of Long-Term Fiscal Outlook (GAO/AIMD/OCE-98-19, Oct. 22, 1997).

                      Page 13                                                            GAO/T-HEHS/AIMD-99-294
Medicare Reform: Ensuring Fiscal
Sustainability While Modernizing the
Program Will Be Challenging

BBA also made historic changes to traditional Medicare. It is gradually
eliminating, for the most part, cost-based reimbursement methods and
replacing them with prospective payment systems (PPS). The intent is to
foster the more efficient use of services and to lower growth rates in
spending for these providers, replicating the experience for acute care
hospitals following the implementation of Medicare’s PPS for hospitals,
which began in the mid-1980s. BBA mandated phasing in PPSs for skilled
nursing facilities, home health agencies (HHA), hospital outpatient
services, and certain hospitals not already paid under such arrangements.

Yet pressures mount to undo some of these changes. Affected providers
are currently seeking to repeal various BBA provisions, some relying on
anecdotal evidence rather than systematic analysis to make their case. An
illustration is the reporting of health plan withdrawals from the
Medicare+Choice program for 1999. Plans cite, and the press reports,
inadequate payment rates as the reason for dropping out of Medicare or
reducing enrollees’ benefits. We have another point of view based on our
fact-gathering and analyses.

BBA sought to moderate Medicare’s payments to managed care plans
because, ironically, Medicare managed care cost, not saved, the
government money. That is, the government was paying more to cover
beneficiaries in managed care than it would have if these individuals had
remained in the traditional fee-for-service program. In our report, we
noted that BBA has reduced, but not eliminated, excess payments.4 In fact,
Medicare’s payments to some plans are generous enough for plans to
make profits and to finance prescription drugs and other extras not
available to the majority of senior and disabled beneficiaries who remain
in traditional Medicare. We have also reported that factors additional to or
even exclusive of payment rates—including competition and other market
conditions—played a significant role in the 1999 plan dropouts.5 Our
ongoing analysis of the year 2000 plan dropouts reveals similar findings.
The question this raises for policymakers is the extent to which they
should be concerned about health plan dropouts from Medicare when plan
participation means that the government finances non-Medicare benefits
for a minority of beneficiaries while paying more for these beneficiaries
than for similar ones in traditional Medicare. Among other lessons,
however, the intensity of pressure to roll back BBA’s curbs on managed

4See Medicare+Choice: Reforms Have Reduced, but Likely Not Eliminated, Excess Plan Payments
(GAO/HEHS-99-144, June 18, 1999).
5See Medicare Managed Care Plans: Many Factors Contribute to Recent Withdrawals; Plan Interest
Continues (GAO/HEHS-99-91, Apr. 27, 1999).

Page 14                                                              GAO/T-HEHS/AIMD-99-294
                       Medicare Reform: Ensuring Fiscal
                       Sustainability While Modernizing the
                       Program Will Be Challenging

                       care rate increases teaches us the difficulty that this Subcommittee and
                       the Congress as a whole face in making Medicare payment reforms.

Dimensions of Reform   Concern continues to be voiced about the obvious gaps in protections for
                       Medicare beneficiaries, in contrast to what is available for most
Include Benefit        individuals with private employer-based coverage. At the same time,
Expansions and         competing concerns remain about the need to check Medicare’s cost
                       growth, even without adding new benefits. In response, the various reform
Financing Changes      options, including those favored by a majority of the Bipartisan
                       Commission, have two major dimensions: (1) expansion of Medicare’s
                       benefit package and (2) cost containment through financing and other
                       structural transformations. Two commonly discussed benefit expansions
                       are the inclusion of a prescription drug benefit and coverage for
                       extraordinary out-of-pocket costs, known as catastrophic coverage. The
                       financing reforms are reflected in three models: fee-for-service
                       modernization, Medicare+Choice modernization, and a premium support
                       system fashioned after FEHBP. Each of these models is designed, to
                       different degrees, to alter program incentives currently in place to make
                       beneficiaries more cost conscious and providers more efficient (See
                       table 2).

                       Table 2: Major Dimensions of Medicare Reform, by Option

                       Updated benefit package options                 Financing and organizational change
                       Coverage for outpatient prescription drugs      Fee-for-service modernization
                       Limit on beneficiary liability                  Medicare+Choice modernization
                                                                       FEHBP-type premium support

Benefit Expansion      Medicare’s basic benefit package largely reflects the offerings of the
                       commercial insurance market in 1965 when the program began. Although
Reforms                commercial policies have evolved since then, Medicare’s package—for the
                       most part—has not.6 For example, unlike many current commercial
                       policies, Medicare does not cover outpatient prescription drugs or cap
                       beneficiaries’ annual out-of-pocket spending. Some beneficiaries can
                       augment their coverage by participating in the Medicaid program (if their

                       6Some Medicare benefits have changed. For example, BBA added or expanded coverage for screening
                       mammograms, prostate cancer screening tests, bone mass measurements, and several screening or
                       preventive services.

                       Page 15                                                             GAO/T-HEHS/AIMD-99-294
                      Medicare Reform: Ensuring Fiscal
                      Sustainability While Modernizing the
                      Program Will Be Challenging

                      incomes are low enough), obtaining a supplemental insurance policy
                      privately or through an employer, or enrolling in a Medicare+Choice plan.
                      However, these options are not available to or affordable for all
                      beneficiaries. Furthermore, to the extent that Medicaid and supplemental
                      policies provide first-dollar coverage of services, the beneficiary
                      population’s sensitivity to service costs is dulled, contributing to some
                      continued excess utilization. Consequently, many reform advocates
                      believe that Medicare’s basic benefit package should be brought into line
                      with current commercial norms for active workers.

                       Two benefit reforms under discussion by policymakers are the inclusion
                      of prescription drugs and stop-loss coverage that caps beneficiary out-of-
                      pocket spending. Each involves myriad options, and assessing the merit of
                      these reforms would depend on the specifics included. For instance, a
                      Medicare prescription drug benefit could be targeted to provide coverage
                      for all beneficiaries, coverage only for beneficiaries with extraordinary
                      drug expenses, coverage only for low-income beneficiaries, or coverage
                      for selected drugs, such as those deemed to be cost beneficial. Such
                      coverage decisions would hinge on understanding how a new
                      pharmaceutical benefit would shift to Medicare portions of the out-of-
                      pocket costs borne by beneficiaries as well as those costs paid by
                      Medicaid, Medigap, or employer plans covering prescription drugs for
                      retirees. How would these new program costs be shared between
                      taxpayers and beneficiaries through premiums, deductibles, and
                      copayments? Would subsidies be provided to help low-income
                      beneficiaries not eligible for Medicaid with these costs? The
                      administration of the benefit raises other questions, such as “Who would
                      set and enforce drug coverage standards among the private health plans
                      participating in Medicare?” and, for traditional Medicare, “How would
                      reimbursable prices be set?” Price-setting options include using a formula
                      based on market prices, negotiating directly with manufacturers, or
                      contracting with pharmaceutical benefit management companies. The
                      Breaux-Thomas proposal favored targeting a drug benefit to low-income
                      beneficiaries while allowing those at higher incomes to buy into the
                      benefit. A catastrophic, or stop-loss, coverage benefit would similarly
                      entail its own design permutations and variables.

Financing and Other   Many Medicare reforms are designed to slow spending growth to keep the
                      program viable for the nation’s growing aged population. Although the
Structural Reforms    various proposals, including those considered by the Bipartisan
                      Commission, differ from one another in concept, they generally include
                      mechanisms to make beneficiaries more cost conscious, and incorporate
                      provider incentives to improve the efficiency of health care delivery. The

                      Page 16                                             GAO/T-HEHS/AIMD-99-294
                  Medicare Reform: Ensuring Fiscal
                  Sustainability While Modernizing the
                  Program Will Be Challenging

                  various financing and structural reforms consist of components of three
                  general models: fee-for-service modernization, Medicare+Choice
                  modernization, and a premium support system fashioned after FEHBP
                  (See table 3).

                  Table 3: Three Medicare Financing and Structural Reforms

                                     Fee-for-service      Medicare+Choice       FEHBP-type
                                     modernization        modernization         premium support
                  Pending under      Prospective          Health-based risk
                  BBA                payment systems      adjustment of rates
                                     for HHAs, hospital
                                     outpatient           Annual enrollment
                                     departments, and     and lock-in
                                                          Competitive pricing

                  Potential under    Selective            Plan savings shared   Premium based on
                  current            purchasing           with program and/or   offered or
                  proposals                               beneficiaries         negotiated price
                                     Negotiated pricing
                                                          Competitive           Beneficiary
                                     Case management      premium pricing       contribution based
                                     for complex and                            on plan cost
                                     chronic conditions
                                                                                Traditional Medicare
                                     Utilization                                incorporated
                                                                                Enhanced flexibility
                                     Medigap and                                Self-financed
                                     beneficiary cost-
                                     sharing reforms

                                     Expanded use of
                                     centers of

Fee-for-Service   BBA improved the efficiency of Medicare’s traditional fee-for-service
Modernization     program by substituting a variety of PPSs and other fee changes for its
                  cost-based reimbursement methods and outdated fees. Nevertheless,
                  Medicare is still not an efficient purchaser. Adjusting its systems of
                  administered prices and fees up or down to ensure beneficiary access or
                  to capture potential savings as the market changes poses an
                  overwhelming, if not impossible, challenge. Medicare largely remains a
                  passive bill payer, exercising little meaningful control over the volume of
                  services used. Proposals to modernize fee-for-service Medicare aim at

                  Page 17                                                       GAO/T-HEHS/AIMD-99-294
                  Medicare Reform: Ensuring Fiscal
                  Sustainability While Modernizing the
                  Program Will Be Challenging

                  providing flexibility to take advantage of market prices and introducing
                  some management of service utilization. In proposing to make fee-for-
                  service more fiscally accountable and to provide it with additional
                  flexibility to achieve these fiscal goals, the Bipartisan Commission also
                  discussed fee-for-service modernization as one of the critical elements of

                  Preferred provider arrangements, whereby insurers select certain
                  providers because of their willingness to accept lower fees and their
                  efficient style of practice, have become commonplace in the commercial
                  insurance market. By accepting negotiated or competitively bid fees that
                  fall below the usual levels, selected providers and the beneficiaries using
                  their services would be afforded certain advantages. The selected
                  providers with lower fees may experience increased demand, while
                  beneficiaries using their services could be subject to lower cost sharing.
                  Comparable arrangements have been proposed for fee-for-service
                  Medicare. Testing of this concept has been under way in the HCFA’s
                  Centers of Excellence demonstrations, where hospitals and physicians
                  agree to provide certain procedures for negotiated all-inclusive fees. BBA
                  also allowed for testing of competitive bidding for medical equipment and
                  supplies, with high bidders being excluded from serving Medicare

                  About 87 percent of beneficiaries in traditional Medicare face little cost
                  sharing in the form of deductibles or copayments for services by virtue of
                  their eligibility for Medicaid or their enrollment in a supplementary
                  insurance plan. While increases in cost sharing have been common in
                  private insurance to make beneficiaries sensitive to the value and cost of
                  services, it has been a cost-containment tool largely unavailable to
                  Medicare. Protecting low-income beneficiaries from financial barriers to
                  care remains a critical concern. One possible change in allowable
                  supplementary coverage would be to restructure cost sharing to heighten
                  beneficiary sensitivity to the cost of services while removing catastrophic
                  costs for those who have intensive health care needs.

                  Private indemnity insurers have moved to incorporate certain utilization
                  management techniques into their policies, such as prior authorization of
                  some expensive services and case management for persons with serious
                  chronic conditions. Although such techniques are increasingly common
                  among private insurers, their effectiveness on the population Medicare
                  covers is unknown.

Medicare+Choice   Medicare+Choice signaled a new phase in efforts to transform Medicare.
Modernization     Built on the program that allowed beneficiaries to enroll in participating

                  Page 18                                               GAO/T-HEHS/AIMD-99-294
Medicare Reform: Ensuring Fiscal
Sustainability While Modernizing the
Program Will Be Challenging

managed care plans, Medicare+Choice expands options available to
beneficiaries and substantially changes plan payment methods. By raising
payments in certain areas and allowing additional types of entities to
contract with Medicare, Medicare+Choice is intended to boost plan
participation and beneficiary enrollment. Payment changes are designed to
adjust the per capita rates to more accurately reflect enrollees’ expected
resource use and slow the growth of spending over time.

Among other payment changes, BBA required HCFA to implement by
January 1, 2000, a methodology to adjust plan payments to reflect the
health status of plan members. Favorable selection—that is, the tendency
for healthier beneficiaries to enroll in managed care plans—has resulted in
payments that are higher than warranted. The new risk adjustment method
developed for Medicare will more closely align payments to the expected
health care costs of plans’ enrollees. This will help produce the savings
originally envisioned when managed care enrollment options were offered
to Medicare beneficiaries and will foster competition among plans on the
basis of benefits and quality rather than enrollment strategies.

The design of the Medicare+Choice program does not, however, allow
taxpayers to benefit from the current competition among health plans. If a
plan can provide the Medicare package of benefits for less than the
Medicare payment, it must cover additional benefits, reduce fees, or both.7
Plans that offer enriched benefit packages—such as including coverage for
outpatient prescription drugs or routine physical examinations—may
attract beneficiaries and gain market share. Medicare, however, pays the
predetermined price even in fiercely competitive markets.

The Medicare+Choice program could be modified, through new
legislation, to require that taxpayers and beneficiaries both benefit from
health plan competition. The Congress could require that when payments
exceed a plan’s cost of services (including reasonable profit), part of the
savings be returned to the program and the rest be used to fund additional
benefits. Another alternative would be to set plan payments through
competitive bidding. In fact, BBA mandates a competitive pricing
demonstration. However, setting the parameters of a competitive pricing
system is a formidable task. Furthermore, this payment-setting approach
may be best suited to urban areas with high concentrations of managed
care members.

7Alternatively, plans can contribute to a stabilization fund that would allow them to provide additional
benefits or lower fees in future years. Before BBA, health plans also had the option of accepting a
lower capitation payment. In practice, plans preferred to add benefits to attract beneficiaries.

Page 19                                                                   GAO/T-HEHS/AIMD-99-294
                  Medicare Reform: Ensuring Fiscal
                  Sustainability While Modernizing the
                  Program Will Be Challenging

FEHBP-Type        Although modernizing traditional Medicare and Medicare+Choice could
Premium Support   improve the control of program spending, several incentives would remain
                  unaltered. For example, beneficiaries would remain partially insulated
                  from the cost consequences of their choices. They would not benefit
                  directly from selecting plans capable of delivering Medicare-covered
                  benefits less expensively because the premiums they pay might well
                  remain constant. Program payments to plans would continue to be
                  established administratively. The Breaux-Thomas proposal recognized
                  beneficiary sensitivity to cost as the critical element missing from the
                  current Medicare program. To remedy this situation, the Breaux-Thomas
                  proposal and others have proposed the adoption of an FEHBP-type
                  premium support for Medicare—a mechanism that could, at the same
                  time, serve to increase beneficiary sensitivity to the cost consequences of
                  their choices and enhance quality/cost based competition.

                  The two defining elements of an FEHBP-type of premium support are (1)
                  the establishment of premium levels for plans through negotiations
                  between the program and plans and (2) the linking of beneficiaries’
                  contributions to the premiums of the plans they join. This system makes
                  transparent to beneficiaries which plans operate less expensively and can
                  therefore charge lower premiums. In principle, it encourages competition
                  because plans that can deliver services more efficiently can lower
                  premiums and attract more enrollees. In practice, some caveats remain.
                  Differences in premiums can reflect more than variation in efficiency. For
                  example, plans may achieve savings through narrower provider networks
                  that, while capable of providing Medicare-covered benefits, could cause
                  beneficiaries inconveniences and delays in accessing services. Providing
                  beneficiaries adequate comparative information on plans’ expected and
                  actual performance becomes even more critical.

                  Because most beneficiaries participate—and are expected to continue to
                  participate—in traditional fee-for-service Medicare, its incorporation into
                  the FEHBP-type system is seen as important. Under current arrangements,
                  the only premium for participating in the traditional program is the fixed
                  monthly amount that beneficiaries voluntarily pay to receive coverage for
                  SMI or to be eligible to enroll in a Medicare+Choice plan. Because the
                  premium amount represents only 25 percent of the program’s cost and is
                  deducted from beneficiaries’ monthly Social Security payments,
                  participants are not as aware of the cost of the traditional Medicare
                  program. The Breaux-Thomas proposal incorporates traditional Medicare
                  as another plan under an FEHBP-type premium support system.
                  Traditional Medicare would propose and negotiate premiums like any
                  other plan and be expected to be self-financing and self-sustaining.
                  Recognizing the challenge the latter requirement creates, the proposal

                  Page 20                                              GAO/T-HEHS/AIMD-99-294
               Medicare Reform: Ensuring Fiscal
               Sustainability While Modernizing the
               Program Will Be Challenging

               would also provide traditional Medicare more flexibility to manage costs
               using tools similar to proposals for fee-for-service modernization.

               Incorporating traditional Medicare as another plan puts all plans on equal
               footing and maximizes beneficiaries awareness of costs. However, the
               sheer size of the traditional program creates questions. How much
               flexibility can be granted to traditional Medicare, given its market power?
               What will it mean for a public plan to be self-sustaining and self-financing?
               Can it generate and retain reserves as a protection against future losses?
               How will losses be managed? The insolvency of traditional Medicare,
               which may continue to enroll the majority of beneficiaries and may be the
               only plan serving many areas of the country, is not acceptable. The
               dilemma of how to guarantee traditional Medicare’s solvency in the
               context of an FEHBP-type premium support system needs to be

               An FEHBP-type premium support system would increase the importance
               of effective program management and design. In particular, the ability to
               risk-adjust premiums to reflect the variation in health status of
               beneficiaries joining different plans would become paramount.
               Participating plans that attract a disproportionate number of more
               seriously ill and costly beneficiaries would be at a competitive
               disadvantage if their premium revenues were not adjusted adequately. In
               turn, enrollees in those plans might find services compromised by the
               plans’ financial situation. Inadequate risk adjustment may be a particular
               problem for the traditional Medicare plan, which may function as a refuge
               for many chronically ill persons who find selecting among plans
               challenging and opt for something familiar.

Concluding     In determining how to reform the Medicare program, much is at stake—
               not only the future of Medicare itself but also assuring the nation’s future
Observations   fiscal flexibility to pursue other important national goals and programs.
               Mr. Chairman, I feel that the greatest risk lies in doing nothing to improve
               the program’s long-term sustainability or, worse, in adopting changes that
               may aggravate the long-term financial outlook for the program and the

               It is my hope that we will think about the unprecedented challenge facing
               future generations in our aging society. Relieving them of some of the
               burden of today’s financing commitments would help fulfill this
               generation’s fiduciary responsibility. It would also preserve some capacity
               to make their own choices by strengthening both the budget and the
               economy they inherit. While not ignoring today’s needs and demands, we

               Page 21                                               GAO/T-HEHS/AIMD-99-294
Medicare Reform: Ensuring Fiscal
Sustainability While Modernizing the
Program Will Be Challenging

should remember that surpluses can be used as an occasion to promote
the transition to a more sustainable future for our children and

General fund infusions and expanded benefits may well be a necessary
part of any major reform initiative. Updating the benefit package may be a
necessary part of any realistic reform program to address the legitimate
expectations of an aging society for health care, both now and in the
future. Such changes, however, need to be considered as part of a broader
initiative to address Medicare’s current fiscal imbalance and promote the
program’s longer-term sustainability. In addition, the Congress should
consider adequate fiscal incentives to control costs and a targeting
strategy in connection with any proposal to provide any new benefit such
as prescription drugs.

I am under no illusions about how difficult Medicare reform will be. The
Breaux-Thomas proposal addresses the principal elements of reform, but
many of the details need to be worked out. Those details will determine
whether reforms will be both effective and acceptable—that is, seen as
guaranteeing the sustainability and preservation of the Medicare
entitlement, a key goal on which there appears to be consensus.
Experience shows that forecasts can be far off the mark. Benefit
expansions are often permanent, while the more belt-tightening payment
reforms—vulnerable to erosion—could be discarded altogether. Recent
experience implementing BBA reforms provides us some sobering lessons
about the difficulty of undertaking reform and the need for effectiveness,
flexibility, and steadfastness. Effectiveness involves collecting the data
necessary to assess impact—separating the transitory from the permanent
and the trivial from the important. Flexibility is critical to make changes
and refinements when conditions warrant and when actual outcomes
differ substantially from the expected ones. Steadfastness is needed when
particular interests pit the primacy of their needs against the more global
interest of making Medicare affordable, sustainable, and effective for
current and future generations of Americans. This makes it all the more
important that any new benefit expansion be carefully designed to balance
needs and affordability, both now and over the longer term.

The bottom line is that surpluses represent both an opportunity and an
obligation. We have an opportunity to use our unprecedented economic
wealth and fiscal good fortune to address today’s needs but an obligation
to do so in a way that improves the prospects for future generations. This
generation has a stewardship responsibility to future generations to
reduce the debt burden they inherit, to provide a strong foundation for
future economic growth, and to ensure that future commitments are both

Page 22                                              GAO/T-HEHS/AIMD-99-294
                   Medicare Reform: Ensuring Fiscal
                   Sustainability While Modernizing the
                   Program Will Be Challenging

                   adequate and affordable. Prudence requires making the tough choices
                   today while the economy is healthy and the workforce is relatively large.
                   National saving pays future dividends over the long term but only if
                   meaningful reform begins soon. Entitlement reform is best done with
                   considerable lead time to phase in changes and before the changes that
                   are needed become dramatic and disruptive. The prudent use of the
                   nation’s current and projected budget surpluses combined with
                   meaningful Medicare and Social Security program reforms can help
                   achieve both of these goals.

                   Mr. Chairman, this concludes my prepared statement. I will be happy to
                   answer any questions you or other Members of the Subcommittee may

GAO Contacts and   If you have any questions regarding this testimony, please call Paul L.
                   Posner, Director of Budget Issues, at (202) 512-9573 or William J. Scanlon,
Acknowledgments    Director of Health Financing and Public Health Issues at (202) 512-7114.
                   Other individuals who made key contributions include Linda F. Baker,
                   James Cosgrove, Hannah F. Fein, James R. McTigue, Walter Ochinko, and
                   Deborah Spielberg.


                   Page 23                                              GAO/T-HEHS/AIMD-99-294
Ordering Information

The first copy of each GAO report and testimony is free.
Additional copies are $2 each. Orders should be sent to the
following address, accompanied by a check or money order made
out to the Superintendent of Documents, when necessary. VISA and
MasterCard credit cards are accepted. Orders for 100 or more copies
to be mailed to a single address are discounted 25 percent.

Orders by mail:

U.S. General Accounting Office
P.O. Box 37050
Washington, DC 20013

or visit:

Room 1100
700 4th St.,NW (Corner of 4th and G Sts. NW)
U.S. General Accounting Office
Washington, DC

Orders may also be placed by calling (202) 512-6000 or by using
fax number (202) 512-6061 or TDD (202) 512-2537.

Each day, GAO issues a list of newly available reports and
testimony. To receive facsimile copies of the daily list or any list
from the past 30 days, please call (202) 512-6000 using a touchtone
phone. A recorded menu will provide information on how to obtain
these lists.

For information on how to access GAO reports on the INTERNET,
send an e-mail message with "info" in the body to:


or visit GAO's World Wide Web Home Page at

United States
General Accounting Office           Bulk Rate
Washington, DC 20548-0001      Postage & Fees Paid
                                Permit No. G100
Official Business
Penalty for Private Use $300
Address Correction Requested