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Testimony on Medicare+Choice by Mike Hash
Deputy Administrator, Health Care Financing Administration
U.S. Department of Health and Human Services

Before the House Commerce Subcommittee on Health
February 25, 1999

Chairman Bilirakis, Congressman Brown, distinguished Committee members, thank you for inviting me here to discuss our efforts to pay health plans accurately and fairly. The Balanced Budget Act of 1997 requires Medicare to "risk adjust" payments to Medicare+Choice organizations, starting January 1, 2000. That means we must base payment to Medicare+Choice plans on the health status of their enrollees.

Risk adjustment is an essential component of the Medicare+Choice program, and represents a vast improvement over the current payment method. It helps assure that payments are appropriate and curtail the disincentive for plans to enroll sicker beneficiaries.

Under risk adjustment, data on individual beneficiaries use of health care services in a given year will be used to adjust payment for each beneficiary enrolled in a Medicare+Choice plan the following year. The payment adjustments are based on the average total cost of care for individuals who had the same diagnoses in the previous year. In order to prevent disruptions to beneficiaries and health plans, we will phase this change in over five years. Initially, we will use data on inpatient hospital stays and move in an orderly fashion, as envisioned in the Balanced Budget Act, to use of data from other health care settings.

We would like to thank plans for their cooperation in providing the data needed to implement this important advance.

Currently, some 6 million of Medicare's 40 million beneficiaries have chosen to enroll in Medicare+Choice plans. Risk adjustment will increase payment to plans for their sickest patients, and thus curtail the disincentive for plans to enroll these beneficiaries. It also will lower payment to plans for their healthier patients. Risk adjustment is an essential step forward for beneficiaries, taxpayers, and health plans.

    Risk adjustment will help beneficiaries feel confident in all their Medicare+Choice options. It will assure beneficiaries that Medicare pays plans the right amount to provide all necessary care because payment to plans will take each enrollee's health status into account. That will help people with serious illnesses, such as cancer or cardiovascular disease, who can benefit most from the coordination of care health plans can provide.

    Risk adjustment will help taxpayers by addressing the main reason that Medicare has lost rather than saved money on managed care. Many studies show that health plans enroll Medicare beneficiaries who, on average, are much healthier and therefore less costly than those who remain in traditional Medicare. This "favorable selection" of healthy beneficiaries has cost taxpayers $2 billion a year, according to a 1997 report by Congress' Physician Payment Review Commission (now part of the Medicare Payment Advisory Commission).

    Risk adjustment will help level the playing field among Medicare+Choice plans. It will temper the risk of significant financial loss when plans enroll beneficiaries who have expensive care needs, and focus competition more on managing care than on avoiding risk. Risk adjustment also will help plans by alleviating concerns among beneficiaries that plans have financial incentives to deny care.

Phasing-In Risk Adjustment

The law requires us to proceed with risk adjustment starting January 1, 2000, and does not call for a transition. However, we believe we must implement these changes in an incremental and prudent fashion, as was done with other new major payment systems. We are, therefore, using flexibility afforded to us in the law to phase in risk adjustment over 5 years to prevent disruptions to beneficiaries or the Medicare+Choice program.

In the first year, only 10 percent of payment to plans for each beneficiary will be calculated based on the new risk adjustment method based on inpatient hospital diagnoses. The remaining 90 percent will be based on the existing method for calculating plan payments, which are flat amounts per enrollee per month based on the average cost to care for Medicare fee-for-service beneficiaries in each county and adjusted for basic demographic factors like age and sex. In 2001, 30 percent of payment amounts will be risk adjusted. In 2002, 55 percent of payment amounts will be based on risk adjustment. In 2003, 80 percent of payment amounts will be based on risk adjustment. By 2004, we and health plans will be ready to use data from all sites of care, not just inpatient hospital information, for risk adjustment. Then, and only then, will payment to plans be 100 percent based on risk adjustment.

Using Inpatient Data

During the first year of data collection for risk adjustment, both the statute and practical issues require that we use hospital inpatient data alone. About one in every five Medicare beneficiaries is hospitalized in a given year. Data on these hospitalizations are relatively easy to gather, easy to audit, and highly predictive of future health care costs. We will use the data to pay plans more for beneficiaries hospitalized the previous year for conditions that are strongly correlated with higher subsequent health care costs. While we will eventually be using a broader data base for risk adjustment, that is simply not feasible at this time.

The Balanced Budget Act clearly stipulated that more comprehensive data on outpatient, physician, and other services could be collected only for services provided on or after July 1, 1998. That was prudent, because it has been no small task for plans to learn how to gather the inpatient data we are using for the initial phase-in of risk adjustment. Requiring plans to provide additional data on outpatient, physician and other services would have been unduly burdensome at this time.

This year, we will issue a schedule and guidance to plans for reporting other encounter data, such as outpatient information. The schedule will provide sufficient time for plans to gather accurate data and for HCFA to analyze and incorporate the data into accurate risk adjusted payments. We are now confident that by 2004 we will be using data on all health care encounters to assess beneficiary health status for risk adjustment. If we could base risk adjustment on more comprehensive data now, we would. But we cannot. The law requires us to move forward. And, even with its limitations, this initial risk adjustment system based on inpatient data alone will increase payment accuracy 5-fold.

The initial risk adjustment system uses only the approximately 60 percent of inpatient hospital diagnoses that are reliably associated with future increased costs. For example, beneficiaries hospitalized for conditions such as heart attacks in aggregate are at higher risk of subsequent cardiovascular problems, and they consistently have higher health care costs in the subsequent year. Hospitalizations for such diagnoses will lead to higher payments to plans in the following year under risk adjustment. Hospitalizations for acute conditions such as appendicitis, however, rarely lead to increased subsequent care costs. They will not lead to higher payments under risk adjustment.

The 60 percent of hospital admission diagnoses that are clearly associated with increased subsequent care costs account for about 30 percent of all Medicare spending the following year. It is important to note that, while risk adjustment is initially based only on inpatient data, the risk adjustment payments account for all costs of care associated with each diagnosis. It is also important to note that risk adjustment is not cost-based reimbursement; it is reimbursement adjusted for projected need based on health status in the previous year.

Determining Diagnosis Groups

The relevant diagnoses will be used to classify beneficiaries into 15 different cost categories. One category is for beneficiaries who were not hospitalized the previous year with relevant diagnoses. For beneficiaries included in any of the other categories, plans will receive an additional payment to cover the increased risk associated with diagnoses in that category.

Payment will continue to be adjusted for demographic factors, such as age, gender, county of residence, and whether a Medicare beneficiary is also a Medicaid beneficiary. We have revised these demographic factors for use with risk adjustment, for example, by no longer including institutional status because the risk adjustment methodology itself does a good job of predicting expenses for nursing home residents.

Medicare will calculate a score for each beneficiary to determine the payment that will be made if they choose to enroll in a Medicare+Choice plan. For example, Medicare's average payment per year to health plans is $5,800. Under risk adjustment, payment for an 85-year-old man will on average be $6,414. It will be an additional $2,060 if he is on Medicaid, another $1,207 if he is disabled, and $8,474 more if he was admitted to the hospital for a stroke the previous year, for a total of $18,155. The score for each beneficiary will be calculated annually, and will follow them if they move from one health plan to another.

Protecting Program Integrity

Most health plans operate with integrity and play by the rules, and we doubt that plans will compromise successful medical management programs that keep patients out of the hospital in order to game the risk adjustment system. However, plans themselves have raised concerns that risk adjustment based on inpatient data alone could create perverse incentives for unnecessary hospitalizations. We, therefore, have taken solid steps to prevent gaming of the system with inappropriate hospital admissions or attempts to inflate the data submitted for use in risk adjustment.

The risk adjustment system does not include hospital stays of just one day, in order to help guard against inappropriate admissions. And it excludes diagnoses that are vague, ambiguous, or rarely the principal reason for hospital admission. In addition, we will use independent experts to assess the validity and completeness of data plans submit to us by conducting targeted medical record reviews and site visits. This will help ensure that plans do not "upcode," or claim that hospital admissions were for more serious conditions that would result in higher payment.

Protecting Taxpayers

It is essential to stress that risk adjustment will not and cannot be budget neutral if we intend to protect the Medicare Trust Fund and be fair to the taxpayers who support our programs. The whole reason for proceeding with risk adjustment and specifically with risk adjustment that is not budget neutral is that Medicare has not been paying plans properly.

There is considerable evidence that we have overpaid plans and continue to overpay plans, in large part because payments are not adjusted for risk.

    The Physician Payment Review Commission, in its 1997 Annual Report to Congress, estimated that Medicare has been making up to $2 billion a year in excess payments to managed care plans. This Congressional advisory body notes that, unlike the private sector where managed care has slowed health care cost growth, managed care has increased Medicare program outlays. The Commission's 1996 Report found that those who enroll in managed care tend to be healthy and those who disenroll tend to be unhealthy, exacerbating Medicare losses.

    Mathematica Policy Research, which has conducted several studies on Medicare HMOs, says care of Medicare beneficiaries in HMOs costs only 85 percent as much as care for those who remain in traditional fee-for-service Medicare. That is 10 percent less than the 95 percent of the average fee-for-service costs plans were being paid.

    The Congressional Budget Office has said managed care plans could offer Medicare benefits for 87 percent of Medicare fee-for-service costs, even though they were paid 95 percent.

Congress also recognized that plans have been paid too little for enrollees with costly conditions, and too much for those with minimal care needs. The simple demographic adjustments made now for age, gender, county of residence, Medicaid and institutional status, do not begin to accurately account for the wide variation in patient care costs. Risk adjustment will.

The vast majority of beneficiaries enrolled in Medicare+Choice cost far less than what Medicare pays plans for each enrollee. Medicare fee-for-service statistics make clear why risk adjustment must not be budget neutral. More than half of all Medicare fee-for-service beneficiaries cost less than $500 per year, while less than 5 percent of fee-for-service beneficiaries cost more than $25,000 per year, according to the latest available statistics for calendar year 1996. The most costly 5 percent account for more than half of all Medicare fee-for-service spending.

Since Medicare+Choice enrollees tend to be healthier than fee-for-service Medicare beneficiaries, the ratio of high to low cost beneficiaries in health plans is even more stark. Clearly, care for the overwhelming majority of Medicare enrollees costs plans much less than what Medicare pays because our payments are predicated on the average beneficiary cost of care, calculated by county. This average includes the most expensive beneficiaries in fee-for-service, who generally do not enroll in managed care.

If risk adjustment was budget neutral, Medicare and the taxpayers who fund it would continue to lose billions of dollars each year on Medicare+Choice. Accurate risk adjustment inevitably and appropriately must change aggregate payment to plans.

Budget neutral risk adjustment would cost taxpayers an estimated $200 million in the first year of the phase-in, and $11.2 billion over 5 years if health plans maintained their current, mostly healthy mix of beneficiaries. It is important to stress that actual savings to taxpayers from risk adjustment will vary to the extent that less healthy beneficiaries enroll in Medicare+Choice plans, resulting in higher payments than health plans receive today.

The amount of payment change will vary among plans and depend on each plan's individual enrollees. Total payment may be higher for some plans as they enroll a mix of beneficiaries that is more representative of the entire Medicare population. As part of our Medicare+Choice March 1 rate announcement, we will send a letter to each health plan with an estimate of how payment will differ from what they are paid now, based on their current mix of enrollees.

Overall, we project that payment to Medicare+Choice plans on average will change by less than one percent in the first year. How it will change over time depends on the mix of beneficiaries in each plan. Risk adjustment significantly changes incentives for plans and could well lead to enrollment of beneficiaries with greater care needs. That could result in plans receiving higher payments than they do now. Phasing in risk adjustment also substantially buffers the financial impact on plans. The federal government is forgoing $1.4 billion in savings in the first year and as much as $4.5 billion over the full 5 years because of the phase in.

Payment changes will be further buffered by an annual payment update for 2000 that our preliminary estimate suggests will be 5.2 percent. This is substantially larger than projections that were made last year. The final figure will be released March 1, 1999. This annual update is based on formulas set in law and projected expenditures for Medicare that are included in the President's fiscal year 2000 budget.


Risk adjustment is an essential step forward for Medicare, beneficiaries, taxpayers and the Medicare+Choice program. It will help Medicare pay plans fairly and accurately. It will curtail disincentives to enroll less healthy beneficiaries. It will help taxpayers and the Medicare Trust Fund start saving, rather than losing, money on managed care. It will help level the playing field among plans. And it is required by law.

We are aware of the magnitude of the impact of risk adjustment and are, therefore, phasing in implementation to avoid undue disruptions. We are also taking proactive steps to prevent potential gaming of the system. We will closely monitor the impact on beneficiaries and plans. We will continue to consult with beneficiary groups, health plans and academic experts. Adjustments can be made each year as we proceed.

But, clearly, we must proceed. Risk adjustment is too important to postpone and too important to implement without a prudent phase-in that allows time for any necessary refinements. Again, I thank you for inviting us here today to discuss this, and I am happy to answer your questions.

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