Coverage gap

What Is a Coverage Gap?

A coverage gap refers to a temporary limit on what an insurance policy will pay for certain health services or prescription drugs after a policyholder and their plan have spent a specific amount of money, but before they reach their out-of-pocket maximum. During this period, the policyholder is typically responsible for a larger percentage of their healthcare drug costs than in other phases of their benefit year. This concept is a significant component within healthcare finance and can impact an individual's financial planning.

History and Origin

The concept of a coverage gap gained widespread prominence with the introduction of the Medicare Part D prescription drug benefit in 2006, where it became widely known as the "donut hole." Under the initial design of Medicare Part D, beneficiaries would pay their deductible and then a portion of their drug costs (initial coverage period). Once combined spending reached a certain limit, they would enter the coverage gap, becoming responsible for a significantly larger share, often 100%, of their prescription drug costs until they reached a catastrophic threshold.⁷

The Patient Protection and Affordable Care Act (ACA) of 2010 initiated a gradual phase-out of this specific coverage gap. The ACA aimed to reduce the percentage beneficiaries paid in the gap, with the goal of closing it by 2020. This was achieved through various subsidies from drug manufacturers and the federal government.⁶

Key Takeaways

A coverage gap represents a temporary period in an insurance plan when the policyholder pays a higher percentage of their healthcare costs.
The most well-known example was the "donut hole" in Medicare Part D, which largely phased out by 2020.
During a coverage gap, standard coinsurance or copayment structures may be altered, leading to increased out-of-pocket expenses.
Understanding potential coverage gaps is crucial for effective financial planning and managing healthcare expenses.

Formula and Calculation

While there isn't a universal formula for "coverage gap" itself, the cost-sharing within a coverage gap phase of an insurance policy can be understood through the calculation of a policyholder's responsibility.

For a specific drug or service, if the price is ( P ), and the policyholder's coinsurance rate during the coverage gap is ( C_{gap} ), the amount the policyholder pays is:

$\text{Policyholder Payment} = P \times C_{gap}$

This contrasts with the initial coverage phase where the coinsurance rate, ( C_{initial} ), might be lower. The coverage gap is triggered once the sum of the deductible and costs paid by both the policyholder and the plan in the initial coverage period reaches a set limit. It ends when the policyholder's total out-of-pocket spending reaches the out-of-pocket maximum for a given benefit period.

Interpreting the Coverage Gap

Interpreting a coverage gap involves understanding the financial burden it places on individuals and its implications for access to necessary care. When a policyholder enters a coverage gap, their financial responsibility for medical services, particularly for pharmaceuticals, significantly increases. This can lead to difficult choices, where individuals might forgo essential medications or treatments due to high immediate costs. Even with the phase-out of the "donut hole" in Medicare Part D, the concept remains relevant in other forms of health insurance or as a conceptual phase within a plan's structure.

The significance of a coverage gap is directly proportional to the cost of care and the individual's income. A large gap can effectively make care unaffordable for those with limited resources, highlighting the importance of robust risk management in personal finance.

Hypothetical Example

Consider Jane, who has a health insurance plan with a $1,000 deductible, 20% coinsurance for the initial coverage period, and a $5,000 "coverage gap trigger" before catastrophic coverage kicks in. Her plan also has a $7,000 out-of-pocket maximum.

Deductible Phase: Jane pays 100% of her medical costs until she meets her $1,000 deductible.
Initial Coverage Phase: After meeting the deductible, Jane pays 20% coinsurance for her medical expenses, and her plan pays 80%. Suppose Jane incurs an additional $4,000 in medical costs. Her share is $800 (20% of $4,000), and the plan pays $3,200. Her total spending (deductible + coinsurance) is now $1,000 + $800 = $1,800. The total combined spending by Jane and her plan is $1,000 (Jane's deductible) + $4,000 (total service cost) = $5,000.
Entering the Coverage Gap: At this point, the combined spending ($5,000) hits the "coverage gap trigger." Now, for any further medical expenses, Jane's responsibility increases. Let's say during the gap, she is responsible for 50% of costs, instead of 20%. If she has another $1,000 in expenses, she would pay $500 (50% of $1,000).
Reaching Out-of-Pocket Maximum: Her total out-of-pocket spending is now $1,800 (from previous phases) + $500 (from the gap) = $2,300. She continues paying 50% in the gap until her cumulative out-of-pocket spending for the year reaches $7,000 (her out-of-pocket maximum). Once she hits $7,000, the plan covers 100% of her remaining eligible medical costs for the rest of the benefit period.

Practical Applications

While the most famous coverage gap in Medicare Part D has been largely eliminated, the concept still applies in other contexts where an individual's financial responsibility for care may temporarily increase.

Underinsured Populations: Individuals are considered underinsured if their health insurance doesn't adequately protect them from high healthcare costs. This can effectively create a personal coverage gap if their premiums, deductibles, or copayments are too high relative to their income, making care inaccessible even with coverage.
Medicaid Gaps: In states that have not expanded Medicaid under the Affordable Care Act, many low-income adults fall into a "Medicaid coverage gap." These individuals earn too much to qualify for traditional Medicaid but too little to qualify for subsidies to purchase private insurance on the Health Insurance Marketplace.⁵
Health Insurance Marketplace Plans: While plans on the Marketplace must cover "minimum essential coverage"⁴, the specific cost-sharing structures can still lead to situations where a person faces significant costs before their maximum out-of-pocket limit is reached.
Specialty Medications: For very high-cost specialty prescription drugs, even with typical insurance, patients might experience phases of higher proportional costs if their plan has tiered benefits or specific limits on certain drug categories.

Limitations and Criticisms

The primary criticism of coverage gaps, historically exemplified by the Medicare Part D "donut hole," centers on their potential to create significant financial hardship and deter individuals from accessing necessary medical care. When patients face unexpectedly high costs during a coverage gap, they may skip doses of medication, delay treatments, or forgo essential medical appointments, leading to poorer health outcomes and potentially higher costs in the long run.³

The original design of such gaps was often intended to control overall program costs. However, critics argued that this cost-saving measure merely shifted the financial burden to the most vulnerable patients, especially those with chronic conditions requiring expensive, ongoing pharmaceuticals. While legislative changes, particularly the Affordable Care Act, have significantly reduced or eliminated prominent coverage gaps like the Medicare Part D "donut hole" by 2020, situations where individuals are underinsured or face specific plan limitations can still result in similar financial barriers to care. As of January 1, 2025, the Medicare Part D coverage gap is officially eliminated, replaced by a $2,000 annual out-of-pocket spending cap for beneficiaries.²

Coverage Gap vs. Donut Hole

The terms "coverage gap" and "donut hole" are often used interchangeably, but "donut hole" specifically refers to the notorious coverage gap phase that existed within the Medicare Part D prescription drug benefit. The "donut hole" was a widely recognized colloquial term because of the characteristic shape of the coverage phases: initial coverage, followed by a gap where beneficiaries paid a higher share, and then catastrophic coverage where costs significantly decreased again.

While the "donut hole" described a very particular type of coverage gap in a government-sponsored program, the term coverage gap itself is a broader financial concept that can apply to any period in an insurance policy where the policyholder's cost-sharing responsibility temporarily increases significantly, typically after initial benefits are exhausted and before a higher level of coverage (like catastrophic coverage) or an out-of-pocket maximum is reached. Therefore, the "donut hole" was a specific instance of a coverage gap, but not all coverage gaps are "donut holes."

FAQs

What does "coverage gap" mean in health insurance?

A coverage gap in health insurance is a period during a policy's benefit period where your share of healthcare costs temporarily increases significantly after you've spent a certain amount, but before you reach your annual out-of-pocket limit.

Is the Medicare Part D "donut hole" still a thing?

No, the Medicare Part D "donut hole," or coverage gap, was gradually phased out by the Affordable Care Act and officially closed as of January 1, 2020. As of January 1, 2025, Medicare Part D includes a $2,000 annual out-of-pocket maximum, after which beneficiaries pay nothing for covered prescription drugs for the rest of the year.¹

How can I avoid a coverage gap?

While the most prominent coverage gap in Medicare Part D has been addressed, reviewing your health insurance plan's specific terms, including deductibles, coinsurance, and out-of-pocket maximums, is essential. Choosing a plan with lower cost-sharing or a more comprehensive insurance policy can help mitigate unexpected high costs.