CMS (formerly HCFA), an agency within the Department of Health and Human Services (HHS), is responsible for administering much of the federal government’s multibillion dollar investment in health care— including the Medicare program. Medicare is a health insurance program for 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. Medicare covers a variety of services. Part A services include inpatient hospital, skilled nursing facilities (SNF), certain home health, and hospice care, while part B services include physician and outpatient hospital services, diagnostic tests, mental health services, and outpatient physical and occupational therapy, including speech-language therapy, ambulance and other medical services and supplies. Each year, Medicare serves about 40 million elderly and disabled Americans and processes about 900 million claims submitted by nearly 1 million hospitals, physicians, and other health care providers. In fiscal year 2000, the program spent over $200 billion—about 11 percent of the federal budget. The Medicare program has two components—the traditional fee-for- service program and Medicare+Choice—its managed care option. Most Medicare beneficiaries participate in the traditional program and receive their health care on a fee-for-service basis, in which providers are reimbursed for each covered service they deliver. CMS contracts with about 50 insurance companies to process and pay these claims. The other principal component—Medicare+Choice—covers about 14 percent of beneficiaries who have enrolled in about 180 prepaid health plans that contract with the government to receive monthly payments in exchange for providing needed Medicare services for enrollees. As the agency that administers Medicare, CMS performs a wide array of management activities. Principal among these are setting prices for services and health plans based on legislatively prescribed guidelines, ensuring prompt and accurate payment to providers and health plans, educating beneficiaries and providers about the Medicare program, ensuring the quality of fee-for-service and managed care services paid by the program, and operating the Medicare+Choice program. See table 1 for examples of these activities. Tasked with administering a highly complex program, HCFA has earned mixed reviews from us and others on its performance in managing Medicare. On one hand, the agency presides over a program that is unparalleled in its popularity with beneficiaries and the general public. HCFA has implemented a variety of payment methods that have helped constrain the growth of program costs. It has also succeeded in ensuring that Medicare claims are paid quickly and at little administrative cost. On the other hand, HCFA has had difficulty making needed refinements to its payment methods. The agency has also fallen short in its efforts to oversee its Medicare claims administration contractors and to ensure that claims are paid accurately and beneficiaries receive quality services. While in the early 1990s HCFA came under increasing criticism for not adequately protecting program payments, some providers have complained recently that its safeguard efforts are unduly burdensome. The size and nature of the Medicare program make it inherently challenging to develop payment methods that prudently reimburse providers while protecting beneficiary access to services. As Medicare’s steward, CMS cannot passively accept what providers want to charge the program. However, because of its size, Medicare profoundly influences health care markets. The agency is often the dominant payer for services or products, and in such cases, it cannot rely on market prices to determine appropriate payment amounts because its share of payments distorts the market. In addition, HCFA has had difficulty relying on competition to determine prices, because finding ways of encouraging competition without excluding some providers has been problematic.This means that HCFA has had to administratively set payment amounts for thousands of services in ways that encourage efficient delivery of, and ensure beneficiary access to, needed health care services and equipment. Adding to the complexity of setting payment amounts is Medicare’s status as a highly visible public program with certain obligations that may not be consistent with efficient business practices. For example, the agency is constrained from acting swiftly to reprice services and supplies even when prevailing market rates suggest that payments should be modified. As Medicare is a public program, its enabling legislation provides that any changes require public input. This minimizes the potential for policymaking to have unintended consequences. However, seeking and responding to public interests, including various provider and supplier groups, can be a time-consuming process that can sometimes thwart efficient program management. Recent changes in provider payment methods, as mandated by the Congress, have constrained rates paid to some providers and slowed the growth of payments to others. This has raised provider concerns about payment adequacy. As Medicare’s payments have become less generous in the aggregate, payment adjustments for cost differences of providers and services become more important. HCFA’s successes in more closely aligning payments to these differences have sometimes been obscured by the concerns of those providers affected, who are adapting to a new payment environment. Despite these challenges, over the last two decades HCFA has had broad experience, and significant success, in developing payment methods that seek to control spending by rewarding provider efficiency and discouraging excessive service use. HCFA’s experience began in 1983 when the Congress passed legislation requiring the development of a hospital inpatient prospective payment system (PPS), a method that pays providers, regardless of their costs, fixed, predetermined amounts that vary according to patient need. This approach, designed to reward hospitals that could deliver care at lower cost than the predetermined payment, succeeded in slowing the growth of Medicare’s inpatient hospital expenditures. Growth in Medicare inpatient hospital expenditures averaged over 15 percent per year prior to 1983, but was generally under 10 percent in subsequent years. HCFA’s next major effort to break the link between providers’ charges and Medicare payments was implementing a fee schedule for physicians, which was phased in during the 1990s. This schedule was not designed to reduce the overall expenditure level, but to redistribute payments for services based on the relative resources used by physicians to provide different types of care. Its development and implementation was complex because HCFA had to calculate payment amounts for over 7,000 procedures, accounting for the three categories of resources used to perform each procedure—physician work, practice expenses, and malpractice insurance expenses. While beneficiary access to physician care was generally not affected, the fee schedule, as intended, led to a shift in payments from surgical and nonsurgical services to primary care and other evaluation and management services. HCFA’s next challenge was to expand use of prospective payment methods for postacute care services, such as those provided by SNFs and home health agencies. In 1997, the Balanced Budget Act (BBA) mandated that HCFA develop and implement four new PPS from fiscal year 1998 through fiscal year 2001—a heavy workload for the agency. For each new PPS, HCFA had to (1) design the payment system—which was based on data-intensive studies—including factors that adjust payments based on the health status of beneficiaries receiving care, (2) develop and issue regulations that incorporated public comment, and (3) plan and program computer system changes. Adding to its challenge, HCFA and its contractors needed to make significant systems changes to implement the new payment methods at the same time that they were renovating information technology (IT) systems for Year 2000 (Y2K) date changes. As a result of the priority HCFA had to give to Y2K systems changes, HCFA moved more slowly than the law required to phase in its new PPS methodologies for home health and hospital outpatient services. Each of these payment methods was an improvement over cost- and charge-based methods, which often rewarded inefficient delivery and excessive provision of unnecessarily costly services. PPS methods reward providers for keeping their costs down, which in turn has helped constrain the overall growth of Medicare payments. However, slower payment growth requires further adjustment to better account for differences in patient needs and the special circumstances of particular providers or facilities to ensure that the program is paying appropriately and adequately. HCFA has had mixed success in refining some of its payment methods. For example, HCFA partially addressed problems with its initial methodology for introducing a resource-based practice expense component into the physicians’ fee schedule when it issued a new methodology in 1998. Overall, we considered HCFA’s new methodology to be acceptable. The new methodology better defined practice expenses by specialty and used a more straightforward and simple-to-understand approach. Although HCFA developed the new methodology using the best available data, the agency had limited data on resource use by some specialties, and HCFA made a series of assumptions and adjustments without confirming their reasonableness. As a result, questions remain about whether payment is appropriate for certain procedures. To address these issues, we recommended that HCFA refine its relative value payments by identifying and then focusing on the areas where the data and methodology weaknesses have the greatest effect, but HCFA has done little to target its refinement efforts. Similarly, we have pointed out design flaws in the new payment methodology for SNFs and home health agencies that could allow providers to increase payments by “gaming” these payment methods. HCFA has begun to address some, but not all, of these weaknesses. HCFA has been successful in performing one of its principal missions— ensuring that claims are generally paid quickly and at little administrative cost to the taxpayer. Medicare contractors process over 90 percent of Medicare claims electronically and pay “clean” claims on average within 17 days after receipt. In contrast, commercial insurers generally take longer to pay provider claims. Costs for processing Medicare claims are roughly $1 to $2 per claim—much less than $6 to $10 or more per claim for private insurers, or $7.50 per claim paid by TRICARE—the Department of Defense’s managed health care program. Nevertheless, some Medicare contractors’ performance has been less than exemplary, and HCFA’s lax and uneven oversight allowed performance problems to continue undetected. In the 1990s, several contractors defrauded the government or settled cases alleging fraud for hundreds of millions of dollars, following allegations of serious problems.