Last week’s annual report from the Medicare Trustees reflects small but noteworthy improvements in the financial outlook of part of the program. Annual growth in Medicare spending per beneficiary slowed to less than 1 percent last year, well below the per capita growth of the economy as measured by gross domestic product (GDP) and enough to push back the projected insolvency date for the Hospital Insurance (HI) Trust Fund (Part A, which pays for inpatient care) to 2026 — two years later than last year’s report.

This is good news but should be seen in context. As Figure 1 shows, annual estimates of HI solvency since 1990 have ranged from four years to 28 years, averaging 13.6 years. So this year’s projection falls just below the 24-year average.

The Trustees Report includes various ways to view Medicare’s fiscal health over time. One metric is to look at long-term projections of Medicare as a share of GDP over the next 75 years. Total Medicare spending includes Supplementary Medical Insurance (SMI, or Part B, which covers physician, outpatient hospital, and some home health costs that are unrelated to a stay in a hospital) as well as prescription drug benefits (Part D). Under the Trustees’ intermediate assumptions, total Medicare expenditures will grow from 3.7 percent of GDP in 2012 to 3.9 percent of GDP in 2020 and 6.5 percent of GDP in 2087, as shown in Figure 2. In the near term — that is, from now through about 2035 — the increase is being driven largely by the increasing numbers of Medicare-eligible baby boomers, who began entering the ranks of beneficiaries in 2011.

The HI Trust Fund. The focus of the media and public on the solvency of the HI Trust Fund reflects its reliance on dedicated revenue sources — unlike SMI, which draws on general revenue to match individual contributions through premiums. While payroll taxes will remain relatively constant as a share of GDP, other relatively minor sources of HI financing will increase slightly, but not enough to cover the projected growth in spending. As a result, the projected HI deficit (the difference between income and outgo) is projected to increase from 0.31 percent of GDP in 2012 to 0.57 percent in 2087, and will average 0.52 percent of GDP over the next 75 years.

Another way to look at the data is to examine the difference between HI income and expenditures as a percent of taxable payroll (that is, all earnings in covered employment). This measure, known as the actuarial balance, answers the question of how much the payroll tax would need to increase to ensure long-term solvency. According to the Trustees’ intermediate assumptions, the projected shortfall over the next 75 years has fallen from 1.35 percent to 1.11 percent of taxable payroll. Accordingly, the HI Trust Fund could be made solvent for the long run by increasing the Medicare payroll tax, now 1.45 percent each for workers and employers, to 2.0 percent.

A 75-year forecast is, of course, highly uncertain for a program paying for health care services and technologies that are bound to change in essentially unknowable ways. An adjustment in the HI payroll tax to achieve solvency for a shorter period of time would be much smaller:  solvency over the next 25 years would require a 0.29 percent increase and solvency over the next 50 years would require a 0.49 percent increase in the payroll tax.

Some analysts prefer to assess Medicare’s financial health in terms of its unfunded obligation, which can be expressed in dollars. It is the difference between the present value of the projected cost of a program over a specified time period and the present value of projected income (including, in Medicare’s case, the initial value of the Trust Fund). In other words, the unfunded obligation is the dollar amount by which outlays  would have to be reduced or revenues to the HI Trust Fund increased to make the program financially sound for the next 75 years. The 2013 Trustees Report estimates that the unfunded obligation of the HI Trust Fund for past, current, and future participants is $4.6 trillion over the next 75 years. This is the equivalent of 1.1 percent of the HI taxable payroll and 0.5 percent of GDP over that period.

The SMI Trust Fund. The SMI Trust Fund is, as previously noted, another story. It has no unfunded obligation because general revenues cover all spending that is not financed by other dedicated funding sources. However, the Trustees Report also provides an estimate of the present value of the required general revenue contributions to Parts B and D of Medicare, equal to $22.4 trillion or 2.4 percent of GDP.

Medicare’s actuaries estimate that the current slow growth in per beneficiary spending – averaging 1.7 percent annually since 2010 – will accelerate after 2015. Much of the recent slowdown in Medicare spending may have been related to the impact of the Great Recession and sluggish recovery rather than driven by underlying changes in the health care system, and the Trustees are not confident that provisions in current law to reduce reimbursements to physicians will be fully implemented. Nor are Trustees persuaded that the providers will see the productivity gains anticipated by the Affordable Care Act. Only time will tell.

Medicare and private insurance. It is certain, however, that Medicare’s cost growth compares favorably to private health insurance, as shown in Figure 3. Since 1997, per capita Medicare spending has grown 3.9 percent annually, on average, compared to 6.3 percent for private health spending. One clear difference between Medicare and private health insurance is the greater impact on private purchasers of the current trend in the consolidation of providers and their ability to drive up prices. Medicare has much greater ability to set prices than even the largest private insurers and can thus keep government payments lower in local healthcare markets, particularly the increasing number of them that lack any competition among providers.

Over the long run, however, Medicare spending is influenced by the same cost drivers that affect the private sector: rising prices charged by providers, greater intensity of services and new medical technologies. Total Medicare spending is also driven by a major demographic change: the impact as the baby boomers acquire their Medicare cards.  The Congressional Budget Office estimates that enrollment in Medicare will nearly double in coming decades, reaching 80 million by 2030.

Comparing Medicare spending with the cost of private health insurance is useful but gets us only so far. The costs of both are being driven by the underlying inefficiencies and excesses of our still largely fee-for-service health care system, and cost-shifting — whether from public to private or vice versa — is not the answer.

Figure-1Source: National Academy of Social Insurance, based on data from Board of Trustees (various years).

Source: Summary of Board of Trustees 2013, Chart C

*Common benefits refers to benefits commonly covered by Medicare and Private Health Insurance. These benefits are hospital services, physician and clinical services, other professional services and durable medical products.
Source: Centers for Medicare & Medicaid Services, 2011.