Statement of Christopher Hogan, Ph.D., President,
Direct Research, LLC, Vienna, Virgina

Testimony Before the Subcommittee on Health
of the House Committee on Ways and Means

Hearing on the Strengthening Medicare: Modernizing Beneficiary Cost Sharing

May 9, 2001

Madam Chairwoman and members of the subcommittee, my name is Christopher Hogan. I'm an economist familiar with the issues of coverage and cost in the Medicare program, having worked almost 10 years on the staff of the Medicare Payment Advisory Commission and the Physician Payment Review Commission. Currently, I am an independent consultant in the area of health services research.

I was asked to talk about the impact of secondary insurance on Medicare beneficiaries' use and cost of services. In the next five minutes, I'd like to make a few points about this, then sketch some possible policies you might pursue. First, I'd like to talk about the impact that secondary insurance has on Medicare program costs. Second, I'd like to talk about some of the beneficiary-oriented aspects of secondary insurance, including impact on use of care. Finally, I'd like to sketch out some potential policy directions you might consider in this area.

The first fact for this discussion is that almost no one actually pays fee-for-service Medicare's copayment and deductible amounts in full. Analysts may quibble about the exact fraction of the Medicare population that has only fee-for-service Medicare and no secondary insurance, but everyone will agree that this fraction is small, on the order of 10 to 15 percent of all non-institutionalized Medicare beneficiaries. The rest have employer-sponsored coverage, individual purchase Medigap, Medicaid, Medicare+Choice, some other coverage or some combination of the above.

Medigap plans by design typically provide first-dollar or very nearly first-dollar coverage, filling in those copayment amounts completely. Employer-sponsored coverage is more of a mixed bag and can be coordinated with Medicare in a variety of ways, but it is increasingly typical for employer-sponsored coverage to fill in only part of Medicare's copayment and deductible amounts. For example, beneficiary financial liability might be limited to the amounts that the employers' policy specifies for active workers.

The second major point I would like to stress is that by filling in Medicare's copayments and deductibles, secondary insurance raises the costs of the Medicare program substantially. Common sense suggests that individuals are more likely to use care if it is free (although "pre-paid" is a better description than "free"). The empirical evidence of this effect is very solid. Numerous researchers using a variety of data sources, methods, populations, and time periods have all shown that removing deductibles and copayments from an unrestricted fee-for-service health plan substantially increases health care use.

This is not news. In addition to research stretching back at least as far as 1972, the impact of secondary insurance on Medicare program costs has been reported by legislative-branch agencies including the Congressional Budget Office and the Physician Payment Review Commission. In fact, the last few years of CBO Budget Options books have included options for restructuring Medicare's copayments and deductibles and for reducing the impact of secondary insurance on Medicare program costs.

Even though there is no particular account or line-item labeled "additional Medicare spending due to secondary insurance", the evidence is so strong that it is not really worth discussing whether or not secondary insurance raises Medicare's costs. Ask any actuary.

We could have some reasonable disagreement on exactly how much the presence of secondary insurance adds to Medicare's costs. The estimates of impact are all based on statistical analyses, and I'm sure that some of you agree with Mark Twain's assessment of statisticians. On a more serious note, we can question whether the statistical analysis adequately controls for factors affecting spending, such as age, health status, income, education and the like. Most analyses of this issue suggest that beneficiaries with secondary insurance cost anywhere between 15 and 30 percent more than beneficiaries with no secondary insurance, after accounting for the factors listed above.

In round numbers, an additional $1,000 per beneficiary per year is a good figure to use when discussing the magnitude of the effect of secondary insurance on the costs of the Medicare program. That's not very precise but it is about the right size, which I think correctly characterizes the literature on the effect of secondary insurance on Medicare costs.

Most analyses also find that Medigap coverage raises Medicare costs somewhat more than does employer-sponsored coverage. The assumption is that this is a result of the copayment structure: Medigap coverage tends to be first-dollar coverage, but some substantial portion of employer sponsored coverage requires some (reduced) beneficiary copayments. That is a plausible explanation but there is not enough detail in available data sources to provide an easy, direct test of this assumption.

Beyond the issue of costs, filling in the deductibles and copayments of fee-for-service Medicare also affects the ability to modernize and improve the traditional Medicare program. Private insurance in many market areas evolved via the PPO model, where individuals are offered modest financial incentives to use preferred providers. Currently, this is the most popular approach for health insurance for the working population. Properly done, modestly higher copayments for out-of-network use are not coercive or hugely restrictive. Instead, subscribers who have no strong preferences about using any particular provider are channeled toward the plan's preferred providers.

Traditional Medicare, by contrast, cannot evolve via that PPO model. Modestly lower copayments for use of preferred providers simply will not work in Medicare because almost no beneficiaries actually pay those copayments in the first place. Medigap plans themselves can adopt this approach (as in Medicare Select), but the Medicare program does not have these financial levers in its control. This tends puts the traditional Medicare program into an evolutionary dead end. It is, to some approximation, an unrestricted fee-for-service program with no copayments or deductibles and no easy path for moving toward alternative approaches to financing care.

Turning now to the beneficiaries, the first fact to absorb is that beneficiaries without secondary insurance are, on average, poorer, more likely to be minority race, and in worse health than the rest of the Medicare population. They can reasonably be characterized as not poor enough for Medicaid, not having had a good enough job to get employer-sponsored coverage, and not well-enough off to want to purchase Medigap. Roughly speaking, the lack of coverage appears driven more by wealth than by health. The disabled (under-65) are also disproportionately represented in this group.

It is worth noting that the cost-increasing effects of secondary insurance are therefore substantially regressive. Medicare costs (and hence the Part B premium) are inflated by better-off beneficiaries who have some secondary insurance. Those without secondary insurance have far lower use of service, but pay a Part B premium that largely reflects the high use of those with complete insurance coverage. In effect, they pay a share of the high costs incurred by better-off, fully-insured beneficiaries.

The second fact to consider is that beneficiaries without secondary insurance consume less of all types of health care services. This includes things that are generally viewed as "good" care, such as preventive services. For five preventive services that can easily be tracked in the 1997 Medicare Current Beneficiary Survey (some physician visit during the year, flu shot, pneumonia shot, mammogram, pap smear), beneficiaries with no secondary insurance had lower use of every service, with use rates ranging from 13 to 30 percent lower than beneficiaries with employer-sponsored or Medigap coverage. (Those use rates were adjusted for differences in age, gender, race, income, health status, and self-reported presence of diseases.)

It is inherently difficult to demonstrate whether or not this has an impact on beneficiaries' health. The definitive study of this issue for the under-65 population was the RAND National Health Insurance Experiment. The conclusion from that research (summarized in the book Free for All by Joseph Newhouse and colleagues) was that modest copayments did not noticeably reduce health status, with the substantial exception of low income individuals with mental health problems. For the Medicare population, the research is less clear-cut. One study found that individuals without secondary insurance were more likely to move from no disability to some disability (limitation on activity of daily living) over a two-year period, but that the progress to higher levels of disability beyond that occurred at the same rate regardless of secondary insurance coverage. In other studies, some have found no differences in outcomes for specific diseases such as cancers, others have found differences in treatment and outcome.

The third relevant fact about beneficiaries and secondary insurance is the strong desire for complete (first-dollar) coverage, to the point of behavior that economists would label irrational or inefficient. Beneficiaries will indeed pay more than $100 to insure the cost of the Part B deductible. Prior to 1990, in the rare instances when beneficiaries were offered inexpensive catastrophic-only Medigap or expensive first-dollar Medigap, few individuals opted for the catastrophic-only plans. After 1990, faced with standardized Medigap products with wildly varying prices, almost no beneficiaries shopped and switched insurers. In a 1996 report, the GAO estimated that, of individuals owning Medigap policies in 1991 and alive in 1994, only about 1 percent had switched insurers over that three-year period. I do not know whether shopping for policies remains as rare in the Medigap market now as it was then.

The point here is that if you expect beneficiaries to engage in what economists would like to think of as reasonable, rational, efficient behavior toward Medigap coverage, you will be sorely disappointed. Behavior in the Medigap market does not suggest that beneficiaries typically act as cost-minimizing rational shoppers. Instead, behavior far more strongly suggests that beneficiaries want first-dollar coverage regardless, and that once they have it they do not want to change coverage.

Allow me to summarize the points in the presentation so far, then to describe some potential directions for policy.

• Only 10 to 15 percent of beneficiaries have fee-for-service Medicare with no secondary insurance.

• Secondary insurance fills in Medicare's deductible and copayment liabilities, increases use of services, and raises Medicare's costs substantially. A reasonable round number for discussion is that secondary insurance raises Medicare outlays by around $1,000 per beneficiary per year.

• Those without secondary insurance tend to be poorer, in worse health, and are more likely to be minorities.

• Individuals without secondary insurance use less of all types of care, including "good" preventive services. It is difficult to say empirically whether their health does or does not suffer as a consequence of that.

• Behavior in the market for Medigap insurance reveals a strong apparent preference for first-dollar insurance coverage and little evidence of price-shopping.

Given these observations on the Medicare beneficiaries' secondary insurance, what types of policy options could you reasonably consider? Several years ago I engaged in discussions of fairly radical approaches in this area, both at the Physician Payment Review Commission and in testimony to the National Bipartisan Commission on the Future of Medicare. These proposals included banning or taxing Medigap, or requiring Medigap insurers to be come full-risk plans under Medicare+Choice. My impression from that earlier experience was that even if the potential cost and cost savings are as exactly as stated above, few would be willing to risk the disruptions that such radical changes might create. Based on my earlier experience, I will limit my suggestions in this testimony to more incremental approaches that would not eliminate Medigap insurance.

Discussion of the issues centers around which concerns you are trying to address. Is your interest on the cost-increasing effects of secondary insurance? Is your concern with the well-being of the 10 to 15 percent who have no secondary coverage? Or is concern on the high prices that beneficiaries and employers must pay to obtain that secondary insurance coverage?

First, I would like to draw your attention to the February 2001 CBO Budget Options book, where there is a short discussion of budget-neutral restructuring of Medicare's copayment and deductible liabilities. In particular, they show a restructuring that would provide maximum out-of-pocket protection for Medicare beneficiaries and generate some small cost savings for Medicare. Nothing is free: in order to provide a stop-loss provision of $2,000, the CBO option would require a combined A/B deductible of $1,000 and a 20 percent copayment for all care above the deductible. So, discussion can start from that basis. It is absolutely feasible to limit beneficiaries' total out-of-pocket costs for Medicare-covered services to $2,000 annually, in exchange for higher payments for care below that catastrophic cap.

A second option would be to try to offer some sort of advantage to that 10 to 15 percent of beneficiaries who have no secondary insurance coverage. It would certainly be fair to offer them a lower Part B premium, since their spending is substantially below that of other beneficiaries. From an actuarial standpoint, that's reasonable. From an operational standpoint, having beneficiaries sign up for this, certify that they don't have secondary insurance, and receive a reduced or zero Part B premium in response is likely to be a difficult system. Hence, this option probably has more theoretical than practical merit.

A third option focusing on those without secondary insurance would be to eliminate Medicare copayment liabilities on selected preventive services. For example, if good health care requires that beneficiaries see a doctor at least once a year, then Medicare could make that first office visit free. This type of approach is likely to have a very high cost per net new preventive service delivered. Not only would it make services free for the vast majority of beneficiaries who have secondary insurance, research shows that most beneficiaries will not obtain preventive care at the recommended rates even when it is free. Thus, the likely cost per additional preventive service actually delivered to those without secondary insurance is likely to be high.

A fourth option would be to take a new benefit design and impose it on the Medigap industry, either for existing policies or, more likely, for all newly-issued policies. For example, first dollar coverage could be replaced by a low and simple copayment structure (e.g., $10 per office visit), while again certain key items of preventive care might be covered in full. This would not achieve the technical efficiencies potentially available in a federally-run alternative (such as paperwork reduction and elimination of overhead costs), but would not displace the current private-sector providers of such insurance. Applying the restructured benefits only to newly issued policies would avoid disrupting Medigap insurers' ongoing lines of business.

In any revised Medigap benefit structure, there has to be some caution about paperwork burden relative to amounts collected. The cost of the paperwork for small copayment amounts may exceed the cost of the copayments. The current first-dollar Medigap system typically results in two financial transactions per service when the Medigap insurer's systems are coordinated with Medicare's. There is a large payment from Medicare to the provider, and a smaller payment from the Medigap insurer to the provider, with the Medicare carrier passing along the bill for the copayment directly to the Medigap insurer. Adding yet a third, even smaller payment directly from the beneficiary to the provider may increase the overall administrative burden of the system unless that payment is very simply structured and is routinely handled at the time of the service, such as a flat $10 copayment per visit.

Finally, I would like to mention an option that was developed in the mid-1990s by the American Medical Association. They proposed a plan that amounted to a prepaid, refundable deductible for Medicare, in effect creating a small Medical Savings Account (MSA) within Medicare for each beneficiary. Beneficiaries would pay an additional monthly premium of (say) $80 to Medicare. All Medicare copayment and deductible liabilities for the year below $960 (80 x 12) would be paid from this pre-funded amount, with no paperwork burden involved. Beneficiaries with under $960 in copayment/deductible liabilities would receive a refund at year-end (similar to an MSA). Those with copayment/deductible liabilities in excess of this amount would pay them as in the current Medicare program. Secondary insurers would be free to cover copayment/deductible liabilities in excess of this $960 limit, but would never see anything below the $960 limit. Employers or others would be free to pay the beneficiary's $80 monthly premium. In effect, this proposal would take the first $960 of current copayment and deductible liabilities and simply make them off-limits to secondary insurers, handling them internally within Medicare instead.

This proposal provides a potential efficiency-versus-equity tradeoff. On the efficiency side, it reduces but does not eliminate the role of secondary insurers and the paperwork burdens from copayment/deductible liabilities. The potential for a rebate provides incentive to constrain use of care (as in an MSA). (If third parties paid the monthly premium and collected any year-end rebate, that would nullify incentives for reduced use of care.) But like the MSA proposal, this approach reduces pooling of risks. Healthy beneficiaries would pay the least and those with high use of care would face an effective $960 deductible, plus any copayment liabilities incurred excess of that (if any). The overall tolerance for this efficiency-versus-equity tradeoff could be fine-tuned by lowering or raising the amount of the prepaid, refundable deductible.

In conclusion, there are few obvious alternatives for restructuring Medicare copayments, liabilities, and secondary insurance. First-dollar coverage from secondary insurance raises Medicare costs and is probably not the most efficient way to structure payment. Yet, beneficiaries' demand for Medigap reveals a strong desire for such coverage. Reworking Medigap to require small copayments for each service would likely be unpopular and might increase paperwork burden disproportionate to the amounts of money involved. As CBO has demonstrated, we could restructure Medicare rather than restructure Medigap, protecting beneficiaries from catastrophic costs at the expense of higher payments from non-catastrophic users. A final alternative that seems plausible is to create, in effect, a mini-MSA for the first few hundred dollars of Medicare copayment/deductible liabilities. This might allow some reductions in overhead and paperwork burdens (and possibly some reduction in service use) without eliminating the private provision of secondary insurance.