The Fiscal Quagmire of Medicaid: Improper Payments and Systemic Governance Challenges

The U.S. Medicaid program, a cornerstone of federal-state healthcare collaboration, faces a growing crisis of fiscal inefficiency and systemic governance failures. Recent data reveals staggering improper payments-funds disbursed for services not rendered, ineligible beneficiaries, or administrative errors-that threaten to undermine the program's financial sustainability. For investors and policymakers, these issues highlight a critical juncture where structural reform is not just prudent but imperative.

The Scale of Improper Payments

According to a 2025 OIG audit, Medicaid agencies made $207.5 million in unallowable capitation payments to managed care organizations (MCOs) on behalf of deceased enrollees between July 2021 and June 2022, with $138.6 million of that amount representing federal funds. This audit, part of a series since 2016, underscores a recurring problem: improper payments are not isolated incidents but systemic. The Government Accountability Office (GAO) further contextualizes this by reporting that federal improper payments across all programs totaled $162 billion in fiscal year 2024, with Medicaid accounting for a significant share according to CMS data.

The Centers for Medicare and Medicaid Services (CMS) estimates a 5.09% improper payment rate for Medicaid in 2024, translating to $31.1 billion in errors. Of this, $23.4 billion stemmed from insufficient documentation, $4.9 billion from non-medically necessary services or ineligible beneficiaries, and $1.5 billion from unenrolled providers according to CBPP analysis. These figures are not merely administrative oversights; they reflect a systemic failure to verify eligibility and service accuracy, exacerbated by fragmented oversight and complex program structures.

Systemic Governance Challenges

The root causes of these inefficiencies lie in the program's governance structure. Medicaid's federal-state partnership creates inherent tensions. Federal funding rules, such as the Federal Medical Assistance Percentage (FMAP), incentivize states to expand enrollment, as higher reimbursement rates for certain populations (e.g., ACA expansion enrollees) amplify federal contributions according to KFF data. This creates perverse incentives: states may prioritize enrollment growth over rigorous eligibility verification, leading to improper payments.

Compounding this, the end of pandemic-era continuous coverage policies in 2025 led to a 7.6% drop in Medicaid enrollment but an 8.6% rise in spending, driven by higher provider rates and specialty drug costs according to a 2025 health management survey. Meanwhile, the One Big Beautiful Bill Act (OBBB Act) has imposed new eligibility verification requirements, mandating six-monthly checks for expansion population enrollees-a policy that increases administrative burdens while risking disenrollment of vulnerable beneficiaries. These shifts strain state budgets and managed care organizations (MCOs), which now face tighter margins and greater scrutiny over capitated payments.

Federal-State Funding Dynamics and Structural Inefficiencies

The federal-state funding model further exacerbates fiscal risks. States receive a 90% FMAP for ACA expansion enrollees, creating strong incentives to classify individuals in this category to maximize federal reimbursement. This has led to practices like hospital presumptive eligibility, where individuals are enrolled based on incomplete data, contributing to improper payments according to Paragon Institute analysis.

Structural inefficiencies are also evident in the Payment Error Rate Measurement (PERM) audits, which historically excluded eligibility reviews. When full eligibility checks were conducted in 2019 and 2020, improper payment rates soared to over 25%, suggesting that CMS's reported $31.1 billion figure may understate the true scale of the problem by a factor of five according to Paragon Institute research. Applying this adjusted rate to Medicaid spending between 2015 and 2024 implies improper payments totaling approximately $1.1 trillion-a figure that dwarfs the program's annual budget.

Implications for Investors

For investors, the fiscal risks of Medicaid are multifaceted. First, improper payments represent a direct drain on federal and state budgets, potentially leading to funding cuts for healthcare providers or reduced benefits for beneficiaries. Second, the administrative complexity of Medicaid-56 state programs with varying rules-creates operational risks for MCOs and sub-capitated providers, who must navigate frequent policy changes and heightened oversight according to a 2025 health management survey. Third, the program's reliance on federal funding makes it vulnerable to political shifts, such as the OBBB Act's work requirements or potential future reforms that could alter reimbursement models.

Investors should also consider the long-term implications of rising healthcare costs and demographic shifts. As the U.S. population ages and chronic disease prevalence increases, Medicaid spending is projected to grow by 7.9% in FY 2026 according to a 2025 health management forecast. Without structural reforms-such as transitioning to a capped block-grant system or enhancing eligibility verification-these pressures could exacerbate fiscal instability.

Conclusion

Medicaid's fiscal challenges are not merely a matter of mismanagement but a symptom of a flawed governance model. The combination of improper payments, federal-state funding incentives, and administrative complexity creates a perfect storm of inefficiency. For investors, the stakes are clear: without systemic reforms, Medicaid's fiscal risks will continue to ripple through healthcare markets, affecting everything from provider reimbursement to public health outcomes. The path forward demands not only tighter oversight but a reimagining of how the program is funded and administered-a task that will define the next decade of U.S. healthcare policy.