Medicare Subvention Demonstration: DOD Costs and Medicare	 
Spending (31-OCT-01, GAO-02-67).				 
								 
The Balanced Budget Act of 1997 (BBA) authorized the Department  
of Defense (DOD) to conduct the Medicare subvention demonstration
for a three-year period. Under this demonstration, DOD formed	 
Medicare managed care organizations--collectively called TRICARE 
Senior Prime--at six sites that provided enrolled older military 
retirees the full range of Medicare-covered services as well as  
additional DOD-covered services, notably prescription drugs. The 
Medicare program was to pay for DOD for Medicare-covered care of 
the enrolled military retirees if DOD continued to spend on all  
aged military retirees at least as much as it had historically.  
Under the subvention demonstration, Senior Prime enrollees' care 
in 1999 cost DOD far more than the Medicare capitation rate that 
was established for the demonstration. This mostly resulted from 
enrollees' heavy use of medical services, although DOD coverage  
of prescription drugs--not included in the Mediare benefit	 
package--also contributed to its high costs of care. Without the 
demonstration, Medicare's spending in 1999 for retirees who	 
enrolled in Senior Prime would have been, on average, about 55	 
percent of the Senior capitation rate. The BBA payment rules	 
resulted in no Medicare payment to DOD in 1999. This was because 
they were designed to prevent the government from paying twice	 
for the same care--once through DOD appropriations and again	 
through Medicare. The rules also required that the payment be	 
adjusted to account for Senior Prime enrollees' health status.	 
These two rules resulted in Medicare paying DOD nothing for care 
provided in 1999.						 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-02-67						        
    ACCNO:   A02409						        
  TITLE:     Medicare Subvention Demonstration: DOD Costs and Medicare
Spending							 
     DATE:   10/31/2001 
  SUBJECT:   Health care costs					 
	     Health care programs				 
	     Managed health care				 
	     Retired military personnel 			 
	     Retirement benefits				 
	     DOD TRICARE Senior Prime Program			 
	     Medicare Choice Program				 
	     Medicare Program					 
	     DOD Medicare Subvention Demonstration		 
	     Program						 								 
	     DOD TRICARE Program				 
	     DOD TRICARE Prime Program				 
	     DOD TRICARE Standard Program			 
	     DOD TRICARE Extra Program				 

******************************************************************
** This file contains an ASCII representation of the text of a  **
** GAO Testimony.                                               **
**                                                              **
** No attempt has been made to display graphic images, although **
** figure captions are reproduced.  Tables are included, but    **
** may not resemble those in the printed version.               **
**                                                              **
** Please see the PDF (Portable Document Format) file, when     **
** available, for a complete electronic file of the printed     **
** document's contents.                                         **
**                                                              **
******************************************************************
GAO-02-67
     
Report to Congressional Committees

United States General Accounting Office

GAO

October 2001 MEDICARE SUBVENTION DEMONSTRATION

DOD Costs and Medicare Spending

GAO- 02- 67

Page i GAO- 02- 67 DOD Costs and Medicare Spending Under Subvention Letter 1

Results in Brief 2 Background 3 DOD?s Costs Per Person Outstripped
Medicare?s Capitation Rate

for Senior Prime 9 The Capitated Rate Exceeded What Medicare Would Have
Spent

on Senior Prime Enrollees Without the Demonstration 11 BBA Payment Rules
Resulted in No Medicare Payment to DOD 12 Concluding Observations 13 Agency
Comments 13

Appendix I DOD Cost Analysis 17 DOD Total Costs 17 DOD Per- Enrollee Costs
18

Appendix II Medicare Spending Analysis 22 Database Construction 22 Modeling
Methodology 24

Appendix III The Level of Effort Requirement and Medicare?s Final Payment to
DOD 26

Appendix IV Comments From the Department of Defense 28

Appendix V Comments From the Centers for Medicare and Medicaid Services 31

Appendix VI GAO Contacts and Staff Acknowledgments 32 GAO Contacts 32 Staff
Acknowledgments 32

Related GAO Products 33 Contents

Page ii GAO- 02- 67 DOD Costs and Medicare Spending Under Subvention Tables

Table 1: Enrollment at the Subvention Demonstration Sites Varied Widely 7
Table 2: Utilization Was Higher in 1999 for Senior Prime Enrollees

Than for Comparable Medicare Fee- for- Service Beneficiaries 11 Table 3:
Senior Prime Per- Enrollee Costs Exceed Its 1999

Capitation Rate 19 Table 4: Calculation of Medicare?s Final 1999 Payment to
DOD 27

Figure

Figure 1: Senior Prime Costs, Senior Prime Rate, and Medicare+ Choice Rate,
1999 10

Abbreviations

BBA Balanced Budget Act of 1997 CMS Centers for Medicare and Medicaid
Services DEERS Defense Enrollment Eligibility Reporting System DOD
Department of Defense DSH disproportionate share hospital GME graduate
medical education HCC Hierarchical Coexisting Conditions HCFA Health Care
Financing Administration HHS Department of Health and Human Services HMO
health maintenance organization IME indirect medical education LOE level of
effort MTF military treatment facility NMOP national mail order pharmacy

Page 1 GAO- 02- 67 DOD Costs and Medicare Spending Under Subvention

October 31, 2001 Congressional Committees The Balanced Budget Act of 1997 1
(BBA) authorized the Department of Defense (DOD) to conduct the Medicare
subvention demonstration for a 3year period. Under this demonstration, DOD
formed Medicare managed care organizations- collectively called TRICARE
Senior Prime- at six sites that provided enrolled older military retirees 2
the full range of Medicare- covered services as well as additional DOD-
covered services, notably prescription drugs. The Medicare program was to
pay DOD for Medicare- covered care of the enrolled military retirees if DOD
continued to spend on all aged military retirees (Senior Prime enrollees and
nonenrollees) at least as much as it had historically.

At the outset, subvention was expected to be beneficial for older military
retirees, the Medicare program, and DOD. After they turn 65, military
retirees remain eligible for hospital and physician care at military
treatment facilities (MTF), but only when space and medical staff are
available, because active duty personnel and other beneficiaries under age
65 have priority. 3 This ?space- available? care is not provided on a
regular and continuous basis, which older retirees often consider important.
Enrollment in Senior Prime gave enrollees higher priority for MTF care than
nonenrolled older military retirees. Subvention was also expected to be
beneficial for Medicare because, under the BBA, Medicare would pay DOD a
discounted capitation rate a fixed monthly payment for enrollees that would
be less than that paid to private plans serving other Medicare
beneficiaries. Subvention gave DOD the opportunity to test its ability to
deliver care to seniors efficiently, thereby providing expanded training
opportunities for its physicians and contributing to military readiness.

1 P. L. 105- 33, sec. 4015. 2 In this report ?older military retirees? and
?older retirees? refer to military retirees, their spouses, and dependents
who are aged 65 or older and are eligible for Medicare. 3 The context for
space- available care changed with the passage of the Floyd D. Spence
National Defense Authorization Act for Fiscal Year 2001 (P. L. 106- 398,
sec. 712). This legislation established a new program, known as TRICARE For
Life, which started October 1, 2001. Under this program, TRICARE is a
secondary payer to Medicare, paying nearly all beneficiary cost- sharing for
Medicare- covered services obtained from civilian providers.

United States General Accounting Office Washington, DC 20548

Page 2 GAO- 02- 67 DOD Costs and Medicare Spending Under Subvention

DOD could also gain by earning additional funds from Medicare to maintain
and improve military health care.

The BBA directed us to evaluate the demonstration?s implementation,
including its effects on DOD costs and Medicare spending. Specifically, this
report (1) examines the costs to DOD of Senior Prime enrollees, (2) compares
Medicare?s capitated rate to what Medicare would have spent on Senior Prime
enrollees without the demonstration, and (3) determines the impact of the
BBA?s payment rules for the demonstration on Medicare?s payments to DOD. 4

To address these issues, we analyzed DOD and Medicare data; interviewed
health care, budgeting, and program evaluation officials at DOD; and spoke
with Medicare officials.

Our analyses are based on 1999 data, the demonstration?s first full year of
operation. DOD costs and Medicare spending may differ in subsequent years.
See appendixes I and II, which describe our methods. We did not
independently verify DOD and Medicare data on enrollment, cost, and
utilization, and did not validate DOD?s method of allocating costs to Senior
Prime enrollees. We conducted our study from January 1999 through September
2001, in accordance with generally accepted government auditing standards.

Under the subvention demonstration, Senior Prime enrollees? care in 1999
cost DOD far more than the Medicare capitation rate that was established for
the demonstration. This mostly resulted from enrollees? heavy use of medical
services, although DOD?s coverage of prescription drugs not included in the
Medicare benefit package also contributed to its high costs of care. Health
conditions did not drive these high costs, since enrollees typically were
not sicker than comparable Medicare beneficiaries.

Without the demonstration, Medicare?s spending in 1999 for retirees who
enrolled in Senior Prime would have been, on average, 55 percent of the
Senior Prime capitation rate. One reason for this was that Senior Prime
enrollees were somewhat healthier than other Medicare beneficiaries with the
same demographic traits. The key factor, however, was that Medicare

4 A list of related GAO products is included at the end of this report.
Results in Brief

Page 3 GAO- 02- 67 DOD Costs and Medicare Spending Under Subvention

would have paid for only part of the enrolled retirees? care. MTFs would
have provided much of their care, which would not have been reflected in
Medicare?s spending on their behalf.

The BBA payment rules resulted in no Medicare payment to DOD in 1999. This
was because they were designed to prevent the government from paying twice
for the same care once through DOD?s appropriations and again through
Medicare. The rules also required that the payment be adjusted to account
for Senior Prime enrollees? health status. Together, these two requirements
resulted in Medicare paying DOD nothing for care provided in 1999. Even
without these two features of the payment rules Medicare still would have
paid DOD less than the monthly Senior Prime capitation rate of $320 per
person. This is because the BBA capped the Medicare payment for all
enrollees at $60 million for 1999 an amount that would have averaged $196
per month for each enrollee.

DOD and CMS reviewed a draft of this report and found its contents to be
generally accurate and appropriate. The agencies provided some updated
information and technical comments, which we incorporated as appropriate.

The military health system has three missions: (1) maintaining the health of
active- duty service members; (2) maintaining readiness the capability to
treat wartime casualties; and (3) providing care to the dependents of
active- duty personnel, retirees and their families, and survivors of
military personnel. In fiscal year 1999, DOD?s annual appropriations
included about $16 billion for health care, of which over $1 billion funded
the care of seniors.

In the mid- 1990s, DOD implemented the TRICARE framework for military health
care in response to rapidly rising costs and beneficiary concerns about
access to military care. Its goals were to improve beneficiary access and
quality while containing costs. TRICARE provides care through over 600 MTFs
and a network of civilian providers managed by outside contractors. TRICARE
offers three options: TRICARE Prime, a managed care option; TRICARE Extra, a
preferred provider option; and TRICARE Standard, a fee- for- service option.
TRICARE covers inpatient services, outpatient services such as physician
visits and lab tests, and skilled nursing facility and other post- acute
care. TRICARE also covers Background

Page 4 GAO- 02- 67 DOD Costs and Medicare Spending Under Subvention

prescription drugs, which are available at MTFs, through DOD?s national mail
order pharmacy (NMOP), and at civilian pharmacies. 5

Medicare is a federally financed health insurance program that covers health
care expenses of the elderly, some people with disabilities, and people with
end- stage kidney disease. Military retirees aged 65 or older are eligible
for Medicare on the same basis as civilian retirees. Medicare enrollees
receive part A benefits and are eligible for optional part B benefits if
they pay a monthly premium. 6

Under traditional Medicare, beneficiaries choose their own providers, and
Medicare reimburses those providers on a fee- for- service basis.
Beneficiaries who receive care through traditional Medicare are responsible
for paying a share of the costs for services. Most beneficiaries have
supplemental coverage that pays for many of the costs not covered by
Medicare. Major sources of this coverage include employer- sponsored health
insurance, ?Medigap? policies sold by private insurers to individuals, and
state Medicaid programs.

Beneficiaries have an alternative to traditional Medicare, the Medicare+
Choice option. Medicare+ Choice allows beneficiaries to enroll in private
managed care plans 7 and other types of health plans. 8 Managed care plans
provide all traditional Medicare benefits and typically offer additional
benefits, such as prescription drug coverage. Plan members generally pay
less out- of- pocket than under traditional Medicare. When choosing a plan,
beneficiaries must weigh these benefits against other features of managed
care. For example, beneficiaries enrolled in Medicare

5 A small copayment is required for prescriptions filled by mail order or at
civilian pharmacies, but not for prescriptions filled at MTFs. 6 Medicare
part A covers inpatient hospital care, skilled nursing facility care, home
health care following an inpatient or skilled nursing facility stay, and
hospice care. Medicare part B covers physician care, other outpatient
services, and home health services not covered by part A for beneficiaries
choosing to pay a monthly premium. In 1999 part A covered about 39 million
enrollees and part B covered 37 million enrollees.

7 In this report, ?managed care plans? refers to capitated plans, which
receive a fixed monthly payment for each Medicare beneficiary they serve-
regardless of the actual costs incurred in providing care to the
beneficiary.

8 In 1999, about 16 percent of Medicare beneficiaries were members of a
Medicare+ Choice plan. Medicare

Page 5 GAO- 02- 67 DOD Costs and Medicare Spending Under Subvention

managed care plans generally must use the physicians in a plan?s network and
often must obtain plan approval before they can see a specialist.

Older military retirees who enroll in Medicare+ Choice plans may choose to
supplement the care they receive through the plan with space- available care
provided by MTFs in their areas. The space- available care they receive
saves the plan money if it otherwise would have provided the care.
Similarly, MTF care provided to older retirees who are in traditional
Medicare reduces Medicare spending.

Today, there are about 1.5 million retired military personnel, dependents,
and survivors aged 65 or older residing in the United States who are
eligible for certain military health care services. About 600,000 of these
seniors live within about 40 miles of an MTF. Retirees have access to all
MTF and network services through TRICARE until they turn age 65 and become
eligible for Medicare. Subsequently, they can only use military health care
on a space- available basis, that is, when MTFs have unused capacity after
caring for younger beneficiaries. 9 In the 1990s, downsizing and changes in
access policies led to reduced space- available care throughout the military
health system. Some retirees aged 65 or older rely heavily on military
facilities for their health care, but most do not, and over 60 percent do
not use military health care facilities at all.

Sweeping changes in retiree benefits and military health care are occurring
in 2001 as a result of the Floyd D. Spence National Defense Authorization
Act for Fiscal Year 2001. This legislation gave older retirees two major
benefits:

 Pharmacy benefit. Beginning April 1, 2001, military retirees from the
uniformed services aged 65 or older have access to prescription drugs
through TRICARE?s NMOP and at civilian pharmacies, as well as through
pharmacies at MTFs. 10

 TRICARE eligibility. On October 1, 2001, older retirees enrolled in
Medicare part B became eligible for TRICARE coverage commonly

9 In addition, retirees aged 65 or older have historically been able to get
prescriptions filled at MTF pharmacies without charge. 10 Beneficiaries who
turned age 65 prior to April 1, 2001, automatically qualify for this
benefit. Those who turned age 65 on or after that date must be enrolled in
Medicare part B to obtain the pharmacy benefit. DOD Health Care for

Medicare- Eligible Military Retirees

Page 6 GAO- 02- 67 DOD Costs and Medicare Spending Under Subvention

termed TRICARE For Life. As a result, TRICARE is now a secondary payer for
these retirees? Medicare- covered services paying most of the required cost-
sharing. In addition, older retirees can enroll in TRICARE Plus a program
that provides MTF primary care. 11

The Medicare subvention demonstration permitted DOD to create managed care
organizations that participate in the Medicare+ Choice program and enroll
older retirees. Medicare may pay DOD for enrollees? care, but only after DOD
has spent an amount equal to what it has spent historically on care for all
older retirees. Under the demonstration, enrolled retirees receive their
Medicare- covered benefits and additional TRICARE benefits (notably
prescription drugs) through TRICARE Senior Prime, the DOD- run managed care
organizations set up by the demonstration. To be eligible for Senior Prime,
retirees must reside in one of the six geographic areas covered by the
demonstration, be enrolled in both Medicare part A and part B, and be
eligible for military health care benefits. They also must have either (1)
used a military treatment facility before July 1, 1997, or (2) turned age 65
on or after July 1, 1997.

Senior Prime is based on TRICARE Prime, DOD?s managed care program for
active- duty personnel, family members, and retirees under age 65. Although
DOD could charge enrollees a premium for Senior Prime, as any Medicare+
Choice organization can, it has chosen not to do so. Services can be
provided, at Senior Prime?s option, at an MTF or by a civilian network
provider. Copayments differ by where the service was provided. For example,
inpatient care is free at the MTF, but a copayment is charged for care at a
civilian hospital.

Senior Prime gives its members priority for treatment at MTFs over other
older military retirees (that is, nonenrollees). Like enrollees in private
Medicare managed care plans, Senior Prime enrollees agree that the plan will
be the sole source of their Medicare benefits. Enrollees who use civilian
providers without authorization are responsible for the full charge.

Senior Prime began delivering care at its first site in September 1998 and
was delivering care at all sites by January 1999. Sites differ in the
numbers of older retirees in their area and enrollment (see table 1), as
well as by

11 The number of enrollees is limited at each site according to capacity and
may not be available at all sites. The Medicare Subvention

Demonstration

Page 7 GAO- 02- 67 DOD Costs and Medicare Spending Under Subvention

geographic region, size of military health facility, and managed care
penetration in the local Medicare market.

Table 1: Enrollment at the Subvention Demonstration Sites Varied Widely Site
Eligible military

retirees a Enrollment b Percentage of

eligible military retirees enrolled

Colorado Springs (Colo.) 14,988 4, 121 27% Dover (Del.) 3,894 1,062 27%
Keesler (Miss.) 8, 309 3,507 42% Madigan (Wash.) 21,072 4, 674 22% San
Antonio c San Antonio Area (Tex.) 36,507 12,451 34% Texoma Area (Tex./
Okla.) 7, 693 2,541 33% San Diego (Calif.) 34,485 4, 751 14%

Total 126,948 33,107 26%

a Data are as of December 31, 2000, for all sites except Dover (as of June
30, 1998). b Data are as of December 31, 2000. c The BBA specifies six test
sites. Although DOD has designated San Antonio as a single site, for the
purpose of analysis we treat the San Antonio area and the Texoma area, which
are roughly 300 miles apart, as separate sites.

Source: TRICARE Senior Prime Plan Operations Report (Washington, D. C.: DOD,
Dec. 31, 2000). The number of eligible retirees (by site and total) is drawn
from DOD?s Defense Enrollment Eligibility Reporting System (DEERS).

The demonstration sites were not representative of all military health care
service areas. This was because sites? ability to support the demonstration
was a factor in site selection. Military health care resources were greater
in demonstration areas than in other military health care service areas. At
the start of the demonstration, about 80 percent of older retirees in the
demonstration areas lived near a military medical center- a teaching
hospital with multiple specialty clinics- whereas in service areas that were
not in the demonstration, only 30 percent of older retirees were served by a
nearby medical center.

The BBA authorized the demonstration for a 3- year period beginning on
January 1, 1998, and ending on December 31, 2000. The Floyd D. Spence
National Defense Authorization Act for Fiscal Year 2001 extended the
demonstration for another year- through 2001. DOD has announced that Senior
Prime will end on December 31, 2001, because the new TRICARE

Page 8 GAO- 02- 67 DOD Costs and Medicare Spending Under Subvention

For Life program will provide expanded health care coverage to older
military retirees.

In establishing the demonstration, the BBA also established rules for
Medicare to follow in paying DOD. The monthly Senior Prime capitation rate
was set at 95 percent of the Medicare+ Choice capitation rate, consistent
with a belief that DOD could provide care at lower cost than the private
sector. The rate was further adjusted by excluding the part of the Medicare+
Choice rate that reflects graduate medical education (GME) and
disproportionate share hospital (DSH) payments, 12 as well as a percentage
of payments made for hospitals? capital costs. The GME and capital costs
exclusions took into account the fact that GME and capital costs in the
military health system are funded by DOD appropriations, and the DSH
exclusion recognizes that DOD medical facilities do not treat the lowincome
patients for whom DSH payments compensate hospitals. The law directed the
Health Care Financing Administration (HCFA) 13 and DOD to determine the
amount of the capital adjustment, and the two agencies agreed to exclude
two- thirds of the capital costs reflected in the Medicare+ Choice rate.

The total amount that Medicare could pay DOD for the demonstration was
capped at $50 million in 1998, $60 million in 1999, and $65 million in 2000.
The BBA also required that participating MTFs maintain their ?level of
effort? (LOE). That is, they had to spend as much on care for older retirees
as they did prior to the demonstration before Medicare could make any
payment. This provision ensured that the government would not pay for the
same care twice- through both the DOD appropriations and Medicare. (Appendix
III explains how LOE works in practice and how Medicare?s final payment to
DOD is determined.)

12 GME payments cover Medicare?s share of teaching hospitals? expenses
incurred in training medical interns and residents. DSH payments assist
hospitals that treat a disproportionate number of uninsured and indigent
patients.

13 On June 14, 2001, the Secretary of Health and Human Services announced
that the name of HCFA had been changed to the Centers for Medicare and
Medicaid Services (CMS). In this report, we will continue to refer to HCFA
where our findings apply to the organizational structure and operations
associated with that name. Medicare Payments to

DOD for TRICARE Senior Prime

Page 9 GAO- 02- 67 DOD Costs and Medicare Spending Under Subvention

DOD?s costs of providing care to Senior Prime enrollees were considerably
higher in 1999 than what Medicare could pay Senior Prime or any other
managed care organization. This difference was not because Senior Prime
enrollees were sicker than other Medicare beneficiaries. Instead, it was
mostly due to Senior Prime enrollees? heavy use of services. A smaller part
of the difference reflected DOD?s coverage of prescription drugs.

Contrary to initial expectations, DOD was unable to provide care to
enrollees within the capitated rate. In 1999 DOD?s monthly costs for Senior
Prime members were $586 per person. 14 Senior Prime?s monthly capitated rate
was $320 per person- a difference of $266. (See fig. 1.) Even if DOD had
been paid the full Medicare+ Choice rate, the monthly difference would still
have been over $200 per person. 15

14 This amount includes overhead costs and prescription drug expenses. See
app. I. 15 The Senior Prime capitated rate was $63 lower than the Medicare+
Choice rate because the BBA set it at 95 percent of the Medicare+ Choice
rate, less some adjustments. DOD?s Costs Per

Person Outstripped Medicare?s Capitation Rate for Senior Prime

Page 10 GAO- 02- 67 DOD Costs and Medicare Spending Under Subvention

Figure 1: Senior Prime Costs, Senior Prime Rate, and Medicare+ Choice Rate,
1999

Source: GAO analysis of Medicare data and DOD data from SRA International,
Inc., Medicare Subvention Demonstration CY 1999 Reconciliation Processing,
San Antonio, Texas: March 2001.

Although part of the difference was due to DOD?s coverage of prescription
drugs, the main reason for the difference was Senior Prime enrollees? higher
utilization. Compared to similar Medicare fee- for- service beneficiaries,
enrollees were hospitalized 41 percent more often and had 58 percent more
outpatient visits. 16 (See table 2.) If Senior Prime had matched Medicare
fee- for- service utilization, its monthly costs would have dropped by more
than $150 per person. The higher utilization probably had several sources,
including lower cost- sharing by Senior Prime

16 See Medicare Subvention Demonstration: Greater Access Improved Enrollee
Satisfaction but Raised DOD Costs (GAO- 02- 68, October 31, 2001).

586 320

383

0 100

200 300

400 500

600 700 Dollars per person per month

Senior Prime costs

Senior Prime rate

Medicare+ Choice rate

Page 11 GAO- 02- 67 DOD Costs and Medicare Spending Under Subvention

enrollees and weak incentives to limit inappropriate utilization. However,
their separate impacts cannot be quantified.

Table 2: Utilization Was Higher in 1999 for Senior Prime Enrollees Than for
Comparable Medicare Fee- for- Service Beneficiaries

Utilization of Senior Prime enrollees

Utilization of comparable Medicare

fee- for- service beneficiaries a

Inpatient stays per 1,000 persons 367 261 Outpatient visits per person 16.7
10.6

a Fee- for- service utilization assuming Senior Prime health status and
demographics. See app. I. Source: GAO analysis of DOD and Medicare data.

Officials at several demonstration sites stated that Senior Prime enrollees
had high utilization because they were less healthy than other patient
groups. Although some sites had sicker enrollees than others, overall the
demonstration?s enrollees were not in poorer health than comparable Medicare
beneficiaries. In fact, they were somewhat healthier. 17

In contrast to the high utilization of services by Senior Prime enrollees,
Senior Prime?s drug coverage played a small role. Prescription drugs for
enrollees- not included in the Medicare benefit package- cost DOD on average
$55 per month per enrollee.

Without the demonstration, Medicare in 1999 would have spent 55 percent of
the Senior Prime capitation rate on retirees enrolled in Senior Prime. In
part, this was because Senior Prime enrollees were somewhat healthier- and
therefore somewhat less costly- than other Medicare beneficiaries with the
same demographic characteristics. However, the primary reason was that
Medicare would have paid for only part of their care. Much of their care
would have been provided by MTFs and would have been free to Medicare.

We estimate that, without the demonstration, Medicare would have spent on
the average enrollee $144 per month less than the Senior Prime rate. Most of
this difference reflects the care that fee- for- service beneficiaries

17 See app. I. The Capitated Rate

Exceeded What Medicare Would Have Spent on Senior Prime Enrollees Without
the Demonstration

Page 12 GAO- 02- 67 DOD Costs and Medicare Spending Under Subvention

would have received from MTFs- care that was free to Medicare. Enrollees who
before they enrolled in Senior Prime had been fee- forservice beneficiaries
would have cost Medicare $91 per month-$ 229 less than the Senior Prime
rate. By contrast, enrollees who were former health maintenance
organizations (HMO) beneficiaries would have cost Medicare, on average, the
full Medicare+ Choice capitation rate-$ 63 per month more than the Senior
Prime rate.

The BBA payment rules for the demonstration limited what Medicare could pay
DOD for care rendered to Senior Prime enrollees, reflecting the fact that
DOD had an additional source of funds for retiree health care- its
appropriations. Contrary to expectations, however, these rules resulted in
Medicare owing DOD nothing for the care provided to enrollees during 1999.

The BBA set a ceiling on Medicare?s payment to DOD, consistent with the
expectation that the payment might be sizable. In 1999 Medicare?s payment to
DOD was capped at $60 million for enrollee care. Because DOD allowed 30,228
retirees to enroll and provided them over 305,000 months of care in 1999,
the most that DOD could have been paid was $196 per enrollee per month, or
61 percent of the Senior Prime capitation rate which was $320 per month. Any
Medicare payment would have supplemented DOD?s appropriated funds.

The BBA payment rules resulted in Medicare actually paying DOD nothing for
care provided to Senior Prime enrollees during 1999. Under these rules, DOD
was required to spend as much as it had historically spent on all seniors in
the demonstration areas before it could be paid by Medicare. Otherwise, the
government would have paid twice for the same care- both through Medicare
and the DOD appropriations. The rules also required that the payment be
adjusted upward or downward according to whether Senior Prime enrollees were
sicker or healthier than comparable Medicare beneficiaries. 18 Together,
these two requirements resulted in Medicare owing DOD nothing.

DOD expenditures on care for all retirees (enrolled and not enrolled) in the
demonstration areas exceeded its level of effort requirement by $79 million.
These additional expenditures, which reflect DOD?s high

18 See app. III. BBA Payment Rules

Resulted in No Medicare Payment to DOD

Page 13 GAO- 02- 67 DOD Costs and Medicare Spending Under Subvention

utilization and high costs, were paid with appropriated health care funds.
Using these funds for Senior Prime meant that less was available for other
purposes.

Under the demonstration, Senior Prime enrollees? utilization of care was
substantially higher than that of comparable Medicare beneficiaries. As a
result, DOD?s costs were so high that the full Senior Prime capitation rate
could not have covered its costs.

Without the demonstration, Medicare would have spent less than the Senior
Prime capitation rate on enrollees. This would have occurred because
military retirees who used fee- for- service providers would have obtained
much of their care for free from MTFs and therefore would have cost Medicare
substantially less than the capitation rate.

The BBA rules prevented the government from paying twice for the same care
and protected the Medicare program from a large increase in its spending for
Senior Prime enrollees. However, DOD incurred greater costs for seniors due
to the demonstration and covered these costs by redirecting funds from other
uses.

DOD and CMS reviewed a draft of this report. DOD said that the report
adequately described the financial complexities it faced in implementing,
administering, and managing the Medicare subvention demonstration. However,
DOD found that the report addressed neither the details of the agreement
with CMS concerning LOE nor the annual reconciliation process that
determined the amount of Medicare?s final payment for Senior Prime care.
According to DOD, these features resulted in an extremely complicated
payment mechanism that was difficult for DOD managers to understand and
execute. In response to our reference to the high cost of DOD?s care, DOD
stated that a contributing factor to the high cost of care was the design of
the health care benefit provided by Senior Prime. The agency cited an
estimate by an actuarial consulting firm that the Senior Prime benefit was
worth $105 more per member per month than the typical Medicare+ Choice plan.
It stated that the burden of providing this benefit and the requirement to
maintain fiscal year 1996 Indirect Medical Education (IME) 19 rules made it
difficult for DOD to attain

19 IME is a component of Medicare payments to hospitals for training
physicians. Changes since 1997 in the rules governing IME reduced Medicare
payments to hospitals. Concluding

Observations Agency Comments

Page 14 GAO- 02- 67 DOD Costs and Medicare Spending Under Subvention

its LOE target. In response to our discussion of the effect of risk
adjustment on the final Medicare payment, DOD noted that the latest risk
adjustment calculation shows that the Senior Prime enrollee population is
healthier than the fee- for- service Medicare populations in the
demonstration areas. As a result, DOD received no payment from CMS for
Senior Prime care provided in 1999. Regarding our concluding observation
that DOD incurred greater costs to support Senior Prime and had to cover the
shortfall, the agency observed that the report does not state whether the
federal government as a whole spent more or less as a result of the
demonstration. Finally, DOD suggested that the Hierarchical Coexisting
Conditions (HCC) method 20 for determining beneficiaries? costliness may
have resulted in risk scores that overstated the health of the enrollees,
due to the HCC method?s use of ambulatory data, which in DOD?s case may be
incomplete and may also contain data coding errors.

In an earlier report, 21 we described in detail the LOE mechanism and the
annual reconciliation process that determines Medicare?s final payment. We
also noted in that report that the payment mechanism created uncertainty for
DOD managers. Concerning the burden placed on DOD in meeting the LOE
requirement, we observe that the Senior Prime benefit included both
Medicare- covered services and non- Medicare- covered services. The LOE
requirement applied only to Medicare- covered services, for which DOD
incurred high costs. We agree that maintaining the fiscal year 1996 IME
rules made it more difficult for DOD to meet its LOE requirement, but the
effect was very small. Regarding the 1999 final payment by Medicare to DOD,
the estimate in our draft report was based on preliminary information from
CMS and DOD. We have incorporated into the published report information from
the final accounting recently completed by the agencies that shows that
there was no payment by Medicare for DOD?s 1999 Senior Prime care. Although
the issue of whether the federal government as a whole spent more or less as
a result of the demonstration is outside of the scope of this report, our
analyses indicate that the demonstration?s impact on total federal costs for
the demonstration population was negligible. We share DOD?s concern about
the completeness and reliability of ambulatory care data, but doubt that
these data weaknesses had any substantial effect on the risk adjustment
calculation. We performed the risk adjustment calculation using a method

20 See app. I for a description of this method. 21 Medicare Subvention
Demonstration: DOD Data Limitations May Require Adjustments and Raise
Broader Concerns (GAO/ HEHS- 99- 39, May 28, 1999).

Page 15 GAO- 02- 67 DOD Costs and Medicare Spending Under Subvention

based only on inpatient data and obtained a result comparable to that
obtained using the HCC method.

CMS found the conclusions of the report to be appropriate. The agency noted
that our findings pertained to the initial phase of the demonstration. CMS
observed that start- up conditions in the first year of a demonstration may
affect the findings. The agency therefore recommended that we include a
statement noting that our results are from the initial phase of the
demonstration. We make a statement to this effect in the beginning of the
report. In addition, CMS noted that there were considerable problems
encountered with the DOD cost and use data. We were aware of the limitations
of DOD data during our analysis and have described them in appendix I.

CMS also suggested technical changes to the report, which we incorporated
where appropriate. DOD?s and CMS?s comments appear in appendixes IV and V,
respectively.

We are sending copies of this report to the Secretary of Defense and the
Administrator of the Centers for Medicare and Medicaid Services. We will
make copies available to others upon request.

If you or your staffs have questions about this report, please contact me at
(202) 512- 7114. Other GAO contacts and staff acknowledgments are listed in
appendix VI.

William J. Scanlon Director, Health Care Issues

Page 16 GAO- 02- 67 DOD Costs and Medicare Spending Under Subvention

List of Committees The Honorable Carl Levin Chairman The Honorable John
Warner Ranking Minority Member Committee on Armed Services United States
Senate

The Honorable Max Baucus Chairman The Honorable Charles E. Grassley Ranking
Minority Member Committee on Finance United States Senate

The Honorable Bob Stump Chairman The Honorable Ike Skelton Ranking Minority
Member Committee on Armed Services House of Representatives

The Honorable W. J. ?Billy? Tauzin Chairman The Honorable John D. Dingell
Ranking Minority Member Committee on Energy and Commerce House of
Representatives

The Honorable William M. Thomas Chairman The Honorable Charles B. Rangel
Ranking Minority Member Committee on Ways and Means House of Representatives

Appendix I: DOD Cost Analysis Page 17 GAO- 02- 67 DOD Costs and Medicare
Spending Under Subvention

This appendix summarizes the methods and data underlying our analysis of
Senior Prime financial issues. Specifically, we analyzed the effect of the
Medicare subvention demonstration on DOD?s total costs for enrolled and
nonenrolled retirees at the demonstration sites. In addition, we analyzed
DOD?s costs per Senior Prime enrollee because, under the demonstration?s
rules, the size of these costs has implications for the size of the payment
that DOD receives.

The total costs of the demonstration to DOD- its actual costs of caring for
enrollees and nonenrollees in the demonstration areas- have four components:

 MTF care. Most hospital stays and outpatient visits by Senior Prime
enrollees occurred in MTFs. We based our MTF cost calculations on DOD?s
allocation of the costs for an entire facility to the enrolled retirees.
This allocation of MTF costs is necessary because DOD?s cost accounting
systems do not record or generate cost data for each MTF patient. For the
demonstration MTFs, DOD extracted the facility costs from its accounting
system for MTF costs (the Medical Expense and Performance Reporting System).
Using an elaborate set of cost- allocation rules it had developed, 1 DOD
split an MTF?s costs of caring for all users- whether in Prime, Senior
Prime, or space- available care- between Senior Prime enrollees and all
other users.

 Civilian network care. Senior Prime also paid for enrollees? admissions to
civilian hospitals and visits to civilian physicians in the Senior Prime
network. These network providers submitted claims to TRICARE, which DOD
summed to obtain network costs of inpatient care and of outpatient care for
enrollees.

 Pharmacy. For enrollee prescriptions filled at civilian pharmacies, DOD?s
costs were recorded like other network claims. For prescriptions filled at
MTF pharmacies, DOD reported its costs based on data from local MTF pharmacy
information systems. For enrollees? prescriptions from DOD?s national mail
order pharmacy system, DOD extracted cost information from NMOP?s separate
information system.

1 This set of rules is known as DOD?s Medicare Patient Level Cost Allocation
algorithm. See Methodology for Allocating Expenses to Encounters in Military
Treatment Facilities for the Medicare Demonstration Projects, Director,
Health Services Analysis and Measurement, Health Services Operations and
Readiness, Office of the Assistant Secretary of Defense (Health Affairs),
January 1998. Appendix I: DOD Cost Analysis

DOD Total Costs

Appendix I: DOD Cost Analysis Page 18 GAO- 02- 67 DOD Costs and Medicare
Spending Under Subvention

 Administrative overhead. We used DOD?s figures for Senior Prime?s
administrative costs associated with its managed care support contractors.
DOD officials told us that DOD does not have a central system for collecting
and reporting the administrative costs of MTF care. As a result, our
estimate somewhat understates Senior Prime?s total overhead costs.

We calculated total costs to DOD of the demonstration for enrollees,
nonenrollees, and all older retirees. For enrollees, we calculated DOD?s
total costs by summing the MTF, network, pharmacy, and overhead costs
reported by DOD for 1999. For nonenrollees, we used the total cost estimates
reported by DOD for 1999. 2 To determine DOD?s total costs for all older
retirees, we summed the total costs of enrollees and nonenrollees at the
demonstration sites. To calculate the change in total cost for older
retirees (enrolled and nonenrolled) due to the demonstration, we compared
DOD?s 1999 health care costs for older retirees in the demonstration areas
to its historical LOE.

We analyzed DOD?s per- enrollee costs because they affect the size of
Medicare?s final payment to DOD even though they are not an explicit factor
in the calculation of this payment. 3

We calculated monthly costs per Senior Prime enrollee for 1999 as total
Senior Prime costs- MTF, civilian network, pharmacy, and administrative
overhead- divided by total member months in 1999. Total monthly costs per
enrollee for Senior Prime were $586. This represents the cost to DOD of
providing the combined Medicare and TRICARE Prime benefit package to Senior
Prime enrollees. In contrast, under the demonstration?s payment rules, in
1999 DOD was credited for Senior Prime enrollment at a Medicare capitation
rate of $320 per month per enrollee. 4 We found that DOD?s costs

2 Our enrollee and nonenrollee cost estimates are based on data in SRA
International, Inc., Medicare Subvention Demonstration CY 1999
Reconciliation Processing, San Antonio, Texas: March 2001. 3 Under the
demonstration?s payment rules, DOD?s final payment could have equaled the
1999 payment cap of $60 million if DOD?s per- enrollee costs had been lower-
for example, if they had exceeded the monthly Senior Prime capitation rate
by no more than 19.5 percent- and if DOD had spent the money saved on
increased care for nonenrollees.

4 This represents the risk- adjusted capitation rate that resulted from the
annual end- of- year reconciliation that determines the final payment from
Medicare to DOD. The unadjusted capitation rate would have been $337. DOD
Per- Enrollee

Costs DOD Costs Compared to Senior Prime Capitation Rate

Appendix I: DOD Cost Analysis Page 19 GAO- 02- 67 DOD Costs and Medicare
Spending Under Subvention

for delivering the Senior Prime benefit package (which includes prescription
drug coverage) to enrollees were over 80 percent higher than the Senior
Prime capitation rate.

DOD?s higher costs partly reflected Senior Prime?s coverage of prescription
drugs, but even net of drug expenses Senior Prime?s costs still were high.
Table 3 presents Senior Prime costs in three ways: the first (total costs)
is comprehensive and measures DOD?s costs of providing the Senior Prime
benefit package; the second measures DOD?s costs of providing the Medicare
benefit package, which does not include prescription drug coverage; 5 and
the third (in effect, medical claims) measures DOD?s costs of providing the
Medicare benefit package, net of the overhead costs associated with DOD?s
managed care support contractors for Senior Prime.

Table 3: Senior Prime Per- Enrollee Costs Exceed Its 1999 Capitation Rate
DOD?s Senior Prime per- enrollee costs Medicare capitation rate

for Senior Prime Monthly Annual Monthly Annual Total $586 $7,027 $320 $3,840

Less prescription drugs $531 $6,367 Less prescription drugs

and network overhead $483 $5,804 Source: GAO analysis of DOD data.

Even if one of the less comprehensive measures is selected, DOD?s costs for
Senior Prime enrollees were much higher than the Senior Prime capitation
rate. For example, the difference between the narrowest view of Senior Prime
costs (net of drugs and overhead) and the capitation rate is $1,964
annually.

We examined the relative health status of enrollees because people with
higher medical care costs are usually less healthy. Our analysis showed that
Senior Prime enrollees were healthier on average than their fee- forservice
counterparts. We used the HCC method to determine the costliness of each
beneficiary, based on that person?s clinical diagnoses

5 This second measure does not, however, adjust for the cost of certain
Senior Prime preventive care visits that are not part of the Medicare
benefit. Health Status of Senior

Prime Enrollees

Appendix I: DOD Cost Analysis Page 20 GAO- 02- 67 DOD Costs and Medicare
Spending Under Subvention

and demographic traits, relative to the average Medicare fee- for- service
beneficiary in the United States. 6 Beneficiaries with lower scores are
healthier than beneficiaries with higher scores, and the average Medicare
fee- for- service beneficiary in the United States has an HCC score of 1.00.
In 1999, Senior Prime enrollees had an average HCC score of 0.94 while
Medicare fee- for- service beneficiaries in the demonstration areas had an
average HCC score of 1.19. 7

We analyzed enrollees? relative utilization of services because people who
use more services generally have higher costs. In 1999, Senior Prime
enrollees averaged 0.367 inpatient stays per person and 16.7 outpatient
visits per person. To control for differences by age, sex, and health
status, we estimated a statistical model of inpatient utilization for
Medicare feefor- service beneficiaries in the demonstration areas. Using the
coefficients from this model, we projected the inpatient utilization for
fee- for- service beneficiaries with the same demographic and health traits
as Senior Prime enrollees. We also estimated a similar model for outpatient
utilization, which we used to project outpatient utilization for fee- for-
service beneficiaries with the same characteristics as Senior Prime
enrollees.

6 See Arlene S. Ash and others, ?Using Diagnoses to Describe Populations and
Predict Costs,? Health Care Financing Review, Spring 2000, 21: 3. 7 We used
the Medicare 20- percent sample of fee- for- service beneficiaries residing
in the official demonstration areas. We excluded Medicare+ Choice members,
military retirees, persons with end- stage renal disease, Medicaid
beneficiaries, persons with disabilities (under age 65), and people who lost
Medicare part A or part B entitlement for reasons other than death.
Comparing Senior Prime

Utilization and Medicare Fee- for- Service Utilization

Appendix I: DOD Cost Analysis Page 21 GAO- 02- 67 DOD Costs and Medicare
Spending Under Subvention

Our analysis showed that Medicare fee- for- service beneficiaries similar to
the Senior Prime enrollees would have averaged 0.261 inpatient stays per
person and 10.6 outpatient visits per person in 1999. 8 Consequently, we
found that Senior Prime enrollees were hospitalized 41 percent more often
than similar Medicare fee- for- service beneficiaries and had 58 percent
more physician and other outpatient visits than similar Medicare fee-
forservice beneficiaries.

8 To the extent possible, we counted Medicare and Senior Prime outpatient
visits the same way. For example, we excluded telephone consultations from
our count of Senior Prime outpatient visits. However, we were unable to
exclude certain Senior Prime preventive care visits that are not part of the
Medicare benefit.

Appendix II: Medicare Spending Analysis Page 22 GAO- 02- 67 DOD Costs and
Medicare Spending Under Subvention

This appendix summarizes the data and methods used in our analysis of
Medicare spending during the demonstration. We estimated what Medicare would
have spent without the demonstration for beneficiaries who- before they
enrolled in Senior Prime- were covered by Medicare fee- for- service. We did
this by projecting historical spending patterns of this population into the
demonstration period. We also calculated what Medicare would have spent on
Senior Prime enrollees who were previously members of managed care plans.

We constructed a database of monthly spending for Medicare beneficiaries
spanning January 1994 through December 1999. It included variables that made
it possible to aggregate the data for each month by demonstration site, age,
and sex, or any combination of these characteristics. We also included data
on (1) older military retirees at the eight control sites used in the RAND
evaluation of the demonstration 1 and (2) a sample of nondual eligibles-
Medicare beneficiaries not eligible for military health care- at both the
demonstration and RAND control sites.

Constructing the database involved four major steps: 1. Identifying the
Populations. To identify the population of Medicareeligible military
retirees, we obtained quarterly files 2 from DOD for the

period 1994 through 1999 that included all military retirees and their
dependents aged 65 or older who were eligible for military health care. We
matched a master list of these individuals to Medicare?s Enrollment Data
Base to produce a national file of all Medicare- eligible military retirees.
This file was used to create separate lists for the demonstration and RAND
control sites using Medicare data on beneficiaries? current and previous
residences.

To select comparison samples of Medicare beneficiaries not eligible for
military health care, we created a master list of all nondual eligibles for
each site. To do this, we matched a list of zip codes for the demonstration
and RAND control sites to Medicare?s annual master

1 DOD and HCFA contracted with the RAND Corporation to evaluate the
demonstration. DOD, HCFA, and RAND jointly selected the eight control sites
used in RAND?s evaluation. See Donna O. Farley and others, The First Year of
the Medicare- DoD Subvention Demonstration: Evaluation Report for FY 1999,
RAND Corporation, Contract Number MR1271.0-

HCFA, December 2000. 2 The source files are from DEERS. Appendix II:
Medicare Spending Analysis

Database Construction

Appendix II: Medicare Spending Analysis Page 23 GAO- 02- 67 DOD Costs and
Medicare Spending Under Subvention

lists of beneficiary characteristics and excluded the dual eligibles.
Finally, we selected a random sample of 30,000 beneficiaries for each site.
3

2. Determining Monthly Medicare Payments for Several Populations. We used
the list of older retirees and the sample of nondual eligibles at both the
demonstration and RAND control sites to extract all Medicare fee- for-
service claims for these individuals in the years spanning 1993 through
1999. 4 The payment amount of each claim was prorated among the months
spanning the beginning and end dates of the period during which the service
was provided. The prorated claims were then summed by month for each
beneficiary.

From the same lists of beneficiaries we also identified all former Medicare
HMO enrollees. 5 For each year spanning 1994 through 1999, we used HCFA?s
HMO rate calculation methodology to calculate the capitation rate for every
month during which a beneficiary was enrolled in a Medicare HMO. These data
were then merged with the monthly fee- for- service payments to create a
file of all Medicare payments by month.

3. Creating Variables That Describe Beneficiaries? Characteristics.

We created a separate file of monthly beneficiary characteristics from
Medicare and DOD data. These included age, sex, Medicare part A and part B
enrollment status, eligibility for DOD health care, and residence at a
demonstration or RAND control site. For Senior Prime enrollees we also added
variables indicating their monthly enrollment status, their Senior Prime
capitation rate, and the final Medicare payments to DOD per enrollee for
1998 and 1999.

4. Creating the Master File and Time- Series Variables. We created the
master file by merging the monthly beneficiary characteristics file with the
monthly Medicare payments file. We used the master file to

3 For Holloman Air Force Base in New Mexico we included all beneficiaries
not eligible for military health care because there were fewer than 30, 000
beneficiaries at this location. 4 Claims for 1993 were included so that a
complete history of prior- year spending could be constructed for 1994
through 1999. 5 As of 1999, Medicare HMOs have been part of Medicare+ Choice
and are referred to as Medicare+ Choice organizations.

Appendix II: Medicare Spending Analysis Page 24 GAO- 02- 67 DOD Costs and
Medicare Spending Under Subvention

create two time- series variables- average real 6 monthly Medicare payments
and the number of beneficiaries. For demonstration sites, these segments
included all enrollees, enrollees who were fee- forservice beneficiaries
before the demonstration, nonenrollees, and nondual eligibles. For the RAND
control sites, these segments included all older retirees and nondual
eligibles.

We used a standard statistical method (ordinary least- squares regression)
to estimate forecasting equations of average monthly real Medicare spending
for the population segments included in the database. A common feature of
time- series data is that each period?s value is likely to be correlated
with previous periods? values. We therefore used a standard correction in
our estimates to counteract the forecasting error that would otherwise be
introduced. 7

We assessed the forecasting accuracy of several alternative forecasting
equations. To do this, we estimated an equation for a shortened version of
the average spending series that omitted the 12 months preceding the
demonstration. This equation was then used to forecast the spending variable
for the omitted months. Finally, the actual spending during those months was
compared to the forecast. The equation with the best forecasting accuracy
has two independent variables- a time trend and average monthly real
Medicare payments for nondual eligibles.

We used this equation to estimate spending during the predemonstration
period for 1999 Senior Prime enrollees and nonenrollees. We tested the
forecasting accuracy of the equation using data from the RAND control sites.
In this case, the forecast period was the demonstration period itself
(September 1998 through December 1999). The resulting forecast error was 1.9
percent, indicating that the equation produces reasonable forecasts for a
comparable set of sites.

We used the forecasting equation to project the 1999 monthly average
Medicare spending for enrollees who were former fee- for- service
beneficiaries. We defined this population as enrollees who were not HMO

6 ?Real? indicates that payments are deflated by the consumer price index
for medical care. 7 This is known as a first- order autoregression
correction. Modeling

Methodology Forecasting Accuracy Spending for Former Feefor- Service
Beneficiaries

Appendix II: Medicare Spending Analysis Page 25 GAO- 02- 67 DOD Costs and
Medicare Spending Under Subvention

enrollees at any time during the 6- month period preceding their enrollment
in Senior Prime.

Appendix III: The Level of Effort Requirement and Medicare?s Final Payment
to DOD

Page 26 GAO- 02- 67 DOD Costs and Medicare Spending Under Subvention

The BBA required DOD to maintain its level of effort (LOE) in providing care
to older military retirees. That is, DOD must spend as much on care for
older retirees as it did historically before it could receive any payment
from Medicare. This provision ensured that the government would not pay for
the same care twice- through both the DOD appropriations and Medicare.

In establishing the LOE requirement, DOD and HCFA defined LOE as the amount
DOD spent on space- available care for retirees 65 and over in 1996- the
most recent year for which complete data were available. To receive Medicare
payments, DOD must exceed the 1996 LOE, which was approximately $172 million
for all the demonstration sites combined. The LOE threshold remained
constant throughout the demonstration with no adjustment for inflation.

In measuring DOD?s spending for the LOE test, care provided to Senior Prime
enrollees and to nonenrolled retirees are valued differently. According to
rules that DOD and HCFA agreed to, for each month a retiree is enrolled, DOD
is credited with the Senior Prime capitation rate regardless of the services
the retiree received. In 1999 this rule magnified the effect of the LOE
requirement because the Senior Prime rate was much less than what enrollees?
care cost DOD. The capitation rates are adjusted if there is ?compelling?
evidence that enrollees are healthier or sicker than their fee- for- service
Medicare counterparts. 1 Nonenrollees? care is credited at DOD?s estimated
cost of the actual Medicare- covered services they receive. In each year
Senior Prime enrollees? care must account for a minimum percentage of LOE-
30 percent in 1998, 35 percent in 1999, and 47.5 percent in 2000. In
principle, the entire LOE could be met by care provided to enrollees; there
is no required minimum amount for spaceavailable care provided to
nonenrollees.

If DOD meets its LOE and enrolled care requirements it receives a Medicare
payment equal to the difference between the amount credited for care
provided to all older retirees and the LOE requirement. If this amount

1 The HCC method is used to adjust payments for beneficiaries? care based on
their clinical diagnoses and demographic traits, relative to the average
Medicare fee- for- service beneficiary. HCFA and DOD agreed that if the
difference between the adjusted and unadjusted payments equaled or exceeded
2.5 percent of the unadjusted payments, then there is compelling evidence
that enrollees? health status differs from that of their Medicare
counterparts. Appendix III: The Level of Effort

Requirement and Medicare?s Final Payment to DOD

Appendix III: The Level of Effort Requirement and Medicare?s Final Payment
to DOD

Page 27 GAO- 02- 67 DOD Costs and Medicare Spending Under Subvention

is less than the spending cap specified in the BBA-$ 60 million for 1999-
then DOD gets the full amount; otherwise it gets the cap.

The payment rules resulted in Medicare owing DOD nothing for care provided
in 1999. Table 4 shows how this amount was calculated. DOD was credited $98
million for care provided to enrollees. This included an adjustment for the
health status of enrollees, who were found to be significantly healthier
than Medicare fee- for- service beneficiaries with the same demographic
characteristics. DOD was also credited $72 million for care provided to
nonenrollees, so the total credited amount of care provided to older
retirees was $170 million. This amount was then compared to the LOE
requirement of $172 million. Since DOD fell short of this target, the final
payment from Medicare was zero.

Table 4: Calculation of Medicare?s Final 1999 Payment to DOD

$72 million a Credit for providing care to nonenrollees (credited at DOD?s
cost) $98 million a Credit for providing care to

enrollees: $320 Senior Prime capitation rate

ï¿½ 305,456 member months

Credits for providing care to older retirees in the demonstration areas

$170 million a Total credit for providing care to older retirees in the
demonstration areas

Deduction for amount of care provided historically through DOD?s
appropriations

$172 million a LOE requirement $0 b Medicare payment to DOD a Dollars
rounded to the nearest million. b Since DOD fell short of the LOE target by
$2 million, the final payment from Medicare was zero.

Appendix IV: Comments From the Department of Defense

Page 28 GAO- 02- 67 DOD Costs and Medicare Spending Under Subvention

Appendix IV: Comments From the Department of Defense

Appendix IV: Comments From the Department of Defense

Page 29 GAO- 02- 67 DOD Costs and Medicare Spending Under Subvention

Appendix IV: Comments From the Department of Defense

Page 30 GAO- 02- 67 DOD Costs and Medicare Spending Under Subvention

Appendix V: Comments From the Centers for Medicare and Medicaid Services

Page 31 GAO- 02- 67 DOD Costs and Medicare Spending Under Subvention

Appendix V: Comments From the Centers for Medicare and Medicaid Services

Appendix VI: GAO Contacts and Staff Acknowledgments

Page 32 GAO- 02- 67 DOD Costs and Medicare Spending Under Subvention

Phyllis Thorburn, (202) 512- 7012 Jonathan Ratner, (202) 512- 7107

Contributors to this report were Eric Wedum, Martha Wood, Dae Park, Jessica
Farb, Robert DeRoy, Wayne Turowski, and Judy Chesley. Appendix VI: GAO
Contacts and Staff

Acknowledgments GAO Contacts Staff Acknowledgments

Related GAO Products Page 33 GAO- 02- 67 DOD Costs and Medicare Spending
Under Subvention

Medicare Subvention Demonstration: Greater Access Improved Enrollee
Satisfaction but Raised DOD Costs (GAO- 02- 68, October 31, 2001).

Medicare Subvention Demonstration: DOD?s Pilot Appealed to Seniors,
Underscored Management Complexities (GAO- 01- 671, June 14, 2001).

Medicare Subvention Demonstration: Enrollment in DOD Pilot Reflects Retiree
Experiences and Local Markets (GAO/ HEHS- 00- 35, Jan. 31, 2000).

Medicare Subvention Demonstration: DOD Start- up Overcame Obstacles, Yields
Lessons, and Raises Issues (GAO/ GGD/ HEHS- 99- 161, Sept. 28, 1999).

Medicare Subvention Demonstration: DOD Data Limitations May Require
Adjustments and Raise Broader Concerns (GAO/ HEHS- 99- 39, May 28, 1999).
Related GAO Products

(290027)

The General Accounting Office, the investigative arm of Congress, exists to
support Congress in meeting its constitutional responsibilities and to help
improve the performance and accountability of the federal government for the
American people. GAO examines the use of public funds; evaluates federal
programs and policies; and provides analyses, recommendations, and other
assistance to help Congress make informed oversight, policy, and funding
decisions. GAO?s commitment to good government is reflected in its core
values of accountability, integrity, and reliability.

The fastest and easiest way to obtain copies of GAO documents is through the
Internet. GAO?s Web site (www. gao. gov) contains abstracts and full- text
files of current reports and testimony and an expanding archive of older
products. The Web site features a search engine to help you locate documents
using key words and phrases. You can print these documents in their
entirety, including charts and other graphics.

Each day, GAO issues a list of newly released reports, testimony, and
correspondence. GAO posts this list, known as ?Today?s Reports,? on its Web
site daily. The list contains links to the full- text document files. To
have GAO E- mail this list to you every afternoon, go to our home page and
complete the easy- to- use electronic order form found under ?To Order GAO
Products.?

The first copy of each printed report is free. Additional copies are $2
each. A check or money order should be made out to the Superintendent of
Documents. GAO also accepts VISA and Mastercard. Orders for 100 or more
copies mailed to a single address are discounted 25 percent. Orders should
be sent to:

U. S. General Accounting Office P. O. Box 37050 Washington, D. C. 20013

To order by phone: Voice: (202) 512- 6000 TDD: (301) 413- 0006 Fax: (202)
258- 4066

GAO Building Room 1100, 700 4th Street, NW (corner of 4th and G Streets, NW)
Washington, D. C. 20013

Contact: Web site: www. gao. gov/ fraudnet/ fraudnet. htm, E- mail:
fraudnet@ gao. gov, or 1- 800- 424- 5454 (automated answering system).

Jeff Nelligan, Managing Director, NelliganJ@ gao. gov (202) 512- 4800 U. S.
General Accounting Office, 441 G. Street NW, Room 7149, Washington, D. C.
20548 GAO?s Mission

Obtaining Copies of GAO Reports and Testimony

Order by Mail or Phone Visit GAO?s Document Distribution Center

To Report Fraud, Waste, and Abuse in Federal Programs

Public Affairs
*** End of document. ***