Social insurance programs in the United States fall into four categories:

• social security
• unemployment insurance
• temporary disability insurance
• workers’ compensation insurance

Social security, a totally federal program, is described in this chapter.

Social insurance programs are significant for several reasons. First, in the United States nearly one-quarter of the dollars employers spend on benefits for their employees is used to make legally required payments to social insurance programs. For employers with meager benefit plans this proportion will be much higher and may even account for the majority of the total benefit package.

Second, the most significant insurance expense for most individuals is their contribution to social security. For many persons this contribution will exceed the combined cost of all other types of insurance purchased directly by the individual.

Third, these programs form the foundation on which employee benefit programs and individual insurance plans are built. Employers’ medical expense, disability income, and retirement plans are often designed in light of the benefits already available to employees under social insurance programs. Some benefit plans apply only to those employees not adequately covered under comparable social insurance programs; other benefit plans may cover all employees but may provide reduced benefits in those areas where similar social insurance benefits are available. In addition, it is impossible to do a proper job of personal insurance planning without taking potential social security benefits into consideration.

The existence and scope of social insurance programs are the result of several factors, probably the most significant of which is the need to solve the major social problems that affect a large portion of society. The industrialization of American society and the decreasing self-sufficiency of families have resulted in a greater dependence on monetary income to provide economic security. The widespread lack of such income during the Great Depression led to the passage of the Social Security Act as an attempt to provide economic security by attacking the sources of economic insecurity, including old age and unemployment.

A second reason for the existence of social insurance programs is the difficulty of privately insuring certain types of losses. For example, the inability to predict future unemployment rates and the potential for catastrophic losses make the peril of unemployment virtually uninsurable in the private sector. In addition, broad medical expense coverage for the aged can be marketed commercially only at a price beyond the financial means of many retirees.

Even though there are variations in social insurance programs, and exceptions to the rule always exist, social insurance programs tend to have the following distinguishing characteristics:

Most social insurance programs are compulsory and require that the persons covered be attached—either presently or by past service—to the labor force. If a social insurance program is to meet a social need through the redistribution of income, it must have widespread participation.

Benefits under social insurance programs are based more on social adequacy than on individual equity. Under the principle of social adequacy, benefits are designed to provide a minimum floor of income to all beneficiaries under the program regardless of their economic status. Above this floor of benefits persons are expected to provide additional resources from their own savings, employment, or private insurance programs. This emphasis on social adequacy also results in disproportionately large benefits in relation to contributions for some groups of beneficiaries. For some programs high-income persons, single persons or small families, and the young are subsidizing low-income persons, large families, and the retired.

In this book, the broad term social security refers to the old-age, survivors, disability, and health insurance (OASDHI) program of the federal government. However, OASDHI is only one of several programs resulting from the Social Security Act of 1935 and its frequent amendments over the years. The act established four programs aimed at providing economic security for the American society:

• old-age insurance
• unemployment insurance
• federal grants for assistance to certain needy groups: the aged, the blind, and children
• federal grants for maternal and child welfare, public health work, and vocational rehabilitation

The old-age insurance program and the benefits that have been added to that program over the years to make it what we now call social security will be discussed here. These additional benefits include survivors insurance (1939), disability insurance (1956), hospital insurance (1965), and supplementary medical insurance (1965). The latter two parts of social security comprise medicare and are often referred to as part A and part B, respectively.  

Over 90 percent of the workers in the United States are in covered employment under the social security program. This means that these workers have wages (if they are employees) or self-employment income (if they are self-employed) on which social security taxes must be paid. The following are the major categories of workers who are not covered under the program or who are covered only if they have met specific conditions:

Part B of medicare is financed by a combination of monthly premiums paid by persons eligible for benefits and contributions from the federal government. Part A of medicare and all the benefits of the OASDI program are financed through a system of payroll and self-employment taxes paid by all persons covered under the program. In addition, employers of covered persons are also taxed.

In 1997 an employee and his or her employer pay a tax of 7.65 percent each on the first $65,400 of the employee’s wages. Of this tax rate 6.2 percent is for OASDI; 1.45 percent is for the hospital insurance portion of medicare. The medicare tax rate of 1.45 percent is also levied on all wages in excess of $65,400. The tax rates are currently scheduled to remain the same after 1997. However, the wage bases are adjusted annually for changes in the national level of wages. Therefore if wage levels increase by 4 percent in a particular year, the wage base for the following year will also increase by 4 percent. The tax rate for the self-employed is 15.3 percent on the first $65,400 of self-employment income and 2.9 percent on the balance of any self-employment income. This is equal to the combined employee and employer rates.

The social security program is essentially based on a system of pay-as-you-go financing with limited trust funds. This means that current payroll taxes and other contributions the program receives are used to pay the current benefits of persons who are no longer paying social security taxes because of death, old age, or disability. This is in direct contrast to private insurance or retirement plans, which are based on advance funding, whereby assets are accumulated from current contributions to pay the future benefits of those making the contributions.

All payroll taxes and other sources of funds for social security are deposited into four trust funds: an old-age and survivors fund, a disability fund, and two medicare funds. Benefits and administrative expenses are paid out of the appropriate trust fund from contributions to that fund and any interest earnings on accumulated assets. The social security program does have limited reserves to serve as emergency funds in periods when benefits exceed contributions, such as in times of high unemployment. However, current reserves are relatively small and could pay benefits for only a limited time if contributions to a fund ceased. In addition, the reserves consist primarily of IOUs from the Treasury since the contributions have been "borrowed" to finance the government’s deficit.

In the early 1980s considerable concern arose over the potential inability of payroll taxes to pay promised benefits in the future. Through a series of changes, the most significant being the 1983 amendments to the Social Security Act, these problems appeared to have been solved for the OASDI portion of the program—at least in the short run. The changes approached the problem from two directions. On one hand, payroll tax rates were increased; on the other hand, some benefits were eliminated and future increases in other benefits were scaled back. However, the solutions of 1983 have not worked. Without further adjust- ments, the trust funds will have inadequate resources to pay claims in the foreseeable future.

In times of high unemployment rates and/or downsizing, social security disability claims normally increase in both frequency and duration. Such has been the case for the last few years. As a result the disability trust fund will need additional resources in the very near future. There are plans to strengthen this fund by transferring monies from the old-age and survivors fund.

The trust fund for old-age and survivors benefits will continue to grow and will be quite large by the time the current baby boomers retire. At that time benefits will exceed income, and the fund will begin to decrease as the percentage of retirees grows rapidly. Until recently projections indicated that the size of the fund would stabilize as the baby boomers died and the percentage of elderly returned to a more normal level. However, current projections indicate that the fund will run out of money in about 35 years. Higher interest rates and lower unemployment rates in future years will maintain the solvency of the fund for a longer period.

Because of an increasing number of persons aged 65 or older and medical costs that continue to grow at an alarming rate, there is also concern about the medicare portion of the program. In early 1997, there were estimates that its trust funds would be depleted by the year 2000. However, several changes that should maintain the solvency of these funds until about 2007 were made by the Balanced Budget Act of 1997. These changes include slowing the rate of growth of payments to medical care providers, making changes that will increase part B premiums, and allowing medicare beneficiaries more choice in electing options to the traditional medicare program. In addition, the act creates a bipartisan commission to explore longer-range solutions.

It is obvious that changes must be made—either now or later—in the social security program. This demand for change, of course, has significant political implications. While most members of Congress realize the need for reform, neither political party seems willing to take the necessary initiative and risk losing public support. Probably the most important step in finding a solution is to convince the public that changes in a very popular entitlement program must be made.

In the broadest sense the solution lies in doing one or both of the following: increasing revenue into the trust funds or decreasing benefit costs. Possibilities for increasing revenue include the following:

• increasing the social security and/or medicare tax rate
• increasing the wage base on which OASDI taxes are paid
• using more general tax revenue to fund the program
• subjecting a greater portion of income benefits to taxation and depositing the increased tax revenue into the trust funds
• investing all or a portion of trust fund assets in higher-yielding investments than Treasury securities

Suggestions that have been made for decreasing benefit costs include the following:

• raising the normal retirement age beyond the planned increase to age 67
• raising the early retirement age beyond 62
• lowering the benefit formula so that future retirees will get somewhat reduced benefits
• lowering cost-of-living increases
• imposing a means test for benefits
• increasing medicare deductibles and coinsurance
• increasing the medicare part B premium for everyone or possibly only for higher-income retirees

Any single change will clearly offend one important group of voters or another. As a result, any ultimate solution will probably involve a combination of several of these changes so that everyone will bear a little of the pain.

Report of Advisory Council on Social Security

A bipartisan advisory council was established in 1994 to make recommendations to solve the long-range financing of OASDI. The 13-member council issued its report in late 1996 but failed to reach consensus on a solution. Instead, the council split into three factions, with each faction offering its own solution. While the options are very different, all the options have some items in common. All three options call for requiring newly hired state and local government workers to be covered under OASDI and increasing income tax on OASDI benefits that exceed lifetime contributions. In addition, the method for investing OASDI revenues would change.

One option largely maintains existing benefits. The payroll tax rate would increase, but not until 2045. This option proposes studying the issue of increasing revenue by investing up to 40 percent of OASDI assets in the stock market.

A second option maintains existing benefits for persons aged 55 or older. A new and radically different OASDI program would be phased in for younger workers. Five percentage points of the payroll tax would be diverted to personal security accounts. A worker would be allowed considerable flexibility in how his or her account was invested and would bear all investment risk. The remaining payroll taxes would be used to finance a minimum guaranteed retirement benefit of $410 per month. The cost to phase in this option would be significant, requiring a 1.52 percentage point increase in the payroll tax rate for 72 years and $1.9 trillion of government borrowing over the next 40 years.

To be eligible for benefits under OASDI, an individual must have credit for a minimum amount of work under social security. This credit is based on quarters of coverage. For 1997 a worker receives credit for one quarter of coverage for each $670 in annual earnings on which social security taxes are paid. However, credit for no more than 4 quarters of coverage may be earned in any one calendar year, even if all wages are earned within one calendar quarter. Consequently a worker paying social security taxes on as little as $2,680 (that is, $670 x 4) during the year will receive credit for the maximum 4 quarters. As in the case of the wage base, the amount of earnings necessary for a quarter of coverage is adjusted annually for changes in the national level of wages.

A person is fully insured under OASDI if either of two tests is met. The first test requires credit for 40 quarters of coverage. Once a person acquires such credit, he or she is fully insured for life even if covered employment under social security ceases.

In order to receive disability benefits under OASDI, it is necessary to be disability insured. At a minimum a disability-insured status requires that a worker (1) be fully insured and (2) have a minimum amount of work under social security within a recent time period. In connection with the latter requirement, workers aged 31 or older must have credit for at least 20 of the last 40 quarters ending with the quarter in which disability occurs; workers between the ages of 24 and 30, inclusively, must have credit for at least half the quarters of coverage from the time they turned 21 and the quarter in which disability begins; and workers under age 24 must have credit for 6 out of the last 12 quarters, ending with the quarter in which disability begins.

As its name implies, the OASDI portion of social security provides three principal types of benefits:

A worker who is fully insured under OASDI is eligible to receive monthly retirement benefits as early as age 62. However, the election to receive benefits prior to the normal retirement age of age 65 results in a permanently reduced benefit.

In addition to the retired worker, the following dependents of persons receiving retirement benefits are also eligible for monthly benefits:

• a spouse aged 62 or older. However, benefits are permanently reduced if this benefit is elected prior to the spouse’s reaching age 65. This benefit is also available to a divorced spouse under certain circumstances if the marriage lasted at least 10 years.
• a spouse of any age if the spouse is caring for at least one child of the retired worker who is (1) under age 16 or (2) disabled and entitled to a child’s benefit as described below. This benefit is commonly referred to as a mother’s or father’s benefit.
• dependent, unmarried children under 18. This child’s benefit will continue until age 19 as long as a child is a full-time student in elementary or secondary school. In addition, disabled children of any age are eligible for benefits as long as they were disabled before reaching age 22.

It is important to note that retirement benefits, as well as all other benefits under social security, are not automatically paid upon eligibility but must be applied for.

All categories of survivors benefits are payable if a worker is fully insured at the time of death. However, three types of benefits are also payable if a worker is only currently insured. The first is a lump-sum death benefit of $255, payable in the following order of priority:

• to a surviving spouse who was living with the deceased worker at the time of death
• to a surviving spouse (other than a divorced spouse) who was not living with the deceased worker at the time of death if the surviving spouse is eligible for or entitled to benefits based on the deceased wage earner’s record for the month of death
• to children who are eligible for or entitled to benefits based on the deceased wage earner’s record for the month of death

If none of these categories of survivors exists, the benefit is not paid.

There are two categories of persons who are eligible for income benefits as survivors if a deceased worker was either fully or currently insured at the time of death:

• dependent, unmarried children under the same conditions as previously described for retirement benefits
• a spouse (including a divorced spouse) caring for a child or children under the same conditions as previously described for retirement benefits

The following categories of persons are also eligible for benefits, but only if the deceased worker was fully insured:

A disabled worker under age 65 is eligible to receive benefits under OASDI as long as he or she is disability insured and meets the definition of disability under the law. The definition of disability is very rigid and requires a mental or physical impairment that prevents the worker from engaging in any substantial gainful employment. The disability must also have lasted (or be expected to last) at least 12 months or be expected to result in death. A more liberal definition of disability applies to blind workers who are aged 55 or older. They are considered disabled if they are unable to perform work that requires skills or abilities comparable to those required by the work they regularly performed before reaching age 55 or becoming blind, if later.

Disability benefits are subject to a waiting period and are payable beginning with the sixth full calendar month of disability. In addition to the benefit paid to a disabled worker, the other categories of benefits available are the same as those described under retirement benefits.

Monthly benefits to any social security recipient cease upon death. When a retired or disabled worker dies, the family members’ benefits that are based on the worker’s retirement or disability benefits also cease, but the family members are then eligible for survivors benefits.

Disability benefits for a worker technically terminate at age 65 but are then replaced by comparable retirement benefits. In addition, any benefits payable because of disability cease if the definition of disability is no longer satisfied. However, the disability benefits continue during a readjustment period that consists of the month of recovery and 2 additional months.

As long as children are not disabled, benefits will usually terminate at age 18 but may continue until age 19 if the child is a full-time student in elementary or secondary school.

Even though they may initially seem rather complex, the steps in calculating a worker’s AIME are relatively simple. These steps are outlined below and will be best understood by referring to table 2-3, which shows the computation of the AIME for a worker who attained age 30 in 1997 and became disabled.

• First, list the earnings on which social security taxes were paid for each year beginning with 1951 (or the year in which age 22 was attained, if later) up to and including the year of death or the year prior to disability or retirement. This list includes all applicable years even if there were no wages subject to social security tax, in which case a zero is included for covered wages. The example in table 2-3 begins with 1989 because that was the year the worker attained age 22.
• Second, index these earnings by multiplying them by an indexing factor that reflects changing wage levels. The only years that are indexed are those prior to the indexing year, which is the year a worker turned 60 for retirement purposes or 2 years preceding the year of death or disability for purposes of survivors or disability benefits. Therefore the indexing

factor for the indexing year (1995 in the example) and subsequent years is one. For years prior to the indexing year, the indexing factor for each year is equal to the average annual covered wages in the indexing year divided by the average annual covered wages in the year in which earnings are to be indexed. Average annual covered wages are the average wages on which social security taxes were paid. Each year the government makes the figure for the previous year available. In the example the indexing factor for 1989 is 1.229164 because average annual covered wages were $24,705.66 in 1995 and $20,099.55 in 1989.

• Third, determine the number of years to be included in the calculation. For retirement and survivors benefits the number of years is 5 less than the minimum number of quarters necessary to be fully insured. For disability benefits a subtraction may also be made from the minimum number of quarters necessary for fully insured status. This subtraction is five for workers aged 47 or over, four for workers aged 42 through 46, three for workers aged 37 through 41, two for workers aged 32 through 36, one for workers aged 27 through 31, and none for workers under age 27. However, for survivors or disability benefits at least 2 years must remain for purposes of calculating benefits. In the example the worker needs a minimum of 8 quarters to be fully insured, since 8 is the number of years after the worker reached age 21 and prior to the year of disability. Because the worker is aged 30, one year can be subtracted, which leaves 7 years to be included in the calculation. (Note: Up to 3 additional years may be dropped from the calculation if the worker had no income during the year and had a child under the age of 3 living in his or her household during the entire year.)
• Fourth, determine the years to be excluded from the calculation. These will be the years with the lowest indexed earnings. Of course the number of years determined in the previous step must remain. In the example only one year (1989) can be excluded.
• Fifth, add the indexed earnings for the years to be included in the AIME calculation and divide the result by the number of months in these years. In the example the divisor is 84 months, which represents the 7 years of earnings included in the calculation.

Once a worker’s AIME has been calculated, his or her PIA is determined by applying a formula to the AIME. The 1997 formula is as follows:

90 percent of the first $455 of AIME

plus 32 percent of the AIME in excess of $455 through $2,741

plus 15 percent of the AIME in excess of $2,741

The dollar figures in this formula are adjusted annually for changes in the national level of wages. The formula used to determine a worker’s retirement benefit is the formula for the year in which the worker turned age 62. Therefore a worker retiring at age 65 in 1997 would use the 1994 formula rather than the 1997 formula. The formula used to determine survivors and disability benefits is the formula in existence for the year in which death or disability occurs, even if application for benefits is made in a later year.

Using the formula for 1997, a disabled worker with an AIME of $2,800 would have a PIA of $l,149.80, calculated as follows:

90 percent of $455 = $ 409.50

plus 32 percent of $2,286 = 731.52

plus 15 percent of $59 =    8.85

$1,149.87

(rounded to $1,149.80, the next lower $.10)

The PIA is the amount a worker will receive if he or she retires at age 65 or becomes disabled, and it is the amount on which benefits for family members are based. (Note: Initial calculations such as the PIA and family maximum are rounded to the next lower $.10. After all calculations, the benefit paid to any individual is rounded to the next lower dollar.) In 1997 a worker who has had average earnings during his or her lifetime can expect a PIA of about $900. A worker who has continually earned the maximum income subject to social security taxes can expect a PIA of about $1,300 for retirement purposes and a PIA of between $1,300 and $1,450 for purposes of disability and survivors benefits. The higher PIA occurs for workers who are disabled or die at younger ages.

If a worker is retired or disabled, these benefits are paid to family members:

Percentage of

Category Worker’s PIA

Spouse aged 65 50%

Spouse caring for

disabled child or

child under 16 50%

Child under 18 or

disabled 50% each

If the worker dies, survivors benefits are as follows:

Percentage of

Category Worker’s PIA

Spouse aged 65 100%

Spouse caring for

disabled child or

child under 16 75%

Child under 18 or

disabled 75% each

Dependent parent 82.5% for one,

75% each for two

However, the full benefits described above may not be payable because of a limitation imposed on the total benefits that may be paid to a family. This family maximum will usually be reached if three or more family members (including a retired or disabled worker) are eligible for benefits. The family maximum for purposes of retirement and survivors benefits can be determined for 1997 from the following formula, which, like the PIA formula, is adjusted annually based on changing wage levels:

150 percent of the first $581 of PIA

plus 272 percent of the PIA in excess of $581 through $839

plus 134 percent of the PIA in excess of $839 through $1,094

plus 175 percent of the PIA in excess of $1,094

The family maximum for purposes of disability benefits is limited to 85 percent of the worker’s AIME or 150 percent of the worker’s PIA, whichever is lower. However, in no case can the maximum be reduced below the worker’s PIA.

Special Minimum PIA

There is a minimum PIA for workers who have been covered under OASDI for at least 10 years but at very low wages. This PIA is used only if it is higher than a worker’s PIA based on actual wages, which is usually not the case. The benefit is first determined by multiplying $11.50 times the number of years of coverage less 10, subject to a maximum of 20. This figure is then adjusted for the cumulative change in the consumer price index (CPI) since 1979. In 1997 a worker with 30 or more years of coverage under OASDI will have a minimum PIA at age 65 of $548.30.

Benefits Taken Early

If a worker elects to receive retirement benefits prior to age 65, benefits are permanently reduced by 5/9 of one percent for every month that the early retirement precedes age 65. For example, for a worker who retires at age 62, the monthly benefit will be only 80 percent of that worker’s PIA. A spouse who elects retirement benefits prior to age 65 will have benefits reduced by 25/36 of one percent per month, and a widow or widower will have benefits reduced by 19/40 of one percent per month. In the latter case, benefits at age 60 will be 71 1/2 percent of the worker’s PIA. If the widow or widower elects benefits at an earlier age because of disability, there is no further reduction.

Delayed Retirement

It should be pointed out that these increases apply to a worker’s PIA as determined at the time a worker applies for retirement benefits. If a person continues to work during the period of delayed retirement and covered wages are sufficiently high, it is possible for a worker’s PIA to be higher than it would have been at normal retirement age. Therefore the increased monthly retirement benefit from working past normal retirement age may be greater than the percentages in the table.

Earnings Test

Benefits are reduced for social security beneficiaries under the age of 70 if they have work wages that exceed a specified level. The rationale behind having such a reduction tied to wages, referred to as an earnings test, is that social security benefits are intended to replace lost wages but not other income such as dividends or interest. In 1997 social security beneficiaries aged 65 through 69 are allowed annual wages of $13,500 without any reduction in their benefits. This amount is scheduled to increase to $14,500 in 1998, $15,500 in 1999, $17,000 in 2000, $25,000 in 2001, and $30,000 in 2002. Beneficiaries under age 65 are allowed earnings of $8,640. This figure is adjusted annually on the basis of national wage levels. If a beneficiary earns in excess of the allowable amount, his or her social security benefit is reduced. For persons aged 65 through 69 the reduction is $1 for every $3 of excess earnings; for persons under age 65 the reduction is $1 for every $2 of excess earnings. Social security beneficiaries aged 70 or older can earn any amount of wages without a reduction of benefits.

The reduction in a retired worker’s benefits resulting from excess earnings is charged against the entire benefits that are paid to a family and based on the worker’s social security record. If large enough, this reduction may totally eliminate all benefits otherwise payable to the worker and family members. In contrast, excess earnings of family members are charged against their individual benefits only. For example, a widowed mother who holds a job outside the home may lose her mother’s benefit, but any benefits received by her children will be unaffected.

Cost-of-living Adjustments

OASDI benefits are increased automatically each January as long as there has been an increase in the CPI for the one-year period ending in the third quarter of the prior year. The increase is the same as the increase in the CPI since the last cost-of-living adjustment, rounded to the nearest 0.1 percent.

There is one exception to this adjustment. In any year that the combined reserves of the OASDI trust funds drop below 20 percent of expected benefits, the cost-of-living adjustment will be limited to the lesser of the increase in the CPI or the increase in national wages used to adjust the wage base for social security taxes. When benefit increases have been based on wage levels, future cost-of-living increases can be larger than changes in the CPI to make up for the lower benefit increases in those years when the CPI was not used. However, this extra cost-of-living increase can be made only in years when the reserve is equal to at least 32 percent of expected benefits.

Offset for Other Benefits

In 1995 the Social Security Administration began sending an annual Earnings and Benefit Estimate Statement to each worker aged 60 and older. By the year 2000, this statement will be provided annually to all workers over age 25. In the meantime these persons should periodically check their records with the Social Security Administration by filing Form SSA-7004 (Request for Earnings and Benefit Estimate Statement). The form is quite brief, and the statement received enables an employee to verify his or her contributions to the OASDI program and medicare. It also contains an estimate of benefits that will be available upon retirement, disability, or death.

Part A, the hospital portion of medicare, is available to any person aged 65 or older as long as the person is entitled to monthly retirement benefits under social security or the railroad retirement program. Civilian employees of the federal government aged 65 or older are also eligible. It is not necessary for these workers to actually be receiving retirement benefits, but they must be fully insured for purposes of retirement benefits. The following persons are also eligible for part A of medicare at no monthly cost:

• persons aged 65 or older who are dependents of fully insured workers aged 62 or older
• survivors aged 65 or older who are eligible for OASDI survivors benefits
• disabled persons at any age who have been eligible to receive OASDI benefits for 2 years because of their disability. This includes workers under age 65, disabled widows and widowers aged 50 or over, and children 18 or older who were disabled prior to age 22.
• workers who are either fully or currently insured and their spouses and dependent children with end-stage renal (kidney) disease who require renal dialysis or kidney transplants. Coverage begins either the first day of the third month after dialysis begins or earlier for admission to a hospital for kidney-transplant surgery.

Most persons aged 65 or over who do not meet the previously discussed eligibility requirements may voluntarily enroll in medicare. However, they must pay a monthly part A premium and also enroll in part B. The part A premium may be as high as $311 in 1997, depending on the quarters of coverage a person earned under social security. The premium is adjusted annually to reflect the full cost of the benefits provided.

Any person eligible for part A of medicare is also eligible for part B. However, a monthly premium must be paid for part B. This premium, $43.80 in 1997, is adjusted annually to cover about 25 percent of the cost of the benefits provided. The remaining cost of the program is financed from the general revenues of the federal government. The transfer of most home health care benefits from part A to part B will result in this premium increasing significantly over the next 10 years.

Persons receiving social security or railroad retirement benefits are automatically enrolled in medicare if they are eligible. If they do not want part B, they must reject it in writing. Other persons eligible for medicare must apply for benefits. As a general rule, anyone who rejects part B or who does not enroll when initially eligible may later apply for benefits during a general enrollment period that occurs between January 1 and March 31 of each year. However, the monthly premium will be increased by 10 percent for each 12-month period during which the person was eligible but failed to enroll.

Part A of medicare provides benefits for expenses incurred in hospitals, skilled-nursing facilities, and hospices. Home health care benefits are also covered. In order for benefits to be paid, the facility or agency providing benefits must participate in the medicare program. Virtually all hospitals are participants, as are most other facilities or agencies that meet the requirements of medicare.

Part A pays for inpatient hospital services for up to 90 days in each benefit period (also referred to as a spell of illness). A benefit period begins the first time a medicare recipient is hospitalized and ends only after the recipient has been out of a hospital or skilled-nursing facility for 60 consecutive days. A subsequent hospitalization then begins a new benefit period.

In each benefit period, covered hospital expenses are paid in full for 60 days, subject to an initial deductible of $760 in 1997. This deductible is adjusted annually to reflect increasing hospital costs. Benefits for an additional 30 days of hospitalization are also provided in each benefit period, but the patient must pay a daily coinsurance charge ($190 in 1997) equal to 25 percent of the initial deductible amount. Each recipient also has a lifetime reserve of 60 additional days that may be used if the regular 90 days of benefits have been exhausted. However, once a reserve day is used, it cannot be restored for use in future benefit periods. When using reserve days, patients must pay a daily coinsurance charge ($380 in 1997) equal to 50 percent of the initial deductible amount.

There is no limit on the number of benefit periods a person may have during his or her lifetime. However, there is a lifetime limit of 190 days of benefits for treatment in psychiatric hospitals.

Covered inpatient expenses include the following:

• room and board in semiprivate accommodations. Private rooms are covered only if required for medical reasons.
• nursing services (except private-duty nurses)
• use of regular hospital equipment, such as oxygen tents or wheelchairs
• drugs and biologicals ordinarily furnished by the hospital
• diagnostic or therapeutic items or services
• operating room costs
• blood transfusions after the first three pints of blood. Patients must pay for the first three pints of blood unless they get donors to replace the blood.

In many cases a patient may no longer require continuous hospital care but may not be well enough to go home. Consequently part A provides benefits for care in a skilled-nursing facility if a physician certifies that skilled-nursing care or rehabilitative services are needed for a condition that was treated in a hospital within the last 30 days. In addition, the prior hospitalization must have lasted at least 3 days. Benefits are paid in full for 20 days in each benefit period and for an additional 80 days with a daily coinsurance charge ($95 in 1997) that is equal to 12.5 percent of the initial hospital deductible. Covered expenses are the same as those described for hospital benefits.

A skilled-nursing facility may be a separate facility for providing such care or a separate section of a hospital or nursing home. The facility must have at least one full-time registered nurse, and nursing services must be provided at all times. Every patient must be under the supervision of a physician, and a physician must always be available for emergency care.

If a patient can be treated at home for a medical condition, medicare will pay the full cost for an unlimited number of home visits by a home-health-care agency. Such agencies specialize in providing nursing services and other therapeutic services. To receive these benefits, a person must be confined at home and be treated under a home health plan set up by a physician. No prior hospitalization is required. The care needed must include skilled-nursing services, physical therapy, or speech therapy. In addition to these services, medicare will also pay for the cost of part-time home health aides, medical social services, occupational therapy, and medical supplies and equipment provided by the home health agency. There is no charge for these benefits other than a required 20 percent copayment for the cost of durable medical equipment such as iron lungs, oxygen tanks, and hospital beds. Medicare does not cover home services furnished primarily to assist people in activities of daily living such as housecleaning, preparing meals, shopping, dressing, or bathing.

Hospice benefits are available under part A of medicare for terminally ill persons who have a life expectancy of 6 months or less. While a hospice is thought of as a facility for treating the terminally ill, medicare benefits are available primarily for hospice-type benefits provided to patients in their own homes. However, up to 20 percent of the days of hospice treatment may be as an inpatient in a facility of the organization providing home treatment or in a hospital or other facility with which it cooperates. In addition to including the types of benefits described for home health care, hospice benefits also include drugs, bereavement counseling, and inpatient respite care when family members need a break from caring for the ill person.

In order to qualify for hospice benefits, a medicare recipient must elect such coverage in lieu of other medicare benefits, except for the services of the attending physician or services and benefits that do not pertain to the terminal condition. There are modest copayments for some services.

There are some circumstances under which part A of medicare will not pay benefits. In addition, there are times when medicare will act as the secondary payer of benefits. Exclusions under part A include the following:

• services outside the United States and its territories or possessions. However, there are a few exceptions to this rule for qualified Mexican and Canadian hospitals. Benefits will be paid if an emergency occurs in the United States and the closest hospital is in one of these countries. However, persons living closer to a hospital in one of these countries than to a hospital in the United States may use the foreign hospital even if an emergency does not exist. Finally, there is coverage for Canadian hospitals if a person needs hospitalization while traveling the most direct route between Alaska and another state in the United States. However, this latter provision does not apply to persons vacationing in Canada.
• elective luxury services, such as private rooms or televisions
• hospitalization for services not necessary for the treatment of an illness or injury, such as custodial care or elective cosmetic surgery
• services performed in a federal facility, such as a veterans’ hospital
• services covered under workers’ compensation

Under the following circumstances, medicare is the secondary payer of benefits:

• when primary coverage under an employer-provided medical expense plan is elected by (1) an employee or spouse aged 65 or older or (2) a disabled beneficiary
• when medical care can be paid under any liability policy, including policies providing automobile no-fault benefits
• in the first 18 months for end-stage renal disease when an employer- provided medical expense plan provides coverage. By law employer plans cannot specifically exclude this coverage during this 18-month period.

Part B of medicare provides benefits for the following medical expenses not covered under part A:

Although the preceding list may appear to be comprehensive, there are numerous medical products and services not covered by part B, some of which represent significant expenses for the elderly. They include the following:

• drugs and biologicals that can be self-administered except drugs for osteoporosis
• routine physical, eye, and hearing examinations. However, there is some preventive health care coverage in the form of pap smears, bone density measurement, and screening for breast cancer, prostate cancer, and colorectal cancer.
• routine foot care
• immunizations, except pneumococcal vaccinations or immunization required because of an injury or immediate risk of infection
• cosmetic surgery unless it is needed because of an accidental injury or to improve the function of a malformed part of the body
• dental care unless it involves jaw or facial bone surgery or the setting of fractures
• custodial care
• eyeglasses, hearing aids, or orthopedic shoes

With some exceptions part B pays 80 percent of the approved charges for covered medical expenses after the satisfaction of a $100 annual deductible. Annual maximums apply to outpatient psychiatric benefits ($450) and physical therapy in a therapist’s office or at the patient’s home ($400). A few charges are paid in full without any cost sharing. These include (1) home health services, (2) pneumococcal vaccine and its administration, (3) certain surgical procedures that are performed on an outpatient basis in lieu of hospitalization, and (4) diagnostic preadmission tests performed on an outpatient basis within 7 days prior to hospitalization.

Beginning in 1992 the approved charge for doctor’s services covered by medicare is based on a fee schedule issued by the Health Care Financing Administration. A patient will be reimbursed for only 80 percent of the approved charges above the deductible—regardless of the doctor’s actual charge. Most doctors and other suppliers of medical services accept an assignment of medicare benefits and therefore are prohibited from charging a patient in excess of the fee schedule. They can, however, bill the patient for any portion of the approved charges that were not paid by medicare because of the annual deductible and/or coinsurance. They can also bill for any services that are not covered by medicare.

Since 1993 doctors who do not accept assignment of medicare benefits have not been permitted to charge a medicare patient more than 115 percent of the approved fee for nonparticipating doctors. Because the approved fee for nonparticipating doctors is set at 95 percent of the fee paid for participating doctors, a doctor who does not accept an assignment of medicare benefits can charge a fee that is only 9.25 percent greater than if an assignment had been accepted (115 percent x 95 percent = 109.25 percent). As a result, some doctors either do not see medicare participants, or they limit the number of such patients that they treat.

Medicare participants may elect to have covered services provided through a managed care plan offered by a health maintenance organization (HMO) or an insurance company, and a growing number (currently about 10 percent) of medicare participants are electing this option. HMOs and other forms of managed care are covered in detail later in this book. For many persons a managed care option is a viable alternative to a medigap policy for obtaining broader coverage than is available under medicare.

It is important to note that a medicare participant can terminate coverage under a managed care plan and return to the regular medicare program, effective the first day of the following month.

In order for an HMO to enroll medicare participants, the HMO must enter into a contract with the Department of Health and Human Services. Approval requires that the HMO offer benefits at least as broad as those that are available under medicare. As a general rule, approval also requires the HMO to have been in existence for at least 2 years and to have an enrollment comprising at least 25,000 persons. Furthermore, no more than 50 percent of the HMO’s enrollment can consist of medicare participants. The HMO is then reimbursed by medicare for the services it provides to participants who elect coverage. In effect, the HMO is acting as a subcontractor in providing benefits for medicare.

If an HMO is approved to participate, a medicare participant can elect coverage during a specified 30-day open enrollment period. Under the first two HMO arrangements described below, all eligible applicants must be accepted, subject to certain maximum limits; under the third arrangement, an HMO can reject unhealthy applicants. In order to be eligible, a medicare participant must meet the following requirements:

• be enrolled in part B of medicare and continue to pay the part B premium
• live in the service area of the HMO
• not be receiving care in a medicare-certified hospice
• not have permanent kidney failure

In addition, the person must pay any periodic premium charged by the HMO. This premium is set in a manner that takes into account the contribution that will be made by medicare, which is 95 percent of what medicare would have paid in benefits for the same class of employees if they had remained under medicare. Because of economies associated with the HMO arrangement, most medicare HMOs are able to provide coverage without an additional premium while also increasing benefits. Such benefits include eliminating deductibles, lowering copayments, and providing expanded coverage for such benefits as prescription drugs, eyeglasses, hearing aids, and routine physical examinations. However, some HMOs do charge a small premium when these additional benefits are provided, particularly if the additional benefits are substantial.

There may be some drawbacks to HMO participation. Probably the most significant one is that participants may have negative attitudes toward the concept of managed care. For example, participants must use the HMO’s network of doctors and hospitals and will have less choice in selecting providers than under the regular medicare program. However, this drawback will concern fewer persons as more employees have coverage under managed care plans at the time of retirement.

One issue that persons electing a medicare HMO must address is whether there is any need to purchase a medigap policy or maintain a policy already in force. There is little need for such a policy because it will only duplicate (and therefore not pay) benefits provided by the medicare HMO. However, if a medicare HMO participant later leaves the HMO and wants a medigap policy to supplement regular medicare benefits, he or she may be unable to buy the policy of choice, particularly if health problems exist. (The Clinton administration has proposed a change in medigap rules so that a person who drops a medigap policy after joining a medicare managed care plan can obtain a new policy without evidence of insurability if the person leaves the managed care plan.)

There are three types of arrangements for providing HMO benefits to medicare participants. It is unlikely that any individual HMO will make more than one of these arrangements available. These three arrangements are listed in order of their prevalence.

Medicare Risk Plan

The medicare risk plan is by far the most common HMO arrangement for medicare beneficiaries. Under a medicare risk plan, the HMO provides all medicare services and normally also provides additional benefits to the participant. Once HMO coverage is elected, the participant has effectively rejected the regular medicare program and must look to the HMO coverage.

A problem may arise if a medicare risk plan participant lives part of the year in another location or travels extensively. While medicare and a medigap policy would provide coverage at these locations (at least in the United States), it might be difficult to obtain HMO benefits in nonemergency situations. However, some medicare risk plans affiliate with one another to provide coverage when a participant travels from one HMO’s service area to another’s service area.

Medicare Cost Plan

Under a medicare cost plan, a participant can receive all medical care from the HMO or go outside the HMO network for services as desired. Medicare reimburses the HMO for the actual cost of providing care to participants. When care is received outside the HMO network, medicare pays its usual benefits, which means that participants are responsible for the usual medicare deductibles and coinsurance.

Medicare Health Care Prepayment Plan

Medicare select policies are available through a trial program. Under this program, participants may purchase a private insurance contract that is similar to a medigap policy. However, the policy must also provide part A benefits and possibly part B benefits. In order to receive benefits provided under the policy, a participant must receive care from a designated network of medical providers. However, the subscriber can receive services outside the network and receive regular medicare benefits. This is a form of point-of-service plan, which is discussed in a subsequent chapter on managed care.

If a participant decides to terminate a medicare select policy and return to regular medicare coverage, he or she must be given the option to purchase any medigap policy sold by the company that issues the medicare select policy.

Until 1984 all social security benefits were received free of federal income taxation. Since that time, benefits received in the form of monthly income under OASDI have been partially subject to income taxation for some social security recipients. To determine the amount of social security benefits subject to taxation, it is necessary to calculate modified adjusted gross income, which is the sum of the following:

• the taxpayer’s adjusted gross income (disregarding any foreign income and savings bond exclusions)
• the taxpayer’s tax-exempt interest received or accrued during the year
• one-half of the social security benefits for the year