Strengthened Tool to Address Health-Related Social Needs: The New Medicaid Managed Care Regulation’s “In Lieu of Services” Explained

Medicaid managed care plans have long covered “In Lieu of Services” (ILOS), which are services that are provided in substitution of traditional Medicaid state plan services. For example, a managed care plan might provide a community-based depression screening in lieu of an office visit screening. In 2016, CMS first defined the contours of ILOS in regulations. In the final managed care regulation promulgated last month (“Managed Care Rule”), CMS has updated the definition and oversight of ILOS in important ways that should both increase flexibility to use ILOS as a tool for improving health and increase the integrity of ILOS spending. (You can view all of our blogs about the Managed Care Rule and companion Access Rule here.)

ILOS Background

Let’s start by remembering why ILOS are so important. A basic premise of Medicaid managed care is that capitated managed care plans will have an incentive to make efficient, innovative health services investments beyond the traditional state plan services. However, the long-standing mechanism to cover such “value-added services,” raises incentive problems. Those “extra” services do not get counted in the rate-setting for plan capitation. Furthermore, when successful, the extra services may actually reduce future plan rates because they reduce the need for future services. And on top of that, the extra services also may count as “administrative” spending instead of “services” for medical loss ratio (MLR) purposes, which makes the plan look inefficient. Long-story short, there are major disincentives for plans to provide value-added services that go beyond the traditional Medicaid state plan services.

ILOS help solve this problem because they are substituting for Medicaid state plan services, and thus CMS has historically allowed them to count for rate-setting and on the services side of the MLR ledger (and the new rule codifies this for ILOS). This means that if a service can be covered as an ILOS (instead of as a value-added service), there is a stronger incentive for the managed care plan to provide the service—and thus the services are much more likely to materialize. ILOS have become a particularly important tool for states in recent years, as the states think about how to creatively expand access to services that address health-related social needs (HRSN) but are not traditional state plan services. ILOS can be a vehicle for covering those services and making sure rates are inclusive of their costs—so they are actually provided in practice.

Expanded Definition of ILOS

The first and most critical thing the new Managed Care Rule does is expand the definition of ILOS services. The current regulatory definition sensibly requires them to be “medically appropriate and cost effective,” but also tends to limit ILOS to services that are an exact and immediate substitute for a state plan service (such as my community screening in place of office screening example above). The new definition will explicitly include services that are “an immediate or longer-term substitute for a covered service or setting” or that “can be expected to reduce or prevent the future need to utilize the covered service or setting.” As an example, CMS in the preamble to the rule suggests that a state might cover medically tailored meals for individuals with diabetes based on the potential reduction of emergency room visits and inpatient hospital stays.

By considering longer-term substitution and future needs, the new definition opens the door to states creatively using ILOS to do strategic prevention and address unmet HRSN. It is important to note that while the definition is new in regulation, CMS has already been gravitating toward it in practice over the past few years, approving ILOS that make investments in HRSNs in several states (such as in California). The new definition, along with the protections for individuals described in the next section, officially goes into effect on July 9, 2024 (the Managed Care Rule’s effective date).

Protections for Individuals Using ILOS

A second and important thing the Managed Care Rule does is codify many protections that CMS has built into ILOS policy guidance in recent years. These include requirements that: (1) individuals accessing ILOS have all rights and protections that apply to traditional Medicaid managed care services (including appeals rights); (2) individuals retain the right to receive state plan services, regardless of being offered, using, or previously using ILOS; (3) ILOS may not be used to discourage access to state plan services; (4) plans must describe these protections in enrollee handbooks; and (5) states must include these requirements in plan contracts. These protections will help ensure that the addition of substitute ILOS service options does not result in reduced access to the traditional Medicaid covered services.

However, CMS will also need to make certain that payment policy ensures that managed care is actually and sufficiently funded to provide both the substitute and traditional services; particularly if CMS expects ILOS to sometimes represent “longer term” investments in health. CMS will also need to ensure there is sufficient information for providers and people enrolled in Medicaid to know about the ILOS options that are available. Finally, CMS’s rule does build in some protections, including public transitions of care policies, for individuals enrolled in Medicaid that apply when an ILOS option is discontinued by the state or managed care plan.

Oversight of ILOS Use and Spending

The third major thing the Managed Care Rule does is increase oversight of ILOS. Oversight of ILOS can be challenging. Consider, for example, a state offering an ILOS that is an innovative new preventive service. By definition, this will often not be a service with a long and predictable track record in health care. It may be hard to predict how often the service will be utilized or how much it will cost over time. Since capitation rates are actuarial estimates of use and spending, it will be hard to accurately fund managed care to account for some such ILOS. In addition, of course, some ILOS may end up being more effective at improving health than others. In order to ensure the ILOS spending is appropriate, efficient, and provides value for Medicaid, the Managed Care Rule establishes several new policies for oversight over ILOS use and spending. The provisions described in this section go into effect for rating periods beginning on or after September 9, 2024.

The regulation requires states to document the content and basis for ILOS they are providing, including: the name and definition of the ILOS, what service is being substituted, documentation of medical appropriateness and cost effectiveness of the ILOS, and the clinically defined target population for the ILOS. State contracts must also require plans to use specific codes to identify ILOS in encounter data, so that the services are easier to track and monitor.

States will also be required to submit at least three distinct annual ILOS reports: (1) projected ILOS capitation as a percentage of total capitation (for the coming year); (2) a final report on actual ILOS capitation paid as a percentage of total capitation paid; and (3) a summary report of actual ILOS spending based on claims and encounter data from managed care plans. States will have increased documentation requirements if their projected ILOS capitation exceeds 1.5% of total capitation, and an additional retrospective evaluation report to file if their final cost percentage exceeds 1.5% of total capitation. Finally, the rule also sets an outer limit for ILOS funding, with 5% of capitation being the maximum allowable amount for either the projected or final cost percentage. This combination of oversight requirements should help ensure that CMS is able to track what is being paid for and how much is being paid, with the 5% guardrail in place to ensure ILOS spending won’t get wildly ahead of oversight.

The rule also includes requirements for states to adjust ILOS rates when ILOS are terminated (a new requirement) or actual payment deviates too far from the predicted rates (clarifying current policy), and new processes related to the termination of ILOS options, including transition plan requirements.

One piece of disappointing news here is that while CMS has developed strong new policies for oversight, the regulation does not include similarly broad requirements for public transparency of all the ILOS oversight information that will be collected. Instead, CMS suggests that the existing public availability of managed care contracts and T-MSIS data can satisfy the public’s interest in some of the oversight data. But other key information, such as the annual reporting of actual ILOS spending, will simply be unavailable for now. (CMS did say it “will take this into consideration in the future.”)


The new Managed Care Rule’s provisions on ILOS are confirming the arrival of a new era in Medicaid. State Medicaid programs and their managed care plans now have clear authority to expand the services covered in managed care, including most notably services that target HRSNs. Considering that upwards of 80% of individuals in Medicaid are enrolled in managed care, this is a significant development. At the same time, CMS has worked carefully to implement oversight policies that should help protect Medicaid program integrity as the broadened definition of ILOS leads to new kinds of services and spending. We hope CMS will soon take action to address the last missing pieces on public transparency of ILOS spending.

[This is part of a blog series on two key federal regulations that aim to improve access to care for people enrolled in Medicaid and CHIP across delivery systems. Learn more about the “Ensuring Access to Medicaid Services” and “Medicaid, CHIP Managed Care Access, Finance, and Quality” rules here.]

Leonardo Cuello is a Research Professor at the Georgetown University McCourt School of Public Policy’s Center for Children and Families.