American Journal of Law & Medicine

Medigap: should private insurers pay public rates and who should make the decision?


The most complex issues in the field of healthcare policy can often be reduced to the simple question "who is going to pay?" Legislatures, whether at the state or national level, are generally the entity responsible for allocating healthcare costs. When a legislative body acts to allocate healthcare costs, it simultaneously amends a society-wide, interwoven web of regulation and incentives that is steeped in decades of tradition. Further, and perhaps more importantly, healthcare cost allocation affects each individual in our society on an intimate level. (1) Medicare is one of the most controversial elements in this grand scheme of cost allocation policy. (2)

Medicare serves approximately 37 million senior citizens in the United States. (3) Of course, Medicare benefits are limited. (4) With minor exceptions, Medicare fully covers only the first ninety days of hospitalization for an eligible citizen. (5) After such period, a Medicare-eligible citizen may draw upon a non-renewable lifetime reserve, which provides Medicare hospitalization coverage for an additional sixty days. (6) Medicare recipients who wish to expand their hospitalization coverage beyond these basic limits can purchase private supplemental insurance plans, commonly referred to as "Medigap policies." (7) Only private insurers provide Medigap policies, although Congress regulates their format."

Medicare and private Medigap insurers organize their payment systems in similar ways. Specifically, because the cost of hospital care varies greatly depending on a given patient's diagnosis, both Medicare and Medigap insurers base their per-day hospitalization payment rates on a given patient's ailment. (9) When a Medicare eligible patient enters the hospital, her physician examines her and provides her with a diagnosis. Her diagnosis will fall, in turn, into a category that Medicare has established beforehand, a category called a Diagnostic Related Group ("DRG"). (10) Stated simply, a DRG lumps together, for the purposes of payment, several diagnoses that have similar costs of treatment. A DRG classification determines the rate a hospital may bill, on a daily basis, for a patient's care. (11)

Most insurance providers, whether Medicare or a private company such as Blue Cross/Blue Shield, establish DRG rates by negotiating with hospitals or larger healthcare organizations. Medicare, however, is in a unique position during such negotiations. Medicare runs at an annual cost of approximately $150 billion; in other words, healthcare providers receive approximately $150 billion dollars in Medicare payouts every year. (12) Thus, Medicare accounts for a very large percentage of healthcare providers' income and, accordingly, Medicare has great leverage in negotiating DRG rates. (13)

Since 1999, (14) healthcare providers have advanced several lawsuits against Medigap insurance providers. (15) The issue in such cases is always the same: whether private Medigap insurers should pay the very low per diem hospitalization rates that Medicare has "negotiated," or negotiate their own DRG rates. (16)

The Ninth Circuit Court of Appeals has determined that Medigap insurers are entitled to Medicare-negotiated rates. (17) This Note contends that the Ninth Circuit's decision is legally unfounded, politically unwise and, further, that it creates a shortsighted public policy. From a legal perspective, the bulk of analysis offered by the Ninth Circuit is either arbitrary or irrelevant. (18) Politically, the Ninth Circuit's holding is both undemocratic and relatively uninformed. From a policy perspective, the court's position is unsound because: (1) it creates ambiguity in the healthcare markets; and (2) the position has broad implications that are dangerously unclear.

Part II of this Note creates a context for the Medigap line of cases by examining the current economic environment and by offering a limited description of both Medigap policies and Medicare. Part III considers the approach of the Ninth Circuit Court of Appeals to the Medigap rate question. Part IV addresses the D.C. Circuit's analysis of the issue and Parts V and VI will discuss the legal and policy arguments against the majority approach, respectively.



The world of healthcare is a more complicated and frightening place than ever before. (19) Although our national economy is beginning to show signs of revival, (20) the United States has lost approximately three million jobs since the recent recession began in March of 2001. (21) Accordingly, the average person has fewer resources available to him than he had in the recent past. This is complicated by the fact that the cost of healthcare continues to rise, as does the number of individuals who are either underinsured or uninsured altogether. (22)

In the year 2000, the United States as a whole spent 1.3 trillion dollars, 14% of the country's gross domestic product ("GDP"), on healthcare. (23) This is more than the country spent on housing, food, or transportation. (24) In fact, no other country in the world spends such a large percentage of its gross domestic product on healthcare. (25) Contrast these numbers with national healthcare spending in 1963, when the United States spent only 6% of its GDP on healthcare. (26) Such a drastic change in the numbers is not problematic in and of itself; in other words, if the United States chooses to allocate 14% of its GDP to healthcare, and can do so without any deleterious effect, there is no problem.

Unfortunately, it appears that a problem does exist. While our investment has created a technologically advanced system of care, more importantly, it has not created a healthy nation as the United States still lags behind other industrialized nations in the major indices of public health, such as infant mortality and life expectancy. (27) Moreover, it appears that our current investment is insufficient. According to the New York Times, out of 5,000 hospitals recently surveyed in the United States, more than 1,300 have reduced services in response to economic hardship. (28) Six percent of such facilities have cut entire wards. (29) In spite of all this, if the United States merely maintains its current rate of annual spending increases, spending on healthcare will constitute more than 16% of our GDP by the year 2005. (30)

Due to the economic downturn beginning in 2001, the situation described above is likely to get worse before it gets better. (31) The government, which now subsidizes approximately 50% of the nation's health costs, (32) will likely experience a slump in revenue due to a reduction of the average household income and a decrease in consumer spending. Additionally, corporate tax revenues will decrease as companies experience a decrease in earnings or go out of business entirely. Simultaneously, absent any drastic change in national healthcare policy, we can assume that the costs of healthcare will continue to rise at a rate significantly higher than that of inflation. (33)

The government can do one of only two things to remedy such a situation: (1) it can cut services or (2) it can increase taxes to maintain its traditional level of healthcare subsidization. (34) Either scenario will force the average citizen to part with more of his or her scarce financial resources. The only difference will be whether the average citizen sees such a rise in costs in the form of increased insurance premiums or increased taxes.

While the above is taking place, private employers (who currently cover approximately 34% of healthcare costs) (35) will likely cut the health benefits currently available to employees. …

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