Calculating Costs To and Through
the Part D Doughnut Hole

The Centers for Medicare & Medicaid Services (CMS) says that cost is one of the factors beneficiaries should consider when choosing a Medicare prescription drug plan.  Yet calculating costs can be an onerous task.  In fact, CMS cautions against trying to calculate the potential costs of enrollment “by hand” and recommends that beneficiaries rely on the calculations achieved through the web tools available on

Many times the cost of a plan can be deceptive.  A plan with the lowest premium is not the best option if its formulary, or covered drug list, does not include the medicines a beneficiary takes or if its network of pharmacies does not include the drug store a beneficiary uses.  We know that plans can change the prices of their drugs weekly so that what appears to be the cheapest plan one week may not be the cheapest plan the next week.  CMS has even suspended providing information about some plans on its prescription drug plan finder because of discrepancies in information about drug costs.  We know also that, starting in March, plans will be able to remove drugs from their formularies or change their tiers or cost-sharing levels.

Even after a beneficiary does the calculations, the plan with the lowest cost on a yearly basis may still not be the best option.  Plan benefit structures vary greatly. Some require beneficiaries to pay more up-front at the beginning of the year, while some require beneficiaries to pay more at the end of the year. Because most Medicare beneficiaries live on fixed incomes, they may want to consider their overall expenses and when they want to incur larger prescription drug costs.  A beneficiary may be more comfortable paying a little extra for a drug plan in order to pay steady amount out-of-pocket throughout the year or at certain times of the year.  The calculations can be particularly significant for beneficiaries with large drug costs who are not eligible for the low-income subsidy, or “extra help.”

In making these determinations, beneficiaries need to take into consideration two important calculations. The first is the calculation of the initial coverage limit.  A beneficiary who reaches the initial coverage limit falls into the “doughnut hole” or coverage gap and becomes responsible for the total costs of all medications.  The statutory standard initial coverage limit is $2400 for 2007.  This amount is reached by taking into consideration the full cost of the drugs, not just the beneficiary’s out-of-pocket cost-sharing. For example, if a drug costs $150 and the beneficiary’s co-payment is $40, the full $150 counts towards the initial coverage limit.

The second calculation is the beneficiary’s out-of-pocket expenses.  A beneficiary who incurs $3,850 in out-of-pocket expenses (OOP) in 2007, which include any deductible, co-payment or co-insurance, will arise from the doughnut hole and become eligible for catastrophic coverage.  In the above example, only the $40 paid by the beneficiary is counted towards the OOP limit.  Thus, because the OOP limit is based on what a beneficiary pays directly, and not on the total cost of the drugs, a beneficiary who pays less at the beginning of the year will have fewer expenses that count towards the OOP and may take longer to get out of the doughnut hole.

To complicate matters, beneficiaries also need to understand what expenses count towards both of these figures.  Payments for drugs that are not on the formulary, for formulary drugs bought at a non-network pharmacy (with some exceptions), or for drugs bought in Canada or another foreign country do not count towards either the initial coverage limit or the OOP limit. Payments made by insurance or employer plans and payments made by AIDS Drug Assistance Programs (ADAPs) do not count towards the $3850 OOP limit.

Though, as CMS says, the calculations are difficult to do without a computer program, the following example illustrates the issues. Mrs. Jones has monthly drug costs of $800 for three drugs that cost $200, $200 and $300.  Assuming that all of the plans in which she is interested have a $2400 initial coverage limit (ICL), and that all of her drugs are on the plans’ formularies, she will reach the doughnut hole or coverage gap in three months.  If she enrolls in a plan offering the standard benefit ($265 deductible and 25% co-insurance), her out-of-pocket (OOP) costs will be $865 when she reaches the ICL. She will need to incur an additional $2885 in OOP to reach the catastrophic insurance.  She will therefore be in the doughnut hole for almost four months ($800/month drug costs x 4 = $3200).[1]

Suppose Mrs. Jones enrolls instead in a zero-deductible plan, and each of her drugs has a $40 flat co-payment rate.  Her costs in January and each month thereafter will only be $120, so her initial monthly expenses will be less than if she were enrolled in a plan with a standard benefit. However, because she will have only incurred $375 towards her OOP when she reaches the ICL, she will need to pay $3475 out of pocket to reach the catastrophic limit, instead of $2885.  She may need to spend an additional month in the doughnut hole paying the full costs of her drugs before she reaches the catastrophic limit.

Suppose further that Mrs. Jones never wants to pay the full cost of her drugs and decides to enroll in a plan that provides some coverage during the doughnut hole.  In addition to considering the extra premium cost for this kind of plan, she will need to calculate the effect on her ability to meet the out-of-pocket limit.  She may prefer to pay more in total costs during the year than she would without doughnut hole coverage to avoid the coverage gap and to have consistent monthly payments for her prescriptions.

Total cost to the beneficiary is clearly a factor to evaluate when choosing a plan.  Preference on when and how a beneficiary will incur the significant costs associated with Part D may outweigh the need to enroll in the cheapest plan.

Medigap Reminder

As of January 1, 2006, insurers that sell Medicare Supplemental (Medigap) insurance will no longer be allowed to sell standard plans H, I and J with prescription drug coverage.  Individuals who currently have one of these policies have four choices: 1) they can retain their H, I, J policy with drug coverage; 2) they can keep H, I, and J without drug coverage and purchase a prescription drug plan (PDP); 3) they can change to a Medigap plan A, B, C, or F offered by their current insurance company and purchase a PDP; or 4) they can enroll in a Medicare Advantage plan with prescription drug coverage (MA-PD).  They should have received a letter from their insurance company describing their options.

Standard plans H, I, and J with prescription drug coverage are not creditable coverage.  In other words, the drug benefit they offer is not “as good as” the Part D drug benefit.  Individuals who decide to retain these policies with drug coverage at the end of the initial enrollment period will therefore have to pay a late penalty on their Part D premium if they subsequently decide to enroll in a Part D plan.  Although no new H, I, and J policies with drug coverage will be sold after January 1, people who currently have those policies still have until May 15, 2006 to enroll in a PDP.

[1] Mrs. Jones’ costs are as follows:  January: $250 deductible, $125 co-insurance (25% x. $500); February $187.50 co-insurance (25% x $750 ); March:$187.50 co-insurance (25% x. $750), for a total of  $750.

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