On February 2, 2026, the Centers for Medicare & Medicaid Services (CMS) issued new guidance implementing section 71116 of H.R. 1 (the “One Big Beautiful Bill Act” or P.L. 119-21), which restricts state-directed payments (SDPs) to hospitals and other health care providers. Under SDPs, states may require Medicaid managed care plans to increase provider rates or set minimum rates for a provider type. These provider rate increases are intended to improve patient access and increase provider participation in Medicaid. To enhance access in four key service areas — inpatient hospital services, outpatient hospital services, nursing facility services, and qualified practitioner services at an academic medical center — a CMS rule finalized in May 2024 permitted states to set SDPs for such services up to the Average Commercial Rate.
Section 71116 required the Secretary of Health and Human Services to revise the rule to prohibit — for any “rating period” beginning on or after the date of enactment — expansion states from instituting new SDPs that exceed Medicare rates and non-expansion states from instituting new SDPs that exceed 110 percent of Medicare rates. Certain SDPs are temporarily grandfathered. These include existing SDPs, as well as new SDPs, in all states that go as high as the Average Commercial Rate and that apply to rating periods occurring within 180 days before and after enactment (1) for which states received federal written approval or made a good faith effort to obtain such approval prior to May 1, 2025, (2) for rural hospitals for which states received written approval or made a good faith effort to obtain such approval prior to the date of enactment, or (3) for which states applied for federal approval through a completed “preprint” submission prior to enactment. Starting with rating periods that begin on or after January 1, 2028, grandfathered SDPs in all states are phased down by 10 percentage points each year until they comply with the applicable SDP Medicare-based limits.
Barring future SDPs that exceed the Medicare rate and annually reducing existing or new SDPs that are grandfathered beginning in 2028 means lower Medicaid reimbursement rates to hospitals and other providers over time, which will likely reduce provider participation in Medicaid, restrict patient access to needed care, and worsen the financial stability of providers that already suffer from thin or negative operating margins. The CBO estimates that this provision will cut federal Medicaid spending by $149.4 billion over ten years.
The CMS guidance includes some information about how CMS will implement these SDP restrictions in H.R. 1:
- Intending to propose a forthcoming rule that may go beyond H.R. 1 requirements and further restrict SDPs. CMS is required to revise existing regulations (located at 42 C.F.R. 438.6(c)(2)(iii)) in order to comport with the requirements of section 71116. This will include how the phasedown in grandfathered SDP payments will be implemented. However, in the guidance, CMS indicates that it will not only issue a proposed rule to do so but also that this proposed rule could restrict SDPs for other services outside of inpatient hospital services, outpatient hospital services, nursing facility services, and qualified practitioner services at an academic medical center. CMS does not specify what services could be subject to new SDP limits, what the SDP limits for other services could be, or what grandfathering provisions (if any) could be available for existing SDPs for those services if they currently exceed any new proposed SDP limits.
- Defining what existing or new SDPs are eligible to be grandfathered and can exceed the Medicare-based caps. For determining whether grandfathered SDPs had rating periods within 180 days of the date of enactment, CMS will use business days. That is, SDPs (whether existing or are new but had pending applications) that had rating periods occurring no more than 180 business days before enactment (October 11, 2024 through July 3, 2025) and 180 business days after enactment (July 7, 2025 through May 27, 2026) are eligible to be grandfathered. For determining whether a new SDP can be grandfathered because there had either been a good faith effort to obtain approval or submission of a completed preprint application, CMS views the two as equivalent: a completed preprint application with all relevant backup tables submitted before enactment (July 4, 2025) is the only way a state can demonstrate it had made a good faith effort so that the SDP is eligible for grandfathering. If an existing or new SDP is grandfathered, the total payment amount under the SDP (as specified in the most recent preprint application) cannot be increased but can be decreased at any time. If a grandfathered existing or new SDP has two rating periods that fit within the 180 business-day eligibility window, the rating period version of the SDP with the highest total dollar amount can be grandfathered. Finally, the guidance reiterates that any existing or new grandfathered SDP may not include payments that exceed the Average Commercial Rate.
- Providing preliminary grandfathering to approved SDPs but not to those with pending applications. CMS states that if it had approved a SDP for one of the four services — inpatient hospital services, outpatient hospital services, nursing facility services, and qualified practitioner services at an academic medical center — before issuance of the guidance on February 2, 2026 and the SDP otherwise meets the grandfathering criteria of section 71116, those SDPs are “preliminarily grandfathered.” But for new SDPs with submitted preprint applications that have not yet been approved and are still under review, they will not be automatically grandfathered. Instead, CMS will provide “preliminary feedback in our adjudication letters on whether that preprint is likely eligible for the grandfathering period.” CMS also reserves the right to change a SDP’s grandfathered status if “further information is identified that revises the initial assessment or as a result of regulatory changes.” Presumably, such regulatory changes could include policy changes in the forthcoming proposed rule (if finalized) that add to section 71116 SDP restrictions or that differ from this guidance.