The Effect of Medicare on Medical Expenditures, Mortality, and Spending Risk

The introduction of Medicare in 1965, providing nearly universal health insurance coverage for the elderly, was the largest change in health insurance coverage in U.S. history. Medicare currently covers nearly 42 million beneficiaries, or one in seven U.S. citizens. Medicare expenditures were $295 Million in 2004, or nearly one-fifth of total health expenditures in the U.S.

The introduction of such a large government health insurance program is likely to have had important consequences for both beneficiaries and the health care system at large. These consequences are the focus of two new working papers.

In The Aggregate Effects of Health Insurance: Evidence from the Introduction of Medicare (NBER Working Paper 11619) Amy Finklestein examines the impact of the introduction of Medicare on health spending and technology adoption.

A central challenge in such analysis is distinguishing the impact of the introduction of Medicare from the effect of other changes that may have occurred at the same time or from the underlying growth pattern of health spending. To do so, the author makes use of the substantial geographic variation in private health insurance coverage among the elderly prior to 1965, which meant that Medicare had a much larger effect on insurance coverage in some regions of the country than in others. For example, half of New England residents over age 65 had meaningful health insurance prior to Medicare, compared to only 12 percent of older residents in the East South Central United States.

The author compiles an annual hospital-level data set from 1948-1975 for six hospital outcomes: total expenditures, payroll expenditures, employment, beds, admissions, and patient-days. If the introduction of Medicare affected these hospital outcomes, there should be a break in any pre-existing trend in these variables at the time of its introduction, and the break should be larger in areas with a lower rate of insurance coverage prior to its introduction.

The author finds compelling evidence to support this hypothesis. For example, prior to 1965, hospital admissions were growing more slowly in the low-insurance areas than in the high-insurance areas, but after 1965 this pattern reversed, with admissions growing much more quickly in those areas most affected by Medicare's introduction. Similar patterns are evident in the other hospital outcome variables, including expenditures. The results from this analysis suggest that, in its first five years, the introduction of Medicare was associated with a 23 percent rise in total hospital spending (for all ages). Extrapolating from these results suggests that the overall spread of health insurance may be able to explain at least 40 percent of the dramatic increase in health spending in the U.S. between 1950 and 1990.

The author's estimated impact of Medicare on hospital spending is over four times larger than what would have been predicted from small scale changes in health insurance such as those analyzed by the Rand Health Insurance Experiment of the 1970s. The author conjectures that the reason for this discrepancy is that market-wide changes in health insurance - such as the introduction of Medicare - may have fundamentally different effects on health spending than experiments affecting only isolated individuals. For example, market wide changes in health insurance may increase market demand for health care enough to make it worthwhile for hospitals to incur the fixed cost of adopting a new technology. Consistent with this, the author presents suggestive evidence of faster adoption of new cardiac technologies following Medicare's introduction.

This evidence of a considerable impact of Medicare on the health care sector raises the natural question of what benefits Medicare produced for health care consumers. In a related paper, "What Did Medicare Do (And Was It Worth It)?" (NBER Working paper 11609), Amy Finklestein and Robin McKnight examine this question. When Medicare was signed in to law, President Lyndon Johnson proclaimed, "No longer will older Americans be denied the healing miracle of modern medicine. No longer will illness crush and destroy the savings that they have so carefully put away over a lifetime." Thus, from the start it was envisioned that Medicare would provide both health benefits and risk-reduction benefits.

However, using several different empirical strategies, the authors find that in its first ten years, the establishment of universal health insurance for the elderly had no discernible impact on their mortality. They present evidence suggesting that the explanation for this finding is that, prior to Medicare, elderly individuals with life-threatening, treatable health conditions (such as pneumonia) sought care even if they lacked insurance, as long as they had legal access to hospitals.

Even absent any measurable health benefits, the introduction of Medicare may still have benefited older individuals by reducing the risk of large out-of-pocket medical expenditures. The authors document that prior to the introduction of Medicare, a small portion of the elderly faced extremely large out of pocket medical expenditures. They then compare the change in the distribution of out of pocked medical expenditures for those aged 65 to 74 between 1963 and 1970, using the change for those aged 55 to 64 to proxy for non-Medicare related trends in spending. They conclude that the introduction of Medicare was associated with a substantial reduction in out-of-pocket spending for those with the largest out of pocket medical expenditures. Specifically, they find that the introduction of Medicare had no significant effect on out-of-pocket spending for those in the bottom three-quarters of the out of pocket expenditure distribution, but led to a 40 percent decline in spending for those in the top quartile. For those in the top decile, the average decline in out of pocket medical spending was $1,200 (in year 2000 dollars) per person.

The authors conduct a cost benefit analysis comparing the insurance value of the risk reduction provided by Medicare with the efficiency costs of the program (namely, the cost of raising government revenue and of increased health spending resulting from insurance coverage). They estimate the insurance value to be $519 per beneficiary, or $9.9 Billion per year (again, in year 2000 dollars), a sum that would cover 45 to 75 percent of the costs of Medicare.

The authors conclude "our empirical findings underscore the importance of considering the direct consumption smoothing benefits of health insurance, in addition to any indirect benefits from the effect of insurance on health." However, they caution that their analysis is conducted in a static environment in which medical technology is taken as given. Given the evidence that the introduction of Medicare was associated with a more rapid adoption of new cardiac technologies, its effects on mortality in the long-run may be much larger than the ten-year impact that the authors examine.

The authors gratefully acknowledge financial support from the National Institute on Aging (grant P30-AG12810) and the Harvard Milton Fund.