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JUNE 28, 2001

Chairman Bilirakis, Chairman Greenwood, Congressman Brown, Congressman Deutsch, distinguished subcommittee members, thank you for inviting me here to testify about Medicare contracting reform.

A former Deputy Administrator in the Health Care Financing Administration, now known as the Centers for Medicare and Medicaid Services (CMS), once said, "There is substantial evidence that the Medicare cost-based contracts do not contain sufficient incentives for efficient, innovative and cost-effective operations. Since contractors are reimbursed for whatever ‘reasonable costs’ they incur, they have no financial motivation to be innovative in attempting to improve service to beneficiaries or in saving money. In other areas of federal procurement of this magnitude, contractors are required to compete for the business and are rarely reimbursed under the kind of no-risk, cost based contracts which are used in Medicare." These are not my words, but words that were spoken in 1980 by Deputy Administrator Earl Collier at a Ways and Means Health Subcommittee hearing on fee-for-service contractors. My point is that contracting reform has been needed for decades, but nothing has changed.

Efforts to reform Medicare’s contracting arrangements have been around for years. When I was at the Office of Management and Budget from 1989 to 1993, I pushed it without success. Let me assure you, however, that no Administration, Secretary, or Administrator, has been nearly as committed to fixing this situation than this one.

When Secretary Thompson went to CMS (then HCFA) for a week in May, he was briefed in depth on a wide variety of issues. He was already pretty worked up about our outdated computer and accounting systems before that week. The single issue that outraged him most during his intense week of Medicare and Medicaid briefings was the crazy and antiquated way that the Medicare contracting system works. He has been talking about the issue daily since, and he has been prodding me since, almost daily, to fix it. I am not always a slow learner – so this is at the top of the CMS reform list. In the past this has been low on the reform lists of prior administrations, from Carter and Reagan to Bush and Clinton. That is no longer the case. A strong Medicare demands a rational contracting system. The Secretary’s intense interest can be a strong spur to drive this long overdue change—and we are excited to work with you, and our contractors, to fix the system.

Today, the Administration is proposing legislation to reform the current system, and I am pleased to discuss the details of that proposal. I look forward to working with the Committee in the coming months to achieve this important objective.


Since Medicare was created in 1965, the government has used private health insurance company contractors to process Medicare claims and perform related administrative services for beneficiaries and health care providers. Today, CMS uses 49 contractors, across the country, including the contract with the Blue Cross Blue Shield Association of America, to process nearly a billion claims each year, from over one million health care providers, and provide customer services to 33 million Medicare beneficiaries. These contractors employ over 21,000 people. This year, Medicare contractors will pay out more than $175 billion for beneficiary health care services, the vast majority of these transactions occurring electronically.

The fee-for-service contractors are governed by Medicare laws that impose outdated requirements and diverge from general federal acquisition laws in several respects. The current Medicare statute restricts the Secretary from competing the fee-for-service claim processing contracts to the most qualified entities. Rather, institutional providers, such as hospitals and nursing facilities, nominate the contractor, or fiscal intermediary, that processes and pays their Medicare Part A claims. While the statute does not require the Secretary to accept the nominations, it effectively ties the Secretary’s hands because it also does not allow the Secretary to contract outside the nomination process. In 1965, the American Hospital Association nominated the Blue Cross Blue Shield Association of America to be the fiscal intermediary contractor, who subcontracts with local Blue Cross plans. That arrangement continues today. At the time, some providers nominated other commercial insurers to serve as their fiscal intermediaries. Mutual of Omaha is the only major commercial insurer among that original group that continues as an intermediary today. The statute was amended in 1977 to allow the Secretary to designate regional or national intermediaries for administering home health claims. These intermediaries, referred to as Regional Home Health Intermediaries (RHHIs), must already be fiscal intermediaries in order to participate.

For most Part B claims processing, the law is more prescriptive and requires that the Secretary select and use health insurers, referred to as carriers, to process claims and make payments to physicians, ambulance companies, and other suppliers. Similar to the RHHIs, the statute was amended in 1987 to permit the Secretary to designate regional carriers to process claims for durable medical equipment, prosthetics, orthotics, and supplies. These durable medical equipment regional carriers, or DMERCs, also must be health insurers.


Today, there are 28 fiscal intermediaries and 20 carriers processing Medicare fee-for-service claims. Twenty-six of the fiscal intermediaries are Blue Cross plans and two are commercial insurance companies. On the Part B side, fifteen of the current carriers are Blue Shield plans and the remaining five are commercial insurance companies.

As you can see in Chart 1, some contractors, such as Nebraska Blue Cross, serve only one State. By contrast, many contractors serve multiple and sometimes non-contiguous states, resulting in a patchwork of coverage and service across the country. For example, on the Part A side, Wisconsin Blue Cross (known outside Wisconsin as United Government Services) serves Wisconsin and Michigan, as well as California and Nevada. The same holds true on the Part B side of Medicare as indicated in Chart 2. Some contractors are both fiscal intermediaries and carriers, for example, South Carolina Blue Cross/Blue Shield, also known as Palmetto, is a fiscal intermediary, carrier, DMERC and RHHI. This patchwork of coverage is a result of the large number of transitions by insurers out of the Medicare program. Since 1994, an average of four contractors has left the program each year (Chart 3).

Medicare’s fee-for-service contractors are responsible for a wide range of Medicare program activities. The fiscal intermediaries and carriers receive and control Medicare claims from hospitals and other providers, as well as perform edits on these claims to determine whether the claims are complete and should be paid. In addition, the fiscal intermediaries and carriers calculate Medicare payment amounts and remit these payments to the appropriate party.

The role of the intermediaries and carriers goes beyond claims processing. For example, they conduct reviews and hold hearings on appeals of claims from physicians and providers; they respond to beneficiary inquiries; they make coverage decisions for new procedures and devices in local areas; and they conduct a variety of different provider services, such as enrolling new providers in the program, and educating them on Medicare’s rules and regulations and billing procedures. The fiscal intermediaries and carriers also staff Medicare’s provider toll-free lines across the country to answer a wide-range of provider questions. In addition, the fiscal intermediaries and carriers perform a variety of functions to ensure the financial integrity of the Medicare program. Currently, all fee-for-service contractors – the fiscal intermediaries and the carriers –are governed by cost reimbursement contracts. By broadening the type of contracts available for use in Medicare contracting and taking greater advantage of competition and other contracting principles in the Federal Acquisition Regulation, the Secretary would be allowed to maximize incentives to encourage more efficient, innovative, and cost-effective contractor operations.


CMS has taken a variety of steps over the last several years to improve oversight and management of Medicare’s fee-for-service contractors. One of the first, and among the most important, steps we took was to restructure and consolidate CMS’s management of the contractors. One individual, the Deputy Director for Medicare Contractor Management, now is directly responsible for all Medicare contractor management activities within the Agency. When the Agency restructuring plan I announced earlier this month is fully implemented, this position will be located in the Center for Medicare Management. We have created direct lines of communication between the contractors and the Deputy Director through our Consortium Contractor Management Officers. These groups are located in each of our four regional consortia and serve as the "eyes and ears" of the Agency for the contractors. Our goal is to be more consistent in our management of fee-for-service contractor performance and to open the lines of communication between our Agency and our contractor partners.

The groups regularly monitor the contractors’ performance; provide management and guidance; work with technical experts in the Agency to approve budgets, establish Corrective Action Plans; and help to eliminate Agency obstacles in obtaining answers, feedback, and guidance from CMS’s central office and the regions. Furthermore, the Medicare Contractor Oversight Board provides executive leadership and establishes guiding principles for CMSs oversight of the Medicare fee-for-service contractor network.

We also have made substantial improvements to our contractor evaluation processes. In 1999, we revamped our Contractor Performance Evaluation process to ensure greater consistency and objectivity in our review of the contractors. We have incorporated specific, objective standards on a wide-range of contractor functions into our annual review plan. These standards help provide consistent guidance to contractors as to what is expected of them and what improvements are needed. Through accountability and leadership at the senior level of the Agency, we have developed nationally based review protocols and created national review teams for monitoring and reviewing contractor performance. These national review teams, which include experts in Agency business functions, come from every region and the central office. They help to ensure that performance reviews are consistent from region to region and contractor to contractor. In establishing our review of the contractors’ performance, we use risk assessment tools to help focus our monitoring and target our resources most appropriately. In addition, in an effort to ensure consistency in our review process, we have increased our educational training and sponsored several national conferences for our reviewers. Our current evaluations are focused on the greatest risk -- financial integrity. In the future, we plan to focus our reviews more on customer service. This will include feedback from providers and beneficiaries. Without contractor reform, however, our ability to provide strong incentives to reward improvements in performance is quite limited.


In conjunction with this new approach to contractor management and oversight, we are developing a long-term business strategy for Medicare fee-for-service contractor operations, taking into account both our past experience and current factors, including the changing business environment. There are several key factors driving the need for this strategic business plan. Our primary concerns are the need to prepare the Medicare program for the future, to ensure that the Medicare fee-for-service program and its contractors are both responsive to providers and, above all, contribute to providing high-value services for beneficiaries; and to protect the trust funds from needless error and waste while also remaining accountable to taxpayers.

Our strategic business plan will provide us with a framework for decision-making and articulating our business vision to our contractors. It also will assist us in improving our management and oversight and stabilizing our business relationships with them. Our goal is to promote organizational learning and innovation within the Agency as well as with our contractors. We know, for example, that there is a growing need for flexibility in administering the fee-for-service program. And we have learned a great deal about the need to respond quickly and think in innovative ways to adapt to changes following the passage of the Balanced Budget Act, Balanced Budget Refinement Act, and subsequent legislation. Our business plan will help ensure that our contractor systems have the operational capacity to respond to these complex and multiple programmatic changes, such as modifications to Medicare coverage or the addition of new and complex payment systems, and to meet future programmatic challenges.

Our business plan also is focused on our continuing to meet the needs of our beneficiary, provider, and contractor stakeholders. This includes the transition of claims processing work from a contractor leaving the program to one assuming additional work with minimal disruption to providers and beneficiaries, improving educational services provided to beneficiaries and providers by our contractors, and compensating contractors appropriately for the work they do. At the same time, we must strive to improve the financial management of the Medicare program by minimizing the potential for abuse and errors, considering cost-effective ways to implement program and system changes, and improving the integrity of the provider enrollment process.


We must continue to manage the Medicare program efficiently and effectively and to fully implement our business strategy. To do that, we must fundamentally change our relationship with the Medicare fee-for-service contractors. I firmly believe that the Medicare fee-for-service contracting work should be awarded competitively to the best-qualified entities, using performance-based service contracts that include appropriate payment methodologies. This is something that current law will not allow.

I believe these contracts should result in contractors receiving payment when they deliver something of value, and profit only when they perform at or above the satisfactory level. We must be able to maximize economies of scale and improve the level of service to our beneficiaries and providers. We would like to work cooperatively with our existing contractors to get to this goal, but these changes require legislative action. As I mentioned, today we are proposing legislation to address these differences and we want to work with this Committee and the Congress on a viable, sensible solution.

Through these legislative changes, CMS hopes to accomplish the following:

    • Provide flexibility to CMS and its contractors to work together more effectively and better adapt to changes in the Medicare Program.
    • Promote competition, leading to more efficiency and greater accountability.
    • Establish better coordination and communication between CMS, contractors and providers.
    • Promote CMS’s ability to negotiate incentives to reward Medicare contractors that perform well.

These changes will enhance the Agency’s ability to more effectively manage claims processing for the Medicare program in the future, and ensure that the future changes to the Medicare program’s operating structure are free from unnecessary constraints.

We are continuing to proceed with the implementation of our long-range business strategy. To capture the benefits of integrated data processing, we have begun to consolidate our claims processing workload among our existing contractors, and are moving to consolidate and standardize contractor claims systems. Our goal is to have one system for intermediary claims, one for carrier claims, and one for durable medical equipment claims. And we will continue to establish more direct control of our data centers, which should reduce costs and improve efficiency. This consolidation will allow us to make changes efficiently and consistently, and help streamline our information technology infrastructure. Over time, based on the results of ongoing risk and cost benefit analysis, we anticipate expanding our current pool of contractors to include those who can perform specific functions, such as program integrity and coordination of benefits. In addition, we will continue to build the systems interfaces needed to ensure the full integration of Medicare’s contractor operations with the new integrated general ledger accounting system initiative to enhance the contractors’ financial management, and protect the Medicare trust funds for the future.


I appreciate the opportunity to appear before you today and share our vision for reforming the Centers for Medicare and Medicaid Services’ administration of Medicare’s fee-for-service claims processing contractors. Together, we can take aggressive action to reform Medicare’s current contracting arrangement. We must build on the strengths of our current contracting relationships and foster a environment of accountability, innovation, and flexibility. We already have a strong business strategy in place. Through the implementation of this plan, and the realization of our contracting reform objectives as set forth in our legislative proposal, I am confident the Medicare program will be strengthened and better prepared to meet future challenges. I look forward to working with this Committee and the Congress on a bipartisan basis to enact this critical reform legislation. Thank you and I am happy to answer your questions.

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Last revised: July 2, 2001