Title XIX of the Social Security Act authorizes federal funding to states for Medicaid, which finances health care services including acute and long- term care for certain low-income, aged, or disabled individuals. States have considerable flexibility in designing and operating their Medicaid programs. Within broad federal requirements, each state determines which services to cover and to what extent, establishes its own eligibility requirements, sets provider payment rates, and develops its own administrative structure. In addition to groups for which federal law requires coverage—such as children and pregnant women at specified income levels and certain persons with disabilities—states may choose to expand eligibility or add benefits that the statute defines as optional. Medicaid is an open-ended entitlement: states are generally obligated to pay for covered services provided to eligible individuals, and the federal government is obligated to pay its share of a state’s expenditures under a CMS-approved state Medicaid plan. The federal share of each state’s Medicaid expenditures is based on a statutory formula linked to a state’s per capita income in relation to national per capita income. In 2002, the specified federal share of each state’s expenditures ranged from 50 percent to 76 percent; in the aggregate, the federal share of total Medicaid expenditures was 57 percent. The Social Security Act provides that up to 60 percent of the state share of Medicaid spending can come from local- government revenues and sources. Some states design their Medicaid programs to require local governments to contribute to the programs’ costs. For more than a decade, some states have used various financing schemes, some involving IGTs, to create the illusion of a valid state Medicaid expenditure to a health care provider. This payment has enabled states to claim federal matching funds regardless of whether the program services paid for had actually been provided. As various schemes have come to light, Congress and CMS have taken actions to curtail them (see table 1). Many of these schemes involve payment arrangements between the state and government-owned or government-operated providers, such as local- government-operated nursing homes. A variant of these creative financing arrangements involves states’ exploitation of Medicaid’s upper payment limit (UPL) provisions. These schemes share certain characteristics, including IGTs, with other financing schemes from prior years (see table 1). In particular, these arrangements create the illusion that a state has made a large Medicaid payment— separate from and in addition to Medicaid expenditures that providers have already received for covered services—which enables the state to obtain a federal matching payment. In reality, the large payment is temporary, since the funds essentially make a round-trip from the state to the Medicaid providers and back to the state. As a result of such round-trip arrangements, states obtain excessive federal Medicaid matching funds while their own state expenditures remain unchanged or even decrease. Figure 1, which is based on our earlier work, illustrates how this mechanism operated in one state (Michigan). As shown in figure 1, the state made Medicaid payments totaling $277 million to certain county health facilities; the total included $155 million in federal funds and $122 million in state funds (step 1). On the same day that the county health facilities received the funds, they transferred all but $6 million back to the state, which retained $271 million (steps 2 and 3). From this transaction, the state realized a net gain of $149 million over the state’s original outlay of $122 million. In cases like this, local-government facilities can use IGTs to easily return the excessive Medicaid payments to the state via electronic wire transfers. We have found that these round-trip transfers can be accomplished in less than 1 hour. The IGT is critical, because if the payment does not go back to the state, the state gains no financial benefit and actually loses from the arrangement because it has simply paid the provider more than its standard Medicaid payment rate for the services. In a variant of this practice, some states require a few counties to initiate the transaction, by taking out bank loans for the total amount the states determined they can pay under the UPL. The counties wire the funds to the states, which then send most or all of the funds back to the counties as Medicaid payments. The counties use these “Medicaid payments” to repay the bank loans. Meanwhile, the states claim federal matching funds on the total amount. Consistent with past actions, Congress and CMS have taken steps to curtail UPL financing schemes when they have come to light. At the direction of Congress, the agency—then called the Health Care Financing Administration (HCFA)—finalized a regulation in 2001 that significantly narrowed the UPL loophole by limiting the amount of excessive funds states could claim. HCFA estimated that its 2001 regulation would reduce the federal government’s financial liability due to inappropriate UPL arrangements by $55 billion over 10 years; a related 2002 regulation was estimated to yield an additional $9 billion over 5 years. CMS recognized that some states had developed a long-standing reliance on these excessive UPL funds, and the law and regulation authorized transition periods of up to 8 years for states to come into compliance with the new requirements. As we recently reported, however, even under the new regulations, states can still aggregate payments to all local-government nursing homes under one UPL to generate excessive federal matching payments beyond their standard Medicaid claims. For example, CMS information about states complying with the new regulation indicates that, through UPL arrangements with public nursing homes and other public facilities, states can still claim about $2.2 billion annually in federal matching funds exceeding their standard Medicaid claims. States’ use of these creative financing mechanisms undermines the federal-state Medicaid partnership as well as the program’s fiscal integrity in at least three ways. First, state financing schemes effectively increase the federal matching rate established under federal law by increasing federal expenditures while state contributions remain unchanged or even decrease. For example, for one state we analyzed (Wisconsin), we estimated that by obtaining excessive federal matching payments and using these funds as the state share of other Medicaid expenditures, the state effectively increased the federal matching share of its total Medicaid expenditures from 59 percent to 68 percent in state fiscal year 2001. The state did so by generating nearly $400 million in excessive federal matching funds via round-trip arrangements with three counties. Similarly, the HHS Office of the Inspector General found that a comparably structured arrangement in Pennsylvania effectively increased that state’s statutorily determined matching rate from 54 percent to about 65 percent. Second, CMS has no assurance that these increased federal matching payments are used for Medicaid services. Federal Medicaid matching funds are intended for Medicaid-covered services for the Medicaid-eligible individuals on whose behalf payments are made. Under state financing schemes, however, states can use funds returned to them at their own discretion. We recently examined how six states with large UPL financing schemes involving nursing homes used the federal funds they generated. As in the past, some states in our review deposited excessive funds from UPL arrangements into their general funds, which the states may or may not use for Medicaid purposes. For example, one state (Oregon) has used funds generated by its UPL arrangement to help finance education programs. Table 2 provides further information on how states used their UPL funds in recent years, as reported by the six states we reviewed. Third, these state financing schemes undermine the fiscal integrity of the Medicaid program because they enable states to make to providers payments that significantly exceed their costs. In our view, this practice is inconsistent with the statutory requirement that states ensure that Medicaid payments are economical and efficient. Under UPL financing arrangements, some states pay a few public providers excessive amounts, well beyond the cost of services provided. We found, for example, that Virginia’s proposed arrangement would allow the state to pay six local- government nursing homes, on average, $670 in federal funds per Medicaid nursing home resident per day—more than 12 times the $53 daily federal payment these nursing homes normally received, on average, per Medicaid resident. Although CMS and the Congress have often acted to curtail states’ financing schemes, problems persist. Improved CMS oversight and additional congressional action could help address continuing concerns with UPL financing schemes and other inappropriate arrangements. We recently reported that CMS has taken several actions to improve its oversight of state UPL arrangements, including forming a team to coordinate its review of states’ proposed and continuing arrangements, drafting internal guidelines for reviewing state methods for calculating UPL amounts, and conducting financial reviews that have identified hundreds of millions of dollars in improper claims. Starting in August 2003, when considering states’ proposals to change how they would pay nursing homes or other institutions, CMS also began to ask states to provide previously unrequested information. The information includes sources of state matching funds for supplemental payments to Medicaid providers, the extent to which total payments would exceed providers’ costs, how a state would use the additional funds, and whether a state required providers to return payments (and, if so, how the state planned to spend such funds). As of October 2003, CMS indicated that it had asked 30 states with proposed state Medicaid plan amendments to provide additional information, and the agency was in the process of receiving and reviewing states’ initial responses. We also reported, however, that CMS’s efforts do not go far enough to ensure that states’ UPL claims are for Medicaid-covered services provided to eligible beneficiaries. Moreover, we remain concerned that in carrying out its oversight responsibilities, CMS at times takes actions inconsistent with its stated goals for limiting states’ use of these arrangements. For example, we previously reported that while the agency was attempting to narrow the glaring UPL loophole in 2001, it was allowing additional states to engage in the very schemes it was trying to shut down, at a substantial cost to the federal government. More recently, we reported that CMS’s granting two states the longest available transition period of 8 years, for phasing out excessive claims under their UPL arrangements, was not consistent with the agency’s stated goals. We estimated that, as a result of these decisions, these two states can claim about $633 million more in federal matching funds under their 8-year transition periods than they could have claimed under shorter transition periods consistent with CMS’s stated policies and goals. In our view, additional congressional action also could help address continuing concerns about Medicaid financing schemes. Although Congress and CMS have taken significant steps to help curb inappropriate UPL arrangements and other financing schemes, states can still claim federal matching funds for more than a public provider’s actual costs of providing Medicaid-covered services. As long as states are allowed to make payments exceeding a facility’s actual costs, the loophole remains. A recommendation open from one of our earlier reports would, if implemented, close the existing loophole and thus mitigate these continuing concerns. We previously recommended that Congress consider prohibiting Medicaid payments that exceed actual costs for any government-owned facility. If this recommendation were implemented, a facility’s payment would be limited to the reasonable costs of covered services it actually provides to eligible beneficiaries, thus eliminating the possibility of the exorbitant payments that are now passed through individual facilities to states. The Administration appears to support such legislative action; the President’s budget for fiscal year 2005 sets forth a legislative proposal to cap Medicaid payments to government providers (such as public hospitals or county-owned nursing homes) to the actual cost of providing services to Medicaid beneficiaries. The term “IGTs” has come to be closely associated—if not synonymous— with the abusive financing schemes undertaken by some states in connection with illusory payments for Medicaid services to claim excessive federal matching funds. IGTs are a legitimate state budget tool and not problematic in themselves. But when they are used to carry out questionable financial transactions that inappropriately shift state Medicaid costs to the federal government, they become problematic. We believe the problem goes beyond IGTs. An observation we made in our first report on this issue in 1994 is as valid today as it was then: in our view, the Medicaid program should not allow states to benefit from arrangements where federal funds purported to benefit providers are given to providers with one hand, only to be taken back with the other. State financing schemes, variants of which have been applied for a decade or longer, circumvent the federal and state funding balance set under law. They have also resulted in the diversion of federal funds intended to pay for covered services for Medicaid-eligible individuals to whatever purpose a state chooses. Although Congress and CMS have often acted to address Medicaid financing schemes once they become apparent, new variations continue to emerge. Experience shows that some states are likely to continue looking for creative means to supplant state financing, making a compelling case for the Congress and CMS to sustain vigilance over federal Medicaid payments. Understandably, states that have relied on federal funding as a staple for their own share of Medicaid spending are feeling the budgetary pressure from the actual or potential loss of these funds. The continuing challenge remains to find the proper balance between states’ flexibility to administer their Medicaid programs and the shared federal-state fiduciary responsibility to manage program finances efficiently and economically in a way that ensures the program’s fiscal integrity. Mr. Chairman, this concludes my prepared statement. I will be happy to answer any questions that you or Members of the Subcommittee may have. For future contacts regarding this testimony, please call Kathryn G. Allen at (202) 512-7118. Katherine Iritani, Tim Bushfield, Ellen W. Chu, Helen Desaulniers, Behn Miller Kelly, and Terry Saiki also made key contributions to this testimony. Medicaid: Improved Federal Oversight of State Financing Schemes Is Needed. GAO-04-228. Washington, D.C.: February 13, 2004. Major Management Challenges and Program Risks: Department of Health and Human Services. GAO-03-101. Washington, D.C.: January 2003. Medicaid: HCFA Reversed Its Position and Approved Additional State Financing Schemes. GAO-02-147. Washington, D.C.: October 30, 2001. Medicaid: State Financing Schemes Again Drive Up Federal Payments. GAO/T-HEHS-00-193. Washington, D.C.: September 6, 2000. State Medicaid Financing Practices. GAO/HEHS-96-76R. Washington, D.C.: January 23, 1996. Michigan Financing Arrangements. GAO/HEHS-95-146R. Washington, D.C.: May 5, 1995. Medicaid: States Use Illusory Approaches to Shift Program Costs to Federal Government. GAO/HEHS-94-133. Washington, D.C.: August 1, 1994. This is a work of the U.S. government and is not subject to copyright protection in the United States. It may be reproduced and distributed in its entirety without further permission from GAO. 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Summary: Medicaid, the federal-state health financing program for many of the nation's most vulnerable populations, finances health care for an estimated 53 million lowincome Americans, at a cost of $244 billion in 2002. Congress structured Medicaid as a shared fiduciary responsibility of the federal government and the states, with the federal share of each state's Medicaid payments determined by a formula specified by law. In 2002, the federal share of each state's expenditures ranged from 50 to 76 percent under this formula; in the aggregate, the federal share of total Medicaid expenditures was 57 percent. Some states have used a number of creative financing schemes that take advantage of statutory and regulatory loopholes to claim excessive federal matching payments. GAO was asked to summarize prior work on how some of these schemes operated, including the role of intergovernmental transfers (IGT), which enable government entities--such as the state and local-government facilities like county nursing homes--to transfer funds among themselves. GAO was also asked to discuss these schemes' effects on the federalstate Medicaid partnership and to discuss what can be done to curtail them. For many years states have used varied financing schemes, sometimes involving IGTs, to inappropriately increase federal Medicaid matching payments. Some states, for example, receive federal matching funds on the basis of large Medicaid payments to certain providers, such as nursing homes operated by local governments, which greatly exceed established Medicaid rates. In reality, the large payments are often temporary, since states can require the local-government providers to return all or most of the money to the states. States can use these funds--which essentially make a round-trip from the states to providers and back to the states--at their own discretion. States' financing schemes undermine the federal-state Medicaid partnership, as well as the program's fiscal integrity, in at least three ways. The schemes effectively increase the federal matching rate established under federal law by increasing federal expenditures while state contributions remain unchanged or even decrease. GAO estimated that one state effectively increased the federal matching share of its total Medicaid expenditures from 59 percent to 68 percent in state fiscal year 2001, by obtaining excessive federal funds and using these as the state's share of other Medicaid expenditures. There is no assurance that these increased federal matching payments are used for Medicaid services, since states use funds returned to them via these schemes at their own discretion. In examining how six states with large schemes used the federal funds they generated, GAO found that one state used the funds to help finance its education programs, and others deposited the funds into state general funds or other special state accounts that could be used for non-Medicaid purposes or to supplant the states' share of other Medicaid expenditures. The schemes enable states to pay a few public providers amounts that well exceed the costs of services provided, which is inconsistent with the statutory requirement that states ensure economical and efficient Medicaid payments. In one state, GAO found that the state's proposed scheme increased the daily federal payment per Medicaid resident from $53 to $670 in six local-government-operated nursing homes. Although Congress and the Centers for Medicare & Medicaid Services have acted to curtail financing schemes when detected, problems persist. States can still claim excessive federal matching funds for payments exceeding public facilities' actual costs. GAO suggests that Congress consider a recommendation open from prior work, that is, to prohibit Medicaid payments that exceed actual costs for any government-owned facility.