Centers for Medicare & Medicaid Services (CMS) Administrator Don Berwick calls it the central law of improvement: "Every system is perfectly designed to achieve the results it achieves." Our current health-care system pays for procedures and services. Therefore, providers deliver lots of procedures and services, without much regard for costs or results. Arkansas Medicaid director Gene Gessow is trying to change that.

At the behest of his boss, Arkansas Gov. Mike Beebe, Gessow is now spearheading the state's effort to create the nation's first statewide payment system, an early example of the type of delivery reform that many health-care experts believe is necessary to control costs and improve outcomes. Earlier this month, I asked Gessow about Arkansas's plan in this edited transcript.

Arkansas has long had a patchwork of fee-for-service payment systems. But earlier this year, Gov. Mike Beebe proposed changing that by creating what he described as the nation's first statewide payment reform initiative. Could you explain the idea?

We quickly realized that Medicaid alone can't provide enough of an incentive or direction to the provider community, especially if Medicaid goes in one direction, [Arkansas Blue Cross and Blue Shield] goes in another direction, and Medicare goes in another direction. Since all the payers, public and private, essentially share the same provider base (and in a place like Arkansas, probably the same patient base as well), in order to address questions of effectiveness and efficiency, we decided that we needed to address the health system as a whole. Medicaid and Medicare, Blue Cross, QualChoice, the other private carriers here, needed not to set the same rates but be aligned about what were the most effective and efficient practices.

Getting insurers to agree to work together in this fashion and getting providers to respond seems like a pretty tall order. How have you gone about doing that?

We're a relatively small state in terms of population, and we do have a strong and very smart governor. He can get things done. When he wanted to talk about this with Blue Cross, the president of Blue Cross came across town [and] sat down with the governor. It was not an extended negotiation. They knew each other. They understood the health-care system in Arkansas [and] what it needed. It's not that opaque in a place like Arkansas.

What was the reaction from the provider community?

The provider community was split, initially.

It sounds like there is concern among some that this is a kind of back door attempt to move to capitation or managed care.

Yes, but I think the governor's letter to [Health and Human Services] Sec. [Kathleen] Sebelius [asking for permission from CMS to pursue this initiative] was quite specific. It's not our intention to shift medical risk to the provider community. We believe that it makes perfect sense (from an insurance point of view) for the state to assume the medical risks.

What we did want to do is emphasize the responsibility of the providers to be organized, efficient and effective. That's why we've decided to focus on episodes of care and identify best practices for those episodes, while recognizing that the ability to engage in best practices in different parts of Arkansas was different. We have lots of small practices in rural areas where you can't expect doctors to hire a nurse who does nothing but care coordination. In those cases, we don't want to set up a system that would require those practices (in order to adopt best practices) to be bought out by a hospital or combine into a 100-physician practice. What we've tentatively said is that we will be making payments to partnerships of providers.

Sort of like accountable care organizations (ACO)?

If you looked at the proposed ACO regulations, they are very prescriptive as to how people have to be organized. We don't think that there's necessarily one pattern of organization that will fit every place. The reason we picked the term "partnership" is that [it] is the most flexible form of organization possible.

How does Arkansas plan to go about identifying best practices?

First of all, we don't have to reinvent that. There are a number of efforts throughout the country to identify the concept of an episode of care. You can look at the data. Because we have claims data from public and private providers, you can take a sort of a Dartmouth Atlas approach. What we want to identify is ideally the "best practice," but maybe, at least initially, it's the "better practice."

And will providers be involved? Is there some structure or mechanism for deciding what the best practices are going to be?

Yes, absolutely. The goal here is to figure out what's the basis for various prices. Let's call it a broken leg, just for argument's sake. We look at best practices. We look at all the things that go into making a patient whole, which is not just the care, the days in the hospital and the pain medication. It's the rehabilitation afterwards. It's dealing with the unexpected infection that comes and avoiding unexpected infections.

Let's suppose that we look at that and we say, "OK, well, if you use the best practices, and rehabilitation's right and planned, and there's somebody working with the patient" and so forth. Let's say it [costs a] $1,000. OK, then we'll pay $1,000. Now, suppose the team that's involved in treating that broken leg can do it for $950. That's fine. They get paid $1,000. Suppose they can do it for $900. That's fine. They get a $1,000.

Suppose they can't do it for less than $1,100. Then they probably won't be in that business for a very long time.

What about those areas where Medicaid expenditures aren't really tied to episodes of care?

Chronic disease requires a different approach. It requires more of what might look like preventive care: more checking in, more monitoring. Similarly, long-term care may not be about curing anybody of anything. It just may mean taking care of people. Unless you have a payment system that recognizes those things and says, "This is what we should be paying for in each one of these areas," you're missing one of the largest opportunities to incent the system.

Do you have the resources to do this? To identify best practices, build an all-claims database and so forth?

Between Medicaid, Medicare, Blue Cross and the other insurers, we will have a database covering more than 90 percent of the population. And we have taken the necessary steps. We haven't gotten a final commitment from CMS to have access to Medicare claims, but we have gotten some strong positive signals.

Put this initiative into the context of Arkansas' broader budgetary situation for us. How important is it for this initiative to deliver big cost savings?

Our governor is very conservative from an economic point of view. When the [American Recovery and Reinvestment Act] funds came out, we didn't just spend like they'd go on forever. We are fully funded for fiscal year 2012. Currently, we're anticipating an approximately $60 million state general revenue shortfall in state fiscal year 2013 and that rises to probably in excess of $200 million in state fiscal year 2014. What we have is an opportunity to see if we can discover how to do something other than cut benefits, eligibility and rates or bring in a managed care company to do the same.

Now, we don't believe that we're going to fill a $60-million hole or a $200-million hole simply by the efforts that we're making to change the payment system. We do believe, in order to make the case that Arkansas Medicaid needs to remain whole and viable in 2013 and 2014 and to make the public case at a time when there's not a lot of support for tax increases, that we have to demonstrate a very good faith effort to make our system as effective and efficient as possible.

Must Reads

Congressional leaders have begun to debate the future of Medicaid (which I investigated in a June feature). Reports suggest that Vice President Joe Biden, who is leading the Obama administration's effort to negotiate a debt ceiling increase with Congressional Republicans, is open to cutting the Medicaid program. Meanwhile, Republican governors, led by New Jersey's Chris Christie, are demanding greater leeway to reduce Medicaid spending. Greater flexibility may be on the way. CQ's John Reichard reports (subscription required) that the 2009 "maintenance of effort" requirements may be eliminated. However, he warns that the savings may not significantly reduce Medicaid spending and enrollment, for two reasons:

First, states would only be able to roll back eligibility to a point, meaning savings would be limited. Second, those states most eager to get rid of the rule don't cover that many people in Medicaid anyway.

The Washington Post's Ezra Klein thinks better coordination between Medicare and Medicaid would be more likely to generate cost savings. States might even save money if Medicaid paid more. That's unlikely though. So far this year, some 33 states have slashed payments to health-care providers. Nonetheless, the Center on Budget and Policy Priorities says states are moving ahead with the implementation of the Affordable Care Act. (The Commonwealth Fund offers this handy graphic of where state efforts to establish health insurance exchanges stand.)

Funding opportunities: The U.S. Department of Health and Human Services has announced the availability of $40 million for states interested in developing state chronic disease prevention programs and up to $500 million in funding to stop preventable injuries and complications related to health care acquired conditions and unnecessary readmissions.

Finally (and grimly), the 6.2 percent enhanced federal Medicaid match provided by ARRA expires at the end of the month, a change that will increase state Medicaid costs by 20 percent.