TennCare III Demonstration: Overview and Implications
Jocelyn Guyer, Adam Striar, and Patricia Boozang, Manatt Health
On January 8, the Centers for Medicare and Medicaid Services (CMS) approved a ten-year Medicaid demonstration project in Tennessee that imposes an aggregate cap on federal funding (subject to certain adjustments). The waiver has received much attention because it has been described as a “block grant” and allows Tennessee to access “shared savings,” but also because it allows the state to operate a closed formulary without foregoing rebates, sets a 10-year term for the waiver, and continues a sizable uncompensated care pool. While certain features may generate interest from some states, the waiver is unlikely to establish significant new precedent that will be observed by the Biden administration and, in fact, may be subject to further review by the new administration and to litigation by pharmaceutical companies or others. The Biden administration could potentially seek to unwind components of Tennessee’s waiver, particularly if it becomes clear that the waiver is not “budget neutral” to the federal government or litigation emerges over the prescription drug provisions of the waiver.
Under Tennessee’s Demonstration (referred to as “TennCare III”), the state has accepted a cap on Medicaid expenditures for which it can receive federal Medicaid matching dollars. CMS calculated the aggregate cap for the first five years of the Demonstration based on 2019 expenditure data by trending forward expenditures for each year based on the President’s Budget trend rate for each of the major eligibility groups. If, in a given year, TennCare enrollment is more than 1 percent above or below the 2019 enrollment baseline, the aggregate cap for that year will be adjusted based on actual enrollment and projected per capita expenditures, effectively converting the arrangement to a per capita cap. Since Medicaid enrollment in Tennessee already well exceeds 2019 enrollment, the per capita adjustment (referred to as a “risk corridor” in the terms and conditions of the Demonstration) is likely to go into effect during the first Demonstration year. Furthermore, CMS permitted Tennessee to retain approximately $6 billion in savings from the TennCare II Demonstration, allowing the state to fall back on these savings if it otherwise exceeds its cap.
Tennessee will have the ability to capture “shared savings” if its expenditures fall below the cap in a given year and the state satisfies certain quality benchmarks. Depending on quality performance, the state will have the ability to access up to 55 percent of the difference between the cap and actual Demonstration expenditures. Tennessee will be permitted to divert these “savings” to CMS-approved Designated State Investment Programs (DSIPs)—state-funded health initiatives that would not normally qualify for federal Medicaid funding and that CMS previously indicated would no longer be allowed. While the state is only authorized to spend savings on pre-approved DSIPs, the state will be able to use federal Medicaid dollars to supplant existing state spending on these programs, thereby freeing up state dollars for use on other priorities.
Implications for Other States
The Biden administration is likely to view the Tennessee waiver as an effort by the preceding administration to establish a demonstration with features akin to a block grant before leaving office. As such, it is unlikely to recognize the Tennessee waiver financing strategy as a relevant precedent for other states. Along with concerns about an aggregate cap, the Tennessee Demonstration could prove costly to the federal government. CMS granted Tennessee a per capita trend rate for enrollment adjustments that appears high relative to Tennessee’s recent experience. Specifically, the per capita trend rate for the “risk corridor” is set at between 4.5 percent and 5.5 percent per year, depending on the eligibility group. In comparison, Tennessee’s actual per capita growth in recent years has been substantially lower across most eligibility groups. And even if Tennessee exceeds its aggregate cap, it will be able to fall back on savings carried forward from TennCare II Demonstration. In combination with the “shared savings” provision of the Demonstration, the relatively generous approach to budget neutrality means that the waiver could increase rather than reduce federal expenditures, at least until 2026 when the waiver will be re-based.
While the Biden administration is highly unlikely to approve an aggregate cap similar to Tennessee’s arrangement, it is possible that it may provide more information on how Tennessee secured its trend rates or consider use of Medicaid funds for health-related initiatives, especially if done so in a manner it deems consistent with its priorities for the Medicaid program (e.g., combatting the COVID-19 pandemic, reducing disparities in health outcomes, or addressing the health and well-being of young children).
Closed Formulary with Continued Rebates
Under the Medicaid Drug Rebate Program (MDRP), pharmaceutical manufacturers offer discounts on their prescription drugs in exchange for a guarantee that the drug will be covered in all state Medicaid programs for “traditional” (i.e., non-expansion) Medicaid populations. Under the TennCare III Demonstration, CMS will allow the state to establish a closed formulary that limits coverage to a single drug in each therapeutic class, with certain exceptions, while also continuing to receive federal rebates. The closed formulary can be applied to all non-expansion adults, including pregnant women and people with disabilities.
Implications for Other States
Many states have long been interested in operating a closed formulary without being required to forego rebates. For example, in 2017, Massachusetts submitted a proposed amendment to its 1115 waiver requesting authority to implement a closed formulary in the state’s Medicaid program while retaining mandatory federal rebates. CMS did not approve this request and stated that it would only consider approving a closed formulary if the state agreed to forgo mandatory federal rebates, suggesting that CMS had concluded that it did not have the legal authority to require continued rebates while allowing the state to operate a closed formulary. The Tennessee waiver approval raises the possibility that CMS has determined it may have the authority to require continued rebates even for states establishing closed formularies. Even if this is the case, pharmaceutical manufacturers and other stakeholders are likely to challenge the legality of this section of TennCare III. Moreover, the Biden administration may be unlikely to grant a closed formulary in future waivers given significant concern among patient advocacy groups that such a strategy will reduce access to essential medications.,
Uncompensated Care Funding
TennCare III authorizes continued funding for the state’s virtual disproportionate share hospital (DSH) and uncompensated care fund for charity care pools at levels similar to those authorized under the TennCare II waiver. However, under TennCare III, CMS will allow Tennessee to develop the distribution methodology without prior approval from CMS. In total, the virtual DSH fund is authorized for up to $508 million per year for all ten years of the Demonstration. The uncompensated care fund is authorized up to actual reconciled expenditures through the fund for the last year of the TennCare II Demonstration, which was authorized for up to $253 million per year.
Implications for Other States
During the Obama administration, CMS had increasingly scrutinized states’ uncompensated care pools, and moved toward eliminating federal funding for populations that could otherwise receive comprehensive health coverage under the Affordable Care Act Medicaid expansion. The Trump administration took a different approach to uncompensated care pools, approving a number of demonstrations that will extend into the Biden administration, including 10-year approvals in Texas and Florida in January 2021. Given that Medicaid expansion is a key priority for the Biden administration, it is likely to return a policy of extensively reviewing uncompensated care pools in non-expansion states. It may even seek to modify, or phase down funding of significant uncompensated care pools.
Ten Year Approval Period
CMS authorized TennCare III for a 10-year demonstration period (January 8, 2021 through December 31, 2030). Historically, most Section 1115 demonstrations have been approved for periods of only five years, and prior to TennCare III, no new demonstrations had been approved for a period of ten years.
Given the unprecedented duration of an approval of this nature, TennCare III could be subject to oversight efforts by the Biden administration and Congress related to last-minute waiver approvals by the Trump administration. CMS approved two other ten-year waivers in Florida and Texas less than a week prior to the inauguration of President Biden, bypassing normal public notice requirements in the Texas approval. While approval of the Tennessee Demonstration followed standard public notice procedures, it could become involved in related oversight actions.
Implications for Other States
Many states are likely to be interested in pursuing 10-year waiver approvals, but the position of the Biden administration on this issue is unclear. It is possible that it could allow states to extend existing waivers with demonstrated results for periods of ten years. However, it is highly unlikely that it will allow 10-year approvals of new demonstrations, particularly those that include provisions that have never been approved in other states or that are the subject of controversy.
The waiver approval authorizes several other policies providing Tennessee with additional programmatic flexibilities. Notable examples include the following:
- The state will be permitted to add coverage for new populations or new services during the Demonstration period without approval from CMS. The state will have broad flexibility to target these changes, including by imposing enrollment caps on newly covered populations or by limiting newly covered benefits to only certain Medicaid populations.
- As under the state’s previous demonstration, Tennessee will be permitted to impose cost sharing on prescription drugs and certain hospital and physician services in addition to premiums and a $15,000 annual coverage maximum for wraparound services for certain children enrolled via the “Katie Beckett” eligibility pathway.
- The state will be permitted to suspend Medicaid eligibility for up to 12 months for individuals who have been convicted of Medicaid fraud.
The waiver also includes some requirements to protect enrollees in light of newly approved flexibilities:
- The state will be required to provide three-month retroactive coverage to pregnant women, children, and young adults, paring back Tennessee’s previous waiver of retroactive eligibility.
- The state will be required to adhere to quality and access monitoring requirements in order to track the impact of the aggregate cap model.
Implications for Other States
Many of these provisions are long-standing features of the TennCare system. In general, they appear designed to give the state flexibility to limit or target coverage and/or benefits and, as such, are not likely to be of particular interest to a Biden administration. Notably, the Trump administration scaled back the state’s existing waiver of retroactive eligibility, a decision with which the Biden administration is likely to agree, suggesting that states with existing retroactive eligibility waivers should perhaps be prepared that they could be rolled back or fully eliminated.
While there are aspects of the TennCare III Demonstration that could be beneficial to certain states, it is unlikely that this approval will establish significant precedent. Rather, the Biden administration may view the approval as a last-minute effort to advance longstanding goals to restructure Medicaid financing. President Biden signed an executive order on January 28, 2021 directing federal agencies to “examine” demonstrations and waivers. The decision to issue this order just eight days after taking office suggests CMS is likely to be scrutinizing the Tennessee and other recent waivers with extra care, minimizing or eliminating the extent to which they provide a precedent for future waiver approvals.
 The waiver term runs from January 8, 2021 through December 31, 2030.
 CMS will also “rebase” expenditures and enrollment beginning in year 6 of the 10-year Demonstration.
 The terms and conditions of the wavier do not explicitly address how the cap would be adjusted if Tennessee were to expand Medicaid in the future, but, the per capita adjustment creates a vehicle by which Tennessee could potentially add the expansion group to the waiver in future years.
 Tennessee is the first state to receive an aggregate funding limit in many years, but, such financing mechanisms are not entirely unprecedented. The Bush administration approved an aggregate cap for Vermont in 2005 and for Rhode Island in 2009. As with the Tennessee Demonstration, Rhode Island and Vermont were allowed to access a share of federal Medicaid “savings” if actual expenditures came in beneath the aggregate cap via a mechanism similar to DSIPs.
 The Katie Beckett program provides a special Medicaid eligibility pathway for children with disabilities or other complex medical needs. The $15,000 cap applies only to certain wraparound services for a limited subset of enrollees; the cap will not apply to regular medical benefits.