States' Use of Medicaid UPL and DSH Financing Mechanisms in 2001

This document contains the full text of a report submitted to the Henry J. Kaiser Family Foundation in January 2003. An abbreviated version highlighting the key findings was published in the March/April 2004 issue of the journal Health Affairs. We expect that most readers will prefer the shorter version. This full text is intended for readers who want additional background on these programs or who are interested in our detailed findings, which include observations from case studies of the development and evolution of DSH and UPL programs in three states.

The citation for the abbreviated version is: Coughlin, Teresa A., Brian K. Bruen and Jennifer King. "States' Use of Medicaid UPL and DSH Financing Mechanisms." Health Affairs 23(2), 245-257.

The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.

Note: This report is available in its entirety in the Portable Document Format (PDF).

EXECUTIVE SUMMARY

One of the most controversial issues in recent Medicaid policy debates has been states' use of upper payment limit or UPL programs. Members of the Bush administration have referred to UPL programs as "Medicaid scams" that have caused the federal government to pay more than its share of Medicaid expenditures. Both the Bush and Clinton administrations as well as some members of Congress have sought to limit states' use of UPL payments, which were estimated to total more than $11 billion (federal and state) in 2001 (Congressional Budget Office 2002). State and local officials as well as some provider industry groups, however, have fought this effort.

The Medicaid hospital disproportionate share or DSH program has caused a similar tug-of-war between states and the federal government. Designed to provide financial help to safety net hospitals, the $15.8 billion (federal and state) Medicaid DSH program has sparked considerable debate between state and federal policymakers. Though not as hotly debated in the last couple of years, controversy surrounding the DSH program will likely resurface soon: Barring a change in current federal law, 35 states are slated to lose about $1 billion in federal DSH funds in fiscal year 2003 (Miller 2002).

At the heart of DSH and UPL controversy is that many states draw extra federal matching funds with limited or no state money involved. For the past several years, the principal way states have done this is through use of intergovernmental transfers (IGTs) or state transfers which entail the transfer of funds from local governments to the state or fund transfers between different state agencies. These fund transfers are then used as the state share for Medicaid DSH and UPL payments, and, in the process, the state obtains federal matching dollars. By using mechanisms like IGTs and state transfers, states are not contributing their full share of Medicaid expenditures while the federal government is paying more than its share. In short, these mechanisms have shifted the balance of federal Medicaid spending among states and compromised the federal-state partnership as set out in Medicaid law.

Another key issue in the DSH and UPL controversy is that with the infusion of federal Medicaid dollars, some states are not necessarily using the new funds to improve or expand health care services for Medicaid beneficiaries or to broaden health care services to the uninsured (Ku 2000). Indeed, to a very large extent, federal funds generate through these mechanisms become unaccountable once they reach the states and states can use the funds for a range of purposes, including non-health purposes.

Building on earlier surveys (Ku and Coughlin 1995; Coughlin et al. 2000) in this study we report findings from a 2002 survey of states' UPL and DSH programs. Completed by 34 states, the survey focused on revenues and expenditures for both the DSH and UPL programs in state fiscal year (SFY) 2001. In brief, the survey results suggest that an increasing share of available DSH gains appear to being paid to hospitals in 2001 as compared to 1997. In contrast, survey data suggest that the bulk of available UPL gains are being kept by states and not by providers. Of the available provider UPL gains, most accrued to hospitals; very little accrued to nursing homes. Using simulation analyses, we estimated that, owing to DSH and UPL strategies, the effective federal Medicaid match rate was 3 percentage points higher on average among survey states in 2001 than it would have been otherwise.

The findings in this paper reflect states' DSH and UPL programs prior to actions taken by the federal government to significantly limit states' use of UPL mechanisms. With the passage of the 2001 Benefits Improvement and Protection Act (BIPA), the federal government changed how states calculate UPLs for hospitals, nursing homes, and other facilities. BIPA also set out various transition times for states to ensure that provider payments conformed to new federal regulations, which went into effect in March 2001 (U.S. Department of Health and Human Services, 2001).

Highlights of Findings

Medicaid DSH Program

• The 34 survey states made a total of $10.7 billion (federal and state) in DSH payments in SFY 2001, with the level of DSH expenditures varying greatly across the states. States put up $4.5 billion (42 percent) of this total and the federal government provided $6.2 billion (58 percent) in matching funds.
• Many survey states do not put up their own funds to support their DSH payments. Seventeen states obtained some or all of the state share through IGTs from non-state government entities or through provider taxes. IGTs accounted for about 45 percent of state funding, followed by state general funds at 25 percent, fund transfers from state sources at 20 percent and provider taxes at 11 percent. Most states using general funds or state transfers as funding for DSH recoup some or all of these amounts out of the federal matching funds.
• Survey states generally made DSH payments to more than one type of provider. Acute care hospitals received 82 percent of the DSH payments, with most (68 percent) going to private and local or county-owned facilities. Fourteen percent went to state-owned acute care hospitals such as university hospitals. The remaining share (18 percent) went to mental hospitals, primarily state-owned facilities.
• By comparing funding and payments, we estimated net gains that both states and hospitals received from the DSH program. Assuming that states and individual hospitals get "paid back" (as DSH payments or other transfers) some or all of what they contribute toward the state share, we estimate that, as a group, hospitals in the survey states and states themselves gained about $6.2 billion through DSH programs in SFY 2001.¹ This gain is equal to the amount of federal matching payments for DSH programs. Non-state public hospitals netted almost 74 percent of the total gains, whereas states (including both state-owned hospitals and state governments) netted about 26 percent of total gains (Figure I).

• We determined changes in DSH funding, paybacks and provider gains between 1997 and 2001 by comparing survey responses for 27 states that responded in both years.² Funding levels, the distribution of funding among sources (state, county/local, and private), and total DSH payments did not change appreciably over this period. How states allocated their DSH payments shifted considerably. In 1997, non-state public entities received $3.0 billion (52 percent) of total DSH gains in the 27 states; by 2001, they received $4.1 billion (70 percent) of total gains (Figure II). Gains to state hospitals and residual funds for state use declined.³
• Part of the distributional shift in DSH payments toward county, local and private hospitals observed in 2001 could be due to provisions included in the Balanced Budget Act of 1997 that limited how much of a state's federal DSH allotment can be paid to mental hospitals, most of which are state facilities. At a broader level, during the late 1990s states enjoyed strong economies and may have had less of need to retain potential gains available under the DSH program. Many states also implemented Medicaid UPL programs during this period,which provided another avenue to leverage federal dollars.

Medicaid UPL Payments

• During SFY 2001 or 2002, 23 of the 34 reporting states operated at least one UPL program. The number of programs within each state ranged from 1 to as many as 9 distinct programs.
• The 19 survey states with active UPL programs in SFY 2001 made a total of $5.8 billion (federal and state) in UPL payments, with the level of DSH expenditures varying greatly across states. The states put up $2.4 billion (42 percent) of this total and the federal government provided $3.4 billion (58 percent) in matching funds.
• None of the survey states incurred a net expense to operate their UPL programs in 2001. Eight states financed some or all of the state share of UPL payments with IGTs from local governments, which accounted for nearly 60 percent of the state share across all survey states combined. The balance of the state share was financed either with state general funds (31 percent) or with certified public expenditures (CPEs) and transfers from state sources (10 percent). Every state that used state funds to support its UPL program(s) kept some or all of the federal matching funds or made payments to state facilities in order to recoup the initial outlays from state sources.
• More than 60 percent of UPL payments in SFY 2001 went to nursing homes, largely publicly owned facilities. Roughly 19 percent went to private or non-state government-owned hospitals for both inpatient and outpatient services. A small share (3 percent) went to state hospitals, primarily university hospitals. Another 15 percent of UPL funds were kept by states as residual funds; that is, several states took in more funding for UPL payments than they paid out and retained the additional funds to be used for other purposes.
• In contrast to the DSH program, we estimate that most of the gains available through UPL payments accrued to states in 2001. We estimate that 81 percent of gains from UPL programs went to states as a general gains while only 19 percent of payments were provider gains (Figure III). The bulk of provider UPL gain went to non-state providers, primarily hospitals. So, although the majority of UPL payments go to nursing homes, most provider gains accrue to hospitals. This pattern occurs because states generally kept most or all of the federal matching funds for nursing home UPL programs, but such arrangements were less common for hospital UPL programs.

• Most states indicated that state gains from UPL programs in 2001 went to finance health care expenses. A few put gains into dedicated health care accounts, but most put the gains into the Medicaid general fund. Once in Medicaid, UPL gains could be "recycled" to finance the state share of other Medicaid payments, allowing the state to earn additional federal match—or a "match on match" payment. The survey could not determine whether these federal UPL dollars help to maintain or expand states' commitments to Medicaid, or whether they simply provide general fiscal relief.

Impacts of DSH and UPL Payments on Medicaid Spending Patterns and on Federal Financing

• We used the survey data and Medicaid administrative data to assess how DSH and UPL payments affected Medicaid spending patterns and federal financing of the program among survey states in SFY 2001. We estimated that $6.5 billion of DSH and UPL expenditures reported by the states do not represent real state outlays, as states used private or non-state government funds to support the programs or paid themselves back (using federal funds) for some or all of the state dollars that they initially used to finance the state share. This amount represents 5 percent of total reported Medicaid expenditures in these states.
• After reducing the reported state share of spending in each state to reflect real state outlays, we estimated that DSH and UPL programs resulted in effective federal Medicaid match rates in the survey states that were, on average, three percentage points higher in 2001 than they would have been otherwise. Though this increase seems relatively small, it has considerable implications given the structure of the Federal Assistance Matching Percentage (FMAP) formula. By shifting the effective FMAP up three percentage points, we estimate that federal spending per dollar of state general revenue spent increased by an average of 13 percent as a result of how some states finance their share of UPL and DSH payments.

Looking Beyond 2001

• Although our survey describes state UPL and DSH programs in 2001, many changes to these programs have occurred or will soon occur. These include:
• How UPLs are determined;
• Elimination of the 150 percent UPL for non-state public hospitals;
• New state option to operate a 175 percent DSH program for public hospitals; and
• Reductions in federal DSH allotments.
• Most of these changes will limit states ability to draw down federal funds through DSH and UPL financing mechanisms over the long term, although the higher DSH limit for public hospitals could provide relief for some states.

Conclusions

The Medicaid DSH program continues to evolve. Although the level of DSH spending and state financing has not substantially changed in recent years, the way that states distribute DSH funds shifted dramatically. Importantly, more of the available DSH gains are paid to hospitals. However, our data do not allow us to determine whether DSH payments simply substitute for state or local hospital funding or represent real new supplemental funding for hospitals.

Although the survey data suggest that more DSH gains are accruing to hospitals, several issues still persist in the DSH program. For example, states still retain a sizable share of the gains. Another lingering issue is that the distribution of DSH spending still varies considerably among states—accounting for less than 1 percent of state spending in some states to more than 10 percent in others—and is not based on need or a national formula but more on the willingness of a state to use the DSH program to leverage federal funds during the early 1990s, before federal policymakers started imposing program limits. Finally, the current survey data show that states often contribute little or no state funds to DSH, causing the federal government to pay for more than its share of Medicaid program expenditures.

We find that the DSH and UPL programs are alike in many ways. For example, the data reveal that states finance UPL enhancements incurring little to no state expense. Also, like DSH, the extent to which individual states engaged in UPL activity varied widely across states and does not appear to be tried to any single factor. Although DSH and UPL are a lot alike, an important difference between the two programs is that under DSH most of the gains accrue to providers whereas under UPL programs the bulk of the gains go to the state.

Without doubt, the DSH and UPL programs are going to go through yet more changes in the near term. Indeed, changes have already been implemented or are about to be implemented. While it is too early to determine how these new provisions will affect DSH and UPL, our results indicate that reforms are warranted so that programs become based on sound and defensible policies. Without implementing reforms, state and federal policymakers will continue to do battle over the DSH and UPL programs to the detriment of the spirit of federal-state cooperation on which Medicaid is based.

Note: This report is available in its entirety in the Portable Document Format (PDF).

ACKNOWLEDGMENTS

The authors thank the many state officials who completed the survey and participated in the case study. Without their support, this project could not have been completed. Special thanks are due to Diane Rowland of the Kaiser Commission on Medicaid and the Uninsured who wrote a letter of endorsement for the survey. In addition, the authors thank David Rousseau and Barbara Lyons of the Kaiser Commission for their help and suggestions throughout the project. Finally, the authors thank John Holahan and Stephen Zuckerman of the Urban Institute, Jocelyn Guyer and Andy Schneider of the Kaiser Commission, and Leighton Ku of the Center on Budget and Policy Priorities for their many helpful comments on earlier drafts.

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Disclaimer: The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.