The Medicare hospital inpatient prospective payment system (PPS) is designed to pay hospitals for services provided to Medicare beneficiaries based on a national average payment amount, adjusted for two factors that affect hospitals' costs: the patient's condition and related treatment strategy and market conditions in the hospital's location. Policy adjustments are also made for hospitals that operate resident training programs, treat a disproportionate share of low-income patients or are located in a rural area and meet certain criteria. The adjustments to the national rate are intended to recognize differences in resource use across types and location of hospitals. According to the Medicare Payment Advisory Commission (MedPAC), inpatient PPS payment rates are "intended to cover the costs that reasonably efficient providers would incur in furnishing high quality care."
One of the significant adjustments in the IPPS is an adjustment for market conditions, or the area wage index (AWI). The AWI is intended to measure differences in hospital wage rates among labor markets; it compares the average hourly wage for hospital workers in each metropolitan statistical area (MSA) or statewide rural area to the nationwide average. A hospital may request reclassification to an adjacent market area for its wage index (and capital payment geographic adjustment factor), based on certain wage and distance criteria. In 2007, CMS implemented an "occupational mix" adjustment to the AWI for nursing-related personnel to ensure that wage index values do not reflect the effects of differences in the mix of workers (for example, a greater share of RNs and smaller share of nurse aides in some areas). The AWI is revised each year based on wage data reported by inpatient PPS hospitals.
The AWI adjusts a large portion-the labor-related portion of the national average base rate (usually called the "labor share"). The "labor share" reflects an estimate of the portion of costs affected by local wage rates and fringe benefits. CMS currently estimates the labor share at 68.8 percent, which is utilized in calculating payments to hospitals with a wage index above 1.0. Congress legislated a labor share of 62 percent for areas with a wage index less than or equal to 1.0.
In 2011, the AHA created a Task Force to identify and evaluate the strengths and weaknesses of the current hospital area wage index; develop a set of principles by which to evaluate various proposals to modify the hospital area wage index, including review of AHA's existing principles; evaluate proposals and studies to change the hospital area wage index; and make recommendations to improve the accuracy, fairness and effectiveness of the hospital area wage index.