Medicare

Medicare is a social insurance program that provides health insurance coverage to over 48 million Americans—almost everyone over age 65 and recipients of Social Security disability benefits. Pressures to curb health care spending, the projected insolvency of the Hospital Insurance Trust Fund, and concerns about gaps in coverage that leave beneficiaries exposed to significant health care costs will shape the evolution of the Medicare program.

Where the Money Comes From

Medicare is the largest health program in the United States: a federal social insurance program covering 40 million persons over the age of 65 and 8 million persons with disabilities.

Payroll Taxes and Premiums

Medicare has four basic programs, Parts A through D. Part A covers hospital insurance; this includes inpatient hospital stays, skilled nursing facility stays, hospice care and home health visits. Part A is primarily financed by a 1.45% payroll tax on all wage and salary income for the worker and the employer. Self-employed persons pay the full 2.9% of earnings.

Example: Jo Waller makes $50,000 a year. She would pay $725 a year. Her employer also would pay $725. If Jo were self-employed, she would pay $1,450 a year.

While Social Security taxes are capped at $110,100, there is no maximum wage base for Medicare taxes. An individual making $1,000,000 a year would pay a Medicare payroll tax of $14,500, and his employer would pay an equal amount.

Medicare Part B is a voluntary program that helps pay for doctor bills and other outpatient health care. Medicare beneficiaries pay a premium of $99.90 a month for their part B coverage. Part B premiums can be deducted from the beneficiary's monthly Social Security benefit check. The premium is set annually to cover about 25 percent of Part B spending, while the other 75 percent is paid from general revenues.

Medicare Part C is known as Medicare Advantage (MA), and gives seniors the option of receiving their benefits through private health plan.

Medicare Part D provides prescription drug benefits through private plans that contract with Medicare and Medicare Advantage prescription drug plans. The average monthly premium for Part D is $31.

Income-Related Part B Premium

Beneficiaries with incomes above $85,000 a year ($170,000 for couples) are responsible for paying a higher share of the cost of Part B. Medicaid pays Part B premiums for low-income beneficiaries who are currently enrolled in Medicaid; beneficiaries with higher incomes pay an income-related Part B premium that ranges from $139.90 to $319.70 per month. Medicare provides low-income subsidies to those who qualify. 

For more information on Medicare funding, see:

The official Medicare website is www.medicare.gov.

Getting Benefits

Part A

In 2012, a Medicare enrollee who goes to the hospital pays a deductible of $1,156 for the first day in the hospital. The next 59 days are fully covered by Medicare. For days 61 through 90, the patient is responsible for paying $275 a day (called a co-payment), and Medicare covers the rest. For any additional days, the patient can use up to 60 lifetime reserve days, with a co-payment of $550 a day.

A Medicare enrollee in a skilled nursing facility must pay $144.50 for days 21 through 100. For enrollees who have been hospitalized for three days or more, Medicare covers the first 20 days, but does not cover anything past day 100. Medicare also covers home health, with no limit on the number of visits.

Part B

Medicare enrollees are responsible for paying the first $140 a year in doctor bills—this payment is called the annual deductible. Medicare pays 80% of the approved fee, and the individual pays the remaining 20%, which is called a co-insurance. Doctors may charge more than the Medicare fee schedule under a process called balanced billing. But the patient is not responsible for paying more than 15% above the Medicare fee schedule.

The vast majority—about 76%—of people enrolled in Medicare participate in fee-for-service, or traditional, Medicare. They can choose any doctor or hospital that agrees to take Medicare patients.

About 11.9 million Medicare beneficiaries are enrolled in private health plans, or Medicare Advantage. These plans include managed care plans, preferred provider organizations, private fee-for-service plans, and Medicare specialty plans. If a person decides to join a Medicare Advantage plan, he or she must pay the monthly Medicare Part B premium. The enrollee may also have to pay an additional premium to the Medicare Advantage plan. In return, the beneficiary may receive benefits not covered by fee-for-service Medicare, such as extra days in the hospital and lower cost-sharing. The beneficiary may also be restricted to the plan's network of doctors and hospitals.

The official Medicare website is www.medicare.gov.

How Medicare Spends Its Money

Benefits totaled $515.8 billion in 2010. Main categories included:

The average benefit spending for the 48 million persons enrolled in Medicare was  $11,762 during 2010.

In 2010, Medicare paid $7 billion in administrative expenses for the Hospital Insurance and Supplementary Medical Insurance Trust Funds combined. Administrative expenses equaled 1.4 percent of benefit payments.

For more information on how Medicare spends its money, see:

The official Medicare website is www.medicare.gov.

The Medicare Drug Benefit: Part D of Medicare

A Medicare prescription drug program was introduced in the Medicare Modernization Act (MMA) of 2003. While 90 percent of Medicare enrollees have some source of prescription drug coverage, 60 percent are enrolled in either a Medicare stand-alone prescription drug plan (PDP) or a Medicare Advantage drug plan.

How the Drug Benefit Works

Medicare drug benefits are available only through private health plans:

Prescription Drug Plans (PDPs)

The standard prescription drug plan has a $310 annual deductible in 2010. For the next $2,520 in drug costs, the individual pays 25% ($630), and Medicare pays 75% ($1,890). For spending above $2,830, the beneficiary pays the full charges until spending reaches $6,440. (This means the individual has spent $4,550 in out of pocket costs, a figure that includes the $310 deductible, the $630 co-payment, and $3,610 in full payments). Costs in excess of $6,440 are considered catastrophic, and Medicare will pay for 95% of these additional expenses.

The gap in coverage between $2,830 and $6,440, with all financial responsibility falling on the consumer, is referred to as the “doughnut hole”. The Affordable Care Act phases in coverage in the gap so that the gap is entirely eliminated by 2020. By 2020, enrollees will only pay 25 percent of their costs until they reach catastrophic coverage (as opposed to the 100 percent they currently pay).

Low-Income Subsidies

Medicare enrollees with low incomes are eligible for subsidies for prescription drug coverage through the Part D low-income subsidy (LIS) program. In 2009, 9.6 million Part D enrollees received low-income subsidies. Dual eligibles and those enrolled in the Medicare Savings Program automatically receive the subsidy; these two groups together account for 8.1 million enrollees, or 65 percent of Part D LIS enrollees. Another 1.5 million applied for the subsidy and qualified based on an income and asset test, and 2.3 million were eligible, but did not receive a subsidy.  

“Full-subsidy eligible individuals” pay no premium, no deductible, and reduced co-payments. Medicare enrollees  receiving full Medicaid benefits (dual eligibles), participants in the Medicare Savings Programs, and Supplemental Security Income (SSI) beneficiaries fall in this category, regardless of their income or assets. This category also includes people with incomes below 135 percent of the federal poverty line. Full-subsidy eligible individuals pay no more than $2.50 for generic and $6.30 for brand-name drugs.

People with incomes between 135 percent and  150 percent of the federal poverty level are eligible for a partial subsidy. Enrollees who belong to this group have a sliding scale monthly premium pegged to their income, a $60 annual deductible, and a 15 percent co-payment for drugs up to $6,440. When their out of pocket expenses reach $4,550 a year, their payments are limited to a co-payment of $2.50 for generic drugs and $6.30 for brand-name prescriptions.

The official Medicare website is www.Medicare.gov

Medicare's Role in Reducing Racial and Ethnic Health Disparities

Medicare makes a vital contribution to reducing disparities in access to medical care among its beneficiaries. Upon reaching age 65, virtually all Americans—rich and poor, minority and white—become eligible for Medicare, and minorities under age 65 constitute a disproportionate share of those who qualify for Medicare on the basis of a long-term disability. All beneficiaries are eligible for the same package of benefits. And the vast majority of health care providers and institutions participate in Medicare, which helps ensure that all beneficiaries have access to services.

Marked disparities nonetheless persist in health care among Medicare beneficiaries, although disparities in the use of health care services by race and income have diminished since the program’s implementation. The 2002 Institute of Medicine report Unequal Treatment found sizable racial and ethnic disparities in health care usage and outcomes among Medicare beneficiaries, even after adjusting for socioeconomic differences and other health care access-related factors. Minority beneficiaries also fall short of whites on many measures of health status. Blacks, for example, have a shorter life expectancy at age 65 than whites, and black beneficiaries are more likely than whites to have chronic conditions, such as hypertension or diabetes. Although many outcomes (such as life expectancy at age 65) have improved for minority beneficiaries in recent years, the same outcomes have also improved for whites, so that the relative disparity has actually increased.

The Centers for Medicare & Medicaid Services, which administers Medicare, has recently undertaken a number of initiatives aimed at reducing disparities. Although these steps are helpful, a report by a National Academy of Social Insurance study panel concludes that a strengthened, multi-pronged strategy will be necessary for Medicare to realize its full potential in reducing racial and ethnic health disparities.

For more information on Medicare and disparities, see:

The official Medicare website is www.Medicare.gov.

Private Health Plans in Medicare

The majority of Medicare beneficiaries, about 76 percent, are enrolled in traditional fee-for-service Medicare, which allows individuals to receive services from any doctor or hospital that participates in the Medicare program. The other 24 percent (11.4 million) voluntarily enrolled in various types of private health plans, primarily health maintenance organizations (HMOs) and preferred provider organizations (PPOs) that participate in the Medicare Advantage (MA) program. MA plans typically require or encourage Medicare enrollees to stay within their network of doctors and hospitals.

MA plans are able to provide enrollees with supplemental benefits to the Medicare-covered benefits if the plan can achieve bids below county benchmarks. In 2010, 54 percent of MA rebates were spent on reducing cost-sharing, 21 percent on added benefits, 13 percent on enhanced Part B benefits, and 12 percent on reduced premiums.

Role of Private Health Plans

The National Academy of Social Insurance's Study Panel on Medicare and Markets found that private plans have made a positive contribution to Medicare, although they have fallen short of meeting all the expectations set for them. It also found that the Congress has established conflicting expectations for private health plans in Medicare that have hampered their performance, produced unexpected consequences, and failed to account for the distinct needs of Medicare beneficiaries. The panel advised Congress to moderate its expectations of savings from private plans, provide targeted incentives to improve quality, and conduct demonstrations setting payments to plans based on competitive bids.

The Medicare Modernization Act of 2003 provides additional federal funding to encourage private plans to participate in Medicare Advantage by increasing payment rates. Historically, participation of plans in Medicare has fluctuated. Proponents of private plans see the funding increase as the needed jumpstart to the program; skeptics claim that payments are excessive. The higher payment rates have encouraged plans to participate in Medicare Advantage, but only time will tell whether Congress will continue supporting higher payment levels to plans, and whether the plans' interest will be sustained.

For more information on Medicare and private health plans, see:

The official Medicare website is http://www.Medicare.gov.

Medicare and Home Care

Medicare covers care at home if the person is recovering from an acute illness, a doctor orders the services, or if the beneficiary is homebound. Coverage is available for people who need skilled, intermittent care. Intermittent care means fewer than seven days a week, or less than eight hours a day.

The coverage includes skilled nursing care and physical, speech, and occupational therapy. For example, a recovering stroke victim could get occupational therapy—assistance with learning anew how to handle the most essential activities of daily life, such as eating and getting dressed.

The coverage may also include the services of a home-health aide, who may help with bathing, dressing, or using the toilet. The home-health aide is a person who does not have a nursing license. The aide's work, assisting a patient with personal care, is not covered by Medicare if these are the only services a patient needs. However they are covered if the patient is getting skilled-nursing care or therapy services.

Example: Ms. Brown has had major surgery, is recovering at home, and her dressings must be changed twice a day by a nurse. She is bed-bound. A nurse is needed to change the dressings. But the patient may also receive help from a home-health aide who will bathe her.

A person can receive home care only if a doctor orders it, and if the person is “normally unable to leave the house.” Home care is limited to less than eight hours a day, and cannot exceed 28 hours a week.

For more information on Medicare and home care, see:

The official Medicare website is www.medicare.gov.

Gaps in Medicare

Medicare DOES NOT cover the cost routine dental care, eyeglasses, hearing aids, and most long-term services and supports. Specifically, Medicare does not cover custodial care, which means the care for people who are unable to live independently, but do not have an acute condition requiring skilled medical services. For example, people with Alzheimer's disease or other dementias living in nursing homes would not have their residential bills covered by Medicare. If they suffered a heart attack, or came down with pneumonia, Medicare would cover medical expenses.

Custodial care in a nursing home typically costs more than $78,000 a year, and is covered for the poor under the Medicaid program. But it requires patients to “spend down,” which means using all their financial assets except $2,000 on the nursing home bill before they become eligible for Medicaid.

Most people enrolled in Medicare have some sort of supplemental insurance to help them pay for the things not covered by Medicare, such as extra days in the hospital. This can be a significant additional expense because the individual is paying premiums, either for retiree health coverage from a former job, or for the supplemental Medigap policies.

According to the Academy's Study Panel on Medicare Financing, "Medicare's benefit package has been criticized widely for its inadequacy, a problem that leads both to the reliance by many on supplemental insurance and to a very high out-of-pocket burden on beneficiaries. The use of supplemental insurance may make the provision of care less efficient for some beneficiaries when it creates first dollar coverage, and the administrative costs of these supplemental policies are relatively expensive. Moreover, beneficiaries already bear a considerable share of the costs of their care and, as noted earlier, a typical elderly beneficiary in traditional “fee-for-service” Medicare spends about 19 percent of her income for medical care and insurance. Even with no change in policy, that share could rise to nearly 30 percent of income for a typical elderly beneficiary in 2025 in the likely event that health care costs continue to outpace income.”

For a more detailed discussion, see:

The official Medicare website is www.Medicare.gov.

What is the History of Medicare?

Medicare was created in 1965 when people over 65 found it virtually impossible to get private health insurance coverage. Medicare has made access to health care a universal right for Americans once they reach age 65. This has helped improve the health and longevity of older Americans.

However, the program was created during an era when the big financial worry was that an illness might put someone in the hospital and generate huge bills. This was a period before the widespread use of prescription drugs to combat illness. The basic design of the Medicare program was modeled on the private insurance system in place in the 1960s. As the health care system has changed, many would argue that Medicare's benefits have not kept pace.

For more on the history of Medicare, see:

The official Medicare website is www.medicare.gov.

The Future of Medicare

The population of Medicare-eligible people began growing rapidly in 2011, when the first of the baby boomers (the generation born in the years 1946 through 1965) reached age 65 and became eligible for Medicare. By the year 2030, when the youngest boomers have reached age 65, Medicare enrollment will nearly double to an estimated 80 million.

Spending for Medicare totaled about 3.6% of the Gross Domestic Product (GDP) in 2010. The figure is projected to rise to 5.1% by the year 2030.

Even with Medicare, many older Americans face large out-of-pocket health care costs. First, most pay premiums for coverage under Part B and Part D of Medicare. Second, they may pay premiums to private Medigap plans or to Medicare Advantage plans to cover items not covered by traditional Medicare. Third, they must make direct payments to doctors, hospitals, and nursing homes for services not covered by their health insurance. The cost of health care has been rising much faster than both the general growth rate of the economy and the increase in Social Security benefits. If current trends continue, income after taxes and health care spending for the typical married couple will be no higher in 2030 than it was in 2000. (See Richard W. Johnson and Rudolph G. Penner, Will Health Care Costs Erode Retirement Security? Center for Retirement Research at Boston College, Issue in Brief No. 23, October 2004.)

For more information on the future of Medicare, see:

The official Medicare website is www.medicare.gov.

Medicare's Fiscal Future

Medicare’s finances are handled through two trust funds, the Hospital Insurance (HI, or Medicare Part A) Trust Fund and the Supplementary Medical Insurance (SMI) Trust Fund.

According to current projections, the Hospital Insurance Trust Fund will receive income of $215.6 billion in 2010 and pay out $247.9 billion in benefits and administrative expenses, leaving a deficit of $32.3 billion for the year. At the end of the year, the HI Trust Fund will hold $271.9 billion in assets. Current income and trust fund reserves will be sufficient to pay hospital insurance benefits through 2024, when the reserves are projected to be depleted. At that point, if no changes are made, scheduled HI income will cover 90 percent of estimated expenditures.

The Supplementary Medical Insurance Trust Fund is always adequately financed because beneficiary premiums and general revenue contribution are set annually to cover the expected costs of Parts B and D of Medicare for the coming year. However, the rapid rate of growth in program costs will place increasing demands on both beneficiaries (to pay the premiums) and taxpayers (to provide the general revenues).

Medicare’s spending is growing rapidly for the same reasons that private health spending is growing rapidly—higher prices, new medical technology and an aging population.

For more information, see:

The official Medicare website is www.medicare.gov.

Health Savings Accounts and Medical Savings Accounts

Medicare Medical Savings Accounts

The Balanced Budget Act of 1997 created a demonstration project for Medicare medical savings account (MSA) plans, but no health plans ever joined the demonstration. The Medicare Modernization Act of 2003 made MSAs a permanent option for health plans in Medicare. As of April 2007, two MSA plans with 2,000 enrollees were participating in Medicare.

A Medicare MSA option has two parts. One part is a Medicare MSA health insurance policy with a high deductible. The other part is a special savings account in which Medicare deposits the difference between the cost of a standard health plan and the cost of the high-deductible plan. Enrollees can withdraw funds from their MSA tax-free to pay for qualifying medical expenses.

Health Savings Accounts

The Medicare Modernization Act of 2003 also created the health savings account (HSA)—a new savings vehicle with special tax advantages that is used only in conjunction with a high-deductible health plan (HDHP). Although created by the Medicare Modernization Act, HSAs are not available to people enrolled in Medicare.

A business may offer a high-deductible health plan and MSA to its workers. An individual who does not have health insurance at work can open a health savings account if he or she purchases a high-deductible health insurance plan.

To be eligible for an MSA, a HDHP must have a deductible of at least $1,100 for an individual and $2,200 for a family in 2008. This means that an individual must pay the first $1,100 each year in medical costs, and a family must pay the first $2,200 in medical bills. Many HDHPs have deductibles that are much higher than these amounts. Also, purchase of certain health care services may not count towards meeting the deductible.

However, the plan is allowed to provide coverage for preventive care, such as an annual physical, mammograms for women, well-baby examinations without a deductible. That might mean a co-payment for the office visit of $20 or $25 when someone gets a physical examination. The purpose of not applying the deductible to preventive services is to encourage their use.

Once an individual has enrolled in an eligible high-deductible health plan, he or she can make a contribution to a health savings account. For 2008, the contribution is limited to $2,900 for an individual and $5,800 for a family. Individuals over the age of 55 can add another $900 to the deposit in the health savings account.

The law says the insurance plan linked to the health savings account must offer financial protection in the event of unusually large medical bills. This requirement aims to prevent an individual or family from being wiped out financially by a catastrophic illness. The out-of-pocket spending limit in 2008 is $5,600 for an individual and $11,200 for a family. Once those figures have been reached, all additional bills are fully covered by the insurance policy.

Both the employer and the worker can contribute to a health savings account. The money can be withdrawn from the account to pay for any qualified medical expenses, meaning any bill submitted by a doctor or hospital. Prescription drugs can be purchased with funds from the account. Payments for over-the-counter drugs also will be reimbursed.

The money is contributed on a pre-tax basis. This can mean significant savings as income rises. The health savings account contribution reduces the tax bill just as an Individual Retirement Account (IRA) deposit would save taxes. For example, a couple in the top tax bracket, 33%, who do not have health coverage through their jobs, might each enroll in an insurance plan with a $2,000 deductible. Each of them deposits $2,000 into a health savings account. They could deduct the $4,000 on their joint federal tax return and save a total of $1,320 on their taxes. The deposit can be repeated each year, offering the same tax savings. The same advantages apply when the money is taken out to pay for medical costs: no taxes are paid.

If the money in a HSA isn't used during the current year, it can be rolled over indefinitely without any penalty from one year to the next. This arrangement differs from the “use it or lose it requirement” applicable to flexible spending accounts (FSAs), which allow workers to use up to $5,000 a year in salary to pay for medical expenses or childcare. In a FSA, any remaining money is lost at the end of the year if it has not been withdrawn to pay bills. Banks, credit unions, insurance companies, or brokerage firms may serve as trustees for health savings accounts, managing the money they contain.

Enrollment in High-Deductible Health Plans and Health Savings Accounts

According to a survey by the Employee Benefit Research Institute and the Commonwealth Fund, 2.3 million people aged 21-64 (1 percent of the privately insured population) are enrolled in high-deductible health plans with a tax-exempt savings account in 2007. Another 12.5 million people have high-deductible plans but no account. (See EBRI Issue Brief No. 315, March 2008.)

Some health experts are concerned that the HSAs could fragment the risk pool for health insurance. It is possible that healthier and wealthier people would opt for the HSAs, because they have the financial resources to handle a large deductible. If this group of people, who are less likely to file medical claims, move in large numbers into HSAs, the pool for comprehensive insurance would have fewer people over which to spread the risk of illness. And many of the people remaining would be those with lower incomes and more serious health problems. Their premiums would rise, reflecting the comparatively high cost of caring for them. However, advocates of HSAs say they would make people more prudent buyers of health care because their own money would be at stake when they decided whether to visit the doctor's office.

Hypothetical Examples of Health Savings Accounts

Jane Smith has a $2,000 deductible insurance plan. She deposits $2,000 into an HSA account. Jane has a healthy year, seeing the doctor twice for office visits when she has a cold and slight fever for which she gets prescription medications. Each office visit costs $35, and the drugs cost another $25 each time, for a total of $120. She pays these expenses from her HSA, leaving a balance of $1880. It carries over into the next year, when she deposits a new $2,000. With the deposit, Jane will have a total of $3,880 for medical bills for the second year. Meanwhile, the account is growing because she has placed the money with a bank, where it is in an interest-bearing savings account.

The money accumulates tax-free, and Jane can withdraw it at any time for medical costs. If the money builds up, it can ultimately serve as a retirement health account. She can use it to pay Medicare premiums, or to pay for long-term care insurance or nursing care, or any other expenses that might arrive along with old age.

Take another individual, John Jones, who also has a $2,000 deductible and opens a $2,000 account. But John isn't as lucky with his health. He undergoes coronary bypass surgery and has a slow recovery, and has a total of $75,000 in medical bills for the year. The coverage provides for 80% payment by his insurance plan and 20% payment by John. He pays the first $2,000, his deductible, and then withdraws the $2,000 from the HSA.

For the remaining $73,000 in medical bills, John's 20% share would be $14,600. However, remember that the out-of-pocket limit for insurance with an HSA is $5,250. John spends $3,250, because he has already paid $2,000, reaching the limit for his personal outlays. All the rest of the money, $69,750, would be paid by the insurance plan.

Next year, John starts fresh with a new $2,000 deposit into his health savings account.

Funds withdrawn for any purposes other than medical care are subject to regular taxation plus a 10 percent penalty.

Money in the account can be used to pay premiums for coverage under COBRA (Consolidated Omnibus Reconciliation Act), which permits an individual to purchase health insurance as part of a former employer's group after a person leaves a job. The former worker must pay 102% of the group rate premium, the full company share plus the worker's share, plus a 2% administrative fee. This can be costly for someone who is unemployed, although it is likely to be less expensive than obtaining an individual insurance policy. Some individuals with health problems might not be able to buy an individual insurance policy because insurers consider them uninsurable, or bad risks. Money from the health savings account could ease this financial burden. COBRA spending for insurance premiums is considered an acceptable use of Health savings account funds.

When an individual reaches age 65, no more contributions are allowed because the individual has now qualified for Medicare. The money in the account can be withdrawn tax free and used to pay for Medicare Part B monthly premiums, or the costs of enrolling in a private health plan that participates in Medicare. The money also could be used for the individual's share of retiree medical insurance from a former employer. These costs can be significant, since many firms are limiting their spending for retiree coverage.