An Overview of Medicare Financing and Payments

Medicare Part A Financing: Financing for the Hospital Insurance Program is primarily through a mandatory payroll deduction, the "FICA tax." Currently, the FICA tax is 1.45% of earnings paid by each employee and their employer, or 2.90% for the self-employed. The money is paid into a trust fund that is a special account in the U.S. Treasury. The trust fund also receives income from a portion of income taxes levied on Social Security benefits paid to high income beneficiaries, premiums from those who are not otherwise entitled Medicare benefits and choose to enroll voluntarily, and interest earnings. The taxes paid each year are used primarily to pay benefits for current beneficiaries. The hospital insurance funds can be used only to pay for the Medicare Part A, and Part B funds cannot be transferred for Part A use.

Medicare Part B Financing: Medicare Part B is financed through general federal revenues (72%), premiums (26%), and interest and other sources (2%).  In 2020, the standard part B premium was $144.60 per month, but this amount increases for individuals with incomes >$87,000 per year. The premium is usually deducted from the Social Security benefit checks of those enrolled in Part B.

Beneficiary Payment Liabilities and Medicare Part C: Beneficiaries are responsible for charges not covered by the Medicare Program and for the various cost-sharing aspects of Parts A and B. These liabilities may be paid "out of pocket" by the beneficiary, or by a third party insurance company as part of a "medigap" coverage plan. Medigap refers to private insurance policies that will pay most of the health care charges not covered by Parts A or B. These plans are also called Medicare Advantage Plans or Medicare Part C. These policies must meet Federally imposed standards, and are offered by commercial health insurance companies, such as Blue Cross and Blue Shield. If a Medicare beneficiary joins a Medicare advantage plan, the plan provides part A (hospital insurance) and part B (medical insurance). Many plans offer extra coverage such as dental, hearing, vision, and prescription drug coverage. Plans may have additional costs as well as provider and coverage limitations.

For Part A (hospital insurance), the beneficiary's payment share is a one time deductible of $1,408 at the beginning of each benefit period. This covers the beneficiary's first 60 days of each period of hospital care. If continued care is needed beyond 60 days, (days 61-90) additional co-insurance payments of $352 per day are required through hospital day 90. Medicare payments stop after 90 in-patient days, unless the beneficiary elects to use "lifetime reserve" for which a co-payment of $704 per day is required.

For skilled nursing care, the first 20 days are fully covered, but days 21 through 100 require a co-payment of $176 per day. Medicare payments stop after 100 days. Home health care has no deductible or co-insurance payments.

For Part B, the beneficiary pays one annual deductible of $198, the monthly premiums, and co-insurance payments of 20% of the medically allowed charges.

Medicare Part D: Various commercial health companies offer Medicare prescription drug coverage plans. These plans have premiums that are in addition to the medicare part B premium.  Premiums vary according to the plan selected as well as the income of the beneficiary.  Deductibles, copayments, and coinsurance rates vary plan to plan within certain limits set by medicare.  Additionally, each plan has a coverage gap (also called the “donut hole”).    Once the beneficiary and the plan have spent $4,020 on covered drugs in 2020, the beneficiary pays 25% of the cost of prescription drugs until $6,350 of spending is reached.  At this point, catastrophic coverage takes over and Medicare pays 95% of drug costs.

Vendor Payments: Since 1983, Medicare payments are made for hospital care under a plan known as the Prospective Payment System (PPS). Under PPS, the hospital is paid a pre-determined amount based upon the patient's diagnosis within a "diagnosis related group" or DRG. This payment pays for whatever medical care is required; in some cases, it is less than the hospital's actual costs, in some cases it is more. Certain payment adjustments exist for extraordinary costly cases.

Beginning in 1992, outpatient physicians were paid an "allowed charge" defined as the lesser of (1) submitted charges or (2) a fee schedule based on a relative value scale (RVS). If a physician agrees to accept the approved payment rate, it becomes payment in full for services rendered to Medicare beneficiaries. No added payments (beyond the initial deductible and co-insurance) may be sought for that service from the beneficiary or Medicare. If the provider does not accept the fee schedule, the beneficiary will be charged for the difference between the charge and the Medicare payment. However, limits now exist on the excess that doctors can charge. Physicians are "participating" physicians if they agree before the beginning of the year to accept Medicare's fee schedule for all Medicare services they furnish for the year. Since Medicare beneficiaries can select their own doctors, they have the option to choose those doctors who participate with Medicare.