Modernizing Medi-Cal Rate-Setting to Improve Health and Manage Costs

Health Highlights

Editor’s Note: A new report prepared for the California Health Care Foundation reviews California’s Medicaid rate-setting process and offers recommendations for adjusting that process to encourage health plan investments in benefits and services that improve care and lower costs. The report, summarized below, is based on output from a work group comprised of leaders from several Medi-Cal managed care organizations (MCOs), with the Medi-Cal director serving as an advisor. Click here to download a free copy of the full report.


The Medi-Cal program plays a critical role in California, providing health coverage for a third of all residents, including those with complex healthcare needs and significant economic and social challenges. With 81% of Medi-Cal beneficiaries enrolled in managed care, Medi-Cal MCOs are central to achieving the program’s objective—supporting innovative models of care that have the potential both to improve member health outcomes and reduce cost trends over the long term.

Several plans already are investing in innovative models that go beyond the required benefits, such as enhancing case management; providing housing supports to older, disabled members; and integrating physical and behavioral health. These plans have been hampered in their efforts to bring such initiatives to scale and maintain them over time, however, by disincentives built into the Medi-Cal MCO rate structure.

An unintended consequence of the current rate-setting methodology is that plans are negatively impacted when they invest in initiatives that lower costs. This can occur when an MCO invests in services to enhance care—such as improved care coordination or housing supports—that result in a decrease in inpatient hospital use, emergency department use or other high-cost utilization. In these cases, the cost basis for the plan’s future rate declines, and the plan receives a lower rate than it would have without the intervention.

The state recognized the dilemma in its 1115 waiver renewal and proposed a program where plans could receive some of the savings generated through improvements in care. (This initiative was ultimately not part of the approved waiver, although a waiver is not necessary to implement such a program.)

To seek possible solutions to the unintended consequences of rate-setting methods, the California Health Care Foundation, with support from Manatt and Optumas, convened a work group to explore options for addressing this issue and encouraging joint state and plan investments in innovative health-related initiatives. The work group was required to stay within current Medi-Cal funding constraints—designing approaches that would not require any net investments by the state. Additional state investments, however, to improve Medi-Cal access and quality would augment the impact of the group’s recommendations.

Recommended Approach for Moving Forward

Implementing a rate adjustment. While the group considered a variety of options, the primary component of the recommended approach is to devise a rate adjustment that encourages plans to consistently invest significant dollars in care improvements and health-related services that generate savings. The approach updates the rate-setting process so that it supports the state’s desire to improve healthcare outcomes while reducing healthcare spending. A plan-specific rate adjustment would be triggered if a plan meets three criteria:

1. It generates savings above a certain threshold. The size of the adjustment depends on how much savings are generated (i.e., the return on investment for health-related initiatives), as well as certain design decisions—or state policy levers—relating to the overall approach, including:

  • The shared savings split. The state and a qualified plan would share the savings, and, as such, the size of the adjustment would depend on both the level of savings and how the savings are split between the state and plans (e.g., on a 50/50 basis).
  • The minimum-savings rate. The rate adjustment is triggered if a plan achieves savings above a minimum level. The level selected will influence whether a plan qualifies for an adjustment.
  • The threshold for the health-related investment. The adjustment is only made if a plan invests in approved initiatives. The state would need to set the level of investment that would qualify and establish the types of investments that would be recognized.

2. It meets specified quality targets. To receive the rate adjustment, a plan must not only bend the cost curve but also attain quality metrics. The quality criterion helps ensure that the recommended approach actively advances the state’s quality objectives, and cost savings do not come at the expense of quality and access. The work group recommended developing a balanced scorecard that includes social determinants of health metrics and indicators of data reporting quality and completeness, in addition to more traditional quality measures, such as the Healthcare Effectiveness Data and Information Set (HEDIS).

3. It makes an investment in approved health-related initiatives at a level set by the state. Plans must make health-related investments as a condition of qualifying for the rate adjustment. Like the quality component, the investment criterion is aimed at ensuring the approach achieves health improvements as well as savings. Investments may be targeted to help address social and economic conditions that affect health, improve or maintain member health, and/or support delivery system reform efforts. The state in consultation with the plans will need to set the level of investment required and identify the types of investments that would qualify. The state and the plans then would need a way to account for the plans’ level of investment, while minimizing the administrative burden. While plans would not be required to show causation between savings and investments, they would need to evaluate the impact of their investments and refine their strategies over time.

Enhancing financing for health-related investments. The work group also recommended a complementary strategy that would support and enhance the investments that plans would make under the rate-adjustment approach. Specifically, plans expressed a strong interest in both clarifying what types of investments can count within the current plan expense base and exploring additional avenues for financing those investments. The state has a variety of ways to recognize some of the investments that plans would be making when it calculates the MCO rates. Certain investments may be counted in the medical load when setting rates. Other investments may be deemed quality improvement activities and can be counted in the nonmedical load when setting capitation rates. Investments that do not qualify for inclusion in the medical or nonmedical loads can be paid for through other plan resources.

Establishing a social determinants of health risk adjustment. The work group recommended an additional complementary strategy to explore adding a social determinants of health risk adjustment to the Medi-Cal rate-setting methodology. California’s current risk-adjustment model is driven by medical diagnoses. A risk adjustment that reflects members’ socioeconomic status could help identify subpopulations that would benefit from targeted interventions. In addition, layering social determinants into the risk-adjustment methodology could enhance the equity of resource distribution across plans to ensure that resources are being directed to the plans serving the most vulnerable populations.

Key Takeaways

The work group’s analyses yielded the following key takeaways:

  • Relative to the status quo, the rate-adjustment approach would better align plans’ incentives with state goals. The approach is aimed at improving health and health outcomes while reducing costs. The modeling shows the approach can generate savings for the state and avoid the disincentives in the current rate-setting methodology that discourage plans from making ongoing, substantial cost-effective investments.
  • The design can be dynamic to encourage continued investments and balance risks and benefits for states and plans. How policy levers are set plays a critical role in ensuring impact for all stakeholders. If all of the savings accrue to the state—as they do currently—plans would not invest as aggressively or in a sustained manner, and state savings would not materialize. If the plans reap all the savings, the state has no reason to revise its rate-setting methodology. Further, the levers could be adjusted over time to ensure that ongoing investments and cost savings are sustainable.
  • Downside risks for all parties are limited. If the investments fail to generate meaningful savings, the state may have incurred some expenses (by recognizing some of the investment in the medical and nonmedical loads of plan rates), as will have the plans. Other than those early investment losses, however, not much would change if the approach does not generate meaningful savings, because behaviors would regress to being very similar to the status quo. The state could mitigate its exposure by requiring plans to bear more, or even the entirety, of their investments, perhaps until the efficacy of the intervention becomes apparent.
  • Beneficiaries would see improvements in care. While the state and plans both benefit through better alignment of Medi-Cal’s rate-setting methodology with quality and cost goals, beneficiaries potentially stand to gain the most from the recommended approach. The investments in health-related initiatives are aimed at making the care delivery system more responsive to beneficiary needs, more preventive and outpatient-oriented, and more attuned to the whole person’s situation—not simply their medical ailments.


While states are facing increased economic and federal government pressure to slow the growth of Medicaid spending, there is broad agreement that cost containment should not come at the expense of quality, access and innovation. California has the opportunity to be on the leading edge of advancing models of care and interventions with the potential to improve member health and reduce costs.

With few downside risks, the work group-recommended approach could be expected to generate savings while promoting plan investments to address the complex and interrelated medical and socioeconomic needs of Medi-Cal beneficiaries. The recommended approach also could help the state evolve and continue successful 1115 waiver pilot initiatives after the waiver ends. Finally, although one of the parameters for this project was that the initiative would not result in any new investment by the state, additional state investment to improve Medi-Cal access and quality could augment the impact of the recommended approach and yield health improvements for members.



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