Young people growing up in California lived under the dark shadow of the risk of a cataclysmic earthquake (also known as “The Big One”) that would destroy their homes and lives. Two significant earthquakes—the 1971 Sylmar quake in the Los Angeles’ suburban San Fernando Valley (6.6 on the Richter Scale) and the 1989 Loma Prieta quake (6.9 on the Richter Scale) in the southern mountains of the San Francisco Bay Area—killed dozens, reminding residents of nature’s frightening hidden power. But these quakes left the rest of California intact. So far, the Big One has not arrived.

On May 4, 2017, with the passage of the Republicans’ American Health Care Act (AHCA) in the US House of Representatives, a sharp tremor was felt by California’s vast health system. The AHCA threatens withdrawal of at least $150 billion from the state’s health system over the next ten years, with the sharpest reductions felt from 2020 thru 2022. However, even if the House bill fails to become law, if history is any guide, California’s notoriously cyclical economy may not ultimately sustain the weight of the state’s expanded Medi-Cal program, posing future economic risks to its care system.

Sheer Scale Of California’s Coverage Expansion

California’s aggressive expansion of Medi-Cal and the state’s insurance exchange, Covered California, brought the state’s uninsured rate down by a full 10 percentage points, from more than 17 percent in 2013 to around 7 percent today. In a state with almost 39 million residents, there are less than three million uninsured. Of this number, 60 percent are undocumented adults. Undocumented children younger than age 19 were covered by a special, state-funded supplemental Medi-Cal program that started in 2016.

California’s 60 percent coverage expansion resulted in a gargantuan Medi-Cal program, covering more than 14 million people, 36 percent of the state’s residents. Medi-Cal spending has more than tripled from $33 billion in 2005 to $112 billion in the current fiscal year. There are only three other states in the United States with more total residents than California’s Medi-Cal enrollment (Texas, New York, and Florida). One California Medi-Cal managed care plan, the county-sponsored Inland Empire Health Plan covering San Bernardino and Riverside counties, has nearly 25 percent more enrollees than the entire Medicaid program in Oregon.

Even though California’s regular Medicaid federal matching rate is 50 percent, the federal government presently picks up fully two-thirds of Medi-Cal spending, among the enhanced federal match for the expansion group (those between 100 percent and 138 percent of poverty), enhanced State Children’s Health Insurance Program matching, nearly $10 billion for a five-year 1115 Medicaid waiver, and a few other programs.

Moreover, the non-federal part of Medi-Cal’s funding is highly diversified. The state’s general fund, which is notoriously responsive to economic trouble and dependent on the incomes of a few hundred thousand very wealthy Californians, picks up only a little more than half (58 percent) of the total state share of Medi-Cal. Most of the incremental state funding for the Medi-Cal expansion has come from provider taxes, dubbed (in a creative feat of political labeling) quality assurance fees, which kick in another roughly $5 billion.

Exhibit 1

Source: California Legislative Analyst’s Office, 2017.

In November 2016, California voters approved Proposition 52 by a 70 percent majority, making the hospital quality assurance fees permanent and providing the state’s general fund an additional $1 billion. Proposition 52 required a two-thirds vote of the legislature to abolish the quality assurance fees and forbade the legislature from using the funds for other purposes than Medi-Cal funding.

Proposition 52 also mandated that hospital payment rates for the fee-for-service portion of Medi-Cal could not be reduced as long as the fee, and federal matching for the fee, remained in place! The success of this ballot measure was testimony to the power of California’s hospital advocates.

There are also state taxes on nursing homes and intermediate care facilities and on health plans. Counties also contribute more than $5 billion to Medi-Cal. Finally, 83 percent of California’s steep tobacco tax is allocated to Medi-Cal funding, as well as a yet-to-be-determined chunk of the state’s new tax on marijuana, legalized for recreational use in 2016. The powerful incentive behind raising these supplemental revenues is that they are basically doubled by the federal government through its 50 percent federal match.

A Successful Health Exchange Complemented The Medi-Cal Expansion

California also created its own health exchange, Covered California, which has enrolled 1.4 million people, supported by $5.4 billion in federal subsidies from the Affordable Care Act (ACA), $4.6 billion in direct premium subsidies, and $800 million in cost-sharing reduction payments to reduce out-of-pocket outlays for subscribers. Covered California is an “active” exchange, curating insurance offerings based on a competitive process. Eleven insurers participate, and in all but one county, exchange users have four choices of health plans conforming to the federal benefit and actuarial value requirements.

The active curation by Covered California held annual premium increases in the first two years of operations down to 4 percent, a notable contrast to other state exchanges. Rates rebounded somewhat, to a 13 percent increase for the 2017 enrollment year, still far below the experience in most other states.

Useful operational knowledge for Covered California came from more than a decade’s experience with the state’s vast public employee benefit system, called the California Public Employees’ Retirement System (CalPERS). With more than 1.8 million covered lives, CalPERS has long used competitive health plan offerings to lower its members’ health costs.

California’s Population-Based Payment System

California has the most elaborate managed care infrastructure in the United States and one of most heavily regulated. In fact, health maintenance organizations accounted for so much of the state’s health financing that California created a separate Department of Managed Health Care to regulate it.

California’s coverage expansion rested on an at-risk payment and care system infrastructure that is in many ways what the ACA intended for the rest of the country. Much of this infrastructure came into being in the 1980s, coincident with the state’s managed care explosion. This explosion was a response of private practicing clinicians and hospital systems to the continued threat of Kaiser Permanente, three-fourths of whose 11.3 million person enrollment is in California.

California’s metropolitan health care markets are characterized by a complex structure of risk-bearing enterprises such as independent practice associations, mainly physician controlled, that accept delegated risk from the state’s health plans. This structure is particularly dense in Southern California’s metropolitan markets, which have significantly lower hospital per capita revenues not only than in Northern California’s large markets but also the rest of the United States.

Exhibit 2

Source: Glenn Melnick, from OSPD database, adjusted for Medicare wage index.

Capitation Appears To Be Shifting From California’s Commercial Market To Its Public Coverage Programs

However, this delegated risk model appears to be shrinking in scope in the commercially insured segment of California’s market. According to a recent analysis for the California Health Care Foundation, the number of capitated lives among risk-bearing organizations (not counting Kaiser) fell by a third from 2004 to 2014. The author cites independent analysis of federal Medical Expenditure Panel Survey data showing that capitated payments to California’s physicians fell by roughly 20 percent from 2003 to 2013, to only about 26 percent of the state’s estimated total physician payments, consistent with a national and regional decline in capitated payment.

Of the 1.4 million individuals enrolled in insurance by Covered California, half are in high-deductible plans. A significant percentage of these insurance carriers are not capitating their provider networks, relying instead on deep discounts and patient financial responsibility to maintain cost discipline.

No reliable data exist on the extent of capitation among the expanded Medi-Cal population. However, anecdotal evidence suggests that a large majority of the four million Medi-Cal expansion lives may have flowed into capitated arrangements between health plans and the care system. Perhaps 80 percent of Medi-Cal’s total enrollment is paid for through capitated arrangements. California’s growing Medicare Advantage population has also flowed to the care system in the main through delegated risk arrangements. This means that, increasingly, publicly funded patients are emerging as the dominant force in population-based payment schemes, portending lower margins and cyclical payment risk.

Interviews with two of the largest Medi-Cal managed care providers in California suggested that they are relying on capitated payments to a vast network of risk bearing entities. LA Care, the largest Medi-Cal managed care provider in the state at more than two million members living in Los Angeles County, relies almost completely on capitation to physician-sponsored independent practice associations and subcapitation to Anthem Blue Cross, CareFirst, and Kaiser Permanente.

However, LA Care’s network of 28 independent practice associations is plagued by overlap, excess administrative overhead, and dramatic variation in quality performance. Some physicians are reachable through as many as five different independent practice associations, suggesting that duplicative managed care overhead is a problem. LA Care’s new CEO, John Baackes, created a stir in the county earlier this year by sharing data showing the dramatic quality variation among his network constituents. He warned of a coming narrowing of LA Care’s network based on provider quality scores.

Metro Los Angeles is the California health care market where risk-bearing provider entities are thickest on the ground, and it is probably ripe for a shaking out, both in the commercial and Medi-Cal spaces. Two major equity funded enterprises—dialysis king DaVita and United Healthcare’s OptumHealth subsidiary—have attempted consolidation plays in risk-bearing physician enterprises in metro Los Angeles but do not have enough influence to move the market.

The second largest public Medi-Cal plan in the state is Inland Empire Health Plan (IEHP), with more than 1.2 million beneficiaries. It relies for its health care delivery on a combination of direct contracting with capitated primary care providers and fee-for-service specialists as well as an independent practice association network that is capitated and delegates risk for professional and related services. The IEHP does have shared risk arrangements and continues to examine other value-based payment methodologies.

As in Oregon, actuarial estimates of the cost of the expansion Medi-Cal population significantly overshot their actual costs (meaning that the new population was healthier and used fewer services than preexisting beneficiaries). This resulted in large windfall gains for many health plans in the first years of the expansion

Potential Impact Of The AHCA On California

In May, the House passed the AHCA to selectively repeal and partially replace the ACA. This bill would have a devastating impact on California’s health insurers, physicians, and hospitals, threatening $23.4 billion in annual federal support.

Beginning in 2020, the AHCA would liquidate the $18 billion in enhanced federal matching presently funding California’s Medi-Cal expansion. Having to replace even a portion of this lost $18 billion would grievously stress California’s general fund and force the state to consider raising money from other sources or dramatically cutting back enrollment. The AHCA would also end the current ACA exchange premium support subsidies and cost-sharing reductions. The legislation would “replace” these payments with much smaller federal tax credits Californians could use to purchase coverage.

The AHCA’s Likely Effect On Covered California And Its Enrollees

Because the replacement tax subsidies in the AHCA are far less than their ACA counterparts, they would reduce federal funding for exchange-based subsidies by billions of dollars. Moreover, the AHCA’s tax subsidies are age-related but not tied to the cost of health insurance. As a result, they would leave millions of Californians (particularly older Californians) far short of the ability to purchase coverage comparable to what they have now.

Only younger people living in metro Los Angeles (Los Angeles, San Bernardino, and Riverside counties) would get more help from the new legislation than from the ACA. The balance of California’s citizens would receive far less from the AHCA, and they would be locked out of insurance markets. Some older Californians would see their federal support reduced by more than $10,000 per year per person.

Moreover, because the new tax credits would be applicable inside or outside of health exchanges, they would markedly reduce the pool of individuals in Covered California, eviscerating the exchange’s ability to bargain with health plans to lower rates (as well as to cover the exchange’s operating costs). These changes would probably doom one of the country’s most successful health exchanges.

The AHCA’s Likely Effect On Medi-Cal And California’s Risk-Bearing Care Providers

Because California’s risk-bearing care enterprises have become far more dependent on Medi-Cal, the AHCA’s federal Medicaid funding reductions would effectively destroy the network of risk-bearing physician enterprises for which California’s health system is known. It would also inevitably result in ruinous funding reductions for public safety-net providers reliant on Medi-Cal for a significant fraction of their patients’ coverage.

The AHCA would deepen access problems for physician care, particularly in the poorer counties in the state’s mountainous northern tier, the eastern segment of Los Angeles metropolitan area, the east side of the San Francisco Bay, and large parts of the state’s agricultural bread basket, the Central Valley.

The per capita cap methodology intended to replace the current system of federal matching for Medicaid would have the effect of limiting future federal matching for the substantial state and county funding effort talked about above. The per capita cap would make it impossible for the state to recoup its federal matching losses in the out years with increased state and local fiscal effort, because the federal contribution would be frozen and rise only with inflation in the cost of care.

Politics Are Unforgiving … And So Are Economics

As of this writing, the Senate is considering how to configure and fund an ACA replacement. Because California gave Hillary Clinton a 4.2 million vote victory in the 2016 general election, the state has no friends in the Trump White House. Even though California’s Kevin McCarthy is Majority Leader in the House, he represents an arch-conservative agricultural district at the southern end of the Central Valley; McCarthy actively supported the AHCA despite its likely impact on the rest of his state and even his own district. It is a long way from the days of Henry Waxman’s and Nancy Pelosi’s House majority.

However, even if the Senate substantially changes the AHCA, or if Republicans fail to pass their ACA repeal and replacement legislation at all, California’s notoriously cyclical economy may ultimately render the state’s heroic coverage expansion untenable. It is entirely possible that at the bottom of the next recession, there could be north of 15 million Californians on Medicaid, possibly exceeding 40 percent of the state’s citizenry. This would put enormous stress on the state’s general fund. Poorer counties would struggle to sustain their share of Medi-Cal funding. A shaking out in the state’s substantial risk-bearing physician organizations also seems likely regardless of congressional action.

Despite the superficial cultural images of LaLa Land and Silicon Valley, California is a complex and heterogeneous place. The state made a remarkable commitment to expanding coverage to its uncovered citizens and executed it in a responsible manner, passing major financial risk both to insurers and the care system. However, this coverage expansion is both fragile and politically fraught. Sustaining it is almost certain to be the most significant challenge facing Governor Jerry Brown’s successor, whoever that lucky individual may be. The Big One might well loom for California’s health system.

Author’s Note

The author would like to thank Glenn Melnick, Anne McLeod, Brad Gilbert, John Baackes, Bill Barcellona, Ian Morrison, Tom Priselac, and Chris Wing for contributing thoughts and data to this analysis.