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CMS Finalizes Medicaid Rule on State Directed Payments

On May 10, 2024, the Centers for Medicare & Medicaid Services (“CMS”) issued a final rule (“Final Rule”) amending the regulations governing state directed payments to providers through Medicaid managed care organizations at 42 C.F.R. Part 438. This blog post is a follow-up to our earlier post explaining the background of state directed payments and CMS’ proposals from last year. 

Question 1.                What is a state directed payment?

In general, when a State utilizes a managed care program to implement its Medicaid program, it will pay Medicaid managed care organizations based on a capitated, per member per month method.  This capitation rate is required to be actuarially sound; in general terms, this means that the State establishes the rate in a way that an actuary certifies that it projects the costs require to cover the services carved into the scope of coverage under the managed care agreement.  This capitation rate is typically established prior to the rating period. 

To preserve the concept of the actuarially sound capitation rate, CMS has long restricted states from supplementing the capitation rates by paying providers directly for services once delegated to managed care plans.  However, some states continue to seek to instruct the way in which managed care plans pay providers, whether by specifying value-based methodologies or minimum or maximum fee schedules.  The regulation at 42 C.F.R. section 438.6 provides the authority for states to do so, while establishing the requirements applicable to each methodology.

Question 2.     In what ways can states direct Medicaid managed care expenditures to providers?

The forms of currently permitted SDPs are: (1) value-based purchasing, such as pay for performance or bundled payment arrangements; (2) delivery system reform or performance improvement initiatives; and (3) required payments based on minimum fee schedules, uniform dollar or percentage increases or maximum fee schedules.

Question 3.            How do directed payments differ from pass-through payments?

Pass-through payments are payments that a State requires a Medicaid managed care organization to include on top of existing payment rates to hospitals, physicians, or nursing facilities that are not state directed payments.  In general, these payments are not tied to specific services or benefits provided to an enrollee during the current rating year.  These are often tied to so-called “upper payment limit” programs, and based on historical utilization.  CMS is requiring a phase-out of pass-through payments because it believes the utilization of pass-through payments to be inconsistent with the statutory concept of an actuarially sound capitation rate.  Pass-through payments should no longer be used for contract periods beginning on or after July 1, 2027.

In this Final Rule, CMS confirmed that SDPs must condition payment only on the utilization and delivery of services during the rating period. It prohibits a state requirement that plans make interim payments be made based on utilization and delivery of services outside the rating period and later reconcile those interim payments based on current utilization at the end of a rating period.

Question 4.              What is a grey area payment?

CMS refers to situations in which a State mandates that a plan must pay a specified amount for a certain purpose, but does not direct individual payments to individual providers as “grey area payments.” In the Final Rule, CMS confirms that these grey area payments are only permissible if they meet the standards for permissible SDPs, subject to the rules in 42 C.F.R. section 438.6.

Question 5.               Are there situations in which a state may direct plan expenditures that fall outside of the SDP requirements in 42 C.F.R. section 438.6?

Yes.  States are required to comply with the SDP requirements in 42 C.F.R. section 438.6 except as specified “in a specific provision of Title XIX, or in another regulation implementing a Title XIX provision related to payments to providers[.]”  CMS clarifies in the Final Rule that “the payment of statutorily-required PPS rates to FQHCs and RHCs under Title XIX or CCBHC demonstrations under section 223 of the Protecting Access to Medicare Act of 2014 are not considered SDPs[.]”  Likewise, the federally mandate payment of specific rates to Indian health care providers is also excluded from the SDP requirements.  Given the historical interpretation of 42 U.S.C. section 1396u-2(b)(2)(D) to mandate payments from Medicaid managed care organizations to providers of emergency services, this has also been used as a basis for the direction of payments for emergency services.

Question 6.            Does network participation status impact whether a provider is eligible to receive a directed payment?

Historically, CMS limited SDPs to network providers only.  The Final Rule lifts this restriction and grants states the flexibility to direct payments to both network and non-network providers.  States may exercise this authority by the manner in which they define the class of providers eligible for a specific SDP.

In our experience, Medicaid managed care organizations are increasingly leveraging the historical requirement that SDPs be tied to network provider status to unfairly reduce base rates that they are willing to pay to healthcare providers.  The expansion of SDPs to network and non-network providers will avoid this unintended consequence of the prior rule.

Question 7.             When does CMS have to pre-approve SDPs?

Not all SDPs require pre-approval by CMS.  The State may adopt SDPs requiring a minimum fee schedule based on state plan-approved rates, i.e., Medicaid fee-for-service rates, or based on a total published Medicare payment rate that was in effect no more than 3 years prior to the start of the rating period if the minimum fee schedule is set at 100% of Medicare.  All other SDPs subject to 42 C.F.R. section 438.6 must be pre-approved by CMS.

Question 8.             What are the general requirements for SDPs?

Each SDP must:

  • Be determined by how services are used and delivered.

  • Ensure funds are distributed equally and under the same conditions to all providers offering the same service under the contract. 

  • Help achieve at least one goal in the State’s quality strategy outlined in 42 C.F.R. section 438.340. These goals include, but not limited to:

    • Ensuring enough providers and services are available

    • Continuously improving healthcare quality, considering health of all state residents.

    • Using specific quality metrics and performance targets to measure and improve care.

    • Conducing annual, independent reviews.

    • Having a clear policy for transitioning patient care.

    • Identifying and reducing health disparities based on age, race, ethnicity, sex, primary language, and disability status.

    • For Managed Care Organizations, using appropriate use of intermediate sanctions

  • Have a plan to evaluate how well the payments help achieve at least one goal in the quality strategy required by § 438.340. The evaluation plan must include all the following elements: 

    • Identifying at least two specific metrics to measure the effectiveness of the payments annually.

    • Ensuring these metrics are directly related to the payments and reflect the performance of providers across all state managed care programs.

    • Including at least one performance measure from the federal regulations.

    • Providing baseline statistics for these metrics.

    • Setting performance targets that either maintain or improve upon these baseline statistics.

    • Committing to submit an evaluation report if the cost percentage of the final payment exceeds 1.5%

  • Not require providers to enter or follow intergovernmental transfer agreements in order to participate.

  • Achieve the stated goals and objectives in line with the State’s evaluation plan. If requested by CMS, the State must provide an evaluation report showing these achievements.

  • Comply all federal rules for funding the state’s share of costs, including 42 CFR 433, subpart B, which detail the state plan requirements for state financial participation in medical assistance expenditures.

  • Ensure that providers receiving these payments confirm they do not participate in any “hold harmless” arrangements for health-care related taxes, as discussed below in questions 12 and 13

  • Set reasonable, appropriate, and attainable total payment rate for each service and provider group. If requested by CMS, the State must provide documentation showing the payment rates.

  • Be developed in accordance with § 438.4 (actuarial soundness) and meeting standards in § 438.5 (rate development), § 438.7 (rate certification), § 438.8 (medical loss ratio).

Question 9.             What are the additional requirements for SDPs that do require prior approval?

Evaluation Plan: States must submit a written evaluation plan for SDPs that require prior approval with the request for prior approval. That evaluation plan must include: (1) identification of at least two metrics that will be used to measure the effectiveness of the SDP in advancing at least one of the quality goals and strategies, which must be specific to the SDP and include at least one quantitative measure with a numerator and denominator used to monitor performance at a point in time or track performance over time of provider service delivery, quality of care, or outcomes (a “performance measure”); (2) include baseline statistics on all metrics; (3) include performance targets for all metrics; and (4) include a commitment to submit an evaluation report if the final SDP cost percentage exceeds 1.5 percent, discussed below.

Payment comparison analysis of SDP to Medicare and/or ACR: As discussed below, certain types of SDPs (inpatient hospital services, outpatient hospital services, nursing facility services, and qualified practitioner services at an academic medical center) are subject to a limitation that the total payment rate may not exceed the average commercial rate.  For each such SDP, the State must prepare an average commercial rate demonstration to substantiate the average commercial rate, as well as a total payment rate comparison to calculate the total Medicaid payments for the specified services to providers within the provider class as a percentage of the average commercial rate.

Question 10.              What is the approval process for a SDP?

For SDPs that require prior approval, CMS proposes numerous new requirements. First, the State must include a written evaluation plan with its submission for approval.

For SDPs that require prior approval that have a final SDP cost percentage greater than 1.5 percent, the State would be required to complete and submit an evaluation report using the evaluation plan submitted with the request for approval. The evaluation report must: (1) include all the elements outlined in the evaluation report; (2) include the three most recent and complete years of annual results for each metric; and (3) be published on a state website. Such an evaluation report would be required to be submitted no later than 2 years after the conclusion of the 3-year evaluation period.

 In the absence of the submission of an evaluation report, the State must submit a SDP cost percentage report to confirm that the SDP cost percentage is lower than 1.5 percent.  The final SDP cost percentage must be submitted annually for review as a separate report with the rate certification submitted by the State.

To the extent the SDP is subject to the average commercial rate limitation, the State must include the average commercial rate demonstration with the initial documentation submitted for written prior approval of the SDP, and then must be updated at least once every 3 years. The State must also submit the total payment rate comparison with the documentation submitted for written prior approval and be updated with each amendment and subsequent renewal.

States must submit preprint requests and all required documentation for SDPs requiring prior approval prior to the start date of the SDP, and any amendments prior to the start date of the amendment to the SDP.  Approvals for value-based or delivery system reform or performance improvement initiative SDPs will be fore one rating period, unless specified criteria are met for multi-year approval up to three rating periods.  Approval of all other SDPs will be limited to a single rating period.  SDPs will not be automatically renewed.

Question 11.              When the State pays a Medicaid managed care organization for SDPs, can it equal exactly the amount that the State directs the Medicaid managed care organization to pay providers?

Unlikely.  The federal rules governing SDPs require that all SDPs be developed in accordance with actuarially soundness.  In practice, this generally requires the payments to be translated into a per member-per month methodology, rather than a pass-through aggregate amount.

CMS has codified its current practice for two methods of incorporating SDPs into a State’s actuarial rates to plans. Such rates must be developed in accordance with accepted actuarial practices. Historically, CMS has permitted a separate payment term method, by which a state establishes a finite and predetermined pool of funding that is paid by the State to the plan(s) separately and in addition to the capitation payments for a specific SDP. This separate term method will be eliminated.

Question 12.               How will Medicaid managed care organizations know they are required to make directed payments?

Each State must specifically describe and document SDPs in the contracts with Medicaid managed care organizations.  The Final Rule outlines specific information that must be included for different types of SDPs.  Such proposed language must be submitted to CMS no later than 120 days after the start date of the SDP.  Some states may supplement the instruction to Medicaid managed care organizations through statutes, regulations, or informal guidance such as all plan letters. 

Question 13.              Why is my State asking for an attestation in order to receive a directed payment?

Among the new rules is a requirement by CMS that states ensure that recipients of SDPs attest that they do not participate in any hold harmless arrangement for any health care-related tax, and ensure that upon CMS request, states can either make available such attestations or explain to CMS’ satisfaction why they are not available.  This requirement goes into effect the first rating period after January 1, 2028.  However, we have seen states already start implementing this requirement even if it is not required by federal regulation.  CMS explicitly states that it will deny SDPs that it determines do not comply with the rules governing state share of Medicaid expenditures, including the hold harmless requirement.

Question 14.              What is a hold harmless arrangement?

Federal law prohibits the use of healthcare related taxes that involve “hold harmless” arrangements. The statute governing this prohibition defines a “hold harmless” to involve situations in which the state or other unit of government imposing the tax provides directly or indirectly for our payment, offset, or waiver that is either positively correlated to the amount of the tax or the difference between the amount of the tax and the amount of the Medicaid payment, or that guarantees to hold taxpayers harmless for any portion of the costs of the tax. Historically, this requirement has been interpreted to apply primarily to state action, prohibiting states from holding taxpayers harmless when implementing Medicaid reimbursement programs funded by healthcare related taxes.

In this Final Rule, CMS states in the preamble it's position that “pre-arranged agreements to redistribute Medicaid payments” between providers would constitute an impermissible hold harmless arrangement, causing the revenues of such a health care related tax to be impermissible state funding for a Medicaid program. This interpretation was proposed in the Medicaid Fiscal Accountability Rule proposed by CMS in 2019 but never finalized. Since then, this interpretation has been the subject of legal disputes evolving at least two states. Given the plain language of the applicable statutory language, and the recent Supreme Court decision on judicial deference to administrative agency interpretation of unambiguous statutes, this is an area in which we expect to see additional judicial intervention in the future.

Question 15.              How do state directed payments work in the context of healthcare providers, like FQHCs and RHCs, where CMS imposes specific state payment requirements?


As discussed above, SDPs only come into play when there is not a federal statute that dictates the amount of payment required. For certain types of providers, such as Indian health care providers, federal law requires Medicaid managed care plans to pay at specific rates. As discussed above, in those situations, a state may direct payments without compliance with the SDP rules.


With respect to FQHCs and RHCs, federal law imposes a requirement on the states to ensure payment at the prospective payment system amount.  While the federal statute does not explicitly mandate that states take back payments to the extent that Medicaid managed care payments (including SDPs) that exceed the prospective payment system rate, most states are likely to do so based on the statutory requirement that payment be equal to the prospective payment system amount. Payment to FQHCs and RHCs based on an alternative payment method may give states more flexibility in this regard.

Question 16.              What expenditure limits does CMS now impose on SDPs?

In the Final Rule, CMS declined to impose an expenditure limit for all SDPs in a state.  CMS further requires that each State ensure that the total payment rate for each service and provider class included in a SDP be reasonable, appropriate, and attainable. 

CMS also clarified the application of the “actuarially sound” limitation to SDPs for inpatient and outpatient hospital services, nursing facility services, and the professional services at an academic medical center to mean that the total rate cannot exceed the average commercial rate. The average commercial rate (“ACR”) will be service-specific from the state, but not ownership-specific like the upper payment limit, and must rely on data no older than three years old. The ACR must include any cost-sharing and deductibles, but exclude: (i) payments to federally qualified health centers and rural health clinics, (ii) payments from non-commercial payers, such as Medicare; and (iii) payments for services carved out of the plan’s Medicaid managed care contract.  CMS left the door open as to whether it may define a similar limit to other service types.

Question 17.               What are the new requirements for value-based SDPs?

Value-based performance SDPs will: (1) not be able to be conditioned on administrative activities; (2) be required to use a common set of performance measures across all of the payers and providers; (3) be required to define and use a performance measurement period that does not exceed the length of the rating period and that does not precede the start of the rating period by more than 12 months; (4) be required to include all payments in the rate certification for the rating period in which payment is delivered; (5) be required to identify baseline statistics on all metrics used to measure performance; and (6) be required to use measurable performance statistics.

Question 18.               What are the requirements for population-based SDPs?

Population-based or condition-based SDPs will be required to: (1) be based upon the delivery by the provider of one or more specified Medicaid covered service(s) during a rating period or the attribution of a covered enrollee to a provider for treatment for the rating period (if the latter, be based on an attribution methodology no later than 3 years old and meeting other requirements); (2) replace the negotiated rate between the plan and providers for the Medicaid covered service(s) with no other payment permitted from the plan to the provider for the same services included in the population or condition-based payment; and (3) include at least one metric in the evaluation plan that measures performance at the provider class level, which is set to demonstrate improvement over baseline.

Question 19.              Why did CMS revise the rules governing state directed payments?


CMS’ stated goals for the revised rule are to further the following: (1) access to high-quality care under Medicaid managed care SDP payment arrangements; (2) appropriate linkage between SDPs and Medicaid quality goals and objectives for providers receiving payments; and (3) appropriate fiscal and program integrity guardrails by CMS and States.

Question 20.                When do the new revisions to 42 C.F.R. section 438.6 go into effect?

Applicability Dates


July 9, 2024

(a): Definitions


(c)(1), (c)(1)(iii) Introductory paragraph (sunset of SDPs only to network providers and description of minimum/maximum or uniform dollar/percentage increase SDPs


(c)(2)(i): Written prior approval for specified SDPs.


(c)(2)(ii)(A) through (C): All SDPs to be based on utilization and delivery of services, direct expenditures equally and on same terms of performance, and advance at least one of the quality goals and objectives


(c)(2)(ii)(E): No SDPs may be conditioned on IGT agreement


(c)(2)(ii)(G): All SDPs must comply with federal legal requirements for non-federal share of Medicaid expenditures


(c)(2)(ii)(I) and (J): All SDPs must be reasonable, appropriate and attainable, and be developed in accordance with § 438.4 (actuarial soundness) and meeting standards in § 438.5 (rate development), § 438.7 (rate certification), § 438.8 (medical loss ratio).


(c)(2)(vi)(A): Make participation in value-based purchasing, delivery system reform, or performance improvement initiative available using the same terms of performance to a class of providers


(c)(3): Approval and renewal timeframes

First rating period for contracts beginning on or after July 9, 2024

(c)(2)(iii): Average commercial rate limit for inpatient hospital services, outpatient hospital services, nursing facility services and qualified practitioner services at an academic medical center


(c)(2)(vi)(B): New requirements on value-based SDPs


(c)(2)(vi)(C)(1) and (2): For population-based or condition-based payment, SDP must be based upon the delivery of one  or more specified Medicaid covered service(s) during the rating period or the attribution of a covered enrollee to a provider; and if basing the payment on attribution of enrollees to provider, have an attribution method that complies with specified requirements

First rating period for contracts beginning on or after July 9, 2026

(c)(2)(vi)(C)(3) and (4): For population-based or condition-based payment, SDP must replace negotiated rate between Medicaid managed care organization and the provider with no other payment made by the Medicaid managed care organization to the same provider for the same services included in the SDP and include at least one metric in the evaluation plan that measures performance at the provider class level


(c)(2)(viii): Submission of all required documentation for each SDP for which prior approval requirement or amendment before start date


(c)(5)(i) through (iv): SDPs specifically described and documented in Medicaid managed care organization contracts

First rating period for contracts beginning on or after July 9, 2027

(c)(2)(ii)(D) and (F): Evaluation plan and result in achievement of the stated goals and objectives


(c)(2)(iv): Submission of written approval plan for SDPs requiring federal approval


(c)(2)(v): Submission of evaluation report that has a final SDP total cost percentage greater than 1.5%


(c)(2)(vii): Requirements on fee schedule or percent or dollar increase SDPs that payments be conditioned only on the utilization and delivery of services under the contract for the rating period and prohibiting payment based on utilization and delivery of services outside the rating period with reconciliation to current data.


(c)(6): Requirement that final capitation account for SDPs, accounted for in base data, as an adjustment to trend, or an adjustment as specified in section 438.5 or 438.7(b).


(c)(7): Final state directed payment cost percentage.

First rating period for contracts beginning on or after July 9, 2028

(c)(5)(v): Medicaid managed care organization contract amendments to incorporate SDPs submitted no later than 120 days after start date of SDP

First rating period for contracts beginning on or after January 1, 2028

(c)(2)(ii)(H): Attestation requirement by recipients of SDPs that they do not participate in a hold harmless arrangement


Athene Law, LLP routinely works with providers regarding state directed payment programs and Medicaid financing.  For more information on the final Medicaid regulations or state directed payments, please contact Felicia Y Sze. Ms. Sze thanks Katrina Kim for her assistance with this bulletin.

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