Legislative Analyst's Office Analysis of the 2002-03 Budget Bill

California Medical Assistance Program (4260)

In California, the federal Medicaid Program is administered by the state as the California Medical Assistance Program (Medi-Cal). This program provides health care services to welfare recipients and other qualified low-income persons (primarily families with children and the aged, blind, or disabled). Expenditures for medical benefits are shared about equally by the General Fund and by federal funds. The Medi-Cal budget also includes additional federal funds for (1) disproportionate share hospital (DSH) payments, which provide additional funds to hospitals that serve a disproportionate number of Medi-Cal or other low-income patients, and (2) matching funds for state and local funds in other related programs.

At the state level, the Department of Health Services (DHS) administers the Medi-Cal Program. Other state agencies, including the California Medical Assistance Commission, the Department of Social Services, the Department of Mental Health, the Department of Developmental Services, the California Department of Aging, and the Department of Alcohol and Drug Programs receive Medi-Cal funding from DHS for eligible services that they provide to Medi-Cal beneficiaries. At the local level, county welfare departments determine the eligibility of applicants for Medi-Cal and are reimbursed by DHS for the cost of those activities. The federal Centers for Medicare and Medicaid Services (formerly known as the Health Care Financing Administration) oversees the program to ensure compliance with federal law.

Proposed Spending. The budget for DHS proposes Medi-Cal expenditures totaling $27.2 billion from all funds for state operations and local assistance in 2002-03. The General Fund portion of this spending ($10.2 billion) increases by $367.3 million, or 4 percent, compared with estimated General Fund spending in the current year. The remaining expenditures for the program are mostly federal funds ($15.2 billion) or 1 percent less than the federal funds estimated to be received in the current year.

The Governor's spending plan assumes that the state will receive $400 million in federal funds in the current fiscal year to offset a projected decrease in the federal cost-sharing ratio (Federal Medicaid Assistance Percentage [FMAP]) for the state's Medicaid payments. The FMAP is based on per-capita income and revised by the federal government each year. In the budget year this decrease in the federal sharing ratio would require an increase in state funding of $174 million from the General Fund for the Medi-Cal Program. The impact of the FMAP change on other state departments in the budget year is estimated to be $48.2 million. The budget plan does not indicate how this $400 million in anticipated relief would be allocated among the different health programs.

The spending total for the Medi-Cal budget includes an estimated $1.8 billion (federal funds and local matching funds) for payments to DSH hospitals, and about $3.5 billion budgeted elsewhere for programs operated by other departments, counties, and the University of California.

Medi-Cal Benefits and Eligibility

What Benefits Does Medi-Cal Provide?

Federal law requires the Medi-Cal Program to provide a core of basic services, including hospital inpatient and outpatient care, skilled nursing care, doctor visits, laboratory tests and x-rays, family planning, and regular examinations for children under the age of 21. California also has chosen to offer 34 optional services, such as outpatient drugs and adult dental care, for which the federal government provides matching funds. Certain Medi-Cal services--such as hospitalization in many circumstances--require prior authorization from DHS as medically necessary in order to qualify for payment.

How Medi-Cal Works

Based on recent caseload information, half (51 percent) of the Medi-Cal caseload consists of participants in the state's two major welfare programs, which include Medi-Cal coverage in their package of benefits. These programs are (1) the California Work Opportunity and Responsibility to Kids (CalWORKs) program, which provides assistance to fami lies with children and replaces the former Aid to Families with Dependent Children program, and (2) the Supplemental Security Income/State Supplementary Program (SSI/SSP), which assists elderly, blind, or disabled persons. Counties administer the CalWORKs program through county welfare offices which determine eligibility for CalWORKs benefits and Medi-Cal coverage concurrently. Counties also determine Medi-Cal eligibility for persons who are not eligible for (or do not wish) welfare benefits. The federal Social Security Administration determines eligibility for SSI/SSP, and the state automatically adds SSI/SSP beneficiaries to the Medi-Cal rolls.

Generally, persons who have been determined eligible for Medi-Cal benefits (Medi-Cal "eligibles") receive a Medi-Cal card, which they use to obtain services from providers who agree to accept Medi-Cal patients. Medi-Cal provides health care through two basic types of arrangements--fee-for-service and managed care.

Fee-for-Service. This is the traditional arrangement for health care in which providers are paid for each examination, procedure, or other service that they furnish. Beneficiaries generally may obtain services from any provider who has agreed to accept Medi-Cal payments. The Medi-Cal Program employs a variety of "utilization control" techniques (such as requiring prior authorization for some services) designed to avoid costs for medically unnecessary or duplicative services.

Managed Care. Prepaid health plans generally provide managed care. The plans receive monthly "capitation" payments from the Medi-Cal Program for each enrollee in return for providing all of the covered care needed by those enrollees. These plans are similar to health plans offered by many public and private employers. More than half (2.9 million of the total of 5.6 million Medi-Cal eligibles in August 2001) are enrolled in managed care organizations. Beneficiaries in managed care choose a plan and then must use providers in that plan for most services. Since payments to the plan do not vary with the amount of service provided, there is much less need for utilization control by the state. Instead, plans must be monitored to ensure that they provide adequate care to enrollees.

Who Is Eligible for Medi-Cal?

Almost all Medi-Cal eligibles fall into two broad groups of people. They either are aged, blind, or disabled or they are in families with children. More than half of Medi-Cal eligibles are welfare recipients. Figure 1 shows for each of the major Medi-Cal eligibility categories, the maximum income limit for eligibility for health benefits and the estimated caseload and total benefit costs for 2001-02. The figure also indicates, for each category, whether an asset limit applies and whether eligible persons with incomes over the limit can participate on a "spend down" basis. If spend down is allowed, then Medi-Cal will pay the portion of any qualifying medical expenses that exceed the person's "share-of-cost," which is the amount by which that person's income exceeds the applicable Medi-Cal income limit.

Aged, Blind, or Disabled Persons. About 1.4 million low-income persons who are (1) at least 65 years old or (2) disabled or blind persons of any age receive Medi-Cal coverage--about 23 percent of the estimated total Medi-Cal caseload for the current year. Overall, the disabled make up more than half (61 percent) of this portion of the Medi-Cal caseload. Most of the aged, blind, or disabled persons on Medi-Cal (83 percent) are recipients of SSI/SSP benefits and receive Medi-Cal coverage automatically.

The other aged, blind, or disabled eligibles are in the "medically needy" category. They also have low incomes, but do not qualify for, or choose not to participate in SSI/SSP. For example, aged low-income noncitizens generally may not apply for SSI/SSP (although they may continue on SSI/SSP if they already were in the program as of August 22, 1996). As another example, some of the medically needy persons in this category have incomes above the Medi-Cal limit and participate on a share-of-cost basis.

Included in the number of eligibles in the "medically needy" category are aged and disabled persons with incomes up to 133 percent of the poverty level. Beginning January 1, 2001, these persons could receive Medi-Cal coverage without a share-of-cost.

The number of Medi-Cal eligibles in long-term care is small--only 66,900 people, or 1 percent of the total caseload. Because long-term care is very expensive, benefit costs for this group total $2.8 billion, or 14 percent of total Medi-Cal benefit costs.

Almost 60 percent of the aged or disabled Medi-Cal eligibles also have health coverage under the federal Medicare Program. Medi-Cal generally pays the Medicare premiums, deductibles, and any copayments for these "dual beneficiaries," and Medi-Cal pays for services not covered by Medicare, such as drugs and long-term care. Medi-Cal also provides some limited assistance to a small number of Medicare eligibles who have incomes somewhat higher than the medically needy standard.

Families with Children. Medi-Cal provides coverage to families with children in three eligibility categories. The first two categories were created by Section 1931(b) of the Social Security Act, which required states to grant Medicaid eligibility to anyone who would have been eligible for cash-assistance under the welfare requirements in place on July 16, 1996. One of these categories consists of CalWORKs welfare recipients who automatically receive Medi-Cal. The second category--referred to as the 1931(b)-only group--consists of families who are eligible for CalWORKs, but who choose only to receive Medi-Cal services. The income limit for families in this second category is 100 percent of the federal poverty level (FPL). However, once enrolled in Section 1931(b) coverage, families may work and remain on Medi-Cal at higher income levels (up to about 155 percent of the FPL indefinitely, or a higher amount for up to two years).

A third eligibility category referred to as the medically needy, consists of families who do not qualify for CalWORKs, but nevertheless have relatively low incomes. These families have incomes up to 80 percent of the FPL, have less than $3,300 in assets, and meet additional requirements. Families whose incomes are above the medically needy limits, but who meet all of the other medically needy qualifications, may receive Medi-Cal benefits on a share-of-cost basis.

About 27 percent of all Medi-Cal eligibles are CalWORKs welfare recipients. Although CalWORKs recipients constitute the largest single group of Medi-Cal eligibles by far, they account for only 17 percent of total Medi-Cal benefit costs. This is because almost all CalWORKs recipients are children or able-bodied working-age adults, who generally are relatively healthy. Similarly, 1931(b)-only and medically needy families who are Medi-Cal eligible account for 39 percent of all Medi-Cal eligibles and only 15 percent of total benefit costs.

Women and Children. Medi-Cal includes a number of additional eligibility categories for pregnant women and for children. Medi-Cal covers all health care services for poor pregnant women in the medically indigent category, which has the same income and asset limits and spend-down provisions as apply to medically needy families. However, pregnancy-related care is covered with no share-of-cost and no limit on assets for women with family incomes up to 200 percent of the FPL (an annual income of $35,300 for a family of four).

The medically indigent category also covers children and young adults under age 21. Several special categories provide coverage without a share-of-cost or an asset limit to children in families with higher incomes--200 percent of the FPL for infants, 133 percent of the FPL for children ages 1 through 5, and 100 percent of the FPL for children ages 6 through 18. Pregnant women and the FPL-group children also may use a simplified mail-in application to apply for Medi-Cal or Healthy Families Program coverage (for children above the Medi-Cal income limits). Medi-Cal also provides family planning services for women or men with income up to 200 percent of FPL who do not qualify for regular Medi-Cal.

Emergency-Only Medi-Cal. Noncitizens who are undocumented immigrants, or are otherwise not qualified immigrants under federal law, may apply for Medi-Cal coverage in any of the regular categories. However, benefits are restricted to emergency care (including labor and delivery). Medi-Cal also provides prenatal care and long-term care to undocumented immigrants. These services, as well as nonemergency services for recent legal immigrants, do not qualify for federal funds and are supported entirely by the General Fund.

Most Medi-Cal Spending Is For the Elderly or Disabled

The average cost per eligible for the aged and disabled Medi-Cal caseload (including long-term care) is much higher than the average cost per eligible for families and children on Medi-Cal. As a result, almost two-thirds of Medi-Cal spending is for the elderly and disabled, although they account for only about one-fourth of the total Medi-Cal caseload, as shown in Figure 2.

Medi-Cal Expenditures

Moderate Overall Spending Growth in the Current Year

Figure 3 presents a summary of Medi-Cal General Fund expenditures in the DHS budget for the past, current, and budget years.

The budget estimates that for the current year the General Fund share of Medi-Cal local assistance costs will increase by about $537 million (5.9 percent), compared with 2000-01. The bulk of this increase is for benefit costs, which will total an estimated $9.1 billion in 2001-02. Other local assistance costs will also increase in the current year compared with 2000-01. For example, county administrative costs for eligibility determinations will go up about $80 million (about 20 percent) and costs related to claims processing by the fiscal intermediary will increase by about $18 million (about 22 percent).

Caseload Increase Reflects Eligibility Expansions and Simplification. Most of the $537 million increase in benefit costs will accommodate an estimated additional 900,000 Medi-Cal eligibles, about a 17 percent increase over the prior year. The major factors driving the caseload growth are policy decisions to simplify enrollment procedures. This includes decisions to provide continuous eligibility for medical benefits to children 19 years of age and younger and persons leaving the CalWORKs program, as well as the elimination of the quarterly status reports.

Caseloads are also growing because of the prior decision to expand eligibility for families with children in the so-called 1931(b) category with income at or below 100 percent of the FPL, as well as the decision to provide Medi-Cal benefits without a share-of-cost to aged, blind, and disabled persons with current income equivalent to 133 percent of FPL or less. The budget pays for these two program expansions from the Tobacco Settlement Fund in the current year.

Settlement of Hospital Litigation. The settlement of a ten-year-old lawsuit (Orthopaedic Hospital v. Belshe') and other related lawsuits over the amount Medi-Cal pays for hospital outpatient services was originally proposed to be paid in 2000-01. However, the settlement was not paid at that time because of a delay in federal approval of the retroactive portion of the settlement. Final agreement is now expected to be reached in the current fiscal year, which would increase expenditures in that period by $255 million General Fund. The settlement provides for a lump-sum payment of $350 million ($175 million General Fund) for retroactive payments and $80 million General Fund for 30 percent rate increases. Under the agreement, rates are to be increased 3.3 percent annually in the following three years.

Other Costs Increasing Current-Year Expenditures. The remainder of the cost increase reflects items funded in the 2001-02 Budget Act to provide a state contribution of $24 million annually to the Los Angeles Medicaid Demonstration Project, rate increases for nursing facilities, and supplemental reimbursements of about $7 million from the General Fund for freestanding long-term care facilities.

General Fund Deficiency in 2001-02$54 Million

The Governor's budget proposes a net increase in Medi-Cal spending of $54 million above the levels anticipated in the 2001-02 Budget Act. This is primarily because DHS has determined that savings the Legislature included in the 2001-02 budget cannot accrue to the current fiscal year--specifically, anticipated savings of about $24 million for the collection of drug rates and $25 million for antifraud savings. In addition, the fiscal intermediary's costs are expected to increase by $5.5 million for the inclusion of half-year costs for the implementation of the Health Insurance Portability and Accountability Act (HIPAA) that were previously budgeted in the HIPAA Fund Item 9909.

The net cost of the deficiency is projected to be $54 million because there are also some savings from new proposals that partly offset additional costs that would be increases in the Medi-Cal Program in the cur rent year. For example, effective October 1, 2001, Medi-Cal has begun covering the cost of tests that allow for the early detection of preterm labor. The DHS anticipates that this will save $18 million General Fund in the current year (and also result in full-year savings of $24 million General Fund in 2002-03).

Budget-Year Expenditure Growth

The Governor's proposed budget estimates that total General Fund spending for Medi-Cal local assistance will be $10.1 billion in 2002-03, an increase of $367 million, or 3.8 percent, above the estimated spending in the current year. If $400 million in financial relief were provided by the federal government--as assumed under the Governor's budget plan--and the Medi-Cal Program received $174 million of that sum, the year-to-year growth in Medi-Cal expenditures would be $541 million or 5.7 percent rather than the smaller increase shown in Figure 3. The budget estimates that the Medi-Cal caseload will increase by 300,000 (about 5 percent) in 2002-03 to a total of almost 6.5 million average monthly eligibles--roughly 18 percent of the state's population. Most of the added spending in 2002-03 is for benefit costs. General Fund costs for Medi-Cal benefits would increase by $338 million (nearly 4 percent) in 2002-03. Figure 4 shows the major components of the change in benefit costs, which we discuss below.

Increased Utilization and Cost-of-Services. The increase in Medi-Cal benefit costs in the budget year is due in large part to higher costs for drugs. This includes price and utilization increases of about $230 million for existing drugs and for new drugs added to the Medi-Cal formulary. These costs are partly offset by rebates of about $61 million obtained through the ongoing drug-rebate program.

Medi-Cal "buy-in" payments for Medicare premiums also are increasing. Medi-Cal pays Medicare premiums for Medi-Cal enrollees who also are eligible for Medicare (dual eligibles) in order to obtain 100 percent federal funding for those services covered by Medicare. The budget estimates that the General Fund cost of these buy-in payments will increase by $52 million in 2002-03. The budget also projects a $5 million increase in the monthly premium that the Medi-Cal Program pays to health maintenance organizations that have enrolled beneficiaries eligible for both the Medi-Cal and Medicare programs.

Caseload Increases. The $42 million in caseload-related cost increases is primarily due to two components--previous eligibility expansions for the working poor and the aged, blind, and disabled. 

First, the phase-in of the program to expand 1931(b) eligibility to cover both children and parents in families with incomes at or below 100 percent of the FPL was initially slower than anticipated, but the caseload growth is now expected to eventually exceed the original estimates. Continuing caseload growth in this eligibility group is expected to increase General Fund costs by $22 million. 

Second, legislation enacted in 2000 expanded Medi-Cal benefits for aged, blind, and disabled persons. Effective January 2001, Medi-Cal benefits are being provided without a share-of-cost to all aged, blind, and disabled persons with current income equivalent to 133 percent of the FPL or less. The approximately $20 million increase in the budget year for this eligibility group is due to continued growth in the number of persons over age 65 applying for this program.

Past and present simplifications in the eligibility process are anticipated to further increase the caseload in the budget year and result in additional costs of about $35 million to the General Fund. This includes an increase of about $21 million to fund additional caseload increases from implementation of continuous eligibility to children 19 years of age and younger, and $9.6 million for caseload increases resulting from eliminating quarterly status reporting requirements for parents--both effective January 1, 2001. In addition, under the provisions of the Healthy Families parental expansion waiver, children applying for Medi-Cal through the so-called single point of entry will be eligible for accelerated eligibility at an increased General Fund cost of $4.1 million.

About $21 million in caseload growth is expected to result from the implementation of Chapter 894, Statutes of 2001 (AB 59, Cedillo) and Chapter 897, Statutes of 2001 (SB 493, Sher) in July 2002. Chapter 894 establishes "Express Lane Eligibility" for children by deeming that any child enrolled in the National School Lunch Program has met the eligibility requirements for the Medi-Cal Program. Both new laws require county welfare departments to provide notices regarding Medi-Cal to persons applying for nonassistance food stamps.

Pass-Through Funding for Other Departments and Programs. Costs are expected to increase for some of the health programs that are funded by Medi-Cal but are administered by other state departments. The cost of mental health services administered under the Department of Mental Health, including services provided to children under the Early and Periodic Screening, Diagnosis, and Treatment Program, are expected to increase about $85 million. In addition, costs for the Multipurpose Senior Services Program and the Adult Day Health Care Program are expected to go up by $34 million because of an increase in the number of providers and allowable patients per site.

Changes in Payments. Each year, the federal government calculates its cost-sharing ratio for each state's Medicaid program. This sharing-ratio referred to as the FMAP is based on per-capita income. The budget assumes that in October 2002, the federal sharing ratio will decrease due to recalculations of per-capita income based on the 2000 Census. This will result in a General Fund increase of $174 million to replace the lost federal funding. As noted earlier, the Governor's budget assumes that the federal government will provide, in the current year, a lump-sum payment of $400 million to offset the effect of the FMAP decline on Medi-Cal and other affected health programs.

New Proposals to Reduce Costs. The budget contains a number of steps anticipated to produce Medi-Cal savings. About $100 million in General Fund savings would be captured through strategies to reduce drug costs, including:

• Negotiation of contracts with generic drug manufacturers that include a rebate (estimated $27 million savings).
• Ensuring that the Medi-Cal list of approved antipsychotic and antiinflammatory drugs includes the most cost-effective drugs without compromising patient needs (estimated $23 million savings).
• Negotiation of contracts that include a rebate for nutritional products (estimated $9 million savings) and a reduction of pharmacy reimbursement for these products (estimated $11 million savings).
• Negotiation with medical supply manufacturers of blood glucose strips to obtain a lower price (estimated $9 million savings).
• Monitoring the number and types of prescriptions filled by beneficiaries to identify patterns of misuse (estimated $8 million savings).
• Negotiation with manufacturers of AIDS and cancer drug suppliers to obtain rebates (estimated $7 million savings).
• Addressing the existing backlog of drug rebate contract disputes (estimated $7 million savings).

Sixteen additional positions and four contract staff are proposed to be added to the Medi-Cal Drug program at a cost of $2 million ($634,000 General Fund) to achieve these savings.

The budget plan also reduces the rates paid to selected providers of medical services for adults by $78 million. The reductions target the ser vices that had received rate increases in 2000-01 and are allocated in such a manner to leave intact the rate increases for providers of children's services and long-term care services. The budget also proposes to impose copayments on adult patients receiving specific Medi-Cal outpatient services and reduce the provider rates for these services by the copayment amounts for estimated savings of $31 million General Fund. Under this proposal, copayments will not be required for some services such as those for individuals under 18, women receiving pregnancy services, and emergency services. In addition, a $55 million savings would result from replacing General Fund resources with an increase in the state's "takeout" from the DSH state administrative fee. These reduction proposals will be discussed in more detail later in this Analysis.

Medi-Cal Cost and Caseload Trends

Figure 5 illustrates how Medi-Cal caseload and per-eligible costs have changed since 1992-93, along with projections of these measures for 2001-02 and 2002-03 based on the budget estimates.

Budget Forecasts Continued Caseload Growth and Dropping Costs

The budget projects that in the current year the number of eligibles will grow and the cost of benefits per eligible will decline. This trend is projected to continue in the budget year.

Caseload. Between 1992-93 and 1995-96, the Medi-Cal average monthly caseload grew from 5 million eligibles to 5.5 million eligibles. The Medi-Cal caseload subsequently leveled off, and then dropped by almost 300,000 eligibles (5.4 percent) in 1997-98. The change in the Medi-Cal caseload roughly paralleled changes in the CalWORKs welfare caseload. Caseload began a sharp drop at that time in response to the turnaround in the state's economy, and greater emphasis on moving families from welfare-to-work in the wake of the enactment of state and federal welfare reform legislation. Another factor contributing to declining welfare and Medi-Cal caseloads was probably the reluctance among immigrant Californians to make use of public benefits because of concerns about whether such use might adversely affect their ability to naturalize or to sponsor the immigration of family members in the future.

From 1997-98 through 1999-00, the Medi-Cal caseload remained relatively flat even though the CalWORKs caseload continued to decline. The Medi-Cal caseload did not decline during this period primarily because of the backlog of eligibility determinations for former CalWORKs recipients that resulted from the delay in implementation of Section 1931(b) Medi-Cal eligibility by DHS and the counties. In the current year and 2002-03, the budget estimates that the Medi-Cal caseload will grow once more, primarily due to a variety of eligibility expansions and simplified eligibility processes.

Cost Per Eligible. While the caseload has gone up and down, the cost trend per eligible had been almost steadily upward until 2000-01. The average annual growth rate of the estimated cost of benefits per eligible (excluding pass-through funding to other departments and local governments) is 4 percent during the period of 1992-93 through 2002-03, which is twice the rate of general inflation during this period, as measured by the Gross Domestic Product deflator.

The temporary dip in the cost per eligible that occurred in 1994-95 and 1995-96 was partly the result of a change in the caseload mix, rather than an underlying drop in health care costs. This is because the rapid increase in the number of families on welfare (whose health care costs are relatively low) temporarily reduced the proportion of aged and disabled persons (relatively high-cost groups) in the Medi-Cal caseload, and this change in the mix tended to reduce the average cost per eligible. As the CalWORKs welfare caseload subsequently fell, the elderly and disabled share of the Medi-Cal caseload returned to its earlier level of about 26 percent, and the cost per eligible resumed its growth in 1996-97. Between 1996-97 and 2000-01 the average annual estimated cost per eligible increased by 8 percent.

Based on the Governor's budget, these costs would decrease by 7 percent in the current year and further decrease by 2 percent in the budget year. The turnaround in the trend seen in 2001-02 and 2002-03 appears to be the result of an increase in the number of healthy beneficiaries rather than a decrease in health care costs. The simplification that has occurred in the eligibility process means that the Medi-Cal Program probably is retaining a greater number of children and families on its caseload who do not regularly need health care services. In the past, these individuals might not have submitted quarterly status reports because they did not need health care services at that time and, as a result, they were dropped from Medi-Cal coverage. These individuals would probably reenroll later when they needed health care services. With continuous eligibility, these individuals are much less likely to leave the program. Therefore, the Medi-Cal caseload increase will include a larger segment of the population that is healthy, resulting in fewer additional program costs compared to other beneficiaries, such as the aged, blind, and disabled.

Overall Caseload Estimate Reasonable

We find that the budget's overall estimate for the Medi-Cal caseload is reasonable. We will monitor caseload trends and recommend appropriate adjustments at the time of the May Revision.

Figure 6 shows the budget's forecast for the Medi-Cal caseload in the current year and 2002-03. The majority of the projected Medi-Cal caseload growth consists of families and children. The budget estimates that the caseload for this group will increase by 22 percent in the current year and about 6 percent in the budget year. Nonwelfare families account for most of the projected increase in Medi-Cal eligible families and children. The budget estimates that the caseload of Medi-Cal eligible nonwelfare families will increase by about 59 percent in the current year, and an additional 11 percent in the budget year. While the projected growth is significant, our analysis found that recent caseload estimates by DHS have tracked caseload growth fairly closely.

The projected caseload increase for the families and children caseload is primarily the result of the implementation of new continuous eligibility rules for children, elimination of the quarterly status reporting requirements for adults, and growth in the 1931(b) program. Some additional growth in this caseload is the result of the elimination of the Childhood Health and Disability Prevention program which the Governor's budget projects will add 54,000 eligibles to the Medi-Cal Program.

Caseloads for the aged, blind, and disabled are expected to grow by about 55,000 in the current year and 30,000 in the budget year. This budget forecast also appears reasonable, given the recent expansions of eligibility for this group and recent caseload trends.

Major Uncertainty: The Economy. It is highly uncertain at this time whether the caseload trends will be sustained. There are a number of factors that could result in higher caseloads as well as factors that could produce lower caseloads. The biggest single factor contributing to this uncertainty is the current economic downturn. This is the first significant recession since the expansion and simplification of eligibility in the Medi-Cal Program and federal welfare reform in 1996. It is possible that a number of the individuals who may have recently become unemployed as a result of the recession are already enrolled in Medi-Cal. Although such individuals and their families would shift between Medi-Cal eligibility categories, their impact on overall Medi-Cal caseload and costs would be minimal. Alternatively, children of newly unemployed persons who were not on Medi-Cal previously may now enroll instead in the Healthy Families program.

Potential Risks to Accuracy of Caseload Projections and Cost Estimates. The accuracy of the department's caseload projections and cost estimates are also dependent upon a number of other more general factors. Among the factors that could cause the Medi-Cal program's caseload and cost to vary from the projections are:

• Federal actions such as a federal minimum wage rate increase or the enactment of laws expanding Medi-Cal eligibility and benefits.
• Further changes in state laws and regulations adopted by the Legislature and the Governor or through the initiative process. For example, pursuant to legislation, regulations setting new minimum nurse-to-patient staffing ratios are likely to be finalized this year that could affect hospital and managed care rates. Also, the state minimum wage was increased in January 2002.
• Effect of the Governor's Budget Proposals. The Governor's proposal to impose copayments on beneficiaries for the use of certain medical services could reduce utilization of those services (for example, requiring copayments for services in nongovernment health care plans has reduced the use of some services) and further increase the estimated savings. The proposal to reduce funding for media campaigns and other outreach activities for the Medi-Cal and Healthy Families Programs could minimize caseload growth.

In summary, we do not recommend a specific budget adjustment at this time because we believe that there is both upside and downside risk to the caseload estimate. That is because it is not yet clear whether the economic downturn will significantly impact the Medi-Cal caseload. Accordingly, we will continue to monitor the Medi-Cal caseload trends and recommend appropriate adjustments at the time of the May Revision.

Assessing the Governor's Budget Reduction Proposals

Assumption on Federal Relief is Risky

The Governor's budget assumes that federal legislation will be enacted to provide California with an additional $400 million in federal funds to offset the cost of medical services. However, there is a significant risk that the state will receive only some or none of the anticipated federal relief. We recommend that the Legislature closely monitor the prospects of a federal stimulus package that offers Medicaid relief and consider other ways to achieve savings if these funds are not forthcoming.

The Governor's Proposal. As we discussed earlier, the federal cost-sharing ratio for the Medi-Cal Program will decrease in the budget year and 2003-04. The Governor's budget assumes the enactment of federal legislation that would provide California with an additional $400 million in federal funds in the current year to offset the cost of medical services--in effect, a 2 percent increase in the federal cost-sharing ratio in the current year. The Department of Finance estimates the FMAP decrease would otherwise result in cost increases of $222 million in the budget year in the various departments that provide services to Medi-Cal eligibles, as shown in Figure 7. Notably, while the majority of the impact of the FMAP shift actually occurs in the budget year and 2003-04, the Governor's budget assumes that the federal relief will be provided in the current year.

State Medicaid Matching Rates and Federal Relief. Other states, like California, are experiencing a reduction in their federal Medicaid matching rates and are seeking relief from Congress in order to avoid reductions in coverage and benefits for Medicaid recipients. One estimate of the potential impact of the FMAP reduction on California will be a loss of several hundreds of millions of dollars in the federal fiscal year 2003 (October 2002 to September 2003).

Several ways to provide federal relief have been under consideration. For example, a federal stimulus package proposed last fall included $1.4 billion in relief nationwide to boost the federal match to states' Medicaid programs. Others have proposed that the relief could take the form of an across-the-board short-term 1 percent increase in the FMAP rate. Raising the FMAP by 1 percent would increase California's federal Medicaid funding by $292 million. A number of other approaches to the provision of federal relief are possible. For example, the National Governor's Association has proposed that the federal government could hold states harmless for the decrease for half of the 2002 federal fiscal year. Relief could be targeted to states with high unemployment or higher percentages of nonelderly, nondisabled adults and children--the persons most likely to suffer from higher unemployment.

However, at the time this analysis was prepared, there were few public indications that Congress would approve any version of an economic stimulus package or federal relief related to changes in the FMAP. Given this situation, the prospects for substantial federal relief that will benefit California are highly uncertain.

Analyst's Recommendation. We recommend that the Legislature closely monitor federal activity and gauge the likelihood of federal relief for changes in the federal Medicaid matching rate. Because the receipt of federal relief is highly uncertain, we recommend that the Legislature consider other ways to help close the state's budget gap if these funds are not forthcoming. Our office has offered other budget reduction options in a separate report.

Provider Rate Reductions Could Reduce Access to Care

We recommend that the Legislature not adopt the Governor's proposal to cut provider rates by $78 million General Fund because Medi-Cal rates are generally so low that further reductions might reduce patient access to care. There are other, better options the Legislature could consider to reduce General Fund expenditures for the Medi-Cal Program. We further recommend the Legislature require the Department of Health Services to establish a rational rate-setting process for fee-for-service provider rates so that the state can ensure reasonable access in the future to health care services. (Increase Item 4260-101-0001 by $78 million and Item 4260-101-0890 by $78 million.)

Background. The Medi-Cal Program will spend an estimated $1.1 billion ($500 million General Fund) during 2001-02 for physician services in the traditional "fee-for-service" portion of the program in which providers are paid for each examination, procedure, or other service that they furnish. In addition, a significant portion of the estimated $4.6 billion ($2.2 billion General Fund) in premiums that Medi-Cal provides to health plans for beneficiaries in managed care indirectly pays for physician services. About half of the persons eligible for Medi-Cal are enrolled in managed care organizations while the remainder receive services under the fee-for-service portion of the program.

Proposed Rate Reductions Partially Roll Back Recent Increases. The 2000-01 Budget Act included provider rate increases for a variety of medical services totaling approximately $800 million ($403 million General Fund). These substantial increases in rates generally targeted services for which Medi-Cal physician rates were relatively low in comparison to the Medicare Program (as well as private purchasers of health care). The 2000-01 budget increased payments for long-term care services by 10 percent, increased rates for medical procedures performed by physicians by 16.7 percent, and various other rates increased from 7 percent to 250 percent. The amount paid to managed care plans for the services they provide was adjusted to reflect these increases. These were the first across-the-board rate increases in the Medi-Cal Program since 1985-86.

The Governor's budget proposes provider rate reductions of $155 million ($78 million General Fund). The proposed rate reductions which are summarized in Figure 8 represent the overall savings that would occur in each service category and, thus, assume savings both from fee-for-service and managed care providers. The actual percentage rate reductions for specific services within each service category has not yet been determined by DHS. For example, DHS could reduce the rate physicians are paid for adult office visits, but not change the amount paid for children's examinations. The Administration has indicated that it intends to restore funding for provider rates when the state's fiscal condition improves.

According to DHS, the proposed rate reductions would generally minimize the impact to providers that serve children and long-term care patients. The DHS has indicated that it plans to convene stakeholder meetings in 2002 to discuss the proposed decreases and to gather information that would help it determine where to make the cuts. A similar process was used by DHS to implement the 2000-01 rate increases.

Provider Rates Are Still Low. A PricewaterhouseCoopers study completed last year found that, even after accounting for the rate increase provided in 2000-01, Medi-Cal payment rates continue to significantly lag behind those of other purchasers of health care coverage in California. The gap in rates narrowed for physicians who provide services in primary care settings or who practice in emergency rooms or community clinics. However, the study found that Medi-Cal fee-for-service payment levels amounted to 35 percent to 60 percent of what private health care plans paid for the same services. Another study released last year found that while the 2000-01 Medi-Cal rate increases were substantial, they collectively only brought the Medi-Cal provider rates from 58 percent to 65 percent of California's average Medicare payment rates.

Even after implementation of the 2000-01 rate increases, Medi-Cal's fee-for-service physician payment rates ranked 42 out of 51 of the Medicaid programs in the country when adjusted for differences in the cost of living. The trend nationally has been to equalize Medicaid payments to more closely match the rates paid by other health care purchasers. A study by the Lewin Group indicated that 14 states now pay rates that average at least 90 percent of those paid by Medicare, 26 states pay rates that average at least 80 percent of Medicare, and only six states pay rates that average below 60 percent of Medicare.

Studies Link Rates and Health Care. There is some evidence that the rates paid to providers could affect access to health care and the quality of care to patients. A recent national analysis of Medicaid physician rates by The Urban Institute concluded that physician fee levels affect both access and outcomes for Medicaid patients. The Urban Institute cited a study which found that higher rates were associated with a small, but significant, decline in the infant mortality rate. Another study found that children enrolled in Medicaid programs with relatively higher physician fees were more likely to obtain care at a doctor's office.

The findings of this national study are consistent with a recent survey of Medi-Cal beneficiaries. The Medi-Cal Policy Institute reported that 80 percent of program participants believe that they are receiving high-quality medical services. However, 56 percent reported difficulty finding doctors who would provide them treatment.

No Rational Basis for Rate System. The DHS has no regular process in place for the periodic evaluation of the adequacy of physician rates or for periodically adjusting them. Rate adjustments approved in recent years in the budget process have generally been adopted on an ad hoc basis, usually in response to complaints about limited access to specific services and to provider requests for rate increases. (We explain this process in more detail in our February 2001 report entitled, A More Rational Approach to Setting Medi-Cal Physician Rates.) In comparison, Medicare uses a comprehensive, annually updated, rate-setting system that is available for use by other government programs and the public generally.

The rate increases included in the 2000-01 budget, for example, were based upon general legislative concerns about the adequacy of rates and overall budget priorities. They were not based on any specific objective measures of the adequacy of those rates in ensuring patient access to care or quality of care. While DHS has used additional funding received through the budget to adjust Medi-Cal physician rates to reduce some of the disparities with Medicare, large differences still exist for some medical procedures.

Our analysis indicated that the lack of a rational system for physician rate setting has significant potential ramifications for the provision of health care for Medi-Cal beneficiaries and the administration of the program: (1) the state will not ensure reasonable access to quality health care services; (2) physician services will be used less efficiently, with overpayments for some medical procedures and underpayments for others, providing an incentive for the overuse of some services and the underuse of others; (3) some medical providers may not be fairly compensated for certain medical procedures; and (4) the Medi-Cal rate system will remain complex and difficult to administer for DHS and participating physicians.

Future Rate Setting. Because of these concerns, we continue to recommend that the Legislature establish a process for establishing Medi-Cal fee-for-service rates and for periodically reviewing and adjusting those rates. Under this approach, DHS would perform a comprehensive analysis of access to physician services and the quality of care provided to Medi-Cal beneficiaries, and offer proposals for periodic future adjustments to physician rates based upon that analysis.

Managed Care Rates Are Based on Fee-For-Service Payments. The DHS uses historical fee-for-service Medi-Cal data as the basis for establishing the managed care rates and the upper payment limit for these rates. The problems with this approach are discussed in more detail in our analysis of Medi-Cal managed care.

Alternatives to Reducing Provider Rates. In our view, there are better options for reducing General Fund expenditures for the Medi-Cal Program than provider rate reductions. For example, expanding the medical case management program to additional Medi-Cal patients would achieve estimated savings of $17 million General Fund (this is described in greater detail in our analysis of Medi-Cal managed care programs later in this section). Making corrections to overpayments in the managed care program could result in an estimated savings of up to $7 million General Fund. We discuss these and other opportunities for reducing Medi-Cal costs in this Analysis and in a separate document entitled Options for Addressing the State's Fiscal Problem.

Analyst's Recommendation. The Governor's rate reduction proposal to help balance the budget does not consider how cuts in provider rates might affect access or quality of care. The evidence suggests that the rate reduction could negatively affect access to care and quality of care. Although rates are intended to be restored when the state's fiscal condition improves, because of the significant cost of increasing rates, cutting rates now would also make it less likely that rates will keep up in the future.

Accordingly, we recommend that the Legislature not adopt the Governor's proposal to reduce provider rates and consider alternative approaches to achieving savings in the Medi-Cal Program such as those we have discussed above. We further recommend that the Legislature enact legislation to require the department to establish a rational rate-setting process for fee-for-service provider rates. A more detailed discussion of this recommendation can be found in our February 2001 report A More Rational Approach to Setting Medi-Cal Physician Rates.

Proposed Copayments Decrease Provider Rates

We recommend that the Legislature not adopt the Governor's budget proposal to reduce some provider rates by an amount equivalent to copayments for a General Fund savings of $31 million. We instead recommend an alternative approach that could save the state tens of millions of dollars by imposing significant increases in copayments for nonessential services.

Background. Current state law requires many Medi-Cal patients to make a small copayment, $1 in most cases, each time they receive a prescription drug or medical service. The payment may be collected and retained, or waived by the provider. However, both state and federal law prohibit the denial of health care services if a patient cannot or does not make the copayment. State and federal law also specify that copayments cannot be required for Medi-Cal beneficiaries who are 18 years old and under, for those 21 years old or younger living in boarding homes or institutions, and for any children living in foster care. Also exempted from copayments are pregnant women, institutionalized individuals, managed-care enrollees, beneficiaries receiving family planning services, and individuals receiving emergency services (although copayments are allowed for nonemergency services in emergency rooms). State law, but not federal law, prohibits copayments for inpatient care.

Proposal Requires State Law Change. Current state law prohibits the department from reducing reimbursement due to the provider by the amount of a beneficiary copayment. In effect, copayments currently are compensation provided in addition to existing rates. The Governor's budget proposes to change state law and achieve savings of $31 million General Fund by reducing the amount the Medi-Cal Program pays providers for 22 types of services by the amount of proposed copayments. Providers would have the option of billing a patient receiving one of these services the amount of the copayment in order to make up the difference.

Providers Might Not Be Able to Collect Copayments. If a provider cannot collect the proposed copayment because of a client's inability to pay, the provider's payment amount is, in effect, reduced. Our analysis indicates that providers might not be able to collect the copayment because, as we noted, state and federal law specifies that services cannot be denied to Medi-Cal patients who cannot afford the copayment. In addition, because the copayment amounts are so small, some providers are likely to determine that the collection of copayments entails additional administrative expense and therefore that attempting to collect the payments would not be cost-effective.

For these reasons, the main effect of the Governor's approach to copayments will probably be a further reduction in rates for providers. Seven of the 22 service categories that have been proposed to receive copayments are also services that the budget targets for provider rate reductions. Providers of these services, thus are particularly at risk of being discouraged from participating in the Medi-Cal Program. These services are identified in Figure 9.

Effects of Copayments on Utilization Are Varied. Little information is available about the ability of Medicaid providers in California or other states to collect copayments. However, studies have been conducted which examine the impact of copayments generally on health care. Our review of these studies found that the effects of copayments may vary considerably. For example, copayments have been found to reduce the unnecessary use of medical services especially for low-income populations, with even nominal cost-sharing leading to decreased use. However, these studies also indicate imposing cost-sharing on low-income populations could do more than target inappropriate and medically unnecessary care--it could also affect appropriate and medically necessary care. The underutilization of services that might result could have some adverse health effects. Anecdotally, others have said that copayments have a minimal impact on state Medicaid programs.

Notably, the Governor's budget does not assume any savings from the decreased use of services that may occur once copayments are implemented. Given the likelihood that few copayments will be collected under the administration's proposal and many of these services previously required copayments, we believe that its effect on medical utilization would probably be minor.

Copayments May Increase Emergency Room Use. Reducing the rates paid to providers of primary care services by copayment amounts could discourage providers from seeing new Medi-Cal patients or cause providers to withdraw completely from the Medi-Cal Program. Such a reduction in providers could make it more difficult for Medi-Cal patients to access primary-care services. Studies have shown that when patients lack access to primary-care providers, they are more likely to visit emergency rooms for routine sick care.

Inappropriate use of emergency rooms is already a problem. A study focused on New York conducted by the Commonwealth Foundation in 2000 found that in 1998, excluding emergency room patients admitted to the hospital, nearly 75 percent of all emergency room visits were for conditions that could have been treated less expensively in a primary care setting. The study concluded that low-income New Yorkers might depend on emergency room care even more as Medicaid physician reimbursement rates are cut and the primary care delivery system deteriorates.

Thus, to the extent California's experience is similar to New York's, the Governor's copayment proposal could indirectly result in additional costs to the Medi-Cal Program from a rise in the use of emergency departments. The amount of these additional costs is unknown and would depend upon the extent that rate reductions limited access to primary care and the extent to which beneficiaries who did not receive such care (or do not seek it due to the copayment requirement) subsequently developed more serious illnesses that required emergency or inpatient services.

Structure Copayments to Encourage Certain Behaviors. We believe that it is possible to structure a copayment system for Medi-Cal that does not further reduce provider rates, creates a deterrent to overutilization of certain services without undue harm to Medi-Cal patients, and generates some program savings.

Under our proposal, preventive services, such as those provided by physicians, and essential medications, such as insulin, would be exempt from cost-sharing to increase the likelihood that patients would obtain these essential services.

Under our proposal, the maximum federal copayment (ranging from 50 cents to $3 depending on the state's payment for the services) would be imposed on services which are valuable but not as essential as others--chiropractic, podiatry, acupuncture, and transportation to and from medical care. Our approach would also attempt to discourage the misuse of services which some experts believe occurs, by implementing a copayment of $25 for the nonemergency use of emergency rooms as well as for elective surgeries. The State of Washington's Medicaid program, for example, has implemented a $25 copayment for the nonemergency use of emergency rooms. We estimate that the state could achieve General Fund savings of up to tens of millions annually by discouraging the misuse of these services. Our proposal would not change the rules regarding which patients can be charged copayments.

Under the LAO approach, consistent with current state law, all copayments would constitute payments that would be received by providers in addition to provider reimbursements, as opposed to the Governor's proposal to reduce provider rates by copayment amounts.

Analyst's Recommendation. For the reasons discussed above, we recommend that the Legislature not adopt the Governor's copayment proposal to reduce provider rates. We recommend an alternative copayment system for Medi-Cal that would be less burdensome to medical providers and create a deterrent to overutilization of certain services without undue harm to Medi-Cal patients. Specifically, we recommend eliminating copayments for essential services and increasing copayments for nonessential services. We further recommend that the Legislature direct DHS to provide, at budget hearings, its assessment of the feasibility and fiscal impact of our alternative approach. The exact savings from this approach are unknown at this time, but we estimate that they would probably amount to tens of millions of dollars in savings annually to the General Fund.

Drug Budget Savings Rely on Filling Pharmacists Positions

We recommend adoption of the budget proposal to reduce the Medi-Cal drug budget by $201 million ($100 million General Fund). To ensure the Governor's plan achieves the proposed level of savings, we recommend the Legislature modify the budget proposal to provide for higher-level pharmacists positions. We further recommend that the Legislature direct the department to implement competitive contracting for durable medical equipment and laboratory supplies for an additional savings of $17 million to the General Fund. The Legislature could also consider limiting payment for certain over-the-counter drugs covered by the Medi-Cal Program to achieve additional General Fund savings of $7.4 million annually. (Reduce Item 4260-101-0001 by $17 million and reduce Item 4260-101-0890 by $17 million.)

Proposed Drug Budget Reduction Could Achieve Significant Savings. The Governor's budget includes several proposals anticipated to achieve savings of $201 million ($100 million General Fund) in the Medi-Cal drug program. These include:

• Negotiation of contracts with generic drug manufacturers to include a rebate (estimated $27 million savings).
• Ensuring that the Medi-Cal list of approved antipsychotic and antiinflammatory drugs includes the most cost-effective drugs without compromising patient needs (estimated $23 million savings).
• Negotiation of contracts that include a rebate for nutritional products (estimated $9 million savings) and a reduction of pharmacy reimbursement for these products (estimated $11 million savings).
• Negotiation with medical supply manufacturers for blood glucose strips to obtain a lower price (estimated $9 million savings).
• Monitoring the number and types of prescriptions filled by beneficiaries to identify patterns of misuse (estimated $8 million savings).
• Negotiation with manufacturers of AIDS and cancer drug suppliers to obtain rebates (estimated $7 million savings).
• Addressing the existing backlog of drug rebate contract disputes (estimated $7 million savings).

Based on our analysis, we believe that it is likely that taking these proposed steps will result in savings to the Medi-Cal drug budget.

Achieving Savings Requires Additional Staff. The department does not currently have the staff needed to implement this proposal. Therefore, to achieve the proposed savings, the budget proposes to increase the DHS staff by eight pharmacists (and to contract with the state's fiscal intermediary for the services of four more), one nurse consultant, and seven other staff (two staff services managers, four associate governmental program analysts, and one office technician) at a cost of $2 million ($643,000 General Fund). The salaries of the pharmacist positions and the nurse consultant are eligible for a federal funding match of 75 percent while the other positions are eligible for 50 percent federal funding.

While we believe the Governor's proposal has merit, DHS's inability to hire and retain pharmacists could reduce the savings it could otherwise achieve. Presently, the department has 11 pharmacist positions authorized, of which six are vacant. One position has been vacant since May 2001. Four vacancies are positions provided in the 2001-02 Budget Act that DHS has not been able to fill. One position became vacant in December 2001. The department attributes the persistent staffing difficulties to a nationwide pharmacist shortage and the discrepancy between DHS salaries and those offered by its competitors. The maximum DHS pharmacist salary is $6,323 per month, while the University of California at Davis pays a maximum of $8,767 per month--nearly 40 percent more. The private sector offers relatively inexperienced pharmacists (entry level) nearly $8,000 per month in addition to signing bonuses, that DHS cannot provide.

Part of the department's difficulty in hiring pharmacists is a requirement that the department only fill the positions through internal promotion of existing staff. The department has obtained a waiver from this state policy, and plans to send a job description letter to all pharmacists practicing in California to interest them in DHS positions. This approach was successful in the early 1990s. However, the department is concerned it may not work as well this time to solve the problem because of the increased demand for pharmacists in the job market.

If the department cannot fill the pharmacist positions, the savings that it can achieve will be significantly less because implementing most of the strategies requires pharmacists. We estimate that the savings could be reduced to only $16 million General Fund absent such staffing.

To attract the pharmacists that are needed, the department should consult with the Department of Personnel Administration to establish a higher-level pharmacist position that offers a salary commensurate with the public and private sector. This approach should increase the likelihood that DHS can fill the existing vacancies and new positions. The department should estimate and report to the Legislature at budget hearings on the additional state operations cost from upgrading the level of these positions. Because as much as 75 percent of the cost of these positions would be supported with federal funding, increasing the level of these positions should not significantly increase General Fund expenditures.

Additional Drug Budget Savings Proposals. In addition to the Governor's proposal, we believe there are other opportunities for the department to achieve savings in the drug budget.

Presently, the department does not competitively contract for durable medical equipment and laboratory supplies. Instead it uses a "cost-plus" approach, reimbursing providers for the cost of the item plus an additional amount as a service fee. We estimate that implementing a competitive contracting program to contract for durable medical equipment, such as wheelchairs and hearing aids, as well as for various clinical laboratory services would result in estimated General Fund savings of about $17 million.

Also, the department could achieve savings by excluding over-the-counter cough and cold drugs from Medi-Cal benefits coverage. The coverage of these drugs is not required by the federal government and the state has the option of limiting drug expenditures by reducing the drugs it covers. Elimination of cough and cold drugs (including aspirin and Acetaminophen) could save the state $7.4 million annually. This option would in effect conform Medi-Cal drug coverage more closely to many private health coverage plans.

Analyst's Recommendation. We recommend the Legislature adopt the Governor's proposal to reduce Medi-Cal drug budget expenditures by $100 million General Fund ($201 million all funds). To ensure the Governor's plan achieves the proposed level of savings, we recommend the Legislature modify the budget proposal to provide for higher-level pharmacists positions. The DHS should be directed to report at budget hearings on the additional cost of reclassifying existing positions as well as the new positions that are proposed. We further recommend that the Legislature adopt budget bill language directing the department to implement a contracting program for certain laboratory services and durable medical equipment (for a savings of $17 million General Fund). We also recommend the Legislature consider limiting payments for certain over-the-counter drugs now covered by the Medi-Cal Program to achieve additional savings.

Cuts Proposed in Medi-Cal Hospital Funding

The state began the Disproportionate Share Hospitals Program (DSH) in 1991 during budgetary constraints to generate new federal funding to supplement Medicaid payments to hospitals that serve a disproportionate share of Medi-Cal and other low-income individuals. The Governor's budget proposes to increase the state's takeout from the DSH allocation in 2002-03 for a General Fund savings of $55 million. We recommend the Legislature adopt the Governor's proposal to reduce the budget shortfall.

Please see our discussion of hospital financial problems in the "Crosscutting Issues" section of this chapter for our discussion of the Governor's proposal to reduce the total funding available to Medi-Cal hospitals that receive DSH funding.

Medi-Cal Managed Care: Where Do We Go From Here?

Nearly ten years have passed since the Department of Health Services released a strategic plan to move the Medi-Cal Program toward managed care throughout California in 1993. In this section we review options that the Legislature may wish to consider for reform in Medi-Cal managed care. These options include changing the managed care rate-setting methodology, increasing competition, and enrolling the elderly and disabled in managed care.

Background. The number of enrollees in Medi-Cal managed care has increased significantly since legislation accompanying the 1992-93 Budget Act gave the department broad authority to expand managed care in California with the goals of improving beneficiary access to care and containing costs in the Medi-Cal Program. In August 2001, 2.9 million of the total 5.6 million Medi-Cal eligibles--more than half--were enrolled in managed care.

Under managed care, providers are reimbursed on a "capitated" basis or a predetermined amount per-person per-month regardless of the number of services an individual received. In contrast, under the fee-for-service system, the other payment mechanism the Medi-Cal Program uses to reimburse providers, a provider receives an individual payment for each medical service that is provided.

Managed Care Rates Lack Basis

When the Medi-Cal Program first expanded its use of managed care in the early 1980s, rates were based on information the department collected about the use of services by patients enrolled in fee-for-service and the rates paid to those providers. Today, managed care rates are still based on fee-for-service rates. Basing capitation rates on fee-for-service provider rates was clearly appropriate at a time when the fee-for-service population was comparable to the managed care population.

However, the majority of the current fee-for-service population (elderly and disabled) is no longer comparable to most of the managed care population (children and families). Now, mostly children and families with lesser medical needs are enrolled in Medi-Cal managed care plans, while the elderly and disabled who typically have greater health care needs are enrolled in the fee-for-service portion of Medi-Cal. Thus, the Medi-Cal population enrolled in fee-for-service is no longer representative of the medical needs and utilization patterns of beneficiaries enrolled in managed care. According to DHS, the historical fee-for-service data upon which managed care rates are based has not been representative of actual program costs since 1996-97.

This is an important issue for the Medi-Cal Program's operations and finances. Under the current rate-setting system, health care plans are being paid rates that might be inappropriate for the cost of the care they are actually providing to Medi-Cal patients. If the rates are inadequate, DHS runs the risk that health care plans might eventually withdraw from participation in Medi-Cal. In that event, beneficiaries might have to return to a fee-for-service environment. If the rates are excessive, the state may be spending more than is necessary for managed care.

Efforts to Improve Process Unsuccessful. Despite the department's awareness for several years that managed care rates lack a sound analytical basis, so far there has been little apparent progress toward new methodologies for setting managed care capitation rates. The DHS could not indicate when a new methodology would be developed or explain the reasons for the delay in its development.

However, it is apparent that part of the reason DHS has not made progress is because of its lack of complete and accurate data about the utilization of managed care services by Medi-Cal patients. A Medi-Cal Policy Institute report released in 2001 analyzed the Medi-Cal Programs Medical Management Information System's Decision Support System (MIS/DSS) that the Legislature instructed DHS to develop in 1996. This system, which has cost the state more than $44 million to develop since 1997, was intended to integrate data from managed care plans so that DHS would have the tools to monitor and evaluate the quality of care provided to beneficiaries, establish provider rates, and analyze ways to improve both the managed care and fee-for-service systems. The Medi-Cal Policy Institute's study found, however, that the data in the MIS/DSS system is not accurate or complete enough to use to determine provider rates or make sound policy decisions.

The Medi-Cal Policy Institute's study found that part of the problem is that DHS has not worked with providers, health care plans, and contractors to solve problems in data collection. The Institute recommended that DHS make it a priority throughout the department to improve the quality of the managed care data being collected.

Whether managed care rates would increase or decrease if the rate-setting process were improved is not clear. The DHS does not know if it pays providers too much or too little for the services they deliver under managed care because managed care rates are based on fee-for-service utilization data from patients with greater health needs. While DHS attempts to adjust managed care rates for this factor, there is no way now to determine whether these adjustments have resulted in managed care rates that are adequate, inadequate, or excessive.

Rate-Setting Methods to Consider. Other states have taken different approaches to setting rates for their Medicaid managed care programs. The Legislature may wish to consider whether any of these rate-setting methods should be implemented for Medi-Cal.

Five states have designed diagnosis-based risk-adjustment payment systems for their Medicaid programs. That means that these systems estimate the expected level of health care services for specific groups and individuals enrolled in managed care based on their medical history and set rates accordingly. The payment rates are designed to be adequate to ensure access for high-risk patients and to make health plans compete on efficiency and quality of care.

Some states use a different system that was initially developed for disabled populations. This rate-setting approach recognizes the differences in health care needs for individuals with disabilities. The system analyzes information about a patient's use of services to come up with a relative "risk score" that is used to determine payment rates to health plans.

An increasing number of states (17 in 1999) use a process involving both competitive bidding and negotiation of individual rates with health care plans. For example, Arizona, which has enrolled most of its Medicaid population in managed care, competitively bids and negotiates rates under five-year contracts that include interim adjustments for inflation, and programmatic and legislative changes. Arizona's Medicaid program contracted with outside actuaries to develop a set of appropriate payment ranges that it used as a frame of reference during the negotiation process. The ranges were not disclosed to the health care plans.

Performance Incentives to Promote Quality of Care. Once DHS establishes a sound methodology for setting managed care rates and sets appropriate rates for Medi-Cal managed care plans, it could develop incentives to motivate plans to improve the high standard of quality of care. The department could use data about health outcomes and the preventative services provided by the plans to measure the quality of the services each health plan provides. These quality measures could also be used during rate negotiations or to reward plans with a small payment when they meet specific goals, such as providing preventative services to a certain specified percentage of the enrolled Medi-Cal population. The DHS could also impose financial sanctions on plans that fail to meet quality standards.

Nonfinancial incentives could also be effective. For example, DHS could be directed to create award programs and to publicize information about health plan performance against the standards for quality of care.

Increasing Competition Could Reduce Costs

There are three main models of Medi-Cal managed care in California: the Two-Plan Model, County Organized Health Systems (COHS), and Geographic Managed Care (GMC). Under the Two-Plan Model that exists in 12 counties, DHS contracts with one county-developed health care plan and one commercial health plan. In the seven COHS locations there is one plan operated by the county and enrollment is mandatory for almost the entire Medi-Cal population. The GMC model, in place in two counties, allows multiple health care plans to operate in a designated region. For the most part, the Medi-Cal program relies on one or two health care plans in each region to provide services to Medi-Cal patients. In our view, this approach does not ensure adequate competition in managed care--increased competition could help contain program costs.

The United States General Accounting Office (GAO) reviewed the Medi-Cal program in 1995 and found that more competition would improve California's plan to expand managed care. The GAO reviewed the level of competition in the regions that operate a two-plan model and reported that, while the state sought to benefit from competition, allowing only two plans to serve an area did not create a competitive environment and limited beneficiaries' choice of health plans.

The study noted that limiting a region to two health plans actually requires plans that normally compete against one another to form joint entities that are large enough to handle the enrollment requirements of some counties. Thus, plans that are supposed to compete with one another are forced under state limits on competition to share confidential information. Also, GAO noted that limiting competition could make health plans unresponsive to market demands for increased quality of care.

According to GAO, the two-plan model also puts the state at a serious disadvantage as it contracts for Medi-Cal managed care services. Because the Medi-Cal Program has a strong interest in ensuring that patient care is not disrupted, DHS could be compelled to continue existing contracts even if one of the two plans is performing poorly.

The Legislature should consider whether the Two-Plan Model should be modified to allow "all comers" to compete to participate in the Medi-Cal managed care system. The ability of Medi-Cal to introduce competition and achieve additional savings should also be explored in regions where one plan now dominates--such as the COHS and GMCs.

Expanding Managed Care to the Elderly and Disabled

Most of the population enrolled in Medi-Cal managed care is children and nondisabled adults. This is largely because, in the majority of counties, enrollment in managed care is mandatory for children and families and voluntary for the elderly and disabled. Nevertheless, currently about 230,000 or 15 percent of the total number of elderly and disabled Medi-Cal patients are enrolled in managed care plans.

Like California, most Medicaid programs in other states have focused on enrolling children and nondisabled adults in managed care rather than the elderly and disabled. High-need populations such as the elderly and disabled were traditionally carved out of Medicaid managed care because of the challenges associated with controlling costs and delivering comprehensive services to these groups. However, several states have started to enroll nonelderly disabled patients into managed care using federal waivers. Approximately 1.6 million persons with disabilities were enrolled in Medicaid managed care programs in 36 different states in 1996.

Benefits of Managed Care. The state has been interested in managed care in the form of health maintenance organizations for several reasons. Two of those reasons are that managed care can eliminate incentives for overutilization of services and provide an incentive for reducing costs.

This approach could also improve medical care for the elderly and disabled. Managed care has the potential to provide such groups which have relatively high medical needs with a "medical home" that would help to ensure the coordination of their care. In this regard, the Medi-Cal Program could establish contracts with managed care plans that require them to provide case management services for such high-risk populations.

In addition, enrolling a higher percentage of the Medi-Cal population in managed care would enable the state to better predict its Medi-Cal costs. In 2001-02, about two-thirds of the program's total expenditures are projected to be for the elderly and disabled. Establishing capitated rates for their coverage would mean the state would generally know in advance what it would pay for health care. The only significant variable in budgeting after rates are set would be Medi-Cal patient caseload in each health plan.

The COHS as a Model. Eight counties operate COHS and require enrollment in managed care for almost every Medi-Cal patient, including the elderly and disabled. The COHS approach could thus serve as a model--relying on case management services and coordination of care--for expanding managed care to the elderly and disabled.

Improved Rate-Setting Method Is Critical. If Medi-Cal were to expand enrollment in managed care for the elderly and disabled, it would be important to ensure that the rates paid to managed care plans generally are appropriately based on the relative health care needs of enrollees. This may require DHS to develop more complex rate-setting methods, such as the risk-based adjustment system that we described earlier. Providers may be discouraged from participating in an expanded managed care system if rates were inadequate. Inappropriate rates could also result in access problems for high-risk enrollees, or result in the state spending more than is necessary for the care of these individuals. 

Potential Savings. If managed care were expanded to the elderly and disabled we would suggest that the state start doing so in counties that have existing managed care plans. This would involve about one million beneficiaries. Initially establishing managed care rates at a level somewhat below fee-for-service expenditures, and phasing in this population over a two-year time frame, could result in General Fund savings of up to $70 million in 2002-03 and up to $140 million in 2003-04. These estimated savings are less than 3 percent of what the state currently pays for Medi-Cal services for the elderly and disabled population on a fee-for-service basis.

Our estimate is based on the department's current practice of setting managed care rates at a fixed percentage lower than fee-for-service costs in order to achieve savings. Our estimate of savings assumes that certain services, such as long-term care and some drug costs, would continue to be provided on a fee-for-service basis rather than under managed care. As noted earlier, the quality of information about managed care is poor. Our estimate is based on the best information available at the time this analysis was prepared and, thus, is subject to revision. Implementation of such a change would be subject to approval by the federal government.

Options

In this analysis, we have discussed several approaches to reforming Medi-Cal's managed care system:

• The Legislature could consider directing the department to complete development of new managed care rate-setting methodologies by the end of the current fiscal year so that they can be implemented in the budget year. This would enable the department to ensure that appropriate rates are paid.
• Because additional state savings could be achieved by increasing competition in counties where Medi-Cal managed care has been introduced, the Legislature could direct DHS to report on the feasibility of the approaches we have discussed in this report for increasing competition in specified counties where the opportunities for success are the best.
• If the Legislature wishes to consider enrolling the elderly and disabled Medi-Cal population in managed care coverage, more detailed analysis would be needed
• to determine the likely level of savings. The Legislature could direct DHS to estimate these potential savings.

More Oversight Needed for Antifraud Activities

We recommend the adoption of supplemental report language directing the Department of Health Services to submit an annual report evaluating the department's antifraud activities and the overall cost-effectiveness of resources allocated for this purpose.

Antifraud Efforts Now in Third Year. Since 1999-00, the DHS has received additional funding and positions to combat the problem of Medi-Cal fraud and abuse. That year, DHS received $2.7 million ($1.3 million General Fund) and 41 new positions for this purpose. In the following year, 2000-01, DHS received an additional $21 million ($9 million General Fund) and 192 more positions for the Governor's Medi-Cal Fraud and Fiscal Integrity Initiative. Now in its third year, the antifraud efforts are continuing with these augmented resources.

According to DHS, the beneficial fiscal effects of the antifraud efforts are twofold: cost savings and cost avoidance. Savings are deemed to have occurred as a result of the antifraud effort when providers already enrolled in the program are found to be engaging in fraud or abuse and their activities are stopped. "Cost avoidance" is deemed to have resulted primarily when new providers who are potentially fraudulent are prevented from enrolling in the Medi-Cal Program. The savings estimates include General Fund and federal funds. According to DHS, antifraud activities resulted in $95 million in savings and $226 million in cost avoidance in 2000-01. These results are displayed in Figure 10 which indicates a savings of $3 for every $1 spent. The DHS originally had estimated that it would achieve $75 million in savings in 2000-01.

The DHS estimates that antifraud activities conducted in 2001-02 will produce $108 million in annual savings and $126 million in annual cost avoidance. Budget-year actions are projected to result in $163 million in savings and $173 million in cost avoidance. Therefore, for every $1 spent on antifraud activities, they are predicted to achieve an additional $4 in savings for actions taken in 2001-02 and an additional $6 in savings for actions taken in 2002-03.

The savings and cost avoidance outcomes from antifraud activities discussed above are different from the figures for savings and cost avoidance that are displayed in the Medi-Cal budget as offsets that reduce General Fund expenditures for the program. This is because of technical differences when the savings and cost avoidance resulting from antifraud activities are counted.

Analyst's Recommendation. Given the large number of additional staff that were provided to DHS for antifraud efforts in recent years, we believe that the Legislature should receive the information necessary on an ongoing basis to evaluate the cost-effectiveness of these resources. Accordingly, we recommend adoption of supplemental report language directing DHS to report to the Legislature by December 1 of each year on its antifraud activities and the results of those activities. The report should include a description of each type of activity, the nature and quantity of actions taken as a result of each antifraud activity, the savings and cost avoidance associated with the actions taken, and the overall cost-effectiveness of the resources allocated for antifraud activities. We recommend the adoption of the following language:

The Department of Health Services shall report annually to the Chair of the Joint Legislative Budget Committee and the chairs of the fiscal committees of both houses of the Legislature on its antifraud activities that occurred in the prior fiscal year. The report shall include a description of each type of activity, the nature and quantity of actions taken as a result of each antifraud activity, the savings and cost avoidance associated with the actions taken, and the overall cost-effectiveness of the resources allocated for antifraud activities. The report shall be due on or before December 1 of each year.

Nursing Home Proposal Would Add 55.5 Positions

We recommend approval of the Governor's proposal to change staffing standards and rate-setting for Medi-Cal nursing homes with some modifications. Specifically, we recommend deleting 11.5 of the proposed 55.5 positions and the adoption of budget bill language requiring that unspent funding from salaries for positions that are approved revert to the General Fund. (Reduce Item 4260-001-0001 by $336,000 and Item 4260-001-0890 by $336,000.)

Background. Chapter 684, Statutes of 2001 (AB 1075, Shelley) directs DHS to complete two major tasks. First, by August 1, 2003, DHS must develop minimum staffing requirements at nursing homes based on the ratio of nursing staff to patients. Currently, nursing home staffing rules are based on the number of hours of nursing care required for each patient.

Second, by August 1, 2004, DHS must implement rates based on the specific acuity level of patients at each Medi-Cal certified nursing facility, including both so-called freestanding facilities and those that are parts of hospitals. Currently, Medi-Cal rates paid to freestanding nursing facilities generally are a flat rate, based on the median of all of the facilities' costs reported to DHS annually. Rates paid to hospital-based facilities generally are based on a facility's cost or on a median cost of similar facilities, whichever is lower.

The changes in these staffing requirements and the rate system would result in significant additional workload for DHS. In order to develop this new rate methodology, DHS indicates that it would hire a rate-development contractor at an estimated cost of $1 million. The DHS indicates that it would also need to verify the accuracy of operating cost and patient acuity data reported by nursing facilities that participate in Medi-Cal through an audit of each of the freestanding facilities once every three years by its audit staff. The DHS estimates that this would generate an additional 417 audits per year, more than double the number it now conducts each year. The audits would expand not only in number but in scope to include a review of payroll records and other labor-related reports.

According to the department, licensing and certification staff would conduct separate reviews of each facility, also every three years, in order to verify the accuracy of the patient acuity data reported by the nursing facilities. The DHS has not reviewed such data in the past, since patient acuity has not been a factor in establishing new rates for nursing facilities.

In order to implement the new staffing-ratio standards required by Chapter 684, DHS will be required to develop regulations and to verify compliance with the new regulations. The department also will need to assess the impact of the new standards on rates once they have been developed.

Governor's Proposal. The Governor's budget proposes to add 55.5 positions and $5.3 million ($2.7 million General Fund) to implement the requirements of Chapter 684. This funding would be in addition to $1 million in funding previously provided in the DHS budget for review of alternative rate systems.

Specifically, the proposal would add 35 positions for audits and investigations, 13.5 positions for licensing and certification, five positions for medical care services, and two positions for legal services. Three of the positions would be two-year limited-term positions. All positions are budgeted for the full year. Figure 11 summarizes these proposed positions and provides a brief explanation of their purpose. We are advised that this proposal represents the full number of positions that DHS anticipates it would need to implement the requirements of Chapter 684.

Analyst's Recommendations. We recommend approval of the Governor's proposal with some modifications.

First, we recommend deleting 1.5 health facility evaluators in Licensing and Certification and three analysts proposed for Medical Care Services, because establishment of these positions in 2002-03 would be premature. Specifically, the proposed Licensing and Certification positions would verify compliance with staffing ratios that would not exist until 2003-04. Similarly, we believe three Medical Care Services positions would not be needed until the development of facility-specific rates is much further along.

In addition, we recommend deleting five auditor positions because the budget proposal overstates the number of freestanding nursing facilities. Assuming a three year audit cycle as proposed by the department, we estimate that Audits and Investigations would audit about 363 facilities each year instead of the 417 estimated by DHS. (This is based on a total number of 1,090 facilities that participate in Medi-Cal.)

Finally, we recommend denial of the two positions requested for the Office of Legal Services. The Governor's proposal does not explain why currently authorized positions in the office could not be directed to develop staffing-ratio regulations or to provide legal support for the development of the new rate methodology.

The DHS' plan to hire all of the proposed positions by July 1, 2002 is ambitious. Ordinarily, such a large expansion in staff would take many months into the new fiscal year to accomplish. If that were to happen, the Governor's proposal would provide DHS more funding and positions than it could actually use in the budget year. We are advised that in order to accomplish the proposed hiring schedule, the department will seek to redirect other existing positions that would be filled in advance of the start of the new fiscal year. The DHS is seeking an exemption from the statewide hiring freeze that would allow this to occur. However, at the time this analysis was prepared, the exemption from the hiring freeze had not been approved. Given the uncertainty that would remain, in any event, over DHS' ability to fill and maintain so many new program positions so quickly, we recommend the adoption of budget bill language specifying that any salary savings resulting from these new positions revert to the General Fund at the end of the budget year. Accordingly, we recommend the following language under Item 4260-001-0001:

Notwithstanding any other law, any salary savings resulting from positions authorized for the implementation of Chapter 684, Statutes of 2001, shall revert to the General Fund at the end of 2002-03.

Deletion of the 11.5 positions would result in a total savings of $672,000 ($336,000 General Fund). We recommend approval of the remaining 44 positions.

Dual Enrollment in Healthy Families and Medi-Cal

An unknown but probably substantial number of individuals enrolled in the Healthy Families Program are also enrolled in Medi-Cal. We recommend that the Department of Health Services and the Managed Risk Medical Insurance Board report at budget hearings on the steps they are taking to ensure that the state is not paying twice for health coverage for the same individuals.

A recent study conducted by the Department of Mental Health suggested that an unknown, but probably substantial, number of individuals enrolled in the Healthy Families Program are also enrolled in Medi-Cal. Please see our analysis of the Managed Risk Medical Insurance Board and the Healthy Families Program later in this chapter for our discussion of this issue.