Medicare funding: Problems and solutions

Medicare's funding problems often get overlooked when the Social Security trustees issue their annual report on the funded status of the Social Security and Medicare programs. Yet together they form the twin pillars of financial security for retirees. That's why it's important to understand Medicare's financial situation, so you can be an informed health care planner -- and voter.

According to the summary of the 2017 annual report, "Both Social Security and Medicare face long-term financing shortfalls under currently scheduled benefits and financing. Lawmakers have a broad continuum of policy options that would close or reduce the long-term financing shortfall of both programs."

In addition to taxes collected from workers, Medicare is funded through two separate trust funds:

  1. The Hospital Insurance (HI) Trust Fund. This fund supports Medicare Part A, which pays for hospitalizations, home health services following hospital stays, care at skilled nursing facility and hospice care for the aged and disabled.
  2. The Supplemental Medical Insurance (SMI) Trust Fund. This fund supports Medicare Parts B and D, which pay for care from physicians, outpatient facilities, home health care, prescription drugs, and other services for the aged and disabled who have voluntarily enrolled in Parts B and D.

The Trustees project that the HI Trust Fund will be depleted in 2029. At that time, ongoing tax collections from workers will pay for approximately 88 percent of HI benefits. If Congress allows the HI Trust Fund to become depleted, then Medicare Part A benefits will need to be reduced accordingly.

The 75-year actuarial deficit of the HI Trust fund amounts to 0.64 percent of the payroll of covered workers, or 0.3 percent of GDP through 2091. So even though the dollar numbers are quite large, the percentage deficits are quite small and could be fixed with moderate increases in revenue or restraints on benefits.

The Trustees report that the SMI Trust Fund will remain adequately funded indefinitely because current law provides financing from both general federal tax revenues and premiums retirees pay each year to meet the next year's expected costs. 

However, SMI costs are projected to grow from 2.1 percent of GDP in 2016 to approximately 3.4 percent in 2037 and then increase more slowly to 3.7 percent of GDP by 2091. General federal tax revenues will pay for roughly three-fourths of SMI costs, with premiums retirees and beneficiaries pay covering almost all the balance.

Once again, even though the dollar amounts are quite large, the percentages are relatively small.

Under Medicare's current structure, there are six ways to manage and contain the program's long-term deficits:

  1. Increase payroll taxes current workers pay to the HI Trust Fund to support Part A benefits.
  2. Increase income taxes paid to the general federal fund to support benefits paid for Parts B and D.
  3. Increase premiums retirees and beneficiaries pay for Parts B and D.
  4. Increase deductibles and co-payments retirees and beneficiaries pay for Parts A, B and D.
  5. Improve efficiency in the medical care delivery system, so that it takes less money to care for retirees and beneficiaries. Often this involves implementing incentives to use efficient providers and disincentives to use inefficient providers.
  6. Improve the health of retirees and beneficiaries.

None of these steps will be easy or popular. The harsh reality is that everybody will feel the negative consequences of any solution to Medicare's funding challenges.

What can individuals do to prepare?

  • Be very serious about improving your health through proper nutrition, exercise, getting sufficient sleep and stopping smoking.
  • Become an informed shopper for medical care, and take responsibility for making medical care decisions.
  • Get ready to spend more on Medicare deductibles, co-payments and premiums for Parts B and D, and factor these increases into your retirement budget.

The threat of high medical insurance and out-of-pocket costs is one more reason to consider working longer, so you can reduce the time you're relying exclusively on your retirement resources.

Medical costs represent a tough retirement planning challenge with no easy solutions. Consider it part of the cost for living longer than previous generations of retirees. Would you rather face these challenges or be dead?

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    Steve Vernon helped large employers design and manage their retirement programs for more than 35 years as a consulting actuary. Now he's a research scholar for the Stanford Center on Longevity, where he helps collect, direct and disseminate research that will improve the financial security of seniors. He's also president of Rest-of-Life Communications, delivers retirement planning workshops and authored Money for Life: Turn Your IRA and 401(k) Into a Lifetime Retirement Paycheck and Recession-Proof Your Retirement Years.