Balancing Flexibility and Oversight

Medicaid, the joint federal and state program that provides health care for low-income individuals, has long been a critical part of the U.S. health care system. Over the years, states have explored various mechanisms to increase the flexibility and efficiency of Medicaid spending. In 2016, the Centers for Medicare and Medicaid Services (CMS) created a new option to pay providers according to specific rates known as directed payments.  Since 2016, states have greatly increased their use of directed payments. Now, lawmakers are asking: Should Medicaid directed payments continue as they are, or do they need stricter oversight? 

History of Medicaid Directed Payments 

In 2016, CMS created directed payments to allow states to pay providers according to specified rates and methods.  The payments were originally designed to require Managed Care Organizations (MCOs) to pay providers a certain amount.  In practice, directed payments allow Medicaid funds to be used in ways that are not directly tied to traditional reimbursement methods, such as fee-for-service (FFS). This flexibility has enabled states to target resources where they believe they will have the most impact, such as for certain population groups or in areas with pressing health care needs. 

These payments have drawn attention and controversy, particularly regarding their transparency and potential for misuse.  According to the Medicaid and CHIP Payment and Access Commission, directed payment use increased from 23 states in 2016 to 37 in 2020 – growing from 65 distinct payment agreements to 230.  In 2024, total state spending on directed payments was $110 billion, an amount much greater than on each of the two largest types of FFS supplemental payments – disproportionate share hospital (DSH) and upper payment limit (UPL) payments.   The largest beneficiaries of state-directed payments are hospitals, particularly rural and safety-net hospitals.   

Critics argue that directed payments can lead to distortions in the allocation of resources, favoring certain providers or services over others, potentially undermining the program’s goals of equity and efficiency. 

The Pros of Medicaid Directed Payments 

1. Increased Flexibility: Directed payments give states more leeway in how they allocate Medicaid funds, enabling them to target specific health care challenges. This can be particularly beneficial in addressing local health disparities or funding innovative models of care delivery. 
2. Potential for Cost Savings: When states can direct payments toward cost-effective health care solutions, they may see savings. For example, incentivizing preventive care or effective chronic disease management can reduce the need for more expensive emergency care or hospitalizations. 
3. Focus on Quality of Care: Directed payments can also be tied to quality metrics, encouraging health care providers to focus on improving patient outcomes. This can incentivize better care practices, which may lead to healthier patient populations in the long run.

The Cons of Medicaid Directed Payments 

1. Potential for Misallocation: Critics argue that Medicaid directed payments can lead to the misallocation of resources. Without proper oversight, funds could be directed toward specific providers or services based on political influence or lobbying efforts rather than public health needs. 
2. Lack of Transparency: Directed payments can sometimes operate behind closed doors, making it difficult for the public to track how funds are being spent. This lack of transparency raises concerns about accountability and fairness in how Medicaid dollars are distributed. 
3. Inequity in Access: Directed payments could disproportionately benefit certain providers, particularly those with more political influence or better access to state decision-makers. This could lead to inequities in care access, particularly in underserved or rural areas where providers may have less sway in shaping payment decisions. 

Cost Cutting Measures in the New White House and Congress  

The House-passed budget places limits on state directed payments (SDPs), with an estimated savings of $25 billion.  It would also limit Medicaid provider taxes, lowering the safe harbor from 6% down to 2%, creating savings of $175 billion.  Lowering provider taxes also lowers the amounts used for state directed payments, as many states use the provider tax to fund SDPs.   

Ultimately, Medicaid directed payments are likely to remain a contentious issue, as the balance between state flexibility and federal oversight remains a key point of contention in U.S. health care policy. The pressure is high to create some type of savings on the federal level, even if the result is to handicap states’ ability to shore up safety-net and rural hospitals.