The Big Picture
The Centers for Medicare & Medicaid Services (CMS) made sweeping changes to the regulatory landscape for Medicaid and the Children's Health Insurance Program in its recent set of final Medicaid access regulations (here and here), including significant changes to CMS' oversight of provider payment rates. In particular, CMS revised federal rules governing State Directed Payments (SDPs), which allow states to direct Medicaid managed care plans to use specific provider payment methodologies that promote access, quality, and delivery system reform.
SDPs have grown significantly since their inception in 2016 and are now a foundational part of Medicaid reimbursement for many providers. SDPs have reached almost $80 billion annually, making up more than 15% of total Medicaid managed care spending.
Importantly, for the first time CMS codified a previously informal policy that states may require Medicaid managed care plans to pay providers up to rates equivalent to commercial payors (called the average commercial rate, or ACR), a significant change for the Medicaid program which has historically paid providers substantially less than commercial and Medicare rates. CMS highlighted that allowing SDPs up to average commercial rates enables Medicaid to compete with commercial insurers to ensure robust access for Medicaid enrollees.
However, CMS also included new guardrails for SDPs, including a new prohibition on the use of separate payment terms, a common methodology under which managed care plans pay providers separate from their monthly capitation rates. The separate payment term prohibition, which is effective for plan years starting after July 9, 2027, will require many states to redesign their SDP methodologies to come into compliance.
What Are Separate Payment Terms?
Under existing rules, SDPs must be tied to utilization and distributed to a defined class of providers. To obtain approval for SDPs, states must document arrangements in their managed care contracts and in the managed care rate certification. Additionally, for most SDPs, states must also submit a preprinted form to CMS to receive pre-approval for the arrangement.
States currently have two options for ensuring managed care plans have sufficient funding to make SDPs to providers: (1) adjustments to the base capitation rate, where states incorporate the SDP in the prospective, per-member per-month (PMPM) payments made to plans, or (2) a separate payment term, where an aggregate pool of funding is reserved for the SDP, separate from the base capitation rate.
- Base Capitation Approach Example. Using SDP authority, a state requires managed care plans to make an additional payment to eligible hospitals for inpatient services. To incorporate the SDP into capitation rates, the state and its actuary estimate future inpatient hospital utilization and determine an appropriate adjustment to the managed care base capitation PMPM. Under this approach, the plans are "at risk"—if utilization exceeds what was assumed in developing the base capitation rate, plans must still pay eligible providers the full SDP amount. If utilization is less than assumed in the PMPM, plans keep the excess funding.
- Separate Payment Term Approach Example. A state identifies a fixed pool of funding for inpatient hospital directed payments. The state then requires plans to pay hospitals retrospectively based on utilization from a prior time period (e.g., prior quarter), and in some cases adjusts the per-service payment amount throughout the year to exhaust the aggregate pool by year end. Under this approach, plans are not "at risk" for the SDP and do not see financial gains or losses if actual SDPs differ from projections.
Why Do Many States and Providers Leverage Separate Payment Terms Rather Than Base Capitation Adjustments to Implement SDPs?
States and providers often prefer separate payment terms for a variety of reasons. When the non-federal share of an SDP is financed by provider taxes or intergovernmental transfers (IGTs), providers often prefer that the tax or IGT precisely align with the non-federal share of the payment that providers actually receive, which is easier to accomplish with a fixed pool of dollars.
Additionally, for SDP arrangements targeted to a narrow set of providers separate payment terms remove the incentive for plans to steer utilization to comparable providers not eligible for the directed payment (and that, from the plan's perspective, are less expensive than the providers receiving directed payments). In cases where states are directing SDPs to certain high-Medicaid and financially vulnerable providers like safety net hospitals, states and providers may fear that without a separate payment term, a program intended to help specific providers could hurt them by steering volume—and dollars—away from them.
What Do the New Regulations Require?
Under the final rule, states must incorporate all SDPs into Medicaid managed care base capitation rates for rating periods starting on or after July 9, 2027. States also cannot withhold capitation payments to plans or direct plans to reserve a portion of capitation payments for the purposes of making SDPs to providers under a separate payment term.
This prohibition represents a departure from CMS' proposed rule, under which CMS would have permitted separate payment terms subject to certain restrictions. In the preamble to the final rule, CMS justified the policy change based on the concern that the frequent use of separate payment terms undermines risk-based managed care.
What Should States Consider in Adapting to This New Requirement?
The phaseout of separate payment terms will have significant implications for states and providers. CMS estimated that 55% of all SDPs that began in 2021 were structured as separate payment terms, meaning about half of existing SDPs will need to be restructured, should they continue into rating periods for contracts beginning on or after July 9, 2027.
Importantly, states will need to closely partner with their actuaries to ensure the SDP amount added to base capitation reflects as accurate an estimate as possible—with managed care plans at risk and providers often financing the non-federal share of SDPs, the stakes are much higher to develop a precise projection of SDP payments to providers. If estimates are too low, plans suffer financial losses, while if estimates are too high, provider taxes or IGTs are larger than the non-federal share of the payment providers receive.
Where the nonfederal share of an SDP is financed with provider taxes or IGTs, many states will need to restructure these nonfederal share financing arrangements, for example tying the nonfederal share financing to a percentage of base capitation rather than a fixed dollar amount. Because base capitation is paid on a PMPM basis, this approach allows the provider tax or IGT to fluctuate with managed care enrollment. If enrollment increases, the tax or IGT would increase to reflect expected additional utilization (and higher SDPs for the eligible class of providers). Such a methodology is still not as precise as a separate payment term, because increases in enrollment may not lead to a proportionate increase in SDPs to the providers eligible for the payment.
For SDPs focused on a narrow group of providers, states will need to develop strategies that limit the incentive for plans to steer utilization to providers not eligible for the SDP. For example, states could closely monitor utilization among SDP-eligible providers for evidence of steerage and could consider tying stable utilization among such providers to managed care incentives or withholds. Within federal managed care rate-setting parameters, states can also work with their actuaries to develop base capitation adjustments that account for differences in managed care plans' networks (i.e., some plans may have greater or fewer providers eligible for the SDP in their networks compared to other plans, meaning differential adjustments by plan are appropriate).
As a safeguard for plans, providers, and states, CMS indicates in the final rule preamble that states can recoup unspent SDPs from plans, which would mitigate some of the risk related to base capitation adjustments. However, the implications for rate-setting and provider payments remain unclear. CMS policy will emerge as it reviews SDP pre-prints from states, and this is likely to be a rapidly evolving space in the coming years.
With CMS' codification of the ACR for hospitals and key providers, SDPs are likely to become even more pervasive in the coming years. However, the prohibition on separate payment terms means that states, plans and providers will need to work together to transition these payments into a framework that CMS views is more consistent with risk-based managed care, while mitigating risks to states, providers and plans.
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