Commentary

Solving the Medicare Crisis with MSAs

By Peter J. Ferrara
February 18, 1997

Everyone knows the Medicare crisis is real. Not only to the government’s own reports show Medicare will run out of funds to pay promised benefits within a few years. Over the long run, the financial gap in the program becomes enormous. At best, the current sources of funding for Medicare will finance only about one-third of currently promised benefits to today’s young workers.

Solving the problem over the long run under the current Medicare structure would require not only at least tripling Medicare payroll taxes for workers, but also increasing Medicare premiums to about $3,000 to $4,000 per year per elderly couple in today’s dollars.

As a result, some fundamental change in Medicare is inevitable. The key is to find ways to address the system’s financial crisis other than just raising taxes or cutting benefits, both of which will hurt people. One way this can be done is through Medical Savings Accounts (MSAs), which will provide powerful incentives and competition to control costs, while offering even better benefits than Medicare.

Seniors can be given the freedom to choose to have their Medicare coverage provided by an MSA. Medicare would then pay a private insurance company chosen by the retiree to provide the MSA coverage to the retiree. The retiree would pay no more than he or she does for Medicare now. Those retirees who did not want MSAs could stay in Medicare.

Grassroots seniors groups like the 60 Plus Association, with 475,000 members nationwide, are now vigorously campaigning for such an MSA option under Medicare. The president of 60 Plus, Jim Martin, predicts that because of the many advantages of MSAs, almost all retires would choose them over Medicare.

A study by the National Center for Policy Analysis conducted with the assistance of the nation’s top actuarial firm showed how such an MSA would work under Medicare:

  • The insurance company would pay for an expenses of more than $3,000 per year.
  • Medicare would pay $1,500 into a savings account for the retiree every year to be used for expenses below $3,000.
  • If the retiree does not use all of the $1,500 for medical expenses in a year, he or she can keep it in the MSA and use it for medical expenses the following year. Or the retiree could withdraw unused MSA funds at the end of the year and use them for any purpose.

Such MSAs would create powerful incentives and competition to control costs. With retirees able to keep what they don’t spend for such care, they would seek to avoid unnecessary care or tests, and look for doctors and hospitals that would provide needed care at the lowest cost. This in turn would stimulate a true cost competition among doctors and hospitals seeking to attract senior patients who are looking to save their MSA funds.

This is quite different from what happens with traditional insurance, including Medicare. With someone else paying the bill, neither the patient nor the doctor is concerned about costs, and the result is high and rapidly increasing health costs.

Such MSAs are already sweeping the country, with more than 3,000 companies now offering MSAs to their workers. Their experience shows that the incentives and competition to reduce costs resulting from MSAs actuary cut health cost 30 percent or more. If MSAs can reduce Medicare costs by this much as well, they would go a long way toward solving the long-term financial crisis of Medicare.

Moreover, these MSAs would actuary provide better benefits than Medicare in several ways. The MSA plan provides complete catastrophic coverage for an expenses above the $3,000 floor while Medicare does not.

The MSA plan also provides a maximum cap on out-of-pocket expenses for retirees. The most a retiree would have to pay in any one year is the difference between the $1,500 put in the MSA and the floor of $3,000 where the insurance coverage starts. Medicare, by contrast, has no cap on out of pocket expenses. A retiree under the program can be liable for tens of thousands in expenses each year, even for services that are covered by Medicare.

That is why about 70 percent of the elderly buy Medigap insurance that will cost them an average of $1,200 in premiums this year. Indeed, with the MSA, the retiree would not need the Medigap insurance, and could contribute the $1,200 instead to the MSA. This would virtually eliminate any other out-of-pocket expenses for services covered by Medicare.

The MSA plan can provide substantial cash benefits to seniors as well. With an MSA, the retiree can withdraw any unspent funds at the end of the year and use them for any purpose. This enables seniors to share directly in the reward for keeping Medicare costs down. Alternatively, if the retiree keeps the funds in the MSA, then after one or two healthy years, the retiree will have enough funds in the account to pay for all expenses below the insurance floor. The retiree can then keep the $1,200 per year most are paying for Medigap insurance today, plus other out-of-pocket health expenses retirees are paying themselves today.

Finally, retirees with MSAs would enjoy broader freedom of choice and higher quality care than under Medicare.

Such MSAs would be better than Medicare for sick retirees as well. All of the above advantages of MSAs over Medicare would be particularly valuable for the sick. The same is true for lower-income retirees.

The necessary fundamental reform of Medicare can provide a valuable opportunity for seniors. If reformers focus on improving efficiency incentives and competition in health care under Medicare, the reform need not be harmful to retirees. Indeed, with innovative new ideas like MSAs, seniors can actually end up with better benefits than under Medicare today.

Peter Ferrara is general counsel and chief economist at Americans for Tax Reform and an associate policy analyst at the Cato Institute.