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POTENTIAL COST SHIFTING UNDER PROPOSED FUNDING REDUCTIONS FOR MEDICARE AND MEDICAID: THE BUDGET RECONCILIATION ACT OF 1995

Final Report

Prepared For:
The National Leadership Coalition On Health Care

By:
John F. Sheils
Gary J. Claxton

Lewin-VHI, Inc.

December 6, 1995

EXECUTIVE SUMMARY

      The Budget Reconciliation Act of 1995 would reduce funding for Medicare and Medicaid by about $434 billion over the next seven years. These spending reductions would be achieved through expanded enrollment in managed care, increased premiums for Medicare beneficiaries, reduced coverage, and reduced payments to hospitals, nursing homes and other providers. However, some portion of the reductions in provider payments under these programs is likely to be passed on to privately-insured persons in the form of higher charges through cost shifting.

      In this study we estimate the potential effects of this cost shifting on private insurance premiums and costs for employers and families. We also estimated the number of persons who would lose coverage under the bill due to reductions in eligibility under the Medicaid program or increases in private plan premiums. In addition, we estimate the increase in charity care expenses due to increases in the uninsured population.

      We begin by summarizing the Medicare and Medicaid spending reductions and reviewing the evidence on cost shifting. We also estimate the cost shift under these budget cuts and the impact that this would have on employers and families. In addition, we estimate the change in insurance coverage likely to result from this increase in insurance premiums.

    Medicare Spending Reductions

      The Reconciliation Act would reduce Medicare program funding by $270 billion over the next seven years. The act establishes the “MedicarePlus” program which would permit Medicare beneficiaries to enroll in a broader variety of private health plans. The act would also increase beneficiary Part-B premium payments and would improve fraud detection and coordination of benefits for persons with employer-based coverage. The plan also specifies specific cuts in provider payments and creates a “fail-safe” mechanism which would further reduce provider payments if budget spending targets under the bill are exceeded in future years.

      The Congressional Budget Office (CBO) estimates that Medicare would save $57.3 billion due to the Part-B premium increase and another $9.1 billion through fraud detection and coordination of benefits provisions. Another $26.7 billion would be saved through increased enrollment in private plans. The reductions in provider payments for services (including “fail-safe” amounts) would be $105.3 billion for hospitals, $27.0 billion for long-term care and $44.5 billion for physicians and other providers.

    Medicaid Spending Reductions

      The act reduces federal Medicaid funding by about $163.4 billion over the 1996 through 2002 period. The bill converts the Medicaid program to a block grant program to states. The amount of each states grant would be based upon spending levels prior to implementing these reforms and would be indexed based upon an overall budget ceiling calibrated to produce $163.4 billion in federal budget savings over the 1996 through 2002 period. States must match the federal contribution based on state matching rates under the current program in order to receive the maximum federal grant

      We assume that states will put into the program only what is required to obtain the maximum federal match under the federal grant program. This implies an additional reduction in state Medicaid spending of $123.3 billion over the 1996 through 2002 period. We assume that states will reduce provider payment rates so that per-capita growth in costs under the program is reduced from its current growth rate of 7.0 percent to 5.0 percent. If further funding reductions are necessary, they would take the form of reduced eligibility under the program. Under these assumptions, Medicaid enrollment is reduced by 8.5 million persons by 2002.

    Evidence on Cost Shifting

      Cost shifting is the process whereby providers recover uncompensated care costs and payment shortfalls for public program enrollees through higher charges to private payers. For example, hospital payment rates under public programs are on average about 10 percent below costs. Hospitals also incur about $12.3 billion in uncompensated care expenses for uninsured and underinsured persons.1 These shortfalls are recovered at least in part by increasing charges to private payers as much as 30 percent above actual costs for persons covered under private plans.

      Some studies suggest that hospitals shift as much as half of these payment shortfalls to private payers while others show less evidence of cost shifting. Our own analyses indicate that in recent years about 40 percent of the increase in hospital payment shortfalls in each year is passed on to consumers in the form of higher mark-ups on care provided to privately-insured persons. In addition, a recent study of physician pricing by Thomas Rice, et al. indicates that each one percent reduction in public payer rates is associated with a 0.2 percent increase in physician charges to private payers.2 It is clear from these studies, however, that providers are able to shift only a portion of payment shortfalls to private payers in part because selective contracting by health plans has made it more difficult for providers to shift costs.

      Based upon a review of the literature, we assumed that 40 percent of the increase in hospital payment shortfalls under these budget cuts would be passed on to private payers in the form of higher charges. However, we assume that the percent of payment shortfalls that are shifted declines in future years to reflect continued growth in selective contracting. We also estimated cost shifting for physician payment shortfalls based upon the Rice analysis.

      Under the assumptions used in this analysis, payments to providers would be reduced by about $218.9 billion over the 1996 through 2002 period. Uncompensated care expenses for those who become uninsured would also increase by about $65.5 billion over this period. The total increase in provider payment shortfalls would be about $284.4 billion. We estimate that in response to this, providers would shift about $84.7 billion (29.7 percent) of the $284.4 billion in payment shortfalls to private payers (Figure ES-1). About 52.7 percent of the increase in cost shifting would be attributed to the Medicare cuts while 47.3 percent would be attributed to Medicaid cuts.FIGURE ES- 1
ESTIMATED COST SHIFT UNDER MEDICARE
AND MEDICAID BUDGET CUTS

Hospital
Cost Shift a/		Other Provider
Cost Shift b/		Total
Cost Shift
1996
1997
1998
1999
2000
2001
2002		$1.6
3.0
6.8
10.3
11.7
14.4
16.5		$0.4
0.9
2.4
3.5
3.9
4.4
4.9		$ 2.0
3.9
9.2
13.8
15.6
18.8
21.4
Total 1996-2002$ 64.3$ 20.4$ 84.7
a/Includes a percentage of hospital budget cuts under Medicare and Medicaid. The percentage of hospital budget cuts that we assume to be cost shifted is 40 percent in 1994 phasing down to 30 percent by 2002.
b/Assumes that each 1.0 percent reduction in other provider payments under the bill results in a 0.2 percent increase in private sector rates.

Source: Lewin-VHI estimates.

    Cost Shift by Payer

      The increase in provider charges to private payers resulting from the cost shift ($84.7 billion) would be reflected in higher private insurance premiums. Employer health spending would increase by $69.3 billion over the 1996 through 2002 period, while employee contributions for employer health coverage would increase by $5.9 billion. Expenditures for individually purchased non-group insurance would increase by $10.2 billion over this period due to the cost shift. As a result of this cost shift, by 2002, private insurance costs would be about $21.4 billion (four percent) higher than under current trends (Figure ES- 2).FIGURE ES- 2
CHANGE IN PRIVATE INSURANCE COSTS RESULTING FROM MEDICARE AND MEDICAID BUDGET CUTS UNDER THE BUDGET RECONCILIATION ACT OF 1995

Line Graph - Figure 2

Source: Lewin-VHI estimates using the Health Benefits Simulation Model (HBSM).

    Impact on Workers and Families

      Empirical evidence indicates that employers are likely to pass on much of the increase in employer costs to employees in the form of reduced wages. Based upon a review of the literature, we estimate that about $61.0 billion of the $69.3 billion increase in employer costs due to cost shifting would be passed on to workers in the form of lost wage growth. This wage loss is in addition to the $5.9 billion increase in employee premium contributions resulting from higher private insurance premiums. Overall, the amount of the cost shift passed through to workers would be $66.9 billion including lost wage growth ($61.0 billion) and higher employee premium contributions ($5.9 billion). Lost wages and increased premium contributions — commonly called the pass-through — would equal about $925 per covered worker over the 1996 through 2002 period (Figure ES- 3).

      The cost shift would affect costs for both public and private employee health benefits plans. About 18 percent of the cost shift pass-through to workers would fall on government employees (i.e., state, local and federal government employees) while about 82 percent would fall on covered workers in private health plans (Figure ES- 3). The amount of the pass-through per worker would tend to be highest among industries with the most comprehensive health plans such as manufacturing and transportation.FIGURE ES- 3
DISTRIBUTION OF COST SHIFT PASS-THROUGH TO COVERED WORKERS BY INDUSTRY (1996 THROUGH 2002)

Pass-through
to Covered
Workers
(billions) a/		Pass-through
per
Worker		Percent
of Total
Industry
Construction
Manufacturing
Transportation
Wholesale Trade
Retail Trade
Services
Finance
Other		$3.1
$15.1
$6.4
$2.8
$5.2
$15.3
$4.3
$2.8		$968
$936
$1,229
$973
$653
$908
$914
$973		4.6%
22.6%
9.6%
4.2%
7.8%
22.9%
6.4%
4.2%
Government b/$11.9$95017.8%
Total$66.9$925100.0%
a/Includes the increase in employee share of premium and the amount of the employer share of the cost increase that is passed on to workers in the form of lost wages.
b/Includes federal, state and local employees.

Source: Lewin-VHI estimates using the Health Benefits Simulation Model (HBSM).

      The pass-through of the cost shift will have a disproportionate impact on insured workers in lower wage groups. The lost wage increases resulting from these budget cuts would on average equal about 2.5 percent of the wage increase that workers would have received in the absence of these budget cuts over the 1996 through 2002 period (Figure ES- 4). However, the wage growth lost due to cost shifting would vary from about 9.3 percent for covered workers earning $6.00 or less per hour to only 1.6 percent for persons earning $25 or more per hour. This reflects the fact that health benefits represent a much greater share of total compensation expenses for lower-wage covered workers than for higher-wage covered workers.

      The cost shifting resulting from the proposed Medicare and Medicaid cuts would be distributed across families in all income brackets. Much of the increase in family expenditures would be concentrated among middle and upper income households where private insurance coverage is most prevalent. About 60 percent of the pass-through would fall on families with annual incomes between $20,000 and $75,000. About 10 percent would fall on families with incomes below $20,000 while 30 percent would fall on families with incomes in excess of $75,000 per year.FIGURE ES- 4
PERCENT OF WAGE INCREASE FOR COVERED WORKERS OFFSET BY COST SHIFT FROM MEDICARE AND MEDICAID CUTS: 1996 THROUGH 2002 a/

Bar Graph Figure 4
a/This figure shows the cost shift pass-through (i.e., lost wages and increased payroll deductions) as a percentage of the total amount of wage increases that would have occurred over the 1996 through 2002 period for covered workers if the Medicare and Medicaid cuts had not been enacted.

Source: Lewin-VHI estimates using the Health Benefits Simulation Model (HBSM).

    Insurance Coverage

      We estimate that the number of uninsured persons in the U.S. under current policy will increase from 39.7 million persons in 1995 to 45.9 million persons by 2002. At the same time, Medicaid coverage is expected to increase from 36.8 million persons in 1995 to 45.9 million in 2002. With the reductions in funding under the reconciliation act, it is unlikely that states will be able to fund this increase in enrollment. In addition, private insurance costs will increase due to increased cost shifting under the act. Thus, the number of uninsured is likely to increase under the act due to reductions in Medicaid eligibility and higher private insurance costs.

      Under the reconciliation act, the number of uninsured in 2002 would increase from 45.9 million to 53.7 million (Figure ES- 5). This is an increase in the number of uninsured persons of 7.8 million persons in that year. This includes: about 7.2 million persons who lose Medicaid coverage under the bill who have no other coverage; and about 647,000 persons who lose employer coverage due to premium increases resulting from the cost shift.FIGURE ES- 5
NUMBER OF UNINSURED WITH AND WITHOUT THE RECONCILIATION BILL (IN MILLIONS)Line Graph - Figure 5

Source: Lewin-VHI estimates using the Health Benefits Simulation Model (HBSM).

    Summary and Caveats

      Ultimately, families will pay for the cost shift. Private insurers pass the burden of higher prices on to their customers in the form of higher premiums. Employers then pass on much of these increased premium costs to workers in the form of reduced wage growth and increased employee contributions. We estimate that the proposed Medicare and Medicaid budget cuts are expected to increase real health expenditures for workers by $66.9 billion over the 1996 through 2002 period. The cost shift could be substantially different than we have estimated here depending upon the effectiveness of managed care and the way in which providers respond to the budget cuts.

      This analysis is limited to the financial effects on employers and employees by industry, firm size and income. It does not describe the effects of increased public- program shortfalls on the availability and quality of care for program beneficiaries and the uninsured. It also does not describe the impact of cost shifting on health care providers beyond the loss of revenues. Moreover, this study examined only the impact of those provisions of recent budgetary legislation affecting Medicare and Medicaid. The study does not examine the impact of various other budgetary changes affecting families such as tax reductions or cutbacks in public assistance benefits.

1Estimates reflect the impact of hospital disproportionate share payments under Medicare and Medicaid. (Back to study)
2A summary of these studies is presented in the main body of the paper. (Back to study)