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


Common-Sense Reforms

To reduce Medicaid costs, states should begin by employing measures that are common in the private sector and that achieve results.  Some states are already implementing these reforms, and the following are some examples. 

"There are many opportunities to improve quality and control costs."

Substituting Less-Expensive for More-Expensive Therapies.  Treatment in outpatient settings, such as doctors' offices, is generally less expensive than treatment in a hospital.  However, Medicaid patients have limited access to physicians other than in public health clinics or hospital emergency rooms.  Paying higher physician fees for examinations, tests and procedures that can be performed in a doctor's office would increase patients' access to health care and reduce expensive emergency room visits.

Performing more procedures in outpatient settings that were once only performed in hospitals (such as minor surgeries that don't require an overnight stay) is a common way of reducing costs.104  A Pennsylvania study found that about 10 percent of all hospitalizations for patients under age 65 are potentially avoidable.  Caring for these patients in lower-cost, more-appropriate settings could have saved the state about $2.8 billion in 2003.  In some cases, procedures performed in hospitals could have been done in outpatient clinics.  In other cases, inpatient care could have been avoided by timely physician care.105

West Virginia, for example, recently changed its Medicaid program to give recipients the option to sign a "personal responsibility contract," stipulating certain requirements such as using emergency room services only for emergencies and not being late for doctor's appointments.  In return, beneficiaries will receive credits they can use for other health benefits, such as fees for exercise classes.  The contract is optional, but will apply to about 160,000 beneficiaries.  Those who choose not to sign a contract will have more limited benefits than those who do.106

Substituting Less-Expensive for More-Expensive Providers.  Why pay more when the same quality of care is available for less?  Private-sector health plans routinely contract selectively, choosing to direct enrollees to providers who charge less for the same level of quality.  These plans typically require enrollees to use facilities and physicians that are "in-network," or to pay a larger share of the cost if they use providers that are "out-of-network."

Medicaid could selectively contract specific high-cost procedures to "Centers of Excellence," which are hospitals that perform a high volume of particular procedures for which there is a demonstrated relationship between volume and quality.  Hospitals that do not receive contracts would not be reimbursed unless the services were preauthorized or the patient was admitted due to an emergency.  This is a modest reform that is long overdue.107

Through specialization, hospitals can perform a large volume of procedures or care for a large volume of patients with similar conditions at a lower cost.  Hospitals can reduce costs by eliminating inefficiencies, including unnecessary services, excessively long hospital stays, excessive compensation to noncritical staff, inefficient staffing levels and so forth.  Hospital executives will find innovative ways to cut costs when they have better incentives to do so.108

"Selective contracting provides opportunities to negotiate discounts."

Selective contracting provides opportunities to negotiate discounts for most medical services.  Many states use competitive bidding and selective contracting for eyeglasses, medical equipment, transportation and other services.109   For example, Medi-Cal, California's Medicaid program, began selective contracting for hospital services in the early 1980s.  Four years later the state was spending nearly 8 percent less than it was projected to spend without selective contracting.110  The Centers for Medicare and Medicaid Services (CMS) found that contracting reduced the daily cost of a hospital stay about 16 percent below what it otherwise would have been.  The greatest savings were in areas with stiff competition among hospitals.111

Other states have also had success with selective contracting.  For example: 112

  • Oregon implemented selective contracting for its Medicaid transportation services and saved 15 percent while increasing patients' access to care.
  • Colorado saved about $6.5 million by contracting out its mental health services in 1996.

Substituting Less-Expensive for More-Expensive Drugs.  Private-sector managed care plans use a variety of techniques to control drug costs, including preferred-drug lists, formularies, negotiated prices with drug companies and single-source drug distributors.  For example, many plans require enrollees to use a specific mail-order drug supplier to avoid higher copays.  Health plans frequently contract with a pharmacy benefit manager (PBM) to handle drug benefits.  PBMs require enrollees to obtain a preauthorization to purchase brand-name drugs that aren't on their list of preferred or formulary drugs, or to use a non-network pharmacy. 

However, patients may prefer a drug that is not on the formulary; an alternative drug may be more effective, or have fewer side effects, for them.  If a patient is willing to pay a higher share of the costs, they can usually obtain coverage for these drugs.  Health Savings Accounts or Flexible Spending Accounts can also help defray the increased cost of nonformulary drugs.  And the same principle can be applied to Medicaid enrollees (see the section on Personal Health Accounts following).

Medicaid managed care plans generally also use PBMs to manage their drug benefits.  However, some states have rules and regulations that limit the ability of PBMs to control drug costs.  For instance, some states have laws that prevent a PBM from requiring the substitution of generic drugs for expensive brand-name drugs.113  Other states have bills pending that would further limit PBMs.  In New York, for example, legislation was introduced to limit the ability of PBMs to require the use of mail-order pharmacies.114  Another bill would require PBMs to reimburse any pharmacy willing to meet the requirements of a drug plan.  These measures would limit the discounts PBMs are able to negotiate with competing pharmacies.

Figure X - State Medicaid Programs with the Highest Generic Dispensing Rates

"Generic drugs often can save money without any reduction in quality."

Additionally, several states do not take advantage of cheaper generic drugs that are of the same quality as name-brand drugs.  Generics account for 51.9 percent of all drugs dispensed by state Medicaid programs. Washington, Oregon, Alabama New Mexico and Hawaii have the highest dispensing rates. [See Figure X]. On the other hand, California, Connecticut, Texas, Louisiana and New Jersey use far fewer generic drugs than the average state.115  These states should en-courage the use of less-expensive drug alternatives when quality is the same - including therapeutic, generic and over-the-counter substitutes.  Patients who prefer brand-name drugs should be able to choose them if they make a copayment, as they would in a private insurance plan.

A 2003 study from Brigham and Women's Hospital and Harvard Medical School examined the effect of substituting comparable generic drugs for brand-name drugs in an unnamed state's Medicaid program.  The cost of the brand-name drugs purchased through Medicaid totaled about $95.3 million.116  Among commonly prescribed drugs, they found:

  • The use of generic anti-anxiety medicine would have saved $461,000.
  • Using generic calcium channel blockers would have saved $420,000.
  • Generic nonsteroidal, anti-inflammatory drugs would have saved Medicaid $294,000.

There were other drugs savings as well.  Using just the generic form of the top-three prescribed drugs would have saved the state's Medicaid program well over $1 million.  Total savings on all drugs examined would have totaled $3.4 million.

"Medicaid will not pay for over-the-counter drugs that can substitute for prescription drugs."

In the past few years, a number of prescription drugs have been moved over the counter and are available at a much lower cost and without a prescription.  For example, when Claritin, a prescription drug used by allergy sufferers, became available over the counter, the price fell substantially.  The current prescription version of the drug, called Clarinex, is chemically similar.117  Yet a year's supply of Clarinex costs about $800, compared to only $190 for Claritin and less than $16 for an over-the-counter generic equivalent.118  Another example is Nexium, the prescription version of the heartburn medication Prilosec.  Nexium costs $146 for 30 capsules at drugstore.com, for a daily cost of about $4.83.  Costco.com sells a box of over-the-counter Prilosec with 42 capsules for $25.99, for a daily cost of $0.62.

In 2006, the drug company GlaxoSmithKline USA asked the FDA for the right to sell the obesity drug Xenical (Orlistat) over the counter.  Glaxo expects the over-the-counter version to cost about two-thirds less than the prescription price.119  However, past experience indicates that many doctors will continue to prescribe the prescription version because it will cost Medicaid patients less out of pocket, even if they are charged a small copay (usually $3).  Unfortunately, Medicaid (and Medicare) will not pay for over-the-counter drugs, even if they can be substituted for more-expensive prescription drug therapies. 

Furthermore, there is a danger that drug formularies will become bureaucratic obstacles to needed therapies, particularly for patients who cannot pay higher copays for nonformulary drugs.  Economist Linda Gorman of the Independence Institute reports that substituting generics for brand-name drugs can adversely affect patients.  For example:120

  • A survey of 200 physicians in Tennessee's TennCare program found that two-thirds of doctors reported they had patients who had serious adverse reactions, including death and stroke, when they were switched to generic substitutes.
  • In a British Columbia survey, 27 percent of doctors reported admitting patients to hospital emergency rooms as a result of having switched them to drugs mandated by government formularies.

One way to resolve these problems is to allow Medicaid patients to control some of the funds for their own health care.  States should consider allowing patients and their physicians, rather than bureaucrats, to make these choices.

Contracting with the Private Sector.  Instead of paying for Medicaid services on a fee-for-service basis, states could contract with hospitals, clinics and physicians for specific services and therapies.  This would allow the program to coordinate care and establish quality standards. 

Disease Management and Care Coordination.  Many patients have multiple illnesses that require treatment by different specialists or in different facilities.121  Unfortunately, these health care providers often have little (if any) contact with one another.  The lack of coordination leads to poor-quality health care and medical errors, such as harmful drug interactions. 

"Coordinated care could reduce harmful drug interactions."

Coordinating care typically involves a case manager who reviews the patient's medical history and claims data, ensures providers communicate with each other about the patient's condition and monitors the patient's progress.  Case managers can help ensure appropriate care is given and clinical protocols are followed.  Coordinated care allows health care providers and state social service agencies to exchange relevant information about all the services received by a patient. 

Coordinated care can reduce the risk of adverse drug interactions from inappropriate or contraindicated drugs.  Recent studies have found that seniors often take too many medications - many of which are contraindicated.  About 20 percent of seniors - seven million - have at least one prescription each year that is questionable.122  Often, one medication is used merely to combat the side effects of another drug.123  A demonstration project funded by the Robert Wood Johnson Foundation reduced the use of medications judged to be potentially inappropriate by more than one-third (36 percent) over the course of 18 months.124

Disease management involves developing a treatment plan based on current treatment protocols for patients and training them how to the follow protocols.125  With the help of a case manager, patients formulate a plan for the control and treatment of their condition.  The plan is essentially a list of established guidelines indicating which actions to take in response to various symptoms.126  Although monitored by a physician, much of the day-to-day care is administered by patients themselves so training is a necessary part of such programs.

As of 2004, nine states had implemented disease management programs.  While results are preliminary, these programs appear to reduce costs and improve treatment for chronic conditions:127

  • In Colorado, average costs for asthmatics participating in disease management programs dropped 37 percent.
  • The proportion of asthmatics receiving inhaled steroid treatment increased from 49 percent to 95 percent.
  • In Washington, a diabetic disease management program saved $900,000 in its first year, and the percentage of diabetics taking daily aspirin or other blood thinners increased from 41 percent to 64 percent.

"In Colorado, disease management reduced costs 37 percent for asthmatics."

In 2005, Utah established a Primary Care Network (PCN) that stresses preventive care and disease management.128  In fact, in a 2005 performance survey, recipients rated the Utah plan (on a scale of 1 to 10) more highly than recipients rated Medicaid nationwide with respect to getting needed care, how well doctors communicated with patients and the helpfulness of office staff.  Furthermore, Utah's plan ranked above the national average in the timeliness of prenatal and post-partum care and the rate of immunizations for children up to two years of age.129  [See the sidebar on "The Utah Experience."]

"Patients can be trained to manage chronic conditions."

Self-Managed Care.  Patients can also be trained to manage their own care, including administering drugs, monitoring vital signs, caring for wounds and so forth.  For example, numerous studies have shown considerable benefit from self-management training for patients with Type 2 diabetes.130  Diabetes is the sixth leading cause of death by disease in the United States.  Diabetics spend four times more money on health care than nondiabetics.131  By one estimate, nearly $2.5 billion in annual hospital costs for diabetes complications could be averted with appropriate self-managed care.132  Patients can be taught to inject insulin, monitor and maintain a log of blood glucose levels, and use the results to adjust their dietary intake, activity levels and medicine doses.133  In addition, many diabetics can reduce reliance on medications and control their diabetes completely by adhering to a meal plan, losing weight and exercising.134 

Uncontrolled asthma is another costly chronic disease.135  The Asthma and Allergy Foundations of America estimates nearly 20 million Americans suffer from asthma - resulting in 500,000 hospital stays each year.136  More than 2.5 million school-age children suffer from asthma, missing nearly 15 million school days per year.  The economic loss averages out to nearly $800 per child per year.137  A Dutch study comparing self-management to standard care with a primary physician found that the treatment costs of those patients who monitored their own asthma cost about 7 percent less than conventional care the first year and 28 percent less the second year.138

Caring for Special-Needs Patients.  The problems of people with disabilities and chronic conditions range from schizophrenia to mental retardation to blindness to diabetes.  These conditions require special therapies and specialists that many Medicaid patients may have difficulty accessing.  If payments to managed care plans are not adjusted for the cost of caring for these patients, they have an incentive to avoid enrolling them or to skimp on care.  Medicaid should contract with specialists and specialized facilities for these patients, pay risk-adjusted premiums based on the cost of care and offer incentives for performance (discussed below).  For example, a network providing care for psychiatric patients could be given incentives to use outpatient therapy and drug treatment rather than more costly institutional care when it can achieve the same therapeutic outcomes. 

Florida contracts with various private-sector entities to serve people with specific types of disabilities.  This allows benefits to be tailored to the needs of the individual enrollee.139  States that do not use private-sector contractors should explore such opportunities.  For example, different providers could serve the mentally ill, the physically disabled, the drug addicted and so forth.  The comparative advantage of these various providers would reduce costs and increase the quality of service.140

The services provided by contractors could be limited to those related to the disability.  Regular Medicaid could provide other health services, or the disabled/chronically ill could be offered premium support to purchase other coverage.  Higher-cost individuals with disabilities could be provided a larger personal health account to cover their needs (discussed below).  This would allow them a choice of benefits and health plans similar to the HIFA waivers in Florida and South Carolina. 

"Patient satisfaction with Cash and Counseling programs is almost 100 percent!"

Cash Accounts for Patients with Disabilities.  About half of the states have set up cash accounts disabled Medicaid enrollees can use to manage their own health care dollars and directly purchase needed services.141  These pro-grams, often called "Cash and Counseling," use a defined contribution approach.142  The patient is given a set dollar contribution and is free to choose his or her providers.  The programs also involve counseling to assure that the patient is well-informed.  Under traditional Medicaid, the states select the providers without patient input.  Under this program, the patient can now choose his or her own provider.  Surveys of participants in the program show that they have a higher quality of life with fewer unmet health needs.143  Remarkably, patient satisfaction is almost 100 percent.144

Pay for Performance.  A 2002 National Academy of Sciences report recommended that all federal health programs begin paying for quality care rather than paying for services rendered.145  The NAS says the programs should initially focus on the treatment of health conditions that account for most of the spending in public health programs, such as diabetes, depression, osteoporosis, asthma, heart disease and stroke. 

Medicare has begun implementing pay-for-performance initiatives.146  Medicaid would also benefit from such initiatives.  If a state program only paid providers for outcomes it deemed worthwhile, it might reap significant savings.  For example, Bridges to Excellence, an initiative of the Robert Wood Johnson Foundation, pays additional funds to physicians of diabetics in private health plans who achieve certain quality standards.  The cost per diabetic is about $175, but that is only half of the estimated saving per diabetic patient from the reduction in treatment complications.147

Reducing Medical Errors and Improving Quality of Care.  Eliminating errors in diagnosis can lead to better treatment at lower cost.148  Many states have created patient safety databases, which allow consumers to research the outcome records of hospitals and physicians.  These help to level the playing field of information between patients and health care providers.  Currently, 20 out of 50 states have some type of patient safety database.  Most require only the reporting of errors that lead to serious injury or death, while less-serious errors can be reported on a voluntary basis.  Additionally, 19 states have confidentiality rules barring information on medical errors from being used in malpractice litigation against hospitals or physicians.149

A recent study examined the effect of New York's Cardiac Surgery Reporting System (CSRS) on patient health outcomes.  Authors David Cutler, Robert Huckman and Mary Beth Landrum examined CSRS data from 1991 to 1999 on death rates in New York hospitals that performed cardiac catheterization procedures.  The study, published by the National Bureau of Economic Research, found:150

  • Moving from a low-quality to a higher-quality hospital would significantly reduce a patient's risk-adjusted mortality rate.
  • Patient admissions increased at hospitals with low mortality rates the first year following a favorable CSRS report; however, the increased number of cases dropped off after the first year.
  • Patient admissions at hospitals identified as having a lower quality of surgery declined by about 10 percent during the year following a poor CSRS rating report; the decline remained stable for three years.
  • Low-quality hospitals were still performing the same number of emergency surgeries as before the report, indicating that some patients cannot or do not shop around for better-quality hospitals in emergency situations.

"Paying for results improves quality."

Furthermore, the NBER study suggests that since cardiac surgery is profitable for hospitals, they will improve their quality of care to attract new patients to replace ones that have gone elsewhere.

Medicaid should contract only with providers that institute infection-control programs.  Payments to hospitals could be adjusted to reward facilities that achieve low infection rates and penalize those with higher infection rates.  Hospital-acquired infections are a type of medical error that should be measured for quality ratings and addressed in contracts with providers.

Some hospitals are taking aggressive steps to improve quality of care by reducing infection rates, and both state and federal policies are changing to reduce this spreading epidemic:

  • Some hospitals, such as the University of Pittsburgh system, are imposing stiff penalties, including termination and suspension of practice privileges for staff and doctors who fail to wash their hands.
  • Some states have passed laws that publicize a hospital's "infection report card," allowing patients to compare hospital infection rates before surgery; ideally, hospitals would compete for patients by reducing infection rates.

Additionally, the 21st Century Information Act, introduced in Congress last year, would authorize grants to establish regional electronic databases among groups of hospitals, health care providers, insurers and patient groups.  The government would make matching payments to states whose electronic health care networks benefit Medicaid providers.151

Health care providers are already taking steps to establish electronic medical records.  Many hospitals are using bar-code or radio-frequency technology on patient identification bracelets to ensure medications are administered to the correct patient at the correct dosage.  Nursing homes can benefit from such a program as well, since, as discussed earlier, medication errors can be a problem for the elderly in long-term care institutions.  [For a discussion of steps states can take to improve the quality of nursing home care, see the sidebar "Improving Nursing Home Quality."]

"Software can help identify fraud."

Pursuing Fraud Aggressively.  Some states have established Medicaid provider information exchange databases to identify fraud, abuse, overuse and unnecessary care.  In other states, most abuse is identified through tips and other unreliable means.  Establishing a state database of billing information on Medicaid providers in New York has proven useful.  If one provider's Medicaid billing began to increase significantly, case workers can quickly identify and check into the trend.152  The provisions of current "whistleblower" laws that allow private citizens who identify fraudulent providers to receive some of the recovered funds may also be useful in fighting fraud. 

Software firms have developed information technology to more easily examine Medicaid billings using a number of different criteria.  Salient Corporation is working with Chemung County, New York, to better manage Medicaid spending.  Using Muni-Minder software, officials can analyze the billings of individual suppliers and track product and service utilization, allowing them to uncover inefficiency, waste and abuse anywhere in the program.  For example, Muni-Minder allows investigators to quickly identify the number and cost of prescriptions for brand-name drugs filled when a generic was available.  A chart of the amount per recipient spent for any provider is easily created with only a few keystrokes.153

Despite the political difficulties in cracking down on fraud, states have taken action on Medicaid fraud and abuse.  In 2003, Texas established an inspector general's office responsible for detecting Medicaid fraud.  As a result, Texas recovered $441 million in 2005 from erroneous or fraudulent charges.154  Kansas recently followed suit. In addition, a recently-enacted Kansas law makes Medicaid fraud a civil matter - as well as a criminal offense - thereby enabling the state to recover improperly paid Medicaid money.155


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