Medicaid’s Perverse Incentives
Jeffersonian Principles in Action
Back to the Healthcare in Crisis PageAMERICAN LEGISLATIVE EXCHANGE COUNCIL
1129 20th Street, NW, Suite 500 Washington, DC 20036 phone: 202-466-3800 fax: 202-466-3801 www.ALEC.org
By James Frogue July 2004
State Medicaid programs across the country are in perennial financial crisis. Members of Congress and state legislators have come to realize that runaway Medicaid spending is unsustainable and presents a very real threat to other budget priorities such as education, highways and law enforcement. But these same leaders have too little appreciation of what is wrong with Medicaid and how to fix it.
The root cause of Medicaid’s problems is that the program is replete with perverse incentives from top to bottom. Every entity and individual from the federal government, through state capitals, providers, all the way down to the patient not only has no interest in providing and consuming care efficiently, most are actually rewarded financially for doing so inefficiently. Until federal and state legislators grasp this, Medicaid costs will continue to spiral out of control. Ironically, despite these massive and everhigher outlays, access to care for Medicaid patients continues to decline.
On March 18 and April 1, 2004, the House Energy and Commerce Committee’s Subcommittee on Health held two hearings that offered rare glimpses into Medicaid’s perverse incentives in action. At the first hearing, testimony from representatives of the General Accounting Office (GAO) and the U.S.Department of Health and Human Services’ (HHS) Office of the Inspector General (OIG) described the accounting games and gimmicks in great detail. What they revealed was a never-ending game of financial cat-and-mouse between states and the federal government where the state mouse is always a step ahead of the federal cat. The second hearing on April 1 featured testimony from the Bush administration’s Centers for Medicare and Medicaid Services (CMS) and the National Governors Association (NGA). The administration correctly acknowledged and described the financial shenanigans that permeate Medicaid programs across the country. Several new anti-fraud initiatives were detailed as well. But the administration, like the GAO and the HHS OIG, stopped short of articulating that until the open-ended federal match is reformed in the direction of capped block grants, all the auditors in Washington, D.C. will not be enough. The NGA expressed its concern that any kind of federal crackdown on the budgetary shell games would ultimately result in harm to patients. This “ends justify the means” testimony failed to offer any alternative solutions to runaway costs and deteriorating patient access to care under the current structure.
The picture painted by these two hearings was one in which virtually every state political leader from both parties, in conjunction with Medicaid providers and assorted vested interests, are sufficiently content with the current program to not call for any serious change to the present federal/state financing arrangement. Congress could affect genuine, positive change but is unable or unwilling to do so.
Congress established Medicaid in Title XIX of the 1965 Social Security Act. Medicaid is a joint federal state entitlement program designed to finance health care services for certain low-income individuals. Medicaid was created almost as a legislative afterthought to the much higher profile Medicare program that was designed to insure the health care needs of America’s seniors.
July 2004
States have some flexibility to design and operate their individual Medicaid programs, and as a result, no two programs are alike. The federal government sets broad general coverage guidelines for Medicaid that states must include in order to participate in the program. But states are free to exceed the federal minimums for eligibility and covered benefits at their discretion. Thus, a person eligible for Medicaid in one state may not be in another, and even if he or she is eligible, the same treatments may not be covered.1 In addition to defining the minimum level of eligible populations and benefits, the federal government also pays for the majority of Medicaid spending through the Federal Medical Assistance Percentage (FMAP), commonly known as the federal match. This formula dictates how much each state receives from Washington. The match is completely open-ended. Whatever a state spends, the federal government is legally obligated to pay its percentage share. The average federal match is 57 percent with poorer states getting a higher match. The 12 richest states get a 50 percent match.
2 Mississippi is the poorest so it gets the highest match of 77 percent. The nine states with the largest Medicaid programs received 51 percent of the federal dollars spent on Medicaid. New York, the state with the largest program, received $18 billion alone in 2002. This was fully 13 percent of total federal outlays.
3 In 1966, the first full year of operation for Medicaid, spending totaled $1 billion. For 2004, the Congressional Budget Office projects total Medicaid spending will be $305 billion.
4 That figure will increase at well over seven percent annually through 2014.
5 The U.S. economy will not grow at seven percent per year for the next decade meaning Medicaid spending will continue to grow disproportionately relative to the general economy.
Medicaid is characterized by perverse incentives from top to bottom. This flawed structure encourages massive overspending with minimal accountability. States, providers, and patients all behave as if someone else is footing the bill and therefore have little incentive to spend dollars wisely. The federal match that states receive is open ended.
No matter how much a state spends on Medicaid, the federal government will add on the pre-determined match rate. This creates strong incentives for states to not only spend more on Medicaid, but also to be very creative with what constitutes “Medicaid” spending so that they can maximize their match. A veritable army of highly paid lawyers, lobbyists, and consultants helps them do it. CMS State Operations Director Dennis Smith politely calls this a “natural tension” for states to enhance their revenue at the expense of federal coffers.
6 The problem for taxpayers is that they pay both federal and state taxes. So contrary to how state budget officials think and act, the federal Medicaid matching funds they receive is not “free money.” To the extent that states draw on their match, it is still their local businesses and residents who are paying it. The only difference is that the money first passes through Washington, D.C. instead of their state capital. Providers who accept Medicaid patients must contend with reimbursement rates that are 30 percent to 50 percent below what even Medicare pays.
7 It is widely acknowledged that Medicare significantly low-balls private sector insurers and self-pay patients. So physicians and other providers who accept Medicaid patients have the incentive to over-treat, over-service, and over-medicate Medicaid patients in order to make ends meet. Such low fees make it almost necessary to throw in an extra xray or test to justify the time spent with a Medicaid patient. This is not to say all doctors behave this way, or that such behavior is limited to Medicaid (the structure of Medicare and many private employer-based insurance arrangements contain similar incentives). It is simply to say that the incentives for providers who accept Medicaid must be realigned.
Medicaid patients have negligible, if any, cost-sharing requirements so they have no incentive to question the cost or frequency of the treatments they receive. Asking if there is a more efficient way to achieve the same health outcome and then pursuing that option does not result in any personal savings. To take it a step further, Medicaid unwittingly encourages patients to utilize high-cost emergency rooms for routine (or what should have been routine) visits instead of a primary care doctor.
THE STATE FACTOR
3
If the cost to patients for ER use is nothing or close to nothing, then it makes sense to visit an ER where appointments are not required, attention is immediate, and transportation via ambulance is free. Due to this unbroken waterfall of perverse incentives, it should come as no surprise that Medicaid is a program where abuse of taxpayer dollars is a metaphysical certainty. Until the underlying incentives are restructured, the program will continue its downward spiral into financial disaster.
The open-ended federal match is most responsible for the fiscal problems with Medicaid. States and municipalities have every incentive to try and maximize that match and not always in ways that are legal. Unfortunately for taxpayers, both political parties are guilty of exploiting various loopholes to paper over their state budget gaps. As a result, there is little political momentum at the state level for changing the existing federal/state match. Indeed, any effort by Congress to reform the federal match would be met by stiff resistance from a nearly unified front of governors, state legislators, mayors, and county executives regardless of party affiliation. The March 18, 2004 hearing displayed agreement between the HHS Office of the Inspector General and the General Accounting Office that state activities in this area require vigilant and ongoing federal oversight. Indeed, a 90-page GAO report released in February was entitled, “Medicaid: Improved Federal Oversight of State Financing Schemes Is Needed.”
8 Both the GAO and OIG representatives stopped short, however, of clearly stating that it is the federal match itself that must be reformed in order to bring a halt to these activities. Their recommendations addressed the symptoms of what is wrong with the Medicaid structure, not the root cause. HHS Assistant Inspector General George Reeb began his testimony by making very clear that many state Medicaid financing schemes, “are designed solely to maximize federal reimbursements to states and serve to obfuscate the source and final use of both state and federal funds.” In other words, it is all too common for Medicaid dollars to be purposely routed toward non-Medicaid items. He went on to say that actions by Congress and CMS have “helped to curb the effect of such practices, but significant vulnerabilities remain.”
9 Mr. Reeb suggested that effective use of Medicaid dollars should be based on these widely accepted accounting principles: Mr. Reeb’s testimony included a brief historical overview of state efforts to game the match. It dovetailed with the GAO chart that appears on page five. He conceded that while the federal government may eventually catch on to these schemes, it takes time, if they are uncovered at all. His remarks painted a bleak picture of the federal government’s ultimate ability to protect taxpayers from state abuses of the federal matching dollars. Two noteworthy ways in which states game the federal match are via the Upper Payment Limit (UPL) and the Disproportionate Share Hospital (DSH) program. The UPL establishes the maximum amount that a state can pay providers participating in its Medicaid program and still qualify for federal matching funds. The UPL itself is what Medicare pays for the same services. States can pay providers more than the UPL, but those excess payments would not be eligible for the federal match.
For the purpose of estimating their payments to providers under the UPL, federal guidelines allow states to aggregate their payments to whole classes of providers, as opposed to one by one. This aggregate estimation can allow certain preferred facilities, usually county-owned, to receive higher payments, on average, than individual institutions. Those higher payments can then be recycled back to the state in the form of Intergovernmental Transfers (IGTs).
4 _______________________________________________________________________________________ July 2004
11 The GAO uncovered one proposed UPL scheme in Virginia where the state was planning to pay six local-government nursing homes 12 times the standard $53 rate per Medicaid patient.
12 The HHS OIG conducted audits in six states and uncovered the following:
A further example of how states abuse the UPL through IGTs is via creation of state-maintained funding pools designed to maximize payments to county-government-owned nursing homes. The pool is calculated by determining the difference between the UPL and what the state actually pays to nursing homes under Medicaid. That difference is first filled by state dollars, which lay claim to federal matching funds. This money is then paid to county nursing homes as an enhanced payment. But then utilizing IGTs it is rerouted back to state coffers and available for any purpose. Mr. Reeb remarked, “Little or none of the funds are retained by the nursing facilities for the benefit of their Medicaid residents.”
13 States are also successful at exploiting Disproportionate Share Hospital (DSH) payments. DSH payments are made to hospitals that serve a disproportionate number of uninsured and Medicaid patients. States are able to divert DSH payments back into state coffers by utilizing IGTs in the same way they have with the UPL. In one particular state that goes unmentioned in his testimony, $738 million in DSH payments were made to acute care hospitals from 1999 to 2000. $632 million (or 86 percent) was rerouted back to the state. Those recaptured funds were then available for any use, be it Medicaid-related or not.
14 Mr. Reeb concluded his testimony by pointing to areas that remain vulnerable to similar kinds of accounting gimmicks. One in particular involves funding for school-based health services that is permitted under Medicaid. Already, the inspector general has uncovered examples of school districts being required to funnel money back to the states in the form of IGTs. Physicians employed by the state and hospital graduate medical education payments could also serve as conduits for recycling federal funds back to state coffers via IGTs.
15 Dennis Smith, director of state operations for CMS, testified to the same subcommittee on April 1. His testimony echoed the concerns of GAO and the HHS OIG. He agreed that states, “have managed to inappropriately draw down more federal Medicaid dollars with fewer state dollars, resulting in an effective FMAP that is higher than the statutorily determined matching rates.”
16 But like the GAO and OIG, he did not explicitly call for reform of the federal match itself as the only cure for these ongoing accounting games. Mr. Smith stated his agreement with the GAO and OIG recommendation that payments to government owned facilities be tied to costs. The administration is proposing to restrict federal match dollars to no more than the net cost of providing services to Medicaid beneficiaries in government-owned facilities.
17 This could be helpful in clamping down on the IGTs flowing out of those institutions. The administration has also made a notable achievement toward appropriate use of federal monies by forcing states to wait until any State Plan Amendment (SPA) is approved before federal matching funds begin to flow. Up until 2001 when this new regulation was put in place, states could draw matching 5 dollars simply by submitting an SPA.
THE STATE FACTOR
As a result, it was not uncommon for states to string out their approval process for years because they were already getting the milk for free and did not want to risk the possibility of CMS turning down their SPA request. Since the Bush administration began focusing on SPAs, 82 have been approved, four have been disapproved, five have been withdrawn entirely, and 39 have been temporarily withdrawn.
One hundred and fifty three additional SPA requests are being currently studied by CMS.
18 All of these financial shenanigans are made possible, and will continue to be made possible, by the structure of the federal match. The Bush administration can accurately diagnose and treat the symptoms of the problem, perhaps more effectively than any previous administration. But if the federal government remains on the hook financially for an open-ended match, these accounting shell games will undoubtedly morph into heretofore unseen and unpredicted schemes. It is not helpful that a well known organization like the National Conference of State Legislatures, a taxpayer-supported group, has what amounts to a “How To” list on its website to educate political leaders about using IGTs.
19 This lends legitimacy to a practice called into serious question by the HHS OIG and CMS. Kathryn Allen with the GAO called IGTs, “closely associated – if not synonymous –with the abusive financing schemes undertaken by some states in connection with illusory payments for Medicaid services to claim excessive federal matching funds.”
20
6 _______________________________________________________________________________________ July 2004
It is worth asking if all of these extra dollars that states manage to garner for their Medicaid programs are benefiting people on Medicaid. In 2002, the Medicare Payment Advisory Commission (MedPAC) conducted a study to determine the number of doctors who participate in the Medicaid program. They found that from 1999-2002 the percentage of practices open to “all new Medicaid patients” declined by 23 percent.
21 Over the same time period, however, national spending on Medicaid skyrocketed by over 36 percent, growing from $189 billion in 1999 to $258 billion in 2002, according to the Congressional Budget Office.
22 Thus, if access to physicians is a worthy standard by which to judge performance, the Medicaid program is performing miserably despite massive infusions of taxpayer funds. In one study out of California, researchers pretending to be Medicaid patients suffering from a broken arm called 50 orthopedic doctors asking for treatment. Fully 94 percent of the doctors contacted refused to treat the caller.
23 This illustrates the problem of access to specialists for people on Medicaid. The problem is particularly acute in states with very generous eligibility and benefits packages such as California, New York and New Jersey. On paper, these states have Medicaid programs with broad and diverse coverage. But this generosity is “paid for” by having very low reimbursement rates to providers.
24 This limits physician participation in Medicaid and therefore restricts choice for Medicaid patients. There is one demonstration project in Medicaid where the incentives are properly aligned. It is called Cash and Counseling and allows certain Medicaid beneficiaries receiving personal care services at home to opt for a cash allowance with which to buy those services.
25 The patient controls the dollars and as a result can choose who they want as providers, when, and at what price. To emphasize who is the employer, paychecks received by providers bear the name of the Medicaid patient, not the state. Leftover funds accrue in the account and can be used for larger items related to the patient’s health care such as a lift chair to assist with stair climbing.
26 Contrary to some initial concerns, the program has witnessed, “no major instances of fraud and abuse.”
27 Patient satisfaction rates with this program are astronomical. In Arkansas, 96 percent of patients would recommend the program to others. Additionally, 82 percent say the program has improved their lives and 65 percent say it has improved their lives “a great deal.” In New Jersey, 97 percent of those surveyed would recommend the program.
28 Similar rates of satisfaction have been reported in Florida.
29 Florida’s recently approved expansion of their program will still only allow 3,300 people to participate, which is less than 10 percent of the 47,000 who could benefit from this approach. The waiting lists to get on the Florida program attest to its popularity.
30 The latest research on Cash and Counseling indicates that spending during the initial year of operation is higher relative to the traditional agency model, due in part to induced demand. However, “the program greatly increased consumers’ access to care and ability to purchase needed equipment and supplies.”
31 By the second post-enrollment year, the spending differential vanished and “offsetting savings…could grow over time.”
32 The potential for considerable savings over the long term is significant. Giving patients control over their own health care dollars and allowing them access to the free market will do what it does in every other sector of the economy – increase quality and bring down cost. Additionally, because patients are getting better care in a timely manner, they are more likely to stay out of high cost institutions such as nursing homes and hospital emergency rooms.
The Cash and Counseling model has shown the promise of engaging Medicaid beneficiaries in their own health care decisions that comes with aligning the incentives appropriately. This approach should be expanded beyond just a narrow population for a limited range of services and attempted in areas where long-term chronic conditions are present. A Cash and Counseling-type approach that provides resources for diabetes patients to purchase needed care and equipment might be valuable. High-cost patients with one or more chronic conditions could prove very able to select a case manager, be it a doctor, nurse, or pharmacist, to coordinate their care.
33 This can only be done, however, if the patient controls the dollars. HHS Secretary Tommy Thompson is very eager to approve waivers to this end, but cannot do so if states do not take a leadership role and apply.
THE STATE FACTOR
7 True Medicaid reform will not come until policymakers grasp the need to change the program’s inherent perverse incentives. One way this could be done is for Congress to block-grant the program in order to eliminate states’ incentives to game the federal match. The other way is to put dollars in the hands of patients, thereby tapping into the free market for medical goods and services, and the natural creativity and resourcefulness of consumers with their own money at stake. The current structure of the Medicaid program can only result in underserved patients and wasted tax dollars. There are better ways. Policy-makers owe it to taxpayers. But more importantly, they owe it to the poorest and more vulnerable members of our society who have no choice but to rely on Medicaid in its present form.
James Frogue is Director of the Health and Human Services Task Force at the American Legislative Exchange Council.
1 Centers for Medicare and Medicaid Services, Medicaid: A Brief Summary, at http://www.cms.gov/publications/overview-medicare-medicaid/default4.asp.
2 The 12 richest states are CA, CO, CT, DE, IL, MD, MA, MN, NH, NJ, NY, WA.
3 The author is indebted to Dr. Robert Helms, Resident Scholar and Director of Health Policy Studies at the American Enterprise Institute for pointing this out.
4 Figure is total combined federal and state Medicaid spending with federal portion at 57 percent.
5 Congressional Budget Office, Current Budget Projections, at http://www.cbo.gov/showdoc.cfm?index=1944&sequence=0
6 Dennis Smith, Director, Center for Medicaid and State Operations, Centers for Medicare and Medicaid Services, Testimony to the House Energy and Commerce Committee, Subcommittee on Health, April 1, 2004.
7 John Iglehart, “The Dilemma of Medicaid,” The New England Journal of Medicine, May 22, 2003, p. 2144.
8 GAO report #GAO-04-228, February 2004.
9 George Reeb, Assistant Inspector General for Centers for Medicare and Medicaid Audits, HHS Office of the Inspector General. Testimony to the U.S. House Energy and Commerce Committee Subcommittee on Health, March 18, 2004.
10 Ibid.
11 IGTs are explicitly legal in the Medicaid statute, Section 1902(a)(2) or (42 U.S.C. 1396a(a)(2)(2000). Up to 60 percent of a state’s share of Medicaid spending can come from local government revenue and sources. The justifiable purpose of this is to acknowledge that county dollars being spent on Medicaid should be treated equal to state dollars and therefore be eligible for federal matching funds. The problem arises, however, when counties are exploited to launder money for the state government.
12 Statement of Kathryn Allen, Director, Health Care – Medicaid and Private Health Insurance Issue, “Medicaid – Intergovernmental Transfers Have Facilitated State Financing Schemes,” General Accounting Office, GAO-04-574T, March 18, 2004.
13 George Reeb testimony, March 18, 2004.
14 Ibid.
15 Ibid.
16 Dennis Smith testimony, April 1, 2004.
17 Ibid.
18 Ibid.
19 http://www.ncsl.org/programs/health/forum/cost/strat3.htm
20 GAO-04-574T p. 12.
21 “Physician Payment Crunch: Medicare Cuts Hit Medicaid Access,” by Miriam Hawryluk, Amednews.com, October 21, 2002. http://www.ama-assn.org/amednews/2002/10/21/gvl11021.htm
22 http://www.cbo.gov/showdoc.cfm?index=1944&sequence=0
23 John Iglehart, “The Dilemma of Medicaid,” The New England Journal of Medicine, May 22, 2003.
24 Ibid, p. 2144.
25 1915c beneficiaries in four categories: Frail Elders (60+); Adults (ages 18-64) with physical disabilities; Children (ages 3-17) with developmental disabilities; Adults (ages 18-64) with developmental disabilities.
26 James Frogue, “The Future of Medicaid: Consumer-Directed Care,” The Heritage Foundation, Backgrounder 1618, January 16, 2003.
27 Kevin Mahoney, PhD, Associate Professor at Boston College and National Program Director for Cash and Counseling Demonstration and Evaluation. Testimony to the House Energy and Commerce Committee Subcommittee on Health, June 5, 2003. http://energycommerce.house.gov/108/Hearings/06052003hearing949/Mahoney1513.htm
28 Ibid.
29 “Cash and Counseling, Demonstration and Evaluation Program,” published by Centers for Medicare and Medicaid Services, and “Cash and Counseling: Consumers’ Early Experiences in Florida,” Interim Memo, written by Leslie Foster et al., Mathematica Policy Research Inc., Princeton, New Jersey, April 2002.
30 Rachel Richardson, “Independent Spirits,” The Tampa Tribune, July 20, 2003.
31 Stacey Dale, et al., “The Effects of Cash and Counseling on Personal Care Services and Medicaid Costs in Arkansas,” Health Affairs, Web Exclusive, November 19, 2003, pgs. W3-566 – W3-575.
32 Ibid.
33 In all Medicaid programs across the country a very small and relatively predictable minority of patients is responsible for large chunks of the outlays. In Arkansas and Florida, five percent of the Medicaid population is responsible for 50 percent of Medicaid spending. This is typical of all states. Targeted disease management of these individuals holds massive promise for lowering overall costs and vastly improving patient outcomes. For more information see testimony presented by Rhonda Medows, Dan Hilferty and Chris Selecky to the House Energy and Commerce Committee Subcommittee on Health, October 15, 2003, http://energycommerce.house.gov/108/Hearings/10152003hearing1111/hearing.htm
8 _______________________________________________________________________________________ July 2004
AMERICAN LEGISLATIVE EXCHANGE COUNCIL
Medicaid’s Perverse Incentives has been published by the American Legislative Exchange Council (ALEC) as part of its mission to discuss, develop and disseminate policies which expand free markets, promote economic growth, limit government and preserve individual liberty. ALEC is the nation's largest nonpartisan, voluntary membership organization of state legislators, with nearly 2,400 members across the nation. ALEC is governed by a 23-member Board of Directors of state legislators, which is advised by a 21-member Private Enterprise Board representing major corporate and foundation sponsors. Copyright © July 2004 by the American Legislative Exchange Council. All rights reserved. Except as permitted under the United States Copyright Act of 1976, no part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior permission of the publisher.
Published by American Legislative Exchange Council 1129 20th Street, N.W., Suite 500 Washington, DC 20036
Publications Order Code: 0420
Cost to non-members: $10.00 + S/H