In 1997, Medicare’s fee-for-service program covered about 87 percent, or 33 million, of Medicare’s beneficiaries. Physicians, hospitals, and other providers submit claims to Medicare to receive payment for services they have provided to beneficiaries. HCFA administers Medicare’s fee-for-service program through a network of more than 60 claims processing contractors, that is, insurance companies—like Blue Cross and Blue Shield plans, Mutual of Omaha, and CIGNA—that process and pay Medicare claims. In fiscal year 1997, contractors processed about 900 million Medicare claims. Medicare contractors use federal funds to pay health care providers and beneficiaries and are reimbursed for the costs they incur in performing the work. They are also responsible for payment safeguard activities intended to protect Medicare from paying inappropriately. The contractors have broad discretion in conducting these activities, resulting in significant variation among contractors in implementing payment safeguards. HCFA budgets funding for five main types of program safeguard activities carried out by Medicare contractors: (1) medical review, (2) Medicare secondary payer review, (3) audit of provider cost reports, (4) fraud unit investigations, and (5) provider education. Medical review includes automated and manual, prepayment and postpayment reviews of Medicare claims; it is intended to identify claims for noncovered or medically unnecessary services. Medicare secondary payer review focuses on identifying other primary sources of payment, such as employer-sponsored health insurance or third-party liability settlements, for claims submitted to Medicare. The audit process involves auditing cost reports submitted by providers, such as skilled nursing facilities and home health agencies. Contractor fraud units investigate potential cases of fraud or abuse identified through beneficiary complaints, other contractor safeguard units, or other sources. Provider education can include mailings to providers, briefings, and workshops to increase provider awareness of coverage and billing policies as well as coding and documentation requirements. Beginning with fiscal year 1997, HIPAA stipulates that annual funding levels be appropriated from the Medicare Trust Fund to carry out HCFA’s program safeguard activities. This process ensures that HCFA has funding for these important functions. Starting with the $440 million that was available for program safeguard activities in 1997 and the $500 million expected to be used for fiscal year 1998, HIPAA increases funding annually up to a maximum of $720 million in 2003 and following fiscal years. Funding levels provided by HIPAA in the Medicare Integrity Program for fiscal years 1997 through 2003 are summarized in table 1. Before HIPAA was enacted, program safeguard activities were funded out of Medicare’s general contractor program management budget, and the level of funding available for program safeguard activities could be constrained by the need to fund ongoing Medicare program functions—such as processing claims. In fact, while the number of Medicare claims grew by 70 percent between 1989 and 1996, funding for claims review grew less than 11 percent. In 1994, HHS proposed a program safeguard funding arrangement similar to that in HIPAA, saying that it would improve program safeguards by creating “a stable level of funding from year to year so that HCFA and its contractors could plan and manage the function on a multi-year basis.” HHS went on to say that “ast fluctuations in funding have made it difficult to retain experienced staff who understand the complexities of the program.” Appendix II summarizes program safeguard funding for fiscal years 1994 through 1998, by type of program safeguard activity. Although HIPAA provides significant new resources and authorities, the timing of the act—the passage of which occurred only 6 weeks before the start of fiscal year 1997—limited the opportunity for change in the first year. Then, HCFA failed to take advantage of the advance knowledge of fiscal year 1998 program safeguard funding by providing safeguard budgets to its contractors at the beginning of fiscal year 1998. That delay has hindered contractors’ ability to expand their program safeguard activities. However, HCFA has taken steps to direct program safeguard funding to identified weaknesses and program safeguard activities where it is most needed. Notification of fiscal year 1998 program safeguard funding was not given to contractors until January 1998—nearly one-third of the way into the fiscal year. HCFA officials told us that they waited so that HCFA could notify contractors of their program safeguard funding at the same time as claims processing funding. As a result of this late start, it may be difficult for the contractors to complete all of the program safeguard work that HCFA expected them to accomplish with this increased funding. Although HIPAA appropriated program safeguard funding for fiscal year 1998, HCFA officials believed that distribution of that funding needed to be delayed until funds for contractors’ other activities were distributed. They stated that contractors might use Medicare Integrity Program funds for other program management purposes if these program safeguard funds were released in advance of program management funds. Despite HCFA’s concerns, its contractors are required to use Medicare Integrity Program funding only for program safeguard activities. After reviewing a draft of this report, HCFA told us that it would notify contractors of their fiscal year 1999 base program safeguard funding before the first day of the fiscal year. In addition to being late, the January 1998 funding notification to contractors did not include all of the fiscal year 1998 contractors’ funding. As of the end of February, HCFA had not released more than $40 million in program safeguard funding for various projects to be carried out by its contractors. Some of these projects were made possible by the supplemental program safeguard funding provided in November by HHS’ fiscal year 1998 appropriation. The contractors told us that funding received later in the fiscal year is more difficult for them to use effectively because HCFA requires them to complete the projects by the end of September or use a subcontractor. While subcontracting allows the contractor to commit all of its fiscal year funds, contractor officials told us that it does not contribute to building valuable expertise within their own staff. Despite fiscal year 1998 budget increases, neither of the contractors we visited had significantly increased their staff available to perform program safeguard activities, such as provider audit and claims review. While it is difficult to make precise comparisons because of reorganizations at both contractors, contractor officials said that there has been little or no hiring of program safeguard staff, other than some replacements to offset attrition. In some areas, contractors have not filled all of their existing vacancies. Furthermore, contractors’ staffing for some important program safeguard activities is now less than it was before HIPAA. For example, both contractors reported that as of the end of March 1998, they had fewer staff on board to audit provider cost reports than they did in September 1996, before implementation of HIPAA. One contractor currently employs 77 audit staff, down from 88 in September 1996. The other contractor currently employs 151 audit and reimbursement staff, down from 158 in 1996. The latter contractor’s medical review staff has also declined, from 86 in 1996 to 83 at the time of our visit. Because they were uncertain about their level of safeguard funding until well into the year, the contractors also indicated they were not hiring staff to carry out other HCFA-directed projects. In particular, contractors expressed reluctance to hire permanent staff to carry out special projects that are funded only for the current fiscal year. As a result, these projects can affect other program safeguard work. For example, both contractors we visited indicated that the HCFA-directed project to review claims for physician evaluation and management services will require a complex level of review that needs to be done by experienced full-time staff in their medical review units—rather than being carried out by temporary employees or subcontractors—thereby reducing the time that trained and experienced staff are available for the contractors’ ongoing claims review workload. In fiscal year 1998, HCFA has begun to direct program safeguard funding to address weaknesses identified by the HHS OIG’s financial audit of HCFA for fiscal year 1996, and to expand its analysis of how funding can best be allocated among Medicare contractors and program safeguard activities. Although this does not address our concerns about the timeliness of contractor safeguard budgets, HCFA is attempting to better target the safeguard funds. To address the findings of the HHS OIG’s audit of HCFA’s fiscal year 1996 financial statement, HCFA is using fiscal year 1998 program safeguard funding to carry out several corrective actions to supplement regular program safeguard activities, such as the following: To increase the level of claims review, 28 Medicare part B contractors have been directed to conduct a special prepayment review of more than 166,000 physician claims for evaluation and management services. All contractors are to manually perform prepayment reviews of a sample of claims that cleared their automated screens, and each may decide what types of claims it will sample and choose its sampling method. HCFA and its contractors will carry out numerous other targeted efforts and special projects, such as home health agency reviews, the correct coding initiative for part B claims, and numerous information system upgrades. Beginning in fiscal year 1998, HCFA also required Medicare contractors to provide more information and support for their Medicare program safeguard budget requests than it had in prior years, and a HCFA official told us HCFA will continue this practice in fiscal year 1999. Also in fiscal year 1998, HCFA used a new methodology for allocating the program safeguard budget to Medicare contractors. Under this methodology, HCFA incorporates measures of contractor performance (such as return on investment) and program funds at risk in deciding how to allocate Medicare Integrity Program funding to contractors and to specific activities. In addition to providing an assured and increasing source of funding for HCFA’s program safeguard activities, HIPAA directs HHS to contract for program safeguard activities separately from claims processing and payment activities to better ensure the integrity of the Medicare benefit payments. Historically, Medicare program safeguard activities, including such things as medical review of claims, audit of provider cost reports, and investigation of beneficiary complaints, have been conducted by the same contractors who process Medicare claims. HCFA intends that these new competitively awarded contracts will establish program safeguard contractors who specialize in program integrity and have enhanced data analysis capabilities.