essays in public finance and industrial organization a dissertation ...

CHAPTER 3. MEDIGAP 118
of a primary insurance policy can affect total utilization, imposing a fiscal externality
on the provider of the primary insurance product.
This paper estimates the effect of private supplemental Medigap insurance on pub-
lic Medicare spending. Medicare is the primary insurer of elderly Americans, covering
about 70 percent of the care they receive. To insure against the remaining costs, most
Medicare beneficiaries (91 percent) hold some form of supplemental insurance, which
reduces out-of-pocket financial risk but also blunts the cost-sharing requirements of
Medicare that are designed to limit utilization.
To identify the effect of Medigap supplemental insurance on total utilization, we
construct an instrument that leverages discontinuities in Medigap premiums at state
boundaries. Medical costs, and thus the costs financed through supplemental Medi-
gap insurance, exhibit considerable within-state variation due to factors ranging from
household incomes to local physician practice styles to the supply of medical resources.
Yet despite this local variation, within-state variation in Medigap premiums is very
limited (?). This means that on opposite sides of state boundaries, otherwise identical
individuals who belong to the same hospital catchment area can face very different
Medigap premiums solely due to Medicare costs in other parts of their states. Our
empirical strategy uses this exogenous premium variation—and the corresponding
exogenous shift of individuals in and out of Medigap coverage—to identify the pre-
mium elasticity of Medigap demand and the causal effect of Medigap on total medical
spending.
The effect we identify is of substantial policy relevance. The high level and growth
rate of Medicare spending makes it a primary concern of long-run US federal budget
experts (?). Because of this, mechanisms that increase costs and the corresponding
policies that could be used to address these rising costs are attracting close atten-
tion. However, as we discuss below, the current estimates of the effect of Medigap are
biased due to selection on unobservables. This bias means that previous estimates
may not reflect the behavioral responses to typical policies, such as a tax on Medi-
gap premiums. Our approach overcomes these shortcomings allowing us to explore
economically meaningful policy counterfactuals.
In addition to the direct relevance for Medicare and Medigap policy, our study may