GOVERNMENT Government can not exactly be described as an industry segment but it has significant effect on the rest of the industry in every segment. Due to this big effect, we agreed that the two major effects of the government come in the form of Medicare and Medicaid. These two programs effect millions of people and eventually the health industry overall. Analyzing these programs that are very complex and intertwined with each other was a complex job. Even though we tried our best to separate them as two different segments, many problems are similar.

We believe this information is essential while analyzing the rest of the industry. MEDICARE AND MEDICAID A) MEDICARE HISTORICAL CONTEXT Medicare was enacted in 1965 under Title XVIII of the Social Security Act to help older persons obtain and pay for medical care. In the early 1960s before Medicare, only about half of older Americans had any health insurance, compared to 75 percent of those under 65. Some people, seeking private coverage, were denied on the basis of age or pre-existing conditions. Others could not afford it.

Medicare is divided into two parts: Hospital Insurance (Part A) and Supplementary Medical Insurance (Part B) which represent two of the four Social Security Trust Funds (the others address retirement/survivors and disability income). In 1972, the program was extended to certain people under age 65: those with kidney failure and those receiving Social Security Disability Insurance (DI) benefits for at least two years. WHO IS ELIGIBLE FOR MEDICARE? In 1994, Medicare covered 36 million people (32 million aged and 4 million disabled), including: a) Persons age 65 and over eligible for Social Security benefits (including retired workers, spouses of retired or disabled workers or surviving spouses); b) Persons under age 65 receiving DI for two-years (including workers and their surviving spouse or adult disabled child); c) Persons of any age with end-stage renal disease (ESRD) (including workers, spouses, or children); and persons, age 65 or older, who are otherwise not eligible but elect to enroll by paying a monthly premium ($261 in 1995). As a “social insurance” program, Medicare Part A is an earned benefit for most people and requires no premium upon eligibility. In contrast, participation in Part B is voluntary for a monthly premium ($46.10 in 1995). In 1994, over 98 percent of older and 88 percent of disabled beneficiaries elected Part B.

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MEDICARE S IMPORTANCE IN THE OVERALL HEALTH INDUSTRY Medicare is a major payer in the U.S. health care system, accounting for 28% of all hospital and 20% of all physician payments. It also covers 45 percent of health care spending for the elderly overall, but less for the oldest old, who require more nursing home care. MEDICARE EXPENDITURES AND ENROLLMENT In 1994, Medicare outlays were $163 billion. Approximately 9 percent of Medicare spending is for disabled beneficiaries, 5 percent for those with end-stage renal disease (ESRD), and the rest for the aged. About five percent of enrollees account for 50 percent of spending. Beneficiaries with ESRD incur the highest costs per person.

PROBLEMS AND WORRIES ABOUT FUTURE Medicare is projected to grow at an average rate of about 10 percent per year and spending is projected to reach over $450 billion in 2005 under current law. Over time, Medicare spending has grown as a percentage of the federal budget and of gross domestic product (GDP). Simultaneously, health care costs have outpaced the incomes of older and disabled persons. What drives these growth figures? In the near term, Medicare projections primarily are based on expected increases in medical prices and the volume and intensity of services and new technologies. These are largely the same factors causing spending growth in the private sector, although Medicare’s population is generally in poorer health. Over the long-term powerful forces are projected to push up costs and, thus, expenditures.

Technological change is likely to continue being a cost-driver. In combination with technology, our demographics are also changing, i.e., our society is “aging” as a result of the retirement of the baby boom and longer life expectancy. Unless dramatic new ways are found to attain efficiency in Medicare, changes will have to occur in enrollment, benefits, or funding. COST CONTAINMENT EFFORTS Efforts to control Medicare costs have taken many forms, such as fee limits or utilization review to reduce unnecessary services. In the early years, controlling prices to reduce program spending was frequently undermined because the total volume of services rose. In 1983, the Prospective Payment System (PPS) was created, which set limits on hospital reimbursement for inpatient care by establishing a set amount to be paid for each patient’s case, depending on the medical condition or “diagnosis-related group.” Hospitals were no longer paid for whatever treatment they provided.

Beginning in January 1992, the Medicare Fee Schedule for physician services was implemented. The fee schedule uses a “resource-based relative value scale,” which sets a relative value according to the time and complexity of the service performed, rather than paying physicians their usual or customary fees. Despite these changes, Medicare expenditures continued to grow, albeit at a slower rate than might have occurred otherwise (see Table-1). In recent years, skilled nursing facility and home health have grown much faster than hospital and physician care. MEDICARE FINANCING Two trust funds are used to finance the Medicare program, the Hospital Insurance (HI) Trust Fund and the Supplementary Medical Insurance (SMI) Trust Fund. Current employees and their employers each pay 1.45 percent of a worker’s salary (self employed workers pay 2.90 percent) to HI. The trust fund also receives interest earned on trust fund balances and revenue from some taxes on Social Security benefits.

The HI trust fund, in contrast to the Social Security retirement trust fund, is not accumulating a large balance for future years. It is operating largely on a “pay-as-you-go” basis. Because of the rapid health cost spiral, lifetime Medicare benefits are much greater than the average worker pays in, although the ratio has declined due to recent increases in the payroll tax. SMI is financed by premium contributions of enrollees (covering about 25 percent of costs) and from general federal revenue (covering the remaining 75 percent). The SMI Trust Fund is not designed to accumulate funds for future benefit payments. PROBLEMS and SOLUTIONS ON MEDICARE The 1995 Trustees report projects that, under a “best guess” scenario, the HI Trust Fund will be depleted by 2002.

In contrast, the SMI Trust Fund, because it is financed on a year-by-year basis, is “adequately financed” in the short run. Health programs, like retirement programs, are affected by the aging of our society. Unlike retirement programs, though, they are affected by the rapid development of medical technology and the rising costs of health care. Proposed short-term solutions for the Medicare funding gap include raising payroll taxes, shifting contributions from other Trust Funds, changing premiums and co-pays, expanding managed care, or reexamining cost-sharing to influence the use of certain services. Each of these options has different side-effects for current as well as future beneficiaries, and each has strong supporters and opponents.

More systematic changes may be needed to sustain Medicare financing over the long run. Among the types of changes that have been debated include restructured or combined Parts A and B, increased contributions, different benefits, higher age of eligibility, new managed care rules or provider reimbursement, vouchers for the purchase of private insurance, taxes on benefits, and income-related beneficiary cost-sharing. Table 1: Medicare Growth PAYMENTS*: 1967 1975 1985 1995** 2005** HI (Part A): 3.0 10.5 42.3 110.2 240.0 SMI (Part B): 1.3 4.0 21.6 64.0 209.3 Total: 4.2 14.5 63.8 174.2 449.3 Total as % GDP: 0.52 0.92 1.58 2.45 3.70 (Avg. growth/year: 1967-75: 17%; 1975-85: 16%; 1985-95: 11%; 1995-2005: 10%) ENROLLMENT (mil) 1967 1975 1985 1995* 2005** Aged: 19.5 22.8 28.2 33.3 35.3 Disabled: 2.2 2.9 3.9 6.8 Total: 19.5 25.0 31.1 36.2 42.1 (Avg. growth/year: 1967-75:3%; 1975-85: 2%; 1985-95: 2%; 1995-2005: 2%) $per enrollee 217 583 2,055 4,818 10,677 adj. for cost per indiv. 217 362 638 1,066 1,645 *not including administrative costs **projected Source: Health Care Financing Admin., Congressional Budget Office B) MEDICAID Medicaid, the joint federal-state program that provides health care insurance to some 34 million low-income Americans, faces the most radical changes in its thirty-year history.

Under congressional proposals, federal Medicaid payments would be reduced dramatically compared to current law, many low-income Americans now guaranteed coverage regardless of where they live would no longer be entitled to Medicaid, and states would assume far greater responsibility for deciding who receives coverage and who does not. The federal role would be limited to providing Medicaid block grants. This role can be defined as a fixed amount to be given to each state without a requirement for matching funds or rules about how the funds are to be allocated; the formula to be used to determine the amount each state will receive has yet to be decided. Under current law, federal Medicaid spending is projected to grow from $89 billion in 1995 to $178 billion in 2002 — about 10 percent a year. The main reasons for the anticipated growth are 1) rapid inflation throughout the health care system, which far exceeds the general inflation rate; 2) especially big cost increases in nursing home care and services for the disabled, which Medicaid covers; and 3) rising numbers of children who will become eligible for coverage. From 1995 to 2002, total spending over and above current annual expenditures would be a cumulative $332 billion. Congress has agreed to reduce that projected growth in the program by $163 billion over the next seven years.

Reductions in federal payments relative to current law would be 18 percent per year on average over the seven-year period. Because the size of the cuts increases over time, in 2002 federal outlays would be more than 28 percent less than they would be under current law. Moreover, many federal requirements governing how the money is spent would be eliminated. The federal government’s role would be limited mainly to delivering a lump sum payment (known as a block grant) to each state, which would then determine how the Medicaid funds would be spent. Because Medicaid would cease to be an entitlement, many impoverished children, pregnant women, elderly Americans confined to nursing homes, and disabled people would lose health care coverage, reversing more than fifteen years of federal efforts to extend Medicaid coverage to more of these people. In many respects, those changes succeeded in expanding access to medical services for millions of low-income Americans, especially children. The enormous decline in U.S. infant mortality since the enactment of Medicaid, which now finances a third of all baby deliveries, is largely attributable to the program.

Certainly, embracing more beneficiaries has been costly. Covering greater numbers of people has required more money, and federal and state Medicaid outlays have soared in recent years. One way the congressional plan would likely reduce the program’s rate of growth is by removing some of those people from Medicaid eligibility, leaving them uninsured. In addition, Medicaid’s already low payment rates to doctors, hospitals, and managed care providers such as health maintenance organizations would be cut further. One consequence of payment reductions would be the risk that doctors would be reluctant to accept Medicaid recipients as patients. Inflation throughout the entire private and public health care system – not just Medicaid – has also far outpaced price increases in the rest of the economy.

The main force driving rampant health care inflation is the proliferation of expensive new medical technology. Curtailing federal spending on Medicaid and Medicare is unlikely to dampen demand for that technology. Instead, doctors, hospitals, and other providers are likely to shift those costs from the government to the private sector as they have in the past. The public will still have to pay in the end. Most of the 34 million Americans now covered by Medicaid have low incomes and meager financial resources. Enrollment in Medicaid increased by 53 percent from 1985 to 1993 while the share of working Americans with employer-sponsored health insurance declined.

The proportion of the population covered by Medicaid increased from 8 percent in the early 1970s to 13 percent today. If the growth in Medicaid over the past five years had not offset part of the decline in employer-based insurance, it is estimated that the number of uninsured Americans would have climbed from 41 million to 50 million. Under Medicaid, poor people who meet certain requirements are entitled to health care that the federal government and the states jointly finance. Medicaid has extended much better medical services to many more impoverished children, pregnant women, and elderly Americans. Medicaid constitutes a relatively small portion of the federal budget.

In 1994, the federal portion of Medicaid accounted for 6 percent of federal outlays. That was less than Social Security (22 percent), defense (19 percent), discretionary (non-entitlement), domestic spending (17 percent), and Medicare (11 percent). Medicaid accounted for only 10 percent of federal entitlement spending in 1994. That compares with 40 percent for Social Security and 20 percent for Medicare. Medicaid benefits are determined by certain federal guidelines and are further determined by individual state policies.

Figures D and E show the various income eligibility standards for different categories of Medicaid recipients. (Note that the federal poverty line is $7,470 for an individual, $10,030 for a single mother with one child, and $12,590 for a family of three.) When Medicaid was enacted in 1965, the U.S. infant mortality rate (for children under one year old, excluding fetal deaths) was 93 per 1,000 live births. By 1992, that figure had declined to 34. A number of factors contributed to the decline, including improved medical technology, but analysts agree that Medicaid coverage played a role by helping the poor gain access to the health care system.

For every dollar Medicaid spent on prenatal health services, more than two dollars was saved on medical costs for infants under two months old. In addition to federally mandated coverage of physician, hospital, and nursing facility services, all states have chosen to cover eye care, dental care, and prescription drugs. Almost all states also include physical therapy, hospice care, and a variety of rehabilitative services. About half of the states provide screening, prevention, and diagnostic services for adults, and chiropractic and occupational therapy. Only 22 percent of those receiving Medicaid did not see a doctor within the past year, compared to almost half of the uninsured poor. Among those who saw a doctor during the year, Medicaid beneficiaries averaged 6.3 visits compared to 3.8 visits per year for uninsured, impoverished Americans. Children on Medicaid are more likely than uninsured poor children to receive routine medical treatment and dental examinations prior to kindergarten.

Moreover, poor children with Medicaid are more likely to receive phys …


.. ical examinations at recommended intervals than other children. Only 14 percent of Medicaid beneficiaries report dissatisfaction with the health care services they received, compared to 30 percent for the uninsured and 13 percent for those with private insurance. Unlike Medicare and private insurance policies, Medicaid generally does not require beneficiaries to pay premiums, deductibles, co-payments, or other out-of-pocket (so-called cost-sharing) fees that might discourage them from seeking treatment that they need. Because their incomes are so low, such charges would discourage many from visiting doctors or other health care providers.

Most state Medicaid programs have made progress in enrolling pregnant women in health care in their first trimester and encouraging care throughout the pregnancy. Most states have received waivers from certain federal requirements, such as the federal mandate giving beneficiaries the freedom to choose any doctor who accepts Medicaid patients. In fact, forty-five states require some Medicaid beneficiaries to enroll in private, “managed care” programs. The number of Medicaid beneficiaries enrolled in managed care has increased steadily from 800,000 in 1983 to 7.8 million, or about one-quarter of those covered, in 1994. Most of those enrolled in managed care plans are poor children and their parents.

Health maintenance organizations, which charge Medicaid a monthly fee for each patient in exchange for providing a menu of services, cover more than half of the Medicaid beneficiaries enrolled in managed care programs. All of the states have received federal waivers allowing them to pay for home and community care for elderly beneficiaries who otherwise would end up in nursing homes. Because nursing home care is more expensive and often less desirable than home health care, the federal government has not been reluctant to grant the waivers. Thirteen states have received federal government approval to carry out statewide Medicaid demonstration programs (including five states with programs already implemented), allowing them to initiate ambitious managed care efforts designed primarily to expand coverage for low-income adults and their children rather than the disabled and elderly in nursing homes. The most well publicized effort is in Oregon, where Medicaid covers a wide spectrum of the poor population for services that are deemed effective. It does not cover some procedures that are covered in other states, however.

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The federal government reimburses states based mainly on their per capita incomes. States with high per capita incomes such as New York, California, and Illinois receive 50 cents from the federal government for every dollar they spend on Medicaid. Poorer states receive more, ranging up to the 79 percent matching rate that Mississippi gets. The national average matching level is 57 percent. States have considerable leeway in setting eligibility, coverage, and reimbursement rates in their Medicaid programs.

Despite the complexity of Medicaid, states administer the program for about 4 percent of total costs. That compares with administrative costs of 5.5 percent for private plans that serve large companies and 25 percent for those serving smaller firms. Unlike private plans, Medicaid does not face such costs as sales, marketing, risk assessment, and insurance commissions. According to a recent study by the Physician Payment Review Commission, Medicaid fee-for-service payments to physicians average about 47 percent of private insurance payments for comparable services. And data from the Prospective Payment Assessment Commission indicate that Medicaid payments to hospitals average only 72 percent of private payer levels.

Even though Medicaid pays doctors much less than private plans or Medicare, three-quarters of all physicians treat Medicaid patients. In 1994, the Physician Payment Review Commission found that 10 percent of Medicaid patients did not receive care when needed, compared to 8 percent of privately insured individuals. In contrast, 34 percent of the uninsured did not receive needed treatment. Medicaid provides subsidies to public hospitals and others that serve large numbers of low-income patients through disproportionate share hospital (DSH) payments. States have wide leeway in designating which hospitals qualify for the DSH payments and in setting the formulas for determining how much is paid. Previously, cities and counties were often responsible for covering the expenses of low-income patients who could not afford to pay for their own treatment.

By any measure, Medicaid spending has increased dramatically: PROBLEMS ABOUT MEDICAID Between 1984 and 1994, combined federal and state Medicaid spending nearly quadrupled from $36.7 billion to $135.5 billion. Federal Medicaid expenditures increased from $20.1 billion to $77.4 billion, while state expenditures increased from $16.5 billion to $58.2 billion. Although the number of Americans covered by Medicaid increased from 21.0 million to 33.5 million, spending on elderly beneficiaries increased faster in inflation-adjusted dollars than outlays for other groups. Medicaid grew from 1 percent of the federal budget in 1970 to 6 percent of the federal budget in fiscal year 1995. Between 1987 and 1994, Medicaid, as a proportion of state general fund spending, increased from 8.1 percent to 13.3 percent.

The Congressional Budget Office has estimated that without changes, total Medicaid spending will increase by more than 10 percent annually over the next five years, reaching $262 billion by 2002. Some analysts argue that the growth rate in Medicaid expenditures is unsustainable and that rapidly increasing health care spending is “crowding out” spending on other public programs. State governments, for instance, have faced increasing Medicaid costs in the face of slow tax revenue growth and balanced budget requirements. In some cases, increased spending on Medicaid has required cuts in other programs. In the early 1990s, Medicaid surpassed higher education as the second-largest state spending program.

Public and private health care cost acceleration in the United States has far exceeded the rate of inflation throughout the rest of the economy for decades. A variety of factors have contributed to health care inflation, led by the proliferation of enormously expensive medical technology as well as the growth of labor-intensive services such as home health care. Beyond those forces pushing up health care costs generally, Medicaid confronts additional spending pressures: Those receiving Medicaid are among the least healthy Americans. About 68 percent of Medicaid spending cover services for disabled, blind, and nursing-home-confined elderly. Those beneficiaries require extremely costly health care. Medicaid spending per elderly recipient ($9,792) is more than nine times greater than the average for dependent children ($1,079).

The Boren amendment: Passed in 1980, the Boren amendment required states to set “reasonable” payment rates for nursing facilities and hospitals. Subsequent lawsuits led by nursing homes forced some states to raise their payments substantially. Nursing home standards: In 1987, the U.S. Congress passed legislation that made nursing home standards more rigorous. The cost of these requirements is reflected in the Medicaid program.

Federally mandated expansions in coverage: In three separate pieces of legislation passed in 1988, 1989, and 1990, Congress required states to provide Medicaid benefits to an increasing percentage of infants, children, and pregnant women from low-income households. Sullivan v. Zebly: This 1990 U.S. Supreme Court case retroactively changed Supplemental Security Income – and, therefore, Medicaid -eligibility criteria for children. According to the Urban Institute, this decision doubled the number of children eligible for SSI. Economic downturn: The national recession of the early 1990s severely hurt many states, including those in New England, the Mid-Atlantic, and the Far West. As unemployment rates increased, the number of people eligible for Medicaid grew as well. Demographic changes: The population of elderly Americans has increased dramatically in recent years.

In fact, individuals over the age of eighty-five constitute the fastest-growing segment of the population; between 1995 and 2005, the number of Americans over the age of eighty-five is projected to increase 41.2 percent, compared to a 9.4 percent increase for the entire population. This trend has increased Medicaid spending since the majority of Medicaid expenditures are for the eldest of older Americans. About 42 percent of Americans living in poverty are not covered by Medicaid. Most of those uninsured poor do not qualify because they have no children, they are not disabled, and they are not pregnant. In a two-parent family with one parent working full time, only the children are eligible for coverage unless the mother is pregnant. The father is never eligible.

While Medicare covers virtually everyone over age sixty-five, only Americans facing severe deprivation are eligible for Medicaid. Because opinions vary widely about who most needs and deserves Medicaid, political horse trading and compromises at both the federal and state level have determined who receives coverage and who does not. The resulting eligibility rules are complex, confusing, and often arbitrary. To deter fraud, applying for Medicaid requires demonstrating eligibility with financial documents and passing time-consuming and cumbersome verification checks. In some states, application forms exceed thirty pages, and many of these forms are difficult to understand. Documentation required ranges from pay stubs to utility receipts to automobile titles and so forth.

(See box) Some who are eligible do not apply because of the hassles involved. Others do not apply because they are unaware that they are eligible. Low reimbursement rates to doctors discourage them from providing care to Medicaid patients. About a third of the nation’s doctors limit the number of Medicaid patients they see, and a quarter report that they will not see Medicaid patients at all. As a result, beneficiaries must rely heavily on care in clinics and hospital emergency rooms and outpatient departments.

Such care is often more expensive than the services private doctors provide. Federal law sets fewer guidelines for paying doctors than it does for paying hospitals or nursing homes. As a result, Medicaid cuts usually reduce payments to doctors more than they decrease compensation to hospitals and nursing homes. Unlike physicians, hospitals cannot legally refuse to serve patients. But lower payment rates from Medicaid to hospitals compared with Medicare and private insurance may lead to poorer service for Medicaid patients. An estimated 10 percent of Medicaid outlays are squandered on fraud, according to a recent study published by the U.S.

General Accounting Office. The size and complexity of the system, with every state administering the program as it sees fit, creates opportunities for private health care providers and state employees to engage in abuse. Relatively little fraud is attributable to individuals who are not eligible for Medicaid receiving coverage by submitting false information. Because most managed care companies such as health maintenance organizations and preferred provider organizations seek profits, there is a risk that they will give short shrift to a mostly poor Medicaid population in light of the program’s low reimbursement rates. In Florida, for example, Medicaid HMOs have been sanctioned for quality problems. Anticipating such problems, some states have created boards to review the quality of care and improve monitoring of managed care providers. Still, many states have had difficulty recruiting the best managed care plans to serve Medicaid patients.

Managed care plans have little desire to cover the Medicaid beneficiaries who cost the program the most: the elderly in nursing homes and the disabled. The preventive services that managed care plans emphasize to reduce costs will not alleviate the expensive needs of those groups. A survey of twelve studies that examined the impact of managed care on Medicaid costs found mixed results. Seven reported a decrease in costs to state Medicaid agencies, two reported cost increases, and the remainder showed unchanged, variable, or ambiguous results. Managed care works best for individuals who remain covered for an extended period of time because ongoing preventive and primary care helps to deter the need for high-cost emergency services and intensive treatment.

Because of the turnover in the Medicaid program population as eligibility changes, the purported health benefits to enrollees of managed care may be diminished. One reason why converting Medicaid to a block grant program has gained popularity is that the federal government imposed more than thirty mandates on states between 1987 and 1992 related to program eligibility, reimbursement, and services. Most of those requirements were intended to reduce variability among the states and create more consistency in the coverage available to low-income Americans. But state officials believe they ought to have greater flexibility to decide how the money is spent because Medicaid constitutes a growing portion of state budgets. Disputes often arise between the states and the federal government about whether particular bills are covered or not and the extent to which the federal government should contribute. The rapid growth of Medicaid spending is only partly due to expanding eligibility or services to poor people. Earlier in this decade, states employed clever fiscal strategies that sizably boosted their federal reimbursements without significantly raising their own contributions.

Although recent congressional legislation closed these loopholes for voluntary provider taxes and disproportionate share hospital funds, they played an important role in expanding federal Medicaid outlays. Voluntary provider taxes: Under this loophole, states would tax or ask for donations from hospitals and other health care providers, return the money to those providers in the form of higher reimbursement rates or lump sums, and then collect federal matching funds for those payments. Those arrangements enabled the states to claim more money from Washington without having to spend additional funds of their own. Recent legislation aimed at restricting such state financing schemes have slowed growth rates substantially. Disproportionate share for hospital funds: The federal portion of DSH payments ballooned from $449 million in 1988 to $16.8 billion in 1994. As in the case of health care provider taxes, DSH payments have been employed as vehicles to increase federal matching payments. Earlier in the decade, a state was able to make a DSH payment, containing both state and federal Medicaid funds, to a designated hospital.

The hospital would immediately return the payment to the state through an intergovernmental transfer, and the state would enjoy a net benefit from the federal DSH payment. These funding schemes were curtailed under the 1993 Omnibus Budget Reconciliation Act. Shifting state health programs to Medicaid: In recent years, many states have transferred state-funded health programs to their Medicaid budgets. That has had the effect of cutting state expenditures for those programs by at least 50 percent, depending upon the state’s federal matching rate. There are no reliable estimates of the magnitude of program shifting that has occurred through the “Medicaiding” of state health programs.


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