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
Federal statute requires that Medicaid payments be consistent with efficiency, economy, and quality; avoid payment for unnecessary utilization; and are sufficient to enlist enough providers (§1902(a)(30)(A) of the Social Security Act). In addition, the Omnibus Budget Reconciliation Act of 1981 (OBRA 1981, P.L. 97-35) added the requirement that capitation payments to risk-based managed care plans be made on an actuarially sound basis (§1903(m)(2)(A)(iii) of the 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the cost of providing the same services in FFS Medicaid to an actuarially equivalent population group (42 CFR 447.361 [repealed]).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 (CMS 2001). In addition, the FFS data may not have been useful for comparison purposes, for example, if these data reflect lower use of preventive screenings and services such as vaccinations than would be typical for managed care plans (American Academy of Actuaries 2005).
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)). 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 incorporate the following (or explain why the requirements are not applicable) (42 CFR 438.6(c)(3)):
- base utilization and cost data for the applicable Medicaid population or, if not, adjusted to make the data comparable to the Medicaid population;
- adjustments to smooth data and to account for factors such as medical trend inflation, incomplete data, and utilization;
- rate groupings specific to eligibility category, age, gender, locality/region, and (optionally) diagnosis or health status; and
- other mechanisms and assumptions that are appropriate for individuals with chronic illness, disability, ongoing health care needs, or catastrophic claims, using risk adjustment, risk sharing, or other appropriate cost-neutral methods.
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.
States must demonstrate compliance with the actuarial soundness requirements by documenting the rate-setting methodology and the base utilization data used to set rates. CMS staff use a checklist to verify states’ compliance with these requirements that includes statutory and regulatory citations for specific requirements, descriptions of acceptable methods for complying with the requirements.
Learn more about managed care rate setting: