Financed jointly by the federal government and states, Medicaid is the nation’s health care lifeline for two statutorily defined groups of low-income residents—families, primarily women and children; and the aged, blind, and disabled. In reality, Medicaid is not 1, but rather 56 separate programs that differ dramatically across states. While federal statute mandates who is eligible for coverage and the broad categories of services that must be provided, each participating state designs and administers its own program by (1) setting certain income and asset eligibility requirements, (2) selecting which optional groups and services to cover, and (3) determining the scope of mandatory and optional services. As a result of this flexibility, Medicaid is not available to everyone who is poor. In 1993, Medicaid provided health care coverage to less than half of those with incomes below the poverty level. The Health Care Financing Administration (HCFA) within the Department of Health and Human Services (HHS) monitors each state program for compliance with federal regulations. (App. II contains more background information on the Medicaid program.) The $130 billion Medicaid program is at a crossroads. Between 1985 and 1993, Medicaid costs tripled and the number of beneficiaries increased by over 50 percent. Current projections suggest that program costs will double over the next 5 to 7 years. To constrain rising health care costs, states are increasingly turning to mandatory enrollment of some or all Medicaid beneficiaries in managed care delivery plans—arrangements that limit a beneficiary’s choice of physicians and hospitals. In many cases, these managed care plans are prepaid a fixed amount per enrollee. This financing arrangement has demonstrated the ability to lower service utilization, which in turn can hold down costs. In order to implement mandatory managed care programs, states must obtain a waiver of certain Medicaid requirements. The waiver authority that gives states the greatest flexibility is section 1115 of the Social Security Act. Section 1115 allows the executive branch to waive most federal Medicaid requirements for demonstration projects likely to assist in promoting program objectives. Since 1992, 22 states have asked to use this demonstration authority to restructure their Medicaid programs. The common thread present in what have been termed “comprehensive” 1115 demonstration waivers is (1) the switch from a fee-for-service to a managed care approach to delivering health benefits and (2) the use of anticipated savings plus other funding streams to expand coverage to groups previously ineligible for Medicaid. Eleven states with 1115 waivers approved since 1993 have undertaken an ambitious experiment to demonstrate that the Medicaid program can actually save money while simultaneously expanding coverage. The administration has entered into 5-year budget commitments that allow each state to reinvest managed care savings and redirect other funds in order to expand coverage to currently uninsured individuals. Compared to expenditure trends for the predemonstration program, states suggest that the net result of waivers will be lower costs—even though managed care savings are being reinvested. Eleven more waivers are pending, and all but a few applicants are pursuing a similar managed care cost-containment/coverage expansion strategy. Only Illinois, Oklahoma, and Kentucky (the state’s 1995 demonstration application) propose using 1115 waiver authority to reduce both state and federal Medicaid expenditures without expanding coverage. The use of 1115 waivers to restructure state Medicaid programs has been facilitated by a new federal flexibility in assessing the budget neutrality of such demonstrations—particularly, the administration’s avowed openness to “new methodologies” to estimate what the continuation of a state’s existing Medicaid program would have cost. By redefining the terms of budget neutrality, the administration has made it easier for states to demonstrate that waivers will cost less than their existing Medicaid programs. The administration asserts, nonetheless, that all approved 1115 waivers are budget neutral and that the demonstration authority is not being used to expand entitlement spending. Oregon’s 1991 application—a major component of a broader reform of its health care system—was the first request since 1982 to operate a comprehensive, statewide demonstration program. After a year of review, the Bush administration rejected the application on the grounds that the state’s proposed benefits package might violate the Americans With Disabilities Act. A report prepared for the National Governors’ Association criticized the handling of Oregon’s application, noting that the review process did not give due weight to the state role in Medicaid, had a “chilling” effect on innovative proposals, and imposed budget neutrality requirements that were too narrow. The Clinton administration subsequently announced plans to streamline and expedite the review process for 1115 waivers. Oregon revised and resubmitted its waiver application in late 1992 and the following March became the first state in over 10 years to obtain approval for a comprehensive 1115 demonstration. Since then, 10 additional waivers have been approved. Another 11 states have applications pending, and others have expressed interest in submitting requests for 1115 waivers. States with approved and pending waivers account for about 49 percent of the nation’s Medicaid beneficiaries and 52 percent of total Medicaid expenditures. As of July 1995, however, only five states—Oregon, Hawaii, Tennessee, Rhode Island, and Minnesota—had begun implementation. Appendix III summarizes the status of all approved and pending comprehensive 1115 demonstrations submitted since 1992. Requirements intended to preserve quality by protecting a Medicaid beneficiary’s freedom to choose a provider have limited states’ ability to mandate enrollment in HMO-style managed care. HMO-style health plans are prepaid a fixed amount based on the number of enrollees rather than reimbursed after each service is rendered. Such prepayment on a per capita basis is often referred to as “capitation.” A convergence of trends—spiraling Medicaid expenditures coupled with a stronger interest on the part of mainstream HMOs in serving the Medicaid population—has given impetus to as well as facilitated the adoption of a managed care cost-containment strategy by states. And rather than turning to physician gatekeeper arrangements that dominated past managed care experiments, many states are using the flexibility gained under 1115 Medicaid waivers to adopt capitated alternatives. Reacting to quality-of-care, marketing, and other problems that surfaced in a number of Medicaid managed care programs, the Congress enacted provisions in 1976 with the general goal of encouraging HMOs to provide public clients a quality of care comparable to that available to private clients. At the time, HMOs were the prevalent form of managed care. One provision discouraged the creation of HMOs serving only Medicaid beneficiaries by requiring that at least a certain percentage of the patients be privately insured. The participation of private-paying patients, who presumably have a choice of health plans, was instituted as a proxy for quality. A second provision added in 1981 allows recipients to terminate enrollment in an HMO at any time. From the beneficiary’s perspective, these provisions offer protection against enrollment in an HMO seeking excessive profit at the expense of quality. From the HMO’s perspective, however, unrestricted freedom to disenroll makes it difficult to plan financially and therefore renders the enrollment of Medicaid recipients less attractive. This provision added to the hesitancy of many mainstream HMOs to participate in Medicaid, further restricting states’ ability to experiment with fully capitated health plans. In 1993, about 4.8 million beneficiaries, or about 12 percent of the Medicaid population, were enrolled in some type of managed care.Though a number of voluntary and mandatory managed care options are available to states, the enrollment of Medicaid beneficiaries has lagged behind national trends. Without an 1115 waiver, states essentially have three managed care options: voluntary enrollment in an HMO, in which case the beneficiary must also have a choice of obtaining services on a fee-for-service basis and be allowed to disenroll at will; mandatory enrollment in an HMO, provided the beneficiary can choose from among a number of competing HMOs, with disenrollment allowed on a monthly basis (or every 6 months if an HMO meets certain federal requirements); and voluntary or mandatory enrollment in a physician gatekeeper system in which either the physician’s charges are partially capitated or the physician is reimbursed under fee-for-service. The last two options require waivers of Medicaid provisions that have been widely provided under section 1915(b) of the Social Security Act. As of July 1994, 37 states operated 1915(b) waiver programs. These programs were primarily substate (that is, in a limited geographic area), voluntary, and involved physician gatekeepers rather than HMOs. Until 1993, only two states—Arizona and Minnesota—operated mandatory HMO managed care programs under the authority of an 1115 waiver. Table 1.1 delineates the additional flexibility available under an 1115 waiver compared with 1915(b) authority. Though all approved 1115 waivers expand eligibility, the nature and extent of coverage expansion varies. Waivers use income standards to define and, in effect, limit who is eligible, but states further restrict the number of individuals that can actually obtain coverage through explicit enrollment caps, other barriers, and even premiums. Because of greater than anticipated enrollment, several states are taking additional steps to limit the number applying for coverage. Most states are adding groups who were previously ineligible for Medicaid—single adults and childless couples. However, it is important to recognize that some categories of newly eligible individuals in one state may already be enrolled in Medicaid in another because of differences in the qualifying income levels established by states for families and optional coverage expansions allowed by statute. Moreover, states may have previously provided health coverage to some new eligibles outside of Medicaid—that is, through state-funded programs. For example, Kentucky’s planned expansion under its now suspended 1993 waiver includes both previously ineligible individuals and individuals who could have been included in Medicaid at state option. In Rhode Island, Hawaii, and Minnesota the expansions either are limited to or include individuals who could have been Medicaid- eligible at state option. Both Hawaii and Minnesota offered state-funded coverage to many included in their waivers. Table 1.2 summarizes the coverage expansion goals of seven states with approved 1115 waivers. Generally, expansion goals are stated in terms of the number of newly eligible individuals expected to be covered under the waiver at the end of the 5-year period of each demonstration. Enrollment in year 1 may be less than the 5-year enrollment goal, since states typically anticipate reaching “full enrollment” gradually. State goals should be viewed as targets subject to a number of constraints, especially financing. Some waivers indicate that the state will limit enrollment if funding proves to be inadequate. At least one state, Tennessee, has already done so. At one end of the expansion continuum, Tennessee’s waiver program has no eligibility income limit and requires only those enrollees above 400 percent of the poverty level to pay the full premium. Tennessee set an original enrollment cap of 500,000 on new eligibles and excluded individuals who were insured before a certain cutoff date to forestall a migration from private insurance. The state lowered its cap in December 1994, in effect limiting the expansion to the approximately 400,000 previously uninsured individuals already enrolled. In contrast, Oregon’s expansion goals are less ambitious because, in part, the employer mandate was expected to cover low-income workers. The waiver expands eligibility up to 100 percent of the poverty level, requires no premiums from participants, and has no explicit enrollment cap. In order to address budgetary constraints, the legislature enacted several changes that the state began implementing on October 1, 1995. However, HCFA has yet to approve Oregon’s request to require premiums of some newly eligible participants. Some 1115 waivers, such as Hawaii’s, target individuals who were already covered by state-funded expansion programs outside of Medicaid.Consequently, Hawaii did not anticipate much additional enrollment as a result of its waiver. Unlike Hawaii, Minnesota’s waiver application did not include single adults and childless couples covered under state-funded MinnesotaCare. State officials told us that requesting a federal match for this group would have created a budget neutrality problem because of the cost. Instead, the approved waiver shifts children covered under MinnesotaCare into Medicaid—a group that could have been included in the program at state option. Finally, Rhode Island’s expansion group is limited to pregnant women and children who could also have been covered at state option without an 1115 waiver. Embedded in many comprehensive 1115 demonstrations is a controversial philosophical shift in the way publicly supported health care is provided to the poor—a shift (1) inherent in the adoption of managed care delivery systems and (2) visible in the treatment of those newly eligible under the demonstration. The cumulative effect of these changes is to place more responsibility on the individual beneficiary. Advocacy groups for the poorand waiver states disagree on the extent to which low-income beneficiaries can shoulder these responsibilities. Advocacy groups typically see Medicaid beneficiaries, as well as many of the working poor to whom coverage is being extended, as a vulnerable, high-risk, and sicker segment of the population. They are concerned about the ability of the poor to access services in a managed care system. As noted earlier, some critics of managed care argue that it creates a “perverse incentive” to deliver fewer or less costly services than may be needed. Advocacy groups also worry that managed care will (1) further reduce the historically low Medicaid reimbursement levels, (2) diminish quality of care, and (3) curtail access to providers that have traditionally served the poor. Finally, they see a disincentive for the poor to participate in waiver programs when premiums, though subsidized, are high relative to income. States, on the other hand, point out that the waivers require them to implement significant quality assurance programs such as collecting and analyzing encounter data and conducting annual satisfaction surveys. They contend that access and quality were never optimal under a fee-for-service delivery system in which choice was guaranteed but not necessarily available and high emergency room use was an underlying symptom of access problems. Finally, states generally see employment as a proxy for health and evidence for distinguishing between the newly eligible working poor and the more vulnerable beneficiaries typically enrolled in Medicaid. The “mainstreaming” of new eligibles—that is, the attempt to treat them as if they were purchasers of private insurance—is perhaps the hallmark of most state 1115 demonstrations. For the newly insured, states have attempted to break Medicaid’s psychological link with welfare by establishing eligibility criteria and enrollment mechanisms distinct from those that apply to traditional beneficiaries, many of whom qualify for Medicaid by virtue of receiving cash assistance. For example, most waivers eliminate the asset test, often criticized as intrusive and expensive to administer, and rely instead on a gross income test. Moreover, rather than the frequent redeterminations of eligibility associated with Medicaid, many newly eligible individuals are enrolled for periods ranging from 6 to 12 months. In some states, enrollment of new eligibles is not handled by the agency that administers Medicaid. In fact, Florida plans to hand this task over to insurance agents—further underscoring the similarity to a private insurance product. In general, application forms are simpler and in some states can even be mailed. Newly eligible individuals usually receive the full acute care benefit package available to traditional Medicaid recipients. Only in the case of Florida is the benefit package more restrictive. Finally, many states require individuals with incomes above the poverty level to contribute toward the cost of health care coverage by charging premiums, co-payments, and deductibles. For the traditional Medicaid population, the major change associated with 1115 waivers is the wholesale movement from fee-for-service to some type of managed care—even in rural areas and, often, even for those who are aged, blind, or disabled. For some, such as low-income families in Oregon and Minnesota who were already enrolled in mandatory managed care programs, the change may be imperceptible. Under most 1115 waivers, eligibility requirements are unchanged and benefits remain the same or are more generous. For example, Tennessee lifted service restrictions on its Medicaid benefit package. Only Oregon altered benefits to help finance coverage expansion. The redefined package, commonly known as the “prioritized list,” eliminates some costly health services while adding a broad array of preventive care. A notable feature of the growing number of 1115 waivers is their divergent techniques for using Medicaid as a springboard to achieve some degree of reform in state health care systems. Numerous states that have submitted waiver applications are recognized leaders representing diverse approaches to health care reform. Though many waivers were conceived when national reform appeared imminent, the recent retrenchment from broader reform goals suggests that Medicaid waivers have become a more important component of state health care reform. Appendix IV compares several states across a range of indices that are relevant to understanding the diversity evident in waiver designs. The 1115 waiver is health care reform in Tennessee. The state’s emphasis on managed care promises to increase penetration by that delivery system in a region long resistant to such a change while at the same time significantly reducing the number of uninsured. The success of this policy hinges on the adoption of a stringent cost-containment strategy with regard to health care financed through the waiver. In contrast to Tennessee’s nascent reform program, Florida’s as yet unimplemented waiver represents a logical progression from earlier small market reforms intended to provide access to affordable insurance for the working poor. The state hopes to use its waiver to achieve a dramatic enrollment expansion in the state’s voluntary, small business-oriented purchasing cooperatives and a significant reduction in its estimated 24-percent uninsured rate. Florida stands alone in the extent to which it distinguishes between traditional and newly eligible Medicaid recipients. While the former are required to choose between different forms of managed care, newly eligible recipients may select any health plan offered by state-supported purchasing cooperatives with the sole proviso that the enrollee is responsible for any difference between the subsidy and the plan premium. Florida’s 1992 health reform legislation established a goal of universal coverage, and the legislature promised to revisit the choice of a voluntary over a mandatory approach unless there was a significant reduction in the number of uninsured. In Minnesota, Oregon, and Hawaii, the waiver is only one element of a much more ambitious reform agenda—an agenda that some state officials believe has been brought into question since the 1994 health care debate. All three states have universal coverage as a goal. Hawaii already has a limited exemption from the requirements of the Employee Retirement Income Security Act of 1974 (ERISA) that allows it to require employers to offer health insurance to their workers. Oregon’s Medicaid waiver is also built around an ERISA exemption to permit enactment of an employer mandate. Obtaining that exemption is now considered unlikely. In contrast, Minnesota had been attempting to finance universal coverage with an individual mandate, though state officials told us that this approach is no longer considered a possibility. Both Hawaii and Minnesota have relatively small uninsured populations and, prior to the 1115 Medicaid waiver, had already taken steps to address this problem through the establishment of state-funded coverage expansions. All three states have significant managed care penetration. Moreover, Oregon and Minnesota have a decade of experience with Medicaid managed care. An important element of the administration’s commitment to streamline and expedite the review of 1115 waivers was the promise to maintain the principle of waiver budget neutrality “more flexibly than has been the case in the past.” Despite this commitment, a number of factors have contributed to a lengthening of the process, including extensive negotiations over financing. In fact, both administration and state officials told us that budget neutrality is often the most contentious issue. Though a policy of budget neutrality has been in effect since the early 1980s, previous 1115 Medicaid demonstrations were usually small-scale experiments targeted at specific populations (for example, pregnant drug-users on Medicaid) or implemented in a limited geographic area. As a result, the potential impact on state and federal expenditures was more circumscribed and the task of devising a cap to ensure cost neutrality was less challenging. Oregon’s 1991 waiver application was the first of a new breed of “comprehensive” 1115 demonstrations—complex proposals that were sometimes controversial and often tied to broader health reform agendas. HCFA officials told us that the number, scope, and complexity of such comprehensive demonstrations in effect elevated the importance of budget neutrality while making it more difficult to evaluate and enforce. In a memo preceding promulgation of a more flexible approach to budget neutrality, HHS officials recognized the incentive for states to shift costs to the federal government and the need to constrain such behavior. Nonetheless, they outlined several arguments for a less strict approach. For example, they pointed out that the federal government might want to (1) share in the risks and costs of testing innovations that were ultimately in its own interest; (2) set the stage for health reform by supporting changes that should not wait even if they are somewhat more costly; and, finally, (3) provide some fiscal relief to states overburdened by the rising number of uninsured, increasing charity care requirements, and federally mandated expansions. Most importantly, the memo recognized that whatever policy was adopted needed to be clear and consistently applied. There are two key aspects to the administration’s revised budget neutrality policy. First, states are allowed to demonstrate budget neutrality over the life of the waiver rather than on a yearly basis, allowing more time to recoup any associated start-up costs. Second, recognizing the difficulty in estimating the costs of continuing the prewaiver program over the period of the demonstration and the inherent element of judgment in undertaking such an estimate, the administration announced that it was open to state suggestions on the development of a new baseline methodology. According to HHS and Office of Management and Budget (OMB) officials who share responsibility for implementing this revised policy, there are three critical steps in determining baseline costs: (1) selecting a base year, (2) developing a trend factor for growth from the base year to the first year of implementation, and (3) developing a trend factor for baseline costs over the period of the waiver. The method used to develop baseline costs is important because it is the benchmark against which the administration assesses waiver costs. The higher the baseline, the easier it is for a state to demonstrate cost neutrality. The final waiver agreement consists of a set of terms and conditions that, among other things, spells out how budget neutrality will be monitored and enforced. Although there are important state-specific variations, the administration has taken two basic approaches to enforcement. Tennessee and Florida have an aggregate cap on the amount of federal matching funds available for their demonstrations, while all other states have a per capita limit. The federal government will not match state expenditures above the specified caps. Table 1.3 highlights the important differences in what the expenditure caps cover and how they work in the four states whose budget neutrality agreements we assessed. Aggregate caps are the most straightforward and uniform of the two approaches. In Tennessee and Florida, the federal government agreed to an explicit expenditure limit on demonstration costs. With the exception of certain recipient growth in Florida, the federal government will not match any costs above this cap. For states that use the per capita approach, the federal government agreed to a cost-per-recipient limit. For Hawaii, this cost limit is based on per capita fee-for-service costs from 1993 trended forward to the first year of the demonstration. If, as the state anticipates, the switch to managed care produces savings over fee-for-service rates, they can be applied to the costs of those newly eligible. In Oregon, the agreement specifies per capita cost limits for both traditional and newly eligible enrollees. However, the number of new eligibles is limited to an agreed-upon percentage of traditional Medicaid enrollment. With the exception of Tennessee, no state is held at risk for growth in the Medicaid population caused by an economic downturn. Florida has an escape valve from its aggregate cap if growth in the Medicaid population exceeds projections by 3 percent or more. We reviewed the financing arrangements for approved 1115 Medicaid demonstration waivers in several states, with a focus on (1) the relationship between the waiver and other state health reform initiatives, (2) the planned sources of funding available to finance expanded coverage, (3) the potential net impact of these waivers on federal Medicaid expenditures, and (4) the actual waiver expenditures of states with the most implementation experience. Although our study focused on 1115 waivers in Tennessee, Florida, Oregon, and Hawaii, we closely monitored other pending waivers, which we use as examples throughout this report. For a detailed description of our methodology, see appendix I. Our review was conducted from August 1994 through August 1995 in accordance with generally accepted government auditing standards. Although the administration has adopted a more flexible approach toward budget neutrality, it contends that all approved comprehensive 1115 demonstrations are in fact budget neutral. Before addressing this issue in the next chapter, this chapter describes and categorizes waiver funding strategies—strategies that states say will result in coverage expansion without increasing expenditures beyond what their smaller, prewaiver Medicaid programs would have cost. In fact, compared to the cost of continuing the existing Medicaid program, many states project that the demonstrations could actually save money. State officials estimate that the four 1115 demonstrations whose financing we examined in detail could add up to 2 million previously uninsured individuals while yielding savings of about $6 billion over 5 years. States rely on a similar mix of funding sources that, analytically, can be grouped into two major categories: (1) Medicaid resources redirected from existing programs, such as the Disproportionate Share Hospital Program (DSH), and (2) expected savings, primarily from different forms of managed care delivery. In addition, many states collect user fees—the premiums charged to new program enrollees. Finally, in a few cases, state funds used to subsidize insurance programs for low-income residents are being folded into the waiver. Based on a review of waiver applications and discussions with HCFA and state officials, table 2.2 (1) summarizes the planned funding sources for expanded coverage in four states over the 5-year terms of the demonstrations and (2) highlights the relative importance of the various categories of funding. Comparing the major funding sources across states can be tricky. For example, Hawaii’s waiver application never quantified expected managed care Tennessee’s waiver application identified premiums but not DSH as a Florida quantified its funding sources but omitted premiums because they will be used to offset state costs. Despite these obstacles, a few generalizations can be made about the magnitude and relative importance of core, coverage expansion funding. The conventional wisdom that 1115 expansions are financed largely by managed care savings is misleading. In at least two states with approved waivers, funds redirected from DSH and other programs play a more significant role. On the other hand, states with relatively small DSH allotments rely to a greater extent on managed care or other forms of savings. Finally, premiums are a less important and more uncertain source of funding. Based on a review of waiver applications and discussions with HCFA and state officials, DSH and other redirected funds in Tennessee’s and Hawaii’s demonstrations appear to be a more important coverage expansion financing source than either expected managed care savings or any capitation discount obtained from managed care organizations. As shown in table 2.3, both states had relatively large DSH programs at the time their waivers were approved. The theory behind eliminating or greatly reducing DSH payments to hospitals is that fewer uninsured will translate into less uncompensated care. Compared to other financing sources, DSH appears to be the most tangible and assured source of financing. Tennessee’s waiver also proposes to redirect funds from two additional sources—public health programs and DSH-like payments, referred to as local government charity care. As with DSH, state officials believe that routine access to health care by those currently uninsured should decrease the funding needed for programs such as those for communicable disease control and maternal and child health. Florida’s 1115 waiver caps enrollment at about 1.1 million previously uninsured individuals—less than half of the state’s uninsured population. Since hospitals would continue to face significant levels of uncompensated care, the state was reluctant to redirect all of its DSH funds. Consequently, Florida’s finance plan only shifts growth in its DSH resources toward coverage expansion. Because of the relative modesty of its DSH payments, Florida was forced to search for an alternative funding source. The state decided to eliminate Medically Needy Program coverage and to reallocate those funds to help subsidize the purchase of private health insurance. A state is not required to offer a Medically Needy Program under Medicaid. Because the Medically Needy Program pays for health services only after individuals have already incurred large liabilities, Florida considers the program to be similar to DSH. That is, it reimburses hospitals for bills that otherwise might go unpaid. Together with DSH, redirected funds are only about one-third of the financing identified in Florida’s waiver. States with relatively smaller DSH allotments like Oregon and Florida rely to a much greater extent than Tennessee and Hawaii on program savings to finance coverage expansion. Those expected savings, however, represent more than just the transition to managed care. Though all 1115 waivers anticipate managed care savings, there appears to be little unanimity on how quickly savings can be achieved or on what type of managed care delivery system is the most efficient. Without substantial DSH funding, Oregon’s expansion goals, as outlined in the waiver, rely almost exclusively on program savings. In addition to managed care efficiencies, the state also anticipates lower Medicaid costs under the waiver as a result of adopting its redefined benefit package, known as the prioritized list, and an employer mandate. The mandate would reduce state costs by requiring employers to provide health insurance coverage to low-income workers initially covered under the waiver. State estimates suggest that about 85 percent of the financing for expanded coverage is attributable to the combination of switching to managed care delivery arrangements and using the prioritized list. Although the state attributes a specific amount of savings to the list, its officials told us that, in fact, it is difficult to distinguish such savings from managed care efficiencies. About two-thirds of Florida’s financing also relies on program savings. However, almost half of those savings would result from proposed reimbursement reforms. Unlike Medicaid physician fees, other medical services in Florida have had a built-in inflation adjustment. Under the reimbursement reforms, price increases for services rendered by HMOs, pharmacies, and clinics, and on an outpatient basis at hospitals, will be lowered by limiting them to increases in the Consumer Price Index plus a declining number of percentage points with each subsequent year. Despite the common thread of reliance on anticipated managed care savings as a funding strategy, state definitions of just what constitutes managed care and their approaches toward achieving those savings differ. Thus, Tennessee uses a reimbursement strategy in the form of a capitation discount to achieve immediate savings. In contrast, Oregon offers relatively generous capitation payments but expects control over utilization of services to reduce the rate of future cost increases. These differing strategies reflect each state’s decision on how best to balance the need for savings against (1) the extent and maturity of the state’s managed care infrastructure and (2) concerns about enrollee access, quality, and choice. Demonstrations typically rely on a mix of different types of managed care delivery, though one is often predominant: HMO-style systems in Oregon, PPOs in Tennessee, and physician gatekeeper arrangements in Florida. Table 2.4 shows the actual enrollment of beneficiaries in Tennessee and Oregon, and Florida’s projection of enrollment if the state implements its approved waiver. The high penetration of HMOs in Oregon, with enrollment of almost one-third of the state’s population, facilitated the state’s decision to rely on this type of managed care delivery system. In Tennessee and Florida, enrollment in HMOs is significantly lower—6 percent and 18 percent of each state’s residents, respectively. HMOs and PPOs participating in the 1115 demonstration in all three states are reimbursed on a per capita basis, referred to as a capitation payment. Physician gatekeepers, on the other hand, are often paid on a fee-for-service basis, though some are partially capitated. What differentiates managed care from fee-for-service is not only the method of reimbursement but the attempt to control the utilization of services. Although gatekeepers in Florida would be paid for each service delivered, enrollees must get prior authorization to see a specialist. PPOs in Tennessee, on the other hand, have 3 years to employ physician gatekeepers to help control the length of inpatient hospital stays and the utilization of other services. Tennessee’s approach to managed care reflects the strategy used by large employers. The state asked for and received a substantial capitation discount from participating HMOs and PPOs. Tennessee acknowledges that its shift from fee-for-service to capitation is unlikely to result in significant utilization savings at the outset, since most traditional and newly eligible recipients are enrolled in PPOs that lack gatekeepers rather than in more structured HMO-style managed care arrangements. Despite the belief that utilization savings will be lower during this initial phase-in period, substantial capitation discount savings still accrue to the state. Tennessee officials noted that PPOs in turn often obtain significant pricing discounts from their providers. Our recent report on the Tennessee demonstration notes that a primary concern about the future of the demonstration is the poor financial performance of participating managed care plans and the willingness of physicians to contract with those plans. The demonstration’s viability, we concluded, may hinge on the continued willingness of the health care community to participate in the program in spite of the low reimbursement levels. Although analysis of access to and quality of health care under the waiver has been limited because of problems in collecting data on enrollee visits to providers, beneficiary surveys and advocacy groups both indicate that access is a problem. In contrast to Tennessee’s steep, up-front, capitation discounts, Oregon took a longer range approach that emphasizes access and quality. Concerned about the adverse impact of its already low Medicaid fee-for-service rates on the delivery of services, Oregon’s initial capitation rates represent an increase over comparable fee-for-service rates prior to the 1115 demonstration. According to state officials, this increase contributed to the decision of a large number of HMOs to participate in the demonstration. As a result, about 91 percent of the recipients covered under Oregon’s 1115 waiver are enrolled in some type of fully capitated HMO—over three times more than the state’s original estimate. Oregon assumes that more highly structured managed care will better control the utilization of services and that over time health care costs will rise at a slower rate than under the old fee-for-service reimbursement system. Finally, there appears to be a wide spectrum of opinion among 1115 waiver states about the extent of savings from alternative managed care structures. Florida assumes that a physician gatekeeper arrangement, which preserves recipient choice, will produce the greatest managed care savings and anticipates that the majority of its Medicaid population will select this option. Only one-third of the state’s Medicaid population is expected to enroll in fully capitated HMOs, the system that Oregon considers to be the most cost-effective form of managed care delivery. The gradual erosion of savings in Kentucky, which employs physician gatekeepers under a 1915(b) waiver, suggests that state enforcement and oversight of such managed care arrangements are critical. According to state officials, emergency room use has risen again after an initial decline. Kentucky’s 1115 waiver application envisioned an eventual transition to more highly structured forms of managed care. Although the waiver proposals we reviewed rely primarily on redirected funds and expected program savings to finance coverage expansions, many state financing strategies incorporate new money raised by charging premiums to certain enrollees. Such premiums appear to make a modest contribution toward overall financing, ranging from a high of about 15 percent to as little as 1 percent of the core funding strategies we discussed. Moreover, at least one state’s application recognized that not all premiums are likely to be collected. The 1115 waivers in Tennessee, Florida, and Hawaii require most recipients with incomes above the poverty level to pay premiums on a sliding scale. In addition, Florida expects a minimal premium contribution from individuals below the poverty level if they have any income. Expected premiums in Tennessee are about 8 percent of the combined total of redirected funds and the capitation discount. In Florida, premiums account for about 15 percent of the funds the state says it needs to provide insurance to a target group of about 1.1 million. Officials in Hawaii told us that premiums expected from newly eligible beneficiaries represent only about 1 percent of coverage expansion funding. Under the approved waiver agreements, a substantial portion of the premiums collected in Tennessee and Florida can be counted as state match, with no reduction in federal expenditures. In Hawaii, the state and federal governments share equally in the cost offset represented by individual premiums. Table 2.5 provides hypothetical examples of the different types of arrangements used to allocate premiums. Hawaii and Minnesota are folding existing state subsidized insurance programs for low-income residents into their waiver programs and, in the process, bringing along the state dollars that financed them. These program dollars now qualify for federal match. While some individuals in these state-sponsored expansions were eligible for Medicaid under optional programs for pregnant women and children authorized in the late 1980s, others were not. Previously, states chose to expand coverage outside of Medicaid for a number of reasons. First, men, single adults, and childless couples were generally ineligible for Medicaid unless they were elderly or disabled. Second, such programs made it easier for states to provide coverage to entire families. Third, freed from Medicaid rules, states were able to offer more modest benefits and to require participants to pay premiums, co-payments, and deductibles. At least one state, Minnesota, cited another rationale for its self-funded program, MinnesotaCare. State consultants concluded that the lack of an employer mandate would result in the migration of children from private insurance to Medicaid. Eligibility rules in MinnesotaCare were designed to prevent such a migration. Thus, MinnesotaCare enrollees must have been uninsured for the 4 months immediately preceding enrollment and may not have had access to employer-subsidized health insurance for the previous 18 months. HCFA allowed Minnesota to maintain these barriers in its approved 1115 waiver. Contrary to the administration’s assertion that approved Medicaid 1115 waivers are budget neutral, net federal spending in the four states we examined could potentially exceed projected without-waiver program costs over the 5-year duration of the demonstrations. The net additional federal funding available in these four states is small in relation to allowable demonstration spending. However, overall federal Medicaid expenditures could grow significantly if the administration shows a similar flexibility in reviewing the large backlog of pending waivers. Administration officials told us that, since some states’ Medicaid expenditures were growing faster than the national average in the past, the budget neutrality of each proposed waiver should be evaluated independently in order to capture these variations. Such an approach is difficult because of the lack of consistently generated, state-specific forecasts. Lacking such data, we relied on the only available forecasts—national projections of how the current Medicaid program would grow over the 5-year duration of waiver programs. At the same time, we reviewed waiver applications and talked with state officials to identify factors suggesting whether a state’s Medicaid expenditures would indeed exceed the national norm. We found no evidence to support the high budget caps agreed to by the administration. Medicaid 1115 waiver programs are popular because they allow the administration to grant states significant program flexibility. Since the 1980s, OMB has used its budget neutrality policy to ensure that states were not given access to additional federal funding at the same time they were provided with greater program flexibility. Rather than applying a uniform methodology to measure the budget neutrality of waiver applications approved since 1993, the administration has allowed considerable variation in growth of baseline costs from state to state. According to the administration, each of the waiver programs is budget neutral, even though the individual growth rates vary significantly. The results of the administration’s flexible, state-specific approach are shown in table 3.1, which summarizes the rates of increase allowed in the four agreements—Florida, Tennessee, Oregon, and Hawaii. Also included in the table are the administration’s projected rates of growth for Medicaid on a nationwide, current services basis over roughly the same time period. Table 3.1 shows that in three out of four states, the waiver agreements permit growth above what OMB projected for the Medicaid program as a whole at the time the waivers were approved. The growth patterns among states also vary. The growth rates of Tennessee, Florida, and Hawaii are the highest in the first year of their waiver. While Florida’s growth rate declines gradually in each subsequent year, both Tennessee’s and Hawaii’s drop dramatically in the second year and then decline more slowly in the remaining years of their demonstrations. In Oregon, however, the highest rate of growth is in the second and third years, with dramatically lower increases in the last two. Given the unique state setting of each Medicaid program, some variation in the rate of Medicaid growth among states is to be expected. However, even though OMB was predicting overall lower growth in Medicaid, state waiver applications did not identify future trends to justify their higher-than-average growth rates over the course of the demonstrations. Instead, states used a variety of arguments primarily based on history and options available under current statute to convince the administration that their particular situation warranted a high rate of growth. HCFA and state officials admit that, in some states, continued Medicaid growth at historical rates is unsustainable because of the great strain it places on state budgets. Moreover, several of the primary contributors to the growth of state Medicaid budgets over the past 5 years are no longer present. For example, some states’ use of targeted provider taxes and donations contributed to the rapid rise in DSH funding between 1989 and 1993, but recent legislation strictly limits—and in some cases caps—such growth. It also appears unlikely that states will be asked to absorb major new federally mandated expansions of populations and benefits—a practice that contributed to high growth rates in the past. As shown in figure 3.1, the assumption that higher historical rates of Medicaid growth will continue runs contrary to the administration’s own projections of nationwide Medicaid growth on a current services basis. Each successive projection since 1993 shows a decline in the rate of growth in Medicaid. In addition to pointing to the history of recent rapid growth in Medicaid expenditures, states used the so-called “hypotheticals” argument to justify higher baselines. They argued that groups who were hypothetically eligible for Medicaid coverage under existing law, but had not been included in a state’s Medicaid plan, should be considered part of the state’s baseline population for the purpose of determining budget neutrality. Including hypotheticals raises baseline costs, making budget neutrality easier to achieve. The Hawaii, Kentucky, Minnesota, Rhode Island, and Ohio waiver agreements allow hypothetical populations to be included in the baselines. To date, the inclusion of hypotheticals has been limited to those individuals who would actually be covered by the demonstration and who are optionally eligible for Medicaid under section 1902(r)(2) of the Social Security Act. Hawaii and Minnesota have covered some of this population outside the Medicaid program in the past through state-only funded programs. A Hawaii Medicaid official estimated that including the 1902(r)(2) population added approximately $56 million to the state’s waiver baseline over the 5-year life of the program—about 4 percent of total waiver agreement funding. In Kentucky, Rhode Island, and Ohio, however, hypotheticals were not covered by any state-funded program. In each waiver we reviewed that included hypotheticals in the baseline, state officials mentioned cost containment as a primary consideration in seeking 1115 demonstration authority. It is questionable, therefore, that these states would have added optional eligibility groups to their Medicaid programs without the waiver. The complexity of and variation in individual state programs makes it difficult to assess budget neutrality without a consistent frame of reference. Lacking state-specific Medicaid expenditure forecasts, we used OMB’s current services projections of growth in Medicaid for the nation as a whole. A current services projection is policy neutral and only reflects medical inflation, normal growth in the eligible population, and changes in utilization for the entire Medicaid program. To determine if the four approved waivers were budget neutral, we first estimated the cost of continuing the traditional Medicaid program—absent the demonstration—in each state. This estimate—referred to as “without-waiver spending”—was developed by adjusting for inflation in the following manner: We adjusted the cost of providing Medicaid in the year prior to waiver implementation at the rate specified by OMB in its forecast of future Medicaid current services outlays. We compared this without-waiver spending estimate to total projected costs under the waiver expenditure caps negotiated by each state and the administration. The difference between our without-waiver projection and the waiver expenditure cap in each state is the basis for our conclusion of whether an agreement is budget neutral. When the difference was positive, we examined state-specific information to determine if there was any identifiable reason why the waiver expenditure cap should exceed our without-waiver spending projection and still be regarded as budget neutral. We applied this methodology to the two types of waiver spending caps agreed to by the administration, aggregate and per capita expenditure limits. For states that use the aggregate cap—Tennessee and Florida—the waiver funding limits are specified in the terms and conditions approving the demonstration. For states with per capita limits—Hawaii and Oregon—the spending cap depends on the actual number of enrollees in the waiver program. To assess the potential budget neutrality of these per capita agreements, we used enrollment projections developed by each state and submitted to HCFA in conjunction with approval of the waiver. If actual enrollment proves to be higher than these initial projections, then the waiver agreement funding limit will generally be higher and the state will have access to more funds than we projected. Conversely, if enrollment falls below these projections, fewer additional resources would be available. For the Tennessee demonstration, the administration specified an aggregate federal funding cap, with any spending above that cap ineligible for federal match. The relatively low rates of growth under this spending limit mimic the growth caps used in the President’s 1993 health care reform proposal. The waiver agreement expenditure cap covers all aspects of Tennessee’s Medicaid program, whether or not the associated populations are being moved into managed care. Figure 3.2 shows a comparison of Tennessee’s waiver agreement spending cap and our without-waiver projection of spending. Our without-waiver estimate was derived by increasing actual expenditures in the year prior to implementation of the demonstration at the national current services growth rate projected by OMB. When compared with our without-waiver spending projection, Tennessee’s waiver expenditure cap is budget neutral. Savings in subsequent years make up for initial demonstration costs that exceed projected without-waiver spending. While the Tennessee waiver agreement is budget neutral using the current services methodology, the administration’s treatment of DSH funds raises another issue. After the first year of the waiver, DSH funding disappears as a budget item since it is built into the baseline that increases at the agreed-to rates of growth on overall Medicaid spending. However, DSH funding in Tennessee and a number of other states is capped by law because it is more than 12 percent of the state’s total Medicaid expenditures. In such states, DSH funding is only permitted to grow when it falls below this 12-percent cap. Under the waiver agreement, Tennessee’s DSH funding is allowed to grow after the first year of the waiver, even though it exceeds the 12-percent limit. Consequently, Tennessee is eligible for approximately $250 million in DSH growth that would not have been allowed without the waiver. Without this additional DSH funding, net savings to the state and the federal government under the Tennessee waiver agreement would have been higher. Since the Tennessee agreement, the administration has separated DSH funding from other aspects of waiver program funding. This approach allows the cap on DSH growth to be enforced. Moreover, HCFA officials told us that if DSH funding is growing at a slower rate than the other program elements covered by the waiver, then that lower growth rate is applied to any DSH growth. As in Tennessee, the Florida waiver agreement has an aggregate cap on demonstration expenditures. The cap only applies to the acute care and DSH portions of the state’s Medicaid program. Florida relied heavily on an historical argument to justify its higher-than-average rates of growth under the waiver, even though some state officials later told us that it was unlikely that such growth could be sustained. Figure 3.3 compares estimated waiver agreement spending and spending without the waiver. Our without-waiver estimate was derived by increasing actual expenditures in the year prior to implementation of the demonstration at the national current services growth rate projected by OMB. The comparison shows that the waiver spending cap exceeds our without-waiver estimate, with the difference equaling $4.5 billion in state and federal funding. We also analyzed the extent to which Florida’s coverage expansion goals depend on this $4.5 billion in excess funding. Our analysis shows that Florida’s enrollment plans would have to be scaled back without the excess funds provided under the waiver agreement. If the funding limits for Florida’s waiver agreement had been based on national projections of growth in the Medicaid program, both DSH and the state’s Medically Needy Program would have grown at slower rates. As a result, almost $1 billion less than the amount needed to meet the state’s expansion goals would have been available. As shown in table 3.2, the $4.5 billion in excess funding potentially available under the waiver more than covers that shortfall. We believe that the difference between the excess funds available and the shortfall—about $3.5 billion—provides a backup if state assumptions about managed care savings or other funding sources prove faulty. It is more difficult to apply our methodology to states with per capita waiver agreements, like Oregon. As implied by the term “per capita,” estimating both the waiver agreement spending cap and without-waiver expenditures requires assumptions about enrollment. Moreover, in Oregon, the mix of benefits changed in the transition from traditional fee-for-service Medicaid to the demonstration, making it more difficult to arrive at a base-year cost. In addressing these methodological challenges, we used the projected enrollment in the waiver agreement to estimate spending, and we derived a base-year cost from state reports. We discussed our methodology with Oregon officials, who agreed that it was appropriate. Figure 3.4 compares estimated waiver agreement spending and spending without the waiver. Our without-waiver projection was derived by increasing base-year estimated expenditures at the national current services growth rate projected by OMB. The comparison shows that the Oregon waiver spending ceiling exceeds our without-waiver projection. The Hawaii waiver expenditure cap is also based on per capita costs. As with the Oregon spending limit, all the pieces needed to calculate the projected waiver costs were not included in the waiver agreement documents. HCFA and Hawaii have agreed to use 1993 as the base year to calculate budget neutrality, but have not yet agreed on per capita costs for the various eligible populations. Our analysis was further complicated by the fact that Hawaii has not yet completed its final enrollment count for the base year. To make our calculation of program costs, we used a preliminary state average per capita cost and an estimate of the base-year enrollment from waiver documents. According to state officials, these were the best figures available. Figure 3.5 compares estimated waiver agreement spending and spending without the waiver. Our without-waiver projection was derived by increasing base-year estimated expenditures at the national current services growth rate forecast by OMB. The comparison shows that the waiver expenditure cap exceeds our without-waiver spending projection. Of the four waiver agreements we analyzed, only Hawaii’s included a hypothetical population in its baseline. As illustrated by figure 3.6, our analysis shows that the inclusion of this hypothetical population—made up of children that had previously been covered by state-only funded programs and who were eligible for Medicaid under section 1902(r)(2)—did not significantly affect the cost of implementing the waiver over its 5-year life. In responding to our work on budget neutrality, the administration said that the characteristics of individual states—primarily historical trends—justified waiver growth limits higher than projected national average program growth. However, none of the four waiver applications we analyzed in detail offered a rationale for the expected higher-than-average rates of growth in expenditures, enrollment, or medical inflation. OMB officials also told us that the four state Medicaid programs we analyzed in detail had been growing faster than the national average. Table 3.3 compares the national average with growth in Medicaid spending from 1988 to 1993 for Florida, Tennessee, Oregon, and Hawaii. This analysis shows that, with the exception of Florida, these states were not growing significantly faster than the national average. In fact, the trend in Medicaid expenditures in Hawaii suggests that it might be appropriate for its waiver program to grow more slowly than the national average. Federal mandates have contributed significantly to variations in state Medicaid growth rates over the last 8 years. According to a 1994 Urban Institute study, states with historically more restrictive Medicaid programs grew very rapidly during the period 1988 to 1992, with much of the growth attributable to newly eligible adults and children coming into the program under federal mandates. Such new mandates were at least partially responsible for escalating costs in Florida, a state whose Medicaid growth rate from 1988 to 1993 was significantly higher than the national average. Thus, previously ineligible adults, children, elderly, and disabled individuals accounted for more than 30 percent of the increase in Medicaid spending between 1989 and 1990. According to state officials, the establishment of an optional Medically Needy Program—which totaled $98 million by 1993—also contributed to state expenditure growth. More significantly, it had the unintended consequence of helping to greatly expand enrollment of low-income families. Florida officials explained that an outreach program designed to increase participation in the Medically Needy Program uncovered many low-income families eligible for Medicaid. Enrollment of low-income families rose nearly 24 percent per year from 1990 to 1993, with associated expenditures more than doubling from just under $500 million to nearly $1.2 billion. Finally, state officials told us that the recession in 1991 also contributed to growth in the number of low-income families enrolled in Medicaid. Although these factors contributed to the sharp rise in Florida’s Medicaid expenditures in the early 1990s and resulted in waiver growth rates significantly higher than the national average, even Florida officials do not expect a continuation of past trends. Actual experience appears to support their predictions. For example, while the waiver agreement estimated that acute care expenditures would grow at 17 percent in 1994, the base year, actual spending increased by only 12 percent without implementation of the waiver. Moreover, Florida officials told us that enrollment growth among low-income families has leveled off at around 4 or 5 percent over the past 18 months. The Florida waiver agreement estimates that low-income family enrollment growth will fluctuate between 2 and 3 percent over the life of the waiver. While the administration contends that each of the waiver agreements we reviewed is budget neutral, our analysis of both national and state-specific data shows that most of the agreed-upon rates of growth are too high. As a result, the agreements provide these states with access to significant additional federal Medicaid funding. Table 3.4 compares the waiver agreement spending caps and our without-waiver expenditure projections (based on national Medicaid growth rates), aggregated over the 5-year duration of the programs. The $1.9 billion in net additional federal funds should not be interpreted as a precise prediction of the amount of additional funds available under these four waivers; rather, it reflects the significant magnitude of the differences between the two projections. We analyzed preliminary financial results from 1115 demonstrations in Tennessee, Oregon, and Hawaii—three states with significant waiver implementation experience. The data suggest that waivers will continue to evolve as states attempt to balance coverage expansion goals against systemic cost-containment pressures. Changing political/fiscal realities in all three states and the potential for an acceleration in the rate of medical inflation underscore the challenges in implementing fixed-cost agreements in a variable-cost environment. Enrollment of previously uninsured individuals in both Oregon and Hawaii surpassed state estimates. Oregon was able to meet greater than expected demand without exceeding its waiver agreement expenditure cap. Hawaii, however, projects demonstration spending will be about 23 percent higher than permitted by its waiver agreement—costs it will have to offset in future years if it is to live within the expenditure cap. After maintaining open enrollment for a full year and achieving about 80 percent of its coverage expansion goal, Tennessee abruptly cut off enrollment because of a budget crisis it attributes to the demonstration. In contrast to Hawaii, Tennessee’s first-year demonstration costs were 14 percent below its waiver agreement spending cap. While Tennessee’s waiver program covered several hundred thousand previously uninsured individuals, total expenditures were on a par with its significantly smaller prewaiver program. Despite the slowdown in medical inflation, all three states face pressures to contain future waiver costs. Oregon and Hawaii have announced a number of initiatives to do so, including higher cost sharing and new eligibility rules. Since resources up to a state’s waiver funding cap are available until the end of the demonstration, expenditures to date may not be a reliable indication of demonstration costs—particularly if medical inflation accelerates. Greater than anticipated managed care savings allowed Oregon to offer insurance to about 50 percent more new enrollees than anticipated during 1994—without breaching the waiver funding agreement. Though the exact amount of the cap is in dispute, HCFA data show that waiver expenditures of $347 million were about $34 million less than the administration’s estimate of the waiver agreement ceiling. As shown in table 4.1, actual 1994 expenditures were remarkably close to the 1993 cost estimates that formed the basis of the federal-state financing agreement—within about $600,000. However, as this table also demonstrates, traditional Medicaid beneficiaries were less expensive than the state estimated. Table 4.2 provides our analysis of costs for traditional Medicaid beneficiaries and those newly eligible under the waiver on a per-person-per-month (PPPM) basis. On average, traditional eligibles cost 25 percent less than anticipated. Those newly eligible, however, cost 36 percent more. Oregon officials attribute the higher costs of new eligibles, in part, to the fact that many are sick when they apply for coverage. Thus, hospitals are signing up individuals for health benefits under the waiver as soon as they are admitted. Currently, eligibility for benefits commences with the submission date rather than with the subsequent approval of the application. Until the newly eligible individual is enrolled in a managed care plan, providers are reimbursed on a fee-for-service basis, further increasing state costs. Higher costs for newly eligible individuals, however, were offset by additional managed care savings of $38 PPPM for each traditional Medicaid recipient. In part, state officials credit increased savings to the fact that all but 8 of 36 counties are served by fully capitated, HMO-style health plans. As a result, about 91 percent of waiver enrollees, rather than the estimated 28 percent, are receiving services from what the state believes is the most cost-effective form of managed care. We also believe that the current ebb in medical inflation contributed to lower than expected costs. Despite greater-than-expected managed care savings in Oregon, state officials are concerned about the financial implications of current cost/enrollment trends. The concern stems from the fact that the traditional Medicaid population determines the funding base for covering new eligibles. Under the per capita cost agreement, federal matching funds for new eligibles are tied to a fixed ratio of new to current eligibles. Thus, for every four current eligibles, Oregon can claim a federal match for one new eligible in the first year of the waiver. In the first year, unexpected enrollment by new eligibles and higher-than-anticipated costs for this group was accompanied by a drop in the number of low-income families—the major component of the coverage expansion funding base. Should these trends continue, fewer federal dollars than needed would be available to meet future waiver costs. In mid-1995, Oregon officials asked HCFA for approval to implement a number of cost-reduction initiatives. As of October 1995, Oregon had received approval to change waiver eligibility rules and delay full implementation of mental health services. HCFA has yet to approve the state’s request to reduce benefits and require premiums/some co-payments for newly eligible individuals. In addition, state officials told us that greater-than-anticipated managed care efficiencies may allow them to reduce the capitation rate. Other, more general, fiscal concerns in Oregon stem from the impact of a 1991 tax initiative, new state priorities that reflect the outcome of the 1994 elections, and uncertainty about the fate of the employer mandate. Under the tax initiative, any shortfall in education funding that results from a mandated reduction in the property tax rate must be offset by general revenues. Funding for the 1115 waiver also comes from general revenues—rather than from a dedicated tax paid by a specific group. Similarly, a number of new priorities, such as prison construction, may further increase the competition for state funds. The employer mandate plays an important role in Oregon’s waiver finance plan. Oregon estimates that the mandate, originally scheduled to be phased in during the last 2 years of the waiver, would reduce both the number of traditional Medicaid beneficiaries and newly eligible individuals covered under the waiver. In addition, program costs will be reduced for low-wage workers who obtain employer-provided coverage but have incomes below the poverty level. For these individuals, Medicaid will only pay for costs not covered by the employer-provided insurance. Growing business opposition to the mandate coupled with a political realignment in the state legislature creates considerable uncertainty about the future of this funding source. In 1993, the legislature postponed implementation of the mandate, potentially increasing state costs in the process. Although state legislation requires that the mandate be repealed unless the Congress grants Oregon an exemption to ERISA by January 1996, the legislature recently sent the Governor a bill that would have repealed the mandate outright. He vetoed the bill in July 1995. According to state officials, the administration has indicated that no adjustments will be made to the waiver financing agreement if the employer mandate is not implemented. And without the mandate, waiver costs will increase, forcing the state to make up the difference or to develop additional cost-containment strategies. In 1994, Oregon estimated that the employer mandate accounted for about 16 percent of the funds necessary to finance coverage expansion under the waiver. Hawaii believed that state-funded programs subsumed under the waiver had already identified most of those newly eligible—the so-called gap group that included those who were not eligible for Medicaid and those who were either dependents or part-time workers not covered by the state’s limited employer mandate. During the first year of operation, however, Hawaii enrolled about 36,000 newly eligible individuals who had not participated in the former state-funded programs. According to state officials, a significant number of these new recipients are hypothetically eligible at state option under section 1902(r)(2) —pregnant women or children—who had not enrolled in the previous state-funded program but instead were covered by private insurance; the state believes these individuals dropped private insurance in favor of less expensive coverage through the waiver. These officials also attributed the unexpected high enrollment to Hawaii’s current economic slowdown. Table 4.3 compares estimated and actual enrollment under the waiver for both traditional and new eligibles. Hawaii officials project that as a result of this higher-than-expected enrollment, the waiver will exceed the federal budget limit for 1994-95 by approximately 23 percent—$47 million. Under the waiver agreement, higher costs in one year can be offset by lower costs in another—as long as expenditures over the 5-year life of the waiver do not exceed the cap. Hawaii officials told us that the state expects waiver costs to be slightly under the cap for the full 5 years of the program as a result of state efforts to reduce program expenditures. The following changes in eligibility standards and premiums were effective on August 1, 1995: (1) the point at which enrollees will be charged the full premium will be reduced from 296 percent of the federal poverty level to 201 percent, (2) individuals eligible for coverage under the employer mandate but who meet demonstration income requirements will be disenrolled, (3) self-employed individuals will be required to pay a minimum of 50 percent of the premium—regardless of their stated income, and (4) parental income will be taken into consideration when determining the eligibility of students under age 21. The state suspects that these last two groups either understate income or do not appropriately account for parental income. Officials in Hawaii told us that premium collections are keeping pace with expectations. During its first year of waiver implementation, Tennessee enrolled about 418,000 previously uninsured or uninsurable individuals. Although its waiver application proposed an open enrollment period once a year, the state actually accepted and processed enrollment requests throughout 1994. Moreover, Tennessee liberalized a restriction that had disqualified participation by individuals with access to insurance as of March 1993 by moving the effective date to July 1994. In late December 1994, however, the state unexpectedly announced an end to open enrollment for individuals not traditionally eligible for Medicaid. Enrollment—including both traditional Medicaid and new eligibles was about 39,000 less than the state’s 1994 enrollment cap of 1.3 million. Tennessee also informed HCFA that the enrollment cap for the remainder of the demonstration would be 1.3 million rather than 1.5 million beneficiaries. State officials attributed the freeze in enrollment of new eligibles to a budget crisis caused, in part, by demonstration costs. HCFA reports indicate that the state spent about $443 million (14 percent) less than allowed under the waiver agreement cap. Nonetheless, Tennessee covered several hundred thousand newly eligible individuals while increasing expenditures by less than half a percent from SFY 1993 to SFY 1994. Table 4.4 compares SFY 1993 enrollment and expenditures with those in SFY 1994, the first year in which the waiver became effective. Moreover, as shown in table 4.5, the state is now projecting lower waiver expenditures that could increase federal savings over earlier estimates. In the first 3 years alone, lower expenditures could more than double the state’s previous estimate of savings due to the waiver. Both the (1) gap between 1994 waiver expenditures and the federal cap on spending and (2) projected reduction in waiver expenditures to well below the amount permitted under the state’s 1115 financing agreement may be linked to problems in identifying state matching funds for DSH. HCFA officials told us that, from the outset, they anticipated Tennessee would have difficulty in drawing down federal funds up to the maximum allowed under the waiver agreement. They pointed out that although the Tennessee DSH program was available to provide a major source of funding for coverage expansion, the state discontinued its hospital tax with the onset of waiver implementation. This tax had been a source of state match for federal DSH funds. Undoubtedly, the shortfall in premiums collected from newly eligible enrollees and counted as part of state matching funds also contributed to Tennessee’s financing problems. Tennessee has encountered serious problems in collecting enrollee premiums. Initially, the state estimated that it would collect about $21 million in premiums during the first 6 months of the waiver as new eligibles gradually signed up for the program; premiums would increase up to $117 million in the last year when full enrollment had been achieved. However, for the first 6 months, Tennessee only collected $2.4 million, forcing it to find other sources of state matching funds. Lower-than-expected premium revenues in Tennessee are due, in part, to a series of administrative glitches. Even though enrollment of the uninsured began in January 1994, initial premium notices were not mailed until June 1994. The notice informed enrollees that premium booklets would be mailed soon for monthly payments beginning with July. Then, the state contractor failed to mail up to 80,000 premium booklets, an error that was not discovered until November 1994. In February 1995, the state sent letters to nearly 60,000 households notifying them of past due premiums totaling $31 million. Approximately 62,000 individuals—about 15 percent of new eligibles—had been disenrolled from the program as of June 1995 and upwards of 20,000 more were within the 30-day notification period for termination. Another 17,000 families were placed on payment plans to address overdue premiums. Though the three waivers discussed in this chapter were approved during a period of economic recovery and a slowdown in medical inflation, the recession of the early 1990s coupled with rapid medical price increases serve as a reminder of the risks posed by fixed-cost agreements in variable-cost environments. While states have benefited from recent economic trends, the potential for a resurgence in medical inflation, a recession, and large numbers of traditional and/or new eligibles could create problems for Tennessee, Oregon, and Hawaii. In Tennessee, the 1115 agreement provides the state with a fixed budget to serve both traditional Medicaid and newly eligible recipients. Though the state appears to have a tight lid on cost increases, it is already under pressure to raise capitation rates that most providers consider unrealistically low. A slowdown in economic growth and the associated increase in Medicaid enrollment due to rising unemployment could further exacerbate the state’s current budget crisis and provide additional ammunition to already aggrieved providers. Increased medical inflation and a recession could pose a somewhat different dilemma for Oregon and Hawaii. Under the terms of their waiver expenditure caps, these two states are not at risk for changing economic conditions that could increase the number of traditional Medicaid beneficiaries. Thus, the limit on demonstration costs floats upward with enrollment, permitting increased federal and state Medicaid expenditures. If increased state costs associated with covering more traditional beneficiaries is accompanied by an acceleration in medical price increases, however, the additional budget resources required could threaten Oregon’s and Hawaii’s coverage expansion plans. Comprehensive 1115 Medicaid demonstrations have given states flexibility to test innovative approaches for the delivery of publicly funded health care services. While the waivers were intended to give states program flexibility, it is not clear whether the administration’s decision to simultaneously provide budgetary flexibility is consistent with the current emphasis on reducing the federal budget deficit. Under the four approved waivers we analyzed, the federal government is potentially at risk for a net increase of about $2 billion in Medicaid expenditures. While Tennessee’s waiver agreement meets the test of budget neutrality, those of Florida, Oregon, and Hawaii do not. The agreements in these three states represent the antithesis of the budgetary certainty that the Congress appears to be moving toward in social program spending. We believe the granting of additional section 1115 waivers merits close scrutiny for several reasons. First, the potential budget impact of 1115 waivers may increase if the administration continues to show budgetary flexibility in its review of additional state proposals. The administration has granted a number of additional waivers since Florida’s, the most recently approved waiver whose budget neutrality agreement we examined in detail. Moreover, the number of pending waivers continues to grow and now includes New York, whose Medicaid expenditures represented about 16 percent of national program costs in fiscal year 1993. Second, given the priority attached to reducing the deficit, it may be appropriate to consider whether or at what point taxpayers should benefit from managed care savings that are currently being reinvested to expand Medicaid coverage to millions of additional individuals. Finally, though comprehensive 1115 Medicaid waivers were approved during a period of economic recovery and a slowdown in medical inflation, the recession of the early 1990s coupled with rapid medical price increases serve as a reminder of the risks posed by fixed agreements in variable-cost environments. The combination of higher medical inflation, a recession, and large numbers of traditional and newly eligible Medicaid enrollees could pose equally unattractive alternatives for both the federal government and states: (1) increasing funding or (2) reducing benefits/denying coverage to hundreds of thousands of people newly enrolled under the waivers. Consequently, we question whether demonstration waivers granted for a limited period are the best approach to reducing states’ uninsured populations. The Department of Health and Human Services and OMB disagreed with our conclusion that the waiver funding caps for Oregon, Hawaii, and Florida are not budget neutral. We continue to believe that the administration’s waiver funding caps for these states may result in increased federal spending. We do not believe that our methodology is the only appropriate method to estimate budget neutrality baselines, and agree that using a tailored, state-specific approach would be more appropriate. We did tailor our methodology to the specific services covered by the demonstrations and did reflect current DSH rules. We saw no evidence, however, that the administration itself adopted this approach. The only state-specific data evident in the negotiating record were historical trends, which were clearly not expected to continue. The acute and long-term care cost projections cited in the administration’s comments are not consistent with OMB’s published forecast of overall growth in the Medicaid program. While OMB characterized its own approach to budget neutrality as “ad hoc,” we adopted a consistent and uniform methodology that challenges the administration to support its contention that these demonstrations should grow at such high rates. To date, the administration’s own methodology remains shrouded in generalities. We believe that potential program cost increases of hundreds of millions of dollars should be based on a more clearly specified methodology. Second, contrary to the administration’s assertion, state variation in Medicaid programs and expenditures was a central component of our assessment of budget neutrality. After using OMB’s national forecasts to project without-waiver expenditure trends, we examined the waiver negotiating record and asked state officials to identify why future state Medicaid expenditures should exceed the national norm. As noted, we found no state-specific evidence to support the high budget caps agreed to by the administration. Even in the case of Florida, whose Medicaid program had been growing faster than the national average, the state’s own estimates show that key factors contributing to past growth were not expected to be sustained. OMB maintains that “it is more appropriate to use a current law rather than a current services baseline for adjudicating budget neutrality.” Yet, it points out that “the President’s budget does not differentiate between the two.” We do not question OMB’s authority to estimate the baseline, including anticipated behavioral changes in mandatory programs where such changes are allowable under current law. We do question whether in this case such an adjustment is appropriate, based on our review of state practices in these programs. The only explicit use of current law evident in the waiver approval process is OMB’s decision to include those hypothetically eligible for Medicaid under current law within their baseline. Of the four states we reviewed, OMB’s approach only affected the baseline for Hawaii, as is reflected in figure 3.6. Since no attempt was made in Hawaii’s or in other states’ waivers to suggest that they would have expanded Medicaid eligibility to hypothetical groups if their 1115 demonstrations had not been approved, we chose not to include hypotheticals in the baseline. Finally, the administration questioned the basis for our estimate of expenditures under the waiver funding agreements for Oregon and Hawaii, states with per capita funding limits. We asked and were told by administration officials that no estimates had been made of potential expenditures under those caps. Consequently, we worked closely with state officials to develop such estimates. State Medicaid officials reviewed and agreed with our methodology, described in detail in appendix I.

Summary: Pursuant to a congressional request, GAO examined the financing arrangements for four approved section 1115 Medicaid demonstration waivers. GAO found that: (1) the approved spending limits for demonstration waivers in Oregon, Hawaii, and Florida are not budget neutral and could increase federal Medicaid expenditures; (2) Tennessee's 1115 waiver agreement should cost less than the continuation of its prewaiver program and result in savings; (3) although additional federal funding is relatively lower than demonstration spending under federal expenditure caps, federal Medicaid expenditures could increase rapidly if similar flexibility in reviewing state 1115 financing strategies is allowed; (4) five waivers have been approved since late 1994, and the backlog of pending waivers includes three states with large Medicaid programs; (5) additional federal funding is available to protect against the uncertainties states face in implementing demonstrations; and (6) it remains unclear whether the states implementing demonstrations will exceed their 1115 waiver funding caps.