Exploring Medicare's Financial Challenges and Future in 2023

Medicare provides essential health care services to millions of Americans, predominantly age 65 and older. However, the sustainability and future of this significant program is under threat, prompting urgent need for comprehensive understanding and discussion of potential solutions.

Why is a System Like Medicare Needed?

Health care expenditures at ages 65+ are much higher than at earlier ages, while income at ages 65+ tends to be much lower than at earlier ages. For this reason, additional monies are needed for many people at ages 65+ to enable delivery of necessary health care services. The program also provides benefits for some disabled individuals under age 65. Some form of risk transfer system is necessary to address these risks, and Medicare attempts to do just that.

How are Medicare Benefits Earned and Funded?

An estimated 65 million people will receive Medicare benefits in 2023 via Medicare Part A: Hospital Benefits, Part B: Professional Services, Part C: Medicare Advantage Program, and Part D: Prescription Drugs. Benefits under the program are “earned” for Parts A and/or C through lifetime payment of wage related taxes; once “earned”, benefits are payable based on a fixed formula and are not conditioned on other criteria. Part B and D benefits are conditioned on eligibility for Part A benefits and payment of premiums for Part B and D; those premiums are intended to cover roughly 25% of related costs with the remaining costs covered by other federal tax revenues.

What Will Happen to Medicare Without Changes Moving Forward?

Without any changes to the existing program, Trust Fund dollars are projected to be depleted in less than 10 years. If that happens, benefit amounts by law will be automatically reduced so that the program can continue to operate. The initial reduction is expected to be at least 10%, with additional reductions expected after that. Unlike Social Security benefit reductions, where benefits are proportionately reduced across all recipients, benefit reductions in Medicare would be made by delaying payments to providers. The ramifications of these actions would be to reduce access to medicals services over time, which would result in various other negative impacts on the health care system.

Why is Medicare Facing Serious Financial Problems?

Contributors to the financial problem are many. These include: 

1. Demographic Shifts
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   A. People are living longer while the eligibility age for Medicare aged benefits has not changed from age 65 since program inception in 1965. Life expectancy for those attaining age 65 is significantly longer today than those who reached this age at program inception. In 1965, the life expectancy of a person 65 was roughly 14.8; today it is roughly 20 years.
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   B. People are having fewer children today than in 1956; this means fewer than expect workers are entering the work force.
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   C. The net immigration inflow to the work force has also declined during this period.
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   D. The combination of these three factors has led to a dramatic reduction in the ratio of current contributing workers to retirees (from roughly 5 in the early years to less than 3 now). As this ratio declines further, which is expected, the current tax/benefit relationship cannot be sustained.
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2. Flawed Benefit Design, Including Program Changes and Failure to Recognize Impacts of Inflation
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   The benefit design of the Medicare program encourages high utilization of services by beneficiaries, as nearly all costs are paid by third parties (including government and private coverage). Medicare pays roughly 75% of all costs, while private supplemental coverages pay most of the remaining piece (only a few per cent of costs are paid out of pocket). Further, the design of Medicare in numerous instances covers costs that are predictable, while leaving some catastrophic costs for the private market or out-of-pocket, contrary to the purpose of insurance. Over the years, Medicare has expanded benefit eligibility, such as covering disabled individuals under age 65 and adding more covered benefits. These changes have not only increased costs due to more covered benefits and corresponding higher utilization of such services, but also increased inflation of medical costs both within and outside of Medicare.
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3. Inadequate Funding Mechanisms
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   From its inception, Medicare was designed to be primarily pay-as-you-go funding, with no intent to become fully funded to cover accumulating benefit liabilities. Modest accumulations occurred in the early years of the program when there were many contributing workers, and relatively few beneficiaries. Trust Fund investment earnings have not provided meaningful support for plan benefits; primarily because the accumulations were modest; and secondarily because, by law, funds can only be invested in government securities which historically have provided lower returns than other investments (and which have produced artificially low returns for the last 15years). As the demographic changes have combined with the design and related issues, the modest amounts in the Trust Funds have been further depleted. Medicare has attempted to mitigate funding issues repeatedly by setting prices to vendors at well below market prices; this has had serious ramifications on access to care and population health status across the entire health care system (see CAUS reports on modeling of health care system-add footnote). Nonetheless, the price restraints have not been able to stem financing difficulties. In addition, by law, the federal Government pays roughly 75% of all Medicare Part B and D costs through general revenue. This subsidy has resulted in accumulating Federal Deficits and additional unintended consequences, while the Trust Funds continue to be depleted.
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4. Violations of Professional Principles
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   In summary, the combination of the issues above have culminated in a violation of numerous professional principles as established by the actuarial, economic, accounting, medical and legal professions. These principles and violations of them are summarized in a supporting document.

What are the Options for Fixing Medicare?

If the Medicare system as we know it is to be fixed, the solution must come from some blend of benefit cuts, tax/premium increases, program redesign, changes in funding mechanisms, and other program changes. And any such changes must necessarily remedy the violations of professional principles referenced above. Possible changes in each category which have been proposed are discussed below or at least noted below.

Benefit Cuts

Some proposals have been made to increase the program’s benefit eligibility age. A gradual move to higher ages could be accomplished without serious disruption for most workers and would mitigate both the higher number of retirees as well as the reducing number of workers. Another significant benefit change which has been floated is the adoption of a “means test” or other mechanism which would reduce or eliminate benefits for the wealthier segment of the retired population. Such a change would significantly alter the “earned nature” of the program.

Tax/Premium Increases

The current tax for Medicare is 1.45% of earned wages (plus a matching payment by employers), without a payroll wage base cap (this cap was eliminated many years ago). In addition, The Affordable Care Act implemented a .9% tax on employers and a 3.8% tax on individuals/families for investment earnings where they exceed a designated amount, such as ($200,000 in total earnings for individuals) to help defray Medicare costs. Beneficiaries also contribute by paying premiums for benefits on Parts B and D, as noted previously. Still, these revenues do not come close to covering Medicare costs today and general revenues must therefore make up the remainder of funding to cover total costs. As such, substantial increases in tax revenues and/or premiums would be needed to support Medicare costs. These changes could include many types of taxes or premiums, including premiums on items where none is currently paid. Incorporation of these types of taxes or premiums could materially change the current relationship between wage-based tax revenues and future benefit entitlements. The level of tax and/or premium increases required to cover such costs by themselves is unlikely to have much popular appeal as: i) Total FICA taxes (7.65% before the employer matching amount) are already the highest tax paid by a large segment of the US working population, and ii) Premium increases of a significant amount on a largely retired population with relatively low incomes is a difficult proposition

Program Design

The design of Medicare over the years has changed to make the program more benefit rich. In response to these increased costs, Medicare has usually put constraints on prices, which have resulted in numerous negative side effects on health care, both within and outside of Medicare. All of these changes have tended to increase medical utilization while ignoring actuarial, economic, and other professional principles; and they have made the program increasingly difficult to repair. As a result, few proposals to mitigate these violations of principles have been made to date. Examples of program redesign proposals can be found in suggestions by former Trustee Tom Savings and a book by Mark Litow and Merrill Matthews.

Funding Mechanisms/Pre-Funding/Investment Returns

A proposal for a “Sovereign Wealth Fund” has been included in at least one bipartisan proposal for a partial solution to the Social Security dilemma, which could also be applied to Medicare. While attaining some level of pre-funding and improvement of investment returns within the system seem to be worthwhile goals, the actual implementation of such a plan has several serious questions: 1--Where does the seed money come from? 2-- What impact would this move have on the overall Federal Budget? 3—If enough funds are deposited to make a significant difference to the Medicare funding, how would the investment of those funds in the market affect market prices and other market activity?

Other Program Changes

Still other program changes could be considered to Medicare such as amendments to benefit provisions and/or eligibility under the program's various parts. Such proposals do occasionally occur, but in general they increase costs and financial pressures, not decrease them.

Conclusion

The complexities and challenges that Medicare is currently facing are considerable, shaped by shifting demographics, an outdated benefit design, and struggling funding mechanisms. Nevertheless, Medicare’s role in safeguarding public health and serving the aging population remains essential.  The financial strain might seem overwhelming, but with thoughtful adaptations and strategic implementations, these pressures can be alleviated. Potential solutions range from benefit cuts and tax/premium increases to program redesign and changes in funding mechanisms. As we look towards the future, continuous exploration of these options will be critical in ensuring the sustainability and efficacy of Medicare. In doing so, we can continue to uphold this critical safety net for millions of Americans who depend on it.