Medicaid Demonstrations: Federal Action Needed to Improve Oversight of Spending
Published: 2017-04-03T00:00:00

Fast Facts:
Many states conduct Medicaid demonstrations, which allow them to test new approaches for delivering Medicaid services. The Centers for Medicare & Medicaid Services monitors spending under these demonstrations to ensure that the federal government does not pay more for them than it would have paid for the state's traditional Medicaid program.
We found that, over the last decade, Medicaid has spent increasing amounts on these demonstrations. We also found inconsistences in how CMS monitors these funds.
We recommended that CMS develop standard operating procedures to ensure that Medicaid's demonstration funds are consistently monitored.

Highlights:
section_title: Why GAO Did This Study
paragraphs: As of November 2016, 37 states had demonstrations under section 1115 of the Social Security Act, under which the Secretary of HHS may allow costs that Medicaid would not otherwise cover for state projects that are likely to promote Medicaid objectives. By policy, demonstrations must be budget neutral; that is, the federal government should spend no more for a state's Medicaid program than it would have spent without the demonstration. CMS is responsible for monitoring spending and assessing compliance with demonstration terms and conditions for how funds can be spent and applying spending limits to maintain budget neutrality.
GAO was asked to examine federal spending for demonstrations and CMS's oversight of spending. This report examines (1) federal spending over time, (2) CMS's monitoring process, and (3) CMS's application of spending limits. GAO reviewed federal expenditure data for fiscal years 2005-2015, relevant documentation for 4 states, selected based on variation among their demonstrations, and federal internal control standards, and also interviewed CMS and state Medicaid officials.
section_title: What GAO Found
paragraphs: Over the last decade, federal spending under Medicaid section 1115 demonstrations, which allow states flexibility to test new approaches for delivering Medicaid services, has increased significantly.
The Centers for Medicare & Medicaid Services (CMS), within the Department of Health and Human Services (HHS), took a number of steps to monitor demonstration spending in GAO's 4 selected states. However, GAO also found inconsistencies in CMS's monitoring process. For example, CMS did not consistently require selected states to report the information needed to assess compliance with demonstration spending limits. The inconsistencies may have resulted from a lack of written standard procedures. CMS officials told GAO that CMS was developing procedures to better standardize monitoring, but did not have detailed plans for doing so. Thus, it is too soon to determine whether these efforts will address the inconsistencies GAO found. Federal standards require that federal agencies design control activities to achieve objectives. Without standard, documented procedures, CMS may not identify cases where states are inappropriately using federal funds or exceeding spending limits.
In applying demonstration spending limits, CMS allowed states to accrue unspent funds (more specifically, unused spending authority) when state spending is below the limit and use them to finance expansions of the original demonstration. For example, CMS allowed New York to use $8 billion in unspent federal funds to expand its demonstration to include an incentive payment pool for Medicaid providers. In May 2016, CMS released a slide presentation outlining new restrictions on the accrual of unspent funds. Per federal standards, formal guidance helps ensure that policies are consistently carried out. However, CMS has not issued formal guidance on the policy and does not consistently track unspent funds under the spending limit, raising questions as to whether the revised policy will be effective in better controlling costs.
section_title: What GAO Recommends
paragraphs: GAO recommends that CMS (1) develop and document standard operating procedures for sufficient reporting requirements and to require consistent monitoring and (2) issue formal guidance on its revised policy for restricting accrual of unspent funds. HHS agreed with GAO's first recommendation and neither agreed nor disagreed with GAO's second recommendation.

section_title: Letter
paragraphs: In fiscal year 2015, federal spending for Medicaid section 1115  demonstrations, which allow states to test and evaluate new approaches  for delivering Medicaid services, was over a $100 billion. As of  November 2016, 37 states were operating a portion of their Medicaid  program under one or more of these demonstrations. Under section 1115  of the Social Security Act, the Secretary of Health and Human Services  may waive certain federal Medicaid requirements and allow costs that  would not otherwise be eligible for federal funds for demonstration  projects that, in the Secretary’s judgment, are likely to promote the  objectives of the Medicaid program. For example, the Secretary has  approved states’ proposals to extend Medicaid coverage under the  demonstrations to populations or services that would not otherwise be  covered under traditional Medicaid. Under section 1115, the Secretary  has also allowed states to use Medicaid funds to finance other types of  costs, for example, those for state health programs or incentive payments  to providers to improve access to and quality of care.
The Secretary of Health and Human Services has delegated  responsibility for overseeing section 1115 demonstrations to the Centers  for Medicare & Medicaid Services (CMS), the agency within the  Department of Health and Human Services (HHS) that oversees  Medicaid. CMS’s oversight responsibilities include monitoring  demonstrations. This includes assessing whether states are complying  with requirements for how federal funds can be spent under the  demonstration and with limits on the amount of federal funds that can be spent over the life of a demonstration, referred to as spending limits.  CMS sets requirements for how funds can be spent, spending limits, how  the limits will be enforced, and related state reporting requirements in the  special terms and conditions (STC) for each demonstration, which  represents the agreement between CMS and the state.
CMS policy requires that demonstrations be budget neutral to the federal  government; that is, the federal government should spend no more for  Medicaid under a state’s demonstration than it would have spent without  the demonstration. A demonstration’s spending limit reflects CMS’s  estimate of what the federal government would have spent without the  demonstration. Ensuring that demonstrations are budget neutral depends  both on how limits are set and how CMS applies the limits during the  course of the demonstration. GAO found in past work that approved  spending limits for some demonstrations were too high and, therefore, did  not ensure that demonstrations were budget neutral.
Given the significant amount of federal spending under demonstrations,  as well as past concerns about whether demonstrations were budget  neutral, you asked us to examine federal spending for Medicaid  demonstrations and CMS’s monitoring of spending under demonstrations.  This report examines the following:  1.  Federal spending over time under Medicaid section 1115  demonstrations.  2.  CMS’s process for monitoring spending under section 1115  demonstrations.  3.  CMS’s application of demonstration spending limits.
To examine federal spending for Medicaid section 1115 demonstrations  over time, we analyzed federal Medicaid expenditure data for fiscal years  2005 through 2015. Specifically, we reviewed data from CMS’s Quarterly  Medicaid Statement of Expenditures for the Medical Assistance  Program—known as the CMS-64 form—extracted on October 3, 2016.  We reviewed the federal share of expenditures for section 1115  demonstrations from fiscal years 2005 through 2015, including state-by- state and national expenditures. We analyzed spending under  demonstrations as a share of total Medicaid spending over this time  period. To assess the reliability of the federal expenditure data, we  reviewed related documentation, including the forms used to collect the  data and their instructions, and performed manual and electronic tests for  outliers or anomalies. We also interviewed knowledgeable CMS officials  about the data trends, quality, and limitations, including the steps they  take to ensure data reliability. We determined that these data were  sufficiently reliable for our purposes.
To examine CMS’s process for monitoring spending under  demonstrations, we reviewed documentation for demonstrations in four  states: California, Indiana, New York, and Tennessee. We selected states  with demonstrations that were at least 5 years old and that varied in terms  of the approaches each state was testing under the demonstration. Our  states also varied geographically. For each demonstration, we reviewed  reporting requirements contained in the STCs that were in effect as of the  end of 2015, as well as any renewals approved after that date. We also  reviewed available quarterly and annual performance reports and  quarterly expenditure reports for 2013 through 2015 submitted by those  states to CMS to assess whether reports were consistent with reporting  requirements. Finally, where relevant, we reviewed documentation of  CMS deferrals of federal Medicaid funds—decisions to withhold payments  to states until further review—related to the demonstrations in these  states. To supplement our review, we interviewed CMS officials about  their monitoring practices in general and for the demonstrations in our  selected states, and we interviewed state Medicaid officials in the four  states. In evaluating this information, we compared policies and  procedures against GAO’s Standards for Internal Control in the Federal  Government, which provide guidance to federal agencies on ensuring  accountability.
To examine how CMS applied demonstration spending limits, we  interviewed CMS officials about their policy for applying spending limits  and reviewed related documentation. We also reviewed the STCs for our  selected states’ demonstrations to examine how CMS’s policies were  reflected in the STCs. For the one selected state where sufficient data  were available, we examined combined state and federal expenditures to  compare actual spending to the demonstration spending limit.
We conducted this performance audit from September 2015 to April 2017  in accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.
subsections: section_title: Background
paragraphs: The federal government sets broad federal requirements for Medicaid— such as requiring that state Medicaid programs cover certain populations  and benefits—and matches state Medicaid expenditures with federal  funds for most services. States administer their respective Medicaid  programs on a day-to-day basis, and have the flexibility to, among other  things, establish provider payment rates and cover many types of optional  benefits and populations. Section 1115 demonstrations provide a further  way for states to innovate in ways that fall outside of many of Medicaid’s  otherwise applicable requirements, and to receive federal matching  Medicaid funds for costs that would not otherwise be matchable. For  example, states may use these demonstrations to test new approaches  for delivering care to generate savings or efficiencies or improve quality  and access. Such changes have included expanding benefits to cover  populations that would not otherwise be eligible for Medicaid, altering the  state’s Medicaid benefit package, or financing payment pools, for  example, for state-operated health programs or supplemental provider  payments. Demonstrations are typically approved for an initial 5-year  period that can be renewed for future demonstration periods. Some states  have operated some or all of their Medicaid programs for decades under  section 1115 demonstrations.
subsections: section_title: Demonstration Terms and Conditions
paragraphs: Each demonstration is governed by STCs, which reflect the agreement  between CMS and the state. The STCs include any provisions governing  spending under the demonstration. For example, STCs indicate for what  populations and services funds can be spent. In states receiving approval  to implement payment pools for state health programs and supplemental  provider payments, the STCs could include parameters for payments  under those pools. For example, they may require that payment pools be  capped at certain levels. The STCs may also include criteria for providers  to receive payments and protocols that states must have to ensure the  appropriateness of the payments and allow CMS to review those  payments. The STCs also include the limits on the amount of federal  funds that can be spent on the demonstration—referred to as spending  limits—and indicate how spending limits will be enforced. Finally, the  STCs include the reporting requirements the state must meet. Reporting  requirements—as contained in the STCs—may include regular telephone  calls between the state and CMS, regular performance reports, and  quarterly expenditure reports. The STCs outline what the state should  include in each of these reports, which can vary by demonstration.
section_title: Demonstration Spending Limits
paragraphs: CMS policy requires that section 1115 demonstrations be budget neutral  to the federal government—that is, the federal government should spend  no more under a state’s demonstration than it would have spent without  the demonstration. Once approved, each demonstration operates under a  negotiated budget neutrality agreement, documented in its STCs, that  places a limit on federal Medicaid spending over the life of the  demonstration. This limit is referred to as the spending limit. If a state  exceeds the demonstration spending limit at the end of the demonstration  period, it must return the excess federal funds.
Spending limits can be a per person limit that sets a dollar limit for each  Medicaid enrollee included in the demonstration in each month, a set  dollar amount for the entire demonstration period regardless of the level  of enrollment, or a combination of both. Spending limits are calculated by  establishing a spending base and applying a rate of growth over the  period of the demonstration. The spending base generally reflects a  recent year of state expenditures for populations included in the  demonstration, and the growth rate to be applied is generally based on  the lower of a state-specific historical growth rate or a federal nationwide  estimate. Different data elements may be required by CMS to assess a  state’s compliance with the spending limit. For example, for a per person  spending limit, which is generally a defined dollar limit per enrollee per  month, CMS needs both expenditure and enrollment data to assess  compliance with the spending limit.
section_title: Demonstration Monitoring
paragraphs: CMS is responsible for monitoring compliance with the STCs during the  demonstration, including compliance with requirements around how  Medicaid funds can be spent and spending limits. Monitoring efforts may include reviewing performance reports and quarterly financial reporting  required under the STCs and discussing questions and concerns with the  state. When a state seeks a renewal of a demonstration, that request  offers CMS an opportunity to negotiate revisions to the STCs with the  state, which could include changes to spending limits and reporting  requirements. (See fig. 1.)
States are required to report Medicaid expenditures, including  expenditures under demonstrations, to CMS at the end of each quarter.  CMS reviews these expenditures on a quarterly basis for  reasonableness. If, during the expenditure review, CMS is uncertain as  to whether a particular state expenditure is allowable, then CMS may  withhold payment pending further review (referred to as a deferral). With  regard to reporting on expenditures under demonstrations, the STCs  dictate the level of detail that the state is required to include in the  quarterly expenditure reporting. For example, they might require the state  to report expenditures by population and by payment pool approved  under the demonstration.
section_title: Federal Spending under Demonstrations Grew Significantly over the Past Decade and Represents a Third of All Medicaid Spending
paragraphs: Federal spending under section 1115 Medicaid demonstrations increased  significantly from fiscal year 2005 through fiscal year 2015, rising from  $29 billion in 2005 to over $100 billion in 2015. Federal spending on  demonstrations also increased as a share of total federal Medicaid  spending during the same period, rising from 14 percent of all federal  Medicaid spending in fiscal year 2005 to 33 percent in fiscal year 2015.  (See fig. 2.) Several factors likely contributed to these trends. First, the  number of states with demonstrations increased during this period, with  31 states reporting demonstration expenditures in fiscal year 2005 and 40  reporting such expenditures in fiscal year 2015. Second, some states  expanded their demonstrations over this period, with demonstration  spending in 24 states representing a greater proportion of total Medicaid  spending in fiscal year 2015 than in fiscal year 2005. For example, CMS  officials told us that, during this period, some states shifted expenditures  for managed care and home and community based services from other  Medicaid authorities to section 1115 demonstrations. In addition, during  2010 through 2015, a number of states expanded coverage through  demonstrations to low-income adults, which, as CMS officials told us,  likely contributed to the increase in demonstration spending.
Demonstration spending as a proportion of total federal Medicaid  spending varied across states and represented most—75 percent or  more—of Medicaid spending in 10 of the 40 states that reported  expenditures in fiscal year 2015. (See fig. 3.) Further, in 5 of these 10  states, demonstration spending represented more than 90 percent of the  state’s total federal Medicaid spending. In contrast, in fiscal year 2005,  spending under demonstrations did not exceed 75 percent of total  Medicaid spending in any state. In that year, demonstration spending  represented between 25 percent and 75 percent of total Medicaid  spending in 10 states and less than 25 percent in 21 states. (See app. I.)
The extent to which demonstration spending changed over time varied  across states, as illustrated by the most recent 5 years of spending data  in our selected states. In two of our four selected states—California and  Indiana—spending under demonstrations increased between fiscal years  2011 and 2015, consistent with the national trend. (See table 1.)  California’s demonstration spending increased the most significantly— more than tripling—during this time frame, during which the state  expanded its demonstration to, among other things, provide coverage to  low-income adults. Indiana reported a 22 percent increase in  demonstration spending between fiscal years 2011 and 2015. In contrast,  Tennessee reported a 3 percent decrease during that period. With regard  to the change in the proportion of total Medicaid spending that  demonstrations represented, the proportion did not change between 2011  and 2015 for Indiana and Tennessee and doubled in California, from a  quarter of its total Medicaid expenditures in 2011 to half of its total  Medicaid expenditures in 2015. We could not assess the change in  spending for the fourth state—New York—because the state’s  expenditure reporting for fiscal year 2015 was incomplete.
section_title: CMS’s Monitoring of Demonstration Spending Lacked Consistency
paragraphs: We found that CMS took a number of steps to monitor demonstration  spending in our selected states. For example, CMS held calls with states  and performed various steps to assess the appropriateness of  expenditures.
Held monitoring calls. CMS and state officials told us that they held  monitoring telephone calls to discuss any significant current or  expected developments in the demonstrations. CMS officials  confirmed they may use the calls to obtain information to supplement  their review of states’ performance and expenditure reports. For  example, CMS officials said they used the calls with Tennessee to  raise questions about the content of the state’s submitted quarterly  reports. In addition, California officials told us that CMS used these  calls to get updates and supporting documentation on state programs.
Checked for the appropriateness of expenditures. In reviewing the  quarterly expenditure reports, CMS officials told us that they assessed  the appropriateness of expenditures. For example, the agency  checked that the amounts claimed complied with federal requirements  for matching funds. As a result of these checks, CMS issued several  deferrals to withhold payment of federal funds to California until the  state could account for expenditures claimed. Officials also told us  that as part of the checks, they assessed the appropriateness of pool  payments, such as those for supplemental payments to providers,  where relevant. Assessing the appropriateness of pool payments  involves ensuring that pool payments align with the approved  purposes of the pool and that the payments were made to approved  providers. For example, CMS officials told us that for one of the  pools in the New York demonstration, agency staff checked whether  the payments made were to eligible providers, the requirements of  which were described in the STCs. As a result of this review, CMS  deferred providing over $38 million in federal funds to New York for  payments made to providers under the pool in the quarter ending  March 31, 2016, until the state could provide documentation that the  providers were eligible to receive payment. CMS officials also told us  that they checked to ensure that the state was not receiving funds  from other federal funding sources that are intended to serve the  same purposes as funds in their payment pools (i.e., duplicating  federal funds), and that the state’s share of funding for the pools is  from permissible sources, such as the state’s general revenue.  According to CMS officials, as a result of the agency’s checks of  spending for New York’s demonstration, CMS identified $172 million  in federal funds that were inappropriately used to finance the state  share of demonstration costs. CMS recovered these funds in fiscal  year 2015.
However, we also found inconsistencies in CMS’s monitoring process that  potentially limited the effectiveness of the agency’s monitoring efforts in  the selected states. The inconsistencies included the following:
Reporting requirements were sometimes insufficient to provide  information needed to assess compliance with spending limits.  CMS did not consistently require states to report the elements needed  for the agency review staff to compare actual demonstration spending  to the spending limit. For example, although CMS needs states to  report the number of enrollees per month—referred to as member  months—to assess compliance with per person spending limits, the  agency only required such reporting for two of the four selected  states’ demonstrations. CMS acknowledged that having member  month data is important to assess spending limit compliance. For  example, CMS did not require California to report enrolled member  months for its demonstration from 2010 to 2015, but the agency  amended the STCs to include this requirement when the state’s  demonstration was renewed beginning in 2016. Including this  requirement will prevent CMS from having to use alternative means to  gain necessary information for this compliance assessment. For  example, CMS officials said that they have used monitoring calls to  obtain the missing enrollment information from the state.
Enforcement of expenditure reporting requirements was  inconsistent. We found that the selected states did not report  demonstration expenditures in all of the categories specified under  their demonstration STCs. For example, California’s expenditure  reporting did not align with the STC reporting requirements for 2010  through 2015. California officials told us this was largely because  CMS had not enforced the reporting requirements prior to 2015.  Therefore, based on our review, CMS would not be able to assess  compliance with the spending limit for California using the data  included in its expenditure report, if CMS tried to do so.
Monitoring compliance with spending limits was inconsistent.
CMS did not consistently assess compliance with the spending limit in  all our selected states. CMS officials told us that they assessed  compliance with the spending limits on a quarterly basis for the  demonstrations in Tennessee and Indiana. However, the agency did  not regularly assess compliance for the California and New York  demonstrations—which represented tens of billions of dollars in  federal spending annually—due to limitations in the state-reported  expenditure data. CMS officials told us that they did not assess  California’s compliance with the spending limit because the  expenditure data submitted by the state was not accurate.  Furthermore, the agency’s focus was on resolving a number of  broader financial compliance issues in the state (see sidebar), the  resolution of which, according to officials, was necessary before the  agency could assess compliance with the spending limit. With regard  to New York, CMS had not assessed compliance with the spending  limit since 2011, because the state’s reporting of expenditures has  been significantly incomplete since then. According to CMS officials,  significant staff transitions disrupted New York’s ability to report  expenditures to CMS as required. The state delayed reporting  expenditures, and it did not report them in the categories specified in  the STCs. Although CMS did not assess compliance with the  spending limit for either of these two states, officials told us that they  were not concerned that California or New York exceeded their  spending limits because the limits in those states have historically  been higher than actual spending.
These inconsistencies may have resulted, in part, from CMS’s lack of  written, standard operating procedures for monitoring spending under  demonstrations. For example, CMS does not have internal guidance on  the elements that must be included in reporting requirements for states. In  addition, regarding the state performance reports, CMS does not have a  review protocol or a requirement that staff check that reports contain the  elements required by the STCs, for example, enrollment data needed to  assess a state’s compliance with the spending limit. CMS has written  materials to train staff on how spending limits are set and how  demonstration spending is monitored. However, these materials are  limited to high-level descriptions of the monitoring roles and do not  contain specific procedures for staff to use in monitoring. Regarding the  review of quarterly expenditure reports, CMS has guidance for agency  staff who review them, but the guidance lacks detailed direction on what  checks of demonstration expenditure data should occur.
CMS also lacks standard procedures for documenting its monitoring  efforts. For example, the agency has no written requirements for its staff  to document that required performance reports have been submitted by  the states. Furthermore, the agency does not require its staff to document  the content of monitoring calls, including any concerns and potential  resolutions discussed. In addition, CMS does not require its staff to  systematically document checks performed for state compliance with  demonstration spending limits or the appropriateness of pool payments.  According to CMS officials, while there are not written requirements to do  so, there is an expectation that staff maintain documentation of their  monitoring efforts. However, officials also told us that any documentation  of checks that a demonstration complied with its spending limits is likely  included in the personal notes of individual CMS staff. As such, they may  not necessarily be accessible to all staff who have oversight responsibility  of the demonstration. One example of evidence we observed of CMS  documenting its monitoring efforts was when checks for appropriateness  of expenditures resulted in a deferral of federal funds, which were  documented in letters to the states.
CMS officials told us that they are in the early stages of developing  standard operating procedures and a management information system to  better standardize the monitoring of demonstrations:
Standard operating procedures. CMS officials told us that they are  developing protocols for monitoring state demonstration programs and  state compliance with demonstration spending limits. Officials told us  that the protocols would outline staff roles and responsibilities.  Officials also told us that they are working on standardizing the format  and content of required state performance reports, which could help  ensure that CMS is receiving the information needed to monitor  spending under the demonstration. As of December 2016, CMS  officials expected that the first phase of standard procedures, which  will focus on assessments of compliance with the spending limit, will  be developed and documented in the next year. They explained that  developing the procedures is an iterative process and that it could  take the agency 2 years to completely develop and document its  plans.
Management information system. CMS officials also told us that  they are in the initial phases of building a management information  system to facilitate and document demonstration oversight. The first  part of the system, which was in use as of September 2016, allowed  CMS to centralize the collection of state demonstration performance  reports. In future phases of system development, officials told us that  the system will include alerts for missing reports or incomplete  reviews and prompts for CMS’s staff to document completion of  monitoring checks. CMS also plans for the system to include a  database of demonstration STCs that CMS staff can search, which  could help to ensure that STCs consistently include necessary  reporting requirements.
It is too early to determine how well CMS’s planned standard operating  procedures and management information system will address the  inconsistencies in its demonstration monitoring process. CMS officials did  not have any written documentation regarding the agency’s plans as of  December 2016. As such, it was unclear, for example, whether the  procedures and new system would include mechanisms to ensure that  STCs consistently require states to report the information needed for  CMS to assess compliance with the spending limits. In addition, it was  unclear if the procedures or new system would ensure that agency staff  regularly check that expenditure reporting complies with reporting  requirements. CMS officials said they intend for the procedures and new  system to include mechanisms to ensure consistency in those areas.  Federal internal control standards require that federal agencies design  control activities to achieve objectives and respond to risks, and that  agencies implement control activities, including documenting the  responsibilities for these activities through policies and procedures.  Without standard procedures for monitoring demonstration spending and  documenting those efforts, CMS faces the risk of continued  inconsistencies in monitoring and the risk that it may not identify cases  where states may be inappropriately using federal funds or exceeding  spending limits.
section_title: CMS Is Implementing a Revised Policy for Applying Spending Limits, but the Extent to Which It Will Effectively Control Costs Is Unclear
paragraphs: CMS’s policy for applying demonstration spending limits has allowed our  selected states to accrue unused spending authority under the  demonstration spending limit (referred to in this report as unspent funds)  and use it to expand demonstrations to include new costs. According to  CMS officials, under long-standing policy, if a state spends less than the  spending limit, the agency allows the state to accrue the difference  between actual expenditures and the spending limit and carry forward the  unspent funds into future demonstration periods. CMS allowed our  selected states to use unspent funds to expand the demonstration by, for  example, financing care for additional eligibility groups or additional  supplemental payments. For example, according to CMS officials, Indiana  accrued $600 million in unspent state and federal funds during the first  demonstration period and was using a portion of that—approximately $2  million a year—to finance care for a small group of beneficiaries with end- stage renal disease in a subsequent period of the demonstration. CMS  allowed New York to use $8 billion in accrued unspent federal funds from  previous demonstration periods to expand its demonstration by including  a new supplemental payment pool for incentive payments to Medicaid  providers, costs that would not have been eligible for federal matching  funds outside of the demonstration. If a state were to exceed its  spending limit in a demonstration period, the agency allows it to draw  upon unspent funds from previous demonstration periods to cover  demonstration expenses, which, according to CMS officials, is consistent  with the budget neutrality policy, under which spending limits are enforced  over the life of the demonstration including any extensions beyond the  initial 5-year term.
The flexibility afforded to states in their accrual and use of unspent funds  may explain, in part, why CMS has infrequently found that states exceed  spending limits. Agency officials told us the agency has only withheld  federal funds once as a result of a state exceeding its spending limit.  Specifically, in 2007, CMS found that Wisconsin exceeded its  demonstration spending limit and required the state to return $10.2 million  to the federal government.
Among our selected states, we found that states could accrue significant  amounts of unspent funds. For example, CMS officials estimated that  New York and California accrued billions of dollars in unspent funds.  Based on our analysis, we found that Tennessee accrued approximately  $11.6 billion in unspent funds over 3 years. (See fig. 4) According to CMS  officials, growth in health care costs has proven lower than the agency  and states assumed when setting the spending limits, resulting in  spending that consistently falls below spending limits across  demonstrations. In past work, we found that HHS had approved spending  limits that were higher than the budget neutrality policy suggested.  Among other concerns, we reported that HHS allows methods for  establishing the spending limit that may be inappropriate—including  application of inappropriately high growth rates—and may result in  excessively high spending limits. For example, we found four  demonstrations where the spending limits were a total of $32 billion  higher than they should have been for the demonstration periods,  typically 5 years.
In May 2016, CMS communicated to states that the budget neutrality  policy had been revised to, among other things, restrict the accrual of  unspent funds to better control demonstration costs. Specifically, for  demonstrations renewed starting in January 2016, CMS restricts the  amount of unspent funds states can accrue over time in two ways. First,  when states apply to renew their demonstrations, they can only carry over  unspent funds from the past 5 years of the demonstration. Second, for  demonstrations renewed through 2021, CMS limits the amount of unspent  funds states can accrue each year in the renewal period. Specifically,  after a state’s initial 5-year demonstration period, the amount of expected  unspent funds that a state can accrue is reduced by 10 percent per year,  until states can only accrue 25 percent of expected unspent funds under  the spending limit. For example, a state renewing its demonstration after  completing its first 5-year demonstration period would be able to keep 90  percent of the unspent funds it would accrue under the spending limit in  the sixth year of the demonstration—which is the first year of the renewal  period—80 percent in the seventh year, and so on. States that had  renewed previously would experience further restrictions until the 13th  year of the demonstration, at which point a state would be limited to  accruing 25 percent a year.
For demonstration renewals starting in 2021, states will still be limited to  carrying over 5 years of unspent funds, but the percentage restrictions will  be replaced with different requirements that could lower spending limits.  Specifically, CMS will require states to submit new cost estimates using  recent cost data (i.e., to rebase their cost projections). Those new cost  projections, subject to adjustment, would become the basis of spending  limits for the renewal period. To the extent that using more recent cost  data results in spending limits that more closely reflect actual costs— which have proven lower than assumed by states and CMS when setting  the spending limit—this requirement may lower spending limits and  accordingly may reduce the unspent funds that states accrue under those  limits.
As of mid-December 2016, CMS was in the early stages of implementing  the restrictions, having approved six demonstration renewals under the  revised policy—those for Arizona, California, Massachusetts, New York,  Tennessee, and Vermont. The updated STCs for the new  demonstration periods in each state limited the states’ access to unspent  funds to the last 5 years and reduced the amount of unspent funds the  states can accrue over the next 5 years. For example, under the revised  policy, California’s expected accrued unspent funds over its next  demonstration period will be reduced by approximately $15 billion. (See  fig. 5.)
The effectiveness of the revised policy in controlling costs will depend, in  part, on whether CMS consistently implements the revisions. We found  two weaknesses that could lead to inconsistent application.
Lack of formal guidance. CMS released a slide presentation on the  revised policy during a teleconference with all states but has not  issued formal guidance. CMS made the slides available on the  agency’s website, but they were not included in the database of  guidance—typically letters—for state Medicaid directors. CMS officials  told us that there was no plan to issue additional guidance to states.  Although the slides detail how unspent funds will be reduced, without  formal guidance, it is unclear whether CMS will consistently apply  these new requirements during demonstration renewals.
Inconsistent tracking of unspent funds. We found that CMS was  not consistently tracking unspent funds under the spending limits in  our selected states, which makes it difficult for CMS to ensure the  unspent funds are reduced by the amount specified under the new  policy. For example, New York had not provided the financial  reporting CMS needed to calculate the state’s actual costs for the  different eligibility groups covered by the demonstration or its accrued  unspent funds, even though there were specific spending limits for  these different groups. As a result, CMS could not track unspent funds  in the state. CMS officials told us the agency required New York to  produce that information as part of the application for renewing the  state’s demonstration. Similarly, the agency did not have actual  costs for California’s demonstration, given California’s lack of  reporting as specified under the STCs, and required the state to  provide that information under its renewed demonstration. CMS  officials told us the standard operating procedures, as noted above,  that the agency is developing for monitoring demonstrations will  reflect the revisions to CMS’s budget neutrality policy. It is too soon to  determine if these procedures will ensure consistent tracking of  unspent funds because, as we noted earlier, there was no  documentation of the agency’s plans for these procedures as of  December 2016.
Federal internal control standards require that federal agencies should  design control activities to achieve objectives. Control activities like  formal guidance and standard procedures that clarify the application of  agency policies help ensure that those policies—such as the revised  budget neutrality policy—are consistently carried out in achieving cost  control objectives. Without addressing potential weaknesses, including  the lack of formal guidance and the lack of consistent tracking of unspent  funds across all demonstrations, CMS may not be able to effectively  implement the policy and achieve its related cost-control objectives.
section_title: Conclusions
paragraphs: Medicaid section 1115 demonstrations are an important tool for states to  test new approaches to delivering care that, among other things, may be  more cost effective. However, the growing federal expenditures for demonstrations—now at over $100 billion a year—for costs that, in some  cases, would not otherwise be eligible for Medicaid funding makes  monitoring of those dollars critical. While our work found that CMS was  monitoring demonstration spending in our selected states, the agency’s  process also raised concerns. CMS’s lack of standard procedures for its  monitoring process has contributed to insufficient reporting requirements  for states and inconsistent enforcement of those requirements.  Insufficient reporting can create a barrier to monitoring efforts, including  assessing compliance with spending limits. Inconsistent enforcement  might allow compliance issues to go undetected for extended periods of  time, which, as demonstrated by the issues in California and New York,  can take years to resolve.
A key principle for demonstrations has long been the policy that they must  be budget neutral to the federal government. Whether demonstrations  adhere to that principle depends both on how CMS approves and applies  spending limits during the demonstration. We have raised concerns in the  past about demonstration approvals, including that in some cases  spending limits for demonstrations were set too high. Our current work  found that as a result of high spending limits, states are accruing  significant amounts of unspent funds under the spending limits and using  those funds to finance expansions of the demonstration. CMS’s move  under the revised budget neutrality policy to begin restricting the amount  of unspent funds that states can accrue is a positive step toward the  agency’s goal of better controlling demonstration costs. However, states  may continue to accrue significant amounts of unspent funds. Without  standard procedures for tracking these funds, CMS will not be able to  effectively enforce the limits on those funds. Further, without formal  guidance on the revised policy, it is unclear whether CMS will consistently  apply the policy.
section_title: Recommendations for Executive Action
paragraphs: To improve consistency in CMS oversight of federal spending under  section 1115 demonstrations, we recommend that the Secretary of Health  and Human Services require the Administrator of CMS to take the  following two actions:  1.  Develop and document standard operating procedures for monitoring  a.  Require setting reporting requirements for states that provide  CMS the data elements needed for CMS to assess compliance  with demonstration spending limits;  b.  Require consistent enforcement of states’ compliance with  financial reporting requirements; and  c.  Require consistent tracking of the amount of unspent funds under  demonstration spending limits.  2.  Issue formal guidance on the revised budget neutrality policy,  including information on how the policy will be applied.
section_title: Agency Comments and Our Evaluation
paragraphs: We provided a draft of this report to HHS for review and comment. HHS  concurred with our first recommendation that the agency should develop  and document standard operating procedures for monitoring  demonstration spending.  In its response to this recommendation, HHS  added that the department is developing infrastructure and procedures to  better support demonstration monitoring.  HHS did not explicitly agree or  disagree with the second recommendation that the agency should issue  formal guidance on the revised budget neutrality policy and how it will be  applied.  In its response to this recommendation, HHS noted that the new  policy is being incorporated into new budget neutrality workbook  templates and monitoring procedures, which will be used by the states  and reviewers. The agency stated that it will determine if additional  guidance is needed as implementation continues. Given the importance  of this policy in controlling demonstration costs, we believe that  developing formal guidance is necessary to ensure consistent application.
HHS also provided technical comments, which we incorporated as  appropriate. HHS’s comments are reprinted in appendix II.
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If you or your staff members have any questions about this report, please  contact me at (202) 512-7114 or iritanik@gao.gov. Contact points for our  Offices of Congressional Relations and Public Affairs may be found on  the last page of this report. GAO staff who made key contributions to this  report are listed in appendix II.
section_title: Appendix I: Federal Spending for Medicaid Section 1115 Demonstrations, by State, Federal Fiscal Years 2005 and 2015
subsections: section_title: State
paragraphs: Total  Medicaid  expenditures  (millions)
Expenditures for  demonstrations  (millions)
Total Medicaid  expenditures  (millions)
Expenditures for  demonstrations  (millions)
section_title: State
paragraphs: Total  Medicaid  expenditures  (millions)
Expenditures for  demonstrations  (millions)
Total Medicaid  expenditures  (millions)
Expenditures for  demonstrations  (millions)
section_title: Appendix II: Comments from the Department of Health and Human Services
section_title: Appendix III: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Staff Acknowledgments
paragraphs: In addition to the contact named above, Susan Barnidge (Assistant  Director), Jasleen Modi (Analyst-in-Charge), Shamonda Braithwaite,  Elizabeth Miller, and Giao N. Nguyen made key contributions to this  report. Also contributing were Giselle Hicks, Laurie Pachter, and Emily  Wilson.