Retiree Health Trends and Implications of Possible Medicare Reforms

Part II: Implications of Potential Medicare Reforms

Most changes to the Medicare program discussed in Congress and by various health policy experts will directly affect the retiree health programs offered by employers and the retirees covered thereunder. For example, unless the employer changes its program, an increase in the Medicare Part B deductible will increase the cost of the employer-sponsored medical program. Why? If the Part B deductible is increased from $100 to, say, $300, there is an additional cost passed through to the employer plan, which would then have to cover the additional $200 in expenses. Assuming a typical 80 percent/20 percent coinsurance between the plan and the retiree, the plan would pick up an additional cost of $160 (80 percent coinsurance rate of $200) and the retiree would pay $40 more (20 percent coinsurance rate of $200). Effects of other types of Medicare changes may be more subtle.

In assessing the likely reactions to Medicare reform proposals by employers sponsoring retiree health programs, it is important to recognize that such reforms might be viewed as confirmation of existing beliefs that there is a high degree of financial risk associated with these programs because of potential government action. Employers already fear that the federal government will push additional financial obligations onto them, to offset reductions in future benefits under Medicare and Social Security. In a recent survey of chief financial officers of large companies, 86 percent said they fear the federal government will push additional obligations on them. And 63 percent said that they believe the federal government will make it more difficult for companies to change or reduce their retiree health benefits in the future.²⁵

In other words, when confronted with Medicare changes that would shift large costs to retiree health programs, the financially prudent course of action could easily suggest that employers move to change or reduce or terminate programs now, while there may be a window of opportunity before further changes and constraints emerge.

Three of the more significant proposed Medicare changes are discussed in this section.

Proposed increase in the eligibility age for entitlement to the Medicare program;
Proposed changes in payments to Medicare managed care plans; and
Proposed shift to a defined contribution program.

Proposed Increase in Eligibility Age

A proposal to increase the Medicare eligibility age from 65 to 67 has received increased attention because of recent legislative efforts to raise it. And although the latest effort failed, as discussed below, this proposal will continue to receive active consideration in anticipation of the retirement of the "baby boom" generation and the continued cost pressures facing Medicare over the long term. But despite all this attention, relatively little discussion or analysis has been done of the effects on employer-sponsored retiree health benefits of raising the Medicare age of eligibility.

The Senate-passed version of 1997 budget reconciliation legislation relating to Medicare (H.R. 2015) included a provision raising the Medicare age of eligibility to 67, gradually, in tandem with the Social Security normal retirement age²⁶, as shown in Figure 7. By a vote of 62-38, the Senate agreed to include this provision by overriding a procedural objection (" a point of order") that had been raised against it, after heated debate. This outcome on the Senate vote was very different from what occurred previously, in 1995, when the Senate Committee on Finance had included the same provision in its version of the then-pending budget reconciliation bill. In 1995, however, this provision was easily removed on the Senate floor by a successful procedural objection, without serious floor debate of the merits of the provision or a roll-call vote on a motion to waive the point of order.

Despite the strong vote of support, the 1997 Senate provision was dropped from the conference agreement on the Balanced Budget Act, after the House had earlier voted by 414-14 to instruct its negotiators to reject the Senate provision increasing the Medicare eligibility age.

The proposal to raise the Medicare age is likely to resurface again soon, as the National Bipartisan Commission on the Future of Medicare, created by the Balanced Budget Act of 1997, begins its work toward making recommendations to the President and Congress by March 1, 1999, on ensuring Medicare's long-term financial integrity. In fact, the statute charges the national commission with making recommendations "on modifying age-based eligibility to correspond to changes in age-based eligibility" under Social Security, and on the feasibility of allowing individuals between the ages of 62 and the Medicare eligibility age to "buy into" the Medicare program.²⁷

Among the many potential solutions to Medicare's financial problems, the national commission is specifically directed to analyze "trends in employment-related health care for retirees."

Groups outside of Congress have also seized upon the idea of raising the Medicare eligibility age as part of an overall effort to restore Medicare's long-term financial solvency. The American Academy of Actuaries, for example, in its white paper addressing the Medicare crisis, recommended increasing the eligibility age to 70 to keep the program viable.²⁸ If the Medicare eligibility age is linked in law to the Social Security retirement age, then any future change in the Social Security normal retirement age as a result of eventual Social Security financing reforms would automatically raise the Medicare age beyond age 67, as well.

In evaluating these proposals to raise the Medicare eligibility age, the similarities and differences between the Social Security program and Medicare need to be considered, as well as the interconnections between such Medicare changes and retiree health plans.

Similarities Between Social Security and Medicare

Medicare and Social Security benefits are both part of the Social Security Act, and are both key elements in providing financial security to retirees.

Both Social Security and Medicare Hospital Insurance (Part A) are funded by employee and employer payroll taxes during the employee's working career, although Medicare Supplementary Medical Insurance (Part B) is funded by beneficiary premiums and general tax revenues.

Beyond those basic similarities, Social Security and Medicare have important differences.

Differences Between Social Security and Medicare

As noted above, Social Security provides reduced benefits at earlier ages. Medicare does not. There is already a gap between the age at which individuals actually retire and the current Medicare age. According to the Social Security Administration, of benefits initially awarded to retired workers in 1995, 77 percent were for individuals between the ages of 62 and 64, and 58 percent of retired workers claimed Social Security benefits at the earliest age available. Women were even more likely to claim Social Security benefits earlier, with 80 percent of women in 1995 claiming Social Security benefits before age 65, and 62 percent of women claiming Social Security at the earliest available age of 62.²⁹

Retirees with pension coverage often retire before the Social Security earliest age of 62, making the gap between actual retirement and Medicare eligibility for this group even greater than the gap between actual retirement and the age when Social Security benefits are claimed. The U.S. General Accounting Office (GAO) has reported that early receipt of employer-sponsored pensions is common, with pension receipt at younger ages (50-64) growing much faster than among individuals age 65 and over. GAO also found that early pension recipients tend to stop working. And while a majority of early retirees appeared to be voluntarily retired, a significant minority had retired due to disability or poor health; the earlier the age of retirement, the greater the frequency that health or disability were cited by retirees as the primary reason for retiring.³⁰

For retirement planning purposes, the benefit implications of a reduction in Social Security benefits can be anticipated and employees can potentially adjust by saving more through employer plans, individual retirement accounts, or on their own, or by supplementing Social Security with part-time work. For example, with advance notice, a two-month increase in the Social Security eligibility age can be budgeted for by an employee who still wants to retire early. The financial consequences of being without Medicare coverage are harder for the individual to predict, however. A retiree without health insurance coverage could in a two-month interval experience catastrophic medical expenses that could radically diminish their retirement assets and income. And the longer the period without Medicare, the greater the risk of such an unforeseen occurrence.

Individuals anticipating a Social Security age increase can continue to work, and virtually all jobs in the U.S. economy, full-time or part-time, are covered by Social Security. By contrast, with respect to delayed Medicare coverage, one can plan to continue to work longer but many jobs available to older individuals may not include health insurance coverage. And overall, the share of the total U.S. population with employer-sponsored coverage has been declining. Retirees without Medicare have no guaranteed access to health insurance. COBRA continuation coverage for former employees is expensive for the individual (and the employer) and limited to 18 months. A recent study for The Commonwealth Fund found that for each one-year increase in the Medicare age of eligibility, an additional 200,000 individuals would become uninsured.³¹

Interconnections Between Medicare Eligibility Age and Retiree Health Plans

A Medicare eligibility age increase would reduce long-term Medicare expenditure increases by shifting costs to retiree health plans, possibly causing more employers to cease offering coverage, or further reduce benefits, and/or shift costs to active employees and to retirees, thereby accelerating trends that are already in evidence.

To understand how employers sponsoring retiree health plans might react to such a change in Medicare, it would be helpful to review briefly how the FAS 106 accounting rules work and the way in which these rules might influence employer's decisionmaking.

Immediate Financial Impact of Prospective Increase in Medicare Age

As discussed above, the FAS 106 accounting rules stipulate the way companies expense for post-retirement medical benefits. It requires employers to accrue the cost of retiree health and other post-retirement benefits during the working careers of active employees.

The most important point to understand is that because of the way in which the FAS 106 rules work, even a prospective and gradual increase in the Medicare age that is years away will have an immediate impact on the balance sheet of a company sponsoring retiree health benefits. Here are some reasons why the accounting rules work in this manner.

The unique aspect of both pension and retiree medical benefits is that employees in some way "earn" the benefit during their career, but the payment is not made until after the end of the employees' careers. Since the general focus of accounting is to assign costs to the time when the company supposedly realizes a benefit, the focus of both FAS 87 (pensions) and FAS 106 (other post-employment benefits) is to assign a current expense for these future events. The employer's total accrued liability is the hypothetical amount of the benefit obligation which the company is presently responsible to pay in the future. In that calculation, the employer's obligation for future retiree health claims of post-65 retirees is reduced by the portion of the gross medical claims charges paid by Medicare under current law.

A reduction in future Medicare benefits, e.g., an increase in the age of Medicare eligibility, all other things being equal and without any offsetting reduction in the employer's share of the future cost, would increase the employer's liability for accrued retiree health benefits. The precise amount of that increase is a complex determination based on each company's individual situation. But even though a change in the age of Medicare eligibility may not begin to take effect until after the year 2000, the recognition of the increased employer liabilities on the company's financial statement can be immediate.

Cost Effects of Eligibility Age Increase

Changes to the Medicare eligibility age will have a dramatic effect on the costs of a typical employer-sponsored retiree medical plan and the typical beneficiary. Unlike the situation with Social Security, where reduced benefits are payable for individuals retiring before the normal retirement age, nothing would be paid from the Medicare program for retirees prior to the eligibility age, unless some partial Medicare benefit were created by law (which was not part of the most recent Senate proposal). (Medicare eligibility for disabled Social Security beneficiaries would not be affected.)

If the employer does not change its design or retiree contribution requirements, the Medicare eligibility change to 67 will add another two years of benefit payments for every future retiree and for which the retiree health plan pays for the full benefit (i.e., no offset for Medicare). This change will increase the actuarial cost of the employer-provided retiree health plan benefits by roughly 10 to 20 percent. If the Medicare age were increased to age 70, that would add 5 years of benefit payments from the employer plan without any Medicare offset, raising the actuarial cost by roughly 30 to 40 percent.

Because the Medicare offset to the retiree health plan would be eliminated for the individuals retiring before the new Medicare eligibility age, raising the eligibility age to age 67 would immediately mean that a 65-year-old retiree will have average unpaid medical costs (absent other private insurance) that are two to four times (depending on plan design) greater than when Medicare covered that retiree. For example, plan costs for retirees who are not eligible for Medicare are about $4,000 per year in 1997 compared to an average $1,350 for a Medicare-eligible retiree.³² This difference reflects the value of Medicare's payment of health care costs for the retirees.

Figure 8 shows the actuarial cost percentage increase³³ relative to current costs for three possible changes in the Medicare eligibility age for two hypothetical companies with a younger workforce (average age 33, average service 5 years) and an older workforce (average age 44, average service 12 years). The three possible Medicare age of eligibility changes considered are:

1. A phased-in increase to 67, tied to the Social Security normal retirement age (SSNRA);

2. A direct change to age 67, which also approximates what the cost effects would be once the Medicare/SSNRA change is fully phased in; and

3. An immediate change to age 70, as has been suggested by some analysts for both Social Security and Medicare.

The decision facing sponsors of retiree health programs is how to react to such increases in terms of additional employer contributions, retiree contributions, benefit/eligibility modifications, or some combination thereof.

For example, using projections from Figure 8, raising the Medicare eligibility age to 67 will result in a 16 percent increase in the actuarial cost of lifetime retiree benefits for the plan of an employer with a young workforce (e.g., technology firm). For an employer with an older workforce (e.g., manufacturing company) the actuarial cost increase would be 18 percent.

The actuarial cost increase would be significantly greater if the eligibility age was raised to 70. An employer with a younger workforce would experience a 38 percent increase while an employer with a older workforce would experience a 43 percent increase in the actuarial cost of the plan.

Employers sponsoring retiree health plans may react differently to this type of cost increase, depending on their current plan design. Much will depend on the current level of plan benefits and the employer subsidy of the pre-Medicare plan.

On one extreme, if retirees pay the full cost of the plan, employers may do little since the cost to them will be minimal. A key issue in this situation is that retirees without Medicare are more likely to have a very high cost claim. Therefore, there is a higher risk (than before the eligibility age change) of a catastrophic claim, and therefore the possibility of higher premiums by retirees.

On the other extreme where the employer pays the full cost of pre-Medicare health care, there may be serious discussion of limiting the employer's obligations, in effect passing greater risk to retirees.

For employers in between those two extremes, a response to the increased costs from a change in the Medicare age may lead them to reduce their retiree health financial commitment to active employees or decide not to provide retiree coverage at all for future retirees. Employers will be far less likely to eliminate coverage for existing retirees, but the additional expense may cause them to increase premiums, further shift costs, and make other design changes affecting pre- and post-65 retirees, similar to the key trends discussed earlier for the period between 1991 and 1996.

Specifically, in reaction to a Medicare eligibility age increase, employers sponsoring retiree health benefits may:

Increase the eligibility requirements.

For example, employers might require a retiree to be at least age 60 with 10 years of service instead of age 55 with 10 years of service. For most employers, about 5 percent of their employees who are eligible to retire under age 60, actually retire each year. If the minimum eligibility age for retiree medical is increased, and employees do not alter their retirement decision based on the availability of retiree medical benefits, about 23 percent of an employer's retirees will not be eligible for retiree medical benefits when they would have been eligible prior to the change.
Increase retiree contribution requirements for ages over 65 to compensate for the higher cost.

For example, in a retiree plan using the typical "carveout" approach of coordinating with Medicare (as described in Part I of this report), eliminating Medicare eligibility may increase the costs for a 66-year old from $1,000 per person per year to $4,000. To keep the effect cost neutral, the employer could require the retiree to pay the extra $3,000 for coverage.
Eliminate coverage.

Retirees will then be on their own to find coverage. Currently, it is difficult to find individual coverage at these ages but this may change in the future if health plans seek to enroll this population in order to retain them after they are eligible for Medicare. Current individual medical premiums for a 60 year old range between $4,500 and $6,000 per person for a healthy retiree enrolling in a comprehensive medical plan.
Adopt some other plan design changes, such as increases in plan deductibles to help lower the costs of the pre-Medicare retiree group.

In order to offer a plan for a retiree not eligible for Medicare that would cost the same as a Medicare-eligible retiree, the employer would have to offer, for example, a plan with a $10,000 deductible and 50 percent coinsurance with a $50,000 out-of-pocket limit on the retiree's obligations. Few employers and retirees would view this as adequate coverage.

Any of the possible plan design reactions cited above could force some employees to delay retirement or be uninsured for a period of time. Those with health care needs may seek other outside insurance or consider paying the COBRA premiums to stay in the employer's plan as long as possible. This increased demand for coverage may help to stimulate the availability of individual health insurance through legislated action designed to fill in the gap. Also, health plans may seek to enroll such individuals, viewing them as a new source of eventual Medicare members. Or, it may mean that the average age of retirement will increase.

Publication Number: 1318
Publish Date: 1997-09-01