Capitation, actuarial soundness, and the medical loss ratio: the three rules that govern how states pay Medicaid managed care plans.
A Medicaid managed care contract rests on three linked rules: how the plan is paid, how the rate is set, and how much of the payment must reach care. Together they define what an MCO can and cannot do with the state’s money.
1. Capitation
The state pays each MCO a capitation rate: a fixed amount per member per month, risk-adjusted, regardless of how much care the member uses. The plan keeps what it does not spend and absorbs the loss if care costs more. This is the population-based payment from the intro course, applied at the level of the plan rather than the provider.
2. Actuarial soundness
States cannot set those rates arbitrarily. Since 1981, federal law has required Medicaid capitation rates to be actuarially sound: developed by qualified actuaries using accepted principles, and appropriate for the population and services covered (42 CFR 438.4). Sound rates protect both sides: too low and plans exit or stint on care; too high and the state overpays.
3. The medical loss ratio
The medical loss ratio (MLR) governs how the plan spends the payment. Since 2019, states must develop rates so that each MCO can reasonably achieve an MLR of at least 85 percent, meaning at least 85 cents of every capitation dollar goes to care and quality, and no more than 15 cents to administration and profit.
| Term | What it controls |
|---|---|
| Capitation | How the plan is paid (fixed per member per month) |
| Actuarial soundness | How the rate is set (certified, appropriate, since 1981) |
| Medical loss ratio | How the payment is spent (85%+ on care) |
Worth remembering: the MLR is a floor on care spending, not a value-based incentive by itself. It stops a plan from pocketing the capitation payment, but it does not reward better outcomes. That is why states add value-based requirements on top, the subject of the next lesson.
Key takeaways
- States pay MCOs a fixed, risk-adjusted capitation rate per member per month.
- Rates must be actuarially sound, a federal requirement since 1981 (42 CFR 438.4).
- The 85 percent MLR floor forces most of the payment to reach care, but does not by itself reward value.
Sources
Check your understanding
The medical loss ratio (MLR) floor requires Medicaid MCOs to spend at least what share of capitation revenue on care?
Since 2019, states must set rates so each MCO can reasonably achieve an MLR of at least 85 percent, leaving no more than 15 percent for administration and profit.