United States General Accounting Office

GAO Report to the Permanent Subcommittee

on Investigations, Committee on

Governmental Affairs, U.S. Senate

September 1998 MEDICARE HMO

INSTITUTIONAL

PAYMENTS

Improved HCFA

Oversight, More Recent

Cost Data Could Reduce

Overpayments

GAO/HEHS-98-153

GAO United States

General Accounting Office

Washington, D.C. 20548

Health, Education, and

Human Services Division

B-279730 

September 9, 1998

The Honorable Susan M. Collins

Chairman

The Honorable John Glenn 

Ranking Minority Member

Permanent Subcommittee on Investigations

Committee on Governmental Affairs

United States Senate

The Congress has focused increasingly in recent years on rapidly growing

Medicare expenditures. Between 1990 and 1997, Medicare spending grew

from $107 billion to $207 billion, or about 12 percent per year. Although

the bulk of program outlays is for services delivered through traditional

fee-for-service Medicare, a growing number of seniors—approximately

5 million out of 38 million Medicare beneficiaries—receive care through

health maintenance organizations (HMO) that participate in Medicare’s risk

contract program. Unlike fee-for-service providers, which are paid on a

per-claim basis, these HMOs receive from Medicare a monthly fixed sum

per enrolled beneficiary—a capitation rate—and assume the risk of

providing beneficiary health care, regardless of the actual costs incurred.

Part of the process for setting capitation rates involves risk adjustment.

The Health Care Financing Administration (HCFA), the agency responsible

for administering Medicare, adjusts the capitation rate for such factors as

age and sex to reflect the expectation that different classes of

beneficiaries are likely to incur higher or lower costs than the average

beneficiary. For example, HCFA has determined that the estimated

2.6 million Medicare beneficiaries living in nursing homes and other

long-term care facilities frequently incur greater-than-average

Medicare-covered expenses. Consequently, the “institutional” risk adjuster

generally raises capitation payments for the approximately 50,000

Medicare HMO enrollees residing in such facilities. The payments are

intended to cover expected higher-than-average costs for

Medicare-covered acute-care and post-acute-care services.

Concerned about the potential incentive for some HMOs to inappropriately

classify beneficiaries as institutionalized and the possibility that flaws in

the methodology for calculating the institutional rate are generating

excessive payments, you asked us to examine (1) the criteria HCFA uses to

determine a beneficiary’s institutional status, (2) the methods HCFA

employs to ensure that HMOs properly classify beneficiaries as

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B-279730 

institutionalized, and (3) whether the higher capitation rate for

beneficiaries who live in institutions is justified by higher health care

costs.

To do this work, we visited selected facilities classified by HMOs as

institutions; reviewed HCFA’s relevant policy and procedure manuals at

HCFA headquarters and the agency’s reporting and verification procedures

at two regional offices (San Francisco and Seattle) that cover high

managed care penetration areas; and interviewed HCFA officials, industry

groups, and Medicare HMO representatives. In addition, we reviewed

previous research on the health cost estimates for institutional-status

beneficiaries that HCFA used to set HMO rates. We also analyzed data from

HCFA’s Medicare Current Beneficiary Survey (MCBS) to examine cost

differences for beneficiaries residing in different types of facilities. HCFA

officials have reconciled the MCBS data with Medicare claims and other

administrative information to produce data the agency believes to be

generally accurate and complete. Given HCFA’s intensive efforts, we did not

independently verify the accuracy of the information in the MCBS data files.

Our work was performed from January 1997 to April 1998 in accordance

with generally accepted government auditing standards.

Results in Brief Until recently, HCFA’s broad definition of “institution” allowed HMOs to

claim institutional status for individuals residing in facilities not likely to

house sicker-than-average seniors. Some of the facilities we visited that

HMOs had classified as institutional residences provided no medical care

but rather offered a menu of recreational activities for seniors capable of

living independently. HCFA acted on our findings and those of others by

narrowing the definition of eligible institutions, effective January 1, 1998.

Even with more stringent criteria, however, HCFA relies on the HMOs to

determine which beneficiaries qualify for institutional status. HCFA

conducts only limited reviews, approximately every 2 years, to confirm the

accuracy of HMO records. Studies by the Department of Health and Human

Services (HHS) Inspector General reviewing the accuracy of HMO

institutional status data support our finding that HCFA’s reviews are not

adequate to detect the extent of errors or overpayments resulting from

HMOs’ misclassification of beneficiaries. The task of ensuring accurate data

may be further complicated by HCFA’s policy that allows HMOs 3 years to

retroactively change institutional status data in beneficiary records. The

lack of a systematic approach for identifying errors limits HCFA’s efforts to

recover overpayments and ensure that appropriate payments are made to

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HMOs. Moreover, HCFA generally waits 2 years to verify that HMOs have

corrected inaccurate record-keeping systems, even when serious errors

have been identified.

Finally, HCFA continues to use 20-year-old cost data in determining the

payment rates for institutionalized enrollees. As a result, HCFA

overcompensates HMOs for their enrolled, institutionalized beneficiaries.

HCFA’s own analysis confirms that updating the institutional risk factor

with more recent cost data, which are available, would result in

substantially lower payments for aged institutionalized enrollees. For

example, an HMO would receive a little more than half the current payment

rate for a 74-year-old male Medicare beneficiary classified as residing in an

institution if the institutional risk factors were updated. This overpayment

problem may be corrected when HCFA implements a revised set of risk

factors in 2000. However, provisions of the Balanced Budget Act of 1997

(BBA)1

 that use 1997 rates as the basis for 1998 and future rates effectively

preclude a revision to the institutional risk factor at this time.

While HCFA has revised its definition of eligible institutions, concerns

remain that HCFA’s oversight of payments for institutional status is

inadequate. HCFA has no system to estimate and recover total

overpayments when institutional status errors are detected or to verify

HMOs’ retroactive adjustment requests. Further, HCFA does not ensure

timely review of those HMOs found to have submitted inaccurate

institutional status data, and its use of outdated cost data in determining

payments continues to overcompensate HMOs for institutionalized

enrollees.

Background Medicare provides health insurance for nearly all elderly Americans (those

aged 65 and older) and certain of the nation’s disabled. Most Medicare

beneficiaries receive services through the fee-for-service sector. However,

as of April 1998, roughly 15 percent of Medicare’s beneficiaries—up from

about 7 percent in mid-1995—were enrolled in risk contract HMOs.2

 Of

these, about 50,000 beneficiaries are classified as institutionalized each

month.3

1

Sec. 4001 of P.L. 105-33 added sec. 1853 (42 U.S.C. 1395w-23) to the Social Security Act.

2

Other Medicare managed care plans include cost contract HMOs and health care prepayment plans,

which together enroll fewer than 2 percent of the total Medicare population. Because Medicare pays

these plans using methods other than capitation rates, they are not the subject of this report.

3

A beneficiary’s institutional status can change on a monthly basis.

Page 3 GAO/HEHS-98-153 Medicare HMO Institutional Payments
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HCFA, an agency within HHS, administers the Medicare program and is

responsible for ensuring that Medicare HMOs comply with data reporting,

beneficiary protection, and care delivery requirements. HCFA seeks to

ensure that HMOs meet financial solvency and enrollment requirements, do

not earn excessive profits,4

 operate internal quality assurance systems,

and establish grievance and appeals procedures. HCFA also implements the

capitation rate formula authorized by legislation and calculates payments

for each HMO. Further, HCFA is responsible for monitoring HMOs to ensure

that all Medicare requirements are met, including that HMOs’ reports of

beneficiaries’ institutional status are accurate. HCFA is also responsible for

ensuring that corrective actions are taken if overpayments,

underpayments, or other errors are discovered. HCFA established a national

policy in 1994 permitting HMOs to seek retroactive payment

adjustments—for either overpayments or underpayments—for the prior

3-year period.5

Size and Distribution of

Medicare HMO Population

With Institutional Status

About 1 percent of Medicare’s roughly 5 million HMO enrollees are

classified as living in institutions, as compared with about 7 percent of

beneficiaries covered under Medicare fee-for-service. In 1997, Medicare

paid $197 million more to HMOs because of their enrollees’ institutional

status.

The distribution of enrollees with institutional status varies among HMOs

and among geographic regions. In December 1997, most institutional

enrollment rates for individual HMOs ranged from 0 to about 10 percent,

although one outlier exceeded 44 percent. (See fig. 1.)

4

HMOs are permitted to retain all profits up to the level earned on non-Medicare business.

5

Technically, every institutional rate adjustment is retroactive because it applies to the month

preceding the month in which the adjustment is being reported. (The regional staff we contacted

considered the months prior to the “current” adjustment month as a retroactive period.)

Page 4 GAO/HEHS-98-153 Medicare HMO Institutional Payments
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Figure 1: Percentage of Institutional

Medicare Beneficiaries Enrolled in

HMOs, December 1997

Notes: Institutional beneficiaries are those who reside in an eligible institution for at least 30

consecutive days.

The range of institutional enrollment excludes HMOs participating in certain demonstrations that,

for payment purposes, classify all HMO members as institutionalized.

Source: GAO analysis of HCFA data.

Page 5 GAO/HEHS-98-153 Medicare HMO Institutional Payments
B-279730 

The Role of the

Institutional Risk Factor in

Setting HMO Rates

Medicare’s risk contract program was designed to save Medicare money

by paying HMOs 95 percent of the amount Medicare estimated it would

spend on similar beneficiaries in the fee-for-service sector. It was believed

that HMOs would have lower costs because of their greater emphasis on

preventive health services and their incentive to eliminate unnecessary

services. The base capitation rate in each county—the amount an HMO

receives each month for enrolling an average-cost beneficiary—is

determined by law, largely on the basis of Medicare’s per capita

fee-for-service spending.6

An HMO’s monthly capitation payment is adjusted for the expected care

costs of each individual enrolled. To make the adjustment, HCFA assigns

weights to defined risk classes of beneficiaries on the basis of age; sex;

and disability, Medicaid, institutional, and employment status. The weights

are expressed as ratios of the national average per capita costs for each

risk class relative to the overall national average. For example, in 1997,

compared with the national average weight set at 1.0, the weight assigned

to the risk class for men aged 85 or older with institutional status was 2.25.

Thus, HCFA’s estimate was that institutionalized men aged 85 and older

would have health care costs that were 2.25 times the costs for the average

beneficiary. HCFA adjusts capitation rates for most institutionalized

beneficiaries upward to reflect the expected differential.7

The additional monthly payment amount associated with institutional

status can be substantial. For example, in 1998 a Los Angeles HMO receives

$618 more per month for a 65-year-old man living in an institution than for

one who is not living in an institution ($1,071 instead of $453). (See fig. 2

for a comparison of monthly HMO payments in Los Angeles for institutional

and noninstitutional enrollees.)

6

Medicare determines four capitation rates for each county: two rates for part A services (one for the

aged and one for the disabled) and two rates for part B services (one for the aged and one for the

disabled). Under the Medicare program, part A covers primarily inpatient services; part B covers

physician and other services. Capitation payment provisions of the BBA, which established minimum

payment amounts, minimum updates, and blended local and national rates, loosened but did not

eliminate the link between local fee-for-service spending and local capitation rates.

7

For all aged beneficiaries and most disabled beneficiaries, institutional status raises the capitation

rate paid to HMOs. For a few age groups of disabled beneficiaries, institutional status can reduce HMO

payments, however. In these cases, therefore, HMOs have no financial incentive to report institutional

status.

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Figure 2: Comparison of Monthly HMO

Payments in Los Angeles for Aged

Institutional and Noninstitutional

Enrollees, for Selected Age Groups,

1998

0

200

400

600

800

1,000

1,200

1,400

1,600

453

390

803

708

1,071

934

1,348

1,212

Medicare Dollars 

Age Groups

Men 65-69 Women 65-69 Men 85+ Women 85+

Noninstitutionalized Beneficiaries Who Are Not Medicaid-Eligible or Working

Institutional Beneficiaries Who Are Not Medicaid-Eligible or Working

Source: GAO analysis of HCFA’s 1998 capitation rates.

In 2000, HCFA is required by the BBA to implement a new risk adjustment

methodology that uses direct indicators of health status—in addition to

any other demographic adjusters such as age and sex—to better reflect

differences in individuals’ expected health care costs.

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Broad Criteria Have

Allowed HMOs to

Claim Higher Payment

Rates for Certain

Seniors

Until recently, HCFA has defined the term “institution” to include skilled

nursing facilities, nursing homes, sanitoriums, rest homes, convalescent

homes, long-term care hospitals, domiciliary homes, swing-bed facilities,8

and intermediate-care facilities.9 HCFA based the higher payment rates for

institutional status on historical evidence that beneficiaries living in these

types of facilities had greater medical needs and higher medical costs than

those who lived in the community. These types of facilities, however, have

evolved to serve individuals with varied health care needs. Thus, HCFA’s

broad criteria permitted an HMO to classify virtually any residential facility

as an institution for payment purposes. Consequently, HMOs considered as

institutions many facilities that were housing seniors whose expected

health needs were at or below those of the average Medicare beneficiary.

HMOs have had an incentive to broadly interpret HCFA’s institution criteria.

For example, if an HMO classified a residential facility as an institution, the

HMO would receive a much higher capitation payment—up to $766 more

per month—for every enrollee living in that facility. In fact, the increased

institutional payments to one relatively small HMO amounted to about an

additional $135,000 for 1 month. For HMOs with larger institutionalized

enrollment, the annual additional capitation payments could be on the

order of $4 million to $9 million.

Medicare’s payment system is based on the assumption that HMO enrollees

living in institutions generate above-average health care costs. However,

some facilities classified by HMOs as institutions clearly did not serve

seniors with serious health problems. For example, among the designated

institutions we visited, one (called by its manager an “independent living

facility”) provided private apartments, meals in a communal setting, and

field trips to tourist and shopping sites. About 12 percent of the residents

owned and drove their own cars. The facility did not provide any medical

care. Another facility we visited—a retirement center—was characterized

by its marketing brochure as “a clean, comfortable home for those who do

not need nursing care.” This facility employed a full-time activity director

and housed several residents who drove their own cars.

Moreover, HCFA’s institutional payment policy is unclear when a single

facility offers a range of assistance levels—from independent living

arrangements to skilled nursing care. For example, one residential

8

Swing-bed facilities are hospitals that are permitted to provide skilled nursing services to Medicare

beneficiaries occupying acute-care beds.

9

To be eligible for the institutional rate during a particular month, the beneficiary must have been a

resident for the 30 consecutive days immediately preceding the last day of the month.

Page 8 GAO/HEHS-98-153 Medicare HMO Institutional Payments
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community we visited consisted of two facilities: one, a skilled nursing

care facility, provided subacute, skilled, and custodial care; the other, an

independent living facility, provided limited assistance, such as helping

individuals get to the communal dining room. An HMO planned to classify

the entire residential community as an institution. However, the residential

community’s manager disagreed that the independent living facility

constituted an institution. Although the HMO ultimately chose not to

classify those beneficiaries living in the independent facility as

institutionalized, no HCFA policy would have prevented such classification.

Facilities of this nature pose continued challenges in appropriately

determining which beneficiaries should be classified as institutionalized

for payment purposes.

Even though some regional HCFA officials felt that some facilities should

not have been classified as institutions, these officials believed they had

little basis for challenging any classification. In a 1995 memorandum to

HCFA headquarters, for example, the director of a HCFA region’s managed

care operations noted that “the manual provides no guidance regarding the

level of care provided to residents [needed to qualify for institutional

status]” and that “HCFA has the obligation to provide better guidance to

plans regarding the types of facilities which may be designated as

‘institutions.’”

On July 24, 1997, HCFA issued a policy letter that narrowed the definition of

eligible institutions effective January 1, 1998. The letter cited a history of

interpretation problems in using the broader definition as well as the

concerns we, the HHS Inspector General, and the agency itself have raised

about the potential for making improper payments to HMOs. Under the new

definition, only specified Medicare- or Medicaid-certified institutions are

included, thus limiting eligibility to institutions qualifying under the Social

Security Act, such as skilled nursing and nursing facilities; intermediate

care facilities for the mentally retarded; and psychiatric, rehabilitation,

long-term care, and swing-bed hospitals. Tying eligibility to certain

Medicare- and Medicaid-certified institutions effectively rules out

eligibility for independent or low-level assisted living facilities.

In principle, this change could significantly improve HCFA’s ability to

ensure that the higher capitation rate is being paid on behalf of only those

beneficiaries likely to have higher health care needs and costs. However,

in practice, the collocation of independent living arrangements with

eligible institutions and HCFA’s infrequent and narrow review of HMO

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B-279730 

records, as discussed in the next section, may limit the practical impact of

HCFA’s new policy.

HCFA Oversight Is

Inadequate to Prevent

and Recover

Inappropriate HMO

Payments

The process HCFA uses to verify that HMOs appropriately claim the

institutional payment rate is inadequate. HCFA relies on the HMOs

themselves to identify and report the names of beneficiaries for whom the

HMOs should receive the institutional rate. Using these mostly unaudited,

HMO-reported data, HCFA adjusts the capitation payments for the HMOs’

Medicare members who live in institutions.

HCFA does not conduct either comprehensive or spot checks at the

institutional facilities to assess the accuracy of the institutional status data

reported by HMOs. Instead, HCFA regional staff make site visits to each HMO

about every 2 years and examine a small sample of beneficiary records

maintained by the HMO. Results of previous HHS Inspector General audits

and our work show that the lack of effective oversight fails to hold HMOs

accountable for submitting accurate records and thus does not ensure that

HMOs receive appropriate payments.

HCFA Relies on

Error-Prone Data to

Determine Whether to

Increase HMO Payment

HCFA bases its institutional rate adjustments solely on HMO-reported data.

Each HMO is responsible for establishing a system to identify and report its

institutionalized beneficiaries to receive the pay adjustment from HCFA.

The reporting process works roughly as follows: Each month, the HMO

identifies those members who have resided in eligible facilities for 30

consecutive days prior to the reporting month and sends HCFA a list of

beneficiaries qualifying for institutional status.10 Using the HMO’s

information, HCFA then develops and sends to the HMO its monthly report of

the HMO’s qualifying beneficiaries (the HMO is responsible for informing

HCFA of any further changes in beneficiary status). On the basis of the final,

HMO-corrected report, HCFA adjusts—generally substantially

increasing—the HMO’s capitation payment for each institutionalized

beneficiary.

HCFA regional staff and HMO staff concur that, for a variety of reasons, HMO

data on institutionalized beneficiaries can be inaccurate. The financial

incentive for HMOs to classify beneficiaries as institutionalized is one

possible explanation for inaccurate data. Other explanations include

10The list of institutional beneficiaries becomes part of a larger report sent to HCFA that includes other

demographic information about the HMO’s Medicare enrollees.

Page 10 GAO/HEHS-98-153 Medicare HMO Institutional Payments
B-279730 

financial incentives for physicians to misclassify beneficiaries, inaccurate

data reported by institutions, and data entry errors by HMOs.

Some HMOs may have difficulty ensuring accurate data because their

providers financially benefit if enrollees are classified as living in

institutions. For example, the primary care providers in the

Minnesota-based HMO cited in a 1995 HHS Inspector General’s report11

received from 85 to 90 percent of Medicare’s per capita payment, while the

HMO kept the remainder. The HMO required these providers to notify it

when their Medicare patients entered or left an institutional setting or

otherwise changed their status. However, the Inspector General found that

the providers failed to do so and did not correct HMO reports sent to them

for reconciliation purposes. As a consequence, the HMO substantially

overreported the number of enrollees living in institutions.

HMO staff also reported difficulty obtaining accurate information on

beneficiaries’ current residence in particular facilities. HMO staff who were

responsible for verifying enrollees’ institutional status said they typically

contacted facilities by phone or mail monthly to determine which

enrollees resided in those facilities. However, facilities housing an HMO’s

Medicare enrollees do not necessarily have a contractual or financial

relationship with the HMO. Consequently, these facilities have no

compelling reason to comply with an HMO’s information requests. HMO staff

reported instances of not learning of changes in beneficiaries’ institutional

status, even when the HMOs had requested verification and received regular

responses from facility personnel.

Data entry errors are a third possible reason for inaccurate data. The 1995

Inspector General’s report attributed some instances of institutional status

misclassification and Medicare overpayments to the HMO’s own data entry

errors.

HCFA Allows HMOs a

3-Year Period to Adjust

Payments for Institutional

Enrollees

Verifying HMOs’ historical institutional status data is even more difficult

than ensuring the accuracy of current data. The period of time being

scrutinized is longer, and HCFA’s policy of allowing HMOs 3 years to correct

institutional status data and adjust payments accordingly compounds the

problem. For example, after a 1992 monitoring review of an HMO, HCFA

required the HMO to correct problems in its procedures for verifying its

Medicare enrollees’ institutional status and to conduct an audit of its own

11See HHS, Office of Inspector General, Review of Medicare Payments for Institutionalized

Beneficiaries (A-05-94-00053) (Washington, D.C.: HHS, May 1995).

Page 11 GAO/HEHS-98-153 Medicare HMO Institutional Payments
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institutional status records. As a result of the audit, the HMO reported

nearly $5 million in overbillings and more than $4.5 million in underbillings

to Medicare during a 2-1/2-year period. HCFA accepted the results of the

HMO’s self-audit and the HMO’s request to repay Medicare the difference

between the two amounts (approximately $500,000). The accuracy of the

HMO’s audit results was found to be questionable, however, when,

according to one HCFA official we interviewed, the HMO later attempted to

reverify its audit findings and was unable to do so because facilities had

changed the information they had originally reported to the HMO.

Concerned about potential errors in HMOs’ historical institutional status

data, three of the four HCFA regional offices we contacted for this study do

not permit, or permit only by exception, retroactive reimbursements.

Officials in HCFA’s central office said that the regional offices should be

following the national policy, which allows corrections in institutional

status, and related reimbursements, for up to 3 years. They also said,

however, that they are aware that regional offices are not doing so. These

officials said that, because of the frequent changes in HMOs’ historical

institutional status data, following the national policy would require

substantial additional regional work to validate and update the necessary

corrections to HCFA’s payment system.

HCFA’s Oversight Fails to

Ensure Accurate Payments

Our review and the Inspector General audits underscore the need for HCFA

to improve its oversight of the HMO data used in determining Medicare

payments to HMOs. HMOs’ records are normally checked by HCFA only during

routine monitoring visits, which occur about every 2 years. During a

monitoring visit, HCFA staff focus primarily on whether the HMO has a data

verification system in place. That is, they review the HMO’s policies and

procedures for both updating the HCFA report on institutionalized

beneficiaries and contacting facilities to verify residence and length-of-stay

information. HCFA regional staff also contact a few facilities to confirm the

residence and length of stay of some beneficiaries. Specifically, HCFA

protocol requires regional staff to verify the status of 30 enrollees living in

at least three different institutions and to contact three of the institutions.

HCFA’s verification practices may be too superficial to determine whether

HMOs accurately report beneficiaries’ institutional status. For example,

after HCFA reviewed one Minnesota-based HMO’s institutional reporting

procedures and records and found no problems, an Inspector General

audit of the same HMO revealed significant errors. The Inspector General

examined the records of 100 enrollees randomly selected from the 1,941

Page 12 GAO/HEHS-98-153 Medicare HMO Institutional Payments
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Medicare beneficiaries the HMO listed as living in an institution during

April 1994.12 By checking the HMO’s records against those of the

institutions, the Inspector General determined that 15 of the 100

beneficiaries did not reside in the listed institution. The Inspector General

also checked historical records and found that some of the 15

misclassified beneficiaries had never lived in an institution while enrolled

in the HMO. In some cases, the HMO had misclassified the beneficiaries and

collected the institutional payment rate for over 5 years. Total

overpayments for the 15 misclassified beneficiaries amounted to $93,252.

In 1993, the Inspector General cited two Massachusetts-based HMOs for

receiving enhanced payments on the basis of HMO data that inaccurately

classified beneficiaries as institutionalized.13 Moreover, the HMOs’ internal

reporting systems did not accurately reflect the discharge dates of some

institutionalized beneficiaries. The Inspector General identified

overpayments of about $215,000 for the two HMOs over roughly a 2-year

period ending June 30, 1993.14

When HCFA staff identify faulty HMO data on institutional beneficiaries, the

agency frequently does little to determine the full extent of the errors or

the total overpayments generated by the faulty data. HCFA generally

requires only that the HMO develop a corrective action plan describing how

the HMO intends to generate better data. In some cases, HCFA also requires

HMOs to self-audit their prior institutional reporting.

After HCFA identifies HMO data errors, mandates corrective actions, and

approves a corrective action plan, it often waits 2 years or more before

verifying HMO compliance. Once HCFA has approved an action plan to

correct an identified problem, the agency typically does not check to

determine whether the HMO has implemented the plan until HCFA staff

conduct the next routine monitoring review. Sometimes this monitoring

review is delayed beyond the routine 2-year schedule, even when a serious

reporting problem was found to have existed earlier. Such was the case for

the Minnesota-based HMO cited in a previous example. HCFA did not review

the HMO’s institutional records until the fall of 1997, over 2 years after the

Inspector General reported the HMO’s inaccurate record-keeping and

12See HHS, Review of Medicare Payments for Institutionalized Beneficiaries, May 1995.

13See HHS, Office of the Inspector General, Premium Payments for Medicare Beneficiaries Enrolled in

Risk-Based Health Maintenance Organizations, (A-01-93-00500) (Washington, D.C.: Dec. 1993).

14The Inspector General also identified approximately $115,000 in premium payments made on behalf

of Medicare beneficiaries who were deceased. In some cases, the beneficiaries had been deceased for

over 2 years.

Page 13 GAO/HEHS-98-153 Medicare HMO Institutional Payments
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resulting overpayments, even though the HMO continued to maintain a rate

of institutionalized enrollment that was five times the national average.

The Inspector General is completing a study designed to determine the

extent of institutional status misreporting and to project total national

overpayments. The Inspector General is reviewing the institutional records

at eight HMOs to determine whether beneficiaries resided in the facilities

listed in the HMOs’ records for the dates indicated. If data errors are found,

the Inspector General intends to project and recoup overpayments from

these specific HMOs and also use the projections to estimate national

overpayments. Preliminary results indicate data problems at five of the

eight HMOs. Because the Inspector General’s study does not attempt to

determine whether the listed facilities fit HCFA’s criteria for an eligible

institution, the study’s overpayment estimate may understate the full

extent of the problem.

HCFA Lacks a Systematic

Approach to Recovering

Overpayments

HCFA’s procedures do not ensure that Medicare overpayments are

recovered when HMO data reporting errors are found. In such cases, HCFA

requires HMOs to improve data reporting in the future, but often the agency

makes no attempt to estimate and recover overpayments resulting from

the faulty data. HCFA sometimes, but not always, requires HMOs to perform

self-audits and bases payment adjustments on the results. However,

beyond the limited number of beneficiary records reviewed during routine

monitoring visits, HCFA does not attempt to verify HMO data or the results of

HMOs’ self-audits.

A random sample of records of beneficiaries listed as living in institutions

can be useful in projecting and recovering total Medicare overpayments.

For example, in the case of the Minnesota-based HMO discussed earlier, the

Inspector General found that the status of 15 out of 100 randomly selected

beneficiaries classified by the HMO as living in institutions had been

misreported. The overpayments associated with the 15 beneficiaries

amounted to $93,252. On the basis of the random sample, the Inspector

General projected that the HMO had inappropriately received at least

$861,000, and perhaps as much as $2.8 million, from January 1989 through

September 1994 for all enrollees misclassified as living in institutions. The

Inspector General’s findings enabled HCFA to recoup about $861,000 from

the HMO.

15

15The Inspector General estimated that the HMO had been overpaid by $1,810,021 during the 5-year

period. However, every statistical projection has an associated “confidence interval.” In this case, the

Inspector General determined that the overpayments ranged somewhere between $861,615 and

$2,758,428. HCFA adopted a conservative approach and required the HMO to repay the lower amount.

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HCFA Data Show

Medicare Overpaying

for Institutionalized

Beneficiaries

HCFA’s most recent data show that the current institutional risk adjuster

substantially overcompensates HMOs for the institutionalized beneficiaries

they serve. As a result, in July 1997, HCFA proposed new weights for the

institutional risk adjuster to more accurately reflect the health care costs

of institutional beneficiaries. However, in September of 1997, HCFA halted

implementation of the new weights, announcing that provisions of the

recently passed BBA precluded the agency from modifying any of the risk

factors’ weights at that time. Nonetheless, HCFA’s new criteria for eligible

institutions—which exclude facilities housing beneficiaries with relatively

low expected health care costs—should help reduce overpayments to

HMOs serving institutional beneficiaries.

New Data Would

Substantially Lower

Capitation Payments for

Institutionalized

Beneficiaries

In the course of our review, HCFA developed new cost estimates for

institutionalized beneficiaries that were based on the 1993 MCBS data. The

expected health care costs for institutionalized beneficiaries, based on the

1993 MCBS, were much lower than those estimated from the 1974-76 survey

data, which are currently used to set the risk factor for institutional

beneficiaries. Using the new cost data, HCFA calculated lower adjustments

to the capitation payments for aged institutionalized beneficiaries.16 For

example, a Medicare HMO that enrolls a 74-year-old male beneficiary living

in an institution in Los Angeles receives a monthly payment of about

$1,307 in 1998. If HCFA had implemented its revised rates, the HMO would be

receiving about $761 per month17—an amount that more accurately

reflects the expected costs associated with institutionalized beneficiaries.

Table 1 shows that the Medicare part A component of the monthly

capitation payments would have fallen by as much as 24 percent for

beneficiaries aged 85 and older and by as much as 62 percent for

beneficiaries aged 65 to 84. The decrease in the part B component would

have been somewhat less.

16Because risk factors represent relative weights, a change in any one risk factor must be offset by

changes in others. In this instance, the dramatic drop in the institutional risk factor for the small

number of institutional beneficiaries would have been accompanied by a very small increase in the risk

factors for the more numerous noninstitutional beneficiaries. While overall Medicare payments,

theoretically, might not have been affected, payments to individual HMOs could have changed

substantially.

17This estimate is based on the 1998 county rate for Los Angeles, which would be somewhat different

had HCFA adopted new weights for the risk adjustment factors.

Page 15 GAO/HEHS-98-153 Medicare HMO Institutional Payments
B-279730 

Table 1: Comparison of Current

Weights and Weights HCFA Calculated

Using More Recent Cost Data for the

Institutionalized Aged

Age

Existing

weights

Proposed

weights

Percentage

change from

existing to

proposed

payment rate

Medicare part A—male

65 - 69 1.75 0.80 –54

70 - 74 2.25 1.05 –53

75 - 79 2.25 1.40 –38

80 - 84 2.25 1.75 –22

85 + 2.25 2.15 –4

Medicare part A—female

65 - 69 1.45 0.55 –62

70 - 74 1.80 0.75 –58

75 - 79 2.10 1.05 –50

80 - 84 2.10 1.30 –38

85 + 2.10 1.60 –24

Medicare part B—male

65 - 69 1.60 1.10 –31

70 - 74 1.80 1.40 –22

75 - 79 1.95 1.65 –15

80 - 84 1.95 1.80 –8

85 + 1.95 1.85 –5

Medicare part B—female

65 - 69 1.50 1.05 –30

70 - 74 1.65 1.30 –21

75 - 79 1.65 1.45 –12

80 - 84 1.65 1.60 –3

85 + 1.65 1.65 0

Source: HCFA.

Although HCFA announced plans in July 1997 to recalculate the weights of

the current demographic risk factors, including the institutional risk

adjuster, it halted this effort after the enactment of the BBA in August 1997.

HCFA reverted to the old factors for the 1998 rate calculations because the

BBA specified a new methodology for setting the basic capitation rate in

each county that explicitly used the established 1997 county rates as a

base. HCFA officials stated that the new weights could only have been

Page 16 GAO/HEHS-98-153 Medicare HMO Institutional Payments
B-279730 

applied to capitation payment calculations if the weights had also been

used in the calculation of the county rates.

Variation in Expected

Costs for Institutional

Beneficiaries Provides

Opportunities for

Overpayment

Although HCFA uses the institutional risk adjuster to take into account the

expected higher costs of health care for institutionalized beneficiaries,

research on the risk adjuster indicates that institutional residence is

actually only weakly related to a beneficiary’s expected health care costs.

In a 1977 report, HCFA staff suggested that the average medical

expenditures for institutionalized beneficiaries could vary widely by type

of facility “to the extent that legal requirements and administrative policies

of institutions differentiate among the characteristics of their residence.”

Our own analysis of the 1992-94 MCBS, the most recent data available at the

time of our analysis, found substantial differences in Medicare costs

among beneficiaries living in institutions. The average annual Medicare

cost for beneficiaries in nursing homes—at about $8,000, for

example—was more than $3,700 higher than the average annual cost for

beneficiaries in assisted living facilities.

HMOs could benefit financially if they were able to draw their institutional

populations disproportionately from those types of institutions whose

average beneficiary costs were lower than those of other institutions.

HCFA’s new definition of eligible institutions includes certified nursing

facilities but generally excludes assisted living facilities. This narrower

definition could potentially improve the accuracy of HMO payments for the

beneficiaries they serve by limiting the potential variation in average

expected health care costs among different types of institutions.

Conclusions Recent data clearly show that HMOs can be overcompensated for the

institutional beneficiaries they enroll. Although provisions of the BBA

prevent HCFA from eliminating these excess payments at this time, HCFA

will have an opportunity to fully address this problem when it develops a

new set of risk adjusters, mandated by the BBA, to be implemented in 2000.

By tightening the definition of what constitutes an institution, HCFA has

taken a step toward improving the accuracy of HMO payments. For

example, HMOs should no longer receive enhanced capitation payments for

serving beneficiaries in independent living facilities. Nonetheless, given

HCFA’s HMO monitoring practices, it is doubtful that the agency can quickly

or effectively determine the extent to which HMOs are complying with the

new definition.

Page 17 GAO/HEHS-98-153 Medicare HMO Institutional Payments
B-279730 

Moreover, the Medicare program remains open to potential abuse by HMOs

because HCFA performs only infrequent and limited checks of HMO-reported

data. HCFA’s use of unaudited HMO data to determine payments to HMOs

engenders little confidence in the accuracy of the data and resulting

payments. HCFA also lacks a systematic approach for identifying and

recovering total overpayments once HMO reporting errors are discovered.

Instead, HCFA typically requires HMOs only to develop corrective plans to

gather and report more accurate data in the future. Even when serious HMO

reporting errors—resulting in substantial overpayments—have been

discovered, HCFA may wait 2 years or more before checking to see if the

HMO has implemented a revised data gathering and reporting system.

Recommendations to

the Administrator of

the Health Care

Financing

Administration

To better protect the integrity of Medicare capitation payments, we

recommend that the HCFA Administrator take the following actions:

• Establish a system to estimate and recover total overpayments when

institutional status data errors are detected.

• Allow HMOs to revise records and claim retroactive payment adjustments

for beneficiaries with institutional status only when HMO records have been

verified by an independent third party.

• Conduct timely follow-up reviews of those HMOs found to have submitted

inaccurate institutional status data.

• Use more recent cost data to calculate the institutional risk adjuster in the

event HCFA continues to include institutional status as a part of its new risk

adjustment methodology.

Agency Comments HCFA agreed with our recommendations to improve the integrity of

capitation payments for institutionalized beneficiaries. HCFA noted several

initiatives it is considering to improve oversight and rate-setting methods.

We believe that these initiatives are a step in the right direction but that

HCFA must remain committed to implementing the new methodologies. The

full text of HCFA’s comments appears in appendix I.

As arranged with your office, unless you publicly announce the contents of

this report earlier, we plan no further distribution until 30 days after its

issue date. At that time, we will send copies to the Secretary of Health and

Human Services; the Director, Office of Management and Budget; the

Administrator of the Health Care Financing Administration; and other

Page 18 GAO/HEHS-98-153 Medicare HMO Institutional Payments
B-279730 

interested parties. We will also make copies available to others upon

request.

This work was done under the direction of James Cosgrove, Assistant

Director. If you or your staff have any questions about this report, please

contact Mr. Cosgrove at (202) 512-7029 or me at (202) 512-7114. Other GAO

contacts and staff acknowledgments are listed in appendix II.

William J. Scanlon

Director, Health Financing

 and Systems Issues

Page 19 GAO/HEHS-98-153 Medicare HMO Institutional Payments
Appendix I 

Comments From the Health Care Financing

Administration

Page 20 GAO/HEHS-98-153 Medicare HMO Institutional Payments
Appendix I 

Comments From the Health Care Financing

Administration

Page 21 GAO/HEHS-98-153 Medicare HMO Institutional Payments
Appendix I 

Comments From the Health Care Financing

Administration

Page 22 GAO/HEHS-98-153 Medicare HMO Institutional Payments
Appendix II 

GAO Contacts and Staff Acknowledgments

GAO Contacts James C. Cosgrove, Assistant Director, (202) 512-7029

Marie Cushing James, Co-Project Manager, (202) 512-3597

Bonnie Hall, Co-Project Manager

Staff

Acknowledgments

The following team members also made important contributions to this

report: Hannah F. Fein, Senior Evaluator; Robert DeRoy, Assistant

Director; and George Bogart, Senior Attorney.

(101514) Page 23 GAO/HEHS-98-153 Medicare HMO Institutional Payments
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