Medicare: Financial Outlook Poses Challenges for Sustaining	 
Program and Adding Drug Coverage (17-APR-02, GAO-02-643T).	 
                                                                 
The lack of outpatient prescription drug coverage may leave	 
Medicare's most vulnerable beneficiaries with high out-of-pocket 
costs. Recent estimates suggest that, at any given time, more	 
than a third of Medicare beneficiaries lack prescription drug	 
coverage. The rest have some coverage through various		 
sources--most commonly employer-sponsored health plans. Recent	 
evidence indicates that this coverage is beginning to erode. The 
short- and long-term cost pressures facing  Medicare will require
substantial financing and programmatic reforms to put future	 
Medicare on a sustainable footing. In the absence of a drug	 
benefit, many Medicare beneficiaries obtain coverage through	 
health plans, public programs, and the Medigap insurance market. 
The price, availability, and level of such coverage varies	 
widely, leaving substantial gaps and exposure to high		 
out-of-pocket costs for thousands. Despite pressures to adopt a  
prescription drug benefit, the rapidly rising cost of current	 
obligations argues for careful deliberation and extreme caution  
in expanding benefits. GAO's long-term simulations show that the 
aging of the baby boomers and rising per capita health care	 
spending will, absent meaningful reform, lead to massive fiscal  
challenges in future years.					 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-02-643T					        
    ACCNO:   A03083						        
  TITLE:     Medicare: Financial Outlook Poses Challenges for	      
Sustaining Program and Adding Drug Coverage			 
     DATE:   04/17/2002 
  SUBJECT:   Beneficiaries					 
	     Drugs						 
	     Future budget projections				 
	     Health care cost control				 
	     Health insurance					 
	     Managed health care				 
	     Medicaid Program					 
	     Medicare Hospital Insurance Trust Fund		 
	     Medicare Program					 
	     Medicare Supplemental Medical Insurance		 
	     Program						 
                                                                 
	     Medigap						 
	     Social Security Program				 

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GAO-02-643T
     
United States General Accounting Office

GAO Testimony

Before the Committee on Ways and Means, House of Representatives

For Release on Delivery
Expected at 10:30 a.m.
Wednesday, April 17, 2002 MEDICARE

Financial Outlook Poses Challenges for Sustaining Program and Adding Drug
Coverage

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

GAO-02-643T

Mr. Chairman and Members of the Committee:

I am pleased to be here today as you discuss options for increasing Medicare
beneficiaries' access to prescription drugs. 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, over 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 short-term and long-term cost pressures
facing the existing Medicare program are considerable. After a brief
slowdown in the late 1990s, Medicare spending growth has recently
accelerated. In the last fiscal year, growth in program spending reached
nearly 9 percent, with spending on certain services increasing much more
rapidly. For example, spending for home health grew about 30 percent and
spending for skilled nursing facility care grew slightly over 20 percent.

As I have noted previously, 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
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, which
is already unsustainable in its present form.

We must also remain mindful that the fiscal pressures created by the
retirement of the baby boom generation and rising health care costs are just
over the horizon. Between now and 2035, the number of people who are 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 left behind
fewer workers to support them in retirement. Absent substantive reform of
the entitlement programs, a rapid escalation of federal spending for Social
Security, Medicare, and Medicaid beginning less than 10 years from now is
virtually certain to overwhelm the rest of the federal budget.

As figure 1 shows, fiscal flexibility has already decreased as spending for
Social Security, Medicare, and Medicaid have absorbed an increasingly large
share of the federal budget. Reductions in defense spending have helped
accommodate the growth in these entitlement programs. However, reductions in
defense spending can no longer be used as a means to help fund other claims
on the budget; indeed, spending on defense and homeland security will grow
as we seek to combat threats to our nation.

Figure 1: Composition of Federal Spending by Budget Function.

1982 2002

Defense Social Security Medicare and Medicaid Net interest All other
spending

Note: 2002 data based on OMB current services estimate.

Source: Budget of the United States Government, Fiscal Year 2003, Office of
Management and Budget.

Today my remarks will focus on (1) the access and affordability issues that
underlie the interest in a Medicare prescription drug benefit, (2) the
financial challenges Medicare faces to meet its current obligations, and (3)
key considerations in light of the tension between benefit expansions and
budgetary pressures.

In summary, intentions to add prescription drug coverage to Medicare's
benefits come during a period of rapid growth in national spending for
pharmaceuticals. Between 1995 and 2000, spending for prescription drugs rose
more than 2 1/2 times faster than spending for health care overall, and this
dramatic growth is expected to continue in the coming years. In the absence
of a drug benefit in the Medicare program, many beneficiaries obtain
coverage from other sources, including health plans, public

programs, and the Medigap insurance market. But the price, availability, and
level of such coverage vary widely, leaving substantial gaps and exposure to
high out-of-pocket costs for hundreds of thousands of beneficiaries.

Despite the various pressures to adopt a prescription drug benefit, the
rapidly escalating cost of meeting current obligations for present and
future beneficiaries argues for careful deliberation and extreme caution in
crafting any benefit expansion. Medicare's trustees have indicated in recent
years that the Medicare program is already unsustainable in its present
form. GAO's long-term budget simulations show that the aging of the baby
boom generation and rising per capita health care spending will, absent
meaningful reform, lead to massive fiscal challenges in future years.
Assuming, for example, that last year's tax reductions are made permanent
and discretionary spending keeps pace with the economy, by mid-century,
spending for the current Medicare program-without the addition of a drug
benefit-is projected to account for more than one-quarter of all federal
revenues. In fact, federal revenues may only be adequate to pay Social
Security and interest on the federal debt. As a result, massive spending,
tax increases, or some combination of the two would be necessary to obtain
balance. (See fig. 2.)

Figure 2: Composition of Spending as a Share of Gross Domestic Product (GDP)
Assuming  Discretionary Spending  Grows  with GDP  and the  Tax Cuts  Do Not
Sunset.

40 Percent of GDP

                                     30

                                     20

                                     10

                                     0

2000 2015 2030 2050 Fiscal year

All other spending

Source: GAO's March 2002 analysis.

The huge budgetary pressures that we are sure to face in the coming years
require that we 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. At the same time, it is important
that benefit expansion proposals include targeting mechanisms to ensure that
federal support is directed at the beneficiaries with the greatest financial
risk. Nevertheless, as I have stated previously, no matter how well designed
a new benefit may be, adding benefits without fundamentally reforming the
existing program will merely hasten the exhaustion of Medicare's Hospital
Insurance (HI) trust fund and the draining of general revenues. Any benefit
expansion will also serve to make our long-range fiscal challenge even
greater. Ideally, Medicare

Rising Drug Spending Elevates Beneficiary Access Concerns

reforms should be designed to improve our long-range fiscal situation. At a
minimum, they should be designed so as not to make our long-range fiscal
challenge worse.

Extensive research and development have led to new and improved prescription
drug therapies that, in some instances, have replaced other health care
interventions. For example, new medications for the treatment of ulcers have
virtually eliminated the need for some surgical treatments. As a result of
these innovations, the importance of prescription drugs as part of health
care has grown. However, not all new drug therapies serve to reduce the need
for more invasive and expensive medical procedures. Some new drug therapies
are substitutes for already existing, less expensive, ones and may not
appreciably improve efficacy or reduce side effects. Others may be used more
for making lifestyle enhancements than for extending life or treating a
serious medical condition. Spending on the new drug therapies, along with
the mass media advertising of prescription drugs, serves to significantly
increase total drug spending as a component of health care costs.

The Medicare benefit package, largely designed in 1965, provides virtually
no outpatient drug coverage. Beneficiaries may fill this coverage gap in
various ways. All beneficiaries have access to individually purchased
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 Medicare health maintenance
organizations (HMO). In recent years, coverage through these sources has
become more expensive and less widely available. Beneficiaries whose income
falls below certain thresholds may qualify for Medicaid or other public
programs.

                           Prescription Drug Costs
                          Continue to Rise Rapidly

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 almost 15 percent per year from 1995 to 2000,
well more than double the 5.6 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 6.1 percent in 1995
to 9.4 percent in 2000. By 2011, 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,
                                 1995-2000.

Year

  Prescription drug expenditures (in billions) Annual growth in prescription
 drug expenditures from previous year (percent) Annual growth in health care
                                  expenditures from previous year (percent)

Source: Centers
for Medicare and
Medicaid
Services, Office
of the Actuary.

Total drug
expenditures
have been driven
up by several
factors. Drug
coverage by private insurance has likely contributed to the rise in
spending, because insured consumers are partially insulated from the costs.
In the years from 1993 to 2000, the share of prescription drug expenditures
paid by private health insurers rose from more than a fourth to almost a
half. (See fig. 3.) The development of new, more expensive drug
therapies-including new drugs that replace old drugs and new drugs that
treat disease more effectively-also contributed to the growth in drug
spending by boosting the volume of drugs used as well as the average price
for drugs used. Similarly, biotechnology advances and a growing knowledge of
the human immune system are significantly shaping the discovery, design, and
production of drugs. Advertising pitched to consumers has also served to
increase the demand for prescription drugs. A recent study found that, in
2000, the 50 drugs most heavily advertised directly to consumers were
responsible for nearly half of the roughly $21-billion increase in retail
spending on prescription drugs from 1999 to 2000.1

1The National Institute for Health Care Management Research and Educational
Foundation, Prescription Drugs and Mass Media Advertising, 2000 (Washington,
D.C.: Nov. 2001).

Figure  3: Shares of  National Outpatient  Drug Expenditures by  Payer Type,
1993 and 2000.

                                 1993 2000

In 2001, CBO estimated that the average Medicare beneficiary would use
$1,756 worth of prescription drugs. This is a substantial amount considering
that some beneficiaries lack any drug coverage and others with coverage may
have less than in previous years. Moreover, significant numbers of
beneficiaries have drug expenses much higher than those of the average
beneficiary. CBO also estimated that some 10 percent of Medicare
beneficiaries would have expenditures of $4,000 or more.2

According to a recent survey, in the fall of 1999, nearly two-thirds of
Medicare beneficiaries had some form of drug coverage from a

                                     1%

                                  Medicare

Other public
Total Medicaid
Private health insurance
Out-of-pocket

Note: Out-of-pocket expenditures include direct spending by consumers for
prescription drugs, such as coinsurance, deductibles, and any amounts not
covered by insurance. Out-of-pocket premiums paid by individuals are not
counted here.

Source: Centers for Medicare and Medicaid Services, Office of the Actuary,
National Health Statistics Group.

Drug Coverage for Medicare Beneficiaries Is Becoming More Expensive and Less
Available

2CBO estimates reported in Michael E. Gluck and Kristina W. Hanson, Medicare
Chart Book  (Menlo Park, Calif.: The Henry J. Kaiser Family Foundation, fall
2001).

  supplemental insurance policy, health plan, or public program. More than
one-third reported that they lacked drug coverage altogether.3 (See fig. 4.)

Figure 4: Source of Drug Coverage for Medicare Beneficiaries, Fall 1999.

2% Other public

Medicare supplemental (Medigap)

Medicaid

Medicare HMO

Employer-sponsored

No drug coverage

Source: Barents Group analysis of 1996 through 1999 Medicare Current
Beneficiary Survey Access to Care Data.

Employer-sponsored health plans provide drug coverage to the largest segment
of the Medicare population with coverage. However, there are signs that this
coverage is eroding. Fewer employers are offering health benefits to
retirees eligible for Medicare, and those that continue to offer coverage
are requiring retirees to pay a larger share of costs. The proportion of
large employers offering health coverage to retirees eligible for Medicare
declined from 31 percent in 1997 to 23 percent in 2001. At the same time,
the proportion of large employers requiring Medicare-eligible

3Mary A. Laschober and others, "Trends in Medicare Supplemental Insurance
and Prescription Drug Coverage, 1996 to 1999," Health Affairs,
www.healthaffairs.org (Feb. 27, 2002).

retirees to pay the full cost of their health coverage increased from 27
percent to 31 percent.4

In March 2001, 10 percent of Medicare beneficiaries obtained prescription
drug coverage through a Medicare HMO, down from about 15 percent in 1999.
Medicare HMOs have found drug coverage to be an attractive benefit that
beneficiaries consider when choosing to enroll. However, owing to rising
drug expenditures and their effect on plan costs, fewer Medicare HMOs are
offering a drug benefit. In 2002, 50 percent of Medicare beneficiaries have
access to a Medicare HMO with drug coverage, down from 65 percent in 1999.
The drug benefits the plans do offer have become less generous, increasing
enrollees' out-of-pocket costs and limiting their total drug coverage.

About 7 percent of beneficiaries purchase Medigap policies that provide drug
coverage. These policies have shortcomings: they tend to be expensive,
involve significant cost-sharing, and do not provide protection against
catastrophic out-of-pocket expenses. In 1999, average premiums for standard
Medigap policies that included drug coverage ranged from about $1,400 per
year to $1,700 per year.5 Beneficiaries remained responsible for a $250
deductible for drugs and 50-percent coinsurance. The drug benefit was capped
at an annual limit of $1,250 or $3,000. Furthermore, Medigap premiums have
been increasing in recent years. One recent study reported that, from 1999
to 2000, premiums for the Medigap plans offering prescription drug coverage
rose the most-by 17 to 34 percent-compared to 4 to 10 percent increases for
Medigap plans without prescription drug coverage.6

All Medicare beneficiaries who qualify for full Medicaid benefits receive
drug coverage that may include some limits, such as restrictions on the
number of prescriptions that can be filled per month, depending on the
state's Medicaid plan. Individuals with low incomes who are not eligible

4William M. Mercer, Incorporated, Mercer/Foster Higgins National Survey of
Employer-Sponsored Health Plans, 1997 (New York, N.Y.: 1998) and
Mercer/Foster Higgins National Survey of Employer-Sponsored Health Plans,
2001 (New York, N.Y.: 2002).

5U.S. General Accounting Office, Medigap: Current Policies Contain Coverage
Gaps, Undermine Cost Control Incentives, GAO-02-533T (Washington, DC: Mar.
14, 2002).

6Weiss Ratings Inc., "Prescription Drug Costs Boost Medigap Premiums
Dramatically,"
http://www.weissratings.com/NewsReleases/Ins_Medigap/20010326Medigap.htm
(Palm Beach Gardens, Fla.: Mar. 26, 2001).

for full Medicaid benefits may have access to some drug coverage through a
state pharmacy assistance program. As of April 2002, 26 states and the
District of Columbia had such a program in operation.

Access barriers to prescription drugs may be particularly acute for Medicare
beneficiaries who lack drug coverage and have substantial health care needs.
In 1998, among beneficiaries in poor health, those without drug coverage had
drug expenditures that were $910 lower than those with drug coverage and
they filled 14.5 fewer prescriptions. The difference in expenditures and use
between the two groups suggests that the lack of drug coverage may impose
barriers to health care.7

Expanding Benefits The current Medicare program, without improvements, is
ill suited to

serve future generations of seniors and eligible disabled Americans. Needs
to Be Although the need to modernize Medicare's benefit package is
compelling, Considered in Light of the program is already fiscally
unsustainable in its present form, and the

disparity between program expenditures and program revenues isLarger
Medicare expected to widen dramatically in the coming years.

Fiscal Concerns

As Currently Structured, Medicare Is Fiscally Unsustainable

On March 26, 2002, the trustees of the Medicare trust funds reported on the
current and projected financial status of the program over the next 75
years. The report stated that, while the near-term financial condition has
improved slightly since last year's report, Medicare continues to face
substantial financial challenges in the not-too-distant future that need to
be addressed soon.

Medicare's fiscal health is often gauged by the projected solvency of the HI
trust fund, which pays for inpatient hospital stays, skilled nursing care,
hospice, and certain home health services and is financed by payroll taxes.
The gap between income and costs can best be expressed relative to taxable
payroll (the HI trust fund's funding base). This year, under the trustees'
2002 intermediate estimates, the 75-year actuarial deficit is projected to
be 2.02 percent of taxable payroll-an increase from last year's projected
deficit of 1.97 percent. This means that to bring the HI

7John A. Poisal and Lauren Murray, "Growing Differences Between Medicare
Beneficiaries With and Without Drug Coverage," Health Affairs vol. 20, no. 2
(March/April 2001).

trust fund into balance over the 75-year period, either program outlays
would have to be immediately reduced by 38 percent or payroll tax income
immediately increased by almost 70 percent, or some combination of the two.

The trustees' report also projected that the trust fund for Medicare's HI
component would remain solvent until 2030. However, the projection that the
HI trust fund is not facing imminent insolvency does not mean that we can or
should wait until 2030 to take action. Although HI revenues currently exceed
HI outlays, the March 2002 trustees' report projects that cash deficits will
reemerge in 2016 and grow larger with each passing year. (See fig. 5.)
Unlike private trust funds that can set aside money for the future by
investing in financial assets, the Medicare HI trust fund is essentially an
accounting device. It allows the government to track the extent to which
earmarked payroll taxes cover Medicare's HI outlays. While the U.S. Treasury
securities in the HI trust fund are backed by the full faith and credit of
the U.S. government, they essentially represent an unfunded promise to pay,
which will require tough fiscal choices in future years.

Figure 5: Net Cash Flow of the Medicare Hospital Insurance Trust Fund,
2000-2040.

100 Billions of 2002 dollars

0

                                    -100

                                    -200

                                    -300

2000 2005 2010 2015 2020 2025 2030 2035

Cash surplus

Source: GAO analysis based on the intermediate assumptions of the 2002
Annual Report of the Boards of Trustees of the Federal Hospital Insurance
and Federal Supplementary Medical Insurance Trust Funds.

To finance its cash deficits, the HI trust fund will need to draw on the
special- issue Treasury securities acquired during the years when the
program generated cash surpluses. The negative cash flow will place
increased pressure on the federal budget. In essence, for HI to "redeem" its
securities, the government will need to obtain cash through some combination
of increased taxes, spending cuts, increased borrowing from the public (or
correspondingly less debt reduction than would have been the case had cash
flow remained positive).

A focus on HI solvency alone, however, does not provide a complete picture
of the Medicare program `s expected future fiscal claims. The Supplementary
Medical Insurance (SMI) portion of Medicare, which covers physician and
outpatient hospital services, diagnostic tests, and certain other medical
services, is not reflected in the HI solvency measure. SMI is largely funded
through general revenues and its outlays are projected to grow even faster
than HI outlays in the near future.

Bleak Outlook for Medicare's Long-Term Sustainability Increases Urgency for
Program Reform

Without meaningful reform, the long-term financial outlook for Medicare is
bleak. Together, Medicare's HI and SMI expenditures are expected to increase
dramatically, rising from about 11 percent of federal revenues in 2001 to
more than one-quarter by mid-century. Over the same time frame, Medicare's
expenditures are expected to more than double as a share of the nation's
economy, from 2.4 to 6.0 percent, as shown in figure 6. Moreover, relatively
fewer potential workers will be available to shoulder Medicare's financial
burden. In 2000 there were 4.9 working-age persons (18 to 64 years) per
elderly person, but by 2030, this ratio is projected to decline to 2.8.8

Figure 6: Medicare Spending as a Percentage of GDP, 2000-2075

10 Percent of GDP

8

6

4

2

0

2000 2010 2020 2030 2040 2050 2060

Note: Projections based on intermediate assumptions of the 2002 HI and SMI
trustees' report.

Source: Centers for Medicare and Medicaid Services, Office of the Actuary.

The progressive absorption of a greater share of the nation's resources for
health care is in part a reflection of the rising share of the population
that is elderly. Medicare's rolls are expanding and are projected to
increase rapidly with the retirement of the baby boomers. Today's elderly
make up

8For the HI portion of Medicare, in 2001 there were 4 covered workers per HI
beneficiary. Under their intermediate 2002 estimates, the trustees project
that by 2030 there will be only 2.4 covered workers per HI beneficiary.

about 12 percent of the total population; by 2030, they will comprise 20
percent. Medicare growth rates, however, reflect not only a rapidly
increasing beneficiary population, but also the escalation of health care
costs at rates well exceeding general rates of inflation.

When viewed from the perspective of the entire budget and the economy, the
growth in Medicare spending will become progressively unsustainable over the
longer term. Our updated budget 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 last year's tax reductions are made permanent and
discretionary spending keeps pace with the economy, spending for net
interest, Social Security, Medicare, and Medicaid consumes nearly 50 percent
of federal revenue by 2015 and more than three-quarters of federal revenue
by 2030, leaving little room for other federal priorities including defense
and education. (See fig. 2.) By 2050, total federal revenue is insufficient
to fund entitlement spending and interest payments, resulting in deficits
that are escalating out of control.

Our long-term simulations illustrate the magnitude of the fiscal challenges
associated with an aging society and the significance of the related
challenges the government will be called upon to address. As I have stated
previously, early action to reform Medicare and other programs would yield
the highest fiscal dividends for the federal budget and would provide a
longer period for prospective beneficiaries to make adjustments in their own
planning.9 Waiting to build economic resources and reform future claims
entails significant risks. First, we lose an important window during which
today's relatively large workforce can increase savings and enhance
productivity, two elements critical to growing the future economy. Second,
we lose the opportunity to reduce the interest burden on the federal budget,
thereby creating a legacy of higher debt. Third and most critically, we risk
losing the opportunity to phase in changes gradually so that all affected
parties can make the adjustments needed to adequately plan for the future.

Unfortunately, our long-range challenge has become more difficult, and the
window of opportunity to address the entitlement challenge is

9U.S. General Accounting Office, Budget Issues: Long-Term Fiscal Challenges,
GAO-02-467T (Washington, D.C.: Feb. 27, 2002) and Medicare: New Spending
Estimates Underscore Need for Reform, GAO-01-1010T (July 25, 2001).

Private Health Insurance Principles Should Guide Reform Efforts

narrowing. It remains more important than ever to return to these issues
over the next several years. Ultimately, the critical question is not how
much a trust fund has in assets, but whether the government as a whole can
afford the promised benefits now and in the future and at what cost to other
claims on scarce resources.

Given the current federal fiscal environment, we cannot afford to ignore the
difficult policy choices that must be made to keep the Medicare program on a
sustainable footing. Adding prescription drug coverage to the Medicare
benefit package would require balancing competing concerns about program
sustainability, federal obligations, and the hardship faced by some
beneficiaries. The addition of a benefit that has the potential to be
massively expensive should be focused on meeting the needs deemed to be of
the highest priority. This focus would entail targeting financial help to
beneficiaries most in need and, to the extent possible, avoiding the
substitution of public for private coverage. I continue to maintain, that,
optimally, benefit expansions should be made in the context of overall
program reforms that are designed to make the program more sustainable over
the long term.

Several basic principles of health insurance provide a framework for keeping
any new prescription drug benefit more affordable for both beneficiaries and
the taxpayers. First, as health insurance is intended to protect individuals
against large, or catastrophic, expenses, a well-designed benefit should
limit beneficiaries' liability for out-of-pocket expenses. Second, a benefit
should be designed to include reasonable cost-sharing to encourage the
appropriate use of services. Third, the benefit should include features to
avoid adverse selection, that is, avoid covering only beneficiaries who will
use the benefit. Including the individuals who may not currently need the
benefit-but may need it in the future-can spread the risk and help keep the
cost down for everyone.

Leading proposals to integrate prescription drug coverage into the Medicare
program, to varying degrees, incorporate these principles. For example, the
proposals commonly limit a beneficiary's financial liability for
prescription drug costs. They seek to restrain inappropriate spending, in
part by requiring cost-sharing in the form of a deductible and coinsurance.
To make drug coverage attractive to a broader spectrum of beneficiaries, the
proposals subsidize the beneficiary premium. To further encourage
beneficiaries to sign up for prescription drug coverage when they are
healthy, the proposals include provisions that discourage delayed
enrollment. Finally, because even modest cost-sharing amounts might

prove too burdensome for some individuals, the proposals include targeting
mechanisms to help prevent low income from becoming a barrier to obtaining
prescription drug coverage.

Although the leading prescription drug coverage proposals share certain key
design features, they differ in important details, such as the amount of
required cost sharing and the limit on beneficiary out-of-pocket costs.
These differences reflect trade-offs in cost-control mechanisms, benefit
generosity, and protections for beneficiaries with high needs. Careful
debate about the different trade-offs is important, because both the overall
design of a new benefit and the associated details determine the likely
impact on both beneficiaries and taxpayers. 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 the next
10 years. For this reason, I cannot overstate the importance of adopting
meaningful financial reforms to ensure that Medicare remains viable for
future generations.

Concluding Observations

Updating the Medicare benefit package may be an important step in addressing
an aging society's legitimate expectations for health care. Expanding access
to prescription drugs could ease the significant financial burden some
Medicare beneficiaries face because of outpatient drug costs. However, it is
essential that we not take our eye off the ball. The most critical issue
facing Medicare is the need to ensure the program's long-range financial
integrity and sustainability. Care must be taken to ensure that any
potential expansion of the program be balanced with other programmatic
reforms so that we do not worsen Medicare's existing financial imbalances.
The program needs to include adequate fiscal incentives to control costs and
should be carefully targeted to meet genuine needs while remaining
affordable.

This generation has a stewardship responsibility to future generations to
reduce the debt burden they will inherit, to provide a strong foundation for
future economic growth, and to ensure that future commitments are both
adequate and affordable. Changes need to be considered as part of a broader
initiative to address Medicare's current fiscal imbalance and promote the
program's longer-term sustainability. Balancing these competing concerns may
require the best from government-run programs and private sector efforts to
modernize Medicare for the future. Medicare reform and modernization are
best done with considerable lead-time to phase in changes and take action
before the changes that are needed become dramatic and disruptive.

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

Contacts and For future contacts regarding this testimony, please call
William J. Scanlon, Director, Health Care Issues, at (202) 512-7114 or Laura
A.

Acknowledgments Dummit, Director, Health Care-Medicare Payment Issues, at
(202) 512-7119. Other individuals who made key contributions include Linda
Baker, James Cosgrove, Hannah Fein, James McTigue, Jennifer Podulka, and
Lisa Rogers.

                                  (290185)
*** End of document. ***