Saturday, August 18, 2012

Protecting Medicare: Projecting into the Future

The Medicare Program has taken center stage in the 2012 presidential election race. Everyone seems to agree that projecting past cost growth into the future leads to an untenable fiscal situation. The Democrats want to keep benefits essentially the same and control costs by making healthcare delivery more efficient. It is not generally agreed that this is a viable path. The Republicans wish to limit costs by converting from a defined-benefit program to a defined-contribution program. A fixed amount of money will be provided to seniors to purchase commercial medical insurance and beyond that they are on their own. The argument is made that the market will find a cost-effective solution and all will turn out well. There is no intention in intervening in the market to encourage efficiency. It is generally agreed that the motive of the Republicans is to eliminate federal government involvement in society to as great an extent as possible.

The projection of Medicare costs into the future is at the heart of this issue. Such projections are not simple. The Boards of Trustees of the two main components of Medicare are responsible for issuing a report to Congress each year. The latest version was issued in April of this year. Let’s look at what it has to say about Medicare and its fiscal future.

First we must define some terms. There are two components to the Medicare Program: Hospital Insurance (HI), more familiar as Medicare Part A, and Supplementary Medical Insurance (SMI), known as Medicare Parts B and D which cover non-hospital-related costs and drug expenses.

This chart is provided to compare expected costs as a percentage of GDP.

The curve labeled "Current Law" considers the full implementation of the recent legislation (Obamacare) with credit applied for some efficiencies built into the law. It also includes a reduction in physician payment schedules that Congress always overrides. If one assumes they are overridden again then one arrives at "Alternate to SGR." The top line assumes that all the legislated improvements in efficiency are phased out over the period 2020-2035.

One thing that is clear is that there is room for efficiency. Obamacare, as implemented, and with estimated efficiencies, cuts costs tremendously in the out years. The second thing to notice is that the cost increases significantly, from about 3.7% of GDP today to about 6% in 2040, and about 6.7% in 2085.

This chart indicates the expected sources of funds required to meet the costs as incurred assuming the current law is in place.

General revenue transfers are already being made to cover costs. Congress treats HI and SMI separately. In any event, when accumulated funds for HI run out (projected in 2024) the shortfall will also have to be covered by general revenue.

Now let’s examine the numbers used in making these projections.

This table includes a projection of SMI costs against expected growth in GDP. HI costs are projected to closely follow SMI costs so this provides a respectable comparison with total costs. Note that the table has SMI per capita cost increasing at 9.2% per year over the interval 2002-2011. Drug coverage was introduced in 2006 and caused a step function in costs. When that year is eliminated the annual growth rate was 6.4%. In the out years the annual growth is estimated to be in the range 4-5%.  GDP growth is expected to be about 4.6% over the entire period. The excess in costs, mainly from growth in the number of retirees, explain the rising share of GDP that must be devoted to Medicare.

Projecting medical costs into the future is extremely difficult. One thing we know for sure is that there is a lot of waste in the system. We also know that there has been little success in controlling costs in the past. The effects of technological advances are unknown, but it must be recognized that new technologies have, in the past, tended to drive up costs. The projections by the Trustees have consequently been conservative. The text they provided indicates that they are even doubtful that the efficiencies assumed to be realized from the current law can be attained.

On the other hand, the current legislation has been in place for about three years. Although not fully implemented yet, it is assumed that it will be. Perhaps more importantly, the constant and passionate discussion about cost has convinced the medical industry that they must change their ways if their profit stream is to be maintained. We have written here numerous times of examples in which industry participants have taken the initiative to implement more efficient procedures—and with considerable success. Given that there appears to have been progress made in recent years, is there any data that might enlighten us as to what the future might hold?

Data on costs are provided by S&P and can be accessed here.
"The S&P Healthcare Economic Indices seek to reflect the monthly rate of change in the principal cost components of the U.S. healthcare market. The indices are designed to estimate the per capita change in total allowed claim costs incurred each month by patients (through their co-payments) and their healthcare benefit programs for services rendered by hospitals and physicians."

This chart is provided.

There is a subtle but definite trend downward for these indices. Consider the Medicare Index where change is more dramatic. It was at about 5% in annual growth in 2009, but in the last two years it has been in the 2-3% range. If these numbers adequately represent the trends in Medicare expenditures, then it would seem to indicate that efficiency measures are succeeding and cost is coming under control. If one can arrive at growth in expenditure that is less than the growth in GDP, then the budget impact of Medicare will go down rather than up.

Let us hope that these numbers are representative of what the future actually holds in store. Let us not panic and do something foolish like destroying Medicare in order to save Medicare.

An update for this article exists.  See Medicare: The Fiscal Outlook Continues to Improve.

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