Medigap Increases Medical Consumption and Drives Up Costs—Study

Medicare enrollees who purchase Medigap insurance spend an average of $2,300 more annually on health care than those who don’t, according to the authors of a Michigan Retirement and Disability Research Center (MRDRC) study.

In an MRDRC working paper titled “Insurance Purchases of Older Americans,” funded by the U.S. Social Security Administration (SSA), University of Michigan researchers examined why older Americans purchase Medigap insurance to pay for medical costs not covered by Medicare. The study found no evidence the higher spending is caused by adverse selection of the less healthy in the insurance market and only modest evidence that crowd-out and behavioral factors are significant. On the contrary, the study found Medigap purchasers tend to be healthier than those who do not carry the additional coverage, which indicates higher spending is not related to greater need due to poorer health.

The results are consistent with the view higher spending is caused by a moral hazard driven by the lower out-of-pocket costs for additional care faced by those with Medigap, state the authors.

Data Sources

The primary data source for the study was Health and Retirement Study (HRS) survey data linked to restricted administrative Medicare and Medicaid records, which provide information on health care spending and out-of-pocket medical payments.

A secondary data source was the Medical Expenditure Panel Survey (MEPS), which was used to impute medical payments from other sources, including those made by Medicare Part C, private insurers, and other smaller payors such as the Veterans Administration and state or local health departments.

The HRS is a nationally representative biennial survey of the over-50 U.S. population and their spouses, while the MEPS is a nationally representative survey of non-institutionalized households.

Medigap Premium Costs

Medigap premiums range from $50 to more than $300 monthly depending on such factors as tobacco use, health issues, gender, location, and age, while most Medicare Part B users pay a monthly premium of $174.40.

The study found that for Medicare recipients on a fixed income, the additional cost of Medigap results in Medicare users often either moving to Medicaid or defaulting on outstanding medical expenses in the event of costly or catastrophic medical conditions. While some financial advisors cast the purchase of Medigap as the fiscally responsible option, that may not be true.

‘People Tend to Over-Consume’

Medigap can make enrollees oblivious to the cost of care, says John C. Goodman, president of the Goodman Institute for Public Policy Research and co-publisher of Health Care News.

“Most health economists have never had a good word to say about Medigap insurance,” said Goodman. “By law, it has to cover the deductibles and coinsurance in regular Medicare. This means medical care is essentially free to Medicare enrollees who also have a Medigap plan.”

There tends to be waste when goods and services are provided free, says Goodman.

“When you remove the financial incentives to be economical in the consumption of medical care, people tend to over-consume it,” said Goodman. “They obtain medical services they would not have obtained if they had to pay full price. There is a great deal of waste in the health care system. Some observers think one of every three dollars is wasteful. Medigap insurance contributes to that waste.”

A Moral Hazard

The tendency to take greater risks, known as “moral hazard” because the primary agent suffers no penalty for making a bad choice, is complicated when it comes to Medigap, says Robert Klein, an independent Medicare and long-term care consultant who is a policy advisor to the Heartland Institute, which publishes Health Care News.

“I will argue that the moral hazard with Medicare is based on two key issues,” said Klein. “First, Medicare B is grossly underfunded. The premiums one pays when enrolled cover about 25 percent of the actual cost. Second, in the case of Medicare Advantage (MA), too many policies have too low of a premium or are premium-free. They also reimburse providers much less than Medigap.”

As a result, MA provider networks are becoming narrower and there are fewer choices of plans, says Klein.

“Older, sicker people cannot switch,” said Klein. “More providers will drop out of accepting Advantage. The simple answer is that government involvement often distorts markets and encourages bad behavior. Medicaid was supposed to be a safety net for the poor and disabled, not a planning tool when you screw up.”

‘More Skin in the Game’

Klein says over-reliance on government-sponsored health insurance is a problem that needs to be remedied.

“Insured persons should be in the position of being better consumers by understanding that insurance is not supposed to cover you from the first dollar of a loss,” said Klein. “Insurance exists to cover risks you cannot absorb.”

Seniors in traditional Medicare who purchase supplemental insurance will face higher premium payments, but have more choice of providers than MA enrollees, says Klein.

“What is likely to happen here is premiums for Medigap will continue to rise but those with Medigap will likely have better choices for services,” said Klein. “A good solution here is to look into high-deductible Medigap Plans—have some more skin in the game with a deductible but offset it with low premiums.”

Kevin Stone (kevin.s.stone@gmail.com) writes from Arlington, Texas.

Internet info:

Karolos Arapakis, Eric French, John Bailey Jones, and Jeremy McCauley, “Insurance Purchases of Older Americans,” Working Paper 2023-463, Michigan Retirement and Disability Research Center of the University of Michigan: https://mrdrc.isr.umich.edu/publications/papers/pdf/wp463.pdf