Medicaid is one of the largest programs in federal and state budgets. In fiscal year 2005, Medicaid expenditures totaled an estimated $317 billion. States pay qualified health providers for a broad range of covered services provided to eligible beneficiaries. The federal government reimburses states for a share of these expenditures. The federal matching share of each state’s Medicaid expenditures for services is determined by a formula defined under federal law and can range from 50 to 83 percent. Each state administers its Medicaid program in accordance with a state Medicaid plan that must be approved by HHS. Traditional Medicaid programs represent an open-ended entitlement, meaning the state will enroll all eligible individuals who apply for Medicaid, and both the state and federal government will pay their shares of expenditures for individuals covered under a state’s approved Medicaid plan. States have considerable flexibility in designing their Medicaid programs, but under federal Medicaid law, states generally must meet certain requirements for what benefits are provided and who is eligible for the program. Medicaid demonstrations provide a way for states to innovate outside of many of Medicaid’s usual requirements. Under section 1115 of the Social Security Act, the Secretary has authority to waive certain federal Medicaid requirements and authorize otherwise unallowable expenditures for “experimental, pilot, or demonstration projects” that are likely to promote Medicaid objectives. States have used the flexibility granted through section 1115 to implement major changes to existing state Medicaid programs. For example, some states used Medicaid section 1115 demonstrations in the 1980s and 1990s to introduce mandatory managed care for their Medicaid beneficiaries. Since the early 1980s, HHS has required that states show that their proposed section 1115 demonstrations will be budget neutral to the federal government—that is, federal expenditures under a state’s demonstration will not be greater than if the state had continued its existing Medicaid program. HHS requires states to show that proposed demonstrations are budget neutral by preparing 5-year projections of spending (1) under the current Medicaid program and (2) under the proposed demonstration. HHS policy states that for a demonstration to be considered budget neutral, the federal share of projected Medicaid expenditures under the demonstration can be no greater than the federal share of projected Medicaid expenditures based on continuing the existing Medicaid program. Because HHS bases spending limits for proposed demonstrations on the projected cost of continuing an existing Medicaid program, a state has an incentive to maximize its projected costs. HHS policy states that the federal share of spending on demonstrations will be limited by spending limits calculated from two components: Spending base. States select a recently completed fiscal year that establishes base levels of funding for services and programs affected by the proposed demonstration—a state’s “spending base.” States also identify beneficiary groups for inclusion in the proposed demonstration. These beneficiary groups can, at the Secretary’s discretion, include individuals enrolled in other demonstrations a state may be operating and beneficiaries from the State Children’s Health Insurance Program (SCHIP), which provides health coverage to children in families whose incomes, while low, are above Medicaid’s eligibility requirements. Growth rates. States should submit to HHS 5 years of historical data for per person costs and beneficiary enrollment in their existing Medicaid programs, including quantified explanations for anomalies in their historical trends. HHS policy says that spending limits should be based on growth rates that are the lower of state-specific history or estimates of nationwide growth for the beneficiary groups included in the demonstration (referred to in this report as benchmark growth rates). HHS’s guidance is specific to per person cost growth rates and does not explicitly address the application of enrollment growth rates; however, HHS refers to state historical and nationwide enrollment growth rates in considering the spending limits. Nationwide estimates of cost and beneficiary enrollment growth are developed by CMS actuaries to assist OMB in preparing the President’s Budget. To project the costs of continuing a state’s existing Medicaid program, HHS policy calls for applying the benchmark growth rates to the state’s spending base over a 5-year period to establish total projected costs absent the demonstration. HHS sets spending limits for proposed demonstrations based in part on these total projected costs (see fig. 1). HHS allows states to use higher-than-benchmark growth rates if they can establish that historical or nationwide data do not accurately depict anticipated growth in the state Medicaid program. HHS considers spending limits to be a product of negotiations that are informed by HHS’s policy to consider the state’s historical experience and projections of growth in the President’s Budget. In addition, HHS’s policy indicates that states, in providing HHS with state-specific historical growth rates, must quantify any anomalies in the trends. Recently approved section 1115 Medicaid demonstrations in Florida and Vermont significantly change the operation of the two states’ Medicaid programs. Both demonstrations expand the use of managed care by requiring most Medicaid beneficiaries to enroll in managed care plans: Florida through state contracts with multiple managed care plans to provide services and Vermont by creating a single managed care organization operated by an office within the state Medicaid agency. Florida: Approved by HHS in October 2005 and launched in July 2006, Florida’s demonstration is designed to give Medicaid beneficiaries different options for health care plans and benefits through increased use of managed care plans to provide Medicaid coverage to beneficiaries, in a competitive environment. In the initial phase of the demonstration, certain Medicaid beneficiaries in two counties are required to enroll in state-approved managed care plans. Managed care plans compete for Medicaid beneficiaries by offering different coverage options, including customized benefits and cost sharing, subject to certain limitations. Unlike many other previous Medicaid managed care systems, managed care plans in Florida have the authority to design benefit packages subject to approval by the state. Initially implemented in a two-county area, the managed care components of the demonstration are planned for statewide implementation by June 2010. Another key component of Florida’s demonstration was the establishment of a pool of funds to finance supplemental payments—payments above the state’s usual payment rate— to certain types of Florida health care providers. Known as the low-income pool, this component of the demonstration was designed in part to continue funding for a supplemental payment program for hospitals that the state had in place prior to the demonstration. Payments from the $5 billion low-income pool ($1 billion annually) are authorized for selected Medicaid providers statewide to help offset the cost of providing care to Medicaid beneficiaries and underinsured and uninsured individuals. Vermont: Approved by HHS in September 2005 and launched the following month, Vermont’s demonstration is designed to contain costs and, by potentially delivering services to Medicaid beneficiaries for less and reinvesting excess revenue, to allow the state to serve more of its uninsured population. Under the demonstration, Vermont created a single, state-operated managed care organization to cover virtually all of the state’s Medicaid population. HHS approved a managed care arrangement whereby the state Medicaid agency contracts with one of its own components (the Office of Vermont Health Access) to operate as a managed care organization. The Office of Vermont Health Access receives monthly actuarially certified lump-sum payments from the state Medicaid agency, which in turn receives the federal share of these lump- sum payments. The monthly payment is intended to cover the medical costs and administrative expenses of serving enrolled beneficiaries. Vermont also received authority to retain “savings,” that is, any excess revenue generated by the state managed care organization, and apply them to programs that meet certain agreed-upon health objectives, such as increasing health insurance coverage. On several occasions since the mid-1990s, we have reported concerns that HHS had approved Medicaid demonstrations that were not budget neutral to the federal government. In 1995 we reported that HHS applied new, more flexible budget neutrality guidance allowing three states to consider “new methodologies” for determining budget neutrality of proposed demonstrations. Based in part on these new methodologies, HHS had approved spending limits for these demonstrations that were not budget neutral and could increase federal Medicaid expenditures. In 2002, we reported that HHS approved spending limits for demonstrations that were not budget neutral to the federal government by allowing two states to include inappropriate or impermissible costs in their spending projections. We recommended that HHS ensure that valid methods are used to demonstrate budget neutrality by developing and implementing consistent criteria for reviewing and approving states’ budget neutrality analyses. HHS disagreed with the recommendation, stating that its methods were valid. In 2004, we reported that HHS approved spending limits for section 1115 demonstrations in four states that were not budget neutral to the federal government. These states projected the costs of their Medicaid programs at rates of growth exceeding state-specific and nationwide benchmarks for Medicaid cost and enrollment growth without documenting the rationale for the higher growth rates. We recommended that HHS (1) clarify criteria for reviewing and approving spending limits of states’ proposed demonstrations and (2) reconsider the spending limits of recently approved demonstrations. We also recommended that HHS document and make public the basis for any section 1115 demonstration approvals, including the basis for cost and enrollment growth rates used to set spending limits, and ensure that states comply with reporting and evaluation requirements. HHS concurred with our recommendations to make public the basis for its approvals, but did not concur with our recommendations on clarifying approval criteria and reconsidering recently approved demonstrations using these criteria. Our past work also includes reports addressing concerns with aspects of HHS’s oversight of certain state supplemental payment arrangements that threatened the fiscal integrity of Medicaid’s federal-state partnership. States, with HHS approval, can make supplemental Medicaid payments— payments above the state’s usual Medicaid payment rates for certain services, such as nursing home care—and they often do so for appropriate reasons. For example, states may make supplemental Medicaid payments to certain safety net providers that serve a large share of high-cost Medicaid beneficiaries. However, our work since the early 1990s examining some of these arrangements found that many states were, in essence, finding ways through the arrangements to inappropriately increase the federal share of Medicaid spending at little or no cost to the state. In February 2004, for example, we reported that states were taking advantage of Medicaid upper payment limit (UPL) provisions, resulting in excess federal payments. The UPL is the upper bound on what the federal government will pay as its share of Medicaid costs for different classes of covered services, and this limit often exceeds what states actually pay providers for services. This difference creates a “gap” between what states typically pay for services and the UPL. Some states took advantage of this gap between their usual payment rates and what Medicaid could pay under the UPL by making large supplemental payments to government providers, acquiring a federal share of those payments, and subsequently requiring the providers to return most or all of the supplemental payments to the state. These states have collected billions of excessive federal dollars in past years and often used these returned payments and the accompanying federal funds to finance their own share of the Medicaid program. We have reported on, and HHS has attempted to curb, such recycling of federal Medicaid funds. HHS approved 5-year demonstration spending limits for Florida and Vermont based on projections of cost and beneficiary enrollment growth rates that exceeded HHS’s own benchmarks—that is, the lower of the state’s recent historical experience or estimates of Medicaid growth nationwide—without adequate support for these deviations. For each state, HHS provided support for some, but not all, of the increase above these benchmark levels. For Florida, the unsupported difference totals about $6.9 billion of the $52.6 billion in projected spending over the 5-year demonstration. For Vermont, the unsupported difference totals about $246 million over its 5-year demonstration. HHS approved higher- than-benchmark growth rates in calculating spending limits for the demonstrations and, in the case of Vermont, allowed the state to include hypothetical projected expenses inappropriately. In particular, HHS allowed Vermont to include projected costs in its spending limit based on costs that had been budgeted for and allowed under a previous 1115 demonstration but that had not been spent. Although HHS provided some documentation to justify the deviations from its benchmarks that it approved, HHS did not justify all the deviations. In some cases, HHS officials told us that the higher growth rates were the results of negotiations. However, such negotiations were not always fully documented. HHS approved a spending limit for Florida’s demonstration that exceeded the amount HHS could have approved under its benchmark policy, but did not fully support the additional spending. Florida’s spending limit has two primary components, beneficiary services and supplemental payments to safety net hospitals. Beneficiary services account for the bulk of Medicaid spending and include the medical costs of demonstration enrollees. For beneficiary services, HHS established annual per person limits on federal funds for medical services to groups of beneficiaries. Projected over the 5 years of the demonstration, these per person limits would result in estimated Medicaid spending of about $47.6 billion. However, under HHS’s benchmark policy of limiting projected growth to the lower of a state’s recent historical experience or nationwide estimates of Medicaid growth, the maximum spending allowed would have been a projected $38.6 billion, or about $9 billion less. HHS supported deviations from its benchmarks that would allow spending projected at an estimated $40.7 billion— $2.1 billion above the level the benchmarks would have allowed, but still $6.9 billion less than what it approved. Table 1 shows the spending limit originally proposed by Florida and agreed to by HHS. It also shows the spending limit that would have resulted using the benchmark growth rates of the lower of the state’s historical growth or the growth projected in the President’s Budget, as well as the estimated spending limit that HHS and state officials supported through explanations and documentation. A further discussion of HHS’s explanations of its approvals follows. Projected spending on medical services to beneficiary groups in Florida is based on assumptions of per person cost and beneficiary enrollment growth rates for two primary groups of Medicaid beneficiaries: (1) the aged, blind, and disabled and (2) children and families. Florida submitted to HHS 5 years of historical data and calculations of cost growth rates over this period for the two groups. HHS, in turn, compared Florida’s state- specific history to estimates of Medicaid growth for these beneficiary groups nationwide. However, neither Florida’s proposed nor HHS’s approved spending limit is based on projected spending using the lower of the state-specific or nationwide benchmarks consistent with HHS policy. Instead, according to HHS and state officials, Florida proposed—and HHS approved—higher per person cost growth based on adjustments to the growth rates that were made during negotiations between HHS and state officials that were not documented. The cost growth rates HHS accepted in negotiations were substantially above those that would have been allowed under HHS’s benchmark policy. As table 2 shows, HHS approved cost growth rates of 8 percent for both aged, blind, and disabled beneficiaries, and for families and children—lower than Florida was proposing for the first group, and slightly higher than Florida was proposing for the second group. Under HHS’s benchmark policy, which calls for basing spending limits on projections of growth at the lower of state-specific history or estimates of Medicaid growth nationwide, the approved cost growth rates would have been 4.80 percent for aged, blind, and disabled beneficiaries and 3.11 percent for children and families. HHS officials allow states to use higher cost growth rates if state officials can establish that state-specific or nationwide data do not accurately depict expected growth in the state Medicaid program. HHS’s policy indicates that states are to provide quantified explanations of growth rate anomalies. For the Florida demonstration, HHS officials explained and provided public or internal documents to support part, but not all, of the increases to benchmark cost growth rates that HHS approved. 1. For aged, blind, and disabled beneficiaries, HHS allowed adjustments to nationwide estimates of cost growth to account for effects of the Medicare prescription drug benefit, but quantified explanations for only part of the approved increase. HHS officials explained that the implementation of the Medicare Part D prescription drug benefit, which would have the effect of shifting the cost of many prescription drugs out of the Medicaid program and into Medicare, caused a sharp decrease in estimated costs for aged, blind, and disabled Medicaid beneficiaries nationwide in 2006. This decrease in the cost growth rate for that unusual year lowered the nationwide benchmark growth rate for these beneficiaries. HHS officials adjusted for the effects of the Medicare prescription drug benefit by removing drug-related expenditures from the nationwide estimates over the time period under review and recalculating estimated nationwide cost growth. As a result of these adjustments, HHS provided quantified explanations to the deviation from its benchmark and supported projected cost growth of 6.45 percent for aged, blind, and disabled beneficiaries—higher than the 4.80 percent allowed under its benchmark policy. HHS officials indicated that the remaining deviation from the benchmark was attributable to adjustments they made to the growth rate to account for an expected increase in enrollment of low-cost beneficiaries. HHS officials, however, did not identify and correct anomalies in the nationwide enrollment data to support the additional increase in cost growth from 6.45 percent to the 8 percent HHS approved for the demonstration. 2. For families and children, HHS claimed that higher growth over a selected time period more accurately reflected cost growth. According to HHS’s guidance, state-specific growth rates are based on 5 years of historical data. HHS, however, allowed Florida to calculate a cost growth rate for its families and children based on data from a truncated period of higher growth of 3 years and 9 months. Cost growth over this shortened period of time was 5.88 percent, as compared to cost growth of 3.11 percent when using data from the full 5 years leading up to Florida’s base year. HHS officials explained that they allowed Florida to selectively use the higher years of data to calculate its growth rates for two reasons: (1) that the shortened time period replaced earlier years of unusually low cost growth with more recent data and (2) that HHS had recently approved a higher cost growth rate for a subset of this particular beneficiary group in renewing an ongoing Medicaid managed care demonstration. HHS officials did not, however, identify and correct an anomaly in the state’s earlier data, nor did HHS document and explain why the state was allowed to establish its spending limits using growth rates that were based on anticipated higher growth under the demonstration. In particular, the state, in its application, stated that it anticipated higher cost growth under the demonstration due to greater use of managed care by Medicaid children and families. A review of Florida’s historical cost growth that includes more recent data cited by HHS officials, and that uses data from a 5-year period as indicated by HHS policy, supports a cost growth rate of 3.77 percent. HHS officials maintained that HHS’s methods for ensuring budget neutrality are valid and indicated that the department’s budget neutrality decisions are, to some extent, the product of negotiations. HHS officials also said that HHS can assign growth rates that vary from the results of analysis of historical data and the President’s Budget projections if officials are convinced that the trends are merited. To a lesser degree than Florida, HHS approved a spending limit for Vermont’s demonstration based on assumptions of beneficiary enrollment growth that exceeded HHS’s benchmarks. HHS approved a spending limit of $4.7 billion for Vermont’s 5-year demonstration. This spending limit, however, is $180 million above the maximum supported by HHS and the state in explanations and documentation. HHS also allowed Vermont to include in its spending limit funds that were “hypothetical,” that is, $67 million in funds that had been approved as budget neutral for a prior section 1115 demonstration but that the state had not actually spent. Table 3 shows the spending limit as originally proposed by Vermont and as agreed to by HHS. It also shows the limit that would apply if HHS benchmarks had been used and the limit that HHS and state officials explained and supported in documentation. Although HHS reduced Vermont’s proposed spending limit by over $1.4 billion, this reduction resulted from an agreement that the state not include the financing of three major programs in the demonstration. These three programs that were removed from the state’s initial proposal—a long-term care demonstration, payments to hospitals under the Disproportionate Share Hospital program, and SCHIP—account for most of the $1.4 billion and will continue to be operated and reimbursed apart from the Vermont demonstration, thus having no affect on the budget neutrality of the demonstration. Vermont submitted 5 years of historical cost and beneficiary enrollment data for assessment by HHS. For per person costs, HHS required Vermont to hold growth rates in line with the department’s benchmark policy. For beneficiary enrollment, however, HHS approved growth rates that were higher than benchmark levels. For example, the benchmark rate for enrollment growth of aged, blind, and disabled beneficiaries was 1.52 percent per year; HHS approved a rate of 2.52 percent. For the largest group of beneficiaries under the demonstration—families and children— HHS approved an enrollment growth rate of 1.99 percent, higher than the 1.05 percent nationwide benchmark for this group (see table 4). Similar to Florida, but to a lesser degree, a portion of Vermont’s spending limit that exceeds HHS benchmarks was not supported. HHS used beneficiary cost and enrollment growth rates to provide the basis for Vermont’s aggregate spending limit. Although HHS held Vermont’s beneficiary cost growth rates to the lower of HHS’s benchmarks, HHS did not do so with regard to enrollment growth rates. HHS approved enrollment growth rates that were proposed by Vermont but were higher than the benchmarks without adequate documentation for the higher growth rate (see table 4). HHS officials told us the higher growth rates were the results of negotiations. However, such negotiations were not well documented. For one group of beneficiaries—families and children—HHS approved an enrollment growth rate of 1.99 percent, consistent with the state’s historical growth but almost twice the 1.05 percent nationwide benchmark for this group, without explanation. For another group— beneficiaries from an ongoing developmental services demonstration— HHS allowed the state to exceed the benchmark growth rate based in part on a state management plan to cover more people in the future by removing them from a waiting list for developmental services. For this same group, Vermont supported part, but not all, of the spending limit in excess of the benchmarks by presenting a more narrowly focused analysis of its historical enrollment data. Specifically, for this subset of the state’s aged, blind, and disabled beneficiary group, Vermont officials identified enrollment growth of 4.25 percent, higher than the benchmark level for aged, blind, and disabled beneficiaries. HHS officials told us that they considered both state-specific and nationwide benchmarks before approving Vermont’s requested enrollment growth rates. We estimate that the higher-than-benchmark enrollment growth rates approved by HHS that were not supported by explanation and documentation increased Vermont’s spending ceiling by about $180 million. HHS also allowed Vermont to include in its spending limit the projected costs for “hypothetical” expenditures, that is, expenditures the state could have made but did not make. Specifically, HHS allowed Vermont to include in its spending limit nearly $67 million that the state was authorized to have spent under an ongoing Medicaid section 1115 demonstration, but that was unspent under the program. At the time of its proposal, Vermont had an ongoing 1115 demonstration called the Vermont Health Access Program that began in 1996 and was later extended. While program expenditures for the Vermont Health Access Program were well under that demonstration’s spending limit in the early years of the demonstration, in 2004 the program began operating at a deficit as expenditures exceeded its annual spending targets (see fig. 2). Vermont ended this demonstration early because the state could no longer afford to incur the deficits. Because of its early completion, $67 million under the spending limit for the demonstration was unspent. HHS policy requires a state to capture actual expenditures in its spending base, and the $67 million allowed was a hypothetical expenditure that did not represent true expenditures of the state under its program. We have previously reported a concern about HHS’s allowing states to include hypothetical costs in their spending limits. For example, in 2002, we reported that HHS had approved an inflated spending limit for one state by allowing the state to include projected costs of covering a population that the state had not actually covered under its program. HHS has not ensured that demonstrations in Florida and Vermont maintain the fiscal integrity of the Medicaid program. In Florida, HHS approved the state’s use of spending from a problematic supplemental payment arrangement that the state had in place prior to the demonstration as the basis for allowed spending under the demonstration, without correcting all identified problems. A 2005 HHS financial management review found several problems with the earlier financing arrangement that involved supplemental payments to certain hospitals and other health care providers. Among the problems, the HHS review found that Florida had incorrectly calculated the level of supplemental payments for which federal Medicaid funds could be obtained, resulting in inflated payments under the arrangement. Without taking corrective action, HHS allowed Florida to use the prior financing arrangement as the basis for allowed spending in a $1 billion per year low-income pool under its current demonstration. We had, in 2004, recommended that HHS establish methods for states’ calculations of supplemental payments, but HHS has not implemented this recommendation. In Vermont, HHS allowed the state to operate a managed care organization and, through this arrangement, retain excess revenue from payments to the organization for previously state-funded programs. In July 2007, we raised concerns about this demonstration’s consistency with federal law. We recommended that the Secretary reexamine Vermont’s demonstration and, where appropriate, either modify the terms of the demonstration or seek statutory authorization for the state to continue the demonstration in its present form. A key component of Florida’s demonstration is a pool of federal, state, and local money to supplement payments to the state, or to hospitals, clinics, or other providers (see table 5). Florida agreed to discontinue its supplemental payment program under the terms of the demonstration, but to ensure continued funding for providers that had been receiving supplemental payments under the former program, requested HHS approval to make supplemental payments through a low-income pool. HHS approved a $5 billion low-income pool that allows Florida to spend $1 billion per year for the 5 years of the demonstration for uncompensated medical care costs to the uninsured and underinsured, Medicaid costs above standard Medicaid reimbursement rates, health insurance premiums, and insurance products for such services provided to otherwise uninsured individuals. At the time the demonstration was approved, however, HHS also had indications that Florida made excessive supplemental payments through the existing supplemental payment arrangement, and these concerns had not been resolved as of the time the demonstration was approved. A September 2005 HHS review of Florida’s financing arrangements found that the methods and data used to calculate the amount of supplemental payments eligible for federal matching funds were unreliable. The reviewer, for example, found that Florida established Medicaid UPLs— which cannot exceed what Medicare would pay for the same services, and which determine the maximum amount of federal matching funds the state could obtain for its supplemental payment program—without making adjustments to account for the fact that Medicare beneficiaries are typically older and more expensive to treat. For example, the review found that the state’s estimate of what Medicare would pay for hospital services was nearly three times what Medicaid would typically pay, which the reviewer questioned. Not adjusting for the higher cost of treating Medicare patients inflates the state’s calculation of allowable payments under the program. HHS’s review also found that the data used to calculate the supplemental payment levels under Medicaid’s UPL contained errors and did not provide a reliable basis for determining the appropriate payment levels. HHS’s 2005 review did not estimate the actual allowable payments under the program or the extent that the prior supplemental payment arrangement was considered excessive or inflated. HHS required the state to correct one issue the review had identified with the source of the state’s own funding for the supplemental payments it was making as a condition of approving the demonstration. However, HHS did not require Florida to address the problems with the methodology and data used to determine the amount of supplemental payments eligible for federal matching funds before projecting allowed spending under the demonstration. HHS’s required terms of the demonstration, however, did allow for future adjustments to the spending limit under certain circumstances. In November 2006, HHS officials said that problems identified with the improper calculation of states’ allowed supplemental payment amounts would be corrected at a later date. Under Vermont’s demonstration, HHS authorized the state to operate its own managed care organization and, through this arrangement, to apply federal Medicaid matching funds to programs that were previously funded by the state and that do not exclusively benefit those eligible for Medicaid. Under this approach, the state’s Medicaid agency—the Agency of Human Services—makes actuarially certified monthly lump-sum payments to one of its own offices. That office, the Office of Vermont Health Access, serves as the managed care organization for the Medicaid program. In state fiscal year 2006, for example, the state Medicaid agency made lump-sum payments to its Office of Vermont Health Access of $65.4 million per month. The Agency of Human Services, in turn, receives federal Medicaid matching funds on these monthly payments. If Vermont can operate its public managed care organization and provide services to Medicaid beneficiaries for less than $65.4 million per month, HHS allows the state, under the demonstration, to spend excess revenues on programs that meet any of four broad health care objectives: (1) increase health insurance coverage, (2) increase access to quality health care for Medicaid enrollees and those lacking adequate insurance, (3) improve health outcomes and quality of life for Medicaid-eligible individuals, and, (4) encourage public- private health care partnerships. In fiscal year 2006—the first full year of the demonstration—the Vermont- operated managed care organization generated $56.5 million in excess revenues and invested $43 million of the funds into various programs. HHS allowed Vermont to invest the remainder of the excess revenues generated by the managed care organization in a reserve fund for future use. Over the 5 years of the demonstration, Vermont estimates that it will accumulate $300 million in excess revenues. The state plans to use these excess revenues to supplant state funding for a number of programs that do not exclusively benefit Medicaid-eligible individuals (see table 6). For example, Vermont plans to use excess revenues from the demonstration to fund a grant for the University of Vermont and to provide loan forgiveness for doctors and dentists. Vermont officials indicated that state funds— freed up by investment of excess revenues from the demonstration—could then be used to reduce Vermont’s budgetary constraints, projected in the demonstration’s proposal as a $656.8 million 5-year shortfall in state funds to pay for the state’s own share of Medicaid expenditures. The Vermont arrangement generates excess administrative reimbursement in two ways. First, HHS allowed the Agency of Human Services to pay its Office of Vermont Health Access at a rate that, while typical for private managed care organizations, is higher than the rate Vermont had been paid prior to the demonstration and higher than average Medicaid agency administrative costs. Second, because the payments for which matching funds are provided are lump-sum payments that include the managed care organization’s administrative costs, HHS pays a higher portion of the administrative costs associated with the managed care organization than it pays for administrative costs in the rest of Vermont’s Medicaid program or in Medicaid programs in other states. At the state’s historical rate and in a proportion consistent with other states’ administrative costs, Vermont would have received an estimated $71 million less. The reimbursement attributable to administrative costs could help ensure that the state has excess revenues for the state’s purposes, including supplanting state funding for non-Medicaid programs. A September 2005 independent review and risk analysis conducted by a consultant to Vermont concluded that the likelihood that there would be savings under the demonstration available to be used for programs formerly funded with state dollars was very high for two reasons. First, the spending limit and corresponding premium structure of the managed care organization assumed a 9 percent administrative cost component, which is typical for private managed care organizations but nearly double the average state Medicaid agency administrative costs. According to the consultant, such costs typically run in the 3 to 5 percent range. According to HHS data, administrative costs averaged 4.6 percent nationwide in fiscal year 2005. Second, unlike the situation where the state contracts with a private managed care organization, there is an incentive to pay the state-operated managed care organization on the high end of the actuarial range approved for the managed care premium because any excess payments can be used for state-funded programs. This financing arrangement allows Vermont to increase federal Medicaid payments to the state without a commensurate increase in state Medicaid spending. The state agency, by making a payment to itself in excess of the cost of providing Medicaid services, generates federal matching funds, which can be used to supplant state spending on certain programs. This supplanted state money, in turn, can be used to reduce Vermont’s projected $656.8 million 5-year shortfall in state funds for Medicaid, thus generating even more federal matching funds in a process known as recycling. Curtailing practices that allow states to reduce the proportion of Medicaid spending for which they are responsible has been part of the ongoing congressional scrutiny of Medicaid programs. In a letter to the Secretary of HHS, we raised concerns about the Vermont program’s consistency with federal law. These concerns stemmed from HHS’s decision to allow the state to operate its own managed care organization and, through this arrangement, to apply federal Medicaid matching funds to programs previously funded by the state. The approval of the Vermont program raised the question whether the Vermont Medicaid agency could enter into a managed care contract with one of its own offices and receive federal matching funds for lump-sum payments to that office rather than for payments based on actual costs. The letter also noted that in connection with its managed care regulations, HHS has expressed concerns about states obtaining federal matching funds through managed care contracts for state-funded services for which such funds would not ordinarily be available. Given our concerns, we recommended that the Secretary of HHS reexamine the demonstration and, where appropriate, either modify its terms or seek statutory authorization for it to continue in its current form. After examining HHS’s approvals of demonstrations in Florida and Vermont, our long-standing cost and oversight concerns related to HHS approvals of comprehensive Medicaid demonstration proposals remain. In determining the budget neutrality of proposed demonstrations, HHS approved spending limits for Florida and Vermont that exceeded its own benchmarks without adequately supporting the basis for the deviations. Our findings in Florida and Vermont are similar to the concerns we raised in our earlier reports—during its budget neutrality process, HHS did not adequately support the deviations from benchmark rates that it allowed in the development of states’ spending limits, or clearly document and make public the basis for the approved limits. When combined, the spending limits approved for Florida and Vermont are nearly $7.2 billion more than what the documentation and explanations support for the demonstrations. Given the significant federal expenditures for these demonstrations, improved accountability and transparency in HHS’s budget neutrality process, including in the approval of states’ spending limits, is warranted. HHS’s approvals in Florida and Vermont also raise concerns about precedents they establish that affect the federal and state partnership and fiscal integrity of the Medicaid program. By allowing Florida to use spending from a prior supplemental payment arrangement as the basis for new spending without correcting known problems, and by allowing Vermont to create its own state-run managed care organization and use excess revenue to fund other state programs, HHS has not taken the steps needed to ensure that Medicaid funds are used for Medicaid purposes. HHS has not corrected the problems it found with historical spending under Florida’s supplemental payment arrangement—historical spending that was used to set the spending limit under the demonstration—and reexamined the level of Florida’s spending limit accordingly. We believe a related recommendation from our 2004 report on the fiscal integrity of state Medicaid supplemental payment arrangements remains valid: that the department establish uniform guidance to states setting forth acceptable methods for calculating supplemental payment arrangements, such as the one that served as the basis for Florida’s low-income pool. Such guidance could help ensure that payments under ongoing supplemental payment arrangements, and any related demonstration proposals, are appropriate in the future. HHS agreed to implement this recommendation in responding to our 2004 report, but as of December 2007 had not done so. Our concerns about HHS approvals extend beyond those related to costs and oversight. The Secretary’s approval of the Vermont demonstration establishes a precedent for future proposals, but raises legal concerns. As of January 2008, HHS had no plans to implement our July 2007 recommendation to address concerns with the demonstration’s consistency with federal law. Because HHS disagrees with this recommendation—and other recommendations we have made to improve the demonstration review process—we are elevating this and other recommendations to the Congress for its consideration. The Congress should consider requiring increased attention to fiscal responsibility in the approval of section 1115 Medicaid demonstrations by requiring the Secretary of HHS to improve the demonstration review process through steps such as (1) clarifying criteria for reviewing and approving states’ proposed spending limits, (2) better ensuring that valid methods are used to demonstrate budget neutrality, and (3) documenting and making public material explaining the basis for any approvals. The Congress should consider addressing whether demonstrations that allow states to operate public managed care organizations and retain excess revenue to support programs previously funded by the state— including the Vermont demonstration—are within the scope of the Secretary of HHS’s authority under section 1115 of the Social Security Act. To help ensure that the Florida demonstration will maintain the fiscal integrity of the Medicaid program, we recommend that the Secretary of HHS ensure that the level of supplemental payments for which the state could have obtained federal Medicaid funds in the absence of the proposed demonstration is calculated using appropriate methods and accurate data sources, and adjust the approved spending limit appropriately. We provided a draft of this report for comment to HHS, Florida, and Vermont. All three provided written comments which we summarize and evaluate below. The full text of HHS’s comments is reprinted in appendix II along with our response to certain comments. Florida’s and Vermont’s comments are reprinted in appendixes III and IV, respectively. HHS and each state also provided technical comments, which we incorporated as appropriate. In commenting on a draft of this report, HHS strongly disagreed with our findings, conclusions, and recommendation, stating that the draft report mischaracterized the nature of the approved demonstration programs and HHS’s budget neutrality policies. We based our characterizations of HHS programs and policies on documentation obtained from HHS and states and interviews with HHS and state officials; we believe we have captured and reported them accurately. In its comments, HHS also said that our analysis did not adequately account for the likelihood of differences in professional interpretation in quantifiable analyses. HHS emphasized that the demonstrations are approved at the discretion of the Secretary of HHS and that the review of demonstration proposals includes both budgetary and programmatic elements. We recognize that the Secretary has some discretion in approving demonstrations and in establishing policies and processes for doing so. But we believe that to maintain accountability and transparency in the Medicaid program, of which section 1115 demonstrations are a major component, the Secretary has the responsibility to approve demonstrations based on clearly articulated policies and spending limits that are consistent with these policies. In conducting our work and preparing the draft report, we accepted HHS’s explanations for spending limit amounts that deviated from HHS’s benchmarks when they were clearly articulated and documented. Our draft report acknowledged these explanations in noting that some of the deviations from the benchmarks were explained. We did not, however, accept estimates when program officials could not clearly articulate the reasoning they had used, demonstrate how this reasoning was consistent with budget neutrality and fiscal integrity principles, and explain how the resulting spending limits were derived. HHS commented that we unnecessarily cite points from prior reviews regarding section 1115 demonstrations. We cite our earlier work to provide a broader perspective and context for our discussion about individual states. We also use our prior work as a basis to highlight actions that we have recommended that HHS take and that relate to problems we identified in this review, but that HHS has not acted upon. We believe it is an important part of our work to underscore recurring problems as well as areas where HHS has made significant progress. HHS also said that we had not given the agency sufficient credit for the steps it has taken to ensure fiscal integrity within the Medicaid program, stating that we overlooked and understated the progress HHS has made since the early 1990s to curtail improper financing arrangements. HHS said that the draft report inappropriately focused on our 2004 report that did not address related issues and omitted mention of our other relevant reports, including those that had recognized HHS’s efforts. The reports we have cited were those that focused on areas relevant to the scope of this work. We have acknowledged in earlier reports that the agency has taken a number of steps in recent years to strengthen Medicaid’s financial management, but in the particular areas of concern here—the demonstration criteria, methods, and documentation for agreed-upon spending limits—HHS has chosen not to make changes that would better ensure accountability and transparency. In 2002 and 2004, we recommended that HHS undertake these changes. Because it has not, we now raise these as a matter for congressional consideration. HHS stated that there are multiple methods of establishing that a project is budget neutral and that each agreement must be considered as part of a larger picture, and suggested that we inappropriately characterized HHS’s internal guideline as a “benchmark policy” and then criticized HHS for making minor adjustments for real-world factors that could affect a state’s spending. We presented the information on HHS’s policy in the draft report as found in written HHS guidelines on its Web site in March 2007 and as told to us by HHS officials. As noted in the draft report, HHS’s policy for reviewing and approving demonstration proposals and their spending limits lacks transparency. HHS’s complete policy should be clearly identifiable, in writing, and publicly available. Furthermore, we disagree that adjustments that account for billions of dollars in federal spending, without documentation and explanation, are of a minor nature. Agreements that commit the federal government to reimbursing states tens of billions of dollars should be documented and include explanations of the basic reasoning behind the final spending limits, including the adjustments to benchmarks that have been approved. HHS noted that one of its most significant concerns about the draft was that it failed to acknowledge that HHS had capped Medicaid program growth in Florida, which had averaged 13 percent in recent years. We disagree. As noted in the draft report, HHS approved a per person spending limit for Florida’s demonstration; however, there is no aggregate cap on spending in Florida similar to that in Vermont, where HHS placed a cap on total spending. HHS also strongly disagreed with our recommendation that it recalculate the Florida spending limit using appropriate methods and data sources and adjust the spending limit accordingly. HHS indicated that Florida’s data and methods for calculating payments for its supplemental payment program were irrelevant to the development of the Florida demonstration. We disagree that Florida’s calculations were not relevant to the Florida demonstration, since Florida’s historical payments were used as a basis for the low-income pool spending limit under the demonstration, and as a result, the spending limit allows for continuation of spending that a HHS review suggests should not have been allowed. With regard to HHS’s approval of the Vermont demonstration, HHS disagreed with our concerns and prior recommendation to reexamine the terms of the demonstration and, where appropriate, to either modify its terms or seek statutory authority for the demonstration to continue in its current form. HHS maintained that issues of legal authority were adequately and appropriately addressed in the information provided to us during the course of our fieldwork. We disagree and note that HHS has not addressed the concerns raised in our July 2007 letter. HHS also commented that our concern regarding excessive reimbursement for administrative expenditures for the public managed care organization in Vermont was unwarranted because all demonstration revenue must be spent for demonstration purposes and costs matched by federal funds would be clearly identified. Our concern remains that the broad scope of costs identified as for “demonstration purposes”—for example, funding the state public health laboratory—can allow Vermont to shift costs to the federal government that were previously funded by the state and that do not exclusively benefit individuals eligible for Medicaid. We provided a draft of this report to Florida and Vermont. Florida stated that during the negotiations over the demonstration waiver, state officials worked closely with HHS to ensure that all data and documentation were provided in a timely and accurate manner to support the waiver application. Vermont indicated that the state had assumed an unprecedented amount of risk related to program expenditures in exchange for the flexibility granted by the Secretary and that state and federal staff had engaged in extensive discussion and analysis of Vermont’s historical expenditures, cost and caseload trends, and program policies in arriving at the final budget neutrality spending limit. Vermont also questioned our finding that HHS agreed to reimburse the state’s administrative expenditures under the demonstration at a rate higher than prior to the demonstration, indicating that an independent actuary relied on Vermont’s historical administrative expenditures in developing this component of the capitation rate. We agree that the states provided data and documentation to HHS to show the basis for their demonstration proposals. Our concern remains, however, with the lack of sufficient documentation showing how the final spending limits were derived, particularly since they were different from the proposals and were based on assumptions about cost and enrollment growth that were higher than HHS’s benchmarks. Finally, we base our finding that HHS agreed to reimburse Vermont at a rate higher than what the state received prior to its demonstration in part on our review of the independent actuary’s report. As arranged with your offices, unless you publicly announce the contents of this report earlier, we plan no further distribution 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 the Centers for Medicare & Medicaid Services, and other interested parties. We will also make copies available to others upon request. In addition, the report will be available at no charge on the GAO Web site at http://www.gao.gov. If you or your staff members have any questions, please contact me at (202) 512-7114 or kanofm@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. Major contributors to this report are acknowledged in appendix V. Section 1115 of the Social Security Act provides the Secretary of Health and Human Services the authority to approve demonstration projects that test policy innovations likely to further the objectives of certain programs, including Medicaid. Under section 1115, the Secretary has authority to waive provisions of the Social Security Act, allowing states to operate demonstrations, and to provide federal Medicaid matching funds for states’ costs that otherwise cannot be matched under federal law. Section 1115 demonstrations vary in scope, from targeted demonstrations limited to specific services or populations, to comprehensive demonstrations affecting Medicaid populations and services throughout a state and including most of a state’s Medicaid expenditures. For example, a section 1115 demonstration in Virginia that the Department of Health and Human Services (HHS) approved in July 2002 affects limited Medicaid services—family planning services—for about 8,300 beneficiaries. A section 1115 demonstration in New York that HHS approved in July 1997, on the other hand, changes the delivery of a broad range of Medicaid benefits for over 2.5 million beneficiaries from fee-for-service to managed care. Our review addressed the budget neutrality and fiscal integrity of recently approved, comprehensive section 1115 demonstrations. We selected demonstrations to include in this review based on when they were approved and whether they were comprehensive and accounted for a major portion of the state’s Medicaid program. Specifically, we selected demonstrations based on the following: 1. Approval by HHS from July 2004 (when we last reviewed HHS- approved section 1115 demonstrations) through December 2006. 2. Meeting HHS’s definition of comprehensive, that is, those that affect a broad range of services for Medicaid populations statewide. 3. The demonstration accounted for greater than 50 percent of the state’s Medicaid expenditures. We used a two-step process to identify demonstrations that met our criteria. First, to identify comprehensive section 1115 demonstrations approved by HHS from July 2004 through December 2006, we reviewed a Centers for Medicare & Medicaid Services (CMS) report that listed all section 1115 demonstrations approved through February 2006 and updated the list though discussions with agency officials. Four comprehensive demonstrations met these criteria: the California Medi-Cal Hospital Uninsured Care program; the Florida Medicaid Reform program; the IowaCare program, and the Vermont Global Commitment to Health program. Second, to identify which of these four demonstrations met our third criterion that expenditures under the demonstration account for a majority of state Medicaid spending, we compared estimated first-year spending under the demonstration to 2004 total Medicaid spending in each state. First-year spending in two of the four states, California and Iowa, was less than 5 percent of total 2004 Medicaid spending, so we did not include these two states in our study. First-year demonstration spending in Florida and Vermont was projected to account for 59.9 and 117.2 percent, respectively, of 2004 Medicaid spending, so we included the demonstrations in these two states for further review in our study. To determine the extent to which the Secretary of HHS ensured that Medicaid section 1115 demonstrations would be budget neutral to the federal government prior to approving them, we reviewed HHS’s policies for determining budget neutrality as documented on HHS’s Web site and in information provided by HHS officials. We examined each state’s projection of the total spending needed to maintain its existing Medicaid program in the absence of the proposed demonstrations. Specifically, we assessed the extent to which each state’s assumptions about per person cost and beneficiary enrollment growth conform to HHS’s policy that these growth rates are the lower of state-specific or nationwide benchmarks of Medicaid growth. In instances where per person and beneficiary enrollment growth rates exceeded the lower of these two benchmarks, we asked HHS and state officials for explanations and documentation to support the higher growth rates HHS approved. We also compared spending limits for the demonstrations—based on the per person cost and beneficiary enrollment growth rates HHS approved—against (1) our estimates of demonstration spending limits had HHS required Florida and Vermont to have spending limits consistent with benchmarks and (2) our estimates of the spending limits had HHS held per person cost and beneficiary enrollment growth in each state to levels we determined that HHS and state officials had explained with quantified support. HHS’s policy states that adjustments to benchmark growth rates should address anomalies in the underlying data. To determine the extent to which HHS ensured that the Florida and Vermont demonstrations maintain the fiscal integrity of the Medicaid federal-state financial partnership, we evaluated HHS’s process for reviewing section 1115 demonstration proposals and reviewed related financial management reports. We interviewed HHS officials from the Center for Medicaid and State Operations that has direct oversight responsibilities for these demonstrations, including officials from the Division of Reimbursement and State Financing who reviewed funding of the demonstrations in Florida and Vermont to ensure consistency and compliance with federal requirements. We also interviewed state officials to gain their understanding of the waiver authorities HHS granted each state by approving its demonstration, as well as their understanding of the special terms and conditions that govern each demonstration. We also relied on the work conducted for an earlier study that reviewed the consistency of the Florida and Vermont demonstrations with federal law. Our findings concerning HHS’s approval of these two states’ demonstrations cannot be generalized to HHS’s approval of other states’ demonstrations. We used the selection criteria discussed above for purposes of assessing HHS’s process as it was applied in these particular cases of importance. We considered these cases to be important because they allowed significant changes in the states’ Medicaid programs and the majority of the states’ Medicaid spending was governed by the terms of the demonstrations. To assess the reliability of the data submitted by states to HHS to calculate historical state spending and enrollment growth rates, we reviewed the steps HHS takes to ensure the accuracy of spending data compiled in states’ automated Medicaid information systems. We obtained the data states’ submitted to HHS and reviewed them for anomalies and missing information. We also interviewed HHS and state officials knowledgeable about the data. We discussed limitations of the automated Medicaid data, such as potentially incomplete data and states’ ability to revise data for up to 2 years, with HHS officials. Because the data used to establish spending limits were for a time frame for which the states’ data should have been largely completed and finalized, we concluded that states’ Medicaid spending and enrollment data are sufficiently reliable for the purposes of this report. We conducted our work from June 2006 through January 2008 in accordance with generally accepted government auditing standards. The following are GAO’s comments to certain concerns raised in HHS’s letter dated December 21, 2007. 1. We refer to our 2004 report because of the significant role supplemental payments play in Florida’s demonstration and our concern that HHS did not require the state to correct known problems with these supplemental payments before establishing a spending limit on the basis of historical payments. HHS stated that we did not address financing arrangements in our 2004 report, but we disagree. An objective of the 2004 report was to determine if HHS’s continuing oversight of supplemental payment arrangements was sufficient to ensure that claims submitted by states were calculated appropriately and complied with Medicaid requirements. Although we noted that HHS had taken a number of steps to strengthen its oversight of these payment arrangements, we found that HHS had not issued guidance for states’ use on appropriate methods for calculating their Medicaid Upper Payment Limit (UPL). We recommended that HHS establish uniform guidance that would set forth to states acceptable methods for calculating the UPL. Our concern in this report is that HHS approved a spending limit for Florida’s low income pool based on the state’s UPL without first requiring Florida to address problems HHS identified in Florida’s methodology for calculating this UPL. We disagree that the draft of this report erroneously suggested that Medicaid payment limits necessarily result in proper sources of state financing. As noted in the draft, we are concerned that HHS approved a spending limit for the low-income pool based on potentially inflated historical payments. Our draft report credited HHS for requiring Florida to correct the issue the department had identified with the source of the state’s financing. 2. We disagree with HHS’s characterization of the findings from our 2006 and 2007 reports. Although our 2006 and 2007 reports addressed HHS oversight of Medicaid and discussed agency actions to strengthen oversight, certain of the findings of these earlier reports resonate with our current findings. In 2007, for example, we found HHS review and approval of state plan amendments to be marked by a lack of transparency and clear guidance. And in 2006, although we noted recent improvements in the financial management processes HHS uses in its oversight of states, we found it too soon to assess their impact, and further noted additional weaknesses that HHS had not addressed. 3. As discussed in the draft report, we are concerned that HHS allowed Vermont to seek reimbursement for administrative costs higher than that of other public health entities, and that HHS agreed to reimburse Vermont for a larger portion of these administrative costs than typically afforded other states. We disagree that HHS transparently identified costs for which federal reimbursement of excess revenues from the public managed care organization are available. As noted in the report, the purposes for which Vermont may spend these excess revenues are governed only by a set of broad health objectives. For example, HHS allowed Vermont to spend excess revenues on expenditures that increase access to quality health care for Medicaid enrollees and those lacking adequate insurance and that improve health outcomes and quality of life for Medicaid-eligible individuals. 4. Our draft report recognized HHS’s discretion in making adjustments in the spending limits. For example, we accepted a projected $2.1 billion in adjustments to the spending limits for Florida and Vermont because these adjustments were supported by quantified explanations. As noted in the draft, seemingly small changes to per person cost growth rates are amplified by the high volume of beneficiaries that access Medicaid services and the number of years across which these cost growth rates are applied. As noted in the draft, the seemingly small changes to the growth rates in Florida and Vermont resulted in nearly $7.2 billion that we identified as not budget neutral. 5. As noted in the draft report, the established agreement did limit how Medicaid spending in Florida could grow in the future. Our concern, however, is that these spending limits are not budget neutral. Furthermore, we disagree with HHS’s assertion that Florida’s spending limits reflect projected future growth in the absence of the demonstration. For example, over $5.5 billion in projected spending we identified as not budget neutral stems from an adjustment to reflect in part what the state projected would be higher anticipated costs of delivering Medicaid services in a managed care environment. These costs would not be incurred absent the demonstration, and as noted in the draft report, absent evidence supporting the approved changes to benchmark amounts, HHS should not have allowed them as a consideration in establishing a higher spending limit for the demonstration. We also disagree that HHS capped Medicaid program growth in Florida. The agency approved per person spending limits rather than a total limit on programmatic spending. Thus Medicaid spending in Florida may grow by more or less than 13 percent per year depending on enrollment in the program. 6. We believe the spending limit HHS approved for Florida’s low-income pool was problematic because HHS did not require Florida to correct known deficiencies in the state’s method for calculating historical supplemental payments that served as the basis for the spending limit. We did not estimate how the low-income pool should have been adjusted because HHS’s September 2005 review—which identified the problems with Florida’s calculation of its financing arrangement—did not estimate the actual allowable payments under the program or the extent that the prior supplemental payment arrangement was considered excessive or inflated. Consequently, we did not have the information available to us that would allow a detailed estimate of how the low-income pool spending limit should be adjusted. We believe that the concerns raised by HHS’s own review should have been addressed prior to establishing a spending limit based on historical spending. As noted in the draft report, HHS should ensure that the level of supplemental payments for which Florida could have obtained federal Medicaid funds in the absence of the demonstration is calculated accurately, and adjust the approved spending limit accordingly. 7. By not requiring Florida to correct known deficiencies in the state’s historical spending, we believe HHS did not ensure the fiscal integrity of Florida’s low-income pool. In the draft report we credited HHS for requiring Florida to correct a problem the department identified with the manner in which Florida used local financing as the nonfederal share of its supplemental payments. Our concern remains, however, that HHS did not require Florida to correct a separate problem the department identified in the methods and data by which the state calculated the amount of supplemental payments eligible for federal matching funds under its program. By not requiring Florida to correct its method and data sources as a condition of approving the demonstration, HHS approved a spending limit for the low-income pool based on potentially inflated historical spending. 8. We believe that we accurately characterized Florida’s low-income pool in this report. We agree that Florida discontinued its inpatient supplemental payment UPL program as a condition of the demonstration, and have clarified the language to indicate that HHS allowed Florida to develop the low-income pool in order to continue funding for a program of supplemental payments to providers. 9. HHS’s estimation of the maximum amount Florida could have spent under its UPL is irrelevant to the discussion of the appropriate spending limit for the low-income pool. As we stated in the draft report, consistent with HHS policy, spending limits should be based on actual historical spending and quantified explanations for trend anomalies. We believe that, in the absence of reliable historical data, spending limits should be based on transparent, clearly articulated methodologies. Our concern is that HHS allowed Florida to base this spending limit on potentially inflated historical payments as a result of the state’s flawed methodology for calculating its UPL. 10. HHS’s efforts to limit and document Florida’s Medicaid state plan spending and low-income pool spending under the demonstration do not speak to the extent to which HHS ensured the fiscal integrity and budget neutrality of the state’s proposed demonstration prior to approving it. We are concerned that HHS approved growth rates for the demonstration without adequate support and did not require Florida to correct problems the department identified in the state’s methodology for calculating its UPL. 11. To ensure that the spending limit on Florida’s low-income pool is budget neutral and based on allowable historical spending, we believe that HHS should require Florida to correct problems the agency identified in Florida’s methodology for calculating its UPL and adjust the spending limit for future payments made under the low-income pool accordingly. We are not suggesting a retroactive adjustment to the spending under the supplemental payment program. This recommendation is consistent with our long-standing conclusions that spending limits for proposed demonstrations should be based on valid methods. 12. We characterize accumulated savings from an expired demonstration in Vermont as hypothetical because they do not represent actual expenditures incurred during the historical period HHS reviewed in approving a new demonstration in Vermont. We do not object to consideration of actual expenditures from a predecessor demonstration in determining a spending limit for a new demonstration. But according to HHS’s written budget neutrality guidance, surpluses generated early in the life of the expired demonstration would not have been available to Vermont in the absence of a new demonstration. 13. During the course of our review of the Vermont demonstration, we considered the statutory provisions cited by HHS, and nonetheless, as indicated in the July 2007 letter, had concerns about the consistency of the Vermont demonstration with federal law. 14. Our discussion and use of enrollment growth benchmarks reflect HHS’s description of its policy, as written in guidance and as described by officials. During the course of our work, HHS officials told us that they considered benchmarks of enrollment growth in determining an aggregate spending limit for the Vermont demonstration. Yet HHS approved enrollment growth rates for the demonstration equal to, and in some cases exceeding, the highest rates HHS considered. Our main concern is that HHS’s basis for approving these enrollment growth rates was not well documented. We believe that to maintain accountability and transparency in the Medicaid program, the Secretary’s approvals should be based on clearly articulated policies and spending limits that are consistent with these policies. In addition to the contact named above, Katherine M. Iritani, Assistant Director; Kathryn Allen; Ted Burik; Tim Bushfield; Helen Desaulniers; Tom Moscovitch; Hemi Tewarson; Terry Saiki; Stan Stenersen; and Jennifer Whitworth made key contributions to this report. Medicaid Demonstration Waivers: Lack of Opportunity for Public Input during Federal Approval Process Still a Concern. GAO-07-694R. Washington, D.C.: July 24, 2007. Medicaid Demonstration Projects in Florida and Vermont Approved Under Section 1115 of the Social Security Act. B-309734. Washington, D.C.: July 24, 2007. High-Risk Series: An Update. GAO-07-310. Washington, D.C.: January 2007. Medicaid Financial Management: Steps Taken to Improve Federal Oversight but Other Actions Needed to Sustain Efforts. GAO-06-705. Washington, D.C.: June 22, 2006. Medicaid: States’ Efforts to Maximize Federal Reimbursements Highlight Need for Improved Federal Oversight. GAO-05-836T. Washington, D.C.: June 28, 2005. Medicaid Waivers: HHS Approvals of Pharmacy Plus Demonstrations Continue to Raise Cost and Oversight Concerns. GAO-04-480. Washington, D.C.: June 30, 2004. Medicaid: Improved Federal Oversight of State Financing Schemes Is Needed. GAO-04-228. Washington, D.C.: February 13, 2004. SCHIP: HHS Continues to Approve Waivers That Are Inconsistent with Program Goals. GAO-04-166R. Washington, D.C.: January 5, 2004. Medicaid and SCHIP: Recent HHS Approvals of Demonstration Waiver Projects Raise Concerns. GAO-02-817. Washington, D.C.: July 12, 2002. Medicare and Medicaid: Implementing State Demonstrations for Dual Eligibles Has Proven Challenging. GAO/HEHS-00-94. Washington, D.C.: August 18, 2000. Medicaid Section 1115 Waivers: Flexible Approach to Approving Demonstrations Could Increase Federal Costs. GAO/HEHS-96-44. Washington, D.C.: November 8, 1995. Medicaid: Statewide Section 1115 Demonstrations’ Impact on Eligibility, Service Delivery, and Program Cost. GAO/T-HEHS-95-182. Washington, D.C.: June 21, 1995.

Summary: Medicaid, a joint federal and state program, finances health care for 60 million low-income people. Section 1115 of the Social Security Act authorizes the Secretary of Health and Human Services to waive certain federal Medicaid requirements and allow demonstration projects that are likely to promote Medicaid objectives. Under federal policy, states must show that federal spending for proposed demonstrations will be no greater than if the state's existing Medicaid program were continued. GAO examined the extent to which HHS ensured that recent comprehensive 1115 demonstrations--affecting a broad range of services for beneficiaries statewide--will (1) be budget neutral to the federal government and (2) maintain Medicaid's fiscal integrity. For demonstrations approved in 2005 (Florida and Vermont), GAO obtained information from federal and state officials and also relied on past reviews of other demonstrations. HHS did not adequately ensure that Florida's and Vermont's Medicaid demonstrations will be budget neutral to the federal government before approving them. HHS approved spending limits that were higher than the limits that would have been granted if HHS had held the states to limits based on benchmark growth rates, that is, the lower of the state's historical spending growth or nationwide estimates of Medicaid growth. Although HHS allows states to deviate from these benchmarks if states can show that using them would not provide accurate projections, HHS's basis for approving the higher spending limits was not fully supported by documentation. In Florida, HHS approved a $52.6 billion spending limit for the 5 year demonstration-- $6.9 billion more than the documentation supported. In Vermont, HHS approved a $4.7 billion spending limit--$246 million higher than supported. HHS also did not ensure that the two demonstrations maintain Medicaid's fiscal integrity. In Florida, HHS allowed the state to establish a spending limit using a historical spending base that included payments HHS had previously identified as problematic. In 2005, an HHS review found several problems with the payment arrangement--problems that potentially resulted in inflated and inaccurate payments. In Vermont, where the state proposed operating a managed care organization, HHS agreed to an administrative reimbursement rate higher than what the state received prior to the demonstration. Under this arrangement, the state can use excess revenues to pay for health-related programs that were previously funded by the state and that do not exclusively benefit Medicaid beneficiaries, such as a grant to the University of Vermont medical school. A July 2007 GAO letter to the Secretary discussed concerns about this approval's consistency with federal law and recommended that the Secretary reexamine Vermont's demonstration and, where appropriate, either modify its terms or seek statutory authority for it to continue in its current form. Concerns about HHS's demonstration approval process in this report are consistent with those GAO has raised in past reviews of other states' demonstration proposals. In 2002 and 2004, GAO recommended that HHS take steps to strengthen its fiscal oversight of Medicaid by improving the Medicaid demonstration review and approval process, in part by (1) clarifying criteria for reviewing and approving states' demonstration spending limits, (2) better ensuring that valid methods are used to demonstrate budget neutrality and (3) documenting and making public material explaining the basis for any approvals. HHS has not taken action on these recommendations and maintains that its process is sufficient. Because HHS continues to disagree with these recommendations and with the need to reexamine the Vermont demonstration, GAO is elevating these issues to the Congress for consideration.