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Testimony on Medicare Savings, Balanced Budget Plan by Jacob J. Lew
Deputy Director, Office of Management and Budget
U.S. Department of Health and Human Services

Before the Senate Committee on the Budget
January 23, 1997

Mr. Chairman, thank you for your invitation to the Administration to testify at this hearing today. We very much appreciate the opportunity to follow up to the President's statement on Tuesday regarding the Medicare savings in his balanced budget plan.

We win, of course give you and your staff a full briefing on the details of the budget after it is transmitted to the Congress on February 6. In the meantime, I hope you will understand that we may have to defer answering some of your more detailed questions until that time.

The President believes we have a unique opportunity to balance the budget if we work together on a bipartisan basis. He announced the broad outlines of his Medicare policy a few days ago because he wanted to seize the moment to work together.

The President articulated three principles underlying the Medicare policy that will be presented in his budget. First, it will include structural reforms that will make the program work more efficiently and take advantage of changes in the health care marketplace. Second, it will meet his goal of extending the solvency of the Medicare Part A Trust Fund for ten years. Third, because the Medicare policy will save $138 billion over six years, it will meet the Congress halfway and bring us closer to bipartisan agreement on a balanced budget.

Today I would like to provide an overview of the policies in the Administration's Medicare package. Because both the President and the Congress have committed to balancing the budget by 2002 -- five years from now -- I will describe the budget policies in terms of their five-year savings. Since most observers are familiar with the six-year savings numbers from the budget debate last year, I will present six-year savings figures as well.

As I said earlier, the President's plan saves $138 billion from the Medicare program over six years; the equivalent five-year estimate is $ 1 00 billion. The savings total is net of proposed benefit increases and does not reflect the reallocation of certain home health care expenditures from Part A to Part B.


The 1998 budget preserves and improves Medicare, extending the solvency of the Part A Hospital Insurance Trust Fund into 2007. This budget, like the President's previous two budgets, gives beneficiaries more choices among private health plans, makes Medicare more efficient and responsive to beneficiary needs, and reduces provider payments.

The President's 1998 budget builds on his 1997 budget:

Last year, we wanted to extend the solvency of the Part A Trust Fund by 10 years. According to the Chief Actuary at the Health Care Financing Administration, the Medicare policy in the budget will extend the solvency of the Trust Fund to 2007.

Last year, we wanted to restrain provider payments at a level that would continue to ensure the quality of and access to care. This year, we believe that we can restrict provider payments -- particularly in the areas of managed care and hospitals -- more than we did last year, without harming quality and access.

Last year, we wanted to protect beneficiaries from major new out-of-pocket expenditures and allow them to take advantage of advances in preventive care. This year, we continue to adhere to this principle by keeping the Part B premium at 25 percent of program costs and by proposing new preventive health benefits.

The Medicare policy in our 1998 budget is similar in many ways to our policy last year. However, based on our most current analysis, there are several policy changes of note, in particular with regard to payment rates for managed care, outpatient prospective payment, and competitive bidding for laboratory services and durable medical equipment.

Managed care

There is substantial evidence that Medicare pays too much for managed care plans and, in fact, loses money for every beneficiary who opts for managed care. The new policy proposals will reduce reimbursements to managed care plans by about $34 billion over five years ($46 .billion over six years). Savings will come from three sources:

  1. The 1998 budget will propose to reduce Medicare reimbursement to managed care plans from its current rate of 95 percent of fee-for-service rates to 90 percent. The reduction does not start until 2000, and it accounts for $6 billion in savings over five years (about $8 billion over six years).

  2. There will be indirect savings of $18 billion over five years (and $25 billion over six years) attributable to cuts in the traditional fee-for-service side of the program. Because HMO payments are based on a percentage of fee-for-service payments, HMO payments are reduced as a function of our proposed cuts in the fee-for-service side of the program.

  3. Finally, the policy carves out the medical education and uncompensated care payments from the HMO reimbursement formula. These funds will be paid directly to academic health centers and to HMOs that run their own residency programs. This aspect of the plan would reduce direct managed care payments by $10 billion over five years (and $13 billion over six years).

The proposals in the 1998 budget relating to hospitals will reduce the annual inflation increase, or "update," for hospitals; reduce payments for hospital capital; reform payments for graduate medical education; and implement prospective payment for outpatient departments while protecting beneficiaries from increasing charges for those services. The budget will propose to achieve $33 billion in net savings over five years ($46 billion over six years).

The budget will also propose to establish new provider service networks (PSNs), which will allow hospitals and other providers to establish their own health care plans to compete with cur-rent Medicare HMOs.

As I mentioned earlier, the budget will establish a new pool of funding, about $1 0 billion over five years, for direct payment to academic health centers and eligible HMOs. These payments will compensate academic health centers for the costs of medical education and care for indigent patients. We propose establishing this new pool at the same time we remove medical education and uncompensated care costs from the formula we use to pay HMOs. The net hospital savings of $33 billion reflect these payments to teaching hospitals.


With regard to physicians, the budget will propose to save about $7 billion over five years (about $ 1 0 billion over six years) through a reduction in physician updates. This reduction is relatively small because Medicare has been fairly effective in constraining growth in reimbursement to physicians.

Skilled Nursing Facilities

With regard to skilled nursing facilities, the budget will propose to save about $7 billion over five years ($9 billion over six years) through the establishment of a prospective payment system. This benefit has been growing at double-digit rates, and there is a consensus that moving to capitated rates will help contain costs.

Fraud and Abuse

The budget proposes strong fraud and abuse provisions, including measures to eliminate fraud in home health care -- such as by ensuring that home health agencies are reimbursed based on the location of the service, not the billing office. The budget also would repeal several provisions in last year's health reform law that weakened anti-fraud enforcement (e.g., we propose repealing the advisory opinions). The anti-fraud initiatives in the budget would save $9 billion over five years ($12 billion over six years).


The 1998 budget will propose a number of changes in law that affect beneficiaries, including new benefits, Medigap protections, and proposals to increase beneficiary choice.

First, the 1998 budget will propose extending current law that sets the Part B premium at 25 percent of program costs. This policy achieves $10 billion in savings over five years ($18 billion over six years). Without this policy, the Part B premium would drop below 25 percent after 1998.

Second, the budget will propose new preventive health care benefits to improve the health of senior citizens and reduce the incidence of disease. The plan covers colorectal screening, diabetes management, and annual mammograms without copayments. It also increases reimbursement rates for certain immunizations to ensure that seniors are protected from pneumonia, influenza, and hepatitis. The budget will also propose a new Alzheimer's respite benefit starting in 1998 to assist families of Medicare beneficiaries with Alzheimer's diseases. Total beneficiary investments in the budget will cost $13 billion over five years ($22 billion over six years).

Third, because of a flaw in reimbursement methodology, beneficiaries now in effect contribute a 50 percent copayment for outpatient visits. The 1998 budget will propose to prevent further increases in copayments and reduce the copayment to 20 percent over the next decade.

Fourth, the budget will propose new Medigap protections (such as new open enrollment requirements and prohibitions against the use of pre-existing condition exclusions) to increase the security of Medicare beneficiaries who wish to opt for managed care but fear they will be unable to obtain Medigap insurance if they decide to return to fee-for-service plans. I understand that this provision is consistent with bipartisan legislation pending before Congress.

Last, the budget will propose new private plan choices -- through new PPO and Provider Service Network choices -- for beneficiaries.

Structural Reform

The 1998 budget will propose a number of structural reforms to bring the Medicare program into the 21st century:

  1. We will propose establishing new private health Plan options (such as PPOs and Provider Service Networks) for the program.

  2. We will propose annual open enrollment for all Medicare plans -- with an independent third-party responsible for informing beneficiaries of their options and enrolling those interested in the managed care plan of their choice.

  3. We will propose market-oriented purchasing for Medicare, including the new prospective payment systems for home health care, nursing home care, and outpatient hospital services. We will also propose competitive bidding authority and the use of centers of excellence to improve quality and cut back on costs.

  4. We will propose adding new Medigap protections, such as prohibiting pre-existing condition exclusions and requiring annual open enrollments that make it possible for beneficiaries to switch back from a managed care plan to traditional Medicare without the fear that they will be unable to obtain affordable Medigap insurance.
Home Health

Home health care has become one of the fastest growing components of the Medicare program, growing at double digit rates. The home health program was originally designed as an acute care service for beneficiaries who had been hospitalized. However, over time, home health care has increasingly become a chronic care benefit not linked to hospitalization.

The budget will propose to establish a new prospective payment system for home health and a number of program integrity initiatives. Together, these proposals will save $14 billion over five years ($18 billion over six years), and are included in our total Medicare savings estimate of $100 billion over five years (and $138 billion over six years).

The President's proposal will also restore the original split of home health care payments between Parts A and B of Medicare. The first 100 home health visits following a 3-day hospitalization would be reimbursed by Part A. All other visits - including those not following hospitalization -- would be reimbursed by Part B. This is the same policy in the President's 1997 budget. It is also similar to a provision in a Medicare reform bill the House passed last year.

There has been a great deal of public discussion about the home health reallocation recently, so I want to be very clear that this proposal is not scored as yielding budget savings.

The $100 billion of five-year savings and the $138 billion of six-year savings includes no contribution from the home health reallocation. In addition, beneficiaries will not be affected by this restoration of the original policy. This policy avoids the need for excessive reductions in payments to hospitals, physicians, and other health care providers while helping to extend the solvency of the Part A Trust Fund.

Part A Trust Fund Solvency

If we do not make any changes to the Part A program, the Part A Trust Fund will become insolvent by early in calendar year 2001. Clearly, we cannot allow this to happen. Therefore, the 1998 budget has real Part A savings, as well as structural reforms, that extend the solvency of the Trust Fund to 2007:

We reduce the growth of payments to hospitals.

We reform the payment system for home health agencies and skilled nursing facilities to increase incentives for these providers to contain costs.

We also reduce payments to HMOs from 95 percent to 90 percent of fee-for-service costs and reduce the growth in HMO payment rates.


The Medicare policies in the 1998 budget are consistent with our principles last year: to extend the solvency of the trust fund, to reduce provider payments without damaging quality and access, and to protect beneficiaries. The savings we have added to this budget -- in managed care, outpatient payments, and competitive bidding -- bridge the gap between the Congress and the Administration that remained at the end of the balanced budget negotiations last year.

We believe these Medicare proposals are the most appropriate ones to extend the solvency of the trust fund, protect Medicare, and reduce the deficit. We look forward to working with the Congress in the spirit of bipartisanship to make sure that we can keep Medicare's promise to current and future generations and to balance the budget by 2002.

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