New Jersey could be forced to repay more than $600 million in Medicaid funding that federal officials insist it improperly claimed, or can’t adequately justify, for state expenditures on school-based healthcare and support services over more than a decade.

An audit released Tuesday by the U.S. Department of Health and Human Services said the state received $300.5 million to cover school-based Medicaid services that were not allowed under federal regulations, and urged the state to return the funds. The federal agency is also challenging the state’s claim on an additional $306.2 million, which it now wants to review with state officials. The report covers claims made between July 2003 and June 2015.

Among other things, the audit claims New Jersey — and a contractor hired by the state to develop the fee structure for the school-based Medicaid program — included in their calculations staff time and costs that were not eligible. It also asserts the rates take into account some $435 million in payments to the teachers’ pension fund that federal officials said were never made.

The state fires back

Leaders at the state Department of Human Services, which oversees the Medicaid program, defended the rate system, questioned the logic used in the audit, and said they will contest the results, including challenging the findings in federal court, if needed. Acting DHS Commissioner Elizabeth Connelly, whose response to the audit was included, also said the findings were premature, since the federal agency had yet to rule on a proposal that would impact the fee structure, which the state submitted to them six years ago.

“It’s important to note that the report is just the first of many steps in the process of a federal audit,” DHS spokesperson Nicole Brosssoie said Tuesday. The audit will next be reviewed by the federal Centers for Medicare and Medicaid Services, she said, and the state can appeal their decision if they don’t agree with the outcome.

While $600 million is a relatively small part of the state’s $34.7 billion annual budget, it is the equivalent to the budget gap that emerged at the end of fiscal year 2016 — or to the amount Gov.-elect Phil Murphy suggests could be raised in a so-called millionaires tax.

Riddled with errors

The state’s contractor, Public Consulting Group, which was hired in 2005 to oversee the program, said the audit was riddled with errors and inconsistencies and urged federal officials to withdraw the report. Among other things, he said the state did make all but 4 percent of the pension payments in question.

The company suggested that HHS had decided years ago that New Jersey’s rates — which were increased significantly in 2005, more than doubling in some cases — were too high and set out to prove it through the audit.

“It appears from the Draft Report that the audit was performed to support this erroneous premise rather than as an objective review of the facts,” PCG’s Bryan Hawkom wrote to the federal agency in July, according to a 13-page letter included as a response to the audit.

In fact, Hawkom notes, federally approved accounting from 2012 through 2015 shows that the state was actually undercharging for these services, proving that the rates PCG set were in fact too low.

New Jersey spent nearly $287 million on school-based Medicaid services in 2015, some $143 million of which was provided by the federal government, according to a report released in April by the national Center on Budget and Policy Priorities, which found only three states — Texas, Michigan and Illinois — collected more.

Covering costs for low-income kids

Schools that are registered with the Medicaid program can tap into the funding to cover healthcare screenings for low-income children; fund nurses, therapists and other healthcare staff; or operate asthma or diabetes education programs. The program can also cover assessments, individual assistance, and medical devices, like wheelchairs and hearing aids, for children with disabilities.

According to the audit, schools provide these services then submit the details to PCG, a Boston-based company with three decades experience working on education and social-service programs throughout the nation. PCG developed a claim, based on the rate structure it created, and the state evaluated this claim and passed it on to the federal government for partial reimbursement. (PCG is paid a percentage of the claims.)

The dispute involves how PCG set the rates it used to calculate these claims. Federal officials question the fee schedule the company used between 2005 and 2011 because they said it was based on an improper assessment of the time certain professionals spent providing medical care — traced through a system of codes.

They also challenged a number of “unallowable costs,” like the salaries of special education teachers not eligible for reimbursement under Medicaid, or pension payments they said the state had not actually made.

“PCG’s inclusion of costs based on the use of incorrect activity codes, unpaid pension costs, and unallowable special education costs inflated the payment rates used to claim Federal Medicaid reimbursement,” wrote Daniel R. Levinson, HHS inspector general, and author of the audit.

Problems with proposal

Auditors also found fault with the system New Jersey started using in 2012, based on a proposal it had submitted to HHS for approval in 2011; a final federal decision on this “amended state plan” is still pending. More than $80 million was collected based on this unapproved plan, federal officials said.

But the state and PCG vehemently defended their process to develop the rates and other reimbursement protocols. They suggest federal officials erred in their review of the latest rate structure, applying the wrong set of considerations, and missing the obvious: that their own “cost settlement” process has confirmed that New Jersey schools were essentially underpaid by as much as $54 million annually in recent years.

“Over the years, federal Medicaid program requirements have been made increasingly complex and burdensome for schools providing these services, while CMS has been unable to respond promptly to state-plan amendment requests,” Hawkom, of PCG noted.

The company followed all available federal guidelines in assessing the information and developing the rates, he said, and their methodology was “reasonable, appropriate and in compliance with the law. The results of the annual cost settlements support this conclusion.”