Medicare Contracting Reform: Opportunities and Challenges in	 
Contracting for Claims Administration Services (28-JUN-01,	 
GAO-01-918T).							 
								 
Discussions about how to reform and modernize the Medicare	 
Program have, in part, focused on whether the structure that was 
adopted in 1965 is optimal today. In that context, questions have
been raised about whether the program could benefit from changes 
to the way Medicare's claims processing contractors are selected 
and the functions they perform. Medicare could benefit from full 
and open competition and its relative flexibility to promote	 
better performance and accountability. If legislation removes the
current limits on Medicare contracting authority, the Centers for
Medicare and Medicaid Services could (1) select contractors on a 
competitive basis from a broader array of entities capable of	 
performing needed program activities, (2) issue contracts for	 
discrete program functions to improve contractor performance	 
through specialization, (3) pay contractors based on how well	 
they perform rather than simply reimbursing them for their costs,
and (4) terminate poor performers more efficiently.		 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-01-918T					        
    ACCNO:   A01280						        
    TITLE:   Medicare Contracting Reform: Opportunities and Challenges
             in Contracting for Claims Administration Services                
     DATE:   06/28/2001 
  SUBJECT:   Claims processing					 
	     Health insurance					 
	     Contract administration				 
	     Medicare Program					 

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GAO-01-918T
     
Testimony Before the Subcommittee on Health and the Subcommittee on
Oversight and Investigations, Committee on Energy and Commerce, House of
Representatives

United States General Accounting Office

GAO For Release on Delivery Expected at 10: 30 a. m. Thursday, June 28, 2001
MEDICARE

CONTRACTING REFORM Opportunities and Challenges in Contracting for Claims
Administration Services

Statement of Leslie G. Aronovitz Director, Health Care- Program

Administration and Integrity Issues

GAO- 01- 918T

Page 1 GAO- 01- 918T

Messrs. Chairmen and Members of the Subcommittees: I am pleased to be here
today as you continue to consider how the Medicare program might be
modified. Discussions about how to reform and modernize Medicare have, in
part, focused on whether the structure that was adopted in 1965 is optimal
today. In that context, questions have been raised about whether the program
could benefit from changes to the way Medicare?s claims processing
contractors are selected and the functions they perform.

The original Medicare statute, along with subsequent regulations and
practices, limits how the program may contract for these services in ways
that differ from most federal contracts. There is no full and open
competition for the contracts; the agency is limited to choosing among
health insurers; contracts generally must cover the full range of claims
processing and related activities; and the agency is limited in its ability
to terminate contracts. The Health Care Financing Administration (HCFA),
recently renamed the Centers for Medicare and Medicaid Services (CMS), has,
since 1993, repeatedly proposed legislation to lift current contracting
restrictions in order to increase competition for these contracts and
provide more flexibility in how they are structured. 1 This year, the agency
again plans to seek such changes in order to improve program management.

To assist the Subcommittees as they consider ways to strengthen Medicare?s
program administration, my remarks today focus on our analysis of
contracting reform issues. Specifically, I will discuss (1) how reform might
help to address concerns that current contracting policy may impede
effective program management, and (2) challenges in implementing reform. My
comments are based on our prior and ongoing work related to strengthening
Medicare operations.

In summary, Medicare could benefit from full and open competition and its
relative flexibility to promote better performance and accountability. If
legislation removes the current limits on Medicare contracting authority,
CMS could (1) select contractors on a competitive basis from a broader array
of entities capable of performing needed program activities; (2) issue
contracts for discrete program functions to improve contractor

1 Our statement will continue to refer to HCFA where our findings apply to
the organizational structure and operations associated with that name.

Page 2 GAO- 01- 918T

performance through specialization; (3) pay contractors based on how well
they perform rather than simply reimbursing them for their costs; and (4)
terminate poor performers more efficiently.

Freeing Medicare from current contracting limitations is only the first step
in realizing potential benefits. Recent experiences with special contractors
for Medicare program safeguard activities provide useful lessons that the
agency could draw upon if it were free to use full and open competition.
These experiences also presage the challenges in achieving the potential
benefits of more flexible contracting authority. For example, CMS would need
to marshal its expertise to effectively use competitive bidding authority
and increased flexibility. It would need to carefully define the scope of
work in any new contracts and develop sound contractor selection criteria.
Transition to full and open competition for all contractors would need to be
phased in to ensure effective coordination of functions among all
contractors and to avoid disruption in service to beneficiaries and
providers. And, if contracts with financial incentives for high- quality
performance were used, CMS would need to develop adequate performance goals
and reliable measures to monitor and evaluate the extent to which contract
specifications were being met and awards earned.

Medicare is a federal health insurance program designed to assist elderly
and disabled beneficiaries. Hospital insurance, or part A, covers inpatient
hospital, skilled nursing facility, hospice care, and certain home health
services. Supplemental medical insurance, or part B, covers physician and
outpatient hospital services, laboratory and other services. Claims are paid
by a network of 49 claims administration contractors called intermediaries
and carriers. Intermediaries process claims from hospitals and other
institutional providers under part A while carriers process part B claims.
The intermediaries? and carriers? responsibilities include: reviewing and
paying claims; maintaining program safeguards to prevent inappropriate
payment; and educating and responding to provider and beneficiary concerns.

Medicare contracting for intermediaries and carriers differs from that of
most federal programs. Most federal agencies, under the Competition in
Contracting Act and its implementing regulations known as the Federal
Acquisition Regulation (FAR), 2 generally may contract with any qualified

2 48 CFR, Chapter 1. Background

Page 3 GAO- 01- 918T

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 FAR generally requires agencies to conduct full and
open competition for contracts and allows contractors to earn profits.

Medicare, however, is authorized to deviate from the FAR under provisions of
the Social Security Act enacted in 1965. 3 For example, there is no full and
open competition for intermediary or carrier contracts. Rather,
intermediaries are selected in a process called nomination by provider
associations, such as the American Hospital Association. This provision was
intended at the time of Medicare?s creation to encourage hospitals to
participate by giving them some choice in their claims processor. Currently,
there are three intermediary contracts, including the national Blue Cross
Blue Shield Association, which serves as the prime contractor for 26 local
member plan subcontractors. When one of the local Blue plans declines to
renew its subcontract, the Association nominates the replacement contractor.
Carriers are chosen by the Secretary of Health and Human Services from a
small pool of health insurers, and the number of such companies seeking
Medicare claims- processing work has been dwindling in recent years.

The Social Security Act also 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 but does not expressly
provide for profit. 4 Further, Medicare contractors cannot be terminated
from the program unless they are first provided with an opportunity for a
public hearing-- a process not afforded under the FAR.

3 Section 1816 addresses fiscal intermediaries and section 1842 addresses
carriers. 4 CMS has some limited authority to build financial incentives
into intermediary and carrier contracts. This authority was 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.

Page 4 GAO- 01- 918T

Medicare could benefit from various contracting reforms. Freeing the program
to directly choose contractors on a competitive basis from a broader array
of entities able to perform needed tasks would enable Medicare to benefit
from efficiency and performance improvements related to competition. It also
could address concerns about the dwindling number of insurers with which the
program now contracts. Allowing Medicare to have contractors specialize in
specific functions rather than assume all claims- related activities, as is
the case now, also could lead to greater efficiency and better performance.
Authorizing Medicare to pay contractors based on how well they perform
rather than simply reimbursing them for their costs, as well as allowing the
program to terminate contracts more efficiently when program needs change or
performance is inadequate, could also result in better program management.

Since Medicare was implemented in 1966, the program has used health insurers
to process and pay claims. Before Medicare?s enactment, providers feared
that the program would give the government too much control over health
care. To win acceptance, the program was designed to be administered by
health insurers like Blue Cross and Blue Shield. Subsequent regulations and
decades of the agency?s own practices have further limited how the program
contracts for claims administration services. The result is that agency
officials believe they must contract with health insurers to handle all
aspects of administering Medicare claims, even though the number of such
companies willing to serve as Medicare contractors has declined and the
number of other entities capable of doing the work has increased.

While using only health insurers for claims administration may have made
sense when Medicare was created, that may be much less so today. The
explosion in information technology has increased the potential for Medicare
to use new types of business entities to administer its claims processing
and related functions. Additionally, the need to broaden the pool of
entities allowed to be contractors has increased in light of contractor
attrition. Since 1980, the number of contractors has dropped by more than
half, as many have decided to concentrate on other lines of business. This
has left the program with fewer choices when one contractor withdraws, or is
terminated, and another must be chosen to replace it.

Since 1993, the agency has repeatedly submitted legislative proposals to
repeal the provider nomination authority and make explicit its authority to
Medicare Could

Benefit from Open Competition and Increased Flexibility

Ability to Contract With a Broader Array of Entities Would Expand CMS
Options

Page 5 GAO- 01- 918T

contract for claims administration with entities other than health insurers.
Just this month, the Secretary of Health and Human Services told the Senate
Finance Committee that CMS should be able to competitively award contracts
to the entities best qualified to perform these functions and stated that
such changes would require legislative action. With such changes, when a
contractor leaves the program, CMS could award its workload on a competitive
basis to any qualified company or combination of companies- including those
outside the existing contractor pool, such as data processing firms.

Allowing Medicare to have separate contractors for specific claims
administration activities- also called functional contracting- could further
improve program management. Functional contracting would enable CMS to
select contractors that are more skilled at certain tasks and allow these
contractors to concentrate on those tasks, potentially resulting in better
program service. For example, the agency could establish specific
contractors to improve and bring uniformity to efforts to educate and
respond to providers and beneficiaries, efforts that now vary widely among
existing contractors.

Currently, CMS interprets the Social Security Act and the regulations
implementing it as constraining the agency from awarding separate contracts
for individual claims administration activities, such as handling
beneficiary inquiries or educating providers about program policies. Current
regulations stipulate that, to qualify as an intermediary or carrier, the
contracting organization must perform all of the Medicare claims
administration functions. Thus, agency officials feel precluded from
consolidating one or more functions into a single contract or a few regional
contracts to achieve economies of scale and allow specialization to enhance
performance.

CMS has had some experience with functional contracting under authority
granted in 1996 to hire entities other than health insurers to focus on
Contracting for Specific

Functions Could Strengthen Service to Beneficiaries and Providers

Page 6 GAO- 01- 918T

program safeguards. 5 CMS has contracted with 12 program safeguard
contractors (PSC) who compete among themselves to perform taskspecific
contracts called task orders. 6 These entities represent a mix of health
insurers, including many with prior experience as Medicare contractors,
along with consulting organizations, and other types of firms. The
experience with PSCs, however, makes clear that functional contracting has
challenges of its own, which are discussed later in this testimony.

Allowing Medicare to offer financial incentives to contractors for
highquality performance also may have benefits. According to CMS, the Social
Security Act now precludes the program from offering such incentives because
it generally stipulates that payments be based on costs. Contractors are
paid for necessary and proper costs of carrying out Medicare activities but
do not make a profit. Repeal of cost- based restrictions would free CMS to
award different types of contracts-- including those that provide
contractors with financial incentives and permit them to earn profits. CMS
could test different payment options to determine which work best. If
effective in encouraging contractor performance, such contracts could lead
to improved program operations and, potentially, to lower administrative
costs. Again, implementing performance- based contracting will not be
without significant challenges.

5 This authority was granted under section 1893 of the Social Security Act
as amended. Program safeguard activities are intended to prevent and detect
fraudulent and abusive activities of providers and beneficiaries. These
activities include (1) medical review of claims to determine if they are for
covered, medically necessary and reasonable services, (2) reviews to
identify other primary sources of payment, (3) audits of cost reports
submitted by institutional providers to determine if costs are allowable and
reasonable, (4) identification and investigation of possible fraud cases,
and (5) provider education and training related to Medicare coverage
policies and appropriate billing practices.

6 HCFA developed an indefinite- delivery/ indefinite- quantity contract that
allowed it to select contractors and outline in broad terms the activities
to be performed. Each task order identifies a specific function to be
performed. For example, one task order involves conducting unannounced site
visits to selected community mental health centers to determine whether they
are complying with Medicare regulations. Offering Contractors

Payment Incentives Could Result in Greater Efficiencies

Page 7 GAO- 01- 918T

Allowing Medicare to terminate contractors more efficiently may also promote
better program management. The Social Security Act now limits the agency?s
ability to terminate intermediaries and carriers, and the provisions are
one- sided. Intermediaries and carriers may terminate their contracts
without cause simply by providing CMS with 180 days notice. CMS, on the
other hand, must demonstrate, that (1) the contractor has failed
substantially to carry out its contract or that (2) continuation of the
contract is disadvantageous or inconsistent with the effective
administration of Medicare. CMS must provide the contractor with an
opportunity for a public hearing prior to termination. Furthermore, CMS may
not terminate a contractor without cause as can most federal agencies under
the FAR.

In past years, the agency has requested statutory authority to eliminate the
public hearing requirement and the ability of contractors to unilaterally
initiate contract termination. Such changes would bring Medicare claims
administration contractors under the same legal framework as other
government contractors and provide greater flexibility to more quickly
terminate poor performers. Eliminating contractors? ability to unilaterally
terminate contracts also may help address challenges the agency faces in
finding replacement contractors on short notice.

While Medicare could benefit from greater contracting flexibility, time and
care would be needed to implement changes to effectively promote better
performance and accountability and avoid disrupting program services.
Competitive contracting with new entities for specific claims administration
services in particular will pose new challenges to CMS-- challenges that
will likely take significant time to fully address. These include preparing
clear statements of work and contractor selection criteria, efficiently
integrating the new contractors into Medicare?s claims processing
operations, and developing sound evaluation criteria for assessing
performance. Because these challenges are so significant, CMS would be wise
to adopt an experimental, incremental approach. The experience with
authority granted in 1996 to hire special contractors for specific tasks
related to program integrity can provide valuable lessons for CMS officials
if new contracting authorities are granted. CMS Needs to be Able to

Terminate Poor Performers More Efficiently

Contracting Reform Poses Many Implementation Issues

Page 8 GAO- 01- 918T

If given authority to contract competitively with new entities, CMS would
need time to accomplish several tasks. First among these would be
development of clear statements of work and associated requests for
proposals detailing work to be performed and how performance will be
assessed. CMS has relatively little experience in this area for Medicare
claims administration because current contracts instead incorporate by
reference all regulations and general instructions issued by the Secretary
of Health and Human Services to define contractor responsibilities. CMS has
experience with competitive contracting from hiring PSCs. It did take 3
years to determine how best to implement the new authority through its broad
umbrella contract, develop the statement of work, issue the proposed
regulations governing the PSCs, develop selection criteria, review
proposals, and select contractors. Program officials have told us they are
optimistic about their ability to act more quickly if contracting reform
legislation were enacted, given the lessons they have learned. However, we
expect that it would take CMS a significant amount of time to develop its
implementation strategy and undertake all the necessary steps to take full
advantage of any changes in its contracting authority. CMS took an
incremental approach to awarding its PSC task orders, and the same would be
prudent for implementing any changes in Medicare?s claims administration
contracting authorities.

Even after new contractors are hired, CMS should not expect immediate
results. The PSC experience demonstrates that it will take time for them to
begin performing their duties. PSCs had to hire staff, obtain operating
space and equipment, and develop the systems needed to ultimately fulfill
contract requirements-- activities that often took many months to complete.
Without sufficient start- up time, new contractors might not operate
effectively and services to beneficiaries or providers could be disrupted.

Developing a strategy for how to incorporate functional contractors into the
program and coordinate their activities is key. While there may be benefits
from specialization, having multiple companies performing different claims
administration tasks could easily create coordination difficulties for the
contractors, providers, and CMS staff. For example, between 1997 and 2000,
HCFA contracted with a claims administration contractor that subcontracted
with another company for the review of the Contracting With New

Entities Will Take Time and Require Careful Planning

Coordination Is Critical for Functional Contractors

Page 9 GAO- 01- 918T

medical necessity of claims before they were paid. 7 The agency found that
having two different contractors perform these functions posed logistical
challenges that could make it difficult to complete prepayment reviews
without creating a backlog of unprocessed claims.

The need for effective coordination was also seen in the PSC experience.
PSCs and the claims administration contractors need to coordinate their
activities in cases where the PSCs assumed responsibility for some or all of
the program safeguard functions previously performed by the contractors. In
these situations, HCFA officials had to ensure that active claims did not
get lost or ignored while in the processing stream.

Coordination is also necessary to ensure that new efficiencies in one
program area do not adversely affect another area. For example, better
review of the medical necessity of claims before they are paid could lead to
more accurate payment. This would clearly be beneficial, but could also lead
to an increase in the number of appeals for claims denials. Careful planning
would be required to ensure adequate resources were in place to adjudicate
those appeals and prevent a backlog.

CMS has not stated how claims administration activities might be divided if
the agency could do functional contracting. It would be wise for CMS to
develop a strategy for testing different options on a limited scale. In our
report on HCFA?s contracting for PSC services, we recommended, and the
agency generally agreed, that it should adopt such a plan because HCFA was
not in a position to identify how best to use the PSCs to promote program
integrity in the long term. 8

Taking advantage of benefits from competition and performance- based
contracting hinges on being able to identify goals and objectives and to
measure progress in achieving them. Specific and appropriate evaluation
criteria would be needed to effectively manage any new arrangements under
contracting reform. Effective evaluations are dependent, in part, upon clear
statements of expected outcomes tied to quantifiable measures and standards.
Because it has not developed such criteria for most of its

7 A claims administration contractor has the flexibility to subcontract
under section 1842 of the Social Security Act. 8 Medicare: Opportunities and
Challenges in Contracting for Program Safeguards (GAO- 01- 616, May 18,
2001). Experience Is Needed to

Develop Effective Evaluation Criteria

Page 10 GAO- 01- 918T

PSC task orders, we reported 9 that CMS is not in a position to effectively
evaluate its PSCs? performance even though 8 of the 15 task orders had been
ongoing for at least a year as of April 2001. If CMS begins using full and
open competition to hire new entities for other specific functions, it
should attempt to move quickly to develop effective outcomes, measures, and
standards for evaluating such entities.

Effective criteria are also critical if financial incentives are to be
offered to contractors. Prior experiments with financial incentives for
Medicare claims administration contractors generally have not been
successful. This experience raises concerns about the possibility for
success of any immediate implementation of such authority without further
testing. For example, between 1977 and 1986, HCFA established eight
competitive fixed- price- plus- incentive- fee contracts designed to
consolidate the workload of two or more small contractors on an experimental
basis. Contractors could benefit financially by achieving performance goals
in certain areas at the potential detriment of performance in other
activities. In 1986, we reported that two of the contracts generated
administrative savings estimated at $48 million to $50 million. 10 However,
the two contractors? activities also resulted in $130 million in benefit
payment errors (both overpayments and underpayments) that may have offset
the estimated savings. One of these contractors subsequently agreed to pay
over $140 million in civil and criminal fines for its failure to safeguard
Medicare funds.

Removing the contracting limitations imposed at Medicare?s inception to
promote full and open competition and increase flexibility could help to
modernize the program and lead to more efficient and effective management.
However, change will not yield immediate results, and lessons learned from
the experience with PSC contractors underscore the need for careful and
deliberate implementation of any reforms that may be enacted.

This concludes my statement. I would be happy to answer any questions that
either Subcommittee Chairman or Members may have.

9 GAO- 01- 616, May 18, 2001. 10 Medicare: Existing Contracting Authority
Can Provide for Effective Program Administration (GAO/ HRD- 86- 48, Apr. 22,
1986). Concluding

Observations

Page 11 GAO- 01- 918T

For further information regarding this testimony, please contact me at (312)
220- 7600. Sheila Avruch, Bonnie Brown, Paul Cotton, and Robert Dee also
made key contributions to this statement. GAO Contact and Staff

Acknowledgments

Page 12 GAO- 01- 918T

Medicare Management: Current and Future Challenges (GAO- 01- 878T, June 19,
2001).

Medicare: Opportunities and Challenges in Contracting for Program Safeguards
(GAO- 01- 616, May 18, 2001).

Major Management Challenges and Program Risks: Department of Health and
Human Services (GAO- 01- 247, Jan. 2001).

High Risk: An Update (GAO- 01- 263, Jan. 2001). Medicare: 21st Century
Challenges Prompt Fresh Thinking About Program?s Administrative Structure
(GAO/ T- HEHS- 00- 108, May 4, 2000).

Medicare Contractors: Further Improvement Needed in Headquarters and
Regional Office Oversight (GAO/ HEHS- 00- 46, Mar. 23, 2000).

Medicare: Program Safeguard Activities Expand, but Results Difficult to
Measure (GAO/ HEHS- 99- 165, Aug. 4, 1999).

Medicare Contractors: Despite Its Efforts, HCFA Cannot Ensure Their
Effectiveness or Integrity (GAO/ HEHS- 99- 115, July 14, 1999).

HCFA Management: Agency Faces Multiple Challenges in Managing Its Transition
to the 21st Century (GAO/ T- HEHS- 99- 58, Feb. 11, 1999).

Medicare: HCFA Faces Multiple Challenges to Prepare for the 21st Century
(GAO/ T- HEHS- 98- 85, Jan. 29, 1998).

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