CMS Proposes Rate Limits on $145B in Medicaid State-Directed Payments

From certifying Medicaid managed care capitation rates across multiple state programs, the treatment of state-directed payments has always been the most contested line item in the rate development workbook. On May 22, 2026, CMS published a Notice of Proposed Rulemaking (CMS-2449-P, 91 FR 30400) that would impose payment rate limits on all state-directed payment (SDP) preprint categories for the first time. With SDP spending projected at $144.6 billion for FY 2026, up 48% from $97.8 billion in FY 2024, the proposed rule arrives at the intersection of fiscal policy and actuarial practice. For the certifying actuary, the question is immediate: how should SDP dollars that function as supplemental provider payments rather than risk-based capitation be treated when testing rate adequacy and developing the non-benefit load?

What CMS-2449-P Proposes

The NPRM implements Section 71116 of the Working Families Tax Cut Act (Pub. L. 119-21, enacted July 4, 2025) and extends its payment limit framework well beyond the four service categories the statute mandates. The rule has three core components.

Medicare-based payment limits for statutory categories. For inpatient hospital, outpatient hospital, nursing facility, and qualified practitioner services at academic medical centers, the proposed rule caps SDP payment rates at 100% of the total published Medicare rate in Medicaid expansion states and 110% in non-expansion states. Where no Medicare equivalent exists, the cap defaults to 100% of the state plan-approved rate. These limits apply per service and per provider, not in aggregate, closing the methodological flexibility that allowed states to blend high-payment and low-payment providers under prior average commercial rate (ACR) ceilings.

Extension to all SDP categories. The NPRM proposes extending UPL-style payment rate limits to every SDP preprint type: minimum fee schedule, maximum fee schedule, uniform dollar or percentage increase, value-based purchasing, and population-based payment arrangements. Previously, only fee schedule-based SDPs were subject to rate caps. Uniform dollar increases, which accounted for 67% of all approved SDPs according to MACPAC's October 2024 analysis of 302 preprints, operated without an explicit payment ceiling. CMS proposes closing this gap by January 1, 2029, with a ban on new uniform increase SDPs effective January 1, 2028.

Grandfathering with phase-down. SDPs with completed preprints submitted before July 4, 2025 receive grandfathered status, but the grandfathered amount declines by 10 percentage points annually beginning January 1, 2028, using the original approved total as the baseline. A $1 billion SDP, for example, would reduce by $100 million each year until it reaches the Medicare-based limit or expires.

Effective Date	Provision
July 4, 2025	Medicare-based limit applies to four WFTC statutory service categories
July 9, 2026	SDP preprints must be submitted prospectively before the SDP start date
July 21, 2026	Comment period closes (Regulations.gov docket CMS-2026-1916)
Jan 1, 2027	Grandfathered SDP annual reporting begins; actuary-certified comparisons required
Jan 1, 2028	Grandfathered SDP phase-down initiates; uniform increase SDPs banned for new arrangements
Jan 1, 2029	Medicare-based limit extends to all SDPs, all services, all states

The SDP Spending Trajectory That Prompted the Rule

The scale of the SDP program has grown faster than any other component of Medicaid managed care spending. Only two states used SDPs in 2016, submitting four preprint applications. By 2024, 41 states had filed 366 active preprints, with cumulative submissions exceeding 1,950 since the program's inception. CMS projects that without this rule, SDP spending would reach $295.9 billion by FY 2034, nearly tripling the FY 2024 level.

The financing structure explains why. MACPAC documented that 80.8% of SDPs paying above Medicare rates are funded wholly or partly through intergovernmental transfers (IGTs) or provider taxes. States use these mechanisms to draw down federal matching funds at their applicable FMAP rate, creating a fiscal multiplier: a public hospital contributes IGT funds to the state, the state directs the MCO to pay that hospital above the base rate, and the federal match effectively returns more money than the original IGT contribution. The proposed rule's Medicare-based cap is designed to compress this multiplier by limiting the total payment that can flow through the SDP channel.

CMS's regulatory impact analysis estimates total computable savings of $774.8 billion over 10 years under its medium scenario, with $510.1 billion in federal savings. This figure exceeds the Congressional Budget Office's $149.4 billion statutory score by more than three times, because the proposed rule extends Medicare-based limits to all SDPs and all service categories, not just the four categories the statute requires. Georgetown's Center for Children and Families has flagged this gap as a major point of contention for the comment period.

Capitation Rate Decomposition: The Core Actuarial Challenge

Under 42 CFR 438.4, Medicaid managed care capitation rates must be certified as actuarially sound, meaning they are "projected to provide for all reasonable, appropriate, and attainable costs" for the covered population. The certifying actuary develops rates using base-period encounter data, applies trend factors for medical and administrative costs, layers risk adjustment (typically CDPS+Rx or a state-specific model), and builds a non-benefit load covering administrative expenses, margin, and risk contingency.

The proposed rule fundamentally changes this process by requiring the actuary to decompose the capitation rate into two distinct streams: the actuarially derived risk-based component and the SDP pass-through component. When a state directs an MCO to pay providers at 150% of the Medicaid fee schedule, the certifying actuary must now determine whether the incremental cost above the base fee schedule belongs in the risk-based capitation (subject to actuarial soundness standards) or constitutes a separable pass-through that must be tested against the Medicare-based UPL benchmark.

This decomposition has not been required at this level of specificity before. Under the current framework, ASOP No. 49 instructs the actuary to consider "the extent to which payments to the managed care plan are expected to be used to pay for covered services versus other costs." That consideration has historically been advisory. The NPRM would make it enforceable: the actuary's rate certification must document how SDP dollars are allocated, and the SDP component must independently satisfy the proposed payment limit.

The OBBBA-driven enrollment volatility already complicating Medicaid rate certifications makes this decomposition harder. When the enrollment denominator is itself unstable, separating SDP pass-through costs from risk-based costs on a per-member-per-month basis requires assumptions about which members are receiving SDP-funded services and at what rate. If a state's SDP primarily funds hospital inpatient rate increases, but the MCO's membership mix shifts toward a lower-acuity population through accelerated redeterminations, the SDP cost per remaining member changes even if the per-service payment rate stays constant.

Non-Benefit Load Distortion

The non-benefit load calculation changes materially when SDP pass-through payments inflate total MCO revenue. Consider a state where SDPs represent 30% of total MCO payments. The MCO receives capitation revenue that includes both risk-based and SDP components, but the SDP dollars flow through to providers with near-zero underwriting risk to the plan. The MCO functions as a payment conduit for the SDP share, not as a risk-bearing entity.

This structure distorts three metrics that are central to rate development and financial monitoring.

Medical loss ratio. Under 42 CFR 438.4(b)(9), capitation rates must be set to "reasonably achieve" an MLR of at least 85%. When the denominator includes SDP pass-through revenue that carries no underwriting risk, the observed MLR mechanically exceeds 85% regardless of the plan's actual performance on risk-based services. A plan could underperform on its risk-based medical management while appearing compliant on MLR because the SDP pass-through inflates both the numerator (medical expense) and denominator (total revenue) proportionally. The NPRM's requirement to segregate SDP from risk-based revenue would allow the 85% MLR test to apply to the risk-bearing portion of the capitation, producing a more meaningful measure of plan performance.

Administrative cost allocation. MCO administrative costs are typically expressed as a percentage of total revenue in rate development. If total revenue includes SDP pass-through payments, the administrative expense ratio appears lower than it actually is on a risk-adjusted basis. A plan spending $50 million on administration against $500 million in total revenue shows a 10% admin load. Remove $150 million in SDP pass-throughs and the same $50 million represents a 14.3% admin load against $350 million in risk-based revenue. The rate certification must reflect the true administrative burden relative to the costs the MCO is actually managing.

Margin and risk contingency. The margin component of the non-benefit load compensates the MCO for bearing underwriting risk. Applying a 2% margin to total revenue that includes SDP pass-throughs produces a margin dollar amount that exceeds what the underwriting risk profile justifies. The certifying actuary, under both the current ASOP 49 and the proposed rule, should tie the margin to the risk-based component, not the total payment including pass-throughs.

Double-Counting Risk in Risk Adjustment

The interaction between SDPs and diagnostic-based risk adjustment models creates a more subtle problem. Most Medicaid managed care programs use CDPS+Rx or a comparable model to adjust capitation rates for enrollee acuity. These models rely on encounter data: the diagnoses and procedures recorded in claims submitted by MCOs to the state. If SDP-funded services appear in the encounter data used for acuity scoring, the risk-adjusted base rate may already capture costs that the SDP separately reimburses.

For example, suppose a state's SDP directs MCOs to pay hospitals a uniform 25% increase above the negotiated rate for all inpatient stays. The encounter data submitted by the MCO includes the inpatient diagnoses, which feed into the CDPS risk adjustment model and increase the risk score for members with those conditions. The risk-adjusted base rate rises to reflect the higher acuity of those members. But the SDP also separately reimburses the 25% increment. The hospital effectively receives both the risk-adjusted base payment (which already accounts for the higher-cost conditions that drove the inpatient stays) and the SDP supplement (which independently increases the payment for those same stays). This is the double-counting risk that the proposed rule aims to address through segregated documentation and UPL testing.

The CMS 2026-2027 Medicaid Managed Care Rate Development Guide, released February 19, 2026, already requires that in-lieu-of-services (ILOS) costs be "separately documented with claims and encounter data certified by the state actuary in a separate actuarial report." The NPRM extends this documentation principle to all SDP arrangements, requiring the certifying actuary to trace whether the encounter data underlying the risk adjustment model includes service volumes or cost levels that are already compensated through the SDP channel.

ASOP 49 Exposure Draft Tightens in Parallel

The timing is not coincidental. The Actuarial Standards Board released an exposure draft revising ASOP No. 49 (now titled "Medicaid Managed Care Capitation Rates," dropping "Development and Certification" from the original 2015 title) with a comment deadline of September 1, 2026. The revised standard adds new guidance on considerations the actuary should address when developing managed care adjustments, including the treatment of supplemental payment streams that do not reflect risk-based pricing.

Together, the NPRM and the ASOP 49 revision create a two-layer compliance framework. The federal regulation (42 CFR 438.6(c)) would establish enforceable payment limits and documentation requirements for SDP arrangements. The professional standard (ASOP 49) would establish the actuarial methodology for incorporating those limits into rate development. An actuary certifying a Medicaid managed care capitation rate in 2027 or 2028 will need to satisfy both: the rate must be actuarially sound under the regulatory standard, and the methodology must comply with the professional standard's enhanced guidance on pass-through payment treatment.

The March 11, 2026 CMS informational bulletin on managed care monitoring and oversight adds a third layer. The CIB signals heightened scrutiny of MCO financial performance under SDP arrangements, requiring states to submit supplemental financial data with rate certifications and establishing optional reporting templates for MLR monitoring. For actuaries, the bulletin means that rate certifications will face more granular federal review, particularly where SDP payments constitute a large share of total MCO revenue.

Fiscal Impact on States: The Matching Fund Compression

For states using SDPs to draw federal matching funds at enhanced FMAP rates, the proposed Medicare-based payment cap creates a direct fiscal constraint. A state currently directing MCOs to pay hospitals at 175% of the Medicaid fee schedule through an SDP would need to reduce that directed payment to no more than 100% (or 110% in non-expansion states) of the Medicare rate for the same service. The difference between the current payment and the Medicare-based cap represents lost federal matching revenue.

The actuarial soundness challenge compounds this fiscal pressure. If a state reduces its SDP to comply with the proposed cap, the certifying actuary must determine whether the resulting capitation rate, now with a smaller SDP component, still provides for all reasonable and attainable costs. In states where SDPs fund 20% to 40% of total MCO payments, a reduction to Medicare-based limits could create a gap between the actuarially sound rate and the state's fiscal capacity to fund it. The certifying actuary cannot certify a rate as actuarially sound if the state's directed payments fall below the level needed to support the provider payment rates that the encounter data and trend assumptions were built upon.

This dynamic is particularly acute for safety-net hospitals and academic medical centers that have come to depend on SDP revenue. GAO's December 2023 report (GAO-24-106202) estimated 2022 SDP spending at $38.5 billion and found that CMS lacked defined standards for assessing whether SDP payment rates were "reasonable and appropriate." The NPRM provides those standards for the first time, but the transition from unregulated to Medicare-capped payments will force difficult conversations between states, providers, and the actuaries certifying the rates that connect them.

Why This Matters

CMS-2449-P is the most significant structural change to Medicaid managed care payment methodology since the 2016 managed care final rule. It transforms the certifying actuary's role from one that accommodated SDP pass-throughs within a flexible rate development framework to one that must explicitly segregate, document, and test SDP payments against federally defined benchmarks. The comment period closes July 21, 2026, and the ASOP 49 exposure draft comment period extends to September 1, 2026, giving the actuarial profession a narrow window to shape both the regulatory and professional standards simultaneously.

For Medicaid pricing actuaries, the immediate action items are concrete. First, inventory every SDP arrangement in each state engagement and classify it by preprint category, identifying which fall under the statutory four-service limit (effective now) and which will be captured by the broader regulatory extension (effective January 1, 2029). Second, build the rate decomposition framework that separates risk-based capitation from SDP pass-through components, testing each against the applicable payment limit. Third, review encounter data submissions to identify potential double-counting between risk-adjusted base rates and SDP-funded service costs. Fourth, coordinate with state Medicaid agencies on the grandfathering determination and phase-down schedule, as these timelines directly affect the multi-year rate development trajectory.

The interaction with OBBBA's enrollment churn provisions compounds the complexity. Certifying actuaries are simultaneously absorbing enrollment volatility from accelerated redeterminations and decomposing payment streams under new SDP constraints. Both forces compress the margin for error in Medicaid managed care rate development, and both arrive in the same 2027-2028 rating periods. This is the most demanding rate-setting environment for Medicaid health actuaries in over a decade.