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Spotlight on... Medicaid:
State Policies That Result in Inflated Federal Costs

Signed into law in 1965, Medicaid ensures health coverage for nearly 60 million Americans today. Since the Medicaid program was established, the costs and responsibilities for administering it have been shared between the States and the Federal Government. However, a number of OIG reports have cited examples of State policies that distort the cost-sharing arrangement, causing the Federal Government to pay more than its share of Medicaid expenditures. These mechanisms do not result in any increase in benefit to beneficiaries, and while they increase States' funds, they do so at the expense of the Federal Government and, ultimately, Federal taxpayers.

For example, a 2014 report entitled Pennsylvania's Gross Receipts Tax on Medicaid Managed Care Organizations found that a specific tax Pennsylvania introduced on Medicaid managed care organizations appears to be an "impermissible health-care-related tax" under Federal requirements. A State cannot use such funds to finance its share of Medicaid costs. However, OIG found that Pennsylvania applied a portion of what it collected from the tax to its share of Medicaid costs and, as a result, obtained nearly $1 billion in Federal Medicaid funds from 2009-2012. OIG recommended that to address this problem in Pennsylvania and other States, CMS clarify its policy concerning permissible health-care-related taxes. As a result, on July 25, 2014, CMS issued guidance to State Medicaid Directors and State Health Officials on the taxation of health-care-related services and items.

State policies that inflate Federal costs for Medicaid are not a new trend; OIG identified this issue in a series of reports from the early 2000s focusing on hospitals and nursing homes. These reports found numerous examples in which States developed creative funding mechanisms to apply money from intergovernmental transfers - between government entities - to the States' share of Medicaid costs, thus driving up the amount the Federal Government would have to match. States transferred the additional Federal Medicaid money to their general treasury funds to use for a range of purposes with no direct link to improving quality of care or increasing Medicaid services. In essence, the intergovernmental transfers reduced the States' share of Medicaid costs and provided them with money to apply for whatever purposes they wanted by gaming the matching formula so the Federal Government would pay significantly more than its share. OIG has seen numerous examples in which States then redirected that additional money for other purposes while medical facilities remain underfunded.

Since these reports, both CMS and Congress initiated a number of changes to close this loophole, most notably the introduction of an upper payment limit for State-owned providers, non-State-owned government providers, and private providers. These changes limit the amount a State can pay for a service to the amount that Medicare would pay for that service. This restricts States' abilities to collect excessive funds from Federal matching. The changes did produce improvements: a projected $79 billion saved over 10 years.

However, other potential loopholes remain. For example, the report entitled Medicaid Rates for New York State-Operated Developmental Centers May Be Excessive notes that for developmental centers, a type of facility providing care for beneficiaries with intellectual and developmental disabilities, there is no equivalent Medicare benefit to use as a guideline for the upper payment limit. Payment rates, instead, were based on "total reimbursable operating costs," which reflects several factors, but the actual cost of the service is not one of them. This is particularly concerning because the daily payment rate for a Medicaid beneficiary in a developmental center jumped from $195 per day in 1985 to $4,116 a day in 2009, more than nine times the rate of increase in that timeframe at similar care centers. Put in context, if New York used actual costs in calculating its payment rates for fiscal year (FY) 2009, payments would have been $1.41 billion less, saving the Federal Government $701 million. Since we issued our report, CMS has kept us informed on this topic. CMS is currently taking action to recover a portion of the payments from State FY 2010 - 2011 as well as to retroactively adjust reimbursement rates for State FY 2013 - 2014, which were based on data from State FY 2010 - 2011. Since Medicare does not pay for these services, CMS found that these payments violated previously issued guidance on upper payment limits requiring States to pay based on reasonable cost.

OIG found similar evidence of inflated payments in the report entitled Medicaid Rates for Residential Rehabilitation Services Provided at New York State-Operated Residences Are Excessive. These services are covered under a waiver program, and payment rates are calculated according to three factors set forth in 1992, which do not include actual costs. Examining payments in FY 2010, OIG found that the payment rate for residential rehabilitation services at State-operated residences was more than double the average rate at privately operated residences. If New York used actual costs to calculate payment rates for FY 2011, total reimbursement would have been $692 million less than what New York claimed, a difference of $346 million for the Federal Government's share.

Collectively, the findings of OIG work suggest a need for a definitive regulation linking Medicaid payments to the actual cost of service. In January 2007, CMS proposed a rule that would have limited Medicaid reimbursement rates for public providers to provider's costs. It was estimated that this would result in savings of $120 million in the first year and $3.87 billion over 5 years. CMS published the final rule in May 2007. However, this occurred during the Congressional moratorium prohibiting the implementation of such a rule for 1 year, and therefore a 2008 U.S. District Court decision forced CMS to eventually withdraw the regulation.

OIG continues to recommend that CMS seek this legislative change to strengthen its ability to curb the wasteful Federal spending that occurs when States claim reimbursement for excessive payments. OIG's Compendium of Priority Recommendations highlights this issue and recommendation as a critical way to protect the integrity of the Medicaid program for years to come.


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