Order Code RL31058
CRS Report for Congress
Received through the CRS Web
Medicare Structural Reform:
Background and Options
July 24, 2001
Jennifer O’Sullivan, Hinda Ripps Chaikind, and Sibyl Tilson
Specialists in Social Legislation
Domestic Social Policy Division
Congressional Research Service ˜ The Library of Congress

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Medicare Structural Reform: Background and Options
Summary
Medicare is a nationwide health insurance program for the aged and certain
disabled persons. Over its nearly 35-year history, it has provided important
protections for millions of Americans. However, the program is facing a number of
problems. One concern is that Medicare’s financing mechanisms will be unable to
sustain it in the long run. Many are also concerned that the program’s structure,
which in large measure reflects both the health care delivery system as well as political
considerations in effect at the time of enactment, has failed to keep pace with the
changes in the health care system as a whole.
The major problems facing Medicare, and possible solutions to these problems,
have been debated for a number of years. Some persons suggest that major structural
reforms are required. However, others contend that the existing system should be
improved rather than replaced. To date, no consensus has been reached. In recent
years, the major focus has been on providing prescription drug coverage for
beneficiaries. Some observers state that it would be inappropriate to add a new costly
benefit before structural reforms are enacted. Other observers state that seniors,
particularly low-income seniors, should not be required to wait for benefits until
resolution of the entire restructuring issue.
The 107th Congress is expected to consider a variety of Medicare reform
proposals. Some changes could be made while still retaining Medicare’s current
structure. Examples include increasing the program’s eligibility age, introducing
means testing, increasing beneficiary cost-sharing, and introducing innovations into
the current fee-for-service program. Other changes could only be made in the context
of major program restructuring. Proposals which have been suggested include
modernizing the benefit structure and combining the Part A and Part B programs.
Also receiving attention is a premium support model under which beneficiaries would
be entitled to a specified level of financial support toward the costs of Medicare
covered services. Many of the proposals could be combined as part of an overall
reform package.
The 107th Congress is likely to consider Medicare reform issues and prescription
drug coverage. It is also likely to review the operations of the agency that administers
Medicare and could consider restructuring that agency. In June 2001, the name of the
administering agency, the Health Care Financing Administration (HCFA), was
changed to the Centers for Medicare and Medicaid Services (CMS) and reorganized
through administrative action. The FY2002 budget resolution allows for up to $300
billion over the FY2003-FY2011 period for a reserve fund for Medicare reform and
prescription drugs. This report will be revised to reflect any major changes in the
focus of the debate.

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Contents
Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Medicare and the Federal Budget . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Medicare Financing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Solvency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Current Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Benefit Structure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Coverage Gaps . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Interaction With Other Coverage . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Low-Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Benefit Design . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Beneficiary Perceptions and Concerns . . . . . . . . . . . . . . . . . . . . . . . . 3
Program Administration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Current Reform Discussion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Background on the Medicare Program . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Coverage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Covered Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Payments for Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Medicare+Choice . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Administration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Supplementary Coverage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Beneficiary Characteristics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Beneficiary Incomes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Beneficiary Spending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Medicare Financing: Background and Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Financing Part A and Part B . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Financial Status of Part A and Part B . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Part A Projections . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Current Projections . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Demographic Considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Who Pays for Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Medicare and the Federal Budget . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Current Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
HI “Surplus” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Budget Resolution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Status of Program as a Whole . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Other Major Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Response to Changes in the Health Care Delivery System . . . . . . . . . . . . 14
Medicare Benefits Package . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Role of Supplemental Coverage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Managed Care Plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Employer-Based Coverage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Medigap . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Medicaid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

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Protections for Low-Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
Impact of Demographic and Other Changes . . . . . . . . . . . . . . . . . . . . . . . 20
Reform Options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
Increasing the Program’s Eligibility Age From 65 to 67 . . . . . . . . . . . . . . 20
Means Testing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
Modifications in Beneficiary Cost-Sharing . . . . . . . . . . . . . . . . . . . . . . . . 24
Redesign the Medicare Benefit Package . . . . . . . . . . . . . . . . . . . . . . . . . . 25
Medigap Modifications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
Fee-for-Service (FFS) Modernizations . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Combine Part A and Part B . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
Premium Support . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
Derivation of Premium Support . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
Evolution of Premium Support . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
Current Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33
CMS Restructuring . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
Prospects for the 107th Congress . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36
List of Tables
Table 1. Proposed Eligibility Age by Year of Birth . . . . . . . . . . . . . . . . . . . . . 21

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Medicare Structural Reform:
Background and Options
Overview
Medicare is a nationwide health insurance program for the aged and certain
disabled persons. Over its nearly 35-year history, it has provided important
protections for millions of Americans. However, the program is facing a number of
problems. One concern is that Medicare’s financing mechanism will be unable to
sustain it in the long run. Many are also concerned that the program’s structure,
which in large measure reflects both the health care delivery system as well as political
considerations in effect at the time of enactment, has failed to keep pace with the
changes in the health care system as a whole. A related concern is whether the
program’s benefit structure adequately responds to the health care needs of today’s
aged and disabled populations.
A number of observers have stated that the program is now at a critical juncture.
Some persons suggest that major structural reforms are required. However, others
contend that the existing system should be improved rather than revamped. The
following is a brief overview of the major issues underlying the debate. These issues
are discussed in more detail in subsequent sections of the report.
Medicare and the Federal Budget
Medicare is the nation’s second largest social welfare program, exceeded only
by Social Security. It is an open-ended entitlement program that provides coverage
for a defined package of services. Medicare is a mandatory spending program; it
pays for as many covered medical services as the eligible population uses. As a result,
it is difficult to control overall program spending.
Medicare is a key concern for policymakers, not only because of its role in
financing health care for the elderly, but also because it represents a major spending
item in the federal budget. Net program outlays (after deduction of beneficiary
premiums) will represent an estimated 11.7% of total federal outlays ($217.7 billion)
in FY 2001and are expected to reach 17.1% of total federal outlays ($436.7 billion)
by 2011.
Medicare Financing
Solvency. Medicare is actually two programs – Medicare Part A and Medicare
Part B. Each program has a different financing mechanism. Medicare Part A is
primarily financed by current workers and their employers through a payroll tax.

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Medicare Part B (Supplementary Medical Insurance (SMI)) is financed by a
combination of monthly premiums levied on current beneficiaries and federal general
revenues (tax dollars).
Because of its financing mechanism, Part A has been subject to considerable
scrutiny. Almost from its beginning, the program has faced a projected shortfall. At
the present time, income to the Part A Hospital Insurance (HI) trust fund exceeds
benefit payments and administrative costs. However, this situation is slated to
reverse in the future with outgo exceeding income. At some point, the assets in the
program will be insufficient to pay benefits. Under current projections, the first year
that outgo will exceed income (excluding interest) is 2016 and the year the program
will become insolvent is 2029. These dates represent a significant improvement over
projections made only a few years earlier and reflect the impact of legislative changes
which had the effect of restraining the growth in Part A spending. Despite the short
term improvements, the long range deficit is significant. The long-range projections
reflect a number of factors including an increase in medical care costs, the increase in
size of the Medicare population with the retirement of the baby boomers, and a
reduction in the ratio of workers paying the payroll tax (which finances the Part A
program) to beneficiaries receiving benefits.
Many observers contend that it is no longer appropriate to view the Part A and
Part B programs separately. Part B does not face exhaustion because of the way it
is financed. However, projected spending growth in both programs is viewed as
unsustainable over time. Many persons suggest that a comprehensive approach is
required both to address the program’s financing issues and to bring the program’s
benefit structure into the 21st century.
Current Issues. Beginning this year, considerable attention has been focused
on the Medicare Part A “surplus.” As noted, income to the HI trust fund during a
year currently exceeds outgo during the year. Some persons have labeled the
difference between HI income and outgo as a “surplus.” Any excess in a year is
treated as part of the overall “on budget” surplus (unlike the Social Security surplus
which is off budget). Some persons are concerned that the temporary Medicare
surplus will be used either for other government spending or to finance a new drug
benefit, thereby shortening the time before the program becomes insolvent. However,
others suggest that using the “surplus” for the Medicare population, for example to
finance a new drug benefit, would be appropriate.
Benefit Structure
Medicare’s benefit design has remained relatively unchanged since enactment of
the program in 1966. Many persons view this time as an opportunity to reexamine
the structure as well as the financing of the program. Several key components of the
current system are being reexamined.
Coverage Gaps. While Medicare provides broad protection against the costs
of many, primarily acute care, services, it only covers about one-half of beneficiaries’
total health care bill. The program includes significant cost-sharing charges for most
covered services, provides only limited protection for some other services (such as
prescription drugs and nursing home care) and includes no protection against the

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costs of some other services (such as hearing aids). Further, the program includes no
upper limit (“catastrophic limit”) on cost-sharing charges.
Interaction With Other Coverage. Most individuals have some coverage
in addition to basic Medicare benefits. Many observers have suggested that when
reviewing Medicare’s coverage, it is important to understand the interaction of this
supplementary coverage with Medicare. This is not an easy task, since there is wide
variation among plans in the services covered and total costs to beneficiaries. Further,
there are indications that the scope of supplementary coverage available to some
persons may be eroding.
Low-Income. Of particular concern to policymakers is the impact of out-of-
pocket health spending on low-income persons without supplementary insurance
protection. This population group is generally viewed as being the most at risk for
health costs not covered by Medicare.
Benefit Design. Currently Medicare guarantees beneficiaries coverage for a
defined set of benefits. Some observers have suggested that the concept of a defined
package of Medicare benefits should be reexamined. They suggest that the program
should use a defined contribution model under which the federal government would
guarantee a defined payment per beneficiary. A variation on this approach is known
as the premium support model. Under premium support, payment would be made to
private health care plans for a portion of the premiums charged by the plans for
covered Medicare benefits.
Beneficiary Perceptions and Concerns. Medicare provides millions of
senior citizens with significant protection against the costs of their health care.
Beneficiaries value the program and register strong opposition when policymakers
suggest reducing the benefits or increasing the program’s premiums or cost-sharing
charges. The ability of seniors to shoulder additional costs is of concern, particularly
in light of the fact that most beneficiaries have relatively modest incomes. For
example, 60% of the aged population had incomes below $20,000 in 1998.
Program Administration
For some time, observers have expressed concern over the way in which
Medicare has been administered. Some persons feel that the Centers for Medicare
and Medicaid Services (CMS), formerly the Health Care Financing Administration
(HCFA), has not been provided with sufficient resources, both staff and funding, or
management flexibility to enable it to carry out its ever increasing responsibilities.
Others believe it is time to restructure Medicare’s administrative entity – either by
separating Medicare administration from the oversight of Medicaid and other state-
based health programs or, alternatively, creating a separate entity to administer
Medicare’s managed care program and any new prescription drug benefit. This last
view may have been partially addressed by the recent administrative reorganization
of HCFA into CMS with its three divisions: the Center for Medicare Management
which will be responsible for Medicare’s fee-for-service program; the Center for
Beneficiary Services which will be responsible for beneficiary education, the Medicare
+Choice program, demonstration projects, and grievance and appeals; and the Center

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for Medicaid and State Operations which be responsible for programs administered
by the states.

Current Reform Discussion
The major problems facing Medicare, and possible solutions to these problems,
have been debated for a number of years. However, to date, no consensus has been
reached. In recent years, the major focus has been on providing prescription drug
coverage for beneficiaries. However, some observers have suggested that it would
be inappropriate to add a new costly benefit before the financial soundness of the
basic program is assured. They also suggest that drug coverage should not be added
until the whole benefit structure is reexamined. Other observers have stated that
seniors, particularly low-income seniors, need a drug benefit. They contend that these
persons should not be required to wait for drug benefits until resolution of the entire
restructuring issue. Further, some of these persons argue that while the program
needs improvements, major structural reforms are not required.
A number of these concerns were considered by the National Bipartisan
Commission on the Future of Medicare (hereinafter referred to as the Medicare
Commission). This Commission, established by the Balanced Budget Act of 1997
(BBA 97, P.L. 105-33), was to develop recommendations concerning a number of
program issues. The recommendations were to be submitted to the Congress by
March 1, 1999. The Commission failed to get the required 11 of 17 Commissioners’
votes for a reform proposal. However, the “Breaux-Thomas proposal” (named after
Senator Breaux and Congressman Thomas, the two chairmen of the Commission)
gained 10 votes. This plan, which was based on the premium support model, served
as the basis for subsequent discussion of the issues. A modification of this proposal
was introduced in the 106th Congress (S.1895); this was known as “Breaux-Frist
1"(after Senators Breaux and Frist). A revised version, which focused primarily on
drug coverage and some managed care reforms, was also introduced several months
later (S.2807); this was known as “Breaux-Frist 2" Slightly revised versions of these
bills have been introduced in the 107th Congress (S.357, the Medicare Preservation
and Improvement Act of 2001, and S.358, the Medicare Prescription Drug and
Modernization Act of 2001). They are also referred to as “Breaux-Frist 1" and
“Breaux-Frist 2." Many persons have suggested that these measures will serve as the
starting point for the discussion of Medicare reform in the 107th Congress.
The FY2002 budget resolution allows for up to $300 billion over the FY2003-
2011 period for a reserve fund for Medicare reform and prescription drugs. The
Committees of jurisdiction (House Ways and Means, House Commerce, and Senate
Finance) are expected to markup bills this summer or fall. At this writing, it is difficult
to predict what specific actions the Congress will take.

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Background on the Medicare Program
Medicare is a nationwide health insurance program. In FY2001, the program
will cover an estimated 34.3 million aged persons and an additional 5.6 million
disabled individuals. CBO estimates total program outlays in FY2001 at $241.3
billion; net Medicare outlays (after deduction of beneficiary premiums) are estimated
at $217.7 billion. Medicare actually consists of two distinct parts — Part A ( HI) and
Part B (Supplementary Medical Insurance, SMI).
Coverage
Medicare is not a means tested program; that is, there are no income or assets
tests for coverage. Almost all persons over age 65 are automatically entitled to
Medicare Part A. Part A also provides coverage, after a 24-month waiting period, for
persons under age 65 receiving social security cash benefits on the basis of disability.
Most persons who need a kidney transplant or renal dialysis are also covered,
regardless of age.
Medicare Part B is voluntary. All persons over 65 and all those enrolled in Part
A may enroll in Part B by paying a monthly premium ($50 in 2001). Most persons
eligible to enroll in Part B do so.
Benefits
Covered Services. The Part A program covers the following services:
! Inpatient Hospital Services – Days 1-60 in a benefit period1 are subject to a
deductible ($792 in 2001). Days 61-90 in a benefit period are subject to a
daily coinsurance charge ($198 in 2001). Beneficiaries have 60 lifetime reserve
days which may be drawn upon for stays in excess of 90 days; these lifetime
reserve days are subject to a daily coinsurance charge ($396 in 2001).
! Skilled Nursing Facility (SNF) Services – Up to 100 days post-hospital care
in a benefit period. Days 21-100 are subject to a daily coinsurance charge ($99
in 2001)
! Home Health Care – No cost-sharing is required
! Hospice Care (home care services for the terminally ill). Nominal copayments
are charged for outpatient prescription drugs and respite care.
Part B covers physicians services, laboratory services, durable medical
equipment, other medical services, as well as a portion of home health expenses. In
general, beneficiaries are liable for a $100 deductible. The program then pays 80%
of Medicare’s recognized payment amount, while the beneficiary is liable for the
remaining 20%. Beneficiary cost sharing does not apply to clinical laboratory services
and home health care .
1A benefit period begins when a person enters a hospital or skilled nursing facility and ends
when the individual has not received hospital or skilled nursing care for 60 days in a row. An
individual can have an unlimited number of benefit periods.

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Payments for Services. Under “traditional” or “fee-for-service” (FFS)
Medicare, beneficiaries obtain services from providers of their choice. Medicare’s
payment policies determine the amounts that providers will be paid for covered
services and supplies used by the beneficiaries. These payment policies have moved
away from paying fees for each service rendered and basing this reimbursement on
allowable costs or allowable charges. Instead, Medicare uses different rate setting
methods for each provider type or category of service to determine payment amounts.
Depending upon the setting, services can be bundled together; most payment amounts
are predetermined in that they are set in advance; many are subject to certain limits;
some are still partially determined by a provider’s incurred costs. Medicare’s current
payment policies are myriad, complex, and often affected by past reimbursement
practices. Simply put, Medicare does not negotiate prices or solicit bids to set
competitively determined payments.
In general, Medicare uses either prospective payment systems or fee schedules
to establish specific predetermined payment amounts for each type of patient seen or
each unit of service provided. Medicare adjusts these predetermined payments to
account for factors, such as practice location or cost of living differences, that affect
costs but cannot be controlled by the individual provider or supplier.
Under a prospective payment system (PPS), Medicare bases reimbursement on
the average costs associated with an episode of care, regardless of the scope, type,
and level of services provided to an individual patient. Medicare adopted the first
PPS for inpatient hospital services in the early 1980s. In this PPS, hospitals are paid
a standard amount or average cost for each discharge adjusted for a patient’s
diagnosis (specifically, a patient’s diagnosis related group or DRG) as well as the
hospitals’ geographic location, extent of physicians’ training programs, and amount
of care provided to low-income patients (as a disproportionate share hospital). Most
recently, Medicare has established prospective payment systems for skilled nursing
facility services (SNF) services, home health services and hospital outpatient services.
The specifics of these payment policies, including the unit of payment and patient
classification system that establishes the episode of care, vary by provider.
Medicare pays for a number of services under Part B using a fee schedule,
including physician and laboratory services as well as durable medical equipment.
Again the payments are determined in advance. However, the unit of payment tends
to be narrower than the services that are bundled together and used as the basis of
reimbursement in many of Medicare’s prospective payment systems. For example,
under the physician fee schedule, a payment is made for each service provided during
the office visit. In most cases, a physician can bill for more than one service provided
during that office visit. The examples where services are bundled together and
covered under one payment, such as a global fee which covers all physician services
provided for a surgical procedure, are few.
Medicare+Choice. Since the early 1980s, Medicare beneficiaries have been
able to enroll in health maintenance organizations (HMOs). Beneficiaries get all of
their Medicare services through the HMO. The HMO agrees to assume the risk for
paying for covered services; in return, Medicare makes a predetermined monthly
payment to the plan for each enrollee. This capitated payment is fixed and does not
vary by the amount of resources used.

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The Balanced Budget Act of 1997 (BBA 97, P.L.105-33) established the
Medicare+Choice program. This program, which became effective January 1, 1999,
expanded the types of managed care arrangements that could potentially serve
Medicare beneficiaries to include, among others, preferred provider organizations, and
provider sponsored organizations. However, HMOs remain the primary managed
care arrangement available to them. Approximately 14% of the Medicare population
obtains services through Medicare+Choice plans.
Traditionally, Medicare payments to HMOs varied considerably throughout the
country. In areas where payment rates were high (for example, Southern Florida),
HMOs were typically able (and were often required) to offer services in addition to
those covered under the basic Medicare program. Of particular importance was the
ability of a number of plans to offer prescription drug coverage at little or no
additional cost to beneficiaries. Conversely, in lower payment areas (for example
Minneapolis-St.Paul metro area), plans typically did not offer a similar scope of
additional benefits. If they did cover extra benefits, they charged the beneficiary a
premium (which was in addition to the Part B premium which all enrollees are
required to pay).
BBA 97 significantly modified the payment methodology beginning January 1,
1998. The changes were designed to reduce the wide variation in payments and the
year-to-year volatility that resulted from the old payment rules, especially in less
populated counties. As a result, capitation payments in many previously high payment
areas are seeing relatively small year-to-year increases. The managed care industry has
argued that the changes in payment policies have resulted in inadequate
reimbursement rates. However, reviews by both the General Accounting Office
(GAO)2 and the Inspector General of the Department of Health and Human Services
(HHS)3 suggest that the payments are still adequate to cover the costs of Medicare
covered benefits. In many cases, the issue is whether plans can continue to offer a
range of extra services at relatively low cost to beneficiaries. Many plans question
whether they can continue to be competitive if they drop prescription drug coverage
or, alternatively, institute significant cost-sharing requirements for the coverage.
These concerns, coupled with other business considerations, led a number of
Medicare+Choice organizations to reduce their service areas or pull out of the
program entirely.4 In response to these concerns, the Balanced Budget Refinement
Act of 1999 (BBRA 99, P.L.106-113) and the Medicare, Medicaid, and SCHIP
Benefits Improvement Protection Act of 2000 (BIPA, P.L.106-554) included
provisions designed to encourage organizations to participate in the Medicare+Choice
program.
2U.S. General Accounting Office. Medicare+Choice: Plan Withdrawals Indicate Difficulty
of Providing Choice While Achieving Savings. GAO/HEHS-00-183. September 2000.
3U.S. Department of Health and Human Services. Office of Inspector General. Adequacy
of Medicare’s Managed Care Payments After the Balanced Budget Act of 1997.
Memorandum to HCFA Administrator, A-14-00-00212. September 18, 2000.
4For a further discussion of M+C see CRS Report RL30702, Medicare+Choice, by Hinda
Ripps Chaikind and Madeleine Smith.

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CRS-8
Administration
Since 1977, Medicare has been administered by HCFA, now the Centers for
Medicare and Medicaid Services (CMS), of the HHS. CMS is also responsible for
administering Medicaid, the State Children’s Health Insurance program, and the
Clinical Laboratory Improvement Act and performing other survey and certification
and insurance oversight functions, including enforcement of the Health Insurance
Portability and Accountability Act (HIPPA). To perform these duties, CMS has
about 4,500 full time employees, about 65% of whom work in the agency’s
headquarters offices in Baltimore, MD, and Washington, DC, with the remainder
working in the agency’s 10 regional offices around the country. In addition to the
agency’s federal workforce, CMS oversees about 50 claims processing contractors
(generally private insurance companies) who employ an estimated 21,500 people to
evaluate and pay Medicare claims. Other private and public sector employees – those
who work for peer review organizations (PROs) that determine the appropriateness
of care in hospitals and other settings, private sector accrediting agencies (such as the
Joint Commission on Accreditation of Healthcare Organizations or JCAHO), or state
agencies – also perform review, inspection, and evaluation functions to support the
Medicare program.
Supplementary Coverage
Most beneficiaries depend on some form of private or public coverage to
supplement their Medicare coverage. In 1998, only about 6.8% of community-based
(i.e., non-institutionalized) beneficiaries relied solely on the traditional fee-for-service
Medicare program for protection against the costs of care; an additional 16.5% were
enrolled in managed care organizations.5 (The proportion enrolled in managed care
has since dropped to 14%.)
The majority of the community-based Medicare population (59.7% in 1998) have
private supplemental coverage. This private insurance protection may be obtained
through a current or former employer (36.1% had such coverage in 1998). It may
also be obtained through an individually-purchased policy, commonly referred to as
a “Medigap” policy (23.6% had these plans in 1998). In addition, a smaller
percentage (about 13.2% in 1998) have coverage under Medicaid, the means tested
federal-state health insurance program for the poor or persons who become poor after
incurring large medical expenses. A small group (3.8% in 1998) have supplemental
coverage from one of a variety of other sources (such as state-sponsored pharmacy
assistance programs or through the Veterans Administration).6
5Data are from the 1998 Medicare Current Beneficiary Survey (MCBS). Beneficiaries were
classified by their primary health insurance and were counted in only one of the following
categories (in hierarchical order for beneficiaries with more than one type): Medicare HMO,
Medicaid, employer-sponsored plan, Medigap, other public, and fee-for-service only. Poisal,
John and Lauren Murray. Growing Differences Between Medicare Beneficiaries With and
Without Drug Coverage. Health Affairs, v.20, no.2, March/April 2001.
6Ibid.

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CRS-9
Beneficiary Characteristics
Beneficiary Incomes. Most beneficiaries have relatively low incomes. In
1998, 23.2% of elderly households had incomes below $10,000, 59.9% below
$20,000, and 86.2% below $40,000. Of the 13.8% of those with incomes of $40,000
or above, only 4.0% had incomes of $70,000 or above.7
Despite the relatively low average income levels, there has been a significant
improvement in the poverty rate for the elderly. In 1970, 24.6% of the elderly
population had incomes below poverty; in 1998 the figure had declined to 10.5%.
However, the rate for children climbed slightly over the period (from 15.0% to
18.3%) and is now considerably above that for the elderly.8 These findings have
raised questions regarding the appropriate use of limited resources available to assist
persons across all age groups.
Beneficiary Spending. Most beneficiaries pay out-of-pocket for a portion
of their health care expenses. These payments vary not only by the total level of an
individual’s health care expenses, but also by whether or not the individual has
supplementary coverage and what type of supplementary coverage the individual has.
Several studies have examined the level of out-of-pocket expenses and the
relationship of these expenses to income. An analysis by researchers at the Urban
Institute estimated that elderly beneficiaries would spend, on average, $3,142 out-of-
pocket for their health care in 2000. Of this amount, 20.9% was for Medicare cost-
sharing charges, 20.5% for the Part B premium, 30.3% for non-Medicare services and
28.3% for premiums for supplemental health insurance. The authors estimated that
out-of-pocket spending represented 21.7% of income for elderly beneficiaries; the
percentage was significantly higher for those in poor health with no insurance (44.0%)
and for older low-income single women in poor health (51.6%). The authors further
projected that out-of pocket spending would increase rapidly over the following
decade, in part because of the high growth rate for drug spending.9
Medicare Financing: Background and Issues
Financing Part A and Part B
The financing mechanisms for Part A and Part B are completely different. Part
A is primarily financed by current workers and their employers through a payroll tax.
Each pays a payroll tax of 1.45% on earnings. The self-employed pay 2.9%. Unlike
Social Security (which in 2001 has a taxable earnings base of $80,400), there is no
7DHHS, HCFA, Medicare: A Profile; Medicare 2000: 35 Years of Improving Americans’
Health and Security, July 2000.
8U.S. Social Security Administration. Annual Statistical Supplement, 2000.
9Maxwell, Stephanie, Marilyn Moon, and Misha Segal. Growth in Medicare and Out-of-
Pocket Spending: Impact on Vulnerable Beneficiaries. Commonwealth Fund, Urban
Institute. January 2001.

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CRS-10
upper limit on the amount of earnings subject to the tax. Part B is financed by a
combination of monthly premiums levied on current program beneficiaries and
federal general revenues. In 2001, the monthly premium is $50.00. By law,
beneficiary premiums equal 25% of Part B costs; federal general revenues (i.e., tax
dollars) account for the remaining 75%.
Financial operations for Part A are accounted for through the Health Insurance
(HI) trust fund while those for Part B are accounted for through the Supplementary
Medical Insurance (SMI) trust fund. Both funds are maintained by the Department
of the Treasury.10 Each fund is overseen by a Board of Trustees who makes annual
reports to Congress concerning their financial status.
Financial Status of Part A and Part B
Almost from its inception, the HI trust fund has faced a projected shortfall.
When observers refer to the impending insolvency of Medicare they are actually
referring to the pending insolvency of the HI trust fund. The SMI trust fund does not
face exhaustion because of the way it is financed. However, the SMI trustees
continue to voice concern about the rapid growth in Part B program costs.
Part A Projections. The Board of Trustees projected insolvency for the HI
fund beginning with the 1970 report (which was less than 4 years after the program
went into effect). The insolvency date was postponed a number of times, primarily
due to legislative changes which had the effect of restraining the growth in program
spending. The lower growth rates were achieved largely through reductions in
payments to providers, primarily hospitals and physicians. Generally, these measures
were part of larger budget reconciliation laws which attempted to restrain overall
federal spending.
Efforts to curtail program spending intensified as Congress considered legislation
to bring the entire federal budget into balance and culminated in the passage of BBA
97.11 This legislation achieved significant savings in Medicare and extended the
solvency of the Part A trust fund. The legislation achieved these savings by again
slowing the rate of growth in payments to providers and by establishing new payment
methodologies for certain service categories. BBA 97 also provided for the transfer
of some home health spending from Part A to Part B. While the actual transfer from
Part A did not reduce overall program spending, it did reduce Part A spending and
thus delayed the Part A projected insolvency date.
A number of observers contended that the savings achieved through the
enactment of BBA 97 were greater than intended at the time of enactment and had
unintended consequences for health care providers. As a result of these concerns,
10The trust funds are an accounting mechanism; there is no actual transfer of money into and
out of the fund.
11For a history and summary of BBA 97 see CRS Report 97-802, Medicare Provisions of
the Balanced Budget Act of 1997 (BBA 97, P.L. 105-33), by Jennifer O’Sullivan, Celinda
Franco, Beth Fuchs, Bob Lyke, and Richard Price.

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CRS-11
Congress subsequently enacted BBRA 99 and BIPA 2000. These measures were
designed to restore some of the BBA 97 spending reductions.12
Current Projections. In early 1997, the trustees projected that the Part A
fund would become insolvent in 2001. Following enactment of BBA 97, significant
improvements were recorded in the short-term projections. These new projections
reflect a number of factors including BBA 97 and strong economic growth. Despite
enactment of both BBRA 99 and BIPA 2000, which increased program spending, the
trustees have continued to delay the projected insolvency date. Most recently, the
2001 report projects that the program will remain solvent until 2029, 4 years later
than projected in the 2000 report.
While short-term estimates have improved, the deficit is greater than previously
thought for the long-range projection period. In large measure, this is attributable to
a revision in the assumptions used to calculate expenditure growth. Specifically, the
2001 report projects a higher growth rate in medical care expenditures than had been
used in earlier reports.
The trustees state that to bring Part A into financial solvency over 75 years
(CY2001-CY2075), either outlays would have to be reduced by 37% or total income
increased by 60% (or some combination thereof) throughout the 75-year period. As
noted, the primary income source for Part A is payroll taxes. Many observers oppose
any increase in payroll taxes to support the program. They feel that current taxes
already represent a considerable drain on the incomes of many middle class workers.
They also suggest that merely increasing taxes would not address the program’s
inherent inefficiencies, including the inability of the program to constrain cost growth.
Demographic Considerations
The financing problems facing Medicare are expected to be magnified starting
in 2011 when the program will begin to experience the impact of major demographic
changes. First, baby boomers (those born between 1946 and 1964) begin turning age
65. Second, there is a shift in the number of workers paying the Medicare payroll tax
and supporting those persons receiving benefits under Part A. Currently, there are
approximately 4.0 workers per beneficiary; in 2010 there will be 3.7. By 2030 the
ratio will have declined to 2.3.
12For a discussion of the BBRA and BIPA legislation as well as the Medicare cost estimates
made subsequent to enactment of BBA 97, see: 1) CRS Report RS20484, Trends in
Medicare Spending: Fact Sheet, by Hinda Ripps Chaikind; 2) CRS Report RL30860,
Medicare Provisions in the Balanced Budget Refinement Act of 1999 (P.L.106-113), by
Carolyn Merck, Jennifer O’Sullivan, Madeleine Smith, and Sibyl Tilson; and 3) CRS Report
RL30707, Medicare Provisions in the Medicare, Medicaid, and SCHIP Benefits
Improvement and Protection Act of 2000 (BIPA, P.L.106-554) by Hinda Ripps Chaikind,
Sibyl Tilson, Jennifer O’Sullivan, Carolyn Merck, and Madeleine Smith.

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CRS-12
Who Pays for Benefits
Another series of issues relates to who is, or should be, paying for covered
benefits. Many beneficiaries feel that the combination of the payroll tax they paid
during their working careers coupled with their Part B premiums represents full
payment for their Medicare benefits. Various studies have shown that this is not the
case. Most persons on Medicare today receive considerably more in Medicare
benefits over their lifetimes than they pay in; this trend is expected to continue into
future years for low and average wage earners; however, over time, high wage earners
are expected to pay more into the system than they get back.
Under the current system, current workers pay a payroll tax to cover benefits for
current Part A beneficiaries. Current workers also pay the majority of Part B costs
since the federal government (i.e., current taxpayers) funds 75% of the costs of that
program. These financing mechanisms have raised intergenerational equity issues.
Many younger persons recognize that the program provides significant help to their
parents and grandparents and has relieved them of some potential health-care
expenses for family members. However, some younger individuals contend that they
should not be required to assume a major portion of the costs for older populations.
Many of these same individuals question whether Medicare will be there when they
retire.
Medicare and the Federal Budget
Medicare is a key concern for policymakers, not only because of its role in
financing health care for the elderly, but also because it represents a major spending
item in the federal budget. The Congressional Budget Office (CBO) estimates total
Medicare outlays for FY2001 at $241.3 billion; net outlays (after deduction of
beneficiary premiums) are estimated at $217.7 billion. Net outlays represent an
estimated 11.7% of total federal outlays in FY2001. CBO estimates the percentage
will rise to 17.1% of total federal outlays by 2011. CBO further estimates that total
Medicare spending will represent 2.3% of the gross domestic product (GDP) in 2001,
rising to 2.9% in 2011.13
Current Issues
HI “Surplus”. In general, income to the Hospital Insurance Trust fund during
a year exceeds outgo during the year.14 Under current projections, the first year that
outgo will exceed income, excluding interest, is 2016. The first year that outgo will
exceed income, including interest, is 2021. Some persons have labeled the difference
between HI income and outgo as a “surplus.” The trustees estimate that the total
surplus would be $435 billion over the FY 2002-FY 2010 period. CBO estimates the
surplus at $358.3 for the same period.
13Congressional Budget Office. The Budget and Economic Outlook: Fiscal Years 2002-
2011, January 2001, and accompanying Medicare tables.
14Outgo exceeded income in 1995, 1996, and 1997.

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CRS-13
Any excess in a year is treated as part of the overall “on-budget” surplus (unlike
the Social Security surplus which is off budget). Many persons are concerned that the
temporary Medicare surplus would be used for other government spending rather than
debt reduction. To counter this, some Members have recommended that the
Medicare funds be placed in a “lockbox.” Under a lockbox proposal, a point of order
could be raised on the House or Senate floor against any tax or spending legislation
in a year that would reduce the on-budget surplus to less than the HI surplus receipts
in that year.15
Budget Resolution. The Conference report on the Concurrent Resolution
on the Budget for FY2002 (H.Con.Res. 83) passed the House on May 9, 2001 and
the Senate on May 10, 2001. Section 211 contains language relating to a Medicare
Reserve Fund. Under the provision, the Chairman of the House or Senate Budget
Committee could increase the spending levels in the resolution to pay for Medicare
reform and prescription drug coverage. This could occur if a bill containing such
provisions is reported by a committee or if a conference report containing such
provisions is filed. The amount allowed under the resolution is $59.1 billion over the
period FY2003–FY2006 and $300 billion over the period FY2003–FY 2011 period.16
The Conference report on this provision states:
The Conferees note that it would be appropriate for the cost of such legislation
(but no other legislation ) to be funded in whole or in part from the surpluses of the
Hospital Insurance Trust Fund.
The Conference report on H.Con.Res. 83 also contains additional language
relating to the Part A trust fund surpluses. One provision applies in the Senate only
and one in the House only. The Senate provision, Section 217, establishes a reserve
fund for defense. The House provision, Section 218, establishes a strategic reserve
fund for the Department of Defense, a prescription drug benefit, or other appropriate
legislation. Under both provisions, any additional resources may not, when taken
together with all other previously enacted legislation (except that enacted pursuant
to Section 211) reduce the on-budget surplus below the level of the Part A trust fund
surplus in any fiscal year covered by the resolution.
The use of the HI surplus has been a major subject of debate in the early months
of the 107th Congress. Some persons argue that the surplus represents Medicare
money and therefore can be used for any Medicare-related purpose including a
prescription drug benefit. Others argue that if surpluses from the trust fund are used
for a new drug benefit or Medicare reform, the insolvency issues facing Medicare will
occur much earlier than currently projected.17
15See: CRS Report RS20165, Social Security and Medicare "Lock Boxes", by David S.
Koitz, Dawn Nuschler, and Geoffrey Kollman.
16 The Conference report specifies that, in the Senate, the authority granted under Section 211
does not permit the Chairman of the Budget Committee to make any adjustments for floor
amendments offered to unrelated legislation.
17 See CRS Report 94-593, Social Security Taxes: Where do Surplus Taxes Go and How Are
(continued...)

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CRS-14
Status of Program as a Whole. A number of observers have suggested that
it is inappropriate to view Medicare solvency only in terms of the Part A program.
Rather, they suggest that the program should be viewed as a whole. The trustees
point out that “it is important to recognize the financial challenges facing the
Medicare program as a whole and the need for integrated solutions.” They further
note that combined Part A and Part B expenditures are expected to rise from 2.24%
of the gross domestic product (in 2000) to 5.03% in 2035 and 8.49% in 2075.18
The HHS press release accompanying President Bush’s budget states that
viewing Medicare HI activities in isolation is flawed. It states that the Medicare
program will require a $1.2 trillion transfer from general revenues to meet
expenditures over the FY2002-FY2011 period. (This is essentially the 75% general
revenue contribution to Part B required by law). It labels this amount as a “deficit”
and states that when Medicare is examined in a more comprehensive manner over the
FY2002-2011 period, the projected HI surplus is overwhelmed by the SMI deficit.
The Administration plans to work toward establishing a comprehensive measure of
Medicare solvency.
While many persons agree that the Medicare program should be viewed in its
entirety, they object to the “deficit spending” label. They note that, using the
Administration’s language, virtually all general revenue spending, including that for
defense and education, could be labeled deficit spending.
Many persons suggest that adoption of a comprehensive measure of solvency
should occur in conjunction with the merger of Part A and Part B into a single
program. This issue is discussed further in a later chapter.
Other Major Issues
While program financing is of major concern to policymakers, it is only one of
the issues facing Medicare. Other important issues include: whether the program has
responded to changes in the health care delivery system, whether the benefit package
adequately responds to the health care needs of aged and disabled beneficiaries, the
role of supplementary insurance coverage, and whether the needs of the low-income
are being addressed.
Response to Changes in the Health Care Delivery System
Many observers argue that the program’s current structure, relying primarily on
traditional fee-for-service mechanisms, has failed to adequately reflect changes that
have occurred in the health care delivery system as a whole. While 90% of persons
with employer-sponsored coverage are currently enrolled in some form of managed
17(...continued)
They Used? By David S. Koitz.
18Board of Trustees of the Federal Hospital Insurance Trust Fund. 2001 Annual Report of
the Federal Hospital Insurance Trust Fund. Washington D.C. March 2001.

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CRS-15
care, only about 14% of the Medicare population is enrolled in such arrangements.
While this number is expected to grow, fee-for-service is expected to remain the
program’s predominant delivery system.
Medicare Benefits Package
Medicare provides broad protection against the costs of many, primarily acute
care, services. However, beneficiaries are still faced with significant additional health
care expenses. The program requires cost-sharing for most covered services,
provides only limited protection for some services (such as outpatient prescription
drugs and long-term care) and includes no protection against the costs of other
services (such as hearing aids and dentures). Further, unlike most large group health
insurance plans, Medicare contains no upper (“catastrophic”) limit on out-of-pocket
expenses. As a result, the program covers only about half of beneficiaries’ total health
bill.
Medicare’s benefit package is somewhat less generous than typical employment-
based coverage. It contains more generous coverage of mental illness and substance
abuse than typical employment-based plans for the non-elderly. However, it lacks
coverage for most outpatient prescription drugs, dental care, and a catastrophic limit
on the amount of out-of-pocket expenses. These items are generally found in
employment-based plans.
Many observers have recommended expansions in Medicare coverage. In recent
years, the primary focus has been on prescription drugs. However, there is currently
no consensus on how a drug benefit should be structured. One of the chief concerns
is the potential cost of a new benefit and how these costs would be financed over
time. There are also a number of organizational and administrative questions. These
include whether a drug benefit should be enacted prior to or as part of overall
structural reform; whether the new benefit should be part of the Medicare program
itself or administered as a separate program; and the degree of reliance that should be
placed on the private sector, both for administering the benefit and assuming a portion
of the financial risk.
Coverage of preventive services has also received attention in recent years.
Initially, Medicare coverage was restricted to the diagnosis and treatment of illness.
Over time, coverage was added for some routine screening services. Recently,
significant expansion in preventive services was included in BBA 97 and BIPA 2000.
Some persons have recommended additional expansions arguing that the provision of
preventive care services actually results in savings over the long term.
Role of Supplemental Coverage
As noted earlier, most beneficiaries have coverage to supplement some of
Medicare’s coverage gaps. There is wide variation among beneficiaries in the types
of coverage offered, the source of coverage, and depth of coverage. When
considering Medicare restructuring proposals, it is important to remember that these
proposals could have a very different impact depending on the type of supplemental
coverage (if any) held by the beneficiary. It is also important to consider the

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CRS-16
implications of Medicare changes for other stakeholders providing this coverage such
as managed care plans, private insurers, and state governments.
Managed Care Plans. As noted earlier, a number of Medicare+Choice
organizations have reduced their service areas or dropped out of the program entirely.
Other plans have reduced their coverage of extra services such as prescription drugs
or increased the costs to beneficiaries for such services. As a result, many observers
state that the current Medicare+Choice program requires reform. Many of the
restructuring plans would incorporate a premium support or similar mechanism; this
is intended to encourage a larger number of plans to participate in the program. (See
discussion of premium support later in this report.) When reviewing various
proposals it is important to consider what the impact will be on the actual number of
plans willing to participate, the number of beneficiaries who will have a choice among
plans, and the benefits these plans will offer.
It is also important to consider whether plans will be able to design their
packages so that beneficiaries will be encouraged to enroll in a managed care
arrangement. Beneficiaries are typically risk adverse. Therefore it could be expected
that plans will need to be able to offer fairly broad coverage (including some
prescription drug coverage) with predictable (and affordable) premium and cost
sharing charges. It will also be important for beneficiaries to know that the plans will
continue to participate in the program over time.
Employer-Based Coverage. There are indications that the percentage of
employers offering retiree health coverage for their Medicare-covered retirees is
dropping. In addition, many other employers are pursuing strategies to lower their
liabilities for retiree health costs. Some employers are moving toward a defined dollar
contribution model for retiree health benefits; this means that the employer offers
coverage up to a specified dollar amount, rather than offering coverage for a specific
package of benefits. Others are using Medicare+Choice plans and other managed
care organizations to deliver services to their retirees. These employer choices have
a significant impact on the supplemental health insurance available to program
beneficiaries.
It is not entirely clear how the implementation of Medicare reform would affect
the provision of employer-based retiree coverage. Obviously, this would in part
depend on how the reform is structured. Some observers cite the decline in the
percentage of employers offering such coverage; they suggest that this trend is likely
to continue and might perhaps accelerate if employers saw this as an opportunity to
further reduce their involvement (though this trend might be countered somewhat by
union contracts with large employers). Others suggest that certain reforms (for
example, the addition of some prescription drug coverage) might slow the trend.
Many are concerned that any expansion in federal coverage might merely result
in a dollar-for-dollar offset in coverage provided by employers. Under this scenario,
federal dollars might increase but overall benefits for beneficiaries would remain
relatively unchanged. Several prescription drug proposals attempt to address this
concern by providing employers with financial incentives to maintain their drug
programs and have their retirees continue to receive services through these plans
rather than a new federal program.

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CRS-17
Medigap. Beneficiaries with Medigap insurance have coverage for Medicare’s
deductibles and coinsurance and for some services not covered by Medicare.
Beneficiaries generally select a Medigap policy from one of 10 standardized plans.19
These are known as Plan A through Plan J. The Plan A package covers a basic
package of benefits. Each of the other nine plans includes the basic benefits plus a
different combination of additional benefits. Plan J is the most comprehensive.
The intention of standardized policies is to enable consumers to better
understand policy choices and to prevent marketing abuses. However, some
observers suggest that the current policy options overemphasize first dollar coverage
(namely coverage of Medicare’s cost-sharing charges) which many beneficiaries could
potentially budget for. At the same time, the plans provide less generous coverage
for other services not covered by the program. (For example, only three standardized
plans – Plans H, I and J – cover some drug costs and even the most generous
requires significant out-of-pocket payments by beneficiaries.)
Many observers contend that Medigap premiums are difficult for many elderly
individuals to afford.20 Some observers have suggested that policy options should be
redesigned to place greater emphasis on catastrophic coverage. A change authorized
by BBA 97 added two high deductible plans to the list of 10 standard plans. With the
exception of the high deductible feature, the benefit package under the high deductible
plans is the same as under Plan F or Plan J. The removal of first dollar coverage was
expected to result in lower premiums. However, these plans are not widely available.
Many beneficiaries tend to be risk adverse. They therefore purchase Medigap
policies which protect them from most Medicare cost-sharing charges. While they
face substantial premium costs for coverage, they may face little or no out-of-pocket
costs at the time they actually use services. They thus perceive the service to be free
and therefore use more services. Spending for beneficiaries with private supplemental
coverage is estimated to be significantly higher than expenditures for those without
such coverage. A review of 1995 data by the Physician Payment Review Commission
(PPRC) showed that Medicare expenditures for beneficiaries having Medicare
coverage only were less than 75% of those for beneficiaries with Medigap. (Medicare
19Beneficiaries who originally purchased supplemental policies before July 1992, can continue
to renew these policies indefinitely. Approximately one-third of beneficiaries still have these
policies. (Chollet, Deborah J., Senior Fellow, Mathematica Policy Research Inc., Testimony
before Senate Finance Committee, April 24, 2001.)
20There is wide variation in Medigap premiums for both drug and non-drug policies
nationwide. This reflects a number of factors including differences in the benefits of Plan A
through Plan J, differences in medical underwriting practices, and differences in pricing
structures. For example, Weiss Ratings reports that the national average premium in 2000
for Plan F (the most commonly sold) was $1,301; state averages ranged from $1049 to $1954.
The national average premium for Plan J (the plan with the most drug coverage) was $3,065;
state averages ranged from $2289 to $4,030. (Weiss Ratings, Inc. Prescription Drug Costs
Boost Medigap Premiums Dramatically, March 26, 2001;
[http://weissratings.com/newsreleases/ins_Medigap/200110326Medigap.htm], accessed April
2001.) These are premiums for a 65-year old male. A March 2000 GAO survey of 1999
Medigap premiums showed that average premiums for 75-year olds were higher than those
for 65-year olds.

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CRS-18
spending for beneficiaries with employer-provided benefits averaged 10% less than
spending for persons with Medigap.) Higher Medicare spending reflects higher
overall use of services. High service use among beneficiaries with secondary
insurance appears to be a direct consequence of having such insurance. Comparison
of service use between those with and without private coverage suggests that there
may be some overutilization of services by those with supplementary coverage.
However, some of the increased use of services likely represents the provision of
appropriate care. Therefore, persons without supplementary coverage may not be
getting some needed services.
Some observers suggest that as part of restructuring, the standardized Medigap
policies should be redesigned to prevent first dollar coverage, for example, Medigap
plans would be prohibited from paying the first $250 in Medicare cost-sharing
changes. The intent of this approach would be to make beneficiaries more cost
conscious at the time they used covered services, thereby lowering Medicare
spending. It should also result in a reduction in Medigap premium costs.
Many persons have suggested that if certain reforms were made to Medicare (for
example if there were an upper limit on out-of-pocket costs) beneficiaries would have
less need to purchase Medigap policies. However, given the risk adverse nature of
this population, it might be difficult to convince them that it was no longer necessary
to purchase supplementary coverage. Further, the insurance industry would likely
oppose an approach which could potentially result in a considerable loss in revenues.
Medicaid. Some low-income aged and disabled persons receive full or partial
supplementary health coverage under Medicaid. Persons entitled to full Medicaid
protection generally have all of their health care expenses met by a combination of
Medicare and Medicaid. For these “dual eligibles” Medicare pays first. Medicaid
picks up Medicare cost-sharing charges and provides protection against the cost of
services generally not covered by Medicare, such as outpatient prescription drugs and
long-term care.
Several population groups are entitled to more limited Medicaid protection.
These are qualified Medicare beneficiaries (QMBs), specified low-income
beneficiaries (SLIMBs), and certain qualified individuals added by BBA 97. QMBs
are individuals with incomes below 100% of the poverty line and resources below
200% of the resource limit established for the Supplemental Security Income (SSI)
program.21 SLIMBs are persons meeting the QMB criteria except that their income
limit is 120% of poverty. Medicaid pays Medicare’s cost-sharing and premium
charges for the QMB population; it pays only the Part B premium for the SLIMB
population. Medicaid coverage is limited to payment of these charges unless the
individual is otherwise eligible for full Medicaid benefits.22
21The 2001 monthly income limits for QMBs are $736 for an individual and $988 for a couple
(these numbers reflect a disregard of the first $20 of income). The resource limits are $4,000
for a single and $6,000 for a couple; certain items such as an individual’s home are excluded
from the calculation.
22BBA 97 added coverage for two groups of “qualified individuals (QIs).” The first group
(continued...)

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CRS-19
Many persons eligible for QMB, or SLIMB coverage do not actually enroll in
these programs. Many observers attribute the low enrollment rates to the fact that the
programs are linked to Medicaid and therefore have a welfare stigma. However, the
enrollment levels would likely increase if the benefits available to this population
group were expanded. For example, many prescription drug proposals would provide
full or virtually full drug coverage to persons below 135% of poverty.
A number of Medicare reforms would involve some modification to Medicare’s
benefit package. Any such change would have specific budgetary implications for the
Medicaid program. If Medicare’s benefit package were expanded, Medicaid’s
obligations could potentially be reduced. Conversely, if Medicare’s coverage were
reduced (either through a reduction in services or the introduction of significant up-
front cost-sharing), Medicaid costs could go up accordingly. States could choose to
limit their cost increases by reducing the scope of Medicaid benefits. In this instance,
beneficiaries would be entitled to fewer benefits.
The implications of any Medicare changes would depend, in part, on what
portion of any new costs would be assumed by the federal government versus the
state governments. Medicaid costs (including those for the QMB and SLIMB
programs) are shared by the federal government and the states. Many states have
specifically objected to “unfunded federal mandates;” in the case of Medicaid this
occurs when the federal government mandates coverage of specific population groups
and states are required to pay some of the costs. As a result of this concern,
expanded coverage in BBA 97 was primarily paid for by the federal government.
Protections for Low-Income
Policymakers are concerned about the health care coverage available to low-
income populations. Persons with full Medicaid coverage have perhaps the most
comprehensive supplemental protection. Those persons with partial Medicaid
coverage have less generous protection. Low-income persons without any Medicaid
coverage are also the least likely to have private supplementary coverage. This
population group is viewed by many persons as being the most at risk for health care
costs not covered by Medicare. Many reform proposals would target the low-income
population (typically defined as below 135% or 150% of poverty) for special
assistance.
22(...continued)
(QI-1) is composed of persons, not eligible for Medicaid, whose income is between 120% and
135% of poverty. These persons are eligible to have their Part B premiums paid through a
block grant program. Potentially eligible persons are served on a first-come, first served basis
up to the state’s allocation limit under the block grant. The second group (QI-2) is composed
of persons whose income is between 135% and 175% of poverty; these persons are only
entitled to have a small portion of their Part B premium paid for ($3.09 in 2001). QI-1s and
QI-2s are never entitled to full Medicaid coverage.

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Impact of Demographic and Other Changes
Medicare will begin to face the impact of the baby boom population in 2011.
This will result in a rapid increase in the sheer number of aged Medicare beneficiaries
over the ensuing 20 years. The baby boom population is likely to live longer than
previous generations. This will mean an increase in the number of “old old”
beneficiaries (i.e., those 85 and over).
The combination of these factors is estimated to increase the size of the aged
Medicare population from 34.2 million in 2000 to 38.7 million in 2010 and 61.0
million in 2025. Total Medicare enrollees will increase from 39.6 million in 2000 to
46.0 million in 2010 to 69.7 million in 2025.
The number and health status of the aged population will also be affected by
future advances in medical technology. Some changes will not only improve the
health status of the aged but also prolong lives. The net impact on per capita health
spending, and by extension on Medicare health spending, is difficult to predict.
Reform Options
As noted, the problems facing Medicare are not new. Until recently, the primary
focus has been on enacting short-term measures designed to achieve budget savings
and to postpone the Part A insolvency date. Generally this involved enacting
legislation limiting increases in payments to providers, primarily hospitals and
physicians. This approach culminated in the passage of BBA 97. Limiting year-to-
year increases in provider payments helped to lower the overall program growth rate
and lengthen the solvency period for the Part A trust fund. However, most observers
agree that broader reforms are needed to address both the long-term financing issues
as well as to make needed program improvements.
The 107th Congress is expected to consider a variety of Medicare reform
proposals. Some changes could be made while still retaining Medicare’s current
structure. Examples include increasing the program’s eligibility age, introducing
means testing, increasing beneficiary cost-sharing, and introducing innovations into
the current fee-for-service program. Other changes could only be made in the context
of major program restructuring. Proposals which have been suggested include
modernizing the benefit structure, combining the Part A and Part B programs, or
replacing the program’s current guarantee of a defined benefit package with a
premium support system. Many of the proposals could be combined as part of an
overall reform package. The following is a discussion of some of the major proposals
offered to date.
Increasing the Program’s Eligibility Age From 65 to 67
The Social Security Act Amendments of 1983 (P.L. 98-21) was designed to
address long-range financing problems in the Social Security cash benefits program.
One provision in that law raised the full retirement age (the age at which one receives

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CRS-21
unreduced cash benefits) from age 65 to 67 over the 2003-2027 period. The
Medicare eligibility age remained at 65.
Some persons have suggested that the Medicare eligibility age should be
increased according to the same phase-in schedule established for Social Security
benefits. (Table 1 shows what the phase-in schedule would be under this approach.)
The Senate-passed version of BBA 97 included this provision; it proved very
controversial and was dropped in conference. The Breaux-Thomas proposal
considered by the Medicare Commission also recommended the same phased-in
increase in the eligibility age; however, under that proposal an exemption process
would be developed for affected beneficiaries with special needs, such as those unable
to work and otherwise get health coverage.
Table 1. Proposed Eligibility Age by Year of Birth
Year of birth
Eligibility age
Year of birth
Eligibility age
Before 1938
65 years, 0 months
1955
66 years, 2 months
1938
65 years, 2 months
1956
66 years, 4 months
1939
65 years, 4 months
1957
66 years, 6 months
1940
65 years, 6 months
1958
66 years, 8 months
1941
65 years, 8 months
1959
66 years, 10 months
1942
65 years, 10 months
1960 and after
67 years, 0 months
1943-1954
66 years, 0 months
Source: Table prepared by CRS.
Proponents of raising Medicare’s eligibility age argue that it is reasonable given
the increases in life expectancy and general improvements in health status that have
occurred since the program was enacted in 1965. Average life expectancy for a 65
year old increased from 14.3 years in 1960 to 17.8 years in 1998.23 Additionally,
people in their 60s are in generally better health and perhaps could work a few more
years.
Raising the age would result in program savings. The Senate-passed provision
would have phased-in beginning in CY2003. CBO estimated that the provision would
save $10.2 billion over the FY2003–FY2007 period.24 (Estimates were not made for
savings over the full phase-in period.)
23DHHS, Centers for Disease Control and Prevention, National Center for Health Statistics.
Health, United States, 2000. DHHS pub. no. 00-1232. July 2000.
24Congressional Budget Office Cost Estimate. S. 947/H.R. 2015, Balanced Budget Act of
1997, as passed by the Senate on June 25, 1997. July 2, 1997.

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Opponents of increasing the eligibility age argue that it would place a number of
seniors at risk. They cite the circumstances of the uninsured population aged 62-64
and suggest that the problems could be magnified for the population aged 65-66.
Among the younger group, 15% were uninsured in 1998. Of these, 26% were poor
and 52% were neither employed nor the dependent spouse of an employed person25
— characteristics that would make it unlikely for these persons to be able to afford
insurance. Employment-based group coverage generally spreads costs across all
workers in the same health insurance plan. However, private non-group insurance
premiums for persons 62-64 generally reflect the higher risk attributable to the
individual policyholder’s age and health status.
Raising the eligibility age could have the effect of lengthening the period when
some persons were uninsured or faced very high premiums for coverage. It is likely
that those most affected would be lower-paid workers. This suggests that higher paid
workers could keep their employment-based coverage for the additional 2 years.
However, recent trends in retiree health coverage suggest that this might not be the
case. A number of studies have shown that a declining share of large employers are
offering health benefits to their retirees (though most grandfather in benefits for
current retirees and those close to retirement). Further, the number of such employers
charging premiums, tightening eligibility requirements, encouraging the use of
managed care, and placing caps on coverage has increased.
The tendency of employers to restrict or drop coverage might be exacerbated if
the proposal to increase the eligibility age were enacted. Many employers might
decide that the provision of health insurance coverage for retirees was just too
expensive. A report by Hewitt Associates26 estimated that gradually raising the
eligibility age to 67 (using the same schedule applicable for social security) would
increase the actuarial costs for lifetime retiree benefits by 12% for large employers
with a younger workforce and 8% for employers with an older workforce. Once the
phase-in to age 67 were complete (or if there were no phase-in) the increase would
be 16% for employers with a younger workforce and 18% for those with an older
workforce. These figures reflect the fact that the employer’s average per capita cost
for a retiree before Medicare eligibility is about three times that of a retiree with
Medicare coverage ($4,000 vs. $1,350 in 1997).
Raising the eligibility age would also have implications for Medicaid. Under
current law, some low-income Medicare beneficiaries are also entitled to Medicaid on
the basis of age (currently 65 or over) or disability. Medicaid supplements Medicare
coverage for this group. If the Medicare eligibility age were raised, Medicaid would
(under current law) assume some expenses previously assumed by Medicare. As a
result, a portion of the anticipated Medicare savings would translate into increased
federal and state Medicaid costs. Alternatively, the eligibility age for Medicaid could
25Shea, Dennis G., Pamela Farley Short, and M. Paige Powell. Betwixt and Between:
Targeting Coverage Reforms to Those Approaching Medicare. Health Affairs,
January/February 2001.
26Hewitt Associates LLC. Retiree Health Trends and Implications of Possible Medicare
Reforms. Report prepared for Kaiser Medicare Policy Project (Henry J. Kaiser Foundation
Grant Number 96-1710B), Washington, September 1997.

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CRS-23
also be increased; however, this would leave some low-income individuals without
any insurance coverage.
Means Testing
Medicare is not a means tested program. There are no income or assets tests for
coverage. Further, the benefits and cost-sharing requirements are the same for all
persons, regardless of income. Some observers have suggested that means testing
should be incorporated into the program. The most common proposal is that of
means testing the Part B premium.
Under current law, all persons enrolled in Part B pay a monthly premium equal
to 25% of program costs. Federal general revenues account for the remaining 75%;
(sometimes referred to as the federal subsidy). Many persons argue that it is
inappropriate for taxpayers to pay three-quarters of Part B costs for high income
Medicare beneficiaries. They point out that low and middle income working persons
may be subsidizing higher income elderly persons. In response to these concerns,
proposals to income-relate the Part B premium have been offered on a number of
occasions.
The Senate-passed version of BBA 97 would have provided for an income-
related Part B premium for individuals with incomes over $50,000 and couples with
incomes over $75,000. The federal subsidy would have been phased-out for
individuals with incomes between $50,000 and $100,000 and for couples with
incomes between $75,000 to $125,000. Individuals with incomes at or above
$100,000 and couples with incomes at or above $125,000 would have paid 100% of
program costs.27 At the time BBA 97 was considered, it was estimated that
approximately 5% of the noninstitutionalized aged population would have
experienced higher Part B premiums.
The Senate-passed BBA provision was controversial and was dropped in
conference. Many observers are reluctant to introduce means testing into the current
program. They note that once means testing is approved, it would be easier to lower
the income threshold at some future date as part of a budget savings measure. Means
testing could thus affect persons with more modest incomes. Another concern is that
if some beneficiaries are required to pay 100% of Part B costs, they might drop
Medicare Part B and seek alternative coverage. At this point, insurers do not market
Part B coverage (except for supplementary coverage) to the over-65 population.
However, this might change if insurers felt there was a market for this type of
product. If too many healthier people dropped Part B, this could potentially result in
adverse selection, with sicker people staying in Part B and driving up the per capita
costs.
27For example, the 2001 Part B premium is $50 per month ($600 per year) which represents
25% of costs; the federal subsidy is $150 per month (which represents 75% of costs). Over
the year, the federal subsidy is $1,800. If the Senate provision were in effect, individuals with
incomes over $100,000, would be subject to a Part B premium of $200 a month ($2,400 a
year, 100% of costs). Individuals with incomes between $50,000 and $100,000 would have
monthly premium amounts between $50 (the current amount) and $200.

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CRS-24
The major issue during the 1997 debate was how means testing would be
administered. Many claim that income-relating the Part B premium would be costly
to administer because of the need to obtain and verify income information. While
available through Internal Revenue Service (IRS) records, there is no other currently
operational system of identifying income. The Senate-passed version of BBA 97 had
proposed that a parallel system to the IRS be created through CMS to identify income
level. Some argued that this proposal would have required a large resource
commitment. Many argue that given that the IRS already accesses income data, it
should be the entity to administer an income-related premium. However, others are
concerned that if the IRS administers the income-related premium it will be viewed
as a tax.
Modifications in Beneficiary Cost-Sharing
Some observers have suggested that beneficiary cost-sharing should be modified.
Some proposals would be limited to changing existing cost-sharing levels. Other
proposals, such as adding a catastrophic out-of-pocket limit, would likely be linked
to broader benefit design changes.

Proposed changes in current cost-sharing requirements include increasing the
Part B coinsurance from 20% to 25%, increasing the Part B deductible from the
current $100 to a level more comparable to that in private insurance plans (such as
$200-$250), and imposing coinsurance on services not currently subject to such
charges (such as home health care and lab services).
Increased cost-sharing would presumably make beneficiaries more cost
conscious in their use of services. However, some persons are concerned that
increasing cost-sharing charges could impede access for some beneficiaries. Data
show that close to 60% of aged Medicare beneficiaries had incomes below $20,000
in 1998.
Most beneficiaries have supplementary coverage and therefore would not directly
feel the impact at the time they obtained services. Persons likely to be most
immediately affected by changes in cost-sharing requirements are persons in fee-for-
service Medicare without any supplementary health insurance coverage. Many of
these individuals have incomes above the levels necessary to qualify for full Medicaid
or QMB coverage but not high enough for them to obtain other supplementary
protection.
Beneficiaries with employer-based coverage might or might not see increased
out-of-pocket expenses if cost-sharing charges were raised. This would depend on
their employer’s response. As noted previously, a number of employers are rethinking
the amount of supplementary coverage they are offering their retirees. Beneficiaries
with Medigap insurance (which covers cost-sharing charges) would likely see
increased premium charges unless Medigap modifications were made at the same
time. However, as noted earlier, other factors could offset these increases. These
include the addition of an out-of-pocket limit on Medicare cost-sharing charges
(catastrophic cap) and/or the prohibition on coverage of first dollar costs under
standardized Medigap packages.

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CRS-25
Redesign the Medicare Benefit Package
Many observers state that Medicare’s benefit structure does not reflect the
current health care delivery system. As noted earlier, Medicare’s benefit package is
somewhat less generous than typical employment-based coverage. Some persons
have suggested that a redesign is appropriate. They recommend inclusion of such
additional items as prescription drugs or a limit on out-of-pocket expenses (sometimes
referred to as a catastrophic cap). However, such expansions have the potential for
significantly increasing Medicare’s costs. (The possible coverage of prescription
drugs raises a series of program design issues. These are addressed in a separate CRS
report.28)
Other program reforms would, by definition, affect benefit design. For example,
under a premium support system (discussed later) beneficiaries might be given more
freedom in selecting a benefit package tailored to their individual needs. Any benefit
redesign would need to be considered in the context of the entire package of benefits
available to the Medicare population, including their supplementary coverage. For
instance, a program change which increased beneficiary cost-sharing charges might
at the same time include a broader benefit package and thus lessen the need to
purchase Medigap policies.
Medigap Modifications
Some have suggested that incentives in current Medigap policies should be
revised. As noted earlier, beneficiaries with Medigap coverage tend to perceive
services as “free” at the point when they are actually using them; thus they use more
services and cost Medicare more dollars than those without supplementary coverage.
Another concern is that while current Medigap policies offer good protection against
some Medicare-related costs, they offer less adequate protection against other
potential expenses of the elderly. For example, even the most generous Medigap
policy (Plan J) limits coverage for prescription drugs to 50% of the cost of
prescriptions after the policyholder meets a $250 per year drug deductible; the
maximum annual drug benefit is $3,000.
The BBA 97 permitted beneficiaries to purchase policies which have high
deductibles in exchange for lower premium charges. The intent was to enable
beneficiaries to obtain catastrophic Medigap protection at a lower premium charge.
However, these plans are not widely available.
As noted earlier, some analysts have suggested taking this approach a step
further by prohibiting some or all of the 10 standard Medigap packages from offering
first dollar coverage. This presumably would make beneficiaries more cost conscious
in their use of services and by extension lower Medicare costs. It should also have the
advantage of lowering Medigap premiums. However, the elderly are generally risk
adverse and tend to want full coverage. Some of this concern might be allayed if
28CRS Report RL30819, Medicare Prescription Drug Coverage for Beneficiaries:
Background and Issues, by Jennifer O’Sullivan.

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CRS-26
provision were made for full coverage after an individual had incurred a certain level
of catastrophic expenses.
Fee-for-Service (FFS) Modernizations
Some have suggested that Medicare’s FFS program should incorporate certain
managed care techniques which are currently used by private insurers in their
indemnity insurance products. Specifically, Medicare could establish disease and case
management programs that identify and enroll individuals with certain health
conditions in order to provide higher quality of care at lower costs.29 Under these
programs, Medicare beneficiaries with health conditions such as congestive heart
failure, chronic obstructive pulmonary disease, diabetes, hypertension, arthritis, or
chronic pain could elect to participate in case management programs which would
provide patient education (for self-management of chronic conditions), prevention and
management of services, or other flexible benefits. The programs would employ tools
such as data analysis to help identify and target beneficiaries, bundled payments to
physicians and other providers (for all items and services used during an episode of
care) and prior authorization or review of services that could also be incorporated
more generally into FFS Medicare. Congress took a step in this direction in BBA 97
by authorizing payment for diabetes self-management training services.
Others recommend that Medicare be permitted to use selective contracting or
to provide beneficiaries incentives to use selected providers. Some private plans
restrict enrollees to providers who meet certain cost or quality standards; others
preserve enrollees’ freedom of choice but give them financial incentives to choose
preferred providers. Presently CMS does not have the statutory authority to establish
or contract with networks of preferred provider organizations in Medicare FFS
though Medicare+Choice does include this option. This approach is often linked with
the proposal to use bundled payments to physicians and providers for some or all
associated services related to a specific surgical procedure which is comparable to the
payment arrangement used in the Center of Excellence Demonstration project.
In the Centers of Excellence Demonstration, which is currently lapsed but
scheduled to restart sometime in 2001, a single fee covered all the facility, diagnostic
and physician services for designated procedures such as coronary artery by-pass
grafts (CABGs) that were provided in selected participating hospitals. Beneficiaries
are given incentives to choose these centers for the covered services because of lower
out-of-pocket payments. Under the restarted demonstration, which will be limited to
selected hospitals in Michigan, Illinois and Ohio, area surgeons will not be
discouraged from performing surgical procedures covered under the demonstration
in other Medicare certified hospitals and other facilities. Hospitals and physicians in
the area that are not involved in the demonstration will continue to provide services
in FFS Medicare.
29Generally, case management programs target “high-risk” patients who are likely to suffer
costly hospitalizations and adverse health outcomes because of complex social and medical
vulnerabilities; disease management programs target patients with a relatively standard set of
needs related to a specific disease, although certain comorbid conditions may be addressed as
well.

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CRS-27
Finally, some believe that CMS should use competitive pricing or improved
procurement practices when paying for both health care and administrative services.
Private health plans use their buying power in the marketplace to realize savings in
the cost of goods and services through negotiated pricing. Aside from limited
demonstration projects,30 CMS sets payment rates through different rate-setting
methods (sometimes referred to as administered pricing) not competition between or
negotiation with health care providers. Even when purchasing claims processing
services, CMS is directed to contract exclusively with certain private insurers for
functions related to paying FFS bills.31 At a minimum, analysts propose that CMS be
able to solicit competitive bids and contract with entities other than insurance
companies to provide claims processing services.

These changes, in one form or another, have been recommended for
consideration by the National Academy of Social Insurance,32 were discussed by the
Medicare Commission, and were part of the Clinton Administration’s proposal to
modernize Medicare. However, there are no systematic data establishing the
prevalence of these managed care tools in the private sector. Still, evidence indicates
private insurers use many of the managed care tools primarily to control costs and,
to some lesser extent, enhance quality. At best, however, the literature on the
effectiveness of these programs with respect to cost savings or quality improvement
is mixed and there is little hard evidence that these programs save money or enhance
the coordination of care.
It should be noted that CMS has established various demonstration projects to
test the applicability and effectiveness of many of these managed care tools, including
case management, selective contracting, bundled payments, competitive pricing and
competitive procurement. Some of the projects are ongoing; some have not yet been
started; others are long completed. Depending upon the project, the results have
been mixed in terms of cost savings, implementation costs, impact on utilization,
beneficiary interest, and provider resistance. Although small scale experiments are
necessary in order to learn (and are viewed as more prudent than wholesale changes
to the program), the projects take a long time to set up and are temporary by design.
30For example, BBA 1997 authorized five competitive bidding demonstration projects for
nonphysician Part B services such as laboratory and durable medical equipment supplies in
competitive acquisition areas where private payers paid less than Medicare. Under the
demonstration, CMS is required to protect beneficiaries’ access to a broad range of providers
and suppliers as well as to maintain a viable number of providers and suppliers in the
marketplace to assure an effective procurement process in future years.
31The Health Insurance Portability and Accountability Act (HIPAA) established the Medicare
Integrity Program (MIP) and gave CMS the flexibility to contract with other entities to
perform certain program safeguard functions that had been part of the claims processing
contracts.
32From a Generation Behind to a Generation Ahead: Transforming Traditional Medicare,
Final Report of the Study Panel on Fee-for-Service Medicare, National Academy of Social
Insurance. January 1998.

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CRS-28
However, at this point, most Medicare beneficiaries continue to receive care in
Medicare FFS where overuse, underuse and misuse of services are thought to be
common. Historically, a small proportion of Medicare beneficiaries has accounted for
a major proportion of Medicare expenditures. In 1996, 12.1% of Medicare
beneficiaries accounted for 75.5% of Medicare FFS payments. Many of the high-cost
beneficiaries are chronically ill with certain common diagnoses with much of the
Medicare expenditures attributed to repeated hospitalizations. As the population
ages, and life expectancy extends, the number of these beneficiaries is expected to
grow. According to some, Medicare FFS often fails to meet the needs of chronically
ill people, because: (1) treatment regimens for chronic illness often do not conform
to practice guidelines; (2) care is frequently rushed and overly dependent on patient
initiated followup; (3) providers typically devote little time to assessing function,
providing instruction in behavior change or self-care, or addressing emotional or
social distress; and, (4) finally, care is fragmented, with little communication across
settings and providers.33 In essence, Medicare spends a large amount of money on a
small proportion of chronically ill beneficiaries; many unplanned hospitalizations of
these beneficiaries appear to be preventable; and care might be better managed if FFS
Medicare were changed so providers had stronger incentives to do so.
Some of the FFS modernizations discussed here face major hurdles in
implementation. Medicare FFS accounts for a significant portion of revenue for
physicians, hospitals, other providers and suppliers. Innovations that steer FFS
Medicare business away from some providers or are perceived as inequitably
benefitting some providers at the expense of others can cause economic disruptions
in the marketplace, will be controversial, and may elicit a call for congressional
intervention. Similarly, a program targeting certain beneficiaries that is perceived as
advantageous by other excluded beneficiaries may be controversial as well. Some
believe that managed care techniques that are available to private insurers may be
significantly more difficult for Medicare to adopt.
Combine Part A and Part B
Frequently, proposals to redefine Medicare’s benefit structure include a
recommendation to combine the current Part A and B programs. Many persons
suggest that Medicare’s current two part structure is no longer appropriate. They
note that the vast majority of beneficiaries are enrolled in both programs. They also
cite the program’s increasing emphasis on managed care approaches and the fact that
the Medicare+Choice program requires enrollment in both Parts A and B. The
Breaux-Thomas proposal considered by the Medicare Commission would have
combined Part A and Part B. It would have replaced the separate Part A and Part B
deductibles with a single $400 combined deductible (in 2003), indexed in future years
to the growth in Medicare costs.
While many observers agree that the current structure may not be the most
appropriate in the face of today’s realities, they question how the two vastly different
systems should be combined. Of particular concern are the two different financing
33For further information see, Chen, Arnold, et al. Best Practices in Coordinated Care.
Washington, Mathematica Policy Research, March 22, 2000.

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CRS-29
structures. Part A is funded by current workers through a payroll tax, while Part B
is funded by current beneficiaries and federal general revenues. Under the current
design, Part A becomes insolvent when assets in the trust fund are not sufficient to
meet current obligations. Under current law, no general revenue financing is available
for Part A. A combination of the two programs could potentially alter this situation,
since all revenue sources would potentially be combined into a single fund. Many are
concerned that if the two programs were combined, there would be less incentive to
control costs since “general revenues would be available.” Alternatively, combining
the two programs could also result in a new test for the availability of general revenue
financing.
The Breaux-Thomas proposal presented to the Medicare Commission included
a new measure of Medicare solvency. Under the proposal, Part A and B trust funds
would be combined into a single fund with current revenue sources from both funds
maintained. Congress would be required to authorize any additional contributions to
the new trust fund in any year in which general revenue contributions were expected
to exceed 40% of annual outlays. At the time the proposal was considered (early
1999), this trigger was not expected to be reached until after 2005. “Breaux-Frist 1"
(S. 357) contains similar provisions.
Premium Support
One methodology for restructuring the Medicare program involves introducing
a premium support system. A premium support system is one approach for providing
financial assistance to individuals for the purchase of health care insurance. In a
premium support system, a predetermined subsidy for insurance plan premiums would
be given to individuals, who could then choose from a set of competing plans having
different total premium amounts. The level of premium support could be set at a fixed
dollar amount, or at a fixed percentage of the total premium that plans charge to
provide insurance. While the premium subsidy would be set at a defined amount for
all participating individuals (with adjustments in payments for geographic variations,
demographic and other risk factors), the decision as to what constitutes the benefit
package and payments to providers could be left completely or partially to the
discretion of the entities offering the health insurance. Options for approved benefit
packages can range from allowing a limited choice among only one or two benefit
packages with a core set of benefits to allowing maximum choice by placing no
restrictions on the design of the benefit package, or anywhere in between.
The goal of the premium support approach is to give individuals some amount
of flexibility to choose the health insurance coverage that meets their needs, along
with incentives to choose plans that are the best value for them within financial
constraints they may have for supplementing the premium subsidy. The premium
support model differs from the current Medicare program model which operates as
a defined benefit model with administered pricing. The current Medicare program
guarantees beneficiaries a defined set of benefits under an open-ended entitlement
program and determines the prices that will be paid to providers. Under premium
support, beneficiaries would instead be entitled to a level of support for their
Medicare covered services.

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The premium support concept has emerged as one of the leading proposals for
re-inventing or restructuring Medicare. Proponents say it would both reduce
Medicare spending growth and provide a more efficient health care insurance model
for Medicare beneficiaries. Just as Medicare was originally designed to reflect the
structure of private health insurance in 1965, many argue that the program has not
kept pace with market innovations and with health insurance plan coverage typically
provided today. As a result, they contend, the current Medicare program reflects an
antiquated system that must be reformed. At the core of the debate on premium
support is the tension between those who want to control spending growth and the
40 million beneficiaries who are concerned about reform and any increases in their
out-of-pocket costs.
In essence, a shift from a defined benefit program to a premium support program
would represent a major paradigm shift in health insurance coverage. For the
Medicare program and population in particular, there are a number of special issues
and problems related to a shift from a defined benefit program to premium support
program.
Derivation of Premium Support. Many health economists have proposed
that price competition among health plans would improve the efficiency of health care
spending. In fact, premium support is a variant of “managed competition” purchasing
reforms advocated by Alain Enthoven and others economists. In 1995, Aaron and
Reischauer34 introduced their concept of premium support for Medicare. They
defined a Medicare premium support system as one in which Medicare would pay a
defined sum toward the purchase of a health insurance policy that provided a defined
set of services. In effect, Medicare beneficiaries would receive a predetermined
amount of money (a premium subsidy) to use towards the purchase of a health plan,
which would in turn provide a defined set of benefits. They proposed to vary federal
support across health care markets, but not within an area.
Aaron and Reischauer’s premium support model would involve: 1) defining the
health-care market area; 2) accepting bids from entities for the provision of the
defined benefit package; 3) developing local marketing organizations to handle the
sale of insurance that would assist Medicare beneficiaries; 4) providing “risk-adjusted
payments”, that is payments which would vary based on an individual’s demographic
and health factors; and 5) phasing-in the system using a blend of cost-based and per-
capita (a fixed dollar amount per person) reimbursement. Each of these components
raises a number of implementation issues. The first question is how to make this
dramatic change more acceptable to beneficiaries. Their solution involved redesigning
the benefits package to include some form of prescription drug benefits as well as
catastrophic coverage. They envisioned a standard benefit package, along with
standardized cost-sharing requirements, so that participants could more easily
compare costs and quality.
However, others argue that there is a trade-off between standardizing plans to
make it easier to compare benefits and allowing maximum choice and flexibility by
34 Aaron, Henry J., and Robert D. Reischauer. The Medicare Reform Debate: What is the
Next Step. Health Affairs, winter 1995.

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permitting insurers to design different plans for the varying needs of the population.
More flexibility would give individuals more choice to purchase the health insurance
that fits their needs and budget. The current Medicare+Choice program requires that
all private plans offer the standard Medicare benefit package and then provides strict
guidelines for adding services, with specific cost-sharing requirements. This differs
from the federal employees health benefits plans (FEHBP), which has established few
minimum benefits requirements and, therefore, provides both plans and purchasers
maximum flexibility. Opponents of offering an FEHBP type plan to Medicare
beneficiaries claim that seniors need the standardized plans to eliminate confusion and
guarantee adequate and appropriate coverage.
Determining a suitable federal contribution, or premium subsidy, raises other
issues. Aaron and Reischauer suggested setting the federal payment at 95% of the
cost of the current Medicare package in each market area, with some adjustments.
Over the phase-in period, the federal contribution would be set to grow more slowly
than projected current-law baseline costs, so that in the long run, the federal Medicare
contribution would reflect the per capita spending growth of the non-elderly. Aaron
and Reischauer recognized this model had the potential to lead to risk segmentation
caused by income differences. Risk segmentation occurs when individuals with a
larger risk of consuming medical services are in one set of plans, while those
individuals with a smaller risk of using services are in another set of plans. Because
higher income individuals tend to be healthier than lower income individuals, plans
with high deductibles and high cost-sharing would attract relatively wealthier and
therefore healthier beneficiaries. To counter this and to provide more equity, their
model would require both supplements for low-income participants to allow this
population to have some choice among plans and risk-adjusting the government
contribution to ensure that plans that enrolled higher-cost individuals would be
reasonably compensated.
The infrastructure necessary to sustain a Medicare premium support system
would take time to build. It would be necessary to create an environment of
competition among plans, develop the apparatus to regulate the marketing of
insurance, implement risk adjustment procedures and overcome difficulties of
increasing Medicare costs for many current beneficiaries. They suggested dual
Medicare systems – the “old” program for current enrollees, and the new structure for
newly eligible beneficiaries, while acknowledging that new enrollees might not
provide a sufficient population base for this phase in. They would leave in place the
Medicare system of administered pricing, at least during the transition period, as well
as significant federal regulation, to ensure that the new system could be shored-up in
case of a failure.
Evolution of Premium Support. Since the original Aaron and Reischauer
plan, a number of different proposals have been offered for establishing premium
support. As one study pointed out, despite their differences, premium support models
tend to share 6 core features:35 1) beneficiaries would be able to select a Medicare
approved plan on an annual basis; 2) plans would calculate and then submit a “bid”
35Oberlander, Jonathan. Is Premium Support the Right Medicine for Medicare? Health
Affairs, September/October 2000.

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for the total premium amount they would charge; 3) the “bids” would provide a basis
for calculating the federal payment amount; 4) the federal government would provide
a fixed premium subsidy; 5) beneficiaries would pay different premiums, depending
on the plan they selected; and 6) the traditional Medicare program would compete on
the same terms as private plans. Policymakers have yet to reach consensus on these
six elements. For example, some premium support proposals require the Medicare
FFS program to compete on the same playing field as private plans, while others do
not include FFS in their premium support model.
As noted earlier, the “Breaux-Thomas” proposal presented to the Medicare
Commission would have provided premium support to pay part of the total premium
for an approved health plan selected by a Medicare beneficiary. The FFS program
would compete for enrollment on the same basis as other approved private plans, so
that the government would pay a portion of the cost of providing traditional
Medicare-covered benefits. Under the proposal, a new Medicare Board would be
established to administer the program, and would be given broad powers to oversee
and negotiate with plans.
Building on the Commission’s model, “Breaux-Frist 1" introduced in the 106th
Congress would have set the premium subsidy at 88% of the nationally weighted
average of plan premiums. Beneficiary premiums would vary depending on the cost
of the plan they selected, ranging from potentially no premium to premiums covering
all of the excess costs that exceeded the subsidy level. Plans would be required to
provide a benefit package equivalent to current Medicare coverage, called core
benefits. All plans, including Medicare FFS, would be required to offer high-option
plans that included some prescription drug coverage and coverage to limit yearly
Medicare out-of-pocket expenditures for covered services other than drugs.
Subsidies would be provided to low-income beneficiaries to purchase of at least one
of the high option plans covering prescription drugs. Plans would submit bids,
providing information about benefits covered under the plan, the proposed premium
to be charged for enrollment, and the service area. Plans would be allowed to have
reasonable variation in cost-sharing. The proposal also included the establishment of
an independent Medicare Board to oversee health plan competition and beneficiary
choice.
President Clinton also outlined a proposal for Medicare restructuring during the
106th Congress. This was largely incorporated into legislation introduced by Senator
Moynihan (S.2342, The Medicare Modernization Act of 2000). This legislation
would have created a competitive defined benefit program, administered by CMS
(then HCFA), that allowed for competitive bids for a standard Medicare benefit
package. This legislation differed from previous premium support proposals, because
it did not include the FFS program in the competitive bidding process. However,
prescription drug coverage was included in this legislation.
Subsequently, Senators Breaux and Frist introduced S.2807, the Medicare
Prescription Drug and Modernization Act of 2000 (Breaux-Frist 2), which was a
scaled down version of Breaux-Frist 1. This bill would provide for optional Medicare
prescription drug coverage, establish a Competitive Medicare Agency similar in
concept to the Medicare Board, and allow for competitive bidding within the
Medicare+Choice program. However, this bill more closely resembled the Moynihan

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legislation than the Breaux-Frist 1 model, in that it did not include FFS in the
competitive bidding process.
As noted earlier, slightly revised versions of “Breaux-Frist 1" and “Breaux-Frist
2" have been introduced in the 107th Congress (S.357 and S.358).
Current Issues. The premium support model would face a number of
implementation issues, such as whether or not to include FFS in a such a model. If
FFS is included, then perhaps the largest stumbling block is the higher expected
premiums for beneficiaries who choose to remain in Medicare FFS. The CMS
actuaries estimated that under the original Breaux-Frist 1 plan, enrollees remaining in
FFS in 2003 could expect to pay premiums that were 47% higher than the Part B
premium under current law.36 Although a larger premium subsidy could reduce this
differential, any expected savings to the Medicare program would also be lowered.
The domino effect of Medicare FFS plan price spiraling could further serve to
increase FFS costs. As relatively healthy beneficiaries decided that the FFS premiums
were no longer a good value, they could make the decision to move to lower cost
plans, thus leaving a smaller pool of higher-cost beneficiaries in FFS. This smaller
pool of sicker beneficiaries would further drive up the costs of FFS Medicare. For the
majority of Medicare beneficiaries who are currently in FFS, these changes could
prove to be very unsatisfactory.
Comprehensive Medicare reform would not only affect beneficiaries, it would
also have a significant impact on health care providers and others who have an interest
in the Medicare program, such as suppliers and persons investing in health plans. The
success of a major innovation, such as premium support, would depend in a large part
on the way these groups viewed and then responded to the changes.
Other components of a premium support model each present their own
challenges, and the possibilities for combinations of different solutions are huge. For
example, S.357 would offer a limited number of plans, so as to minimize beneficiary
confusion and make comparing plans for quality and efficiency relatively easy. The
age, disability, and health care needs of the Medicare population are significant
hurdles faced by policymakers seeking major Medicare changes, and a standardized
package could be designed to address common needs of this population, while
minimizing confusion about plan comparability. This is similar to the current structure
of the Medicare+Choice program. However, limiting the variety across plans would
make it more difficult for plans to offer maximum choice to beneficiaries and to tailor
plans for different health care preferences and needs.
Developing a premium “bid” that would cover a core benefit package is viewed
as one of the cornerstones of Medicare structural reform, because it would introduce
competition into the Medicare system by allowing plans to independently determine
the premium they would charge. Under the current Medicare+Choice program, plans
36Memorandum written by Rick Foster, Office of the Actuary on February 23, 2000. The
47% increase could be even higher if more beneficiaries choose to enroll in plans that cost less
than FFS. This estimate assumed no change in the distribution of enrollees in private plans
versus FFS.

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are given a preset per capita amount for each enrollee, with explicit rules for
determining cost-sharing and premiums. Under Medicare’s current rules, a plan may
not earn a higher rate of return from its Medicare business than it does in the
commercial market.37
Another feature of a premium support model involves determining the federal
government level of the premium subsidy and then providing that subsidy to
beneficiaries. Subsidies could be set as a percentage of the average or the total of the
plan “bids”, so that higher-cost plans would require larger beneficiary contributions.
The opposing issues here are saving money versus providing incentives for
beneficiaries to choose the plans that fit their needs. The higher the subsidy, the fewer
incentives individuals would have to act as prudent purchasers. Once coverage is
purchased, there is even less incentive to act as a prudent purchaser. However, the
smaller the subsidy, the less “choice” or flexibility low-income individuals would have
in choosing a plan. If FFS were to become a relatively expensive option, then low-
income individuals and even individuals living in areas with no alternative to FFS
would be placed in a particularly disadvantageous situation.
In a premium support model, premiums for the approved plans may vary
depending on the plan selected. Thus individuals choosing more expensive plans
would be required to pay a larger share of the premium. For individuals with limited
resources, this could translate into limited choice. They might only be able to select
plans with little or no additional premiums above the subsidy level. While a larger
premium subsidy for low-income individuals would reduce or eliminate this problem,
depending on the level of the subsidy, savings to the Medicare program could also be
reduced. As previously discussed, this division between higher-income and therefore
healthier beneficiaries could lead to risk segmentation as well as issues of inequality.
Other issues that must be considered for restructuring include how to best gain
beneficiary support and acceptance; and how to implement, phase-in, and administer
such a program. To the extent that beneficiaries envision this reform as part of a
larger plan to modernize the Medicare benefit package, including the provision of
prescription drug coverage and stop-loss coverage, they might be more willing to
accept broad Medicare reform. This comprehensive change may best be diffused by
phasing-in such a system, although again the various methodologies offer a trade-off
between savings and efficiency. Opponents of such a system would be quick to point
out that once a premium subsidy is set, it would be relatively easy to achieve
budgetary savings by either reducing the percentage or even holding it constant in the
face of inflationary increases and changes in medical technology. Over time, the
subsidy could erode to represent a smaller and smaller share of the actual cost of total
premiums. Effectively only those with higher incomes would be able to afford the
higher-cost plans, as they became even more expensive.
Another key consideration is the participation of plans. The current
Medicare+Choice program is experiencing difficulties as plans withdraw from the
program. Ensuring that the premium support model was more attractive to plans so
37See CRS Report RL30702, Medicare+Choice, by Hinda Chaikind and Madeline Smith, for
a detailed discussion of payments and benefits in the Medicare+ Choice program.

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that they would choose to participate and then remain in the program would be
crucial. Today, few plans are available in rural areas, in part because of the difficulty
of forming provider networks. Most individuals in these areas must rely on FFS, not
because they necessarily prefer this option, but because there is no other choice for
Medicare coverage. If FFS is included in a premium support model, and FFS
becomes an higher-cost option, then financial protections for individuals with little or
no choice may be necessary to guarantee equity. However, if FFS is not included in
a premium support model, then it would be difficult to contain Medicare growth.
CMS Restructuring
CMS is currently responsible for the oversight and administration of the
Medicare program as well as other duties. Some reform bills proposed in both the
106th and 107th Congress would add a new outpatient prescription drug benefit and,
in some instances, move toward a competitively negotiated managed care benefit.
Certain of the reform bills would also change the administrative structure of Medicare.
Although HCFA has been renamed and reorganized into the existing CMS, critics of
Medicare’s management may not be satisfied with the extent of these changes. Some
are skeptical that CMS could oversee an expanded, more complex Medicare program,
in part, because they question whether its internal culture, geared toward regulation
of the fee-for-service program, could be easily reoriented to administer a new
managed care program. They also claim that the inherent conflict of interest in
administering both the existing fee-for-service and a new managed care program
remains despite the reorganization. Moreover, some express concern over the
willingness of CMS to adapt its regulatory approach if it manages a new prescription
drug benefit. On the other hand, other critics see the possibility that the change in
agency leadership may transform the agency’s culture and regulatory orientation.
Other analysts contend that problems with Medicare’s administration stem from
inadequate resources, not necessarily organizational shortcomings. In an open letter
to Congress, in January 1999, 14 experts representing a variety of perspectives, cited
the unwillingness to provide HCFA (now CMS) with the resources and administrative
flexibility to accomplish its assigned tasks as the source of the agency’s difficulties.
In their view, these constraints had been imposed at a time when Congress had
imposed additional responsibilities and some of the agency’s most capable
administrators had left. These concerns have not been allayed by the change in the
agency’s management, name, or structure.
Various proposals to address perceived weaknesses in the administration of
Medicare have been discussed. Some plans would retain Medicare’s fee-for service-
program in CMS, while creating a new agency, either in HHS or outside of HHS.
The new agency would be responsible for oversight of the Medicare managed care
benefit and the new prescription drug benefit, as well as for beneficiary eligibility
determinations, enrollment, education, and outreach for the entire program. Some see
the HCFA reorganization into CMS with the creation of the Center for Beneficiary
Choices as a discrete entity responsible for these functions as a first step to its
transformation into a separate agency. Others are postponing judgment in order to
assess the impact of reorganization on agency behavior.

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Some of the proposals would establish a Medicare Board, either to administer
the new agency or to act as an advisory committee to the entity responsible for
program administration. To varying degrees, the new administrative entity would be
given greater flexibility in managing the program than CMS now has. An alternative
plan is to replace CMS with two separate agencies within HHS: one agency would
administer Medicare, the other would administer Medicaid and other state-operated
health programs.38 Proponents of this change suggest that even with additional
resources, the operational tasks currently assigned to CMS are unwieldy and would
overwhelm any administrative entity charged with oversight of Medicare. Critics,
however, cite the need for coordinated federal action in health care due to overlapping
activities, such as survey and certification efforts, that affect the Medicare and
Medicaid programs jointly as one reason to keep CMS’s current functions together
in one agency. In their view, the recent administrative reorganization of CMS with
the establishment of separate administrative entities within the same agency may be
an adequate response, particularly if agency resources are increased.
Depending upon the administrative structure selected, two separate agencies
responsible for administering different elements of a Medicare program could face
programmatic and managerial problems, such as inconsistent treatment of Medicare
beneficiaries, confusion among beneficiaries and providers, conflicting regulations,
and duplicative staff functions. These problems could be compounded in the absence
of a higher official who has direct responsibility over both agencies who can resolve
interagency disputes.
Prospects for the 107th Congress
It is expected that the 107th Congress will consider a number of Medicare reform
options. On July 12, 2001, President Bush announced the endorsement of a discount
drug card program which would help beneficiaries lower their out-of-pocket drug
costs. This plan is intended to give seniors immediate assistance while Congress and
the Administration work on designing a plan for coverage of prescription drugs as
part of a modernized Medicare program. The President also announced 8 key
principles which would constitute a modernized Medicare program. These are: 1)
all seniors should have the option of a subsidized prescription drug benefit as part of
modernized Medicare; 2) modernized Medicare should provide better coverage for
preventive care and serious illnesses; 3) today’s beneficiaries and those approaching
retirement should have the option of keeping the traditional plan with no changes; 4)
Medicare should provide better health insurance options like those available to all
federal employees; 5) Medicare legislation should strengthen the program’s long-term
financial security; 6) the management of the government Medicare plan should be
strengthened so it can provide better care for seniors; 7) Medicare’s regulations and
administrative procedures should be updated and streamlined, while the instances of
fraud and abuse should be reduced; and 8) Medicare should encourage high-quality
health care for all seniors.
38 Etheredge, Lynn. Medicare’s Governance and Structure: A Proposal. Health Affairs, v.
19, no. 5, September/October 2000.

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The Committees of jurisdiction (House Ways and Means, House Commerce, and
Senate Finance) are expected to markup bills this fall. At this writing, it is difficult to
predict what specific actions the Congress will take.

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