How Medicare Works

President Lyndon B. Johnson signs the Medicare bill in July 1965.
President Lyndon B. Johnson signs the Medicare bill in July 1965.
© Bettmann/CORBIS

Medicare became America's first federal health insurance program when it was signed into law on July 30, 1965. The program offers health insurance to seniors over the age of 65 regardless of their current health, medical history and income. President Lyndon B. Johnson presented the first Medicare card to former President Harry S. Truman, calling him the "real daddy" of Medicare [source: Updegrove]. Truman had tried but failed to implement public health insurance for elderly Americans during his presidency. (Franklin D. Roosevelt had also considered including public health insurance in the Social Security Act of 1935, part of the New Deal legislation, but ultimately left the idea out.)

Before the introduction of Medicare in the U.S., only about half of individuals 65 and older had health insurance — and life expectancy rates, compared to today, were eight years less for American men, and five years less for American women [source: Center for Medicare Advocacy]. On July 1, 1966, when Medicare services were made available to all of America's seniors, more than 19 million enrolled [source: Stanton]. In 1972, under President Nixon's expansion of Social Security, Medicare hospital insurance benefits were extended to disabled individuals under 65.


Today, to receive Medicare, you first have to be eligible for Social Security benefits. For someone 65 or over, this means you or your spouse must have worked at least 10 years (they don't have to be consecutive) with Social Security and Medicare Withholding tax withheld from your pay (this tax is part of the Federal Insurance Contributions Act, which shows up as FICA on your pay stub). Individuals younger than 65 may be eligible for Medicare's hospitalization insurance benefits, either subsidized or as an out-of-pocket monthly expense, if they're diagnosed with end-stage renal disease (ESRD) or a qualifying long-term disability.

Medicare Basics: Hospital Insurance (Part A) and Medical Insurance (Part B)

Medicare's publicly funded health insurance was originally modeled after private health insurance plans offered at the time and was introduced as a two-part program. Those parts are Medicare Part A, which is hospital insurance coverage, and Medicare Part B, which is an elective health insurance plan. When it was rolled out, Plan A beneficiaries were responsible for a $40 annual deductible, and those who chose to enroll in the Plan B program paid a $3-per-month premium [source: Stanton].

Today Medicare Part A and Part B are called Original Medicare. Medicare Part A is also known as hospital insurance, and its beneficiaries can expect inpatient hospital stays in a semi-private room to be covered (a private room is not covered unless it is deemed medically necessary). In addition, rehabilitation and other skilled nursing services are also covered. Home health care is covered but only if it's medically necessary, and then only on a part-time, intermittent basis; this includes physical, occupational and speech therapies when conducted by a Medicare-approved health agency. Durable medical equipment (DME) such as walkers and wheelchairs are covered, as are other medical supplies. Finally, Part A covers hospice care for terminally ill patients and includes drugs and support services for treating symptoms and relieving pain.


Medicare Part B offers optional medical insurance, and those who elect coverage pay a monthly insurance premium. Part B covers medically necessary health care appointments, including doctors' appointments, outpatient medical and surgical services, diagnostic tests and some coverage for home health care. In 2015 the majority of people enrolled in Part B paid a monthly premium of $104.90, with coverage beginning after they met an annual deductible of $147 [source:].

Medicare won't cover everything, though. You'll have to look elsewhere for some common services that aren't covered under Medicare programs, including long-term care, most dental care (including dentures), cosmetic surgery, acupuncture, chiropractic, routine foot care, hearing aids and fittings, and vision care [source:].

Those who are enrolled in Original Medicare may also apply for Medicare Supplement Insurance, also known as Medigap. Medigap policies are intended to help cover expenses not covered by Part A and Part B, such as copays, coinsurance costs and deductibles. Some plans may offer additional coverage, such as overseas medical care while traveling. These policies are sold and administered by private insurance companies, and enrollees pay a monthly premium. In 2010, the year Congress standardized Medigap plans, just about 20 percent of 65-year-old Medicare beneficiaries enrolled in a Medigap policy; the most popular plans, C and F, are those that also include the Medicare Part B deductible [source: KFF]. Not all Medigap policies include prescription drug coverage, though, and beneficiaries may not have a concurrent Medical Savings Account.

Medicare Advantage Plans (Part C)

Selecting the right plan for your needs may require a bit of research.
Selecting the right plan for your needs may require a bit of research.
© zimmytws/iStockphoto

Until the late 1990s, Medicare was structured as a fee-for-service program. In 1997 Medicare began to offer HMO-modeled plans for the program's beneficiaries; these private insurance plans were then known as Medicare+Choice, then as Medicare Part C. Today they're primarily called Medicare Advantage plans. In 2014, about 70 percent of Medicare beneficiaries were enrolled in traditional fee-for-service programs; 30 percent were enrolled in Medicare Advantage programs, nearly tripling the number of Advantage enrollees between 2004 and 2014 [source: KFF].

Advantage plans allow Medicare users to customize plans most closely aligned with their specific medical and prescription needs and are an alternative to carrying Medicare Parts A and B. Private insurance companies provide some of the coverage in Advantage programs, and some of these plans offer prescription drug coverage.


There are four types of Medicare Advantage plans:

Health Maintenance Organization (HMO) plans — These plans emphasize preventive health care. Only doctors within the HMO network are covered, and an appointment with a specialist requires a referral from a primary care physician. Additionally, HMO Point of Service (HMOPOS) plans are offered, but they're not popular; HMOPOS beneficiaries have access to some out-of-network care and services but usually at a high cost. The majority — 64 percent — of Medicare Advantage enrollees are covered by HMO plans [source: KFF].

Preferred Provider Organization (PPO) plans — PPOs are similar to HMOs, except beneficiaries have the option of seeing a physician who's outside the plan network, although out-of-network services typically cost more. A referral from a primary care doctor is not usually required for specialist appointments. Twenty-three percent of Medicare Advantage beneficiaries are enrolled in PPOs [source: KFF].

Private Fee-for-Service (PFFS) plans — PFFS plans are offered by private insurance companies, and those insurance companies decide what benefits are offered, the cost and payment terms. Under PFFS plans, beneficiaries aren't required to choose a primary care doctor, nor are referrals required for specialist appointments. Not all doctors and hospitals accept PFFS plans, though, and these plans might not be available in your state or county. Originally local PFFS plans did not have established care networks, but in 2011 health care reform laws required most to do so. In 2014 about only 2 percent of people carrying Medicare Advantage plans were enrolled in PFFS plans [source: KFF].

Special Needs plans (SNPs) — Special Needs Plans are plans tailored for specific groups of people. SNPs include access to both doctors who specialize in the needs of those enrolled in a specific plan, and Medicare prescription drug coverage. People with diabetes, people who live in nursing homes, and people who are eligible for both Medicare and Medicaid, for example, might be eligible for a Special Needs Plan. Between 2006 and 2014, enrollment in SNPs increased from half a million to nearly 2 million people [source: KFF].

Additionally, some regions offer Medicare Medical Savings Accounts (MSAs), which are similar to Health Savings Accounts (HSAs) for individuals under 65. Medicare MSAs are a combination of two plans: a high-deductible Medicare Advantage plan and a special medical savings account (funded by Medicare) to pay for health care costs incurred before you meet the deductible in your Medical Advantage plan.

Medicare Cost plans are also available, again depending on where you live. Enrollees in Medicare Cost plans must carry both Medicare Part A and Part B, but this hybrid plan gives beneficiaries the option to go to out-of-network providers on a fee-for-service structure (including the expense of Part A and Part B deductibles and co-insurance). In 2013, 50 percent of Medicare recipients had incomes below $23,500 [source: KFF]. Medicare Savings Programs (MSP) are available to help seniors pay their Medicare premiums, Original Medicare deductibles, co-pays, coinsurance and prescription costs, but these plans are limited and on a state-to-state basis.

Details such as coverage and price depend on the specific program and the state the beneficiary lives in; in Pennsylvania in 2015, for example, there were 129 plans to choose from [source: Scandlen].

Medicare Prescription Drug Coverage (Part D)

President George W. Bush signing the Medicare Prescription Drug Improvement and Modernization Act of 2003.
President George W. Bush signing the Medicare Prescription Drug Improvement and Modernization Act of 2003.

In December 2003, President George W. Bush signed the Medicare Modernization Act, expanding Medicare to offer optional subsidized prescription drug coverage; the result, Medicare Part D, was introduced on Jan. 1, 2006.

Any individual who is eligible for Medicare Part A, Part B or Part C is also eligible to enroll in Medicare Part D, which offers prescription drug coverage. There are two types of prescription drug benefit packages: a stand-alone prescription drug plan (PDP) and the Medicare Advantage prescription drug plan (MA-PD), which blends medical and drug coverage. In 2014 roughly 37 million people received Medicare Part D benefits as part of a PDP or MA-PD [source: KFF].


Medicare Part D is optional, and enrollees may be responsible for paying monthly premiums, annual deductibles, co-payments, co-insurance and other expenses as applicable, such as late enrollment penalties.

There is a coverage gap, also known as the donut hole, in Part D that works — very basically — like this: Part D enrollees pay monthly premiums and also pay a percent (in some cases up to 100 percent) of prescription drug costs until hitting the plan's yearly deductible. In 2010 that annual deductible was $310. Once they meet the deductible, enrollees are responsible for 25 percent of prescription drug costs — that is, until another limit is hit (in 2010 that limit was $2,800). And this is when beneficiaries fall into the donut hole; once the second limit has been reached, beneficiaries become responsible for 100 percent of all their prescription drug expenses. That is, until another spending limit is met — that annual limit was $4,550 in 2010. Once the third limit is met, enrollees become responsible for a small percentage of prescription drug costs.

It won't be until 2020 when the donut hole is closed and Medicare Part D no longer has these restrictions; Part D enrollees will then pay 25 percent of prescription expenses until reaching the plan's annual out-of-pocket maximum [source: Blum].

The plans have varying costs and formularies (the list of drugs covered under the plan). People who want to sign up for Medicare Part D are encouraged to compare the plans and find one that covers the drugs they need, or expect to need, in the future. Changes to plans may be made during the open enrollment period at the end of each calendar year.

As part of health care reform and the Patient Protection and Affordable Care Act (PPACA, also known as Obamacare) signed by President Barack Obama on March 23, 2010, annual wellness exams and certain types of preventive care — such as mammograms and other health screenings — became available to Medicare beneficiaries at no cost for Part D enrollees.


Enrollment periods and procedures differ depending on the type of Medicare plan. Enrolling in Medicare occurs over a period of seven months: during the three months before the month of your 65th birthday, the month of your birthday and the three months after your birthday month. If you're born in June, for example, your Initial Enrollment Period (IEP) is March through September.

Anyone already receiving Social Security retirement benefits qualifies for Medicare Part A and Part B and is automatically enrolled at age 65.


Individuals who are 65 and still working and who receive group health coverage through an employer, union, or spouse may delay enrolling in Part B during the IEP without incurring penalties. They may enroll at any time while still covered by a group health plan or during the eight months after that group coverage ends.

Oct. 15 through Dec. 7 is Medicare's open enrollment period, during which beneficiaries may switch plans, or join or drop Medicare Part D. Coverage begins on Jan. 1, and the Medicare Advantage disenrollment period runs from Jan. 1 through Feb. 14. During this period, enrollees may leave Medicare Advantage and enroll in Original Medicare coverage. They can also enroll in a Medicare Prescription Drug plan (Part D) [source:].

Anyone who is 65 and isn't receiving Social Security retirement benefits may apply for Medicare. You can enroll online, in person at a local Social Security office or by telephone at 1-800-MEDICARE (1-800-633-4227). Open enrollment happens on an annual basis, allowing new enrollees to sign up and current beneficiaries to change coverage as needed.

Administration and Funding

U.S. President Barack Obama signing the Improving Medicare Post-acute Care Transformation Act of 2014
U.S. President Barack Obama signing the Improving Medicare Post-acute Care Transformation Act of 2014
©Chip Somodevilla/Getty Images

Medicare remains a vital means of paying for health care for many Americans. An estimated 15 percent of Americans were enrolled in Medicare programs in 2015. That's about 46 million seniors, of which roughly 13 percent are 85 or older, in addition to about 9 million receiving Social Security disability benefits [sources: Center for Medicare Advocacy, KFF]. Despite being a vital program for older Americans' health and financial security, funding for Medicare has always been a sensitive political issue in the U.S.

Medicare is funded through a few different revenue streams, primarily general revenues (most of which comes from federal income tax payments), payroll taxes and beneficiary sources.


Payroll taxes paid by American employees and employers finance Part A, for example. Under PPACA in 2013, the Additional Medicare Tax, generally withheld from high-wage earners, was introduced.

Part B is mostly financed by general revenues and beneficiary premiums.

Part D is also financed by general revenues and beneficiary premiums, in addition to state funding for individuals eligible for both Medicare and Medicaid (called dual eligibles).

Part C, the Medicare Advantage program, is its own creature but isn't much different. Advantage programs are composed of Medicare Part A, Part B and sometimes Part D, and they're financed in the same ways as Part A, Part B and Part D. The money comes from general revenues, payroll taxes and monthly premiums. The difference is that individuals enrolled in these plans are also responsible for additional costs for the supplementary benefits available in Advantage plans.

Medicare has and continues to undergo changes under the PPACA health care reform laws of 2010, including new policy options such as Medicare Advantage, and coverage such as free preventive care services — but beneficiaries have seen and will see changes in out-of-pocket expenses, such as deductibles and payroll taxes.

Under the Budget Control Act of 2011, $1.2 trillion in federal spending cuts were approved, including a 2 percent cut to Medicare provider payments, as well as to claims for durable medical equipment, prosthetics, orthotics and supplies beginning in April 2013. In 2013 the U.S. spent roughly $586 billion on Medicare, which is 20 percent of America's health care spending. That year nearly 4,000 health care providers were paid about $1 million — each. And a handful of doctors saw as much as $10 million in Medicare reimbursements. Medicare payments of $62 billion went to hospitals and outpatient facilities [source: Tracer]. The Congressional Budget Office (CBO) predicts that reductions between 2013 and 2021 will total $123 billion, adding up to roughly $31 billion in savings [source: Medicare NewsGroup].

In October 2014, President Barack Obama signed the Improving Medicare Post-acute Care Transformation Act of 2014 (known as the IMPACT Act). The goal of the act is to standardize patient-care assessment data for quality, payment and resource management (such as discharge planning) in Medicare's post-acute care settings, which include home health agencies, inpatient rehabilitation facilities, long-term care facilities, hospitals, and skilled nursing facilities [source: CMS].

Among these changes is also the Medicare Access and CHIP Reauthorization Act (MACRA), enacted in April 2015 as an update to the Balanced Budget Act of 1997. MACRA improves the way physicians are reimbursed under Medicare and reduces vulnerabilities in the payment model, making it more difficult to commit Medicare fraud.

Author's Note: How Medicare Works

Health care fraud is big business, and Medicare beneficiaries are popular targets — for predatory strangers, family, and even physicians and health care facilities. It's estimated that in 2012, fraud added nearly $100 billion, or roughly 10 percent, to Medicare and Medicaid spending that year. You can help prevent Medicare fraud by following a few simple tips:

  • Safeguard your Medicare number; it contains your social security number.
  • Don't give in to hard-sell or scare tactics.
  • Be suspicious of "free" tests or doctors who waive your co-pay.
  • Watch for providers who bill for procedures that they never performed.
  • Report Medicare fraud to the Office of Inspector General by calling 1-800-HHS-TIPS (1-800-447-8477) or file a fraud report online.

Related Sources

More Great Links


  • Berlin, Rebecca. "What are payroll taxes?"
  • Blum, Jonathan. "What is the donut hole?" The Medicare Blog. April 9, 2010. (June 5, 2015)
  • Burgess, Michael C. "H.R.2 - Medicare Access and CHIP Reauthorization Act of 2015." April 16, 2015. (June 5, 2015)
  • Bash, Dana. "Bush: New Medicare price tag means 'tough choices.'" CNN. Jan. 30, 2004.
  • Centers for Medicare & Medicaid Services - "Costs in the coverage gap." (June 5, 2015)
  • Centers for Medicare & Medicaid Services - "Different types of Medicare Advantage Plans." 2015. (June 5, 2015)
  • Centers for Medicare & Medicaid Services - "Get help paying costs" 2015. (June 5, 2015)
  • Centers for Medicare & Medicaid Services. "History: Key Milestones in CMS Programs." (June 5, 2015)
  • Centers for Medicare & Medicaid Services. "IMPACT Act of 2014 & Cross Setting Measures." April 17, 2015. (June 5, 2015)
  • Centers for Medicare & Medicaid Services - "Medicare Medical Savings Account (MSA) Plans?" 2015. (June 5, 2015)
  • Centers for Medicare & Medicaid Services - "Understanding Medicare Part C & D Enrollment Periods." August 2014. (June 5, 2015)
  • Centers for Medicare & Medicaid Services - "What's not covered by Part A & Part B?" 2015. (June 5, 2015)
  • Center for Medicare Advocacy. "50 Insights for Medicare's 50th Anniversary." 2015. (June 5, 2015)
  • Center for Medicare Advocacy. "Medicare's 50th Anniversary." 2015. (June 5, 2015)
  • Crane, Thomas S. and Samantha P. Kingsbury. "Medicare Access and CHIP Reauthorization Act of 2015: Program Integrity and Fraud and Abuse Provisions." The National Law Review. April 23, 2015. (June 5, 2015)
  • Internal Revenue Service. "Questions and Answers for the Additional Medicare Tax." March 5, 2015. (June 5, 2015)
  • Internal Revenue Service. "Topic 751 - Social Security and Medicare Withholding Rates." May 27, 2015. (June 5, 2015)
  • Jacobson, Gretchen et al. "Medigap Enrollment Among New Medicare Beneficiaries: How Many 65-Year Olds Enroll In Plans With First-Dollar Coverage?" Kaiser Family Foundation. April 13, 2015. (June 5, 2015)
  • Kaiser Family Foundation. "Medicare at a Glance." Sept. 2, 2014. (June 5, 2015)
  • Medicare Health Plans (MHP). "Changes to Medicare 2015. Feb. 27, 2014. (June 5, 2015)
  • Morales, Tatiana. "Medicare discount cards from hell?" CBS News Online, May 25, 2004.
  • Muñoz, Cecilia. "Celebrating the Latest Law Improving Health Care: The Medicare Access and CHIP Reauthorization Act." The White House Blog. April 21, 2015. (June 5, 2015)
  • National Academy of Social Insurance. "What is the history of Medicare?" (June 5, 2015)
  • Noridian Healthcare Solutions. "Mandatory Payment Reductions in the Medicare Fee-for-service Program." May 27, 2015. (June 5, 2015)
  • Olivero, Magaly and Evi Heilbrunn. "Medicare Advantage vs. Medicare Cost Plans: What's the Difference?" U.S. News & World Report. Oct. 31, 2014. (June 5, 2015)
  • Scandlen, Greg. "Medicare's Biggest Little Secret: Seniors Can Have A Medical Savings Account." Forbes. Feb. 12, 2015. (June 5, 2015)
  • Stanton, Melissa. "Medicare Turns 48." AARP. July 2013. (June 5, 2015)
  • The Economist. "The $272 Billion Swindle." May 21, 2014. (June 5, 2015)
  • The Medicare NewsGroup. "What Does Sequestration Mean to Medicare?" (June 5, 2015)
  • Tracer, Zachary and Caroline Chen. "At Least 3,900 Medicare Millionaires Revealed in U.S. Data." Bloomberg. June 3, 2015. (June 5, 2015)
  • UnitedHealthcare - Medicare Made Clear. "10 Key Medicare Facts." July 30, 2014. (June 5, 2015)
  • Updegrove, Mark K. "Making Harry Truman's Dream Come True." LBJ Presidential Library. March 13, 2012. (June 5, 2015)
  • Williams, Joseph P. "How to Make the Best of the Medicare 'Donut Hole.'" U.S. News & World Report. Oct. 14, 2014. (June 5, 2015)
  • Zamosky, Lisa. "Medicare Advantage: Private Health Insurance Through Medicare." WebMD. Nov. 20, 2014. (June 5, 2015)