Medicare+Choice: Reforms Have Reduced, but Likely Not Eliminated, Excess
Plan Payments (Letter Report, 06/18/1999, GAO/HEHS-99-144).

The Medicare+Choice program was created in 1997 to expand beneficiaries'
health plan options, both by encouraging the wider availability of
health maintenance organizations and by permitting other types of health
plans, such as preferred provider organizations, to participate in
Medicare. At the same time, the methodology used to determine plan
payments was changed, in part because of concerns that (1) many health
plans were overcompensated for the beneficiaries they served and (2)
Medicare's managed care program had not, as originally expected, saved
the program money. The new methodology is designed to both slow the
growth of aggregate payments and more closely align per capita payments
with the expected health care costs of plan members. Some health plan
and industry representatives believe that these payment changes were too
severe and will reduce beneficiaries' access to plans and additional
benefits, such as outpatient prescription drug coverage, that are
unavailable under fee-for-service plans. This report (1) reviews the
extent to which health plans now provide additional benefits and whether
they could continue to provide additional benefits if payments were
reduced, (2) summarizes the evidence about managed care's effect on
Medicare spending, and (3) assesses whether the provisions of the
Balanced Budget Act will eliminate excess plan payments.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  HEHS-99-144
     TITLE:  Medicare+Choice: Reforms Have Reduced, but Likely Not
	     Eliminated, Excess Plan Payments
      DATE:  06/18/1999
   SUBJECT:  Health care programs
	     Managed health care
	     Health insurance
	     Health maintenance organizations
	     Overpayments
	     Medical services rates
	     Health insurance cost control
	     Cost analysis
IDENTIFIER:  Medicare Choice Program
	     Medicare Program
	     Medigap
	     Medicare Risk Contract Program
	     Medicare Fee-for-Service Program

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    United States General Accounting Office GAO                Report
    to Congressional Requesters June 1999          MEDICARE+CHOICE
    Reforms Have Reduced, but Likely Not Eliminated, Excess Plan
    Payments GAO/HEHS-99-144 GAO    United States General Accounting
    Office Washington, D.C. 20548 Health, Education, and Human
    Services Division B-282937 June 18, 1999 The Honorable Daniel
    Patrick Moynihan Ranking Minority Member Committee on Finance
    United States Senate The Honorable John D. Dingell Ranking
    Minority Member Committee on Commerce House of Representatives The
    Honorable Fortney (Pete) Stark Ranking Minority Member
    Subcommittee on Health Committee on Ways and Means House of
    Representatives The Balanced Budget Act of 1997 (BBA) created the
    Medicare+Choice program to expand beneficiaries' health plan
    options, both by encouraging the wider availability of health
    maintenance organizations (HMO) and by permitting other types of
    health plans, such as preferred provider organizations, to
    participate in Medicare. BBA also modified the methodology used to
    determine plan payments, in part because of concerns that (1) many
    health plans were overcompensated for the beneficiaries they
    served and (2) Medicare's managed care program had not, as
    originally anticipated, saved the program money. The new
    methodology is designed to both slow the growth of aggregate
    payments and more closely align per capita payments with the
    expected health care costs of plan members. BBA's creation of
    Medicare+Choice represents one important means of helping to
    address the growing challenge of financing the Medicare program.
    The Congressional Budget Office (CBO) has estimated that BBA's
    fee-for-service (FFS) and Medicare+Choice reforms will lower
    program spending by $386 billion over the next 10 years. Some
    health plan and industry representatives believe that BBA's health
    plan payment changes were too severe and will reduce
    beneficiaries' access to plans and additional benefits, such as
    outpatient prescription drug coverage, that are not available
    under FFS. The American Association of Health Plans (AAHP)
    contends that Medicare will spend substantially less on health
    plan enrollees than for FFS beneficiaries, a discrepancy it terms
    a "fairness gap." To assist congressional consideration of these
    concerns, Page 1                         GAO/HEHS-99-144 Payments
    to Medicare+Choice Plans B-282937 you asked us to (1) review the
    extent to which health plans currently provide additional benefits
    and whether they could continue to provide additional benefits if
    payments were reduced, (2) summarize the evidence regarding
    managed care's effect on Medicare spending, and (3) assess whether
    BBA provisions will eliminate excess plan payments. To answer
    these questions we analyzed data that plans submitted to the
    Health Care Financing Administration (HCFA) and synthesized
    findings from our previous reports and studies by HCFA, CBO, and
    others. Our work was done from May to June 1999 in accordance with
    generally accepted government auditing standards. Results in Brief
    Although all health plans are required to provide at least the
    package of benefits available in traditional FFS, most plans
    provide many more benefits-such as coverage for outpatient
    prescription drugs, routine physical exams, and dental care.1 The
    extra benefits result, in part, because projected Medicare
    payments tend to exceed plans' estimated costs of providing the
    FFS package of benefits, and the program requires that the
    difference between payments and plan costs be used to fund
    additional benefits.2 Data submitted by health plans indicate that
    they were required, on average, to provide additional benefits
    equivalent to nearly 13 percent of Medicare's payments in 1997.
    For competitive reasons, many health plans voluntarily enrich
    their benefit packages beyond Medicare's requirements. In 1997,
    the average enrollee in a health plan received more than $90 per
    month in required and voluntary additional benefits. Thus, even if
    plan payments were reduced, the typical plan could provide the FFS
    package of benefits as well as some additional benefits and still
    earn a profit. Health plans have not, however, produced the
    expected savings for the Medicare program. Until 1997, Medicare
    plans were paid 95 percent of the expected FFS cost of
    beneficiaries. The 5-percent discount was established to allow the
    program to benefit from the efficiencies commonly associated with
    managed care. However, numerous studies conducted by us, the
    Physician Payment Review Commission (PPRC)-which has been
    incorporated into the Medicare Payment Advisory Commission-HCFA,
    and others demonstrated that the Medicare program spent more on
    1Except where otherwise noted, this report uses the term "plan" to
    refer to organizations that receive a fixed monthly payment-known
    as a capitation payment-for each beneficiary they enroll
    regardless of that beneficiary's costs. Before BBA created the
    Medicare+Choice program, these organizations were known as risk-
    contract HMOs. 2Plans can provide additional benefits in the
    contract year or contribute to a stabilization fund, which the
    plan can draw on in future years to avoid fluctuations in its
    benefit package. Page 2
    GAO/HEHS-99-144 Payments to Medicare+Choice Plans B-282937
    beneficiaries enrolled in health plans than it would have if the
    same individuals had been in FFS. This unexpected result occurred
    because Medicare payments were based on the estimated cost of FFS
    beneficiaries in average health and were not adequately adjusted
    to reflect the fact that plans tended to enroll beneficiaries with
    better-than-average health who had lower health care costs-a
    phenomenon known as favorable selection. BBA's new formula for
    paying health plans-implemented in 1998-takes steps to lower, but
    probably not eliminate, excess plan payments. Among other changes,
    the new formula slows the growth of plan payment rates relative to
    FFS spending growth for 5 years. More importantly, BBA mandates
    the implementation of a health-based "risk adjustment" system
    intended to better match payments to beneficiaries' expected
    health care costs and reduce the excess payments caused by
    favorable selection. The effect of these changes is reduced,
    however, because BBA locked in place the excessive payment rates
    that existed in 1997. For example, when HCFA actuaries set 1997
    payment rates, they based those rates on a forecast of 1997 FFS
    spending. The actuaries now know that those rates were too high
    because the forecast overestimated FFS spending by 4.2 percent.
    However, BBA specified that the 1997 rates be used as the basis
    for the 1998 rates. This implicit inclusion of the forecast error
    resulted in excess payments of $1.3 billion in 1998. Furthermore,
    the annual excess payments associated with the forecast error will
    increase each year as more beneficiaries join health plans.
    Background    As of June 1, 1999, about 6.9 million people-or
    approximately 18 percent of Medicare's 39 million beneficiaries-
    were provided care through managed care plans, most of which are
    capitated health plans.3 Capitated plans receive a fixed monthly
    amount for each beneficiary, regardless of what individual
    enrollees' care actually costs. The remaining 82 percent receive
    health care on an FFS basis, under which providers are paid for
    each covered service they deliver to beneficiaries. Inherent in
    Medicare's FFS program is an incentive for providers to deliver
    more services than necessary, driving up program costs.
    Policymakers have, therefore, looked to managed care-namely, the
    use of capitated plans-to curb unnecessary spending because these
    plans have a financial incentive to provide care efficiently. In
    fact, among BBA's major reforms to 3About 90 percent of the 6.9
    million Medicare beneficiaries were enrolled in managed care plans
    that receive fixed monthly capitation payments. The remainder were
    enrolled in plans that are reimbursed for the costs they incur,
    less the estimated value of beneficiary cost-sharing. Page 3
    GAO/HEHS-99-144 Payments to Medicare+Choice Plans B-282937 contain
    Medicare spending was the creation of Medicare+Choice, which was
    intended to increase the plan options available to Medicare
    beneficiaries. Before BBA changed the rate-setting process in
    1998, the monthly amount Medicare paid plans for each plan member
    was directly tied to local spending in the FFS program. In general
    terms, the pre-BBA rate-setting methodology worked as follows.
    Every year, HCFA estimated how much it would spend in each county
    to serve the "average" FFS beneficiary. It would then discount
    that amount by 5 percent under the assumption that the managed
    care plans provided care more efficiently than the unmanaged FFS
    program. The resulting amount constituted a base county rate to be
    paid to the plans operating in that county. Because some
    beneficiaries were expected to require more health services than
    others, HCFA "risk adjusted" the base rate up or down for each
    beneficiary, depending on certain beneficiary characteristics-
    specifically, age; sex; eligibility for Medicaid; employment
    status; disability status; and residence in an institution, such
    as a skilled nursing facility.4 BBA substantially changed the
    method used to set the payment rates for Medicare plans. As of
    January 1, 1998, plan payment rates for each county are based on
    the highest rate resulting from three alternative methodologies: a
    minimum amount, a minimum increase over the previous year's
    payment rate, or a blend of historical FFS spending in a county
    and national average costs adjusted for local price levels. The
    changes were intended to address criticisms of the original
    payment system by loosening the link between local FFS spending
    increases and plan payment rate increases in each county. In
    addition, the establishment of a minimum payment rate was meant to
    encourage plans to offer services in areas that historically have
    had low payment rates and few participating plans-primarily rural
    counties. BBA also directed the Secretary of Health and Human
    Services to develop and implement a better risk-adjustment system
    based on beneficiary health status by January 1, 2000. 4Separate
    rates are calculated for beneficiaries who qualify for Medicare
    because of a disability (under age 65) and the aged. Separate
    rates are also set for beneficiaries with end-stage renal disease
    (kidney failure). Page 4
    GAO/HEHS-99-144 Payments to Medicare+Choice Plans B-282937
    Medicare+Choice        For many beneficiaries, health plans cost
    less than traditional FFS and offer Plans Provide          a more
    comprehensive benefit package. For example, beneficiaries in plans
    often pay a small copayment each time they use an outpatient
    Additional Benefits    service but are generally not responsible
    for the deductibles and Because Medicare       coinsurance amounts
    they would pay in FFS. The out-of-pocket cost for a plan enrollee
    is often lower than the premium for a supplemental, or Payments
    Exceed        Medigap, insurance policy-another way that
    beneficiaries obtain Plans' Costs           increased coverage.
    The trade-off is that beneficiaries must generally use only plan-
    approved providers and abide by other plan rules to receive
    covered services. More than two-thirds of all beneficiaries live
    in areas served by at least one health plan. About 85 percent of
    these beneficiaries could enroll without paying a separate monthly
    premium, and 88 percent have access to a plan that provides
    coverage for outpatient prescription drugs.5 All, or nearly all,
    beneficiaries who could join a plan have access to a plan that
    offers coverage for routine physical, eye, and hearing exams. Many
    of these beneficiaries have access to a plan that also provides
    dental care. One reason for the enhanced benefit packages is that
    plans' estimated cost of providing the traditional FFS benefit
    package-including the amount of profit normally earned on
    commercial contracts-tends to be lower than Medicare's projected
    payment.6 Under Medicare's payment terms, when a plan's estimated
    cost to provide the FFS package of benefits is less than projected
    payments, the plan must use the difference-an amount known as
    "savings"-to enhance its benefit package by adding benefits or
    reducing cost-sharing.7 In 1997, plans' savings averaged nearly 13
    percent of payments. Consequently, plans were required to provide
    additional benefits worth $60 per member per month. Although the
    relationship between plans' costs and their Medicare payments may
    have changed since 1997, our analysis of 1999 data 5Beneficiaries
    who wish to participate in the Medicare+Choice program must pay
    the Medicare part B premium of $45.50 per month. (See Medicare
    Managed Care Plans: Many Factors Contribute to Recent Withdrawals;
    Plan Interest Continues (GAO/HEHS-99-91, Apr. 27, 1999).) 6The
    accuracy of the cost data submitted by plans is unknown. Recent
    reports by the Department of Health and Human Services' Office of
    the Inspector General suggest that the administrative cost
    component for some HMOs may be too high and that, consequently,
    the amount of required additional benefits may be too low. (See
    Department of Health and Human Services, Office of the Inspector
    General, Administrative Costs Submitted by Risk-Based Health
    Maintenance Organizations on the Adjusted Community Rate Proposals
    Are Highly Inflated A-14-97-00202 (July 1998).) 7Alternatively,
    plans may deposit the amount in a benefit stabilization fund for
    use in future years. Before 1998, plans had a third option of
    returning the savings to Medicare. Historically, however, plans
    have enhanced their benefit packages in an attempt to attract
    members. Page 5                                     GAO/HEHS-99-
    144 Payments to Medicare+Choice Plans B-282937 submitted by plans
    serving Los Angeles County suggests that the estimated costs of
    some plans continues to be well below Medicare projected payments.
    On average, Los Angeles plans could provide the FFS package of
    benefits for 79 percent of the current payment amount. They
    complied with Medicare's requirements by using the approximately
    $117 per beneficiary per month difference between Medicare
    payments and their costs to provide additional benefits. (See fig.
    1.) This amount of additional benefits may be higher than the
    national average because of the historically high payment rates in
    the area. However, the example of Los Angeles illustrates that, in
    the second year of BBA's payment reforms, some plans' projected
    payments far exceed their estimated costs of providing the
    traditional FFS benefit package. Page 6
    GAO/HEHS-99-144 Payments to Medicare+Choice Plans B-282937 Figure
    1: Los Angeles Plans' Estimated Costs of Providing Medicare FFS
    Benefit Package, Required Additional Benefits, and Nonrequired
    Extra Benefits Provided, 1999 Note: Medicare's payments vary by
    plan because of variations in plans' geographic service areas
    (although each plan's service area includes Los Angeles county)
    and the demographic characteristics of plans' members. Source: GAO
    analysis of 1999 adjusted community rate proposal data submitted
    to HCFA by Medicare+Choice plans. Plans may also choose, for
    competitive or other reasons, to exceed Medicare's minimum
    requirements and further enhance their benefit packages.
    Nationally, plans added more than $33 in extra benefits per member
    per month-in addition to the $60 in required additional benefits-
    in 1997.8 The Los Angeles plans added an average of $21 per
    beneficiary per month in extra benefits during 1999. Although all
    Los Angeles plans offer some extra benefits, the dollar amount
    varies by plan from $0.43 per beneficiary per month to $80 per
    beneficiary per month. 8On average, plans reported voluntarily
    providing $33 in additional benefits. Many plans, however, further
    enhanced their benefit packages in certain parts of their
    geographic service areas. The dollar amount of these enhancements
    is not included in the $33. Page 7
    GAO/HEHS-99-144 Payments to Medicare+Choice Plans B-282937 The
    ability of plans to provide additional benefits (both required and
    voluntary) suggests that planned cuts in rate increases may not
    threaten the typical plan's ability to earn a profit while
    providing a benefit package that is more comprehensive than the
    one available in Medicare FFS. Plans' benefit packages may be
    especially attractive to beneficiaries when contrasted with
    private supplemental insurance, known as Medigap.9 Medigap
    policies generally cost beneficiaries $95 per month or more and
    provide less extensive coverage than many plans. For example,
    although most of the 10 standard Medigap policies cover Medicare's
    coinsurance and hospitalization deductible amounts, only three of
    the standard policies cover outpatient prescription drugs. These
    policies require a $250 deductible with a 50-percent copayment,
    and coverage is capped at a fixed annual dollar amount. In
    contrast, some managed care plans offer unlimited coverage for
    prescription drugs with minimal copayments and no deductible.
    These differences suggest that even if plans charged a significant
    premium, they may still be cheaper and provide more comprehensive
    coverage than a Medigap policy for many beneficiaries. Medicare's
    Managed    Although Medicare's pre-BBA payment methodology based
    plan payments Care Option           on FFS spending discounted by
    5 percent, beneficiary enrollment in plans did not produce savings
    for the program. In fact, evidence from several Substantially
    studies shows that Medicare's managed care option substantially
    Increased Program     increased program spending. In general
    terms, this result occurred because plans enrolled healthier-than-
    average beneficiaries while Spending              Medicare's
    methodology based payments on the estimated FFS cost of serving
    the average beneficiary and the payment adjustments did not
    adequately reflect this favorable enrollment. On average, Medicare
    beneficiaries enrolled in plans are in better health and need less
    care than beneficiaries in the FFS program. In a 1996 beneficiary
    survey, approximately 81 percent of HMO enrollees report their
    health status as good or better while 19 percent indicated that
    their health was fair or poor.10 Among the beneficiaries in FFS,
    70 percent assessed their health as good or better, while 30
    percent responded that their health was fair or poor. Moreover,
    11.7 percent of FFS beneficiaries reported that 9Approximately 34
    percent of beneficiaries in FFS purchase Medigap policies.
    Approximately an additional 53 percent have coverage through an
    employer-sponsored plan or other plan or the Medicaid program.
    10Medicare Current Beneficiary Survey, 1996, as reported in HCFA,
    A Profile of Medicare: Chartbook 1998 (May 1998). Page 8
    GAO/HEHS-99-144 Payments to Medicare+Choice Plans B-282937 they
    had three or more activity of daily living (ADL) limitations (ADLs
    include such activities as eating and bathing), whereas only 4.9
    percent of HMO enrollees reported a similar number of ADLs. The
    survey also found that better health translates into lower health
    care costs. In 1996, average FFS spending per beneficiary in
    excellent to good health ranged from about $2,130 to $4,430. In
    contrast, average FFS spending was approximately $7,030 for a
    beneficiary in fair health and $11,740 for a beneficiary in poor
    health. The problem is not that beneficiaries in plans tend to be
    healthier than beneficiaries in FFS, but that Medicare's current
    risk adjustment methodology-based on simple demographic
    characteristics, such as age and sex-does not sufficiently adjust
    payments to reflect that fact.11 For example, the estimated FFS
    cost of an average 74-year-old male not living in an institution
    or receiving Medicaid was about $581 per month in Los Angeles
    County in 1997. Of course, some 74-year-old males suffer from
    serious chronic conditions and need much more care, while others
    may experience only occasional minor ailments and need much less
    care. Plans that attracted a disproportionate number of healthier
    74-year-olds would be overcompensated because they would incur
    much lower costs but still receive about $552 (95 percent of $581)
    per month per member. Alternatively, plans that attracted the less
    healthy, higher-cost 74-year-olds would be undercompensated.
    Because relatively few beneficiaries account for the majority of
    Medicare spending (10 percent of the elderly beneficiaries account
    for 63 percent of Medicare spending on the elderly), a plan's
    costs can be greatly affected to the extent that it enrolls
    beneficiaries from this group. The financial consequences of a
    poor risk adjustment methodology in the presence of favorable
    selection are huge. For example, in our 1997 study of Medicare
    payment rates in California, we estimated that the program paid
    about $1 billion in excess payments to health plans in that state
    in 1995.12 On average, Medicare overpaid plans by about 16
    percent, but this percentage varied by county. For example, we
    estimated that plans in Los Angeles were overpaid by nearly 21
    percent. About one-quarter of the excess payments occurred because
    HCFA's methodology for setting base rates in each county did not
    take into account the effect of favorable selection. In the
    presence of favorable selection, HCFA's method tended to 11HCFA
    has long recognized the inadequacies of the current risk
    adjustment system and has funded research on alternative
    approaches. 12Medicare HMOs: HCFA Can Promptly Eliminate Hundreds
    of Millions in Excess Payments (GAO/HEHS-97-16, Apr. 25, 1997).
    Page 9                                  GAO/HEHS-99-144 Payments
    to Medicare+Choice Plans B-282937 overestimate per-beneficiary
    average cost because it included the costs of the generally less
    healthy, more expensive FFS beneficiaries and excluded the costs
    of the generally healthier, less expensive plan enrollees. Our
    study found that, partly as a result of this flawed methodology,
    excess payments as a percent of total payments tended to be
    highest in counties with a large proportion of beneficiaries in
    managed care plans. This finding suggests that aggregate excess
    payments likely increased since 1995 as managed care enrollment
    grew. Other studies have also concluded that Medicare's current
    risk adjustment methodology does not adequately reflect the
    generally healthier status of plan enrollees and results in excess
    payments to plans. For example, in a 1996 study based on 1994
    data, HCFA researchers estimated that managed care enrollees'
    expected FFS costs were 12 to 14 percent below average, after
    adjusting for their demographic characteristics. Based on those
    findings, PPRC in its 1997 Annual Report to Congress estimated
    that an improved risk adjustment method could save Medicare $2
    billion per year.13 A comprehensive study by Mathematica Policy
    Research, Inc., based on 1990 data found that enrollees' costs
    were approximately 11 percent below average, after adjusting for
    demographic traits. Moreover, Mathematica's results may
    underestimate the cost differences because its study excluded the
    costs of beneficiaries who died during the year. Because end-of-
    life health care is expensive and mortality rates in plans are
    much lower than in FFS, the exclusion of this group of
    beneficiaries likely reduced the estimated per-beneficiary cost
    differences between plans and FFS. In contrast to almost all other
    studies, a 1996 study commissioned by AAHP and conducted by Price
    Waterhouse (PW) found little favorable selection among Medicare
    enrollees, concluding that health plans enroll both healthy, low-
    cost beneficiaries and chronically ill, high-cost beneficiaries.14
    However, a CBO analyst in a 1996 memorandum argued that ". . . the
    findings in the PW study are not credible because of flaws in the
    data and methods used. Adjustment for obvious biases in the PW
    results would more than quadruple its estimate of favorable
    selection."15 13PPRC's 1996 Annual Report to Congress contains a
    detailed table of studies on favorable selection (table 15-1).
    14Jack Rodgers and Karen Smith, Is There Biased Selection in
    Medicare HMOs? (Washington, D.C.: Health Policy Economics Group,
    Price Waterhouse LLP, Mar. 14, 1996). 15Biased Selection in
    Medicare's HMOs, CBO memorandum dated July 17, 1996. Page 10
    GAO/HEHS-99-144 Payments to Medicare+Choice Plans B-282937 BBA
    Payment              Beginning in 1998, BBA substantially changed
    the method used to set health Revisions Likely Have    plan
    payments. Some of the new payment provisions are designed to
    reduce excess payments, while others are designed for different
    Not Eliminated           purposes-such as increasing plan
    participation in geographic areas that Excess Payments
    had low payment rates. The most important of the cost-reducing
    changes is a new health-based risk adjustment system, to be
    implemented in 2000. Substantial excess payments may persist,
    however, because the excess that existed in 1997 was incorporated
    into the base rates. One way BBA aims to reduce the excess in
    Medicare's health plan payments is by holding down per capita
    spending increases for 5 years. Specifically, BBA sets the factor
    used to update managed care payment rates to equal the national
    per capita Medicare growth minus a specified percent: 0.8 percent
    in 1998 and 0.5 percent in each of the following 4 years. This
    across-the-board type of approach can produce savings. The
    cumulative reduction of less than 3 percent, however, is
    considerably smaller than the prior estimates of excess payments,
    which generally exceed 10 percent. Moreover, this approach does
    not address the problem that the excess payments can vary among
    geographic areas and plans. In our study of California health
    plans, we found that excess payments tended to be much higher in
    some counties than in others. BBA also provides for a
    methodological approach known as "blending," which is designed to
    reduce the geographic disparity in payment rates and encourage
    more widespread plan participation.16 Blending will work over time
    to move all rates closer to a national average by providing for
    larger payment increases in low-rate counties and smaller payment
    increases in high-rate counties. According to a 1997 PPRC study,
    there is some evidence that excess payments are more likely to
    occur in high-payment-rate counties. Thus, blending may indirectly
    reduce excess payments by holding down payment increases in high-
    rate counties. BBA's mandated health-based risk adjustment system
    is the provision that most directly targets the excess health plan
    payment problem. BBA requires HCFA to implement, beginning January
    1, 2000, a method to adjust plan payments based on beneficiary
    health status. Although HCFA's proposed interim health-based risk
    adjustment method uses only hospital inpatient data to gauge
    beneficiary health status, it still represents a major 16Because
    of low growth in Medicare spending and BBA's budget neutrality and
    minimum payment requirements, no county received a blended rate in
    1998 or 1999. According to HCFA actuaries, the blending provision
    could not be funded because BBA's minimum payment requirements
    resulted in total plan spending that exceeded BBA's mandated
    budget neutrality provision by $95 million in 1998 and $80 million
    in 1999. Blending will occur for the first time in 2000. Page 11
    GAO/HEHS-99-144 Payments to Medicare+Choice Plans B-282937
    improvement over the current method.17 For the first time, plans
    can expect to be paid more for serving Medicare beneficiaries with
    serious health problems and less for serving relatively healthy
    ones. HCFA proposes to phase in the new interim risk adjustment
    system slowly. In 2000, only 10 percent of health plans' payments
    will be based on the new system. This percentage will be increased
    each year until 2003, when 80 percent of plans' payments will be
    based on the interim system. In 2004, HCFA intends to implement a
    more accurate risk adjuster that uses medical data from physician
    offices, hospital outpatient departments, and other health care
    settings and providers-in addition to inpatient hospital data.
    This type of risk adjustment system cannot be implemented now
    because many health plans report that they do not have the
    capability to provide such comprehensive information. Although a
    gradual phase-in of the interim risk adjuster delays the full
    realization of Medicare savings, it also minimizes potential
    disruptions for both health plans and beneficiaries. BBA may not
    eliminate excess payments, however, in part because the law
    specified that 1997 county rates be used as the basis for all
    future county rates beginning in 1998. In effect, BBA tended to
    lock in prior excess payments. As we reported in 1997, HCFA's then
    current methodology ignored the effects of favorable selection and
    resulted in county rates that were generally too high.18 In
    addition, excess payments are built into the current rates because
    BBA did not allow HCFA to adjust the 1997 county rates for
    previous forecast errors. Such adjustments had been a critical
    component of the pre-BBA rate-setting process. HCFA actuaries now
    estimate that the forecast error resulted in 1997 managed care
    rates that were 4.2 percent too high. While BBA permits HCFA to
    correct forecasts in future years, it did not include a provision
    that would have allowed HCFA to correct its forecast for 1997.
    Consequently, according to HCFA actuaries, about $1.3 billion in
    excess payments were built into plans' annual payment rates in
    1998. Furthermore, these excess payments remain in the base rates
    and will grow over time as health plan enrollment grows.
    Conclusions    Beneficiaries who enroll in health plans typically
    reduce their out-of-pocket costs and receive coverage for
    benefits, such as outpatient prescription drugs, that FFS Medicare
    does not cover. If these extra benefits resulted exclusively from
    the efficiencies of health plans, then 17Medicare Managed Care:
    Better Risk Adjustment Expected to Reduce Excess Payments Overall
    While Making Them Fairer to Individual Plans (GAO/T-HEHS-99-72,
    Feb. 25, 1999). 18GAO/HEHS-97-16. Page 12
    GAO/HEHS-99-144 Payments to Medicare+Choice Plans B-282937 there
    would be no cause for taxpayers to be concerned. However, the
    evidence shows that Medicare's payments are too high and that
    plans turn these excess payments into extra benefits to attract
    beneficiaries. Instead of producing savings as originally
    envisioned, Medicare's managed care option has added substantially
    to program spending. Fortunately, extra benefits for Medicare
    beneficiaries and program savings are not mutually exclusive
    goals. According to their own data, some plans could make a normal
    profit and provide enhanced benefit packages even if Medicare
    payments were reduced. The resulting benefit packages may not be
    as rich as they are today, but they could still be more generous
    than the FFS package and cost beneficiaries less than an
    equivalent Medigap policy. Achieving program savings while
    preserving extra benefits for beneficiaries enrolled in plans
    requires an improved risk adjustment system that more closely
    matches plan payments to the expected health care costs of the
    beneficiaries they serve. HCFA is working on implementing an
    improved risk adjustment system in 2000. However, achieving the
    two goals also requires that the base payment rate accurately
    reflects the cost of serving the average beneficiary. Our work
    indicates that the current base rates are too high because they
    incorporate the excess payments that were present in 1997. Thus,
    as we previously reported, correcting the base rates is necessary
    to prevent continuing excess payments. In 1997, we recommended
    that the Secretary of Health and Human Services take action to
    reduce excess plan payments by directing the HCFA Administrator to
    revise the agency's methodology for establishing base payment
    rates in each county. Shortly after we made our recommendation,
    the Congress enacted BBA. The new law included several provisions,
    such as reduced annual updates and health-based risk adjustments,
    that will help to reduce excess payments. However, by specifying
    that the 1997 rates be used to determine future rates, it also
    tended to lock in place the pattern of excess payments that
    existed in 1997. Matters for      To avoid unnecessary Medicare
    spending, the Congress may wish to Congressional    consider
    revising each county's base rate to more accurately reflect the
    estimated fee-for-service cost of serving the average Medicare
    beneficiary. Consideration    Such a revision would eliminate
    Medicare+Choice and FFS spending disparities caused by (1) flaws
    in the methodology HCFA used to set base rates in each county
    before BBA, (2) the incorporation of the 1997 forecast error in
    1998 and future rates, and (3) the annual payment rate update Page
    13                        GAO/HEHS-99-144 Payments to
    Medicare+Choice Plans B-282937 reductions mandated by BBA. If the
    Congress wishes to share in the efficiencies of Medicare+Choice
    plans, base rates should be set below estimated average FFS costs
    as they were under the Medicare risk-contract program. The
    Congress may also want to consider maintaining a minimum base rate
    to encourage greater participation by Medicare+Choice plans in
    rural areas. Agency Comments    In commenting on our report, HCFA
    agreed that the available evidence indicates that Medicare's
    managed care option has substantially increased program spending.
    HCFA stated that the most recent evidence of favorable selection
    and excess plan payments can be found in its March 1999 report to
    the Congress on risk adjustment. The agency also agreed with our
    finding that the typical plan could continue to provide benefits
    beyond those covered by part A and part B of Medicare, even if
    payments are reduced. Finally, HCFA concurred that excess payments
    will be lowered, but not completely eliminated, by BBA's new
    formula for paying health plans. In response to our matters for
    congressional consideration regarding revising base rates, HCFA
    suggested that careful consideration first be given to the
    potential impact on beneficiaries and plan participation in
    Medicare+Choice. It noted that some BBA payment revisions,
    including the new risk adjustment system, have yet to be
    implemented. The agency agreed, however, that correcting the
    forecast error built into the 1997 rates would help reduce excess
    payments. BBA reflects the Congress' intentions of achieving
    Medicare savings, partly by reducing excess plan payments.
    Revising base rates so that they more accurately reflect the cost
    of serving beneficiaries is an important step in reaching that
    goal. Although we agree that the impact on beneficiaries and plans
    should be carefully considered, we believe that base rate
    revisions could be accomplished with minimal disruptions by
    phasing in the changes-in much the same way that the interim risk
    adjustment system will be phased in. HCFA also provided a number
    of technical comments, which we incorporated as appropriate.
    HCFA's comments are reprinted in the appendix. Page 14
    GAO/HEHS-99-144 Payments to Medicare+Choice Plans B-282937 As
    agreed with your office, unless you publicly announce its contents
    earlier, we plan no further distribution until 30 days from the
    date of this letter. We will then make copies available to others
    who are interested. Please call me on (202) 512-6806 or William J.
    Scanlon, Director, Health Financing and Public Health Issues, on
    (202) 512-7114 if you or your staff have any questions about this
    report. Major contributors to this report are James C. Cosgrove,
    George M. Duncan, Hannah F. Fein, and Beverly Ross. Richard L.
    Hembra Assistant Comptroller General Page 15
    GAO/HEHS-99-144 Payments to Medicare+Choice Plans Contents Letter
    1 Appendix
    18 Comments From the Health Care Financing Administration Figure
    Figure 1: Los Angeles Plans' Estimated Costs of Providing
    7 Medicare FFS Benefit Package, Required Additional Benefits, and
    Nonrequired Extra Benefits Provided, 1999 Abbreviations AAHP
    American Association of Health Plans ADL          activity of
    daily living BBA          Balanced Budget Act of 1997 CBO
    Congressional Budget Office FFS          fee-for-service HCFA
    Health Care Financing Administration HMO          health
    maintenance organization PPRC         Physician Payment Review
    Commission PW           Price Waterhouse Page 16
    GAO/HEHS-99-144 Payments to Medicare+Choice Plans Page 17
    GAO/HEHS-99-144 Payments to Medicare+Choice Plans Appendix
    Comments From the Health Care Financing Administration (101820)
    Page 18      GAO/HEHS-99-144 Payments to Medicare+Choice Plans
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