Paul Keckley
Christopher Kalkhof 

As a healthcare financial manager, you can do several things to help keep the holes in your state's Medicaid safety net from getting larger.

At a Glance
To respond to the challenges posed by potential healthcare reform:

  • Maintain ongoing awareness of your state's reform initiatives.
  • Evaluate each reform initiative in terms of how it will affect your organization.
  • Conduct a state healthcare reform rapid readiness assessment in your organization.
  • Engage your physicians, board, and community leaders in understanding Medicaid.
  • Get ready and stay ready!

Imagine, if you will, the following remarks by hypothetical Gov. Stretched at the opening of his state's 100th legislative session:

Ladies and gentlemen: Welcome to this legislative session. It promises to be our most challenging session to date. Teachers want more pay and smaller class sizes. Our transportation system requires immediate attention. Homeland security remains a priority, and the human services for our most fragile citizens require ongoing attention and resources. Voters aren't inclined to support tax increases and are convinced we need to do more with less.

And if we don't completely overhaul the Medicaid program, we'll not be able to do anything else. Like most states, the majority of our future revenue growth is already earmarked to fund this program. We have no option. And while we do that, Medicaid enrollment is expected to grow, employer-sponsored insurance programs are expected to decrease, and the burden of bad debt and provider frustration will increase exponentially. In our state, Medicaid is a perfect storm. Incremental approaches to address its challenges will not work; a transformational change is necessary. Medicaid is issue No. 1 in this session. It's a clear and present danger to the viability of our state.

Managing their Medicaid programs effectively and efficiently is one of the most important challenges facing states. Medicaid is a vital safety net supporting the economic stability of every state-but, regrettably, it is badly in need of repair.

There is widespread consensus across state political aisles about five current realities: 

  • According to the Congressional Budget Office, by 2008, an estimated 64 million individuals will be covered by Medicaid, making Medicaid recipients the largest group covered by public financing in the United States.
  • The Medicaid population's health and healthcare needs are unique.
  • Most Medicaid programs are challenged to meet their beneficiaries' healthcare needs.
  • Balancing cost, access, and quality is the goal, but managing costs is the current priority with many states.
  • Systemic change, innovation, public-private collaboration, and disruptive change are believed to be necessary to reform Medicaid by many lawmakers.

Although state-level guiding principles appear to be nonpartisan, strategies and tactics to address Medicaid reform vary greatly. Fortunately, bolstered by the encouragement of organizations such as the National Governors Association and National Conference of State Legislatures, increased public- and private-sector attention is being paid to states where innovations and best practices are shared.

Systemic Medicaid Reform: A Framework

With declining state tax revenues and decreased federal financial support, compounded by increased numbers of unfunded mandates, social services costs, and Medicaid expenditures, states are forced to seek better value for their healthcare dollars. By linking Medicaid with other sweeping reforms, states are developing a framework to alter the landscape of healthcare delivery and transform a system much in need of change.

Increased access, improved quality, and reduced cost serve as the cornerstones for Medicaid state reform initiatives. What these terms mean, however, depends on whether you are a purchaser, recipient, or provider of healthcare services. Access. Increased access means improved access for Medicaid-eligible and uninsured individuals to medically necessary services in the appropriate provider setting, as well as when, where, and how these individuals desire to receive healthcare services.

Quality. Improved quality refers to the delivery of healthcare services that are safe and necessary based on scientific evidence matching signs and symptoms with therapeutic interventions known to work for most patients. Safe and effective care is measurable. States support safe and effective care in two major areas: policies for coverage and denial of services, and licensing and oversight of healthcare providers. States also consider inefficient and/or ineffective health care as "poor quality."

Cost. Healthcare cost refers to the actual costs associated with services provided to patient populations, sometimes augmented by the indirect costs associated with the impact of the population's health status on social services and the economy. In the Medicaid population, direct costs are reflected in claims submitted for payment by providers. Indirect costs are primarily those associated with the array of social programs that support Medicaid beneficiaries' ability to live within a community. 

Innovative State Medicaid Reform Efforts

The exhibit below lists popular state Medicaid reforms currently under way. Although it is too soon to know how these reforms might change with states introducing universal coverage programs for the uninsured, it appears that these initiatives are moving reform in the right direction.

View Exhibit 1  


The exhibit illustrates the margin gap created through cost shifting in a large teaching hospital in an urban setting-a gap that is all too common with hospitals across the country. This hospital experienced $29.6 million in annualized losses, though it had a favorable Medicare payment relative to cost, due to GME/IME payments. For most hospitals, total Medicare payment typically represents 93 percent to 95 percent of full costs.

The cost-containment initiatives shown in the exhibit can be grouped into three broad, categories: 

  • Reducing state administrative costs
  • Integrating technology solutions for increased cost efficiencies, cost effectiveness, and streamlining workflow processes
  • Reducing total expenditure outlays on provider claims

Reforming Medicaid across the above areas of emphasis requires states to make considerable investments in planning and a dedicated commitment to effective execution. And the process of accounting for Medicaid program costs and estimating potential returns from investments is a science unto itself. Typically, states go through extended hearings to assess multiple reform programs, ultimately arriving at a package that's unique to the state. Almost all packages include a combination of mandated programs and optional approaches, incorporating both in their financial modeling. This results in a customized approach to Medicaid reforms that must be approved by the Centers for Medicare and Medicaid Services regardless of the state's waiver status. States with Section 1115 waivers have more latitude than those that do not, but all are required to comply with certain federal policies and procedures.

Most states use a "micro-simulation" model to predict costs and financial impact. These financial models vary in complexity based on the program initiative being assessed. With respect to those states pursuing comprehensive reform initiatives that are intent on transformational versus incremental change, many more stakeholder groups are incorporated into the micro-simulation models. Following are five variables modeled in comprehensive reform initiatives.

Cost/revenue impact. In this analysis, Medicaid program costs and revenue or funding requirements are evaluated by using a range of different financing options. The analysis also incorporates historical program expenditures for healthcare services and different utilization levels by provider care setting.

State goals. This analysis is intended to assess the extent to which the different Medicaid transformational models advance the core goals of improved access, quality, and cost containment.

Employers. This analysis determines the financial and overall economic impact of policy decisions on the business community and employment.

Beneficiaries. This analysis is meant to assess the impact of different reform proposals on general scope of benefits, quality of care provided, utilization of services, and beneficiaries' out-of-pocket costs (if applicable) and choices of providers.

Providers. This analysis assesses the overall financial impact of alternate coverage/access/provider payment and reimbursement methodologies on the provider community. 

Medicaid Reforms and Hospitals: Delicate, Unavoidable Convergence

Medicaid reforms can have a dramatic financial impact on providers and hospitals. When considering Medicaid reform initiatives, many lawmakers believe the state is paying its fair share and that the problems with the state healthcare system are overcapacity and hospital inefficiencies, coupled with the delivery of care that is not cost-effective. Although there is a factual basis behind these views, lawmakers often do not demonstrate a true understanding of hospital economics or the impact that state healthcare policies have on hospitals.

State policymakers understand that there are certain cost and economic factors outside the control of hospital management, such as: 

  • The misalignment in payment/cost control incentives between physicians and hospitals
  • The independent nature of medical staff members
  • The number of uninsured, underinsured, elderly, and poor served by the hospital
  • State Medicaid payments, which do not keep up with hospital cost inflation

Although many lawmakers understand that environmental considerations are out of the control of hospital management, those lawmakers still have to deal with their budget constraints and the fact that they have seen little evidence of improved access, quality, and affordability, despite the billions of dollars most states spend every year on Medicaid healthcare services, uninsured bad debt charity care, and graduate medical education (GME)/indirect medical education (IME). State legislators tend to expect every hospital to be an active participant in Medicaid reform and act responsibly with respect to their own ongoing improvements in several areas: 

  • Staffing, clinical workflow, and process efficiency
  • Effectiveness of revenue cycle management processes and supply chain management
  • Balancing facility capacity and service offerings with patient demand
  • Efficacy of resource use in patient care while ensuring patient safety and quality of care
  • Monitoring, tracking, measuring, and reporting on quality, cost, and access goal achievement
  • Hospital-medical staff collaborations to better manage resources

There also seems to be a general recognition among lawmakers that cost shifting is a reality for hospitals-that is, commercially insured patients make up for the shortfall from uninsured patients and from Medicaid and Medicare payments that are below full cost. These factors have taken on a high level of interest in states pursuing comprehensive healthcare reform. 

The exhibit above illustrates a not-for-profit teaching hospital's pricing and cost-shifting predicament relative to total organizational financial performance.

Preparing Your Hospital for State Reform Initiatives: What's Ahead?

Many states are increasingly exploring universal coverage and the possibilities for integrating that with Medicaid reform initiatives. The potential for synergistic and transformational change from the perspective of public policy and public good is hard for state lawmakers and regulators to ignore.

This portends necessary changes in the ways that hospitals modify associated systems, approaches, and financial strategies. In our view, hospitals should include the following assumptions in their internal strategic financial planning and modeling processes: 

  • Pay-for-performance methodologies increasingly will be used for hospitals and integrated hospital-physician scenarios.
  • Universal coverage program payments will be based on the state's current Medicaid fee-for-service payment system, and enrollees will have multiple copayments and deductibles.
  • In states pursuing integrated Medicaid and universal coverage reforms, these states will modify their existing base Medicaid payment system to some degree to get closer to covering the full costs.
  • Bad debt/charity care payment may be further reduced or eliminated in states with universal coverage initiatives.
  • GME/IME payment will be reduced or reallocated into a modified payment methodology.
  • Disproportionate share funding will be modified and reallocated. Whether or not a hospital is considered "essential" to a community will be a key factor.
  • The favored financing/care delivery model under Medicaid reform initiatives is the managed care plan model (primarily health maintenance organizations). We expect states to pursue both "general mandated" managed care health plan enrollment and "competitive bid" mandatory managed care enrollment processes. Under both scenarios, eligible individuals will b2e required to enroll in geographically applicable, participating managed care plans; any eligible individuals not selecting a specific managed care plan will be auto-enrolled in one of the participating managed care plans. The difference between the two approaches is one of "targeted savings" (general) and "guaranteed savings" (competitive). Both approaches represent potentially unfavorable reimbursements for providers, with the "competitive bid" approach representing the larger threat.
  • Changing eligibility, increased technology integration, and outsourcing arrangements by the state may lead to increased hospital administrative costs.
  • Understanding the potential value that IT solutions can offer, states will likely expect their health plan partners and participating provider organizations to have compatible information management capabilities and be better able to demonstrate to the state their quality improvements and cost-effective care delivery.

Multiple financial modeling and decision support tools, which also link clinical and financial data into an effective information management process for making business decisions, will be needed to address hospital strategy, capital allocation, revenue cycle management, operations improvement, and quality improvement.

Responding to the Challenges of Reform

Medicaid reforms are essential if governors and state legislators are to effectively manage the program and maintain some level of fiscal health-and hospitals most likely will be dramatically affected by these reforms. Every hospital owes its board, physicians, employees, and community a clear strategy and well-designed plan to respond to these challenges. To that end, it is prudent for hospital managers to be vigilant, proactive, and prepared.

One action you should consider taking is to maintain ongoing awareness of your state's healthcare and Medicaid reform initiatives. Another is to evaluate each reform initiative in terms of how it will affect your organization financially, operationally, competitively, and clinically, and incorporate that information into your organization's strategic financial planning processes. Be prepared to address and respond to the following as part of your planning process: 

  • Price transparency will increase in importance.
  • End-to-end revenue cycle changes may be necessary.
  • A defined and executable managed care contracting strategy will be key. With state reforms coupled with efforts by the federal government to increase enrollments in Medicare Advantage plans, it is conceivable that a large number of hospitals will find in two or three years that 70 percent or more of their patient volume will come from negotiated payment agreements.
  • Hospitals that do not have integrated clinical and financial applications with sustainable, realigned operational processes will find themselves at a competitive disadvantage in the coming business environment.
  • A comprehensive, coordinated case management and length-of-stay management program will be essential.

You should also consider conducting a state healthcare reform rapid readiness assessment to determine your organization's ability to adapt to and assimilate your operations and patient care processes into a specific healthcare reform model. And last, you should consider engaging your physicians, board, and community leaders in understanding Medicaid, and preparing them for the hospital's response to possible changes.

Paul Keckley, PhD, is executive director, Deloitte Center for Health Solutions, Washington, D.C. (

Christopher Kalkhof, FACHE, is director, health care and government practice, Deloitte Consulting LLP, Cleveland (

Publication Date: Saturday, December 01, 2007

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