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Did California’s Medicaid HMO contracts save the state money?

Written By: Jason Shafrin - Apr• 28•08

Throughout its history, Medicaid provided health insurance for the nation’s poor. It did this by reimbursing providers on a fee-for-service basis. In the 1990s, however, California and other states decided to let private insurance companies bid for the right to provide services for Medicaid patients. These HMOs would receive a fixed per patient per month payment and the private insurer would be responsible for providing health care to Medicaid enrollees.

HMOs may be more efficient than the government since 1) they have an incentive to keep enrollees healthy to save cost, 2) they can negotiate lower input prices, and 3) competition may lead to higher quality, lower priced medical care. On the other hand, keeping the government run fee-for-service program may have been more efficient if 1) the government’s size and negotiating power could decrease input costs, 2) there may be increasing returns to scale, 3) the HMOs may include significant markups in their bids, and 4) HMOs may offer medical services which do not appeal to unhealthy enrollees (i.e., adverse selection).

A paper by Mark Duggan in the Journal of Public Economics in 2004 aims to see if contracting out Medicaid health care provision to private HMOs decreased costs. Duggan uses the fact that California enacted a mandate that all AFDC Medicaid enrollees must switch to a private HMO. For other individuals, such as those on SSI and those who were disabled, deaf or blind, the switch to the HMO was voluntary. This mandate was enacted between January 1993 and December 1999 depending on the county. The author uses variation in the county enactment date to find the effect of Medicaid HMOs on cost.


The manner in which California instituted the transitioned individuals into private managed care plans can be categorized into 3 groupings:

  1. Geographic Managed Care. “the state government contracts with several commercial HMOs to coordinate care for Medicaid recipients. Plans initially applied by submitting a menu of prices at which they would be willing to insure each type of Medicaid recipient. The government then awarded contracts to the plans most likely to deliver high quality medical care at a low price, though the weight placed on quality and spending was not specified.”
  2. County Organized Health System (COHS). “Under this model, the not-for-profit, community-based HMO was reimbursed a fixed amount per recipient-month that varied by eligibility category.” Individuals did not have any plan choice and the state did not allow bids from for-profit firms.
  3. “Two plan” counties. In these counties, the Medicaid enrollees would be able to choose between one private, commercial plan and one not-for profit plan. “…the state solicited bids from private companies and awarded a contract to just one of the plans.”

The following chart gives the type and date of managed care mandate by county.

County Mandate Type Date of mandate Pre-mandate % MC
Santa Barbara COHS 9/83
San Mateo COHS 12/87
Sacramento GMC 4/94 8.5%
Solano COHS 5/94 1.4%
Orange COHS 10/95 22.3%
Alameda Two-plan 1/96 4.6%
Santa Cruz COHS 1/96 0.0%
San Joaquin Two-plan 2/96 0.9%
Kern Two-plan 7/96 0.0%
San Francisco Two-plan 7/96 14.1%
Riverside Two-plan 9/96 30.3%
San Bernardino Two-plan 9/96 30.2%
Santa Clara Two-plan 10/96 4.1%
Fresno Two-plan 11/96 4.3%
Contra Costa Two-plan 2/97 22.6%
Stanislaus Two-plan 2/97 0.0%
Los Angeles Two-plan 4/97 39.0%
Napa COHS 3/98 0.0%
San Diego GMC 7/98 58.3%
Tulare Two-plan 2/99 0.0%
Monterey COHS 10/99 0.0%


Duggan uses the following equations to estimate spending.

  • ManCarejkt = α1 + γ1Mandatekt + μ1Xjkt + θ1j + λ1t + t*ρ1k + ε1jkt
  • Spendingjkt = α2 + γ2Mandatekt + μ2Xjkt + θ2j + λ2t + t*ρ2k + ε2jkt

Subscripts j, k, and t index individuals, counties, and years respectively. The variable Mandate is equal to the fraction of individual j‘s Medicaid eligible months in which a mandate was in effect. ManCare is equal to the fraction of the j‘s eligible months in which he is actually enrolled in an HMO. Spending is equal to the Medicaid spending for person j at time t.


Duggan finds that the managed care mandate increased Medicaid spending. Medicaid spending increased by between 17% and 23% for counties in which the mandate came into effect. These results, however, were less pronounced where there was competitive bidding between insurance companies (i.e., the Geographic Managed Care and “Two plan” counties).

Also, despite the increased spending, the author finds no evidence of increased quality in terms of better infant birth outcomes.

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