Editor's Note: This Manatt on Medicaid is the third in a series of updates focused on CMS's new Medicaid/CHIP managed care regulations. In the coming weeks, Manatt will be exploring key provisions of the regulations and highlighting their implications.

On April 25, 2016, the Centers for Medicare and Medicaid Services (CMS) released its highly anticipated final rule to overhaul the regulations governing Medicaid managed care (MMC) and make conforming changes to state Children's Health Insurance Program (CHIP) regulations. In one of the most significant changes between the proposed and final rule, CMS clarifies and codifies limits on "pass-through" payments—supplemental payments that states require managed care plans to distribute to specific providers—and phases out states' ability to use most pass-through payments by 2022 or 2027, depending on the type of payment. Although CMS describes these payments as inconsistent with basic concepts of managed care and value-based purchasing strategies and imposes limitations that will foreclose the ability of states to make pass-through payments in the long run, it opens the door for a new stream of supplemental payments in the short run. Many states are likely to explore using this new form of supplemental payment, relying on intergovernmental transfers and provider taxes to finance the nonfederal share; it remains to be seen how CMS will view these new payment strategies in the context of its review of states' managed care rates.

In the final rule, CMS defines a pass-through payment as "any amount required by the state to be added to the contracted payment rates, and considered in calculating the actuarially sound capitation rate, between the MCO . . . and hospitals, physicians, or nursing facilities."1 The rule permits states to provide pass-through payments after 2027 (and for some providers, after 2022), only for wrap-around payments to Federally Qualified Health Centers and Rural Health Centers, as well as graduate medical education payments. All other payments not directly linked to services delivered to enrollees under the contract (or bonuses related to outcomes of those services) will be prohibited.

In the preamble, CMS states that this rule codifies a longstanding interpretation of the current prohibition found at 42 C.F.R. § 438.60 on states making payments directly to providers for services covered through the state's contract with the managed care organizations. CMS indicates that it has interpreted this provision as also prohibiting pass-through or supplemental payments to a provider through a managed care plan. CMS also acknowledges that, despite the existing prohibition, many states do direct their plans to make supplemental payments to providers. This is in part because as states have expanded to managed care, their ability to make supplemental payments that are computed based on fee-for-service payments has been shrinking. As CMS notes: "Commonly, states that have moved from [fee-for-service] to managed care have sought to ensure a consistent payment stream for certain critical safety-net hospitals and providers and to avoid disrupting existing [intergovernmental transfer], [certified public expenditures], and provider tax mechanisms associated with the supplemental payments."

Acknowledging the potential disruption for certain providers accustomed to receiving supplemental payments paid through plans, the final rule delineates a process and timeframes for ending these types of payments. The final rule calls out three specific provider types—hospitals, physicians and nursing facilities—that are the primary provider types to which states make supplemental payments and have sought to continue to make pass-through payments through plans. Because of the much heavier reliance on these payments for hospitals, states are provided with a 10-year transition until July 1, 2027 for hospital payments, while payments to physicians and nursing facilities are afforded a 5-year transition until July 1, 2022.

CMS prescribes a phase-down approach for hospital pass-through payments. The process entails:

  • Calculating a base amount of allowable pass-through payments through a four-step process, re-basing annually. CMS likens this process to performing hospital upper payment limit (UPL) calculations under a Medicaid FFS delivery system, which identifies the "UPL gap" by comparing what Medicare would have paid to what Medicaid paid for services. The base amount is calculated annually by applying utilization data from the most recently available data two years prior to the rating period.
  • Reducing the pass-through payment limit annually. States are permitted to make pass-through payments to hospitals of up to 100 percent of the base amount through plan contracts starting on or after July 1, 2017. The limit then ratchets down by ten percentage points for each successive year, so that states are permitted to make pass-through payments to hospitals of up to 90 percent through plan contracts starting on or after July 1, 2018, and so on. States may not make pass-through payments to hospitals through plan contracts on or after July 1, 2027.

CMS does not similarly prescribe an approach for phase-down of pass-through payments to physician and nursing facilities because these are generally smaller payments and the transition period is limited to 5 years.

The clear limits on both the amount and duration of pass-through payments are described as an effort to curtail the use of supplemental payments in Medicaid managed care. CMS, as well as federal oversight bodies, have had longstanding concerns with the use of supplemental payments—particularly those directed through managed care plans. In the preamble to the final rule, CMS underscores its concerns with supplemental payments, emphasizing that pass-through payments limit plans' ability to effectively implement value-based purchasing.

Despite CMS's concerns, as noted, the final rule does not limit the phase-out period to only existing pass-through payments. In other words, CMS does not "grandfather" existing supplemental payments on which safety-net providers may have come to rely. Instead, the rule contemplates states establishing new pass-through payments during the phase-down period, clarifying in the preamble that pass-through payments established in later years of the phase-down period are capped at the same percentage of the base amount as longstanding pass-through payments made in that year.

Further, the phase-out requirements implicitly authorize a new type of supplemental payment—a UPL payment based on services delivered through managed care. Previously, states were able to make UPL payments based only on the difference between what Medicare would have paid and what the state Medicaid agency paid for services delivered through fee-for-service. As described above, under the first step of calculating the base amount for the new pass-through payments, states calculate the difference between what Medicare would have paid and what Medicaid managed care plans paid for services delivered through managed care. As a result, states can now calculate a UPL gap in Medicaid managed care in addition to a UPL gap in fee-for-service. Particularly in states with large Medicaid managed care programs, this presents an opportunity to establish a large, albeit time-limited, new stream of supplemental payments to providers. CMS intends to review new and existing pass-through payments through the managed care rate review process. Given the intent to phase out these payments, new supplemental payments may trigger additional CMS scrutiny.

The final rule allows states the ability to gradually transition existing supplemental payments to more value-based arrangements but also presents states the option of establishing new payments that could interfere with those strategies but help address low provider payment rates and assist safety net hospitals. Much will depend on how states and providers view these choices and on CMS's approach to approving new arrangements.