In implementing the law’s rate-setting provisions, HCFA estimates a county’s average per-beneficiary cost and multiplies the result by 0.95.The product is the county adjusted average per capita cost rate. Much has been written about the inadequacy of Medicare’s risk adjuster to account for the tendency of HMOs to experience favorable selection. HCFA Could Improve Its Rate-Setting Method by Including HMO Enrollees in Its Calculations of County Average Cost

Independent of risk adjustment, modifying the method for calculating county rate would help reduce Medicare’s excess HMO payments. However, in counties where there are cost disparities between Medicare’s FFS 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. Therefore, we developed a method to estimate HMO enrollees’ expected FFS costs using information available to HCFA. This new average produced a county rate that reflected the costs of all Medicare beneficiaries. We found that our method could have reduced excess payments by more than 25 percent. Substantially better risk adjustment, which appears to be years away from implementation, would target the remaining 75 percent of excess payments. Applying our method for setting county rates would have reduced the excess by about $276 million. 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—from counties with up to a 39-percent HMO penetration—indicated that excess payments as a percentage of total HMO payments were higher in counties with higher Medicare penetration. However, to the extent that the health care costs of Medicare’s HMO enrollee population are lower, on average, than those of beneficiaries in FFS, the exclusion of HMO enrollees’ costs (that is, what they would have cost Medicare in FFS) causes SAC and, ultimately, the capitation rate, to be too high. 1. Calculating County-Rate Excess Payments That Are Due to Using Only FFS Beneficiaries’ Experience to Set Rates

After estimating the average expected costs of serving all of a county’s beneficiaries in FFS (SACALL), we could estimate the excess capitation payments that resulted from HCFA’s method of calculating SAC and the county rate. Adjustments for Regression Toward the Mean and Death-Related Costs in Estimating Excess Payments to Medicare HMOs

As explained in appendix I, establishing the Medicare capitation rate for HMOs on the basis of the cost of serving beneficiaries hinges on estimating the expected FFS costs of HMO enrollees (SACHMO). Studies have generally found that, after a beneficiary enrolls in an HMO, his or her service use and costs rise. 1. 2. 4. 2. 3. This amount represents about 16 percent of Medicare’s payments to California HMOs under the risk contract program in 1995. This is not accurate.
Why GAO Did This Study

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.

What GAO Found

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.