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New Requirements for Managed Care Coverage of In Lieu of Services

Julie Kozminski
January 13, 2023

A Jan. 4, 2023, letter to state Medicaid directors from the Centers for Medicare & Medicaid Services (CMS) provides additional guidance on the ability of states and Medicaid managed care plans to cover in lieu of services and settings (ILOSs) — services or settings that substitute for state plan–covered services or settings.

The letter adds to previous guidance to clarify how this mechanism can be used to reduce health disparities and address the unmet health-related social needs (HRSN) of Medicaid and CHIP enrollees.

While outlining a clear pathway to use Medicaid managed care programs to support investments in HRSNs, the letter also establishes limits on ILOS expenditures and adopts new documentation and review requirements. States already including ILOSs in the programs will have until the contract rating period beginning on or after Jan. 1, 2024, to comply with the new guidance.

New Clarifications and Requirements

Under the new guidance, CMS identifies six principles states must meet to obtain approval of managed care contracts and rates that include ILOSs:

  1. Must advance the objectives of the Medicaid program. ILOSs will be limited to services that are approvable through a state plan amendment or a Section 1915(c) home- and community-based services waiver.
  2. Must be cost-effective. Current regulations already require states to demonstrate that ILOSs are a cost-effective substitute for state plan services. Under the new guidance, states will be required to submit ILOS cost percentages (see below) for each managed care program, and CMS will limit total expenditures for ILOSs, other than ILOSs covering short-term stays in institutions for mental diseases (IMDs) to 5 percent of total expenditures for each managed care program.
  3. Must be medically appropriate. States must specify the state plan service for which each ILOS substitutes and the clinical criteria for its use, along with provider documentation requirements for compliance with those criteria.
  4. Must be provided in a manner that preserves enrollee rights and protections.
  5. Must be subject to appropriate monitoring and oversight.
  6. Must be subject to retrospective evaluation, when applicable. States are required to complete a five-year retrospective evaluation for all ILOS programs with more than a de minimis final (retrospective) ILOS cost percentage assessing the program’s impact.

Acknowledging the administrative burden on states, CMS will use a risk-based review process with documentation, monitoring, and evaluation requirements to demonstrate compliance with the six principles. The agency will streamline the review process for states with an ILOS cost percentage of 1.5 percent or less, while states with higher use will be subject to additional requirements. The ILOS cost percentage is defined as:

Total capitation payments attributable to all ILOSs, excluding short-term stays in IMDs /

Total capitation payments specific to the managed care program, including all CMS-approved state directed payments and pass-through payments.

States will be required to submit their annual projected ILOS cost percentages along with their rate certifications, as well as retrospective final ILOS cost percentage based on actual experience, no later than two years after the end of the contract year. As noted above, CMS will cap ILOS cost percentages at 5 percent. CMS will deny approval for any ILOS that does not meet the requirements in the guidance.

CMS explicitly states that the SMD letter does not alter existing regulatory and subregulatory guidance regarding the use of short-term stays in an IMD as an ILOS.

Contact Director of Policy Rob Nelb, MPH, at or 202.585.0127 with questions.

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