Medicare plays a major role in the health care system, accounting for 20% of total national health spending in 2014, 29% of spending on retail sales of prescription drugs, 26% of spending on hospital care, and 23% of spending on physician services.1 This issue brief includes the most recent historical and projected Medicare spending data from the Centers for Medicare & Medicaid Services (CMS) Office of the Actuary (OACT), the 2016 annual report of the Boards of Medicare Trustees2 and the 2016 Medicare baseline and projections from the Congressional Budget Office (CBO).3
Medicare benefit payments totaled $632 billion in 2015; just under one-fourth was for hospital inpatient services (23%), 12% for the Part D drug benefit, and 11% for physician services (Figure 2). More than one-fourth of benefit spending (27%) was for Medicare Advantage private health plans covering all Part A and Part B benefits; in 2016, 31% of Medicare beneficiaries are enrolled in Medicare Advantage plans.4
Both in the aggregate and on a per capita basis, Medicare spending growth has slowed in recent years. While spending is expected to continue to grow more slowly in the future compared to historical trends, there are signs that spending growth could increase at a faster rate than in recent years, in part due to rising prescription drug spending, growing enrollment in Medicare, increases in provider payments, and higher growth in input prices for medical care.5 Net Medicare spending is projected to grow modestly as a share of the federal budget and the nation’s economy in the next ten years.
Historical Trends in Medicare Spending
Trends in Total and Per Capita Medicare Spending
The recent years have seen a notable reduction in the growth of Medicare spending compared to prior decades, both overall and per beneficiary.
- Average annual growth in total Medicare spending was 4.4% between 2010 and 2015, down from 9.0% between 2000 and 2010, despite faster growth in enrollment since 2011 with the baby boom generation reaching Medicare eligibility age (Figure 3).
- Average annual growth in spending per beneficiary averaged just 1.4% between 2010 and 2015, down from 7.4% between 2000 and 2010.
Slower growth in Medicare spending in recent years can be attributed in part to policy changes that took effect as part of the Affordable Care Act (ACA) and the Budget Control Act of 2011 (BCA).6 The ACA included reductions in Medicare payments to plans and providers and introduced delivery system reforms that aimed to improve efficiency and quality of patient care and reduce costs, including accountable care organizations (ACOs), medical homes, bundled payments, and value-based purchasing initiatives. The BCA lowered Medicare spending through sequestration that reduced payments to providers and plans by 2% beginning in 2013. In addition to policy changes implemented through legislation, the trajectory of Medicare spending in recent years has shifted downward due to slower growth in prescription drug spending, a reduction in inpatient hospital readmissions, a sharp decline in home health spending, and recoveries from program integrity efforts.
Spending trends for medicare compared to private health insurance
Over the past 25 years, Medicare spending has grown at a slightly slower rate than private health insurance spending on a per enrollee basis. With the recent slowdown in the growth of Medicare spending, the difference in growth rates between Medicare and private health insurance spending per enrollee widened.
- Between 1989 and 2014, Medicare spending per enrollee grew at an average annual rate of 5.5%, somewhat slower than the 6.3% average annual growth rate in private insurance spending per enrollee over these years.7
- Between 2000 and 2010, per enrollee spending growth rates were comparable for Medicare and private insurance (Figure 3). Between 2010 and 2015, however, Medicare per capita spending grew considerably more slowly than private insurance spending, increasing at an average annual rate of just 1.4% over this time period, while average annual growth in private health insurance spending per capita increased at just over twice that rate (3.0%).
Medicare Spending Projections
Short-term spending projections for the next ten years
Looking ahead, net Medicare spending (that is, mandatory Medicare spending minus income from premiums and other offsetting receipts) is projected to increase from $591 billion in 2016 to $1.1 trillion in 2026, according to CBO. CBO projects total Medicare spending to increase from $695 billion to $1.3 trillion over this time period (Figure 4).8 Net Medicare spending is projected to grow modestly as a share of the federal budget and the nation’s economy over the next ten years. Between 2016 and 2026, Medicare’s share of the budget is projected to increase from 15.2% to 16.8%, while Medicare spending as a share of the gross domestic product (GDP) is projected to increase from 3.2% to 3.9%.
Spending growth rate projections
- Average annual growth in total Medicare spending is projected to be 7.1% between 2015 and 2025, faster than the 4.4% average annual growth rate between 2010 and 2015.
- On a per capita basis, Medicare spending is projected to grow at a faster rate between 2015 and 2025 (4.3%) than it has in recent years, but somewhat more slowly than average annual growth in per capita private health insurance spending over this time period (4.8%) (Figure 5).
- Medicare per capita spending is not expected to grow uniformly across the coming ten-year period, however. Average annual per capita spending growth is expected to be slower in the first five years of the projection period than in the last five years: 3.9% between 2015 and 2020, increasing to 4.7% between 2020 and 2025.
Rising prescription drug spending
- OACT projects a comparatively higher per capita growth rate in the coming years for Part D than for the other parts of the program due to higher costs associated with expensive specialty drugs. Per capita spending growth is projected to be 5.8% for Part D, compared to 3.2% for Part A and 4.6% for Part B (Figure 6).
Long-term spending projections
Over the longer term (that is, beyond the next ten years), both CBO and OACT expect Medicare spending to rise more rapidly relative to GDP due to a number of factors, including the aging of the population and faster growth in health care costs than growth in the economy on a per capita basis. According to CBO’s most recent long-term projections, net Medicare spending will grow from 3.2% of GDP in 2016 to 3.9% in 2026, 5.0% in 2036, and 5.7% in 2046.9
Over the next 30 years, CBO projects that “excess” health care cost growth10 will account for a somewhat larger share of projected growth in spending on the nation’s major health care programs (Medicare, Medicaid, and subsidies for ACA Marketplace coverage) than the aging of the population.11 CBO cites new medical technology and rising personal income as the driving factors behind projections of rising health care costs. At the same time, CBO notes that the projected rate of excess cost growth in Medicare spending for the coming years is lower than the historical rate of growth, based on the expectation that use of Medicare services will continue to grow slowly and on the smaller provider payment updates called for under current law relative to past payment increases.12
How Is Medicare Financed?
Medicare is funded primarily from three sources: general revenues (42%), payroll taxes (37%), and beneficiary premiums (13%) (Figure 7).
- Part A is financed primarily through a 2.9% tax on earnings paid by employers and employees (1.45% each) (accounting for 88% of Part A revenue). Higher-income taxpayers (more than $200,000/individual and $250,000/couple) pay a higher payroll tax on earnings (2.35%).
- Part B is financed through general revenues (73%), beneficiary premiums (25%), and interest and other sources (2%). Beneficiaries with annual incomes over $85,000/individual or $170,000/couple pay a higher, income-related Part B premium reflecting a larger share of total Part B spending, ranging from 35% to 80%. The ACA froze the income thresholds through 2019, and beginning in 2020, the income thresholds will once again be indexed to inflation, based on their levels in 2019 (a provision in the Medicare Access and CHIP Reauthorization Act of 201513). As a result, the number and share of beneficiaries paying income-related premiums will increase as the number of people on Medicare continues to grow in future years and as their incomes rise.
- Part D is financed by general revenues (77%), beneficiary premiums (14%), and state payments for dually eligible beneficiaries (10%). As for Part B, higher-income enrollees pay a larger share of the cost of Part D coverage.
- The Medicare Advantage program (Part C) is not separately financed. Medicare Advantage plans such as HMOs and PPOs cover all Part A, Part B, and (typically) Part D benefits. Beneficiaries enrolled in Medicare Advantage typically pay monthly premiums for additional benefits covered by their plan, in addition to the Part B premium.
Assessing Medicare’s Financial Condition
Medicare’s financial condition can be assessed in different ways, including estimating the solvency of the Medicare Hospital Insurance (Part A) trust fund, and comparing various measures of Medicare spending—overall or per capita—to other spending measures, such as Medicare spending as a share of the federal budget or as a share of GDP. Such measures are also used in the context of broader discussions of the national budget and federal debt and in the Independent Payment Advisory Board (IPAB) process, described below.
Solvency of the Medicare Hospital Insurance Trust Fund
The solvency of the Medicare Hospital Insurance trust fund, out of which Part A benefits are paid, is one way of measuring Medicare’s financial status, though because it only focuses on the status of Part A, it does not present a complete picture of program spending overall. The solvency of Medicare in this context is measured by the level of assets in the Part A trust fund. In years when annual income to the trust fund exceeds benefits spending, the asset level increases, and when annual spending exceeds income, the asset level decreases. When spending exceeds income and the assets are fully depleted, Medicare will not have sufficient funds to pay all Part A benefits.
Each year, the Medicare Trustees provide an estimate of the year when the asset level is projected to be fully depleted. The Trustees now project that the Part A trust fund will be depleted in 2028, two years earlier than was projected in 2015, attributable to lower payroll tax receipts and a slowing rate of reduction in inpatient utilization (Figure 8).
Because of slower growth in Medicare spending in recent years, the solvency of the Part A trust fund has been extended further into the future compared to projections before the ACA was passed. Part A trust fund solvency is also affected by the level of growth in the economy, which affects Medicare’s revenue from payroll tax contributions, by overall health care spending trends, and by demographic trends—of note, an increasing number of beneficiaries—especially between 2010 and 2030 when the baby boom generation reaches Medicare eligibility age—and a declining ratio of workers per beneficiary making payroll tax contributions.
Part B and Part D do not have financing challenges similar to Part A, because both are funded by beneficiary premiums and general revenues that are set annually to match expected outlays. Expected future increases in spending under Part B and Part D, however, will require increases in general revenue funding and higher premiums paid by beneficiaries.
The Independent Payment Advisory Board
The Independent Payment Advisory Board (IPAB), authorized by the ACA, is a new approach to controlling Medicare spending. IPAB is required to recommend Medicare spending reductions to Congress if projected spending growth exceeds specified target levels. The Board is to consist of 15 full-time members appointed by the President and confirmed by the Senate. To date, however, no members have been appointed, and in fact there have several attempts by Congress to repeal the Board altogether.14
IPAB is required to propose spending reductions if the 5-year average growth rate in Medicare per capita spending is projected to exceed the per capita target growth rate, based on general and medical inflation (2015-2019) or growth in the economy (2020 and beyond). If there are no Board members appointed when a proposal for spending reductions is required, the Secretary of Health and Human Services is responsible for making recommendations to achieve the required spending reductions.
Based on its most recent Medicare spending growth rate projections relative to the targets, OACT has estimated that the IPAB process will first be triggered in 2017 (Figure 9). This would initiate a three-year cycle ending with spending reductions implemented in 2019. OACT also projects that spending growth will exceed the target growth rate in 2022, 2024, and 2025. CBO has projected that Medicare spending growth will be below the target growth rate for each fiscal year through 2018, but will exceed the target growth rate in 2019, 2024, and 2026. Based on its IPAB projections, CBO estimates Medicare savings of $8 billion as a result of the IPAB process between 2019 and 2026.15
The Future Outlook
While Medicare spending is on a slower upward trajectory now than in past decades, total and per capita annual growth rates appear to be edging away from their historically low levels of the past few years. This raises several questions about recent spending trends and projections for future spending growth: Can the recent slowdown in Medicare spending be sustained and can this be done without adversely affecting access to or quality of care? How are payment and delivery system reforms influencing spending levels? How will future spending be affected by Medicare’s new approaches to physician payment that will be established pursuant to the 2015 law known as MACRA?16 What steps could be taken to moderate the projected growth in Medicare spending due to the availability of new specialty drugs and medical technology?
A number of changes to Medicare have been proposed that could help to address the health care spending challenges posed by the aging of the population, including: restructuring Medicare benefits and cost sharing; eliminating “first-dollar” Medigap coverage; further increasing Medicare premiums for beneficiaries with relatively high incomes; raising the Medicare eligibility age; shifting Medicare from a defined benefit structure to a “premium support” system; and accelerating the ACA’s delivery system reforms. At the same time, changes have been proposed to improve coverage under Medicare in order to limit the financial burden of health care costs on older Americans and younger beneficiaries with disabilities, though such changes would likely require additional spending. In addition to these potential changes, which would affect future spending levels, revenue options could also be considered to help finance care for Medicare’s growing and aging population.17
The prospects for these and other proposals that would affect Medicare spending and financing are unknown, but few would question the importance of carefully deliberating ways to bolster the Medicare program for today’s beneficiaries and for the growing number of people who will depend on Medicare in the future.