Recent Updates to Section 1115 Waiver Budget Neutrality Policy: Overview and Implications for States

Health Highlights

Editor’s Note: Section 1115 Medicaid demonstrations enable states to develop innovative programs for improving the health and well-being of Medicaid enrollees. Long-standing federal policy requires that 1115 waivers be “budget neutral” to the federal government. Though conceptually simple, budget neutrality policy has evolved into a complex process that is burdensome to states and the Centers for Medicare & Medicaid Services (CMS). During the summer of 2022, CMS began to roll out a series of changes to budget neutrality policy through state waiver approvals. In a new issue brief prepared for the Robert Wood Johnson Foundation State Health and Value Strategies program, summarized below, Manatt highlights the key policy changes established through recent waiver approvals in Oregon and Massachusetts (and reinforced through approvals in Arizona and Arkansas) and discusses key implications for states. Click here to download a free copy of the full issue brief.

To register for our upcoming webinar sharing how the innovative 1115 waivers that CMS approved for Oregon, Massachusetts and Arizona articulate a new framework for waivers seeking to implement health-related social needs (HRSN) initiatives, click here. The webinar will feature a panel of state leaders from Oregon, Massachusetts and Arizona providing key insights into the HRSN approval process—and real-world lessons for other states considering their own HRSN programs.


Section 1115 Medicaid demonstrations are a powerful tool for states to pursue a range of innovative programs aimed at improving the health and well-being of Medicaid enrollees by allowing the secretary of the Department of Health and Human Services (HHS) to waive components of federal Medicaid law and provide federal funding to support demonstration initiatives. States have used 1115 waivers for a variety of purposes, including expanding coverage to new populations, providing enhanced benefits to enrollees and implementing programs targeting health-related social needs (HRSN).

While not required under federal law or regulation, long-standing federal policy requires that 1115 waivers be “budget neutral” to the federal government—in other words, demonstrations must not increase federal spending relative to a state not pursuing an 1115 demonstration. At a high level, this involves projecting what a state would have spent in the absence of the demonstration (known as “without waiver” expenditures) and comparing this amount to actual expenditures (known as “with waiver” expenditures). States that spend less than their “without waiver” projections have historically been permitted to carry forward savings to finance new initiatives.

Though conceptually simple, budget neutrality policy has evolved over the years into a complex process that is burdensome to states and CMS, hamstrings states’ ability to respond to emerging events on the ground and increasingly bears little resemblance to actual Medicaid cost growth trends. CMS first attempted to fix some of the key issues with budget neutrality policy through a 2018 State Medicaid Director Letter (SMDL) establishing a new budget neutrality “rebasing” policy. This policy attempted to reduce inequities across states by changing the without waiver baseline calculation to be set based on actual spending (rather than continuing to trend forward historic spending in perpetuity). While this policy did level the playing field to some extent, it did not create room for innovation in states with newer waivers and forced states with long-standing investments to make drastic cuts.

Recent Efforts to Improve Budget Neutrality

During the summer of 2022, CMS began to roll out a series of changes to budget neutrality policy through state waiver approvals. In June, CMS approved an amendment to Kansas’ 1115 waiver adjusting the state’s budget neutrality agreement. It also approved an extension to Vermont’s long-standing demonstration streamlining the process to request budget neutrality adjustments moving forward.

CMS then rolled out in late September a series of more comprehensive and far-reaching updates to budget neutrality policy through renewals of long-standing waivers in Oregon and Massachusetts. These policy changes were subsequently reinforced through a renewal of Arizona’s demonstration and an amendment to Arkansas’ demonstration. Key changes to budget neutrality policy introduced through these approvals include:

  • Calculating without waiver baselines using a weighted average of each state’s pre-2018 without waiver baseline and actual expenditures (rather than relying entirely on actual expenditures);
  • Trending without waiver baselines using the President’s Budget trend (rather than the lower of the President’s Budget trend or the state’s historical growth rate);
  • Allowing savings to carry forward for ten years (instead of five);
  • Capping total savings at 15% of total Medicaid expenditures (previously there was no cap; this provision likely will only impact states with long-standing waivers and significant banked savings);
  • Allowing states to treat expenditures on certain programs addressing HRSN as hypothetical (i.e., states will not have to use savings to finance these programs); and
  • Permitting states to make mid-course changes to budget neutrality without a formal amendment.

(For a detailed table summarizing the key policy changes and highlighting key implications for states, click here to download a free copy of Manatt’s new issue brief.)


While historical 1115 waiver budget neutrality policy arose from a desire to promote fiscal accountability, the policy had become excessively complex, constrained states’ ability to make worthy investments, and treated states inequitably.

Through several recent waiver approvals, CMS introduced a suite of significant policy changes aimed at addressing many of the core problems of the agency’s historical budget neutrality policy. While 1115 waiver budget neutrality policy will likely continue to be a challenging exercise for both CMS and states, this change in direction from CMS is a significant step toward rationalizing the agency’s approach to budget neutrality and streamlining pathways for states to develop ambitious, innovative programs aimed at addressing some of our nation’s most pressing health-related changes.



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