Medicare’s Medigap Effect: Government Created and Government Hated – by Robert Nelson, MD

Medicare’s Medigap Effect: 

Government Created & Government Hated

By Robert W. Nelson, MD

So, what does the government really care about when it comes to healthcare?  Is it costs, coverage, or care access?

Real answer: It depends who is in power and the direction of the political winds and pressures of the moment.  But let’s focus on that question as it relates to Medicare.

After reading the article by KNN staff writer Jay Hancock about spending and costs incurred by seniors with Medigap coverage, I find no shortage of irony and inconsistency on the part of the federal government.  What I find to be a “head scratcher” is the odd reaction of the government to their own policy. I call this the Medigap effect.  It makes Lawmakers and Presidential administrations behave in bizarre ways, proposing all kinds nonsensical solutions to problems they created in the first place.

It appears the government is concerned about seniors costing Medicare too much, but not the least concerned about having to “borrow” 716 billion dollars from Medicare Advantage set asides in order to help fund the ACA for the first 10 years.  Strike one against an argument that they care about long term sustainability of the program (access).  Seems like a cost thing again.

Remember, these supplemental “Medigap” plans are legal and sanctioned under CMMS. They are also marketed by some heavy hitters like AARP and United Healthcare because they are profitable (somewhat at taxpayer’s expense) for reasons other than the premiums they charge.  There are other players to be sure.

So, when it comes to medical care for senior citizens, does the government care more about coverage, costs or care access?  It can’t seem to make up its mind.  I guess the answer depends on whether you are cynic, a policy wonk or an idealist.  At best, the government’s position is a schizophrenic view; this is very apparent when it come to the Medigap Effect.   Could this be because Medicare (and Medicaid even more so) is flawed by design and wrongly implemented?  I believe the answer is yes, but that is a subject of another discussion. 

Let’s get back to the issue of this article, which is the cost of Medigap as it applies to the over-all Medicare program.

The article discusses a study done by economists from University of Texas and the University of Chicago: “Marika Cabral and Neale Mahoney who analyzed interstate metro areas where MediGap premiums varied significantly based on which state subscribers lived in.”  The article goes on to point out that …“Cabral and Mahoney focused on the disparities to measure how higher prices reduced demand for Medigap plans and how cross-border differences in Medigap use affected Medicare treatment and spending among similar populations.”

It appears federal officials, some members of congress from both parties and President Obama are “concerned” (emphasis mine) about over-utilization among Medicare recipients who purchase (often former employer-sponsored plans) supplemental Medigap coverage from private insurers, which basically cut to nearly zero their out-of-pocket cost sharing (if you don’t count the cost of the premium).  Implicit in paying to have insurance is the incentive to maximize the effect of the benefits, thus increasing the value to the individual subscriber.

Huh?  Now it appears they are mainly concerned with cost more than access.  I am confused, because wasn’t access and coverage the expressed intent of passing the ACA?  Kind of like Medicare for all.

Those with Medigap coverage incur on average 22.2% more Medicare-covered expenses than Medicare folks without Medigap “coverage” ~ thus costing Medicare about 22% more for their “care”.  “If someone has Medigap relative to not having Medigap, the public system is going to spend $1,396 more on them a year,” Cabral said in an interview.

It seems those folks have great access and all kinds of coverage.  Isn’t that the main goal?  Why all the hand-wringing by policy wonks in the administration and some in congress?

Now here is where it gets interesting and curious.  According to Hancock’s article, premiums for Medigap varied from about $1,000 per year in Vermont to about $1,500 per year in New York.  Turns out the costs for Medigap coverage are very wide depending on which state you live and even which zip code.  Premiums for Medigap policies can range between about $1000 per year to as much as $3000 per year.  Nationwide, the average median yearly cost looking at 10 standard plans is $1523.

Huh?  Looks like it should pay for itself.  But this is true only if the premium went straight to Medicare which is doesn’t. Apparently, the real costs to Medicare are 22% more per covered person ($1,396 more in absolute terms); in the form of extra services paid by Medicare.

This should not unexpected if you remember the purpose of the Medigap coverage, which is to indemnify against out-of-pocket expenses, deductibles and spend downs that are possible under standard Medicare.  Once those are met, the remainder of the bills go to Medicare.  It is basically insurance on top of insurance; a double-decker of insurance if you will.

This can be a very expensive way to obtain medical care, as we know from experience with the third-party model in primary care.  Under this situation, there would be no incentive NOT to incur costs being picked up by someone else.  I am not saying the utilization, thus the costs, were medically unnecessary or frivolous.  But, I suspect there is some indiscriminate over-utilization.  Remember, Implicit in paying to have insurance, is the incentive to maximize the effect of the benefits, thus increasing the value to the individual subscriber.

Hey, maybe the government is on to something here.  Could there really be a better way to provide care than Medicare, Medigap and Medi-whatever-third party-paid care?  Just a thought.

One criticism or caveat pointed out about the study was whether or not the 22% increase in costs were medically necessary.  I don’t think we can know this and it begs a more important question:  Who should decide what is medically necessary?  The answer is the stakeholders.

Now all we have to do is have the right stakeholders at the table, correct?  Well, is it any surprise that the main stakeholders in this kind of arrangement are neither the patient nor the doctor, but rather the government (CMS) and the insurance company?  This goes to my point about the system being flawed.  That is for a different discussion.

For now, let’s assume Medicare is just peachy.

One proposal to “limit” use of Medigap policies, and thus hold down Medicare costs, was to levy a tax on these policies to make them more expensive, thus less attractive to buy.  Since Medicare is funded by payroll taxes, why should we worry about cost unless it is spending more than it takes in?  The answer, of course, is that Medicare IS spending more than it takes in; and has promised more than it can deliver in the future.  This is a classic example of the unintended consequences of “benevolent” government programs that eventually lead to cost overruns, more taxes, lower reimbursements to doctors and hospitals, and rationing of services.

So once again, why would the government want to limit policies that increase access to health care???  Think, think… Yes!  I keep forgetting.  It is because of the costs associated with this type of over-insured prepaid care arrangement.  I am really glad the government is there to remind me of this truth.

In 1965, the feds created a situation by legislation/regulation that by default makes the government the de facto  single payer of medical services for seniors, essentially eliminating private sector mechanisms of funding as the primary source of medical care financing.  Here is the inconsistent part; the same government then attempts to control its own costs by taxing a product that its own policies help create.

So it really shouldn’t surprise us that the government, which has assumed the role of single payer for those over age 65, and the Medigap insurers that profit, would be at odds.  Isn’t it ironic that the same government that created and sanctioned “coverage” for seniors is now finding ways to discourage purchase and utilization of this same “benefit”?

Only a group of people that don’t concern themselves with the laws of economics, because they get to spend other people’s money, would come up with such an unsustainable plan.

I hope I am not the only one that sees this reaction as bizarre, wrong-headed and totally unnecessary.

The core problem with Medigap according to the government is the 22% ($1,396) of increased costs per Medicare enrollee that utilize Medigap coverage.  (I wish this was the main problem with Medicare).  So anyway, how do we deal with the increased costs of Medigap to the system?  Let’s assume there are better ways than the ridiculous tax plan that has been proposed.

We know that the average median national premium for supplemental coverage is about $1,500 and the average burden to Medicare is about $1,396 per covered person.  So the cost of insurance to the individual is a little more than the increased costs incurred by Medicare for those enrolled in Medigap plans.  You would think that considering those numbers, a compromise beneficial to both parties could be worked out.  Maybe part of the answer involves something that gives people incentives to keep and manage their own money, as opposed to spending it on insurance for something they may or may not need.

However, our current tax laws make that solution very unlikely.  Let’s examine how this might work with the proper incentives in place.

We know that the premiums (medical expenses) are an income deduction only IF a person itemizes their deductions.  Since many seniors are on fixed incomes or take limited distributions of IRA’s, many don’t itemize.  Instead, they take the standard deduction which means out-of-pocket medical expenses are not deductible.  Even if they do itemize, deductions must exceeds 7.5% of AGI to meet deductibility threshold.  Now consider the fact that is just an income deduction, not a tax credit.  This means that for a large percentage of seniors, they are paying 100% of the Medigap premium with after-tax money. For others, at best, they are reducing their tax bill by about 300 – $500, thus reducing the effective cost of the premium to about $1,000 to $1,200.

The answer:

Allow those that currently pay for Medigap coverage to self-fund with pre-tax dollars most of their own out-of-pockets with the money they would normally use to pay their premium. This could be accomplished with giving them an automatic above-the-line (before AGI) income deduction of the entire premium amount if it is deposited into a Health Savings Account or other designated tax-favored account for medical expenses. IRS rules should allow this account to be passed tax-free to the surviving spouse for same purposes.  Withdrawals for non-medical expenses should be permitted and subject to their marginal income tax rate for the year of the withdrawal, but no other penalty.

Problem solved:

The patient gets to keep more of their own money instead of spending it on premiums for a benefit they may or may not use.  They are allowed to pay out-of-pockets with pre-tax money.  They are free to shop for the best value for their money.  They can pass that sum on to their surviving spouse without tax consequences.  If need be, they can use the money for other expenses and pay the tax.  Studies show patients are more careful and price conscious when they spend their own money on medical care.  They tend to ask more questions about medical necessity and look for the best value.

Does this plan guarantee a savings for Medicare?  No, but it stands to reason if out-of-pockets are NOT prepaid in the form of premiums, then there will be more consideration given to price by the individual.   Overall, this should delay or obviate the need for Medicare benefits to kick in.  This is not the case with the Medigap model, which effectively insulates the subscriber from the effect of costs, making cost considerations irrelevant in the decision to seek certain treatment or testing.

People having access to their own tax-exempt money also opens up other means of obtaining alternative forms medical care that may not even involve Medicare billing, such as Direct Pay Primary Care or other providers that don’t accept Medicare. Can you imagine how much savings could be had by utilizing Direct Pay Primary Care models for routine medical care?

There are much better alternatives than taxing Medigap policies in the hope of getting less of them.  People will still find ways to get the care they need, so we should at least not penalize them for it.  We should, however, make it as easy as possible for them to spend their own money responsibly free of punitive tax ramifications.  This self-funded approach benefits the true stakeholders and encourages price transparency where there was no incentive to do so before.  And, it will likely save the government (taxpayers) a few bucks.

Based on our current fiscal calamity, you would think anything that would save Medicare money would be embraced; including going outside the system.  This would, of course, require giving people a degree of freedom with their own money that the government has thus far shown an aversion to. Who knows, we might even discover a better way to deliver and pay for primary care and routine outpatient services that don’t involve a third party!

Robert Nelson, MD

January 9, 2014