FACT SHEET

Background: Most of Medicare’s more than 39 million beneficiaries receive care through original fee-for-service Medicare. Nearly all Americans over the age of 65 or disabled Americans under 65 are eligible for the Medicare program. Of the more than 39 million Americans in Medicare, about 70 percent have a managed care option, but only about 6.2 million beneficiaries – about 16 percent -- have chosen to join Medicare HMOs, or Medicare managed care plans, which are paid a congressionally-mandated rate for each Medicare beneficiary enrolled in the plan.

Medicare managed health care options have been available to some Medicare beneficiaries since 1982. In 1997, Congress passed the Balanced Budget Act (BBA), creating the Medicare+Choice program, introducing a wider range of private health plan choices to beneficiaries. In 1999, Congress enacted the Balanced Budget Refinement Act which provided additional incentives for health plans to participate in the Medicare+Choice program.

The BBA also created a new payment methodology for the Medicare+Choice program. The law changed the flat per-person payment to a formula that assures plans of minimum payment increases each year. This means that managed care plans get payment increases, even when overall Medicare fee-for-service spending declines. The law also requires risk adjustment, a payment formula which pays plans more for treating sicker enrollees.

The Clinton administration has proposed a voluntary, affordable prescription drug benefit that would help plans pay for drug coverage for beneficiaries who choose to enroll in a managed care plan or in original fee-for-service Medicare.

Medicare payment rates for coordinated care plans are referred to as capitation rates, meaning that plans are paid "per person" or "per capita" rates. Before the Balanced Budget Act, Medicare paid managed care organizations on a per person, or capitated, basis. The Adjusted Average Per Capita Cost, or AAPCC, methodology determined payments.

HCFA first calculated the capitation rate for each county, based on adjusted average per person costs in fee-for-service Medicare in that county. This rate was standardized by demographic factors to account for differences among counties and included sex, age, institutional status

(community-based versus institutional residence, such as a nursing home), Medicaid eligibility, and working aged status (those who had health insurance coverage through an employer or whose spouse had employer coverage).

Capitation rates were set at 95 percent of Medicare fee-for-service rates as determined through the AAPCC methodology. The final rates were published annually, with separate rates for aged, disabled and beneficiaries with end-stage renal disease for both Part A (hospital) and Part B (physician and supplies) services. Monthly payments were made to each plan, based on the capitation rate for the county of residence. This rate was adjusted based on the individual enrollee’s demographic information, such as age or gender.

Under the AAPCC system, payment rates per county varied widely. For example, the 1997 capitation rate for beneficiaries 65 and older for Part A and Part B services ranged from a low of $220.92 in Arthur County, Nebraska to a high of $767.35 in Richmond County, New York. Some states had variations of more than 20 percent between adjacent counties. Since county fee-for-service costs were used to estimate county capitation rates, managed care payments reflected differences among counties and regions in fee-for-service utilization patterns and cost structures.

Although payments were 95 percent of the fee-for-service payments, studies by the HHS Office of the Inspector General, Government Accounting Office and others found there was significant evidence that Medicare paid more for beneficiaries in managed care than it would have paid if these same beneficiaries were in fee-for-service Medicare.

The factors used to adjust payments under the earlier methodology did not include any adjustment for an individual’s health status. But managed care enrollees tended to be somewhat healthier than individuals in fee-for-service Medicare and capitation rates were based on average fee-for-service costs. The 1997 annual report of the Physician Payment Review Commission (now the Medicare Payment Advisory Committee) said that using the "best available (risk adjustment) methods would solve some of Medicare’s risk-selection problems" and would allow the program to recoup "excess payments to managed-care plans."

The most significant changes Congress made in the BBA were to separate capitated Medicare payments from local fee-for-service rates and to use a methodology known as risk adjustment to pay plans more for treating sicker beneficiaries.

The Medicare+Choice program reduces the wide disparities in county capitation rates by bringing both high and low payment rates closer to the national average. The law bases payments for these rates on 1997 and mandates that the county payment rate is the greatest of three amounts:

Minimum 2 percent increase over the prior year's rates, which was meant to protect high payment areas as the medical education reductions and reductions in geographic disparities took effect.

Minimum amount or "floor" amount that increases rates in historically lower-rate counties where Medicare managed care plans generally have not been offered. Beginning in 1998, the BBA set the floor rate at $367; it is adjusted annually by the rate of growth of the overall Medicare program. In 2000 it is $415.

Blended amount that blends county and national rates, increasing rates in historically lower-rate counties while reducing rates in historically higher-rate counties. Each year, from 1998 to 2003, a greater percentage is based on the national rate, until a 50/50 blend is reached. The blend percentage for 2000 was 74 percent county and 26 percent national rates. The county rates reflect certain adjustments specified in the BBA. A national rate for each county is derived by adjusting the national rate by each county’s Medicare hospital wage index and geographic physician practice cost index.

Once the highest of the three rates is determined for each county, a budget neutrality adjustment is used to determine the final rates. This adjustment means that the total payments based on the minimum increase, the floor rate, and the blended rates must equal aggregate payments that would have been made if payments were based on area specific rates only. Only blended payment rates may be adjusted to account for budget neutrality requirements.

As in the earlier law, the BBA requires plans to compute whether their projected Medicare revenues, based on Medicare capitation payments, will be higher than the projected cost for providing basic Medicare services. If the revenues are higher than the costs, the plan must provide additional benefits at no additional cost to the enrollee. In 2000, Medicare+Choice plans are using more than 22 percent of their Medicare revenues to provide additional benefits that are not covered by Medicare, such as routine vision care, dental care and prescription drugs. While some plans have said their payments are not adequate to continue in Medicare, they have been able to provide the basic Medicare benefits and spend 22 percent of their Medicare revenue on additional benefits.

Beneficiary premiums and other charges, such as copayments, for Medicare-covered services may not exceed the national average fee-for-service beneficiary liability. For 2000, that amount is about $107 per month. Medicare+Choice plans may also offer additional benefits, such as prescription drugs, and may charge premiums and other copayments for those benefits. Thus, depending on the non-Medicare benefits that a plan offers, the Medicare law allows plans to charge beneficiary premiums that are over $100 per month.

The BBA requires HCFA to adjust county capitation rates based on the health status of plan enrollees. Risk adjustment was designed to allow payment amounts to reflect variations in per capita costs due to beneficiaries’ health status.

The risk adjustment system that incorporates health status, requires data from inpatient hospitals on the medical conditions of beneficiaries and is being phased in over a five-year period. Comprehensive risk adjustment will be in effect by 2004 and will use data from all sites of treatment, both inpatient and outpatient settings. Thus, the BBA envisioned use of a risk adjustment system based on data from inpatient hospitals initially, to be followed by use of a comprehensive methodology using data from outpatient sites of treatment. HCFA selected the Principal Inpatient Diagnostic Cost Group (PIP-DCG) model for implementation in January, 2000 and intends to implement a comprehensive risk adjustment method in 2004.

To assist managed care plans, HCFA took the added step of adding a transition period to provide a safeguard against abrupt changes in payments to Medicare+Choice organizations. The transition schedule stipulates a blend of payment amounts using rates based on the PIP-DCG risk adjustment methodology (see above) and rates based on the 1997 AAPCC demographic factors (see page 1).

Medicare+Choice organizations receive prospective monthly payments that are a blend of these two methodologies for all enrollees. Under the Balanced Budget Refinement Act of 1999, the transition to risk adjustment in 2001 will be based on a blend percentage of 10 percent risk adjusted payment and 90 percent based on the adjustment for demographic factors. Payments are scheduled to be 100 percent risk-based by 2004.

The President’s plan also assures that the government pays for the full geographic costs in high-cost areas B more than what would be paid under the BBA. Implementing competition among managed care plans would also enable Medicare to pay plans for their real costs of providing care in their local communities.

And, perhaps most importantly, managed care plans would be explicitly paid for providing a prescription drug benefit. They would no longer be dependent on what the rate is in an area to determine whether or not they can afford to offer a decent drug benefit to their enrollees. These changes would strengthen and stabilize the Medicare managed care market.

Finally, the President’s proposal dedicates 15 percent of the surplus - more than $370 billion dollars over 10 years - to extend the life of the trust fund and responsibly finance the prescription drug benefit. This will help keep Medicare on a sound foundation as the baby boom generation begins to retire.

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Fact Sheet Listing

Last Updated June 10, 2000