Medicare+Choice: Reforms Have Reduced, but Likely Not Eliminated, Excess Plan Payments

Published by the Government Accountability Office on 1999-06-18.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                  United States General Accounting Office

GAO               Report to Congressional Requesters

June 1999
                  Reforms Have
                  Reduced, but Likely
                  Not Eliminated, Excess
                  Plan Payments

      United States
GAO   General Accounting Office
      Washington, D.C. 20548

      Health, Education, and
      Human Services Division


      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

                   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.

                   Although all health plans are required to provide at least the package of
Results in Brief   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

                    Except 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.
                    Plans 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

             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

             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.

             As of June 1, 1999, about 6.9 million people—or approximately 18 percent
Background   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

              About 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

contain Medicare spending was the creation of Medicare+Choice, which
was intended to increase the plan options available to Medicare

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.

 Separate 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

Page 4                                    GAO/HEHS-99-144 Payments to Medicare+Choice Plans

                      For many beneficiaries, health plans cost less than traditional FFS and offer
Medicare+Choice       a more comprehensive benefit package. For example, beneficiaries in
Plans Provide         plans often pay a small copayment each time they use an outpatient
Additional Benefits   service but are generally not responsible for the deductibles and
                      coinsurance amounts they would pay in FFS. The out-of-pocket cost for a
Because Medicare      plan enrollee is often lower than the premium for a supplemental, or
Payments Exceed       Medigap, insurance policy—another way that beneficiaries obtain
                      increased coverage. The trade-off is that beneficiaries must generally use
Plans’ Costs          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

                       Beneficiaries 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).)
                       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 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).)
                       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.

                      Page 5                                    GAO/HEHS-99-144 Payments to Medicare+Choice Plans

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

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.

                                         On 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

                     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.

                     Although Medicare’s pre-BBA payment methodology based plan payments
Medicare’s Managed   on FFS spending discounted by 5 percent, beneficiary enrollment in plans
Care Option          did not produce savings for the program. In fact, evidence from several
Substantially        studies shows that Medicare’s managed care option substantially
                     increased program spending. In general terms, this result occurred
Increased Program    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

                      Approximately 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.
                      Medicare 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

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

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

  HCFA has long recognized the inadequacies of the current risk adjustment system and has funded
research on alternative approaches.
 Medicare 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

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

   PPRC’s 1996 Annual Report to Congress contains a detailed table of studies on favorable selection
(table 15-1).
 Jack Rodgers and Karen Smith, Is There Biased Selection in Medicare HMOs? (Washington, D.C.:
Health Policy Economics Group, Price Waterhouse LLP, Mar. 14, 1996).
  Biased Selection in Medicare’s HMOs, CBO memorandum dated July 17, 1996.

Page 10                                   GAO/HEHS-99-144 Payments to Medicare+Choice Plans

                        Beginning in 1998, BBA substantially changed the method used to set health
BBA Payment             plan payments. Some of the new payment provisions are designed to
Revisions Likely Have   reduce excess payments, while others are designed for different
Not Eliminated          purposes—such as increasing plan participation in geographic areas that
                        had low payment rates. The most important of the cost-reducing changes
Excess Payments         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

                          Because 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

              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.

              Beneficiaries who enroll in health plans typically reduce their
Conclusions   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

               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).

              Page 12                               GAO/HEHS-99-144 Payments to Medicare+Choice Plans

                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.

                To avoid unnecessary Medicare spending, the Congress may wish to
Matters for     consider revising each county’s base rate to more accurately reflect the
Congressional   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

                  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.

                  In commenting on our report, HCFA agreed that the available evidence
Agency Comments   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

                  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

                  Page 14                        GAO/HEHS-99-144 Payments to Medicare+Choice Plans

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

Letter                                                                                              1

Appendix                                                                                           18

Comments From the
Health Care Financing
Figure                  Figure 1: Los Angeles Plans’ Estimated Costs of Providing                   7
                          Medicare FFS Benefit Package, Required Additional Benefits, and
                          Nonrequired Extra Benefits Provided, 1999


                        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

Comments From the Health Care Financing

(101820)      Page 18    GAO/HEHS-99-144 Payments to Medicare+Choice Plans
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