Indiana’s bumpy road to privatization

Louise Cohoon was at home when her 80-year-old mother called in a panic from Terre Haute: The $97 monthly Medicaid payment she relied on to supplement her $600-a-month income had been cut without warning by a private company that had taken over the state’s welfare system.

Later, the state explained why: She failed to call into an eligibility hot line on a day in 2008 when she was hospitalized for congestive heart failure.

“I thought the news was going to kill my mother, she was so upset,” said Cohoon, 63. Her mother had to get by on support from cash-strapped relatives for months until the state restored her benefits under pressure from Legal Services attorneys.

Cohoon’s mother, now suffering from Alzheimer’s disease, was one of thousands of Indiana residents who abruptly and erroneously lost their welfare, Medicaid or food stamp benefits after Republican Gov. Mitch Daniels privatized the state’s public assistance program — the result of an efficiency plan that went awry from the very beginning, the state now admits.

Though the $1.37-billion project proved disastrous for many of the state’s poor, elderly and disabled, it was a financial bonanza for a handful of firms with ties to Daniels and his political allies, which landed state contracts worth millions.

The disparate effects underscore the risks of handing control over public services to the private sector. Whether the approach will ultimately improve services and save money remains a matter of fierce debate in Indiana. But the state’s experience shows that without adequate safeguards, privatization can compound the very problems it is designed to correct: bureaucratic burdens, perceptions of influence-peddling and a lack of competition.

It’s an issue that is likely to persist, as Republicans in statehouses nationwide turn to private companies as they seek to shrink government and weaken the hold of public-sector unions. One of the main proponents has been Daniels, who privatized a prison and a major toll road and sought unsuccessfully to lease out the state lottery, cultivating a reputation for fiscal discipline that led major party figures to urge him to run for president in 2012. He recently declined, but retains considerable influence in his party.

Republican Gov. Scott Walker of Wisconsin is seeking to privatize aspects of his state’s welfare programs, much as Daniels did — an idea that has drawn warnings from federal officials who noted the problems Indiana encountered.

Critics say that in Indiana, the privatization process barreled forward with little public input and was marred by the appearance of conflicts of interest. Despite the massive nature of the changes he was proposing, Daniels insisted he did not need legislative approval. And the only public hearing occurred after he announced he would proceed with the project.

Key players involved in the process had ties to Affiliated Computer Services, the company that benefited the most from the deal. Mitch Roob — a Daniels appointee who ran the state’s Family and Social Services Administration when it awarded the contract — was a former ACS vice president. As the state began the project, Roob occasionally sought advice from former Indianapolis Mayor Stephen Goldsmith, a political ally of Daniels and fellow privatization advocate who also had been an ACS vice president.

John Donahue, who studies public sector reform at Harvard University’s Kennedy School of Government, said even the appearance of too-cozy contracting ties can taint a well-intentioned privatization effort.

“Contractual hygiene is pretty important,” said Donahue, formerly an assistant secretary of Labor in the Clinton administration. “People tend to be paranoid about conflicts of interest, and for good reason.”

In a brief interview, Daniels called “completely bogus” the suggestion that his administration was too close to companies that won lucrative contracts.

“There is no evidence of that,” he said. “Our approach was either firms perform well — or we will get rid of them and try someone else.”

Yet it took two years before the governor acknowledged that replacing caseworkers with centralized call centers “just didn’t work.” In October 2009, Daniels canceled a 10-year contract with an IBM-led consortium of companies that included ACS among its subcontractors. IBM and Indiana are now engaged in dueling lawsuits scheduled to go to trial next February.

After IBM was fired, ACS — which was blamed by welfare advocates for many of the problems — was given a new eight-year contract worth $638 million to continue its work, according to state records.

All told, three politically connected firms gained from the welfare privatization effort in Indiana: ACS; the Lucas Group, a Boston-based firm that wrote the specifications for the contract; and Barnes & Thornburg, the Indianapolis law firm that lobbies for ACS and is representing the state in its suit against IBM.

ACS — via several political action committees — donated nearly $50,000 to Daniels’ gubernatorial campaigns and his state leadership PAC between 2003 and 2010. Barnes & Thornburg gave Daniels almost $120,000 between 2004 and 2010.

Daniels began pursuing the idea of privatizing Indiana’s welfare eligibility system soon after his 2005 inauguration. The idea was taken up enthusiastically by Roob, whom Daniels had brought over from ACS, and who repeatedly described the failings of Indiana’s social services agency, which serves more than 1 million needy residents.

But advocates for the poor and disabled said that although Indiana residents often had to wait long hours to see government caseworkers, the system reliably delivered benefits — something that would change when private companies took over.

In the case of food stamps, for example, the state’s negative error rate — how often cases are incorrectly closed or denied — was below the national average from 2001 to 2007, according to the U.S. Department of Agriculture, which oversees how states manage the program. In the 2008 fiscal year, one year after private firms took over, the error rate jumped to just over 13%, more than double the previous year’s and the largest rate increase in the nation.

Even before Daniels signed off on the privatization effort, the little-known Lucas Group started reaping benefits. Its role was not publicized at the time, but the consulting firm had a nearly $4-million contract — signed by Roob — to write the specifications by which the bidding companies would take over the system.

Like ACS, the Lucas Group had ties to former mayor Goldsmith: He served for a time as a senior consultant for the firm, which is run by a longtime associate. Goldsmith, now a deputy mayor in New York, said in an interview that he had nothing to do with the state’s awarding of contracts to the Lucas Group or ACS.

When states look to privatize, they frequently turn to ACS, a powerhouse known for exercising political muscle in pursuit of government contracts.

The Dallas-based company, which was purchased by Xerox in 2009, is one of the country’s biggest providers of government services, currently working with more than 25 federal agencies, all 50 states and many major cities. In the last decade, Los Angeles has paid ACS nearly $56 million to administer parking tickets, among other services. This fall, ACS is slated to begin operations on a 10-year, $1.6-billion contract in California to process claims for Medi-Cal, the state’s Medicaid program, which serves more than 7 million beneficiaries.

During Indiana’s deliberations, ACS was under fire from federal regulators examining backdating of stock options, as well as from officials in several states who complained of delays, technical problems and, in one case, manipulation of data to justify bonus payments.

Ken Ericson, a spokesman for ACS, said the company remained in good standing with its government clients, continuing to provide services in all 50 states.

Despite its troubles around the country, ACS — as a subcontractor to IBM — ended up with the biggest piece of the contract in Indiana. The company hired 1,500 former state workers, built the system’s call center and provided the staff that did the initial processing of welfare applications. It was also poised to make a minimum of $596 million in fixed fees, according to documents obtained by the Tribune Washington Bureau/Los Angeles Times.

Roob, whose agency solicited bids for the project, did not return calls for comment. But aides to Daniels said the former Family and Social Services Administration secretary played no role in the selection process.

They noted that the winning consortium, then led by IBM, ended up being the only bidder for the deal after another group led by Accenture dropped out in May 2006. An interagency review committee studied the proposal by the IBM-led consortium and recommended that the governor move forward with the project.

“No one ever said, ‘We want to make sure ACS is part of this,’” said Earl Goode, Daniels’ chief of staff, who chaired the review committee. “It was looking at the best solution and what’s best for the taxpayers of Indiana.”

In late November 2006, Daniels announced he had accepted the review committee’s recommendation. A week later, the state held the only public hearing on the proposal. He signed the deal with IBM a month later, declaring the move would save taxpayers $1 billion.

Under the privatized system, clients applied for benefits online and through call centers, rather than by waiting to see a caseworker. ACS employees screened applicants before state caseworkers would determine their eligibility.

From the beginning, however, there were problems: According to the state’s lawsuit, documents were lost, cases piled up and workers started routinely denying applications just to reduce the backlog.

“People were being dumped off food stamps and Medicaid in large numbers; people with profound disabilities were told they weren’t cooperating,” said John Cardwell, chairman of the Indiana Home Care Task Force, a coalition of organizations for the elderly and disabled.

IBM said the problems were due to an unexpected surge in applications.

“Our contention has always been there weren’t enough caseworkers,” said IBM spokesman Clint Roswell.

The state said the issue was IBM’s oversight of ACS.

“The state is now managing them and they’re doing fine,” said Peter Rusthoven, one of the lawyers representing the state in its suit against IBM.

When the state decided to sue, the Daniels administration opted to hire Rusthoven’s firm — Barnes & Thornburg, which also represents ACS — to handle the case, rather than rely on the state attorney general. One of the Barnes & Thornburg partners listed on the $5.25-million contract is Brian Burdick, the brother of Daniels’ deputy chief of staff.

Mark Massa, who was Daniels’ general counsel at the time, said hiring outside counsel was necessary because of the complexity of the case.

“I just wanted to hire the best litigators I could find,” Massa said. “The decision was solely mine and I didn’t take political considerations into account.”

But Democrats complain that the hiring of Barnes & Thornburg was emblematic of the entire privatization process.

“This administration has a culture of conflicts of interest and secrecy that I have never seen before,” said state Senate Democratic leader Vi Simpson, who has served in the Indiana Senate since 1984.

Despite the problems Indiana encountered, Daniels said the experience has reinforced his support for privatization. “Unlike dealing with a government monopoly, if you don’t get it right the first time, you can switch to a different firm,” he said.

The current system, still largely run by private companies, “is working vastly better than it was originally,” he said. The state’s negative error rate for food stamps, for example, was 4% in fiscal year 2010, according to the USDA. That was down from 13% the previous year and bested the nationwide average of 8.4%.

Still, the success of privatization remains hard to gauge — a third of the state’s counties are still being run under the old welfare program. Social services advocates say the improvements in the rest of the state are largely due to the return of caseworkers to the field.

Critics say the episode showed the limits of Daniels’ philosophy.

“Highways are different; contracts for construction are different,” said state Sen. Vaneta Becker, a Republican from Evansville. “When you’re talking about people’s lives and whether or not children have access to healthcare, whether or not parents have access to nursing home care, it’s critical you have people in the trenches who can help.”

matea.gold@latimes.com

melanie.mason@latimes.com

tom.hamburger@latimes.com