Legislative Analyst's Office
February 22, 1995

California Medical Assistance (Medi-Cal) Program (4260)

County Administrative Claims

Federal Ruling Casts Doubt on $400 Million For the State and Potentially $2 Billion for Counties

A recent decision by the federal Health Care Financing Administration (HCFA) places at serious risk $400 million in General Fund savings assumed in the budget and potentially $2 billion in net federal revenues to counties over the course of the current year and 1995-96. We recommend that the department report at budget hearings on the status of its negotiations with the HCFA to (1) allow reimbursement for some Medi-Cal administrative claim activities during 1995-96, and (2) establish an expedited appeal of the HCFA denial regarding claims already submit ted.

The federal Health Care Financing Administration (HCFA), which oversees the Medicaid Program (Medi-Cal in California), informed the department in January 1995 that it intends to deny payment for "Medi-Cal Administrative Claiming" (MAC), citing a number of concerns regarding the appropriateness of recent claims. This decision casts serious doubt on the likelihood that the General Fund will receive $400 million in reimbursements assumed in the budget in 1994-95 and 1995-96. Similarly, the decision jeopardizes potentially as much as $2 billion in federal revenues to counties that were anticipated from MAC reimbursement over the same time period.

Background. Chapter 1179/91 (SB 910, McCorquodale) established the MAC Program, whereby counties are reimbursed for case management and other adminis-trative activities associated with the Medi-Cal Program and performed by various county and non-profit agencies.

Examples of MAC activities claimed by counties include:

Under the program, counties transfer to the state the required 50 percent match to receive federal reimbursement for MAC activities.

HCFA Action. Following an audit of a sample of MAC claims, the HCFA notified the department in December 1994 that it was deferring payment of all claims submitted for reimbursement of MAC activities. The HCFA cited a number of concerns in deferring payment of the claims. These include the agency's view that:

In January 1995, the HCFA indicated to the department that it intends to deny payment of all of the claims due to these concerns.

The department indicates that it intends to appeal the HCFA decision, and is currently negotiating with the HCFA regarding (1) the possibility of reimbursing some MAC activities in 1995-96, and (2) an expedited appeal process regarding the denied claims.

Budget Implications. The budget assumes dramatically higher federal reimbursements for MAC activities in 1994-95 and 1995-96, based on claims submitted by counties. Specifically, the budget assumes MAC reimbursements would increase from a total of approximately $17 million in 1992-93 and 1993-94 to about $850 million in 1994-95 and $750 million in 1995-96. Recognizing this increase, the 1994 Budget Act also required counties to transfer to the state $200 million annually to offset General Fund costs for the Medi-Cal Program--if federal reimbursements for MAC activities were received. The budget proposal continues to assume receipt of these revenues by counties--and the associated offset of $200 million annually to the General Fund--for 1994-95 and 1995-96.

Based on the HCFA action and the length of time necessary to complete an appeal of the HCFA denial, it appears improbable that MAC claims will be reimbursed to the extent anticipated. As a result, it appears similarly doubtful that the state will receive from the counties the offsets assumed in the budget, thereby increasing the General Fund cost for the Medi-Cal Program by up to $400 million over the course of the current and budget years.

Figure 16 (see next page) shows the total federal revenues that may be lost by counties as a result of the HCFA denial. The amount of revenue that may be lost varies considerably by county. As the figure indicates, Los Angeles County is particularly affected by the HCFA action. Note that the figure shows the department's estimate of potential revenue losses (rather than actual claim amounts) for the current and prior years because the counties are still in the process of submitting claims for these years. (Similarly, the figure provides only an estimate of revenues at stake for 1995-96 because these claims have yet to be submitted.)

Due to the magnitude of the potential revenue loss to counties and the General Fund offsets that are in doubt, we recommend that the department report at budget hearings on the status of its negotiations with the HCFA to (1) allow reimbursement for some MAC activities during 1995-96, and (2) establish a process to expedite the state's appeal of the HCFA denial regarding claims already submitted.

Copayments and Drugs

Beneficiary Copayments Proposal Should Be Modified

We recommend modifying the proposal to charge copayments for services to certain Medi-Cal beneficiaries by (1) reducing the pharmacy dispensing fee for all prescriptions, irrespective of whether copayments can be collected and (2) exempting from the copayment requirement outpatient clinic and physician services, thereby reducing the potential for primary care access problems and cost-shifting that might otherwise result. This will result in a net General Fund savings of $8.4 million in 1995-96. (Reduce Item 4260-101-001 by $8.4 million.)

The budget assumes enactment of legislation that will result in savings of $40.2 million ($20.1 million General Fund) by requiring some Medi-Cal beneficiaries to pay copayments for certain Medi-Cal services.

Background. Current state law permits Medi-Cal providers to collect copayments for certain services. However, prior budgets have not assumed collection of the copayments because federal law prohibits providers from refusing services to a beneficiary if he or she cannot make a copayment.

Federal law also requires Medi-Cal to exempt beneficiaries in the following categories from copayment requirements:

Budget Proposal. The budget proposes to (1) require that providers charge copayments (unless the beneficiary indicates that he or she is unable to pay it), and (2) reduce Medi-Cal reimbursement rates to providers by the amount of the copayment required. The budget proposal would exempt from copayment requirements those categories of Medi-Cal beneficiaries that are exempted under federal law. Accordingly, the proposed copayments would apply to beneficiaries who are:

Proposal Has Potential Drawbacks. The proposed legislation will not change the requirements in current federal law that prohibits providers from refusing to provide services to Medi-Cal beneficiaries if they cannot pay the copayment. Thus, to the extent beneficiaries are unwilling to make the copayment, providers must accept a lower level of net reimbursements.

Most providers who would face reduced Medi-Cal rates under this proposal have not received Medi-Cal rate increases since 1985-86. Accordingly, even though the copayments are small, some providers (such as physicians and outpatient clinics) may respond to the rate reductions by refusing to provide services to Medi-Cal beneficiaries, thereby reducing access to primary care under the Medi-Cal Program. (We note, for example, that the number of physicians participating in the Medi-Cal Program has remained essentially unchanged between 1988 and 1993, whereas the program's caseload increased at an average annual rate of about 10 percent during that period.) This, in turn, could result in additional costs to Medi-Cal, to the extent that beneficiaries do not receive primary care (or do not seek it due to the copayment requirement) and develop more serious illnesses that require emergency or inpatient services.

Given these potential drawbacks, we recommend that the Legislature modify the budget proposal, as discussed below.

Expand Pharmacist Rate Reduction. First, as Figure 17 shows, most of the savings from copayments are attributable to reducing the "dispensing fee" that is paid to pharmacists each time they fill a prescription. The current Medi-Cal reimbursement for each prescription is $3.55, plus ingredient costs for the drug. We note that this amount is significantly higher than the amount paid by other "third- party" payers. For example, the state's Public Employees' Retirement System, reimburses pharmacists $2.65 per prescription (plus drug ingredient costs)--90 cents below the Medi-Cal reimbursement rate.

Accordingly, we believe the administration's proposal should be modified to eliminate the additional amount currently being paid to pharmacists. Specifically, because the pharmacy dispensing fee is above the rate paid by other third-party payers, we recommend that the Legislature authorize copayments on drugs and reduce the dispensing fee paid to pharmacists by $1 per prescription for all beneficiaries, irrespective of whether the pharmacist can charge a copayment, and that the reduced rate take affect on July 1, 1995 rather than in October as the budget proposes.

We note that the per-prescription reimbursement we recommend ($2.55) essentially conforms the Medi-Cal reimbursement rate to the level currently paid by non- Medi-Cal providers--even if pharmacists are unable to collect any copayments. Thus, we do not believe the proposal would adversely affect beneficiary access to prescription drugs. We estimate that this action, together with the earlier implementation date, would result in General Fund savings of $13.2 million above the savings proposed in the budget.

Exempt Physician and Clinic Services. We also recommend that a portion of these savings be redirected to eliminate the proposed copayments in those cases where, in our judgment, the potential for primary care access problems and cost-shifting is most clearly an issue--specifically, for physician and clinic services. This component of our recommendation would reduce the budgeted level of savings by $4.8 million from the General Fund.

Impact of Recommendation. The net result of these recommendations would be an additional reduction of $16.7 million ($8.4 million General Fund) beyond the amount assumed in the budget. In summary, our recommendation would (1) fully conform the Medi-Cal pharmacy dispensing fee to levels paid by other payers, (2) reduce the potential for primary care access problems and cost-shifting, and (3) achieve an additional General Fund savings of $8.4 million.

Medi-Cal Drug Ingredient Costs Should Be Reduced

We recommend that the Legislature lower the reimbursement rate ceiling for prescription drug ingredient costs from Average Wholesale Price (AWP) minus 5 percent to AWP minus 10 percent, for a General Fund savings of $14.9 million, because the existing reimbursement level exceeds rates paid by other high-volume purchasers of drugs. (Reduce Item 4260-101-001 by $14,900,000.)

The Medi-Cal Program provides coverage for about 50 million drug prescriptions annually for its beneficiaries. The budget proposes about $500 million from the General Fund to reimburse pharmacists for this purpose. Of this amount, about $425 million is for the ingredient cost of the drug, while the remainder is for the pharmacists' dispensing fee. (Due to a lack of data, the figures exclude prescription drug costs for Medi-Cal beneficiaries enrolled in commercial prepaid health plans and county-organized health systems.)

Under current law, the Medi-Cal Program uses various methods to determine how much it will reimburse pharmacists for drug ingredient costs. Generally, the program uses as a benchmark the "Average Wholesale Price" (AWP), which is the estimated average price that wholesalers charge to retailers, less 5 percent (unless the pharmacist's charges are below this amount). This benchmark has been in place since 1989 and, until January 1995, federal law prohibited states from reducing their reimbursement levels.

Our review indicates that the AWP minus 5 percent reimbursement benchmark is higher than the rate paid by other major purchasers of drugs, as well as by many other state Medicaid programs. For example, the Public Employees' Retirement System (PERS), which provides health insurance for state employees, reimburses pharmacists at AWP minus 10 percent. Because the current Medi-Cal reimbursement rate is higher than the rate paid by other major health insurers, we believe the Medi- Cal rate should be reduced. Accordingly, we recommend that the Legislature establish a new reimbursement ceiling at AWP minus 10 percent, which is the rate paid by the PERS. We estimate that this action would result in General Fund savings of $14.9 million in 1995-96.

Nursing Facility Rates

The budget proposes several major changes involving nursing facility reimbursement rates. In our view, these proposals could be more effectively implemented through a contracting program for nursing facilities. We discuss these proposals below.

Minimum Nursing Hours and Distinct Part Rate Reductions

We recommend that, in lieu of the budget proposals to reduce (1) hospital-based "distinct part" nursing facility rates, and (2) freestanding facility minimum staffing levels and reimbursement rates, the Legislature implement a contracting program for nursing facilities similar to the one currently in place for hospitals.

"Distinct Part" Nursing Facility Rate Reduction. The budget proposes to reduce by an average of 20 percent, the reimbursement rates it pays to nursing facilities that operate as a "distinct part" of a hospital for a General Fund savings of $25.6 million in 1995-96. Currently, these facilities receive, on average, nearly three times the reimbursement rate paid to freestanding nursing facilities. This is due to a number of factors, including much higher overhead and labor costs associated with a large hospital.

However, under federal law (specifically, a provision commonly referred to as the "Boren amendment"), hospital and nursing facility reimbursement rates paid by Medi-Cal must be "reasonably sufficient to cover the costs of an efficiently and economically operated facility." In general, this requirement has been interpreted to require reimbursement of facilities, including "distinct part" nursing facilities, on the basis of reported actual costs. Thus, in order to reduce distinct part reimbursement rates, the department would need to demonstrate that existing rates exceed the costs to operate these facilities. At the time this analysis was prepared, the department had not indicated how it intends to achieve the proposed 20 percent reduction, given the requirements of the Boren amendment.

Minimum Nursing Hours Reduction. The budget also proposes to reduce reimbursement rates for freestanding nursing facilities by rescinding a legal settlement the department entered into in August 1993 in the case of Valdivia v. Department of Health Services. In the suit, the nursing facility industry alleged that the federal Omnibus Budget Reconciliation Act of 1987 (OBRA) effectively required increased facility staffing levels due to a number of its provisions, including a requirement that facilities assist patients in attaining their "highest practicable level of functioning."

Under the settlement, the department agreed to increase nursing facility reimbursement rates by about $2 per day (or 2.5 percent) and to raise nursing staff requirements from a minimum of 3 to 3.2 nursing hours per patient per day. The settlement expires in August 1996, but the administration proposes to lower reimbursement rates and the minimum staffing requirement for freestanding facilities, effective August 1995, to their prior levels for a General Fund savings of $20.2 million. According to the department, this proposal requires the agreement of the nursing home industry.

Impact of Proposal On Quality of Care Is Unknown. The department indicates it does not have data regarding the extent to which nursing facilities have increased their staffing levels in response to the higher reimbursement rate and the higher minimum hours of care. In the absence of these data, it is difficult for the Legislature to determine what impact the department's proposal would have on the quality of care provided to Medi-Cal beneficiaries residing in nursing facilities.

Analyst's Recommendations. The budget proposal involves considerable uncertainty regarding (1) the likelihood of the freestanding nursing facility industry's willingness to agree to the department's proposal to reduce minimum nursing hours in those facilities, (2) the potentially adverse effects on quality of care associated with that proposal, and (3) for the distinct part proposal, the potential complications due to the requirements of the Boren amendment. This uncertainty, and the risk it creates, could be avoided through an alternative approach that would still achieve significant General Fund savings. Specifically, in the Analysis of the 1994-95 Budget Bill, we recommended that nursing facility rates be determined on a negotiated basis through the California Medical Assistance Commission (CMAC)--the process by which most hospital reimbursement rates are determined currently.

We believe that if such a system were implemented, the freestanding nursing facility rate reductions could be achieved without violating the terms of the settlement with the industry. Moreover, it may be possible to achieve rate reductions of the magnitude proposed in the budget without lowering minimum staffing requirements for these facilities. This is because (1) Medi-Cal Program reimbursement provides nursing facilities approximately 65 percent of the revenues they receive, and (2) occupancy rates in nursing facilities have declined over the last several years. As a result, the Medi-Cal Program may be able to take advantage of a "buyer's market" for nursing facility services through contracting.

Similarly, for the distinct part proposal, the federal Health Care Financing Administration, has determined that the Boren amendment does not apply with regard to facilities that agree to a rate on the basis of voluntary negotiations. Accordingly, most hospitals in California have negotiated rates that are significantly lower than the "cost- based" rate in order to (1) attract the volume of patients who are eligible for Medi-Cal and (2) in many cases, gain access to federal disproportionate share (DSH) payments. Therefore, we believe similar reductions could be achieved in distinct part reimbursement rates--just as the CMAC currently achieves savings on hospital inpatient rates.

The contracting approach has an additional advantage with regard to distinct part facilities, in that the amount of the reduction would not need to be uniform across the state. This is particularly important because approximately one-third of distinct part reimbursements are paid to county-operated facilities and those in rural areas of the state. As a result, under contracting, the state would have flexibility to achieve lower reimbursement rates in many cases, while retaining the ability to pay higher rates in cases where other policy objectives--such as maintaining access to acute care hospitals in rural areas--are considered to outweigh the need to achieve Medi-Cal Program savings.

Accordingly, we recommend that the Legislature adopt a contracting system for both distinct part and freestanding nursing facility rates in lieu of the budget proposals. We further recommend that the department and the CMAC report at budget hearings on the fiscal impact of adopting this alternative.

Subacute Care Proposal Should Be Modified

We recommend that the department report at budget hearings on several aspects of its proposed nursing facility subacute care program. In addition, to maximize savings, we recommend that if this program is established, the Legislature (1) adopt "per discharge" rather than "per diem" reimbursement rates in certain cases, and (2) limit the new subacute rates to patients referred from hospitals.

Subacute Reimbursement Rate. The budget proposes to increase nursing facility reimbursement rates for facilities that agree to provide "subacute" care to patients who would otherwise be treated in hospitals. Subacute rates currently are provided to a limited number of nursing facilities for a small number of Medi-Cal beneficiaries with specific diagnoses. According to the department, the practice of discharging patients at an earlier date from hospitals to nursing facility settings has become increasingly common in the federal Medicare program and in the private sector, and should be incorporated on a wider scale in the Medi-Cal Program.

The department has not yet determined how much it would increase reimbursements to nursing facilities. However, the budget assumes that the rates will average approximately $500 per day less than hospital inpatient rates. Accordingly, the proposal would result in a net General Fund savings of $30 million in 1995-96 through shorter hospital stays.

Analyst's Comments and Recommendations. At the time this analysis was prepared, many details regarding the department's proposal were unclear. For example, the department is currently evaluating which groups of Medi-Cal patients and nursing facilities may participate in the new program, and what level of reimbursement will be provided. We recommend that the department report on these issues at budget hearings.

In concept, however, we believe the proposal has considerable merit. First, we agree with the department's assertion that the practice of moving patients from hospital to nursing home settings for recuperation has become increasingly common. Moreover, a recent report prepared by a private consulting firm found significantly longer average lengths of stay among Medi-Cal patients when compared to Medicare and other third-party payer patients with identical diagnoses.

As with the nursing facility proposals discussed above, we believe that the proposed subacute rate program could be more effectively established through a contracting process. This is because of the highly competitive nature of the nursing facility industry in California. In effect, the state may be able to take advantage of a "buyer's market" in negotiating the new higher rates, thereby increasing the potential for program savings.

We believe it is important to recognize, however, that the proposal could result in significant cost increases to the Medi-Cal Program, rather than savings, if the assumed reductions in average hospital stays do not occur. We note, for example, that the shorter average hospital stays that have been identified for the Medicare program and for private payers have occurred in an environment where hospitals generally are reimbursed on a "per discharge," rather than on a per diem basis (the current practice in the Medi-Cal Program in most cases).

In the Analysis of the 1994-95 Budget Bill, we recommended that the Medi- Cal Program move toward a per discharge system for all hospital reimbursements. Under this approach, hospitals would receive a fixed payment for each patient, irrespective of how long the patient is hospitalized, thereby creating an incentive for patients to be discharged earlier.

We believe it would be particularly important that a per discharge system be adopted for those hospitals and patient diagnoses where savings under the proposed subacute program are expected to occur. If such a change is not adopted, the Legislature has no assurance that the department's proposal will result in the shorter lengths of stay that have been achieved by other payers. In contrast, under a per-discharge approach, the savings would be automatic because the shorter length of stay could be assumed "up front," and reflected in the rate.

Finally, we recommend that the proposal be limited to those cases where a Medi- Cal beneficiary is being discharged from a hospital setting, rather than for patients already residing in nursing homes. This is because it would be difficult to monitor whether patients already in nursing facilities require the higher level of care (and associated higher reimbursement rate) in order to remain there.

Certificate Of Need Program Should Be Considered

We recommend that the department report at budget hearings on the merits of a "Certificate of Need" requirement for new distinct part facilities, and the potential savings such a requirement would achieve in 1995-96.

Prior to 1987, California required all health facilities to apply for a "Certificate of Need" (CON) in order to expand their facilities, including "distinct part" nursing facilities. In 1987, the state eliminated the CON requirement due to concerns that it was an overly regulatory approach to cost containment. Similar programs were also eliminated in 10 other states in the mid-1980s.

Since the repeal of California's CON requirement, the number of hospital-based nursing facility beds has more than doubled, increasing from about 5,000 licensed beds in 1986 to nearly 11,000 beds in 1993, as shown in Figure 18 (see next page). In contrast, the number of freestanding nursing facility beds has remained fairly steady, increasing by about 1 percent annually over the seven-year period. (Put differently, hospital-based nursing facility capacity has grown at 10 times the rate of freestanding facilities.) Similarly, the volume of Medi-Cal patients served in distinct part nursing facilities has increased by an average of 6 percent annually, whereas the volume of Medi-Cal patients served in freestanding facilities has declined slightly.

As noted previously in our analysis, Medi-Cal reimburses distinct part facilities at a rate nearly three times the amount it pays for services provided to beneficiaries who receive care in freestanding facilities (about $210 per day in distinct part facilities versus about $75 per day for freestanding facilities). This higher reimbursement rate for distinct part facilities almost certainly explains some of the growth in these facilities. (Other factors include declining hospital occupancy rates and the federal Medicare program's practice of reimbursing hospitals on a per-discharge basis, which encourages hospitals to discharge patients sooner--in many cases to the hospital's "distinct part" nursing facility.)

We acknowledge that the CON requirement represents a greater reliance on a regulatory approach to cost containment and, as such, may result in inefficiencies. However, we believe this approach should be reevaluated primarily because its repeal appears to be at least partly responsible for the proliferation of higher-cost facilities and the increase in the number of Medi-Cal patients served in them. Moreover, we are not aware of any indication that the care they receive would be diminished in less costly freestanding facilities.

Accordingly, we recommend that the department report at budget hearings on the merits of a CON requirement that would apply only to new distinct part facilities, and the potential savings such a requirement would achieve in 1995-96.

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