Ten Things You Should Know About Medicare

Published May 3, 2011


President Obama and his allies ominously warn that House Budget Chairman Paul Ryan’s plan would “end Medicare as we know it.”

But if you’re under age 65, there’s a good chance you know very little about Medicare. You have had no reason to, at least until now.

Five years ago I created a simple, two-page outline to help a Cabinet Secretary and a senior White House staffer get up to speed on the basics of Medicare. I have updated the numbers in that document and offer it here. This outline won’t make you an expert, but at least it will give you a starting point.

All numbers below are from the Congressional Budget Office, except the enrollment data, which are from the Medicare trustees.

10 Things You Should Know About Medicare

Who gets it and what they get:

1. Medicare is a federal government program that pays for health care for seniors and the disabled.

  • Approximately 40 million seniors enter at age 65 to get their health care through Medicare.
  • You cannot enroll early, as you can with Social Security.
  • About eight million disabled persons are also enrolled.
  • That means one-eighth of the nation’s population is in Medicare.

2. It was created in 1965 to cover only acute care costs. The cost-sharing structure is “upside down.”

  • The benefit was modeled after an early 1960s Blue Cross/Blue Shield benefit.
  • It has low deductibles and copayments.
  • It does not cover catastrophic costs.
  • It generally does not cover long-term care costs (with caveats).
  • Part A = Hospital care (+ more)
  • Part B = Physician care (+ more)
  • Other benefits include home health care, skilled nursing care, hospice, and now drugs (Part D).
  • Modern private health insurance, by contrast, generally has high deductibles and copayments and often covers catastrophic costs.

3. Most seniors don’t pay the limited deductibles or copayments directly.

  • Many have employer-provided “wraparound” coverage,
  • or they purchase supplemental “Medigap” insurance (which is inefficient),
  • while the poor have Medicaid to cover their cost-sharing.

4. The Bush administration and Congress added a voluntary drug benefit in 2003.

  • Medicare now subsidizes the purchase of privately offered insurance covering prescription drug costs, with specific cost-sharing requirements.

How it’s delivered:

5. For most recipients, Medicare is a government-financed, government-administered, fee-for-service benefit.

  • Aka “single payer health care.”
  • Three-fourths of Medicare beneficiaries are in this “traditional fee-for-service Medicare.”
  • Government sets prices in FFS Medicare through laws and administrative mechanisms.
  • A senior goes to a doctor or hospital, gets treated. The government reimburses that provider.
  • In FFS Medicare, the government directly reimburses and regulates providers of medical goods and services.
  • This is slow, bureaucratic, and subject to political influence through the legislative and regulatory processes.

6. One-quarter of Medicare’s beneficiaries are in a better “defined contribution” system in which the government finances the purchase of privately offered health insurance.

  • This is “Part C”, aka “Medicare Advantage” or “MA.”
  • This looks like employer-provided health insurance, except the government pays the premiums.
  • In MA, the government reimburses and regulates private insurers, who in turn reimburse and manage providers of medical goods and services.
  • Seniors can choose among competing private health plans. Those plans can more flexibly manage medical providers and costs.

How Medicare is financed:

7. It’s enormous, and it’s growing unsustainably fast.

  • It takes up about $491 billion of net government spending this year. (For comparison, Social Security costs $727 B.)
  • It’s projected to grow by approximately 5.4 percent per year for the next ten years.
  • Medicare spending = 3.8 percent of GDP today, will be 4.1 percent of GDP in 2030.
  • Per beneficiary net government spending is approximately $10,200 a year.
  • 70/10 rule: 10 percent of the seniors account for 70 percent of the costs. The healthiest 50 percent of seniors account for only 4 percent of the costs.

8. It has all the demographic challenges of Social Security, plus unsustainable health care cost growth.

  • Medicare is so big its payment structures are directly responsible for much of the macro- and micro-structure of U.S. health care delivery.
  • Politically it’s harder to reform than Social Security because provider groups (doctors, hospitals, etc.) join seniors in lobbying for more funding.

9. There are three main sources of financing.

  • The three main financing sources are dedicated payroll taxes, beneficiary premiums, and general revenues (income taxes).
  • Payroll taxes: 2.9 percent of all wages. ½ paid by employee, ½ by employer.
  • Premiums: 25 percent of “part B” costs, approximately $96-115 per month per recipient. High-income seniors (income > $85K/person) pay higher premiums.
  • Premiums: a percentage of “Part D” drug costs (a complex formula). High-income seniors pay higher premiums.
  • General revenues = total spending – (payroll taxes + premiums).

10. The “Trust Funds” are misleading anachronisms.

  • The distinctions between parts A, B, C, and D are historic and irrational.
  • Technically, payroll taxes are dedicated to “part A” (hospital) spending and go into a “Part A trust fund.”
  • Technically, part B premiums cover 25 percent of part B spending, with general revenues covering the other 75 percent.
  • There is some symbolic aspect to the “balance” in the “part A trust fund”, but we think about spending on a cash flow and aggregate basis.

Keith Hennessey (http://keithhennessey.com/) is a research fellow at the Hoover Institution and a lecturer at the Stanford University Graduate School of Business.