Why Does U.S. Health Care Cost So Much? (Part IV: A Primer on Medicare)

December 12, 2008, 6:30 am

By Uwe E. Reinhardt


Uwe E. Reinhardt is an economist at Princeton. For previous posts in his series on why America pays so much for health care, click here, here and here.

Medicare, the federal health-insurance program for America’s elderly, plays a major and highly controversial role in our health-care system. To many Americans it is a blessing. Others view it as a source of all that’s wrong with American health care. I propose to explore these views in this and the next two posts to this blog.

Congress established Medicare in 1965, when close to 40 percent of America’s elderly lived at or below the federal poverty line. They simply could not afford the ever more sophisticated and expensive health care then starting to come on line.

The program now covers 45 million Americans 65 or older, as well as younger people with permanent disabilities, among them patients afflicted with End Stage Renal Disease. About half of Medicare beneficiaries live at or below 200 percent of the federal poverty line (i.e., $20,800 annual income for a single person and $28,000 for a couple). Over a third of the beneficiaries are afflicted with three or more chronic conditions.

In 2009, Medicare is expected to cost the federal government about $480 billion. That represents over a fifth of total national health spending on personal health care, 13 percent of the federal budget and close to 3.5 percent of the country’s gross domestic product. These outlays are financed with a combination of payroll taxes (41 percent), general tax revenues (39 percent), premiums paid by the elderly (12 percent) and sundry other sources, including interest earned on a trust fund established for the program.

Because Medicare’s benefit package traditionally has been less generous than traditional employment-based private insurance for younger Americans –- it has covered prescription drugs only since 2006 — many beneficiaries have sought supplemental, wrap-around coverage from their former employers (about 33 percent) or from a purchase of a private Medigap policy (about 20 percent). The federal-state Medicaid program for the poor provides such gap coverage for some 7 million (or 15.5 percent) Medicare beneficiaries, called “dual eligibles.”

Even with such supplemental coverage, however, out-of-pocket cost-sharing at the time health care is received has always been high relative to employment-based private insurance for younger Americans. In 2005, the median fraction of income Medicare beneficiaries spent out of pocket for their care was 16.1 percent. For the 11 percent of beneficiaries without supplemental coverage, out-of-pocket spending can absorb 30 percent or more of their income.

Medicare was originally established as a single-payer, government-run, fee-for-service plan whose claims by patients and health care providers were administered, for a modest fee, by a select group of private insurance plans called Medicare Intermediaries -– typically Blue Cross plans. This arrangement is now known as “Traditional FFS Medicare.”

Starting in the 1970s, however, Medicare beneficiaries have had the option of enrolling in a variety of health plans offered by private insurers. Starting with the Medicare Modernization Act passed in December 2003, which offered beneficiaries drug coverage for the first time, these private insurance options have been called “Medicare Advantage” plans. About 23 percent of Medicare beneficiaries have chosen this option.

Driven by an ideological preference for private over government-run health insurance, the Republican Congress in 2003 made taxpayers effectively pay these private plans an average of 13 percent more per Medicare beneficiary than these beneficiaries would have cost taxpayers under the government-run program. Consequently, the private plans can offer beneficiaries superior benefits, which has caused enrollment in them to double from 5.3 million to 10.1 million between 2003 and 2008. Because it is hard to justify this extra public subsidy to the private plans on the basis of health policy, however, it has been highly controversial among health policy experts and is likely to be eliminated by the new Congress in the next few years.

Although often decried by its critics as “socialized medicine,” Medicare remains a highly popular health-insurance product among the elderly, who rate the quality of care they receive under it higher than younger, privately insured Americans rate their health care (see, for example, this and also this, Charts 4:1 to 4:3).

This sentiment is not surprising, because, from both the patient’s and the provider’s perspective, claims processing under Medicare is relatively simple in comparison with the complexity of private health insurance, although Medicare is much more administratively complex than are similar government-run, single-payer health insurance systems in other countries (e.g., Taiwan or Canada).

Furthermore, in surveys of Americans 50 and older, respondents expressed greater trust in Medicare as a source of health insurance, possibly still remembering the late 1990s, when many private plans terminated their coverage of Medicare patients.

In the next post, I shall assess the often-made claim that Medicare is not much longer “sustainable.” Thereafter I shall explore whether Medicare in its current form should be sustained, even if it were affordable in that form. In the meantime, readers who wish more detail on the program than could be offered here may wish to consult the excellent primer on Medicare found at the Henry J. Kaiser Family Foundation’s Web site.