Medigap insurance drives up health-care costs

By Andrea Mustain     
June 17, 2014

From: Magazine

If you're a US resident aged 65 or older, you can get insurance to help cover the cost of sky-high health insurance deductibles and costly co-pays. This can help senior citizens on fixed incomes—and also drive up the cost of Medicare, the US government health insurance program for over-65s. 

About 86% of senior citizens with traditional Medicare have some kind of supplemental insurance to help cover the cost of copays and coinsurance for everything from hospital stays to imaging and testing. Some get it through former employers, while about 40% buy coverage through private insurance companies. This latter type of coverage is known in the industry and by people working on Medicare issues as "Medigap." 

Since such supplemental health insurance protects people from the real costs of medical care—acting as a sort of all-access pass at the county fair, as opposed to a pay-per-ride model—one might expect that people who have it would use more medical services. Indeed, research by Chicago Booth Assistant Professor Neale Mahoney and UT Austin's Marika Cabral confirms this is the case, at least for patients with Medigap.

The researchers looked at the medical services used by people who buy private Medigap insurance. They find that these people end up using $1,400 more in health services annually, and much of that additional spending is going toward services that are “more discretionary,” says Mahoney. People with the extra coverage typically have 42% more imaging and 74% more testing done than the average Medicare recipient. Mahoney and Cabral find that from 1999 to 2005, people with Medigap insurance cost Medicare 22% more than those without. 

Given the large impact of Medigap on Medicare spending, would it make sense to levy a tax on Medigap premiums? Mahoney notes that this idea has been proposed by White House advisors and the Brookings Institution, among others. The argument is that a tax would help offset the extra costs Medigap users incur and save some money for taxpayers, who foot the bill for Medicare—and it would provide “some kind of financial incentive to use care appropriately,” says Mahoney.  

Previous studies that compare spending for individuals who purchase Medigap versus spending for those who do not are limited by patients’ self-selection into Medigap: Is it Medigap that prompts the additional spending, or are the patients who purchase it less healthy or more prone to use more medical services? 

Mahoney and Cabral overcome this challenge by comparing Medigap numbers in areas that straddle state borders. In these areas, people can go to the same hospital, visit the same doctors, and incur the same medical costs, but pay vastly different Medigap premiums. The difference in Medigap premiums serves as a handy proxy for a tax, allowing the researchers to examine how two effectively identical populations act when one pays more for Medigap than another. 

The researchers point to the community surrounding Bennington, Vermont, as a prime example. The hospital there serves residents in Vermont, where Medigap costs $1,200 per year. The hospital also serves people who live just across the border in upstate New York, where Medigap costs $1,706 per year, 30% more thanks to the high cost of care in New York City. 

The researchers find that a tax on Medigap premiums would raise additional revenue and dissuade some people from buying Medigap in the first place. They calculate that a 15% tax, a figure suggested in President Obama’s 2013 budget plan, could save Medicare $12.9 billion a year.

As attractive as those savings sound, Mahoney says a Medigap tax is just one suggested way to deal with ballooning costs of Medicare. Medigap is popular because Medicare recipients face real financial worries. There are no yearly or lifetime caps on out-of-pocket costs, and a long hospital stay can eat up savings. “We encourage conversation about lots of different ways of reforming the system,” he says.

Work cited

Marika Cabral and Neale Mahoney, "Externalities and Taxation of Supplemental Insurance: A Study of Medicare and Medigap," Working paper, December 2013.