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Arkansas's Medicaid Expansion Waiver Raises Cost Concerns' which was 
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GAO-14-689R: 

United States Government Accountability Office: 
GAO:
441 G St. N.W. 
Washington, DC 20548: 

August 8, 2014: 

The Honorable Orrin Hatch: 
Ranking Member: 
Committee on Finance: 
United States Senate: 

The Honorable Fred Upton: 
Chairman: 
Committee on Energy and Commerce: 
House of Representatives: 

Medicaid Demonstrations: HHS's Approval Process for Arkansas's 
Medicaid Expansion Waiver Raises Cost Concerns: 

Section 1115 of the Social Security Act authorizes the Secretary of 
the Department of Health and Human Services (HHS) to waive certain 
federal Medicaid requirements and allow costs that would not otherwise 
be eligible for federal matching funds for demonstration projects that 
promote the objectives of the Medicaid program.[Footnote 1] A 
significant and growing portion of federal Medicaid expenditures, 
which totaled $265 billion in fiscal year 2013, is for care provided 
under section 1115 demonstrations, which allow states to test and 
evaluate new approaches for delivering and financing Medicaid 
services.[Footnote 2] Under the Patient Protection and Affordable Care 
Act (PPACA),[Footnote 3] states may opt to expand their Medicaid 
programs by covering adults with incomes at or below 133 percent of 
the federal poverty level (FPL) under their state plan.[Footnote 4] In 
August 2013, Arkansas proposed an unprecedented alternative to this 
expansion under the authority of a section 1115 demonstration. In 
September 2013, HHS approved Arkansas's demonstration proposal to 
expand its program by allowing federal Medicaid funds to be used to 
provide premium assistance to enable newly eligible beneficiaries to 
purchase private insurance offered through the state's health 
insurance exchange.[Footnote 5] This approved demonstration, for the 
state of Arkansas, is the first of its kind testing the use of premium 
assistance in purchasing exchange coverage for a state's entire 
Medicaid expansion population. Subsequently, in December 2013, HHS 
approved another state's--Iowa's--demonstration to use premium 
assistance to purchase private insurance on its exchange for a more 
limited group of newly eligible beneficiaries. HHS has indicated that 
these demonstrations will help inform the planning and approval of 
future state demonstrations.[Footnote 6] 

HHS policy requires that section 1115 demonstrations be budget-neutral 
to the federal government; that is, the federal government should 
spend no more under a state's demonstration than it would have spent 
without the demonstration.[Footnote 7] Once approved, each 
demonstration operates under a negotiated budget neutrality agreement 
that places a limit on federal Medicaid spending over the life of the 
demonstration. The spending limit set by HHS is generally based on 
state projections of what the state's existing Medicaid program would 
have cost the federal government absent the demonstration. 

You asked that we develop information about HHS's approval of the use 
of Medicaid funds to provide premium assistance to enable newly 
eligible beneficiaries to purchase coverage offered on the exchange in 
Arkansas and how HHS ensured the demonstration would not increase 
federal costs. For this report, we examined (1) what HHS approved 
under the Arkansas demonstration; (2) the extent to which HHS has 
ensured that the Arkansas demonstration is budget-neutral; and (3) the 
extent to which other states have approached HHS to seek information 
on or approval for implementing an approach similar to Arkansas. 

To describe what HHS has approved under the Arkansas demonstration and 
assess the extent to which HHS ensured the budget neutrality of the 
demonstration, we reviewed the demonstration documentation, including 
the application and the budget neutrality analysis submitted by the 
state, HHS's approval letter, and HHS's special terms and conditions 
for approving the demonstration. We examined the basis of HHS's 
approved spending limit for the demonstration and determined whether 
it was based on expenditures that the state made, expenditures the 
state could have made but did not (i.e., hypothetical costs), or both. 
We then compared the spending limit approved by HHS with our estimates 
of the spending limit absent any hypothetical costs. We calculated our 
estimates using the historical expenditure data submitted by the state 
as the basis of its cost projection, state enrollment projections, and 
the growth rate approved by HHS for the demonstration.[Footnote 8] For 
our analysis, we did not compare the underlying spending data used to 
develop the spending limit to source documentation on spending or 
determine whether the baseline expenditures included impermissible 
costs. To the extent baseline spending or projected enrollment were 
overstated or understated, our estimates of the spending limit could 
also be overstated or understated. We determined that the historical 
expenditure data were sufficiently reliable for the purpose of 
estimating the spending limit absent hypothetical costs. These data 
were submitted by the state and used by HHS to represent the baseline 
cost of what the state's existing Medicaid program would have cost 
absent the demonstration, prior to adjustments HHS allowed to account 
for expected costs under the demonstration. To supplement our review 
and analysis, we interviewed HHS officials about their approval of the 
demonstration, the basis for the spending limit for the Arkansas 
demonstration, and the steps taken to assess the reasonableness of the 
state's budget neutrality analysis. We also interviewed HHS officials 
about the extent to which other states had received HHS approval to 
demonstrate a similar approach to that of Arkansas--using Medicaid 
funds for premium assistance to purchase private coverage on exchanges 
for those newly eligible under PPACA--or were seeking or considering 
seeking HHS approval for such an approach. We did not assess other 
states' proposals or HHS's approval of other demonstrations. 

We conducted this performance audit from April 2014 to August 2014 in 
accordance with generally accepted government auditing standards. 
Those standards require that we plan and perform the audit to obtain 
sufficient, appropriate evidence to provide a reasonable basis for our 
findings and conclusions based on our audit objectives. We believe 
that the evidence obtained provides a reasonable basis for our 
findings and conclusions based on our audit objectives. 

Results in Brief: 

In approving Arkansas's Medicaid Section 1115 demonstration, HHS 
allowed Arkansas to test whether using premium assistance to purchase 
coverage offered on the exchange will, among other things, improve 
access to care for individuals newly eligible under PPACA. 
Specifically, under the demonstration, HHS approved Arkansas to 
receive federal Medicaid funds to purchase private coverage offered on 
the exchange for individuals newly eligible for Medicaid and required 
the state to pay directly for any services covered under its 
traditional Medicaid program that are not covered by exchange plans. 

In approving the demonstration, HHS did not ensure budget neutrality. 
Specifically, HHS approved a spending limit for the demonstration that 
was based, in part, on hypothetical costs--significantly higher 
payment amounts the state assumed it would have to make to providers 
if it expanded coverage under the traditional Medicaid program--
without requesting any data to support the state's assumptions. We 
estimated that, by including these costs, the 3-year, nearly $4.0 
billion spending limit that HHS approved for the state's demonstration 
was approximately $778 million more than what the spending limit would 
have been if it was based on the state's actual payment rates for 
services provided to adult beneficiaries under the traditional 
Medicaid program. In addition, HHS gave Arkansas the flexibility to 
adjust the spending limit if actual costs under the demonstration 
proved higher than expected, and HHS officials told us that the 
Department granted the same flexibility--one which HHS has not 
provided in the past--to 11 other states implementing demonstrations 
that affect services for newly eligible beneficiaries. Finally, HHS in 
effect waived its cost-effectiveness requirement that providing 
premium assistance to purchase individual coverage on the private 
market prove comparable to the cost of providing direct coverage under 
the state's Medicaid plan--further increasing the risk that the 
demonstration will not be budget-neutral.[Footnote 9] 

As of June 2014, HHS had approved one additional state's--Iowa's--
demonstration to use premium assistance to purchase exchange coverage. 
Iowa's demonstration is more limited in scope in that it covers only a 
portion of the expansion population, those with incomes of 101 percent 
to 133 percent of the FPL. As with its approval of the Arkansas 
demonstration, HHS gave Iowa the flexibility to adjust its spending 
limit and waived the cost-effectiveness requirement. According to HHS 
officials, as of June 2014, three other states had indicated an 
interest in implementing a similar approach. 

We provided a draft of this report to HHS for comment, and HHS's 
comments are attached as enclosure I. In its written comments, HHS 
disagreed with our findings that HHS's budget neutrality policy and 
process did not ensure that the Arkansas demonstration will be budget-
neutral. We maintain the validity of our findings. HHS also provided 
technical comments which we incorporated as appropriate. 

Background: 

For many years, section 1115 demonstrations offered the only avenue 
for states to provide Medicaid coverage to otherwise ineligible 
childless adults. Although states have flexibility under their 
traditional programs to, among other things, establish provider 
payment rates and cover many types of optional benefits and 
populations, demonstrations provide a way for states to innovate 
outside of many of Medicaid's otherwise applicable requirements. 
[Footnote 10] For example, states may test ways to obtain savings or 
efficiencies in how services are delivered in order to cover otherwise 
ineligible populations. 

HHS policy requires that section 1115 demonstrations be budget-neutral 
to the federal government. According to HHS policy, the spending 
limits for demonstrations are to be based on the projected cost of 
continuing states' existing Medicaid programs without a demonstration. 
The higher these projected costs, the higher the spending limit, and 
the more federal funding states are potentially eligible to receive 
for the demonstration, in the form of a federal match on their actual 
expenditures. The spending limits can be either an annual per-person 
limit or an aggregate spending limit that remains fixed for the entire 
length of the demonstration, or a combination of both. Spending limits 
for demonstrations are calculated by establishing a spending base and 
applying a rate of growth over the period of the demonstration. The 
spending base generally reflects a recent year of state expenditures 
for populations included in the demonstration. 

PPACA authorizes states to expand Medicaid coverage to adults with 
incomes up to 133 percent of the FPL, and provides enhanced federal 
funding for these newly eligible beneficiaries. Specifically, states 
are to receive an increased federal match for newly eligible 
individuals at 100 percent for 2014 through 2016.[Footnote 11] For new 
populations, such as those newly eligible under PPACA, demonstration 
spending limits are based on state projections of cost for the 
population, which are developed using historical spending data. 
According to HHS policy, states must provide a justification for the 
projections, including a description of the data sources and 
methodology used for their estimates. 

Federal law allows states to require Medicaid beneficiaries to enroll 
in employer-sponsored insurance and use federal Medicaid funds to 
provide premium assistance for this coverage, provided that such 
premium assistance is cost-effective.[Footnote 12] A number of states 
have used this authority to provide premium assistance for Medicaid 
beneficiaries enrolled in employer-sponsored coverage. States, 
however, may also receive federal Medicaid funds to provide premium 
assistance to Medicaid beneficiaries who voluntarily purchase private 
coverage on the individual market, which includes enrollment in 
qualified health plans (QHPs) offered through the exchanges. States 
must meet certain requirements to offer this assistance, including 
ensuring that premium assistance is cost-effective, hereafter referred 
to as the cost-effectiveness requirement. Specifically, HHS requires 
that the total cost of purchasing private insurance coverage must be 
comparable to the cost of providing direct coverage under the state's 
Medicaid plan.[Footnote 13] 

We have had long-standing concerns with HHS's policy, process, and 
criteria for reviewing and approving section 1115 demonstrations, 
including the lack of transparency in the basis for approved spending 
limits.[Footnote 14] We have previously reported that HHS's budget 
neutrality policy and process did not provide assurances that 
demonstrations would be budget-neutral to the federal government. 
Among other concerns, we reported that HHS allows methods for 
establishing the spending limit that we believe are inappropriate, 
such as allowing states to include hypothetical costs--expenditures 
that the state could have made under its Medicaid program but did not--
in establishing the baseline for the spending limits. As a result of 
these findings, we made recommendations to HHS to improve the budget 
neutrality process and reexamine spending limits.[Footnote 15] HHS 
disagreed with our recommendations and, as of June 2014, HHS has not 
addressed these issues. In 2008, because HHS disagreed that changes to 
the budget neutrality policy and review process were needed, we 
suggested that Congress consider requiring the Secretary of HHS to 
improve the demonstration review process by, for example, better 
ensuring that valid methods are used to demonstrate budget neutrality 
and documenting and making public the basis for such approvals. 

HHS Approved Arkansas's Demonstration to Expand Medicaid to Low-Income 
Adults through Premium Assistance for Private Health Coverage 
Purchased through the Exchange: 

In September 2013, HHS approved Arkansas's demonstration, giving the 
state the authority to provide health insurance coverage to adults 
newly eligible for Medicaid under PPACA outside of the traditional fee-
for-service (FFS) Medicaid model, in which health care providers are 
paid directly by the Medicaid program for each service provided. Under 
HHS's terms for the approved demonstration, which runs from 2014 
through 2016, newly eligible adults, including adults with incomes 
between 0 and 133 percent of FPL,[Footnote 16] are to shop for 
coverage offered on the exchange through the state's web-based portal 
and select a QHP. The QHP is to issue the insurance card and the state 
is to pay the premium directly to the QHP on behalf of the individual. 
In the event that an individual does not select a QHP, the state is to 
automatically assign one. Arkansas estimated that 200,000 adults would 
enroll under the demonstration. Enrollment in QHPs began on October 1, 
2013, with eligibility effective January 1, 2014. 

Under the approved demonstration, the demonstration population is 
eligible for the same benefit package as outlined in the state's 
alternative benefit plan, which has a more limited set of benefits 
than the traditional Medicaid benefit package but a more generous set 
than is required of QHPs.[Footnote 17] Under the terms of the approved 
demonstration, services that are covered under the state's alternative 
benefit plan but not in the QHP package, known as wrap-around 
benefits, are to be provided through the state's Medicaid FFS program. 
[Footnote 18] Cost-sharing under the demonstration would also be the 
same as is detailed in the state's Medicaid plan. For individuals in 
the demonstration population, enrollment in a QHP is mandatory, and a 
choice between at least two QHPs is guaranteed under the terms of the 
demonstration. All expenditures under the demonstration are to be 
financed by the federal government because the demonstration 
population is eligible for enhanced federal matching funds under 
PPACA--100 percent in the 3 years of the demonstration. 

According to the state's application, the demonstration was designed 
to address two potential access issues facing the newly eligible 
population: continuity of coverage and access to care. The state 
projected that the newly eligible adults would likely have frequent 
income fluctuations that would lead to changes in eligibility for the 
different affordable coverage options--Medicaid or advanced premium 
tax credits and cost sharing reductions available to subsidize coverage 
purchased through exchanges.[Footnote 19] These eligibility changes 
could result in coverage gaps and changes in benefits, provider 
networks, premiums, and cost-sharing. Under the demonstration, 
individuals could stay enrolled in the same QHP regardless of whether 
their coverage is financed through Medicaid or federal subsidies. In 
addition to maintaining continuity of coverage, the state's 
application proposed that the demonstration would provide better 
access to care than the traditional Medicaid program. According to the 
state's proposal, the state's existing network of Medicaid FFS 
providers was at capacity. By purchasing QHP coverage for newly 
eligible beneficiaries, the state suggested it could improve access to 
care because beneficiaries would have access to expanded provider 
networks through their QHPs. 

As a condition of HHS's approval, the state is required to evaluate 
the demonstration, including whether it maintains or improves access 
for the demonstration population.[Footnote 20] HHS approved Arkansas's 
evaluation plan in March 2014 and, according to the plan, the state 
will be evaluating whether the demonstration population has equal or 
better access to health care and better continuity of coverage than 
what they would have had under Medicaid FFS. The evaluation plan does 
not include measures that assess whether the demonstration will affect 
access for those in the FFS program. However, according to HHS 
officials, the FFS Medicaid population is included as a comparison 
group in the evaluation and a pre-demonstration baseline will be 
established for the group. Thus, HHS officials indicated that through 
the use of this data and ongoing monitoring, they would be able to 
identify any declines in access. Arkansas is required to submit the 
first set of results from the evaluation in March 2016. 

HHS's Approval of the Arkansas Demonstration Did Not Ensure Budget 
Neutrality as the Demonstration Will Likely Raise Federal Costs, and 
Raises New Concern About HHS's Approval Process: 

In approving the spending limit for the Arkansas demonstration, HHS 
did not ensure budget neutrality. HHS approved a spending limit that 
included hypothetical costs despite questionable state assumptions and 
limited supporting documentation. Specifically, Arkansas's projections 
of the cost of expanding Medicaid without the demonstration assumed 
the state would have had to pay its Medicaid providers rates 
comparable to private insurance payment rates--significantly higher 
rates than the rates the state was paying its FFS providers--to ensure 
access for newly eligible beneficiaries. For example, the state 
assumed that it would have to pay 67 percent above its FFS payment 
rate for primary care services and, for higher-cost services, such as 
inpatient and long-term care services, the state assumed it would have 
to pay 10 percent more. HHS approving officials told us that they 
thought the state's underlying concern about the insufficient capacity 
of the state's Medicaid provider network was valid given a projected 
25 percent increase in the number of individuals covered under the 
state's Medicaid program. HHS officials did not request data to 
support the state's assertion. In addition, HHS officials told us they 
accepted the state's projection of the increased cost of expanding 
Medicaid in the absence of a demonstration without requesting data to 
support the state's assumptions about specific payment 
increases.[Footnote 21] HHS officials did request that CMS's Office of 
the Actuary (OACT) review the state's projections.[Footnote 22] An 
OACT official told us that OACT questioned the reasonableness of the 
state's assumptions about the higher payment rates, including 
questioning the projected payment rates for physician, hospital, and 
pharmacy services. The OACT official told us they would have needed 
additional information from the state beyond what was provided in 
order to assess the validity of the assumptions. HHS program officials 
confirmed that they did not request further information from the 
state. They explained that, in assessing budget neutrality, they 
generally do not request or assess the data that drives state 
assumptions beyond the extent done in this case. We estimate that by 
including the costs associated with the hypothetical provider payment 
rate increases, the $4.0 billion spending limit approved by HHS was 
about $778 million more that what it would have been if based on the 
rates Arkansas was actually paying providers for services provided to 
adult beneficiaries under the traditional Medicaid FFS program. 
[Footnote 23] 

Furthermore, HHS gave Arkansas the flexibility to adjust the approved 
spending limit if costs, once the demonstration is underway, prove 
higher than expected. To make such an adjustment, the state is 
required to submit for HHS's review actual expenditure data for the 
demonstration that would justify such an adjustment.[Footnote 24] 
Officials said that they have included the same flexibility to adjust 
the spending limit--a flexibility that has not been granted for 
demonstrations in the past--for 11 other state demonstrations that 
affect services for newly eligible beneficiaries, citing the lack of 
data on the potential cost of the expansion population when setting 
the spending limit for these demonstrations.[Footnote 25] HHS 
officials told us that this flexibility to adjust budget neutrality 
projections without having to amend the terms and conditions of the 
demonstration has not been provided for demonstrations outside those 
related to Medicaid expansion. Typically, under demonstration budget 
neutrality agreements, the state must either seek an amendment 
requesting a revised budget neutrality calculation because of changes 
in circumstance, or bear the risk of costs being higher than 
projected. The flexibility to adjust the spending limit increases the 
risk to the federal government. Officials confirmed that HHS has no 
documented criteria for approving such an adjustment but told us that 
approval for such an adjustment would factor in a review of actual 
expenditure data and that such adjustments would be documented and 
made public. HHS officials told us that neither Arkansas nor any of 
the other 11 states had requested an adjustment to demonstration 
spending limits as of June 2014. 

Finally, HHS waived the requirement that premium assistance to 
purchase coverage on the individual market be cost-effective, further 
increasing the risk that the demonstration will not be budget-neutral. 
Rather than apply HHS's test of cost-effectiveness--that the cost of 
purchasing coverage be comparable to the cost of providing direct 
coverage under Medicaid--HHS allowed Arkansas to apply a state-
developed test of cost-effectiveness. HHS officials told us that under 
the state's test, the demonstration could cost more than the costs of 
providing coverage in the state's Medicaid FFS system and still be 
deemed cost-effective by HHS. Specifically, under HHS's terms, 
Arkansas's test of cost-effectiveness is expected to factor in the 
results of the full 3 years of the demonstration and to account for 
the value of other impacts such as gains in continuity of coverage and 
improvements in service delivery and health outcomes. HHS officials 
said that the rationale for permitting an alternative test of cost-
effectiveness was to capture the cost implications of certain 
qualitative effects of the demonstration such as reduced "churn"--that 
is, the disruption that would be caused by the fluctuation in 
beneficiary eligibility--in the insurance marketplace. 

One State Has Received HHS's Approval to Implement a Similar 
Demonstration, and Several Other States Have Indicated an Interest in 
Doing So: 

As of June 2014, HHS has granted approval to one state--Iowa--to 
implement a demonstration using an approach similar to that of 
Arkansas's for a more limited population and has provided similar 
spending flexibility. Iowa received approval from HHS in December 2013 
for a 3-year demonstration that runs from 2014 through 2016, under 
which the state will use premium assistance to purchase insurance on 
the state's exchange for newly eligible Medicaid beneficiaries who 
have incomes between 101 and 133 percent of the FPL, a smaller portion 
of the Medicaid expansion population than was included in the Arkansas 
demonstration.[Footnote 26] As it did in the Arkansas demonstration, 
HHS, in effect, waived the cost-effectiveness requirement for using 
premium assistance to purchase coverage on the individual market and, 
as noted earlier, gave Iowa the flexibility to adjust the spending 
limit for the demonstration if costs proved higher than expected. 

In addition to Arkansas and Iowa, HHS officials told us that three 
other states have indicated interest in using premium assistance to 
purchase coverage offered on the exchanges in their states to expand 
their Medicaid programs. Officials told us that, as of June 2014, 
Pennsylvania had a pending application for a demonstration that 
included an approach of using premium assistance to purchase exchange 
coverage as one of its options for expanding Medicaid. According to 
officials, during the review process the state decided against this 
approach and directed its efforts toward a different model of 
providing private coverage. In addition to Pennsylvania, HHS officials 
told us that as of June 2014, two other states--New Hampshire and 
Utah--have shown some indication of pursuing a similar approach but 
have not submitted a demonstration application. 

Concluding Observations: 

Section 1115 demonstrations have long been an important tool to test 
new approaches to improve states' Medicaid programs. Arkansas's 
demonstration may prove an important test of whether using Medicaid 
funds to finance coverage offered through exchanges will improve 
access to care and continuity of coverage for the adult population 
that the demonstration aims to cover. However, the increasing use of 
demonstrations has shifted a significant portion of federal Medicaid 
funds into financing care that is not subject to all of the federal 
Medicaid requirements. While HHS policy requires that demonstrations 
be budget-neutral and therefore not increase the costs to the federal 
government, we have had long-standing concerns about the Department's 
ability to ensure budget neutrality given HHS's flexible approach 
towards approving spending for new demonstrations. These concerns have 
centered around how HHS allows states to use questionable methods and 
assumptions when developing cost projections that serve as the basis 
for demonstration spending limits, without providing adequate 
documentation to support these projections. We have made a number of 
recommendations in the past to improve the budget neutrality process 
for Medicaid demonstrations generally and reexamine spending limits 
for specific demonstrations. However, HHS has disagreed with those 
recommendations and has continued to use a process that lacks criteria 
and transparency and allows spending limits to include inappropriate 
costs. In 2008, because HHS disagreed that changes to the budget 
neutrality policy and review process were needed, we suggested that 
Congress consider requiring increased attention to fiscal 
responsibility in the approval of section 1115 demonstrations. 
Specifically, we suggested that Congress require the Secretary of HHS 
to improve the demonstration review process by, for example, better 
ensuring that valid methods are used to demonstrate budget neutrality 
and documenting and making public the basis for such approvals. 

HHS's approval of $778 million dollars of hypothetical costs in the 
Arkansas demonstration spending limit and the department's waiver of 
its cost-effectiveness requirement is further evidence of our long-
standing concerns that HHS is approving demonstrations that may not be 
budget-neutral. HHS's approval of the Arkansas demonstration suggests 
that the Secretary may continue to approve section 1115 Medicaid 
demonstrations that raise federal costs, inconsistent with the 
Department's policy of budget neutrality. Moreover, the additional 
flexibility granted to Arkansas and 11 other states to increase the 
spending limit if costs prove higher than expected sets another 
precedent, further eroding the integrity of HHS's process. If, as it 
did with Arkansas, HHS allows states to use an approach to expanding 
Medicaid that is expected to cost more than expansion under the 
existing Medicaid program with fewer cost controls in place, there 
could be significant cost implications for the federal government. 
Efforts to ensure cost-effectiveness and budget neutrality in Medicaid 
expansion demonstrations have even greater fiscal implications given 
that states that choose to do so will receive enhanced federal funding 
for the newly eligible population. 

Agency Comments and Our Evaluation: 

We provided a draft of this report to HHS for comment. In its written 
comments, HHS disagreed with our findings that HHS's budget neutrality 
policy and process did not ensure that the Arkansas demonstration will 
be budget-neutral. Specifically, HHS disagreed with GAO's conclusion 
that HHS continues to allow states to use questionable methods and 
assumptions when developing cost projections that serve as the basis 
for demonstration spending limits without adequate documentation to 
support these projections. HHS stated that Arkansas provided an 
explanation of how the demonstration would achieve budget neutrality 
and the data to support its rationale. As noted in this report, we 
reviewed Arkansas's budget neutrality explanation as provided to HHS, 
and we found that the state's assumptions that the state would pay 
Medicaid providers significantly higher rates in the absence of the 
demonstration were questionable and supporting documentation was 
limited. 

HHS also disagreed with our finding that HHS approved a spending limit 
that did not ensure budget neutrality because it included 
approximately $778 million in hypothetical costs. HHS said that our 
estimate relied on a subset of the data HHS used to assess and 
determine the spending limit and did not account for major program 
changes as a result of the expansion of Medicaid. In conducting our 
analysis, we reviewed all the data and information that HHS officials 
reviewed in developing the spending limit. In estimating the spending 
limit, we did not factor in questionable assumptions about provider 
payment rates, and we based our estimate on the historical expenditure 
data provided by Arkansas, which we believe is the appropriate subset 
of data for developing such an estimate. HHS also stated that our 
reading of the budget neutrality policy did not appropriately account 
for major program changes as a result of the expansion of Medicaid 
created by PPACA, and stated that in approving the new spending limit, 
they took into account market prices for similar populations. We 
continue to believe that a budget neutrality policy that allows for 
hypothetical costs based on assumptions that higher spending is 
allowed under Medicaid or, in this case, is necessary to ensure 
access, is flawed without sound supporting evidence. In our view, if 
the state was not paying these costs before the demonstration, these 
costs should not be approved under demonstration spending limits 
without strong evidence supporting the deviation from HHS's policy of 
relying on state historical spending for projecting future costs. 

With regard to our finding that HHS, in effect, waived its cost-
effectiveness requirement, HHS noted that it allowed the state to 
apply its own cost-effectiveness test to allow for a more expansive 
cost-benefit analysis than would be captured under the Department's 
test. As we acknowledge in our report, this demonstration may prove an 
important test of the benefits of using Medicaid to finance coverage 
offered on the exchanges. However, under the state's test the 
demonstration could cost more than the costs of providing coverage 
through the state's traditional Medicaid program, further increasing 
the risk that the demonstration will not be budget-neutral. 

HHS comments are reproduced in enclosure I. HHS also provided 
technical comments, which we incorporated as appropriate. 

As agreed with your offices, unless you publicly announce the contents 
of this report earlier, we plan no further distribution until 30 days 
from the report date. At that time, we will send copies of this report 
to the Secretary of Health and Human Services, appropriate 
congressional committees, and other interested parties. The 
correspondence is also available at no charge on the GAO website at 
[hyperlink, http://www.gao.gov]. 

If you or your staff members have any questions about this report, 
please contact me at (202) 512-7114 or iritanik@gao.gov. Contact 
points for our Offices of Congressional Relations and Public Affairs 
may be found on the last page of this correspondence. Other key 
contributors to this correspondence included Susan Barnidge, Assistant 
Director; Jasleen Modi, Laurie Pachter, and Hemi Tewarson. 

Signed by: 

Katherine M. Iritani 
Director, Health Care: 

Enclosure: 

[End of section] 

Comments from the Department of Health and Human Services: 

Department of Health & Human Services: 
Office of The Secretary	
Assistant Secretary for Legislation: 
Washington, DC 20201: 

July 22, 2014: 

Katherine Iritani: 
Director, Health Care: 
U.S. Government Accountability Office: 
441 G Street NW: 
Washington, DC 20548: 

Dear Ms. Iritani: 

Attached are comments on the U.S. Government Accountability Office's 
(GAO) report entitled, "Medicaid Demonstrations: HHS Approval Process 
for Arkansas' Medicaid Expansion Waiver Raises Cost Concerns" (GAO-14-
689R). 

The Department appreciates the opportunity to review this report prior 
to publication. 

Sincerely, 

Signed by: 

Jim R. Esquea: 
Assistant Secretary for Legislation: 

Attachment: 

General Comments Of The Department Of Health And Human Services (HHS) 
On The Government Accountability Office's Draft Report Entitled: 
Medicaid Demonstrations: HHS Approval Process For Arkansas' Medicaid 
Expansion Waiver Raises Cost Concerns (GAO-14-689R): 

The Department of Health and Human Services (HHS) appreciates the 
opportunity to review and comment on this draft report. Although GAO 
is not making any recommendations in this report, HHS would like to 
clarify a few points that may be misleading. 

The Government Accountability Office (GAO) concluded that HHS allows 
states to use questionable methods and assumptions when developing 
cost projections that serve as the basis for demonstration spending 
limits without providing adequate documentation to support these 
projections. HHS disagrees as, consistent with our policy that budget 
neutrality calculations should be based on the best available data, 
the state provided an explanation of how the demonstration program 
will achieve budget neutrality and the data to support its rationale. 
The state used assumptions and projected costs that CMS determined 
were comparable to other states' estimates. These estimates were based 
on analysis of the impact of a dramatic and unique increase in adult 
Medicaid enrollment. 

Further, GAO concluded that HHS disagrees with GAO's previous 
recommendations regarding changing the budget neutrality process and 
has continued to use a process that lacks criteria and transparency 
and allows spending limits to include inappropriate costs. GAO 
suggests the Arkansas approval is further evidence of GAO's long-
standing concerns that HHS is approving demonstrations that may not be 
budget neutral, and suggests that the Secretary may continue to 
approve demonstrations that raise federal costs; including the 
additional flexibility granted to Arkansas and 11 other states to 
increase the spending limit if costs prove higher than expected. 

HHS does not concur with GAO's suggestion that the process lacks 
criteria, transparency and includes inappropriate costs. As is 
explained in more detail below, CMS's calculation of these state's 
spending limits were based on the most reasonable and documented cost 
assumptions available regarding the interventions being 
operationalized under the demonstration. 

HHS disagrees with GAO's assertion that HHS's budget neutrality policy 
and process do not assure that the Arkansas demonstration will be 
budget neutral. GAO estimates that HHS approved "approximately $778 
million more than what the spending limit would have been if it was 
based on the state's actual payment rates for services provided to 
adult beneficiaries under the traditional Medicaid program." This 
conclusion is inaccurate. GAO used only a subset of the data that CMS 
uses to assess and determine the appropriate estimates used in 
developing a budget neutrality model that corresponds with the state's 
proposed program intervention. GAO also relied on a very narrow 
reading of HHS budget neutrality policy that does not account for 
major program changes as a result of the expansion of Medicaid created 
by the Affordable Care Act. 

HHS policy is that, in determining what expenditures would have been 
without a demonstration, we use the best available information; 
generally, that means the state's historical spending. However, 
because Arkansas sought to cover the new Medicaid eligibility group 
via a new benefit package, we took into account market prices for 
similar populations. As GAO notes, "Arkansas used expenditure data for 
low-income non-disabled adults with children who were previously 
eligible to establish baseline spending. The data established a base 
unit cost for the various types of services that would be covered 
under the demonstration." As the report further notes, budget 
neutrality calculations set only the upper limits on the federal funds 
available to states under the demonstration; in order to claim federal 
matching funds, states must have actual expenditures that are 
permissible under the terms of the demonstration. 

Finally, regarding the cost-effectiveness test, as the report also 
notes, FIRS allowed for the state to develop its own test to account 
for the value of factors such as gains in continuity of coverage and 
improvement in service delivery and health outcomes. This cost-benefit 
analysis process will yield valuable data applicable not only for this 
demonstration but also more broadly in terms of Medicaid policy. The 
state plan regulatory cost effectiveness test is a cost to cost 
comparison in a given year that does not contemplate the potential 
benefits of a premium assistance model such as the one Arkansas is 
pursuing that can be measured in a formally evaluated demonstration. 
The alternative approved for Arkansas, recognizing that a 
demonstration allows for more expansive cost-benefit analysis than a 
State Plan Amendment premium assistance program, allows for cost 
effectiveness to be studied over a longer period of time and includes 
previously unquantified factors. HHS will consider states' ideas on 
cost effectiveness that include new factors introduced by the creation 
of Health Insurance Marketplaces and the expansion of Medicaid. For 
example, Arkansas may quantify savings from reduced churning (people 
moving between Medicaid and Exchanges as a result of fluctuating 
incomes), improvements in care and in health from reduced 
fragmentation and access to different providers, and increased 
competition in Marketplaces given the additional enrollees due to 
premium assistance. The evaluation of the demonstration will include 
specific analyses on the benefits produced by the model, which can 
then be examined in light of the cost of the demonstration. 

[End of section] 

Footnotes: 

[1] 42 U.S.C. § 1315(a). The federal government and states share in 
the financing of Medicaid expenditures with the federal government 
matching most state expenditures for services on the basis of a 
statutory formula known as the Federal Medical Assistance Percentage 
(FMAP). The FMAP may range from 50 to 83 percent, which depends, in 
part, on a state's per capita income. 

[2] In 2013, $70 billion in federal funds, or about one-fourth of the 
$265 billion in federal Medicaid expenditures, were for services, 
coverage initiatives, and delivery system redesigns provided under 
section 1115 demonstrations. 

[3] Pub. L. No. 111-148, 124 Stat. 119 (2010), as amended by the 
Health Care and Education Reconciliation Act of 2010 (HCERA), Pub. L. 
No. 111-152, 124 Stat. 1029 (2010). For purposes of this report, 
references to PPACA include the amendments made by HCERA. 

[4] Beginning in 2014, states may cover non-elderly, non-pregnant 
adults under their state plan with incomes at or below 133 percent of 
the FPL. PPACA also provides for a 5 percent disregard when 
calculating income for determining Medicaid eligibility for this 
population, which effectively increases this income level to 138 
percent of the FPL. In this report, we refer to this population as 
"newly eligible beneficiaries." 

[5] PPACA required the establishment of health insurance exchanges 
(hereafter referred to as exchanges)--also known as marketplaces--in 
all states. Through the exchanges, eligible individuals can compare 
and select private health plans, known as qualified health plans 
(QHPs). QHPs offered through the exchanges are required to meet 
certain benefit design, consumer protection, and other standards. 

[6] Under PPACA, HHS may approve a new type of waiver, state 
innovation waivers, beginning in 2017. States may apply to waive 
certain federal requirements established under PPACA, including: the 
requirement to offer premium tax credits and cost-sharing reductions 
for coverage purchased through an exchange; the requirement for 
individuals to maintain coverage (known as the individual mandate); 
and the penalties imposed on employers whose employees purchase 
coverage through an exchange and receive premium tax credits. States 
may combine these waivers and section 1115 demonstrations by 
submitting a single application to HHS. 

[7] Budget neutrality for Medicaid section 1115 demonstrations is not 
required under federal law or regulations. 

[8] The historical expenditure data submitted by the state represented 
Medicaid expenditures for an adult population that the state 
determined to be similar to the newly eligible beneficiaries--certain 
low-income, non-disabled parents who were eligible under the state's 
traditional Medicaid program. 

[9] Under the demonstration, HHS provided the state with the authority 
to receive federal Medicaid funds for premium assistance and cost-
sharing payments for newly eligible adults enrolling in plans through 
Arkansas' exchange under an expenditure authority. According to HHS 
officials, the purpose of this authority was to make the cost-
effectiveness requirement not applicable to expenditures, thereby 
allowing the state to use its own tests of cost-effectiveness. For 
purposes of this report, we refer to the flexibility provided under 
this authority as a "waiver" of the cost effectiveness requirement. 

[10] States establish Medicaid payment rates to providers, subject to 
certain federal requirements. For example, under federal law, payments 
to providers must be economical, efficient, and made at a level that 
ensures access to care comparable to those not in the Medicaid program 
in the same geographic area. See 42 U.S.C. § 1396a(a)(30)(A). 

[11] 42 U.S.C. § 1396d(y). 

[12] 42 U.S.C. § 1396e. 

[13] In June 2013, HHS issued regulations clarifying, among other 
things, that states may receive federal Medicaid funds for premium 
assistance to purchase coverage on the individual market under their 
traditional Medicaid program and that such coverage must be cost-
effective. HHS defined the total cost of coverage as the cost of 
premiums and cost sharing, administrative costs and the cost to the 
state of providing Medicaid benefits not covered by the individual 
health plan. 42 C.F.R. § 435.1015(a)(4). According to HHS, this cost-
effectiveness requirement is applied on an annual basis. HHS officials 
also told us that states have some flexibility in how to construct a 
cost-effectiveness calculation and these calculations have generally 
been done on an annual, one-year (versus multi-year) basis. 

[14] See GAO, Medicaid Waivers: HHS Approvals of Pharmacy Plus 
Demonstrations Continue to Raise Cost and Oversight Concerns, 
[hyperlink, http://www.gao.gov/products/GAO-04-480] (Washington, D.C.: 
June 30, 2004); Medicaid Demonstration Waivers: Lack of Opportunity 
for Public Input during Federal Approval Process Still a Concern, 
[hyperlink, http://www.gao.gov/products/GAO-07-694R] (Washington, 
D.C.: July 24, 2007); Medicaid Demonstration Waivers: Recent HHS 
Approvals Continue to Raise Cost and Oversight Concerns, [hyperlink, 
http://www.gao.gov/products/GAO-08-87] (Washington, D.C.: Jan. 31, 
2008); and Medicaid Demonstration Waivers: Approval Process Raises 
Cost Concerns and Lacks Transparency, [hyperlink, 
http://www.gao.gov/products/GAO-13-384] (Washington, D.C.: June 25, 
2013). 

[15] Specifically, we recommended that HHS reconsider its approved 
spending limits for demonstrations in various states including 
Arizona, Florida, Illinois, South Carolina, Texas, and Wisconsin. 

[16] Eligible adults include childless adults between ages 19 through 
64 and with incomes between 0 to 133 percent of FPL, and parents 
between the ages of 19 through 64 with incomes between 17 percent and 
133 percent of FPL. Parents with incomes under 17 percent of the FPL 
are covered under the state's traditional Medicaid program. The 
demonstration excludes those deemed to be medically frail. In 
addition, American Indians and Alaska Natives are excluded from the 
demonstration unless they elect to be included. 

[17] Federal law permits states to seek approval to provide certain 
groups of Medicaid beneficiaries with alternative benefit plan 
coverage, under which the benefits must be equivalent to statutorily 
specified benchmark coverage through their traditional Medicaid 
program. In general, alternative benefit plan coverage may be more 
limited than traditional Medicaid coverage but more generous than 
QHPs. For example, although alternative benefit packages may not cover 
all the services that are covered under traditional Medicaid, they 
must cover certain types of services such as family planning, benefits 
that QHPs are not required to offer. 

[18] These services include non-emergency medical transportation, out-
of-network family planning, and, for those under the age of 21, early 
periodic screening diagnosis and treatment services. 

[19] PPACA provides subsidies for certain individuals enrolled in 
QHPs. Specifically, qualifying individuals and families with income 
between 100 percent and 400 percent of the FPL are eligible for 
premium tax credits, and individuals and families with income between 
100 and 250 percent of the FPL are eligible for cost-sharing 
reductions. To qualify for these income-based financial subsidies, 
individuals must also meet certain criteria, which include not being 
eligible for other health insurance coverage such as Medicaid. 

[20] Specifically, HHS listed a number of hypotheses for the state to 
consider evaluating, including that the demonstration population will 
have: (1) equal or better access to care, including primary care and 
specialty physician networks and services; (2) equal or better access 
to preventive care services; (3) lower non-emergent use of emergency 
room services; (4) fewer gaps in insurance coverage; and (5) 
continuous access to the same health plans and to providers. 

[21] According to HHS officials, a key consideration of their review 
was that the demonstration is intended to test the value of the 
investment and that a rigorous evaluation is required. 

[22] According to HHS officials, typically, OACT does not participate 
formally in the review of state budget neutrality calculations for 
section 1115 demonstrations. Officials characterized OACT's review of 
Arkansas' cost projections as an informal review. 

[23] In projecting costs of covering the demonstration population 
under the traditional FFS program, Arkansas used expenditure data for 
low-income, non-disabled adults with children who were previously 
eligible to establish baseline spending. The data established a base 
unit cost for the various types of services that would be covered 
under the demonstration. The state then adjusted those unit costs to 
reflect the assumed higher payment rates, and HHS used the adjusted 
costs for the basis of the spending limit. We estimated the magnitude 
of Arkansas' hypothetical costs by calculating an estimate of what the 
spending limit would have been based on the state's unadjusted base 
costs--which reflect what providers were paid historically for the 
comparison proxy population--and comparing it with HHS's approved 
spending limit, which was developed using the state's adjusted costs. 

[24] For each calendar year of the demonstration, the state must 
submit documentation to support an adjustment of the spending limit by 
October 1 of the preceding year. 

[25] The 11 states are Arizona, California, Iowa, Massachusetts, 
Michigan, New Jersey, New Mexico, New York, Oregon, Rhode Island, and 
Vermont. 

[26] Individuals in Iowa with incomes below the 100 percent FPL 
threshold will receive direct coverage through a newly created state-
administered Medicaid managed care plan. 

[End of section] 

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