CMS Issues Additional Guidance on Budget Neutrality for Section 1115 Waivers

Anne Karl, Partner, Manatt Health

On Wednesday, August 22, the Centers for Medicare & Medicaid Services (CMS) released a State Medicaid Director Letter (SMDL) memorializing its longstanding budget neutrality policies requiring that waivers under Section 1115 of the Social Security Act (“1115 waivers”) cost no more to the federal government than the Medicaid program would have cost, absent the waiver. The SMDL does not put forth significant new policies. Importantly however, the SMDL marks the first time CMS has issued formal guidance stating its approach to ensuring budget neutrality, providing states with much-needed clarity as they enter into waiver negotiations, and signaling the Trump Administration’s intent to scrutinize waivers to ensure that they are budget neutral.

Budget Neutrality Basics. The SMDL begins by restating that CMS will not approve 1115 waivers unless the applying state can demonstrate that the project will not result in the federal government spending more on the state’s Medicaid program than it would have likely spent without the waiver. Throughout the waiver negotiation process, CMS and the state develop estimates of what the state’s Medicaid program would have cost without the waiver—referred to as the “without waiver” scenario. Those estimates are then incorporated into the waiver’s special terms and conditions, acting as a cap on total spending during the demonstration. If a state exceeds the without waiver limits, it must repay the federal government for any federal spending above the cap. With the result that any spending above the cap must be funded with only state dollars.

Defining Budget Neutrality for New Waivers. Establishing the without waiver limits is a crucial part of any waiver negotiation, and the SMDL articulates the process CMS uses to establish those limits. The process outlined in the SMDL includes the following key features:

• Per capita spending. Budget neutrality limits are generally set on a per enrollee basis, ensuring that the state is at risk for per enrollee spending only and not for spending tied to enrollment increases. Often, per enrollee caps are broken out by eligibility group (e.g., low-income children or disabled adults) to reflect spending differences in different populations. In some limited cases, CMS may approve waivers with an aggregate spending cap, rather than a per enrollee cap, thereby putting the state at risk for increased enrollment.
• Historical spending data. The SMDL requires that states use spending data from the most recent five years to develop the spending baseline.
• Trend. The SMDL reiterates longstanding CMS policy that historical data will be trended forward based on the lower of the state’s historical spending trend or the Medicaid trend projected in the President’s budget (but never below zero). CMS notes that in rare circumstances, CMS may adjust the state’s historic trend to reflect unusual circumstances that are unlikely to recur in the future.
• Hypothetical expenditures. The SMDL also clarifies that certain expenditures during the waiver period that do not require waiver authority, like covering new optional benefits or populations, may be treated as “hypothetical” expenditures under the waiver. This means that the state will generally not need to use waiver savings to pay for those expenditures, but states also may not accrue waiver savings on these expenditures. Examples of hypothetical expenditures include expenditures for home and community based services similar to those that could be covered under section 1915(c) waivers or expenditures for the new adult group.

Re-Evaluating Budget Neutrality for Existing Waivers. The SMDL also describes how CMS will re-evaluate budget neutrality limits at waiver renewal, reiterating policy changes first announced in an all-state webinar in 2016.

Prior to the 2016 policy change, states with longstanding 1115 waivers could amass sizeable savings by trending forward base data used during the initial approval. In some cases, base data would be from twenty years prior, with no connection to recent Medicaid spending in the state. States with these longstanding waivers could then seek to reinvest these hypothetical savings to fund a wide range of initiatives, including waiver pools to support delivery system reform or cover uncompensated care.

Under the 2016 policy change and restated in the SMDL, states will no longer be able to carry forward waiver savings indefinitely. Instead, states can roll forward savings accrued in one waiver period only into the next waiver period. Additionally, CMS will rebase the without waiver spending caps using more recent historical data at each renewal effective beginning January 1, 2021. For states with existing 1115 waivers up for renewal prior to the January 1, 2021 rebasing, CMS announced a policy to phase down the waiver savings they have carried forward, allowing states to retain a larger portion of newly accrued savings and a smaller portion of older savings.

These changes will reduce the ability of states with longstanding 1115 waivers to accrue and use savings to support investments in the Medicaid program. For example, several states used waiver savings to fund Delivery System Reform Incentive Payment (DSRIP) programs. But for states seeking new waivers, this policy change effectively levels the playing field. Prior to this policy change, states with existing 1115 waivers often had large reserves of theoretical savings to tap into, while states applying for new waivers struggled to demonstrate that their waivers would be budget neutral. Going forward, all states will be required to identify new savings to off-set federal support for investments in delivery system reform or social interventions that might not otherwise be eligible for federal Medicaid.

By describing in some detail how CMS will apply the principles it uses when establishing budget neutrality caps, the SMDL demystifies what is frequently one of the most challenging parts of 1115 waiver negotiations. Armed with a clear roadmap for how to demonstrate budget neutrality, states are now better positioned to identify and remedy potential budget neutrality challenges prior to submission, allowing for smoother negotiation processes.