COVID-19, State Budget Deficits, and Medicaid Managed Care

The COVID-19 pandemic has unleashed not just death, but also massive unemployment and a steep recession.  Among the economic casualties are state budgets, which have been knocked badly out of balance by the resulting drop in revenues and the prospect of increased enrollment in Medicaid and other safety net programs.   Among those spared from the economic damage—at least so far—are Medicaid managed care organizations.  MCOs cannot, by themselves, fix these budget holes, but in states that contract with MCOs (most do so) they are potentially part of the solution.  To understand why, you need to understand the basics of how Medicaid MCOs are paid.  This can get very complicated very quickly; here’s the 101 version, in four easy paragraphs.

Rather than paying providers for furnishing services to Medicaid beneficiaries themselves, states can contract with MCOs to do so.  Under these contracts, the MCO’s core responsibility is to organize a network of hospitals, clinics, practitioners, and other providers who will deliver services when beneficiaries need them and to make sure that beneficiaries are receiving quality care.  In exchange, the State pays the MCO a fixed amount for each month that a beneficiary is enrolled with the MCO.  That payment is called a capitation or per member per month (PMPM) payment.  With the revenues from those monthly payments, MCOs pay their network providers for delivering services to enrollees, cover the costs of quality assurance and other administrative expenses, pay taxes and fees, fund capital reserves, and in the case of for-profit plans, pay dividends to their investors.

The key is that the monthly payment is a fixed amount over the term of the contract.  If the MCO pays out more for covered services than the monthly payment will support, the MCO eats the loss.  If the MCO pays out less for covered services than the monthly payment was intended to support, the MCO keeps the gain.  The MCO’s incentive is to limit the amounts it pays network providers for services so it can keep more for itself, potentially putting both the enrollees and the providers at risk of service or payment denials.   Federal Medicaid rules contain a number of protections for both enrollees and providers, including a requirement that the monthly capitation payments be “actuarially sound”—that is, they should reflect what it would cost an efficient MCO to arrange for the delivery of the services for which it is responsible to its enrollees, taking into account their health care needs.  The greater the health care needs of a group of enrollees, the higher the capitation rate (for example, the rates for infants under age 1 are higher than those for children age 1 to 13).

One aspect of an “actuarially sound” rate is that the MCO has enough to pay its network providers for services that its enrollees need and enough to cover its reasonable administrative and other non-benefit costs.  The metric for this balancing is the medical loss ratio (MLR).  Basically, the MLR is the percentage of the MCO’s revenues from capitation that pays for covered services.  If an MCO pays out, say, 85 percent of its capitation revenues to providers for furnishing services to its enrollees over a certain period, its MLR is 85 percent, leaving it 15 percent of capitation revenues for administration, marketing, and profits. The emphasis here is on basically; there is much complexity in the calculation of an MLR (who knew that numerators and denominators could be so much fun).  The bottom line:  the lower the MLR, the less that is paid out to providers for furnishing services to enrollees, and the more that is retained by the MCO.

The federal government has established a minimum MLR (85 percent) for Medicare Advantage, and minimum MLRs for individual (80 percent) and small and large employer group (85 percent) insurance.  It has not established a minimum MLR for Medicaid.  Moreover, states are not required to establish a minimum MLR in their contracts with MCOs.  (They are, however, required to set their capitation rates so that the MLR is 85 percent, and MCOs are required to report their MLR performance to the state).  If states want to require that MCOs achieve a minimum MLR, the standard can’t be lower than 85 percent.  States can also decide whether to enforce whatever minimum MLR they have established by collecting remittances from the MCOs that do not meet the standard. Generally, the amount of the remittance is the difference between the percentage of the capitation revenues the MCO has spent on services (and quality assurance) and the amount it would have spent had it achieved the minimum MLR standard.

Because of stay-at-home orders and social distancing, the use of elective and non-essential health care services has declined dramatically.  Milliman, the actuarial firm, projects that “the cost of service deferral and elimination will greatly exceed the cost of testing for and treating COVID-19 in 2020.  The reduced medical costs imply … a benefit cost reduction for health care payers, including the commercial market and the government.”  This analysis is not specific to Medicaid MCOs, but it does suggest that the same dynamics are at play in the Medicaid market: use of services and payments to network providers may have declined but states continue to make monthly capitation payments at rates that assume normal use of services.   In many cases, MLRs may be significantly lower than 85 percent.  As the Milliman analysis notes, there is a lot of uncertainty about how long the pandemic will last, when a treatment and/or a vaccine will be developed and what they will cost, and how large the pent-up demand for health care will be once things return to normal.  How this plays out will also affect MLRs next year and beyond.

In the short run, however, lower MLRs—i.e., higher amounts retained by MCOs—give state policymakers some potential options for addressing their budget shortfalls as well as the financial losses of providers.  This is especially true in states that have taken up Medicaid expansion and enroll this population in MCOs; researchers at the Kaiser Family Foundation estimate that nationally nearly half of the newly unemployed will be eligible for Medicaid, creating the potential for large enrollment gains for MCOs that will translate into higher revenues for them.

The most obvious option is to raise revenues by imposing a tax on managed care organizations (not just Medicaid MCOs).  Governor Newsom’s revised budget for California includes an MCO tax that is projected to raise $1.7 billion in the fiscal year starting July 1.  (The imposition of a tax, or increase in an existing tax, will reduce the denominator, increasing the MLR).

Another potential source of revenue—far smaller than potential MCO tax revenues but not insignificant—is remittances.  As explained above, states may establish a minimum MLR of 85 percent and require MCOs that do not meet that minimum to pay remittances.  A  Kaiser Family Foundation/Health Management Associates survey found that, in 2019, 24 states reported always collecting remittances, and 6 states reported sometimes doing so.  States that sometimes or never collect remittances might want to reconsider.

The gains to the state treasury are potentially significant.  Health insurers that did not meet their MLR requirements will be paying consumers an estimated $2.7 billion in premium rebates in 2020, according to Kaiser Family Foundation researchers.  While these estimates apply to the individual, small group, and large group markets, not the Medicaid market, they suggest that the performance of MCOs may be worth looking into. And in the case of states that have taken up Medicaid expansion, the federal government’s share of any remittances will be significantly lower, allowing the state to keep more of the funds collected.

Finally, state policymakers may want to ask what Medicaid MCOs are doing to support their network providers.  Keeping providers afloat financially will reduce the number of closed businesses and unemployed health care workers, avoiding further revenue losses for the state.  To date, federal relief funds have not yet reached providers who serve largely Medicaid and uninsured children and adults, so states and MCOs may need to step up.  Last week, the Center for Medicaid and CHIP Services issued guidance explaining what state Medicaid agencies can do on a temporary basis to direct MCOs to provide fiscal relief to network providers.  The options are limited and require considerable documentation, but state policymakers should explore them.

In addition, MCOs should consider doing the right thing.  As the CMS guidance indicates, “managed care plans have the discretion to voluntarily implement a number of techniques, which may include advance payments, in order to fulfill their contractual requirements to ensure access to care and network adequacy.” For MCOs that currently pay their network providers on a fee-for-service basis, one option is to shift to prospective payment arrangements. Two publicly-operated MCOs in California, L.A. Care and Inland Empire, have already taken steps to shore up their network providers.

Andy Schneider is a Research Professor at the Georgetown University McCourt School of Public Policy.