Report to Congressional Requesters

United States General Accounting Office

GAO

October 2001 MEDICAID

HCFA Reversed Its

Position and

Approved Additional

State Financing

Schemes

GAO-02-147
Page i GAO-02-147 Medicaid State Financing Schemes

Letter 1

Results in Brief 2

Background 3

HCFA’s Position Reversal Opened the Door for More Excessive

Payments 8

HCFA’s Position Reversal Had Substantial Financial Effect 9

Conclusions 14

Agency and State Comments 15

Appendix I Chronology of HCFA’s Changing Position on Pending

State Plan Amendments 19

Appendix II Comments From the Centers for Medicare and

Medicaid Services 20

Appendix III Comments From the Commonwealth of Virginia 22

Appendix IV Comments From the State of Wisconsin 25

Related GAO Products 26

Tables

Table 1: Previous Medicaid Financing Schemes for Generating

Excessive Federal Funds Without Committing a

Corresponding State Contribution 5

Table 2: Overview of Process for Exploiting Upper Payment Limit 10

Table 3: Federal Share of Excessive Payments in Virginia and

Wisconsin Under HCFA’s January 2001 Regulation 11

Table 4: Impact of September 5, 2001, Rule on Excessive Federal

Payments to Virginia and Wisconsin 12

Contents
Page ii GAO-02-147 Medicaid State Financing Schemes

Figures

Figure 1: Key Dates in Revising the Upper Payment Limit (UPL)

Regulation and Approving Pending Plan Amendments in

Virginia and Wisconsin 13

Abbreviations

BIPA Medicare, Medicaid, and SCHIP Benefits Improvement and

Protection Act of 2000

CMS Centers for Medicare and Medicaid Services

DSH disproportionate share hospital

HCFA Health Care Financing Administration

HHS Department of Health and Human Services

OIG Office of Inspector General

UPL upper payment limit
Page 1 GAO-02-147 Medicaid State Financing Schemes

October 30, 2001

The Honorable Max Baucus

Chairman

The Honorable Charles E. Grassley

Ranking Minority Member

Committee on Finance

United States Senate

The Honorable Don Nickles

United States Senate

States have been searching for ways to help finance the $196 billion

Medicaid program, a jointly funded federal-state program providing health

care services to certain low-income, elderly, and disabled people. Over the

years, some states have taken advantage of the flexibility that the

Congress has built into the Medicaid program by devising financing

schemes that inappropriately boost the federal share of program

expenditures. Last year, we testified about a regulatory loophole some

states were exploiting to increase federal Medicaid payments under

existing “upper payment limit” provisions.1

 These provisions represent

upper bounds on what the federal government is willing to pay as its share

of the costs of different classes of covered services. States were

inappropriately increasing federal Medicaid payments by paying nursing

homes and hospitals owned by local governments more than they would

normally receive and then having them return the bulk of the extra money

to the state. The states then sought federal matching funds—based on the

full amount they paid to providers—which they were free to use as they

wished. These schemes were adding billions of dollars a year to federal

Medicaid costs without the states paying their statutorily specified share

of program costs and with some of the federal funds being spent for nonMedicaid purposes. The Congressional Budget Office concluded in

January 2001 that such schemes were the most notable factor behind

recent increases in federal Medicaid spending, which is growing at a rate

nine times that of the Medicaid population.2

 1

Medicaid: State Financing Schemes Again Drive Up Federal Payments

(GAO/T-HEHS-00-193, Sept. 6, 2000).

2

The Budget and Economic Outlook: Fiscal Years 2002-2011 (Washington, D.C.:

Congressional Budget Office, Jan. 2001).

United States General Accounting Office

Washington, DC 20548
Page 2 GAO-02-147 Medicaid State Financing Schemes

After hearing about this latest financing scheme, the Congress acted

promptly to stop it, as it has done in the past when similar schemes have

come to light. In response to the Medicare, Medicaid, and SCHIP Benefits

Improvement and Protection Act of 2000 (BIPA),3

 the Health Care

Financing Administration (HCFA)4

 issued regulations in January 2001

designed to curtail financing schemes involving excessive payments to

local government providers, for which a separate upper payment limit did

not exist. However, in April 2001, less than 1 month after the revised upper

payment limit regulation became effective, HCFA decided to amend the

regulation to shorten the amount of time some states were allowed to

comply with the new regulation. This latest revision to the upper payment

limit regulation was published on September 5, 2001.

This report addresses (1) how HCFA’s actions to implement the January

2001 upper payment limit regulation permitted additional states to

establish the same type of financing schemes that it was attempting to

curtail and (2) the estimated additional costs to the federal government of

the largest two of these newly established schemes. In preparing this

report, we reviewed HCFA’s notices of proposed rule-making and final

regulations and documentation related to the four states affected by the

September 2001 regulation: Florida, Michigan, Virginia, and Wisconsin. We

focused our work on Virginia and Wisconsin because they represented 96

percent of the excessive federal payments the agency identified as subject

to its latest regulation. We also drew upon our earlier work.5

 We

conducted our work between August and September 2001 in accordance

with generally accepted government auditing standards.

HCFA reversed its stated position that it would deny approval of any

pending state plan amendments that would not comply with the new upper

payment limit regulation. The position reversal resulted in its approval of

new financing schemes for several states—including Virginia and

Wisconsin—that had pending proposals mimicking the schemes identified

last year. These schemes include funneling excessive Medicaid payments

 3

P.L. 106-554, Appendix F, Sec. 705, 114 Stat. 2763, 2763A-575.

4

In June 2001, HCFA was renamed the Centers for Medicare and Medicaid Services (CMS).

We continue to refer to HCFA where agency actions were taken under its former name.

5

See list of related GAO products at the end of this report.

Results in Brief
Page 3 GAO-02-147 Medicaid State Financing Schemes

through local governments on behalf of nursing homes to secure federal

matching funds.

HCFA’s approval of Virginia’s and Wisconsin’s new financing schemes

enables these two states to generate an estimated $722 million in

excessive federal payments. The agency’s September regulation, which

limited the length of time states can operate their newly approved

excessive funding schemes, reduced these estimated excessive federal

payments by about $483 million from an earlier estimate of $1.2 billion.

HCFA’s January regulation had established transition periods to allow

states time to reduce their reliance on federal funds that state schemes

had generated. The transition periods were of varying lengths, depending

on how long a state had been receiving excessive federal payments from

one of these schemes. Believing that states just starting to receive

excessive federal payments—such as Virginia and Wisconsin—did not

need the 2-year transition period established in the January regulation,

HCFA decided to shorten the transition period in order to limit federal

liability. While this September regulation will reduce the drain on federal

Medicaid funds, we question HCFA’s decision to approve additional

financing schemes, given the explicit effort to curtail such schemes.

In commenting on a draft of this report, the Administrator of the Centers

for Medicare and Medicaid Services (CMS) and the Virginia and Wisconsin

state Medicaid directors disagreed with our conclusion that HCFA’s

decision in January 2001 to approve additional state financing schemes

was unjustified. We continue to believe that HCFA had the authority, the

discretion, and the responsibility to deny any proposed state plan

amendments that were inconsistent with protecting the fiscal integrity of

the Medicaid program.

The Congress has structured Medicaid as a federal-state partnership that

provides federal matching funds for covered state expenditures and,

within broad federal guidelines, gives states considerable flexibility in

deciding what medical services to cover and how much to reimburse

medical providers. At the federal level, the program is administered by

CMS, within the Department of Health and Human Services (HHS). Each

state operates its program under a plan that CMS must approve for

compliance with current law and regulations. CMS must also approve any

amendments to the plan. On average, the federal government pays 57

Background
Page 4 GAO-02-147 Medicaid State Financing Schemes

percent of Medicaid costs, which totaled an estimated $196 billion in fiscal

year 2000.6

To ensure the reasonableness of payments to providers, HCFA established

a set of upper payment limits on the total amounts it would agree to pay

for a variety of services.7

 The upper limits are based on what Medicare (the

federal health care program for elderly and some disabled individuals)

would pay for comparable services. The upper payment limit is not a price

to be paid for each service provided or a limit on the amount paid to

individual facilities, but rather a ceiling on Medicaid payments for a

category of providers above which the federal government will not share.

Because state Medicaid payment rates are generally less than Medicare

rates, states often have large gaps between their actual Medicaid payments

and what they would pay using Medicare payment rates. States’ upper

payment limit schemes are designed to exploit this gap so the state can

obtain federal matching funds without paying its statutorily determined

share.

Despite limits on federal payments, the flexibility that states have to set

Medicaid’s payment rates has provided the opportunity for some to

develop various financing schemes in the past that inappropriately

increased federal Medicaid payments. Over more than a decade, states

have used a variety of schemes to boost federal Medicaid funding without

contributing their specified share. As these schemes came to light, they

were subsequently restricted by law or regulation (see table 1). For

example, after HCFA became aware of schemes involving excessive

federal payments to state-owned hospitals and nursing homes, it

promulgated regulations to restrict excessive payments to these providers.

Such restrictions, however, did not extend to certain government health

care providers, such as local- and county-level providers.

 6

The federal matching rate varies for each state, ranging from 50 to 83 percent. States with

lower per capita income receive a higher federal matching rate.

7

Separate upper payment limits exist for several different classes of services. These include

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

intermediate care services for the mentally retarded.

Previous State Financing

Schemes—and Efforts to

Curtail Them—Go Back

More Than a Decade
Page 5 GAO-02-147 Medicaid State Financing Schemes

Table 1: Previous Medicaid Financing Schemes for Generating Excessive Federal

Funds Without Committing a Corresponding State Contribution

Financing

scheme Summary How subsequently restricted

Excessive

payments to state

facilities

Excessive payments were made

to state-owned facilities,

increasing federal payments.

HCFA promulgated regulations

in 1987 that established

payment limits for stateoperated inpatient and

institutional facilities.

Provider taxes

and contributions

Revenues from provider-specific

taxes or donations were used to

increase state Medicaid spending.

The taxes and contributions were

matched with federal funds and

paid to the providers. These

providers could then return most

of the federal moneys to the state.

The Medicaid Voluntary

Contribution and ProviderSpecific Tax Amendments of

1991 barred certain provider

donations, placed restrictions on

provider taxes, and set other

restrictions for state

contributions.

Excessive

disproportionate

share hospital

(DSH) payments

DSH payments are meant to

compensate those hospitals that

care for a disproportionate

number of low-income patients.

Unusually large DSH payments

were made to certain hospitals,

which then returned the bulk of

the state and federal funds to the

state.

The Omnibus Budget

Reconciliation Act of 1993

limited which hospitals could

receive DSH payments, capped

the amount of DSH payments

individual hospitals could

receive, and capped states’ total

DSH payments. The Balanced

Budget Act of 1997 further

reduced state-specific DSH

allotments for fiscal years 1998

through 2002.

Excessive DSH

payments to state

mental hospitals

A large proportion of state DSH

payments were directly returned

to the state treasury or were paid

to state-operated psychiatric

hospitals to indirectly cover the

cost of services provided to

patients that Medicaid cannot

directly pay for.

The Balanced Budget Act of

1997 limited the proportion of a

state’s DSH payment that can

be paid to state psychiatric

hospitals.

Source: GAO/T-HEHS-00-193, Sept. 6, 2000.

The financing scheme we identified last year was the latest variant being

used by some states. In this scheme, excessive payments were made to

health facilities owned by local governments. Such providers included

county-owned nursing homes and hospitals and local hospital districts.

States determined the amount of the excessive payments by computing the

difference between the upper payment limit (that is, the maximum

payment eligible for a federal match) and the total amount the state would

normally have paid to Medicaid providers. The state then made payments

equaling all or part of the difference to certain local government-operated

Latest Financing Scheme

Involved Local

Government Providers
Page 6 GAO-02-147 Medicaid State Financing Schemes

facilities. These excessive payments were separate and in addition to what

the state would normally pay for services these facilities provided. The

facilities would agree in advance to return most or all of the extra money.

Once the money was returned, the state then had additional money that it

could use to pay its share of future Medicaid payments—thus generating

even more federal matching funds—or to spend however else it decided. A

variation of this scheme involved local providers advancing funds to the

state, which it would then simply return to the local providers in the guise

of a payment for valid covered services. The state would then claim

federal matching funds on the excessive payment without having spent

any state funds.

Such funding arrangements violate the integrity of the Medicaid program

for several reasons. First, they effectively increase the federal matching

rates—which are set by law—because they generate additional federal

Medicaid expenditures, while total state contributions remain unchanged.

For example, as we testified last year, New Jersey’s financing arrangement

with local nursing homes would effectively increase the federal matching

rate from 50 percent to 62 percent if the state retained all $500 million of

the excessive federal funds it generated. Second, the schemes funnel

federal Medicaid dollars to the state that can be used at its discretion, with

no assurance that the money is used for valid Medicaid services. The state

can actually use these funds to supplant part of its share of Medicaid

expenditures, thereby essentially bringing in still more federal Medicaid

dollars. Third, these funding arrangements are inconsistent with statutory

requirements that the states ensure that Medicaid payments are

economical and efficient, because the chosen methods result in grossly

excessive payments, well beyond the cost of services provided.8

By fiscal year 2000, the number of states taking advantage of these types of

schemes and making excessive payments to local government providers

had grown to 28, according to the HHS Inspector General, costing

Medicaid an estimated $5.8 billion that year alone. Last September, the

HHS Office of Inspector General (OIG) testified before the Senate Finance

Committee that in some cases it was clear the federal funds were not

reimbursing valid Medicaid costs. For example, the OIG found that

between 1997 and 1999, Pennsylvania generated about $1.9 billion in

excessive federal Medicaid payments, of which $407 million was known to

have been spent on non-Medicaid services; another $558 million was

 8

42 U.S.C. sec. 1396(a)(30)(A).
Page 7 GAO-02-147 Medicaid State Financing Schemes

unbudgeted and available to the state for non-Medicaid uses. Similarly, we

found that Iowa’s excessive payment arrangement with county nursing

homes resulted in average federal spending of about $969 daily per

Medicaid bed—an 18-fold increase from the prior federal spending level of

$54 per bed per day.

In December 2000, the Congress mandated that HCFA’s pending regulation

be finalized to revise the upper payment limit.9 This regulation restricts the

ability of states to inappropriately generate federal funds through these

financing schemes with local government providers. In doing so, however,

the Congress and HCFA recognized that some states had used these

schemes long enough to develop considerable reliance on the excessive

federal payments as part of their overall state budgets. Thus, the

regulation provided for three transition periods, ranging from about 2

years to 8 years, before states had to fully comply. In effect, this provision

gave the states a period of time during which they could continue to

receive excessive federal payments. The length of a state’s transition

period depended on how long it had been using the scheme. For those in

effect since before October 1992, states could continue to receive some

excessive payments until October 2008. By contrast, states with approved

state plan amendments that did not comply with the revised regulation and

took effect after October 1999 would have their payments phased out by

October 2002. HCFA justified the shorter transition period for these latter

states because it had notified all states on July 26, 2000, that it intended to

change the rules to close this loophole and that the states should therefore

not develop a reliance on these funds. The regulation was published on

January 12, 2001, and became effective on March 13, 2001.

 9

In response to BIPA, HCFA established several new upper payment limits for different

provider classes in addition to those that already existed for state-owned or -operated

facilities (42 C.F.R. 447). These included an aggregate upper payment limit for inpatient

hospitals, nursing facilities, and intermediate care facilities for the mentally retarded

furnished by all other government-owned or -operated facilities (that is, local government

facilities). An aggregate upper payment limit was also established for outpatient hospital

and clinic services provided by state government facilities and a separate aggregate upper

payment limit was established for outpatient hospital and clinic services provided by all

other government facilities. The regulation also provided for an increased upper payment

limit—up to 150 percent of what would be paid for comparable services under Medicare

payment principles—for services provided by nonstate public hospitals.
Page 8 GAO-02-147 Medicaid State Financing Schemes

HCFA decided in April 2001 to change its stated position on the January

upper payment regulation to allow approval of pending state plan

amendments under the old rule. This change allowed even more states to

exploit the upper payment limit loophole. While HCFA was developing the

January regulation, a number of state plan amendments with upper

payment limit provisions had been submitted but not approved. HCFA’s

position about how to handle pending plan amendments—submitted

before the March 13, 2001, effective date of the regulation but

unapproved—changed over time, as follows:

1. In responding to public comments as part of its January 2001 published

regulation, HCFA’s stated position was that pending state plan

amendments would be reviewed under the new regulation. HCFA

indicated that, once the final regulations were issued, it would rely on

them to review state plan amendments and would disapprove

amendments that did not comply with them. This meant that these

states would not qualify for a transition period to bring their plans into

compliance with the new regulation’s requirements.10 In publishing the

January regulation, HCFA stated:

“We have given all states ample notice of our position that these programs are abusive

and of our intent to publish this regulation to curtail such programs. To affirmatively

approve pending applications would be counterproductive to our purposes of

preserving the fiscal integrity of the Medicaid program.”

11

2. This stated position notwithstanding, the January 2001 regulation was

silent as to whether plan amendments currently under consideration

would be reviewed using the new regulation or the old one. On April 3,

2001, HCFA indicated in a new proposed rule that it had decided to

review pending plan amendments under the old regulation, essentially

 10This statement of policy was expressed in the October 10, 2000, proposed regulation and

in the agency’s response to comments published with the final regulation on January 12,

2001. The language of the proposed regulation explicitly states that plan amendments not

in compliance with the new regulation would receive a transition period only if they were

approved before the effective date of the new regulation.

11If CMS neither approves nor denies an amendment within 90 days, the amendment is

deemed approved. In some cases, the process may extend up to 180 days if additional

information is requested from the state. Some earlier state financing schemes were in

effect as a result of this deemed approval status because HCFA had decided not to

affirmatively approve them.

HCFA’s Position

Reversal Opened the

Door for More

Excessive Payments
Page 9 GAO-02-147 Medicaid State Financing Schemes

reversing its earlier position.12 Reviewing plan amendments under the

old regulation, without modification, gave states the opportunity to

receive excessive federal payments through September 30, 2002.

3. On September 5, 2001, CMS issued a rule shortening the transition

period from September 30, 2002, for those upper payment limit

financing schemes in plan amendments that were pending when the

January regulation was issued, that were subsequently approved, and

that did not comply with the January regulation.13 CMS stated that the

full transition period for these recent plan amendments was not

appropriate. The final rule limited the transition period to 1 year after

the effective date of the plan amendment or November 5, 2001,

whichever is later.

These changes affected the amount of time given to states before they had

to comply with the upper payment limit regulation that went into effect on

March 13, 2001, and the period during which they could still collect

excessive federal matching payments. (See app. I for a chronology of

events related to HCFA’s change of position on pending state plan

amendments.)

HCFA’s reversal of its position on approving abusive financing schemes

involved a number of states, with substantial financial effect. In April 2001,

HCFA reported that 11 states with pending plan amendments might be

affected by its proposed rule to shorten the transition period. However, by

the time CMS issued the rule in September 2001, the number of states had

narrowed to four: Florida, Michigan, Virginia, and Wisconsin.14 HCFA

approved Virginia’s and Wisconsin’s state plan amendments—which

contain the same kinds of inappropriate schemes we reported last year in

other states—on June 4, 2001, and May 8, 2001, respectively. Under the

January 2001 rule, CMS data show that these states would have generated

over $1.2 billion in excessive federal matching payments. The September

 12Because the wording in the January rule was not explicit, the agency had the discretion to

interpret the regulation differently, change its position, and still comply with the new

regulation, according to HHS legal and program officials.

13This new regulation applies to state plan amendments effective after September 30, 1999,

submitted to HCFA before March 13, 2001, and approved by HCFA after January 21, 2001.

14CMS indicated that the remaining seven states would comply with the January 2001

regulation and therefore would not be affected by the September regulation.

HCFA’s Position

Reversal Had

Substantial Financial

Effect
Page 10 GAO-02-147 Medicaid State Financing Schemes

rule will reduce this estimate to about $722 million. In our view, approving

these state plan amendments and granting any transition period is

inconsistent with CMS’ stated position about its intent to curtail such

schemes and continues to undermine the integrity of the financing

partnership.

As with the abusive schemes we have reported previously, Virginia and

Wisconsin were given approval to employ financing schemes that make

excessive Medicaid payments—well beyond the cost of the services

provided—to a few local governments on behalf of nursing homes. The

excessive payments are made to obtain federal matching funds, with the

local providers keeping little, if any, of the funds. The states, which

contribute little or none of their own funds, can ultimately retain the

excessive federal payments to use for any purpose they choose.

Virginia’s and Wisconsin’s approved plan amendments both rely on sameday wire transfers involving banks, local governments that own or operate

nursing homes, and the state. These transfers create the illusion of

legitimate Medicaid payments, which are then used to bring in hundreds of

millions in matching federal Medicaid dollars. In both states, this

mechanism involves relatively few local-government-owned or -operated

nursing homes—six homes in Virginia and five in Wisconsin. There are

essentially six steps to the process, as shown in table 2. These steps

include having the local government take out a bank loan and wire the

proceeds to the state, which then immediately transfers the money back to

the local government. This round-trip transfer of funds can be completed

in a matter of minutes.

Table 2: Overview of Process for Exploiting Upper Payment Limit

Step Activity

1 State calculates difference in upper payment limit amount (what Medicare

would have paid for comparable services) and what the state actually pays

nursing homes for Medicaid services.

2 County government takes out a bank loan that is based on calculation in step

1. The loan covers the full amount, both the state and the federal share, of

the excessive Medicaid payment.

3 County wires the loaned money from its bank account directly to the state.

4 State creates an official “Medicaid payment” by immediately wiring the

loaned funds back to the county bank account.

5 County uses money returned by the state to pay off the loan.

6 State can then claim the federal share of the payment that it made to the

county.

Most Recent Plan

Amendments Continue

Abusive Funding Schemes
Page 11 GAO-02-147 Medicaid State Financing Schemes

A substantial amount of money is anticipated to be processed in these two

states through these same-day wire transactions and through the federal

matching funds generated by the transactions. As illustrated in table 3, the

amount of excessive federal matching funds that would have been

generated under the January rule exceeds $1.2 billion.

Table 3: Federal Share of Excessive Payments in Virginia and Wisconsin Under

HCFA’s January 2001 Regulation

Dollars in millions

State Fiscal year 2000 Fiscal year 2001 Fiscal year 2002 Total

Virginia $146a $218 $364

Wisconsin $93b374 374 841

Total $93 $520 $592 $1,205

a

Virginia can claim excessive payments for 8 months in fiscal year 2001.

b

Wisconsin made excessive payments in 3 months of fiscal year 2000. These earlier payments are

allowed because the Wisconsin amendment was effective July 1, 2000.

Source: Calculations are based on CMS estimates, updated to reflect the latest available statespecific data.

The payments permissible under Virginia’s and Wisconsin’s approved

financing schemes grossly exceed what the states typically pay for

comparable services. Moreover, the states are free to use the federal

proceeds as they wish. For example, Virginia would provide six local

government nursing homes, on average, an additional $617 in federal funds

per Medicaid nursing home resident per day over the $53 per day in federal

funds, on average, that these homes normally receive per Medicaid nursing

home resident. Wisconsin indicated, in documents submitted to HCFA,

that the $748 million in federal matching funds that it would draw down

over fiscal years 2001 and 2002 will be deposited in a newly created and

interest-earning Medicaid Trust Fund. According to state information, the

federal funds will be used in future fiscal years to finance payment

increases for a variety of Medicaid providers, beyond nursing homes in

three counties. If it does so, the state would essentially be recycling

federal funds to draw down additional federal funds to be used for other

purposes.
Page 12 GAO-02-147 Medicaid State Financing Schemes

By shortening the allowed transition period to comply with the new upper

payment limits, the September rule will reduce the magnitude of excessive

federal payments for these two states by about $483 million—from over

$1.2 billion to about $722 million (see table 4).

Table 4: Impact of September 5, 2001, Rule on Excessive Federal Payments to

Virginia and Wisconsin

Dollars in millions

State

Excessive federal

payments under

January 2001 rule

Reduction

(savings) under

September 2001 rule

Estimated excessive

federal payments

Virginia $364 $146 $218

Wisconsin 841 337 504

Total $1,205 $483 $722

Source: GAO analysis of state plan amendment documentation.

If both states had been limited to a 1-year transition period as specified in

the latest proposed rule, the estimated savings would have been higher.

However, the time associated with finalizing the rule and establishing its

effective date as November 5, 2001, essentially cost another $130 million in

excessive federal payments. Wisconsin will effectively have a period of

over 16 months during which it can claim excessive federal payments.

Because of the July 2000 effective date of Wisconsin’s plan amendment,

the state is able to operate its financing scheme for 127 days beyond its 1-

year transition period. We estimate that for every day the state exceeds its

1-year transition period, about $1 million can be generated in excessive

matching funds. In total, Wisconsin will be able to claim about $130

million in additional excessive federal payments from July 1, 2001, to

November 5, 2001.

Our review of the facts surrounding the Virginia and Wisconsin plan

amendments does not support the need for any transition period to

comply with the January 2001 regulation intended to curtail abusive upper

payment limit schemes. The fact that Virginia’s and Wisconsin’s plan

amendments are recent argues against the need for a transition period.

Transition periods established in HCFA’s January 2001 rule to allow states

time to achieve compliance with the new upper payment limit regulations

were aimed at states that had developed a budgetary reliance on excessive

payment schemes. Virginia and Wisconsin do not meet that criterion. As

illustrated in figure 1, Virginia’s and Wisconsin’s plan amendments were

September Rule Will

Reduce Magnitude of

Expected Excessive

Payments

No Apparent Justification

for Transition Period for

Newest Plan Amendments
Page 13 GAO-02-147 Medicaid State Financing Schemes

submitted and approved after HCFA began to take regulatory action to

stop these excessive payment schemes.

Figure 1: Key Dates in Revising the Upper Payment Limit (UPL) Regulation and

Approving Pending Plan Amendments in Virginia and Wisconsin

Virginia did not propose its excessive payment scheme until after HCFA

publicly released the draft of its regulation to curb such schemes.

Wisconsin first introduced its $374 million annual upper payment limit

provision to HCFA in February 2001, after the January rule was published,

as part of a response to HCFA questions on unrelated issues in a broader

state plan amendment submitted on September 21, 2000.

July 26, 2000

HCFA notifies states of intent to

change UPL regulation

Timeline

February 7, 2001

Wisconsin submits UPL

proposal as addition to a

previous state plan amendment

October 10, 2000

HCFA publishes proposed rule

to revise UPL regulation

November 30, 2000

Virginia submits state plan

amendment with UPL provision

January 12, 2001

HCFA publishes revised UPL

regulation

May 8, 2001

HCFA approves Wisconsin’s

plan amendment

June 4, 2001

HCFA approves Virginia’s

plan amendment

HCFA Action State Action
Page 14 GAO-02-147 Medicaid State Financing Schemes

CMS’ response to public comments in its September 5, 2001, rule-making

appears to question the appropriateness of approving any new financing

schemes, especially Wisconsin’s. For example, CMS stated:

“We...believe that any State that submitted an amendment after the January 12, 2001

publication date of the final rule arguably had no basis to expect the amendment would be

approved or had any history of reliance on such spending.”

Nevertheless, the agency did not apply this criterion to Wisconsin’s plan. It

concluded that the excessive payment provisions submitted February 7,

2001, did not constitute a new plan amendment but were rather a change

to an earlier plan amendment submitted in September 2000. According to

agency officials, there was no clear guidance on how to consider a revised

state proposal such as Wisconsin’s.15

HCFA’s actions in implementing its revised upper payment limit

regulations are troubling. At the same time that HCFA was attempting to

close a glaring loophole, it allowed additional states to engage in the very

schemes it was trying to shut down, at a substantial additional cost to the

federal government. The January 2001 regulation was designed to provide

a balance between protecting the integrity of the Medicaid program and

providing a reasonable transition for those states that had developed some

budgetary reliance on excessive Medicaid payments. Given HCFA’s stated

position since July 2000 that it viewed these state financing schemes as

abusive, we believe that its approval of additional schemes was

unjustified.

Experience tells us that even as the Congress and HCFA have in the past

identified and acted to close down various state financing schemes that

exploit the federal share of the Medicaid program, other schemes

invariably emerge. Consequently, continued vigilance is needed to identify

and respond to the next scheme before it reaches the financial magnitude

that makes it both a staple of state financing and a potential threat to the

integrity of the funding partnership. Furthermore, it is imperative that

federal and state partners work together to protect the financial integrity

of the Medicaid program and to ensure that scarce resources are

 15To prevent similar last-minute changes, HCFA stated in its April 3, 2001, proposed rule

that any material changes submitted after March 13, 2001, to a pending plan amendment

would be treated as a new plan amendment.

Conclusions
Page 15 GAO-02-147 Medicaid State Financing Schemes

appropriately used to meet the health needs of Medicaid-eligible

beneficiaries.

We obtained comments on a draft of this report from the Administrator of

CMS and the Virginia and Wisconsin state Medicaid directors (see apps. II,

III, and IV). They disagreed with our conclusion that HCFA’s decision to

approve additional state financing schemes was unjustified. However, the

Administrator pointed out the agency’s strong opposition to financing

schemes and its intent to ensure the protection of federal funds by

ensuring that states receive a federal match only for appropriate

expenditures that are also appropriately matched with state funds.

A central issue raised in these comments related to proposed state plan

amendments that were pending at the time of HCFA's issuance of the

January 12, 2001, rule with its March 13 effective date. The CMS

Administrator commented that the treatment of pending amendments was

not clearly addressed in the January 12 rule and that our draft report did

not cite any clear statement on this issue. The Virginia Medicaid director

asserted that HCFA's approval of Virginia's plan amendment, which was

pending at the time the rule was finalized on January 12, was not only

permissible but also consistent with past practice and necessary to avoid

the retroactive application of the final rule. He further asserted that HCFA

had no choice but to approve Virginia's plan.

We agree that the January 12 rule was not clear on how to address pending

state plan amendments; we have revised the report to clarify that the rule

was silent on this point and added appendix I to provide a more complete

chronology of HCFA's changing position on approving state plan

amendments. We concluded that a careful analysis of the public record of

proposed and final rules demonstrated a fundamental shift in HCFA's

position in how to deal with a pending state plan amendment—from an

initial stated intent to deny any pending proposals that would not comply

with the revised upper payment limits to a subsequent decision to approve

them.

We disagree, however, with Virginia's position that HCFA had no choice

but to approve its proposal. Under Medicaid, federal funding is authorized

for amounts spent for covered medical and other services. As our report

points out, the funding schemes that these pending amendments proposed

do not relate to amounts that would actually be spent for covered services

but to arrangements between states, counties, and local providers to

obtain excessive federal payments. The Administrator has the statutory

Agency and State

Comments and Our

Evaluation
Page 16 GAO-02-147 Medicaid State Financing Schemes

authority to disapprove any proposed state plan amendment that is

inconsistent with the Medicaid statute. Given the long-standing and clearly

stated congressional and HCFA intent to eliminate abusive state financing

schemes and given the evidence that HCFA had in hand that Virginia's and

Wisconsin's proposals would continue such practices with no assurance

that excessive federal payments were being spent for valid Medicaid

services and beneficiaries, we continue to believe that HCFA had the

statutory authority, the discretion, and the responsibility to deny any such

proposed state plan amendments regardless of the extent to which similar

abusive practices existed in the past.

The CMS Administrator also commented that, once the Virginia and

Wisconsin state plan amendments were approved (June 4 and May 8, 2001,

respectively), he did not have the authority to retroactively deny payments

under the September 5 final rule that shortened transition periods for

states with newly approved amendments. Our analysis and report did not

address issues dealing with retroactive denial of payments. We concluded

that HCFA’s approvals of these two states’ state plan amendments were

unjustified, given clearly stated congressional and HCFA intent to

eliminate such abusive state financing practices. Having affirmatively

approved these two states’ plan amendments, however, we support the

agency’s efforts to phase out federal matching payments as quickly as

possible.

The CMS Administrator and Virginia Medicaid director raised issues

pertaining to the scope of our work and the sense that we were singling

out certain states or individuals for criticism. We clearly pointed out in our

report that our scope was restricted to those four states that were affected

by the September 2001 regulation, and we further limited our work to

Virginia and Wisconsin because these two states accounted for 96 percent

of the excessive federal payments that the CMS actuary identified as

resulting from the regulation. In the course of our work, we did not

investigate the role that individual federal officials did or did not play, or

whether any officials recused themselves from the decision-making

process. As specified in the report, we based our analysis and conclusions

on the public record of HCFA’s proposed and final rules, public comments

submitted as part of the formal rule-making process, and supporting

documentation that HCFA had available on proposed state plan

amendments.

Finally, the CMS Administrator commented that he has been especially

vocal about stopping financing schemes that simply recycle state dollars

for federal dollars with no real expenditure being made—a common
Page 17 GAO-02-147 Medicaid State Financing Schemes

practice across the country—and that he intends to end these practices in

order to ensure the fiscal integrity of the Medicaid program. We fully

support CMS efforts in this regard and believe that it should exert its full

authority and discretion to do so.

The Virginia Medicaid director also stated that HCFA has made clear on

numerous occasions that it permits states to engage in intergovernmental

transfers in connection with provider payments that do not exceed upper

payment limits and that such transfers are not inconsistent with governing

law. In this report, we did not take issue with intergovernmental transfers

as a legitimate tool or mechanism that state and local governments use in

jointly financing activities of government. We do take issue, however, with

the fact that this mechanism is often inappropriately used as a subterfuge

to create the illusion that a state has made payments for valid Medicaid

services for eligible Medicaid beneficiaries in order to claim matching

federal payments.

The Wisconsin Medicaid director commented that the state has had an

approved intergovernmental transfer funding mechanism in place since

1985, and therefore our conclusion that it had no budgetary reliance on

this funding, which was the basis for HCFA’s granting states varying

transition periods to wean themselves from the excessive federal funding,

was incorrect. We disagree with this point of view. The $374 million

annual upper payment limit provision that Wisconsin submitted to HCFA

on February 7, 2001, was separate from, and in addition to, its previously

approved arrangements costing about $23 million annually. Wisconsin

therefore had no established historical budgetary reliance on its February

7 proposed financing scheme, which HCFA approved in May 2001.

As arranged with your offices, unless you release its contents earlier, we

plan no further distribution of this report until 30 days after its issuance

date. At that time, we will send copies of this report to the Secretary of

Health and Human Services, the Administrator of CMS, and other

interested parties. We will make copies available to others upon request.
Page 18 GAO-02-147 Medicaid State Financing Schemes

If you or your staffs have any questions regarding this report, please

contact me on (202) 512-7118 or Frank Pasquier on (206) 287-4861. Other

major contributors included Tim Bushfield, Terry Saiki, Stan Stenersen,

and Stefanie Weldon.

Kathryn G. Allen

Director, Health Care—Medicaid and

 Private Health Insurance Issues
Appendix I: Chronology of HCFA’s Changing

Position on Pending State Plan Amendments

Page 19 GAO-02-147 Medicaid State Financing Schemes

Date Event

Impact of event on states with pending

amendments

July 26, 2000 HCFA sends

letter to all state

Medicaid

directors

Letter announces HCFA’s intent to (1) phase

out upper payment limit financing mechanisms

and (2) pursue steps that put an immediate

end to paying states that file plan amendments

in the intervening period before any regulation

takes effect.

October 10, 2000 HCFA issues

proposed rule

The proposed rule says that states with

pending plan amendments not in compliance

with the new regulation would qualify for a

transition period only if they were approved

before the effective date of the final regulation.

December 21, 2000 Medicare,

Medicaid, and

SCHIP Benefits

Improvement

and Protection

Act of 2000

The act directs the Secretary of Health and

Human Services to issue a final regulation

based on the October 2000 proposed rule.

HCFA responds

to public

comments

HCFA again says that noncompliant pending

plan amendments would be reviewed under

the new regulation. Plan amendments not in

compliance with the new regulations would not

qualify for transition periods.

January 12, 2001

HCFA issues

final rule

The final rule is silent as to whether plan

amendments currently under consideration

would be reviewed using the new regulation or

the old one. According to HCFA officials, the

language change from the proposed rule

resulted from an inadvertent editing revision.

April 3, 2001 HCFA issues

proposed rule

HCFA indicated that it had decided to review

pending plan amendments under the old

regulation, essentially reversing its earlier

position. This change in position gave states

with such plan amendments the opportunity to

receive excess federal payments through

September 30, 2002. The rule proposes

reducing the transition period to 1 year for

such pending plan amendments.

September 5, 2001 CMS issues final

rule

The final rule adopts shorter transition periods

for plan amendments that were pending when

the January regulation was issued, that were

subsequently approved, and that did not

comply with the January regulation. The final

rule limits the transition period to 1 year after

the effective date of the plan amendment or

November 5, 2001, whichever is later.

Appendix I: Chronology of HCFA’s Changing

Position on Pending State Plan Amendments
Appendix II: Comments From the Centers for

Medicare and Medicaid Services

Page 20 GAO-02-147 Medicaid State Financing Schemes

Appendix II: Comments From the Centers for

Medicare and Medicaid Services
Appendix II: Comments From the Centers for

Medicare and Medicaid Services

Page 21 GAO-02-147 Medicaid State Financing Schemes
Appendix III: Comments From the

Commonwealth of Virginia

Page 22 GAO-02-147 Medicaid State Financing Schemes

Appendix III: Comments From the

Commonwealth of Virginia
Appendix III: Comments From the

Commonwealth of Virginia

Page 23 GAO-02-147 Medicaid State Financing Schemes
Appendix III: Comments From the

Commonwealth of Virginia

Page 24 GAO-02-147 Medicaid State Financing Schemes
Appendix IV: Comments From the State of

Wisconsin

Page 25 GAO-02-147 Medicaid State Financing Schemes

Appendix IV: Comments From the State of

Wisconsin
Related GAO Products

Page 26 GAO-02-147 Medicaid State Financing Schemes

Medicaid: State Financing Schemes Again Drive Up Federal Payments

(GAO/T-HEHS-00-193, Sept. 6, 2000).

Medicaid in Schools: Poor Oversight and Improper Payments

Compromise Potential Benefit (GAO/T-HEHS/OSI-00-87, Apr. 5, 2000).

Medicaid in Schools: Improper Payments Demand Improvement in

HCFA Oversight (GAO/HEHS/OSI-00-69, Apr. 5, 2000).

Medicaid: Disproportionate Share Payments to State Psychiatric

Hospitals (GAO/HEHS-98-52, Jan. 23, 1998).

State Medicaid Financing Practices (GAO/HEHS-96-76R, Jan. 23, 1996).

Michigan Financing Arrangements (GAO/HEHS-95-146R, May 5, 1995).

Medicaid: States Use Illusory Approaches to Shift Program Costs to

Federal Government (GAO/HEHS-94-133, Aug. 1, 1994).

Related GAO Products

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