Reduce Medicare Costs by Changing the Cost-Sharing Structures for Medicare and Medigap Insurance

In Medicare's traditional fee-for-service program--that is, services covered under Part A (primarily hospital and post-acute care) and Part B (physicians' and other outpatient services)--enrollees' cost sharing varies significantly depending on the type of service provided. For example, enrollees must pay a Part A deductible, which the Congressional Budget Office estimates will be $1,184 in 2013, for each "spell of illness" or injury for which they are hospitalized; in addition, enrollees are subject to substantial daily copayments for extended hospital and skilled nursing care. Meanwhile, the annual deductible for outpatient services covered under Medicare's Part B is estimated to be $163 in 2013. Beyond that deductible, enrollees generally pay 20 percent of allowable costs for most Part B services, but cost sharing is higher for some outpatient hospital care. At the same time, certain services that are covered by Medicare, such as home health visits and laboratory tests, require no cost sharing at all. As a result of those variations, enrollees lack consistent incentives to weigh relative costs when choosing among options for treatment. Moreover, if Medicare patients incur extremely high medical costs, they may face a significant amount of cost sharing because the program does not place a limit on those expenses.

Because the cost-sharing requirements in Medicare's fee- for-service program can be substantial, about 90 percent of enrollees obtain supplemental coverage. About 15 percent of fee-for-service enrollees have Medicaid coverage as well, and about 40 percent also have coverage through an employer. About another 30 percent of fee-for-service enrollees buy medigap policies--individual insurance policies that are designed to cover most or all of Medicare's cost-sharing requirements. Studies have found that medigap policyholders use about 25 percent more services than Medicare enrollees who have no supplemental coverage and about 10 percent more services than enrollees who have supplemental coverage from a former employer (which tends to reduce, but not eliminate, their cost-sharing liabilities). Those differences probably arise in part because of the incentive effects of cost sharing and in part because of differences in health status and attitudes toward health care. Because Medicare enrollees with supplemental coverage are liable for only a portion of the costs of those additional services, it is taxpayers (through Medicare) and not supplemental insurers or the policyholders themselves who bear most of the resulting costs. Federal costs for Medicare could be reduced if medigap plans were restructured so that policyholders faced some cost sharing for Medicare services but still had a limit on their out-of-pocket costs.

This option presents three alternatives to reduce Medicare costs by modifying the cost sharing that Medicare beneficiaries face. The first alternative would replace Medicare's current mix of cost-sharing requirements with a single combined annual deductible of $550 covering all Part A and Part B services, a uniform coinsurance rate of 20 percent for amounts above that deductible (including inpatient expenses), and an annual cap of $5,500 on each enrollee's total cost-sharing liabilities. If this option took effect on January 1, 2013, and the various thresholds were indexed to growth in per capita costs for the Medicare program in later years, federal outlays would be reduced by about $13 billion over the 2012-2016 period and by about $32 billion over the 2012-2021 period.

The second alternative would bar medigap policies from paying any of the first $550 of an enrollee's cost-sharing liabilities for calendar year 2013 and would limit coverage to 50 percent of the next $4,950 in Medicare cost sharing. (All further cost sharing would be covered by the medigap policy, so enrollees in such policies would not pay more than about $3,025 in cost sharing in that year.) If this option took effect on January 1, 2013, and the various thresholds were indexed as specified in the first alternative, federal outlays would be reduced by about $20 billion over the 2012-2016 period and by roughly $53 billion over the 2012-2021 period.

The third alternative combines the restructuring parameters for the first two. Therefore, medigap plans would be prohibited from covering any of the new $550 combined deductible--which would apply to both Part A and Part B of Medicare's fee-for-service program. Under this combined option, the level of beneficiary spending at which the medigap policy's cap on out-of-pocket costs was reached would be equal to the level at which the Medicare program's cap was reached. For spending between the deductible and the cap on the out-of-pocket expenditures, medigap policyholders would face a uniform coinsurance rate of 10 percent for all services; Medicare beneficiaries without other types of supplemental coverage would face a uniform coinsurance rate of 20 percent for all services. If this option took effect on January 1, 2013, and the various thresholds were indexed to growth in per capita costs for the Medicare program in later years, federal outlays would be reduced by about $35 billion over the 2012-2016 period and by roughly $93 billion over the 2012-2021 period. Those savings do not equal the sum of the savings that would result from the first two alternatives because of the interactions between their effects.

An argument in favor of this option is that it would appreciably strengthen incentives for more prudent use of medical services--both by raising the initial threshold of health care costs that most Medicare beneficiaries face and by ensuring that more enrollees pay at least a portion of all subsequent costs up to the out-of-pocket limit. Because medigap plans would be barred from paying the first $550 of an enrollee's cost-sharing liabilities (under the second and third alternatives), the costs borne by medigap plans would decrease, and therefore so would the premiums that the medigap plans charge. Another argument in support of this option is that it would provide greater protection against catastrophic costs. Capping enrollees' out-of-pocket expenses would especially help people who develop serious illnesses, require extended care, or undergo repeated hospitalizations but lack supplemental coverage for their cost sharing.

An argument against the option is that it would boost cost-sharing liabilities for most Medicare enrollees. Another argument against the option (specifically, under the second and third alternatives) is that the restructuring of medigap coverage would mean that people would not be able to purchase policies with the low levels of cost sharing for which they have revealed a preference in the past. Even with the new cap on out-of-pocket expenses, some enrollees would object to any policy that denied them access to full supplemental coverage for their cost sharing. Furthermore, in any given year, some enrollees would see their combined payments for premiums and cost sharing rise.