Medicaid was established in 1965 as a system of federal matching funds for states to deliver health care to low-income Americans. Initially, all states paid directly for medical services, but they increasingly subcontracted with private insurers, known as Managed Care Organizations, to administer and procure care. By 2024, 42 states employed MCOs to deliver Medicaid benefits to 78 percent of the program’s enrollees—at a cost of $491 billion.
That arrangement raises uncomfortable questions. Why do states subcontract Medicaid to private insurers if the government provides all the money, tells the insurers what they must cover and how much they have to pay for it, and doesn’t competitively bid the contracts? What’s the point of these middle men?
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The answer, as I show in a new Manhattan Institute report, is that private insurers are exempt from normal limits on fees that states can claim from the federal government to finance Medicaid services. Routing money through these firms makes funding much harder to track—in turn letting states obtain billions of dollars in federal aid every year for purposes Congress never approved.
Managed care was originally meant to reduce needlessly high prices and volumes of health-care services. For Medicare, for example, the federal government’s Medicare Advantage program effectively gives beneficiaries a voucher to buy managed-care plans from private insurers. This arrangement in turn motivates insurers to procure cost-effective medical procedures and to encourage the use of preventive care services. For Medicare, the managed-care approach has worked well: it has helped avoid expensive hospitalizations, yielding better medical outcomes at lower cost.
But management by private insurers fits more awkwardly into Medicaid. Plans cannot compete for enrollees by reducing premiums since the government provides all the funding. Insurers must accept every eligible beneficiary who seeks to enroll, which creates a strong incentive for them to skimp on quality medical services that could attract seriously ill (and therefore expensive) beneficiaries. The program’s benefits and payments to providers are therefore specified in detail by law, which leaves little room for innovation.
The resultant system often works poorly. It’s hard for states to specify, regulate, and assure the quality of access to medical care indirectly through contracts with insurers. They often fail to enforce adequate provider networks as required by law, and denials of care due to prior authorization are much more common in Medicaid Managed Care (13 percent) than in Medicare Advantage (6 percent), due to the absence of federal oversight.
The government can more effectively (and efficiently) assure satisfactory access to care if it pays for it directly. That is also true of preventative care services, such as vaccinations or care coordination assistance, which are supposedly the strength of managed care. But Medicaid patients with major disabilities, who need the most care coordination assistance, are often specifically exempt from managed care by states.
As my new report details, the savings promised during Medicaid Managed Care’s expansion over the past four decades have consistently failed to materialize. Medicaid already pays very low rates for hospital care, physician services, and drugs, due to mandatory discounts. Few additional savings can be gained from further narrowing provider networks.
The involvement of private insurers tends to add another layer of administrative costs to Medicaid. These firms must negotiate contracts with providers, finance required capital reserves, advertise themselves to beneficiaries, and generate profits for shareholders. The government must police overpayments to plans and to providers. Payments to plans are often inflated. Three quarters of states pay Medicaid insurers without competitive bidding due to a concern that the winner of such bidding would be the insurer that most underestimated the cost of delivering care to beneficiaries.
To mitigate this risk of insolvency, the federal government requires that state Medicaid payments to insurers exceed their expected medical costs. But, as states typically sign three-to-five-year contracts with insurers, this effectively locks them into a higher level of expenditure and prevents them from reining in commitments when program costs increase. This arrangement also undermines the central point of managed care by encouraging insurers to inflate the volume of medical services they fund in order to increase the payments that states must give them.
Given all this, why do most states subcontract Medicaid to private insurers? The answer is that doing so expands access to free-flowing federal dollars.
Medicaid allows states to claim up to $9 in federal funding for every $1 they spend on services covered by the program—without any upper limit. But payments to private insurers are exempt from normally tight limits on fees and services that states can use to claim this enormously lucrative federal matching aid. By routing payment for Medicaid services through private insurers, states can greatly inflate the funding they obtain from Washington.
Such “Medicaid money laundering” schemes have become notorious in recent years. Subcontracting with private insurers allows states to lump together expenditures for different services, obscuring how the funding gets used. A 2021 federal investigation found that only eight states provided complete and accurate data on the utilization of medical services, the data on which states base Medicaid payments to plans.
The workarounds can be elaborate. California obtained $19 billion in federal funding by taxing insurers it used to cover Medicaid patients—claiming that this represented an increase in the program’s costs. Various states use Medicaid MCOs to expand welfare benefits from housing to food under the pretext that doing so yields incidental health benefits. The federal government estimates that the exemption of managed-care plans from limits on Medicaid payments for services will account for $145 billion in Medicaid spending this year alone.
Last year’s One Big Beautiful Bill Act sought to curb such practices. But Medicaid Managed Care still makes it easy for states to develop similar schemes in the future, which will likely enable them to side-step whatever restrictions emerge.