Opportunities for State Medicaid Reform

Studies | Health

No. 288
Thursday, September 28, 2006
by John C. Goodman, Michael Bond, Devon M. Herrick, and Pamela Villarreal


Comparing Medicaid Costs among States

Medicaid spending by state varies widely.  In 2004, the average state spent 22.3 percent of its budget on Medicaid, ranging from 4.6 percent in Wyoming to 35.2 percent in Tennessee.46  Expenditures per enrollee also vary substantially.  New Hampshire spends about $12,093 per enrollee, the most of any state, compared to the nationwide average annual cost of about $6,834.  Arkansas, by contrast, spends only $4,410 per enrollee.  [See Figure VIII.]

Why Do Some States Spend More Than Others?  Some might assume that Medicaid costs are higher in states such as New York because the local cost of living is much higher.  However, a comparison of New York City to Columbus, Ohio, where the local cost of living is at the national average, shows:

  • In fiscal year 2003-2004, Medicaid spending in New York City averaged $9,842 per enrollee, almost twice as much as the $5,082 spent in Franklin County (Columbus).
  • Adjusted for the cost of living in each area, New York City spending per enrollee was still twice as high as in Columbus, Ohio.47 

The most important contributing factors to greater spending are policies that encourage more spending and discourage cost control:

  • Some states offer coverage to virtually all optional populations, and cover almost all optional services.
  • Many state Medicaid programs underpay physicians (69 percent of what Medicare pays, on average) and overpay hospitals, although treatment in doctors' offices is less expensive than inpatient care or hospital-based clinics.
  • Some states pay premium prices for drugs though lower-cost alternatives are often just as effective.
  • In all states, the lack of cost-sharing and direct control by patients over some benefits encourages waste and unwise health care choices.
  • Many states do not aggressively pursue fraud - even failing to spend a substantial portion of the federal funds available for antifraud efforts.

Many states have imposed regulations on private health insurance that drive up the cost of private coverage, increasing demand for Medicaid services.  The following sections examine how these features of the system raise costs.

Figure VIII - Medicaid Expenditures per Enrollee%2C 2004

“Some states spend much more per Medicaid enrollee than other states.”

Costly Policy: Offering More Benefits to More People.  One reason Medicaid is so costly is that some states cover virtually all optional populations and provide virtually all optional benefits.48  In Tennessee and New Mexico, Medicaid covers more than one out of every five residents - considerably higher than the national average (14.3 percent).49

“Some states cover virtually all optional populations and benefi ts.”

Upon expanding coverage to parents of Medicaid-eligible children 150 percent to 200 percent above the poverty level, Maine's Dirigo program now enrolls the largest percentage of the population under the age of 65 of any state -18 percent.50 Additionally, Maine's Dirigo Health Board of Directors recently approved a new tax on insurers that is projected to raise $44 million to cover costs.  Of course, the tax will be passed on to insurance policyholders.51

There are 35 optional Medicaid services for which the federal government will provide matching funds if a state chooses to cover them.  [For a list of optional benefits, see Appendix Table IIa-c.]  For instance, rehabilitative therapy (covered in 31 states) and podiatry (covered in 27 states).  New York tops the list, providing 31 different optional services.52 

Optional Benefit: Long-Term Care.  One example of an optional benefit that all states provide is long-term care, which either takes place in a nursing home or in a patient's home.  In 2004, 35 percent of national Medicaid spending was allocated to long-term care.  But state expenditures vary:

  • North Dakota proportionally spent the most - almost 60 percent of its Medicaid budget (or $293 million) - on long-term care.53
  • By comparison, Tennessee spent the lowest percentage - 22 percent of its Medicaid budget (or $1.5 billion) - on long-term care.54

What accounts for the variation in spending on long-term care?  Some states have a higher proportion of blind, aged and disabled beneficiaries than the U.S. average.  In Alabama, Maine, Mississippi and Pennsylvania, more than one-third of enrollees fall into these categories, compared to the national average of 24 percent.55

Also, some states spend more on long-term care per beneficiary.  In Connecticut, more than half of the state's Medicaid expenditures went for long-term care.  The state's nursing home costs rank third highest in the nation, at about $97,000 per patient annually.56 

“Ohio taxpayers subsidize 12,000 empty nursing home beds.”

The method used to reimburse nursing homes affects the cost of nursing home care in a state.  For example, Ohio and many other states reimburse nursing homes based on the number of beds, not patients.  Hence, Ohio taxpayers subsidize about 12,000 empty nursing home beds annually.57  Furthermore, Medicaid reimbursements are based on "cost plus" - the cost of services provided by a nursing home plus a small profit.  This discourages nursing homes from reducing costs and improving quality.

Optional Benefit: Personal Care and Home Care.  Another widely utilized benefit is personal care and home care.  Personal care, sometimes referred to as "custodial care," generally involves assistance with activities related to daily living (bathing, toilet assistance, eating, grocery shopping, taking medication and housekeeping, although housekeeping cannot be the sole purpose for the personal care).  Waivers allow extended services such as transportation and adult day care.58  Home care provides assistance with daily living activities, but also includes skilled nursing.59

Enrollees often begin receiving personal care after discharge from a hospital when a Medicaid official assesses their level of disability and calculates the number of hours of assistance they need for daily living activities.  Though home care can be beneficial since it often replaces more expensive nursing home care, it can also be abused.  In New York, which provides much more home care than any other state, beneficiaries receive an average of 30 hours of home care per week, compared to the national average of 11 hours per week.60   

Once recuperated, most recipients come to expect the higher level of service they received while incapacitated and resist cuts in their personal care.  If patients complain, the system generally favors clients over administrators.  In New York, for example, Medicaid enrollees have been found to use home care attendants for nonmedical tasks such as shopping.  Furthermore, in some cases, assistants are chosen by the recipients themselves, and can include other members of the household, relatives or neighbors.  Thus, Medicaid often pays family members to do what they would have done anyway. Many individuals receiving home care could perform more of the tasks themselves and are receiving more assistance than is needed to keep them out of institutionalized care.  In these cases, home care often amounts to free maid service.  

About half of states that offer personal care services impose hourly per day limits, while about one-third impose cost limits.61  Annual personal care expenditures per enrollee from 1997 to 1998 ranged from $37,596 in Massachusetts to $144 in Arizona (the national average was $6,870).62

“In some places, Medicaid transportation is a free taxi service.”

Optional Benefit: Transportation.  States also provide such nonmedical services as transportation.63  For example, New York Medicaid pays for wheelchair-accessible vans to transport enrollees with mobility problems to and from medical treatments.  The service is intended to provide transportation only to those who use wheelchairs or who cannot walk without assistance.  But many individuals taking ambulette rides have no mobility problems; for them, the service is actually a free taxi service.  In 2005, the New York Times reported:64

  • Two doctors each ordered more than 90 trips per day for patients.
  • At another clinic, one patient used the service 153 times in a single year while another patient used the service 152 times - about one ride every 2.5 days.
  • Other patients used the service more than 130 times each. 

For patients who qualify for the service, cheaper alternatives exist.  A typical bus ride in New York City costs $2 and a taxi ride costs $10, according to the New York Times.  But Medicaid typically pays ambulette contractors $25 to $31 each way.  Overall, New York Medicaid spent $316 million to transport patients to doctors' offices and hospitals in 2003.  This works out to 10.5 million to 12.5 million rides per year.65 

Costly Policy: Underpaying Physicians and Overpaying Hospitals.  Routine examinations and treatments - including minor surgical procedures - often can be provided more efficiently and at less cost in a doctor's office than in a hospital emergency room.  Health care providers are reimbursed for routine Medicaid services according to fee schedules set by state administrators.  But many doctors do not participate in Medicaid because reimbursement is so low.  As a result, the patients turn to much costlier settings, such as hospital clinics and emergency rooms.

The Effects of Underpaying Physicians.  In every state, Medicaid reimbursement rates for physicians are typically lower than what physicians receive from the private sector.  One way to think about Medicaid physician payments is to compare them to what Medicare pays:

  • Medicare pays physicians only 83 percent as much as private insurers, on the average, nationwide.66
  • Nationwide, Medicaid fees for physician services average 69 percent of what Medicare pays, according to the American Academy of Pediatrics,67 and perhaps as little as 62 percent, according to an Urban Institute estimate.68

Table II - Medicaid Provider Fees in Four States

Furthermore, reimbursement fees among states vary widely.  For example:69

  • Alaska reimburses physicians about 137 percent of what Medicare pays.
  • In contrast, Rhode Island's reimbursement rate for physicians is only 42 percent of what Medicare pays.

“Medicaid usually pays physicians less than Medicare.”

These rates represent an overall average of primary care, obstetric care and other services.  There are also stark differences in reimbursement rates for specific services.  For instance:70

  • A New York doctor receives $30 for a highly complex examination of an established patient, whereas Mississippi pays a physician about $100 for the same exam.  [See Table II.]
  • l  An eye doctor in New York receives $30 for a comprehensive exam of a new patient, whereas Texas and Florida pay more than twice as much for the same service.

These reimbursement rates affect access to care.  Laurence C. Baker and Anne Beeson Royalty found that a 10 percent increase in Medicaid fees raised the number of poor patients visiting office-based (private) physicians by 3.4 percent and correspondingly reduced the number visiting public physicians (such as in public health clinics) by 3 percent.71   When private physicians are rewarded for taking complex cases, they have an incentive to accept them.  When fees are not adjusted for the complexity of the case, they have an incentive to avoid them.

“Reimbursement rates affect access to care.”

The Effects of Overpaying HospitalsWhen access to private physicians is limited, patients rely more on inpatient hospital treatment.  In New York, for example, 18 percent of Medicaid patients receive inpatient care compared to just 11 percent nationally.72  Furthermore, in contrast to its reimbursements for physicians, New York pays hospitals generously.  When New York deregulated the hospital industry in 1997, the Medicaid fee-for-service system was left largely intact, allowing Medicaid enrollees to go to any public or nonprofit hospital, regardless of its efficiency.  Consequently, Medicaid began to pay the highest fees of any payers - including private insurers.73  In most states, Medicaid pays the lowest fees of any payer.

This generous payment policy does not give hospitals any incentive to increase productivity or reduce costs.  In 2003, New York Medicaid paid about $10 billion to hospitals for inpatient care, subsidies for graduate medical education and hospital-based clinics - more than any other state Medicaid program.  Furthermore, among large states, the inpatient cost per enrollee is greatest in New York at $1,794 in 2003, compared to $725 in Texas, $815 in California and Ohio, and $884 in Florida.74  [See Figure IX.]

Costly Policy: Paying Premium Prices for Drugs.  Prescription drug expenditures are one of the fastest growing components of the Medicaid program.  From 1990 to 2003, Medicaid's outpatient prescription drug expenditures rose eight-fold to $33.8 billion nationally.75  There are a number of reasons for this increase.

Many private health plans and most state Medicaid programs have some type of preferred-drug list with increased cost-sharing for drugs that have significantly cheaper alternatives.  The drugs are selected through a competitive bidding process, and drug companies usually agree to reimbursement rates that are steeply discounted from the retail price.  Many states will only include one drug from a class in the formulary.

Some states have taken steps to reduce drug spending but not all efforts are successful.  For example, New York recently began encouraging the use of generic drugs, but doctors can easily substitute higher-priced brand-name drugs.76

As with other types of managed care there is a danger that drug formularies can become bureaucratic obstacles that prevent patients from getting the drugs they need.  Also, administrators may be tempted to sacrifice quality care in order to reduce costs.  Ideal drug policies minimize costs without harming patient welfare.  Poor drug policies harm patients and may (because of adverse health effects) not even reduce costs.77  

Frank Lichtenberg of Columbia University has found that newer, more-expensive drugs may offer more effective treatment and reduce total health care costs.  Lichtenberg found that lowering the average age of drugs used by roughly a decade (that is, from 15 years to 5.5 years) results in an increase of $18 in drug spending but a net reduction in total health care spending by $111.  Most of the net reduction was due to decreased hospitalizations and fewer office visits.78

Prescription drugs can also reduce Medicaid program costs by substituting for expensive emergency treatments.  For example:79

  • Spending just $4,500 a year for pricey atypical anti-psychotic drugs could save $73,000 a year in institutional costs for the mentally ill.
  • "Clot buster" drugs for strokes could save about four times the drug price by reducing the cost of treating patients in hospitals.

Figure IX - Inpatient Cost per Medicaid Enrollee%2C 2003

“New York spending per patient is higher than in other large states.”

Furthermore, as Linda Gorman of the Independence Institute notes, Medicaid populations tend to have a disproportionate number of people who need newer, more-expensive drugs with fewer side effects.80

Costly Policy: Ineffective Managed Care.  As noted, managed care was introduced into Medicaid in order to increase access to care and to provide services efficiently.  Managed care organizations usually contract with area hospitals and doctors to provide services at negotiated discounts.  In 2004, enrollment rates for the Medicaid population were as high as 88 percent in Arizona.81  In fact, all but seven states have at least half of their Medicaid beneficiaries enrolled in managed care plans.82

However, most states exempt substantial patient populations from their mandatory managed care enrollment: the elderly and disabled, who are the most intensive users of Medicaid.  In New York, for example, 70 percent of Medicaid costs are for the elderly and disabled.  For many of them, managed care is not even available on a voluntary basis.  The average yearly cost per person to care for them is 10 times higher than for nondisabled children and five times the cost of caring for the parents of nondisabled children.  Exempting the most intensive users of Medicaid services from cost-control efforts is an expensive missed opportunity.  These patient groups have problems accessing care and could benefit from the continuum of care and case management that managed care networks offer.   

An alternative to managed care is to allow patients to manage their own health care dollars and shop for care as empowered consumers in the medical marketplace.  This option will be considered below. 

Costly Policy:  Little or No Cost-Sharing.  Economic theory predicts that individuals will consume more of a good if it is free.  Health care is no exception.  Therefore, Medicaid recipients who pay no copays or deductibles are not aware of the cost of health care services and have no incentive to economize. 

“Medicaid recipients have no incentive to economize.”

Many states recognize the necessity of cost-sharing and have imposed small copays of 50 cents to $3.00 on prescription drugs or office visits for Medicaid recipients.  But critics argue that even small copays - while leading to a reduction in the use of Medicaid services - hurt the poor by discouraging them from purchasing necessary drugs or services.  Some studies show this leads to an increase in costly adverse medical events and emergency room visits, which defeat the purpose of cost-sharing.83  Furthermore, some cost-sharing programs - in Michigan and Minnesota, for example - have been found to violate the federal Medicaid Act, which prohibits withholding care or services to recipients based on their ability to pay.84  However, there are forms of personal health accounts, discussed later in this paper - such as reverse HSAs - that would give patients incentives to reduce unnecessary utilization of health care, while encouraging them to seek needed care.

Costly Policy:  Treatment Errors and Adverse Medical Events.  Eliminating errors in diagnosis can lead to better treatment at lower cost.85  Some of the most dangerous and costly problems in our health system include drug misuse, antibiotic overuse, preventable hospital-acquired infections, and the under-diagnosis and mistreatment of chronic conditions.86  The Institute of Medicine found that between 44,000 and 98,000 people die each year from preventable medical errors.  Further, medical errors cost the health care system an estimated $37.6 billion a year, of which $17 billion is due to preventable errors.87 

Researchers found no one particular cause of medical errors; instead, they found multiple causes that result in a larger systemic failure of hospital protocols.  They classified these errors into two categories:88 1) active errors by health care providers (that is, doctor, nurse or other worker), which are usually detected quickly, and 2) latent errors, such as poor system maintenance or equipment design or poorly organized health care systems, which are more difficult to detect because they are beyond the control of individual caregivers.

A 2000 study by the Agency for Healthcare Research and Quality found that children in the Medicaid program were more likely to experience treatment errors than children on private insurance.89  They were also more likely to be victims of post-care infections, postoperative respiratory failure and postoperative sepsis.90

Another quality problem is adverse drug events, which are common among the elderly.  A Massachusetts study found that the elderly population in nursing homes was especially vulnerable:91

  • Adverse drugs events occurred at a rate of 1.89 for every 100 resident months; hence, the risk of occurrence is almost 25 percent annually.
  • Of the 546 adverse drug events examined, 38 percent were considered serious, 6 percent were life-threatening and one was fatal.
  • However, about 51 percent were considered preventable.

Since Medicaid covers 58 percent of nursing home patients, this implies that Medicaid patients are particularly at risk. 

“Hospital-acquired infections are the fourth-largest killer in America.”

Costly Policy:  Failure to Control Infections.  Hospital-acquired infections are the fourth-largest killer in America.  A recent report found that nearly 100,000 people may die annually of hospital-acquired infections alone.92  Even more frightening, a new and deadly infection known as MRSA (methicillin-resistant Staphylococcus auerus) does not respond to commonly used antibioticsMany Medicaid hospital patients are infected with this dangerous disease.  In 2003, 57 percent of staph infections were a result of MRSA, and the percentage is rising.  Infections of all kinds are common in nursing homes, but MRSA infections are on the rise and the prognosis is worse for the elderly than for the young.  Infections in long-term care facilities result in one-quarter to one-half of transfers to hospitals.93

Costly Policy:  Failure to Control Fraud and Abuse.  Fraud and abuse have plagued Medicaid since its inception.  In 1997, the Government Accountability Office estimated that fraud and abuse may be as high as 10 percent of Medicaid spending.94  For example, a 1993 investigative report of the Illinois Medicaid system by the Chicago Tribune found:95

  • In one year, 71,064 Medicaid patients visited a doctor's office more than 11 times (compared to a national average of six visits per year), while four patients made more than 300 visits in one year.
  • In one day, one patient saw five doctors, visited a pharmacy seven times and had 22 prescriptions filled with 663 pills. 
  • Attempts by government to rein in these abuses have resulted in some improvements, but fraud involving the use of Medicaid transportation still abounds.  Recently, for example:
  • In Illinois, a woman operating transportation services from her home for Medicaid recipients was found guilty of $150,104 worth of false billings for mileage, attendants and a wheelchair-accessible van.96
  • A New Jersey transportation operator was sentenced to state prison for billing Medicaid for unauthorized uses of transportation (to nonmedical destinations) and kickbacks worth $214,840.97

“Fraud and abuse may be as high as 10 percent of Medicaid spending.”

The Tribune also uncovered "Medicaid mills" that freely prescribed drugs, syringes and other medical products that were then sold by patients on the street.  More recently, a year-long investigation of New York Medicaid by the New York Times found massive provider fraud.  For example:98

  • Dr. Rosen, a dentist in New York's Medicaid program, claimed to have performed nearly 1,000 procedures in a single day.
  • In September alone she claimed to have performed 9,500 procedures.
  • All told, she and a colleague billed New York Medicaid $5.4 million in 2003. 

Most fraud is committed by physicians and other providers, rather than patients, but providers often turn a blind eye to unscrupulous patients abusing or defrauding the system.  For instance, the Times reports that a Brooklyn doctor prescribed more than $11 million worth of a synthetic growth hormone used to treat AIDS patients over a three year period.  Investigators say these patients were part of an elaborate scheme to obtain a drug popular with bodybuilders buying on the black market.  New York Medicaid's yearly cost for this growth hormone grew from $7 million to $50 million within a year of the scheme becoming prevalent. 

Another source of fraud and abuse is the federal Supplemental Security Income (SSI) program.  Many people with disabilities access Medicaid benefits by qualifying for SSI.  Since coverage is often related to medical conditions that are fairly easy to fabricate or exaggerate, individuals and parents have incentives to misrepresent medical conditions.  For example, according to the Government Accountability Office (GAO), "middlemen" provide translation services to beneficiaries who do not speak English and coach them on feigning and exaggerating mental disabilities in order to receive SSI benefits.  Middlemen also work with dishonest health care providers to supply faulty medical information.  Additionally, a number of SSI recipients have admitted to transferring ownership of assets in order to quality for SSI benefits: 99

  • Between 1990 and 1994, an estimated $74 million in assets were transferred, including cars, cash, houses and land.
  • Between 1996 and 1997, the Inspector General's Office received 12,680 complaints of SSI fraud, constituting about 37 percent of all fraud allegations received from the public.

Thus, these recipients "game" the system to obtain coverage.

“State regulations raise the cost of private health insurance.”

Costly Policy:  Regulations That Raise the Cost of Private Insurance.  As noted, Medicaid crowds out private insurance coverage by offering a free alternative.  Contributing to that rise are regulations that raise the cost of health insurance.  Nationwide, state insurance mandates require private carriers to cover more than 1,800 specific benefits and service providers (such as acupuncturists and chiropractors).100  These mandates raise the cost of health insurance.  Economists estimate that up to one-fourth of the uninsured are priced out of the market for health insurance due to cost-increasing regulations.101 

Two regulations are particularly notable.  Community rating charges enrollees the same premium regardless of health status.  In doing so, it essentially overcharges young, healthy individuals to cross-subsidize older, less-healthy individuals.  Enrollees who are overcharged are prone to drop their coverage.  Guaranteed issue, which requires insurance companies to provide health insurance regardless of an individual's health status, makes it easy for people to wait to obtain insurance until after they become sick.  With fewer and fewer healthy individuals to offset the sick, the risk pool becomes increasingly unhealthy.  Over time, this cycle causes premiums to sky-rocket and insurance becomes unaffordable.


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