State-Directed Payments: Overview, Trends and Proposed Changes

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In 2020, Medicaid spent $220.8 billion on hospital care. Hospital care accounted for 33% of Medicaid spending.

Supplemental payments are critical for closing the gap between hospital costs and Medicaid reimbursement, helping ensure Medicaid enrollees’ access to care. They serve different purposes, however, and vary significantly among states. Some help supplement Medicaid base payment rates that are often below costs, while others help support the costs of care for uninsured patients.

Types of Hospital Supplemental Payments—and How They Are Financed

There are five types of hospital supplemental payments:

1. Disproportionate Share Hospital (DSH) Payments. Offering broad flexibility on how payments are distributed, DSH payments are statutorily required to address unreimbursed costs of Medicaid and uninsured patients. They are subject to hospital-level and state-level caps.
2. Upper Payment Level (UPL) Payments. Intended to offset low Medicaid payment rates, UPL payments cannot exceed an “upper payment limit” measured by what Medicare would have paid to specified classes of providers.
3. Graduate Medical Education (GME) Payments. Funding the training costs of residents and fellows, GME payments cover direct and indirect costs of medical education. (In some states these are UPL payments.) Unlike Medicare, Medicaid GME payments are not statutorily required. 
4. 1115 Waiver Payments. These payments may be used to fund hospital uncompensated care and/or delivery system reform as a component of a demonstration project that “furthers the objectives” of Medicaid.
5. Directed Payments. States may direct MCOs to make payments to designated providers (subject to federal approval). Direct payments are often used to make enhanced payments to providers in the context of managed care to promote access and/or quality. They must be tied to claims.

States may use general funds to finance the nonfederal share of their supplemental payments, but they often rely on provider taxes and Intergovernmental Transfers/Certified Public Expenditures instead. When understanding potential risks and mitigations to supplemental payments, it is important to consider both the supplemental payment and the financing source.

State-Directed Payments (SDP) Context

Under current managed care rules, states are permitted to direct managed care organizations, prepaid inpatient health plans and prepaid ambulatory health plans to use particular provider payment methodologies that promote access, quality and delivery system reform. States can mandate two broad types of SDPs:

• Minimum, maximum or uniform payment increases that plans must pay providers (state-directed fee schedules)
• State-specified value-based purchasing (VBP) and delivery system reform methodologies (VBP-directed payments)

SDPs must be tied to utilization and distributed to a defined class of providers, but states have flexibility to define the class. To obtain approval for SDPs, states must document arrangements in the contract with plans and the managed care rate certification. In most cases, under current rules, states must also submit a preprinted form to CMS requesting pre-approval for the arrangement.

Overview of Inventoried SDPs

In response to a Freedom of Information Act (FOIA) request, Manatt Health created an inventory of SDPs of CMS-approved directed payments between March 2021 and August 2022. Our analysis found that:

• The majority of directed payments require a payment to be made in addition to the negotiated rates between the plans and providers.
• ~50% of payment schedules are based on Medicare payment rates.
• States use a variety of mechanisms to finance the nonfederal share of directed payments. State general revenues are used by ~50% of directed payments, but a large number of directed payments are funded by provider assessments and IGTs as well.

Overview of the Managed Care and Access Proposed Rules

On April 27, 2023, CMS released two highly anticipated proposed rules that would reshape the federal regulatory landscape for Medicaid and the Children’s Health Insurance Program (CHIP):

• “Managed Care Access, Finance, and Quality” (or the “Managed Care Proposed Rule”), focused on the managed care delivery system
• “Ensuring Access to Medicaid Services” (or the “Access Proposed Rule”), focused on the fee-for-service delivery system and home- and community-based services across systems 

Together these two rules would transform:

• Standards for ensuring access to care
• Engagement of people enrolled in Medicaid
• Transparency/oversight of payment rates
• State-directed payments
• Program accountability

Overview of Proposed Requirements for SDPs

In the proposed rule, CMS recognizes the important role of SDPs in promoting state access and quality goals, but also identifies concerns about the growth of SDPs and certain state approaches to financing the nonfederal share of SDPs. The proposed rule would:

• Codify the Average Commercial Rate (ACR) as the SDP payment ceiling for hospitals and other key providers, with new flexibility to calculate the ACR.
• Grant new flexibilities, including permitting SDPs for non-network providers and exempting SDPs that match Medicare rates from the formal preapproval process.
• Mandate that states collect attestations from all providers receiving SDPs that they do not participate in “hold harmless” arrangements associated with provider taxes.
• Require new, provider-level reporting on SDPs to increase transparency and accountability, limit formal evaluation reports to large SDPs that exceed a certain expenditure level, and heighten requirements for the evaluation reports to improve the link between SDPs and quality.

The proposed rule indicates CMS’s preference to permit large SDPs as a key tool in support of state quality and access objectives, while enforcing federal rules related to nonfederal share financing arrangements that CMS has long believed undermine the fiscal integrity of the Medicaid program.