BOSTON -- Massachusetts regulators are escalating their battle with HMOs over prescription drug benefits for retirees eligible for Medicare.

In the latest twist of a dispute that could have repercussions in other states, the Massachusetts Division of Insurance is launching a probe into Harvard Pilgrim Health Care's proposal to offer a scaled-back prescription drug benefit in 1999 to the roughly 60,000 retirees enrolled in its Medicare risk HMO.

Currently, Brookline, Mass.-based Harvard Pilgrim offers a risk HMO plan with an unlimited prescription drug benefit, with retirees paying a $71 monthly premium. It also offers a zero-premium plan with no drug benefits.

Next year, Harvard Pilgrim intends to offer, in most parts of the state, a zero-premium plan with an $800 annual limit on prescription drugs. To try to control costs, other risk HMOs in the state also intend to place dollar caps on plans that now offer unlimited prescription drug benefits (BI, Aug. 24).

This change, Harvard Pilgrim told its members, would mean cost savings for most members. Take the example of a retiree now in the unlimited prescription drug plan. That retiree now pays $852 a year in premiums. If the retiree this year had prescription drug costs of $800, that retiree's total cost for prescription drugs still would be the $852 premium.

Under the new zero-premium program, if that retiree had $800 in prescription drug costs in 1999, his or her total cost would be zero, as the plan's prescription drug limit is $800.

Such a plan would fit the HMO's goal of finding the right balance between premium costs and out-of-pocket costs for members, said Alan Raymond, Harvard Pilgrim's vp-public affairs.

But Gov. Paul Cellucci this month instructed the Division of Insurance, which regulates HMOs, to open a full investigation of Harvard Pilgrim's proposal to cap prescription drug benefits in its Medicare risk HMO.

"Thousands depend on these drug benefits, and I will not allow these companies to take advantage of our seniors. We will keep fighting to ensure that our seniors get the drug benefits they deserve," Gov. Cellucci said.

Gov. Celluci, who is completing the term of William Weld, who resigned to seek an ambassadorship, is running for re-election in November.

Harvard Pilgrim's Mr. Raymond said the Insurance Division has requested information about its proposed benefit changes for next year, and that Harvard Pilgrim will cooperate fully with the division.

"This will, most likely, need to be resolved by either a federal or state judge. Our primary interest is to get this resolved as quickly as possible," Mr. Raymond said.

A spokesman for the Division of Insurance said the probe could be a prelude to litigation. "HMOs need to be in compliance with the law," the spokesman added.

The Massachusetts controversy involves the interaction of both state and federal laws and regulations.

Under a 1994 Massachusetts law and later regulations, HMOs and other health insurers must provide either unlimited or no prescription drug coverage in plans they offer retirees eligible for Medicare.

But HMOs say the 1997 federal Balanced Budget Act pre-empts state laws affecting private plans -- known as Medicare + Choice -- that contract with the Health Care Financing Administration to provide coverage to retirees opting out of the traditional Medicare program.

That interpretation is backed by HCFA Administrator Nancy-Ann DeParle, who says the 1997 federal law pre-empts states from specifying what must be included as a federal Medicare benefit (BI, Sept. 7).

The outcome of the Massachusetts' prescription drug controversy could have implications beyond that state. If Massachusetts regulators are successful in enforcing the state's prescription drug benefit mandate, that could be a signal to other states to mandate benefits -- at substantially higher cost -- for HMOs and other health care plans that cover retired workers opting out of Medicare and into their own plans.

The Massachusetts controversy currently affects only individual policies that HMOs offer to retired workers who have opted out of the traditional Medicare program and receive coverage through "Medicare risk HMOs."

Massachusetts regulators have not tried to order Medicare risk HMOs to comply with the prescription drug benefit mandate for coverage negotiated by employers for retired workers, believing it is beyond their authority.

But employers could feel the impact of state mandates on risk HMOs and other plans at the end of next year, when the Balanced Budget Act giving retirees new private market alternatives to Medicare fully goes into effect.

With more private market alternatives to the traditional Medicare program almost certain to develop, more employers are likely to drop their own plans and reimburse retirees for all or a portion of those plans' premiums.

But if Medicare alternative plans are loaded down with expensive state mandates, that could increase costs for employers that drop their supplemental plans in favor of subsidizing Medicare risk HMOs for retirees.