April 19, 2014

How Much Are We Going to Spend on Medicare?

In late April, the Medicare Trustees released an annual report on the financial status of the program. In their report, the trustees are required to analyze where Medicare costs are heading based on a strict reading of current law. However, there are numerous reasons to believe that these numbers do not give the full picture. As noted by the trustees, “Medicare’s actual future costs are highly uncertain and are likely to exceed those shown by the current-law projections in this report.”

To illustrate the cost picture more fully, the Medicare actuaries just released their updated 2012 “Illustrated Alternative Scenarios” which examine some of the shortcomings of the official Medicare projections.

 Medicare Cost Projection Percent of GDP 
  2030 2080
2009 (PRE-ACA) Trustees' Official Projection 6.26% 10.69%
2012 TRUSTEES' Official Projection 5.29% 6.69%
2012 Alternative Illustration WITH DOC FIXES 5.70% 7.76%
2012 FULL ALTERNATIVE Illustration 5.80% 9.97%

The official projections from the trustees show the program growing from 3.67 percent of GDP in 2011 to 5.29 percent by 2030, and 6.69 percent by 2080. Under these projections, Medicare growth primarily reflects the aging of the population combined with only gradual increases in payments for health care due to statutory changes, made through the Affordable Care Act (ACA), that tempered their growth.

These ACA changes made a significant difference in Medicare cost projections. Before the law,  payments were scheduled to grow much more quickly -- aligned closely with the rapid health care cost inflation historically seen in this country. For comparison’s sake, in 2009, prior to enactment of the ACA, the trustees projected Medicare costs to grow to 6.26 percent of GDP in 2030 and 10.69 percent of GDP by 2080.

The scenarios from the actuaries assume payments will not slow as quickly as the ACA sets in law. Their first illustration adds the cost of the annual “doc fixes” that Congress passes to prevent steep cuts to physician payments under Medicare Part B -- a recurring problem that predates the ACA. The currently used formula, called the Sustainable Growth Rate (SGR), calls for ever-growing cuts that are so large they would be nearly impossible to implement. For example, the SGR calls for a cut in payments of about 30 percent next January. Instead of permanently reforming the formula -- which would cost in the neighborhood of $300 billion over 10 years -- Congress repeatedly passes smaller, temporary fixes.

When adding in these fixes over the long term, projected Medicare costs rise to 5.7 percent of GDP by 2030 and 7.76 percent by 2080.

The second illustration by the actuaries includes the extended doc fix assumption, but adds an alteration in the assumption about how other Medicare payment changes promoted by the ACA will fare. Those changes slow Medicare costs because they alter the formulas that determine payments for health care services.

The formulas, called “productivity adjustments,” are written to hold health care payments to the growth of economy-wide productivity. However, most health care economists feel that over the long term, this decline in payments will prove impossible to sustain. One reason is that service-intensive industries like the health care sector tend to lag behind manufacturing sectors in achieving efficiency gains. An additional concern is that unless the private health care market faces the same constraints and/or experiences the same efficiency gains, the growing gap between private and public payments will lead to providers abandoning the government programs or even going out of business. Thus, the actuaries assume Congress will eventually abandon these strict formulas and health care costs will grow more closely to the growth in the economy. (They set their assumption at GDP growth plus one percent.)

This leads to Medicare costs growing to 5.8 percent of GDP in 2030 and 9.97 percent by 2080.

The actuaries’ second illustration also assumes the Independent Payment Advisory Boad (IPAB) created by the ACA will be limited in efficacy and thus inconsequential.

Under the spending levels implied by the legislated formulas discussed above, costs will be so low until 2019 that the IPAB wouldn’t even be triggered into action. Beyond then, the board is required to issue recommendations if Medicare costs grow in excess of GDP plus one percent. However, the IPAB’s reach is limited to altering payment levels similar to the ones targeted by the above formulas  -- for example, it won’t be allowed to alter beneficiary cost-sharing and there are many categories of Medicare expenditures exempt from their domain. Thus, the actuaries feel that IPAB’s toolbox is too small to have any real effect on Medicare spending.

Importantly, these scenarios do not represent a judgment on whether or not the ACA will succeed in controlling health care costs -- the judgement is limited to whether austere formulas for payment will, on their own, be sustainable. The law does initiate numerous experiments and pilot projects that attempt to determine how to slow health care cost inflation and have the potential to affect not just spending through government programs, but throughout the health care system. However, whether or not these attempts will succeed is unknowable at this point, and thus the actuaries (and the Congressional Budget Office in its estimates ) do not project cost savings from these measures.

In fact, the primary assumption the actuaries make -- ultimately tying government health care cost growth to the growth in GDP plus one percent -- closely reflects the end-goal of both the Obama administration’s reform efforts and the Medicare reform plan touted by Republican Paul Ryan and reflected in the House Budget. As the actuaries write about reform and their scenarios:

“Expectations must be tempered by awareness of the difficult challenges that lie ahead in improving the quality of care and making health care far more cost efficient. The sizable differences in projected Medicare cost levels between current law and the illustrative alternative scenarios highlight the critical importance of finding ways to bring Medicare costs -- and health care costs in the U.S. generally -- more in line with society’s ability to afford them.”