ARTICLE
15 April 2024

California Health Care Providers To Face Greater Headwinds As State Implements Health Care Cost Targets

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Health care providers in California should carefully monitor OHCA's activities and begin to plan for coming changes in their relations with health plans, health insurers, and other payers.
United States Food, Drugs, Healthcare, Life Sciences
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In Short

The Situation: Pursuant to California's Health Care Quality and Affordability Act (the "HCQA"), the newly created Office of Health Care Affordability ("OHCA") recently proposed statewide health care cost targets and standards and goals for the adoption of alternative payment models ("APMs").

The Result: The proposed health care cost targets and APM adoption goals will increase the pressure on California health care entities to reduce costs. These pressures will have a material impact on negotiations between health care providers and health care payers, and are likely to force many health care providers to rethink their approach to payer contracting.

Looking Ahead: Health care providers in California should carefully monitor OHCA's activities and begin to plan for coming changes in their relations with health plans, health insurers, and other payers.

Cost Targets

The HCQA requires OHCA to establish both statewide and health care sector-specific cost targets that will apply to health care entities, including insurers and commercial and governmental health plans, hospitals and other licensed health facilities, and physician organizations. The cost targets to be established by OHCA are not absolute dollar figures, but are trend numbers, defined as the target percentage for the maximum annual increase in per capita health care expenditures. Health care expenditures include, among other things, amounts paid to health care providers for covered health care benefits, cost sharing (e.g., co-pay, coinsurance, and deductible) amounts for covered health care benefits paid by California residents, and health plan and insurer administrative costs and profits. Under the HCQA, the cost targets established by OHCA must "promote a predictable and sustainable rate of change in per capita total health care expenditures."

OHCA must establish the first statewide health care cost target no later than June 1, 2024. Recently, OHCA proposed a statewide cost target of 3% for each of the five years commencing January 1, 2025. The proposed target is based not on historical changes in health care costs or spending, but on the average annual rate of change in historical median household income over the 20-year period from 2002-2022. In contrast to the 3% annual growth in median household income, the average annual growth in per capita health care spending over roughly the same period (2000-2020) was 5.4%, a figure that excludes certain costs included in OHCA's proposed cost target. The difference between the two figures is likely to pose serious challenges for health care providers in California, many of whom are still reeling from the impacts of the pandemic, inflationary pressures, and a significant increase in workforce wages. Nevertheless, OHCA believes that a cost target based on median household income is appropriate, as it best "places California on the path of a more sustainable, affordable and equitable health care system, slowing the trajectory of growth [in health care costs] and improving affordability for all."

In addition to a statewide health care cost target, the HCQA requires OHCA to establish cost targets for specific health care sectors. Health sectors, to be defined by OHCA, may include geographic regions as well as individual health care entities. Thus, it is quite possible that payers, hospitals, and other providers will be subject to their own individualized cost target. Given that any provider-specific target must support the attainment of the statewide target, and that there are potential sanctions for exceeding the statewide target, it seems reasonable to assume that provider-specific targets typically will be no greater than the statewide target adopted by OHCA. Sector-specific cost targets need not be set by OHCA until June 1, 2028, so health care entities have some time to prepare.

Enforcement

Unlike the laws of most of the handful of other states that have adopted some sort of cost growth benchmarking programs, the HCQA expressly contemplates that the state will take enforcement action against health care entities that fail to comply with applicable statewide and/or sector-specific cost targets. Specifically, the director of OHCA is authorized to:

  • Provide technical assistance to the health care entity to assist it to come into compliance;
  • Require or compel public testimony by the health care entity regarding its failure to comply with applicable cost target(s);
  • Require submission and implementation of performance improvement plans, including review and input from OHCA prior to approval; and
  • Assess penalties in amounts initially commensurate with the failure to meet applicable cost targets, and in escalating amounts for repeated or continuing failure to meet such cost targets.

In taking action against a health care entity, OHCA will consider the entity's contribution to cost growth in excess of the applicable target and any actions by the entity that "have eroded, or are likely to erode, access, quality, equity, or workforce stability, factors that contribute to spending in excess of the applicable target, and the extent to which each entity has control over the applicable components of its cost target."

OHCA will not enforce compliance with the statewide cost target established for 2025, but will enforce compliance with the targets established for 2026 and beyond. Despite this lag, health care payers and health care providers should be feeling pressure to conform with the cost targets sooner rather than later, as deals they negotiate within the next year may impact their ability to meet cost targets in 2026. As such, compliance with cost targets will very soon become a key driver in payer-provider negotiations. From here on out, providers can almost certainly expect payers to refuse to entertain negotiated rate increases that exceed statewide or payer-specific cost targets. With margins already thin, controlling their own costs in equal measure will become a critical objective for most providers.

Promotion of Alternative Payment Models

In addition to setting and enforcing cost targets, OHCA is responsible under the HCQA for promoting a shift away from traditional fee-for-service reimbursement to APMs that financially incentivize high-quality and cost-efficient care. To do so, OHCA is charged with, among other things, adopting standards for APMs that may be used during contracting between health care entities, setting statewide goals for the adoption of APMs, and measuring the state's progress toward those goals by requiring payers to submit data and other information to OHCA as appropriate.

The HCQA requires OHCA to adopt the APM standards no later than July 1, 2024. In February of this year, OHCA released its proposed set of APM standards. The standards set forth a set of 10 "best practices" for APM contracting that focus on improving quality, affordability, and equity and that highlight the importance of data collection, data sharing, and transparency. At the same time, OHCA released its statewide goal for APM adoption, which seeks to have reimbursement for at least 75% of members enrolled in commercial, Medi-Cal, and Medicare Advantage plans paid under some sort of APM arrangement—specifically, one defined as either a Category 3 or Category 4 arrangement by the Health Care Payment Learning and Action Network within the next 10 years (by 2034).

While OHCA must promote and monitor use of the APM standards by contracting entities, OHCA does not yet have authority to enforce those standards or its statewide goal for APM adoption. As such, OHCA has signaled that it will seek to obtain stakeholder endorsement of the APM standards and a commitment from payers and purchasers to using the standards to guide their future contracting efforts. Given the breadth of the standards, and with enforcement of the health care cost targets not long off, it seems reasonable to assume that OHCA will have very little trouble engaging payers in support of these goals. Accordingly, health care providers can anticipate increased pressure from payers to move to APM reimbursement models.

Five Key Takeaways

  1. The threat of cost target enforcement activity by OHCA will compel many health care providers to find new ways to control costs without sacrificing quality, access, or workforce stability.
  2. Similar pressures placed on health plans, insurers, and other payers will trickle down and will very soon become a key driver in payer-provider negotiations. Providers can almost certainly expect payers to refuse to entertain negotiated rate increases that exceed statewide or payer-specific cost targets.
  3. While OHCA has no ability to enforce the APM standards or adoption goals, pressure to move to APMs will nevertheless increase, as payers look to meet health care cost targets in a manner that supports state efforts to promote APMs.
  4. While some California providers (IPAs and large medical groups) are accustomed to managing risk, others (e.g., hospitals) are not. The transition to APMs is going to require provider contract managers and their staff to utilize (or recruit for) a whole new set of skill and support, including actuarial support, legal contract drafting, etc.
  5. Though scale may play a role in managing financial risk, health care providers looking to form or grow networks through mergers, acquisitions, and other transactions will need to be mindful of OHCA's Material Change Transaction and Pre-Transaction Review processes, which may create additional barriers to growth.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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