(Editor’s note: This post was updated at 5:05 p.m. on May 8.)

Kentucky’s Medicaid managed care meltdown continues.

Sources are telling Insider Louisville that Coventry Cares officials put 10 hospitals on notice last Thursday and Friday, threatening to terminate contracts with providers including King’s Daughter Medical Center in Ashland, Ky. and Louisville-based Baptist Healthcare System.

Tom Dearing, spokesman for the 400-bed King’s Daughter facility, told Insider Louisville that Coventry executives notified KDMC officials in a letter two weeks ago they were planning to terminate their contract with KDMC effective May 26.

KDMC officials are “evaluating” the situation, Dearing said, adding that he did not have additional details.

Matt Eyles, vice president of Public Affairs and Policy at Coventry’s headquarters in Bethesda, Md. did not return calls for comment.

Coventry executives have stated they have too many high-risk Medicaid members and are looking at major losses unless the state gives the insurer a risk adjustment; ie, bumps up the original fee-per-month-per-patient rate. (See details at the end of this post.)

(As Insider Louisville reported April 30, Kentucky’s Cabinet for Health and Family Services granted Coventry a risk adjustment, but apparently not to Coventry’s satisfaction.)

Coventry’s action could complicate how or even whether care providers in some of the poorest parts of Kentucky will get paid, and whether there will be interruptions in treatment for the tens of thousands of Kentuckians enrolled with Coventry.

The bottom line is, no hospital in the state can survive for long should Medicaid reimbursement be held hostage.

And this essentially is one more installment in an everything-that-could-go-wrong, goes-wrong chain reaction.

First, the Beshear Administration tried to cut the state’s huge Medicaid costs by switching last November 1 to managed care from fees for services. Medicaid managed care organizations theoretically provide tighter monitoring, eliminating unneeded treatment or drugs. Then, in a rush to institute the changes, Coventry apparently ended up with a larger share of high-risk patients than the other Medicaid Managed Care organizations, Centene Corp. and WellCare Health Plans.

One stock analyst who covers Centene told Insider Louisville Centene officials confirmed the insurer’s managed care membership in Kentucky dropped by 40,000 – to 140,000 from 180,000 members – during a two-month open period in November and December. Most, if not all, of those members went to Coventry.

In testimony, health care providers and patients have accused the Medicaid managed care organizations of delaying reimbursements and denying care, trying to control the financial bleeding.

Last month, Insider Louisville broke the story that Appalachian Regional Healthcare, based in Lexington, Ky., sued Coventry and Kentucky Spirit, demanding millions in overdue, uncontested reimbursements for care. That suit led to a temporary truce between ARH and Coventry, which had declard ARH “out of system,” until June 30.

Meanwhile, Coventry – as George Clooney put it so memorably in “O Brother Where Art Thou?” – is in a tight spot.

Financial analysts across the United States are concerned that its MCO deal in Kentucky may hurt the company long-term.
This is a recent analyst overview of Coventry by Morgan Stanley Research:

The KY rollout headwinds proved worse than expected. Our new forecasts now incorporate this business remaining a drag in 2012 and beyond. Key to improving sentiment will be demonstrating progress towards mitigating this earnings drag.

Updating forecasts to reflect sustained KY earnings drag, which may prove conservative. We are lowering our forecasts to reflect weak results in KY. On a consolidated basis, we have raised our MLR by 160 (book value per share) in 2012, 80 bps in 2013 and 40 bps in 2014. We are basing our forecasts on KY Medicaid posting (medical loss ratios) of 113%/100%/95% for 2012/13/14. Our forecast also bakes in the commercial MLR rising from 81.5% in 2012 to 81.9% in 2013 and 82.2% in 2014.

Expect KY rate resolution by Q2 earnings. CVH is in active discussions with KY to increase revenues (unclear whether these will be retro or prospective rate increases but the 2012 exit run rate is the key, in our view). We expect favorable resolution to result in incremental payments to CVH from KY for (1) risk-adjuster payments and (2) hospital pass-through payments, which should help sentiment.

2013 earnings upside potential. For 2013, our current forecast bakes in a KY MLR of 100%, suggesting a ~$0.30 EPS drag on 2013 earnings, so any improvement toward a positive gross margin would be upside. In addition, our forecast factors in CVH running its balance sheet with ~$900 mm of deployable cash just sitting stagnant at the parent.

If the losses grow too painful, it could cause Coventry officials to decide to walk away from its Kentucky MCO contracts, say our sources. The insurer posted $25 million performance bonds as part of the contract process back in July, 2011. But if Coventry starts bleeding money, surrendering the $25 million may turn into the least painful way out of the deal.

The Herald-Leader just posted a story that Coventry Cares notified Baptist Healthcare System last Friday that the MCO wants to renegotiate its contract with the hospital chain, quoting Baptist spokesman Ruth Ann Childers.

The Herald-Leader story by Beth Musgrave and Valarie Honeycutt-Spears quotes Childers as saying if a deal can’t be reached by November 1, Coventry will walk away.

Most of the Baptist system’s beds are the in the Louisville market, covered by Passport Health Plan. But the Baptist system also has an Eastern Kentucky hospital in Corbin and other facilities in Elizabethtown, Lexington and Paducah.

The back story on Medicaid changes in Kentucky: In April, 2011, state officials asked health insurers to submit managed-care proposals for the $6 billion worth of care 800,000 poor and elderly Kentuckians receive annually under the federal/state Medicaid program. At the time, Gov. Steve Beshear touted the switch to managed care from fee-for-services as saving the state $375 million over the life of the initial three-year contracts. Insiders said officials in other states such as Georgia took as long as 18 months to make the change while Kentucky tried to do it in less than six months.

The three companies receiving MCO contracts were Centene, WellCare and Coventry Cares, all publicly traded companies. (Passport Health Plan, a Louisville-based non-profit controlled by providers, is the managed care insurer for Jefferson County and 17 surrounding counties.)

Each bid for the Kentucky MCO business was based on per-member, per-month health care costs projections. Low-bidder Centene bid $330 per member, per month, according to documents submitted to Insider Louisville. WellCare bid was based on $400 per member per month, and Coventry bid $436 per member per month.

The algorithm state officials used to choose the winners favored the low-cost plans, obviously, because therein lies the savings.

The state methodology initially assigned members to a plan, with the two lowest cost plans getting more members than the highest.

If Centene’s manged care system, for example, could actually get each member to spend less than $330 per month, they’d make a profit. But crucial to getting costs that low would mean lowering reimbursements to health care providers such as doctors and pharmacies, which meant losing some.