In the USA, mental health expenditures have been rising at a rate that exceeds other medical expenditures. To control these costs, insurance companies and governmental agencies responsible for health benefit plans have turned to managed care companies who review utilisation of services and who negotiate fee reductions with providers. In this study, we examined changes in patterns of care and per person expenditures among Medicaid enrollees with major mental illness. We found that after the introduction of managed care, per person expenditures were reduced by about 25%, accomplished primarily by limiting hospital admissions. We also found that admissions (and the associated costs) were not shifted to the Department of Mental Health, which funds state hospital long-term care for the indigent. Measures of continuity of care were unchanged during the study period. We conclude that managed care met its cost-containment goals without shifting costs to another state agency.