Medicaid: Tennessee's Program Broadens Coverage But Faces Uncertain
Future (Letter Report, 09/01/95, GAO/HEHS-95-186).

Pursuant to a congressional request, GAO reviewed Tennessee's Medicaid
capitated managed care program (TennCare), focusing 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.

GAO found that: (1) TennCare's objectives are to expand health care
coverage to the state's uninsured and to control program costs by
mandating that Medicaid participants enroll in managed care
organizations (MCO) and covering certain uninsured, Medicaid-ineligible
persons; (2) Tennessee has cut costs by setting its capitation rates
below historical Medicaid costs, applying an additional discount based
on the assumption that extensive insurance coverage would reduce charity
care costs, and discontinuing certain supplemental payments; (3) in
granting the Medicaid waiver, the Health Care Financing Administration
has required Tennessee to implement measures to monitor and ensure
access to quality care and has limited federal payments over the
program's 5 years to ensure that federal costs do not exceed what they
would have been without the waiver; (4) despite the increased number of
participants, federal and state TennCare expenditures have increased
much less than the national average for Medicaid programs and program
costs have actually declined when uncapitated administrative and
long-term care costs are excluded; (5) access to and quality of care
could not be measured because Tennessee and MCO have not yet set up
their monitoring systems, but a survey of beneficiaries revealed
significant dissatisfaction with the new program because of the limited
choice of doctors and difficulty in finding providers; (6) many MCO and
providers lost money in 1994 despite receiving supplemental payments
from TennCare; and (7) although TennCare has met its initial objectives,
its long-term success is uncertain.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  HEHS-95-186
     TITLE:  Medicaid: Tennessee's Program Broadens Coverage But Faces 
             Uncertain Future
      DATE:  09/01/95
   SUBJECT:  Medicaid programs
             State-administered programs
             Financial management
             Waivers
             Health care cost control
             Health maintenance organizations
             Medical services rates
             Disadvantaged persons
             Federal/state relations
             Health resources utilization
IDENTIFIER:  Tennessee
             TennCare
             Tennessee Children's Plan
             Medicaid Disproportionate Share Program
             Tennessee Primary Care Provider Fund
             Tennessee Comprehensive Health Insurance Program
             
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Cover
================================================================ COVER


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

Tennessee Medicaid Managed Care

(101308)


Abbreviations
=============================================================== ABBREV

  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

Letter
=============================================================== LETTER


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
------------------------------------------------------------ Letter :1

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 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 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
------------------------------------------------------------ Letter :2

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 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 requirements\1 --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. 


   SCOPE AND METHODOLOGY
------------------------------------------------------------ Letter :3

To meet our reporting objectives, we interviewed officials and
reviewed documents from the TennCare Bureau\4 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. 


--------------------
\4 Until 1995, the TennCare Bureau was part of the Tennessee
Department of Health.  It is now under the Department of Finance and
Administration. 


   TENNCARE PROGRAM DESIGNED TO
   EXPAND COVERAGE AND CONTAIN
   COSTS
------------------------------------------------------------ Letter :4

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
---------------------------------------------------------- Letter :4.1

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, 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. 


      TENNCARE INTRODUCED
      STATEWIDE PREPAID MANAGED
      CARE TO MEDICAID
---------------------------------------------------------- Letter :4.2

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 Plan\12 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. 

   Figure 1:  TennCare's MCOs by
   Region

   (See figure in printed
   edition.)

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. 



                                Table 1
                
                       TennCare Enrollment by MCO

                                                Ty  Enrollme   Percent
MCO                                             pe        nt  of total
----------------------------------------------  --  --------  --------
BlueCross BlueShield of Tennessee               PP   602,361     49.87
                                                 O
Access MedPLUS                                  HM   286,639     23.73
                                                 O
Health Net                                      PP    75,276      6.23
                                                 O
OmniCare Health Plan                            PP    64,006      5.30
                                                 O
Preferred Health Partnership                    PP    61,514      5.09
                                                 O
TLC Family Care Healthplan                      HM    35,421      2.93
                                                 O
Phoenix HealthCare                              HM    34,821      2.88
                                                 O
John Deere HealthCare/Heritage National Health  HM    17,155      1.42
 Plan                                            O
VHP Community Care                              HM    12,558      1.04
                                                 O
Prudential Community Care                       HM     7,989      0.66
                                                 O
Total Health Plus                               HM     6,316      0.52
                                                 O
TennSource                                      PP     3,834      0.32
                                                 O
======================================================================
Total                                               1,207,89    100.00
                                                           0
----------------------------------------------------------------------
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. 


--------------------
\10 On 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. 

\11 Tennessee 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. 

\12 The 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. 

\13 PPOs' 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. 


      SUPPLEMENTAL PAYMENTS ASSIST
      PARTICIPATING HOSPITALS AND
      PHYSICIANS
---------------------------------------------------------- Letter :4.3

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. 

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
---------------------------------------------------------- Letter :4.4

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 year\15 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. 



                          Table 2
          
           Estimated State Fiscal Year 1995 Costs
                   for Expanded Coverage

                   (Dollars in millions)

--------------------------------------------------  --  --
Additional costs
----------------------------------------------------------
Capitation payments for 500,000\a uninsured net of  $5
 discounts                                          19
Primary Care Provider Fund                          17
                                                     1
Net additional costs                                    $6
                                                        90

Costs avoided
----------------------------------------------------------
Reduction in capitation rate for 1 million          (3
 Medicaid eligibles                                 82
 for charity care, including local government        )
 contributions\b
Discontinued DSH payments\c                         (4
                                                    38
                                                     )
Net costs avoided                                       $(
                                                        82
                                                        0)
Net cost of state fiscal year 1995 coverage             $(
 expansion                                              13
                                                        0)
----------------------------------------------------------
Note:  The numbers used for Medicaid eligibles, uninsured, and the
Primary Care Provider Fund are for the second year of the waiver. 

\a Based 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. 

\b The average enrollee monthly charity care and local government
deductions equal $31.83. 

\c Amount 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. 


--------------------
\14 The 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. 

\15 Tennessee'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. 

\16 After 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. 


      WAIVER IMPOSES LIMIT ON
      FEDERAL SPENDING
---------------------------------------------------------- Letter :4.5

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 without TennCare\17 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)

                                                  Spending
State fiscal year                                    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)

                                  Percent cumulative limit
State fiscal    Cumulative          exceeds sum of federal
year                 limit                 spending limits
--------------  ----------  ------------------------------
1994                $2.277                               8
1995                 4.654                               6
1996                 7.119                               4
1997                 9.628                               2
1998               $12.165                            none
----------------------------------------------------------
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


--------------------
\17 To 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. 

\18 We 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. 


      FINANCING ARRANGEMENTS AND
      EXPANSION OF COVERAGE FAVOR
      THE STATE
---------------------------------------------------------- Letter :4.6

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. 

The state is allowed to claim hospital losses incurred in caring for
TennCare eligibles at certain public and private hospitals\19 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 coverage\22 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 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 Program\24 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


--------------------
\19 HCFA 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. 

\20 State 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. 

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

\22 Coverage is limited to the first 30 days of an inpatient episode,
subject to an annual aggregate limit of 60 days. 

\23 Although 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. 

\24 Tennessee Comprehensive Health Insurance Program is a state
insurance program for the uninsurable, who are automatically eligible
for TennCare. 

\25 The 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. 

\26 According to the Deputy Commissioner, Tennessee Department of
Commerce and Insurance, PPOs paid the taxes under protest and may
file a suit against the state. 


      WAIVER INCLUDES VARIOUS
      ACCESS AND QUALITY ASSURANCE
      STANDARDS
---------------------------------------------------------- Letter :4.7

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
------------------------------------------------------------ Letter :5

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


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


      COST AND CONTROL OBJECTIVES
      LARGELY MET
---------------------------------------------------------- Letter :5.1

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 system\30
on January 1, 1994, that paid rates far below historical Medicaid
payments. 


--------------------
\28 Although 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. 

\29 Tennessee'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. 

\30 From 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. 


      ACCESS AND QUALITY OF CARE
      UNCERTAIN
---------------------------------------------------------- Letter :5.2

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.  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 1994\32 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 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. 


--------------------
\31 In 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. 

\32 We 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. 

\33 The 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. 


   PROGRAM FUTURE DEPENDS ON
   SEVERAL FACTORS
------------------------------------------------------------ Letter :6

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. 


      TENNCARE'S QUESTIONABLE
      CAPITATION RATES MAY
      SIGNIFICANTLY AFFECT PROGRAM
      SUCCESS
---------------------------------------------------------- Letter :6.1

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 Bureau\35

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.)


--------------------
\34 According to Milliman and Robertson, Inc., the state reported
regional cost variations ranging from 83 to 122 percent of statewide
average costs. 

\35 The 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. 


      MCOS REPORT LOSSES
---------------------------------------------------------- Letter :6.2

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 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 payments\37 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 not
reflect the excess medical costs on its financial statement because
officials said it was the providers' liability. 


--------------------
\36 We 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. 

\37 Reported 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. 


      TENNCARE'S FINANCIAL IMPACT
      ON PROVIDERS UNCERTAIN
---------------------------------------------------------- Letter :6.3

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
-------------------------------------------------------- Letter :6.3.1

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' 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. 


--------------------
\38 The purpose of the study was to calculate the allowable TennCare
claim for federal reimbursement on the basis of losses at publicly
funded, nonstate hospitals. 

\39 The 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. 

\40 THA 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. 


         PHYSICIANS REPORT THEIR
         PRACTICES ARE FINANCIALLY
         WORSE OFF UNDER TENNCARE
-------------------------------------------------------- Letter :6.3.2

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 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. 


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


         COMPARING BLUECROSS
         BLUESHIELD TENNCARE
         PHYSICIAN REIMBURSEMENT
         RATES WITH MEDICAID IS
         INCONCLUSIVE
-------------------------------------------------------- Letter :6.3.3

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
---------------------------------------------------------- Letter :6.4

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
-------------------------------------------------------- Letter :6.4.1

Although all participating MCOs have renewed their contracts for
state fiscal year 1996, concerns remain.  We talked to officials from
three MCOs 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 cost-
containment efforts fail, the MCO will simply make payments until it
can no longer do so. 


--------------------
\42 In 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. 


         CONTINUED PROVIDER
         PARTICIPATION ALSO
         UNCERTAIN
-------------------------------------------------------- Letter :6.4.2

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 hospitals\43 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. 


--------------------
\43 HCFA 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. 


   CONCLUSIONS
------------------------------------------------------------ Letter :7

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 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
------------------------------------------------------------ Letter :8


      RECENT STATE EFFORTS
---------------------------------------------------------- Letter :8.1

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. 


--------------------
\44 The 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. 


      MCOS' RENEWALS
---------------------------------------------------------- Letter :8.2

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 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
---------------------------------------------------------- Letter :8.3

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
---------------------------------------------------------- Letter :8.4

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 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
---------------------------------------------------------- Letter :8.5

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.)


---------------------------------------------------------- Letter :8.6

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


TENNESSEE'S METHODOLOGY FOR
SETTING CAPITATION RATES AND
CONCERNS ABOUT THE METHODOLOGY
=========================================================== Appendix I

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
--------------------------------------------------------- Appendix I:1

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 $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. 


--------------------
\45 The estimate is based on information from the University of
Tennessee and estimates made by health care providers in meetings
with state officials. 


   VALIDITY OF CAPITATION RATES
   QUESTIONED
--------------------------------------------------------- Appendix I:2

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 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 TennCare\47
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 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 the deductible reductions were too high because
they are based on the assumption that all enrollees would incur costs
exceeding the deductible. 

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. 


--------------------
\46 Peat 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. 

\47 Formally 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. 

\48 Although 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. 

\49 As 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. 


   BLUECROSS BLUESHIELD REPORTED
   LOSSES FOR THE FIRST YEAR OF
   TENNCARE
-------------------------------------------------------- Appendix II:1

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. 


--------------------
\50 BlueCross 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. 


   OTHER PPOS' FINANCIAL REPORTS
   RAISE CONCERNS
-------------------------------------------------------- Appendix II:2

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. 


   HMOS' REPORTED EARNINGS MIXED
-------------------------------------------------------- Appendix II:3

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

                                                Enrollees\
HMO                                 Net income           a
----------------------------------  ----------  ----------
Access MedPLUS                         $66,127     286,639
John Deere Health Care/Heritage            0\b      17,155
 National Health Plan
TLC Family Care Health Plan            391,305      35,421
Phoenix Healthcare                     794,433      34,821
Prudential Community Care             94,743\c       7,989
Total Health Plus                   (1,016,839       6,316
                                             )
VHP Community Care                  ($4,301,61      12,558
                                            4)
----------------------------------------------------------
\a TennCare enrollment as reported by the state as of May 12, 1995. 

\b Both 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. 

\c The 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
-------------------------------------------------------- Appendix II:4

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 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. 


--------------------
\51 Access 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. 

\52 The financial reports are filed by the Tennessee Managed Care
Network, Inc.  TennCare beneficiaries in Access MedPLUS constitute
nearly all of the network's enrollment. 


START-UP PROBLEMS
========================================================= Appendix III

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
------------------------------------------------------- Appendix III:1

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 "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. 


--------------------
\53 National Association of Public Hospitals, Assessing the Design
and Implementation of TennCare; A National Health Reform Briefing
Paper (Washington, D.C.:  1942). 


   PROVIDERS TAKE ACTION AGAINST
   TENNCARE
------------------------------------------------------- Appendix III:2

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
------------------------------------------------------- Appendix III:3

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 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
------------------------------------------------------- Appendix III:4

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 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. 




(See figure in printed edition.)Appendix IV
COMMENTS FROM THE HEALTH CARE
FINANCING ADMINISTRATION
========================================================= Appendix III



(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)




(See figure in printed edition.)Appendix V
COMMENTS FROM THE BUREAU OF
TENNCARE
========================================================= Appendix III



(See figure in printed edition.)



(See figure in printed edition.)


MAJOR CONTRIBUTORS TO THIS REPORT
========================================================== Appendix VI

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

