The Congress has structured Medicaid as a federal-state partnership that provides federal matching funds for covered state expenditures and, within broad federal guidelines, gives states considerable flexibility in deciding what medical services to cover and how much to reimburse medical providers. At the federal level, the program is administered by CMS, within the Department of Health and Human Services (HHS). Each state operates its program under a plan that CMS must approve for compliance with current law and regulations. CMS must also approve any amendments to the plan. On average, the federal government pays 57 percent of Medicaid costs, which totaled an estimated $196 billion in fiscal year 2000. To ensure the reasonableness of payments to providers, HCFA established a set of upper payment limits on the total amounts it would agree to pay for a variety of services. The upper limits are based on what Medicare (the federal health care program for elderly and some disabled individuals) would pay for comparable services. The upper payment limit is not a price to be paid for each service provided or a limit on the amount paid to individual facilities, but rather a ceiling on Medicaid payments for a category of providers above which the federal government will not share. Because state Medicaid payment rates are generally less than Medicare rates, states often have large gaps between their actual Medicaid payments and what they would pay using Medicare payment rates. States’ upper payment limit schemes are designed to exploit this gap so the state can obtain federal matching funds without paying its statutorily determined share. Despite limits on federal payments, the flexibility that states have to set Medicaid’s payment rates has provided the opportunity for some to develop various financing schemes in the past that inappropriately increased federal Medicaid payments. Over more than a decade, states have used a variety of schemes to boost federal Medicaid funding without contributing their specified share. As these schemes came to light, they were subsequently restricted by law or regulation (see table 1). For example, after HCFA became aware of schemes involving excessive federal payments to state-owned hospitals and nursing homes, it promulgated regulations to restrict excessive payments to these providers. Such restrictions, however, did not extend to certain government health care providers, such as local- and county-level providers. The financing scheme we identified last year was the latest variant being used by some states. In this scheme, excessive payments were made to health facilities owned by local governments. Such providers included county-owned nursing homes and hospitals and local hospital districts. States determined the amount of the excessive payments by computing the difference between the upper payment limit (that is, the maximum payment eligible for a federal match) and the total amount the state would normally have paid to Medicaid providers. The state then made payments equaling all or part of the difference to certain local government-operated facilities. These excessive payments were separate and in addition to what the state would normally pay for services these facilities provided. The facilities would agree in advance to return most or all of the extra money. Once the money was returned, the state then had additional money that it could use to pay its share of future Medicaid payments—thus generating even more federal matching funds—or to spend however else it decided. A variation of this scheme involved local providers advancing funds to the state, which it would then simply return to the local providers in the guise of a payment for valid covered services. The state would then claim federal matching funds on the excessive payment without having spent any state funds. Such funding arrangements violate the integrity of the Medicaid program for several reasons. First, they effectively increase the federal matching rates—which are set by law—because they generate additional federal Medicaid expenditures, while total state contributions remain unchanged. For example, as we testified last year, New Jersey’s financing arrangement with local nursing homes would effectively increase the federal matching rate from 50 percent to 62 percent if the state retained all $500 million of the excessive federal funds it generated. Second, the schemes funnel federal Medicaid dollars to the state that can be used at its discretion, with no assurance that the money is used for valid Medicaid services. The state can actually use these funds to supplant part of its share of Medicaid expenditures, thereby essentially bringing in still more federal Medicaid dollars. Third, these funding arrangements are inconsistent with statutory requirements that the states ensure that Medicaid payments are economical and efficient, because the chosen methods result in grossly excessive payments, well beyond the cost of services provided. By fiscal year 2000, the number of states taking advantage of these types of schemes and making excessive payments to local government providers had grown to 28, according to the HHS Inspector General, costing Medicaid an estimated $5.8 billion that year alone. Last September, the HHS Office of Inspector General (OIG) testified before the Senate Finance Committee that in some cases it was clear the federal funds were not reimbursing valid Medicaid costs. For example, the OIG found that between 1997 and 1999, Pennsylvania generated about $1.9 billion in excessive federal Medicaid payments, of which $407 million was known to have been spent on non-Medicaid services; another $558 million was unbudgeted and available to the state for non-Medicaid uses. Similarly, we found that Iowa’s excessive payment arrangement with county nursing homes resulted in average federal spending of about $969 daily per Medicaid bed—an 18-fold increase from the prior federal spending level of $54 per bed per day. In December 2000, the Congress mandated that HCFA’s pending regulation be finalized to revise the upper payment limit. This regulation restricts the ability of states to inappropriately generate federal funds through these financing schemes with local government providers. In doing so, however, the Congress and HCFA recognized that some states had used these schemes long enough to develop considerable reliance on the excessive federal payments as part of their overall state budgets. Thus, the regulation provided for three transition periods, ranging from about 2 years to 8 years, before states had to fully comply. In effect, this provision gave the states a period of time during which they could continue to receive excessive federal payments. The length of a state’s transition period depended on how long it had been using the scheme. For those in effect since before October 1992, states could continue to receive some excessive payments until October 2008. By contrast, states with approved state plan amendments that did not comply with the revised regulation and took effect after October 1999 would have their payments phased out by October 2002. HCFA justified the shorter transition period for these latter states because it had notified all states on July 26, 2000, that it intended to change the rules to close this loophole and that the states should therefore not develop a reliance on these funds. The regulation was published on January 12, 2001, and became effective on March 13, 2001. “We have given all states ample notice of our position that these programs are abusive and of our intent to publish this regulation to curtail such programs. To affirmatively approve pending applications would be counterproductive to our purposes of preserving the fiscal integrity of the Medicaid program.” 2. This stated position notwithstanding, the January 2001 regulation was silent as to whether plan amendments currently under consideration would be reviewed using the new regulation or the old one. On April 3, 2001, HCFA indicated in a new proposed rule that it had decided to review pending plan amendments under the old regulation, essentially reversing its earlier position. Reviewing plan amendments under the old regulation, without modification, gave states the opportunity to receive excessive federal payments through September 30, 2002. 3. On September 5, 2001, CMS issued a rule shortening the transition period from September 30, 2002, for those upper payment limit financing schemes in plan amendments that were pending when the January regulation was issued, that were subsequently approved, and that did not comply with the January regulation. CMS stated that the full transition period for these recent plan amendments was not appropriate. The final rule limited the transition period to 1 year after the effective date of the plan amendment or November 5, 2001, whichever is later. These changes affected the amount of time given to states before they had to comply with the upper payment limit regulation that went into effect on March 13, 2001, and the period during which they could still collect excessive federal matching payments. (See app. I for a chronology of events related to HCFA’s change of position on pending state plan amendments.) HCFA’s reversal of its position on approving abusive financing schemes involved a number of states, with substantial financial effect. In April 2001, HCFA reported that 11 states with pending plan amendments might be affected by its proposed rule to shorten the transition period. However, by the time CMS issued the rule in September 2001, the number of states had narrowed to four: Florida, Michigan, Virginia, and Wisconsin. HCFA approved Virginia’s and Wisconsin’s state plan amendments—which contain the same kinds of inappropriate schemes we reported last year in other states—on June 4, 2001, and May 8, 2001, respectively. Under the January 2001 rule, CMS data show that these states would have generated over $1.2 billion in excessive federal matching payments. The September rule will reduce this estimate to about $722 million. In our view, approving these state plan amendments and granting any transition period is inconsistent with CMS’ stated position about its intent to curtail such schemes and continues to undermine the integrity of the financing partnership. As with the abusive schemes we have reported previously, Virginia and Wisconsin were given approval to employ financing schemes that make excessive Medicaid payments—well beyond the cost of the services provided—to a few local governments on behalf of nursing homes. The excessive payments are made to obtain federal matching funds, with the local providers keeping little, if any, of the funds. The states, which contribute little or none of their own funds, can ultimately retain the excessive federal payments to use for any purpose they choose. Virginia’s and Wisconsin’s approved plan amendments both rely on same- day wire transfers involving banks, local governments that own or operate nursing homes, and the state. These transfers create the illusion of legitimate Medicaid payments, which are then used to bring in hundreds of millions in matching federal Medicaid dollars. In both states, this mechanism involves relatively few local-government-owned or -operated nursing homes—six homes in Virginia and five in Wisconsin. There are essentially six steps to the process, as shown in table 2. These steps include having the local government take out a bank loan and wire the proceeds to the state, which then immediately transfers the money back to the local government. This round-trip transfer of funds can be completed in a matter of minutes. A substantial amount of money is anticipated to be processed in these two states through these same-day wire transactions and through the federal matching funds generated by the transactions. As illustrated in table 3, the amount of excessive federal matching funds that would have been generated under the January rule exceeds $1.2 billion. The payments permissible under Virginia’s and Wisconsin’s approved financing schemes grossly exceed what the states typically pay for comparable services. Moreover, the states are free to use the federal proceeds as they wish. For example, Virginia would provide six local government nursing homes, on average, an additional $617 in federal funds per Medicaid nursing home resident per day over the $53 per day in federal funds, on average, that these homes normally receive per Medicaid nursing home resident. Wisconsin indicated, in documents submitted to HCFA, that the $748 million in federal matching funds that it would draw down over fiscal years 2001 and 2002 will be deposited in a newly created and interest-earning Medicaid Trust Fund. According to state information, the federal funds will be used in future fiscal years to finance payment increases for a variety of Medicaid providers, beyond nursing homes in three counties. If it does so, the state would essentially be recycling federal funds to draw down additional federal funds to be used for other purposes. By shortening the allowed transition period to comply with the new upper payment limits, the September rule will reduce the magnitude of excessive federal payments for these two states by about $483 million—from over $1.2 billion to about $722 million (see table 4). If both states had been limited to a 1-year transition period as specified in the latest proposed rule, the estimated savings would have been higher. However, the time associated with finalizing the rule and establishing its effective date as November 5, 2001, essentially cost another $130 million in excessive federal payments. Wisconsin will effectively have a period of over 16 months during which it can claim excessive federal payments. Because of the July 2000 effective date of Wisconsin’s plan amendment, the state is able to operate its financing scheme for 127 days beyond its 1- year transition period. We estimate that for every day the state exceeds its 1-year transition period, about $1 million can be generated in excessive matching funds. In total, Wisconsin will be able to claim about $130 million in additional excessive federal payments from July 1, 2001, to November 5, 2001. Our review of the facts surrounding the Virginia and Wisconsin plan amendments does not support the need for any transition period to comply with the January 2001 regulation intended to curtail abusive upper payment limit schemes. The fact that Virginia’s and Wisconsin’s plan amendments are recent argues against the need for a transition period. Transition periods established in HCFA’s January 2001 rule to allow states time to achieve compliance with the new upper payment limit regulations were aimed at states that had developed a budgetary reliance on excessive payment schemes. Virginia and Wisconsin do not meet that criterion. As illustrated in figure 1, Virginia’s and Wisconsin’s plan amendments were submitted and approved after HCFA began to take regulatory action to stop these excessive payment schemes. Virginia did not propose its excessive payment scheme until after HCFA publicly released the draft of its regulation to curb such schemes. Wisconsin first introduced its $374 million annual upper payment limit provision to HCFA in February 2001, after the January rule was published, as part of a response to HCFA questions on unrelated issues in a broader state plan amendment submitted on September 21, 2000. “We…believe that any State that submitted an amendment after the January 12, 2001 publication date of the final rule arguably had no basis to expect the amendment would be approved or had any history of reliance on such spending.” Nevertheless, the agency did not apply this criterion to Wisconsin’s plan. It concluded that the excessive payment provisions submitted February 7, 2001, did not constitute a new plan amendment but were rather a change to an earlier plan amendment submitted in September 2000. According to agency officials, there was no clear guidance on how to consider a revised state proposal such as Wisconsin’s. HCFA’s actions in implementing its revised upper payment limit regulations are troubling. At the same time that HCFA was attempting to close a glaring loophole, it allowed additional states to engage in the very schemes it was trying to shut down, at a substantial additional cost to the federal government. The January 2001 regulation was designed to provide a balance between protecting the integrity of the Medicaid program and providing a reasonable transition for those states that had developed some budgetary reliance on excessive Medicaid payments. Given HCFA’s stated position since July 2000 that it viewed these state financing schemes as abusive, we believe that its approval of additional schemes was unjustified. Experience tells us that even as the Congress and HCFA have in the past identified and acted to close down various state financing schemes that exploit the federal share of the Medicaid program, other schemes invariably emerge. Consequently, continued vigilance is needed to identify and respond to the next scheme before it reaches the financial magnitude that makes it both a staple of state financing and a potential threat to the integrity of the funding partnership. Furthermore, it is imperative that federal and state partners work together to protect the financial integrity of the Medicaid program and to ensure that scarce resources are appropriately used to meet the health needs of Medicaid-eligible beneficiaries. We obtained comments on a draft of this report from the Administrator of CMS and the Virginia and Wisconsin state Medicaid directors (see apps. II, III, and IV). They disagreed with our conclusion that HCFA’s decision to approve additional state financing schemes was unjustified. However, the Administrator pointed out the agency’s strong opposition to financing schemes and its intent to ensure the protection of federal funds by ensuring that states receive a federal match only for appropriate expenditures that are also appropriately matched with state funds. A central issue raised in these comments related to proposed state plan amendments that were pending at the time of HCFA's issuance of the January 12, 2001, rule with its March 13 effective date. The CMS Administrator commented that the treatment of pending amendments was not clearly addressed in the January 12 rule and that our draft report did not cite any clear statement on this issue. The Virginia Medicaid director asserted that HCFA's approval of Virginia's plan amendment, which was pending at the time the rule was finalized on January 12, was not only permissible but also consistent with past practice and necessary to avoid the retroactive application of the final rule. He further asserted that HCFA had no choice but to approve Virginia's plan. We agree that the January 12 rule was not clear on how to address pending state plan amendments; we have revised the report to clarify that the rule was silent on this point and added appendix I to provide a more complete chronology of HCFA's changing position on approving state plan amendments. We concluded that a careful analysis of the public record of proposed and final rules demonstrated a fundamental shift in HCFA's position in how to deal with a pending state plan amendment—from an initial stated intent to deny any pending proposals that would not comply with the revised upper payment limits to a subsequent decision to approve them. We disagree, however, with Virginia's position that HCFA had no choice but to approve its proposal. Under Medicaid, federal funding is authorized for amounts spent for covered medical and other services. As our report points out, the funding schemes that these pending amendments proposed do not relate to amounts that would actually be spent for covered services but to arrangements between states, counties, and local providers to obtain excessive federal payments. The Administrator has the statutory authority to disapprove any proposed state plan amendment that is inconsistent with the Medicaid statute. Given the long-standing and clearly stated congressional and HCFA intent to eliminate abusive state financing schemes and given the evidence that HCFA had in hand that Virginia's and Wisconsin's proposals would continue such practices with no assurance that excessive federal payments were being spent for valid Medicaid services and beneficiaries, we continue to believe that HCFA had the statutory authority, the discretion, and the responsibility to deny any such proposed state plan amendments regardless of the extent to which similar abusive practices existed in the past. The CMS Administrator also commented that, once the Virginia and Wisconsin state plan amendments were approved (June 4 and May 8, 2001, respectively), he did not have the authority to retroactively deny payments under the September 5 final rule that shortened transition periods for states with newly approved amendments. Our analysis and report did not address issues dealing with retroactive denial of payments. We concluded that HCFA’s approvals of these two states’ state plan amendments were unjustified, given clearly stated congressional and HCFA intent to eliminate such abusive state financing practices. Having affirmatively approved these two states’ plan amendments, however, we support the agency’s efforts to phase out federal matching payments as quickly as possible. The CMS Administrator and Virginia Medicaid director raised issues pertaining to the scope of our work and the sense that we were singling out certain states or individuals for criticism. We clearly pointed out in our report that our scope was restricted to those four states that were affected by the September 2001 regulation, and we further limited our work to Virginia and Wisconsin because these two states accounted for 96 percent of the excessive federal payments that the CMS actuary identified as resulting from the regulation. In the course of our work, we did not investigate the role that individual federal officials did or did not play, or whether any officials recused themselves from the decision-making process. As specified in the report, we based our analysis and conclusions on the public record of HCFA’s proposed and final rules, public comments submitted as part of the formal rule-making process, and supporting documentation that HCFA had available on proposed state plan amendments. Finally, the CMS Administrator commented that he has been especially vocal about stopping financing schemes that simply recycle state dollars for federal dollars with no real expenditure being made—a common practice across the country—and that he intends to end these practices in order to ensure the fiscal integrity of the Medicaid program. We fully support CMS efforts in this regard and believe that it should exert its full authority and discretion to do so. The Virginia Medicaid director also stated that HCFA has made clear on numerous occasions that it permits states to engage in intergovernmental transfers in connection with provider payments that do not exceed upper payment limits and that such transfers are not inconsistent with governing law. In this report, we did not take issue with intergovernmental transfers as a legitimate tool or mechanism that state and local governments use in jointly financing activities of government. We do take issue, however, with the fact that this mechanism is often inappropriately used as a subterfuge to create the illusion that a state has made payments for valid Medicaid services for eligible Medicaid beneficiaries in order to claim matching federal payments. The Wisconsin Medicaid director commented that the state has had an approved intergovernmental transfer funding mechanism in place since 1985, and therefore our conclusion that it had no budgetary reliance on this funding, which was the basis for HCFA’s granting states varying transition periods to wean themselves from the excessive federal funding, was incorrect. We disagree with this point of view. The $374 million annual upper payment limit provision that Wisconsin submitted to HCFA on February 7, 2001, was separate from, and in addition to, its previously approved arrangements costing about $23 million annually. Wisconsin therefore had no established historical budgetary reliance on its February 7 proposed financing scheme, which HCFA approved in May 2001. As arranged with your offices, unless you release its contents earlier, we plan no further distribution of this report until 30 days after its issuance date. At that time, we will send copies of this report to the Secretary of Health and Human Services, the Administrator of CMS, and other interested parties. We will make copies available to others upon request. If you or your staffs have any questions regarding this report, please contact me on (202) 512-7118 or Frank Pasquier on (206) 287-4861. Other major contributors included Tim Bushfield, Terry Saiki, Stan Stenersen, and Stefanie Weldon. Impact of event on states with pending amendments Letter announces HCFA’s intent to (1) phase out upper payment limit financing mechanisms and (2) pursue steps that put an immediate end to paying states that file plan amendments in the intervening period before any regulation takes effect. The proposed rule says that states with pending plan amendments not in compliance with the new regulation would qualify for a transition period only if they were approved before the effective date of the final regulation. The act directs the Secretary of Health and Human Services to issue a final regulation based on the October 2000 proposed rule. HCFA again says that noncompliant pending plan amendments would be reviewed under the new regulation. Plan amendments not in compliance with the new regulations would not qualify for transition periods. The final rule is silent as to whether plan amendments currently under consideration would be reviewed using the new regulation or the old one. According to HCFA officials, the language change from the proposed rule resulted from an inadvertent editing revision. HCFA indicated that it had decided to review pending plan amendments under the old regulation, essentially reversing its earlier position. This change in position gave states with such plan amendments the opportunity to receive excess federal payments through September 30, 2002. The rule proposes reducing the transition period to 1 year for such pending plan amendments. The final rule adopts shorter transition periods for plan amendments that were pending when the January regulation was issued, that were subsequently approved, and that did not comply with the January regulation. The final rule limits the transition period to 1 year after the effective date of the plan amendment or November 5, 2001, whichever is later. Medicaid: State Financing Schemes Again Drive Up Federal Payments (GAO/T-HEHS-00-193, Sept. 6, 2000). Medicaid in Schools: Poor Oversight and Improper Payments Compromise Potential Benefit (GAO/T-HEHS/OSI-00-87, Apr. 5, 2000). Medicaid in Schools: Improper Payments Demand Improvement in HCFA Oversight (GAO/HEHS/OSI-00-69, Apr. 5, 2000). Medicaid: Disproportionate Share Payments to State Psychiatric Hospitals (GAO/HEHS-98-52, Jan. 23, 1998). State Medicaid Financing Practices (GAO/HEHS-96-76R, Jan. 23, 1996). Michigan Financing Arrangements (GAO/HEHS-95-146R, May 5, 1995). Medicaid: States Use Illusory Approaches to Shift Program Costs to Federal Government (GAO/HEHS-94-133, Aug. 1, 1994).

Summary: Some states have taken advantage of the flexibility that Congress built into the Medicaid program by devising schemes that inappropriately boost the federal share of program expenditures. These schemes were adding billions of dollars a year to federal Medicaid costs without the states paying their statutorily specified share of program costs. Moreover, some of the federal funds were being spent for non-Medicaid purposes. After hearing about these financing schemes, Congress passed the Medicare, Medicaid, and SCHIP Benefits Improvement and Protection Act of 2000 (BIPA). In response, the Health Care Financing Administration (HCFA) issued regulations in January 2001 to curtail financing schemes involving excessive payments to local government providers for which a separate upper payment limit did not exist. However, less than a month after the revised upper payment limit regulation became effective, HCFA decided to amend the regulation to shorten the time some states were allowed to comply with it. This reversal resulted in the approval of new financing schemes for several states that had pending proposals mimicking the schemes identified last year. The transition periods were of varying lengths, depending on how long a state had been receiving excessive federal payments from one of these schemes. Believing that states just starting to receive excessive federal payments did not need the two-year transition period established in the January regulation, HCFA decided to shorten the transition period to limit federal liability. Although the September regulation--which limited the length of time states can operate their newly approved excessive funding schemes--will reduce the drain on federal Medicaid funds, GAO questions HCFA's decision to approve additional financing schemes, given the explicit effort to curtail them.