Program Financing Beneficiary Liabilities and Provider Payments

All financial operations for Medicare are handled through two trust funds, one for HI (Part A) and one for SMI (Parts B and D). These trust funds, which are special accounts in the U.S. Treasury, are credited with all receipts and charged with all expenditures for benefits and administrative costs. The trust funds cannot be used for any other purpose. Assets not needed for the payment of costs are invested in special Treasury securities. The following sections describe Medicare's financing provisions, beneficiary cost-sharing requirements, and the basis for determining Medicare reimbursements to healthcare providers.

Program Financing

The HI trust fund is financed primarily through a mandatory payroll tax. Almost all employees and self-employed workers in the United States work in employment covered by Part A and pay taxes to support the cost of benefits for aged and disabled beneficiaries. The Part A tax rate is 1.45 percent of earnings, to be paid by each employee and a matching amount by the employer for each employee, and 2.90 percent for self-employed persons. Beginning in 1994, this tax is paid on all covered wages and self-employment income without limit. (Prior to 1994, the tax applied only up to a specified maximum amount of earnings.) The Part A tax rate is specified in the Social Security Act and cannot be changed without legislation.

Part A also receives income from the following sources: (1) a portion of the income taxes levied on Social Security benefits paid to high-income beneficiaries; (2) premiums from certain persons who are not otherwise eligible and choose to enroll voluntarily; (3) reimbursements from the general fund of the U.S. Treasury for the cost of providing Part A coverage to certain aged persons who retired when Part A began and thus were unable to earn sufficient quarters of coverage (and those Federal retirees similarly unable to earn sufficient quarters of Medicare-qualified Federal employment); (4) interest earnings on its invested assets; and (5) other small miscellaneous income sources. The taxes paid each year are used mainly to pay benefits for current beneficiaries.

The SMI trust fund differs fundamentally from the HI trust fund with regard to the nature of its financing. As previously noted, SMI is now composed of two parts, Part B and Part D, each with its own separate account within the SMI trust fund. The nature of the financing for both parts of SMI

is similar, in that both parts are primarily financed by beneficiary premiums and contributions from the general fund of the U.S. Treasury.

Part B is financed through premium payments ($78.20 per beneficiary per month in 2005) and contributions from the general fund of the U.S. Treasury. (Penalties for late enrollment may apply.) Beneficiary premiums are generally set at a level that covers 25 percent of the average expenditures for aged beneficiaries. Therefore, the contributions from the general fund of the U.S. Treasury are the largest source of Part B income.

Similarly, Part D, once under way in 2006, will be financed primarily through premium payments and contributions from the general fund of the U.S. Treasury, with general fund contributions accounting for the largest source of Part D income, since beneficiary premiums are to represent, on average, 25.5 percent of the cost of standard coverage (as described in the next section). The premiums and general fund contributions for Part D will be determined separately from those for Part B. (In 2004 and 2005, the general fund of the U.S. Treasury will finance the transitional assistance benefit for low-income beneficiaries by providing funds to a Transitional Assistance account within the SMI trust fund. The proceeds will be transferred to the Part D account at the conclusion of the temporary program.)

The SMI trust fund also receives income from interest earnings on its invested assets, as well as a small amount of miscellaneous income. For both Parts B and D separately, beneficiary premiums and general fund payments are redetermined annually, to match estimated program costs for the following year. (Beginning in 2007, the Part B premium will be increased for beneficiaries meeting certain income thresholds.)

Capitation payments to Medicare Advantage plans are financed from both the HI trust fund and the Part B account within the SMI trust fund in proportion to the relative weights of Part A and Part B benefits to the total benefits paid by the Medicare program.

Beneficiary Payment Liabilities

Fee-for-service beneficiaries are responsible for charges not covered by the Medicare program and for various cost-sharing aspects of both Part A and Part B. These liabilities may be paid (1) by the Medicare beneficiary; (2) by a third party, such as an employer-sponsored retiree health plan or private "Medigap" insurance; or (3) by Medicaid, if the person is eligible. The term "Medigap" is used to mean private health insurance that pays, within limits, most of the healthcare service charges not covered by Parts A or B of Medicare. These policies, which must meet federally imposed standards, are offered by Blue Cross and Blue Shield and various commercial health insurance companies.

For beneficiaries enrolled in Medicare Advantage plans, the beneficiary's payment share is based on the cost-sharing structure of the specific plan selected by the beneficiary, since each plan has its own requirements. Most plans have lower deductibles and coinsurance than are required of fee-for-service beneficiaries. Such beneficiaries pay the monthly Part B premium and may, depending on the plan, pay an additional plan premium.

For hospital care covered under Part A, a fee-for-service beneficiary's payment share includes a one-time deductible amount at the beginning of each benefit period ($912 in 2005). This deductible covers the beneficiary's part of the first 60 days of each spell of inpatient hospital care. If continued inpatient care is needed beyond the 60 days, additional coinsurance payments ($228 per day in 2005) are required through the 90th day of a benefit period. Each Part A beneficiary also has a "lifetime reserve" of 60 additional hospital days that may be used when the covered days within a benefit period have been exhausted. Lifetime reserve days may be used only once, and coinsurance payments ($456 per day in 2005) are required.

For skilled nursing care covered under Part A, Medicare fully covers the first 20 days ofSNF care in a benefit period. But for days 21-100, a copayment ($115 per day in 2005) is required from the beneficiary. After 100 days ofSNF care per benefit period, Medicare pays nothing for SNF care. Home health care has no deductible or coinsurance payment by the beneficiary. In any Part A service, the beneficiary is responsible for fees to cover the first 3 pints or units of non-replaced blood per calendar year. The beneficiary has the option of paying the fee or of having the blood replaced.

There are no premiums for most people covered by Part A. Eligibility is generally earned through the work experience of the beneficiary or of his or her spouse. However, most aged people who are otherwise ineligible for premium-free Part A coverage can enroll voluntarily by paying a monthly premium, if they also enroll in Part B. For people with fewer than 30 quarters of coverage as defined by the Social Security Administration (SSA), the 2005 Part A monthly premium rate is $375; for those with 30 to 39 quarters of coverage, the rate is reduced to $206. Voluntary coverage upon payment of the Part A premium, with or without enrolling in Part B, is also available to disabled individuals for whom cash benefits have ceased due to earnings in excess of those allowed for receiving cash benefits. (Penalties for late enrollment may apply.)

For Part B, the beneficiary's payment share includes the following: one annual deductible ($110 in 2005); the monthly premiums; the coinsurance payments for Part B services (usually 20 percent of the medically allowed charges); a deductible for blood; certain charges above the Medicare-allowed charge (for claims not on assignment); and payment for any services that are not covered by Medicare. For outpatient mental health treatment services, the beneficiary is liable for 50 percent of the approved charges.

For Part D, standard coverage is defined for 2006 as having a $250 deductible with 25 percent coinsurance (or other actuarially equivalent amounts)

for drug costs above the deductible and below an initial coverage limit of $2,250. The beneficiary is then responsible for all costs until a $3,600 out-of-pocket limit is reached. For higher costs, there is catastrophic coverage that requires enrollees to pay the greater of 5 percent coinsurance or a small copay ($2 for generic or preferred brands and $5 for any other drug). After 2006, these benefit parameters are indexed to the growth in per capita spending in Part D. In determining out-of-pocket costs, only those amounts actually paid by the enrollee or another individual (and not reimbursed through insurance) are counted. The exception to this provision is cost-sharing assistance from Medicare's low-income subsidies and from State Pharmacy Assistance programs. The monthly premiums required for Part D coverage are described in the previous section.

Provider Payments

For Part A, before 1983, payments to providers were made on a reasonable cost basis. Medicare payments for most inpatient hospital services are now made under a reimbursement mechanism known as the prospective payment system (PPS). Under PPS, a specific predetermined amount is paid for each inpatient hospital stay, based on each stay's diagnosis-related group (DRG) classification. In some cases the payment the hospital receives is less than the hospital's actual cost for providing the Part A-covered inpatient hospital services for the stay; in other cases it is more. The hospital absorbs the loss or makes a profit. Certain payment adjustments exist for extraordinarily costly inpatient hospital stays. Payments for skilled nursing care, home health care, inpatient rehabilitation, and long-term hospital care are made under separate prospective payment systems. Payments for psychiatric hospital care are currently reimbursed on a reasonable cost basis, but a prospective payment system is expected to be implemented in the near future, as required by the BBA.

For Part B, before 1992, physicians were paid on the basis of reasonable charge. This amount was initially defined as the lowest of (1) the physician's actual charge; (2) the physician's customary charge; or (3) the prevailing charge for similar services in that locality. Beginning January 1992, allowed charges were defined as the lesser of (1) the submitted charges, or (2) the amount determined by a fee schedule based on a relative value scale (RVS). Payments for DME and clinical laboratory services are also based on a fee schedule. Most hospital outpatient services are reimbursed on a prospective payment system, and home health care is reimbursed under the same prospective payment system as Part A.

If a doctor or supplier agrees to accept the Medicare-approved rate as payment in full ("takes assignment"), then payments provided must be considered as payments in full for that service. The provider may not request any added payments (beyond the initial annual deductible and coinsurance) from the beneficiary or insurer. If the provider does not take assignment, the beneficiary will be charged for the excess (which may be paid by Medigap insurance). Limits now exist on the excess that doctors or suppliers can charge. Physicians are "participating physicians" if they agree before the beginning of the year to accept assignment for all Medicare services they furnish during the year. Since Medicare beneficiaries may select their doctors, they have the option to choose those who participate.

Medicare payments to Medicare Advantage plans are based on a blend of local and national capitated rates, generally determined by the capitation payment methodology described in section 1853 of the Social Security Act. Actual payments to plans vary based on demographic characteristics of the enrolled population. New "risk adjusters" based on demographics and health status are currently being phased in to better match Medicare capitation payments to the expected costs of individual beneficiaries. As previously mentioned, the Medicare Advantage program will undergo changes beginning in 2006. Plan bids will be replacing the current payment structure for Medicare Advantage plans.

For Part D, in 2006 and later, PDPs (including the prescription drug portion of Medicare Advantage plans) will pay for most FDA-approved prescription drugs and biologicals under the benefit structure described in the previous section. Plans may set up formularies for their prescription drug coverage, subject to statutory standards.

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