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Each week, Health Affairs' Rob Lott brings you in-depth conversations with leading researchers and influencers shaping the big ideas in health policy and the health care industry.
A Health Podyssey goes beyond the pages of the health policy journal Health Affairs to tell stories behind the research and share policy implications. Learn how academics and economists frame their research questions and journey to the intersection of health, health care, and policy. Health policy nerds rejoice! This podcast is for you.
Welcome to A Health Podyssey. I'm your host, Rob Lott. In July 2025, when Congress passed a huge budget reconciliation bill, also called the One Big Beautiful Bill Act or HR1, it extended a slew of costly tax cuts and famously paid for it by reducing federal health spending to the tune of roughly $1,000,000,000,000 over the next decade. One way that Congress achieved these reductions is through measures such as Medicaid work requirements and more frequent eligibility checks, which are expected to decrease the number of people on the Medicaid rolls. Another way the law aims to reduce spending is by limiting a handful of state Medicaid financing practices, including something called state directed payments.
Rob Lott:These are essentially a mechanism that allows states to steer funding toward specific providers or policy goals within Medicaid managed care. For example, a state might require Medicaid managed care plans to make higher payments to hospitals than they otherwise would have with the goal of strengthening access, to care or supporting financially stressed providers. Now, in addition to boosting provider pay, this has the effect of boosting the amount that states get from the federal government and Medicaid matching funds. That's led some to criticize state directed payments and may explain why Republicans sought as a potential target for savings to be achieved by imposing new limits on how states can use the practice. Now, it's pretty clear that when these limits take effect, they will lead to reductions in states overall Medicaid budgets.
Rob Lott:But for some time, the details have been less certain. To what extent will state budgets be constricted and which states will feel it most acutely? Those are some of the questions we'll be asking on the podcast today. I'm here with Deborah Lipson, who for two decades served as a senior fellow with the research organization Mathematica. Since leaving Mathematica, she's been engaged in independent research and health policy analysis, including the work underpinning a vital new article in the September issue of Health Affairs.
Rob Lott:Its title is one of its main findings. Quote, new Medicaid state directed payment limits are likely to decrease Medicaid spending 10% to 25% in 17 states. I cannot wait to learn more about this incredibly timely research. Deborah Lipson, welcome to A Health Podyssey.
Deborah Lipson:Thank you, Rob. I'm delighted to be here. Thanks so much for inviting me.
Rob Lott:Absolutely. And thank you for sort of bearing with what was a very kind of detailed and, in the weeds overview of how we got here. And I wanted to sort of make sure to kind of have that as our starting point. And I figured maybe we can go forward from there. Can you describe a little bit about sort of the initial purpose of state directed payment arrangements and sort of how one of these arrangements kind of works in practical terms?
Deborah Lipson:Sure. Sure. Let me try to make it somewhat simple. It's a little bit of a nerdy topic, but state directed payments were first introduced about ten years ago, 2016, when CMS did a comprehensive update to the federal Medicaid managed care regulations. STPs were introduced to allow state Medicaid agencies that enroll beneficiaries in Medicaid and managed care programs to require all the managed care plans that it contracts with to pay providers at specific rates or through certain methods.
Deborah Lipson:And these policies which became known as state directed payments were needed because federal law otherwise prohibits states from telling the managed care plans how much or in what manner to pay providers in their networks. So these STP arrangements, which are reviewed very carefully and approved by CMS, permit these requirements as long as the payment is tied to improved access or quality for Medicaid beneficiaries as you said in the beginning. So the mechanics of how SDPs work is a little complicated, but let me take a stab at trying to explain it simply. Let's take a uniform fee increase for hospitals as an example because that's one of the most common SDP arrangements. So let's say a state based on its analysis of managed care plan expenditures, a state Medicaid agency sees that the plans are paying a class of hospitals at rates that mirror or may even be less than Medicaid fee for service rates.
Rob Lott:Which is pretty low
Deborah Lipson:to Typically get lower than what it costs to serve Medicaid patients. So, the state designs an SDP that requires all the plans to pay a standard fee increase to that class of hospitals that bring total reimbursement above Medicaid fee for service, maybe up to the Medicare rate, or maybe even close to what private insurers pay those hospitals what is known as average commercial rate. But in exchange for the additional reimbursement, these hospitals have to give something back and in this case they have to serve let's say a minimum number of Medicaid patients or maybe even increase the number of patients they serve. And that helps to ensure availability of care equal to the general population, a principle that's really been enshrined in Medicaid law for over forty years. The state could also require the hospitals to demonstrate certain quality improvements like lower emergency room or hospital readmission rates or maybe fewer healthcare associated infections.
Deborah Lipson:The increased provider fees are then incorporated into managed care capitation rates or paid separately on top of the capitation rate. Then when managed care plans get bills from hospitals, they pay the hospitals at the higher rate and use the claims to verify that let's say those utilization targets are being met. You know utilization equals visits and you can make that all very clear. So the additional amounts paid to hospitals via the managed care plans count towards the state's Medicaid spending and as with everything else in Medicaid, state spending on STPs is matched by federal funds at the federal Medicaid match rate, which in turn is based on average state per capita income. That's at least 50% in higher income states and 70 to 75% of the cost is picked up by the feds in states like Mississippi, West Virginia, New Mexico, and Kentucky.
Deborah Lipson:So in the end, providers get higher payment and both state and federal Medicaid spending is increased.
Rob Lott:But you said these have been around about ten years and my understanding is that they've grown over that period. Do you have a sense of sort of to what extent that they have grown?
Deborah Lipson:Deborah Yeah, well, I've been studying this ever since they began in 2016. So I watched the growth. It's really been tremendous growth, both in terms of the number of state directed payments, as well as spending on these particular arrangements. The number grew from about 120 in 2018, once the implementation really became effective, to more than 300 in 2024 tripling really over that time. And really, there's really widespread.
Deborah Lipson:All 40 states that contract with managed care plans to deliver care to their Medicaid beneficiaries had at least one SDP by 2024, and many states have upwards of 20 STPs, each of which targets a variety of different providers using different payment methods. So it's very common, very widespread, but even more notable than the growth in numbers was the growth in total federal and state spending, which again tripled from about 27,000,000,000 in 2020 to nearly 98,000,000,000 billion with a B in federal fiscal year 2024 and that's an increase from four to 12% of total Medicaid spending federal and state over that period. It's the kind of rate of growth definitely gets the attention of federal budget officials, right? So you might wonder why did STPs become so widespread? Well the initial growth you know from 2017 to 2020 was driven by a couple of factors.
Deborah Lipson:First, before 2016 CMS didn't have the authority to approve these types of arrangements and they really didn't know how many there were out there. It turned out to be a lot more of these arrangements that states were directing managed care plans to say than they ever expected. The second reason was that another provision in the 2016 update to the federal managed care rules required states to phase out something called pass through payments. These are when fee for service supplemental payments to providers were carried over to managed care when the state switched, let's say from a fee for service to a managed care system something many, many states were doing at that time. And CMS actually encouraged states to use state directed payments as a vehicle to transition these supplemental payments to managed care.
Deborah Lipson:But then a different set of factors were going on since 2021. First, hospitals and other institutional providers realized the potential for these STPs to raise their payment rates, particularly those that pay a uniform fee increase like the kind that we were just talking about before. In fact, in some states providers actually lobbied their legislature to adopt these kinds of STPs which the legislature did through various means and then they kind of left the state Medicaid agency to work out the detail. But just as important, the states themselves realize the potential for STPs to achieve what they really couldn't do very easily before and that's hold the providers directly accountable for their use of Medicaid revenues. So instead of handing providers just a lump sum supplemental payment without any strings attached, states could make additional STP payments contingent on actual service use and improvements in quality and access metrics, a really big advance.
Rob Lott:Got it. So perhaps not how they were originally envisioned, but the folks out there on the front line sort of realized an opportunity there. And we saw that growth. Now that growth, as you said, kind of makes it a pretty ripe target. And as I mentioned in the introduction, HR one, the 2025 budget reconciliation bill attempted to sort of reform or apply limits to these STPs.
Rob Lott:Very briefly, can you say what the reconciliation bill does to STPs?
Deborah Lipson:Sure, sure. So the section of HR one that changed or that set these STP limits 71,116, if anybody wants to go read the actual text, says that starting July 2025, so a little over a year ago, total SDP provider reimbursement could not be greater than Medicare equivalent rates for specific provider types: hospital inpatient services, hospital outpatient services, nursing facility services, and health professionals at academic medical centers. But it kind of tweaked it a little bit. It said the Medicare equivalent rate is a 100% for states that expanded Medicaid to low income adults under the Affordable Care Act and 110% more for non expansion states. Now the Congressional Budget Office estimated that this change in policy would reduce federal Medicaid spending by $149,000,000,000 over the next ten years and that's about 15% of the total reduction in federal spending, the trillion dollars that you referred to in the introduction, due to all the Medicaid policy changes.
Deborah Lipson:So only the Medicaid work requirements and some other provider tax restrictions exceed the cuts of this magnitude for the STPs. It's a lot of money. But the HR1 did one more thing. It said, all right, this is a big change. We understand this is a big change.
Deborah Lipson:We'll provide another transition period or a phase down period for STPs that pay more than Medicaid rates if they qualify for something called temporary grandfather status. So, this basically allows states to continue making payments above the Medicare rates until January 2028 if that state directed payment arrangement meets certain criteria. That means the STP has to cover rating periods that included any days from about October 2024 through March 2026. So they did put an end date on that And then the state had to submit a completed STP application for CMS approval before 07/04/2025, the date HR1 was signed. After January 2028, states with these grandfathered STPs have to start reducing their STP spending gradually until they reach their applicable Medicare rate.
Deborah Lipson:So these reductions are going to occur gradually over time anywhere from five to ten years, depending on how much has to be reduced.
Rob Lott:Gotcha. Okay. Well, so let's dive into your paper here and the analysis you did, where you basically computed the average state level spending during fiscal years '24 and '25 for all state directed payments that paid more than Medicare rates. And then you compare that to the share of total FY '24 state Medicaid spending. And then you determine basically how much would have to be cut to comply with the law's new rules.
Rob Lott:So big picture, can you describe some of your top line findings from that work?
Deborah Lipson:Sure, I'd be happy to. First, total Medicaid spending in 39 states on STPs that pay providers at rates higher than Medicare averaged about $106,000,000,000 annually during the twenty twenty four-twenty twenty five rating periods. So that's essentially the baseline we're talking about. That's about 12.5% of total fiscal year twenty twenty four Medicaid spending in these states. But there was tremendous state variation from less than 1% of Medicaid spending in Maryland to a whopping 31% in Tennessee.
Deborah Lipson:That's a lot of money on these things. Now one caveat here which I have to introduce and make sure your listeners understand is this was based on STPs approved by CMS and posted on medicaid.gov by 05/31/2026. And several STPs that do pay above Medicare and so on and so forth were approved since then for that rating period. So the average spending that we just talked about 106,000,000,000 annually on average could be higher once all of those STPs come online again. So the second major finding was that when STP spending is limited just to 37 of those states that have the highest paying STPs, meaning those that pay providers at or near the average commercial rate, the total amount that has to be cut might be about $52,000,000,000.
Deborah Lipson:Yeah, whenever you're thinking about these numbers, that billion is just
Rob Lott:Hard to wrap up.
Deborah Lipson:Mind about Yeah, go roll with it here. When you're talking Medicaid, you're talking really big numbers. Anyway, 52,000,000,000 is about 6.4% of 2024 Medicaid spending in those states. But again, the state variation is really striking from less than 1% of 2024 Medicaid spending in about seven states to 38% in Nebraska and 32% in Louisiana. Again, huge numbers.
Deborah Lipson:So these are states that are spending a lot on STPs and those STPs are paying pretty damn close to the average commercial rate. So, the estimated reductions in state Medicaid budgets from this provision alone are 10 to 25% of total state Medicaid spending in 17 states. Again, that paid providers at or close to the average commercial rate. Now Rob, forgive me here, but I think these results might surprise some congressional members who voted for this without really understanding how it would affect their state and the people that they represent. I'd be curious to know what Senators Cassidy and Grassley from Iowa, for example, would think about these results.
Deborah Lipson:But let me just go on a little bit more a couple of other interesting findings or the insights that I obtained along the way here. Trying to understand the factors that drive the magnitude of these cuts. Why is it so you know such a huge variation in the percentage of state Medicaid budgets that have to be cut? Well, one is obvious. I mean prior state use of STPs for these four provider types, the paid above the Medicare benchmark, as well as how much above the Medicare benchmark they pay.
Deborah Lipson:But another factor that was a little more subtle driving the magnitude of the potential state Medicaid budget cuts required is the state's average commercial rate to Medicare ratio. Now in 2022, the most recent data that I had to use for this study, the ACR to Medicare ratio was about 2.5 to one nationally ranging from less than two to one in Mississippi to more than three to one in states like Florida and West Virginia.
Rob Lott:So we know commercial insurance pays a lot more than Medicaid and so in a state where it's 2.5 to one, basically for a service that maybe costs $100 to Medicare might cost $250 to the
Deborah Lipson:Exactly, commercial and that ratio varies across the states depending on what the average commercial rate is, how much private insurers are willing to pay hospitals or any of the other providers. So obviously states with higher ACR to Medicare ratios are higher risk of having to make larger cuts, right? The last thing I found which was a little surprising was that contrary to what policymakers who designed this provision might have intended, the Medicare equivalent rate which remember varies it's a 100% for Medicaid expansion rates and 110% for non Medicaid expansion rates has really very little effect on the magnitude of the budget cuts across the states. So for example, let's take Florida. Florida did not expand Medicaid, so its Medicare equivalent rate is 110%, right?
Deborah Lipson:So based on its previous spending on STPs that paid more than Medicare, Florida might have to cut an estimated $5,760,000,000 just in Florida on STP spending over the next several years, but it saves only about $244,000,000 just 4% of what it would otherwise have to cut if instead it had to go all the way down to 100% of Medicare. It's not may have thought they were doing something tricky here, but it's really not, you know, it's at the margin.
Rob Lott:Got it. Wow. Well, I want to sort of plug this research back into kind of that bigger picture statement you made, which is that maybe the lawmakers didn't quite realize how significant the cuts would be. How did we or how did Congress sort of miss that? Was CBO not kind of running these numbers?
Rob Lott:Or, it seems like you're sort of the first person to be doing this in a comprehensive and systematic way. I'm glad Health Affairs is able to be the platform to publish that work. But why did we have to wait for your paper to realize just how significant that gap was?
Deborah Lipson:Well, there's a couple of things going on here. First, CBO rarely looks at state by state effects of federal policy changes. So it wasn't really I mean they might have kind of tried to take a look at it just by rolling up a lot of the information at the state level, but they really didn't sort it out. The other thing is listen, I've been a Medicaid policy analyst for most of my career and I know we all know that Medicaid is different in every state. The classic line is what you see in one Medicaid program, you see in one Medicaid program, So my immediate thought was, Gee, how is this going to affect the states differently?
Deborah Lipson:And the data behind this may be publicly available. I only use publicly available data for this study, but it's really not easy to use and understand. And having studied STPs, I was able to go in and find the information that allowed me to do it.
Rob Lott:Got it. Well, what a really important set of findings and perhaps the foundation for some important conversations to come over the next year or so. Deborah Lipson, thank you so much for doing this research and for joining us here on A Health Podyssey.
Deborah Lipson:Thanks so much, Rob. It was great to be here.
Rob Lott:To our listeners, thanks for tuning in. If you enjoyed this episode, check out the paper in the September issue of Health Affairs. If you enjoy listening to A Health Podyssey, please subscribe, recommend it to a friend, leave a review, and of course, tune in next week. Thanks, everyone.