Hospitals prepare for $149B cut to Medicaid state-directed payments

Hospitals are putting major expansion projects on hold and bracing for service cuts as new limits on Medicaid state-directed payments threaten to squeeze already tight finances. 

Making matters worse, many hospitals will see their revenue and margins decline as millions of Americans lose health coverage and uncompensated care costs rise under the recently enacted budget reconciliation package, dubbed the One Big Beautiful Bill.

The law restricts new Medicaid state-directed payments, financial arrangements allowing states to make supplemental payments to healthcare providers for services covered under managed care contracts. It caps such payments at 100% of Medicare rates in Medicaid expansion states and 110% in non-expansion states, while gradually cutting existing payments above those levels starting in 2028. 

The changes will slash federal Medicaid spending by $149 billion over 10 years, according to health policy research firm KFF.

State-directed payments enable states to mandate that Medicaid managed care plans compensate providers at specific rates, which have been benchmarked against commercial insurance rates that can be double or triple what Medicare pays. The payments have become a critical revenue source, totaling more than $100 billion in annual Medicaid spending nationwide.

As state-directed payments are cut, hospitals will also have to contend with a rise in the uninsured population, which is expected to increase by 10 million under the legislation and add $433 billion to hospitals’ uncompensated care costs from 2025 to 2034.

Safety-net hospitals will be especially vulnerable because they treat large numbers of Medicaid and uninsured patients.

“Our member hospitals are really going to be in double jeopardy over the next few years,” said Beth Feldpush, senior vice president of advocacy and policy at America’s Essential Hospitals, which represents more than 350 safety-net providers. “Their uncompensated care costs are going to rise because people are still going to come to them for treatment, and once they’re uncovered, a lot of those costs are just going to end up as uncompensated care costs for our hospitals.”

The bigger picture

The state-directed payment cuts, which are the third-largest source of federal Medicaid savings in the reconciliation package, come as congressional watchdogs raise concerns about the rapid growth and transparency of state-directed payments. 

The Medicaid and CHIP Payment and Access Commission, which advises Congress on Medicaid payment policy, has called for better oversight, noting that “it’s not clear the extent to which state directed payments have made meaningful improvements in access” to care. 

MACPAC has also raised concerns about states using creative financing schemes that could inflate federal Medicaid funding without states having to invest their own resources.

Hospitals say state-directed payments are an important source of funding, especially for providers in rural and underserved communities with a large share of Medicaid patients, because the program typically reimburses significantly less than Medicare or commercial insurance. 

Providers or facilities that care for a lot of Medicaid patients rely on a patchwork of funding streams, including state-directed and disproportionate share hospital payments, to shore up their balance sheets, hospitals say.

“Beyond just supporting day-to-day operations, these programs have been truly transformative in communities across the country,” Feldpush said. “Those are the communities that are on the edge for healthcare access as it is — in these small towns or rural counties, they are really at risk of losing healthcare in those areas if this all moves forward.”

Limited state options

States can try to replace the lost federal funding, but many are constrained by their budgets. Although the new limits on state-directed payments will cut 14% of total federal Medicaid spending over 10 years, some states, such as Louisiana, Illinois, Nevada and Oregon, face spending reductions of 19% or more.

Many financing arrangements exist because states don’t have enough general funds to support their Medicaid programs fully.

“It’s going to be incredibly challenging for states to backfill that funding because states typically aren’t sitting around with a lot of cash available to them,” Feldpush said.

States will likely need to make tough choices, including cutting provider payment rates, eliminating optional benefits or limiting Medicaid eligibility, according to Avi Herring, managing director at Manatt Health.