Summary

During the 1980s, the per capita costs of providing health care to the elderly under Medicare increased 59 percent, even after adjusting for inflation. To slow this cost spiral, Congress allowed Medicare to contract with health maintenance organizations (HMO) under an alternative payment system. Medicare's traditional fee-for-service payment method created incentives for overuse of medical care because providers could boost their incomes by encouraging greater use of services. By contrast, HMOs receive an up-front fixed monthly fee for each patient's care instead of a fee for each service. Government researchers and outside analysts, however, have claimed that HMOs can be more expensive than fee-for-service care. These analysts argue that beneficiaries enrolled in Medicare HMOs are healthier (and less costly to care for) than beneficiaries in the fee-for-service sector and that Medicare payments to HMOs do not fully reflect these differences in costs. In addition to this problem, industry representatives and other analysts claim that Medicare payment rates are too low in some areas and show unjustifiably wide variation across geographic boundaries. This report examines Medicare's HMO rate setting methodology to determine the existence and the magnitude of these problems and to review proposed solutions. Specifically, GAO discusses the impact of favorable selection and rate variation on the ability of the Medicare risk contract program to yield cost savings.

GAO found that: (1) the Medicare risk contract program has not reduced Medicare costs because the Health Care Financing Administration's (HCFA) rate setting methodology and administrative controls are insufficient to prevent HMO from benefitting from favorable selection; (2) although none of the proposals for a new risk adjustment system provide a definitive alternative to the HCFA methodology, any one of several available proposals would probably improve the system; (3) the Medicare risk contract program faces difficulties not only with risk adjustment, but also with constructing the base payment rate to which these risk adjustments apply; (4) improving the risk adjustment methodology will not correct the problems associated with wide variations in HMO payment rates; and (5) although researchers and HMO industry representatives have proposed a number of alternatives for determining base payment rates under the risk contract program, evidence is insufficient to determine whether any of these proposals would improve the system.