Medicare+Choice: Impact of 1997 Balanced Budget Act Payment Reforms on
Beneficiaries and Plans (Testimony, 06/09/99, GAO/T-HEHS-99-137).

Pursuant to a congressional request, GAO discussed on the impact of
payment reforms in the Balanced Budget Act of 1997 (BBA) on the Medicare
Choice program.

GAO noted that: (1) the net effect of BBA payment revisions has been to
reduce but not fully eliminate excess payments to health plans; (2) some
of the provisions, such as the reduced annual updates, have already been
implemented, while others, such as the health-based risk adjustment
system, will be phased in over time; (3) despite industry alarm over the
increase in plan withdrawals in 1999, GAO's work suggests that sweeping
amendments to the BBA are not yet warranted for several reasons; (4) the
net effect of BBA reforms on plans has been modest to date; (5) cuts in
rate increases have held down per capita payment growth by only a little
more than 1 percent; (6) data submitted by plans themselves indicate
that at least some plans can provide the traditional Medicare package of
benefits, offer some additional benefits, and make a profit even if they
are paid less than they are today; (7) according to their own data,
plans serving the Los Angeles area can provide the traditional Medicare
package of benefits for about 79 percent of what they are currently
paid; (8) the withdrawals GAO observed this year were not a reaction to
BBA rate reductions alone; (9) market forces appear to have played a
larger role; (10) because of cuts in rate increases and expected
improvements in risk adjustment, the BBA's health plan payment reforms
will reduce aggregate excess payments; (11) as a consequence, some
Medicare Choice plans may reduce supplemental benefits and rethink their
participation in the Medicare program; and (12) the continuing challenge
for Congress is to strike the appropriate balance between containing
Medicare spending and fostering growth in Medicare Choice.

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

 REPORTNUM:  T-HEHS-99-137
     TITLE:  Medicare+Choice: Impact of 1997 Balanced Budget Act
	     Payment Reforms on Beneficiaries and Plans
      DATE:  06/09/99
   SUBJECT:  Health care programs
	     Health insurance cost control
	     Managed health care
	     Medical services rates
	     Overpayments
	     Health care costs
IDENTIFIER:  Medicare Choice Program
	     Medigap
	     Medicare Program

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Cover
================================================================ COVER

Before the Committee on Finance, U.S.  Senate

For Release on Delivery
Expected at 10:00 a.m.
Wednesday, June 9, 1999

MEDICARE+CHOICE - IMPACT OF 1997
BALANCED BUDGET ACT PAYMENT
REFORMS ON BENEFICIARIES AND PLANS

Statement of William J.  Scanlon, Director
Health, Financing and Public Health Issues
Health, Education, and Human Services Division

GAO/T-HEHS-99-137

GAO/HEHS-99-137T

(101857)

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

  BBA - Balanced Budget Act of 1997
  GME - graduate medical education
  FFS - fee-for-service
  HCFA - Health Care Financing Administration
  HMO - health maintenance organization

MEDICARE+CHOICE:  IMPACT OF 1997
BALANCED BUDGET ACT PAYMENT
REFORMS ON BENEFICIARIE AND PLANS
============================================================ Chapter 0

Mr.  Chairman and Members of the Committee: 

We are pleased to be here as you discuss the impact of payment
reforms in the Balanced Budget Act of 1997 (BBA) on the
Medicare+Choice program.  BBA's creation of Medicare+Choice
represents one important means of helping to address the growing
challenge of financing the Medicare program.  Collectively, BBA
reforms are expected to lower program spending by $386 billion over
the next 10 years. 

In creating the Medicare+Choice program, BBA furthered the use of a
choice-based managed care model of providing Medicare benefits. 
Prior to BBA, Medicare's managed care model was limited largely to
health maintenance organizations (HMO).\1

BBA expanded beneficiaries' health plan options, both by encouraging
the wider availability of HMOs across areas and by permitting other
types of health plans to participate in Medicare.  BBA also sought to
pay health plans more appropriately than Medicare had done under the
program's previous HMO payment formula.  A decade of research by GAO
and others found that, instead of saving the government money as
intended, the managed care program that preceded Medicare+Choice
overpaid health plans in the aggregate--estimated to be several
billions of dollars beyond what would have been paid had the enrolled
beneficiaries been served under Medicare's traditional
fee-for-service (FFS) program. 

Some health plan and industry representatives believe that BBA's
payment changes were too severe, citing plan withdrawals from
Medicare+Choice as evidence of BBA's adverse effects.  This hearing
provides an opportunity to examine the overall effect to date of BBA
payment reforms affecting Medicare+Choice plans.  My statement today
will focus on whether BBA reforms have improved Medicare's ability to
pay health plans more appropriately and whether recent experience
implementing these reforms suggests the need for modifications. 
These remarks are based on GAO's prior and ongoing work on
Medicare+Choice. 

In summary, the net effect of BBA payment revisions has been to
reduce but not fully eliminate excess payments to health plans.  Some
of the provisions, such as the reduced annual updates, have already
been implemented, while others, such as the health-based risk
adjustment system, will be phased in over time. 

Despite industry alarm over the increase in plan withdrawals in 1999,
our work suggests that sweeping amendments to BBA are not yet
warranted for several reasons.  First, the net effect of BBA reforms
on plans has been modest to date.  Cuts in rate increases, for
example, have held down per capita payment growth by only a little
more than 1 percent.  Second, data submitted by plans themselves
indicate that at least some plans can provide the traditional
Medicare package of benefits, offer some additional benefits, and
make a profit even if they are paid less than they are today.  For
example, according to their own data, plans serving the Los Angeles
area can provide the traditional Medicare package of benefits for
about 79 percent of what they are currently paid.  Third, the
withdrawals we observed this year were not a reaction to BBA rate
reductions alone.  Market forces appear to have played a larger role. 

Because of cuts in rate increases and expected improvements in risk
adjustment, BBA's health plan payment reforms will reduce aggregate
excess payments.  As a consequence, some Medicare+Choice plans may
reduce supplemental benefits and rethink their participation in the
Medicare program.  The continuing challenge for the Congress is to
strike the appropriate balance between containing Medicare spending
and fostering growth in Medicare+Choice. 

--------------------
\1 For the purposes of this statement, the term HMO refers to plans
with Medicare risk contracts, which accounted for about 90 percent of
Medicare managed care enrollment in 1997.  Prior to BBA, Medicare
managed care plans also included cost contract HMOs and health care
prepayment plans. 

   BACKGROUND
---------------------------------------------------------- Chapter 0:1

Medicare's use of prepaid health plans, which typically have a
financial incentive to hold down costs, is intended to save the
government from unnecessary spending on Medicare services without
compromising the provision of covered benefits.  In addition, from
the beneficiary's perspective, these plans can be an attractive
alternative to traditional Medicare because they usually offer more
benefits and lower out-of-pocket costs.  All plans serving Medicare
beneficiaries are required to provide Medicare's statutorily covered
benefits, and many provide additional services--such as outpatient
prescription drugs, routine physical exams, hearing aids, and
eyeglasses--that are not covered under traditional Medicare.  In
exchange for these advantages, beneficiaries give up their freedom to
choose any provider. 

As of March 1, 1999, about 6.7 million people--or 17 percent of
Medicare's 39 million beneficiaries--were enrolled in 300 health
plans, most of which were prepaid.\2 Prepaid plans receive for each
beneficiary a fixed monthly amount--called a capitation
rate--regardless of what a beneficiary's care actually costs.  The
remaining 83 percent of Medicare beneficiaries receive health care on
a FFS basis, where providers are paid for each covered service they
deliver. 

Although Medicare's pre-BBA managed care program attracted an
increasing number of beneficiaries, it had several serious
shortcomings.  First, it was overly expensive for the government. 
During the decade preceding BBA, a mounting body of research showed
that government payments to HMOs for their Medicare enrollees
exceeded spending for similar beneficiaries in the traditional FFS
program, even though plan payment rates were discounted by 5 percent
from estimated FFS levels.  This excess spending resulted from faulty
calculation of the base rate and inadequate adjustments to that rate
for the healthier-than-average population enrolled in Medicare's
prepaid plans.  In addition, HMOs were not available everywhere.  In
1996, more than 25 percent of beneficiaries lived in areas not served
by HMOs.  Widely disparate payment rates across geographic areas
contributed to this variability in access and to sizable differences
in supplemental benefits.  Finally, the program did not include
options, such as preferred provider organizations, that had become
popular in the private sector because they offered cost management
but were more flexible than HMOs. 

BBA changed the capitation rate formula used to compensate the
prepaid plans.  Among several changes, BBA required that the Health
Care Financing Administration (HCFA), the agency responsible for
administering Medicare, improve Medicare's current risk adjuster--the
mechanism designed to adjust a plan's capitation rates upward or
downward to reflect the extent to which an enrollee's expected health
care costs differ from the average beneficiary's.  As we have
previously reported, Medicare's current risk adjuster cannot
sufficiently raise or lower rates because it is based primarily on
demographic factors such as age and sex, which alone are poor
predictors of an individual's health care costs.  To illustrate: 
under Medicare's current risk adjuster, a plan would receive the same
payment for two enrollees of the same age and sex, even if one is
expected to incur only minimal health care costs for treatment of
occasional minor ailments and the other is expected to require
expensive treatment for a serious chronic condition. 

Without the use of health status factors to make better adjustments,
Medicare generally overcompensates health plans because they tend to
enroll beneficiaries who are healthier than average.  Our 1997 study
on payments to California HMOs, which enrolled more than a third of
Medicare's managed care population, found that health plan enrollees
had expected costs that were more than 16 percent below those for
demographically similar beneficiaries in traditional Medicare.\3 Such
ï¿½favorable selectionï¿½ by Medicare's prepaid health plans--that is,
their tendency to attract healthier-than-average enrollees--is not
surprising.  People with chronic or severe illnesses may not be
attracted to HMOs because they have established relationships with
providers and feel a need for easy access to specialists.  Moreover,
given the inadequacy of Medicare's risk adjuster to lower--or
raise--payments appropriately, plans could put themselves out of
business if they attracted significant numbers of high-cost
beneficiaries. 

--------------------
\2 About 90 percent of the 6.7 million Medicare beneficiaries were
enrolled in managed care plans that receive fixed monthly payments. 
The remainder were enrolled in plans that are reimbursed for the
costs they incur, less the estimated value of beneficiary
cost-sharing. 

\3 (Medicare HMOs:  HCFA Can Promptly Eliminate Hundreds of Millions
in Excess Payments (GAO/HEHS-97-16, Apr.  25, 1997).  This is
consistent with a 1996 study by HCFA researchers finding that health
plan enrollees had costs roughly 12 to 14 percent below the average
beneficiary's.  (Riley and others, HCFA Review, 1996.)

   UNDER BBA, MEDICARE'S PAYMENTS
   TO HEALTH PLANS LIKELY REMAIN
   EXCESSIVE IN THE AGGREGATE
---------------------------------------------------------- Chapter 0:2

Beginning in 1998, BBA substantially changed the method used to set
Medicare+Choice plan payments.  Some of the new payment provisions
will tend to reduce excess payments.  The most important of these is
a new health-based risk adjustment system, to be implemented in two
stages, with an interim adjuster to be introduced in 2000 followed by
a more comprehensive adjuster in 2004.  Substantial excess payments
may persist, however, because other BBA provisions tended to
incorporate some of the excess that existed in 1997 into the current
rates. 

One way BBA will reduce the excess in Medicare's managed care
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 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.  Although these across-the-board reductions
can help produce savings, the cumulative reduction of less than 3
percent 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 plans, we
found that excess payments tended to be much higher in some counties
than others. 

BBA also provides for a methodological approach known as ï¿½blending,ï¿½
which is designed to reduce the geographic disparity in payment rates
and encourage more widespread plan participation.\4 Blending will
work 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 study by the
Physician Payment Review Commission (now the Medicare Payment
Advisory Commission), there is some evidence that excess payments are
more likely to occur in high payment rate counties.\5 Thus, blending
may indirectly reduce excess payments by holding down payment
increases in high rate counties. 

A more targeted reduction in plan payments resulted from BBA
provision to ï¿½carve outï¿½ of the rate that portion that previously
constituted Medicare's subsidy to teaching hospitals for graduate
medical education (GME).  Beginning in 1999, BBA removes an
increasing portion of the Medicare capitation payment attributable to
GME and instead requires HCFA to pay teaching hospitals caring for
Medicare+Choice plan enrollees directly.  This provision was designed
to address the concern that the capitation rates incorporated
Medicare payments designed to cover GME expenditures, even when plans
did not pass such amounts along to teaching hospitals in their
payments to these facilities. 

When implementation of BBA is complete, however, excess payments may
not be fully eliminated.  Because the law specified that 1997 county
rates be used as the basis for all future county rates beginning in
1998, BBA froze in place prior excess payments.  As we reported in
1997, HCFA's then current methodology resulted in county rates that
were generally too high.\6 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 too high by 4.2 percent.  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, about $1.3 billion in overpayments were built
into plans' annual payment rates for 1998.  This error will be
compounded as managed care enrollment grows. 

BBA's mandated health-based risk adjustment system is the provision
that most directly targets the excess payment problem.  BBA requires
HCFA to implement, beginning January 1, 2000, a method to base plan
payments on beneficiaries' health status.  HCFA's proposed interim
health-based risk adjustment method uses only hospital inpatient data
to gauge beneficiaries' health status but still represents a major
improvement over the current method.\7 For the first time, Medicare's
prepaid health plans can expect to be paid more for serving
beneficiaries with serious health problems and less for serving
relatively healthy ones. 

Nevertheless, HCFA proposes to phase in the new interim risk
adjustment system slowly.  In 2000, only 10 percent of health plans'
payments will be adjusted using the new method.  This proportion will
be increased each year until 2003, when 80 percent of plans' payments
will be adjusted using the interim system.  In 2004, HCFA intends to
implement a more finely tuned risk adjuster that uses medical data
from physician offices, skilled nursing facilities, home health
agencies, and other health care settings and providers--in addition
to inpatient hospital data.  This improved risk adjustment system
cannot be implemented currently because many plans say they do not
have the capability to report 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. 

--------------------
\4 Because of BBA-mandated budget neutrality and minimum payment
constraints, no county received a blended rate in 1998 or 1999. 
Blending will occur for the first time in 2000. 

\5 Physician Payment Review Commission, 1997 Annual Report to the
Congress. 

\6 GAO/HEHS-97-16. 

\7 Medicare 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). 

   RECENT EXPERIENCE SUGGESTS
   SWEEPING ACTION NOT WARRANTED
   IN THE SHORT TERM
---------------------------------------------------------- Chapter 0:3

Announcements of plan withdrawals in the last year have prompted
debate about whether to revise certain BBA provisions governing
Medicare+Choice.  As we recently reported, several factors suggest
that such revisions could be premature.\8 First, although an
unusually large number of managed care plans left the program in
1999, a number of plans have applied to enter the program or expand
their participation.  Data on approved and pending Medicare plans as
of January 1999 show that, nationwide, beneficiary access to prepaid
plans is likely to increase slightly this year.  Although for some
localities withdrawals have meant significantly diminished or no
access, only 1 percent of previously covered managed care enrollees
were left without any Medicare+Choice plan option. 

Second, it would be inaccurate to conclude that lower payment rates
alone were responsible for these plan withdrawals.  The current
movement of plans in and out of Medicare is likely to be a normal
reaction to market competition and conditions.  While new payment
rates were certain to have been considered in plans' decisions to
withdraw from certain geographic areas, other factors--including
recent entry into the market, low enrollment, and the presence of
large competitors--likely played a role as well.  Supporting this
conclusion is the fact that plan withdrawals were not limited to low
payment rate counties:  10 of the 11 counties with the highest
payment rates were affected by the withdrawals.  Moreover, a number
of new plans either have approved or pending applications to
participate in the program.  If all applicants are approved, slightly
more beneficiaries will have access to a Medicare+Choice plan in 1999
than had access to one in 1998 before the withdrawals occurred. 

Third, recent data show that, despite BBA's lowering of rate
increases, Medicare's payments to plans still exceed the plans' cost
of providing the traditional Medicare package and plans can continue
to provide benefits well beyond that.  Most Medicare+Choice plans do
not charge beneficiaries a separate monthly premium and charge only a
small copayment for each outpatient service.\9 Nearly all plans offer
coverage for routine physical, eye, and hearing exams.  Most provide
coverage for outpatient prescription drugs.\10 Some provide dental
care.  In contrast, Medigap policies--of which there are 10 standard
types--generally cost beneficiaries about $95 or more a month in
premiums, while 7 of the 10 standard Medigap policies do not cover
outpatient prescription drugs.  Those Medigap policies offering a
drug benefit require a $250 deductible with a 50-percent copayment
and an upper limit on payments. 

Many prepaid health plans have had considerable latitude in offering
benefits because Medicare pays more than it costs them to provide the
traditional FFS benefit package, even after accounting for allowable
profits.\11 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
ï¿½savingsï¿½--to enhance its benefit package by adding benefits or
reducing fees.\12 In 1997, plan 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
submitted by plans serving Los Angeles county suggests that their
costs continue to be well below Medicare payments.  On average, Los
Angeles plans could provide the traditional package for about 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.  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, 2 years after BBA's payment reforms were
implemented, some plans receive payments that far exceed their costs
of providing the traditional FFS benefit package. 

Plans may choose, for competitive or other reasons, to exceed
Medicare's minimum requirements and further enhance their benefit
packages.  In 1997 nationally, plans on average added more than $33
in extra benefits per member per month--in addition to the $60 in
required additional benefits.  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 almost
$80 per beneficiary per month.  The ability of plans to provide
additional benefits (both required and voluntary) suggests that
planned cuts in rate increases are not likely to 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. 

--------------------
\8 Medicare Managed Care Plans:  Many Factors Contribute to Recent
Withdrawals; Plan Interest Continues (GAO/HEHS-99-91, Apr.  27,
1999). 

\9 Beneficiaries who wish to participate in the Medicare+Choice
program must pay the Medicare part B premium of $45.50 per month. 

\10 GAO/HEHS-99-91. 

\11 The 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 reported by some HMOs may be too high.  See Administrative
Costs Submitted by Risk-Based Health Maintenance Organizations on the
Adjusted Community Rate Proposals Are Highly Inflated
(A-14-97-00202), Department of Health and Human Services, Office of
the Inspector General, July 1998. 

\12 Alternatively, 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. 

   CONCLUDING OBSERVATIONS
---------------------------------------------------------- Chapter 0:4

In creating the Medicare+Choice program, BBA substantially changed
the way plan payments are determined.  Some plan and industry
representatives have suggested that BBA's payment reforms were too
severe.  They point to the recent plan withdrawals to back up their
claims that the Medicare+Choice program is in danger of floundering. 
We believe, for a number of reasons, that these concerns must be
viewed in a broader context, as follows: 

  -- The effect on plan payments to date has been modest and, on
     average, has removed only a portion of excess payments built
     into the base rates. 

  -- Data submitted by plans suggest that many of them can provide
     the FFS package of benefits, offer some additional benefits, and
     make a profit even if they are paid less than they are today. 

  -- The withdrawals we observed this year appear to have been
     influenced by external market conditions not fully attributable
     to Medicare+Choice provisions. 

Decisions to modify Medicare+Choice need to balance industry concerns
about BBA's changes to health plan payment rates against a reasoned
assessment of the program's purpose and a systematic analysis of
BBA's impact.  Medicare managed care was instituted to save the
program money.  Although HMO payments before BBA were discounted by 5
percent from what was paid for traditional Medicare beneficiaries,
methodological shortcomings led to Medicare's HMO enrollees costing
the program and taxpayers more.  The excess payments benefited plans
and their enrollees as plans offered additional benefits like
prescription drug coverage. 

Adjusting plan payments so that the program pays no more for a
Medicare+Choice enrollee than for a traditional Medicare beneficiary
with equivalent health status is going to mean smaller payments and
most likely lower profits for plans as well as fewer supplementary
benefits for enrollees.  These consequences raise for the Congress
the question of whether BBA's payment changes should be modified to
protect plans and the fraction of the Medicare beneficiary population
enrolled--even if that protection results in Medicare's spending more
on the Medicare+Choice beneficiary than for the traditional Medicare
beneficiary. 

-------------------------------------------------------- Chapter 0:4.1

Mr.  Chairman, this concludes my prepared statement.  I will be happy
to answer any questions you or the other Members of the Committee may
have. 

   GAO CONTACT AND ACKNOWLEDGMENTS
---------------------------------------------------------- Chapter 0:5

For future contacts regarding this testimony, please call William J. 
Scanlon at (202) 512-7114.  Key contributors to this testimony
include James C.  Cosgrove and Hannah F.  Fein. 

*** End of document. ***