Medicare: How much more will they cut?

MONEY Magazine -- This is the second-part of MONEY's ongoing series on Medicare.

For all the chatter about how politicians have to buckle down and get serious about reining in Medicare, you might have missed this development: Last year's health reform bill cut $500 billion out of two big Medicare programs over a decade, while increasing the number of high-income retirees who have to pay larger Part B premiums.

"It's as if that never happened," says Jonathan Oberlander, a professor of health policy at the University of North Carolina.

To be sure, health reform wasn't a let's-shrink-the-government project. The reason Democrats got their hands grimy and made cuts to the program was to help pay for a new health care entitlement, making it easier for Americans under 65 to buy their own insurance. Still, the new law shows that liberal lawmakers will slice into Medicare if needed, and offers a glimpse into how they'll try to do it.

The central idea behind the maze of cost-control provisions health reform establishes: Focus on trimming fat before reducing benefits. One approach is to reduce the power of providers to drive spending. When your doctor says you need this test or that surgery, you tend to take his word for it, even if you have hefty out-of-pocket costs. Hospitals, meanwhile, have consolidated in recent decades, giving them considerable price-setting power.

Results: There's substantial evidence that doctors at times over-treat, and you overpay for just about everything. "For a long hospital stay we pay $18,000, vs. $4,000 or $5,000 in Germany or Japan," says Gerard Anderson, director of the Center

Just say no to high prices

One way Democrats try to knock down provider costs is to flatly insist on lower ones. Payments to private insurers who run Medicare Advantage plans have been cut, for instance, and the fees that Medicare pays to hospitals have been curbed as well. That's where the $500 billion in Medicare savings under the new law came from.

The legislation also establishes the Independent Payment Advisory Board, or IPAB, experts appointed by the White House to find ways to restrain Medicare spending growth to GDP plus one percentage point. To override the IPAB's recommendations, Congress would have to come up with its own equivalent cuts.

Will docs say no right back?

The law also sets up programs that aim at changing financial incentives for providers. "The care system in general is set up to pay for how much you do do three CAT scans, you get paid three times," says Donald Berwick, the current head of Medicare. "[The patient] doesn't want CAT scans; she wants to be home and healthy."

The legislation encourages doctors and hospitals to set up networks, which will be rewarded financially if they can show they've kept costs down without compromising your health. (You'd be able to opt out.)

Will such measures save enough money? Since they haven't been tried, no one knows; the CBO, for Jim Capretta, a former George W. Bush administration budget official who is now at a think tank called the Ethics and Public Policy, raise another concern, arguing that government cost controls tend to be blunt instruments.

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In the end, they say, the IPAB or Congress will have to resort to across-the-board payment cuts. And if the cuts get deep enough, hospitals could run into financial trouble. If cuts later extended to doctors, they could decide to stop seeing Medicare patients or quit taking on new ones, just as many now refuse to treat Medicaid patients.

That's why Medicare's own actuary has warned that health reform's cuts may not be sustainable for long. If there started to be serious access issues, says Wilensky, "I think seniors would rise up and take the heads off politicians who let that happen."

What happens in Medicare doesn't stay in Medicare

The pressure to fix Medicare won't just affect seniors; people younger than 65 will be affected too. The likely changes might reduce costs. They could also mean you are less likely to get your coverage through your employer -- or that the coverage you do get will be less generous.

Many liberal solutions to Medicare's woes, for instance, focus more generally on health care reform. "The ability to constrain Medicare costs is limited by what's happening in the private sector," says Bruce Vladeck, who ran Medicare during the Clinton administration.

If Medicare can't be cheap in a country where health care is expensive, the thinking goes, the goal should be to make all medicine more affordable.

What health care reform is (and isn't) doing now

How? UNC's Oberlander says one idea that could gain currency is something called "all payer" pricing, which would make it harder for hospitals to charge different prices to different insurers.

Maryland has a form of this, in which an independent state board sets rates. If it worked (a big if), health plans could have more leverage in negotiating what they pay and providers would have to get more serious about getting efficient.

Other initiatives would more directly affect the kind of insurance you could get. Many Democrats still cherish the idea of adding a public option to the new health insurance exchanges that will start offering plans to people without workplace coverage in 2014.

The belief is that a big public health plan would have lower overhead and more leverage to negotiate. It's also a step toward the kind of tax-financed universal health care system that exists in other rich countries -- which, advocates point out, all spend less on medical services than the U.S. does.

Work plans could take a hit

Health reform did put a cap on this break for the highest-end plans, but it's pretty high. Republicans may be ready to go further, even though it would technically be a tax hike. As President, George Bush supported raising taxes on "Cadillac" health plans, and candidate John McCain wanted to replace the employer tax break with, yes, a voucher.

The upshot of limiting the employer subsidy is that some companies could decide not to offer a health plan because the benefit would become less valuable to current and prospective employees. And those that continued to provide coverage would probably pick lower-cost policies with bigger out-of-pocket costs.

With more of your own money on the line for medical bills, you'd probably become pickier about which insurance plan to go with and what health services you're willing to buy. That, in turn, proponents say, would also help keep a lid on costs.

Raising the eligibility age doesn't help that much. America's other big public retirement benefit, Social Security, saw its fiscal health improve dramatically in 1983, in part because Congress voted to gradually raise the age for full-retirement benefits from 65 to 67.

So it's not exactly a shocker that some reform proponents are now suggesting a similar phased-in boost in the eligibility age for Medicare -- including President Obama, who reportedly floated the idea during the debt-ceiling debate.

Medicare, however, is different from Social Security in important ways that make raising the age limit less of a slam-dunk. For one thing, notes Juliette Cubanski, a Medicare policy analyst at the Kaiser Family Foundation, there is no early retirement option that would allow people younger than 67 to get federal retiree health coverage, albeit with reduced benefits. If you were forced to stop working because of a layoff or illness, your main fallback would be the health exchanges established under reform the ones that many conservatives are hoping to repeal.

The savings aren't huge

Then, too, the Social Security check you get in your sixties, in real terms, is basically the same as the one you'll get at 100. In Medicare, by contrast, 65- and 66-year-olds are generally healthier than older beneficiaries, which makes them the program's cheapest customers.

The CBO estimates that the federal government would spend 0.4% of GDP less on Medicare by 2035 if the eligibility age were raised to 67 starting in 2014. That's a lot of money. But with Medicare on track to eat up almost 6% of GDP by then, it's a long way from being the solution.

There's also a more fundamental problem with raising the eligibility age: "Not a dollar is saved in overall health care costs," argues UNC's Oberlander; the costs would simply shift to other payers and other parts of the federal budget.

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Employers, for instance, would pick up part of the tab via company health plans, and states and the feds would get hit with a bigger Medicaid bill for low-income 65- and 66-year-olds. And since insurance premiums for couples earning less than $59,000 will be subsidized under health reform, part of that cost would end up back with Uncle Sam -- and by extension with you, the taxpayer.

You would also feel a direct hit. If you're 65 or 66 and can't get coverage through an employer, you would have to buy your own insurance. If you're already on Medicare, be prepared to pay slightly higher Part B premiums, which would be needed to cover a pool of people who would be a bit older and sicker than under current law. And if you're younger than 65 and will be buying coverage on the exchanges, you would also face modest premium hikes as more 65- and 66-year-olds are added to the rolls.

You will face higher out-of-pocket costs soon.

As a part of the recent deal to raise the debt ceiling, the congressional super-committee must identify $1.2 trillion in deficit reductions over the next 10 years. (If it can't hammer out an agreement by the end of November, Medicare payments to providers will be cut automatically.) Among the ideas that may be floated are several that could take cash out of the pockets of some current or near retirees:

Streamlining co-insurance and deductibles.

Medicare beneficiaries bear different costs depending on which part of Medicare they tap -- a steep deductible for hospitalization, for instance, and 20% co-insurance for doctors. The recent Bowles-Simpson deficit reduction commission (the committee before the super-committee) proposed creating one deductible of about $550 and applying the 20% co-insurance rate to both hospital and doctor bills. The commission also suggested limiting out-of-pocket costs a key protection that traditional Medicare doesn't now offer. For people who become seriously ill, imposing a maximum on how much you're on the hook for would save serious money. Most beneficiaries would pay an average $500 more a year, a CBO analysis found.

Today the premiums for Medicare Part B are set at 25% of the programs' costs. A proposal in June by senators Joe Lieberman (I-Conn.) and Tom Coburn (R-Okla.) would gradually lift that limit to 35%. If the rule were in place this year, monthly premiums would go from about $115 to $161, according to a study by the Kaiser Family Foundation.

Restrictions on Medigap plans.

Because of the holes in Medicare's coverage, most seniors get supplemental coverage, such as a retiree health plan or private Medigap insurance, which may cover a big chunk of their deductibles and co-insurance. That reduces their incentive to consider less expensive treatment options, which many health economists think is essential for keeping medical costs down. The Lieberman-Coburn plan suggests restricting Medigap protection, allowing the plans to cover as much as 50% of coinsurance up to a certain limit.

That is sure to be wildly unpopular. "The perception that seniors are out there using services willy-nilly because they don't have to pay for them is just not true," says Bonnie Burns, a policy specialist with California Health Advocates. But it's not clear that the change would actually add to most beneficiaries' overall costs, because Medigap plans without such broad coverage would have lower premiums. Kaiser found that on average, enrollees might save a bit, though anyone needing hospital care would be likely to pay more.

Higher premiums for the affluent.

This change may be the one most likely to become law, says Oberlander. In fact, so-called means testing is already in place for Part B and D beneficiaries with earnings of $170,000 for a couple ($85,000 for singles). After that, premiums rise on a sliding income scale, from 35% of program costs (or $162 a month for Part B this year) to as high as 80% ($369). Those thresholds used to be indexed for inflation, but the health care reform law froze them. As a result, about 14% of beneficiaries will have to pay more for their Medicare in 2019.

Even with reforms, this is going to be tough.

Talk to any honest health policy analyst for more than 10 minutes, and you hear a lot of uncertainty. Here is conservative Capretta on how much seniors would pay for insurance under the Ryan-like plan he'd support: "Nobody really knows." Would private policies be affordable? "We hope so. We don't know that," says Gail Wilensky, who ran the Medicare system during the George H.W. Bush administration. (That's why she'd argue for keeping vouchers high enough to buy at least one plan.)

Now here's the liberal Henry Aaron, an economist at the centrist-liberal Brookings Institution, on the cost controls in the Democrats' Affordable Care Act: "We may strike out. None may work."

Aaron cites an economists' joke: If you are driving from L.A. to Boston, the first thing you need to know is to head east. Advocates on both sides think they at least have a functioning compass. But whether you believe spiraling costs can best be cured by spurring competition in the health care market or through government intervention to encourage greater efficiency in the industry, other economic forces are pushing prices higher. And they will complicate everyone's best-laid plans to keep a lid on spending.

First, despite today's tough economy, the country is getting richer in the long run -- and, says Boston University health economist Austin Frakt, richer societies may well prefer to spend a rising portion of their income on health. We have to spend the added wealth on something, and living healthier longer is one of the better options.

If health spending grows one percentage point faster than GDP, a recent study projects, it will eat up 40% of all gains in real income between now and 2050, about the time that today's twenty-somethings achieve senior status. That still leaves 60% of new wealth to spend on everything else.

Second, medical technology keeps getting better. And that adds to the pressure to spend. The health care we want to buy isn't some fixed menu of services; we want whatever a doctor suggests in response to the question, "I am sick -- what can you do for me?"

In the 19th century he had leeches, which did have the virtue of being cheap. By 1966, when Medicare began, he could offer some invasive surgery and a stay in a clean hospital. Today he has 3-D imaging equipment and lasers for keyhole surgery. Tomorrow, who knows?

Get ready for tax hikes

What this means to you is that even if America moves to a more market-driven system, over the long run you can bet that taxes will have to go up to support whatever federal health spending remains. That might make the Tea Party furious, but the fact is, Republicans care about the over-65 vote every bit as much as Democrats do.

On the other side of the political spectrum, the constant thrum of rising costs could force even the most liberal lawmakers to make their peace with benefit cuts, especially for wealthier retirees, and tougher caps on Medicare budgets.

To keep spending more on Medicare makes it hard not only to keep taxes low but to have government do much of anything else. The Urban Institute's Steuerle frames it provocatively as a choice between more $400,000-a-year surgeons or $50,000-a-year teaching assistants.

Automatic caps will hurt

In coming months one idea you'll hear debated a lot is imposing a numerical cap on future government spending or revenue -- say, 21% of GDP or even 18%.

No matter what the specific numbers proposed are, growing health care costs are on a path to push the size of government well beyond those limits. If that happens, Medicare would go from long-term challenge to immediate crisis. Big changes would have to happen fast. Budget hawks ought to be specific about what those changes will be.

All you can know for sure now: This country not just the government, but each of us as individuals -- is facing a monster of a doctor's bill, and there's no easy way to get around paying it.

Additional reporting by Amanda Gengler.

Read the first-part of this series: Medicare: What no one is telling you