DEPARTMENT OF HEALTH & HUMAN SERVICES 
Centers for Medicare & Medicaid Services 
7500 Security Boulevard, Mail Stop S2-26-12 
Baltimore, Maryland  21244-1850 
SMD # 18-009
RE: Budget Neutrality Policies for 
Section 1115(a) Medicaid 
Demonstration Projects 
August 22, 2018
Dear State Medicaid Director: 
This letter describes the Centers for Medicare & Medicaid Services (CMS) current policies related to 
budget neutrality for Medicaid demonstration projects authorized under section 1115(a) of the Social 
Security Act (the Act) and is intended to give states and interested parties insight into CMSs 
decision-making process. The letter also outlines recent changes that CMS made to its approach to 
budget neutrality for demonstration project extensions, in order to strengthen fiscal accountability and 
prevent the federal governments exposure to excessive expenditures under section 1115(a) 
demonstrations. 
Section 1115(a) Medicaid Demonstration Projects 
Under section 1115(a) of the Act, the Secretary of Health and Human Services (Secretary) or CMS, 
operating under the Secretarys delegated authority, may authorize a state to conduct experimental, 
pilot, or demonstration projects that, in the judgment of the Secretary, are likely to assist in promoting 
the objectives of title XIX of the Act. The Secretary (1) may, under section 1115(a)(1), waive 
provisions in section 1902 of the Act; and/or (2) may, under section 1115(a)(2)(A), authorize federal 
financial participation (FFP) for state expenditures that would not qualify for FFP under section 1903 
of the Act (i.e., provide expenditure authority). Section 1902 of the Act lists what elements the 
Medicaid state plan must include, such as provisions relating to eligibility, beneficiary protections, 
benefits, services, and premiums. Section 1903, Payments to States, describes expenditures that 
may be matched with federal title XIX dollars, allowable sources of non-federal share, and managed 
care requirements.1
Budget Neutrality Overview 
Currently, CMS will not approve a demonstration project under section 1115(a) of the Act unless the 
project is expected to be budget neutral to the federal government. A budget neutral demonstration 
project does not result in Medicaid costs to the federal government that are greater than what the 
federal governments Medicaid costs would likely have been absent the demonstration.2 The 
1 CMS reviews state requests for waiver or expenditure authority under section 1115(a) on a case-by-case basis to 
determine whether each such request is consistent with the requirements of section 1115(a) and other applicable laws. 
2 What the federal governments Medicaid costs would likely have been absent the demonstration may also include costs 
that could be federally matched if the state were to amend its Medicaid state plan or obtain waivers under certain title XIX 
authorities. These costs may be deemed hypothetical if the state could otherwise have covered these costs under a state 
plan amendment or a waiver under section 1915 of the Act.  Page 2  State Medicaid Director 
overarching goal of CMSs approach to budget neutrality is, therefore, to limit federal fiscal exposure 
resulting from the use of section 1115(a) authority in Medicaid. 
Currently, budget neutrality for each demonstration project is determined as one key component of 
CMS and state negotiations over the specific terms and conditions of the demonstration project. To 
assess budget neutrality, CMS currently subjects each demonstration to a budget neutrality test, 
which results in limits that are placed on the amount of federal Medicaid funding the state may 
receive over the course of the demonstration approval. The budget neutrality expenditure limits are 
based on projections of the amount of FFP that the state would likely have received in the absence of 
the demonstration.3
The essential parameters of the budget neutrality test are specified in the demonstrations Special 
Terms and Conditions (STC). CMSs determination that a demonstration is expected to be budget 
neutral is based on forecasts, using reasonable projections of future spending and enrollment trends. 
CMS monitors budget neutrality throughout the demonstration period, and also performs a formal 
adjudication at the end of the demonstration period to determine whether the states actual spending 
has remained within the specified limit. As a condition of each section 1115(a) demonstration 
approval, the STCs require that state officials attest to the accuracy of the data provided to CMS. 
CMS performs an adjudication for every demonstration at the conclusion of each approval period 
irrespective of length of the approval period.4 Another condition that CMS currently places on  
section 1115(a) demonstration approval is that states agree to limit their receipt of FFP to the 
amounts indicated in the budget neutrality test, and to return any funds they receive in excess of those 
limits to CMS via the expenditure reconciliation process described below. 
CMS currently applies a budget neutrality test to any section 1115(a) demonstration project, 
regardless of whether it involves use of section 1115(a)(1) waivers, section 1115(a)(2)(A) 
expenditure authority, or both. However, for demonstrations that include only waiver authorities 
under section 1115(a)(1) (i.e., only demonstrations not requiring authority for costs not otherwise 
matchable), CMS sometimes determines that the authorized waivers will not result in an increase in 
federal Medicaid spending, and deems the demonstration to be budget neutral without carrying out 
the calculations under the general approach described in this letter.5
 
3 In most cases, for convenience and ease of analysis, the budget neutrality test is specified in terms of total computable 
Medicaid expenditures (i.e., both the federal and non-federal shares of the total expenditure). The demonstrations terms 
and conditions include conversion factors  known as Composite Federal Share Ratios  that are used to convert the total 
computable budget neutrality expenditure limits into federal share equivalents that can be used as a limit on actual federal 
expenditures. 
4 Generally, section 1115(a) demonstrations are approved for an initial five-year period and are extended for an additional 
three to five years. In general, CMS uses the terms renewal of an existing demonstration and extension of an existing 
demonstration interchangeably, and in this document, CMS uses the term extension to refer collectively to renewals 
and extensions approved under section 1115(a), 1115(e), or 1115(f). The CMS-approved expiration date indicates the end 
of the demonstration approval period, and each extension or renewal (whether approved under section 1115(a), 1115(e), 
or 1115(f)) initiates a new demonstration approval period. There are also instances when a temporary extension to the 
current period is provided to permit CMS and a state time to finish negotiating terms of a new period. 
5 See, for example, Wisconsins "BadgerCare" section 1115(a) demonstration (11-W-00125/5)January 1, 2011 through 
December 31, 2013 approval period.  Page 3  State Medicaid Director 
For demonstrations with authorized expenditure authority under section 1115(a)(2), determinations of 
budget neutrality currently involve calculating that the demonstration project will likely achieve 
federal Medicaid savings sufficient to offset the additional projected federal costs resulting from 
the expenditure authority. Under CMSs current approach, offsetting savings are factored into the 
overall budget neutrality test for the demonstration and, if the total federal cost of the portion of the 
states Medicaid program affected by the demonstration plus the expenditure authority is less than or 
equal to the projection of federal Medicaid spending for that same portion of the states Medicaid 
program without the demonstration, the demonstration as a whole (including the expenditure 
authority), is determined to be budget neutral. 
In cases where expenditure authority is provided for coverage of populations or services that the state 
could have otherwise provided through its Medicaid state plan or other title XIX authority, such as a 
waiver under section 1915 of the Act, CMS considers these expenditures to be hypothetical; that is, 
the expenditures would have been eligible to receive FFP elsewhere in the Medicaid program. For 
these hypothetical expenditures, CMS currently makes adjustments to the budget neutrality test which 
effectively treats these expenditures as if they were approved Medicaid state plan services. 
Hypothetical expenditures, therefore, do not necessitate savings to offset the otherwise allowable 
services. This approach reflects CMSs current view that states should not have to pay for, with 
demonstration savings, costs that could have been otherwise eligible for FFP under a Medicaid state 
plan or other title XIX authority; however, when evaluating budget neutrality, CMS does not offset 
non-hypothetical expenditures with projected or accrued savings from hypothetical expenditures. 
That is, savings are not generated from a hypothetical population or service. 
Budget Neutrality Calculation 
Under its current approach, when calculating budget neutrality, CMS refers to the projected 
expenditures that could have occurred absent the demonstration as the Without Waiver (WOW) 
expenditures, or baseline expenditures. The baseline expenditures are the basis for the budget 
neutrality expenditure limit. CMS refers to the actual expenditures under the demonstration as the 
With Waiver (WW) expenditures.6
Generally, calculation of the WOW budget neutrality expenditure limit(s) is based on spending per 
eligible individual, per month. Using this per member per month (PMPM) approach, the state is not 
at risk for increased costs associated with increases in enrollment, and does not accrue savings from 
decreases in enrollment. Unexpected increases in enrollment could be a consequence of factors 
outside the demonstration and beyond the states complete controlsuch as changing economic 
conditions and natural disasters. To obtain projected PMPM expenditure limits, projected WOW 
PMPM costs are multiplied by the states actual member month caseload.7 Therefore, the state is at 
risk only for increases to the PMPM cost growthnot for the increases in its caseload. This per 
6 The terms With Waiver and Without Waiver are CMS shorthand for with, and without, the section 1115(a) 
demonstration, including both waiver and expenditure authorities. 
7 In calculating the cost for a PMPM, states are encouraged to leverage existing federal investments and data sources and 
utilize T-MSIS data as it becomes available. States may additionally need to use enhanced system support for calculating 
the PMPM and should work closely with their CMS contact for the best avenue for system support.  Page 4  State Medicaid Director 
capita, or PMPM, budget neutrality test is the model most commonly employed in Medicaid section 
1115(a) demonstrations. 
The formula to calculate PMPM expenditure limits for demonstrations is as follows: 
(BN expenditure limit) = (projected WOW PMPM) x (actual Member Months) 
On occasion, CMS has approved a demonstration under which the state deployed an alternative 
approach to budget neutrality calculation, depending on the type of waivers and expenditure 
authorities approved under the demonstration proposal, and the likely financial impacts of the 
initiative relative to Medicaid spending under the state plan. One such alternative is the aggregate 
limit model, which places a fixed total dollar cap on state expenditures for the demonstration for 
which FFP can be obtainedoften referred to as an aggregate cap. With this model, the state is at 
risk for all increases in expendituresincluding those due to increased enrollment or caseload 
partially outside of a states control. Unlike the PMPM model, the dollar limits are fixed with 
aggregate caps and do not vary by caseload. Aggregate expenditure limits can also be used for 
demonstrations to include categories of Medicaid expenditures that are not easily associated with 
particular beneficiaries, such as supplemental provider payments.8
The formula to calculate aggregate limits for demonstrations is as follows: 
(BN expenditure limit) = (projected WOW total spending) 
Total budget neutrality expenditure limits (whether calculated as PMPM or in an aggregate model) 
are often made up of multiple sub-limits. Sub-limits can be defined based on Medicaid coverage 
expenditures for various Medicaid populations (e.g., children, adults, aged, or disabled), or other 
categories of Medicaid expenditures, such as supplemental provider payments. These sub-limits can 
be PMPM sub-limits, aggregate sub-limits, or bothand are determined based on the nature of the 
historical expenditures and/or state- and CMS-negotiated estimations of new sub-limits. Sub-limits 
are also differentiated by their applicable time periods, usually in terms of demonstration years 
(DY). The overall budget neutrality expenditure limit is, therefore, determined by adding the sub- 
limits together to create a single limit.9 The single budget neutrality limit applies to all relevant 
categories of Medicaid expenditure as specified in the demonstrations STCsand is currently the 
sole determinant in assessing whether the demonstration is budget neutral. 
Budget Neutrality Methodologies 
Historical Expenditures -- To facilitate calculation of a new demonstrations budget neutrality limit, 
states currently provide CMS with five years of complete/continuous historical expenditure data as 
part of their Medicaid section 1115(a) demonstration applications. The historical expenditure data 
8 The most recently approved comprehensive demonstration in which an aggregate cap model was employed is the 
Virginia Governor's Access Plan for the Seriously Mentally Ill (GAP) demonstration (No. 11-W-00297/3, 
https://www.medicaid.gov/medicaid/section-1115-demo/demonstration-and-waiver-list/?entry=29032). 
9 In other words, under CMSs current approach, states sometimes exceed individual budget neutrality sub-limits, but if a 
state exceeds the overall budget neutrality expenditure limit the demonstration is no longer considered to be budget 
neutral.  Page 5  State Medicaid Director 
include member months of eligibility and expenditures for Medicaid populations that are to be 
included in, or affected by, the demonstration. The expenditure data might be categorized by 
Medicaid Eligibility Groups (MEG)such as adults, children, individuals eligible based on 
disability, or dual eligible beneficiaries. These MEGs represent the populations and services included 
in the demonstration, and they could be aggregated or disaggregated in order to develop appropriate 
trend rates over the lifetime of the demonstration.10 Historical data might also include expenditure 
data related to prior years disproportionate share hospital (DSH) or supplemental provider payments 
when states propose to divert those payments toward demonstration-specific programs or goals that 
promote the objectives of title XIX. 
Trend Rates  The future spending projections for each demonstrations MEGs are based on an 
extrapolation of the historical trending discussed above. Under CMSs current approach, after those 
historical trend rates have been calculated and submitted to CMS for review, staff compare the rates 
to the most recent years Medicaid baseline PMPM coverage cost trends from the annual Presidents 
Budget. The Presidents Budget trends that are employed under the current approach are for the 
Medicaid population categories that most closely correspond to the populations represented by each 
demonstrations MEGs (i.e., disabled, aged, child, or adult). CMS then compares each MEGs actual 
trend rate to a corresponding rate in the Presidents Budget trends and applies a lower of the two 
rates policyor zero in the event that a MEGs historical trend rate is negative. Limiting per capita 
cost trends to no more than the Presidents Budget trends reflects CMSs effort to align its approach 
to budget neutrality with federal budgeting principles and assumptions. 
States sometimes propose alternate trend rates to their historical trends, where doing so is supported 
by additional data and analysis. Approval of alternate trend rates might reflect acknowledgement of 
state-specific anomalies or non-recurring circumstances, which resulted in past trends not being 
representative of likely future Medicaid spending trends. CMS carefully analyzes states rationales 
for proposed alternate trend rates, and approvals of such adjustments are infrequent. 
The formula to calculate average PMPM cost trend rates across multiple years is as follows: 
Average trend = (end PMPM/start PMPM)^(1/# of changes) -1 
Budget Neutrality Additional Considerations 
Hypothetical Expenditures  Under its current approach to budget neutrality, CMS generally treats 
expenditures for populations or services which could have otherwise been covered via the Medicaid 
state plan, or other title XIX authority, such as a section 1915 waiver, as hypothetical expenditures 
for the purposes of budget neutrality. In these cases, CMS makes adjustments to budget neutrality in 
the manner discussed below to account for the spending which the state could have hypothetically 
provided through the Medicaid state plan or other title XIX authority. CMS does not, however, 
currently allow for budget neutrality savings accrual as a result of including hypothetical populations 
or services in section 1115(a) demonstration projects. 
10 States and/or CMS might aggregate or disaggregate MEGs to, for example, isolate population-specific trends or more 
easily compare trends to eligibility groups commonly utilized by the federal government, actuaries, and others.   
Page 6  State Medicaid Director 
 
To allow for hypothetical expenditures, while preventing them from resulting in savings, CMS 
currently applies a separate, independent budget neutrality supplemental test for hypothetical 
expenditures. These supplemental budget neutrality tests subject the hypothetical expenditures to pre- 
determined limits to which the state and CMS agree, and that CMS approves, during negotiations. If 
the states WW hypothetical spending exceeds the supplemental tests expenditure limit, the state 
agrees (as a condition of CMS approval) to offset that excess spending by savings elsewhere in the 
demonstration or to refund the FFP to CMS. 
 
CMS currently employs a variety of alternate estimation methodologies, based on evidence-based 
econometric principles, to determine the budget neutrality expenditure limits for hypothetical 
expenditures, because, often, there are no historical expenditures that can be used to establish a 
spending baseline. CMS therefore bases the budget neutrality expenditure limit for hypothetical 
populations or services on a reasonable and methodologically sound estimate of the programs 
expected costs (e.g., expenditures for like-populations/proxies and/or actuarial analyses of expected 
costs). 
 
Examples of hypothetical expenditures that CMS has previously approved include: 
 
1.  Expenditures for home and community based services (HCBS) that are similar to those that 
may be provided through section 1915(c) waivers;11
 
2.  Expenditures for family planning services similar to what may be provided through the 
optional categorically needy group described in section 1902(a)(10)(A)(ii)(XXI) of the Act;12
 
3.  Expenditures for medical assistance for aged and disabled individuals similar to what may be 
provided through the optional categorically needy group described in section 
1902(a)(10)(A)(ii)(X) of the Act;13 and 
4.  Expenditures for services furnished to beneficiaries who are residing in an institution for 
mental diseases (IMD) primarily to receive treatment for a substance use disorder (SUD) 
which would have been otherwise allowable under Medicaid were it not for the IMD/settings 
prohibitionas described in State Medicaid Director Letter #17-003, Strategies to Address 
the Opioid Epidemic.14
 
 
For states that provide Medicaid coverage for new adults under section 1902(a)(10)(A)(i)(VIII) of 
the Act, CMS also currently counts section 1115(a) demonstration expenditures for this group as 
hypothetical expenditures if the state has not included this group in its Medicaid state plan. 
Additionally, even if the state has included this group in its Medicaid state plan, CMS currently treats 
demonstration expenditures for this group as if they were hypothetical expenditures, due to the high 
 
11 See, for example, Tennessees TennCare II section 1115(a) demonstration, TennCare CHOICES (11-W-00151/4). 
Available at https://www.medicaid.gov/Medicaid-CHIP-Program-Information/By-Topics/Waivers/1115/downloads/tn/tn- 
tenncare-ii-ca.pdf. 
12 See, for example, Alabamas Plan First section 1115(a) family planning demonstration (11 -W-00133/4). Available at 
https://www.medicaid.gov/Medicaid-CHIP-Program-Information/By-Topics/Waivers/1115/downloads/al/al-family- 
planning-ca.pdf. 
13 See, for example, Floridas Managed Medical Assistance section 1115(a) demonstration, MEDS-AD population (11- 
W-00206/4). Available at https://www.medicaid.gov/Medicaid-CHIP-Program-Information/By- 
Topics/Waivers/1115/downloads/fl/fl-medicaid-reform-ca.pdf. 
14 Available at https://www.medicaid.gov/federal-policy-guidance/downloads/smd17003.pdf.  Page 7  State Medicaid Director 
degree of cost variability from one year to the next, which, due to that volatility, produced highly 
anomalous trend rates. 
DSH Diversion  CMS has approved section 1115(a) demonstrations that include alternative uses for 
funds normally used to provide payment adjustments to Disproportionate Share Hospitals (DSH), if 
CMS determined that those uses were likely to further the goals and objectives outlined in title XIX 
of the Act. The budget neutrality expenditure limits that CMS currently applies to DSH diversion 
within demonstrations are aggregate limits based on a projection of the states DSH expenditures 
absent the demonstration. The diverted DSH limits reflect the states actual historical expenditures 
for DSH payments. CMS currently limits annual demonstration expenditures for DSH diversion, 
combined with any remaining DSH payments, to the states annual DSH allotment. 
Budget Neutrality for Demonstration Extensions15
 
To calculate budget neutrality for expenditures associated with an extension of a section 1115(a) 
demonstration, which provides a new period under the demonstration, CMS currently conducts a 
comprehensive review of the prior demonstration periods budget neutrality test to ensure the 
accuracy of each states expenditure reporting. CMS also makes appropriate adjustments for any 
changes in waivers and expenditure authorities under the extended demonstration. Specifically, CMS 
staff compare the states data and analysis to CMS-64 reports in order to confirm that the state has 
not exceeded its budget neutrality limits, and has reported expenditures correctly under the prior 
approval period.16  Now that states have begun submitting their utilization, claims and other  
Medicaid data to CMS via the Transformed Medicaid Statistical Information System (T-MSIS), CMS 
might also make appropriate adjustments based on those data, where appropriate.17
 
Budget Neutrality Savings Accrual & Rebasing  CMSs approach to establishing budget neutrality 
parameters for the new approval period under a demonstration extension has been to extend the 
demonstrations existing WOW baseline/limits for additional years. Until recently, CMS considered 
the budget neutrality savings from the prior approval period(s) to roll over into the next 
demonstration approval period. 
Over time, CMS noted that states with long-running demonstrations accumulated substantial amounts 
of unspent budget neutrality savings due to this policy of permitting savings to roll over from one 
approval period to the next. Furthermore, as a result of CMSs practice of extending WOW baselines 
for additional years without adjustment, the WOW baseline came to be based on antiquated historical 
data after multiple extensions, with little grounding in the states current health care environment and 
associated expenditures. Based on their unspent savings, states requested that CMS authorize 
additional demonstration expenditures through amendments and extensions, leading to increased 
federal Medicaid spending and putting the fiscal integrity of the program at risk. 
15 For additional discussion and definition of section 1115(a) extensions, see footnote #3 above. 
16 On a quarterly basis, states report budgeted and actual Medicaid expenditures on the CMS-64 form which serves as the 
basis for the amount of FFP paid to states to fund their Medicaid programs. 
17 For additional information related to T-MSIS, see https://www.medicaid.gov/medicaid/data-and- 
systems/macbis/tmsis/index.html.  Page 8  State Medicaid Director 
In 2016, CMS updated its approach to create a more accurate budget neutrality test based on recent 
state spending trends.18 The following methodology adjustments have been incorporated into CMSs 
current approach to budget neutrality and CMS expects to phase them in fully for demonstration 
extension approvals beginning January 1, 2021, with a transitional phase-in preceding this date as 
described below. 
1. At most, savings from the most recent five years can roll over into an extension from prior
approval periods.19
 
2. Beginning with the next demonstration extension approval period starting on or after January
1, 2021, WOW baselines are expected to be rebased to more accurately reflect recent state
spending trends.
3. Beginning with the next extension of states demonstration projects, there is expected to be a
transitional phase-down of the accrued savings which resulted from a continuation of the
baseline trending from prior period(s).
4. The growth of upper payment limit (UPL) diversionary spending is limited.
Limiting Savings Rollover Under CMSs previous budget neutrality approach, states were permitted 
to roll over savings from older demonstration approval periods rather than limiting roll-over savings 
to recent years. Under CMSs current approach to budget neutrality, states are permitted to roll over 
accumulated budget neutrality savings only from the most recently-approved five years. If 
expenditures from the most recent approval period are greater than or equal to that periods budget 
neutrality limit, then no savings will roll over. 
Rebasing WOW Baselines  Beginning with demonstration extension periods with effective dates on 
or after January 1, 2021, CMS expects to rebase the demonstrations budget neutrality expenditure 
limits to better reflect the states most recent historical experience. At each new extension thereafter, 
CMS expects to adjust WOW PMPM cost estimates to match recent actual PMPM costs experienced 
during the prior demonstration approval period. CMS also expects to apply its current policy of 
trending PMPM costs using the lower of the state historical trend or the Presidents Budget (including 
the zero substitution methodology described above) to the rebased WOW baseline. CMS expects to 
rebase all demonstrations which are approved for an extension with an approval period beginning on 
or after January 1, 2021. The transitional phase-down, discussed next, precedes rebasing. 
Transitional Phase-Down of Newly Accrued Savings  Until CMS has rebased all current 
demonstrations (i.e., before January 1, 2021), at each demonstrations next approved extension, CMS 
expects to apply  a transitional phase-down percentage to the demonstrations annual savings based 
on when the state implemented the policy that produced the savings. CMS anticipates that savings 
phase-down would apply only during the extension approval period; however, CMS expects that the 
amount of phase-down would be determined based on the length of time since the state originally 
18 See CMSs Budget Neutrality for Section 1115(a) Medicaid DemonstrationsNew Adjustments in Methodology (May 
12, 2016) presented during All-State State Operations and Technical Assistance Call; available at 
https://www.medicaid.gov/medicaid/section-1115-demo/downloads/about-1115/all-state-presentation.pdf. 
19 See, for example, the most recent section 1115(a) approvals of Texas Healthcare Transformation and Quality 
Improvement Program (Project No. 11-W-00278/6) and Floridas Managed Medical Assistance Program (Project No. 
11-W-00206/4).   
Page 9  State Medicaid Director 
 
implemented the aspect of the demonstration that produced the savings. For the first five years post- 
implementation of the savings-producing policy, 100 percent of budget neutrality savings will 
accumulate and carry forward, but starting with the sixth year post-implementation of the savings- 
producing policy, savings will be phased down by 10 percent per demonstration year, until savings 
are reduced to no less than 25 percent of the amount of savings realized based on the original 
baseline. CMS expects to apply this transitional phasedown to demonstration extensions taking effect 
on or before December 31, 2020. For extensions taking effect later than that date, or for 
demonstrations that have already had a transitional phase-down period, CMS expects to conduct a 
full rebasing, as described above. This phase-down of savings aligns with the overall goal of budget 
neutrality teststo limit federal fiscal exposure resulting from the use of 1115(a) authority in 
Medicaid. 
 
Limiting UPL Diversionary Spending  States with approved UPL diversionary spending have the 
choice of either rebasing UPL diversion estimates based on their current levels of fee-for-service 
utilization, or of carrying forward UPL without growth at each extension (which means they would 
be limited to the capped annual amount in the final DY of the previous demonstration approval 
period). 
 
Reporting and Monitoring on Budget Neutrality 
 
Each currently approved demonstrations STCs include sections describing the monitoring of budget 
neutrality, general financial requirements, and corrective actions in the event that actual spending 
exceeds the specified limits. Together, these STCs describe the process by which the calculations 
described above are performedas well as how the state reports expenditures to CMS and the 
reconciliation processes. 
 
Monitoring and Corrective Action Throughout Demonstration Period of Performance  CMS 
regularly monitors states budget neutrality reports, including the expenditures reported on the CMS- 
64 quarterly expenditure reports. If demonstration expenditures are determined to be at risk of 
exceeding the budget neutrality limits based on specified thresholds in the STCs, states currently 
agree, as a condition of continued CMS approval of their demonstration project, to provide a 
corrective action plan in order to bring their expenditures in line with the pre-specified limits. CMS 
has also developed a monitoring tool to aid in timely identification of budget neutrality-related 
issues.20
 
 
Exceeding Budget Neutrality and Return of Federal Funds  As a condition of demonstration 
approval, states currently agree that if the state is found to have exceeded its budget neutrality 
expenditure limit at the end of its demonstrations period of performance, it will return excess funds 
 
20 42 CFR 431.420(a)(2) provides that states must comply with the terms and conditions of the agreement between the 
Secretary (or designee) and the state to implement a demonstration project, and 431.420(b)(1) states that the terms and 
conditions will provide that the state will perform periodic reviews of the implementation of the demonstration. CMSs 
current approach is to include language in STCs requiring, as a condition of demonstration approval, that states provide, 
as part of their periodic reviews, regular reports of the actual costs which are subject to the budget neutrality limit. CMS 
has obtained Office of Management and Budget (OMB) approval of the monitoring tool under the Paperwork Reduction 
Act (OMB Control No. 0938  1148) and intends to include, in STCs governing budget neutrality reporting, language 
providing that states will agree to use the tool as a condition of demonstration approval.  Page 10  State Medicaid Director 
to CMS. States return funds by entering a negative adjustment to expenditures claimed on their CMS- 
64 reports. 
CMS continues to revise and improve its approach to budget neutrality for section 1115(a) 
demonstrations. While we do not envision deviating from these policies in the near future, CMS may 
issue additional information based on, for example, changes in federal legislation or regulations. 
CMS will remain available to provide technical assistance to states regarding all aspects of its current 
and ongoing approaches to budget neutrality and continues development of numerous templates and 
tools to facilitate those discussions. CMS will also be conducting a series of technical assistance 
webinars and all-state calls. If you have any questions, or would like to schedule a state-specific 
technical assistance call, please contact your project officer or Paul Boben, Senior Advisor, State 
Demonstrations Group at (410) 786-6629. 
We look forward to continuing our work together on these important issues. 
Sincerely, 
/s/ 
Timothy B. Hill 
Acting Director 
cc: 
National Association of Medicaid Directors 
National Academy for State Health Policy 
National Governors Association 
American Public Human Services Association 
Association of State and Territorial Health Officials 
Council of State Governments 
National Conference of State Legislatures 
Academy Health