GAO-01-1046R Medicare Contracting Reform Proposal

United States General Accounting Office

Washington, DC 20548

August 17, 2001

The Honorable Michael Bilirakis

Chairman

The Honorable Sherrod Brown

Ranking Minority Member

Subcommittee on Health

Committee on Energy and Commerce

House of Representatives

The Honorable Jim Greenwood

Chairman

The Honorable Peter Deutsch

Ranking Minority Member

Subcommittee on Oversight

 and Investigations

Committee on Energy and Commerce

House of Representatives

Subject: Medicare: Comments on HHS’ Claims Administration Contracting Reform

 Proposal

On June 28, 2001, I testified before your subcommittees that the Medicare program

could benefit from reformed claims administration contracting authority and

practice.1

 On the same day, the Secretary of Health and Human Services (HHS)

submitted a legislative proposal that would modify Medicare’s contracting authority.

You asked us to comment on whether the proposal gives the Centers for Medicare

and Medicaid Services (CMS)2

 —the agency within HHS that manages Medicare—the

flexibility to promote better performance and accountability in its contracting

activities. 3 Accordingly, this correspondence discusses (1) current law and practice

in Medicare claims administration contracting, (2) provisions in the proposal that

would increase CMS’ contracting flexibility, and (3) provisions that deviate from

standard federal contracting requirements for full and open competition and

indemnification of contractors.

In brief, due to statute and long-standing practice, Medicare claims administration

contracting does not follow standard federal contracting rules in a number of ways.

 1

Medicare Contracting Reform: Opportunities and Challenges in Contracting for Claims

Administration Services (GAO-01-918T, June 28, 2001). 2

 CMS was known until recently as the Health Care Financing Administration.

3

 The Secretary has delegated authority to administer the Medicare program, including managing

claims administration contractors, to CMS.
2 GAO-01-1046R Medicare Contracting Reform Proposal

Medicare contractors are chosen from among health insurers without full and open

competition—not from among all potentially qualified vendors. In addition, CMS

almost always uses cost-only contracts and is limited in its ability to terminate

contractors short of the full contract term, while the contractors have greater rights

to terminate during the contract year than other federal contractors. The proposed

legislation would modify Medicare law by providing CMS with explicit authority to

contract with any qualified entities to perform any claims administration functions,

reimbursing them through any payment method permitted under federal contracting

rules. It would also give CMS the same authority as other federal agencies to retain

or terminate contractors. We believe these provisions would benefit the Medicare

program by increasing the agency’s flexibility to promote contractor performance

and accountability. However, we are concerned that certain provisions in this

legislative proposal would allow CMS to continue to bypass federal contracting rules

for Medicare claims administration in two ways. The proposal would permit, but not

require, the selection or renewal of claims administration contractors through full

and open competition. In addition, the proposal includes a provision that would

require CMS to indemnify claims administration contractors from certain liabilities in

a way that creates a potential open-ended liability for the government while reducing

contractor accountability.

In commenting on a draft of this correspondence, CMS generally agreed with us on

the benefits of the proposal, but was concerned that requiring full and open

competition for these contracts on a regular schedule—such as every 5 years-- might

be too burdensome. In addition, CMS did not agree that the provisions on

indemnification in the Secretary’s proposal created an open-ended liability and

pointed to existing statutory provisions as precedence for providing the type of

indemnification proposed.

BACKGROUND

Medicare is a health insurance program for about 40 million beneficiaries—people

aged 65 years and older, some disabled people under 65 years of age, and people with

end-stage renal disease, which is permanent kidney failure treated with dialysis or a

transplant. About 85 percent of beneficiaries are enrolled in the traditional program

and receive their health care on a fee-for-service basis, while the rest are enrolled in

prepaid health plans that contract with the government to receive monthly payments

in exchange for providing needed Medicare services to enrollees. Medicare part A

services include inpatient hospital, skilled nursing facility, and certain home health

and hospice care, while part B services include physician and outpatient hospital

services, and certain other medical services, such as clinical laboratory, outpatient

physical and occupational therapy services, and durable medical equipment and

supplies.

To process and pay claims for services in the traditional program, CMS has 49

contracts with insurance companies called fiscal intermediaries and carriers. Fiscal

intermediaries process claims from hospitals and other institutional providers under
3 GAO-01-1046R Medicare Contracting Reform Proposal

part A while carriers process claims for physicians and other health care providers

under part B.

CLAIMS ADMINISTRATION CONTRACTING

DEVIATES FROM STANDARD FEDERAL

CONTRACTING IN SEVERAL WAYS

Contracting for Medicare claims administration services by fiscal intermediaries and

carriers differs from that of most federal programs. Under the Competition in

Contracting Act of 1984 (CICA) and its implementing regulations, known as the

Federal Acquisition Regulation (FAR),4 federal agencies generally may contract with

any qualified 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 CICA, as implemented by the FAR, generally requires agencies to

conduct full and open competitions, because the Congress recognized that such

competition generally resulted in the government receiving the best value for

products or services it acquires. The FAR also allows contractors to earn profits and

requires that contractors perform until the end of the contract term.

In contrast, since Medicare's establishment in 1965, the Secretary of Health and

Human Services has been authorized by statute to select contractors to process

Medicare claims under parts A and B without competition. When Medicare was

established, there was concern about whether the federal government should be

involved in medical decision- making and had the expertise to process large numbers

of what would essentially be health insurance claims. The Medicare statute permits

entities with experience processing these types of claims, which have generally been

health insurance companies, to perform this role for Medicare. In addition, Medicare

gave hospitals a role in selecting their claims processor. Under section 1816(a) of the

Social Security Act (SSA), if provider associations nominate fiscal intermediaries to

process part A claims for them, the Secretary is authorized to contract with those

entities without competition.5

 Soon after Medicare was established, the American

Hospital Association nominated the BlueCross BlueShield Association to process

hospital claims.6 In regard to physician and other part B claims, Section 1842(b)(1) of

the SSA provides that the Secretary may enter into contracts with carriers to process

part B claims without following the usual requirements related to requests for

proposals or "any other provision of law requiring competitive bidding.”

7

The Secretary was authorized to contract with entities that were existing payers of

health care services. Thus, the Secretary began and has continued to contract with

such entities—almost exclusively health insurers—including the BlueCross

 4

 48 C.F.R., Chapter 1.

5

 42 U.S.C. 1395h(a).

6

 The Association subcontracts with 26 member plans to process part A claims in different states or

regions of the country.

7

 42 U.S.C. 1395u(b)(1).
4 GAO-01-1046R Medicare Contracting Reform Proposal

BlueShield Association on behalf of its member companies. The statutory language

authorizing the Secretary to contract for Medicare claims administration described a

set of activities or functions to be performed. Claims administration contractors have

generally been expected to perform all of these functions, except where the Congress

has given explicit authority to the Secretary to contract separately for a claims

administration function, as it did in 1996.8

Furthermore, the Social Security Act 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. However, these contracts do not

expressly provide for profit.9 Therefore, CMS has long paid claims administration

contractors only for their incurred costs and generally has not offered them the type

of fee incentives used in other federal procurement contexts.

Unlike standard federal contracting rules, sections 1816 and 1842 explicitly limit

CMS’ flexibility and options regarding termination of claims administration contracts.

Although federal agencies can generally terminate a contract at any time, CMS cannot

terminate contracts with Medicare claims administration contractors at the federal

government’s convenience.10 On the other hand, claims administration contractors

may terminate their contracts without penalty by providing the Secretary with 180

days notice.11

PROPOSED LEGISLATION WOULD GIVE

CMS NEEDED CONTRACTING FLEXIBILITY

The Secretary’s legislative proposal would give CMS flexibility to better manage its

contractors and their performance. It would grant CMS express authority to contract

with any qualified entity for parts A and B claims administration. This would include

qualified entities that were not health insurers. Further, the intermediary nomination

process under section 1816(a) would be eliminated and the proposal would provide

explicit authority for CMS to enter into contracts for the performance of specific

functions.

 8

 For example, the Health Insurance Portability and Accountability Act of 1996 gave the Secretary

explicit authority to contract separately for program safeguard activities, such as medical review of

claims to ensure that the services were medically necessary.

9

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

This authority was first 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.

10 CMS contracts with poorly performing claims administration contractors may be terminated only

after providing the contractor with 90 days notice and an administrative hearing if the contractor

requests one. In contrast, under the FAR, contracts may be terminated when a contractor fails to

remedy a performance problem within 10 days (unless extended by the agency) after receiving an

agency notice specifying the problem.

11 This is an option not normally available to federal contractors. Under the FAR, federal contractors

are liable for breach of contract if they fail to perform or fail to make progess meeting time frames

specified in the contract.
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Under the proposal, CMS would also be able to use incentive-based payment methods

available to other agencies to compensate contractors. The Secretary could use cost

reimbursement contracts that could include the payment of fees in addition to cost or

any other arrangements permitted under standard federal contracting rules. The

proposed legislation would also eliminate a contractor's ability to terminate a

contract unilaterally.12 All of these provisions are consistent with standard federal

contracting requirements.

PROPOSED LEGISLATION WOULD ALLOW, BUT

NOT REQUIRE, FULL AND OPEN COMPETITION

While the provisions discussed above are important, we are concerned that the

proposal might not result in CMS fully benefiting from an improved contractor

selection process. The proposal would not require that CMS initiate or complete a

move to exclusive use of full and open competition to select claims administration

contractors. As a result, CMS could continue to select claims administration

contractors noncompetitively, without being required to use a selection process that

is consistent with standard federal contracting requirements.

The FAR provides agencies with detailed rules governing the procedures to be used

in the competitive procurement process. Among other things, the FAR provides that

federal agencies generally must compete contracts at least every 5 years and may

unilaterally terminate them at any time. Officials at CMS are experienced with these

FAR requirements because the agency generally uses full and open competition to

select contractors that provide it with goods and services other than the

administration of Medicare claims.

Although the proposal states that competitive contracting procedures should be used

when hiring claims administration contractors, it does not require such procedures to

be put in place within a given time frame. In addition, under this legislative proposal,

the Secretary would retain authority to deviate from the FAR’s competition

requirements when initiating and renewing its claims administration contracts.

Specifically, subsection (2)(i) would permit the Secretary to enter into initial claims

administration contracts without full and open competition. In addition, subsection

(2)(h) would permit the Secretary to renew claims administration contracts without

requiring competition when the contractor has met or exceeded contract

performance requirements.

Provisions that allow CMS to deviate from FAR in its initial selection of contractors

and reallocation of work could permit postponing the introduction of competition

indefinitely. We recognize that transition from the current arrangement to

competitive selection is apt to be difficult and potentially disruptive to providers and

beneficiaries. For these reasons, as we noted in our testimony, sufficient time should

 12 The proposal would also repeal the provision requiring the government to offer the contractor a

hearing before a contract could be terminated.
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be allotted for the transition to fully competitive contracts for all of Medicare’s claims

administration workload. Medicare’s claims administration contractors currently pay

about 900 million claims each year to nearly 1 million hospitals, physicians, and other

health care providers billing the program. Given this massive workload, moving to

competitively-selected contractors will need to be done in stages so that in the future

CMS will be able to stagger its contract competitions and not have to compete all of

its workload in the same year. Nevertheless, we believe that there needs to be a

definite beginning and ending date for this transition.

INDEMNIFICATION PROVISIONS COULD

CREATE OPEN-ENDED LIABILITIY

FOR THE FEDERAL GOVERNMENT

Our review of the proposed legislation has also raised concerns regarding its

indemnification provisions. Generally under an indemnification agreement, one party

promises, in effect, to reimburse another party’s losses or expenses. Absent express

statutory authority, an agency generally may not enter into an agreement to

indemnify where the amount of the government’s liability is indefinite, indeterminate,

or potentially unlimited. An agreement to do that would violate both the

Antideficiency Act, 32 U.S.C. §1341, and the Adequacy of Appropriations Act, 41

U.S.C. §11 because it can never be said that sufficient funds have been appropriated

to cover an unlimited liability.

However, subsection (2)(f) of the proposed legislation would require, among other

things, that the Secretary pay all reasonable expenses incurred by a claims

administration contractor in connection with the defense of any civil suit, action, or

proceeding so long as the contractor exercised due care. While it appears that the

proposed language attempts to limit liability, for example, by the use of such

modifiers as “reasonable amount of expenses incurred, as determined by the

Secretary,” it would create an open-ended, potentially unlimited liability. The

Congress has rarely authorized this type of open-ended liability and the Secretary has

not explained the need for claims administration contractors to receive such an

unusual benefit.

If legislation were to be enacted to require indemnification in this context, a more

prudent approach would be to clearly limit CMS’ liability. Because federal agencies

are seldom authorized to indemnify their contractors, another alternative is to cover

the cost to contractors for private insurance against potential liability. This approach

would need to be studied to see if it would be a cost-effective alternative for Medicare

claims administration contracting.

In conclusion, due to statutory language and current practice, Medicare claims

administration does not follow standard federal contracting requirements. The

Secretary's legislative proposal has provisions that we believe would be beneficial to

the Medicare program, such as giving the Secretary express authority to contract with

any qualified entity for claims administration and to use payment methods and

termination procedures currently routine at other federal agencies. However,
7 GAO-01-1046R Medicare Contracting Reform Proposal

because the provisions that would permit CMS to continue contracting without

competition and require CMS to provide open-ended indemnification do not follow

standard federal contracting requirements, we believe that those provisions should be

modified.

AGENCY COMMENTS AND OUR EVALUATION

We provided CMS with a draft of this correspondence for comment. In its written

comments (see enclosure I), CMS agreed that the Secretary’s proposal would

increase its contracting flexibility and emphasized the agency’s intention to move to

full and open competition in contracting for Medicare claims administration services.

CMS stated that the proposal would initially permit it to enter into new

noncompetitive contracts and it must use full and open competitive procedures

thereafter. However, agency officials expressed concern that requiring competition

on a regular schedule—such as every 5 years—would be difficult and potentially

disruptive.

It is not clear to us, however, that a contractor successfully performing its duties

would ever have to compete in a full and open competition under the Secretary’s

proposal. This is because subsection (2)(i) would permit the Secretary to enter into

initial claims administration contracts without full and open competition as well as

renew claims administration contracts without requiring competition when the

contractor has met or exceeded contract performance requirements. While we agree

that CMS needs time to make the transition to full and open competition, without a

requirement to move to competitive procurements within a specified time frame, the

agency could avoid such competition indefinitely. In addition, without a requirement

to compete these contracts periodically, Medicare would not realize the full benefits

of competition.

CMS also took issue with our characterization of the provision indemnifying

contractors’ against legal costs of civil suits as open-ended and inappropriate for the

Medicare program. CMS pointed out that within the Medicare program, there is

statutory precedent for indemnifying contractors, because the proposed language

regarding contractors’ indemnification was modeled on similar provisions applicable

to peer review organizations. CMS officials stated that the indemnification provision

is essential to ensuring competition in their future contracting efforts. They also

asserted that it was likely to be far less expensive to indemnify the contractors than

to cover the costs of insuring them against the full risks associated with the legal

costs of third party claims. While we recognize that there may be a precedent within

the Medicare program,13 we remain concerned that the wording of the provision to

indemnify contractors for the “reasonable” costs of defending against third party suits

is too broad and exposes the government to potentially unlimited liability. The

agency would need to explore whether paying for private insurance to cover the legal

expenses of suits would be cost-effective.

 13 42 U.S.C. 1320c-6 (d).
8 GAO-01-1046R Medicare Contracting Reform Proposal

CMS also stressed the importance of providing a federal limitation on contractors’

liability with respect to third party claims. Under this provision for limitation on civil

liability in the Secretary’s proposal, as long as contractors exercise due care in

performing Medicare duties, a third party lawsuit cannot proceed against them. This

provision is also part of the statutory framework for peer review organizations, and

has been referenced in statutory provisions pertaining to the Medicare Integrity

Program.14 We do not take issue with the limitation on civil liability, which would

provide contractors with strong protection against suits by third parties, at no cost to

the government, so long as they exercised due care in the performance of their

responsibilities.

CMS also provided technical comments, which we incorporated as appropriate.

_ _ _ _ _

As agreed with your offices, unless you publicly announce its contents earlier, we

plan no further distribution of it until 30 days from the date of this letter. At that

time, we will send copies to the Secretary of Health and Human Services and other

interested parties. The letter will also be available on GAO’s home page at

http://www.gao.gov. Please contact me at (312) 220-7600 or Sheila K. Avruch at (202)

512-7277 if you or your staff have any questions. Stefanie Weldon and Craig Winslow

made key contributions to this correspondence.

Leslie G. Aronovitz

Director, Health Care—Program

 Administration and Integrity Issues

Enclosure

 14 42 U.S.C. 1395ddd(e).
9 GAO-01-1046R Medicare Contracting Reform Proposal

Enclosure I: Comments from the Centers for Medicare and Medicaid Services
10 GAO-01-1046R Medicare Contracting Reform Proposal
11 GAO-01-1046R Medicare Contracting Reform Proposal
12 GAO-01-1046R Medicare Contracting Reform Proposal

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