United States General Accounting Office

GAO Report to the Ranking Minority Member,

Committee on Commerce

House of Representatives

September 1995 MEDICAID

Tennessee’s Program

Broadens Coverage but

Faces Uncertain

Future

GAO/HEHS-95-186

GAO United States

General Accounting Office

Washington, D.C. 20548

Health, Education, and

Human Services Division

B-258562 

September 1, 1995

The Honorable John Dingell

Ranking Minority Member

Committee on Commerce

House of Representatives

Dear Mr. Dingell:

In early 1993, Tennessee projected that increases in state Medicaid

expenditures and the loss of certain tax revenues used to help finance

Medicaid costs would cause a financial crisis. Meanwhile, state officials

believed that a portion of the medical costs for as many as three-quarters

of a million uninsured persons were being shifted to the Medicaid program

and other payers. To avert a financial crisis, control its Medicaid

expenditures, and extend health insurance coverage to most state

residents, Tennessee got federal permission to replace its fee-for-service

Medicaid program with a capitated managed care program called

TennCare.

Since then, Tennessee’s Medicaid waiver program has generated both

praise and criticism. TennCare has provided coverage to most of the

uninsured persons in the state, while reducing Medicaid cost increases.

However, concerns have been raised about TennCare’s rapid approval and

implementation, lack of provider buy-in to the program, and delays in

implementing systems for monitoring TennCare’s access and quality of

care. In addition, the soundness of the methodology for determining and

the resulting adequacy of the program’s capitation rates have been

questioned.

In response to your concerns about the controversy over TennCare, we

examined the available information on (1) TennCare’s basic design and

objectives, (2) the degree to which the program is meeting these

objectives, and (3) the experiences of TennCare insurers and medical

providers and their implications for TennCare’s future.

Results in Brief In seeking its 5-year waiver approval from the Department of Health and

Human Services (HHS), Tennessee had several objectives. Two of these

were to expand health care coverage to the state’s uninsured and to

control total program and state costs. Specifically, Tennessee requested

permission to mandate Medicaid enrollment in managed care and to cover

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certain uninsured previously not determined eligible for Medicaid. In

granting the waiver, HHS required that Tennessee implement measures to

monitor and ensure access to quality care. In addition, HHS and Tennessee

agreed that federal payments for the 5 years would be no more than

$12.165 billion to ensure that federal costs not exceed what they would

have been without the waiver.

In less than 2 months after receiving approval, Tennessee had contracted

with 12 managed care organizations (MCO) to place its entire Medicaid

population in its new capitated managed health care program, TennCare,

and to open enrollment to uninsured persons in the state. By the end of the

first year, Tennessee had enrolled approximately 800,000 Medicaid-eligible

persons and over 400,000 uninsured persons who were not determined to

be eligible for Medicaid in TennCare, with two of the MCOs accounting for

nearly three-quarters of the over 1.2 million enrollees.

Despite this increase in the number of persons covered, federal and state

reported expenditures for Tennessee’s Medicaid program increased less

than 1 percent in state fiscal year 1994, much below the national average.

Excluding long-term care and administrative costs, which are not

capitated, program costs actually declined. These reductions were realized

largely from capitation rates paid to MCOs that were substantially below

prior Medicaid per beneficiary costs. The rate-setting methodology

understated historical Medicaid costs by approximately 25 percent, and,

further, the state applied an additional discount of 22 percent on the

assumption that more extensive insurance coverage would reduce charity

care costs. Meanwhile, the state effectively reduced its share of Medicaid

costs by claiming losses incurred by hospitals in caring for TennCare

eligibles as federally reimbursable expenses without reimbursing the

hospitals. In addition, the state recouped some federal dollars paid to MCOs

through a state tax on capitation payments and retained a substantial

share of premiums paid by TennCare enrollees.

Although TennCare essentially met its objectives to provide health care

coverage to many uninsured individuals while controlling costs, concerns

remain about TennCare. Primary among these concerns are enrollee

access to quality care and MCO financial performance. Facts about access

and quality of care are largely unknown due to delays in the MCOs’ and

state’s implementation of adequate monitoring systems. One beneficiary

survey, however, indicates that significant numbers of enrollees are less

than satisfied with the program. Almost half of the beneficiaries surveyed

felt that the care they received under TennCare was worse than under

Page 2 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
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Medicaid because their choice of doctors was limited and finding

providers was difficult. In another survey, almost one-third of the

physicians who were signed up with at least one MCO and said that their

practices were accepting new patients also said that they did not accept

new TennCare patients.

Concerns also have been raised about the MCOs’ financial performance.

Overall, MCOs lost money in 1994, even after receiving substantial

supplementary payments in addition to their usual capitation payments.

The largest MCO, with almost 50 percent of TennCare enrollees, lost almost

$9 million in its first year in TennCare and is projecting a fourfold increase

in losses for its second year primarily because some supplemental

payments were discontinued on January 1, 1995, and utilization is

expected to be higher. And although the second largest MCO reported a

slight gain for 1994, concerns persist that its financial condition may be

worse than reported.

So far, TennCare has met its initial objectives, but its long-range success is

uncertain. Success will depend on the health care community’s willingness

to continue to participate. The largest MCO has stated that without a

10-percent increase in the capitation rate, it will have to reassess its

participation in TennCare. To compensate for past losses and avoid future

losses, some MCOs may act to contain costs that could reduce payments to

providers. Institutional providers, already claiming large losses, face

elimination of substantial state subsidies. Moreover, physicians have

reported widespread dissatisfaction with the program, and a significant

number of them have indicated that, overall, their practices are financially

worse off under TennCare than under Medicaid. Further, many of the

physicians in the largest MCO reportedly felt coerced to participate in

TennCare because the MCO implemented a policy that required its network

physicians to participate in TennCare. If providers decide to reduce their

TennCare participation or leave the program in significant numbers, the

viability of the MCOs and TennCare could be seriously threatened.

Background Medicaid was established in 1965 as a jointly funded federal-state program

providing medical assistance to qualified low-income persons. Each state

designs and administers its own Medicaid program, subject to federal

requirements for eligibility, services covered, and provider payments.

States decide whether to cover optional services and how much to

reimburse providers for a particular service. The federal government pays

a portion of whatever qualifying expenditures a state Medicaid program

Page 3 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
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incurs. At the federal level, the program is administered by the Health Care

Financing Administration (HCFA), an HHS agency.

In recent years, Medicaid costs have escalated. To control these costs,

some states have sought to move some or most of their Medicaid

population into a capitated managed care system. However, certain

provisions of the Medicaid law—such as freedom of choice and the “75-25”

beneficiary requirements1

—inhibit states’ use of managed care. States may

obtain waivers of these provisions from HCFA under the authority of

section 1115 of the Social Security Act.2

 Section 1115 of the act offers HCFA

the authority to waive a broad range of Medicaid requirements for state

demonstration projects.

In granting a waiver, HCFA requires the applying state to demonstrate that

its proposal is budget neutral—that is, that federal expenditures for the

entire demonstration project will not exceed costs projected for the

existing Medicaid program. Until recently, budget neutrality was expected

to be achieved in each year of the demonstration. However, HCFA now

allows increased costs in some years as long as states achieve budget

neutrality for the entire demonstration. HCFA may also require the state to

implement improved quality assurance systems, which may include data

collection on enrollee medical care utilization and an assessment of these

data to determine the adequacy of enrollee access to and quality of

medical care.

As of June 1995, 10 states had HHS-approved statewide waivers, 8 had

applications pending, and 5 had inquired about submitting waiver

applications. In November 1993, 5 months after Tennessee submitted its

1115 waiver application, HHS approved it. On January 1, 1994, Tennessee

became the first state to move its Medicaid program enrollees to a

statewide demonstration project.3

1

The freedom-of-choice requirement allows Medicaid beneficiaries to choose any provider willing to

accept Medicaid reimbursement. The 75-25 requirement specifies that the patient load of health

maintenance organizations (HMO) serving Medicaid beneficiaries be more than 25 percent private

patients.

2

States may also obtain waivers of the freedom-of-choice requirement and establish managed care

programs under section 1915(b) of the Social Security Act. However, significantly more flexibility is

available under section 1115.

3

Arizona has operated its Medicaid program under a statewide 1115 waiver since 1982; however, it did

not have a Medicaid program before the waiver.

Page 4 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
B-258562 

Scope and

Methodology

To meet our reporting objectives, we interviewed officials and reviewed

documents from the TennCare Bureau4

 and HCFA’s Central Office in

Baltimore and its Regional Office in Atlanta. In addition, we spoke with

Tennessee officials from the Department of Finance and Administration

and the Department of Commerce and Insurance, as well as officials from

the Tennessee Medical Association (TMA), Tennessee Hospital Association,

Tennessee Health Care Campaign, MCOs, federally qualified health centers,

hospitals, physicians, and other advocacy groups. We also reviewed the

results of provider and beneficiary surveys conducted by HCFA, the

University of Tennessee, TMA, and the Tennessee Association of Legal

Services and other available literature and studies. We also obtained

financial data from MCOs and from financial reports filed with the

Tennessee Department of Commerce and Insurance. Much of the MCO

financial data were unaudited, and we did not attempt to verify them. Our

work was performed between April 1994 and May 1995 in accordance with

generally accepted government auditing standards.

TennCare Program

Designed to Expand

Coverage and Contain

Costs

Tennessee’s demonstration project was designed to use a capitated

managed care system to expand coverage to the uninsured population and

to control total program and state costs. TennCare’s ceilings on total

allowable federal funding are intended to be budget neutral—a

requirement for HCFA approval of all demonstration projects. The

state-federal sharing arrangements of the financing plan tend to favor the

state since several waiver provisions allow it to effectively reduce its share

of total spending. In addition, the waiver includes provisions to monitor

and ensure enrollee access to quality care.

TennCare Designed to

Expand Coverage

TennCare was designed to expand health coverage by allowing

non-Medicaid eligible persons to enroll and by extending the period of

coverage for Medicaid-eligible persons. It also increased the scope of

coverage by lifting restrictions on many services and by allowing

additional types of services to all enrollees.

In addition to including all Medicaid eligible persons, TennCare offered

insurance to uninsured and uninsurable persons regardless of income who

were not eligible for Medicaid. To qualify as an uninsured enrollee, a

person must not have had access to health insurance on or after March 1,

4

Until 1995, the TennCare Bureau was part of the Tennessee Department of Health. It is now under the

Department of Finance and Administration.

Page 5 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
B-258562 

1993.5 Therefore, a person must have been uninsured at least 10 months to

qualify for TennCare as an uninsured person on January 1, 1994.6

 To stay

within budget ceilings, the state limited total enrollment to 1.3 million for

the first year and 1.5 million in succeeding years. Tennessee expected

enrollment of uninsured and uninsurables of 300,000 in the first year and

500,000 in succeeding years. The state expected that the 500,000 would

include most of its uninsured.7

Under TennCare, enrollees who are not eligible for Medicaid and have

incomes above the poverty level would be required to pay monthly

premiums based on their income. At the MCO’s option, these enrollees also

may be required to pay a deductible and make copayments for costs that

exceed the deductible as medical costs are incurred.8

 However, TennCare

enrollees cannot be required to make deductible payments or copayments

for preventive care, and copayments depend on the enrollee’s gross

income. TennCare limits the total enrollee out-of-pocket expense.

TennCare also extended the period of health coverage for many persons

qualifying under Medicaid. Under TennCare, over 65 percent of

Medicaid-eligible persons are effectively guaranteed 12 months of

coverage at no cost to themselves because TennCare eligibility

redeterminations are made only once every 12 months.9

 If, after that time,

these enrollees no longer qualify for Medicaid, they can continue in

TennCare, subject to the same requirements as the formerly uninsured. In

addition, TennCare expanded services to include inpatient psychiatric

facility services for persons between 21 and 65 years old and outpatient

substance abuse treatment programs. TennCare also lifted many

restrictions and limitations, such as the allowable number of inpatient

physician services, outpatient visits, home health visits, and prescriptions.

5

According to the TennCare Bureau this date was chosen to avoid employers’ dropping their health

plans in favor of TennCare, which was announced in April 1993.

6

As of October 1994, the TennCare Bureau allowed people to enroll in the program as “uninsured” if

they did not have health insurance available to them on or after July 1, 1994. However, enrollment of

additional uninsureds was severely curtailed as of January 1, 1995.

7

In its application, Tennessee stated that recent studies showed that it had approximately 392,000 to

775,000 uninsured residents.

8

Capitation payments to MCOs for the uninsured are reduced on the assumption that the MCOs will

collect the deductibles and copayments. However, at least two MCOs waived the requirement due to

the difficulty of collecting the deductibles and copayments.

9

As of December 31, 1994, over 500,000 Medicaid-eligible enrollees in particular eligibility categories

had been guaranteed 12 months of TennCare eligibility due to this change.

Page 6 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
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TennCare Introduced

Statewide Prepaid

Managed Care to Medicaid

To implement its prepaid managed care system, the state contracted with

12 MCOs to provide delivery of all Medicaid acute and primary care services

and to handle claims processing in exchange for a monthly payment per

enrollee. In addition to these monthly payments, MCOs having enrollees

with high-cost chronic conditions and higher than average utilization rates

would receive additional payments.10 Subject to the availability of

unallocated TennCare funds,11 MCOs could also receive payments for the

cost of providing the first 30 days of care to uninsured and uninsurable

enrollees and one-time payments for financial difficulties attributed to

TennCare start-up. MCOs are not responsible for long-term care services or

for special services to the severely and persistently mentally ill or to

Children’s Plan12 enrollees.

TennCare contracts with health maintenance organizations (HMO) and

preferred provider organizations (PPO) to operate as MCOs. The state

requires HMOs to be licensed as such. The primary contractual distinctions

between these types of organizations are that (1) administrative fees and

operating profits are restricted for PPOs but not for HMOs and (2) the

TennCare Bureau required on January 1, 1994, that HMOs assign each of

their enrollees to a primary care physician responsible for managing and

coordinating the enrollee’s care; the contract with PPOs allows them until

January 1, 1997, to assign enrollees to primary care physicians.13

Most enrollees have a choice of four MCOs, and enrollees in metropolitan

areas have a choice of as many as seven. Figure 1 shows the geographic

divisions of the state and the number of MCOs participating in each

division.

10On July 17, 1995, HCFA approved a Tennessee proposal to use only the high chronic condition

payment methodology and not the higher than average utilization rates in determining adverse

selection payments to MCOs.

11Tennessee has designated an unallocated fund pool equaling the difference between the capitation

payments required if TennCare reached its total enrollment cap and the actual capitation payments

made.

12The Children’s Plan is a total care program that addresses the needs of children in state custody or at

risk of being in state custody. The state covers special services for this population, such as case

management and therapeutic intervention, and MCOs cover basic medical services. Special services to

severely and persistently mentally ill enrollees include both inpatient and outpatient mental health

services.

13PPOs’ administrative fees cannot exceed 10 percent of their total TennCare revenues. The TennCare

Bureau requires that any savings on overall PPO operations be shared: 5 percent with the PPO,

5 percent with the medical providers, and 90 percent with the TennCare Bureau. The TennCare Bureau

does not share in MCO losses.

Page 7 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
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Figure 1: TennCare’s MCOs by Region

The two largest MCOs, BlueCross BlueShield and Access MedPLUS, operate

statewide and account for 73 percent of enrollees. Table 1 lists each MCO

and shows the type of contract, number of enrollees, and percent of total

enrollees. The table lists MCOs in descending order according to the

percentage of total TennCare enrollees in the MCO.

Page 8 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
B-258562 

Table 1: TennCare Enrollment by MCO

MCO Type Enrollment

Percent of

total

BlueCross BlueShield of Tennessee PPO 602,361 49.87

Access MedPLUS HMO 286,639 23.73

Health Net PPO 75,276 6.23

OmniCare Health Plan PPO 64,006 5.30

Preferred Health Partnership PPO 61,514 5.09

TLC Family Care Healthplan HMO 35,421 2.93

Phoenix HealthCare HMO 34,821 2.88

John Deere HealthCare/Heritage National Health Plan HMO 17,155 1.42

VHP Community Care HMO 12,558 1.04

Prudential Community Care HMO 7,989 0.66

Total Health Plus HMO 6,316 0.52

TennSource PPO 3,834 0.32

Total 1,207,890 100.00

Source: TennCare Bureau,”Statewide Summary Eligibles by MCO,” May 12, 1995.

In addition to making capitated payments to MCOs, TennCare seeks to

encourage managed care in several ways. TennCare requires that by 1997,

all MCOs assign their enrollees to primary care physicians responsible for

managing and coordinating enrollee care. As of February 1995, MCOs had

assigned approximately half of all enrollees to primary care physicians.

TennCare promotes continuity of care by requiring enrollees to stay with

the same MCO for a year, by providing extended enrollment periods to

many Medicaid eligibles, and by allowing persons to continue in TennCare

as “uninsured” if they lose their Medicaid eligibility. TennCare also

encourages preventive care by not allowing deductibles and copayments

for preventive care services.

Supplemental Payments

Assist Participating

Hospitals and Physicians

TennCare provides for incentive payments to physicians and allows

several types of supplemental payments to hospitals based on the

availability of unallocated funds. TennCare’s design provides for two types

of annual incentive payments to participating physicians: one to

physicians that have a greater than average TennCare patient load and

another to physicians whose practices are at least 10 percent TennCare to

pay a portion of their malpractice insurance premiums.

Page 9 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
B-258562 

Subject to the availability of unallocated funds, TennCare may also make

supplemental payments to hospitals for graduate medical education and

care provided to those eligible for, but not enrolled in, TennCare as well as

payments to hospitals that provide care to large numbers of TennCare or

indigent persons.

Savings From Capitation

Discounts and

Discontinued

Disproportionate Share

Hospital (DSH) Program

Allow Expanded Coverage

To finance expanded coverage while keeping Medicaid expenditures

within the budget limits set by the waiver agreement, Tennessee set

capitation rates that are substantially below historical Medicaid costs.

Further, it discontinued its DSH program and established a smaller Primary

Care Provider Fund.

In setting capitation rates, the state began with the average annual cost per

Medicaid-eligible person and then made “charity care” adjustments, which

reduced the average capitation rate by 22 percent.14 The state’s rationale

for making these adjustments was that the costs of charity care that had

been built into the rates paid historically to providers would be

significantly reduced by expanded insurance coverage.

To save additional funds, Tennessee also discontinued its DSH program and

established a smaller Primary Care Provider Fund. Under its Medicaid DSH

program in state fiscal year15 1993, the state provided $438 million in

supplementary payments to hospitals that served large numbers of

Medicaid enrollees or low-income persons. The Primary Care Provider

Fund, budgeted for $185 million in state fiscal year 1994, was intended to

provide essential provider payments, a reserve for MCO adverse selection

of enrollees or other unforeseen circumstances, and payments to primary

care physicians with large TennCare caseloads.16

Table 2 illustrates how savings from capitation discounts and the

elimination of the DSH program offset the expected costs of expanded

coverage and the new Primary Care Provider Fund.

14The state’s methodology in setting capitation rates by using average annual cost per Medicaid eligible

rather than average costs during participating months understates the historical cost of Medicaid. See

appendix I for a complete discussion.

15Tennessee’s state fiscal year runs from July 1 to June 30. For example, state fiscal year 1993 runs

from July 1, 1992, through June 30, 1993.

16After TennCare enrollment began, the Primary Care Provider Fund terminology was no longer used.

Supplemental payment components, methodology, and amounts have continued to change during the

program.

Page 10 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
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Table 2: Estimated State Fiscal Year

1995 Costs for Expanded Coverage Dollars in millions

Additional costs

Capitation payments for 500,000a uninsured net of discounts $519

Primary Care Provider Fund 171

Net additional costs $690

Costs avoided

Reduction in capitation rate for 1 million Medicaid eligibles

for charity care, including local government contributionsb (382)

Discontinued DSH paymentsc (438)

Net costs avoided $(820)

Net cost of state fiscal year 1995 coverage expansion $(130)

Note: The numbers used for Medicaid eligibles, uninsured, and the Primary Care Provider Fund

are for the second year of the waiver.

aBased on the maximum enrollment of 500,000 allowed to enroll in years 2 to 5 of the waiver.

Discounts are for charity care, local government, and enrollee cost-sharing deductions to the

capitation payments.

bThe average enrollee monthly charity care and local government deductions equal $31.83.

cAmount is the state fiscal year 1993 actual payments.

As shown in the table, savings from charity discounts and foregone DSH

payments would more than offset the costs associated with the expanded

coverage.

Waiver Imposes Limit on

Federal Spending

In accordance with the requirement that demonstration waivers be budget

neutral, the TennCare waiver agreement includes an overall available

federal funding limit for the 5-year waiver period and sets interim limits on

the availability of federal funding. The federal spending limits apply to the

total TennCare program expenditures, including Medicaid expenditures

for services not covered under capitated payments, such as long-term care.

For the 5-year TennCare waiver period, the federal government will

provide no more than $12.165 billion. For every $1 in TennCare

expenditures, the federal government pays approximately $.67 and the

state pays approximately $.33. The overall federal funding limit for the

waiver period was established by estimating what the federal funding for

Tennessee’s Medicaid program would have been during the first year

Page 11 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
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without TennCare17 and increasing federal funding 8.3 percent or by the

amount of the growth caps included in the President’s 1993 health care

reform proposal, whichever is lower, each subsequent year. For the first

year, HCFA estimated that federal expenditures under Tennessee’s existing

Medicaid program would be slightly more than $2 billion, a 15.5-percent

increase over the previous year’s federal funding. Increases in federal

funding for the subsequent years would range from 5.1 to 8.3 percent.

Table 3 shows the annual spending limits calculated for each year.

Table 3: TennCare Federal Funding

Spending Limits Dollars in billions

State fiscal year Spending limit

1994 $2.108

1995 2.283

1996 2.454

1997 2.594

1998 2.726

Total $12.165

However, because HCFA allows budget neutrality to be achieved over the

waiver’s duration and not each year, the state has flexibility in annual

spending. HCFA established cumulative federal funding targets that allow

federal TennCare funding to exceed the spending limits as long as the

cumulative annual spending limits are not exceeded by more than the set

percentage. Table 4 shows the cumulative annual spending targets and the

percentage by which they exceed the sum of the cumulative annual

spending limits.

Table 4: TennCare Cumulative Federal

Funding Targets Dollars in billions

State fiscal year

Cumulative

limit

Percent cumulative limit exceeds sum of

federal spending limits

1994 $2.277 8

1995 4.654 6

1996 7.119 4

1997 9.628 2

1998 $12.165 none

17To determine the expenditure estimate, HCFA multiplied the prior year’s expenditures by the average

percentage expenditure growth over the prior 5 years, separately for the medical component and

administrative component, then added in the prior year’s DSH spending.

Page 12 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
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If TennCare exceeds the cumulative limit for the first year, it must

downsize the program or otherwise reduce expenditures. In its waiver

application, Tennessee stated that it would control TennCare spending to

stay within the available resources. The waiver provides for cost

containment by beginning to restrict new enrollment of uninsured persons

when enrollment reaches 85 percent of the limit.

The federal spending limits apply to the entire TennCare program, which

includes services that are not part of TennCare’s capitated managed care

program. Long-term care and special services to severely and persistently

mentally ill and Children’s Plan enrollees are not included in TennCare’s

capitated program. The year before TennCare’s implementation, the

increase in long-term care expenditures was over 18 percent.

Our analysis of federal spending ceilings in the waiver agreement shows

that the amount of federal spending allowed in the first year of TennCare

exceeds the federal funds estimated to be spent if the state’s Medicaid

program had continued. However, the amounts allowed in the second

through fifth years are less than we estimate would be spent under

Medicaid, and the federal spending limit of $12.165 billion for the entire

waiver is less than would be spent if the state’s current Medicaid program

had continued.18

Financing Arrangements

and Expansion of

Coverage Favor the State

TennCare’s financing mechanisms and program expansions have enabled

Tennessee to reduce its revenue contributions while increasing the federal

dollars it receives. The waiver agreement explicitly allows the state to

claim losses incurred by some nonstate hospitals in caring for TennCare

eligibles and to keep most of the premiums paid by TennCare participants.

In addition, the waiver permits federal cost sharing for expenditures for

services to enrollees in state mental hospitals that are not normally

covered by Medicaid. The TennCare waiver provides other, indirect

benefits to the state by expanding coverage for those not previously

eligible under Medicaid but who received services through other

state-funded programs, which allows the state to reduce its funding of

such programs. In addition, since TennCare is a capitated program, the

state obtains revenue from state taxes on capitation payments made to

MCOs.

18We obtained these results by comparing the ceiling on expenditures under the demonstration with

the administration’s “current services” estimate for the year in which TennCare was approved. The

current services estimate is the projected amount of federal and state spending necessary to maintain

the current level of Medicaid services.

Page 13 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
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The state is allowed to claim hospital losses incurred in caring for

TennCare eligibles at certain public and private hospitals19 as TennCare

expenses, which makes these claims eligible for federal cost sharing.

However, the state is not required to forward any of the resulting federal

payments to the hospitals. For the first 6 months of 1994, the state

estimated that qualifying hospitals would incur total losses of

approximately $64 million; however, these hospitals incurred only

$34 million in such losses, according to a subsequent analysis by the

Tennessee Office of the Comptroller of the Treasury. The federal

government paid its share on the $34 million claim, which is

approximately $23 million.20

The state is also allowed to keep most of the premiums paid by TennCare

participants who are required to pay premiums—about half of the

non-Medicaid TennCare enrollees. The state and HCFA agreed that for the

first $75 million in premium revenues collected annually, the state gets

$.90 of each dollar and shares the remaining $.10 with the federal

government, according to the standard sharing rate. As revenue

collections surpass $75 million, the percentage of premium revenue

allowable as state share gradually decreases. The state initially estimated

that it would collect $21 million for state fiscal year 1994 and an additional

$101 million for state fiscal year 1995 but subsequently revised its state

fiscal year 1995 estimate to $30 million. Actual collections to date have

been less than estimated.21

The state benefits from federal funding provided to state mental hospitals

for expanded TennCare coverage, some of which is not covered under

Medicaid rules. Most significantly, Medicaid does not cover persons

between the ages of 21 and 65 in state mental hospitals. TennCare allows

short-term coverage22 of this population and reimburses mental hospitals

directly for the actual costs of such services. Federal TennCare cost

sharing for this population reduces the amount of state subsidy needed for

19HCFA agreed that the state could claim unreimbursed TennCare expenditures for private hospitals in

the Knoxville and Nashville areas, up to the amount of indigent care funds that the counties transfer to

these hospitals for such expenditures.

20State officials have also claimed $22 million for the first 6 months of 1994 in local government

funding of three hospitals as TennCare expenses, which would draw $15 million in federal cost-sharing

funds. However, HCFA deferred federal funding for the claim, asserting that local government funding

is not a TennCare expense because it would, in effect, be a duplicate claim. The state subsequently

agreed to withdraw its claim.

21See appendix III for more detailed information on premium collections.

22Coverage is limited to the first 30 days of an inpatient episode, subject to an annual aggregate limit of

60 days.

Page 14 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
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state mental hospitals. As a result, Tennessee officials identified

$69 million in annual state funding of state mental hospitals that could be

used to fund TennCare.23

Indirect benefits to the state result from covering persons not previously

included in Medicaid and making capitated payments to MCOs instead of

fee-for-service reimbursements to individual providers. Covering the

uninsured and uninsurable allows the state to reduce its funding for other

state programs that had served these populations. Therefore, in addition to

the state funding of mental hospitals, state officials identified $91 million

in annual funding of other state programs that could be used to fund

TennCare, which now provides such services to the uninsured. Most of

this funding—$65 million—comes from reduced state funding of

community mental health services. Also included is $5 million in reduced

state funding for the Tennessee Comprehensive Health Insurance

Program24 and $21 million for public health services, such as

communicable diseases and hemophilia services.

Making capitated payments to MCOs indirectly benefits the state because

these payments are then subject to certain taxes; fee-for-service payments

to providers generally were not. The state has a tax of 2 percent on

payments made to HMOs and 1.75 percent on payments to PPOs. The tax on

HMOs existed before TennCare, and a tax on accident and health insurers

that existed before TennCare was extended to include PPOs.25 Although the

HMO tax existed before TennCare, only one HMO, which covered about

25,000 Medicaid-eligible persons, had been subject to the tax for Medicaid

revenues. Total capitation tax payments for 1994 were approximately

$24 million, $16 million of which are essentially federal dollars returned to

the state treasury.26

23Although a Tennessee Department of Mental Health and Retardation official said that the majority of

residents in state mental institutions are between the ages of 21 and 65, the funds transfer also

accounts for savings resulting from federal cost sharing for state mental hospital services for

uninsured and uninsurable TennCare enrollees aged 21 and younger and 65 and older.

24Tennessee Comprehensive Health Insurance Program is a state insurance program for the

uninsurable, who are automatically eligible for TennCare.

25The state legislation that made TennCare MCOs subject to the requirements of accident and health

insurers was effective on May 2, 1994. However, a state official told us that PPOs are liable for the tax

for the entire calendar year 1994.

26According to the Deputy Commissioner, Tennessee Department of Commerce and Insurance, PPOs

paid the taxes under protest and may file a suit against the state.

Page 15 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
B-258562 

Waiver Includes Various

Access and Quality

Assurance Standards

Under the waiver agreement, HCFA permitted new requirements to address

enrollee access to care and systems to evaluate the quality of care

provided to substitute for the usual Medicaid quality assurance

requirements and systems. HCFA waived the requirement that beneficiaries

have the freedom to choose any participating provider and the

requirement that participating HMOs have at least 25 percent private

enrollment. Under TennCare, HCFA requires the TennCare Bureau to

ensure adequate enrollee access to providers and quality of care. HCFA

further requires the state to submit quarterly progress reports on quality of

care, access, utilization of health services, financial results, benefits

packages, and other operational issues.

HCFA’s primary care access standards for TennCare MCO networks include a

minimum primary care provider to patient ratio (1 to 2,500), maximum

travel distances and times (30 miles or 30 minutes for rural areas and 20

miles or 30 minutes for urban areas), and maximum allowable delays for

scheduling and waiting for appointments (3 weeks for nonemergency

scheduling and 45 minutes for waiting). In addition, TennCare has

standards for specialty care, hospitalization, and other services.

TennCare’s planned monitoring of these standards includes periodically

evaluating the ratio of primary care providers to enrollees; surveying

recipients, including measuring waiting periods for health care services;

and measuring referral rates to specialist physicians.

HCFA’s quality standards for TennCare include ensuring the implementation

of quality monitoring programs and evaluating MCO data to assess quality

of care. TennCare’s quality monitoring program derives from the National

Committee for Quality Assurance quality monitoring program

requirements for its MCO quality assurance programs. These requirements

include credentialing of providers, grievance procedures, and utilization

review. In addition, the state has included a required minimum data set of

quality indicators.

TennCare Has Initially

Met Its Objectives, but

Access and Quality

Assurance Measures

Have Been Delayed

For the first year, TennCare essentially met its objectives of expanding

coverage and controlling costs. The state had expanded eligibility to

include 300,000 of the state’s uninsured, yet actual program costs for the

state fiscal year ending June 30, 1994, were less than budgeted. However,

the operation of a key monitoring system to determine the accessibility

Page 16 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
B-258562 

and quality of medical care provided through TennCare has been delayed.27

Cost and Control

Objectives Largely Met

In January 1995, more than 400,000 uninsured persons and almost 800,000

Medicaid-eligible persons were enrolled in TennCare. The state expanded

eligibility as of October 1, 1994, by allowing persons to enroll who had

(1) lost private coverage from March 1993 to July 1994 or (2) insurance

that offered limited coverage. However, on January 1, 1995, TennCare

stopped new enrollment for most uninsured. Only persons who (1) had

applications pending before January 1, 1995, or they would lose Medicaid

eligibility or (2) could not obtain commercial insurance because of serious

medical conditions continued to be eligible. Because of this, enrollment

may decrease as the formerly uninsured leave the program and the

currently uninsured are not allowed to enroll.28

During state fiscal year 1994, the first year in which the waiver became

effective, TennCare expenditures were $2.7 billion, less than 1 percent

over the prior year’s Medicaid expenditures and significantly less than the

10 percent increase in national Medicaid expenditures for federal fiscal

year 1994.29 The state achieved these savings even though (1) Tennessee’s

regular Medicaid program remained in effect for the first 6 months of the

year, (2) enrollment increased by hundreds of thousands in the last 6

months of the year, and (3) long-term care costs increased 11 percent for

the year. Our analysis shows that the overall increase in expenditures was

attributable to lower than expected Medicaid expenditures during the first

6 months and the introduction of a capitated payment system30 on

January 1, 1994, that paid rates far below historical Medicaid payments.

Access and Quality of Care

Uncertain

Delays in the MCOs’ implementation of information systems have severely

affected the state’s ability to monitor enrollee utilization, patient access,

physician practice patterns, and enrollee medical outcomes for TennCare.

27See appendix III for a discussion of start-up problems that affected the implementation of the

monitoring system.

28Although the formerly uninsured may leave the program for many reasons, the TennCare Bureau

reported that it had terminated TennCare coverage of approximately 62,000 people as of June 1995 for

failure to pay premiums. See appendix III for more information on the state’s collection of premiums.

29Tennessee’s reported expenditures for federal fiscal year, October 1, 1993, to September 30, 1994,

were also less than 1 percent greater than the previous federal fiscal year’s.

30From January through June 1994, the TennCare Bureau paid or accrued about $620 million in basic

capitated payments to MCOs and about $250 million for supplemental payments to MCOs, hospitals,

and physicians.

Page 17 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
B-258562 

The state has conducted other analyses that generally indicate that MCOs

are in compliance with the required numbers of primary care physicians.

Nonetheless, surveyed beneficiaries indicated access problems, and

almost half of those surveyed with prior Medicaid said that the care they

received was worse than under Medicaid. Advocacy groups also reported

that access to care is a problem.

An important part of the state’s quality assurance program is the analysis

of encounter data (information on each enrollee’s use of services). Using

such data, the state can analyze utilization, access, physician practice

patterns, and medical outcomes. However, the state has had difficulty

obtaining data from the MCOs and has conducted only limited analyses of

available data. According to HCFA’s 1994 TennCare Monitoring Report, at

the year’s end, three MCOs were still submitting data in a format not usable

to the state. Additionally, the state had identified problems with the data

from the other nine MCOs. During the first year of the program, the state

withheld 10 percent of capitation payments for a varying number of

months to all but one MCO for failure to comply with reporting

requirements. To help ensure that the MCOs gather accurate data, the state

is reviewing the MCOs’ data systems and providing technical assistance to

them. The state estimates that data for the first year of TennCare’s

operation will not be available before summer 1995.31

The state also reviewed MCO provider networks and contracted with a state

university to conduct a beneficiary survey to assess access and quality of

care. Although the TennCare Bureau reported that the MCOs generally had

met the required standards for primary care, the state has not provided the

data on all the access standards to HCFA. As a result, HCFA has been unable

to validate the TennCare Bureau’s determination. Further, HCFA

recommends that the state require the MCOs to provide data that ensure

that provider networks have been validated as adequate and requests that

the state submit provider lists whose accuracy has been validated.

A beneficiary survey conducted for the state by the University of

Tennessee in September 199432 also raised concerns about access and

quality of care. The survey indicated that 45 percent of TennCare enrollees

who had previously been on Medicaid said that the care they received

31In the TennCare Bureau’s response to a draft of this report, it said that, as of June 1995, the 1994

encounter data are now available to TennCare staff to perform quality assurance reviews. It noted that

it has problems with some of the data.

32We used the responses for the head of household. The survey sometimes also asked the same

questions for the youngest child and the child most in need of medical attention.

Page 18 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
B-258562 

under TennCare was worse than under Medicaid, citing limited choice of

doctors and difficulty in finding providers as the most significant reasons.

The survey also provided information on MCO adherence to HCFA’s access

standards. Enrollees were able to schedule appointments generally within

3 weeks, the requirement for primary care; however, 12 percent responded

that it took over 3 weeks for the first available appointment, and

21 percent said it took more than 3 weeks for a follow-up appointment.

The survey results show that it took enrollees an average of 25 minutes to

travel to their doctor’s office, but the survey did not indicate how often

travel time exceeded the 30-minute requirement for primary care.33 In

addition, average reported waiting time in physician offices was an hour

longer than TennCare’s maximum waiting time of 45 minutes.

Advocacy groups have also expressed concerns about the availability of

medical care under TennCare. In October 1994, the Tennessee Association

of Legal Services surveyed physicians who had been identified as

participating in TennCare in an April 1994 survey. Of 461 physicians who

said that their practices were accepting new patients, 144 or 31 percent

said that they were not accepting new TennCare patients. In January 1995,

a TennCare monitoring group—made up of patient advocates, health care

providers, researchers, and others—expressed concerns about the

inadequate numbers of both primary and specialty care physicians in some

areas of the state.

Program Future

Depends on Several

Factors

Several factors could jeopardize TennCare’s future. The capitation rates

that have been set are questionable and may be insufficient to allow MCOs

to operate profitably while paying reimbursement rates sufficient to enlist

and sustain provider participation. Almost half of the MCOs, representing

over 60 percent of TennCare enrollees, reported losses in the first year.

Although the program’s financial impact on providers is inconclusive at

this writing, hospitals have indicated that TennCare payments did not

cover their estimated costs of treating TennCare patients, and physicians

report that their practices are financially worse off than they were under

Medicaid. Expected reductions in future supplemental payments from the

TennCare Bureau will also negatively affect MCOs and providers. And

although access and quality of care have not yet been fully analyzed,

access to care will likely be inadequate if large numbers of providers

choose to discontinue or drastically reduce their participation.

33The 30-minute travel requirement was not met for the youngest child and the child most in need of

medical attention; the survey reported 31 minutes and 35 minutes, respectively.

Page 19 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
B-258562 

TennCare’s Questionable

Capitation Rates May

Significantly Affect

Program Success

TennCare’s success in expanding coverage and controlling costs stems

primarily from its average capitation rates being substantially below

adjusted historical Medicaid per capita fee-for-services costs. In its

November 16, 1993, report, Milliman and Robertson, Inc., consultants to

the state legislature, concluded that in the aggregate, the capitation rates

were about 25 percent below projected 1994 fee-for-service Medicaid

costs, even before capitation discounts, and did not account for regional

cost variations.34 In addition, the report stated that the (1) capitation rates

were not based on commonly accepted actuarial methods, (2) calculations

had inconsistencies, and (3) bases for capitation rate reductions were not

explicit or well documented. The report also estimated that since MCOs

would incur administrative costs, which are not reflected in the capitation

payment, they would have to significantly reduce medical costs to succeed

financially.

Despite these criticisms, state officials maintain that the capitation rates

were reasonable. For example, the former Assistant Commissioner in

charge of the TennCare Bureau35 indicated to us his belief that the health

costs for the uninsured averaged less than those for Medicaid

beneficiaries. He also stated that Medicaid had had a lot of overutilized

services and that he believed the minimum savings from managed care

was 15 percent. He further stated that historical cost was only one piece of

information used in setting the capitation rates. The state used several

factors and knowledge of the health care system to develop the rates.

While HCFA officials said that they believed that the capitation rates were

low, they believed that the willingness of several MCOs to contract for the

capitation rate indicated that the rates were adequate. (A detailed

discussion of the TennCare capitation rates and their actuarial soundness

appears in app. I.)

MCOs Report Losses Financial data reported by MCOs for the first year of TennCare show that 5

of the 12 MCOs, which cover 60 percent of beneficiaries, experienced

losses. BlueCross BlueShield, the largest MCO, reported an $8.8 million

loss. And although Access MedPLUS, the second largest MCO, reported a

34According to Milliman and Robertson, Inc., the state reported regional cost variations ranging from

83 to 122 percent of statewide average costs.

35The former Tennessee Department of Health Assistant Commissioner in charge of the TennCare

Bureau, who served from January 1994 to April 1995, was previously in charge of the Tennessee

Bureau of Medicaid.

Page 20 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
B-258562 

slight gain, its financial condition may be worse than reported.36 In

addition, the reported net income for some PPOs does not reflect the

impact of capitation taxes or substantial deficits incurred for medical

services costs. (A detailed discussion of MCOs’ financial performances

appears in app. II.)

The MCOs’ reported financial conditions would have been worse except for

supplemental payments, which are likely to be reduced in 1995. Without

these payments, all of the HMOs would have incurred losses. The MCOs’ 1994

financial statements included more than $100 million in both actual and

anticipated supplemental payments37 for (1) a supplement to capitation

rates paid for 1994, (2) the first 30 days of care to formerly uninsured

enrollees, and (3) adverse selection. As of May 1995, the TennCare Bureau

had paid MCOs the capitation rate supplement and some payments for the

first 30 days of care for the formerly uninsured. However, although

one-half of the MCOs had included anticipated adverse selection payments

in their 1994 financial results, the TennCare Bureau had made no such

payments as of May 1995, almost 1 year and 6 months since the MCOs

began participating in the program.

Only one PPO included the 1.75-percent capitation tax expense in its

computation of net income, which, according to state officials, PPOs are

required to pay. Officials from two of the five PPOs said that they were not

aware that they were liable for the tax until they received a February 1995

notice. The additional cost of the capitation tax would reduce these PPOs’

net income or the amount available to pay for medical services by

approximately $4 million.

Two PPO financial reports included only the results from administrative

operations and not the surplus or deficit for medical service expenses.

One of these PPOs has a contractual arrangement with providers that puts

them at risk for deficits resulting from excess medical costs. Officials from

both PPOs indicated that their plans experienced a medical operating

deficit of over $5 million representing about 7 percent of total capitation

payments received by each plan. However, these medical deficits did not

reduce these MCOs’ net incomes. One plan established an accounts

receivable of over $5 million due from providers, while the other PPO did

36We did not verify the financial condition of Access MedPLUS. The state required that we subpoena

the information that would have enabled us to do so. We chose not to issue a subpoena because it

would have delayed this report.

37Reported total supplemental payments received and expected for 1994 are as much as $26 million

less than the $128 million the TennCare Bureau said is available for 1994. Thus, the Bureau could make

some additional supplemental payments to MCOs, improving their financial position.

Page 21 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
B-258562 

not reflect the excess medical costs on its financial statement because

officials said it was the providers’ liability.

TennCare’s Financial

Impact on Providers

Uncertain

TennCare’s financial impact on providers—hospitals, health centers, and

physicians—is uncertain. Although available analyses suggest that

TennCare has negatively affected providers, these analyses are not

conclusive because they do not (1) compare TennCare reimbursements

received with Medicaid reimbursement, (2) consider all TennCare

reimbursement, or (3) provide actual financial data on which to base a

conclusion. In addition, comparing physician reimbursement rates under

BlueCross BlueShield, the largest TennCare MCO, and under the prior

Medicaid system yields mixed results: the rates are generally lower under

BlueCross BlueShield, except for office visits and consultations.

Hospitals and Health Centers

Analyses Inconclusive

Analyses conducted by the Tennessee Office of the Comptroller of the

Treasury and the Tennessee Hospital Association (THA) of hospitals’ and

federally qualified health centers’ costs under TennCare are inconclusive.

The two analyses of hospital finances indicate that hospitals incurred

losses under TennCare, but neither analysis compared the TennCare

experience with the hospitals’ experience under Medicaid. A comparison

of federally qualified health center finances under TennCare and under

Medicaid showed that most of the centers’ profits were reduced under

TennCare, but the Comptroller’s office expressed concerns about the

reliability of the data submitted.

Tennessee’s Comptroller’s office analyzed whether TennCare payments to

publicly funded, nonstate hospitals covered the cost of caring for

TennCare enrollees from January 1, 1994, through June 30, 1994.38 Even

accounting for supplemental payments, 27 of 34 hospitals incurred

$34 million in estimated losses by treating TennCare patients. All 34

hospitals would have reported losses, and total losses would have been

much greater if the analysis had not accounted for supplemental TennCare

payments.39 THA claimed that TennCare payments did not cover hospitals’

38The purpose of the study was to calculate the allowable TennCare claim for federal reimbursement

on the basis of losses at publicly funded, nonstate hospitals.

39The analysis included $30 million in medical education payments that had been paid to these

hospitals; in addition, the Comptroller included $48 million in estimated high-volume payments that

had not been received by the hospitals. The Comptroller did not include estimated TennCare payments

made to the hospitals for care to TennCare eligible but not enrolled people. This was not included

because the actual cost of providing services to such people had not been determined.

Page 22 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
B-258562 

estimated costs of treating TennCare patients.40 But this analysis did not

compare TennCare hospital reimbursement with prior Medicaid

reimbursement. In addition, the THA analysis did not include supplemental

payments made to hospitals for caring for large numbers of TennCare and

indigent persons because the payments had not been made at the time of

the study. THA officials told us that hospitals subsequently received

$50 million in such supplemental payments. However, this is only half of

the $100 million that hospitals had expected to receive from the state.

As part of the state’s waiver agreement with HCFA, the Comptroller’s office

reviewed cost reports from participating federally qualified health centers

for the first 6 months of TennCare and concluded that, “it appears the

clinics are not performing as well under TennCare compared to Medicaid.”

However, the Comptroller’s office said that its analysis was not conclusive

because it could not be sure that changes in costs were caused solely by

TennCare nor that health centers accurately reported revenues,

particularly pending payments. Our review of the Comptroller summary of

the health centers’ data shows that although 14 of 20 health centers had

reduced total clinic profits during the TennCare period, only 3 reported an

overall loss.

Physicians Report Their

Practices Are Financially Worse

Off Under TennCare

An opinion survey conducted by the TMA in October 1994 found that,

compared with Medicaid, more than three-quarters of the physicians

reported that their practices were somewhat or much worse off financially

under TennCare.41 Because the TMA survey was an opinion survey, it does

not provide financial data on physicians’ TennCare and Medicaid

experiences. Further, a TMA official said that the physicians’ financial

situations may be worse than the survey reported because the physicians

may have included in their assessments supplemental payments from the

TennCare Bureau that had not been received as promised. In addition,

physicians may have expected MCOs to return withheld reimbursements for

1994, but much of these have not been returned.

At the time of the survey, no supplemental TennCare payments had been

made to the physicians, and withholds of physician reimbursement by the

largest MCO had not been settled. The TennCare Bureau accrued

$15 million in supplemental funds for payments to physicians for January

to June 1994 but had not made any payments. As of March 1995, payments

40THA contracted with Ernst & Young LLP to compare TennCare payments for 35 hospitals with the

estimated costs of providing care for the first 6 months of TennCare.

41TMA reported that the 1,221 responses it received from practices represented more than 4,631

physicians.

Page 23 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
B-258562 

had still not been made. For state fiscal year 1995, $15 million has again

been budgeted for supplemental physician payments.

At least six MCOs withhold part of their physician reimbursements, ranging

from 5 to 25 percent. We talked to two MCOs that used such withholds to

offset excess costs, as necessary. According to their physician contracts,

these MCOs assess their plan’s performance for the year and decide how

much of the withhold to return, if any. BlueCross BlueShield had a

5-percent withhold on physician reimbursement and kept the entire

amount for most of the providers. John Deere has a withhold of up to

25 percent of physician reimbursement and paid back approximately

one-fourth of the withheld funds and may make further distributions.

Comparing BlueCross

BlueShield TennCare Physician

Reimbursement Rates With

Medicaid Is Inconclusive

A TMA physician survey indicated that the reimbursement levels offered

under TennCare had the most negative impact on physician practices. A

comparison of BlueCross BlueShield TennCare reimbursements for

selected services to Medicaid reimbursements shows that TennCare rates

are generally lower than Medicaid rates, except for visits and

consultations.

In comparing selected BlueCross BlueShield TennCare rates to Medicaid

rates, BlueCross BlueShield pays at least slightly better for visits and

consultations and significantly less for other services. For example,

BlueCross BlueShield reimbursement rates for office, inpatient, and

outpatient visits and consultations are higher than Medicaid rates;

however, BlueCross BlueShield rates for other selected surgery and

radiology services are significantly less than Medicaid rates, with

differences for many services ranging from 20 to 50 percent less than

Medicaid rates. The impact on a particular physician practice depends on

the frequency and type of services provided.

TennCare’s MCO and

Provider Networks

Threatened

The success of TennCare will also depend on the continued participation

of the MCOs and providers for the duration of the 5-year demonstration.

MCO officials are hesitant about continuing to participate in TennCare,

given their financial performance in the first year; and

providers—disconcerted about low reimbursement rates, heavy

administrative burdens, payment delays, and lack of involvement in

developing TennCare—could withdraw in large numbers.

Continued MCO Participation

Uncertain

Although all participating MCOs have renewed their contracts for state

fiscal year 1996, concerns remain. We talked to officials from three MCOs

Page 24 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
B-258562 

about TennCare’s future, and they expressed several concerns about

operating without supplemental TennCare revenues, compensating for

1994 operations shortfalls, and maintaining an adequate provider network.

The TennCare Bureau budgeted less for MCO supplemental payments for

1995 than were paid and accrued for 1994. In 1994, TennCare supplemental

payments designated for MCOs totaled $128 million. However, only

$76 million had been paid as of May 1995, although the TennCare Bureau

says it will make additional payments. For 1995, the TennCare Bureau has

designated only $40 million in supplemental payments to MCOs and plans a

5-percent increase in capitation payments effective July 1, 1995.42

BlueCross BlueShield officials told us that they incurred a loss of

$8.8 million in 1994, and they forecast a loss of $35 million for their 1995

TennCare operations, even though they plan to implement cost-control

measures during the year. BlueCross BlueShield’s projected deficit

increase reflects expected reduced supplemental payments from the

TennCare Bureau and higher utilization, which officials believe was low in

1994 due to the initial confusion over TennCare. To control costs,

BlueCross BlueShield plans to (1) retain reimbursement rates at initial

1994 levels, (2) increase the percentage withheld from providers in some

areas of the state, (3) control utilization by emphasizing outpatient visits

over hospital admissions, and (4) aggressively address billing of

unnecessary services.

BlueCross BlueShield officials have indicated that the company does not

intend to continue to lose money. They have said that unless capitation

rates are increased 10 percent retroactively to January 1, 1995, BlueCross

BlueShield will face a decision about its participation. Since BlueCross

BlueShield had enrolled nearly 50 percent of the beneficiaries and is one

of only two statewide MCOs, changes in its participation could significantly

affect TennCare.

Officials from two other MCOs that are holding providers responsible for

their plans’ 1994 medical services operating deficits expressed uncertainty

about whether these deficits can be recouped. Officials said that efforts to

reduce provider reimbursement would jeopardize their providers’

continued participation. An official from one MCO said that if costcontainment efforts fail, the MCO will simply make payments until it can no

longer do so.

42In the TennCare Bureau’s response to our draft report, it said that for state fiscal year 1996 an

additional 4.5 percent capitation supplement will be made available to MCOs that meet the

performance standards specified in a contract amendment being sent to the MCOs.

Page 25 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
B-258562 

Continued Provider

Participation Also Uncertain

In early 1995, officials from THA, as well as from several major hospitals,

expressed concern because the TennCare Bureau had announced that

hospitals would not receive supplemental payments in 1995. Supplemental

payments to hospitals for graduate medical education, care for TennCare

eligible but not enrolled persons, and special payments to hospitals that

cared for large numbers of TennCare and indigent persons totaled

approximately $220 million for 1994. Subsequently, on the basis of a

June 27, 1995, agreement with HCFA, the TennCare Bureau announced that

it intends to make $55 million in one-time payments to two hospitals43 and

resume medical education payments to hospitals.

In addition to low reimbursement rates, other MCO actions may affect

physician participation. For example, at least two other MCOs did not

return all withholds to physicians on reimbursements for the first year of

operation, and at least two MCOs held physicians liable for medical services

deficits. As MCOs try to further control and contain costs, their network

providers may assume additional administrative burdens as well as

reduced reimbursement. These pressures will add to the dissatisfaction

that providers already have with the program. An October 1994 TMA

satisfaction survey of TennCare physicians reported that 86 percent of

respondents felt dissatisfied with the program, and 77 percent felt that

TennCare reimbursement was worse than under Medicaid.

Physician dissatisfaction was evident from TennCare’s inception, when

many doctors reported feeling coerced to participate. To guarantee a

sufficient network, BlueCross BlueShield implemented a policy requiring

physicians who participated in an existing network that operated for state

employees and others to participate in TennCare. The policy, which

became known as the “cram down” provision, prompted about a third of

the 6,500 physicians in the existing network to drop out. Although most

physicians returned to the network, their dissatisfaction with the cram

down policy has persisted, and stakeholders and policymakers continually

discuss eliminating it. If the policy were eliminated, BlueCross BlueShield

officials believe many network providers might choose to stop treating

TennCare patients.

Conclusions Tennessee’s capitated managed care program has enabled the state to

control costs and provide health care coverage to hundreds of thousands

of uninsured persons. In addition, it has established a system that enables

43HCFA requires that the hospitals be allowed to retain at least $18 million of these payments and

allows the remainder of the payments to be transferred from the hospitals to the state.

Page 26 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
B-258562 

persons who lose their Medicaid eligibility to keep health care coverage.

But serious questions exist about the program’s future. The quality and

accessibility of medical care are largely unknown, but early indications are

that quality and access could be improved.

Moreover, the rates paid to MCOs were substantially below prior Medicaid

per beneficiary costs. Overall, MCOs lost money in the first year, even after

receiving substantial one-time supplemental payments. In the absence of

these supplements, MCOs may need to cut payment rates for providers

and/or pressure providers to hold down costs to remain in the program.

Most providers have already indicated that their financial situations are

worse off under TennCare than they were under Medicaid. MCO

cost-control efforts and the termination of large supplemental payments to

hospitals will only exacerbate their condition. If providers decide to

reduce their TennCare participation or leave the program in significant

numbers, the viability of the MCOs and TennCare could be threatened.

Agency Comments

Recent State Efforts Both HCFA and the TennCare Bureau said that recent actions by the new

state administration to address some of the problems we identified should

be included in our report. We recognize that the organizational change

regarding MCO financial oversight, forums for discussion and input

provided by the TennCare Roundtable,44 and the proposed plan to provide

MCO performance-based incentive payments of up to 4.5 percent of the

capitation payments are potentially significant. However, because of the

recency of the changes, their impact on the problems we identify is

uncertain at this time.

MCOs’ Renewals HCFA and the TennCare Bureau also pointed out that MCOs have renewed

their contracts to participate in TennCare for at least the next 12 months.

As a result, the TennCare Bureau said that our concern about the

uncertainty of continued MCO participation is inconsistent with the MCOs’

behavior. Our concern is that MCOs continue to participate for the duration

of the 5-year demonstration project and that MCOs’ financial difficulties not

44The TennCare Roundtable was a group of providers, MCOs, and beneficiary advocates appointed by

Governor Sundquist to hold public hearings and make recommendations on how the program can be

improved. It issued a report on June 29, 1995.

Page 27 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
B-258562 

threaten TennCare enrollees’ access to and quality of care. On the basis of

our review of MCO financial information, discussions with MCO officials, and

the uncertainty of supplemental funding from the TennCare Bureau, we

remain concerned about the continued participation of MCOs and their

ability to maintain adequate provider networks.

MCO Start-Up Costs The TennCare Bureau also wanted our report to recognize that MCOs

incurred start-up costs during the first year, writing that “the profits and

losses in any business situation during the first year do not typically reflect

what may result during ongoing operations.” Although we recognize that

start-up costs were incurred and that they do contribute to reduced profits

or increased losses for the year, other factors should be considered. First,

MCOs shared in an unexpected $54 million in additional capitation

supplements for 1994 to address MCO financial difficulties, as well as

additional payments of more than $20 million for the first 30 days of care

provided to the uninsured. Similar payments are not planned in the future.

Second, start-up costs were offset to some extent by lower utilization

resulting from beneficiary and provider confusion during the first few

months. Third, system development and start-up-like costs will continue to

be incurred by some MCOs; for example,BlueCross BlueShield officials said

that they will incur an additional cost in 1995 to purchase an HMO

information system to operate as a gatekeeper. Fourth, MCO officials we

talked to expected to experience financial difficulty in the second year,

both because of the medical costs they expect to incur and reduced

supplemental TennCare funding they expect to receive so they saw the

need to act to mitigate future losses.

Federal Cost Sharing On the issue of cost sharing, HCFA officials reiterated several times that

HCFA has not changed the federal matching rate in the TennCare

demonstration. We agree with HCFA that the federal matching rate applied

to qualifying TennCare expenditures has not changed. However, a number

of waiver provisions effectively increased the federal cost-sharing rate by

reducing the net financial contribution required of the state. In particular,

certain hospital losses are treated as qualifying TennCare expenditures,

although the state does not pay the hospitals for those losses. The state

can also recoup a share of both its and the federal government’s

contribution to MCO capitation payments through a tax on the capitation

payment and by retaining 90 percent of premium collections. How such

arrangements can effectively increase federal cost sharing is fully

Page 28 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
B-258562 

described in Medicaid: States Use Illusory Approaches to Shift Program

Costs to the Federal Government (GAO/HEHS-94-133, Aug. 1, 1994).

Quality Assurance

Programs

HCFA officials described the difficulties of the state staff and MCOs due to

their lack of experience and having to simultaneously address their

financial and organizational problems. HCFA officials also said that the

state is working with an external organization to help fully implement

quality programs at the MCOs. HCFA indicated that the state’s progress in

implementing its quality assurance monitoring plan is slow and that HCFA is

requiring the state to develop interim monitoring strategies to ensure

access and quality. We agree with HCFA’s assessment and attribute the

magnitude of these problems to inadequate planning and TennCare’s rapid

implementation. (See apps. IV and V for comment letters from HCFA and

the TennCare Bureau, respectively.)

As arranged with your office, unless you announce its contents earlier, we

plan no further distribution of this report until 30 days after the date of

this letter. At that time, we will send copies to the Secretary of Health and

Human Services, Tennessee officials, and the chairmen and ranking

minority members of congressional committees with an interest in these

matters. We will make copies available to others on request.

Please contact me on (202) 512-7123 if you or your staff have any

questions. Major contributors to this report are listed in appendix VI.

Sincerely yours,

William J. Scanlon

Associate Director, Health Financing

 and Public Health Issues

Page 29 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
Contents

Letter 1

Appendix I 

Tennessee’s

Methodology for

Setting Capitation

Rates and Concerns

About the

Methodology

32

Establishment of Capitation Rates 32

Validity of Capitation Rates Questioned 33

Appendix II 

Financial

Performance of

TennCare’s MCOs

37

BlueCross BlueShield Reported Losses for the First Year of

TennCare

37

Other PPOs’ Financial Reports Raise Concerns 38

HMOs’ Reported Earnings Mixed 39

Adequacy of Reserves Questioned for Three HMOs 39

Appendix III 

Start-Up Problems

41

Limited Managed Care Experience Led to Confusion Among

MCOs, Beneficiaries, and Providers

41

Providers Take Action Against TennCare 42

Poor Communication and Outreach Led to Delays in Enrollment 42

Claims Processing and Premium Payments Delayed 43

Appendix IV 

Comments From the

Health Care Financing

Administration

45

Appendix V 

Comments From the

Bureau of TennCare

51

Page 30 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
Contents

Appendix VI 

Major Contributors to

This Report

54

Tables Table 1: TennCare Enrollment by MCO 9

Table 2: Estimated State Fiscal Year 1995 Costs for Expanded

Coverage

11

Table 3: TennCare Federal Funding Spending Limits 12

Table 4: TennCare Cumulative Federal Funding Targets 12

Table II.1: First-Year Earnings for Seven TennCare HMOs 39

Figure Figure 1: TennCare’s MCOs by Region 8

Abbreviations

DSH Disproportionate Share Hospital

HCFA Health Care Financing Administration

HHS Department of Health and Human Services

HMO health maintenance organization

MCO managed care organization

NAPH National Association of Public Hospitals

PPO preferred provider organization

THA Tennessee Hospital Association

TMA Tennessee Medical Association

Page 31 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
Appendix I 

Tennessee’s Methodology for Setting

Capitation Rates and Concerns About the

Methodology

To control its health care costs, TennCare makes monthly capitation

payments to MCOs for each of their enrollees. The state’s methodology for

setting the capitation rates, however, has raised some concerns. For

example, consultants to the state legislature reported that the aggregate

capitation was understated by more than 25 percent.

The capitation rates are based on historical Medicaid costs and set by

enrollee type; the rates are then reduced by charity care deductions and

enrollee cost sharing. Before the capitation rates were established,

consultants to Tennessee’s Bureau of Medicaid reviewed the state’s

historical Medicaid cost information. Although the consultants found this

information to be generally acceptable, they recommended that the

capitation rates (1) reflect historical costs for eligible months and

(2) account for regional cost variations. The TennCare Bureau did not

follow either recommendation.

After the capitation rates were established, consultants to the state

legislature reviewed the state’s rate-setting methodology and found it

actuarially unsound. As a result, the consultants recommended that

capitation rates be increased 20 percent, even when allowing for cost

savings from potential utilization reductions.

Establishment of

Capitation Rates

To set monthly capitation rates, Tennessee used 1992 Medicaid costs

projected to 1994 for each enrollee type. These rates were then reduced

for charity care, local government funding, and enrollee cost-sharing

adjustments. The state also calculated an overall average capitation rate

used for budgeting purposes and not for paying MCOs. The overall average

rate for 1994 was $136.75 a month. After a reduction of $35.65 for charity

care, local government expenditures, and coinsurance and deductibles, the

rate was $101.10. Effective July 1, 1994, the TennCare Bureau increased

capitation rates 5 percent.

Tennessee set rates for eight categories of eligibles determined by factors

such as age, gender, and whether the enrollee has a disability. Deductions

to the capitation rates are based on various assumptions about charity

care, local government funding, and medical costs incurred by the

uninsured.

The charity care deduction—meant to capture approximately one-half of

the estimated cost of charity care provided in the state—was estimated at

Page 32 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
Appendix I 

Tennessee’s Methodology for Setting

Capitation Rates and Concerns About the

Methodology

$595 million annually.45 The state assumed that Medicaid and other payers

had been paying for charity care when medical providers shifted charity

care costs to others. Because coverage of the uninsured would reduce

charity care, the state reduced the capitation rate accordingly. On average,

a monthly charity care deduction of $27.96 was applied to each monthly

capitation rate on the basis of the state’s estimated upper limit of the total

number of Medicaid and uninsured people.

The deduction for local government funding—meant to capture an amount

equal to the local government funding that would be expected to be

provided without TennCare—was estimated at $50 million annually. On

average, a local government deduction of $2.35 was applied to each

monthly capitation on the basis of the state’s estimated upper limit of the

total number of Medicaid and uninsured people.

The third deduction, for copayments and deductibles, applies only for

non-Medicaid eligible TennCare enrollees with incomes above the federal

poverty level and is computed on an individual basis. For budget purposes,

the state computed an average deductible and copayment deduction equal

to $5.35 monthly. In calculating these deductions, the state assumes that

everyone will exhaust their deductible and make copayments. For

example, the monthly capitation rate for a non-Medicaid TennCare

enrollee with income above the federal poverty level would be reduced for

one-twelfth of the annual deductible and up to an additional 10 percent of

the reduced capitation to account for expected copayments. Enrollees

subject to cost sharing are required to pay the deductible and copayments

to MCOs or providers as they incur medical costs.

Validity of Capitation

Rates Questioned

In May 1993, Peat Marwick, as consultants to the state’s Bureau of

Medicaid, reviewed the historical Medicaid cost information on which the

Bureau planned to base its capitation rates. Peat Marwick found that the

data underlying the state’s cost projections were sound, except for an

understatement of incurred claims.46 However, it made several

recommendations on factors to include in setting rates. Among the

recommendations was that claims data should be used to set monthly

45The estimate is based on information from the University of Tennessee and estimates made by health

care providers in meetings with state officials.

46Peat Marwick’s analysis was based on the assumption that TennCare benefits would be the same as

Medicaid, with the exception of eliminating prescription limitations, and that cost reductions due to

managed care aspects of the new provider arrangements would offset this benefit expansion. A Peat

Marwick letter stating that the methodology used in calculating the cost per eligible month was

actuarially sound was attached to the TennCare waiver application.

Page 33 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
Appendix I 

Tennessee’s Methodology for Setting

Capitation Rates and Concerns About the

Methodology

rates on the basis of eligible months rather than the number of eligibles

participating in Medicaid for some period during the year. Peat Marwick

also recommended that regional capitation rates be established. The state

did recompute the capitation rates, but it used total number of eligibles to

establish an annual cost regardless of eligible months, and it did not

establish regional rates.

When TennCare’s capitation rates were announced about 3 months after

the Peat Marwick review, concerns were raised. To address these

concerns, the Legislative Oversight Committee on TennCare47 contracted

Milliman and Robertson, Inc. (in conjunction with Schubert & Associates)

to review the TennCare Bureau’s capitation rate-setting methodology.

In its November 1993 report, Milliman and Robertson stated that in the

aggregate, the capitation rates were about 25 percent below projected

1994 fee-for-service Medicaid costs. Further, since MCOs would incur

administrative costs not reflected in the capitation payment, Milliman and

Robertson estimated that MCOs would have to significantly reduce medical

costs to succeed financially. In addition, Milliman and Robertson agreed

with Peat Marwick’s recommendation that rates should address regional

variation and said that the variations were too significant to be ignored.

According to Milliman and Robertson, the state’s analysis showed that

costs by region were as low as 83 percent and as high as 122 percent of

statewide average costs.

The report made several conclusions: (1) the gross capitation rates were

not based on commonly accepted actuarial methods, (2) inconsistencies

existed between the Bureau’s reported methodology and the actual

calculations, (3) no explicit assumptions existed on cost reductions in the

gross capitation rate development, and (4) capitation rate reductions were

not well documented.

Milliman and Robertson found that the gross capitation rates were not

based on commonly accepted actuarial methods because the state used

the total number of people who received Medicaid during the year

regardless of length of time on the program to determine capitation rates

and ignored Medicaid cost variations by area. The state’s computation of

capitation rates, in effect, assumed that every Medicaid recipient in 1992

was covered for the entire 12 months. Milliman and Robertson calculated

that on average, Medicaid recipients were only enrolled for 8.72 months

47Formally established by Tennessee law on April 18, 1994, as the Select Oversight Committee on

TennCare, the Committee is made up of seven members each from the State House and the Senate.

The Committee has broad oversight responsibility and authority.

Page 34 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
Appendix I 

Tennessee’s Methodology for Setting

Capitation Rates and Concerns About the

Methodology

during 1992, which understated the aggregate capitation by 26.2 percent.

Also, the state projected 1994 rates from 1992 data, on the basis of a

5.5 percent annual inflation rate.48 However, the state may have

understated actual inflation increases since it had provided information in

its TennCare application that showed an average annual increase of

8.7 percent from fiscal years 1988-1989 to 1991-1992.

In addition, Milliman and Robertson said that the average gross capitation

rate that TennCare used for budget purposes overstated the actual rates

paid by eligibility category. This was due to an error in how Tennessee

weighted the eligibility categories. In calculating each of the eight

capitation rates, the state counted people equally regardless of how many

months they had been in the program and whether they were in more than

one capitation category. For example, a 9-month-old child qualifying for

Medicaid halfway through the calendar year would be counted in

determining the capitation rate for each of two categories—“less than one

year of age” and “aged 1 to 13”—even though the child would have been in

each category for only a few months. This understates the per capita costs

because the child is treated, in effect, as having received services for an

entire year in each capitation category. Milliman and Robertson calculated

that the gross capitation rates by eligibility category were about

6.2 percent too low to achieve the TennCare Bureau’s reported average

gross capitation rate because of this error.

Milliman and Robertson also reported that no explicit assumptions existed

about cost savings under TennCare. They said that the state’s utilization

data indicated the potential for significant utilization reductions. Given

this and other states’ experiences, Milliman and Robertson said that a

10-percent reduction assumption for 1994 would have been appropriate to

apply to otherwise actuarially sound rates. Even when allowing for the

utilization cost reduction, Milliman and Robertson said that an overall

increase of 20 percent was still needed to address problems in the

rate-setting methodology.

Further, Milliman and Robertson noted that the Bureau did not provide

them with the necessary information to evaluate the capitation reductions

for charity care, local government funding, and enrollee cost-sharing

adjustments. They also said that the data available to them suggested that

48Although the state reported that it increased the 1992 costs by 5.5 percent for each of 2 years to

arrive at the 1994 costs, we found that the actual average rate applied to Medicaid enrollees was about

6.4 percent. According to state officials, increases were originally calculated using a 5.5 percent rate.

However, the amount budgeted for TennCare exceeded the expected capitation payments required for

the number of people believed to be eligible for TennCare. The state consequently increased the

individual capitation rates to reflect the higher amount budgeted.

Page 35 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
Appendix I 

Tennessee’s Methodology for Setting

Capitation Rates and Concerns About the

Methodology

the deductible reductions were too high because they are based on the

assumption that all enrollees would incur costs exceeding the deductible.

Page 36 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
Appendix II 

Financial Performance of TennCare’s MCOs

The overall financial performance of the five PPOs and seven HMOs that

TennCare contracted with appears to have been weak for the first year of

participation. According to its financial analysis,49 BlueCross BlueShield,

the largest TennCare MCO, with almost half of the state’s TennCare

enrollees, estimated that its losses on TennCare revenues total almost

$9 million. These losses could be more than twice that amount if incurred

claims expenses have been underestimated—even though the MCO

withheld payments from providers and limited its administrative costs.

The financial condition of Access MedPLUS, the second largest TennCare

MCO, with nearly a quarter of the state’s TennCare enrollees, is unknown,

but examiners of the HMO’s records have discovered weak controls in its

financial reporting and have questioned its financial viability.

For our review, we used the annual financial reports that HMOs submitted

to the Tennessee Department of Commerce and Insurance, and we

obtained financial reports from participating PPOs. Four PPOs provided us

with unaudited information, and one PPO, BlueCross BlueShield, provided

us with an audited report, although it contained little specific information

on its TennCare operations and additional financial analyses.

BlueCross BlueShield

Reported Losses for

the First Year of

TennCare

BlueCross BlueShield, the state’s largest PPO,

50 estimated that it lost about

$8.8 million on TennCare revenues of about $610 million even though it

(1) retained about $17 million that it had withheld from providers to cover

losses and (2) limited administrative costs to 7 percent of premiums plus

the $9 million in premium taxes it paid. According to BlueCross BlueShield

officials, the loss could be as much as $18.8 million if incurred claims

expenses have been underestimated. In calculating its loss, BlueCross

BlueShield included received and anticipated supplements to the

capitation rate of $45.9 million. These consisted of a retroactive premium

increase payment of $23.8 million, anticipated adverse selection payments

of $9 million, and anticipated payments of $3 million for the first 30 days of

care for formerly uninsured enrollees, as well as $10.1 million that had

already been received for the first 30 days of care.

49As part of their contract with TennCare, MCOs are required to file an audited annual report 9 months

after the end of their corporate operating year. In addition, HMOs are required to file quarterly

financial reports with the Tennessee Department of Commerce and Insurance.

50BlueCross BlueShield has about half of the state’s TennCare enrollees and about three times as many

enrollees as the combined total of the other four PPOs.

Page 37 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
Appendix II 

Financial Performance of TennCare’s MCOs

Other PPOs’ Financial

Reports Raise

Concerns

Most of the data provided to us by the other four PPOs were unaudited or

informally produced, and differences in their reporting methods preclude

combining their results in a meaningful way.

One PPO’s unaudited financial statements did not include income or

expenses related to medical costs. Its income statement, which showed a

net income of about $93,000, was limited to administrative costs because

PPOs are not considered at risk for medical costs. The PPO’s financial

statements only record the liabilities for medical services equal to the

amount of available funds. A PPO official told us that approximately

$5 million in excess medical services liabilities is not recorded because

this is the medical providers’ liability. On the basis of discussions with a

PPO official, the medical deficit could be reduced to less than $3 million if

the PPO receives estimated adverse selection payments and additional

payments for the first 30 days of care provided to uninsured enrollees. The

PPO plans to recover the deficit through utilization reduction efforts during

1995; according to the official, providers would leave the network if the

PPO reduced its fees.

Officials from another PPO provided us with unaudited financial statements

that showed a $77,212 loss for 1994, which did not account for the 1.75

percent state tax on capitation payments. However, the PPO’s deficit would

have been $5.3 million higher had it not established a $5.3 million accounts

receivable item for provider-shared risk. This item, which equals about

7 percent of the capitation payments received from the state, represents

the amount of operating deficit to be recovered from future provider

reimbursements. Officials from the first PPO gave several examples of

plans to contain costs, but they were uncertain what impact their efforts

would have. Officials from both PPOs expressed concern about maintaining

their provider network.

A third PPO reported a loss of over $2 million. However, according to the

PPO TennCare contract, PPOs must account for their administrative and

medical operations separately. Using the PPO’s unaudited financial

statements, we computed that the PPO incurred about a $3 million loss,

after taxes, even though it realized a gain of $1 million on its medical

operations—of which 90 percent would have to be returned to the state

and 5 percent distributed to providers, according to the contract

provisions.

Page 38 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
Appendix II 

Financial Performance of TennCare’s MCOs

HMOs’ Reported

Earnings Mixed

Table II.1 shows the reported earnings for the first year of TennCare for

the seven HMOs.

Table II.1: First-Year Earnings for

Seven TennCare HMOs HMO Net income Enrolleesa

Access MedPLUS $66,127 286,639

John Deere Health Care/Heritage National Health Plan 0b 17,155

TLC Family Care Health Plan 391,305 35,421

Phoenix Healthcare 794,433 34,821

Prudential Community Care 94,743c 7,989

Total Health Plus (1,016,839) 6,316

VHP Community Care ($4,301,614) 12,558

aTennCare enrollment as reported by the state as of May 12, 1995.

bBoth John Deere and Prudential reported for their overall health care organizations rather than

only for their TennCare plans. An official of John Deere Health Care, which reported earnings of

$3.8 million on its Heritage National Health Plan of Tennessee, told us that it broke even on its

TennCare plan.

cThe Prudential Health Care Plan reported a net income of $25,497,539 for all its health care

plans. Information provided to us by a Prudential official showed that it earned $94,743 from its

TennCare operations after receipt of a supplemental capitation payment.

Adequacy of Reserves

Questioned for Three

HMOs

Reports reviewed by the Department of Commerce and Insurance for the

quarterly period ending June 30, 1994, indicated problems with the

adequacy of reserves for three HMOs. The problem was eliminated for one

HMO and largely eliminated for another when the Commissioner of Finance

and Administration assured the Commissioner of Commerce and

Insurance that the state would make adverse selection payments that

would address the reserves question. However, financial problems of the

third HMO—Access MedPLUS, which is one of the two statewide MCOs

serving TennCare beneficiaries and about 2.3 times the size of all other

HMOs combined—may not have been resolved.51

Examiners for the Department of Commerce and Insurance have raised

questions about Access MedPLUS’ financial viability.52 They reported that

a major asset—advance payments to medical providers—on the MCO’s

51Access MedPLUS has been criticized for its nonpayment of claims and an inadequate provider

network. A Tennessee Medical Association member survey ranked Access MedPLUS last among the

MCOs in physician satisfaction with MCOs’ fulfillment of their duties.

52The financial reports are filed by the Tennessee Managed Care Network, Inc. TennCare beneficiaries

in Access MedPLUS constitute nearly all of the network’s enrollment.

Page 39 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
Appendix II 

Financial Performance of TennCare’s MCOs

financial statements, representing about half of Access MedPLUS assets,

was questionable. They also could not reconcile the data in the financial

statements to the MCO’s general ledger and noted that the MCO did not

appear to have sufficient management and accounting controls to ensure

that funds were available to pay claims. They recommended that the MCO

be placed under the supervision of the Department of Commerce and

Insurance.

Further efforts to determine the financial performance of Access

MedPLUS have been problematic. According to Department of Commerce

and Insurance records, a Deloitte & Touche LLP review of the MCO,

contracted through the state, included determining (1) claims processing

ability, (2) amounts owed to providers, and (3) solvency or the degree of

insolvency. We sought the results of this review, but the State Attorney

General’s office would not release the report without a subpoena,

maintaining that the documents are confidential in accordance with state

law and that the report and its confidentiality were the subject of pending

litigation. To avoid the delay and expense that could result from issuing

and enforcing a subpoena, we decided not to use GAO’s statutory authority

to subpoena such records and to proceed without them.

State officials subsequently advised us that they were committed to

ensuring that MCOs are in full compliance with all statutory and contractual

requirements mandated by their participation in the TennCare program.

They stated that if any MCO is found not in compliance, the state will either

act to bring the MCO into compliance or pursue other remedies to protect

TennCare. They noted that, at this point, the state has taken no action to

place Access MedPLUS under supervision.

Page 40 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
Appendix III 

Start-Up Problems

Less than 7 months after submitting its waiver application to HCFA,

Tennessee placed its entire Medicaid population in a statewide prepaid

managed care program and opened enrollment to the uninsured. Before

TennCare, the state Medicaid program had little capitated managed care

experience nor a model to follow since Tennessee was the first state to

place its Medicaid population into such a program. Rapid program

implementation and lack of managed care experience led to several

problems, such as confusion among enrollees, providers, and MCOs;

provider resistance; and delays in enrollment, claims processing, and

premium payments.

Although many of these problems have been addressed to some degree,

the Assistant Commissioner in charge of the TennCare Bureau testified in

March 1995 that TennCare continues to experience several problems as

does any program in its “infancy.”

Limited Managed Care

Experience Led to

Confusion Among

MCOs, Beneficiaries,

and Providers

TennCare introduced a prepaid, capitated system, in which the TennCare

Bureau makes monthly payments to MCOs for enrollee care, and the Bureau

assumes responsibility for MCO oversight. The state Medicaid program had

primarily operated a fee-for-service reimbursement system. As a result,

state staff were inexperienced with the characteristics and complexities of

MCOs, and the state’s relationship with physicians and hospitals changed

dramatically under TennCare. Despite this lack of experience and the

magnitude of these changes, Tennessee began operating its statewide

program within 9 months of announcing it.

According to TennCare Bureau officials, they met with parties interested

in contracting as TennCare MCOs beginning in the summer of 1993.

However, interested parties did not enter into TennCare contracts until

late November, little more than a month before actual enrollment was to

begin. Of the 12 contracted MCOs, only 1 had experience serving the

Medicaid population before TennCare, and most of the MCOs developed

their TennCare products in response to TennCare. This inexperience

caused confusion for the contracted MCOs as well as TennCare

beneficiaries and participating providers. TennCare reported that after

program start-up, the state’s hotline averaged 50,000 calls a day, from

beneficiaries, MCOs, and providers—compared with 9,000 calls a day in the

following quarter. For all parties involved, the transition to TennCare was

Page 41 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
Appendix III 

Start-Up Problems

“traumatic,” according to a National Association of Public Hospitals (NAPH)

report in April 1994.53

The state reported general start-up problems for MCOs, such as inability to

handle the large volume of enrollee calls, adjusting to the increased

enrollment, and claims processing problems. According to the NAPH report,

the MCOs were unprepared to assume many of the contractual

responsibilities for TennCare. One MCO’s enrollment grew overnight from

35,000 to over 260,000, and officials from the MCO reported receiving 2,000

calls each hour in the first days of implementation. In addition, HCFA

Region IV’s 1994 Monitoring Report found that during the first months of

TennCare, multiple changes to enrollment and eligibility—some

retroactive—further burdened the MCOs. The president of one MCO said that

enrollment changed by over a third in 1 week. Officials from the MCOs we

visited found that verifying participant enrollment was nearly impossible

in the first months of the program.

Providers Take Action

Against TennCare

In December 1993, the Tennessee Medical Association (TMA) filed an

injunction to stop TennCare’s implementation. The court dismissed the

case, but TMA appealed the ruling. TMA opposed TennCare in part because it

had been implemented without opportunity for public comment on its

development and payment rates for providers were inadequate. TMA also

opposed BlueCross BlueShield’s “cram down” provision, which required

physicians who participated in a network that operated for state

employees and others to participate in TennCare. The provision prompted

about a third of the 6,500 providers in the network to drop out in the early

months of TennCare and providers in some parts of the state, particularly

rural Western Tennessee, to boycott the program. The state, however,

characterized initial problems with provider participation as the providers’

unwillingness to accept change.

Poor Communication

and Outreach Led to

Delays in Enrollment

Several start-up problems have been attributed to poor communication

and outreach, which affected providers and TennCare beneficiaries alike.

HCFA reported that (1) provider directories were not available to enrollees,

(2) information on operational guidelines for the general Medicaid

population was insufficient, and (3) notifications of MCO enrollment were

delayed. As a result, beneficiaries were confused about the number and

type of plans and the available providers, and some families signed up with

53National Association of Public Hospitals, Assessing the Design and Implementation of TennCare; A

National Health Reform Briefing Paper (Washington, D.C.: 1942).

Page 42 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
Appendix III 

Start-Up Problems

more than one MCO, exacerbating difficulties in managing enrollment.

Some beneficiaries were further frustrated when they found that their

primary care physicians were not participating in TennCare. A TMA

satisfaction survey of physicians in October 1994 reported lack of patient

understanding of TennCare as a major problem and recommended better

efforts by MCOs to educate and manage patients. In its 1994 monitoring

report, HCFA recommended expanding education and outreach efforts to

raise awareness of the availability of services and the method of obtaining

these services as well as frequent mailings to enrollees to explain benefits

and services.

Delays in signing providers with MCO networks and assigning patients to

primary care providers also presented several problems. To complicate

matters, providers—like the MCOs—had difficulty in obtaining information

on patient eligibility and identifying with which TennCare MCO a patient

was enrolled. Providers we talked to reported problems getting through by

phone to the state and MCOs to verify patient information. As a result,

providers needed to hire additional staff to manage the increased

administrative burden in dealing with more than one MCO.

Claims Processing

and Premium

Payments Delayed

Delays in claims processing and collecting premium payments have been a

problem. According to the state, MCOs had difficulty fully developing their

claims processing systems. For example, Access MedPLUS initially was

processing claims manually, which delayed provider reimbursement. In

addition, state external review organization reports from July to

November 1994 reported that 5 of the 12 MCOs exceeded the state 30-day

requirement to process claims. The largest discrepancy reported was a

76-day average from receipt of claim to the payment date.

The state initially estimated that it would collect premiums from qualifying

uninsured people of about $21 million during the first 6 months of

TennCare; however, it collected only $2.4 million. Over the next 12 months

(state fiscal year 1995), TennCare initially estimated collections of

$101 million and subsequently reduced this estimate to $30 million.

However, as of March 1995, with less than 4 months left in the state fiscal

year, only $10 million had been collected.

These collection shortfalls were due in part to the state’s delay in

establishing its premium billing process. Although enrollment of uninsured

people began in January 1994, the initial billings were not mailed until

June 1994. In addition, enrollees were given two alternatives to reduce the

Page 43 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
Appendix III 

Start-Up Problems

burden of paying the full accumulated premiums for the prior months:

(1) pay reduced premiums by retroactively changing from a low

cost-sharing plan to a cost-sharing plan with a higher deductible and

higher total out-of-pocket liability or (2) pay no premiums by changing

their effective enrollment dates to June 1, 1994. Enrollees were to receive

premium booklets and begin scheduled monthly payments in July 1994.

However, the state contractor failed to mail some of the booklets, and this

error was not discovered until November 1994. In February 1995, the

TennCare Bureau sent letters to nearly 60,000 TennCare households

notifying them of past due premiums totaling $31 million. As of June 1995,

a TennCare Bureau official said it had terminated TennCare coverage of

approximately 62,000 people for not paying premiums. In addition, 17,000

family units are now on a payment plan to pay past due premiums.

Page 44 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
Appendix IV 

Comments From the Health Care Financing

Administration

Page 45 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
Appendix IV 

Comments From the Health Care Financing

Administration

Page 46 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
Appendix IV 

Comments From the Health Care Financing

Administration

Page 47 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
Appendix IV 

Comments From the Health Care Financing

Administration

Page 48 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
Appendix IV 

Comments From the Health Care Financing

Administration

Page 49 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
Appendix IV 

Comments From the Health Care Financing

Administration

Page 50 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
Appendix V 

Comments From the Bureau of TennCare

Page 51 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
Appendix V 

Comments From the Bureau of TennCare

Page 52 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
Appendix V 

Comments From the Bureau of TennCare

Page 53 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
Appendix VI 

Major Contributors to This Report

Robert Hughes, Assistant Director

Daniel S. Meyer, Evaluator-in-Charge, (312) 220-7683

Richard N. Jensen, (202) 512-7146

Karin A. Lennon

Betty J. Kirksey

Karen Sloan

(101308) Page 54 GAO/HEHS-95-186 Tennessee Medicaid Managed Care
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