FQHCs and RHCs operate under separate programs, both of which were established to increase access to care for low-income people in medically underserved areas. FQHCs are required to provide a comprehensive set of primary care services to any individual, regardless of ability to pay. In addition, a distinguishing feature of FQHCs is that they provide enabling services that help patients gain access to health care, such as outreach, translation, and transportation. FQHCs include community health centers, migrant health centers, public housing programs, health care for the homeless, and other centers and clinics. FQHCs vary considerably based on their location, size of their uninsured and Medicaid populations, revenue mix, market competition, and managed care penetration in the surrounding area. For instance, an FQHC may be located in an urban area with a large uninsured or Medicaid population and high capitated Medicaid managed care penetration, or in a rural area, where it serves as the only source of primary health care for several communities. Currently, there are over 1,200 FQHCs operating over 3,000 delivery sites that provide services to about 11 million people each year. Unlike FQHCs, RHCs are not required to provide services to all individuals; however, they are required to operate in areas that are designated as underserved. RHCs can operate either independently or as parts of larger organizations, such as hospitals, skilled nursing facilities, or home health agencies. RHCs can serve as specialty clinics, focusing their services on particular populations or specialties such as pediatrics or obstetrics and gynecology. There are now approximately 3,500 RHCs. FQHCs and RHCs receive, on average, one-quarter to one-third of their revenues from Medicaid, a joint federal-state program that annually finances health care for more than 40 million low-income Americans. (See fig. 1.) FQHCs primarily rely on Medicaid reimbursement and HRSA grant funds as sources of revenue. From 1996 through 1999, Medicaid dollars per Medicaid patient increased from $348 to $383, while HRSA grant dollars per uninsured FQHC patient declined from $228 to $219. FQHCs also receive revenue from state, local, and private grants; Medicare and other public insurance; and self-pay and commercial insurance. In contrast, RHCs receive a smaller proportion of revenue from Medicaid and a much higher proportion of Medicare, commercial insurance, and self-pay revenue. Prior to BBA, federal law required state Medicaid programs to pay FQHCs and RHCs on a cost-related basis. In determining payments, states required FQHCs and RHCs to submit cost reports. States reviewed these cost reports to determine which reported costs were allowable (related to providing services to Medicaid beneficiaries) and reasonable (not an excessive amount for a type of cost or service). For purposes of reimbursing FQHCs and RHCs for services, the Medicaid statute directs states to follow the Medicare statute and regulations. The Medicare regulations provide guidance on the types of allowable costs, citing activities such as compensation for physicians and other staff, supplies, administrative overhead, and other items. With regard to reasonableness of cost, states may set limits, or in the case of RHCs, may rely on Medicare limits on the cost of providing a service. These limits can include a ceiling on recognized costs per service, such as a medical visit, or a limit on a type of cost, such as administrative costs. Since regulations require payments to be based on actual costs—which could only be reported after the close of an FQHC’s or RHC’s fiscal year— states generally made interim payments to FQHCs and RHCs throughout the year and subsequently adjusted these payments after actual cost reports were filed. The regulations state that these interim payments to FQHCs and RHCs are subject to reconciliation, which generally occurred after the submission of a cost report. During reconciliation, the total amount of reasonable costs was determined and compared to the interim payments that the FQHCs or RHCs received, and the state Medicaid program either paid any shortfall or recouped any overage. BBA gave states the option of phasing out cost-based reimbursement by percentage reductions in reasonable costs reimbursed—to 95 percent of an FQHC’s or RHC’s reasonable costs in 2000, 90 percent in 2001, 85 percent in 2002, and 70 percent in 2003—and discontinuing the cost-based reimbursement requirement after 2003. States were simultaneously required to make supplemental payments to FQHCs and RHCs that served capitated Medicaid managed care plan enrollees. Under BBA, states were required to compare the aggregate managed care plans’ payments to the amount that an FQHC or RHC would receive under the cost-based reimbursement methodology. In the event that total managed care payments were less, states were expected to provide supplemental payments to FQHCs and RHCs to make up the difference. BBRA slowed the phase out of cost-based reimbursement, freezing allowed reductions at 95 percent for 2001 and 2002. It allowed states to resume reductions to 90 percent of costs in 2003, 85 percent of costs for 2004, and a complete phase out of the cost-based reimbursement requirement in 2005. BBRA also extended requirements for supplemental payments through 2004 for FQHCs and RHCs participating in capitated Medicaid managed care. BIPA specified a new nationwide PPS to reimburse FQHCs and RHCs for Medicaid visits. An FQHC’s or RHC’s PPS rate is the average of its own 1999 and 2000 reasonable costs per visit, effective for services provided beginning January 1, 2001. For future years’ payments, this amount will be adjusted annually for inflation. In addition to this annual adjustment, BIPA requires that payments to FQHCs and RHCs be adjusted in the event of any increase or decrease in the scope of services furnished. States also may receive approval from HCFA to use an alternative system if they can demonstrate that the alternative payment methodology used results in rates no lower than the prospective system’s minimum payment and if the FQHC or RHC agrees to its use. In fulfilling prior federal requirements to use cost-based reimbursement for FQHCs and RHCs, many states controlled payment rates by imposing limits on costs considered reasonable. States generally reported using three types of spending limits—setting overall caps, limiting administrative costs, or setting performance standards—in defining reasonable costs. As a result, not all costs incurred by FQHCs, RHCs, or both were reimbursed. A few states did not reconcile costs—that is, compare the total Medicaid reimbursement with the total amount of Medicaid payments for a reporting period and settle any over- or under-payments—as required by HCFA regulation. BBA contained two major provisions regarding Medicaid reimbursement for FQHCs and RHCs: allowing states to reduce the percentage of reasonable cost reimbursed and mandating that states make supplemental payments. With regard to the first provision, most states did not choose to modify their payment practices and reduce the percentage of reasonable costs reimbursed. With regard to the second provision, 38 states and the District of Columbia were subject to the BBA requirement to provide supplemental payments to FQHCs and RHCs that were contracting with capitated Medicaid managed care plans in the event that plan payments were less than what these FQHCs and RHCs would have received under cost-based reimbursement. Many states’ Medicaid programs reported imposing one or more limits in defining FQHCs’ and RHCs’ reasonable costs. These limits can significantly affect what FQHCs and RHCs are paid. While most states employed a retrospective system that reconciled reimbursement with actual reasonable costs, at least seven states based payments for FQHCs, RHCs, or both on a prior period’s reasonable costs, and most adjusted them for inflation without a reconciliation process—a practice that is inconsistent with HCFA reconciliation regulations. For FQHCs, states reported using three types of limits in defining reasonable costs: setting overall caps, setting performance standards, or limiting administrative costs. Twenty-four states reported limits on how much they reimbursed for a patient’s visit, sometimes by comparing FQHCs’ costs across the state to establish a cap. Alabama and Florida, for example, limited reasonable costs to the 80th percentile of FQHCs’ costs per visit, while Maryland limited reasonable costs by establishing an overall cap at 115 percent of the median cost per visit across FQHCs. Twelve states limited reasonable costs by setting performance or productivity standards. For instance, some states stipulated the number of visits per year that a full-time-equivalent physician should provide; similar guidelines were used for nurse practitioners and physician assistants. Similarly, New Jersey required a certain number of visits per hour for physicians and other medical personnel. Ten states reported limits on administrative costs, disallowing administrative costs exceeding 30 to 45 percent of total costs. For example, Maryland limited the amount of administrative costs reimbursed to one-third of total costs, while Wisconsin did not reimburse administrative costs in excess of 30 percent of the center’s total costs. With regard to RHCs, 32 of the 45 states with RHCs reported relying on Medicare’s payment methodology for determining reasonable costs. Medicare payment policies include both an overall cap and a performance or productivity standard. In 2000, the Medicare payment cap for RHCs was $61.85 per visit. As noted above, HCFA regulations provide that Medicaid interim payments to FQHCs and RHCs are subject to reconciliation based on actual reasonable costs. Most states reimbursed FQHCs and RHCs under a retrospective system that includes interim payments based on estimated costs and a year-end reconciliation process to account for differences in reimbursement and actual reasonable costs. However, seven states (Colorado, Connecticut, Delaware, Florida, Maryland, New York, and Rhode Island) and the District of Columbia reported setting payment rates for FQHCs based on a prior year’s costs with most adjusting for inflation— essentially establishing prospectively determined rates. The difference between these states’ processes and states with end-of-year reconciliation is illustrated in figure 2. Four of the seven states—Delaware, Maryland, New York, and Rhode Island—were granted a waiver of the reconciliation requirement under Section 1115 of the Social Security Act. However, the remaining three states—Colorado, Connecticut, and Florida—and the District of Columbia were not in compliance with the reconciliation regulation since they did not reconcile with their FQHCs and RHCs and did not obtain a waiver of this requirement. Most states chose not to reduce their reimbursements to FQHCs and RHCs as allowed by BBA. According to our survey, five states and the District of Columbia chose to implement the BBA reduction to 95 percent of reasonable costs for their FQHCs, RHCs, or both. Alabama, Minnesota, and Nevada reduced payments to both FQHCs and RHCs. Connecticut and the District of Columbia reduced payments to FQHCs, while Maine did so for RHCs. As required by BBA, states with capitated managed care plans did make supplemental payments to FQHCs or RHCs or received a waiver from HCFA from this requirement. These supplemental payments were to make up the difference between the reimbursement FQHCs and RHCs received from managed care organizations and what they would have received under cost-based reimbursement. Not all states were required to make supplemental payments. Thirty-eight states and the District of Columbia were subject to this BBA requirement, while the remaining 12 states received approval from HCFA to waive supplemental payments. (See fig. 3.) Of the 38 states and the District of Columbia that were subject to the BBA requirement for supplemental payments, 12 states did not have capitated Medicaid managed care, so the BBA policy did not affect them. Twenty- five of the remaining 26 states and the District of Columbia made supplemental payments to FQHCs participating in Medicaid managed care, while 16 states made payments to RHCs. Fewer RHCs qualified for supplemental payments because many operated in areas that did not have managed care. (App. II shows states’ practices with regard to supplemental payments.) The 12 states that have received approval to waive supplemental payments are operating under Section 1115 waivers, under which HCFA can allow states to waive most federal Medicaid requirements for a demonstration project that is likely to assist in promoting program objectives. Of the 12 states with waivers, 4 states—Arizona, Hawaii, New York, and Rhode Island—made supplemental payments, but not the full amount that would be required under BBA. New York, for example, provided varying percentages of the difference between reasonable costs and managed care payments, depending on when mandatory managed care enrollment began in the county where the FQHC is located. New York reimbursed FQHCs 90 percent of the difference during the first year of mandatory managed care and 50 percent in subsequent years. RHCs in New York received supplemental payments only if (1) at least 50 percent of the RHC’s visits were provided to Medicaid beneficiaries or (2) 60 percent of the visits were provided to Medicaid beneficiaries and indigent persons; as of April 2001, no RHCs had qualified under this provision. In Rhode Island, supplemental payments were unrelated to the costs of an FQHC or RHC; instead, the state legislature allocated funds that were distributed to FQHCs and RHCs based on a set per-member-per-month amount. BIPA established a new nationwide PPS for Medicaid that is likely to constrain future payments. In particular, some FQHCs and RHCs may receive Medicaid payment increases that are lower than what they have received in the past. Ultimately, an FQHC’s or RHC’s ability to manage under the new PPS will depend on its initial payment rate, and changes it can make to keep its cost growth at or below the inflation index. All states—including those with 1115 waivers—will have to comply with the new payment system requirement established by BIPA. Under this new system, an FQHC’s or RHC’s prospective payment rate is the average of its own 1999 and 2000 reasonable costs per visit, which will be updated for inflation in future years. These initial rates became effective for services provided beginning January 1, 2001. States may receive approval from HCFA to use an alternative system to reimburse some or all of their FQHCs and RHCs, if they can demonstrate that the alternative payment methodology would result in rates no lower than the prospective system’s minimum payment and if the FQHC or RHC agrees to the alternative methodology. In addition, BIPA requires that we assess the need for adjusting the initial rate for FQHCs and RHCs. States can continue to use their prior methods of determining reasonable costs in establishing the 2001 payment rate under the PPS. Under these circumstances, the initial PPS rates would reflect average 1999 and 2000 per-visit reasonable costs rather than the actual costs incurred by the FQHC or RHC. For the FQHCs and RHCs in the states that have applied limits in determining reasonable costs, this could result in 2001 PPS rates well below their actual costs. In contrast, the 2001 PPS rate for FQHCs and RHCs in states that did not incorporate reasonable cost limits—or that have costs below their states’ overall caps—will be closer to their actual costs. Further, the 2001 PPS rate will not be updated for inflation from 1999 through 2001. This could mean that most FQHCs and RHCs would receive lower per-visit payments in 2001 than in the prior year. BIPA does require the rates for 2002 be adjusted for inflation using the Medicare Economic Index for primary care services (MEI-PC). This adjustment will be the only automatic annual modification of Medicaid rates to reflect increasing costs. If changes in patients’ needs or other factors result in costs increasing more than the index, those additional costs will not result automatically in higher Medicaid rates as they did under the prior state systems. The MEI-PC has increased less than other measures of inflation, making the Medicaid payment increases under the PPS less than what some states have used in the past. For example, four states that previously set prospective rates using a prior year’s cost updated for inflation used inflation indexes that have grown faster than the MEI-PC. (See table 1.) The PPS created by BIPA provides stronger control over state payments to FQHCs and RHCs than the previously required cost-based systems by limiting per-visit payment increases to what appears to be a historically low measure of inflation. It also creates incentives and pressures for FQHCs and RHCs to operate efficiently. However, the pressure on individual FQHCs and RHCs to control or reduce costs, created by the PPS, could vary considerably. If payment increases lag behind necessary cost increases, FQHCs and RHCs with low average costs may have less ability to keep future costs at or below their payment rates than higher cost centers. FQHCs’ and RHCs’ ability to manage under the new PPS will depend on their initial rate and their ability to keep cost growth at or below the inflation index. For example, FQHCs and RHCs that had a low volume of visits and high per-visit costs when the rates were established may be better able to manage by increasing service volume to lower their per-visit costs. FQHCs and RHCs with low initial per-visit costs, however, may have more difficulties. To the extent that lower initial per-visit costs already reflect greater efficiency, there may be fewer options for an efficient FQHC or RHC to adapt to necessary cost increases not reflected in the inflation index. FQHCs and RHCs that face an increasingly complex mix of patients may be also disadvantaged as the PPS incorporates payment increases only related to inflation or changes in scope of service. Because of their heightened reliance on Medicaid, FQHCs are likely to be more affected than RHCs by the new payment system. As noted earlier, grant dollars per uninsured FQHC patient have been declining, making Medicaid reimbursement even more critical to FQHC operations. In part because of their mandate to preserve and expand necessary primary care health services, FQHCs and RHCs have received reimbursement based on their costs in an effort to ensure adequate payment. However, this approach does little to encourage efficiency. The new payment system mandated by BIPA attempts to ensure adequacy by basing payments on historical rates while promoting efficiency by limiting increases. However, the combination of reimbursement limits imposed historically by many states and the inflation adjustments in the new PPS may constrain future Medicaid payment to some FQHCs and RHCs. Finding a mechanism to strike the proper balance between payment adequacy and incentives for efficiency has been, and will likely be, a challenge. We provided HHS an opportunity to comment on a draft of this report. In its comments, HHS generally concurred that the new BIPA PPS has the potential to limit payments to FQHCs and RHCs. Although HHS stated that the BIPA payment system may result in higher payments than the staged phase out of cost-based reimbursement, as we note in the report, we found that few states had taken action aimed at making reductions in cost-based reimbursement. HHS also agreed that the effects of the new system would vary among FQHCs and RHCs, and that FQHCs and RHCs that are already operating efficiently could be penalized. HHS suggested that we place greater emphasis on three aspects of the BIPA PPS. In particular, HHS suggested that we include more discussion about potential adjustments to the base rate in addition to those for inflation. We have done so by including additional reference to BIPA’s provision that rates should be adjusted to account for a change in the scope of service. Second, HHS suggested that we place greater emphasis on states’ ability to implement an alternative payment methodology under BIPA, which may result in higher payments to FQHCs and RHCs. Our draft report already recognized that payments under the alternative methodology can be no lower than payments under the PPS, and we have not changed the report. Third, HHS requested that we emphasize that states cannot impose a stricter definition of reasonable costs in establishing 2001 payment rates than they had under the prior reimbursement system. We have no basis to question HHS’ position, but because BIPA does not include explicit language to that effect, we have not modified the report. HHS also provided technical comments, which we incorporated where appropriate. HHS’ comments are provided in appendix III. We are sending copies of this report to the Secretary of Health and Human Services and other interested parties. We will also make copies available to others on request. If you or your staffs have questions about this report, please contact me or Janet Heinrich at (202) 512-7114. An additional GAO contact and the names of other staff who made key contributions to this report are listed in appendix IV. To describe how states implemented cost-based reimbursement and the extent to which states’ practices changed as a result of BBA, we surveyed Medicaid officials in the 50 states and the District of Columbia regarding their FQHC and RHC reimbursement policies. We analyzed responses to our mail survey from all 50 states and the District of Columbia regarding whether states were phasing out or continuing cost-based reimbursement or had a waiver of the cost-based reimbursement requirement, states’ reimbursement practices, managed care participation and supplemental payments, and general information on other funding sources. Additionally, we interviewed representatives from 12 state Primary Care Associations, which are private, nonprofit membership organizations that receive grant funds from HRSA. We also analyzed national demographic, financial, and utilization information on FQHCs using HRSA’s Uniform Data System (UDS) for 1996 through 1999. We conducted site visits in five states: Michigan, New York, Ohio, Oklahoma, and Rhode Island. We selected these states because they had (1) unique reimbursement methodologies, (2) rural and/or urban populations, or (3) different levels of managed care penetration. These states also varied in their policies regarding supplemental payments, ranging from making the full payments required by BBA to having received approval to waive supplemental payments entirely. Within each state, we interviewed representatives from the Medicaid office and Medicaid managed care organizations. We also met with officials from eight FQHCs and nine RHCs. To assess the impact of the new PPS enacted under BIPA for 2001, we examined BIPA in light of previous statutes regarding Medicaid reimbursement for FQHCs and RHCs and HCFA regulations applicable to the new statute. We examined the indexes used by four states– Connecticut, Colorado, Delaware, and Florida—from 1996 through 1999 and compared them to the annual inflation adjustments specified in BIPA. Our work was conducted from May 2000 through May 2001 in accordance with generally accepted government auditing standards. Table 2 shows states’ practices regarding the provision of supplemental payments to FQHCs and RHCs participating in capitated Medicaid managed care. As shown below, 25 states and the District of Columbia have made supplemental payments to FQHCs as required by BBA. Additionally, four states have made payments to FQHCs that are not the full amount required under BBA since the states have 1115 waivers. RHCs have received supplemental payments as required by BBA in 16 states, while 2 states with 1115 waivers have made some level of payment to RHCs. The remaining states do not make supplemental payments to FQHCs or RHCs because there is no capitated Medicaid managed care in the state, no FQHCs or RHCs contract with Medicaid managed care organizations, or the state has an 1115 waiver and thus is not required to make supplemental payments. Catina Bradley, Barbara Chapman, Michelle Rosenberg, Behn Miller, Sharon Brigner, Anne Dievler, and Evan Stoll made key contributions to this report. Health Care Access: Programs for Underserved Populations Could Be Improved (GAO/T-HEHS-00-81, Mar. 23, 2000). Community Health Centers: Adapting to Changing Health Care Environment Key to Continued Success (GAO/HEHS-00-39, Mar. 10, 2000). Health Care Access: Opportunities to Target Programs and Improve Accountability (GAO/T-HEHS-97-204, Sept. 11, 1997). Rural Health Clinics: Rising Program Expenditures Not Focused on Improving Care in Isolated Areas (GAO/HEHS-97-24, Nov. 22, 1996).

Summary: To increase the accessibility of primary and preventive health services for low-income people living in medically underserved areas, Congress made federally qualified health centers and rural health clinics eligible for Medicaid payments. Since 1989, federal law has required Medicaid to reimburse both the centers and the clinics on the basis of reasonable costs they incurred in providing services to beneficiaries. Cost-based reimbursement can ensure that service providers are reimbursed for necessary costs; it is also regarded as inflationary because providers can increase their payments by raising their costs. In part because of their mandate to preserve and expand necessary primary health care services, the centers and the clinics have traditionally been reimbursed on the basis of their costs in an effort to ensure adequate payment. However, this approach does little to encourage efficiency. The new payment system mandated by the Benefits Improvement and Protection Act attempts to ensure adequacy by basing payments on historical rates while promoting efficiency by limiting increases. However, the combination of reimbursement limits imposed historically by most states and the inflation adjustments in the new prospective payment system may contain future Medicaid payment to some centers and clinics. Finding a way to strike the proper balance between payment adequacy and incentives for efficiency has been, and will likely be, a challenge.