How Medicare Works

Medicare's publicly funded health insurance was originally modeled after private health insurance plans offered at the time and was introduced as a two-part program. Those parts are Medicare Part A, which is hospital insurance coverage, and Medicare Part B, which is an elective health insurance plan. When it was rolled out, Plan A beneficiaries were responsible for a $40 annual deductible, and those who chose to enroll in the Plan B program paid a $3-per-month premium [source: Stanton].

Today, Medicare Part A and Part B are called "Original Medicare." Medicare Part A is also known as hospital insurance, and its beneficiaries can expect inpatient hospital stays in a semi-private room to be covered (a private room is not covered unless it is deemed medically necessary). In addition, rehabilitation and other skilled nursing services are also covered. Home health care is covered as well, but only if it's medically necessary, and then only on a part-time, intermittent basis. This care includes physical, occupational and speech therapies when conducted by a Medicare-approved health agency. Durable medical equipment (DME) such as walkers and wheelchairs are covered, as are other medical supplies. Finally, Part A covers hospice care for terminally ill patients and includes drugs and support services for treating symptoms and relieving pain.

Medicare Part B offers optional medical insurance, and those who elect coverage pay a monthly insurance premium. Part B covers medically necessary health care appointments, including doctors' appointments, outpatient medical and surgical services, diagnostic tests and some coverage for home health care. It also covers preventive services. In 2020, the majority of people enrolled in Part B paid a monthly premium of $144.60, with coverage beginning after they met an annual deductible of $198 [source: Medicare.gov].

Medicare won't cover everything, though. You'll have to look elsewhere for some common services that aren't covered under Medicare programs, including long-term care, most dental care (including dentures), cosmetic surgery, acupuncture, routine foot care, hearing aids and fittings, and eye exams related to prescribing glasses [source: Medicare.gov].

Those who are enrolled in Original Medicare may also apply for Medicare Supplement Insurance, also known as Medigap. Medigap policies, sold and administered by private insurers with federal government oversight, are intended to help cover expenses not covered by Part A and Part B, such as copays, coinsurance costs and deductibles. Some plans offer additional coverage, too, such as the cost of overseas medical care while traveling. No Medigap policies cover prescription drugs, however, and policyholders may not pay their Medigap premiums with funds from a health savings account. In 2018, more than 14 million Americans carried Medigap insurance.

Until the late 1990s, Medicare was structured as a fee-for-service program. In 1997, Medicare began to offer HMO-modeled plans for the program's beneficiaries through private insurers. These plans were known as Medicare+ Choice, then as Medicare Part C. Today, the plans are called Medicare Advantage plans. They provide all of the same benefits as Medicare Part A and B, and sometimes offer prescription drug coverage. The plans are popular because they typically cost much less than original Medicare plus Medigap, although you typically have to go through the plan's provider network. (The 2020 monthly premium was estimated at $23.00 according to the U.S. government's Centers for Medicare and Medicaid Services.) In 2019, 34 percent of all Medicare beneficiaries were enrolled in a Medicare Advantage plan. And the Congressional Budget Office (CBO) predicts that by 2029, the percentage will rise to nearly 50 [source: KFF].

There are four types of Medicare Advantage plans:

Health Maintenance Organization (HMO) plans — These plans emphasize preventive health care. Only doctors within the HMO network are covered, and an appointment with a specialist requires a referral from a primary care physician. Additionally, HMO Point of Service (HMOPOS) plans are offered, which allow you to go outside of the network for care, although you'll have to pay more to do so. The majority of Medicare Advantage enrollees – 62 percent – are covered by HMO plans [source: KFF].

Preferred Provider Organization (PPO) plans — PPOs are similar to HMOs, except beneficiaries have the option of seeing a physician who's outside the plan network, although out-of-network services typically cost more. A referral from a primary care doctor is not usually required for specialist appointments. In 2019, 31 percent of Medicare Advantage beneficiaries were enrolled in PPOs [source: KFF].

Private Fee-for-Service (PFFS) plans — PFFS plans are offered by private insurance companies. While PFFS plans are required to offer the same benefits as Original Medicare, the insurers can offer additional benefits and require different fees and payment terms. Although most PFFS plans use provider networks, they are required to cover out-of-network care. However, you may pay more if you see an out-of-network professional. One downside of PFFS plans is that not all doctors and hospitals accept them, plus these plans might not be available in your state or county. In 2019, only 1 percent of people carrying Medicare Advantage plans were enrolled in PFFS plans [source: KFF].

Special Needs plans (SNPs) — Special Needs Plans are for three specific groups of people: those eligible for both Medicare and Medicaid; those living in long-term care institutions; and those with certain chronic conditions. In 2019, nearly 3 million people were enrolled in SNPs, the vast majority of whom gained eligibility by being dually eligible for Medicare and Medicaid [source: KFF].

Additionally, some regions offer Medicare Medical Savings Accounts (MSAs), which are similar to Health Savings Accounts (HSAs) for individuals under 65. Medicare MSAs are a combination of two plans: a high-deductible Medicare Advantage (Part C) plan and a special Medical Savings Account (funded by Medicare) to pay for health care costs incurred before you meet the deductible in your Medical Advantage plan.

Medicare Cost plans are also available, but only in certain parts of the U.S. Enrollees in Medicare Cost plans can join if they carry Original Medicare or just Medicare Part B. This hybrid plan gives beneficiaries the option to go to out-of-network providers on a fee-for-service structure (including the expense of Part A and Part B deductibles and coinsurance).

Medicare Savings Programs (MSP) are available to help low-income seniors pay their Medicare premiums. Sometimes they also pick up the cost of Original Medicare deductibles, copays, coinsurance and prescription costs. To qualify, participants have to meet state income and asset limits. In 2019, the gross monthly income limit for qualified Medicare beneficiaries in most states was $1,061 for individuals and $1,430 for couples, while the asset limits were $7,730 for individuals and $11,600 for couples.

In December 2003, President George W. Bush signed the Medicare Modernization Act, expanding Medicare to offer optional subsidized prescription drug coverage. The result, Medicare Part D, was introduced on Jan. 1, 2006.

Any individual who is eligible for Medicare Part A, Part B or Part C is also eligible to enroll in Medicare Part D, which offers prescription drug coverage. There are two types of prescription drug benefit packages: a stand-alone prescription drug plan (PDP) and the Medicare Advantage prescription drug plan (MA-PD), which blends medical and drug coverage. In 2019, 45 million people received Medicare Part D benefits as part of a PDP or MA-PD [source: KFF].

Medicare Part D is optional, and enrollees may be responsible for paying monthly premiums, annual deductibles, copayments, coinsurance and other expenses as applicable, such as late enrollment penalties.

Originally, Medicare Part D had a coverage gap known as the donut hole. It worked like this. Part D enrollees paid the full cost for prescription drugs until they met their plan's deductible. After that, Part D began picking up some of the drug costs. When enrollees reached a certain out-of-pocket payment level – for most plans in 2020, it was $4,020 in total drug costs – you entered the dreaded donut hole. Here, enrollees had to pay a high percentage of their drug expenses until they reached the catastrophic coverage threshold, at which time Part D began paying the majority of the drug costs. The donut hole closed in 2020. Today, when enrollees reach the coverage gap, they only have to pay 25 percent of all drug costs. Once they hit a certain figure (in 2020 it was $6,350), Part D's catastrophic coverage kicks in and enrollees pay significantly less for the rest of the year [source: Medicare Interactive].

Medicare Part D plans have varying costs and formularies (the list of drugs covered under the plan). People who want to sign up for Part D should compare the plans and find one that covers the drugs they need, or expect to need, in the future. Changes to plans may be made during the open enrollment period at the end of each calendar year.

Enrollment in Medicare

Enrollment periods and procedures differ depending on the type of Medicare plan. Enrolling in Medicare occurs over a period of seven months: during the three months before the month of your 65th birthday, the month of your birthday and the three months after your birthday month. If you're born in June, for example, your Initial Enrollment Period (IEP) is March through September.

Anyone already receiving benefits from Social Security or the Railroad Retirement Board qualifies for Medicare Part A and Part B and is automatically enrolled at age 65.

Individuals who are 65 and still working and who receive group health coverage through an employer, union, or spouse may delay enrolling in Part B during the IEP without incurring penalties. They may enroll at any time while still covered by a group health plan or during the eight months after that group coverage ends.

Oct. 15 through Dec. 7 is Medicare's open enrollment period, during which beneficiaries may switch plans, or join or drop Medicare Part D. Coverage begins on Jan. 1, and the Medicare Advantage disenrollment period runs from Jan. 1 through Feb. 14. During this period, enrollees may leave Medicare Advantage and enroll in Original Medicare coverage. They can also enroll in a Medicare Prescription Drug plan (Part D), although a late enrollment penalty may apply if they're enrolling after they were initially eligible [source: Medicare.gov].

Anyone who is 65 and isn't receiving Social Security retirement benefits must apply for Medicare. You can enroll online or in person at a local Social Security office. Open enrollment happens on an annual basis, allowing new enrollees to sign up and current beneficiaries to change coverage as needed.

Medicare remains a vital means of paying for health care for many Americans. In 2018, some 61 million Americans were receiving Medicare: 52.6 million seniors and 8.6 million younger people with qualifying disabilities [source: Centers for Medicare & Medicaid Services ]. Yet despite being a vital program for older Americans' health and financial security, funding for Medicare has always been a sensitive political issue in the U.S.

Medicare is funded through a few different revenue streams, primarily general revenues (most of which comes from federal income tax payments), payroll taxes and beneficiary sources.

Payroll taxes paid by American employees and employers finance Part A, for example. Under PPACA in 2013, the Additional Medicare Tax, generally withheld from high-wage earners, was introduced.

Part B is mostly financed by general revenues and beneficiary premiums.

Part D is also financed by general revenues and beneficiary premiums, in addition to state funding for individuals eligible for both Medicare and Medicaid (called dual eligibles).

Part C, the Medicare Advantage program, is its own creature but isn't much different. Advantage programs are composed of Medicare Part A, Part B and sometimes Part D, and they're financed in the same ways as Part A, Part B and Part D. The money comes from general revenues, payroll taxes and monthly premiums. The difference is that individuals enrolled in these plans are also responsible for additional costs for the supplementary benefits available in Advantage plans.

Medicare has, and continues to undergo, changes under the PPACA health care reform laws of 2010, including new policy options such as Medicare Advantage, and coverage such as free preventive care services — but beneficiaries have seen, and will see, changes in out-of-pocket expenses, such as deductibles and payroll taxes.

Medicare will always be changing, due to politics, money and the public will. But here are a few of the more recent changes as of 2020 [source: Norris].

Upgrade for Medicare Plan Finder. The most-used tool on Medicare.gov is the plan finder, which helps users compare Medicare Advantage and Part D plans. In 2019, the plan finder was upgraded for the first time in a decade. The new version is mobile friendly and features a fresh, easy-to-read design. It also creates a personalized experience for users to enhance their ability to select coverage that best meets their needs [source: CMS].

Fees and Deductibles Increased. No surprise here. Part A premiums rose, for the 1 percent of Medicare Part A enrollees who pay them. So did Part B premiums and Part A and B deductibles.

Popular Medigap Plans C and F are no longer available for new enrollees. Previously, there were 10 standardized Medigap plans, all identified by a letter. Now there are eight. Those who had the popular plans C and F prior to 2020 may keep them. But new enrollees can't sign up for them. Why the change? Plans C and F are the only Medigap plans that pay all Part B deductibles in full. Some government officials believe this results in people using services when they don't really need them. So, going forward, new enrollees will always have to pay something for Part B services.

New Medigap Plan G. Plan G is a new, high-deductible plan that replaces F, which was also a high-deductible option.

New High-Income Brackets. If you had a high income, you have to pay more for Parts B and D. But the income brackets for those plans were set in 2007 and 2011, respectively. In 2020, the annual high-income brackets for Part B rose to $87,000 for singles and $174,000 for married couples.

Part D Donut Hole Closed. After meeting the Part D deductible, enrollees pay just 25 percent of drug costs until they reach the catastrophic coverage level, when Plan D picks up more of the costs. Previously, enrollees who fell into the "donut hole" paid a much higher percentage of drug costs.