Key Takeaways

  • CMS proposes to codify its longstanding policy prohibiting states from directing Sponsor expenditures while formalizing a series of exceptions to facilitate states’ ability to implement active purchasing strategies and accelerate delivery system reform.
  • CMS proposes to require that new incentive arrangements be designed to support program initiatives tied to meaningful quality goals and performance measure outcomes.
  • CMS proposes to allow payment for services for individuals with short-term stays of no more than 15 days in an institution for mental disease, and to clarify the “in lieu of” standard, which provides Sponsors with the flexibility to furnish care in alternative settings that meet an enrollee’s needs.

In the wake of the implementation of the Affordable Care Act, the recent Medicare Managed Care Proposed Rule (the Proposed Rule) exemplifies the accelerated push by the Department of Health and Human Services and Centers for Medicare & Medicaid Services (CMS) for payments for federal health care programs to be based on value rather than volume. The Proposed Rule incentivizes such compensation shifts in Medicaid, while to a significant degree preserving deference to the states. States always have had latitude to engage in payment and delivery reforms through several waiver programs. The Medicaid managed care Proposed Rule affirmatively encourages states to develop insurance and delivery system reforms capable of improving access and quality of care while reducing costs. In parallel, CMS would (i) expand the definition of care coordination beyond medical care to include a range of community-based social support services; (ii) promote quality improvement by requiring comprehensive state quality programs and implementing a quality rating system; and (iii), as further described, clarify Sponsors’ flexibility to provide care in alternative settings, including the ability to receive payment for enrollees during short stays in institutions for mental disease.

In turn, the proposals are representative of a growing set of tools beyond the traditional waivers that the federal government is using to encourage states to deliver value-based reforms to their Medicaid programs.

Comments on the Proposed Rule are due to CMS no later than 5 pm EDT on July 27, 2015.

Context of Proposed Modernizations

Since the enactment of the Affordable Care Act (ACA), CMS has assumed an active role in promoting the development of a more effective healthcare delivery system that provides higher quality, patient-centered care at lower costs, as exemplified in initiatives such as the Medicare Shared Savings Program, the government’s permanent accountable care organization program, and the CMS Innovation Center, with its mandate to test various new payment and delivery system models for potential scaling across the Medicare, Medicaid, and/or Children’s Health Insurance Program (CHIP) programs. CMS also has recognized the critical contribution that states can play in fostering value-based care, such as (i) CMS’s advancement of two State Innovations Model initiatives to provide funding and technical support to state-led, multi-payer health care payment and service delivery models; (ii) CMS’s partnership with the state of Maryland in an ambitious modernization of its all-payer rate setting system for hospital services; and (iii) initiation of the Delivery System Reform Incentive Payment (DSRIP) program, which dedicates approximately $30 billion across seven states, with payments linked to providers’ attainment of performance metrics and milestones correlated with delivery system reform. In addition, the CMS Innovation Center separately has signaled its interest in developing innovative Medicaid managed care models by issuing an October 2014 Request for Information.

CMS Would Formalize Circumstances Whereby States May Direct Sponsor Expenditures, Including Value-Based Purchasing and Multi-Payer Delivery System Reforms

The Proposed Rule clarifies CMS’s longstanding policy that states may not “direct” Sponsor expenditures under risk contracts. This policy has stemmed from CMS’s interpretation of (i) 42 CFR §438.6(c)(4), which limits the capitation rate paid to Sponsors to the cost of covered services under the contract and associated administrative expenses, and (ii) 42 CFR §438.60, under which states must ensure that no payment is made to a provider for a service covered under the contract other than payment to the Sponsor, except under certain limited exceptions.

CMS would also carve out certain exceptions to the agency’s non-direction rule, consistent with existing practices and thus permitting states to require Sponsors to:

  • Adopt value-based purchasing models (e.g., pay for performance, bundled payments, and other service payment models rewarding value and outcomes over the volume) 
  • Participate in multi-payer delivery system reforms and performance improvement initiatives (e.g., patient-centered medical homes, initiatives to reduce low birth weight, and provider health information exchanges)
  • Adopt minimum fee schedules or uniform payment increases for specific categories of providers to ensure timely access to high-quality care

CMS would require states to receive prior approval from CMS before imposing any contractual arrangement that specifically directs Sponsor expenditures. The proposed criteria for evaluation by CMS include that the arrangement (i) be based on the utilization and delivery of services; (ii) apply uniformly to all participating public and private providers; (iii) advance at least one of the goals or objectives in the state’s comprehensive quality strategy, which is measured under an evaluation plan; (iv) not condition provider participation on intergovernmental transfer agreements; and (v) not be renewed automatically. The Proposed Rule would also set standards for state-led, multi-payer demonstrations, requiring that such demonstrations use a common set of performance measures for all payers and providers, thus enabling CMS to measure the degree to which multi-payer efforts achieve their stated goals.

Although Medicaid programs currently have flexibility to develop innovative payment and delivery system reforms under various waiver programs, the proposal to formally adopt these exceptions can be read as an explicit encouragement for states to become more active purchasers. The need is potentially acute because Medicaid managed care has grown rapidly in prominence (and is expected to cover 75 percent of Medicaid beneficiaries by 2016), while simultaneously facing growing challenges in restraining costs. Well-designed programs under the identified exceptions could constrain costs and incentivize improved population health. Further, CMS’s exception for minimum fee schedules and uniform payment increases for specific categories of providers would more explicitly empower states to encourage and retain certain categories of providers to deliver care to Medicaid managed care beneficiaries.

In an October 2014 Request for Information, CMS observed that private plans participating in CMS programs — including Medicaid managed care plans — have been slow to adopt various innovations used in the commercial sector for care delivery, plan design, beneficiary and provider incentives and network design. CMS has indicated that it is considering developing Medicaid managed care models in a series of (notably interrelated) areas, including (i) pharmacy and medication therapy management; (ii) value-based insurance design; (iii) remote access technologies; (iv) hospice care; (v) long-term services and supports; (vi) behavioral health; and (vii) provider incentive arrangements, such as accountable care organizations. Whether CMS will also propose specific Medicaid managed care models in the future remains to be seen; however, the Proposed Rule serves as an added encouragement for state-led reforms.

Practical Implications:

  • While new payment and delivery system reforms can drive down healthcare costs, the Proposed Rule’s lack of engagement in the area of financing is notable. Certain expenditures contemplated by CMS could be particularly significant, such as the state’s provision of EHR incentive payments to behavioral health, home- and community-based, and long-term and post-acute care providers, which were not eligible for incentive payments under the HITECH Act. Given the simultaneous need for states to address the compliance costs associated with the Proposed Rule broadly, as a practical matter this omission could hamper already cash-strapped states from pursuing the tailored reforms contemplated by the Proposed Rule that in the longer term can improve the efficiency and quality of state Medicaid programs. Presumably, existing resources such as CMS’s State Innovations Model, Medicaid Innovation Accelerator, and DSRIP programs may be leveraged by states as vehicles to receive value-based financial and technical support.

CMS Extends Requirements for Incentive and Withhold Arrangements; Requests Input on Appropriate Federal Regulation

Incentive and withhold arrangements are recognized as two important mechanisms designed to drive health plan performance towards identified goals and outcomes. Currently, CMS requires that incentive arrangements between states and Sponsors must be (i) time limited; (ii) not renewed automatically; (iii) made available to both public and private contractors; (iv) not conditioned on intergovernmental transfer agreements; (v) necessary for the specified activities and targets; and (vi) limited to 5 percent of the certified capitation rate.

Under the Proposed Rule, CMS would add a new standard at § 438.6(b)(2)(v), requiring that incentive arrangements be designed to support program initiatives tied to meaningful quality goals and performance measure outcomes. This change is intended to support delivery system reform initiatives that include incentive arrangements for quality goals and outcomes.

The Proposed Rule also addresses standards for contractual withhold arrangements, which in contrast to incentive payments are paid based on satisfactory performance with respect to specified measures or outcomes related to the contract. CMS would impose identical requirements to incentive arrangements, with the exception of the 5 percent upper limit. CMS proposes that contracts must ensure that the capitation payment, minus any portion of a withhold that is not reasonably achievable, is actuarially sound, as certified by an actuary. The total amount of the withhold, whether or not achievable, would be required to be reasonable and to take into consideration the Sponsor’s financial operating needs, accounting for the size and characteristics of the populations covered under the contract as well as the Sponsor’s capital reserves, as measured by the risk-based capital level, months of claims reserve, or other appropriate measure of reserves. Further, documentation regarding data, assumptions, and methodologies used to determine the portion of the withhold considered reasonably achievable would be required to be included with the rate certification.

CMS requests comment as to whether the current 5 percent upper limit on the amount attributable to an incentive arrangement may serve as a barrier to incentivizing performance, and further, whether CMS should continue to set expectations pertaining to incentive arrangements between states and health plans.

Practical Implications:

  • CMS’s proposed 5 percent cap may restrict states in their ability to incentivize the changes in behavior that they seek to encourage from Sponsors, and importantly may reduce the impact of CMS’s proposed new standard § 438.6(b)(2)(v) requiring that incentive arrangements must support program initiatives tied to meaningful quality goals and performance measure outcomes. To the extent that states utilize a variety of metrics for payment and impose minimal compensation at risk for any given metric, there is limited incentive to achieve individual outcome goals. While an overall 5 percent cap may limit Sponsor incentives, its impact will be further reduced if spread across multiple payment metrics. 
  • Incentivizing behavioral change at the provider level is critical to realizing value-based care. While Medicaid managed care has inherent incentives at the Sponsor level due to capitation, network providers often are not subject to these incentives, nor to other value-based incentives, even though healthcare is locally driven at the point of care. In the Proposed Rule, CMS does not address the connection between Sponsor and provider incentives. Further, to the extent that Sponsors choose to pass the value of any incentive arrangements through to the providers who are responsible for the conduct that is being incentivized (rather than dipping into their state capitation payments), a 5 percent cap on incentive arrangements would restrain the amount of incentivization, particularly if there is little at-risk compensation for any given provider metric. (See, e.g., Khullar et al., “How 10 Leading Health Systems Pay Their Doctors,” The Journal of Delivery Science and Innovation, Vol.3, Is. 2 (June 2015), pp. 60-2.)

Promoting Flexibility for Care in Alternate Settings, Including Institutions for Mental Disease

Under the Proposed Rule, CMS would clarify the “in lieu of” standard, which provides Sponsors with the flexibility to furnish care in alternative settings that meet an enrollee’s medical needs. Specifically, CMS would clarify that “managed care plans have had the flexibility under risk contracts to provide alternative services or services in alternative settings in lieu of covered services or settings if cost-effective, on an optional basis, and to the extent the managed care plan and the enrollee agree that such setting or service would provide medically appropriate care.”

The “in lieu of” standard has wide-reaching implications. Namely, it enables Sponsors to vary from state plan coverage limits, which may limit coverage itself (e.g., exclusions of preventive services), otherwise lawful settings of care (e.g., homes, schools), or categories of health professionals that are legally allowed to provide care but who are excluded under the state plan. While Sponsors in a state may not require enrollees to use “in lieu of” services as a substitute for services or settings covered under the state plan, CMS’s clarification provides a critical tool for Sponsors to provide what they reasonably perceive to be appropriate care in a more cost efficient manner. This clarification also serves as a foundation for CMS’s significant proposal to overturn in part the institutions for mental disease (IMD) exclusion. Current Medicaid law prohibits federal financial participation for the cost of services for adult beneficiaries ages 21–64 during the period that the beneficiary is a resident of an IMD, despite wide recognition that inpatient treatment may be appropriate in certain instances and given growing efforts to achieve mental health parity. The Proposed Rule clarifies that Sponsors may receive a capitation payment from the state for enrollees who have a short-term stay of no more than 15 days in an IMD, so long as the facility is an inpatient hospital or a sub-acute facility providing short-term crisis residential services.

Given Medicaid expansion and the growth in Medicaid managed care, it is predictable that mental health and substance use disorder services among Medicaid populations may experience greater demand. CMS’s proposal would constitute a significant change in Medicaid financing, which could help respond to reported shortages in short-term inpatient mental health and substance use disorder services. CMS estimates that 7.1 percent of adults aged 18–64 currently meet the criteria for serious mental illness.

Practical Implications:

  • The Proposed Rule sets a 15-day outer limit on IMD stays for Sponsors to be able to receive continuous capitation payments. Thus, practically speaking, if an enrollee remains in an IMD for 16 days during the same month, the Sponsor would lose eligibility for capitation payments. This hard limit is arguably arbitrary and may prove detrimental to the continuity of care for enrollees who are residents at an IMD for a temporary period but whose individual clinical needs require longer interventions. While CMS explains that the proposed design is intended to secure compliance with section 1905(a)(29)(B) of Social Security Act statute, which would otherwise require CMS to exclude or prohibit payment, and the 15-day limit derives from IMD length of stay data in its Medicaid Emergency Psychiatric Demonstration, a more flexible, clinically-based standard or longer time period may be more appropriate to respond to enrollees’ needs while preserving compliance with statutory requirements.


The proposed changes are notable because they appear to dovetail with CMS’s growing efforts to accelerate payment and delivery system reform across payers and also to incentivize state-led reforms specifically. CMS has acknowledged that in order for new payment models to succeed, providers must make significant operational changes in how they deliver care. In order for there to be a persuasive case for a return on investment for providers, however, a critical mass of payers must support such new payment models. CMS has also signaled characteristics that it believes are fundamental to a transformed health care system, including that 80 percent of payments to providers from all payers be in fee-for-service alternatives that link payment to value and providers across the state and care continuum’s participation in integrated or virtually integrated delivery models (State Innovations Model, Round Two Funding Opportunity Announcement). Alongside the growing prominence of Medicaid managed care and cost concerns, the portions of the Proposed Rule that address Medicaid managed care payment and delivery reform should be read in this broader context.