CMS Finalizes Medicaid Rule Likely to Increase Spending

In a rule finalized at the end of April, the Centers for Medicare and Medicaid Services (CMS) introduced significant changes to financing and enforcement guidelines for states’ use of managed care for Medicaid benefits – including regulations governing state directed payments (SDPs) that are projected to increase federal Medicaid costs by between $50 billion and $220 billion over a decade.

As we have written, supplemental payments, of which SDPs are just one type, are lump-sum payments made to health care providers not linked to or based on the provision of specific Medicaid services. They are either distributed to providers on top of the per-person payments given to managed care organizations or distributed in addition to base fee-for-service payments. States' use of supplemental payments makes it easier for them to rely on provider taxes and other financing gimmicks to inflate total Medicaid costs and shift those costs onto the federal government while reducing the use of state general funds.

SDPs are tied to managed care arrangements with private insurers – which provide benefits to 75 percent of Medicaid recipients – and constitute the largest of all types of supplemental payments. The federal government requires state payments to adequately cover the costs of services for Medicaid beneficiaries enrolled by a plan, which definitionally requires that payments be high enough to ensure access to providers. Despite that requirement, states use SDPs to get more money to providers, often in financing schemes (like provider taxes) created in conjunction with providers so that they can obtain higher payments. 

In 2016, CMS noticed states were inappropriately passing additional payments to providers through managed care contracts. Instead of cracking down on the problem, CMS formalized these add-ons to managed care payments through the creation of SDPs as a new type of supplemental payment. Since then, the use of SDPs has surged, with spending increasing to $52 billion by 2022, $78 billion in 2023, and a CMS-projected $93 billion by 2028, even prior to the enactment of these new regulations.

CMS could have used this rulemaking opportunity to address the growing costs of these SDPs by at least following past precedent and enacting reasonable upper-payment limits on SDPs to providers (as we suggested in our brief on Medicaid supplemental payments.) In regulations governing earlier supplemental payment schemes, CMS limited provider payments to the levels paid by Medicare. The new rules will instead accelerate the use and cost of SDPs by effectively formalizing SDPs’ upper payment limits to the level of commercial insurance rates, which are higher than Medicare – and in some cases, substantially higher. For example, we have found that hospital prices average 210 percent of Medicare overall, which climbs to around 300 percent in the 300 most expensive hospitals.

As a result, CMS estimates that the new regulations will increase federal SDP costs by between $18 billion and $84 billion over the 2024-2028 time period, with a middle estimate of $51 billion. We estimate this would mean an increase in federal Medicaid costs by between $50 billion and $220 billion over ten years, with a middle estimate of $135 billion.

How Much Would SDPs Increase Federal Medicaid Spending?

Scenarios 5 Year Total  10 Year Total  
Low impact  $18 billion $50 billion
High Impact $84 billion $220 billion
Middle impact  $51 billion $135 billion
Total (state + federal) Pre-Policy Baseline for SDP Spending $413 billion $984 billion

Sources: Centers for Medicare and Medicaid Services and Committee for a Responsible Federal Budget.

In addition to the direct costs, there is evidence that having Medicaid pay at commercial rates will drive commercial prices even higher in the health care system writ large. Medicaid payments at commercial rates would increase the return from higher prices resulting from negotiations with insurers and incentivize increased industry consolidation because SDPs mainly raise payments for hospitals and physicians working for hospitals (along with nursing homes) at the expense of independent physicians. 

CMS acknowledges the projected increased costs by suggesting there are other aspects of the rule that might eventually work to limit state financing gimmicks and the SDPs tied to them. For one, the rule does help make these financing arrangements more transparent, which would eventually help CMS and Congress understand state financing schemes better to help limit them in the future. However, the main provision CMS points to as a restraint on the growth of SDPs – requiring providers to attest that they are not being “held harmless” by tax and SDP payment schemes – has been delayed until 2028 as it works its way through legal challenges. 

Ultimately, Congress should step in and legislate these schemes out of existence, either through broad reforms that limit state financing games or at least through piecemeal upper payment limits at Medicare rates. For now, this rule represents a lost opportunity and will likely contribute to even faster rising Medicaid costs over the next decade.