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Medicare Drug Plan: What's Covered, What's Not

TheStreet.com Ratings explains what to expect from the government-sponsored prescription-drug plans.

For information on the basics of Medicare Part D, check out the first article in Gavin Magor's series here.

Medicare Part D's coverage can get confusing, but don't let it trip you up. You have too much to gain. The most important thing to understand is that the prescription drug benefit provides security and peace of mind, since your catastrophic drug costs are covered.

Even if you may not depend on medications now, it is crucial to view this new coverage as insurance protection against future prescription drug costs. The benefit is also appealing because the government pays for a good portion of the coverage for all beneficiaries.

There's an initial enrollment period that begins three months before the month someone meets the Medicare eligibility requirements, and ends three months after the month of eligibility. During this time, individuals may enroll in a Part D plan without penalty.

If you haven't signed up before your initial eligibility ends, you'll be faced with a 1% surcharge (based on the average national premium) that accrues each month that you delay signing up.

Levels of Coverage

There are basically four levels to the coverage:

Level 1 -- Deductible

: You will need to spend $275 on drugs before coverage kicks in; however, you'll most likely get your prescriptions at a lower price than you pay now, since a Part D provider will probably have negotiated discounts with suppliers.

Level 2 -- Deductible

: You will have to pay a partial amount of the next $2,235 in drug expenses you incur. In this level of the benefit, the government pays 75% of the costs, while you are responsible for 25%. The maximum you will have to pay is $558.75.

Level 3 -- Coverage Gap

: You will have to pay the full amount of the next $3,216 in drug costs you incur. Keep in mind that you'll likely pay lower rates for your drugs than you otherwise would, thanks to discounted prices your plan has negotiated.

Level 4 -- Catastrophic Coverage

: Once you have moved through levels 1 through 3, you will pay a maximum of 5% for any additional drug costs you need in that calendar year.

In a nutshell, once you have spent $4,050 out of pocket -- on $5,726 worth of drugs -- you will reach Level 4, where catastrophic coverage kicks in.

Let's go over a few scenarios of what you would pay and how much you would save, under the Standard Medicare Prescription Drug Benefit. As you'll see from these examples, as your costs rise, the savings of the new drug benefit can really add up.

In

Scenario A

, let's assume you spend $380 per month on prescriptions. That comes to $4,560 per year. With the Standard Medicare Prescription Drug Benefit:

You pay the Level 1 $275 deductible,

Plus the $558.75 co-insurance in Level 2.

Then in Level 3, you have $2,050 to pay.

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Your total annual costs add up to $2,883.75.

Compare that to the $4,560 you would have paid, for savings of $1,676.25.

In

Scenario B

, let's assume you spend $520 per month on prescriptions. That comes to $6,240 per year. With the Standard Medicare Prescription Drug Benefit:

You pay the Level 1 $275 deductible,

Plus the $558.75 co-insurance in Level 2.

Then in Level 3, you pay the full coverage gap amount of $3,216.

Once in Level 4, you pay 5% of any remaining costs, which would total $25.70.

Your total annual costs add up to $4,075.45.

Compare that to the $6,240 you would have paid, for savings of $2,164.55.

In Scenario C, let's assume you spend $760 per month on prescriptions. That comes to $9,120 per year. With the Standard Medicare Prescription Drug Benefit:

You pay the Level 1 $275 deductible,

Plus the $558.75 co-insurance in Level 2.

Then in Level 3, you pay the full coverage gap amount of $3,216.

Once in Level 4, you pay 5% of any remaining costs which would total $169.70.

Your total annual costs add up to $4,219.45.

Compare that to the $9,120 you would have paid, for savings of $4,900.55.

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Gavin Magor joined TheStreet.com Ratings in 2008, and is the senior analyst responsible for assigning financial strength ratings to health insurers and supporting other health care-related consumer products, including Medicare supplement insurance, long-term care insurance and elder care information. He conducts industry analysis in these areas. He has more than 20 years' international experience in credit risk management, commercial lending and analysis, working in the U.K., Sweden, Mexico, Brazil and the U.S. He holds a master's degree in business administration from The Open University in the U.K.