CMS’ Harmful Directed Payment Rule: Impacts and Texas’ Legal Challenge

With Medicare and Medicaid providing more than half of most hospitals’ patient revenue, any changes to either of these government-sponsored programs have a significant impact on hospitals.

In April 2024, the Centers for Medicare & Medicaid Services (CMS) released its Medicaid managed care rule. The rule includes new regulations on state-directed payment programs (SDPs). CMS did not finalize harmful limits on payment rates and total expenditures, as the proposed rule initially considered, but did adopt provisions related to financing and appeals that Texas hospitals opposed.

However, CMS allowed a lengthy runway until enforcement to allow current legal challenges to play out. (See more details below.) In an informational bulletin accompanying the rule, CMS indicates it will defer enforcement of prohibitions on hold harmless arrangements until 2028.

Below is a chart detailing THA’s analysis of beneficial and harmful pieces of the CMS final rule. THA urged CMS to withdraw the rule before it was finalized, noting that it would significantly limit total amounts available under directed payment programs and restrict states’ ability to draw down federal Medicaid dollars. Also below are details on a current legal challenge to the rule by the State of Texas.

Summary of CMS Actions in Managed Care Rule CMS-2439-F

Beneficial actions taken	What it means
CMS codified a total payment rate limit for SDPs at 100% of the average commercial rate (ACR).	Going forward, states cannot set payment rates in Medicaid SDPs that are any higher than what an average commercial payer would have paid for the same services. The hospital industry supported 100% of ACR as a reasonable limit. The new limit would not require Texas to change its current programs. CMS affirmed that rates tied to the ACR are “reasonable and appropriate,” acknowledging Medicaid managed care plans need to offer competitive payments to providers in their networks to maintain access. Anything lower could jeopardize states’ ability to use SDPs to further the goals of its Medicaid program.
CMS did not adopt limits on total SDP expenditures.	Total expenditure limits, such as those capping SDP expenditures at a fixed percentage of a state’s total Medicaid spending, would penalize states that use SDPs to offset underfunded base rates. These limits impede state flexibility, limit access to care, and could prevent Texas from operating even a fraction of its current programs. Texas hospitals were alarmed that CMS contemplated such limits, and will continue to oppose them in future rulemaking.
Harmful actions taken	What it means
CMS finalized an improper interpretation that private hold-harmless arrangements are impermissible.	CMS will now explicitly require states to demonstrate that the non-federal share of SDPs is funded with a permissible source, and will require attestations from participating providers that they do not take part in any hold harmless arrangements related to state-directed payments. CMS demonstrates in the rule preamble that they are continuing to rely on a faulty interpretation of federal law. THA has never objected to requiring providers to attest they are following federal law, but opposes CMS using attestations to enforce its view that private redistribution agreements are impermissible. In the rule, CMS acknowledges the preliminary injunction currently in effect in Texas that prevents CMS from implementing the changes it finalizes in this rule. CMS says it will abide by the injunction as long as it is in effect.
CMS will direct disputes over SDP approvals to the Departmental Appeals Board (DAB).	This provision allows CMS to insulate itself from judicial review of its decisions while depriving Medicaid providers of needed payments during lengthy DAB reviews. Courts typically require a state to exhaust administrative review options before seeking judicial relief. DAB appeals often take years to resolve, far exceeding the one-year lifespan of an SDP.

“Sleight of Hand”: Texas’ Legal Challenge to the Rule

On May 22, 2024, the State of Texas filed a supplemental complaint to its existing federal court challenge of CMS’ position regarding the permissibility of the disputed Medicaid financing arrangements.

The supplemental complaint challenges CMS’s final rule issued in April of this year. The original lawsuit was filed in April 2023 and challenged CMS’s informational bulletin issued the previous February, when CMS first purported to expand the definition of “hold harmless arrangements” to prohibit arrangements in which private providers agree to redistribute Medicaid payments amongst themselves. Texas was granted a preliminary injunction in that lawsuit in June 2023, prohibiting CMS from enforcing the 2023 bulletin on the grounds that it exceeded CMS’s legal authority under the Social Security Act.

The final Medicaid rule released in April regulatorily adopted the position that the agency set out in the 2023 bulletin. Around the same time, CMS also issued a second bulletin setting out its position on the enforcement timeframe for the new rule because of the complicating factor of the injunction. The latest bulletin indicates that CMS will not enforce the new rule until Jan. 1, 2028.

The state’s new supplemental complaint challenges the final rule essentially on the same grounds as its injunction against the 2023 bulletin: that the rule purports to enforce CMS’s position in the 2023 bulletin – which the court has already found exceeds CMS’s authority – and tries to do so “without addressing any of the legal faults” the court identified.

The supplemental complaint also attacks the portion of the final rule requiring states to funnel disputes regarding SDPs into the Departmental Appeals Board (DAB). The state says that requirement strips the courts of any practical jurisdiction to review CMS’s application of its unlawful theory of hold harmless agreements, and notes that the DAB’s average review time well exceeds the lifespan of an SDP, citing examples of years-long DAB reviews.

Finally, Texas’s supplemental complaint attacks CMS’s “sleight of hand regarding effective dates.” According to the state, CMS claimed in its 2024 bulletin that it would “not enforce” the sections pertaining to hold-harmless arrangements that exist as of April 22, would defer enforcement until 2028 and would abide by the previously issued injunction “as long as it remains in effect.” However, Texas contends that a close read of the 2024 bulletin reveals that “CMS very much expects States and private parties to begin complying with the Final Rule immediately.”

Effectively, according to Texas, CMS expects states with existing hold harmless arrangements to undertake changes necessary well before the claimed enforcement date in 2028.

Texas challenges the final rule on several grounds, including that it exceeds CMS’s statutory authority by adopting an interpretation of the hold-harmless provision of the Social Security Act that is not in accordance with law, and by depriving states of effective judicial review of SDP denials. The state’s request for relief in the supplemental complaint asks the court to:

Issue preliminary and permanent injunctive relief prohibiting CMS from enforcing or implementing the final rule;
Compel CMS to cease any Medicaid audit and oversight activities against Texas that are inconsistent with the Social Security Act and its implementing regulations, which do not govern private-party agreements; and
Vacate the final rule on the grounds that it is either substantively unlawful or arbitrary and capricious under the Administrative Procedures Act (APA), and to issue a declaratory judgment to that effect.