Medicare Reform: Ensuring Fiscal Sustainability While Modernizing the
Program Will be Challenging (Testimony, 09/22/1999,
GAO/T-HEHS/AIMD-99-294).

Pursuant to a congressional request, GAO discussed efforts to reform the
administration, structure, and financing of the Medicare program.

GAO noted that: (1) in March, the Bipartisan Commission on the Future of
Medicare completed its deliberations; (2) reform options emerged from
these discussions that touched on all aspects of the Medicare program,
including: (a) modernization of the traditional Medicare fee-for-service
program both to update the benefit package and enhance its potential for
containing program costs; (b) modernization of the Medicare Choice
program to ensure beneficiaries health plan choices and allow the
program to more efficiently purchase plan services; and (c) adoption of
a Federal Employees Health Benefits Program-like model to foster quality
and price based competition among health plans and to elevate
beneficiary consciousness about and responsibility for program costs;
(3) given the size of Medicare's unfunded liability, it is realistic to
expect that reforms intended to bring down future costs will have to
proceed in an incremental fashion; (4) ideally, 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; (5) if additional benefits are added, policymakers need to
consider targeting strategies and fully offsetting the related costs;
(6) they may also want to design a mechanism to monitor these and
aggregate program costs over time as well as establish expenditure or
funding thresholds that would trigger a call for fiscal action; (7) in
addition, any potential program expansion should be accompanied by
meaningful reform of the Medicare program to help ensure its
sustainability; (8) to qualify for meaningful reform, a proposal should
make a significant down payment toward ensuring Medicare's long-range
financial integrity and sustainability; (9) the 1999 annual reports of
the Medicare Trustees project that program costs will continue to grow
faster than the rest of the economy; (10) proposals to reform Medicare
should be assessed against the following criteria: affordability,
equity, adequacy, feasibility, and acceptance; (11) the particulars of
payment mechanisms largely determine the extent to which a reform option
can eliminate excess government spending while protecting beneficiaries'
access to care; (12) revisions to newly implemented policies should be
based on a thorough assessment of their effects so that they are not
unduly affected by external pressures and premature conclusions or
remain static when change is clearly warranted; and (13) for
choice-based models to function as intended, consumers must have
information that is sufficiently comparable.

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

 REPORTNUM:  T-HEHS/AIMD-99-294
     TITLE:  Medicare Reform: Ensuring Fiscal Sustainability While
	     Modernizing the Program Will be Challenging
      DATE:  09/22/1999
   SUBJECT:  Health care programs
	     Managed health care
	     Health services administration
	     Health insurance
	     Health insurance cost control
	     Financial management
	     Future budget projections
IDENTIFIER:  Medicare Choice Program
	     Federal Employees Health Benefits Program
	     Social Security Program
	     Medicare Hospital Insurance Trust Fund
	     Medicare Fee-for-Service Program
	     Medicare Program

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    United States General Accounting Office Testimony GAO
    Before the Subcommittee on Health, Committee on Ways and Means,
    House of Representatives For Release on Delivery Expected at 2:00
    p.m.            MEDICARE REFORM Wednesday, September 22, 1999
    Ensuring Fiscal Sustainability While Modernizing the Program Will
    Be Challenging Statement of David M. Walker Comptroller General of
    the United States GAO/T-HEHS/AIMD-99-294 Medicare Reform:
    Ensuring Fiscal Sustainability While Modernizing the Program Will
    Be Challenging Mr. Chairman and Members of the Subcommittee: I am
    pleased to be here today as you discuss efforts to reform the
    administration, structure, and financing of Medicaresteps
    essential to maintaining the program's long-term solvency and to
    its modernization. There appears to be an emerging consensus that
    substantive financing and programmatic reforms are necessary to
    put Medicare on a sustainable footing for the future. The long-
    term cost pressures facing this program are considerable.
    Fundamental program reforms are vital to reducing the program's
    growth, which threatens to absorb ever-increasing shares of the
    nation's budgetary and economic resources. Against this backdrop,
    I want to acknowledge your efforts, Mr. Chairman, as well as the
    contributions of the other members of the Bipartisan Commission on
    the Future of Medicare. The Breaux-Thomas proposal, which grew out
    of the Commission's deliberations, included a comprehensive reform
    plan on a technically difficult issue that touches on both the
    future health of beneficiaries and the fiscal health of the U.S.
    economy.1 I also want to commend both this Subcommittee and the
    Congress as a whole for remaining steadfast in the face of intense
    pressure to roll back the Medicare payment reforms included in the
    Balanced Budget Act of 1997 (BBA). It is in no sense hyperbole to
    note that the BBA changes constituted a critical down payment for
    Medicare reform. I know that the Subcommittee appreciates the
    vital importance of waiting for strong evidence that demonstrates
    the need for any modifications before acting. You must be
    especially prudent during this period of prosperity as you
    consider Medicare reform initiatives. Please remember that, even
    as recent estimates have increased the size of budget surpluses,
    these are projected budget surpluses, and we know that the
    business cycle has not been repealed. Current projected surpluses
    could well prove to be fleeting, and thus appropriate caution
    should be exercised when creating new entitlements that establish
    permanent claims on future resources. While I do not relish being
    the accountability cop at the surplus celebration party, that is
    part of my job as Comptroller General of the United States.
    Moreover, while the size of future surpluses could exceed or fall
    short of projections, we know that demographic and cost trends
    will, in the ------------------ 1The National Bipartisan
    Commission on the Future of Medicare held its last meeting on
    March 16, 1999. By a vote of 10 to 7, the Commission failed to
    achieve the 11-member super majority required by law to report a
    recommendation to the Congress. Page 1
    GAO/T-HEHS/AIMD-99-294 Medicare Reform:  Ensuring Fiscal
    Sustainability While Modernizing the Program Will Be Challenging
    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 address the structural imbalances in
    Medicare, Social Security, and other entitlement programs before
    the approaching demographic tidal wave makes the imbalances more
    dramatic and meaningful reform less feasible. As the foregoing
    suggests, the stakes associated with Medicare reform are high for
    the program itself and for the rest of the federal budget, both
    now and for future generations. Current policy decisions can help
    us prepare for the challenges of an aging society in several
    important ways: (1) reducing public debt to increase national
    savings and investment, (2) reforming entitlement programs to
    reduce future claims and free up resources for other competing
    priorities, and (3) establishing a more sustainable Medicare
    program that delivers effective and affordable health care to our
    seniors. In this context, I would like to make a few summary
    points before delving into the specifics of Medicare's financial
    health and a discussion of potential reform. * In March, the
    Bipartisan Commission on the Future of Medicare completed its
    deliberations. Reform options emerged from these and other
    discussions that touched on all aspects of the Medicare program,
    including (1) modernization of the traditional Medicare fee-for-
    service program, both to update the benefit package and enhance
    its potential for containing program costs; (2) modernization of
    the Medicare+Choice program to ensure that beneficiaries have
    health plan choices and allow the program to more efficiently
    purchase plan services; and (3) adoption of a program like the
    Federal Employees Health Benefits Program (FEHBP) or a premium
    support model to foster quality and price based competition among
    health plans and to elevate beneficiaries' consciousness about and
    responsibility for program costs. Given the size of Medicare's
    unfunded liability, it is realistic to expect that reforms
    intended to bring down future costs will have to proceed
    incrementally. The time to begin the difficult but necessary steps
    to reclaim our fiscal future is now, when we have budget surpluses
    and a demographic "holiday" with retirees a far smaller proportion
    of the population than they will be in the future. Ideally, 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. To do otherwise might
    be politically Page 2
    GAO/T-HEHS/AIMD-99-294 Medicare Reform:  Ensuring Fiscal
    Sustainability While Modernizing the Program Will Be Challenging
    attractive but not fiscally prudent. If benefits are added,
    policymakers need to consider targeting strategies that fully
    offset the related costs. They may also want to design a mechanism
    to monitor aggregate program costs over time and to establish
    expenditure or funding thresholds that would trigger a call for
    fiscal action. Our history shows that when benefits are
    attractive, fiscal controls and constraints are difficult to
    maintain. In addition, any potential program expansion should be
    accompanied by meaningful reform of the current Medicare program
    to help ensure its sustainability. To qualify as meaningful
    reform, a proposal should make a significant down payment toward
    ensuring Medicare's long-range financial integrity and
    sustainabilitythe most critical issue facing Medicare. The 1999
    annual reports of the Medicare trustees project that program costs
    will continue to grow faster than the rest of the economy. Care
    must be taken to ensure that any potential expansion of the
    program is balanced with other programmatic reforms so that we do
    not worsen Medicare's existing financial imbalances. Proposals to
    reform Medicare should be assessed against the following criteria:
    affordability, equity, adequacy, feasibility, and acceptance. (See
    table 1.) Table 1: Criteria for Assessing the Merits of Medicare
    Reform Proposals Criterion          What this means for a proposal
    Affordability      A proposal should be evaluated in terms of its
    effect on the long-term sustainability of Medicare expenditures
    Equity             A proposal should be fair to providers and
    across groups of beneficiaries Adequacy           A proposal
    should include resources that allow appropriate access and
    provisions that foster cost-effective and clinically meaningful
    innovations that address patients' needs Feasibility        A
    proposal should incorporate elements that facilitate effective
    implementation and adequate monitoring Acceptance         A
    proposal should be transparent and should educate provider and
    beneficiary communities about its costs and the realities of
    tradeoffs required by significant policy changes People want
    unfettered access to health care, and some have needs that are not
    being met. However, health care costs compete with other
    legitimate priorities in the federal budget, and their projected
    future growth threatens to crowd out future generations'
    flexibility to decide which of these competing priorities will be
    met. Thus, in making important fiscal decisions for our nation,
    policymakers need to consider the fundamental differences between
    wants, needs, and what both individuals Page 3
    GAO/T-HEHS/AIMD-99-294 Medicare Reform:  Ensuring Fiscal
    Sustainability While Modernizing the Program Will Be Challenging
    and our nation can afford. This concept applies to all major
    aspects of government, from major weapons system acquisitions to
    issues affecting domestic programs. It also points to the
    fiduciary and stewardship responsibility that we all share to
    ensure the sustainability of Medicare for current and future
    generations within a broader context of providing for other
    important national needs and economic growth. Let's not kid
    ourselves-reforming Medicare is hard work. Health care spending
    accounts for one-seventh of the nation's economy, and Medicare is
    the nation's single largest health care payer. The program's
    beneficiary populations consist of roughly 35 million seniors and
    4 million disabled individuals under age 65. The Health Care
    Financing Administration (HCFA) estimates that the program's
    billers-physicians, hospitals, equipment suppliers, and other
    providers of health services-number about 1 million. As the
    various reform options come under scrutiny, the importance of
    design details should not be overlooked. Our work on efforts to
    implement reforms mandated in the BBA is instructive regarding
    reform specifics. Three principal lessons can be drawn from recent
    experience: (1) The particulars of payment mechanisms largely
    determine the extent to which a reform option can eliminate excess
    government spending while protecting beneficiaries access' to
    care. (2) Revisions to newly implemented policies should be based
    on a thorough assessment of their effects so that, at one extreme,
    they are not unduly affected by external pressures and premature
    conclusions or, at the other extreme, they remain static when
    change is clearly warranted. (3) For choice-based models to
    function as intendedthat is, to foster competition based on cost
    and qualityconsumers must have information that is sufficiently
    comparable. At this time, I would like to discuss the competing
    concerns at the crux of Medicare reform, in general, and to
    provide a conceptual framework for considering the various
    possible combinations of reform options, in particular. The
    current Medicare program, without improvements, is ill suited to
    Competing Concerns       serve future generations of seniors and
    eligible disabled Americans. On Pose Challenges for      the one
    hand, the program is fiscally unsustainable in its present form,
    as Medicare Reform          the disparity between program
    expenditures and program revenues is expected to widen
    dramatically in the coming years. On the other, the program is
    outmoded in that it has not been able to adopt modern, market-
    based management tools, and its benefit package contains gaps in
    desired coverage compared to private employer coverage.
    Compounding the Page 4
    GAO/T-HEHS/AIMD-99-294 Medicare Reform:  Ensuring Fiscal
    Sustainability While Modernizing the Program Will Be Challenging
    difficulties of responding to these competing concerns is the
    sheer size of the Medicare program-even modest program changes
    send ripples across the program's 39-million-strong beneficiary
    population and the approximately 1 million health care providers
    that bill the program. Balancing the needs of all these parties
    requires hard choices that have been brought before this
    Subcommittee, the Congress, and the National Bipartisan Commission
    on the Future of Medicare. Unlike private trust funds that can set
    aside money for the future by Medicare Is Already in the
    investing in financial assets, the Medicare Hospital Insurance
    (HI) Trust Red                           Fund-which pays for
    inpatient hospital stays, skilled nursing care, hospice, and
    certain home health services-is essentially an accounting device.
    It allows the government to track the extent to which earmarked
    payroll taxes cover Medicare's HI outlays. In serving the tracking
    purpose, annual trust fund reports show that Medicare's HI
    component is, on a cash basis, in the red and has been since 1992.
    (See fig. 1.) Currently, earmarked payroll taxes cover only 89
    percent of HI spending and, including all earmarked revenue, the
    fund is projected to have a $7 billion cash deficit for fiscal
    year 1999 alone. To finance this deficit, Medicare has been
    drawing on its special issue Treasury securities acquired during
    the years when the program generated a cash surplus. Consequently,
    Medicare is already a net claimant on the Treasury-a threshold
    that Social Security is not currently expected to reach until
    2014. In essence, for Medicare to "redeem" its securities, the
    government must raise taxes, cut spending for other programs, or
    reduce the projected surplus. Outlays for Medicare services
    covered under Supplementary Medical Insurance (SMI)physician and
    outpatient hospital services, diagnostic tests, and certain other
    medical services and suppliesare already funded largely through
    general revenues. Page 5
    GAO/T-HEHS/AIMD-99-294 Medicare Reform:  Ensuring Fiscal
    Sustainability While Modernizing the Program Will Be Challenging
    Figure 1: Financial Outlook of the Hospital Insurance Trust Fund,
    1990 to 2025 200 150 100 Cash Deficit 1992 50
    20           2          2 1           0         0 5           20
    25 0          19        19          20       20        20 Dollars
    in billions -50     90        95          00        05       10 -
    100 -150 -200 Cash Surplus/Deficit          Fund Balance 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 12 percent in 1999 to more
    than a quarter of all federal revenues by mid century. 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 Fig. 2.
    Page 6
    GAO/T-HEHS/AIMD-99-294 Medicare Reform:  Ensuring Fiscal
    Sustainability While Modernizing the Program Will Be Challenging
    Figure 2: Composition of Medicare Funding as a Percent of Gross
    Domestic Product (GDP), 1999 to 2071 6% 5% 4% PD f G o 3% ntceerP
    2% 1% 0% 99          03          07          11          15
    19          23          27          31          35          39
    43          47          51           55          59          63
    67          71 19          20          20          20          20
    20          20          20          20          20          20
    20          20          20           20          20          20
    20          20 General Revenue or Other
    Payroll Tax                    Premiums 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
    elderly in the population. Medicare's rolls are expanding and are
    projected to increase rapidly with the retirement of the baby
    boom. Today's elderly make up about 13 percent of the total
    population; by 2030, they will comprise 20 percent as the baby
    boom generation ages and the ratio of workers to retirees declines
    from 3.4 to one today to roughly two to one. However, 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 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. Page 7
    GAO/T-HEHS/AIMD-99-294 Medicare Reform:  Ensuring Fiscal
    Sustainability While Modernizing the Program Will Be Challenging
    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. Even assuming that
    all projected surpluses are saved and existing discretionary
    budget caps are complied with, our long-term model shows a world
    by 2030 in which Social Security, Medicare, and Medicaid
    increasingly absorb available revenues within the federal budget.
    (See fig. 3.) If none of the surplus is saved, the long-term
    outlook is even more daunting. (See fig. 4.) Budgetary flexibility
    declines drastically, and there is little or no room for programs
    for national defense, the young, infrastructure, and law
    enforcement. In short, there will be essentially no discretionary
    programs at all. Figure 3: Composition of Spending as a Share of
    GDP Under "Save the Unified Surplus" Simulation 60% 50% 40% 30%
    Revenue Percent of GDP 20% 10% 0% 1998                       2030*
    2050                     2070 Social Security        Medicare &
    Medicaid              Net Interest     All other spending *In
    2030, all other spending includes offsetting interest receipts.
    Page 8
    GAO/T-HEHS/AIMD-99-294 Medicare Reform:  Ensuring Fiscal
    Sustainability While Modernizing the Program Will Be Challenging
    Figure 4: Composition of Spending as a Share of GDP Under "No
    Unified Surplus" Simulation 60% 50% 40% 30%                Revenue
    Percent of GDP 20% 10% 0% 1998                   2030
    2050 Social Security    Medicare & Medicaid    Net Interest
    All other spending When viewed together with Social Security, the
    financial burden of Medicare on the future taxpayers becomes
    unsustainable. As figure 5 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. Page 9
    GAO/T-HEHS/AIMD-99-294 Medicare Reform:  Ensuring Fiscal
    Sustainability While Modernizing the Program Will Be Challenging
    Figure 5: Social Security and Medicare HI as a Percent of Taxable
    Payroll, 1999 to 2074 30 25 20 15 Current Level 10 Percent of
    taxable payroll     5 0 1999 2002 2005 2008 2011 2014 2017 2020
    2023 2026 2029 2032 2035 2038 2041 2044 2047 2050 2053 2056 2059
    2062 2065 2068 2071 2074 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 trust fund. This analysis, moreover, does
    not incorporate the financing challenges associated with the SMI
    and Medicaid programs. Early action to address the structural
    imbalances in Medicare is critical. First, ample time is required
    to phase in the reforms needed to put this program on a more
    sustainable footing before the baby boomers retire. Second, timely
    action to bring costs down pays large fiscal dividends for the
    program and the budget. Our long-term budget simulations, as shown
    in figure 6, illustrate how critical early action on Medicare
    reform is to our long-term fiscal future. If the annual growth in
    per person Medicare spending could be slowed to 4 percent over the
    70-year period it would yield the kind of savings needed to
    establish a truly sustainable budget policy for the long term.
    This is not easy however. Although over 70 years the projected
    average annual growth in per person spending is 4.5 percent, over
    the next 10 years it is nearly 5 percent. The high projected
    growth of Medicare in the coming years, means that the earlier the
    reform begins, the greater the savings will be as a result of the
    effects of compounding. Reforms fully phased in by 2005 would
    enable us to maintain surpluses over the entire 70-year simulation
    period. Page 10
    GAO/T-HEHS/AIMD-99-294 Medicare Reform:  Ensuring Fiscal
    Sustainability While Modernizing the Program Will Be Challenging
    Figure 6: Federal Deficits as a Share of GDP Under Alternative
    Medicare Simulations, 1999 to 2069 20 15 10 No action 5 Percent of
    GDP
    Action taken in 2015 0 Action taken in 2005 -5 1999 2004 2009 2014
    2019 2024 2029 2034 2039 2044 2049 2054 2059 2064 2069 The actions
    necessary to bring about a more sustainable program will no doubt
    call for some hard choices. Some suggest that the size of the
    imbalances between Medicare's outlays and payroll tax revenues for
    the HI program may well justify the need for additional resources.
    One possible source could be general revenues. Although this may
    eventually prove necessary, such additional financing should be
    considered as part of a broader initiative to ensure the program's
    long-range financial integrity and sustainability. What concerns
    me most is that devoting general funds to the HI may be used to
    extend HI's solvency without addressing the hard choices needed to
    make the whole Medicare program more sustainable in economic or
    budgetary terms. Increasing the HI trust fund balance alone,
    without underlying program reform, does nothing to make the
    Medicare program more sustainable-that is, it does not reduce the
    program's projected share of GDP or the federal budget. From a
    macro economic perspective, the critical question is not how much
    a trust fund has in assets but whether the government as a whole
    has the economic capacity to finance all Medicare's promised
    benefits-both now and in the future. If more fundamental program
    reforms are not made, I fear that general fund infusions would
    interfere with the vital signaling function that trust fund
    mechanisms can serve for policymakers about underlying fiscal
    imbalances in covered programs. The greatest risk is that
    dedicating Page 11
    GAO/T-HEHS/AIMD-99-294 Medicare Reform:  Ensuring Fiscal
    Sustainability While Modernizing the Program Will Be Challenging
    general funds to the HI program will reduce the sense of urgency
    that impending trust fund bankruptcy provides to policymakers by
    artificially extending the solvency of the HI program.
    Furthermore, increasing the trust fund's paper solvency does not
    address cost growth in the SMI portion of Medicare, which is
    projected to grow even faster than HI in coming decades. Beyond
    reforming the Medicare program itself, maintaining an overall
    Long-Term Fiscal Policy    sustainable fiscal policy and strong
    economy is vital to enhancing our Choices
    nation's future capacity to afford paying benefits in the face of
    an aging society. Decisions on how we use today's surpluses can
    have wide-ranging impacts on our ability to afford tomorrow's
    commitments. As we know, there have been a variety of proposals to
    use the surpluses for purposes other than debt reduction. Although
    these proposals have various pros and cons, we need to be mindful
    of the risk associated with using projected surpluses to finance
    permanent future claims on the budget, whether they are on the
    spending or tax side.2 Commitments often prove to be permanent
    while projected surpluses can be fleeting. For instance, current
    projections assume full compliance with tight discretionary
    spending caps. Moreover, relatively small changes in economic
    assumptions can lead to very large changes in the fiscal outlook,
    especially when carried out over a decade. In a recent report, the
    Congressional Budget Office (CBO) compared the actual deficits or
    surpluses for 1988 through 1998 with the first projection it had
    produced 5 years before the start of each fiscal year. Excluding
    the estimated impact of legislation, CBO says that its errors
    averaged about 13 percent of actual outlays. Such a shift in 2004
    would mean a potential swing of about $250 billion in the
    projected surplus. Although most would not argue for devoting 100
    percent of the surplus to debt reduction over the next 10 years,
    saving a good portion of our surpluses would yield fiscal and
    economic dividends as the nation faces the challenges of financing
    an aging society. Our work on the long-term budget outlook
    illustrates the benefits of maintaining surpluses for debt
    reduction. Reducing the publicly held debt reduces interest costs,
    freeing up budgetary resources for other programmatic priorities.
    For the economy, running surpluses and reducing debt increase
    national saving and free up resources for private investment.
    These results, in turn, lead to stronger economic growth and
    higher incomes over the long term. ------------------ 2See Federal
    Budget: The President's Midsession Review (GAO/OCG-99-29, July 21,
    1999). Page 12
    GAO/T-HEHS/AIMD-99-294 Medicare Reform:  Ensuring Fiscal
    Sustainability While Modernizing the Program Will Be Challenging
    Over the last several years, our simulations illustrate the long-
    term economic consequences flowing from different fiscal policy
    paths.3 Our models consistently show that saving all or a major
    share of projected budget surpluses ultimately leads to
    demonstrable gains in GDP per capita. Over a 50-year period, GDP
    per capita would more than double from present levels by saving
    all or most of projected surpluses, while incomes would eventually
    fall if we failed to sustain any of the surplus. Although rising
    productivity and living standards are always important, they are
    especially critical for the 21st century, for they will increase
    the economic capacity of the projected smaller workforce to
    finance future government programs along with the obligations and
    commitments for the baby boomers' retirement. In addition to its
    significant financial imbalance, Medicare is outmoded BBA Made
    Medicare      from a programmatic perspective. In its current
    form, the program lacks Reform Down Payment    the flexibility to
    readily adjust its administered prices and fees in line with
    market rates and lacks the tools to exercise meaningful control
    over the volume of services used. Nevertheless, BBA reforms
    enacted in 1997 have begun to address certain programmatic
    shortcomings by modernizing the program's pricing and payment
    strategies and by moving toward quality- based competition among
    health plans. The act's combination of structural reforms,
    constraints on provider fees, and increases in beneficiary
    payments was expected to lower program spending by $386 billion
    over 10 years. Because certain key provisions have only recently
    or have not yet been phased in, the full effects of the BBA on
    providers, beneficiaries, and taxpayers will not be known for some
    time. Of particular significance was BBA's creation of the
    Medicare+Choice program, which furthered the use of a choice-based
    model of providing Medicare benefits. Medicare+Choice expanded
    Medicare's managed care options to include, in addition to health
    maintenance organizations (HMO), health plans such as preferred
    provider organizations, provider- sponsored organizations, and
    private fee-for-service plans. In making this expanded consumer
    choice program, BBA provisions placed a dramatic new emphasis on
    the development and dissemination of comparative plan information
    to consumers to foster quality-based plan competition. Other BBA
    provisions were designed to pay health plans more appropriately
    than Medicare had done under the previous HMO payment formula. ---
    --------------- 3See Budget Issues: Long-Term Fiscal Outlook
    (GAO/T-AIMD/OCE-98-83, Feb. 25, 1998) and Budget Issues: Analysis
    of Long-Term Fiscal Outlook (GAO/AIMD/OCE-98-19, Oct. 22, 1997).
    Page 13
    GAO/T-HEHS/AIMD-99-294 Medicare Reform:  Ensuring Fiscal
    Sustainability While Modernizing the Program Will Be Challenging
    BBA also made historic changes to traditional Medicare. It is
    gradually eliminating, for the most part, cost-based reimbursement
    methods and replacing them with prospective payment systems (PPS).
    The intent is to foster the more efficient use of services and to
    lower growth rates in spending for these providers, replicating
    the experience for acute care hospitals following the
    implementation of Medicare's PPS for hospitals, which began in the
    mid-1980s. BBA mandated phasing in PPSs for skilled nursing
    facilities, home health agencies (HHA), hospital outpatient
    services, and certain hospitals not already paid under such
    arrangements. Yet pressures mount to undo some of these changes.
    Affected providers are currently seeking to repeal various BBA
    provisions, some relying on anecdotal evidence rather than
    systematic analysis to make their case. An illustration is the
    reporting of health plan withdrawals from the Medicare+Choice
    program for 1999. Plans cite, and the press reports, inadequate
    payment rates as the reason for dropping out of Medicare or
    reducing enrollees' benefits. We have another point of view based
    on our fact-gathering and analyses. BBA sought to moderate
    Medicare's payments to managed care plans because, ironically,
    Medicare managed care cost, not saved, the government money. That
    is, the government was paying more to cover beneficiaries in
    managed care than it would have if these individuals had remained
    in the traditional fee-for-service program. In our report, we
    noted that BBA has reduced, but not eliminated, excess payments.4
    In fact, Medicare's payments to some plans are generous enough for
    plans to make profits and to finance prescription drugs and other
    extras not available to the majority of senior and disabled
    beneficiaries who remain in traditional Medicare. We have also
    reported that factors additional to or even exclusive of payment
    rates-including competition and other market conditions-played a
    significant role in the 1999 plan dropouts.5 Our ongoing analysis
    of the year 2000 plan dropouts reveals similar findings. The
    question this raises for policymakers is the extent to which they
    should be concerned about health plan dropouts from Medicare when
    plan participation means that the government finances non-Medicare
    benefits for a minority of beneficiaries while paying more for
    these beneficiaries than for similar ones in traditional Medicare.
    Among other lessons, however, the intensity of pressure to roll
    back BBA's curbs on managed ------------------ 4See
    Medicare+Choice: Reforms Have Reduced, but Likely Not Eliminated,
    Excess Plan Payments (GAO/HEHS-99-144, June 18, 1999). 5See
    Medicare Managed Care Plans: Many Factors Contribute to Recent
    Withdrawals; Plan Interest Continues (GAO/HEHS-99-91, Apr. 27,
    1999). Page 14
    GAO/T-HEHS/AIMD-99-294 Medicare Reform:  Ensuring Fiscal
    Sustainability While Modernizing the Program Will Be Challenging
    care rate increases teaches us the difficulty that this
    Subcommittee and the Congress as a whole face in making Medicare
    payment reforms. Concern continues to be voiced about the obvious
    gaps in protections for Dimensions of Reform    Medicare
    beneficiaries, in contrast to what is available for most Include
    Benefit         individuals with private employer-based coverage.
    At the same time, Expansions and          competing concerns
    remain about the need to check Medicare's cost growth, even
    without adding new benefits. In response, the various reform
    Financing Changes       options, including those favored by a
    majority of the Bipartisan Commission, have two major dimensions:
    (1) expansion of Medicare's benefit package and (2) cost
    containment through financing and other structural
    transformations. Two commonly discussed benefit expansions are the
    inclusion of a prescription drug benefit and coverage for
    extraordinary out-of-pocket costs, known as catastrophic coverage.
    The financing reforms are reflected in three models: fee-for-
    service modernization, Medicare+Choice modernization, and a
    premium support system fashioned after FEHBP. Each of these models
    is designed, to different degrees, to alter program incentives
    currently in place to make beneficiaries more cost conscious and
    providers more efficient (See table 2). Table 2: Major Dimensions
    of Medicare Reform, by Option Updated benefit package options
    Financing and organizational change options Coverage for
    outpatient prescription drugs Fee-for-service modernization Limit
    on beneficiary liability                  Medicare+Choice
    modernization FEHBP-type premium support Medicare's basic benefit
    package largely reflects the offerings of the Benefit Expansion
    commercial insurance market in 1965 when the program began.
    Although Reforms                 commercial policies have evolved
    since then, Medicare's package-for the most part-has not.6 For
    example, unlike many current commercial policies, Medicare does
    not cover outpatient prescription drugs or cap beneficiaries'
    annual out-of-pocket spending. Some beneficiaries can augment
    their coverage by participating in the Medicaid program (if their
    ------------------ 6Some Medicare benefits have changed. For
    example, BBA added or expanded coverage for screening mammograms,
    prostate cancer screening tests, bone mass measurements, and
    several screening or preventive services. Page 15
    GAO/T-HEHS/AIMD-99-294 Medicare Reform:  Ensuring Fiscal
    Sustainability While Modernizing the Program Will Be Challenging
    incomes are low enough), obtaining a supplemental insurance policy
    privately or through an employer, or enrolling in a
    Medicare+Choice plan. However, these options are not available to
    or affordable for all beneficiaries. Furthermore, to the extent
    that Medicaid and supplemental policies provide first-dollar
    coverage of services, the beneficiary population's sensitivity to
    service costs is dulled, contributing to some continued excess
    utilization. Consequently, many reform advocates believe that
    Medicare's basic benefit package should be brought into line with
    current commercial norms for active workers. Two benefit reforms
    under discussion by policymakers are the inclusion of prescription
    drugs and stop-loss coverage that caps beneficiary out-of- pocket
    spending. Each involves myriad options, and assessing the merit of
    these reforms would depend on the specifics included. For
    instance, a Medicare prescription drug benefit could be targeted
    to provide coverage for all beneficiaries, coverage only for
    beneficiaries with extraordinary drug expenses, coverage only for
    low-income beneficiaries, or coverage for selected drugs, such as
    those deemed to be cost beneficial. Such coverage decisions would
    hinge on understanding how a new pharmaceutical benefit would
    shift to Medicare portions of the out-of- pocket costs borne by
    beneficiaries as well as those costs paid by Medicaid, Medigap, or
    employer plans covering prescription drugs for retirees. How would
    these new program costs be shared between taxpayers and
    beneficiaries through premiums, deductibles, and copayments? Would
    subsidies be provided to help low-income beneficiaries not
    eligible for Medicaid with these costs? The administration of the
    benefit raises other questions, such as "Who would set and enforce
    drug coverage standards among the private health plans
    participating in Medicare?" and, for traditional Medicare, "How
    would reimbursable prices be set?" Price-setting options include
    using a formula based on market prices, negotiating directly with
    manufacturers, or contracting with pharmaceutical benefit
    management companies. The Breaux-Thomas proposal favored targeting
    a drug benefit to low-income beneficiaries while allowing those at
    higher incomes to buy into the benefit. A catastrophic, or stop-
    loss, coverage benefit would similarly entail its own design
    permutations and variables. Many Medicare reforms are designed to
    slow spending growth to keep the Financing and Other    program
    viable for the nation's growing aged population. Although the
    Structural Reforms     various proposals, including those
    considered by the Bipartisan Commission, differ from one another
    in concept, they generally include mechanisms to make
    beneficiaries more cost conscious, and incorporate provider
    incentives to improve the efficiency of health care delivery. The
    Page 16                                                GAO/T-
    HEHS/AIMD-99-294 Medicare Reform:  Ensuring Fiscal Sustainability
    While Modernizing the Program Will Be Challenging various
    financing and structural reforms consist of components of three
    general models: fee-for-service modernization, Medicare+Choice
    modernization, and a premium support system fashioned after FEHBP
    (See table 3). Table 3: Three Medicare Financing and Structural
    Reforms Fee-for-service       Medicare+Choice        FEHBP-type
    modernization         modernization          premium support
    Pending under      Prospective           Health-based risk BBA
    payment systems       adjustment of rates for HHAs, hospital
    outpatient            Annual enrollment departments, and      and
    lock-in others                Competitive pricing demonstration
    Potential under    Selective             Plan savings shared
    Premium based on current            purchasing            with
    program and/or offered or proposals
    beneficiaries          negotiated price Negotiated pricing
    Competitive            Beneficiary Case management       premium
    pricing        contribution based for complex and
    on plan cost chronic conditions
    Traditional Medicare Utilization
    incorporated management                                   Enhanced
    flexibility Medigap and                                  Self-
    financed beneficiary cost- sharing reforms Expanded use of centers
    of excellence Fee-for-Service    BBA improved the efficiency of
    Medicare's traditional fee-for-service Modernization      program
    by substituting a variety of PPSs and other fee changes for its
    cost-based reimbursement methods and outdated fees. Nevertheless,
    Medicare is still not an efficient purchaser. Adjusting its
    systems of administered prices and fees up or down to ensure
    beneficiary access or to capture potential savings as the market
    changes poses an overwhelming, if not impossible, challenge.
    Medicare largely remains a passive bill payer, exercising little
    meaningful control over the volume of services used. Proposals to
    modernize fee-for-service Medicare aim at Page 17
    GAO/T-HEHS/AIMD-99-294 Medicare Reform:  Ensuring Fiscal
    Sustainability While Modernizing the Program Will Be Challenging
    providing flexibility to take advantage of market prices and
    introducing some management of service utilization. In proposing
    to make fee-for- service more fiscally accountable and to provide
    it with additional flexibility to achieve these fiscal goals, the
    Bipartisan Commission also discussed fee-for-service modernization
    as one of the critical elements of reform. Preferred provider
    arrangements, whereby insurers select certain providers because of
    their willingness to accept lower fees and their efficient style
    of practice, have become commonplace in the commercial insurance
    market. By accepting negotiated or competitively bid fees that
    fall below the usual levels, selected providers and the
    beneficiaries using their services would be afforded certain
    advantages. The selected providers with lower fees may experience
    increased demand, while beneficiaries using their services could
    be subject to lower cost sharing. Comparable arrangements have
    been proposed for fee-for-service Medicare. Testing of this
    concept has been under way in the HCFA's Centers of Excellence
    demonstrations, where hospitals and physicians agree to provide
    certain procedures for negotiated all-inclusive fees. BBA also
    allowed for testing of competitive bidding for medical equipment
    and supplies, with high bidders being excluded from serving
    Medicare beneficiaries. About 87 percent of beneficiaries in
    traditional Medicare face little cost sharing in the form of
    deductibles or copayments for services by virtue of their
    eligibility for Medicaid or their enrollment in a supplementary
    insurance plan. While increases in cost sharing have been common
    in private insurance to make beneficiaries sensitive to the value
    and cost of services, it has been a cost-containment tool largely
    unavailable to Medicare. Protecting low-income beneficiaries from
    financial barriers to care remains a critical concern. One
    possible change in allowable supplementary coverage would be to
    restructure cost sharing to heighten beneficiary sensitivity to
    the cost of services while removing catastrophic costs for those
    who have intensive health care needs. Private indemnity insurers
    have moved to incorporate certain utilization management
    techniques into their policies, such as prior authorization of
    some expensive services and case management for persons with
    serious chronic conditions. Although such techniques are
    increasingly common among private insurers, their effectiveness on
    the population Medicare covers is unknown. Medicare+Choice
    Medicare+Choice signaled a new phase in efforts to transform
    Medicare. Modernization      Built on the program that allowed
    beneficiaries to enroll in participating Page 18
    GAO/T-HEHS/AIMD-99-294 Medicare Reform:  Ensuring Fiscal
    Sustainability While Modernizing the Program Will Be Challenging
    managed care plans, Medicare+Choice expands options available to
    beneficiaries and substantially changes plan payment methods. By
    raising payments in certain areas and allowing additional types of
    entities to contract with Medicare, Medicare+Choice is intended to
    boost plan participation and beneficiary enrollment. Payment
    changes are designed to adjust the per capita rates to more
    accurately reflect enrollees' expected resource use and slow the
    growth of spending over time. Among other payment changes, BBA
    required HCFA to implement by January 1, 2000, a methodology to
    adjust plan payments to reflect the health status of plan members.
    Favorable selection-that is, the tendency for healthier
    beneficiaries to enroll in managed care plans-has resulted in
    payments that are higher than warranted. The new risk adjustment
    method developed for Medicare will more closely align payments to
    the expected health care costs of plans' enrollees. This will help
    produce the savings originally envisioned when managed care
    enrollment options were offered to Medicare beneficiaries and will
    foster competition among plans on the basis of benefits and
    quality rather than enrollment strategies. The design of the
    Medicare+Choice program does not, however, allow taxpayers to
    benefit from the current competition among health plans. If a plan
    can provide the Medicare package of benefits for less than the
    Medicare payment, it must cover additional benefits, reduce fees,
    or both.7 Plans that offer enriched benefit packages-such as
    including coverage for outpatient prescription drugs or routine
    physical examinations-may attract beneficiaries and gain market
    share. Medicare, however, pays the predetermined price even in
    fiercely competitive markets. The Medicare+Choice program could be
    modified, through new legislation, to require that taxpayers and
    beneficiaries both benefit from health plan competition. The
    Congress could require that when payments exceed a plan's cost of
    services (including reasonable profit), part of the savings be
    returned to the program and the rest be used to fund additional
    benefits. Another alternative would be to set plan payments
    through competitive bidding. In fact, BBA mandates a competitive
    pricing demonstration. However, setting the parameters of a
    competitive pricing system is a formidable task. Furthermore, this
    payment-setting approach may be best suited to urban areas with
    high concentrations of managed care members. ------------------
    7Alternatively, plans can contribute to a stabilization fund that
    would allow them to provide additional benefits or lower fees in
    future years. Before BBA, health plans also had the option of
    accepting a lower capitation payment. In practice, plans preferred
    to add benefits to attract beneficiaries. Page 19
    GAO/T-HEHS/AIMD-99-294 Medicare Reform:  Ensuring Fiscal
    Sustainability While Modernizing the Program Will Be Challenging
    FEHBP-Type         Although modernizing traditional Medicare and
    Medicare+Choice could Premium Support    improve the control of
    program spending, several incentives would remain unaltered. For
    example, beneficiaries would remain partially insulated from the
    cost consequences of their choices. They would not benefit
    directly from selecting plans capable of delivering Medicare-
    covered benefits less expensively because the premiums they pay
    might well remain constant. Program payments to plans would
    continue to be established administratively. The Breaux-Thomas
    proposal recognized beneficiary sensitivity to cost as the
    critical element missing from the current Medicare program. To
    remedy this situation, the Breaux-Thomas proposal and others have
    proposed the adoption of an FEHBP-type premium support for
    Medicare-a mechanism that could, at the same time, serve to
    increase beneficiary sensitivity to the cost consequences of their
    choices and enhance quality/cost based competition. The two
    defining elements of an FEHBP-type of premium support are (1) the
    establishment of premium levels for plans through negotiations
    between the program and plans and (2) the linking of
    beneficiaries' contributions to the premiums of the plans they
    join. This system makes transparent to beneficiaries which plans
    operate less expensively and can therefore charge lower premiums.
    In principle, it encourages competition because plans that can
    deliver services more efficiently can lower premiums and attract
    more enrollees. In practice, some caveats remain. Differences in
    premiums can reflect more than variation in efficiency. For
    example, plans may achieve savings through narrower provider
    networks that, while capable of providing Medicare-covered
    benefits, could cause beneficiaries inconveniences and delays in
    accessing services. Providing beneficiaries adequate comparative
    information on plans' expected and actual performance becomes even
    more critical. Because most beneficiaries participate-and are
    expected to continue to participate-in traditional fee-for-service
    Medicare, its incorporation into the FEHBP-type system is seen as
    important. Under current arrangements, the only premium for
    participating in the traditional program is the fixed monthly
    amount that beneficiaries voluntarily pay to receive coverage for
    SMI or to be eligible to enroll in a Medicare+Choice plan. Because
    the premium amount represents only 25 percent of the program's
    cost and is deducted from beneficiaries' monthly Social Security
    payments, participants are not as aware of the cost of the
    traditional Medicare program. The Breaux-Thomas proposal
    incorporates traditional Medicare as another plan under an FEHBP-
    type premium support system. Traditional Medicare would propose
    and negotiate premiums like any other plan and be expected to be
    self-financing and self-sustaining. Recognizing the challenge the
    latter requirement creates, the proposal Page 20
    GAO/T-HEHS/AIMD-99-294 Medicare Reform:  Ensuring Fiscal
    Sustainability While Modernizing the Program Will Be Challenging
    would also provide traditional Medicare more flexibility to manage
    costs using tools similar to proposals for fee-for-service
    modernization. Incorporating traditional Medicare as another plan
    puts all plans on equal footing and maximizes beneficiaries
    awareness of costs. However, the sheer size of the traditional
    program creates questions. How much flexibility can be granted to
    traditional Medicare, given its market power? What will it mean
    for a public plan to be self-sustaining and self-financing? Can it
    generate and retain reserves as a protection against future
    losses? How will losses be managed? The insolvency of traditional
    Medicare, which may continue to enroll the majority of
    beneficiaries and may be the only plan serving many areas of the
    country, is not acceptable. The dilemma of how to guarantee
    traditional Medicare's solvency in the context of an FEHBP-type
    premium support system needs to be addressed. An FEHBP-type
    premium support system would increase the importance of effective
    program management and design. In particular, the ability to risk-
    adjust premiums to reflect the variation in health status of
    beneficiaries joining different plans would become paramount.
    Participating plans that attract a disproportionate number of more
    seriously ill and costly beneficiaries would be at a competitive
    disadvantage if their premium revenues were not adjusted
    adequately. In turn, enrollees in those plans might find services
    compromised by the plans' financial situation. Inadequate risk
    adjustment may be a particular problem for the traditional
    Medicare plan, which may function as a refuge for many chronically
    ill persons who find selecting among plans challenging and opt for
    something familiar. In determining how to reform the Medicare
    program, much is at stake- Concluding      not only the future of
    Medicare itself but also assuring the nation's future Observations
    fiscal flexibility to pursue other important national goals and
    programs. Mr. Chairman, I feel that the greatest risk lies in
    doing nothing to improve the program's long-term sustainability
    or, worse, in adopting changes that may aggravate the long-term
    financial outlook for the program and the budget. 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 Page 21
    GAO/T-HEHS/AIMD-99-294 Medicare Reform:  Ensuring Fiscal
    Sustainability While Modernizing the Program Will Be Challenging
    should remember that surpluses can be used as an occasion to
    promote the transition to a more sustainable future for our
    children and grandchildren. General fund infusions and expanded
    benefits may well be a necessary part of any major reform
    initiative. Updating the benefit package may be a necessary part
    of any realistic reform program to address the legitimate
    expectations of an aging society for health care, both now and in
    the future. Such changes, however, 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, the Congress should consider adequate fiscal incentives
    to control costs and a targeting strategy in connection with any
    proposal to provide any new benefit such as prescription drugs. I
    am under no illusions about how difficult Medicare reform will be.
    The Breaux-Thomas proposal addresses 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 guaranteeing 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. Recent experience implementing BBA
    reforms provides us some sobering lessons about the difficulty of
    undertaking reform and the need for effectiveness, flexibility,
    and steadfastness. Effectiveness involves collecting the data
    necessary to assess impact-separating the transitory from the
    permanent and the trivial from the important. Flexibility is
    critical to make changes and refinements when conditions warrant
    and when actual outcomes differ substantially from the expected
    ones. Steadfastness is needed when particular interests pit the
    primacy of their needs against the more global interest of making
    Medicare affordable, sustainable, and effective for current and
    future generations of Americans. This makes it all the more
    important that any new benefit expansion be carefully designed to
    balance needs and affordability, both now and over the longer
    term. 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 inherit, to provide a strong foundation for
    future economic growth, and to ensure that future commitments are
    both Page 22                                                GAO/T-
    HEHS/AIMD-99-294 Medicare Reform:  Ensuring Fiscal Sustainability
    While Modernizing the Program Will Be Challenging 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. Mr. Chairman, this
    concludes my prepared statement. I will be happy to answer any
    questions you or other Members of the Subcommittee may have. If
    you have any questions regarding this testimony, please call Paul
    L. GAO Contacts and    Posner, Director of Budget Issues, at (202)
    512-9573 or William J. Scanlon, Acknowledgments     Director of
    Health Financing and Public Health Issues at (202) 512-7114. Other
    individuals who made key contributions include Linda F. Baker,
    James Cosgrove, Hannah F. Fein, James R. McTigue, Walter Ochinko,
    and Deborah Spielberg. (101896/935333) Page 23
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