The Obama administration faces two large and related domestic policy challenges: reforming health care and reducing the federal deficit. To get the biggest bang for its buck, the administration could look to one of the most sidelined and expensive areas of health care—long-term care.

In 2005, an estimated $207 billion of all health care costs were for long-term care, including nursing homes, services for persons with disabilities, home-based services, and hospice care. This figure does not account for an estimated 70 percent of informal care-giving provided to the elderly by family members or friends.

The high costs of long-term care are particularly important for state governments because they administer and partially fund Medicaid, the public health insurance program for low-income citizens. The following data speak for themselves. Medicaid funds close to half of all long-term care; only 25 percent of the enrollees receive Medicaid for long-term care but consume over 70 percent of costs; expenses for the elderly and disabled are nearly six times those for children and adults enrolled in Medicaid.

With the aging of the baby boom generation and a growing federal deficit that is largely driven by health-related programs, issues surrounding long-term care should be front and center in discussions about health reform. In only two years the oldest boomers will turn 65, placing enormous pressure on state and federal long-term care finances.

What can be done to reform long-term care? For decades, states have been experimenting with ways to improve its quality and reduce its costs. State innovations could serve as models for nationwide reforms. Here are some examples.

Home and community-based care programs provide long-term care to the elderly and younger people with disabilities in the privacy of their homes and in their communities rather than in institutions. States have been making the shift to home and community-based care for decades by using “waiver” programs. Regulations require these programs not be any more expensive than if care were provided in an institutional setting. The transformation from a system that puts people with long-term care needs into nursing homes to one that provides care in people’s homes and in their community has been slow going in some cases, but the American Association for Retired Persons (AARP) estimates that spending on home and community services increased much faster (65 percent) from 2001-2006, than spending on nursing homes (16 percent). The federal government could continue to offer incentives to states to provide care in home and community settings, while states could quickly adopt reforms for a wider and more effective use of such care.

Green Houses are an example of a very new method of care delivery for individuals who need skilled nursing care. They are designed to provide services in much smaller settings—10-12 residents—compared to traditional nursing homes, which often have an average capacity of over 100 residents. Their name comes from the idea of having sunlight, plants, and outdoor places as part of the nursing homes’ architecture. It has been found that such accommodations increase resident satisfaction, health outcomes, and staff retention as care and the living environments are personalized to create a sense of community, characteristics sometimes lacking in large nursing facilities. Because it is difficult for providers or states to acquire the capital to build Green Houses, federal assistance would help.

Individual’s choice. Some states also give increased power to individuals to make decisions regarding who provides care. Instead of relying on the help of a home care agency, many individuals are choosing less expensive options, including relatives, who often know best what type of support their loved ones need. One of these consumer-driven programs, known as “cash and counseling,” is relatively successful. Cash and counseling programs have been shown to improve patient satisfaction, reduce unmet care needs, improve caregiver satisfaction and not adversely affect health outcomes. Research also found that the programs did not increase costs to the Medicaid program. The federal government could continue to encourage the expansion of these methods of care delivery.

Programs of All-Inclusive Care for the Elderly (PACE). With federal incentives, states have also developed programs to better manage long-term care through what are known as PACE. These programs include services for an entire continuum of care: adult day care; physician medical care; home health and personal care; all required prescription drugs; social services; medical specialists; respite; and hospital and nursing home care, as necessary.

These are just some examples of how the federal government could learn from and work with states to reform long-term care. For those programs that have proven impacts on cost or quality, now is the time for government to go beyond experiments and to better diffuse innovative methods of care delivery that have proved to be successful. Innovation is needed if the nation’s longer-term challenges are to be met in the next decade.