Among the many sweeping changes to the Medicaid program included in the One Big Beautiful Bill Act (“OBBBA”), Congress established new statutory caps on state-directed payments (“SDPs”) in Medicaid managed care. SDPs have long served as a critical mechanism for states pursuing value-based payment (“VBP”) reforms, addressing network adequacy, and advancing health equity for underserved populations. OBBBA imposes explicit Medicare-based caps on new SDPs, time-limited exceptions for certain SDPs that were approved or in development on or before July 4, 2025, and a phased transition to new payment caps beginning January 1, 2028, that will reshape state payment policy tools to drive VBP, narrow disparities, and close gaps in access.[1] State Medicaid agencies, healthcare providers, patient advocacy groups, and other stakeholders should prepare to weigh in as the Centers for Medicare and Medicaid Services (“CMS”) proposes regulations to implement these changes in the coming months.

Evolution of State-Directed Payments

In 2016, CMS finalized a comprehensive update to Medicaid managed care regulations, authorizing SDPs as a replacement for pass-through payments and to reinforce programmatic goals.[2] Under 42 C.F.R. § 438.6(c), directed payment arrangements must be tied to utilization and delivery of covered services, distributed equally among specified providers, advance objectives in the state’s managed care quality strategy, and not be conditioned on intergovernmental transfer agreements.[3] This framework enabled states to require managed care organizations (“MCOs”) to honor minimum or maximum fee schedules, implement uniform rate increases, or adopt VBP models that reward providers for meeting quality and cost-efficiency targets.

In July 2024, CMS further revised the Medicaid managed care rules and codified the use of the “average commercial rate” as a regulatory upper limit for hospitals, academic medical centers, and nursing facilities.[4]

Statutory Caps under OBBBA and Impact on Value-Based Initiatives

OBBBA enforces the first-ever binding federal statutory caps on all new SDP arrangements in Medicaid managed care, which drastically reduces flexibility for states to use targeted financial incentives. In states that expanded Medicaid eligibility to adults with incomes up to 138% of the federal poverty level pursuant to the Affordable Care Act (ACA), SDP payments will be limited to 100 percent (100%) of the “specified total published Medicare payment rate,” and, if there is no a published Medicare rate, such as for services that Medicare does not cover like nursing facility services, SDP payments are capped at the Medicaid payment rate. States that did not adopt the ACA Medicaid expansion can pay up to 110 percent (110%) of the total published Medicare rate. These statutory limits eliminate existing CMS and State discretion, requiring that any SDP initiated after the effective date of OBBBA conform to these limits. This top-down approach also underscores a notable shift in the federal-state Medicaid partnership. Whereas states have traditionally exercised broad discretion to tailor provider payments to local market realities and policy priorities, OBBBA centralizes control with the federal government.

By codifying these limits, Congress aims to curb escalating federal expenditures on SDP programs by directly constraining many of the “uniform rate increase” SDPs and by harmonizing Medicaid managed care payment levels more closely with those of Medicare. For states, this will limit the financial flexibility used to support VBP incentives, encourage provider participation, and facilitate access to care. States whose SDP programs rely heavily on rates above Medicare, or commercial-rate funding, will need to redesign payment models, renegotiate plan contracts, and reallocate resources within the new statutory boundaries. The impact also extends to SDPs that support behavioral health, mental health, and other services, where access may already be limited. Healthcare providers delivering these services could experience operational and financial challenges as a result of these changes.

Since many current VBP models “stack” incremental incentive payments on top of higher base rates, the new statutory caps may limit future flexibility in VBP design by placing fixed constraints on both provider incentives and the overall funding pool available for these arrangements. This impact will be particularly pronounced in states where commercial or fee-for-service rates are significantly higher than Medicare, or where providers have relied on supplemental payments to support delivery system improvements.

Grandfathering and Phase-Down of Existing Arrangements

OBBBA provides for a grandfathering mechanism that exempts existing SDPs from the new payment limits until January 1, 2028. Specifically, SDPs are exempt from the new payment limits if:

1. CMS approved the SDP prior to May 1, 2025;
2. CMS determines that the state made a “good faith” effort to obtain approval of the SDP prior to May 1, 2025;
3. the SDP is for a rural hospital, applies to a state Medicaid plan rating period “occurring” within 180 days of July 4, 2025 (i.e., by December 31, 2025) and CMS approval (or a good faith attempt at approval) was obtained prior to July 4, 2025; or
4. the SDP is for a completed preprint, applies to a state Medicaid plan rating period “occurring” within 180 days of July 4, 2025, and was submitted to CMS prior to July 4, 2025.

Beginning with the rating period on or after January 1, 2028, the total payment amount for exempt SDPs will be reduced by 10 percent per year until the total payment rate reaches the applicable Medicare-based payment limit.

This approach is designed to provide states and providers with a multi-year runway for transitioning their provider revenue models, workforce, and VBP arrangements to the new federal standards.

Notwithstanding the broad grandfathering language, OBBBA leaves unresolved whether SDP programs approved only for discrete “rating periods” (a period of 12 months selected by each State) qualify for an exemption if their current CMS approved preprint is for a specified time frame (e.g., calendar year 2025) that ends before January 1, 2028.

CMS retains significant discretion to determine what constitutes a “good faith effort” to obtain CMS approval and whether a preprint to renew an existing SDP for rating periods that occur in 2026 or 2027 will continue to be exempt from the new payment limits. In the absence of clarifying rulemaking or other guidance to implement these provisions, states risk substantial exposure for major reductions in SDP-funded VBP initiatives. While states may seek to renew CMS-approved SDPs to remain “grandfathered” until January 1, 2028, stakeholders should be aware that CMS could interpret the exemptions more narrowly, requiring continuous, uninterrupted approval through the start of the phase-down period or a formal CMS determination that pending applications meet the “good faith” standard.

Regulatory Outlook and State Preparations

To address these ambiguities, CMS is likely to engage in notice-and-comment rulemaking or issue sub-regulatory guidance later this year. As CMS prepares to issue regulatory guidance, advocacy groups and stakeholders have an opportunity to shape definitions and enforcement parameters. Through formal comments, stakeholder coalitions, and legal policy advocacy groups can urge CMS to interpret the SDP exemption broadly, thereby minimizing disruption to provider networks and communities that are most dependent on Medicaid funding.

For now, it is imperative that states, MCOs, and providers: (1) review their existing SDP arrangements and opportunities to renew them for rating periods prior to January 1, 2028; (2) meticulously document correspondence with CMS related to approval of SDPs and plans for renewals; (3) assess the impact of SDP rate caps and phase-down schedules to Medicaid payments to providers, especially for high-Medicaid hospitals, behavioral health networks, and VBP incentive pools; and (4) begin financial modeling for the eventual transition to lower SDPs, including potential revisions to State contracts with MCOs and MCO contracts with providers.

The fiscal impact will be especially acute for states and provider systems with large, multi-billion-dollar SDPs that make payments to providers using total amounts that exceed the Medicare payment rates for those services. The effect on Medicaid access, quality, service delivery and care model innovation will largely depend on how CMS implements the grandfathering transition and how successfully states and MCOs adapt VBP models within the new capped payment framework.

Conclusion

The new SDP limits in OBBBA represent a paradigm shift in Medicaid managed care financing, harmonizing rates with Medicare benchmarks while simultaneously constraining the robust value-based care frameworks that states have built over the last decade. Although the grandfathering provisions offer a transitional buffer, outstanding questions regarding annual-renewal SDP approvals require timely clarification to help prevent potential disruptions to provider networks and ongoing program initiatives. As CMS undertakes rulemaking and states refine their SDP architectures, stakeholders must remain vigilant in tracking policy developments, safeguarding existing arrangements, and reengineering payment strategies to thrive within the new federal framework.

All analyses reflect information current as of July 2025 and are subject to change as CMS issues additional guidance or rulemaking.

FOOTNOTES

[1] See H.R. 1, 119th Cong. (2025).

[2] See 42 C.F.R. § 438.6(c).

[3] See CMS, 81 Fed. Reg. 27498 (May 6, 2016); MACPAC, Directed Payments in Medicaid Managed Care, Oct. 2024 (hereinafter, “MACPAC, 2024”).

[4] See CMS, Medicaid & CHIP Managed Care Final Rules.

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This article was co-authored by Jessica Missel