Title XIX of the Social Security Act establishes Medicaid as a joint federal- state program to finance health care for certain low-income, aged, or disabled individuals. Medicaid is an open-ended entitlement program, under which the federal government is obligated to pay its share of expenditures for covered services provided to eligible individuals under each state’s federally approved Medicaid plan. States operate their Medicaid programs by paying qualified health care providers for a range of covered services provided to eligible beneficiaries and then seeking reimbursement for the federal share of those payments. CMS has an important role in ensuring that states comply with certain statutory Medicaid payment principles when claiming federal reimbursements for payments made to institutional and other providers who serve Medicaid beneficiaries. For example, Medicaid payments by law must be “consistent with efficiency, economy, and quality care,” and states must share in Medicaid costs in proportions established according to a statutory formula. Within broad federal requirements, each state administers and operates its Medicaid program in accordance with a state Medicaid plan, which must be approved by CMS. A state Medicaid plan details the populations a state’s program serves, the services the program covers (such as physicians’ services, nursing home care, and inpatient hospital care), and the rates of and methods for calculating payments to providers. State Medicaid plans generally do not detail the specific arrangements a state uses to finance the nonfederal share of program spending. Title XIX of the Social Security Act allows states to derive up to 60 percent of the nonfederal share from local governments, as long as the state itself contributes at least 40 percent. Over the last several years, CMS has taken a number of steps to help ensure the fiscal integrity of the Medicaid program. These include making internal organizational changes that centralize the review of states’ Medicaid financing arrangements and hiring additional staff to review each state’s Medicaid financing. The agency also published in May 2007 a final rule related to Medicaid payment and financing. This rule would, among other things, limit payments to government providers to their cost of providing Medicaid services. Congress has imposed a moratorium on this rule until May 25, 2008. From 1994 through 2005, we have reported numerous times on a number of financing arrangements that create the illusion of a valid state Medicaid expenditure to a health care provider. Payments under these arrangements have enabled states to claim federal matching funds regardless of whether the program services paid for had actually been provided. As various schemes have come to light, the Congress and CMS took several actions from 1987 through 2002, through law and regulation, to curtail them (see table 1). Many of these arrangements involve payment arrangements between the state and government-owned or government-operated providers, such as local government-operated nursing homes. They also involved supplemental payments—payments states made to these providers separate from and in addition to those made at a state’s standard Medicaid payment rate. The supplemental payments connected with these arrangements were illusory, however, because states required these government providers to return part or all of the payments to the states. Because government entities were involved, all or a portion of the supplemental payments could be returned to the state through an IGT. Financing arrangements involving illusory payments to Medicaid providers have significant fiscal implications for the federal government and states. The exact amount of additional federal Medicaid funds generated through these arrangements is not known, but was in the billions of dollars. For example, a 2001 regulation to curtail states’ misuse of the UPL for certain provider payments was estimated to have saved the federal government approximately $17 billion from fiscal year 2002 through fiscal year 2006. In 2003, we designated Medicaid to be a program at high risk of mismanagement, waste, and abuse, in part because of concerns about states’ use of inappropriate financing arrangements. States’ use of these creative financing mechanisms undermined the federal-state Medicaid partnership as well as the program’s fiscal integrity in at least three ways. First, inappropriate state financing arrangements effectively increased the federal matching rate established under federal law by increasing federal expenditures while state contributions remain unchanged or even decrease. Figure 1 illustrates a state’s arrangement in place in 2004 in which the state increased federal expenditures without a commensurate increase in state spending. In this case, the state made a $41 million supplemental payment to a local government hospital. Under its Medicaid matching formula, the state paid $10.5 million and CMS paid $30.5 million as the federal share of the supplemental payment. However, after receiving the supplemental payment the hospital transferred back to the state approximately $39 million of the $41 million payment, retaining just $2 million. Creating the illusion of a $41 million hospital payment when only $2 million was actually retained by the provider enabled the state to obtain additional federal reimbursements without effectively contributing a nonfederal share—in this case, the state actually netted $28.5 million as a result of the arrangement. Second, CMS had no assurance that these increased federal matching payments were retained by the providers and used to pay for Medicaid services. Federal Medicaid matching funds are intended for Medicaid- covered services for the Medicaid-eligible individuals on whose behalf payments are made. However, under these arrangements payments for such Medicaid-covered services were returned to the states, which could then use the returned funds at their own discretion. In 2004, we examined how six states with large supplemental payment financing arrangements involving nursing homes used the federal funds they generated. As in the past, some states deposited excessive funds from financing arrangements into their general funds, which may or may not be used for Medicaid purposes. Table 2 provides further information on how states used their funds from supplemental payment arrangements, as reported by the six states we reviewed in 2004. Third, these state financing arrangements undermined the fiscal integrity of the Medicaid program because they enabled states to make payments to government providers that could significantly exceed their costs. In our view, this practice was inconsistent with the statutory requirement that states ensure that Medicaid payments are economical and efficient. Our March 2007 report on a recent CMS oversight initiative to end certain financing arrangements where providers did not retain the payments provides context for CMS’s May rule. Responding to concerns about states’ continuing use of creative financing arrangements to shift costs to the federal government, CMS has taken steps starting in August 2003 to end inappropriate state financing arrangements by closely reviewing state plan amendments on a state-by-state basis. As a result of the CMS initiative, from August 2003 through August 2006, 29 states ended one or more arrangements for financing supplemental payments, because providers were not retaining the Medicaid payments for which states had received federal matching funds. We found CMS’s actions under its oversight initiative to be consistent with Medicaid payment principles—for example, that payment for services be consistent with efficiency, economy, and quality of care. We also found, however, that CMS’s initiative to end inappropriate financing arrangements lacked transparency, in that CMS had not issued written guidance about the specific approval standards for state financing arrangements. CMS’s initiative was a departure from the agency’s past oversight approach, which did not focus on whether individual providers were retaining the supplemental payments they received. In contacting the 29 states that ended a financing arrangement from August 2003 through August 2006 under the initiative, only 8 states reported that they had received any written guidance or clarification from CMS regarding appropriate and inappropriate financing arrangements. CMS had not used any of the means by which it typically provides information to states about the Medicaid program, such as its published state Medicaid manual, standard letters issued to all state Medicaid directors, or technical guidance manuals, to inform states about the specific standards it used for reviewing and approving states’ financing arrangements. State officials told us that it was not always clear what financing arrangements CMS would allow and why arrangements approved in the past would no longer be approved. Twenty-four of 29 states reported that CMS had changed its policy regarding financing arrangements, and 1 state challenged CMS’s disapproval of its state plan amendment, in part on the grounds that CMS changed its policy regarding payment arrangements and should have done so through rule making. The lack of transparency in CMS’s review standards raised questions about the consistency with which states had been treated in ending their financing arrangements. We consequently recommended that CMS issue guidance to clarify allowable financing arrangements. Our recommendation for CMS to issue guidance for allowable financing arrangements paralleled a recommendation we had made in earlier work reviewing states’ use of consultants on a contingency-fee basis to maximize federal Medicaid revenues. Problematic projects where claims for federal matching funds appeared to be inconsistent with CMS’s policy or with federal law, or that—as with inappropriate supplemental payment arrangements—undermined Medicaid’s fiscal integrity, involved Medicaid payments to government entities and categories of claims where federal requirements had been inconsistently applied, were evolving, or were not specific. We recommended that CMS establish or clarify and communicate its policies in these areas, including supplemental payment arrangements. CMS’s responded that clarifying guidance was under development for targeted case management, rehabilitation services, and supplemental payment arrangements. We have ongoing work to examine the amount and distribution of states’ Medicaid supplemental payments, but have not reported on the May 2007 rule or other rules related to Medicaid financing issued this year. Certain elements of the May 2007 rule relate to the concerns our past work has raised. Some aspects of the final rule appear to be responsive to recommendations from our past work, to the extent that its implementation could help ensure that Medicaid providers, on whose behalf states’ receive federal matching funds, retain the payments made by the state. The extent to which the rule would address concerns about the transparency of CMS’s initiative and review standards will depend on how CMS implements it. As the nation’s health care safety net, the Medicaid program is of critical importance to beneficiaries and the providers that serve them. The federal government and states have a responsibility to administer the program in a manner that ensures that expenditures benefit those low-income people for whom benefits were intended. With annual expenditures totaling more than $300 billion per year accountability for the significant program expenditures is critical to providing those assurances. Ensuring the program’s long-term fiscal sustainability is important for beneficiaries, providers, states, and the federal government. For more than a decade, we have reported on various methods that states have used to inappropriately maximize federal Medicaid reimbursement, and we have made recommendations to end these inappropriate financing arrangements. Supplemental payments involving government providers have resulted in billions of excess federal dollars for states, yet accountability for these payments—assurances that they are retained by providers of Medicaid services to Medicaid beneficiaries—has been lacking. CMS has taken important steps in recent years to improve its financial management of Medicaid, yet more can be done. Mr. Chairman, this concludes my prepared statement. I will be happy to answer any questions that you or members of the subcommittee may have. For information regarding this testimony, please contact James Cosgrove at (202) 512-7114 or cosgrovej@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this testimony. Katherine Iritani, Assistant Director; Carolyn Yocom, Assistant Director; Ted Burik; Tim Bushfield; Tom Moscovitch; and Terry Saiki also made key contributions to this testimony. Medicaid Financing: Long-Standing Concerns about Inappropriate State Arrangements Support Need for Improved Federal Oversight. GAO-08-255T. Washington, D.C.: November 1, 2007. Medicaid Financing: Federal Oversight Initiative Is Consistent with Medicaid Payment Principles but Needs Greater Transparency. GAO-07-214. Washington, D.C.: March 30, 2007. High-Risk Series: An Update. GAO-07-310. Washington, D.C.: January 2007. Medicaid Financial Management: Steps Taken to Improve Federal Oversight but Other Actions Needed to Sustain Efforts. GAO-06-705. Washington, D.C.: June 22, 2006. Medicaid: States’ Efforts to Maximize Federal Reimbursements Highlight Need for Improved Federal Oversight. GAO-05-836T. Washington, D.C.: June 28, 2005. Medicaid Financing: States’ Use of Contingency-Fee Consultants to Maximize Federal Reimbursements Highlights Need for Improved Federal Oversight. GAO-05-748. Washington, D.C.: June 28, 2005. Medicaid: Intergovernmental Transfers Have Facilitated State Financing Schemes. GAO-04-574T. Washington, D.C.: March 18, 2004. Medicaid: Improved Federal Oversight of State Financing Schemes Is Needed. GAO-04-228. Washington, D.C.: February 13, 2004. Major Management Challenges and Program Risks: Department of Health and Human Services. GAO-03-101. Washington, D.C.: January 2003. Medicaid: HCFA Reversed Its Position and Approved Additional State Financing Schemes. GAO-02-147. Washington, D.C.: October 30, 2001. Medicaid: State Financing Schemes Again Drive Up Federal Payments. GAO/T-HEHS-00-193. Washington, D.C.: September 6, 2000. Medicaid in Schools: Improper Payments Demand Improvements in HCFA Oversight. GAO/HEHS/OSI-00-69. Washington, D.C.: April 5, 2000. Medicaid in Schools: Poor Oversight and Improper Payments Compromise Potential Benefit. GAO/T-HEHS/OSI-00-87. Washington, D.C.: April 5, 2000. Medicaid: States Use Illusory Approaches to Shift Program Costs to Federal Government. GAO/HEHS-94-133. Washington, D.C.: August 1, 1994. This is a work of the U.S. government and is not subject to copyright protection in the United States. It may be reproduced and distributed in its entirety without further permission from GAO. However, because this work may contain copyrighted images or other material, permission from the copyright holder may be necessary if you wish to reproduce this material separately.

Summary: Medicaid, a joint federal-state program, financed the health care for about 59 million low-income people in fiscal year 2006. States have considerable flexibility in deciding what medical services and individuals to cover and the amount to pay providers, and the federal government reimburses a portion of states' expenditures according to a formula established by law. The Centers for Medicare & Medicaid Services (CMS) is the federal agency responsible for overseeing Medicaid. Growing pressures on federal and state budgets have increased tensions between the federal government and states regarding this program, including concerns about whether states were appropriately financing their share of the program. GAO's testimony describes findings from prior work conducted from 1994 through March 2007 on (1) certain inappropriate state Medicaid financing arrangements and their implications for Medicaid's fiscal integrity and (2) outcomes and transparency of a CMS oversight initiative begun in 2003 to end such inappropriate arrangements. GAO has reported for more than a decade on varied financing arrangements that inappropriately increase federal Medicaid matching payments. In reports issued from 1994 through 2005, GAO found that some states had received federal matching funds by paying certain government providers, such as county-operated nursing homes, amounts that greatly exceeded established Medicaid rates. States would then bill CMS for the federal share of the payment. However, these large payments were often temporary, since some states required the providers to return most or all of the amount. States used the federal matching funds obtained in making these payments as they wished. Such financing arrangements had significant fiscal implications for the federal government and states. The exact amount of additional federal Medicaid funds generated through these arrangements is unknown, but was in the billions of dollars. Because such financing arrangements effectively increase the federal Medicaid share above what is established by law, they threaten the fiscal integrity of Medicaid's federal and state partnership. They shift costs inappropriately from the states to the federal government, and take funding intended for covered Medicaid costs from providers, who do not under these arrangements retain the full payments. In 2003, CMS began an oversight initiative that by August 2006 resulted in 29 states ending one or more inappropriate financing arrangements. Under the initiative, CMS sought satisfactory assurances that a state was ending financing arrangements that the agency found to be inappropriate. According to CMS, the arrangements had to be ended because the providers did not retain all payments made to them but returned all or a portion to the states. GAO reported in 2007 that although CMS's initiative was consistent with Medicaid payment principles, it was not transparent in implementation. CMS had not used any of the means by which it normally provides states with information about Medicaid program requirements, such as the published state Medicaid manual, standard letters issued to all state Medicaid directors, or technical guidance manuals. Such guidance could be helpful by informing states about the specific standards used for reviewing and approving states' financing arrangements. In May 2007, CMS issued a final rule that, if implemented, would, among other things, limit Medicaid payments to government providers' costs. We have not reviewed the substance of the May 2007 rule. The extent to which the May 2007 rule would respond to GAO's concerns about the transparency of CMS's initiative and review standards will depend on how CMS implements it.