Among many matters being discussed in the debate over the debt limit are proposals to reform health insurance policies used to supplement Medicare, such as so-called Medigap plans. Such reforms reportedly could save $53 billion over ten years. The reforms under discussion would entail increasing the amounts that seniors with such policies pay out-of-pocket. This, of course, might invite a tsunami of protest from angry seniors. So why is this controversial idea being debated?
While it may sound counterintuitive, the basic problem is that a large number of elderly have too much health insurance coverage. Admittedly, Medicare itself is not particularly good health coverage. In 2007, the average benefit value of Medicare ($10,610) was lower than the benefit value of both the typical large employer PPO ($12,160) and the Federal Employees Health Benefits Program (FEHBP) standard option ($11,780). This benefit value represents the amount that each form of coverage would pay out of the average total amount of spending generated by a typical senior ($14,270). Put a different way, Medicare would pay only 74 percent of costs associated with covered benefits, whereas the typical large employer PPO would cover 85 percent and the most widely used plan for federal employees would cover 83 percent. Medicare is less generous because relative to these other plans offered by large employers, “it has higher cost-sharing for inpatient care under Part A (particularly for relatively short hospital stays), no out-of-pocket limit on services provided under Part B, and less generous drug coverage under the standard Part D benefit.” Medicare also has no annual maximum upper limit on the amount beneficiaries might have to pay—a shortcoming that understandably frightens many seniors relying on fixed incomes.
But the story does not end there. Because Medicare coverage is so inadequate, most elderly have some form of supplemental coverage to fill in the gaps. As illustrated in the chart, more than one-third of seniors have employer-based coverage (either from their own active or retiree health plan or that of a spouse), another one-quarter purchase their own individual (non-group) policy (the so-called Medigap policies), while one in eleven has Medicaid and one in twelve has military health benefits. In addition, about one-fifth of the elderly have coverage through a Medicare Advantage plan, many of which cover deductibles, coinsurance, or prescription drug costs that those relying exclusively on Medicare fee-for-service coverage would have to pay. In fact, excluding Medicare Advantage beneficiaries, 89 percent of non-institutionalized Medicare fee-for-service beneficiaries had some form of secondary coverage in 2005.
Extensive evidence shows that the first dollar protection provided by many of these supplemental Medicare plans increases utilization of Medicare services. This is known as “moral hazard:” if something is subsidized, more of it will be purchased. The most recent study of this phenomenon found that Medicare spending for those with employer-sponsored supplemental Medicare policies was 17 percent higher than those without such supplements; those with Medigap policies had 33 percent higher spending. Closer examination showed that most of this additional use was accounted for by those whose supplements (in conjunction with Medicare) provided them with free or nearly free medical services. That is, among those whose combined coverage paid 95 percent or more of expenses, the increase in Medicare spending was 68 percent for those with employer-sponsored supplements and 85 percent for those with Medigap policies.
Obviously, not all of this incremental spending is waste: some of the additional services used surely had value to Medicare beneficiaries. The problem is that the value of these services is generally far below the actual cost of delivering them. Economists define “waste” as the difference between that value and actual cost and have sophisticated methods for measuring this difference. The best scientific evidence we have about the magnitude of waste associated with free (fully subsidized) medical care comes from the RAND Health Insurance Experiment. This study found that health spending for individuals with free medical care was 32 percent higher than for those who had to pay 25 percent of the bill out of pocket. Fully 93 percent of that spending difference came in the form of “waste” rather than added value to the patient.
If the sizable difference in spending was embedded in the premiums paid for supplemental Medicare coverage, there would be no problem. Those purchasing such policies would entirely finance the extra spending. But that’s not how health insurance coverage works. For each additional physician visit encouraged by a supplemental Medicare policy, Medicare will generally be on the hook for 80 percent of the cost and the supplement only has to pick up the remaining 20 percent. So most of the incremental cost is being loaded onto U.S. taxpayers. This is why budget negotiators are seriously considering proposals to charge $530 to seniors who buy the most generous Medicare supplements. Seniors may not be happy about having to pay more, but it’s hard to argue with the efficiency and equity logic driving these ideas.
Christopher J. Conover is a research scholar at Duke University’s Center for Health Policy and Inequalities Research and an adjunct scholar at AEI. The charts shown are from his new book American Health Economy Illustrated, to be released in January 2012 by AEI Press. See PowerPoint version of Figure 13.5b and Excel spreadsheet on health insurance coverage for seniors for data, sources and methods.