Medicare HMOs: HCFA Could Promptly Reduce Excess Payments by Improving Accuracy of County Payment Rates

Published by the Government Accountability Office on 1997-02-27.

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

                              United States General Accounting Office

GAO                           Testimony
                              Before the Subcommittee on Health and Environment,
                              Committee on Commerce, House of Representatives

For Release on Delivery
Expected at 1:00 p.m.
Thursday, February 27, 1997
                              MEDICARE HMOs

                              HCFA Could Promptly
                              Reduce Excess Payments
                              by Improving Accuracy of
                              County Payment Rates
                              Statement of Jonathan Ratner, Associate Director
                              Health Financing and Systems
                              Health, Education, and Human Services Division

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 Chairman, Subcommittee on Health, House
             Committee on Ways and Means, 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.

              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.
              See the attached list of related GAO products.
              This estimate was contained in material presented to the Commissioners for their December 12-13,
             1996, meeting.

             Page 1                                                                         GAO/T-HEHS-97-82
                      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-97-82
                      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
                      attracted 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.

                       Section 1876(a)(4) of the Social Security Act (42 U.S.C. 1395mm(a)(4) (1994)).
                       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.
                      Medicare determines four capitation rates for each county, one each for part A aged, part B aged, part
                      A disabled, and part B disabled.
                        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-97-82
                           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 had they 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

                            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-97-82
                           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—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 in 1995, ranging
                           from 5.1 to 6.6 percent, were also among the counties with the highest
                           enrollment rates.

                            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-97-82
                          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 and HCFA take no action, thus preserving
                          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.

                          Page 6                                                       GAO/T-HEHS-97-82
Page 7   GAO/T-HEHS-97-82
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).

(101545)      Page 8                                                 GAO/T-HEHS-97-82
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