Federal Approval of a Reauthorized Managed Care Organization Tax Now Appears More Likely

Managed care organizations (MCOs) are health insurance plans that arrange and pay for the health care of their members. Since 2016‑17, the state has imposed a per-member tax on the Medi-Cal and non-Medi-Cal enrollment of MCOs. The current MCO tax, which leverages federal funding for Medi-Cal, generates substantial General Fund savings—as much as $1.5 billion in 2018‑19. Under state law, the MCO tax expires at the end of 2018‑19, eliminating the General Fund savings. Should the Legislature wish to renew the MCO tax, it will almost certainly have to receive federal approval in order to be implemented. The state’s prospects for receiving federal approval of a similarly structured MCO tax—uncertain until recently—appear significantly improved following recent federal approval of a similarly structured health insurer tax in Michigan. This post provides background on California’s MCO tax and analyzes how federal approval of Michigan’s tax likely impacts California’s prospects for renewing the state’s MCO tax.

Federal Rules on Health Care-Related Taxes

Many states levy licensing fees, assessments, or other mandatory payments on the provision of health care service or items. These are referred to as “health care-related taxes.” The federal government has rules that regulate states’ health care-related taxes to the extent that they are used to draw down federal Medicaid funds. The rules apply, for example, to taxes on direct health care services (such as hospital inpatient stays) as well as to taxes on health insurer (such as an MCO) revenue or enrollment. The rules are in place to prevent states from imposing taxes that place too great a burden on federal Medicaid funds. Therefore, to receive federal approval, a state must prove to the federal government that the burden of paying a health care-related tax does not fall too disproportionately on Medicaid as opposed to non-Medicaid services. In addition, a state may not hold payers of the health care-related tax harmless by providing its payers direct or indirect payments that do so.

California’s MCO Tax

Prior to 2016‑17, California imposed an MCO tax on the total operating revenue received by MCOs through their Medi-Cal line of business. Because this tax only applied to MCOs’ Medi-Cal line of business, it was later found to be in violation of federal rules on health care-related taxes, compelling the state to establish a new MCO tax structure beginning in 2016‑17. That fiscal year, the Legislature approved a significantly restructured MCO tax package that ultimately received federal approval.

Existing MCO Tax Structure. The structure of the existing MCO tax—in effect from 2016‑17 through 2018‑19—is as follows:

• Imposed on Most MCOs, Including Their Non-Medi-Cal Lines of Business. MCOs are health insurance plans overseen by the Department of Managed Health Care or the Department of Health Care Services. They do not include health insurance products regulated by the California Department of Insurance. The MCO tax is imposed on most of the state’s MCOs, and applies to their Medi-Cal and non-Medi-Cal lines of business. Certain health plans are exempt from the tax—for example, those that offer only limited services such as vision or dental coverage.

• Enrollment-Based Tax. The existing MCO tax is an enrollment-based tax where MCOs are taxed according to their total number of enrollee member months over the fixed time period of October 2014 through September 2015. A member month is defined as one member being enrolled for one month in an MCO. For example, if an individual is enrolled in the Kaiser Foundation Health Plan for the 12-month period specified above, Kaiser would be taxed for 12 member months for each of the fiscal years 2016-17, 2017-18, and 2018-19.

• Tiered Rate Structure. The existing MCO tax features a tiered rate structure whereby MCOs are charged different tax rates based on the following:

• Enrollment Type. MCOs are generally taxed at higher rates for Medi-Cal enrollee member months than non-Medi-Cal enrollee member months.

• Enrollment Size. MCOs with higher enrollee member months are taxed at lower effective rates.

• Fiscal Year. The tax rates generally increase each fiscal year.

• MCO Structure. The MCO tax applies a unique tax rate to non-Medi-Cal enrollment in any MCO that qualifies as an “Alternate Health Care Service Plan,” defined as a nonprofit health plan that has high statewide enrollment, that owns or operates pharmacies, and that exclusively contract with a single medical group in all of its geographic areas of operation. Kaiser Foundation Health Plan is the only MCO that qualifies under this definition.

Figure 1 details the existing MCO tax’s overall structure.

MCO Tax Package Included Changes to Other Taxes Paid by Some MCOs. The MCO tax package cut other taxes paid by some MCOs and certain affiliated health insurance companies. Specifically, certain types of income currently subject to the corporation tax is exempted from taxation and certain premium revenue is subject to a 0 percent insurance tax (also known as the gross premiums tax) rate during the period in which the MCO tax is in effect. The administration estimated that these tax cuts would reduce corporate and insurance tax revenue—which support the General Fund—by around $400 million per year. Due in part to these tax cuts offsetting the impact of the MCO tax, the administration estimated that the health insurer industry as a whole would receive an approximately $100 million net benefit annually. Although the health insurance industry as a whole was expected to benefit on net, total state taxes for some MCOs were expected to increase under the MCO tax package.

MCO Tax Package Restored In-Home Supportive Services (IHSS) Service Hours to Pre-Recession Levels. IHSS beneficiaries’ service hours were reduced across the board by 7 percent in an effort to reduce the General Fund shortfall in the aftermath of the most recent recession. The MCO tax package restored IHSS service hours to pre-recession levels for the years the MCO tax is in effect, at an annual General Fund cost of about $300 million.

Federal Approval of a Reauthorized MCO Tax Now Appears More Likely

Prospects of Renewing MCO Tax After 2018-19 Initially Appeared Uncertain. Following federal approval of the existing MCO tax, there was initial uncertainty among state health policymakers over whether the federal government would approve a similarly structured MCO tax after the expiration of the existing tax. At that time, state policymakers were expecting revisions to federal rules on health care-related taxes that could have, in the years following 2018-19, prohibited a MCO tax similar in structure to the state’s current MCO tax. Such revisions to federal rules, however, were never made.

Until Recently, No Similar Health Insurer Taxes Had Been Proposed or Approved During Current Federal Administration. To our understanding, until recently, no state had proposed or received federal approval of a health insurer tax similar to California’s MCO tax since Ohio in 2016. (Ohio’s health insurer tax is modeled after California’s MCO tax. The Obama administration approved Ohio’s health insurer tax at the end of 2016.)

Michigan Recently Enacted a Health Insurer Tax That Is Structurally Very Similar to California’s Current MCO Tax. Earlier this year, the Michigan Legislature passed—and its Governor signed—a series of legislation that makes significant changes to the taxes imposed on Michigan health insurers. The new tax on Michigan health insurers is structured very similarly to California’s current MCO tax. Like California’s MCO tax, Michigan’s new health insurer tax (1) is enrollment-based, (2) applies to Medicaid and non-Medicaid enrollment, and (3) and is tiered so that the tax rate varies based on whether a member is enrolled through Medicaid as well as on insurers’ enrollment numbers. Unlike California’s MCO tax, Michigan’s health insurer tax is based on annually updated insurer enrollment numbers. In addition to imposing the above new tax, Michigan repealed other state taxes on health insurers, including a one percent tax on insurers’ health claims, which serves to offset the costs of the new health insurer tax.

Current Federal Administration Recently Approved Michigan’s Tax. In December 2018, the federal government approved Michigan’s new insurer tax.

Prospect of Renewing California’s MCO Tax Appear Improved. Prior to approving Michigan’s new health insurer tax, the current federal administration had not considered or approved a health insurer tax similar to California’s current MCO tax. As a result, there was some uncertainty going forward as to whether the current federal administration would permit a health insurer tax like California’s MCO tax. Having approved Michigan’s new health insurer tax, California’s prospects of receiving federal approval of a reauthorized MCO tax appear improved. In addition to requiring federal approval, renewing California’s MCO tax will require statutory authorization from the state Legislature.