Jessica M. Roth
Eric Zimmerman

At a Glance

Recent recommendations by the Medicare Payment Advisory Commission (MedPAC) could, if implemented, substantially alter the wage index-and redistribute billions to hospitals in the process. The Centers for Medicare & Medicaid Services (CMS) is expected to publish its recommendations soon. Whether CMS will endorse or reject MedPAC's recommendations is unclear.

In recent years, no aspect of Medicare's hospital inpatient prospective payment system (IPPS) has become more controversial, more manipulated, or more reviled by hospitals, Medicare officials, and lawmakers than the wage index.

Originally intended to be a benign and stable payment adjustment to reflect geographic variations in labor costs across the country, the wage index now often significantly affects hospital revenue. Unanticipated but frequently common wild swings in distributions from year to year profoundly impact hospital budgets and margins, drawing tremendous ire from hospital executives.

In 2006, in a display of frustration over growing complaints about the hospital wage index, Congress enacted legislation setting in motion a major overhaul of the geographic adjustment.  These changes could be implemented as early as this year.

Recent recommendations by the Medicare Payment Advisory Commission (MedPAC) could, if implemented, substantially alter the wage index and redistribute billions of dollars in payments to hospitals in the process.

Medicare's Hospital Wage Index

Medicare's hospital wage index system can result in sharp variations from one metropolitan statistical area (MSA) to another (see exhibit 1). These sharp variations, often referred to as cliffs, have given rise to a series of exceptions and supplemental adjustments. More than one-third of hospitals receive a higher wage index through exceptions to the current system. Consider that the FY09 wage index for rural Washington (area 50) is 1.0142, while the wage index for the Tacoma, Wash., area (area 45104) for this period is 1.1114. As a result, many hospitals in neighboring communities can experience significant differences in reimbursement. Moreover, when one considers that the wage index also is used to adjust payments for outpatient services, a 0.10 difference in the wage index can have a profound impact on hospital revenues.

View exhibit 1


Congress Shows Frustration

Because of both the profound impact of the wage index and the perceived systemic inequities, beginning in the mid-1990s, hospital executives began urging Congress to remedy discrete, localized problems. At first, Congress obliged in limited fashion. In 1997, Congress directed CMS to create a special reclassification exception that enabled a single hospital in Massachusetts to qualify for geographic reclassification. In 1999, Congress required CMS to reclassify 20 hospitals in seven counties in seven states.

But restraint gave way in 2003 with the Medicare Modernization Act. In that bill, Congress included a seemingly innocuous provision requiring CMS to establish a special one-time reclassification process using newly established qualification criteria. What followed, however, was the largest one-time reshuffling of hospital fortunes. The approval process established by CMS to implement the infamous Section 508 enabled approximately 120 hospitals to qualify for reclassification.

By 2004, hundreds of hospitals were lobbying Congress for wage index remedies. By 2006, Congress was overwhelmed and fed up. In December 2006, Congress enacted the Tax Relief and Health Care Act of 2006 (TRHCA), which, among other things, directed CMS to propose revisions to the hospital wage index system after considering recommendations from the Medicare Payment Advisory Commission (Pub. L. 109-432, § 106[b]).

MedPAC Weighs In

In its June 2007 Report to Congress, Promoting Greater Efficiency in Medicare, MedPAC recommended that Congress replace the hospital wage index statute with a new methodology that would address perceived problems with the current system.

One such perceived problem rests with imperfect data sources. CMS currently uses wage and benefit data self-reported annually by hospitals via cost reports. MedPAC asserts that relying solely on data self-reported by hospitals creates a problem of circularity whereby hospitals directly drive changes to the wage index through changes to their hourly wages. MedPAC recommends basing the wage index on three data sources:

  • The Bureau of Labor Statistics (BLS) Occupational Employment Statistics (OES) survey
  • 2000 decennial census data
  • Benefit data from Worksheet A of hospital cost reports submitted to CMS by providers

Notably, the BLS wage data used by MedPAC are for all employers of an occupation (e.g., hospitals, physicians, nursing homes, home health agencies, and insurance companies all may employ registered nurses). This is an important difference from the CMS index, which uses wage data from hospital employers only.

MedPAC argues that including data from all employers addresses the problem of circularity because hospitals have less influence on the resulting wage levels. To capture total compensation in its index, MedPAC adjusts the described wage index calculation using a benefit-to-wage ratio derived from benefit data reported by hospitals on Worksheet A of the Medicare hospital cost report. MedPAC believes the combination of these alternative data sets provides a better result by decreasing year-to-year volatility, lowering variations between contiguous geographic areas, and automatically adjusting for occupational mix.

MedPAC also has proposed ways to refine the current MSA-defined labor markets. For example, MedPAC suggests adjusting MSA wage levels at the county level, and smoothing over large differences between counties. Under MedPAC's proposed methodology, the wage index for a hospital would be at least 90 percent of a neighboring hospital's wage index and 90 percent of the highest wage index in the hospital's MSA or rural area (MedPAC, Report to the Congress: Promoting Greater Efficiency in Medicare, June 2007). According to MedPAC, this approach would eliminate the sharp differences that can arise from one MSA to another under the current system and would do away with the need for reclassifications and other wage index exceptions. As a result, refinement processes would no longer be needed.

CMS's Turn

The original TRHCA mandate required MedPAC to make reform recommendations, and more important, instructed CMS to include one or more proposals to revise the wage index in the FY09 IPPS proposed rule, based on MedPAC's recommendations. Although 16 months had passed since enactment of the TRHCA and 10 months since MedPAC's June 2007 report, CMS was not ready by April 2008-when the FY09 IPPS proposed rule was published-to make the broad-based reform recommendations required by Congress. Instead, as an interim step toward fulfilling its statutory obligation, CMS implemented two tweaks to the wage index. The extent to which these relatively small changes impact hospitals illustrates the challenges of wage index reform.

First, CMS changed the criteria that hospitals must satisfy to qualify for geographic reclassification and a higher wage index. Previously, to qualify for geographic reclassification, a hospital in an urban area had to demonstrate, in part, that its average hourly wage was at least 84 percent of the average hourly wage for the area to which it sought reclassification. Hospitals in rural areas had a slightly lower threshold of 82 percent. Once the new rule is fully phased in, urban hospitals must satisfy an 88 percent threshold, while rural hospitals must satisfy an 86 percent threshold. The net result is that as many as 170 hospitals may fail to qualify for reclassification.

CMS also revised the manner in which it funds the rural and imputed floor. The rural floor, established by Section 4410 of the Balanced Budget Act of 1997 (BBA), provides that the wage index of a hospital in an MSA may not be less than the wage index applicable to hospitals in the state's rural area. For states without hospitals in rural areas (e.g., New Jersey), CMS imputes a floor. The cost of implementing the rural and imputed floors, which affect 266 hospitals in 27 states under CMS's estimates, previously was funded through a nationwide budget neutrality adjustment. In other words, all hospitals nationwide bore the cost of benefiting approximately 266 hospitals. But beginning in October 2008, CMS has transitioned from a nationwide to a state-specific budget neutrality adjustment. Under this new methodology, the wage index values for all hospitals in a state are adjusted downward if a single hospital in that state receives the rural floor.

These minor refinements are hardly the final word. CMS intends to more fully respond to the congressional mandate with additional reform proposals. Exactly when, however, is not entirely clear.

CMS also has engaged Acumen, LLC, to conduct a detailed impact analysis that compares the effects of MedPAC's new index with the CMS wage index to assist in developing proposals that address nine study points specified by Congress under Section 106(b) of the TRHCA. Specifically, Acumen will evaluate whether differences between the two types of wage data produce significant differences in wage index values among labor market areas. Acumen also will consider alternative methods of incorporating benefit costs into the construction of the wage index, alternative labor market area definitions, and how aspects of the MedPAC recommended index might be applied to the CMS wage data in constructing a new methodology for the wage index.

Bigger Bumps Ahead

CMS is expected to publish its recommendations soon. Whether CMS will endorse or reject MedPAC's recommendations is unclear. CMS is not bound to embrace and implement MedPAC's proposal. In fact, CMS will not even be the final arbiter of changes that are made. Rather, given current statutory constraints, congressional action almost certainly will be necessary to impose the kind of change contemplated by MedPAC.

Nonetheless, given that Congress historically respects MedPAC's advice and may therefore adopt at least parts of MedPAC's proposal, hospitals should be aware of how the proposed changes would affect Medicare reimbursement.

In general, MedPAC's methodology has the potential to be less volatile than the current wage index system, to minimize differences between adjoining geographic areas, and to inherently account for occupational mix influences. However, on a hospital-specific level, the changes may not always be positive-or welcome.

Hospitals with no exceptions-which tend to pay for the exceptions and reclassifications available to other hospitals because these adjustments most often are budget neutral-generally can expect to see a small increase in their wage index and their Medicare inpatient payments of approximately 1.6 percent and 0.4 percent. The biggest losers under a system like the one contemplated by MedPAC would be those hospitals that currently receive a big wage index boost through reclassification or some special exception. Also in the loser category would be large rural hospitals, which already tend to lag behind their urban counterparts in Medicare payments and margins.

Of course, these are aggregated numbers for select hospital categories. Individual hospital experience will vary significantly, and some hospitals may see Medicare payment swings of 10 percent or more.

Whether Congress will be able to muster the political will to adopt these or other major system changes-and whether it should-is unclear. Given the profound shifting of dollars that would result from these changes, there will likely be significant divisions within the hospital community, and enormous opposition mounted from hospitals that would be adversely impacted. Unless Congress is willing to provide some means of holding harmless those that otherwise would be negatively impacted, it is difficult to imagine how something so controversial and divisive could be approved.

The current system is far from perfect, and leaves many hospitals wanting. However, it is conceivable that by embracing MedPAC's proposal, Congress could be merely reshuffling the deck and exchanging one set of problems for another. Regardless of how much MedPAC and others might try to minimize disparities among neighboring hospitals, disparities will exist, and some hospitals will justifiably feel as though they are treated unfairly by the system.


Jessica M. Roth is the assistant director of legislation and health policy, McDermott Will & Emery LLP, Washington, D.C. (

Eric Zimmerman, JD, is a partner, McDermott Will & Emery LLP, Washington, D.C. ( 

Publication Date: Sunday, February 01, 2009

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