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A grim prognosis for a highly touted program that provides health insurance for poor children in California: A federal review says a plan to save California Healthy Families Program may violate tax laws.

The bipartisan agreement was touted as a crucial piece of legislation that helped save the California Healthy Families Program from devastating budget cuts.

Just before young patients were kicked off the program, health insurers agreed to be taxed 2 percent. Because of that, combined with higher co-pays from families, the state was able to keep the program afloat for 700,000 poor children in California.

“We have found a solution. It is one of shared responsibility between government, health plans and the working families that are enrolled in the program,” said Governor Arnold Schwarzenegger on September 22.

But the Obama administration sent a warning recently saying that last-ditch effort, specifically the tax, may violate federal guidelines.

Children’s advocates say the consequences could be traumatic.

“If the program doesn’t have enough money going forward, the health coverage of a million children will be at risk, especially during this economic downturn. This is not a time when it’s going to be helpful to children and families,” said Kelly Hardy, associate director of Children Now, a public policy organization for children’s health.

And it’s not lost on California leaders that at a time when President Barack Obama is pushing for universal healthcare that such a ruling could jeopardize coverage for children.

“It doesn’t quite fit that they would not move forward to help California implement this law that would a save our program,” said Hardy.

Dozens of organizations have appealed the preliminary ruling. They say a new $21-billion deficit means the state has no other means to pay for the program.

The thought of losing their healthcare prompted numerous working families to trek to Sacramento several times this past year, upset leaders would even think about slashing their benefits.

“It’s really important. This is not something to play with. This is something we need to have,” said Yesenia Gonsales, a Healthy Families patient, on June 17.

The feds say California may need to tweak some state laws to resolve the issue, but it’s not clear whether it can be done in time.

Oleta Fitzgerald, director of the Children’s Defense Fund’s Southern Regional Office, says she is concerned over the welfare of Mississippi children if either of the two health-care reform packages considered by the U.S. House and Senate ever make it into law.

The House passed H.R. 3962 earlier this month, and Senate Democrats managed to beat back the threat of a Republican filibuster a few weeks ago, allowing the Senate to move forward with debate on the Patient Protection and Affordable Care Act, H.R. 3590. Both bills promise big reforms in the health-care and health-insurance industries. The Association for American Medical Colleges states that nearly 15 million people will be newly eligible for Medicaid and the Children’s Health Insurance Program under H.R. 3590, at an estimated cost of $374 billion over 10 years.

Fitzgerald says both bills contain huge holes regarding CHIP coverage for Mississippi children: “Right now, the fight over health-care reform in the House and Senate is all about abortion and the public option, but the children are getting lost in this discussion,” Fitzgerald said.

The issue, she said, centers on Mississippi’s unconventional requirement for CHIP eligibility.

Many states recently expanded their Medicaid program requirements to accept people who are a little further from the federal standard for poverty. Eleven states recently extended CHIP-eligible families’ income levels up to 200 percent of the federal poverty level, or higher. ($20,800 for an individual or $35,200 for a family of three).

But instead of expanding Medicaid, Mississippi set up a new health insurance program that contracts with private insurance companies. The states that expanded Medicaid will continue to receive federal support for those programs under both the bills under discussion in the House and Senate. But in Mississippi, all children and their families over 150 percent of the federal poverty level ($16,245 a year for an individual and $27,465 a year for a family of three) would go into an insurance exchange created by the House and Senate bills. The Senate bill plans to put CHIP-eligible kids in an exchange by the year 2019, while the House bill has them transferred by 2013.

Insurance exchanges do not promise the reliability of a government health program, Fitzgerald warns.

“Going into the exchange could require co-pays and premiums, the children would get lumped in with adults, and it’s not clear what requirements the insurance companies would have for their benefit packages,” she said.

There is also the question of permanence. Exchanges like the ones proposed by the House and Senate bills have not always been long-lasting. Texas, Florida, North Carolina and California all attempted—and failed—to create enduring insurance exchanges, primarily because private insurers tampered with the market.

A July report issued by the California HealthCare Foundation tried to pinpoint some of the factors that killed the California insurance exchange, which closed its doors in 2006. According to the report, the California exchange became too expensive when the clients it served became too costly. An exchange requires a certain number of healthy individuals to complement the more sickly participants of the exchange’s customer base; otherwise the cost of participation becomes too high for all participants.

But insurance companies in California lured healthy customers with lower premiums and steered the more sickly individuals into the exchange, creating a disproportionately expensive customer base.

“People involved in operations of the California exchange agreed that when there is competition for the same customers within and outside the exchange, the exchange is in ‘extreme peril’ of becoming a victim of adverse selection,” the report states. “If an exchange attracts a disproportionate share of higher risk individuals and groups as the California exchange did at various times, it cannot succeed.”

Fitzgerald said Mississippi’s eagerness to boot CHIP-eligible children from the program to keep down state costs is another factor complicating the new bills.

“Another problem is enrollment. We need enrollment in the exchanges to be simplified, because enrolling in state health programs have a history of being anything but simple in Mississippi,” Fitzgerald said, referencing a Medicaid policy championed by Republican Gov. Haley Barbour, which requires Medicaid recipients to meet Medicaid personnel “face-to-face” to be considered for program renewal.

CDF is working with its national office in trying to insert an amendment in the Senate bill though Democratic Sens. Robert Casey and Jay Rockefeller, which would keep all children up to 300 percent of the federal poverty level in the CHIP program until the new insurance exchange is thoroughly vetted.