Analysis of the 2006-07 Budget Bill Legislative Analyst's Office February 2006

Medi-Cal (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 federal funds for (1) disproportionate share hospital (DSH) payments and other supplemental payments, which provide additional funds to certain hospitals that serve Medi-Cal or other low-income patients; and (2) matching funds for state and local funds in other related programs.

Governor’s 2006-07 Medi-Cal Budget Proposal

The budget proposes Medi-Cal expenditures totaling $35 billion from all funds for state operations and local assistance in 2006-07. Figure 1 displays a summary of Medi-Cal General Fund expenditures in the Department of Health Services (DHS) budget for the past, current, and budget years. The General Fund portion of the spending for local assistance ($13.7 billion) increases by about $542 million, or 4.1 percent, compared with estimated General Fund spending in the current year. However, this understates expenditure growth in this program. This is because about $359 million that would have previously been included in the DHS General Fund budget for Medi-Cal (about $340 million in base costs for mental health services plus $19 million in related caseload growth) is proposed to be shifted to the Department of Mental Health (DMH) budget in a purely technical change. If these funds were to remain in the Medi-Cal budget, General Fund expenditures for Medi-Cal would total $14.1 billion, an increase of $901 million, or 6.8 percent.

The remaining expenditures for the program are mostly federal funds, which are budgeted at $20 billion, or 2.3 percent more than estimated to be received in the current year. In addition, the spending total for the Medi-Cal budget includes an estimated $708 million in local government funds for payments to DSH hospitals. About $3.9 billion of total Medi-Cal spending consists of funds budgeted for programs operated by other departments, counties, and the University of California.

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 ($493 Million Cost). The budget plan proposes a $493 million increase in General Fund expenditures for “baseline” costs for prescription drugs and inpatient hospitals. These increases are unrelated to any change in state policy and are due to estimated increases in caseload, costs, and utilization of services mostly by aged, blind, and disabled beneficiaries.

• Medicare Part D Adjustments ($212 Million Cost). The federal Medicare Modernization Act passed in 2003 created the new Part D prescription drug benefit that shifted drug coverage for persons eligible for both Medi-Cal and Medicare (referred to as dual eligibles) to the federal Medicare program effective January 1, 2006. The Governor’s budget projects that this shift will result in a net increase in costs of $212 million General Fund in 2006-07. The factors contributing to the net increase include a $1 billion General Fund reduction in drug costs. This savings would be more than offset by increased costs of (1) $768 million resulting from state contributions to the federal government required by the law and (2) a loss of $544 million General Fund from the decrease in rebates now paid by drug manufacturers to the state.

• Medicare Premiums ($147 Million Cost). The Medi-Cal Program pays the 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 $147 million in 2006-07.

• Reversal of Savings From One-Time Actions ($49 Million Cost). The 2005-06 budget plan achieved savings of $183 million for the General Fund by claiming federal funding for prenatal services provided 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 amount of savings reflected two years of claiming. Savings to the state are expected to be $91 million less in 2006-07 because the budget request is now based on only one year of claiming. In addition, the budget plan assumes the state will achieve $42 million in savings in 2005-06 on a one-time basis from the settlement of a lawsuit related to the state being overcharged for a drug used by AIDS patients.

• Cost and Caseload Increases ($115 Million Cost). Medi-Cal managed care plans are expected to experience increased costs of nearly $70 million General Fund due to growth in the number of enrollees. Rate increases provided to certain long-term care facilities as required by Chapter 875, Statutes to 2004 (AB 1629, Frommer), are also expected to increase General Fund expenditures by more than $40 million in the budget year. In addition, General Fund costs for legal immigrants whose benefit costs are not shared by the federal government are expected to increase by $23 million. These costs are partly offset with $18 million in General Fund savings that are projected to result from a 5 percent reduction in the rates paid to certain providers that went into effect upon the resolution of a court case challenging the rate reduction. The budget plan reflects the automatic end of the rate reduction in January 2007, consistent with current state law.

• Expansion of Children’s Coverage ($20 Million Cost). As part of the Governor’s proposal to expand medical coverage for California children, the Medi-Cal annual redetermination form is being revised to make it easier for Medi-Cal beneficiaries to complete. This change is projected in the budget plan to increase caseload and related General Fund costs by $20 million in 2006-07. The budget plan includes other proposals to increase the Medi-Cal children’s caseload.

• Mental Health Funding Shift ($359 Million Savings). As mentioned previously, about $359 million in the Medi-Cal General Fund was shifted to the DMH budget in a purely technical change to more accurately reflect the program for which these expenditures are made.

• Hospital Financing Waiver Savings ($121 Million Savings). Following an increase of $135 million in General Fund costs in 2005-06 for hospital services, the Governor’s budget proposal reflects a decrease of $121 million in these costs for the budget year. This is due to a shift of certain Medi-Cal hospital costs to local governments under the terms of a statewide hospital financing waiver provided by the federal government and state legislation (Chapter 560, Statutes of 2005 [SB 1100, Perata]).

Caseload Projection Reasonable

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 unknown effects of the budget proposal to increase children’s enrollment and continuing effects of recent policy changes. We will monitor caseload trends and recommend appropriate adjustments at the May Revision.

Administration’s Caseload Projections. The budget projects that the average monthly caseload of individuals enrolled in Medi-Cal will grow in the current and budget years. However, we note that the current-year projections are nearly 60,000 below the caseload assumed in the 2005-06 Budget Act. The Governor’s budget plan estimates caseload growth from 2004-05 to be 1.5 percent in 2005-06 and nearly 2 percent in 2006-07. The Governor’s estimated growth rates for the current and budget year are projected to somewhat exceed the overall state population growth rates.

Nonwelfare Families Caseload Continues to Grow. Figure 2 shows the budget’s forecast for the Medi-Cal caseload in the current year and 2006-07. 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 1.2 percent in the current year and an additional 1.4 percent in the budget year, although these overall increases mask some larger, contrasting trends within this category. Nonwelfare families account for most of the caseload increases. The budget estimates that the caseload of Medi-Cal eligible nonwelfare families will increase by about 4 percent in the current year and by an additional 2 percent in the budget year. Some of this projected budget year growth is the result of the Governor’s proposal to simplify the annual redetermination form, which is expected to result in a caseload increase of 18,000. However, caseload for the California Work Opportunity and Responsiblity to Kids (CalWORKs) families is expected to decline by 3.7 percent in the current year and remain flat in the budget year, reflecting overall CalWORKs trends.

The overall projection of nonwelfare families and children caseload growth appears consistent with recent trends and generally reflects growth rates that may be gradually slowing. However, the impact of ongoing changes in Medi-Cal is hard to predict, and significant revisions to the projection could be occurring for various reasons. The Governor’s budget proposals to increase children’s enrollment in Medi-Cal and the continuing effects of recent policy changes, such as funding Medi-Cal application assistance in the 2005 budget, add uncertainty to the 2006-07 caseload projection.

Significant Growth in Medically Needy Aged and Disabled. Caseloads for the aged, blind, and disabled are expected to grow by about 51,000 beneficiaries, or about 3 percent, in the current year and by an additional 56,000 beneficiaries, or about 3 percent, in the budget year. The increase in the current year is consistent with underlying population 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, 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 20,500, or 11 percent, in 2006-07, and the disabled caseload is expected to grow by about 11,200 or 10 percent. Some of the projected growth in the aged and disabled population that qualifies as medically needed is also expected to result from the Governor’s proposal to simplify the annual eligibility redetermination form.

The public assistance and long-term care eligibility categories project modest growth of less than 2 percent for the aged, blind, and disabled in 2006-07. These categories are not assumed to be affected by the Governor’s proposal to change the annual eligibility redetermination form.

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 simplification of the annual eligibility redetermination form will result in fewer eligibles than assumed in the Governor’s budget plan, it is also possible that this action, combined with other actions to increase the children and families caseload, could result in caseload growth that is greater than projected. Given this situation, we will continue to monitor Medi-Cal caseload trends and will recommend any appropriate adjustments to the budget estimate at the May Revision.

The Effect of the Medicare Drug Benefit on Medi-Cal

The January 1, 2006 rollout of the new Medicare Part D prescription drug benefit has had a direct and immediate impact on the state’s Medi-Cal Program and the approximately one million beneficiaries whose drug coverage was shifted from Medi-Cal to Medicare. In this analysis, we briefly review implementation of Part D, describe the state’s response to recent implementation problems, and recommend that the Legislature reduce state spending by about $330 million in the current year and budget year combined to adjust for this rapidly changing situation. (Reduce Item 4260-101-0001 by $275 million.)

Background

The Medicare Prescription Drug, Improvement and Modernization Act, also referred to as the Medicare Modernization Act (MMA), became law on December 8, 2003. The Medicare drug benefit component of MMA, known as Part D, went into effect beginning January 1, 2006. As of that date, Medicare began to pay for outpatient prescription drugs through prescription drug plans (PDPs) and through Medicare managed care plans known as Medicare Advantage. The implementation of Medicare Part D has already had far-reaching fiscal and policy implications for the state, which we describe in more detail later in this analysis. For further information on the Medicare Part D drug benefit and its impact on the state, please see our Analysis of the 2005-06 Budget Bill (page C-105, “Part ‘D’ Stands for ‘Deficit’: How the Medicare Drug Benefit Affects Medi-Cal”).

Medicare and Medicaid. The two major federally supported health programs are Medicare and Medicaid, both of which are administered by the U.S. Centers for Medicare and Medicaid Services (CMS). Medicare is a federal health insurance program that provides coverage to eligible seniors and persons with disabilities (SPDs). Most individuals 65 and over are automatically entitled to some Medicare coverage if they or their spouse are eligible for Social Security payments. People under 65 who receive Social Security cash payments due to a disability generally are eligible for Medicare after a two-year waiting period.

Medicaid (known as Medi-Cal in California) provides health care services to welfare recipients and other qualified low-income persons, primarily families with children and SPDs. Medi-Cal is administered by the state Department of Health Services (DHS). Medi-Cal costs are shared about equally between the state General Fund and federal funds.

Dual Eligibles. So-called “dual eligibles” are individuals who are entitled to some Medicare benefits and some Medicaid benefits. In California, about one million dual eligibles are enrolled in Medicare and Medi-Cal. Dual eligibles tend more often than the population generally to be in fair or poor health due to chronic illnesses and conditions that require ongoing treatment.

Mandatory Transition for Dual Eligibles to Part D. As of January 1, 2006, dual eligibles who had been receiving their drugs through the Medi-Cal Program began to receive their drugs instead through the new Part D benefit. Those dual eligibles that had not enrolled with a PDP or a Medicare Advantage plan during a voluntary enrollment period that began November 15, 2005 and ended December 31, 2005 were automatically assigned to a Part D provider. Generally, this assignment was made without any review as to whether a drug plan’s formulary is the most appropriate for the patient. However, dual eligibles are permitted to transfer to another PDP or Medicare Advantage plan if they find another provider would better meet their needs.

Also effective January 1, 2006, the state lost almost all federal matching funds for drugs that had previously been provided to the dual eligibles under the Medi-Cal Program. (The federal government will continue to share in the cost of these drugs for other Medi-Cal beneficiaries.) As a result, under the terms of MMA, any continued coverage the state were to provide for dual eligibles would generally be paid for entirely with state General Fund resources. The state is able to receive a federal match for certain drugs for dual eligibles that are not covered under Medicare Part D, such as over-the-counter drugs or certain medical supplies. Coverage for these drugs is often termed “wraparound” coverage.

The Effect of Part D on the Medi-Cal Budget

The implementation of the Part D benefit affects the Medi-Cal budget in several important respects. The DHS estimates that, after a series of separate budgetary components of Part D have been taken into account, the overall result will be a net General Fund savings to Medi-Cal local assistance of about $205 million in 2005-06 and that cost and savings will mostly offset each other in 2006-07.

However, we note that these budget estimates were prepared by the administration before a recent decision by federal CMS administrators that could significantly increase the state savings in the Medi-Cal Program that will result from the implementation of the new Medicare drug benefit. We discuss these recent developments later in this analysis.

Below we describe several of the major components of implementing Part D that affect the Medi-Cal budget in the near term. Figure 3 summarizes the fiscal effects of Part D as it is reflected in the 2006-07 Governor’s Budget proposal.

Medicare Part D Drug Benefit. As a result of the transition of dual eligibles from Medi-Cal drug coverage to Medicare Part D, the state will no longer pay for drugs for dual eligibles (with a few exceptions that we discuss later). These costs will be funded by the federal government. As a result, the Governor’s budget plan assumes that General Fund costs for drugs for Medi-Cal dual eligibles will decrease by $706 million General Fund in 2005-06 and by about $1.8 billion in 2006-07.

Clawback. The MMA does not allow California or other states to keep all of the savings they will realize from the reduction in their drug costs due to the implementation of Part D drug coverage for dual eligibles. The measure includes a so-called “clawback” provision that is intended to require each state to pay back much of its estimated savings on dual eligible drug coverage to the Medicare Program. The MMA requires the states to pay the federal government 90 percent of their estimated savings in calendar year 2006. During the following nine years, the clawback percentage is reduced by 1.66 percent per year until state contributions reach 75 percent of their estimated drug savings on dual eligibles. The clawback payments would then remain set at that percentage of their estimated savings.

The Governor’s budget plan estimates that the state’s clawback payment will be about $503 million from the General Fund for 2005-06 and at $1.3 billion for 2006-07, the first full year of these payments to the federal government. However, on February 6, 2006, CMS announced that it had reduced the clawback payments it had previously assessed to California and other states on the basis of updated estimates of prescription drug costs for dual eligibles. For California, the revisions will mean a reduction in clawback payments of more than $110 million in the 2006 calendar year. This recent federal action is not reflected in the Governor’s budget plan.

The state Attorney General has announced that California will challenge the clawback payment in court. We provide more detail on this lawsuit in the text box.

Drug Rebates. Under federal law, California and other states may obtain rebates from drug manufacturers that partly offset the cost of the drug coverage they provide for their Medicaid beneficiaries. The shift of dual eligibles to Medicare Part D coverage means that the Medi-Cal Program will receive lower amounts of these rebates in the future since these beneficiaries will no longer receive their drug coverage from Medi-Cal. This decline in the collection of these rebates has the effect of eventually increasing state General Fund costs for the support of the Medi-Cal Program to make up for the loss of these state revenues.

The effect on Medi-Cal from the shift of dual eligibles is likely to be particularly significant because, prior to implementation of Part D, dual eligibles had accounted for about 57 percent of total Medi-Cal drug purchases. Because the collection of rebates often lags as much as a year behind the date when the drugs were initially provided to Medi-Cal beneficiaries, the loss of rebates is not expected to begin to affect the Medi-Cal budget until 2006-07. Specifically, the Governor’s budget plan assumes that the loss of rebates due to Part D coverage will increase state General Fund costs by $544 million in 2006-07.

Managed Care Savings. The Governor’s budget plan reduces the capitation rates paid to Medi-Cal managed care plans for the dual eligible enrollees. This adjustment accounts for the savings that will be realized by these plans on pharmaceutical costs for dual eligibles that will now be covered under Part D. As a result, the Governor’s budget plan assumes that General Fund costs for Medi-Cal managed care plans will decline by about $58 million in 2005-06 and by $115 million in 2006-07.

Wraparound Coverage. As noted earlier, Medi-Cal will continue to provide coverage for dual eligibles of certain drugs that are excluded from Part D coverage. The Governor’s budget assumes that the General Fund cost of wraparound coverage to the Medi-Cal Program will be about $41 million in 2005-06 and about $103 million in 2006-07.

100-Day Prescription Drug Supply. In order to assist in the transition of dual eligiles to Part D, the Governor’s budget plan provided for some added drug benefits in the current year. Specifically, dual eligibles were allowed to obtain 100-day prescription refills in December 2005, in effect allowing them to obtain a larger supply of drugs for which they normally would only have been able to obtain a 30-day prescription. This change was intended to address concerns that implementation of Part D might disrupt dual eligibles’ prescription drug supplies. The Governor’s budget plan assumes the 100-day supply allowance will result in state General Fund costs of about $19 million in the current year.

Miscellaneous Costs Associated With Part D. In addition to the major state fiscal impacts described above, the implementation of Part D was anticipated to result in other, smaller costs to the Medi-Cal Program. This included the costs of beneficiary outreach, provider relations, and eligibility systems changes. The Governor’s budget plan assumes these factors will result in a combined increase in General Fund costs of about $1.8 million General Fund in 2005-06 and $55,000 in 2006-07. The implementation of Part D is also estimated in the Governor’s budget plan to result in state savings on processing of treatment authorization requests, adjudication of claims, and other changes that are expected to amount to about $5.8 million from the General Fund in 2005-06 and about $11 million in 2006-07.

Ongoing Staff Workload for Part D Implementation. The administration budget plan requests four staff positions for DHS in the budget year at a cost of $264,000 from all fund sources ($66,000 from the General Fund) for the third-party liability unit at DHS. This unit has additional workload created by the implementation of the federal Medicare Part D drug benefit, such as resolving problems related to the enrollment of Medi-Cal beneficiaries into Medicare Part D and ensuring that Medi-Cal is the payer of last resort for medical benefits.

State Taking Action to Help Transition to Part D

In our 2005-06 Analysis, we noted that the MMA and CMS had established an aggressive timeline for choosing the providers that will deliver Part D benefits and that this tight schedule could complicate the rollout of the new drug benefit to Medicare beneficiaries. The DHS also voiced concerns at the time that the federal rollout of the Part D benefit would likely result in confusion and uncertainty for dual eligibles.

To address these concerns, the Legislature approved some measures in the 2005-06 Budget Act to assist the dual eligibles with this transition. For example, the Legislature approved about $1.1 million from the General Fund for beneficiary outreach that was conducted by DHS and adopted statutory language directing DHS to develop a plan to provide drug coverage to dual eligibles in the event that the federal implementation of Part D was problematic. However, DHS did not request funds for the implementation of such a plan in the proposed 2006-07 Medi-Cal budget.

Federal Implementation of Part D Has Been Problematic

Medicare Part D coverage for dual eligibles began on January 1, 2006 and, almost immediately, some beneficiaries experienced difficulty obtaining their drugs or were unable to obtain their drugs at all. In response, the state stepped in to ensure that dual eligibles would be able to obtain their drugs while Part D implementation problems were addressed by federal authorities.

Specifically, the Legislature and Governor approved a deficiency request providing $22.5 million in General Fund resources to reimburse pharmacists for prescription drugs given to dual eligibles who were unable to obtain their medications under Part D. The program began on January 12, 2006 and originally was approved to continue on an emergency basis for five days. On January 20, additional legislation was enacted (Chapter 2, Statutes of 2006 [AB 132, Nuñez]), bringing the total General Fund appropriation for these purposes to $150 million from the General Fund so that this emergency drug coverage for dual eligibles could be extended in phases until February 11, 2006. Then, on February 9, legislation was enacted (Chapter 7, Statutes of 2006 [SB 1233, Perata]), to extend this emergency drug coverage to at least February 15, 2006 and, with advance notice to the Legislature, for additional 30-day periods of time until May 16, 2006.

We note that federal authorities have indicated that the states will be reimbursed for most of the costs that they incurred to maintain drug coverage for dual eligibles. However, at the time this analysis was prepared, it was unclear how much of these costs would be reimbursed or the time frame for reimbursement.

Adjustments to Governor’s Budget Plan Warranted

Our analysis of the Governor’s budget plan indicates that the state is likely overbudgeted in several areas as it takes into account the various fiscal effects of Medicare Part D. We outline our findings below.

Federal Clawback Calculations Have Changed. As noted earlier, the Governor’s budget plan does not take into account the most recent CMS determination of California’s clawback payment. As part of the President’s proposed new federal budget plan, the assessment to California and other states will be revised downward to reflect slower growth in the prescription drug costs for dual eligibles than it had assumed. Previously, CMS assumed a 36 percent increase in the cost of providing drugs for Medi-Cal dual eligibles. The CMS has now revised its rate of growth in these costs to about 25 percent.

On this basis, federal authorities estimate that the state’s clawback payments for the 2006 calendar year would decrease by more than $110 million. This roughly 10 percentage point reduction in clawback costs would result in as much as a $55 million reduction in General Fund spending for Medi-Cal local assistance in the current fiscal year, which ends in June. Assuming these lower clawback assessments stay in place through 2007, we estimate that General Fund support for Medi-Cal local assistance is similarly overbudgeted by as much as $150 million in the budget year.

Impact of Drug Rebates Overstated in the Budget Year. Our analysis indicates that the loss of drug rebates, and the resulting increase in General Fund costs for the Medi-Cal Program due to the implementation of Part D, is overstated by as much as $125 million in the budget year.

The Governor’s budget estimates that this loss of rebates will be $544 million in 2005-06. We are advised by DHS that this estimate assumes that about 97 percent of drug rebates are ordinarily collected within six months after the drugs are provided to Medi-Cal beneficiaries. However, the data we have reviewed indicate that it sometimes can actually take up to a year for DHS to collect some rebates. If this is the case, then the loss of rebates in 2006-07 is significantly overstated in the budget plan.

Most Emergency Drug Coverage Funds Likely To Go Unspent. The DHS indicated on February 1, 2006 that, of the $150 million in General Fund appropriated to date for emergency drug coverage for dual eligibles, only about $12 million to $15 million had actually been spent. At this spending rate, it is unlikely that much more of the $150 million that was made available will be needed.

Moreover, as we discussed above, federal authorities have indicated that they will reimburse the states for most of the costs of providing emergency drug coverage to the dual eligibles.

Chapter 2 provides that any unspent funds would revert to the General Fund as of June 30, 2007. However, reversion of these funds at the end of the budget year means they would not be available for other purposes as the Legislature deliberates on a budget for 2006-07.

100-Day Drug Prescriptions May Be Overbudgeted. As noted above, the Governor’s budget provided $19 million in General Fund support in the current year for providing 100-day subscriptions in December 2005 for dual eligibles. We are advised that preliminary data indicates that fewer than expected dual eligibles actually obtained 100-day subscriptions. Thus, the budget plan likely provides more funding for this purpose than was necessary.

Further Part D Adjustments Warranted. State law requires Medi-Cal providers to submit treatment authorization requests (TARs) for reimbursement for specific procedures and services, such as prescription drugs. The volume of prescription drugs paid for by Medi-Cal is expected to decrease by 57 percent beginning January 2006 because of the implementation of Medicare Part D. It is likely that the TAR volume for prescription drugs will decrease by at least an equivalent amount.

The 2006-07 budget proposes a reduction of $4.8 million (with a savings of $1.2 million to the General Fund) for contract staff, including pharmacists and support staff, who process TARs. Seven contract pharmacist positions would remain, however, in addition to some support staff. Also, none of the 55 state pharmacist positions or state support positions have been proposed for reduction. The relatively small staff reduction raises a question as to whether further adjustments in DHS staffing are warranted.

At this time, the Legislature does not have sufficient information to evaluate DHS’ separate budget proposal requesting additional staff for the third-party liability unit. The ongoing level of workload that would justify the continuation of these positions is not clear.

Analyst’s Recommendations

Based on the above findings, we recommend that the Legislature adopt the following adjustments to the Medi-Cal budget and other DHS budgets:

• Reduction in Clawback Payments. We recommend the Legislature reduce the General Fund budget for Medi-Cal local assistance by $55 million in 2005-06 and $150 million in 2006-07 to reflect the reduction in the CMS assessment of California’s clawback payments. The DHS has advised us that it will present the Legislature with an updated estimate of state clawback payments, as well as other fiscal effects of the Medicare drug benefit on Medi-Cal, at the time of the May Revision.

• Rebate Adjustment. We recommend that the Legislature reduce the General Fund budget for Medi-Cal local assistance by $125 million in 2006-07 to reflect the likelihood that the full loss of rebates due to Part D implementation will not occur until 2007-08. We estimate that the loss of rebate revenues will be $125 million lower than the administration has projected, and thus that the backfill of these losses through an increase in General Fund expenditures for Medi-Cal is likewise overstated by $125 million. At the time this analysis was prepared, we were awaiting additional information from DHS regarding the lags that occur in the timing of rebate collections. Accordingly, we will provide the Legislature with an updated estimate of this adjustment once we have received this additional information from DHS.

• Reversion of Emergency Funds. We recommend enactment of legislation to revert some or all of the remaining General Fund appropriation provided for emergency drug coverage for dual eligibles at the end of the current fiscal year instead of at the end of the budget year, as now provided under Chapter 2. It appears unlikely that any significant additional portion of these funds will be necessary to provide emergency drug coverage to dual eligibles. This action would make these funds available to help balance the 2006-07 state budget.

• Revert Some Funds for 100-Day Drug Prescriptions. We recommend that the Legislature require DHS to report at budget hearings regarding how much of the $19 million in General Fund support included in the current year for 100-day prescriptions was actually spent for these purposes. Once this information has been obtained, the Legislature should reduce the Medi-Cal budget in the current year by this amount.

• Ongoing Workload for Medicare Part D. We withhold recommendation on the proposal to provide additional staff for DHS’ third-party liability unit until the Legislature has been provided the information it needs to conduct an updated workload analysis of the request. Once this information is forthcoming, we will provide the Legislature with an updated recommendation regarding this proposal at budget hearings.

• TARs Staff Reduction. Based on the information now available, it is unclear if the administration’s proposed reduction in TARs unit staffing to account for the implementation of Part D is commensurate with the expected reduction in the volume of TARs. We have requested information from the department about the level of filled and vacant positions, but, at the time this analysis was prepared, we had not received it. Accordingly, we withhold recommendation on this proposal until the Legislature can determine if an appropriate number of DHS staff positions has been eliminated.

A Targeted Strategy to Constrain Medi-Cal Costs And Improve Access to Community Care

We recommend that the Legislature take advantage of the opportunities now being provided by federal authorities to deter costly nonemergency visits to emergency rooms (ERs) and to improve access and quality of care at clinics and alternative sources of community care. In order to implement this strategy, we recommend that the Legislature establish effective copayments on the inappropriate use of ERs and seek available federal grant funds to improve access to primary care in the community.

Care Not Always Delivered in the Best Medical Setting

California’s projected 6.8 million Medi-Cal beneficiaries qualify for a wide range of medical services, including primary care in doctors’ offices or community clinics for prevention and treatment of less serious illnesses and injuries. In addition, emergency services provided in hospital ERs are intended mainly to treat immediate care needs that result from severe trauma and other life-threatening problems. However, Medi-Cal beneficiaries do not always receive medical care in the most medically effective and cost-efficient setting. For example, many Medi-Cal beneficiaries with relatively minor medical illnesses seek care in ERs instead of in doctor’s offices or community clinics.

Below, we examine how and why this is often the case for participants in the Medi-Cal Program, and how this situation often contributes to the state paying more for health care than might otherwise be the case.

ERs Frequently Used for Nonemergency Care. Crowded conditions have been widely reported in many ERs in recent years. One major factor contributing to ER crowding is the frequent use of ERs by some patients as a source of nonemergency care. Various academic studies have documented the frequent use of emergency rooms by patients for primary care services or other nonemergency conditions that could have been provided in a less costly medical setting. Estimates of such nonemergency use of ERs have varied. A 2004 report by the California Institute for County Government cited data from the California Office of Statewide Health Planning and Development indicating that about 40 percent of all hospital ER visits for Medi-Cal and other patients in California are for conditions classified as “nonurgent.”

Why aren’t more patients going to clinics or doctor’s offices instead of emergency rooms? One study of children in Medicaid who suffer from asthma found that their mothers cited a number of barriers to primary care as the reasons for seeking care at hospital ERs. These barriers included limited availability of appointments from primary care providers, limited availability of appointments after regular work hours, and a perception that primary care providers wanted them to use the ER. Also, the relatively low rates paid to physicians voluntarily participating in the Medi-Cal Program could be affecting access by patients to primary care and specialists in some communities. The Kaiser Family Foundation indicates that Medi-Cal payments for primary care services have recently fallen to 51 percent of Medicare levels (based on 2003 data), placing California 44th among states by that measure.

Payment Rates Vary by Care Setting. Where Medi-Cal patients receive their health care services can have significant fiscal ramifications for the state. In many cases, Medi-Cal pays different rates for the same medical procedure depending on the setting in which that service is provided. For example, Medi-Cal payment rates for many procedures are 24 percent higher when the procedure is performed in an ER rather than a physician’s office. Medi-Cal must typically also pay a facility charge for care obtained in an ER in addition to the payment for the health care practitioner’s services. Various studies have concluded that many services provided in hospital emergency rooms cost more than when the patient receives the same services in nonemergency settings.

The potential higher cost of this health care is of particular concern given the state’s ongoing fiscal problems and rising hospital costs. General Fund spending for Medi-Cal outpatient hospital services (including part of the cost of ER services) is projected to increase by more than $100 million, or 50 percent, between 2000-01 and 2006-07, as shown in Figure 4.

Copayments Commonplace in Health Care Systems

Other Health Systems. Many private and public health care systems require their beneficiaries to make copayments, which are specified fees that patients must contribute to a provider in order to receive services. Medicare, the Veterans Administration system, and California Public Employees’ Retirement System health coverage all employ copayments to discourage overutilization of health care.

Current Medi-Cal Copayments Not Frequently Collected. Copayments are also authorized under federal and state rules in the Medi-Cal Program. In theory, Medi-Cal allows $5 to be charged per visit for a nonemergency visit to an ER, $1 per drug prescription filled, and $1 per visit for a variety of other types of providers, such as physicians, optometrists, and chiropractors. This copayment is ordinarily supposed to be collected by the medical provider.

However, relatively few such copayments are actually now being collected. That is primarily because federal law, until very recently, prohibited the denial of health care services if a patient cannot or does not make the copayment. In addition, federal and state law had specified that copayments generally 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 generally exempted from copayments were pregnant women, institutionalized individuals, and beneficiaries receiving family planning services. Individuals receiving emergency services could not be charged copayments, although persons receiving nonemergency services in emergency rooms were subject to them.

Medi-Cal providers’ inability to actually collect copayments and the limits on which beneficiaries must pay them have rendered Medi-Cal copayments largely ineffective as a deterrent to the inappropriate use of medical services, including in ERs. That is the case even though there is substantial evidence, as discussed below, that copayments could be an effective strategy to reshape the way these services are provided in the Medi-Cal Program.

Copayments Can Affect Utilization of Services. Various studies published in health care journals have sought to determine the effect of different forms of cost-sharing on health care utilization. Some studies indicate that copayments appear to reduce unnecessary utilization of medical services, with even nominal cost-sharing leading to decreased use. However, the evidence regarding copayments’ effectiveness also raises additional issues. Some research studies caution that such cost-sharing requirements can do more than curb overutilization of services by creating obstacles to appropriate and medically necessary care. Thus, the particular design of copayments is important because of the significant potential effects on the overall provision of health care.

Notably, California experimented in the early 1970s with a new copayment on Medi-Cal doctor visits while leaving hospital care free of charge. A subsequent study by RAND found some evidence that this copayment policy likely reduced the demand for doctor visits by 8 percent, while demand for more costly hospital inpatient service increased by 17 percent.

Recent Federal Policy Changes Provide Opportunities to Reshape System

Findings from the RAND study and other research raise a further important question: Could Medi-Cal copayments be structured in a way to accomplish just the reverse of what occurred in California in the early 1970s? That is to say, could Medi-Cal copayments be established to encourage less costly primary care and discourage the inappropriate or excessive use of more costly hospital services? Our analysis indicates that recent changes in federal law and other recent developments in federal policy are opening the door to such a strategy.

Copayment Rules Easing. In recent years, CMS, the federal agency which administers the Medicaid Program (of which Medi-Cal is a part), granted some states greater flexibility in applying copayments by approving waivers of federal laws. Some states have used such waivers to enact copayments above the nominal level for various services, including the nonemergency use of ERs. In addition, the recently enacted federal Deficit Reduction Act of 2005 further increases states’ flexibility to establish Medicaid copayments without first obtaining waivers. (See the nearby text box for a summary of several key changes contained in the new federal measure.) The measure contains a number of significant provisions regarding copayment levels and collections as well as various restrictions on who can be required to share in such costs. However, the federal measure maintains the authority of CMS to grant waivers to states to implement differing copayment options.

New Federal Funding Could Help Improve Emergency Room Alternatives. On their own, copayments for nonemergency ER use may be insufficient to encourage use of primary care providers because of the barriers beneficiaries face in accessing such providers. The recently enacted federal law offers states an opportunity to try to address these issues through newly available federal grant funds ($200 million nationwide) earmarked for improving access to primary care systems and implementing innovative programs to reduce Medicaid costs. These monies could contribute to implementing new approaches that would help “safety net” clinics and other primary care providers attract more Medi-Cal patients so that fewer would seek care at ERs.

While the federal grant amounts available to individual states are likely to be modest, California has demonstrated that it can operate a successful program to improve access to community care with limited resources. The Rural Health Demonstration Project (RHDP), operated by the Managed Risk Medical Insurance Board (MRMIB) to improve access to primary care for children under the Healthy Families Program, could serve as a model for using any additional funds available to the state in targeted areas. The program awards grants to address specific areas of need, such as increasing the number of hours that clinics are open on nights and on weekends and subsidizing the rates paid to providers so that they will offer care. A 2002 evaluation by MRMIB indicated that many clinics that received grants continued to offer expanded hours after their RHDP grants expired.

A Targeted Strategy to Reduce Medi-Cal Costs and Improve Community Care

As discussed above, recent changes in federal law and policy have created an opportunity to begin reshaping the Medi-Cal Program to provide better access to preventive-oriented community care and to reduce state spending for inappropriate visits to sometimes overcrowded ERs. At least one state has demonstrated that such a strategy could be effective. A review of a Medicaid demonstration project in Florida found, for example, that there was reduced use of ERs by Medicaid children resulting from coordinated efforts that included expansion of clinic or doctor’s office hours and copayments for certain ER use.

Accordingly, we recommend that the Legislature take steps now, primarily though the enactment of policy legislation, to implement a new strategy that takes advantage of these opportunities. We summarize below the key components of this strategy:

• Seek Federal Help to Improve Access to Primary Care. We recommend that the Legislature direct DHS to apply for part of the $50 million in federal grant funding that will be made available over four years to help states improve access to primary care systems. The DHS should also be directed to seek proceeds from the $150 million in federal funding designated for implementing innovative approaches to reducing Medicaid costs, which we believe this new state strategy represents.

• Build on the RHDP Model. We propose that DHS, possibly in collaboration with MRMIB, develop and implement a targeted new program to improve access to primary care services for Medi-Cal patients in areas where such access is now problematic. The new program could be modeled after RHDP or possibly established as an actual expansion of RHDP in order to minimize administrative costs. The program should initially focus on improving primary care in communities near hospital emergency rooms where Medi-Cal patients are frequently receiving services for nonemergency care.

• Establish an Effective and Meaningful ER Copayment. We recommend that the Legislature enact a meaningful and enforceable copayment in Medi-Cal-perhaps as much as $25 per visit in order to be effective as a deterrent to the nonemergency use of ERs. These copayments should be applied to health services provided through managed care as well as those provided on a fee-for-service basis. Providers would have the authority to deny medical services if a beneficiary declined to make a copayment. We recommend that the Legislature include most Medi-Cal beneficiaries in these requirements, given our proposed approach under which no Medi-Cal beneficiary would need to make a copayment to receive care from an appropriate primary care provider. We also recommend that the imposition of copayments begin no sooner than 2007-08, so that efforts to improve primary care systems can be undertaken before the new copayments go into effect.

• Direct Patients Toward ER Alternatives With No Copayments. We recommend that the state implement the new federal rules that would ensure that Medi-Cal patients can receive the nonemergency care they need with no copayment so long as they obtain that care in a medically appropriate location instead of an ER. Hospital ERs would screen incoming patients and assess their medical condition. If it were determined that a Medi-Cal beneficiary in an ER did not require emergency care, that beneficiary would be provided with the name, location, and a referral to an alternate medical provider verified as being available to provide services to them without a copayment. In addition, we recommend that the state repeal the existing “nominal” copayments for primary care in order to encourage more patient visits to clinics and doctor’s offices instead of ERs.

• Use Copayments to Compensate Providers. We propose that any copayments collected from Medi-Cal patients be considered compensation for providers in addition to the amounts that Medi-Cal would otherwise reimburse them for services. In effect, collecting the copayment would provide a modest increase in overall reimbursement to providers that should help offset potential additional costs to them for collecting copayments from Medi-Cal beneficiaries and referring them to primary care providers.

• Carefully Monitor Results. Because of the significant potential effect of these changes on the health care of Medi-Cal beneficiaries, the state should carefully monitor the effect of this new strategy on the quality of care and the cost of care in both ERs and the network of primary care providers.

State and County Savings Likely. If an effective and meaningful copayment is established for receiving nonemergency services in ERs, some Medi-Cal ER users would likely seek care from appropriate primary care providers, which are generally less expensive than ER care. Some studies have indicated that in some cases copayments may deter visits to health care facilities that are medically unnecessary. In these cases, beneficiaries may decide to forego receiving nonurgent care in any setting, resulting in further savings. Based on our review of data on Medi-Cal payments to hospitals for 2004, such a change could result in significant state and county savings if ER use by Medi-Cal patients could be deterred or redirected to less costly care settings. These savings could be realized in both fee-for-service and managed care Medi-Cal. On a fee-for-service basis, payments per beneficiary would likely decrease. In managed care, additional savings to the state might eventually be realized through reduced pressure to increase rates for managed care organizations, which in turn would probably pay less in the future for services provided to their Medi-Cal enrollees.

In addition, we believe there would probably also be significant positive fiscal impacts (and positive health outcomes) from directing more patients to an improved primary care system. This improved system could lead to more preventive care that encourages Medi-Cal patients to maintain good health, as opposed to their current overreliance on episodic care, in which individuals inappropriately wait until they are seriously ill before seeking health care.

The amount of the combined savings to the state and counties from these direct and indirect fiscal effects are unknown but would probably eventually amount to the tens of millions of dollars annually.

Administrative Costs. Administrative costs to the state to implement this proposal are likely to be minimal if the amount of the copayment was strictly limited to the level outlined in the new federal legislation. Establishing them at higher levels and for a larger portion of the Medi-Cal population, such as we have proposed, would require a federal waiver and probably result in modestly higher state administrative costs. For example, some additional staffing and funding may be needed by DHS to monitor care trends in areas that receive grants or to make one-time adjustments to eligibility information systems. However, these largely one-time administrative costs would eventually be much less than the savings we have identified above. The administrative costs for ERs themselves to collect the copayments (including UC and county hospitals) would likely not be significant because hospitals already typically collect copayments from privately insured individuals.

Analyst’s Recommendation

We recommend that the Legislature enact policy legislation to promote use of the most cost-effective and medically appropriate settings for primary care for Medi-Cal beneficiaries. This could be accomplished through a combination of (1) a targeted copayment for nonemergency use of ERs and (2) the use of available federal grant funding to improve access to primary care through a program comparable to the existing RHDP. We believe that this approach would improve health care outcomes for beneficiaries, in part by linking them more closely to preventive care instead of episodic care. We believe this approach would also be cost-effective for the state.

Hospital Waiver Increasing State General Fund Costs

The Governor’s budget proposal estimates that a new federal hospital financing waiver will result in a net increase of state General Fund costs over the first two years of about $39 million. However, the waiver could instead be implemented in a manner that avoids these costs and generates significant state savings. Accordingly, we recommend that the Legislature shift support for additional “safety net” health care programs to federal hospital funds so as to achieve net General Fund savings for the state. (Reduce Item 4260-111-0001 by $35 million.)

Background

Federal Waiver and Related State Legislation. In June 2005, the state received general approval from the Centers for Medicare and Medicaid Services (CMS) for a new waiver program that restructures the way Medi-Cal funding is used to finance inpatient hospital services in the state. The Legislature subsequently approved legislation (Chapter 560, Statutes of 2005 [SB 1100, Perata]) that in effect ratifies and implements this waiver package.

Waiver Had Several Key Goals. The key goals of the waiver included increasing the overall federal funding that would be available for hospital inpatient services while ensuring that no hospital now participating in the Medi-Cal Program would lose funding as a result of these changes. The waiver also sought to curb the state’s use of transactions known as intergovernmental transfers, some of which CMS contended inappropriately increased federal reimbursements for hospital services. (See page C-87 of our Analysis of the 2005-06 Budget Bill for a more detailed description of the waiver and related state fiscal issues.)

State-Only Programs Authorized for Federal Funding. Under the waiver terms, General Fund spending for state safety net health care programs can be offset with federal funds. Chapter 560 authorized the use of a designated part of the new federal hospital funds to offset specific state General Fund costs. Chapter 560 selected four existing programs operated by DHS for potential use in this way: the Medi-Cal Medically Indigent Adults Long-Term Care Program, the Medi-Cal Breast and Cervical Cancer Treatment Program, the California Children’s Services Program, and the Genetically Handicapped Persons Program (GHPP). Under the waiver‘s terms, the state could have offset more General Fund spending for additional state-only programs with federal hospital funds.

Governor’s Budget Proposal

Hospital Funding Shifts. The 2006-07 Governor’s Budget implements the hospital financing waiver agreement through various shifts of General Fund, local funding, and federal funds for the support of both private and public hospitals and other state safety net health care programs for the poor. Figure 5 provides a summary of the various detailed funding changes that are proposed in the Governor’s budget plan. These changes have a number of significant net fiscal effects in both the current fiscal year and the budget year that we discuss below.