How Did We Get Here? An Early Legislative History of Medicaid Managed Care

Here is where we are today.   Managed care—more precisely, comprehensive risk-based managed care—is the dominant delivery system in Medicaid.  States can require beneficiaries to enroll in Medicaid managed care organizations (MCOs) in order to receive the health care services to which they are entitled, and 40 states now do so.  MCOs can limit the network of providers to which their enrollees have access, and all 285 of them do so.  States contract with MCOs under one or more of three different authorities: the section 1932 option, a 1915(b) freedom-of-choice waiver, or a section 1115 demonstration.

It wasn’t always this way.  When Medicaid was launched in 1965, fee-for-service was the dominant delivery system in the U.S.  Freedom to choose one’s provider was a policy pillar of the program:  providers were not required to participate, and beneficiaries could choose among providers willing to serve them.  Section 1115 demonstration authority was on the books, but there was no section 1932 state plan option to contract with MCOs and no 1915(b) freedom-of-choice waiver authority.

How did we get from there to here?  In a recent interpretation, Sellers Dorsey, the Medicaid Health Plans of America, and the Association of Community-Affiliated Plans pick up the story in 1997.  They note—correctly—that the Balanced Budget Act of that year was a watershed event in Medicaid managed care policy. This allowed states, at their option, to require most beneficiaries to obtain the services to which they are entitled through an MCO that enrolls Medicaid beneficiaries exclusively.  Key to this option was the repeal of the 75/25 rule—the requirement that no more than 75 percent of an MCO’s enrollment could consist of Medicaid or Medicare beneficiaries.

The battle over this policy is a little-known piece of Medicaid managed care’s origin story.  What follows is a brief recap of the rise and fall of the 75/25 rule focusing on the three definitive legislative moments: its enactment in 1976, its modification in 1981, and its repeal in 1997.  Of course, the 75/25 rule was only one of many moving parts in federal Medicaid managed care policy over that period (a far more comprehensive examination of the evolution of Medicaid managed care is available in MACPAC’s June 2011 Report to Congress).  But it is a thread worth understanding, if only as a reminder that regulation of Medicaid managed care matters.

The 75/25 Rule is Born: California Schemin’ (1971-1976)

Our story begins in California.  As David Chavkin and Anne Treseder document in their definitive history of these events, the state in 1968 started the first of several pilot projects to test whether prepayment for services could reduce Medicaid costs in relation to fee-for-service.  But it was the enactment of the Medi-Cal Reform Act (A.B. 949) in August of 1971, at the request of Governor Ronald Reagan, that launched Medicaid managed care statewide.  The thrust of the Act was to control the costs of California’s Medicaid program.  To this end, it gave the state Medicaid agency authority to contract with prepaid health plans (PHPs) to provide care to beneficiaries for a negotiated per-patient amount.

At the time there was no federal statutory or regulatory framework for Medicaid managed care.  Stepping into this vacuum, the Governor Reagan’s Administration began contracting with prepaid health plans.  It did not take long for problems to surface: on December 10, 1972, the Los Angeles Times published “New Gold-Rush—Prepaid Medi-Cal Franchises Sought.” Over the next few years, persistent accounts of the relentless profiteering by many of the prepaid health plans, combined with the state Medicaid agency’s laissez-faire regulatory philosophy, eventually caught the attention of the Senate Permanent Subcommittee on Investigations.

In March of 1975, and again in December of 1976, the Subcommittee, chaired by Senator Henry Jackson (D-WA), held hearings on Medi-Cal Prepaid Health Plans.  The Subcommittee summarized its findings in its 67-page, 95-footnote bipartisan report:

“The Subcommittee inquiry found that almost all of the 54 California prepaid health plans reviewed by the Subcommittee were non-profit, tax-exempt organizations that subcontracted with for-profit corporations and partnerships owned or controlled by officers or directors of the non-profit organizations.  The inquiry showed that this type of corporate structure and contracting practice opened the way for the diversion of Medicaid funds away from the program’s purposes.

Consultants served as brokers, promoting State contracts for interested entrepreneurs in return for a percentage of Medicaid program payments made under State contracts.  The money to finance these contracts came from the poor who were enrolled in prepaid health plans by door-to-door salesmen employed by the plans, some of whom threatened, coerced and forced the signatures of Medicaid beneficiaries on the plan enrollment forms.

The quality of much of the health care—sometimes provided through non-accredited and substandard hospitals—was judged to be poor and even dangerous by State medical auditors.  State program managers ignored these reports as well as findings of the State’s own fraud investigators, legislative hearings, audits and exposes in the press.  The State’s failure to respond to compelling evidence of fraud and abuse was part of the extraordinary government mismanagement of the Medi-Cal program.”

(Author’s note:  It is perhaps not surprising that oversight of federal funds in this matter by President Reagan’s DHEW was, in the Subcommittee’s judgment, “lax”).

The 75/25 rule was born the year after the first set of Subcommittee hearings.  In the HMO Amendments of 1976, Congress gave state Medicaid programs the express authority to use federal Medicaid matching funds to purchase services “under a prepaid capitation risk basis or under any other risk basis.”  However, the authority was structured in such a way that predatory prepaid health plans could no longer operate in California and their business model could not spread to other states. Specifically, the legislation provided that states could only use federal matching funds to purchase services on a risk basis from organizations that (1) met the regulatory requirements for federal qualification as a Health Maintenance Organization (HMO) and (2) had no more than half of their enrollment from Medicaid or Medicare beneficiaries.

The policy rationale for this 50/50 rule was the “private market test”—i.e., that the profiteering prepaid health plans would not be able to attract enough private sector enrollees to meet this standard.  At the same time, reputable HMOs with provider networks sufficient to attract and retain at least half of their enrollees from the private sector would not pose a program integrity risk to Medicaid or its beneficiaries. The legislation did not restrict beneficiary freedom of choice of provider, ensuring that beneficiaries would continue to have the choice between fee-for-service Medicaid and enrolling in a Medicaid HMO.  This regulatory framework for Medicaid managed care was short-lived.

The 50/50 Rule Becomes the 75/25 Rule (1981)

In 1981, as part of broad agenda to reduce the role of the federal government in American life, newly-elected President Ronald Reagan proposed to convert Medicaid from an open-ended federal-state matching program into a block grant.  Under his proposal, the federal government would permanently limit its financial exposure for health and long-term care costs of the poor; in exchange, states would have broad flexibility in operating their Medicaid programs.  Among the many flexibilities for states were elimination of the 50/50 rule and repeal of the right to freedom of choice of provider.

The Republican Senate largely adopted the President’s proposal; the Democratic House did not.  The compromise, hammered out in the Omnibus Budget Reconciliation Act of 1981, did not block grant the program but did give states greater flexibility across a wide range of issues.  As David Smith and Judith Moore note in their classic Medicaid Politics and Policy (2nd Edition 2015), OBRA 81 was “the moving cause of a number of subsequent developments that continue to shape [Medicaid] policy today.”

On the managed care front, OBRA 81 loosened the 50/50 rule to 75/25; that is, in order for a state to receive federal matching funds on its payments to a Medicaid managed care organization, no more than 75 percent of the enrollment of the plan could be Medicaid and Medicare beneficiaries.  (The requirement that Medicaid managed care organizations meet the standards of federally-qualified HMOs was eliminated).  As to freedom of choice of provider, OBRA 81 did not repeal the provision altogether, but it gave the Secretary authority, under section 1915(b) of the Social Security Act, to waive beneficiary freedom of choice of provider in certain circumstances.  The waiver language did not expressly reference managed care organizations, but it was broad enough to be interpreted to allow states to mandate beneficiary enrollment in MCOs.  (It is still used for this purpose today, most recently—and ironically—in California).

The 75/25 Rule is Repealed (1997)

In the 16 years following OBRA 81, a torrent of new federal Medicaid policy changes were enacted.  Some of these involved managed care, but the 75/25 rule and the 1915(b) waiver remained in place.  In 1995, House Speaker Newt Gingrich proposed to block grant the Medicaid program; among the new flexibilities for the states would be repeal of the 75/25 rule and freedom of choice of provider.  That legislation, the Medicaid Transformation Act, was part of the Balanced Budget Act of 1995 vetoed by President Clinton.

Which brings us to 1997.  Another year, another Balanced Budget Act.  This time, however, the President was involved in the negotiations leading up to the bill that he signed into law.  BBA 97 repealed the 75/25 rule and created the section 1932 state option to mandate enrollment of most beneficiaries into MCOs with exclusively Medicaid enrollees.  As a substitute for the 75/25 rule, the legislation established a number of beneficiary protections (e.g., network adequacy) and quality assurance standards (e.g., review by an external quality review organization) for all MCOs.

And the rest, as they say, is history.

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