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Proposed Medicaid Rules: In-Lieu of Services (“ILOS”) Reforms


On May 3, 2023, the Centers for Medicare & Medicaid Services (“CMS”) published two proposed rules amending the regulations governing Medicaid managed care organizations at 42 C.F.R. Part 438. The proposed rules, Managed Care Access, Finance, and Quality, and Ensuring Access to Medicaid Services, aim to improve access to care and quality outcomes for managed care beneficiaries. This is the fourth of a series of blog posts outlining the proposals by CMS. Comments on the proposed rules are due by July 3, 2023.


Background of ILOSs


In 2016, as part of an overhaul of the Medicaid managed care regulations, CMS authorized for Medicaid managed care plans (“MCPs”) to cover “services or settings that are in lieu of services of settings” covered under Medicaid fee-for-service where: (1) the State determines that the alternate service or setting is a medically appropriate and cost effective substitute for the covered service or setting; (2) the enrollee is not required to use the alternative service or setting; (3) the approved alternate services are authorized and identified in the Medicaid managed care contract with the State and are offered at the option of the plans; and (4) the utilization and actual cost of the alternative services is taken into account in developing capitation rates.


ILOSs have been utilized by states and their MCPs to address social determinants of health and health-related social needs. The notion is that these alternative services will substitute for or reduce utilization of more expensive services, such as emergency department visits and inpatient hospital services. For example, as illustrated by CMS, “offering medically tailored meals as an ILOS may improve health outcomes and facilitate greater access to care to HCBS, thereby preventing or delaying enrollees’ need for nursing facility care.”


California is at the forefront of the ILOS movement. Last year, California began implementing its CalAim initiative, which includes an ILOS program called “Community Supports.” This program provides Medi-Cal MCPs the option of providing one or more community support, like housing navigation services, respite services, day habilitation programs, sobering centers, and home modifications.


In response to the proliferation of ILOSs within states’ Medicaid programs, CMS has proposed adding more robust regulations to ensure the effective and efficient use of these services. The proposed provisions will enable CMS to assess ILOSs prior to approval and on an ongoing basis, provide increased monitoring, and implement fiscal protections and accountability of expenditures. These changes will likely result in corresponding updates to states’ Medicaid managed care contracts, as well as to contracts between MCPs and providers.


Proposed Changes to ILOS

  • Clarification of General Parameters: The regulations will set forth the definition and general parameters of what constitutes an ILOS:

  • “ILOS” will be defined as “a service or setting that is provided to an enrollee as a substitute for a covered service or setting under the State plan.”

  • The current regulation at 42 C.F.R. section 438.3(e)(2)(i) requires an ILOS to be “medically appropriate and cost effective.” CMS clarified that it interprets this to mean “an ILOS may serve as an immediate or longer term substitute for a covered service or setting under the State plan, or when the ILOS can be expected to reduce or prevent the future need to utilize a covered service or setting under the State plan.”

  • An ILOS must be approvable as a service or setting through a State plan amendment, or 1915(k) of the Act, or a waiver under section 1915(c) of the Act.


  • New State-MCP Contract Requirements: For each ILOS that the MCP elects to offer, certain information will be required in the MCPs managed care contract with the state, including:

  • The name and definition of the ILOS;

  • The state plan covered service or setting for which the ILOS has been determined to be a medically appropriate and cost effective substitute;

  • The target populations; and

  • A process that a provider must use to determine whether the ILOS is medically appropriate for a specific enrollee.


  • 5% Limitation: For each Medicaid program, the state must calculate the percentage of total ILOS costs in relation to the total capitation payments (including directed payments). This will be called the ILOS cost percentage. CMS will cap the ILOS cost percentage and associated expenditures at 5 percent. This may significantly curb ambitious new state programs offering alternative services.

  • The ILOS cost percentage will be measured annually on both a prospective basis when capitation rates are developed (“Projected ILOS Cost Percentage”) and on a final basis after capitation payments are made by states to MCPs (“Final ILOS Cost Percentage”)

  • The 5 percent limit is structured similarly to incentive arrangements that are capped at 105% of approved payments attributable to enrollees or services.

  • The ILOS cost percentages must be included as a separate report in a state’s rate certification process to CMS.

  • Notably, CMS is not basing the ILOS cost percentage on actual expenditures and paid amounts. Nevertheless, state must still provide CMS with a report of actual MCP costs for delivering ILOSs based on claims and encounter data.


  • Risk-based Approach for CMS Review: States with a higher share of ILOS will be subject to increased CMS oversight and documentation requirements.

  • If a state’s Projected ILOS Cost Percentage is at or below 1.5%, CMS will generally perform a streamlined initial review of each ILOS.

  • If the Projected ILOS Cost Percentage exceeds 1.5%, percent, CMS’s initial evaluation will require descriptions and supporting evidence the state used to determine that the ILOS is medically appropriate and cost-effective. States will also be required to submit a retrospective evaluation every five years to evaluate 1) cost, 2) utilization, 3) access, 4) grievances and appeals, and 5) quality of care for each ILOS.


  • Payment and rate development: Utilization and actual cost of ILOSs must be taken into account developing capitation rates. Since rates are set prospectively, rate adjustments may be necessary if actual uptakes of ILOS vary from what is initially assumed.


  • Enrollee rights and protections: The proposed regulations reinforce the concept that if an enrollee is offered or utilizes an ILOS (or chooses not to utilize an ILOS), the enrollee retains all rights and protections found in 42 C.F.R. Part 438. ILOSs cannot be used coercively with the intent to interfere with the provision of covered services, nor can MCPs deny covered service due to ILOS. MCPs will be required to include explicit language on these ILOS protections in its enrollee handbooks.


  • ILOS Termination Process: States must notify CMS within 30 days of determining that an ILOS is no longer medically appropriate or cost-effective, or is otherwise noncompliant with the regulations. If an ILOS must be terminated, states must develop a transition plan to arrange for services to be provided to enrollees with minimal disruption to care. This will also necessitate an adjustment to capitation rates to account for removal of ILOS utilization and costs.


This proposed rulemaking marks a notable increase in CMS’s review and oversight of ILOSs. We encourage relevant stakeholders to submit comments to regulations.gov. Comments will be accepted until 5 p.m. on July 3, 2023.


For more information on the proposed Medicaid regulations or ILOS, please contact Felicia Y Sze or Kyle Brierly.


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