New Federal Guidance on In Lieu of Services

Health Highlights

The Big Picture

On January 4, the Centers for Medicare & Medicaid Services (CMS) issued a new State Medicaid Director (SMD) letter on how states can make expanded use of ILOS authority, including to address social drivers of health. ILOS authority, which was formally established by regulation in 2016,1 allows states to authorize Medicaid managed care plans to pay for alternative services instead of standard Medicaid benefits without the need for waiver approval, when it is medically appropriate and cost-effective to do so. States already use ILOS to cover a wide range of services not included in their State Plans. For example, a state might allow chiropractic treatment in lieu of physiotherapy. As discussed below, in December 2021, California was permitted under ILOS authority to provide a range of health-related services to address social drivers of health.

The new CMS guidance is significant in two ways: 1) It opens the door to states wishing to comprehensively address social drivers of health using managed care authority, without the need for a waiver; and 2) it places significant new guardrails and requirements on most ILOS that states can offer, including ILOS already approved by CMS. The guidance is effective immediately for new ILOS. For ILOS that have already been approved by CMS via managed care contract review, the guidance is effective as of January 1, 2024.

Opening the Door to Addressing Health Related Social Needs via ILOS as an Alternative to a Section 1115 Waiver

In recent years, states have increasingly sought to use Medicaid to address social drivers of health—factors like unhealthy living environments or lack of nutritious food that are outside of traditional health care but are among the largest contributors to health outcomes. States have most commonly used state plan, home- and community-based services (HCBS), and/or Section 1115 waiver authority to offer nonmedical services in Medicaid to address these needs, and CMS recently laid out a “federal framework” for how such services (now known at CMS as “Health Related Social Needs,” or HRSNs) can be authorized and financed through 1115 waivers. Under this new framework, states are provided with a clear opportunity to cover nutrition and housing supports (with specific examples given), as well as supporting case management, but must stay within certain constraints, including keeping total HRSN expenditure below 3 percent of annual total Medicaid spend.

The SMD letter provides further guidance on ILOS authority as an alternative pathway to many, but not all, of the same services that are available under Section 1115 waivers. Starting in 2022, California was the first state to use ILOS authority, rather than waiver authority, at scale to address social drivers of health, allowing a holistic approach to care for people with complex health and social needs through Medicaid Managed Care. However, a handful of states had previously used ILOS to offer HCBS, housing, or nutrition services on a more limited scale. The new guidance codifies the more flexible view of ILOS authority CMS approved for California. Following the example CMS set in California, the guidance clarifies that ILOS services can be preventive in nature and do not need to be immediate substitutes to standard Medicaid benefits as long as they advance the objectives of the Medicaid program and are approvable in Medicaid. For example, housing supports can be considered “in lieu of” emergency medical care because the evidence shows that they can prevent the need for it.2 As such, a wide range of services can be offered as ILOS, including, using examples from California, nutritious meals, asthma remediation, and supports to allow people to remain in or return to their communities, including housing deposits, sobering centers, housing navigation and tenancy support services, day habilitation, caregiver respite, home modifications, and personal care and homemaker services. Services relating to room and board cannot be authorized under ILOS regulatory authority and would need to be pursued through a Section 1115 waiver.

The ILOS pathway offers a stable funding source for allowable services, as costs are accounted for in managed care rates. Further, ILOS affords states the opportunity to incorporate community-based organizations and nontraditional service providers with experience providing social services into their managed care network, ideally working side by side with traditional health care providers. Regulatory authority for offering HRSN services avoids the need for resource-consuming waiver submissions and reviews.

New Guardrails and Requirements for New and Existing ILOS

Anticipating the expanded use of ILOS, the guidance establishes new financial guardrails and reporting requirements, reminds states of the medical appropriateness and cost effectiveness standards in regulations, and outlines enrollee protections and other requirements that are applicable to all ILOS except those aimed at covering stays in Institutions for Mental Diseases (IMDs), which have their own pre-existing limitations in federal law and regulations.3 These newly formalized guardrails will apply whether or not ILOS are related to social drivers of health and will apply both to new ILOS and, as of the contract rating period beginning January 2024, ILOS already in place.

Financial Guardrails

Most notably, the guidance requires state actuaries to establish and annually certify the projected costs of ILOS relative to total managed care capitation and provide information on the expected “materiality” of ILOS on managed care rates as part of annual rate certification submissions to CMS. The guidance indicates that CMS may not approve ILOS that are expected to have costs of more than 5 percent of managed care capitation in any given managed care delivery system (if, for example, a state has a separate managed care delivery system for behavioral health, CMS will look at ILOS allowed in each delivery system).4 States must also take a retrospective look at their actual ILOS costs once the services have been delivered and provide a separate actuarial report for each delivery system on those costs and cost ratios within two years following the end of the contract year that included ILOS.

The guidance reiterates that ILOS must be cost-effective (as required by the 2016 federal regulations) but remains high-level on how CMS will define cost-effectiveness. States appear to have significant flexibility when determining how to measure and demonstrate cost-effectiveness of a proposed ILOS, but such demonstration must be included in managed care contract submissions to CMS for CMS review and approval. Significantly, there are no requirements for individual determinations of cost-effectiveness or likely cost-effectiveness for each enrollee receiving ILOS, allowing states to authorize ILOS that are cost-effective in the aggregate.

Medical Appropriateness

Also, in line with the existing federal regulations, the guidance notes that ILOS must be medically appropriate substitutes for state plan-covered services or settings, and CMS will also review state determinations of medical appropriateness as part of managed care contract review. Specifically, the guidance requires states to specify for each ILOS the name, definition, state plan service/setting being substituted, and coding for claims/encounter data. Importantly, states must have “clinically oriented” eligibility definitions for ILOS and must require managed care plans to ensure that a provider (at the plan or contracted network provider level) has determined and documented that the ILOS is medically appropriate for each enrollee receiving the service, for example, documenting this through an enrollee’s care plan or medical record.

Further, for states with ILOS exceeding 1.5 percent of capitation, CMS requires additional information supporting medical appropriateness, such as literature on the impact of the services, program evaluations, or analyses of state administrative data.

Enrollee Protections

CMS emphasizes existing regulatory protections for enrollees and clarifies that existing rights and protections for Medicaid managed care enrollees apply to enrollees receiving ILOS, including rights to file appeals and grievances, to fair hearings, and to receive information on available treatment options and alternatives. Further, the guidance is clear that states and/or managed care plans may not require an enrollee to utilize ILOS or reduce, discourage, or jeopardize enrollee access to state plan services or settings irrespective of if an enrollee opts to receive ILOS.

Monitoring and Evaluation

States must monitor that ILOS “remain medically appropriate and cost effective” once implemented, including by ensuring that managed care plans submit timely and accurate encounter data for ILOS and audit encounter data. The guidance outlines processes for a state to notify CMS if an ILOS is determined to no longer be medically appropriate or cost-effective; notes that in this case, CMS may opt to terminate an ILOS; and lays out requirements to ensure transition of care policies that would minimize disruption for enrollees receiving ILOS.

Formal retrospective evaluations of ILOS are required only for states with ILOS costs exceeding 1.5 percent of capitation. Requirements for evaluations are described only at a high level but include evaluating the impact of each ILOS on state plan service utilization, quality of care, medical appropriateness, costs and cost-effectiveness, appeals/grievances and state hearings, and impact of each ILOS on health equity. Again, CMS reserves the right to require modification or termination of an ILOS that is found not to be cost-effective and medically appropriate, with appropriate transitions of care policies. The guidance does not anticipate any disallowance for an ILOS that, after approval and implementation, turns out not to be cost-effective, and in fact, states that in this circumstance, CMS may require the state to conduct a second evaluation spanning a further five years of experience.

Looking Ahead

Through its clarification of ILOS authority and the opportunity it brings to states to allow managed care plans to offer medically appropriate services that can improve health and, in the aggregate, avoid more costly services, CMS is expanding the arsenal of tools available to states to address social needs that can markedly affect health. While not addressing key questions states may have—for example, how cost-effectiveness is calculated for preventive services where savings may accrue over multiple years—it provides important new information for states, managed care plans, and stakeholders on ways to finance an important array of services. Notably, while not mentioned in the guidance, it appears that CMS is planning a forthcoming regulation on ILOS; the Fall 2022 HHS Regulatory Agenda indicated that a proposed rule would be forthcoming in spring of 2023 related to ILOS.

1 42 CFR § 438.3(e)(2).


3 Medicaid and CHIP Managed Care Final Rule (CMS-2309-F) Frequently Asked Questions (FAQs) – Section 438.6(e))

4 Any IMD ILOS will not count toward the 5 percent; however, any supplemental payments, directed payments, or pass-throughs for the applicable delivery system will count toward the 5 percent.



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