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A Guide to the 2012 Medicare Trustees Report

Charles Blahous | 04/30/2012

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This is the second of two articles on the 2012 Social Security and Medicare Trustees’ reports. In the last article I discussed Social Security. This article will focus on the Medicare report.

Important Takeaways from the Current Report

The story of Medicare finances concerns much more than HI Trust Fund solvency. The Medicare Hospital Insurance (HI) Trust Fund operates somewhat similarly to Social Security’s. It is financed primarily by a payroll tax, its solvency is constantly open to re-evaluation, and total benefits aren’t supposed to exceed what participants have paid for. But Medicare Supplementary Medical Insurance (SMI), which covers physician services, prescription drug benefits and other health services, is financed quite differently. It is funded primarily from general government revenues and to a lesser extent from beneficiary premiums, and is deemed “solvent” virtually by definition. To grasp total Medicare finances one can’t look only to the HI solvency projection but must understand cost/income trends for Medicare as a whole.

In the near term population aging will drive rising Medicare costs as it does Social Security’s. In the long-run Medicare becomes an even bigger financing problem because of health cost inflation. The accompanying graph from the report summary should make this clear. Much of the cost growth relative to GDP occurs prior to 2035 in each program. This is primarily because of the baby boomers entering the benefit rolls. Because Medicare is also affected by health cost inflation its costs are projected to ultimately pass Social Security’s. Still, the biggest challenge facing each program is demographic.

Social Security and Medicare Cost as a Percentage of GDP

Medicare is straining the federal budget. In 2012, $217 billion in general revenues will be needed for its SMI program while HI costs will exceed tax/premium income by a further $38 billion. HI costs have exceeded tax/premium collections since 2008 and are projected to do so in every future year. Because total general revenue needs exceed 45% of Medicare costs in 2012, a statutory “funding warning” has been triggered. This warning is designed to precipitate various responses from elected officials, but no legislation has yet been enacted in response to the funding warnings in the last five consecutive reports.

Medicare HI insolvency is projected for 2024 and its financing deficit is estimated at 1.35% of taxable worker earnings. This is both better and worse than Social Security’s situation, depending on the point of emphasis. On the one hand Social Security’s financing imbalance is bigger than HI’s. On the other hand HI is but one piece of Medicare; financing the other part as well (SMI) will together put greater strain on government resources than Social Security will over the long term. The HI insolvency date of 2024 is earlier than that of the combined Social Security Trust Funds (2033), but later than the Social Security Disability Insurance Trust Fund when separately considered (2016).

Actual Medicare costs are almost certain to be higher than projected. The main reason for this is that under current law physician payments would be suddenly cut by nearly 31% in 2013. Almost no one expect this to happen, as lawmakers have repeatedly overridden these payment reductions for a decade. There is also an open question as to whether the Medicare cost constraints enacted in 2010 with the Affordable Care Act (ACA) will be sustained, though opinions here are much more diverse than with the physician payment reduction. As discussed below, the latest trustees’ report has changed how these uncertainties are presented.

How Did the Projections Change This Year?

Near-term: In the short-term the projections changed very little. The 2024 HI insolvency date is the same as projected last year. Through 2035, total Medicare costs as a % of GDP are within 0.2 points of last year’s projections. The near-term picture was affected by various offsetting factors. On the negative side, the economy was weaker than projected. On the positive side, the 2011 Budget Control Act requires a 2% reduction in Medicare expenditures over the next decade. Had it not been for this debt-ceiling-induced legislation, the HI insolvency date would likely have moved earlier.

Long-term: Although the 2024 date didn’t move, the long-term HI actuarial deficit increased from 0.79% to 1.35% -- a 70% increase. Projected Medicare costs in 2085 are now projected at 6.7% of GDP in comparison with last year’s estimate of 6.2%. The main reason for the increase is a change in how the trustees project long-term health care cost growth. More on this below.

It’s Tough to Make Predictions, Especially About the Future (For Wonks)

This year the trustees had the benefit of the work of a Medicare Technical Review Panel. Their recommendations changed how we present the information that actual costs will likely be higher than under current law due to legislative overrides. In the previous years’ reports, the trustees had blessed the creation of an “illustrative alternative” scenario in which various provisions of current law were assumed to be overridden. This scenario was analyzed in a separate memo issued by the CMS Medicare Actuary.

This year the alternative analysis was imported into the main report and refined somewhat. Rather than a single illustrative alternative scenario, we now show two. In the first of these two alternatives, the near-certain overrides of the physician payment cuts occur. For the next ten years, these overrides allow for physician payment growth similar to that over the last ten years. Beyond then the physician payments are assumed to grow with the Medicare Economic Index.

In the second alternative, not only the physician payments but certain cost-saving provisions of current law (the ACA) are partially overridden. Under current law, many Medicare reimbursement rates will rise about 1.1% slower annually than providers’ input prices. In the second alternative, these differentials are relaxed to 0.4% over the years 2020-35.

The 0.4% figure reflects a technical panel estimate for the rate of productivity improvement sustainable within the broader health sector. Basically, this alternative scenario reflects a view in which current-law Medicare payment reductions create a politically unsustainable wedge between the quality of health care under Medicare vs elsewhere, leading to their being phased down from 2020-35. The inclusion of this alternative scenario in no way implies a prediction or recommendation by the trustees, but is instead designed to inform lawmakers of the financial consequences if the ACA’s payment growth reductions are not sustained.

Under current law, total Medicare costs would be 6.7% of GDP in 2085. Under the first alternative, they’d be 7.8% of GDP. Under the second, they’d be 10.3% of GDP.

These alternatives are explained in greater detail in a new Introduction to the Medicare report. As it states, “Projections of Medicare costs are highly uncertain, especially when looking out more than several decades.” Yogi Berra once put it similarly: “It’s tough to make predictions, especially about the future.”

Projecting Long-Term Health Cost Growth (For Serious Wonks)

Another important change is to our assumption for long-run health care cost growth. Previously the trustees had assumed that health cost inflation would average per-capita GDP plus one percent on average over the next 75 years. The annual growth rate would be higher in the near term and lower in the long-term as health care costs continually absorb a larger share of the economy.

This year, pursuant to a recommendation of the technical panel, the trustees’ view of this “GDP plus 1%” assumption was refined to represent the net of input price growth of (GDP + 1.4%), minus annual health care productivity growth of 0.4%. As a result, before considering the cost constraints in the 2010 ACA, it’s now assumed that Medicare per-capita cost growth would have averaged GDP plus 1.4% over the next 75 years. Subtracting the 1.1% adjustments under the ACA would therefore produce a Medicare cost growth assumption of GDP + 0.3%. It’s also now anticipated that the ACA’s payment constraints will result in slower health care volume and intensity growth, resulting in a final average growth rate for these Medicare services of GDP plus 0.2%, on average over 75 years.

As with previous projections, this growth rate of GDP + 0.2% is assumed to be higher in the near term and lower in the long run. At the end of 75 years, for example, it would be GDP minus 0.5%. Though many question the political sustainability of Medicare cost growth rates slower than GDP, this is nevertheless higher than assumed in last year’s report and we regard it as somewhat more realistic.

The trustees also adopted a recommendation of the technical panel projecting faster case mix growth in skilled nursing facilities and home health services, and slower growth in inpatient hospital services. This is based on an “assumed continuation of the current trend toward treating less complicated cases in outpatient settings.”

The trustees have also taken a significant step toward changing the methodology by which future cost growth is projected. The “GDP + X%” formula for estimating future growth has become increasingly problematic especially as it has become more clear that “X” did not hold constant in the past, and few experts are comfortable with assuming it will remain constant in the future. This year the trustees embraced a new “factors contributing to growth” model in which such factors as income levels and existing health prices affect the rate of future health inflation. This model was used to smooth our cost growth projections in years 25-75 of the valuation period. Though the trustees did not make a clean break with the “GDP + X%” methodology this year, we have stated our intention to move completely to the factors model in next year’s report.


In sum, the Medicare trustees’ report continues to show a financially troubled program. In the near-term the qualitative picture looks much like it did last year, but the long-term picture has appeared to worsen. I say “appeared to” because the long-term change is primarily the result of methodological improvements in our Medicare cost growth projections over those presented in the 2011 report.

Charles Blahous is a research fellow with the Hoover Institution, a senior research fellow with the Mercatus Center, and the author of Social Security: The Unfinished Work.