KEY POINTS:

The HI trust fund is projected to be depleted in 2029, leaving only about 10 years to find a solution.
   
Total Medicare spending will continue to grow faster than the economy, increasing the pressure on beneficiary household budgets and the federal budget and threatening the program’s sustainability.
   
Changes are needed to improve Medicare’s long-term solvency and sustainability. The longer corrective measures are delayed, the worse the financial challenges will become and the greater the burden that might be imposed on beneficiaries and taxpayers.




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Craig Hanna, Director of Public Policy
Cori Uccello, Senior Health Fellow

© 2017 American Academy of Actuaries. All rights reserved.


Members of the Medicare Subcommittee include: Michael Thompson, MAAA, FSA—chairperson; Jill H. Brostowitz, MAAA, FSA; Michael V. Carstens, MAAA, FSA; April S. Choi, MAAA, FSA; Randall S. Edwards, MAAA, FSA; Dennis J. Hulet, MAAA, FSA, FCA; Troy M. Filipek, MAAA, FSA, FCA; Dustin Grzeskowiak, MAAA, ASA; Joel C. Kabala, MAAA, ASA; Margot D. Kaplan, MAAA, FCA, ASA; Jinn-Feng Lin, MAAA, FSA, FCA; Joe Liss, MAAA, FSA; Mark E. Litow, MAAA, FSA; Leslie Lucas, MAAA, FSA; Bob Mone, MAAA, FSA; Steve Niu, MAAA, FSA, EA; Vanessa Olson, MAAA, FSA; Susan E. Pierce, MAAA, FSA; Robert J. Pipich, MAAA, FSA; Anna M. Rappaport, MAAA, FSA, EA; Jeremiah D. Reuter, MAAA, ASA; Geoff Sandler, MAAA, FSA; Andrea Sheldon, MAAA, FSA; Gordon R. Trapnell, MAAA, FSA; Cori E. Uccello, MAAA, FSA, FCA, MPP; John A. Wandishin, MAAA, FSA; Thomas F. Wildsmith, MAAA, FSA; Carl Wright, MAAA, FSA.

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Medicare’s Financial Condition: Beyond Actuarial Balance

Each year, the Boards of Trustees of the Federal Hospital Insurance (HI) and Supplementary Medical Insurance (SMI) trust funds report to Congress on the Medicare program’s financial condition. The program is operated through two trust funds. The HI trust fund (Medicare  Part A) pays primarily for inpatient hospital services. The SMI trust fund includes accounts for the Medicare Part B program, which covers physician and outpatient hospital services, and the Medicare Part D program, which covers the prescription drug  program.

The Medicare Trustees Report is the primary source of information on the financial status of the Medicare program, and the American Academy of Actuaries proudly recognizes the important contribution that members of the actuarial profession have made in preparing the report. They play a vital role in providing information to the public about the important issues surrounding the program’s solvency and
sustainability.

The 2017 Medicare Trustees Report finds that compared with the projections from the 2016 report, the projected financial condition of Medicare has improved in the short term for parts A and D and deteriorated for Part B.1 Despite these short-term fluctuations, the long-term prospects for the Medicare program have not changed. The depletion of the HI trust fund has been, for the past several years, projected to be near the end of the next decade.

As we approach the end of this decade, that leaves only about 10 years to find a solution. The program faces three fundamental long-range financing challenges:

  • Income to the HI trust fund is not adequate to fund the HI portion of Medicare benefits;
  • Increases in SMI costs increase pressure on beneficiary household budgets and the federal budget; and
  • Increases in total Medicare spending threaten the program’s sustainability.
 
The trustees conclude: “The projections in this year’s report continue to demonstrate the need for timely and effective action to address Medicare’s remaining financial challenges—including the projected depletion of the HI trust fund, this fund’s long-range financial imbalance, and the rapid growth in Medicare expenditures.”
 
The American Academy of Actuaries’ Medicare Subcommittee concurs with the trustees’ conclusion that the Medicare program continues to face serious financing problems. Because Medicare plays a critically important role in ensuring that Americans age 65 and older and certain younger adults with permanent disabilities have access to health care, the Medicare Subcommittee urges action to address the long-term solvency and financial sustainability of the program. The longer corrective measures are delayed, the worse the financial challenges will become and the greater the burden that is likely imposed on beneficiaries and taxpayers. This issue brief more closely examines the findings of the Medicare Trustees Report with respect to program solvency and sustainability.
 

Medicare HI Trust Fund Income Falls Short of the Amount Needed To Fund HI Benefits

Medicare’s trust funds account for all income and expenditures. The HI and SMI programs operate separate trust funds with different financing  mechanisms.  General  revenues, payroll taxes, premiums, and other income are credited to the trust funds, which are used to pay benefits and administrative costs. Any unused income is required by law to be invested in U.S. government securities for use in future years. In effect, the trust fund assets represent loans to the U.S. Treasury’s general fund. The HI trust fund, which pays for hospital services, is funded primarily  through earmarked payroll taxes.
 
The projections of Medicare’s financial outlook in the report are based on current law. Under these projections, the financial condition of the HI trust fund has improved since the 2016 Medicare Trustees Report. This improvement primarily reflects lower-than-estimated spending in 2016 and lower projected inpatient hospital utilization. The projected trust fund exhaustion date is 2029 (one year later than estimated in last year’s report), and the 75-year HI deficit decreased from 0.73 percent of taxable payroll to 0.64 percent.

  • HI revenues exceed HI expenditures, but only temporarily. A surplus is projected for a few years before HI expenditures are expected to exceed revenues, including interest income, for the remainder of the 75-year projection period. The HI trust fund assets, therefore, will need to be redeemed. If the federal government is experiencing unified budget deficits, funding the redemptions will require that additional money be borrowed from the public, thereby increasing the federal deficit and debt.
  • The HI trust fund is projected to be depleted in 2029. At that time, tax revenues are projected to cover only 88 percent of program costs, with the share declining to 81 percent in 2041 and then increasing to 88 percent in 2091. There is no current provision for general fund transfers to cover HI expenditures in excess of dedicated revenues.
  • The projected HI deficit over the next 75 years is 0.64 percent of taxable payroll. Eliminating this deficit would require an immediate 22 percent increase in standard payroll taxes or an immediate 14 percent reduction in expenditures—or some combination of the two. Delaying action would require more severe changes in the future.

In this year’s report, the trustees’ projections of Medicare’s financial outlook are based on benefits and revenues scheduled under current law. The trustees acknowledge that these estimates could understate the seriousness of Medicare’s financial condition, because actual Medicare expenses might exceed current law estimates. In particular, the trustees and the chief actuary point to scheduled reductions in provider payments that may not occur. Current law requires downward adjustments in payment updates for most non-physician providers to reflect productivity improvements; these adjustments might not be sustainable in the long term. Current law also requires updates for physician services that are not expected to keep up with physician costs. In the Statement of Actuarial Opinion that accompanies the report, Paul Spitalnic, the chief actuary of the Centers for Medicare & Medicaid Services (CMS), specifically states, “Overriding the price updates specified in current law … would lead to substantially higher costs for Medicare in the long range than those projected in this report.”

At the request of the trustees, the CMS Office of the Actuary developed an alternative analysis that provides an illustration of the potential understatement of current-law Medicare cost projections if the productivity adjustments are phased down gradually beginning in 2020, physician updates are more consistent with cost growth, and there are no savings from the Independent Payment Advisory Board (IPAB).2 Although the illustrative alternative projections are not intended to be interpreted as the official best estimates of future Medicare costs, they do, as noted in the alternative analysis, “help illustrate and quantify the potential magnitude of the cost understatement.”

Under the alternative scenario, the HI trust fund would be depleted in 2029, and the projected deficit over the next 75 years would be 1.76 percent of taxable payroll—compared to 0.64 percent under current law. Eliminating this deficit would require an immediate 61 percent increase in standard payroll taxes or a 31 percent reduction in expenditures—or some combination of the two.

Increases in SMI Costs Increase Pressure on Beneficiary Household Budgets and the Federal Budget

The SMI trust fund includes accounts for the Medicare Part B program, which covers physician and outpatient hospital services, and the Medicare Part D program, which covers the prescription drug program. Approximately one- quarter of SMI spending is financed through beneficiary premiums, with federal general tax revenues covering the remaining three-quarters.3

The SMI trust fund is expected to remain solvent because its financing is reset each year to meet projected future costs. As a result, increases in SMI costs will require increases in beneficiary premiums and general revenue contributions. Increases in general revenue contributions will put more pressure on the federal budget. SMI general revenue funding is scheduled to nearly double from 1.5 percent of GDP in 2017 to 2.7 percent in 2091.

Premium increases similarly will place pressure on beneficiaries, especially when considered in conjunction with increasing beneficiary cost-sharing expenses. The average beneficiary expenses (premiums and cost-sharing) for Parts B and D combined are currently 24 percent of the average Social Security benefit. These expenses will increase to 33 percent of the average Social Security benefit by 2091. These expenses do not include cost-sharing under Part A.

The 2017 Medicare Trustees Report projects that total SMI spending will continue to grow faster than GDP, increasing from 2.1 percent of GDP in 2016 to 3.1 percent of GDP in 2030, and to 3.7 percent of GDP in 2091.

Spending under the illustrative alternative analysis would be higher, especially in the long term, reflecting the phase-down of productivity adjustments for non-physician provider payments, higher physician updates in the long range, and assuming no savings from IPAB. SMI spending would increase from 2.1 percent of GDP in 2016 to 3.2 percent of GDP in 2030, and to 5.4 percent of GDP in 2091.

Increases in Total Medicare Spending Threaten the Program’s Sustainability

A broader issue related to Medicare’s financial condition is whether the economy can sustain Medicare spending in the long run. To help gauge the future sustainability of the Medicare program, the trustees consider the share of GDP that will be consumed by Medicare. Because Medicare spending is expected to continue growing faster than GDP, greater shares of the economic growth will be devoted to Medicare over time, meaning smaller shares of the economy will be available for other priorities.

Table 1: Total Medicare Expenditures as a Percent of GDP
Calendar
Year
2017 Report 2017 Alternative
Projection
2016 3.6 3.6
2020 3.9 3.9
2030 5.0 5.2
2040 5.6 6.2
2050 5.6 6.6
2060 5.7 7.1
2070 5.8 7.8
2080 5.8 8.4
2090 5.9 8.9
2091 5.9 9.0
Sources: 2017 Medicare Trustees Report, CMS Office of the Actuary

Under current law, Medicare expenditures as a percentage of GDP will grow from 3.6 percent of GDP in 2016 to 5.9 percent of GDP in 2091. Under the CMS Office of the Actuary alternative scenario, however, total Medicare expenditures would increase to 9.0 percent of GDP in 2091.

Conclusion

The Affordable Care Act (ACA), enacted in 2010, includes provisions designed to reduce Medicare costs, increase Medicare revenues, and develop new health care delivery systems and payment models that improve health care quality and cost efficiency.4 Additional steps need to be taken, however, to address the long-term financial challenges to Medicare.
 
The HI trust fund is projected to be depleted in 2029, and Medicare spending will continue to grow faster than the economy—increasing the pressure on beneficiary household budgets and the federal budget and threatening the program’s sustainability.
 
In addition, Medicare’s financial challenges could be more severe than projected in the report. The report’s Medicare spending projections are considered understated to the extent that the ACA’s provisions for downward adjustments in non-physician provider payment updates to reflect productivity improvements and long-range physician payment updates being held below physician costs are unsustainable in the long term. If Medicare projections are calculated using assumptions that the productivity adjustments are phased down and physician updates are more in line with their costs, Medicare’s financial condition is shown to be even worse than under the projected baseline.

The American Academy of Actuaries’ Medicare Subcommittee has significant concerns about Medicare’s financing problems, and strongly recommends that policymakers implement changes to improve Medicare’s financial outlook.

We concur with the 2017 conclusions of the trustees when they say:

The Board of Trustees believes that solutions can and must be found to ensure the financial integrity of HI in the short and long term and to reduce the rate of growth in Medicare costs through viable means. Consideration of such reforms should not be delayed. The sooner the solutions are enacted, the more flexible and gradual they can be. Moreover, the early introduction of reforms increases the time available for affected individuals and organizations—including health care providers, beneficiaries, and taxpayers—to adjust their expectations and behavior. The Board recommends that Congress and the executive branch work closely together with a sense of urgency to address these challenges.

And we wish to underscore the need for this call for action.


1. Compared to the 2016 report, the report for 2017 estimates slightly higher future cost increases for Part B benefits and slightly lower cost increases for Part D benefits. In addition, the Part B projection reflects the impact of a “hold harmless” provision that limited 2017 premium increases for many beneficiaries.
 
2. The IPAB is required to submit proposals to slow Medicare spending growth the year following a determination that the projected Medicare per capita growth rate exceeds a target growth rate. The first year of such a determination is projected to be 2021. Members of the IPAB have not been appointed.
 
3. Premiums for Medicare Parts B and D are income-related. Standard premiums are set to cover approximately 25 percent of program costs. Higher-income beneficiaries pay higher premiums, ranging from 35 percent of program costs to 80 percent of program costs. According to the Kaiser Family Foundation, in 2015, 6 percent of beneficiaries will face the higher income-related premiums for Part B and 5 percent of beneficiaries will face the higher income-related premiums for Part D. These shares are expected to increase over time. See the Kaiser Family Foundation, “Medicare’s Income-Related Premiums: A Data Note,” June 2015.
 
Many Part D beneficiaries will receive low-income premium subsidies, lowering their premiums below 25 percent of program costs. In the aggregate, beneficiary premiums will cover only about 16 percent of total Part D costs in 2017. State payments on behalf of certain beneficiaries will cover about 11 percent of costs and general revenues will cover the remaining 73 percent of costs.
 
4. To date, the CMS Office of the Actuary has certified that expansions of the Pioneer ACO model and the Medicare Diabetes Prevention Program would reduce (or not increase) net Medicare spending. These certifications allow for the models to be expanded to additional Medicare beneficiaries. See https://www.cms.gov/Research-Statistics-Data-and-Systems/Research/ActuarialStudies/CMMI-Model-Certifications.html.