Medicare needs to impose some patient costsharing. Private Medicare supplementary insurance removes cost-sharing for as many as 78 percent of all elderly and disabled Medicare beneficiaries. The effect of this price distortion has been documented by numerous studies. Medicare supplements were associated with a 23.8 percent increase in spending for Medicare Part A and 24.3 percent for Part B. Part of this increase in Medicare spending could be due to "adverse selection," meaning that the individuals who purchase Medigap policies are sicker than those without Medigap. At first glance, this seems unlikely, because the elderly who purchase Medigap policies are younger and in better self-assessed health than those without supplements.
These findings do not, however, rule out the possibility that these individuals have unmeasured characteristics that are associated with greater need for medical care. Two studies have attempted to control for unmeasured selection into Medigap. First, Susan Ettner examined spending differences between elderly individuals without Medigap and those who got Medigap insurance through an employer. She argued that getting Medigap through an employer reduces the importance of individual selection. Her findings indicated that persons with "basic" Medigap coverage (that is, policies that do not cover prescription drugs or nursing home care) spent USD 281 more in Medicarereimbursed services in 1991 than those without Medigap. Policies with either prescription drugs or nursing home care or both were associated with USD 760 of additional Medicare reimbursement. Second, Adam Atherly used an econometric technique to model the choice of both individual and employer-provided Medigap plans. After correcting for unobserved selection into these policies, Atherly found that "individual supplemental plans without prescription drugs increased Medicare expenditures by USD 914 annually, while those with drugs increased Medicare expenditures by USD 491. Employer policies also increased Medicare.
Based on these results, it is clear that Medigap insurance removes price as a factor influencing the demand for medical care among elderly policyholders. Furthermore, once the Medigap policy has fulfilled Medicare's cost-sharing requirements, approximately 80 percent of the additional physicians' expenses and as much as 100 percent of the additional hospital expenses are paid by Medicare. According to Frech, "The most important immediate reform of Medicare would be to prohibit or discourage Medigap policies that fill in Medicare's cost-sharing." Therefore, at long last, let's get rid of private Medicare supplements.
The 2003 Medicare Modernization Act took a giant step in this direction by prohibiting Medigap plans from selling coverage supplementing the Medicare Part D drug benefit. As of January 1, 2006, no new "Medigap Rx policy" could be sold, issued, or renewed to Part D enrollees. This applied to individuals who were not enrolled, as well, except that continuation was permitted for those who purchased a Medigap Rx policy prior to that date.
One would be to end the current federal subsidy of Medigap premiums. Each time a patient with Medigap uses a covered Medicare service, approximately 80 percent of the cost after the statutory deductible for Part B and 100 percent of the cost after the deductible for Part A is paid by Medicare, leaving the Medigap plan to pay only the remaining amount. We suggested that Medigap premiums could be taxed by an amount equal to the effect of the Medigap policy on basic Medicare fee-for-service costs. A second way to end the subsidy would be to end Medigap insurance itself by requiring Medigap insurers to become comprehensive health plans that take financial responsibility for covering the full cost of basic Medicare benefits, just like Medicare HMOs. Those insurers could then sell any package of supplementary benefits they wished, at whatever premium the market would pay, but they would be responsible for 100 percent of the costs. This analysis still is relevant.
It might be argued that Medigap insurance would disappear on its own if we moved to a Medicare indemnity system because there would be no demand for covering deductibles and coinsurance if these were replaced by an indemnity. Patients might demand supplemental insurance, however, to cover the difference between the indemnity and their treatment costs under a "worst case" scenario. If a patient who purchased such a policy experienced a less-serious illness, he or she might decide to spend the whole indemnity, rather than cashing part of it, in order to qualify for additional subsidized spending under the supplementary policy. Any time we let the supplementary policy cover the same condition that is covered by the primary insurer, the supplement will create perverse incentives for overspending. Thus, while the demand for supplementary insurance to cover "front-end" expenses would presumably disappear under an indemnity system, the existence of supplementary insurance as secondary payer would continue to be a problem unless steps such as those outlined above were taken.
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