Setting capitations for Medicaid: a case study

Health Care Financing Review, Summer, 1990 by Arleen Leibowitz, Joan L. Buchanan

Setting capitations for Medicaid: A case study

Introduction

Many States are interested in the potential of prepaid plans to improve access, provide continuity, and control the costs of providing care to Medicaid recipients. The ability of prepaid plans to reduce State expenditures for Medicaid recipients, however, rests importantly on the level of the capitation rate given to the prepaid plan.

From a fiscal point of view, one advantage of the capitated plans is that the monthly cost of providing health care to a given Medicaid population is known in advance. Many States also believe that if the capitation rate is set at 90 or 95 percent of the average Medicaid expenditure, that will reduce their expenditures on Medicaid services. However, this will only be true if the prepaid plans enroll "average" patients. If, on average, the prepaid plan enrollees are lower users of medical care, the State may pay only 95 percent of the average Medicaid cost, and still pay more than they would have paid for those enrollees in the fee-for-service system (FFS). (1) On the other hand, if prepaid enrollees are higher than average users of medical care, the State may save money in the short-run, but the plans may not be financially viable.

Actuarially fair capitation rates for Medicaid enrollees are important from both the health maintenance organization's (HMO's) point of view and from that of the State. Without a capitation that covers the cost of treating Medicaid patients, the HMO's long-run viability could be threatened. Certainly the willingness of plans to participate in the program through time will diminish if capitation rates are not at least actuarially fair.

Ratesetting differences

The Medicaid capitations differ from the HMO capitations for employee groups in several ways. Typically, HMOs have set community-based, rather than experienced-based capitation rates for their commercial enrollees. In this situation, the fee charged for an individual is not a function of that individual's characteristics, or even of the characteristics of that individual's firm. However, States have a mandate not to pay more for Medicaid health care in an HMO than they pay for health care in the FFS system. Consequently, States have negotiated Medicaid-specific rates based on FFS Medicaid experience.

The mechanism for setting Medicaid capitations also differs from the procedure that HMOs usually employ. Whereas the community-based capitations are determined by the HMO and are based on their cost structure, Medicaid rates are often proposed by the States and are based on FFS Medicaid claims, which bear no necessary relationship to HMO costs.

However, the expected costs for a particular Medicaid enrollee can vary in a systematic way with many factors, including age, sex, and aid category. States are becoming increasingly aware of the importance of incorporating these factors into their calculation of capitation rates.

An additional complication States face in setting capitation rates derives from the fact that ratesetting is inherently a forecasting problem. Therefore, estimates of future price trends and usage patterns are necessary. These estimates must often be made with incomplete data, which require adjustment for the purpose of estimating a capitation rate.

Several studies consider the factors that should be included in capitation formulas, by examining what variables best explain medical care expenditures (Newhouse et al., 1989; McClure, 1984; Newhouse, 1986; Lubitz, Beebe, and Riley, 1985; Anderson et al., 1986). Most of these studies examine the adjusted average per capita cost (AAPCC) formula used in setting Medicare capitation rates. There has been little focus on Medicaid ratesetting for HMOs. To our knowledge, no previous study examines how ratesetting is actually implemented.

Ratesetting problem

In this section we describe the calculation of the capitation rate for calendar year 1986 for Health Care Plus (HCP). This discussion draws heavily on materials supplied by the New York State Department of Health (NYS) (Tenan, 1986; New York State Prepaid Health Service Plans Waiver).

NYS attempted to use both HMO cost data and data on FFS equivalent expenditures in setting Medicaid HMO capitation rates. The State proposed a two-stage plan for setting prepaid capitation rates for Medicaid. In the first stage, health plans would calculate their actual costs of providing service to Medicaid enrollees. Administrative and marketing costs would be included in these costs, as well as contributions toward a reserve account. However, since the final capitation rate cannot exceed the cost of providing medical care to enrolled Medicaid eligibles in the FFS system, the capitation rate would be set as the minimum of the HMO cost calculation and the FFS equivalent costs. In practice, because plans had little or no experience treating Medicaid recipients and consequently had inadequate information for setting cost estimates, the capitation was based only on the FFS equivalent costs, which were termed the "FFS cap"