This chapter builds on the description of labor markets in Chapter 2 and the discussion of the HWI in Chapter 3. It begins by providing background on the current wage index, the extent of the “wage cliff” problem, and how wage differentials between nearby areas are addressed under the current geographic adjustment system through the system of reclassifications and exceptions described in Chapters 1 and 3. The chapter goes on to describe other approaches for refining markets using formula-based smoothing techniques, and then examines modeling results for three specific smoothing methods that were evaluated by the committee. Finally, the chapter offers the committee’s recommendations for a smoothing approach based on commuting patterns of health care workers.


The original current HWI is computed from Inpatient Prospective Payment System (IPPS) hospital data, after adjusting the hourly wages for occupational mix differences but before making any labor market reassignments or other adjustments. The values of the 2011 original (or “pre-reclassification”) index range from 0.671 to 1.638, excluding values in the territories. Reclassification and other adjustments narrow the range—the lowest index value after reclassification is 0.743. Reclassification also reduces the number of wage cliffs. Under the original index, there are 1,709 pairs of hospitals located within 25 miles of each other that have an index value difference of 0.10 points or more. Under the final post-reclassification index, there are only 614 pairs of hospitals with a difference of 0.10 points or more.

Adjustments and exceptions to labor markets under the current IPPS can be grouped into three types: those with a rationale based on commuting patterns, those with a rationale based on individual hospital wages, and those that serve a policy or political objective but are not based on technical improvements to the index (see Table 4-1).

“Lugar counties” were the first wage index exceptions, enacted as part of the Omnibus Reconciliation Act of 1987. Lugar counties are nonmetropolitan counties located at the edges of non-MSA rest-of-state labor markets, where there is documentation that a substantial part of the population commutes into the neighboring MSA.1 Hospitals located in a Lugar county are “deemed urban” and automatically re-reclassified into the neighboring MSA.2

The most common type of labor market adjustment is reclassification granted through the Medicare Geographic Classification Review Board (MGCRB). Most of these are individual hospital reclassifications, and they can be granted for hospitals wanting to reclassify from a nonmetropolitan market to a nearby MSA, or from one MSA to another MSA. As described in Chapter 3, criteria for individual hospital reclassifications are based on geographic proximity to higher-wage markets as well as hospital-specific wage costs. Hospitals must meet what are known as “wage comparability criteria,” which require that the hospitals’ own average hourly wage is both comparable to the average wage of the labor market to which they are requesting reclassification and higher than the market wage where they are geographically located.

MGCRB can also grant requests to re-designate whole nonmetropolitan counties as metropolitan, which will qualify all hospitals in the county for reclassification into a neighboring


1 Code of Federal Regulations, Section 412.63.

2 The Omnibus Reconciliation Act of 1987 (P.L. 100-203) simply “deemed” them to be part of the neighboring MSA; a later amendment in the Omnibus Reconciliation Act of 1989 (P.L. 1-1-239) revised this and established Lugar counties as a type of reclassification in order to avoid penalizing the rural markets in which Lugar hospitals were physically located.

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