how was the landscape before SDP was introduced?

Before State Directed Payments (SDPs) were formally established in 2016, the system states used to funnel extra money to healthcare providers was much looser, highly opaque, and largely detached from the actual care patients received.

To understand the landscape before 2016, you have to look at how states handled the massive transition from traditional Medicaid to Managed Care.

The Era of "Pass-Through" Payments

Historically, Medicaid was a Fee-For-Service (FFS) program. The state paid doctors and hospitals directly for each service. If a state knew its base payment rates were too low to keep a critical safety-net hospital open, the state could simply send that hospital a lump-sum "supplemental payment" at the end of the year using federal and state funds.

However, beginning in the 1990s and accelerating into the 2010s, states moved the vast majority of their Medicaid populations into private Managed Care Organizations (MCOs).

When a state outsourced its Medicaid program to an MCO, it lost the legal ability to pay doctors and hospitals directly. But the underlying problem remained: the MCO base rates were still too low to keep vital hospitals afloat.

To solve this, states invented "Pass-Through Payments." A state would take a massive lump sum of money, hand it to the MCO, and contractually order the MCO to simply "pass it through" to specific hospitals or provider networks.

Why the Federal Government Intervened

By the mid-2010s, pass-through payments had grown into a multi-billion-dollar shadow system that troubled the Centers for Medicare & Medicaid Services (CMS) for several reasons:

1. No Tie to Actual Care (Utilization) Pass-through payments were usually guaranteed lump sums based on historical data. A hospital might receive $10 million in pass-through money from an MCO regardless of whether it treated 1,000 Medicaid managed care patients that year or just 10. The money wasn't tied to the actual volume of services delivered.

2. No Quality Incentives Because the payments were guaranteed historical lump sums, hospitals had no financial incentive to improve patient outcomes, reduce readmissions, or expand access to care.

3. Actuarial and Legal Problems The core concept of managed care is that an insurer is paid a capitated rate (a set amount per member per month) to manage the risk of delivering care. Pass-through payments distorted these rates. MCOs were acting as mere pass-through vehicles for state funds, which violated federal rules requiring managed care rates to be strictly actuarially sound and based on the risk of providing actual medical services.

4. "Grey Area" Deals Because there was little federal oversight of pass-throughs, states and MCOs often engaged in "grey area" handshake agreements. A state might verbally pressure an MCO to pay a specific politically powerful hospital system higher rates without putting it formally in the contract, shielding the arrangement from federal scrutiny.

The 2016 "Grand Bargain"

In 2016, CMS implemented a massive overhaul of Medicaid managed care regulations to clean up this system. They struck a compromise with the states:

1. The Ban: CMS ordered the complete phase-out of all lump-sum pass-through payments (giving hospitals 10 years and physicians 5 years to adjust).
2. The Replacement: In exchange for killing pass-throughs, CMS created State Directed Payments (SDPs).

Pass-Throughs vs. SDPs

The fundamental shift from pass-throughs to SDPs was about accountability:

Ultimately, the pre-SDP landscape was a "blank check" environment. The introduction of SDPs didn't stop the flow of money—in fact, SDP spending has since ballooned to over $110 billion annually—but it forced states to legally tie that money to the actual delivery of medical care.