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Managing Medicare's Costs

What to look for (and not) in choosing a Medigap policy

Until the early 1990s, an insurance company could design a Medicare supplemental plan in almost any way it wanted. Because it did not have to adhere to a standard, an insurer could create a plan that mimicked another company’s benefit design, add one or two minor benefits, and then advertise that the new policy had superior coverage. As plans and benefit designs multiplied, people found it increasingly difficult to understand the differences among Medicare supplemental plans.

According to a 1992 study published in Health Affairs, at least 83 Medigap plans were sold commercially in the late 1980s (page 198). Even though these plans had overlapping benefits, some retirees bought more than one plan to make sure they had good coverage. Then in 1990, Congress passed legislation that resulted in the creation of ten standard Medigap benefit designs (these plans were first sold in 1992). In addition, the new law made it a violation for people to own more than one Medigap plan.

This standardization greatly simplified the choices for retirees who wanted to purchase supplemental coverage. But it failed to create an efficient Medigap market. Today there are wide discrepancies in Medigap premiums, with one policyholder often paying 50% or even 75% more in premiums than does another same-age policyholder for a plan with identical coverage.

Individual states often relax – or in some cases further restrict – Medicare’s rules about how Medigap policies can be priced and when they can be purchased. Unlike Medicare’s broadly publicized rules for the purchase of Medigap policies, state regulations are not well known. As a result, retirees may be unaware of state-specific opportunities to save money.

One example is California’s unique “birthday rule.” This law gives current Medigap policyholders a 30-day period each year following their birthdays to switch to another insurer’s Medigap plan of equal or lesser benefits without having to undergo health screenings. Thus in California a 75-year-old retiree paying $4,000 in annual premiums for Plan F has a guaranteed right each year in the 30 days following his or her birthday to switch to another company’s Plan F with premiums for healthy 75-year-olds that are, for example, $3,200 a year.

In most states, people can switch Medigap policies at any time. While they do not have a guaranteed right to buy a Medigap policy after their six-month initial enrollment period is past, they will likely be able to do so if they are in reasonably good health. Still, it’s probably not a good idea for them to switch insurers for small premium savings (which can easily be reversed the following year).

But those with overpriced policies can often save hundreds of dollars a year by changing to lower-premium insurers. The best way to compare prices is to use each state’s online Medigap premium comparisons. Because the premiums shown in these comparisons are sometimes out of date, it’s wise to contact three or four of the lowest-premium insurers for current quotes (the toll-free numbers are also listed in most online comparisons). Links to each state’s comparisons can be found here (seven states and the District of Columbia do not have online Medigap premium comparisons).

In addition, when people purchase a Medigap policy or change insurers, they should not be concerned with the particular method that an insurance company uses to set premiums. The majority of companies set premiums using the “attained-age” method, which adjusts premiums by about three percent for each year of additional age. So, in 2011 an insurance company using this method will have 30% higher premiums for 75-year-olds than it will for 65-year-olds, or three percent for each additional year of age.

Attained-age policies also include annual premium increases for healthcare inflation, typically another three percent a year. Thus, these policies are expected to average annual premium increases in the six percent range – one-half of that increase due to healthcare inflation and one-half an age adjustment.

A few insurers determine Medigap premiums using the “issue-age” method, which usually results in higher premiums for younger retirees. With issue-age policies, premiums rise by smaller amounts since the annual age-adjustments have already been priced in. A more complete description of the ratings approaches (including community ratings) is available in Medicare’s booklet Choosing a Medigap Policy (pp. 17-18).

In theory, attained-age policies are the least expensive choices for younger retirees, although their premiums will rise more quickly. By comparison, issue-age policies are more costly for younger retirees, but because their premiums will increase more gradually, they should be less expensive for retirees in their late 70s and 80s.

Yet this theory doesn’t always pan out, and even when it does, people will have to wait years to know whether it did. The reason is that there are other important factors that influence premiums. Other things being equal, an insurer who pays agents a 6% commission for each policy sold will have higher premiums than an insurer who pays a 4% commission.

An insurer whose risk pool is 25,000 people will likely have higher premiums than another insurance company with a risk pool of 75,000 people. Also, a company’s administrative costs, the composition of its Medigap risk pools, its claims history, its underwriting standards and the cost of medical services in the particular geographic areas where its policyholders live are all considerations in setting premiums. The particular rating method, then, that insurance companies use is just one of several factors involved, and often not the most important one.

Florida and Arizona, two states with large numbers of retirees, both prohibit insurance companies from using attained-age ratings. This requirement is based on the assumption that issue-age ratings will make policies more affordable as people age. Yet older retirees are not necessarily protected from high premiums by this requirement.

In northwest Florida, for example, an 80-year-old who buys an issue-age rated Medigap Plan F from Humana will pay $1,200 more each year than an 80-year old who lives a few miles north in Alabama and who buys an attained-age rated Plan F from Humana. Or, if the Florida 80-year-old has a Plan F sold by State Farm, he or she will pay $356 more each year than an 80-year-old Alabaman will pay in attained-age premiums for the same policy.

There are several reasons why Florida’s Medigap premiums for 80-year-olds may be higher than in neighboring Alabama – medical services could be more expensive in Florida than in Alabama, people may be less healthy in Florida, and insurers may have experienced several years of larger-than-usual claims from Florida policyholders. It is conceivable, of course, that Florida’s premiums for older retirees would be even higher if insurance companies weren’t required to use the issue-age ratings method. But that is hard to know, particularly since much of the information that goes into premium setting is proprietary.

Some consumer publications recommend that retirees buy issue-age policies when they have a choice between issue-age and attained-age policies – even though they will initially pay higher premiums. But it’s risky to overpay for a policy just because it might be cheaper over the next 10 or 20 years.

Even in states that permit both types of ratings, there are usually some issue-age policies that have lower premiums than do attained-age policies, which indicates that the two ratings methods do not always follow the theory. In most instances retirees are best advised to ignore the ratings method and to focus on premiums and the strength of the insurance company.

The Medicare web site sometimes lists the ratings method that an insurance company uses in a particular state. Those interested in seeing an insurance company’s ratings method in their state can go to this page at the Medicare web site, enter their zip code, and then on the following page click on the instruction “View companies that offer Medigap Policy (choose a letter).” The site will then display the companies selling that plan and in some cases the ratings method they use.

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