CMS provides more leeway to Medicaid state-directed payments before new limits kick in

March 23 update

The Committee for a Responsible Federal Budget (CRFB), which advocates for deficit reduction, issued an analysis criticizing the extent to which states are capitalizing on the grandfathering clause to maintain higher rates for state-directed payments (SDPs) through 2027.

CRFP reported that Illinois and Texas have increased their SDP rates by 50% since the legislation known as the One Big Beautiful Bill Act (OBBBA) passed, amounting to nearly $40 billion in additional Medicaid costs over a decade, including close to $20 billion in federal expenditures.

CMS approved an increase in the SDP for inpatient and outpatient hospital care in Illinois from $4.7 billion in 2024 to $8 billion post-OBBBA. In Texas, the corresponding increase was from $6.5 billion to $9.1 billion.

“Given the large difference between commercial and Medicare rates and slow phase-down rate for SDPs, allowing large payments to be initiated this year will increase federal costs for years to come,” CRFB wrote.

Before the OBBBA, the limit for hospital and skilled nursing facility SDPs was the average commercial rate. That must be reduced by 10% per year starting in 2028 until reaching 110% of the Medicare rate in Medicaid non-expansion states, and 100% of the Medicare rate in expansion states.

CRFB said a backlog of applications from other states could lead to similar increases if approved. The committee said CMS’s decision to provide 180 business days, rather than calendar days, as the grandfathering window (see the original story below) could prove significant because the many SDPs requested for early 2026 thus can be grandfathered, as long as applications were submitted prior to July 4, 2025.

“In the near-term, these actions will increase federal costs above even pre-OBBBA levels, and remain in place until 2028,” CRFB wrote. “Over a decade, they could cost the federal government tens of billions of dollars or more.”

Original story

CMS issued guidance that expands the opportunity for providers to receive a key Medicaid supplemental payment at a higher rate over the next two years.

The bulletin regarding Medicaid state-directed payments (SDPs) makes it easier for states to maintain eligibility for higher SDPs before the legislation known as the One Big Beautiful Bill Act (OBBBA) ushers in new restrictions starting in 2028.

That’s when existing SDPs must be reduced by 10% per year until reaching new caps of 110% of the Medicare rate in non-expansion states and 100% in expansion states. Those limits already apply to non-grandfathered SDPs, per the legislation. Before the OBBBA, the regulatory ceiling for hospital and skilled nursing facility SDPs was the average commercial rate.

According to the guidance, SDP rates can be grandfathered and thus continue to exceed the new caps through 2027 if the state submitted a completed preprint by the OBBBA’s enactment date of July 4, 2025, and if the SDP has a Medicaid rating period within 180 business days before or after that date. The specific windows are:

• Oct. 11, 2024, through July 3, 2025
• July 7, 2025, through March 27, 2026

The new guidance supplants September 2025 guidance that set the time frame at 180 calendar days, rather than business days, meaning the revision gives states a larger window in which to capitalize on the grandfather option.

For example, rating periods corresponding to CY24 and CY26 now are eligible to be grandfathered, joining state FY25, CY25 and state FY26. If an SDP spans two eligible rating periods with different payment rates, the higher rate can be grandfathered.

SDP spending totaled nearly $98 billion in FY25. The Congressional Budget Office projected that the legislation’s SDP provisions would generate more than $149 billion in federal savings over 10 years.

Grandfathering criteria for state-directed payments

As stipulated in the 2025 guidance and the new guidance, pending SDPs can be grandfathered if the state submitted a completed preprint (or if the SDP already was approved) before July 4, 2025, for rural hospitals or May 1, 2025, for nonrural hospitals.

Grandfathered payments cannot exceed the average commercial rate nor be increased through amendments, renewals or revisions. They can be decreased at the state’s discretion.

States cannot change the rating period for a submitted preprint in an effort to bypass the grandfathering criteria, CMS said, adding that it will provide preliminary feedback in adjudication letters on whether pending SDPs are eligible to be grandfathered.

A proposed rule implementing the new limits on SDPs will be forthcoming, CMS said. Whereas the OBBBA and the new guidance address SDPs for hospital inpatient and outpatient services, skilled nursing facility (SNF) care, and clinician services at academic medical centers, the agency said the proposed rule could include unspecified additional healthcare segments.

Millions of dollars on the line for hospitals

State- and hospital-level data illustrate why SDPs are considered a high-stakes proposition.

For example, the for-profit health system HCA Healthcare projects a 2026 decline of $250 million to $400 million in net benefit from SDPs, but the impact could be lessened by about a third if an SDP program in Texas is renewed.

“There was a [Texas healthcare] commissioner who issued a termination notice on that program on their way out as they were leaving office,” Mike Marks, CFO of HCA Healthcare, said in January during the company’s latest earnings call. “The new executive commissioner who is now in place has agreed to review that program, effectively putting it on pause versus terminated. We don’t know yet the timeline for this review, but we are encouraged that the department is willing to review the program and consider a potential reinstatement.”

The SDP issue also bears watching in Florida, where legal and administrative roadblocks have delayed CMS’s approval of an application that was submitted in May. In a February letter to CMS, members of the state’s GOP delegation in the U.S. House of Representatives urged swift approval.

“Because of this ongoing delay, Florida hospitals are increasingly concerned about the potential consequences for their patients, including limited access to essential healthcare services,” the legislators wrote.

In a published column, the head of the Florida Hospital Association (FHA) said approval of the pending SDP is vital, noting CMS has approved SDPs that were submitted after Florida’s.

“SDPs and the provider tax that makes them possible are not a luxury or a bailout,” wrote Mary Mayhew, president and CEO of the FHA. “They are a basic component of Medicaid financing.”

Services for maternity care, behavioral health and pediatric care already are being affected, Mayhew said.

SDP funding mechanism also curtailed

The guidance follows a 2026 final rule that affects Medicaid provider taxes, a key funding source for SDPs. Through that rule, CMS sought to close a loophole that it said allowed a handful of states to boost Medicaid payments primarily to managed care organizations (MCOs) but, in one instance, also to hospitals.

Anticipating more states would have sought to capitalize on the loophole, CMS projected that the change will save Medicaid $125 billion in federal and state funding from 2027 through 2036.

As described in the final rule, the loophole is found in the statistical formula for determining whether a provider tax meets the requirement to be generally redistributive, meaning payments derived from the tax do not benefit taxpaying providers in proportion to their Medicaid volumes. Regulators say that guardrail is necessary to ensure provider taxes function as legitimate revenue sources rather than schemes to game federal matching funds.

Although the proposed version of the rule was issued before passage of the OBBBA, the legislation has similar provisions and makes them statutory.