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Recent changes in the U.S. political environment have once again stirred up discussions of major reforms to the healthcare market. While a main topic in news discussions has been proposed reforms to health insurance exchanges created by the Patient Protection and Affordable Care Act (ACA), Medicaid reform has the potential to affect more people than any other source of coverage.
Republican Medicaid reform proposals have thus far focused on converting federal funding from the current approach of proportional federal and state financing to either block grants or per capita caps. While these funding approaches may sound relatively straightforward, understanding the implications of such changes requires consideration of several factors.
In this paper, we have broken down the detailed considerations into two primary categories: initial benchmark development and annual growth rates. Defining the assumptions and methodologies used to establish benchmarks and growth rates is key to aligning service cost with funding under alternative federal financing for Medicaid. Without consideration of these concepts, the actual cost of Medicaid relative to the federal budget for Medicaid will begin to diverge, and the gap may become wider over time. As this theoretical funding gap emerges, states will be at increased risk for funding additional program cost.
Figure 1 identifies detailed assumptions to consider for each key category. Additional details for each are included in the last section of this paper. Figure 2 illustrates state and federal expenditure growth risks and considerations for current funding, block grants, and per capita caps.
Figure 1: Considerations to alternative funding
|Key categories of consideration|
|Initial benchmark development||Annual growth rates|
|Category of aid||Medical cost & utilization trends|
|Age, gender, & care settings||Emerging medical treatment cost|
|Geographic cost variance||Historical or prospective trends|
|Base data period & source||Aging demographics|
|Benefit design||Population reliance on Medicaid|
|Federal medical assistance percentage||Economic growth rates/indices|
Figure 2: Potential risk by funding source
|Funding attribute||Current||Block grant||Per capita cap|
|Funding limit||None, as long as regulatory requirements are met.||Established in advance, unchanged with population growth or environmental factors.||Established in advance, varies based on population size, but unchanged for environmental factors.|
|State vs. federal medical growth rate||Consistent growth rates.||Federal growth defined in advance. State growth leveraged based on overall growth.||Federal growth is mitigated. State growth may be leveraged if cost per enrollee is more than projected.|
|Enrollment mix change risk||Federal risk varies by FMAP: if populations with higher federal match increase at a faster rate than the overall population, state share of bill is lower. For states with low/no expansion enrollment, match is relatively steady.||Federal government transfers risk to states.||Depends on structure. If cap is per capita on an aid category basis, then risk is similar to current. If not based on aid category, mix of members by aid category could negatively impact states as population groups age and LTSS become more prevalent.|
|Enrollment growth mix||Consistent risk state versus federal.||Federal government transfers risk to states.||Consistent risk state versus federal, as long as new members don't have higher-than-average cost.|
Medicaid was originally established as an assistance program for medical coverage of low-income children and disabled citizens under Title XIX of the Social Security Act (the Act) in 1965. It offers comprehensive healthcare coverage for a range of federally mandated and state-optional services. Each state administers its own program and has some autonomy over eligibility criteria and benefit packages. The program is regulated federally by the Centers for Medicare and Medicaid Services (CMS). Medicaid coverage has been revised over time, with the two most notable expansions being Title XXI of the Act, creating the State Children’s Health Insurance Program (CHIP)—covering children of families with higher income levels—and the optional extension of coverage under the Patient Protection and Affordable Care Act (ACA), effectively covering adults up to 138% of the federal poverty level (FPL).1 Medicaid and CHIP covered an average of 74.6 million people in federal fiscal year (FFY) 2015, as the largest single source of healthcare coverage in the country. Figure 3 illustrates a breakdown of enrollment and expenditures on the financial outlook for Medicaid, published by CMS and based on the two most recently available actuarial reports.2,3 It should be noted that the managed care expenditure value includes both acute and long-term services and supports (LTSS). LTSS expenditures appear to decrease in FFY 2015, however this is related to a shift from FFS to managed care delivery of these services. Values also include nonclaim costs such as Medicare premiums/cost sharing and Part D clawback; however, we have excluded disproportionate share hospital (DSH) payments as well as adjustments and administration cost.
Figure 3: Medicaid enrollment and expenditures
|Average monthly enrollment (# millions)|
|Population group||FFY 2014||FFY 2015|
|Title XXI CHIP4||5.9||6.1|
|Annual expenditures ($ billions)|
|Expense category||FFY 2014||FFY 2015|
|Title XXI CHIP4||$13.2||$14.6|
Medicaid is jointly funded by state and federal governments. The federal medical assistance percentage (FMAP) varies by state and is updated each year based primarily on state per capita income relative to the national average. FMAP rates range between 50% and 75% of traditional Medicaid service cost (as of federal fiscal year 2017), and states must comply with federally mandated eligibility and covered service requirements to receive federal funding.5 Federal participation also varies for different cohorts of the population, providing enhanced FMAPs for CHIP-eligible members under the CHIP Reauthorization Act of 2009 (CHIPRA) and for newly eligible adults under ACA expansion.6 Under the current financing system, states pay all medical cost incurred by Medicaid enrollees and submit quarterly expenses on a cash basis to CMS to draw down federal funds at the established FMAP rate.7 Figure 4 illustrates historical annual federal and state/local Medicaid expenditures, federal Medicaid funding as a percentage of total Medicaid expenditures, and the federal and state/local Medicaid expenditure growth rates from calendar year 2010 to 2015.8 It should be noted that the American Recovery and Reinvestment Act of 2009 (ARRA) provided for enhanced federal funding from October 2008 through June 2011.9 The increase in federal funding for 2014 and 2015 is primarily linked to expansion of eligibility for low-income adults under the ACA.
Figure 4: Medicaid spending by funding source
|CY||Federal||State/local||% Federal||Federal growth rate||State growth rate|
There is no fixed limit to Medicaid spending as long as states meet regulatory requirements for approved populations and services, so federal and state spending will increase proportionally when enrollment grows or medical costs trend upward. This open-ended financing system is difficult to forecast, and is a key reason that alternative funding proposals have been introduced from time to time. With the current transition to Republican control of the White House and Congress, Medicaid reform has again become a key topic of discussion.
Two alternative federal funding methods have been proposed by current Republican leadership: block grants and per capita caps. This paper discusses these methods at a high level, offering important considerations in setting up alternate funding.
Block grants are a funding mechanism that has been proposed at various times for Medicaid, and it serves as the current funding methodology for some nonmedical assistance social programs, e.g., Temporary Assistance for Needy Families (TANF).10 Under this proposal, each state would receive a predetermined amount of funds each year to provide Medicaid coverage. Unlike the current funding system, states would be responsible for funding all costs in excess of the federally established block grant budget amount rather than receive a proportional federal match for all cost. From a federal perspective, this makes budget planning more predictable, as the amount of funding provided to the states is formulaic and known in advance each year.
To establish block grant funding, historical medical cost would be the most likely place to start in establishing a baseline for first-year funding. Updates would be made annually for subsequent years based on formulaic trend factors intended to account for growth in both enrollment and cost of care as well as potential adjustments related to FMAP changes. In an effort to constrain federal spending on the Medicaid program, annual trend rates may be set lower than historical Medicaid trends.
Although a trend methodology has not been defined at this point, it is likely that the funding growth would not tie directly to the many complex factors that drive the growth of Medicaid expenditures. The gross domestic product (GDP) has been discussed as a potential growth rate, but may not reflect trends in aggregate future medical costs. For example, in times of recession, Medicaid enrollment often increases as unemployment increases and more people meet the income-based eligibility criteria. Additionally, the growth of block grant funding may not reflect ever-changing factors that drive per enrollee costs of healthcare, such as the emergence of new, expensive (but innovative) therapies and the aging demographics of the U.S. population.
It is a common expectation that if federal funding changes to block grants, states are likely to be given more flexibility to design more cost-effective programs, such as establishing state-determined eligibility requirement minimums and covered services.11 Each state is currently responsible for the administration of its Medicaid program. States have some latitude in designing their programs. However, in order to receive federal funding they must comply with mandated eligibility and benefit coverage requirements. If a block grant methodology is employed, based on previously proposed models and without modifying current Medicaid State Plan benefits, federal costs will increase at a defined rate, while state cost increases may be leveraged disproportionately to subsidize remaining cost as total program cost increases. To the extent that program cost requires additional state funding, the removal of certain CMS requirements could mitigate budget concerns. Some examples of added flexibility include:
Block grant funding may serve as an upper limit to federal funding, working in a manner consistent with current reporting and reimbursement. For example, total expenditures would be reported quarterly, and states would draw down funds up to the maximum allowable amount, based on FMAP rates. This structure would eliminate the incentive for states to make drastic cuts and use this federal funding for other purposes.
History of proposals
Figure 5 illustrates a history of proposals for funding Medicaid using a block grant or per capita cap funding mechanism.
Figure 5: Timeline of block grant proposals
Example of block grant funding for medical services
A prominent example of using block grants to finance a public healthcare system is the U.K.'s National Health Service (NHS), which currently provides comprehensive healthcare coverage for more than 64 million people across the U.K.16 Each year, Parliament decides on the amount of money that will be allocated to fund the program, and most of this funding is ultimately passed on to locally focused Clinical Commissioning Groups (CCGs), which purchase care from providers participating in the system.
However, over the last several years, a lack of funding to appropriately compensate providers has become an increasingly exacerbated issue. Overall in fiscal year 2016, NHS providers recorded a deficit of approximately GBP 2.45 billion, as costs for providers outpaced the total financing allocated from Parliament through the NHS. Furthermore, many individual CCGs and their corresponding local providers realized deficits that were even larger proportionally, as the formulas used to allocate funding to each CCG did not necessarily match the needs of the providers in the CCG. These formulas utilize information such as age/gender, poverty levels, and population size in order to decide how much healthcare funding each CCG should need to pay providers. However, to the extent that actual healthcare costs differ from the costs predicted by these formulas, there will be a disconnect between funding for providers and their actual costs.17
The funding issues surrounding the NHS have been well publicized and are a major focus of the current political discussion in the U.K. The experiences of the program highlight the importance of assumptions in determining the overall growth of block grant funding, as well as how that funding is allocated to localized purchasers of healthcare, where states, managed care entities, and medical providers will all be at risk for funding deficits.
Per capita caps
Another proposed methodology for determining federal Medicaid financing involves appropriating funds based on per capita caps. Under this proposal, a maximum baseline amount of funding is established per Medicaid enrollee, and this per enrollee cost cap would grow based on formulaic cost of care trend factors consistent with block grant funding. Also consistent with block grant funding, per capita cap funding would require states to cover all spending in excess of the cap. Unlike block grant funding, however, per capita caps allow for enrollment growth without penalizing state budgets. While the per capita cap mitigates state risk of higher-than-expected enrollment growth, it also means that federal funding amounts are not as predictable as they are under a block grant system.
Like block grant funding, a baseline per capita amount would be established for each state in the first year, and then the per capita amount would be calculated using a predetermined formulaic growth methodology. The applied growth factors would be designed to reflect an estimated increase in cost per enrollee. If the growth rates were to be set lower than historical Medicaid cost trends, it may reduce federal spending over time.
Although the per capita cap system is designed to allow for adjustments in funding as the number of people enrolled in Medicaid changes, it is not yet known whether the growth methodology would account for changes in factors such as the mix of members enrolled in Medicaid. Healthcare utilization and the average cost of services incurred by members vary by the demographics of the member, such as age, gender, or institutional care needs. For example, members requiring LTSS will be much more expensive than an average healthy child.
Figure 6 summarizes proposals that have been introduced for per capita cap funding.
Figure 6: Per capita cap proposals
Example of per capita cap funding
Section 1115 demonstration waivers are a long-standing example of how per capita funding could operate within Medicaid. Currently, Section 1115 of the Act allows the Secretary of the U.S. Department of Health and Human Services (HHS) to approve experimental programs that provide services or eligibility for populations not traditionally covered by Medicaid.20 In order to attain approval, states must show budget neutrality to the federal government, meaning that required federal funding must be no more than the estimated federal cost without the program.
Typically, budget neutrality is demonstrated by establishing a benchmark per capita cost based on historical experience, which is trended forward using a calculated growth rate assumption. The actual per capita cost under the waiver program is reported on a regular basis and must prove lower than the trended benchmark cost to satisfy neutrality requirements. If actual per capita spending exceeds the trended benchmark amount, states must either cover the excess cost or submit a formal request to modify the benchmarks, based on extenuating circumstances.
In applying for Section 1115 waiver approval, states establish benchmark per capita cost and growth rates using historical experience by Medicaid population. This mitigates the risk of varying growth rates in populations that have significantly different per capita costs. This process is analogous to how a per capita funding mechanism could work, although it is not clear whether states would be responsible for providing the initial assumptions or if the federal government would determine these assumptions.
We have outlined several technical and general considerations for stakeholders involved in converting the federal funding to an alternative proposal. If overlooked, these factors could cause inequities among states or a divergence in medical expenditure and funding growth rates over time.
Initial benchmark rates
Initial benchmarks must be set under either a block grant or per capita cap federal funding scheme. In developing benchmarks, there are many assumptions that must be addressed.
Annual growth rate selection
Once benchmark rates have been established, they will need to be trended forward to the funding period and updated annually thereafter.
Figure 7: Medical and nonmedical annual change
Medicaid spending accounts for approximately 20% of individual state budgets costs, second in size only to education spending.35 Because of how much state spending is tied to Medicaid, there tend to be significant pressures on state lawmakers to reduce Medicaid spending when budgets are tight. Moving to a fixed federal funding formula rather than the current proportional federal funding could increase state responsibility and introduce additional variability to state funding requirements. As pressures to reduce state spending continue, significant policy decisions will need to be made to reduce budgetary requirements. Some examples of budgetary actions include:
In addition to the potential policy changes already noted, states may begin turning to alternative benefit designs for administering Medicaid. Some states have applied for Section 1115 demonstration waivers to provide such coverage to the Medicaid expansion population and other nondisabled adults. Two examples of these demonstrations include the Healthy Indiana Plan (HIP) and Healthy Ohio.
Some states have also begun to explore delivery system reforms that focus on incentivizing providers to promote the health of the population while finding efficiencies in medical care. Two examples of such reforms include Oregon’s Coordinated Care Organizations (CCOs) and New York’s Medicaid Reform Transformation (MRT) Waiver.
As states seek out ways to continue offering Medicaid coverage under more limited federal funding, reformed coverage terms such as those introduced in the Indiana and Ohio demonstration waiver applications may become more widespread, increasing the financial participation and engagement of Medicaid enrollees in their healthcare purchasing. H.R. 277, a new ACA repeal bill, has been released by the Republican Study Committee and would permit states to offer HSA-like accounts for Medicaid enrollees.
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