Legislative Analyst's Office Analysis of the 2002-03 Budget Bill

Public Employees' Retirement System (1900)

The Public Employees' Retirement System (PERS) administers the retirement benefit program for state employees (excluding the University of California) and the health benefits program for employees and annuitants. The current value of the Public Employees' Retirement Fund is about $150 billion. As a result of Proposition 162, which was approved by voters in November 1992, PERS has authority to spend funds to administer the retirement program for state employees without appropriation by the Legislature. However, because the health benefits program is separate from the retirement program, the Legislature does approve the budget for the health program. The entire PERS budget, however, is included in the budget bill as an informational item, with budget bill language that requires PERS to report specified budget information to the Legislature.

The Governor's budget shows 2002-03 expenditures for PERS of $249 million, an increase of $4.4 million, or 1.8 percent, over estimated current-year expenditures. However, this does not include an additional off-budget amount of $142 million for investment consultants, which brings proposed budget-year expenditures to $391 million. This amount reflects a continuation of existing activities and does not include any new spending proposals for 2002-03 outside of the health program. Total expenditures for the budget year, including new spending proposals, will not be known until the PERS Board approves the 2002-03 PERS budget in the spring.

Proposed Patient Data Project Needs Additional Oversight Controls

Background

The PERS is responsible for administering the health program for employees and retirees of the state and local governments that contract with PERS for this service. This includes negotiating annual premiums with the health maintenance organizations (HMOs) that provide healthcare to enrollees. The PERS also administers and sets premiums for two preferred provider organization (PPO) plans. 

Budget Proposal. For 2002-03, the budget proposes $3.5 million and three positions for PERS to develop a Health Care Decision Support System (HCDSS). The project involves the purchase of off-the-shelf software to establish a "data warehouse" consisting of information on the use of medical services and prescription drugs by those enrolled in PERS-administered health plans. Figure 1 shows one-time and ongoing project costs. One-time acquisition costs would total $6.2 million. Beginning in 2004-05, ongoing costs to support the system would be $3.3 million per year.

Project Expected to Improve Patient Care, Limit Premium Increases

The Public Employees' Retirement System (PERS) plans to use medical and pharmaceutical claims data to help improve patient care and limit healthcare costs and premium increases. The PERS estimates that premium savings would outweigh project costs.

Project Aims to Improve Treatment, Limit Costs and Premium Increases. The PERS indicates that medical and pharmaceutical claims information from HCDSS would be used to improve patient care and help contain increases in health insurance premiums. For example, PERS would be able to compare treatment regimens used by its health plans for particular illnesses in order to determine the most cost-effective courses of treatment. The claims information would also be used to determine best practices for addressing particular health problems so that PERS could require the health plans it contracts with to adopt those best practices.

On the cost side, HCDSS would allow PERS to identify which diagnoses and prescription drugs are most costly or most prevalent, track historical trends, and simulate the impact of changing plan provisions regarding copayments and deductibles. This would help PERS identify elements that significantly affect enrollee health costs so that PERS can develop strategies to limit those costs when negotiating annual contracts with HMOs.

The PERS would also use HCDSS to more accurately calculate health plans' per-member costs to better assess the HMO premium proposals submitted during negotiations each year.

Anticipated Savings From Avoided Premiums. With the capabilities provided by HCDSS to improve treatment outcomes, limit costs, and evaluate HMO premium proposals based on actual cost experience, PERS estimates premium cost savings as shown in Figure 2. At 2002 premium levels, PERS estimates savings of about $22 million in avoided premium increases in the first year of operation. These premium savings would accumulate from one year to the next. Thus, the total estimated savings in 2006 would be the previous year's $22 million plus an additional $15 million, and so forth for 2007 and beyond.

Benefits Likely to Outweigh Estimated Costs, But Costs Could Escalate. As shown in Figure 2, PERS estimates that premium savings for the first three years of system operation would total $48 million. To the extent these savings are realized, they would fully offset the estimated cost of the project. Even if savings were only half those estimated by PERS, or $24 million, they would still exceed total estimated project costs. However, in the following sections, we discuss our concerns with the proposal that, among other things, could cause project costs to escalate.

Project Has Insufficient Risk Management and Contract Oversight

We recommend that the Legislature adopt budget bill language that requires the Public Employees' Retirement System (PERS) to prepare a complete risk management plan and a contract evaluation before obligating funds for the Health Care Decision Support System contract.

The PERS Does Not Have a Complete Risk Mitigation Plan. State policy requires that every automation project complete a risk mitigation plan that considers (1) the potential business disruptions that could occur while implementing the project, and (2) the actions the state will take to reduce or "mitigate" those risks. For example, the HCDSS project would receive data from health providers and if the data is not properly formatted, the system may not be able to operate. With a risk mitigation plan, PERS would predetermine (1) what to do to prevent such a problem and (2) what to do should the problem occur. To our knowledge, PERS has only completed portions of a risk mitigation plan.

For this reason, we recommend that the Legislature direct PERS to prepare a complete risk mitigation plan before obligating funds for the HCDSS contract. The plan should include contingencies for software integration, clean-up of provider data, delays in receiving accurate provider data, and system inaccessibility. The following budget bill language is consistent with this recommendation:

It is the intent of the Legislature that the Public Employees' Retirement System (PERS) shall prepare a complete risk management plan before entering into a contract that obligates state funds for the Health Care Decision Support System (HCDSS). The plan shall include, but is not limited to, contingencies for problems related to software integration, system inaccessibility, and healthcare provider data.

Independent Evaluation of Proposed Contract Needed. The PERS is proposing to enter into a contract for the development, implementation, and maintenance of the HCDSS system. The state has historically had problems with such contracts because the contract did not include all the services that the state would need over the life of the system. As a consequence, the state has had to amend or renegotiate these contracts, resulting in increased costs and delays in implementing the system. For this reason, we recommend that an independent evaluation be conducted of the proposed contract before obligating state funds. The evaluation should:

• Compare PERS' negotiated contract with the business requirements specified in the HCDSS request for proposal to ensure all requirements are included in the contract.
• Review contract terms and conditions to ensure there is adequate legal protection in the event the contractor does not perform to specifications.
• Compare other government and private industry contracts of similar size and scope to ensure all necessary services to operate and maintain the HCDSS system have been included.
• Examine the hardware and software replacement schedules to ensure they conform to industry standards.

Specifically, we recommend that the Legislature adopt the following budget bill language:

It is the intent of the Legislature that an independent evaluation be conducted of the proposed contract for the Health Care Decision Support System (HCDSS) before PERS enters into or obligates state funds for this project. The evaluation shall include, but not be limited to, a comparison of the business requirements in the contract and the procurement document, review of contract terms and conditions assessing protections for the state, comparison of the HCDSS contract with contracts of similar size and scope to assess coverage of necessary support services, and assessment of hardware and software replacement schedules to ensure conformance with industry standards.