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By Rachel Streiff & Will Humble

Have you ever wondered why most US states have so many homeless individuals with severe mental illnesses? Perhaps you have noticed a stark contrast to other disabled populations, such as those with developmental, physical or elderly disabilities. While services may not be perfect for these other vulnerable populations, they’re still, generally, housed.

AHCCCS’ last report showed more than 6,000 Arizonans formally designated with a Serious Mental Illness (SMI) on a waiting list for housing. Yet, the Arizona Long Term Care System (ALTCS) for both the Elderly and Physically Disabled (EPD) and Division of Developmental Disabilities (DDD) populations report relatively few on their housing waitlists; generally less than couple hundred such individuals are “in between” placements.

Arizona’s Medicaid system has a unique entitlement program that covers SMI treatment, offering a range of short-term services including inpatient hospitals and Behavioral Health Residential Facilities (BHRF’s).

Yet there are scant few housing options once they are discharged. More fortunate individuals may go home to a family caregiver, or to the scarce network of SMI supported housing units. Those less fortunate find themselves on streets, in shelters, in carceral settings, or worse: the morgue. I have extensively reported on the deadly combination of SMI, homelessness, and the Arizona heat.

The enormous housing gap uniquely affecting the SMI population is a direct result of the “IMD exclusion.” Perhaps you’ve heard of it but aren’t sure what it is and what it’s doing.

What’s the IMD Exclusion?

Medicaid was set up in 1965 under the Social Security Act. It included a provision called the Institution for Mental Diseases (IMD) exclusion which banned federal funds from being used for treatment in psychiatric facilities with more than 16 beds. The goal was to stop federal funding of state asylums which had few care standards, no oversight, and were notorious for indefinitely warehousing people with disabilities, including SMI.

This kicked off a movement known as “Deinstitutionalization.” States were de-incentivized to institutionalize people and were expected to create mental health systems that provided treatment in their communities.

Over time, advances in medicine and law made institutionalization far less likely. Psychiatric and medical inpatient admissions criteria were set up, as well as legal criteria needed to justify involuntary treatment. Medications like antipsychotics became increasingly more effective.

Despite these advances, certain conditions like Schizophrenia still had a subset of individuals that needed a higher level of care to keep stability and safety. Eventually, the IMD exclusion caused major unintended consequences for this chronic SMI population – not just by restricting access to hospitals, but also by cutting off pathways to permanent housing for many people with SMI.

Both ALTCS populations (EPD and DDD) have not faced chronic homelessness in the same way. This is because, almost since its start, Medicaid provided funding for Intermediate Care Facilities (ICFs) serving individuals with intellectual disabilities. Then in 1981, Congress added the Home and Community-Based Services (HCBS) waiver.

This allowed state Medicaid programs to cover long-term care for individuals with intellectual and developmental disabilities (IDD) outside of institutional settings, in homes and group homes.

These same Long-Term Support Services were extended to the EPD population, since their conditions were defined as physical or medical rather than “mental diseases.” This allowed skilled nursing facilities — and later HCBS programs — to use federal Medicaid dollars for residential care.

These “ exceptions” to the IMD exclusion made Medicaid housing coverage possible for certain disabled populations: if you are eligible for a Medicaid-funded institution, Medicaid can pay for you to live in a home or group home instead. By contrast, a comparable waiver was never created for the SMI population.

The IMD exclusion serves to double-down on Congress’s stance that individuals living with mental illness ought not to receive the long-term care benefits provided to the IDD and EPD populations.

Instead of being reintegrated into supported community residential settings, people with SMI were often deinstitutionalized into homelessness, jails, and prisons — a process known as trans institutionalization.

The IMD exclusion, meant to prevent warehousing in large, locked hospitals, evolved into a blanket ban on Medicaid’s participation in almost ALL housing for adults with SMI—even small, unlocked, community-based group homes with fewer than 16 beds.

Without federal help, state budgets must cover the SMI housing gap, and most states fall short. Although the Olmstead decision mandated that states provide disabled people with appropriate community-based settings, it does not override Medicaid’s funding restrictions.

From a parity standpoint, the IMD exclusion effectively institutionalized diagnostic discrimination: people with physical or developmental disabilities receive full Medicaid-funded residential options, while those with psychiatric disabilities do not. It’s not a historical accident — it’s a structural inequity written into the architecture of Medicaid itself.

Deinstitutionalization was necessary, but many — including myself — believe the IMD exclusion now does more harm than good. Many people with SMI are denied the longer-term residential supports essential for stabilization, recovery, and crisis prevention.

How the Exclusion Limits Critical Housing Needs

Arizona’s public health community has long recognized the interlocking challenges of homelessness, incarceration, and behavioral health. I saw it firsthand when I was the Director at ADHS when we did the behavioral health part of Medicaid (which has been since moved to AHCCCS).

What Gets Measured Gets Done: Tackling Housing & Incarceration Challenges for Persons with Serious Mental Illness – AZ Public Health Association

When states can’t access federal Medicaid funds for residential care, it undercuts efforts to build continuum-of-care models that could reduce emergency department use, criminal justice involvement, and community instability.

Here are the downstream effects of the IMD exclusion:

• Many states, including Arizona, short-change permanent supportive SMI housing because federal matching funds can’t be used.
• People with SMI are often discharged too soon into unstable settings because there is no financially practical residential alternative. Homelessness can result – which of course is lethal here in Arizona.
• Crisis systems build up pressure: psychiatric screening centers face crowded conditions and long hold times associated with a large backlog waiting for a hospital bed. Sometimes, 72-hour involuntary hold orders expire, releasing potentially unstable and even dangerous individuals without necessary treatment.
• Some end up in jails or prisons because they weren’t given long-term support for recovery. Treatment Advocacy Center estimates individuals with SMI in Arizona are 32 times more likely to be incarcerated than to be placed in a state hospital bed.
• Many SMI individuals rotate in and out of psychiatric hospitals by stringing together Medicaid-funded 15-day stays, with no long-term viable treatment options. This is often the only avenue to access federal funds for treatment.
• Creative innovations involving Section 1115 waivers offer short-term treatment options, not long-term housing solutions. Waivers are complex to secure and renew, requiring CMS and now legislative approvals.
• Even the 2014 Arnold vs. Sarn lawsuit agreement promising permanent supported housing for the SMI population did not require adequate state funding.

Two key proposals in the current Congress reflect different reform paths:

• Michelle Alyssa Go Act (H.R. 5462) — instead of full repeal, this bill would raise the bed threshold for eligible inpatient psychiatric facilities (from 16 beds up to 36) so that more institutions could qualify for Medicaid reimbursement. While this is a positive step toward increasing access to institutional care, this does little to help the SMI permanent housing crisis.
• Increasing Behavioral Health Treatment Act (H.R. 4022) — this is closer to a full repeal. It would lift the IMD exclusion for states that commit to expanding outpatient services, crisis stabilization, and stronger community-based systems. In effect, it would allow states to integrate inpatient, residential, and outpatient support under Medicaid with guardrails.

Another path?: Congress could create a new Medicaid benefit category—say, Community Residential Treatment Facilities — for people with a SMI. This could carve out funding for small, recovery-oriented residential programs that aren’t hospitals; like the waivers and HCBS options currently available for DDD and ALTCS populations.

These would have tight conditions (e.g. maximum bed count, oversight reviews, and choice standards) to protect the deinstitutionalization goal while embedding housing supports into Medicaid for people with SMI. This would preserve the IMD exclusion for large institutions but allow Medicaid coverage for small, community SMI programs.

Today, AHCCCS is implementing a limited 1115 Demonstration Waiver program called Housing and Health Opportunities (“H2O”), which allows Medicaid to pay for up to 6 months of housing services for certain qualifying SMI members. This can help SMI members transition into Permanent Supportive Housing (PSH) with services also funded by AHCCCS. 

Unfortunately, this program still doesn’t provide sustainable funding for appropriate residential care needed by many individuals living with SMI. While the H2O program does allow some SMI housing flexibility, Arizona (and many states) will still face severe limitations as long as the IMD exclusion is still in place.

Note: AHCCCS’ H2O program just celebrated the 1-year anniversary since its launch. The program provides Transitional Housing Assistance; Housing Transition and Move-In Support; Home Accessibility Modifications; and Pre-Tenancy and Tenancy Sustaining Services.

AHCCCS Tackling Housing Instability with Their New ‘H2O’ Program – AZ Public Health Association

Call to Action

The IMD Exclusion is doing more harm than good. It’s undermining  integrated care, behavioral health equity and recovery for people with serious mental illness because it effectively prevents using federal matching Medicaid funds for permanent supported community housing for persons with a Serious Mental Illness (an exclusion that for example doesn’t exist for persons with developmental disabilities).

For Arizona to build a more humane, effective behavioral health system, reforming or repealing this exclusion is no longer optional — it’s urgent in my opinion.

Below is a helpful table that summarizes what housing options can be paid for using federal Medicaid dollars.

Population	IMDs (>16 beds)	Small Group Homes (<16 beds)	Room & Board Coverage (<16 beds)	Who Bears Responsibility for Housing Gap
Serious Mental Illness (SMI)	Excluded under IMD rule; Medicaid cannot fund services or room/board for ages 21–64	Not IMDs; Medicaid can fund services, but not housing	Excluded: Medicaid covers services only; room/board not reimbursable	State subsidies (limited), SSI/SSDI, or homelessness fill the gap
Developmental Disabilities (ICF/IID, HCBS)	Not defined as IMDs; ICF/IID carved out in statute	Small homes licensed as ICF/IID or HCBS waiver homes	Bundled daily rates integrate habilitation/ residential supports; SSI applied to room/board	Shared: SSI covers housing, Medicaid funds habilitation, reducing state burden
Dementia / Elderly (Assisted Living / Nursing Facilities)	Nursing facilities covered: Medicaid pays room, board, and care	Assisted living under HCBS waivers; services covered, room/board excluded	Resident SSI/SSDI pays for housing; Medicaid covers care services	Less state-only burden than SMI; Medicaid and SSI fill most of the gap

ICF/IID = Intermediate Care Facility for Individuals with Intellectual Disabilities; HCBS = Home and Community-Based Services; SSI = Supplemental Security Income; SSDI = Social Security Disability Insurance. Table Courtesy of Arizona Mad Moms