Medicare Reform: Leading Proposals Lay Groundwork, While Design Decisions
Lie Ahead (Testimony, 02/24/2000, GAO/T-HEHS/AIMD-00-103).

Pursuant to a congressional request, GAO discussed two leading proposals
on Medicare reform: (1) the President's Plan to Modernize and Strengthen
Medicare for the 21st Century; and (2) S. 1895, entitled the Medicare
Preservation and Improvement Act of 1999, which is commonly referred to
as the Breax-Frist proposal.

GAO noted that: (1) the elements of restructuring of Medicare as
proposed by the President and Breaux-Frist are best understood in light
of Medicare's current structure; (2) from the perspective of the
program's benefit package, most beneficiaries have two broad choices:
they can receive health care coverage through Medicare's traditional
fee-for-service program or through its managed care component, called
Medicare Choice; (3) the choice between traditional Medicare and a
Medicare Choice plan typically involves certain trade-offs related to
selection of providers, services covered, and out-of-pocket costs; (4)
the President's plan and the Breaux-Frist proposal are similar in three
key areas but contain two major differences; (5) to varying degrees,
both proposals: (a) introduce a competitive premium model, similar in
concept to the Federal Employees Health Benefit Program, to achieve cost
efficiencies; (b) preserve the traditional fee-for-service Medicare
program with enhanced opportunities to adopt prudent purchasing
strategies; and (c) modernize Medicare's benefit package by making
coverage available for prescription drug and catastrophic Medicare
costs; (6) the proposals differ, however, in the extent to which
traditional Medicare could face competitive pressure from private plans;
and (7) under the President's plan, the Health Care Financing
Administration would administer the program, whereas under the
Breaux-Frist proposal, an independent Medicare board would perform that
function.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  T-HEHS/AIMD-00-103
     TITLE:  Medicare Reform: Leading Proposals Lay Groundwork, While
	     Design Decisions Lie Ahead
      DATE:  02/24/2000
   SUBJECT:  Health care programs
	     Managed health care
	     Future budget projections
	     Patient care services
	     Proposed legislation
	     Medical services rates
	     Health insurance cost control
	     Health services administration
IDENTIFIER:  Medicare Program
	     Medicare Choice Program
	     Federal Employees Health Benefits Program
	     Medigap Program
	     Social Security Program
	     Medicare Prospective Payment System
	     Medicaid Program

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     Expected at 10:00 a.m.

Thursday, February 24, 2000

GAO/T-HEHS/AIMD-00-103

MEDICARE REFORM

Leading Proposals Lay Groundwork, While Design Decisions Lie Ahead

        Statement of David M. Walker

Comptroller General of the United States

Testimony

Before the Committee on Finance, U.S. Senate

United States General Accounting Office

GAO

Medicare Reform: Leading Proposals Lay Groundwork, While Design Decisions
Lie Ahead

Mr. Chairman and Members of the Committee:

I am pleased to be here today as you discuss Medicare reform. I would like
to focus my remarks on the two leading proposals that involve more
comprehensive reform-that is, reform that addresses cost containment as well
as expanded benefits. However, before examining these proposals, I would
like to speak again about a budgetary context for understanding the proposed
reforms in light of Medicare' s future sustainability and the long-range
budget outlook.

I spoke with you twice last year about this topic, and despite some very
positive, short-term developments regarding our economy, the federal
surplus, and Medicare spending, the bigger picture remains virtually
unchanged. Long-term cost pressures facing the Medicare program are
considerable. Even before adding a prescription drug benefit, for example,
projected program spending threatens to absorb ever-increasing shares of the
nation's budgetary and economic resources.

It is tempting to push aside this gloomy forecast in the face of today's
sunny budget report. In its most recent projections, the Congressional
Budget Office (CBO) shows both unified and on-budget surpluses throughout
the next 10 years. However, good news does not mean that hard choices are a
thing of the past. First, it is important to recognize that, by their very
nature, projections are uncertain. This is especially true today because, as
CBO notes, it is too soon to tell whether recent boosts in revenue reflect a
major structural change in the economy or a more temporary divergence from
historical trends. Indeed, CBO points out that assuming a return to
historical trends and slightly faster growth in Medicare would change the
on-budget surplus to a growing deficit. This means we should treat surplus
predictions with caution. Because current projected surpluses could prove to
be fleeting, appropriate steps should be taken if new entitlements are
created that establish permanent claims on future resources.

Moreover, while the size of future surpluses could exceed or fall short of
projections, we know that demographic and cost trends will, in the absence
of meaningful reform, drive Medicare spending to levels that will prove
unsustainable for future generations of taxpayers. Accordingly, we need to
view this period of projected prosperity as an opportunity to begin
addressing the structural imbalances in Medicare, Social Security, and other
entitlement programs before the approaching demographic tidal wave makes the
imbalances more dramatic and possible solutions much more painful.

It is in this context that we are discussing Medicare reform today. Among
various proposals, the two I will focus on are the President's Plan to
Modernize and Strengthen Medicare for the 21st Century and S. 1895, entitled
the Medicare Preservation and Improvement Act of 1999, which is commonly
referred to as the Breaux-Frist proposal. By including a more comprehensive
reform, the intent of these proposals would be consistent with the position
we have maintained from the beginning of these deliberations; namely, that
the unfunded promises associated with today's program should be addressed
before or concurrent with proposals to make new ones, such as adding
prescription drug coverage. Such additions 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. In addition, a reform
package should include a mechanism to monitor aggregate program costs over
time and establish expenditure or funding thresholds that would trigger a
call for fiscal action.

As we consider key elements of these two proposals, I would ask you to keep
in mind the following: these two plans reflect considerable efforts by the
Administration and the Congress to wrestle with the twin problems of program
adequacy and sustainability. However, unlike the game show, "Who Wants To Be
A Millionaire," comprehensive reform does not come with a "final answer."
Nor is it something that, once implemented, can be put on automatic pilot.
Recent experience implementing changes to the current program shows that
reform is a dynamic process requiring vigilance, flexibility, and endurance.
We must be able to monitor the impact of reform, make changes when actual
outcomes differ substantially from the expected ones, and remain steadfast
when particular interests pit the primacy of their wants against the more
global interest of making Medicare affordable, sustainable, and effective
for current and future generations of Americans.

Medicare's Financial Condition

Without meaningful reform, the long-term financial outlook for Medicare is
bleak. Together, Hospital Insurance (HI) and Supplementary Medical Insurance
(SMI) expenditures are expected to increase dramatically, rising from about
12 percent in 1999 to about a quarter of all federal revenues by
mid-century, even without adding to the benefit package. Over the same time
frame, Medicare's expenditures are expected to double as a share of the
economy, from 2.5 to 5.3 percent, as shown in figure 1.

Source: 1999 Annual Report, Board of Trustees of the Federal Hospital
Insurance Trust Fund and 1999 Annual Report, Federal Supplementary Insurance
Trust Fund.

The progressive absorption of a greater share of the nation's resources for
health care, like Social Security, is in part a reflection of the rising
share of the elderly population, but Medicare growth rates also reflect 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. Moreover, the
actual costs of health care consumption are not transparent. Third-party
payers generally insulate consumers from the cost of health care decisions.
In traditional Medicare, for example, the impact of the cost-sharing
provisions designed to curb the use of services is muted because about 80
percent of beneficiaries have some form of supplemental health care coverage
(such as Medigap insurance) that pays these costs. For these reasons, among
others, Medicare represents a much greater and more complex fiscal challenge
than even Social Security over the longer term.

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 without making changes in the Social Security, Medicare, and Medicaid
programs is to envision a very different role for the federal government.
Assuming, for example, that the Congress and the President adhere to the
often-stated goal of saving the Social Security surpluses, our long-term
model shows a world by 2030 in which Social Security, Medicare, and Medicaid
increasingly absorb available revenues within the federal budget. Under this
scenario, these programs would require more than three-quarters of total
federal revenue. (See fig. 2.) Budgetary flexibility would be drastically
constrained and little room would be left for programs for national defense,
the young, infrastructure, and law enforcement.

*The "Eliminate non-Social Security surpluses" simulation can only be run
through 2066 due to the elimination of the capital stock.

Notes:

Revenue as a share of GDP during the simulation period is lower than the
1999 level due to unspecified permanent policy actions that reduce revenue
and increase spending to eliminate the non-Social Security surpluses.

Medicare expenditure projections follow the Trustees' 1999 intermediate
assumptions. The projections reflect the current benefit and financing
structure.

Source: GAO's January 2000 analysis.

When viewed together with Social Security, the financial burden of Medicare
on future taxpayers becomes unsustainable, absent reform. As figure 3 shows,
the cost of these two programs combined would nearly double as a share of
the payroll tax base over the long term. Assuming no other changes, these
programs would constitute an unimaginable drain on the earnings of our
future workers.

Figure 3: Social Security and Medicare HI as a Percentage of Taxable
Payroll, 1999 to 2074

Source: 1999 Annual Report, Board of Trustees of the Federal Hospital
Insurance Trust Fund, and 1999 Annual Report, Board of Trustees of the
Federal Old Age and Survivors Disability Insurance Trust Funds.

While the problems facing the Social Security program are significant,
Medicare's challenges are even more daunting. To close Social Security's
deficit today would require a 17 percent increase in the payroll tax,
whereas the HI payroll tax would have to be raised 50 percent to restore
actuarial balance to the HI trust fund. This analysis, moreover, does not
incorporate the financing challenges associated with the SMI and Medicaid
programs.

Today's Medicare Program

Differences Between Traditional Medicare and Medicare+Choice

   * Provider choice. Under traditional Medicare, beneficiaries may obtain
     covered services from any physician, hospital, or other health care
     provider that receives Medicare payments. Because most providers accept
     Medicare payments, beneficiaries have virtually unlimited choice. In
     contrast, beneficiaries in managed care face a more restricted list of
     providers. Private plan enrollees can generally use only their plan's
     network of doctors, hospitals, or other providers for nonemergency
     care.
   * Services offered. Although offering less provider choice,
     Medicare+Choice plans typically cover more services. For example,
     Medicare+Choice plans often cover routine physicals, outpatient
     prescription drugs, and dental care-services that traditional Medicare
     does not cover.
   * Out-of-pocket costs. Out-of-pocket costs are generally higher for
     beneficiaries in traditional Medicare than for those in
     Medicare+Choice. Traditional Medicare, which has a two-part benefit
     package, does not pay the full costs of most covered services. Part A
     has no premium and helps pay for hospitalization, skilled nursing
     facility care, some home health care, and hospice care. Part B, which
     is optional in traditional Medicare, requires a monthly premium
     ($45.50) and helps pay for physician services, clinical laboratory
     services, hospital outpatient care, and certain other medical services.
     In addition to the monthly premium, beneficiaries are responsible for
     an annual $100-deductible and for 20 percent of the Medicare-approved
     amount for most part B services. To cover these out-of-pocket expenses,
     many beneficiaries purchase private supplemental insurance, known as
     Medigap, or may have similar insurance through a former employer.
   * In contrast, beneficiaries covered through a Medicare+Choice plan are
     required to pay part B premiums but often do not pay the plan a monthly
     premium or pay a monthly fee that is less than the cost of an
     equivalent Medigap policy. Plan enrollees may also pay a copayment for
     each visit or service.
   * Program payments. Another key difference between traditional Medicare
     and Medicare+Choice involves the program's payment methods. In
     traditional Medicare, hospitals, physicians, and other providers
     receive a separate payment for each covered medical service or course
     of treatment provided. In contrast, Medicare+Choice plans receive a
     fixed monthly amount for each beneficiary they enroll, commonly known
     as a capitation payment. This amount covers the expected costs of all
     Medicare part A and part B services. If Medicare's payment is projected
     to result in a plan's earning above normal profits-that is, above the
     rate of return earned on its commercial contracts-the plan generally
     must use the excess to fund additional benefits.

Overspending on Medicare+Choice

Nevertheless, as we reported last year, program savings and extra benefits
for Medicare beneficiaries are not mutually exclusive goals. According to
their own data, many plans could make a normal profit and provide enhanced
benefit packages, even if Medicare payments were reduced. However, to lower
program spending would require a better method of adjusting plan payments
for differences in the health status of beneficiaries, a process commonly
known as risk adjustment. Medicare's current risk adjustment methodology
cannot adequately account for the fact that, on average, beneficiaries in
Medicare+Choice are healthier than those in traditional Medicare.

Issues Related to Prescription Drug Benefit

Extensive research and development over the past 10 years have led to new
prescription drug therapies and improvements over existing therapies. In
some instances, new medications have expanded the array of conditions and
diseases that can be treated effectively. In other cases, they have replaced
alternative 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, new drug therapies have
also contributed to a significant increase in drug spending as a component
of health care costs. The Medicare benefit package, largely designed in
1965, provides virtually no coverage. This does not mean, however, that all
Medicare beneficiaries lack coverage for prescription drug costs. In 1996,
almost one third of beneficiaries had employer-sponsored health coverage, as
retirees, that included drug benefits. More than 10 percent of beneficiaries
received coverage through Medicaid or other public programs. To protect
against drug costs, the remainder of Medicare beneficiaries can choose to
enroll in a Medicare+Choice plan with drug coverage if one is available in
their area or purchase a Medigap policy.

The burden of prescription drug costs falls most heavily on the Medicare
beneficiaries who lack drug coverage or who have substantial health care
needs. Drug coverage is less prevalent among beneficiaries with lower
incomes. In 1995, 38 percent of beneficiaries with income below $20,000 were
without drug coverage, compared to 30 percent of beneficiaries with higher
incomes. Additionally, the 1995 data show that drug coverage is slightly
higher among those with poorer self-reported health status. At the same
time, however, beneficiaries without drug coverage and in poor health had
drug expenditures that were $400 lower than the expenditures of
beneficiaries with drug coverage and in poor health. This might indicate
access problems for this segment of the population.

Even for beneficiaries who have drug coverage, the extent of the protection
it affords varies, and there are signs that this coverage could be eroding.
The value of a beneficiary's drug benefit is affected by the benefit design,
including cost-sharing requirements and benefit limitations. Although
reasonable cost sharing serves to make the consumer a more prudent
purchaser, copayments, deductibles, and annual coverage limits can reduce
the value of drug coverage to the beneficiary. Recent trends of declining
employer coverage and more stringent Medicare+Choice benefit limits suggest
that the proportion of beneficiaries without effective protection may grow.

Expanding access to more affordable prescription drugs could involve either
subsidizing prescription drug coverage or allowing beneficiaries access to
discounted pharmaceutical prices. The design of a drug coverage option, that
is, the scope of the benefit, the targeted population, and the mechanisms
used to contain costs, as well as its implementation, will determine the
option's effect on beneficiaries, Medicare or federal spending, and the
pharmaceutical market. Any option would need to consider how to balance
competing concerns about the sustainability of Medicare, federal
obligations, and the hardship faced by some beneficiaries.

the President's Plan And The Breaux-Frist Proposal Are Similar In Three Key
Areas But Contain Two Major Differences. To Varying Degrees, Both Proposals

   * introduce a competitive premium model, similar in concept to the
     Federal Employees Health Benefit Program (FEHBP), to achieve cost
     efficiencies;
   * preserve the traditional fee-for-service Medicare program with enhanced
     opportunities to adopt prudent purchasing strategies; and
   * modernize Medicare's benefit package by making coverage available for
     prescription drug and catastrophic Medicare costs.

The proposals differ, however, in the extent to which traditional Medicare
could face competitive pressure from private plans. In addition, under the
President's plan, the Health Care Financing Administration (HCFA) would
administer the program, whereas under the Breaux-Frist proposal, an
independent Medicare board would perform that function.

An elaboration of these points helps explain where the two proposals share
common ground and where they diverge.

Competitive Model for Setting Premiums

In contrast, the competitive premium approach included in the Breaux-Frist
and President's proposals offers certain advantages. Under either version,
beneficiaries can better see what they and the government are paying for. In
addition, plans that can reduce costs can lower premiums and attract more
enrollees. As the more efficient plans gain market share, the government's
spending on Medicare will decrease.

Fundamentally, this approach is intended to spur price competition. Instead
of administratively setting 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 a common Medicare benefit
package. Under both proposals, beneficiaries would generally pay a small
portion of the premium and the government would pay the rest. Plans that
operate at lower cost could reduce premiums, attract beneficiaries, and
increase market share. Beneficiaries who joined these plans would enjoy
lower out-of-pocket expenses. Taxpayers, however, would also benefit from
the competitive forces. As beneficiaries migrated to lower cost plans, the
average government payment would fall. (See table 1.)

Table 1: Under Both Versions of Competitive Approach, Medicare and
Beneficiaries Can Enjoy Direct Savings

                  Medicare+Choice     President          Breaux-Frist
                  Administratively    Plans determine
                  determined,         own premium for    Plans determine
 Payment rates    largely based on    providing          own premium for
                  fee-for-service     Medicare-covered   providing benefits
                  (FFS) costs         benefits
                                      - For private
                                      plans, 85% of
                                                         88% of national
 Maximum          About 89% of        traditional        average premium,
 government       administratively    Medicare costb     includes
 contribution     determined payment                     HCFA-sponsored FFS
                  ratea               - For traditional
                                      Medicare, about    planc

                                      89% of cost
                                      - Difference
                                      between private

                                      plan premium and
                                      government
                                                         - Difference
                                      contribution       between plan
                  - Monthly part B
                  premium to          - Nothing for      premium and
                                      private plans with government
                  Medicare
 Beneficiary                          premiums below     contribution
 contribution     - May pay           about 80% of
                  additional premium                     - Nothing for
                  to                  FFS cost           plans with

                  plan                - If in            premiums at or
                                      traditional FFS,   below 85% of

                                      approximately 11%  national average
                                      of per

                                      capita program
                                      cost
                  - Pay monthly part
 Impact on        B premium to
 beneficiary if
 enrolled in plan Medicare            - Pay premium      - Pay premium
 with relatively
 high costs       - Pay premium to
                  plan
                  Pay monthly part B
                  premium to
 Impact on        Medicare
 beneficiary if
 enrolled in plan Pay little or no    - Pay little or no - Pay little or no
 with relatively  premium to plan     premium            premium
 low costs
                  Receive extra
                  benefits
 Impact on
 Medicare if
 beneficiary
 enrolled in plan None; savings flow  Receives portion   Receives portion
 with costs below to plan and         of savings         of savings
 maximum          beneficiaries
 government
 contribution

aNet effect, government payments offset by beneficiary part B premiums
(assumed to total about 11 percent of FFS costs).

bNet effect, maximum government payment set at 96 percent of average FFS
cost offset by beneficiary part B premiums revenue (assumed to equal about
11 percent of FFS costs).

cPlans submit premium for benefit package that may include benefits not
covered by Medicare. Medicare Board determines the portion of the premium
associated with Medicare-covered benefits and uses that amount to compute
the enrollment-weighted national average.

One major difference between the two proposals concerns how the beneficiary
premium would be set for those who remained in the traditional
fee-for-service program. Under Breaux-Frist, there would be no separate part
B premium. All plans-including traditional Medicare-would calculate a total
premium expected to cover the cost of providing Medicare-covered services to
the average beneficiary. The maximum government contribution would be based
on a formula. Beneficiaries would pay no premiums if they chose plans
costing 85 percent or less than the national enrollment-weighted average
premium. For plans with higher premiums, beneficiaries would pay an
increasing portion of the premium. The traditional fee-for-service Medicare
program would be regarded as one more plan. The monthly amount beneficiaries
would pay to enroll in it, therefore, would depend on how expensive it was
relative to the private plans.

In contrast, under the President's proposal, the beneficiary premium for
traditional Medicare-the part B premium-would continue to be set
administratively. As under Breaux-Frist, all other plans would submit
competitive premiums. The maximum government contribution to private plans
would be set at 96 percent of the average spending per-beneficiary in
traditional Medicare. Beneficiaries who joined plans that cost less than
that amount would pay reduced, or no, part B premiums. Beneficiaries who
joined more expensive plans would pay higher part B premiums.

Some believe the design of the President's proposal would tend to insulate
the traditional fee-for-service program, and those beneficiaries that remain
in it, from market forces. At least in the short run, however, the practical
differences between the President's proposal and the Breaux-Frist proposal
may be small. Because the vast majority of beneficiaries are enrolled in the
traditional fee-for-service program, the national average premium under
Breaux-Frist would, in all likelihood, largely reflect the cost of
traditional Medicare.

Table 2 presents a hypothetical example to illustrate how similar
beneficiary and government contributions would be under Breaux-Frist and the
President's proposal. It assumes private plans could provide
Medicare-covered benefits for 90 percent of the cost incurred in the
traditional fee-for-service program and that they enroll 17 percent of all
beneficiaries (the percentage of beneficiaries currently enrolled in private
plans). In this example, beneficiaries in private plans would pay slightly
less under the Breaux-Frist proposal compared to their contribution under
the President's proposal. Beneficiaries in the traditional program would pay
slightly more under Breaux-Frist.

Table 2: Simulation Showing Similarities Between Two Proposals in Monthly
Premium Contribution Amounts
                                       President's Proposal   Breaux-Frist Proposal
            Total
            per      Beneficiaries Beneficiary   Government   Beneficiary   Government
            capita   enrolled      contribution  contribution contribution  contribution
            premium
 Private                           $33           $418         $26           $424
            $450a    17%
 plans                             (7.2%)        (92.8%)      (5.7%)        (94.3%)

 Traditional                       $55           $445         $67           $433
 FFS        $500     83%
                                   (11.0%)       (89.0%)      (13.5%)       (86.5%)
 Overall                           $51           $440         $60           $431

 average                           (10.3%)       (89.7%)      (12.2%)       (87.8%)

aPrivate plan premium is a hypothetical example that assumes plans could
provide Medicare-covered benefits for 90 percent of the costs incurred by
the fee-for-service program.

Source: GAO analysis.

Over the longer term, larger differences will emerge only if private plans
decide to compete aggressively on the basis of price for market share or
traditional fee-for-service Medicare becomes significantly less able to
control the growth of costs relative to private plans. Although the premium
support proposals are intended to slow health care spending through
competition, it is not certain that this will occur. Private plans may very
well find that their most profitable strategy is to "shadow price" (set
prices only slightly under) traditional Medicare and be satisfied with
smaller market share. (Paradoxically, serving larger numbers of
beneficiaries could lead to higher costs and less profit.)

The greater ability of private plans to control cost growth and thereby
offer significantly lower premiums is not a foregone conclusion. Medicare's
fee-for-service cost containment record over the longer term has not
differed substantially from that of the private sector. In some periods,
Medicare's cost growth has been lower; in others, higher. Today, actually,
we are witnessing a resurgence of cost growth in private plans, while
Medicare spending projections have flattened.

Prudent Purchasing Strategies for Traditional Medicare

The President's proposal outlines several new approaches to controlling
costs. It would, for example, allow the Secretary of Health and Human
Services to contract with preferred provider organizations (PPO), negotiate
discounted payment rates for specific services, and develop systems to
manage the care (in a fee-for-service setting) of certain diseases or
beneficiaries. The proposal would also adjust payments to providers and
change beneficiary cost sharing requirements. Adopting these changes will
entail considerable challenges given the sheer size of the Medicare program,
its complexity, and the need for transparent policies in a public program.
Moreover, how much the changes would save is uncertain and likely depends on
how, and to what extent, these measures are implemented. For example,
without supplemental insurance reform, a PPO option may not attract many
beneficiaries because a majority have first-dollar coverage through
supplemental policies and thus are insensitive to provider charges.
Furthermore, cuts in provider payments are certain to meet with fierce
opposition.

The Breaux-Frist proposal provides a vehicle to reform traditional Medicare,
but does not suggest specific cost control devices. The proposal calls for
HCFA to prepare an annual business plan, which would outline intended
payment and management strategies, describe partnership arrangements with
entities to provide prescription drug benefits, and recommend benefit
improvements. It would also include any legislative specifications necessary
to enact the plan. Until 2008, HCFA would need explicit congressional
approval to implement its business plan. After that, the plan would take
effect without Congress' explicit approval. Clearly, the Breaux-Frist
proposal could increase HCFA's options for managing the traditional program
and controlling spending. Like the President's proposal, however, the extent
of its success will depend on the specific details and other reform elements
that HCFA designs and the Congress allows to be adopted.

Coverage for Prescription Drug and Catastrophic Costs

Table 3: Prescription Drug And Stop-Loss Coverage.
 President                             Breaux-Frist
 Drug benefit available through new    Drug benefit available through
 part D program.                       high-option plans.

 Drug coverage up to $1,000 per year inDrug coverage with an actuarial
 2003, rising to $2,500 in 2009.       value of $800 per year in 2003, to
                                       be increased annually.a
 Medicare subsidizes between 25% and   Medicare subsidizes between 25% and
 100% of drug benefit cost based on    100% of drug benefit cost based on
 beneficiary income.                   beneficiary income.
 Incentives for employers to retain
 retiree drug coverage.                No incentives specified.
 Stop-loss for non-drug Medicare       Stop-loss for non-drug Medicare
 expenses available through new        expenses over $2,000 per year
 Medigap policy. Reserve fund for a    available through optional high
 future catastrophic drug benefit.     option plans.

aBecause the coverage limit is specified as an actuarial equivalent, it is
not directly comparable to the limit in the President's proposal.

Under Breaux-Frist, all participating health care organizations-including
HCFA-would be required to offer a high option plan that provided
prescription drug and stop-loss coverage, in addition to coverage for
Medicare core benefits. The President's proposal calls for a new voluntary
prescription drug benefit, known as part D, and a new Medigap policy that
would feature increased cost-sharing and stop-loss coverage. Under both
proposals HCFA would contract with private entities to provide drug coverage
for beneficiaries enrolled in its high option plan (Breaux-Frist) or in
Medicare part D (President). Entities that managed the drug benefit for HCFA
or private plans would be permitted to use cost containment mechanisms, such
as formularies. The President's proposal includes incentives for private
employers to retain drug coverage for their retirees.

Reform Outcomes Hinge on Design Details

To What Extent Should Premiums Be Adjusted for Geographic Variations in
Health Care Markets?

For proposals that include elements of premium support, the task of
determining the government's contribution toward each plan's premium raises
several technical issues that have profound policy implications. In general,
the government's share is greater or smaller, depending on whether the
plan's premium is below or above the average of all plan premiums. However,
some plans can incur higher-than-average expenses because of local market
conditions outside of their control. Unless the government contribution is
adjusted for these circumstances, beneficiaries could face higher
out-of-pocket costs and plans could be at a competitive disadvantage. The
Breaux-Frist proposal allows adjustments for medical price variation only.
The President's proposal allows adjustments for medical price variation and
regional differences in medical service use.

An adjustment for differences in local medical prices is clearly desirable
under a premium support system. Without it, beneficiary premiums in
high-price areas will tend to be above the national average. Adjusting the
government contribution for input price differences can help ensure fair
price competition between local and national plans and avoid having
beneficiaries pay a higher premium, or higher share of a premium, simply
because they live in a high-price area.

In addition, the use of medical services varies dramatically among
communities because of differences in local medical practices. Under premium
support approaches, plan premiums in high-use areas will likely exceed the
national average. Whether, or to what extent, to adjust the government
contribution for this outcome is a matter of policy choice. On the one hand,
without an adjustment, beneficiaries living in high-use areas who join local
private plans could face substantial out-of-pocket costs for circumstances
outside of their control. Consequently, private plans in these areas might
have difficulty competing with a traditional Medicare plan that charged a
fixed national premium based on an overall average of medical service use.
On the other hand, there have been longstanding concerns about unwarranted
variations in medical practice. By not adjusting the government contribution
for utilization differences, financial pressures could encourage providers
to reduce inappropriate levels of use.

What Parameters Would Define Activities of Entity Administering Restructured
Medicare Program?

Whatever the administrative entity is under Medicare reform, the following
are questions that policymakers will want to consider. First, how will this
entity's mission be defined? Will the emphasis be on controlling costs,
protecting beneficiaries, maximizing choice, or some combination of these
goals? Policy choices would flow from the stated mission. Second, how much
independence would be permitted to the administrative entity to carry out
its mission? Would it be appropriately shielded from the pressure exerted by
special interest groups? Third, how would the administrative entity hold
plans accountable for meeting Medicare standards? Would it rely chiefly on
public accountability, in which the process and procedures for compliance
are clearly defined and actively monitored, or on market accountability, by
providing comparative information on competing plans and letting beneficiary
enrollment choices weed out poor performers? Answers to these questions will
determine, to a large extent, whether a restructured Medicare program will
be administered effectively.

Addressing Immediate Concerns Can Aid Reform Efforts

Importance of Better Risk Adjustment

Need for Better Consumer Information

If Medicare is restructured to incorporate a competitive premium support
approach, the need for beneficiaries to be well informed about their health
care options becomes more critical. To guide its efforts to improve consumer
information, HCFA should look to FEHBP-the choice-based health insurance
program for federal employees. In FEHBP, for example, health plans are
required to follow standard formats and use standard terms in their
marketing literature. Informing Medicare beneficiaries, however, is likely
to involve challenges not encountered in informing current and former
federal employees. For one thing, the size of the Medicare program makes any
education campaign a daunting task. Moreover, many beneficiaries have a poor
understanding of the current program and may not understand how the proposed
changes would affect their situations.

Need for Timely Information on Policy Effects

In testifying before the Congress in the fall of 1999, we remarked on the
need for obtaining information that could identify and distinguish between
desirable and undesirable consequences. More recently, we recommended that
HCFA establish a process to assess the potential effects of implementing
legislated Medicare changes. This process would entail developing baseline
information from available claims data. The information from such
assessments would be all the more critical during a period of implementing
fundamental reforms.

Ensuring Program Sustainability Requires Early Warning Mechanism

While Medicare will inevitably grow, it must not grow out of control. The
risk is that federal resources may not be available for other national
priorities, such as education for young people and national defense. In
response, both Breaux-Frist and the President's proposals include elements
designed to moderate future Medicare spending. Their approaches are
untested, however, and it would be imprudent to adopt these-or any other
reforms-without a means to monitor their effects. What is needed along with
reform is a mechanism that will gauge spending and revenues and will sound
an early warning if policy course corrections are warranted. Although both
proposals include a warning mechanism, the Breaux-Frist approach would be a
more comprehensive measure of program financing imbalances.

Under the current Medicare structure, the program consists of two parts.
Medicare's HI Trust Fund, also known as part A, is financed primarily by
payroll taxes paid by workers and employers. Supplementary Medical Insurance
(SMI), also known as part B, is financed largely through general revenues.
Currently, the financial health of Medicare is gauged by the solvency of the
HI trust fund and not the imbalance between total revenues and total
spending. The 1999 Trustees' annual report showed that Medicare's HI
component has been, on a cash basis, in the red since 1992, and in fiscal
year 1998, earmarked payroll taxes covered only 89 percent of HI spending.
Although the Office of Management and Budget has recently reported a $12
billion cash surplus for the HI program in fiscal year 1999 due to lower
than expected program outlays, the Trustees' report issued in March 1999
projected continued cash deficits for the HI trust fund. (See fig. 4.)

Figure 4: Financial Outlook of the Hospital Insurance Trust Fund, 1990 to
2025

When the program has a cash deficit, as it did from 1992 through 1998,
Medicare is a net claimant on the Treasury-a threshold that Social Security
is not currently expected to reach until 2014. To finance these cash
deficits, Medicare drew on its special issue Treasury securities acquired
during the years when the program generated a cash surplus. In essence, for
Medicare to "redeem" its securities, the government must raise taxes, cut
spending for other programs, or reduce the projected surplus.

When outlays outstrip revenues in the HI fund, it is tempting to shift some
expenditures to SMI. Such cost-shifting extends the solvency of the HI Trust
Fund, but does nothing to address the fundamental financial health of the
program. Worse, it masks the problem and may cause fiscal imbalances to go
unnoticed. For example, in 1997 BBA reallocated a portion of home health
spending from the HI Trust Fund to SMI. This reallocation extended HI Trust
Fund solvency but at the same time increased the draw on general revenues in
SMI while generating little net savings.

The President's plan preserves the program's divided financing structure and
continues to rely on projections of HI Trust Fund solvency to warn of fiscal
imbalances. By devoting a portion of the non-Social-Security surpluses to
Medicare, the President's plan would extend the HI Trust Fund's solvency.
This proposed infusion of general revenues represents a major departure in
the financing of the HI program. Established as a payroll tax funded
program, HI would now receive an explicit grant of funds from general
revenues not supported by underlying payroll tax receipts. In effect, this
grant would constitute a new claim on the general fund that would limit the
ability to set budgetary priorities in the future. It would also further
weaken the incomplete signaling mechanism of Medicare's future fiscal
imbalances provided by the HI Trust Fund solvency measure.

Under an approach that would combine the two trust funds, a continued need
would exist for measures of program sustainability that would signal
potential future fiscal imbalance. Such measures might include the
percentage of program funding provided by general revenues, the percentage
of total federal revenues or gross domestic product devoted to Medicare, or
program spending per enrollee. As such measures were developed, questions
would need to be asked about the appropriate level of general revenue
funding as well as the actions to be taken if projections showed that
program expenditures would exceed the chosen level.

The Breaux-Frist proposal would unify the currently separate HI and SMI
trust funds, and, in so doing, would eliminate the ability to shift costs
between two funding sources. The Breaux-Frist early warning mechanism
consists of defining program insolvency as a year in which general revenue
contributions exceed 40 percent of total Medicare expenditures. At that
time, the Congress would have several choices. It could raise the limit on
general revenue contributions, raise payroll taxes, raise beneficiary
premiums, reduce benefits, cut provider payments, or introduce efficiencies
to moderate spending. Supporters of the Breaux-Frist proposal have suggested
that a more comprehensive measure of program financing would be more useful
to policymakers.

Current spending projections show that absent reform that addresses total
program cost, this limit would be reached in less than 10 years. (See fig.
5.) These data underscore the need for reform to include appropriate
measures of fiscal sustainability as well as a credible process to give
policymakers timely warning when fiscal targets are in danger of being
overshot.

Figure 5: Projected Funding Gap Under a 40-Percent Cap in General Revenue
Contributions

Source: 1999 Annual Report, Board of Trustees of the Federal Hospital
Insurance Trust Fund and 1999 Annual Report, Federal Supplementary Insurance
Trust Fund.

Concluding Observations

It is my hope that we will think about the unprecedented challenge facing
future generations in our aging society. Relieving them of some of the
burden of today's financing commitments would help fulfill this generation's
fiduciary responsibility. It would also preserve some capacity to make their
own choices by strengthening both the budget and the economy they inherit.
While not ignoring today's needs and demands, we should remember that
surpluses can be used as an occasion to promote the transition to a more
sustainable future for our children and grandchildren.

I am under no illusions about how difficult Medicare reform will be. The
President's and Breaux-Frist proposals address the principal elements of
reform, but many of the details need to be worked out. Those details will
determine whether reforms will be both effective and acceptable-that is,
seen as helping guarantee the sustainability and preservation of the
Medicare entitlement, a key goal on which there appears to be consensus.
Experience shows that forecasts can be far off the mark. Benefit expansions
are often permanent, while the more belt-tightening payment
reforms-vulnerable to erosion-could be discarded altogether.

The bottom line is that surpluses represent both an opportunity and an
obligation. We have an opportunity to use our unprecedented economic wealth
and fiscal good fortune to address today's needs but an obligation to do so
in a way that improves the prospects for future generations. 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. Prudence requires making the tough choices today while the
economy is healthy and the workforce is relatively large. National saving
pays future dividends over the long term but only if meaningful reform
begins soon. Entitlement reform is best done with considerable lead time to
phase in changes and before the changes that are needed become dramatic and
disruptive. The prudent use of the nation's current and projected budget
surpluses combined with meaningful Medicare and Social Security program
reforms can help achieve both of these goals.

GAO Contacts and Acknowledgments

For future contacts regarding this testimony, please call William J.
Scanlon, Director, Health Financing and Public Health Issues, at (202)
512-7114 or Paul L. Posner, Director, Budget Issues, at (202) 512-9573.
Other individuals who made key contributions include Linda F. Baker, James
C. Cosgrove, Hannah F. Fein, and James R. McTigue.

(201035/935357)

  
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