Medicaid and Medicare are in the news of late, as Congressional Republicans spar with President Obama and the Democrats on how best to rein in the ballooning costs of these entitlement programs, which make up a growing share of federal and state budgets. But what few policy makers seem to be talking about — at least in public — are the perverse financial incentives built into the system that allow the companies who manage Medicaid contracts on a statewide basis to make profits at the expense of quality health care for Medicaid recipients. As a result of these perverse incentives, many Medicaid patients, particularly those being treated for mental health problems, are either terribly under-served or in some cases, badly over-treated. The upshot, in many cases, is poorer health outcomes and higher Medicaid costs.

Allow me to explain. In most states, Medicaid contracts for mental health and substance abuse are separated out from medical services and handled by managed care companies that make their money from keeping patients out of expensive hospitals. As a result of the way many contracts have been drawn up, drug treatments for emotional and behavioral problems do not count as costs to the behavioral health managed care entity, but instead fall under the plan’s general prescription drug coverage. However, hospitalizations and psychosocial treatments (such as different forms of therapy and family interventions) do fall under the managed care’s costs. So to make a profit, managed care in almost every state has done a spectacular job over the last two decades of limiting hospitalizations and access to psychosocial interventions, according to a new Hastings Center Special Report, which focuses primarily on troubled children.

As the report concludes, it’s much easier for “patients to obtain referrals for medication management and psychopharmacology.” This perverse incentive goes a long way to explaining why so many Medicaid recipients, both children and adults, are prescribed expensive psychotropic drugs, which cause serious side effects, rather than alternative therapies, which might be more effective and less hazardous to their health. Managed care companies make more money that way.

As one top medical official for New York State told me, “If you’re a managed care entity and the pharmacy benefit is not part of your budget, you’re happy if a symptom can be controlled by someone prescribing a dubious and expensive drug. It’s not your problem.” Or, as the authors of the Hastings report put it,

“The country’s mental health care system makes it difficult for children to access psychosocial care, but relatively straightforward to access medication treatments (even if those treatments are not monitored or reassessed as recommended).”

And the same, of course, holds true for adults.

Not only do individuals with mental health problems suffer as a result, but state governments actually end up spending more when these patients don’t receive the most effective treatments and interventions. Some patients will inevitably “end up on the streets or in prison where the costs don’t accrue to the managed care companies,” the New York state medical official explains. The states, of course, still pick up the costs — but out of separate budgets for prisons, homeless shelters and programs for troubled teens.

The plot thickens. In many states, large insurance companies such as United Health care, WellPoint and Blue Cross Blue Shield have joined large managed care companies such as Americhoice and Centene in managing Medicaid contracts, according to this article in The Washington Post. Some states have flat-rate contracts with managed care companies that are designed to balance the need to limit costs with providing appropriate mental and physical health care. But in other states such as Colorado, Florida and Tennessee, managed care companies have what is known as “at-risk contracts” — contracts whereby they make a percentage profit based on how much is spent on each Medicaid patient. And with such contracts comes another perverse financial incentive that, in some cases, make patients sicker.

For example, some managed care companies actually benefit twice-over when patients are over-prescribed anti-psychotic drugs such as Seroquel and Zyprexa, according to Edward Knight, a former executive with a managed care company in Colorado and a recovery consultant. This is how: while the behavioral health arm of the company makes money by referring patients for drug prescriptions rather than more expensive psychosocial treatments, another arm of the company makes money by managing the diseases such as obesity and diabetes caused by the over-use of these drugs. The off-label use of anti-psychotics like Seroquel, Risperdal and Zyprexa is widespread in many states, with disastrous effects on some patients, as many bloggers, myself included, have already noted. To think that some companies managing Medicaid contracts are actually profiting from that over-use is indeed perverse.

Seems to me that until we do something about the conflicting financial incentives that are built into the Medicaid system, fighting over how to cut Medicaid funding to the states is a waste of time. As the New York medical official says, setting up contracts based on a specific dollar amount is fruitless. “If it’s just dollars, [the managed care company] will cheat and figure out ways to get other entities to pick up costs, or they’ll just deny care,” he says. “We have to change the contract incentives so that these companies can earn X number of dollars when they improve health care. We have to get to risk-based contracts based on performance metrics rather than profits.” Amen.