United States General Accounting Office
GAO Testimony
Before the Subcommittee on Health, Committee on Ways
and Means, House of Representatives
For Release on Delivery
Expected at 9:00 a.m.
Tuesday, February 25, 1997
MEDICARE HMOs
HCFA Could Promptly
Reduce Excess Payments
by Improving Accuracy of
County Payment Rates
Statement of William J. Scanlon, Director
Health Financing and Systems
Health, Education, and Human Services Division
GAO/T-HEHS-97-78
Medicare HMOs: HCFA Could Promptly
Reduce Excess Payments by Improving
Accuracy of County Payment Rates
Mr. Chairman and Members of the Subcommittee:
We are pleased to be here today to discuss the rates Medicare pays health
maintenance organizations (HMO) in its risk contract program, Medicare’s
principal managed care option.1 As you know, Medicare’s method for
paying risk contract HMOs was designed to save the program 5 percent of
the costs for beneficiaries who enroll in HMOs. However, 10 years of
research on Medicare’s costs under HMOs has found that the program’s
rate-setting method results in excess payments to HMOs because HMO
enrollees would have cost Medicare less if they had stayed in the
fee-for-service sector.2 Recently, the Physician Payment Review
Commission (PPRC) estimated that annual excess payments to HMOs
nationwide could total $2 billion.3
A number of proposals have been made recently to help alleviate
Medicare’s HMO payment problems. For example, the proposed Balanced
Budget Act of 1995 called for, among other things, mechanisms to lessen
rate disparities across geographic areas and to decouple annual HMO rate
increases from annual fee-for-service spending increases. The
administration’s current budget proposal adopts several provisions from
the proposed Balanced Budget Act but also adds new twists—such as an
across-the-board reduction in Medicare’s HMO payments that would lower
the payments from 95 percent to 90 percent of estimated fee-for-service
costs. Under the auspices of the Health Care Financing Administration
(HCFA), which administers the Medicare program, several demonstration
projects are planned or under way, including efforts to improve risk
adjustment and using a process of competitive bidding to set rates.
At the request of the Subcommittee’s Chairman, we reviewed HCFA’s
method for setting HMO rates to identify feasible options for promptly
reducing the amount of excess payments. A comprehensive discussion of
our work is included in a forthcoming report. In conducting our study, we
reviewed previous research on Medicare’s HMO rate-setting method;
analyzed available HCFA data; and had our findings reviewed by experts on
HMO payment issues, including staff at PPRC and HCFA.
1
Other Medicare managed care plans include cost contract HMOs and health care prepayment plans,
which together enroll fewer than 2 percent of the total Medicare population. Because Medicare pays
these plans using methods other than capitation rates, they are not the subject of this statement.
2
See the attached list of related GAO products.
3
This estimate was contained in material presented to the Commissioners for their December 12-13,
1996, meeting.
Page 1 GAO/T-HEHS-97-78
Medicare HMOs: HCFA Could Promptly
Reduce Excess Payments by Improving
Accuracy of County Payment Rates
Today, I would like to focus my comments on our proposed modification
to HCFA’s HMO rate-setting method. We believe this modification could help
reduce excess HMO payments under Medicare’s current payment method,
the administration’s method, or other methods that rely on fee-for-service
costs to set initial HMO rates or update those rates. Central to the current
method and proposals for setting HMO rates is an estimate of the average
cost of serving Medicare beneficiaries under fee-for-service in defined
geographic areas (currently, counties). The actual rates paid HMOs for an
enrollee are set by adjusting these averages up or down on the basis of the
enrollee’s “risk” of incurring higher or lower costs. Considerable attention
has focused on the failure of current risk adjustment methodology to
adequately account for favorable selection, the term used to describe the
tendency of HMOs to attract a population of Medicare seniors whose health
costs are generally lower than those of the average beneficiary. Our work
centers on the estimate of average cost of serving a county’s beneficiaries:
the county rate.
In summary, we found that HCFA’s current method of determining the
county rate produces excess payments. Because HCFA’s method excludes
HMO enrollees’ costs from estimates of the per-beneficiary average cost, it
bases county payment rates on the average per-beneficiary cost of only
those beneficiaries that remain in the fee-for-service sector and ignores the
costs HMO enrollees would have incurred if they had remained in
fee-for-service. Research has shown the costs of those remaining in
fee-for-service to be higher on average than the likely costs of HMO
enrollees. A difficulty in correcting the problem is that HCFA cannot
directly observe the costs HMO enrollees would have incurred if they had
remained in the fee-for-service sector. Our proposed modification is
designed to fix that problem. We developed a way to estimate HMO
enrollees’ expected fee-for-service costs using information available to
HCFA. Our approach produces a county rate that represents the costs of all
Medicare beneficiaries and could result in hundreds of millions of dollars
in savings to Medicare.
Essentially, HCFA’s calculation of its per-enrollee (capitation) rate can be
How Medicare expressed as follows:
Determines an HMO’s
Payment Rate Capitation rate = average per-beneficiary cost x .95 x
risk adjustment factor
Page 2 GAO/T-HEHS-97-78
Medicare HMOs: HCFA Could Promptly
Reduce Excess Payments by Improving
Accuracy of County Payment Rates
Medicare pays risk HMOs a fixed amount per enrollee—a capitation
rate—regardless of what each enrollee’s care actually costs. Medicare law
stipulates that the capitation rate be set at 95 percent of the costs
Medicare would have incurred for HMO enrollees if they had remained in
fee-for-service.4 In implementing the law’s rate-setting provisions, HCFA
estimates a county’s average per-beneficiary cost and multiplies the result
by 0.95.5 The product is the county adjusted average per capita cost rate.6
HCFA then applies a risk-adjustment factor to the county rate. Under HCFA’s
risk-adjustment system, beneficiaries are sorted into groups according to
their demographic traits (age; sex; and Medicaid, institutional, and
working status). HCFA calculates a risk factor for each group—the group’s
average cost in relation to the cost of all beneficiaries nationwide. For
example, in 1995 the risk factor for younger seniors (65- to 70-year-old
males) was .85, whereas for older seniors (85-year-old or older males) it
was 1.3. HCFA uses the risk factor to adjust the county rate, thereby raising
or lowering Medicare’s per capita payment for each HMO enrollee,
depending on the individual’s demographic characteristics.
One reason the HMO rate-setting method overstates the expected
Medicare’s HMO fee-for-service costs of HMO enrollees is that it uses only the cost
Rate-Setting Method experience of fee-for-service beneficiaries. If the health status of the mix
Has Led to Excess of beneficiaries enrolled by HMOs were the same as the health status of
those in fee-for-service, using fee-for-service beneficiaries to estimate the
Payments expected fee-for-service costs of HMO enrollees would be an appropriate
method. However, because research has shown that HMOs have in general
enrolled healthier-than-average beneficiaries, the beneficiaries remaining
in fee-for-service represent a sicker-than-average population.7 This, in turn,
means that using data on fee-for-service beneficiaries exclusively produces
HMO payment rates higher than envisioned when the current rate setting
provisions were enacted.
4
Section 1876(a)(4) of the Social Security Act (42 U.S.C. 1395mm(a)(4) (1994)).
5
A 5-percent discount is taken on the premise that, compared with fee-for-service care, managed care
plans achieve certain efficiencies. For example, HMOs can negotiate with hospitals, physicians, and
other providers to obtain discounts on services and supplies.
6
Medicare determines four capitation rates for each county, one each for part A aged, part B aged, part
A disabled, and part B disabled.
7
HCFA’s Health Care Financing Review, a 1996 study using postdisenrollment data, estimated that
HMO enrollees’ costs were 12 percent lower than average, while a 1996 PPRC study using
preenrollment data estimated that enrollees’ costs were 37 percent lower than for comparable
fee-for-service beneficiaries.
Page 3 GAO/T-HEHS-97-78
Medicare HMOs: HCFA Could Promptly
Reduce Excess Payments by Improving
Accuracy of County Payment Rates
Medicare’s risk adjustors explain about 3 percent of the variation in
individual-level health care costs and are thus not adequate to account for
the cost differences among beneficiaries. The difficulty is that, within the
same demographic group, HMO enrollees are healthier than fee-for-service
beneficiaries; for example, 70-year-old males in HMOs are, on average,
healthier than 70-year-old males in fee-for-service. Medicare’s risk adjustor
is said to be inadequate because, while it makes broad distinctions among
beneficiaries of different age, sex, and other demographic characteristics,
it does not account for the significant health differences among
demographically identical beneficiaries. The cost implications of health
status differences can be dramatic—for two demographically alike
beneficiaries, one may experience occasional minor ailments while the
other may suffer from a serious chronic condition.
Independent of improved risk adjustment, modifying the method for
Including HMO calculating the county rate would help reduce Medicare’s excess HMO
Enrollees’ Costs in payments. In setting county rates, HCFA currently estimates the average
County Average Medicare costs of a county’s beneficiaries using the costs of only those
beneficiaries in Medicare’s fee-for-service sector. This method would be
Improves Accuracy of appropriate if the average health cost of fee-for-service beneficiaries were
County Rates the same as that of demographically comparable HMO enrollees. However,
in counties where there are cost disparities between Medicare’s
fee-for-service and HMO enrollee populations, this method can either
overstate the average costs of all Medicare beneficiaries and lead to
overpayment or understate average costs and lead to underpayment.
Correcting this problem is difficult because it is impossible to observe the
costs HMO enrollees would have incurred if they had remained in the
fee-for-service sector. Therefore, we developed a method to estimate HMO
enrollees’ expected fee-for-service costs using information available to
HCFA. Our method consists of two main steps:
• First, we compute the average cost of demographically similar new HMO
enrollees during the year before they enrolled—that is, while they were
still in fee-for-service Medicare. These fee-for-service costs are available
through HCFA’s claims data.
• Next, we adjust this amount to reflect the expectation that a new
enrollee’s use of health services will, over time, rise.8
8
Our analysis adjusts for (1) the tendency for enrollees’ costs to become more like—or “regress”
toward—the fee-for-service cost mean after joining an HMO and (2) the costs incurred by HMO
enrollees who die while enrolled. How our method accounts for these costs is discussed more
thoroughly in our report.
Page 4 GAO/T-HEHS-97-78
Medicare HMOs: HCFA Could Promptly
Reduce Excess Payments by Improving
Accuracy of County Payment Rates
Having completed these steps, we combine the result with an estimate of
the average cost of fee-for-service beneficiaries. This new average
produces a county rate that reflects the costs of all Medicare beneficiaries.
Selected 1995 County To illustrate the effect of our approach, we analyzed data for counties with
Rates Produced different shares of beneficiaries enrolled in HMOs. We chose counties
Substantial Excess within a single state to eliminate variations attributable to state
differences. We selected California because it covers 36 percent of all
Payments Medicare HMO enrollees and includes counties that in 1995 had the nation’s
highest HMO penetration rates. We found that our method could have
reduced excess payments by more than 25 percent. Although better risk
adjustors could further reduce the large remainder of excess payments,
improvements to risk adjustment require developing direct measures of
health status, which is a complex effort that may take years.
The following key points also emerged from our analysis:
• First, for the counties that we analyzed, we estimate that total excess
payments in 1995 amounted to about $1 billion (of about $6 billion in total
Medicare payments to risk HMOs in the state). Applying our method for
setting county rates would have reduced the excess by about $276 million.
• Second, the excess payments attributable to inflated county rates were
concentrated in 12 counties with large HMO enrollment and ranged from
less than 1 percent to 6.6 percent of the counties’ total HMO payments,
representing between $200,000 and $135.3 million.9 Despite the size of
these amounts, the application of our method would have produced
relatively small changes in the monthly, per-beneficiary capitation
payments, ranging from $3 to $38.
• Third, our analysis did not support the hypothesis, put forward by the HMO
industry and others, that the excess payment problem will be mitigated as
more beneficiaries enroll in Medicare managed care and HMOs
progressively enroll a more expensive mix of beneficiaries. Our
data—which include counties with up to a 39-percent HMO penetration in
1995—indicated that the disparity between Medicare rates and our rates is
larger in counties with higher Medicare penetration. For example, the four
counties with the highest rates of excess payment, ranging from 5.1 to
6.6 percent, were also among the counties with the highest enrollment
rates in 1995.
9
For the state’s remaining 46 counties, excess payments attributable to inflated county rates amounted
to less than 3 percent of the 58-county total.
Page 5 GAO/T-HEHS-97-78
Medicare HMOs: HCFA Could Promptly
Reduce Excess Payments by Improving
Accuracy of County Payment Rates
Data Are Available to Because the data we used to estimate HMO enrollees’ costs come from data
Enable HCFA to Promptly that HCFA compiles to update HMO rates each year, our method has two
Adjust County Rates important advantages. First, HCFA’s implementation of our proposal could
be achieved in a relatively short time. The time element is important,
because the prompt implementation of our method would avoid locking in
a current methodological flaw that would persist in any adopted changes
to Medicare’s HMO payment method that continued to use current county
rates as a baseline or fee-for-service costs to set future rates. Second, the
availability of the data would also make our proposal economical: we
believe that the savings to be achieved from reducing county-rate excess
payments would be much greater than the administrative costs of
implementing the process.
Medicare’s HMO rate-setting problems have prevented it from realizing the
Conclusions savings that were anticipated from enrolling beneficiaries in capitated
managed care plans. In fact, enrolling more beneficiaries in managed care
could increase rather than lower Medicare spending—unless Medicare’s
method of setting HMO rates is revised. Our method of calculating the
county rate would have the effect of reducing payments more for HMOs in
counties with higher excess payments and less for HMOs in counties with
lower excess payments. In this way, our method represents a targeted
approach to reducing excess payments and could lower Medicare
expenditures by at least several hundred million dollars each year.
Furthermore, our approach is useful under several possible scenarios,
including whether (1) the Congress adopts any proposal that uses current
county rates as a baseline, (2) HCFA develops and adopts improved risk
adjustors, or (3) the Congress takes no action and preserves Medicare’s
current rate-setting process.
Mr. Chairman, this concludes my prepared statement. I would be pleased
to answer any questions.
For more information on this testimony, please call Jonathan Ratner,
Contributors Associate Director, on (202) 512-7107 or James C. Cosgrove, Assistant
Director, on (202) 512-7029. The analysis was conducted by Scott L. Smith,
Project Director, and Richard M. Lipinski, Project Manager. Other major
contributors to this statement included Thomas Dowdal and Hannah F.
Fein.
Page 6 GAO/T-HEHS-97-78
Page 7 GAO/T-HEHS-97-78
Related GAO Products
Medicare HMOs: Rapid Enrollment Growth Concentrated in Selected States
(GAO/HEHS-96-63, Jan. 18, 1996).
Medicare Managed Care: Growing Enrollment Adds Urgency to Fixing HMO
Payment Problem (GAO/HEHS-96-21, Nov. 8, 1995).
Medicare: Changes to HMO Rate Setting Method Are Needed to Reduce
Program Costs (GAO/HEHS-94-119, Sept. 2, 1994).
(101541) Page 8 GAO/T-HEHS-97-78
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Address Correction Requested
Medicare HMOs: HCFA Could Promptly Reduce Excess Payments by Improving Accuracy of County Payment Rates
Published by the Government Accountability Office on 1997-02-25.
Below is a raw (and likely hideous) rendition of the original report. (PDF)