The purpose of the CMS PERM program is to produce a national-level improper payment error rate for Medicaid. CMS developed PERM in order to comply with the requirements of IPIA, which was amended by IPERA. PERM uses a 17-state, 3-year rotation for measuring Medicaid improper payments. Medicaid improper payments are estimated on a federal fiscal year basis through the PERM process. The estimate measures three component error rates: (1) fee-for-service (FFS), (2) managed care, and (3) eligibility. FFS is a traditional method of paying for medical services under which providers are paid for each service rendered. Each selected FFS claim is subjected to a data processing review. The majority of FFS claims also undergo a medical review. Managed care is a system where the state contracts with health plans to deliver health services through a specified network of doctors and hospitals. Managed care claims are subject only to a data processing review. Eligibility refers to meeting the state’s categorical and financial criteria for receipt of benefits under the Medicaid program. States perform their own eligibility reviews according to state and federal eligibility criteria. See appendix II for additional details on these three components. CMS uses its PERM Manual to provide detailed guidance for implementing CMS regulations on PERM. PERM regulations set forth the methodology for states to estimate Medicaid improper payments and outline the requirements for state CAPs. Figure 1 shows the PERM process for estimating and reducing Medicaid improper payments. Through its use of federal contractors, CMS measures the FFS and managed care components while states perform the eligibility component measurement. CMS contracts with two vendors—a statistical contractor and a review contractor—to conduct the FFS and managed care review components of PERM and calculate error rates. The statistical contractor is responsible for (1) collecting and sampling claims and payment data for review, including performing procedures to ensure that the universe is accurate and complete; (2) reviewing state eligibility sampling plans; and (3) calculating state and national error rates. The review contractor is responsible for conducting data processing and medical reviews after the statistical contractor selects the samples of claims. Beginning with the fiscal year 2011 measurement cycle, state-specific sample sizes are calculated based on the prior measurement cycle’s component-level error rates and precision. All payment error rate calculations for the Medicaid program (the FFS component, managed care component, eligibility component, and overall Medicaid error rate) are based on the ratio of estimated dollars of improper payments to the estimated dollars of total payments. The overall Medicaid error rate represents the combination of FFS, managed care, and eligibility error rates. Individual state error rate components and state overall Medicaid error rates are combined to calculate the national component error rates and national overall Medicaid error rate. PERM accounts for the overlap between claims and eligibility reviews by calculating a small correction factor to ensure that Medicaid eligibility errors do not get “double counted” if the sampled item was also tested in either the FFS or managed care components. National component error rates and the national overall Medicaid program error rate are weighted by state size in terms of outlays, so that a state with a $10 billion Medicaid program “counts” 10 times more toward the national rate than a state with a $1 billion Medicaid program. For fiscal year 2011 reporting—the reporting period covered by our audit—CMS reported an estimated national Medicaid improper payment error rate of 8.1 percent or $21.9 billion ($21,448 million in overpayments and $453 million in underpayments). The weighted national component error rates are as follows: for Medicaid FFS, 2.7 percent; for Medicaid managed care, 0.3 percent; and for Medicaid eligibility, 6.1 percent. See appendix III for the state and national error rates for HHS’s fiscal year 2011 reporting of Medicaid improper payments. See appendix IV for the national Medicaid outlays and the estimated improper payment error rate reported in HHS’s AFRs for fiscal years 2007 to 2011. On February 4, 2009, the Children’s Health Insurance Program Reauthorization Act of 2009 (CHIPRA) was enacted. As required under Section 601 of CHIPRA, HHS published a final rule on August 11, 2010, effective September 30, 2010, which requires that PERM eligibility reviews be consistent with the state’s eligibility verification policy rather than reviewing eligibility against a single, federal methodology, which was done in the past. After publication of the final rule, states were allowed to review cases under the new methodology. Figure 2 shows the roll up of the error rate reported for fiscal year 2011. IPIA, as amended, requires the heads of federal agencies to report on the actions the agency is taking to reduce improper payments, including a description of the causes of improper payments identified, actions planned or taken to correct those causes, and the planned or actual completion date of the actions taken to address those causes. This law also requires heads of federal agencies to report on a description of the steps the agency has taken to ensure that agency managers, programs, and, where appropriate, states and localities are held accountable through annual appraisal criteria for (1) meeting applicable improper payment reduction targets and (2) establishing and maintaining sufficient internal controls, including an appropriate control environment that effectively prevents improper payments from being made and promptly detects and recovers improper payments that are made. According to OMB’s implementing guidance for IPERA, agencies should utilize the results of their statistical sampling measurements to identify the root causes of improper payments and implement corrective actions to prevent and reduce improper payments associated with these root causes. Agencies should continuously use their improper payment measurement results to identify new and innovative corrective actions to prevent and reduce improper payments. Agencies should also annually review their existing corrective actions to determine if any existing action can be intensified or expanded, resulting in a high-impact, high return on investment in terms of reduced or prevented improper payments. While CMS has responsibility for interpreting and implementing the federal Medicaid statute and ensuring that federal funds are appropriately spent—including estimating improper payments—the program is administered at the state level with significant state financing. Consequently, CMS relies primarily on states to develop and implement CAPs to address reported PERM errors. Following each measurement cycle, the states included in the measurement are required to complete and submit a CAP based on the errors found during the PERM process. In addition to guidance in the PERM Manual, CMS provides guidance to states on the CAP process upon releasing the PERM error rates and throughout CAP development. CMS’s PERM methodology for reporting a national Medicaid program improper payment estimate is statistically sound and meets OMB requirements. However, the process for accumulating the data used in deriving the reported national estimate does not consider the extent of any significant changes in state-level improper payment data that occurred after the initial year-end cutoff for state reporting. The impact of any such significant changes in states’ PERM reviews that were not concluded by the annual measurement cycle cutoff dates could significantly affect the calculation of the rolling 3-year average national Medicaid error rate reported each year. The design of CMS’s PERM methodology meets OMB requirements. CMS has documented the steps it took to design the sample and the steps taken to construct the sampling frame for the FFS, managed care, and eligibility review samples in its PERM Manual. The documentation also includes CMS’s process for ensuring that each sampling frame was accurate, timely, and complete. For error rate measurement for the FFS and managed care components, as outlined in the PERM Manual, CMS uses a stratified random sample selected quarterly within each state to provide cases for the data processing and medical review testing. For the eligibility component, as outlined in CMS’s PERM Manual, states use a simple random sample of eligible cases and negative cases, which are drawn each month during the measurement cycle. Absent an alternate methodology specifically approved by OMB, agencies must obtain a statistically valid estimate of the annual amount of improper payments in programs and activities for those programs that are identified as susceptible to significant improper payments. The estimates are to be based on the equivalent of a statistically random sample of sufficient size to yield an estimate with a 90 percent confidence interval of not more than plus or minus 2.5 percentage points around the estimate of the percentage of improper payments. CMS reports national Medicaid error rates at this 90 percent confidence interval to be consistent with OMB’s requirements, but CMS’s procedures provide that the sample size for PERM is to conform to OMB optional guidance for estimating payment errors—specifically, the PERM Manual specifies a target precision of plus or minus 3 percentage points at a 95 percent level of confidence within each state. The PERM Manual provides for the sample size for each state to be based upon the previous payment error rate and the OMB optional standard for the precision and confidence level. To estimate the percentage of dollars paid in error, CMS’s PERM Manual provides for using a ratio estimation methodology to produce the PERM estimate. This means the PERM payment error rate is a ratio of the estimated total dollars paid in error divided by the estimated total payments. The choice of ratio estimation methodology under these circumstances is statistically appropriate. The PERM Manual describes the data collection methods for the medical reviews, data processing reviews, and eligibility determinations. The PERM Manual also describes the statistical ratio estimation methodology to be used to produce the estimated percentage of dollars paid in error. CMS’s PERM Manual also provides for the error rates and summary reports to be provided to each state participating in the measurement cycle. We found that CMS’s PERM Manual is consistent with OMB statistical guidance. Although the CMS PERM methodology is statistically sound, CMS did not have procedures for considering the impact of any revisions to state-level error rates in calculating the national error rate after the cutoff date for each of the 3 measurement years. Specifically, the individual state error rates used to calculate the national error rate are not updated to reflect activities occurring after the PERM cycle cutoff.