Make Value-Based Payment Work Again
The CMS-proposed state-directed payment rule sharply curtails state authority to reward Medicaid providers for better care, not higher volume.
Author: Anne Karl and Avi Herring
Editors: Patti Boozang and Amanda Eisenberg
tl;dr
America’s health care affordability crisis is raging, driven in large part by a payment system that still too often pays for volume rather than value. Medicaid is no exception, and scaling value-based payment (VBP) in Medicaid is one tool for moving the health care system toward better care, better health and lower costs.
The Centers for Medicare & Medicaid Services (CMS)’ proposed state-directed payment (SDP) rule would govern how states can direct Medicaid managed care plans to pay providers and, by forcing VBP arrangements into Medicare fee-for-service payment limits and reconciliation requirements, would dramatically restrict states’ ability to use VBP in Medicaid.
This policy is the latest in a cascade of federal actions that would increase state and consumer health care costs — including Medicaid funding and coverage cuts, Marketplace enrollment restrictions, and less federal funding to help consumers to purchase coverage — while undercutting one of the few tools states have to pay for keeping people healthy.
The 80 Million Impact
CMS released a proposed rule on May 20 that implements limits on SDPs enacted under H.R. 1. The proposal would go far beyond the SDP limits imposed in the new law, which would effectively cap Medicaid managed care payments at Medicare rates for all services and threaten to shut down VBP arrangements in Medicaid.
The stakes are bigger than Medicaid payment. U.S. health care spending reached $5.3 trillion in 2024 — 18 percent of the economy — and continues to grow. The health care cost crisis is fueled in large part by the basic economics of fee-for-service medicine: providers are paid more when more services are delivered, not necessarily when people are healthier. CMS itself describes value-based programs as an effort to move toward paying providers based on quality rather than quantity. Medicaid cannot be left out of that transformation. With nearly 75 million people covered by Medicaid and the Children’s Health Insurance Program, meaningful progress in Medicaid VBP is essential not just to Medicaid, but also to changing incentives across the health care system. The Medicaid program also often serves as a catalyst for payment reform across payers, so if Medicaid VBP is restricted, it could spill over to the other parts of the market.
Under CMS’ proposal, states’ efforts to pay for value would be sharply curtailed. The rule would require states directing managed care plans to implement VBP models to ensure that provider payments never exceed what Medicare would have paid for each service. States would also need to reconcile and claw back any “excess” dollars if providers succeed in reducing avoidable utilization and reimburse the federal government.
That requirement defeats the purpose of VBP, which is to give providers flexibility — and financial upside — to keep people healthy and avoid unnecessary care. If providers have to return savings when they succeed, the incentive disappears.
State-Directed Payments 101
States can direct managed care plans to pay categories of providers at specific rates so long as they meet certain regulatory requirements and, in most cases, receive written approval from CMS. These payments, known as SDPs, are a primary tool states use to increase Medicaid payment rates, which have historically lagged far behind commercial and Medicare levels.
Many SDPs are structured as increases to Medicaid base rates (e.g., a per-dollar add-on for each inpatient discharge). Others are structured as VBP arrangements — including quality incentives, bundled payments and population-based payments — that reward providers for performance on access, quality and cost. SDPs also can be designed to address capacity and access gaps in critical areas, including behavioral health and primary care, where Medicaid beneficiaries often face persistent shortages that drive higher health care expenditures and poorer health outcomes.
Taking the Most Restrictive Approach
Prior to H.R. 1, total payment levels for SDPs were permitted up to the average commercial rate (ACR) for the specific service and geographic region. H.R. 1 limited the total payment rate for new SDPs to 100 percent of Medicare rates for expansion states and 110 percent of Medicare rates for non-expansion states, or 100 percent of Medicaid state plan rates for services that are not covered by Medicare (the 100 percent and 110 percent of Medicare limits are referred to as the “Medicare-based limit” in this article). States with existing SDPs above these Medicare-based limits are temporarily “grandfathered” and subject to reductions beginning in 2028. Importantly, the H.R. 1 limits apply to SDPs made for inpatient and outpatient hospital services, nursing facility services and qualified practitioner services at academic medical centers.
H.R. 1’s SDP limits raised several important questions for CMS to address through rulemaking. First, would CMS narrowly apply the Medicare-based limits to the four service categories limited in H.R. 1, or would the agency attempt to more broadly limit SDPs for other services? And second, how would CMS define the Medicare-based limit for impacted SDPs, especially VBP arrangements that do not pay based on standardized rates for each service delivered?
CMS’ proposed rule takes the most restrictive possible approach. Beginning in 2029, the proposed rule would extend Medicare-based limits to all SDPs — regardless of service or provider type. This means that any service with a Medicare rate — including adult and pediatric primary care, behavioral health services and maternity care — would be subject to the limit. CMS would also define the Medicare rate in most cases based on what Medicare Part A and B actually pay at the service-code level. If, for example, a physician provided maternity care to a Medicaid enrollee, the Medicare fee schedule rates would be the limit — even though those rates were not developed with the Medicaid population in mind.
CMS would also impose stringent limits on value-based SDPs in a stated effort to prevent state “workarounds” to the Medicare-based payment limit. Because VBP SDPs often depart from code-level reimbursement, CMS notes that they pose a challenge for enforcing the payment limit. To address this challenge, CMS proposes that states provide a “detailed validation methodology” that ensures providers do not receive more than the Medicare-based limit on a service code basis. In practice, states would need to compare Medicare rates for each service delivered to actual payments under the VBP arrangement. The requirement would, in cases where existing VBP arrangements pay at or near Medicare levels, remove the financial incentive for providers to participate in VBP models. It would also be practically impossible for states to administer.
Curtailing State Efforts to Pay For Value in Medicaid
The proposed limit would be devastating for almost 20% of SDPs currently structured as VBP models. Most importantly, it would effectively prevent the use of VBP in Medicaid managed care at scale going forward, putting the brakes on promising models designed to keep people healthy and reduce Medicaid costs that CMS professes to support.
Two simplified examples bring home why the proposed change would be so damaging:
Primary Care. A state requires managed care plans to pay primary care providers (PCPs) a per-member, per-month (PMPM) payment to care for a defined patient panel, based on a rate designed to approximate 100% of Medicare. The PMPM is built on expected utilization of billable services (e.g., 100 visits per year at $50 each, or $5,000 total). Under current rules, PCPs can manage within that fixed $5,000 budget and fund non-billable services that reduce avoidable utilization. For example, the practice could hire a community health worker (CHW) who delivers health education and social needs navigation to their panel of patients. If the CHW keeps patients healthier, billable visits may fall to 80 per year (i.e., $4,000 in billable revenue), but the practice still retains the full $5,000 and can use it to pay for the CHW. Under the proposed rule, however, the provider would have to reconcile payments to Medicare-equivalent, service-level utilization and return the $1,000 difference. That eliminates funding for the CHW and with it, the incentive to invest in services that reduce avoidable visits in the first place.
Hospital Services. A state requires managed care plans to pay hospitals a bundled payment covering prenatal care, delivery and 60-day postpartum follow-up, set at a rate approximating 100% of Medicare for the episode. Under current rules, providers can invest in non-billable services to reduce C-section rates and prevent readmissions, including use of doulas for labor support and home visits to prevent readmissions. Because the bundled payment amount is fixed, there is a direct financial incentive to avoid unnecessary C-sections and reduce readmissions. Under the proposed rule, providers would have to return any amount by which the fixed episode payment exceeds actual billable claims — eliminating the incentives to use non-billable services that reduce C-sections, prevent postpartum readmissions and drive episode savings in the first place.
If you’re scratching your heads, so are we. The proposal is hard to square with the administration’s own policy. CMS continues to describe value-based care as care designed around quality, provider performance and the patient experience — including coordinated, integrated care that helps people avoid emergency department visits and hospitalizations. The administration’s Center for Medicare and Medicaid Innovation agenda relies on value-based payment models in Medicaid and Medicare to test exactly these kinds of incentives, including primary care and population-based payment models intended to support care management, behavioral health integration, chronic disease prevention and fewer avoidable visits. In other words: CMS is saying it wants providers to keep people healthy while proposing a policy that would claw back the Medicaid dollars providers need to do it.
The Bottom Line
At a moment when health care cost growth and affordability are a national crisis, the proposed SDP rule adds another pressure point. While the policy is framed as fiscal discipline, reducing SDPs will likely push Medicaid programs and the health care system writ large into maintaining a status quo approach to payment that drives up health care costs without improving health care outcomes.
CMS itself identifies a solution that could address the problem in the preamble to the proposed rule: an alternative that would require an actuary to certify upfront that the VBP SDP was designed not to exceed the Medicare-based limit. Under this alternative, VBPs would not be subject to reconciliation against the Medicare-based limit, meaning providers could keep the savings if they use non-billable or outpatient services to reduce avoidable utilization. During the comment period, which ends July 21, states, providers and other stakeholders should urge that CMS change course.