Medicare Financing
The Status of the Medicare Part A and Part B Trust Funds: The Trustees' 2001 Reports
Research Report
Craig Caplan, AARP Public Policy Institute
David Gross, AARP Public Policy Institute
March 2001
Table of Contents:
- I. Introduction
- II. The Federal Hospital Insurance (HI) Trust Fund—Medicare Part A
- III. The Federal Supplementary Medical Insurance (SMI) Trust Fund—Medicare Part B
- IV. The Medicare HI and SMI Programs Combined
- V. Trustees' Conclusions
I. Introduction
Financial transactions of the Medicare program operate through two Trust Funds. The Federal Hospital Insurance (HI) Trust Fund finances Medicare Part A, which covers inpatient hospital, home health,1 skilled nursing facility, psychiatric hospital, and hospice care services. The Supplementary Medical Insurance (SMI) Trust Fund finances Part B, which covers physician visits, outpatient services, some mental health services, durable medical equipment, some preventive services, and home health visits not covered under Part A.2 This Data Digest summarizes the current and projected financial status of these Trust Funds, as determined by the Trustees in their year 2001 reports to Congress.
The Trustees assess the status of each Trust Fund under three scenarios (pessimistic, intermediate, and optimistic), each of which uses different sets of assumptions about such factors as general and health care inflation, wage growth, mortality, and fertility rates. Unless otherwise noted, the information presented in this Data Digest represents the Trustees' intermediate estimates, commonly referred to as the actuaries' "best guess." 3
II. The Federal Hospital Insurance (HI) Trust Fund—Medicare Part A
The Trustees of the HI Trust Fund examine the Fund's financial health by comparing its projected income with its projected expenditures. The primary source of income for the Part A Fund is a 2.9 percent payroll tax paid by employers and employees (1.45% each). Self-employed individuals pay 2.9 percent of wages.4
The Trustees report that the Fund's annual income in 2000 exceeded annual spending for Part A services by $36.1 billion. Expenditures were $131.1 billion, and income (from payroll taxes and other sources) was $167.2 billion. On December 31, 2000, HI Trust Fund reserves stood at $177.5 billion. These reserves are invested in U.S. Government securities, which earned an effective rate of 7.3 percent in interest for the Trust Fund.
Short-Term Financial Status
The Trustees project that the HI Trust Fund will remain solvent until 2029, four years later than projected in their 2000 report (and fourteen years later than projected in their 1999 report). This extended period of solvency is due to both higher income and lower Part A spending than the Trustees projected in their 2000 report.
The increase in income is attributed to robust economic growth, particularly growth in the labor market. The Trustees attribute the decrease in Part A spending to: (1) the continuing implementation of measures in the Balanced Budget Act of 1997 (BBA); 5(2) low growth of health care costs in general; (3) additional efforts to reduce fraud and abuse; and (4) a substantial drop in the utilization of home health care and skilled nursing facility services.
The Trustees project that Part A income will exceed expenditures each year between 2000 and 2020. Beginning in 2021, annual expenditures will exceed annual income, thereby reducing and ultimately depleting the Trust Fund reserves in the year 2029. Figure 1 illustrates projections of the Fund's financial status through 2029.
Under the Trustees' pessimistic scenario, insolvency would occur in 2016. Under the Trustees' optimistic scenario, annual trust fund income would exceed expenditures for at least the next 75 years.
Long-Term Financial Status
The Trustees also look at the financial health of the HI Trust Fund for the next 25, 50, and 75 years. For this long-term analysis, income and costs are expressed as a percentage of taxable payroll (hereafter referred to as the income rate and cost rate, respectively).
In contrast to their favorable short-term financial outlook, the Trustees project a substantial gap between the projected income rate and cost rates for the long term (see Figure 2). The income rate will remain virtually constant over the next 75 years, while the cost rate is expected to increase over time from 2.7 percent of workers' earnings in 2001 to 10.7 percent in 2075.
To test the long-range financial health of the Trust Fund, the Trustees examine its actuarial balance, which is a summary of the differences between the annual income rate and cost rate over a period of years (i.e., 25, 50, or 75 years). 6 A negative actuarial balance means the fund has a deficit and fails the Trustees' test of financial health.
The Trustees project that, over a 75-year period, the Part A Trust Fund will have an actuarial balance deficit of 1.97 percent of taxable payroll. They note that, while this is less than one-half of the level projected prior to the BBA, it still suggests that the program fails by a large margin to meet their long-range test of close actuarial balance. To demonstrate the severity of this deficit, the Trustees project that achieving actuarial balance would require either increasing the payroll tax from its current level of 2.9 percent to 4.87 percent, reducing expenditures by a comparable amount, or some combination of the two measures.
Under the optimistic scenario, the Trust Fund has a positive actuarial balance, which indicates that income would cover program expenses over the next 75 years. By contrast, under the pessimistic scenario, the cost rate is almost three times the income rate over this time period. The vast differences in these projections illustrate the uncertainty of predicting future spending as well as the impact of economic and demographic conditions.
The actuarial balance deficit projected in this year's report (1.97) is substantially higher than the level projected in the Trustees' 2000 report (1.21% of taxable payroll). This difference is largely due to a revision in the Trustees' assumptions about long-range Medicare expenditure growth. In previous years, the Trustees assumed that, after 25 years, per beneficiary expenditures would grow at the same rate as average hourly earnings in the economy. Beginning this year, the Trustees assume that per beneficiary expenditures will increase by one percentage point above the rate of increase in per capita growth of Gross Domestic Product (GDP). This revision, recommended by an independent review panel of actuaries and economists convened by the Trustees, reflects a belief that advances in medical technology will contribute to increases in health care spending and in HI spending that exceed overall economic growth. (These assumptions also affect projections of SMI spending.)
In addition to rising costs, the ratio of workers paying payroll taxes to the number of beneficiaries enrolled will steadily decline as baby boomers become eligible for Medicare and life expectancy continues to increase. While there were 4.0 workers paying for each beneficiary's HI benefit in 2000, there will be only 2.3 workers per beneficiary in 2030, when all of the baby boomers will have reached age 65.
Top of PageIII. The Federal Supplementary Medical Insurance (SMI) Trust Fund—Medicare Part B
The Trustees of the SMI Trust Fund do not assess the Fund's financial health in the same manner as they do with the HI Trust Fund because of key differences in how the two Funds operate. Income to the SMI Trust Fund comes primarily from federal general revenues and beneficiary premiums. General revenues finance about 75 percent of program spending, while beneficiary premiums cover about 25 percent.7
Similar to Part A, SMI income and benefit payments are funneled through its Trust Fund. However, in the SMI Trust Fund, income from the federal government is adjusted each year to ensure that all expenses are covered. Therefore, by statute and its structure, the SMI Trust Fund can never be depleted, unlike the HI Trust Fund. Also, SMI income is estimated each year to match the expected program costs for the following year, so reserves in the SMI Trust Fund fluc-tuate, depending on the difference between estimated spending and actual experience.
The Trustees report that, in 2000, expenditures from the SMI Trust Fund were $90.7 billion. Federal general revenues financed approximately 73 percent of these expenditures, and premiums covered 23 percent. Interest and other miscellaneous income paid the remaining 4 percent. As of December 31, 2000, the balance of the SMI Trust Fund was $44.0 billion.
Short-Term and Long-Term Financial Status
The Trustees report that the SMI Trust Fund will remain adequately financed into the indefinite future because of the automatic yearly financing from the government. The Trustees' current projections of Part B expenditures over the next decade are slightly higher than previously forecasted partly as a result of provisions of the Medicare, Medicaid, and SCHIP Benefits Improvement and Protection Act of 2000 (BIPA). However, the Trustees note that BIPA's impact is mostly offset by lower outpatient hospital payments for 2000 than previously projected and lower medical inflation rates assumed in the future.
However, the Trustees express concern about the rate of growth of Part B spending. Between 1995 and 2000, expenditures increased by 37 percent, or about 1 percent faster than the economy as a whole (as measured by growth in the Gross Domestic Product, or GDP). In 2000, SMI benefit payments increased by 10 percent, a rapid increase largely due to the BBA and the Balanced Budget Refinement Act of 1999 (BBRA), which included new preventive care benefits under Part B, and a shift of some health costs from Part A to Part B that took place in 2000. The Trustees expect Part B expenditures to increase at about 7 percent annually through 2010 (see Figure 3), which is faster than the economy as a whole. In 2001, SMI expenditures are expected to grow by almost 15 percent, due in part to such BBA provisions as the transfer of some home health care costs from the HI program to the SMI program.
The Trustees also calculate Part B expenditures as a percentage of GDP to examine the potential impact on the economy.8 From 1966 through 2000, Part B expenditures were less than 1 percent of GDP. SMI expenditures are expected to increase to 2.2 percent of GDP within 30 years and to 3.8 percent by 2075. Such a trend means that Part B expenditures can be expected to consume growing shares of our country's productivity.9
The Trustees predict that Part B spending will grow rapidly over the next decade and beyond, in part, because of increases in the volume and intensity of services provided per beneficiary. After2010, the influx of baby boomers will also greatly influence the increase in spending.
Under the Trustees' more pessimistic assumptions, Part B spending would grow much more rapidly than GDP even beyond 2010. Under the Trustees' more optimistic assumptions, expenditures would grow faster than GDP for only a few years, then slow to about the same rate of increase as GDP.
Impact on Beneficiaries and on Taxpayers
Because spending is expected to grow faster than GDP, beneficiaries would see increases in premiums over time. The Trustees estimate that, in 2000, about 6 percent of a typical 65-year-old beneficiary's Social Security benefit was withheld to pay the monthly Medicare Part B premium of $45.50. In 20 years, under the intermediate assumptions, 11 percent of the same beneficiary's Social Security benefit would need to be withheld for premiums.
In fiscal year 2000, the federal general revenues required to cover Part B expenditures were equivalent to 5.4 percent of the personal and corporate income taxes collected. The Trustees project that, in 2070, if these taxes remain at their current level, the federal general revenues needed to finance SMI expenditures would equal about 22 percent of total income taxes.
IV. The Medicare HI and SMI Programs Combined
The Trustees report that it is important to examine the financial status of the Medicare program as a whole (i.e., both Part A and Part B), and to recognize the need for integrated solutions. The Trustees state that people often tend to focus primarily on the financial status of the HI Trust Fund and place less emphasis on the SMI Trust Fund, due in large part to the different means by which both programs are financed. The HI program is financed through statutory tax rates that can only be adjusted through legislation. By contrast, SMI general revenue financing and beneficiary premiums are reestablished annually to match the expected program costs for the following year. Because of these financing mechanisms, attention to spending growth and financing requirements of SMI tends to be muted.
Under current law, the Medicare program as a whole will consume greater shares of GDP in the future. In 2000, the Medicare program as a whole accounted for about 2.24 percent of GDP. The Trustees project that the HI and SMI programs combined will increase to about 5 percent of GDP by 2035 and to 8.49 percent of GDP by 2075. The Trustees acknowledge, however, that projecting forward so far into the future is difficult.
V. Trustees' Conclusions
The short-term outlook of the HI Trust Fund has improved significantly since the 2000 report. The Trust Fund surpluses forecast over the next several years result from a favorable economic climate and Medicare's success in holding down increases in outlays. However, the Trustees note that the Fund's long-term financial status remains problematic. Furthermore, if these conditions change, deficits could return sooner than projected.
By design, the SMI Trust Fund is financially solvent into the indefinite future. However, the Trustees remain concerned about the growth rate of SMI spending, which continues to increase faster than GDP.
The Trustees urge policymakers to use the time gained by the later depletion of the HI Trust Fund productively to solve the Fund's long-term problems. They also recommend that policymakers explore effective means of controlling SMI spending and address the financial impact of the impending retirement of the baby boom generation.
The Trustees find the recent and widespread interest of policymakers in Medicare's financial status encouraging. They also recognize that the nation's health care system is changing rapidly, and note that information on the quality and cost of alternative modes of treatment and service delivery should contribute to better legislative decisions regarding Medicare's long-range financial outlook. They urge policymakers to take timely and effective action in both Parts A and B to build upon the strong steps taken in recent reforms.
Footnotes
1 Medicare Part A covers up to 100
home health visits following a hospital stay of at least three
days.
2 Part B covers visits not preceded by
a hospital stay and visits over the 100-day Part A
limit.
3 Unless otherwise noted, all figures
are calendar year estimates.
4 In 2000, payroll taxes made up 86
percent of the HI Trust Fund's income. Additional sources
of income include interest on federal securities, taxation of
a portion of Social Security benefits, premiums paid by
voluntary enrollees, and government credits.
5The BBA reduced payments to
hospitals, established new payment methodologies for home
health agencies and skilled nursing facilities, and shifted
certain home health costs from Part A to Part B. The BBA did
not enact measures to increase income to the Trust Fund.
6 The actuarial balance is adjusted to
include the beginning fund balance and the cost of ending the
projection period with a fund balance equal to estimated
spending for the following year.
7 The premium rates between 1998 and
2003 will cover less than 25 percent of actual program costs,
as a result of the gradual phase-in of the transfer of some
home health costs from Part A to Part B.
8 Includes benefit payments and
administrative expenses.
9 SMI expenditures as a share of GDP
in 2075 are much higher than projected in the 2000 report
because of a revision in the long-term Medicare growth rate
assumptions. Previously, the Trustees assumed that, after 25
years, per beneficiary Part B spending would grow at the rate
of GDP. The Trustees now assume that per beneficiary
expenditures will grow at the rate of GDP plus 1 percentage
point.
Source
2001 Annual Reports of the Board of Trustees of the Federal Hospital Insurance (HI) Trust Fund and of the Supplementary Medical Insurance (SMI) Trust Fund, March 19, 2001.
Written by Craig Caplan and David Gross, AARP Public Policy
Institute
March 2001
©2001 AARP
May be copied only for noncommercial purposes and with
attribution; permission required for all other purposes.
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