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Managing Medicare's Costs

Medigap policies: a tale of two markets (3 of 3)

One way to gauge the rise in seniors’ out-of-pocket medical costs is to look at Medigap Plan F premiums. Plan F is the most popular Medigap policy, and it not only covers all of the gaps in Part A and Part B, but it has some benefits for services that Medicare doesn’t cover, like foreign-travel emergencies. Over the past 15 years or so, this plan’s premiums have grown at about the same rate as seniors’ overall healthcare spending.

In 1999, the average annual premium for a Medigap Plan F was $1,217, according to a 2002 analysis (page 9) by the Government Accountability Office. By 2010, according to a Kaiser Family Foundation issue brief (page 7), the average annual premium for Plan F was $172 a month, or $2,064 a year, which represented a 4.9% annual increase over the 11 years since 1999. The 4.9% growth rate is approximate, since Medicare’s and Plan F’s benefit designs changed slightly during that period. Also, the demographics of Plan F policyholders may have changed, and as a group they could have been older (or younger) in 1999 than in 2010.

Still, the 4.9% number is just below the range of five to seven percent annual increases that Medigap policy owners should expect, depending on their Medigap insurer and the state where they live. And because Medigap premiums are typically the largest healthcare expenses for the retirees who have these policies, it makes sense that they would reflect the overall trend in out-of-pocket costs.

Most retirees’ incomes increase more gradually than do their out-of-pocket costs for healthcare. Over the past decade, Social Security’s cost-of-living adjustments have averaged just over 2.5%, the S&P 500 Index has recorded an average annual return of 2.8%, and the average defined-benefit pension payment has increased by less than 2% a year. Since Medigap premiums grow twice as fast as seniors’ incomes, they eventually crowd out other kinds of spending. And for many seniors, they become unaffordable.

The Medigap market has two segments. One is younger and typically healthier retirees, who have a six-month open enrollment period when they first get Parts A and B. This segment of the Medigap market is moderately efficient, with new beneficiaries in particular comparing premiums before buying policies. And if their Medigap premiums happen to spike, younger retirees are more likely to search for alternatives — either finding a different insurance company that has lower premiums or enrolling in a Medicare Advantage plan.

But the older-retiree segment of the market is not efficient. A 75-year-old woman who has been hospitalized twice in the last year (and once in the last 90 days) will almost certainly not be able to change to a lower-premium insurance company unless she happens to reside in one of the handful of states where Medigap policies are community rated. She may live another 10 or 15 years locked into a high-cost policy whose premiums will grow (ideally) by six percent a year. Her only other option is to transfer to a Medicare Advantage plan, where she may have to choose new physicians.

If she were in good health, she might be able to switch to a Medigap policy from an insurance company that has lower premiums. In theory, older retirees can to do this – the Medigap premium comparisons found on most state insurance department websites list premiums for 80-year-olds and even in a few instances for 85-year-olds. But in practice older retirees do not often change insurers to reduce their premiums. That may be because they’re unaware that they can change, or they may not know how to go about finding lower premiums. So they stay put.

The market failure in the older-retiree segment can have a large financial impact on many seniors. Older people are more likely to be dependent on their Medigap coverage, and they tend to stick with expensive policies as long as they can. They use more medical services than younger retirees. They also understand that Medigap policies are well suited for people who use more medical services, who see numerous physicians and who want the fewest restrictions on their access to care.

In rural areas they may not have any suitable Advantage plans they can enroll in. A young retiree who lives in a small town may be willing to drive 50 miles to the closest primary care physician in an Advantage plan’s network, but an older one is less likely to do so.

The result is that Medigap policies tend to have high concentrations of older people. A 2008 study in the journal Health Affairs found that, based on a sample from one state, 63% of Medigap policyholders were age 75 or older (page 475).

Why are Medigap policies so expensive? The answer is not that insurance companies are overcharging. According to data from the National Association of Insurance Commissioners, last year Medigap carriers used 79% of their premiums to pay for medical services. And the year before, according to Kaiser Family Foundation data (page 5), they paid out 77.5%. Those percentages indicate that most companies are not inflating premiums. The new Health Reform law, for instance, will require that in 2014 individual policies (not including Medigap policies) have an 80% medical loss ratio, which is considered to be a stretch target for many companies.

The most widely sold policies – Plans C and F – are expensive because they cover just about everything. They were designed in the early 1990s by insurance experts. Yet these plans are not insurance by its traditional definition, which is to let people to pay small costs but protect them from catastrophic losses. These two plans reverse that definition. They cover tiny losses but don’t have strong catastrophic protection (because they don’t have out-of-pocket limits).

The high cost of these policies has caused their popularity to slip. Today about 20% of people enrolled in Medicare have a Medigap policy, which is down from 24% a decade ago. Also more people are buying one of the less comprehensive (and less expensive) Medigap policies. An analysis by the industry group America’s Health Insurance Plans found that the four newest plans (K, L, M, and N) accounted for 12% of all Medigap purchases in 2010, even though two of those plans were not available until June of that year. Moreover, these four plans, which require cost-sharing but have lower premiums, were responsible for 23% of all Medigap sales in the first quarter of this year (page 1).

Another reason for Medigap plans’ declining popularity is that Medicare Advantage plans have become more viable choices in recent years. Advantage plans have two attributes that most Medigap plans do not – low (or zero) premiums and out-of-pocket limits. It’s also common for people in good health to save $1,500 or more a year if they enroll in an Advantage plan instead of buying a Medigap policy.

Before purchasing a comprehensive Medigap policy, younger retirees should project what it will cost them in the long run. If they are lucky enough to be able to buy a Plan F for $1,500 a year, and premiums increase 6% annually, after 20 years they will have paid $55,000 and after 25 years more than $82,000 just for Medigap premiums.

Add in Part B premiums that will be $1,200 next year, and if those increase 3% annually, then the total for Medigap and Part B premiums comes to $87,000 for 20 years and $125,000 over 25 years. Those numbers don’t include costs for prescription drug coverage, medical services that Medicare does not cover, over-the-counter drugs, concierge fees and miscellaneous other personal healthcare costs.

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