in Figure 1-1. In summary, the payment for each patient is determined by making adjustments to a national standard payment rate to account for patient and hospital characteristics, including hospital location, that are thought to affect the cost of efficiently provided inpatient care. Patient characteristics are accounted for by the case mix adjustment. Each patient is assigned to one of 747 Medicare Severity-Diagnosis Related Groups (MS-DRGs). Each MS-DRG carries a specific weight, which reflects the relative costliness of patients in that category compared with the average Medicare patient. Hospital location is accounted for by the wage index adjustment. Each hospital is assigned to a labor market: a metropolitan statistical area (MSA) or a statewide non-MSA. Each labor market is assigned a specific index value, which is intended to reflect the variation in prevailing wage levels across labor markets.

In addition to these adjustments to the standard payment rate, separate amounts are added to fulfill certain public policy goals. These policy adjustments include a percent add-on to Medicare payments for teaching hospitals and for hospitals that serve a disproportionate number of low-income patients. Extra payments are also made to reimburse hospitals for the cost of using certain expensive new technologies and to protect against the risk of large financial losses associated with treating atypically high-cost patients. A reduction is made if the hospital transfers a patient earlier than usual to another hospital or a post-acute care setting (such as a skilled nursing facility). Table 3-1 illustrates the calculation of the wage index and shows the effects of each adjustment, including the wage index, on payments to hospitals in four different geographic areas.

Other payment supports apply to hospitals in nonmetropolitan areas. Rural referral centers1 (RRCs) receive payments for inpatient care equal to what hospitals in metropolitan areas would receive for furnishing the same services (42 CFR 412.96). Sole community hospitals2 (SCHs) receive the IPPS federal rate, or the updated hospital-specific rate based on fiscal years 1982, 1987, 1996, or 2006 per discharge—whichever is highest (CMS, 2011). Finally, critical access hospitals3 (CAHs) are small rural facilities that are not paid under the IPPS system; rather, Medicare pays 101 percent of their costs on a per-patient basis (MedPAC, 2007b).

Figure 3-1 shows how different wage indexes affect payment for the same type of patient at hospitals in four different areas.

The wage index adjustment is currently computed as the average hourly wage (AHW) paid by all IPPS hospitals in each labor market area divided by the AHW for all IPPS hospitals nationwide. The data come from Worksheet S-3 (see Appendix H) of the cost reports that hospitals are required to submit annually to the Centers for Medicare and Medicaid Services (CMS). The index is updated each year on the basis of the latest available complete set of data, after review and verification or correction of any questionable data. Constructing the HWI requires three basic steps:


1 A facility qualifies as an RRC if it is located in a rural area and has a minimum of 275 beds. At least 50 percent of RRC Medicare patients are referred by another hospital or physician, and at least 60 percent of those patients live more than 25 miles away.

2 A facility qualifies as an SCH if it is the only entity that can make inpatient services “reasonably available” to a given population due to isolation, geographic barriers, weather, or distance (the hospital is at least 35 miles away from the next nearest hospital).

3 A facility qualifies as a CAH if it has a maximum of 25 beds dedicated to acute care patients, up to 10 beds for psychiatric care, and 10 beds for rehabilitation. A CAH is at least 15 miles by secondary road, or 35 miles by main road, from the nearest hospital, or it is deemed a “necessary provider.”

The National Academies | 500 Fifth St. N.W. | Washington, D.C. 20001
Copyright © National Academy of Sciences. All rights reserved.
Terms of Use and Privacy Statement