Recent Advances in Section 1115 Waiver Budget Neutrality Policy

Section 1115 of the Social Security Act allows the Secretary of the Department of Health and Human Services to waive certain rules of the Medicaid program and provide federal funding for states to test innovative coverage and delivery system reforms that would further the goals of the Medicaid program. While not a legal or regulatory requirement, the Centers for Medicare & Medicaid Services (CMS) has a long-standing policy of requiring Section 1115 demonstrations to be “budget neutral” to the federal government; in other words, the cost to the federal government. of the demonstration must not be greater than the cost it would have had in the absence of the demonstration. At the beginning of each demonstration period, states negotiate with CMS what Medicaid spending would have been without the demonstration; this is known as the “no exemption” baseline and serves as the state’s budget neutrality limit. In general, states must keep actual waiver expenditures below the non-waiver baseline or may be required to reimburse CMS.


While conceptually straightforward, budget neutrality has become an intricate set of calculations that do not always reflect actual Medicaid cost growth or states’ need for flexibility in responding to dynamic real-world circumstances (eg. , a pandemic, or a substance use disorder crisis). Cindy Mann and Anne Karl of Manatt, along with Heather Howard of Princeton University, outlined some of the challenges of budget neutrality in a recent health matters cutting edge item. They point out that the current approach to budget neutrality:


  • It does not recognize that increases in spending may be necessary to achieve key objectives. Budget neutrality focuses entirely on program spending and does not take into account how investments can lead to significant improvements in quality, access, equity, or other priorities (even if they do not result in financial savings).
  • It discourages innovation. States are at complete risk when initiatives cost more than expected, discouraging them from pursuing bold new programs.
  • It impedes efforts to address historical inequalities. Addressing historical underinvestment in communities and providers serving historically underserved populations may require states to make compensatory spending reductions in other program areas, discouraging these types of investments.
  • Promotes short-term thinking. States only get a budget neutrality “credit” for savings achieved within the five-year demonstration period. This discourages investments that are likely to generate long-term savings (eg, investments in children’s health).
  • it is inequitable. Some states with longstanding exemptions can access large hypothetical “savings,” allowing them to finance substantial investments. At the same time, states with more recent waivers and those without a history of saving-generating policies are left without the ability to innovate without offsetting the cuts.
  • is inflexible CMS has generally not allowed states to make mid-demonstration adjustments to budget neutrality to account for routine programmatic changes (for example, state plan rate increases).
  • Does not take into account savings between programs. Section 1115 exemption demonstrations may result in savings for other federal programs (for example, Medicare). Currently, states do not get budget neutrality credit for these savings.


CMS has recently attempted to mitigate some of these shortcomings through its policy of “rebase” announced in 2018. This policy levels the playing field for budget neutrality in some respects by limiting the ability of states with longstanding exemptions to “stack” budget neutrality savings in perpetuity. However, this new policy does nothing to address many of the other challenges outlined above and may create more unintended challenges for states and CMS.


In recent months, CMS has signaled an interest in addressing critical 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 limits to allow for pay rate increases that would otherwise have been permitted. under the state Medicaid plan or other authorities. (for example, 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 particular issue. We describe the key features of each of these waiver approvals below:


  • Kansas. On June 17, CMS approved a amendment to the state’s KanCare demonstration for the sole purpose of adjusting the demonstration’s budget neutrality limits to account for changes in the state’s Healthcare Access Improvement Program (HCAIP). HCAIP includes state-directed payments to hospitals that are licensed outside of the demonstration; The Kansas legislature recently passed legislation authorizing the state to increase these payments. This waiver amendment adjusts the state’s budget neutrality limits for current and future demonstration years to accommodate these changes. In the recent past, CMS generally did not allow states to amend demonstrations solely for the purpose of making changes to budget neutrality, even if the policy requiring the change had been permitted under federal Medicaid law. This amendment suggests that CMS may take a more flexible approach to authorizing these types of changes in the future.
  • Vermont. On June 28, CMS approved a extension to Vermont’s longstanding Global Commitment to Health demonstration. Along with many other changes, the approval provides continued authority for the state to make adjustments to budget neutrality to account for increases in provider rates. In particular, CMS will allow Vermont to make such changes without filing a formal amendment. Instead, Vermont would simply need to apply separately for a budget neutrality adjustment from CMS; if approved by CMS, any changes would take effect on the effective date of the rate increase. This approach, which allows for budget neutrality adjustments without an amendment, further streamlines the budget neutrality adjustment process compared to the approach used in Kansas. While it is unclear what approach CMS will take for other states in the future, it is encouraging that CMS recognizes this key shortcoming of the existing budget neutrality policy and is taking steps to address it.


With a number of states in negotiations with CMS over significant changes to existing waivers and new showings, CMS may be ready 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 approval of waiver amendments, extensions, and new showings (as in Kansas and Vermont). It could also choose to publish a guide that would take a more holistic approach to changing the budget neutrality policy. In any event, states and other stakeholders should be encouraged that CMS has begun to take concrete steps to mitigate some of the biggest challenges associated with the current budget neutrality policy. States have long used the authority of Section 1115 to make significant investments in advancing key federal and state health care priorities, such as health equity, expanding coverage, improving of quality and access, and the reform of the delivery and payment system. Streamlining the budget neutrality policy will ensure that Section 1115 authority continues to serve as a valuable tool to further these priorities.


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