Testimony

Before the Subcommittee on Health and the

Subcommittee on Oversight and Investigations,

Committee on Energy and Commerce, House of

Representatives

United States General Accounting Office

GAO

For Release on Delivery

Expected at 10:30 a.m.

Thursday, June 28, 2001 MEDICARE

CONTRACTING REFORM

Opportunities and

Challenges in Contracting

for Claims Administration

Services

Statement of Leslie G. Aronovitz

Director, Health Care—Program

 Administration and Integrity Issues

GAO-01-918T
Page 1 GAO-01-918T

Messrs. Chairmen and Members of the Subcommittees:

I am pleased to be here today as you continue to consider how the

Medicare program might be modified. Discussions about how to reform

and modernize Medicare have, in part, focused on whether the structure

that was adopted in 1965 is optimal today. In that context, questions have

been raised about whether the program could benefit from changes to the

way Medicare’s claims processing contractors are selected and the

functions they perform.

The original Medicare statute, along with subsequent regulations and

practices, limits how the program may contract for these services in ways

that differ from most federal contracts. There is no full and open

competition for the contracts; the agency is limited to choosing among

health insurers; contracts generally must cover the full range of claims

processing and related activities; and the agency is limited in its ability to

terminate contracts. The Health Care Financing Administration (HCFA),

recently renamed the Centers for Medicare and Medicaid Services (CMS),

has, since 1993, repeatedly proposed legislation to lift current contracting

restrictions in order to increase competition for these contracts and

provide more flexibility in how they are structured.1

 This year, the agency

again plans to seek such changes in order to improve program

management.

To assist the Subcommittees as they consider ways to strengthen

Medicare’s program administration, my remarks today focus on our

analysis of contracting reform issues. Specifically, I will discuss (1) how

reform might help to address concerns that current contracting policy may

impede effective program management, and (2) challenges in

implementing reform. My comments are based on our prior and ongoing

work related to strengthening Medicare operations.

In summary, Medicare could benefit from full and open competition and

its relative flexibility to promote better performance and accountability. If

legislation removes the current limits on Medicare contracting authority,

CMS could (1) select contractors on a competitive basis from a broader

array of entities capable of performing needed program activities; (2) issue

contracts for discrete program functions to improve contractor

 1

Our statement will continue to refer to HCFA where our findings apply to the

organizational structure and operations associated with that name.
Page 2 GAO-01-918T

performance through specialization; (3) pay contractors based on how

well they perform rather than simply reimbursing them for their costs; and

(4) terminate poor performers more efficiently.

Freeing Medicare from current contracting limitations is only the first step

in realizing potential benefits. Recent experiences with special contractors

for Medicare program safeguard activities provide useful lessons that the

agency could draw upon if it were free to use full and open competition.

These experiences also presage the challenges in achieving the potential

benefits of more flexible contracting authority. For example, CMS would

need to marshal its expertise to effectively use competitive bidding

authority and increased flexibility. It would need to carefully define the

scope of work in any new contracts and develop sound contractor

selection criteria. Transition to full and open competition for all

contractors would need to be phased in to ensure effective coordination of

functions among all contractors and to avoid disruption in service to

beneficiaries and providers. And, if contracts with financial incentives for

high- quality performance were used, CMS would need to develop

adequate performance goals and reliable measures to monitor and

evaluate the extent to which contract specifications were being met and

awards earned.

Medicare is a federal health insurance program designed to assist elderly

and disabled beneficiaries. Hospital insurance, or part A, covers inpatient

hospital, skilled nursing facility, hospice care, and certain home health

services. Supplemental medical insurance, or part B, covers physician and

outpatient hospital services, laboratory and other services. Claims are paid

by a network of 49 claims administration contractors called intermediaries

and carriers. Intermediaries process claims from hospitals and other

institutional providers under part A while carriers process part B claims.

The intermediaries’ and carriers’ responsibilities include: reviewing and

paying claims; maintaining program safeguards to prevent inappropriate

payment; and educating and responding to provider and beneficiary

concerns.

Medicare contracting for intermediaries and carriers differs from that of

most federal programs. Most federal agencies, under the Competition in

Contracting Act and its implementing regulations known as the Federal

Acquisition Regulation (FAR),2

 generally may contract with any qualified

 2

48 CFR, Chapter 1.

Background
Page 3 GAO-01-918T

entity for any authorized purpose so long as that entity is not debarred

from government contracting and the contract is not for what is essentially

a government function. Agencies are to use contractors that have a track

record of successful past performance or that demonstrate a current

superior ability to perform. The FAR generally requires agencies to

conduct full and open competition for contracts and allows contractors to

earn profits.

Medicare, however, is authorized to deviate from the FAR under

provisions of the Social Security Act enacted in 1965.3

 For example, there

is no full and open competition for intermediary or carrier contracts.

Rather, intermediaries are selected in a process called nomination by

provider associations, such as the American Hospital Association. This

provision was intended at the time of Medicare’s creation to encourage

hospitals to participate by giving them some choice in their claims

processor. Currently, there are three intermediary contracts, including the

national Blue Cross Blue Shield Association, which serves as the prime

contractor for 26 local member plan subcontractors. When one of the local

Blue plans declines to renew its subcontract, the Association nominates

the replacement contractor. Carriers are chosen by the Secretary of Health

and Human Services from a small pool of health insurers, and the number

of such companies seeking Medicare claims-processing work has been

dwindling in recent years.

The Social Security Act also generally calls for the use of cost-based

reimbursement contracts under which contractors are reimbursed for

necessary and proper costs of carrying out Medicare activities but does

not expressly provide for profit.4

 Further, Medicare contractors cannot be

terminated from the program unless they are first provided with an

opportunity for a public hearing––a process not afforded under the FAR.

 3

Section 1816 addresses fiscal intermediaries and section 1842 addresses carriers.

4

CMS has some limited authority to build financial incentives into intermediary and carrier

contracts. This authority was granted under section 2326(a) of the Deficit Reduction Act of

1984 and made permanent by section 159 of the Social Security Act Amendments of 1994.
Page 4 GAO-01-918T

Medicare could benefit from various contracting reforms. Freeing the

program to directly choose contractors on a competitive basis from a

broader array of entities able to perform needed tasks would enable

Medicare to benefit from efficiency and performance improvements

related to competition. It also could address concerns about the dwindling

number of insurers with which the program now contracts. Allowing

Medicare to have contractors specialize in specific functions rather than

assume all claims-related activities, as is the case now, also could lead to

greater efficiency and better performance. Authorizing Medicare to pay

contractors based on how well they perform rather than simply

reimbursing them for their costs, as well as allowing the program to

terminate contracts more efficiently when program needs change or

performance is inadequate, could also result in better program

management.

Since Medicare was implemented in 1966, the program has used health

insurers to process and pay claims. Before Medicare’s enactment,

providers feared that the program would give the government too much

control over health care. To win acceptance, the program was designed to

be administered by health insurers like Blue Cross and Blue Shield.

Subsequent regulations and decades of the agency’s own practices have

further limited how the program contracts for claims administration

services. The result is that agency officials believe they must contract with

health insurers to handle all aspects of administering Medicare claims,

even though the number of such companies willing to serve as Medicare

contractors has declined and the number of other entities capable of doing

the work has increased.

While using only health insurers for claims administration may have made

sense when Medicare was created, that may be much less so today. The

explosion in information technology has increased the potential for

Medicare to use new types of business entities to administer its claims

processing and related functions. Additionally, the need to broaden the

pool of entities allowed to be contractors has increased in light of

contractor attrition. Since 1980, the number of contractors has dropped by

more than half, as many have decided to concentrate on other lines of

business. This has left the program with fewer choices when one

contractor withdraws, or is terminated, and another must be chosen to

replace it.

Since 1993, the agency has repeatedly submitted legislative proposals to

repeal the provider nomination authority and make explicit its authority to

Medicare Could

Benefit from Open

Competition and

Increased Flexibility

Ability to Contract With a

Broader Array of Entities

Would Expand CMS

Options
Page 5 GAO-01-918T

contract for claims administration with entities other than health insurers.

Just this month, the Secretary of Health and Human Services told the

Senate Finance Committee that CMS should be able to competitively

award contracts to the entities best qualified to perform these functions

and stated that such changes would require legislative action. With such

changes, when a contractor leaves the program, CMS could award its

workload on a competitive basis to any qualified company or combination

of companies—including those outside the existing contractor pool, such

as data processing firms.

Allowing Medicare to have separate contractors for specific claims

administration activities—also called functional contracting—could

further improve program management. Functional contracting would

enable CMS to select contractors that are more skilled at certain tasks and

allow these contractors to concentrate on those tasks, potentially resulting

in better program service. For example, the agency could establish specific

contractors to improve and bring uniformity to efforts to educate and

respond to providers and beneficiaries, efforts that now vary widely

among existing contractors.

Currently, CMS interprets the Social Security Act and the regulations

implementing it as constraining the agency from awarding separate

contracts for individual claims administration activities, such as handling

beneficiary inquiries or educating providers about program policies.

Current regulations stipulate that, to qualify as an intermediary or carrier,

the contracting organization must perform all of the Medicare claims

administration functions. Thus, agency officials feel precluded from

consolidating one or more functions into a single contract or a few

regional contracts to achieve economies of scale and allow specialization

to enhance performance.

CMS has had some experience with functional contracting under authority

granted in 1996 to hire entities other than health insurers to focus on

Contracting for Specific

Functions Could

Strengthen Service to

Beneficiaries and

Providers
Page 6 GAO-01-918T

program safeguards.5 CMS has contracted with 12 program safeguard

contractors (PSC) who compete among themselves to perform taskspecific contracts called task orders.6

 These entities represent a mix of

health insurers, including many with prior experience as Medicare

contractors, along with consulting organizations, and other types of firms.

The experience with PSCs, however, makes clear that functional

contracting has challenges of its own, which are discussed later in this

testimony.

Allowing Medicare to offer financial incentives to contractors for highquality performance also may have benefits. According to CMS, the Social

Security Act now precludes the program from offering such incentives

because it generally stipulates that payments be based on costs.

Contractors are paid for necessary and proper costs of carrying out

Medicare activities but do not make a profit. Repeal of cost-based

restrictions would free CMS to award different types of contracts––

including those that provide contractors with financial incentives and

permit them to earn profits. CMS could test different payment options to

determine which work best. If effective in encouraging contractor

performance, such contracts could lead to improved program operations

and, potentially, to lower administrative costs. Again, implementing

performance-based contracting will not be without significant challenges.

 5

This authority was granted under section 1893 of the Social Security Act as amended.

Program safeguard activities are intended to prevent and detect fraudulent and abusive

activities of providers and beneficiaries. These activities include (1) medical review of

claims to determine if they are for covered, medically necessary and reasonable services,

(2) reviews to identify other primary sources of payment, (3) audits of cost reports

submitted by institutional providers to determine if costs are allowable and reasonable, (4)

identification and investigation of possible fraud cases, and (5) provider education and

training related to Medicare coverage policies and appropriate billing practices.

6

HCFA developed an indefinite-delivery/indefinite-quantity contract that allowed it to select

contractors and outline in broad terms the activities to be performed. Each task order

identifies a specific function to be performed. For example, one task order involves

conducting unannounced site visits to selected community mental health centers to

determine whether they are complying with Medicare regulations.

Offering Contractors

Payment Incentives Could

Result in Greater

Efficiencies
Page 7 GAO-01-918T

Allowing Medicare to terminate contractors more efficiently may also

promote better program management. The Social Security Act now limits

the agency’s ability to terminate intermediaries and carriers, and the

provisions are one-sided. Intermediaries and carriers may terminate their

contracts without cause simply by providing CMS with 180 days notice.

CMS, on the other hand, must demonstrate, that (1) the contractor has

failed substantially to carry out its contract or that (2) continuation of the

contract is disadvantageous or inconsistent with the effective

administration of Medicare. CMS must provide the contractor with an

opportunity for a public hearing prior to termination. Furthermore, CMS

may not terminate a contractor without cause as can most federal

agencies under the FAR.

In past years, the agency has requested statutory authority to eliminate the

public hearing requirement and the ability of contractors to unilaterally

initiate contract termination. Such changes would bring Medicare claims

administration contractors under the same legal framework as other

government contractors and provide greater flexibility to more quickly

terminate poor performers. Eliminating contractors’ ability to unilaterally

terminate contracts also may help address challenges the agency faces in

finding replacement contractors on short notice.

While Medicare could benefit from greater contracting flexibility, time and

care would be needed to implement changes to effectively promote better

performance and accountability and avoid disrupting program services.

Competitive contracting with new entities for specific claims

administration services in particular will pose new challenges to CMS––

challenges that will likely take significant time to fully address. These

include preparing clear statements of work and contractor selection

criteria, efficiently integrating the new contractors into Medicare’s claims

processing operations, and developing sound evaluation criteria for

assessing performance. Because these challenges are so significant, CMS

would be wise to adopt an experimental, incremental approach. The

experience with authority granted in 1996 to hire special contractors for

specific tasks related to program integrity can provide valuable lessons for

CMS officials if new contracting authorities are granted.

CMS Needs to be Able to

Terminate Poor

Performers More

Efficiently

Contracting Reform

Poses Many

Implementation

Issues
Page 8 GAO-01-918T

If given authority to contract competitively with new entities, CMS would

need time to accomplish several tasks. First among these would be

development of clear statements of work and associated requests for

proposals detailing work to be performed and how performance will be

assessed. CMS has relatively little experience in this area for Medicare

claims administration because current contracts instead incorporate by

reference all regulations and general instructions issued by the Secretary

of Health and Human Services to define contractor responsibilities. CMS

has experience with competitive contracting from hiring PSCs. It did take

3 years to determine how best to implement the new authority through its

broad umbrella contract, develop the statement of work, issue the

proposed regulations governing the PSCs, develop selection criteria,

review proposals, and select contractors. Program officials have told us

they are optimistic about their ability to act more quickly if contracting

reform legislation were enacted, given the lessons they have learned.

However, we expect that it would take CMS a significant amount of time

to develop its implementation strategy and undertake all the necessary

steps to take full advantage of any changes in its contracting authority.

CMS took an incremental approach to awarding its PSC task orders, and

the same would be prudent for implementing any changes in Medicare’s

claims administration contracting authorities.

Even after new contractors are hired, CMS should not expect immediate

results. The PSC experience demonstrates that it will take time for them to

begin performing their duties. PSCs had to hire staff, obtain operating

space and equipment, and develop the systems needed to ultimately fulfill

contract requirements––activities that often took many months to

complete. Without sufficient start-up time, new contractors might not

operate effectively and services to beneficiaries or providers could be

disrupted.

Developing a strategy for how to incorporate functional contractors into

the program and coordinate their activities is key. While there may be

benefits from specialization, having multiple companies performing

different claims administration tasks could easily create coordination

difficulties for the contractors, providers, and CMS staff. For example,

between 1997 and 2000, HCFA contracted with a claims administration

contractor that subcontracted with another company for the review of the

Contracting With New

Entities Will Take Time

and Require Careful

Planning

Coordination Is Critical for

Functional Contractors
Page 9 GAO-01-918T

medical necessity of claims before they were paid.7 The agency found that

having two different contractors perform these functions posed logistical

challenges that could make it difficult to complete prepayment reviews

without creating a backlog of unprocessed claims.

The need for effective coordination was also seen in the PSC experience.

PSCs and the claims administration contractors need to coordinate their

activities in cases where the PSCs assumed responsibility for some or all

of the program safeguard functions previously performed by the

contractors. In these situations, HCFA officials had to ensure that active

claims did not get lost or ignored while in the processing stream.

Coordination is also necessary to ensure that new efficiencies in one

program area do not adversely affect another area. For example, better

review of the medical necessity of claims before they are paid could lead

to more accurate payment. This would clearly be beneficial, but could also

lead to an increase in the number of appeals for claims denials. Careful

planning would be required to ensure adequate resources were in place to

adjudicate those appeals and prevent a backlog.

CMS has not stated how claims administration activities might be divided

if the agency could do functional contracting. It would be wise for CMS to

develop a strategy for testing different options on a limited scale. In our

report on HCFA’s contracting for PSC services, we recommended, and the

agency generally agreed, that it should adopt such a plan because HCFA

was not in a position to identify how best to use the PSCs to promote

program integrity in the long term.8

Taking advantage of benefits from competition and performance-based

contracting hinges on being able to identify goals and objectives and to

measure progress in achieving them. Specific and appropriate evaluation

criteria would be needed to effectively manage any new arrangements

under contracting reform. Effective evaluations are dependent, in part,

upon clear statements of expected outcomes tied to quantifiable measures

and standards. Because it has not developed such criteria for most of its

 7

A claims administration contractor has the flexibility to subcontract under section 1842 of

the Social Security Act.

8

Medicare: Opportunities and Challenges in Contracting for Program Safeguards

(GAO-01-616, May 18, 2001).

Experience Is Needed to

Develop Effective

Evaluation Criteria
Page 10 GAO-01-918T

PSC task orders, we reported9 that CMS is not in a position to effectively

evaluate its PSCs’ performance even though 8 of the 15 task orders had

been ongoing for at least a year as of April 2001. If CMS begins using full

and open competition to hire new entities for other specific functions, it

should attempt to move quickly to develop effective outcomes, measures,

and standards for evaluating such entities.

Effective criteria are also critical if financial incentives are to be offered to

contractors. Prior experiments with financial incentives for Medicare

claims administration contractors generally have not been successful. This

experience raises concerns about the possibility for success of any

immediate implementation of such authority without further testing. For

example, between 1977 and 1986, HCFA established eight competitive

fixed-price-plus-incentive-fee contracts designed to consolidate the

workload of two or more small contractors on an experimental basis.

Contractors could benefit financially by achieving performance goals in

certain areas at the potential detriment of performance in other activities.

In 1986, we reported that two of the contracts generated administrative

savings estimated at $48 million to $50 million.10 However, the two

contractors’ activities also resulted in $130 million in benefit payment

errors (both overpayments and underpayments) that may have offset the

estimated savings. One of these contractors subsequently agreed to pay

over $140 million in civil and criminal fines for its failure to safeguard

Medicare funds.

Removing the contracting limitations imposed at Medicare’s inception to

promote full and open competition and increase flexibility could help to

modernize the program and lead to more efficient and effective

management. However, change will not yield immediate results, and

lessons learned from the experience with PSC contractors underscore the

need for careful and deliberate implementation of any reforms that may be

enacted.

This concludes my statement. I would be happy to answer any questions

that either Subcommittee Chairman or Members may have.

 9

GAO-01-616, May 18, 2001.

10Medicare: Existing Contracting Authority Can Provide for Effective Program

Administration (GAO/HRD-86-48, Apr. 22, 1986).

Concluding

Observations
Page 11 GAO-01-918T

For further information regarding this testimony, please contact me at

(312) 220-7600. Sheila Avruch, Bonnie Brown, Paul Cotton, and Robert

Dee also made key contributions to this statement.

GAO Contact and Staff

Acknowledgments
Page 12 GAO-01-918T

Medicare Management: Current and Future Challenges (GAO-01-878T,

June 19, 2001).

Medicare: Opportunities and Challenges in Contracting for Program

Safeguards (GAO-01-616, May 18, 2001).

Major Management Challenges and Program Risks: Department of Health

and Human Services (GAO-01-247, Jan. 2001).

High Risk: An Update (GAO-01-263, Jan. 2001).

Medicare: 21st Century Challenges Prompt Fresh Thinking About

Program’s Administrative Structure (GAO/T-HEHS-00-108, May 4, 2000).

Medicare Contractors: Further Improvement Needed in Headquarters and

Regional Office Oversight (GAO/HEHS-00-46, Mar. 23, 2000).

Medicare: Program Safeguard Activities Expand, but Results Difficult to

Measure (GAO/HEHS-99-165, Aug. 4, 1999).

Medicare Contractors: Despite Its Efforts, HCFA Cannot Ensure Their

Effectiveness or Integrity (GAO/HEHS-99-115, July 14, 1999).

HCFA Management: Agency Faces Multiple Challenges in Managing Its

Transition to the 21st Century (GAO/T-HEHS-99-58, Feb. 11, 1999).

Medicare: HCFA Faces Multiple Challenges to Prepare for the 21st Century

(GAO/T-HEHS-98-85, Jan. 29, 1998).

(290094)

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