How to Make the Most of Medicare

Medicare provides an important safety net in your retirement, but if you don't understand the ins and outs of this critical program, you might not get the most out of it.

In this episode of The Motley Fool's Industry Focus: Healthcare podcast, analyst Kristine Harjes is joined by contributor Todd Campbell to explain the program, what it covers, and how stocks like UnitedHealth Group (UNH -1.03%) and Humana (HUM 0.82%) could benefit from growing enrollment from aging baby boomers. The two also offer up insight into how Medicare could look under presidential hopefuls Hillary Clinton and Donald Trump.

A full transcript follows the video.

This podcast was recorded on September 14, 2016.

Kristine Harjes: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's September 14th, a Wednesday, so we're talking about healthcare, specifically Medicare, today. I'm your host, Kristine Harjes, and as usual, healthcare contributor Todd Campbell is calling into Fool HQ in Alexandria, Virginia. Todd, welcome to the show.

Todd Campbell: Hi, Kristine!

Harjes: As I mentioned, we're going to talk about Medicare today. We're going to get some basics about the different parts and what's covered. And regardless of our listeners' ages, whether they're of age to get Medicare or nowhere close to it, I figured it would be useful if we could give some investing takeaways, what you can learn about Medicare spending, and other ways that Medicare overlaps with the world of investing. What do you think?

Campbell: I think that's a great approach; let's dive right in. This is going to be an interesting show for people to listen to, especially if they're coming up on 65.

Harjes: Exactly. As you mentioned, 65 is when you become eligible for Medicare. So, you have this seven-month window around your birthday month in which you can enroll. Realistically, you probably should enroll right about then, otherwise you face a bit of a risk of your premiums rising, particularly the longer you wait, the longer the premium could go up. And for part B, especially -- we'll talk about how there are different lettered parts to Medicare -- the penalty will continue on your premium for the rest of your life, unless you qualify for certain exceptions, such as if you work past 65, then you might end up not needing to claim it right away in order to avoid the penalty.

Campbell: That's a pretty stiff penalty when you think about it! A 10% penalty forever!

Harjes: Indefinitely, yeah.

Campbell: Just for missing a few months.

Harjes: Let's not talk about B too much before we talk about part A. Todd, do you want to give us the rundown on Medicare part A?

Campbell: As you alluded to, we have various parts of Medicare, they're all responsible for covering different parts of healthcare for recipients. Part A is original Medicare. It's the part that handles inpatient hospitalization. So, you get sick, you go to the hospital, you get admitted, and that's where Medicare will step up and cover that cost. Most Americans qualify for Medicare part A without having to pay a premium.

Harjes: Once you're 65 and up, you will qualify, unless you didn't pay into Social Security for 10 years or more. And we'll talk a little bit more about where all this money comes from and how it's funded later, but essentially, it's funded by the same tax that pays for things like Social Security.

Campbell: Right, you basically have two forms of payment for all of these. Like you said, we'll get into the nuts and bolts of that a little bit further on. But it's either going to come via government, or it's going to come via premiums.

Harjes: Right. So, that's part A. There's also part B, which is quite different from part A. It covers things like doctor visits and your out-patient costs -- that can be things like medical equipment or medical therapy. Also in this bucket would be preventive screenings and testings. And you actually will end up paying a monthly premium. This is not completely free. This is where that penalty that we talked about first thing in the show will really matter. Typically, can you pay a monthly premium that's around $100. You can imagine, 10% on top of that, if you were a year late in enrolling, that's pretty significant over your lifetime.

Campbell: It can absolutely add up. If you were new to part B in 2016, you could be paying $120. You could be paying even more than that if you're a high-income earner, because part B premiums, there's a standard rate, and there's also an income adjustment. Your premiums could go up into hundreds of dollars, depending on how much income you report.

Harjes: Exactly. Once you've paid your premium, you're not quite done paying to get part B covered, because you have a deductible per year that you have to meet, meaning expenses that come out of your pocket before the plan's coverage kicks in. That is $166 per year. After that, you'll still pay 20% co-insurance.

Campbell: Yeah, I think a lot of people think of Medicare part A and part B as, "I get 100% of my care taken care of." That's not the case. With part A, your first 60 days or so of being in the hospital are covered, but beyond that, you start to contribute to that care on a daily basis. And with part B, like you said, you have not only the premiums, but you have a small deductible, and then you're responsible for that 20% share of the costs.

Harjes: Right. That's part A and part B. There is something that's referred to as part C, but I think it'll make more sense for us to talk first about part D, which is your prescription drug plans that are optional and can be added for a cost. These are administered by private insurers, not just coming out of the normal Medicare pot of part A and part B. Essentially, what happens here is you can pay a certain amount, and after that, your drug costs will be largely covered. There are so many different options out here for part D. If you're eligible, you really want to look at what types of drugs you need, how often, how much you're spending, and compare the plans to make sure you get the best one for you.

Campbell: Yeah, it's very important for everyone to remember this. Part D plan costs can vary widely. And every one of these plans, because they're run by private companies, they can use drug formularies that reimburse very different amounts depending on the medications that you take. So, when you go to enroll in part D, make sure that you take the time to look through and make sure that any medication that you're on currently is covered in the best tier possible so that your out-of-pocket costs are less, because yes, part D will have premiums, but you'll also be on the hook for some other costs associated with that, including co-insurance and a deductible.

Harjes: Exactly. That was part A, and B, and D, so now it's probably time to talk about part C, which is more commonly known as Medicare Advantage. Todd, do you want to take that one?

Campbell: Yeah. And by the way, you did that right. It's hard to talk about part C if you don't know what part A, B, and C are. Part D is Medicare Advantage. They're plans that are offered by private insurers that oftentime bundle together and take over the responsibilities of part A, part B, and part D. Sometimes, you won't have to pay any extra premium to get a part C plan. Other times, you will. It's really going to depend on the insurer, the level of coverage, how much copayments will be, how much your co-insurance will be, etc. The thing to remember about Medicare Advantage, why it even exists, is that Medicare original, we'll call it, part A and part B, they don't cap out your spending. So, theoretically, you could pay the 20% co-insurance in part B forever. And you could pay your share of the hospitalization costs, once you get beyond that 60 days, forever. There's no cap on how much you spend in any given year. Part C plans do cap that spending.

Harjes: Right, exactly, and that's something that's important to a lot of people, to have that safety and the assurance that your spending will be kept. 31% of Medicare beneficiaries are enrolled in Medicare Advantage. They can be very different, but in general, it'll cover stuff that Medicare doesn't. You can have hearing, vision, dental. There are a lot of things that aren't covered, surprisingly, by original Medicare that you can find a Medicare Advantage plan to cover.

Campbell: You're right. Hearing aids is a huge one that most of us are probably going to end up meeting at some point. And they can cost thousands of dollars, and you have to replace them every so often. And that's not covered by Medicare part A and part B. Part C plans, those Medicare Advantage plans, they can roll in dental coverage, they can roll in vision, all sorts of things. Of course, you'll have to pay a higher premium for those, but it gives you the flexibility to choose what kind of coverage you want.

Harjes: Exactly. If you know that listening to Industry Focus is a priority for the rest of your life, and you might need a hearing aid to do so, then you might want to consider this coverage.

Campbell: There are drawbacks, though, that we should probably touch on really quickly, on the Medicare Advantage plans. While they do give you more flexibility, and potentially more coverage, and a little bit more protection, most of them are set up as HMOs or PPOs, which means they have limited doctor networks, so you have to stay in the network, whereas if you're with original Medicare part A and part B, those restrictions don't apply. Anyone that takes Medicare, you can go see.

Harjes: Right, that's a good point, too. And that reminds me about the star rating system, which I don't think a lot of people know about. Essentially, your Medicare Advantage plans will get a star rating, which is given by the Medicare system itself. It lets you know which plans it thinks are the best. 

Campbell: Right, if you Google it, you can find out which one is the highest ranked. There are some advantages to being higher ranked for the insurers, so they'll try and get that five-star ranking. It's important to know just how highly ranked your plan is. I recommend everybody goes out and at least takes a look at that.

Harjes: Exactly. I want to move on, eventually, to some of the stocks in this space, and how investors can use this information. But first, I promised that we would talk about funding. We all, as in the workforce in the United States, pay 1.45% of our earnings into the Federal Insurance Contributions Act, which goes toward Medicare. Employers, meanwhile, pay another 1.45%, so you have a total of 2.9%. As an asterisk there, if you're self-employed, you pay the entire 2.9%. There's a portion of this pool that covers Social Security systems. It's interesting because that tax is actually only levied on the first $118,599 in your earnings for 2016. Interestingly, the Medicare tax is levied on every single penny that you earn. So, that's where this money comes from. Do you have anything to add?

Campbell: They way that they break that out -- this will be interesting for our listeners to know -- the general fund, or tax receipts, that covers the cost of Medicare part A. Part B, the way they break that out is it starts at 75% of the funding, roughly, comes from tax receipts, and 25% comes from the premiums that are charged to the recipients. But, that can climb, obviously, depending on income, because of the premium income adjustment. But, roughly 75-25 to begin.

Harjes: That is interesting. So, let's spin to some socks. I'll start by pitching Humana. They are one of the biggest Medicare players, they offer plans [in] all 50 states, they've been part of the program for over 30 years. Over 46% of Humana's 14 million members come from individual Medicare Advantage or Medicare part D plans. So, this is one easy way that you can invest in the space.

Campbell: UnitedHealth Group, they are a Goliath. Humana is a Goliath. These are big players in Medicare Advantage and the part D programs, and they're getting bigger every year, because remember, we have 76 million baby boomers, and they're turning 65 at a pace of 10,000 people per day. Anybody who's not opting for original part A and part B is theoretically providing additional revenue to these private insurers.

Harjes: Yeah, around $3 trillion each year is spent on healthcare in the U.S. And that's only growing. About $0.20 for each of those dollars supposedly comes from Medicare, which added up to about $587 billion in 2013. Meanwhile, that's expected to grow substantially. The Congressional Budget Office expects that net Medicare outlays will increase by 67% by the year 2024, which would bring it to $866 billion. Todd, as you mention, you have an aging population, you have healthcare becoming more expensive, and that does mean that Medicare spending is going up.

Campbell: Right. It's tough sometimes for investors, because we're trying to figure out, what's the purest way to invest in a particular area where we think that growth is going to be coming. In Medicare, it's difficult, because most of the large insurers are diversified private insurers. They're providing employer-sponsored insurance, they're participating in the Obamacare exchanges, they're running Medicare programs for various states, and then they're also doing these Medicare offerings, selling these Medicare plans. I think for investors who want to have that diversification across the entire health insurance industry, a company like United Healthcare can make a lot of sense. And then for people who might be interested in more of a pure play on Medicare, consider Humana, because Humana gets 73% of the revenue directly from Medicare-related products, so, part C and part D plans.

Harjes: United Health is a really interesting one, here. Their Medicare supplement numbers, and their Medicare Advantage, that's handled by OptumRx, and that has been a humongous driver of their revenue growth lately. If it keeps up with current pace at that growth, this OptumRx segment of the company could catch up to the non-Optum part. So, UNH is becoming more and more of a way to play Medicare.

Campbell: Right. It's a services and technology company, too. As we get to the point where we're trying to find out the best ways to provide the right treatment to the right patient at the right time, insurers are starting to play a larger and larger role in helping to accomplish that. That's obviously creating new revenue streams, and Optima is a great example of how that is playing out.

Harjes: Exactly. So, that's one route you can take -- looking at the insurers. Another way that an investor can look at this is dive into the figures that are published publicly about how and where Medicare spends most of its money. 14 drugs costs Medicare a billion dollars or more in 2013. These are for your chronic conditions like diabetes, depression, high cholesterol. Some of the names that stood out to me in this list, the first one was Nexium. Nexium was the costliest drug in 2013. It cost the system $2.5 billion to cover to 1.5 million Medicare patients that were being prescribed the drug. This is an AstraZeneca drug, although Pfizer introduced a generic back in 2015. If you look at the numbers for Nexium, it's still making quite a bit of money. That generic came out in February of 2015, the Nexium brand still brought in $2.5 billion for AstraZeneca in 2015. Even though this was down from 2014 numbers, this is still a drug that's very common among Medicare recipients. In 2015, it was still the second most expensive to the program.

Another one that stood out was Sovaldi, which we talked about a bunch on this show. This is Gilead's hepatitis C drug. This was actually, in 2014, the No. 1 biggest expense drug for Medicare, weighing in at $3.1 billion. That was to treat just 33,000 beneficiaries. That's compared to roughly 1.4 million for Nexium. So, interesting dynamics there.

Campbell: You know, what's interesting here, too, Kristine, for investors, we also have to remember that Medicare, yeah, there's a large population of elderly people, and they're obviously going to be demanding a certain amount of drugs. But these companies are not pure plays. And there's risks that could be associated with that. We've all seen in the news over the course of the last year, all this payer pushback that could lead to regulatory changes that put the kibosh on future price increases for drugs.

Harjes: Exactly. I think that actually segues nicely into how we should wrap up the episode, which is to say that with the upcoming presidential election, so much of this could be subject to change. You have two candidates right now that each have their own policy proposals, and there's really no way to predict exactly what's going to happen to Medicare going forward.

Campbell: Yeah. There are some common themes across the two major candidates. Both Clinton and Trump have said that they would like to have Medicare be able to negotiate directly with drugmakers. That's one thing. They both also suggested that they wouldn't be against allowing for the importation of drugs from cheaper countries into the United States, assuming, of course, that you could guarantee the safety and the authenticity of that medication. Clinton has some additional proposals, including expanding Medicare to people who are younger than 65, maybe people as early as 55 would be able to enroll in the program. She's also proposed some caps in out-of-pocket spending on drugs that could help Medicare patients. Meanwhile, Trump has said that he feels it's a third-rail topic, and we shouldn't be looking at reducing benefits to Medicare, we should probably leave it as it is from here.

Harjes: Right. So, it will definitely be an interesting thing to watch going forward. Every time we talk about politics, I feel like we have to mention that given that you can't predict these things, it's very difficult to try to [work] them in to your investing, and this sort of uncertainty touches just about every industry that there is. Unless you want to opt out of the stock market altogether, you have some sort of regulatory risk. But of course, with the pharmaceutical industry coming under such scrutiny lately, it's a hot topic in these presidential campaigns, and I'm sure we'll be hearing more on it from the two candidates as the election season goes forward. 

That about wraps up our show for today. I believe we're out of time. Todd, thank you so much, as always, for coming out. Folks, thanks for listening. As always, people on the program may have interests in the stocks that they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. For Todd Campbell, I'm Kristine Harjes. Thanks for listening, and Fool on!