State Medicaid Demonstrations Must Prove Budget Neutrality Beginning January 1, 2027

June 24, 2026  |  Medicaid, CMS, State-Directed Payments (SDP)

Mike Rawaan, Founder and Managing Director

2. Section 1115 Medicaid Demonstration Budget Neutrality (SMDL #26-003, June 11)

In the second piece of CMS’ sweeping June 2026 policy changes, we examine the State Medicaid Director Letter (SMDL #26-003) released on June 11, which establishes a new framework for how Section 1115 demonstration waivers must prove budget neutrality.

Nearly one-third of all federal Medicaid dollars flow through Section 1115 demonstration projects. [3]

The scale of what this rule impacts cannot be understated. Nearly every state has at least one active Section 1115 waiver, and many have multiple. [4] The SMDL #26-003 framework reaches all of them.

Beginning January 1, 2027, CMS will not approve new demonstrations, renewals, or amendments unless the CMS Chief Actuary certifies that the demonstration project is not expected to increase federal spending compared to the state’s Medicaid program without the demonstration. [3, 4]

The framework introduces two categories of demonstration activities:

• Medicaid Authorizable Populations and Services (MAPS): activities that could otherwise be authorized under the Medicaid state plan - treated as zero net financial impact for budget neutrality purposes [4]

• Section 1115-only activities: everything that cannot be authorized through existing Medicaid authority - these become the primary focus of budget neutrality review, requiring states to document both costs and savings [4]

  
  

The rule also eliminates the prior “hypothetical expenditure” approach that had given states flexibility. CMS’s own letter acknowledges it anticipates the policy will reduce federal spending on Section 1115 demonstrations. Administrative costs are now included in budget neutrality calculations - a significant shift from current practice. [5]

States with demonstrations up for renewal in 2027 face the most acute pressure. CMS acknowledged this and committed to offering technical assistance to help states through the transition. [6]

What This Means in Dollar Terms

The scale of exposure varies dramatically by state, but the stakes are real everywhere. Section 71118 of OBBBA codified budget neutrality as a statutory requirement for the first time, shifting what was previously an executive policy condition into a less flexible legal standard - and shifting financial risk squarely onto states. States have historically relied on favorable budget neutrality methodologies - including hypothetical spending for health-related social needs (HRSN) initiatives - to unlock federal matching funds. That flexibility is gone. [7]

A GAO review of five states illustrates how expensive waiver programs already are to administer:

• Five states estimated a combined $408 million in implementation costs for Section 1115 work requirement demonstrations alone - ranging from $6.1 million in New Hampshire to $271.6 million in Kentucky. [8]

• Georgia’s experience added further evidence: in the first four-and-a-half years of its work requirement demonstration, the state spent $54 million on administrative costs alone - two-thirds of total demonstration spending, with the federal government covering 88 percent of those costs. [8]

  
  

Under the new framework, those administrative costs now count against budget neutrality. States that build expensive administrative infrastructure into their 1115 demonstrations face a harder neutrality calculation than ever before. The math that worked last year may not work next year.

How States Handle Actuarial Work - And Why That’s a Problem

The Chief Actuary certification requirement sounds procedural. It isn’t. It demands:

• Actuarially sound modeling of projected spending with and without the demonstration

• Classification of all covered activities into the MAPS/1115-only framework

• Documentation of cost-and-savings methodology acceptable to the CMS Chief Actuary

• Ongoing monitoring and reporting throughout the demonstration period

Most state Medicaid agencies do not have this capacity in-house. That’s not a criticism; it’s a structural reality.

Federal regulations have required actuarial soundness certifications for Medicaid managed care capitation rates since 2003. The actuary performing the certification may be either a state employee or a contracted consulting actuary - and in practice, the vast majority of states rely on outside contractors. [9]

Arkansas’s experience implementing its Section 1115 Medicaid expansion waiver makes the point directly. The state relied heavily on contractors for legal, policy, actuarial, and project facilitation support and, in several cases, found it needed more help than originally anticipated, repeatedly amending vendor contracts to expand scope. As one state official put it: “There were a number of issues we just didn’t have internal capacity to do, like those types of sophisticated actuarial analyses, so we did rely on contractors pretty heavily.” [10]

State Medicaid directors already know most of the vendors that provide actuarial services. Still, they may not be prepared for the compressed timeline: demonstrations up for January 2027 renewal need actuarial certification packages in development now or no later than Q3 2026. The vendor market will tighten as deadline pressure builds across all 50 states simultaneously.

Operationalizing SMDL #26-003: The Immediate Playbook

This is a big lift - and the sequencing matters. Here is the order of operations:

1. Classify every current 1115 activity as MAPS or 1115-only. This is the foundation. You cannot build an actuarial certification package until you know what category each activity falls into. Some classifications are clear-cut; others will require policy and legal analysis. Don’t guess - a misclassification surfaces during CMS Chief Actuary review and derails the entire package.

2. Engage your actuarial vendor - now. The 1115 waiver process already requires budget neutrality calculations before submission, tribal consultation, and formal public comment periods, all of which take months. [12] Adding Chief Actuary certification to that process compresses an already tight timeline. States that haven’t started vendor procurement are already competing for capacity in a constrained market. Covalence Health can help you select the right actuarial firm in less than two weeks.

3. Prioritize demonstrations up for renewal in early 2027. These are your highest-risk items. Get them into the actuarial pipeline first. Demonstrations with later renewal dates give you more runway - use it to build a repeatable certification methodology rather than scrambling on each renewal.

4. Take CMS up on their technical assistance offer. CMS explicitly committed to offering technical assistance to states navigating the new framework. [3] That offer has a shelf life - states that engage early get more runway and more goodwill. States that wait arrive with less time and more urgency.

5. Do not assume MAPS activities are risk-free. Activities classified as MAPS carry zero net financial impact for budget neutrality purposes, but that classification must be defensible to the CMS Chief Actuary. If CMS disagrees with your classification, the entire certification package is at risk. Document the policy rationale for every MAPS determination.

Most states will need outside help for this process. Actuarial modeling, policy classification, and federal certification preparation require a skillset that state Medicaid agencies do not maintain at scale. The firms that provide this support are already fielding calls. Get in the queue.

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Sources and Citations

[3] CMS. “CMS Takes Bold New Approach to Stewarding Medicaid Demonstration Project Spending.” Press Release, June 11, 2026. https://www.cms.gov/newsroom/press-releases/cms-takes-bold-new-approach-stewarding-medicaid-demonstration-project-spending

[4] KFF. “Medicaid Section 1115 Waivers: The Basics.” August 2025. https://www.kff.org/medicaid/medicaid-section-1115-waivers-the-basics/

[5] Center on Budget and Policy Priorities. “Executive Action Watch: Section 1115 Budget Neutrality.” June 18, 2026. https://www.cbpp.org/research/federal-budget/executive-action-watch

[6] Health Management Associates. “CMS Proposes New Budget Neutrality Framework for Medicaid Section 1115 Demonstrations.” June 18, 2026. https://www.healthmanagement.com/blog/cms-proposes-new-budget-neutrality-framework-for-medicaid-section-1115-demonstrations/

[7] Petrie-Flom Center, Harvard Law School. “Why It Matters: HR1’s Change to Medicaid Waiver Budget Neutrality Rules.” February 19, 2026. https://petrieflom.law.harvard.edu/2026/02/19/why-it-matters-hr1s-change-to-medicaid-waiver-budget-neutrality-rules/

[8] Georgetown University Center for Children and Families. “Implementing Costly Medicaid Work Reporting Requirements: Who Will Foot the Bill?” April 14, 2026. https://ccf.georgetown.edu/2026/02/11/implementing-costly-medicaid-work-reporting-requirements-who-will-foot-the-bill/

[9] Actuarial Standards Board. ASOP No. 49: Medicaid Managed Care Capitation Rate Development and Certification. http://www.actuarialstandardsboard.org/asops/medicaid-managed-care-capitation-rate-development-and-certification/

[10] MACPAC. “Section 1115 Medicaid Expansion Waivers: Implementation Experiences.” February 2018. https://www.macpac.gov/wp-content/uploads/2018/02/Section-1115-Medicaid-Expansion-Waivers-Implementation-Experiences.pdf

[11] Milliman. “Medicaid Consulting Services - State Agencies.” 2026. https://us.milliman.com/en/services/medicaid-consulting-services/state-agencies

[12] National Association of Medicaid Directors. “Medicaid Innovation Pathway: How 1115 Waivers Work.” May 28, 2024. https://medicaiddirectors.org/resource/how-1115-waivers-work/

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