Medicare: Comments on HHS' Claims Administration Contracting	 
Reform Proposal (17-AUG-01, GAO-01-1046R).			 
								 
The Department of Health and Human Services (HHS) submitted a	 
legislative proposal that would modify Medicare's contracting	 
authority. This report examines (1) the current law and practice 
in Medicare claims administration contracting,(2) provisions in  
the proposal that would increase HHS Centers for Medicare and	 
Medicaid Services' (CMS) contracting flexibility, and (3) the	 
provisions that deviate from standard federal contracting	 
requirements for full and open competition and indemnification of
contractors. Because of statutes and long-standing practices,	 
Medicare claims administration contracting does not follow	 
standard federal contracting rules in several ways. For example, 
federal agencies can generally terminate a contract at any time, 
but CMS cannot terminate contracts with Medicare claims 	 
administration contractors at the federal government's		 
convenience. The proposed legislation would give CMS the same	 
authority as other federal agencies to retain or terminate	 
contractors. These provisions would increase the agency's	 
flexibility to promote the contractor's performance and 	 
accountability. GAO is concerned, however, that the provisions	 
would also allow CMS to bypass federal contracting rules for full
and open competition. In addition, the proposal includes a	 
provision that would require CMS to indemnify claims		 
administration contractors from certain liabilities in a way that
creates a potential open-ended liability for the government while
reducing contractor accountability.				 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-01-1046R					        
    ACCNO:   A01627						        
  TITLE:     Medicare: Comments on HHS' Claims Administration	      
             Contracting Reform Proposal                                      
     DATE:   08/17/2001 
  SUBJECT:   Health care programs				 
	     Health insurance					 
	     Contract administration				 
	     Proposed legislation				 
	     Claims processing					 
	     Federal procurement				 
	     Accountability					 
	     Medicare Program					 

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GAO-01-1046R
     
GAO- 01- 1046R Medicare Contracting Reform Proposal United States General
Accounting Office

Washington, DC 20548

August 17, 2001 The Honorable Michael Bilirakis Chairman The Honorable
Sherrod Brown Ranking Minority Member Subcommittee on Health Committee on
Energy and Commerce House of Representatives

The Honorable Jim Greenwood Chairman The Honorable Peter Deutsch Ranking
Minority Member Subcommittee on Oversight

and Investigations Committee on Energy and Commerce House of Representatives

Subject: Medicare: Comments on HHS? Claims Administration Contracting Reform
Proposal

On June 28, 2001, I testified before your subcommittees that the Medicare
program could benefit from reformed claims administration contracting
authority and practice. 1 On the same day, the Secretary of Health and Human
Services (HHS) submitted a legislative proposal that would modify Medicare?s
contracting authority. You asked us to comment on whether the proposal gives
the Centers for Medicare and Medicaid Services (CMS) 2 -the agency within
HHS that manages Medicare- the flexibility to promote better performance and
accountability in its contracting activities. 3 Accordingly, this
correspondence discusses (1) current law and practice in Medicare claims
administration contracting, (2) provisions in the proposal that would
increase CMS? contracting flexibility, and (3) provisions that deviate from
standard federal contracting requirements for full and open competition and
indemnification of contractors.

In brief, due to statute and long- standing practice, Medicare claims
administration contracting does not follow standard federal contracting
rules in a number of ways.

1 Medicare Contracting Reform: Opportunities and Challenges in Contracting
for Claims Administration Services (GAO- 01- 918T, June 28, 2001). 2 CMS was
known until recently as the Health Care Financing Administration.

3 The Secretary has delegated authority to administer the Medicare program,
including managing claims administration contractors, to CMS.

GAO- 01- 1046R Medicare Contracting Reform Proposal 2 Medicare contractors
are chosen from among health insurers without full and open

competition- not from among all potentially qualified vendors. In addition,
CMS almost always uses cost- only contracts and is limited in its ability to
terminate contractors short of the full contract term, while the contractors
have greater rights to terminate during the contract year than other federal
contractors. The proposed legislation would modify Medicare law by providing
CMS with explicit authority to contract with any qualified entities to
perform any claims administration functions, reimbursing them through any
payment method permitted under federal contracting rules. It would also give
CMS the same authority as other federal agencies to retain or terminate
contractors. We believe these provisions would benefit the Medicare program
by increasing the agency?s flexibility to promote contractor performance and
accountability. However, we are concerned that certain provisions in this
legislative proposal would allow CMS to continue to bypass federal
contracting rules for Medicare claims administration in two ways. The
proposal would permit, but not require, the selection or renewal of claims
administration contractors through full and open competition. In addition,
the proposal includes a provision that would require CMS to indemnify claims
administration contractors from certain liabilities in a way that creates a
potential open- ended liability for the government while reducing contractor
accountability.

In commenting on a draft of this correspondence, CMS generally agreed with
us on the benefits of the proposal, but was concerned that requiring full
and open competition for these contracts on a regular schedule- such as
every 5 years-- might be too burdensome. In addition, CMS did not agree that
the provisions on indemnification in the Secretary?s proposal created an
open- ended liability and pointed to existing statutory provisions as
precedence for providing the type of indemnification proposed.

BACKGROUND Medicare is a health insurance program for about 40 million
beneficiaries- people aged 65 years and older, some disabled people under 65
years of age, and people with end- stage renal disease, which is permanent
kidney failure treated with dialysis or a transplant. About 85 percent of
beneficiaries are enrolled in the traditional program and receive their
health care on a fee- for- service basis, while the rest are enrolled in
prepaid health plans that contract with the government to receive monthly
payments in exchange for providing needed Medicare services to enrollees.
Medicare part A services include inpatient hospital, skilled nursing
facility, and certain home health and hospice care, while part B services
include physician and outpatient hospital services, and certain other
medical services, such as clinical laboratory, outpatient physical and
occupational therapy services, and durable medical equipment and supplies.

To process and pay claims for services in the traditional program, CMS has
49 contracts with insurance companies called fiscal intermediaries and
carriers. Fiscal intermediaries process claims from hospitals and other
institutional providers under

GAO- 01- 1046R Medicare Contracting Reform Proposal 3 part A while carriers
process claims for physicians and other health care providers

under part B. CLAIMS ADMINISTRATION CONTRACTING DEVIATES FROM STANDARD
FEDERAL CONTRACTING IN SEVERAL WAYS

Contracting for Medicare claims administration services by fiscal
intermediaries and carriers differs from that of most federal programs.
Under the Competition in Contracting Act of 1984 (CICA) and its implementing
regulations, known as the Federal Acquisition Regulation (FAR), 4 federal
agencies generally may contract with any qualified entity for any authorized
purpose, so long as that entity is not debarred from government contracting
and the contract is not for what is essentially a government function.
Agencies are to use contractors that have a track record of successful past
performance or that demonstrate a current superior ability to perform. The
CICA, as implemented by the FAR, generally requires agencies to conduct full
and open competitions, because the Congress recognized that such competition
generally resulted in the government receiving the best value for products
or services it acquires. The FAR also allows contractors to earn profits and
requires that contractors perform until the end of the contract term.

In contrast, since Medicare's establishment in 1965, the Secretary of Health
and Human Services has been authorized by statute to select contractors to
process Medicare claims under parts A and B without competition. When
Medicare was established, there was concern about whether the federal
government should be involved in medical decision- making and had the
expertise to process large numbers of what would essentially be health
insurance claims. The Medicare statute permits entities with experience
processing these types of claims, which have generally been health insurance
companies, to perform this role for Medicare. In addition, Medicare gave
hospitals a role in selecting their claims processor. Under section 1816( a)
of the Social Security Act (SSA), if provider associations nominate fiscal
intermediaries to process part A claims for them, the Secretary is
authorized to contract with those entities without competition. 5 Soon after
Medicare was established, the American Hospital Association nominated the
BlueCross BlueShield Association to process hospital claims. 6 In regard to
physician and other part B claims, Section 1842( b)( 1) of the SSA provides
that the Secretary may enter into contracts with carriers to process part B
claims without following the usual requirements related to requests for
proposals or "any other provision of law requiring competitive bidding.? 7

The Secretary was authorized to contract with entities that were existing
payers of health care services. Thus, the Secretary began and has continued
to contract with such entities- almost exclusively health insurers-
including the BlueCross

4 48 C. F. R., Chapter 1. 5 42 U. S. C. 1395h( a). 6 The Association
subcontracts with 26 member plans to process part A claims in different
states or

regions of the country. 7 42 U. S. C. 1395u( b)( 1).

GAO- 01- 1046R Medicare Contracting Reform Proposal 4 BlueShield Association
on behalf of its member companies. The statutory language

authorizing the Secretary to contract for Medicare claims administration
described a set of activities or functions to be performed. Claims
administration contractors have generally been expected to perform all of
these functions, except where the Congress has given explicit authority to
the Secretary to contract separately for a claims administration function,
as it did in 1996. 8

Furthermore, the Social Security Act generally calls for the use of cost-
based reimbursement contracts, under which contractors are reimbursed for
necessary and proper costs of carrying out Medicare activities. However,
these contracts do not expressly provide for profit. 9 Therefore, CMS has
long paid claims administration contractors only for their incurred costs
and generally has not offered them the type of fee incentives used in other
federal procurement contexts.

Unlike standard federal contracting rules, sections 1816 and 1842 explicitly
limit CMS? flexibility and options regarding termination of claims
administration contracts. Although federal agencies can generally terminate
a contract at any time, CMS cannot terminate contracts with Medicare claims
administration contractors at the federal government?s convenience. 10 On
the other hand, claims administration contractors may terminate their
contracts without penalty by providing the Secretary with 180 days notice.
11

PROPOSED LEGISLATION WOULD GIVE CMS NEEDED CONTRACTING FLEXIBILITY

The Secretary?s legislative proposal would give CMS flexibility to better
manage its contractors and their performance. It would grant CMS express
authority to contract with any qualified entity for parts A and B claims
administration. This would include qualified entities that were not health
insurers. Further, the intermediary nomination process under section 1816(
a) would be eliminated and the proposal would provide explicit authority for
CMS to enter into contracts for the performance of specific functions.

8 For example, the Health Insurance Portability and Accountability Act of
1996 gave the Secretary explicit authority to contract separately for
program safeguard activities, such as medical review of claims to ensure
that the services were medically necessary. 9 CMS has some limited authority
to build financial incentives into intermediary and carrier contracts.

This authority was first granted under section 2326( a) of the Deficit
Reduction Act of 1984 and made permanent by section 159 of the Social
Security Act Amendments of 1994. 10 CMS contracts with poorly performing
claims administration contractors may be terminated only

after providing the contractor with 90 days notice and an administrative
hearing if the contractor requests one. In contrast, under the FAR,
contracts may be terminated when a contractor fails to remedy a performance
problem within 10 days (unless extended by the agency) after receiving an
agency notice specifying the problem. 11 This is an option not normally
available to federal contractors. Under the FAR, federal contractors

are liable for breach of contract if they fail to perform or fail to make
progess meeting time frames specified in the contract.

GAO- 01- 1046R Medicare Contracting Reform Proposal 5 Under the proposal,
CMS would also be able to use incentive- based payment methods

available to other agencies to compensate contractors. The Secretary could
use cost reimbursement contracts that could include the payment of fees in
addition to cost or any other arrangements permitted under standard federal
contracting rules. The proposed legislation would also eliminate a
contractor's ability to terminate a contract unilaterally. 12 All of these
provisions are consistent with standard federal contracting requirements.

PROPOSED LEGISLATION WOULD ALLOW, BUT NOT REQUIRE, FULL AND OPEN COMPETITION

While the provisions discussed above are important, we are concerned that
the proposal might not result in CMS fully benefiting from an improved
contractor selection process. The proposal would not require that CMS
initiate or complete a move to exclusive use of full and open competition to
select claims administration contractors. As a result, CMS could continue to
select claims administration contractors noncompetitively, without being
required to use a selection process that is consistent with standard federal
contracting requirements.

The FAR provides agencies with detailed rules governing the procedures to be
used in the competitive procurement process. Among other things, the FAR
provides that federal agencies generally must compete contracts at least
every 5 years and may unilaterally terminate them at any time. Officials at
CMS are experienced with these FAR requirements because the agency generally
uses full and open competition to select contractors that provide it with
goods and services other than the administration of Medicare claims.

Although the proposal states that competitive contracting procedures should
be used when hiring claims administration contractors, it does not require
such procedures to be put in place within a given time frame. In addition,
under this legislative proposal, the Secretary would retain authority to
deviate from the FAR?s competition requirements when initiating and renewing
its claims administration contracts. Specifically, subsection (2)( i) would
permit the Secretary to enter into initial claims administration contracts
without full and open competition. In addition, subsection (2)( h) would
permit the Secretary to renew claims administration contracts without
requiring competition when the contractor has met or exceeded contract
performance requirements.

Provisions that allow CMS to deviate from FAR in its initial selection of
contractors and reallocation of work could permit postponing the
introduction of competition indefinitely. We recognize that transition from
the current arrangement to competitive selection is apt to be difficult and
potentially disruptive to providers and beneficiaries. For these reasons, as
we noted in our testimony, sufficient time should

12 The proposal would also repeal the provision requiring the government to
offer the contractor a hearing before a contract could be terminated.

GAO- 01- 1046R Medicare Contracting Reform Proposal 6 be allotted for the
transition to fully competitive contracts for all of Medicare?s claims

administration workload. Medicare?s claims administration contractors
currently pay about 900 million claims each year to nearly 1 million
hospitals, physicians, and other health care providers billing the program.
Given this massive workload, moving to competitively- selected contractors
will need to be done in stages so that in the future CMS will be able to
stagger its contract competitions and not have to compete all of its
workload in the same year. Nevertheless, we believe that there needs to be a
definite beginning and ending date for this transition.

INDEMNIFICATION PROVISIONS COULD CREATE OPEN- ENDED LIABILITIY FOR THE
FEDERAL GOVERNMENT

Our review of the proposed legislation has also raised concerns regarding
its indemnification provisions. Generally under an indemnification
agreement, one party promises, in effect, to reimburse another party?s
losses or expenses. Absent express statutory authority, an agency generally
may not enter into an agreement to indemnify where the amount of the
government?s liability is indefinite, indeterminate, or potentially
unlimited. An agreement to do that would violate both the Antideficiency
Act, 32 U. S. C. sect.1341, and the Adequacy of Appropriations Act, 41 U. S. C.
sect.11 because it can never be said that sufficient funds have been
appropriated to cover an unlimited liability.

However, subsection (2)( f) of the proposed legislation would require, among
other things, that the Secretary pay all reasonable expenses incurred by a
claims administration contractor in connection with the defense of any civil
suit, action, or proceeding so long as the contractor exercised due care.
While it appears that the proposed language attempts to limit liability, for
example, by the use of such modifiers as ?reasonable amount of expenses
incurred, as determined by the Secretary,? it would create an open- ended,
potentially unlimited liability. The Congress has rarely authorized this
type of open- ended liability and the Secretary has not explained the need
for claims administration contractors to receive such an unusual benefit.

If legislation were to be enacted to require indemnification in this
context, a more prudent approach would be to clearly limit CMS? liability.
Because federal agencies are seldom authorized to indemnify their
contractors, another alternative is to cover the cost to contractors for
private insurance against potential liability. This approach would need to
be studied to see if it would be a cost- effective alternative for Medicare
claims administration contracting.

In conclusion, due to statutory language and current practice, Medicare
claims administration does not follow standard federal contracting
requirements. The Secretary's legislative proposal has provisions that we
believe would be beneficial to the Medicare program, such as giving the
Secretary express authority to contract with any qualified entity for claims
administration and to use payment methods and termination procedures
currently routine at other federal agencies. However,

GAO- 01- 1046R Medicare Contracting Reform Proposal 7 because the provisions
that would permit CMS to continue contracting without

competition and require CMS to provide open- ended indemnification do not
follow standard federal contracting requirements, we believe that those
provisions should be modified.

AGENCY COMMENTS AND OUR EVALUATION We provided CMS with a draft of this
correspondence for comment. In its written comments (see enclosure I), CMS
agreed that the Secretary?s proposal would increase its contracting
flexibility and emphasized the agency?s intention to move to full and open
competition in contracting for Medicare claims administration services. CMS
stated that the proposal would initially permit it to enter into new
noncompetitive contracts and it must use full and open competitive
procedures thereafter. However, agency officials expressed concern that
requiring competition on a regular schedule- such as every 5 years- would be
difficult and potentially disruptive.

It is not clear to us, however, that a contractor successfully performing
its duties would ever have to compete in a full and open competition under
the Secretary?s proposal. This is because subsection (2)( i) would permit
the Secretary to enter into initial claims administration contracts without
full and open competition as well as renew claims administration contracts
without requiring competition when the contractor has met or exceeded
contract performance requirements. While we agree that CMS needs time to
make the transition to full and open competition, without a requirement to
move to competitive procurements within a specified time frame, the agency
could avoid such competition indefinitely. In addition, without a
requirement to compete these contracts periodically, Medicare would not
realize the full benefits of competition.

CMS also took issue with our characterization of the provision indemnifying
contractors? against legal costs of civil suits as open- ended and
inappropriate for the Medicare program. CMS pointed out that within the
Medicare program, there is statutory precedent for indemnifying contractors,
because the proposed language regarding contractors? indemnification was
modeled on similar provisions applicable to peer review organizations. CMS
officials stated that the indemnification provision is essential to ensuring
competition in their future contracting efforts. They also asserted that it
was likely to be far less expensive to indemnify the contractors than to
cover the costs of insuring them against the full risks associated with the
legal costs of third party claims. While we recognize that there may be a
precedent within the Medicare program, 13 we remain concerned that the
wording of the provision to indemnify contractors for the ?reasonable? costs
of defending against third party suits is too broad and exposes the
government to potentially unlimited liability. The agency would need to
explore whether paying for private insurance to cover the legal expenses of
suits would be cost- effective.

13 42 U. S. C. 1320c- 6 (d).

GAO- 01- 1046R Medicare Contracting Reform Proposal 8 CMS also stressed the
importance of providing a federal limitation on contractors?

liability with respect to third party claims. Under this provision for
limitation on civil liability in the Secretary?s proposal, as long as
contractors exercise due care in performing Medicare duties, a third party
lawsuit cannot proceed against them. This provision is also part of the
statutory framework for peer review organizations, and has been referenced
in statutory provisions pertaining to the Medicare Integrity Program. 14 We
do not take issue with the limitation on civil liability, which would
provide contractors with strong protection against suits by third parties,
at no cost to the government, so long as they exercised due care in the
performance of their responsibilities.

CMS also provided technical comments, which we incorporated as appropriate.
_ _ _ _ _ As agreed with your offices, unless you publicly announce its
contents earlier, we plan no further distribution of it until 30 days from
the date of this letter. At that time, we will send copies to the Secretary
of Health and Human Services and other interested parties. The letter will
also be available on GAO?s home page at http:// www. gao. gov. Please
contact me at (312) 220- 7600 or Sheila K. Avruch at (202) 512- 7277 if you
or your staff have any questions. Stefanie Weldon and Craig Winslow made key
contributions to this correspondence.

Leslie G. Aronovitz Director, Health Care- Program

Administration and Integrity Issues Enclosure

14 42 U. S. C. 1395ddd( e).

GAO- 01- 1046R Medicare Contracting Reform Proposal 9 Enclosure I: Comments
from the Centers for Medicare and Medicaid Services

GAO- 01- 1046R Medicare Contracting Reform Proposal 10

GAO- 01- 1046R Medicare Contracting Reform Proposal 11

GAO- 01- 1046R Medicare Contracting Reform Proposal 12 (290110)
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