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Also, since medicare may be only a small portion of the plans’ business, the ability of the Government to impose limitations on executive salaries, which are indirect costs, is questionable.

Mr. Chairman, that concludes our statement. We will be happy to answer your questions.

Mr. STARK. Thank you very much.

Before we go on, I would like to introduce a gentleman who by his tardiness has elevated me to this lofty position of chairman this morning, the chairman of the Oversight Subcommittee, Mr. Vanik, and my distinguished colleague from New York, Congressman Rangel, who have joined us during your testimony.

Mr. VANIK. Mr. Stark, I want to point out that this is the first in a series of hearings that we plan on the administration of medicare.

I have asked our colleague, Mr. Stark, to chair this particular section dealing with the medicare administrative problems.

I want to commend our colleague, Mr. Stark, because he has already turned over things to the audit agency that have saved considerable sums of money for the medicare trust fund.

His special interest in these problems can be an instrument by which we can make medicare more effective and reduce some of the excessive costs.

I would say that our interests probably extend beyond certain luxury items, but these items are things that illustrate certain issues of public accountability and responsiveness which have been a longrange concern of the subcommittee.

I certainly want to support Mr. Stark in continuing in this matter of great interest, a matter which can be a great saving to the medicare trust fund and make the system more effective.

I will have some questions further on as the testimony develops. Mr. STARK. Mr. Rangel?

Mr. Rangel. Both my chairman and acting chairman, I would like to prepare some written questions concerning this most important matter and thank Mr. Stark for initiating this type of investigation which is of concern to most of the poor people in this country.

Mr. STARK. Certainly.

Without objection, some of the members may want to submit some written questions to you or all of the witnesses for inclusion in the record later.

We would appreciate your response to those.
Thank you, Mr. Rangel.
Thank you, gentlemen.

Our next witness will be Mr. Edward Stepnick who is Director of the HEW Audit Agency, accompaned by his staff.

Please identify your colleagues, Mr. Stepnick, and read your statement or summarize it and submit it for the record, whichever you prefer.

Thank you.



Mr. STEPNICK. Thank you, Mr. Chairman.

To my left is Mr. Larry Simms, who is the chief of our medicare audit branch, and to my right, with a name that is almost the same, Larry Simmons, his assistant.

Mr. STARK. To Mr. Simms and Mr. Simmons, welcome. You may proceed.

Mr. STEPNICK. Having two with similar names is not designed to confuse anyone. It is just the way it happened to come out.

I am pleased to have the opportunity to appear before the subcommittee to discuss our audits of administrative costs of medicare contractors.

From the inception of the medicare program, the HEW Audit Agency has audited the contractors, called intermediaries for hospital and other institutional reimbursement, and carrier for physician and other reimbursement, that participate as claims processing and paying agents under agreement with the Secretary, HEW.

Currently, there are 130 medicare contractors subject to our audits, including 74 Blue Cross organizations, 32 Blue Shield plans, 23 commercial insurance companies, and one State agency.

In fiscal year 1976 these organizations are estimated to have made payments of $16.8 billion for medical services provided beneficiaries and incur reimbursable costs of administration totaling $461 million.

Our audits of medicare contractors are generally performed on a 2- or 3-year cycle. Our audits include reviews of claims processing/ program activities and administrative costs.

For fiscal year 1976 our program reviews are focusing on selected functional operations. For example, with respect to the intermediaries we are reviewing the process by which provider costs reports are audited and settled and the effectiveness of procedures for recovering overpayments from both terminated and actively participating providers.

As to carriers, we are focusing on the adequacy of processing controls to prevent duplicate payment of claims; the propriety of reasonable charge payments to physicians and medical service suppliers; and the enforcement of certain special reimbursement/coverage limits.

Following the close of each contractor's fiscal year, an administrative cost report is submitted containing the claimed costs of administration.

This cost report and supporting data, after audit by the HEW Audit Agency, serve as the basis for final settlement by SSA of the contractor's allowable administrative costs.

In performing examinations of claimed administrative costs, HEW Audit Agency objectives are fivefold:

1. To determine whether the contractor has established effective systems of internal control, accounting and reporting for administrative costs incurred.

2. To ascertain whether the final cost report presents the costs of program administration allowable in accordance with part 1-15.2 of the Federal procurement regulations as interpreted and modified by the medicare agreements.

3. To ascertain whether the contractor has complied with contractual and intermediary manual requirements governing specific items of cost.

4. To identify the underlying causes of significant errors or problems noted and make recommendations for improvement.

5. To follow up on implementation, effectiveness, or corrective action recommended in prior reports.

Our medicare audit instructions require each examination to be sufficiently comprehensive to permit a determination that the audited cost report presents, in all material respects, only the allowable costs of administration.

Recurring examinations include, to the extent considered necessary, evaluations of the accounting system and related internal controls, and tests of the accounting records.

As is normally done in professional auditing generally, individual transactions are examined on a test basis to the extent considered necessary in the auditor's professional judgment.

Many factors influence this judgment, such as:

1. The effectiveness of internal control procedures for screening out unallowable costs.

2. The significance of the amounts. 3. The nature of the items charged.

4. The likelihood that an account or cost center may contain un allowable costs, unreasonable costs, or costs not benefitting the medicare program.

5. Prior audit findings.
6. The coverage and adequacy of SSA program reviews.
7. The extent of audit work performed by other auditors.

Because these factors vary from contractor to contractor the percentages of individual transactions examined during our audits likewise vary from contractor to contractor and we do not accumulate data on these percentages.

On all audits we verify that claimed expenses are supported by the books and records and make comparisons of claimed costs, in total and by line item, to approved budgets and the prior year cost report.

These overall checks are preliminary to the selection of accounts, cost accumulations, and allocation methods for detailed examination.

The administrative costs of intermediaries and carriers are reimbursed in accordance with the “Principles of Reimbursement for Administrative Costs" prescribed for the medicare program.

These cost principles are contained in the program regulations and in the agreements with the contractors. They are based on the Federal Procurement Regulations.

As the previous witness stated, these program principles are the criteria we use in our auditing to evaluate the allowability of claimed costs and on which we base any recommendations for financial adjustments.

Using our audit reports, SSA is responsible for final settlements with the contractors.

During fiscal years 1973 through 1976, the Audit Agency issued 283 audit reports on medicare contractors. In addition, to selected aspects of contractors' operations, the reports covered our examination of $1,031 million of contractors' administrative costs proposed for final reimbursement settlement.

Of this amount, we recommended net downward financial adjustments of $16.4 million.

Almost all of these reports either questioned costs or contained one or more recommendations for improving various aspects of the contractors' operations.

A summary by year of the costs audited, costs questioned, and the numbers of reports containing findings, is attached as Exhibit I to my statement. (Exhibit I follows:]


YEARS 1973-76
(Dollar amounts in millions)

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Mr. STEPNICK. It should be noted that, since costs questioned are subject to negotiation between SSA and the contractors, actual disallowances may be less. Also, determinations are still pending on many reports.

Mr. STARK. Where you have those pending, and they come up year after year where there is some question as to whether they use firstclass air travel or something like that, and a ruling is finally passed, I assume you will go back and collect.

Would you then apply that ruling to all the other intermediaries or do you handle them one at a time?

Mr. STEPNICK. To the extent that a general rule does emerge, then that rule would in effect govern future audits. Frequently, the settlements are based on negotiations individually with each contractor, and it is not that clear to us whether or not we can apply the situation generally.

So, we would in that case then repeat, if we had found the same mistake again.

Mr. STARK. Just take that one more step.
If your opinion, are the regulations that exist tight enough?


I know sometimes you can define regulations so complexly that people can beat the spirit of the law while adhering to the letter if they don't leave the auditor enough judgment.

Do you think that we could define in regulation this whole question of overhead allocation to make your job easier then and make it a little clearer, without unnecessarily hamstringing the intermediaries?

Mr. STEPNICK. I would guess that every time we attempted to pin something down and prescribe that, the danger is we might cure a specific problem but I am a little bit concerned in some areas, particularly in the allocation area, whether in the process wo would create three more.

Mr. Stark. You think using good judgment and aggressive auditing is probably a better way to control it, then? Mr. STEPNICK. Yes; but I would have to at the same time


that in the final analysis the judgments which have to be based on reasonableness are subjective and that this becomes quite frustrating to the auditor because he knows that, unless he can clearly show that something is unreasonable, he is likely to lose in the negotiation process.

So, I am ambivalent to that extent, sir.

Mr. STARK. Bank examining is much the same way. The only tool that the bank examiner has is to become a pest, to keep coming back and auditing till the management gets the idea.

Do the contractors pay for your audits?
Mr. STEPNICK. No, sir.
Mr. STARK. After two or three times does their audit bill go up?

Mr. STEPNICK. No. The contractors don't incur the cost of our audits.

Mr. STARK. Thank you.

Mr. STEPNICK. Most of the administrative costs we have questioned have been in two general categories: (1) Costs which are specifically unallowable under the applicable rules, and (2) inequitable and incorrect allocations of contractors' costs to the medicare program.

Some typical examples of unallowable costs questioned are occupancy costs in excess of prevailing fair rentals, entertainment expenses, first-class air fares in excess of lower rates, and travel for nonmedicare business.

Out of $6.1 million questioned in reports issued in fiscal year 1976, almost $1 million pertained to these four types of unallowable costs.

Occupancy costs were a predominant item, and with the trend toward new building construction by the contractors, we are giving this our particular attention.

Another cost item we have regarded as unallowable is referred to as "Premium Taxes".

Some States have enacted legislation providing for a tax on the gross insurance premiums collected from subscribers of nonprofit insurance carriers which had previously been tax exempt.

Typically, these carriers are Blue Cross and Blue Shield Plans. Mr. STARK. May I interrupt there?

In other words, while we grant these carriers exemption from Federal income tax, some of the States tax them as profitmaking associations; is that correct?

Mr. STEPNICK. This is in the guise of a franchise tax based on their gross commercial receipts.


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