We have issued a document which is a revision of a white paper written in mid-2009 as a draft working paper on the issue of Medicare costs. Recently there has been a great deal of interest in the costs of Medicare and the assumptions herein have been revisited. Specifically Lois Matelan has indicated that an assumption that was made regarding expected lifetimes was in error and we have subsequently addressed that issue in the revision.
The issue which this paper addresses is the assertion that most if not all Medicare beneficiaries receive more than what they contributed. This seems to be predicated upon a report by the Urban Institute and reiterated by journalists of the kind like David Brooks of the NY Times and also republican contenders like Ron Paul. We look at this issue in more detail herein. However we propose a methodology commonly accepted in such circumstances called the net present value, NPV, model. Namely we look at cash flows, discount them, and then compare contributions and disbursements or benefits at a single point in time, in our case at retirement at 65.
The model we use is somewhat simple:
1. We assume a starting salary in 1970 and then we escalate that by a percentage, generally well below inflation. That then yields an ending salary in 2009 when we assume retirement.
2. We assume a Medicare contribution percent of 3% of gross salary. We have not reached any limits with the proposed salaries.
3. We then look at the current annual Medicare costs and we grow them first with inflation and then we add a health care inflation in excess of the core inflation. Thus if we see 2% inflation and we add 3% health care above it the total is 5%.
4. We assume a lifetime of 18 years for someone at 65. We then calculate the NPV for the benefits or distributions from Medicare at age 65.
5. We then compare NPV of contributions and NPV of benefits versus salaries and health care inflation.
We show this summary below in the graph. Note that as the salary increases there are point at which the contributions exceed the benefits. At no excess health care inflation it is at about $83,000 and at 5% excess health care inflation it is at about $112,000. Thus unlike the general statement that Medicare is an excess benefit, it is that only for those of lower incomes.
The above shows two curves, one a set based on excess health care inflation. One curve is the net present value of Medicare contributions at age 65 based on salary at reaching 65 and the second the benefits received in NPV at 65 based upon a specified health care inflation in excess of core inflation. Whenever the contribution exceeds the benefit they individual is funding Medicare in excess and whenever the contribution is less the individual benefits. The Urban report focuses on the lower earning portion of the curve and we consider that less than complete.
Now when one looks at salary distributions we see that over 40% of people are paying in excess of their disbursements. That means that less than 60% are receiving benefits. In fact the people whose contributions have exceeded their disbursements are in many ways covering those who are not. Thus, the bold claim that Medicare beneficiaries are having a free ride must and should be clarified. Some do have a benefit and many provide a benefit to that group.
It should also be noted that this analysis considers the analysis at a high level but it does go, I believe, much deeper than the Urban Institute. Much finer and detailed analyses may reveal even more critical observations.
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