Medicaid Funding of Nursing Homes in Ohio

By Michael T. Bond, Ph.D., posted November 5, 2003

Ohio (and most of the nation’s) Medicaid Plans are in serious financial trouble. The director of Medicaid admits as much in recent testimony and press releases when she states that Medicaid is not sustainable with Ohio’s budget under current laws. There is widespread agreement that the State is headed for a fiscal train wreck unless the growth of Medicaid can be brought under control. Ohio Medicaid has suggested a short-term solution of freezing provider payments and reducing eligibility in the CFC portion of the program. They also advocate freezing nursing home reimbursement rates. They admit that this is not a long-term solution.

It is my view and that of Buckeye that nothing less than fundamental reform of the entire Medicaid program, including nursing home provision, will solve this long term fiscal problem. We believe that government provision of health care is inherently inefficient and that the market forces should be used to simultaneously control costs and increase the quality of medical care for Medicaid beneficiaries. We disagree with several assertions put forward by Ohio Medicaid.

First, we believe it is a fallacy that Ohio Medicaid has administrative costs less than the private sector. The four percent overhead figure given is correct but very misleading. One of the major reasons given for this relatively low number is that the government run program does not need to earn a profit. In effect, health insurance profit is viewed as a deadweight loss. The absurdity of this argument can be quickly taken to its absurd end. If profit is a deadweight loss why not have the government produce autos, televisions and other goods and services. The elimination of profit will produce reduced costs to consumers. History, of course, is riddled with failures of socialist economic systems to produce high living standards and low costs for consumers. They produce the opposite!               

The fundamental problem here is that the four percent overhead figure given by Medicaid administrators dramatically understates the true cost of running these programs. There are numerous reasons for this understatement:

•       Revenue Collection – Private insurers collect premiums from their customers. The cost of this billing and collection is obviously included as insurance overhead. Medicaid is financed with tax dollars that involve collection costs. These are not included as overhead. This is also true with budgeting, accounting and many other overhead items.
   

•       Working Capital – Insurance companies meet the mismatch between their revenues and expenses by a working capital investment. The cost of this is covered in the premiums they receive. Medicaid often pays providers with a significant lag. If a provider has $1 million in Medicaid billings and is paid with a 6-month lag they are carrying $500,000 in accounts receivables. Applying a ten percent cost of capital to this produces a $50,000 capital cost. This means an additional overhead of five percent has been shifted onto providers. This is ignored in the calculation of Medicaid overhead.
   

•       Moral Hazard – Any insurance plan can produce “moral hazard” which means he insurance may cause the event it is supposed to insure. For example, fire insurance increases arson when the building is worth less the insured value. Health insurance increases the use of health care by making it “free”. Private insurers incur costs to prevent unneeded health care by not paying more than market rates for services, negotiating with providers for discounts in exchange for guaranteed volumes, determining if services are really needed, and properly pricing risk. All of this involves overhead. A majority of Medicaid is still provided in a fee for service framework with little or no cost sharing. Even if the prospective and cost based reimbursements in Medicaid were correct the system would encourage overuse and unneeded health care that is less likely to occur in the private sector.
   

•       Health Care Quality – Purchasers of health care in the private sector have numerous choices in terms of co-payments, providers, ready access, geographic convenience, and availability of the latest medical advances. As insurers and HMOs compete to provide these they provide high quality at competitive prices. All of these choices require overhead. Medicaid, from above, pays an administered price to providers or reimburses based on costs rather than quality.  The result is difficulty in obtaining medical services that may be needed and, in the case of health care, providers may deliver lower quality service to offset the low reimbursements. The result is a lower explicit overhead rate for Medicaid than the private sector but also a lower quality product. It is hard to say Medicaid delivers health care for less when the product is lower quality. Quality problems with Medicaid are well documented.
   

•       Compliance Costs – Providers bear significant compliance costs in dealing with Medicaid. A physician whose time is worth $100 loses that much in revenue for each hour spent dealing with complex compliance issues. They must hire administrative staff or outside consultants to deal with the overhead imposed on them by Medicaid. 

This is only a partial list of the administrative costs that are generated by Medicaid and Medicare. When these costs are correctly accounted for the publicly provided health plans have significantly higher overhead than private insurance. One estimate placed government insurance plans as having overhead two-thirds higher than the private sector. The additional overhead is born by tax payments to other agencies and by costs imposed on providers.

Second, Medicaid currently pays for medical services with either administered pricing or by cost reimbursement. A major (and probably fatal) problem with plans like Medicaid is that they are based on a system of administered prices. The current payment system for fee for service is based on a DRG methodology (diagnosis related groups) or, in the case of nursing homes, cost reimbursement. Theoretically, this is a market-based approach to health care and a movement away from the original reimbursement system based on costs. The problem with the original system, which largely remains in place for nursing homes, was that the way providers earned more money was by having higher costs! Since there was essentially little or no consequence to the beneficiaries the result was entirely predictable. Medicare and Medicaid costs exploded at the expense of the taxpayers!

DRGs were a reform that was supposed to solve this problem by making payments “prospective”, i.e., a price that would be paid regardless of provider costs and instead represent the “true value” of medical services. The problem is these prices are not determined in a competitive market but set by plan bureaucrats and their consultants. Every economist worth their salt knows that it is impossible for anything but a decentralized market to set correct prices.

Unfortunately, this is not the case in Medicaid. Since the plans cannot possibly set “correct” prices they will produce “too much” health care when they are too high and “shortages” of health care when they are set too low. The same thing happens when Medicaid arbitrarily sets HMO and managed care payments below the correct price. The result is an enormous misallocation of resources in the health care sector that, since it is inherently inefficient, leads to much higher costs for Medicaid medical services.

This also affects the private sector provision of health care. First, when prices are set too low in public plans providers may attempt to shift costs to the private sector. If private sector purchasers “froze” their payments as Medicaid plans to do their coverage would be cancelled. Second, the deadweight loss produce by DRGs makes the entire health care system much more inefficient. Third, some private payers still reimburse under this method although that has become rare. Thus, what looks like higher costs or medical inflation in the private sector is related to the dramatic inefficiency of government run programs with price setting schemes. 

Nursing homes are reimbursed essentially on a cost based system for Direct Care, Indirect Care, Other Protected and for Capital. Direct care costs are primarily compensation costs. Indirect care costs include food, laundry, housekeeping, maintenance, insurance and other items. Other protected costs include medical supplies, franchise fees, utilities and property taxes. Capital costs include depreciation and amortization of fixed assets, interest and leasing costs.  Despite the best efforts of the State to remove incentives for unneeded costs any cost reimbursement system will have at least some incentive to increase costs.

This, of course, is the opposite of what happens in a competitive free market. One admittedly extreme example of what this does involves an Ohio nursing home whose owners also run a catering business. The food for the service comes from the nursing home. This was clearly not the intention of the development of Medicaid. Another example has to do with capital reimbursement for beds. While Medicaid does not pay nursing homes for unused beds the reimbursement system partially protects them from loss if a bed becomes idle. This clearly encourages unused, unneeded beds in the state. 

One way to reform this system would be to provide those who qualify for Medicaid supported nursing coverage nursing home “grants” (NHGs) to purchase nursing home “insurance” from carriers soliciting business at the Insurance and Provider Exchange (IPE). These would not be insurers in a traditional sense because they would be soliciting business from a group they know will incur nursing home expenses. Rather, these carriers would function as HMO type organizations that would negotiate with nursing homes and other elder care organizations for varying packages of nursing home services. Elderly service providers would compete vigorously for this business producing competitive pricing and increased quality of coverage.  Or nursing homes could simply list themselves at the IPE and “sell” their services directly to beneficiaries.

The State Medicaid Program, as with our CFC Proposal, would operate the insurance exchange and mandate minimum standards for nursing home services. The establishment of the exchange and the development of NHGs would accomplish some of the aged population goals set up in the Buckeye Medicaid Reform Proposal.

First, it would eliminate statutory rate setting.  Rates should be determined by the market, rather than legislation, as much as possible. Qualifying individuals would purchase nursing homes services from providers competing on both price and quality. Second, it would stop the capital practice of encouraging empty beds.  Nursing homes would no longer have an incentive to operate with excess capacity since they would be paid by services provided. They would be more profitable by reducing unneeded capacity as opposed to current system that gives them incentives to add additional empty beds. Ohio currently has over 13,000 empty nursing home beds and has enough beds to last until 2020 at current rates of utilization.  This reform would dramatically reduce that overhead and, in the process, allow nursing homes to provide services at lower costs. 

Third, it would eliminate other wasteful practices.  It would stop the bailing out facilities that are in bankruptcy since the state currently pays owners to continue to operate them until new buyers are found.  If a home goes bankrupt it would seek protection from creditors through normal legal channels while continuing to provide services to patients. If it is unable to continue in business it will shut down and insurance exchange firms will make new arrangements for their Medicaid customers. Allowing inefficient, poor quality homes to leave the market can only produce or more efficient, lower cost, higher quality system of providers. Reimbursement for depreciation and other costs would be eliminated and the incentives for homes to operate properly would be dramatically increased.

Fourth, the insurance exchange firms would solicit bids from low cost community care and home health care facilities. This would accomplish two things. First, it would serve as a source of competition for institutional care facilities and force price competition. Second, it would allow insurance exchange firms to lower their overall price to buyers since community and home health care providers often cost less. Finally, the introduction of competitive forces would increase quality of care and essentially allow for payment of outcomes. This would occur because insurance exchange firms would use quality of care when attempting to attract Medicaid buyers. They would almost certainly attempt to market the quality of their nursing home providers through various quality measures and statistics (bed sores, patient satisfaction, and so forth). Nursing homes would have a strong financial incentive to improve the quality of their care or risk not being solicited by insurance firms.

The State Medicaid program would undertake the operation of the insurance exchange, set minimum nursing home and elderly care standards and assist recipients in purchasing services by providing easy to understand information on the products being offered. In addition, the Medicaid program would retain the role of determining eligibility for nursing home coverage and (through their actuaries) establish the amount of NHGs. Recipients would be free to purchase a broader package of services from exchange providers in excess of the NHG with their own funds. As an incentive to use low cost care the purchase of an elderly service from the exchange that costs less than the NHG could be partially refunded to the beneficiary with the remaining funds returned to Medicaid.    

Would the above provider exchange and NHG’s reign in elderly nursing home costs? We believe that they would control costs and simultaneously improve the quality of care to beneficiaries. It is instructive to note that before the establishment of government run health care systems in 1966 about five percent of U.S. output went for healthcare. Extrapolating the trend up to that point to today would give about seven-to-eight percent of national spending on health care. With the inefficient government run health system in place national output for health care is 14 percent. We believe at least one-third of health care spending is unnecessary and wasteful. Thus, it is our view that there are significant savings to be gained by moving changing Medicaid to a government financed, privately delivered program.

Summary of Buckeye Medicaid Proposals

•       Ohio Medicaid is in serious fiscal trouble. The program or acknowledges this fact. Short run proposal involves freezing payments to providers. Medicaid admits this is not long term solution.
   

•       Nothing less than fundamental market based reform, in Buckeye’s view, will solve Medicaid’s fiscal problem.
   

•       Assertions of low overhead and better cost control by Medicaid are a fallacy. Low overhead ignores numerous costs imposed on providers.
   

•       Supposedly low costs for Medicaid are based on prospective payments set below market, cost shifting to the private sector and lower quality medical services for beneficiaries.
   

•       Both prospective payments and cost reimbursement for nursing homes are very inefficient. Nursing home reimbursement by cost encourages inefficient operation and additional costs such as unneeded beds.
   

•       Solution to the problem is a Medicaid operated Insurance and Provider Exchange (IPE) . This is “mart” where   providers offer packages of services to Medicaid beneficiaries including nursing home residents. Nursing home beneficiaries would receive a Nursing Home Grant (NHG) from Medicaid to purchase services from the IPE. The grant would be designed so that coveree’s benefit financially from selecting lower cost providers either by sharing in cost savings.
   

•       Nursing home costs would fall and quality would increase as providers compete for “customers” at the exchange. Incentives for additional costs and unneeded beds would be eliminated since these would reduce nursing home profitability. Potential loss of business would increase the quality of services. Inefficient, low quality homes would leave the market.
   

•       Given estimates that one-third of health care is waste and inefficiency because of government run programs suggest substantial cost savings from moving to a government financed, privately delivered Medicaid system.

Michael T. Bond, Ph.D., is Director of the Center for Health Care Policy at The Buckeye Institute and a professor in the Department of Finance at Cleveland State University.