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Helath and Human Services Secretary Donna E. Shalala announced today that the Health Care Financing Administration (HCFA) will begin implementing, on a phased-in basis, a more accurate payment method that will assit Medicare managed care plans that enroll the sickest beneficiaries.

Required by the Balanced Budget Act of 1997, the new payment method -- known as risk adustment -- will for the first time begin to reflect the health status of Medicare beneficiaries. The new approach, which will be phased in over five years, will increase payments to plans that care for the sickest beneficiaries who stand to gain the most from managed care's focus on coordinating care. Medicare currently pays health maintenance organizations (HMOs) and other managed care plans a fixed monthly amount per beneficiary, adjusted only by demographic factors.

"There is widespread agreement among health care experts that risk-adjusted payments will pay plans more fairly and reduce incentives for plans to enroll only healthier beneficiaries," Secretary Shalala said. "But we want to be sure that as we move to this new payment system, we do our utmost to provide a stable marketplace for HMOs to protect our Medicare beneficiaries who choose managed care plans. I believe HCFA's phased-in approach will do that."

Risk adjustment looks at a person's diagnosis in one year and predicts how much, if any, additional cost there will be for that person the next year. For example, a person who has appendicitis in one year is not expected to have higher than average costs the following year. If a person has a stroke, however, additional costs beyond the average are predicted and a plan would receive a larger payment to cover the additional expected costs.

As required by law, risk-adjusted payments to plans will begin Jan. 1, 2000. However, to ensure that plans have time to adjust to the new payment method, HCFA built a five-year transition period into the risk adjustment methodology it adopted. In 2000, only 10 percent of a plan's payment for each beneficiary will be calculated based on the new risk adjusters, while 90 percent of the payment for each beneficiary will be based on the current system. The full effects of risk adjustment will be phased in between 2000 and 2004.

"Introducing risk adjustment into Medicare managed care is an important step in making sure beneficiaries have access to the care they need and that Medicare pays plans fairly," HCFA Administrator Nancy-Ann DeParle said. "We are taking a careful and balanced approach to risk adjustment, and we will closely monitor the impact on both beneficiaries and plans."

Of Medicare�s 39 million beneficiaries, over six million are in managed care and over 32 million are in traditional Medicare. On average, 60,000 to 70,000 Medicare beneficiaries enroll in managed care plans every month.

The transition component of HCFA�s risk adjustment methodology significantly lessens the financial impact of risk adjustment on plans. If no transition period were included in HCFA�s risk adjustment methodology, aggregate payment reductions to plans would have been an estimated 7 percent or $1.6 billion in 2000. With a transition period, the aggregate reduction is now less than 1 percent or $200 million in the first year.

Currently, Medicare pays health plans a fixed monthly payment for each beneficiary based largely on fee-for-service Medicare costs in each of the nation's more than 3,000 counties. The payments are adjusted by demographic factors such as age, sex, and whether a beneficiary is eligible for Medicaid in an attempt to better reflect the likely future costs of caring for individual beneficiaries. Risk adjustment adds diagnostic information to the payment calculation and significantly improves the accuracy of predicting expected costs.

The best risk-adjustment models, to date, use encounter data -- information about the kind of care provided to individual beneficiaries in encounters with the health system -- to determine diagnoses. The Balanced Budget Act required HCFA to risk-adjust payments to health plans in 2000. It gave the agency the authority to collect encounter data, but limited its authority to collect only hospital inpatient encounter data in the first year of collection. As a result, the risk-adjustment model HCFA is using for 2000 -- known as the Principal Inpatient Diagnostic Cost Group (PIP/DCG) -- is based on inpatient hospital diagnoses. The risk-adjustment model groups hospital inpatient diagnoses into categories according to total predicted costs of each diagnosis in the next year. Although the model uses hospital information to determine a diagnosis, it uses Medicare costs for all services to determine the amount of additional payments to plans.

In any given year, approximately 20 percent of all Medicare beneficiaries are hospitalized. The HCFA model excludes about 40 percent of these admissions from consideration for increased payments by removing diagnoses, such as appendicitis, that have no expected additional costs in the following year. Although HCFA expects plans and hospitals to submit accurate data, the agency is taking a number of steps to ensure the integrity of the system. Based on the advice of an expert clinical panel, HCFA is excluding admissions that are rarely the principal reason for inpatient hospital care or that are vague or ambiguous. One-day hospital stays are also being excluded to reduce the incentive to increase marginal admissions.

The remaining 60 percent of admissions, predicted to account for about 30 percent of all Medicare spending the following year, are classified into 15 different cost categories. If a beneficiary is included in one of these categories, the health plan will receive an additional payment for that beneficiary.

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