Standardized Choices: Medigap Lessons for Medicare Part D

CRS Report for Congress
Standardized Choices: Medigap Lessons for
Medicare Part D
March 8, 2006
Jim Hahn
Analyst in Social Legislation
Domestic Social Policy Division

Congressional Research Service ˜ The Library of Congress

Standardized Choices: Medigap Lessons for
Medicare Part D
Summary
The Medicare Prescription Drug, Improvement and Modernization Act of 2003
(P.L. 108-173, known as “MMA”) created a new Medicare outpatient prescription
drug benefit. With the rollout of the full benefit in January 2006, beneficiaries face
a large number of choices from numerous insurers offering multiple plans with
different benefits. A similarly complex array of choices in the private supplemental
Medicare insurance (Medigap) market was one of the factors leading to the Medigap
provisions in the Omnibus Budget Reconciliation Act of 1990 (P.L. 101-508, OBRA

90) and the Social Security Act Amendments of 1994 (P.L. 103-432, SSAA 94).

The Medigap reforms addressed the problems in the market by: (1) simplifying
choices, (2) promoting competition as a means to hold down premium increases, and
(3) providing consumer protections. To reduce the variation and number of products
in the market, OBRA 90 limited insurers to selling ten standardized policies with
precisely defined benefits.
The ten standardized policies simplified price comparisons and decision making
for Medicare beneficiaries and led to a consolidation in the market with fewer
products and sellers, however some problems remained. Premium increases
continued, critics expressed dissatisfaction with the range of offerings, claiming that
the limited choices did not fully meet the needs of some beneficiaries, and confusion
persisted in some of the dimensions that were not addressed by the Medigap reforms,
for instance in the methodology used to calculate premium increases over time.
There are several differences between the Medigap experience and Medicare
Part D when considering whether standardizing benefits might yield improvements
in the Part D market. In contrast to Medigap, Medicare Part D is new and the market
is likely to change dramatically in the coming years. Many observers expect that the
Medicare Part D market will consolidate in subsequent years, both in the number of
carriers and the number and scope of products offered, as carriers learn which
products are most attractive to Medicare beneficiaries and which ones are profitable.
A strong federal presence in Medicare Part D and the additional complexities of a
prescription drug benefit when compared to a supplemental insurance product also
suggest that the experiences might not be entirely similar. Consequently, the policy
decision should include considerations about not only whether and how to
standardize benefits but also when to do so.

Contents
Medigap .........................................................1
Background ..................................................1
OBRA 90 and SSAA 94........................................2
Result of Reforms.............................................3
Continuing Problems...........................................3
Decision Making and the Number of Choices ...........................5
Standardization Options for Medigap and Medicare Part D.................7
Differences Between Medigap and Part D Experiences...................10
Market Maturity..............................................10
Strong Federal Role...........................................12
Transitional Nature of the Prescription Drug Market.................12
Standardization Issues.........................................13
List of Figures
Figure 1. Average Loss Ratios for All Medigap Policies, 1990-2000.........4
Figure 2. Distribution of Medigap Plans, 1999...........................5
List of Tables
Table 1. Use of Cost-Sharing Tiers in Medicare Part D Plans...............9
Table 2. Summary of Prescription Drug Plan Offerings Across Regions......11

Standardized Choices: Medigap Lessons for
Medicare Part D
The Medicare Prescription Drug, Improvement and Modernization Act of 2003
(P.L. 108-173, known as “MMA”) created a new Medicare outpatient prescription
drug benefit. With the rollout of the full benefit in January 2006, beneficiaries face
a large number of choices from numerous insurers offering multiple plans with
different benefits. A similarly complex array of choices in the private supplemental
Medicare insurance (Medigap) market was one of the factors leading to the Medigap
provisions in the Omnibus Budget Reconciliation Act of 1990 (P.L. 101-508, OBRA

90) and the Social Security Act Amendments of 1994 (P.L. 103-432, SSAA 94).¹

This report highlights the lessons learned from the Medigap experience and how they
might provide insight into the current Medicare Part D market.
Medigap
Background
The history of Medigap is noteworthy for its lessons in federal regulatory
intervention in health insurance markets. Medigap plans have been in existence since
the 1970s and have been sold by hundreds of insurance companies.² However,
dissatisfaction with the Medigap market grew substantially over the years.
Beneficiaries complained of marketing abuses by companies and agents, where
Medicare beneficiaries were sometimes sold multiple Medigap plans or plans that
duplicated coverage that they already had through retiree health plans. Other plans
offered very little value. The multiplicity of offerings from numerous carriers also
led to a confusing array of Medigap product choices for beneficiaries. High premium
increases compounded the dissatisfaction and Congress responded to complaints of
marketing abuses, high pressure sales practices, fraud, and a confusing array of
choices by passing laws that set restrictions on the Medigap market.
Prior to 1980, states were solely responsible for regulating Medigap but this
changed when Congress enacted Public Law 96-265. Section 507(a), known as the
“Baucus Amendment,” responded to widespread public dissatisfaction by
establishing voluntary certification standards designed to encourage states to enact
legislation that incorporated basic requirements established by the National

¹ For additional information about Medigap, see CRS Report RL31223, Medicare:
Supplementary ‘Medigap’ Coverage, by Jennifer O’Sullivan.
² National Association of Insurance Commissioners, 1990 Loss Ratios for Medicare
Supplemental Insurance, Kansas City, MO, 1992.

Association of Insurance Commissioners (NAIC). Medigap policies were required
to meet minimum benefit package requirements, return a minimum portion of
premiums to beneficiaries in the form of benefits (called a loss ratio), and comply
with various disclosure provisions, including providing a consumer guide and outline
of benefits to prospective policyholders.³
Although the Baucus Amendment achieved many of its goals, there continued
to be a large number of products sold in this market as there were no limits on how
many and what type of benefits could be offered in excess of the minimum
standards.⁴ Beneficiaries found it difficult to comparison shop effectively in the face
of hundreds of policy configurations. OBRA 90 was designed to address this
shortcoming.
OBRA 90 and SSAA 94
The primary changes in the Medigap market were the result of the Medigap
provisions of the Omnibus Budget Reconciliation Act of 1990, most of which went
into effect in 1992, and the Social Security Act Amendments of 1994. These laws
addressed the problems in the market by: (1) simplifying choices, (2) promoting
competition as a means to hold down premium increases, and (3) providing consumer
protections.
The Medigap reforms of OBRA 90 limited insurers to selling 10 standardized
policies with precisely defined benefits.⁵ The 10 packages, designated A through J,
were designed by an advisory group convened by the NAIC with Plan A being the
most basic policy and Plan J being the most comprehensive. Three of the packages,
Plans H, I, and J, offered some prescription drug coverage. OBRA 90 required all
Medigap carriers to offer Plan A, and carriers may choose to offer any of the other
nine options to Medicare beneficiaries at the carriers’ discretion.
OBRA 90 also contained numerous provisions designed to offer more consumer
protections for Medicare beneficiaries. These protections include mandatory open
enrollment periods; limitations on preexisting conditions; the requirement of a “free
look” provision to allow beneficiaries time to decide whether the Medigap plan that
they selected was appropriate for them; limits on high-pressure sales tactics and agent

³ A loss ratio is defined as the proportion of benefit costs to premium revenue. A low loss
ratio means that the amount of benefits paid is much less than the premiums received, and
so the insurer would be more profitable. Correspondingly, a high loss ratio (a value close
to but less than one) indicates that premiums barely cover the cost of benefits paid and so
the insurer would be less profitable. A loss ratio greater than one would mean that
premiums were insufficient to cover the cost of benefits. The Baucus Amendment required
a minimum loss ratio of 60% for individual policies and 75% for group policies.
⁴ GAO, Medigap Insurance: Law Has Increased Protection Against Substandard and
Overpriced Policies, October 1986, GAO/HRD-87-8.
⁵ MMA established two new standardized plan options (K and L) that eliminate first-dollar
coverage for most Medicare cost-sharing and limit out-of-pocket cost-sharing. See CRS
Report RL31223, Medicare: Supplementary ‘Medigap’ Coverage, by Jennifer O’Sullivan
for further details.

commissions; and the creation of funds for beneficiary education. In addition, OBRA
90 also set limits for carrier profitability in an attempt to curb rapidly increasing
premiums; failure to meet standards would generate a requirement for the company
to issue premium refunds.
One of the protections introduced by OBRA 90 made it illegal to sell duplicate
Medigap coverage to beneficiaries, but it also barred the sale of policies that
duplicated other coverage to which a beneficiary was entitled, for instance through
a retiree health plan. As a result, some insurers refused to sell Medigap policies to
beneficiaries who had any kind of retiree plan, even when the retiree plan was very
limited. SSAA 94 amended the OBRA 90 requirements by narrowing the anti-
duplication provisions and clarifying the circumstances when insurers would be
subject to financial penalties.
Result of Reforms
The OBRA 90 Medigap legislation attempted to simplify the Medigap insurance
market, to provide consumer protections and choice, to provide market stability, and
to promote competition and thereby slow down premium increases. Most of these
objectives were satisfied. The 10 standardized policies simplified price comparisons
and decision making for Medicare beneficiaries.⁶ By 1999, about 10.7 million
Medicare beneficiaries (more than one-fourth of all Medicare beneficiaries) were
enrolled in a Medigap policy.⁷ Complaints about carrier and agent abuses also
declined substantially after OBRA 90.⁸
Along with the reduction in the variety of Medigap products came a
consolidation in the market. Following the 1992 implementation of OBRA 90
provisions, there were fewer products and fewer sellers, as many carriers with smaller
market shares left the business.⁹ Over time, the Medigap market stabilized and in the
decade following OBRA 90, there was little change in market share and the number
of carriers with no reported major detrimental impact on the insurance industry.¹⁰
Continuing Problems
Despite the achievements of the Medigap reform legislation contained in OBRA

90 and SSAA 94, some problems remained. Researchers found little effect on

⁶ MA, MN, and WI had Medigap standardization programs in place before the passage of
OBRA 90 and were granted waivers allowing continued operation of those plans.
⁷ GAO, Medigap Insurance: Plans are Widely Available but Have Limited Benefits and May
Have High Costs, July 2001, GAO-01-941.
⁸ U.S. Department of Health and Human Services, Office of Inspector General, The Impact
of OBRA 1990 on State Regulation of Medigap Insurance, OEI-09-93-00230, March 1995.
⁹ L.A. McCormack, P.D. Fox, T. Rice, and M.L. Graham, “Medigap Reform Legislation of
1990: Have the Objectives Been Met?” Health Care Financing Review, vol. 18, no. 1, fall

1996.

¹⁰ P.D. Fox, R.E. Snyder, and T. Rice, “Medigap Reform Legislation of 1990: A 10-Year
Review,” Health Care Financing Review, vol. 24, no. 3, spring 2003.

premium increases and did not find that industry profitability decreased substantially
following standardization. GAO found that the aggregate loss ratio for the industry
dropped by about 10 percentage points in the first two years that OBRA 90 was in
effect compared to the prior four years, from 0.93 to 0.85 for group policies and from
0.86 to 0.75 for individual policies.¹¹ A 10-year analysis found that aggregate loss
ratios were no higher in 2000 than in 1990 and 1991, prior to the implementation of
OBRA 90, indicating no decrease in profitability over the decade (see Figure 1).¹²
Figure 1. Average Loss Ratios for All Medigap Policies, 1990-2000

^Source:^F^o^x^et^al^{., “}^M^edi^g^{ap R}^e^f^o^rm^L^e^gⁱ^s^l^a^tⁱ^o^{n of}^1990:^A^10-^Y^{ear R}^e^vⁱ^ew^,”^Hea^lth^Ca^re
^Fi^nanci^{ng Revi}^ew^{, v}^o^l^.^{24, n}^o^{. 3, s}^p^riⁿ^g^2003.
Critics of the Medigap market and the legislative modifications have also argued
that the standardized benefit packages did not and may not meet consumers’ needs
or policy objectives. Only a few of the packages are popular with beneficiaries; plans
C and F account for over half of the market for standardized plans (see Figure 2),
while some packages, such as the ones that include prescription drug benefits (H, I,
and J) often have premiums that far exceed the actuarial value of the benefit for the
¹¹ GAO, Medigap Insurance: Insurers’ Compliance With Federal Minimum Loss Ratio
Standards, 1988-93, August 1995, GAO/HHS-95-151.
¹² Ibid.

average beneficiary and have much smaller market share.¹³ Standardized choices
may facilitate decision making, but limited choices may fall short of providing the
range of options that would serve many beneficiaries.¹⁴
Figure 2. Distribution of Medigap Plans, 1999

^Source:^C^R^S^an^al^y^sⁱ^s^of^dat^aⁱⁿ^t^h^{e G}^A^O^report^Medi^g^a^p.^C^u^r^r^e^nt^Polⁱ^cⁱ^e^s^C^ont^aiⁿ^C^o^ver^age^G^aps^,
^Under^m^{ine C}^o^s^t^C^ontr^o^{l Incentives}^{, G}^A^O^-^02-^533T^.
Despite the efforts at standardization, some have criticized the OBRA 90
reforms for falling short and allowing too much state leeway. Some insurers and
consumer advocates have complained about inconsistent regulation across states, and
that variation in wording requirements and the presentation of policy forms resulted¹⁵
in less consistency than desired.
Finally, some confusion has remained in the market, particularly in how ratings
methodologies are applied in setting premiums and how this affects beneficiary
choice. Medigap carriers can rate policies in three ways: (1) using community rating
without any age differentiation, (2) with issue-age rating, or (3) with attained-age
rating. The choice of rating methodology has implications for the cost of the
premium over time. Community-rated premiums do not change as the policy holder
ages. Issue-age premiums are based on the age of the beneficiary when the policy is
issued and increase with inflation but not age. Attained-age premiums can be less
expensive initially when purchased, but increase as the beneficiary ages.
Decision Making and the Number of Choices
The effect of having many choices on decision making is not fully understood.
Traditional economic theory argues that more choices lead to greater satisfaction
¹³ Ibid.
¹⁴ While data on Medicare beneficiaries’ choices across Medicare drug plans are not yet
available, CMS administrator Mark McClellan stated on February 8, 2006 before the Senate
Finance Committee that the “vast majority” of Part D enrollees have selected plans that offer
something other than the standard benefit described in MMA.
¹⁵ L.M.B. Alecxih et al., “Can Regulation Improve Long-Term Care Insurance? Lessons
from the Medigap Experience,” Journal of Aging and Social Policy, vol. 7, no. 2, 1995.

since the decision maker can select the choice that is most closely aligned with the
individual’s preferences. However, some behavioral economists, psychologists and
others argue that the cost associated with having to evaluate each choice could offset
the gains provided by achieving the “best fit.” Some research suggests that
individuals faced with many choices may find that having more alternatives can be
counterproductive. Particularly when the differences are small, the prospect of
having too many choices can be demotivating, leading the decision maker to avoid
making any decisions at all. Having more options may lead to less confidence that
the decision maker’s choice is optimal and subsequently a lower willingness to
commit to a single choice.
Some recent empirical studies appear to support this theory. One study found
that plans that offered more 401(k) options had lower participation rates compared
to plans that offered only a handful of choices; “every ten funds added, other things
equal, is associated with a 1.5% to 2% drop in [the] participation rate.”¹⁶ Another
study found that while grocery store consumers were initially more attracted to a
booth displaying 24 jam choices, a higher percentage of consumers who saw only six
choices subsequently purchased the jam by a factor of 10. Related work also showed
that ex poste satisfaction was higher among those who had fewer than those who had
more choices.¹⁷
At the other extreme, having too few choices can also inhibit participation. If
the limited choices available do not provide the decision maker with an improvement
over the status quo, then choosing not to participate will be optimal. Therefore, other
things being equal, the more varied the preferences across the population, the less
likely that one choice will be optimal for the majority.
While these theories might partly explain the early enrollment experience of
Medicare Part D, the late enrollment penalty adds a significant incentive whose
effects have not yet been fully realized. A late-enrollment penalty helps to create and
maintain a broad base of enrollees so that pooling the collective experience can
significantly reduce the average risk for all enrollees. Without such a penalty,
beneficiary enrollment decisions would reflect an appropriate self-assessment of risk;
in the aggregate, this could lead to a premium-inflating spiral where only the highest-
risk beneficiaries choose to enroll, leading to even higher premiums and riskier
enrollees with each iteration. Although Medicare Part B is voluntary and offers one
choice (to participate or not), the participation rate is 94% due in part to the late
enrollment penalty.¹⁸
The early experience with Medicare Part D enrollment may reflect both the
demotivating aspect of having many choices as well as the fact that the late

¹⁶ G. Huberman and W. Jiang, “Offerings vs. Choice by 401(k) Plan Participants: Equity
Exposure and Number of Funds,” Journal of Finance, to appear.
¹⁷ S.S. Iyengar and M.R. Lepper, “When Choice Is Demotivating: Can One Desire Too
Much of a Good Thing?” Journal of Personality and Social Psychology, vol. 79, pp.

995-1006, 2000.

¹⁸ Boards of Trustees of the Federal Hospital Insurance and Federal Supplementary Medical
Insurance Trust Funds, 2005 Annual Report.

enrollment penalty has not yet been imposed. As of mid-February, 2006, about 24%
of Medicare beneficiaries who were not automatically enrolled or did not have other
creditable coverage¹⁹ had signed up for a Medicare Part D plan.²⁰ While more
beneficiaries may enroll as the late-enrollment penalty deadline nears, trying to make
the decision in the face of an impending deadline may also elevate accompanying
stress levels.
Evaluating proposals to extend the open enrollment period before imposing the
late enrollment penalty requires balancing a complex set of costs and benefits to
Medicare beneficiaries, insurers, CMS, and taxpayers. Medicare beneficiaries who
simply need more time to gather and incorporate information to assist in decision
making would be well-served by an extension of the open enrollment period,
however, there are likely to be beneficiaries for whom the extension is simply an
opportunity to delay the choice. For these individuals, the decision process would
not change materially, except that it would occur later. Additionally, insurers
calculated premiums based on expected enrollment linked to a predetermined open
enrollment period. Extending the sign-up period could affect the enrollment and the
covered expenditures in a biased manner. If fewer beneficiaries enroll in the early
part of the year there would be proportionally fewer covered costs incurred if this
happened in a random or unbiased manner. However, extending the open enrollment
period might provide the opportunity for beneficiaries who were low risk (those who
did not use or expect to use many prescription drugs) to postpone enrollment until the
last possible minute, providing an additional period during which no late enrollment
penalty would be in effect. The effect of this scenario would be to create an enrolled
population that differs from the one insurers projected when formulating their plans
and bids.
Standardization Options for Medigap and Medicare
Part D
The Medigap market of the 1980s and the current Medicare Part D market both
present the beneficiary with a great many choices, but the standardization approach
applied to the Medigap market through OBRA90 has limited parallels and
applicability to the current Medicare Part D market. Before the Medigap reforms,
there were no federal restrictions on how vendors could structure their offerings.

¹⁹ A Medicare beneficiary is not subject to a Part D late enrollment penalty if the individual
is enrolled in another insurance plan that provides coverage of prescription drugs costs and
the actuarial value to the individual equals or exceeds the actuarial value of the standard
prescription drug coverage under Part D. A plan that meets this criteria is deemed to be
“creditable coverage.”
²⁰ Out of 43.4 million total Medicare beneficiaries, 10.5 million were either dual eligibles
(6.2 million), enrolled in a Medicare Advantage plan prior to 2006 (4.3 million), or retirees
with creditable coverage (10.0 million). Of the remaining 22.9 million, 4.9 million signed
up for a stand-alone plan and 0.5 million enrolled in a Medicare Advantage drug plan as of
February 13, 2006. See Kaiser Family Foundation policy brief, Tracking Prescription Drug
Coverage Under Medicare: Five Ways to Look at the New Enrollment Numbers, February

2006.

OBRA 90 required vendors to conform to 10 standardized Medigap options, Plan A
through Plan J, that vary by the scope of covered services.²¹ Plan A is the basic
package that covers Part A hospital coinsurance (for days 61-90 in a benefit period
and 60 lifetime reserve days) and 365 days of hospital care after the exhaustion of
Medicare benefits, Part B cost-sharing, and the first three pints of blood. The nine
remaining plans, B through J, offer combinations of additional coverage including
the Part A and/or Part B deductibles, skilled nursing facility care, emergency medical
care in foreign countries, at-home recovery, preventive care, and Part B excess
charges.²² Therefore, since the creation of standards, vendors compete on dimensions
other than covered services, including price (premiums and cost-sharing) and
customer service.
In contrast, vendors participating in the Medicare Part D market have faced at
least two constraints from the beginning of the program. MMA states that each Part
D eligible individual is entitled to obtain either (a) the standard prescription drug
coverage with access to negotiated prices,²³ or (b) alternative prescription drug
coverage with at least actuarially equivalent benefits and access to negotiated
prices.^24, ²⁵ Thus, vendors may vary their products and compete on premiums and
cost-sharing requirements, so long as they meet the actuarial equivalence test as
determined by CMS. The early experience has shown that despite this constraint,
plans have found sufficient flexibility to vary their product offerings substantially.
Second, the MMA also put guidelines in place regarding the scope of drugs that
each plan must cover. United States Pharmacopeia (USP), as directed by MMA,
produced a model formulary that CMS used to evaluate proposed plan formularies.
Plans are required to cover:(1) at least two drugs in each therapeutic category and
pharmacologic class described in the USP Medicare Prescription Drug Benefit Model
Guidelines or an acceptable alternative; (2) substantially all drugs in a handful of
classes dealing with mental health treatments;(3) at least one product representing
each of 119 key drug types defined by USP, and (4) a majority or substantially all

²¹ The Balanced Budget Act of 1997 (BBA 97, P.L.105-33) added two high deductible plans
to the 10 standard plans. With the exception of the high deductible feature, the benefit
packages under the high deductible plans are the same as for Plan F or Plan H.
²² Prior to MMA, Plans H and I also offered a basic drug benefit and Plan J offered an
extended drug benefit, but these drug benefits can not be included in any new policy sold
after December 21, 2005.
²³ The standard benefit for Medicare Part D is defined by a monthly premium ($35),
deductible ($250), co-insurance rate (25% up to the initial coverage limit), and catastrophic
coverage threshold ($5,000). For further details about beneficiary cost-sharing, see CRS
Report RL31525, Beneficiary Cost-Sharing Under the Medicare Part D Benefit, by Jim
Hahn.
²⁴ Social Security Act, Sec. 1860D-2. [42 U.S.C. 1395w-102]
²⁵ The American Academy of Actuaries and the Society of Actuaries state that two plans are
to be considered actuarially equivalent if, for the same population and covered services, the
total costs under each plan design and the net plan per member per month (PMPM) costs
(total costs less member cost sharing) are the same. However, the premiums and cost
sharing structures for individual members could vary between the plan designs.
[ ht t p: / / www.act uar y.or g/ pdf / medi car e/ br i e f i ng_072103.pdf ] .

available products in six drug categories — antidepressants, antipsychotics,
anticonvulsants, antineoplastics, immunosuppressants, and HIV/AIDS drugs.²⁶
Despite these constraints, plans were able to generate and CMS approved a great
diversity of prescription drug benefit designs. Plans differ widely in the number of
covered drugs, their use of cost-sharing tiers, deductibles, and whether or not the plan
includes a gap in coverage. Prescription Drug Plans (PDP) are covering an average
of 1,526 drugs with a maximum of 3,891, while the average for Medicare Advantage-
Prescription Drug (MA-PD) plans is 1,456 with a maximum of 5,823.²⁷ More than
half of the PDP and MA-PD plan offerings include more than four cost-sharing tiers,
with some plans offering up to eight cost-sharing tiers (see Table 1). Most plans
offer variations on the standard benefit; about a third (34%) of the plans will offer the
standard $250 deductible, while 58% will include no deductible, with the remaining

8% offering a deductible somewhere in-between. About one plan in six (15.6%) will²⁸

not have a coverage gap.
Table 1. Use of Cost-Sharing Tiers in Medicare Part D Plans
^PDPs^M^A^-PDs
^{# of}^pl^an^s^%^of^pl^an^s^#^of^pl^an^s^%^of^pl^an^s
^Oⁿ^e^tⁱ^r¹⁵¹^%³⁶²^%
^T^w^{o t}ⁱ^e^rs¹¹¹^8%²⁷⁴^18%
^T^h^{ree t}ⁱ^e^rs⁵⁸²^40%²⁵⁰^17%
^F^o^u^r^tⁱ^e^rs⁵⁶¹^39%⁵⁹⁹^40%
^Fⁱ^v^e^tⁱ^e^rs¹⁶⁷^12%³¹⁴^21%
^Sⁱ^x^tⁱ^e^rs³^<^1%¹⁸^1%
^Se^ve^{n t}ⁱ^e^r^s⁰⁰^%⁷^<¹^%
^Eⁱ^ght^tⁱ^e^r^s⁰⁰^%³^<¹^%
^Source:^A^v^{alere Health}^{, L}^L^C^,^Da^ta^Fra^m^{e N}^e^w^s^{, Decem}^{ber 2005.}
Given these variations, standardization options for Medicare Part D would be
quite different from the approach applied to the Medigap market, where covered
services were grouped into 10 packages. The major dimensions for consideration are
beneficiary cost-sharing through deductibles, coinsurance and copayment rates and
levels, and drug coverage through formulary design. The interaction of these
variables with the plans’ enrolled population, projected drug consumption patterns,
negotiated prices, efficiency of operation and desired profit level will determine the
premium insurers can set for the products.
Within these parameters, potential standardized options can be loosely or more
strictly defined. Standardized formularies can explicitly specify certain products or
provide more general outlines, with guidance on the number or types of included
products (e.g., “at least y products per class, including the most commonly prescribed

²⁶ CMS, Medicare Modernization Act Final Guidelines — Formularies, available at
[ h t t p://new.cms .hhs.gov/PrescriptionDrugCovContra/Downloads/Formu l a r yGu i d a n c e .pdf].
²⁷ Avalere Health, LLC, Understanding the 2006 Medicare Part D Marketplace, January

2006.

²⁸ Goldman Sachs Global Investment Research, Healthcare Services, Oct. 10, 2005.

product”). Vendors would compete on prices (through premiums and cost-sharing
requirements), service (e.g., through their retail networks and mail order programs,
exceptions and grievance procedures) and scope of covered drugs on the formularies.
Differences Between Medigap and Part D
Experiences
While the problem of confusion due to a wide array of choices is common to
both the Medigap market in the 1980s and the current Medicare Part D market, there
are also notable differences between the two experiences.
Market Maturity
Medigap had a long history prior to the federal interventions of the 1980s and
1990s. While the market may have been confusing for beneficiaries at the time, the
market was mature and there were relatively few major changes from year to year in
the number of products offered and the number of carriers in the business. In fact,
the continuing diversity of offerings was a defining characteristic of the market.
In contrast, Medicare Part D is new and the market is likely to change
dramatically in the coming years. The plethora of current choices (see Table 2) may
reflect a deliberate strategy on the part of insurers to cast as wide a net as possible to
appeal to many different kinds of Medicare beneficiaries. Many observers expect the
Medicare Part D market to consolidate in subsequent years, both in the number of
carriers and the number and scope of products offered, as carriers learn which
products are most attractive to Medicare beneficiaries and which ones are profitable.
Under this scenario, the choices beneficiaries face in coming years may become
fewer.²⁹

²⁹ Humana, which offers plans with some of the lowest monthly premiums available, calls
this strategy, “enroll and migrate.” See “New Medicare Drug Benefit Sparks an Industry
Land Grab,” Wall Street Journal, Jan. 25, 2006.

Table 2. Summary of Prescription Drug Plan Offerings Across
Regions
PDPStatesNumber of providersNumber of plans
region
1NH,ME1641
2 CT , MA,RI, V T 17 44
3NY2046
4NJ17
5DE,DC,MD1847
6PA,WV1952
7VA1641
8NC38
9S1845
10GA1842
11FL1843
12AL,TN1641
13MI1740
14OH1743
15IN,KY1642
16WI1745
17IL1642
18MO1541
19AR1540
20MS1538
21LA1639
22TX2047
23OK2342
24KS1540
25 IA,MN,MT ,ND,NE,SD,WY 18 41
26NM1743
27CO1743
28AZ1843
29NV1744
30OR,WA2045
31ID,UT1844
32CA1847
33HI1229
34AK1127
^No^te:^T^h^{e cou}ⁿ^t^s^of^th^{e n}^u^m^{ber of}^prov^idersⁱⁿ^each^regⁱ^onⁱⁿ^clu^d^e^all^prov^iders^of^f^e^rin^g^produ^cts
ⁱⁿ^th^e^r^e^gⁱ^oⁿ^.^T^h^{e to}^{tal n}^u^m^b^e^r^o^f^p^r^o^v^id^er^{s n}^a^tioⁿ^w^id^{e w}^{ill b}^e^{less th}^an^th^{e su}^m^acr^o^{ss all}
^regⁱ^on^s^becau^s^e^of^du^{plicate cou}ⁿ^t^s^.
^Source:^C^eⁿ^t^ers^f^o^{r Medicare an}^{d Medicaid Serv}^ices^.
This abundance of choices is reflected in the diversity of plan characteristics.
The monthly premiums for a Part D plan can vary from $0 to $125 in the same

region. Similarly, beneficiaries in one region deciding between plans can face a
difference in the number of covered drugs that ranges from 626 to 3,360.³⁰
Not only is the Medicare Part D benefit new, but the existence of a free-standing
prescription drug product in the insurance market is also novel and the long-term
viability of this market is unknown.³¹ Since most of the potential cost-savings from
increased availability and use of prescription drugs are likely to accrue to the insurers
of Parts A and B through decreased hospitalization and physician visits, there would
appear to be an advantage for insurers that cover Parts A and B in addition to Part D.
Thus, some industry observers have suggested that some companies may be offering
free-standing Part D plans to entice Medicare beneficiaries who have traditionally
preferred fee-for-service over managed care (for example, Medicare Part C), with the
hope of converting them to managed care enrollees under the companies’ Medicare
Advantage plan over time. This would also result in fewer choices for beneficiaries
in the future.
Strong Federal Role
Regulation of the Medigap industry has been and continues to be the province
of states. However, unlike the Medigap market prior to 1990, there will always be
a significant role for the federal government in the Medicare Part D market.
Variation across insurance products, including Medigap, is due in part to differences
in state regulation. Medigap regulation is one of the only areas of insurance
regulation where the federal government has imposed a standard of consistency
across states.³² In contrast, the Centers for Medicare and Medicaid Services (CMS)
reviews and approves every Part D plan offered by every insurer. Thus, problems
that the Medigap market faced, such as duplicate coverage and low-value policies,
are unlikely to become problems that would require the legislation of standardized
benefits under Medicare Part D.
Transitional Nature of the Prescription Drug Market
The market for prescription drug evolves continually as a consequence of
scientific, legal, and economic factors. New research and innovation eventually leads
to new drugs that can either expand the frontiers of medical science or provide
alternatives to existing practices or products. Approved drugs eventually go off-
patent, possibly leading to the introduction of generic competitors. Advances in
scientific research may bring to light new information on the safety and effectiveness
of prescription drugs. An actively managed formulary will change to reflect the entry
of new medications, as prices change with new competitors and practice patterns, and
as new evidence about drug effectiveness and safety becomes available. In this light,

³⁰ Avalere Health ,LLC, DataFrame News, December 2005.
³¹ Former CMS administrator, Tom Sculley, on March 20, 2003, testified at a hearing before
the Senate Special Committee on Aging that a drug-benefit only insurance plan, “doesn’t
exist in nature,” reflecting the rarity of such offerings.
³² Alecxih et al.

standardization may be overly restrictive if there is not a concomitant ability to revise
and update formularies as situations change.
Standardization Issues
Standardizing benefits implies policy tradeoffs. Creating simplicity and ease of
understanding needs to be balanced with restrictions on industry autonomy and
market choices. In addition, the appropriateness of federal intervention in
standardizing benefits must be weighed carefully when applied to a nascent market.
The level of standardization determines many parameters in the policy debate.
OBRA 90 required the NAIC to develop 10 packages of benefits; while proponents
have touted the simplicity the 10 choices created, others have argued that the
packages are not sufficiently varied and that some beneficiaries are not well-served
by any of the choices for the Medigap market. Consensus on Part D standardization
may also be difficult as to whether there is a manageable number of standardized
packages that can be agreed upon, and the dimensions to be standardized. The
Medigap experience with premium rating illustrates the difficulties and trade-offs
inherent in standardizing a benefit. OBRA 90 did not specify how carriers could set
their premiums and as a result, three methods were used across Medigap products.
Beneficiaries and consumer advocates dislike attained-age rating since the premiums
increase with age as incomes tend to decline. In contrast, most insurance carriers
prefer to have the option to choose the rating methodology so that they can offer
more choices and products in the market.
While the OBRA 90 and SSAA 94 reforms that led to standardized benefits
stabilized the Medigap market, it is not clear that this action would have a similar
effect on the Medicare Part D market; such an approach could be premature. The
problems in the Medigap market were well-established and persistent. The Medicare
Part D market is likely to undergo significant changes as all parties — beneficiaries,
insurers, drug manufacturers, pharmacy benefit manages, CMS — learn about the
new benefit and how it develops. The Medicare Part D market will likely consolidate
over the next few years and some insurers will exit while others enter the market.
However, beneficiaries and plans are likely to face difficulties and challenges while
the market moves through this transition.
Intermediate interventions might help alleviate the difficulties associated with
the great breadth and number of choices without placing restrictions on specific
options before the optimal set of standardized packages are clearly identified.
Whether such actions are most appropriately addressed through legislation or
regulation will depend on the specific objectives. One possible intermediate
intervention would be to limit each plan sponsor to no more than two offerings, as
suggested by a draft “call letter” from CMS to plans considering participating in
2007. While this restriction would reduce the number of choices, it would also force
companies that currently offer more than two choices to change their business
pract i ces.³³

³³ J. Reichard, “‘Medicare Part D 2.0’ — Fewer Plans, Better Service in 2007?” CG
(continued...)

Given the uncertainty surrounding the market, more information on what plans
beneficiaries have chosen and which plans will continue to be offered in subsequent
years will be important in determining the variety of choices under Medicare Part D.
Consequently, the policy decision should include considerations about not only
whether and how to standardize benefits but also when to do so.

³³ (...continued)
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20060307].