Report to the Committee on Finance, 

U.S. Senate 

United States General Accounting Office

GAO 

July 2002 MEDICAID AND 

SCHIP 

Recent HHS 

Approvals of 

Demonstration Waiver 

Projects Raise 

Concerns 

GAO-02-817 
Page i GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

Letter 1

Results in Brief 3

Background 6

HHS Has Approved Four Section 1115 Waivers to Expand 

Insurance or Drug Coverage 9

HHS Has Not Always Ensured That Approved Waivers Are 

Consistent With the Goals and Fiscal Integrity of Medicaid and 

SCHIP 14

HHS Policy to Ensure Public Input to Waivers Has Not Been 

Consistently Followed 25

Conclusions 29

Matters for Congressional Consideration 31

Recommendations for Executive Action 32

Agency and State Comments and Our Evaluation 32

Appendix I Description of Four Recent Section 1115 Waiver 

Approvals 40 

Appendix II Section 1115 Waiver Applications under Review 43 

Appendix III HHS Office of the General Counsel Response to 

GAO Inquiry 47 

Appendix IV Comments from the Department of Health and 

Human Services 49 

Appendix V Comments from the State of Arizona 59 

Appendix VI Comments from the State of Illinois 61 

Contents 
Page ii GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

Appendix VII Comments from the State of Utah 64 

Appendix VIII GAO Contact and Staff Acknowledgments 66 

Related GAO Products 67 

Tables 

Table 1: Highlights of Four Section 1115 Waivers Approved Under 

HHS’s Flexibility Initiatives 12

Table 2: Description of Section 1115 Waivers Approved for Arizona, 

California, Utah, and Illinois 40

Table 3: Section 1115 Waiver Applications Under Review by HHS, 

June 3, 2002 43

Abbreviations 

CMS Centers for Medicare and Medicaid Services 

CBO Congressional Budget Office 

CRS Congressional Research Service 

EPIC Elderly Pharmaceutical Insurance Coverage 

EPSDT Early and Periodic Screening, Diagnostic and Treatment 

FMAP Federal Medical Assistance Percentage 

FOIA Freedom of Information Act 

FPL federal poverty level 

HCFA Health Care Financing Administration 

HHS Department of Health and Human Services 

HIFA Health Insurance Flexibility and Accountability 

OMB Office of Management and Budget 

PAAD Pharmaceutical Assistance to the Aged and Disabled 

SCHIP State Children’s Health Insurance Program 

TANF Temporary Assistance for Needy Families 
Page 1 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

July 12, 2002 

The Honorable Max Baucus 

Chairman 

The Honorable Charles Grassley 

Ranking Minority Member 

Committee on Finance 

United States Senate 

States provide health care coverage to about 40 million low-income 

uninsured adults and children largely through two federal-state 

programs—Medicaid and the State Children’s Health Insurance Program 

(SCHIP). Medicaid generally covers low-income families and elderly and 

disabled individuals, while SCHIP provides health coverage to children in 

families whose incomes, while low, are above Medicaid’s eligibility 

requirements. To receive federal funding, which covered on average about 

57 percent of Medicaid expenditures and 72 percent of SCHIP 

expenditures in 2001, states must meet certain statutory requirements 

including providing a certain level of benefits to specified populations. 

Under section 1115 of the Social Security Act, the Secretary of Health and 

Human Services (HHS) can waive many of the statutory requirements in 

the case of experimental, pilot, or demonstration projects that are likely to 

promote program objectives. As part of their responsibility to protect the 

fiscal integrity of the programs, traditionally, HHS and the Office of 

Management and Budget (OMB) have had a policy that all approved 

waiver projects be “budget neutral” for the federal government—that is, 

the proposed project cannot result in federal expenditures that are higher 

than they would have been without the project. 

Within the past year, HHS indicated that it would allow states greater 

latitude in using section 1115 waivers to modify the Medicaid and SCHIP 

programs and would expedite its consideration of state proposals. 

Specifically, the department announced two new section 1115 initiatives to 

expand health coverage to uninsured populations and to provide 

prescription drug coverage to low-income seniors using section 1115 

waivers. One initiative, the Health Insurance Flexibility and Accountability 

Initiative (HIFA), focuses on proposals for covering more uninsured 

people while at the same time not raising program costs. Another 

initiative, called Pharmacy Plus, encourages states to expand access to 

prescription drug coverage to low-income seniors not eligible for 

Medicaid, again while not raising program costs. 

United States General Accounting Office

Washington, DC 20548 
Page 2 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

The increased emphasis on using section 1115 waivers and these two new 

initiatives have raised concerns about whether HHS can both expedite its 

approval process and at the same time provide adequate review and 

oversight of waiver proposals that could change how, and to whom, 

program services are delivered. The expedited reviews have also raised 

concerns about the adequacy of the public’s ability to review and comment 

on the proposed changes. At your request, we reviewed section 1115 

waiver requests involving expanding coverage to the uninsured or 

providing seniors drug coverage that HHS has received since the first of 

these initiatives was put into effect in August 2001. Specifically, we 

examined three questions regarding the section 1115 waiver proposals 

submitted and approved in line with HHS’s goals of expanding health 

coverage and providing prescription drug benefits to low-income elderly: 

1. What types of waiver proposals have been submitted and approved? 

2. Has HHS ensured that the approved waivers are consistent with the 

goals and fiscal integrity of Medicaid and SCHIP? 

3. To what extent has there been opportunity for public input in the 

expedited process? 

Our work is based on a review and analysis of section 1115 waiver 

proposals for new demonstration projects submitted since August 2001 

and related to expanding insurance or providing pharmacy coverage in 

line with the two new initiatives. We analyzed HHS data on section 1115 

waiver proposals for new programs submitted from August 2001 to May 

2002, and documented the type, number, and outcome of these proposals. 

For the four approved waivers, we reviewed waiver proposals, HHS 

decision memorandums and approval letters, approved waiver 

applications, waiver terms and conditions, and operational protocols when 

available, and documentation of the states’ public process and budget 

neutrality justifications. We also discussed these initiatives and waiver 

approvals with officials at HHS, the Centers for Medicare and Medicaid 

Services (CMS, the agency within HHS with the lead role in receiving and 

reviewing the applications),1

 OMB, and relevant state agencies. To obtain 

 1

Although CMS has lead responsibility for administering Medicaid and SCHIP, throughout 

this report we refer to HHS as the primary program entity, because the section 1115 waiver 

authority resides with the Secretary and other HHS entities are also involved in the review 

and approval process. The CMS Administrator signed the approval letter on behalf of the 

Secretary for the four waivers we reviewed. 
Page 3 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

information on the opportunity for public input to the waiver-approval 

processes and any related research studies, we also contacted several 

health research and advocacy organizations including the Center for 

Budget and Policy Priorities, the National Health Law Program, and the 

Kaiser Commission on Medicaid and the Uninsured. We examined the 

statutory provisions governing the Medicaid and SCHIP programs and the 

section 1115 waiver authority, and obtained HHS’s opinion on a legal 

question through written correspondence. Finally, we relied upon our past 

reports and testimonies on the approval of section 1115 waivers and other 

issues.2

 We conducted our work from December 2001 through June 2002 in 

accordance with generally accepted government auditing standards. 

Since August 2001, HHS has approved 4 of 13 waiver proposals from states 

to either expand health insurance to uninsured populations or extend 

pharmacy coverage to low-income seniors, consistent with the new 

initiatives’ goals. Three of the approved waivers, from Arizona, California, 

and Utah, aim to reduce the number of uninsured, while Illinois’s extends 

drug coverage to low-income seniors. Arizona’s and California’s HIFA 

waivers use unspent SCHIP funds to cover uninsured low-income adults 

not otherwise eligible for Medicaid. California’s waiver allows the state to 

use SCHIP funds to cover the parents of children who are enrolled in 

Medicaid and SCHIP, while Arizona’s waiver allows the state to cover 

previously uninsured low-income adults, including those with no children. 

Utah’s waiver extends limited medical coverage, with an enrollment fee 

and cost sharing, to previously uninsured low-income adults by increasing 

cost-sharing requirements and reducing optional benefits to certain 

current Medicaid beneficiaries. Illinois’s Pharmacy Plus waiver extends 

pharmacy benefits to many low-income seniors under the assumption that 

making this benefit available will avoid these individuals’ spending down 

their resources and becoming eligible for Medicaid, thus reducing 

Medicaid’s nursing home, hospital, and other medical costs. Of the nine 

proposals still under review, five seek to expand coverage to uninsured 

populations, while four would provide pharmacy benefits for low-income 

seniors. 

We have both legal and policy concerns about the extent to which HHS 

has ensured that the approved waivers are consistent with the goals and 

fiscal integrity of Medicaid and SCHIP. The legal concern is that, under the 

 2

See related GAO products at the end of this report. 

Results in Brief 
Page 4 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

Arizona waiver, HHS has allowed the state to use unspent SCHIP funding 

to cover adults without children, despite SCHIP’s statutory objective of 

expanding health coverage to low-income children. In our view, HHS’s 

approval of the waiver to cover childless adults is not consistent with this 

objective, and is not authorized. Allowing the expenditure of unspent 

SCHIP funds on childless adults could prevent the reallocation of these 

funds to states that have already exhausted their allocations, as required 

by the Congress. A related policy concern is that HHS used its waiver 

authority to allow Arizona and California to use SCHIP funds to cover 

parents of SCHIP- and Medicaid-eligible children without regard to cost 

effectiveness, when the statute provides that family coverage may be 

provided only if it is cost effective to do so—that is, with no additional 

costs beyond covering the child. For the Utah and Illinois waivers, we 

believe that HHS has not adequately ensured that approved demonstration 

projects will be budget neutral. In both cases, the projections of what the 

states would have spent without the waiver included certain costs that 

were either inappropriate or impermissible for assessing budget neutrality. 

For the Utah waiver, we estimate that if the project is fully implemented, 

the cost could be $59 million higher for the 5-year waiver than it would 

have been without the waiver. For Illinois, we estimate this amount to be 

at least $275 million. As a result, the federal government is at risk to spend 

more than it would have had the waivers not been approved. 

Opportunity for the public to learn about and comment on pending 

waivers has not been consistently provided in accordance with policy 

adopted by HHS in 1994. At the federal level, HHS has not, since 1998, 

followed the process it established in 1994 to publish notification of new 

and pending section 1115 waiver applications in the Federal Register with 

a 30-day comment period. HHS officials indicated that they now consider 

the public notice and comment on waivers a state, rather than federal, 

responsibility and HHS’s recent policy has been to refer interested parties 

to states for copies of waivers it is reviewing. But for one recently 

approved waiver, advocates were unable to get a copy of the application 

until after the waiver was approved, despite a Freedom of Information Act 

(FOIA) request. HHS’s 1994 policy also directs states to ensure that public 

input is obtained before a waiver is submitted. For the four recent 

approvals, however, public input at the state level varied greatly, and some 

provider and advocacy groups we contacted raised concerns about access 

to information and various aspects of some of the approved waivers, such 

as the benefit reduction and increased cost sharing in the Utah waiver. In 

May, HHS reaffirmed that states need to follow the 1994 public process 

policy and also committed to publishing applications on its Web site, but 
Page 5 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

did not similarly affirm its commitment to follow the policy at the federal 

level, specifically the federal notice and comment period. 

This report includes three matters for congressional consideration. The 

Congress should consider amending title XXI of the Social Security Act to 

(1) specify that SCHIP funds are not available to provide health insurance 

coverage for childless adults and (2) establish, for parents or guardians of 

SCHIP-eligible children, which statutory objectives should take 

precedence—those of title XXI to provide family coverage only if it is cost 

effective, or those of section 1115 that allows the Secretary to waive the 

cost effectiveness test. The Congress should also consider requiring the 

Secretary of HHS to improve the federal public notification and input 

process for state Medicaid and SCHIP section 1115 demonstration 

proposals under consideration. 

This report also includes three recommendations to the Secretary of HHS. 

We are recommending that the Secretary (1) amend the approval of the 

Arizona waiver to prevent future use of SCHIP funds on childless adults, 

and deny any pending or future state proposals for this purpose, (2) better 

ensure that valid methods are used to demonstrate budget neutrality, and 

use these methodologies to adjust the federal obligation under the Utah 

and Illinois waivers as appropriate, and (3) provide for a federal public 

input process that includes, at a minimum, notice in the Federal Register

and a 30-day comment period. 

In commenting on a draft of this report, HHS disagreed with our 

recommendations. HHS stated that, in its view, (1) approving the use of 

SCHIP funds for childless adults in Arizona’s waiver met the broad 

objectives of SCHIP in providing health insurance coverage to those who 

were previously uninsured, (2) its methods for assuring budget neutrality 

are appropriate, and (3) the opportunity for public comment is adequate. 

Because HHS did not provide additional evidence or information on its 

position beyond what we had earlier considered, we maintained these 

recommendations to the Secretary and elevated two of the issues for the 

Congress to consider, as indicated above—the appropriateness of 

spending SCHIP funds on childless adults and the need for a minimum 

federal public process. 

We also provided a copy of a draft of this report to OMB and the states of 

Arizona, California, Illinois, and Utah. OMB and California declined to 

provide written comments. Arizona, Illinois, and Utah provided comments 

similar to HHS’s on our findings related to their state waiver proposals. 
Page 6 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

Medicaid and SCHIP are the nation’s largest health-financing programs for 

low-income people, accounting for about $232 billion in federal and state 

expenditures in 2001 to cover about 40 million people. Medicaid was 

established in 1965 under title XIX of the Social Security Act to provide 

health care coverage to certain categories of low-income families and aged 

and disabled individuals. SCHIP was established in 1997 under title XXI of 

the Social Security Act to provide health care coverage to children living in 

low-income families whose incomes exceed the eligibility requirements for 

Medicaid. Both are federal-state programs whereby, within broad federal 

guidelines, states have considerable flexibility in whom and what they 

cover. 

Medicaid establishes a framework that states must follow in order to 

receive federal funding, known as federal matching payments, for a share 

of a state’s Medicaid program expenditures.3

 States are required to cover 

certain groups of individuals and offer a minimum set of services, such as 

physician, hospital, and nursing facility services, as well as early and 

periodic screening, diagnostic, and treatment (EPSDT) services for 

individuals under the age of 21.4

 States can also receive federal matching 

payments to cover additional optional groups of individuals. For example, 

while states are required to cover children under age 6 in families with 

incomes at or below 133 percent of the federal poverty level (FPL), 

children in families above this level may also be covered at a state’s 

option. States may also choose to provide optional services—such as 

vision and dental services and prescription drugs—but if they do so, they 

must provide the same benefits to all covered beneficiaries. At present, 

nearly two-thirds of Medicaid expenditures are for optional populations 

and services, largely for long-term care services. Medicaid is an openended entitlement, meaning the federal government will pay its share of 

state expenditures for people covered under a state’s approved Medicaid 

plan, and enrollment for those eligible cannot be limited. 

 3

The federal share of a state’s payments for Medicaid services is known as the federal 

medical assistance percentage (FMAP). FMAPs for each state are calculated annually 

based on a formula designed to provider a higher federal matching rate to states with lower 

per capita incomes. No state may have a Medicaid FMAP lower than 50 percent or higher 

than 83 percent. 

4

EPSDT services are required for all children up to age 18 with family incomes at or below 

100 percent of the FPL and for other categorically needy children up to age 21. A state may 

also offer EPSDT services to children between the ages of 19 to 21 as an “optional” service; 

once it does, the service must be made available to all members of that group. 

Background 
Page 7 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

Like Medicaid, SCHIP is administered by states under broad federal 

guidelines to offer coverage to children in families with incomes up to 200 

percent of the FPL who do not qualify for Medicaid.5

 The federal 

government pays a higher share of states’ expenditures under SCHIP than 

under Medicaid. 6

 SCHIP programs must provide a benefit package that 

meets certain standards.7

 In contrast to Medicaid, SCHIP is not an openended entitlement. The Congress in 1997 appropriated a fixed amount for 

the program—specifically, $40 billion in federal matching funds over 10 

years (fiscal years 1998 through 2007) for SCHIP purposes. Annual 

allotments are made to states for use over a 3-year period and the 

Secretary is required to determine an appropriate procedure for 

redistributing the unused SCHIP funds to those states that have already 

spent their SCHIP allotments. In certain circumstances states may restrict 

enrollment if their allotment of federal funds has been expended,8

 but to 

date, SCHIP spending for most states has fallen well below allotment 

levels for a variety of reasons. According to the Congressional Research 

Service, despite the fact that 42 states began their SCHIP programs in late 

1997 or 1998, new programs take time to get off the ground and the 

participation rates have been lower than expected.9

 5

Although SCHIP is generally targeted to families with incomes at or below 200 percent of 

the FPL, each state may set its own income eligibility limits, within certain guidelines. As of 

September 2001, states’ upper income eligibility for SCHIP ranged from 100 to 350 percent 

of FPL. 

6

The SCHIP statute provides for an “enhanced” federal matching rate, based upon the 

state’s Medicaid rate. Each state’s SCHIP enhanced match is the lower of 70 percent of its 

Medicaid matching rate plus 30 percentage points, or 85 percent. 

7

States have three options in designing SCHIP: they may expand their Medicaid programs, 

develop a separate child health program that functions independently of the Medicaid 

program, or do a combination of both. A state’s SCHIP Medicaid-expansion program must 

cover the same services as its Medicaid program, including any covered optional benefits, 

whereas a state’s SCHIP separate child health program is not required to do so. 

8

While SCHIP programs created through a Medicaid expansion must continue to provide 

services to eligible children using Medicaid funds, states with separate SCHIP programs 

can establish waiting lists or stop enrollment when funds are exhausted. 

9

The Congressional Research Service reported that 19 states had spent less than 25 percent 

of their available allotments through September 2001. Of these 19 states, 5 had spent less 

than 10 percent of these funds. Another 22 states had used between one-fourth and one-half 

of their allotments. Only 10 states had expended more than 50 percent of their available 

funds. See Elicia J. Herz and Peter Kraut, State Children’s Health Insurance Program: A 

Brief Overview, Congressional Research Service (Washington, D.C.: Jan. 9, 2002). 
Page 8 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

Section 1115 of the Social Security Act gives the Secretary of HHS broad 

authority to (1) allow states to provide services or cover individuals not 

normally eligible for Medicaid and SCHIP, and (2) provide federal funds 

for services and populations not otherwise eligible for a federal match. 

Title XIX governing Medicaid is one of several titles to which section 1115 

specifically applies, and the Congress, in establishing SCHIP, extended 

section 1115 to SCHIP “in the same manner” as it applies to Medicaid. 

According to one report, in 2001 more than 20 percent of total federal 

Medicaid spending was governed by section 1115 demonstration terms and 

conditions rather than usual Medicaid rules.10 Past demonstrations have 

significantly influenced the development of Medicaid policy, for example, 

by allowing states to restrict the enrollment of beneficiaries to managed 

care. The first statewide section 1115 waiver was approved for Arizona in 

1982, requiring managed care for all beneficiaries and paying health plans 

a fixed amount per person to provide all covered services. Other examples 

of large-scale changes approved through waivers include programs begun 

in Oregon and Tennessee in the early 1990s. Recognizing its fiduciary 

obligations, HHS has since the early 1980s required that states justify that 

their section 1115 waiver demonstrations will not cost the federal 

government more money than the programs would have cost without the 

waivers. However, we have previously reported that section 1115 

demonstration waivers approved for several states in the mid-1990s were 

not budget neutral.11

HHS’s HIFA initiative, using the section 1115 authority, gives states 

flexibility to increase cost sharing and reduce benefits for some program 

beneficiaries in order to help fund coverage for uninsured populations 

within existing Medicaid and SCHIP program resources. HIFA allows 

states to provide different benefit packages to different groups of people 

covered under the waiver. To be considered, proposals must be statewide 

and seek to coordinate coverage with private health insurance options for 

low-income uninsured individuals. Responding to states’ expressed 

concerns about HHS’s prolonged review process for pending waivers, HHS 

has promised more expedited reviews and decisions. To facilitate this, as 

 10See Jeanne Lambrew, Kaiser Commission on Medicaid and the Uninsured, Section 1115 

Waivers in Medicaid and the State Children’s Health Insurance Program: An Overview 

(Washington, D.C.: July 20, 2001). 

11See U.S. General Accounting Office, Medicaid Section 1115 Waivers: Flexible Approach 

to Approving Demonstrations Could Increase Federal Costs, GAO/HEHS-96-44

(Washington, D.C.: Nov. 8, 1995). 
Page 9 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

part of its HIFA initiative HHS has developed a standard template for 

states to use in applying for the waivers. 

Like HIFA, the Pharmacy Plus initiative uses section 1115 waiver 

authority. The Secretary introduced the Pharmacy Plus initiative in 

January 2002 to encourage states to provide pharmacy benefits to lowincome elderly populations. While HHS has described the initiative in 

budget and other documents, it has not published an application template 

and policy guidelines. 

Since HHS announced the HIFA initiative in August 2001, states submitted 

13 proposals for section 1115 demonstration waivers designed to respond 

to HHS’s goals of covering more low-income uninsured individuals and 

expanding pharmacy benefits as of May 1, 2002.12 Eight of these 13 are 

designed to expand coverage for the uninsured, including 6 HIFA 

applications and 2 expansions that were not submitted in HIFA format, 

that is, using the HIFA template and following all of the HIFA principles. 

Five waivers proposed to expand pharmacy benefits, as envisioned by the 

Pharmacy Plus initiative. As of May 1, HHS had approved 4 of the 

proposals: 2 HIFA waivers for Arizona and California; an expansion 

offering primary and preventive care for the uninsured in Utah; and a 

pharmacy benefit waiver in Illinois. The remaining proposals were still 

under review as of early June 2002. 

HHS has approved four section 1115 demonstration waivers to expand 

coverage for the uninsured and pharmacy benefits since August 2001. 

Formal review times for three of these four waivers, which averaged just 

3-1⁄2 months (109 days), ranged from 60 days for the Utah application to 

 12Although the Illinois pharmacy proposal was received July 31, 2001, we include it in this 

group because it was one of the four demonstrations approved under HHS’s flexibility 

initiatives. We do not include the Tennessee TennCare II Medicaid waiver, submitted 

February 12, 2002, and approved May 30, 2002, because it was initially reported to be under 

review as a 1-year extension to the existing TennCare demonstration before being 

approved, according to HHS, as a new 5-year demonstration program. Similarly, we did not 

include the Wisconsin pharmacy waiver in our analysis of approved waivers. HHS 

announced this approval on July 1, 2002. This approval came too late for us to include it in 

our analysis. Likewise, HIFA applications submitted in mid-May or later, including those 

from Colorado, Delaware, Minnesota, and Oregon, were not included in our analysis of 

pending proposals. 

HHS Has Approved 

Four Section 1115 

Waivers to Expand 

Insurance or Drug 

Coverage 

Four Waivers Have Been 

Approved Quickly to 

Expand Coverage 
Page 10 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

182 days for the Illinois pharmacy demonstration.13 These review times 

compare with roughly 10 months’ review, on average, for approved section 

1115 waivers submitted in 2000 or earlier. These average review times do 

not include preliminary discussions and reviews of draft proposals and 

concept papers that state and federal officials indicated occurred for 

varying lengths of time before formal application, depending on the 

particular waiver. 

The HIFA demonstrations approved for California and Arizona both allow 

expansions using unspent SCHIP funds, but the two differ in the 

populations to be added. The California waiver will add coverage for 

uninsured low-income parents, caretaker relatives, and legal guardians of 

children who are enrolled in Medicaid and SCHIP, testing whether 

covering these individuals will increase enrollment of eligible children and 

improve their continuity of care. The approved Arizona waiver will use 

unspent SCHIP funds to cover childless adults as well as parents of 

Medicaid and SCHIP children. HHS’s terms and conditions for the 

approved Arizona waiver specify that SCHIP children are the first priority 

for coverage, then parents of SCHIP- and Medicaid-enrolled children, and 

last priority, childless adults.14 Arizona was, however, allowed to 

retroactively cover childless adults effective November 2001, and parental 

coverage is not required until October 2002. In response to an objective of 

the HIFA initiative, both the Arizona and California waiver approvals 

include feasibility studies of whether and how an employer-sponsored 

insurance component might be incorporated into the demonstrations. 

 13The California waiver, once it was submitted in the HIFA template, was approved in only 

10 days; however, that application was based on a section 1115 waiver proposal that had 

been under review since December 2000. 

14Specifically, HHS’s letter approving the Arizona HIFA waiver and the attached terms and 

conditions establish priorities for the use of SCHIP funds, as follows: “Title XXI [SCHIP] 

funding will be used to provide coverage in the following priority order: first to individuals 

eligible under the title XXI State plan [i.e., children], then to parents of Medicaid and SCHIP 

children between 100 and 200 percent of the FPL, and finally to single adults and childless 

couples up to 100 percent of the FPL. For this last group, title XIX [Medicaid] Federal 

matching funds will be used if title XXI funding is exhausted. Subject to legislative approval 

and the Governor’s signature, the expansion to parents of Medicaid and SCHIP children 

will be implemented on or before October 1, 2002. If this expansion is not implemented, 

Arizona will no longer receive title XXI funding for childless adults.” In addition, the terms 

and conditions require that “The State will not close enrollment, institute waiting lists, or 

decrease eligibility standards with respect to the children covered under its title XXI State 

plan while the HIFA amendment is in effect.” Arizona expects that SCHIP funding for 

childless adults will only be used for 2 years. 
Page 11 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

The Utah waiver will expand coverage to some formerly uninsured adults 

for primary care and preventive services, but exclude other services, such 

as inpatient hospital and specialist care. In addition to enrollment fees and 

cost sharing for services used by this expansion population, the waiver 

will be funded by increased cost sharing and limits on some optional 

services for certain groups of currently eligible adults, including some with 

mandatory eligibility. Among the optional services being limited are 

mental health services, vision screening, and physical therapy. 15

Illinois received approval for the first Pharmacy Plus waiver. The Illinois 

Senior Care program will expand pharmacy coverage to low-income 

seniors, most of whom participate in an existing state-funded pharmacy 

benefits program. The premise as to how the waiver program can be 

implemented without committing additional federal resources is that 

expanded access to medically necessary drugs will help keep seniors 

healthier and avoid medical expenses, including hospitalization and 

nursing home placement, that would reduce their incomes to the level of 

Medicaid eligibility. 

Table 1 presents highlights about the section 1115 waivers approved for 

Arizona, California, Utah, and Illinois. (See app. I for further details about 

these four waiver programs.) 

 15The limits on optional services that apply to some adults with mandatory eligibility, as 

well as medically needy adults with optional eligibility, do not affect children, pregnant 

women, or aged, blind, or disabled Medicaid beneficiaries. However, because the 

demonstration defines adults as age 19 and older, HHS granted Utah a waiver of the EPSDT 

requirement for those individuals aged 19 and 20 who are currently eligible for EPSDT. As 

adults, they will be affected by the limits on optional services. 
Page 12 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

Table 1: Highlights of Four Section 1115 Waivers Approved Under HHS’s Flexibility 

Initiatives 

State and waiver Highlights 

Arizona HIFA 

Demonstration Waiver 

• Waiver approval: The first approved HIFA waiver was 

submitted on September 20, 2001, and approved in 84 

days on December 12, 2001. 

• Populations served: Arizona will expand coverage to 

two groups: (1) an estimated 27,000 childless adults at 

or below 100 percent of FPL, effective retroactively 

November 1, 2001, and (2) an estimated 21,250 

parents of Medicaid- and SCHIP-enrolled children with 

family incomes above 100 and at or below 200 percent 

of FPL, effective October 1, 2002. 

• Cost: Federal spending over 5 years for childless 

adults is estimated at $414 million ($126 million in 

unspent SCHIP funding plus $288 million in Medicaid 

funding). In addition, an estimated $144 million in 

unspent SCHIP funds would cover the expansion to 

parents. 

California Parental 

Coverage Expansion HIFA 

Waiver 

• Waiver approval: Using an application originally 

submitted in December 2000, California revised and 

resubmitted its proposal as a HIFA application on 

January 16, 2002, and it was approved in 10 days on 

January 25, 2002. 

• Populations served: California will expand coverage 

to an estimated 275,000 custodial parents, caretaker 

relatives, and legal guardians of Medicaid and SCHIP 

children, with family incomes at or below 200 percent 

of FPL. 

• Cost: Federal spending over 5 years is estimated at 

$1.6 billion (66 percent of the estimated total cost of 

$2.4 billion). Unspent SCHIP funds will be used to 

cover the expansion. 

Utah Primary Care Network 

Waiver 

• Waiver approval: The Utah demonstration was 

submitted December 11, 2001, and approved February 

8, 2002, after 60 days’ review. 

• Populations served: Utah will offer benefits limited to 

primary and preventive care to two adult expansion 

groups: (1) 16,000 parents with incomes under 150 

percent of FPL and (2) 9,000 childless adults, many 

from a state-only program, with incomes under 150 

percent of FPL. Individuals in the expansion groups will 

pay a $50 annual enrollment fee plus charges for the 

services they use, such as $5 per office visit and $30 

for an emergency room visit. About 17,600 current 

mandatory eligible people and some optional medically 

needy eligible people will receive somewhat reduced 

benefits (e.g., there will be limits on vision, physical 

therapy, chiropractic, dental, and mental health 

services) with cost sharing increased to $3 per 

physician visit, $2 per prescription, and $220 for each 

hospital admission. 

• Cost: Federal spending over 5 years is estimated at 
Page 13 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

State and waiver Highlights 

about $422 million in Medicaid funds (71 percent of the 

estimated total cost of $595 million). The state is 

expected to contribute at least the equivalent of its 

previous state-only program budget. 

Illinois Senior Care 

Program Waiver 

• Waiver approval: Submitted July 31, 2001, the first 

Pharmacy Plus waiver was approved in 182 days on 

January 28, 2002. 

• Populations served: Up to an estimated 256,500 

individuals aged 65 and older with incomes at or below 

200 percent of FPL will be covered for prescription 

drugs with primary care coordination. The program was 

implemented June 1, 2002, with about 140,000 

participants primarily from the state-only pharmacy 

program. Depending on whether their incomes are 

above or below FPL, participants may pay $1 for 

generic or $4 per brand name prescription for benefits 

up to a cap of $1,750, after which they will pay 20 

percent of each prescription plus a nominal 

copayment. 

• Cost: Federal spending over 5 years is capped at an 

estimated $7 billion, or 50 percent of the approximately 

$14 billion aggregate cap on spending for the total 

Medicaid population aged 65 and older. The state will 

contribute at least what was spent on its previous 

state-only program, plus savings from reduced nursing 

home and hospital expenditures for the estimated 

7,500 seniors per year who will be diverted from 

Medicaid eligibility. 

Source: HHS approval letters, approved waiver applications for each state, and other documents. 

As of June 3, 2002, 9 of the 13 section 1115 waiver proposals to expand 

coverage and pharmacy benefits were still under review by HHS (see app. 

II for highlights of these proposals). Most were submitted since January 

2002. These proposals included pending HIFA applications from Illinois, 

Maine, Michigan, and New Mexico. Three of these proposals would use 

unspent federal SCHIP funds to expand coverage to various groups, 

including children, parents, and in some cases, childless adults. Most of 

the HIFA applications require increased cost sharing for the expansion 

groups, and one proposal would reduce benefits for an optional eligibility 

group. One additional proposal under review from Washington, which was 

Nine Waiver Proposals Are 

Still under Review 
Page 14 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

not submitted in HIFA format, would also expand coverage for uninsured 

individuals, including childless adults using unspent SCHIP funds.16

Four states—Connecticut, New Jersey, South Carolina, and Wisconsin—

had pharmacy benefit waiver proposals under review that were consistent 

with the Pharmacy Plus concept. In all cases, pharmacy benefits would be 

expanded to low-income seniors who are not currently eligible for 

Medicaid, and the states would fold in participants from state-only funded 

pharmacy programs.17

HHS has not, with its recent approvals of waivers under the new flexibility 

initiatives, consistently ensured that waivers are in line with program goals 

and are budget neutral. Under the first approved HIFA waivers, HHS is 

allowing the use of unspent federal SCHIP funding to cover adults, 

including adults who have no dependent children. When the Congress 

established SCHIP, it required the Secretary to redistribute unspent funds 

to states that had exhausted their allotments to use for the program 

purposes of covering children. These waivers raise legal and policy 

concerns in light of SCHIP’s stated purpose of expanding health coverage 

to low-income children. Similarly, HHS did not adequately ensure that the 

waivers will be budget neutral. Our review of the documents supporting 

the traditional budget neutrality test used in the two states subject to this 

requirement—Utah and Illinois—found that HHS’s review process did not 

adequately ensure that the costs to the federal government for the 

Medicaid program would be no higher under the waivers than they would 

 16HHS responded to Washington’s proposal by asking for more specific information 

regarding the planned approach and suggesting that the proposal could be more responsive 

to HIFA guidelines. The initial proposal asked for broad authority to reduce benefits, 

impose cost sharing, and cap enrollment. 

17Connecticut, New Jersey, and South Carolina have existing state-funded pharmacy 

assistance programs for seniors that will be folded in or coordinated with their proposed 

pharmacy waiver programs. The Wisconsin legislature authorized such a program to be 

implemented by September 1, 2002, with funding through June 30, 2003, and the 

requirement that the state seek a Medicaid waiver to continue the program. HHS 

announced approval of the Wisconsin pharmacy waiver application on July 1, 2002, too late 

to be included in our review. 

HHS Has Not Always 

Ensured That 

Approved Waivers Are 

Consistent With the 

Goals and Fiscal 

Integrity of Medicaid 

and SCHIP 
Page 15 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

have been without the waivers.18 The approval of the Illinois waiver also 

raises questions about the potential financial risk for the state and 

implications for covered elderly beneficiaries, and the extent to which 

HHS is ensuring that waivers are fiscally sound. 

SCHIP is a program created specifically for low-income children. The 

program is designed to enable states to initiate and expand health 

assistance to low-income, uninsured children in an effective, efficient, and 

coordinated manner. In establishing SCHIP, the Congress directed that 

funds made available under the program be used only for program 

purposes. Further signaling the importance of spending SCHIP funds on 

uninsured children, the Congress also provided for the Secretary to 

redistribute states’ annual allotments remaining unspent after a 3-year 

period of availability to states that have exhausted their SCHIP allotments. 

In April 2002, CMS announced that 18 states and territories would receive 

$1.6 billion in reallocated funds because they had exhausted their own 

allotments.19 Given the statutory objective of reducing the number of 

uninsured children, however, HHS’s approvals of waivers that allow states 

to use unspent SCHIP funds on adults raise certain legal and policy 

questions about appropriate uses of the SCHIP allotments. 

In our view, HHS has not established that its approval of SCHIP funding 

for childless adults in Arizona was reasonable and, therefore, authorized. 

Arizona plans to use $126 million in unspent federal SCHIP funds for 

childless adults. In approving the Arizona waiver, HHS stated that the 

Arizona project would demonstrate whether covering single adults and 

childless couples will improve the overall health of the community and 

reduce overall rates of uninsurance, and asserted that this result would 

“promote the objectives of the Act.” However, HHS did not assert that 

insuring these childless adults would improve the provision of health 

assistance to low-income children. We are not aware of any basis for 

suggesting that the use of SCHIP funds to cover childless adults would 

promote the objectives of SCHIP. 

 18We reviewed the cost-neutrality justifications for the four waivers approved since August 

2001. In Utah and Illinois, the applicable test for these Medicaid waivers was budget 

neutrality. In California and Arizona, the analysis or test of cost neutrality took the form of 

SCHIP allotment neutrality, which requires that combined spending in the state’s SCHIP 

program and any waiver spending not exceed the state’s available SCHIP allotment. These 

two states met the SCHIP allotment-neutrality test. 

19See 67 Fed. Reg. 20794 (2002). 

Allowing SCHIP Funding 

for Adults Raises Legal and 

Policy Concerns 
Page 16 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

In response to our concern that the HIFA policy and Arizona approval are 

inconsistent with statutory objectives, HHS’s Office of General Counsel 

stated that section 1115 provides considerable legal flexibility to authorize 

the use of program funds for items, services, or activities that would not 

normally be paid under the program. In a letter to us (reprinted in app. III), 

HHS also wrote: 

“the language of section 1115 permits approval of demonstration projects based on the 

overall purposes of all of the listed Social Security Act programs (rather than segregating 

each program). In other words, in approving a Medicaid or SCHIP demonstration, the 

Secretary may consider the likelihood of promoting the objectives of the programs 

authorized under any of the titles of the Social Security Act listed in section 1115.”20

The structure and language of section 1115 do not support HHS’s 

interpretation of its authority. Section 1115 identifies the titles of the 

Social Security Act for which demonstration projects may be authorized. It 

also lists the statutory provisions within each title containing the 

requirements or expenditure limitations that may be waived21 and clearly 

indicates that waiver of requirements or expenditure limitations are to 

 20Section 1115 lists title I (Old-Age Assistance), title X (Aid to the Blind), title XIV (Aid to 

the Permanently and Totally Disabled), title XVI (Supplemental Security Income for the 

Aged, Blind and Disabled), or title XIX (Medicaid), or part A (Temporary Assistance for 

Needy Families) or D (Child Support and Enforcement of Paternity) of title IV. 

21Section 1115 of the Social Security Act provides in pertinent part: 

(a) In the case of any experimental, pilot, or demonstration project which, in the judgment 

of the Secretary, is likely to assist in promoting the objectives of title I, X, XIV, XVI, XIX, or 

part A or D of title IV, in a State or States—— 

(1) the Secretary may waive compliance with any of the requirements of section 2, 

402, 454, 1002, 1402, 1602, or 1902, as the case may be, to the extent and for such 

period he finds necessary to enable such State or States to carry out such project, 

and 

(2)(A) costs of such project which would not otherwise be included as 

expenditures under section 3, 455, 1003, 1403, 1603, or 1903, as the case may be, 

and which are not included as part of the cost of projects under section 1110, 

shall, to the extent and for the period prescribed by the Secretary, be regarded as 

expenditures under the State plan or plans approved under such title, or for 

administration of such State plan or plans, as may be appropriate . . .” (emphasis 

added). 
Page 17 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

correspond to the associated titles of the Social Security Act.22 As a result, 

we believe that section 1115 requires HHS to justify that a demonstration 

project will likely assist in promoting the objectives of the particular title 

of the Social Security Act in which the waived program requirements or 

expenditure limitations appear. 23 With respect to programmatic 

requirements or expenditure limitations applicable to SCHIP funds, 

section 1115 requires HHS to establish that a demonstration project would 

promote the objectives of title XXI, which established SCHIP. As stated 

above, HHS has not asserted that the use of SCHIP funds to cover childless 

adults would promote the statutory objectives of the program, although it 

contends that the Arizona waiver, considered in its entirety, does serve 

program objectives. 

HHS’s interpretation of section 1115 effectively eliminates the distinctions 

among the programs authorized under the identified titles of the Social 

Security Act and would allow the agency to waive requirements or 

authorize otherwise impermissible expenditures under one program to 

promote the objectives of any other program. If HHS were to take this 

interpretation to an extreme, it could bypass funding limitations and 

mechanisms established for individual programs by funding any of the 

programs authorized in the identified titles of the Social Security Act with 

funds made available for any other title. This interpretation of section 1115 

is particularly problematic in the context of SCHIP, given the 

congressional direction that allocated funds not spent for program 

purposes be redistributed to states that have exhausted their allotment. 

 22In the section 1115 waiver provision, the phrase “as the case may be” establishes a link 

between the titles of the Social Security Act for which demonstration projects may be 

authorized and the statutory provisions containing the requirements or limitations that may 

be waived. We note that the Congress used a similar structure and the phrase “as the case 

may be” to suggest a program-by-program application of a provision in title XI of the Social 

Security Act concerning penalties for false and misleading statements. Prior to amendment 

in 2000, section 1129A(e) contained a reference to only one title of the Social Security Act 

and only one source of supplementary payments under the act. When the Congress added a 

second title of the Social Security Act and a corresponding source for such payments, it 

used the phrase “as the case may be” to distinguish payments made under one title from 

payments made under the other. 

23While not directly addressing the issue, the court, in Crane v. Mathews, 417 F. Supp. 532 

(N.D. Ga. 1976), suggested that section 1115 authorizes waivers on a program-by-program 

basis. Considering a Medicaid waiver, the court stated that “[t] he only limitation upon the 

Secretary’s authority under section 1115 is that he must judge the project to be one which 

is likely to assist in promoting the applicable title of the act” (emphasis added). Id. at 539. 
Page 18 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

Arizona’s use of SCHIP funds for childless adults raises two additional 

concerns. First, Arizona had already received approval from HHS to use 

Medicaid funds to expand coverage to certain childless adults. As a result 

of the waiver, the federal government will now pay about 77 percent of the 

costs under the SCHIP matching rate, instead of about 66 percent if this 

same population was covered under Medicaid.24 Second, if Arizona 

expends all of its federal SCHIP allotment, it arguably could qualify for 

reallocated unspent federal SCHIP funds from other states. It could then 

apply these reallocated funds to childless adults.25

HHS’s approval of Arizona’s and California’s use of unspent federal SCHIP 

funds to cover parents illustrates the changing policy with regard to the 

use of waiver authority to allow states to cover adults. In creating SCHIP, 

the Congress authorized states to cover the entire family—both the 

parents or custodians and their children—if it was cost effective to do so. 

The cost-effectiveness test for family coverage specifies that the expense 

of covering both adults and children in a family must not exceed the cost 

of covering the children. Under these circumstances, achieving costeffectiveness appears possible only when the cost to SCHIP of covering a 

family is subsidized by employer contributions or other state funds. This 

stringent cost-effectiveness test clearly showed congressional priority for 

covering children over their parents. However, we reported in 1999 that 

some states and advocacy groups were seeking increased flexibility to 

tailor their SCHIP programs to cover uninsured parents through the use of 

section 1115 waiver authority.26 CMS, then called the Health Care 

Financing Administration, had questioned requests for section 1115 

waivers to cover parents during the first year of SCHIP’s implementation, 

expressing a concern that the SCHIP goal of providing insurance to lowincome children should not be circumvented by the waiver process. The 

agency had indicated to states that the purpose of section 1115 waivers 

was to test innovative approaches and not to waive statutory provisions 

that the states found objectionable. In our first report on SCHIP 

 24These percentages represent an average of each of the federal Medicaid and SCHIP 

matching rates for 2002 and 2003. 

25The waiver allows the state in future years to cover more childless adults than initially 

planned, if the state does not through its SCHIP program cover as many children as 

anticipated and the state has unanticipated unspent SCHIP funds. 

26See U.S. General Accounting Office, Children’s Health Insurance Program: State 

Implementation Approaches are Evolving, GAO/HEHS-99-65 (Washington, D.C.: 

May 14, 1999). 
Page 19 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

implementation in 1999, we noted that, as of April 1, 1999, only two states 

had been able to demonstrate cost-effectiveness and had received 

approval to use SCHIP funds to cover adults in families with children.27

Since our earlier report, HHS has changed its policy and no longer requires 

that states demonstrate the cost-effectiveness of family coverage in 

section 1115 waiver proposals. On July 31, 2000, HHS announced to states 

that it would consider section 1115 waivers to use unspent federal SCHIP 

funds to cover parents of SCHIP- and Medicaid-eligible children, but was 

silent on the application of the cost-effectiveness test. Since this 

announcement, four states, in addition to Arizona and California, have 

requested and obtained approval for these types of waivers.28 In our view, 

this change raises broad policy questions about the use of section 1115 

authority to waive those statutory requirements that states have found 

objectionable but that the Congress put in place clearly to demonstrate the 

priority of SCHIP to fund insurance coverage for children. It further raises 

the issue of which statutory objectives should take precedence—the 

Congress’s direction to allow family coverage only if states could 

demonstrate its cost-effectiveness, or the Secretary’s authority under 

section 1115 to allow states to spend money on individuals other than 

children. 

Our review of the supporting documentation for the Utah and Illinois 

waiver approvals found inadequate justification that the waivers would be 

budget neutral—that is, the initiatives would result in no more cost to the 

federal government than under the existing program. To establish that a 

waiver is budget neutral, HHS requires the state to compare estimated 

program costs under two scenarios: (1) costs if the existing program was 

continued (“without-waiver” costs)29 and (2) costs with the new waiver 

program (“with-waiver” costs). We found that the states’ estimates of 

without-waiver costs included inappropriate costs in Utah and 

 27GAO/HEHS-99-65. 

28Minnesota, New Jersey, Rhode Island, and Wisconsin have received SCHIP section 1115 

waiver approvals to cover parents of children eligible for SCHIP or Medicaid. 

29Estimating without-waiver costs involves several key steps. First, a recent 12-month 

period prior to waiver approval is identified as a base year. Second, Medicaid costs and the 

number of Medicaid individuals covered are estimated for the base year. Third, trend rates 

are developed to estimate the changes in costs and people served over the life of the 

waiver. 

Budget Neutrality Not 

Ensured in Utah and 

Illinois Waivers 
Page 20 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

impermissible costs in Illinois. Including these amounts inflated each 

state’s estimate and inappropriately increased the amount the federal 

government could pay in the absence of the proposed waiver. 

• Utah’s without-waiver estimate was inflated because it included the 

estimated cost of services for a new group of people who were not being 

covered under the existing Medicaid program. By including these costs, 

the state in effect inflated the without-waiver costs by about $59 million—

10 percent—over the 5-year life of the waiver. Without this amount, Utah’s 

waiver would not be budget neutral. The costs for this group were 

included based on the “hypothetical population” concept, under which 

HHS has previously allowed states to include the costs of populations that 

they could have hypothetically covered under Medicaid as an optional 

group, but did not actually cover. In 1995, we reported that states were 

using this hypothetical argument to justify higher without-waiver costs, 

making budget neutrality easier to achieve. We concluded that, because 

state officials indicated that cost containment was a primary consideration 

in seeking section 1115 waivers, it was questionable that these states 

would have added optional eligibility groups to their Medicaid programs 

without the waiver.30 For Utah, however, the use of this methodology goes 

beyond our earlier concern because the group in question does not meet 

the criteria for designation as a hypothetical population. The group could 

not have been covered without a waiver, because it will receive a limited 

primary-care-only benefit package that would not be allowed under 

Medicaid’s rules for comprehensive coverage. During the review process, 

some officials within HHS voiced concerns about allowing the use of this 

methodology; however, the waiver was still approved by HHS as a matter 

of policy. 

• Illinois’s without-waiver estimate was inflated for a different reason: it 

failed to account for mandatory reductions in program costs planned for 

the 5-year course of the waiver. These reductions pertain to the state’s use 

of upper payment limit (UPL) arrangements.31 We and the HHS Inspector 

General have reported numerous times about state funding arrangements 

 30HHS and OMB disagreed with our conclusions that certain states’ approved waivers were 

not budget neutral, including our position that the hypothetical population method unduly 

inflates baseline estimates. HHS and we continue to disagree on this point. OMB declined 

to comment on our current report. See GAO/HEHS-96-44. 

31To control federal expenditures, HHS established a set of UPLs on the amount it would 

agree to pay states for certain categories of services. The limits establish an aggregate 

ceiling for payments in service categories, including inpatient hospital services, outpatient 

hospital services, nursing facility services, and intermediate care services for the mentally 

retarded, at both the state and the local government levels. 
Page 21 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

that inappropriately generated excessive federal matching funds, including 

UPL abuses.32 The Congress and HHS subsequently revised the upper 

payment limits and required states to reduce their claims for these 

excessive payments over the next several years.33 Over the course of its 5-

year waiver, Illinois will have to reduce its claims by $1.4 billion in 

accordance with these requirements.34 Over this time period, the state’s 

total payments to the facilities involved in the UPL arrangements will 

decline by 39 percent.35 Based on this decrease, we estimate that at least 

 32We found that states used intergovernmental transfers that exploited UPL and other 

arrangements to inappropriately maximize federal Medicaid funds, which ultimately are not 

used to pay for Medicaid services for Medicaid-eligible individuals. See U.S. General 

Accounting Office, Medicaid: State Financing Schemes Again Drive Up Federal 

Payments, GAO/T-HEHS-00-193 (Washington, D.C.: Sept. 6, 2000); U.S. General Accounting 

Office, Medicaid: HCFA Reversed Its Position and Approved Additional State Financing 

Schemes, GAO-02-147 (Washington, D.C.: Oct. 30, 2001); and U.S. General Accounting 

Office, Medicaid: States Use Illusory Approaches to Shift Program Costs to Federal 

Government, GAO/HEHS-94-133 (Washington, D.C.: Aug. 1, 1994). In a 2001 review of 

Illinois’s UPL arrangements, the HHS Inspector General found that from 1992 through 2000, 

Illinois generated at least $1.6 billion in excessive federal matching funds that were not 

used for services for the Medicaid individuals on whose behalf they were claimed. The 

report found that in 1999 total payments to the county involved in the UPL arrangement 

exceeded the total operating expenses of the facilities involved in the funding arrangement 

by $244 million. See Office of Inspector General, Department of Health and Human 

Services, Review of Illinois’ Use of Intergovernmental Transfers to Finance Enhanced 

Medicaid Payments to Cook County for Hospital Services, A-05-00-00056 (Washington, 

D.C.: Mar. 22, 2001). 

33The final UPL rule that we are referencing was published January 12, 2001, and became 

effective March 13, 2001. The rule gives states a transition period to gradually reduce their 

excessive payments and comply with the new limits. It also increased the UPL for nonstategovernment-owned hospitals from 100 percent of what Medicare would pay for comparable 

services to 150 percent of what Medicare would pay. On January 18, 2002, HHS published 

another final rule that lowered the UPL for nonstate-government-owned hospitals to 100 

percent of what Medicare would pay. The 2002 UPL went into effect May 14, 2002, but it did 

not change the transition period or the rate of reduction in excess UPL payments required 

by the 2001 UPL rule that went into effect March 13, 2001. 

34Under the UPL transition rules, states are required to identify excess UPL payments and 

reduce their claims for payment by a specified amount in accordance with a transition 

schedule set forth in the regulation. Illinois estimated that in 2000, $906 million, which was 

78 percent of its total Medicaid payments to certain hospitals, would be over the new limit. 

Under the phase-out methodology the $906 million over the new limit is frozen and can be 

claimed until 2003, but from 2004 through the end of 2009, it is gradually eliminated. During 

this time, the total reduction is $2.9 billion of which $1.4 billion will occur over the 5-year 

course of the waiver. 

35Under the new limits, Illinois will still be allowed some UPL-related expenses, which can 

increase over the life of the waiver. Combining the reduction in the excessive UPL 

expenses with the increase in the allowed UPL expenses results in a 39-percent net 

decrease in the amount of total payments allowed during the waiver. 
Page 22 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

$275 million in impermissible UPL expenses are included in the estimate.36

This occurred because Illinois’s calculations of without-waiver costs did 

not reflect the required reduction in UPL expenses. Rather, the Illinois 

without-waiver cost estimate projected increases in UPL payments by 51 

percent over the 5-year life of the waiver.37 It appears that, in reviewing 

Illinois’s budget neutrality justification, HHS did not consider the extent to 

which any UPL-related impermissible funds were included. The Secretary 

has the authority, however, to revisit this decision and to require the state 

to recalculate its estimated without-waiver costs to appropriately account 

for the reduction in the amount of UPL expenses. 

We have previously reported similar concerns with the approval of 

demonstration waivers that were not budget neutral and that could 

increase federal Medicaid expenditures. In our 1995 report, we found that, 

contrary to the administration’s assertion, the approved spending limits for 

demonstration waivers in Oregon, Hawaii, and Florida were not budget 

neutral. At that time, we warned that the granting of additional section 

1115 waivers merited close scrutiny in part because of the potential 

budgetary impact.38

 36We believe that our estimate is conservative because the UPL-related expenses that are in 

excess of the new limits are reduced at a lower rate than they will be under the actual 

transition methodology required by regulations. This methodology separates the excess 

UPL expenses and the allowed UPL expenses to estimate total allowed payments during 

the UPL transition. 

37This increase stemmed from attributing a certain percentage of the total UPL payments to 

the aged waiver population for a year prior to the waiver, and then applying the expected 

increases based on projections of how program costs would grow over the life of the 

waiver. In commenting on a draft of this report, Illinois officials stated that any 

impermissible UPL funds would likely be offset by additional spending authority provided 

under the Medicare, Medicaid and SCHIP Benefits Improvement and Protection Act 

(BIPA). We did not consider this additional spending authority because the state and HHS 

did not include it in Illinois’s submitted or approved budget neutrality justifications, and 

because it is unclear whether HHS will allow such spending authority for estimating 

without-waiver costs. 

38See GAO/HEHS-96-44. 
Page 23 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

Another concern related to HHS’s approval of the Illinois waiver is the 

extent to which the agency’s oversight ensures that approved waivers are 

fiscally sound, in particular related to their likelihood of achieving 

projected savings. This concern is separate from budget neutrality; it 

centers instead on whether the waiver project is placing the Medicaid or 

SCHIP programs in a vulnerable position. The waiver may put Illinois at 

financial risk even if federal budget neutrality is maintained. A major 

premise behind this initiative is that the prescription drug benefit will pay 

for itself by preventing low-income elderly individuals from becoming 

Medicaid eligible because of high health care costs, such as those for 

hospital and nursing home care. The Congressional Budget Office (CBO), 

OMB, and CMS’s own actuary, however, have not accepted this premise, in 

assessing the cost of a Medicare prescription drug benefit. There are many 

reasons for this caution. According to a preliminary assessment by CBO, 

Medicare beneficiaries without any drug coverage already consume a large 

number of prescription drugs, and any additional or more expensive drugs 

beneficiaries might receive in gaining coverage would probably provide 

less-dramatic improvements in health than the drugs they are already 

taking. CBO’s assessment stated that greater use of drugs, especially in an 

older population, would increase the chances of side effects, allergic 

reactions, medication errors, and other adverse drug events, which could 

increase the use of hospitals, emergency rooms, and other health care 

services. CBO found that research indicating there might be some savings 

in providing a Medicare prescription drug benefit have been difficult to 

interpret, and concluded that the magnitude of any savings would 

probably be quite small. CBO stated that recent evidence has suggested 

that the net effect of providing coverage may be to lower the cost of other 

services, but that the studies are difficult to interpret, especially in the 

context of a Medicare drug benefit, and that more evidence is expected 

from evaluations of state-level drug programs for low-income elderly 

people.39

While Illinois’s approved waiver is intended to evaluate the extent to 

which a drug benefit may be able to generate cost savings, it makes several 

risky assumptions with regard to the extent of savings, potentially setting a 

precedent for other states’ Pharmacy Plus proposals. In Illinois, many of 

the people who would gain drug coverage under the waiver are already 

 39See Dan Crippen, Director, CBO Letter to the Honorable Michael Bilirakis, Chairman, 

Subcommittee on Health, Committee on Energy and Commerce (Washington, D.C.: Aug. 10, 

2001). www.cbo.gov/showdoc.cfm?index=2989&sequence=0&from=1, downloaded 

March 5, 2002. 

Illinois Waiver Approval 

Raises Questions about the 

Extent That HHS Is 

Ensuring That Waivers Are 

Fiscally Sound 
Page 24 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

receiving some drug coverage benefits under an existing, more limited, 

state-funded program. Despite this, the success of the Illinois waiver relies 

on assumptions that (1) providing the expanded prescription drug benefit 

under the waiver will divert 7,500 people by keeping them from becoming 

Medicaid-eligible, when an estimated 20,000 elderly individuals normally 

enter Medicaid in a given year, (2) this high diversion rate will occur 

immediately, the first year that the drug benefit is provided under the 

waiver, and (3) once diverted, aged individuals would stay out of Medicaid 

for at least 5 years. The waiver’s underlying assumptions offer little margin 

of error. For example, if only half of the projected number of seniors are 

diverted in the first year of the waiver, we estimate that the cost of the 

waiver could increase by $339 million. The implications for elderly 

Medicaid beneficiaries of not achieving the high rate of savings could be 

significant. HHS limited total federal risk for this waiver by establishing an 

aggregate “cap” for payments to the state for all services to the elderly, 

including the drug benefit. However, this cap also means that once the 

state has spent up to this limit then it cannot receive additional federal 

matching funding for Medicaid services for the elderly. One assessment of 

the Illinois financing approach noted that, for any number of reasons, 

Illinois could find the costs of operating its new drug program or of 

serving elderly Medicaid beneficiaries to be higher than expected. If the 

state is unable to achieve savings from diverting people from Medicaid, 

then as Illinois officials acknowledge, it may need to choose other options. 

Such options could include cutting spending on elderly Medicaid 

beneficiaries, cutting spending on its prescription drug program, or paying 

for any unanticipated program costs entirely with state funds. The state 

could also roll back eligibility for optional elderly beneficiaries, increase 

cost sharing, reduce provider reimbursement rates, reduce the size of the 

waiver benefit, or eliminate the waiver altogether.40

HHS officials stated that this approval represents a true demonstration or 

policy experiment, in that the waiver will test whether it is possible to 

provide a drug benefit without increasing costs. Officials also pointed out 

that the federal risk was limited by the aggregate cap approach. As 

indicated earlier, four states have pending waiver proposals similar to 

Illinois’s Pharmacy Plus waiver. 

 40See Jocelyn Guyer, Kaiser Commission on Medicaid and the Uninsured, The Financing of 

Illinois’ Prescription Drug Demonstration Project (Washington, D.C.: April 2002). 
Page 25 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

HHS has not consistently followed its stated policy to ensure that people 

who may be affected by waivers have the opportunity to learn about and 

comment on waiver proposals. Recognizing that people who may be 

affected by a demonstration project “have a legitimate interest in learning 

about proposed projects and having input into the decision-making 

process,” 41 HHS established policies and procedures in a 1994 Federal

Register notice for both a federal- and state-level public notice and 

comment process.42 HHS has not provided a federal level notice and 

comment period in line with the policy since 1998, and instead has relied 

on states to have a public process. The extent of public input varied 

greatly among the four states with recently approved waivers. Although 

HHS recently affirmed the public input requirements for states, its new 

streamlined review process under HIFA may not be sufficient to guarantee 

effective public involvement at the federal level. 

The 1994 notice specifies HHS’s intent to publish regular notices of all 

proposals for section 1115 waivers it receives and to allow a 30-day period 

to receive and review written comments before taking official action. The 

notice describes the policies and procedures HHS will be guided by when 

reviewing section 1115 applications, but is not legally binding. We found 

that the last Federal Register notice of a section 1115 application 

submission and 30-day comment period was published in 1998. According 

to an HHS official, the current agency policy does not include publication 

of notices with a 30-day comment period while applications are under 

review at HHS because the states are considered to be a more appropriate 

forum for public input. Our discussions with HHS officials during the 

spring of 2002 indicated that current agency policy was not to release 

copies of pending waiver applications to interested parties, but to refer 

them to states. In May, the Secretary stated that the agency would publish 

waiver applications and background information on its Web site as soon as 

possible after receipt; HHS officials subsequently clarified to us that this 

includes applications that have been formally submitted but not yet 

approved. We were able to find copies of all but one of the pending HIFA 

 41See 59 Fed. Reg. 49249, September 27, 1994. 

42This notice was HHS’s response to concerns raised in the early 1990s about the rapid 

approval of some controversial statewide section 1115 waivers. For example, concerns 

were raised about the rapid approval and implementation of a waiver submitted by 

Tennessee and that state’s acknowledged failure to consult with all affected stakeholders. 

See GAO/T-HEHS-95-115. 

HHS Policy to Ensure 

Public Input to 

Waivers Has Not Been 

Consistently Followed 

HHS Has Not Followed Its 

Stated Federal Process For 

Public Input Since 1998 
Page 26 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

proposals on CMS’s Web site, along with CMS contact names and phone 

numbers for each proposal. However, copies of any Pharmacy Plus or 

other section 1115 proposals that were not in the HIFA format were not 

yet available on the CMS Web site. 

One problem with HHS’s decision to defer to the states is that states have 

not always released copies of pending waivers when requested by 

interested parties. Advocates reported such difficulty obtaining a copy of 

Arizona’s waiver application that one organization requested a copy from 

HHS under the Freedom of Information Act (FOIA) after the application 

had been submitted for review.43 The FOIA request was made on 

November 15, 2001, and the agency responded in January 2002 stating that 

it was responding to requests in order of receipt and would notify the 

requester “as soon as possible” about the availability of the documents. 

Meanwhile, the waiver had already been approved in December 2001. The 

approved waiver is now posted on the agency’s Web site, but was not 

available to the public during the time it was under review. 

The 1994 policy contains provisions for state-level public participation, 

including a list of one or more approaches states are expected to follow. 

These include 

• public meetings with copies of the proposal and opportunities to 

comment; 

• using a commission where meetings are open to the public; 

• legislation containing the outline of the waiver proposal;44

• formal notice and comment through the state’s administrative procedures 

act with notice given at least 30 days prior to submission of the waiver; 

• publication of notice in a newspaper of general circulation including 

information on how to obtain a copy and submit comments, with a 

comment period of at least 30 days; or 

• any similar process providing an opportunity for interested parties to learn 

about and comment on the proposal.45

 43FOIA, 5 U.S.C. §552 (2002), provides for public access to agency records that do not fall 

within specified exceptions. 

44Specifically, the notice states that a process that results from enactment of a proposal by 

the state legislature prior to submission of the demonstration proposal, where the outline 

of the proposal is contained in the legislative enactment, can satisfy the 1994 policy. 

State Compliance with the 

1994 Policy Varied Widely 

in Recently Approved 

Waivers 
Page 27 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

Such state-level activities allow the public to be informed of and comment 

on proposed demonstration programs, but do not necessarily guarantee 

consensus on a state’s planned waiver. We found wide variation in the 

approaches and level of effort states made to seek and incorporate public 

comment on written copies or descriptions of the waiver proposals, as 

well as the degree of controversy concerning the state proposals, as 

illustrated in the following examples. 

• California had an extensive public process as well as a statute providing 

authorization to seek a waiver.46 In addition, California conducted 

extensive outreach activities, including mailing hundreds of copies of the 

waiver application and soliciting comments, holding public hearings, and 

presenting the approach at a special legislative hearing. 

• Illinois, like California, had a statute authorizing the state to seek a waiver 

for the pharmacy program expansion, which allowed the state to claim 

federal financial participation.47 The interest groups we contacted did not 

raise concerns about the adequacy of the public process. 

• Utah provided opportunity for groups to discuss the proposed waiver 

through meetings that state officials held with provider groups and 

committees involved with improving health coverage in the state. Despite 

these meetings, advocates and others indicated that in their view the 

public process was inadequate given the significance of the state’s 

proposal and planned tradeoffs. Participants in some of these meetings 

indicated they had little or no opportunity to formally comment on and 

influence the waiver proposal.48 Among other issues, advocates and 

providers expressed concern about reduced optional benefits and 

increased cost sharing for current beneficiaries, the planned enrollment 

fee and co-payments, and lack of specialty services and inpatient hospital 

 45HHS has also established a policy to ensure that there are effective, ongoing consultations 

between states and federally-recognized tribal governments during the decision-making 

process for Medicaid and SCHIP matters. 

46Section 12693.755 of the California Insurance Code provided for expanded eligibility for 

SCHIP coverage for uninsured parents of children enrolled in SCHIP and Medi-Cal 

(California’s Medicaid program) whose income does not exceed 250 percent of the FPL if 

authorized by a waiver approved by CMS. 

47305 ILCS 5/5-5. 12a authorized the Illinois Department of Public Aid to seek a Medicaid 

waiver to claim federal financial participation for a pharmacy assistance program for 

persons age 65 and over with income levels at or less than 250 percent of the federal 

poverty level. 

48HHS’s terms and conditions for the Utah waiver required, among other things, that the 

state comply with the 1994 public notice policy and submit documentation of its 

consultation with tribal representatives prior to implementing the waiver. This condition 

was applied after the waiver was approved. 
Page 28 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

coverage for the waiver expansion population. Specialty physicians and 

hospitals would be expected to contribute their services on a volunteer 

basis, and community health centers would receive lower payments for 

the expansion group.49 After the waiver was approved, state officials 

indicated that inpatient hospital specialty physician services would be 

reimbursed, with state-only funds, under certain circumstances. 

• Arizona did not release copies of its proposal until after it was approved. 

Officials indicated that this was because they were negotiating the waiver 

with HHS and did not want to release a document that was changing. 

Arizona’s HIFA waiver application stemmed from a proposition approved 

by state voters in 2000 to extend Medicaid coverage to low-income 

childless adults, and a state law enacted in spring 2001 to provide coverage 

to parents of SCHIP- and Medicaid-eligible children. Although the HHS 

policy lists legislation as an acceptable way to fulfill the public process 

requirement, there was a significant change in Arizona’s waiver 

application request from what was originally authorized. The section of 

the HIFA waiver covering childless adults with SCHIP funding was not 

included in the state statute or otherwise made public before the waiver 

was approved. 

HHS’s new initiatives further reduce the information states must provide 

on the extent of their public process. Prior to HIFA, states were required 

to indicate in their section 1115 applications specifically how they 

complied with HHS’s policy for a public process. The 1994 policy directed 

states to include a narrative description of their public process with their 

applications, which became part of the administrative record for the 

waiver’s approval. Such documentation provided a basis for HHS to 

determine whether the state provided an effective notice and comment 

process. Consistent with the agency’s commitment to streamlining the 

waiver approval process, the HIFA waiver application template allows 

states to simply check a box indicating that they followed a public process 

that allowed beneficiaries and other interested stakeholders to comment 

on the proposal. No description of the state’s public process is required. 

HHS has recently emphasized to states that a public process is a priority, 

but has not similarly committed to a federal-level process. On May 3, 2002, 

 49The Utah approval includes a waiver of the requirement that states reimburse federally 

qualified health centers through a prospective payment system. This only applies to the 

expansion population. State officials estimate that this will result in payments about 10 

percent lower than they would be under the prospective payment system. 

Streamlined Review 

Process Raises Additional 

Concerns 
Page 29 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

CMS sent a letter to all state Medicaid directors encouraging the use of a 

public participation process, and stating that the agency would continue to 

review section 1115 waiver applications to ensure adherence to the 1994 

policy. The letter did not, however, indicate that HHS intended to address 

public input at the federal level in line with its stated policy. The extent to 

which HHS’s notice to states will ensure a process that provides for 

appropriate public input and consideration of comments remains to be 

seen. Concerns about the lack of an appropriate public process have been 

voiced in other states with pending HIFA waivers. 

In providing section 1115 program demonstration authority under the 

Social Security Act, the Congress has indicated its willingness to allow 

states to experiment with innovative approaches in certain public 

programs to enhance their reach and effectiveness, including coverage of 

populations that might otherwise be ineligible for those programs. Over 

the years, many uninsured people in various states have benefited from 

such experimentation, receiving health insurance coverage otherwise 

unavailable to them. Using this same authority, HHS has recently 

committed to work with states to provide additional flexibility and more 

expedited approvals, including developing specific initiatives, such as 

HIFA and Pharmacy Plus. While only a handful of demonstrations have 

been approved to date, several other states have similar waivers under 

consideration that will likely be influenced by prior decisions and 

precedents. 

Our review of recently approved waivers, however, raises certain legal and 

policy concerns that indicate the need to clearly establish purposes and 

populations for which SCHIP funds may be spent. While section 1115 

authority provides the Secretary with broad discretion in approving 

demonstrations that further the program’s objectives, it also creates the 

opportunity for HHS to approve state-operated programs that may not be 

consistent with program objectives established by the Congress. In 

exercising the section 1115 authority available for the SCHIP program, 

recent HHS approvals have allowed SCHIP funds to be spent on 

individuals other than the statute’s stated target population: uninsured 

low-income children. At issue is the appropriateness of covering two 

distinct groups of adults: childless adults and parents or other custodians 

of SCHIP- and Medicaid-eligible children. With respect to childless adults, 

we believe that HHS has not presented a reasonable basis for authorizing 

states to cover childless adults under SCHIP. Furthermore, allowing states 

to cover parents with SCHIP funds without demonstrating its cost 

effectiveness allows limited program funds to be spent on individuals not 

Conclusions 
Page 30 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

targeted in the statute. In this regard, it is not clear which statutory 

objectives should take precedence—those of the SCHIP statute, which 

allows for family coverage only to the extent that it does not exceed the 

cost of insuring eligible children, or section 1115 authority, which allows 

certain statutory provisions—such as cost-effectiveness tests—to be set 

aside. 

Flexibility and program experimentation must be accompanied by 

accountability, as the HIFA name implies. Fiscal accountability is an 

important aspect of the Medicaid and SCHIP federal-state partnerships to 

ensure, among other things, that both the federal and state governments 

pay their fair share of program costs. We found, however, that HHS’s 

review did not adequately ensure that two newly approved waivers were 

budget neutral, as required as a condition of section 1115 waiver 

approvals, because their ceilings included inappropriate or impermissible 

costs. Consequently, these waivers have put the federal government at 

increased financial risk. HHS approval of waivers that were based on use 

of inappropriate methods for demonstrating their budget neutrality is not a 

new problem, as we have earlier reported. However, as more states pursue 

additional flexibility in their Medicaid and SCHIP programs, HHS has an 

opportunity—if not an obligation—to develop more specific and 

consistent criteria on acceptable methodologies to predict permissible 

future costs and to ensure greater accountability in guarding against 

inappropriate federal financial risk. 

Accountability should also entail a process of public input that is adequate 

to allow for the expression of issues and concerns that affected parties 

may have. Expediting the waiver review and approval process is an 

important goal. But it is also important to allow for public input into new 

and pending program proposals to help assure that proposals are 

consistent with overall program goals and that the benefits of waiving 

certain provisions justify forgoing their original purposes. Doing so at the 

state level facilitates informing those potentially most affected by new 

program approaches. However, a federal-level notice and comment 

opportunity is also important because approved waivers represent federal 

policy that may have influence beyond a single state. It also provides for a 

more visible and transparent process for all affected and interested 

parties, including the Congress—something that may be better 

accomplished at the federal level. For these reasons, we believe there is a 

need to adhere to some minimal federal input process for waiver 

proposals, such as the HHS policy established in 1994—in response to 

earlier concerns about the lack of an open process—that provided for 

notification in the Federal Register and a 30-day comment period. 
Page 31 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

We believe the Congress should address three issues we identified in the 

course of our work. Two issues pertain to the availability of SCHIP 

funding to provide health insurance coverage to two distinct groups of 

adults: childless adults and parents or guardians of SCHIP-eligible 

children. The third pertains to the need for an improved federal-level 

process for public notification and input for state applications for 

Medicaid and SCHIP section 1115 demonstration projects. 

In our view, HHS’s use of section 1115 authority to allow states to use 

SCHIP funds to cover childless adults is not consistent with the program’s 

statutory objectives to expand health coverage to uninsured, low-income 

children. Therefore, SCHIP funds should not be available for this purpose. 

Further, states’ use of SCHIP funds to cover childless adults decreases the 

amount of unspent SCHIP funds available for redistribution in future years 

to states with unmet SCHIP needs. HHS disagrees with our view, asserting 

that the objectives of the Arizona HIFA waiver must be viewed as a 

comprehensive approach in providing health insurance coverage to those 

who were previously uninsured, including childless adults and parents. 

Because of the difference in our positions on whether SCHIP funds are 

available to cover childless adults, we are raising this to the attention of 

Congress for resolution. Resolving this issue is important not only for the 

Arizona waiver but also because of the precedent it sets for additional 

pending section 1115 demonstration applications currently under 

consideration and for the future availability of SCHIP funds for uninsured, 

low-income children. 

Therefore, the Congress should consider amending title XXI of the Social 

Security Act to specify that SCHIP funds are not available to provide 

health insurance coverage for childless adults. In addition, the Congress 

should establish, for parents or guardians of SCHIP-eligible children, 

which statutory objectives should take precedence—those of title XXI, 

which allow for family coverage only to the extent it does not exceed the 

cost of insuring eligible children, or section 1115 authority, which allows 

certain statutory provisions—such as cost-effectiveness tests—to be set 

aside. 

The Congress should also consider requiring the Secretary of HHS to 

improve the public notification and input process at the federal level to 

ensure that beneficiaries and groups affected by Medicaid and SCHIP 

section 1115 demonstration waiver proposals receive opportunity to 

review and comment on proposals before they are approved. 

Matters for 

Congressional 

Consideration 
Page 32 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

To ensure that SCHIP funds are spent only for authorized purposes, we 

recommend that the Secretary of HHS 

• amend the approval of Arizona’s HIFA waiver to prevent future use of 

SCHIP funds on childless adults, and 

• deny any pending or future state proposals to spend SCHIP funds for this 

purpose. 

To meet its fiduciary responsibility of ensuring that section 1115 waivers 

are budget neutral, we recommend that the Secretary of HHS 

• better ensure that valid methods are used to demonstrate budget 

neutrality, by developing and implementing consistent criteria for 

consideration of section 1115 demonstration waiver proposals, and 

• reconsider Utah and Illinois’s budget neutrality justifications, in light of 

our conclusions that certain costs were inappropriate or impermissible 

and, to the extent appropriate, adjust the limit on the federal government’s 

financial obligation for these waivers. 

To improve the opportunity for public input into HHS consideration of 

state Medicaid and SCHIP program proposals that waive statutory 

requirements, we recommend that the Secretary of HHS provide for a 

federal public input process that includes, at a minimum, notice of pending 

section 1115 waiver proposals in the Federal Register and a 30-day 

comment period in line with HHS’s 1994 policy. 

We provided a draft of this report for comment to HHS, OMB, Arizona, 

California, Illinois, and Utah. OMB and California declined to provide 

written comments. In its general comments, HHS emphasized that 

increasing access to health insurance and providing prescription drugs to 

senior citizens are among its top priorities, and that given the current state 

of the economy, its actions to increase coverage through waivers are 

appropriate if not imperative. HHS also highlighted its history of using 

section 1115 waivers in the Medicaid program to expand health insurance 

coverage for individuals who would not otherwise be eligible for the 

program. HHS also commented that, since January 2001, the agency has 

approved nearly 1,800 Medicaid and SCHIP state plan amendments, 

managed care waivers, home- and community-based waivers, and section 

1115 waivers and amendments, but noted that, because of the scope of our 

study, our report focused on only 4 of them. We reviewed new section 

1115 demonstration waivers in line with the goals of HHS’s new HIFA and 

Pharmacy Plus initiatives—initiatives of particular interest because of the 

Recommendations for 

Executive Action 

Agency and State 

Comments and Our 

Evaluation 
Page 33 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

significance of their goals and HHS’s plans to grant states new flexibility to 

achieve them—and only 4 had been approved at the time we conducted 

our work. We also considered, in addressing certain issues such as budget 

neutrality, earlier HHS actions and our own prior work. 

HHS disagreed with each of our three recommendations for executive 

action. Arizona, Illinois, and Utah also disagreed with various aspects of 

our findings leading to these recommendations. A summary of their 

concerns and our evaluation follows. HHS’s and states’ comments are 

included in appendixes IV through VII. 

With regard to our recommendation that the Secretary amend the approval 

of Arizona’s HIFA waiver to prevent future use of SCHIP funds on 

childless adults, and deny any pending or future state proposals for this 

purpose, HHS commented that our analysis was extremely narrow and did 

not recognize that the approval of the Arizona HIFA waiver promotes the 

objectives of SCHIP by providing health insurance coverage to those who 

were previously uninsured. HHS and Arizona both commented that the 

approved section 1115 SCHIP demonstration waiver prioritizes spending 

SCHIP (title XXI) funds for children. States are not permitted to limit or 

cap children’s enrollment, and are required to ensure the availability of 

funds for children over funding adult expansion populations. We revised 

the report to better clarify these priorities and requirements for the 

Arizona waiver. HHS also noted that there were no states that were 

entitled to redistributed SCHIP funds that did not receive such funds as a 

result of expenditures on section 1115 demonstrations. 

We acknowledge that covering the uninsured is an important public policy 

goal and that HHS has established coverage of children as a priority for 

use of SCHIP funds in the Arizona waiver terms and conditions. We also 

acknowledge that states that received redistributed funds in 2002 were not 

affected by HHS’s approval of the Arizona waiver. However, any unspent 

SCHIP funds available for redistribution to states in future years to cover 

uninsured low-income children would be reduced because of the Arizona 

approval, and any similar approved state proposals. 

We continue to believe that neither HHS nor Arizona has adequately 

explained how the objectives of the SCHIP statute—to provide health 

assistance to uninsured low-income children—is promoted by insuring 

childless adults. In its comments, HHS introduced a new rationale for this 

approval: that these adults could become parents or caretaker relatives in 

the future. This statement does not clarify how SCHIP funds used for this 

SCHIP Funding for Adults 
Page 34 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

purpose would likely support the program’s objectives. To the contrary, 

HHS’s assertion that it may use SCHIP funds for childless adults suggests 

that it could approve virtually any demonstration project and, thus, 

effectively eliminates the requirement that section 1115 demonstration 

projects be likely to promote the objectives of the particular program for 

which they are authorized. Similarly, HHS’s discussion of the broader 

community benefits of the Arizona HIFA waiver does not clarify how it 

would likely promote the provision of health assistance to low-income 

children. In its detailed comments (number 12), HHS indicated that our 

discussion of the scope of the Secretary’s authority under section 1115 is 

unnecessary and overbroad in view of the HHS position that the Arizona 

HIFA waiver—in its entirety—will promote SCHIP objectives. As 

indicated, our discussion was included in response to HHS’s position that 

the Secretary need not exercise the section 1115 waiver authority on a 

program-by-program basis. Because our positions differ on whether SCHIP 

funds are allowable for this purpose, we believe it is important for the 

Congress to address this issue. Resolving it is also important because the 

Arizona waiver approval sets precedent for future waiver approvals and 

funding commitments that could potentially impact on SCHIP funds 

available for redistribution to states with unmet SCHIP needs. As a result, 

we elevated this issue to a matter for congressional consideration. 

Neither HHS nor the states commented on the draft report’s matter for 

congressional consideration concerning the use of section 1115 authority 

to approve spending SCHIP funds on parents or guardians of SCHIPeligible children without regard to the statutory cost-effectiveness test. 

HHS, Utah, and Illinois disagreed with our findings supporting the 

recommendation that the Secretary better assure that valid methods are 

used to demonstrate budget neutrality. For Utah’s estimate, HHS and Utah 

stated that the methods used to assure budget neutrality were valid. They 

commented that including the costs of a hypothetical population in the 

without-waiver costs was appropriate because the state has “current law” 

flexibility to cover that population at its own option, that is, the state could 

have covered the expansion population through its Medicaid program and 

thus should be allowed to consider the associated costs of their coverage 

as without waiver costs. We continue to maintain—despite HHS’s 

disagreement both currently and in response to our 1995 report—that 

states should not be allowed credit for the costs of covering certain 

hypothetical populations in their without-waiver cost estimates. Indeed, 

the Medicaid statute provides states wide latitude in terms of covered 

populations and services and payment rates for those services, and the 

Budget Neutrality 
Page 35 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

federal government will pay its share of covered expenditures in an openended manner when the states cover the services under their state 

Medicaid plan. If states choose, however, to pursue broader authority 

under section 1115, they are required to meet the budget neutrality test. In 

the case of Utah and other states we have examined in the past, states had 

previously chosen not to cover such optional populations. In our view, to 

allow the inclusion of hypothetical costs for hypothetical populations not 

previously covered—in an attempt to demonstrate budget neutrality of 

new section 1115 demonstration proposals—turns the test of budget 

neutrality into a rather hollow exercise. 

Regarding our conclusion that HHS allowed Illinois to include 

impermissible UPL costs in its baseline, HHS and Illinois each raised a 

different concern. HHS indicated that the final regulation implementing 

the UPL reduction was not in place at the time of the Illinois waiver 

approval. We disagree. The final rule that set new UPLs for nonstategovernmental facilities, including a 150-percent UPL for nonstategovernment-owned hospitals and a mandated phase-out of payments 

above this limit, was published in January 2001 and effective March 2001, 

well before the Illinois waiver was approved in January 2002. A second 

rule, to which HHS may have been referring, reduced the UPL for 

nonstate-government-owned hospitals from the 150-percent level to 100 

percent of what Medicare would pay and was effective May 2002. We 

revised the report to clarify the effective dates of these two rules. HHS in 

its comments recognized that the UPL reduction may now apply, and 

indicated that it was reviewing the budget neutrality cap in light of the new 

rules. 

Illinois disputed that its budget neutrality projections are inflated by 

impermissible costs. The state said that other spending authority found in 

the Medicare, Medicaid and SCHIP Benefits Improvement and Protection 

Act (BIPA) could have been used by the state in its waiver projection 

which would have offset the impact of the inappropriately included UPL 

funds. Illinois officials indicated that these costs that could be incurred in 

future years should have been considered in our assessment of their 

without-waiver estimate. However, the budget neutrality justification that 

Illinois submitted to, and was approved by, HHS did not include these 

hypothetical costs in the ceiling. The state in its comments did not provide 

any evidence that it intended, in the absence of the waiver, to modify its 

program so that some of these hypothetical costs would be incurred by the 

population covered by the waiver. Illinois officials also indicated that, 

even if these BIPA-related costs were not considered, that several 

technical corrections should be made to our estimate of impermissible 
Page 36 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

costs. After the state provided additional documentation for its budget 

neutrality analysis, we adjusted our estimate of impermissible UPL costs 

accordingly, to $275 million from $356 million. We note, however, that our 

methodology and estimate are conservative. We reduced the amount of 

UPL payments included in the without-waiver estimate at a lower rate than 

what would actually occur, because the detailed data needed to determine 

the actual and higher rate of reduction were not available at the time of 

our review. We maintain that our estimate, which remains higher than the 

estimate that the state developed using its own calculation, is a reasonable 

approximation of the impermissible costs included in Illinois’s 

justification, and that HHS should revisit the Illinois budget neutrality 

justification and source documentation in light of this finding as it has 

committed in its comments to do. 

Illinois and HHS also disagreed with our conclusions about the fiscal 

soundness of the Illinois Pharmacy Plus demonstration, restating that the 

premise that the low-income elderly who are provided prescription drug 

coverage will be less likely to become eligible for the Medicaid program is 

valid. Illinois stated that our report fails to cite any of the studies that 

show drug coverage can reduce other medical costs. In the course of our 

work, we reviewed all of the supporting research that Illinois cited in its 

waiver application.50 While the cited studies indicated that access to 

prescription drugs yielded positive health benefits for people in poor 

health, all of them focused on access for people already diagnosed with 

specific conditions, such as diabetes, heart disease, and human 

immunodeficiency virus (HIV). In our view, the cited research did not 

 50Illinois in its comments also cited a report not included in its initial waiver application 

addressing the New York Elderly Pharmaceutical Insurance Coverage (EPIC) Program for 

pharmaceutical assistance to the low-income elderly. We reviewed a copy of the report 

(EPIC Evaluation Report to the Governor and Legislature, “Maintaining Health, Dignity 

and Independence—1987-1995”), which found that improved access to drugs for this 

population had a positive impact on their health. The state estimated $48 million in savings 

associated with lower hospital and institutional care for participants, as compared to the 

$41 million cost of the drug benefit program in 1993. However, the bulk of these savings, 

$42 million, were for reduced hospital costs. Illinois cannot claim such savings for its 

waiver program since Medicare, not Medicaid, pays for these costs for the elderly 

population. Only $6 million of the $48 million in estimated savings was from the expected 

reduction in the rate of nursing home admissions—comparing 17.4 admissions per 

thousand for the state’s senior population, with 16 admissions per thousand for the EPIC 

participants. New York also has reported major changes in average prescription price, 

utilization, participation, and overall spending for EPIC since the early 1990s, the time 

period covered by its analysis of the cost savings from the benefit. New York has not 

conducted a more recent study of the hospital and nursing home admission rates for EPIC 

participants. 
Page 37 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

sufficiently support Illinois’s theory that a full pharmacy benefit for the 

general near-poor elderly population will yield the amount of savings that 

the state depends on for its budget neutrality commitment. Illinois also 

commented that we did not identify the full range of actions the state 

could take should its estimated savings not materialize, such as 

establishing an enrollment cap for the waiver population or increasing 

cost sharing. We modified our report to clarify this point. 

We do not question that some savings from providing a prescription drug 

benefit to low-income elderly may be realized and agree that the premise 

may be appropriate for an evaluation. Our major observation remains—

that HHS is allowing a high level of risk for the state and its elderly 

beneficiaries in the Illinois demonstration, given the specific assumptions 

the state has made regarding the substantial savings it expects to gain 

from offering a drug benefit to this elderly low-income population. The 

state assumes that a drug benefit can largely pay for itself by diverting 

thousands of people from becoming Medicaid-eligible and from entering 

nursing homes. The state assumes this high diversion rate even though the 

majority of the people expected to be covered under the waiver already 

receive some drug benefit, albeit a more limited one, under the state’s 

existing drug program. A broader point, as we report, is that the diversion 

premise is being accepted and applied on a broad scale before its validity 

is tested. HHS has encouraged states to submit Pharmacy Plus waivers and 

several have done so. 

HHS disagreed with our recommendation that the Secretary of HHS 

should improve the federal public process, commenting that the current 

opportunity for public comment in the waiver process is more than 

adequate at both the federal and state levels. HHS stated that CMS 

currently posts some proposals on the CMS Web site, such as HIFA 

proposals, and intends to post all pending and approved proposals on the 

Internet in the future. However, HHS did not specify when in the future it 

would do so. When we checked CMS’s Web site, we were able to find 

copies of all but one of the pending HIFA proposals, but none of the 

Pharmacy Plus proposals and none of the pending proposals requesting 

section 1115 waiver authority that were not presented in the HIFA 

standard format. Consequently, reliance on the Web site provides an 

incomplete source of public information and does not substitute for the 

widely accepted Federal Register notice process. Our broader point 

remains that because of the variation in the level of public process at the 

state level, and because a waiver approval in one state sets precedent for 

others, a more formal and consistent federal approach is needed to ensure 

Public Process 
Page 38 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

that people potentially affected by waivers are aware of the proposals and 

have a structured venue for providing input prior to their approval. It 

would also provide a centralized focus on issues of national public policy 

interest for the Medicaid and SCHIP programs that is otherwise absent 

when relying on individual states as the focal point for public dialogue. 

Because HHS disagreed with our recommendation to improve the public 

notification and input process at the federal level, we elevated this issue to 

a matter for congressional consideration. 

Utah suggested that we reconsider the discussion in the draft report of the 

state’s public process and the concerns raised at the state level with its 

waiver. The state indicated that the concerns expressed about the waiver 

were apart from whether there was appropriate notice and opportunity for 

comment. We agree and have revised the report accordingly. We have 

retained, however, some discussion of the concerns with the waiver that 

groups we contacted felt were not adequately considered during the state’s 

public process. We believe it helps demonstrate the importance of public 

input, particularly when proposed demonstration projects are viewed as 

controversial. 

HHS and the states provided other comments that were not specific to our 

recommendations. Illinois and Utah expressed concerns that the report 

implied that HHS’s expedited review was too fast to provide an adequate 

review. Utah, for example, indicated that much negotiation between the 

state and HHS took place before the waiver was formally submitted. It was 

not our intent to link the amount of time that applications were under 

consideration with the results of HHS’s approval process for individual 

waivers. We revised the report to reflect that more time may be spent than 

indicated by formal approval times, because states and HHS may negotiate 

waiver proposals prior to their formal submission. We note, however, that 

beneficiary advocates raised concerns that these “behind-the-scenes” 

negotiations also result in less public awareness and scrutiny of the 

specific components of the proposals and that the expedited review times 

of the formal proposals may leave less time for public input and discussion 

of the written proposals. We believe that these concerns further support 

the need for a public process at the federal level once the state has 

submitted its proposal, to ensure adequate public notification of the 

proposals’ specific components. Finally, HHS provided additional 

technical comments. We revised the report to address these comments as 

appropriate. 

Other Comments 
Page 39 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

As arranged with your offices, unless you release its contents earlier, we 

plan no further distribution of this report until 30 days after its issuance 

date. At that time, we will send copies of this report to the Secretary of 

Health and Human Services, the Administrator of the Centers for Medicare 

and Medicaid Services, the Director of the Office of Management and 

Budget, and others who are interested. 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 have any questions, please contact me at (202) 512-

7119. Another contact and other major contributors are included in 

appendix VIII. 

Kathryn G. Allen 

Director, Health Care—Medicaid 

and Private Health Insurance Issues 
Appendix I: Description of Four Recent 

Section 1115 Waiver Approvals 

Page 40 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

As of May 1, 2002, HHS had approved 4 of the 13 section 1115 new 

demonstration waivers submitted and under review since August 2001.1

These include the first 2 HIFA waivers, for Arizona and California; the 

expansion of primary care for uninsured individuals in Utah; and the first 

Pharmacy Plus waiver for Illinois. The table below provides further 

specific details about these 4 approved waivers. 

Table 2: Description of Section 1115 Waivers Approved for Arizona, California, Utah, and Illinois 

 Arizona California Utah Illinois 

Name and type of 

waiver 

Arizona HIFA 

Demonstration 

California Parental 

Coverage Expansion 

HIFA 

Utah Primary Care 

Network 

Illinois Senior Care 

Program 

Waiver goals To expand coverage to 

uninsured low-income 

adults, including 

conducting a feasibility 

study of employersponsored insurance 

To expand coverage to 

uninsured low-income 

parents in order to 

increase enrollment and 

continuity of care for 

SCHIP and Medicaid 

children, including 

conducting a feasibility 

study of employersponsored insurance 

To expand primary care 

coverage to uninsured 

low-income adultsa

To extend pharmacy 

benefits to low-income 

seniors 

Sources of funding Unspent SCHIP 

allotment and Medicaid 

(federal and state 

matching payments) 

Unspent SCHIP 

allotment and tobacco 

settlement funds 

Medicaid 

(federal and state 

matching payments) 

Medicaid 

(federal and state 

matching payments) 

Submission and 

approval dates 

Sept. 20, 2001, and 

Dec. 12, 2001 

Dec. 20, 2000 — original 

submission Jan. 16, 2002 

– revised submission in 

HIFA format Jan 25, 

2002 – HIFA approval 

date 

Dec. 11, 2001, and Feb. 

8, 2002 

July 31, 2001, and 

Jan. 28, 2002 

Review timeb 84 days 10 days for HIFA 

application; 401 days 

from original submission 

date 

60 days 182 days 

Implementation date Phase I: 

childless adults, Nov. 1, 

2001 (retroactive 

implementation) 

Phase II: 

parents, Oct. 1, 2002 

January 1, 2003 – 

possible start date, but 

under consideration by 

state legislature 

July 1, 2002 –planned 

start date 

June 1, 2002 – actual 

start date 

 1

As noted elsewhere, HHS approved the Tennessee TennCare II waiver on May 31, 2002, 

and the Wisconsin pharmacy waiver on July 1, 2002, too late to be included in our analysis. 

Appendix I: Description of Four Recent 

Section 1115 Waiver Approvals 
Appendix I: Description of Four Recent 

Section 1115 Waiver Approvals 

Page 41 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

 Arizona California Utah Illinois 

Name and type of 

waiver 

Arizona HIFA 

Demonstration 

California Parental 

Coverage Expansion 

HIFA 

Utah Primary Care 

Network 

Illinois Senior Care 

Program 

Target populations Phase I: 

childless adults at or 

below 100% FPL 

Phase II: 

parents of children in 

Medicaid or SCHIP 

between 100% and 

200% FPL 

Custodial parents, 

caretaker relatives, and 

legal guardians of 

Medicaid and SCHIP 

children, at or below 

200% FPL 

Adults age 19 and older 

below 150% FPL, 

including childless adults 

from state-only program, 

and parents 

Seniors age 65 and 

older, at or below 200% 

FPL, not otherwise 

eligible for Medicaid; 

many from state-only 

pharmacy benefit 

program 

Number of people in 

waiver 

(5 years) 

Phase I: 

27,000 childless adults 

Phase II: 

21,250 parents— both 

groups estimated, no 

enrollment capsc

275,000 adults—

estimated, no enrollment 

capc

9,000 childless adults, 

and 16,000 parents — 

both groups are 

enrollment caps 

Up to 256,500 seniors —

estimated, enrollment 

cap 

Covered benefits Childless adults and 

parents receive 

comprehensive benefits 

plan comparable to 

SCHIP for children 

Parents receive 

comprehensive benefits 

plan similar to SCHIP 

children (comparable to 

state employees) 

Expansion adults receive 

primary care and 

preventive services only, 

no hospital or specialty 

physician services;d

about 17,600 current 

mandatory eligible adults 

and optional medically 

needy adults who are not 

aged, blind or disabled 

receive reduced benefitse

Seniors receive 

assistance in paying for 

prescription drugs, with 

primary care 

coordination; eligible 

beneficiaries have the 

option of premium and 

copayment assistance in 

paying for private 

insurance 

Cost sharing Phase I: 

childless adults have the 

same cost-sharing as 

Medicaid: copayments 

from $1 office visit to 

$5 nonemergency visit to 

emergency room 

Phase II: 

parents have the same 

cost sharing as SCHIP: 

family premiums not to 

exceed $25 per month, 

$5 nonemergency visit to 

emergency room, overall 

limit 5% annual family 

income 

Parents will pay 

premiums based on 

income: $10 per parent 

per month for families at 

or below 150% FPL; 

$20 per parent per month 

for families above 150% 

FPL; plus copayments, 

for example, $5 for an 

office visit or emergency 

care, capped at $250 per 

household per year 

Expansion adults pay 

$50 annual enrollment 

fee plus copayments, for 

example, $5 office visit, 

$30 emergency room 

visit 

Current mandatory 

eligible adults have no 

enrollment fee (optional 

medically needy adults 

have $50 enrollment fee), 

but have copayments, for 

example, $3 office visit, 

$6 nonemergency visit to 

emergency room, $220 

for each hospital 

admission 

Seniors with household 

incomes below the FPL 

pay no charge per 

prescription until 

reaching the benefit cap 

of $1,750 

Seniors with household 

incomes at or above FPL 

pay $1 generic or $4 per 

brand name prescription, 

until reaching the 

$1,750 cap 

Above the cap, 

participant pays 20% of 

each prescription plus a 

nominal copayment 
Appendix I: Description of Four Recent 

Section 1115 Waiver Approvals 

Page 42 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

 Arizona California Utah Illinois 

Name and type of 

waiver 

Arizona HIFA 

Demonstration 

California Parental 

Coverage Expansion 

HIFA 

Utah Primary Care 

Network 

Illinois Senior Care 

Program 

Research plans / 

evaluation 

Outcome measure: 

reduce the rate of 

uninsurance by 1% 

overall 

Report on feasibility 

study of employersponsored insurance 

Research question: 

will enrolling parents 

increase enrollment and 

continuity of care for 

children? 

Report on feasibility 

study of employersponsored insurance 

Research plans being 

refined 

Outcome measures: 

overall decrease in 

Medicaid hospital and 

long-term care stays; 

related cost savings to 

Medicare 

Estimated 5-year 

waiver costs 

Federal share: 

Phase I: childless adults 

SCHIP: $126 million 

Medicaid: $288 million 

total: $414 million 

Phase II: parents SCHIP: 

$144 million 

Federal share: 

estimated $1.6 billion 

(66% of total $2.4 billion) 

Federal share: 

Estimated 

 $422 million 

(71% of the total 

$595 million) 

Federal share: 

estimated $7 billion (50% 

of the total $14 billion) 

a

The Utah waiver approval also includes a separate demonstration population of high-risk pregnant 

women with assets exceeding the state maximum who will receive the full Medicaid benefits package. 

b

Review time is the elapsed time from date of submission to date of approval; It does not include any 

discussions HHS may have had with a state before a waiver was formally submitted for review. 

c

While Arizona and California do not have specific enrollment caps, enrollment is limited by the 

amount of unspent SCHIP funds available. 

d

Although the Utah waiver proposal, as approved, would provide no hospital or specialty physician 

services for individuals receiving primary care, state officials have since stated that they intend to 

cover limited inpatient physician specialty services, if pre-authorized, from state-only funds. 

e

The individuals with mandatory eligibility who will receive reduced benefits include adults age 19 and 

older who are eligible through section 1925 Transitional Medical Assistance or section 1931 

Temporary Assistance for Needy Families (TANF), and adults age 19 through 64 who are medically 

needy and not aged, blind, or disabled. Benefit reductions for these groups affect optional services by 

placing some limitations on vision, physical therapy, chiropractic, dental, and mental health services. 

In addition, these recipients will pay $3 per physician visit (instead of $2) and $2 per prescription 

(instead of $1). 

Sources: HHS approval letters and approved waiver applications for each state. 
Appendix II: Section 1115 Waiver 

Applications under Review 

Page 43 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

Nine of the 13 section 1115 waiver applications submitted since August 

2001 to expand coverage for the uninsured and pharmacy benefits were 

still under review by HHS as of June 3, 2002.1

 These proposals—including 

4 HIFA applications, 1 uninsured expansion not in HIFA format, and 4 

pharmacy proposals—are briefly described below. 

Table 3: Section 1115 Waiver Applications Under Review by HHS, June 3, 2002 

State and waiver Highlights 

Connecticut ConnPACE Pharmacy 

Program Waiver 

• Waiver submission: March 6, 2002; under review for 90 days as of June 3. 

• Populations served: The waiver would expand eligibility for a comprehensive 

prescription drug benefit, by waiver year 5, to an estimated 104,000 individuals age 65 

and older and the disabled age 18 and older with incomes up to 300 percent of the 

FPL. Drugs covered would be the same as those covered under the current state-only 

program. Participants would pay an annual registration fee of $25 and $12 to $20 per 

prescription. 

• Cost: The waiver would be financed by federal and state Medicaid payments, 

estimated to be $1.9 billion over 5 years, including savings from reduced use of 

Medicaid long-term care services and delayed spend-down to Medicaid eligibility. The 

state would also contribute about $76 million per year in state-only funds. 

Illinois KidCare Parent Coverage HIFA 

Waiver 

• Waiver submission: February 15, 2002; under review for 109 days as of June 3. 

• Populations served: The waiver would make health insurance coverage available to 

an estimated 318,200 individuals, the majority of whom would be parents of Medicaid 

and SCHIP children with incomes at or below 185 percent of FPL. Coverage would 

also be offered to low-income and uninsurable adults and children in several small 

state-funded programs, such as those for hemophilia, renal dialysis, and immigrant 

and other low-income children. Benefits would vary by group, ranging from the state’s 

approved SCHIP plan (Medicaid benefits without home and community-based waiver 

services and abortion services) to limited types of services specifically for individuals 

with hemophilia or renal disease. Cost sharing will also vary by group. Newly eligible 

parents with incomes above 150 percent and at or below 185 percent of FPL, for 

example, would pay monthly premiums of from $15 (for one covered person) to $40 

(five or more) plus copayments of $3 to $5 per prescription, $5 per medical visit, and 

$25 for each non-emergency visit to an emergency room. Current eligibles and several 

expansion groups would be offered the option of premium assistance for private 

insurance in lieu of state-administered coverage. 

• Cost: Federal spending over 5 years is estimated at $861 million (66 percent of the 

total estimated cost of $1.3 billion). Funding would come from Medicaid, SCHIP, and 

state general revenues. 

 1

We do not include the TennCare II Medicaid waiver in this group because it was initially 

reported to be under review as an extension of the existing TennCare demonstration 

waiver. HIFA applications submitted in mid-May or later, including those from Colorado, 

Delaware, Minnesota, and Oregon, were not included in our analysis because they were 

submitted too late to be included. Note that this table is largely based on the states’ waiver 

applications as submitted to HHS, and elements of the proposals may change during the 

review process. 

Appendix II: Section 1115 Waiver 

Applications under Review 
Appendix II: Section 1115 Waiver 

Applications under Review 

Page 44 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

State and waiver Highlights 

Maine Care for Childless Adults HIFA 

Waiver 

• Waiver submission: February 22, 2002; under review for 102 days as of June 3. 

• Populations served: The waiver would expand Medicaid coverage to one population 

group: childless adults. In the first year, 11,480 individuals with incomes under 100 

percent of FPL would be covered, and in later years the income limit could rise to 125 

percent of FPL. New enrollees would receive the same benefits as other Medicaid 

beneficiaries with the same nominal cost-sharing. 

• Cost: Maine would finance the waiver, estimated to cost $236 million over 5 years, 

with federal and state Medicaid funds by relinquishing part of its Disproportionate 

Share Hospital allocation. 

Michigan MIFamily Medicaid Expansion 

HIFA Waiver 

• Waiver submission: March 1, 2002; under review for 95 days as of June 3. 

• Populations served: Michigan would expand coverage to an estimated 210,500 

individuals in several groups that would receive different benefits. (1) About 70,000 

parents of children in Medicaid with family incomes between 51 and 100 percent of 

FPL would receive a benefit plan including physician, lab, X-ray, inpatient hospital 

(coverage limited to a defined case rate payment per authorized admission), and many 

outpatient services. Copayments for this group would include $10 for each physician 

visit; $10 to $20 per prescription; and $25 for a nonemergency visit to the emergency 

room (based on the prudent layperson standard). (2) An estimated 62,000 childless 

adults with incomes up to 35 percent of FPL would receive a specified outpatient 

benefit plan, excluding any inpatient coverage. They would pay $3 for physician visits, 

up to $5 per prescription, and $25 for a nonemergency visit to the emergency room. 

(3) Up to 1,500 pregnant women with incomes between 186 and 200 percent of FPL 

would receive full existing Medicaid benefits. (4) Up to 75,000 childless adults with 

incomes between 35 and 100 percent of FPL could receive a specified outpatient 

benefit through county health plan programs supported by a federal, state, and county 

partnership that would be phased in across the state over 5 years. In addition, 

approximately 2,000 disabled Medicaid beneficiaries would be allowed to earn up to 

350 percent of FPL and still receive Medicaid benefits. Waiver beneficiaries could 

receive premium assistance vouchers to purchase private employer-sponsored health 

insurance as an alternative to state programs. 

• Cost: Michigan proposes to fund its expansions, estimated to be $2.4 billion over 5 

years, with unspent SCHIP funds, Medicaid savings from redefined benefits for the 

optional and expansion groups, redirecting a portion of the state’s Disproportionate 

Share Hospital allocation, and new local funds from participating counties. 

New Jersey Pharmaceutical Assistance 

to the Aged and Disabled (PAAD) 

Program Waiver 

• Waiver submission: April 3, 2002; under review for 62 days as of June 3. 

• Populations served: The waiver would refinance the existing state-funded PAAD 

program for seniors age 65 and older and the disabled age 18 and older with incomes 

at or below 200 percent of FPL. State would continue funding its state-only Senior 

Gold pharmacy assistance program for eligible individuals with incomes up to 300 

percent of FPL. These two programs currently serve about 199,000 and 26,000 

individuals, respectively, and in 5 years would together serve an estimated 250,000 

people. Both programs currently and under the waiver would provide the same drugs 

approved for the Medicaid formulary. There would be pharmacy benefit management, 

no enrollment fee, and $5 per prescription cost sharing. 

• Cost: Federal spending over 5 years is estimated at nearly $5 billion, half of the 

estimated total cost of $9.9 billion. The PAAD waiver program would be funded by 

federal and state Medicaid payments, while the Senior Gold program for higher income 

individuals would continue to be state-funded. 

New Mexico State Coverage Initiative 

HIFA Waiver 

• Waiver submission: April 3, 2002; under review for 62 days as of June 3. 

• Populations served: The waiver would expand coverage to up to 40,000 uninsured 

adults ages 19 to 64 with incomes at or below 200 percent of FPL in phase I. The 

expansion would be targeted to employed adults and parents of Medicaid and SCHIP 

children. No children are included in phase I. Benefits would be similar to basic 

commercial managed care packages in the state (including inpatient, physician, lab 
Appendix II: Section 1115 Waiver 

Applications under Review 

Page 45 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

State and waiver Highlights 

and X-ray, pharmacy, and mental health and substance abuse services), with sliding 

scale cost sharing, for example, ranging from $5 per physician visit for individuals with 

incomes up to and including 100 percent of FPL, to $20 for those with incomes 151 

through 200 percent of FPL. Similarly, hospital inpatient copayments would range from 

$25 to $150 per day, and nonemergency visits to the emergency room from $25 to 

$125. Coverage would be offered primarily through an employer-based system. The 

application states that an amendment to the demonstration would be submitted later 

for a phase II, which could reallocate existing Medicaid program resources to shift 

certain enrollees from Medicaid to the phase I benefits package, with the savings 

allowing coverage of an additional 40,000 uninsured adults. This proposal is not 

currently under review. 

• Cost: Federal spending over 5 years for the phase I program is estimated at 

$228 million from the state’s SCHIP allotment, which is 82 percent of total program 

costs estimated at over $277 million. There would also be state and local funding and 

premium cost sharing by participants. 

South Carolina Prescription Drug Benefit 

for Low-Income Seniors Program Waiver 

• Waiver submission: January 8, 2002; under review for 147 days as of June 3. 

• Populations served: This waiver would provide comprehensive pharmacy benefits 

(the same as provided under the state’s Medicaid plan) and medical case 

management for up to 50,000 seniors age 65 and older with incomes at or below 200 

percent of FPL and no private drug coverage. An existing state-funded pharmacy 

program serving about 33,500 seniors with incomes at or below 175 percent of FPL 

would be folded into the waiver. Participants would pay a deductible of $500, then $10 

to $21 per prescription with no ceiling or cost limit. 

• Cost: The program, estimated to cost $2.8 billion over 5 years (including expenditures 

for the Medicaid-aged population as well as the pharmacy benefit program itself), 

would be funded by federal and state Medicaid payments, savings from diverting 

people from Medicaid eligibility and reducing the rate of increase in use of Medicaid 

services, a drug rebate program, and participant copayments. 

Washington Medicaid and SCHIP Reform 

Waiver 

• Waiver submission: November 7, 2001; under review for 209 days as of June 3. On 

January 25, 2002, HHS requested the state to submit a more specific proposal 

outlining exactly what changes would be made to benefits and cost sharing, which 

eligibility groups would be affected, and what the timeframe would be. As of June 3 the 

original waiver was being revised and may be resubmitted as a HIFA. 

• Populations served: The Washington waiver as proposed in November of 2001 would 

cover about 32,000 parents of Medicaid and SCHIP children currently enrolled in the 

state-only Basic Health Plan, who would be transferred to the waiver, plus an 

estimated 20,000 additional parents (a figure that could include an unspecified number 

of childless adults). To do so, the November 2001 waiver proposal sought flexibility to 

adopt cost sharing, change benefits, or limit enrollment as needed in administering the 

state Medicaid program. For example, the application requested flexibility to design 

different benefit packages, with a benefit floor that would apply to both mandatory and 

optional eligibility groups. This benefit floor would be based on the state-funded Basic 

Health Plan—which offers inpatient and outpatient hospital services, ambulance, 

emergency room, physician services, maternity and well-baby care, and pharmacy—

plus outpatient rehabilitation therapies. Cost sharing would be limited to 5 percent of 

family income, on average, from premiums paid by those with incomes above the FPL 

and from copayments on all nonpreventive services. 

• Cost: The state’s November 2001 waiver proposal planned to use unspent SCHIP 

funds estimated at $486 million for the 5 years 2002-2006 to finance the expansion 

populations. 
Appendix II: Section 1115 Waiver 

Applications under Review 

Page 46 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

State and waiver Highlights 

Wisconsin SeniorCare Pharmacy 

Program Waiver 

• Waiver submission: April 1, 2002; under review for 64 days as of June 3.a

• Populations served: As proposed, the waiver would provide comprehensive Medicaid 

prescription drug coverage for an estimated 177,000 seniors age 65 and older with 

incomes below 240 percent of FPL who were not eligible for Medicaid. Participants 

would pay an annual enrollment fee of $20, $5 to $15 per prescription, and individuals 

with incomes between 160 and 240 percent of FPL would pay the first $500 as a 

deductible. State legislation in 2001 established a new state-funded pharmacy 

assistance program, SeniorCare, to be implemented September 1, 2002, and to be 

folded into this pharmacy waiver program once approved. 

• Cost: The program, with an estimated total cost of about $1 billion over 5 years, would 

be financed by federal and state Medicaid payments, including Medicaid savings from 

delaying or diverting seniors from spending down to eligibility. 

a

HHS announced approval of the Wisconsin pharmacy waiver application on July 1, 2002. Because it 

was approved after we completed our work, we did not assess the final approved waiver (which could 

potentially differ in scope from the initial proposal). Our assessment in this table references the initial 

plans included in the state’s waiver proposal. 

Sources: State section 1115 waiver applications. 
Appendix III: HHS Office of the General 

Counsel Response to GAO Inquiry 

Page 47 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

Appendix III: HHS Office of the General 

Counsel Response to GAO Inquiry 
Appendix III: HHS Office of the General 

Counsel Response to GAO Inquiry 

Page 48 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 
Appendix IV: Comments from the Department 

of Health and Human Services 

Page 49 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

Appendix IV: Comments from the 

Department of Health and Human Services 
Appendix IV: Comments from the Department 

of Health and Human Services 

Page 50 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 
Appendix IV: Comments from the Department 

of Health and Human Services 

Page 51 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 
Appendix IV: Comments from the Department 

of Health and Human Services 

Page 52 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 
Appendix IV: Comments from the Department 

of Health and Human Services 

Page 53 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 
Appendix IV: Comments from the Department 

of Health and Human Services 

Page 54 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 
Appendix IV: Comments from the Department 

of Health and Human Services 

Page 55 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

Now on p. 2. 
Appendix IV: Comments from the Department 

of Health and Human Services 

Page 56 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

Now on pp. 40-41. 
Appendix IV: Comments from the Department 

of Health and Human Services 

Page 57 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

Now on p. 40.

Now on p. 24.

Now on pp. 23-24. 

Now on pp. 15-17. 
Appendix IV: Comments from the Department 

of Health and Human Services 

Page 58 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

Now on p. 44. 

Now on p. 42. 

Now on p. 42. 
Appendix V: Comments from the State of Arizona 

Page 59 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

Appendix V: Comments from the State of 

Arizona 
Appendix V: Comments from the State of Arizona 

Page 60 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 
Appendix VI: Comments from the State of 

Illinois 

Page 61 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

Appendix VI: Comments from the State of 

Illinois 
Appendix VI: Comments from the State of 

Illinois 

Page 62 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 
Appendix VI: Comments from the State of 

Illinois 

Page 63 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 
Appendix VII: Comments from the State of 

Utah 

Page 64 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

Appendix VII: Comments from the State of 

Utah 
Appendix VII: Comments from the State of 

Utah 

Page 65 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 
Appendix VIII: GAO Contact and Staff 

Acknowledgments 

Page 66 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

Katherine Iritani, Assistant Director (206) 287-4820 

In addition to those named above, Tim Bushfield, Helen Desaulniers, Behn 

Miller, Amy Murphy, Suzanne Rubins, Ellen M. Smith, and Stan Stenersen 

made key contributions to this report. 

Appendix VIII: GAO Contact and Staff 

Acknowledgments 

GAO Contact 

Acknowledgments 
Related GAO Products 

Page 67 GAO-02-817 Medicaid and SCHIP Demonstration Waivers 

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. 

Medicare and Medicaid: Implementing State Demonstrations for Dual 

Eligibles Has Proven Challenging. GAO/HEHS-00-94. Washington, D.C.: 

August 18, 2000. 

Children’s Health Insurance Program: State Implementation Approaches 

are Evolving. GAO/HEHS-99-65. Washington, D.C.: May 14, 1999. 

State Medicaid Financing Practices. GAO/HEHS-96-76R. Washington, 

D.C.: January 23, 1996. 

Medicaid: Spending Pressures Spur States Toward Program 

Restructuring. GAO/T-HEHS-96-75. Washington, D.C.: January 18, 1996. 

Medicaid Section 1115 Waivers: Flexible Approach to Approving 

Demonstrations Could Increase Federal Costs. GAO/HEHS-96-44. 

Washington, D.C.: November 8, 1995. 

Medicaid: State Flexibility in Implementing Managed Care Programs 

Requires Appropriate Oversight. GAO/T-HEHS-95-206. Washington, D.C.: 

July 12, 1995. 

Medicaid: Statewide Section 1115 Demonstrations’ Impact on 

Eligibility, Service Delivery, and Program Cost. GAO/T-HEHS-95-182. 

Washington, D.C.: June 21, 1995. 

Medicaid: Spending Pressures Drive States Toward Program 

Reinvention. GAO/T-HEHS-95-129. Washington, D.C.: April 4, 1995. 

Medicaid: Spending Pressures Drive States Toward Program 

Reinvention. GAO/HEHS-95-122. Washington, D.C.: April 4, 1995. 

Medicaid: Experience With State Waivers to Promote Cost Control and 

Access to Care. GAO/T-HEHS-95-115. Washington, D.C.: March 23, 1995. 

Medicaid: States Use Illusory Approaches to Shift Program Costs to 

Federal Government. GAO/HEHS-94-133. Washington, D.C.: August 1, 

1994. 

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GAO also accepts VISA and Mastercard. Orders for 100 or more copies mailed to a 

single address are discounted 25 percent. Orders should be sent to: 

U.S. General Accounting Office 

441 G Street NW, Room LM 

Washington, D.C. 20548 

To order by Phone: Voice: (202) 512-6000 

TDD: (202) 512-2537 

Fax: (202) 512-6061 

Contact: 

Web site: www.gao.gov/fraudnet/fraudnet.htm 

E-mail: fraudnet@gao.gov

Automated answering system: (800) 424-5454 or (202) 512-7470 

Jeff Nelligan, managing director, NelliganJ@gao.gov (202) 512-4800 

U.S. General Accounting Office, 441 G Street NW, Room 7149 

Washington, D.C. 20548 

GAO’s Mission 

Obtaining Copies of 

GAO Reports and 

Testimony 

Order by Mail or Phone 

To Report Fraud, 

Waste, and Abuse in 

Federal Programs 

Public Affairs