In April, the Centers for Medicare and Medicaid Services (CMS) released proposed regulations that address states’ authority to direct the amount Medicaid managed care plans pay providers. The final rule will have major implications for the Medicaid program and the more than 70 percent of Medicaid beneficiaries enrolled in managed care.
How State-Directed Payments Can Improve Access and Reduce Disparities
States contracting with Medicaid managed care plans must ensure that the rates they pay plans are “actuarially sound.”1 But historically states had no authority to “direct” the rates plans paid to clinicians or hospitals. In 2016, CMS opened the door to “state-directed payments.” Under regulatory authority, states may require plans to increase payments to providers to promote access, quality, and delivery system reform. States can direct plans to make these payments for a broad or narrow set of services (e.g., all hospital care or outpatient only) and specify the type of provider eligible to receive them (e.g., all acute care hospitals or safety-net hospitals). Although not specified in the current rules, under CMS practice, states also have flexibility in setting the level of directed payments — for instance, by tying it to a percentage of Medicare rates or to commercial rates. For example, Kentucky directs its managed care plans to pay 90 percent of average commercial rates for inpatient and outpatient hospital care provided by most hospitals in the state, as a way to bolster access to high-quality care generally and behavioral health services specifically.
States are increasingly relying on directed payments as a tool to improve health care access for Medicaid beneficiaries and address workforce shortages. Thirty-nine states made directed payments in 2022. Some use directed payments to ensure plans pay at least the state’s Medicaid fee-for-service rates, but increasingly states are setting rates that match average commercial rates. This is a significant departure for Medicaid, which often pays well below both Medicare and commercial rates. As CMS notes in its proposed rule, a growing body of research demonstrates that higher Medicaid payments boost provider participation and improve patient access. More than 50 percent of Medicaid beneficiaries identify as Black, Hispanic, Asian American or another racial or ethnic minority; state-directed payments can meaningfully address disparities in care access.
The proposed rules would strengthen states’ authority to direct payments consistent with CMS’ interest in improving access to care. They would codify states’ ability to pay up to average commercial rates and provide additional flexibility in the design and implementation of directed payments. However, the proposal comes at a time when the size and financing of state-directed payments are under increasing scrutiny and judicial review. If CMS is not able to rein in what it describes as “impermissible state financing practices,” which are sometimes associated with directed payments, it could reverse course and limit these payments in the final rule.
Financing Challenges
Like all Medicaid payments to health care providers, the federal government and states share the cost of directed payments. While states may use general funds for the state (i.e., “nonfederal”) portion, typically the state share of directed payments is funded by a tax on the class of providers eligible to receive the payments. Provider taxes are a permitted and important source of Medicaid financing, but CMS is increasingly concerned about arrangements, referred to as “provider pooling,” under which health care providers (e.g., hospitals) redistribute payments among themselves to ensure no provider pays more in taxes than it receives in payments. By tying payments to the amount of a provider’s tax rather than the amount of services provided to Medicaid beneficiaries, these arrangements shift payments from high-Medicaid providers to low-Medicaid providers and reduce or eliminate the effective tax liability for low-Medicaid providers.
CMS issued guidance in February to rein in these practices. Because state-directed payments are a large and growing share of Medicaid spending often financed by provider taxes, the proposed regulations take a further step to require providers to attest they are not pooling payments.
Federal efforts to curtail pooling arrangements are controversial. Texas has filed a lawsuit, arguing that CMS’ February guidance unlawfully restricts private business arrangements among providers; the court temporarily stopped enforcement while the case proceeds. In response to CMS’ proposed rule, some key stakeholders take the position that the proposal aimed at constraining provider pooling goes beyond CMS’s authority.
Possible Approaches in Final CMS Rulemaking
Stakeholder pressure and legal uncertainty raise hard questions for CMS as it finalizes the rule. CMS’ clear preference is to codify the flexibility for states to set directed payments equivalent to commercial rates as a tool for promoting access to care, while also limiting provider pooling arrangements. If blocked from restricting pooling, CMS may take a different course and limit the size of state-directed payments. CMS notes in the proposed rule that it is considering options to tie state-directed payments to Medicare levels or capping total payment levels for each state. This would reduce state-directed payments and limit the amount of funds subject to pooling. Constraining state-directed payments, however, would not end pooling and could undermine access and equity goals.
There is much at stake in this fluid environment. Future court rulings and CMS’ final rule — expected sometime in 2024 — could have profound consequences for Medicaid financing, payment levels, and provider participation.
