Recent Developments in Section 1115 Waiver Budget Neutrality Policy

Health Highlights

Section 1115 of the Social Security Act permits the secretary of the Department of Health and Human Services to waive certain Medicaid program rules and provide federal funding for states to test innovative coverage and delivery system reforms that would further the objectives of the Medicaid program. While not required by statute or regulation, the Centers for Medicare & Medicaid Services (CMS) has a long-standing policy of requiring that Section 1115 demonstrations be “budget neutral” to the federal government—in other words, the cost to the federal government of the demonstration must be no more than the cost would have been in the absence of the demonstration. At the outset of each demonstration period, states negotiate with CMS what Medicaid spending would have been without the demonstration—this is known as the “without waiver” baseline and serves as a state’s budget neutrality cap. In general, states must keep actual waiver expenditures below the without waiver baseline or they may be required to make repayments to CMS.

While conceptually straightforward, budget neutrality has evolved into a convoluted set of calculations that do not always reflect actual Medicaid cost growth or states’ need for flexibility to respond to dynamic real-world circumstances (e.g., a pandemic or a substance use disorder crisis). Manatt’s Cindy Mann and Anne Karl, along with Heather Howard of Princeton University, described some of the challenges of budget neutrality in a recent Health Affairs forefront article. They point out that the current approach to budget neutrality:

  • Fails to acknowledge that spending increases may be needed to achieve key goals. Budget neutrality focuses entirely on program spending and does not account for how investments may lead to significant improvements in quality, access, equity or other priorities (even if they do not generate financial savings).
  • Discourages innovation. States are fully at risk when initiatives cost more than expected, discouraging states from pursuing bold new programs.
  • Impedes efforts to address historical inequities. Addressing historical underinvestment in communities and providers serving historically marginalized populations can require states to make offsetting spending reductions in other program areas, discouraging these types of investments.
  • Promotes short-term thinking. States only get budget neutrality “credit” for savings achieved within the five-year demonstration period. This discourages investments that are likely to achieve savings over the long term (e.g., investments in children’s health).
  • Is inequitable. Some states with long-standing waivers are able to access vast, hypothetical “savings,” allowing them to fund substantial investments. At the same time, states with newer waivers and those without a history of savings-generating policies are left with no ability to innovate without offsetting cuts.
  • Is inflexible. CMS generally has not allowed states to make mid-demonstration adjustments to budget neutrality to account for routine programmatic changes (e.g., state plan rate increases).
  • Fails to account for cross-program savings. Section 1115 waiver demonstrations may lead to savings for other federal programs (e.g., Medicare). States currently do not get budget neutrality credit for these savings. 

CMS has recently attempted to mitigate some of these shortcomings through its “rebasing” policy announced in 2018. This policy does level the budget neutrality playing field in some respects by limiting the ability of states with long-standing waivers to “bank” budget neutrality savings in perpetuity. However, this new policy does nothing to address many of the other challenges described above and may create further unintended challenges for states and CMS.

In recent months, CMS has stated an interest in addressing fundamental issues with its budget neutrality policy. As discussed above, one issue that states and other observers have raised with CMS as a persistent challenge has been the inability of states to adjust budget neutrality caps to allow for payment rate increases that otherwise would have been allowable under the Medicaid state plan or other authorities (e.g., directed payments). Two recent waiver approvals—an amendment in Kansas and an extension in Vermont—indicate that the administration has begun to take steps to address this issue in particular. We describe key features of each of these waiver approvals below:

  • Kansas. On June 17, CMS approved an amendment to the state’s KanCare demonstration for the sole purpose of adjusting the demonstration’s budget neutrality caps to account for changes to the state’s Health Care Access Improvement Program (HCAIP). HCAIP includes state-directed payments to hospitals that are authorized outside the demonstration; the Kansas legislature recently passed legislation authorizing the state to increase these payments. This waiver amendment adjusts the state’s budget neutrality caps for current and future demonstration years to accommodate these changes. In the recent past, CMS generally would not allow states to amend demonstrations solely for the purpose of making changes to budget neutrality, even if the policy necessitating the change would otherwise have been allowable under federal Medicaid law. This amendment suggests that CMS may take a more flexible approach to authorizing these types of changes moving forward.
  • Vermont. On June 28, CMS approved an extension to Vermont’s long-standing Global Commitment to Health demonstration. Alongside numerous other changes, the approval provides ongoing authority for the state to make adjustments to budget neutrality to account for provider rate increases. Notably, CMS will permit Vermont to make such changes without submitting a formal amendment. Instead, Vermont simply would need to separately request a budget neutrality adjustment from CMS; if approved by CMS, any changes would apply on the effective date of the rate increase. This approach—allowing budget neutrality adjustments without an amendment—further streamlines the budget neutrality adjustment process compared to the approach used in Kansas. While it is unclear which approach CMS will take for other states in the future, it is nonetheless encouraging that CMS recognizes this key shortcoming of existing budget neutrality policy and is taking steps to fix it. 

With a number of states in negotiations with CMS over significant changes to existing waivers and new demonstrations, CMS may be set to release further changes to its budget neutrality policy that go beyond allowing adjustments to account for regular rate increases. CMS could continue to make policy changes through the approval of waiver amendments, extensions and new demonstrations (as in Kansas and Vermont). It could also choose to release guidance that would take a more holistic approach to changing budget neutrality policy. In any case, states and other stakeholders should be encouraged that CMS has begun to take concrete steps to mitigate some of the biggest challenges associated with current budget neutrality policy. Section 1115 authority has long been used by states to make significant investments in advancing the federal government’s and states’ key health care priorities such as health equity, expanding coverage, improving quality and access, and driving delivery system and payment reform. Rationalizing budget neutrality policy will ensure that Section 1115 authority will continue to serve as a valuable tool for advancing these priorities.



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