Medicare Hospital Payments: Refinements Needed to Better Account for Geographic Differences in Wages (30-SEP-02, GAO-02-963). The Medicare program's prospective payment system (PPS) for inpatient hospital services provides incentives for hospitals to operate efficiently by paying them a predetermined, fixed amount for each inpatient hospital stay regardless of the actual costs incurred in providing the care. Although the fixed amount is based on national average costs, actual per stay payments vary widely across hospitals, primarily because of two payment adjustments in the PPS. One adjustment accounts for cost differences across patients due to their care needs and the other accounts for the substantial variation in labor costs across the country. The Medicare program's labor cost adjustment may not adequately account for geographic differences in hospital wages because of problems with the definition of labor markets. The geographic areas used by Medicare to approximate hospital labor markets often encompass large areas in which hospitals in different parts of an area or different types of communities pay widely varying wages. Geographic reclassification does not systematically address inadequacies in the way the Medicare program defines geographic areas, although it allows some, but not all, hospitals that may be in distinct labor market and pay wages above the average in their area to receive a higher labor cost adjustment. Geographic reclassification reduces payments to hospitals that do not reclassify because of the budget neutrality requirement, and the amount of this reduction would vary across hospitals under a state-specific budget neutrality approach depending on their location. In 2002, payments to metropolitan hospitals that were not reclassified were 1 percent lower and payments to nonmetropolitan hospitals that were not reclassified were 0.6 percent lower because of geographic reclassification. If the budget neutrality provision were calculated and applied within individual states instead of nationally, the adjustment would be smaller in those states in which hospitals did not benefit much from reclassification and higher in states where a higher proportion of hospitals reclassified. -------------------------Indexing Terms------------------------- REPORTNUM: GAO-02-963 ACCNO: A05195 TITLE: Medicare Hospital Payments: Refinements Needed to Better Account for Geographic Differences in Wages DATE: 09/30/2002 SUBJECT: Comparative analysis Compensation Health care cost control Health care costs Hospitals Labor costs Managed health care Salary increases Medicare Program Medicare Prospective Payment System Medicare Hospital Payments: Refinements Needed to Better Account for Geographic Differences in Wages (30-SEP-02, GAO-02-963). The Medicare program's prospective payment system (PPS) for inpatient hospital services provides incentives for hospitals to operate efficiently by paying them a predetermined, fixed amount for each inpatient hospital stay regardless of the actual costs incurred in providing the care. Although the fixed amount is based on national average costs, actual per stay payments vary widely across hospitals, primarily because of two payment adjustments in the PPS. One adjustment accounts for cost differences across patients due to their care needs and the other accounts for the substantial variation in labor costs across the country. The Medicare program's labor cost adjustment may not adequately account for geographic differences in hospital wages because of problems with the definition of labor markets. The geographic areas used by Medicare to approximate hospital labor markets often encompass large areas in which hospitals in different parts of an area or different types of communities pay widely varying wages. Geographic reclassification does not systematically address inadequacies in the way the Medicare program defines geographic areas, although it allows some, but not all, hospitals that may be in distinct labor market and pay wages above the average in their area to receive a higher labor cost adjustment. Geographic reclassification reduces payments to hospitals that do not reclassify because of the budget neutrality requirement, and the amount of this reduction would vary across hospitals under a state-specific budget neutrality approach depending on their location. In 2002, payments to metropolitan hospitals that were not reclassified were 1 percent lower and payments to nonmetropolitan hospitals that were not reclassified were 0.6 percent lower because of geographic reclassification. If the budget neutrality provision were calculated and applied within individual states instead of nationally, the adjustment would be smaller in those states in which hospitals did not benefit much from reclassification and higher in states where a higher proportion of hospitals reclassified. -------------------------Indexing Terms------------------------- REPORTNUM: GAO-02-963 ACCNO: A05195 TITLE: Medicare Hospital Payments: Refinements Needed to Better Account for Geographic Differences in Wages DATE: 09/30/2002 SUBJECT: Comparative analysis Compensation Health care cost control Health care costs Hospitals Labor costs Managed health care Salary increases Medicare Program Medicare Prospective Payment System ****************************************************************** ** This file contains an ASCII representation of the text of a ** ** GAO Product. ** ** ** ** No attempt has been made to display graphic images, although ** ** figure captions are reproduced. Tables are included, but ** ** may not resemble those in the printed version. ** ** ** ** Please see the PDF (Portable Document Format) file, when ** ** available, for a complete electronic file of the printed ** ** document's contents. ** ** ** ****************************************************************** GAO-02-963 Report to Congressional Committees United States General Accounting Office GAO September 2002 MEDICARE HOSPITAL PAYMENTS Refinements Needed to Better Account for Geographic Differences in Wages GAO- 02- 963 Page i GAO- 02- 963 Medicare Hospital Wage Variation Letter 1 Results in Brief 3 Background 5 Medicare Labor Cost Adjustment Does Not Adequately Account for Wage Differences within Certain Areas 11 Through Reclassification, Some Hospitals Receive a More Appropriate Labor Cost Adjustment 16 Budget Neutrality Adjustments Are Relatively Modest, but Would Vary under a State- Specific Option 20 Conclusions 22 Recommendations for Executive Action 23 Agency Comments and Our Evaluation 23 Appendix I Scope and Methodology 26 Appendix II The Effect of Accounting for Occupational Mix on the Wage Index 27 Appendix III Average Hospital Wages in Outlying and Central Counties of Metropolitan Areas, by State, Fiscal Year 1997 30 Appendix IV Average Hospital Wages across Community Types in Nonmetropolitan Areas, by State, Fiscal Year 1997 31 Appendix V Effect of the Current and a State- Specific Budget Neutrality Option on Hospital Payments, by State, Fiscal Year 2000 33 Contents Page ii GAO- 02- 963 Medicare Hospital Wage Variation Appendix VI Comments from the Centers for Medicare & Medicaid Services 35 Tables Table 1: Hospital Wage Variation in the Most Populous Metropolitan Statistical Areas, Fiscal Year 1997 13 Table 2: Average Hospital Wages across Nonmetropolitan Areas in Selected States, Fiscal Year 1997 16 Table 3: Reclassified Hospitals by Wage Level and Community Type, Fiscal Year 2001 18 Table 4: Area Average Wage Compared to Hospital Wage, before and after Reclassification, Fiscal Year 2001 20 Table 5: Effect of the Geographic Reclassification Budget Neutrality Requirement on Medicare Inpatient Hospital Payments, by Metropolitan and Nonmetropolitan Status, Fiscal Years 1995 through 2002 21 Table 6: Hospital Wages, Adjusted for Mix of Occupations, Oakland MSA and Nonmetropolitan California, Fiscal Year 1998 28 Table 7: Effect of an Occupational Mix Adjustment on Average Area Wages in California, Fiscal Year 1998 29 Figures Figure 1: Geographic Reclassification Criteria, Wage Index Reclassification for Individual Hospitals 9 Figure 2: Geographic Reclassification Criteria for all Hospitals in an Urban County 9 Figure 3: Hospitals Reclassified for Medicare Payment, Fiscal Years 1993- 2002 11 Figure 4: Hospital Wages by County, Washington, D. C. Metropolitan Statistical Area, Fiscal Year 1997 14 Page iii GAO- 02- 963 Medicare Hospital Wage Variation Abbreviations BBRA Medicare, Medicaid, and SCHIP Balanced Budget Refinement Act of 1999 BIPA Medicare, Medicaid, and SCHIP Benefits Improvement and Protection Act of 2000 CMS Centers for Medicare & Medicaid Services DRG diagnosis- related group HCFA Health Care Financing Administration MGCRB Medicare Geographic Classification Review Board MSA metropolitan statistical area OBRA Omnibus Budget Reconciliation Act OMB Office of Management and Budget PPS prospective payment system RN registered nurse RRC rural referral center RUCA rural urban commuting area SCH sole community hospital SCHIP State Children*s Health Insurance Program Page 1 GAO- 02- 963 Medicare Hospital Wage Variation September 30, 2002 Congressional Committees The Medicare program*s prospective payment system (PPS) for inpatient hospital services provides incentives for hospitals to operate efficiently by paying them a predetermined, fixed amount for each inpatient hospital stay regardless of the actual costs incurred in providing the care. Although the fixed amount is based on national average costs, actual per stay payments vary widely across hospitals, primarily because of two payment adjustments in the PPS. One adjustment accounts for cost differences across patients due to their care needs and the other accounts for the substantial variation in labor costs across the country. The fixed amount is adjusted for these two sources of cost differences because they are largely beyond any individual hospital*s ability to control. The labor cost adjustment is based on a wage index calculated for specified geographic areas across the country. The wage index reflects how average hospital wages in each geographic area compare to average hospital wages nationally. 1 The geographic areas are intended to represent the separate labor markets in which hospitals compete for employees. Each metropolitan area, as defined by the Office of Management and Budget (OMB), is considered a single labor market, and all areas outside of metropolitan areas in each state are treated as a single labor market. All hospitals within a given geographic area receive the same labor cost adjustment. Thus, Medicare*s payment to a hospital in an area with lower wages is below the national average payment and the payment to a hospital in a higher wage area is above the national average. In general, hospitals in nonmetropolitan areas have lower wages than those in metropolitan areas and therefore have a lower wage index and receive lower Medicare payments. Conversely, hospitals in metropolitan areas tend to pay higher wages than hospitals in nonmetropolitan areas and receive higher Medicare payments. The labor cost adjustment has been criticized for failing to appropriately adjust payments to reflect the average wages that some hospitals pay. Some hospitals indicate that the wages they must pay are higher than the 1 The hospital wage index reflects total employee compensation, including hospital spending for employee wages and benefits. United States General Accounting Office Washington, DC 20548 Page 2 GAO- 02- 963 Medicare Hospital Wage Variation average wages in their assigned geographic area because they must compete for employees with hospitals in nearby, higher wage areas. To address these concerns, the Congress in 1989 established an administrative process for geographic reclassification, which allows hospitals that meet criteria concerning their average wages and proximity to a higher wage paying area to reclassify. 2 A reclassified hospital is paid based on the Medicare labor cost adjustment of the higher wage area. In addition, certain specially designated rural hospitals can reclassify to a higher wage area by meeting less stringent criteria. The Congress required that the reclassification policy be budget neutral, that is, not change total Medicare outlays, so the increased payments to reclassified hospitals are offset by an across- the- board reduction in payments to other hospitals. In the Medicare, Medicaid, and SCHIP Balanced Budget Refinement Act of 1999 (BBRA), 3 the Congress directed us to evaluate Medicare*s labor cost adjustment policies. In consultation with the committees of jurisdiction, we have examined (1) whether Medicare*s labor cost adjustment accounts appropriately for geographic variation in average wages, (2) the extent to which reclassification addresses potential problems with Medicare*s labor cost adjustment, and (3) the effect of the budget neutrality adjustment on hospitals that do not reclassify, including the impact of altering the budget neutrality adjustment so that payment increases to reclassified hospitals in a state would be funded by payment reductions to hospitals within the same state, rather than across all hospitals nationwide, as is done now. To address these issues, we used 1997 Medicare hospital cost reports (the comprehensive financial document that hospitals submit annually to receive payment from Medicare) to analyze hospital wage data, because 1997 wage data were used to calculate the 2001 wage indexes. 4 We also analyzed more recent Medicare hospital cost report data, PPS Payment Impact Files, and wage data in California Hospital Annual Disclosure Reports submitted to the California Office of Statewide Health Planning and Development. We also interviewed officials at the Centers for 2 Omnibus Budget Reconciliation Act of 1989, Pub. L. No. 101- 239, sec. 6003( h), 103 Stat. 2106, 2154 (classified to 42 U. S. C. sec. 1395ww( d) (Supp. I 1989)). 3 Pub. L. No. 106- 113, Appendix F, sec. 410, 113 Stat. 1501A- 321, 376. 4 Annual numbers throughout this report refer to fiscal years unless otherwise noted. Page 3 GAO- 02- 963 Medicare Hospital Wage Variation Medicare & Medicaid Services (CMS); 5 the Medicare Geographic Classification Review Board (MGCRB), which reviews and approves reclassification applications; and representatives of some hospitals that have been reclassified. We did our work in accordance with generally accepted government auditing standards from January 2000 through September 2002. A detailed discussion of our scope and methodology is in appendix I. The Medicare program*s labor cost adjustment may not adequately account for geographic differences in hospital wages because of problems with the definition of labor markets. The geographic areas used by Medicare to approximate hospital labor markets often encompass large areas in which hospitals in different parts of an area or different types of communities may pay widely varying wages. The patterns of wage variation indicate that some of the geographic areas combine multiple labor markets. Hospitals in some outlying counties of metropolitan areas pay average wages that are lower than the average wage paid in the entire area, yet the labor cost adjustment to their Medicare payments is based on the entire area*s average and reflects the higher wages of hospitals in the central counties. In nonmetropolitan areas, hospitals in large towns (with populations of 10,000 to 49,999 people) typically pay higher wages than hospitals in small towns and rural communities. Yet, the labor cost adjustment for large town hospitals is based on the average wage of all nonmetropolitan hospitals in their state. As a result, Medicare*s labor cost adjustment for large town hospitals often reflects a lower average wage than if the adjustment were based on the average wages they pay. Geographic reclassification does not systematically address inadequacies in the way the Medicare program defines geographic areas, although it allows some, but not all, hospitals that may be in a distinct labor market and pay wages above the average in their area to receive a higher labor cost adjustment. Hospitals in large towns that pay wages that are so much higher than the average in their area that they satisfy the reclassification wage criterion are likelier than such higher wage hospitals in other community types to reclassify. This is because many hospitals in large towns are specially designated rural hospitals that can reclassify without 5 On July 1, 2001, the agency that administers the Medicare program was renamed from the Health Care Financing Administration (HCFA) to CMS. This report refers to the agency as HCFA when discussing actions taken before the name change and as CMS when discussing actions taken after the name change. Results in Brief Page 4 GAO- 02- 963 Medicare Hospital Wage Variation satisfying the proximity criterion that they be near an area with a higher labor cost adjustment. Metropolitan hospitals with wages that are higher than their area average are less likely to reclassify because they must satisfy the proximity criterion and few are near another metropolitan area with a higher labor cost adjustment. Conversely, a number of hospitals reclassify, even though the wages they pay are not significantly higher than the average in their geographic area. Hospitals that reclassify without satisfying the wage criterion receive a labor cost adjustment that is based on average wages that are higher than what they actually pay. Reclassified hospitals that satisfy the wage criterion tend to receive a labor cost adjustment that more closely reflects the wages they actually pay than their labor cost adjustment prior to reclassification. Geographic reclassification reduces payments to hospitals that do not reclassify because of the budget neutrality requirement, and the amount of this reduction would vary across hospitals under a state- specific budget neutrality approach depending on their location. In 2002, payments to metropolitan hospitals that were not reclassified were about 1 percent lower and payments to nonmetropolitan hospitals that were not reclassified were about 0.6 percent lower because of geographic reclassification. If the budget neutrality provision were calculated and applied within individual states instead of nationally, the adjustment would be smaller in those states in which hospitals did not benefit much from reclassification and higher in states where a higher proportion of hospitals reclassified. For example, our analysis indicates that a statespecific adjustment in 2000 would have reduced payments to hospitals that did not reclassify by almost 3 percent in New Hampshire, where 4 out of its 26 hospitals reclassified, and hospitals in Nevada would not have had their payments changed because no hospitals in that state reclassified. We recommend that the Administrator of CMS improve the adequacy of the Medicare labor cost adjustment by refining the definitions of Medicare geographic areas to more accurately reflect hospital labor markets. In written comments to a draft of this report, CMS agreed that there are problems with Medicare*s current definitions of geographic areas and it stated that there is no consensus on how to improve the definitions. Page 5 GAO- 02- 963 Medicare Hospital Wage Variation Under the Medicare inpatient PPS, hospitals receive a fixed, predetermined payment for each hospital stay. The payment is based on standardized amounts that are calculated separately for hospitals in large metropolitan areas (with populations of 1 million or more) and for hospitals in smaller metropolitan and nonmetropolitan areas. The standardized amounts are the average cost of hospital stays for Medicare beneficiaries based on historical data and are updated annually for inflation. 6 For 2001, the standardized amount for hospitals in large metropolitan areas was $4,028 and for hospitals in other areas it was $3,965. To determine a hospital*s payment for a Medicare beneficiary*s stay, the standardized amount is adjusted to account for variation in the cost of providing care to specific patients in specific locations. The labor cost adjustment accounts for geographic variation in hospitals* labor costs, because the wages hospitals must pay employees vary significantly by area. 7 The portion of the standardized amount (71 percent) that reflects labor- related expenses is multiplied by the area wage index. The remaining portion of the standardized amount (29 percent) is not adjusted. 8 This part of the payment* which covers drugs, medical supplies, utilities, and other nonlabor- related expenses* is uniform nationwide because prices for these items are not perceived as varying significantly from area to area. The case- mix adjustment accounts for differences in resource requirements across types of patients. It is based on the expected care needs of the patient as measured by the diagnosis- related group (DRG) patient classification system. 9 6 This discussion pertains to Medicare*s payments for hospital operating costs; Medicare*s payments for hospital capital costs are not included. 7 For example, wages for registered nurses (RN) in Seattle were 18 percent above the national average in 1999, while wages for RNs in nonmetropolitan Alabama were 16 percent below the national average. 8 Hospitals in Alaska and Hawaii also receive cost- of- living adjustments for the nonlabor portion of the standardized amount. 9 There are approximately 500 DRGs, each of which is intended to distinguish patients with similar clinical conditions who receive similar treatments. Each DRG is assigned a relative weight, which compares its costliness to the average for all DRGs, and is used to adjust the standardized amount. For example, Medicare*s payment to a hospital to treat a Medicare beneficiary with a respiratory infection with complications is nearly twice that for a beneficiary with a kidney and urinary tract infection with complications. Background Page 6 GAO- 02- 963 Medicare Hospital Wage Variation Additional payments are made under PPS to compensate hospitals for costs they incur in performing certain missions beyond caring for individual patients. Teaching hospitals receive additional payments from Medicare to account for costs associated with training medical residents. Hospitals that serve a disproportionate share of low- income Medicare and Medicaid patients also receive additional Medicare payments. The combination of all these adjustments and additional payments may result in widely varying per- stay payments across different types of hospitals or geographic areas. The Medicare labor cost adjustment is based on a wage index that is computed for each of 324 metropolitan and 49 statewide nonmetropolitan areas using data that hospitals submit to Medicare. 10 The wage index for an area is the ratio of the average hourly hospital wage in the area compared to the national average hourly hospital wage. The average hourly wage is calculated for each area by aggregating Medicare- allowable wages for all the hospitals in the area and then dividing that sum by the corresponding staff hours. The area*s average hourly wage is then divided by the national average hourly wage to produce the area*s wage index. 11 For example, if the average hourly wage for all hospitals in a large metropolitan area was $22.59, the wage index for that large metropolitan area would be $22.59 divided by the national average hourly wage of $21.77, for a wage index of 1.04. The wage indexes ranged from roughly 0.74 to 1.5 in 2001. As currently calculated, the wage indexes vary because of geographic differences in wages paid and also because of variation in the mix of higher- and lower- skilled workers employed in an area, termed occupational mix. An area*s average hourly wage can be higher than the national average if hospitals in an area employ more highly skilled (and 10 New Jersey, Rhode Island, and Washington, D. C. do not have any nonmetropolitan areas, and therefore do not have a statewide nonmetropolitan wage index. Numbers include Puerto Rico*s six urban and one rural geographic areas. 11 Calculations for the 2001 Medicare wage index were based on 1997 Medicare hospital cost report data. The fiscal intermediaries who contract with CMS to process Medicare claims review the wage data reported by hospitals on the cost reports. The fiscal intermediaries apply basic checks as directed by CMS, flagging any wage data that fall outside of specific parameters. When aberrant data are found, the fiscal intermediaries require hospitals to either provide documentation to support their reported wage data, or to correct inaccuracies. Among the 4 fiscal intermediaries we contacted, none tracked the frequency of aberrant data, but they did not perceive that inaccurate wage reporting by hospitals was a major problem. Wage Index Page 7 GAO- 02- 963 Medicare Hospital Wage Variation thus more highly paid) workers and lower if an area*s hospitals employ more lower- skilled workers than the national average. 12 When one area*s hospitals have a larger proportion of more skilled, higher wage staff than another area, the former*s wage index will be higher, even if wage rates in both areas for staff with the same skills, such as registered nurses, are identical. While geographic differences in wages paid affect a hospital*s labor costs but are largely beyond an individual hospital*s ability to control, the mix of occupations employed in a hospital reflects managerial decisions. The Congress, in the Medicare, Medicaid, and SCHIP Benefits Improvement and Protection Act of 2000 (BIPA), 13 required the Secretary of Health and Human Services to collect data on hospitals* mix of employees and their corresponding wages and calculate wage indexes beginning October 1, 2004, that are adjusted for occupational mix. (For a more detailed discussion of the impact of occupational mix variation on the wage index, see app. II.) The Medicare program uses OMB*s *metropolitan/ nonmetropolitan* classification system to define its geographic areas for the labor cost adjustment. Each metropolitan statistical area (MSA) is defined as a metropolitan labor market and the residual area in each state is defined as a single, nonmetropolitan labor market. 14 The current geographic areas will most likely change when MSA boundaries are updated in 2003 with population data from the most recent decennial census and revised standards for selecting counties for inclusion in an MSA. 15 12 To the extent that certain hospitals hire more workers in higher- skilled occupations because they treat patients needing more complex care than other hospitals, the payment adjustment that reflects patient care needs, made through the DRG system, is intended to account for the resulting higher costs. 13 Pub. L. No. 106- 554, Appendix F, sec. 304, 114 Stat. 2763A- 463, 494 (classified to 42 U. S. C. sec. 1395ww( d)( 3)( E) (2000)). 14 MSAs are groups of counties containing a core of at least 50, 000 people, together with adjacent areas having a high degree of economic and social integration with that core. OMB defines the central county or counties of an MSA as those containing the largest city or urbanized area. An outlying county or counties qualify for inclusion in a metropolitan area based on the amount of commuting to the central counties and other specified measures of metropolitan character. 15 New standards for whether to include an outlying county in an MSA will be applied to 2000 census data. Previously, the standards were based on population density in the outlying county and the amount of commuting to central counties. The new standards exclude population density as a criterion and apply a single standard of commuting levels. Labor Market Areas Page 8 GAO- 02- 963 Medicare Hospital Wage Variation The Omnibus Budget Reconciliation Act of 1989 established an administrative process for geographic reclassification, in which hospitals meeting certain criteria can apply to be paid for Medicare inpatient hospital services as if they were located in another geographic area. Once reclassified, hospitals receive the higher labor cost adjustment and, where applicable, the large urban standardized amount. 16 To reclassify, a hospital must submit an application to the MGCRB, which determines if the hospital meets the reclassification criteria (see fig. 1). The two standard criteria that individual hospitals must meet to reclassify for a higher wage index are intended to identify hospitals that have higher average wages than other hospitals in their area because they are competing for labor with hospitals in a different nearby area. The first criterion concerns the hospital*s proximity to the higher wage *target* area. The proximity requirement is satisfied if the hospital is within a specified number of miles of the target area or if at least half of the hospital*s employees reside in the target area. The second criterion pertains to the hospital*s wages relative to the average wages in the target area. The wage criterion is satisfied if the hospital*s wages are a specified amount higher than the average in its assigned area and its wages are comparable to the average wages in the target area. Wage index reclassifications are effective for 3 years. 17 16 Initially, geographic reclassification only applied to hospital inpatient PPS payments. However, in establishing the PPS for hospital outpatient services, the Balanced Budget Act of 1997 directed the Secretary of Health and Human Services to develop a method of adjusting outpatient PPS payments to account for variation in wages (Pub. L. No. 105- 33, sec. 4523, 111 Stat. 251, 445 (classified to 42 U. S. C. sec. 13951 (Supp. IV 1998))). The Secretary subsequently determined that outpatient PPS payments would be subject to the inpatient hospital labor cost adjustment, including the effects of geographic reclassifications. As a result, reclassified hospitals receive a higher labor cost adjustment to both inpatient and outpatient payments. 17 A hospital may also reclassify to receive the higher standardized amount. It must satisfy the proximity criterion and its costs must be significantly greater than its current payment. This type of reclassification has declined and is not the focus of our analyses. Geographic Reclassification Page 9 GAO- 02- 963 Medicare Hospital Wage Variation Figure 1: Geographic Reclassification Criteria, Wage Index Reclassification for Individual Hospitals Source: 42 CFR 412.230 (2001). All hospitals in an urban county can reclassify as a group if together the hospitals meet certain criteria, as described in figure 2. Figure 2: Geographic Reclassification Criteria for all Hospitals in an Urban County Source: 42 CFR 412.234 (2001). Rural referral centers (RRC) and sole community hospitals (SCH) can reclassify by meeting less stringent criteria. These hospitals receive special treatment from Medicare because of their role in preserving access to care for beneficiaries in specified areas. RRCs are relatively large rural Page 10 GAO- 02- 963 Medicare Hospital Wage Variation hospitals providing an array of services and treating patients from a wide geographic area. SCHs are small hospitals isolated from other hospitals by location, weather, or travel conditions. 18 RRCs and SCHs do not have to meet the proximity criteria to reclassify. RRCs are also exempt from the requirement that their wages be higher than the average wages in their original area. Hospitals that have lost their RRC designation can continue to reclassify under these less stringent criteria. In 1992, the first year of reclassifications, 930 hospitals were reclassified under less restrictive criteria than those currently used. More than 75 percent of these hospitals were in nonmetropolitan areas. In the following year, almost 1,200 hospitals were reclassified (of which 69 percent were in nonmetropolitan areas). For 1994, HCFA established more restrictive criteria and the number of reclassified hospitals subsequently dropped by approximately 44 percent, to 667 (see fig. 3). From 1995 to 2002, wage index reclassifications became more predominant, increasing by an average of 6 percent annually, while standardized amount reclassifications fell by almost one- quarter. For 2002, 511 nonmetropolitan hospitals and 117 metropolitan hospitals were reclassified for Medicare payment purposes. Individual hospitals have also been reclassified through legislation. Recently, the BBRA reclassified all hospitals in 7 counties (this totaled 26 hospitals) for purposes of the wage index and the standardized amount. 19 18 SCHs may elect to be paid based on their own costs or the applicable PPS payment amount. SCHs electing payments under the PPS may qualify to be reclassified. See U. S. General Accounting Office, Medicare*s Rural Hospital Payment Policies, GAO/ HEHS- 00- 174R, (Washington, D. C.: Sept. 15, 2000) for more detail on rural hospital designations. 19 Sec. 152, 113 Stat. 1501A- 334. Under a statutory provision on the length of wage index reclassifications, these hospitals were effectively reclassified for a 3- year period. See BIPA, Sec. 304, 114 Stat. 2763A- 494. Another example of legislatively reclassified hospitals is found in the so- called *Lugar hospital* designation, enacted in 1987. Certain rural counties are deemed urban if they are adjacent to urban areas and they conform to certain criteria based on residents* commuting patterns and population density as defined by OMB. See Omnibus Budget Reconciliation Act of 1987, Pub. L. No. 100- 203, sec. 4005( a), 101 Stat. 1330, 1330- 47 (classified to 42 U. S. C. sec. 1395 ww( d)( 8) (1988)). Hospitals in these counties receive Medicare payments based on the standardized amount and the wage index of the adjacent urban area. The number of Lugar hospitals stayed relatively constant through 2001, with 27 hospitals in 22 counties affected by this provision. Updates to the criteria for determining metropolitan character resulted in an increase in the number of Lugar hospitals to 41 in 31 counties in 2002. As long as OMB deems the county urban, Lugar hospitals located in the county will continue to receive Medicare payments as urban hospitals. Page 11 GAO- 02- 963 Medicare Hospital Wage Variation Figure 3: Hospitals Reclassified for Medicare Payment, Fiscal Years 1993- 2002 Source: PPS Payment Impact Files, fiscal years 1993- 2002. The geographic areas that Medicare uses for the labor cost adjustment include hospitals that pay wages that may be quite different from the average wage in the entire geographic area. Hospital wages within some Medicare geographic areas* either MSAs or states* nonmetropolitan areas* vary systematically across certain parts of the area or across types of communities. While wages paid by individual hospitals within a labor market may vary, the observed systematic variation suggests that some Medicare geographic areas include multiple labor markets. For example, the average wages of the hospitals in outlying counties of metropolitan areas usually are lower than the average wages for the entire metropolitan area*s hospitals. As a result, the labor cost adjustment for hospitals in outlying counties of metropolitan areas is based on an average wage that is Medicare Labor Cost Adjustment Does Not Adequately Account for Wage Differences within Certain Areas Page 12 GAO- 02- 963 Medicare Hospital Wage Variation often higher than the wages paid by these hospitals. In contrast, the average wages paid by hospitals in large towns (nonmetropolitan communities with between 10,000 and 49,999 people) tend to be significantly higher than the average wage of all hospitals in nonmetropolitan areas in the state. Some MSAs are very large, encompassing a diverse mix of counties. Given the broad expanse of many large MSAs, the hospitals in the different parts of an MSA may not be directly competing with each other for the same pool of employees, and the wages they pay can vary greatly. The most populous MSAs typically cover a region of several thousand square miles (see table 1). Distances between points within an MSA can exceed 100 miles. For example, the Chicago MSA includes 8 counties and 5,065 square miles, and the distance from its northernmost to southernmost point is roughly 110 miles. Hospitals in central counties of an MSA typically paid higher wages than hospitals in outlying counties. In the most populous MSAs, average central county hospital wages ranged from 7 percent higher than outlying county wages in Houston to 38 percent higher in New York in 1997. In most of these MSAs, the average wage difference between central and outlying counties ranged from 11 to 18 percent. 20 20 See appendix III for a comparison of wages in outlying and central counties in metropolitan areas for all states. Medicare Metropolitan Geographic Areas May Encompass Multiple Labor Markets with Varying Average Wages Page 13 GAO- 02- 963 Medicare Hospital Wage Variation Table 1: Hospital Wage Variation in the Most Populous Metropolitan Statistical Areas, Fiscal Year 1997 Average hourly hospital wage within MSA MSA Counties Square miles Hospitals Central counties Outlying counties All counties in MSA Range of hospital wages within MSA a Los Angeles- Long Beach, CA 1 4,060 104 $26.12 N/ A $26.12 $20.09 - 29.84 New York, NY 8 1,141 74 31.93 $23.15 31.86 24.84 - 35.80 Chicago, IL 9 5,065 84 24.30 20.77 24.27 20.17 - 26.56 Philadelphia, PA- NJ 9 3,856 62 23.82 23.15 23.81 19.72 - 26.46 Washington, DC- MD- VA- WV 18 6,465 40 23.70 20.14 23.41 19.66 - 25.72 Detroit, MI 6 3,896 48 22.92 20.57 22.88 18.90 - 24.50 Houston, TX 6 5,921 43 21.23 19.83 21.19 16.75 - 23.18 Atlanta, GA 20 6,126 42 22.40 19.66 21.98 18.36 - 23.97 Boston, MA- NH N/ A b 7,384 76 N/ A N/ A 24.30 19.88 - 26.17 Dallas, TX 8 6,186 36 21.75 18.98 21.58 18.85 - 24.80 Note: N/ A means not applicable. a The range excludes wages that are in the top 10 percent and the bottom 10 percent of the distribution of wages reported in the MSA. b The Boston MSA is comprised of cities and towns rather than counties. Source: GAO analysis of 1997 hospital wages used in construction of the 2001 wage index, as reported in Medicare hospital cost reports and county- level data from the US Census Bureau (http:// www. census. gov/ population/ estimates/ metro- city/ 99mfips. txt) downloaded June, 2002 and the National Association of Counties. The Washington, D. C. MSA illustrates how hospital wages in a large MSA can vary across different counties (see fig. 4). It includes hospitals located in the central city of the District of Columbia, as well as 18 counties in Maryland, Virginia, and West Virginia. Hospital wages averaged more than $23 per hour in 1997 in the District of Columbia and in most of the adjacent suburban Maryland and Virginia counties, but averaged below $20 per hour in several outlying counties. Page 14 GAO- 02- 963 Medicare Hospital Wage Variation Figure 4: Hospital Wages by County, Washington, D. C. Metropolitan Statistical Area, Fiscal Year 1997 Source: GAO analysis of 1997 hospital wages used in construction of 2001 wage index, as reported in Medicare hospital cost reports. Page 15 GAO- 02- 963 Medicare Hospital Wage Variation One reason MSAs are so large is because they are composed of counties, which can also be quite expansive. As with MSAs, an individual county may subsume multiple labor markets within its boundaries. As an example, San Bernardino County, California extends over 150 miles* from the city limits of San Bernardino through the Mojave Desert to the Nevada border. While most of the population is concentrated in the southwest corner of the county, which includes the city of San Bernardino, even the sparsely populated desert and mountainous portions of the county are part of the MSA. As a result, a hospital in the desert community of Joshua Tree, California, receives the same labor cost adjustment as hospitals in the city of San Bernardino 70 miles away, even though hospital wages averaged $20.84 per hour in 1997 in Joshua Tree, 13 percent less than average wages paid in San Bernardino. The Medicare program groups hospitals in nonmetropolitan areas of each state into a single geographic area for the purposes of the labor cost adjustment. Given their vast size, each statewide nonmetropolitan area is not perceived to be a single labor market, but the same labor cost adjustment is applied to hospitals in these areas. However, there are significant differences in average wages across parts of these areas. For example, for all hospitals in the nonmetropolitan area of Washington state, Medicare payments for 2001 were adjusted based on an average wage of $22.71 per hour. Yet, nonmetropolitan hospitals in the western part of the state had average wages of $24.23 per hour. Wages for nonmetropolitan hospitals in the central and eastern parts of the state, however, averaged $21.15 per hour, or 13 percent lower than hospitals in the western part of the state. Other variation in average wages across the statewide nonmetropolitan areas is associated with the type of community. In three- quarters of all states, the average wages paid by hospitals in large towns are higher than those paid by hospitals in small towns or rural areas. As a result, the Medicare labor cost adjustment may be based on average wages that are below those paid by large town hospitals and above those paid by hospitals in small towns and rural areas. For example, the 2001 labor cost adjustment for hospitals in nonmetropolitan Nebraska was based on an average hourly wage of $17.65; yet, Nebraska hospitals in large towns paid an average wage of $19.54. At the same time, small town Nebraska hospitals paid an average of $16. 83 and hospitals in rural areas paid an average of $14.87, or 5 and 16 percent lower, respectively, than the area average (see table 2). In 2001, 38 percent of hospitals in large towns paid wages that were at least 5 percent higher than the average wage in their Some Medicare Nonmetropolitan Geographic Areas Encompass Multiple Community Types with Varying Wages Page 16 GAO- 02- 963 Medicare Hospital Wage Variation area; 16 percent paid wages that were at least 10 percent higher than the area average. 21 Table 2: Average Hospital Wages across Nonmetropolitan Areas in Selected States, Fiscal Year 1997 Number of hospitals Average hourly wage for nonmetropolitan subgroups Large town Small town Rural area Statewide nonmetropolitan average hourly wage Large town Small town Rural area Nebraska 11 32 32 $17.65 $19.54 $16.83 $14.87 Iowa 15 54 24 17.48 18.81 16.74 15.38 Arizona 6 8 2 18.11 19.14 17.00 16.59 Georgia 23 44 18 18.13 18.88 16.61 17.37 Washington 17 8 15 22.71 23.51 21.72 19.19 Note: Large towns have a population of 10,000 to 49, 999, small towns a population of 2,500 to 9,999, and rural areas have populations under 2,500. Source: GAO analysis of 1997 hospital wages used in construction of 2001 wage index, as reported in Medicare hospital cost reports. While reclassification results in more appropriate labor cost adjustments for some higher wage hospitals, the reclassification criteria prevent some of them from reclassifying and exceptions to the criteria allow some lower wage hospitals to do so. In 2001, 419 hospitals, less than 10 percent of all hospitals, reclassified to receive a larger labor cost adjustment. Most of these hospitals had average wages that were above their area*s average by enough to meet the standard reclassification wage criterion. 22 Higher wage hospitals in large towns are likelier to reclassify than higher wage hospitals in other community types because many of them are RRCs, which are exempt from the reclassification proximity criterion. Other higher wage hospitals in large towns and many higher wage hospitals in metropolitan areas, small towns, and rural areas cannot reclassify. About 21 See appendix IV for average wages across community types for all states. 22 To qualify for reclassification through the MGCRB application process, metropolitan hospitals must meet the standard wage criterion that their average wages are at least 8 percent higher than the average in their area and nonmetropolitan hospitals must have average wages that are at least 6 percent higher than the average in their area, unless they are RRCs. However, RRCs must pay wages that are at least 82 percent of the average in the target area. Through Reclassification, Some Hospitals Receive a More Appropriate Labor Cost Adjustment Page 17 GAO- 02- 963 Medicare Hospital Wage Variation one- quarter of hospitals that reclassified had wages that were not high enough to satisfy the standard reclassification wage criterion. These were primarily RRCs. Generally, hospitals that reclassify but do not satisfy the standard wage criterion receive a post- reclassification labor cost adjustment that reflects average wage levels much higher than the wages they actually pay. For hospitals that meet the standard wage criterion, however, reclassification results in an adjustment that better matches their actual labor costs than did their original one. Of the 756 hospitals that paid wages sufficiently higher than their area average wage to meet the reclassification wage criteria, 310 (41 percent) were reclassified in 2001 (see table 3). Hospitals that met the wage criteria, but did not satisfy the proximity criterion, did not reclassify. Just over onequarter of the higher wage hospitals were in large towns, yet large town hospitals made up almost half of the higher wage hospitals that reclassified. Metropolitan hospitals made up 42 percent of the higher wage hospitals, but comprised only 12 percent of the higher wage reclassified hospitals. Higher wage hospitals in large towns are likelier to reclassify than other higher wage hospitals because many are RRCs, and so are exempt from the proximity criterion. Not All Higher Wage Hospitals Can Reclassify Page 18 GAO- 02- 963 Medicare Hospital Wage Variation Table 3: Reclassified Hospitals by Wage Level and Community Type, Fiscal Year 2001 Nonmetropolitan Metropolitan Large town Small town Rural All Higher wage hospitals Total 317 203 168 68 756 Reclassified 38 149 92 31 310 Percent reclassified 12% 73% 55% 46% 41% Non- higher wage hospitals Total 2,407 386 819 478 4,090 Reclassified 11 75 21 2 109 Percent reclassified .5% 19% 3% .4% 3% Note: Higher wage hospitals are those that have wages high enough relative to other hospitals in their geographic area to meet the standard reclassification criterion, which for metropolitan hospitals is average wages at least 8 percent higher than the average in their geographic area, and for nonmetropolitan hospitals is average wages at least 6 percent higher than the average in their area. Large town, small town, and rural areas were defined using rural urban commuting area (RUCA) codes rather than location in a Medicare nonmetropolitan geographic area. Some nonmetropolitan hospitals were defined by RUCA codes as being urban based on their high levels of commuting to urban areas. Source: GAO analysis of 1997 hospital wages used in construction of 2001 wage index, as reported in Medicare hospital cost reports and 2001 PPS Payment Impact File. Analysis excludes hospitals reclassified through legislation, hospitals that receive only a standardized amount reclassification, hospitals with missing wage data, and nonmetropolitan hospitals that were defined by RUCA codes as urban. Close to half of the higher wage hospitals in small towns and rural areas reclassify. Almost 39 percent of the reclassified higher wage small town and rural hospitals were exempt from the proximity criterion because they were RRCs or SCHs. Some nonreclassified, higher wage small town or rural hospitals that were SCHs may have opted out of the PPS to receive cost- based payments from Medicare, making reclassification irrelevant. 23 In 2001, only 38 of the 317 metropolitan hospitals with wages that were at least 8 percent higher than the average for their area, thus satisfying the standard wage criteria, reclassified to receive a higher labor cost adjustment. Nearly two- thirds of all reclassified metropolitan hospitals 23 Only about 11 percent of SCHs reclassified in 2001. It can be more financially advantageous for them to be exempt from the PPS and have their payments based on their actual costs. Page 19 GAO- 02- 963 Medicare Hospital Wage Variation were in two areas* California and the northeast. 24 Metropolitan areas in these two regions are contiguous, so higher wage hospitals may be more likely than hospitals in other areas to satisfy the proximity criterion. 25 In 2001, 109 (about 25 percent) of all hospitals that reclassified for the Medicare labor cost adjustment paid wages that were too low to meet the standard wage criterion for reclassification. Of these, 89 were RRCs. Roughly 42 percent of these RRCs that reclassified had wage costs below the average in their area. Some of the hospitals that were reclassified in 2001 but that did not satisfy the standard wage criterion were part of countywide reclassifications. Others had been reclassified via legislation. The relationship between a hospital*s wages and the average in its geographic area, before and after reclassification, depends on whether it was in a metropolitan or nonmetropolitan area and whether it satisfied the standard reclassification wage criterion (see table 4). Reclassification resulted in higher wage hospitals receiving a labor cost adjustment that more closely reflects the wages they actually paid. For example, prior to their reclassification, the higher wage metropolitan hospitals received a labor cost adjustment based on wages in their original area that averaged 10 percent lower than their own wages. After reclassification, the average wages paid by these hospitals did not differ from the average wages paid by the other hospitals in their area. Higher wage nonmetropolitan hospitals that reclassified joined areas with average wages about 4 percent higher than their own average wages. Before reclassification, the higher wage nonmetropolitan hospitals would have received a labor cost adjustment based on average wages that were much lower than what they actually paid. In contrast, reclassification resulted in hospitals that did not satisfy the standard wage criterion joining areas that, on average, had much higher average wages. Prior to reclassification, nonmetropolitan hospitals that did not satisfy the standard wage criterion paid wages near the average of 24 The northeast region includes New York, New Jersey, Pennsylvania, and Connecticut. 25 Additional Medicare payments for teaching activities and providing a disproportionate share of care to the poor may compensate certain higher wage metropolitan hospitals for their higher labor costs. Certain Hospitals Can Reclassify without Meeting the Standard Wage Criterion Reclassified Hospitals That Did Not Satisfy the Standard Wage Criterion Likely Receive a Labor Cost Adjustment Higher than the Wages They Pay Page 20 GAO- 02- 963 Medicare Hospital Wage Variation their area. After reclassification, they received a labor cost adjustment based on wages that averaged 8 percent above their own average wages. Table 4: Area Average Wage Compared to Hospital Wage, before and after Reclassification, Fiscal Year 2001 Difference between area average wage and hospital- specific wage Category of hospital Before reclassification (percent) After reclassification (percent) Metropolitan Reclassified * higher wage -10% 0% Nonreclassified * higher wage 7 N/ A Nonmetropolitan Reclassified * higher wage 9 4 Reclassified * non- higher wage -1 8 Nonreclassified * higher wage -4 N/ A Note: N/ A means not applicable. Higher wage hospitals are those that have wages high enough relative to other hospitals in their geographic area to meet the reclassification criterion, which for metropolitan hospitals is average wages at least 8 percent higher than the average in their geographic area, and for nonmetropolitan hospitals is average wages at least 6 percent higher than the average in their area. Non- higher wage hospitals are those that cannot satisfy the reclassification wage criterion. Source: GAO analysis of 1997 hospital wages used in construction of 2001 wage index, as reported in Medicare hospital cost reports and 2001 PPS Payment Impact File. Analysis excludes hospitals reclassified through legislation, hospitals that receive only a standardized amount reclassification, and hospitals with missing wage data. While geographic reclassification increases the labor cost adjustment, and thus Medicare payments, to hospitals that reclassify, it does not raise total Medicare outlays because any payment increases must be offset by an across- the- board reduction to Medicare payments for all hospitals. In 2002, this budget neutrality adjustment reduced Medicare payments to nonreclassified metropolitan hospitals by about 1 percent and to nonreclassified nonmetropolitan hospitals by about 0.6 percent. If the budget neutrality adjustment were calculated and applied on a statespecific basis, the payment reductions would be different in each state. A state- specific budget neutrality adjustment would reduce payments more in some states and less in other states than the national adjustment. In states in which overall Medicare hospital payments increase more than the national average increase due to reclassification, a state- specific option would result in a bigger payment reduction. A state- specific adjustment Budget Neutrality Adjustments Are Relatively Modest, but Would Vary under a State- Specific Option Page 21 GAO- 02- 963 Medicare Hospital Wage Variation would reduce payments less in states in which hospitals do not benefit as much from geographic reclassification as the average. Hospital payments would not be reduced in states that have no reclassified hospitals under a state- specific budget neutrality option. To meet the budget neutrality requirement, CMS annually calculates the increase in Medicare payments to reclassified hospitals. This increase is due to the use of a higher wage index or standardized amount, or both. CMS then calculates how much the standardized amount* the fixed, predetermined hospital payment* needs to be reduced so that total Medicare outlays for hospital services do not change because of reclassification. In 2002, Medicare payments to nonreclassified metropolitan hospitals were about 1 percent lower due to the budget neutrality provision than they would have been in the absence of any geographic reclassifications (see table 5). Payments to nonreclassified nonmetropolitan hospitals were about 0.6 percent lower. The effect of the budget neutrality adjustment on hospital payments varies annually depending on how much Medicare payments are increased due to hospitals being reclassified, compared to total Medicare payments to all hospitals. The budget neutrality adjustment will be higher in those years where reclassified hospitals account for a greater share of Medicare payments. Table 5: Effect of the Geographic Reclassification Budget Neutrality Requirement on Medicare Inpatient Hospital Payments, by Metropolitan and Nonmetropolitan Status, Fiscal Years 1995 through 2002 Percent change in per stay payments 1995 1996 1997 1998 1999 2000 2001 2002 Metropolitan Reclassified 2.4 2.6 3.3 3.2 4. 8 4.1 5. 4 4.2 Nonreclassified -0.6 -0.6 -0. 6 -0.5 -0.6 -0.6 -0.7 -1.0 Nonmetropolitan Reclassified 7.4 7.4 8.6 8.7 7. 0 6.5 5.9 5. 5 Nonreclassified -0.4 -0.4 -0. 4 -0.4 -0.4 -0.4 -0.5 -0.6 Source: Impact Analysis Tables from final PPS rules, published in the Federal Register, 1995- 2001. Budget Neutrality Adjustment Calculated to Offset Payment Increases to Reclassified Hospitals Page 22 GAO- 02- 963 Medicare Hospital Wage Variation A state- specific adjustment would reduce payments less than a national adjustment in states where reclassified hospitals account for a smaller share of the state*s Medicare inpatient hospital spending than the national average. For example, in Colorado, where 3 of 64 hospitals were reclassified in 2000, a state- specific budget neutrality adjustment would have reduced hospital payments by only 0.07 percent, compared to a 0.6 percent reduction under the national budget neutrality calculation. 26 For the states that have no hospitals reclassifying, such as Nevada, there would be no budget neutrality adjustment under a state- specific approach. Conversely, a state- specific adjustment would reduce Medicare payments more than a national one in states where reclassified hospitals account for a larger share of Medicare inpatient hospital spending than the national average. In New Hampshire, for example, where a large share of the state*s hospitals was reclassified (4 of 26 hospitals) a state- specific adjustment would have reduced payments to nonreclassified hospitals by nearly 3 percent, compared to a 0.6 percent reduction under the national adjustment. 27 Medicare*s PPS for inpatient services provides incentives to hospitals to deliver care efficiently by allowing them to keep any difference between their Medicare payments and their costs, and by making them responsible for their costs that exceed Medicare payments. To ensure that the PPS rewards efficiency rather than hospitals* circumstances, payment adjustments are intended to account for cost differences across hospitals that are beyond the control of individual facilities. If these cost differences are not adequately accounted for by the payment adjustments, hospitals are inappropriately rewarded or put under fiscal pressure. The adjustment used to account for geographic differences in wages* the labor cost adjustment* does not adequately account for these cost differences because the geographic areas used to define labor markets are too large in many instances. As a result, refinements are needed to address systematic problems in defining hospital labor markets. Such changes could improve payment accuracy and reduce the need for geographic reclassification by grouping hospitals into areas with average wages that better match their own wages. 26 We used 2000 data for this analysis because they were the most recent, complete data available. 27 See appendix V for more information on state- specific budget neutrality. Effect of State- Specific Budget Neutrality Adjustment Would Depend on Benefits of Reclassification for State*s Hospitals Conclusions Page 23 GAO- 02- 963 Medicare Hospital Wage Variation RRCs and certain other specially designated hospitals have easier access to a higher labor cost adjustment because they are allowed to reclassify under less stringent criteria than other hospitals. These hospitals may face higher costs than other hospitals, but they do not necessarily have labor costs that are higher than the average in their geographic area. Reclassification potentially offers some financial relief to a share of these facilities, but it does not address the problem underlying their financial circumstances or assist all such facilities. Identifying the underlying cause of their higher costs is important to develop mechanisms to address their financial circumstances. To improve the adequacy of Medicare*s labor cost adjustments, we recommend that the Administrator of CMS refine the geographic areas used to more accurately reflect the labor markets in which hospitals compete for employees and the geographic variation in hospitals* labor costs. This could include separating large towns in a state into their own labor market area and removing certain outlying counties in MSAs from the metropolitan geographic area if they exhibit wage costs that are significantly different from the rest of the metropolitan area. In its written comments on a draft of this report (see app. VI), CMS stated that it agreed with the problems we identified with the current labor market areas. CMS stated that it had conducted its own analyses of alternative approaches to defining geographic areas and consulted with hospital representatives and concluded that there is no consensus on an alternative to Medicare*s current geographic areas. CMS stated that it will consider whether changes in MSA definitions based on new census figures should be used for refining the geographic areas. CMS noted that a statespecific budget neutrality approach, which we were required to assess, would require statutory change and could make reclassifications within states highly contentious. We believe that Medicare*s current geographic areas could be refined to better reflect variation in area labor costs. While forthcoming changes to MSA definitions are important to consider in refining Medicare*s geographic areas, these changes are unlikely to improve the labor cost adjustment in most large towns. We recognize that consensus on any changes to the geographic areas would be difficult to achieve because any change would redistribute Medicare payments across hospitals so that hospital payments would increase in some areas and decrease in others. Yet, because the refinements would result in Medicare payments that Recommendations for Executive Action Agency Comments and Our Evaluation Page 24 GAO- 02- 963 Medicare Hospital Wage Variation better match the costs that hospitals face, they would strengthen the incentives of the PPS that encourage hospital efficiency and improve Medicare*s payment method. CMS also provided technical comments, which we incorporated as appropriate. We are sending copies of this report to the Administrator of CMS and interested congressional committees. We will also make copies available to others upon request. In addition, this report will be available at no charge on the GAO Web site at http:// www. gao. gov. If you have any other questions about this report, please call me at (202) 512- 7119. Jean Chung, James Mathews, Michael Rose, and Kara Sokol made key contributions to this report. Laura A. Dummit Director, Health Care* Medicare Payment Issues Page 25 GAO- 02- 963 Medicare Hospital Wage Variation List of Committees The Honorable Max Baucus Chairman The Honorable Charles E. Grassley, Jr. Ranking Minority Member Committee on Finance United States Senate The Honorable Bill Thomas Chairman The Honorable Charles B. Rangel Ranking Minority Member Committee on Ways and Means House of Representatives The Honorable W. J. *Billy* Tauzin Chairman The Honorable John D. Dingell Ranking Minority Member Committee on Energy and Commerce House of Representatives Appendix I: Scope and Methodology Page 26 GAO- 02- 963 Medicare Hospital Wage Variation To conduct this work, we recreated the 2001 labor cost adjustment for each hospital in the country prior to any reclassifications, using aggregated wage and hour data reported on 1997 Medicare hospital cost reports. We used data on reclassifications and hospital characteristics from the PPS Payment Impact Files created each year by CMS. Information on metropolitan areas, such as central and outlying counties and the criteria by which counties are included in an MSA, was obtained from the U. S. Census Bureau Web site as well as interviews with Census Bureau staff. We used RUCA codes, developed at the Washington, Wyoming, Alaska, Montana, & Idaho (WWAMI) Rural Health Research Center at the University of Washington, to examine segments of nonmetropolitan areas. We assigned 1 of 30 possible RUCA codes to each hospital based on its census tract. These 30 codes were then collapsed into 4 categories: urban, large town, small town, and rural. We calculated dollar- weighted average hourly hospital wages for each of the nonmetropolitan categories, nationally and by state, by dividing aggregate wages for all hospitals within a category by aggregate hours. We then compared the average hourly hospital wage for each nonmetropolitan subgroup within a state to the statewide nonmetropolitan average hourly wage. To evaluate the potential payment impact of applying a geographic reclassification budget- neutrality factor on a state- specific basis, we used the 2000 PPS Payment Impact File to calculate the Medicare payments to all hospitals within each state, before and after any geographic reclassifications. We then used the difference between pre- and postreclassification payments to calculate a budget neutrality factor for each state. These budget neutrality factors were then used to estimate how payments to reclassified and nonreclassified hospitals in each state would differ under a state- specific budget neutrality adjustment, compared to the current national adjustment. Appendix I: Scope and Methodology Appendix II: The Effect of Accounting for Occupational Mix on the Wage Index Page 27 GAO- 02- 963 Medicare Hospital Wage Variation In BIPA, the Congress required the Secretary of Health and Human Services to collect data on hospitals* mix of occupations and their corresponding wages by September 30, 2003, and calculate wage indexes beginning October 1, 2004, that are adjusted to remove the effects of occupational mix on average wages. Occupational mix data for each acute care hospital will be collected and updated every 3 years. The methodology for adjusting the wage index for occupational mix will be determined after the data have been collected. Average hospital wages vary because of differences in wages paid across hospitals, but also because hospitals employ different mixes of occupations. As a result, average hospital wages are higher than the national average if the hospitals in an area employ more workers in highly skilled occupations and lower if the hospitals employ fewer workers in more highly skilled occupations. The current calculation of the Medicare wage index does not distinguish between wage differences due to geographic labor cost variation and wage differences due to geographic variation in the mix of more highly and less highly skilled occupations. Thus, Medicare*s wage indexes are too high in areas with a more highly skilled mix of hospital workers and too low in areas with a less skilled mix of hospital workers. While geographic differences in wages paid affect hospitals* labor costs, but are beyond an individual hospital*s ability to control, occupational mix generally is within the control of a hospital. Changing the calculation of the wage index to eliminate the effect of occupational mix differences will raise the wage index for some types of hospitals and lower it for others. Wage indexes will be reduced for hospitals, such as metropolitan or teaching hospitals, that tend to hire more employees in highly skilled occupations with higher wages. Wage indexes for rural hospitals, which tend to employ a less skilled mix of employees, are likely to go up. While national data on the occupational mix of hospital employees are not available, data from California demonstrate the potential effects of changing the wage index calculation to eliminate the effects of Appendix II: The Effect of Accounting for Occupational Mix on the Wage Index Appendix II: The Effect of Accounting for Occupational Mix on the Wage Index Page 28 GAO- 02- 963 Medicare Hospital Wage Variation occupational mix differences. 1 Without adjusting for differences in occupational mix, the average hourly wage for hospitals in the Oakland MSA is 57 percent higher than the average hourly wage for nonmetropolitan California hospitals. Hospitals in the Oakland area generally employ a greater proportion of more skilled, and therefore more expensive, staff (see table 6). For example, in Oakland area hospitals, RNs account for approximately 25 percent more of the total hours worked by hospital employees than they do in nonmetropolitan California. Recalculating the wage indexes so that they reflect the same mix of workers in all areas reduces the difference between the Oakland area wages and those paid in nonmetropolitan areas to 50 percent. An occupational mix- adjusted wage index in nonmetropolitan California would be almost 4 percent higher than the current wage index calculation (see table 7). Across metropolitan areas, the change to the wage index would vary. Table 6: Hospital Wages, Adjusted for Mix of Occupations, Oakland MSA and Nonmetropolitan California, Fiscal Year 1998 Average hourly wage Occupational mixadjusted average hourly wage Oakland MSA $36.73 $36.30 Nonmetropolitan areas $23.40 $24.27 Percent difference 57.0% 49.6% Source: GAO analysis of wage data from 1998 California Hospital Annual Disclosure Reports. Area average hourly wages shown here differ from those used in calculating Medicare payments, which are based on wages reported in Medicare hospital cost reports. 1 To evaluate the effects of adjusting the hospital wage index after removing the effects of occupational mix, we obtained occupation- specific hospital wage and staff hour data from the 1998 California Hospital Annual Disclosure Reports submitted to the California Office of Statewide Health Planning and Development. We calculated average hourly wages and average share of hours contributed for each reported occupational category. Wages and hours that were associated with expenses that are not covered by Medicare, such as research, were excluded. Using these data, we calculated an unadjusted average hourly wage and an occupational- mix adjusted average hourly wage with the mix of occupation hours held constant for each geographic area. The difference between the two averages is the effect of occupational mix. Our results are only suggestive of the magnitude and direction of changes when CMS modifies its wage index calculation method. CMS has identified the occupational categories for which it will collect wage data, but has not yet determined the methodology for using these data in calculating the wage index. Appendix II: The Effect of Accounting for Occupational Mix on the Wage Index Page 29 GAO- 02- 963 Medicare Hospital Wage Variation Table 7: Effect of an Occupational Mix Adjustment on Average Area Wages in California, Fiscal Year 1998 California areas Percent difference between average wages calculated with and without an occupational mix adjustment Nonmetropolitan California 3.7% Bakersfield 3.7% Chico- Paradise 3.7% Fresno 2.8% Los Angeles- Long Beach -0.6% Merced 3.7% Modesto 4.8% Oakland -1.2% Orange County -1.5% Redding 0.1% Riverside- San Bernardino 0.0% Sacramento 2.6% Salinas 2.8% San Diego -3.7% San Francisco 0.7% San Jose -0.9% San Luis Obispo- Atascadero- Paso- Robles 1.2% Santa Barbara- Santa Maria- Lompoc -1.0% Santa Cruz- Watsonville -2.2% Santa Rosa -3.1% Stockton- Lodi 3.1% Vallejo- Fairfield- Napa -1.8% Ventura 0.3% Visalia- Tulare- Porterville 3.7% Yolo -3.2% Yuba City -1.5% Source: GAO analysis of wage data from 1998 California Hospital Annual Disclosure Reports. Appendix III: Average Hospital Wages in Outlying and Central Counties of Metropolitan Areas, by State, Fiscal Year 1997 Page 30 GAO- 02- 963 Medicare Hospital Wage Variation State Average percent difference between outlying and central county wages a State Average percent difference between outlying and central county wages a Alabama -8 Montana N/ A Alaska N/ A Nebraska -12 Arizona -17 Nevada -26 Arkansas -6 New Hampshire N/ A California -13 New Jersey -11 Colorado N/ A New Mexico 11 Connecticut -7 New York -14 Delaware -29 North Carolina -12 District of Columbia N/ A North Dakota -1 Florida -8 Ohio -10 Georgia -19 Oklahoma -17 Hawaii N/ A Oregon 2 Idaho -10 Pennsylvania -10 Illinois -1 Rhode Island N/ A Indiana -5 South Carolina -5 Iowa -2 South Dakota -23 Kansas -17 Tennessee -11 Kentucky -13 Texas -7 Louisiana -9 Utah N/ A Maine N/ A Vermont N/ A Maryland -12 Virginia -14 Massachusetts -2 Washington -6 Michigan -7 West Virginia -6 Minnesota -11 Wisconsin -12 Mississippi 6 Wyoming N/ A Missouri -15 Note: N/ A means not applicable. a We averaged the percentage difference between outlying and central county wages within each MSA across all MSAs within each state. Then, we averaged the difference within each MSA across all MSAs that had outlying counties within a state. The percentage difference represents the amount by which outlying county wages are greater or less than central county wages, so a negative number indicates lower wages in outlying counties. These comparisons were not possible in the MSAs that do not have any outlying counties, in the states that have no MSAs with outlying counties, or in the states that have only outlying counties of MSAs with central counties in bordering states. Source: GAO analysis of 1997 hospital wages used in construction of the 2001 wage index, as reported in Medicare hospital cost reports. Appendix III: Average Hospital Wages in Outlying and Central Counties of Metropolitan Areas, by State, Fiscal Year 1997 Appendix IV: Average Hospital Wages across Community Types in Nonmetropolitan Areas, by State, Fiscal Year 1997 Page 31 GAO- 02- 963 Medicare Hospital Wage Variation Number of hospitals Percent difference from nonmetropolitan average wage State Large town Small town Rural Average hourly wage, all nonmetropolitan hospitals Large town hospitals Small town hospitals Rural hospitals Alabama 17 26 10 $16.30 2% -1% -12% Alaska 3 8 2 26.98 -5% 2% -3% Arizona 6 8 2 18.11 6% -6% -8% Arkansas 16 33 7 16.21 6% -4% -18% California 14 19 7 21.47 -4% 4% -3% Colorado 3 20 12 19.52 9% 1% -20% Connecticut 1 1 0 25.50 -1% 1% N/ A Delaware 0 2 0 19.75 N/ A 0% N/ A District of Columbia N/ A N/ A N/ A N/ A N/ A N/ A N/ A Florida 6 17 4 19.42 0% -2% 2% Georgia 23 44 18 18.13 4% -8% -4% Hawaii 5 4 4 24.07 -2% 3% 20% Idaho 7 16 8 18.89 2% -2% -9% Illinois 26 40 5 17.77 4% -9% -7% Indiana 18 25 2 18.73 2% -4% 8% Iowa 15 54 24 17.48 8% -4% -12% Kansas 22 30 39 16.56 5% -4% -10% Kentucky 15 35 21 17.27 3% -3% 1% Louisiana 13 23 10 16.72 2% -3% -1% Maine 2 13 7 19.08 4% -2% 1% Maryland 4 3 1 18.83 0% 0% 0% Massachusetts 1 1 1 24.39 -4% 20% 6% Michigan 15 20 23 19.57 5% 0% -11% Minnesota 19 35 38 19.33 2% 1% -8% Mississippi 27 35 17 16.31 3% -4% -10% Missouri 20 23 17 16.76 4% -7% -6% Montana 6 16 16 18.91 8% -4% -16% Nebraska 11 32 32 17.65 11% -5% -16% Nevada 2 5 3 20.10 5% -5% -11% New Hampshire 6 3 4 21.43 2% 0% -12% New Jersey N/ A N/ A N/ A N/ A N/ A N/ A N/ A New Mexico 14 6 3 18.50 0% -2% 18% New York 12 18 4 18.50 4% -5% -4% North Carolina 20 25 13 18.38 4% -3% -11% North Dakota 6 6 26 16.80 6% -3% -7% Ohio 30 19 2 18.88 2% -4% -25% Oklahoma 17 39 14 16.31 5% -6% -13% Oregon 17 12 3 22.06 0% 2% -2% Appendix IV: Average Hospital Wages across Community Types in Nonmetropolitan Areas, by State, Fiscal Year 1997 Appendix IV: Average Hospital Wages across Community Types in Nonmetropolitan Areas, by State, Fiscal Year 1997 Page 32 GAO- 02- 963 Medicare Hospital Wage Variation Number of hospitals Percent difference from nonmetropolitan average wage State Large town Small town Rural Average hourly wage, all nonmetropolitan hospitals Large town hospitals Small town hospitals Rural hospitals Pennsylvania 11 26 6 18.67 1% 0% -3% Rhode Island N/ A N/ A N/ A N/ A N/ A N/ A N/ A South Carolina 9 18 0 18.22 3% -3% N/ A South Dakota 8 8 21 16.48 4% -3% -10% Tennessee 19 32 14 17.06 4% -3% -7% Texas 46 83 35 16.33 4% -6% -1% Utah 4 9 7 19.67 3% -4% -6% Vermont 2 6 4 20.19 8% -3% -6% Virginia 8 20 9 17.83 4% -2% -6% Washington 17 8 15 22.71 3% -4% -16% West Virginia 9 15 9 17.92 4% -1% -18% Wisconsin 12 34 21 19.33 3% -3% -2% Wyoming 5 12 6 19.19 2% 1% -12% Note: N/ A means not applicable. Source: GAO analysis of 1997 hospital wages used in the construction of the 2001 wage index, as reported in Medicare hospital cost reports. Large town, small town, and rural areas were defined using RUCA codes rather than location in a Medicare nonmetropolitan geographic area. As a result, 45 hospitals that receive the nonmetropolitan labor cost adjustment were excluded from this analysis. Two states and the District of Columbia have no nonmetropolitan areas. Appendix V: Effect of the Current and a StateSpecific Budget Neutrality Option on Hospital Payments, by State, Fiscal Year 2000 Page 33 GAO- 02- 963 Medicare Hospital Wage Variation Change in Medicare hospital payments Under national budget neutrality adjustment (current law) Under state- specific budget neutrality option State Total hospitals Reclassified hospitals Reclassified hospitals Nonreclassified hospitals Reclassified hospitals Nonreclassified hospitals Alabama 109 10 6.3% -0.6% 6.4% -0.5% Alaska 16 1 0. 0% 0. 0% 0.0% 0.0% Arizona 61 2 7. 9% -0.6% 8.4% -0.2% Arkansas 78 18 7.3% -0.6% 6.3% -1.6% California 405 19 6.6% -0.8% 7.0% -0.4% Colorado 64 3 5. 8% -0.6% 6.4% -0.1% Connecticut 33 6 7. 5% -0.6% 7.1% -1.0% Delaware 5 2 6.5% -0.6% 5.6% -1.5% District of Columbia 10 0 N/ A -0.6% N/ A 0.0% Florida 193 10 2.2% -0.5% 2.6% -0.2% Georgia 160 22 10.6% -0.6% 9.7% -1.5% Hawaii 22 1 4. 2% -0.6% 4.9% 0.0% Idaho 43 8 4. 9% -0.5% 4.0% -1.3% Illinois 196 22 6.1% -0.6% 6.4% -0.3% Indiana 112 23 5.0% -0.6% 4.7% -0.9% Iowa 117 8 8. 1% -0.4% 7.3% -1.2% Kansas 113 10 10.5% -0.6% 9.5% -1.5% Kentucky 101 20 6.4% -0.5% 5.4% -1.5% Louisiana 128 11 8.0% -0.5% 8.0% -0.4% Maine 37 1 6. 0% -0.6% 6.2% -0.4% Maryland N/ A N/ A N/ A N/ A N/ A N/ A Massachusetts 80 2 1. 6% -0.6% 2.1% -0.1% Michigan 156 16 4.2% -0.6% 4.6% -0.3% Minnesota 137 14 7.4% -0.6% 7.6% -0.4% Mississippi 99 19 6.9% -0.8% 5.5% -2.1% Missouri 121 13 7.3% -0.6% 7.2% -0.8% Montana 43 4 13.4% -0.6% 12.1% -1.7% Nebraska 87 9 11.3% -0.6% 9.9% -1.9% Nevada 26 0 N/ A -0.6% N/ A 0.0% New Hampshire 26 4 9. 3% -0.6% 6.8% -2.9% New Jersey 84 26 7.6% -2.4% 6.9% -3.0% New Mexico 34 1 11.6% -0.6% 11.6% -0.5% New York 216 16 5.5% -0.6% 6.0% -0.2% North Carolina 121 20 6.8% -0.6% 6.4% -1.0% North Dakota 46 10 2.6% -0.3% 2.4% -0.6% Ohio 170 31 5.9% -0.8% 5.7% -0.9% Oklahoma 113 12 8.1% -0.6% 7.6% -1.0% Oregon 60 9 4. 1% -0.4% 3.9% -0.6% Appendix V: Effect of the Current and a StateSpecific Budget Neutrality Option on Hospital Payments, by State, Fiscal Year 2000 Appendix V: Effect of the Current and a StateSpecific Budget Neutrality Option on Hospital Payments, by State, Fiscal Year 2000 Page 34 GAO- 02- 963 Medicare Hospital Wage Variation Change in Medicare hospital payments Under national budget neutrality adjustment (current law) Under state- specific budget neutrality option State Total hospitals Reclassified hospitals Reclassified hospitals Nonreclassified hospitals Reclassified hospitals Nonreclassified hospitals Pennsylvania 200 13 6.6% -0.8% 6.9% -0.5% Rhode Island 11 2 9. 0% -0.6% 9.2% -0.4% South Carolina 61 10 4.4% -0.6% 4.6% -0.5% South Dakota 47 3 8. 3% -0.6% 7.7% -1.2% Tennessee 123 12 13.2% -0.6% 13.2% -0.6% Texas 376 39 11.6% -0.6% 11.7% -0.6% Utah 40 7 13.1% -0.6% 12.3% -1.3% Vermont 14 2 3. 3% -0.6% 3.5% -0.4% Virginia 92 6 5. 5% -0.6% 5.9% -0.2% Washington 86 5 0. 4% -0.6% 0.9% -0.1% West Virginia 50 7 10.8% -0.6% 8.5% -2.6% Wisconsin 125 13 4.3% -0.6% 4.3% -0.5% Wyoming 24 1 9. 7% -0.5% 9.6% -0.5% National total 6.8% -0.7% 6.5% -0.6% Note: N/ A means not applicable. Hospitals in Maryland are not paid by Medicare under the PPS, so they were excluded from this analysis. Source: GAO analysis of data from 2000 Medicare hospital cost reports and the fiscal year 2000 PPS Payment Impact File from the CMS. Appendix VI: Comments from the Centers for Medicare & Medicaid Services Page 35 GAO- 02- 963 Medicare Hospital Wage Variation Appendix VI: Comments from the Centers for Medicare & Medicaid Services Appendix VI: Comments from the Centers for Medicare & Medicaid Services Page 36 GAO- 02- 963 Medicare Hospital Wage Variation (201034) The General Accounting Office, the investigative arm of Congress, exists to support Congress in meeting its constitutional responsibilities and to help improve the performance and accountability of the federal government for the American people. GAO examines the use of public funds; evaluates federal programs and policies; and provides analyses, recommendations, and other assistance to help Congress make informed oversight, policy, and funding decisions. GAO*s commitment to good government is reflected in its core values of accountability, integrity, and reliability. The fastest and easiest way to obtain copies of GAO documents at no cost is through the Internet. GAO*s Web site (www. gao. gov) contains abstracts and fulltext files of current reports and testimony and an expanding archive of older products. The Web site features a search engine to help you locate documents using key words and phrases. You can print these documents in their entirety, including charts and other graphics. Each day, GAO issues a list of newly released reports, testimony, and correspondence. GAO posts this list, known as *Today*s Reports,* on its Web site daily. The list contains links to the full- text document files. To have GAO e- mail this list to you every afternoon, go to www. gao. gov and select *Subscribe to daily E- mail alert for newly released products* under the GAO Reports heading. The first copy of each printed report is free. Additional copies are $2 each. A check or money order should be made out to the Superintendent of Documents. GAO also accepts VISA and Mastercard. Orders for 100 or more copies mailed to a single address are discounted 25 percent. Orders should be sent to: U. S. General Accounting Office 441 G Street NW, Room LM Washington, D. C. 20548 To order by Phone: Voice: (202) 512- 6000 TDD: (202) 512- 2537 Fax: (202) 512- 6061 Contact: Web site: www. gao. gov/ fraudnet/ fraudnet. htm E- mail: fraudnet@ gao. gov Automated answering system: (800) 424- 5454 or (202) 512- 7470 Jeff Nelligan, managing director, NelliganJ@ gao. gov (202) 512- 4800 U. S. General Accounting Office, 441 G Street NW, Room 7149 Washington, D. C. 20548 GAO*s Mission Obtaining Copies of GAO Reports and Testimony Order by Mail or Phone To Report Fraud, Waste, and Abuse in Federal Programs Public Affairs *** End of document. ***