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the desired level in some future year. Further, in recommending a schedule of tax rates, it is desirable that the rates recommended be rounded to avoid frequent changes in rates charged.

The current-costs of the hospital insurance program over the next 25 years are summarized in table 8, along with that part of the current-cost required to actually pay disbursements in each year. For purposes of comparison, the latter are also shown for past years.

TABLE 8.-EXPENDITURES AND CURRENT COSTS OF THE HOSPITAL INSURANCE PROGRAM AS A PERCENT OF TAXABLE PAYROLL!

1 Taxable payroll is adjusted to take into account the lower contribution rates on self-employed income, on tips, and on multiple employer "excess wages."

2 Benefit payments and administrative expenses for insured beneficiaries.

* Includes provision for maintenance of fund equal to next year's expenditures.

The average cost is the average of the "current costs" for the 25-year period 1974-98, adjusted to build the trust fund to 100 percent of the following year's expenditures.

Since the projected level of the hospital insurance trust fund at the beginning of calendar year 1974 is 72% of the projected disbursements during 1974, provision must be made for increasing the trust fund to the desired level. The average allowance required for this purpose over the 25-year projection period is added to the average of the current costs over this period to obtain the average cost of 2.63% of taxable payroll.

As can be seen from table 8, the ratio of expenditures to taxable payroll has increased from .95% in 1967 to an estimated 1.37% in 1973, reflecting the higher rate of increase in hospital costs than in earnings subject to hospital insurance taxes. This ratio is projected to increase to 1.50% in 1974 and 1.57% in 1975, reflecting both a continuation of this trend and the extension of hospital benefits to disabled beneficiaries and persons suffering from chronic kidney disease. A further increase in this ratio in the long run to 3.35% in 1995 results from the assumed continued increases in the cost of institutional health care at a higher rate than in taxable earnings.

The additional allowance necessary to maintain the trust fund at the level of 100% of the next year's disbursements (provided the trust fund is already at the level of the current year's disbursements at the beginning of the year) is projected to be at a reasonably high level in the short run as a result of increases in disbursements due to the newly added coverage of disabled beneficiaries and persons with chronic kidney disease and due to relatively high rates of increase in hospital costs. In the long run, this factor is relatively less important.

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The current cost is estimated to be 1.63% for 1974, rising to 1.69% for 1975 when the coverage of new beneficiaries has full effect, and is projected to increase to 3.45% by 1995.

The assumptions used in projecting these current cost rates are described in the actuarial appendix. The long run cost of the hospital insurance program depends primarily on the relationship between the aggregate cost of hospital services furnished to beneficiaries and the aggregate taxable payroll. In the long run, the average increase in the average earnings of hospital workers cannot be expected to differ substantially from that for other workers. Consequently, the rate of increase assumed for all workers will affect hospital costs and average earnings in approximately the same way over the long run and is thus a relatively minor parameter. Ultimately, the increase in quality, complexity, and extent of health services furnished in an institutional setting determine the major portion of the increase in the current cost of the hospital insurance program. Demographic aspects play only a secondary role over the 25-year period covered in the projections.

These projections assume that public pressure will keep hospital costs from increasing substantially faster than average earnings, in contrast to what has happened in the recent past. It is specifically assumed that in the long run such pressure will reduce the differential between the rate of increase in hospital costs and the rate of increase in taxable earnings to only 3.5% per year. The cost estimates will prove to be too low should there be a continuation of the rate of increase in the cost of hospital services that has been experienced since the beginning of the program. The 1972 Amendments included a number of provisions permitting administrative actions which when implemented could reduce the cost of the program. Projections of the cost of the program, assuming alternative rates of increase in hospital costs, are discussed in the actuarial appendix, along with a more detailed discussion of the assumptions used.

Table 9 compares the average cost from table 8 with the average combined contribution rate under current law for the same 25-year period. The slightly positive actuarial balance (+0.02% of taxable payroll) indicates that the system is approximately in overall balance, according to the assumptions used.

TABLE 9.-Actuarial balance of the hospital insurance program, as a percent of taxable payroll*

Average contribution rate in present schedule....

Average current cost

Actuarial balance

(Percent)

2. 65

2. 63

+ 0.02

The hospital insurance trust fund balance at the beginning of 1974 is 72 percent of the projected expenditures for that year, below the level of one year's expenditures recommended by the Advisory Council. Under the present financing schedule, the ratio of fund to expenditures will increase, with the trust fund balance projected to reach 100% of the year's expenditures by the beginning of 1977 and to exceed 130% of the year's expenditures by the beginning of 1980. The relatively large trust fund balances projected for the late 1970's and early 1980's reflect contribution rates during these years that are slightly in excess of those required to meet the recommendations of the Advisory Council.

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The present financing schedule is actuarially adequate over the twenty-five year period 1974-98 to provide the expenditures antici pated, including the benefits for newly eligible classes of beneficiaries, provided that the assumptions underlying the estimates prove to be realistic (among these is the assumption of future public influence toward reducing the rate of increase in hospital costs). Although the overall financing of the program is adequate, the year-by-year incidence of contribution rates is such that somewhat higher than necessary contribution rates during the early years of the 25-year period offset inadequate ones during the later years.

APPENDIXES

APPENDIX A. ACTUARIAL METHODOLOGY AND PRINCIPAL ASSUMPTIONS FOR COST ESTIMATES 1

The basic methodology and assumptions used in the estimates for the hospital insurance program are described in this appendix.

1. Methodology

The adequacy of financing for the hospital insurance program (the HI program) for the next 25 years is expressed as an actuarial balance. The actuarial balance is calculated as the difference between the average of the contribution rates specified in current law and the average of the current costs for the 25-year period, adjusted to build the trust fund to the level of a year's expenditures. The current-cost for any year is the ratio to the effective taxable payroll for that year of the cost of benefits and administration for insured persons plus an amount required to maintain the trust fund at the level of the next year's expenditures. In projecting the taxable payroll, it is assumed that the taxable wage base is adjusted periodically to keep pace with rising earnings.

The actuarial balance is +0.02% of payroll indicating that the program is in approximate actuarial balance according to the assumptions used.

2. Principal problems in forecasting the cost of the hospital insurance program The principal problems involved in forecasting the future costs of the hospital insurance program are (1) establishing the present cost of the services provided by type of service, to serve as a base for projecting the future, (2) forecasting of the increase in the cost of hospital services (which account for approximately 95% of the cost of the program), and (3) estimating the cost for new beneficiaries covered as a result of the 1972 Amendments.

(a) Problems involved in establishing the present cost of services incurred as a base for forecasting future costs.-In order to establish a suitable base from which to forecast the future costs of the hospital insurance program, it is necessary to eliminate the effect of any transitory factors. Thus the initial problem is to find the incurred cost of services provided for the most recent year for which reliable estimates can be made. To do this, the non-recurring effects of any changes in regulations or administration of the program and of any irregularities in the system of payments to providers must be eliminated. As the result of the elimination of such transitory factors, the rates of increase in the cost of the health insurance program are different from the increases in cash disbursements shown in tables 5 and 6. This analysis concentrates on the longer run cost of the health insurance program in relation to the designated sources of income.

The hospital insurance program is obligated by the law to reimburse institutions for the actual reasonable cost of providing covered services to beneficiaries. Payment is initially made on an "interim" or temporary basis, with the remainder of reasonable costs paid in a series of subsequent cost settlements with the institutions.

On the average, interim payments have been set at rates lower than actual costs, as recovery of any overpayment is thought to pose a serious problem. Further, there is a delay between the date on which services are performed and the date on which interim payments based on bills are made. Such delay is due to the time required (1) for the institutions to bill intermediaries; (2) for the intermediaries to query the Social Security Administration to determine the benefit period status of the patient, determine that the services are covered, and draw checks for approved services; and (3) for the institutions to present these checks for payment. Current financing payments, not exceeding the program liability for services performed but for which no payment has been made, have in the past been advanced to institutions requesting them. Such payments have been discontinued, and amounts previously advanced are being recovered during fiscal year 1974. Another method

Prepared by the Office of the Actuary, Social Security Administration.

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of interim reimbursement, "periodic interim payments," makes fixed payments to the hospitals at regular intervals throughout the year. The payments are based on projections of estimated reasonable costs from past experience and may vary substantially from the actual bills submitted from month to month.

In order to adjust interim payments to the actual cost of providing services (as determined by cost reports which make the necessary allocations of all of an institution's costs on a functional basis), a series of settlements is made with each institution. The total cost settlements have averaged around 5.5% of the interim payments during the early years of the program; however, the incomplete data available do not permit an accurate estimate of the exact amount. Due to the time that has been required to obtain cost reports from institutions and to verify and, where appropriate, audit these reports, the settlements have lagged behind the liability for such payments by as much as several years for many institutions. The final cost of the program has not been completely determined even for the early years of the program, and more uncertainty exists as to the final cost of subsequent years. The overall incurred costs for any past year can be estimated, however, to within a few percent of the actual cost.

An additional complication stems from the reimbursement of the HI program from the supplementary medical insurance program (the SMI program) for the cost of certain salaried physicians. If a hospital has an agreement with salaried radiologists and pathologists under which the institution bills for the professional component of these services, interim payments are made from the HI trust fund and later reimbursed from the SMI trust fund on the basis of that hospital's cost report. Interim transfers are made from the SMI trust fund to the HI trust fund for the estimated difference between current incurred costs and cash settlements for these services. Reliable data as to the interim cost of these services is not available. Estimates are made on the basis of the final cost settlements, which as noted before are not available on a comprehensive basis for some time after the ends of hospital fiscal years.

Additional problems are posed by changes in administrative or reimbursement policy which have a substantial effect on either the amount or incidence of payment. The extent and incidence with which such changes are incorporated into interim payment rates cannot be determined precisely.

Allocating the various payments to the proper incurred period, using incomplete data and estimates of the impact of administrative actions, presents very difficult problems, the solution of which can only be approximate. Under the circumstances, the best that can be expected is that the actual incurred cost of the program for a recent period can be estimated within a few percent. This situation has the dual effect of (1) increasing the error of forecast directly, by incorporating any error in estimating the base year into all future years and (2) lengthening the periods that must be forecast, since a projection of the most recent year is more accurate than an attempt to reconstruct the actual cost in that year.

Hospital insurance program data from 1972 indicate that aged patients used 3.89 days per capita of hospital services and 0.28 days per capita of skilled nursing facility services.

Program data for 1972, corrected for anticipated final settlements with providers, indicates that the average reimbursement for a day of hospital care for the aged was $77.31 per day. They paid 6.3% of their hospital costs in the form of the inpatient deductible and coinsurance. In 1972, the average reimbursement per day in skilled nursing facilities for services covered by the hospital insurance program was $26.12. The unit reimbursement for home health services was approx imately $14.92 in 1972.

(b) Problems involved in forecasting the increase in hospital costs. In order to evaluate the adequacy of a tax schedule to support the hospital insurance program, it is necessary to relate the increases in the cost of institutional care for beneficiaries to the increases in taxable earnings which support those costs. There are three principal factors to consider: (1) The aggregate increases in expenditures by institutions for producing services of the types covered by the hospital insurance program, (2) the changes in the share of these expenditures that are for beneficiaries and hence will be paid by the HI program (as affected by administrative policy), and (3) the resultant hospital insurance program expenditure increases, relative to the increases in taxable earnings. These factors, in addition to a factor indicating the differential between program costs and taxable carnings, are shown in table A1. The assumptions as to the overall rate of population increase and increases in average carnings affect income and outgo in a parallel way and are thus of secondary importance. Similarly, the number of days of hospitalization by beneficiaries is primarily important as an index of the