Updating the Area Wage Index: We Could Fix It Or Just Move to Value-Based Payments

With a rural senator taking the helm of the all-powerful Senate Finance Committee, hospital policies may see some updates. Charles Grassley, a Republican of Iowa, looks out for rural providers.

But is it small reforms we need, or a broader shift to value-based payments?

Let’s talk about Medicare’s 35-year-old area wage index.

In 1983, Medicare implemented the area wage index as an adjustment to the payment system under Medicare Part A with set rates for each diagnosis-related group, or inpatient prospective system. This was done to recognize that providing care in some areas is more expensive than others. The adjustment assigns each hospital to a labor market and each labor market an index value based on the relative cost of labor, a large component of expense.

This policy began as a measure to push hospitals to operate in a more efficient manner. Basically, the policy ensures that New York City hospitals get more than Montana hospitals.

Each year, the wage index is adjusted based on data the Centers for Medicare and Medicaid Services receives from hospital cost reports. The data are analyzed and defined into core-based statistical areas by the Office of Management and Budget, not CMS. Each CBSA index value is a ratio of that particular area’s average hourly wage to the national hourly wage. So, a CBSA value above 1.0 would be greater than the national average.

Like any rule, there are some exceptions. Realistically, this policy makes sense: Providing higher salaries for employees in areas where the labor market is more competitive likely means recruiting more specialized, qualified workers. However, as it stands, the AWI is not operating with national praise, as the rural areas are not compensated as much. Is it possible that the AWI isn’t the only problem here?

In 2011, the American Hospital Association designed the Medicare Area Wage Index Task Force to identify and help solve the issues in the current area wage index.

The Medicare Payment Advisory Commission, the nonpartisan commission that studies Medicare payment policy, stated “the current wage index is flawed in that it is based only on data from hospitals, rather than data for all of the health care providers in a given market” in a recent letter to CMS Administrator Seema Verma.

The National Academy of Sciences also stated improvements must be made in the area wage index’s data source, inputs and weighting.

In 2017, the bipartisan, budget-neutral Fair Medicare Hospital Payments Act of 2017 was introduced by Rep. Diane Black (R-Tenn.) and would establish a national minimum AWI of 0.874. Rep. John Duncan (R-Tenn.), along with 46 other members, stated their concerns on the AWI in a letter to the Department of Health and Human Services this past year.  

The AHA noted its appreciation for a few policies in the final 2019 IPPS rule but closed the press release by noting “at the same time, there are additional policy changes, including those affecting the area wage index that we are analyzing to determine their ultimate impact.”

This issue can become somewhat convoluted, as other factors also determine the amount a hospital is paid. The main factors are DRG hospital payments, disproportionate share hospital pay, indirect medical education and new technology, as well as outliers. So, is the AWI the real issue here, or is it the fee-for-service model? Can we reach a point where there is a level playing field?

The main drivers for AWI modernization are from rural areas that are not compensated as generously as those along the coast, where there is greater urban density.  

As an example, the mostly rural state of Pennsylvania is currently testing a rural health model that has some of its roots in Maryland’s all-payer model. The goal is to decrease expenditures across payers, while ensuring rural hospitals can survive financially and provide access to high-quality health care. CMS thinks this model will do just that and provide insight on the impact of alternative payment models on rural providers.

Maryland has been using its all-payer model, in some way, for over 40 years. Starting in 2019, the Maryland model will expand to non-hospital settings, which is estimated to save $1 billion over five years, per the Maryland Hospital Association.

So, if one state is doing this successfully and another is testing it on the rural community, why isn’t everyone? Movement toward a single-payer model for health care is a hotly debated topic. This leads us to wonder: Where does the issue lie, and what can be done to solve it? Can we modernize the area wage index, or should we focus our efforts in driving toward a value-based model that will make the payment system more equitable? It is clearly feasible for states to use an all-payer model, but moving in that direction may be a bigger feat.

As a country, we are slowly moving to value-based payments and can begin to reduce the variation in payments nationally, so that we are truly reflecting difference in costs in the area and not also capturing waste.

The area wage index is definitely a contributing factor to rural hospitals’ disapproval of the current payment system, and they will continue to try and modernize this antiquated policy.  What can be done? The Bureau of Labor Statistics could collect better/broader data. Still, how much the AWI contributes to the flaws of the payment system and what the ultimate solution should be remain unclear.

The question becomes: Should we worry about fixing the wage index in a dying fee-for-service world, or should we focus on geographic adjustments within the context of alternative payment models moving forward? We think it’s time for the latter.


Ipsita Smolinski is managing director of Capitol Street, where she advises clients on national health care policy and emerging trends.

Sabrina Thorsen, a fellow of Capitol Street, is a recent graduate of James Madison University, where she studied biotechnology.

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