Print this page

Health > 25. Distribution of Medicaid Supplemental Payments

The Centers for Medicare & Medicaid Services should provide written guidance to state Medicaid programs clarifying its policies that the distribution of Medicaid supplemental payments be linked to the provision of Medicaid-covered services, and that such payments not be made contingent on the availability of local funding for the nonfederal share—actions that could result in substantial cost savings.

Why This Area Is Important

Medicaid, a joint federal-state health care program that provides coverage for low-income and medically needy individuals, involves significant and growing expenditures for the federal government and states.[1] In fiscal year 2015, Medicaid was estimated to cover, on average, approximately 69 million beneficiaries at an estimated cost of $529 billion.[2] In addition to regular payments for covered services, states often make supplemental payments, up to certain limits, for which the federal government also shares in the cost.[3] GAO reported in November 2012 that 39 states made supplemental payments in 2007 that resulted in 505 hospitals having Medicaid payment surpluses—that is, total Medicaid payments in excess of the hospitals’ total costs of providing Medicaid services—totaling about $2.7 billion. GAO designated Medicaid as a high-risk program in 2003, in part due to the program’s size and growth and to concerns about the transparency and oversight of supplemental payments.

Medicaid supplemental payments are typically made under a Medicaid state plan. Each state’s plan is required to be reviewed and approved by the Centers for Medicare & Medicaid Services (CMS), the agency within the Department of Health and Human Services (HHS) responsible for overseeing state Medicaid programs at the federal level. Payments under a state plan, including supplemental payments, must be economical and efficient and within the Medicaid Upper Payment Limit (UPL), which caps federal matching of certain Medicaid payments at the level Medicare would pay for comparable services.[4] The UPL is typically a limit applied to institutional providers, particularly hospitals and nursing facilities. The UPL is not a provider-specific limit, for example, a limit on payments made to any particular hospital, but is instead applied on an aggregate basis for certain provider ownership types (local government, state government, and private) and categories of service (e.g., hospital inpatient, hospital outpatient, and nursing facility). States can estimate the UPL for a category of service for all services provided, for example, by local government hospitals, and make payments up to the UPL. Under the flexibility of the Medicaid UPL, states can make supplemental payments under the UPL—known as UPL supplemental payments—to only a portion of the providers providing a service type. Some states have targeted their UPL supplemental payments to a small number of providers within a particular category—for example, local government hospitals—resulting, in some cases, in Medicaid surpluses.  Medicaid payments that greatly exceed costs raise questions about the purpose of the payments, including how they relate to Medicaid services and if they are economical and efficient, as required by law.

In addition, in recent years states have increasingly made another type of supplemental payment under section 1115 of the Social Security Act, which authorizes the Secretary of Health and Human Services to approve funds for Medicaid demonstration projects—including for costs that would not otherwise be eligible for federal matching funds—if, in the Secretary’s judgment, such spending is likely to assist in promoting Medicaid objectives.[5] Some states have received approval to make these payments—known as demonstration supplemental payments—and ended their UPL supplemental payments. HHS has authorized demonstration supplemental payments for purposes such as paying hospitals for uncompensated care costs and incentive payments for broad health care improvements.

States finance the nonfederal share of their Medicaid programs primarily with state general funds; however, they may, within certain limits, use other sources of funds, including funds from local government providers, such as county-owned hospitals, or from local governments on behalf of government providers. GAO reported in July 2014 that states have increasingly relied on local governments to fund the nonfederal share of state Medicaid payments, particularly for supplemental payments. Trends toward increasing reliance on Medicaid providers and local governments to finance the nonfederal share of Medicaid payments can shift costs to the federal government, changing the nature of the federal-state partnership.[6] GAO has found, for example, that states have established complex payment arrangements involving increased  Medicaid payments to certain institutional providers, such as local government hospitals, and sought funds to finance the nonfederal share of those payment increases from the same providers receiving the payments, or the local government operating them. By increasing the providers’ Medicaid payments and requiring the providers receiving the payments, or the local governments operating them, to supply all or most of the nonfederal share, the states have effectively shifted more of the cost of payments made to those providers to the federal government. The net payment to those providers may largely be made up of federal funds.Such financing arrangements can be within federal rules; however, states may not lower the amount, duration, scope, or quality of Medicaid services provided due to a lack of funds from local sources.[7]

[1]Under a statutory formula, the federal government reimburses from 50 to 83 percent of a state’s Medicaid expenditures for services for most Medicaid beneficiaries.  States with lower per capita incomes receive higher federal matching rates. 42 U.S.C. §§ 1396b(a), 1396d(b).

[2]Department of Health and Human Services, 2014 Actuarial Report on the Financial Outlook for Medicaid (Washington, D.C.: 2015).

[3]States generally make three types of supplemental payments. States are required to make disproportionate share hospital payments to hospitals that serve a large number of Medicaid and uninsured low-income patients. The other two types of supplemental payments that states make, which are the subject of GAO’s February 2016 report, are those made under the Medicaid upper payment limit regulations and those made under approved Medicaid demonstration projects.

[4]Medicare is the federal health program that covers seniors aged 65 and over, individuals with end-stage renal disease, and certain disabled persons.

[5]42 U.S.C. § 1315(a). Medicaid demonstrations are intended to allow states to test and evaluate new approaches for delivering Medicaid services to beneficiaries.

[6]GAO reported that in state fiscal year 2012, across all states, 70 percent of the nonfederal share of UPL supplemental payments was financed by funds from local governments, including local government hospitals, which represented an increase of 13 percentage points since state fiscal year 2008.

[7]42 U.S.C. § 1396a(a)(2); 42 C.F.R. § 433.53(c)(2) (2015).

What GAO Found

In February 2016, GAO found that, in three of four states it reviewed that made supplemental payments resulting in Medicaid payment surpluses, states distributed Medicaid supplemental payments to hospitals largely based on the availability of local government funds to finance the nonfederal share, rather than on the volume of services each hospital provided. While CMS has recently acted to curtail one state’s supplemental payments that were distributed based on availability of local financing, it has not clarified or broadly communicated guidance regarding appropriate payment distribution methods. The absence of CMS guidance on how to distribute Medicaid supplemental payments may be leading to inconsistent application among states and the distribution of supplemental payments that are counter to agency policies, resulting in payments to providers that are not commensurate with the level of Medicaid services provided, or overpayments to providers that contributed local financing. This lack of clarity may partly explain why states have often made supplemental payments that were based on the availability of local financing rather than on their services for Medicaid beneficiaries and why states have increasingly relied on local financing for supplemental payments, which has the effect of shifting state costs to the federal government.

GAO reported that, for three of four selected states—which were selected on the basis of having made the largest Medicaid payments in excess of costs in 2009—the bulk of the supplemental payments to hospitals were made contingent on these hospitals, or the relevant local governments, providing funds to finance the nonfederal share of the payments the hospitals received, rather than on the Medicaid services they provided. Based on its review of applicable state laws, regulations, or Medicaid documents that established the rules regarding which hospitals would receive payments and the amounts of the payments, GAO reported that in 2009 over $3.2 billion—or 92 percent of $3.5 billion the three states made in supplemental payments in total that year—was based on contributions of local funds. For 2012, GAO reported that $4.9 billion—or 97 percent of $5.0 billion the three states made in supplemental payments in total that year—was based on contributions of local funds. GAO reported on several examples of hospitals that did not receive a supplemental payment, or received a smaller payment, because the hospital or local government did not provide the funds, or provided a smaller contribution to the nonfederal share than expected. In one state, for example, GAO found that 18 rural hospitals did not receive UPL payments under a program specifically for hospitals in rural counties because they did not provide local funds for the nonfederal share of the payments.

While states are permitted to use local funds to finance the nonfederal share of their Medicaid programs, GAO findings from its February 2016 report show that distributing payments only to hospitals that are capable of financing the nonfederal share can result in payments not being made to otherwise eligible hospitals that lack the ability either to finance the expected nonfederal share of the payment or to obtain local government support for such financing. In addition, GAO reported that basing the distribution of supplemental payments on the availability of local funding can result in payments that are not aligned with hospitals’ workload of low-income patients, as measured by their uncompensated care costs associated with serving low-income or uninsured individuals. For example, the report highlighted a hospital for which local funding was provided that had $352 million in uncompensated care costs, yet received $384 million in demonstration supplemental payments for those costs, in addition to $77 million in Disproportionate Share Hospital payments.[1] However, another hospital with about $121 million in uncompensated care costs—which was the fourth-highest amount of uncompensated care costs among the state’s hospitals that year—but that had no local funding provided on its behalf received no supplemental payments. GAO also reported in 2014 that reliance on local funds may incentivize states to make Medicaid payments in excess of hospitals’ Medicaid costs because those hospitals are able to provide or secure local financing for the nonfederal share of the payments, which can effectively reduce the state’s obligation for Medicaid payments and shift costs for Medicaid to the federal government.

Federal law requires states to ensure that a lack of local funds will not result in lowering the amount, duration, scope, or quality of Medicaid services,[2] and CMS officials told GAO that the agency interprets this requirement as prohibiting arrangements where Medicaid payments are contingent on local financing. CMS officials also told GAO that the agency’s policy requires that supplemental payments be distributed based on the hospitals’ provision of services to Medicaid and uninsured individuals. However, GAO reported that CMS had not clearly or broadly communicated its policies about appropriate distribution methodologies to states. Federal standards for internal control stress that management should ensure there are adequate means of communicating information to external stakeholders that may have a significant impact on the agency’s achieving its goals.[3] GAO reported that CMS communicated key principles in writing to one state regarding how the state should distribute its demonstration supplemental payments for uncompensated care costs, including that (1) payments should support the provision of services to Medicaid beneficiaries and low-income uninsured individuals, and (2) payments should not be made based on the availability of local financing. In addition, CMS officials told GAO in October 2015 that the agency plans to issue a proposed rule to specify appropriate methodologies for state distribution of UPL supplemental payments under their state plans, and they plan to publish a proposed rule for comment in fall of 2016. However, CMS has not issued written guidance to articulate and broadly communicate its demonstration supplemental payment requirements to all states. Additionally, because the proposed rule was under development as of March 2016, details regarding the UPL supplemental payment distribution methodologies were not available.

[1]States are required by federal law to make Disproportionate Share Hospital payments to certain hospitals, which are payments designed to help offset these hospitals’ uncompensated care costs for serving large numbers of Medicaid and uninsured low-income individuals. See 42 U.S.C. §§ 1396a(13)(A), 1396r-4.

[2]42 U.S.C. § 1396a(a)(2); 42 C.F.R. § 433.53(c)(2).

[3]GAO, Internal Control: Standards for Internal Control in the Federal Government, GAO/AIMD‑00‑21.3.1 (Washington, D.C.: November 1999).

Actions Needed

To promote consistency in the distribution of supplemental payments among states and with CMS policy, GAO recommended in its February 2016 report that the Administrator of CMS take the following two actions:

  • Issue written guidance clarifying its policy that requires a link between the distribution of supplemental payments and the provision of Medicaid-covered services.
  • Issue written guidance clarifying its policy that payments should not be made contingent on the availability of local funding.

Currently it is not possible to estimate the potential cost savings that may result from CMS taking these actions because the total amount of supplemental payments that are distributed based on the availability of local funding is unknown, as is the extent to which payment amounts would be reduced in response to CMS’s clarification of its policies. Previous GAO reports (for example, reports issued in July 2014 and April 2015) have shown that states often make large Medicaid supplemental payments to a small number of providers, increasingly relying on local funding for the nonfederal share of supplemental payments, and effectively shifting costs for Medicaid payments to the federal government in doing so. A November 2012 GAO report found that states had made supplemental payments to hospitals that contributed to about $2.7 billion in Medicaid payment surpluses among hospitals receiving them, suggesting that states were often overpaying hospitals when making supplemental payments. GAO’s February 2016 report provides new information related to why a state might make large supplemental payments in excess of Medicaid costs by financing these payments using local or provider funds. Curtailing the practice of basing payments on the availability of local funding, and instead clarifying that they be distributed based on the level of Medicaid-covered services provided, may result in substantial savings through the reduction of these surpluses.

How GAO Conducted Its Work

The information contained in this analysis is based on findings from the products listed in the related GAO products section. To determine the basis on which states distributed supplemental payments, GAO reviewed documents authorizing the payments, including state plan provisions, the terms and conditions of Medicaid demonstrations, state administrative code provisions, and other state documents. GAO obtained payment data from the four selected states to analyze the extent to which states’ supplemental payments were contingent on local funding and, along with available cost data, to compare hospitals’ payments to their uncompensated care costs.

Table 14 in appendix V lists the program GAO identified that might have opportunities for cost savings or revenue enhancement.

Agency Comments & GAO Contact

In commenting on the February 2016 report on which this analysis is based, HHS concurred with one recommendation and agreed with concerns raised by the other. Specifically, HHS concurred with GAO’s recommendation to articulate in written guidance to all states the agency’s current policy that supplemental payments be distributed based on the provision of services to Medicaid and low-income uninsured individuals. HHS cited the rule it plans to propose in the fall of 2016 that would set forth additional requirements to better ensure that supplemental payments are consistent with the statutory principles of economy, efficiency, and quality of care. HHS also cited its effort to apply new criteria to the approval of demonstrations that contain supplemental payments for uncompensated care, which it has communicated to Florida and other affected states. In responding to GAO’s second recommendation, HHS agreed that Medicaid payments that are contingent on the availability of local funding are a concern, and it referenced again its plans for a proposed rule, indicating that the rule is to highlight the issue. Although HHS did not explicitly concur with GAO’s recommendation, it did state it is considering additional options to address the issue. In light of its findings, GAO plans to continue to monitor HHS actions on these issues.

GAO provided a draft of this report section to HHS for review and comment. The department did not provide comments on this report section.

For additional information about this area, contact Katherine Iritani at (202) 512-7114 or

Related Products

Explore Other Areas

There are no further Duplication areas under this mission.