The Medicare area wage index likely needs a revamp, MedPAC members say

• Policy advisers say the area wage index (AWI) used to adjust Medicare payments is overly complex and not precise.
• Wage index adjustments leave some hospitals at a disadvantage and are costly for the Medicare program.
• An alternative would be a streamlined system with targeted payments to high-need hospitals.

Long a source of confusion for hospitals, Medicare’s area wage index (AWI) is generating opposition at the policy level.

During an October meeting, members of the Medicare Payment Advisory Commission (MedPAC) seemed intent on exploring fixes that may amount to an overhaul of the AWI.

“It is very hard to imagine if there were no Medicare program and we sat down to design it, and we recognized, you know what, we need to adjust payments for differences in costs across areas, that this is what we would come up with,” said Michael Chernew, PhD, commission chair and a professor of healthcare policy at Harvard Medical School.

“But we ended up here in this Byzantine system, and there’s probably a strong case for trying to simplify it, to target it better.”

A complex system

Wage data used in the AWI are derived from hospital cost reports and include staff wages and hours. For the 2022 inpatient prospective payment system (IPPS), according to a presentation at the MedPAC meeting, CMS calculated a wage index for 412 urban areas and 47 rural areas.

An area’s unadjusted wage index is the average hourly wage of hospitals in the market divided by the national average. But numerous adjustments may be applied on either an area level or an individual-provider level.

Since 2007, the share of IPPS hospitals that received at least one special adjustment to their wage index has increased from 40% to 67%. For 5% of hospitals, the adjustment exceeded 20%, leading to “substantial” increases in payments, according to the presentation.

“Because most wage index adjustments are funded through budget neutrality adjustments, IPPS hospitals with wage index adjustments benefit at the expense of all other hospitals,” said Alison Binkowski, MedPAC senior analyst. “On the other hand, non-budget-neutral wage index adjustments increase IPPS payments, which place added strain on the Medicare trust fund and increase beneficiary cost-sharing.”

Adjustments that pose concern

Two types of adjustments particularly cause widespread issues in AWI computations.

One is geographic reclassification, which allows a hospital that meets certain criteria to reclassify to a different market for the purposes of determining its wage index. Among the 33% of hospitals that reclassified for FY22, wage index increases ranged up to 40.7%, with a median of 5.8%

CMS estimated that IPPS base payments would rise by 1.3% due to reclassification, with rural hospitals reaping almost the entire increase. Since reclassification is required to be budget-neutral for Medicare, total IPPS payments were reduced by that same amount.

The rural floor and imputed rural floor are other adjustments that pose concerns. The rural floor ensures that within any state, wage indexes for hospitals in designated urban areas are no less than those in rural areas. The imputed rural floor establishes a minimum index for hospitals in all-urban states (i.e., states without a designated rural area).

In FY22, those floors applied to 11% of IPPS hospitals. The rural floor provided a median 3.9% increase. Like reclassification (but unlike the imputed rural floor), the adjustment must be budget-neutral, causing IPPS payments in FY22 to be reduced by 0.7%.

“In one notable example, the rural floor in one state was set using the wage data of a single rural hospital, resulting in an increase of more than 30% to some urban hospitals in that state,” said Bhavya Sukhavasi, a research assistant with MedPAC.

Criticism from commission members

Brian DeBusk, PhD, a MedPAC member and CEO of DeRoyal Industries, remarked that he lives in Knoxville, Tennessee, “which is a hospital wage index desert.”

Hospitals in that market “can’t afford to pay nurses competitive wages,” DeBusk said. “They can’t afford educational assistance programs. They cannot afford benefit programs. They’re in a perpetual cost-cutting mode.”

At the same time, adjustments to Medicare payments ultimately lead to a lower wage index. “When you get in this spiral, it’s virtually impossible to get out,” DeBusk said.

Paul Ginsburg, PhD, MedPAC vice chairman, chair of health policy studies at the Brookings Institution and professor of health policy at the University of Southern California, said comprehensive reform of the wage index should be considered.

“It was a weak policy from the start, and it seems as though it has only gotten worse over time,” he said. “It’s been modified many times. So this has been a policy failure.”

It’s unclear how receptive Congress would be to enacting recommendations for true reform. Said Ginsburg, “Will they just blow it off and continue to do tweaks that benefit hospitals in their districts, or is there really an appreciation of how the integrity of this whole policy has been repeatedly trashed over time?”

Considering unintended consequences

If MedPAC proposes an alternative to the AWI, said Jonathan Perlin, MD, PhD, a MedPAC member and president of clinical operations and chief medical officer with HCA Healthcare, the impact of changes on various types of hospitals would need to be evaluated.

Struggling hospitals aren’t “solely distributed in the low-AWI areas,” Perlin said. “They’re more broadly distributed. So [changes] could adversely impact a slew of hospitals.”

The ideal scenario would be a streamlined formula in which boosting some hospitals doesn’t risk hampering others. For categories of hospitals that merit additional payments, Binkowski said, “I think we would say they should be outside of wage index policy, which is an inefficient way that affects other hospitals.”

Said Chernew, “If there is a problem with safety net hospitals, for example, the right way to solve that problem is not to have an imputed rural wage floor. The right way to do that would be to find a targeted policy to help those institutions that you really think need help.”