1. McKinsey on Health Care
An in-depth look at the challenges facing senior managers Published by The McKinseyQuarterly January 2005
Intensive care for Medicaid
For even the most timid politicians, inaction willsoon be more dangerous than action.
Article at a glance: Medicaid presents one of the most difficuit budget chalienges facing the United States today.
A new analysis by McKinsey suggests that the costs of the program are becoming unsustainabie: even after economic
growth returns to a steady pace, Medicaid wiiiconsume more than 75 percent of new state revenue inten states by 2009.
As the risks of inaction start to exceed the risks of action, state and federai ieaders must create a new consensus for
reform to put the program on a more stabie footing.
The take-away: Medicaid's current state provides ample opportunity for savings, but capturing them will call for
careful analysis, difficult decisions, and creative political leadership.
2. Intensive care for Medicaid
LennyT. Mendonca, Vivian E. Riefbergr
and Craig R Tanio
Every US policy maker knows that Medicaid
presents vexing budget challenges, but a new analysis
suggests that its costs are becoming truly unsustainable.
McKinsey estimates that even after economic growth
returns to a steady pace, this government health insurance
program, which primarily serves the poor, will consume
more than 75 percent of all new state revenues in 10
states, including Georgia, Indiana, and Oregon, by 2009.
Medicaid will cost 11 other states, including Florida, New
York, and Pennsylvania, from half to 75 percent of their
incremental revenues (Exhibit 1). In an additional 22 states,
this one program will consume 25 to 50 cents of each new
tax dollar.''
EXHIBIT I
Shades of trouble
These results are obviously troubling for state leaders who
have initiatives in education, public safety, transportation,
and other critical areas high on their agendas, as well
as for federal officials already grappling with record
budget deficits. Yet they also present an opportunity. We
believe that Medicaid's challenges have reached a critical
point: the untenable nature of the status quo can be
communicated compellingiy to stakeholders, the press,
and the public. As the risks of inaction—or of muddling
through at the margins—come to be greater than those
of action, creative leaders can communicate the facts in
ways that open up paths toward a new consensus on the
program's future.
Few governors or senators come into office with a deep
desire to fix Medicaid, yet like all political leaders they
%ofstates incremental revenue consumed byMedicaid, 2009 forecast
Montana
NorthOakota
South OakolB
Wyomino
Nrada
Nebiasks
CiHfbn«a Cwrado
Ottahom
T-Vi'V Ariwa
KewMuaco
WteorBMi^ ^
Mrtiiaalfp
Alahaina
VermDnt J
South
CareHni'r
NewKampshita
—Massschuseiij
^.'^Rhotle ISsnd
Confiecticirt
1 PSyiljftaSd ; -^NewJereey
Ddavaie
— Matyiatid
% of state's Number of
revenue consumed states
by Medicaid
25-49
Source:Bureau of lEconomic Analysis(USDepartment of Commerce);Centers for Medicareand Medicaid Services(CMS);
National Association of StareBudgetOfficers (NASBO); USCensusBureau; USCongressional BudgetOffice; McKinsey analysis
^For tfie growth ofstate revenues, weassume a 4.5percent compound annual growth rate, a figure based onestimates from the US Census
Bureau and the National Association of State Budget Officers.
3. Intensive care for Medicad
must take the world as they find it. To stabilize spending,
make room for other investments, keep taxes at levels
consistent with a good business climate, and preserve a
commitment to the neediest US citizens, every governor
is destined to be a "Medicaid reform governor" in the
years ahead. Many federal officials also will need to
engage with these efforts.
EXHIBIT 2.
A big sJice
US healthcare expenditures, 2004
100%=S1.488billion
Out-of-pocket
spending by
individuals
($243billion)
16%
44%
Commercial
health insurance
($556billion)
Medicare
($284 billion)
19%
21%
Medicaid
(S305 billion)
Source: Centen for Medicare and Medicaid Services(CMS);US
Census Bureau
The way forward starts with two steps. First, leaders
must effectively marshal the facts to make the case
for change; then they must develop and assess reform
options that could make the program viable while
honoring Its traditional values. In an effort to contribute to
the thinking of public officials on the future of Medicaid,
in this article we will analyze its unsustainable spending
trajectory, discuss opportunities for savings, and sketch
some of the options for reform.
The program that ate the budget
Medicaid is now the health insurer for 15 percent of the
US population. Thanks to recent coverage expansions,
it has become the country's largest health insurance
program, surpassing Medicare, a program mostly for
retirees, in 2002 (Exhibit 2).
The taxpayers spent $305 billion on Medicaid in 2004, up
from $74 billion in 1990. Enrollment rose to 41 million,
from 23 million, over the same period. One striking
measure of Medicaid's reach and of outsized US per
capita health care spending is the fact that the United
States spends more on Medicaid for 40 million poor
people than the government of Britain spends on health
care for its entire population of 60 million. And there's no
end in sight: spending is expected to grow by roughly 7
to 9 percent annually over the next five years (Exhibit3).^
A recent report from the nation's governors and state
budget officers noted that in 2004, spending on Medicaid
would, for the first time, exceed state expenditures
for elementary and secondary education. Medicaid
represents 21 percent of state budgets, on average, up
from just 13 percent a decade ago. if current trends don't
change, the program's cost will rise to a stunning
26 percent of state spending by 2009—and to as much
as 46 percent of it in some states. The "crowding out"
effect on other priorities will be severe.
Capturing savings opportunities
if these trends suggest that something has to give,
the natural questions are what and how much? The short
answer is that opportunities for savings in health care are
large but capturing them can get complicated. This truth
holds not only for Medicaid but also for other government
health care programs and for private health care.
Consider the opportunities from a systemwide
perspective. The US health care network today is radically
inefficient. To begin with, the country spends 15 percent
of its GDP on health care while many other advanced
nations spend 9 to 10 percent. Those nations insure all
of their citizens, while the United States has more than
40 million people without coverage. Despite a far greater
investment, moreover, the United States doesn't report
better public-health outcomes than other advanced
nations do.
Within the US health care system, huge variations in
practice patterns and medical spending bear no relation
to quality. Medicare, for example, spends two and a
half times more per senior citizen in Miami than in
Minneapolis; health plans report that prices for identical
procedures often vary by as mucih as 500 percent in
^Centers for Medicare and Medicaid Services. National Health Expenditure Projections, 2004 (w/ww.cms.gov).
4. Intensive care for Medicaid
EXHIBIT 3
Budget buster
Medicaidcost projections(2003-09), Sbillion
500
400 -
300 -
200 -
100 113 130 144 159 175
4 Medicaid overall
Other costs
• Professional
• Inpatient
• Outpatient
Phairnaceuticals'
Long-lenn care
Institutional sen/ices
Home healtfi care
Community-based
services
2009
189 Costs associated with disabled
populations billion^
'May not caprurephaimaceucical spendingembeddedin other costcategories (eg,paymentsto managed-care o^anizations).
^Rate of growth in costs for disabled population is related to cost trends for pharmaceuticals and long-term care, sbce disabled
peoplearc heavyusersof theseservices (eg,in aoo2, -45% of cost for disabledpopulationwas for long-term care).
Source: USCongressional Budget Office2004 baselineprojection; USNational Health Expenditure Projections(2003-13),
Centers for Medicare and Medicaid Services(CMS);McKinseyanalysis
(different hospitals, depending on the market. These
variations are not explainable by differences in the health
status of patients or by regional differences in input costs.
Instead, they suggest that a huge amount of unnecessary
or ineffective care is being offered and that, in many local
markets, some providers enjoy unusual market power,
and thus pricing leverage.
Jack Wennberg of Dartmouth and other experts in this
area estimate that up to 30 percent of today's care
could be eliminated if the system evolved toward best-
practice, evidence-based treatment.^ Dr. David Brailer,
the national coordinator for health information technology
at the US Department of Health and Human Services,
estimates that widespread modernization of the archaic
ITinfrastructure of health care could eventually reduce
its cost by 10 percent through administrative and clinical
savings. In a $1.7 trillion health care economy, such
opportunities add up to real money—and a large portion
of it flows through Medicaid.
Why are savings so hard to capture? One big difficulty is
political: every dollar of health care waste is somebody's
dollar of income. Beyond this, the health care system and
Medicaid itself pose structural challenges:
• Insufficient data on outcomes. Policy makers have little
choice but to focus on spending because they lack
good data on outcomes. States and other payers have
no way of knowing if they get more value for the
extra cash they devote to health care. Certainly, some
new expenditures on technology—to treat depression,
cataracts, and heart attacks, for example—have
generated benefits that far outweigh their cost. But
reimbursement methods don't hold providers
accountable for improving quality and performance.
• Rigid benefit rules that bar cost-effective tailoring.
Federal benefit and enrollment rules make it hard for
states to offer more cost-effective solutions to
different populations, in some states, for example.
^Elliott S.Fisher, Daniel J. Gottlieb, RL. Lucas, Etoile L. Finder,Therese A. Stuckel, andDavid E.Wennberg, "The implications ofregional
variations in Medicare spending. Part 1:The content, quality, and accessibility of care," Annals of Internal Medic/Ae, Volume 138, Number 4
(February 2003), pp. 273-87
5. Intensive care for Medicaid
the core set of federally mandated Medicaid benefits
accounts for only 30 percent of the program's overall
cost (Exhibit 4). States may add services, such as
long-term care and coverage for prescription drugs,
and federal regulations generally require that other
covered groups receive the same benefits, even when
they may not be necessary, (The benefits required
for optimal service to the blind and disabled, for
instance, are more elaborate than those needed by
the broader population of low-Income uninsured
people.) Also, when all beneficiaries must receive
comparable benefits, coverage for low-income workers
who qualify for Medicaid can be substantial enough
to induce employers to stop providing private health
insurance for their employees,
' Lack of consumer involvement. Because states are
sensitive to the burdens of their poorer citizens, they
have exempted Medicaid recipients from playing
any role in constraining costs. Co-payments for visits
to physicians, for instance, are nominal—$1 and
$3 for an appointment with a primary-care physician
and a specialist, respectively—and haven't been
adjusted for inflation in 20 years.
Shrinking access to providers. In most states
Medicaid already pays less than other payers do—
sometimes less than the actual cost of providing
care. At the same time, the program has expanded
to cover a greater percentage of the population,
so doctors, hospitals, and other providers have found
it more difficult to recoup some of these lost revenues
by charging more to patients covered by other
programs. A growing number of providers therefore
refuse to take Medicaid patients.
•Federal rules that reward big spenders. Perverse
incentives or unintended consequences often flow
from the rules of the federal government, Medicaid
regulations call for it to match state spending on
the program, thus giving more support to poorer
states. Yet because state coverage decisions ulti
mately drive the size of this match, federal formulas
direct more absolute aid to higher-spending states,
leaving large intrastate gaps. In 2001, for instance.
New Yorkspent $11,060 per recipient and received
$5,520 (or 50 percent of the total); Mississippi spent
$4,400 per recipient and received $3,380 (77 percent
of the total).
EXHIBIT 4
A broad range of populations and services
Mandatory'
.:';^rte.ct«lben^iaries
• Children under age 6 withfamily income s133%of
federally defined poverty level |FPL) oraged6-9 with
family income <100% of FPL
>Needy families thatqualify fortemporary assistance
' Pregnantwomen with income s133% of FPL
' Low-income aged, blind, ordisabledpersons
Optional'
' Medically needy (ie, people whose
medical costsseverelyaffectability
to liveon income)
' Children underage 1 withfamily
income 134-185% of FPL
' Pregnantwomenwithincome equal
to134-185% of FPL
Inpatient. outpatient treatments
Professional services(eg,frfiysician. nursepractitioner,
lab,X-ray)
Prenatal care
Early periodic screening, diagnosis, treatmentfor
children underage 21
Nursing facility/home healthcare
•Prescription drugs
' Some behavioral-health treatments (eg, substance-abuse
rehabilitation)
' Durable medical equipment (eg.wheelchairs), supplies
(eg,insulin-dispensing products fordiabetics)
• Physical-rehabilitation therapy
• Flospicecare
'Mandatory: USfederallaw requires staresto offersomeMedicaid benefits to certain populations; optional:states mayoffer
additional Medicaid benefitsto selectedother populations without waiver,Medicaid programs vary from state to state.
Source: Centers for Medicare and Medicaid Services(CMS); interviews;Henry J. Kaiser FamilyFoundation's Kaiser Commission
on Medicaid and the Uninsured
6. Intensive care for Medicaid
Reforming an entrenched program like Medicaid is
politically risky, so early efforts have been modest.
With a few exceptions, the first instinct has been to
muddle through in the traditional way, by slowing the
pace of enrollment and reducing payments to providers.
However, policy makers will quickly learn that the usual
steps can't return Medicaid to a sustainable path.
Toward sustainable reform
Given the complexity of any effort to address the real
drivers of medical costs and the structural problems of
Medicaid, policy makers will likely need a combination
of potential solutions and reform themes. These ideas
fit within two broad categories: reforms that fiscally
strapped states can begin to implement now, largely
on their own, and longer-term changes requiring federal
leadership or more extensive federal-state collaboration.
Getting started now
Five areas offer serious opportunities for near-term
improvement. These proposed reforms may not fully
cure Medicaid, but they can deliver major savings and
Improve the quality of care while the dialogue about
longer-term reform begins.
Maximizing value from pharmaceuticals. No single
reform prescription can control the growth of spending
on pharmaceuticals, but real opportunities to get more
quality for less money do exist. Clinical guidelines and
carefully designed lists of preferentially covered drugs
(formularies), for example, can encourage doctors and
patients to select the lowest-cost drug that is safe and
effective. Other techniques, such as reviewing specific
clinical decisions (preauthorization), are available, too. The
increased use of generic drugs can often reduce costs
within therapeutic categories by 30 to 40 percent. Policy
makers should emphasize three metrics: total drug costs
(rather than maximum drug rebates), total health care
costs, and clinical outcomes.
Measuring outcomes is important because drugs are
both overused and underused. To target overuse, state
Medicaid agencies should conduct prospective and
retrospective utilization-review programs. Behavioral
drugs, such as antidepressants and antipsychotics, would
be a good place to start, since their cost is exploding
and cases in which they were prescribed inappropriately
have been widely reported. Underuse is an issue when
taking medicine today could prevent more costly problems
tomorrow. Raising the proportion of Medicaid enrollees
who take medication to treat high blood pressure, for
example, would probably deliver excellent health returns
for relatively modest investments in education and
outreach.
Innovating in care for the disabled. Many Medicaid
beneficiaries suffer from a number of medical conditions,
and an integrated approach could improve outcomes
and manage costs. What's more, our analysis in
Tennessee suggests that this population's turnover rate
is quite low. In that analysis, more than 40 percent of all
Medicaid beneficiaries, unlike people with commercial
insurance, remained in the high-cost group from year
to year (Exhibit 5). Cost and quality improvements from
disease-management programs are therefore likelyto be
significant and enduring.
Recognizing that truth, Medicaid agencies and managed-
care companies are beginning to replace stand-alone
efforts for each medical condition with more specialized
and integrated case- and disease-management programs
targeted at this population. Promising innovations
include collecting better information about enrollees,
using improved predictive-modeling techniques, training
Medicaid staff members in the social and cultural issues
of serving a diverse group of consumers, and developing
a more integrated approach to coordinating care for this
challenging population.
Moreover, the cost of hospitalizing disabled beneficiaries
who are also institutionalized in long-term-care facilities
could be reduced. Medicare currently pays for these
patients' hospital costs, while Medicaid covers long-
term care. This division of expenses creates a perverse
incentive encouraging unnecessarily long hospital stays.
Better care-management practices—such as the use of
hospitalists (specialists who primarily serve inpatients in
hospitals)—should reduce their length and raise the level
of expertise, thereby generating substantial savings.^
Developing standards for providers. States are large
purchasers of health care and also regulate commercial
*To realize these savings, states vi/ould have to negotiate a waiver with the Centers forMedicaid andMedicare Services.
7. Intensive care for Medicaid
EXHIBIT 5
Year after year
Distribution ofMedicaid's high-spending users, FY 2001-03'
Ofhigh-spending
usersin1^2003...
10Q%= 28,400 in 2003
... 42%were high-
spending users in
FY2002...
...and 20% of those
were also high-spending
users in FY2001
42%
retention rate
42%
48%
retention rate
20%
10%s typical retention
rate for high-spending
users of commercial
health insurance
100%
22%
7%
XTO 5,^
FY20Q3 FY2D02 FY2001
High-spending users Low-spending users
'State of TennesseeMedicaid example; high-spendinggroup in FY looj definedas all enrolleeswho generated >$io,ooo in claims
related to inpatienc,outpatient, professional, and pharmaceutical servicesfrom managed-careorganizations.
Source:TennCare Management Information System(State of Tennessee);McKinseyanalysis
insurance to a significant degree, so they have a unique
position to craft standards for provider practices and
patient care. These standards should include meaningful
measurements of outcomes, pay for performance,
and evidence-based medical guidelines that reduce
variations in care and the associated costs. The creation
of these standards offers opportunities for public-private
collaboration. In California, for instance, six commercial
health plans—covering eight million people treated by
30,000 physicians—started working together in 2002
to develop standard metrics for outcomes. The metrics
cover immunization, screening for cancer, the monitoring
of diabetes, asthma medication rates, patient satisfaction,
the use of technology, and more, if California's Medicaid
program joined such commercial efforts, it could
accelerate the adoption and increase the impact of these
standards.
in particular, states should take the lead in establishing
evidence-based practice guidelines—an area in which
a great deal of underlying work has been completed.
Professional societies, managed-care organizations, and
academic medical centers have already developed a wide
set of guidelines for most conditions and symptoms.
What has been missing is a commitment by public and
commercial health care purchasers to endorse a specific
standard of care, hold providers to it, and show the
public how well the system is performing.
Creating tiered benefits. Medicaid serves several
populations with special needs, including pregnant
women, children, and disabled adults, as well as
additional "optional" populations that states can choose
to add. A tiered benefit structure would help states
match coverage to the needs of each group while
also saving money; an example might be higher
co-payments and less extensive benefits for the optional
population and lower co-payments and richer benefits
for the disabled one. Likewise, changing the levels of
co-payments for drugs (along the lines of the
three- or four-tiered co-payment programs of commercial
insurance) could provide greater coverage at the
same cost.
While critics may argue that ail Medicaid patients
deserve the same coverage, policy makers could explain
that the suggested changes are part of a necessary
effort to preserve benefits for the broader low-income
8. Intensive care for Medicaid
population over the long term. A move toward tiering
requires federal support: the federal Centers for Medicaid
and Medicare Services (CMS), which help administer
Medicaid and Medicare, would have to give states more
flexibility in developing their programs. Governors, in a
spirit similar to that of their participation in welfare reform
during the late 1980s and early 1990s, may present CMS
with a united front promoting new solutions.
Creating fixed budgets. Medicaid budgets are now open-
ended, so cost savings might come from some form
of cap. Block grants are one way to provide it. Another
method, which could work under the current federal
matching system, would be for states to create their
own internally set budget targets. A state might, for
example, enact a budget trigger that forced action when
Medicaid (or total health care expenditures) reached a
certain percentage of overall spending. Exceeding this
budget threshold could prompt a study by an advisory
commission that would recommend adjustments to
benefits, eligibility, and coverage—as happens routinely
in private-sector companies when they exceed cost
targets for their employees. Such devices have been
discussed at the federal level to control long-term
spending on entitlements, and one version was adopted
in the 2003 Medicare legislation.
While a fixed budget isn't a solution in itself, it forces
policy makers to confront critical trade-offs. These are
essentially a matter of political values: how should
the desire to cover the broadest number of people be
weighed against the level (and thus the cost) of benefits
for each insured person? Such wide-versus-deep choices
are always made Implicitly; one virtue of fixed budgets is
a more explicit consideration of the trade-offs.
Longer-term reforms
Other reforms involve a fundamental rethinking of the
system, greater federal-state collaboration, and more
active federal leadership. These approaches are better
seen as part of the longer-term debate. Policy makers
may want to address the following questions:
Should Medicaid alter its eligibility criteria' Like many
government programs. Medicaid has extended coverage
to different groups at various times, more for political
'EBRI Health Benefits Databook, 1998.
reasons than from any grand or consistent design. As
a result, more than 8 million people who have incomes
upward of 150 percent of the federal poverty level are
now covered, while roughly 18 million poor working
people (especially unmarried adults and childless
couples) who have incomes less than 150 percent of
the federal poverty levelare not.^Some analysts say it is
time to change the rules so that coverage Is more closely
tied to financial need.
Should Medicaid promote consumei-directed health
decisions? Medicaid has traditionally been paternalistic.
But in some contexts, giving patients choice and even
requiring them to share costs to a modest extent may
be appropriate ways to enhance the quality of health
care and to cut spending on it. States could, for example,
increase funding for programs that give consumers
information about the opportunities for home-based
alternatives to long-term care. In addition, consumer-
directed health savings accounts, though now in their
infancy, may be relevant for some Medicaid patients if
they are designed carefully.
Should governrnems c.'^eaie Medicaid vouchers? States
or the federal government might give Medicaid recipients
vouchers they would use to purchase insurance on
an appropriately regulated private insurance market.
A variant of this approach has been used in the
40-year-old Federal Employees Health Benefits Program,
which covers nine million federal workers and retirees.
Consumers would purchase insurance—such as fee-for-
service or managed-care plans, as well as health savings
accounts—from a variety of state-approved companies,
and since consumers would own the policies, they could
be fully portable.
While such reforms are often associated with the
Republicans, former senator Bill Bradley, a Democrat,
offered a similar framework during his 2000 presidential
campaign. In addition, the health economist Victor
Fuchs is working on a proposal for universal health care
vouchers to make the system more fair and efficient.
The road to reform
Our work helping leaders address such challenges
suggests how vital it is to begin by making the case for
