Medicare Reform

Published 28 Feb 2017

Table of content


Medicare was enacted in 1965 as a compromise on the road toward a comprehensive system of national health insurance. The Medicare program, enacted on July 30, 1965, as Title XVIII of the Social Security Act, is the most important piece of health insurance legislation in U.S. history like most great compromises, its original design reflected prevailing concepts about health benefits and health care delivery that have changed substantially in the last thirty-five years. As the second largest social insurance program in the United States after Social Security, Medicare continues to provide tremendous benefit to beneficiaries and their families, who might otherwise individually bear the entire health care costs associated with aging. More than a safety net, Medicare gives seniors and the disabled access to the highest-quality health care. But as the United States enters the twenty-first century, Medicare is facing several significant challenges that threaten the very principles on which the program was originally based.

Effect on Health Care

Because capitation creates incentives for health plans to reduce utilization and possibly to stint on needed services, increased attention has been focused on measuring quality of care and health plan performance. A review of the literature performed by Robert Miller and Harold Luft (1997) showed mixed evidence regarding the quality of clinical care provided by managed care organizations in general. This should be unsurprising, since HMOs across the country differ greatly in the populations served, local market conditions, the amount of care delegated to physician organizations, and physician payment incentives.

In its final form, Medicare included two parts, Hospital Insurance (Part A) and Supplementary Medical Insurance (Part B). The major benefits covered under Part A originally were ninety days of hospital care per episode of care plus sixty lifetime reserve days, one hundred days of post-hospital care per episode in a skilled nursing facility (SNF) if preceded by an inpatient admission, one hundred post-hospital home health visits per year, and one hundred ninety lifetime days of inpatient psychiatric care. Hospice benefits were added later, and home health care was shifted to Part B. Part B covered most physician services, outpatient hospital services, and durable medical equipment. There was no coverage for outpatient prescription drugs, nor any limit on a beneficiary’s out-of-pocket expenses. The original Medicare benefits package remains essentially unchanged.

Impact on Cost

Medicare program has imposed increasing financial burdens on beneficiaries. From a system wide perspective, the impact of premium support on beneficiaries would depend on where the level of government support is set relative to the current Part B premium and average expenditures for Medigap premiums. Since a principal goal of the premium support approach is to limit the federal government’s financial obligation, the federal contribution could be expected to decrease as a proportion of the total premium if health costs resume a high rate of growth. By definition, the financial burden on beneficiaries would increase.
All beneficiaries in traditional Medicare currently pay the same premium for Part B and face the same deductibles and coinsurance rates. Under premium support, health plans would be free to vary each of these factors. The financial impact on beneficiaries would differ depending on the premiums offered by health plans in their area and which plan they chose. In fact, this is the intent of premium support—to create a financial incentive for beneficiaries to select a lower-cost health plan.

Impact on Quality

However, health plan premiums may not reflect true differences in efficiency and quality, but instead differences in health status that cannot be fully accounted for because of inadequate risk-adjustment mechanisms. Without adequate risk-adjusters, beneficiaries with severe disabilities or chronic illnesses may receive better care if they remain in the traditional program. In addition, not all beneficiaries live in markets with sufficient health plan competition, so beneficiaries in these markets could be subject to significantly higher costs. One study estimated out-of-pocket costs for traditional Medicare or a high-priced private plan could reach more than 39 percent of beneficiary income by 2025 (Moon, 1999).

Overall, no significant differences were found in the clinical quality of care provided by HMOs and FFS health plans. Their review did note several studies in which chronically ill and vulnerable patients had significantly worse outcomes when enrolled in an HMO in comparison with traditional Medicare.

A Florida study showed that Medicare HMOs in the state enrolled beneficiaries who were healthier than those who stayed in traditional Medicare—and that health plan members were more likely to disenroll when they incurred higher utilization, that is, when they became sicker (Dudley et. al., 1998). Evidence on member satisfaction is mixed as well.78 Enrollees in FFS plans generally are more satisfied with the nonfinancial aspects of care, such as quality of physician interaction and access to specialists. HMO enrollees tend to be more satisfied with their cost of care in comparison with the out-of-pocket costs incurred by enrollees in an FFS plan. However, individuals with chronic illness enrolled in managed care plans report a significantly higher level of dissatisfaction than chronically ill persons in an FFS health plan (Druss et al., 2000).

In Favor Group

The program was positioned as a solution to the financial difficulties of the elderly that resulted from use of medical services, particularly costly hospitalization, rather than one that would comprehensively address their health needs. As a strategy to temper the AMa’s opposition, physician services were not included in the initial Medicare proposals.

Between 1958 and 1963, numerous congressional hearings and intense lobbying took place on the subject of Medicare. Although it was now generally accepted that there was strong public support for a program of health insurance for the elderly, there was vociferous debate between social insurance and welfare advocates regarding the benefits and structure of the program and whether it should be administered by the federal government or by the states. President John F. Kennedy strongly supported providing hospital insurance for the elderly through the Social Security program. However, he was unable to obtain the support of the majority on the House Ways and Means Committee, which had authority for proposed legislation requiring new federal expenditures and whose members included a conservative coalition of Republicans and Southern Democrats opposed to expansion of federal programs. Finally, the landslide Democratic victories in the 1964 elections led President Lyndon Johnson to make hospital insurance for the elderly the first piece of legislation introduced into both houses of Congress as part of his Great Society program.

Opposed Group

There is probably no element more important to equitable implementation of a competitive market approach to Medicare reform than developing an adequate risk-adjustment mechanism. In a social insurance program such as traditional Medicare, risk is pooled so those beneficiaries with extensive health needs pay the same premium as do those who are healthy. Traditional FFS offers an incentive to provide additional services to those with the greatest need, even if this incentive results in overprovision of care. Medicare HMOs, however, receive a fixed amount per beneficiary, which creates an incentive to attract the healthiest members and to provide fewer services. As noted by one recent report, “[t]he more the Medicare beneficiary risk pool is split up, the greater the burden on the risk-adjustment mechanism to protect universal access” (Urban Institute, 1999). In 1996, 5 percent of elderly Medicare beneficiaries accounted for 45 percent of program.

In its purest form, defined contribution would limit the obligation of the federal government by providing beneficiaries a fixed dollar amount with which they would purchase their own health insurance in the private market. The amount of the government contribution would be adjusted for inflation using a standard economic indicator such as the Consumer Price Index (CPI) or the GDP. Thus, federal Medicare expenditures would be fixed at a targeted level, equal to the government’s contribution multiplied by the number of eligible beneficiaries, and beneficiaries would pay any difference between the cost of the plan they chose and the federal contribution.


Medicare was implemented in 1965 as an incremental step toward national health insurance in the United States. Thirty-five years later, it survives as the country’s second largest social insurance program and is likely to continue well into the twenty-first century as a separate program. The fundamental challenge facing the future of Medicare is whether it will continue to be a defined benefits program, or whether it will transition to a defined contribution program. When Medicare was enacted, a founding principle was that it was supposed to reflect mainstream medicine, including mainstream delivery and payment methodologies. One obvious question regarding the future of Medicare is whether various reform proposals are consistent with this original principle. Despite the substantial movement during the past two decades toward defined contributions for pension benefits in the private sector, defined contributions for health benefits are still not common (Marquis & Long,1999). Before beginning a grand experiment with the future of Medicare, perhaps policy makers should wait until the private market fully embraces this reform.

In the meantime, incremental efforts to expand benefits and offer additional subsidies to low-income beneficiaries are likely to reduce existing disparities within the program and to
improve the health and financial stability of those who are most vulnerable.


  • Druss, B. A., Schlesinger, M., Thomas, T., and Allen, H. (2000). Chronic Illness and Plan Satisfaction Under Managed Care.” Health Affairs, 19, 203–209.
  • Dudley, R. A., Miller, R. H., Korenbrot, T. Y., and Luft, H. S. (1998). The Impact of Financial Incentives on Quality of Health Care. Milbank Quarterly, 76, 649–686.
  • Marquis, M. S., and Long, S. H. (1999). Trends in Managed Care and Managed Competition, 1993–1997.” Health Affairs, 18, 75–88.
  • Miller, R. H., and Luft, H. S. (1997). Does Managed Care Lead to Better or Worse Quality of Care? Health Affairs, 16, 7–25.
  • Moon, M. (1999). Restructuring Medicare: Impacts on Beneficiaries. Washington, D.C.: Urban Institute.
  • Urban Institute. (1999). Can Competition Improve Medicare? A Look at Premium Support. Washington, D.C.: Urban Institute, p. 16.
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