Final CMS Wage Index Rule May Seriously Impact Urban Hospitals

August 8, 2019

By: Linda A. Malek and Khaled Mowad

The Centers for Medicaid & Medicare Services (“CMS”) has issued a key rule revising its calculation methodology under the inpatient prospective payment system (“IPPS”) used to determine payments to acute care hospitals under Medicare Part A (hospital insurance).   

Among other things, the new rule increases the labor-related share of reimbursement for acute care hospitals in poorer rural areas, while maintaining budget-neutrality by reducing the national standardized IPPS base amount applicable to all hospitals. 

By way of background, Section 1886(g) of the Social Security Act (the “Act”) requires that CMS use a prospective payment system to pay for the capital-related costs of inpatient hospital services for acute care hospitals.  The base IPPS payment rate is comprised of a standardized amount that is divided into a labor-related share and a nonlabor-related share.  In order to account for variations in wages nationwide, the labor-related share is adjusted by the wage index applicable to the area where the hospital is located.  The IPPS also factors in additional payments if a hospital treats a high percentage of uninsured patients (disproportionate share hospital adjustment), is a teaching hospital (indirect medical education adjustment), and for particular cases that are unusually costly.

Rural Hospitals versus Urban Hospitals

Acknowledging the deep financial strains faced by many rural hospitals in part exacerbated by a phenomenon whereby a hospital with a low wage index reports those wages to CMS, which results in an even lower wage index (as the hospital may not have received the additional funds to raise wages to a competitive rate in light of actual growing wages) and corresponding difficulty retaining personnel, CMS proposed to substantially increase the wage index for hospitals with a wage index value below the 25th percentile.  However, CMS proposed to accomplish this in a budget neutral way by decreasing the wage index for hospitals with wage index values above the 75th percentile, a category comprised, in many cases, of urban hospitals serving low-income communities.   

Hospital associations across the country objected forcefully to the proposed rule, arguing that it would arbitrarily aid struggling rural hospitals at the expense of struggling urban hospitals without any evidence that the wage index inaccurately reflects actual disparities between wages in different parts of the country.1 These associations agreed that a better solution would be for greater Medicare Part A funding overall given that Medicare reimburses at rates below the actual cost of care, and argued that the Act does not mandate budget neutrality with respect to its adjustments to the wage index.   

The Final Rule

In the final rule, CMS decided to increase the wage index for hospitals with a wage index value below the 25th percentile.  The increase will be by half the difference between the otherwise applicable final wage index value for a year for that particular hospital and the 25th percentile wage index value for that year across all hospitals.  CMS, however, determined it was statutorily required to maintain budget neutrality.  It did so by adjusting the national standardized IPPS base amount applicable to all hospitals rather than just reducing the wage index for hospitals in the top quartile as it had initially sought to do in the proposed rule.  CMS argued that a wage index adjustment was justified from a technical perspective because wage indexes for low wage index hospitals did not reflect updated compensation data due to the lag time between cost reporting to CMS and when CMS’s wage index calculation is set.   Since this time lag applies to all hospitals and CMS produced no evidence of widespread data inaccuracies, it is debatable whether either the initially proposed reduction or the reduction in the final rule constitutes merely a “technical fix.”  

The new policy will be effective for at least four years beginning FY 2020 in order to allow hospital employee compensation increases sufficient time to be reflected in the wage index calculation.  CMS indicated it would consider providing even more implementation time for compensation increases to factor into the wage index.  To soften the blow to hospitals above the 25th percentile, CMS placed a 5 percent cap on any decrease in a hospital’s wage index from the hospital’s wage index in FY 2019.

In addition, CMS finalized its plan to remove wage data derived from urban hospitals that reclassified as rural hospitals from the calculation of the so-called “rural floor.”  The Balanced Budget Act of 1997 provides that the area wage index applicable to any hospital that is located in an urban area of a state may not be less than the area wage index applicable to hospitals located in rural areas of the state, i.e.  a “rural floor.”  The initial thinking here was to prevent the “anomaly” of an urban hospital (presumably facing higher labor costs) from being paid less than the average rural hospital in that state.  Beginning in FY 2020, the rural floor will calculated without including wage data of hospitals that have reclassified as rural. CMS explained that when an urban hospital reclassifies as rural in accordance under with Section 1886(d)(8)(E) of the Act and that hospital’s wage index is higher than the rural wage index, the “floor” is automatically raised thereby artificially raising the wage index.    CMS described this phenomenon as one of the “unanticipated effects of rural reclassifications on the rural floor.”  Whether this finding by CMS, as well as a 2018 report by the Office of Inspector General recommending that Congress repeal the rural floor, will actually lead to further policy changes, remains to be seen.   

Looking Ahead

Although the impact of the final rule on urban hospitals will be less drastic than the originally-proposed wage index adjustment, the effect will still be significant, in particular for states where the rural floor was influenced by reclassifications of urban hospitals.  This effect will likely be most pronounced in urban hospitals that serve large low income and uninsured communities.    While the final rule did adjust some aspects of the disproportionate share hospital adjustment calculation, including increasing payments by approximately $78 million, it does not appear that those changes were made with any view towards how hospitals receiving such payments (which tend to be the most financially vulnerable hospitals) might be disproportionately affected by the wage index changes as a whole.  We are actively monitoring policy changes to the IPPS and will provide updates as they arise.

1 See American Hospital Association, Detailed Comments on the PPS Proposed Rule for Fiscal Year 2020 (June 24, 2019),