Defense Health Program: Future Costs Are Likely to Be Greater than
Estimated (Briefing Report, 02/21/97, GAO/NSIAD-97-83BR).

GAO analyzed the budgetary trends of the Department of Defense's (DOD)
Defense Health Program.

GAO noted that: (1) future Defense Health Program costs are likely to be
greater than DOD has estimated; (2) GAO's analysis showed that one key
assumption DOD used to estimate future program costs appeared to be
unrealistic and another was questionable; (3) first, DOD assumed that no
cost growth would be attributable to advances in medical technology and
the intensity of treatment, an important and valid health care cost
growth factor; (4) second, DOD assumed that a certain level of savings
would be achieved from its new emphasis on utilization management
techniques to reduce unnecessary treatment and testing, although it did
not use a formal methodology or analysis to derive the savings; (5)
DOD's projection that health program budgets will not increase in
constant dollars during fiscal years 1998 to 2003 also appears to be
unrealistic, given that during fiscal years 1985 to 1996, the operation
and maintenance funds in DOD's health program increased by 73 percent in
real terms (operation and maintenance funds take about two-thirds of the
Defense Health Program budget); (6) in developing its budget estimates,
DOD applied a factor of zero for technology and intensity; (7) according
to health care financing experts, DOD's Defense Health Program is
subject to some level of cost growth because of the addition of new
technology and increased intensity of treatment; (8) these experts
agreed that a factor of between 1 and 2 percent would be appropriate to
apply to DOD's program; (9) DOD assumed in its program objective
memorandum (POM) estimate that it would save 5 percent from utilization
management techniques, even though it did not have a formal methodology
for estimating this level of savings; (10) although DOD's budget
assumptions appear to be optimistic, the extent to which future costs
might exceed the budget estimates is unknown; (11) GAO analyzed the
effects of using different assumptions on the budget estimates for
fiscal years 1998 to 2003; (12) if DOD had accounted for technology and
intensity of treatment at a rate of 1.5 percent, for example, in
constructing its initial estimates, the projections would have been $3.2
billion higher cumulatively; (13) if DOD is unable to achieve the level
of estimated savings it anticipates from utilization management
techniques, program costs would exceed the budget estimate by an
additional amount; (14) GAO also compared the 1998 POM to revised budge*

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

 REPORTNUM:  NSIAD-97-83BR
     TITLE:  Defense Health Program: Future Costs Are Likely to Be 
             Greater than Estimated
      DATE:  02/21/97
   SUBJECT:  Defense cost control
             Future budget projections
             Defense economic analysis
             Health care programs
             Financial management
             Defense budgets
             Patient care services
             Total obligational authority
             Managed health care
             Health resources utilization
IDENTIFIER:  Defense Health Program
             DOD TRICARE Program
             Civilian Health and Medical Program of the Uniformed 
             Services
             DOD Future Years Defense Program
             CHAMPUS
             DOD TRICARE Prime Program
             Medicare Program
             DOD Military Health Services System
             
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Cover
================================================================ COVER


Briefing Report to the Chairman and Ranking Minority Member,
Subcommittee on National Security, Committee on Appropriations, House
of Representatives

February 1997

DEFENSE HEALTH PROGRAM - FUTURE
COSTS ARE LIKELY TO BE GREATER
THAN ESTIMATED

GAO/NSIAD-97-83BR

Defense Health Program

(701102)


Abbreviations
=============================================================== ABBREV

  CHAMPUS - Civilian Health and Medical Program of the Uniformed
     Services
  DOD - Department of Defense
  PA&E - Program Analysis and Evaluation
  POM - Program Objective Memorandum
  PBD - program budget decision
  TOA - total obligational authority

Letter
=============================================================== LETTER


B-275854

February 21, 1997

The Honorable C.W.  Bill Young
Chairman
The Honorable John P.  Murtha
Ranking Minority Member
Subcommittee on National Security
Committee on Appropriations
House of Representatives

We recently briefed your subcommittee staff on our analysis of
budgetary trends of the Defense Health Program.  This report
summarizes the content of that briefing.  Because the Department of
Defense (DOD) wants to reduce spending for infrastructure activities
to pay for modern weapon systems, we have been reviewing how DOD
categorizes and budgets for infrastructure functions.  Last year we
reported that DOD will realize no significant net infrastructure
savings in its budget estimates between fiscal year 1996 and 2001.\1
DOD defines infrastructure as activities that provide support
services to mission programs and primarily operate from fixed
locations.  It assigns infrastructure activities among eight
categories, one of which is central medical.  Central medical is the
third largest infrastructure category, and nearly all the funds
within that category are used for the Defense Health Program. 


--------------------
\1 Defense Infrastructure:  Budget Estimates for 1996-2001 Offer
Little Savings for Modernization (GAO/NSIAD-96-131, Apr.  4, 1996)
and Defense Infrastructure:  Costs Projected to Increase Between 1997
and 2001 (GAO/NSIAD-96-174, May 31, 1996). 


   BACKGROUND
------------------------------------------------------------ Letter :1

The $15-billion Defense Health Program accounts for about 6 percent
of DOD's total budget.  The Defense Health 1998 Program Objective
Memorandum (POM) shows that total obligational authority is projected
to increase by about $2.7 billion, or 18 percent, from $15.1 billion
in 1997 to $17.8 billion in 2003, in current dollars.\2 The POM
reflects no program growth when expressed in constant dollars.  In
addition to meeting wartime patient care requirements, the program
provides health care benefits for active duty personnel and their
dependents as well as for retirees and their dependents. 
Beneficiaries may receive health care through DOD's new managed
health care system called TRICARE.  They may use DOD facilities
and/or one of three options under DOD contract:  a health maintenance
organization, a preferred provider, and a fee-for-service option,
formerly known as the Civilian Health and Medical Program of the
Uniformed Services (CHAMPUS).  Retirees and dependents over age 65
are not eligible for TRICARE because they receive Medicare benefits. 
However, they may receive health care in DOD medical facilities on a
space-available basis.  DOD has managed care initiatives in place
that it hopes will result in efficiencies and savings. 


--------------------
\2 We based our analysis on the Fiscal Year 1998 POM, the most
current data available at the time of our review.  During the course
of our review, DOD revised the POM estimates as it developed the
President's Budget and the 1998 Future Years Defense Program.  We
provide information on these revised estimates in our report. 


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :2

Future Defense Health Program costs are likely to be greater than DOD
has estimated.  Our analysis showed that one key assumption DOD used
to estimate future program costs appeared to be unrealistic and
another was questionable.  First, DOD assumed that no cost growth
would be attributable to advances in medical technology and the
intensity of treatment, an important and valid health care cost
growth factor.\3 Second, DOD assumed that a certain level of savings
would be achieved from its new emphasis on utilization management
techniques to reduce unnecessary treatment and testing, although it
did not use a formal methodology or analysis to derive the savings. 
DOD's projection that health program budgets will not increase in
constant dollars during fiscal years 1998-2003 also appears to be
unrealistic, given that during fiscal years 1985-96, the operation
and maintenance funds in DOD's health program increased by 73 percent
in real terms (operation and maintenance funds take about two-thirds
of the Defense Health Program budget). 

In developing its budget estimates, DOD applied a factor of zero for
technology and intensity.  According to health care financing
experts, DOD's Defense Health Program is subject to some level of
cost growth because of the addition of new technology and increased
intensity of treatment.  These experts agreed that a factor of
between 1 and 2 percent would be appropriate to apply to DOD's
program.  Also, DOD assumed in its POM estimate that it would save 5
percent from utilization management techniques, even though it did
not have a formal methodology for estimating this level of savings. 
For example, DOD could have derived utilization management savings
estimates from analogous private sector health care programs with an
adjustment for DOD-unique aspects.  Instead, DOD officials discussed
and agreed on the target number from a range of savings (2 to 14
percent) reported by private sector managed health care
organizations.  Later, in a revised health program budget estimate,
DOD projected a 7-percent savings during fiscal years 1998-2003 from
utilization management techniques and its prime vendor program that
uses best management practices to buy medical supplies and
pharmaceuticals.  The revised projected savings, along with other
measures, effectively reduced health program budget projections below
POM estimates. 

Although DOD's budget assumptions appear to be optimistic, the extent
to which future costs might exceed the budget estimates is unknown. 
We analyzed the effects of using different assumptions on the budget
estimates for fiscal years 1998-2003.  If DOD had accounted for
technology and intensity of treatment at a rate of 1.5 percent, for
example, in constructing its initial estimates, the projections would
have been $3.2 billion higher cumulatively.  And if DOD is unable to
achieve the level of estimated savings it anticipates from
utilization management techniques, program costs would exceed the
budget estimate by an additional amount.  For example, if DOD
achieves a 3-percent savings from utilization management over fiscal
years 1998-2003 (instead of the 5-percent assumption it used in
initial estimates) and accounts for technology and intensity of
treatment at the 1.5 percent rate, program costs would be $4.5
billion greater than estimated.  We also compared the 1998 POM--with
the 1.5 percent technology factor and the reduced 3-percent savings
from utilization management--to revised budget estimates from the
post-program and budget decision cycle.  This comparison showed that
health program costs for fiscal years 1998-2003 could be $8.4 billion
greater than estimated.  However, the extent to which future costs
exceed the Defense Health Program budget estimates depends on the
specific assumptions applied. 


--------------------
\3 Technological advances such as CAT scans, magnetic resonance
imaging, organ transplants, and new drug treatments increase costs. 
Costs are often compounded when new procedures increase the intensity
of treatment. 


   AGENCY COMMENTS
------------------------------------------------------------ Letter :3

We discussed our draft report with DOD officials, who partially
concurred with the findings.  We incorporated their suggestions into
this report as appropriate.  DOD commented that it is not appropriate
to include an additional cost growth factor for technology and
intensity at this time because the matter is still under study. 
However, our analysis of the literature and discussions with experts
show that technology and intensity is widely recognized as a health
care cost growth factor that is by definition beyond medical
inflation in the private and public sectors.  Health care financing
experts and Defense Health Affairs officials agree that cost growth
from technology and intensity of treatment affects the Defense Health
Program.  While DOD has not yet determined the specific rate to apply
to its program, experts told us a factor of about 1 or 2 percent
would be appropriate to apply to the capitation model.  As a result,
we believe that while the study has not yet been completed, it is
reasonable for DOD to include a factor for cost growth from
technology and intensity in the budget estimates. 

DOD also commented that the 73-percent real growth in operation and
maintenance spending in the health program between 1985 and 1996
reflects the consolidation in 1991 of the various medical programs in
the military services into the Defense Health Program and that
earlier data on costs were compiled from inconsistent historical
data.  While DOD correctly points out that its health and medical
program spending was spread among the military services until the
Defense Health Program was created, our analysis of this cost growth
was taken from various DOD Future Years Defense Programs using
defense mission categories that cut across military service-specific
programs. 

DOD agreed that it had no formal methodology or analysis to support
its assumptions of 5 percent and 7 percent utilization management
savings through fiscal year 2003.  DOD also commented that while the
DOD Comptroller supports the capitation model concept for budgeting
purposes, that office does not necessarily agree with the data or
assumptions currently being used to generate the estimate. 


   SCOPE AND METHODOLOGY
------------------------------------------------------------ Letter :4

We extracted and analyzed estimated total obligational authority data
for the Defense Health Program from the 1998 POM.  As DOD revised its
estimates to prepare the President's budget and the 1998 Future Years
Defense Program, we obtained updated information and compared it to
the original POM.  We also obtained information on the capitation
model concept that DOD Health Affairs uses to make program budget
projections and discussed the factors and assumptions used in the
model with DOD Health Affairs and DOD Program Analysis and Evaluation
officials.  At our request, DOD Health Affairs applied the model
using a technology and intensity of treatment cost growth factor and
a lower rate of utilization management savings in order for us to
estimate the health program budgets under different assumptions.  We
also discussed the model with knowledgeable experts outside DOD and
reviewed reports on health care costs available from federal agencies
and private organizations.  However, we did not validate the accuracy
or completeness of DOD's capitation model. 

We performed our review between September 1996 and January 1997 in
accordance with generally accepted government auditing standards. 


---------------------------------------------------------- Letter :4.1

We are providing copies of this report to the Chairmen and Ranking
Minority Members of the House Committee on National Security, the
Senate Committee on Armed Services, and the Senate Committee on
Appropriations; the Secretaries of Defense, the Army, the Navy, and
the Air Force; and the Director, Office of Management and Budget. 
Copies will also be made available to others upon request. 

If you have any questions about this report, please contact me at
(202) 512-3504.  The major contributors to this report were Davi M. 
D'Agostino and Richard A.  McGeary. 

Richard Davis
Director, National Security
 Analysis


BACKGROUND
============================================================ Chapter I



   (See figure in printed
   edition.)


   DEFENSE HEALTH PROGAM IN THE
   DEFENSE BUDGET
---------------------------------------------------------- Chapter I:1


Central medical is the third largest of eight infrastructure
categories, after installation support and central training, and is
expected to remain the third largest for the foreseeable future. 
Most of the central medical infrastructure category consists of the
Defense Health Program.  The Department of Defense (DOD) projects
that the program will represent about 6 percent of DOD's total budget
through at least fiscal year 2003. 

DOD Health Affairs develops the Defense Health Program budget
consistent with guidance and direction from the DOD Program Analysis
and Evaluation (PA&E) directorate and the DOD Comptroller. 




   (See figure in printed
   edition.)


   MOST DEFENSE HEALTH SPENDING IS
   FOR PATIENT CARE
---------------------------------------------------------- Chapter I:2


The majority of the Defense Health Program budget is dedicated to
patient care.  In addition to providing patient care to meet wartime
readiness requirements, the program also serves the peacetime health
care needs of its beneficiaries.  Active duty and retired military
personnel under age 65 and dependents are eligible for care in DOD
medical facilities under title 10, U.S.C., or they may choose
DOD-contracted care in the private sector.  Military retirees over
age 65 are eligible for treatment in DOD medical facilities on a
space-available basis. 

Although the DOD budget is discretionary, active duty and retired
military personnel and their dependents consider the Defense Health
Program to be an integral part of their employment and retirement
benefits.  For this reason, the Defense Health Program is regarded
somewhat like an entitlement program. 



   (See figure in printed
   edition.)


   DEFENSE HEALTH CARE BENEFITS
   AND TRICARE PROGRAM COMPONENTS
---------------------------------------------------------- Chapter I:3


Direct care (patient care provided in DOD medical facilities) is very
inexpensive to the beneficiary.  For example, outpatient care
provided in DOD medical facilities is free.  Inpatient care for
retired enlisted personnel is also free.  Retired officers pay $4.75
per day, and dependents pay $9.50 per day for inpatient care. 

Beneficiaries may also choose one of the three options in DOD's new
TRICARE system.  TRICARE Prime is a health maintenance organization
type of plan.  Retirees pay $230 per year ($460 for families), $12
per outpatient visit, and the greater of $25 per hospital admission
or
$11 per day.  Members can also enroll in Prime with a military
treatment facility and avoid the per visit charges.  TRICARE Extra is
a preferred provider organization plan.  It has a $300 deductible per
family and a $150 deductible per person, along with a 15-percent
co-payment for active duty families and a 20-percent co-payment for
retirees for outpatient care.  Inpatient care costs $250 per day or
25 percent of the charge.  Lastly, TRICARE Standard is the former
Civilian Health and Medical Program of the Uniformed Services
(CHAMPUS).  It has a maximum $300 deductible and a 20-percent
co-payment for active duty family members' outpatient care, and a
25-percent co-payment for retirees and their dependents.  Inpatient
care costs $323 per day or 25 percent of the charge. 


BUDGET TRENDS
=========================================================== Chapter II



   (See figure in printed
   edition.)


   PROJECTED TOTAL OBLIGATIONAL
   AUTHORITY FOR DEFENSE HEALTH
   PROGRAM
--------------------------------------------------------- Chapter II:1

   Note:  Total Obligational
   Authority (TOA).

   (See figure in printed
   edition.)

   Source:  1998 Program Objective
   Memorandum (POM).

   (See figure in printed
   edition.)


The 1998 POM shows that DOD projects the Defense Health Program to
increase by about $2.7 billion, or 18 percent, from fiscal year 1998
to fiscal year 2003, in current-year dollars.  When viewed in
constant dollars, DOD projects no program growth.  However, between
fiscal year 1985 and 1996, the operation and maintenance funds in
DOD's health program increased by 73 percent in real terms. 
Operation and maintenance funds account for about two-thirds of the
Defense Health Program budget. 




   (See figure in printed
   edition.)


   DISTRIBUTION OF DEFENSE HEALTH
   PROGRAM FUNDS BY MAJOR COST
   CATEGORIES
--------------------------------------------------------- Chapter II:2

   Source:  1998 POM.

   (See figure in printed
   edition.)


The majority of the Defense Health Program budget is for total
patient care.  In the fiscal year 1998 estimate, patient care
accounts for $11.2 billion of the $15.5 billion budget.  This portion
of the budget is projected to remain at about 73 percent. 
Consequently, the driving force behind the Defense Health Program
budget is patient care, both medical care for active duty personnel
and their dependents and health care benefits received by military
retirees and their dependents. 



   (See figure in printed
   edition.)


   TRENDS IN DEFENSE HEALTH
   PROGRAM TOA BY CATEGORY
--------------------------------------------------------- Chapter II:3

   Source:  1998 POM.

   (See figure in printed
   edition.)


Direct patient care, which DOD provides in its medical facilities, is
the largest portion of the Defense Health Program budget.  The
estimated TOA for direct care is projected to increase by about 16
percent, from $6.9 billion in fiscal year 1997 to $7.9 billion in
fiscal year 2003.  Patient care that is purchased or provided under
contract is projected to increase by 31 percent, from $3.5 billion to
$4.6 billion.  Other budget categories within the Defense Health
Program are also projected to increase, but to less extent.  For
example, patient care support is projected to increase by 23 percent. 
Patient care support includes a number of functions such as
management headquarters, military public and occupational health,
veterinary services, examining activities, the aeromedical evacuation
system, and the Armed Forces Institute of Pathology. 



   (See figure in printed
   edition.)


   TRENDS IN PATIENT CARE BY
   SOURCE
--------------------------------------------------------- Chapter II:4

   Source:  1998 POM.

   (See figure in printed
   edition.)


We further analyzed the patient care portion of the Defense Health
Program POM.  DOD projects in the 1998 POM that TOA for all patient
care--both care in military treatment facilities and
government-funded care from civilian providers--will increase 21
percent, from $10.8 billion in fiscal year 1997 to $13.1 billion in
fiscal year 2003.  Patient care consists of care provided directly in
DOD facilities, managed care provided through contracts, the former
CHAMPUS fee-for-service health care plan, and care provided in
non-DOD facilities such as emergency rooms or Uniformed Services
Treatment Facilities.\1

DOD direct care is the largest portion of the patient care budget
category and is projected to continue as the dominant category
through
fiscal year 2003.  However, managed care support spending is
projected to expand.  Health care support contracts under the new
TRICARE system are projected to increase by 67 percent, from $2.4
billion to $4 billion, while the CHAMPUS portion is projected to
decrease, from $1 billion to about $514 million. 



   (See figure in printed
   edition.)


--------------------
\1 Uniformed Services Treatment Facilities are former Public Health
Service hospitals now under civilian ownership and designated by the
Congress in the Military Construction Authorization Act of 1982 (42
U.S.C.  248c) to be part of the Military Health Services System. 


   DISTRIBUTION OF DEFENSE HEALTH
   PROGRAM BENEFICIARIES
--------------------------------------------------------- Chapter II:5

   Source:  1998 POM.

   (See figure in printed
   edition.)


Among all users of the DOD health system, DOD projects a slight
decrease in the share of active duty personnel and their dependents
and a slight increase in the share of retirees and their dependents
between fiscal year 1997 and 2003.  Of user beneficiaries, 61 percent
are projected to be active duty personnel and their dependents in
fiscal year 1997 compared to 59 percent in fiscal year 2003. 
However, retired beneficiaries and their dependents who use the
system are projected to increase as a percentage of the user
population, from 39 percent in fiscal year 1997 to 41 percent in
fiscal year 2003. 

More people are eligible to obtain health care benefits under the
Defense Health Program than the number who actually use the benefits. 
For example, some retirees and their dependents may be eligible for
non-DOD health care benefits through their current private sector
employer.  Among the total of those eligible for DOD health care
benefits, the percentage of active duty personnel and their
dependents is projected to decrease by 2 percent between fiscal year
1997 and 2003, from 48 percent to 46 percent, while the percentage of
retirees and their dependents is expected to increase by 2 percent,
from 52 percent to 54 percent, over the same period.\2



   (See figure in printed
   edition.)


--------------------
\2 DOD Health Affairs officials expect the number of military
retirees over age 65 to increase through 2014.  Although the elderly
may tend to require more health care than some other segments of the
population--which could affect health care costs--military retirees
receive care in DOD medical facilities on a space- available basis. 
Medicare-eligible dependents and retirees are not eligible for
DOD-contracted care under the TRICARE system. 


   HISTORICAL DEFENSE HEALTH TOA
   TRENDS
--------------------------------------------------------- Chapter II:6

   Source:  DOD Health Affairs
   historical data and 1998 POM.

   (See figure in printed
   edition.)


The TOA for the medical program has increased from about $2 billion
in fiscal year 1970 to $17 billion projected for fiscal year 2001.\3
(Both fiscal years' amounts are expressed in current dollars.) DOD
Health Affairs attributes the flattening of the curve since fiscal
year 1990 to the reduced force structure and initiatives to better
manage patient care.  For example, DOD has reduced the average length
of hospital stays in DOD medical facilities. 




   (See figure in printed
   edition.)


--------------------
\3 Because an appropriate DOD deflator is unavailable, we present TOA
in current dollars.  It should be noted that some of the increase
since 1970 is due to general price level inflation. 


   HISTORICAL AND PROJECTED
   DEFENSE HEALTH SHARE OF DOD'S
   TOA
--------------------------------------------------------- Chapter II:7

   Source:  DOD Health Affairs.

   (See figure in printed
   edition.)


The medical share of DOD's TOA has increased from 1.7 percent 30
years ago to 6.2 percent in recent years.  Although the historical
data show an upward trend in the Defense Health portion of the total
DOD budget, DOD projects a flat 6.2-percent share of TOA from fiscal
year 1996 to fiscal year 2001. 




   (See figure in printed
   edition.)


   HISTORY OF DOD'S UNDERESTIMATED
   DEFENSE MEDICAL PROGRAM TOA
--------------------------------------------------------- Chapter II:8

   Source:  DOD Health Affairs.

   (See figure in printed
   edition.)


DOD has a history of underestimating its medical program budget
authority.  DOD officials attributed this problem to the difficulty
in estimating CHAMPUS costs.  For 8 of the 12 fiscal years since
1986, DOD's health program has received additional funds above those
budgeted.  The understated budgets were addressed by either
reprogramming funds or supplemental funding in 6 years.  There were
appropriation adjustments in 2 years.  In 4 of the past
6 years additional funding was not required. 


MODEL AND ASSUMPTIONS
========================================================== Chapter III



   (See figure in printed
   edition.)


   DOD'S METHODOLOGY AND
   ASSUMPTIONS IN CONSTRUCTING THE
   ESTIMATE
-------------------------------------------------------- Chapter III:1


To construct the Defense Health Program budget, DOD Health Affairs
uses a capitation financing model that estimates per capita health
care costs on the basis of the user population, adjusted for gender
and age and other factors such as inflation.  The budget is
constructed under the guidance and direction of the Defense
Comptroller and PA&E. 

PA&E and the Defense Comptroller accept the model as a reasonable
approach for estimating patient care costs.  An Institute for Defense
Analysis analyst who is familiar with the model agrees.  Health Care
Financing Administration officials noted that DOD's current approach
is an improvement over previous DOD budgeting methods, which were
based on historical workload. 



   (See figure in printed
   edition.)


   DOD'S METHODOLOGY AND
   ASSUMPTIONS IN CONSTRUCTING THE
   ESTIMATE
-------------------------------------------------------- Chapter III:2


Managed health care allows for the application of utilization
management techniques, such as gatekeepers, to reduce unnecessary
treatment and testing.  The introduction of such techniques within
the Defense Health Program may result in lower costs.  DOD initially
estimated cumulative savings of 5 percent from utilization management
in the Defense Health Program POM, but during the course of our
review it increased the projection to 7 percent in revised budget
projections. 

PA&E and DOD Health Affairs did not have managed care program
performance data to permit a more reliable estimate and, in the
absence of such data, did not derive the utilization management
savings assumption from a formal methodology or analysis.  For
example, DOD might have derived estimated utilization management
savings from an analysis of analogous programs in the private sector,
or from a blend of specific savings from specific types of health
care programs that apply utilization management techniques similar to
those being employed in DOD's program.  DOD could have then adjusted
these estimates for DOD-unique conditions.  Instead, DOD officials
who constructed the estimates explained that they discussed and
agreed on savings estimates from a range of 2 to 14 percent
experienced in the private sector without a formal methodology or
analysis as a basis. 

In a July 1995 study, the Congressional Budget Office stated that
depending on the assumptions, the broad application of managed care
techniques--including utilization management--under DOD's new TRICARE
system in fiscal year 1996 could generate a savings of no more than 1
percent under optimistic assumptions and increased costs of up to 6
percent under pessimistic assumptions.  Health Care Financing
Administration officials stated that although the introduction of
utilization management generally can be expected to generate one-time
savings, they could not offer an estimate as to the extent of savings
that DOD might achieve. 



   (See figure in printed
   edition.)


   DOD'S METHODOLOGY AND
   ASSUMPTIONS IN CONSTRUCTING THE
   ESTIMATE
-------------------------------------------------------- Chapter III:3


As health care providers adopt new and expensive medical technologies
and offer more intensive patient treatment, medical cost growth
occurs above the rate of medical inflation.  Under a DOD contract,
the Institute for Defense Analysis has been studying for over a year
the extent to which new technology and increased intensity of
treatment affect the Defense Health Program budget.  DOD Health
Affairs has allowed for a technology and intensity of treatment
factor within its cost-estimating model.  However, because the
contractor had not yet issued its report, DOD Health Affairs applied
zero for this cost growth factor. 

A PA&E official stated that it is appropriate to apply a zero factor
for technology because DOD has a number of small, low-technology
facilities and performs fewer complex and expensive procedures
compared to some private sector hospitals.  Further, the official
stated that medical inflation rates already account for technology
cost growth. 

We reviewed information on specialized units, medical procedures, and
services available at some of DOD's larger medical facilities and
found, for example, that neonatal intensive care, oncology, HIV-AIDS,
and open heart surgery were common.  All officials with whom we spoke
within DOD and outside of DOD agreed that precisely measuring the
technology cost growth factor is very complex and difficult. 
Nevertheless, analysts from the Health Care Financing Administration
and the Institute for Defense Analysis estimated that a cost growth
factor of about 1 or 2 percent for technology and intensity of
treatment is a reasonable factor for DOD to apply in estimating the
Defense Health Program budget.  It is widely recognized in health
care financing literature that technology and intensity cost growth
occurs beyond medical inflation. 



   (See figure in printed
   edition.)


   DEFENSE HEALTH POM ESTIMATE,
   ADDING 1.5 PERCENT FOR
   TECHNOLOGY AND INTENSITY
-------------------------------------------------------- Chapter III:4

   Source:  1998 POM.

   (See figure in printed
   edition.)


Because DOD does not account for the technology and intensity of
treatment cost growth factor in its budget estimate, its Defense
Health Program budget is likely to be understated.  To illustrate the
effect of accounting for this factor, we asked DOD Health Affairs to
apply the model using a technology cost growth factor of 1.5 percent
instead of zero.\1 The addition of this technology factor to the
model increased the POM estimate by a cumulative $3.4 billion between
fiscal year 1998 and 2003. 



   (See figure in printed
   edition.)


--------------------
\1 A 1.5 percent factor is the approximate midpoint of the range of
estimates that health care financing experts thought was reasonable. 
Although DOD has not yet determined the appropriate factor for the
Defense Health Program, we believe that adding 1.5 percent
illustrates the potential effect of applying a factor within this
range. 


   DEFENSE HEALTH POM WITH 3
   PERCENT UTILIZATION SAVINGS AND
   1.5 PERCENT TECHNOLOGY COST
-------------------------------------------------------- Chapter III:5

   Source:  1998 POM.

   (See figure in printed
   edition.)


The extent of savings expected from utilization management techniques
is speculative.  DOD applied a 5-percent savings rate to the 1998 POM
estimate.  This estimate was not based on a study or other
methodology, but rather was a percentage DOD selected because it fell
within the 2- to 14-percent range experienced by private sector
managed health care providers.  We asked DOD Health Affairs to apply
the model using both a 1.5-percent technology cost growth factor and
a reduced utilization management savings rate of 3 percent.  Although
the savings rate, if any, is unknown at this time, applying a
3-percent rate illustrates the effect of a lower rate of savings than
DOD has included in its estimates.  Using these two adjusted factors,
the combined cumulative underbudgeting of the Defense Health Program
between fiscal year 1998 and 2003 would be $4.5 billion. 



   (See figure in printed
   edition.)


   1998 POM AND 1998 POST-PROGRAM
   BUDGET DECISION CYCLE DATA
-------------------------------------------------------- Chapter III:6

   Note:  Program Budget
   Decision--PBD.

   (See figure in printed
   edition.)

   Source:  1998 POM and post-PBD
   cycle data.

   (See figure in printed
   edition.)


As the programming and budgeting process continued after the Defense
Health Program POM was issued, DOD reduced its estimate of TOA for
fiscal years 1998-2003.  The 1998 POM estimate for fiscal year 2003
was $17.9 billion, for example, whereas the post-program budget
decision (PBD) estimate was $16.9 billion.  DOD increased its
estimated savings from utilization management from 5 percent to 7
percent, lowered the cost of living assumption in the base year
because 1996 inflation was lower than expected, and reduced operation
and maintenance funding among other measures. 



   (See figure in printed
   edition.)


   UPDATED BUDGET ESTIMATE AND
   1998 POM WITH 3 PERCENT
   UTILIZATION MANAGEMENT SAVINGS
   AND 1.5 PERCENT TECHNOLOGY COST
-------------------------------------------------------- Chapter III:7

   Source:  1998 post-PBD cycle
   data and 1998 POM.

   (See figure in printed
   edition.)


To illustrate the effect of DOD's lower estimate of Defense Health
Program TOA, we compared the post-PBD cycle estimate to the POM
estimate that incorporated a 1.5-percent technology factor and a
lower utilization management savings of 3 percent.  TOA using the
post-PBD cycle data was $16.9 billion in 2003, for example, while the
estimated program requirement using the revised assumptions for
technology and utilization management savings was $19.3 billion. 
Using these assumptions, the post-PBD estimates could be understated
by a cumulative $8.4 billion from fiscal year 1998 to fiscal year
2003. 

*** End of document. ***