OBJECTIVES There is a scarcity of the literature evaluating the impact of Medicaid payment mechanisms on outcomes in diabetes. The objectives of this study was to examine the impact of Capitated vs. Fee-For-Service (FFS) health plans on medication adherence and health care service utilizations in type-2 diabetes Medicaid enrollees. METHODS A retrospective database study comprised of patients with type-2 diabetes (n=8,581) enrolled in the Medstat MarketScan® MultiState Medicaid database from July 1, 2002 to December 31, 2005. Patients were followed for 6 months before and 12 months after the index anti-diabetic medication to collect the data on the baseline characteristics, medication adherence and health care service utilizations. Multiple log-linear regression analysis was used to predict medication adherence and logistic regressions were used to examine the health care service utilizations. RESULTS A total of 3763 (44%) of the patients enrolled in capitated plans and 4818 (56%) in FFS plans. Patients with capitated plans had 5% lower adherence to anti-diabetes medications compared to those with FFS plans (5%; P<0.05). Patients with capitated health plans had 33% more likelihood of getting hospitalized (OR: 1.33; 95% CI: 1.17, 1.49) and 16% increased odds of having ER visit as compared to those with FFS (OR: 1.16; 95% CI: 1.06, 1.28). Further, 10% increase in medication adherence was associated with 7% decreased in the odds of hospitalizations (OR: 0.53; 95%CI: 0.46, 0.66) and 6% decreased in the odds of ER visits (OR: 0.48; 95% CI: 0.40, 0.55). CONCLUSIONS Patients with capitated health plans had significant lower medication adherence and also associated with significantly higher health care service utilizations. Capitated managed care plans may not be cost effective for the long term management of chronic conditions such as diabetes.