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Total Medicare expenditures were $523 billion in 2010 and are expected to increase in most future years at a somewhat faster pace than either workers’ earnings or the economy overall. Based on the intermediate set of assumptions and current law, expenditures as a percentage of GDP are projected to increase from the current 3.6 percent to 6.2 percent by 2085.

The assets of the HI trust fund declined by $32.3 billion in 2010 and are expected to continue decreasing under current law. The trust fund is projected to be exhausted in 2024, 5 years earlier than was estimated in last year’s report. Actual HI taxable earnings in 2010 were considerably lower than previously projected, and the projected level of real (inflation-adjusted) HI taxes remains lower than in last year’s report, although the difference narrows as the economy recovers from the recent economic recession, with real average earnings growth in 2011-2019 projected to be faster than in the 2010 Trustees Report. Actual HI expenditures in 2010 were close to the previous estimate, but real HI expenditures in 2011 and later exceed last year’s projection, primarily due to higher provider payments arising from the faster assumed growth in economy-wide real average compensation. The HI trust fund fails to meet the Board of Trustees’ short-range test of financial adequacy.

The HI actuarial deficit in this year’s report is 0.79 percent of taxable payroll, up slightly from 0.66 percent in last year’s report but still substantially better than the deficit projected prior to enactment of the Affordable Care Act. As in past reports, the HI trust fund fails to meet the Trustees’ long-range test of close actuarial balance.

The financial outlook for SMI is fundamentally different than for HI, due to the statutory differences in how these two components of Medicare are financed. Both the Part B and Part D accounts of the SMI trust fund are projected to remain in financial balance for all future years, because beneficiary premiums and general revenue transfers will be set to meet expected costs each year. However, SMI costs are projected to more than double as a share of GDP over the next 75 years, from 1.9 percent to 4.1 percent. This projection assumes a reduction of almost 30 percent in payment rates for physician services in 2012, as required under current law; if Congress acts to prevent this decrease, as it has for 2003 through 2011, then actual Part B and total SMI costs will substantially exceed the projections shown in this report.

The projected Part B and Part D costs shown in this report are somewhat lower than in previous reports, reflecting an unusually

small increase in the volume and intensity of Part B services in 2010 and an expected slower growth trend for drug costs generally.

The financial projections shown for the Medicare program in this report continue to represent a substantial, but very uncertain, improvement over those prior to 2010 as a result of the Affordable Care Act. Compared to the projections in the 2009 annual report, projected Medicare costs as a percentage of GDP have decreased from 4.5 percent to 4.0 percent in 2020, from 8.7 percent to 5.9 percent in 2050, and from 11.2 percent to 6.3 percent in 2080. At the time of enactment, the legislation was estimated to postpone the date of exhaustion for the HI trust fund by about 12 years. At 0.79 percent of taxable payroll, the long-range actuarial deficit for HI is only one-fifth of its 2009 level. Projected long-range expenditures for SMI Part B are also substantially lower than before enactment of the law, while Part D expenditures are slightly lower.

It is important to note, however, that the substantially improved results for HI and SMI Part B depend in part on the long-range feasibility of the various cost-saving measures in the Affordable Care Act—in particular, the lower increases in Medicare payment rates to most categories of health care providers. Without fundamental change in the current delivery system, these adjustments would probably not be viable indefinitely. Under current law, the annual increase in Medicare prices for most health services will be reduced by about 1.1 percentage points (the estimated growth in economy- wide multifactor productivity) below the increase in prices that providers must pay to purchase the goods and services they need to provide health care services. Over time, unless providers could alter their use of goods and services to reduce their cost per service correspondingly, the prices paid by Medicare for health services would fall increasingly below such costs and providers would eventually become unwilling or unable to treat Medicare beneficiaries.

For example, if future improvements in provider productivity remained similar to what has been achieved in the recent past, then Medicare payment levels for inpatient hospital services at the end of the long-range projection period would be only about one-third of the corresponding level paid by private health insurance (assuming that private payer rate increases follow historic patterns of growth, independent of Medicare or other health system changes). In this case, the lower Medicare payment rates would result in negative total facility margins for an estimated 15 percent of hospitals, skilled nursing facilities, and home health agencies by 2019, and this percentage would reach roughly 25 percent in 2030 and 40 percent by 2050. Providers could not sustain continuing negative margins and

would have to withdraw from providing services to Medicare beneficiaries, merge with other provider groups, or shift substantial portions of Medicare costs to their non-Medicare, non-Medicaid payers.

In addition, projected Part B expenditures for physicians’ services are very likely to be substantially understated. Under current law, the SGR system requires a reduction in January 2012 of almost 30 percent in the physician fee schedule, which, on average, currently sets fees that are significantly below those for private health insurance. If the rate of growth of private payments were not affected by continued implementation of the SGR, Medicare physician payments would be less than 40 percent of the corresponding private health insurance prices within 20 years and, by the end of the 75-year period, would be only about 25 percent of private insurance levels. If such payment differentials were allowed to occur, Medicare beneficiaries would almost certainly face increasingly severe problems with access to physician services.

For these reasons, it is important to note that the actual future costs for Medicare are likely to exceed those shown by the current-law projections in this report. The potential magnitude of the understatement can be illustrated by use of an alternative projection. Specifically, if Medicare payments to physicians were updated by the Medicare Economic Index, rather than decreasing over 29 percent in 2012 as required under current law, and if the productivity adjustments to price updates for other Medicare services were gradually phased out starting in 2020, then the projected total cost of Medicare in 2080 would be 10.4 percent of GDP (versus 6.2 percent under current law), and HI trust fund exhaustion would still occur in 2024, but the HI actuarial deficit would be 2.15 percent of taxable payroll (versus 0.79 percent). These levels still represent a very significant improvement compared to the estimates prior to the Affordable Care Act, but they clearly illustrate that the relatively favorable projection results shown under current law rely partially on the scheduled reductions in physician payments and heavily on the permanent annual reductions in Medicare price updates for most non-physician services.

The immediate physician fee reductions are clearly unworkable and are almost certain to be overridden by Congress. The productivity adjustments will affect other Medicare price levels much more gradually, but there is a strong likelihood that without very substantial and transformational changes in health care practices, payment rates would become inadequate in the long range. As a result, the projections shown in this report for current law should not be interpreted as our best expectation of actual Medicare financial

operations in the future but rather as illustrations of the very favorable impact of permanently slower growth in health care costs, if such slower growth can be achieved. The illustrative alternative projection underscores this uncertainty.

It is possible that healthcare providers could improve their productivity, reduce wasteful expenditures, and take other steps to keep their cost growth within the bounds imposed by the Medicare price limitations. For such efforts to be successful in the long range, however, providers would have to generate and sustain unprecedented levels of productivity gains—a very challenging and uncertain prospect.

The possibility also exists that health care in the U.S. can be trans- formed, in both the way that it is delivered and the manner in which it is financed. The Affordable Care Act takes important steps in this direction by initiating programs of research into innovative payment and service delivery models, such as accountable care organizations, patient-centered “medical homes,” improvement in care coordination for individuals with multiple chronic health conditions, improvement in coordination of post-acute care, payment bundling, “pay for performance,” and assistance for individuals in making informed health choices. If the new approaches developed through these research initiatives can be demonstrated to improve the quality of health care and/or reduce costs, then they can be adopted for Medicare without further legislation.18 _{Such changes have the}

potential to reduce health care costs and cost growth rates and could, as a result, help lower Medicare cost growth rates to levels compatible with the lower price updates payable under current law. The ability of new delivery and payment methods to significantly lower cost growth rates is very uncertain at this time, since specific changes have not yet been designed, tested, or evaluated. Hopes for success are high, but it would be imprudent to assume that improvements in efficiency can be made of the magnitude needed to align with the statutory Medicare price updates, until such enhancements are proven.

For these reasons, while the substantial improvements in Medicare’s financial outlook under the Affordable Care Act are welcome and encouraging, expectations must be tempered by awareness of the

18_{Under the Affordable Care Act, tested changes can be adopted nationally without}

further legislation if (i) the Secretary of Health and Human Services determines that the expansion is expected to improve quality of care without increasing spending or to reduce spending without reducing the quality of care and (ii) the Chief Actuary of the Centers for Medicare & Medicaid Services certifies that expansion would reduce (or would not result in any increase in) net program expenditures.

difficult challenges that lie ahead in making health care far more cost efficient while ensuring high-quality care. The sizable differences in projected Medicare cost levels between current law and the illustrative alternative scenario highlight the critical importance of the research agenda that is getting under way. Every effort must be made not only to bring Medicare costs—and health care costs in the U.S. generally—more in line with society’s ability to afford them but also to improve the quality of health care outcomes.

Given the uncertain ability of delivery and payment reforms to reduce costs, it will also be important to monitor the adequacy of Medicare payment rates over time to ensure beneficiary access to high-quality care.

The time gained by postponing the depletion of the HI trust fund should be used to determine effective solutions to the remaining long- range HI financial imbalance. Even assuming that the current-law payment rates will be adequate, the HI program does not meet either our short-range test of financial adequacy or our long-range test of close actuarial balance. Under current law, scheduled HI tax income would cover only 90 percent of estimated expenditures in 2024 and 76 percent in 2050. By the end of the 75-year projection period, 88 percent of HI costs could be paid from HI revenues. Planning efforts should also consider the likelihood that the price adjustments in current law will not be permanently viable and should develop additional and/or alternative means to achieve financial balance. The projections in this year’s report continue to demonstrate the need for timely and effective action to address Medicare’s remaining financial challenges—including the projected exhaustion of the HI trust fund, this fund’s long-range financial imbalance, and the issue of rapid growth in Medicare expenditures. Furthermore, if the lower prices payable for health services under Medicare are overridden, the financial challenges in the long range would be much more severe. We believe that solutions can and must be found to ensure the financial integrity of HI in the short and long term and to reduce the rate of growth in Medicare costs through viable means, building on the measures enacted as part of the Affordable Care Act. Consideration of such further reforms should occur in the near future. The sooner the solutions are enacted, the more flexible and gradual they can be. Moreover, the early introduction of reforms increases the time available for affected individuals and organizations—including health care providers, beneficiaries, and taxpayers—to adjust their expectations. We believe that prompt action is necessary to address these challenges.