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GAO/T-HEHS-00-193

MEDICAID

State Financing Schemes

Again Drive Up Federal

Payments

Statement of Kathryn G. Allen, Associate Director

Health Financing and Public Health Issues

Health, Education, and Human Services Division

Testimony

Before the Committee on Finance, U.S. Senate

United States General Accounting Office

GAO
Page 1 GAO/T-HEHS-00-193

Mr. Chairman and Members of the Committee:

We are pleased to be here today as you discuss the federal government’s

role in helping pay for Medicaid. The Congress has structured Medicaid as

a federal/state partnership that provides federal matching funds and gives

states considerable flexibility in deciding what medical services and

individuals to cover, as long as certain basic requirements are met. Over

the years, the Congress has also attempted to make the program easier for

states to administer and to provide more flexibility in how they may

distribute funds to Medicaid providers. However, several times in the

1990s reports surfaced that some states were abusing this flexibility

through various financing schemes that increased the federal share of

program costs beyond what the partnership agreement calls for. When

these practices came to light, laws or regulations were rewritten to stop or

restrict them. Now there are reports that a number of states are engaging

in a practice that is a variant of previous practices. Limiting this practice

would involve taking similar action to what has been done in the past.

In my testimony today, I will (1) describe how this current financing

scheme works and (2) discuss how it compromises the agreement for

federal/state sharing of Medicaid financing. We have reviewed state plans

describing this financing arrangement and have discussed the issue with

officials of the Health Care Financing Administration (HCFA) and other

agencies. We have not yet identified the extent to which these schemes

have been implemented or the amount of money involved, but at the

request of the Committee, we will be continuing our work in this regard.

Because this scheme is so similar to some practiced previously, I will also

draw on our prior work.1

In brief, the current scheme inappropriately increases federal Medicaid

payments by paying certain providers more than they would normally

receive and then having the providers return the bulk of the extra monies

to the state. By making an excess payment, the state generates additional

federal matching funds, which can be used to pay its share of future

Medicaid payments—thus generating even more federal matching funds—

or spent however the state determines. The providers receiving the

inflated payments and passing back the excess to the state are entities

owned by local governments—for example, county-owned nursing homes

and local hospital districts. According to HCFA, as of late July, 17 states

have state plans that could allow them to use this practice, and 11 other

1See the list of related GAO products at the end of this statement.

Medicaid: State Financing Schemes Again

Drive Up Federal Payments
Medicaid: State Financing Schemes Again

Drive Up Federal Payments

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states have drafted plans for doing so. The exact amount of additional

federal Medicaid dollars generated through this process is unknown, but it

is in the billions of dollars and growing. While most states do not

specifically acknowledge how they will use the money that makes the

round-trip back to their treasuries, intended uses reported by elected

officials in some states include funding other health-care or education

programs, as well as subsidizing a state tax cut.

In our view, this financing practice violates the integrity of Medicaid’s

federal/state partnership. By receiving part of the money back from the

provider and keeping the federal share associated with it, the state is—in

effect—able to lower its own Medicaid contribution substantially below

the share specified in federal law. We have not yet been able to specifically

determine how much of an effect this current practice will have in any one

state. However, our analysis of previous financing schemes showed that

the effect can be substantial. For example, in 1994 we analyzed Michigan’s

use of similar funding mechanisms (including excessive payments to

county nursing homes) and found they had the effect of raising the federal

share for Medicaid expenditures from 56 percent to 68 percent. When

related schemes came to light in years past, steps were taken to curtail

them and restore the federal/state partnership as intended. HCFA has

drafted a regulation that would curtail this scheme, but the draft has not

moved far in the rulemaking process. We urge the Administration to

finalize this regulation and reiterate a recommendation to the Congress,

first made in 1994, that would close the door on financing practices that

inflate the federal share by making excessive payments to governmentowned facilities.

The federal and state governments’ shares in the cost of Medicaid are

based on a statutory formula designed to reflect differences in each state’s

program needs and capacity to finance them. At a minimum, the federal

government pays 50 percent of the cost. However, poorer states—those

with a low per capita income—receive federal contributions at a higher

matching rate. The aim is to reduce differences among the states in

medical care coverage for the poor and distribute fairly the burden of

financing program benefits among the states. Under this statutory formula,

the federal payment for the poorest states can be up to 83 percent of the

program’s cost.

Within a broad legal framework, each state designs and administers its

own Medicaid program, including deciding how much to pay providers for

a particular service. Each state operates its program under a plan that

Background
Medicaid: State Financing Schemes Again

Drive Up Federal Payments

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HCFA must approve for compliance with current federal law and

regulations. In addition, HCFA must approve any amendments to this plan.

To control federal expenditures, HCFA established a set of upper payment

limits on the total amount it would agree to pay states for a variety of

services. For example, one upper payment limit sets a maximum amount

of federal payments for all nursing homes in a state.2 The upper limits are

based on the payment amount allowed under the Medicare program,

which is the federal government’s program for providing medical services

for the elderly and the disabled. The upper limit is not a price to be paid

for each service provided, but rather a ceiling on Medicaid expenses above

which the federal government will not share.

The flexibility states have to set Medicaid’s payment rates has provided

them the opportunity to develop various financing schemes in the past that

effectively changed what the federal government paid (see table 1). Most

of these financing schemes have subsequently been restricted by law or

regulation. While such restrictions curtailed the specific schemes that had

been brought to light, the restrictions did not extend to transactions with

certain government health care providers, such as local- and county-level

providers. To address this problem, in 1994 we recommended that the

Congress enact legislation to prohibit Medicaid payments that exceed

costs to any government-owned facility. That recommendation remains

outstanding.

2Upper payment limits currently exist for different classes of services, including inpatient hospital

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

mentally retarded. Separate upper payment limits are set for state-operated facilities that provide each

of these services, with the exception of outpatient hospital services, which have no upper payment

limit.
Medicaid: State Financing Schemes Again

Drive Up Federal Payments

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Table 1: Examples of Previous Medicaid Financing Schemes for Generating Federal Funds

Without Committing a Corresponding State Contribution

Financing

practice

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 state-operated

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 then returned most of the

federal monies to the state.

The Medicaid Voluntary Contribution and

Provider-Specific Tax Amendments of 1991

essentially banned provider donations,

placed a series of restrictions on provider

taxes, and set certain other restrictions for

each state.

Excessive

disproportionate

share hospital

(DSH) payments

DSH payments are meant to

compensate those hospitals that care

for a disproportionate number of lowincome 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 1998-2002.

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 stateoperated 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.

To better ensure that federal Medicaid dollars are used for Medicaid

services, in the Balanced Budget Act of 1997 the Congress explicitly

banned the use of federal matching funds for any non-health-related items

or for any item or service not covered by a state’s Medicaid plan.

The current practice is a variation of past practices in which federal

dollars make a round-trip from the state, to a Medicaid provider, and then

back to the state. Under the current scheme, excessive payments are made

to health facilities owned by local governments. Such providers include

county-owned nursing homes, local hospital districts, and county

hospitals. Unlike schemes involving other types of providers, which have

been addressed through legislation or changes in regulation, restrictions

on excessive payments to local government providers are fewer. The

Additional Federal

Funds Are Obtained

Through Excessive

Payments to Local

Government

Providers
Medicaid: State Financing Schemes Again

Drive Up Federal Payments

Page 5 GAO/T-HEHS-00-193

round-trip arrangement that maximizes federal dollars for the state

essentially involves two steps, as shown in figure 1.

Figure 1: Overview of Process for Maximizing Federal Medicaid Dollars

In the first step, states make a payment to certain Medicaid providers over

and above the amount that Medicaid actually intends to pay them. States

determine the amount of the excess payment by computing the difference

between the upper payment limit (that is, the maximum amount of total

Medicaid expenses eligible for federal matching payments) and the total

amount the state would normally pay to Medicaid providers using its

payment rates. Local government health care facilities such as nursing

homes and hospitals constitute good candidates for these excessive

payments because states are not limited in how much they may pay local

government providers, as long as their total payments to that provider

group as a whole fall below the upper limit for that category of provider.

For example, if actual Medicaid payments to all nursing homes in a state

were $100 million under normal Medicaid rates, and the upper payment

Step 1: A payment is made to local government

Medicaid providers that exceeds what the state

intends to pay for the services provided.

State Local Government

Providers

Step 2: Local government providers receive

excess payments and send all or a portion back to the state.
Medicaid: State Financing Schemes Again

Drive Up Federal Payments

Page 6 GAO/T-HEHS-00-193

limit was $120 million, the amount available for the excessive payment to

county-owned nursing homes would be $20 million.3 Assuming a 50-

percent federal matching rate, the federal share of the aggregate payments

would thus be driven from $50 million to $60 million.

The second step is the transfer of all or an agreed-upon share of the excess

payments from the local government providers back to the state treasury.

Without this step, the local providers would benefit, but the states would

realize no financial benefit. In fact, the state would actually lose from the

arrangement, because it would simply be paying more than normal for the

same services. However, once a payment is made to a local government

provider, the funds become local government funds, and the local

government is free to make any intergovernmental transfer of the funds.

Thus, the states can receive the transfer and reap the financial benefit of

the federal share of the excess payment.

While most states are silent on the distribution of excessive payments

once the local government providers are paid, some states are quite clear

that the money is intended to complete the round-trip and be returned to

the state (see table 2 for examples).

3When the excess payments are made, they are a combination of federal and state funds.
Medicaid: State Financing Schemes Again

Drive Up Federal Payments

Page 7 GAO/T-HEHS-00-193

Table 2: Examples of State Plan Descriptions of Disposition of Excess Payments

State Excerpts from state plan amendments StatusaEffective date

Alaska “While it is probable that some portion of the payments

will be retained by the publicly owned and operated

hospitals, Alaska intends that the largest share of the

payments will be returned to the State through an

intergovernmental transfer.”

Pending Deemed approval estimated

for November 2000

South Dakota “A government nursing facility funding pool is created to

increase payments to nursing facilities that are owned by

political subdivisions of the state (publicly owned). . .

Each publicly owned nursing facility, upon receiving a

distribution of the funding pool, remits the amount of that

payment, less a transaction fee, to the Department of

Social Services thereby creating an intergovernmental

transfer of funds.”

Pending Deemed approval estimated

for September 2000

Tennessee “. . .(B)ased upon an executed intergovernmental

transfer agreement and subsequent transfer of funds,

qualifying Medicaid level II nursing facilities shall receive

a Medicaid nursing facility level II disproportionate share

payment one time each fiscal year.”

Deemed approved July 2000

Washington “The supplemental payments made to public hospital

districts are subject to. . .a contractual commitment by

each hospital district to return a minimum of 82% by

intergovernmental transfer to the state treasurer. . .”

Approved September 1999

a

By law, if HCFA neither denies nor approves plan amendments submitted by the states

within 90 days, the amendments automatically become accepted and approved. In some

cases, HCFA does not have grounds to deny the state proposals but will not officially

approve them. As a result, these proposals become “deemed approved” after 90 days. In

some cases, this process extends up to 180 days if additional information is requested

from the state.

Figure 2 shows how the round-trip payment process works in one state we

examined in prior work, illustrating how long the practice has prevailed.

The illustration is based on a financing arrangement between the state of

Michigan and some county nursing homes. We first reported on it in 1994.4

As illustrated, the state determined that it could pay an additional $277

million to county nursing homes and still stay under the upper payment

limit for all nursing homes. Michigan then made a payment of $277 million,

which included $155 million in federal matching funds, to the homes. On

the same day that the county facilities received the money, they wired

$271 million of the payment back to the state. None of these funds were

returned to the federal government but instead were intended to reduce

the state’s share of Medicaid payments.

4See Medicaid: States Use Illusory Approaches to Shift Program Costs to Federal Government

(GAO/HEHS-94-133, Aug. 1, 1994).)
Medicaid: State Financing Schemes Again

Drive Up Federal Payments

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Figure 2: Michigan’s Excessive Payment Arrangement With County Nursing Homes, 1993

Several variations to this basic approach exist among state plans. For

example, in one state, county-owned nursing homes obtain the equivalent

of a bank loan to finance both the state and federal shares of the excessive

payment. The county-owned nursing homes transfer the total amount

borrowed to the state, which returns all the funds plus a transaction fee to

the county-owned nursing homes as a Medicaid payment for nursing

services. The nursing homes use the payment to pay off their loans. The

net result of this variation is the same: hundreds of millions of dollars in

federal funds are generated with ultimately no state contribution.

The exact amount of additional federal Medicaid matching dollars

generated from states’ use of these practices is unknown, but it is likely

$277 Million Excess Payments

Federal Share = $155 million

State Share = $122 million

State

County Nursing Homes

$6 Million Retained

$271 Million Returned to State

the Same Day It was Received

Upper Payment

Limit for All Nursing

Homes = $1,199 million

Normal Payment

Using State

Rates = $890 million

Excess

Available = $309 million

Excess

Payment = $277 million
Medicaid: State Financing Schemes Again

Drive Up Federal Payments

Page 9 GAO/T-HEHS-00-193

substantial and increasing. HCFA estimates that of a $3.4 billion increase

in its fiscal year 2000 spending above earlier projections, $1.9 billion was

likely due to the circulation of funds through round-trip arrangements with

local government providers. According to HCFA, as of July 26, 2000, 17

states had approved state plans that would permit the use of this

reimbursement practice, and another 11 states have submitted proposed

plan amendments for approval to do so. The quick and dramatic increase

in Medicaid expenditures that accompanied the adoption of schemes

involving DSH payments in the early 1990s shows the potential of the

current financing arrangement to increase expenditures. In that earlier set

of schemes, DSH payments increased from $1 billion in 1990 to over $17

billion in 1992.

Because HCFA regulations currently allow excessive payments as long as

they do not exceed the upper payment limit, HCFA’s position is that it has

no grounds to deny these plans. A review of just a few of the proposals,

approved plan amendments, and various media reports shows the

potential for generating a significant amount of additional Medicaid

federal matching dollars without assurances that the money will be spent

on Medicaid services and beneficiaries.

• Iowa’s plan, which took effect last year, pays county nursing homes this

year about $95 million and will pay an estimated $125 million in 2001 in

additional federal dollars.5 These payments will result in average federal

spending of about $969 daily per Medicaid bed in county nursing homes, or

a 1,700-percent increase from the current federal spending level of $54 per

bed per day. While Iowa’s plan does not specify how these funds will be

spent, a state Medicaid official told us the funds will be returned to the

state to create a trust fund that will be spent on assisted living for the

elderly, which may or may not be related to covered Medicaid services or

beneficiaries.

• New Jersey’s plan, which lapsed into effect September 1, will generate an

additional federal payment of about $500 million over a 15-month period

by increasing payments to county nursing facilities by $999 million. The

counties initiate the excess payment by transferring the total expected

excess payment amount, both state and federal shares, to the state. The

state immediately sends the money back to the county facilities as a

Medicaid payment. This state payment triggers the federal share of the

payment, which it can then spend at its discretion.

5 This year’s excess payment amount is based on a 9-month period. In 2001, the payment amount will

be based on a full 12 months, which is the basis for our estimate.
Medicaid: State Financing Schemes Again

Drive Up Federal Payments

Page 10 GAO/T-HEHS-00-193

• Media reports from some other states have cited elected officials’ plans to

use the federal funds for state education programs or to subsidize a state

tax cut.

The fiscal integrity of the Medicaid program is a shared federal/state

responsibility. As such, states have considerable programmatic flexibility

but also the fiduciary responsibility to manage program finances

efficiently and economically and to make responsible spending decisions.

Because states share in the program costs, they have a strong incentive to

contain health care costs through prudent program decisions.

The current funding arrangements with local government health providers

undermine this incentive and circumvent the federal and state funding

balance that is set by law. These funding arrangements effectively increase

the federal matching rate by increasing federal expenditures, while total

state contributions remain unchanged or even decrease. For example, we

reported in 1994 that the state of Michigan increased its federal matching

rate from 56 percent to 68 percent by reducing state payments by $773

million through several different funding practices. These practices

included the funding arrangement explained in figure 2.

The current excessive payment rates used or proposed by states have the

same potential. For example, under New Jersey’s excessive payment plan

to county nursing facilities, an additional $500 million in federal funds will

be paid over a 15-month period. While the state has not indicated how

much of this payment it will ultimately retain, keeping all additional

federal funds would have the effect of increasing the federal share from 50

percent to 62 percent. HCFA is aware of 15 other similar plan amendments

involving local government nursing homes. Together, these 16 state

funding arrangements, if they all take effect, could result in over $2 billion

in annual excessive federal payments.

In the past, efforts to curtail round-trip financing schemes have focused on

restricting the size of the excessive payments. The same approach can be

taken for the current scheme. More specifically, in 1987, in response to

some states’ excessive Medicaid payments to state-operated facilities,

HCFA promulgated regulations that established separate upper payment

limits for state-owned facilities in certain provider categories. Expanding

this approach to include all government-owned Medicaid providers would

essentially shrink the upper payment limit loophole and reduce the

financial benefit of current financing arrangements with local government

providers. For example, if an upper payment limit was established for

Financing Scheme

Undermines

Congressionally

Determined Federal

Share of Medicaid

Expenditures

Restricting the Size of

Excessive Payments Can

Limit Financing Schemes
Medicaid: State Financing Schemes Again

Drive Up Federal Payments

Page 11 GAO/T-HEHS-00-193

payments to all government providers, the federal share of the excessive

payment amount in Iowa could be reduced from over $95 million to less

than $3 million. This decline would occur because the excess amount

available for payment would be reduced from $151 million for all nursing

homes to about $4 million for nursing homes operated by local

governments.

Some action on this front is under way. In response to the increasing

magnitude of the current payment schemes, HCFA has drafted regulations

that, if put into effect, would curtail excessive payments to local

government providers in the same manner as for state-owned facilities.

HCFA officials acknowledged that they had been aware that some states

have been using the current scheme for a number of years. They said they

had become more motivated to take action because of the increasing

number of states submitting plans to use the scheme and the drain of

federal dollars as a result. HCFA’s draft regulations are awaiting approval

from the Office of Management and Budget (OMB). If OMB approves

them, the regulations must undergo a public comment period before they

can take effect. HCFA officials were unable to definitively estimate when

proposed regulations would be issued for public comment.

The financing scheme that states are increasingly using is basically no

different from the schemes that have been identified and subsequently

prohibited in the past. The current schemes take advantage of a

technicality that allows states to, in effect, supplant state Medicaid dollars

with federal Medicaid dollars. In so doing, states violate the basic integrity

of Medicaid as a joint federal/state program.

HCFA’s proposed regulatory change, which would impose an upper

payment limit on providers owned by local government entities, would

extend the existing limits on payments to state-owned facilities. While

such a change would probably not discourage other attempts to find ways

to increase federal payments, it would at least curtail the scheme now in

widest use. Because of the potential for excessive payments to persist in

other forms, the Congress should consider implementing a

recommendation that remains outstanding from our 1994 work to enact

legislation to prohibit Medicaid payments that exceed costs to any

government-owned facility. Finally, continuing attempts to exploit

program loopholes also point to the need to be ever vigilant to identify the

next innovative arrangement before it reaches such financial magnitude

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

the integrity of the funding partnership.

Conclusions and

Previous

Recommendation
Medicaid: State Financing Schemes Again

Drive Up Federal Payments

Page 12 GAO/T-HEHS-00-193

Mr. Chairman, this concludes my prepared statement. I will be happy to

answer any questions that you or Members of the Committee may have.

For future contacts regarding this testimony, please call Kathryn G. Allen

at (202) 512-7118. Frank Pasquier, Tim Bushfield, Robert Crystal, Evan

Stoll, and Stan Stenersen also made key contributions to this testimony .

GAO Contact and

Staff

Acknowledgments
Page 13 GAO/T-HEHS-00-193

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
Related GAO Products

Page 14 GAO/T-HEHS-00-193

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