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CHAPTER 3. MEDIGAP 122
3.2 Background
Medicare is the government health insurance program for elderly, covering nearly
all individuals 65 and older in the United States. In 2008, Medicare covered 44
million beneficiaries at a cost of $468 billion, accounting for about 13 percent of
government expenditure and 3.2 percent of GDP. By 2025, Medicare is projected to
cover 71 million beneficiaries, consuming 20 percent of government expenditure and
5.5 percent of GDP. 7
Medicare beneficiaries choose between publicly administered traditional fee-for-
service (FFS) insurance coverage and Medicare Advantage policies, private insurance
plans with premiums subsidized by Medicare. 8 The majority (88 percent) of Medicare
beneficiaries have FFS coverage. This coverage allows beneficiaries their choice of
doctor and the ability to see a specialist without a referral. To control costs, fee-
for-service Medicare uses cost-sharing, exposing beneficiaries to about 20 percent of
the cost of care received on the margin. A key feature of traditional Medicare is
that there is no annual or lifetime out-of-pocket maximum amount that a beneficiary
will pay, so individuals are exposed to significant financial risk. Traditional Medicare
cost-sharing instruments for 2000 and 2005 (the first and last years of our sample)
are shown in Table 3.1.
To protect against the financial risk of traditional Medicare, the vast majority
(91 percent) of beneficiaries carry supplemental insurance. Some beneficiaries obtain
supplemental insurance through a former employer, poor beneficiaries may qualify for
supplemental insurance through the government sponsored Medicaid program, and
everyone else has the option to purchase private Medigap coverage. Medicare Ad-
vantage is an alternative to traditional fee-for-service Medicare that is available to
many beneficiaries. 9 These private insurance policies are subsidized by Medicare, and
7 Percent of GDP numbers are gross of premiums; percent of budget numbers are net (Annual
Report of the Boards of Trustees of the Federal Hospital Insurance and Federal Supplementary
Medical Insurance Trust Funds, 2010; Analytical Perspectives: Budget of the U.S. Government,
2010).
8 We will refer to Medicare Part C as Medicare Advantage in this paper, although this option was
called Medicare + Choice during the beginning of the period we analyze.
9 Although Medicare Advantage beneficiaries can technically sign up for Medigap policies, this is
discouraged by Medicare and individuals do not seem to do this in practice. Medicare Advantage