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CMS Finds a Way Around the Prohibition on the Use of Medicaid Funds for Institutions for Mental Diseases

May.10.2016

In a controversial move, HHS’ new rules for Medicaid Managed Care plans create a novel work-around for the prohibition on the use of Medicaid funds for mental hospital stays. One of the most venerable Medicaid rules—which was included in the original Act in 1965—is the exclusion of Medicaid assistance “for the care or services for any individual who has not attained 65 years of age and who is a patient in an institution for mental diseases” (IMD).1 An IMD is an institution “that is primarily engaged in providing diagnosis, treatment, or care of persons with mental diseases, including medical attention, nursing care and related services.”2 The exclusion thus covers state and private mental hospitals, which have traditionally provided long-term care, often in locked wards, but not psychiatric wards in general med/surg hospitals.

The IMD exclusion was put in place during the deinstitutionalization movement, and reflected Congress’ intent to keep funding for the old-line mental hospitals the responsibility of the states. In rulings such as Olmstead v. Zimring, the Supreme Court has recognized that “unjustified institutional isolation of persons with disabilities is a form of discrimination.”3

As Medicaid began to assume ever-greater roles in funding mental health services, the IMD exclusion became a significant factor in the decline of state mental hospitals. But the IMD exclusion was never absolute, since it did not cover Medicaid recipients over age 65. In 1977, it was amended to exempt children under age 21.4 And in 1988, it was amended to permit Medicaid coverage for mental health institutions with 16 or fewer beds.5 In recent years, activists such as Dr. E. Fuller Torrey have called for a rollback of deinstitutionalization and an increase in the number inpatient psychiatric beds.6 Rep. Timothy Murphy (R.Pa.) has for some years sponsored legislation to allow a limited exception to the IMD exclusion to permit Medicaid funds to be used for inpatient stays at a state mental hospital unit if the average stay at the unit was less than 30 days.7

Section 2706 of Affordable Care Act provided for a 3-year demonstration project that would permit Medicaid to pay for emergency and stabilization care for persons ages 21-64 in an IMD.8 This project was limited—only providing $75 million in total funding, which was split between 11 States. In its final rule for Medicaid Managed Care Organizations (MCOs), CMS has created an even more substantial work-around for the IMD exclusion.9

Under this rule, Medicaid MCOs will be permitted to pay for treatment for their Medicaid beneficiaries for a “short-term” stay in an IMD for up to 15 days in a month (“during the period of the monthly capitation payment”).10 The stay also would have to meet the requirements for “in lieu of services”—alternative services or settings that are not ordinarily covered by Medicaid. These rules require, inter alia, that the State determine that the alternate setting is medically appropriate and cost-effective and, that the enrollee “is not required by the MCO . . . to use the alternative service or setting.”11

The preamble to the Final Rule suggests that HHS believes it is treading on thin soil with this rule. Its logic is that in managed care contracts, State Medicaid agencies pay MCOs for taking the financial risk for patient care for an entire month. So as long as a patient doesn’t stay in an IMD for more than half of a month (15 days), then the MCO is still taking risk for the patient and can be made a full capitation payment. The MCO would compensate the IMD for the short-term stay at the prices used for other providers under the State plan.12

The preamble contends that permitting coverage of stays for up to 15 days in an IMD fits in well with the findings of the ACA Section 2706 demonstration project. The project found that the average stay in an IMD was 8.2 days. This suggests that most IMD stays could be covered by the 15 day rule. The preamble further notes that the 15 days could be extended to up 30 total days, if the IMD stay began in one capitation month but ended in the next.

Some comments to the proposed rule had contended that this IMD work around was contrary to deinstitutionalization principles. CMS responded:

We do not intend to incentivize admissions to inpatient psychiatric settings for services that are not medically necessary or appropriate, nor incentivize lengths of stay in inpatient psychiatric settings that are not medically necessary or appropriate. We take seriously our commitment to community integration approaches and adherence to Olmstead provisions requiring treatment in the least restrictive setting. However, we balance those points with the recognition that short-term inpatient stays may be necessary for individuals with the most acute behavioral health needs and are concerned that access to them may not currently be sufficient. We remind states and managed care plans of their obligations under the ADA and Olmstead decision to provide services in the least restrictive setting and to promote community integration. Nothing in this final rule excuses failure to comply with these responsibilities.

Despite this defense, some will argue that it is up to Congress, not HHS, to create an exception to such as venerable rule as the IMD exclusion. It would not be surprising if this new rule draws a court challenge.

This client alert is Part II in our continuing series on the Medicaid Managed Care Final Rule. Part I, which provides an overview of the rule and analyzes the medical loss ratio and actuarial soundness requirements, is available here.


1 42 U.S.C. 1396d § (a)(29)(B).

2 Id. at § 1396d(i).

3 527 U.S. 581 (1999); see also O’Connor v. Donaldson, 422 U.S. 563 (1975).

4 42 U.S.C. § 1396d(1)(16).

5 42 U.S.C. § 1905(a)(B).

6 E. Fuller Torrey, American Psychosis (2013).

7 H.R. 3717 (2013), § 501.

8 ACA Section 2706.

9CMS, Medicaid and Children’s Health Insurance Program (CHIP) Programs, Medicaid Managed Care, CHIP Delivered in Managed Care, and Revisions to Third Party Liability, Final Rule (filed April 26, 2016).

10 42 C.F.R. § 438.6(e).

11 42 C.F.R. § 438.3(e)(2). Medicaid services are covered by Section 504 of the Rehabilitation Act (29 U.S.C. § 794). HHS’ regulations for Section 504 provide that if separate (segregated) services are provided to a disabled Medicaid beneficiary, the beneficiary must be given the opportunity to participate in benefits that are not separate. 45 C.F.R. § 84.4(b)(3).

12 42 C.F.R. § 438.6(e).


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David Didier Johnson
Counsel – San Francisco
Phone: +1 415.986.2800
Email: davidjohnson@crowell.com