Editor's Note: This “Manatt on Medicaid” is the fourth 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.

In the final Medicaid managed care (MMC) rule published on April 25, 2016, the Centers for Medicare and Medicaid Services (CMS) clarifies states’ flexibility to use their contracts with plans for the purpose of advancing federal and state efforts to improve access, quality and efficiency in the Medicaid program (and by extension the healthcare delivery system overall). In this article, we look at opportunities for states to establish contract standards relating to the financial relationship between the state and plans and between plans and their network providers.1 We also describe the parameters for states to authorize and pay for cost-effective and medically appropriate services “in lieu of” state plan services otherwise covered in the managed care contract.2 These provisions of the final rule, along with provisions on pass-through payments, discussed in the previous “Manatt on Medicaid,” and actuarial soundness and medical loss ratios, to be discussed in a forthcoming “Manatt on Medicaid,” set forth the payment and financing policies to which states must adhere. Equally important, they provide the framework within which states may leverage their Medicaid managed care systems to advance payment and delivery system reforms.

State Payments to Plans

In the final rule, CMS requires that states tie incentive and withhold arrangements (in which a portion of plans’ base capitation is withheld pending achievement of particular outcomes) to meaningful quality goals and performance outcome measures specified in the contract. This provision is meant to enable states to drive plan performance in ways distinct from the general operational requirements under the MMC contract. For example, states may use these arrangements to incentivize plans to ensure that a specific percentage of network providers are paid through value-based payment arrangements or to reward plans for meeting certain quality metrics.

CMS maintains the longstanding requirement that incentive arrangements may not exceed 105% of the capitation payment. There is no comparable requirement on withhold arrangements; however, the regulations require that the base rate minus any withhold that is not reasonably obtainable be certified as actuarially sound (though CMS does not define reasonably obtainable). In addition, CMS specifies that incentive arrangements must be made equally available to public and private contractors and may not be conditioned on plan participation in intergovernmental transfer (IGT) agreements.

Plan Payments to Providers

CMS clarifies the circumstances under which states may require plans to use certain provider payment methodologies and to pay providers or classes of providers at prescribed minimum or maximum payment levels. Specifically, states may require plans to implement bundled payments, shared savings or other arrangements intended to shift payment from volume to value, or to participate in multipayer reform initiatives. States may also require plans to pay providers at minimum levels: for example, payment tied to state Medicaid fee-for-service or Medicare rate levels. Mandated payment rates or rate enhancements may be targeted at subclasses of providers, such as primary care providers or safety net hospitals.

To obtain CMS approval for such arrangements, states must demonstrate in writing that the arrangement meets certain requirements, including that it is based on utilization and delivery of services, advances the state’s quality strategy and does not condition provider participation on IGT arrangements. It bears noting that CMS conditions states’ ability to incentivize or dictate certain payment arrangements—whether between the state and the plan or the plan and the provider—on advancing access, quality and efficiency goals. These state-directed provider payments are to be distinguished from supplemental or pass-through payments that, as CMS notes, limit plans’ ability to implement value-based purchasing and are phased out over time by the final rule.

“In Lieu of” and Value-Add Services

The regulation specifically authorizes “in lieu of” services and implicitly authorizes value-add services. “In lieu of” services are services or settings that a state determines are medically appropriate, cost-effective alternatives to state plan services or settings covered in the MMC contract. Value-add services are services not included in the state plan or MMC contract that a plan determines to purchase and provide to enrollees to improve health and reduce costs, including interventions intended to address social determinants of health.

In order to address a shortage of short-term psychiatric and substance use disorder services, CMS specifically authorizes states to make capitation payments for enrollees receiving inpatient treatment in Institutions for Mental Disease (IMDs) as an “in lieu of” setting, so long as the stay is no more than 15 days in any one month. The Social Security Act otherwise does not permit Medicaid coverage of enrollees in IMDs. For purposes of rate setting, states may use the utilization of IMD services to determine utilization of state plan services (inpatient mental health or substance use disorder services), but may not directly include the cost of IMD services in setting the capitation rates paid to plans.

CMS takes a somewhat different approach with respect to “in lieu of” services that are not otherwise prohibited by the Social Security Act. So long as an “in lieu of” service is authorized in the MMC contract and utilization is voluntary (for both the plan and the enrollee), the state must take into account the utilization and costs of the service in calculating plan capitation rates. Such costs will also be considered in the calculation of the plan’s medical loss ratio (MLR). Where plans determine to use capitation dollars to underwrite the cost of value add services (such as social interventions), the cost of these services may also be included in the numerator of the plan’s MLR calculation, but it may not be included in calculating plan capitation rates.

Putting It All Together

The final MMC rule provides new opportunities for states to leverage their MMC plan contracts to advance state and federal policy priorities for the purposes of improving access, quality and efficiency and transitioning from a volume-based to a value-based system. A key question with which states and plans will grapple in crafting these arrangements remains: When these efforts are successful at improving quality and reducing costs, will plans be able to retain the savings generated as a result? Since the regulations provide states with the flexibility to decide whether or not to recoup funds where plans report an MLR below the state standard (which pursuant to the rule must be at least 85%), it would appear that states may (but are not required to) allow plans to retain the savings (the amount between a state’s MLR and the plan’s actual MLR). With respect to setting the following year’s capitation rate, it appears—but is not absolutely clear—that states may maintain some or all of the savings in the rate so long as the savings were or will be reinvested in quality improvement activities. This issue requires further exploration, but suffice it to say that absent an ability to maintain some or all of the savings in the capitation rate, there may be little incentive or ability for plans to invest in services that reduce the costs of state plan services.