States typically pay managed care organizations for risk-based managed care services through fixed periodic payments for a defined package of benefits. These capitation payments are typically made on a per member per month (PMPM) basis. Managed care organizations negotiate with providers to provide services to their enrollees, either on a fee-for-service (FFS) basis, or through arrangements under which they pay providers a fixed periodic amount to provide services.
Statutory and regulatory overview
The Omnibus Budget Reconciliation Act of 1981 (OBRA 1981, P.L. 97-35) requires that capitation payments to risk-based managed care plans be made on an actuarially sound basis (§1903(m)(2)(A)(iii) of the Social Security Act).
Prior to 2002, federal regulations provided little guidance regarding actuarial soundness, limiting capitation payments to an upper payment limit (UPL) equal to the cost of providing the same services in FFS Medicaid to an actuarially equivalent population group (42 CFR Part 447.361 [repealed]). While the statute required the rates to be actuarially sound, the UPL placed more emphasis on setting a ceiling for rates rather than establishing a floor.
Under the UPL requirement, states compared baseline FFS data to expenditures under managed care. However, after several years of providing services through managed care plans for large segments of their Medicaid population, many states found it increasingly difficult to make meaningful comparisons to FFS Medicaid since recent FFS data were no longer available. In addition, the FFS data may not have been useful for comparison purposes, for example, if these data reflected lower use of preventive screenings and services such as vaccinations than would be typical for managed care plans.
To address these issues, the Centers for Medicare & Medicaid Services (CMS) replaced the UPL requirement in 2002 with regulations codifying the statutory requirement that states’ capitation rates under risk contracts be actuarially sound (42 CFR 438.6(c)). These regulations were updated in 2016 with the issuance of a new rule that added to the existing standard and specified standards and procedures for developing and documenting capitation rates (42 CFR 438.4). Further, the rule clarified that any proposed differences among capitation rates for specific covered populations must be based on valid rate development standards and not based on the rate of federal match associated with the covered populations.
Rate development standards
The regulations require that state Medicaid managed care rates be developed in accordance with generally accepted actuarial principles and practices, appropriate for the population and services, and certified by qualified actuaries.
The regulations further require that in setting actuarially sound rates states must follow the steps outlined in 42 CFR 438.5(b) or explain why the requirements are not applicable. These steps are:
- identify and develop base utilization and price data;
- develop and apply trend factors to base data developed from actual experience of the Medicaid or similar population in accordance with generally accepted actuarial practices and principles;
- develop the non-benefit component of the rate;
- make appropriate and reasonable adjustments;
- take into account managed care plans’ past medical loss ratio experience; and,
- if risk adjustment is applied, select an appropriate model and apply it in a budget neutral manner.
For managed care contracts beginning on or after July 1, 2018, states must ensure that capitation rates are adequate to meet MCO contractual requirements regarding availability of services, assurance of adequate capacity and services, and coordination and continuity of care.
For managed care contracts beginning on or after July 1, 2019, states must develop capitation rates in such a way that the managed care plan would reasonably achieve a medical loss ratio (MLR) of at least 85 percent for the rate year. An MLR generally measures how much a managed care plan spends on the provision of covered services compared to the total revenue it receives in capitation payments from the state.
These requirements apply to comprehensive risk-based Medicaid managed care plans as well as risk-based limited-benefit plans, such as those providing only dental or behavioral health benefits. Most rules related to Medicaid rate setting do not apply to CHIP managed care because the same actuarial soundness requirement for rates does not apply.
Directed and pass-through payments
The 2016 rule also established a new option allowing states to require managed care plans to direct rate increases or payment for quality improvement activities to particular providers without a waiver. This new option permits states to direct specific payments made by MCOs to providers under certain circumstances and can assist states in furthering the goals and priorities of their Medicaid programs.
These state-directed payments must be based on delivery and utilization of services to Medicaid beneficiaries covered under the contract, outcomes, and quality of the delivered services. State directed payments can be in one or more of the following categories: directing MCOs to implement specific value-based purchasing models; directing MCOs to implement multi-payer or Medicaid-specific delivery system reform or performance improvement initiatives; and directing MCOs to adopt certain provider payments (e.g., minimum fee schedules, a uniform dollar or percentage increase, or maximum fee schedules).
All state directed payments must be directed equally, using the same terms of performance across a class of providers, and provider participation in these state-directed payments cannot be conditioned upon the provider entering into or adhering to intergovernmental transfer agreements. The directed payments must also advance at least one of the goals and objectives in the state’s Medicaid managed care quality strategy and have an evaluation plan to assess the degree to which the directed payment arrangement achieves its objectives.
At the same time, the 2016 rule required states that were making pass-through payments to providers through MCOs to phase them out over no more than 10 years, because pass-through payments in managed care are lump sum payments that are not directly tied to services.
Federal review and certification
States must demonstrate compliance with the actuarial soundness requirements by documenting the rate-setting methodology and the data used to set rates. For example, states must document trend factors, adjustments and the development of non-benefit costs. States must also provide all validated encounter data, fee-for-service data (as appropriate), and audited financial reports for the three most recent years.
CMS staff verify states’ compliance with these requirements and review capitation rates for adequacy and appropriateness. For example, CMS or an actuary applying generally accepted actuarial principles and practices will evaluate each trend factor to determine the reasonableness of the trend for the enrolled population and will review non-benefit cost documentation to evaluate the reasonableness of the cost assumptions underlying each expense.
Following federal approval, states can increase or decrease the certified capitation rate by one and a half percent without the need to submit a revised rate certification for CMS’s review and approval.
See our related issue brief: Medicaid Managed Care Capitation Rate Setting.