By CHARLES E. BEGLEY and DAVID C. COLBY

C o n t r o l l i n g   M e d i c a i d   c o s t s
What Illinois is doing and what it can do

The Department of Public Aid has cut Medicaid coverage and reimbursement, but this action will probably not solve the escalating costs of health care. The authors propose additional strategies the state could use to control the health care economy in Illinois

ILLINOIS must gain greater control of its Medicaid budget. This is not news; for the last decade Medicaid has been an increasing drain on the state's revenues. But now federal support is declining while Medicaid costs, along with health care costs in general, continue to rise. To cope, the state has reduced Medicaid rates, coverage and eligibility. The state can continue to pursue this strategy, and the governor's budget message indicates that it will, but there is another more equitable alternative which could achieve greater long-term savings. Illinois could make better use of two regulatory agencies already in place: the Health Facilities Planning Board and the Illinois Health Finance Authority. Both agencies were designed to exert control over health care costs; both are involved in the rationing of scarce medical resources, and both affect all providers in the state — not just participants in the Medicaid system. Taking this approach may be difficult, however, since it would require reform of the Health Facilities Planning Board (currently too generous to the industry) and renewal by the General Assembly of the (as yet inoperative) Health Finance Authority.

The crisis in the state's Medicaid budget is part of a much larger problem. In 1980, Americans spent $1 out of every $10 earned on health care services. The nation's total health care bill rose to $247 billion, an increase of 15.2 percent over 1979, and the largest annual increase since 1966. The projected spending figure for 1981 of nearly $300 billion will produce an even larger increase than in 1980. This dramatic rise in health spending severely strains government budgets, which over the last 15 years have become the major source of payment for health care. In 1966, private health insurance companies paid most of the bill; today the federal, state and local governments have assumed that responsibility and are now financing over 42 percent of all health care expenditures.

As a major source of health care payment in Illinois, state government is being squeezed between rapidly rising health care costs and declining revenues. In 1975, the state spent just over $1 out of overy $10 it received in taxes for health care services; by 1980, it spent $2 out of every $10 on health care. The largest and most dramatically rising expenditures are for Medicaid — the public health insurance plan for welfare recipients, the disabled and the elderly. Medicaid expenditures by the Illinois Department of Public Aid (DPA) rose from $84.5 million in 1966 to $202 million in 1970 and will reach an estimated $1.6 billion in 1982. In 1981, the increase in DPA's budget for medical assistance (which is predominantly Medicaid) represented 70 percent of the department's entire budget increase and was over $250 million. Over the last decade, DPA's medical assistance budget has increased five times faster than the rest of its budget.

Although the rate of Medicaid spending is expected to continue to rise, the federal government has reduced its contribution to the program by placing a "flexible cap" on the amount that it will reimburse Illinois for Medicaid. Under the 1981 budget reconciliation act, federal payments to the states will be cut by 3 percent in fiscal year 1982 (based upon the current reimbursement formula), 4 percent in fiscal 1983 and 4.5 percent in fiscal 1984. Under the act, these cuts maybe reduced in states which restrain expenditure increases below 9 percent annual growth, have an acceptable hospital rate review program, high unemployment or an adequate fraud and abuse recovery program. DPA estimates that with the 1982 cuts it will receive $758 million from the federal government for Medicaid. This amount represents a 6 percent increase over 1981 but falls far short of the 15 to 20 percent rate at which Medicaid spending is rising.

Medicaid costs

In response to the crisis created by the simultaneous rise in costs and decline in federal support, DPA has initiated a cost containment program that includes a number of changes in reimbursement designed to relieve some of the pressures on the Medicaid budget. These changes are the result of a complex planning process that involved various actors including the federal government, the health care industry and the legislature. With the new policies in place, the department hopes to save about $150 million in this year's total spending, but it is not yet clear what effect the policy changes will have on health care costs or the access to care for Medicaid recipients. While the changes may represent the best options available to deal with the current budget crisis, it is important to consider some of their long-term implications, as well as some alternative cost containment strategies.

In developing its Medicaid cost containment program, DPA considered four basic strategies: (1) reduce the size of the eligible population; (2) reduce services covered (Illinois currently covers all eight mandatory services and 29 of 32 optional services); (3) reduce the amount paid providers; or (4) reduce the amount of services purchased. DPA chose to focus its efforts on the last two options by making reductions in payments to health care providers and by attempting to reduce utilization of health care services with special emphasis on hospitals. (Medicaid payments for hospital care have been increasing about 18 percent per year and currently absorb more than half of the entire annual budget.)

In October 1981 DPA instituted two major changes:

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1. In an effort to reduce hospital utilization, payments for preoperative hospital stays were restricted to one day, and certain surgeries are no longer reimbursed except on an outpatient basis.
2.   DPA called for expansion of Medicaid's utilization review program, which reviews and monitors recipients identified as overutilizers of health care.

Two months later the department instituted additional changes:

1.  DPA expanded its efforts to collect payment from other third-party payors for recipients who have insurance coverage in addition to Medicaid.
2.  DPA informed hospitals that reimbursement caps would be placed on Medicaid payments. This change will be achieved by placing a ceiling on the total revenues that a hospital can expect to receive from Medicaid this year. In effect, the department informed hospitals that reimbursements will not cover projected cost increases.
3.  With the cooperation of the Illinois Medical Society, DPA developed a surgical review program which identifies and monitors physicians who do an excessive number of procedures during the year.


It would be inconsistent to have Medicaid making cutbacks in payments while the HFPB is encouraging hospitals to increase capital costs or the IHFA is approving big rate hikes

4.  DPA significantly reduced dental coverage for adults by limiting reimbursement to extractions and fillings.
5.  The department began restricting payment for glasses to one pair per year per individual except in unusual circumstances.
6.  Reimbursement for certain prescription and nonprescription drugs was eliminated.

As necessary as these changes may be to cope with the immediate crisis, they do not address the underlying causes for the Medicaid budget problem. A major cause of the rise in Medicaid spending is the health care market itself: Consumers demand the best (most technological and advanced) medical care available; third-party payors insulate both providers and consumers from having to face the true cost of health care; and providers have little incentive or training to keep costs down. These market factors, combined with the development of more expensive medical technology and increasing specialization have brought about the rise in Medicaid spending.

DPA's approach to cost containment may produce budget reductions in the short run, but these are unlikely to have much lasting impact on health care costs. To be successful, a cost-containment program must address the market conditions that encourage high costs. To do this, DPA will be required to make major changes in the way it conducts business, such as: instituting competitive bidding by providers rather than paying on a cost-reimbursement or fee-for-service basis; making mandatory assignments of patients to certain health care providers; and fixing prices paid for drugs and laboratory services. Moreover, other third-party payors like Blue Cross and Blue Shield must adopt similar reforms to improve the incentives for efficiency.

Unfortunately, even if there were political support for these measures, it is unlikely that such broad changes could be made in time to solve the immediate fiscal crisis. Meanwhile, DPA's cost-cutting reimbursement policies may produce some perverse effects. For example, between 1972 and 1973, California experimented with a selective co-payment scheme for outpatient cure. The result was an increase in hospital utilization because people substituted hospital care for outpatient care in order to avoid the co-payments. If this occurs in Illinois it will reduce the effectiveness of the co-payment strategy. Similarly, the limitation on per diem rates may cause them to increase utilization in order to make up for lost revenues, or it may generate more investment in outpatient care facilities.

Most importantly, any reduction in access as a result of the cost-containment program is unfair to Medicaid recipients and providers because all health care consumers and providers, not just those involved in Medicaid, have contributed to the cost problem. Unfortunately, because of Medicaid's budget problems, those who can financially and medically afford it the least are being forced to bite the bullet first. Health care providers who serve the Medicaid population will suffer more than other providers, and the disincentives to accept Medicaid patients will continue to rise. If the state continues this policy, medical resources will eventually move away from the Medicaid population. Meanwhile, providers who serve the Medicaid population will attempt to pass on much of the costs Medicaid no longer covers to other payors. Thus, although Medicaid's budget may be reduced, other payors will be asked to pay a greater percentage of the bill.

Capital expansion

Although much publicity has been given to the Medicaid cost-containment program, the Health Facilities Planning Board (HFPB) and the Illinois Health Finance Authority (IHFA) have remained in the background in spite of the important roles they could play in the state's health care economy. The HFPB regulates capital expansion in the hospital and nursing home industries, and the IHFA will regulate hospital charges.

The purpose of both agencies is to contain inflationary pressures in the imperfect health care services market by regulating providers, an approach that may have greater potential for overall cost savings than DPA's current budget-cutting strategy. And since decisions made by either of these agencies have a direct effect on the Medicaid budget, their performance should be an important part of DPA's cost containment program. It would be inconsistent, for example, to have Medicaid making cutbacks in payments while the HFPB is encouraging hospitals to increase capital costs or the IHFA is approving large rate increases. Unfortunately, the cost-containment potential of these agencies has not been realized, and there has been little coordination between them and the Medicaid program.

The regulation of health care capital is performed by the HFPB which must award a certificate of need for capital expenditures for construction, modification or renovation that: (1) costs over $150,000; (2) significantly

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alters services; (3) changes the number or category of beds, or (4) discontinues a service by a health facility. The primary purpose of the HFPB and the certificate of need procedure is two-fold: to promote the orderly development of health care services and to contain costs. (For an in-depth examination of the purpose and early history of the certificate of need, see Begley and Hillman, "Containing Hospital Costs: The Illinois Certificate of Need Program," Illinois Issues, October 1979.)

Since nearly every capital project raises health care costs, the decisions made by the HFPB commit the Medicaid budget for the future. For example, the construction of a replacement facility for a hospital in Chicago recently approved by HFPB was estimated to increase per-patient-day expenses by $57. According to estimates by the Illinois Department of Public Health's office of health finance, the capital expense for this one hospital will raise the Medicaid budget by at least $1.5 million in 1984. Overall, the office estimates that the board's past decisions may affect the Medicaid budget by as much as $50 million per year.

There is no indication that the HFPB is aware of the impact its decisions have on health care costs. Since the program began in March 1975, over 1,200 hospital projects costing more than $2.9 billion have been reviewed, and over 90 percent of all proposed projects were approved. The high approval rate indicates the board's unwillingness to deny the industry's investment plans despite their effect on future costs to consumers. Although it is true that the review process tends to weed out projects or scale them down before approvals are made, there is little evidence that the board has achieved these deterrent effects on a large scale. (See Begley and Colby, "Regulating Hospital Facilities Construction: The Illinois Experience, 1975-79," Illinois Government Research, January 1982.) Further evidence of the HFPB's generosity to the health care industry was provided by a recent examination of the disposition of 144 projects reviewed by the board. In 22 percent of the cases, approvals were issued to projects which violated the board's own criteria for need, and/or economic and financial feasibility.

Given the apparent impotence of the certificate of need program, it is understandable that the HFPB has not been given a major role in the Medicaid cost containment effort up to this time. Despite the crisis in Medicaid spending, the board's approval rate remains high, and the board is currently in the process of adopting new criteria for economic and financial feasibility which will make it easier for projects to be approved. Moreover, federal cutbacks to health planning systems threaten to eliminate the certificate of need process at the regional level.

Yet there are a number of reforms that could be made to strengthen the program and make the HFPB a more effective tool for cost containment. Obviously, a change in the composition of the board would be a temporary solution, but structural reforms would provide a permanent one. The following reforms are suggested for consideration:

•  Grant the Department of Public Aid the right to appeal Health Facilities Planning Board decisions which have a heavy impact on its budget. Presently, any health care facility proposing a capital project may appeal an intent-to-deny issued by the HFPB. Since many of these projects have hidden and uncontrollable effects on the Medicaid budget, fairness to DPA requires that it also have the right to appeal decisions. In conjunction with this, DPA's ex-officio member on the board should prepare an analysis of the impact of projects on the Medicaid budget based upon the projected Medicaid/non-Medicaid patient mix for the appropriate services. This analysis would make the board more aware of the effects of its decisions on the state budget.

•  Require the HFPB to provide reasons for decisions which are contrary to its own review criteria. The formal designation of reasons for approval of these projects would require the HFPB to examine whether its decisions are based upon reasonable interpretations of the regulations. It would also clarify the board's position for future applicants and assist in the reformulation of regulations.

•  Allow the HFPB to make decisions on portions of projects. Currently, the HFPB must approve or disapprove projects in total. This is one of the most difficult problems of decision-making. Many times the board is forced either to approve a multifaceted project that has some unjustified elements or to disapprove a project with some needed elements. The ability to approve some portions of a proposal while disapproving others would eliminate this dilemma. After a partial approval, the health care facility could then reformulate its plans and proceed with the approved portions.

•  Place a cap on the total project costs which may be approved in any year. A limit on the number of dollars which the HFPB is allowed to approve would provide an incentive to deny clearly questionable projects and critically scrutinize the marginal ones. There are many ways to determine the cap: It might be the average of past approved costs (adjusted for inflation), or it could be determined by the state health plan. For example, if the health plan proposes an 11 percent growth rate in health care expenditures, the growth in the capital resources of the health care facilities in the state might be limited to 11 percent. A cap could also be adjusted to reward projects which save money: Cost savings could be subtracted from the capital costs of the project when figuring allowable growth in capital expenditures.

Hospital rates

The other major cost control mechanism available to the state is prospective rate setting for hospitals by the Illinois Health Finance Authority (IHFA). Prospective rate setting is designed to restrain costs by establishing revenue limits for hospital facilities. Under current market conditions, insurance coverage reimburses hospitals for services on a cost-plus basis, effectively insulating hospital administrators from budget constraints. The revenue limits established by the IHFA would provide such constraints. Hospitals would have an incentive to provide less costly services to patients in order to keep costs below what the IHFA would allow them to charge third-party payors. In states where it has been used, prospective rate setting has produced significant savings: Studies indicate that limits on reimbursement reduce the rate of growth in hospital expenditures from 3 to 5 percent, compared to growth rates in states with no regulation. Unfortunately, prospective rate setting can force painful adjustments on health care facilities when it

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is imposed rigorously, as in New York.

Although the law creating the IHFA was passed in 1978, the rate-setting process has not yet begun because of the time required to establish rules and regulations. To date, the program has obtained an agreement from the federal government that Medicare will pay the rates set by the IHFA and from Gov. James R. Thompson that Medicaid will also pay these rates. Uniform hospital cost reports are being submitted by each hospital in the state and will be used to justify rate increases. Once the program begins, a hospital desiring a rate increase has two options: It may apply to the IHFA for an incentive rate increase (based on a formula which includes an adjustment for inflation, the number of patients cared for and the intensity of care), or it may request a formal cost review by the IHFA which will be the basis for a new rate.

Unfortunately, there is a possibility that prospective rate setting in Illinois will be shelved before it has ever been tried. The law creating the state's prospective rate-setting program requires renewal in this year's legislative session. Gov. Thompson is supporting renewal on the basis of the program's potential for containing hospital costs, but the IHFA's long start-up period and opposition from the hospital industry may work against it.

Reform of the IHPB and renewal of the IHFA would give Illinois a chance to address some of the built-in causes of its escalating Medicaid costs. Making use of these regulatory agencies is certainly more equitable than putting the whole burden of cost containment on the Medicaid population — and may also be more effective in terms of significant long-range savings. These reforms would still fall far short of the measures needed to correct fundamental distortions in the nation's health care services market. But it would be a mistake for Illinois not to take these first important steps.

Charles E. Begley is assistant professor of economics at Sangamon State University and Southern Illinois University School of Medicine. He specializes in health economics research and health policy analysis. David C. Colby is assistant professor of political science at Williams College, Williamstown, Mass., and specializes in public policy research.

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