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SUMMARY

CHAPTER I. INTRODUCTION AND OVERVIEW

CHAPTER II. THE CURRENT PROGRAM

• The Administration of the Medicare Program
• The Cost of Medicare Administration
• Problems with the Current System

CHAPTER III. COMPETITION IN THE SELECTION OF MEDICARE CONTRACTORS

• Competition and Administrative Savings
• Competition and Administrative Performance

CHAPTER IV. PROGRAM ALTERNATIVES

• Competition in the Award of All Contracts, With Fixed-Price Reimbursement
• Competition Limited to Replacement of Administratively Costly Contractors, With Fixed-Price Reimbursement
• Competition to Replace Contractors Performing Poorly in Benefit-Safeguard Activities, With Cost Reimbursement

In fiscal year 1983, Medicare contractors are expected to process 280 million claims and provide reimbursement for benefit payments totaling more than $56 billion. The federal government uses contractors to perform four types of activities:

• Process claims promptly and accurately;
  
  
• Design and implement claims review procedures to ensure that payment is provided only for reasonable and necessary medical services;
  
  
• Maintain good relations with the health-care provider and beneficiary communities; and
  
  
• Adjudicate beneficiary appeals arising from insufficient reimbursement or denial.

Medicare will pay approximately $800 million, or 1.4 percent of total program costs, for these services.
 

BACKGROUND

When Medicare was enacted, profit and nonprofit health insurance corporations were selected by local providers of health-care services to serve as Health Insurance (HI) contractors--known as intermediaries--and Supplemental Medical Insurance (SMI) contractors--known as carriers. When more than one contractor has been approved for a local area, individual providers can chose among them.

Contractors are generally reimbursed for all costs associated with their Medicare activities. In fiscal year 1982, however, an unusually tight appropriation led the Health Care Financing Administration (HCFA) to reimburse contractors for only part of the expenses above budgets negotiated at the beginning of the year.

Theoretically, cost reimbursement perpetuates insufficient and ineffective management practices. Under such a payment system, contractors are not encouraged financially to implement cost-efficient managerial practices. Indeed, in some circumstances, the system encourages contractors to shift expenses from their private business to Medicare. Differences in managerial efficiency across contractors contribute, in part, to variations in the average cost of processing a claim (unit costs). In fiscal year 1982, HI claims processing costs varied between $2.79 and $7.35 per claim; SMI unit costs varied between $1.91 and $3.92. Some contend that the recent departure from cost reimbursement that has been forced by budget stringency has increased efficiency significantly, however.

Another criticism of the current system is that the method used to evaluate contractors' performance may overemphasize low administrative costs and exclude other activities designed to limit the total benefits paid by the program. In effect, small reductions in administrative costs may be achieved at a much larger cost for benefits that should not be reimbursed by Medicare, since too few resources may be devoted to medical utilization reviews and other costly activities that reduce payments for unnecessary or duplicative services. While the evaluation system used to measure contractors' performance examines these so called "benefit-safeguard" activities, this assessment focuses primarily on the existence rather than the effectiveness of these activities. As a result, contractors differ considerably in the resources they devote to ensuring accurate benefit payments.
 

COMPETITION AND THE FIXED-PRICE CONTRACT

The competitive award of Medicare administrative contracts, used in conjunction with a fixed-price contract, has been proposed as a mechanism to encourage cost-efficient management by contractors. The introduction of market forces in awarding contracts could force competitors to adopt managerial improvements that would increase efficiency and could reduce outlays for Medicare's administration.

Because Medicare's administrative costs constitute only 1.4 percent of total program costs, however, such a reduction in administrative costs might not significantly reduce total Medicare outlays. Attention focused exclusively on administrative costs could encourage contractors to reduce resources for benefit safeguard activities and for those activities that provide a high level of service to the beneficiary and provider communities. In addition, the quality, accuracy, and promptness with which claims are processed could be reduced during the transition to contractors winning the competitively awarded contracts.

Under demonstration authority, HCFA has implemented seven competitively awarded, fixed-price contracts. Valuable information was obtained from these experiments with which to assess the impact of competition on several aspects of the Medicare program:

• Administrative costs,
  
  
• Total benefit payments, and
  
  
• The promptness of claims processing.

These effects are discussed in the following sections.

Administrative Costs

When several competitors participated in the contract solicitation, Medicare payments to contractors were reduced by approximately 10 percent relative to the projected costs of continuing with the incumbent cost-reimbursement contractor. In solicitations that drew few bidders, however, bids were considerably higher than the projected costs of the incumbent contractor and, in one competition, the solicitation was withdrawn because of the high price of the only bid.

Recent solicitations have produced few competitors, clouding the otherwise significant potential of competition to reduce administrative costs. This reluctance to bid on the part of potential contractors may reflect the recent uncertainties about the cost-reimbursement system--under which some costs have not actually been reimbursed. In essence, contractors may see small potential gains and large potential losses associated with the fixed-price contract.

Benefit Payments

The impact of competition on total benefit payments is unclear, since in the three states where data are available the differences between amounts paid under the demonstration projects and those projected under the previous system varied considerably. Moreover, cost data submitted by fixed-price contractors were insufficiently detailed to determine if the level of resources expended for benefit-safeguard activities affected the level of benefit payments or if this variation resulted from other factors. This issue remains a primary concern with the fixed-price contract for, as discussed, the differential allocation of resources for benefit safeguards could easily more than offset any administrative efficiencies induced by competition.

Another discouraging finding is that fixed-price contractors consistently and significantly increased the rate of erroneous payments and, because overpayments exceeded underpayments, expenditures increased unnecessarily. This inaccuracy may also have affected numerous individual beneficiaries who may have had to absorb underpayments made by the contractor.

Timeliness of Claims Processing

Contractors were, in most circumstances, able to maintain the promptness with which claims were processed by incumbents. In the one situation, the average processing time doubled, however, creating massive dissatisfaction and complaints among providers and beneficiaries.
 

OPTIONS

This report analyzes three options to modify the existing system for the award of Medicare contractors. The discussion is limited to SMI contractors because of the current lack of data from the HI demonstration projections. The first alternative would use competition to select all contractors and reimburse them through fixed-price contracts. The second would substitute competition only to replace contractors with high administrative costs and also use fixed-price contracts. The third option would use competition cost-reimbursement contracts to replace those contractors with repeatedly high levels of erroneous benefit payments or with ineffective procedures to safeguard benefit payments. The budget impact of each alternative for fiscal years 1984 to 1988 is shown in Summary Table 1.
 

Competition to Award All Contracts (Using Fixed-Price Reimbursement)

This option would award all Medicare contracts on the basis of competitive procurement. Contractors would be reimbursed at a rate based on a fixed price for a designated period of time or for some predefined unit of work determined at the time of contract award. The transition to competitively awarded, fixed-price contracts would occur over four years beginning with fiscal year 1984.

Under this alternative, total program costs would increase by $40 million in fiscal year 1984 and by $660 million over the period of fiscal years 1984 to 1988. Administrative costs would account for $270 million of the five-year rise. Although competition theoretically would reduce program administrative costs relative to the cost-reimbursement system, the limited interest in competition among potential bidders, the small savings obtainable from those contractors that are currently performing efficiently, and the significant transition costs would actually raise them.

Benefit payments would also increase--by $390 million over the period--because of increased error rates. Higher error rates would raise outlays since overpayments tend to exceed underpayments. This estimate assumes that the results of claims review would be about the same as under current law, because fixed-price contractors would devote roughly the same levels of resources to benefit safeguard activities. (This assumption is consistent with the mixed claims-review experience of the demonstration projects.)

Moreover, the implementation of the competitive fixed-price contract would require 14 SMI solicitations per year; the continual monitoring and technical assistance necessary to maintain the functioning of the overall system would tax the oversight capabilities of HCFA, unless central and regional staff were increased substantially. Lastly, this option would disrupt the contractors' operations for three quarters.

Competition to Replace High-Cost Contractors (Using Fixed-Price Reimbursement)

In contrast to the first alternative, the second would limit competition to those territories currently served by contractors with consistently high administrative costs. The selective use of competition is intended to replace high-cost performers while minimizing the potentially disruptive and costly effects of competition on contractors' performance.

This alternative would increase total program costs by $20 million in fiscal year 1984, during which the initial solicitations would be awarded and transition activities would occur. Over the period 1984 to 1988, this alternative would raise total program outlays by $120 million--the net effect of lower administrative costs but higher benefit payments.

The option would reduce administrative costs by $30 million over the five years when 14 contracts would be awarded competitively. These savings are limited, in part, by the large transition costs associated with the establishment of facilities and operations in the new territory. Consequently, savings might be expected to increase in future years. Since incumbent cost-reimbursement contractors with low administrative costs would be retained, they would have incentives to invest in new technologies and other cost-efficient management strategies in order to achieve future efficiencies and avoid competition for their contracts.

Benefit payments would increase by $150 million between fiscal years and 1988, because of higher error rates, however. As in the first option, fixed-price contractors are assumed to continue roughly the same levels of benefit safeguard activities as their cost-reimbursement predecessors. In spite of these activities, erroneous benefit payments would rise more than offsetting the administrative savings realized by the selective application of competition.

Competition to Replace Contractors Performing Poorly on Benefit-Safeguard Activities (Using Cost Reimbursement)

This alternative would introduce competition in the award of Medicare administrative contracts to eliminate those who perform poorly on benefit safeguard activities. Contractors would be replaced by competitors with the demonstrated capabilities to implement innovative and cost-efficient activities designed to improve the accuracy of benefit payments to eligible individuals. Performance on the payment-deductible error rate or some other measure that objectively embodies this payment-safeguard orientation would serve as the most important selection criterion. As under the current system, the contractor would be reimbursed for the actual costs of performing administrative activities.

In fiscal year 1984, this option would save $7 million; between fiscal years 1984 and 1988, total program outlays would be reduced by $240 million. The higher level of safeguard activities would reduce benefit payments by $370 million over the five-year period, but raise administrative costs by $130 million. Some uncertainty is associated with the estimate of benefit payment reductions, however. While the General Accounting Office (GAO) has estimated that benefit safeguard activities return $7 for each $1 spent, it is not known at what point diminishing returns would set in.

This approach would have the additional advantage that it would serve as a stimulus for all contractors to implement effective benefit reduction activities in order to avoid the competitive process. This effect is not, however, included in the estimate of federal savings.

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