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Other Budget Issues

Last Updated: 4/23/2010
Budget Issue: An issue has arisen regarding the transition costs in 2010-11 of switching to a new fiscal intermediary (FI) for Medi-Cal. The Department of Health Care Services (DHCS) estimates the new contract will result in savings of $0.9 million in 2010-11 while the current FI's consultant, Blue Sky Consulting, believes that the switch will result in costs of $11 to $13 million.
Program: Medi-Cal Fiscal Intermediary Contract
Finding or Recommendation: Found that costs in 2010-11 are likely to be similar regardless of whether the state goes forward with a new fiscal intermediary (FI) or extends the current contract. Moreover, any modest difference in short-run costs is not a significant enough factor, in our view, to delay moving forward with the new long-term FI contract.
Further Detail

Considering the New Medi-Cal Fiscal Intermediary Contract

Findings In Brief

An issue has arisen regarding the potential transition costs in 2010-11 of switching to a new fiscal intermediary (FI) contract.  Specifically, the Department of Health Care Services (DHCS) has prepared worksheets showing that switching to the new contractor would result in savings of approximately $0.9 million during 2010-11.  The incumbent FI, Electronic Data Systems (EDS), disputes the DHCS estimate and hired a private firm, Blue Sky Consulting, to analyze the DHCS comparison worksheets.

After reviewing documents prepared by the (DHCS) and Blue Sky Consulting, and meeting with both, we believe that costs in 2010-11 are likely to be similar regardless of whether the state goes forward with a new FI or extends the current contract. Moreover, any modest difference in short-run costs is not a significant enough factor, in our view, to delay moving forward with the new long-term FI contract. Below, we provide background on this issue and explain our findings.


Medi-Cal and the FI Contract. In California, the federal Medicaid program is administered by DHCS as the California Medical Assistance (Medi-Cal) Program. The Medi-Cal Program provides health care services to low-income persons. Claims payments for Medi-Cal, in addition to some other health care programs, such as California Children’s Services, are handled by the state’s FI. To provide this claims processing service, the FI maintains and operates an automation system known as the Medicaid Management Information System (MMIS). With federal financial participation, the state pays the FI based on transaction volume and other factors specified in its contract with the FI. The contract with the current FI expires on June 30, 2011, but the administration plans to terminate the contract sometime earlier in the fiscal year pursuant to a provision in the existing contract.

Procuring a New FI. Since 1987, Electronic Data Systems (EDS), now a subsidiary of Hewlett-Packard (HP), has been the FI. The state began the process of planning for the procurement of a new FI several years ago. This was after several analyses concluded that the state needed a new system because (1) the present system was 30 years old and could not support needed programmatic changes and (2) the present system lacked sufficient ability to detect and prevent fraud in Medi-Cal Program claims. In 2008, DHCS issued a request for proposals for a new FI and MMIS. In early 2010, DHCS selected Xerox/ACS as the new FI. The DHCS obtained federal approval for the new FI and signed a contract with Xerox/ACS on March 31, 2010, with an effective contract start date of May 1, 2010. The proposed contract runs for ten years.

Protest. The incumbent FI, HP/EDS, competed along with at least two other firms to be the new FI to develop and operate a new MMIS. Because DHCS found HP/EDS’s proposal to be unsatisfactory, their proposal was ultimately disqualified from the competition and their sealed cost proposal was never opened. The HP/EDS protested the DHCS procurement process to the Department of General Services (DGS). In March 2010, an independent hearing officer assigned by DGS ruled that DHCS had properly procured a new FI and rejected HP/EDS’s challenge to the process.


Recently, HP/EDS representatives expressed a concern that transitioning to a new FI would result in substantial costs to the state during 2010-11. In response to these concerns, DHCS prepared a comparison of the known costs, pursuant to their proposed contract, of transitioning to the new FI to their estimated costs of continuing with the existing FI beyond December 31, 2010. In making this comparison, DHCS estimated the costs of continuing with the existing FI based on assumptions about the likely volume of claims that would be processed under the existing contractual arrangements. Because the new MMIS contract includes features that remediate identified problems, DHCS also had to make a series of assumptions about the corresponding costs of remedying these problems if the state continued with the existing FI.

DHCS Comparison. The DHCS created a side-by-side worksheet which was meant to provide an “apples-to-apples” comparison between continuing with the incumbent FI versus switching to the new FI. According to the DHCS worksheets, the state savings from switching to the new contractor would be approximately $0.9 million in 2010-11 and $9.7 million in 2011-12.

HP/EDS Report Disputes DHCS Findings. The HP/EDS hired Blue Sky Consulting Group to analyze the DHCS comparison worksheets. In a report dated April 2, 2010, Blue Sky concluded that switching to a new FI would result in state costs of between $11 million and $13 million in 2010-11. Essentially, Blue Sky concluded that DHCS had substantially overstated the cost of remaining with incumbent FI. Blue Sky based most of its estimated costs of continuing the contract with the existing FI on information provided by HP/EDS.

LAO Review

Our office has reviewed the DHCS worksheets and Blue Sky report. In addition, we met separately with staff from DHCS and Blue Sky. In these meetings, we determined that Blue Sky never discussed its approach to this issue with DHCS staff.

Blue Sky’s Findings. Essentially, Blue Sky argued that the cost of remaining with the incumbent FI (HP/EDS) was overstated for several cost categories, because DHCS had assigned transition costs to the HP/EDS FI while assigning no corresponding costs to Xerox/ACS. In addition, Blue Sky found that DHCS budget projections have consistently overestimated the actual cost of the existing FI services.

Issues With the Blue Sky Analysis. As noted above, Blue Sky based their conclusions on information provided by its client, the incumbent FI, HP/EDS, and did not discuss its analysis with DHCS prior to issuing its report on April 2. We identified the following issues with the Blue Sky analysis.

In its report, Blue Sky had identified several examples of costs which were charged to HP/EDS and appeared not to be reflected as costs for Xerox/ACS. However, the DHCS advised us that these costs were generally built into the contracted price of processing claims by the new system to be provided by Xerox/ACS. In other words, the department indicated that certain costs separately identified in the existing FI contract were rolled up in the new vendor’s total contract price.

We have been unable to validate Blue Sky’s further assertion that DHCS consistently overestimated the actual costs for the FI. However, because this finding was not factored into Blue Sky’s estimate of the cost of continuing the contract under HP/EDS, we concluded that this assertion is irrelevant for the purposes of comparing this option with the option of proceeding with Xerox/ACS.

Transition Year Impact Not Significant. As noted earlier, making an apples-to-apples comparison of transition costs is difficult. After adjusting for certain factors which Blue Sky was not able to take into account, there would be little significant fiscal impact in 2010-11 under either FI scenario.

No Information on Long-Term Costs. Because the Blue Sky report focused on the short-term transition costs, our review focused on the 2010-11 fiscal impact of making a switch to a new FI contractor.  However, we believe the more important question is the long-term implications of this change. Unfortunately, our office does not have sufficient information to assess whether switching to a new FI would benefit the state General Fund over the ten-year life of the new contract. This is because we do not know what the long-term costs would be for remaining with HP/EDS. These unknowns include (1) whether federal funding would continue to be available for the support of MMIS while undertaking a new procurement, (2) the cost of reprocurement and the availability of federal funds for this process, and (3) the ultimate cost of the winning bid. Thus, even if the Blue Sky findings were correct, a short-run difference in costs would not necessarily be a reason for the Legislature to reject an appropriation for the costs of the new contract. As stated earlier, several analyses have found that procuring a new MMIS was necessary to support programmatic changes and improve fraud detection. Moreover, with the rollout of federal health care reform it will be even more critical that the state has a modern system that can effectively manage this change.