On August 22, 2018, the Centers for Medicare & Medicaid Services (CMS) released a State Medicaid Director Letter (SMDL) memorializing its long-standing 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 waivers. 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 act 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 costs is a crucial part of any waiver negotiation, and the SMDL articulates the process CMS uses to establish those limits. Under the process outlined in the SMDL, states will use spending data from the most recent five years to calculate a historical spending baseline. CMS will then trend forward that baseline using the lower of the state’s historical spending trend or the Medicaid trend projected in the president’s budget. The trended baseline spending will serve as a per capita spending cap, putting the state at risk for spending per enrollee but not for spending tied to enrollment growth. The SMDL highlights a few exceptions to this general process, such as for certain expenditures during the waiver period that do not require waiver authority.

Reevaluating Budget Neutrality for Existing Waivers. The SMDL also describes how CMS will reevaluate 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 existing 1115 waivers could amass sizeable savings by trending forward base data used during the initial approval. In some cases, base data would be from 20 years prior, with no connection to recent Medicaid spending in the state. States with these waivers could then seek to reinvest these hypothetical savings into a wide range of initiatives, including waiver pools to support delivery system reform or cover uncompensated care.

Under the 2016 policy change and as restated in the SMDL, states will no longer be able to carry forward waiver savings indefinitely. Instead, CMS will limit how long a state may carry forward waiver savings, and CMS will rebase all without-waiver spending caps using more recent historical data at each renewal, effective beginning January 1, 2021.

These changes will reduce the ability of states with long-standing 1115 waivers to accrue and use savings to support new investments in the Medicaid program, reducing federal spending. For example, several states used waiver savings to fund Delivery System Reform Incentive Payment (DSRIP) programs. 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 offset federal support for investments in delivery system reform or social interventions that might not otherwise be eligible for federal Medicaid funding.

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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 road map 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.