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Summary
The budget neutrality requirement under a comprehensive section
1115 waiver has received little scrutiny so far during the Medi-Cal
Redesign workgroup meetings but poses substantial risks to state
finances, to millions of Medi-Cal beneficiaries, and to the health
care providers that serve them.
Under a comprehensive section 1115 waiver, the federal
government requires a state to demonstrate budget neutrality. That
is, federal Medicaid spending under the waiver must not be any higher
than it would have been in the absence of the waiver. (This requirement
even applies to waivers that do not propose to expand Medicaid coverage
to new populations or benefits.) In order to enforce this waiver
requirement, the Office of Management and Budget (OMB), in conjunction
with the Centers for Medicare and Medicaid Services (CMS), requires
the state to accept a cap on federal Medicaid financing over the
five-year life of the comprehensive waiver. The cap is intended
to approximate future federal Medicaid expenditures in the state's
Medicaid program as if the waiver was not in place. If a state is
in danger of breaching the budget neutrality limit, the state must
reduce its federal Medicaid spending accordingly during the five-year
duration of the waiver to stay within the budget neutrality cap.
The chief concern with the budget neutrality requirement
is that it would place a limit on the federal Medicaid funds available
to the state for the entire Medi-Cal program over the next five
years. Unlike the current Medicaid financing structure where the
federal government guarantees it will pay a proportion of state
Medicaid costs whether they are higher or lower-than-expected (50
percent for California), a cap would provide a fixed amount of federal
Medicaid funding (either calculated on an aggregate or on a per
beneficiary basis) irrespective of a state's actual needs. Only
a few states have accepted the fiscal risk of a cap placed on a
large portion of their Medicaid programs but have done so only in
exchange for major expansions to new populations and/or benefits.
In that case, if a state runs afoul of the budget neutrality limit,
the new expansion would be primarily at risk, not current beneficiaries.
In the case of California's proposed Medi-Cal waiver, however, no
coverage expansions are contemplated and thus the adverse consequences
of a budget neutrality cap would fall exclusively on current beneficiaries.
The inflexible nature of such a federal funding
cap is likely to severely restrict the ability of the state in meeting
the needs of its residents due to unexpected circumstances such
as an economic downturn, an epidemic, a natural disaster, or the
availability of a new breakthrough health care drug or technology.
If such events increase state Medi-Cal costs to higher-than-expected
levels, federal funds would not automatically rise in response.
Moreover, it is likely to deter enactment of future improvements
to the Medi-Cal program because the state may not receive additional
federal funds to help pay for those improvements or expansions.
As a result, if this budget neutrality cap amount proves to be inadequate
to meet the financing needs of the state of California, of the more
than six million beneficiaries on the Medi-Cal program, and the
health care providers that serve them, the state may have no choice
but to institute further cuts to eligibility, benefits and/or provider
reimbursement rates, in addition to the cost containment provisions
proposed under the waiver, in order to stay below the budget neutrality
limit over the five-year life of the waiver.
Consequently, while the state is proposing a comprehensive
Medi-Cal reform waiver in order to constrain Medi-Cal spending over
time, the waiver may in fact place the state at great financial
risk. Moreover, within a context of a worsening federal fiscal outlook
and the Bush Administration seeking to reduce federal Medicaid funding
for all state Medicaid programs through a variety of legislative
and administrative proposals, it is likely that the federal government
would strictly enforce the budget neutrality requirement.
Because of the large risks such a budget neutrality
cap poses to the state of California, it is essential that state
policymakers, beneficiaries and health care providers understand
the dangers of these waiver financing issues. In particular, for
the many cost-efficiencies and federal funding maximization strategies
that could be accomplished without a waiver, the state should weigh
the benefits of instituting such changes within a waiver (even though
they are already permitted under federal law) against the substantial
fiscal risks inherent in any comprehensive Medicaid waiver.
Background on the Federal Budget Neutrality
Requirement for Waivers
The Office of Management and Budget and CMS require that any state
seeking a comprehensive section 1115 Medicaid waiver must show
that the waiver demonstration project will be “budget neutral”
in terms of federal Medicaid expenditures. In other words, over
the customary five-year period of an 1115 waiver, federal Medicaid
expenditures must not exceed what the federal government would
have spent in the absence of the waiver. Budget neutrality is not
required by statute or regulation but is a long-standing OMB administrative
policy.
The federal government requires a state to meet
the budget neutrality requirement in one of two ways. A state can
accept an aggregate limit on federal Medicaid spending subject to
the waiver (i.e. a fixed dollar limit or allocation for all Medicaid
spending subject to the waiver) or a state can accept a per capita
cap (i.e. a fixed dollar limit or allocation per beneficiary subject
to the waiver). The limits are set at a level negotiated by the
state and the federal government that is intended to approximate
what federal spending over the next five years would have been without
the waiver in place. In general, such limits are based on a state's
historical spending for the parts of the Medicaid program to which
the waiver applies and then inflated annually by a negotiated trend
rate.
The federal government sets year-by-year federal
spending targets and periodically reviews state compliance with
such targets to determine if the state is on track in meeting the
overall budget neutrality requirement. If the federal government
or the state expects the state will exceed the budget neutrality
limits during the five-year life of the waiver, the state must reduce
Medicaid spending accordingly to stay below the federal spending
cap. (Alternatively, the state may repay any excess federal Medicaid
funding to the federal government at the end of the five-year life
of the waiver, though it is our understanding that no state has
ever elected this repayment option.)
Significant Concerns with the Budget
Neutrality Requirement for Waivers
The federal budget neutrality requirement requires that the state
of California accept an effective cap on federal Medicaid funding
as a condition for federal approval of its waiver. Because the state
may institute a number of the policy changes envisioned in its waiver
proposal under existing federal law without a waiver, it does not
appear fiscally prudent or necessary that the state pursue a waiver
and thus allow the federal government to place an effective cap
on federal funding over the entire Medi-Cal program.
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All 1115 waivers must meet a budget neutrality requirement
including waivers without coverage expansions. Some state officials
may believe that the Medi-Cal redesign waiver would not run
afoul of budget neutrality requirements because the waiver does
not propose any Medi-Cal expansions to new populations or benefits.
Yet the state of Washington made a similar argument as part
of its waiver to impose and/or increase premiums on its Medicaid
beneficiaries; the state argued that because its new premium
requirements would discourage enrollment, it would reduce federal
and state Medicaid costs and therefore the state would not have
to subject itself to a budget neutrality cap. The federal government,
however, advised the state that it was nonetheless required
to meet federal budget neutrality requirements. As a result,
the federal government required the state of Washington to accept
a per capita cap under its Medicaid program as part of its premium
waiver.
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A budget neutrality requirement effectively places a cap
on federal Medicaid financing just as a “block grant”
would limit federal funding. The budget neutrality limit intended
to approximate federal Medicaid spending in the absence of a
waiver is usually based on a state's historical federal Medicaid
spending adjusted annually by a negotiated trend rate. Like
a “block grant”, this limit constitutes a cap on
federal Medicaid spending for the state.
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Under a block grant, such as one proposed by the Bush Administration
as part of its fiscal year 2004 budget, a state would accept
annually a capped allotment of federal Medicaid funding for
most or all of its Medicaid program. As with a budget neutrality
cap, the capped allotment would be likely based on a state's
historical spending adjusted by some inflation rate whether
national or state-specific (the Bush Administration had discussed
a trend rate equal to the average annual projected national
Medicaid spending increase over the next 10 years). Such an
aggregate cap would not automatically adjust for unforeseen
events such as economic downturns or the availability of new
health care technologies that would lead to higher-than-expected
Medicaid costs as would the current federal Medicaid matching
rate system. If a state exceeds its block grant allocation,
it would have no choice but to scale back eligibility, benefits
and provider reimbursement rates or increase state funding.
A state at its block grant limit would also be unable to receive
additional federal funding to share in financing any improvements
to its Medicaid program such as expanded eligibility or more
adequate provider rates.
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Some recent comprehensive Medicaid waivers include budget
neutrality caps that look virtually identical to the federal
funding caps under the Administration's proposed block grant.
As part of
“Pharmacy Plus” waivers that extended Medicaid
drug coverage to low-income Medicare beneficiaries with incomes
too high for Medicaid, in order to meet budget neutrality requirements,
the federal government required states to accept aggregate
caps on all Medicaid spending for the existing non-expansion
elderly beneficiaries. While the caps applied only to the elderly,
the caps were highly similar to the block grant proposal's
capped allotments. The Bush Administration block grant caps,
however, would have applied to all Medicaid spending for optional
beneficiaries and/or benefits (which constitutes nearly two-thirds
of total Medicaid spending) while the Pharmacy Plus caps apply
to all mandatory and optional spending related only to the
elderly.
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State officials have attempted to allay stakeholder concerns
that the Medi-Cal waiver may lead to a block grant of federal
financing of California's Medi-Cal program by stating that the
state would never accept a block grant as part of its waiver
negotiations with the federal government. However, by seeking
a comprehensive section 1115 waiver applying to its entire Medi-Cal
program and having to satisfy federal budget neutrality requirements
whether as an aggregate cap or a per capita cap, the state is
essentially limiting the federal Medicaid funding the state
can receive over the five-year life of the waiver just like
it would have under a capped allotment provided under the Bush
Administration's block grant proposal from last year.
Using a per capita calculation to meet the budget neutrality
requirement rather than an aggregate cap does not eliminate
the risks that budget neutrality poses to the Medi-Cal program.
As noted, the federal government requires states to meet the
federal budget neutrality requirements using either an aggregate
cap or a per-capita cap. A per capita budget neutrality calculation,
however, does not eliminate the fiscal risks. A per capita limit
is preferable to an aggregate cap because such a limit automatically
adjusts for higher-than-expected increases in Medicaid enrollment.
For example, during an economic downturn, more people lose their
jobs and health insurance and become eligible for Medicaid.
A per capita cap would be able to adjust automatically for this
contingency. For any other factor that would produce greater
costs than projected per beneficiary (such as the availability
of new breakthrough drugs or other medical technologies), the
state would still bear the financial risk that such factors
would increase Medi-Cal costs in excess of the budget neutrality
per-capita limit.
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Basing the budget neutrality calculation on historical costs
incorporates the state's traditionally lower-than-average per
capita spending as well as recently enacted Medi-Cal cuts and
cost-containment measures. As noted, budget neutrality caps
are calculated based on historical costs adjusted by an annual
inflation trend rate. Yet, Medicaid spending per capita in
California is already the lowest in the nation. That depressed
per capita spending (which was further reduced by recent budget
cuts and other cost-containment measures) would serve as the
basis for the budget neutrality cap under the waiver, whether
instituted as an aggregate cap or per capita cap. If the state
of California decides over the life of the waiver to restore
or further increase provider reimbursement rates, it is likely
to run afoul of the budget neutrality cap even if Medi-Cal
costs do not otherwise rise at a faster rate than the annual
trend rate provided under the budget neutrality calculation.
That is because low reimbursement rates are one of the principal
factors driving the low per capita spending in California.
Similarly, if the state wishes to reverse some of the recently
enacted Medi-Cal budget cuts once the state budget recovers,
it would face similar financial difficulty. Future such improvements
in the Medi-Cal program over the five-year life of the waiver
are therefore likely to be effectively barred by the budget
neutrality requirement. The state would get no additional federal
funds to help finance provider rate increases or budget cut
restorations if the improvements would push the state over
the budget neutrality limit. Alternatively, the state would
have to pay for the rate increase or restorations with solely
state dollars.
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Negotiating a “good budget neutrality deal” does
not guarantee adequate federal Medicaid financing. While presumably
no state would intentionally accept a “bad deal”
with a patently inadequate budget neutrality cap, there are
examples where a state has placed itself at obvious risk of
having insufficient federal funding. In South Carolina's Pharmacy
Plus waiver, the federal government required (and the state
accepted) a Medicaid spending inflation trend rate for its
funding cap of the elderly population that was well below its
historical Medicaid inflation rates for the elderly. Under
the South Carolina waiver, the budget neutrality trend rate
averaged 7.4 percent over the five-year life of the waiver.
That rate was substantially lower than South Carolina's historical
Medicaid spending increases for the elderly which constituted
7.8 percent in the year prior to the waiver and averaged 11.1
percent over the previous three years.
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Even if the state of California does not follow in South Carolina's
footsteps and believes it has negotiated a budget neutrality
cap “with lots of room” that equals or exceeds historical
Medi-Cal spending in prior years, it remains a distinct possibility
that the state may still experience higher-than-expected increases
in Medi-Cal costs due to a host of unforeseen events occurring
over the course of the waiver. A “good budget neutrality
deal” may still end up being inadequate in providing sufficient
federal Medi-Cal funding to meet the needs of the state (and
provide less federal matching funds than would have been available
under the current federal Medicaid matching structure). Moreover,
there is no “good budget neutrality deal” when
the cap on federal Medicaid funding would apply to the entire
Medi-Cal program.
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Adjustments and exceptions to the budget neutrality requirement
are neither likely to be accepted by the federal government
nor likely to be adequate in meeting unexpected state Medi-Cal
costs. State officials have stated they would seek to ensure
to have their budget neutrality cap adjusted upwards if unforeseen
circumstances occur (though CMS has not indicated whether it
would even entertain and/or grant these adjustments). Yet these
protections are unlikely to be approved by the federal government.
To our knowledge, current or past waivers have not permitted
states to have similar such exceptions or adjustments to their
budget neutrality caps. (The state of Washington sent a letter
unilaterally to CMS seeking such exceptions after the waiver
was finalized over growing concerns about the effect of the
budget neutrality limit on the state's finances but it does
not appear that CMS accepted that demand.)
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Furthermore, any budget neutrality adjustments gained by the
state would still likely be inadequate. Rising Medi-Cal costs
attributable to factors that are not among the enumerated exceptions
would not trigger more federal funding. For example, the state
may negotiate an exception for new drugs or technologies but
not increases in utilization of more expensive, existing services.
No state can predict all of the potential scenarios that would
drive Medicaid costs to higher-than-expected levels. Nor is
there any guarantee that the adjustment would equal the federal
funding increase that the state of California would have otherwise
received under the current federal matching structure. If the
state can only obtain an upward adjustment through the waiver
negotiation process, there is no assurance that the state will
have continued leverage to get adequate adjustments once the
waiver is already implemented.
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The federal government is more likely to strictly enforce
the budget neutrality requirement than in the past. State officials
may argue that in recent years a number of states have operated
comprehensive waivers without any fiscal concerns about the
budget neutrality requirement. That is because in order to encourage
waivers that have expanded coverage, the federal government
has traditionally negotiated budget neutrality trend rates generously
and has not strictly enforced the budget neutrality requirement.
(Or in the case of the Los Angeles County waiver, the federal
government expansively defined budget neutrality in order to
explicitly stabilize financially the county's safety net.)
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The federal environment has since transformed substantially.
The federal government is now committed to reducing or limiting
federal financial responsibility for Medicaid and increasing
federal oversight of state Medicaid programs. As already discussed,
the Bush Administration has previously proposed to cap federal
Medicaid spending through a block grant. This year, it has proposed
to reduce federal Medicaid spending by $24 billion over 10 years
through a crackdown on state Medicaid financing schemes. In
an unprecedented (and in part, likely unlawful move), it has
also proposed administratively to require pre-approval of state
Medicaid budgets, prospectively withhold federal Medicaid funds
to which states are entitled, and place up to 100 federal auditors
in state budget offices to ensure that states are using federal
Medicaid funds more appropriately. Furthermore, as of federal
fiscal year 2001, spending under comprehensive section 1115
waivers accounted for nearly one-fifth of total Medicaid spending
nationwide. With such a large percentage of federal Medicaid
spending already operating under waivers (and California's Medi-Cal
reform waiver, if implemented, would substantially increase
that proportion), federal scrutiny (and enforcement) of section
1115 waivers and their federal financing is likely to be strict.
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The state would likely have little bargaining leverage when
the waiver is up for renewal in five years and as a result,
the budget neutrality cap is likely to be further reduced.
Considering the ballooning federal budget deficit, the looming
retirement of the baby boom generation and rising health care
costs generally, the federal government is likely to be far
less generous in negotiating a budget neutrality limit when
the waiver comes up for renewal in five years. Even if the
state believes it has negotiated a “good deal” for the initial five-year
waiver period — for example, the state gets some additional
upfront federal spending built into its budget neutrality base
to create more “room” — the federal government
is likely to substantially reduce the budget neutrality limits
upon renewal.
Conclusion
The financing and waiver budget neutrality issues are critical components
of the waiver that must be examined more closely by state policymakers,
beneficiaries and health care providers alike. Subjecting the entire
Medi-Cal program to a federal funding cap (whether as an aggregate
cap or on a per capita basis), as would be required under federal
waiver budget neutrality rules, is likely to pose substantial risks
to state finances, to the more than six million low-income Californians
who rely on the Medi-Cal program, and the health care providers
that serve them. As a result, the state should reconsider pursuing
a comprehensive Medi-Cal reform waiver and instead institute a number
of the various cost-saving and federal maximization strategies that
minimize the adverse effect on beneficiaries and providers and that
were discussed and recommended during the workgroup process. Many
of these potential changes to the Medi-Cal program are already permissible
under federal law and thereby could be implemented relatively quickly
without the financial risk of a waiver.
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