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Testimony on Medicare Choices & Competitive Pricing Demonstrations by Bruce C. Vladeck
Administrator, Health Care Financing Administration
U.S. Department of Health and Human Services

Before the House Committee on Ways and Means, Subcommittee on Health
July 12, 1996


Good morning. I am pleased to be back to testify before this subcommittee. As was the case last time I appeared before you, my subject today involves demonstration projects of the Health Care Financing Administration (HCFA). Last time, the subject was long-term care. Today, my testimony will focus on two projects -- the Medicare Choices demonstration and the Competitive Pricing demonstration -- central to our agenda of expanding managed care choices available to Medicare beneficiaries while improving our payment methodologies.


Over the past three decades, HCFNs use of its demonstration authorities has had a profound impact on the evolution and success of the Medicare and Medicaid programs. Through support, development and testing of innovations in payment, delivery, access and quality, HCFA has contributed significantly to major program reforms and improvements. Let me just mention a few examples.

As the result of a program of research and demonstrations begun in 1976, Medicare moved in 1983 from cost-based reimbursement for hospital care to a prospectively determined per case payment based on diagnosis. The prospective payment system saves billions of Medicare dollars annually while the Diagnostic Related Group (DRG) classification system on which it is based is used today by half of the State Medicaid programs, CHAMPUS, and many private insurers, managed care plans, and other countries.

When the hospice movement was still in its infancy, HCFA initiated a Medicare and Medicaid demonstration to determine whether hospice could maximize patient autonomy during the last weeks of life and allow terminally ill patients to die with as much dignity as possible and relatively free of pain. Largely as a result of this successful demonstration effort, legislation established hospices as authorized Medicare providers. In 1994, about 270,000 Medicare beneficiaries used hospice care.

Beginning in the mid-1970s, HCFA sponsored a series of innovative Medicare and Medicaid demonstrations throughout the country to test the use of community-based services as substitutes for more costly institutional long-term care. These demonstrations served as the framework for the legislation authorizing the Medicaid waiver program under Section 1915(c) of the Social Security Act, under which home and community-based services may be covered.

HCFA's managed care programs were also rooted in extensive demonstration efforts. Beginning in 1980, HCFA tested the use of capitation payments for HMOs participating in Medicare. This pioneering effort demonstrated to plans, Congress, and the executive branch that HMO participation in Medicare on a capitated basis made sense for both beneficiaries and the program. Since HCFA implemented the Medicare managed care program in 1985, both the number of beneficiaries enrolling in risk plans and number of risk plans contracting with Medicare have increased steadily. In 1985, only 309,000 beneficiaries were enrolled in risk plans whereas today over 3.6 million are enrolled in these plans, an increase of over ten-fold. Similarly, in 1985, only 32 risk plans contracted with Medicare. Today, 218 risk plans contract with Medicare.

There is general consensus among this Administration, the Congress, managed care plans, beneficiary advocates, and other providers that the Medicare managed care program should keep pace with private sector innovations while still ensuring that beneficiaries receive high quality care. For our purposes today, let me cite three areas that receive frequent mention. First, many believe that the types of managed care choices available to beneficiaries should be expanded to provide as many options as the commercial sector does. Within our current statutory authority, HCFA has recently expanded beneficiaries' managed care options to include a point-of-service option HMO. However, making additional choices such as provider sponsored organizations (PSOS) or preferred provider organizations (PPOS) widely available to Medicare beneficiaries is not possible under current law. Both the Administration and the Congress' balanced budget proposals include provisions which would allow Medicare to contract with these managed care organizations on a permanent basis.

Second, there is agreement that beneficiaries need reliable, comparative information on the managed care plans available in their local market areas in order to make informed decisions regarding enrollment. Again, there is common ground in the Administration and Congressional proposals. Both plans would require the Secretary of Health and Human Services to disseminate comparative information on managed care options at initial Medicare eligibility and during annual open enrollment periods. The Administration's bill also requires that information on Medigap plans be included in the comparative materials.

And third, most observers believe that the current payment methodology for managed care plans is flawed and should be improved. Under current law, the payment methodology is based on the Adjusted Average Per Capita Cost (AAPCC), generally referred to as "the AAPCC". Under the AAPCC methodology, payment levels for HMOs are derived from the utilization and cost experience in Medicare's fee-for-service population. There is general agreement that Medicare's payments to managed care plans should be "delinked" from fee-for-service costs in particular localities. In addition, recent research by HCFA confirms previous research findings that, because the current payment methodology does not adequately take into account the better health status of beneficiaries enrolled in Medicare HMOs, the Medicare program pays more for these beneficiaries than it would if they had remained in fee-for-service Medicare.

Congress has given HCFA broad demonstration authority to test potential improvements with which to address concerns like these. My testimony today will focus on two such demonstrations: Medicare Choices and the Competitive Pricing demonstration.


The purpose of Medicare Choices is to test the receptivity of Medicare beneficiaries to a broad range of managed care delivery system options and to evaluate the suitability of these options for the Medicare program. Our goal is to provide beneficiaries with additional delivery system choices and to increase options available to beneficiaries in rural areas. In addition, the Medicare Choices demonstration will help to develop approaches to a wide range of implementation issues- including payment methods, certification requirements and quality monitoring systems--which would be associated with some of the new Medicare managed care choices piloted in this demonstration. In developing the design specifications for Medicare Choices, HCFA and its contractor consulted extensively with interested parties including managed care plans.

In order to minimize unnecessary investment of resources by applicants, HCFA used a two-step application process to select the managed care plans participating in the Medicare Choices demonstration. HCFA first asked plans to submit a pre-application statement of interest and a brief project description. After reviewing the pre-applications, HCFA then requested selected organizations to submit more detailed proposals.

During the pre-application process, HCFA encouraged a broad range of managed care organizations, including PPOS, PSOs and HMOs, to submit innovative managed care proposals, such as point-of-service and primary care case management systems. We also encouraged applicants to propose alternative payment methodologies such as risk corridors and blended capitation payments and to indicate a willingness to test risk adjustment methods.

HCFA targeted nine cities as well as rural areas. The nine target cities were Hartford, CT; Sacramento, CA; Jacksonville, FL; Atlanta, GA; New Orleans, LA; Columbus, OH; Philadelphia, PA; Louisville, KY; and Houston, TX. These sites represent areas with high managed care penetration in the commercial sector but low Medicare HMO penetration. We also accepted innovative pre- applications from interested organizations outside these target areas. We received 372 pre-applications, representing nearly every State in the nation.

From these 372 pre-applications, HCFA selected 52 managed care plans for further consideration; we requested these plans to submit final applications to HCFA by December 15, 1995. Plans invited to submit final applications offered a wide range of managed care delivery models and proposed a variety of payment methodologies.

We selected "award candidates" based on geographic factors, innovation of design, and ability to meet eligibility requirements. We selected 25 award candidates for final consideration -- nine PSOS, eight provider-owned HMOs or providers with HMO partners, eight HMOs or other managed care organizations.

The 25 award candidates submitted a variety of payment proposals -- thirteen requested 95% of the AAPCC, five requested risk corridors around the AAPCC, seven requested other payment models such as partial capitation, blended payments, or capped fee-for-service payments. Sixteen of the 25 indicated an interest in testing a risk adjustment method. Five of the 25 award candidates are located in rural areas.

Award candidates are currently in the final steps of the Medicare Choices demonstration award process, which includes negotiations regarding payment methodology. Once these remaining details are worked out, HCFA will review plans to determine whether they meet standards regarding access, beneficiary protections, financial solvency, and quality assurance. While generally expecting plans to meet current law standards for Medicare HMOs, HCFA will evaluate plans participating in the Medicare Choices demonstration on a case-by-case basis.

HCFA expects plans to be certified and ready to enroll beneficiaries in 1997, but some may be ready to enroll beneficiaries sooner.

Both the Administration and the Congress support expanding Medicare managed care choices to include PPOs and PSOs and support similar provisions regarding PSO State licensing, solvency, and quality requirements. In the past, demonstrations have provided valuable information on implementing such program expansions. If HCFA is authorized in the future to contract with PPOs and PSOs on a permanent basis, the lessons learned from the Medicare Choices demonstration will significantly facilitate and accelerate implementation.


As I mentioned earlier, the current payment methodology for managed care plans is flawed and should be improved. For years, health care financing experts encouraged Medicare to move from our fee-for-service based method to one that relies more on a "market- based" payment rate. The managed care industry appeared to agree as well. The Group Health Association of America (now the American Association of Health Plans) testified before this Subcommittee in February 1995 that "payment rates are tied to the Medicare fee-for- service costs in a given area, and do not give the Medicare program the benefits of market dynamics present in the private sector." GHAA further stated that "Medicare payments to health plans should eventually be 'market-based'. " In its 1995 Annual Report to Congress, the Physician Payment Review Commission (PPRC) recommended that "payment rates for Medicare health maintenance organizations established through competitive bidding ultimately should replace payment rates based on adjusted average per capita costs in markets with a sufficient number of HMOs bidding to achieve price competition." However, developing a market-based rate is a complex endeavor and the best methodologies are not immediately obvious. Recognizing both the need to seriously examine market-based rate setting and the intricacy of the task, about two years ago HCFA began to invest significant resources in developing a demonstration which we refer to as "competitive pricing."

HCFA conferred with many experts when designing the demonstration's bidding process, including consultants at Abt Associates, a firm with a long history in health care financing policy; academics recognized as authorities on competitive pricing at the University of Minnesota; additional consultants with expertise in managed care,'and other technical experts, including representatives of the managed care industry and the beneficiary population.

In developing the education and enrollment aspects of the demonstration, we worked with BENOVA (formerly knows as "Health Choice"), a contractor specializing in marketing and consumer education in the private and public sectors. We also convened two expert panels specifically to help develop the education and enrollment design specifications, one comprised of managed care plans and the other of beneficiary-oriented representatives. In addition, another contractor, Research Triangle Institute, conducted numerous focus groups in several states to determine beneficiaries' preferred methods of receiving information on health insurance options and their response to prototype educational materials. We also conducted 35 individual interviews with Medicare beneficiaries in four locations to more carefully examine their reactions to the prototype educational materials and to determine whether beneficiaries understood the most important elements included in these materials.

Components of the Demonstration

The competitive pricing demonstration focuses on two of the three concerns outlined in my introduction: altering the payment methodology for Medicare managed care plans and improving the ability of beneficiaries to make informed choices about their Medicare options. The demonstration has three essential and interrelated components: beneficiary education, third party enrollment and counseling, and market-based rate setting.

Beneficiary Education. HCFA will contract with an independent third party to prepare and distribute a comprehensive set of brochures to all Medicare beneficiaries in a specific market explaining the features of Medicare fee-for-service and managed care programs. The printed materials will highlight issues to consider when choosing between these two delivery systems. The materials will also include a chart comparing the benefit packages and premiums for all Medicare managed care plans in the beneficiaries! local market area in addition to comparisons of Medigap options. It will also include a list of HCFA-sponsored education seminars and informational videos and the number of a toll free counseling call center. The materials will not advocate managed care or fee-for-service Medicare. The materials will clearly state that the beneficiary does not need to take any action and are intended only to provide information.

Third Party Enrollment and Counseling. The independent third party contractor will also conduct all HMO enrollment and disenrollment activities and staff the toll free counseling call center. This neutral third party will provide objective information to Medicare beneficiaries who call seeking more information on their Medicare choices, as well as enroll beneficiaries who want to choose a managed care plan by mail or by telephone. In the competitive environment of this demonstration, managed care enrollment through a neutral third-party will help to ensure that plans do not encourage healthier beneficiaries to enroll and discourage sicker beneficiaries from enrolling in their plan. In addition, while we believe that favorable selection into Medicare BA40s results in part from beneficiary self-selection, we are interested in learning if using a neutral third party has an effect on favorable selection into Medicare HMOs.

Another reason third party enrollment is an important part of this project is that HCFA's recent focus groups have found that Medicare beneficiaries would prefer having access to a third party (as opposed to a plan trying to "sell them something") when learning about and/or making managed care choices.

Several years ago, HCFA successfully piloted a beneficiary education and third party enrollment program in Portland, Oregon. In fact, some of the Oregon plans continued to contract with this third party after the demonstration ended. Third party enrollment is a mechanism used by many public and private sector purchasers, such as 22 State Medicaid programs, the CALPERS program which covers over I million California state and local government employees, and many large employers.

Market-Based Rate Setting. Under this demonstration, Medicare's payment rate will be based on bids submitted by all Medicare managed care plans in the demonstration site. Plans would bid on a "community standard" benefit package, representing the most common plan offered in the area. The rate derived from bids will replace the current AAPCC rate. The same demographic factors now applied to the AAPCC (age, sex, Medicaid, and institutional status) will be applied to this market-based rate to adjust payment to establish the payment rate for individual beneficiaries in the first year of the demonstration. HCFA plans to apply new risk adjustment methodologies after the first year.

We have not determined yet precisely how we will set the Medicare payment based on submitted bids. We are committed to assuring that beneficiaries have access to more than one plan at the current premium level. For example, if most or all of the plans in the demonstration site are currently offering a "zero" premium option, we would set the Medicare payment rate so that several plans could continue to offer such an option.

Site Selection

In determining potential demonstration sites, we targeted those areas with a relatively high AAPCC rate, relatively low Medicare managed care penetration, and enough Medicare HMOs to make competition feasible. We are confident that we have been thorough and careful in gathering together the resources appropriate to design the demonstration. However, we also realize that we made a important mistake after we identified Baltimore as the most appropriate initial site for this demonstration. We did not adequately consult with interested parties at the local level.

Under Mr. Cardin's leadership, HCFA is now in the midst of a series of meetings, chaired by the Congressman, with others from the Maryland Congressional delegation, Baltimore managed care plans, beneficiary representatives, Baltimore business representatives, and representatives of the State government. The purpose of these meetings is to discuss the issues and concerns raised by these parties, something we should have done earlier, but are glad to be doing now.

I'd like to take this opportunity to thank Mr. Cardin for his positive and constructive action after Baltimore was announced as the first potential demonstration site and to reiterate Secretary Shalala's commitment that we will not proceed with the demonstration until members of the Maryland delegation are comfortable with the demonstration's design and timetable.

Clarification of Demonstration's Parameters

The design and implementation of this demonstration is a complex undertaking and, hence, there are many areas where misunderstandings can occur. While it would not be possible to cover all areas, I would like clarify some of the demonstration's parameters.

First, no plan would be excluded on the basis of its submitted bid. The purpose of the bidding process is simply to set the Medicare payment amount on the basis of the managed care marketplace, rather than using the AAPCC rate. Indeed, the use of the phrase "competitive pricing" in lieu of "competitive bidding" is intended to convey that we are only setting the price, not using the bidding process to exclude any interested parties.

Second, beneficiaries will have the option of remaining in fee- for-service Medicare or enrolling in a managed care plan. No action on the beneficiary's part is required to stay in fee-for-service Medicare. The beneficiary's enrollment in a managed care plan will be completely voluntary. The contractor conducting third party enrollment will not be rated or compensated based on the number of beneficiaries enrolling in a managed care plan. The purpose of the education and information is to assure that beneficiaries understand all their options.

Third, managed care plans will be able to market to potential enrollees as they do today through mailings and radio, newspaper, and television advertisements. Their ability to deliver their message to potential enrollees will not be hampered. This demonstration simply provides comparative information on plan choices so that beneficiaries will be able to make informed choices and conducts enrollment and disenrollment through a neutral party, instead of through the plans.

Finally, the managed care industry has for many years expressed an interest in experimenting with a metropolitan statistical area (MSA) wide rate, and we had indicated that we would consider using one MSA-wide payment rate. However, concerns have been raised that this could discourage plans from providing services to individuals in Baltimore City, which has the highest county-specific rate in the region. We have indicated that we are flexible on whether to use one rate for the Baltimore MSA or to adjust the bid for county differences.


Mr. Chairman, you and I and many witnesses before your Subcommittee have expressed our belief that Medicare needs to learn from the private sector by expanding the range of managed care choices available to our beneficiaries, giving beneficiaries the information they need to make informed choices, and reforming how Medicare determines its payment rate to managed care plans to incorporate local market forces. But these are complex problems and no one knows the right solutions at this time. Fortunately, our demonstration authorities allow us to test how to make these important and needed changes. We believe we have worked responsibly with experts and affected parties to craft demonstrations that will allow us to move Medicare into the 21st century.

I would be happy to answer any questions you may have.

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