1. (a) Definitions. As used in this section, the following terms have the indicated meanings:

   Academic medical center means a facility that includes a health professional school with an affiliated teaching hospital.

   Average commercial rate means the average rate paid for services by the highest claiming third-party payers for specific services as measured by claims volume.

   Base amount is the starting amount, calculated according to paragraph (d)(2) of this section, available for pass-through payments to hospitals in a given contract year subject to the schedule in paragraph (d)(3) of this section.

   Condition-based payment means a prospective payment for a defined set of Medicaid covered service(s) that are tied to a specific condition and delivered to Medicaid managed care enrollees under the contract.

   Final State directed payment cost percentage means the annual amount calculated, in accordance with paragraph (c)(7)(iii) of this section, for each State directed payment for which written prior approval is required under paragraph (c)(2)(i) of this section and for each managed care program.

   Incentive arrangement means any payment mechanism under which a MCO, PIHP, or PAHP may receive additional funds over and above the capitation rates it was paid for meeting targets specified in the contract.

   Inpatient hospital services means the same as specified at § 440.10.

   Maximum fee schedule means any State directed payment where the State requires an MCO, PIHP, or PAHP to pay no more than a certain amount for a covered service(s).

   Minimum fee schedule means any State directed payment where the State requires an MCO, PIHP, or PAHP to pay no less than a certain amount for a covered service(s).

   Nursing facility services means the same as specified in § 440.40(a).

   Outpatient hospital services means the same as specified in § 440.20(a).

   Pass-through payment is any amount required by the State to be added to the contracted payment rates, and considered in calculating the actuarially sound capitation rate, between the MCO, PIHP, or PAHP and hospitals, physicians, or nursing facilities that is not for the following purposes: A specific service or benefit provided to a specific enrollee covered under the contract; a provider payment methodology permitted under paragraphs (c)(1)(i) through (iii) of this section for services and enrollees covered under the contract; a subcapitated payment arrangement for a specific set of services and enrollees covered under the contract; GME payments; or FQHC or RHC wrap around payments.

   Performance measure means, for State directed payments, a quantitative measure with a numerator and denominator that is used to monitor performance at a point in time or track performance over time, of service delivery, quality of care, or outcomes as defined in § 438.320 for enrollees.

   Population-based payment means a prospective payment for a defined set of Medicaid service(s) for a population of Medicaid managed care enrollees covered under the contract attributed to a specific provider or provider group.

   Qualified practitioner services at an academic medical center means professional services provided by both physicians and non-physician practitioners affiliated with or employed by an academic medical center.

   Risk corridor means a risk sharing mechanism in which States and MCOs, PIHPs, or PAHPs may share in profits and losses under the contract outside of a predetermined threshold amount.

   State plan approved rates means amounts calculated for specific services identifiable as having been provided to an individual beneficiary described under CMS approved rate methodologies in the Medicaid State plan. Supplemental payments contained in a State plan are not, and do not constitute, State plan approved rates.

   Supplemental payments means amounts paid by the State in its FFS Medicaid delivery system to providers that are described and approved in the State plan or under a demonstration or waiver thereof and are in addition to State plan approved rates. Disproportionate share hospital (DSH) and graduate medical education (GME) payments are not, and do not constitute, supplemental payments.

   Total payment rate means the aggregate for each managed care program of:

   1. (i) The average payment rate paid by all MCOs, PIHPs, or PAHPs to all providers included in the specified provider class for each service identified in the State directed payment;
   2. (ii) The effect of the State directed payment on the average rate paid to providers included in the specified provider class for the same service for which the State is seeking prior approval under paragraph (c)(2)(i) of this section;
   3. (iii) The effect of any and all other State directed payments on the average rate paid to providers included in the specified provider class for the same service for which the State is seeking prior approval under paragraph (c)(2)(i) of this section; and
   4. (iv) The effect of any and all allowable pass-through payments, as defined in paragraph (a) of this section, to be paid to any and all providers included in the provider class specified in the State directed payment for which the State is seeking prior approval under paragraph (c)(2)(i) of this section on the average payment rate to providers in the specified provider class.

   Total published Medicare payment rate means amounts calculated as payment for specific services that have been developed under Title XVIII Part A and Part B.

   Uniform increase means any State directed payment that directs the MCO, PIHP, or PAHP to pay the same amount (the same dollar amount or the same percentage increase) per Medicaid covered service(s) in addition to the rates the MCO, PIHP or PAHP negotiated with the providers included in the specified provider class for the service(s) identified in the State directed payment.

   Withhold arrangement means any payment mechanism under which a portion of a capitation rate is withheld from an MCO, PIHP, or PAHP and a portion of or all of the withheld amount will be paid to the MCO, PIHP, or PAHP for meeting targets specified in the contract. The targets for a withhold arrangement are distinct from general operational requirements under the contract. Arrangements that withhold a portion of a capitation rate for noncompliance with general operational requirements are a penalty and not a withhold arrangement.

2. (b) Basic requirements.

   1. (1) If used in the payment arrangement between the State and the MCO, PIHP, or PAHP, all applicable risk-sharing mechanisms, such as reinsurance, risk corridors, or stop-loss limits, must be documented in the contract and rate certification documents for the rating period prior to the start of the rating period, and must be developed in accordance with § 438.4, the rate development standards in § 438.5, and generally accepted actuarial principles and practices. Risk-sharing mechanisms may not be added or modified after the start of the rating period.

   2. (2) Contracts with incentive arrangements may not provide for payment in excess of 105 percent of the approved capitation payments attributable to the enrollees or services covered by the incentive arrangement, since such total payments will not be considered to be actuarially sound. For all incentive arrangements, the contract must provide that the arrangement is—

      1. (i) For a fixed period of time and performance is measured during the rating period under the contract in which the incentive arrangement is applied.
      2. (ii) Not to be renewed automatically.
      3. (iii) Made available to both public and private contractors under the same terms of performance.
      4. (iv) Does not condition MCO, PIHP, or PAHP participation in the incentive arrangement on the MCO, PIHP, or PAHP entering into or adhering to intergovernmental transfer agreements.
      5. (v) Necessary for the specified activities, targets, performance measures, or quality-based outcomes that support program initiatives as specified in the State's quality strategy at § 438.340.

   3. (3) Contracts that provide for a withhold arrangement must ensure that the capitation payment minus any portion of the withhold that is not reasonably achievable is actuarially sound as determined by an actuary. The total amount of the withhold, achievable or not, must be reasonable and take into consideration the MCO's, PIHP's or PAHP's financial operating needs accounting for the size and characteristics of the populations covered under the contract, as well as the MCO's, PIHP's or PAHP's capital reserves as measured by the risk-based capital level, months of claims reserve, or other appropriate measure of reserves. The data, assumptions, and methodologies used to determine the portion of the withhold that is reasonably achievable must be submitted as part of the documentation required under § 438.7(b)(6). For all withhold arrangements, the contract must provide that the arrangement is—

      1. (i) For a fixed period of time and performance is measured during the rating period under the contract in which the withhold arrangement is applied.
      2. (ii) Not to be renewed automatically.
      3. (iii) Made available to both public and private contractors under the same terms of performance.
      4. (iv) Does not condition MCO, PIHP, or PAHP participation in the withhold arrangement on the MCO, PIHP, or PAHP entering into or adhering to intergovernmental transfer agreements.
      5. (v) Necessary for the specified activities, targets, performance measures, or quality-based outcomes that support program initiatives as specified in the State's quality strategy under § 438.340.

3. (c) State directed payments under MCO, PIHP, or PAHP contracts—(1) General rule. Except as specified in this paragraph (c), in paragraph (d) of this section, in a specific provision of Title XIX, or in another regulation implementing a Title XIX provision related to payments to providers, that is applicable to managed care programs, the State may not in any way direct the MCO's, PIHP's or PAHP's expenditures under the contract.

   1. (i) The State may require the MCO, PIHP or PAHP to implement value-based purchasing models for provider reimbursement, such as pay for performance arrangements, bundled payments, or other service payment models intended to recognize value or outcomes over volume of services.
   2. (ii) The State may require MCOs, PIHPs, or PAHPs to participate in a multi-payer or Medicaid-specific delivery system reform or performance improvement initiative.

   3. (iii) The State may require the MCO, PIHP, or PAHP to:

      1. (A) Adopt a minimum fee schedule for providers that provide a particular service under the contract using State plan approved rates.
      2. (B) Adopt a minimum fee schedule for providers that provide a particular service under the contract using a total published Medicare payment rate that was in effect no more than 3 years prior to the start of the rating period and the minimum fee schedule to be used by the MCO, PIHP, or PAHP is equivalent to 100 percent of the specified total published Medicare payment rate.
      3. (C) Adopt a minimum fee schedule for providers that provide a particular service under the contract using rates other than the State plan approved rates or one or more total published Medicare payment rates described in paragraph (c)(1)(iii)(B) of this section.
      4. (D) Provide a uniform dollar or percentage increase for providers that provide a particular service under the contract.
      5. (E) Adopt a maximum fee schedule for providers that provide a particular service under the contract, so long as the MCO, PIHP, or PAHP retains the ability to reasonably manage risk and has discretion in accomplishing the goals of the contract.

      6. (2) Standards for State directed payments.

         1. (i) State directed payments specified in paragraphs (c)(1)(i) and (ii) and (c)(1)(iii)(C) through (E) of this section must have written prior approval that the standards and requirements in this section are met.

         2. (ii) Each State directed payment must meet the following standards. Specifically, each State directed payment must:

            1. (A) Be based on the utilization and delivery of services;
            2. (B) Direct expenditures equally, and using the same terms of performance, for a class of providers providing the service under the contract;
            3. (C) Expect to advance at least one of the goals and objectives in the quality strategy in § 438.340;
            4. (D) Have an evaluation plan that measures the degree to which the State directed payment advances at least one of the goals and objectives in the quality strategy in § 438.340 and includes all of the elements outlined in paragraph (c)(2)(iv) of this section;
            5. (E) Not condition provider participation in State directed payments on the provider entering into or adhering to intergovernmental transfer agreements;
            6. (F) Result in achievement of the stated goals and objectives in alignment with the State's evaluation plan and, upon request from CMS, the State must provide an evaluation report documenting achievement of these stated goals and objectives;
            7. (G) Comply with all Federal legal requirements for the financing of the non-Federal share, including but not limited to, 42 CFR 433, subpart B;

            8. (H) (1) Ensure that providers receiving payment under a State directed payment attest that they do not participate in any hold harmless arrangement for any health care-related tax as specified in § 433.68(f)(3) of this subchapter in which the State or other unit of government imposing the tax provides for any direct or indirect payment, offset, or waiver such that the provision of the payment, offset, or waiver directly or indirectly guarantees to hold the taxpayer harmless for all or any portion of the tax amount, and

               (2) Ensure either that, upon CMS request, such attestations are available, or that the State provides an explanation that is satisfactory to CMS about why specific providers are unable or unwilling to make such attestations;

            9. (I) Ensure that the total payment rate for each service and provider class included in the State directed payment must be reasonable, appropriate, and attainable and, upon request from CMS, the State must provide documentation demonstrating the total payment rate for each service and provider class; and
            10. (J) Be developed in accordance with § 438.4, and the standards specified in §§ 438.5, 438.7, and 438.8.

         3. (iii) The total payment rate for each State directed payment for which written prior approval is required under paragraph (c)(2)(i) of this section for inpatient hospital services, outpatient hospital services, nursing facility services, or qualified practitioner services at an academic medical center must not exceed the average commercial rate. To demonstrate compliance with this paragraph, States must submit:

            1. (A) The average commercial rate demonstration, for which States must use payment data that:

               (1) Is specific to the State;

               (2) Is no older than from the three most recent and complete years prior to the rating period of the initial request following the applicability date of this section;

               (3) Is specific to the service(s) addressed by the State directed payment;

               (4) Includes the total reimbursement by the third-party payer and any patient liability, such as cost sharing and deductibles;

               (5) Excludes payments to FQHCs, RHCs, and from any non-commercial payers, such as Medicare; and

               (6) Excludes any payment data for services or codes that the applicable Medicaid MCOs, PIHPs, or PAHPs do not cover.

            2. (B) A total payment rate comparison, for which States must provide a comparison of the total payment rate for these services included in the State directed payment to the average commercial rate that:

               (1) Is specific to each managed care program that the State directed payment applies to;

               (2) Is specific to each provider class to which the State directed payment applies;

               (3) Is projected for the rating period for which the State is seeking prior approval of the State directed payment under paragraph (c)(2)(i) of this section;

               (4) Uses payment data that are specific to each service included in the State directed payment; and

               (5) Describes each of the components of the total payment rate as a percentage of the average commercial rate (demonstrated by the State as provided in paragraph (c)(2)(iii)(A) of this section) for each of these services included in the State directed payment.

            3. (C) The ACR demonstration described in paragraph (c)(2)(iii)(A) of this section must be included with the initial documentation submitted for written prior approval of the State directed payment under paragraph (c)(2)(i) of this section, and then subsequently updated at least once every 3 years thereafter as long as the State continues to include the State directed payment that requires prior approval under paragraph (c)(2)(i) of this section in any MCO, PIHP, or PAHP contract. The total payment rate comparison described in paragraph (c)(2)(iii)(B) of this section must be included with the documentation submitted for written prior approval under paragraph (c)(2)(i) of this section and updated with each amendment and subsequent renewal.

         4. (iv) For State directed payments for which written prior approval under paragraph (c)(2)(i) of this section is required, the State must include a written evaluation plan with its submission for written prior approval under paragraph (c)(2)(i) of this section and an updated written evaluation plan with each amendment and subsequent renewal. The evaluation plan must include the following elements:

            1. (A) Identification of at least two metrics that will be used to measure the effectiveness of the State directed payment in advancing at least one of the goals and objectives in the quality strategy on an annual basis, which must:

               (1) Be specific to the State directed payment and, when practicable and relevant, attributable to the performance by the providers for enrollees in all of the State's managed care program(s) to which the State directed payment applies; and

               (2) Include at least one performance measure as defined in § 438.6(a) as part of the metrics used to measure the effectiveness of the State directed payment;

            2. (B) Include baseline statistics on all metrics that will be used in the evaluation of the State directed payment for which the State is seeking written prior approval under paragraph (c)(2)(i) of this section;
            3. (C) Include performance targets for all metrics to be used in the evaluation of the State directed payment for which the State is seeking written prior approval under paragraph (c)(2)(i) of this section that demonstrate either maintenance or improvement over the baseline statistics and not a decline relative to baseline. The target for at least one performance measure, as defined in § 438.6(a), must demonstrate improvement over baseline; and
            4. (D) Include a commitment by the State to submit an evaluation report in accordance with § 438.6(c)(2)(v) if the final State directed payment cost percentage exceeds 1.5 percent.

         5. (v) For any State directed payment for which written prior approval is required under paragraph (c)(2)(i) of this section that has a final State directed payment cost percentage greater than 1.5 percent, the State must complete and submit an evaluation report using the evaluation plan outlined during the prior approval process under paragraph (c)(2)(iv) of this section.

            1. (A) This evaluation report must:

               (1) Include all of the elements in paragraph (c)(2)(iv) of this section as specified in the approved evaluation plan;

               (2) Include three most recent and complete years of annual results for each metric as required in paragraph (c)(2)(iv)(A) of this section; and

               (3) Be published on the public facing website as required under § 438.10(c)(3).

            2. (B) States must submit the initial evaluation report as described in paragraph (c)(2)(v)(A) of this section to CMS no later than 2 years after the conclusion of the 3-year evaluation period. Subsequent evaluation reports must be submitted to CMS every 3 years.

         6. (vi) Any State directed payments described in paragraph (c)(1)(i) or (ii) of this section must:

            1. (A) Make participation in the value-based purchasing, delivery system reform, or performance improvement initiative available using the same terms of performance to a class of providers providing services under the contract related to the reform or improvement initiative;

            2. (B) If the State directed payment for which written prior approval is required under paragraph (c)(2)(i) of this section conditions payment upon performance, the payment to providers under the State directed payment:

               (1) Cannot be conditioned upon administrative activities, such as the reporting of data nor upon the participation in learning collaboratives or similar administrative activities;

               (2) Must use a common set of performance measures across all of the payers and providers specified in the State directed payment;

               (3) Must define and use a performance measurement period that must not exceed the length of the rating period and must not precede the start of the rating period in which the payment is delivered by more than 12 months, and all payments must be documented in the rate certification for the rating period in which the payment is delivered;

               (4) Must identify baseline statistics on all metrics that will be used to measure the performance that is the basis for payment to the provider from the MCO, PIHP, or PAHP; and

               (5) Must use measurable performance targets, which are attributable to the performance by the providers in delivering services to enrollees in each of the State's managed care program(s) to which the State directed payment applies, that demonstrate maintenance or improvement over baseline data on all metrics that will be used to measure the performance that is the basis for payment to the provider from the MCO, PIHP, or PAHP.

            3. (C) If the State directed payment is a population-based or condition-based payment, the State directed payment must:

               (1) Be based upon the delivery by the provider of one or more specified Medicaid covered service(s) during the rating period or the attribution of a covered enrollee to a provider for treatment during the rating period;

               (2) If basing payment on the attribution of enrollees to a provider, have an attribution methodology that uses data that are no older than the three most recent and complete years of data; seeks to preserve existing provider-enrollee relationships; accounts for enrollee preference in choice of provider; and describes when patient panels are attributed, how frequently they are updated, and how those updates are communicated to providers;

               (3) Replace the negotiated rate between an MCO, PIHP, or PAHP and providers for the Medicaid covered service(s) included in the population or condition-based payment; no other payment may be made by an MCO, PIHP, or PAHP to the same provider on behalf of the same enrollee for the same services included in the population or condition-based payment; and

               (4) Include at least one metric in the evaluation plan required under paragraph (c)(2)(iv) of this section that measures performance at the provider class level; the target for this performance measure, as defined in § 438.6(a), must be set to demonstrate improvement over baseline.

         7. (vii) Any State directed payment described in paragraph (c)(1)(iii) of this section must:

            1. (A) Condition payment from the MCO, PIHP, or PAHP to the provider on the utilization and delivery of services under the contract for the rating period for which the State is seeking written prior approval only; and
            2. (B) Not condition payment from the MCO, PIHP, or PAHP to the provider on utilization and delivery of services outside of the rating period for which the State is seeking written prior approval and then require that payments be reconciled to utilization during the rating period.
         8. (viii) A State must complete and submit all required documentation for each State directed payment for which written prior approval is required under (c)(2)(i) and for each amendment to an approved State directed payment, respectively, before the start date of the State directed payment or the start date of the amendment.

      7. (3) Approval and renewal timeframes.

         1. (i) Approval of a State directed payment described in paragraphs (c)(1)(i) and (ii) of this section is for one rating period unless a multi-year approval of up to three rating periods is requested and meets all of the following criteria:

            1. (A) The State has explicitly identified and described the State directed payment in the contract as a multi-year State directed payment, including a description of the State directed payment by year and if the State directed payment varies by year.
            2. (B) The State has developed and described its plan for implementing a multi-year State directed payment, including the State's plan for multi-year evaluation, and the impact of a multi-year State directed payment on the State's goals and objectives in the State's quality strategy in § 438.340.
            3. (C) The State has affirmed that it will not make any changes to the State directed payment methodology, or magnitude of the payment, described in the contract for all years of the multi-year State directed payment without CMS written prior approval. If the State determines that changes to the State directed payment methodology, or magnitude of the payment, are necessary, the State must obtain written prior approval of such changes under paragraph (c)(2) of this section.
         2. (ii) Written prior approval of a State directed payment described in paragraph (c)(1)(iii)(C) through (E) of this section is for one rating period.
         3. (iii) State directed payments are not automatically renewed.

      8. (4) Reporting requirements. The State must submit to CMS, no later than 1 year after each rating period, data to the Transformed Medicaid Statistical Information System, or in any successor format or system designated by CMS, specifying the total dollars expended by each MCO, PIHP, and PAHP for State directed payments, including amounts paid to individual providers. The initial report will be due after the first rating period that begins after the release of reporting instructions by CMS. Minimum data fields to be collected include the following, as applicable:

         1. (i) Provider identifiers.
         2. (ii) Enrollee identifiers.
         3. (iii) MCO, PIHP or PAHP identifiers.
         4. (iv) Procedure and diagnosis codes.
         5. (v) Allowed, billed, and paid amounts. Paid amounts include the amount that represents the MCO's, PIHP's or PAHP's negotiated payment amount, the amount of the State directed payment, and any other amounts included in the total amount paid to the provider.

      9. (5) Requirements for Medicaid Managed Care contract terms for State directed payments. State directed payments must be specifically described and documented in the MCO's, PIHP's, or PAHP's contracts. The MCO's, PIHP's or PAHP's contract must include, at a minimum, the following information for each State directed payment:

         1. (i) The State directed payment start date and, if applicable, the end date within the applicable rating period;
         2. (ii) A description of the provider class eligible for the State directed payment and all eligibility requirements;

         3. (iii) A description of the State directed payment, which must include at a minimum:

            1. (A) For State directed payments described in paragraphs (c)(1)(iii)(A), (B), and (C) of this section:

               (1) The required fee schedule;

               (2) The procedure and diagnosis codes to which the fee schedule applies;

               (3) The applicable dates of service within the rating period for which the fee schedule applies;

               (4) For State directed payments that specify State plan approved rates, the contract must also reference the State plan page, when it was approved, and a link to the currently approved State plan page when possible; and

               (5) For State directed payments that specify a Medicare-referenced fee schedule, the contract must also include information about the Medicare fee schedule(s) that is necessary to implement the State directed payment, including identifying the specific Medicare fee schedule, the time period for which the Medicare fee schedule is in effect, and any material adjustments due to geography or provider type that need to be applied.

            2. (B) For State directed payments described in paragraphs (c)(1)(iii)(D) of this section:

               (1) Whether the uniform increase will be a specific dollar amount or a percentage increase of negotiated rates;

               (2) The procedure and diagnosis codes to which the uniform dollar or percentage increase applies;

               (3) The specific dollar amount or percentage increase that the MCO, PIHP or PAHP must apply or the methodology to establish the specific dollar amount or percentage increase;

               (4) The applicable dates of service within the rating period for which the uniform increase applies; and

               (5) The roles and responsibilities of the State and the MCO, PIHP, or PAHP, the timing of payments, and other significant relevant information.

            3. (C) For State directed payments described in paragraph (c)(1)(iii)(E) of this section:

               (1) The fee schedule the MCO, PIHP, or PAHP must ensure that payments are below;

               (2) The procedure and diagnosis codes to which the fee schedule applies;

               (3) The applicable dates of service within the rating period for which the fee schedule applies; and

               (4) Details of the State's exemption process for MCOs, PIHPs, or PAHPs and providers to follow if they are under contractual obligations that result in the need to pay more than the maximum fee schedule.

            4. (D) For State directed payments described in paragraphs (c)(1)(i) and (ii) of this section that condition payment based upon performance:

               (1) The approved performance measures upon which payment will be conditioned;

               (2) The approved measurement period for those measures;

               (3) The approved baseline statistics for all measures against which performance will be measured;

               (4) The performance targets that must be achieved on each measure for the provider to obtain the performance-based payment;

               (5) The methodology to determine if the provider qualifies for the performance-based payment, as well as the amount of the payment; and

               (6) The roles and responsibilities of the State and the MCO, PIHP, or PAHP, the timing of payments, what to do with any unearned payments, and other significant relevant information.

            5. (E) For State directed payments described in paragraphs (c)(1)(i) and (ii) of this section using a population-based or condition-based payment as defined in paragraph (a) of this section:

               (1) The Medicaid covered service(s) that the population or condition-based payment is for;

               (2) The time period that the population or condition-based payment covers;

               (3) When the population or condition-based payment is to be made and how frequently;

               (4) A description of the attribution methodology, if one is used, which must include at a minimum the data used, when the panels will be established, how frequently those panels will be updated, and how the attribution methodology will be communicated to providers; and

               (5) The roles and responsibilities of the State and the MCO, PIHP, or PAHP in operationalizing the attribution methodology if an attribution methodology is used.

         4. (iv) Any encounter reporting and separate reporting requirements necessary for auditing the State directed payment in addition to the reporting requirements in paragraph (c)(4) of this section; and
         5. (v) All State directed payments must be specifically described and documented in the MCO's, PIHP's, and PAHP's contracts that must be submitted to CMS no later than 120 days after the start date of the State directed payment.
      10. (6) Payment to MCOs, PIHPs, and PAHPs for State Directed Payments. The final capitation rate for each MCO, PIHP, or PAHP as described in § 438.3(c) must account for all State directed payments. Each State directed payment must be accounted for in the base data, as an adjustment to trend, or as an adjustment as specified in § 438.5 and § 438.7(b). The State cannot withhold a portion of the capitation rate to pay the MCO, PIHP, or PAHP separately for a State directed payment nor require an MCO, PIHP, or PAHP to retain a portion of the capitation rate separately to comply with a State directed payment.

      11. (7) Final State directed payment cost percentage. For each State directed payment for which written prior approval is required under paragraph (c)(2)(i) of this section, unless the State voluntarily submits the evaluation report per paragraph (c)(2)(v) of this section, the State must calculate the final State directed payment cost percentage and if the final State directed payment cost percentage is below 1.5 percent the State must provide a final State directed payment cost percentage report to CMS as follows:

          1. (i) State directed payment cost percentage calculation. The final State directed payment cost percentage must be calculated on an annual basis and recalculated annually.
          2. (ii) State directed payment cost percentage certification. The final State directed payment cost percentage must be certified by an actuary and developed in a reasonable and appropriate manner consistent with generally accepted actuarial principles and practices.

          3. (iii) Calculation of the final State directed payment cost percentage. The final State directed payment cost percentage is the result of dividing the amount determined in paragraph (c)(7)(iii)(A) of this section by the amount determined in paragraph (c)(7)(iii)(B) of this section.

             1. (A) The portion of the actual total capitation payments that is attributable to the State directed payment for which the State has obtained written prior approval under paragraph (c)(2)(i) of this section, for each managed care program.
             2. (B) The actual total capitation payments, defined at § 438.2, for each managed care program, including all State directed payments in effect under § 438.6(c) and pass-through payments in effect under § 438.6(d).
          4. (iv) Annual CMS review of the final State directed payment cost percentage. The State must submit the final State directed payment cost percentage annually to CMS for review as a separate report concurrent with the rate certification submission required in § 438.7(a) for the rating period beginning 2 years after the completion of each 12-month rating period that includes a State directed payment for which the State has obtained written prior approval under paragraph (c)(2)(i) of this section.

      12. (8) Applicability dates. States must comply with:

          1. (i) Paragraphs (a), (c)(1), (c)(1)(iii), (c)(2)(i), (c)(2)(ii)(A) through (C), (c)(2)(ii)(E), (c)(2)(ii)(G), (c)(2)(ii)(I) and (J), (c)(2)(vi)(A), (c)(3) of this section beginning on July 9, 2024.
          2. (ii) Paragraphs (c)(2)(iii), (c)(2)(vi)(B), and (c)(2)(vi)(C)(1) and (2) of this section no later than the first rating period for contracts with MCOs, PIHPs and PAHPs beginning on or after July 9, 2024.
          3. (iii) Paragraphs (c)(2)(vi)(C)(3) and (4), (c)(2)(viii) and (c)(5)(i) through (iv) of this section no later than the first rating period for contracts with MCOs, PIHPs and PAHPs beginning on or after 2 years after July 9, 2024.
          4. (iv) Paragraphs (c)(2)(ii)(D) and (F), (c)(2)(iv), (c)(2)(v), (c)(2)(vii), (c)(6) and (c)(7) of this section no later than the first rating period for contracts with MCOs, PIHPs and PAHPs beginning on or after 3 years after July 9, 2024.
          5. (v) Paragraph (c)(5)(v) of this section no later than the first rating period for contracts with MCOs, PIHPs and PAHPs beginning on or after 4 years after July 9, 2024.
          6. (vi) Paragraph (c)(4) of this section no later than the date specified in the T-MSIS reporting instructions released by CMS.
          7. (vii) Paragraph (c)(2)(ii)(H) of this section no later than the first rating period for contracts with MCOs, PIHPs, and PAHPs beginning on or after January 1, 2028.

4. (d) Pass-through payments under MCO, PIHP, and PAHP contracts—(1) General rule. States may continue to require MCOs, PIHPs, and PAHPs to make pass-through payments (as defined in paragraph (a) of this section) to network providers that are hospitals, physicians, or nursing facilities under the contract, provided the requirements of this paragraph (d) are met. States may not require MCOs, PIHPs, and PAHPs to make pass-through payments other than those permitted under this paragraph (d).

   1. (i) In order to use a transition period described in this paragraph (d), a State must demonstrate that it had pass-through payments for hospitals, physicians, or nursing facilities in:

      1. (A) Managed care contract(s) and rate certification(s) for the rating period that includes July 5, 2016, and were submitted for CMS review and approval on or before July 5, 2016; or
      2. (B) If the managed care contract(s) and rate certification(s) for the rating period that includes July 5, 2016 had not been submitted to CMS on or before July 5, 2016, the managed care contract(s) and rate certification(s) for a rating period before July 5, 2016 that had been most recently submitted for CMS review and approval as of July 5, 2016.
   2. (ii) CMS will not approve a retroactive adjustment or amendment, notwithstanding the adjustments to the base amount permitted in paragraph (d)(2) of this section, to managed care contract(s) and rate certification(s) to add new pass-through payments or increase existing pass-through payments defined in paragraph (a) of this section.

   3. (2) Calculation of the base amount. The base amount of pass-through payments is the sum of the results of paragraphs (d)(2)(i) and (ii) of this section.

      1. (i) For inpatient and outpatient hospital services that will be provided to eligible populations through the MCO, PIHP, or PAHP contracts for the rating period that includes pass-through payments and that were provided to the eligible populations under MCO, PIHP, or PAHP contracts two years prior to the rating period, the State must determine reasonable estimates of the aggregate difference between:

         1. (A) The amount Medicare FFS would have paid for those inpatient and outpatient hospital services utilized by the eligible populations under the MCO, PIHP, or PAHP contracts for the 12-month period immediately two years prior to the rating period that will include pass-through payments; and
         2. (B) The amount the MCOs, PIHPs, or PAHPs paid (not including pass through payments) for those inpatient and outpatient hospital services utilized by the eligible populations under MCO, PIHP, or PAHP contracts for the 12-month period immediately 2 years prior to the rating period that will include pass-through payments.

      2. (ii) For inpatient and outpatient hospital services that will be provided to eligible populations through the MCO, PIHP, or PAHP contracts for the rating period that includes pass-through payments and that were provided to the eligible populations under Medicaid FFS for the 12-month period immediately 2 years prior to the rating period, the State must determine reasonable estimates of the aggregate difference between:

         1. (A) The amount Medicare FFS would have paid for those inpatient and outpatient hospital services utilized by the eligible populations under Medicaid FFS for the 12-month period immediately 2 years prior to the rating period that will include pass-through payments; and
         2. (B) The amount the State paid under Medicaid FFS (not including pass through payments) for those inpatient and outpatient hospital services utilized by the eligible populations for the 12-month period immediately 2 years prior to the rating period that will include pass-through payments.
      3. (iii) The base amount must be calculated on an annual basis and is recalculated annually.
      4. (iv) States may calculate reasonable estimates of the aggregate differences in paragraphs (d)(2)(i) and (ii) of this section in accordance with the upper payment limit requirements in 42 CFR part 447.

   4. (3) Schedule for the reduction of the base amount of pass-through payments for hospitals under the MCO, PIHP, or PAHP contract and maximum amount of permitted pass-through payments for each year of the transition period. For States that meet the requirement in paragraph (d)(1)(i) of this section, pass-through payments for hospitals may continue to be required under the contract but must be phased out no longer than on the 10-year schedule, beginning with rating periods for contract(s) that start on or after July 1, 2017. For rating periods for contract(s) beginning on or after July 1, 2027, the State cannot require pass-through payments for hospitals under a MCO, PIHP, or PAHP contract. Until July 1, 2027, the total dollar amount of pass-through payments to hospitals may not exceed the lesser of:

      1. (i) A percentage of the base amount, beginning with 100 percent for rating periods for contract(s) beginning on or after July 1, 2017, and decreasing by 10 percentage points each successive year; or
      2. (ii) The total dollar amount of pass-through payments to hospitals identified in the managed care contract(s) and rate certification(s) used to meet the requirement of paragraph (d)(1)(i) of this section.

   5. (4) Documentation of the base amount for pass-through payments to hospitals. All contract arrangements that direct pass-through payments under the MCO's, PIHP's or PAHP's contract for hospitals must document the calculation of the base amount in the rate certification required in § 438.7. The documentation must include the following:

      1. (i) The data, methodologies, and assumptions used to calculate the base amount;
      2. (ii) The aggregate amounts calculated for paragraphs (d)(2)(i)(A), (d)(2)(i)(B), (d)(2)(ii)(A), (d)(2)(ii)(B) of this section; and
      3. (iii) The calculation of the applicable percentage of the base amount available for pass-through payments under the schedule in paragraph (d)(3) of this section.
   6. (5) Pass-through payments to physicians or nursing facilities. For States that meet the requirement in paragraph (d)(1)(i) of this section, rating periods for contract(s) beginning on or after July 1, 2017 through rating periods for contract(s) beginning on or after July 1, 2021, may continue to require pass-through payments to physicians or nursing facilities under the MCO, PIHP, or PAHP contract of no more than the total dollar amount of pass-through payments to physicians or nursing facilities, respectively, identified in the managed care contract(s) and rate certification(s) used to meet the requirement of paragraph (d)(1)(i) of this section. For rating periods for contract(s) beginning on or after July 1, 2022, the State cannot require pass-through payments for physicians or nursing facilities under a MCO, PIHP, or PAHP contract.

   7. (6) Pass-through payments for States transitioning services and populations from a fee-for-service delivery system to a managed care delivery system. Notwithstanding the restrictions on pass-through payments in paragraphs (d)(1), (3), and (5) of this section, a State may require the MCO, PIHP, or PAHP to make pass-through payments to network providers that are hospitals, nursing facilities, or physicians under the contract, for each rating period of the transition period for up to 3 years, when Medicaid populations or services are initially transitioning from a fee-for-service (FFS) delivery system to a managed care delivery system, provided the following requirements are met:

      1. (i) The services will be covered for the first time under a managed care contract and were previously provided in a FFS delivery system prior to the first rating period of the transition period.
      2. (ii) The State made supplemental payments, as defined in paragraph (a) of this section, to hospitals, nursing facilities, or physicians during the 12-month period immediately 2 years prior to the first year of the transition period.

      3. (iii) The aggregate amount of the pass-through payments that the State requires the MCO, PIHP, or PAHP to make is less than or equal to the amounts calculated in paragraph (d)(6)(iii)(A), (B), or (C) of this section for the relevant provider type for each rating period of the transition period. In determining the amount of each component for the calculations contained in paragraphs (d)(6)(iii)(A) through (C), the State must use the amounts paid for services during the 12-month period immediately 2 years prior to the first rating period of the transition period.

         1. (A) Hospitals. For inpatient and outpatient hospital services, calculate the product of the actual supplemental payments paid and the ratio achieved by dividing the amount paid through payment rates for hospital services that are being transitioned from payment in a FFS delivery system to the managed care contract by the total amount paid through state plan approved rates for hospital services made in the State's FFS delivery system. Both the numerator and denominator of the ratio should exclude any supplemental payments made to the applicable providers.
         2. (B) Nursing facilities. For nursing facility services, calculate the product of the actual supplemental payments paid and the ratio achieved by dividing the amount paid through state plan approved rates for nursing facility services that are being transitioned from payment in a FFS delivery system to the managed care contract by the total amount paid through payment rates for nursing facility services made in the State's FFS delivery system. Both the numerator and denominator of the ratio should exclude any supplemental payments made to the applicable providers.
         3. (C) Physicians. For physician services, calculate the product of the actual supplemental payments paid and the ratio achieved by dividing the amount paid through state plan approved rates for physician services that are being transitioned from payment in a FFS delivery system to the managed care contract by the total amount paid through payment rates for physician services made in the State's FFS delivery system. Both the numerator and denominator of the ratio should exclude any supplemental payments made to the applicable providers.
      4. (iv) The State may require the MCO, PIHP, or PAHP to make pass-through payments for Medicaid populations or services that are initially transitioning from a FFS delivery system to a managed care delivery system for up to 3 years from the beginning of the first rating period in which the services were transitioned from payment in a FFS delivery system to a managed care contract, provided that during the 3 years, the services continue to be provided under a managed care contract with an MCO, PIHP, or PAHP.
5. (e) Payments to MCOs and PIHPs for enrollees that are a patient in an institution for mental disease. The State may make a monthly capitation payment to an MCO or PIHP for an enrollee aged 21-64 receiving inpatient treatment in an Institution for Mental Diseases, as defined in § 435.1010 of this chapter, so long as the facility is a hospital providing mental health or substance use disorder inpatient care or a sub-acute facility providing mental health or substance use disorder crisis residential services, and length of stay in the IMD is for a short term stay of no more than 15 days during the period of the monthly capitation payment. The provision of inpatient mental health or substance use disorder treatment in an IMD must meet the requirements for in lieu of services at § 438.3(e)(2)(i) through (iii). For purposes of rate setting, the State may use the utilization of services provided to an enrollee under this section when developing the inpatient mental health or substance use disorder component of the capitation rate, but must price utilization at the cost of the same services through providers included under the State plan.

[81 FR 27853, May 6, 2016, as amended at 82 FR 39, Jan. 3, 2017; 82 FR 5428, Jan. 18, 2017; 85 FR 72837, Nov. 13, 2020; 85 FR 72839, Nov. 13, 2020; 89 FR 41267, May 10, 2024]