Medicare+Choice: Impact of 1997 Balanced Budget Act Payment Reforms on Beneficiaries and Plans

Published by the Government Accountability Office on 1999-06-09.

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

                          United States General Accounting Office

GAO                       Testimony
                          Before the Committee on Finance, U.S. Senate

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

                          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

Medicare+Choice: Impact of 1997 Balanced
Budget Act Payment Reforms on
Beneficiaries and Plans
              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 on
              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.

               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.

              Page 1                                                                         GAO/T-HEHS-99-137
             Medicare+Choice: Impact of 1997 Balanced
             Budget Act Payment Reforms on
             Beneficiaries and Plans

             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.

             Medicare’s use of prepaid health plans, which typically have a financial
Background   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

              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.

             Page 2                                                                         GAO/T-HEHS-99-137
Medicare+Choice: Impact of 1997 Balanced
Budget Act Payment Reforms on
Beneficiaries and Plans

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

Page 3                                                    GAO/T-HEHS-99-137
                         Medicare+Choice: Impact of 1997 Balanced
                         Budget Act Payment Reforms on
                         Beneficiaries and Plans

                         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
                         “favorable selection” 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.

                         Beginning in 1998, BBA substantially changed the method used to set
Under BBA,               Medicare+Choice plan payments. Some of the new payment provisions
Medicare’s Payments      will tend to reduce excess payments. The most important of these is a new
to Health Plans Likely   health-based risk adjustment system, to be implemented in two stages,
                         with an interim adjuster to be introduced in 2000 followed by a more
Remain Excessive in      comprehensive adjuster in 2004. Substantial excess payments may persist,
the Aggregate            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 “blending,”
                         which is designed to reduce the geographic disparity in payment rates and

                          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.)

                         Page 4                                                                           GAO/T-HEHS-99-137
Medicare+Choice: Impact of 1997 Balanced
Budget Act Payment Reforms on
Beneficiaries and Plans

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 the BBA
provision to “carve out” 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
locked in 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

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

Page 5                                                                      GAO/T-HEHS-99-137
                       Medicare+Choice: Impact of 1997 Balanced
                       Budget Act Payment Reforms on
                       Beneficiaries and Plans

                       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.

                       Announcements of plan withdrawals in the last year have prompted
Recent Experience      debate about whether to revise certain BBA provisions governing
Suggests Sweeping      Medicare+Choice. As we recently reported, several factors suggest that
Action Not Warranted   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
in the Short Term      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 withdrawals have meant significantly
                       diminished or no access in some localities, 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

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

                       Page 6                                                                     GAO/T-HEHS-99-137
Medicare+Choice: Impact of 1997 Balanced
Budget Act Payment Reforms on
Beneficiaries and Plans

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 “savings”—to

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

Page 7                                                                       GAO/T-HEHS-99-137
               Medicare+Choice: Impact of 1997 Balanced
               Budget Act Payment Reforms on
               Beneficiaries and Plans

               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

               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, plans nationally 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.

               In creating the Medicare+Choice program, BBA substantially changed the
Concluding     way plan payments are determined. Some plan and industry
Observations   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:

                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 8                                                                           GAO/T-HEHS-99-137
                      Medicare+Choice: Impact of 1997 Balanced
                      Budget Act Payment Reforms on
                      Beneficiaries and Plans

                  •   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

                      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 FFS Medicare beneficiary.

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

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

(101857)              Page 9                                                     GAO/T-HEHS-99-137
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