Medicare: New Spending Estimates Underscore Need for Reform	 
(25-JUL-01, GAO-01-1010T).					 
								 
Although the short-term outlook of Medicare's hospital insurance 
trust fund improved in the last year, Medicare's long-term	 
prospects have worsened. The Medicare Trustee's latest		 
projections, released in March, use more realistic assumptions	 
about health care spending in the years ahead. These latest	 
projections call into question the program's long-term financial 
health. The Congressional Budget Office also increased its	 
long-term estimates of Medicare spending. The slowdown in	 
Medicare spending growth in recent years appears to have ended.  
In the first eight months of fiscal year 2001, Medicare spending 
was 7.5 percent higher than a year earlier. This testimony	 
discusses several fundamental challenges to Medicare reform.	 
Without meaningful entitlement reform, GAO's long-term budget	 
simulations show that an aging population and rising health care 
spending will eventually drive the country back into deficit and 
debt. The addition of a prescription drug benefits would boost	 
spending projections even further. Properly structured reform to 
promote competition among health plans could make Medicare	 
beneficiaries more cost conscious. The continued importance of	 
traditional Medicare underscores the need to base adjustments to 
provider payments on hard evidence rather than on anecdotal	 
information. Similarly, reforms in the management of the Medicare
program should ensure that adequate resources accompany increased
expectations about performance and accountability. Ultimately,	 
broader health care reforms will be needed to balance health care
spending with other societal priorities.			 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-01-1010T					        
    ACCNO:   A01450						        
  TITLE:     Medicare: New Spending Estimates Underscore Need for     
             Reform                                                           
     DATE:   07/25/2001 
  SUBJECT:   Drugs						 
	     Financial analysis 				 
	     Financial management				 
	     Health care costs					 
	     Health insurance					 
	     Projections					 
	     Trust funds					 
	     Federal Employees Health Benefits			 
	     Program						 
								 
	     Medicare Choice Program				 
	     Medicare Hospital Insurance Program		 
	     Medicare Hospital Insurance Trust Fund		 
	     Medicare Program					 
	     Medigap						 
	     Social Security Program				 
	     Supplemental Medical Insurance Program		 
	     Supplementary Medical Insurance Trust		 
	     Fund						 
								 

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GAO-01-1010T
     
Testimony Before the Committee on the Budget, House of Representatives

United States General Accounting Office

GAO For Release on Delivery Expected at 10: 00 a. m. Wednesday, July 25,
2001 MEDICARE

New Spending Estimates Underscore Need for Reform

Statement of David M. Walker Comptroller General of the United States

GAO- 01- 1010T

Page 1 GAO- 01- 1010T

Mr. Chairman and Members of the Committee: I am pleased to be here today as
you discuss the long- term financial condition of the Medicare program. In
previous congressional testimony over the past several years, I have
consistently stressed that without meaningful reform, demographic and cost
trends will drive Medicare spending to unsustainable levels. 1 These trends
highlight the need to act now rather than later when needed changes will be
increasingly more painful and disruptive.

Although the short- term outlook of Medicare?s Hospital Insurance trust fund
improved somewhat in the last year, the long- term projections are much
worse due to a change in expectations about future health care costs.
Specifically, the Medicare Trustees? latest projections released in March
incorporate more realistic- i. e., higher- assumptions about longterm health
care spending. As a result, the long- term outlook for Medicare?s financial
future- both Hospital Insurance (HI) and Supplementary Medical Insurance
(SMI)- is considerably worse than previously estimated. The Congressional
Budget Office (CBO) also increased its long- term estimates of Medicare
spending. The slowdown in Medicare spending growth that we have seen in
recent years appears to have come to an end. In the first 8 months of fiscal
year 2001, Medicare spending was 7.5 percent higher than the previous year.
The fiscal discipline imposed through the Balanced Budget Act of 1997 (BBA)
continues to be challenged, while interest in modernizing the Medicare
benefits package to include prescription drug coverage has increased. Taken
together, these developments mean higher, not lower health care cost growth.
They reinforce the need to begin taking steps to address the challenges of
meaningful Medicare reform. In pursuing such reform, it is important to
focus on the long- term sustainability of the combined Medicare program,
rather than the solvency of the HI trust fund alone.

Ultimately, any comprehensive Medicare reform must confront several
fundamental challenges. In summary:

1 Medicare: Higher Expected Spending and Call for New Benefit Underscore
Need for Meaningful Reform (GAO- 01- 539T, March 22, 2001); Medicare Reform:
Leading Proposals Lay Groundwork, While Design Decisions Lie Ahead (GAO/ T-
HEHS- AIMD- 00- 103, Feb. 24, 2000); Medicare Reform: Ensuring Fiscal
Sustainability While Modernizing the Program Will Be Challenging (GAO/ T-
HEHS/ AIMD- 99- 294, Sept. 22, 1999).

Page 2 GAO- 01- 1010T

 Medicare spending is likely to grow faster than previously estimated. The
Medicare Trustees are now projecting that, in the long- term, Medicare costs
will eventually grow at 1 percentage point above per- capita gross domestic
product (GDP) each year- about 1 percentage point faster per year than the
previous assumption. Accordingly, as estimated by the Office of the Actuary
at the Centers for Medicare and Medicaid Services (CMS)- formerly known as
the Health Care Financing Administration (HCFA), the estimated net present
value of future additional resources needed to fund Part A HI benefits over
the next 75 years increased from $2.6 trillion last year to $4.6 trillion
this year- an increase of more than 75 percent.

 Our long- term budget simulations show that demographics and health care
spending will drive us back into periods of escalating deficits and debt
absent meaningful entitlement reforms or other significant tax or spending
actions. Our March 2001 long- term simulations show that even if the
oftenstated goal of saving all Social Security surpluses is realized, large
and persistent deficits will return in less than 20 years.

 Medicare?s sustainability can no longer be measured merely using the
traditional measure of HI trust fund solvency. The financial status of this
trust fund does not reflect the whole picture. In fact, focusing on solvency
can be misleading and give a false sense of security regarding the overall
condition of the Medicare program. Both Part A expenditures financed through
payroll taxes and Part B SMI expenditures financed through general revenues
and beneficiary premiums must be taken into consideration. When viewed from
this comprehensive perspective, total Medicare spending is projected to
double as a share of GDP by 2035. Importantly, this estimate does not
include the cost of any prescription drug benefit.

 Since the cost of a drug benefit would boost these spending projections
even further, adding prescription drug coverage will require difficult
policy choices that will likely have significant effects on beneficiaries,
taxpayers, and the program. Recognition of who bears the cost of Medicare is
critical. Currently, there may not be full awareness that beneficiaries?
payroll tax contributions and premiums generally finance considerably less
than their lifetime benefits.

 Properly structured reforms to promote competition among health plans can
help make beneficiaries more cost conscious. However, improvements to
traditional fee- for- service (FFS) Medicare are also critical, as it will
likely remain dominant for some time to come.

 Fiscal discipline is difficult, but the continued importance of
traditional Medicare underscores the need to base adjustments to provider
payments on hard evidence rather than anecdotal information and to carefully
target relief where it is both needed and deserved.

Page 3 GAO- 01- 1010T

 Similarly, reform of Medicare?s management, which is on the table as
discussions of Medicare program reforms proceed, will require carefully
targeted efforts to ensure that adequate resources are appropriately coupled
with improved performance and increased accountability.

 Ultimately, we will need to look at broader health care reforms to balance
health care spending with other societal priorities. In doing this, it is
important to look at the entire range of federal policy tools- tax policy,
spending, and regulation. It is also important to note the fundamental
differences between health care wants, which are virtually unlimited, from
needs, which should be defined and addressed, and overall affordability, of
which there is a limit. In the end, we will need to take a range of steps to
increase the transparency of health care costs and quality, target
assistance to those in need, re- examine incentives, and assure
accountability for desired outcomes.

The consensus that Medicare is likely to cost more than previously estimated
serves to reinforce the need to act soon. Realistically, reforms to address
the Medicare program?s huge long- range financial imbalance will need to
proceed incrementally. In addition, efforts to update the program?s benefits
package will need careful and cautious deliberation. As the Congress
considers Medicare reform, it will be important to adopt effective cost
containment reforms alongside potential benefit expansions. Any benefit
expansion efforts will need to be coupled with adequate program reforms if
Medicare?s long- range financial condition is not to be worsened. This is
especially important in connection with a potential prescription drug
benefit, as this coverage represents the fastest- growing expenditure for
many public and private health plans. Therefore, the time to begin these
difficult, but necessary, incremental steps is now.

As I have stated in other testimony, Medicare as currently structured is
fiscally unsustainable. While many people have focused on the improvement in
the HI trust fund?s shorter- range solvency status, the real news is that we
now have a more realistic view of Medicare?s long- term financial condition
and the outlook is much bleaker. A consensus has emerged that previous
program spending projections have been based on overly optimistic
assumptions and that actual spending will grow faster than has been assumed.
Medicare?s Long- Term

Financial Future Looks Worse

Page 4 GAO- 01- 1010T

First, let me talk about how we measure Medicare?s fiscal health. In the
past, Medicare?s financial status has generally been gauged by the projected
solvency of the HI trust fund, which covers primarily inpatient hospital
care and is financed by payroll taxes. Looked at this way, Medicare- more
precisely, Medicare?s Hospital Insurance trust fund- is described as solvent
through 2029.

However, even from the perspective of HI trust fund solvency, the estimated
exhaustion date of 2029 does not mean that we can or should wait until then
to take action. In fact, delay in addressing the HI trust fund imbalance
means that the actions needed will be larger and more disruptive. Taking
action today to restore solvency to the HI trust fund for the next 75 years
would require benefit cuts of 37 percent or tax increases of 60 percent, or
some combination of the two. While these actions would not be easy or
painless, postponing action until 2029 would require more than doubling of
the payroll tax or cutting benefits by more than half to maintain solvency.
(See fig. 1.) Given that in the long- term, Medicare cost growth is now
projected to grow at 1 percentage point faster than GDP, HI?s financial
condition is expected to continue to worsen after the 75- year period. By
2075, HI?s annual financing shortfall- the difference between program income
and benefit costs- will reach 7.35 percent of taxable payroll. This means
that if no action is taken this year, shifting the 75- year horizon out one
year to 2076- a large deficit year- and dropping 2001- a surplus year- would
yield a higher actuarial deficit, all other things being equal. Traditional
HI Trust Fund

Solvency Measure Is a Poor Indicator of Medicare?s Fiscal Health

Page 5 GAO- 01- 1010T

Figure 1: Estimated Benefit Reduction or Tax Increase Necessary to Restore
HI Trust Fund Solvency

Source: Office of the Actuary, CMS, 2001 intermediate assumptions.

Moreover, HI trust fund solvency does not mean the program is financially
healthy. Under the Trustees? 2001 intermediate estimates, HI outlays are
projected to exceed HI tax revenues beginning in 2016, the same year in
which Social Security outlays are expected to exceed tax revenues. (See fig.
2.) As the baby boom generation retires and the Medicare- eligible
population swells, the imbalance between outlays and revenues will increase
dramatically. Thus, in 15 years the HI trust fund will begin to experience a
growing annual cash deficit. At that point, the HI program must redeem
Treasury securities acquired during years of cash surplus. Treasury, in
turn, must obtain cash for those redeemed securities either through
increased taxes, spending cuts, increased borrowing, retiring less debt, or
some combination thereof.

37 44 54 60 80

119 0 25

50 75

100 125

150 2001- 2075 2016- 2075 2029- 2075 Percent

Benefit Reduction Tax Increase

Page 6 GAO- 01- 1010T

Figure 2: Medicare?s Hospital Insurance Trust Fund Faces Cash Deficits as
Baby Boomers Retire

Source: GAO analysis of data from the Office of the Actuary, CMS, 2001
intermediate assumptions.

Finally, HI trust fund solvency does not measure the growing cost of the
Part B SMI component of Medicare, which covers outpatient services and is
financed through general revenues and beneficiary premiums. 2 Part B
accounts for somewhat more than 40 percent of Medicare spending and is
expected to account for a growing share of total program dollars. As the
Trustees noted in this year?s report, a rapidly growing share of general
revenues and substantial increases in beneficiary premiums will be required
to cover part B expenditures.

2 At Medicare?s inception, the law initially established a formula for Part
B premiums that set the rate to cover 50 percent of expected program costs
for aged enrollees, with the remaining 50 percent covered by general
revenues. Legislation enacted in 1972 limited the annual percentage increase
in the premium to the same percentage by which Social Security benefits were
adjusted for changes in cost of living. As a result, from the mid1970s
through the early 1980s, the portion of program costs covered by premium
income dropped from 50 percent to below 25 percent. Beginning in the early
1980s, Congress regularly voted to set part B premiums at a level to cover
25 percent of expected program costs, in effect overriding the cost- of-
living adjustment limitation. In 1997 BBA permanently set the rate at 25
percent.

-300 -200

-100 0

100 2000 2005 2010 2015 2020 2025 2030 2035 2040

HI cash surplus HI cash deficit Medicare HI

cash deficit 2016 Billions of 2000 dollars

Page 7 GAO- 01- 1010T

Clearly, it is total program spending- both Part A and Part B- relative to
the entire federal budget and national economy that matters. This total
spending approach is a much more realistic way of looking at the combined
Medicare program?s sustainability. In contrast, the historical measure of HI
trust fund solvency cannot tell us whether the program is sustainable over
the long haul. Worse, it can serve to distort perceptions about the timing,
scope, and magnitude of our Medicare challenge.

These figures reflect a worsening of the long- term outlook. Last year a
technical panel advising the Medicare Trustees recommended assuming that
future per- beneficiary costs for both HI and SMI eventually will grow at a
rate 1 percentage point above GDP growth- about 1 percentage point higher
than had previously been assumed. 3 That recommendation- which was
consistent with a similar change CBO had made to its Medicare and Medicaid
long- term cost growth assumptions 4 -was adopted by the Trustees. In their
new estimates published on March 19, 2001, the Trustees adopted the
technical panel?s long- term cost growth recommendation. 5 The Trustees note
in their report that this new assumption substantially raises the long- term
cost estimates for both HI and SMI. In their view, incorporating the
technical panel?s recommendation yields program spending estimates that
represent a more realistic assessment of likely long- term program cost
growth.

Under the old assumption (the Trustees? 2000 best estimate intermediate
assumptions), total Medicare spending consumed 5 percent of GDP by 2063.
Under the new assumption (the Trustees? 2001 best estimate intermediate
assumptions), this occurs almost 30 years sooner in 2035- and by 2075
Medicare consumes over 8 percent of GDP, compared with 5.3 percent under the
old assumption. The difference clearly demonstrates the

3 Technical Review Panel on the Medicare Trustees Reports, Review of
Assumptions and Methods of the Medicare Trustees? Financial Projections
(Dec. 2000). As the panel noted, for many years the Medicare projections
have been based on an assumption that in the long run, average per-
beneficiary costs would increase at about the same rate as program
underlying funding sources. For HI, this meant that expenditures were
assumed to increase at the same rate as average hourly earnings. For SMI,
this meant that per- beneficiary costs were assumed to grow at the same rate
as per- capita GDP.

4 CBO, The Long- Term Budget Outlook (Oct. 2000). 5 See 2001 Annual Report
of the Board of Trustees of the Federal Hospital Insurance Trust Fund (March
2001) and 2001 Annual Report of the Board of Trustees of the Federal
Supplementary Medical Insurance Trust Fund (March 2001). New Estimates
Increase

Urgency of Reform Efforts

Page 8 GAO- 01- 1010T

dramatic implications of a 1- percentage point increase in annual Medicare
spending over time. (See fig. 3)

Figure 3: Medicare Spending as a Share of GDP Under Old and New Assumptions

Note: Data are gross outlays as projected under the Trustees? intermediate
assumptions. Source: GAO analysis of data from the 2000 and 2001 HI and SMI
Trustees Reports.

In part the progressive absorption of a greater share of the nation?s
resources for health care, as with Social Security, is a reflection of the
rising share of the population that is elderly. Both programs face
demographic conditions that require action now to avoid burdening future
generations with the program?s rising costs. Like Social Security,
Medicare?s financial condition is directly affected by the relative size of
the populations of covered workers and beneficiaries. Historically, this
relationship has been favorable. In the near future, however, the covered
worker- to- retiree ratio will change in ways that threaten the financial
solvency and sustainability of this important national program. In 1970
there were 4.6 workers per HI beneficiary. Today there are about 4, and in
2030, this ratio will decline to only 2.3 workers per HI beneficiary. 6 (See
fig. 4.)

6 For Social Security, there were 3.7 covered workers per beneficiary in
1970. Today there are 3.4, and the ratio is expected to decline to 2.1 in
2030.

0 2

4 6

8 10

2000 2010 2020 2030 2040 2050 2060 2070 2075 Percent of GDP

2000 Trustees 2001 Trustees

Page 9 GAO- 01- 1010T

Figure 4: Workers Per HI Beneficiary Expected to Decline

Source: GAO analysis of data from the Office of the Actuary, CMS.

Unlike Social Security, however, Medicare 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. Increases in the
number and quality of health care services have been fueled by the explosive
growth of medical technology. 7 Moreover, the actual costs of health care
consumption are not transparent. Third- party payers generally insulate
consumers from the cost of health care decisions. All of these factors
contribute to making Medicare a much greater and more complex fiscal
challenge than even Social Security.

When viewed from the perspective of the federal budget and the economy, the
growth in health care spending will become increasingly unsustainable over
the longer term. 8 Figure 5 shows the sum of the future expected HI

7 In arriving at their recommendation for Medicare long- term cost growth,
the Medicare Technical Panel observed that historically, the primary long-
run determinant of real health care spending has been the development and
diffusion of new medical technology.

8 See Long- Term Budget Issues: Moving from Balancing the Budget to
Balancing Fiscal Risk (GAO- 01- 385T, Feb. 6, 2001).

0 1

2 3

4 5

1966 1975 1985 1995 2005 2015 2025 2035 2045 2055 2065 2075 Workers per HI
Beneficiary

Page 10 GAO- 01- 1010T

cash deficit and the expected general fund contribution to SMI as a share of
federal income taxes under the Trustees 2001 intermediate estimates. SMI has
received contributions from the general fund since the inception of the
program. This general revenue contribution is projected to grow from about 5
percent of federal personal and corporate income taxes in 2000 to 13 percent
by 2030. Beginning in 2016, use of general fund revenues will be required to
pay benefits as the HI trust fund redeems its Treasury securities. Assuming
general fund revenues are used to pay benefits after the trust fund is
exhausted, by 2030 the HI program alone would consume more than 6 percent of
income tax revenue. On a combined basis, Medicare?s draw on general revenues
would grow from 5.4 percent of income taxes today to nearly 20 percent in
2030 and 45 percent by 2070.

Figure 5: SMI General Revenue Contribution and HI Cash Deficit as a Share of
Federal Corporate and Personal Income Taxes

Note: Estimates are based on the Trustees? 2001 intermediate assumptions and
assume that personal and corporate federal income taxes remain at the same
share of gross domestic product as in 2000.

Source: GAO analysis of data from the Office of the Chief Actuary, CMS, 2001
intermediate assumptions.

Figure 6 reinforces the need to look beyond the HI program. HI is only the
first layer in this figure. The middle layer adds the SMI program, which is
expected to grow faster than HI in the near future. By the end of the 75-

0 5

10 15

20 25

30 35

40 45

50 1970 1980 1990 2000 2010 2020 2030 2040 2050 2060 2070

SMI general revenue contribution HI cash deficit Percent of federal income
taxes

Page 11 GAO- 01- 1010T

year projection period, SMI will represent almost half of total estimated
Medicare costs.

To get a more complete picture of the future federal health care entitlement
burden, Medicaid is added. Medicare and the federal portion of Medicaid
together will grow to 14.5 percent of GDP from today?s 3.5 percent. Taken
together, the two major government health programs- Medicare and Medicaid-
represent an unsustainable burden on future generations. In addition, this
figure does not reflect the taxpayer burden of state and local Medicaid
expenditures. A recent statement by the National Governors Association
argues that increased Medicaid spending has already made it difficult for
states to increase funding for other priorities.

Figure 6: Medicare and Medicaid Spending as a Share of GDP

Notes: 1. Medicare data are gross outlays as projected under the Trustees?
2001 intermediate assumptions. 2. Federal Medicaid data based on CBO?s
October 2000 long- term budget outlook.

Source: GAO analysis of data from the Congressional Budget Office and the
March 2001 HI and SMI Trustees Reports.

Our long- term simulations show that to move into the future with no changes
in federal health and retirement programs is to envision a very different
role for the federal government. Assuming, for example, that Congress and
the President adhere to the often- stated goal of saving the Social Security
surpluses, our long- term simulations show a world by 2030 in which Social
Security, Medicare, and Medicaid absorb most of the available revenues
within the federal budget. Under this scenario, these

0 2

4 6

8 10

12 14

16 2000 2010 2020 2030 2040 2050 2060 2075

Percent of GDP HI SMI

Medicaid

Page 12 GAO- 01- 1010T

programs would require more than three- quarters of total federal revenue
even without adding a Medicare prescription drug benefit. (See fig. 7.)

Figure 7: Composition of Federal Spending as a Share of GDP Under the ?Save
the Social Security Surpluses? Simulation

Notes: Revenue as a share of GDP declines from its 2000 level of 20.6
percent due to unspecified permanent policy actions. In this display, policy
changes are allocated equally between revenue reductions and spending
increases.

The ?Save the Social Security Surpluses? simulation can only be run through
2056 due to the elimination of the capital stock.

Source: GAO?s March 2001 analysis.

This scenario contemplates saving surpluses for 20 years- an unprecedented
period of surpluses in our history- and retiring publicly held debt. Alone,
however, even saving all Social Security surpluses would not be enough to
avoid encumbering the budget with unsustainable costs from these entitlement
programs. Little room would be left for other federal spending priorities
such as national defense, education, and law enforcement. Absent changes in
the structure of Medicare and Social Security, sometime during the 2040s
government would do nothing but mail checks to the elderly and their health
care providers. Accordingly, substantive reform of the Medicare and Social
Security programs remains critical to recapturing our future fiscal
flexibility.

0 10

20 30

40 50

2000 2030 2050

Percent of GDP

Net interest Social Security Medicare & Medicaid All other spending Revenue

Page 13 GAO- 01- 1010T

Demographics argue for early action to address Medicare?s fiscal imbalances.
Ample time is required to phase in the reforms needed to put this program on
a more sustainable footing before the baby boomers retire. In addition,
timely action to bring costs down pays large fiscal dividends for the
program and the budget. The high projected growth of Medicare in the coming
years means that the earlier reform begins, the greater the savings will be
as a result of the effects of compounding.

Beyond reforming the Medicare program itself, maintaining an overall
sustainable fiscal policy and strong economy is vital to enhancing our
nation?s future capacity to afford paying benefits in the face of an aging
society. Today?s decisions can have wide- ranging effects on our ability to
afford tomorrow?s commitments. As I have testified before, you can think of
the budget choices you face as a portfolio of fiscal options balancing
today?s unmet needs with tomorrow?s fiscal challenges. At the one end- with
the lowest risk to the long- range fiscal position- is reducing publicly
held debt. At the other end- offering the greatest risk- is increasing
entitlement spending without fundamental program reform.

Reducing publicly held debt helps lift future fiscal burdens by freeing up
budgetary resources encumbered for interest payments, which currently
represent about 12 cents of every federal dollar spent, and by enhancing the
pool of economic resources available for private investment and longterm
economic growth. This is particularly crucial in view of the known fiscal
pressures that will begin bearing down on future budgets in about 10 years
as the baby boomers start to retire. However, as noted above, debt reduction
is not enough. Our long- term simulations illustrate that, absent
entitlement reform, large and persistent deficits will return.

Despite common agreement that, without reform, future program costs will
consume growing shares of the federal budget, there is also a mounting
consensus that Medicare?s benefit package should be expanded to cover
prescription drugs, which will add billions to the program?s cost. This
places added pressure on policymakers to consider proposals that could
fundamentally reform Medicare. Our previous work provides, I believe, some
considerations that are relevant to deliberations regarding the potential
addition of a prescription drug benefit and Medicare reform options that
would inject competitive mechanisms to help control costs. In addition, our
reviews of HCFA offer lessons for improving Medicare?s management.
Implementing necessary reforms that address Medicare?s financial imbalance
and meet the needs of beneficiaries will not be easy. Medicare?s Bleak

Financial Outlook Drives Need for Meaningful Program and Management Reform

Page 14 GAO- 01- 1010T

We must have a Medicare agency that is ready and able to meet these 21st
century challenges.

Among the major policy challenges facing the Congress today is how to
reconcile Medicare?s unsustainable long- range financial condition with the
growing demand for an expensive new benefit- namely, coverage for
prescription drugs. It is a given that prescription drugs play a far greater
role in health care now than when Medicare was created. Today, Medicare
beneficiaries tend to need and use more drugs than other Americans. However,
because adding a benefit of such potential magnitude could further erode the
program?s already unsustainable financial condition, you face difficult
choices about design and implementation options that will have a significant
impact on beneficiaries, the program, and the marketplace.

Let?s examine the current status regarding Medicare beneficiaries and drug
coverage. About a third of Medicare beneficiaries have no coverage for
prescription drugs. Some beneficiaries with the lowest incomes receive
coverage through Medicaid. Some beneficiaries receive drug coverage through
former employers, some can join Medicare+ Choice plans that offer drug
benefits, and some have supplemental Medigap coverage that pays for drugs.
However, significant gaps remain. For example, Medicare+ Choice plans
offering drug benefits are not available everywhere and generally do not
provide catastrophic coverage. Medigap plans are expensive and have caps
that significantly constrain the protection they offer. Thus, beneficiaries
with modest incomes and high drug expenditures are most vulnerable to these
coverage gaps.

Overall, the nation?s spending on prescription drugs has been increasing
about twice as fast as spending on other health care services, and it is
expected to keep growing. Recent estimates show that national per- person
spending for prescription drugs will increase at an average annual rate
exceeding 10 percent until at least 2010. As the cost of drug coverage has
been increasing, employers and Medicare+ Choice plans have been cutting back
on prescription drug benefits by raising enrollees? cost- sharing, charging
higher copayments for more expensive drugs, or eliminating the benefit
altogether.

It is not news that adding a prescription drug benefit to Medicare will be
costly. However, the cost consequences of a Medicare drug benefit will
depend on choices made about its design- including the benefit?s scope and
financing mechanism. For instance, a Medicare prescription drug Adding a
Fiscally

Responsible Prescription Drug Benefit Will Entail Multiple Trade- Offs

Page 15 GAO- 01- 1010T

benefit could be designed to provide coverage for all beneficiaries,
coverage only for beneficiaries with extraordinary drug expenses, coverage
only for low- income beneficiaries. Policymakers would need to determine how
costs would be shared between taxpayers and beneficiaries through premiums,
deductibles, and copayments and whether subsidies would be available to low-
income, non- Medicaid eligible individuals. Design decisions would also
affect the extent to which a new pharmaceutical benefit might shift to
Medicare portions of the out- ofpocket costs now borne by beneficiaries as
well as those costs now paid by Medicaid, Medigap, or employer plans
covering prescription drugs for retirees. Clearly, the details of a
prescription drug benefit?s implementation would have a significant impact
on both beneficiaries and program spending. Experience suggests that some
combination of enhanced access to discounted prices, targeted subsidies, and
measures to make beneficiaries more aware of costs may be needed. Any option
would need to balance concerns about Medicare sustainability with the need
to address what will likely be a growing hardship for some beneficiaries in
obtaining prescription drugs.

The financial prognosis for Medicare clearly calls for meaningful spending
reforms to help ensure that the program is sustainable over the long haul.
The importance of such reforms will be heightened if financial pressures on
Medicare are increased by the addition of new benefits, such as coverage for
prescription drugs. Some leading reform proposals envision that Medicare
could achieve savings by adapting some of the competitive elements embodied
in the Federal Employees Health Benefits Program. Specifically, these
proposals would move Medicare towards a model in which health plans compete
on the basis of benefits offered and costs to the government and
beneficiaries, making the price of health care more transparent.

Currently, Medicare follows a complex formula to set payment rates for
Medicare+ Choice plans, and plans compete primarily on the richness of their
benefit packages. Medicare permits plans to earn a reasonable profit, equal
to the amount they can earn from a commercial contract. Efficient plans that
keep costs below the fixed payment amount can use the

?savings? to enhance their benefit packages, thus attracting additional
members and gaining market share. Under this arrangement, competition Reform
Options Based on

Competition Offer Advantages but Contain Limitations

Page 16 GAO- 01- 1010T

among Medicare plans may produce advantages for beneficiaries, but the
government reaps no savings. 9

In contrast, a competitive premium approach offers certain advantages.
Instead of having the government administratively set a payment amount and
letting plans decide- subject to some minimum requirements- the benefits
they will offer, plans would set their own premiums and offer at least a
required minimum Medicare benefit package. Under these proposals, Medicare
costs would be more transparent: beneficiaries could better see what they
and the government were paying for in connection with health care
expenditures. Beneficiaries would generally pay a portion of the premium and
Medicare would pay the rest. Plans operating at lower cost could reduce
premiums, attract beneficiaries, and increase market share. Beneficiaries
who joined these plans would enjoy lower out- ofpocket expenses. Unlike
today?s Medicare+ Choice program, the competitive premium approach provides
the potential for taxpayers to benefit from the competitive forces. As
beneficiaries migrated to lowercost plans, the average government payment
would fall.

Experience with the Medicare+ Choice program reminds us that competition in
Medicare has its limits. First, not all geographic areas are able to support
multiple health plans. Medicare health plans historically have had
difficulty operating efficiently in rural areas because of a sparseness of
both beneficiaries and providers. In 2000, 21 percent of rural beneficiaries
had access to a Medicare+ Choice plan, compared to 97 percent of urban
beneficiaries. Second, separating winners from losers is a basic function of
competition. Thus, under a competitive premium approach, not all plans would
thrive, requiring that provisions be made to protect beneficiaries enrolled
in less successful plans.

The extraordinary challenge of developing and implementing Medicare reforms
should not be underestimated. Our look at health care spending projections
shows that, with respect to Medicare reform, small implementation problems
can have huge consequences. To be effective, a good program design will need
to be coupled with competent program

9 In fact, the government has been losing money on the Medicare+ Choice
program. Medicare pays more, on average, for beneficiaries enrolled in
managed care plans than if these individuals had remained in traditional
Medicare. See Medicare+ Choice: Payments Exceed Cost of Fee- for- Service
Benefits, Adding Billions to Spending (GAO/ HEHS- 00- 161,

Aug. 23, 2000). Effective Program

Management Key to Successful Reform Efforts

Page 17 GAO- 01- 1010T

management. Consistent with that view, questions are being raised about the
ability of CMS to administer the Medicare program effectively.

Our reviews of Medicare program activities confirm the legitimacy of these
concerns. In our companion statement today, we discuss not only the Medicare
agency?s performance record but also areas where constraints have limited
the agency?s achievements. We also identify challenges the agency faces in
seeking to meet expectations for the future.

As the Congress and the Administration focus on current Medicare management
issues, our review of HCFA suggests several lessons:

 Managing for results is fundamental to an agency?s ability to set
meaningful goals for performance, measure performance against those goals,
and hold managers accountable for their results. Our work shows that HCFA
has faltered in adopting a results- based approach to agency management,
leaving the agency in a weakened position for assuming upcoming
responsibilities. In some instances, the agency may not have the tools it
needs because it has not been given explicit statutory authority. For
example, the agency has sought explicit statutory authority to use full and
open competition to select claims administration contractors. The agency
believes that without such statutory authority it is at a disadvantage in
selecting the best performers to carry out Medicare claims administration
and customer service functions. To be effective, any agency must be equipped
with the full complement of management tools it needs to get the job done.

 A high- performance organization demands a workforce with, among other
things, up- to- date skills to enhance the agency?s value to its customers
and ensure that it is equipped to achieve its mission. HCFA began workforce
planning efforts that continue today in an effort to identify areas in which
staff skills are not well matched to the agency?s evolving mission. In
addition, CMS recently reorganized its structure to be more responsive to
its customers. It is important that CMS continue to reevaluate its skill
needs and organizational structure as new demands are placed on the agency.

 Data- driven information is essential to assess the budgetary impact of
policy changes and distinguish between desirable and undesirable
consequences. Ideally, the agency that runs Medicare should have the ability
to monitor the effects of Medicare reforms, if enacted- such as adding a
drug benefit or reshaping the program?s design. However, HCFA was unable to
make timely assessments, largely because its information systems were not up
to the task. The status of these systems remains the same, leaving CMS
unprepared to determine, within reasonable time

Page 18 GAO- 01- 1010T

frames, the appropriateness of services provided and program expenditures.
The need for timely, accurate, and useful information is particularly
important in a program where small rate changes developed from faulty
estimates can mean billions of dollars in overpayments or underpayments.

 An agency?s capacity should be commensurate with its responsibilities. As
the Congress continues to modify Medicare, CMS? responsibilities will grow
substantially. HCFA?s tasks increased enormously with the enactment of
landmark Medicare legislation in 1997 and the modifications to that
legislation in 1999 and 2000. In addition to the growth in Medicare
responsibilities, the agency that administers this program is also
responsible for other large health insurance programs and activities. As the
agency?s mission has grown, however, its administrative dollars have been
stretched thinner. Adequate resources are vital to support the kind of
oversight and stewardship activities that Americans have come to count on-
inspection of nursing homes and laboratories, certification of Medicare
providers, collection and analysis of critical health care data, to name a
few. Shortchanging this agency?s administrative budget will put the agency?s
ability to handle upcoming reforms at serious risk.

In short, because Medicare?s future will play such a significant role in the
future of the American economy, we cannot afford to settle for anything less
than a world- class organization to run the program. However, achieving such
a goal will require a clear recognition of the fundamental importance of
efficient and effective day- to- day operations.

In determining how to reform the Medicare program, much is at stake- not
only the future of Medicare itself but also assuring the nation?s future
fiscal flexibility to pursue other important national goals and programs. I
feel that the greatest risk lies in doing nothing to improve the Medicare
program?s long- term sustainability. It is my hope that we will think about
the unprecedented challenge facing future generations in our aging society.
Engaging in a comprehensive effort to reform the Medicare program and put it
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.

Updating Medicare?s benefit package may be a necessary part of any realistic
reform program. Such changes, however, need to be considered in the context
of Medicare?s long- term fiscal outlook and the need to make changes in ways
that will promote the program?s longer- term Conclusions

Page 19 GAO- 01- 1010T

sustainability. We must remember that benefit expansions are often
permanent, while the more belt- tightening payment reforms- vulnerable to
erosion- could be discarded altogether. The BBA experience reminds us about
the difficulty of undertaking reform.

Most importantly, any substantial benefit reform should be coupled with
other meaningful program reforms that will help to ensure the long- term
sustainability of the program. In the end, the Congress should consider
adopting a Hippocratic oath for Medicare reform proposals- namely,

?Don?t make the long- term outlook worse.? Ultimately, we will need to
engage in a much more fundamental health care reform debate to differentiate
wants, which are virtually unlimited, from needs, which should be defined
and addressed, and overall affordability, of which there is a limit.

We at GAO look forward to continuing to work with this Committee and the
Congress in addressing this and other important issues facing our nation. In
doing so, we will be true to our core values of accountability, integrity,
and reliability.

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

(290101)
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