New Payment Caps Force States to Reevaluate Medicaid Managed Care Strategy

A shift in Medicaid financing policy is underway. The Centers for Medicare & Medicaid Services (CMS) has released preliminary guidance on new federal limits for State Directed Payments (SDPs), a move tied to the implementation of the One Big Beautiful Bill Act. Although the rule is not yet final, CMS is offering early instructions to help states prepare for significant restrictions on how managed care dollars can be directed.

Framed publicly as an effort to reduce fraud, waste, and abuse, the policy imposes structured caps on SDP reimbursements for core service categories. While the agency emphasizes its intent to preserve Medicaid access and strengthen fiscal oversight, the underlying consequences extend well beyond payment alignment. For many states, the new rule calls into question how sustainable their Medicaid financing models have become.

The Quiet Expansion of SDPs

SDPs were initially introduced to allow states greater flexibility in shaping how managed care organizations (MCOs) reimburse providers. In practice, these arrangements have grown to serve as a parallel financing system. According to CMS, only two states used SDPs in 2016. As of 2023, that number has increased to 39. The agency projects SDP spending to exceed $124 billion by fiscal year 2025 and climb to over $144 billion in 2026.

The rapid growth of SDPs has raised concerns across regulatory bodies. The Government Accountability Office (GAO), in multiple reviews, has highlighted transparency gaps and oversight limitations in how SDPs are reported and evaluated. Without a centralized mechanism to monitor whether these funds improve access, quality, or equity, the risk of inefficiency or misuse increases.

State Medicaid programs have often relied on SDPs to draw down additional federal funds while minimizing their own financial contributions. These strategies frequently involve intergovernmental transfers, public-private provider arrangements, and creative budget structuring that can obscure the true flow of funds. CMS’s new guidance, anchored in Section 71116 of the new statute, appears designed to curb those practices.

Medicare Rate Caps and the Grandfather Window

Under the guidance, SDP payments for inpatient and outpatient hospital services, nursing facility care, and services provided by qualified practitioners at academic medical centers must adhere to new ceilings. In Medicaid expansion states, payments must not exceed 100 percent of Medicare rates. In non-expansion states, the cap is 110 percent. Where no Medicare equivalent exists, the Medicaid state plan rate will apply.

CMS has also introduced a temporary grandfathering provision. SDPs that are submitted or approved before July 4, 2025, may be permitted to continue under existing terms until the beginning of 2028. After that point, those payments must transition to align with the new caps.

From a compliance standpoint, the letter signals that CMS will not continue reviewing or approving SDPs that exceed the thresholds unless they qualify under the grandfathering clause. For states with pending submissions or existing programs under review, CMS will issue case-specific determinations.

Operational Burden and Strategic Response

The operational impact of this change will not be evenly distributed. States with complex or high-volume SDP structures, including Texas, California, and New York, will need to reassess financial assumptions, contractual language, and internal review processes. Rate-setting, provider contracting, and payment flows will all require reevaluation.

State Medicaid agencies often operate with limited administrative capacity. The volume of revisions triggered by this rule will strain internal teams and legal resources. Moreover, managed care partners may resist contract changes that reduce financial flexibility or disrupt provider relationships.

States that have relied on SDPs to stabilize safety-net hospitals or rural health systems may find the new limits particularly challenging. In regions where Medicaid reimbursement already lags behind the cost of care, any imposed cap may result in reduced access or withdrawal of providers from Medicaid networks.

The American Hospital Association (AHA) has previously cautioned against rigid Medicare-based rate comparisons, noting that these benchmarks often fail to account for local cost differentials, infrastructure burdens, or uncompensated care dynamics. The uniformity introduced by CMS may simplify oversight but could undermine financial viability in fragile markets.

Reclaiming Control Over Medicaid Financing

From a policy standpoint, the CMS move reflects a broader effort to reassert federal control over Medicaid’s financial architecture. SDPs have created a fragmented payment environment where billions in federal funds flow through locally designed mechanisms with uneven accountability. While states value the flexibility, the model has increasingly blurred the lines between strategic innovation and fiscal manipulation.

A 2024 review by Health Affairs observed that SDP expansion has eroded transparency in Medicaid spending, making it difficult to assess whether the additional investments produce measurable improvements in quality or outcomes. CMS’s new limits aim to restore traceability, but they also introduce new risks, especially if states respond by withdrawing support rather than recalibrating systems.

As Medicaid enrollment shifts post-pandemic and redetermination processes resume, states face growing pressure to make their payment structures defensible and efficient. The SDP restrictions will force policy teams to rethink how provider support is delivered and how managed care partnerships are structured. Alternatives such as directed payments under state plan amendments or Section 1115 waivers may gain traction, but none offer the same blend of flexibility and discretion.

Implications for Healthcare Executives

For healthcare executives in finance, compliance, and managed care strategy roles, the new guidance is not a procedural update. It signals a change in how the federal government expects Medicaid resources to be governed. Existing arrangements that once passed quietly through the system are now subject to structured scrutiny and capped reimbursement logic.

Hospitals, provider networks, and MCOs must prepare for renegotiations and realignment. States must reevaluate whether their current reliance on SDPs is a sustainable or defensible long-term strategy. While the new rules do not eliminate SDPs, they reframe them as a risk exposure, one that must now be justified not just to local stakeholders but to CMS auditors.

The next 18 months will test whether states can adapt their Medicaid programs to meet federal expectations without triggering access crises or financial instability. Strategic clarity, rather than political positioning, will determine which programs thrive under the new regime.