November 20, 2014

'Good News' in Medicare Report Isn't As Good As It Sounds

Good news comes and goes rather quickly in the 2010 Medicare Trustees’ Report. It begins with the optimistic news that Medicare’s finances have improved substantially as a result of this year’s health care reform bill, the Affordable Care Act (ACA). However, the report then goes on to explain in great detail why this apparently good news is probably not as good as it sounds.

According to the trustees, “actual future Medicare expenditures are likely to exceed the intermediate projections  shown in this report, possibly by quite large amounts.” A separate memo prepared by the Center for Medicare and Medicaid Services (CMS) Office of the Actuary bluntly states that “the projections in the report do not represent the ‘best estimate’ of actual future Medicare expenditures.”

For those seeking solutions to our nation’s long-term structural deficit, understanding the complex message of the trustees’ report is crucial. Despite the buoyant headlines, the trustees warn, “The financial projections in this report indicate a need for additional steps to address Medicare’s remaining financial challenges.”

On paper, Medicare’s finances have indeed improved. The ACA reduced future non-physician Medicare provider reimbursements and added dedicated revenue through a 0.9 payroll tax increase for individuals earning more than $200,000 and for married couples earning more than $250,000. In addition, the trustees’ report assumes that a 30 percent cut in physician payments over the next three years will be implemented as scheduled under current law.

So total Medicare expenditures are now projected to grow much more slowly. For example, Medicare is projected to equal 5.76 percent of the economy (GDP) in 2040 rather than 7.96 percent projected in last year’s report. The unfunded obligations of the program over the next 75 years have plunged to $22.8 trillion from $38.2 trillion and the solvency of the Medicare Part A Hospital Insurance (HI) trust fund has been extended from 2017 to 2029.

A look behind the numbers, however, reveals a much less comforting picture.

For one thing, it is important to keep in mind that Medicare’s finances remain very problematic, even with the improvements assumed to occur as a result of health care reform. If total expenditures increase as projected to 5.76 percent of GDP in 2040, it will represent a 60 percent increase from today. Increasing amounts of general revenues will be needed to pay promised benefits. This will put a growing strain on the rest of the budget, crowding out other priorities or forcing higher taxes. Even the extra dozen years of Part A trust fund solvency leave that part of the program insolvent by the time people who are now age 46 and younger qualify for benefits.

It is also important to note that the improvement in Medicare’s finances resulting from the health care reform legislation does not translate into a substantial improvement in the federal government’s long-term budget outlook. Most of the ACA’s Medicare savings and added payroll tax income have been dedicated to an expansion of Medicaid and to subsidies for those who need help purchasing mandated health insurance. In other words, the health care legislation does not “bank” its Medicare reforms for future Medicare expenses.

However, the most significant caveat noted by the trustees is that two key assumptions in the official projections are not realistic.

The first of these assumptions is that Medicare’s current law Sustainable Growth Rate (SGR) for physician payments will be followed, starting with a 30 percent cut over the next three years. The ACA did not change this requirement, even though Congress has routinely overridden it and is widely expected to do so again.

The second questionable assumption is that annual adjustments to non-physician provider payments will be limited to the growth of economy-wide productivity. This change was a major cost-saving initiative in the ACA. However, productivity gains in the health care sector have generally not kept pace with economy-wide gains. So maintaining this new standard would necessitate substantial and continuous efficiencies. The CMS actuaries estimate that payments would be 28 percent lower after 30 years than under the pre-ACA law and 56 percent lower after 75 years.

In the actuaries’ view, “neither of these [payment] update reductions is sustainable in the long range and Congress is very likely to legislatively override or otherwise modify the reductions in the future to ensure that Medicare beneficiaries continue to have access to health care services.”

In short, much of the apparent improvement in Medicare’s finances may prove to be illusory.

To illustrate the magnitude of the difference between a strict application of “current law,” as assumed in the official report, and what may happen if the long-term savings assumed in the ACA prove untenable, the Office of the Actuary prepared an alternative scenario in which physician payments are allowed to increase with medical inflation, and the changes in non-physician payment updates are phased out after 2019.

In this alternative scenario, Medicare’s finances still show improvement but not by nearly as much. To use an earlier example, total Medicare costs in the alternative scenario would rise to 7.34 percent of GDP in 2040 rather than 5.76 percent under current law. This would not be a substantial improvement over last year’s report, which projected that Medicare would reach 7.96 percent of GDP in 2040.

The issue is not whether efficiencies from payment update reductions are possible or desirable, but whether it is reasonable to assume that payments can be ratcheted back by as much, and for as long, as projected under the new law. So while the new formula might work for some time at encouraging efficiencies, it is probable that the imposed constraints might become so great that the formula would need reform.

It is possible that other initiatives in the ACA will enable and encourage cost-cutting and productivity increases. The experiments in shifts away from fee-for-service medicine and the investments in comparative effectiveness research and health information technology were designed for that purpose. However, the savings from those efforts are far from certain because, as noted by the trustees, “specific changes have not yet been designed, tested, or evaluated.” The trustees are thus appropriately cautious about the degree to which those changes will enable Medicare providers to continue operating under a system that continually cuts reimbursements below what until now has been an ever-growing trajectory of health care inflation.

None of this is to suggest that setting tough budgetary constraints and targets is a bad thing -- after all, without them efficiency and productivity gains are even less likely (as our current system proves). What it does suggest is that policymakers and the public should not be too quick to celebrate what, on paper, appears to be good news. Viewed more fully, the trustees’ report is yet another wake-up call as to how much more needs to be done just to approach, much less exceed, the new projections.

As the actuaries’ memo observes, the trustees’ report should serve “as illustrations of the very favorable impact of permanently slower growth in health care costs, if such slower growth can be achieved…(but) expectations must be tempered by awareness of the difficult challenges that lie ahead in improving the quality of care and making health care far more cost efficient” (emphasis added).

Policymakers who are now trumpeting the “good news” in the trustees report must also accept responsibility for maintaining this favorable outlook by using a pay-as-you-go basis for any changes that may be needed if current-law assumptions prove to be unworkable. The temptation will always be to not do so, but that is the path to fiscal ruin -- the path that current reformers claimed they were attempting to avoid.