Medicare HMOs:

HCFA Can Promptly Eliminate Hundreds of Millions in Excess Payments

HEHS-97-16: Published: Apr 25, 1997. Publicly Released: May 13, 1997.

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Pursuant to a congressional request, GAO provided information on Medicare's rate-setting method for paying risk contract health maintenance organizations (HMO), focusing on: (1) the conditions under which Medicare's method can yield payment rates that are too high; and (2) a practical improvement to Medicare's method directed at the problems fostering excess payments.

GAO noted that: (1) contrary to the expectations built into Medicare law for paying risk contract HMOs, these HMOs have not produced savings for Medicare; (2) however, Medicare-sponsored research and other studies have found that the program has actually spent more for HMO enrollees than their costs would have been under fee-for-service (FFS); (3) researchers attribute this outcome to favorable selection, or the tendency for healthier-than-average individuals to be enrolled in HMOs; (4) GAO has identified a modification to Medicare's current HMO rate-setting method that could help reduce excess HMO payments; (5) central to the current method is an estimate of the average cost, county by county, of serving Medicare beneficiaries in the FFS sector; (6) the actual rates are set by adjusting the county averages up or down on the basis of each enrollee's likelihood of incurring higher or lower costs, a process known as risk adjustment; (7) although considerable attention has focused on problems with this process, GAO's work centers on a largely overlooked problem regarding the estimates of average county costs, that is, the county rate, commonly known as the AAPCC (adjusted average per capita cost); (8) HCFA's method of determining the county rate excludes HMO enrollees' costs in estimating per-beneficiary average cost; (9) the result is that in counties experiencing favorable selection, HCFA's method overstates the average costs of all Medicare beneficiaries and leads to overpayments; (10) GAO's proposed modification estimates HMO enrollees' expected FFS costs using information available to HCFA; (11) GAO's approach produces a county rate that more accurately represents the costs of all Medicare beneficiaries; (12) in examining the rates HCFA determined for California's 58 counties in 1995, GAO found that applying its approach would have reduced excess payments by about 25 percent, or $276 million; (13) substantially better risk adjustment, which appears to be years away from implementation, would have targeted the remaining 75 percent; (14) GAO also found that Medicare's current method produced a greater overstatement of county average costs in counties with higher Medicare HMO penetration, up to 39 percent; and (15) this finding calls into question the hypothesis put forth by HMO industry advocates and others that the excess payment problem will be mitigated as more beneficiaries enroll in Medicare managed care and HMOs contain a more expensive mix of beneficiaries.

Recommendation for Executive Action

  1. Status: Closed - Implemented

    Comments: The Balanced Budget Act (BBA) of 1997 includes provisions that will reduce the excess HMO payments reported by GAO. The BBA's provisions do not, however, incorporate GAO's method to target payment reductions to areas with the highest excess payments.

    Recommendation: The Secretary of Health and Human Services should direct the Administrator, HCFA, to incorporate the expected FFS costs of HMO enrollees into the methodology for establishing county rates using the method GAO explains in this report and adjust Medicare payment rates to risk contract HMO's accordingly.

    Agency Affected: Department of Health and Human Services


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