The Current Medicare Hospital Wage Index System Creates Winners & Losers

In this paper we explore how the relatively straightforward Medicare hospital wage index (HWI) system was amended over time until the HWI has become a distorted measure of local wage prices, causing inaccuracy in payments made in multiple Medicare prospective payment systems (PPS).

The primary objective of the Medicare inpatient PPS is to create incentives for hospitals to operate efficiently, while ensuring that payments are adequate to compensate hospitals for their reasonable costs in furnishing necessary high-quality care to beneficiaries. The Centers for Medicare & Medicaid Services (CMS) uses the HWI to annually adjust hospital PPS payments to reflect labor prices in local markets. Variations of the HWI also affect payments to other types of providers under other Medicare PPS, such as long-term-care hospitals and skilled nursing facilities. CMS collects wage data from hospitals annually through the hospitals’ Medicare cost reports and uses these data to calculate wage indexes for each core-based statistical area (CBSA) and for each state’s rural hospitals.

Over time, Federal law has been amended to allow a qualifying urban hospital to (1) request reclassification from its geographical CBSA to another CBSA to receive a higher wage index or (2) apply for rural hospital status for Medicare payment purposes. In addition, to correct what it perceived to be an anomaly, Congress legislated that the HWIs applied to urban hospitals in a state cannot be lower than the rural area wage index for that state, without regard to actual local labor prices. This is known as the rural floor. On top of these exceptions, Federal law and CMS policy protect hospitals from having their HWIs lowered because of the reclassification of other hospitals into or out of CBSAs or rural areas.

Our work explores the extent to which these exceptions and hold-harmless policies pose challenges to the HWI system accurately adjusting payments for local labor prices, especially when coupled with CMS’s lack of authority, absent misrepresentation or falsification, to penalize hospitals that submit inaccurate wage data and CMS’s lack of authority to retroactively change payment rates if erroneous wage data are discovered after the payment year begins. (OIG found hundreds of millions of dollars in inaccurate wage data in 41 hospital-specific reports issued from 2004 through 2017.) OIG has observed that hospitals and health systems expend a great deal of effort making decisions about strategic reclassifications, because taking advantage of allowed exceptions is one of the few ways that providers can actively affect their own payment rates. Meanwhile, hospitals that cannot benefit from exceptions may suffer economically. For example, because the rural floor is by law applied in a budget-neutral manner at the nationwide level, all HWIs are lowered slightly to allow for some urban hospitals to get the benefit of the rural floor. This means that rural hospitals, which cannot benefit from the rural floor and which may already be under financial stress, have their Medicare payments reduced to allow some urban hospitals to receive higher payments.