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Managing Medicare's Costs

Medigap policies and their costly virtues (1 of 3)

According to conventional wisdom, Medigap policies have stable pricing and predictable medical costs. Stable pricing because seniors should see their premiums gradually rise at an annual rate between five and seven percent. Predictable medical costs because premiums are often the only payments that seniors make during their year, regardless of how many doctor’s visits, diagnostic tests, or treatments they have.

To some extent, the conventional wisdom is right on both points. Also, Medigap policies have other upsides. There are no network restrictions, so policyholders are covered when they see any doctor who accepts Medicare. Additionally, Medicare (not the Medigap insurer) determines what is covered. This is important because Medicare’s utilization rules are more lenient than those of most managed-care plans. As an example, in some Advantage and employer plans, retirees may have difficulty in getting second opinions, but Medicare routinely covers second and in some cases third opinions.

Seniors also like Medigap policies because of their convenience. Doctors and other medical providers send their bills directly to Medicare, which pays what it owes and then forwards the balance to the Medigap insurance company for payment. In the majority of cases, policyholders do not need to complete any paperwork or mail any checks.

Nonetheless, the conventional wisdom about Medigap policies’ obscures as much as it reveals. There is less premium stability than many people think, and while it’s true that Medigap policies make medical costs highly predictable, the tradeoff is that this certainty comes at an excessive price. Here’s a look at each of these attributes:

Stable Pricing: Many companies do have relatively stable Medigap premium increases. UnitedHealthcare, which sells the most Medigap policies nationally,
publicizes the fact that over the past decade its premiums have increased by less than five percent a year (this is a national average, with retirees in some states having seen bigger increases). Other large insurers, however, often impose double-digit hikes. A year ago United of Omaha announced that for some policyholders, Medigap premiums would increase by 40%. With its announcement, United of Omaha, which is a subsidiary of Mutual of Omaha, prompted a complaint by three U. S. Senators to the Department of Health and Human Services.

Two years ago another large Medigap carrier – Blue Cross Blue Shield of Michigan – sent letters to 215,000 of its policyholders saying that premiums would climb by amounts that averaged just over 36%. Michigan’s attorney general was eventually successful in getting premium increases rolled back to 3.8%. But, after saying that it was losing substantial amounts in its Medigap line of business, Blue Cross Blue Shield of Michigan this year again sought hefty premium increases that averaged 21%. And again the Michigan attorney general (not the same one who secured the 2009 rollback) convinced the insurance company to lower the increase – this time to 9%.

For most of the 10 million retirees with Medigap policies, the stability of their premiums is critical. In the face of rapid premium hikes, older retirees in particular have little defense. For one thing, few retirees compare premiums or change their Medigap insurers. Even if they become aware of an insurance company with lower Medigap premiums, they may find it difficult to switch, especially if they have health problems. And if they cannot switch insurance companies, their only options are to remain in policies that have become almost unaffordable or to enroll in Medicare Advantage plans, which may involve their changing physicians.

Larger insurance companies are sometimes thought to have more stable premiums. Not only can they spread their administrative costs over wider bases, but because of their sizable number of policyholders, they are less likely to be hurt by high claims costs of, say, 75 or 100 people who have serious illnesses during the year.

But many large insurers create smaller groups of policyholders, sometimes in subsidiaries, that are referred to as “blocks of business.” These blocks are expected to show profits on their own, and if they are small or are closed to new entrants, they may not be able to absorb even a few large claims without sharply hiking premiums. In some cases an insurance company will close a particular block of business because of change in Medigap benefit design. And because the closed block does not have younger and healthier enrollees coming into the group, its premiums can escalate more quickly than those in blocks that are still open to younger people.

In 2010, most Medigap plans were required by legislative changes to switch to new benefit designs in mid-year. Initially the rules appeared to allow insurance companies to use “fresh start” pricing and create new (younger and healthier) groups for the revised benefit designs that went into effect in June. Early in 2010, however, the National Association of Insurance Commissioners (NAIC) clarified the rules by saying that the older and newer plans had to be pooled in determining premiums. Even so, there are some exceptions that will permit pricing discrepancies in the old and new groups, and over the next decade the closed blocks, many of which are large, are likely to have greater-than-average price hikes.

There is no way that the average retiree or even the average insurance agent can readily know the size or the age profile of a particular Medigap block of business. Nor – other than asking their insurance agents — is there any way for retirees to know if they are in a block that has been closed and thus may be susceptible to outsized premium increases. For retirees shopping for Medigap policies, community-rated plans (such as those sold by UnitedHealthcare and endorsed by AARP) are probably less likely to have large premium increases, but they are often not among the lowest premium plans for younger retirees.

Predictable Medical Costs: If “predictable” means knowing in January what your medical costs will be for the entire year, then most Medigap plans are predictable. But if it means that you can predict medical costs over a several-year period, then Medigap policies are less predictable because of possible premium spikes. And even the predictability that is inherent in these policies comes at a high cost.

The reason Medigap policies are so expensive is that they tend to cover almost all of Medicare gaps, even the smallest and most ordinary ones like $10 doctors’ office co-pays. In fact, Medigap Plan F, which accounts for 40% of all currently owned Medigap policies, does cover every gap in Medicare.

And Plan C, which accounts for another 20% of existing policies, plugs all of the gaps except for Part B excess charges. By providing first-dollar coverage for small and almost certain costs like doctor’s office co-pays and the Part B deductible, Medigap policies basically require people to prepay likely expenses, often with a profit markup added.

As one example, the only difference in the benefit designs of Medigap Plans C and D is that Plan C covers Medicare’s annual Part B deductible, which is $162 in 2011, while Plan D does not. But with many insurers, Plan C costs $175 or $200 more a year, even though its maximum additional benefit is $162. Similarly, the only difference between Plans F and G is that Plan F covers the Part B deductible while Plan G does not. And yet Plan F’s annual premiums are often higher than Plan G’s by more than $162 a year.

People like the comprehensiveness of Medigap policies without perhaps understanding the cost. Many individuals with moderate incomes buy these policies, often because they live in rural areas where there are no viable Advantage plan choices. Thirty-one percent of current Medigap policyholders have annual incomes below $20,000, according to a recent Kaiser Family Foundation issue brief (page 3). For people in their 80s and even late 70s, comprehensive Medigap policies can cost from $3,500 to $5,000 a year, and in many instances people are spending one-quarter of their incomes on Medigap premiums.

Traditionally health insurance was intended to protect people from catastrophic losses. And because large losses were infrequent, policies were reasonably priced. But Medigap plans’ benefit designs are the opposite. Six of the current 10 plan designs were created 20 years ago when healthcare costs were not the concern that they are today.

In addition, at Congress’ request, Medigap benefit designs are created by the NAIC, which although it provides many excellent services to consumers, tends to staff its committees with insurance executives, actuaries, and insurance consultants. And while these are honorable people working on challenging tasks, they often design products that are favorable to the insurance industry.

It’s hard, for instance, to envision a comprehensive health policy that does not include some type of out-of-pocket limit or stop-loss protection. Yet with the exceptions of the rarely sold Plans K and L, Medigap plans do not have these limits – which creates a risk for the insured while limiting the insurance company’s costs.

Fortunately for retirees, the benefit designs of the most comprehensive Medigap plans are likely to change in the coming years in ways that will encourage people – and particularly those new to Medicare – to opt for less comprehensive and less expensive coverage.

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