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Medigap policies: high cost for peace of mind

Medigap policies are usually the most expensive way of supplementing Medicare, and the reasons are fairly easy to find. The policies were designed by the insurance-friendly National Association of Insurance Commissioners at the request of Congress in the early 1990s, and they were shaped to maximize profits.

Otherwise, it’s hard to see how a group of insurance experts could craft benefit packages that include first-dollar coverage but that do not, with the exception of two plans later introduced in 2006, have out-of-pocket limits. Most other types of Medicare supplemental insurance have these limits.

Another reason that Medigap policies are pricy is that they are the only kind of Medicare supplemental coverage not subsidized in some way by the government. Employer plans receive a tax deduction, Medicare Advantage plans get government subsidies and bonuses, and Medicaid is funded by states and the federal government. Medigap policyholders pick up the full cost of their supplemental coverage.

Added to that, Medigap policies can charge higher premiums to people because they are older or have health problems. Employer supplements and Medicare Advantage plans, on the other hand, charge identical premiums to every enrollee ( Advantage plans can, however, decline coverage for people with end-stage renal disease). But unless a Medigap policy is being sold in one of the eight community-rating states or during the initial six-month open enrollment period, it will be medically underwritten. And next year when Health Reform is fully implemented, Medigap policies will be the only type of health insurance that charges higher premiums to people who have pre-existing conditions.

Still, if you can swallow their high cost, Medigap policies have exceptional benefits. You can see any provider in the United States who accepts Medicare and you’ll be fully covered. If you have Plan F, the most popular Medigap plan, you won’t have any cost sharing for Medicare-covered services. You can go to Johns Hopkins for a diagnosis this week and next week get a second opinion at the Cleveland Clinic. If the second opinion is different from the first one, you’ll likely be covered for a third opinion, and for that you may choose to go to the Mayo Clinic. All without your spending a dollar on deductibles, co-payments, and co-insurance.

Insurance that is this comprehensive has an intangible benefit: it relieves people from worries about cost-sharing, coverage gaps and fine-print exclusions. Last month Glenn Hackbarth made this point when he testified before the House Ways and Means Committee. Hackbarth, Chairman of the Medicare Payment Advisory Commission (MedPAC), said, “For most beneficiaries who purchase Medigap policies, the amount they pay in premiums is often well above the amount they would have incurred in cost sharing in the absence of the supplemental coverage. Yet, beneficiaries continue to buy such coverage because it has value to them in providing peace of mind.”

This sense of security is abetted by the fact that Medigap policies are also the only coverage whose benefits have been stable for more than two decades. The benefit designs of the Medigap plans created in the early 1990s are basically the same today. When the plans’ coverage has been tweaked, it’s typically been to enhance benefits. By contrast, Advantage, Part D, and some employer plans change their benefits yearly.

Medigap policies’ predictability and the peace of mind they elicit are appealing to a large segment of the senior population. One working paper (abstracted here) that was later published found that people less willing accept risk are, among other things, more likely to purchase Medigap policies, annuities, and long-term care insurance.

Risk-averse individuals are also prone to choose lifetime monthly pension payments that are not adjusted for inflation. When they have a choice, the predictable income stream of the pension is preferable to a 401k rollover, which has a larger potential upside but also carries more risk. And if their employer doesn’t offer a monthly pension check, they may purchase an annuity. That same cautious behavior makes some seniors willing to pay a Medigap premium that’s much higher than the average cost of care. As last year’s MedPAC report to Congress commented, “The more risk-averse they are, the more willing they are to pay for the insurance.”

In most cases, those who are risk-averse shoulder the full cost and realize the full benefit of their decisions. But in the case of seniors with comprehensive Medigap and employer plans, the government pays if people overuse medical services because there is no cost-sharing. To counter this tendency, many analysts recommend that Medigap benefits be trimmed. They say that the government and most individuals will be better off financially when that happens.

Two groups oppose any Medigap benefit reductions — the health insurance industry, which will see its profits curtailed, and advocacy groups concerned that lower-income policyholders will take a hit. Roughly one-fourth of Medigap policyholders have incomes below the 300% poverty level, which is about $34,500 for a single person and $46,500 for a married couple. A third group has said that while there needs to increased cost-sharing for Medigap policies, it should be means-tested in some way to protect those with lower incomes.

When it comes to finding ways to reduce Medigap policies’ benefits, there’s no shortage of ideas. The Congressional Budget Office (CBO), the Simpson Bowles Commission and others have suggested a re-designed benefits package along these lines: Medigap policies could not cover the first $550 of cost-sharing, after which they could cover only 50% of Medicare’s required cost sharing until a $3,025 out-of-pocket limit is reached.

In 2011 the Kaiser Family Foundation published an analysis of this particular proposal, as well as two others. It relied on data from the 2006 Medical Expenditure Panel Survey, which is a composite of patient records from several sources. For the CBO/Simpson Bowles proposal, the analysis indicated that 79% of policyholders with Medigap and employer plans would pay less than they do now, mainly because premiums would be much lower. Moreover, one in five Medigap policyholders would see their total costs drop by more than $1,000 a year.

The analysis also found that 21% of Medigap policy owners would pay more than they would without a re-design. Yet only 8% of Medigap policyholders would see total cost increases greater than $1,000. While the analysis didn’t say it, people who paid the most in one year would not likely see that spending pattern repeated year after year.

Medicare would have spent $4.6 billion less in 2011 if this proposal had been in effect in 2011, the analysis estimated. What’s more, Medigap policyholders would have been protected for the first time by an out-of-pocket limit ($3,025). While the CBO/Simpson Bowles proposal did not specifically suggest it, lower income policyholders who wind up paying more because of the added cost-sharing could be kept whole for those years through means-testing, although doing so would reduce the savings.

Even though the CBO/Simpson Bowles and similar Medigap reform proposals would save billions for Medicare and also reduce what most policyholders pay, they are piecemeal solutions. Among their downsides, they would add another layer of complexity on an already confused healthcare system. It is also likely that these reforms cannot legally be applied to currently owned Medigap policies, and a government attempt to change existing insurance contracts would likely be opposed in court.

A Medigap benefit re-design could be applied to future policyholders, but doing so would create a two-tier system. Nor would a proposed re-design of Medigap policies affect comprehensive employer supplemental plans, which MedPAC has said are equally culpable of encouraging overuse. And nobody’s explained how employer-sponsored Medigap plans would be treated.

Several policy experts believe a better approach is to renovate Medicare’s 48-year-old benefit design. One suggestion has been to create a unified deductible for Part A and Part B, perhaps with the provision that certain kinds of coverage not be allowed to cover the deductible in the future. Then Medigap policyholders would not be unfairly singled out.

Good solutions are also available now, although they are unlikely to occur. One is for the insurance companies to promote existing Medigap plans that have cost-sharing. Seniors in good health, for example, could be informed that Plans K and L are good options. If they choose Plan L, they will pay 40% less in premiums and will have a reasonable $2,400 out-of-pocket limit that includes every Medicare-covered service (but it does not include the Part B deductible and Part B excess charges). And they will have 25% cost-sharing until they reach that out-of-pocket limit.

As it now stands, though, seniors will have to inquire about Plan L, since otherwise they probably won’t be told it exists. That’s because Plan F’s higher premiums generate larger profits and commissions. Agents usually don’t mention a lower-premium plan unless someone says he or she cannot afford a comprehensive plan. Finally, many insurance companies don’t sell them, limiting their offerings to the comprehensive plans and to Plan A, which they are required to offer. ◊◊


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