Saving Medicare: a cure that will work.

"SUSAN" IS HARDLY THE PERSON YOU'D pick out as the face of Medicare. She isn't collecting benefits. She isn't retired. She isn't even elderly. But her financial and personal decisions are being driven by a mounting pile of medical bills: her dad's. Susan's father, "Sam Jones," a retired hardscrabble rancher in West Texas, eked out enough of a living to put his children through college. But now his body is slowly withering like the harvest in a West Texas drought, the protracted process of death by cancer. Dying is expensive nowadays, and although Sam Jones worked hard all his life, he can hardly afford the high price that most Americans must pay the ferryman--a cost his Medicare insurance only begins to cover. True, if he were absolutely unable to pay his bills, Medicaid would take care of them; but before he could qualify, Sam would have to spend himself into poverty. To help her family avoid this, his daughter Susan, a 27-year-old public-relations specialist in Washington, D.C., is putting her career plans on hold. She's taking a high-paying but unfulfilling job in a distant city she doesn't like, simply for the money. "I can live frugally on about $20,000 a year," she says, "and have a whole lot of money left over to help pay my father's doctor bills. That will really make a difference."

With medical advances allowing most of us to extend significantly our lifespans, a long and (thanks to the same medical advances) costly decay like Sam Jones's is what virtually everyone can now look forward to. And although the rising cost of run-of-the-mill medical expenses is also a major concern, what worries many people most is the prospect of a catastrophic illness wiping out their savings and leaving them or their families financially strapped. The fear is well-founded. Even Medicare, the government program specifically designed to address the elderly's medical needs, is not structured to meet the growing challenge of catastrophic end-stage expenses. More importantly, Medicare itself is now threatened by the spiraling costs of everyday bills being run up by an elderly population that is about to explode. And virtually all plans to rescue it put the burden right back on the Sam and Susan Joneses of the world.

The Medicare Crisis

Instituted in 1965 as Title XVIII of the Social Security Act, Medicare was, until recently, viewed as perhaps the most successful government program in history--as well it should. Not many today remember an America where the old were largely left to live--or, rather, to die--in poverty. Poverty rates were far higher for the elderly than for the population as a whole, perhaps by as much as 50 percent before the New Deal. Social Security helped, but what really began to lift large numbers of older Americans out of this hole was Medicare. Prior to that, half the aged population in this country had no medical insurance, and the coverage that many seniors did have was inadequate.

Medicare has achieved its results through a combination of approaches to the two major sources of medical bills: hospitalization and non-hospital doctor care. The first of these is addressed through Medicare Part A, known more descriptively as Hospital Insurance (HI), whose purpose is to defray some of the cost of hospital stays. Part B, Supplemental Medical Insurance (SMI), covers a portion of everyday expenses like doctors' bills, outpatient services, lab fees, and durable medical equipment.

Unfortunately, the structure of Medicare coverage does little to help the increasing number of people who die after a protracted illness requiring long term hospital stays. After an initial deductible of $736--roughly equal to the cost of one day in the hospital--Part A picks up all hospitalization costs for the next 60 days. Beyond that, the patient is increasingly on his own for the remainder of that particular "spell of illness"; after 150 days, Medicare can stop reimbursing the patient altogether. If he gets better and leaves the hospital, he then becomes eligible for a new round of Medicare payments (after the deductible) for any subsequent "spell of illness" But if instead that original spell of illness requires hospitalization beyond 60 days--in other words, if the illness is catastrophic--well, that just isn't Medicare's problem. Neither are the mounting co-payments and drug expenditures for those who don't just go quietly into that good night.

Meanwhile, Medicare faces catastrophic expenses of its own, for reasons with which many of us are by now familiar. Part of the problem is demographic: The elderly population is increasing dramatically and living significantly longer. In the next three decades, the number of Americans over 70 will double, and those over 85 represent the fastest-growing segment of our society. As people grow older, they need more--and more expensive--care. Those over 65 see a doctor or enter the hospital about twice as often as younger Americans and spend about four times what the non-elderly spend on care.

The situation is made worse by the rising cost of health care itself. The astounding advances in medical science that allow us to alleviate pain, make life more livable, and extend or save lives in ways previously unimaginable are also terribly expensive. Just about everyone wants these new technologies, and when someone else--the government or insurance companies--is footing the bill, just about everyone chooses them.

Together, these developments have taken quite a toll on Medicare's financial health. Part A (HI) is paid for, like Social Security, through a "trust fund" fed by a payroll tax on all current workers. And, like Social Security, the fund operates on a pay-as-you-go system: The money current retirees paid in was used long ago to care for the prior generation of retirees, and seniors today are spending the money coming in from the payroll taxes of current workers. Unfortunately, they are spending it faster than the working populace can replenish the fund. Cash flow in Medicare Part A, which provided $103 billion for 36 million patients last year, turned negative for the first time in 1996, and by 2001 (or sooner), its $134 billion in reserves will be exhausted. At that point, Medicare won't have the money to pay the benefits currently promised.

Part B (Supplemental Medical Insurance), constitutes more of a traditional insurance program. Subscribers pay a monthly premium of about $43.80. In turn, after they've exceeded a low annual deductible of $100, Medicare covers 80 percent of their everyday medical bills. Though a purely voluntary program, Part B is held by 99.9 percent of those who are eligible. Small wonder: Thanks to large government subsidies, it's a good deal. The premium paid by beneficiaries covers only 31.5 percent of program costs--for which seniors have the politicians to thank. Over the years, Congress has found it much easier to promise higher benefit levels than to enact a means to pay for them. Thus, although the Part B deductible has doubled over Medicare's 30-year existence, to keep pace with actual medical inflation it should have occupied. As a result, the percentage of program costs paid by Part B beneficiaries has fallen from its original 50 percent, to as low as 25 percent. The rest is paid by the government out of general revenues. In other words, since there's no trust fund, SMI itself can't go "bankrupt"; instead, the rest of us can go bankrupt because nearly three-quarters of the program's cost comes out of general tax revenues each year. And these costs--like the costs of medical care--keep going up.

The result of all this is that the Medicare program now costs more than $200 billion a year, accounting for more than 10 percent of all federal spending, and ranking behind only defense, Social Security, and interest payments on the debt. And still the cost continues to rise--to the tune of 10 percent each year.

Catastrophic Policies

Clearly, someone must undertake radical surgery to stop Medicare's hemorrhaging--as well as to protect the elderly and their families from being bankrupted by long illnesses. Preferably, this would be done in a way that didn't ask fixed-income elderly of modest means to shoulder more than their fair share. Unfortunately, none of the plans offered during the last Medicare debate in Congress would have done the job.

In 1995, President Clinton proposed a slight reduction in overall Medicare spending, that, nonetheless, would have allowed per-patient expenditures to rise at a rate just below the private sector's 7.1 percent annual growth rate. In addition, the plan would have cut Part B premiums and actually created new benefits. Even the administration admitted that its proposal would have ensured the solvency of Medicare-Part A only through 2011--a safety-valve, but hardly a solution.

The GOP took a tougher stand. As part of their 1995 deficit reduction plan, House Republicans under the banner of "saving Medicare" passed legislation to cut the projected increase in Medicare spending from 10 percent a year to 6.4 percent. Though unsuccessful, this move by the House led to a heated partisan debate (which Democrats were all too happy to continue into the election year) over whether the GOP's approach constituted a heartless "cut," as the Democrats insisted, or a responsible "slowdown in the rate of growth," as Republicans claimed. In fact, it could be honestly portrayed as both: The increase in Medicare spending must be slowed, which means reducing either the number of beneficiaries or the level of spending per beneficiary. And since the number of beneficiaries is largely beyond policymakers' control (the eligibility age could be raised but not by enough to make a real difference), the amount spent on each person must be cut. Period. Gingrich and company deserve some kudos for having the guts to tell that to the American public.

But the kudos end there. The $270 billion that Republicans sought to cut from Medicare was double what was actually needed to stabilize the trust fund, feeding suspicions that the real intent of this cut was to help pay for the GOP's $245 billion tax break proposal--which would mainly benefit the affluent. Moreover, the mechanism by which Republicans proposed to reduce spending would have disproportionately hurt the poor and sick, while leaving the wealthy and healthy largely unscathed.

To begin with, the Republican plan would have doubled the Part B premium. By the year 2000, this would have cost the average older person about $500 out-of-pocket annually to maintain the level of coverage they currently receive. If you're living on $100,000,a-year, that's $500 you'd rather not spend, but you can afford it; if you're living on $10,000, you are looking at a 5 percent cut in real income.

The Republicans also proposed giving the elderly a choice between traditional "fee-for-service" Medicare and a managed-care version of Medicare. But recent studies suggest that seniors fare better under fee-for-service care. In February 1994, a government-funded study by the Center for Health Policy Research in Denver found that seniors who depended on Medicare to pay their doctor bills received superior home care to those using an HMO. In addition, the seniors least likely to find managed care enticing--or courting them--are those with the biggest medical needs. Thus, the poorest and neediest would remain in the fee-for-service system while the private sector "cherry-picked" healthier, wealthier seniors who already consume fewer medical services. Such an arrangement, by itself, would actually increase government outlays for Medicare (see sidebar, page 14).

But the most radical change Republicans want to offer seniors is the option of investing their Medicare benefits in a Medical Savings Account (MSA). The GOP passion for the MSA may have something to do with the fact that it is an insurance product pioneered by the Golden Rule Insurance Co., a major contributor to Newt Gingrich and his congressional proteges. All the same, the plan has its merits. Every year seniors would receive a cash benefit with which to pay their medical expenses. At year's end, any amount they hadn't used would be theirs to keep, providing the perfect incentive for recipients to cut back on needless health-care spending. Combine this with a plan to cover all medical expenses above a very high deductible--$3,000 per year is the amount usually bandied about--and voila! you have a recipe to encourage health-care consumer consciousness, while ostensibly providing protection against bankruptcy.

MSA proponents estimate that by making patients pay their own bills for a change, the share of GNP going to health care would drop by anywhere from 25 to 50 percent--thereby lowering medical costs and making health care more affordable for everyone. It's hard to argue with: Medical inflation due to over-consumption of expensive care has become a national problem. That, as much as unavailability of care, was the focus of the Clinton health plan--just as it is with these conservative counterparts.

Republicans claim that under the MSA plan seniors would get a sweet deal. Medicare beneficiaries would be given a voucher equal to 95 percent of the value of their current Medicare Part A, which, together with the premium they currently pay for Part B, would have come to $4,848 last year. And because they would no longer need to spend the average $1,178 on "Medigap" premiums--extra insurance that most seniors carry to handle costs not covered by Medicare--most would start out with $6,026 in extra cash. Out of this, they would pay a premium of about $2,740 to receive their new catastrophic coverage with the $3,000 deductible. This would leave them with $3,286 in their MSA. So even if poor health necessitated their spending the full amount up to the deductible, they would still end the year with an additional $286 in the bank. Not bad.

The trouble is, for the 30 percent of seniors too poor to purchase additional insurance (and who therefore don't currently set aside $1,178 of their own money each year for "Medigap"), the MSA plan would represent only $4,848 in extra cash. Once they'd paid the $2,740 premium for catastrophic coverage, they would have only $2,108 left in their MSA--meaning that, if they fell seriously ill, they would have to pay an additional $1,000 out of their own pocket before satisfying the $3,000 deductible.

So, besides returning us to the pre-Medicare world in which medical inflation and waste--and government involvement and taxes--were lower, the MSA plan would also return us to the pre-Medicare world in which those seniors with enough money got all the medical care they wanted and those with too little money got too little care. Not all health care spending is frivolous, and those people who have necessary and costly medical expenses wouldn't get to save much out of their MSA allotment. Healthier old people--who also tend to be wealthier old people--would be able to use MSAs to build up their portfolios while less healthy (i.e., less wealthy) elderly would not. Poor seniors would face difficult choices if necessary care cost more than their cash benefit, but less than the deductible. In essence, the risks of higher costs would be borne more onerously by those more likely to fall ill and those for whom high costs loom proportionately larger. Think of it as means testing in reverse.

Even conservatives concede--albeit grudgingly--that the MSA plan needs to be made more equitable. Cato Institute economists Doug Bandow and Michael Tanner have suggested that "if necessary, vouchers could be provided to low income elderly, sufficient to enable them to cover part or all of the added deductible." Well, many Americans believe that it is "necessary" to make access to medical care available to all on some basis other than their wealth. But we need not jury-rig a means-tested voucher onto an independently crafted catastrophic coverage system. In fact, distributing separate vouchers for the needy is so obvious a welfare device that it would be unlikely to survive more than a few years if it were ever enacted to begin with. A better idea: borrow the "catastrophic coverage" concept from the MSA plan, and from that build a program that is universal, but makes allowances for beneficiaries' particular financial situations.

The Solution

The key to establishing fair, catastrophic Medicare coverage is to recognize that a "catastrophic illness" is defined in terms of an economic calamity, not a medical one. Certainly it is a tragedy when a serious, or even fatal, illness strikes you or a family member, but that is not what health care economists and policymakers mean when they call an illness "catastrophic;' And, of course, what constitutes an economic disaster for a Brooklyn cab driver might run about the same as a night at the Met for a Manhattan lawyer. The best way to address this economic reality is to develop a plan that makes the dollar level at which a household qualifies for "catastrophic" coverage a function of income, thus creating a benefit that is both universal and targeted.

So how exactly would a "means-tested" catastrophic Medicare plan work? In its simplest form, a family's deductible (the initial amount it must pay out-of-pocket before Medicare takes over the bills) could be set as a flat percentage of household income, say, 10 percent. If our Upper East Side lawyer with his $200,000 a year income were over 65, once he spent $20,000 on health care, his catastrophic coverage would kick in and Medicare would handle the rest. Such a system would address the need for "market discipline" in controlling medical costs (most consumers would pause before sinking a tenth of their income into unneeded tests and treatment) as well as the desire of most Americans for protection against overwhelming expenses. And since everyone, not just the poor, would be covered when their medical bills became "catastrophic," the plan is less likely than a voucher system to be labeled-horror of horrors--a "welfare program"

In real economic terms, however, 10 percent hits recipients differently depending on whether they make $15,000, $50,000 or $500,000, since the percentage of income normally devoted to medical expenses, or needed for other necessities, declines as income rises. The system could therefore be refined by decreasing the percentage cap amount as income declines. So, instead of spending up to 10 percent of his income, our cab driver making $20,000 a year would only have to spend, say, 5 percent of his annual earnings before his catastrophic coverage was activated. This percentage could, in fact, decline to near-zero--retaining some minimal deductible to deter utterly frivolous use of medical resources--at some income near the poverty line.

An alternative would be to vary not the percentage of income where catastrophic coverage kicks in, but the co-payment rate on all medical expenses below this cap--the percentage of the bill borne by the patient instead of the insurer--so that the out-of-pocket cost for care below the catastrophic threshold would pose a reasonable deterrent to frivolous consumption but would nonetheless be manageable on the patient's budget.

In either case, this extra subsidy component is more obviously a "welfare" program--but less obviously so than current social welfare programs, which are not integrated in any fashion with efforts to benefit the middle-class or the well-to-do. Under the new system, every older American would receive protection against catastrophic medical expenses and be given responsibility for intelligent management of medical resources below that catastrophic level. But what "catastrophic" means would be recognized to vary from family to family as, in fact, it does in the real world.

Lien on Me

One further refinement: Some analysts object to catastrophic coverage because once a patient has met the high deductible and is completely covered by Medicare, he has no incentive to control spending. After all, why not order up that sixteenth CAT scan if dear ol' Uncle Sam is signing the checks?

To re-inject fiscal discipline, a means-tested lien could be placed on a person's estate for recovery of expenditures that exceeded his total contribution to Medicare. (As veteran health care specialist Barbara Boyle Torrey put it, such a system would truly be "pay as you go.") The clear advantage of this arrangement is that it would allow Medicare to tap beneficiaries' assets--the better measure of ability to pay, especially among the elderly, who tend to be relatively income-poor but asset-rich. And as with the catastrophic deductible, the lien would be means-tested so that it bore a reasonable relationship to the size of any estate left behind. Furthermore, collection could be postponed until after the death of both the patient and the surviving spouse so as to avoid the specter of yanking away a sick old woman's house upon her husband's passing. Nonetheless, if people knew that part of the cost of their health care was to be deducted from their estates, they would choose their treatments more judiciously. And, as one former OMB analyst notes, "If they didn't, at least some of the costs of inefficient use would be recovered?'

What would all of this mean for people like Sam Jones and his daughter Susan? Most prominently, it would mean that Susan and the rest of her family could stop worrying about how to pay for Sam's illness. When expenses reached a catastrophically unaffordable level, as they did long ago for Sam, they would be assumed by Medicare. The bills would not continue to mount threateningly. Then if Sam were to die with substantial assets, a portion of those--keyed to the size of his estate and the level of Medicare benefits he received in excess of the amount he paid into the system over the years--would be reclaimed. But not until after his wife's death. In any event, the Jones's ability to provide for Sam's care and still maintain their own lives would be secured.

Where would the money for this security come from? Some from the post-mortem recoupment of assets. Most from asking Medicare beneficiaries to assume a larger out-of-pocket burden (compared to what they currently pay) during those years in which their medical expenses were significant, but not catastrophic. Most years, of course, Jones--and any other senior--would not incur higher medical costs, because the majority of beneficiaries use few resources in any given year. Some years, however, even moderate income elderly--not to mention the wealthy--might have to pay more than under the current program. This greater potential exposure is the price of not only salvaging the program, but changing it to provide coverage against even greater outlays the coverage most families most want-and making the level of that exposure more equitable for most Americans.

In 1988, Congress actually tried to add a catastrophic care component to Medicare, but had to repeal it within a year in the face of an uprising of the affluent elderly. At that time, however, the change was being sold as an "improvement" to a system that was thought to be in good working order. As soon as some influential seniors--including retired employees of the federal government, for whom Uncle Sam pays most "Medigap" costs--figured out that the system then under consideration would increase their premiums, they launched a revolt.

Today, however, we aren't talking about improving Medicare, but about saving it. The impending bankruptcy of the trust fund looms large, and--for all of its partisan posturing--last year's campaign squabbling over Medicare spotlighted the issue even further. So although attempts to overhaul the system might necessitate certain concessions (such as grandfathering in federal retirees), much of the voting public recognizes that, unless something changes, the program soon won't be around for any of us to rely on.

An income-sensitive catastrophic program would provide a measure of hope, not so much for the growing elderly population, but for the younger Americans who are increasingly asked to assume the burden of our current system. The health care that younger people like Susan Jones received might be substantially cheaper--as suggested by the estimates upon which conservative catastrophic plans are based--because greater consumer discipline would be injected into day-to-day health-care spending decisions. And if such a scheme were extended to cover all Americans, there just might be simple, affordable, and relatively non-bureaucratic national health insurance that would lower costs for all, and make care accessible for those currently without coverage. So, one day, when Susan had children, they could grow up with the same promise of medical attention that we currently reserve only for the rich and the aged.