Analysis of the 2005-06 Budget Bill Legislative Analyst's Office February 2005

Medi-Cal (4260)

Overview of Medi-Cal Budget Proposal

The DHS budget proposes Medi-Cal expenditures totaling $34 billion from all funds for state operations and local assistance in 2005-06. The General Fund portion of this spending ($13.1 billion) increases by about $1 billion, or 8.2 percent, compared with estimated General Fund spending in the current year. The remaining expenditures for the program are mostly federal funds, which are budgeted at $19 billion, or 2.3 percent less than estimated to be received in the current year.

Figure 1 displays a summary of Medi-Cal General Fund expenditures in the DHS budget for the past, current, and budget years. The budget estimates that the General Fund share of Medi-Cal local assistance costs for the budget year will increase by about $984 million, or about 8.2 percent, compared with 2004-05. The bulk of this increase is for benefit costs, which will total an estimated $12 billion in 2005-06. The majority of the overall increase in General Fund spending results from (1) payments proposed for health care providers that will be offset by fees assessed on those providers, which are not included here; and (2) cost increases that occur because certain one-time savings actions taken in 2004-05 will not reappear in 2005-06. After adjusting for these effects, the underlying growth in General Fund expenditures for Medi-Cal caseload and costs is projected to be about $350 million, or 2.9 percent, in 2004-05.

The spending total for the Medi-Cal budget includes an estimated $1.9 billion in local government funds for payments to DSH hospitals. About $4.6 billion of total Medi-Cal spending consists of funds budgeted for programs operated by other departments, counties, and the University of California.

Key Changes in Current-Year Spending

Modest Surplus Projected. The Governor's budget projects a $58 million General Fund surplus in the current year relative to funds budgeted by the 2004-05 Budget Act and Chapter 875, Statutes of 2004 (AB 1629, Frommer). Lower-than-expected caseload for certain managed care plans known as County Organized Health Systems has decreased projected spending by $66 million General Fund, and the Governor's proposed use of Proposition 99 tobacco funds is expected to additionally reduce spending by $54 million General Fund.

Unanticipated delays in obtaining federal approval of "quality improvement fees" that are to be imposed on Medi-Cal managed care plans also contributes to the projected budget surplus in the current year. The delay means a reduction in Medi-Cal expenditures of $79 million General Fund due to the postponement of rate increases that had been budgeted to take effect for these providers in the current year. While the state Medi-Cal budget reflects these savings, we note that there is also a corresponding loss of state revenue related to the postponed imposition of those fees. (As we discuss later in this analysis, the administration now projects that both the rate increases and the fee revenues will take effect in the budget year.)

These and other lowered budget projections more than offset other changes that would increase General Fund expenditures, such as reduced savings estimates associated with antifraud efforts.

Governor's 2005-06 Budget Proposals

The Governor's proposed budget estimates that total General Fund spending for Medi-Cal local assistance will be $12.9 billion in 2005-06, a net increase of about $1 billion, or 8.2 percent, above the estimated spending in the current year. As summarized in the "Health and Social Services Overview" of this chapter of the Analysis, the spending plan proposes a number of significant adjustments and policy changes that are reflected in the budget year totals:

• Baseline Estimates. The budget plan reflects a proposed $381 million increase in expenditures for "baseline" costs—those unrelated to any change in state policy—due to estimated increases in caseload, costs, and utilization of services by aged, blind, and disabled beneficiaries. An additional $93 million was added to the budget for projected increases in baseline spending for caseload, costs, and utilization of services for families and children.
• Quality Improvement Fees. The proposed 2005-06 budget includes General Fund costs totaling $429 million for rate increases granted to both managed care plans and skilled nursing facilities that are to be offset by new revenue from quality improvement fees assessed on these providers. The Governor's budget projects that these revenues will result in a net gain to the state of $35 million General Fund in the budget year.
• Reversal of Savings From Checkwrite Delays. The estimated 2004-05 budget includes savings of $302 million General Fund generated by delaying the weekly Medi-Cal checkwrite one week on two separate occasions. These savings will not reoccur in 2005-06, and therefore these costs must be added back into the budget.
• Prenatal Care Funding Shift. The Governor's budget proposes to claim increased federal funds for prenatal care by providing these services to undocumented immigrants through the State Children's Health Insurance Program, which receives 65 percent federal funding, rather than through the current state-only program. This change is expected to result in $191 million in General Fund savings in Medi-Cal.
• Onetime Gain From Federal Medicare Reform. The recent federal Medicare Modernization Act, which we discuss in more detail later in this Analysis, is expected to shift prescription drug coverage for eligible Medi-Cal beneficiaries to the federal Medicare program effective January 1, 2006. The Governor's budget projects that, as a result of certain one-time factors, this shift in coverage will generate net Medi-Cal savings of about $100 million General Fund for 2005-06. However, the administration estimates that the new federal law will result in net General Fund costs to Medi-Cal beginning in 2006-07 and continuing for at least the next several years.
• Medicare Premiums. The Medi-Cal Program pays the Medicare premiums for Medi-Cal beneficiaries who also are eligible for Medicare, thereby obtaining 100 percent federal funding for those services covered by Medicare. The budget estimates that the General Fund cost of these so-called "buy-in" payments will increase by $156 million in 2005-06 due primarily to increases in Medicare premiums.
• Cost-Cutting Actions for Pharmaceuticals. The state's increasing costs for prescription drugs would be partly offset in the 2005-06 budget plan with an expected increase in savings from pharmacy reimbursement reductions initially implemented in the current year as well as efforts to increase the rebates on drugs paid by drug manufacturers. Together these actions are expected to generate $94 million in additional General Fund savings in 2005-06.
• Specialty Mental Health Services. The DHS Medi-Cal budget includes costs for some programs that are primarily administered by other state departments. Notably, General Fund expenditures for specialty mental health services provided under the Early and Periodic Screening, Diagnosis and Treatment Program administered by the Department of Mental Health are projected to increase by about $43 million due to increases in both caseload and program costs.
• Medi-Cal Redesign Efforts. As part of the Governor's proposal to redesign Medi-Cal, the 2005-06 budget proposal includes estimated savings of $25 million from a $1,000 annual limit on dental services provided to adults. Other reform proposals would initially add administrative costs to the Medi-Cal Program. Other components include expansion of managed care, the imposition of new premiums for higher-income beneficiaries, and restructuring of hospital revenue streams. We discuss these and other components of the Medi-Cal reform plan later in this analysis.

Budget Forecasts Increased Caseload and Costs

While the administration's overall Medi-Cal caseload projection is reasonable, we believe that the population component of nonwelfare families and children could be significantly higher or lower than budgeted due to the contradictory effects of various policy changes. We will monitor caseload trends and recommend appropriate adjustments at the time of the May Revision.

Administration's Cost and Caseload Projections. The budget projects that both the average monthly caseload of individuals eligible for Medi-Cal and the cost of benefits per eligible will grow in the current and budget years. The Governor's budget plan estimates caseload growth to be about 1 percent in 2004-05 and about 3 percent in 2005-06. The estimate for the current year is somewhat less than the overall estimated growth of California's population, while the Governor's estimated growth rate for the budget year is projected to somewhat exceed the overall state population growth rate.

The cost of benefits per eligible (excluding pass-through funding to other departments and local governments) would increase by about 4 percent in the current year according to the Governor's budget plan, and further increase by about 10 percent in the budget year. These increases can be partly attributed to higher rates for nursing facilities and managed care plans, and to the effect of one-time savings actions that reduced costs in previous years but do not recur.

Most Growth Among Nonwelfare Families. Figure 2 shows the budget's forecast for the Medi-Cal caseload in the current year and 2005-06. The majority of the projected Medi-Cal caseload increase occurs in the families and children eligibility categories. The budget plan estimates that the caseload for this group will increase by 3 percent in the current year and an additional 2 percent in the budget year. Within this category, nonwelfare families account for most of the changes. The budget estimates that the caseload of Medi-Cal eligible nonwelfare families will increase by about 8 percent in the current year and by an additional 5 percent in the budget year.

Some of the projected current-year and budget-year growth in the nonwelfare families and children caseload is the result of the continued implementation of a "gateway" in the Child Health and Disability Prevention (CHDP) program. The Governor's budget estimates that efforts to expedite the enrollment of CHDP children into more comprehensive health care coverage will result in the addition of nearly 134,000 eligibles to the Medi-Cal Program over the current and budget years.

The overall projection of nonwelfare families and children caseload growth is consistent with past trends. However, the effect of ongoing changes in the Medi-Cal Program is hard to predict, and significant revisions to the projection could occur for various reasons. For example, Medi-Cal enrollment from the CHDP gateway is now projected to grow by less than anticipated in the 2004-05 budget. The budget year caseload could also be lower than projected. The continued implementation of modifications of eligibility determination procedures approved in recent budgets, which were intended to more quickly identify and disenroll individuals who become ineligible for Medi-Cal, also adds uncertainty to the 2005-06 budget projection.

The same is true for a 2005-06 budget proposal to modify eligibility for CalWORKs. One major effect of such a change would be to shift some existing Medi-Cal beneficiaries from one eligibility category to another, but the implementation of such a change could have additional, unknown effects on the future growth rate of the Medi-Cal caseload.

Significant Growth in Medically Needy Aged and Disabled. Caseloads for the aged, blind, and disabled are expected to grow by about 45,000 beneficiaries or about 3 percent in the current year and by an additional 53,000 beneficiaries or about 3 percent in the budget year. The increase in the current year is consistent with underlying caseload growth trends. Caseload increases for the aged and disabled are being driven primarily by those aged and disabled individuals who qualify as medically needy. (The medically needy category includes those who do not quality for, or choose not to participate in, Supplemental Security Income/State Supplementary Program (SSI/SSP), such as low-income noncitizens or individuals who must pay a certain amount of medical costs themselves before Medi-Cal begins to pay for their care.) The aged caseload in this eligibility category is expected to grow by about 20,000 or 11 percent in 2005-06, and the disabled caseload is expected to grow by about 9,600 or 10 percent. The public assistance and long-term care eligibility categories for the aged, blind, and disabled all are projected to grow by less than 2 percent in 2005-06.

Analyst's Recommendations. Our analysis indicates that the Governor's budget request is reasonable and is generally in line with available Medi-Cal caseload data. Accordingly, we recommend approval of the budget request. However, we note that there is both upside and downside risk to the budget estimate as presented. While it is possible that the CHDP gateway program will result in fewer eligibles than assumed in the Governor's budget plan, it is also possible that recently enacted revisions to eligibility determination procedures will not reduce caseload by as much as the Governor's budget has estimated. Given this situation, we will continue to monitor Medi-Cal caseload trends and will recommend any appropriate adjustments to the budget estimate at the time of the May Revision.

Quality Improvement Fees

Fee Revenues Not Recognized in Governor's Budget.

Our analysis indicates that about $294 million in revenues from so-called quality improvement fees that have been imposed on certain classes of health care providers have not been counted as state revenues in the Governor's budget. We recommend that the Legislature recognize these fee revenues as it drafts its budget plan.

Quality Improvement Fees. Federal Medicaid law permits states to impose quality improvement fees on certain health care service providers and, in turn, offset the increased cost to the providers from the fee through increased reimbursements. (We discussed in detail how such fees can be imposed, and their potential benefit to the state, in the "Crosscutting Issues" section of the Health and Social Services chapter of the Analysis of the 2004-05 Budget Bill.) The revenues from these fees are to be deposited into the state General Fund.

The Legislature has approved and the state has fully implemented with federal approval a quality improvement fee for Intermediate Care Facilities for the Developmentally Disabled (ICF/DDs). With the further approval of the Legislature, the state is currently in the process of seeking federal approval to implement a separate quality improvement fee on Medi-Cal managed care plans as well as another fee affecting nursing homes which serve Medi-Cal patients.

Implementation of such fees can be a lengthy process because it generally involves seeking federal approval of a Medicaid State Plan amendment, a federal waiver of Medicaid law, or both. As a result, implementation of the fee for Medi-Cal managed care plans has previously been delayed, and under the Governor's 2005-06 budget plan would be further delayed until July 2005. Our analysis suggests that it is a reasonable assumption that the new fee finally will be implemented on that projected date, and that it is appropriate that the budget plan presented by the Governor assumes that the associated revenues will be deposited in the General Fund during 2005-06. We note that the Bush administration has recently proposed to limit these types of fees and change how they are applied.

Budget Plan Does Not Account for All Fee Revenues. The schedule of estimated state revenues for the Governor's budget plan reflects an assumption of $120 million in collections of the nursing home fees in the current fiscal year and an additional $257 million in the budget year. However, a review of state revenue projections indicates that the revenues from the quality improvement fees for ICF-DDs and Medi-Cal managed care plans have not been included in the schedule of revenues for the Governor's budget plan. That means that General Fund revenues are currently understated in his budget plan by a combined total of $294 million for the current and budget years.

Analyst's Recommendation. We recommend that the Legislature recognize in its budget plan (1) the $58 million in fee revenue projected to result from the quality improvement fee on ICF/DDs in the current year, (2) $29 million more from the ICF/DD fee expected in the budget year, and (3) $207 million expected from the fee for Medi-Cal managed care plans anticipated in the budget year. We will continue to monitor DHS' progress towards implementing the fees and recommend any appropriate budget adjustments.

Redesign Sound in Principle, But Needs Further Development

The 2005-06 Governor's budget plan includes a package of seven proposals intended to redesign the Medi-Cal program. The proposal would result in broad changes in Medi-Cal managed care and hospital financing as well as some limited changes in benefits, cost-sharing, and eligibility administration. Overall, we find that the Governor's proposals are conceptually sound but that the Legislature needs more information about some aspects of the package and some refinements of the proposals are warranted. (Reduce Item 4260-001-0001 by $602,000.)

A Multifaceted Medi-Cal Redesign Plan

In January 2004, the administration outlined a broad concept for redesign of the Medi-Cal Program and indicated that most of the detailed legislative and budget proposals to implement the proposal would be forthcoming. After a couple of postponements, the Governor's 2005-06 budget plan presents a package of seven proposals to redesign the program. The administration indicates that the purpose of its proposal is to maintain health care coverage for eligible Californians while containing state costs and making the program more efficient.

We summarize below the major components of the Governor's Medi-Cal redesign proposal, along with the administration's estimate of their annual net fiscal effect on the General Fund after they have been fully implemented:

• Expand Medi-Cal Managed Care. Enroll additional individuals who currently receive services through the fee-for-service system (which we explain later in this analysis) into managed care health plans or acute and long-term care integration projects in selected counties. Estimated savings: $85 million.
• Restructure Hospital Payment System. Stabilize the financing of "safety-net" hospitals through a comprehensive restructuring of the manner in which Medi-Cal pays for hospital services. Estimated cost: $1 million.
• Set Dental Benefit Limit for Adults. Modify the Medi-Cal dental benefit by capping dental benefit expenditures to $1,000 annually for certain adults. Estimated savings: $26 million.
• Establish Enrollee Premiums. Impose beneficiary cost-sharing through monthly premiums for certain individuals with incomes above 100 percent of the federal poverty level (FPL) and for aged and disabled individuals with incomes above the level needed to enroll in SSI/SSP. Estimated savings: $22 million.
• Streamline Eligibility Processing for Children. Modify the Medi-Cal eligibility determination process for children whose applications are submitted through the Healthy Families Program vendor, known as the "single point of entry." Estimated savings: $7 million.
• Monitor County Administration. Monitor county compliance with federal and state performance standards pertaining to initial eligibility determinations and annual redeterminations. Estimated cost: $2 million.
• Alter Enrollment for Health Care Providers. Improve the provider enrollment process. (Details of this proposal will not be available until spring 2005). Estimated cost or savings: Unknown.

Redesign Will Take Years to Fully Implement. Compared to the broad concepts for Medi-Cal redesign outlined in the 2004-05 Governor's Budget, the new proposal is more limited. Earlier concepts contemplated the establishment of broad tiers of beneficiaries who would pay varying copayments and premiums for different benefit packages. Other previously discussed concepts have also been dropped from the plan.

Nevertheless, the administration estimates that its current proposal for Medi-Cal redesign would take several years to implement fully. That is because some proposals would require approval by federal authorities, the development of new or modified information technology systems, and hiring and training of new departmental staff.

Below, we separately discuss each of the major components of the redesign package, and then comment on the proposal as a whole. We separately discuss the financial problems facing California hospitals, and how they would be addressed by the component of Medi-Cal redesign involving hospital finances, later in this analysis.

Managed Care Expansion

Overall, we find that the Medi-Cal redesign proposal to expand managed care is conceptually sound and that the projected state savings from these changes are achievable and may even be understated. However, we recommend that the Department of Health Services provide the Legislature with more detail about how it plans to strengthen the existing managed care system and ensure a smooth transition of beneficiaries into managed care in order to fully evaluate its merit.

Three Major Components

The box (see next page) provides a description of the existing fee-for-service and managed care systems of care for Medi-Cal beneficiaries. The Medi-Cal redesign plan has three major components relating to an expansion of managed care: (1) a geographic expansion of managed care into new counties, (2) a shift of a significant portion of the Medi-Cal caseload from fee-for-service into managed care in both existing and new locations, and (3) projects to integrate long-term care services for enrollees in three counties. A number of the changes proposed by the administration require federal approval, or changes in state law and regulations, or both. A more detailed explanation of these proposals is below.

Geographic Expansion. The budget plan proposes to expand managed care into 13 or 14 counties in addition to the 22 where it is already provided. The COHS model would be expanded into six or possibly seven of these counties and the GMC model would be expanded into six or seven of these counties. The remaining counties would continue to provide Medi-Cal services under the fee-for-service model. A caseload of about 262,000 families and children would be affected by these changes.

Shifts of Aged and Disabled Beneficiaries. The redesign proposal would mandate enrollment into managed care for aged or disabled in the 13 or 14 expansion counties and the 14 counties where managed care is already an option but where the aged and disabled are not currently required to participate in managed care. Eventually, this would result in a shift in the source of care for about 554,000 individuals. Some aged and disabled would be excluded from mandatory enrollment into managed care. For example, the Two-Plan and GMC plans would exclude so-called "dual eligibles" who are also enrolled in Medicare.

Expanding Options for Long-Term Care. The redesign proposal includes the development and implementation of Acute and Long-Term Care Integration plans in San Diego, Orange, and Contra Costa Counties. The plans would provide all Medi-Cal and Medicare services to enrolled individuals, including primary care, acute care, drugs, nursing facility care, and home and community-based services. Enrollment of the aged or disabled in the plans would be mandatory. San Diego and Contra Costa County enrollees would have the option of choosing from among two or more plans. In Orange County, the plan would be administered by the existing COHS. It is unknown at this time how many Medi-Cal beneficiaries would participate in these plans.

Combined Fiscal Impact of All Three Components. No state savings are assumed in the budget year from the expansion of managed care as only planning for these changes will occur in 2005-06. Savings would begin to accrue in 2006-07 as new enrollees were placed into managed care and others were phased in upon their annual eligibility redeterminations. The administration estimates that by 2008-09, the proposed expansion of managed care would result in General Fund savings of approximately $89 million ($177 million all funds).

Assessing the Governor's Proposal

The Advantages of Managed Care. Our analysis has found that, if implemented well, managed care has the potential to both improve health care outcomes for beneficiaries while reducing costs for the state. Managed care provides beneficiaries with a primary care physician who has access to each patient's medical history and better coordinates their health care. Preventative care and better overall access to care become more likely. Beneficiaries are ensured access to a network of primary care physicians and specialists. The DHS conducts reviews annually to measure the quality of services provided by health plans; no such reviews take place for Medi-Cal fee-for-service care. These changes can save the state money by preventing health problems and reducing the expensive hospitalization of patients.

Some Key Strategies Included, Others May Be Missing. In a policy report released by our office in March 2004, Better Care Reduces Health Care Costs for Aged and Disabled Persons, we provided a "blueprint" for expanding managed care that included key strategies to ensure a smooth transition of the aged and disabled into a managed care setting. Our analysis indicates that the administration's redesign proposal incorporates a number of these strategies, which are primarily intended to make sure that conditions are right for a shift of beneficiaries to managed care before such a shift occurs.

The DHS indicates that it intends to conduct "readiness reviews" of all new Medi-Cal managed care plans prior to these health plans becoming operational. For example, DHS would ensure that networks of doctors and other medical providers are adequate to meet patients' medical needs, that care is coordinated for consumers who need specialized services, and that the quality of services is monitored. The DHS also indicates that it will research the "lessons learned" from similar enrollments in other states, and identify "best practices" for providing managed care for the aged and disabled based on the experiences of the COHS plans.

Our report outlined needed improvements in the existing managed care system that should be part of any major expansion. Among other improvements, we recommended that DHS ensure that the data collection system the state uses to monitor managed care is working effectively, and that DHS develop quality indicators for the aged and disabled. However, during our review of the redesign proposal we were unable to determine what steps DHS would take to improve the existing managed care data collection systems or the capitation rate-setting process. Nor is it clear what new indicators will be implemented to measure the quality of care of aged and disabled persons. Generally, it appears that the redesign proposal intends to address these issues. However, until further detail is forthcoming, the Legislature will not be in a position to determine whether this is the case.

Savings Estimate Appears to Be Conservative. The administration estimates that expansion of managed care would result in net savings of $89 million for the General Fund by 2008-09. Our analysis indicates that these estimates are achievable and may understate the potential savings. The administration estimate is based on an assumption of 5 percent savings relative to estimated fee-for-service expenditures. However, additional savings could result from improved coordination of care and a greater emphasis on preventative care that could reduce expensive hospitalizations. The amount of these additional state savings is unknown, but could be in the low tens of millions annually.

Expansion of Managed Care Could Go Further. The Governor's redesign plan does not propose to expand managed care in any form to most rural counties, effectively leaving Medi-Cal beneficiaries in the fee-for-service system.

In a report titled HMOs and Rural California, released in August 2002, we examined the reasons for the withdrawal of health plans from California's rural areas, a situation that poses a major barrier to any expansion of Medi-Cal managed care to these communities. We recommended a number of steps to create a more attractive health care marketplace for health plans in these areas, and state assistance to rural counties to establish locally controlled health care systems that could have some of the benefits of managed care.

Analyst's Recommendations

In concept, we support the Governor's proposal to expand managed care, given its potential to both achieve state savings and to improve the quality and access to care in Medi-Cal. We note that the shift of beneficiaries to managed care could be impractical without successful implementation of another significant proposal in the redesign package—hospital payment restructuring—for reasons that we will explain later in this analysis. In any event, the Legislature should await more detailed information from DHS before it acts on the budget request and legislative changes that are proposed to carry out this component of the Governor's plan. Specifically, DHS should advise the Legislature on how it will strengthen the existing managed care system and what other measures it will take to ensure a smooth and successful transition of beneficiaries into managed care.

We further recommend that the Legislature explore other steps it could take at this time to make managed care an option in the future for Medi-Cal beneficiaries in rural counties. Some steps may not be possible to accomplish now because of their costs. However, others, such as enactment of a statutory model for locally controlled health plans or clarification of antitrust regulations in rural areas, have little cost and could move ahead.

Limitations on Adult Dental Benefits

We recommend that the Legislature defer action on the administration's proposal to limit adult dental benefits and direct the Department of Health Services to provide additional information on the proposed limit's potential impact on beneficiaries.

Annual Spending Cap Proposed for Adults

The Medi-Cal redesign proposal would establish an annual limit of $1,000 for certain dental services provided to adult Medi-Cal enrollees. In addition to excluding all children's dental benefits from this limit, this restriction would not apply to certain other dental services for adults, such as emergency services or services provided in hospitals. The DHS estimates that about 95,000 Medi-Cal adult enrollees would be affected by the limit (including 54,000 aged, blind, or disabled eligibles) and that it would result in net General Fund savings of about $26 million ($51 million all funds).

Assessing the Governor's Proposal

Proposal Seeks to Imitate Private Insurance. The administration's proposal seeks to more closely align Medi-Cal benefits with those offered by private dental insurance coverage, although the amount of the cap would differ from private sector coverage. Delta Dental, a private insurer that accounts for a majority of the private dental insurance market in California, limits benefits to $2,000 annually for its coverage for state workers. The DHS contends the proposed Medi-Cal limit is roughly equivalent to Delta's because Medi-Cal pays substantially lower rates to dentists, allowing the program to obtain dental services similar to private plans with a lower spending limit.

In concept, imposing a limit to contain Medi-Cal Program costs makes sense. The proposed limit would affect a relatively small group—about 3 percent of adult beneficiaries. While all Medi-Cal recipients have dental benefits, as many as 44 percent of Californians are estimated to have no dental coverage. For many, direct payment for basic dental services is viewed as a less expensive option than paying for insurance. The administration proposal could be implemented fairly easily in comparison to other Medi-Cal redesign components.

Some Complications Could Arise. The specific approach proposed by the administration raises some concerns. Some procedures such as root canals and tooth restorations that are commonly performed together could put Medi-Cal patients over their annual limit. The DHS has not provided information regarding how these proposed limits would affect dental services for the 95,000 affected beneficiaries. For example, it is possible that all 95,000 would lose a similar, moderate number of services each year under the proposed limit. However, another scenario could be that a small portion of the 95,000 would lose a significant number of services, while the rest would see only a modest reduction in services. Alternative approaches could provide Medi-Cal patients greater flexibility in use of their dental benefits while offering the state some significant savings. For example, a higher dollar limit established over a longer period of time (such as two years) could provide some savings while permitting more one-time procedures such as dentures that would exceed a lower limit.

Dental Managed Care Option. In addition to the administration proposal, or as an alternative, the Legislature could explore the concept of expanding dental managed care coverage for Medi-Cal beneficiaries. The state now provides dental services through capitated arrangements for beneficiaries in some areas. One study suggests that dental managed care plans both improve care and reduce state costs below the amounts paid for dental services on a fee-for-service basis.

Analyst's Recommendations

We concur generally with the concept of tailoring the Medi-Cal dental benefit for adults to conform more closely to private coverage. However, we believe the administration should provide the Legislature with additional information on the proposal's impact on beneficiaries. Accordingly, we recommend that the Legislature direct DHS to present the Legislature with more information regarding how its proposed limit would affect the services of Medi-Cal beneficiaries. The DHS should also provide the Legislature with an estimate of the potential savings from alternative approaches, such as a higher two-year cap or an expansion of dental managed care plans, that might provide additional flexibility to beneficiaries while still achieving some state savings.

Establishment of Enrollee Premiums

Another Medi-Cal redesign component would charge certain enrollees monthly premiums to participate in the program. While we support the imposition of premiums in concept, we recommend that the Legislature defer action on the administration's proposal and direct the Department of Health Services to present it with updated projections on the caseload and fiscal effects of the proposal and an analysis of alternatives.

Monthly Premiums Would Be Similar to Healthy Families

Poorest Beneficiaries Would Be Exempt. Under the Governor's budget proposal, certain Medi-Cal enrollees would pay monthly premiums of $4 per month for a child and $10 per month for adults, with a monthly cap of $27 for each family. Individuals with incomes greater than the federal poverty level (about $15,700 a year for a family of three) would be required to pay the premiums, as would aged, blind, and disabled enrollees with incomes above the CalWORKs eligibility level (about $9,700 per year for individuals and about $17,100 per year for a couple). Certain individuals would be exempt from the premiums, including infants under one year of age, and Medi-Cal "share-of-cost" enrollees who must already pay out of their own pocket for some of their medical expenses before receiving Medi-Cal coverage.

These premiums would be generally consistent with those charged by the Healthy Families Program, which also provides health insurance coverage for children. Similar to Healthy Families, the newly established Medi-Cal premiums would not be charged for coverage provided retroactively. Enrollees could pay the premiums through the mail, over the phone, at certain collection points, or through automated payroll deductions and bank withdrawals, with discounts of about 25 percent for payment of three months in advance. Medi-Cal would disenroll beneficiaries who did not pay the premiums for two consecutive months.

Timetable for Changes. Under the Governor's budget plan, enrollees would not begin paying premiums until January 2007. In the interim, the state would obtain necessary federal approval, contract with a vendor to collect the premiums, and identify the Medi-Cal enrollees required to pay them. The administration estimates that about 460,000 children and nondisabled adults and 90,000 aged and disabled individuals would be subject to premiums and that the change would result in annual General Fund savings of about $22 million ($43 million all funds) beginning in 2007-08.

Assessing the Governor's Proposal

Enrollment Decrease, But Extent of Drop Unclear. Research on the effects of cost-sharing in health programs indicates that some decrease in enrollment is almost certain to result from the imposition of premiums in programs such as Medi-Cal. However, the extent of the enrollment drop, and which income groups would most be affected, is unclear. Academic research on these points has been contradictory, for example, in regard to whether cost-sharing strategies such as premiums have more of an effect on those families with higher incomes or those with lower incomes.

Oregon has been cited as an example of a state where such changes greatly depressed program enrollment. However, Oregon's Medicaid program imposed premiums on certain enrollees with incomes below the federal poverty level, including enrollees with no reported income at all, and individuals were removed from the program for just one month of nonpayment. Because the design of the Oregon program is different from the Governor's proposal, its results may not apply to California.

Administration Reviewing Its Estimates. When it prepared its premium proposal, the administration estimated that the proposed premiums would result in a 20 percent reduction in enrollment among the affected eligibility categories. However, the actual decline in utilization of medical services is expected to be substantially less because many enrollees would rejoin the program as they needed medical services. Even so, disenrollment effects would account for over one-third of the estimated gross savings. However, DHS now indicates that it is reviewing whether its estimates of disenrollment, and its associated savings, are too high. Thus, the caseload and fiscal effects of the administration proposal are unclear.

Cost-Sharing Proposal Reasonable. The establishment of premiums is a reasonable cost-containment option for the Legislature to consider. Notably, many enrollees who would be subject to premiums were not eligible at all for Medi-Cal until eligibility for the program was expanded about five years ago. Could these Medi-Cal beneficiaries afford to pay premiums? One recent study by the Kaiser Commission on Medicaid and the Uninsured indicates that low-income families typically spend 7 percent of their income on health care and a combined 22 percent on entertainment, apparel, and other miscellaneous items. The administration's proposed premiums would amount to between 1 percent and 2 percent of the enrollees' incomes.

Finally, some research has indicated that some individuals may prefer to enroll in health programs that have characteristics, such as premiums, that make them comparable to private insurance plans. For these enrollees, there might be less of the stigma than they may otherwise attach to participation in public health coverage.

Are Premiums the Best Approach to Cost-Sharing? It is not clear that the form of cost-sharing proposed by the administration would be the most effective way to hold down costs in the Medi-Cal Program. Premiums required for participation in Medi-Cal are more likely to reduce utilization for all types of services, potentially reducing the use of preventive medical services (like regular doctor's checkups) that could catch medical problems early and prevent more costly medical problems later. One alternative approach would be to seek a federal waiver to impose meaningful copayments for a targeted list of services, such as the nonemergency use of emergency rooms. However, we note that some attempts by other states to impose such copayments have been blocked in the courts. Nonetheless, the Kaiser Commission indicates that new or increased copayments were imposed by 20 states in fiscal years ending in 2004 and nine states in fiscal years ending in 2005.

Analyst's Recommendation

While we support the imposition of premiums in concept, we recommend that the Legislature defer action on the administration's proposal and direct DHS to present updated projections on the caseload and fiscal effects of the premium proposal, and DHS' analysis of the alternative of imposing copayments for a targeted list of services.

County Administration Monitoring

One component of Medi-Cal redesign requests additional resources to monitor county administration of eligibility. We recommend approval of part of the requested staff to monitor counties' performance. The Legislature could further consider requests for additional monitoring resources after the Department of Health Services has provided the Legislature with (1) an accounting of the progress that has been made to date in improving county eligibility activities and (2) the required report on the county operating guidelines.

Eligibility Determinations Have Been a Problem

Counties Handle Processing Work. The state currently delegates most administration for Medi-Cal eligibility determinations and redeterminations to the counties and reimburses them with state and federal funds for this work. Federal and state laws require the counties to complete initial eligibility determinations within 45 days of application and to annually redetermine enrollees' eligibility. The state has recently taken steps to improve the process, including the establishment of county performance standards for completing eligibility determinations and redeterminations, and the imposition of requirements that counties more regularly reconcile their eligibility rolls with the state's central eligibility system. The DHS is also working with counties to develop operating guidelines covering staffing levels, overhead, and wage increases to control costs while also enabling timely eligibility processing.

The administration proposes that the state contract with a vendor to monitor compliance with the state performance standards for counties that were established in 2003. In effect, DHS is asking for resources in the 2005-06 budget to perform activities for which it was previously granted staff. In the 2003-04 budget, the Legislature authorized nine new DHS positions for this purpose. However, DHS selected these positions and the related funding for elimination as part of that year's mandated statewide reductions in state operations.

The current Medi-Cal redesign proposal is estimated to cost $1.5 million from the General Fund ($3.4 million total funds) once fully implemented. No additional savings from the proposed monitoring effort are assumed beyond those previously budgeted.

Assessing the Governor's Proposal

An Inconsistent Process. As we noted in our Analysis of the 2003-04 Budget Bill (see page C-56), state costs for the county eligibility processing have increased rapidly since the mid-1990s. Counties have been inconsistent in the way they interpret eligibility rules, in what they spend on making eligibility determinations, and in the time they take to process applications. The state's method of allocating funding for eligibility administration, which is partly based on county staffing levels, does not assess county productivity and may actually reward inefficient counties. The 2003-04 Analysis discusses several options for improving the county eligibility determination process.

Proposal May Be Premature. The Medi-Cal redesign proposal may be premature in that it requests additional resources to improve county eligibility administration before the effects of current efforts are known. For example, DHS is now working with seven counties that reportedly failed to meet the state's new performance standards. Also, the DHS has not yet submitted to the Legislature, as required, a progress report on the operating guidelines for county eligibility offices. Thus, a full accounting of the improvements achieved to date from these prior actions has not yet been provided to the Legislature.

Analyst's Recommendation

Absent a full report on the status of current reform efforts, the administration proposal to provide funding for a vendor for a full statewide monitoring effort is not justified. Nonetheless, some limited monitoring on a targeted basis may be prudent given that DHS currently relies on self-reporting by counties on their performance. The Legislature may wish to consider providing resources to monitor the limited number of counties that process most Medi-Cal applications or that may have encountered problems carrying out these duties in the past. Accordingly, we recommend approval of four two-year limited-term positions to monitor selected counties' performance on an exploratory basis. The Legislature could consider requests for additional monitoring resources after DHS has provided (1) a complete accounting of the progress made to date in improving county eligibility activities and (2) the required report on the county operating guidelines.

Streamlining Children's Eligibility Processing

Another component of the proposed Medi-Cal redesign would modify the way the state processes applications for Medi-Cal received through its single point of entry program. We recommend that the Legislature approve this proposal and provide on a limited-term basis a portion of staffing requested.

Single Point of Entry System

Some Applications Forwarded to Counties. In 1999, the state implemented a single point of entry (SPE) to process Healthy Families applications and some Medi-Cal applications to improve coordination of the two programs. An SPE contractor reviews certain applications and makes an initial determination when an applicant appears to be eligible for Medi-Cal. The application is then forwarded to the individual's county of residence, where a county eligibility officer makes the final determination. The DHS estimates that 83,000 applications will be handled this way in 2005-06.

While the SPE provides a uniform, centralized process for receiving, processing, and tracking health program applications, some current practices result in delays and increased Medi-Cal costs. For example, after the SPE determines a child to be initially eligible for Medi-Cal, he or she is placed on the Medi-Cal rolls on an interim basis. If the county later finds that the child is actually ineligible for Medi-Cal, the child is removed from the Medi-Cal rolls. In the interim, however, the state will have paid medical costs for an ineligible child.

State Savings Possible. One component of the Medi-Cal redesign would expand the SPE's role in making Medi-Cal eligibility determinations. After making its initial eligibility determination, the SPE would complete income and immigration status verifications and prepare an eligibility recommendation for the state. State workers, rather than county eligibility offices, would then make the final determination. The case would still be forwarded to the county for ongoing case management and future redeterminations of eligibility.

The DHS estimates that this would reduce state costs by shortening the time during which ineligible children were enrolled in Medi-Cal and by reducing county administration costs. Once fully implemented, the proposal is estimated to generate net General Fund savings of about $7 million ($9 million all funds) annually. It could further benefit the state by allowing eligibility rules to be applied in a more consistent fashion. Adoption of this change would also provide an opportunity to evaluate a centralized process for broader use in Medi-Cal. In our 2003-04 Analysis, we recommended that the Legislature study such an approach. We estimated that a $50 drop per eligibility determination could result in $150 million in General Fund savings statewide.

Analyst's Recommendation

Given the significant problems in the existing system for processing applications for Medi-Cal, and the prospects for testing the merit of centralizing all eligibility processing at the statewide level, we recommend that the Legislature approve this proposal and provide a portion of the staffing requested on a limited-term basis.

Alter Enrollment of Health Care Providers

The administration's Medi-Cal redesign plan provides little information about a proposal to expedite the processing of medical providers so that they may participate in the Medi-Cal Program. We withhold recommendation until a complete proposal is submitted to the Legislature.

Backlog in Medi-Cal Provider Enrollments

Health care providers who wish to participate in the Medi-Cal Program must undergo an application process and be certified. The state performs background checks to ensure they are high-quality providers and to reduce the risk of provider fraud. Processing has slowed in recent years, however, leading to a backlog of these applications. The Medi-Cal redesign package includes a proposal to improve automation and tracking systems, establish a call center to answer provider questions, and hire additional state staff to address the backlog. Information explaining this proposal is to be submitted to the Legislature this spring.

Analyst's Recommendation

We recommend that DHS be directed to submit its proposal to the Legislature no later than April 1 (concurrent with April Finance letters) to provide sufficient time to evaluate this proposal. We withhold recommendation pending receipt and review of the proposal.

Requested Support Resources Appear Excessive

The Department of Health Services has requested $19,410,000 ($7,141,000 General Fund) and 86.5 positions to implement its Medi-Cal redesign proposals. These requests include funding for staff, information technology consulting services, and contract services. Our analysis indicates that some of the proposed positions and related funding are unnecessary at this time. As such, we recommend that the Legislature approve 68.5 of the requested positions and $5,847,000 ($2,391,000 General Fund) of the related funding.

Request for Personnel. Figure 3 summarizes the positions requested to implement the proposed Medi-Cal Redesign components. Our analysis indicates that some of the positions requested exceed the number which are justified on a workload basis at this time. In addition, some positions appear to be a modification of continuing DHS workload rather than a true increase in workload. Others are not likely to be needed until the redesign proposals reach later stages in their proposed implementation, or will no longer be needed once the transition period of making these changes is over.

Analyst's Recommendations. We recommend that the Legislature approve 39 permanent positions and 29.5 limited-term positions in order to implement the Medi-Cal redesign proposals, for General Fund savings of about $600,000 in 2005-06 from a reduction in the requested positions. Our findings and recommendations regarding the requested staffing are summarized as follows:

• Expand Medi-Cal Managed Care. The additional workload necessary to implement this proposal does not justify the establishment of all 47.5 requested positions. We recommend approval of 42 positions, four of which should be limited-term.
• Restructure Hospital Payment System. The workload for some of the requested positions would replace existing tasks rather than be new workload. Other requested positions would likely be needed only in transition to a new system. We recommend approval of five of the 12 requested positions, four of which should be limited-term.
• Dental Benefit Limit for Adults. We withhold recommendation at this time pending additional information from the administration.
• Establish Enrollee Premiums. We withhold recommendation at this time pending additional information from the administration.
• Streamline Eligibility Processing for Children. We believe that this proposal should be viewed as a pilot program, the results of which should be reviewed at a later date. Much of the proposed workload would not begin until DHS prepares to implement the proposed process in early 2006, and it is unclear that all requested positions are necessary. As such, we recommend approval of 17.5 limited-term positions, four of which should be effective beginning July 1, 2005. The remaining 13.5 positions should be authorized beginning January 1, 2006.
• Monitor County Administration. We believe it would be more efficient for state staff to perform the proposed monitoring on a targeted basis rather than contracting out this function. Also, it is unclear at this time that the proposed workload is necessary on a long-term basis. We recommend authorization of four limited-term positions to perform this work in lieu of the staff and contract resources requested.

We withhold recommendation at this time on the request for staff and contract resources to move forward with information technology (IT) projects related to the redesign efforts. As we discuss in our analysis of the DHS state operations budget, the IT-related budget request was submitted to the Legislature without following state administrative procedures that ordinarily require completion of an approved feasibility study report (FSR) before such a project can be budgeted. No FSR is available at this time for these projects.

Conclusion

The administration's redesign proposals warrant careful consideration by the Legislature, given our projections of continued caseload and expenditure growth in the Medi-Cal Program and the state's fiscal difficulties. The Governor's approach for long-term changes to Medi-Cal addresses some of the key factors affecting the quality of services and the continuing growth in the cost of the program to the state.

Except with respect to the proposed managed care expansion and restructuring of hospital finances, the administration's redesign proposal is relatively modest. For this reason, the Legislature may wish to view the package as a starting point to implement a broader reform of the program.

Hospital Financing Plan Could Begin To Right Ailing System

California's hospitals continue to face a variety of fiscal challenges that weigh particularly heavily on public hospitals. In response to continuing financial troubles for hospitals and recent federal steps to alter central aspects of federal funding provided for them, the administration is negotiating with the federal government for a comprehensive redesign of hospital financing. Our review of the plan now under development suggests that it could help preserve the financial stability of California's public hospitals, but the plan also raises some significant fiscal and policy issues.

Public Hospitals Continue to Face Significant Fiscal Pressures

Three major groups of hospitals account for almost all hospital revenue in California. The first group consists of investor-owned hospitals, such as Tenet Healthcare, which generally are shareholder-owned businesses. A second group is the nonprofit hospitals, which include organizations such as Sutter Health and Catholic Healthcare West. Public hospitals comprise the third group, which, for purposes of this discussion, consists of hospitals owned and operated by county governments or the University of California (UC). In our Analysis of the 2002-03 Budget Bill (see page C-38), we described various financial pressures facing California hospitals. Our analysis indicates that these problems continue today.

The cost of providing uncompensated care—which is incurred whenever a patient is unable to fully or even partially pay for their care—is a major factor that has created financial pressures for many hospitals. This is particularly the case for public hospitals that serve large numbers of low-income patients. State-collected data indicate that California hospitals collectively incurred more than $4.7 billion in uncompensated care costs during 2003. County hospitals experienced the largest increase in uncompensated care costs per hospital during the past five years, as shown in Figure 4, and today bear the greatest share of these costs, as shown in Figure 5.

Regulations mandating hospitals to staff one nurse for every six patients on general medical floors, and a state law requiring that hospital buildings meet specified earthquake-safety standards in the future, are also adding to financial problems.

Key Federal Mechanisms Significantly Influence Hospital Financing

The federal government closely regulates Medicaid transactions with hospitals through the federal Centers for Medicare and Medicaid Services (CMS), the main federal agency responsible for the Medicaid Program (Medi-Cal in California). Two financial mechanisms permitted under federal law have had particularly significant influence on California hospital operations in recent years: waivers and intergovernmental transfers. We provide more detailed information below on what these financial mechanisms are, how they work, and what they mean for California hospitals.

Federal Medicaid Waivers Integral to Hospital Financing

The federal government authorizes state governments to operate outside the standard Medicaid rules by approving requests by states to waive specific requirements of the federal program. Two such Medi-Cal waivers—the Selective Provider Contracting Program (SPCP) waiver and the Los Angeles County (LA County) demonstration project waiver—govern the majority of Medi-Cal fee-for-service hospital inpatient care in California. By fee-for-service care, we mean that the state reimburses a hospital or other medical provider on the basis of billings submitted for each service provided to a Medi-Cal patient. In comparison, managed care organizations operate under a "capitated" arrangement, in which they receive a predetermined level of compensation each month for agreeing to provide care for each Medi-Cal patient who enrolls in their plan.

Selective Provider Contracting Program. Under the SPCP waiver, the California Medical Assistance Commission (CMAC) negotiates daily rates for general acute care hospital inpatient services on behalf of the Medi-Cal Program. By picking and choosing the hospitals that get most of the state's Medi-Cal business, and bargaining with them for the best rates, the state is generally able to negotiate lower rates for hospital services through CMAC than if it simply allowed all hospitals to serve Medi-Cal patients and bill the state for services.

The SPCP waiver is now a central component of the Medi-Cal program. For example, in 2002-03 (the most recent year for which complete data are available), hospitals with SPCP contracts provided 2.2 million days of inpatient care, about 90 percent of all fee-for-service inpatient hospital days for Medi-Cal patients and 18 percent of all general short-term hospital inpatient days in California. The SPCP hospitals also received 84 percent of all money spent under Medi-Cal in 2002-03 for fee-for-service general hospital inpatient days.

The SPCP waiver is ordinarily subject to renewal by federal authorities every two years. Medi-Cal recently received a six-month extension for its current two-year SPCP waiver, which is now set to expire June 30, 2005.

LA County Demonstration Project. The current LA County waiver, which we discuss in more detail later in this Analysis, provides an alternate reimbursement mechanism for certain county health care providers in order to financially stabilize the county's safety net for indigent health care. Under the terms of the waiver, LA County will have received an extra $900 million in federal funds and an extra $150 million in state funds over five years. Specifically, Medi-Cal (using federal and state funds) reimburses 100 percent of "reasonable costs" for 30 health care providers in LA County, including six hospitals that collectively received $1.2 billion (total funds) in Medi-Cal payments during 2003. This five-year waiver—the second such demonstration project for LA County permitted by federal authorities—will expire June 30, 2005.

Intergovernmental Transfer Funding for Public Hospitals

Various Intergovernmental Transfers. California uses so-called "intergovernmental transfers," or IGTs, as a means to obtain additional federal funds for payments to both public and private hospitals. Under an IGT mechanism, public entities, including county and UC hospitals, transfer funds to the state, which then pays the money back to hospitals, along with the matching federal funds available under the Medicaid Program. Variations of this mechanism have been employed in California since the early 1990s. As shown in Figure 6, IGT arrangements typically result in net financial gains to both the state government and, typically, to the local entities that put up the local funds used to draw down federal matching funds.

Medi-Cal makes use of IGT funding for two key hospital funding programs:

• Disproportionate Share Hospital (DSH) Program. The state began the DSH program in 1991 to obtain federal funds through IGTs to supplement public and private hospitals that serve a particularly high share of Medi-Cal and other low-income individuals. The DSH funds help to offset hospitals' uncompensated care costs. A hospital's eligibility for DSH funding is determined annually according to federal requirements and is based on the percentage of Medi-Cal and other low-income patients the hospital serves relative to its total number of patients. State law allocates DSH funds based on the number of Medi-Cal inpatient service days provided by each hospital. In 2003-04, 126 California hospitals received $990 million in federal DSH funds. In keeping with federal statute, Congress has allocated about $1 billion annually in DSH funds for California in federal fiscal years 2004 (October 2003-September 2004) and 2005 (October 2004-September 2005).
• Senate Bill 1255 Program. The Emergency Services and Supplemental Payments Fund, commonly called the SB 1255 program, also relies upon an IGT funding mechanism. Under this program, hospitals negotiate supplemental payments with CMAC as part of their contracts to provide inpatient services to Medi-Cal patients. To be eligible for SB 1255 funds, hospitals must contract with Medi-Cal for inpatient services, qualify for DSH funding, and generally provide certain emergency care services. The state provided SB 1255 payments totaling about $1.7 billion (state and federal funds) to 82 hospitals in 2003-04.

Funding Sources Vary Among Hospitals. Different categories of hospitals vary widely in the degree to which they rely on Medi-Cal, DSH payments, and SB 1255 or other supplemental payment