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Expected at 10:00 a.m.

Wednesday, July 19, 2000

GAO/T-HEHS-00-160

MEDICARE

Refinements Should

Continue to Improve

Appropriateness of

Provider Payments

Statement of William J. Scanlon, Director

Health Financing and Public Health Issues

Health, Education, and Human Services Division

Testimony

Before the Subcommittee on Health and Environment,

Committee on Commerce, House of Representatives

United States General Accounting Office

GAO
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Mr. Chairman and Members of the Subcommittee:

I am pleased to be here today as you discuss the effects of recent Medicare

payment reforms and the potential need for additional refinements. The

Medicare payment provisions in the Balanced Budget Act of 1997 (BBA)

were enacted to control rapid spending growth in the traditional fee-forservice program that was neither sustainable nor readily linked to

demonstrated changes in beneficiary needs. Essentially, these reforms

changed the financial incentives inherent in pre-BBA payment methods to

more appropriately reward providers for delivering care efficiently. The

BBA also created Medicare+Choice to expand beneficiaries’ managed care

options under Medicare and bring payments more in line with the costs of

providing covered benefits in the traditional program.

Since the BBA’s enactment, the Congress has faced pressure from

providers to undo the act’s payment reforms. With changes so sweeping,

achieving perfection in all the details at the outset is unrealistic.

Accordingly, the Congress has monitored experience with these changes

and made certain modifications. To date, some of the act’s provisions have

taken effect, some have been modified by the Balanced Budget

Refinement Act of 1999 (BBRA), and others have just recently begun to be

phased in.

Calls for additional changes come at a time when federal budget surpluses

and lower Medicare outlays could make it easier to consider

accommodating enhanced Medicare payments. At the same time, however,

the Congress is considering the addition of an expensive prescription drug

benefit to the current program. In view of the coming upsurge in the

Medicare-eligible population, the Comptroller General has cautioned

repeatedly that, even before expanding benefits, projected Medicare

spending threatens to absorb ever-increasing shares of the nation’s

budgetary and economic resources. Thus, without meaningful reform,

demographic and cost trends will drive Medicare spending to levels that

will prove unsustainable for future generations of taxpayers.1

My comments today focus on the BBA’s payment reforms affecting home

health agencies, skilled nursing facilities (SNF), and the health plans in

Medicare’s managed care program, known as Medicare+Choice. My

remarks are based on our extensive published and ongoing work in each

of these areas.

1 Medicare Reform: Leading Proposals Lay Groundwork, While Design Decisions Lie Ahead (GAO/THEHS/AIMD-00-103, Feb. 24, 2000).

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In brief, the reactions by providers serving Medicare beneficiaries to BBA

and BBRA payment reforms share a similar scenario. Tightened payment

policies have required many providers to adjust their operations. The

adjustments have been particularly disruptive for providers that took

advantage of Medicare’s previous payment policies to finance inefficient

and unnecessary care delivery. Industry representatives are advocating the

partial restoration of payment cuts. Following are the recent developments

that have ensued since the BBA’s implementation in the areas of home

health services, SNF services, and the Medicare+Choice program:

Home health services: Home health utilization has dropped substantially,

well below what would have been required to remain within the BBAimposed payment limits. We expect the new Medicare payment system for

home health services, scheduled for implementation in October, to

generally provide agencies a comfortable cushion to deliver necessary

services.

SNF services: Some corporate chains have declared bankruptcy. The new

Medicare payment system for SNF services adequately covers the cost of

beneficiaries’ services but no longer supports the extensive capital

expansions or the ancillary service business that corporate chains relied

on to boost revenues.

Medicare+Choice program: Many plans are withdrawing from Medicare.

The withdrawals are tied to a combination of Medicare program changes

and plans’ business decisions In addition, our ongoing work shows that

payments to plans for their Medicare enrollees continue to exceed the

expected fee-for-service costs of these individuals. The significance of this

finding is that Medicare managed care, although originally expected to

achieve program savings, continues instead to add to program cost.

In our view, the basis for potential changes to BBA reforms should be how

they affect beneficiaries’ access to necessary services and the long-term

outlook for this program. Therefore, progress needs to continue to better

align provider payments with the expected costs of the beneficiaries

served and to bring about the fiscal discipline needed to contain Medicare

spending in these areas over the longer term. We will continue to monitor

the payment reforms’ effects to help the Congress ensure that beneficiary

access is protected, providers are fairly compensated, and taxpayers do

not shoulder the burden of excessive program spending.

Medicare’s home health care benefit enables beneficiaries with post-acutecare needs and chronic conditions to receive certain skilled nursing, Background
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therapy, and aide services in their homes rather than in other settings. To

qualify for Medicare’s home health benefit, a beneficiary must be confined

to his or her residence (“homebound”) and must require intermittent

skilled nursing, physical therapy, or speech therapy. A beneficiary who

needs only custodial or personal care does not qualify. Beneficiaries are

not liable for any coinsurance or deductibles for these services and may

receive an unlimited number of visits, provided the coverage criteria are

met. Historically, Medicare has reimbursed home health agencies their

costs, subject to limits, for services they provide to the program’s

beneficiaries. A prospective payment system (PPS) for home health

services will go into effect October 1, 2000.

The Medicare SNF benefit provides up to 100 days of post-acute care per

spell of illness. To qualify for SNF services, a Medicare beneficiary must

need daily skilled nursing or rehabilitative therapy services, or both,

generally within 30 days of a hospital stay of at least 3 days in length, and

must be admitted to a Medicare-certified SNF for a condition related to the

hospitalization. When the beneficiary meets these conditions, Medicare

covers all necessary services, including room and board; nursing care; and

ancillary services such as drugs, laboratory tests, and physical therapy.

Beginning on the 21st day of care, the beneficiary is responsible for a daily

coinsurance payment, which equals $97 in 2000. Until 1998, Medicare

reimbursed skilled nursing facilities on a cost basis. Payments for routine

costs, such as room and board, were subject to cost limits, but payments

for capital and ancillary costs were virtually unlimited. Medicare is

phasing in a PPS for SNF services over a 3-year period that began in July

1998.

Medicare managed care plans have provided beneficiaries an attractive

alternative to the traditional fee-for-service program. In return for giving

up the freedom to seek care from any provider, beneficiaries who enroll in

plans typically receive coverage for benefits not offered by the traditional

program (such as routine physical examinations and prescription drugs)

and enjoy lower out-of-pocket expenses. Medicare pays the plans a fixed

monthly amount for each beneficiary, regardless of the actual costs of

providing care to that individual. Previously, plan payment rates were

tightly linked to average local spending in the traditional fee-for-service

program and only adjusted for certain beneficiary characteristics such as

age and sex. The BBA changed how plan payments were calculated

beginning in 1998 by weakening the linkage to fee-for-service spending and

required that, beginning in 2000, payment rates reflect differences in

beneficiary health status.
Medicare: Refinements Should Continue to

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To curb rampant spending growth, BBA overhauled the program’s method

of paying for home health services. Between 1990 and 1997, Medicare

expenditures for home health services went up three times faster than

spending for the program as a whole. This rapid rise has been attributed to

many factors, including a loosened interpretation of the home health

benefit criteria and few controls to protect the program from abusive

billing practices at a time when Medicare paid for every home health visit

with almost no scrutiny. In combination, these factors made conditions

ripe for providers to deliver more services to more beneficiaries in order

to increase their revenues.

In response to these problems, the BBA required, by October 1, 1999, the

implementation of a new home health PPS, and until then, the

implementation of an interim payment system (IPS) to slow spending

growth.2 The IPS made the existing per visit cost limits more stringent and

added an annual agency revenue cap to control the number of services

provided to beneficiaries.

Between 1997 and 1998, Medicare home health spending fell by nearly 15

percent, while total home health visits dropped an unprecedented 40

percent. The Congressional Budget Office (CBO) attributes the decline to

agencies’ tighter compliance with benefit eligibility criteria and their

cautious interpretation of IPS limits.3 Our ongoing work on home health

spending shows that these declines continued in 1999 and that the drop in

utilization was most pronounced in areas where, pre-BBA, use had grown

the most and beneficiary utilization was the highest.

These findings suggest that part of the contraction in service delivery since

the BBA may be a correction of the excessive use when Medicare did little

to control home health spending. However, it may also reflect an

inappropriate response to the IPS by home health agencies. While

remaining within IPS payment limits, all agencies could have served more

beneficiaries and many agencies could have increased the services

provided each beneficiary. Yet the number of beneficiaries receiving home

health services declined 14 percent between 1997 and 1998 and is

2The Omnibus Consolidated and Emergency Supplemental Appropriations Act, 1999, P.L. 105-277,

delayed the implementation of the home health PPS until October 1, 2000

3Impact of the Balanced Budget Act on the Medicare Fee-for-Service Program, Statement of Dan L.

Crippen, Director, Congressional Budget Office, before the House Committee on Commerce Sept. 15,

1999.

Pending Home Health

PPS Rates Likely to

Be Adequate, but Are

Untested to Date
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continuing to fall. Because the payment limits under the IPS are not

adjusted to reflect the needs of individual patients, agencies must maintain

a balance high-cost and low-cost patients in order to keep their costs

below the IPS revenue caps. Agencies that do not fully understand how

these caps are applied may restrict their admissions or reduce care to

current patients further than necessary.

The home health PPS, which replaces the IPS on October 1 of this year, is

a more appropriate payment tool than the IPS because it is designed to

align payments with patient needs. Medicare will pay agencies a perepisode rate based on historical, national average utilization for each 60-

day period during which a patient receives services. PPS rates are

scheduled to be tightened a year later by 15 percent. The per-episode

payments are designed to control service provision during the episode,

while giving home health agencies the flexibility to vary the intensity or

mix of services delivered. Home health industry advocates generally

support the PPS, but argue that the 15-percent payment reduction is

unnecessary.

In our view, the new home health PPS rates overall are likely to provide

agencies a comfortable cushion to deliver necessary services. These rates

are based on pre-BBA beneficiary use levels, which are widely regarded as

excessive. PPS rates will provide sufficient resources to restore a

considerable portion of the service reductions of the past 3 years. They

will not support, however, widely divergent levels of utilization where

some agencies supplied many more services than others for comparable

patients.

Unfortunately, the new PPS has the potential to be advantageous to

agencies at the expense of beneficiaries and taxpayers. Under the perepisode method of payment, agencies can increase profits by skimping on

the number of visits provided within the episode. Agencies can also

inappropriately expand the number of episodes provided by protracting

the delivery of care over a longer period. No standards exist for what the

right amount of care is for specific types of patients, particularly the right

amount of home health aide care, which composed almost half of all visits

in 1997. Implementing safeguards to ensure Medicare payments are used

to deliver services to meet beneficiaries’ needs is a difficult task.

The home health PPS, while having a design superior to the IPS, is largely

untested. It is built on the concept of paying for episodes of care, yet there

is no consensus on what an episode should entail. In addition, similar to

other new PPSs, which vary payments according to patients’ expected

needs, the potential exists for payments to be too low for some episodes
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involving very sick patients and too high for others. To minimize the

potential for adverse effects for the program and individual agencies, we

recommended in April this year that HCFA implement a risk-sharing

provision whereby the government shares in any home health agency’s

losses under the PPS but also protects the program from any agency’s

excessive gains.4

Under Medicare’s SNF PPS, facilities receive a payment for each day of

covered care provided to a Medicare-eligible beneficiary. Previously, SNFs

were paid the reasonable costs they incurred in providing Medicarecovered services. Although there were limits on the payments for the

routine portion of care (that is, general nursing, room and board, and

administrative overhead), payments for ancillary services, such as

rehabilitative therapy, were virtually unlimited. Because higher ancillary

service costs triggered higher payments, facilities had no incentive to

provide these services efficiently or only when necessary.

By establishing fixed per diem payments for all services provided to

beneficiaries, the PPS attempts to provide incentives for SNFs to deliver

care more efficiently. SNFs that previously boosted their Medicare

revenue—by using more or higher-priced ancillary services—will need to

modify their practices more than others.

Recent accounts of nursing home chain bankruptcies raise questions

about the adequacy of Medicare’s SNF payments under the PPS. Our

published and ongoing work identifies several factors that contributed to

the poor financial performance of these corporations.5 Some corporations

invested heavily in the nursing home and ancillary service businesses in

the years immediately before the enactment of the PPS, both expanding

their acquisitions and upgrading facilities to provide higher-intensity

services. Under tighter payment constraints, these debt-laden enterprises

are particularly challenged. The PPS not only puts a premium on operating

their SNFs efficiently, it changes the market for their ancillary services

business as well. It makes other SNF operators sensitive to the costs of

4A risk-sharing arrangement that limits the amount a home health agency can lose or gain would

involve a year-end settlement that compares an agency’s actual Medicare-allowed costs with its total

Medicare payments. Payments above the costs would be constrained to a specific percentage, as

would agency losses. For further detail, see Medicare Home Health: Prospective Payment System Will

Need Refinement As Data Become Available (GAO/HEHS-00-9, Apr. 7, 2000).

5Skilled Nursing Facilities: Medicare Payment Changes Require Provider Adjustments But Maintain

Access (GAO/HEHS-00-23, Dec. 14, 1999).

SNF PPS Rates Cover

Medicare-Related

Costs
Medicare: Refinements Should Continue to

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ancillary services, so they are no longer willing to purchase them at high

prices. Thus, while SNFs have to adapt to the PPS constraints, these large

post-acute care providers may have greater adjustments to make as a

result of the strategic decisions they made during a period when Medicare

was exercising too little control over its payments.

There are indications that SNF payment rates under the BBA are likely to

provide sufficient—or, in some cases, even generous—compensation for

services provided to a facility’s Medicare beneficiaries. Medicare’s average

daily rate under the SNF PPS in fiscal year 1999 was higher than the

average daily SNF payment in fiscal year 1997. The significance of this

comparison is that 1997 payments were thought to be excessive because

they reflected 7 years of cost increases of more than 14 percent per year.

In fact, some providers have been eager to adopt the PPS rates well ahead

of schedule. Currently, PPS rates are being phased in over a 3-year period,

which began in July 1998. This transition period was designed to allow

facilities time to adapt to the new payment system by continuing to tie a

facility’s payment rates to its historical costs. The BBRA gives SNFs the

option of forgoing this transition period. Although a current tally is not

available, HCFA estimates that about half of Medicare-certified SNFs will

opt to forgo the transition period to receive fully prospective rates as soon

as possible.

Beneficiary access to SNFs, moreover, does not appear compromised

under the new PPS. Utilization levels in 1999 were higher than those in

1997. Hospital lengths of stay for admissions likely to lead to a SNF stay

have continued to decline, suggesting that hospitalized patients continue

to find SNF care.

Nevertheless, the SNF PPS initially proposed by HCFA was not flawless.

Last year, we testified before the full Committee about PPS design

problems.6 A primary concern was the possibility that facilities treating a

disproportionate number of high-cost cases might not receive adequate

payments. HCFA is in the process of refining its method to account for

patient needs in its payments. The goal is to redistribute payments across

types of cases so that they more appropriately reflect each patient’s

expected costs. HCFA recently proposed such refinements to the case-mix

6Medicare Post-Acute Care: Better Information Needed Before Modifying BBA Reforms (GAO/THEHS-99-192, Sept. 15, 1999).
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adjustment system, which are scheduled to be implemented on October 1

of this year.7

In the meantime, BBRA included a provision that temporarily boosts

payments for certain cases by 20 percent,8 which will add an estimated

$200 million to Medicare SNF spending in fiscal year 2000. The provision is

scheduled to expire on October 1, 2000, or when HCFA implements a

refined case-mix adjustment system, whichever comes later. Industry

advocates favor prolonging the life of the BBRA provision and delaying the

implementation of HCFA’s proposed payment modifications, which they

assert are not sufficiently refined. CBO estimates that if the 20 percent

payment increase remained in effect for 5 years, spending would increase

by $1.4 billion. In our view, the BBRA increase was helpful as a stopgap

measure, but fiscal prudence argues for implementing research-based

improvements to the rates as soon as practicable. Such improvements aim

to distribute existing payments more appropriately and thereby address

the problem originally identified, while avoiding the unwarranted

expenditure of an additional hundreds of millions of dollars each year.

Although Medicare managed care plans have provided beneficiaries an

attractive alternative to the traditional program, they have never been a

bargain for taxpayers. Prior to the BBA, studies by us, other government

agencies, and private researchers concluded that, instead of producing

expected savings, Medicare’s managed care option substantially increased

program spending. Plans tended to attract relatively healthy, low-cost

beneficiaries, while Medicare’s payment rates reflected the expected costs

of a beneficiary in average health with average health expenses.

Consequently, plans received payments for their Medicare enrollees that

well exceeded what Medicare would have paid had these individuals

remained in the traditional fee-for-service program. Our study of Medicare

plans in California showed that aggregate plan payments exceeded plan

enrollees’ estimated fee-for-service costs by more than an estimated $1

billion in 1995. This finding suggests that many of the additional benefits

enjoyed by plan enrollees were the direct result of Medicare’s overly

generous payment rates, not of efficiencies achieved under managed care.9

7The proposed rule is contained in 65 Fed. Reg. 19188-19291 (Apr. 10, 2000) (to be codified at 42 C.F.R.

pts. 411 and 489).

8We could not determine what criteria were used to select these cases.

9Medicare HMOs: HCFA Can Promptly Eliminate Millions in Excess Payments (GAO/HEHS-97-16, Apr.

25, 1997).

Medicare+Choice

Payments Remain

Problematic
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The BBA sought to improve Medicare’s financial posture by changing the

methodology used to establish managed care payment rates. Accordingly,

the BBA slowed the growth in payment rates relative to the growth in per

capita fee-for-service spending for 5 years and required HCFA to improve

its risk adjustment of plan payments so that they more closely matched

beneficiaries’ expected health care costs. The BBA also included payment

changes and other provisions to achieve a second goal: increase the

availability of plans and allow new types of plans to participate in

Medicare.

The declining participation of health plans in the Medicare+Choice

program suggests that the BBA’s cost containment and expansion goals

may be irreconcilable. Since the BBA’s enactment, 168 plans have either

left the program or reduced the geographic areas they served. Recently,

more plans announced that they will terminate their contracts or reduce

their service areas effective January 1, 2001. Industry representatives have

largely attributed the withdrawals to the BBA’s payment rate changes. The

representatives contend that Medicare is no longer a sufficiently profitable

line of business for some plans and that other plans have had to reduce the

benefits they offer and raise beneficiary premiums. They warn that the

Medicare+Choice program will continue to flounder unless payments are

increased.

Our published and ongoing work suggests that several factors influenced

plans’ decisions about whether to participate in Medicare+Choice or to

participate only in certain areas. As we reported last year, the 1999

withdrawals represented plans that were recent market entrants, had

enrolled few beneficiaries, or faced competitors that had substantially

larger market shares, suggesting that plans made business decisions or

used business strategies that could be sustained only in an era of more

generous Medicare payments.10 We will issue a report soon on the

withdrawals in 2000 and 2001. While information on the 2001 withdrawals

has only been available for a few weeks, our analysis of the withdrawals in

2000 indicate a pattern similar to that found for 1999.

Some health plans may find the payment rates established by the BBA to

be too low to warrant their future participation in Medicare+Choice.

However, in our ongoing work, when we compared plan payments for

enrolled beneficiaries in 1998 with the estimated Medicare fee-for-service

costs for these individuals, we found that plans received payments that

10Medicare Managed Care Plans: Many Factors Contribute to Recent Withdrawals; Plan Interest

Continues (GAO/HEHS-99-91, Apr. 27, 1999).
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substantially exceeded what Medicare would have paid for the plans’

enrollees had they been covered under the fee-for-service program. This

paradox stems from differences in the intent of Medicare+Choice and its

evolution. On the one hand, Medicare+Choice plans are paid too much

relative to the original intent of Medicare managed care—to provide

beneficiaries the package of Medicare-covered services at less cost than

the traditional fee-for-service program. On the other, the plans may be paid

too little for what they have been offering to attract beneficiaries—a more

comprehensive benefit package beyond that authorized for fee-for-service

beneficiaries for only modest or no premiums.

Efforts to expand the Medicare+Choice program, particularly one in which

plans cover prescription drugs, have been important, because the

traditional Medicare program has not provided such coverage, and this

program alternative has provided an avenue for some beneficiaries to

obtain drug coverage. However, if the Congress adopts a prescription drug

benefit for the entire Medicare program, there may be less reason to have

Medicare+Choice payments exceed the costs of providing services in the

traditional program. The problem of excess payments can be addressed in

part by better adjusting payments for the actual health status of enrollees.

Such a step would also protect those plans that attract sicker-than-average

enrollees.

As anticipated, the BBA reforms have had significant effects on the

delivery, cost, and use of Medicare services. Changes in providers’

incomes and services to beneficiaries are becoming a reality. We have seen

a rapid fall-off in home health use, the bankruptcies of several large SNF

chains, and continued health plan withdrawals from the Medicare+Choice

program. Although providers have been quick to attribute these changes to

inadequate Medicare payments and call for extra federal dollars, careful

analysis indicates that these responses are adaptations to appropriately

tightened payments following a period of unchecked growth.

Needed refinements to the BBA’s new payment policies for home health,

SNF, and managed care services are under development or are soon to be

implemented. In assessing the merit of these refinements, prudence

suggests that beneficiary needs and the program’s prospects for long-term

sustainability, not provider profitability, should be paramount. We have

several studies under way to inform these decisions and we will continue

to work with you to provide this important information.

Conclusions
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Mr. Chairman, this concludes my prepared statement. I will be happy to

answer any questions you or other Members of the Subcommittee may

have.

For future contacts regarding this testimony, please call William J. Scanlon

at (202) 512-7114 or Laura A. Dummit at (202) 512-7118. Individuals

making key contributions to this testimony included James C. Cosgrove,

Hannah F. Fein, Dana K. Kelley, Erin M. Kuhls, and James E. Mathews.

(201090)

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