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Chapter 7 - Medicare

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Content Last Updated: 6/17/2010 8:16:46 PM
Graphics Last Updated: 6/15/2009 9:01:51 AM
Note: Terms in green will show glossary definitions when clicked.

Originally written by Gail Wilensky, Ph.D., Project HOPE, former chairman of the Medicare Payment Advisory Commission and former administrator of the Health Care Financing Administration (now the Centers for Medicare and Medicaid Services). Revised April 2010 by Marilyn Moon, Ph.D., American Institutes for Research, former public trustee of the Medicare and Social Security Trust Funds.
This chapter was made possible by the Robert Wood Johnson Foundation. 


  • Medicare is a federal program that covered 45.2 million people in 2008 – 37.8 million aged 65 and over and 7.4 million who met Medicare’s definition of disability.1
  • The first of the baby boomers will reach age 65 – the full Medicare eligibility age for non-disabled people – in 2011. By 2030, when the youngest boomer turns 65, there are expected to be 78 million people on Medicare.2
  • Annual expenditures for Medicare were $461 billion in 2008 and are expected to rise to $943 billion in 2019. 3
  • The American Recovery and Reinvestment Act of 2009 includes Medicare incentive payments to encourage physicians and hospitals to “meaningfully use” electronic health records. The incentives phase out over six years, followed by penalties for non-adopters. 4
  • The health reform law of 2010 (the Patient Protection and Affordable Care Act of 2010 – PPACA – with amendments from the Health Care and Education Reconciliation Act of 2010) will result in a number of changes to the Medicare program. These changes will expand some benefits modestly and will achieve cost savings that will help to fund reforms for younger families.
  • The net effects of the reform legislation are estimated to reduce Medicare spending by $575 billion between 2010 and 2019. 5 (Key changes are described in more detail below).
  • Financial assets of the Hospital Insurance Trust Fund that pays for Part A of Medicare are projected to be exhausted by 2029, an extension of 12 years as a result of the PPACA.6

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Medicare was signed into law in 1965 as a federal program that helps pay medical bills for people age 65 and older. At age 65, a person automatically becomes eligible for Medicare if he or she is a U.S. citizen or a legal resident (green card holder), and has lived in the U.S. for at least five years in a row.7

Medicare has since been expanded in terms of services and populations covered. The most important of these expansions were the decision to cover people with disabilities in 1972 and the coverage of outpatient prescription drugs enacted in 2003. Over 6 million people are on Medicare as disability beneficiaries.

Eligibility for people with disabilities includes those who qualify for cash benefits under Social Security Disability Insurance (SSDI) after a two-year waiting period.8 Special rules apply for those with end-stage renal disease (ESRD) or ALS, also known as Lou Gehrig’s disease.

As with Social Security, eligibility for Medicare does not depend on income. Also like Social Security, much of Medicare is funded on a “pay-as-you-go basis,” which means it depends primarily on today’s working population to fund the expenses of today’s beneficiaries.

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Medicare covers benefits that fall into four parts:

Part A - Hospital Insurance
Part A, known as the Hospital Insurance (or HI) program, covers inpatient hospital care, skilled nursing care for up to 100 days after a hospitalization, home health and hospice care. It is funded by a portion of the wage tax – 2.9 percent, with employers and employees each paying 1.45 percent. The PPACA has increased that contribution for individuals with incomes above $200,000. Beneficiaries pay a deductible ($1,100 for each “spell of illness” in 2010), and substantial copayments for extended inpatient hospital or skilled nursing facility stays. (See the glossary for definitions of deductibles and copayments.) If they or their spouse have worked in the U.S. for 10 years or more (40 quarters of Medicare-covered employment), beneficiaries pay no Part A premium.

Part B - Supplementary Medical Insurance
Part B, known as Supplementary Medical Insurance (or SMI), covers physician services, outpatient care and home health care after 100 visits. It is funded partly by premiums, which accounts for 25 percent of the Part B income.9 The rest comes from the federal government’s general revenue. The monthly premium is officially $110.50 in 2010. For a majority of beneficiaries, however, the premium remains at the $96.40 level from 2009 because of a provision in law that freezes the increase when there is no cost of living increase in Social Security benefits. Some beneficiaries with higher incomes pay higher, income-related premiums; some with low incomes and assets pay no premiums. Most face a Part B deductible of $155 in 2010.

Part C - Medicare Advantage
Part C replaces the benefits from parts A, B and D by enrollment in a private plan called a Medicare Advantage (or MA) plan, which includes at least the benefits associated with traditional Medicare. By April 2010, 11.6 million Medicare beneficiaries were enrolled in Medicare Advantage; 24.8 percent of all beneficiaries were in MA or another private Medicare plan.10 (See the glossary for more.)

Part D - Prescription Drug Benefit
Part D is the Medicare outpatient prescription drug benefit which took effect in 2006. The benefit is provided by free-standing private drug plans (except for beneficiaries who enroll in Medicare Advantage plans with a prescription benefit). It is funded by general federal government revenue, contributions from the states, and premium payments from beneficiaries (an amount that made up 12.1 percent of Part D income in 2008).11 Each plan sets its own premium; the national average in 2010 is $38.94 per month. 12 The deductible cannot be more than $310.

Medicare does not cover some important benefits. These include custodial long-term care, dental services and most vision and hearing services.

For a detailed description of what Medicare covers and how it is financed, go to the websites for the Medicare Rights Center ( and the official U.S. government website for people with Medicare (

Assuring adequate funding for both Social Security and Medicare faces the problem that, with the aging of the population, there will be fewer workers supporting each retiree. (See chart, “Historical and Projected Number of Medicare Beneficiaries and Number of Workers Per Beneficiary.”)

But Medicare has an added problem. Spending on health care has historically grown around 2.5 percentage points faster than the rest of the economy in real (that is, adjusted for inflation) per capita terms—something economists call the “excess spend” in health care. This excess spend will drive up future Medicare expenditures more than will the aging of the population.13

This phenomenon is especially evident in spending for the Medicare prescription drug program (Part D). The Medicare trustees estimate that Part D spending will see an annual growth rate substantially exceeding the other parts of Medicare each year through at least 2018. 14

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A number of changes in Medicare were made in the PPACA. Modest expansions in benefits and some changes to assure access to care are included, as well as substantial reductions in payment levels to achieve savings.

Key provisions of the legislation that affect Medicare are:

  • A gradual elimination of the “donut hole” in the drug benefit, which refers to the gap in coverage that occurs after an individual has spent $2,830 on prescription drugs (the level for 2010, which is adjusted upward each year as spending rises) and before catastrophic protection begins after expenditures of $6,440 (again, the amount for 2010). When a person is “in the donut hole,” he or she is responsible for 100 percent of prescription drug expenses. In 2010, those reaching the donut hole will receive a rebate from the federal government of $250. After that, the beneficiary liability in the donut hole will diminish from 100 percent of spending to 25 percent by 2020.
  • Elimination of cost sharing (i.e. out-of-pocket spending) for preventive services in Medicare and access to a comprehensive health risk assessment.
  • Provision of a 10 percent bonus payment to primary care physicians and to general surgeons practicing in health professional shortage areas from 2011 to 2015, and extra payments in 2011 and 2012 to hospitals in the lowest quartile of Medicare spending.
  • A downward restructuring of payments to Medicare Advantage plans by setting those payments to a share of Medicare fee-for-service rates. The changes will be phased in over time and there will be bonus payments made to plans that achieve 4 or more stars on a 5 star rating scale, as determined by the federal government.
  • Reduction of market basket updates (the calculations used to establish annual increases in payments) for inpatient hospital, home health, skilled nursing facility, hospice and other Medicare providers.
  • Creation of an independent Payment Advisory Board to submit legislative proposals for reducing the per capita rate of growth of Medicare spending if it exceeds a target growth rate. These recommendations will begin in 2014.
  • A freeze on the threshold for income-related Medicare Part B premiums for 2011 through 2019 (increasing the number of beneficiaries subject to that premium) and the addition of an income-related premium to the Medicare Part D program.
  • •Establishment of a wide range of activities to improve quality and performance, including a pilot program to develop bundled payments for services, a hospital value-based purchasing program, and creation of an Innovation Center to test, evaluate and expand different payment structures and methodologies for care delivery.
  • Other changes including reducing the Disproportionate Share Hospital payments, eliminating the Medicare Improvement Fund, and reducing payments to hospitals to account for excess preventable hospital readmissions.

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These new legislative changes are likely to remain controversial and subject to debate as they are phased in over time. In addition, some lingering problems, particularly with physician payment, were not addressed in PPACA and will be on the agenda for further legislation:

Whether the Medicare Advantage changes will be allowed to remain

Reductions in payments to MA plans are likely to result in fewer extra benefits to those who enroll in these plans. These extra benefits have been popular with those who choose MA plans and there is likely to be debate over whether to find ways to sustain them over time.

Whether the cuts in payments to Medicare providers can be achieved without harming the program

The Office of the Actuary of the U.S. Department of Health and Human Services, in a 2010 paper, has raised concerns about whether it will be possible or desirable to attain the savings being sought from the Medicare program in the future.15 While this may not be debated immediately in the Congress, there is likely to be continuing discussion about whether these changes can be successfully implemented over time.

What to do with the sustainable growth rate (SGR) that limits spending on Part B, and more broadly, how to reform physician payment

This important area of Medicare payment was not addressed by the PPACA, largely because it is likely to be very costly to resolve. In 2010, physician fees under Medicare are scheduled to be reduced by about 21 percent because spending on Part B of Medicare has exceeded the SGR over a number of years. (Click here to see text box, “Medicare’s Sustainable Growth Rate Formula.”) Congress has adopted a number of temporary “fixes.” In 2010, these have been very short term adjustments, with the promise of more permanent adjustments to come. Congress needs to decide whether and how to change the SGR and how to change physician reimbursement to reward physicians who provide high quality services.

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  • Some people confuse Medicare with Medicaid. Medicare is the federal program for people over 65 and certain people with permanent and severe disabilities. Medicaid is a federal/state program for certain low-income people.
  • A small number of people are on both Medicare and Medicaid. They are called “dual eligibles” and spend a disproportionately large share of Medicare money. For more, see
  • “End of life” care is always controversial. From 27 to 31 percent of Medicare dollars is spent during the last 12 months of a person’s life.16 This share has been relatively constant for several decades. 17
  • Medicare physician fees have been held at about the same level over most of the decade, but spending on Part B of Medicare has been increasing at 10 to 12 percent per year. This reflects changes in the volume and mix of services that have been provided and is a good reminder that setting prices is not the same as controlling expenditures.
  • Medicare pays for primarily acute care events, although it does provide 100 days of nursing home care following a hospitalization. Most nursing home care is paid for either by Medicaid or directly by individuals, not by Medicare.
  • Medicare covers only about two-thirds of the costs for the services it covers and no coverage at all for some items, like dental care, eyeglasses or hearing aids.18 It provides minimal long-term care.
  • Because Medicare’s coverage is less generous than what many younger families have, many people seek extra coverage from retiree health plans or individually purchased policies called “Medigap.” One reason why MA plans have been popular is that they often offer extra benefits so people can get all their insurance under one plan. The patchwork of insurance plans is often confusing to many beneficiaries, especially those initially enrolling in the program.

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  • Are Medicare beneficiaries worried about the new legislation? Do they understand the changes? Where do they go for reliable information about how they will be affected?
  • The open period for choosing Medicare Advantage plans will be important late in 2010 because of the changes that will be made in payments to the plans. Insurers are likely to be changing a number of aspects of their plans including what extra benefits they offer, the premiums they charge, and the networks of providers they offer. Beneficiaries are traditionally reluctant to change plans, but there is likely to be much more reason to shop around this year. Are they looking carefully at their options this year? The information about these plans will be previewed in the fall and the open period will be from November 15 to March 31.
  • A tax change for employers may reduce their willingness to offer and subsidize retiree health coverage for prescription drugs. Are employers in your area announcing changes?
  • Some experiments and demonstrations on a wide range of areas are likely to be undertaken by Medicare. One of these may be the idea of a medical home—where primary care physicians are given higher payments for providing more comprehensive care to their patients to help them better coordinate their treatment needs. Are there demonstrations being announced in your area? Are patients aware of and interested in these demonstrations? Are primary care physicians encouraged by these changes?
  • Open period for beneficiaries to change their outpatient prescription drug plans is November 15 to March 31 of each year. How many seniors actually change plans? Ask them why they changed plans.
  • Physician access is always an issue – particularly when physician fees are being held almost constant and under threat of reduction. Are seniors in your area having trouble getting appointments with physicians? With new physicians that they haven’t previously seen? With primary care physicians? With specialists? Any indication this is actually occurring, as opposed to predictions that it will occur?
  • Do seniors regard physicians as being responsive to their needs and concerns? Do their clinicians talk with them about ways to stay healthy and improve their quality of life?
  • We hear a lot about problems with nursing homes. Do seniors in your area know that Medicare provides only limited coverage for long-term care? Have they thought about how they would pay for long-term care services?
  • Have seniors made efforts to designate who would be in charge of their health care decisions in case they become incapacitated? Do they know about advance directives and living wills indicating what kind of end-of-life care they want? Do they have one? Does someone else know about it? Are hospitals responsive to patients’ needs? Did the discussion of “death panels” increase interest in this decision-making?
  • What are seniors doing to improve their own health? Are they exercising regularly – including walking on a regular basis? Are there problems in their home or neighborhood that make it difficult for them to stay healthy?

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Henry Aaron , Senior Fellow, Economic Studies, Brookings Institution, 202/797-6128,

Stuart Altman , Professor of National Health Policy, Brandeis University, 781/736-3804,

Drew Altman , President and CEO, Kaiser Family Foundation, 650/854-9400

Gerard Anderson , Director, Center for Health Finance and Management, Johns Hopkins University, 410/955-3241

Joe Baker, President, Medicare Rights Center, 212-869-3850

Robert Berenson , Senior Fellow, Urban Institute, 202/833-7200

Brian Biles , Professor, Department of Health Policy, George Washington University, 202/416- 0066

Linda Blumberg , Principal Research Associate, Urban Institute, 202/261-5769

Stuart Butler , Vice President, The Heritage Foundation, 202/546-4400

Deborah Chollet , Senior Fellow, Mathematica Policy Research, 202/554-7528,

Karen Davis , President, The Commonwealth Fund, 212/606-3800,

Susan Dentzer , Editor in Chief, Health Affairs, 301/656-7401

James Firman , President and CEO, National Council on Aging, 202/479-1200,

Robert Friedland , Associate Professor, School of Nursing and Health Studies, Georgetown University, 202/687-1287

Paul Ginsburg , President, Center for Studying Health System Change, 202/484-5261,

Marsha Gold , Senior Fellow, Mathematica Policy Research, 202/484-4227

Vicki Gottlich , Senior Policy Attorney, Center for Medicare Advocacy, 202/293-5760x103

Stuart Guterman , Assistant Vice President, Payment System Reform, The Commonwealth Fund, (202)292-6735,

Robert Helms , Resident Scholar, American Enterprise Institute, 202/862-5877,

David Himmelstein , Associate Professor of Medicine, Harvard Medical School, 617/497- 1268,

Chris Jennings , President, Jennings Policy Strategies, 202/879-9344

Don McCanne , Senior Health Policy Fellow, Physicians for a National Health Program, 949/493-3714,

Douglas McCarthy , President, Issues Research, Inc., 970/259-7961

Tom Miller , Resident Fellow, American Enterprise Institute, 202/862-5886,

Robert Moffit , Director, Center for Health Policy Studies, The Heritage Foundation, 202/546-4400

Marilyn Moon , Vice President and Director of the Health Program, American Institutes for Research, 301/592-2101,

Patricia Nemore , Attorney, Center for Medicare Advocacy, (202)293-5760x102,

Tricia Neuman , Director, Medicare Policy Project, Kaiser Family Foundation, 202/347-5270

Joseph Newhouse , John D. MacArthur Professor of Health Policy and Management, Harvard University, 617/432-1325

Edwin Park , Co-Director of Health Policy, Center on Budget and Policy Priorities, 510/524-8033

Ron Pollack , Executive Director, Families USA, 202/628-3030, Communications Director: David Lemmon --

John Rother , Executive Vice President for Policy and Strategy, AARP, 202/434-3701,

Diane Rowland , Executive Vice President, Kaiser Family Foundation, 202/347-5270,

Thomas Saving , Director, Private Enterprise Research Center, 979/845-7559,

William Scanlon , Senior Policy Advisor, Health Policy R & D, 202/624-3975

Judith Stein , Executive Director, Center for Medicare Advocacy, 860/456-7790,

Paul VandeWater , Senior Fellow, Center on Budget and Policy Priorities, 202/408-1080,

Bruce Vladeck , Principal, Ernst & Young, 212/773-3000,

Judy Waxman , Vice President for Health and Reproductive Rights, National Women's Law Center, 202/588-5180,

Gail Wilensky , Senior Fellow, Project Hope, 301/656-7401,

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Abby Block , Director, Center for Drug and Health Plan Choice, Centers for Medicare and Medicaid Services, 202/260-1291,

James Cosgrove , Director, Health Care, Government Accountability Office, 202/512-7029,

Elizabeth Fowler , Chief Health Counsel, Senate Committee on Finance 202/224-4515

Kathleen King , Director, Healthcare, Government Accountability Office, 202/512-5154,

Mark Miller , Executive Director, Medicare Payment Advisory Commission, 202/220-3700,

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Anthony Barrueta , Vice President, Government Relations, Kaiser Foundation Health Plan Inc., 510/271-6835,

Christine Burch , Executive Director, National Association of Public Hospitals, 202/585-0100,

Alissa Fox , Senior Vice President, Office of Policy and Representation, Blue Cross Blue Shield Association, 202/626-8681,

Karen Ignagni , President and CEO, America's Health Insurance Plans, 202/778-3200,

Kathleen Jaeger , President and CEO, Generic Pharmaceutical Association, 703/647-2490

Charles Kahn , President, Federation of American Hospitals, 202/624-1500

Mary Kennedy , Director of Medicare, Association for Community Affiliated Plans, 202/701-4749,

David Nexon , Senior Executive Vice President, AdvaMed, 202-783-8700

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Alliance for Health Reform

Alliance of Community Health Plans

American Enterprise Insititute

American Hospital Association

American Institutes for Research

America's Health Insurance Plans

Blue Cross Blue Shield Association

Brookings Institution

Center for Medicare Advocacy

Center for Medicare and Medicaid Services (CMS)

Center for Studying Health System Change

Center on an Aging Society, Georgetown University

Center on Budget and Policy Priorities

The Commonwealth Fund

Consumers Union

Families USA

Federation of American Hospitals

Generic Pharmaceutical Association

Government Accountability Office

Health Affairs

Health Policy R & D

Heller School for Social Policy and Management, Brandeis University

Heritage Foundation

Issues Research, Inc.

Jennings Policy Strategies

Johns Hopkins University School of Public Health

Kaiser Family Foundation

Kaiser Foundation Health Plan Inc.

Kennedy School of Government, Harvard University

Mathematica Policy Research

Medicare Payment Advisory Commission

Medicare Rights Center -- U.S. Government Site for People with Medicare

National Academy of Social Insurance

National Association of Chain Drug Stores

National Association of Public Hospitals

National Council on Aging

National Women's Law Center

Open CRS

Robert Wood Johnson Foundation

UnitedHealth Group

Urban Institute

Wellpoint Health Networks, Inc.


1 Centers for Medicare and Medicaid Services (2009). “2009 Annual Report of the Boards of Trustees of the Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust Funds.” May 12, p.2. (

2 2001 and 2005 Annual Reports of the Boards of Trustees of the Federal Hospital Insurance and Federal Supplementary Medicare Insurance Trust Funds. Cited in Neuman, Tricia (2005). Kaiser Family Foundation (2005). “Medicare: The Basics.” PowerPoint presentation at Alliance for Health Reform – Kaiser Family Foundation briefing, Exhibit 14, May 16. (

3 Congressional Budget Office (2009). “CBO’s March 2009 Baseline: Medicare.” (

4 The American Recovery and Reinvestment Act of 2009 (H.R.1.) Section 4101: Incentives for Eligible Professionals” ( and Rosenbaum, Sara et al. (2009). “An Overview of Major Health Provisions Contained in the American Recovery and Reinvestment Act of 2009.” The George Washington University School of Public Health and Health Services, Feb. 18.

5 Richard S. Foster (2010). “Estimated Financial Effects of the “Patient Protection and Affordable Care Act,” as Amended.” CMS, Office of the Actuary, April 22.

6 Solomon M. Mussey (2010). “Estimated Effects of the “Patient Protection and Affordable Care Act,” as Amended, on the Year of Exhaustion for the Part A Trust Fund, Part B. Premiums, and Part A and Part B Coinsurance Amounts.” CMS, Office of the Actuary, April 22.

7 For details, go to this page at the Medicare Rights Center website – ( ). You will also find useful information at the eligibility page of the federal government’s website for Medicare – (|Home|GeneralEnrollment#TabTop ) – or to the similar page at the website of the Medicare Rights Center – ( ). For an interactive tool to gauge Medicare eligibility, go to ( ).

8 For details, go to this page at the Medicare Rights Center website – ( ).

9 Centers for Medicare and Medicaid Services (2009). “2009 Annual Report of the Boards of Trustees of the Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust Funds.” Table II.B1, May 12, p.5. (

10 Stephanie Peterson and Marsha Gold (2010). “Tracking Medicare Health and Prescription Drug Plans, Monthly Report for April 2010.” Mathematica Policy Research Inc. (

11 Centers for Medicare and Medicaid Services (2009). “2009 Annual Report of the Boards of Trustees of the Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust Funds.” Table II.B1, May 12, p.5. (

12 Kaiser Family Foundation (2010). “Medicare: A Primer 2010.”

13 Congressional Budget Office (2007). "The Long-Term Outlook for Health Care Spending." November.(

14 Centers for Medicare and Medicaid Services (2009). “2009 Annual Report of the Boards of Trustees of the Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust Funds.” Table V.B1, May 12, p. 188. (

15 Richard S. Foster (2010). “Estimated Financial Effects of the “Patient Protection and Affordable Care Act,” as Amended.” CMS, Office of the Actuary, April 22.

16 Hoover, Donald; Crystal, Stephen; Kumar, Rizie and others (2002). “Medical expenditures during the last year of life: findings from the 1992 – 1996 Medicare Current Beneficiary Survey – Cost of Care.” (

17 Austin, Bonnie J;Fleisher, Lisa K (2003). “Financing End-of-Life Care: Challenges for An Aging Population.” February. AcademyHealth. (

18 Davis, Karen; Moon, Marilyn; Cooper, Barbara; Schoen, Cathy (2005). “Medicare Extra: A Comprehensive Benefit Option For Medicare Beneficiaries.” Health Affairs Web Exclusive, Oct. 4. (

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Medicare Provisions in Reform

Graphics for This Chapter

Historical and Projected Number of Medicare Beneficiaries and Number of Workers per Beneficiary

Hospital Insurance (Part A) Trust Fund Balance, 2003-2019

Projected Annual Increases in Medicare Spending per Beneficiary, 2008-2017

Medicare's Sustainable Growth Rate Formula


This sourcebook for journalists was made possible with the support of the Robert Wood Johnson Foundation.

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