Assessing the New Federalism is a multiyear Urban Institute project designed to analyze the devolution of responsibility for social programs from the federal government to the states, focusing primarily on health care, income security, employment and training programs, and social services. Researchers monitor program changes and fiscal developments. In collaboration with Child trends, the project studies changes in family well-being. The project aims to provide timely, nonpartisan information to inform public debate and to help state and local decisionmakers carry out their new responsibilities more effectively.

Key components of the project include a household survey, studies of policies in 13 states, and a database with information on all states and the District of Columbia, available at the Urban Institute's web site. This paper is one in a series of occasional papers analyzing information from these and other sources.

The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.

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Introduction

Discussions between states and managed care plans about capitation rates have become increasingly contentious. In numerous markets, health plans are reportedly responding to low payment rates by either withdrawing from or limiting participation in Medicaid managed care. In particular, an increasing number of mainstream health maintenance organizations (HMOs), those with a majority of commercial and Medicare enrollees, are reported to have ended or limited participation in Medicaid managed programs in Arizona, California, Connecticut, Florida, Georgia, Illinois, Missouri, New York, New Jersey, Ohio, and Pennsylvania (Rabinovitz 1998; Meyer 1997; Langreth 1998; Kilborn 1998).

Some of these plans may have made strategic decisions to focus on commercial or Medicare-risk business or on specific geographic markets. Nonetheless, health plans' negative view of Medicaid payment rates and administrative requirements of Medicaid contracts may constrain states' continued efforts to both "mainstream" Medicaid beneficiaries into the private health care system and achieve cost savings by moving larger numbers of Medicaid beneficiaries into managed care.

This paper provides new information from an Urban Institute survey of state Medicaid managed care payment methods and rates. In particular, the paper summarizes various payment methodologies used in 41 of the nation's 45 states (including the District of Columbia) with capitated Medicaid managed care programs, and it examines interstate and intrastate variation among payment rates. We begin the paper with a brief review of the history of federal and state attempts to use payment arrangements, including capitated managed care programs, to encourage the provision of "mainstream" health care to low-income populations. We then present results from a nationwide managed care payment survey of voluntary or mandatory capitated Temporary Assistance for Needy Families/Aid to Families with Dependent Children (TANF/AFDC) and TANF/AFDC-related managed care programs. This survey was conducted as part of the Urban Institute's Assessing the New Federalism project. Concluding the paper is a comparison of Medicaid capitation rates with Medicare adjusted average per capita cost rates.

Background

In 1965, the federal government enacted Medicaid, a joint federal- and state-financed health insurance program for the poor. One of the primary goals of the program was to provide the uninsured with access to private or "mainstream" health care systems. Over the next 25 years, both program enrollment and expenditures grew well beyond original expectations. Although expanding coverage to needy groups (e.g., children and pregnant women, the disabled, and the medically needy) was a dominant goal of the program, expenditure growth and the pressure it placed on state budgets made cost containment a central objective as well.

Medicaid cost containment has taken many forms, but many states initially found cutting or keeping physician fees low an attractive option. But while states were limiting fee growth, physician fees in the private market continued to rise. This divergence of Medicaid and private fee-for-service rates led to inadequate physician participation in Medicaid programs (Holahan and Held 1985). Consequently, a growing number of Medicaid beneficiaries were left with no choice but to receive primary care through either hospital emergency rooms or physician practices that often provided low-quality care to very high volumes of Medicaid patients.

Some states responded to declining beneficiary access to private-office-based providers (physicians who also see privately insured patients in noninstitutional settings) by offering enhanced physician fees on selective office-based primary care and preventive services (Mitchell 1991; Cohen 1989, 1993; Cohen and Cunningham 1995). But despite resulting increases in office-based visit rates, physician participation in Medicaid continued to lag the private market. Moreover, these efforts to bring the poor into mainstream care were at odds with efforts to contain costs.

Other states implemented Medicaid managed care alternatives, such as primary care case management (PCCM) programs and capitated HMO financial arrangements, to both improve beneficiary access and control costs (U.S. GAO 1993). Two types of PCCM programs arose. One version paid primary care physicians a fixed fee of $3 to $6 per member per month (pmpm) to manage primary care of individual beneficiaries; the other version rewarded primary care physicians with potential bonuses from inpatient cost savings. Unlike the PCCMs, capitated HMOs assumed financial risk for inpatient and outpatient services; each plan received a fixed dollar amount pmpm for providing a comprehensive set of services. Both PCCMs and HMOs had similar effects: Inappropriate emergency room use declined, access to office-based primary care improved, and expenditures fell 5 to 15 percent below fee-for-service levels (U.S. GAO 1993; Hurley, Freund, and Paul 1993; Hurley and Freund 1991).

Over time, states have migrated toward capitated HMO alternatives as the preferred strategy to not only improve access and accountability and reduce costs, but also achieve budget predictability. Furthermore, many states chose to build upon voluntary managed care programs by enrolling beneficiaries on a mandatory basis into capitated managed care programs under 1915(b) freedom of choice or Section 1115 of the Social Security Act managed care demonstration waivers. As of June 1997, Alaska and Wyoming were the only states without some form of managed care. Moreover, as of June 1998, 17 states had implemented Section 1115 waivers, which expand the role of Medicaid managed care.⁽¹⁾

Table 1 provides data on Medicaid managed care penetration by state. The table shows that 15 percent of Medicaid beneficiaries on June 30, 1997, were enrolled in PCCM programs and 30 percent were enrolled in full-risk HMOs. The table also shows large differences in managed care penetration among states. Some states, including Alabama, Mississippi, and Texas, have very little managed care of any kind. Other states, such as Georgia and North Carolina, have high levels of PCCM but very little enrollment in capitated HMOs. Finally, states such as Arizona, Hawaii, Oregon, and Tennessee have very high levels of enrollment in capitated plans.

States have recently found the transition to capitated managed care more difficult than expected. After a wave of interest by mainstream plans in the early 1990s, commercial plans have been hesitant to enter the Medicaid market, and a number of plans have either ended or limited participation in existing Medicaid managed care programs. Many plans leaving the market have cited increased frustration with Medicaid managed care, namely, inadequate capitation rates coupled with the administrative demands of state Medicaid programs.

In response, states contend that they are limited by the "upper payment limit," which restricts their ability to pay more than fee-for-service expenditures for comparable populations. States also argue that mainstream plans were interested in the Medicaid program during the early stages of voluntary programs because rates were attractive, but plans are now not willing to accept more "realistic" rates. Specifically, states perceive rates in the early voluntary programs to have been unnecessarily high. Rates were high because managed care plans initially attracted healthier beneficiaries, who incurred less than the average level of health care expenditures on which rates were based. As voluntary and mandatory programs have expanded, opportunities for risk selection have been diluted by additional enrollment of Medicaid beneficiaries who are less "healthy" into managed care.

On the other hand, mainstream plans see these more "realistic" rates as being (1) a result of state budgetary pressures, not the market, and (2) inadequate to both care for Medicaid beneficiaries and meet the state's administrative and quality reporting requirements. Moreover, the number of beneficiaries a plan expects to enroll has become intertwined with rate discussions. Plan enrollment has lagged behind expectations because of the decline in Medicaid rolls, which is caused by both the nation's economic recovery and the implementation of state and federal welfare reforms. Lower-than-expected enrollment has led plans to question the decision to enter or remain in the Medicaid market. Mainstream plans have also argued that state efforts to protect safety-net-based Medicaid-only plans (i.e., through preferences in autoassignment or higher rates) have created an unlevel playing field for Medicaid managed care.

With the limited amount of hard information available, it is difficult to sort out these competing arguments. Although a number of factors may influence mainstream plan participation, payment rates will probably continue to be a major decision factor for plans and a key policy lever for states during the development of Medicaid managed care programs.⁽²⁾ Without an increased understanding of alternative payment methodologies and payment rates, it is increasingly likely that capitation rates will reflect traditionally low Medicaid fee-for-service payments. Further, payment methodologies are not likely to effectively compensate plans for different levels of risk. As a result, mainstream plan participation will continue to wane, and a growing number of Medicaid beneficiaries will receive care from safety-net-based and Medicaid-only HMOs. This is not to say that safety-net-based and private Medicaid-only HMOs will not provide good quality care. Rather, they will participate not because of rate adequacy but because of their inability to leave Medicaid managed care markets. This paper provides information that will help states establish rates that will attract efficient mainstream plans as well as provide Medicaid-only plans with the resources necessary to care for a Medicaid population. At a minimum, it will help states understand how others are addressing the same issues.

Survey Design

To collect this information, we mailed surveys to Medicaid directors in all 50 states and the District of Columbia and asked only those with capitated HMO programs to respond.⁽³⁾ The survey was designed to elicit only information that was not available from secondary sources. It was also limited to capitated HMO programs for AFDC and AFDC-related eligibility groups (i.e., low-income unemployed parents, poverty-related children, and poverty-related pregnant women). Children's Health Insurance Program expansions, the elderly and disabled, and the medically needy were not included. The survey was mailed to states in March 1998. It asked questions about rate-setting methods, adjustments for disproportionate share hospital payments and graduate medical education, and services carved out from capitation. Each state was also asked to submit a rate sheet that listed, for the most recent contracting period, either fixed capitation rates or average accepted bids for state-specific eligibility categories across regions and pmpm equivalent values for carved-out services. We also asked questions related to add-on payments and adjustments for maternity care and deliveries, safety net providers, high-risk cases, and state administrative savings, as well as rate updating processes and methodologies. If written responses were unclear or additional information was needed, we telephoned the appropriate state contact for clarification.

Out of a possible 45 states, including the District of Columbia, with capitated Medicaid managed care, 41 responded.⁽⁴⁾ Delaware, Oregon, Montana, and Nebraska declined to participate. In aggregate, the participating states accounted for approximately 94 percent of the nation's Medicaid beneficiaries and 96 percent of Medicaid managed care beneficiaries enrolled in capitated managed care programs. As table 2 shows, 22 of the 41 states enrolled beneficiaries on a mandatory basis only; of these, 9 permit beneficiaries a choice between HMOs and PCCM programs. Fourteen states had mandatory programs operating in some areas of the state and voluntary programs in others. The remaining five states had only voluntary capitated programs. All states provided information on payment methods. Thirty-six states provided actual payment rates. (Alabama, Michigan, North Carolina, Pennsylvania, and Vermont provided information on methods but not rates.)

Payment Methods

Administrative Pricing, Negotiation, and Competitive Bidding

Methods for setting rates are summarized in table 3. About half (21) of the respondent states continue to use administered pricing—setting rates that are open to all plans willing to participate. This approach is analogous to the Medicaid fee schedules that states traditionally use to pay physicians who are willing to accept Medicaid-set rates (managed care plans, of course, must also meet a variety of standards in order to participate). These states typically use data from their fee-for-service experience to establish rates. Depending on state policy objectives, states apply some discount from fee-for-service, typically 5 to 15 percent, and then adjust rates on an annual basis. At least one state, Rhode Island, has found competitive bidding to be administratively burdensome and plans to return to administered pricing. On the other hand, a number of the administered rate-setting states plan to (1) implement rate negotiation or competitive bidding as a means of achieving immediate savings and (2) recalibrate state Medicaid managed care rates in the absence of comparable fee-for-service data as more beneficiaries enroll in managed care.

Of the remaining states, 6 negotiate rates with plans individually, while an increasing number of states (14) have moved toward either competitive bidding or competitive bidding with final rate negotiations to procure plans. In general, even the states with competitive bidding end up with a considerable amount of negotiation. Some states, such as New York and Washington, have found that their efforts to arrive at rates through competitive bidding were considerably altered through subsequent negotiations. States also vary in the length (years) of the contracts, the amount of information provided to plans before bidding, and the strictness with which target ranges are adhered to. Some examples of state approaches to negotiation and competitive bidding follow.

Massachusetts is a state that negotiates rates with each plan. Before negotiating rates, the state projects the enrollment distribution by geographic region of the state, indicating the enrollment that the plan would expect under Medicaid managed care during the next contract period. The state then negotiates a single rate for each plan. Plans have the option to include or exclude prescription drugs from the capitation rate. All plans that participate in the state employees' insurance program must submit a "good faith" proposal to contract for the state's Medicaid population.

Minnesota essentially sets rates but only after a round of negotiation. Minnesota first asks plans to submit rate and geographic coverage proposals. After examining all the proposals and discussing rates and geographic coverage with the plans, the state establishes a set of rates that apply to all plans within each managed care region. As a condition of HMO licensure, all Minnesota health plans must participate in Medicaid managed care.

States that use competitive bidding also differ in important ways. Arizona currently competitively bids and negotiates its rates under five-year contracts that include interim adjustments for inflation and programmatic and legislative changes. The state contracted with outside actuaries to develop a set of rate ranges as a frame of reference for the process. The state did not disclose these ranges to plans but compared them against submitted bids as a starting point for negotiations. Rate ranges were developed using (1) state expenditure and utilization data from the previous two and a half years and (2) various trending facts that include changes in utilization and service cost, and programmatic or legislated changes. Rates were also adjusted downward for expected cost of reinsurance and third-party recoveries and adjusted upward for administrative costs, expected profits, and other contingencies.

Hawaii competitively bids contracts every three years. The state does not automatically adjust rates every year; in fact, in the past rates have remained the same or have been lowered. During the last process, the state allowed plans that passed the technical review to visit the state's actuary and discuss assumptions used to prepare its bid. Plans were then given another opportunity to make final adjustments to their submitted bids. However, the state indicated that it will disclose rate ranges during the next bid process and will require plans to submit bids within the range. Individual meetings with plans will not be held, and bids outside the range will be considered nonresponsive.

The state of New York competitively bid rates across selected counties in 1996 with the assumption that it could achieve significant savings relative to fee-for-service expenditures. Before bidding, the state set a range of plus-or-minus 5 percent of a discounted fee-for-service midpoint for six age/gender groups for each of nine geographic regions (groupings of counties). Plans that bid below the range for a group were brought up to the lower payment limit, and plans that bid within the range were contracted at bids. For plans that bid above the range, the state set their rates at the lower payment limits as well. Nearly two-thirds of the plans had rates set at the lower payment limit. Soon after the 1996 process, plans claimed that rates were too low to cover eligible populations. In response, the state commissioned an independent study by Arthur Andersen, Inc., which concluded that rates were not adequate and recommended a 3 to 5 percent increase in capitation payments.

Since the 1996 study, the legislature has raised rates three times. The state raised rates 2 percent in New York City and up to 7 percent in upstate counties beginning in January 1997. Then the state approved two additional rate increases in August 1997. Rates to HMOs and prepaid health service plans for the period January 1, 1997, through March 31, 1998, were retroactively raised 5 to 11 percent. Approximately $20 million in rate increases was split between general increases to all plans ($10 million) and earmarked increases for those plans in need of additional managed care capacity. Using similar methodology, the state scheduled a raise in rates once again in April 1998 by 3 to 4 percent. In addition, each plan received a trend adjustment of approximately 3 percent to account for medical cost inflation during the January 1997 through March 1998 contracting period. Together, these rate adjustments could have potentially increased plans' rates from 13 to 25 percent since the 1996 bid process. Because of its unhappiness with this experience, New York intends to negotiate rates with individual plans in the future.

Finally, the state of Washington competitively bids contracts every three years, with interim adjustments for changes in service coverage, budgeted utilization trends, and inflation. During the last process, the majority of plans bid above the state's undisclosed upper payment limit. As a result, the state had to receive legislative approval for an increase in rates to ensure adequate participation.

Capitation Rate Adjustments

Most states establish different rates for separate demographic groupings. As shown in table 4, these vary from as few as 2 (Kentucky) to as many as 25 (Mississippi). States often make additional adjustments for selected health conditions, such as pregnancy or HIV/AIDS, which are discussed later. Most states also vary rates by region. In general, rate adjustments made solely to directly reflect differences in health status are not very sophisticated. However, five states—Colorado, Maryland, Minnesota, Michigan, and Washington—are moving ahead in designing diagnosis-based risk-adjustment payment systems for Medicaid populations (State Health Watch 1997). These systems are intended to (1) pay plans enough to ensure access for high-risk patients, including allowing them to contract with providers that specialize in high-risk Medicaid patients; (2) protect plans from adverse selection; and (3) make health plans compete on efficiency and quality and not just on the ability to select good risks.

Thus far, only Colorado and Maryland (of the responding states) have begun to implement more sophisticated risk-adjustment systems for their Medicaid populations. Both states perform risk assessment (measuring the predictors of health care costs of the individuals enrolled in a plan) and risk adjustment (compensating plans for differences in risk, as measured by risk assessment). Colorado relies on a disability payment system (DPS), which identifies and groups diagnoses that are chronic in nature and are associated with higher future costs. Approximately 2,400 chronic diagnoses were grouped into 43 major categories that correspond to body systems or specific types of illness or disability. Using two years of data, the state measured the annual cost of the average person in each of three eligibility categories of aid (disabled, AFDC adults, and AFDC children) during the second year. The state then measured the extent to which being in a particular DPS diagnosis group in the first year contributed to the person's health care expenditures in the second year. The correlation between diagnoses groups and second-year costs were then used to determine risk weights attached to each diagnosis group and to persons without any of the diagnoses. The relative risk weights and the frequency with which an HMO's (or fee-for-service's) enrollees fell into each diagnostic group determined an average case-mix factor for each HMO and for the fee-for-service population. This calculation was performed separately for each category of aid. Finally, the case-mix factors for each HMO were multiplied by a standardized baseline rate, which was lower for HMOs than for fee-for-service, to determine final rates for each HMO.⁵

Similarly, Maryland has also implemented a more sophisticated risk adjustment for its Medicaid populations, including AFDC and AFDC-related beneficiaries enrolled in managed care.⁶ The state relies on the Johns Hopkins Adjusted Clinical Groups' (ACGs, formerly Ambulatory Care Groups) diagnosis classification system to risk-adjust demographic rate cells. Under ACGs, enrollees are assigned to 1 of 52 unique morbidity groups based on their age, sex, and the inpatient and ambulatory ICD9-coded diagnoses observed from their previous medical claims. The state then uses aggregate ACG data to define a limited number of risk-adjustment categories (RACs) that reflect levels of relatively homogenous resource utilization and reduce the number of rate cells to a more manageable number for the state. Each individual is then assigned to one of nine RACs based on his or her original ACG. Individuals who do not have sufficient diagnostic data are assigned to one of eleven standard demographic rate cells—covering approximately 60 percent of AFDC enrollees.

Additional Adjustments and Supplemental Payments

Outside of limited risk adjustment, states typically base administrative prices, upper payment limits, or rate ranges for each demographic category on historical fee-for-service experience. Adjustments are made for plan benefit design, Federally Qualified Health Center (FQHC) adjustments, prescription drug rebates, expected changes in unit costs and utilization trends (managed care savings), inflation, and legislative changes.⁷ A number of states (Arizona, Georgia, New Jersey, New York, New Hampshire, Missouri, and South Carolina) also take into account the expected administrative savings of 1 to 4 percent to the state under managed care through administrative allowances by adjusting rates upward. In addition, some states make adjustments for expected favorable risk selection under voluntary enrollment. Georgia made a downward 5 percent adjustment to baseline capitation rates to reflect positive health status of voluntary enrollees. Likewise, South Carolina made a downward 3 percent adjustment to payment rates for AFDC and poverty-related pregnant women.

Seven states made provisions for FQHC or Indian Health Service (IHS) contracts. States either include 100 percent of FQHC costs into capitation calculations or paid plans with FQHC or IHS contracts an additional capitation payment. Five states (Alabama, Florida, New Mexico, New York, and Texas) reported that they pay 100 percent of FQHC costs (that is, no reduction is assessed for managed care savings) in setting capitation rates. Texas estimated that the impact of including 100 percent of FQHC payments in capitation payments results in a $.10 to $3.00 increase in pmpm payments across the different service areas. Connecticut pays a "bump" payment to plans that have contracts with FQHCs. Colorado pays two "bump" rates, one for hospital-based FQHCs and one to free-standing FQHCs. The state estimated that plans that contract with hospital-based FQHCs receive an additional $11.89 pmpm, whereas plans that contract with free-standing FQHCs receive an additional $19.20 pmpm. In Connecticut, these payments range from $1 to $15 pmpm depending on the level of FQHC utilization by plan. Likewise, California's two-plan model pays local initiatives that have contracts with public providers (including FQHCs) a higher capitation rate than it does to mainstream plans. Capitation rates for mainstream plans are approximately 4 to 5 percent lower than for the local initiative.

More than half of our respondent states make special payment arrangements for maternity-related expenses, rather than incorporating these costs into base capitation rates already paid to a plan for AFDC enrollees. The majority of these states make direct lump-sum payments to health plans for these expenses in addition to paying regular capitation rates. Lump-sum payments are typically used to reimburse plans for prenatal, delivery, and postpartum care costs. Colorado was one exception: The state pays plans a lump-sum payment to cover facility costs. Other states pay separate capitation rates for all pregnant women or only poverty-related pregnant women (PRW). California pays a separate PRW rate that varies for each of the counties in the two-plan system. Missouri combines both approaches: The state pays a lump-sum delivery payment for all deliveries and pays a separate PRW rate. Similarly, Texas currently pays a separate rate for PRWs, but plans to move to base rates for AFDC women and PRWs, plus a supplemental lump-sum payment that covers prenatal care, delivery, and postpartum services.

Some states preferred to compensate plans for maternity expenses by transferring a portion of these expenses into newborn rate cells or through risk-sharing arrangements. Mississippi and Texas pay a substantially higher rate for poverty-related newborns to protect plans from these pregnancy-related costs. Similarly, Georgia transferred 35 percent of AFDC newborn birth charges to AFDC males and females one to two months old. Two states reported the use of risk-pooling or risk-sharing mechanisms to protect plans from above-average pregnancy costs. Utah retained a portion of newborn capitation payments to better allocate reimbursement among plans. These capitation deductions are accumulated into a pool and distributed based on an HMO's delivery experience. Rhode Island addressed plans' concerns over maternity risk by offering plans a reinsurance arrangement on neonatal intensive care services in return for a small deduction in capitation. Table 5 summarizes maternity care payment policies among surveyed states.

A few states have also begun to make similar adjustments or create reinsurance mechanisms for HIV/AIDS cases. Maryland treats HIV/AIDS patients as a separate category when setting capitation rates. Massachusetts has a separate rating category for high-cost members with HIV/AIDS for managed care organizations that ask and secure approval for this rating category. Utah makes supplemental monthly payments to plans for each HIV/AIDS patient. New York defrayed some of the risk plans face for symptomatic AIDS patients through a regional stop-loss arrangement. The state estimated that on average approximately 0.1 percent of enrollees or 20 percent of HIV/AIDS enrollees in a region are AIDS symptomatic. Under the arrangement, if a plan's symptomatic AIDS membership is greater than 0.1 percent of its total Medicaid enrollment, the state will pay the plan a 1 to 5 percent capitation increase—depending on the level of AIDS enrollment—across all of the plan's Medicaid patients in that region.

Pennsylvania is using both an HIV/AIDS adjustment and a risk pool in different geographic areas. For the southeast area, plans were asked to submit six months' worth of utilization data and unit cost information by service category (e.g., hospital inpatient, outpatient) for enrollees with and without HIV/AIDS. If the plan's enrollment of HIV/AIDS members was 0.2 percent more than the regional prevalence rate for each eligibility category, the state reimbursed the plan for 90 percent of the cost difference between its HIV/AIDS patients and non-HIV/AIDS patients. For the southwest region, the state has created a quarterly HIV/AIDS risk pool that is financed through a withhold from baseline capitation rates. After each quarter, each plan is required to submit information on its HIV/AIDS enrollees. The state then disburses funds from the pool to each plan based on the plan's share of the HIV/AIDS patients that are enrolled in Medicaid managed care within the region.

Disproportionate Share Payments and Graduate Medical Education

Finally, most states exclude disproportionate share hospital (DSH) payments from Medicaid capitation rates. However, Illinois, Minnesota, West Virginia, and Wisconsin reported that DSH payments were included in the rates. Hospitals have claimed that HMOs do not pass through DSH in the form of higher payment rates. Moreover, the 1997 Balanced Budget Amendment includes provisions that require states to make Medicaid DSH payments directly to hospitals rather than to managed care entities, except for "payment arrangements in effect" on July 1, 1997.

States have also moved forward in excluding both direct medical education and indirect medical education components of graduate medical education (GME) payments.⁸ Only 4 of the 41 surveyed states included DSH payments in HMO capitation rates, and 10 states included GME (see table 6). In these cases, DSH or GME payments were incorporated into capitation rates because they were included in the fee-for-service baseline data used to set rates, upper payment limits, or acceptable bid ranges. However, states varied in their reasons for including these payments. The most common reason for including these payments was that states did not have or were developing the data capability to separate GME or DSH amounts from historical fee-for-service data. Even states with proven data capability chose not to exclude DSH or GME from capitation rates. Massachusetts and New Jersey did not exclude GME payments, which they estimated at approximately $5 and $6 pmpm, respectively. Illinois estimated its DSH inclusion to be approximately $4.59 pmpm. Minnesota estimated that DSH and GME payments, make up 6 percent of Hennepin and 3 percent of Ramsey County rates. It also reported that it made plan-specific adjustments to capitation rates based on plan utilization of DSH and GME hospitals. Washington included 50 percent of DSH and GME payments, with the remaining funds flowing directly to Harborview and the University of Washington Medical Centers.

Carve-Out Services

States carve out services from HMO capitation arrangements for numerous reasons. In addition to potential improvements in quality and access, states may pursue carve-outs to reduce expenditures, limit selection bias, or to protect public or local providers. Often plans do not have experience in managing these services. States may also achieve volume discounts on carve-out services through specialized contractors. States may use behavioral health carve-outs to reduce the incentive of plans to disenroll high-risk beneficiaries as well as to protect plans from the costs of adverse selection of high-risk beneficiaries (Frank et al. 1997). Carve-outs may protect public providers, including mental and public health departments that have traditionally served the Medicaid population, as well as reduce intergovernmental or interagency tensions over Medicaid budgets (Bachman et al. 1997). Likewise, states may use pharmacy and chiropractic carve-outs to protect local allied professionals. According to our survey, the most common carved-out services among states (not including long-term care, which all states carve out) were mental health, substance abuse, dental, and pharmacy (see table 7).

Behavioral health

Of the 41 states, 23 fully or partially carved out mental health services, and 20 states fully or partially carved out substance abuse services. However, states varied in their behavioral health carve-out designs. Some states carve out mental health services to other public agencies, whereas others carve out mental health services to private organizations. Some address these issues with partial carve-out arrangements that require some plans to bear some costs for behavioral health services but establish arrangements to limit plan risks.

In California, responsibility for mental health services for Medicaid beneficiaries covered by the state's two-plan model has been contracted to separate county organizations through a 1915(b) mental health waiver, rather than assigned to two-plan model HMOs. Under the mental health waiver, the Medicaid agency transfers a portion of general revenues to the State Department of Mental Health to cover costs for mental health care previously provided through the Medicaid agency. The State Department of Mental Health then allocates these funds to individual counties, following an allocation formula based on historical utilization of Medicaid mental health services, the number of Medicaid beneficiaries, and other relevant factors. Counties then pool these funds with a portion of proceeds from motor vehicle and sales taxes that are earmarked for mental health services and federal matching payments to provide services to Medicaid beneficiaries. The county organization is free to contract with independent providers on a fee-for-service or capitated basis.

Washington has transferred funding for mental health to the State Department of Mental Health, which pays regional support networks a capitation amount to provide mental health services to Medicaid beneficiaries. Each network may contract with independent providers on either a capitated or fee-for-service basis. In addition to mental health, substance abuse treatment is also carved out, to the Division of Alcohol and Substance Abuse. Kentucky carved out mental health services from managed care organizations and continued delivering services primarily through its network of community mental health centers, Compcare, on a fee-for-service basis. However, the state plans to implement a 1915(b) waiver program that will pay one managed behavioral health organization on a capitated basis in the two managed care regions currently under mandatory enrollment beginning January 1999.