Editor's Note: This "Manatt on Medicaid" is the sixth in a series of updates focused on CMS's new Medicaid/CHIP managed care regulations. In the coming weeks, Manatt will continue to explore key provisions of the regulations and highlight their implications.

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In its April 25, 2016 Medicaid managed care final rule, the Centers for Medicare and Medicaid Services (CMS) addresses a core issue: how managed care plans should be paid by state Medicaid programs. Through provisions addressing medical loss ratio and actuarial soundness requirements, CMS revises its standards on how much states should pay plans and the process states should use in setting payment rates. The rules do not require states to pay plans' specific premium rates. Instead, the final rule sets out a detailed framework that states must follow in establishing the premium amounts that are paid to plans.

This first part addresses the final rule's medical loss ratio requirements, which go into effect for managed care contract rating periods beginning on or after July 1, 2017. The upcoming second part will focus on actuarial soundness requirements.

General Requirements

The medical loss ratio (MLR) is a calculation that compares a plan's spending on medical benefits to its administrative expenses and profits. The Affordable Care Act (ACA) requires Medicare Advantage and commercial health plans to pay rebates to the government or enrollees if their MLRs fall below a certain threshold (85 percent for Medicare Advantage and group health plans; 80 percent for individual and small group plans). The ACA, however, does not impose a similar requirement on Medicaid managed care plans. Lacking the statutory authority to mandate that plans meet a minimum MLR, CMS does not mandate a minimum standard in the final rule. Instead, states have the option of requiring plans to have an MLR at or above 85 percent. Even if states do choose that option, they are not required to demand rebates from plans if their MLRs fall below 85 percent, and if states do require rebates, they have the freedom to set the amount of such rebates. In addition, regardless of whether a state sets a minimum MLR, a state cannot set its capitation rate with a target MLR of less than 85 percent. Thus, even if a state does not have a minimum MLR, if plans have an MLR below 85 percent, the state must take that lower MLR into account in setting rates in future years.

Many states already have minimum MLRs for their Medicaid programs. States with minimums below 85 percent will need to increase the minimum for purposes of setting rates, although they may retain such lower targets for purposes of requiring rebates. States with minimum MLR targets of 85 percent or more can retain such targets. However, since the federal rules may differ from previous state rules regarding the treatment of certain costs in calculating MLR, states may need to reassess whether their minimums make sense in light of the new federal rules.

Treatment of Costs and Revenues

At its heart, the MLR is a means of dividing plan costs into two different categories: costs relating to the payment of medical care and costs for administration of the plan. Spending on medical claims and quality improvement activities are in the medical cost category, while expenses associated with activities such as utilization review, marketing and member services, together with profits, are in the administration category. The MLR is calculated by dividing medical costs (the numerator) by total plan revenues.

In an effort to create uniformity across different product lines, CMS adopted MLR rules that largely track similar rules adopted for the Medicare Advantage and commercial markets. This similarity is true with respect to which costs can be placed in the numerator and which fall in the administrative expense category. Nevertheless, the rules clarify the treatment of certain categories of expenses:

  • Quality improvement expenses: The same categories of expenses that are recognized as quality improvement expenses for commercial plans—such as discharge planning aimed at preventing readmissions, adoption of best practices to reduce medical errors and infection rates, and wellness programs—are treated as such for Medicaid managed care plans. In addition, the costs of external quality review—the amounts that a plan must pay to an external quality review organization to assess the plan on quality, access and timeliness measures—are considered quality improvement expenses.
  • Case management/care coordination: Although not explicitly referenced in the text of the rule, CMS clarifies in the preamble that it considers these activities to be quality improvement expenses.
  • Fraud prevention activities: The final rule aligns the treatment of fraud prevention activities with the treatment of such activities in the commercial market, which does not allow fraud prevention expenses to be considered part of the numerator.

As is the case with Medicare Advantage and commercial plans, taxes are deducted from premium revenues when calculating MLR. The final rule also requires revenues to be adjusted by any risk corridor or risk adjustment payments made or received by plans or one-time "kick" payments (such as payments made to offset the costs related to delivery of newborns) paid to plans. However, pass-through payments that states require plans to distribute to specific providers are not to be considered revenues.

Reporting of MLRs

The final rule requires plans to submit MLR reports to states. States, in turn, must annually submit to CMS a summary of those reports. In addition, MLR results must be made publicly available. States must develop an annual assessment of the performance of their managed care programs and, as part of that assessment, states must discuss the MLR experience of their managed care plans. This annual assessment must be published on each state's website.

Other MLR Issues

The final rule gives states the flexibility to calculate MLRs on a contract basis, on the basis of populations within a contract, or, if the plan has multiple contracts with the state, on an aggregate basis. MLRs, however, must be calculated for Medicaid only and states cannot combine calculations for multiple product lines. In the case of dual eligible Section 1115 demonstration programs, also known as Financial Alignment Initiatives, the MLR must be calculated in accordance with Medicaid rules for the Medicaid portion of the premium.

MLRs must be calculated on an annual basis. CMS rejected proposals to align with ACA requirements that provide for the calculation of MLRs in the commercial market based on a three-year rolling average. The annual calculation requirement makes it more likely that plans will drop below the target MLR because they will not be allowed to offset lower medical expenses in one year against higher expenses in the previous or subsequent year.

Following the commercial and Medicare Advantage MLR rules, plans with small enrollment are subject to "credibility adjustments," which compensate these plans for the probability that they will have more irregular claims experiences and could be more vulnerable to paying rebates.