oversight

Medicare: Observations on Program Sustainability and Strategies to Control Spending on Any Proposed Drug Benefit

Published by the Government Accountability Office on 2003-04-09.

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

                           United States General Accounting Office

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


For Release on Delivery
Expected at 11:00 a.m.
Wednesday, April 9, 2003   MEDICARE
                           Observations on Program
                           Sustainability and Strategies
                           to Control Spending on Any
                           Proposed Drug Benefit
                           Statement of David M. Walker
                           Comptroller General of the United States




GAO-03-650T
                                                April 9, 2003


                                                MEDICARE

                                                Observations on Program Sustainability
Highlights of GAO-03-650T, a testimony
before the Committee on Ways and                and Strategies to Control Spending for
Means, House of Representatives
                                                Any Proposed Drug Benefit


The House Committee on Ways and                 The recent publication of the 2003 Medicare Trustees’ annual report reminds
Means is holding a hearing on                   us that Medicare in its current condition—without a prescription drug
modernizing Medicare and                        benefit—is not sustainable. At the same time there are growing concerns
integrating prescription drugs into             about gaps in the Medicare program, most notably the lack of outpatient
the program.                                    prescription drug coverage, that may leave Medicare’s most vulnerable
There are growing concerns about
                                                beneficiaries with high out-of-pocket costs.
gaps in the Medicare program,
most notably the lack of outpatient             The Hospital Insurance (HI) portion of Medicare faces a huge projected
prescription drug coverage, which               financial imbalance that has worsened significantly in the past year. Under
may leave Medicare’s most                       the Trustees’ 2003 intermediate estimates, the present value of HI’s actuarial
vulnerable beneficiaries with high              deficit is $6.2 trillion—a 20 percent increase over the prior year. Beginning
out-of-pocket costs.                            in 2013, HI’s program outlays are expected to begin to exceed program tax
                                                revenues, putting increased pressure on the federal budget to raise the
At the same time, Medicare already              resources necessary to meet program costs. In addition, Supplementary
faces a huge projected financial                Medical Insurance is projected to place an increasing burden on taxpayers
imbalance that has worsened                     and beneficiaries.
significantly in the past year.

This statement discusses the                    GAO’s long-term budget simulations show that, absent meaningful
challenges of adding a drug benefit             entitlement reforms, demographic trends and rising health care spending
to Medicare in the context of the               will drive escalating federal deficits and debt. Neither slowing the growth of
program’s current and projected                 discretionary spending nor allowing the 2001 tax reductions to sunset will
financial condition. It also                    eliminate the imbalance. While additional economic growth will help ease
examines program design issues to               our burden, the potential fiscal gap is too great to grow our way out of the
be considered with respect to                   problem.
administering any proposed drug
benefit. Specifically, it discusses             The application of basic health insurance principles to any proposed benefit
how private sector health plans                 could help moderate the cost for both beneficiaries and taxpayers. These
have used entities called pharmacy
benefit managers (PBM) to control
                                                include beneficiary protections against the risk of catastrophic medical
drug benefit expenditures.                      expenses and premium contributions and cost-sharing arrangements that
                                                encourage beneficiaries to be cost conscious.

                                                The private sector’s use of PBMs to control drug expenditures may be
                                                instructive for Medicare, but the program’s unique role and nature may
                                                moderate how such entities would be used and the potential efficiency gains
                                                afforded in attempting to transfer PBM-like strategies to Medicare.




www.gao.gov/cgi-bin/getrpt?GAO-03-650T.

To view the full statement, click on the link
above. For more information, contact William
J. Scanlon at 202 512-7114.
Mr. Chairman and Members of the Committee:

I am pleased to be here today as you discuss issues related to an
outpatient prescription drug benefit for Medicare beneficiaries. There are
growing concerns about gaps in the Medicare program, most notably the
lack of outpatient prescription drug coverage, which may leave Medicare’s
most vulnerable beneficiaries with high out-of-pocket costs. Recent
estimates suggest that, at any point in time, about a third of Medicare
beneficiaries lack prescription drug coverage. The rest have at least some
drug coverage through various sources—most commonly employer-
sponsored health plans—although recent evidence indicates that this
coverage is beginning to erode.

At the same time, however, the recent publication of the 2003 Trustees’
annual report reminds us that Medicare in its current condition—with no
prescription drug benefit—already faces a huge projected financial
imbalance that has worsened significantly in the past year. Furthermore,
as the Medicare Trustees made clear over 10 years ago, the current
Medicare program is not fiscally sustainable in its present form.

In 10 years, Hospital Insurance (HI) Trust Fund outlays will begin to
exceed tax receipts, and by 2026 the HI trust fund will be exhausted.
However, trust fund insolvency does not mean the program will cease to
exist; program tax revenues will continue to cover a portion of projected
annual expenditures.1

The huge fiscal pressures created by the retirement of the baby boom
generation and rising health care costs are on our 10-year budget horizon.
Between now and 2035, the number of people age 65 and older will double.
Federal health and retirement spending are expected to surge as people
live longer and spend more time in retirement. In addition, advances in
medical technology are likely to keep pushing up the cost of providing
health care. Moreover, the baby boomers will have fewer workers to
support them in retirement.

We must also remember that Medicare has grown substantially as a
percent of the federal budget since its enactment in 1965. In addition, it is


1
 Under the Trustees 2003 intermediate assumptions, revenues from the HI payroll tax and
the taxation of certain Social Security benefits are initially projected to cover about three-
fourths of projected expenditures once the trust fund is exhausted. This ratio, however, is
projected to decline rapidly.




Page 1                                                                          GAO-03-650T
expected to represent an increasing percentage of the federal budget in
the years ahead. After a brief slowdown in the late 1990s, Medicare
spending growth has recently accelerated. In fiscal year 2001, growth in
program spending reached nearly 9 percent, with spending on certain
services increasing much more rapidly. For example, spending for home
health services grew about 30 percent and spending for skilled nursing
facility care grew slightly over 20 percent. For the first 5 months of fiscal
year 2003, Medicare spending has been growing at 7.6 percent.2

A significant problem that hobbles Medicare’s ability to achieve a
desirable degree of efficiency is that the program too often pays overly
generous rates for certain services and products. For example, for certain
services, our recent work has shown substantially higher Medicare
payments relative to providers’ costs—as much as 35 percent higher for
home health care and 19 percent higher for skilled nursing facility care.3
Similarly, Medicare has overpaid for various medical products. In 2001, we
reported that Medicare paid over $1 billion more than other purchasers in
2000 for certain outpatient drugs that the program covers. Excessive
payments hurt not only the taxpayers but also the program’s beneficiaries
or their supplemental insurers, as beneficiaries are generally liable for
copayments equal to 20 percent of Medicare’s approved fee. For certain
outpatient drugs, Medicare’s payments to providers were so high that the
beneficiaries’ copayments exceeded the price at which providers could
buy the drugs. The Centers for Medicare & Medicaid Services (CMS) has
not acted on our recommendation that Medicare establish payment levels
for drugs more closely related to actual market transaction costs, using
information available to other public programs that pay at lower rates.4

In the face of these short-term and long-term cost pressures, I continue to
maintain that substantive financing and programmatic reforms are
necessary to put Medicare on a sustainable footing for the future. These
fundamental reforms are vital to reducing the program’s growth, which
threatens to absorb ever-increasing shares of the nation’s budgetary and



2
Congressional Budget Office, Monthly Budget Review (Washington, D.C.: Mar. 10, 2003).
3
 See U.S. General Accounting Office, Medicare Home Health Care: Payments to Home
Health Agencies Are Considerably Higher than Costs, GAO-02-663 (Washington, D.C:
May 6, 2002) and Skilled Nursing Facilities: Medicare Payments Exceed Costs for Most
but Not All Facilities, GAO-03-183 (Washington, D.C: Dec. 31, 2002).
4
U.S. General Accounting Office, Medicare: Payments for Covered Outpatient Drugs
Exceed Providers’ Costs, GAO-01-1118 (Washington, D.C.: Sept. 21, 2001).




Page 2                                                                   GAO-03-650T
    economic resources. Thus, any proposals to help seniors with the costs of
    prescription drugs would need to be carefully crafted to avoid further
    erosion of the projected financial condition of the Medicare program.
    Stated differently, it will be prudent to adopt a modified Hippocratic oath
    for Medicare reform—namely, any such reform proposals should “do no
    further harm” to Medicare’s already serious long-range financial
    imbalance.

    As you deliberate on ways to modernize Medicare’s benefit package while
    striving for program sustainability, I would like to highlight several key
    considerations:

•   The traditional measure of HI Trust Fund solvency is a misleading gauge of
    Medicare’s financial health. Long before the HI Trust Fund is projected to
    be insolvent, pressures on the rest of the federal budget will grow as HI’s
    projected cash flow turns negative and the gap between program tax
    revenues and expenditures escalates. Moreover, a focus on the financial
    status of HI ignores the increasing burden Supplemental Medical
    Insurance (SMI)—Medicare part B—will place on taxpayers and
    beneficiaries.

•   GAO’s most recent long-term budget simulations continue to show that,
    absent meaningful entitlement reforms, demographic trends and rising
    health care spending will drive escalating federal deficits and debt. To
    obtain budget balance, massive spending cuts, tax increases, or some
    combination of the two would be necessary. Neither slowing the growth of
    discretionary spending nor allowing the 2001 tax reductions to sunset will
    eliminate the imbalance. In addition, while additional economic growth
    will help ease our burden, the potential fiscal gap is too great to grow our
    way out of the problem.

•   Under the huge budgetary pressures that we are sure to face in the coming
    years, we must set priorities so that any benefit expansions are in line with
    available resources. In this regard, the application of basic health
    insurance principles to any proposed benefit could help moderate the cost
    for both beneficiaries and taxpayers. Under these principles, beneficiaries
    receive protections against the risk of catastrophic medical expenses
    while remaining conscious of the cost of care through their premium
    contributions and cost-sharing arrangements. Given our already huge
    Medicare financial imbalance, it is also important that benefit expansion
    proposals include targeting mechanisms to ensure that federal support is
    directed at the beneficiaries with the greatest financial risk.




    Page 3                                                           GAO-03-650T
                          •   The private sector’s use of entities called pharmacy benefit managers for
                              controlling drug expenditures may be instructive for Medicare, but the
                              program’s unique role and nature may moderate how these strategies will
                              be used and the potential efficiency gains afforded in attempting to
                              transfer these strategies to Medicare.


                              Today the Medicare program faces a long-range and fundamental financing
Outlook Worsening             problem driven by known demographic trends and projected escalation of
for Medicare’s Long-          health care spending beyond general inflation. The lack of an immediate
                              crisis in Medicare financing affects the nature of the challenge, but it does
Term Sustainability           not eliminate the need for change. Within the next 10 years, the first baby
                              boomers will begin to retire, putting increasing pressure on the federal
                              budget. From the perspectives of the program, the federal budget, and the
                              economy, Medicare in its present form is not sustainable. Acting sooner
                              rather than later would allow changes to be phased in so that the
                              individuals who are most likely to be affected, namely younger and future
                              workers, will have time to adjust their retirement planning while helping
                              to avoid related “expectation gaps.” Since there is considerable confusion
                              about Medicare’s current financing arrangements, I would like to begin by
                              describing the nature, timing, and extent of the financing problem.


Demographic Trends and        As you know, Medicare consists of two parts—HI and SMI. HI, which pays
Expected Rise in Health       for inpatient hospital stays, skilled nursing care, hospice, and certain home
Care Costs Drive              health services, is financed by a payroll tax. Like Social Security, HI has
                              always been largely a pay-as-you-go system. SMI, which pays for physician
Medicare’s Long-Term          and outpatient hospital services, diagnostic tests, and certain other
Financing Problem             medical services, is financed by a combination of general revenues and
                              beneficiary premiums. Beneficiary premiums pay for about one-fourth of
                              SMI benefits, with the remainder financed by general revenues. These
                              complex financing arrangements mean that current workers’ taxes




                              Page 4                                                          GAO-03-650T
                                                     primarily pay for current retirees’ benefits except for those financed by
                                                     SMI premiums.5

                                                     As a result, the relative numbers of workers and beneficiaries have a major
                                                     impact on Medicare’s financing. The ratio, however, is changing. In the
                                                     future, relatively fewer workers will be available to shoulder Medicare’s
                                                     financial burden. In 2002 there were 4.9 working-age persons (18 to 64
                                                     years) per elderly person, but by 2030, this ratio is projected to decline to
                                                     2.8. For the HI portion of Medicare, in 2002 there were nearly 4 covered
                                                     workers per HI beneficiary. Under their intermediate 2003 estimates, the
                                                     Medicare Trustees project that by 2030 there will be only 2.4 covered
                                                     workers per HI beneficiary. (See fig. 1.)

Figure 1: Ratio of HI-Covered Workers to Beneficiaries

 Workers per HI beneficiary
 5
      4.6

                       4.1             4.1
                                              4.0
 4
                                                         3.7



 3                                                                 2.9

                                                                              2.4
                                                                                          2.3        2.2         2.1
                                                                                                                            2.0
 2



 1



 0
       1970           1980             1990   2000       2010     2020       2030       2040        2050        2060       2070
 Source: CMS, Office of the Actuary.

                                                     Note: Projections based on the intermediate assumptions of The 2003 Annual Report of the Boards of
                                                     Trustees of the Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust
                                                     Funds.




                                                     5
                                                      Another small source of funding derives from the tax treatment of Social Security benefits.
                                                     Under certain circumstances, up to 85 percent of an individual’s or couple’s Social Security
                                                     benefits are subject to income taxes. Under present law, the Old-Age and Survivors
                                                     Insurance (OASI) and Disability Insurance (DI) Trust Funds are credited with the income
                                                     taxes attributable to the taxation of the first 50 percent of OASDI benefit payments. The
                                                     remainder of the income taxes attributable to the taxation of up to 85 percent of OASDI
                                                     benefit payments is credited to the HI Trust Fund. Any other income taxes paid by retirees
                                                     would also help finance the general revenue contribution to SMI.




                                                     Page 5                                                                            GAO-03-650T
The demographic challenge facing the system has several causes. People
are retiring early and living longer. As the baby boom generation ages, the
share of the population age 65 and over will escalate rapidly. A falling
fertility rate is the other principal factor underlying the growth in the
elderly’s share of the population. In the 1960s, the fertility rate was an
average of 3 children per woman. Today it is a little over 2, and by 2030 it
is expected to fall to 1.95—a rate that is below replacement. The
combination of the aging of the baby boom generation, increased
longevity, and a lower fertility rate will drive the elderly as a share of total
population from today’s 12 percent to almost 20 percent in 2030.

Taken together, these trends threaten both the financial solvency and
fiscal sustainability of this important program. Labor force growth will
continue to decline and by 2025 is expected to be less than a third of what
it is today. (See fig. 2.) Relatively fewer workers will be available to
produce the goods and services that all will consume. Without a major
increase in productivity, low labor force growth will lead to slower growth
in the economy and slower growth of federal revenues. This in turn will
only accentuate the overall pressure on the federal budget. This slowing
labor force growth is not always recognized as part of the Medicare
debate, but it is expected to affect the ability of the federal budget and the
economy to sustain Medicare’s projected spending in the coming years.




Page 6                                                              GAO-03-650T
                              Figure 2: Labor Force Growth

                              Percentage change (5-yr moving average)
                              3




                              2




                              1




                              0
                                  1970     1980       1990       2000        2010       2020       2030       2040   2050   2060   2070   2080
                              Source: Social Security Administration, Office of the Chief Actuary, and GAO.

                              Note: GAO analysis based on the intermediate assumptions of The 2003 Annual Report of the Board
                              of Trustees of the Federal Old-Age and Survivors Insurance and the Federal Disability Insurance
                              Trust Funds. Percentage change is calculated as a centered 5-year moving average.


                              The demographic trends I have described will affect both Medicare and
                              Social Security, but Medicare presents a much greater, more complex, and
                              more urgent challenge. Unlike Social Security, Medicare spending growth
                              rates reflect not only a burgeoning beneficiary population, but also the
                              escalation of health care costs at rates well exceeding general rates of
                              inflation. The growth of medical technology has contributed to increases
                              in the number and quality of health care services. Moreover, the actual
                              costs of health care consumption are not transparent. Third-party payers
                              largely insulate covered consumers from the cost of health care decisions.
                              These factors and others contribute to making Medicare a greater and
                              more complex fiscal challenge than Social Security.


HI’s Trust Fund Faces         Current projections of future HI income and outlays illustrate the timing
Cash Flow Problems Long       and severity of Medicare’s fiscal challenge. Today, the HI Trust Fund takes
before the HI Trust Fund Is   in more in taxes than it spends. Largely because of the known
                              demographic trends I have described, this situation will change. Under the
Projected to Be Insolvent     Trustees’ 2003 intermediate assumptions, program outlays are expected to
                              begin to exceed program tax revenues in 2013. (See fig. 3.) To finance
                              these cash deficits, HI will need to draw on the special-issue Treasury
                              securities acquired during the years of cash surpluses. For HI to “redeem”



                              Page 7                                                                                               GAO-03-650T
                                                         its securities, the government will need to obtain cash through some
                                                         combination of increased taxes, spending cuts, and/or increased
                                                         borrowing from the public (or, if the unified budget is in surplus, less debt
                                                         reduction than would otherwise have been the case). Neither the decline
                                                         in the cash surpluses nor the cash deficits will affect the payment of
                                                         benefits, but the negative cash flow will place increased pressure on the
                                                         federal budget to raise the resources necessary to meet the program’s
                                                         ongoing costs. This pressure will only increase when Social Security also
                                                         experiences negative cash flow and joins HI as a net claimant on the rest
                                                         of the budget.6

Figure 3: Medicare’s HI Trust Fund Faces Cash Deficits as Baby Boomers Retire

Billions of 2003 dollars
200


100


   0


-100
                                               Medicare HI
                                               cash deficit
-200
                                               2013

-300


-400

        2000              2005                 2010           2015               2020           2025             2030             2035             2040

                                                                  Cash surplus

                                                                  Cash deficit

Source: CMS, Office of the Actuary, and GAO.

                                                         Note: GAO analysis based on the intermediate assumptions of The 2003 Annual Report of the
                                                         Boards of Trustees of the Federal Hospital Insurance and Federal Supplementary Medical Insurance
                                                         Trust Funds.


                                                         The gap between HI income and costs shows the severity of HI’s financing
                                                         problem over the longer term. This gap can also be expressed relative to
                                                         taxable payroll (the HI Trust Fund’s funding base) over a 75-year period.



                                                         6
                                                          Under the Trustees’ intermediate 2003 projections, this will occur for Social Security
                                                         (OASDI) in 2018.




                                                         Page 8                                                                           GAO-03-650T
This year, under the Trustees’ 2003 intermediate estimates, the 75-year
actuarial deficit is projected to be 2.40 percent of taxable payroll—a
significant increase from last year’s projected deficit of 2.02 percent. This
means that to bring the HI Trust Fund into balance over the 75-year
period, either program outlays would have to be immediately reduced by
42 percent or program income immediately increased by 71 percent, or
some combination of the two. These estimates of what it would take to
achieve 75-year trust fund solvency understate the extent of the problem
because the program’s financial imbalance gets worse in the 76th and
subsequent years. As each year passes, we drop a positive year and add a
much bigger deficit year.

The projected exhaustion date of the HI Trust Fund is a commonly used
indicator of HI’s financial condition. Under the Trustees’ 2003 intermediate
estimates, the HI Trust Fund is projected to exhaust its assets in 2026. This
solvency indicator provides information about HI’s financial condition, but
it is not an adequate measure of Medicare’s sustainability for several
reasons. In fact, the solvency measure can be misleading and can serve to
give a false sense of security as to Medicare’s true financial condition.
Specifically, HI Trust Fund balances do not provide meaningful
information on the government’s fiscal capacity to pay benefits when
program cash inflows fall below program outlays. As I have described, the
government would need to come up with cash from other sources to pay
for benefits once outlays exceeded program tax income.

In addition, the HI Trust Fund measure provides no information on SMI.
SMI’s expenditures, which currently account for about 43 percent of total
Medicare spending, are projected to grow even faster than those of HI in
the near future. Moreover, Medicare’s complex structure and financing
arrangements mean that a shift of expenditures from HI to SMI can extend
the solvency of the HI Trust Fund, creating the appearance of an
improvement in the program’s financial condition. For example, the
Balanced Budget Act of 1997 modified the home health benefit, which
resulted in shifting a portion of home health spending from the HI Trust
Fund to SMI. Although this shift extended HI Trust Fund solvency, it
increased the draw on general revenues and beneficiary SMI premiums
while generating little net savings.

Ultimately, the critical question is not how much a trust fund has in assets,
but whether the government as a whole and the economy can afford the
promised benefits now and in the future and at what cost to other claims
on available resources. To better monitor and communicate changes in
future total program spending, new measures of Medicare’s sustainability


Page 9                                                            GAO-03-650T
                                                              are needed. As program changes are made, a continued need will exist for
                                                              measures of program sustainability that can signal potential future fiscal
                                                              imbalance. Such measures might include the percentage of program
                                                              funding provided by general revenues, the percentage of total federal
                                                              revenues or gross domestic product (GDP) devoted to Medicare, or
                                                              program spending per enrollee. As such measures are developed,
                                                              questions would need to be asked about actions to be taken if projections
                                                              showed that program expenditures would exceed the chosen level.


Absent Reform of                                              Taken together, Medicare’s HI and SMI expenditures are expected to
Medicare and Other                                            increase dramatically, rising from about 12 percent of federal revenues in
Entitlements for the                                          2002 to more than one-quarter by midcentury. The budgetary challenge
                                                              posed by the growth in Medicare becomes even more significant in
Elderly, Budgetary                                            combination with the expected growth in Medicaid and Social Security
Flexibility Will Disappear                                    spending. As shown in figure 4, Medicare, Medicaid, and Social Security
                                                              have already grown from 13 percent of federal spending in 1962 before
                                                              Medicare and Medicaid were created to 42 percent in 2002.

Figure 4: Composition of Federal Spending by Budget Function, 1962, 1982, and 2002

                           1962                                                             1982                  2002




                                                                                                                         17%
                                                                                                   25%
         31%                                                           34%                                32%
                                        50%
                                                                                                                               23%
                                                                                                    21%
     6%                                                                                                   9%
                                                                          11%
                                                                                                                  19%
                  13%
                                                                                        9%

                                                                         Defense

                                                                         Social Security

                                                                         Medicare and Medicaid

                                                                         Net interest

                                                                         All other spending

Source: Budget of the United States Government, FY 2004, Office of Management and Budget.




                                                              Page 10                                                          GAO-03-650T
                                                     This growth in spending on federal entitlements for retirees will become
                                                     increasingly unsustainable over the longer term, compounding an ongoing
                                                     decline in budgetary flexibility. Over the past few decades, spending on
                                                     mandatory programs has consumed an ever-increasing share of the federal
                                                     budget.7 In 1962, prior to the creation of the Medicare and Medicaid
                                                     programs, spending for mandatory programs plus net interest accounted
                                                     for about 32 percent of total federal spending. By 2002, this share had
                                                     almost doubled to approximately 63 percent of the budget. (See fig. 5.)

Figure 5: Federal Spending for Mandatory and Discretionary Programs, Fiscal Years 1962, 1982, and 2002

                      1962                                                  1982                                    2002

                    6%
                                                                   11%                                           9%



          26%                                                                                                                37%
                                                                                    44%

                                68%                          45%
                                                                                                          54%




                                                             Discretionary

                                                             Mandatory

                                                             Net interest
Source: Budget of the United States Government: Fiscal Year 2004, Office of Management and Budget.




                                                     In much of the past decade, reductions in defense spending helped
                                                     accommodate the growth in these entitlement programs. However, even
                                                     before the terrorist attacks of September 11, 2001, this ceased to be a
                                                     viable option. Indeed, spending on defense and homeland security will
                                                     grow as we seek to combat new threats to our nation’s security.



                                                     7
                                                      “Mandatory spending” refers to outlays for entitlement programs such as food stamps,
                                                     Medicare, and veterans’ pensions; payment of interest on the public debt; and outlays for
                                                     certain nonentitlement programs such as payments to states from Forest Service receipts.
                                                     In 2002 Social Security, Medicare, and Medicaid accounted for over 71 percent of
                                                     mandatory spending.




                                                     Page 11                                                                     GAO-03-650T
GAO prepares long-term budget simulations that seek to illustrate the
likely fiscal consequences of the coming demographic tidal wave and
rising health care costs. These simulations continue to show that to move
into the future with no changes in federal retirement and health programs
is to envision a very different role for the federal government. Assuming,
for example, that the tax reductions enacted in 2001 do not sunset and
discretionary spending keeps pace with the economy, by midcentury
federal revenues may not even be adequate to pay Social Security and
interest on the federal debt. Spending for the current Medicare program—
without any additional new benefits—is projected to account for more
than one-quarter of all federal revenues. To obtain budget balance,
massive spending cuts, tax increases, or some combination of the two
would be necessary. (See fig. 6.) Neither slowing the growth of
discretionary spending nor allowing the tax reductions to sunset
eliminates the imbalance. In addition, while additional economic growth
would help ease our burden, the projected fiscal gap is too great for us to
grow our way out of the problem.




Page 12                                                         GAO-03-650T
Figure 6: Composition of Spending as a Share of GDP Assuming Discretionary
Spending Grows with GDP after 2003 and the 2001 Tax Cuts Do Not Sunset

    Percentage of GDP
    50



    40



    30
                 Revenue



    20



    10



     0
                 2000                   2015                 2030                      2050
         Fiscal year
                 All other spending

                Medicare and Medicaid

                Social Security

                Net interest
Source: GAO’s March 2003 analysis.

Note: Assumes currently scheduled Social Security benefits are paid in full throughout the simulation
period. Social Security and Medicare projections are based on the Trustees’ 2003 intermediate
assumptions.


Indeed, long-term budgetary flexibility is about more than Social Security
and Medicare. While these programs dominate the long-term outlook, they
are not the only federal programs or activities that bind the future. The
federal government undertakes a wide range of programs, responsibilities,
and activities that obligate it to future spending or create an expectation
for spending. A recent GAO report describes the range and measurement
of such fiscal exposures—from explicit liabilities such as environmental
cleanup requirements to the more implicit obligations presented by life-
cycle costs of capital acquisition or disaster assistance.8 Making
government fit the challenges of the future will require not only dealing



8
 U.S. General Accounting Office, Fiscal Exposures: Improving the Budgetary Focus on
Long-Term Costs and Uncertainties, GAO-03-213 (Washington, D.C.: Jan. 24, 2003).




Page 13                                                                               GAO-03-650T
                        with the drivers—such as entitlements for the elderly—but also looking at
                        the range of other federal activities. A fundamental review of what the
                        federal government does and how it does it will be needed. This involves
                        looking at the base of all major spending and tax policies to assess their
                        appropriateness, priority, affordability, and sustainability in the years
                        ahead.


                        At the same time, it is important to look beyond the federal budget to the
Medicare Is Projected   economy as a whole. Figure 7 shows the total future draw on the economy
to Absorb Ever-         represented by Medicare, Medicaid, and Social Security. Under the 2003
                        Trustees’ intermediate estimates and the Congressional Budget Office’s
Increasing Shares of    (CBO) most recent long-term Medicaid estimates, spending for these
the Economy             entitlement programs combined will grow to 14 percent of GDP in 2030
                        from today’s 8.4 percent. Taken together, Social Security, Medicare, and
                        Medicaid represent an unsustainable burden on future generations.

                        Figure 7: Social Security, Medicare, and Medicaid Spending as a Percentage of GDP

                        Percentage of GDP
                        25



                        20



                        15                                                                             Medicaid



                        10
                                                                                                       Medicare



                         5
                                                                                                       Social Security


                         0
                         2000            2010            2020            2030            2040            2050            2060     2070
                        Source: CMS, Office of the Actuary, SSA, Office of the Actuary, CBO and GAO.

                        Note: Projections based on the intermediate assumptions of the 2003 Trustees’ Reports, CBO’s
                        March 2003 short-term Medicaid estimates, and CBO’s June 2002 Medicaid long-term projections
                        under midrange assumptions.


                        Although real incomes are projected to continue to rise, they are expected
                        to grow more slowly than has historically been the case. At the same time,
                        the demographic trends and projected rates of growth in health care
                        spending I have described will mean rapid growth in entitlement spending.



                        Page 14                                                                                                 GAO-03-650T
Taken together, these projections raise serious questions about the
capacity of the relatively smaller number of future workers to absorb the
rapidly escalating costs of these programs.

As HI trust fund assets are redeemed to pay Medicare benefits and SMI
expenditures continue to grow, the program will constitute a claim on real
resources in the future. As a result, taking action now to increase the
future pool of resources is important. To echo Federal Reserve Chairman
Alan Greenspan, the crucial issue of saving in our economy relates to our
ability to build an adequate capital stock to produce enough goods and
services in the future to accommodate both retirees and workers in the
future.9 The most direct way the federal government can raise national
saving is by increasing government saving; that is, as the economy returns
to a higher growth path, a balanced fiscal policy that recognizes our long-
term challenges can help provide a strong foundation for economic growth
and can enhance our future budgetary flexibility. It is my hope that we will
think about the unprecedented challenge facing future generations in our
aging society. Putting Medicare on a sustainable path for the future would
help fulfill this generation’s stewardship responsibility to succeeding
generations. It would also help to preserve some capacity for future
generations to make their own choices for what role they want the federal
government to play.

As with Social Security, both sustainability and solvency considerations
drive us to address Medicare’s fiscal challenges sooner rather than later.
HI Trust Fund exhaustion may be more than 20 years away, but the
squeeze on the federal budget will begin as the baby boom generation
begins to retire. This will begin as early as 2008, when the leading edge of
the baby boom generation becomes eligible for early retirement.10 CBO’s
current 10-year budget and economic outlook reflects this. CBO projects
that economic growth will slow from an average of 3.2 percent a year from
2005 through 2008 to 2.7 percent from 2009 through 2013, reflecting slower
labor force growth. At the same time, annual rates of growth in entitlement
spending will begin to rise. Annual growth in Social Security outlays is
projected to accelerate from 5.2 percent in 2007 to 6.6 percent in 2013.
Annual growth in Medicare enrollees is expected to accelerate from 1.1


9
 Testimony before the Senate Committee on Banking, Housing, and Urban Affairs, July 24,
2001.
10
 In 2008, the first baby boomers will reach age 62 and become eligible for Social Security
benefits; in 2011, they will reach age 65 and become eligible for Medicare benefits.




Page 15                                                                      GAO-03-650T
                        percent today to 2.9 percent in 2013. Acting sooner rather than later is
                        essential to ease future fiscal pressures and also provide a more
                        reasonable planning horizon for future retirees. We are now at a critical
                        juncture. In less than a decade, the profound demographic shift that is a
                        certainty will have begun.


                        Despite a common awareness of Medicare’s current and future fiscal
As Bleak Fiscal         plight, pressure has been building to address recognized gaps in Medicare
Future Looms, Efforts   coverage, especially the lack of a prescription drug benefit and protection
                        against financially devastating medical costs. Filling these gaps could add
to Address Medicare     significant expenses to an already fiscally overburdened program. Under
Coverage Gaps Are       the Trustees’ 2003 intermediate assumptions, the present value of HI’s
                        actuarial deficit is $6.2 trillion, a 20-percent increase from the prior year.11
Being Considered        This difficult situation argues for tackling the greatest needs first and for
                        making any benefit additions part of a larger structural reform effort.

                        The Medicare benefit package, largely designed in 1965, provides virtually
                        no outpatient drug coverage. Beneficiaries may fill this coverage gap in
                        various ways. According to the Medicare Current Beneficiary Survey,
                        nearly two-thirds of Medicare beneficiaries had some form of drug
                        coverage from a supplemental insurance policy, health plan, or public
                        program at some point during 1999. All beneficiaries have the option to
                        purchase supplemental policies—Medigap—when they first become
                        eligible for Medicare at age 65. Those policies that include drug coverage
                        tend to be expensive and provide only limited benefits. Some beneficiaries
                        have access to coverage through employer-sponsored policies or private
                        health plans that contract to serve Medicare beneficiaries. In recent years,
                        coverage through these sources has become more expensive and less
                        widely available. Beneficiaries whose incomes fall below certain
                        thresholds may qualify for Medicaid or other public programs. More than
                        one-third may lack drug coverage altogether.

                        In recent years, prescription drug expenditures have grown substantially,
                        both in total and as a share of all heath care outlays. Prescription drug
                        spending grew an average of 15.9 percent per year from 1996 to 2001, more


                        11
                          This estimate represents the present value of HI’s future expenditures less future tax
                        income, taking into account the amount of HI trust fund assets at hand at the beginning of
                        the projection period and adjusting for the ending target trust fund balance. Excluding the
                        ending target trust fund balance, HI’s unfunded obligation is estimated to be $5.9 trillion
                        over the 75-year period under the Trustees’ 2003 intermediate assumptions.




                        Page 16                                                                       GAO-03-650T
than double the 6.5 percent average growth rate for health care
expenditures overall. (See table 1.) As a result, prescription drugs account
for a growing share of health care spending, rising from 6.5 percent in 1996
to 9.9 percent in 2001. By 2012, prescription drug expenditures are
expected to account for almost 15 percent of total health expenditures.

Table 1: National Expenditures for Prescription Drugs and Health Care, 1996 to 2001

                                                         Annual growth
                                                         in prescription Annual growth in
                                         Prescription              drug       health care
                                                  drug     expenditures     expenditures
                                      expenditures (in    from previous    from previous
 Year                                        billions)    year (percent)   year (percent)
 2001                                          $140.6               15.4              8.7
 2000                                            121.8              17.3              6.9
 1999                                            103.9              19.2              5.7
 1998                                             87.2              15.1              5.4
 1997                                             75.7              12.8              4.9
 1996                                             67.2              10.5              5.0
 Average annual growth from
 1996 through 2001                                                 15.9               6.5
Source: CMS, Office of the Actuary.



In 2002, CBO projected that the average Medicare beneficiary would use
$2,440 worth of prescription drugs in 2003. This is a substantial amount
considering that some beneficiaries lack any drug coverage and others
may have less coverage than in previous years. Moreover, significant
numbers of beneficiaries have drug expenses much higher than those of
the average beneficiary. CBO also estimated that, in 2005, 12 percent of
Medicare beneficiaries would have expenditures above $6,000.

In focusing on the need for prescription drug coverage, we should not
forget that Medicare does not provide complete protection from
catastrophic losses. Under Medicare, beneficiaries have no limit on their
out-of-pocket costs attributable to cost sharing. The average beneficiary
who obtained services had a total liability for Medicare-covered services
of $1,700, consisting of $1,154 in Medicare copayments and deductibles in
addition to the $546 in annual part B premiums in 1999, the most recent
year for which data are available on the distribution of these costs. For
beneficiaries with extensive health care needs, the burden can be much
higher. In 1999, about 1 million beneficiaries were liable for more than
$5,000, and about 260,000 were liable for more than $10,000 for covered
services. In contrast, employer-sponsored health plans for active workers



Page 17                                                                      GAO-03-650T
                      typically limited maximum annual out-of-pocket costs for covered services
                      to less than $2,000 per year for single coverage.12

                      Recently, several proposals have been made to add a prescription drug
                      benefit to the Medicare program. While different in scope and detail, the
                      proposals have certain features in common—including use of a third-party
                      entity to administer the new drug benefit. The remainder of my remarks
                      will focus on the lessons learned from our work regarding the private
                      sector’s use of such an entity to manage the drug benefits of insurers’
                      policyholders and health plans’ enrollees.


                      Some proposals to add a Medicare outpatient prescription drug benefit
Private Sector        look to private sector strategies as a means to administer a drug benefit
Strategies for        and control costs. Most employer-sponsored health plans contract with
                      private entities, known as pharmacy benefit managers (PBM), to
Controlling Drug      administer their prescription drug benefits, and those that do not contract
Expenditures May Be   with PBMs may have units in their organizations that serve the same
                      administrative purpose. Typically, on behalf of the health plans, PBMs
Instructive for       negotiate drug prices with pharmacies, negotiate rebates with drug
Medicare              manufacturers, process drug claims, operate mail-order pharmacies, and
                      employ various cost-control techniques, such as formulary management
                      and drug utilization reviews. In 2001, nearly 200 million Americans had
                      their prescription drug benefits administered through PBMs. This year, we
                      reported on the use of PBMs by health plans in the Federal Employees’
                      Health Benefits Program (FEHBP).13 In considering the application of
                      these findings to Medicare, we are reminded that Medicare’s unique role
                      and nature may temper how the strategies and potential efficiency gains
                      afforded by private sector PBMs may be transferred to benefit the
                      program.


                      12
                       The Kaiser Family Foundation and Health Research and Education Trust, Employer
                      Health Benefits: 2000 Annual Survey (Menlo Park, Calif. and Chicago: 2000).
                      13
                       U.S. General Accounting Office, Federal Employees’ Health Benefits: Effects of Using
                      Pharmacy Benefit Managers on Health Plans, Enrollees, and Pharmacies, GAO-03-196
                      (Washington, D.C.: Jan. 10, 2003). FEHBP covered about 8.3 million federal employees,
                      retirees, and their dependents as of July 2002, and the three FEHBP plans we reviewed
                      accounted for about 55 percent of FEHBP enrollment. The FEHBP plans and PBMs we
                      reviewed were Blue Cross and Blue Shield, which contracted with AdvancePCS for retail
                      pharmacy services and Medco Health Solutions for mail-order services; Government
                      Employees Hospital Association, which contracted with Medco Health Solutions; and
                      PacifiCare of California, which contracted with Prescription Solutions, another subsidiary
                      of PacifiCare Health Systems.




                      Page 18                                                                      GAO-03-650T
Private Sector Uses PBMs   PBMs use purchasing volume to leverage their negotiations with
to Leverage Price          pharmacies and drug manufacturers in seeking favorable prices in the
Negotiations through       form of discounts, rebates, or other advantages. Through negotiations,
                           PBMs create networks of participating retail pharmacies, promising the
Volume Purchasing          pharmacies a greater volume of customers in exchange for discounted
                           prices. PBMs may be able to secure larger discounts by limiting the
                           number of network pharmacies. However, smaller networks provide
                           beneficiaries fewer choices of retailers, thereby limiting convenient
                           access. These are trade-offs health plans must consider in deciding how
                           extensive a pharmacy network they want their PBMs to offer beneficiaries.
                           The health plans we reviewed in our FEHBP study generally provided
                           broad retail pharmacy networks. The average discounted prices PBMs
                           obtained for drugs from retail pharmacies were about 18 percent below
                           the average prices cash-paying customers without drug coverage would
                           have paid for 14 selected widely used brand-name drugs. For 4 selected
                           generic drugs, the PBM-negotiated retail pharmacy prices were 47 percent
                           below the price paid by cash-paying customers.

                           PBMs also use their leverage to negotiate with drug manufacturers for
                           rebates. Rebates generally depend on the volume of a manufacturer’s
                           products purchased. Health plans and PBMs can add to that volume by
                           concentrating beneficiaries’ purchases for particular types of drugs with
                           certain manufacturers. Health plans can steer their beneficiaries’
                           purchases to specific drugs through the use of a formulary—that is, a list
                           of prescription drugs that health plans encourage physicians to prescribe
                           and beneficiaries to use. Determining whether a drug should be on the
                           formulary involves clinical evaluations based on a drug’s safety and
                           effectiveness, and decisions on whether several drugs are therapeutically
                           equivalent.14 Restricting the formulary to fewer drugs within a therapeutic
                           class can provide the PBMs with greater leverage in negotiating higher
                           rebates because they can help increase the manufacturer’s market share
                           for certain drugs. However, a restricted formulary provides beneficiaries
                           with fewer preferred drug alternatives and makes the policies governing




                           14
                             A pharmacy and therapeutics committee within the health plan or a PBM typically makes
                           decisions about whether to include particular brand-name or generic drugs on the plan’s
                           formulary.




                           Page 19                                                                   GAO-03-650T
coverage of nonformulary drugs or the cost sharing for them critical to
beneficiaries.15

The FEHBP plans and PBMs we reviewed provided enrollees with
generally nonrestrictive drug formularies across a broad range of drugs
and therapeutic categories.16 The manufacturer rebates that the PBMs
passed through to the FEHBP plans effectively reduced plans’ annual
spending on prescription drugs by a range of 3 percent to 9 percent. The
share of rebates PBMs passed through to the FEHBP plans varied subject
to contractual agreements negotiated between the plans and the PBMs.

PBMs also assisted the FEHBP plans by providing a less expensive mail-
order drug option. Mail-order prices for the FEHBP plans we reviewed
averaged about 27 percent lower than cash-paying customers would pay
for the same quantity at retail pharmacies for 14 brand-name drugs and 53
percent lower for 4 generic drugs. The FEHBP plans generally had lower
cost-sharing requirements for drugs purchased through mail order,
particularly for more expensive brand-name drugs or maintenance
medications for chronic conditions.

The claims and information processing capabilities PBMs offered also
helped the FEHBP plans to manage drug costs and monitor quality of care.
PBMs maintain a centralized database on each enrollee’s drug history that
can be used to review for potential adverse drug interactions or potentially
less expensive alternative medications. They also use claims data to
monitor patterns of patient use, physician prescribing practices, and
pharmacy dispensing practices. Their systems provide “real-time” claims
adjudication capabilities that allow a customer’s claim for a drug purchase
to be approved or denied at the time the pharmacist begins the process of
filling a prescription. Two plans in our FEHBP study reported savings
ranging from 6 to 9 percent of the plan’s annual drug spending; the savings



15
  Plans generally encourage the use of formulary drugs by having lower cost sharing or
requiring special approval of a nonformulary drug. For example, health plans have
increasingly adopted three-tiered cost-sharing strategies whereby enrollees incur the
lowest out-of-pocket costs for using generic drugs, higher costs for brand-name drugs on
the formulary, and the highest costs for brand-name drugs not included on the formulary.
16
  Our report compared the FEHBP plans’ formularies to the Department of Veterans Affairs
(VA) National Formulary, considered by the Institute of Medicine to be not overly
restrictive. Each FEHBP plan we reviewed included over 90 percent of the drugs listed on
the VA formulary or therapeutically equivalent alternatives, and included at least one drug
in 93 percent to 98 percent of the therapeutic classes covered by VA.




Page 20                                                                      GAO-03-650T
                             were associated primarily with real-time claims denials preventing early
                             drug refills and safety advisories cautioning pharmacists about potential
                             adverse interactions or therapy duplications.


Use of Private-Sector        While Medicare’s sheer size would provide it with significant leverage in
Strategies in Medicare       negotiating with pharmacies and drug manufacturers, doing so would
Would Represent              represent a departure from traditional Medicare. Medicare beneficiaries
                             represent less than 15 percent of the population but a disproportionately
Departure from Traditional   higher share—about 40 percent—of prescription drug spending. However,
Policies and Practices       because of Medicare’s design and obligations as a public program, its
                             current purchasing strategies vary considerably from those of the private
                             sector.

                         •   Any willing provider. In contrast with private payers’ reliance on
                             selective contracting with providers and suppliers, the traditional
                             Medicare program has generally allowed any hospital, physician, or other
                             provider willing to accept Medicare’s reimbursements and requirements to
                             participate in the program. With respect to drug purchasing in particular,
                             private plans determine the extent of their enrollees’ access by the choices
                             they make about the size of their participating pharmacy network and
                             breadth of their drug formulary. Allowing any pharmacy willing to meet
                             Medicare’s terms to participate or allowing all therapeutically equivalent
                             drugs equal coverage on a formulary would restrict the program’s ability to
                             secure advantageous prices. Moreover, health plans and PBMs currently
                             make formulary determinations privately. In contrast, Medicare’s policies
                             have historically been open to public comment.

                         •   Administrative rate-setting. Whereas private health plans typically rely
                             on price negotiations to establish payment rates, Medicare generally
                             establishes payment rates administratively. As discussed earlier,
                             Medicare’s rates often exceed market prices and this is the case for some
                             of the few outpatient prescription drugs covered by Medicare.17 The
                             program’s method of paying for these drugs is prescribed in statute: In
                             essence, Medicare pays 95 percent of a drug’s “average wholesale price”
                             (AWP). Despite its name, however, AWP is not necessarily a price that
                             wholesalers charge and is not based on the price of any actual sale of
                             drugs by a manufacturer. AWPs are published by manufacturers in drug
                             price compendia, and Medicare bases providers’ payments on these
                             published AWPs. Other public and private purchasers typically use the


                             17
                              GAO-01-1118.




                             Page 21                                                         GAO-03-650T
                              leverage of volume and competition to secure better prices. By statute,
                              Medicaid, the nation’s health insurance program for certain low-income
                              Americans, is guaranteed manufacturers’ rebates based on prices charged
                              other purchasers.18 Certain other public payers can pay at rates set in the
                              federal supply schedule, which uses verifiable confidential information on
                              the prices drug manufacturers charge their “most favored” private
                              customers. Manufacturers agree to these prices, in part, in exchange for
                              the right to sell drugs to the more than 40 million Medicaid beneficiaries.

                          •   Low-budget program administration. Duplicating the type of controls
                              PBMs have exercised over private-sector drug benefits would likely
                              involve devoting a larger share of total expenditures to administration
                              than is spent by Medicare currently. Medicare’s administrative costs
                              historically have been extremely low, averaging about 2 percent of the
                              cost of the services themselves.19 This level of expenditure may not be
                              consistent with the level needed to review the volumes of claims data
                              associated with prescription drugs for the elderly or acquire and maintain
                              the on-line systems and databases PBMs use to employ such utilization
                              controls as real-time claims adjudication. The number of prescriptions for
                              Medicare beneficiaries could easily exceed the current number of claims
                              for all other services combined, or over 1 billion annually.


Decisions about the Extent    Medicare would undoubtedly need assistance from external entities to
of Latitude and               administer a drug benefit, just as it has used insurers to process claims in
Competition Allowed Are       the traditional program and Medicare+Choice plans to go further by also
                              managing services and assuming risk. Decisions about the roles assigned
Critical to Administering a   an entity or entities and the latitude allowed them in carrying out those
Medicare Drug Benefit         roles would be critical. These decisions would undoubtedly affect the
                              benefit’s value to beneficiaries and the efficiencies and savings secured for
                              both beneficiaries and taxpayers. Some of these decisions parallel those
                              made by FEHBP plans that I discussed—trade-offs about beneficiaries’
                              interests in broad pharmacy networks and formularies versus potential
                              savings. Others stem from the uniqueness of Medicare, its likely



                              18
                               Since the enactment of the Omnibus Budget Reconciliation Act of 1990, drug
                              manufacturers are required to provide rebates to state Medicaid programs on outpatient
                              drugs based on the “lowest” or “best” prices they charged other purchasers or a minimum
                              of 15.1 percent of the average manufacturers’ price (AMP) for brand-name drugs. Rebates
                              must be at least 11 percent of AMP for generic drugs.
                              19
                               U.S. General Accounting Office, Medicare: HCFA Faces Challenges to Control Improper
                              Payments, GAO/T-HEHS-00-74, (Washington, D.C.: Mar. 9, 2000).




                              Page 22                                                                    GAO-03-650T
disproportionate share of the drug market, and its position as a public
program requiring transparency and fairness.

Insurers and PBMs have been successful in securing some savings on drug
purchases by leveraging their volume to move market share from one
product to another. Medicare’s leverage, given that purchases by the
elderly constitute about 40 percent of the drug market, could be
considerable. Yet the large market share may also be likely to attract
considerable attention. The administration of a Medicare drug benefit
could then be subject to the same intensity of external pressures from
interested parties regarding program prices and rules that can often inhibit
the program from operating efficiently today. The potential for
micromanagement could compromise trying to use the very flexibility
PBMs have employed in negotiating prices and selecting preferred
providers in order to generate savings. An alternative would be to sacrifice
some of the program’s leverage and grant flexibility to multiple PBMs or
similar entities so that any one entity would be responsible for
administering only a share of the market.

Contracting with multiple PBMs or similar entities, however, would pose
other challenges. If each had exclusive responsibility for a geographic
area, beneficiaries who wanted certain drugs could be advantaged or
disadvantaged merely because they lived in a particular area. To minimize
inequities, Medicare could, like some private sector purchasers, specify
core benefit characteristics or maintain clinical control over formulary
decisions instead of delegating those decisions to its contractors.

If multiple PBMs or similar entities operated in a designated area,
beneficiaries could choose among them to administer their drug benefits.
These organizations would compete for consumers directly on the basis of
differences in their drug benefit offerings and administration. This
contrasts with the private sector where drug benefits are typically part of
an overall insurance plan, and PBMs typically compete for contracts with
insurers or other purchasers. Competition could be favorable to
beneficiaries if they were adequately informed about differences among
competing entities offering drug benefits and shared in the savings.
However, adequate oversight would need to be in place to ensure that fair
and effective competition was maintained. For example, a means to ensure
that beneficiaries received comprehensive user-friendly information about
policy and benefit differences among competing entities would be
necessary. Monitoring marketing and customer recruitment strategies and
holding entities accountable for complying with federal requirements
would require adequate investment. The contracting entities could need


Page 23                                                         GAO-03-650T
               protections as well. Some mechanism would be needed to risk adjust
               payments for differences in beneficiaries’ health status so that those
               entities enrolling a disproportionate share of high-use beneficiaries would
               not be disadvantaged.


               Medicare’s financial challenge is very real and growing. The 21st century
Concluding     has arrived and our demographic tidal wave is on the horizon. Within 5
Observations   years, individuals in the vanguard of the baby boom generation will be
               eligible for Social Security and 3 years after that they will be eligible for
               Medicare. The future costs of serving the baby boomers are already
               becoming a factor in CBO’s short-term cost projections.

               Frankly, we know that incorporating a prescription drug benefit into the
               existing Medicare program will add hundreds of billions of dollars to
               program spending over just the next 10 years. For this reason, I cannot
               overstate the importance of adopting meaningful reforms to ensure that
               Medicare remains viable for future generations. Adding a drug benefit to
               Medicare requires serious consideration of how that benefit will affect
               overall program spending. If competing private entities are to be used to
               administer a drug benefit, it is important to understand how these entities
               can be used in the Medicare context to provide a benefit that balances
               beneficiary needs and cost containment.

               Medicare reform would be done best with considerable lead time to phase
               in changes and before the changes that are needed become dramatic and
               disruptive. Given the size of Medicare’s financial challenge, it is only
               realistic to expect that reforms intended to bring down future costs will
               have to proceed incrementally. We should begin this now, when retirees
               are still a far smaller proportion of the population than they will be in the
               future. The sooner we get started, the less difficult the task will be.

               We must also be mindful that health care costs compete with other
               legitimate priorities in the federal budget, and their projected growth
               threatens to crowd out future generations’ flexibility to decide which
               competing priorities will be met. In making important fiscal decisions for
               our nation, policymakers need to consider the fundamental differences
               among wants, needs, and what both individuals 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



               Page 24                                                            GAO-03-650T
                  within a broader context of providing for other important national needs
                  and economic growth.

                  The public sector can play an important role in educating the nation about
                  the limits of public support. Currently, there is a wide gap between what
                  patients and providers expect and what public programs are able to
                  deliver. Moreover, there is insufficient understanding about the terms and
                  conditions under which health care coverage is actually provided by the
                  nation’s public and private payers. In this regard, GAO is preparing a
                  health care framework that includes a set of principles to help
                  policymakers in their efforts to assess various health financing reform
                  options. This framework will examine health care issues systemwide and
                  identify the interconnections between public programs that finance health
                  care and the private insurance market. The framework can serve as a tool
                  for defining policy goals and ensuring the use of consistent criteria for
                  evaluating changes. By facilitating debate, the framework can encourage
                  acceptance of changes necessary to put us on a path to fiscal
                  sustainability. I fear that if we do not make such changes and adopt
                  meaningful reforms, future generations will enjoy little flexibility to fund
                  discretionary programs or make other valuable policy choices.


                  Mr. Chairman, this concludes my prepared statement. I will be happy to
                  answer any questions you or other committee members may have.


                  For future contacts regarding this testimony, please call William J.
Contacts and      Scanlon, Director, Health Care Issues, at (202) 512-7114. Other individuals
Acknowledgments   who made key contributions include Rashmi Agarwal, Linda Baker, John
                  Dicken, Hannah Fein, Kathryn Linehan, James McTigue, Jennifer Rellick,
                  and Melissa Wolf.




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                  Page 25                                                         GAO-03-650T