HMO Federal Qualification & Medicare Cost Contracts

The HMO Act of 1973 (42 U.S.C. §§ 300e et seq.) created a federal framework for qualifying Health Maintenance Organizations — prepaid group health plans that provide comprehensive care through a defined network for a fixed periodic payment. A federally qualified HMO has demonstrated to CMS that it meets specific standards for benefits, quality assurance, open enrollment, and financial soundness. Federal qualification matters for two reasons: (1) employers with 25 or more full-time employees who offer health benefits are required to offer a qualified HMO option if one requests inclusion; (2) HMOs can contract with Medicare through legacy cost-reimbursement arrangements distinct from the current Medicare Advantage (Part C) program.

Current Rule (2026)

What This Rule Does

The Part 417 framework has two distinct tracks. The federal qualification track (Subparts A–F) establishes what an HMO must do to earn the "federally qualified" designation from CMS. A qualified HMO must provide basic health services — physician, inpatient and outpatient hospital, medically necessary emergency, short-term mental health, treatment for alcohol and drug abuse, diagnostic laboratory and radiology, and home health services — to all enrolled members without limits on time or cost when medically necessary (§ 417.101). It must have an ongoing quality assurance program with regular review of clinical outcomes and corrective action procedures (§ 417.106). Financial soundness is required: adequate working capital reserves, adequate excess-of-loss insurance, and protection against enrollee liability if the HMO fails (§§ 417.120–417.122).

The employer inclusion track (Subpart E) implements Congress's mandate for employers to offer HMO alternatives. Any employer with 25 or more full-time employees that pays at least minimum wages and offers a health benefits plan must include a federally qualified HMO in its plan offering if a qualified HMO serving the employer's area submits a written request. The employer's contribution toward HMO premiums must be nondiscriminatory — the employer cannot contribute less per HMO enrollee than it contributes for employees on the traditional plan (§ 417.157). Employers must provide payroll deduction as a payment mechanism if they do so for any health plan (§ 417.158).

The Medicare contract tracks (Subparts J–Q, U) are largely legacy provisions. Before Medicare Advantage was fully established, HMOs could contract with Medicare under two arrangements: "risk" contracts (HMO accepts full financial risk for Medicare beneficiaries in exchange for a fixed capitation payment) and "cost" contracts (HCFA/CMS reimburses actual reasonable costs). Risk contracts evolved into today's Medicare Advantage plans governed by 42 CFR Part 422; most HMOs either converted to MA or exited Medicare contracting. A small number of HMOs still operate under legacy "cost contracts" under Subpart O — these plans receive cost-based reimbursement but allow beneficiaries to use out-of-network Medicare providers, making them attractive in rural areas where HMO networks may be thin.

Key Provisions

• § 417.101 — Basic health services: comprehensive services HMOs must cover without time/cost limits
• § 417.104 — Community rating: HMOs must use community rating (not experience rating) for their premium calculation — all enrolled groups pay premiums based on the community's overall health experience, not their specific group's claims history
• § 417.106 — Quality assurance: ongoing QA program with clinical performance review and corrective action
• § 417.120 — Fiscal soundness: working capital requirements, excess-of-loss insurance, insolvency protection for enrollees
• § 417.122 — Enrollee protection: HMO must protect enrollees from liability for HMO debts; requires specific insolvency safeguards
• § 417.142 — Qualification requirements: CMS evaluates applications based on submitted evidence; site visits permitted
• § 417.151–417.159 — Employer inclusion: which employers are covered, how HMO option must be offered, nondiscrimination in contributions, payroll deduction requirements
• § 417.157 — Employer contribution nondiscrimination: employer's HMO contribution must not be less favorable than the traditional plan contribution
• § 417.401–417.416 — Medicare cost contract enrollment, disenrollment, and eligibility procedures

How It Affects You

If you're an HR manager or benefits administrator at a company with 25+ employees: The Part 417 employer inclusion mandate means that if a federally qualified HMO operating in your area sends a written request to be included in your health benefits package, you must offer it. This is not a theoretical requirement — it still applies even though most insurers today market directly rather than invoking the statutory right. If an HMO does request inclusion, the nondiscrimination rule in § 417.157 requires that your employer contribution toward the HMO be comparable to your contribution toward your existing plan. You cannot structure contributions to financially penalize employees who choose the HMO. In practice, very few HMOs still invoke this right (they prefer competitive market participation), but understanding the obligation is important for any employer receiving such a request.

If you run or advise an HMO or health plan: Federal qualification under Part 417 is optional — most managed care organizations today rely on state licensure, not federal qualification. The federal qualification track adds CMS oversight but provides two benefits: the ability to invoke the employer inclusion mandate (requiring employers to offer you) and eligibility for legacy Medicare cost-contract status. The Medicare Advantage framework (42 CFR Part 422) has largely displaced legacy cost contracting — CMS has frozen the number of cost-contract HMOs, and new market entrants almost universally use the MA pathway. Federal qualification under Part 417 is most relevant for organizations in specific markets where the employer-mandate leverage matters or where legacy cost-contract status provides a competitive advantage with beneficiaries who value out-of-network flexibility.

If you're a Medicare beneficiary enrolled in a legacy cost-contract HMO: Unlike Medicare Advantage plans (which generally require you to use network providers except for emergencies), a cost-contract HMO under Subpart O allows you to use any Medicare-approved provider outside the plan's network — you simply pay standard Medicare cost-sharing rather than the plan's in-network rates. This flexibility can matter significantly for beneficiaries in rural areas or those with established relationships with out-of-network specialists. These plans are rare and available in a limited number of geographic areas; if you're considering switching between a cost-contract HMO and a Medicare Advantage plan, compare the out-of-network access rules carefully before disenrolling — returning to a cost-contract plan may not be possible if enrollment is closed.

Statutory Authority

This rule implements:

• 42 U.S.C. § 300e — HMO Act: definitions of qualified HMO, basic and supplemental health services, community rating requirements, grants and loans to new HMOs
• 42 U.S.C. § 300e-9 — Employer mandates: employers required to offer qualified HMO if one requests
• 42 U.S.C. § 1302 — Secretary of HHS rulemaking authority for Medicare and Medicaid programs

Implementing Regulations

• 42 CFR Part 417 — HMOs, Competitive Medical Plans, and Health Care Prepayment Plans (146 sections):
  • Subparts A–D (general provisions, qualified HMO service requirements, organization requirements, application and qualification process)
  • Subpart E (employer inclusion of qualified HMOs — the mandate and nondiscrimination requirements)
  • Subpart F (continued regulation of federally qualified HMOs)
  • Subparts J–R (Medicare contract qualifying conditions, enrollment, payment on risk and cost basis, beneficiary appeals, contract appeals)
  • Subpart U (Health Care Prepayment Plans — another legacy Medicare arrangement for partial-risk plans)
  • Subpart V (administration of outstanding HMO Act loans and loan guarantees issued under the original 1973 program)

Recent Developments

The Part 417 federal qualification framework has had no major rulemaking since the mid-1990s. CMS has focused its regulatory energy on the Medicare Advantage framework (42 CFR Part 422) and ACA marketplace rules, leaving the HMO Act's original architecture largely intact but increasingly secondary to how managed care actually operates.

• Declining federal qualification: The number of federally qualified HMOs has fallen substantially since the 1990s. Most managed care organizations now rely on state licensure (required in any state where they operate) rather than the additional CMS oversight and compliance burden of federal qualification. The HMO Act's employer inclusion mandate — the main practical benefit of federal qualification — is rarely invoked because most insurers compete for employer clients through direct market relationships rather than statutory rights.
• Medicare Advantage vs. cost contracts: Legacy Medicare cost contracts under Part 417 Subpart O are effectively a frozen population. CMS stopped accepting new cost-contract applications years ago, and most existing cost-contract plans have converted to Medicare Advantage (Part 422) to participate in the far larger and better-resourced MA program. As of 2026, fewer than a dozen legacy cost-contract HMOs remain nationally. Beneficiaries in those plans retain out-of-network Medicare access rights that MA plans don't provide — a meaningful difference for rural beneficiaries or those with established out-of-network specialist relationships.
• ACA and value-based care context: The Affordable Care Act's impact on HMO structure has been substantial, though it operated through different regulatory frameworks (state insurance law, ERISA, and Part 422 for Medicare) rather than amendments to Part 417. HMO-like network structures — narrow-network plans, capitated primary care, gatekeeper models — are now common in ACA marketplace plans and employer-sponsored insurance without requiring federal HMO qualification. The distinction between "federally qualified HMO" and "health plan that uses HMO-style networks" is important: most HMO-model plans today are not federally qualified.
• Telehealth and network adequacy: CMS telehealth flexibility expanded during COVID-19 and has been selectively made permanent. For legacy federally qualified HMOs, the HMO Act's basic health services requirements (§ 417.101) were written for in-person care. CMS has updated network adequacy standards for Medicare Advantage (Part 422) to incorporate telehealth access, but Part 417's requirements for federally qualified HMOs have not been formally updated to reflect virtual care — a gap that affects the small number of plans still seeking or maintaining federal qualification status.