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  • Writer's pictureLaurie Vanhoose

Hot Topic: Medicaid Managed Care In-Lieu of Services

Updated: Oct 25, 2023


Medicaid Managed Care In-Lieu Services


In-lieu of Medicaid managed care services have become a hot topic since the option was federally codified in 2016. Several states have received CMS approval to use the in-lieu of service option, including Texas. The most recent news includes a new State Medicaid Director’s (SMD) letter released by CMS on January 4, 2023, which outlines additional guidance to states on the approval process for the use of in-lieu of services (ILOSs) and on-going monitoring and reporting requirements.


The CMS SMD letter does not create a new pathway for states to use ILOSs. In short, the letter outlines how states must document compliance with federal regulations for initial and ongoing CMS approval of ILOSs and establishes the methodology for showing cost-effectiveness. While the documentation requirements are extensive and prescriptive, CMS requires extensive documentation for states to receive federal approval for federal matching funds under other types of federal authorities (state plans, waivers, etc.). The guidance is clear that ILOSs are not merely a flexibility that can simply be put in a managed care contract to allow coverage of additional services, but that states must initially and annually demonstrate compliance with the federal requirements.


Below is additional background information and a summary of the new guidance from CMS to get you up to speed.


What are the Medicaid Managed Care In-Lieu of Services?


Medicaid managed care ILOSs were federally codified in 2016 and are services that Medicaid managed care organizations (MCOs) can offer in-lieu of an existing covered benefit – see 42 CFR § 438.3(e)(2). An ILOS is used to substitute one service for another more cost effective and appropriate service. For example: offering home delivered meals to help an individual remain at home in-lieu of a nursing facility stay; providing a prenatal home visit in place of an office visit for a high-risk pregnancy; or offering intensive outpatient services in lieu of hospitalization.

Federal regulations outline 4 requirements for the use of ILOSs:

  1. States must determine that the each ILOS is a medically appropriate and cost-effective substitute for covered services or settings under the state plan;

  2. Enrollees cannot be required to use the ILOSs;

  3. Approved ILOSs must be authorized and identified in the managed care plan contract and must be offered to enrollees at the option of the managed care plan; and

  4. The utilization and actual cost of each ILOS is considered in developing the component of the capitation rates that represents the covered state plan services, unless a federal statute or regulation explicitly requires otherwise.

The Episcopal Health Foundation and the Center for Health Care Strategies (CHCS) published a report on December 1, 2022 that provides additional background and summarizes evidence and implementation options for ILOSs in Texas (read the report here).


Texas Use of In-Lieu of Services for Behavioral Health Services:

In 2019 the Texas Legislature passed SB 1177 directing HHSC to implement contract provisions to permit Medicaid MCOs to offer medically appropriate, cost-effective, and evidence-based behavioral health services in lieu of specified Medicaid state plan services.

HHSC divided implementation of the recommended services into three phases.


1. Phase-one services include services in lieu of inpatient hospitalization. Recommended services include:

  • Coordinated specialty care (CSC)

  • Crisis respite

  • Crisis stabilization units

  • Extended observation units

  • Partial hospitalization

  • Intensive outpatient program (IOP) services.

2. Phase-two services include services in lieu of outpatient services.


3. Phase-three services include ILOSs which apply only to specific populations, need further review to determine the appropriate corresponding state plan service, or contain components that are already covered by Medicaid.


HHSC has received CMS approval for 3 new ILOSs for Phase 1 (services in-lieu of inpatient hospitalization) and MCOs that choose to offer these services are in the process of implementing. Services include:

  • Partial Hospitalization

  • Intensive Outpatient

  • Coordinated Specialty Care (CSC) services.

MCOs must submit an operational plan to HHSC for approval 60 days in advance of the MCOs intended implementation date of the services and are in the process of developing and submitting. The Uniformed Managed Care Manual (UMCM 16.3) includes more information on the requirements for MCOs that choose to offer these services and HHSC’s annual report on ILOSs was published November 2022 and can be found here.


Note that CMS approval for the 3 ILOSs took time and at this point HHSC is still negotiating approval of the additional Phase 1 services (crisis respite, crisis stabilization units and extended observation units) with CMS.


Summary of CMS January 4th Guidance:


On January 4, 2023, CMS released a State Medicaid Director (SMD) letter outlining parameters and principles associated with state adoption of ILOSs and states: CMS believes states and managed care plans can use ILOSs to improve access to health care and help address many of the unmet physical, behavioral, developmental, long-term care, and other Health Related Social Needs of Medicaid enrollees.


The guidelines also include very specific requirements related to CMS approval of ILOSs and ongoing monitoring and reporting requirements (outlined below).


1. ILOSs must advance the objectives of the Medicaid program.

  • ILOSs must not violate any applicable federal requirements.

  • ILOSs must be approvable through a state plan amendment.

2. ILOSs must be cost effective.


To level set, it is important to point out that annually (and when the state wants to make a change during the year) CMS must approve the state’s Medicaid managed care contracts and managed care capitation rates. There are very arduous requirements associated with federal approval of managed care rates – every aspect of managed care costs is scrutinized by CMS actuaries to ensure actuarial soundness, access to care, expenses are allowable, and compliance with federal regulations before being certified and approved. CMS has included requirements for ILOSs associated with these reviews in the SMD letter and outlined below.

As part of the managed care contract submission to CMS, states must also submit documentation regarding each ILOSs cost effectiveness. The specificity of the documentation a state must submit is based on the state’s ILOS Cost Percentage for each managed care program.


A State’s ILOS Cost Percentage = Total managed care capitation payment attributable to ALL ILOSs by managed care program divided by the total costs for the managed care program (must include all capitation payments, state directed payments and pass-through payments).


States must annually submit a projected ILOS Cost Percentage and retrospectively a final ILOS Cost Percentage to CMS. If the cost percentage for all ILOSs is greater than 1.5%, states must submit to CMS a description of their process for determining that each ILOS is cost effective. A state’s ILOS Cost Percentage must not exceed 5%.


The final ILOS Cost Percentage report must include the actual MCO costs for ILOSs to ensure transparency and to help with prospective rate development and be submitted to CMS no later than 2 years after the completion of the contract year that includes the ILOSs.

CMS will review projected ILOS Cost Percentage as a component of the annual managed care rates certification and approval process which will result in state actuaries annually estimating, documenting and certifying the ILOS Cost Percentage. CMS outlines very specific requirements for the annual submission:

  • Brief description of each ILOS.

  • Projected ILOS Cost Percentage and document the impact of ILOSs on rates based on materiality:

1. For those that are expected to have a material impact on the rates, include description of data, assumptions, and methodologies used to develop impact


2. For those that expected to have a non-material impact on rates, provide a description of why.


3. ILOSs must be medically appropriate.

This section of the SMD letter outlines what states must submit to CMS when submitting their managed care contracts for review and approval. Elements include:

  1. The name and definition of each ILOS and the covered Medicaid state plan services or settings which they substitute. The state must also include the specific Healthcare Common Procedure Coding System (HCPCS) or Current Procedural Terminology (CPT®) codes that identify each ILOS.

  2. The clinically oriented definitions for the target population(s) for which the state has determined each ILOS to be a medically appropriate and cost-effective substitute.

  3. A contractual requirement for the MCOs to utilize a consistent process to ensure that a provider documents that the ILOS is medically appropriate, and that documentation is kept in the client’s medical record or MCO care plan. If the projected ILOS Cost Percentage is greater than 1.5% states must provide a description of their processes to determine each ILOS is medically appropriate for the target population.

4. ILOSs must be provided in a manner that preserves enrollee rights and protections.

  • Per federal regulations, managed care plans are strictly prohibited from requiring or mandating a member utilizes an ILOS.

  • Managed care plans are not permitted to deny an enrollee a medically appropriate Medicaid covered state plan service or setting on the basis that an enrollee has been offered an ILOS, is currently receiving an ILOS, or has received an ILOS in the past.

  • States that elect to include ILOSs in their managed care plan contracts must ensure that each plan’s enrollee handbook clearly explains the rights and protections.

  • Medicaid grievance, appeal, and state fair hearing provisions apply to ILOSs.

5. ILOSs must be subject to appropriate monitoring and oversight.

  • States must perform ongoing and robust monitoring and oversight activities including evaluating compliance with federal requirements; using appropriate quantitative and qualitative measures, at least annually; and ensuring that managed care plans submit timely, complete, accurate, and validated encounter data for ILOSs.

  • States must submit the following to CMS:

1. Actuarial analysis as outlined under cost-effectiveness guidance outline above.


2. Written notification within 30 days of determining that an ILOS is no longer a medically appropriate or cost-effective substitute. CMS also reserves the right to rescind its approval or require corrective action to address deficiencies for any ILOS if it is no longer medically appropriate, or cost effective, or if there are other issues of non-compliance. If rescinded or the state stops offering the ILOS, the state must submit a transition plan to CMS for approval.


3. An attestation to audit encounter, grievances, appeals, and state fair hearing data to ensure accuracy, completeness, and timeliness. Encounter data, when possible, must include data necessary for the state to stratify the ILOSs utilization by sex, race, ethnicity, disability status, and language spoken.


4. Documentation necessary for CMS to understand how the utilization and cost of an ILOS, as well as any savings resulting from the use of an ILOS, were considered in the development of actuarially sound capitation rates.


6. ILOSs must be subject to retrospective evaluation when the final ILOS Cost Percentage is greater than 1.5 percent.

  • Retrospective evaluations must be submitted to CMS no later than 24 months after the completion of the first five contract years that include ILOSs.

  • If the retrospective evaluation shows that a ILOS is not a cost effective, medically appropriate substitutes for state plan-covered services or settings, or identifies other substantive issues, CMS may determine whether to permit the state to take corrective action to remedy the deficiency or terminate the ILOS.

  • If CMS determines that it is appropriate, the state may be required to conduct a second evaluation using an additional five years of complete, accurate, and validated data.

  • At a minimum, each evaluation should include the following:

  1. Impact each ILOS had on utilization of state plan-covered services or settings, including the associated cost savings, trends in managed care plan and enrollee use of each ILOS, and impact of each ILOS on quality of care;

  2. Assessment of whether encounter data supports the state’s determination that each ILOS is a medically appropriate and cost-effective substitute for identified covered services and settings under the state plan;

  3. The final ILOS Cost Percentage for each year;

  4. Appeals, grievances, and state fair hearings data, reported separately and for each ILOS, including volume, reason, resolution status, and trends; and

  5. The impact each ILOS had on health equity initiatives and efforts undertaken by the state to mitigate health disparities.








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