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Is It the Beginning of the End of the IMD Exclusion? CMS Approves Use of Section 1115 Waivers for Mental Health Treatment


PG Bulletin

December 19, 2018

Emily M. Park (Husch Blackwell LLP, Jefferson City, MO)
Anna S. Whites (Anna Whites Law Office LLC, Frankfort, KY)

This Bulletin is brought to you by AHLA’s Behavioral Health Task Force.

At the end of 2016, the 21st Century Cures Act was signed into law. Included in the Act are various mental health coverage reforms, including a mandate to the Centers for Medicare & Medicaid Services (CMS) that it issue guidance to State Medicaid Directors related to the use of Section 1115 waivers for mental health treatment programs for adults and children. Section 1115 of the Social Security Act permits states to design demonstration projects that test innovative policy and delivery approaches that promote the overall objectives of the Medicaid program. Through Section 1115 demonstration projects, states can receive federal financial participation for costs not otherwise matchable, including costs associated with care provided in settings that are not covered under the Medicaid program (such as care in Institutions for Mental Disease or “IMDs”). The IMD exclusion was created in 1965 at the same time Medicaid was created and prohibits federal financial participation for care provided to Medicaid beneficiaries between the ages of 21 and 64 in a facility with more than 16 beds that is “primarily engaged in providing diagnosis, treatment, or care of persons with mental diseases[.]”1

On November 13, 2018, CMS issued State Medicaid Director Letter 18-011 (SMD 18-011) in compliance with the mandate in the Cures Act.2 Through this letter, CMS announced to the states “opportunities to design innovative service delivery systems for adults with a serious mental illness [SMI] or children with a serious emotional disturbance [SED].” The letter provided guidance to states regarding development of SMI/SED programs under existing authorities and through Section 1115 demonstration projects seeking waiver of the IMD exclusion.

SMD 18-011 follows a string of recent limitations on the IMD exclusion by both CMS and Congress that began in 2015. In 2015, CMS issued guidance to states in response to the national opioid epidemic to allow them to submit applications for Section 1115 demonstration projects to test Substance Use Disorder (SUD) treatment programs.3 In May 2016, CMS finalized an amendment to 42 C.F.R. § 438.6(e) authorizing states to make monthly capitation payments to managed care organizations for treatment in IMDs, so long as the length of stay in the IMD is less than 15 days for the month and the treatment in the IMD is in lieu of treatment provided in a more costly setting.4 Those changes were in line with both enhanced patient care and utilization of cost savings measures incident to best practices.

In November 2017, CMS revised the guidance on SUD demonstration projects to create “a more flexible, streamlined approach”5 in order to provide states “more freedom to design programs that meet the spectrum of diverse needs of their Medicaid population” and “empower all states to advance the next wave of innovative solutions to Medicaid challenges[.]”6

Most recently, on October 24, 2018, Congress passed the IMD CARE Act, which provides an exception to the IMD exclusion for treatment for SUDs for up to 30 days during a 12-month period. The rationale for the ongoing revisions and changes may include the facts that the Affordable Care Act significantly expanded Medicaid coverage to low-income adults, and, while states had flexibility to determine the benefits available to the expansion population, certain beneficiaries had coverage for inpatient behavioral health services that they were unable to access because they are only available in IMDs. In addition, as states have continued to move to managed care delivery systems for their Medicaid programs, beneficiaries often are covered by the same provider networks as individuals enrolled in commercial coverage. These provider networks include facilities that Medicaid considers IMDs, leaving Medicaid enrollees unable to access certain services that other populations have access to and thus exacerbating disparities in care.

Prior to SMD 18-011, Vermont was the only state that had an approved Section 1115 waiver program that allowed it to receive federal financial participation for mental health treatment in IMDs, but the approval from CMS required the state to reduce IMD spending starting in 2021 until completely phased out by 2026. Vermont’s waiver was unique considering that CMS denied a request for waiver of the IMD exclusion for non-SUD mental health treatment as recently as May 7, 2018. Illinois had requested the waiver in its Behavioral Health Transformation project application. The letter from CMS to Illinois stated: “It is CMS’s current policy, as reflected in the November 1, 2017 State Medicaid Director’s Letter #17-003, not to authorize costs of services for individuals residing in an IMD who are in an IMD only to receive mental health treatment.”

Now, under SMD 18-011, CMS confirmed that states may seek approval through a Section 1115 waiver for “short term stays for acute care in psychiatric hospitals or residential treatment settings that qualify as IMDs[.]” In order to receive approval of an SMI/SED demonstration project pursuant to SMD 18-011, the project must be budget neutral, and the state must take action to ensure good quality of care in IMDs and improve access to community-based services. CMS compared the SMI/SED guidance document to the SUD guidance documents issued in 2015 and 2017. CMS specifically noted that states could participate in both the SUD and SMI/SED waiver opportunities. Under both, states are expected to achieve a statewide average length of stay of 30 days for beneficiaries receiving care in IMDs.

It should be expected that (as with SUD programs) many states will be taking full advantage of this new opportunity to design a program offering a full continuum of care for individuals with mental health that includes inpatient and residential treatment, as needed. In the time since the SUD guidance was issued by CMS in 2015, 27 states have approved or pending SUD demonstration projects.7 As of November 27, 2018, three states already had pending Section 1115 applications that included a request for waiver of the IMD exclusion for mental health treatment (Kansas, New Mexico, and Rhode Island). These applications were submitted before SMD 18-011 was issued. Both Kansas and Rhode Island made a broad request for waiver of the IMD exclusion as part of their managed care programs. New Mexico requested that the IMD exclusion be waived for individuals between ages 21 and 64 receiving treatment in an IMD for both SUD and non-SUD diagnoses for up to 30 days. Because of the broad nature of these requests, which pre-date SMD 18-011, it is unclear how CMS will handle them.

Cost neutrality is essential to waiver applications. States must show that federal expenditures will not be greater than what the federal government’s Medicaid costs would likely have been absent the demonstration. These avoided costs may include coverage of populations or services that the state could have otherwise provided through its Medicaid state plan or another Section 1115 waiver. With the approval of its SMI/SED demonstration, the state will have to agree to report all Medicaid expenditures, except spending under certain managed care arrangements, during SMI/SED-related IMD stays in order to track and compare cost and quality of services under both models.

States and providers should be aware that there is a curious limitation in SMD 18-011. Unlike the SUD guidance documents, SMD 18-011 specifically states: “FFP will not be available through these demonstrations for services provided in nursing homes that qualify as IMDs as CMS understands that nursing homes do not specialize in providing mental health treatment and may not have staff with appropriate credentials and training to provide good quality treatment to individuals with SMI or SED.” CMS did not provide any citation or other data supporting this comment. This limitation also seems to contradict CMS regulations that require nursing homes to provide or arrange for mental health treatment for their residents.8 Nursing facilities are specifically required to have sufficient staff with knowledge of and appropriate training and supervision for caring for residents with mental and psychosocial disorders.9 Further, under SMD 18-011, any psychiatric hospital or residential treatment facility participating in an SMI/SED project is required to demonstrate its capacity to address co-morbid physical health conditions during short-term stays, and nursing facilities logically have such capacity.

Lastly, as many states submit applications for waivers under SMD 18-011 over the next few years, states should expect opposition from groups representing disabled individuals. These groups fear that limitation or waiver of the IMD exclusion will cause states to divert funds away from community-based programs. Such comments were received by CMS after it proposed allowing states to make capitated payments to managed care organizations for care provided in IMDs.10 New Mexico also noted in its pending waiver application that disability advocates did not support incentivizing the use of institutional care. States are required to improve access to community-based services as a part of their SMI/SED demonstration projects.

In reviewing an application, CMS will consider the state’s demonstrated commitment to an ongoing maintenance of effort in funding community-based mental health services. CMS strongly encourages states to include in their application a thorough assessment of current availability of mental health services throughout the state, particularly crisis stabilization services, and to outline how the proposal will ensure greater care coverage for the targeted populations.

By requiring improvement of community-based services, while also allowing states to receive reimbursement for short-term institutional services, CMS expects that a full continuum of care will be available to those with SUD or SMI/SED.

The authors wish to thank Robin L. Canowitz (Vorys Sater Seymour & Pease LLP, Columbus, OH) and Matthew W. Wolfe (Parker Poe Adams & Bernstein LLP, Raleigh, NC) for serving as editors of this Bulletin.

1 See Social Security Act, § 1905(a), (i) (42 U.S.C. § 1396d(a), (i)); 42 C.F.R. § 435.1010.
2 See
3 See State Medicaid Director Letter 15-003 (July 27, 2015),
4 See 81 Fed. Reg. 27497 (May 6, 2016).
5 See State Medicaid Director Letter 17-003 (Nov. 1, 2017),
6 See Letter from Thomas E. Price and Seema Verma (Mar. 14, 2017),
7 See KFF, Medicaid Waiver Tracker: Approved and Pending Section 1115 Waivers by State (Nov. 27, 2018),
8 See, e.g., 42 C.F.R. § 483.40.
9 Id.
10 See 81 Fed. Reg. 27497, 27558 (May 6, 2016).
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