FAQs on Medicare Financing and Trust Fund Solvency

Juliette Cubanski Follow @jcubanski on Twitter and Tricia Neuman Follow @tricia_neuman on Twitter Published: Mar 16, 2021

Medicare, the federal health insurance program for more than 60 million people ages 65 and over and younger people with long-term disabilities, helps to pay for hospital and physician visits, prescription drugs, and other acute and post-acute care services. Medicare spending often plays a major role in federal health policy and budget discussions, since it accounts for 21% of national health care spending and 12% of the federal budget. Recent attention has focused on one specific measure of Medicare’s financial condition – the solvency of the Medicare Hospital Insurance (HI) trust fund, out of which Medicare Part A benefits are paid – because the HI trust fund is projected to be depleted in 2026, just five years from now. These FAQs answer key questions about Medicare financing and trust fund solvency.

How is Medicare financed?

Funding for Medicare comes primarily from general revenues, payroll tax revenues, and premiums paid by beneficiaries (Figure 1). Other sources include taxes on Social Security benefits, payments from states, and interest. The different parts of Medicare are funded in varying ways.

·        Part A, which covers inpatient hospital stays, skilled nursing facility (SNF) stays, some home health visits, and hospice care, is financed primarily through a 2.9% tax on earnings paid by employers and employees (1.45% each). Higher-income taxpayers (more than $200,000 per individual and $250,000 per couple) pay a higher payroll tax on earnings (2.35%). Payroll taxes accounted for 88% of Part A revenue in 2019.

·        Part B, which covers physician visits, outpatient services, preventive services, and some home health visits, is financed primarily through a combination of general revenues (72% in 2019) and beneficiary premiums (27%). Beneficiaries with annual incomes over $85,000 per individual or $170,000 per couple pay a higher, income-related Part B premium reflecting a larger share of total Part B spending, ranging from 35% to 85%.

·        Part D, which covers outpatient prescription drugs, is financed primarily by general revenues (71%) and beneficiary premiums (17%), with an additional 12% of revenues coming from state payments for beneficiaries dually eligible for Medicare and Medicaid. Higher-income enrollees pay a larger share of the cost of Part D coverage, as they do for Part B.

The Medicare Advantage program (Part C) is not separately financed. Medicare Advantage plans, such as HMOs and PPOs, cover Part A, Part B, and (typically) Part D benefits. Funds for Part A benefits provided by Medicare Advantage plans are drawn from the Medicare HI trust fund (comprising an estimated 42% of HI trust fund expenses in 2021). Funds for Parts B and D benefits are drawn from the Supplementary Medical Insurance (SMI) trust fund. Beneficiaries enrolled in Medicare Advantage plans pay the Part B premium and may pay an additional premium for their plan.

What does Medicare trust fund solvency mean and why does it matter?

The solvency of the Medicare Hospital Insurance trust fund, out of which Part A benefits are paid, is a common way of measuring Medicare’s financial status, though because it only focuses on the status of Part A, it does not present a complete picture of total program spending. Medicare solvency is measured by the level of assets in the Part A trust fund. In years when annual income to the trust fund exceeds benefits spending, the asset level increases, and when annual spending exceeds income, the asset level decreases. This matters because when spending exceeds income and the assets are fully depleted, Medicare will not have sufficient funds to pay hospitals and other providers for all Part A benefits that are provided in a given year.

Beginning in 2018 and moving forward in the future, Part A spending exceeds Part A revenues, leading to a gradual depletion of assets in the HI trust fund. For example, in 2021, the Medicare actuaries estimated that the HI trust fund would begin the year with $185 billion in assets, but because spending is estimated to exceed revenue by $15 billion this year, the trust fund is expected to end the year with $170 billion in assets (Figure 2). By 2025, assets in the trust fund at the beginning of the year will have decreased to $73 billion, and with $50 billion more in spending than in revenues that year, assets will drop to $23 billion by the end of 2025. And by 2026, the $23 billion in assets in the HI trust fund at the start of the year is projected to be insufficient to cover the shortfall between projected spending and revenues, leading to a deficit of $31 billion by the end of that year.

When is the HI trust fund projected to be depleted, and what happens if there is a shortfall?

Each year, Medicare’s actuaries provide an estimate of the year when the HI trust fund asset level is projected to be fully depleted. In the 2020 Medicare Trustees report, the actuaries projected that assets in the Part A trust fund will be depleted in 2026, just five years from now (Figure 3). A more recent projection from the Congressional Budget Office also estimated depletion of the HI trust fund in 2026.

In the 30 years prior to 2021, the HI trust fund has come within five years of depletion only twice – in 1996 and again in 1997 (Figure 4). At that time, Congress enacted legislation to reduce Medicare spending obligations to improve the fiscal outlook of the trust fund. To date, lawmakers have never allowed the HI trust fund to be fully depleted.

While some describe the trust fund as heading toward “bankruptcy” or “going broke”, it is important to note that the Medicare program will not cease to operate if assets are fully depleted, because revenue will continue flowing into the fund from payroll taxes and other sources. Based on data from Medicare’s actuaries, in 2026, Medicare will be able to cover 94% of Part A benefits spending with revenues plus the small amount of assets remaining at the beginning of the year, and just under 90% with revenues alone in 2027 through 2029. However, there is no automatic process in place or precedent to determine how to apportion the available funds or how to fill the shortfall.

How large is the projected shortfall?

To address the shortfall between Part A spending and revenues, based on CBO’s projections, a total of $517 billion in spending reductions or additional revenues, or some combination of both, would be needed to cover the total deficit between 2026 (the year of trust fund depletion) and 2031 (the final year in CBO’s projection period) (Figure 5). This $517 billion deficit represents the cumulative difference between Part A spending and revenues over this time period. This amount is lower than the total deficit between spending and revenues that will accumulate between 2022 and 2031 ($653 billion over this period), because the lower amount takes into account the assets in the trust fund between 2022 and 2026 that can be used to pay for Part A spending until the assets are depleted.

To put the $517 billion shortfall in context, this amount represents 15% of the projected $3.4 trillion in aggregate total Part A spending between 2026 and 2031, and 18% of the projected $2.9 trillion in total Part A revenues over this same time period. Over a longer 75-year timeframe, the Medicare Trustees estimated that it would take an increase of 0.76% of taxable payroll over the 75-year period, or a 16% reduction in benefits each year over the next 75 years, to bring the HI trust fund into balance.

Are Medicare Part B and Part D also facing insolvency?

The Hospital Insurance trust fund provides financing for only one part of Medicare, and therefore represents only one part of Medicare’s financial picture. While Part A is funded primarily by payroll taxes, benefits for Part B physician and other outpatient services and Part D prescription drugs are funded by general revenues and premiums paid for out of separate accounts in the Supplementary Medical Insurance, or SMI, trust fund. The revenues for Medicare Parts B and D are determined annually to meet expected spending obligations, meaning that the SMI trust fund does not face a funding shortfall, in contrast to the HI trust fund. But higher projected spending for benefits covered under Part B and Part D will increase the amount of general revenue funding and beneficiary premiums required to cover costs for these parts of the program in the future.

What factors affect the solvency of the HI trust fund?

The solvency of the HI trust fund is affected by a number of factors. In addition to legislative and regulatory changes that affect Part A spending and revenues, Part A trust fund solvency is affected by the level of growth in the economy, which affects Medicare’s revenue from payroll tax contributions; by overall health care spending trends; and by demographic trends, such as the increasing number of beneficiaries, especially between 2010 and 2030 when the baby boom generation reaches Medicare eligibility age, and a declining ratio of workers per beneficiary making payroll tax contributions.

To give a recent example of how such factors play into solvency projections, in January 2020, prior to the outbreak of the COVID-19 pandemic, CBO projected that the HI trust fund would be depleted in 2025. In September 2020, six months into the pandemic and in the midst of a significant economic downturn and a substantial reduction in employment leading to a decline in payroll tax revenue, CBO accelerated its projected insolvency date by one year, to 2024. This was primarily based on lower expected revenues over the projection period and an increase in projected Part A spending in 2020, compared to CBO’s January 2020 forecast. By February 2021, CBO had revised its projections yet again, projecting HI trust fund insolvency two years later, in 2026. The revision was due to an increase in the projected amount of payroll tax revenue based on an expectation of faster recovery from the pandemic economic downturn than CBO anticipated in its September 2020 projection, along with lower actual Part A spending in 2020 than CBO had projected in September 2020 and lower projected Part A spending in future years. It remains to be seen how the latest COVID-19 stimulus legislation and the longer-term health and economic effects of the pandemic will affect these projections.

What is the longer term outlook for Medicare financing and trust fund solvency?

Over the longer term, Medicare faces financial pressures associated with higher health care costs and an aging population. To sustain Medicare for the long run, policymakers may consider adopting broader changes to the program that could include both reductions in payments to providers and plans or reductions in benefits, and additional revenues, such as payroll tax increases or new sources of tax revenue. Consideration of such changes would likely involve careful deliberations about the effects on federal expenditures, the Medicare program’s finances, and beneficiaries, health care providers, and taxpayers.

https://www.kff.org/medicare/issue-brief/faqs-on-medicare-financing-and-trust-fund-solvency/