Why This Area Is Important

The Medicaid program—an over $400 billion a year joint federal-state program that finances health care coverage for low-income individuals—involves significant and growing expenditures for the federal government and states. Under section 1115 of the Social Security Act, the Secretary of Health and Human Services may waive certain federal Medicaid requirements and allow costs that would not otherwise be covered for experimental, pilot, or demonstration projects that are likely to promote Medicaid objectives. These demonstrations also allow states to test and evaluate new approaches for delivering Medicaid services. In fiscal year 2013, $70 billion in federal funds, or about one-fourth of the $265 billion in federal Medicaid outlays for that year, were spent under section 1115 demonstrations. In FY 2011, 10 states spent more than half of their total federal Medicaid expenditures for section 1115 demonstrations.

Under the Department of Health and Human Services (HHS) policy, section 1115 Medicaid demonstrations should 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. 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. Demonstration spending limits are based on states’ estimated costs of continuing their Medicaid programs. According to HHS policy, spending limits should be calculated by estimating future costs of baseline spending—actual Medicaid costs typically from the most recently completed fiscal year—using a benchmark growth rate, which is the lower of the state-specific historical growth rates for a recent 5-year historical period, or estimates of nationwide Medicaid growth. The higher the demonstration spending limits, the more federal funds states are able to receive. HHS’s process for setting spending limits allows for adjustments to the benchmark policy to reflect documented anomalies in the historical data that would not result in accurate projections.

In four reports issued between 2002 and 2013, GAO reviewed spending limits of different demonstrations approved during a recent time period. GAO raised concerns about HHS’s process for ensuring that demonstrations would be budget neutral to the federal government. Since 2003, Medicaid has been on GAO’s list of high-risk programs, in part because of concerns about inadequate fiscal oversight including oversight of section 1115 Medicaid demonstrations.

What GAO Found

Between 2002 and 2013, GAO reviewed several states’ approved comprehensive demonstrations and found that HHS had not ensured that all of the demonstrations would be budget neutral. During this period, HHS approved spending limits that, among other concerns, were based on assumptions of cost growth that exceeded benchmark growth rates. Although HHS’s process allows for adjustments to benchmark growth rates, GAO found that adjustments made by states and allowed by HHS were not clear or well supported. GAO estimated that HHS’s approved spending limits could potentially increase the federal government’s fiscal liability by billions of dollars more than it would have been without the demonstrations.

In its most recent report on Medicaid demonstration waivers, issued in June 2013, GAO found that concerns continued. For 4 of 10 states reviewed, HHS approved spending limits that were based on assumptions of cost growth that were higher than its benchmark rates, and that, in some cases, included costs the states had never incurred in the estimates of base year spending. GAO also found limited support and documentation for the use of higher-than-benchmark growth rates HHS approved. If HHS had held the four demonstrations’ spending to levels suggested by its policy, spending limits would have been tens of billions of dollars lower. For example, for two states with demonstrations approved through 2016, GAO found that approved spending limits were not based on valid methods.

• One state’s approved spending limit for 2011-2016 was based on outdated information on spending—1982 data were projected forward to represent baseline spending and state-specific historical spending growth for a recent time period. Had baseline expenditures and benchmark growth rates been based on recent expenditure data that were available, the 5-year spending limit would have totaled about $26 billion less and the federal share of this reduction would have been about $18 billion.
•  Another state’s approved spending limit for 2011-2016 included hypothetical costs in the state’s estimate of its baseline spending, that is, costs the state had not incurred were included in the base year spending estimate. These costs represented higher payment amounts that the state could have paid providers during the base year, but did not actually pay. For example, the state base year included costs based on the state hypothetically paying hospitals the maximum amount allowed under federal law, although the state had not paid the maximum amount. GAO estimated that had the state included only actual expenditures as indicated by HHS’s policy, the 5-year spending limit would have totaled about $4.6 billion less and the federal share of this reduction would have been about $3 billion.

In this report GAO noted that the Secretary of Health and Human Services had disagreed with earlier recommendations to improve the process for reviewing and approving spending under Medicaid demonstrations. Therefore, GAO elevated this matter for consideration by Congress.

Actions Needed

GAO has recommended actions by Congress and the Secretary of Health and Human Services to better ensure Medicaid demonstrations do not increase federal costs:

•  Because the Secretary of Health and Human Services disagreed with GAO’s recommendations to improve the demonstration review process in its prior reports, in January 2008, GAO suggested that Congress consider acting on our findings. In particular, GAO suggested increased attention to fiscal responsibility in the approval of section 1115 Medicaid demonstrations by requiring the Secretary to improve the demonstration review process, through steps such as improving the review criteria, better ensuring that valid methods are used to demonstrate budget neutrality, and documenting and making clear the basis for the approved limits.
• In June 2013, GAO recommended that the Secretary of Health and Human Services reconsider spending limits for the two state demonstrations, and make appropriate adjustments to spending limits for the remaining years of each demonstration.

Estimating the extent of potential cost savings by ensuring that valid methods are used to establish spending limits for Medicaid demonstrations is difficult.  The amount of cost savings depends on how much spending has already occurred under the two demonstrations approved through 2016 and whether the two states will ultimately spend up to their approved spending limits. Additional cost savings in the future would depend on the number of states seeking demonstrations in the future, and the extent to which proposed demonstration spending limits include hypothetical costs in baseline spending and use of growth rates that are greater than benchmarks without clear support for doing so. However, based on GAO estimates—up to $21 billion for two states’ recent demonstrations that GAO reviewed—spending limit reductions resulting from improved budget neutrality methods could be in the billions of dollars. 

How GAO Conducted Its Work

The information contained in this analysis is based on findings from the products in the related GAO products section. To assess the extent to which HHS's budget neutrality policy and process provide assurance that federal costs will not potentially increase over what they would have been in the absence of the demonstration, GAO reviewed HHS's policy and interviewed agency officials. GAO also reviewed documentation for selected new comprehensive demonstrations and budget neutrality analyses prepared by the states and submitted to HHS. GAO compared the spending limits approved by HHS with GAO’s estimates of the spending limits following HHS’s policy.[1]

Table 15 in appendix IV lists the programs GAO identified that might have opportunities for cost savings.

Agency Comments & GAO Contact

In commenting on a draft of the June 2013 report on which this analysis is based, HHS stated that its methods were valid and that it followed its budget neutrality policy. The agency also disagreed with the recommendation that it should make adjustments to the spending limits for two states as suggested by GAO, stating that the adjustments and costs it used were justified. After reviewing HHS’s response to the June 2013 report, GAO determined at that time that its recommendations were warranted because HHS did not provide additional support or clarification for existing spending limit calculations. For example, HHS did not respond to GAO’s finding that one state’s spending limit included about $4 billion dollars in costs that the state could have paid but did not actually pay prior to the demonstration.

GAO provided a draft of this report section to HHS for review and comment. In an email received on February 20, 2014 the HHS agency liaison stated that HHS continues to follow its policy of using the best available data when establishing spending limits and uses sound fiscal methods that are applied consistently and transparently to all demonstrations reviewed. In addition, HHS cited other agency oversight actions, such as review of renewals and amendments to existing demonstrations, after demonstrations are approved and spending limits established. GAO maintains that HHS’s actions for overseeing approved demonstrations does not lessen the need for establishing sound spending limits, and continues to recommend that HHS reconsider and make appropriate spending limits adjustments for the remaining years of each demonstration.

As GAO suggested in a 2008 report and reiterated in the 2013 report, the Congress should consider requiring the Secretary to improve the Section 1115 Medicaid demonstration review process.

For additional information about this area, contact Katherine Iritani at (202) 512-7114 or iritanik@gao.gov.

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