Established in 1965 under title XIX of SSA, Medicaid is the nation’s health care financing program for low-income families and certain people who are age 65 or older or disabled. The program accounted for about $244 billion in federal and state expenditures in fiscal year 2002 and covered an estimated 53 million people. The states and the federal government share Medicaid spending according to a formula that provides a more generous federal match for states where per capita income is lower. Medicaid is an open-ended entitlement program, meaning that the federal government is obligated to pay its share of expenditures for all people and services covered under an HHS-approved state Medicaid plan. To qualify for federal matching payments, state Medicaid programs are required by law to cover certain categories of beneficiaries, including pregnant women and children with family incomes below specific limits, as well as individuals with limited income and assets who are age 65 or older or disabled. State programs are also required to cover certain services, including physician and hospital services and nursing home care. As long as states meet federal requirements and obtain HHS approval for their state Medicaid plans, they have considerable flexibility in designing and operating their programs. For example, states may choose to expand coverage to seniors whose incomes are above statutory limits, and all states have opted to provide prescription drug coverage. In addition, section 1115 of SSA permits the Secretary of HHS to waive certain statutory requirements applicable to Medicaid to allow states to provide services or cover individuals not otherwise eligible for Medicaid and to provide federal funding for services and populations not usually eligible for federal matching payments. The Pharmacy Plus initiative allows states to provide a prescription drug benefit to certain Medicare beneficiaries, specifically seniors and disabled people, with incomes at or below 200 percent of FPL. Typically, Medicaid eligibility under an approved state plan provides access to all state Medicaid-covered services, but eligibility under a Pharmacy Plus demonstration covers only a prescription drug benefit. The premise behind the initiative is that expanded access to medically necessary drugs will help keep low-income seniors healthy enough to avoid medical expenses that could cause them to “spend down” their resources to the point of Medicaid eligibility. The initiative assumes that budget neutrality for pharmacy-only coverage can be achieved by savings to Medicaid from fewer seniors’ enrolling for full benefits, as well as from improved access to prescription drugs, improved service delivery or medication management, and better management of drug benefit costs. Unlike some other section 1115 demonstration waivers, the Pharmacy Plus initiative requires a participating state to accept a fixed spending limit as part of its budget neutrality agreement with HHS. This spending limit— sometimes called an aggregate spending limit or global budget cap— applies not only to services and beneficiaries in the state’s demonstration drug program, but also to all services for all Medicaid seniors in the state. The Pharmacy Plus budget neutrality approach limits the amount the federal government will match for a demonstration according to expected growth in both service costs and enrollment (see app. I). Once a state has reached its Pharmacy Plus spending limit, it cannot receive additional federal matching dollars for any Medicaid services for seniors in the state, nor can the state restrict enrollment of seniors who qualify for full Medicaid benefits. Under the Pharmacy Plus scenario, a state accepts the financial risks inherent in a fixed budget cap for unanticipated changes in both cost and enrollment growth. For some other section 1115 demonstrations, budget neutrality is based on a projected per capita cost for each demonstration beneficiary. This other scenario sets a limit on spending per person, but because federal matching funds are available for all people who enroll, a state does not have to accept financial risk for unexpected growth in enrollment. As of May 2004, HHS had approved four states’ Pharmacy Plus demonstration proposals, denied two, and considered proposals from nine other states. All four approved demonstrations—Florida, Illinois, South Carolina, and Wisconsin—are to operate for 5 years, during which time they might enroll a total of half a million low-income individuals age 65 or older for the new prescription drug coverage. HHS denied two demonstration proposals, from Delaware and Hawaii, because they were not consistent with Pharmacy Plus guidelines. Of the remaining nine proposals, one was withdrawn by the state and others have been on hold since fall 2003, when Congress was considering Medicare prescription drug legislation. At the time we completed our work, legislation providing a new drug benefit through Medicare had been enacted, but HHS had not determined how the new drug program would affect the Pharmacy Plus initiative. HHS has approved Pharmacy Plus demonstrations for low-income seniors in four states: Florida, Illinois, South Carolina, and Wisconsin. As of May 2004, all four demonstrations had been implemented and under way for at least 17 months: Illinois’, Florida’s, and Wisconsin’s demonstrations were implemented in 2002, South Carolina’s in 2003 (see table 1). Together, the four approved demonstrations are projected to enroll as many as 527,800 individuals for Medicaid prescription drug benefits only; as of April 2004, they reported combined enrollment of nearly 372,200 people. Illinois’ demonstration is the largest, with expected enrollment for the drug benefit of more than 250,000 seniors over 5 years. As of April 2004, more than 192,600 people were enrolled in Illinois’ demonstration, the majority of them moved into the Medicaid program from an existing state-funded pharmacy assistance program. All the demonstrations except Florida’s are approved to enroll seniors with incomes at or below 200 percent of FPL, the maximum eligible income established in HHS’s Pharmacy Plus guidance. As approved, Florida’s demonstration covers seniors with incomes from 88 to 120 percent of FPL, but in September 2003, the state submitted an amendment to expand income eligibility to 200 percent of FPL. Illinois also applied in March 2003 to amend its approved demonstration to expand eligibility, in its case to include seniors with incomes at or below 250 percent of FPL. The terms of Illinois’ demonstration approval specifically permit the state to seek this amendment, as long as the state submits data supporting its ability to cover this expansion population at no additional cost to the federal government. As of March 2004, HHS was reviewing both amendments. Projected 5-year costs vary among the four approved demonstrations. For Florida, Illinois, South Carolina, and Wisconsin, total combined federal and state Medicaid spending on the new drug benefit alone is expected to be more than $3.6 billion over 5 years, of which the federal share would be approximately $2.1 billion. The combined federal and state Medicaid spending limits for the four demonstrations—for services to all Medicaid seniors in the four states—would total $44 billion over 5 years, with a federal share of at least $25 billion. The estimated 5-year costs solely for the drug benefit range from $477 million in Florida to $1.4 billion in Illinois, and combined 5-year federal and state spending limits (based on projected costs for services to all Medicaid seniors) range from $5.0 billion in South Carolina to $16.7 billion in Florida. When they applied, three of the four states with approved demonstrations already operated state-funded pharmacy assistance programs for seniors. Most beneficiaries eligible for these programs are also eligible for Pharmacy Plus coverage. HHS allows the states to subsume all or a portion of an existing program under a demonstration, as long as the states’ demonstrations propose to expand either the number of beneficiaries or the scope of drug coverage. In other words, the state may not simply secure federal matching dollars for the costs of an existing state-funded drug program with no expansion. To meet this condition, states with approved demonstrations either raised income eligibility thresholds or expanded the scope of drug coverage beyond that of their existing state programs. For example, Florida doubled its maximum monthly benefit from $80 to $160 per person, and South Carolina expanded eligibility to include seniors with incomes from 175 through 200 percent of FPL. Illinois’ demonstration offered a more comprehensive drug benefit than its state-funded program did. Wisconsin did not previously have a state-funded pharmacy assistance program for seniors. In 2003, HHS denied Pharmacy Plus demonstration proposals from two states, Delaware and Hawaii. (See app. II for descriptions of denied, withdrawn, and pending proposals.) Delaware’s proposal was denied primarily because HHS required that the state expand beyond the existing state-funded program and limit coverage to seniors with incomes at or below 200 percent of FPL. Delaware’s state-funded pharmacy assistance program already covered seniors and disabled adults with incomes up to 200 percent of FPL or whose prescription drug costs exceeded 40 percent of their annual incomes. For this reason, the state could not expand either eligibility or coverage and stay within Pharmacy Plus guidelines. Although Delaware proposed adding a pharmacy benefit management component to monitor appropriate prescription use and to control costs, HHS found this proposed change to the existing program insufficient. Hawaii proposed to make prescription drugs available at the discounted Medicaid rate to state residents of all ages with family incomes at or below 300 percent of FPL. This benefit was to be funded through participant cost sharing, manufacturer rebates, and a fixed state contribution of $1 per prescription. HHS’s denial was based primarily on the request to cover individuals with incomes up to 300 percent instead of 200 percent of FPL. Other reasons for the denial included the proposed coverage for all state residents, instead of targeting seniors and people with disabilities, and the minimal state financial participation of $1 per prescription in the first year of the demonstration. From January 2002 through May 2004, HHS considered Pharmacy Plus demonstration proposals from nine other states: Arkansas, Connecticut, Indiana, Maine, Massachusetts, Michigan, New Jersey, North Carolina, and Rhode Island. As of May 2004, eight were still pending; one proposal, from Massachusetts, had been withdrawn. Most proposals would cover seniors with incomes at or below 200 percent of FPL; several would also cover adults with disabilities. The drug benefits would generally be comprehensive and require participant cost sharing, which in some cases would include an annual enrollment fee and 20 percent co-payment for each prescription. All but one of the states with pending proposals have state-funded pharmacy assistance programs that they propose to include in whole or in part in their demonstrations. (App. II describes these demonstration proposals.) As of May 2004, most of the pending proposals were not under active review by HHS primarily because the department had not determined the effect of the Medicare prescription drug legislation on the Pharmacy Plus demonstration proposals. HHS officials told us in October 2003 that Arkansas, Rhode Island, and Indiana officials had asked that review of their states’ proposals be put on hold until after Congress had completed consideration of the Medicare legislation. At that time HHS was still reviewing a proposal from North Carolina but regarded proposals from four other states as inactive because longtime negotiations with those states had reached an impasse. Connecticut and New Jersey, for example, already had broad state-funded drug coverage for seniors with incomes up to 200 percent of FPL. In such cases, HHS has been unwilling to approve federal financing for existing state-funded programs. The Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (MMA) will provide seniors access to a Medicare-covered prescription drug benefit and will likely affect how HHS and the states manage the Medicaid Pharmacy Plus initiative. This law gives Medicare beneficiaries the opportunity to enroll for prescription drug coverage to begin on January 1, 2006, and, as an interim measure, the opportunity to enroll for Medicare-endorsed drug discount cards beginning in June 2004. It also directs HHS to establish effective coordination between Medicare plans and state Medicaid and pharmacy assistance programs and to establish a commission to address these and other transition issues. In 2006, the Medicare drug benefit will replace Medicaid as the primary source of prescription drug coverage for low-income seniors who would have been eligible for both full benefits under Medicaid and drug benefits under Medicare plans. Under MMA, individuals with limited assets and incomes below 150 percent of FPL will be eligible for federal subsidies to assist with the drug benefit’s cost-sharing requirements. But because Pharmacy Plus demonstrations in Illinois, South Carolina, and Wisconsin cover individuals with incomes above 150 percent and at or below 200 percent of FPL regardless of other assets, some current demonstration beneficiaries may not qualify for these subsidies. Pharmacy Plus beneficiaries are likewise ineligible for the Medicare drug discount cards. As of May 2004, HHS indicated it was considering how enactment of the new law would affect Pharmacy Plus demonstrations and proposals. Officials from the four states with approved demonstrations told us in December 2003 that they were uncertain how the law would affect their demonstrations, but they had no plans to end the demonstrations early. After the Medicare prescription drug benefit begins in 2006, some demonstrations could be discontinued or modified. Early termination could have an impact on the demonstrations’ budget neutrality, which often depends on savings in later years to offset higher start-up costs. Officials in Illinois and Florida indicated in December 2003 that their pharmacy demonstrations might be converted to state-funded programs in 2006. HHS has not adequately ensured that the spending limits it has approved for Pharmacy Plus demonstrations will be budget neutral—in other words, that the federal government will spend no more under the demonstrations than without them. For all four demonstrations, HHS approved 5-year spending limits based on projections of cost and beneficiary enrollment growth that exceeded benchmarks that department officials told us they considered in assessing the reasonableness of states’ demonstration proposals. These cost and enrollment growth benchmarks incorporate states’ historical experience and expectations for Medicaid program growth nationwide. The discrepancies between the growth benchmarks and the approved growth rates were greatest for Illinois and Wisconsin. Neither HHS’s negotiations with the states nor the department’s rationale for approving higher-than-benchmark growth rates is well documented. Had HHS based the 5-year demonstration spending limits on the benchmark growth rates, the federal share of approved spending would be considerably lower, particularly for Illinois and Wisconsin: specifically, $1 billion lower in Illinois and $416 million lower in Wisconsin. For Florida and South Carolina, the federal share of approved spending would have been $55 million and $42 million lower, respectively. HHS based the Pharmacy Plus demonstration spending limits it approved on a range of estimated future growth rates for cost per beneficiary and for enrollment, which in some cases exceeded benchmarks the department told us it considered in assessing the reasonableness of states’ proposals. A standard Pharmacy Plus application form developed by HHS and a technical guidance document are the chief sources of criteria and formal guidance to states for developing demonstration proposals. But HHS has not established written criteria for how it reviews and approves the growth rates that states propose. These growth rates are key elements in the budget neutrality negotiations between states and the federal government because higher rates result in more generous spending limits, which represent the federal government’s agreed-on maximum spending for all the states’ Medicaid seniors during the demonstrations. An inappropriately high spending level can represent a higher federal liability than warranted. The process used by HHS and the states to determine whether states’ proposed Pharmacy Plus demonstrations will be budget neutral requires comparing two cost estimates: (1) projected 5-year costs of a state’s existing Medicaid program for seniors (“without-demonstration costs”) and (2) projected 5-year costs of the state’s existing program plus the drug benefits and beneficiaries added by the demonstration (“with- demonstration costs”). These calculations factor in projected growth in costs and enrollment each year. As long as projected with-demonstration costs do not exceed projected without-demonstration costs, the demonstration can be approved as budget neutral. As a result, the projected costs of a state’s existing, without-waiver Medicaid program for seniors effectively sets the spending limit for all services provided to all Medicaid seniors in the state for the 5-year demonstration term. Appendix I outlines the basic steps HHS follows in setting Pharmacy Plus demonstration spending limits. To determine budget neutral spending limits for the pharmacy demonstrations, HHS officials told us they consider the following for estimating growth in costs and enrollment through the course of the demonstrations: For cost growth per beneficiary, similar to guidelines for other types of section 1115 demonstrations, HHS seeks to approve a growth rate equal to the lower of either the state’s historical average annual growth in per- beneficiary cost (that is, the average annual rate for the 5 years before the demonstration proposal) or the nationwide projected growth rate, developed by CMS’s Office of the Actuary, for Medicaid cost per beneficiary age 65 or older. For enrollment growth, HHS considers the state’s historical average annual growth in enrollment as a starting point and, to a lesser extent, the CMS Actuary’s nationwide rate, but it allows states to present a rationale for a higher rate that anticipates rising future enrollments. HHS’s approved growth rates in some cases exceeded these benchmarks (see table 2). For per-beneficiary cost growth rates in Florida, Illinois, and Wisconsin, HHS did not approve the lower of either the state’s historical average rate or the CMS Actuary’s rate of 6.3 percent. Similarly, for beneficiary enrollment growth rates, HHS approved rates for Illinois and Wisconsin that exceeded both the states’ historical experience and the CMS Actuary’s 1.8 percent projected annual growth rate. In Illinois’ case, the approved rate for beneficiary enrollment growth—5 percent per year over the 5-year demonstration—was considerably higher than the state’s 5-year historical average enrollment growth of 1.6 percent per year. HHS’s basis is unclear for approving growth rates higher than the benchmarks in some cases, particularly for approving higher enrollment growth rates for Illinois and Wisconsin. The department’s negotiation process with these two states, during which officials reached agreement on allowed growth rates, was not documented, nor was its rationale for approving rates that differed from the lower of state historical experience or the CMS Actuary’s projections. In particular, HHS’s internal decision memorandums—which described the factors that HHS, CMS, OMB, and others considered in reviewing the demonstrations and which are not publicly available—did not provide the rationale for the approved spending limits, and neither did the publicly available demonstration approval letters. HHS and state officials told us that Illinois and Wisconsin used a variety of arguments to convince the department that their situations warranted higher enrollment growth rates. But the states provided little specific documentation to HHS or to us to support these arguments. For example: Illinois asserted that its projected annual enrollment growth rate for the demonstration years from 2002 through 2007 should be significantly higher than its 5-year average historical growth rate of 1.6 percent, because income eligibility levels for seniors in its Medicaid program increased from 41 to 100 percent of FPL from July 2000 through July 2002. As support, the state provided HHS with updated Medicaid enrollment data—which were more recent than those included in the original demonstration application and showed increased growth rates for seniors compared with earlier years—but these rates were still lower than the 5 percent HHS approved and did not raise the historical average to 5 percent. The state did not provide documents with actuarial projections of the estimated number of people expected to enroll in Medicaid because of the change in eligibility criteria. Illinois justified applying the 5 percent annual growth rate to all 5 years of the pharmacy demonstration by providing a chart showing that enrollment in a different state program, SCHIP, had grown more than 5 percent per year on average for 3 years after that program’s eligibility criteria were expanded. In our view, however, Illinois’ SCHIP enrollment experience with children does not provide a reasonable basis for predicting enrollment by seniors in the Pharmacy Plus demonstration. Wisconsin asserted that its projected annual enrollment growth rate for the demonstration years should be significantly higher than either its 5-year unadjusted historical growth rate of 0.01 percent or the 0.12 percent rate based on 3 years of historical data reported in its application because of the anticipated effects of a nationwide Social Security Administration mail outreach program to low-income Medicare beneficiaries. This outreach program informed seniors enrolled in Medicare about other benefits, including Medicaid assistance for Medicare cost-sharing requirements, for which they might qualify. Wisconsin officials told us they proposed a 4 percent future annual enrollment growth rate for seniors in the expectation that this outreach program, along with factors including an aging population and the economic downturn, would increase Medicaid enrollment. According to HHS, Wisconsin did not document any projections of how many newly eligible Medicaid individuals could be prompted to enroll after the Social Security Administration outreach mailing. Instead, it submitted information based on a review of a similar outreach effort in Minnesota. According to Wisconsin state officials, during negotiations HHS proposed 1 percent as a more reasonable growth rate, and HHS and state officials agreed to an approved enrollment growth rate of 2 percent per year. Our related work suggests that Wisconsin may be justified in claiming some increase in Medicaid enrollment as a result of the outreach program, but the effect appears to be less than 1 percent. Notably, although the Social Security Administration mail outreach program was nationwide, HHS did not consider its effects when approving enrollment rates for other states. Application of benchmark rates for projected per-beneficiary cost and enrollment growth would have produced lower spending limits for all four approved Pharmacy Plus demonstrations (see table 3). Benchmark-based limits on combined federal and state spending would be approximately $3 billion lower over 5 years than what HHS approved for the four demonstrations, and the federal share alone would come to about $1.6 billion less. The higher-than-benchmark growth rates HHS approved for Illinois and Wisconsin accounted for most of these differences. Had the spending limit for Illinois’ demonstration, in particular, been based strictly on the benchmark rates, combined federal and state spending would have been almost $2.2 billion, or 15 percent, lower, and the federal government’s liability under the demonstration (at the state’s 50 percent federal matching rate) lower by more than $1 billion. The difference is less pronounced for Wisconsin, where the approved federal and state spending limit exceeds what it would have been had benchmark rates been applied by about $713 million, translating into about $416 million in additional federal spending. The spending limits HHS approved for Illinois and Wisconsin exceed estimates based on consistent application of the benchmark growth rates by 15.4 percent and 8.5 percent, respectively. The limits approved for Florida and South Carolina, while not budget neutral compared with the benchmark spending estimates, reflect relatively small differences. Florida’s approved spending limit exceeds the benchmark estimate by less than 1 percent—$94 million of a 5-year approved federal and state spending limit of nearly $16.7 billion—and South Carolina’s approved spending limit exceeds the benchmark by 1.2 percent, or $60 million. CBO has similarly reported that Pharmacy Plus demonstrations are likely to increase federal Medicaid spending. Before passage of MMA, CBO estimated that the Pharmacy Plus demonstrations would add about $18 billion to federal Medicaid spending over the 10 years from 2004 through 2013. According to CBO officials, the agency considered a range of scenarios for how the initiative might grow with new demonstration approvals and estimated the initiative’s overall effect on Medicaid spending. The officials told us that CBO did not include any of the demonstrations’ projected savings in its analysis because it did not find the argument that savings would occur convincing. Neither data from state experience nor other research supports the savings assumptions necessary for budget neutrality in the Pharmacy Plus demonstrations. In developing their demonstration proposals, states assumed that keeping low-income seniors healthy—thus preventing them from spending down their financial resources on health services and “diverting” them from Medicaid eligibility—would generate savings to help offset the increased costs of providing a new drug benefit. Without state- specific evidence, HHS approved savings assumptions negotiated with the states, including significant projected reductions in Medicaid senior enrollment. But the limited research available suggests that potential health care savings due to improved access to prescription drugs are likely to be much less than the levels the states assumed and HHS approved. Had more conservative savings assumptions been used to estimate the demonstrations’ costs, the proposals likely could not have been approved as budget neutral. Moreover, concerns have arisen about what actions states might take to control spending on behalf of seniors if estimated savings do not accrue and states reach or exceed their spending limits under the demonstrations. The approved Pharmacy Plus demonstrations count on expected savings based on reductions in the projected number of seniors who will enroll in states’ Medicaid programs—ranging from a 3 percent reduction in Florida to a 25 percent reduction in South Carolina over the demonstrations’ 5 years. The dollar amounts of combined federal and state savings projected under these assumptions in the demonstrations’ budget neutrality calculations range from $480 million in Florida to $2 billion in Illinois (see table 4). To project the extent to which Pharmacy Plus would reduce its new enrollment of Medicaid seniors, and thus its total senior enrollment, Florida made the relatively conservative assumption that the drug benefit would enable seniors to avoid Medicaid eligibility for 1 year; after 5 years, the state’s total projected number of Medicaid seniors would be 5,900 (3 percent) lower with the demonstration than without it. The other states, in contrast, assumed that everyone diverted in each year of their demonstrations would remain out of Medicaid throughout the full demonstration period and would not, for example, enter a nursing home, which often results in Medicaid eligibility. As a result, Illinois, South Carolina, and Wisconsin projected reductions of nearly 20 percent or more in Medicaid senior enrollments at the end of 5 years. Had these states made more conservative assumptions—assuming, for example, as Florida chose to, that providing access to prescription drugs would delay seniors’ entry into Medicaid by only 1 year instead of 5—their projected with- demonstration costs would have exceeded projected without- demonstration costs and would not have been budget neutral. Although states’ demonstration proposals aim to achieve savings by expanding seniors’ access to prescription drugs and improving their health, in practice it appears that some states’ estimates of expected savings may have been derived in part by determining how much in savings was needed to demonstrate budget neutrality. In their proposals, none of the three states that previously had state-funded pharmacy assistance programs (Florida, Illinois, and South Carolina) provided data from those programs that specifically supported such high projected savings. Based on conversations with Wisconsin health care financing officials and a review of documents, we found that the state’s demonstration savings estimates were a residual of the budget-negotiating process, derived from determining how much was needed in savings to demonstrate budget neutrality, rather than from research or data about what was realistic. The premise that Pharmacy Plus demonstrations will generate savings by keeping low-income seniors from becoming Medicaid-eligible is not supported by research. In a previous report, we reviewed the research studies cited in Illinois’ demonstration proposal and found that they did not sufficiently support the state’s theory that a full drug benefit for low- income seniors would yield the projected level of savings. Although these studies indicated that access to prescription drugs benefited people in poor health, they all focused on people who already had specific diagnosed conditions, such as diabetes, heart disease, or HIV, rather than on a general population of seniors. An extensive 2003 review of research examining drug coverage for low-income seniors found relatively few studies about the effect on Medicaid spending of expanded access to a broad prescription drug benefit. The one study this review considered most relevant, conducted in the mid-1980s, assessed Pennsylvania’s state- funded program, Pharmaceutical Assistance Contract for the Elderly (PACE), and found that despite high enrollment, Medicaid entry among PACE participants was neither prevented nor delayed enough to have a discernible effect on the state’s overall Medicaid budget. Other studies of broad prescription drug benefits for low-income seniors, including one of New York’s program, found some reductions in participants’ health care costs but mainly for inpatient hospital care, which, for people age 65 or older, is covered by Medicare rather than Medicaid. Still other studies in this review examined the more limited question of how access to appropriate drugs affects people already suffering from specific illnesses. Such research sheds little light on the cost-effectiveness of offering comprehensive drug benefits to a broad population of low-income seniors. Some states that have not submitted Pharmacy Plus proposals examined the diversion and savings assumptions behind the demonstrations and found that they would not likely be realized. For example, in considering whether to apply for a demonstration, Minnesota found a substantial risk that seniors receiving only a drug benefit would eventually become Medicaid-eligible over a 5-year follow-up period. In its optimal model, the study estimated that to generate enough savings to offset the new drug costs, the risk of Medicaid entry would have to be reduced by 50 percent for non-nursing-home enrollees and by 30 percent for those who become eligible after entering a nursing home. Minnesota Medicaid officials concluded that this scenario was not realistic and dropped the state’s Pharmacy Plus demonstration proposal. Pennsylvania also conducted a Pharmacy Plus demonstration feasibility study for PACE and the related Pharmaceutical Assistance Contract for the Elderly Needs Enhancement Tier (PACENET) programs, which together enrolled about 270,000 seniors in 2002. The study found that to offset drug benefit costs, the programs would need aggressive cost containment, through such approaches as increased co-payments, reduced provider reimbursements, and a preferred drug list. In addition, the study noted that in states with generous drug benefits, savings from expansion to more seniors are particularly difficult to realize because most beneficiaries who would have avoided expensive nursing home care have already done so. As of March 2004, Pennsylvania had not submitted a Pharmacy Plus demonstration proposal. Although it is early in demonstration implementation, we and others have raised concerns about how states may be affected if savings under Pharmacy Plus do not accrue and the states’ spending reaches or exceeds HHS’s approved spending limits. We noted in our July 2002 report that the Illinois Pharmacy Plus demonstration, as approved, makes several risky assumptions with regard to the extent of the expected savings. In such cases the federal government would not be at financial risk, but the states would be, because the spending limits cover services for all the states’ Medicaid seniors. Any expenditures for Medicaid seniors beyond the demonstration’s federally matched spending limit would be entirely the state’s responsibility. Officials in Florida and Wisconsin expressed concerns that their demonstration spending limits, based on fixed rates of growth projected over 5 years, could not be adjusted to reflect unpredictable changes in costs and enrollment growth. One study has raised concerns about the potential effects on Medicaid seniors, noting that as state spending approaches the limit of what the federal government will match, states may feel pressed to reduce optional expansions of eligibility or optional benefits. States could also try to control spending without reducing eligibility or services by lowering provider reimbursements—a step already taken in Illinois, although not in response to pharmacy demonstration enrollment or spending—or by implementing preferred drug lists. As of February 2004, efforts by the states and HHS to evaluate and monitor the four approved demonstrations, and to address some of the research questions the Pharmacy Plus initiative raises, were in their early stages. The four states with approved demonstrations had taken few steps toward implementing the evaluation plans required as a condition of approval, and an independent evaluation of two of the demonstrations, contracted by HHS and started in October 2002, was not scheduled to report until September 2005. In the interim, HHS has not ensured that the states’ required progress reports contain sufficient information for monitoring whether the demonstrations are functioning as intended or that these reports are submitted in a timely manner. As a condition of Pharmacy Plus approval, HHS requires states to design and carry out an evaluation and to report their results after the demonstration ends. States are required to submit a plan for this evaluation in their proposals and in the operational protocols that HHS approves before states begin the demonstrations. Although the four states with approved Pharmacy Plus demonstrations submitted the required evaluation plans—containing research hypotheses, possible outcome measures, and data needs—as of February 2004, they had taken few steps to put their evaluation plans into practice. As HHS requires, the four states’ initial proposals and operational protocols included plans for how they would evaluate whether their demonstrations were working as intended. With some variations, all the plans proposed to address the overall research question of how providing a pharmacy benefit to non-Medicaid-covered seniors would affect Medicaid costs, service use, and future eligibility trends, including whether savings achieved by diverting individuals from Medicaid eligibility would offset the benefit’s cost. The first demonstration proposal, from Illinois, initially contained an extensive plan to assess demonstration outcomes; the plan later changed significantly. The initial plan proposed that the state collect data from sources such as Medicaid and Medicare claims systems, surveys of participants or case-study interviews, and demonstration- specific claims. In terms of outcome measures, Illinois’ plan proposed comparing seniors who do have the drug benefit with seniors who do not on such measures as hospitalization rates, health care service costs, use of emergency room services, and rates and length of nursing home stays. A later version of Illinois’ plan (as described in the state’s operational protocol), however, calls for using existing Medicaid claims data for only one outcome measure, Medicaid spending for seniors. Both South Carolina and Wisconsin adopted Illinois’ relatively extensive initial evaluation plan in their demonstration proposals, and as of February 2004, neither South Carolina nor Wisconsin had changed its proposed plan. Florida, which did not submit an evaluation plan in its demonstration proposal, provided a two-paragraph discussion in its operational protocol. This discussion listed several hypotheses and indicators to be monitored, noted that data would be collected using the state’s current Medicaid system, and gave no details about how or when the plan would be implemented. As of February 2004, the states had taken few steps to implement their demonstration evaluation plans or to determine how they would collect or analyze data to support their evaluations. States’ evaluation activities were generally limited to collecting and reporting to HHS data from their existing Medicaid data systems. Although plans for Illinois, South Carolina, and Wisconsin call for starting their evaluations at the start of their demonstrations to draw on data about services used before and throughout beneficiaries’ enrollment, these states and Florida indicated they were just beginning to collect and report data to implement their evaluation plans: Florida and South Carolina officials told us that they had not decided whether their evaluations would be designed and conducted by the state Medicaid agency or by an outside entity such as a university. Neither state had developed an evaluation implementation schedule. Illinois and Wisconsin reported providing extensive state data for HHS’s independent evaluation of their demonstrations but, at the time of our review, had not begun their own evaluations. State officials told us they understood that participating in the independent evaluation would exempt them from conducting their own evaluations. But HHS officials told us that state evaluations were still required. HHS has contracted with independent university researchers for an extensive evaluation of the Pharmacy Plus demonstrations in Illinois and Wisconsin. The evaluation’s goal is to document achievements and difficulties in implementing a Pharmacy Plus demonstration, as well as to identify impacts on entry into Medicaid and on costs to Medicare. According to HHS, the evaluation aims to address whether providing prescription drug benefits to non-Medicaid seniors will keep individuals relatively healthy, divert them from full Medicaid eligibility, and thus lower Medicaid and Medicare costs. To address these issues, the evaluation contract calls for four components of work, including (1) site visits to Illinois and Wisconsin to describe the demonstrations and their implementation; (2) telephone surveys of demonstration beneficiaries in those states about their health status, access to health care, and prior drug coverage; (3) analysis of Medicaid, Medicare, and demonstration claims data to assess patterns of drug use and effects on Medicaid and Medicare costs; and (4) an analysis of enrollment trends in each state’s Medicaid program to determine if diversion assumptions are met. In addition, the evaluation aims to compare the experiences of demonstration beneficiaries with a similar population in another state that does not offer a prescription drug benefit. Final results for all components of this planned 3-year evaluation, which began in October 2002, are scheduled to be reported to HHS by September 2005. Specifically, a final report to HHS on the patterns of drug use is due in September 2004; final reports on the demonstrations’ cost effects on Medicaid and Medicare are due in September 2005. The evaluation contract does not indicate when results from the work may be available to other researchers or the public. According to the HHS evaluation project officer, the independent evaluators completed state site visits to Illinois and Wisconsin in July 2003 for the descriptive work component and submitted draft reports to HHS in December. These reports were in review as of March 2004, and the project officer expected them to be approved and posted on HHS’s Web site, although he did not know when posting would occur. A report containing results from the second evaluation component, the telephone surveys of beneficiaries, was expected later in 2004. HHS’s monitoring and reporting requirements, which the states agree to carry out under HHS oversight, are set forth in the terms and conditions attached to each demonstration’s approval letter. Although HHS and the states participated in required telephone conference calls to monitor the demonstrations’ start-up, HHS has not ensured that all states submit the required quarterly and annual progress reports. The lack of sufficient and timely information from progress reports may impair the department’s ability to monitor demonstration operations and accomplishments. Monitoring and reporting requirements are not as clearly established for the Pharmacy Plus initiative as for the Health Insurance Flexibility and Accountability (HIFA) initiative: The HIFA and Pharmacy Plus initiatives both require states to participate with HHS in monthly telephone monitoring calls. For pharmacy demonstrations, however, monthly calls are required for 6 months after implementation and only as needed thereafter; for most approved HIFA demonstrations, monthly calls are unlimited. States with approved HIFA demonstrations are required to submit quarterly progress reports in a format agreed upon with HHS, and demonstration terms and conditions describe the required content of these reports. The terms and conditions for Pharmacy Plus demonstrations are less specific regarding progress report format and content. HIFA demonstrations are expected to submit separate annual reports that discuss progress in evaluating the demonstrations, including results of data collection and analysis to test research hypotheses. Pharmacy Plus annual reports, in contrast, may be combined with or include the fourth quarterly progress report, may follow the same broad content guidelines as quarterly reports, and are not required to report progress in evaluation. As of March 2004, HHS and the four Pharmacy Plus states had participated in the initial monitoring phone calls and begun to gather data on how their demonstrations were working. HHS and the states confirmed participating in monthly telephone calls for the first 6 months and then agreeing to maintain contact as needed. An HHS official told us the department did not set agendas or document these informal contacts, which focused on demonstration operations as states tracked enrollment and began to gather information about drug use and expenditures for new beneficiaries. States reported taking some steps to develop the capacity to report on their demonstrations. Florida, Illinois, and Wisconsin, for example, reported having or developing data management systems containing state Medicaid and other data that are capable of generating demonstration- specific reports. South Carolina expected to rely on existing Medicaid data systems. None of the states, however, were tracking the number of demonstration enrollees who had become eligible for Medicaid, although officials in three states reported the ability to do so. Further, the states had not provided information to HHS to assess whether diversion savings were occurring. The information that HHS requires states to report has been insufficient for determining whether the demonstrations are operating as intended. According to one HHS official, HHS has not prescribed a standard format for, or specific information to be provided in, either the quarterly or annual progress reports; rather, the department works with the states to obtain needed information. The Pharmacy Plus terms and conditions stipulate that written quarterly and annual progress reports contain, at minimum, (1) a discussion of events during the quarter, including “enrollment numbers, lessons learned, and a summary of expenditures”; (2) notable accomplishments; and (3) problems and questions that arose and how they were resolved. The same HHS official told us that in response to these general requirements, states’ progress reports did not always include all information considered useful for monitoring purposes. For example, HHS reported that officials were working with Illinois to obtain additional information to complete its draft annual progress report. Illinois’ six-page annual report, submitted in September 2003, reported only on new demonstration beneficiaries and did not include first-year starting or ending enrollment or cost information for the state’s Medicaid senior program as a whole—the services and population affected by the Pharmacy Plus spending limit. One HHS official told us that after review of Illinois’ report, these cost and enrollment data were specifically requested to assess whether the new drug benefit was keeping seniors from becoming eligible for full Medicaid benefits. As of February 2004, Illinois had not provided this information. Finally, HHS has not insisted on timely submission of the required quarterly and annual reports. Although Pharmacy Plus terms and conditions specify that quarterly reports are due 60 days after the end of the quarter, and annual reports are due 60 days after the end of the fourth quarter, HHS has not ensured that states submit the reports on time. Again, the department’s policy is to work with the states toward compliance. As of January 2004, Florida and Wisconsin had submitted all required written quarterly reports, mostly on time, while South Carolina had submitted only one of three required progress reports. Illinois, whose demonstration was the first to be implemented, did not submit any of the three required quarterly reports before submitting its combined fourth quarterly and first annual report early in September 2003. HHS’s approval and monitoring of state demonstrations under the Pharmacy Plus initiative raise cost and oversight concerns and, ultimately, program concerns. The department’s approval of four states’ demonstrations raises questions about HHS’s basis for its decisions. Because HHS based the spending limits it approved on higher-than- justified growth rates, these spending limits do not, in our view, represent reasonable estimates of demonstration costs over the 5-year trial periods and are not budget neutral. It was difficult to assess the reasonableness of the spending limits themselves, given that they were decided upon through an undocumented negotiation process, and neither public nor HHS internal documents stated the rationale for approving higher growth rates. We found that if HHS’s benchmarks had been used to establish the spending limits, the federal government’s liability for the four demonstrations could have been $1.6 billion lower over 5 years. Moreover, the approved demonstrations rely on highly questionable assumptions about the extent to which savings would accrue to Medicaid from improved health of people receiving the new pharmacy benefit, particularly since many of them already had pharmacy benefits through existing state-funded programs. In addition, the Pharmacy Plus initiative raises important evaluation questions about how improved access to prescription drugs may affect seniors’ health and Medicaid and Medicare costs. Although some of these questions will likely be addressed by the independent evaluation of two states’ demonstrations, in the interim HHS does not appear to be ensuring that states provide sufficient, consistent, and timely information for demonstration monitoring or that states begin implementing their own evaluation plans. The limited available information on how these demonstrations are operating makes it difficult to assess whether they are operating as intended. The concerns about HHS’s approved Pharmacy Plus demonstrations parallel those we have raised about other section 1115 waiver demonstration approvals over the past decade. These include the extent to which the department is protecting the Medicaid program’s fiscal integrity and the need for clear criteria and a public process when HHS reviews and approves demonstrations. Along with the authority to waive Medicaid requirements, and the flexibility given states to test new approaches for delivering services more efficiently and effectively, comes the responsibility for making decisions based on clear criteria and for monitoring the demonstrations and learning from them. More can and should be done to fulfill this responsibility. In light of our findings that the four HHS-approved Pharmacy Plus demonstrations are likely to substantially increase federal Medicaid spending, as previously approved Medicaid section 1115 demonstrations have done; that HHS’s review process and basis for these approvals have not been clearly set forth; and that approved demonstrations are not all meeting evaluation and monitoring requirements, we are making seven recommendations to the Secretary of HHS related to the section 1115 demonstration process. To improve HHS’s process for reviewing and approving states’ budget neutrality proposals for Pharmacy Plus and other Medicaid section 1115 demonstrations, we recommend that the Secretary take three actions: For future demonstrations, clarify criteria for reviewing and approving states’ proposed spending limits. Consider applying these criteria to the four approved Pharmacy Plus demonstrations and reconsider the approval decisions, as appropriate. Document and make public the basis for any section 1115 demonstration approvals, including the basis for the cost and enrollment growth rates used to arrive at the spending limits. To ensure that approved Pharmacy Plus and other Medicaid section 1115 demonstrations fulfill the objectives stated in their evaluation plans, we recommend that the Secretary take two actions: Ensure that states are taking appropriate steps to develop evaluation designs and to implement them by collecting and reporting the specific information needed for a full evaluation of the demonstration objectives. On acceptance, make public the interim and final results of HHS’s independent Pharmacy Plus evaluation. To ensure that the Secretary and other stakeholders have the information needed to monitor approved Pharmacy Plus and other Medicaid section 1115 demonstrations to determine if they are functioning as intended, we recommend that the Secretary take two actions: Ensure that states provide sufficient information in their demonstration progress reports, in a consistent format, to facilitate the department’s monitoring. Ensure that states submit required demonstration progress reports in a timely manner. We provided a draft of this report for comment to HHS and the states of Florida, Illinois, South Carolina, and Wisconsin. HHS and Florida, Illinois, and Wisconsin responded with written comments, which are reproduced in appendixes III through VI, respectively. South Carolina provided technical comments, which we incorporated in our report as appropriate. HHS concurred with five of our recommendations to strengthen the processes for approving and overseeing Pharmacy Plus and other Medicaid section 1115 waivers and disagreed with two. It concurred with our recommendations to make public the basis for section 1115 demonstration approvals and to ensure that Pharmacy Plus and other Medicaid section 1115 demonstrations fulfill the objectives of their evaluation plans by working with the states toward useful program evaluations and making results of the independent Pharmacy Plus evaluation publicly available. HHS also concurred with our recommendation to ensure that adequate information is available to monitor the demonstrations to determine if they are functioning as intended. In this regard, HHS stated that it has provided each state that has implemented a Pharmacy Plus demonstration with an example of an outline and content to be used as a guide for progress reports and that it will make concerted efforts to ensure that states submit the reports in a timely manner. HHS did not concur with our recommendation that the Secretary of HHS clarify criteria for reviewing and approving states’ proposed demonstration spending limits, indicating that although the department recognizes the importance of using criteria for reviewing budget neutrality, strict criteria cannot be determined in advance because states’ circumstances differ. HHS also strongly disagreed with our recommendation that the Secretary consider applying clarified criteria to the four approved Pharmacy Plus demonstrations and reconsider the approval decisions as appropriate. HHS stated that it used criteria to review each of the approved, disapproved, and pending demonstration proposals; believes the four approved demonstrations were based on well- supported budget estimates of future state spending; and does not believe it appropriate to reconsider approved demonstrations before the end of the approval periods. We agree with HHS that some flexibility is appropriate in considering the unique Medicaid section 1115 demonstrations proposed by different states. Consistent with our analyses of other section 1115 demonstration waivers over the past decade, however, we believe HHS’s review process and decision criteria should be clear, and the results—particularly when approved spending limits deviate significantly from limits developed using benchmarks that HHS said it uses as a starting point—should be publicly explained and documented in the demonstrations’ approval letters and terms and conditions. Even though HHS has developed a standard application form for Pharmacy Plus demonstrations, that form and other guidance does not provide written criteria for how HHS reviews and approves the growth rates that states propose. HHS’s rationale for significantly deviating from benchmarks for projecting future program growth in establishing different states’ spending limits has not been documented or made clear to us or to others, including other states that may be seeking approval of demonstration proposals. Without such clarity, questions arise as to how consistently states have been or will be treated in applying for demonstrations. Further, in our view, Pharmacy Plus demonstration approvals were based on questionable savings assumptions. We believe that HHS should establish clear criteria on which to base the spending limits and should reconsider its spending limit decisions for the approved Pharmacy Plus demonstrations in light of such criteria. HHS also commented that it was premature to evaluate the Pharmacy Plus demonstrations given the limited experience from 12 to 18 months of operation. HHS said that were the outcome predetermined, a demonstration would serve no purpose. The agency believes the Pharmacy Plus initiative provides states an opportunity to use a Medicaid demonstration to test if providing drug coverage will prevent the aged and disabled low-income population from becoming Medicaid eligible. HHS noted that the four approved demonstrations together are providing drug coverage to 346,000 seniors who would otherwise be without this important benefit. We agree that it is too early to evaluate the outcomes of the 5-year demonstrations and that section 1115 demonstrations are intended to test new propositions. More needs to be done, however, to ensure that states’ evaluations collect the information needed to determine whether those new propositions are functioning as intended. Four states have Pharmacy Plus demonstrations in place to test such propositions, and substantial federal funding is involved, including costs that were previously paid for by the states themselves. For these reasons, HHS has a responsibility to (1) make fiscally prudent decisions in its approvals, (2) ensure that savings hypotheses have some grounding in experience or research, and (3) ensure that the evaluations are planned and conducted in a way that will produce adequate information regarding the demonstrations’ research hypotheses. We also agree that the demonstrations can provide a valuable benefit to low-income seniors and disabled individuals who might otherwise be without drug coverage. But three of the four states with approved demonstrations had state-funded drug coverage programs in place before implementing their Pharmacy Plus demonstrations, and these state-funded programs became eligible for federal matching funds when the demonstrations were approved. We therefore find HHS’s statement that the demonstrations are providing drug coverage to seniors who would otherwise be without it to be an overstatement. HHS also commented on how MMA may affect the operation of approved Pharmacy Plus demonstrations and the review of pending and new demonstration proposals. HHS stated that seniors covered by the four Pharmacy Plus demonstrations will be able to begin receiving drug coverage under the Medicare Part D program in January 2006, and states will be able to use their own funds to “wrap around” the Medicare benefit to assist other Medicare beneficiaries whose incomes exceed the level for low-income subsidies. At that time, HHS believes there will be less need for Pharmacy Plus demonstrations, given expanded Medicare coverage for prescription drugs, and states operating the demonstrations will need to decide if they want to continue doing so and if their demonstrations can continue to be budget neutral. We have reviewed and incorporated this new information as appropriate. HHS’s written comments appear in appendix III, along with our response to additional comments that HHS provided on the findings in our draft report. The department also provided technical comments, which we considered and incorporated as appropriate. Illinois and Wisconsin officials commented that our draft report overstated the demonstrations’ financial risk to the federal government and was unnecessarily alarming in light of data showing that the demonstrations are operating well within their spending limits. In its comments, Illinois said that it stood by the growth rates it used to develop the spending limit for its Pharmacy Plus demonstration; it further argued for the soundness of its demonstration’s premise—that providing a drug benefit to seniors will keep them healthier than if they had no drug coverage. In its comments, Wisconsin said that the draft report failed to consider the significant benefits its demonstration offers to the federal government and to seniors. We agree that providing a drug benefit to seniors could keep them healthier, and we do not dispute the benefit to seniors of the states’ drug programs started or expanded through Pharmacy Plus demonstrations. The demonstrations were approved, however, on the presumption that the cost of each state’s prescription drug program would be paid for in savings from keeping seniors with little or no previous drug coverage healthy enough that they would not become eligible for full Medicaid benefits. Illinois’ demonstration was approved on this presumption even though most of the beneficiaries were already receiving some prescription drug coverage through the state’s existing state-funded program. We remain concerned that HHS is not maintaining its policy to ensure demonstrations are budget neutral. Illinois also commented that it had taken all necessary steps to conduct its own evaluation and that it had cooperated fully with federal evaluators and HHS officials. Illinois said that although it officially filed its quarterly reports late, it submitted all the detailed data contained in those reports to CMS monthly. We are principally concerned with the extent to which the information that Illinois provided could be used to monitor whether the demonstration was operating as intended. Its one- to two-page quarterly reports, filed late, tallied the number of beneficiaries enrolled in the demonstration and drug expenditures to date and provided a narrative paragraph on accomplishments, problems, or issues. The information itself, however, furnishes little insight as to whether the demonstration is operating as intended or whether the benefit is reducing Medicaid costs. Wisconsin commented that the draft report failed to ascribe any value to the government of Wisconsin’s agreement to cap its federal Medicaid funding for seniors as a condition of Pharmacy Plus demonstration approval. We believe the draft report accurately captured HHS’s approach to limiting the federal liability for the Pharmacy Plus demonstrations by establishing a “cap,” or spending limit, as a condition of approval. We remain neutral on the “value” of this cap for several reasons. Requiring states to abide by a spending limit is a departure from the open-ended entitlement nature of the Medicaid program. We also recognize that under the Medicaid program, states have considerable discretion to alter spending by increasing—or decreasing—coverage for certain populations and services. In addition, we recognize that HHS’s budget neutrality practices provide for flexibility in approach and that HHS has established such a limit on other section 1115 demonstrations before the Pharmacy Plus initiative. Wisconsin also commented that the draft report failed to mention that the demonstrations were reviewed, determined reasonable, and approved by OMB. We recognize that OMB is involved in assessing budget neutrality and other aspects of Pharmacy Plus and mentioned that agency’s role in our draft report. Nevertheless, as OMB officials told us, the authority for section 1115 waiver approval rests with the Secretary of HHS, and responsibility for final Pharmacy Plus approval decisions rests with the Secretary and his designees. Wisconsin further commented that in criticizing CMS for not obtaining better evidence to support projected savings, our report fails to consider that the reason for demonstration projects is precisely to test such propositions. We maintain, however, that when HHS establishes a new initiative to encourage states to apply for Pharmacy Plus demonstrations, it is the agency’s responsibility to ensure that each demonstration’s evaluation objectives are reasonable, each demonstration’s savings assumptions are realistic and grounded in some evidence, and the evaluations are well planned and data monitoring is established early enough to assure that the questions can be answered. Florida commented that its demonstration was predicated upon savings to be achieved over the 5-year life of the program and that its proposed spending limit was close to—less than 1 percent above—the conservative benchmark spending level we calculated. We agree that Florida’s spending limit was relatively close to a limit based on the benchmarks and included that information in the draft report. South Carolina provided technical comments that we incorporated as appropriate. As arranged with your offices, unless you release its contents earlier, we plan no further distribution of this report until 30 days after its date. At that time, we will send copies of this report to the Secretary of Health and Human Services, the Administrator of the Centers for Medicare & Medicaid Services, and others who are interested. We will also make copies available to others upon request. In addition, the report will be available at no charge on the GAO Web site at http://www.gao.gov. If you or your staff have any questions, please contact me at (202) 512- 7118. Another contact and other major contributors are listed in appendix VII. To achieve budget neutrality, a state’s projected 5-year spending with its Pharmacy Plus demonstration cannot exceed 5-year projected costs without the demonstration. As a result, the projected costs of a state’s existing Medicaid program for seniors effectively sets the spending limit while the demonstration is under way. Calculating this without- demonstration limit (steps 1–5 in fig. 1) starts with a base year, generally the most recent full year for which data are available; calculations for each subsequent year are based on numbers from the previous year. The result limits a state’s Medicaid spending for all services provided to all Medicaid seniors in the state. Calculating projected 5-year with-demonstration costs follows the same steps but, in addition, factors in the estimated number of new beneficiaries receiving only the prescription drug benefit; the costs of providing them the benefit; and the expected savings, mainly from keeping these beneficiaries healthy enough to avoid eligibility for full Medicaid. Appendix II: Denied, Withdrawn, and Pending Pharmacy Plus Demonstration Proposals as of May 2004 Projected enrollment: Individuals with incomes at or below 300 percent of the federal poverty level (FPL). Coverage and cost sharing: Sought federal assistance only for administrative costs for a demonstration to make prescription drugs available at the discounted Medicaid rate plus a dispensing fee. State was to contribute $1 toward the cost of each prescription in the first year, increasing to $8 by the fifth year. Reasons for denial: Exceeded the Pharmacy Plus income limit at or below 200 percent of FPL, provided for only minimal state financial contributions to pharmacists, and did not include the necessary budget neutrality analysis. Projected enrollment: Seniors and adults with disabilities with incomes at or below 200 percent of FPL or, if income is above 200 percent of FPL, with prescription drug expenses exceeding 40 percent of their incomes. Coverage and cost sharing: All prescriptions covered by the Medicaid state plan, up to an annual benefit limit of $2,500. Participants to pay co-payments of $5 or 25 percent of the cost per prescription, whichever is greater. Reason for denial: State already provided drug benefits to the people to be covered under the demonstration. Projected enrollment: Seniors with incomes at or below 188 percent of FPL. Coverage and cost sharing: Same broad prescription drug coverage as state Medicaid plan. State proposed three levels of co-payments (exact amounts not specified): generic drugs, designated brand-name drugs, and all other brand-name drugs. Full cost of prescriptions to be covered after participants reached annual out-of-pocket spending limits: for example, a single person would pay the lesser of $2,000 or 10 percent of gross annual income. Reason for withdrawal: State’s existing pharmacy assistance program for seniors already covered the populations to be included in the demonstration, and without an expansion the state and the Department of Health and Human Services (HHS) could not reach agreement on budget neutrality. Projected enrollment: Seniors and adults with disabilities with incomes up to 300 percent of FPL. Coverage and cost sharing: All prescription drugs and insulin and syringes with specified exceptions, such as cosmetics and antihistamines. Annual registration fee of $25 and co-payments of $12 for those with incomes up to approximately 233 percent of FPL and $20 for those above. State program: Covers low-income seniors and people with disabilities with incomes up to approximately 233 percent of FPL. Demonstration would expand eligibility up to 300 percent of FPL. Projected enrollment: Seniors and adults with disabilities with incomes at or below 200 percent of FPL. Coverage and cost sharing: All prescription drugs covered by state Medicaid plan, with $5 co-payment for each prescription. For brand-name drug when generic is available, $5 co-payment plus cost difference between the two. State program: Covers seniors and adults with disabilities with incomes up to 222 percent of FPL if single and 202 percent if married. Demonstration would cover individuals with incomes at or below 200 percent of FPL. Projected enrollment: Qualified Medicare beneficiaries age 65 or older with incomes at or below 85 percent of FPL. Coverage and cost sharing: Would cover two prescriptions per beneficiary per month. Annual $25 enrollment fee and co-payments of $10 for each generic prescription and $20 for each brand-name drug. State program: No state-funded pharmacy assistance program for seniors at the time of demonstration proposal submission. Projected enrollment: Seniors with incomes at or below 135 percent of FPL. Coverage and cost sharing: Same prescription drugs as the state’s Medicaid program, plus insulin, up to annual benefit caps set on a sliding scale: $1,000 for people with incomes up to 100 percent of FPL; $750 for those with incomes up to 120 percent of FPL; and $500 for those with incomes at or below 135 percent of FPL. Participants would pay 50 percent of the discounted program price, which is the same as the Medicaid price, for each prescription. State program: Existing state-funded pharmacy program for low-income seniors to be covered under the demonstration with no change in eligibility or drug coverage. State indicated that increased enrollment was expected in the demonstration following a change from a mail-in rebate system to a point-of-sale system using a discount card. Projected enrollment: Seniors age 62 or older and adults with disabilities with incomes at or below 185 percent of FPL. Coverage and cost sharing: Prescription drugs for specified conditions with 20 percent co-payment for each prescription, or 10 percent if from mail-order sources. Broader range of drugs available for coverage with 20 percent co-payment after $1,000 out-of- pocket expenses. State program: Demonstration would cover state-funded pharmacy program, expand conditions covered, and add voluntary mail-order purchase. Projected enrollment: Seniors and adults with disabilities or chronic illness, including chronic mental illness, with incomes at or below 200 percent of FPL. Coverage and cost sharing: All prescription drugs covered by state Medicaid plan. Annual $25 enrollment fee (waived for first year of program) and co-payments that increase after participants have incurred $1,800 of drug expenses per year under the program, from $2 to $4 for generics and from $8 to $12 for brand-name drugs with no generic equivalent; other brand-name drugs have a $25 co-payment. State program: The demonstration would cover individuals with incomes at or below 200 percent of FPL from three state-funded pharmacy programs, while individuals in those programs with higher incomes would continue to be state funded. The scope of drugs covered by state programs would be expanded under the demonstration. Projected enrollment: Seniors with incomes at or below 200 percent of FPL. Coverage and cost sharing: All prescription drugs and insulin. Co-payments of $5 for generic and $15 for brand-name drugs; annual benefit limit of $1,000 per participant. State program: Demonstration would cover and expand existing state-funded program by broadening prescription drugs covered from drugs for three specific conditions to those for all conditions, reducing cost sharing, and increasing annual benefit limit from $600 to $1,000. Projected enrollment: Seniors with incomes at or below 200 percent of FPL. Coverage and cost sharing: Most prescription drugs covered by state Medicaid plan, plus insulin and syringes. Annual $25 enrollment fee and coinsurance of 20 percent of cost of each prescription up to a monthly cap on a sliding scale determined by household income. An additional co-payment would be charged for brand-name drugs with generic equivalents. State program: Demonstration would cover existing state-funded pharmacy assistance program with the same eligibility and coverage and expand enrollment. In March 2003, Massachusetts withdrew two separate section 1115 demonstration proposals from review: a Pharmacy Plus demonstration for seniors (the proposal described in this appendix) and a prescription drug benefit for individuals with disabilities as an amendment to the state’s section 1115 Medicaid managed care demonstration. At the same time, Massachusetts submitted a new proposal—not a Pharmacy Plus proposal—to add a drug benefit for certain seniors and disabled individuals as an amendment to its existing managed care demonstration. In August 2003, that proposal was also withdrawn. In addition to indicating whether it concurred with our seven recommendations, HHS commented on the report draft’s findings in three areas. HHS disagreed with our conclusion that the four approved Pharmacy Plus demonstrations will not prove to be budget neutral to the Medicaid program and will possibly result in increased federal Medicaid spending. HHS stated that the department takes seriously its responsibility to ensure budget neutrality in the Medicaid demonstrations it approves, noting that it approved four Pharmacy Plus demonstrations while denying two and reviewing but not approving nine other proposals whose budget estimates were not well supported. HHS was concerned that we missed the fundamental purpose of budget neutrality, which HHS says is not to hold states to a formula-driven cap but to estimate the amount of future Medicaid spending. HHS believes that the four approved demonstrations’ spending limits were based on well- supported budget estimates of future state spending,1 and said its policy has never been to hold states to benchmark levels of growth. Those benchmarks are, in HHS’s view, a starting point in projecting how the program will grow, because HHS typically permits states to present rationales for higher growth rates. HHS also stated that the 0.7 percent per year state historical average enrollment growth rate we cite for South Carolina (table 2) is in error, because its records showed that South Carolina’s historical average for enrollment growth was 1.0 percent. In verifying the state’s historical enrollment rate, we noted that the rate had been “rounded up” to the next full percentage from the 0.7 percent actual historical rate. For consistency with other rates in the table, we did not round it. officials and requested all documents that were considered in their budget neutrality negotiations. Those interviews and documents, which we discussed in the draft report, did not fully support the higher growth rates that were approved. We note that enrollment growth rates, in particular, can have a significant multiplier effect on future spending estimates. Further, we note that HHS allowed at least one state to argue for a higher growth rate using broad justifications—such as the effect of the Social Security Administration’s nationwide outreach program for low-income Medicare beneficiaries—that other states could also have used but did not, raising questions of clarity and consistency in both the process and the final decisions. Documentation of HHS’s approval decisions and the basis for approved spending limits could provide a rationale for higher cost and enrollment growth rates and offer guidance and assurance of consistent treatment to other states applying for Pharmacy Plus demonstrations. Absent such documentation, neither HHS nor the states have adequately justified the departures from states’ historical growth rates or the CMS Actuary’s growth projections in establishing states’ spending limits. In its comments, HHS stated that the federal review process for Pharmacy Plus demonstration proposals is similar to the review process for other Medicaid section 1115 demonstrations, indicating that the process is necessarily interactive and involves numerous meetings within the federal team and with states. We acknowledge that the review process for Medicaid section 1115 demonstration proposals benefits from being inclusive and interactive, and we are not suggesting that HHS should establish a new or different review process specifically for the Pharmacy Plus demonstrations. Our concern is that the basis for its decisions and any agreed-upon spending limit be clear and justified, not only for Pharmacy Plus demonstrations but for all section 1115 approvals. As noted in the draft report, the concerns raised by HHS’s approved Pharmacy Plus demonstrations parallel those we have raised about other section 1115 waiver demonstration approvals over the past decade, including concerns about the extent to which the department is protecting the Medicaid program’s fiscal integrity and the need for clear criteria and a public process in reviewing and approving demonstrations. HHS commented that the department plans to continue working with states toward developing useful program evaluations based on consistent data collection as well as sufficient, consistent, and timely monitoring information. HHS also plans to make results of the independent Pharmacy Plus evaluation available on the CMS Web site. With regard to states’ own evaluations, HHS emphasized practical limitations, such as constraints on state financial and staff resources, indicating that while states ideally would develop evaluation plans before implementing demonstrations, in practice such plans often change. HHS commented that it obtains sufficient information for monitoring the demonstrations through telephone contacts and progress reports that respond to an example outline the department provided to each demonstration state. We recognize that state resources are limited, demonstration implementation tends to be a higher priority than evaluation, and the independent contractor evaluation of Pharmacy Plus will provide substantial information. Nonetheless, the lack of action to monitor key information—such as whether demonstration enrollees are being diverted from Medicaid—to plan how their evaluations will be conducted, or to collect data needed for such evaluations suggests a low priority for ensuring that evaluations can and will be done. HHS needs to ensure that states provide sufficient, consistent, and timely information for both demonstration monitoring and for determining whether the demonstrations are functioning as intended and to ensure that evaluation plans are put into place. In addition to overall comments on our draft report contained in its letter and discussed in the body of this report, Wisconsin provided 11 specific comments in an attachment to its letter, which is reproduced on pages 67 through 69. Our responses to Wisconsin’s specific comments are numbered below to correspond with each of the state’s numbered comments. 1. Wisconsin commented that our $416 million figure (the estimated federal share of the difference between HHS-approved and benchmark 5-year spending limits in table 3) exaggerates the federal fiscal effect, because the actual costs of the demonstration’s first years have come in under the projected costs. The state currently projects federal costs for the new drug benefit under the demonstration totaling $250 million over 5 years instead of roughly $537 million, which is the federal share of $919 million approved for the new benefit (see table 1). Although we recognize that the actual costs of Wisconsin’s demonstration to date are less than the costs projected at the time the waiver was approved, our analysis examined the extent to which HHS ensured that the demonstrations—in the form they were approved—maintained spending limits that were budget neutral to the federal government. Because Wisconsin’s approved spending limit represents the total amount the state is authorized to spend over the demonstration’s 5- year life-span, the federal government could be liable for as much as $416 million more than what it would have been liable for had HHS held the state to a spending limit based on benchmark rates (see table 3). 2. Wisconsin commented that it is unreasonable to hold HHS to applying the lower of two benchmark growth rates in calculating budget neutrality: state experience or projections by the Centers for Medicare & Medicaid Services’ (CMS) Actuary for Medicaid costs. The state also expressed concern that our analysis did not incorporate factors other than the benchmarks that affect program growth. We believe that it is reasonable to expect HHS to use objective benchmark growth rates in projecting the Medicaid costs on which it bases spending limits and to document its reasons for deviating from those benchmarks—even if the department regards them as starting points. Otherwise, the department’s rationale for setting higher spending limits (based on higher growth rates) for some states than for others is not apparent to other states involved in waiver negotiations and reviews. As noted in the draft report, HHS responded to Wisconsin’s request for higher growth rates but did not, in our view, adequately document the basis for approving higher rates. In our own analysis of the spending limits, we did not include the additional factors that Wisconsin asserted should raise its spending limits because neither the state nor HHS provided adequate support to justify doing so. 3. Wisconsin stated that our interpretation was unreasonably narrow in not accounting for potential savings accruing to Medicare, as well as to Medicaid, from expanding prescription drug coverage for seniors. We considered savings to Medicaid alone because HHS allows states to include savings only to Medicaid, not Medicare, in determining whether their Medicaid demonstrations are budget neutral. 4. Wisconsin commented that because its historical cost growth rate has been rising, it was appropriate for HHS to calculate the state’s spending limit using a rate higher than its historical 5-year average. We believe that whenever HHS allows growth rate projections that exceed its benchmarks, it should document the basis for this deviation. 5. Wisconsin mentioned two state programs that it believes will, like the Social Security Administration’s outreach program for low-income Medicare beneficiaries, help increase senior enrollment in Wisconsin’s Medicaid program because they are likely to identify individuals who qualify for full Medicaid benefits. But the state did not quantify or provide any data or other evidence to show the potential effects of these programs or of Social Security Administration outreach. We did not include these effects in our benchmark analysis for the same reason we did not include other factors that Wisconsin believed should raise is spending limit (see our response to comment 2). 6. Wisconsin noted that we found no firm evidence to support the idea that expanding drug coverage would produce significant savings in Medicaid by diverting or delaying Medicaid enrollment. The state asserts that this criticism ignores the central purpose of these demonstrations: to determine if an important health care benefit can be delivered cost effectively. We acknowledge the value of demonstrations to test health care alternatives, but we believe that the case for substantial savings to Medicaid due to expanded prescription drug coverage is not well supported. We also believe that HHS has not done enough to ensure that states develop and implement demonstration evaluation designs. Although we do not dispute Wisconsin’s comment that research suggests coverage of prescription drugs benefits seniors, we believe that demonstrating the effects of drug coverage on avoiding Medicaid enrollment is a separate issue. 7. Wisconsin has interpreted our mention of congressional concern about the extent to which HHS has ensured that section 1115 demonstration waivers promote the goals of Medicaid as implying that the state’s demonstration is not providing critical prescription drugs to a vulnerable elderly, low-income, uninsured population. We did not intend to suggest that Wisconsin’s demonstration is not a valuable benefit to these individuals. We were referring to our earlier work on section 1115 Medicaid and State Children’s Health Insurance Program (SCHIP) demonstrations, which, in addition to raising concerns about HHS’s use of section 1115 waiver authority to approve demonstration spending limits that were not budget neutral, also found that HHS was allowing states to use unspent SCHIP funding to cover childless adults, despite SCHIP’s statutory objective of expanding health coverage to low-income children. 8. Wisconsin commented that we mischaracterized the growth rates approved by HHS for the state’s demonstration as too high. See our response to comment 2. 9. Wisconsin objected to our conclusion that the lack of available information on how these demonstrations are operating compromises attempts to assess whether they are operating as intended. This statement does not apply to any one state alone but synthesizes our findings for the four approved demonstrations taken together. We acknowledge that Wisconsin has been responsive to HHS’s requirements for informative and timely progress reports and have revised our report as appropriate. 10. Wisconsin stated that its data reporting system allows its staff to monitor that the demonstration is operating as intended. In the draft report, we noted that Wisconsin officials reported having the capability for monitoring. We have not assessed Wisconsin’s monitoring system. 11. Wisconsin commented on the importance of, and Wisconsin’s full participation in, CMS’s contracted independent evaluation as an effective approach to reviewing the agency’s assumptions relating to budget neutrality and program effectiveness. We believe the draft report captured the plans for this independent evaluation, as well as the apparent confusion over each state’s responsibility for conducting its own evaluation. We have revised our report to reflect that Wisconsin officials believe the state is not required to conduct an evaluation, whereas HHS officials told us the state would be required to do so. In addition, Tim Bushfield, Ellen W. Chu, Helen Desaulniers, Behn Kelly, Suzanne Rubins, Ellen M. Smith, and Stan Stenersen made key contributions to this report. SCHIP: HHS Continues to Approve Waivers That Are Inconsistent with Program Goals. GAO-04-166R. Washington, D.C.: January 5, 2004. Medicaid and SCHIP: Recent HHS Approvals of Demonstration Waiver Projects Raise Concerns. GAO-02-817. Washington, D.C.: July 12, 2002. Medicare and Medicaid: Implementing State Demonstrations for Dual Eligibles Has Proven Challenging. GAO/HEHS-00-94. Washington, D.C.: August 18, 2000. Medicaid Section 1115 Waivers: Flexible Approach to Approving Demonstrations Could Increase Federal Costs. GAO/HEHS-96-44. Washington, D.C.: November 8, 1995. Medicaid: State Flexibility in Implementing Managed Care Programs Requires Appropriate Oversight. GAO/T-HEHS-95-206. Washington, D.C.: July 12, 1995. Medicaid: Statewide Section 1115 Demonstrations’ Impact on Eligibility, Service Delivery, and Program Cost. GAO/T-HEHS-95-182. Washington, D.C.: June 21, 1995. Medicaid: Spending Pressures Drive States toward Program Reinvention. GAO/T-HEHS-95-129. Washington, D.C.: April 4, 1995. Medicaid: Spending Pressures Drive States toward Program Reinvention. GAO/HEHS-95-122. Washington, D.C.: April 4, 1995. Medicaid: Experience with State Waivers to Promote Cost Control and Access to Care. GAO/T-HEHS-95-115. Washington, D.C.: March 23, 1995.

Summary: Under section 1115 of the Social Security Act, the Secretary of Health and Human Services may waive certain Medicaid requirements for states seeking to deliver services through demonstration projects. By policy, these demonstrations must not increase federal spending. GAO has previously reported concerns with HHS's approval process. GAO was asked to provide information on a new Medicaid section 1115 demonstration initiative called Pharmacy Plus, intended to allow states to cover prescription drugs for seniors not otherwise eligible for Medicaid. GAO reviewed the (1) approval status of state proposals, (2) extent to which HHS ensured that demonstrations are budget neutral, (3) basis for savings assumptions, and (4) federal and state steps to evaluate and monitor the demonstrations. From January 2002 through May 2004, HHS reviewed Pharmacy Plus proposals from 15 states and approved four: Florida, Illinois, South Carolina, and Wisconsin. These demonstrations offer prescription drug coverage to low-income seniors not otherwise eligible for Medicaid. HHS denied proposals from Delaware and Hawaii as inconsistent with demonstration guidelines; most of the rest were not under active review because HHS had not determined how new Medicare prescription drug legislation will affect proposed or operating Pharmacy Plus demonstrations. Over 5 years, the four approved demonstrations will provide prescription drug coverage to half a million low-income people age 65 or older, at a projected cost of about $3.6 billion, of which the federal share would be about $2.1 billion. HHS has not adequately ensured that the four approved demonstrations will be budget neutral, that is, that the federal government will not spend more with the demonstrations than without them. HHS approved the demonstrations' 5-year spending limits using projections of cost and beneficiary enrollment growth that exceeded benchmarks that HHS said it considered in assessing budget neutrality, specifically, states' recent average growth rates and projections for Medicaid program growth nationwide. Neither HHS's negotiations with the states nor its rationale for approving higher growth rates is documented. Using the benchmark growth rates, GAO estimates that none of the four demonstrations will be budget neutral and federal spending may increase significantly, for example, by more than $1 billion in Illinois and $416 million in Wisconsin over 5 years. Unrealistic savings assumptions also contribute to demonstration spending limits that are not likely to be budget neutral. States assumed that keeping low-income seniors healthy--thus preventing them from spending down their financial resources on health services and "diverting" them from Medicaid eligibility--would generate sufficient savings to offset the increased costs of providing a new drug benefit. GAO found neither state experience nor other research to support such savings. Without state-specific evidence, HHS approved savings assumptions for the four states ranging from $480 million to $2 billion per state over 5 years. Had more conservative assumptions been used to estimate demonstration savings, the proposals likely could not have been approved as budget neutral. Efforts by the states and HHS to evaluate and monitor the Pharmacy Plus demonstrations are in their early stages. The four states have taken few steps to put their own required evaluation plans into practice, and an independent evaluation contracted by HHS and started in October 2002 is scheduled to report in September 2005. In the interim, HHS has not ensured that all states meet requirements for progress reporting on the demonstrations. The information that states have submitted is often insufficient for determining whether the demonstrations are operating as intended, and this shortcoming will limit HHS's oversight capability.