Medicare, authorized in 1965 under Title XVIII of the Social Security Act, is a federal health insurance program providing coverage to individuals 65 years of age and older and to many of the nation’s disabled. HCFA uses about 70 claims-processing contractors, called intermediaries and carriers, to administer the Medicare program. Intermediaries primarily handle part A claims (those submitted by hospitals, skilled nursing facilities, hospices, and home health agencies), while carriers handle part B claims (those submitted by providers, such as physicians, laboratories, equipment suppliers, outpatient clinics, and other practitioners). The use of incorrect billing codes is a problem faced both by public and private health insurers. Medicare pays part B providers a fee for each covered medical service identified by the American Medical Association’s uniformly accepted coding system, called the physicians’ Current Procedural Terminology (CPT). The coding system is complicated, voluminous, and undergoes annual changes; as a result, physicians and other providers often have difficulty identifying the codes that most accurately describe the services provided. Not only can such complexities lead providers to inadvertently submit improperly coded claims, in some cases it makes it easier to deliberately abuse the billing system, resulting in inappropriate payment. The examples in table 1 illustrate several coding categories commonly used in inappropriate ways. Commercial claims-auditing systems for detecting inappropriate billing have been available for a number of years; as early as 1991, commercial firms marketed specialized auditing systems that identify inappropriately coded claims. The potential value of such a system to Medicare has been noted both by the HHS Inspector General (in 1991) and by us (in 1995). In fact, both the Inspector General and we noted that such a tool could save the Medicare program hundreds of millions of dollars annually. Recognizing its need to address the inappropriate billing problem, HCFA directed its carriers to begin developing claims auditing edits in February 1991. In August 1994, it awarded a contract to further develop these claims auditing edits, called CCI, which it now owns and operates. According to HCFA, the CCI edits helped Medicare save about $217 million in 1996 by successfully identifying inappropriate claims. Nevertheless, inappropriate coding and resulting payments continue to plague Medicare. Last summer HHS’ Office of Inspector General reported that about $23 billion of Medicare’s fee for service payments in fiscal year 1996 were improper, and that about $1 billion of this amount was attributable to incorrect coding by physicians. On September 30, 1996, HCFA initiated action to improve its capability to detect inappropriate claims and payment. It awarded a contract to HBO & Company (HBOC), a vendor marketing a claims-auditing system, to test the vendor’s system in Iowa and evaluate whether it could be effectively used throughout the Medicare program. Our objective was to determine if HCFA was using an adequate methodology for testing the commercial claims auditing system in Iowa for potential implementation with its Medicare claims processing systems. To do this, we analyzed documents related to HCFA’s test, including the test contract, test plans and methodologies, test results and status reports, and task orders. This analysis included assessing the limitations of the test contract, size of the test claims processing sample, representation of users involved with the test, and information provided to management in its oversight role. We also met with HCFA staff responsible for conducting the test to obtain further insight into HCFA’s test methodology. While we reviewed the reports of HCFA’s estimated savings, we did not independently validate the reported savings by validating the sample of paid claims used as the basis for projecting them. However, the magnitude of HCFA’s estimated savings is in line with our earlier estimate of potential annual savings from such systems. We observed operations at the test site in Des Moines, Iowa, and assessed the carrier officials’ role in the test. We visited HBOC offices in Malvern, Pennsylvania, and the Plano, Texas, headquarters of Electronic Data Systems (EDS), the part B system maintainer, into whose system the claims-auditing system was integrated. During these visits, we documented these companies’ roles and responsibilities in testing the system. Also, in August 1997 at a 3-day conference at HCFA headquarters, we observed the test team’s effectiveness and objectivity in discussing the progress made to date and in developing solutions to issues still needing resolution. We compared the adequacy of HCFA’s test methodology with the methodologies used by other public health care insurers to test and integrate a commercial claims-auditing system. We visited offices of these insurers and analyzed documents describing their test and integration approach. Finally, we compared the approach used by these insurers with HCFA’s. The insurers whose methodologies we analyzed consisted of the Department of Defense’s TRICARE support office (formerly called the Civilian Health and Medical Program of the Uniform Services (CHAMPUS)) in Aurora, Colorado; Civilian Health and Medical Program of the Department of Veterans Affairs (CHAMPVA) in Denver, Colorado; and the Kansas and Mississippi state Medicaid agencies in Topeka, Kansas, and Jackson, Mississippi, respectively. To evaluate HCFA’s decisions regarding national implementation of a commercial claims-auditing system, we reviewed the contract and other documents related to the test and evaluated their impact on HCFA’s ability to implement a claims-auditing system nationally. We also discussed HCFA’s rationale for these decisions with senior HCFA officials. Finally, to assess HCFA’s experience in acquiring and using the HCFA-owned CCI claims auditing edits, we reviewed the CCI contract (and related documents). We discussed this project and its results with cognizant HCFA officials. We performed our work from July 1997 through March 1998, in accordance with generally accepted government auditing standards. HCFA provided written comments on a draft of this report. These comments are presented and evaluated in the “Agency Comments and Our Evaluation” section of this report, and are included in appendix I. HCFA used a test methodology that was comparable with processes followed by other public insurers who have successfully tested and implemented such commercial systems. HCFA’s test showed that commercial claims auditing edits could achieve significant savings. Other public insurers—CHAMPVA, TRICARE, and the Kansas and Mississippi Medicaid offices—each used four key steps to test their claims-auditing systems prior to implementation. Specifically, they (1) performed a detailed comparison of their payment policies with the system’s edits to determine where conflicts existed, (2) modified the commercial system’s edits to comply with their payment policies, (3) integrated the system into their claims payment systems, and (4) conducted operational tests to ensure that the integrated systems properly processed claims. These insurers’ activities were comprehensive and required significant time to complete. CHAMPVA took about 18 months to integrate the commercial system at one claims processing site. TRICARE took about 18 months to integrate the system at two sites. It allowed about 2 years to implement the modified system at its nine remaining sites. HCFA’s methodological approach was similar. From the contract award on September 30, 1996, through its conclusion on December 29, 1997, HCFA and contractor staff made significant progress in integrating the test commercial system at the Iowa site and evaluating its potential for Medicare use nationwide. HCFA used two teams to concentrate separately on the policy evaluation and technical aspects of the test. The policy evaluation team consisted of HCFA headquarters individuals and Kansas City (Missouri) and Dallas regional office staff knowledgeable of HCFA policies and the CPT billing codes, as well as individuals representing the Iowa carrier and HBOC. This team conducted a detailed comparison of the commercial system’s payment policy manuals with Medicare policy manuals to identify conflicting edits. The reviews identified inconsistencies that both increased and decreased the amount of Medicare payments. For example, the commercial system pays for the higher cost procedure of those deemed mutually exclusive, while Medicare policy dictates paying for the lower cost procedure. Conversely, the commercial claims-auditing system denies certain payments for assistant surgeons, whereas Medicare policy allows these payments. These and all other conflicts identified were provided to the vendor, who modified the system’s edits to be consistent with HCFA policy. The technical team consisted of staff from HCFA’s headquarters and its Kansas City (Missouri) and Dallas regional offices; HBOC; EDS; and the Iowa carrier. This team prepared and carried out three critical tasks. First, it developed the design specifications and related computer code necessary for integrating the commercial system into the Medicare claims-processing software. Second, it integrated the claims auditing system into the Medicare part B claims-processing system. Finally, the team conducted numerous tests of the integrated system to determine its effect on processing times and its ability to properly process claims. HCFA management was kept apprised of the status of the test through biweekly progress reports and frequent contact with the project management team. HCFA reported that the edits in this commercial system could save Medicare up to $465 million annually by identifying inappropriate claims. Specifically, the analysis showed that the system’s mutually exclusive and incidental procedure edits could save about $205 million, and the diagnosis-to-procedure edits would save about $260 million. HCFA’s analysis was based on a national sample of paid claims that had already been processed by the Medicare part B systems and audited for inappropriate coding with the HCFA-owned CCI edits. While we reviewed the reports of HCFA’s estimated savings, we did not independently verify the national sample from which these savings were derived. However, the magnitude of savings when added to the savings from CCI, which HCFA reported to be about $217 million in 1996, is in line with our earlier estimate that about $600 million in annual savings are possible.