DEPARTMENT OF HEALTH AND HUMAN SERVICES 
Centers for Medicare & Medicaid Services 
7500 Security Boulevard, Mail Stop S2-26-12 
Baltimore, MD 21244-1850 
CMCS Informational Bulletin 
DATE:  May 15, 2019 
FROM:  Chris Traylor, Deputy Administrator and Director 
Center for Medicaid and CHIP Services 
SUBJECT:   Medical Loss Ratio (MLR) Requirements Related to Third-Party Vendors 
The Centers for Medicare & Medicaid Services (CMS) Medicaid and Childrens Health 
Insurance Program (CHIP) managed care final rule1 adopted standards for the calculation and 
reporting of a medical loss ratio (MLR) applicable to Medicaid and CHIP managed care 
contracts, including contracts with managed care organizations (MCOs), prepaid inpatient health 
plans (PIHPs), and prepaid ambulatory health plans (PAHPs).  In Medicaid managed care 
contracts that started on or after July 1, 2017, states were required to include requirements for 
managed care plans to calculate and report an MLR, including related underlying data as 
described in 42 CFR 438.8.  CHIP also adopted the Medicaid requirements for calculating and 
reporting MLRs in 42 CFR 438.8 for CHIP managed care contracts at 42 CFR 457.1203(c) 
through (f); however, the CHIP requirements were effective for CHIP managed care contracts as 
of the state fiscal year beginning on or after July 1, 2018.  Although we refer to the MLR 
requirements as part of the Medicaid program in this CIB, this guidance is equally applicable to 
CHIP managed care entities for contracts and rating periods that begin on or after July 1, 2018, 
pursuant to  457.1203. 
As provided by 42 CFR 438.8(d), the MLR experienced for each managed care plan in an MLR 
reporting year is the ratio of the numerator to the denominator.  Under 42 CFR 438.8(e), the 
numerator of a managed care plans MLR for an MLR reporting year is the sum of the managed 
care plans incurred claims, the managed care plans expenditures for activities that improve 
health care quality, and fraud prevention activities.   
Under 42 CFR 438.8(f), the denominator of a managed care plans MLR for an MLR reporting 
year must equal the adjusted premium revenue.  The adjusted premium revenue is the managed 
care plans premium revenue minus the managed care plans federal, state, and local taxes and 
licensing and regulatory fees and is aggregated for all Medicaid eligibility groups covered under 
the contract with the state unless the state requires separate reporting and a separate MLR 
calculation for specific populations. 
In calculating and reporting the MLR, states are responsible for ensuring that managed care plans 
are complying with these MLR requirements and should be routinely auditing reported data and 
1 Medicaid and Childrens Health Insurance Program (CHIP) Programs; Medicaid Managed Care, CHIP Delivered 
in Managed Care, and Revisions Related to Third Party Liability; Final Rule, 81 Fed. Reg. 27498 (May 6, 2016); 
available at: https://www.federalregister.gov/documents/2016/05/06/2016-09581/medicaid-and-childrens-health-
insurance-program-chip-programs-medicaid-managed-care-chip-delivered.  CMCS Informational Bulletin  Page 2 
 
MLR calculations to ensure that revenues, expenditures, and other amounts are appropriately 
identified and classified within each managed care plans MLR; that is, distinguishing which 
amounts were actually paid for benefits, or activities that improve health care quality, and which 
amounts were actually paid for administrative services, taxes, or other activities. 
To assist states in ensuring that revenues, expenditures, and amounts are appropriately identified 
and classified for each managed care plan, this guidance clarifies and provides an example to 
illustrate some requirements in 42 CFR 438.8(e)(2) for determining the amounts that can be 
included and must be excluded from incurred claims, particularly when a managed care plan uses 
a third-party vendor in a subcontracted arrangement.  Specifically, this CIB highlights and 
clarifies the provisions in 42 CFR 438.8(e)(2)(ii)(B), 438.8(e)(2)(v)(A), 438.8(k)(3), and 
438.230(c)(1).  
42 CFR 438.8(e)(2)(ii)(B) 
Under 42 CFR 438.8(e)(2)(ii)(B), prescription drug rebates received and accrued must be 
deducted from incurred claims. 
 
42 CFR 438.8(e)(2)(v)(A) 
Under 42 CFR 438.8(e)(2)(v)(A), incurred claims must exclude non-claims costs, which include 
the following:  
(1) Amounts paid to third-party vendors for secondary network savings;  
(2) Amounts paid to third-party vendors for network development, administrative fees, 
claims processing, and utilization management;  
(3) Amounts paid, including amounts paid to a provider, for professional or administrative 
services that do not represent compensation or reimbursement for State Plan services or 
services meeting the definition for in-lieu-of services in 42 CFR 438.3(e) and provided to 
an enrollee; and 
(4) Fines and penalties assessed by regulatory authorities. 
 
42 CFR 438.8(k)(3)  
Under 42 CFR 438.8(k)(3), managed care plans must require any third-party vendor providing 
claims adjudication activities to provide all underlying data associated with MLR reporting to the 
managed care plan to calculate and validate the accuracy of MLR reporting. 
 
42 CFR 438.230(c)(1) 
Under 42 CFR 438.230(c)(1), if a managed care plan delegates any of its activities or obligations 
under its contract with the State to a subcontractor, then: 
(1) The delegated activities or obligations, and related reporting responsibilities, must be 
specified in a contract or written agreement;  
(2) The subcontractor must agree to perform the delegated activities and reporting 
responsibilities specified in compliance with the managed care plans contract 
obligations; and  
(3) The contract or written arrangement must either provide for revocation of the delegation 
of activities or obligations, or specify other remedies in instances where the State or the  CMCS Informational Bulletin  Page 3 
 
managed care plan determine that the subcontractor has not performed satisfactorily. 
We highlight these requirements to remind states and managed care plans that when a managed 
care plan subcontracts with a third-party vendor to administer, and potentially provide, a portion 
of Medicaid covered services to enrollees, the subcontractor must report to the managed care 
plan all of the underlying data needed for the Medicaid managed care plan to calculate and report 
the managed care plans MLR.   
General Responsibilities of Subcontractors for Reporting MLR Data  
The Medicaid managed care regulation at 42 CFR 438.230(c)(1) requires, through contractual 
requirements in the managed care contract between the managed care plan and the state, certain 
agreements to be in subcontracts: subcontractors agree to perform the delegated activities and 
reporting responsibilities in compliance with the managed care plans contract obligations.  
Additionally, the regulations at 42 CFR 438.8(k) also require states, through their contracts with 
managed care plans, to require each managed care plan to submit an annual MLR report.  These 
reporting standards specify that managed care plans must require any third-party vendor 
providing claims adjudication activities to provide all underlying data associated with MLR 
calculation and reporting.   
Consequently, all subcontractors that administer claims for the managed care plan must report 
the incurred claims, expenditures for activities that improve health care quality, information 
about mandatory deductions or exclusions from incurred claims (overpayment recoveries, 
rebates, other non-claims costs, etc.) to the managed care plan.  The reporting must be in 
sufficient detail to allow a managed care plan to accurately incorporate the expenditures 
associated with the subcontractors activities into the managed care plans overall MLR 
calculation.  The level of detail must be no less than the reporting requirements in 42 CFR 
438.8(k), but may need to be more if necessary to accurately calculate an overall MLR or to 
comply with any additional reporting requirements imposed by the state in its contract with the 
managed care plan. 
 
Accounting for Subcontractors 
In general, Medicaid requirements for managed care plans to account for expenditures by third-
party vendors under subcontract follow the approach used to account for third-party vendors 
expenditures in the MLR calculations for health insurance issuers subject to the requirements in 
45 CFR Part 1582.  In general, a Medicaid managed care plan may only include in incurred 
claims for Medicaid covered services the amount that the subcontractor actually pays the medical 
provider or supplier for providing Medicaid covered services to enrollees.  Where the 
subcontractor is performing an administrative function such as eligibility and coverage 
verification, claims processing, utilization review, or network development, expenditures and 
                                                 
2 See Question and Answer #12 in the May 13, 2011, CMS, CCIIO Insurance Standards Bulletin related to CCIIO 
Technical Guidance (CCIIO 2011002): Questions and Answers Regarding the Medical Loss Ratio Interim Final 
Rule. The document is available at:  
https://www.cms.gov/CCIIO/Resources/Files/Downloads/mlr-guidance-20110513.pdf 
 
See also Question and Answer #19 in the July 18, 2011, CMS, CCIIO Insurance Standards Bulletin related to CCIIO 
Technical Guidance (CCIIO 2011004): Questions and Answers Regarding the Medical Loss Ratio Interim Final 
Rule.  The document is available at:  
https://www.cms.gov/CCIIO/Resources/Files/Downloads/20110718_mlr_guidance.pdf  CMCS Informational Bulletin  Page 4 
 
profits on these functions would be considered a non-claims administrative expense as described 
in 42 CFR 438.8(e)(2)(v)(A), and should not be counted as an incurred claim for the purposes of 
MLR calculations. 
  
An exception to the general approach applies when a subcontractor, through its own employees, 
provides Medicaid covered services directly to enrollees.  In this circumstance, the entire portion 
of the amount the Medicaid managed care plan pays to the third-party vendor that is attributable 
to the third-party vendors direct provision of Medicaid covered services should be included in 
incurred claims, even if such amount includes reimbursement for the third party vendors own 
administrative costs related to the direct provision of Medicaid covered services3.  The phrase 
through its own employees does not include a subcontractors contracted network of providers 
because such network providers are not considered employees of the third-party vendor.  
Additionally, when the subcontractor is also performing an administrative function not 
attributable to its direct provision of Medicaid covered services, such as eligibility and coverage 
verification, claims processing, utilization review, or network development, payment by the 
managed care plan to the subcontractor for such functions are a non-claims administrative 
expense as described in 42 CFR 438.8(e)(2)(v)(A), and should not be counted as an incurred 
claim for the purposes of MLR calculations. 
 
Accounting for Prescription Drug Rebates Received and Accrued 
The Medicaid managed care regulations at 42 CFR 438.8(e)(2)(ii)(B) require that prescription 
drug rebates received and accrued must be deducted from incurred claims.  CMS interprets this 
regulation to require that any time a managed care plan receives something of value for the 
provision of a Medicaid covered outpatient drug (e.g., manufacturer rebates, incentive payments, 
direct or indirect remuneration, goods in kind, etc.), regardless from whom the item of value is 
received (e.g., pharmaceutical manufacturer, wholesaler, retail pharmacy, etc.), the value of that 
rebate must be deducted from the amount of incurred claims used for calculating and reporting 
the MLR.  CMS also interprets this requirement to apply equally regardless of whether the 
prescription drug rebate is received by the managed care plan (i.e., directly) or by a subcontractor 
(i.e., indirectly) administering the covered outpatient drug benefit on behalf of the managed care 
plan.  This interpretation is consistent with the general requirements in 42 CFR 438.230, which 
require subcontractors to comply with the standards in the managed care plans contract that 
govern the managed care plans performance.  Where the managed care plan is required to treat 
these additional items of value as deductions or exclusions from incurred claims under 
 438.8(e)(2), receipt by a subcontractor rather than the plan itself does not change that 
requirement. 
We are clarifying the treatment and accounting required for prescription drug rebates to ensure 
that there is no confusion related to the calculation of an MLR under Medicaid managed care.  
The regulation at 42 CFR 438.8(e)(2)(ii)(B) requires that prescription drug rebates received and 
accrued must be deducted from incurred claims in calculating and reporting the applicable 
managed care plans MLR.  The regulation does not require that the Medicaid managed care plan 
itself receive the prescription drug rebate directly.  We believe that requiring the managed care 
plan to account for the prescription drug rebate (as we interpret that term) regardless of whether 
                                                 
3 In the circumstance where the third-party vendor provides Medicaid covered services directly to enrollees through 
its own employees, the expenditures are treated in the same manner as a payment to a network provider for the same 
services.  CMCS Informational Bulletin  Page 5 
 
the value of the rebate is received directly, or indirectly through a subcontractor, ensures that the 
MLR calculation does not include artificially inflated totals for incurred claims because a 
subcontractor has been used by the managed care plan.  
Example 
We illustrate the application of these requirements in the situation where a Medicaid managed 
care plan subcontracts with a pharmacy benefit manager (PBM) for the administration of the 
Medicaid covered outpatient drug benefit.  The PBM administers the covered outpatient drug 
benefit through a contracted network of pharmacies and does not provide any of the Medicaid 
covered outpatient drugs directly to enrollees through its own employees.  In this circumstance, 
the PBM is required to report to the managed care plan all of the information necessary for the 
managed care plan to meet its MLR obligations under 42 CFR 438.8.  The PBM is required to 
classify and report revenues and expenditures associated with the administration of the Medicaid 
covered outpatient drug benefit to the managed care plan in the same manner that the managed 
care plan would be required itself to classify and report this information if the managed care plan 
had administered the covered outpatient drug benefit directly. 
Even if the managed care plan pays the PBM a capitated amount in a risk-based arrangement, the 
managed care plan and PBM must classify and report revenues and expenditures associated with 
the administration of the Medicaid covered outpatient drug benefit consistent with 42 CFR 
438.8.  That is, the managed care plan may not use the entire capitated payment to the PBM as 
incurred claims.  Rather, the PBM must calculate incurred claims as the amounts paid to the 
retail or mail-order pharmacy (e.g., drug ingredient costs and dispensing fees) minus any 
prescription drug rebates (as we interpret that term) and accounting for any other applicable 
requirements in 42 CFR 438.8(e)(2).  Other expenditures by the PBM under subcontract with the 
managed care plan (e.g., activities that improve health care quality, non-claims costs for 
administrative services, taxes and fees, etc.) would also need to be classified appropriately and 
reported to the managed care plan to facilitate the managed care plans MLR calculations and 
reporting. 
In this example, the managed care plan only contracted with the PBM for the provision and 
administration of the Medicaid covered outpatient drug benefit.  If the managed care plan 
contracted with the PBM to provide and administer other Medicaid covered services (e.g., 
medication therapy management), the PBM would also need to classify and report revenues and 
expenditures for those additional Medicaid covered services in a manner consistent with the 
regulations and this clarifying guidance. 
Technical Assistance and Audits 
CMS intends to begin working with states to conduct financial audits of Medicaid managed care 
plans MLR calculations.  We are planning for these audits to specifically focus on ensuring that 
subcontractors expenditures (such as PBM costs) are properly incorporated into the MLR 
calculations.  If you have questions or would like to request technical assistance related to this 
guidance or with respect to the MLR standards applicable to Medicaid and CHIP managed care 
contracts, please send an email to ManagedCareRule@cms.hhs.gov.