United States Government Accountability Office

GAO Report to the Committee on Finance, 

U.S. Senate 

MEDICAID 

FINANCING 

Federal Oversight 

Initiative Is Consistent 

with Medicaid 

Payment Principles 

but Needs Greater 

Transparency 

March 2007 

 

GAO-07-214 
What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

Accountability Integrity Reliability

March 2007

MEDICAID FINANCING

Federal Oversight Initiative Is Consistent 

with Medicaid Payment Principles but 

Needs Greater Transparency 

Highlights of GAO-07-214, a report to the 

Committee on Finance, U.S. Senate 

The costs of Medicaid—the federalstate program financing health care

for about 60 million low-income

people—totaled about $317 billion 

in fiscal year 2005. Increasing 

budgetary pressures have created 

tension between the states and the 

federal government, in part 

because some states have used 

inappropriate financing 

arrangements to collect federal 

matching funds when payments

were not retained by the providers.

In August 2003, the federal Centers

for Medicare & Medicaid Services 

(CMS) began an initiative to end 

inappropriate arrangements. 

GAO was asked to examine the 

(1) number, and fiscal effects, of 

states ending particular financing 

arrangements; (2) extent to which

CMS’s initiative represents a

change in agency approach or 

policy; and (3) transparency and

consistency of the initiative. For 

states ending arrangements, GAO 

surveyed state officials, reviewed 

CMS documents, and interviewed

CMS and state officials. 

What GAO Recommends

GAO recommends that the 

Administrator of CMS (1) issue 

guidance to clarify allowable 

financing arrangements and 

(2) explain its determinations in 

writing to states and interested

parties. CMS said recent actions 

would respond to the first 

recommendation. Although CMS 

disagreed with the second 

recommendation, GAO believes it

remains valid. 

From August 2003 through August 2006, 29 states ended certain financing 

arrangements as a result of CMS’s oversight initiative. The ended 

arrangements involved supplemental payments—those separate from and in 

addition to the states’ standard Medicaid payments—made to government 

health care providers, most often government nursing homes and hospitals. 

According to CMS, the arrangements had to be ended because the providers 

did not retain all the payments made to them but returned all or a portion to

the states. The fiscal effects on the states and on the federal government of 

ending specific arrangements were uncertain, as nearly two-thirds of states 

ending arrangements were seeking to continue obtaining federal 

reimbursements for the related supplemental payments by using different 

financing arrangements from those they were required to end. 

CMS’s initiative departs from the agency’s past approach and is consistent 

with Medicaid payment principles—for example, that payment for services

must be consistent with efficiency, economy, and quality of care. In the past, 

CMS limited states’ inappropriate financing arrangements through means 

other than examining whether providers were retaining supplemental 

payments. Twenty-four of 29 states reported the view that CMS had changed 

its policy. One state has challenged CMS’s disapproval of its state plan 

amendment, in part on the grounds that CMS changed its policy and should 

have gone through rule making beforehand. In another case, unrelated to the 

initiative, in which a state challenged a CMS disapproval, a 2005 federal

court ruling upheld CMS’s determination that the state’s arrangement, in 

which providers did not fully retain payments, was inconsistent with 

Medicaid payment principles. 

CMS has not implemented its initiative transparently, contributing to 

concerns about the consistency of its reviews of state financing 

arrangements. CMS’s initiative has lacked transparency in two ways. First, in

implementing its initiative, CMS did not issue written guidance about the 

specific approval standards for state financing arrangements, although a 

proposed regulation published in the Federal Register on January 18, 2007, 

when finalized, could provide such guidance. Second, CMS has not always 

provided states with clear, written explanations of its determinations. GAO’s 

review of CMS documentation related to the financing arrangements ended 

in 29 states found that for only one-fourth of the financing arrangements did 

CMS explain to the affected states in writing the specific basis for 

determining that their financing arrangements were inconsistent with one or 

more Medicaid payment principles. This lack of transparency has raised 

questions for some states about the consistency with which states have been 

treated and precluded GAO from determining whether CMS has treated 

states consistently. www.gao.gov/cgi-bin/getrpt?GAO-07-214.

To view the full product, including the scope 

and methodology, click on the link above. 

For more information, contact Kathryn G. 

Allen at (202) 512-7118 or allenk@gao.gov. 
Contents 

Letter 1

Results in Brief 5

Background 8

Twenty-nine States Ended Financing Arrangements, with 

Uncertain Fiscal Effects 13 

CMS’s Initiative Departs from Past Approach and Is Consistent 

with Medicaid Payment Principles 21 

CMS’s Initiative Lacks Transparency, Raising Concerns about 

Consistent Review of State Financing Arrangements 27 

Conclusions 34

Recommendations for Executive Action 34 

Agency Comments and Our Evaluation 35 

Appendix I Methodology for Determining the Number of 

States Ending Financing Arrangements 38 

Appendix II Methodology for Analyzing CMS Case Files 40 

Appendix III Comments from the Centers for Medicare & 

Medicaid Services 42 

Appendix IV GAO Contact and Staff Acknowledgments 48 

Related GAO Products 49 

Tables 

Table 1: Financing Arrangements Ended, by State and Type of 

Supplemental Provider Payment Involved, from August 

2003 through August 2006 15 

Table 2: Number of States Planning or Implementing Certain 

Alternative Arrangements for Financing the Nonfederal 

Share of Payments, as of October 2006 19 

Page i GAO-07-214 Federal Medicaid Oversight Initiative
Figure 

Figure 1: Inappropriate State Financing Arrangement in Which 

Provider Did Not Retain the Full Supplemental Payment 11 

Abbreviations 

CMS Centers for Medicare & Medicaid Services 

CPE certified public expenditure 

DSH disproportionate share hospital 

HCFA Health Care Financing Administration

IGT intergovernmental transfer 

UPL upper payment limit 

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Page ii GAO-07-214 Federal Medicaid Oversight Initiative
United States Government Accountability Office

Washington, DC 20548 

March 30, 2007 

The Honorable Max Baucus 

Chairman 

The Honorable Charles Grassley 

Ranking Minority Member 

Committee on Finance 

United States Senate 

Growing pressures on federal and state budgets have increased tensions 

between the federal government and the states regarding Medicaid, the 

joint federal-state health care financing program for about 60 million 

individuals, including low-income children, families, and aged or disabled 

individuals. The federal government and the states share in the cost of the 

program, which in fiscal year 2005 totaled about $317 billion.1

 The Centers 

for Medicare & Medicaid Services (CMS)—the federal agency responsible 

for overseeing states’ programs—has an important role in ensuring that 

states comply with certain statutory Medicaid payment principles when 

claiming federal reimbursements for payments made to institutional and 

other providers that serve Medicaid beneficiaries. For example, Medicaid 

payments must be “consistent with efficiency, economy, and quality of 

care,”2

 and states must share in any reported Medicaid costs in proportions 

established according to a statutory formula.3

 In recent years, tensions 

have arisen between the federal government and states with regard to 

CMS’s actions to oversee the appropriateness of Medicaid provider 

payments for which states have sought federal matching reimbursement, 

including concerns over whether states were appropriately financing their 

share, that is, the nonfederal share of the payments. 

We and others have reported that some states have inappropriately 

established financing arrangements creating the appearance of payments 

to government-owned or government-operated providers, such as nursing 

 1

This figure represents estimated combined federal and state Medicaid expenditures for 

provider services and administration in fiscal year 2005, the last year for which data were 

available. 

2

42 U.S.C § 1396a(a)(30)(A) (2000). 

3

42 U.S.C § 1396d(b) (2000). 

Page 1 GAO-07-214 Federal Medicaid Oversight Initiative
homes, in order to obtain additional federal matching funds.4

 These 

arrangements involved supplemental payments—payments that states 

made to providers that were separate from and in addition to those made 

at a state’s standard Medicaid payment rate. The supplemental payments 

connected with these arrangements were illusory, because states required 

the government providers to return part or all of them to the states. States 

could then use the money to fund the nonfederal share of other Medicaid 

expenditures. Such arrangements effectively increased the federal share of 

the states’ total Medicaid expenditures because federal funding increased 

without a commensurate increase in nonfederal funding. Financing 

arrangements involving illusory payments to Medicaid providers have had 

significant fiscal implications for the federal government and states. In 

2003, we designated Medicaid as a program at high risk of 

mismanagement, waste, and abuse, in part because of concerns about 

inappropriate financing arrangements.5

 As states’ arrangements involving 

illusory payments have come to light, Congress and CMS have taken steps 

to limit them, including establishing a regulation estimated to have saved 

the federal government approximately $17 billion from fiscal year 2002 

through fiscal year 2006.

In August 2003, CMS launched an oversight initiative to review and 

evaluate the appropriateness of states’ Medicaid payments for which 

federal matching reimbursement was sought, by assessing whether states 

had financing arrangements that required providers to return payments to 

the states. Under this initiative, a state’s submission of a proposal to 

change provider payments in its state Medicaid plan—the plan approved 

by CMS that defines how each state will operate its Medicaid program, 

including which populations and services are covered and the rates at 

which providers will be paid for serving Medicaid beneficiaries—triggers 

CMS scrutiny of the appropriateness of any related financing arrangement. 

CMS withholds approval of a proposed state plan amendment until 

obtaining satisfactory assurances that a state is ending financing 

arrangements the agency finds to be inappropriate. As CMS has carried 

out this initiative, concerns have been raised that CMS’s policies have not 

been transparent, that is, clearly explained and available to interested 

parties; represent a change in policy that should have undergone a rulemaking process during which a proposed regulation would have been 

 4

A list of related GAO products appears at the end of this report. 

5

GAO, High-Risk Series: An Update, GAO-05-207 (Washington, D.C.: January 2005). 

Page 2 GAO-07-214 Federal Medicaid Oversight Initiative
published for public comment; and have not been implemented 

consistently from state to state. 

You asked us to review CMS’s efforts under its oversight initiative begun in

August 2003, including the process the agency has used and the outcomes 

of that process, focusing on states that were required to end Medicaid 

financing arrangements that CMS found to be inappropriate. This report 

addresses the following questions: 

1. How many states have ended Medicaid financing arrangements as a 

result of CMS’s initiative, and what have been the fiscal effects? 

2. To what extent does CMS’s initiative reflect a change in approach or 

policy for overseeing states’ Medicaid financing arrangements? 

3. To what extent has CMS implemented its initiative in a transparent 

manner and consistently across states? 

To determine the number of states among the 50 states and the District of 

Columbia that ended financing arrangements and the fiscal effects of 

ending the arrangements under CMS’s oversight initiative, we obtained 

information from CMS on the financing arrangements that were ended 

from August 2003 through August 2006, reviewed CMS’s files containing 

agency and state documents regarding the ended arrangements, and 

discussed with CMS officials the characteristics of and the basis for the 

agency’s determinations concerning states’ arrangements and the potential

federal fiscal effects from states’ ending arrangements. To ensure that we 

had an accurate count of states that had ended one or more financing 

arrangements, we verified this information with each state that, according 

to CMS, had ended an arrangement. In addition, we contacted all states 

not identified by CMS as having ended an arrangement and asked them 

whether they had ended certain financing arrangements as a result of 

CMS’s initiative. We determined that the information provided by CMS 

about which states ended financing arrangements, coupled with 

confirmation provided by states, was sufficiently reliable for the purposes 

of our review. To learn more about the ended financing arrangements, we 

sent a questionnaire to, and obtained responses from 100 percent of, the 

subset of states that we determined had ended an arrangement from 

August 2003 through August 2006. Our questions sought information and 

associated documentation to verify the characteristics of the financing 

arrangements that the states had ended; the actions the states had taken or 

planned to take as a result of CMS’s initiative, including states’ proposals 

to implement different financing arrangements as an alternative to the

Page 3 GAO-07-214 Federal Medicaid Oversight Initiative
arrangements they had ended; and the potential fiscal effects on state 

budgets of ending financing arrangements. We updated our information on 

the status of states’ plans to implement alternative arrangements in 

October 2006. We also obtained additional information about CMS’s 

initiative by interviewing officials from nearly two-thirds of the states 

receiving our questionnaire, including officials from states whose 

questionnaire responses required clarification or who requested an 

interview. We did not independently validate the information the states 

provided to us about fiscal effects. (See app. I for a more detailed 

description of our methodology for determining the number of states that 

ended financing arrangements.) 

To examine the extent to which CMS’s initiative reflects a change in 

approach or policy for overseeing states’ Medicaid financing

arrangements, we reviewed the legal and programmatic bases for CMS’s 

initiative; reviewed relevant legal opinions and related materials; 

interviewed CMS officials concerning CMS’s oversight in the past and 

under the initiative; reviewed agency and congressional actions to address 

states’ inappropriate financing arrangements from 1994, when we first 

reported on these issues, through November 2006; and reviewed public 

statements by CMS officials and CMS documents that discussed the 

agency’s actions under its initiative. In our questionnaire to the states that 

ended financing arrangements under the initiative, we asked whether each 

state viewed CMS’s actions as a change from the agency’s prior approach.

To assess the extent to which CMS’s initiative has been implemented in a 

transparent manner, we performed a structured review of documentation 

contained in CMS’s files for the subset of states that had ended financing 

arrangements, including examining correspondence and other information 

related to each state review under the initiative. We assessed how CMS 

communicated to the states that ended financing arrangements its 

determinations about financing arrangements and the basis for its 

determinations, including assessing the extent to which CMS provided 

states with written information on the statutory basis for its 

determinations under the initiative. We did not assess the validity of CMS’s 

determinations that states must end certain financing arrangements, nor 

did we compare the basis for these determinations with CMS’s approvals 

of other financing arrangements it reviewed. (See app. II for further 

information on our methodology for analyzing CMS’s files.) Through our 

questionnaire to the states that ended financing arrangements, we sought 

information on their views of CMS’s review process, including information 

on whether, in the opinion of state officials, CMS explained why the state 

should end its financing arrangement, on what basis CMS concluded that

Page 4 GAO-07-214 Federal Medicaid Oversight Initiative
the state should end its financing arrangement, and what guidance—such 

as letters to state Medicaid directors or technical guidance manuals—CMS 

provided the state on financing arrangements. To assess the consistency of

CMS’s reviews under the initiative, we examined information in CMS’s 

files for evidence of any differences in CMS’s reviews of states that ended

financing arrangements, including differences in the concerns that CMS 

identified. Because of limitations in the file documents, however, we were 

unable to determine whether CMS had treated states that ended financing 

arrangements consistently. For example, CMS’s files did not contain 

records of oral discussions or explanations of relevant differences in the 

states’ Medicaid programs. Through our questionnaire, we sought the 

views of state officials on whether the states that ended financing 

arrangements believed CMS had been consistent across states in its 

reviews. In part to better understand how CMS’s reviews had affected 

states that ended financing arrangements, we interviewed officials in 

nearly two-thirds of the states that received our questionnaire and who 

had, for example, requested an interview or whose responses to the 

questionnaire needed clarification. Finally, we interviewed CMS officials 

about the agency’s review process under the initiative and the basis for its 

determinations regarding states’ financing arrangements. Our findings, 

conclusions, and recommendations are based on the evidence we obtained 

in reviewing states that ended financing arrangements as a result of CMS’s 

oversight initiative. We conducted our review from July 2005 through 

March 2007 in accordance with generally accepted government auditing 

standards. 

From August 2003 through August 2006, 29 states ended Medicaid 

financing arrangements that CMS determined to be inappropriate as a 

result of its oversight initiative; the fiscal effects of ending such 

arrangements were uncertain at the time of our review. The ended 

financing arrangements involved supplemental payments made to 

government-owned or government-operated health care providers, most 

often government nursing homes and hospitals. CMS officials informed us 

that in all the cases, they required states to end the financing arrangements 

because under the arrangements, government providers did not retain all

of the supplemental payments made to them but instead returned part or 

all of the payments to the states. In more than half the cases, we identified 

documents in CMS’s files confirming that under the arrangements, 

providers retained less than the full amounts of the supplemental 

payments they received. The fiscal effects on the states and on the federal

government of ending such arrangements remained uncertain at the time 

of our analysis because nearly two-thirds of states (19 of 29) that ended 

Results in Brief 

Page 5 GAO-07-214 Federal Medicaid Oversight Initiative
financing arrangements were either planning or implementing different 

arrangements for financing the nonfederal share of the related 

supplemental payments. For example, 10 states were adopting 

arrangements under which the supplemental payments would be based on

funds expended by government providers and certified as allowable 

expenditures for providing Medicaid services to Medicaid beneficiaries. As 

of October 2006, only 12 of the 19 states planning or implementing 

alternative arrangements had begun seeking federal reimbursements, and 

those states faced further CMS review before obtaining reimbursements. 

CMS’s initiative reflects a departure from the agency’s past oversight 

approach and is consistent with Medicaid payment principles requiring, 

for example, that payment for services be consistent with efficiency, 

economy, and quality of care. In the past, CMS limited states’ 

inappropriate financing arrangements through means other than 

determining whether the individual providers involved were retaining the

supplemental payments made to them. Consequently, CMS previously 

approved states’ financing arrangements even in some cases where it was 

aware that the providers did not retain the full payments. Most states that 

ended financing arrangements view CMS’s initiative as a change in CMS 

policy. In response to our questionnaire, officials in 24 of 29 states that 

ended financing arrangements reported that CMS had changed its policy 

on allowable state financing; in additional written comments, officials of 6 

of these states expressed concern that CMS objected to provisions it had 

previously approved and did so without first notifying states through rule 

making of its policy changes. Whether CMS’s initiative represents a change

in policy that would require rule making was, as of February 2007, under 

review in federal court. In July 2004, Minnesota challenged CMS’s 

disapproval of its state plan amendment in part on the grounds that CMS 

should have gone through rule making before disapproving the state’s plan 

amendment under the initiative. CMS’s disapproval was affirmed by the 

Administrator in July 2006. Minnesota officials in September 2006 filed an

appeal of the Administrator’s decision in federal court; the appeal was 

pending as of February 2007. In another case, unrelated to the initiative, in

which a state challenged CMS’s disapproval of a state plan amendment 

involving an inappropriate financing arrangement, a 2005 federal court 

ruling upheld CMS’s determination that the state’s financing arrangement, 

in which the providers did not retain Medicaid payments, was inconsistent 

with Medicaid payment principles. 

Page 6 GAO-07-214 Federal Medicaid Oversight Initiative
CMS’s initiative has not been implemented in a transparent manner, 

contributing to concerns about the consistency of its reviews of financing 

arrangements across states. CMS’s initiative has lacked transparency in

two ways. First, under the initiative, CMS did not issue written guidance 

about the specific approval standards related to allowable financing 

methods that it was applying in reviewing states’ financing arrangements. 

In January 2007, after receiving a draft of this report for review and 

comment, CMS published a proposed regulation that could, when 

finalized, provide guidance clarifying allowable arrangements for states to 

finance the nonfederal share of their Medicaid payments. Second, CMS has 

not always provided states that ended financing arrangements with clear, 

written explanations for its determinations, which could inform the 

directly affected states, as well as other states and interested parties, 

about allowable financing arrangements. In only one-fourth of the 

financing arrangements that states ended did CMS provide written 

explanations to the affected states of the specific bases for determining 

that their financing arrangements were inconsistent with one or more 

Medicaid payment principles. Although CMS officials said that their 

reviews of states’ financing arrangements under the initiative have been 

consistent, the lack of transparency has contributed to some states’ 

concerns about consistent treatment and precluded us from determining 

whether CMS treated states that ended financing arrangements 

consistently.

To improve the transparency of CMS’s oversight of states’ Medicaid 

financing arrangements, we are recommending that the Administrator of 

CMS issue guidance to clarify allowable arrangements for financing the 

nonfederal share of Medicaid payments. Such clarification could be 

accomplished through one of the many different avenues CMS has for 

providing states with guidance, including finalizing the regulation 

proposed on January 18, 2007. We also recommend that the Administrator 

provide to each state it reviews, and make available to all states and other 

interested parties, written explanations of agency determinations on the 

allowability of various arrangements for financing the nonfederal share of

Medicaid payments. 

In commenting on a draft of this report, CMS indicated that the agency 

was in the process of implementing our first recommendation and not in 

agreement with the second. 

• CMS stated that the proposed regulation published on January 18, 2007, 

would respond to our first recommendation that the agency issue 

guidance to clarify allowable financing arrangements. We agree, and

Page 7 GAO-07-214 Federal Medicaid Oversight Initiative
updated our report to recognize the publication of the proposed regulation 

after CMS had received a draft of our report for review and comment. We 

note, however, that CMS’s regulation is not final, and we therefore 

maintain our recommendation. 

• In disagreeing with our recommendation that it provide states with written 

explanations of the agency’s determinations under the initiative, CMS 

raised concerns about providing details on the allowability of 

arrangements that states have since corrected or terminated and indicated

that the proposed regulation would satisfy the recommendation on a 

nationwide scale. Our recommendation was not intended to be applied

retroactively but, rather, to be used in ongoing and future determinations. 

We have clarified this intent in our report. Although we agree that the 

proposed regulation, when finalized, could address some concerns about 

the transparency of CMS’s efforts, we continue to believe that specific 

written explanations of the agency’s future determinations are also needed

because they would further delineate for states and others how CMS is 

applying its guidance in reviewing specific arrangements. We therefore 

maintain our recommendation. 

CMS also commented that the report overemphasized the need for 

transparency and overlooked the fairness of CMS’s review activities. We 

maintain that CMS’s changed oversight approach, states’ concerns about 

the lack of guidance and consistent treatment, and the significant potential 

fiscal effects of CMS’s determinations on states’ budgets show the need for 

more transparency in the agency’s guidance and determinations. 

Title XIX of the Social Security Act establishes Medicaid as a joint federalstate program to finance health care for certain low-income, aged, or 

disabled individuals.6

 Medicaid is an open-ended entitlement program, 

under which the federal government is obligated to pay its share of 

expenditures for covered services provided to eligible individuals under 

each state’s federally approved Medicaid plan. States operate their 

Medicaid programs by paying qualified health care providers for a range of

covered services provided to eligible beneficiaries and then seeking 

reimbursement for the federal share of those payments.7

 CMS provides 

Background 

 6

42 U.S.C. §§ 1396 et seq. (2000). 

7

Throughout this report, we refer to funds used by state Medicaid programs to pay

providers for rendering Medicaid services as “payments.” We refer to federal funds

received by states from CMS for the federal share of states’ Medicaid payments as 

“reimbursements.” 

Page 8 GAO-07-214 Federal Medicaid Oversight Initiative
information to states about Medicaid program requirements through 

federal regulations; a published State Medicaid Manual; standard letters

issued to all state Medicaid directors (known as state Medicaid directors 

letters), which are also available on CMS’s Web site; and technical 

guidance manuals on particular topics. 

Within broad federal requirements, each state administers and operates its 

Medicaid program in accordance with a state Medicaid plan, which must 

be approved by CMS. A state Medicaid plan details the populations a 

state’s program serves, the services the program covers (such as 

physicians’ services and nursing home and inpatient hospital care), and 

the rates of and methods for calculating payments to providers. Any 

changes a state wishes to make in its Medicaid program must be submitted 

to CMS for review and approval in the form of a proposed state plan 

amendment. A state plan amendment is valid indefinitely, barring any

changes to federal law or policy or the state’s decision to further amend 

that part of its state plan. Changes may range from editorial changes, such 

as updates for agency name changes, to substantive program changes, 

such as establishing new methods for developing provider payment rates, 

adding certain types of payments, or modifying eligibility for program 

services. State plan amendments may be needed to reflect developments 

in federal law, regulation, or case law or changes in state law, 

organization, policy, or operation of the Medicaid program. States are not 

required to submit state plan amendments on a regular basis but, rather, as 

needed when the states seek to change some aspect of their programs. Nor 

are states limited in the number of state plan amendments they may 

submit. In fiscal year 2005, for example, 722 state plan amendments were 

submitted for CMS review, with the number per state ranging from a low 

of 5 in three states to a high of 41 in two states. 

Under a statutory formula, the federal government may pay from 50 to 

83 percent of a state’s Medicaid expenditures.8

 Certain inappropriate 

financing arrangements, however, have allowed some states to effectively 

increase the federal share of their Medicaid expenditures. Medicaid plans 

generally do not detail the specific arrangements a state uses to finance

the nonfederal share of program spending. Title XIX of the Social Security 

Act allows states to derive up to 60 percent of this nonfederal share from 

local governments, as long as the state itself contributes at least 40 

 8

Under Medicaid law, states with lower per capita incomes receive higher federal matching

rates. 42 U.S.C § 1396d(b) (2000). 

Page 9 GAO-07-214 Federal Medicaid Oversight Initiative
percent.9

 In the past, we and others have reported that some states were 

using inappropriate financing arrangements to boost the federal share of

program expenditures, most recently through misuse of Medicaid upper 

payment limit (UPL) provisions. UPLs are the federal government’s way of 

placing ceilings on the federal share of a state’s Medicaid program; they 

are the upper bound on the amounts the federal government will 

reimburse a state for the federal share of state spending on certain 

services. Some states have paid certain providers supplemental payments

up to the UPL, and the federal government has shared in those payments.10

These supplemental payments were separate from and in addition to those 

made at the states’ standard Medicaid payment rates, and some states 

required providers to return most or all of these supplemental payments to 

the state, thus increasing federal funding without a commensurate 

increase in nonfederal funding. 

When government entities were involved, states were able to increase 

federal funding inappropriately because supplemental payments could be 

returned to the state through a mechanism known as an intergovernmental

transfer, or IGT. An IGT is a legitimate feature in state finance that enables 

state and local governments to carry out their shared governmental 

functions, for example, through the transfer of revenues between 

governmental entities. Some state supplemental payments involving IGTs, 

however, have been part of inappropriate financing arrangements in which 

states received federal Medicaid reimbursements based on payment 

amounts that were greater than the amounts actually retained by the 

providers for Medicaid purposes—effectively shifting Medicaid program 

costs to the federal government. Figure 1 illustrates one such example. In 

this case, the state made a $41 million supplemental payment to a localgovernment hospital. Under its Medicaid matching formula, the state paid

$10.5 million and CMS paid $30.5 million as the federal share of the 

supplemental payment. After receiving the supplemental payment, 

however, the hospital transferred back to the state approximately 

$39 million of the $41 million payment, retaining $2 million. Essentially, 

the state created the illusion of a $41 million supplemental hospital 

 9

42 U.S.C § 1396a(a)(2) (2000). 

10UPLs are based on the amounts that Medicare, the federal health care program that 

covers seniors aged 65 and older and some disabled persons, pays for comparable services. 

Because states’ standard Medicaid payment rates are often lower than Medicare rates for 

the same services, some states calculated the difference between what they actually paid 

providers using standard Medicaid rates and the UPL, and then made a supplemental 

payment for the difference to a few government providers.

Page 10 GAO-07-214 Federal Medicaid Oversight Initiative
payment when only $2 million was actually retained by the provider. This 

illusory payment netted the state tens of millions of dollars in excess 

federal funds. 

Figure 1: Inappropriate State Financing Arrangement in Which Provider Did Not 

Retain the Full Supplemental Payment 

This type of financing arrangement is inappropriate for at least two 

reasons. First, it enables states to obtain additional federal 

reimbursements, effectively without contributing a nonfederal share; in 

this case, the state actually netted $28.5 million as a result of the 

arrangement. Second, it makes federal Medicaid reimbursements available 

for other purposes. In some cases, states have used the returned funds as

the nonfederal share of additional Medicaid payments to providers to seek 

Source: GAO analysis of one state’s financing arrangement for state fiscal year 2004.

1. State Medicaid agency made a

$41 million supplemental payment to 

local-government hospital, consisting of 

$10.5 million in state funds and $30.5 million 

provided by CMS as the federal share

$39 million ✖

Local-government 

hospital

$30.5 million $10.5 million

$41

million

CMS

State Medicaid 

agency

2. Local-government hospital 

transferred $39 million back to 

state via an IGT

Local-government 

hospital retained 

$2 million

State netted 

$28.5 million

CMS paid 

$30.5 million

Page 11 GAO-07-214 Federal Medicaid Oversight Initiative
still more federal reimbursements, thus recycling federal funds to produce 

additional federal funds.

CMS’s initiative was undertaken as part of the agency’s efforts to 

strengthen financial oversight and ensure payment accuracy and the fiscal

integrity of the Medicaid program. Under this initiative, whenever a state 

submitted to CMS for review and approval a proposed state plan 

amendment revising a section of the state plan related to payments to 

providers, CMS officials asked the state five standard funding questions 

intended to gauge the appropriateness of the state’s financing 

arrangement. Specifically, CMS asked states to describe 

• whether Medicaid providers would retain all Medicaid payments made to 

them, including the federal and nonfederal shares, or whether any portion 

would be returned to the state, local-government entity, or other 

organization;

• sources of state funds used to make the Medicaid payments, for example, 

whether the nonfederal share came from appropriations from the 

legislature or from IGT arrangements or other sources; 

• the total amount of any supplemental payments made to each Medicaid 

provider; 

• the methods used by the state to estimate the UPL for different types of 

providers; and 

• whether total Medicaid payments to government providers exceeded the 

providers’ costs of providing services to Medicaid beneficiaries. 

Under the initiative, a state typically responds to CMS’s questions, which 

starts a series of communications between state and CMS officials via email, telephone, or formal letters and culminates in a decision by CMS as 

to the appropriateness of the state’s financing arrangements related to the

Medicaid payments. If CMS determines that providers are not fully 

retaining payments they received from the state, CMS withholds approval

of state plan amendments until the state provides assurances that it will 

end inappropriate financing arrangements. After ending the arrangement, 

the state may, with CMS approval, continue making the related 

supplemental payments under a different financing arrangement. 

Page 12 GAO-07-214 Federal Medicaid Oversight Initiative
As a result of CMS’s oversight initiative, 29 states ended arrangements for 

financing Medicaid supplemental payments to government providers, most 

often nursing homes and hospitals, from August 2003 through August 2006.

According to CMS, under each of the ended arrangements, government 

providers retained less than the full payment amounts. At the time of our 

review, 19 of the 29 states that ended financing arrangements were 

planning or implementing alternative ways to finance the nonfederal share 

of the supplemental payments, but they had not begun receiving federal 

reimbursements under those alternatives. Hence, the fiscal effects of the 

ended financing arrangements remained uncertain. 

From August 2003 through August 2006, 29 states ended one or more 

financing arrangements, each of which involved supplemental payments to 

health care providers—most often nursing homes and hospitals—that 

were owned or operated by government entities, such as states and 

counties. According to CMS, all of these arrangements were inconsistent 

with Medicaid payment principles because the related payments were not 

retained in full by these government providers. CMS completed many 

reviews that did not result in a state’s ending a financing arrangement. 

Specifically, according to CMS data, 19 of the 29 states that ended an 

arrangement had other arrangements that had been reviewed with no 

objections from CMS. In addition, 18 states other than the 29 that ended

arrangements underwent reviews of one or more financing arrangements 

that met with CMS’s approval and therefore did not have to be ended.

11

In total, the 29 states ended 55 financing arrangements involving 

supplemental payments made to government providers for various 

Medicaid services identified in states’ Medicaid plans. States most 

frequently ended arrangements to finance supplemental payments made to 

government-operated nursing homes (for example, county nursing homes) 

and hospitals (such as county, municipal, and state university hospitals). 

For example, one state supplemented its standard Medicaid payments with 

quarterly payments to county nursing homes. The state noted in a letter to 

CMS that in state fiscal year 2003, two eligible county nursing homes 

received supplemental payments totaling $18 million, of which the nursing 

homes retained $509,000. Combined, arrangements for financing nursing

Twenty-nine States 

Ended Financing 

Arrangements, with 

Uncertain Fiscal 

Effects

Ended Arrangements 

Involved Supplemental 

Payments Not Fully 

Retained by Government 

Providers 

 11On the basis of information from CMS and our contacts with the states, we determined 

that the three remaining states and the District of Columbia had not ended a financing 

arrangement as a result of CMS’s initiative. 

Page 13 GAO-07-214 Federal Medicaid Oversight Initiative
home payments and hospital payments for inpatient services (42 percent 

and 24 percent, respectively) represented about two-thirds of all 55 ended 

arrangements in the 29 states. The remaining one-third of ended financing

arrangements most often involved disproportionate share hospital, or 

DSH, payments12 (20 percent) and hospital payments for outpatient 

hospital services (11 percent). See table 1 for a summary of the financing

arrangements ended by states from August 2003 through August 2006. 

 12DSH payments are separate Medicaid payments states make to hospitals. Under Medicaid 

law, states are required to make special hospital payments to supplement standard 

Medicaid payment rates and help offset costs for hospitals that serve a disproportionate

share of low-income or uninsured patients; these payments came to be known as 

disproportionate share hospital, or DSH, payments. States have some discretion in

designating which hospitals, including hospitals owned or operated by local governments, 

qualify for DSH payments. In response to inappropriate state financing arrangements 

involving DSH payments in the early 1990s, Congress passed provisions capping the

amount of DSH payments a hospital may receive and limiting the total amount of DSH 

payments a state may make to all hospitals. 42 U.S.C. § 1396r-4(f)–(g) (2000).

Page 14 GAO-07-214 Federal Medicaid Oversight Initiative
Table 1: Financing Arrangements Ended, by State and Type of Supplemental Provider Payment Involved, from August 2003 

through August 2006 

Type of supplemental payment involved in ended arrangement

State Nursing home Inpatient hospital 

Disproportionate

share hospital Outpatient hospital Home health Physician 

Alabama z z z z

Alaska z

Arkansas z z

California z z

Georgia z z z z

Iowa z z z

Kansas z z

Kentucky z z z

Louisiana z z z

Massachusetts z z z

Michigan z z

Minnesota z

Mississippi z

Missouri z

Montana z

Nebraska z

New Hampshire z

New Jersey z

New York z z z z

North Carolina z

Oklahoma z z

Oregon z

Pennsylvania z

South Carolina z z

South Dakota z

Tennessee z

Virginia z z z

Washington z z

Wisconsin z

Total (29) 23 13 11 6 1 1 

Source: CMS and states. 

Note: Data from GAO analysis of CMS documents and state responses to GAO’s questionnaire. 

Page 15 GAO-07-214 Federal Medicaid Oversight Initiative
Although the specific details of the ended financing arrangements differed

from state to state, in more than half of all cases (31 of 55), we identified

documents in CMS’s files confirming that under the arrangements, 

providers retained less than the full amount of the supplemental payments 

they received. For example: 

• One state explained in its responses to CMS’s standard funding questions

that a portion of the supplemental payments to non-state-governmentowned hospitals for inpatient services was returned to the state. Payments

were made to the hospitals, which retained an amount equal to 3 percent

of the payments plus 50 percent of the federal share of the payment. The

remaining funds were transferred by the hospitals to their county 

governments. The counties transferred these funds back to the state via an 

IGT. The transferred funds were allocated to the state’s Medicaid program 

to fund additional Medicaid services.

• An official from another state noted in an e-mail to CMS that facilities 

participating in the state’s UPL program transferred an amount that 

exceeded the nonfederal share of certain payments. For example, as 

explained in a response from a CMS official to the state, under the state’s 

arrangement for supplemental nursing home payments, providers were 

required to transfer to the state the nonfederal share of the supplemental 

payments plus approximately an additional 43 percent, which the state 

used to fund other Medicaid expenditures. CMS concluded that under such 

an arrangement, the nursing homes netted only 57 percent of the total 

supplemental payment reported by the state. 

In the remaining cases, we could not conclusively determine from 

reviewing CMS’s documentation whether the involved providers retained 

less than the full amount of the supplemental payment. CMS reported to 

us, however, that in all of the arrangements states ended, providers 

retained less than the full amount of the supplemental payments they 

received because the states required providers to either (1) return a 

portion of the payment to the state through an IGT or (2) transfer to the 

state more than the nonfederal share of the payment before the state made

the payment to providers and sought federal reimbursement. 

In about two-thirds of cases, states ended financing arrangements by 

removing or revising the pertinent supplemental payment provisions in 

their state plans. Specifically, states added provisions to their state plan 

amendments that would, as of a given date (most often, it was the end of 

the states’ fiscal year 2005), end the type of supplemental payments under 

CMS review. As CMS explained to one state, providing such an end date in

Page 16 GAO-07-214 Federal Medicaid Oversight Initiative
writing assured CMS that the state would not continue the payments in 

question (in this case, supplemental payments to local-government 

hospitals) under the inappropriate financing arrangement; moreover, if the 

state did not agree to end the arrangement, CMS would not approve the 

state’s proposed state plan amendment. In response, the state resubmitted 

its amendment, adding a provision ending its supplemental payments to 

local-government hospitals as of June 30, 2005, and in its cover letter to 

CMS noted that the state would resume making such payments only under 

an arrangement acceptable to CMS. In another case, CMS required a state 

to end its arrangements for certain supplemental payments as a condition

for approving the state’s section 1115 waiver proposal.13 Under the waiver 

agreement, CMS required the state to end, by amending its state plan, the 

supplemental inpatient hospital payments, nursing home payments, and 

DSH payments for which providers did not retain the full amounts. This 

process—in which CMS required states to remove from their state plans 

provisions governing certain supplemental payments, thereby ending the 

inappropriate financing arrangements—was the typical approach that CMS 

took with states under the initiative. In some cases (5 of 55), however, 

CMS accepted from states written assurance that the state would end an

inappropriate financing arrangement. For example, one state wrote to 

CMS that it would in the future revise its arrangement to comply with 

CMS’s current policy. 

The state and federal fiscal effects of states’ ending their financing 

arrangements were unclear because most of the states (19 of 29 states) 

were planning or implementing alternative arrangements to continue 

obtaining federal reimbursements for the related supplemental payments. 

As of October 2006, only 12 of the 19 states that were planning or 

implementing different financing arrangements had resumed seeking 

federal matching funds. Until states begin to obtain federal matching funds 

under the alternative arrangements, the fiscal effects of the initiative will 

remain unclear. 

The 29 states we contacted provided us estimates of potential annual 

reductions in federal reimbursement related to ended arrangements—

Fiscal Effects Are 

Uncertain Because Most 

States Were Seeking 

Continued Federal

Reimbursements under 

Alternative Arrangements 

 13Section 1115 of the Social Security Act allows the Secretary of Health and Human 

Services, in connection with experimental, pilot, or demonstration projects likely to 

promote program objectives, to waive certain statutory Medicaid requirements and provide 

federal matching funds for expenditures for which federal matching funds would not

otherwise be available. 42 U.S.C. § 1315 (2000). 

Page 17 GAO-07-214 Federal Medicaid Oversight Initiative
most frequently based on the amount of federal reimbursement under the 

ended arrangements in their fiscal year 2005—that totaled nearly 

$1.9 billion and ranged from $0 to approximately $382 million among the 

states. Of the 29 states, 14 states chose not to continue making the 

supplemental payments related to one or more ended arrangements.14 For 

example, one state discontinued its supplemental payments to public 

nursing homes at the end of its fiscal year 2005 and, as a result, would no 

longer receive federal reimbursement for such payments—reimbursement 

totaling nearly $5 million in state fiscal year 2004. The 14 states that were 

not taking steps to continue obtaining comparable federal reimbursement 

estimated that they would each annually receive from $0 to $69 million 

less in federal matching funds.15

Most states’ estimates were preliminary as of October 2006, because 

19 states were planning or implementing different arrangements for 

financing the related supplemental payments from those that CMS had 

required them to end. Doing so would allow the states to continue to seek 

federal reimbursement for those payments. To obtain such federal 

reimbursement, however, states were subject to CMS review of their 

alternative arrangements for financing the nonfederal share of their 

payments. Several states were continuing to use an IGT to fund the 

nonfederal share, but with changes that they expected to meet with CMS 

approval; specifically, under a revised IGT, providers would retain in full 

the supplemental payments made to them. Other states were planning or 

implementing other arrangements, such as increasing appropriations or 

generating new revenues by imposing taxes on certain providers, to 

continue making supplemental payments. The alternative chosen by the 

largest number of states—10 of the 19 states adopting alternative 

arrangements—was an approach based on government providers’ 

certifying their Medicaid expenditures to the state. Such certified public 

expenditures, or CPEs, do not involve an actual transfer of funds by 

 14Four states that ended more than one financing arrangement chose to discontinue

supplemental payments related to one of the ended arrangements. However, these states 

were also planning to use an alternative financing arrangement to continue making 

payments related to another of the ended arrangements. As a result, we counted the four 

states in the total number of states discontinuing payments related to an ended financing 

arrangement and in the total number of states continuing payments under an alternative 

arrangement.

15The state that estimated a potential reduction of $69 million in federal matching funds 

also reported that approximately $58 million would be offset by new federal funding made 

available under a section 1115 demonstration project that included federal funding for

health care expenditures previously paid with state and local funds. 

Page 18 GAO-07-214 Federal Medicaid Oversight Initiative
government providers to the state.16 Table 2 describes these alternatives 

and the number of states planning or implementing each one. 

Table 2: Number of States Planning or Implementing Certain Alternative Arrangements for Financing the Nonfederal Share of

Payments, as of October 2006 

Alternative 

arrangement Number of states Description Example

Medicaid certified 

public expenditure 

(CPE) 

10 Government provider, such as a county 

hospital, certifies to a state the amount of 

expenditures for a Medicaid-covered service

provided to a Medicaid beneficiary. The state 

obtains federal Medicaid matching funds 

based on the amount of the expenditure. 

Under one state proposal, 22 

government hospitals would be paid in 

advance for the full cost of providing 

services to indigent individuals, including 

Medicaid beneficiaries. The hospitals 

would certify the total amount of 

Medicaid expenditures to the state, and 

the state would then seek federal 

reimbursement on the basis of the 

certified amount.a

Revised 

intergovernmental 

transfer (IGT) 

8 Continued use of IGTs with revisions agreed 

to by CMS. Specifically, CMS is requiring that 

(1) IGTs from providers to a state occur 

before supplemental payments are made and 

(2) the amount of an IGT not exceed the 

nonfederal share of the Medicaid costs. This 

approach provides some assurance that 

government providers are contributing only 

toward the nonfederal share of a state’s 

Medicaid costs, as prescribed by federal 

statute. 

During state fiscal year 2006, one state 

will continue using IGTs for inpatient 

hospital services. Transfers will be

limited to the nonfederal share of the 

Medicaid supplemental payment. The 

state will obtain assurances from entities 

making IGTs that all payments will 

remain with the hospitals. 

Provider tax 4 A tax, fee, assessment, or other mandatory 

payment, imposed on health care services or 

providers. States may use resulting revenue 

to pay their nonfederal share of Medicaid 

costs under statutorily specified

circumstances.b

 

One state legislature passed an act 

authorizing the state to implement a 

provider tax on public, non-stategovernment hospitals to fund the 

nonfederal share of Medicaid payments 

for inpatient and outpatient services, 

effective July 2007. 

State appropriation 3 State revenue set aside to pay for the 

nonfederal share of Medicaid spending. 

One state partially replaced the portion of 

the nonfederal share previously funded 

by an IGT with state appropriations. 

Source: CMS and states. 

 16Under a CPE arrangement, government providers certify their Medicaid expenditures to

the state, and the state then obtains federal reimbursement on the basis of the certified 

expenditures. Medicaid law allows states to finance the nonfederal share of payments with

CPEs as long as the funds are (1) derived from state or local tax revenue and (2) certified 

by units of local or state government as eligible for federal reimbursement. 

42 U.S.C. § 1396b(w)(6) (2000). States are responsible for ensuring that expenditures are 

eligible for federal reimbursement by reviewing standard cost reports filed annually by

each government provider. 

Page 19 GAO-07-214 Federal Medicaid Oversight Initiative
Notes: Data from GAO analysis of CMS and state documents, state responses to GAO questionnaire, 

and information reported by state officials. Numbers do not sum to 19—the number of states reporting

that they were planning or implementing alternative arrangements for financing the nonfederal 

share—because some states were using a combination of alternatives. 

a

This state received CMS approval to use CPEs to finance the nonfederal share of supplemental 

inpatient and DSH payments and to restructure Medicaid payments for all inpatient hospital services 

under a waiver of Medicaid requirements granted under section 1115 of the Social Security Act, 

42 U.S.C. § 1315 (2000). 

b

42 U.S.C. § 1396b(w)(6) (2000). States may receive federal matching funds for provider taxes only if 

such taxes are broad-based (i.e., imposed on all items or services in the class of services or

providers thereof); uniformly imposed (i.e., all items or services in the class or providers thereof pay 

the same rate of tax); and do not result in any taxpayers being held harmless (i.e., receiving state 

funds to reduce the net payment to the state to below the amount of the tax). 42 U.S.C. § 1396b(w)(3) 

(2000). When the tax rate is higher than 6 percent, CMS will consider the hold-harmless requirement 

violated if 75 percent or more of the taxpayers receive 75 percent or more of the taxes paid back from

the state in enhanced Medicaid or other state payments. 42 C.F.R. § 433.68(f)(3) (2006). 

States had differing views about the potential fiscal effects of adopting 

alternative arrangements for financing the nonfederal share of

supplemental payments. Half of the states using CPEs (5 of 10) expected 

CPEs to result in federal reimbursement comparable to what they had

received under their ended financing arrangements. For example, officials 

from one state explained that under its previous arrangement, DSH 

payments had been limited to costs, and under the state’s CPE 

arrangement (approved by CMS in December 2005), the state would 

continue obtaining the same amount of federal reimbursement. In 

contrast, officials from the remaining 5 states using CPEs expressed 

concern that CPEs could yield less in federal funds than the arrangements 

they replaced, in part because CPEs must be based on the documented 

facility-specific costs of providing Medicaid services to Medicaid 

beneficiaries. An official from 1 of the 5 states explained that, under a 

prior financing arrangement, the state sought federal reimbursement on 

amounts up to the UPL, regardless of the facilities’ actual costs for 

providing services. In using CPEs, however, the state will seek federal 

reimbursement for the lower of either a facility’s UPL or its actual 

Medicaid expenditures, and some facilities’ expenditures were less than 

the UPL. 

The fiscal effects of states’ replacing their ended financing arrangements 

with alternative arrangements, such as CPEs, were uncertain as of October 

2006 because several states had not fully implemented the alternatives and 

others faced further CMS review before receiving federal matching funds. 

Specifically, 1 of the 19 states was still planning its approaches; 6 states 

reported having implemented alternative arrangements but had not begun 

seeking federal reimbursements; and the remaining states (12 of 19 states) 

had made payments under their alternative arrangements and had begun 

Page 20 GAO-07-214 Federal Medicaid Oversight Initiative
seeking federal reimbursements. Those 12 states, however, faced further 

CMS review before receiving reimbursements. CMS officials informed us 

that CMS had efforts under way to monitor states’ use of alternative 

arrangements as the states resumed seeking federal reimbursement. CMS’s 

efforts may affect the amount of federal reimbursements the states 

receive. For example, CMS deferred paying close to $2 million in federal

matching funds to a state that resumed seeking reimbursement for 

supplemental hospital payments under a revised IGT arrangement. As of 

October 2006, the state and CMS were still working to resolve CMS’s 

concerns with the state’s alternative arrangement. CMS also plans to 

review other types of alternative arrangements. For example, in its 

approvals granted from December 2005 through April 2006 of 3 states’ 

plans to use CPEs, CMS informed the states that it planned to conduct 

financial reviews to ensure that the states’ reported expenditures were 

accurate and that all supplemental payments to certifying facilities had 

appropriate nonfederal funding.17

CMS’s initiative is a departure from the agency’s past oversight approach 

and is consistent with Medicaid payment principles. In the past, CMS’s 

approach to inappropriate state financing arrangements did not involve 

any assessment of whether individual providers were retaining the 

supplemental payments they received from states. As a result, before the 

initiative, CMS authorized some states to make supplemental payments 

even when the agency was aware that providers were not retaining the full 

payment amount. States that ended financing arrangements view CMS’s 

initiative as a change in policy. One state, Minnesota, challenged CMS’s 

disapproval of its state plan amendment in July 2004. Minnesota argued, in

part, that CMS had departed from its past interpretation of Medicaid 

requirements and should have gone through the process of proposing and 

receiving comments on a regulation (known as “notice-and-comment rule 

making”) before disapproving the amendment.18 In July 2006, this 

argument was rejected, and the disapproval was upheld by the CMS 

CMS’s Initiative 

Departs from Past 

Approach and Is 

Consistent with 

Medicaid Payment 

Principles 

 17In addition to these efforts, CMS identified CPEs as an issue for focused financial reviews 

in the last 3 fiscal years, 2004 through 2006. See GAO, Medicaid Financial Management: 

Steps Taken to Improve Federal Oversight, but Other Actions Needed to Sustain Efforts, 

GAO-06-705 (Washington, D.C.: June 22, 2006).

18Notice-and-comment rule making (also referred to as informal rule making) is a process

in which an agency publishes a proposed rule in the Federal Register for public comment.

After considering the comments received, the agency issues a final rule.

Page 21 GAO-07-214 Federal Medicaid Oversight Initiative
Administrator.19 The state filed an appeal in federal court in September 

2006, and as of February 2007, this appeal was pending. In another case, 

unrelated to CMS’s initiative, in which a state challenged CMS’s 

disapproval of a state plan amendment involving an inappropriate 

financing arrangement, a 2005 federal court ruling upheld CMS’s 

determination that the state’s financing arrangement, in which the 

providers did not retain Medicaid payments, was inconsistent with 

Medicaid payment principles.20

CMS’s Initiative Departs 

from Past Oversight 

Approach 

CMS’s requirement that states end financing arrangements in which 

providers do not retain the full payment represents a departure from the 

agency’s past oversight approach to ensuring that states adhere to 

Medicaid payment principles. Before 2003, CMS’s most recent approach 

for addressing inappropriate state financing arrangements curtailed such 

arrangements by restricting states’ ability to combine, or “aggregate,” the 

amount of payments they could make under the UPL to different types of

providers. CMS placed this restriction by revising Medicaid’s UPL 

 19In re The Disapproval of the Minnesota State Plan Amendment 03-006, No. 2004-04 at 

15, note 36 (CMS Administrator, July 12, 2006). 

20Alaska Dep’t of Health & Soc. Servs. v. Ctr. for Medicare & Medicaid Servs., 424 F.3d 

931, 939–40 (9th Cir. 2005). 

Page 22 GAO-07-214 Federal Medicaid Oversight Initiative
regulation in 2001.21 The revision took place after some states were found 

taking advantage of the UPL by making supplemental payments to 

government facilities at rates much higher than established Medicaid rates 

and then requiring the facilities to return most or all of the supplemental 

payments to the state.22 CMS determined that these financing 

arrangements were not consistent with Medicaid’s principle of efficiency 

and economy and restricted states’ ability to aggregate payments across 

different types of providers. The revised regulation did not address the use 

of IGTs—the transfer of funds between states and local-government 

providers—or whether providers were retaining the Medicaid payments 

made under the new limits. At the time it issued the regulation, CMS 

determined that the best option for reducing excessive federal 

reimbursements was to revise the UPL regulation to limit the extent to 

which aggregated supplemental payments could be made. CMS recognized 

the possibility that excessive federal funds could still be obtained under 

the new regulation. In the preamble to its 2001 regulation, CMS reported 

that it was concerned about how some states used fund transfers between 

states and local governments and noted that, if problems continued in the 

 21Before the 2001 regulation, separate UPLs existed for different classes of Medicaid 

services, such as inpatient hospital services, outpatient hospital services, and nursing

facility services. 42 C.F.R. § 447.272 (2000). Within the different provider types—stategovernment-operated facilities, local-government-operated facilities, and private 

facilities—only state-operated facilities had separate UPLs for each class of service, with 

the exception of outpatient hospital services, which did not have a separate UPL for stategovernment facilities. As a result, within each service class, some states sought federal 

reimbursement for large supplemental payments by combining—or aggregating—the 

payment amount allowed under their UPLs for the entire group of local-government and

private facilities, even if the actual payment was made to only a handful of selected 

government facilities. In December 2000, Congress directed the Health Care Financing 

Administration (HCFA, the former name for CMS) to issue a final regulation to revise the

UPL regulation and limit states’ ability to obtain excessive federal reimbursements. 

Medicare, Medicaid, and SCHIP Benefits Improvement and Protection Act of 2000, 

Pub. L. No. 106-554, app. F, § 705(a), 114 Stat. 2763, 2763A-575–2763A-576. In January 2001, 

HCFA issued the final UPL regulation, which established separate UPLs for private 

facilities and for local-government facilities for different classes of services, including 

inpatient hospital services, outpatient hospital and clinic services, and nursing facility 

services. 66 Fed. Reg. 3,148 (Jan. 12, 2001). The final rule also contained provisions that set 

the UPL for hospitals operated by local governments at 150 percent of what Medicare 

would pay, rather than 100 percent, which allowed states to make larger supplemental 

payments to such hospitals. In January 2002, CMS issued another final UPL regulation that

replaced the 150 percent UPL for local-government hospitals with a 100 percent UPL. 

67 Fed. Reg. 2,602 (Jan. 28, 2002). 

22For additional information, see GAO, Medicaid: Improved Federal Oversight of State

Financing Schemes Is Needed, GAO-04-228 (Washington, D.C.: Feb. 13, 2004). 

Page 23 GAO-07-214 Federal Medicaid Oversight Initiative
future, further actions could be needed to ensure that federal funds were 

used to match bona fide expenditures. 

In the months after CMS issued its 2001 regulation and before its initiative, 

CMS approved some states’ financing arrangements that entailed the 

transfer of Medicaid supplemental payments from government providers 

back to the state. CMS’s efforts after issuing the 2001 UPL regulation 

focused on ensuring that states were not seeking excessive federal 

reimbursements based on aggregated local-government and private-facility 

UPLs, as states had done before the regulation. Otherwise, CMS did not 

curtail financing arrangements, even when they involved providers’ not 

retaining all of the payments made to them.23 After the 2001 UPL regulation

went into effect and before the initiative began, CMS approved states’ 

Medicaid plan amendments establishing supplemental payments to 

government providers even when the agency was aware that providers 

were not retaining the supplemental payments. Subsequently, however, 

CMS determined that these approved arrangements were inappropriate 

because the providers were not retaining the payments. For example: 

• On March 13, 2002, CMS approved one state’s proposal to establish a 

supplemental payment for inpatient hospital services provided by localgovernment hospitals. During CMS’s review of this proposal, the state 

informed CMS via letter that it was likely that the majority of the payments 

would be returned by the providers to the state. In state fiscal year 2002,

the state’s estimated supplemental payments to local-government 

providers totaled about $22 million. On October 23, 2003, however, after 

submitting a state plan amendment to adjust its standard Medicaid 

payment rates for hospitals, the state received CMS’s standard funding 

questions under the initiative. CMS’s subsequent review resulted in the 

state’s ending the previously approved supplemental payment involving 

local-government hospitals. 

• On May 19, 2003, CMS approved another state’s supplemental payment for 

inpatient hospital services provided in government hospitals. During the 

agency’s review of the state plan amendment for these payments, the state

 23On numerous occasions, we have reported concerns related to CMS’s oversight of states’ 

UPL arrangements, including concerns that CMS was approving new state financing 

arrangements that were inappropriate and allowing states to continue claiming excessive 

federal reimbursements that were not consistent with the purpose of CMS’s UPL 

regulations. See, for example, GAO, Medicaid: HCFA Reversed Its Position and Approved

Additional State Financing Schemes, GAO-02-147 (Washington, D.C.: Oct. 30, 2001), and 

GAO-04-228. 

Page 24 GAO-07-214 Federal Medicaid Oversight Initiative
informed CMS in writing that this proposal would use state plan language 

similar to the state’s supplemental county nursing home payment. CMS 

had approved this nursing home payment in 2001, even though the agency 

had been informed when the payment was proposed that the underlying 

financing arrangement involved bank loans and wire transfers among 

counties. Less than 2 months before the state submitted its state plan 

amendment for the supplemental payment to government hospitals, CMS 

was informed that the county nursing homes would retain little of the 

supplemental payments made to them.24 Nevertheless, CMS approved the 

similar request involving supplemental payments for inpatient hospital 

services in local-government hospitals. On August 21, 2003, the state 

received CMS’s standard questions under the initiative after it had 

submitted a nonsupplemental inpatient hospital state plan amendment to 

CMS for review. CMS’s subsequent review led to the state’s ending its 

supplemental payments to the local-government hospitals. 

Twenty-four of the 29 states that ended financing arrangements and that 

we contacted reported that under its initiative, CMS has changed its 

policies on what is an appropriate state financing arrangement. Four states 

reported that they had no basis to judge whether CMS has changed its 

policy, 1 state responded that CMS’s actions do not represent a change in 

policy, and 1 state did not respond to this question.25 Officials of 6 states 

expressed concerns that before objecting to state plan provisions 

comparable to what it had approved in the past, CMS should have used a 

rule-making process to enable states to comment on any proposed 

changes.26 According to CMS, however, the agency did not adopt a new 

policy but is scrutinizing states’ payments and their underlying financing 

arrangements more closely to ensure that they comport with existing laws 

and regulations and that federal reimbursement is justified. 

States Report That CMS 

Has Changed Certain of Its 

Policies on State Financing 

Arrangements 

 24In October 2001, we reported that the state’s financing arrangements for supplemental 

county nursing home payments inappropriately generated hundreds of millions of dollars in 

federal matching funds without a corresponding nonfederal share or an actual payment for 

services. See GAO-02-147. 

25The number of states totals 30 in this instance because 1 state provided a different 

response for each of the two financing arrangements it ended. 

26The questions we sent to the states did not ask about rule making; some states, however, 

volunteered this information in narrative comments on CMS’s initiative. 

Page 25 GAO-07-214 Federal Medicaid Oversight Initiative
One state, Minnesota, challenged CMS’s disapproval under the initiative of

a state plan amendment27 by formally requesting that the CMS 

Administrator reconsider the disapproval.28 In its July 2004 reconsideration 

request, the state argued, among other points, that the disapproval of its 

state plan amendment to increase supplemental payments to countyoperated nursing homes was based on a new policy that constituted a 

major departure from past CMS policy.29 The state noted that CMS 

reviewed and approved the county nursing home payment on two previous 

occasions without asking any questions about whether the nursing homes 

retained the funds they were paid.30 According to the state, CMS changed 

its policy without going through notice-and-comment rule making, and 

thus the agency’s post–August 2003 policy could not be used to disapprove 

the state’s plan amendment. The Administrator upheld CMS’s disapproval 

on July 12, 2006, finding the state’s argument that CMS was required to use 

notice-and-comment rule making unsupported. The Administrator’s 

decision stated that CMS is required to administer the Medicaid program 

in a manner consistent with statute, and applying the law correctly does 

not require notice-and-comment rule making. In September 2006, the state 

 27On June 1, 2004, CMS sent the Minnesota Medicaid agency a letter disapproving 

Minnesota’s state plan amendment to increase supplemental payments to county nursing 

homes. Before this disapproval, the state and CMS had had numerous exchanges orally and

in writing about details of the state’s existing supplemental payments to county nursing 

homes. These exchanges were triggered by CMS’s August 5, 2003, letter to the state 

requesting responses to CMS’s standard funding questions. In its June disapproval letter,

CMS explained that the state had not provided assurances to CMS that county nursing 

homes would retain the increased payments and had also failed to demonstrate that the 

proposed amendment would be consistent with Medicaid principles, including providing a 

nonfederal share for the payments and ensuring that payments would be economical and 

efficient. 

28Under Medicaid law and regulation, states can request the Administrator of CMS to

reconsider disapprovals of state plan amendments. 42 U.S.C § 1316 (2000) and 42 C.F.R. § 

430.18 (2006). These appeals typically result in a hearing before a CMS hearing officer, who 

reviews the evidence and arguments presented by the appealing state and CMS and then

makes a recommendation to the CMS Administrator. The Administrator makes the final

administrative decision on whether to uphold the agency’s disapproval. If the CMS 

Administrator upholds a disapproval, the state may then appeal in federal circuit court. 

29The state also argued in its appeal that the state plan amendment met all the statutory and 

regulatory requirements for approval. For example, the state argued, the amendment would

result in efficient and economical payments because the payments did not exceed the UPL

for local-government nursing homes. The state also argued that CMS violated the Social 

Security Act by insisting that the state eliminate the intergovernmental transfers of funds 

from the counties that owned and operated the nursing homes receiving the payments. 

30The supplemental payment to county nursing homes was established by a state plan 

amendment approved in 1994, and a state plan amendment was submitted and approved in 

2002 to increase the payment. 

Page 26 GAO-07-214 Federal Medicaid Oversight Initiative
appealed the decision to a federal circuit court; the appeal was pending as 

of February 2007. 

A 2005 court case found that CMS acted appropriately in disapproving one 

state’s proposed plan amendment in which providers would retain only 

10 percent of the payments they received. While this disapproval did not

result from CMS’s initiative, the basis for CMS’s actions in the case shared

key characteristics with CMS’s basis for ending states’ financing 

arrangements under its initiative.31 In a September 12, 2005, ruling, the 

United States Court of Appeals for the Ninth Circuit upheld CMS’s 

disapproval of a state plan amendment that was estimated to increase 

federal reimbursements by $50 million a year even though providers would 

retain only $5 million of the payments that had been made to them.32 CMS 

disapproved the state’s proposal, finding that it would result in payments 

that were not consistent with Medicaid’s principle of efficiency, economy, 

and quality of care because the providers would return the bulk of the 

payment to the state. The court found that CMS had an obligation to 

ensure that the Medicaid statute was satisfied before approving a state 

plan amendment and that CMS correctly applied the Medicaid statute in

disapproving the plan amendment. Specifically, the court upheld CMS’s 

determination that the state’s proposed payment was not consistent with 

the principle that provider payments be efficient and economical. 

As implemented, CMS’s oversight initiative has lacked transparency and 

raised concerns about consistency in CMS’s reviews of states that ended

financing arrangements. The initiative has not been transparent in that 

CMS did not issue written guidance about its specific approval standards 

related to allowable financing methods under the initiative—that is, the 

conditions upon which the agency would or would not approve a state’s 

financing arrangement. CMS published a proposed regulation in the 

Federal Register on January 18, 2007, that could, when finalized, provide 

guidance clarifying allowable arrangements for financing the nonfederal 

share of Medicaid payments. In addition, CMS has not always clearly 

A Federal Court Found a 

Similar Action to Be Within 

CMS’s Authority and 

Consistent with Medicaid 

Payment Principles 

CMS’s Initiative Lacks 

Transparency, Raising 

Concerns about 

Consistent Review of 

State Financing 

Arrangements 

 31While the case involved Medicaid payments to tribal facilities and not facilities owned and 

operated by state or local-government entities, CMS’s disapproval was based on the same 

standard that the agency applied under its initiative, specifically, that providers did not 

retain the full payment amount. 

32Alaska Dep’t of Health & Soc. Servs., 424 F.3d 931, 939–40.

Page 27 GAO-07-214 Federal Medicaid Oversight Initiative
communicated in writing its review determinations to individual states 

that ended financing arrangements or provided to all states a record of its 

determinations under the initiative. Although CMS officials said that their 

reviews have been consistent because the same funding questions have 

been asked consistently of all states, the lack of transparency has 

prompted states to raise questions about the consistency of CMS’s reviews 

and precluded us from determining whether CMS treated states that ended 

financing arrangements consistently.

CMS’s initiative has lacked transparency in two ways. First, the agency did 

not issue written guidance explaining the specific standards it used for 

reviewing and approving states’ financing arrangements. Consequently, 

officials in several of the 29 states that ended financing arrangements told 

us that it was unclear exactly what financing arrangements CMS would 

and would not allow and why arrangements approved in the past were no 

longer allowed. Second, CMS did not always explain in writing to the 

states that ended financing arrangements the specific bases for its 

determinations, nor did it make available for the benefit of other states 

and interested parties any record of its determinations that certain 

arrangements were unallowable. 

CMS did not, before or under the initiative, provide guidance to the states 

about its specific approval standards, something it had done for some 

previous oversight actions. For example, before the agency took actions in 

2001 and 2002 to further limit states’ UPL-related financing arrangements, 

CMS issued a letter to state Medicaid directors. In each case, the letters 

communicated the problems the agency had identified with existing UPL 

regulations and associated financing arrangements, the problems’ effect 

on the Medicaid program and why action was needed, and the type of

action the agency proposed to take. In contrast, for the 2003 oversight 

initiative, CMS did not issue a state Medicaid directors letter or other 

written guidance that would explain the nature of the agency’s intent to 

address the problem or its specific standards for allowable financing 

methods, such as allowable use of IGTs. Rather, CMS began asking states 

submitting state plan amendments for review to answer the five standard 

questions about how they financed the nonfederal share of their payments. 

The lack of CMS guidance to explain the specific standards used under the 

initiative has resulted in confusion among states about allowable financing 

arrangements. When states did receive guidance, it was more likely to be

oral than written. Only 8 of the 29 states (28 percent) we contacted that 

had ended financing arrangements reported they had received written 

CMS’s Initiative Has 

Lacked Transparency 

CMS Did Not Provide Guidance 

about Its Specific Approval 

Standards under the Initiative 

Page 28 GAO-07-214 Federal Medicaid Oversight Initiative
guidance or clarification from CMS, before or during the review process, 

regarding appropriate and inappropriate financing arrangements. States 

told us it was not always clear what financing arrangements CMS would 

allow and why arrangements approved in the past would no longer be 

approved. Officials in several states that ended financing arrangements 

told us that CMS did not provide the guidance they needed about such 

topics, including appropriate and inappropriate use of IGTs and CPEs. For 

example, officials from one state commented that they did not understand 

why CMS would no longer approve the financing arrangement involving 

transfer payments with local-government providers that the state had used 

for more than a decade. Officials from another state remarked that the 

distinction between IGTs and CPEs, and the reasons CMS appeared to 

approve of CPEs over IGTs, were not always clear. According to CMS 

officials, the agency has provided guidance on CPEs by working with 

states individually as the states have developed their proposed financing 

arrangements. 

During our review, a senior CMS official informed us that the agency was 

considering providing guidance to all states on proper methods for 

financing the nonfederal share of Medicaid payments, including 

clarification on issues such as IGTs and CPEs. On January 18, 2007, after it

received a draft of this report for review and comment, CMS published a 

notice of proposed rule making to expressly limit Medicaid payments to 

government providers to the providers’ actual Medicaid costs.33 The 

proposed regulation also includes additional guidance related to state 

financing arrangements and, when finalized, could provide states with 

needed clarifications. 

 33See 72 Fed. Reg. 2,236 (Jan. 18, 2007). In budget proposals for fiscal years 2005 and 2006, 

the administration proposed that Congress pass legislation to specifically prohibit federal 

reimbursement for state payments to government providers that exceeded the providers’

actual costs of providing Medicaid services, but Congress did not pass such legislation. 

CMS’s January proposed rule sought to implement this limitation administratively. 

According to CMS officials, the administration has authority to implement such limits

administratively but proposed the legislation to ensure the program’s fiscal integrity over

time. CMS’s proposal is consistent with an earlier recommendation we made to Congress:

to pass legislation to specifically prohibit Medicaid payments to any government facility 

that exceed costs. See GAO, Medicaid: States Use Illusory Approaches to Shift Program 

Costs to Federal Government, GAO/HEHS-94-133 (Washington, D.C.: Aug. 1, 1994). 

Page 29 GAO-07-214 Federal Medicaid Oversight Initiative
CMS did not communicate with states in clear, specific terms in writing 

that the states’ financing arrangements were inconsistent with Medicaid 

payment principles or why they were inconsistent and should be ended. 

We reviewed case files obtained from CMS to assess how the agency 

communicated its determinations to the 29 states that ended 55 

arrangements under the initiative. In more than half the cases (30 of 55 

arrangements, or 52 percent), we found no documentation that CMS 

communicated to the states in writing the reasons that a state’s 

arrangement was inconsistent, and in another 10 cases (17 percent), we 

found only general explanations of CMS’s concerns with the financing 

arrangement in question.34

In only one-fourth of the cases did CMS communicate in writing to a state

the specific basis for its concerns with that state’s financing arrangement. 

Specifically, for 14 of the 55 arrangements (25 percent) the states ended, 

CMS informed the state in writing that its arrangement was inconsistent 

with particular Medicaid payment principles and explained why it was 

inconsistent. The following example illustrates one of the cases where 

CMS communicated its determinations in writing to the state, including

the basis for its determination: 

CMS Did Not Always 

Document Its Determinations 

or Make Them Available to 

States 

• First, CMS clearly identified in writing the statutory provisions with which

it found the state’s financing arrangement to be inconsistent: “the State is 

claiming Federal matching funds for payments to non-state public 

hospitals for which a significant portion of the payments are returned to 

the State. CMS considers this funding arrangement to be inconsistent with 

Sections 1902(a)(2), 1902(a)(30), and 1903(a) of the Social Security Act.” 

• Second, CMS discussed each statutory provision cited above to explain 

why the state’s financing arrangement was not consistent with a given 

principle. For example, CMS wrote about section 1902(a)(30)(A): “The 

supplemental payments are not consistent with the requirement under 

section 1902(a)(30)(A) of the Act that payment rates must be consistent 

with ‘efficiency, economy and quality of care.’ In light of the State’s 

admission that the facilities are refunding a significant portion of the 

supplemental payments, the proposed payment rate is not consistent with 

 34In the case of 1 of the 55 ended financing arrangements, CMS communicated to the state 

in writing—but only in general terms—that the state’s financing arrangement was or 

appeared to be inconsistent with Medicaid payment principles. CMS also provided the state 

a written explanation specifying why the arrangement was inconsistent with Medicaid 

payment principles in general, without specifying which principle or principles.

Page 30 GAO-07-214 Federal Medicaid Oversight Initiative
either efficiency or economy. The refund requirement indicates that the 

State itself has determined that the full payment amount is not required by 

the facilities to ensure Medicaid beneficiaries’ access to services. 

Moreover, the proposed payment rate is not consistent with either 

economy or quality of care because it exceeds the funding actually made 

available to support the provision of services to Medicaid beneficiaries.”

In most cases, CMS did not provide states with similar written 

explanations of the basis for its determinations. For 30 of the 55 financing 

arrangements that we reviewed and that CMS determined were 

unallowable under the initiative, we found no evidence that CMS 

communicated in writing to the states, even in general terms, that the 

states’ arrangements were inconsistent with Medicaid payment principles 

or why. For 10 arrangements, either CMS provided a general written 

explanation that the state’s arrangement was inconsistent with a payment

principle and why, or CMS’s written communications were incomplete or

difficult to interpret. For example, CMS wrote in a letter to one state that

its financing arrangement for nursing home payments appeared to be 

inconsistent with portions of the Social Security Act, but the agency did 

not further explain why.

CMS has not made its determinations about any particular state’s financing 

arrangement known or available to other states, as has been done in other 

contexts. The Department of Health and Human Services’ Food and Drug 

Administration, for example, maintains on its Web site various directories 

of guidance documents it has issued, including an annual comprehensive 

list with links to the documents themselves, and a searchable docket

management system that provides access to the agency’s official 

repository for administrative proceedings and other materials. In another

example, the Medicare Prescription Drug, Improvement, and 

Modernization Act of 200335 requires the Department of Health and Human 

Services to make publicly available the factors it considers in making 

national Medicare coverage determinations—that is, whether an item or 

service is reasonable and necessary and thus eligible for Medicare 

coverage. These determinations are posted on CMS’s Web site, where they 

are available for public comment. CMS has noted that such coverage 

guidance documents represent the agency’s current thinking on a 

particular topic but do not create or confer any rights for any individual 

and do not bind CMS or the public. In contrast, under CMS’s initiative—

involving substantial state and federal Medicaid dollars—CMS does not 

 35Pub. L. No. 108-173, § 731(a), 117 Stat. 2066, 2349–51. 

Page 31 GAO-07-214 Federal Medicaid Oversight Initiative
have any similar procedure in place for publicizing its case-by-case 

determinations on financing arrangements. 

The lack of information to states on the basis for CMS’s determinations 

under the initiative has raised concerns among the states we contacted 

about whether CMS has treated them consistently; from CMS’s point of 

view, however, the agency has taken several steps to ensure consistent 

application of the review process. The lack of written guidance appears to 

have resulted in differences in states’ understanding of what CMS would 

approve. For example, several states understood that they were required 

to end the use of IGTs, while other states understood that they would be 

able to continue using IGTs with revisions that met with CMS approval. 

Determining whether such differences of understanding resulted from 

inconsistent treatment by CMS is difficult without a complete and clear 

written record of CMS’s discussions with states about appropriate and 

inappropriate financing arrangements. Some of the states that responded 

to our questionnaire, or that we interviewed, expressed concerns about 

perceived differences in how CMS had reviewed state financing 

arrangements and allowed states to deal with arrangements that the 

agency found to be inconsistent with Medicaid payment principles. 

Officials of one state observed, “Because the decisions and reasoning are 

not written and issued to all states, we have no way of ensuring that CMS 

decisions are made consistently across all states.” 

Six of the 29 states that ended financing arrangements and responded to 

our questionnaire expressed the opinion that CMS’s case-by-case review 

process was not implemented consistently across states; another 17 states

responded that they had no basis for judging whether CMS treated states 

consistently; and only 3 states responded that CMS had been consistent.36

Officials of one state added that while CMS had attempted to apply a 

consistent review technique by asking the same standard funding 

questions about each plan amendment that each state submitted, the 

results of the reviews seemed to vary across states: some states were 

required to return funds, while others were required to end their financing 

arrangements. The Medicaid director of another state remarked that 

asking the standard funding questions every time a state submits a plan 

amendment was a waste of time and duplicative, and, moreover, the CMS 

Lack of Transparency Has 

Raised Concerns among 

States about Consistent 

Review of State Financing 

Arrangements 

 36Two of the three remaining states responded “other” without providing an explanation,

and the last state did not answer the question. 

Page 32 GAO-07-214 Federal Medicaid Oversight Initiative
review process had not been applied consistently because states had been 

able to negotiate different deals with CMS to replace their IGTs with other 

financing arrangements. 

A September 2006 report prepared for the Department of Health and 

Human Services’ Office of Inspector General, which reviewed CMS’s 

financial management oversight of the Medicaid program, raised concerns

about the need for transparency and clear guidelines in CMS’s process for 

reviewing and approving state plan amendments. The report 

recommended, among other things, that CMS “to the extent possible, 

provide visibility into the program administration activities, including 

judgments regarding individual state operations, which can help ensure 

that decisions are made transparently and consistently across jurisdictions 

recognizing the unique nature of each local Medicaid program. Because 

routine judgments or interpretations may have long-term funding 

consequences, a process to assess which decisions merit further visibility 

should be developed and implemented.”37

CMS officials told us that the agency had several controls in place to 

ensure that its review of state financing arrangements was implemented 

consistently. Officials told us that they followed CMS’s established state 

plan amendment review procedures and asked the same standard funding

questions about each plan amendment submitted by each state. In 

addition, in early 2005, after the initiative was under way, CMS created a 

unit to centralize responsibility for reviewing and approving state plan 

amendments related to reimbursement. This central office unit, the 

Division of Reimbursement and State Financing, also directs about 

90 funding specialists hired from late 2004 through April 2006 to help CMS 

(1) gain a better understanding of how states budget for and finance their 

portion of Medicaid expenditures and (2) actively identify state financing 

arrangements that could result in inappropriate claims for federal 

reimbursement or increased federal costs. A major activity of the funding 

specialists during their first year was to complete state Medicaid program 

profiles, which describe the sources of each state’s nonfederal share of 

Medicaid funds, state payment methodologies, and financing-related 

concerns that may need to be addressed. CMS officials told us that routine 

review of states’ quarterly Medicaid expenditure reports and focused 

 37See Department of Health and Human Services, Office of Inspector General, Ernst & 

Young Final Report, Review of the Centers for Medicare & Medicaid Services’ Medicaid 

Financial Management Oversight (Washington, D.C.: Sept. 25, 2006).

Page 33 GAO-07-214 Federal Medicaid Oversight Initiative
financial management reviews help ensure that high-risk financing 

arrangements that have not been reviewed under the initiative’s state plan 

amendment process also receive scrutiny. 

We have long been concerned about states’ financing arrangements that 

inappropriately boost the federal share of Medicaid program costs without 

providing corresponding state dollars, thus undermining the fiscal integrity 

of the federal-state partnership. CMS’s initiative is a direct attempt to 

address these long-standing problems and to better ensure that states’ 

financing arrangements are consistent with Medicaid payment principles.

The basis for CMS’s determinations under this high-profile initiative, 

however—with substantial state and federal dollars at stake—has not 

been transparent to states. CMS did not provide written guidance to states; 

did not always explain to each state in writing the basis for its 

determinations; and did not make its determinations available to other 

states and interested parties as a means of communicating its standards 

for allowable arrangements, as it has done for other programs. A case-bycase review of financing arrangements used in states’ Medicaid programs 

is not only appropriate but warranted in a program as complex and diverse 

across states as Medicaid. Nevertheless, determinations that can affect a 

state’s Medicaid budget by tens of millions, or even billions, of dollars over 

a number of years demand a clear basis and an open process. The lack of 

transparency under CMS’s initiative has contributed to concerns about 

whether states have been treated consistently; such concerns are likely to

continue unless CMS alters its oversight approach. Further, many states 

have been seeking to resume supplemental payments to government 

providers by seeking to make changes that respond to CMS’s objections,

yet they have had little written guidance from CMS on what changes are 

needed or few explanations for determinations that CMS has made. In this

federal-state Medicaid partnership, it is appropriate that the federal 

government review and act upon concerns affecting the program’s fiscal 

integrity—and equally appropriate for states to expect and receive a clear 

explanation of what federal policy allows. 

To enhance the transparency of CMS oversight and clarify and 

communicate the types of allowable state financing arrangements, we 

recommend that the Administrator of CMS take the following two actions: 

Conclusions 

Recommendations for 

Executive Action 

Page 34 GAO-07-214 Federal Medicaid Oversight Initiative
1. Issue guidance to clarify allowable financing arrangements, consistent 

with Medicaid payment principles. 

2. Provide each state CMS reviews under its initiative with specific and 

written explanations regarding agency determinations on the 

allowability of various arrangements for financing the nonfederal share 

of Medicaid payments and make these determinations available to all 

states and interested parties. 

We provided a draft of this report to CMS for comment on January 3, 2007, 

and received a written response from the agency (reproduced in app. III). 

In commenting on the report, CMS indicated that ongoing actions would 

respond to our first recommendation that the agency issue guidance to

states. CMS disagreed with our second recommendation to provide states 

with explanations regarding the agency’s determinations. 

CMS reported that the regulation proposed on January 18, 2007, would 

respond to our first recommendation, that the agency issue guidance to

clarify allowable state financing arrangements. CMS said that when 

finalized, the regulation will provide states with guidance to clarify 

appropriate sources of nonfederal Medicaid funds, including the use of 

IGTs and CPEs, and reaffirm agency policy that health providers must 

retain in full the Medicaid payments they receive. We agree that the 

regulation, when finalized, could help clarify for states the allowability of 

certain financing arrangements and respond to our recommendation. We 

updated our report to recognize publication of the proposed regulation 

after CMS received a draft of our report for review and comment. 

Nevertheless, because the regulation has been proposed but not finalized, 

we have maintained our recommendation in the report. 

CMS did not agree with our second recommendation to enhance the 

transparency of its oversight initiative by providing states with specific, 

written explanations of agency determinations on the allowability of 

financing arrangements and by making these determinations available to 

all states and interested parties. CMS disagreed with the conclusion that 

the agency had not implemented its initiative transparently, stating that 

the agency communicated its concerns to each involved state and that its 

process was as transparent as possible given variation among states’ 

financing arrangements. CMS cited several specific reservations about the 

report’s findings regarding the lack of transparency and concerns of 

inconsistency and about this associated recommendation. 

Agency Comments 

and Our Evaluation 

Page 35 GAO-07-214 Federal Medicaid Oversight Initiative
• CMS commented that the report confused the regulatory state plan review 

process with a lack of transparency in its reviews and determinations. 

CMS stated it followed the appropriate parameters of the review process 

and held conference calls to understand states’ financing arrangements 

and discuss remaining issues. CMS also stated that it is not standard 

practice to document each communication during these processes. CMS 

questioned the benefit of documenting all discussions between CMS and 

states and of making them publicly available, particularly for states that 

have already ended arrangements. 

• CMS commented that the reported concerns about the consistency of 

CMS’s review are misleading and generally unfair. Highlighting the report 

draft’s finding that CMS’s initiative was consistent with Medicaid payment

principles, CMS assumed that this conclusion meant that states were 

treated in the same manner. 

• CMS commented that the statistics in the report based on states’ 

“opinions” have little merit without supporting evidence. CMS also said 

that GAO overlooked a “strong indication” that most states do not believe 

they were treated unfairly or inequitably, since only one state has appealed

a determination made under the initiative. 

We do not agree with CMS’s view that the report confuses the state plan

review process with a lack of transparency or that the report suggests that 

CMS should maintain and make publicly available detailed records of all 

its discussions and communications with state officials. The report clearly

relates concerns about transparency to the lack of information to states 

about the specific bases for CMS’s determinations that particular 

arrangements were unallowable. We provide specific examples in which 

CMS clearly communicated this information to some but not all states and 

also report that such clear written communication occurred in only onefourth of the cases. We did not intend to suggest, as CMS understood, that 

CMS communicate the basis for its determinations retroactively, and we 

have clarified this point in our report’s recommendation. 

We also do not agree with CMS’s view that our conclusion that the 

agency’s initiative was consistent with Medicaid payment principles 

suggests that all states were treated consistently. This finding was related 

to the broader initiative and based on what CMS officials reported as the 

overall basis for their determinations. As we stated in the draft report, 

however, we were unable to determine to what extent the initiative was 

implemented consistently for individual states because, in most cases, a 

written record of the basis for CMS’s determinations did not exist. 

Page 36 GAO-07-214 Federal Medicaid Oversight Initiative
With regard to CMS’s concerns about the reporting of states’ opinions 

without supporting evidence, we point to the evidence provided in the 

draft report of CMS’s changed approach. For example, the draft report 

cited instances in which CMS had, before its initiative, reviewed and 

approved states’ plan amendments even though the amendments clearly 

showed that the financing methods involved were the same as those CMS

later questioned under its initiative. Finally, with regard to CMS’s view that 

states believe they were treated fairly because only one state appealed its

determination, we note that states could choose not to appeal a 

determination for many reasons, including the time and costs involved in

doing so, and point to the states’ many reported concerns about the 

initiative’s transparency. We found that states’ reported concerns were 

remarkably consistent, and we maintain that our reporting on matters 

such as states’ receipt of explanations and guidance from CMS is valid. 

As arranged with your offices, unless you publicly announce the contents 

of this report earlier, we plan no further distribution of this report until 30 

days after its issue date. At that time, we will send copies of the report to 

the Secretary of Health and Human Services, the Administrator of the 

Centers for Medicare & Medicaid Services, and other interested parties. 

We will also make copies available to others upon request. In addition, the 

report will be available at no charge on the GAO Web site at 

http://www.gao.gov. 

If you or your staff members have any questions, please contact me at 

(202) 512-7118. Contact points for our Offices of Congressional Relations 

and Public Affairs may be found on the last page of this report. GAO staff 

who made major contributions to this report are listed in appendix IV. 

Kathryn G. Allen 

Director, Health Care 

Page 37 GAO-07-214 Federal Medicaid Oversight Initiative
Appendix I: Methodology for Determining the 

Number of States Ending Financing Appendix I: Methodology for Determining the Arrangements 

Number of States Ending Financing 

Arrangements 

Our process for determining the number of states that ended Medicaid 

financing arrangements, and for determining the number of arrangements 

each of the states ended as a result of the Centers for Medicare & Medicaid 

Services’ (CMS) oversight initiative, involved three phases. First, we 

obtained from CMS its list of the states that had ended financing 

arrangements; second, we contacted all 50 states and the District of 

Columbia to verify CMS’s data; and, finally, we took several steps to 

resolve discrepancies, identified in our review, between CMS data and 

information provided by states. We limited the scope of our review to 

those states we determined to have ended a financing arrangement during 

the period August 2003 through August 2006. 

We obtained from CMS a one-page summary spreadsheet that identified 

the states that as of July 2005 had ended financing arrangements and the 

particular arrangements ended. For example, the spreadsheet indicated 

that several states ended arrangements for both nursing home and hospital 

payments. As noted by a CMS official, the summary spreadsheet was an 

internal document used for tracking the results of the initiative and was 

updated periodically. During our review, we obtained periodic updates of 

this list from CMS. From July 2005 through August 2006, CMS added two 

states to its list of those that had ended a financing arrangement, and we 

included those states in the scope of our review. 

To assess the accuracy of the summary list provided by CMS, we sent a 

standard questionnaire via e-mail to those states that CMS identified as 

having ended a financing arrangement and, as part of the questionnaire, 

asked the states to confirm the data provided by CMS.1

 Specifically, we 

asked whether the state had ended the particular arrangement or 

arrangements reported by CMS and whether the state had ended any other 

arrangements not identified in CMS’s list. In addition, we interviewed 

officials from two groups of states: five states that CMS suspected were 

using one or more inappropriate financing arrangements that had not been 

ended and three states that, according to CMS, had not submitted a 

 1

We later also sent our standard questionnaire to the two states CMS added to its list from 

July 2005 through August 2006. 

Page 38 GAO-07-214 Federal Medicaid Oversight Initiative
Appendix I: Methodology for Determining the 

Number of States Ending Financing 

Arrangements 

proposal to amend their state Medicaid plans and thus had not undergone 

a CMS review.2

In analyzing the data provided by CMS, states’ responses to our 

questionnaire, and interviews with state officials, we found one 

discrepancy that could potentially have affected our findings. Specifically,

in our interviews with states, officials from one state reported that their 

state had ended an arrangement, although CMS’s list indicated that it had

not. According to data provided by CMS, the state has not claimed federal

reimbursement for the arrangement in the last 4 years. A CMS official told

us, however, that the agency did not consider the state’s arrangement 

ended because the state had not revised its state plan. For the purposes of 

our review, we concluded that the state had ended the arrangement and 

included the state in our count. 

Because of the differences we found between CMS’s original data 

provided to us and what we learned from some of the states, we contacted 

all states, including those that received our questionnaire or participated 

in interviews, to further test the reliability of the information in CMS’s 

summary list. In spring 2006, we sent a short set of questions by e-mail to 

all 50 states and the District of Columbia, asking them to confirm whether 

CMS had reviewed certain financing arrangements and to indicate the

outcomes of any reviews conducted. The states’ responses did not identify

additional financing arrangements ended by states. We determined that the

information provided by CMS about the states—coupled with information 

provided by the states through our questionnaire, confirmation e-mail, and 

interviews—was sufficiently reliable for the purposes of our review. 

 2

When we contacted the states CMS identified as not having submitted any proposals to 

change their state Medicaid plans, officials from the three states told us that their states 

had submitted proposals and undergone several CMS reviews. These differences did not 

affect our findings, however, because the state officials confirmed that their states had not

ended a payment arrangement as a result of review under CMS’s initiative. 

Page 39 GAO-07-214 Federal Medicaid Oversight Initiative
Appendix II: Methodology for Analyzing CMS Appendix II: Methodology for Analyzing CMS Case Files 

Case Files 

To evaluate how CMS implemented its initiative and, in particular, the 

extent to which the initiative was implemented in a transparent manner, 

we examined copies of CMS case files, provided by the agency, for each 

review under the initiative that resulted in a state’s ending a financing 

arrangement. The files included CMS and state documents, such as official

letters between CMS and states and records of e-mail correspondence,

relevant to CMS’s review of the ended arrangements. We carried out a 

structured content analysis of each case file to identify how and to what 

extent CMS communicated in writing to the state the basis for its 

determination that a state’s financing arrangement was not appropriate. 

The objectives of our content analysis of CMS’s files for each state were to 

determine the extent to which CMS communicated in writing to the state 

(1) that it found the state’s financing arrangement inconsistent with 

statutory or regulatory Medicaid payment principles and (2) the reasons 

for CMS’s determination. For each of these two objectives, we assessed 

whether CMS’s written communications to the states, contained in the 

case files, could be classified as specific or general. 

• In regard to finding that a state’s financing arrangement was inconsistent 

with Medicaid payment principles, we classified CMS’s communication as 

specific if the agency wrote to state officials in a letter or e-mail to inform 

them that the state’s financing arrangement was inconsistent with 

Medicaid payment principles, and the agency specified the particular 

Medicaid statute, regulation, or policy with which it was not consistent. If, 

on the other hand, CMS informed the state in writing that its arrangement 

was inconsistent with Medicaid payment principles but did not specify 

which principle or principles, we classified the communication as general. 

• In regard to explaining the reason for its determination, we classified 

CMS’s communication as specific if the agency communicated in writing 

to the state the reasons the state’s financing arrangement was or appeared 

to be inconsistent with Medicaid payment principles. If a CMS file 

contained documents that (1) described CMS’s concern about a state 

financing arrangement but did not clearly indicate that the arrangement 

was inconsistent with Medicaid payment principles or (2) identified or 

alluded to concerns with a state’s financing arrangement but did not link 

the concerns with any agency determination, we classified CMS’s 

communication as general. 

Page 40 GAO-07-214 Federal Medicaid Oversight Initiative
Appendix II: Methodology for Analyzing CMS 

Case Files 

If we found no evidence that CMS communicated in writing its 

determination or the reasons for its determination, we classified such 

cases as ones in which CMS did not communicate to the state in writing in 

either general or specific terms. 

Our content analysis approach was validated by GAO’s research methods 

staff, and a random sample of our assessments was reviewed by GAO’s 

general counsel staff. 

Page 41 GAO-07-214 Federal Medicaid Oversight Initiative
Appendix III: Comments from the Centers Appendix III: Comments from the Centers for for Medicare & Medicaid Services 

Medicare & Medicaid Services 

Page 42 GAO-07-214 Federal Medicaid Oversight Initiative
Appendix III: Comments from the Centers 

for Medicare & Medicaid Services 

Page 43 GAO-07-214 Federal Medicaid Oversight Initiative
Appendix III: Comments from the Centers 

for Medicare & Medicaid Services 

Page 44 GAO-07-214 Federal Medicaid Oversight Initiative
Appendix III: Comments from the Centers 

for Medicare & Medicaid Services 

Page 45 GAO-07-214 Federal Medicaid Oversight Initiative
Appendix III: Comments from the Centers 

for Medicare & Medicaid Services 

Page 46 GAO-07-214 Federal Medicaid Oversight Initiative
Appendix III: Comments from the Centers 

for Medicare & Medicaid Services 

Page 47 GAO-07-214 Federal Medicaid Oversight Initiative
Appendix IV: 

A

GAO Contact and Staff 

cknowledgments 

Page 48 GAO-07-214

Appendix IV: GAO Contact and Staff 

Acknowledgments 

GAO Contact Kathryn G. Allen, (202) 512-7118 or allenk@gao.gov. 

In addition to the contact named above, Katherine Iritani, Assistant 

Director; Susan Barnidge; Tim S. Bushfield; Ellen W. Chu; Helen 

Desaulniers; Ellen M. Smith; and Craig Winslow made key contributions to 

this report. 

Staff 

Acknowledgments 

Federal Medicaid Oversight Initiative
Related GAO Products Related GAO Products 

Medicaid Financial Management: Steps Taken to Improve Federal 

Oversight but Other Actions Needed to Sustain Efforts. GAO-06-705. 

Washington, D.C.: June 22, 2006. 

Medicaid: States’ Efforts to Maximize Federal Reimbursements 

Highlight Need for Improved Federal Oversight. GAO-05-836T. 

Washington, D.C.: June 28, 2005. 

Medicaid Financing: States’ Use of Contingency-Fee Consultants to 

Maximize Federal Reimbursements Highlights Need for Improved 

Federal Oversight. GAO-05-748. Washington, D.C.: June 28, 2005. 

High-Risk Series: An Update. GAO-05-207. Washington, D.C.: January 

2005. 

Medicaid: Intergovernmental Transfers Have Facilitated State 

Financing Schemes. GAO-04-574T. Washington, D.C.: March 18, 2004. 

Medicaid: Improved Federal Oversight of State Financing Schemes Is 

Needed. GAO-04-228. Washington, D.C.: February 13, 2004. 

Major Management Challenges and Program Risks: Department of 

Health and Human Services. GAO-03-101. Washington, D.C.: January 

2003. 

Medicaid: HCFA Reversed Its Position and Approved Additional State 

Financing Schemes. GAO-02-147. Washington, D.C.: October 30, 2001. 

Medicaid: State Financing Schemes Again Drive Up Federal Payments. 

GAO/T-HEHS-00-193. Washington, D.C.: September 6, 2000. 

Medicaid: States Use Illusory Approaches to Shift Program Costs to 

Federal Government. GAO/HEHS-94-133. Washington, D.C.: August 1, 

1994. 

(290462) Page 49 GAO-07-214 Federal Medicaid Oversight Initiative
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