United States General Accounting Office

GAO Report to the Chairman, Committee on

the Budget, House of Representatives

April 1995 MEDICAID

Spending Pressures

Drive States Toward

Program Reinvention

GAO/HEHS-95-122

GAO United States

General Accounting Office

Washington, D.C. 20548

Health, Education, and

Human Services Division

B-233299 

April 4, 1995

The Honorable John R. Kasich

Chairman, Committee on the Budget

House of Representatives

Dear Mr. Chairman:

This report, prepared at your request, reviews federal and state spending trends and states’

efforts to restructure their Medicaid programs.

We are sending copies of this report to the Secretary of Health and Human Services; the

Administrator, Health Care Financing Administration; the Director, Office of Management and

Budget; and other congressional committees. Copies of this report will also be made available

to others on request. If you or your staff have any questions, please call me at (202) 512-6806.

Major contributors to this report are listed in appendix V.

Sincerely yours,

Janet L. Shikles

Assistant Comptroller General
Executive Summary

Purpose The $131 billion Medicaid program, a health care lifeline for over

33 million low-income Americans, is at a crossroads. Between 1985 and

1993 Medicaid costs tripled and the number of beneficiaries increased by

over 50 percent. Current projections suggest that program costs will

double over the next 5 to 7 years. While federal and state budgetary

constraints highlight the urgency of containing costs, a number of states

are pressuring to expand the program and enroll hundreds of thousands of

new beneficiaries. The cost of expanded coverage, they believe, will be

offset by the reallocation of certain Medicaid funds and the wholesale

movement of beneficiaries into some type of managed care arrangement.

The House Budget Committee is examining Medicaid, among other

entitlement programs, looking for opportunities to increase program

efficiency and constrain spending growth. In light of this effort, the

Chairman of the Committee asked GAO to examine (1) federal and state

Medicaid spending, (2) some states’ efforts to contain Medicaid costs and

expand coverage through waivers of certain federal requirements, and

(3) the potential impact of these waivers on federal spending and on

Medicaid’s program structure overall.

Background Medicaid is not 1, but 56 separate programs (including the 50 states,

District of Columbia, Puerto Rico, and the U.S. territories). Federal

mandates call for common eligibility and benefit requirements, but states

have discretion in how they implement their programs. As a result, the

populations served and benefits provided vary across states. For example,

Nevada serves 284 Medicaid beneficiaries for every 1,000 poor or

near-poor individuals in the state, whereas Rhode Island serves 913 per

1,000. Similarly, Mississippi spends, on average, less than $2,400 per

person on Medicaid services, while New York spends an average of almost

$7,300 per person.

State programs also vary in the percentage of program expenditures that

are covered by the federal government. The federal percentage is

determined by a formula based on a state’s per capita income. Low-income

states receive higher percentages, though the range is legislatively limited

from a minimum of 50 percent to a maximum of 83 percent. The federal

government matches what the state spends on Medicaid by this

percentage. In fiscal year 1993, 13 states, including New York, received 50

cents for every dollar spent on their respective Medicaid programs,

whereas Mississippi, West Virginia, and Utah each received more than 75

cents for every Medicaid dollar spent. Yet because of the differences in

Page 2 GAO/HEHS-95-122 Medicaid Spending Pressures
Executive Summary

prices and in the benefits and services offered, New York receives $3,600

per beneficiary in federal aid, while Mississippi receives $1,900.

Since the 1970s states have been experimenting with a variety of managed

care networks that limit which physicians and hospitals can serve the

state’s Medicaid beneficiaries. In some cases, the managed care networks

are prepaid a fixed amount per enrollee. This financing arrangement is

known as capitation and has demonstrated the ability to lower service

utilization, which in turn can hold down costs.

More recently, escalating program costs have persuaded some states to

move most or all of their Medicaid population into capitated managed care

as a way of controlling future cost growth. To do so, states must obtain

approval to waive certain federal Medicaid requirements. The waiver

authority that gives states the greatest flexibility in implementing

statewide managed care programs resides in section 1115 of the Social

Security Act. Most waiver states are simultaneously seeking authority to

use Medicaid funds to provide health care coverage to a portion of their

low-income population that is currently ineligible for Medicaid benefits.

States anticipate that savings from capitated managed care systems plus

the redirection of other Medicaid or state funds will finance the coverage

of these additional people. As part of the process of obtaining a section

1115 waiver, states must propose a financing plan that, over 5 years, is

intended not to require greater federal expenditures on their Medicaid

program than would have been the case without a waiver.

Results in Brief Medicaid costs are projected to increase from about $131 billion to

$260 billion by the year 2000, according to the Congressional Budget

Office. Between 1985 and 1993, federal Medicaid expenditures grew each

year, on average, by 16 percent. Although the program’s current growth

rate has moderated from that experienced in the early 1990s, it is still

much higher than the 3.8-percent rate at which the overall federal budget

has been growing. The continued phasing in of mandated populations and

the increase in the expensive aged and disabled populations figure into

estimates of Medicaid’s future growth rate.

In the mid-1980s, some states began using creative financing mechanisms

to leverage additional federal dollars. States collected donations and taxes

from specific hospitals and then returned a portion of the collected funds

to the same providers as special Medicaid payments. Because these

payments (called DSH payments) were made to hospitals that served a

Page 3 GAO/HEHS-95-122 Medicaid Spending Pressures
Executive Summary

disproportionate share of Medicaid and low-income patients, they

generated matching federal dollars. The states’ bookkeeping

sleight-of-hand increased federal payments without the states having to

dip deeper into their own treasuries. Thus, the states were able to

effectively increase the share of Medicaid funded by the federal

government. This phenomenon helped fuel annual federal spending

increases to over 25 percent—representing billions of dollars—in both

1991 and 1992. Although federal law has limited DSH payment growth since

1993, the gaming of these payments in some states has both increased the

level and affected the distribution of current and future federal Medicaid

spending.

More recently, states began seeking section 1115 waivers designed to

contain the cost of their Medicaid programs through the use of capitated

managed care delivery systems and expand coverage to uninsured

individuals who would not normally qualify for Medicaid benefits. Certain

states’ initial estimates of these newly eligible individuals are high:

1.1 million in Florida, 395,000 in Ohio, and 500,000 in Tennessee. In

addition to the 7 waivers approved since 1993, 15 states have either

applied for waivers or made inquiries about submitting waiver

applications. If similar coverage expansions are approved for additional

and more densely populated states, the federal government as well as the

states could be supporting millions more Medicaid beneficiaries.

GAO’s analysis to date of four states with approved waivers shows that

Florida, Hawaii, and Oregon may obtain more federal funding than they

would have likely received under their original Medicaid programs. For

Tennessee, on the other hand, GAO estimates that federal Medicaid

spending over the life of the waiver may be less than might have been

spent had the waiver not been approved. GAO has not analyzed the

potential impact of the other waivers on federal spending.

To date, the administration has portrayed all statewide 1115

demonstration waivers as budget neutral to the federal government. Its

approvals of waivers, however, may have state Medicaid programs

working at cross purposes with federal deficit reduction goals. While these

expansions will extend health care benefits to more low-income

individuals, the result could also be a heavier burden on the federal

budget.

Page 4 GAO/HEHS-95-122 Medicaid Spending Pressures
Executive Summary

Principal Findings

Medicaid Consumes

Growing Share of the

Federal Budget

Medicaid currently consumes about 6 percent of all federal outlays (three

times the share devoted to Food Stamps and five times the share devoted

to Aid to Families with Dependent Children). Moreover, Medicaid’s slice of

the federal budget is growing faster than most other major budget items. If

Medicaid continues indefinitely at its expected pace (10.7 percent), federal

spending on the program will double roughly every 5 to 7 years.

Creative financing mechanisms used by states to leverage additional

federal dollars contributed significantly to Medicaid’s spending growth of

over 25 percent in both 1991 and 1992. (Fig. 1 illustrates recent Medicaid

spending growth.) Part of these financing mechanisms involved making

payments to hospitals that served a disproportionate share of Medicaid

and other low-income patients. These payments exploded from slightly

less than $1 billion in 1990 to over $17 billion in 1992. However, the

Medicaid Voluntary Contribution and Provider-Specific Tax Amendments

of 1991 as well as provisions in the Omnibus Budget Reconciliation Act of

1993 now prevent these payments from rising faster than overall Medicaid

spending.

Page 5 GAO/HEHS-95-122 Medicaid Spending Pressures
Executive Summary

Figure 1: Medicaid Spending More Than Tripled Since 1985

Billions of Dollars

0

20

40

60

80

100

120

140

160

1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994

est.

Fiscal Year

State

Federal

Sources: Medicaid Source Book: Background Data and Analysis (A 1993 Update) (A Report

Prepared by the Congressional Research Service for the Use of the Subcommittee on Health and

the Environment of the Committee on Energy and Commerce, U.S. House of Representatives,

Jan. 1993), and HCFA.

Other factors have worked to increase Medicaid costs: medical inflation,

higher utilization of services, and more beneficiaries. Although many of

the new beneficiaries were pregnant women and children made eligible by

congressional mandates enacted since 1984, the addition of this group

played a less significant role in increasing Medicaid costs because these

individuals are relatively inexpensive to serve. The pressure on Medicaid

costs is expected to continue. For example, the number of individuals with

disabilities receiving Medicaid benefits is growing faster than any other

beneficiary group. While only about 15 percent of all Medicaid

beneficiaries are disabled, this group accounts for a much larger share of

program costs.

Page 6 GAO/HEHS-95-122 Medicaid Spending Pressures
Executive Summary

Waivers Used to Contain

Costs and Expand Program

Coverage

Section 1115 waivers are intended to permit experimentation by allowing

states to run demonstration projects that further the goals of the Medicaid

program. As such, these projects must have an evaluation component and

are expected to run for a limited period of time. The only prior use of

section 1115 authority comparable to recent statewide waiver applications

was the 1982 initiation of a managed care program in Arizona, a state that

had not participated previously in Medicaid. On a number of occasions,

the Congress and the executive branch have extended the Arizona

demonstration authority.

Section 1115 waivers are significant in two regards: they allow states

greater flexibility to test cost containment strategies—namely alternative

delivery arrangements such as capitated managed care—and they allow

states to expand program eligibility beyond traditional Medicaid

populations. Since 1993, the Health Care Financing Administration (HCFA),

which oversees the Medicaid program, has approved seven statewide

demonstration waivers for implementation: Florida, Hawaii, Kentucky,

Ohio, Oregon, Rhode Island, and Tennessee. Florida and Ohio are awaiting

state legislative approval and have not yet implemented their programs. In

Kentucky, state legislators refused to authorize waiver implementation

because they doubted that managed care savings would be sufficient to

offset the costs associated with coverage of additional groups. Another 12

states have applications pending, and 3 more states have held discussions

with HCFA about statewide demonstrations.

States are seeking waivers of managed care restrictions because they

believe capitated managed care can cut health care costs. As of June 1994,

15 percent of program beneficiaries were signed up with capitated health

plans, the fastest growing type of Medicaid managed care enrollment.

However, some of the managed care restrictions being waived were partly

a response to quality of care problems that emerged from states’

experiments with managed care during the 1970s. When waiving these

managed care restrictions through 1115 demonstration authority, HCFA has

required states to implement improved quality assurance systems,

including the collection of encounter data.

Because only two states have completed their first full year of waiver

implementation, it is too early to assess the impact of the shift to managed

care on beneficiary access to services and quality of care. However, the

experience of Tennessee is instructive regarding the need to proceed

cautiously when implementing a capitated managed care program

statewide. At the outset, Tennessee start-up problems threatened

Page 7 GAO/HEHS-95-122 Medicaid Spending Pressures
Executive Summary

beneficiary access to services. The managed care networks were

incomplete when beneficiaries were required to choose a plan and even on

“opening day,” many physicians had not yet determined which networks to

join. During the first months of implementation, some providers reported

slow or no payments for services. Also, a significant number of

beneficiaries have expressed dissatisfaction with Tennessee’s managed

care program. The most recent beneficiary survey reported that 45 percent

of enrollees who had previously received care under Medicaid’s

fee-for-service program were less than satisfied with TennCare.

Section 1115

Demonstrations Could

Increase Federal Spending

The administration asserts that all of the approved statewide 1115 waivers

are “budget neutral”—that is, federal spending for the demonstrations will

not exceed what would have been spent if the states continued to operate

their previous Medicaid programs. However, the administration has shown

considerable flexibility in establishing 1115 waiver spending limits. For

example, the cost of covering populations that could have been but were

not covered—so-called “hypotheticals”—under the predemonstration

program, have been considered budget neutral. Such flexibility has made it

easier for demonstrations to meet the administration’s redefined

budget-neutrality test.

In contrast, GAO’s initial test of budget neutrality involved a comparison of

the approved waiver spending limits to a current services benchmark. This

benchmark is defined by applying the administration’s national projection

of Medicaid spending growth during the life of the waiver to actual

spending in the year prior to waiver approval. This comparison indicates

that federal spending has the potential to be greater in Florida, Hawaii,

and Oregon than it would have been in the absence of waivers, whereas

federal spending over the life of Tennessee’s waiver may be less than it

otherwise would have been. The potential net spending impact associated

with the four state waivers we analyzed is likely to be small relative to

overall federal Medicaid spending. However, the impact of section 1115

demonstrations could increase substantially if the waivers pending or

proposed by several additional states—or even a few large states—are not

budget neutral.

Because of the bilateral nature of the negotiations between states and the

administration, and because of the discretion granted to the executive

branch in approving 1115 waivers, the terms and conditions for each state

are unique. As a result, the federal government’s financial liability varies

with each state, depending on the waiver terms negotiated. Most states

Page 8 GAO/HEHS-95-122 Medicaid Spending Pressures
Executive Summary

have agreed to limits on federal spending per person, or per capita caps.

Two have agreed to a total spending limit, or aggregate cap. Although for

some states federal liability is potentially greater than would be the case

without the waiver, it is limited in that each waiver agreement ensures a

ceiling on federal spending and holds some financial risk for the states.

Observations on

Medicaid’s Future

Over 33 million low-income women, children, elderly, blind, and disabled

Americans depend upon health care made possible by the Medicaid

program. However, the program’s double-digit spending growth rate

imperils efforts to bring the federal deficit under control. Consistent with

the Committee’s interest in constraining federal spending, states believe

they need the flexibility to manage their respective programs. Requiring

states to obtain waiver approval in order to aggressively pursue managed

care strategies may hamper their cost containment efforts. Yet, because

current program restrictions on managed care were designed to reinforce

quality assurance, in the absence of these restrictions, continuous

oversight of managed care systems is required to protect both Medicaid

beneficiaries from inappropriate denials of care and federal dollars from

payment abuses. Finally, GAO believes that the potential for increased

federal spending under future statewide demonstrations warrants close

scrutiny of section 1115 waiver approvals.

Agency Comments GAO discussed its findings with officials of HCFA’s Medicaid Bureau, the

Office of Research and Demonstrations, and the Office of State Health

Reform. In addition, GAO discussed its approach to measuring budget

neutrality with officials at the Office of Management and Budget (OMB).

The administration’s technical comments have been reflected, as

appropriate, in this report.

Administration officials agreed with GAO that their waiver review policies,

which they describe as more flexible, differ from those of previous

administrations. In particular, the administration’s approach to defining

budget neutrality is characterized by (1) flexibility in determining

appropriate baseline expenditures and (2) assessment of budget neutrality

over the life of the waiver rather than year by year. The administration

disagrees with GAO’s efforts to develop a consistent methodology for

assessing budget neutrality by using OMB’s national estimate of projected

Medicaid spending. Instead, it suggests that a “state-specific approach”

that incorporates states’ historical experience is necessary to reflect the

“dramatic variation” that exists in state Medicaid programs. This report

Page 9 GAO/HEHS-95-122 Medicaid Spending Pressures
Executive Summary

notes, however, that recent growth in Medicaid expenditures was

influenced by a number of state strategies, such as DSH payment schemes

and federal eligibility mandates, that are unlikely to be repeated. GAO

believes that using unique methods in each state has created the potential

for budget-neutrality decisions to be based on the technique most

favorable to a particular state. If state-specific reasons exist for future

Medicaid growth to differ from the national average, they should be well

documented.

The administration disputes GAO’s contention that the comprehensive

scope of the waiver demonstrations makes it controversial to characterize

them as experimental. GAO’s view remains that regardless of how

innovative the elements of these demonstrations are, the extension of

health care coverage to several hundred thousand people will make it

difficult to terminate a demonstration that fails to achieve its objectives.

(The complete text of the administration’s comments is in app. IV.)

Page 10 GAO/HEHS-95-122 Medicaid Spending Pressures
Page 11 GAO/HEHS-95-122 Medicaid Spending Pressures
Contents

Executive Summary 2

Chapter 1 

Introduction

16

Not 1, but 56 Separate Medicaid Programs 16

Services for Elderly and Disabled Consume Greatest Share of

Funding

19

Federal Medical Assistance Payments Based on Per Capita

Income

21

Section 1115 Waivers Permit Major Program Changes Without

Congressional Debate

22

Objectives, Scope, and Methodology 24

Chapter 2 

Despite a Recent

Slowdown, Medicaid

Consumes a Growing

Share of the Federal

Budget

26

Medicaid Coverage Has Expanded Since 1984 27

Medicaid Grew Faster Than Medical Inflation, Other Spending 29

Medicaid Spending Grew Faster Than Enrollment 32

Disproportionate Share Hospital Payments Responsible for Huge

Rise in 1991-92 Spending

33

Medicaid’s Share of Federal Budget Expected to Grow 34

Chapter 3 

Some States Use

Medicaid Waivers to

Increase Managed

Care and Expand

Coverage

36

Waivers Ease Restrictions on Use of Managed Care for Medicaid

Population

38

Section 1115 Waivers Permit States to Expand Eligibility Beyond

Traditional Medicaid Population

42

As Growing Number of States Seek Section 1115 Waivers,

Controversy Ensues

43

Chapter 4 

Some Section 1115

Demonstrations Could

Increase Federal

Expenditures

44

Budget Neutrality Redefined 45

Partial Caps May Limit Federal Liability While Heightening State

Risk

47

Page 12 GAO/HEHS-95-122 Medicaid Spending Pressures
Contents

Chapter 5 

Observations on

Medicaid’s Future

50

Chapter 6 

Agency Comments

and Our Evaluation

52

Changes in Waiver Review Policy 52

The Administration’s Budget-Neutrality Methodology 52

Demonstration Nature of the Section 1115 Waivers 53

Key Areas of Disagreement 53

Appendixes Appendix I: Major Federal Expansions of Medicaid Eligibility and

Services (1984-93)

56

Appendix II: Application of the Disproportionate Share Hospital

Program

63

Appendix III: GAO Products on Medicaid 66

Appendix IV: Comments From the Administration 69

Appendix V: Major Contributors to This Report 74

Tables Table 1.1: Medicaid Expenditures by State, Fiscal Year 1993 18

Table 3.1: Section 1115 Statewide Demonstration Waivers

Applied for Since 1991, by Submission Date

37

Table 3.2: Estimated Maximum Number of New Eligibles Under

Approved Statewide Section 1115 Waivers, by State

42

Table 4.1: Type of Expenditure Cap and Annual Adjustment, by

State

48

Table I.1: Federal Medicaid Expansion to AFDC Recipients and

Related Populations

56

Table I.2: Federal Medicaid Expansion to the Population

Receiving SSI

60

Table I.3: Federal Medicaid Expansion to Other Populations and

Service Additions

62

Figures Figure 1: Medicaid Spending More Than Tripled Since 1985 6

Figure 1.1: Average Spending per Medicaid Beneficiary Varies

Across States

17

Figure 1.2: Cost of Serving Disabled and Elderly High Compared

With That of Serving Other Children and Adults

20

Figure 1.3: Long-Term Care Accounts for One-Third of Medicaid’s

Spending for Services

21

Page 13 GAO/HEHS-95-122 Medicaid Spending Pressures
Contents

Figure 2.1: Medicaid Spending Outpaced Rise in Beneficiary

Numbers from 1983 to 1993

26

Figure 2.2: Medicaid Expected to Grow to $260 Billion by Year

2000

27

Figure 2.3: Enrollment Increases Highest for Those Not Receiving

Cash Assistance

29

Figure 2.4: Dramatic Increases in Medicaid Expenditures Slowed

in 1993

30

Figure 2.5: Medicaid Spending Approached Spending for

Medicare in 1992

31

Figure 2.6: Medicaid Increased More Than Other Social Programs

From 1985 to 1993

32

Figure 3.1: HCFA Has Approved Eight Statewide Demonstration

Projects

38

Abbreviations

AFDC Aid to Families with Dependent Children

COBRA Consolidated Omnibus Budget Reconciliation Act of 1985

DEFRA Deficit Reduction Act of 1984

DSH disproportionate share hospital

EPSDT early and periodic screening, diagnostic, and treatment

FMAP federal medical assistance percentage

FPL federal poverty level

HCFA Health Care Financing Administration

HHS Department of Health and Human Services

HMO health maintenance organization

IRCA Immigration Reform and Control Act of 1986

MCCA Medicare Catastrophic Coverage Act of 1988

NACHC National Association of Community Health Centers

OBRA 1986 Omnibus Budget Reconciliation Act of 1986

OBRA 1987 Omnibus Budget Reconciliation Act of 1987

OBRA 1989 Omnibus Budget Reconciliation Act of 1989

OBRA 1990 Omnibus Budget Reconciliation Act of 1990

OBRA 1993 Omnibus Budget Reconciliation Act of 1993

OMB Office of Management and Budget

SSI Supplemental Security Income

Page 14 GAO/HEHS-95-122 Medicaid Spending Pressures
Page 15 GAO/HEHS-95-122 Medicaid Spending Pressures
Chapter 1 

Introduction

In 1993, Medicaid, the government’s health financing program for certain

low-income populations, cost the federal and state governments $131

billion—almost $100 billion more than just a decade ago.1

 During that

same period, the number of Medicaid beneficiaries increased from

22 million to 33 million. Although about three-quarters of the beneficiaries

are poor children and their parents, two-thirds of the expenditures are for

poor elderly, blind, and disabled individuals. Funding is a shared

responsibility between the federal and state governments, with respective

federal and state shares determined through a statutory matching formula.

Federal law mandates coverage of certain medical services and population

groups. It also includes coverage options, allowing states to choose

whether to cover additional services or low-income population groups.

Not 1, but 56 Separate

Medicaid Programs

Dramatic differences in Medicaid programs across states reflect spending

priorities of the states, their ability to pay, and incentives inherent in the

federal matching formula.2

 States partly determine the extent of their

Medicaid program when they set eligibility requirements for receiving cash

assistance (primarily Aid to Families with Dependent Children—AFDC).3

Under federal law, AFDC recipients are automatically eligible for Medicaid.

States also determine program scope by selecting which optional services

or groups to include in their programs. With some discretion to modify

eligibility and benefit provisions, the proportion of the poor (as defined by

the federal poverty level) and near-poor served by Medicaid varies greatly

by state.4

 For example, for every 1,000 people with incomes under

150 percent of the federal poverty level, Rhode Island serves 913

beneficiaries, whereas Nevada serves 284. Nationally, in 1994 Medicaid

covered medical services for 58 percent of people under age 65 living in

poverty.

State Medicaid programs also vary in the levels of benefits provided. For

example, some states limit their Medicaid coverage of inpatient days (a

required service) to a certain number per person. States also have the

1

Amounts include both health services and administrative costs.

2

Participation in the Medicaid program by states is voluntary. However, all 50 states plus the District of

Columbia and American Samoa, Guam, the Northern Mariana Islands, Puerto Rico, and the Virgin

Islands have elected to administer Medicaid programs. We refer to all 56 entities as “states” for this

report.

3

In 1993, the qualifying level for AFDC varied across states from 17 to 93 percent of the federal poverty

level, which in 1993 was income of $11,890 for a family of three.

4

States also have discretion in setting their own standards and methods for reimbursement of Medicaid

services.

Page 16 GAO/HEHS-95-122 Medicaid Spending Pressures
Chapter 1 

Introduction

discretion to drop their coverage of optional services, such as dental or

optical care. The average Medicaid benefit (that is, total medical spending

divided by total beneficiaries) ranges from $2,372 in Mississippi to $7,286

in New York. (See fig. 1.1 for grouping of states by their average benefit

level and table 1.1 for state-by-state data.) States with higher Medicaid

benefits tend to cover a greater proportion of poor people, relative to

states with lower benefits. Thus, the differences among states in spending

per poor person are even greater than the differences among states in

spending per beneficiary.

Figure 1.1: Average Spending Per Medicaid Beneficiary Varies Across States

Less Than $3,000

$3,000 to 3,999

$4,000 to 4,999

$5,000 or More

Source: Medicaid Statistics, Program and Financial Statistics, 1993, U.S. Department of Health

and Human Services, Health Care Financing Administration.

Page 17 GAO/HEHS-95-122 Medicaid Spending Pressures
Chapter 1 

Introduction

Table 1.1: Medicaid Expenditures by

State, Fiscal Year 1993

State

Federal

and state

Medicaid

spendinga

(thousands)

Federal

medical

assistance

percentageb

Medicaid

spending

per

beneficiary

Medicaid

spending

per person

in poverty

Federal

Medicaid

spending

per person

in poverty

Alabama $1,637,242 71.45 $3,139 $2,258 $1,616

Alaska 295,384 50.00 4,539 5,680 3,034

Arizona 1,365,046 65.89 3,379 2,220 1,481

Arkansas 1,031,148 74.41 3,038 2,130 1,587

California 13,538,038 50.00 2,801 2,333 1,168

Colorado 1,091,709 54.42 3,890 3,084 1,687

Connecticut 2,274,592 50.00 6,817 8,212 4,118

Delaware 252,993 50.00 3,670 3,466 1,742

District of Columbia 686,719 50.00 5,710 4,346 2,176

Florida 4,948,988 55.03 2,836 1,974 1,088

Georgia 2,798,657 62.08 2,930 3,045 1,898

Hawaii 380,668 50.00 3,462 4,183 2,098

Idaho 293,674 71.20 2,951 1,958 1,397

Illinois 4,981,454 50.00 3,569 3,113 1,561

Indiana 2,815,525 63.21 4,984 3,999 2,532

Iowa 987,200 62.74 3,413 3,404 2,141

Kansas 889,666 58.18 3,663 2,721 1,587

Kentucky 1,863,697 71.69 3,017 2,443 1,754

Louisiana 3,493,823 73.71 4,651 3,122 2,303

Maine 855,860 61.81 5,070 4,367 2,704

Maryland 1,960,419 50.00 4,409 4,093 2,054

Massachusetts 4,131,904 50.00 5,402 6,446 3,228

Michigan 4,362,644 55.84 3,724 2,958 1,655

Minnesota 2,167,025 54.93 5,093 4,283 2,358

Mississippi 1,196,475 79.01 2,372 1,872 1,480

Missouri 2,251,606 60.26 3,695 2,706 1,635

Montana 323,271 70.92 3,631 2,545 1,822

Nebraska 564,169 61.32 3,426 3,338 2,052

Nevada 423,447 52.28 4,789 3,003 1,578

New Hampshire 417,627 50.00 5,264 3,729 1,874

New Jersey 4,706,049 50.00 5,930 5,434 2,724

New Mexico 571,200 73.85 2,373 2,026 1,510

New York 19,980,838 50.00 7,286 6,703 3,360

North Carolina 2,896,330 65.92 3,224 2,998 1,982

North Dakota 269,675 72.21 4,343 3,852 2,795

(continued)

Page 18 GAO/HEHS-95-122 Medicaid Spending Pressures
Chapter 1 

Introduction

State

Federal

and state

Medicaid

spendinga

(thousands)

Federal

medical

assistance

percentageb

Medicaid

spending

per

beneficiary

Medicaid

spending

per person

in poverty

Federal

Medicaid

spending

per person

in poverty

Ohio 5,179,121 60.25 3,474 3,545 2,139

Oklahoma 1,089,730 69.67 2,819 1,646 1,153

Oregon 955,605 62.39 2,938 2,633 1,647

Pennsylvania 5,612,714 55.48 4,589 3,512 1,953

Rhode Island 829,026 53.64 4,337 7,676 4,123

South Carolina 1,682,379 71.28 3,576 2,481 1,772

South Dakota 266,294 70.27 3,826 2,611 1,859

Tennessee 2,675,390 67.57 2,943 2,681 1,812

Texas 7,118,558 64.44 3,084 2,241 1,448

Utah 477,624 75.29 3,224 2,353 1,773

Vermont 255,476 59.88 3,171 4,330 2,605

Virginia 1,791,773 50.00 3,111 2,858 1,435

Washington 2,316,480 55.02 3,657 3,654 2,017

West Virginia 1,200,412 76.29 3,459 3,001 2,290

Wisconsin 2,114,971 60.42 4,489 3,325 2,014

Wyoming 134,793 67.11 2,914 2,106 1,423

Total $126,405,107

National average 57.34c $3,870 $3,223 $1,846

aIncludes payments made to disproportionate share hospitals (DSH). Excludes federal and state

administrative costs.

bThe FMAP is the federal government’s share of each state’s payments for services.

cWeighted average.

Source: Medicaid Statistics, Program and Financial Statistics, 1993, and Bureau of the Census.

Services for Elderly

and Disabled

Consume Greatest

Share of Funding

By far, the majority of Medicaid funds are paid on behalf of poor elderly,

blind, and disabled individuals. Representing only slightly more than a

fourth of all Medicaid beneficiaries, these groups incurred about 66

percent ($82.2 billion) of Medicaid’s 1993 expenditures, as shown in figure

1.2.5

 The average per person spending for these beneficiaries exceeded

$9,200—four times more than was spent on other adults ($2,292) and

seven times more than was spent on other children ($1,360). The per

5

These figures represent national averages—percentages for specific states may be higher or lower.

Page 19 GAO/HEHS-95-122 Medicaid Spending Pressures
Chapter 1 

Introduction

person spending for all Medicaid beneficiaries averaged nearly $3,900; in

contrast, health spending per person for the U.S. population averaged

about $3,300.

Figure 1.2: Cost of Serving Disabled

and Elderly High Compared With That

of Serving Other Children and Adults

Percent of Total

0

10

20

30

40

50

Children Adults Blind or

Disabled

Elderly

Cost per Recipient

$1,360 $2,292 $9,226 $9,862

Beneficiaries

1993 Expenditures

Source: The Kaiser Commission on the Future of Medicaid.

In 1993, about 35 percent of Medicaid spending was for long-term care,

including nursing home care payments. Medicaid pays about 52 cents of

every nursing home care dollar. About 46 percent of all Medicaid spending

was for acute care. (See fig. 1.3 for a breakdown of Medicaid spending.)

Page 20 GAO/HEHS-95-122 Medicaid Spending Pressures
Chapter 1 

Introduction

Figure 1.3: Long-Term Care Accounts

for One-Third of Medicaid’s Spending

for Services

46% • Acute Care

35%•

Long-Term Care

•

2%

Payments to Medicare

•

3%

Payments to HMOs

•13%

Disproportionate Share Paymentsa

aPayments to hospitals that serve a disproportionate number of Medicaid and other low-income

patients with special needs. There are no federal restrictions on how hospitals use these

payments.

Source: The Kaiser Commission on the Future of Medicaid.

Federal Medical

Assistance Payments

Based on Per Capita

Income

The financing of Medicaid is shared by the federal government and the

states. The federal share paid to a state is based on the federal medical

assistance percentage (FMAP). Determined separately for each state, the

FMAP ranges from a minimum of 50 percent to a maximum of 83 percent of

total Medicaid costs.

The formula for determining the FMAP is based on a state’s per capita

income. It is designed to provide a higher federal match to states with low

per capita incomes. In fiscal year 1993, Mississippi, West Virginia, and

Utah had the highest federal match percentages; each received more than

Page 21 GAO/HEHS-95-122 Medicaid Spending Pressures
Chapter 1 

Introduction

75 percent of its Medicaid program funding from the federal government.

Alternatively for that year, the federal government paid 50 percent of

Medicaid costs, the minimum match, in 12 states and the District of

Columbia.

In spite of the formula’s sliding match rate, federal spending per Medicaid

beneficiary tends to be highest in states with high per capita incomes.

Because high-income states tend to offer relatively generous benefits, the

absolute amount of federal spending per beneficiary is high, even though

the match rate is only 50 percent.6

 For example, New York—a high-income

state with a 50-percent match—receives $3,600 per beneficiary in federal

aid, while Mississippi—a low-income state with approximately an

80-percent match—receives $1,900 per beneficiary in federal aid.7

Reporting on this subject in 1983, 1990, and 1993, we noted that the FMAP

formula could be improved to meet federal goals.8 The federal assistance

formula is designed to reduce differences among the states in medical care

coverage of the poor and distribute fairly among the states the burden of

financing program benefits. However, the formula’s reliance on a state’s

per capita income does not adequately address these equity goals. In fiscal

year 1991, for example, the District of Columbia and Nevada received the

same FMAP, despite the District’s greater proportion of people eligible for

Medicaid. Our prior work in this area concluded that the formula could

better adjust for states’ different needs and varying abilities to fund

benefits by considering a state’s number of persons in poverty and more

comprehensive measures of taxing capacity.

Section 1115 Waivers

Permit Major Program

Changes Without

Congressional Debate

In recent years, many states have been experimenting with health

financing reforms. Under Medicaid law, states proposing to implement

payment and service delivery innovations outside the range allowed by

federal rules must seek approval to waive certain federal requirements.

Until recently, though, Medicaid experiments have been relatively limited.

6

The top six states in terms of spending per beneficiary (New York, Connecticut, New Jersey, District

of Columbia, Massachusetts, and New Hampshire) have high per capita incomes, relative to the

national average, and receive only a 50-percent federal share.

7

To the extent that the cost of medical services varies with state per capita income, the dollar

differences somewhat overstate the differences in real Medicaid services provided by states.

8

Medicaid: Changing Medicaid Formula Can Improve Distribution of Funds to States (GAO/GGD-83-27,

Mar. 9, 1983), Medicaid Formula: Fairness Could Be Improved (GAO/T-HRD-91-5, Dec. 7, 1990), and

Medicaid: Improving Funds Distribution (GAO/HRD-93-112FS, Aug. 20, 1993).

Page 22 GAO/HEHS-95-122 Medicaid Spending Pressures
Chapter 1 

Introduction

However, states have been seeking approval for broader changes under

section 1115 waivers, so called because of the statutory provision

authorizing them,9

 which offer more open-ended opportunities to make

major changes in Medicaid than program waivers.10 Changes proposed in

section 1115 waiver applications are considered demonstration projects.

Unlike the routine approvals for program waivers, approvals for

demonstration waivers are subject to much greater discretion by the

Secretary of the Department of Health and Human Services (HHS). (The

Health Care Financing Administration (HCFA) and the Office of

Management and Budget (OMB) have also been key players in the waiver

approval process.) Section 1115 waivers can exempt states from

compliance with normal Medicaid requirements and allow them to receive

federal funding for expenditures normally not eligible for such assistance.

HHS requires that waiver applications include a formal research or

experimental methodology, and historically waivers have not been

considered automatically renewable. Section 1115 waivers typically

involve limited research projects, but since 1993 several statewide

demonstration projects have been approved.

Among other things, recent section 1115 waivers have allowed states to

mandate enrollment of all their beneficiaries in Medicaid-participating

managed care plans and to prevent disenrollment for specific periods of

time, usually 6 to 12 months. States with recently approved waivers have

proposed expanding coverage of their indigent citizens by recycling

savings anticipated in changing from a fee-for-service to a managed care

system and redirecting other Medicaid and state funds. If these states’

demonstrations are implemented as planned, the states would be covering

some low-income individuals that would not otherwise qualify for

Medicaid. We discuss the significance of these waivers to the restructuring

of the Medicaid program in chapter 3 and their potential impact on the

federal budget in chapter 4.

9

The waiver authority resides in section 1115(a) of the Social Security Act, 42 U.S.C. 1315(a), which

gives the Secretary of HHS broad authority to waive statutory requirements for Medicaid and other

programs, such as AFDC, to permit states to run experimental, pilot, or demonstration projects “likely

to assist in promoting the [program’s] objectives.” States may be exempted from compliance with

program requirements, or receive federal funding for expenditures normally not eligible for such

assistance, or both.

10There are various types of waivers under Medicaid, and those typically referred to as “program”

waivers (approval to waive certain requirements for a specific population or geographic area) are

designed for routine approval, as long as states meet certain qualifications. States may apply for

periodic renewals. In 1994 all states, except for Arizona and the District of Columbia, operated one or

more innovations under program waivers.

Page 23 GAO/HEHS-95-122 Medicaid Spending Pressures
Chapter 1 

Introduction

Objectives, Scope,

and Methodology

The House Budget Committee asked us to examine (1) the nature of

federal and state Medicaid spending in recent years, (2) some states’

efforts to contain Medicaid costs and expand coverage through waivers of

certain federal requirements, and (3) the potential impact of the waivers

on federal spending and on Medicaid’s program structure overall.

Collecting Information on

Medicaid Spending and

Waivers

To address the issue of federal and state Medicaid spending, we analyzed

data contained in HCFA statistical reports and also reviewed and

synthesized information from research articles and major studies that

focused on Medicaid costs. To obtain information on states’ efforts to

contain Medicaid costs and expand coverage through waivers, we

interviewed Medicaid program and other state agency officials, providers,

advocacy groups, and state legislators in five of the eight states with

approved waivers. We also interviewed HCFA officials responsible for

examining waiver proposals and reviewed documentation for the

approved and pending projects as well as statistical and other reports on

the Medicaid program.

Examining the Potential

Impact of Waivers

We determined the potential impact of waivers on federal spending by

developing and applying a consistent framework that compares spending

limits approved in each waiver with a benchmark incorporating current

services budgeting concepts.11 To eliminate the effect of accelerated

program growth from past years—acceleration due in part to high medical

inflation, large increases in state disproportionate share hospital (DSH)

payments, and mandated expansions in program eligibility—we compared

the waiver spending limits with a projection of spending for each state’s

current Medicaid program over the life of the waiver. To make these

projections we used the administration’s estimated rate of growth of

Medicaid current services outlays for the nation as a whole. These

estimated growth rates are based only on expected increases to medical

inflation and program population growth—without any change in

eligibility requirements.

11According to HCFA, each approved waiver is budget neutral, that is, the waiver programs—including

the expanded populations—will cost no more to operate than the traditional Medicaid programs would

have in each state over the 5 years of the demonstrations. However, in determining the theoretical

funding level for continuing the traditional Medicaid program, HCFA and the states made assumptions

that we do not believe are consistent with the concept of “budget neutrality,” such as including

persons who states could make, but are not currently, eligible (frequently referred to as

“hypotheticals”) in the program baseline and allowing for program growth that more closely

approximates historically high levels than the lower projection of future growth.

Page 24 GAO/HEHS-95-122 Medicaid Spending Pressures
Chapter 1 

Introduction

To make the current services projection for each state’s Medicaid program

(what we call our budget-neutrality benchmark) we multiplied each state’s

base-year estimates of Medicaid funding (for the segment of the

population to be covered by their waiver) by the administration’s

estimates of national program growth made when HCFA approved the

waiver. We adjusted our baseline, when necessary, to reflect constraints

on the growth of DSH payments in each state’s Medicaid program. The

actual process varied slightly, depending on whether the state’s waiver

was subject to an aggregate or per capita funding limit.

Once we had determined our administration-based estimate of current

services outlays, we compared it with the estimated program funding from

the waiver agreements. In states with aggregate caps, we compared our

estimates with actual program caps. In states with per capita caps, we

compared our estimates with state program funding levels consistent with

the enrollment figures found in the waiver applications, recognizing that

actual funding ceilings would be higher or lower, depending on actual

enrollment.

We subtracted our annual, budget-neutrality benchmark figures from the

waiver agreement figures and then discounted this amount to determine

the present value of potential annual savings or increased funding. The

difference—if positive—showed the amount of program funds above our

benchmark amount that might be needed to finance the program and—if

negative—showed the amount the program might save.

We did our work for this report and other related studies between August

1994 and March 1995 in accordance with generally accepted government

auditing standards.

Page 25 GAO/HEHS-95-122 Medicaid Spending Pressures
Chapter 2 

Despite a Recent Slowdown, Medicaid

Consumes a Growing Share of the Federal

Budget

Medicaid has become one of the fastest growing components of federal

and state budgets. In part, this is the result of program expansions. After

remaining relatively stable for a decade, the number of Medicaid

beneficiaries began to climb rapidly after the mid-1980s.12 Since that time,

the number of beneficiaries served annually has increased by over

11 million, reaching 33.4 million in 1993. However, costs have grown even

faster than the number of beneficiaries. (See fig. 2.1.) Between 1985 and

1993, federal Medicaid expenditures grew each year, on average, by 16

percent. During this time, state Medicaid expenditures grew at a slightly

slower rate of 15 percent. In 5 years, Medicaid spending is expected to

exceed $260 billion annually. (See fig. 2.2.)

Figure 2.1: Medicaid Spending

Outpaced Rise in Beneficiary Numbers

From 1983 to 1993

Percent Change Since 1983

0

50

100

150

200

250

300

1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993

Expenditures

Beneficiaries

Sources: Medicaid Source Book: Background Data and Analysis (A 1993 Update) (A Report

Prepared by the Congressional Research Service for the Use of the Subcommittee on Health and

the Environment of the Committee on Energy and Commerce, U.S. House of Representatives,

Jan. 1993) and Medicaid Statistics, Program and Financial Statistics for 1991-93.

12Between 1975 and 1985 the total number of beneficiaries varied by less than 1.5 million, ranging from

21.5 million to 22.8 million.

Page 26 GAO/HEHS-95-122 Medicaid Spending Pressures
Chapter 2 

Despite a Recent Slowdown, Medicaid

Consumes a Growing Share of the Federal

Budget

Figure 2.2: Medicaid Expected to Grow to $260 Billion by Year 2000

Billions of Dollars

0

50

100

150

200

250

300

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000

Fiscal Year

Actual Expenditures

Congressional Budget Office Projections

Sources: Medicaid Source Book: Background Data and Analysis (A 1993 Update), Medicaid

Statistics, Program and Financial Statistics for 1991-93, and Congressional Budget Office

estimates.

Medicaid Coverage

Has Expanded Since

1984

The federal government influences total Medicaid spending indirectly by

specifying the percentage of state Medicaid expenditures the federal

government will pay (higher matching rates encourage greater state

spending), and directly by specifying some eligibility and benefit

requirements. Between 1984 and 1990, the Congress expanded Medicaid

coverage by mandating that states serve certain low-income groups and

provide certain services, and allowing optional coverage for other

low-income groups and services.13 (See app. I.)

The mandates extended coverage primarily to additional low-income

pregnant women, children, and Medicare beneficiaries. The mandates also

extended transitional Medicaid coverage for families leaving AFDC for

gainful employment, established a new categorically needy coverage group

13The Congress also required states to increase certain aspects of service coverage.

Page 27 GAO/HEHS-95-122 Medicaid Spending Pressures
Chapter 2 

Despite a Recent Slowdown, Medicaid

Consumes a Growing Share of the Federal

Budget

for severely impaired individuals under the age of 65, and added coverage

of certain chronically ill or disabled individuals.14 The Kaiser Commission

on the Future of Medicaid noted that between 1990 and 1992, enrollment

increased by about 6 million individuals, with about one-third of this

increase attributable to pregnant women and children.15 Since some states

provided benefits when coverage of these groups was optional, the

mandates tended to equalize benefits among states.

Because both the mandates and options tied coverage to the federal

poverty level, which is uniform across states, they greatly increased the

number of persons receiving Medicaid who were not eligible for cash

assistance. (See fig. 2.3.) This resulted in a decline in the proportion of

beneficiaries eligible for Medicaid through a cash-assistance-related

category. In 1993, about 60 percent of the beneficiaries were eligible for

Medicaid coverage under a cash-assistance-related category, down from

68 percent in 1990.

14Access to Medicaid coverage for disabled children has increased since 1990, when the Supreme

Court ruled that disability standards for children may be no more narrow than those applied to adults.

Sullivan v. Zebley, 493 U.S. 521 (1990). As a result, eligibility criteria for children are based on the

child’s developmental delay and limitations on the child’s ability to engage in age-appropriate activities

of daily living. This has increased the number of children classified as disabled. Prior to 1990, the same

disability criteria that applied to adults, which emphasize inability to engage in employment, were also

applied to children.

15Kaiser Commission Update: Medicaid Spending Growth, 1990 to 1992, The Kaiser Commission on the

Future of Medicaid, Policy Brief, No. 1 (Washington, D.C.: July 1991).

Page 28 GAO/HEHS-95-122 Medicaid Spending Pressures
Chapter 2 

Despite a Recent Slowdown, Medicaid

Consumes a Growing Share of the Federal

Budget

Figure 2.3: Enrollment Increases Highest for Those Not Receiving Cash Assistance

Millions

0

5

10

15

20

25

30

35

1981 1983 1985 1987 1989 1991 1993

Fiscal Year

Not Receiving Cash Assistance

Medically Needya

Receiving Cash Assistance

aIndividuals who have incomes too high to qualify for cash assistance, but who have incurred

medical expenses that depleted their incomes and resources to levels that make them needy.

States are permitted, but not required, to cover medically needy individuals.

Sources: Medicaid Source Book: Background Data and Analysis (A 1993 Update) and Medicaid

Statistics, Program and Financial Statistics for 1991-93.

Medicaid Grew Faster

Than Medical

Inflation, Other

Spending

During most of the 1980s, spending for Medicaid, private health insurance,

and Medicare grew at an annual rate of 10 to 11 percent. In 1989, however,

Medicaid’s spending growth began to rise sharply. In 1991 Medicaid’s

27-percent annual growth rate was over three times greater than the

growth rate for national health expenditures and over four times greater

than the rate for Medicare. (See fig. 2.4.) In 1992 Medicaid’s annual growth

rate reached a record high of about 29 percent. Even though it fell to

11 percent in 1993, Medicaid’s annual growth rate continued to outpace

the consumer price index and, except for Medicare, other key indicators

Page 29 GAO/HEHS-95-122 Medicaid Spending Pressures
Chapter 2 

Despite a Recent Slowdown, Medicaid

Consumes a Growing Share of the Federal

Budget

used to measure health care spending. Medicaid consumes slightly more

than 14 cents of every personal health care dollar.

Figure 2.4: Dramatic Increases in

Medicaid Expenditures Slowed in 1993 Annual Growth Rate (Percent)

0

5

10

15

20

25

30

1989 1990 1991 1992 1993

Fiscal Year

Medicaid

Medicare

National Health

CPI-Medical Care

Consumer Price Index (CPI)

Sources: Data for Medicaid are from Medicaid Source Book: Background Data and Analysis (A

1993 Update). Data for Medicare are from annual reports of the trust funds’ trustees, 1989-93.

Data for national health expenditures are from Department of Health and Human Services

National Health Expenditures for 1993. Data for CPI and Medical Care Index are from Bureau of

Labor Statistics.

Figure 2.5 illustrates spending by Medicaid and Medicare since 1981.

Historically, Medicaid spending on health care services for the poor has

been significantly less than Medicare spending for the nation’s elderly. In

the 1980s, the gap widened, and by 1990, Medicare spending exceeded

Page 30 GAO/HEHS-95-122 Medicaid Spending Pressures
Chapter 2 

Despite a Recent Slowdown, Medicaid

Consumes a Growing Share of the Federal

Budget

Medicaid’s by over $37 billion. By 1992, however, the difference had

narrowed to $14 billion.

Figure 2.5: Medicaid Spending Approached Spending for Medicare in 1992

Billions of Dollars

0

20

40

60

80

100

120

140

160

1981 1983 1985 1987 1989 1991 1993

Fiscal Year

Medicaid—Combined Federal and State

Medicare

Sources: Medicaid data are from Medicaid Source Book: Background Data and Analysis (A 1993

Update). Medicare data are from annual reports of the trust funds’ trustees, 1981-93.

Medicaid spending has also increased sharply when compared with

spending for other federal social programs. (See fig. 2.6.) In 1993, Medicaid

consumed 46 percent of all the funds spent on means-tested programs,

over three times more than its closest competitor—Food Stamps. By the

year 2000, federal spending for Medicaid is expected to reach $149 billion,

or about 51 percent of the dollars spent on means-tested programs.

Page 31 GAO/HEHS-95-122 Medicaid Spending Pressures
Chapter 2 

Despite a Recent Slowdown, Medicaid

Consumes a Growing Share of the Federal

Budget

Figure 2.6: Medicaid Increased More Than Other Social Programs From 1985 to 1993

Medicaid

Welfare and Other

Cash Assistance

Housing

Food and Nutrition

Education Aid

Jobs and Training

0

Federal Spending (Billions of Dollars)

1993

1990

1985

10 20 30 40 50 60 70 80

Source: Budget of the United States Government, Historical Tables, Fiscal Year 1996.

Medicaid Spending

Grew Faster Than

Enrollment

Enrollment growth—over 11 million between 1983 and 1993—does not

fully explain the rise in Medicaid spending. For example, the Kaiser

Commission estimated that enrollment growth accounted for less than half

of the increase in Medicaid costs during the period 1990 to 1992. The

Page 32 GAO/HEHS-95-122 Medicaid Spending Pressures
Chapter 2 

Despite a Recent Slowdown, Medicaid

Consumes a Growing Share of the Federal

Budget

federal mandates of the 1980s that added low-income pregnant women

and low-income children to the rolls were a minor factor in increasing

costs, accounting for about 6.5 percent of spending growth. Although the

mandates added a large number of beneficiaries, the populations

added—low-income pregnant women and children—are relatively

inexpensive to serve. In contrast, low-income elderly, disabled, and blind

beneficiaries were responsible for about 25 percent of the total

expenditure growth, even though they accounted for only 18 percent of

the enrollment growth from 1990 to 1992.

In addition to enrollment increases, medical price inflation, higher

provider reimbursements (that, to some extent, have been fueled by the

Boren amendment16), utilization growth, and creative financing

mechanisms have also contributed to the significant growth in Medicaid

expenditures. The importance of each of these factors in explaining cost

growth depends upon the specific time period selected. For example, in

1993 the Kaiser Commission reported that enrollment expansions, medical

price inflation, and increases in expenditures per beneficiary above

inflation each accounted for about one-third of the $37 billion increase in

annual Medicaid expenditures from 1988 through 1991.17

Disproportionate

Share Hospital

Payments Responsible

for Huge Rise in

1991-92 Spending

Disproportionate share hospital (DSH) payments were the most important

cost driver in 1991 and 1992, when Medicaid spending grew by 27 percent

and 29 percent, respectively. These are supplemental payments to

hospitals that serve large numbers (a disproportionate share) of Medicaid

and other low-income patients. The payments are intended to partially

reimburse hospitals for the cost of providing care not covered by public or

private insurance. In 2 years, DSH payments grew from slightly less than

$1 billion in 1990 to $17.4 billion in 1992 and represented about $1 of every

$7 Medicaid spent on medical services.

16Provider suits brought under the Boren Amendment, 42 U.S.C. 1396a(13), have been a major factor

pressuring states to increase payment rates. Enacted in the early 1980s, the Boren Amendment

modified federal requirements related to Medicaid payment rates to hospitals and nursing homes. The

intent was to provide states with greater flexibility, which some states utilized, for example, to initiate

prospective payment systems. Specifically, the Boren Amendment requires states to provide payments

“which the state finds . . . are reasonable and adequate to meet the costs which must be incurred by

efficiently and economically operated facilities in order to provide care and services in conformity

with applicable . . . standards and to assure that individuals eligible for medical assistance have

reasonable access to inpatient hospital services of adequate quality.” Particularly in recent years,

states have been dogged by provider lawsuits forcing them to better justify or raise their Medicaid

payment rates to hospitals and nursing homes.

17The Medicaid Cost Explosion: Causes and Consequences (Baltimore, Maryland: The Kaiser

Commission on the Future of Medicaid, Feb. 1993).

Page 33 GAO/HEHS-95-122 Medicaid Spending Pressures
Chapter 2 

Despite a Recent Slowdown, Medicaid

Consumes a Growing Share of the Federal

Budget

DSH payments grew rapidly because they were part of creative financing

mechanisms that allowed states to gain additional federal dollars and

effectively increase the federal government’s share of Medicaid funding.

Beginning in the mid-1980s, states were allowed to use revenue raised

from “provider-specific” taxes—that is, taxes imposed on hospitals serving

Medicaid patients—and “voluntary contributions” (called donations), as

part of the state share eligible for federal matching funds. States then

returned to providers the funds collected from such taxes and donations

along with part of the matching federal payments. In some cases, a portion

of the federal matching funds was then redirected to state general

revenues and spent on nonhealth-care services. This swapping and

redirecting of revenues among providers, the state, and the federal

government resulted in increased federal spending, increased funds for

providers, and—in some cases—additional revenue for states’ treasuries.

(See app. II for examples of how states used provider-specific taxes and

donations to obtain federal matching dollars without actually spending

state funds.)

DSH payments are now capped as a result of the Medicaid Voluntary

Contribution and Provider-Specific Tax Amendments of 1991 and will not

be a significant cost driver in the future. In 1993, DSH payments fell slightly

to about $16.7 billion. The 1991 amendments also severely restricted

states’ ability to use provider-specific taxes and donations (but not

intergovernmental transfers) as a source of matching funds, and capped

DSH payments at 12 percent of the Medicaid program.18 States that relied

heavily on this financing mechanism are now seeking a new revenue

source, cutting their Medicaid programs, or dramatically restructuring

their programs under a section 1115 waiver (see ch. 3).

Medicaid’s Share of

Federal Budget

Expected to Grow

Medicaid’s tremendous spending growth of the late 1980s and early 1990s

is not likely to recur. In 1994, Medicaid spending is expected to have

grown about 8 percent. The Congressional Budget Office estimates that

program spending will grow by 10.7 percent annually over the next 5

years. As in the past, future growth will be determined by medical

inflation, provider reimbursement, utilization, and enrollment increases.

Although no new eligibility or benefit mandates are foreseen, some of

those already legislated are still being phased in. Mandatory coverage of

poor children under the age of 19 will not be fully effective until 2002.

Furthermore, the number of disabled individuals covered by Medicaid,

18Legislation passed in 1993 placed additional restrictions on DSH payments. (See app. II.)

Page 34 GAO/HEHS-95-122 Medicaid Spending Pressures
Chapter 2 

Despite a Recent Slowdown, Medicaid

Consumes a Growing Share of the Federal

Budget

although relatively small, is rising rapidly (12 percent between 1992 and

1993) and will increase costs.

Page 35 GAO/HEHS-95-122 Medicaid Spending Pressures
Chapter 3 

Some States Use Medicaid Waivers to

Increase Managed Care and Expand

Coverage

In the past, some states solved their health care financing problems by

capitalizing on the use of federal subsidies. Most notably, the DSH payment

mechanisms mentioned earlier were used to augment a state’s total

Medicaid spending to obtain higher federal matching payments: the higher

the state’s own spending on Medicaid, the higher the federal match.

However, since the limits on state DSH payments that were enacted in 1991,

continuing budget shortfalls have pressured states to seek alternative

financing measures. Now some states are seeking waivers from federal

requirements in order to make greater use of alternatives such as prepaid,

or HMO-type, managed care.

Under the broad authority of section 1115 of the Social Security Act, HHS

has allowed some states to waive certain federal requirements in exchange

for the states’ expansion of Medicaid coverage and agreement to specific

federal funding limits. The waiver authority, as recently granted, permits

states to mandate enrollment in managed care health plans; subsidize

health care coverage for people with incomes above the federal poverty

level; and use funding from other sources, such as public and mental

health programs, to finance these efforts.

As of April 1995, 8 states have HHS-approved waivers, 12 have applications

pending, and 3 have made inquiries about submitting waiver

applications.19,20 (See table 3.1 and fig. 3.1.) Together, these 23 states have

about 50 percent of the Medicaid beneficiaries in the country.

19HCFA has approved seven statewide section 1115 waivers since 1993. The eighth state, Arizona, has

operated its Medicaid program under a section 1115 waiver since 1982.

20Texas, Utah, and Washington have inquired about submitting waiver applications with HCFA.

Page 36 GAO/HEHS-95-122 Medicaid Spending Pressures
Chapter 3 

Some States Use Medicaid Waivers to

Increase Managed Care and Expand

Coverage

Table 3.1: Section 1115 Statewide

Demonstration Waivers Applied for

Since 1991, by Submission Date

State Submission Approval Implementation

Oregon Aug. 1991a Mar. 1993 Feb. 1994

Kentucky Mar. 1993 Dec. 1993 b

Hawaii Apr. 1993 July 1993 Aug. 1994

Tennessee June 1993 Nov. 1993 Jan. 1994

Rhode Island July 1993 Nov. 1993 Aug. 1994

Florida Feb. 1994 Sept. 1994 b

Ohio Mar. 1994 Jan. 1995 b

South Carolina Mar. 1994 c

Massachusetts Apr. 1994

New Hampshire June 1994

Missouri June 1994

Delaware July 1994

Minnesota July 1994

Illinois Sept. 1994

Louisiana Jan. 1995

Oklahoma Jan. 1995

Vermont Feb. 1995

New York Mar. 1995

Kansas Mar. 1995

aOregon’s initial proposal was denied in August 1992. The state revised and resubmitted the

proposal, which was approved in March 1993.

bAwaiting state legislature approval.

cHCFA has approved South Carolina’s waiver proposal framework. However, certain issues must

be resolved before the state is allowed to implement its demonstration program.

Source: HCFA.

Page 37 GAO/HEHS-95-122 Medicaid Spending Pressures
Chapter 3 

Some States Use Medicaid Waivers to

Increase Managed Care and Expand

Coverage

Figure 3.1: HCFA Has Approved Eight Statewide Demonstration Projects

Waiver Approved 

Application Pending

Waiver Concepts 

Discussed With HCFA

Little or No Interest

Expressed Yet

Source: HCFA.

Waivers Ease

Restrictions on Use of

Managed Care for

Medicaid Population

Waivers Increase Managed

Care Options

To constrain rising health care costs, states are increasingly turning to the

mandatory enrollment of portions of their Medicaid population into

prepaid managed care delivery plans that limit enrollees to certain

provider networks as a way to control utilization and costs. Because

federal Medicaid law requires that beneficiaries have freedom to choose

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among providers willing to accept Medicaid reimbursement, states have

had to seek approval to waive this freedom-of-choice requirement. The

Secretary of HHS may waive this requirement under two sections of the

Social Security Act. Section 1915(b) allows states, among other things, to

implement a primary care case management system, to contract with

HMOs, and to selectively contract with a limited set of providers. Section

1115 waivers, which are more difficult to obtain, allow states greater

flexibility in the use of managed care options, particularly HMO-type

delivery. As described in chapter 1, under section 1115 waivers, states can

establish criteria to designate prepaid plans that serve only Medicaid

enrollees and can prohibit disenrollment from these plans for a certain

period of time—two provisions not generally permitted by Medicaid law.

State Experience Indicates

Need for Careful Planning

When Implementing New

Managed Care Networks

States are seeking waivers of managed care requirements because they

believe managed care financing and delivery systems can cut health care

costs as well as improve access to and quality of care. In our 1993 studies

of Medicaid managed care and private sector managed care, we reported

that a combination of factors rendered findings of cost savings

inconclusive.21 Because the term managed care refers to a range of

financing arrangements—including traditional fee-for-service plans with

very few care management features, such as prior approval of

hospitalization—our studies of cost savings are quick to distinguish among

the various forms of managed care. For the most service-restrictive form

of managed care—the “capitated” HMO—reported evidence of lower

utilization is straightforward. This promise of lower utilization has made

HMO-type plans attractive to the states.22

As of June 1994, 15 percent of Medicaid beneficiaries were enrolled in fully

capitated health plans. In one year (June 1993 to June 1994), Medicaid

full-risk capitation enrollment grew by 91 percent, in part because of the

statewide managed care demonstrations obtained through the section 1115

waivers. In the past, the elderly and disabled Medicaid population, which

consumes the largest share of state Medicaid budgets (about 66 percent),

has rarely been covered by managed care programs. Increasingly,

however, states are including or plan to include these populations as well.

21Medicaid: States Turn to Managed Care to Improve Access and Control Costs (GAO/HRD-93-46,

Mar. 17, 1993) and Managed Health Care: Effect on Employers’ Costs Difficult to Measure

(GAO/HEHS-94-3, Oct. 19, 1993).

22States with approved section 1115 waivers are using a variety of forms of managed care.

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When we and others reported in the 1970s on quality of care problems and

other abuses in some Medicaid managed care experiments, the Congress

placed restrictions on HMO enrollment for Medicaid beneficiaries.23 In

general, these restrictions were designed to ensure that HMOs provide

Medicaid beneficiaries a standard of care equal to that provided to private

patients. Under section 1115 waivers, HCFA can waive these restrictions to

help states enlist HMOs to serve Medicaid beneficiaries. HCFA can waive the

“75-25 rule,” which specifies that HMOs serving Medicaid beneficiaries must

have at least 25 percent of their enrollment consist of private patients

(with certain limited exceptions), a rule that—in effect—prohibits

Medicaid-only HMOs.24 HCFA can also waive a federal provision permitting

beneficiaries to terminate their enrollment in an HMO at any time; this

provision prevents the “lock-in” of beneficiaries that are dissatisfied with a

plan.25 From the beneficiary’s perspective, these provisions provide some

protection against the possibility of being enrolled by an HMO seeking

excessive profit at the expense of quality. From the HMO’s perspective,

however, the provision allowing beneficiaries to disenroll at will makes

planning for financial stability difficult and therefore makes the enrollment

of Medicaid patients less attractive.26

In February 1995 we testified that, with the Medicare program (which

covers medical services for the nation’s elderly and certain other groups)

HCFA has not aggressively enforced compliance with federal HMO

standards.27 Similar concerns arise about enforcement of standards for

plans that enroll Medicaid beneficiaries, particularly because large-scale

enrollment in prepaid HMOs is a recent occurrence and state Medicaid

departments have limited experience in overseeing such delivery systems.

Advocacy groups in some states with waivers have stated that while

23Better Controls Needed for Health Maintenance Organizations Under Medicaid in California (Sept.

1974, B-164031(3)), Deficiencies in Determining Payments to Prepaid Health Plans Under California’s

Medicaid Program (Aug. 1975, MWD-76-15), and Relationships Between Nonprofit Prepaid Health

Plans With California Medicaid Contracts and For Profit Entities Affiliated With Them (Nov. 1976,

HRD-77-4). For a summary of the status of Medicaid HMO contracting as of early 1981 and the

outstanding problems at that time, see Trieger, Sidney, Trudi W. Galblum, and Gerald Riley, HMOs:

Issues and Alternatives for Medicare and Medicaid, HCFA Pub. No. 03107 (Baltimore: 1981).

24HCFA regulations allow waiver of the 75-25 rule in some cases without a section 1115 waiver.

25States can opt to restrict disenrollments, without a waiver, for up to 6 months for federally qualified

HMOs.

26The longer the guaranteed enrollment per enrollee, the more stability the HMO experiences in cash

flow and the greater the opportunity to adequately plan for meeting the health care needs of its

enrollees.

27Medicare: Opportunities Are Available to Apply Managed Care Strategies (GAO/T-HEHS-95-81,

Feb. 10, 1995).

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HMO-type managed care may potentially expand beneficiaries’ access to

providers, quality of care and access problems will go undetected without

adequate beneficiary education and vigorous state and federal oversight.28

The recent experience of Tennessee’s section 1115 demonstration program

illustrates the need to proceed cautiously when implementing a capitated

HMO program statewide.29 In response to escalating Medicaid costs,

Tennessee sought a section 1115 waiver in 1993. The state proposed

“TennCare,” a demonstration to enroll in managed care organizations30 all

its Medicaid beneficiaries, in addition to its medically uninsurable citizens

and certain other uninsured residents.31

In fewer than 2 months after HCFA granted the waiver, Tennessee

implemented TennCare. In 1993, the year before the demonstration began,

about 2.7 percent of the state’s Medicaid population was enrolled in

managed care, compared with about 12.4 percent nationally. As of

January 1, 1994—TennCare’s “opening day”—plans for contracting with

provider networks were incomplete, and many of the state’s physicians

had not yet determined which networks, if any, they might join. Some

beneficiaries were initially required to choose a plan without knowing

which ones would include their physicians. Systems to process bills were

not fully developed, and some providers reported slow or no payments for

services during the first months of the waiver. The submission of

encounter data to the state, which allow officials to monitor access and

quality, was not complete even 1 year after the program began. The most

recent beneficiary satisfaction survey taken in 1994 reported that

45 percent of enrollees who had previously received care under Medicaid’s

fee-for-service program were less than satisfied with TennCare.

Individuals who were previously uninsured, however, were not as

dissatisfied (8 percent).

28HCFA has required states, through its special terms and conditions associated with approved section

1115 waivers, to implement improved quality assurance systems and collect encounter data. HCFA has

also contracted for evaluations to examine cost, quality, and access to care.

29Medicaid: Experience With State Waivers to Promote Cost Control and Access to Care

(GAO/T-HEHS-95-115, Mar. 23, 1995).

30These managed care organizations are prepaid plans, some of which operate as HMOs with

“gatekeepers” (providers designated to coordinate the care for individual enrollees) and some as

preferred provider organizations, which do not use gatekeepers.

31These are residents of any income level without access to employer-sponsored or other insurance,

although with higher incomes, greater cost-sharing is expected.

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Section 1115 Waivers

Permit States to

Expand Eligibility

Beyond Traditional

Medicaid Population

States are also using section 1115 waivers to expand Medicaid coverage to

more individuals. Most states’ demonstrations expand coverage to

low-income individuals and families who were previously ineligible for

Medicaid (although income and categorical requirements for these new

eligibles vary considerably from state to state).32 In sheer numbers,

Tennessee, Florida, and Ohio have the most ambitious expansion

programs. Oregon, Kentucky, Hawaii, and Rhode Island plan more modest

expansions. (See table 3.2.)

Table 3.2: Estimated Maximum Number of New Eligibles Under Approved Statewide Section 1115 Waivers, by State

State New eligiblesa Eligibility requirements

Florida

1,100,000

Individuals and families with incomes below 250% of the federal poverty level

(FPL) are eligible for subsidized private insurance.

Individuals and families are eligible only if uninsured for 12 months or recently

disenrolled from Medicaid.

Hawaii 80,000 Uninsured persons below 300% of FPL.

Kentucky 201,000 Individuals with incomes below FPL.

Ohio 395,000 Individuals and families with incomes below FPL.

Oregon 112,000b Individuals and families with incomes below FPL.

Rhode Island

11,000

Pregnant women and children up to age 6 with family incomes between 185%

and 250% of FPL.

Extension of family planning services for women for 2 years after giving birth.

Tennessee

500,000c

All uninsured, regardless of employment or income status, including individuals

who cannot obtain coverage because of a preexisting condition. (Enrollment

capped for newly entitled, not capped for traditional Medicaid recipients.

Eligibility restricted to those uninsured prior to a date within the last year.)

aIncludes expansions to optional groups of Medicaid eligibles.

bActual new enrollment as of March 3, 1995.

cIn January 1995, Tennessee closed enrollment to the uninsured; demonstration enrollment was

438,000 in February 1995.

Source: State waiver proposals and supporting documentation.

If all states were granted waivers that permitted eligibility expansions, the

number of individuals in Medicaid-supported programs could be sizeable.

In a recent study,33 the Urban Institute estimates that expanding coverage

32Some states include in their demonstration individuals and families who could have been covered at

state option under the regular Medicaid program.

33Increasing Insurance Coverage Through Medicaid Waiver Programs (Washington, D.C.: Nov. 1994).

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up to 200 percent of the federal poverty level would increase the number

of beneficiaries between 18 million and 45 million, depending on the

extent to which eligible people apply.34 A more limited expansion covering

individuals with incomes up to the federal poverty level, as approved for

Oregon and Kentucky, would increase the number of beneficiaries

between 8 million and 14 million.

As Growing Number

of States Seek Section

1115 Waivers,

Controversy Ensues

Section 1115 waivers are granted for research purposes to test program

improvements in keeping with Medicaid goals or examine issues of

interest to HCFA. Until Oregon’s application was approved in March 1993,

only Arizona had been granted authority to run its demonstration

statewide.35 Before that time, most section 1115 demonstrations were

relatively small and affected only a small geographic area, target

population, or provider group.

Objecting to the section 1115 demonstrations, a legal challenge has been

mounted against the waivers. In June 1994, the National Association of

Community Health Centers (NACHC) filed suit in federal court (NACHC v.

Shalala). NACHC argues, among other things, that the Secretary of HHS acted

beyond her statutory powers in approving these statewide section 1115

waivers. The suit challenges the award of waivers granted before the suit

was filed and seeks injunctive relief against subsequent approval of similar

waivers. Waiver approvals for Hawaii, Kentucky, Oregon, Rhode Island,

and Tennessee preceded the suit. Since the suit was filed, Florida and

Ohio have also been granted section 1115 waivers.

The issue of expanded coverage may stall the implementation of proposed

section 1115 demonstrations in certain states. Florida, Kentucky, and Ohio

have waivers approved by HCFA but not by their own state legislatures.

Lawmakers in these states are concerned that implementation of the

waivers will increase, not decrease, state costs. The Kentucky legislature

has required that the state realize savings from managed care before

coverage is expanded.

34These figures do not represent a net decrease in the number of uninsured, since some of these new

eligibles currently have private insurance. Some states with generous program expansions, like

Florida, plan to limit the substitution of Medicaid for private insurance by requiring a 12-month waiting

period before new eligibles can receive benefits.

35Since its inception in 1982, Arizona’s entire medical assistance program for AFDC and SSI recipients

has been operated as a section 1115 demonstration known as the Arizona Health Care Cost

Containment System.

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Some states with approved section 1115 waivers could be eligible for more

federal Medicaid funds than they might have received without the waivers.

Some states have proposed ambitious coverage expansions, which,

through the waivers, would be financed in part by the Medicaid program.

While estimating the demonstration projects’ potential impact on federal

spending is difficult, the administration’s approval of the waivers as

budget neutral depends on a number of critical assumptions that could be

subject to challenge. Furthermore, it is not clear that the administration’s

rationale for defining budget neutrality in the approved statewide waivers

is consistent across all waivers.

We have been evaluating the budget neutrality of approved waivers using a

consistent framework that compares approved budgets with a benchmark

using current services budgeting concepts. While more extensive analysis

is in progress, it appears that one of the four waivers we analyzed may be

budget neutral, but three others may not be if fully implemented by the

states.36 In Tennessee, our analysis indicates that federal spending on the

Medicaid demonstration program could be lower over the life of the

waiver, compared with what might have been spent without the waiver.

However, the demonstration programs in Hawaii, Florida, and Oregon may

increase federal spending on Medicaid acute care. Because the waiver

agreements only specify ceilings on federal spending, the total amount of

new federal dollars that could be required by the demonstrations depends

upon several factors, including future action by the states. For example,

federal spending for Florida will depend, partly, upon how many of the

planned maximum 1,100,000 newly eligible individuals that state will

actually cover.

The potential net spending impact associated with the four state waivers

we analyzed, while it could amount to hundreds of millions of additional

federal dollars, is small relative to overall federal Medicaid spending.

However, the impact of the section 1115 demonstrations could increase

substantially if the waivers pending or proposed by several additional

states—or even a few large states—are not budget neutral.

36These results are derived by comparing the maximum potential costs of the demonstrations (as

outlined in the waiver applications) with a “current services” baseline (the projected amount of federal

and state spending necessary to maintain the current level of Medicaid services) calculated separately

for each demonstration project. Our ongoing analysis is examining ways to adjust the current services

baseline for differences in state experiences. The results of this analysis will be reported at a later

date.

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Budget Neutrality

Redefined

Since the early 1980s, the administration has required that federal

spending on a state’s section 1115 demonstration project be budget

neutral—that is, federal expenditures may not exceed what would have

been spent without the waiver. This budget-neutrality policy is still in

force. Since 1993, however, the administration has applied the financial

test in such a way as to allow states more flexibility in showing that their

proposed projects would be budget neutral.

Projecting future spending for the current program is a critical element in

determining budget neutrality since this amount represents the baseline

against which spending for the demonstration project is compared. The

two key steps in developing projections for the current program are

estimating (1) base, or initial-year, spending and (2) future annual

increases. From a state’s perspective, higher base costs or higher annual

increases make it easier to claim budget neutrality. That is, a higher

baseline makes it possible for planned spending to increase while still

meeting the definition of budget neutrality. States have used one or both of

the following arguments to secure access to increased federal funds while

complying with the current budget-neutrality policy.

• Hypothetical Expansion Argument. Four states—Hawaii, Rhode Island,

Kentucky, and Ohio—successfully argued that their baselines should

include the cost of extending coverage to optional eligibility groups that

could have been, but were not then, served by the state’s Medicaid

program. These hypothetical expansions primarily covered women and

children (but may also include elderly and disabled individuals), whose

coverage was optional.37 Although in Hawaii many of these individuals

received limited benefits under one of two state-funded programs, these

groups were not served at all in the Medicaid programs. The states argued

that since they could have submitted a state plan amendment and thus

received federal medical assistance payments for providing health services

to these groups, an equivalent amount of federal funding for the Medicaid

demonstration project, which would include them, should be considered

budget neutral. Including the section 1902(r)(2) population increased

Hawaii’s baseline by about $58 million over 5 years. Although the

Kentucky legislature suspended implementation of the state’s waiver,

inclusion of the section 1902(r)(2) populations that included the elderly

37Under section 1902(r)(2) of the Social Security Act, 42 U.S.C. 1396b(r)(2), states were essentially

given the option to cover such individuals by being permitted to employ less restrictive eligibility

methodologies. As a matter of policy, HCFA generally limits arguments for hypothetical expansions to

those individuals eligible under 1902(r)(2) who will be included in the demonstration.

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and disabled with incomes up to the federal poverty level would have

added about $524 million to the baseline over 5 years.38

• Historical Inflation Argument. The administration allowed some states to

project increases in their baseline costs at rates higher than the

administration’s existing projections of national Medicaid spending

growth. These states successfully argued that past years’ spending

increases exceeded average national spending growth and thus justified a

higher or faster growing baseline. For example, in the first year of their

waivers, Florida and Tennessee received relatively large increases (about

16 percent) compared with the previous year. Florida also received large

annual increases for the remaining years of the waiver.

Because Medicaid costs in the late 1980s and the early 1990s grew for

reasons not expected to affect future spending, estimates of future

Medicaid expenditures that rely on historical cost growth may be inflated.

For example, although the states’ use of provider taxes and donations

contributed to the rapid rise of DSH payments between 1989 and 1993,

recent legislation strictly limits DSH growth. Also, some of the past cost

increases were due to the absorption of mandated and optional

populations and changes in benefits. Major new mandates have not been

added since 1991 and are not likely to be added in the foreseeable future.39

 Furthermore, continued rapid Medicaid cost increases may have been

unsustainable because of the great strain they placed on state budgets.

Facing rapid cost increases, states would have increased incentive to

adopt cost-containment measures. For example, Tennessee officials said

the state would have faced massive health care coverage reductions had

the waiver not been approved. In another example, after refusing to

approve the waiver, the Kentucky legislature reduced physician

reimbursements by $50 million.

Another part of the policy change since 1993 is to allow demonstrations to

show budget neutrality over the life of the waiver, but not to require it year

by year. HCFA agreed that states’ demonstration projects may involve

temporary start-up costs and permitted increased federal funding to help

pay these initial costs, as long as states expected to offset these costs by

38Federal Medicaid expenditures could increase substantially if all states provided eligibility for their

1902(r)(2) populations either under a section 1115 demonstration or as part of their regular program.

In its November 1994 report, the Urban Institute estimates that annual state and federal spending

could increase by between $5.5 billion and $23 billion. The exact amount would depend on how many

eligible individuals applied for coverage and how many individuals with private or employer-provided

insurance migrated to the publicly subsidized Medicaid program.

39As in the past, however, some states may attempt to shift state-funded health and social service

programs into Medicaid by extending coverage to optional beneficiaries and thus obtain federal

matching payments.

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reduced federal funding in later years. Oregon, and perhaps some of the

other states with waivers approved since 1993, expect that lower Medicaid

cost growth in later years will compensate the federal government for

higher expenses in the early years of the demonstrations.

Partial Caps May

Limit Federal Liability

While Heightening

State Risk

Each of the waiver agreements ensures some limits on federal spending

and holds some financial risk for the states. Because of the bilateral nature

of the negotiations between the states and HHS, and because of the

discretion granted to the Secretary of HHS in approving the waivers, the

terms and conditions for each state are unique. Thus, the net effect on

federal spending resulting from the waiver states’ Medicaid programs after

the 5-year life of the demonstrations may be different for each state. Under

any of the negotiated waivers, however, states are not to receive federal

assistance in paying for costs above the agreed-upon limits.

Hawaii, Kentucky, Ohio, Oregon, and Rhode Island have agreed to federal

spending limits called per capita caps, which are based on Medicaid

spending per person.40 As shown in table 4.1, these caps allow per person

spending to increase by a fixed percentage (plus the percentage change in

medical prices in Hawaii and Kentucky). Thus, if the number of eligibles

rises or, in Hawaii and Kentucky, if medical prices increase, the states can

obtain additional funding. However, if spending rises because of greater

utilization of services or a change in the mix of services provided, the

states are financially liable.

Under the waiver agreements for Tennessee and Florida, “aggregate caps,”

or limits on total spending, limit the federal government’s financial

exposure. In Tennessee, the state and the federal government agreed to set

a maximum for federal funding for each year of the waiver. Under these

terms, spending for Tennessee’s Medicaid program may increase from

$2.7 billion in 1993 to $4.1 billion in 1998. Florida and the federal

government also set a maximum for annual federal Medicaid funding.

Unlike Tennessee’s agreement, however, federal spending can exceed the

specified amounts if the number of traditional Medicaid beneficiaries

exceeds the projected number by more than 3 percent. This means the

state’s financial risk is limited if the Medicaid rolls swell because of an

40In Hawaii, Kentucky, Ohio, and Rhode Island, federal spending limits are based on the number of

Medicaid eligibles (including the hypothetical expansions) multiplied by historically based per person

fee-for-service costs, adjusted for actual inflation experience. In Oregon, the federal spending limit is

based on the number of Medicaid eligibles plus a portion of otherwise ineligible individuals multiplied

by actuarially developed per person costs that are agreed to by HCFA and the state.

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economic downturn, for example. The two caps also differ in that

Tennessee’s covers long-term care expenditures, while Florida’s does not.

Table 4.1: Type of Expenditure Cap

and Annual Adjustment, by State

State Type of cap Annual adjustment

Hawaii Per capita 4% plus medical inflationa

Tennessee Aggregate 5.1% to 8.3%b

Florida Aggregatec 14.3% to 15.7%b

Kentucky Per capita 3% plus medical inflation

Ohio Per capita 6.7% to 9.4%d

Oregon Per capita 8.5%

Rhode Island Per capita 4% to 8%b

aMedical inflation is measured by the medical component of the consumer price index.

bVaries by year.

cFederal funding is increased if the number of Medicaid eligibles grows by more than 3 percent.

dVaries by year and category of spending.

Some states may find funding their planned expansions difficult. Hawaii is

experiencing financial problems largely because more new eligibles

enrolled than expected. Oregon may also face difficulty, due in part to

higher than anticipated enrollment of new eligibles and the continuing

effects of a tax initiative passed in 1990 that limits state funds available for

Medicaid and other programs. Oregon is considering reducing the

capitation rate, changing eligibility rules, implementing premiums and

copayments, delaying full implementation of mental health services, and

reducing benefits, but will need HCFA approval before doing so. Moreover,

a state analysis suggests the program will not be budget neutral without

the cost savings anticipated from an employer mandate, for which the

state must obtain congressional action.41 Even with the necessary

congressional action, however, state political support for the mandate has

eroded because of business opposition and changes in the makeup of the

state legislature.

The impact of higher than anticipated costs on federal funding depends on

the specific waiver agreement and HCFA’s enforcement. In Florida’s case,

HCFA would help pay for the increased costs over the life of the waiver, but

41To mandate that employers provide health insurance to their employees, states need an exception to

provisions of the Employee Retirement Income Security Act. To date, only Hawaii has obtained such

an exception, largely because its employer mandate predated the passage of the act.

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expects to get paid back for the excess costs at the end of the 5-year

project. Ohio’s agreement is similar to Florida’s, except that it specifies

cumulative cost overrun ceilings. If Ohio’s cumulative spending exceeds

the ceiling, the state must submit a corrective action plan. In Tennessee,

the budget-neutrality agreement has a formula to prevent federal

expenditures from exceeding the yearly cap by more than a specified

percentage. Tennessee has agreed to take steps such as limiting

enrollment when this happens.

The total amount of federal funding required for the demonstrations also

depends, in part, on how HCFA defines and enforces its methodology for

determining the federal expenditure cap in states with per capita limits.

For example, even though the Oregon demonstration has been operating

for more than a year, HCFA and the state have yet to agree on a specific

methodology. The difference between two possible methods for

calculating the upper limit on federal spending amounts to more than

5 percent of the state’s Medicaid demonstration budget.42

42Other implementation and enforcement issues may also affect federal spending. For example, most

state demonstrations change the method for counting qualifying income from a net to a gross income

test. This change makes counting the number of Medicaid-eligible individuals imprecise. As a result,

the per capita cap states can only estimate the numbers to determine total federal expenditures for the

demonstration. The estimated counts will likely be different from actual counts using the net income

test, but whether they will be higher or lower is unknown.

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Chapter 5 

Observations on Medicaid’s Future

Millions of Americans—not only poor mothers and children, but also poor

elderly, blind, and disabled individuals—depend upon health care made

possible by the Medicaid program. Medicaid pays for both acute care and

long-term care services. The program underwrites the deliveries of about

one-third of the babies born in the United States each year and finances

about 50 cents of every dollar paid to nursing homes.

Medicaid is an expensive program. It currently consumes about 6 percent

of all federal outlays (3 times the share devoted to Food Stamps and 5

times the share devoted to AFDC). Moreover, Medicaid’s slice of the federal

budget is growing faster than most other major budget items, including

Medicare. If Medicaid continues indefinitely at its forecast growth rate

(10.7 percent), federal spending on the program will double roughly every

5 to 7 years.

Success in containing cost growth in Medicaid, as for the health care

sector at large, has been elusive. Care for the elderly, blind, and disabled

populations—particularly long-term care—is expensive, consuming more

than $80 billion of the $130 billion cost of Medicaid in 1993. For acute care

services, however, the promise of lower utilization has made the capitated

payment features of managed care plans attractive to the states.

Federal restrictions on the use of managed care reflect concerns for

quality, because capitated payments allow profits to be earned from

underservice. For example, the 75-25 rule seeks to ensure that Medicaid

managed care plans are of sufficient quality, as demonstrated by their

ability to attract private enrollees. At the same time, states believe that

restrictions like this hamper their efforts to implement managed care

effectively and that the need to obtain section 1115 waiver approval poses

unnecessary obstacles. Requiring states to seek waivers before

implementing these health care delivery system reforms may be

burdensome, especially if alternatives for addressing quality of care

concerns exist. Nonetheless, continuous oversight of managed care

systems is required to protect Medicaid beneficiaries from inappropriate

denial of care and federal dollars from payment abuses.

Section 1115 waivers, while freeing states to implement managed care

cost-containment strategies, could in the long run undermine efforts to

contain federal expenditures. Our study of the section 1115 waivers

approved to date raises the following concerns:

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Observations on Medicaid’s Future

• The administration is allowing states to apply the federal share of

Medicaid savings from managed care to finance coverage of additional

populations not included under Medicaid law. To meet the

budget-neutrality terms of section 1115 waivers, the administration and

states assume that the enrollment of the Medicaid populations in HMOs will

save states enough money to cover additional low-income people in the

state at no extra cost to the federal government. Even if the proposed

demonstrations will not require new federal dollars, the administration’s

approval of coverage expansions means that anticipated Medicaid cost

savings (from more aggressive use of capitated care) will not be used to

reduce federal spending. At issue is whether the federal treasury should

benefit from these savings. Also of concern is whether eligibility should be

made available for new groups only after congressional debate and

legislative action.

• The administration’s method for determining budget neutrality may allow

states access to more federal funding than they would have received

without the waiver. Our initial examination of four states’ proposed

demonstrations suggests that claims of budget neutrality for these states

may not be sustainable in all cases. While Tennessee’s demonstration

project may be budget neutral, the demonstrations in Florida, Hawaii, and

Oregon may require increased financial commitment from the federal

government. Relative to overall federal Medicaid spending, the amount

spent in states with approved section 1115 waivers is small. However, the

methods used by the administration to assess the budget neutrality of

pending and future waiver proposals may greatly affect federal Medicaid

spending in the years to come.

• The Congress may find it difficult to scale back section 1115

demonstrations if they prove more costly than forecast. A demonstration

waiver, granted for a limited period of time, may be a shortsighted

approach to reducing states’ uninsured populations. If at the end of 5 years

the demonstrations have cost much more than estimated, the Congress

may face the choice of increasing federal funding or relying on the states

to reduce benefits or deny coverage to hundreds of thousands of people

newly enrolled under the waivers.

For these reasons, we believe that the granting of additional section 1115

waivers merits close scrutiny.

Page 51 GAO/HEHS-95-122 Medicaid Spending Pressures
Chapter 6 

Agency Comments and Our Evaluation

The administration’s comments focused on two aspects of this report:

waiver review policy changes and our approach to analyzing the budget

neutrality of approved statewide section 1115 waivers, with which it

disagreed.43 In brief, our approach begins with a uniform and consistent

budget “neutrality” benchmark—OMB’s current services projections of

future Medicaid growth—for assessing the potential budget impact of

waivers. The administration contends that by using OMB’s national estimate

of projected Medicaid spending growth, we do not accurately capture the

variation in state spending patterns. Moreover, it maintains that current

services is an inappropriate tool for establishing budget neutrality.

Changes in Waiver

Review Policy

The administration’s response notes that its approach both to reviewing

waivers and to determining budget neutrality represents a departure from

previous administrations’ policies. Overall, it characterized its new

approach as “more flexible.”

Although budget neutrality is not specifically defined by regulation or

statute, the administration’s new approach is characterized by

(1) flexibility in determining appropriate baseline expenditures and

(2) assessment of budget neutrality over the life of the waiver rather than

year by year. Our analysis recognizes these key differences. In fact, we

conclude that the administration’s new approach represents a redefinition

of budget neutrality.

The Administration’s

Budget-Neutrality

Methodology

The administration characterizes its budget-neutrality policy as

“state-specific,” reflecting the historically “dramatic variation in state

Medicaid programs.” These variations, the administration notes, have

resulted in “radically different levels of expenditures and growth rates

across the states.” Lacking a state-specific Medicaid baseline, the

administration compares its national estimate of growth in Medicaid for

the nation as a whole with state historical expenditure growth in

determining a budget-neutrality benchmark.

Furthermore, the administration points out that it relies on current federal

law in establishing a state-specific neutrality benchmark. It notes that

“under current federal law states are able to engage in program

expansions and contractions” and that, in establishing a state-specific

budget-neutrality baseline, some judgment about states’ behavior should

be involved.

43Our methodology is described in chapter 1.

Page 52 GAO/HEHS-95-122 Medicaid Spending Pressures
Chapter 6 

Agency Comments and Our Evaluation

Our discussion of the administration’s approach to budget neutrality

recognizes the state-specific nature of its methodology. Thus, in chapter 4,

we indicate that the waiver funding agreements for Florida and Tennessee

were based on an analysis of large annual growth rates over the past 5

years. We conclude, however, that some of the factors underlying

Medicaid’s very rapid and recent cost growth will be much less significant

in the future and that relying on historical cost growth is inappropriate.

For example, a major cause of Medicaid’s rapid growth in the past—DSH

payments—has been strictly limited by 1991 and 1993 legislation. In

addition, major new mandatory coverage expansions are not likely to be

undertaken in the foreseeable future.

Demonstration Nature

of the Section 1115

Waivers

The administration disputes our contention that the comprehensive scope

of the waiver demonstrations makes it controversial to characterize them

as experimental. It notes that the waivers allow states to experiment with

innovative delivery and payments systems for their Medicaid and

low-income populations and that each demonstration has unique

components deemed worthy of evaluation. We view the sheer magnitude

of some of the waiver projects as what makes it difficult to consider them

experimental. Once coverage has been extended to several hundred

thousand people, we anticipate significant difficulty in terminating a

demonstration if the innovations being tested fail to achieve the intended

objectives.

Key Areas of

Disagreement

As suggested by the administration, in our initial analysis we have applied

a more rigid method for assessing budget neutrality. We take a more

uniform base—previous-year spending—and allow it to grow at the rate of

increase expected by OMB for the national program. Because we recognize

the significant differences in state Medicaid programs’ experiences, our

preference would have been to use consistently generated state forecasts

of expected Medicaid spending. However, neither OMB nor the

Congressional Budget Office has developed such forecasts. We believe

that using states’ historical experiences without adjustments may not be a

good guide for the future. In our ongoing work, we are examining

state-specific information to determine what adjustments to the national

forecasts might be appropriate.

In contrast to our efforts to develop a consistent methodology, the

administration’s budget-neutrality assessments appear not to be

consistent. Thus, in some states, aggregate spending trends over the past 5

Page 53 GAO/HEHS-95-122 Medicaid Spending Pressures
Chapter 6 

Agency Comments and Our Evaluation

years appear to have been the dominant factor used to project

budget-neutral spending over the next 5 years. In other states, trends in

average costs per person were the major factor used to define

budget-neutral trends over the life of the waiver. By using unique methods

in each state, the administration has created the potential for

budget-neutrality decisions to be based on the technique most favorable to

a particular state. We continue to believe that a consistent approach is

more appropriate for budget purposes.

If state-specific reasons exist for future Medicaid program growth above

(or below) national standards, they should be well documented. However,

in reviewing state waiver submissions, no special factors were identified

that would justify future growth above a national benchmark.

Finally, the administration suggests that a current law baseline is more

appropriate than a current services baseline in assessing budget neutrality.

That is, the budget-neutrality assessment should be based on “what states

might do” under current law rather than “what states are doing.” However,

the administration also notes that the President’s budget does not

distinguish between current services and current law. Although current

law gives states the latitude to expand coverage to optional populations,

not all states have chosen to do so. We continue to believe that “what

states are doing” should be the basis for determining budget neutrality.

The complete text of the administration’s comments is in appendix IV.

Page 54 GAO/HEHS-95-122 Medicaid Spending Pressures
Page 55 GAO/HEHS-95-122 Medicaid Spending Pressures
Appendix I 

Major Federal Expansions of Medicaid

Eligibility and Services (1984-93)

Table I.1: Federal Medicaid Expansion

to AFDC Recipients and Related

Populations

Population affected Expansion Mandate/option

DEFRA (Deficit Reduction Act of 1984) (P.L. 98-369)

Infantsa and children Requires coverage of all

children born after 9/30/83

who meet state AFDC

income and resource

standards, regardless of

family structure.

Mandate

Pregnant women Requires coverage from

date of medical verification

of pregnancy, providing the

mother would (1) qualify for

AFDC once child was born

or (2) qualify for AFDC-UPb

once child was born,

regardless of whether state

has AFDC-UP program.

Mandate

Infants Requires automatic

coverage for 1 year after

birth if mother already is

receiving Medicaid and

remains eligible and infant

resides with her.

Mandate

AFDC families Requires limited extension

of Medicaid coverage if

AFDC eligibility is lost as a

result of increased earnings.

Mandatec

AFDC families Extends earned income

disregardd from 4 to 12

months.

Mandate

COBRA (Consolidated Omnibus Budget Reconciliation Act of 1985) (P.L. 99-272)

Pregnant women Requires coverage if family

income and resources are

below state AFDC levels,

regardless of family

structure.

Mandate

Postpartum women Requires 60-day extension

of coverage postpartum if

eligibility was

pregnancy-related.

Mandate

Pregnant women Allows provision of

enhanced benefits.

Option

Infants and children Allows extension of DEFRA

coverage up to age 5

immediately, instead of

requiring phase-in by birth

date.

Option

(continued)

Page 56 GAO/HEHS-95-122 Medicaid Spending Pressures
Appendix I 

Major Federal Expansions of Medicaid

Eligibility and Services (1984-93)

Population affected Expansion Mandate/option

Adoptive and foster children Requires coverage even if

adoption/foster agreement

was entered into in another

state.

Mandate

OBRA 1986 (Omnibus Budget Reconciliation Act of 1986) (P.L. 99-509)

Pregnant women and infants Creates new optional

categorically needy group

for those with incomes

below poverty line. Women

receive pregnancy-related

services only.

Option

Pregnant women and infants Allows assets test to be

dropped for this newly

defined category of

applicants.

Option

Pregnant women Allows presumptive

eligibility for up to 45 days

to be determined by

qualified provider.

Option

Pregnant women Allows guarantee of

continuous eligibility

through postpartum period.

Option

Children Allows coverage up to age

5 if family income is below

poverty line (phased in).

Option

Infants and children Requires continuation of

eligibility (for those who

otherwise would become

ineligible) if individuals are

hospital inpatients when

age limit is reached.

Mandate

OBRA 1987 (Omnibus Budget Reconciliation Act of 1987) (P.L. 100-203)

Pregnant women and infants Allows coverage if family

income is below 185% of

poverty line.

Option

Children Allows immediate extension

of OBRA 1986 coverage for

children up to age 5 in

families with incomes up to

the poverty line.

Option

Children Clarifies that states may

provide in-home services

for qualified disabled

children.

Option

Children Allows coverage for

children aged 5-7 up to

state AFDC level (phased in

by age).

Option

(continued)

Page 57 GAO/HEHS-95-122 Medicaid Spending Pressures
Appendix I 

Major Federal Expansions of Medicaid

Eligibility and Services (1984-93)

Population affected Expansion Mandate/option

Children Allows coverage for

children below age 9 in

families with incomes up to

the poverty line (phased in

by age).

Option

MCCA (Medicare Catastrophic Coverage Act of 1988) (P.L. 100-360)

Pregnant women and infants Makes mandatory the

OBRA 1986 option of

coverage up to the poverty

line (phased in by % of

poverty line).

Mandate

Family Support Act of 1988 (P.L. 100-485)

AFDC families Increases required period

of Medicaid coverage if

AFDC cash assistance is

lost as a result of increased

earnings.

Mandatee

AFDC families with

unemployed parent

(AFDC-UP)

Requires coverage if

otherwise qualified.

Mandate

OBRA 1989 (Omnibus Budget Reconciliation Act of 1989) (P.L. 101-239)

Pregnant women and infants Requires coverage if family

income is below 133% of

poverty line.

Mandate

Children Requires coverage up to

age 6 if family income is

below 133% of poverty line.

Mandate

Children Requires provision of all

Medicaid-allowed treatment

to correct problems

identified during early and

periodic screening,

diagnostic, and treatment

(EPSDT), even if treatment

is not covered otherwise

under state’s Medicaid plan.

Mandate

Children Requires interperiodicf

screenings under EPSDT

when medical problem is

suspected.

Was an option, now

mandated

OBRA 1990 (Omnibus Budget Reconciliation Act of 1990) (P.L. 101-508)

Children Requires coverage up to

age 18 if family income is

below the poverty line

(phased in by age).

Mandate

Pregnant women Makes mandatory the

OBRA 1986 option of

continuous eligibility

through postpartum period.

Mandate

(continued)

Page 58 GAO/HEHS-95-122 Medicaid Spending Pressures
Appendix I 

Major Federal Expansions of Medicaid

Eligibility and Services (1984-93)

Population affected Expansion Mandate/option

Pregnant women Extends period of

presumptive eligibility

before written application

must be submitted.

Mandate

Pregnant women and children Requires states to receive

and process applications at

convenient outreach sites.

Mandate

Infants Requires continuous

eligibility if (1) born to

Medicaid-eligible mother

who would remain eligible if

pregnant and (2) remaining

in mother’s household.

Mandate

OBRA 1993 (Omnibus Budget Reconciliation Act of 1993) (P.L. 103-66)

Mothers and newborns Expands scope of required

nurse-midwife services to

include services outside the

maternity cycle that

midwives are authorized to

perform under state law.

Mandate

Children Requires state Medicaid

programs to establish a

program to distribute

pediatric vaccines

furnished by the federal

government.

Mandate

aInfants are children up to age 1.

bAFDC-UP allows coverage in two-parent families if principal wage-earner is unemployed.

cMandate is for 9 months. State may opt to provide additional 6-month period of coverage.

dCertain expenses associated with work are disregarded from income in calculating AFDC

eligibility.

eMandate is for 12 months. State may opt to provide additional 6-month period of coverage.

f

States establish a screening schedule: “Interperiodic” visits are added to the standard schedule

if a problem is suspected.

Page 59 GAO/HEHS-95-122 Medicaid Spending Pressures
Appendix I 

Major Federal Expansions of Medicaid

Eligibility and Services (1984-93)

Table I.2: Federal Medicaid Expansion

to the Population Receiving SSI Population affected Expansion Mandate/option

DEFRA (Deficit Reduction Act of 1984) (P.L. 98-369)

SSI recipients Increases qualifying asset

limits for applicants for

limited time period

(1984-89).

Mandate

COBRA (Consolidated Omnibus Budget Reconciliation Act of 1985) (P.L. 99-272)

Children with special needs Requires coverage

regardless of

income/resources of

adoptive/foster parents.

Mandate

OBRA 1986 (Omnibus Budget Reconciliation Act of 1986) (P.L. 99-509)

Aged and disabled Creates new optional

categorically needy group

for those with incomes

below the poverty line

under certain resource

constraints. Option can be

exercised for this group

only if exercised also for

pregnant women and

infants.

Option

Aged and disabled Allows Medicare buy-ina up

to the poverty line for

qualified Medicare

beneficiaries under certain

resource constraints.

Option

Severely impaired individuals Establishes new mandatory

categorically needy

coverage group for

qualified individuals under

age 65.

Mandate

Ventilator-dependent

individuals

Allows coverage of at-home

respiratory care services.

Option

SSI recipients Makes permanent the

previous temporary

provision requiring

coverage of some former

disabled SSI recipients who

have returned to work.

Mandate

Employment Opportunities for Disabled Americans Act of 1986 (P.L. 99-643)

Disabled individuals Makes permanent a

previous demonstration

program for individuals able

to engage in substantial

gainful activity despite

severe medical impairments.

Mandate

(continued)

Page 60 GAO/HEHS-95-122 Medicaid Spending Pressures
Appendix I 

Major Federal Expansions of Medicaid

Eligibility and Services (1984-93)

Population affected Expansion Mandate/option

OBRA 1987 (Omnibus Budget Reconciliation Act of 1987) (P.L. 100-203)

Elderly Allows provision of home

and community-based

services to those who

otherwise would need

nursing home care.b

Option

Nursing home applicants Requires states to establish

preadmission screening

programs for mentally ill

and retarded individuals.

Mandate

Nursing home residents Requires preadmission

screening and annual

resident review for mentally

ill or retarded individuals.

Mandate

MCCA (Medicare Catastrophic Coverage Act of 1988) (P.L. 100-360)

Elderly and disabled

individuals

Makes mandatory for

qualified Medicare

beneficiaries the OBRA

1986 option of Medicare

buy-in for individuals with

incomes up to the poverty

line (phased in by % of

poverty line).

Mandate

OBRA 1990 (Omnibus Budget Reconciliation Act of 1990) (P.L. 101-508)

Elderly and disabled

individuals

Extends the MCCA qualified

Medicare beneficiary

provision to individuals with

incomes up to 120% of

poverty line (phased in by

% of poverty line).

Mandate

Elderly and disabled

individuals

Allows limited program

permitting states to provide

home and

community-based services

to functionally disabled

individuals, and

community-supported living

arrangements to mentally

retarded/ developmentally

disabled individuals.

Option

OBRA 1993 (Omnibus Budget Reconciliation Act of 1993) (P.L. 103-66)

SSI recipients Allows states to offer

Medicaid coverage to

TB-infected individuals who

meet the state’s income and

resource tests.

Option

aMedicaid covers Medicare cost-sharing charges: premiums, deductibles, and coinsurance.

bThis is not automatic. HCFA must grant a waiver to any state wishing to provide these services.

Page 61 GAO/HEHS-95-122 Medicaid Spending Pressures
Appendix I 

Major Federal Expansions of Medicaid

Eligibility and Services (1984-93)

Table I.3: Federal Medicaid Expansion

to Other Populations and Service

Additions

Population affected Expansion Mandate/option

COBRA (Consolidated Omnibus Budget Reconciliation Act of 1985) (P.L. 99-272)

Terminally ill individuals Allows provision of hospice

services.

Option

OBRA 1986 (Omnibus Budget Reconciliation Act of 1986) (P.L. 99-509)

Aliens Requires provision of

emergency services if

otherwise eligible

(financially and

categorically).

Mandate

IRCA (Immigration Reform and Control Act of 1986) (P.L. 99-603)

Newly legalized aliens Requires provision of

emergency and

pregnancy-related services

if otherwise eligible. Also

requires full coverage for

eligible individuals under 18.

Mandate

Anti-Drug Abuse Act of 1986 (P.L. 99-570)

Homeless Requires state to provide

proof of eligibility for

individuals otherwise

eligible but having no

permanent address.

Mandate

OBRA 1993 (Omnibus Budget Reconciliation Act of 1993) (P.L. 103-66)

Medicaid beneficiaries Makes coverage of

personal care services

outside the home an

optional rather than a

mandatory service.

Option

Aliens Clarifies that

Medicaid-covered

emergency services for

aliens do not include care

and services related to

organ transplant

procedures.

Mandate

Page 62 GAO/HEHS-95-122 Medicaid Spending Pressures
Appendix II 

Application of the Disproportionate Share

Hospital Program

Overview of Program

Operation

The disproportionate share hospital (DSH) program was established in 1981

to enable states to provide additional payments to hospitals with heavy

caseloads of Medicaid and other low-income patients. The supplemental

payments are intended to help defray costs not covered by Medicaid

(because of low reimbursement rates) or private insurance. Subject to

certain minimums required by federal law, each state decides on its own

criteria for identifying DSHs and its formula for making payments to these

hospitals.

In the mid-1980s, some states began using recently relaxed rules on raising

state Medicaid funds, together with the DSH program, to leverage additional

federal dollars. Using this creative financing scheme, these states were

able to increase the share of the state Medicaid program funded by the

federal government. One common variant of the financing mechanism

could be described as follows. A state would receive donations from or

levy a tax on specific hospitals. The state would then return the funds to

the same hospitals in the form of DSH payments. Because these payments

would trigger federal medical assistance payments, the hospitals would

receive more in DSH payments than they had provided to the state in

donations or taxes. In the end, the hospitals would have received more

money because of the scheme, all of it coming from the federal

government and none from the state. States could also set the DSH

payments so that the new federal funding flowed to the state, and the

hospitals received total DSH payments (federal and state combined) just

large enough to exactly compensate them for their taxes and donations.

Our August 1994 report detailed how Michigan, Tennessee, and Texas

used various financing schemes to increase the federal share of Medicaid

expenditures without effectively committing their share of state matching

funds.44

Financing

Mechanisms Used in

Michigan

In fiscal year 1993, Michigan used hospital donations to help raise funds

for its Medicaid program. Michigan made DSH payments of $458 million,

including $256 million in federal matching funds, to 53 hospitals; however,

the hospitals returned all but $6 million to the state. As a result, the state

received a $250 million net benefit from the federal share of the DSH

payments. Michigan stopped this practice because 1991 federal legislation,

which took effect for Michigan on January 1, 1993, severely limited

provider donations.

44Medicaid: States Use Illusory Approaches to Shift Program Costs to Federal Government

(GAO/HEHS-94-133, Aug. 1, 1994).

Page 63 GAO/HEHS-95-122 Medicaid Spending Pressures
Appendix II 

Application of the Disproportionate Share

Hospital Program

In response to these limitations, Michigan’s 1994 DSH program included

$489 million for those hospitals that provided at least 6 percent of

inpatient services to indigent patients in the state. State officials

determined that only one hospital would qualify—the state-owned

University of Michigan hospital.

On October 2, 1993, Michigan made a DSH payment of $489 million to the

University of Michigan hospital. This included $276 million in federal

matching funds and $213 million in state funds. Later that day, the hospital

returned the entire payment to the state, resulting in a net benefit to the

state of $276 million.

Beginning in 1995, the University of Michigan DSH payment will be severely

restricted by the Omnibus Budget Reconciliation Act of 1993.45 State

officials have calculated that the state can make a 1995 DSH payment to the

University of Michigan hospital of $136.3 million. To make up for the

shortfall from the restrictions on the payments to the University of

Michigan in 1995, the state has proposed making payments of about

$590 million, including federal funds of $335 million, to 92

government-owned hospitals and community health boards. According to

the proposal, these governmental entities will then transfer the funds back

to the state, thereby allowing the state to continue to benefit from federal

Medicaid matching funds.

Under each of the financing mechanisms, providers that received Medicaid

payments from the state in turn paid the state almost as much as they

received.46 In effect, in fiscal year 1993 Michigan increased the federal

percentage share of total Medicaid spending from 56 percent to 68 percent.

The Urban Institute’s

DSH Study

In addition to our work on this issue, a December 1994 Urban Institute

study reported on how 39 states developed special financing programs.47

45This legislation limits such payments for 1995 to 200 percent of each qualifying hospital’s costs for

Medicaid and uninsured patients, less the hospital’s total Medicaid reimbursement and payments

received from the uninsured. In subsequent years, the act limits DSH payments to the amount of a

hospital’s uncovered costs.

46HCFA advised us that other states are using similar financing arrangements.

47Medicaid Disproportionate Share and Other Special Financing Programs: A Fiscal Dilemma for States

and the Federal Government, The Urban Institute, (Dec. 1994). The study was sponsored by the Kaiser

Commission on the Future of Medicaid. It obtained information from 39 state Medicaid agencies

relating to special financing programs and described the types of hospitals that participated in the

programs, how much they contributed, and how much they received in DSH and related payments. To

obtain detailed information about the use of DSH funds at the state, county, and hospital levels, case

studies, using telephone interviews, were conducted in six states.

Page 64 GAO/HEHS-95-122 Medicaid Spending Pressures
Appendix II 

Application of the Disproportionate Share

Hospital Program

States collected $5.8 billion through intergovernmental transfers, and

taxes and donations from private and county health care providers. This

money was augmented with $7.6 billion from federal matching payments,

for a total of about $13.4 billion. The states used these revenues to make

payments to private, county, and state providers.

The study found that most of the DSH payments, about $8.5 billion, were

made to help needy private and county providers. Since these providers

contributed $5.8 billion, they realized a gain of $2.7 billion. Hospital

officials stated that they used these funds to (1) cover overall hospital

operations, including uncompensated care and losses on Medicaid

patients; (2) provide AIDS services; (3) pay for capital expenditures, such

as opening a new clinic, purchasing an ambulance, or replacing x-ray

equipment; (4) secure a commercial bank loan; (5) maintain day-to-day

operations because Medicaid payments were often in arrears; and

(6) generate income that resulted from placing the funds in interest

bearing trusts. These officials emphasized that although the DSH payments

helped their hospitals, they were not enough to cover total uncompensated

care losses.

State hospitals received $4.8 billion in DSH payments. However, hospital

officials indicated that only a small share of the gains were actually

retained and available to pay for health care services, such as

uncompensated care. Instead, most of the gains were transferred back to

state general revenue accounts. Here, they were mixed with other state

funds and used to help balance overall state budgets. In some cases, the

extra funds were used to support Medicaid, mental health, or general

health and welfare spending. Hospital officials believed that to the extent

that the DSH programs helped the overall state budget, the programs

indirectly helped the hospital’s budget. State officials believed that these

additional funds prevented larger cuts in the Medicaid program.

Page 65 GAO/HEHS-95-122 Medicaid Spending Pressures
Appendix III 

GAO Products on Medicaid

Medicaid: Restructuring Approaches Leave Many Questions

(GAO/HEHS-95-103, Apr. 4, 1995).

Uninsured and Children on Medicaid (GAO/HEHS-95-83R, Feb. 14, 1995).

Medicaid Long-Term Care: Successful State Efforts to Expand Home

Services While Limiting Costs (GAO/HEHS-94-167, Aug. 11, 1994).

Medicaid: Changes in Best Price for Outpatient Drugs Purchased by HMOs

and Hospitals (GAO/HEHS-94-194FS, Aug. 5, 1994).

Medicaid: States Use Illusory Approaches to Shift Program Costs to

Federal Government (GAO/HEHS-94-133, Aug. 1, 1994).

Health Care Reform: Potential Difficulties in Determining Eligibility for

Low-Income People (GAO/HEHS-94-176, July 11, 1994).

Medicaid Prenatal Care: States Improve Access and Enhance Services, but

Face New Challenges (GAO/HEHS-94-152BR, May 10, 1994).

Managed Health Care: Effect on Employers’ Costs Difficult to Measure

(GAO/HRD-94-3, Oct. 19, 1993).

Medicaid Managed Care: Healthy Moms, Healthy Kids—A New Program

for Chicago (GAO/HRD-93-121, Sept. 7, 1993).

Medicaid: Improving Funds Distribution (GAO/HRD-93-112FS, Aug. 20, 1993).

Medicaid Drug Fraud: Federal Leadership Needed to Reduce Program

Vulnerabilities (GAO/HRD-93-118, Aug. 2, 1993).

Medicaid Estate Planning (GAO/HRD-93-29R, July 20, 1993).

Medicaid: Data Improvements Needed to Help Manage Health Care

Program (GAO/IMTEC-93-18, May 13, 1993).

Medicaid: HealthPASS—An Evaluation of a Managed Care Program for

Certain Philadelphia Recipients (GAO/HRD-93-67, May 7, 1993).

Medicaid: The Texas Disproportionate Share Program Favors Public

Hospitals (GAO/HRD-93-86, Apr. 30, 1993).

Page 66 GAO/HEHS-95-122 Medicaid Spending Pressures
Appendix III 

GAO Products on Medicaid

Medicaid Formula Alternatives (GAO/HRD-93-18R, Mar. 31, 1993).

Medicaid: Outpatient Drug Costs and Reimbursements for Selected

Pharmacies in Illinois and Maryland (GAO/HRD-93-55FS, Mar. 18, 1993).

Medicaid: States Turn to Managed Care to Improve Access and Control

Costs (GAO/HRD-93-46, Mar. 17, 1993).

Medicaid Formula Alternative (GAO/HRD-93-17R, Mar. 2, 1993).

Medicaid: Changes in Drug Prices Paid by HMOs and Hospitals Since

Enactment of Rebate Provisions (GAO/HRD-93-43, Jan. 15, 1993).

Medicaid: Disproportionate Share Policy (GAO/HRD-93-3R, Dec. 22, 1992).

Medicaid: Oregon’s Managed Care Program and Implications for

Expansions (GAO/HRD-92-89, June 19, 1992).

Medicaid: Ensuring That Noncustodial Parents Provide Health Insurance

Can Save Costs (GAO/HRD-92-80, June 17, 1992).

Medicaid Third-Party Liability (GAO/HRD-92-21R, Mar. 3, 1992).

Medicaid: Changes in Drug Prices Paid by VA and DOD Since Enactment

of Rebate Provisions (GAO/HRD-91-139, Sept. 18, 1991).

Managed Care: Oregon Program Appears Successful But Expansion

Should Be Implemented Cautiously (GAO/T-HRD-91-48, Sept. 16, 1991).

Medicaid Expansions: Coverage Improves But State Fiscal Problems

Jeopardize Continued Progress (GAO/HRD-91-78, June 25, 1991).

Substance Abuse Treatment: Medicaid Allows Some Services But

Generally Limits Coverage (GAO/HRD-91-92, June 13, 1991).

Medicaid: Alternatives for Improving the Distribution of Funds

(GAO/HRD-91-66FS, May 20, 1991).

Medicaid: HCFA Needs Authority to Enforce Third-Party Requirements on

States (GAO/HRD-91-60, Apr. 11, 1991).

Page 67 GAO/HEHS-95-122 Medicaid Spending Pressures
Appendix III 

GAO Products on Medicaid

Medicaid: Legislation Needed to Improve Collections From Private

Insurers (GAO/HRD-91-25, Nov. 30, 1990).

Medicaid: Millions of Dollars Not Recovered From Michigan Blue

Cross/Blue Shield (GAO/HRD-91-12, Nov. 30, 1990).

Long-Term Care Insurance: Proposals to Link Private Insurance and

Medicaid Need Close Scrutiny (GAO/HRD-90-154, Sept. 10, 1990).

Nursing Homes: Admission Problems for Medicaid Recipients and

Attempts to Solve Them (GAO/HRD-90-135, Sept. 5, 1990).

Medicaid: Oversight of Health Maintenance Organizations in the Chicago

Area (GAO/HRD-90-81, Aug. 27, 1990).

Medicaid: States Expand Coverage for Pregnant Women, Infants, and

Children (GAO/HRD-89-90, Aug. 16, 1989).

Medicaid: Recoveries From Nursing Home Residents’ Estates Could Offset

Program Costs (GAO/HRD-89-56, Mar. 7, 1989).

Medicaid: Some Recipients Neglect to Report U.S. Savings Bond Holdings

(GAO/HRD-89-43, Jan. 18, 1989).

Medicaid: Changing Medicaid Formula Can Improve Distribution of Funds

to States (GAO/GGD-83-27, Mar. 9, 1983).

Page 68 GAO/HEHS-95-122 Medicaid Spending Pressures
Appendix IV 

Comments From the Administration

Page 69 GAO/HEHS-95-122 Medicaid Spending Pressures
Appendix IV 

Comments From the Administration

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Appendix IV 

Comments From the Administration

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Appendix IV 

Comments From the Administration

Page 72 GAO/HEHS-95-122 Medicaid Spending Pressures
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Comments From the Administration

Page 73 GAO/HEHS-95-122 Medicaid Spending Pressures
Appendix V 

Major Contributors to This Report

GAO Contacts William J. Scanlon, Associate Director, (202) 512-4561

James C. Cosgrove, Assistant Director, (202) 512-7029

Alfred R. Schnupp, Evaluator-in-Charge, (202) 512-7159

Acknowledgments In addition to those named above, the following individuals made

important contributions to this report: Hannah F. Fein wrote major

sections of the draft; Michael Gutowski, Walter S. Ochinko, and Cheryl A.

Williams provided information and analysis on section 1115 Medicaid

waivers; Richard N. Jensen provided advice on Medicaid programmatic

details; Paul T. Wagner, Jr. gathered data and produced the graphics.

(101331) Page 74 GAO/HEHS-95-122 Medicaid Spending Pressures
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