The 2018-19 Budget: The May Revision

Governor’s May Revision Medi-Cal Budget

Overview. The Governor’s May Revision includes Medi-Cal spending of $20.3 billion from the General Fund ($97.3 billion total funds) in 2017‑18 and $22.9 billion from the General Fund ($103.9 billion total funds) in 2018‑19. For both fiscal years, the administration estimates higher General Fund spending in Medi-Cal compared to the Governor’s January budget proposal. As shown in the figure below, the May Revision reflects $287 million in additional General Fund spending in 2017‑18 and almost $1.4 billion in additional General Fund spending in 2018‑19—for a total of about $1.6 billion over the two years—relative to the Governor’s January budget proposal.

2017‑18 Deficiency. For 2017‑18, the $287 million in increased costs identified in the May Revision is added to the $544 million in increased costs identified in the Governor’s January budget proposal relative to the 2017‑18 Budget Act. This creates the need for a supplemental appropriation of $830 million for 2017‑18, assuming the Governor’s budget is approved without adjustment.

Increased General Fund Costs in 2017‑18 and 2018‑19 Largely Due to Technical Budget Adjustments. The Governor’s May Revision budget proposal features few changes in policy related to Medi-Cal. Rather, increased estimated General Fund spending is largely due to the net effect of several technical budget adjustments.

Technical Adjustments Warrant Scrutiny. Given the magnitude of the increased General Fund costs, we recommend that the Legislature scrutinize these technical adjustments through the May Revision hearing process. Below, we summarize some of the major driving factors behind the net increase in estimated General Fund costs. We also highlight issues related to the most significant of these factors for the Legislature to consider based on our very preliminary review of the May Revision. Additionally, we comment on the administration’s Medi-Cal caseload estimates, provide updates on proposals that were included in the Governor’s January budget, and assess one new information technology proposal included the May Revision.

Major May Revision Budget Adjustments

The $1.6 billion upward adjustment across the 2017‑18 and 2018‑19 fiscal years reflects the net General Fund impact of a wide variety of changes in projected Medi-Cal spending. To a significant degree, these changes reflect a shift of costs to the General Fund from other fund sources, rather than an overall increase in program costs. We describe several of the major changes below.

Savings of $900 Million From Children’s Health Insurance Program (CHIP) Reauthorization. The Governor’s January budget assumed federal funding for CHIP would be reauthorized, but not at California’s enhanced CHIP federal medical assistance percentage (FMAP) of 88 percent authorized under the Patient Protection and Affordable Care Act. Instead, the January budget assumes the state would receive its traditional CHIP FMAP of 65 percent starting January 1, 2018. The May Revision reflects the recent reauthorization of federal CHIP funding at the enhanced FMAP of 88 percent, reducing the General Fund costs of the program by a total of $900 million—$300 million in 2017‑18 and $600 million in 2018‑19. This General Fund savings amount is consistent with what was estimated in our analysis of the Governor’s January budget to be the fiscal impact of the recent federal action.

General Fund Costs of $1.5 Billion to Repay Federal Funds Received for Potentially Disallowed Claims. The most significant May Revision Medi-Cal adjustment relates to a $1.5 billion General Fund adjustment over the Governor’s January budget—$680 million in 2017‑18 and $820 million in 2018‑19—to replace a projected loss in federal funds related to an increased amount of claims the federal government now disputes. Based on our initial review, this amount likely represents a high-end estimate of the amount that is at risk. The state may be able to recover a portion of this funding by submitting required supporting documentation for the claims, but the amount and timing for recovering funds is unknown at this time. In the coming days we will attempt to identify the causes of increased disputed claims and whether any of the potentially disallowed claims could be resolved in 2018‑19.

Other Adjustments. Beyond the two large adjustments described above, several other relatively smaller, but still significant, adjustments contribute to the net increase in General Fund spending in Medi-Cal in the May Revision. In the coming days, we will continue to review these items.

• $620 Million in General Fund Costs Related to Drug Rebates. Medi-Cal collects rebates on prescription drugs that are paid for by the program. These rebates come in the form of savings and are used to offset General Fund spending on Medi-Cal. The Governor’s May Revision estimates $620 million in lower General Fund savings across 2017‑18 and 2018‑19 resulting from Medi-Cal prescription drug rebates relative to the January budget. This appears to be due to (1) lower projections of the total savings associated with future drug rebates and (2) a higher share of rebate savings being remitted to the federal government, and therefore not resulting in General Fund savings.

• $428 Million in General Fund Costs Related to Managed Care Organization (MCO) Taxes. The MCO tax is assessed on a large number of managed care plans statewide and its revenues leverage additional federal funding for Medi-Cal that provides a substantial General Fund offset. General Fund savings from the MCO tax are offset by increases in plans’ capitation payments owing to the tax. The May Revision estimates that net General Fund savings associated with the MCO tax are lower by $428 million over 2017‑18 and 2018‑19 as compared to the Governor’s January budget. This results in higher General Fund costs in Medi-Cal of an equivalent amount.

• $445 Million in General Fund Costs Related to Hospital Quality Assurance Fee (QAF) Withholding. Most private hospitals in the state are required to pay a QAF to the state, which uses these revenues to draw down additional federal funding for payments to hospitals, as well as to offset some General Fund costs in Medi-Cal. When hospitals fall behind on QAF payments, the state withholds a portion of the Medi-Cal payments that otherwise would be paid to those hospitals. The May Revision newly identifies $450 million in General Fund costs—$131 million in 2017‑18 and $313 million in 2018‑19—related to the timing of these withheld payments.

• Various Other Offsetting Adjustments. In addition to the adjustment listed above, the May Revision reflects numerous other adjustments to estimated General Fund spending resulting in both costs and savings.

Key Questions. In the coming days, we will work with the administration to better understand these adjustments and will provide any additional comments we have to the Legislature on a flow basis. In the meantime, we provide some key questions below to guide the Legislature’s review of these adjustments.

• Is the Adjustment Based on a Change in Federal Policy? In some cases, adjustments may be partly the result of changes in federal policy. If the adjustment is largely driven by a federal policy change, it is more likely to be beyond the state’s control.

• Is the Adjustment Based on a Change in Estimating Methodology? In some cases, these adjustments may be partly the result of a change in the administration’s approach to estimating uncertain future spending. The Legislature may wish to ask the administration to provide additional information about the level of uncertainty in the estimate, the reliability of the previous approach to estimation, and how the new approach represents an improvement.

• Will the Adjustment Be One Time or Ongoing? Some of these adjustments may be expected to result in ongoing costs or savings, while others may be more short term. The Legislature may wish to ask the administration for more information about how the costs and savings associated with these adjustments are expected to change in future years.

Caseload Estimates

May Revision Caseload Estimates Slightly Lower Than January Estimates. The May Revision projects a declining Medi-Cal caseload in both 2017‑18 and 2018‑19. Specifically, the May Revision projects total average monthly enrollment of 13,343,800 individuals in 2017‑18, down 1.3 percent from the prior year. The May Revision projects total average monthly enrollment of 13,328,200 in 2018‑19, down only 0.1 percent from updated estimates of 2017‑18. Estimates for both 2017‑18 and 2018‑19 are slightly lower than administration’s January estimates.

Children and Families Caseload Projection Is Cautious. Within the Medi-Cal caseload, the families and children caseload (as distinct from seniors, persons with disabilities, or childless adults) has been declining at a rate equivalent to roughly 3 percent annually beginning in 2016‑17. This downward trend is likely due to the combination of (1) steps taken to address automation challenges that delayed disenrollment of beneficiaries that were no longer eligible and (2) fewer eligible families due to increased earnings in an improving labor market and as a result of a higher minimum wage. The May Revision projects a much slower decline for the families and children caseload of less than 1 percent in 2018‑19. Given the number and magnitude of changes in the Medi-Cal program in recent years, there is uncertainty about how the families and children caseload trend may change in the future. However, we believe there is a good chance the decline will be somewhat more rapid than assumed in the May Revision, provided that current economic conditions continue. For example, if trends observed since 2016‑17 were to continue, we estimate the families and children caseload would decline by about 3 percent in 2018‑19 and the total Medi-Cal caseload would be closer to 13.2 million, a little more than 1 percent lower than assumed in the May Revision.

Adopting Lower Caseload Estimate Could Free Up Funding for Other Priorities . . . Assuming a more rapid decline in the families and children caseload as described above would free up General Fund in Medi-Cal for other priorities in the state budget. The amount of potential General Fund savings is uncertain, but would likely be in the low hundreds of millions.

. . . But Increases Risk of Insufficient Funding if Trends Change. At the same time, assuming savings from a more rapid caseload decline based on recent trends increases the risk that program funding will be insufficient if those trends change. The Legislature may wish to ask the administration to provide more information on the likelihood that the families and children caseload will decline at a faster rate than assumed in the May Revision and the potential savings that could result from assuming a more rapid decline.

Proposition 55

May Revision Includes No Additional Medi-Cal Funding Under Proposition 55. In 2016, voters passed Proposition 55, which extended tax rate increases on high-income Californians. Proposition 55 includes a budget formula that provides additional funding to Medi-Cal if, in the estimation of the Department of Finance (DOF), General Fund revenues will exceed constitutionally required spending on schools and the “workload budget” costs of other government programs that were in place as of January 2016. Under calculations made for the Governor’s January budget proposal, the Director of Finance found that General Fund revenues would not be sufficient to trigger additional funding for Medi-Cal pursuant to the Proposition 55 formula. The DOF released updated Proposition 55 estimates with the May Revision. These updated estimates similarly find that General Fund revenues will not be sufficient to trigger additional funding for Medi-Cal. Therefore, the May Revision includes no additional funding for Medi-Cal under the Proposition 55 formula.

Proposition 56

Summary of the Governor’s May Revision Proposition 56 (2016) Proposal. The Governor’s May Revision proposal does the following:

• Maintains January budget proposal to spend the maximum amount ($1.346 billion) authorized in the two-year budget agreement on provider payment increases funded from Proposition 56 revenues that was part of the 2017‑18 budget package.

• Maintains the January budget’s proposed extension of the Proposition 56-funded supplemental payments authorized in 2017-18 into 2018-19, consistent with the 2017-18 budget agreement.

• Reduces the estimated General Fund cost of continuing the currently authorized supplemental payments into 2018-19 by an additional $151 million relative to the January budget.

• Proposes using $225 million in Proposition 56 funding to offset General Fund spending on cost growth in Medi-Cal in 2018-19. This represents a $56 million increase over the amount proposed in January.

• Projects $53 million in higher Proposition 56 revenues dedicated to Medi-Cal over 2017-18 and 2018-19 relative to January budget estimates.

• Does not include a detailed plan for how to fully expend between $600 million and $700 million in Proposition 56 funding dedicated to Medi-Cal provider payment increases.

Background. Proposition 56 raised state taxes on tobacco products and dedicates the majority of associated revenues to Medi-Cal on an ongoing basis. Proposition 56 revenues that are dedicated to Medi-Cal can be used for two main purposes: (1) augmenting the program, such as, for example, by increasing Medi-Cal provider payments and (2) offsetting General Fund spending on cost growth in Medi-Cal. For background on the use of Proposition 56 funding in Medi-Cal, please refer to our February 2018 report: The 2018-19 Budget: Analysis of the Health and Human Services Budget.

Governor’s January 2018-19 Budget Proposed Spending Maximum Amount Authorized in 2017-18 Budget Agreement on Provider Payment Increases. The Governor’s January 2018-19 budget proposed spending the maximum amount authorized in a 2017-18 Proposition 56 budget agreement ($1.346 billion) on provider payment increases within the provider and service categories designated in the 2017-18 agreement. Specifically, the Governor’s January budget proposal extended the provider payment increases structured in the 2017-18 agreement into 2018-19. In addition, the January budget allocated a remaining portion of Proposition 56 funding to pay for new provider payment increases above 2017-18 levels ($523 million) and dedicated $169 million in Proposition 56 funding to offset General Fund spending on cost growth in Medi-Cal.

Governor’s May Revision Maintains January’s Proposal to Spend Maximum Amount on Provider Payment Increases. The Governor’s May Revision similarly proposes to spend the full $1.346 billion of Proposition 56 funding authorized in the 2017-18 agreement for provider payment increases. The May Revision dedicates this funding to the provider and service categories included in the 2017-18 agreement, with most of the funding going to physician and dental services supplemental payments.

Higher Proposed General Fund Offset. In addition, the Governor proposes using $225 million of Proposition 56 revenues to offset General Fund spending on cost growth in Medi-Cal, a $56 million increase over the amount proposed in January. To a significant degree, this $56 million proposed increase is paid for by higher projected Proposition 56 revenues that are dedicated to Medi-Cal, which—across 2017-18 and 2018-19—are $53 million higher as of the May Revision compared to the Governor’s January budget.

May Revision Does Not Include a Detailed Plan for How to Fully Expend Funding for Provider Payment Increases. As was the case under the Governor’s January proposal, the Governor’s May Revision budget does not include a detailed plan for how to fully spend this $1.346 billion in Proposition 56 funding dedicated to Medi-Cal provider payment increases. According to our initial review of updated budget estimates, it appears that approximately 50 percent of this $1.346 billion is needed to fund the provider payment increases currently authorized through 2018-19. This potentially leaves between $600 million and $700 million to be committed by the Legislature in 2018-19 to new provider payment increases beyond those currently authorized. While the May Revision appears to broadly dedicate this available funding to physician and dental services supplemental payments, the Governor’s May Revision does not include a detailed plan for how to target and structure these additional payments.

LAO Comments

Governor’s January Proposal—Continued in the May Revision—to Extend the Currently Authorized Provider Payment Increases Into 2018-19 Has Merit. Implementation of the currently authorized provider payment increases is just getting underway following initial delays and challenges. At this time, it is difficult to tell whether they are having an impact on increasing access to Medi-Cal services. Extending the currently authorized provider payment increases into 2018-19—consistent with the 2017-18 budget agreement—would (1) likely meet fewer implementation challenges than occurred in 2017-18 and (2) give the Legislature more time to evaluate whether the provider payment increases are having their intended impact. Accordingly, we believe that extending the currently authorized provider payment increases through 2018-19 has merit.

Consider Longer-Term Supplemental Payments for Providers. Longer-term increases to provider payments are likely more effective in improving access to care than temporary, year-at-a-time increases. The challenges associated with implementing the 2017-18 supplemental payments have left the Legislature without a solid understanding of the impact that the payment increases have had on access to care. A longer-term piloting of supplemental provider payments may give the Legislature a better opportunity to evaluate the impact of the improved payments on access to care in order to determine whether provider payment increases should be made permanent.

The Legislature Has Additional Options in Deciding How Available Funding Is Spent. The absence of a detailed plan for how to fully spend between $600 million and $700 million in Proposition 56 funding leaves the Legislature with a notable opportunity to provide input into how this available funding is spent. The administration has signaled an openness to working with the Legislature to decide its allocation. Below, we provide a preliminary analysis of a few of the options before the Legislature for spending this available funding.

• Further Increase One-Time Supplemental Payments for Providers. As proposed by the Governor, the Legislature could elect to use some or all of the available funding to increase physician and dental services supplemental payments beyond those currently authorized. Should it wish to pursue this general option, the Legislature can provide input into how this funding is targeted. For example, the Legislature could designate additional physician and dental services beyond those currently receiving supplemental payments to be eligible for supplemental payments. Alternatively, or in addition, the Legislature could potentially increase the supplemental payment levels for services currently receiving Proposition 56-funded supplemental payments. Given the challenges experienced during the first round of Proposition 56 supplemental payments implementation, simple supplemental payment proposals should be preferred over complex ones to minimize implementation challenges and payment delays.

• Augment the Medi-Cal Program in Ways Other Than Supplemental Payments. The Legislature could consider augmenting Medi-Cal in ways other than providing additional supplemental payments. The Legislature could consider alternative one-time uses of Proposition 56 funding in Medi-Cal that allow for a focus on improving the program’s infrastructure. Alternatively, the Legislature could consider augmenting the program in other ways on an ongoing basis—such as, for example, by expanding coverage or covered benefits.

• Increase the General Fund Offset for Medi-Cal Cost Growth. The Legislature could consider increasing the amount of Proposition 56 funding that offsets General Fund spending on cost growth in Medi-Cal beyond the $225 million proposed in the May Revision for 2018-19. This would free up additional General Fund resources that could be used to fund other new programs or, alternatively, saved for economic uncertainties.

340B Drug Pricing Program Medi-Cal Proposal

Governor’s May Revision Budget Maintains Proposal to Eliminate the Use of the 340B Drug Pricing Program in Medi-Cal. The Governor’s January budget proposal included a proposal to eliminate the use of the 340B prescription drug discount program in Medi-Cal. For background on the 340B Program, its use in Medi-Cal, and the Governor’s January proposal, please refer to our March report: The 2018-19 Budget: The Governor’s Medi-Cal Proposal for the 340B Drug Pricing Program. The Governor’s May Revision budget proposal maintains the existing January proposal for this program.

May Revision Budget Estimates Upfront Costs but Long-Term Savings. The Department of Health Care Services (DHCS) estimates no fiscal impact in 2018-19 and net General Fund costs of $26 million in 2019-20 resulting from the proposal. DHCS estimates out-year General Fund net savings of almost $17 million ($72 million total funds) annually beginning in 2020-21 as a result of eliminating the use of the 340B Program in Medi-Cal.

LAO Comments. At this time, our understanding of how DHCS arrived at its estimate of General Fund and total funds savings from the maintained January proposal is limited. In the coming days, we will evaluate the savings estimate to ascertain its reasonableness, and will notify the Legislature if we have any concerns. Should the savings estimate prove reasonable, it would suggest that the Governor’s 340B proposal would have a relatively minor impact on (1) General Fund savings and (2) covered entities’ losses resulting from the elimination of the use of 340B Program in Medi-Cal. In light of this potentially limited adverse fiscal impact on covered entities, the Governor’s proposal continues to have merit since it would (1) significantly reduce the complexity of administering the Medi-Cal prescription drug benefit and (2) ensure compliance with federal law by effectively preventing duplicate discounts.

California Medicaid Management Information System (CA-MMIS) Modernization Approach Budget Change Proposal (BCP)

Proposal. DHCS requests expenditure authority of $42 million ($10 million General Fund, $32 million federal funds) and 17 permanent positions in 2018-19 to continue efforts to modernize CA-MMIS—the state’s fee-for-service claims processing system for Medi-Cal. (The BCP adds an additional eight permanent positions in 2019-20, with no additional expenditure authority requested at this time.) The administration estimates that the total cost of the CA-MMIS modernization project will be between $400 million and $600 million, $40 million to $60 million of which will be General Fund as the project likely qualifies for an enhanced FMAP of 90 percent. (Design, development, and implementation activities that support state MMIS systems generally qualify for a 90 percent FMAP.) The administration also estimates that it will take about ten years to complete the modernization project.

LAO Assessment. We have concerns about the lack of detail included in the project timeline and about the provisional language attached to the proposal:

• Proposed Timeline Lacks Sufficient Detail. The administration’s proposed timeline of about ten years, with a total cost of between $400 million and $600 million, does not provide the Legislature with enough information about—as examples—the estimated completion dates for currently proposed system modules, the future modules that are being considered as part of the project, and the estimated costs associated with each module. Limited information prevents the Legislature from exercising its oversight responsibility for this project.

• Provisional Language Provides Administration Too Much Discretion to Increase Costs. Provisional language included in the BCP allows the administration to augment appropriations for this proposal by $53 million ($5.3 million General Fund, $47.7 million federal funds). This means appropriations for the proposal could more than double, if approved by the DOF. The provisional language also reduces the number of days the Joint Legislative Budget Committee (JLBC) has to review any proposed augmentation from 30 calendar days down to 10 days. This shorter time frame would inappropriately limit legislative oversight of the project.

LAO Recommendations. Based on our assessment, we recommend the Legislature:

• Request Additional Information About the Project From DHCS. We recommend the Legislature request that DHCS provide more information about the project, including those details we described that are currently lacking in the department’s proposed timeline.

• Require DHCS to Justify Augmentation Language. We recommend the Legislature require that DHCS justify the maximum amounts included in the proposed augmentation language. Should DHCS be unable to provide sufficient evidence of the need for these maximum amounts, the Legislature could consider reducing those amounts to (at a minimum) less than the cost of the proposal.

• Revise Provisional Language to Provide JLBC With 30 Calendar Days to Review Proposed Augmentations. We recommend the Legislature revise the proposed provisional language to give the JLBC its traditional 30-day time frame to review proposed augmentations of appropriations for this project.