Strategy 7: Rate Adjustment

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Description of Strategy

As medical costs continue to rise and budget constraints become tighter, states may consider adjusting provider reimbursement rates for selected services as a cost containment strategy. Because Medicaid rates for some services traditionally have been lower than market rates, this strategy requires careful service-by-service analysis to be workable.

States use a wide variety of rate-setting strategies for setting rates for services, including procedure rates for particular outpatient activities and bundled rates based on episodes or days of care for institutional rates. States should examine each of their rate setting strategies separately as they undertake rate adjustment strategies. Changing payment rates saves money in the simplest way-by paying less for the same care. However, such changes inevitably affect what providers will do even if the response is as simple as shunning Medicaid.

Complex rate adjustments often are needed to make providers equally willing to care for people with a range of health care needs (case-mix strategies or risk adjustment, for example) and induce providers to treat efficiently for a given condition. However, systems that are adjusted based on health characteristics and needs must be carefully designed so as not to create financial incentives to withhold care or provide anything that can be construed as a kickback to providers. New federal regulations will require states to demonstrate that adjusted capitation rates are actuarially sound.(1)

One approach that can ease the transition to a new system is to create opportunities to share both the upside and downside risks through techniques such as "hold-harmless" clauses, bonus payment, or, in capitated arrangements, reinsurance or risk corridors. In a stop-loss or reinsurance arrangement, states may agree to share costs in excess of a predetermined threshold. Risk corridors establish both a floor and a ceiling, allowing states to share in profits as well as losses.

Examples of state activities on rate adjustment include reducing or freezing payment rates for some services, using case mix and/or risk adjustments, changing the payment methodology, and setting Medicaid rates at appropriate levels. As states and the federal government try out different payment systems to better reflect actual costs for patients, motivate plans and providers to give the most effective and economical treatment, and reward them fairly for taking on complex patients, research is needed to identify what strategies work under what conditions. (See figure 7.)

Reducing or freezing payment rates. This strategy is difficult to implement and is loathed by providers. Although it is likely to be difficult to reach policy consensus on rate reductions, states have the authority to set lower rates for particular services if they can ensure that rate reduction does not compromise consumer choice or quality. Even below-market rates may still be enough to attract providers with fixed costs and excess capacity.

If a state's rates are lower than the private market or Medicare for particular services, a state may have limited ability to cut or freeze reimbursement rates enough to achieve significant savings without compromising access and quality. Growing provider resistance to lower rates negotiated through managed care and a desire to make up for several years of flat payment have led to difficult price negotiations for public and private payers alike. In fact, at least 10 states-despite looming budget crises-actually raised reimbursement rates for certain services in 2001 to ensure an adequate supply of providers.

Special rules apply to institutional rate-setting. For many years, states were required to pay institutional providers-hospitals and nursing homes-rates that were, in the words of the Boren amendment "reasonable and adequate to meet incurred costs." The 1997 repeal of the Boren amendment gives states more flexibility in setting provider reimbursement rates; however, states now are required to:

1. Use a public process for determining rates;

2. Publish proposed and final rates, the methodologies underlying the rates, and justifications for the rates; and

3. Give interested parties a reasonable opportunity for review and comment on the proposed rates, methodologies, and justifications.(2)

Case mix adjustment. Under this strategy, payments are adjusted to reflect the actual (or expected) mix of care provided and the health status of patients treated. This is often combined with techniques that prospectively define reimbursement rates for various services or treatment of specific types of conditions (diagnosis-related groups). Many states use case mix reimbursement systems for nursing facilities.

Risk adjustment. This strategy involves refining payment rates to better reflect expected costs to provide care to the specific people being treated. Most states that use some form of Medicaid managed care adjust for demographic characteristics of the covered population-age, sex, eligibility category and geographical region. States may consider making more sophisticated adjustments to rates by adjusting for things such as health status and prior utilization. Both Colorado and Maryland have implemented diagnosis-based risk adjustment systems.(3) Successful risk adjustment may be key to inducing managed care plans to treat people with disabling conditions.

Change the payment methodology. This involves revising the total basis for determining payments. One approach is to change from a system in which payments are determined retrospectively based on cost reports to a prospective system in which prices are set up front. Another is to change from a fee-for-service methodology to managed care (or vice versa). This is not an all-or-nothing matter. States can adjust capitation rates, make lump-sum payments for certain services, or selectively carve out services from capitated payments.

Setting Medicaid reimbursement rates at appropriate levels. State Medicaid programs are required by federal law to set their payment rates at a level sufficient to achieve access to needed care. Medicaid may want to set rates to achieve specific public policy objectives, such as access to primary care, well-child care, prenatal care or deliveries.

Rates for safety net providers, including FQHCs and rural health centers, can be set to ensure their financial viability. Federal law specifies cost-related reimbursement methods for FQHCs, but meeting the minimum legal requirement may not ensure full reimbursement of costs for Medicaid patients. Medicaid has the option under the law to provide full-cost reimbursement for these providers.

The maximum amount that the state Medicaid programs are allowed to pay is defined by the upper payment limit, which is generally the amount Medicare would have paid for the same services and patients. If a Medicaid program were to pay an amount greater than the upper payment limit, the amount above the limit would not qualify for federal Medicaid matching funds.

Special disproportionate share hospital (DSH) payments can be made to hospitals that qualify on the basis of their service to Medicaid and the uninsured. Each state is able to define the specific criteria these hospitals must meet to qualify. Funds are distributed based on a state-defined formula. DSH payments are limited to inpatient and outpatient hospital providers.

Pros and Cons

Pros

States can slow growth in spending by freezing rates. Reducing rates by a small percentage can produce significant savings.

Rate adjustments can produce rates that more accurately reflect the cost of care. This can make expenditures more predictable and reduce risk to providers, thereby increasing participation.

Flat capitated rates may give providers an incentive to engage in risk-selection by selecting the healthiest patients; risk adjustments may reduce or eliminate that incentive. Case mix systems reduce the incentive for nursing homes-or health plans-to select the healthiest patients by reimbursing them for the actual cost of delivering care.

Cons

Lower rates may lead to decreased participation rates among providers and consequently compromise both quality and access to care. Decreased participation rates in certain service areas may further increase the strain on providers-such as disproportionate share hospitals-that have significant numbers of Medicaid patients.

The methodologies are complex, not perfected, and may be costly to administer. Accurately predicting a person's health needs can be difficult. More complicated payment methods, such as case-mix reimbursement or risk-adjusted managed care payments, may increase administrative costs.

Changes in incentives under different payment systems may not operate as planned. In long-term care facilities, case-mix reimbursement may provide a disincentive to rehabilitate some patients and/or lead facilities to misreport a patient's condition. Increasing payments for higher cost patients does not guarantee that patient will receive better quality care.

State Experience

Kentucky, in response to a projected budget shortfall, recently enacted a rate freeze for acute hospitals, home health providers, and local health departments. It is expected to save the state $20 million.(4)

Colorado has implemented a risk-adjustment system for Medicaid managed care that assesses risk based on health status and then adjusts accordingly. Before 1998, the state set managed care capitation rates at 95 percent of the historical per capita fee-for-service costs for each Medicaid eligibility category.(5) The state made further adjustments for federally qualified health centers (FQHCs) and regions. In 1998, Colorado adopted a diagnosis-based risk adjustment system for its managed care system. The system uses diagnoses to develop case-mix factors for AFDC-related children, AFDC-related adults, and disabled people. The factors then are multiplied by a base payment rate to calculate the adjusted capitation rate.(6)

Maryland also uses a diagnosis-based adjustment system with its health plans. The state uses the Johns Hopkins adjusted clinical groups (ACG) classification system, which classifies illness on the basis of duration, severity, diagnostic certainty, etiology, and specialty care requirements.

Design and Policy Issues

Will cutting or freezing reimbursement rates affect access and quality of care provided to Medicaid recipients? A nominal reduction or freezing of the rate may result in significant savings without compromising access or care, especially if there are a large number of providers of a particular service. However, if Medicaid payment rates are considered low for a particular service and provider participation rates are low, further reductions may result in even lower participation rates.

Do you want to make adjustments to rates? Is it necessary? Making adjustments to rates can help states manage costs, predict expenditures, encourage participation, and manage care for special populations. Administrative costs are associated with making adjustments. States should consider how rates currently are set, what data currently is available, and what effect current rates have on provider participation. In managed care, risk sharing and carve-outs may be an alternative to complicated rate-setting methodologies. In fee-for-service systems, temporary rate adjustments may be more palatable than permanent changes in rates or reimbursement formulas.

What adjustments should your state make? Adjustments in case-mix systems or risk-adjustment capitation system are commonly made by age, gender and location, but more sophisticated adjustments for health status may more accurately predict costs. Data are readily available for some demographic categories, but may be difficult to find for more specific categories relating to health status. It may not be possible to make adjustments based on old data; new risk assessments may be required for health-based adjustments. States may consider using prior utilization rates as an alternative to diagnosis-based adjustments.

Federal and State Involvement/Constraints

Federal regulations will require states to demonstrate that adjusted capitation rates are actuarially sound.

Notes

1 Health Care Financing Administration, Medicaid Managed Care; 42 CFR Part 400, et.al,. (Washington, D.C.: HCFA, January 19, 2001). See http://www.hcfa.gov/medicaid/omchmpg.htm

2 Sally K Richardson, Letter to State Medicaid Directors: Guidance on the Implementation of the Balanced Budget Act of 1997 (BBA) (Washington, D.C.: HCFA, December 10, 1997). See http://www.hcfa.gov/medicaid/bbaboren.htm

3 John Holahon, Suresh Rangerajan, and Matthew Schirmer , Medicaid Managed Care Payment Methods and Capitation Rates: Results of a National Survey (Washington, D.C., Urban Institute, 1999). See http://newfederalism.urban.org/html/occa26.html

4 Kentucky Cabinet for Health Services, State Announces Medicaid Rates To Be Held At Current Levels (Frankfurt: Cabinet for Health Services, 2001). See http://chs.state.ky.us/chs/news/newsreleases/2001/nr0621.doc

5 Marilyn Moon et al., Health Policy for Low-Income People in Colorado (Washington, D.C.: Urban Institute, 1998). See http://newfederalism.urban.org/html/hpcolorado.html

6 Ibid.