Medicare Program; Changes to the Hospital Inpatient Prospective Payment Systems and Fiscal Year 1995 Rates

SUMMARY: We are proposing to revise the Medicare hospital inpatient

prospective payment systems for operating costs and capital-related

costs to implement necessary changes arising from our continuing

experience with the system. In addition, in the addendum to this

proposed rule, we are describing proposed changes in the amounts and

factors necessary to determine prospective payment rates for Medicare

hospital inpatient services for operating costs and capital-related

costs. These changes would be applicable to discharges occurring on or

after October 1, 1994. We are also setting proposed rate-of-increase

limits for hospitals and hospital units excluded from the prospective

payment systems.

DATES: Comments will be considered received at the appropriate address,

as provided below, no later than 5 p.m. on July 26, 1994.

ADDRESSES: Mail written comments (an original and 3 copies) to the

following address:

Health Care Financing Administration, Department of Health and Human

Services, Attention: BPD-802-P, P.O. Box 7517, Baltimore, MD 21207-

0517.

. If you prefer, you may deliver your written comments (an original

and 3 copies) to one of the following addresses:

Room 309-G, Hubert H. Humphrey Building, 200 Independence Avenue, SW.,

Washington, DC 20201, or

Room 132, East High Rise Building, 6325 Security Boulevard, Baltimore,

MD 21207.

Because of staffing and resource limitations, we cannot accept

comments by facsimile (FAX) transmission. In commenting, please refer

to file code BPD-802-P. Comments received timely will be available for

public inspection as they are received, generally beginning

approximately 3 weeks after publication of a document, in Room 309-G of

the Department's offices at 200 Independence Avenue, SW., Washington,

DC, on Monday through Friday of each week from 8:30 a.m. to 5 p.m.

(phone: (202) 690-7890).

For comments that relate to information collection requirements,

mail a copy of comments to: Office of Information and Regulatory

Affairs, Office of Management and Budget, Room 3001, New Executive

Office Building, Washington, DC 20503, Attn: Allison Herron Eydt, HCFA

Desk Officer.

Copies: To order copies of the Federal Register containing this

document, send your request to: New Orders, Superintendent of

Documents, P.O. Box 371954, Pittsburgh, PA 15250-7954. Specify the date

of the issue requested and enclose a check or money order payable to

the Superintendent of Documents, or enclose your Visa or Master Card

number and expiration date. Credit card orders can also be placed by

calling the order desk at (202) 783-3238 or by faxing to (202) 275-

6802. The cost for each copy is $6.00. As an alternative, you can view

and photocopy the Federal Register document at most libraries

designated as Federal Depository Libraries and at many other public and

academic libraries throughout the country that receive the Federal

Register.

To obtain data used in deriving the standardized amounts and DRG

relative weights, see section VIII.B. of the Supplementary Information

section of this preamble, Requests for Data From the Public.

FOR FURTHER INFORMATION CONTACT: Lana Price, (410) 966-4529.

SUPPLEMENTARY INFORMATION:

I. Background

A. Summary

Under section 1886(d) of the Social Security Act (the Act), a

system of payment for the operating costs of acute hospital inpatient

stays under Medicare Part A (Hospital Insurance) based on

prospectively-set rates was established effective with hospital cost

reporting periods beginning on or after October 1, 1983. Under this

system, Medicare payment for hospital inpatient operating costs is made

at a predetermined, specific rate for each hospital discharge. All

discharges are classified according to a list of diagnosis-related

groups (DRGs). The regulations governing the hospital inpatient

prospective payment system are located in 42 CFR part 412. On September

1, 1993, we published a final rule with comment period (58 FR 46270) to

implement changes to the prospective payment system for hospital

operating costs beginning with Federal fiscal year (FY) 1994.

For cost reporting periods beginning before October 1, 1991,

hospital inpatient operating costs were the only costs covered under

the prospective payment system. Payment for capital-related costs had

been made on a reasonable cost basis because, under sections 1886(a)(4)

and (d)(1)(A) of the Act, those costs had been specifically excluded

from the definition of inpatient operating costs. However, section

4006(b) of the Omnibus Budget Reconciliation Act of 1987 (Public Law

100-203) revised section 1886(g)(1) of the Act to require that, for

hospitals paid under the prospective payment system for operating

costs, capital-related costs would also be paid under a prospective

payment system effective with cost reporting periods beginning on or

after October 1, 1991. As required by section 1886(g) of the Act, we

replaced the reasonable cost-based payment methodology with a

prospective payment methodology for hospital inpatient capital-related

costs. Under the new methodology, effective for cost reporting periods

beginning on or after October 1, 1991, a predetermined payment amount

per discharge is made for Medicare inpatient capital-related costs.

(See subpart M of 42 CFR part 412, and the August 30, 1991, final rule

(56 FR 43358) for a complete discussion of the prospective payment

system for hospital inpatient capital-related costs.)

B. Major Contents of This Proposed Rule

In this proposed rule, we are setting forth proposed changes to the

Medicare hospital inpatient prospective payment systems for both

operating costs and capital-related costs. This proposed rule would be

effective for discharges occurring on or after October 1, 1994.

Following is a summary of the major changes that we are proposing to

make:

1. Changes to the DRG Classification and Relative Weights

As required by section 1886(d)(4)(C) of the Act, we must adjust the

DRG classifications and relative weights at least annually. Our

proposed changes for FY 1995 are set forth in section II of this

preamble.

2. Changes to the Hospital Wage Index

In section III of this preamble, we discuss revisions to the wage

index and the annual update of the wage data. Specific issues addressed

in this section include:

FY 1995 wage index update.

Changes in the reporting of hospital wage index data.

Revisions to the wage index based on hospital

redesignations.

Impact of the revised hospital wage index.

Occupational mix adjustment.

Research on refinements to labor market areas.

State labor market options.

3. Other Changes to the Prospective Payment System for Inpatient

Operating Costs

In section IV of this preamble, we discuss several provisions of

the regulations in 42 CFR parts 412, 413, 485, and 489 and set forth

certain proposed changes concerning the following:

Definition of and payment for transfer cases.

Review of DRG assignments.

National average standardized amounts for FY 1995.

Outliers.

Rural referral centers.

Determination of number of beds in determining the

indirect medical education adjustment.

Disproportionate share adjustment.

Changes affecting essential access community hospitals

(EACHs) and rural primary care hospitals (RPCHs).

Clarification of payments to rural referral center/EACH

hospitals.

Direct graduate medical education payment.

Other technical changes.

4. Changes and Clarifications to the Prospective Payment System for

Capital-Related Costs

In section V of this preamble, we discuss several provisions of the

regulations in 42 CFR parts 412 and 413 and set forth certain proposed

changes concerning the following:

Evaluation of provisions relating to obligated capital for

hospitals subject to lengthy certificate-of-need (CON) process.

Specific adjustment for taxes to the capital prospective

payment system federal rate.

Revision of provision relating to exceptions payments.

Extraordinary circumstances exceptions payments.

Funding of depreciation.

5. Changes for Hospitals Excluded from the Prospective Payment System

In section VI of this preamble, we discuss changes to the

regulations at 42 CFR parts 412 and 413 for hospitals and hospital

units excluded from the prospective payment system. The proposed

changes concern the following:

New requirements for certain long-term care hospitals

excluded from the prospective payment systems.

Removal of the 1986 malpractice rule.

Related technical changes.

6. Determining Prospective Payment Rates and Rate-of-Increase Limits

In the addendum to this proposed rule, we set forth proposed

changes to the amounts and factors for determining the FY 1995

prospective payment rates for operating costs and capital-related

costs. We are also proposing new update factors for determining the

rate-of-increase limits for cost reporting periods beginning in FY 1995

for hospitals and hospital units excluded from the prospective payment

system.

7. Impact Analysis

In Appendix A, we set forth an analysis of the impact that the

proposed changes described in this rule would have on affected

entities.

8. Capital Acquisition Model

Appendix B contains the technical appendix on the proposed FY 1995

capital acquisition model and budget neutrality adjustment.

9. Report to Congress on the Update Factor for Prospective Payment

Hospitals and Hospitals Excluded from the Prospective Payment System

Section 1886(e)(3)(B) of the Act requires that the Secretary report

to Congress no later than March 1, 1994 on our initial estimate of an

update factor for FY 1995 for both prospective payment hospitals and

hospitals excluded from the prospective payment system. This report is

included as Appendix C to this proposed rule.

10. Proposed Recommendation of Update Factor for Hospital Inpatient

Operating Costs

As required by sections 1886 (e)(4) and (e)(5) of the Act, Appendix

D provides our recommendation of the appropriate percentage change for

FY 1995 for the following:

Large urban, other urban, and rural average standardized

amounts (and hospital-specific rates applicable to sole community

hospitals) for hospital inpatient services paid for under the

prospective payment system for operating costs.

Target rate-of-increase limits to the allowable operating

costs of hospital inpatient services furnished by hospitals and

hospital units excluded from the prospective payment system.

11. Framework for Capital Update

In Appendix E, we are setting forth a preliminary framework for

developing the annual update factor for inpatient hospital capital-

related costs.

12. Discussion of Prospective Payment Assessment Commission

Recommendations

The Prospective Payment Assessment Commission (ProPAC) is directed

by section 1886(e)(2)(A) of the Act to make recommendations on the

appropriate percentage change factor to be used in updating the average

standardized amounts. In addition, section 1886(e)(2)(B) of the Act

directs ProPAC to make recommendations regarding changes in each of the

Medicare payment policies under which payments to an institution are

prospectively determined. In particular, the recommendations relating

to the hospital inpatient prospective payment systems are to include

recommendations concerning the number of DRGs used to classify

patients, adjustments to the DRGs to reflect severity of illness, and

changes in the methods under which hospitals are paid for capital-

related costs. Under section 1886(e)(3)(A) of the Act, the

recommendations required of ProPAC under sections 1886(e)(2) (A) and

(B) of the Act are to be reported to Congress not later than March 1 of

each year.

We are printing ProPAC's March 1, 1994 report, which includes its

recommendations, as Appendix F of this document. The recommendations,

and the actions we are proposing to take with regard to them (when an

action is recommended), are discussed in detail in the appropriate

sections of this preamble, the addendum, or the appendices to this

proposed rule. See section VII of this preamble for specific

information concerning where individual recommendations are addressed.

For a brief summary of the ProPAC recommendations, we refer the reader

to the beginning of the ProPAC report as set forth in Appendix F of

this proposed rule. ProPAC also produced technical appendices in its

March 1, 1994 report that provide background material and detailed

analyses used in preparation of the ProPAC recommendations. For further

information relating specifically to the ProPAC report or to obtain a

copy of the technical appendices, contact ProPAC at (202) 401-8986.

II. Proposed Changes to DRG Classifications and Relative Weights

A. Background

Under the prospective payment system, we pay for inpatient hospital

services on the basis of a rate per discharge that varies by the DRG to

which a beneficiary's stay is assigned. The formula used to calculate

payment for a specific case takes an individual hospital's payment rate

per case and multiplies it by the weight of the DRG to which the case

is assigned. Each DRG weight represents the average resources required

to care for cases in that particular DRG relative to the average

resources used to treat cases in other DRGs.

Congress recognized that it would be necessary to recalculate the

DRG relative weights periodically to account for changes in resource

consumption. Accordingly, section 1886(d)(4)(C) of the Act requires

that the Secretary adjust the DRG classifications and relative weights

annually. These adjustments are made to reflect changes in treatment

patterns, technology, and any other factors that may change the

relative use of hospital resources. The proposed changes to the DRG

classification system and the proposed recalibration of the DRG weights

for discharges occurring on or after October 1, 1994 are discussed

below.

B. DRG Reclassification

1. General

Cases are classified into DRGs for payment under the prospective

payment system based on the principal diagnosis, up to eight additional

diagnoses, and up to six procedures performed during the stay, as well

as age, sex, and discharge status of the patient. The diagnosis and

procedure information is reported by the hospital using codes from the

International Classification of Diseases, Ninth Edition, Clinical

Modification (ICD-9-CM). The Medicare fiscal intermediary enters the

information into its claims system and subjects it to a series of

automated screens called the Medicare Code Editor (MCE). These screens

are designed to identify cases that require further review before

classification into a DRG can be accomplished.

After screening through the MCE and any further development of the

claims, cases are classified by the GROUPER software program into the

appropriate DRG. The GROUPER program was developed as a means of

classifying each case into a DRG on the basis of the diagnosis and

procedure codes and demographic information (that is, sex, age, and

discharge status). It is used both to classify past cases in order to

measure relative hospital resource consumption to establish the DRG

weights and to classify current cases for purposes of determining

payment. The records for all Medicare hospital inpatient discharges are

maintained in the Medicare Provider Analysis and Review (MedPAR) file.

The data in this file are used to evaluate possible DRG classification

changes and to recalibrate the DRG weights.

Currently, cases are assigned to one of 491 DRGs in 25 major

diagnostic categories (MDCs). Most MDCs are based on a particular organ

system of the body (for example, MDC 6, Diseases and Disorders of the

Digestive System); however, some MDCs are not constructed on this basis

since they involve multiple organ systems (for example, MDC 22, Burns).

In general, principal diagnosis determines MDC assignment. However,

there are four DRGs to which cases are assigned on the basis of

procedure codes rather than first assigning them to an MDC based on the

principal diagnosis. These are the DRGs for liver and bone marrow

transplant (DRGs 480 and 481, respectively) and the two DRGs for

tracheostomies (DRGs 482 and 483). Cases are assigned to these DRGs

before classification to an MDC.

Within most MDCs, cases are then divided into surgical DRGs (based

on a surgical hierarchy that orders individual procedures or groups of

procedures by resource intensity) and medical DRGs. Medical DRGs

generally are differentiated on the basis of diagnosis and age. Some

surgical and medical DRGs are further differentiated based on the

presence or absence of complications or comorbidities (hereafter CC).

Generally, GROUPER does not consider other procedures; that is,

nonsurgical procedures or minor surgical procedures generally not

performed in an operating room are not listed as operating room (OR)

procedures in the GROUPER decision tables. However, there are a few

non-OR procedures that do affect DRG assignment for certain principal

diagnoses, such as extracorporeal shock wave lithotripsy for patients

with a principal diagnosis of urinary stones.

The changes we are proposing to make to the DRG classification

system for FY 1995 are set forth below.

2. MDC 2 (Diseases and Disorders of the Eye)

When a case is coded with a principal diagnosis of subcorneal

pustular dermatosis (diagnosis code 694.1), it is classified to MDC 2

(Diseases and Disorders of the Eye), where it is assigned to DRGs 46,

47, and 48 (Other Disorders of the Eye).\1\ We recently received a

suggestion from the public that we should review the DRG classification

of subcorneal pustular dermatosis because it is a dermatological

condition and is not a disease or disorder of the eye.

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\1\A single title combined with two DRG numbers is used to

signify pairs. Generally, the first DRG is for cases with CC and the

second is for cases without CC. If a third number is included, it

represents cases of patients who are age 0-17. Occasionally, a pair

of DRGs is split on age >17 and age 0-17.

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Since this issue involves a possible medical misclassification of a

diagnosis, we asked our medical consultants to evaluate the condition.

They determined that subcorneal pustular dermatosis is indeed a

dermatological condition and not an eye condition. Based on their

determination and recommendations, we propose to remove diagnosis code

694.1 from its current classification in MDC 2 and assign it to MDC 9

(Diseases and Disorders of the Skin, Subcutaneous Tissue and Breast).

In order to determine the appropriate DRG assignment in MDC 9, we

first made a clinical evaluation of the medical DRGs. Based on the

current MDC 9 configuration, the only possible DRGs appear to be DRGs

272 and 273 (Major Skin Disorders) or DRGs 283 and 284 (Minor Skin

Disorders). After reviewing the average standardized charges and the

types of costs assigned to DRGs 272 and 273, we believe the best

assignment for 694.1 is DRGs 283 and 284. We note that the proposed FY

1995 relative weights of DRGs 46, 47, and 48 (0.7573, 0.4330, and

0.4182, respectively) are approximately equal to those of DRGs 283 and

284 (0.7142 and 0.4358, respectively). Therefore, we propose to move

diagnosis code 694.1 to DRGs 283 and 284.

3. MDC 15 (Newborns and Other Neonates with Conditions Originating in

the Perinatal Period)

In the September 1, 1993 final rule (58 FR 46283), we stated that

we would be evaluating the newborn and neonate DRG classifications and

relative weights for possible improvements. Because of the low volume

of cases in these DRGs in the MedPAR file, we stated that we intended

to rely on data bases outside the Medicare claims file to supplement

our data. We expect that any major reclassification changes to MDC 15

will be based on an evaluation of actual neonate case data, including

charges and clinical information.

As we have not yet completed this evaluation, we will not be

proposing our MDC 15 revisions for FY 1995. However, since publication

of the September 1, 1993 final rule, we have received several

suggestions from the public concerning improvements for the neonate DRG

classifications. Some commenters suggested that we reevaluate the

diagnoses that are currently considered significant problems in

determining the assignment of a neonate case to DRG 390 (Neonate with

Other Significant Problems) rather than DRG 391 (Normal Newborn). These

commenters believe that many of the diagnoses currently assigned to DRG

390 are not truly significant clinically and in terms of resource use.

These commenters also identified specific diagnoses within this group

that are problematic. Even though we are not ready to proceed with a

comprehensive proposal for revising MDC 15, we did ask our medical

specialists to evaluate the specific conditions that were identified as

problematic in the assignment of newborns to DRG 390.

Currently, cases of otherwise normal newborns with one of the

following diagnoses are assigned to DRG 390 rather than DRG 391:

752.5--Undescended testicle

795.4--Other nonspecific abnormal histological findings

V05.3--Need for prophylactic vaccination against viral hepatitis

V05.4--Need for prophylactic vaccination against Varicella

V20.1--Other healthy infant or child receiving care

All of these diagnoses were identified by the commenters as

nonsignificant conditions that are either not problems or require only

minimal diagnostic work-up, no treatment, and result in the consumption

of minimal or no additional resources. For these reasons, the

commenters believe that these diagnoses should be added to the list of

conditions that may be found as secondary diagnoses for DRG 391.

Specifically, a healthy newborn with undescended testicles requires

only a minimal diagnostic work-up and no treatment at the time of

birth. In addition, the conditions that are assigned to diagnosis code

795.4 (Other nonspecific abnormal histological findings) are

nonsignificant problems and require no additional resources to treat.

Commenters also pointed out that it has become standard practice to

inoculate newborns against viral hepatitis, and that a prophylactic

vaccination against Varicella is normal and routine and does not

indicate a problem with the newborn. Diagnosis code V20.1 is generally

used to identify a healthy infant that remains in the hospital for an

extended period of time because of maternal illness, and should not be

considered a significant problem.

All of the conditions listed above were reevaluated on a clinical

basis by our medical specialists, who determined that these diagnoses

are not significant problems in neonates. Therefore, we are proposing

to add them to the list of secondary diagnoses that would assign an

otherwise normal newborn to DRG 391.

Based on comments received, we also reevaluated perinatal jaundice

(diagnosis codes 774.0 through 774.7) and its DRG assignments.

Currently, all of these diagnosis codes except 774.6 (unspecified fetal

and neonatal jaundice) are considered major problems and are assigned

to DRGs 387 (Prematurity with Major Problems) and 389 (Full Term

Neonate with Major Problems). Diagnosis code 774.6 is not considered a

significant problem and is assigned to DRG 388 (Prematurity without

Major Problems) and DRG 391. Some commenters did not believe that 774.6

should be assigned to DRG 391 when all the other perinatal jaundice

codes are considered major problems. Other commenters believe that some

of the perinatal jaundice diagnoses that are currently considered major

are really not that resource intensive.

Our medical specialists reevaluated these perinatal jaundice

conditions, and, based on their determinations, we are proposing

several revisions to the neonatal DRG assignments. First, the following

diagnosis codes would be removed from the major problems list in DRGs

387 and 389 and would be added to the significant problems list:

774.0--Perinatal jaundice from hereditary hemolytic anemias

774.1--Perinatal jaundice from other excessive hemolysis

774.2--Neonatal jaundice associated with preterm delivery

Thus, a premature newborn with one of these codes would be assigned to

DRG 388 and a full-term newborn with one of these codes would be

assigned to DRG 390.

The following diagnosis codes would be removed from the major

problems list in DRGs 387 and 389 and would not be added to the

significant problems list:

774.30--Neonatal jaundice due to delayed conjugation, cause unspecified

774.31--Neonatal jaundice due to delayed conjugation in diseases

classified elsewhere

774.39--Other neonatal jaundice due to delayed conjugation from other

causes

774.5--Perinatal jaundice from other causes

Therefore, a premature newborn with one of these conditions would be

assigned to DRG 388 and a full-term newborn with one of these

conditions would be assigned to DRG 391.

The following diagnosis codes would remain on the major problems

list and continue to result in assignment to DRGs 387 and 389:

774.4--Perinatal jaundice due to hepatocellular damage

774.7--Kernicterus not due to isoimmunization

Finally, diagnosis codes 774.6 (Unspecified fetal and neonatal

jaundice) would continue to be considered a nonsignificant condition

and result in assignment to DRGs 388 and 391.

We note again that these proposals are based only on clinical

considerations and respond to specific requests made by the public. We

will continue our work on a more comprehensive evaluation of the MDC 15

DRGs and will announce our proposal when that evaluation is completed.

4. Surgical Hierarchies

Some inpatient stays entail multiple surgical procedures, each one

of which, occurring by itself, could result in assignment of the case

to a different DRG within the MDC to which the principal diagnosis is

assigned. It is, therefore, necessary to have a decision rule by which

these cases are assigned to a single DRG. The surgical hierarchy, an

ordering of surgical classes from most to least resource intensive,

performs that function. Its application ensures that cases involving

multiple surgical procedures are assigned to the DRG associated with

the most resource-intensive surgical class.

Because the relative resource intensity of surgical classes can

shift as a function of DRG reclassification and recalibration, we

reviewed the surgical hierarchy of each MDC, as we have for previous

reclassifications, to determine if the ordering of classes coincided

with the intensity of resource utilization, as measured by the same

billing data used to compute the DRG relative weights.

A surgical class can be composed of one or more DRGs. For example,

in MDC 5, the surgical class ``heart transplant'' consists of a single

DRG (DRG 103) and the class ``coronary bypass'' consists of two DRGs

(DRGs 106 and 107). Consequently, in many cases, the surgical hierarchy

has an impact on more than one DRG. The methodology for determining the

most resource-intensive surgical class, therefore, involves weighting

each DRG for frequency to determine the average resources for each

surgical class. For example, assume surgical class A includes DRGs 1

and 2 and surgical class B includes DRGs 3, 4, and 5, and that the

average charge of DRG 1 is higher than that of DRG 3, but the average

charges of DRGs 4 and 5 are higher than the average charge of DRG 2. To

determine whether surgical class A should be higher or lower than

surgical class B in the surgical hierarchy, we would weight the average

charge of each DRG by frequency (that is, by the number of cases in the

DRG) to determine average resource consumption for the surgical class.

The surgical classes would then be ordered from the class with the

highest average resource utilization to that with the lowest, with the

exception of ``other OR procedures'' as discussed below.

This methodology may occasionally result in a case involving

multiple procedures being assigned to the lower-weighted DRG (in the

highest, most resource-intensive surgical class) of the available

alternatives. However, given that the logic underlying the surgical

hierarchy provides that the GROUPER searches for the procedure in the

most resource-intensive surgical class, which may sometimes occur in

cases involving multiple procedures, this result is unavoidable.

We note that, notwithstanding the foregoing discussion, there are a

few instances when a surgical class with a lower average relative

weight is ordered above a surgical class with a higher average relative

weight. For example, the ``other OR procedures'' surgical class is

uniformly ordered last in the surgical hierarchy of each MDC in which

it occurs, regardless of the fact that the relative weight for the DRG

or DRGs in that surgical class may be higher than that for other

surgical classes in the MDC. The ``other OR procedures'' class is a

group of procedures that are least likely to be related to the

diagnoses in the MDC but are occasionally performed on patients with

these diagnoses. Therefore, these procedures should only be considered

if no other procedure more closely related to the diagnoses in the MDC

has been performed.

A second example occurs when the difference between the average

weights for two surgical classes is very small. We have found that

small differences generally do not warrant reordering of the hierarchy

since, by virtue of the hierarchy change, the relative weights are

likely to shift such that the higher-ordered surgical class has a lower

average weight than the class ordered below it.

Based on the preliminary recalibration of the DRGs, we are

proposing to modify the surgical hierarchy as set forth below. As we

stated in the September 1, 1989 final rule (54 FR 36457), we are unable

to test the effects of the proposed revisions to the surgical hierarchy

and to reflect these changes in the proposed relative weights due to

the unavailability of revised GROUPER software at the time this

proposed rule is prepared. Rather, we simulate most major

classification changes to approximate the placement of cases under the

proposed reclassification and then determine the average charge for

each DRG. These average charges then serve as our best estimate of

relative resource use for each surgical class. We test the proposed

surgical hierarchy changes after the revised GROUPER is received and

reflect the final changes in the DRG relative weights in the final

rule. Further, as discussed below in section II.C of this preamble, we

anticipate that the final recalibrated weights will be somewhat

different from those proposed, since they will be based on more

complete data. Consequently, further revision of the hierarchy, using

the above principles, may be necessary in the final rule.

At this time, we would revise the surgical hierarchy for MDC 2

(Diseases and Disorders of the Eye) and MDC 3 (Diseases and Disorders

of the Ear, Nose, Mouth and Throat).

In MDC 2, we would reorder Extraocular Procedures Except

Orbit (DRGs 40 and 41) above Intraocular Procedures Except Retina, Iris

and Lens (DRG 42).

In MDC 3, we would reorder Rhinoplasty (DRG 56) above

Salivary Gland Procedures Except Sialoadenectomy (DRG 51).

5. Refinement of Complications and Comorbidities List

There is a standard list of diagnoses that are considered

complications or comorbidities (CCs). We developed this list using

physician panels to include those diagnoses that, when present as a

secondary condition, would be considered a substantial complication or

comorbidity. In preparing the original CC list, a substantial CC was

defined as a condition that, because of its presence with a specific

principal diagnosis, would increase the length of stay by at least 1

day for at least 75 percent of the patients.

In previous years, we have made changes to the standard list of

CCs, either by adding new CCs or deleting CCs already on the list. For

FY 1995, we are not proposing to make any changes to the current CC

list.

In the September 1, 1987 final notice concerning changes to the DRG

classification system (52 FR 33143), we modified the GROUPER logic so

that certain diagnoses included on the standard list of CCs would not

be considered a valid CC in combination with a particular principal

diagnosis. Thus, we created the CC Exclusions List. We made these

changes to preclude coding of CCs for closely related conditions, to

preclude duplicative coding or inconsistent coding from being treated

as CCs, and to ensure that cases are appropriately classified between

the complicated and uncomplicated DRGs in a pair.

In the May 19, 1987 proposed notice concerning changes to the DRG

classification system (52 FR 18877), we explained that the excluded

secondary diagnoses were established using the following five

principles:

Chronic and acute manifestations of the same condition

should not be considered CCs for one another (as subsequently corrected

in the September 1, 1987 final notice (52 FR 33154)).

Specific and nonspecific (that is, not otherwise specified

(NOS)) diagnosis codes for a condition should not be considered CCs for

one another.

Conditions that may not co-exist, such as partial/total,

unilateral/bilateral, obstructed/unobstructed, and benign/malignant,

should not be considered CCs for one another.

The same condition in anatomically proximal sites should

not be considered CCs for one another.

Closely related conditions should not be considered CCs

for one another.

The creation of the CC Exclusions List was a major project

involving hundreds of codes. The FY 1988 revisions were intended to be

only a first step toward refinement of the CC list in that the criteria

used for eliminating certain diagnoses from consideration as CCs were

intended to identify only the most obvious diagnoses that should not be

considered complications or comorbidities of another diagnosis. For

that reason, and in light of comments and questions on the CC list, we

have continued to review the remaining CCs to identify additional

exclusions and to remove diagnoses from the master list that have been

shown not to meet the definition of a CC stated above, as appropriate.

(See the September 30, 1988 final rule for the revision made for the

discharges occurring in FY 1989 (53 FR 38485), the September 1, 1989

final rule for the revision made for discharges occurring in FY 1990

(54 FR 36552), the September 4, 1990 final rule for the revision made

for discharges occurring in FY 1991 (55 FR 36126), the August 30, 1991

final rule for the revision made for discharges occurring in FY 1992

(56 FR 43209), the September 1, 1992 final rule for the revisions made

for discharges occurring in FY 1993 (57 FR 39753), and the September 1,

1993 final rule for the revisions made for discharges occurring in FY

1994 (58 FR 46278).)

We are proposing a limited revision of the CC Exclusions List to

take into account the changes that will be made in the ICD-9-CM

diagnosis coding system effective October 1, 1994. (See section II.B.7,

below, for a discussion of these changes.) These proposed changes are

being made in accordance with the principles established when we

created the CC Exclusions List in 1987.

In addition, upon review of our current CC Exclusions List, we

found that there are some diagnosis codes that do not exclude

themselves as CCs. In the September 1, 1987 final notice, we noted that

a very few codes were not excluded from themselves because they may

signify the bilateral occurrence of a particular condition (for

example, diagnosis code 730.02 (acute osteomyelitis of upper arm)) (52

FR 33154). However, we found some diagnosis codes that do not meet this

criterion. Therefore, we are proposing to add the following diagnosis

codes to the CC Exclusions List as excluding themselves when they are

secondary diagnoses:

710.0--Systemic lupus erythematous

710.1--Systemic sclerosis

710.3--Sicca syndrome

710.4--Dermatomyositis

710.8--Other specified diffuse diseases of connective tissue

Based on a comment we received, we are also proposing to exclude

diagnosis code 707.1 (Ulcer of lower limb, except decubitus) as a CC

when the principal diagnosis is 440.23 (atherosclerosis of the

extremities with ulceration). The commenter believes that this

exclusion is similar to the current exclusion of 785.4 (Gangrene) when

the principal diagnosis is 440.24 (Atherosclerosis of the extremities

with gangrene), and we agree with the commenter's assessment.

Finally, it was brought to our attention by another commenter that

when a patient's principal diagnosis is complication of a transplant

condition (diagnosis codes 996.71 and 996.8x), the diagnosis codes used

to denote transplant status (V42.x) should not be considered CCs. Thus,

for the following principal diagnoses, we are proposing to delete the

indicated status code:

For code 996.71 (Complications due to heart valve

prosthesis) delete code V42.2 (Heart valve transplant influencing

health status) as a CC.

For code 996.80 (Complications of unspecified organ

transplant) delete codes V42.0 (Kidney transplant influencing health

status), V42.1 (Heart transplant influencing health status), V42.6

(Lung transplant influencing health status), V42.7 (Liver transplant

influencing health status), and V42.8 (Other specified organ or tissue

transplant influencing health status) as CCs.

For code 996.81 (Complications of kidney transplant)

delete code V42.0 (Kidney transplant influencing health status) as a

CC.

For code 996.82 (Complications of liver transplant) delete

code V42.7 (Liver transplant influencing health status)

For code 996.83 (Complications of heart transplant) delete

code V42.1 (Heart transplant influencing health status) as a CC.

For code 996.84 (Complications of lung transplant) delete

code V42.6 (Lung transplant influencing health status) as a CC.

For code 996.86 (Complications of pancreas transplant)

delete code V42.8 (Other specified organ or tissue transplant

influencing health status) as a CC.

For code 996.89 (Complications of other specified organ

transplant) V42.8 (Other specified organ or tissue transplant

influencing health status) as a CC.

All of the changes discussed above have been added to Table 6f,

Additions to the CC Exclusions List, in section V of the addendum to

this proposed rule.

Tables 6f and 6g in section V of the addendum to this proposed rule

contain the proposed revisions to the CC Exclusions List that would be

effective for discharges occurring on or after October 1, 1994. Each

table shows the principal diagnoses with proposed changes to the

excluded CCs. Each of these principal diagnoses is shown with an

asterisk and the additions or deletions to the CC Exclusions List are

provided in an indented column immediately following the affected

principal diagnosis.

CCs that are added to the list are in Table 6f--Additions to the CC

Exclusions List. Beginning with discharges on or after October 1, 1994,

the indented diagnoses will not be recognized by the GROUPER as valid

CCs for the asterisked principal diagnosis.

CCs that are deleted from the list are in Table 6g--Deletions from

the CC Exclusions List. Beginning with discharges on or after October

1, 1994, the indented diagnoses will be recognized by the GROUPER as

valid CCs for the asterisked principal diagnosis.

Copies of the original CC Exclusions List applicable to FY 1988 can

be obtained from the National Technical Information Service (NTIS) of

the Department of Commerce. It is available in hard copy for $84.00 and

on microfiche for $20.50, plus $3.00 for shipping and handling. A

request for the FY 1988 CC Exclusions List (which should include the

identification accession number, (PB) 88-133970) should be made to the

following address: National Technical Information Service; United

States Department of Commerce; 5285 Port Royal Road, Springfield,

Virginia 22161; or by calling (703) 487-4650.

Users should be aware of the fact that all revisions to the CC

Exclusions List (FYs 1989, 1990, 1991, 1992, 1993, and 1994) and those

in Tables 6f and 6g of this document must be incorporated into the list

purchased from NTIS in order to obtain the CC Exclusions List

applicable for discharges occurring on or after October 1, 1994.

Alternatively, the complete documentation of the GROUPER logic,

including the current CC Exclusions List, is available from 3M/Health

Information Systems (HIS), which, under contract with HCFA, is

responsible for updating and maintaining the GROUPER program. The

current DRG Definitions Manual, Version 11.0, is available for $195.00,

which includes $15.00 for shipping and handling. Version 12.0 of this

manual, which will include the changes proposed in this document as

finalized in response to public comment, will be available in September

1994 for $195.00. These manuals may be obtained by writing 3M/HIS at:

100 Barnes Road; Wallingford, Connecticut 06492; or by calling (203)

949-0303. Please specify the revision or revisions requested.

6. Review of Procedure Codes in DRGs 468, 476, and 477

Each year, we review cases assigned to DRG 468 (Extensive OR

Procedure Unrelated to Principal Diagnosis), DRG 476 (Prostatic OR

procedure Unrelated to Principal Diagnosis), and DRG 477 (Nonextensive

OR Procedure Unrelated to Principal Diagnosis) in order to determine

whether procedures are properly assigned among these DRGs.

DRGs 468, 476, and 477 are reserved for those cases in which none

of the OR procedures performed is related to the principal diagnosis.

These DRGs are intended to capture atypical cases, that is, those cases

not occurring with sufficient frequency to represent a distinct,

recognizable clinical group. DRG 476 is assigned to those discharges in

which one or more of the following prostatic procedures are performed

and are unrelated to the principal diagnosis:

60.0--Incision of prostate

60.12--Open biopsy of prostate

60.15--Biopsy of periprostatic tissue

60.18--Other diagnostic procedures on prostate and periprostatic tissue

60.2--Transurethral prostatectomy

60.61--Local excision of lesion of prostate

60.69--Prostatectomy NEC

60.81--Incision of periprostatic tissue

60.82--Excision of periprostatic tissue

60.93--Repair of prostate

60.94--Control of (postoperative) hemorrhage of prostate

60.95--Transurethral balloon dilation of the prostratic urethra

60.99--Other operations on prostate

All remaining OR procedures are assigned to DRGs 468 and 477, with

DRG 477 assigned to those discharges in which the only procedures

performed are nonextensive procedures that are unrelated to the

principal diagnosis. The original list of the ICD-9-CM procedure codes

for the procedures we consider nonextensive procedures if performed

with an unrelated principal diagnosis was published in Table 6C in

section IV of the addendum to the September 30, 1988 final rule (53 FR

38591). As part of the final rules published on September 4, 1990,

August 30, 1991, September 1, 1992, and September 1, 1993, we moved

several other procedures from DRG 468 to 477. (See 55 FR 36135, 56 FR

43212, 57 FR 23625, and 58 FR 46279, respectively.)

a. Adding Procedure Codes to MDCs. We annually conduct a review of

procedures producing DRG 468 or 477 assignments on the basis of volume

of cases in these DRGs with each procedure. Our medical consultants

then identify those procedures occurring in conjunction with certain

principal diagnoses with sufficient frequency to justify adding them to

one of the surgical DRGs for the MDC in which the diagnosis falls. On

the basis of this review, we are proposing the following DRG

classification changes in order to reduce unnecessary assignment of

cases to DRG 468 or 477.

MDC 1 (Diseases and Disorders of the Nervous System)

We have observed that surgical pacemaker procedures are being

performed with increasing frequency for anatomical nerve problems

associated with heart block. These diagnoses, diagnosis codes 337.0

(Idiopathic peripheral autonomic neuropathy), 742.8 (Other specified

anomalies of nervous system), and 742.9 (Unspecified anomaly of brain,

spinal cord, and nervous system), are assigned to MDC 1, but the

surgical pacemaker procedures are not. Consequently, when a pacemaker

procedure is performed on a patient with one of these diagnoses, the

case is assigned to DRG 468. Therefore, we propose to add the following

procedure codes to DRGs 7 and 8 (Peripheral and Cranial Nerve and Other

Nervous System Procedures):

37.74--Insertion or replacement of epicardial lead (electrode) into

epicardium

37.75--Revision of lead (electrode)

37.76--Replacement of transvenous atrial and/or ventricular lead(s)

(electrode)

37.77--Removal of lead(s) (electrode) without replacement

37.79--Revision or relocation of pacemaker pocket

37.80--Insertion of permanent pacemaker, initial or replacement, type

of device not specified

37.85--Replacement of any type pacemaker device with single-chamber

device, not specified as rate responsive

37.86--Replacement of any type pacemaker device with single-chamber

device, rate responsive

37.87--Replacement of any type pacemaker device with dual-chamber

device

37.89--Revision or removal of pacemaker device

In addition, during our review of DRG 468 cases, we found that

there are several hundred cases of lower limb amputation procedures

with a principal diagnosis from MDC 1. Patients with diabetes often

develop complications that require the performance of a lower limb

amputation. Although the majority of the diagnosis codes for diabetes

are assigned to MDC 10 (Endocrine, Nutritional and Metabolic Diseases

and Disorders), cases with a principal diagnosis of diabetes with

neurological manifestations (diagnosis codes 250.60, 250.61, 250.62 and

250.63) are assigned to MDC 1. Therefore, we are proposing to move the

following procedures to DRGs 7 and 8:

84.11--Amputation of toe

84.12--Amputation through foot

84.13--Disarticulation of ankle

84.14--Amputation of ankle through malleoli of tibia and fibula

84.15--Other amputation below knee

84.16--Disarticulation of knee

84.17--Amputation above knee

MDC 5 (Diseases and Disorders of the Circulatory System)

Closed endoscopic biopsy of lung (procedure code 33.27) and open

biopsy of lung (procedure code 33.28), diagnostic tools for vascular

tumors, are often performed on patients with a principal diagnosis of

228.00 (Hemangioma of unspecified site) or 228.09 (Hemangioma of other

sites). Although these principal diagnoses are assigned to MDC 5, the

diagnostic procedures are not. Thus, if they are included together on

the same claim, the case will be assigned to DRG 468. Therefore, we are

proposing to assign procedure codes 33.27 and 33.28 to DRG 120 (Other

Circulatory System OR Procedures) in MDC 5.

In addition, we identified the following nonextensive OR procedures

(that is, procedures assigned to DRG 477) as appropriate to move to MDC

5:

40.11--Biopsy of lymph structure

40.19--Other diagnostic procedures on lymphatic structures

40.21--Excision of deep cervical lymph node

40.23--Excision of axillary lymph node

40.24--Excision of inguinal lymph node

40.29--Simple excision of other lymphatic structure

40.3--Regional lymph node excision

These procedures are commonly performed with a variety of diagnoses

found in MDC 5 such as disorders of the peripheral vascular system

(diagnosis codes 747.60 and 747.69) and peripheral angiopathy

(diagnosis code 443.81), as well as a number of heart conditions

including malignant neoplasm of the heart (diagnosis code 164.1), and

coxsackie carditis, coxsackie pericarditis, coxsackie endocarditis, and

coxsackie myocarditis (diagnosis codes 074.20, 074.21, 074.22, 074.23,

respectively). We note that these commonly performed diagnostic

procedures are assigned to virtually every other MDC because they are

associated with many diagnoses. Therefore, we propose to move these

procedures to DRG 120.

We also note that hemangioma and anomalies of the peripheral

vascular system may require open rectal biopsy (procedure code 48.25)

or excision of the rectal lesion (procedure code 48.35) as part of

their treatment. At the present time, neither of these procedure codes

classify to MDC 5. Thus, we are proposing to move procedure codes 48.25

and 48.35 to DRG 120.

MDC 6 (Diseases and Disorders of the Digestive System)

A total splenectomy (procedure code 41.5) may be performed on

patients with a principal diagnosis of secondary malignant neoplasm of

other digestive organs and spleen (diagnosis code 197.8). This

diagnosis is included in MDC 6, but the procedure is not, resulting in

the assignment of cases to DRG 468. Thus, we propose to add procedure

code 41.5 to DRG 170 and 171 (Other Digestive System OR Procedures) in

MDC 6.

b. Reassignment of Procedures Among DRGs 468, 476, and 477. We also

reviewed the list of procedures that produce assignments to each of DRG

468, 476, and 477 to ascertain if any of those procedures should be

moved to one of the other DRGs based on average charges and length of

stay. Generally, we move only those procedures for which we have an

adequate number of discharges to analyze the data. Based on our review

this year, we are proposing to move a limited number of procedures.

In reviewing the list of OR procedures that produce DRG 468

assignments, we analyzed the average charge and length of stay data for

cases assigned to that DRG to identify those procedures that are more

similar to the discharges that currently group to either DRG 476 or

477. We identified three procedures that are significantly less

resource intensive than the other procedures assigned to DRG 468.

Therefore, we are proposing to move the following procedures to the

list of procedures that result in assignment to DRG 477:

24.5--Alveoloplasty

53.61--Incisional hernia repair with prosthesis

53.69--Repair of other hernia of anterior abdominal wall with

prosthesis

We conducted a similar analysis of the procedures that assign cases

to DRG 477 to determine if any of those procedures might more

appropriately be classified to DRG 468. Again, we analyzed charge and

length of stay data to identify procedures that were more similar to

discharges assigned to DRG 468 than to those classified in DRG 477. We

did not identify any procedures in DRG 477 that should be assigned to

DRG 468.

All of the proposed reassignments of procedures in DRGs 468 and 477

would be effective with discharges beginning on or after October 1,

1994.

7. Changes to the ICD-9-CM Coding System

As discussed above in section II.B.1. of this preamble, the ICD-9-

CM is a coding system that is used for the reporting of diagnoses and

procedures performed on a patient. In September 1985, the ICD-9-CM

Coordination and Maintenance Committee was formed. This is a Federal

interdepartmental committee charged with the mission of maintaining and

updating the ICD-9-CM. That mission includes approving coding changes,

and developing errata, addenda, and other modifications to the ICD-9-CM

to reflect newly developed procedures and technologies and newly

identified diseases. The Committee is also responsible for promoting

the use of Federal and non-Federal educational programs and other

communication techniques with a view toward standardizing coding

applications and upgrading the quality of the classification system.

The Committee is co-chaired by the National Center for Health

Statistics (NCHS) and HCFA. The NCHS has lead responsibility for the

ICD-9-CM diagnosis codes included in Volume 1--Diseases: Tabular List

and Volume 2--Diseases: Alphabetic Index, while HCFA has lead

responsibility for the ICD-9-CM procedure codes included in Volume 3--

Procedures: Tabular List and Alphabetic Index.

The Committee encourages participation in the above process by

health-related organizations. In this regard, the Committee holds

public meetings for discussion of educational issues and proposed

coding changes. These meetings provide an opportunity for

representatives of recognized organizations in the coding fields, such

as the American Health Information Management Association (AHIMA)

(formerly American Medical Record Association (AMRA)), the American

Hospital Association (AHA), and various physician specialty groups as

well as physicians, medical record administrators, health information

management professionals, and other members of the public to contribute

ideas on coding matters. After considering the opinions expressed at

the public meetings and in writing, the Committee formulates

recommendations, which then must be approved by the agencies.

The Committee presented proposals for coding changes at public

meetings held on May 6, August 5, and December 2, 1993, and finalized

the coding changes after consideration of comments received at the

meetings and in writing within 30 days following the December 1993

meeting. The initial meeting for consideration of coding issues for

implementation in FY 1996 will be held on May 5, 1994. Copies of the

minutes of these meetings may be obtained by writing to one of the co-

chairpersons representing NCHS and HCFA. We encourage commenters to

address suggestions on coding issues involving diagnosis codes to: Sue

Meads, Co-Chairperson; ICD-9-CM Coordination and Maintenance Committee;

NCHS; Rm. 9-58; 6525 Belcrest Road; Hyattsville, Maryland 20782.

Questions and comments concerning the procedure codes should be

addressed to: Patricia E. Brooks, Co-Chairperson; ICD-9-CM Coordination

and Maintenance Committee; HCFA, Office of Coverage and Eligibility

Policy; Rm. 401 East High Rise Building; 6325 Security Boulevard;

Baltimore, Maryland 21207.

The ICD-9-CM code changes that have been approved will become

effective October 1, 1994. The new ICD-9-CM codes are listed, along

with their proposed DRG classifications, in Tables 6a and 6b (New

Diagnosis Codes and New Procedure Codes, respectively) in section IV of

the addendum to this proposed rule. As we stated above, the code

numbers and their titles were presented for public comment in the ICD-

9-CM Coordination and Maintenance Committee meetings. Both oral and

written comments were considered before the codes were approved.

Therefore, we are soliciting comments only on the proposed DRG

classification.

Further, the Committee has approved the expansion of certain ICD-9-

CM codes to require an additional digit for valid code assignment.

Diagnosis codes that have been replaced by expanded codes, other codes,

or have been deleted are in Table 6c (Invalid Diagnosis Codes). The

invalid diagnosis codes will not be recognized by the GROUPER beginning

with discharges occurring on or after October 1, 1994. The

corresponding new or expanded codes are included in Tables 6a and 6b.

The committee did not delete any procedure codes effective for October

1, 1994. Revisions to diagnosis and procedure code titles are in Tables

6d (Revised Diagnosis Code Titles) and 6e (Revised Procedure Code

Titles), which also include the proposed DRG assignments for these

revised codes.

8. DRG Refinements

For several years, we have been analyzing major refinements to the

DRG classification system to compensate hospitals more equitably for

treating severely ill Medicare patients. These refinements, generally

referred to as severity of illness adjustments, would create DRGs

specifically for hospital discharges involving very ill patients who

consume far more resources than do other patients classified to the

same DRGs in the current system. This approach has been taken by

various other groups in refining the DRG system, most notably the

research done for Yale, the changes incorporated by the State of New

York into its all patient (AP) DRG system, and the all-patient refined

(APR) DRGs, which are a joint effort of 3M/HIS and the National

Association of Children's Hospitals and Related Institutions.

Our preliminary work on these refinements is finished, and we have

prepared a paper available to the public for comment that describes our

proposed severity DRG classification system as well as the analysis

upon which our proposal was formulated. Briefly, our approach was to

develop a list of secondary diagnoses that have a major effect on the

resources used by hospitals in treating patients across DRGs and to

evaluate the need to create DRGs for major CCs on a DRG-by-DRG basis.

The following is a description of our methodology:

Our first step, similar to the process used by Yale, was

to collapse the current paired DRG groupings (DRGs with and without

CCs). We also evaluated the current DRGs to determine if any of them

could be combined. Based on this analysis, we eliminated 24 DRGs.

Our next step was to evaluate individual diagnosis codes

to determine if the presence of the diagnosis as a secondary condition

resulted in increased resource use for hospitals across all DRGs. We

analyzed how the presence of the secondary diagnosis affected resource

use compared to other secondary diagnoses that have been classified as

non-CC, CC, or major CC.

Although our final decisions of the CC designation of a

secondary diagnosis were primarily data driven, we did make some

designations based on other factors. Specifically, regardless of the

data, we did not designate a diagnosis as major if it is indicative of

poor quality of care or is prone to hospital upcoding.

After finalizing the classification of secondary

diagnoses, we evaluated which collapsed DRGs should be split on the

basis of the presence of a major CC, other CCs, or both. We developed

criteria for this evaluation that allow a DRG to split only if the

volume and difference in resource use is significantly different from

the remainder of the cases in the DRG and there is a significant

reduction in variance. The collapsed DRGs can be split into three

variations:

--DRG With CC or Major CC

--DRG Without CC

--DRG With Major CC

--DRG Without Major CC

--DRG With Major CC

--DRG With CC

--DRG Without CC

There are 120 DRGs that do not split at all. This final step resulted

in the creation of 652 DRGs compared to the 491 DRGs we currently use.

The paper we have prepared includes a listing of the revised DRGs

as well as the relative weights that would have been assigned to the

DRGs using the FY 1992 MedPAR data and a list of every diagnosis code

in effect in FY 1993 with its current and proposed CC assignment (non-

CC, CC, or major CC). In order to begin consultation with the hospital

industry and other interested organizations before formally proposing

our revised system, we will be distributing the paper to many hospital-

related associations and organizations for their comment. In addition,

requests for the DRG severity refinement paper may be made to the

following address: Division of Hospital Payment Policy, 1-H-1 East Low

Rise, 6325 Security Boulevard, Baltimore, Maryland 21207, Attn: Nancy

Edwards; or by calling (410) 966-4532. Comments are due to HCFA by

September 30, 1994.

Similar to our usual practice for proposed DRG changes to the

prospective payment system, we are making available to the public an FY

1992 Expanded Modified MedPAR File for Severity that contains the

discharge records we used to calculate the severity DRG relative

weights. Requests for this file can be made by following the

instructions set forth in section VIII.B of this preamble (Requests for

Data from the Public). Also available are Severity versions of the HCFA

Medicare Case-Mix Index File, Table 5 DRG, and the AOR/BOR File.

Our plan is to incorporate comments and suggestions we receive and

to consider proposing the complete revised DRG system as part of the FY

1996 prospective payment system proposed rule, which will be published

in the spring of 1995. However, as the final rule published on

September 1, 1992 (57 FR 39761) indicates, we would not propose to make

significant changes to the DRG classification system unless we are able

either to improve our ability to predict coding changes by validating

in advance the impact that potential DRG changes may have on coding

behavior, or to make methodological changes to prevent building the

inflationary effects of the coding changes into future program

payments.

Besides the mandate of section 1886(d)(4)(C)(iii) of the Act, which

provides that aggregate payments may not be affected by DRG

reclassification and recalibration changes, we do not believe it is

prudent policy to make changes for which we cannot predict the effect

on the case-mix index and, thus, payments. Our goal is to refine our

methodology so that we can fulfill, in the most appropriate manner,

both the statutory requirement to make appropriate DRG classification

changes and to recalibrate DRG relative weights (as mandated by section

1886(d)(4)(C) of the Act) as well as to make DRG changes in a budget

neutral manner.

One approach to this problem would be to maintain the average case

weight at 1.0 after recalibration, thereby eliminating the process of

normalization. In other words, after recalibration, we would not scale

the new relative weights upward to carry forward the cumulative effects

of past case-mix increases. We would, instead, make an adjustment or

include in the annual update factor a specific allowance for any real

case-mix change that occurred during the previous year. This is a

relatively simple and straightforward system for preventing the effects

of year-to-year increase in the case-mix index from accumulating in the

DRG weights.

In addition to the severity changes, we also intend to improve the

classification and relative weights of the DRGs that apply to newborns,

children, and maternity patients. The Medicare population does not

include many of these individuals. The original DRG classification

system was developed from analysis of claims data representative of the

total inpatient population. When we calculated the original Medicare

weights for the DRGs to which newborn, children and maternity patients

are classified, we used non-MedPAR discharge records from Maryland and

Michigan hospitals because there were either no MedPAR cases or too few

cases assigned to these DRGs to provide a reasonably precise estimate

of the average cost of care. (See the September 1, 1983 prospective

payment final rule with comment period (48 FR 39768).) Since that time,

because of the lack of MedPAR data, these low-volume DRGs have not been

analyzed and refined, and the relative weights assigned to them may no

longer be entirely reflective of the resources needed to treat the

patients. We again intend to rely on data bases outside the MedPAR file

to supplement our data.

C. Recalibration of DRG Weights

We are proposing to use the same basic methodology for the FY 1995

recalibration as we did for FY 1994. (See the September 1, 1993 final

rule (58 FR 46290).) That is, we would recalibrate the weights based on

charge data for Medicare discharges. However, we would use the most

current charge information available, the FY 1993 MedPAR file, rather

than the FY 1992 MedPAR file. The MedPAR file is based on fully-coded

diagnostic and surgical procedure data for all Medicare inpatient

hospital bills.

The proposed recalibrated DRG relative weights are constructed from

FY 1993 MedPAR data, received by HCFA through December 1993, from all

hospitals subject to the prospective payment system and short-term

acute care hospitals in waiver States. The FY 1993 MedPAR file includes

data for approximately 10.5 million Medicare discharges.

The methodology used to calculate the proposed DRG relative weights

from the FY 1993 MedPAR file is as follows:

To the extent possible, all the claims were regrouped

using the proposed DRG classification revisions discussed above in

section II.B of this preamble. As noted in section II.B.4, due to the

unavailability of revised GROUPER software, we simulate most major

classification changes to approximate the placement of cases under the

proposed reclassification. However, there are some changes that cannot

be modeled.

Charges were standardized to remove the effects of

differences in area wage levels, indirect medical education costs,

disproportionate share payments, and, for hospitals in Alaska and

Hawaii, the applicable cost-of-living adjustment.

The average standardized charge per DRG was calculated by

summing the standardized charges for all cases in the DRG and dividing

that amount by the number of cases classified in the DRG.

We then eliminated statistical outliers using the same

criterion as was used in computing the current weights. That is, all

cases outside of 3.0 standard deviations from the mean of the log

distribution of charges per case for each DRG were eliminated.

The average charge for each DRG was then recomputed

(excluding the statistical outliers) and divided by the national

average standardized charge per case to determine the relative weight.

We established the relative weight for heart transplants

(DRG 103) in a manner consistent with the methodology for all other

DRGs except that the heart transplant cases that were used to establish

the weight were limited to those Medicare-approved heart transplant

centers that have cases in the FY 1993 MedPAR file. Similarly, we

limited the liver transplant cases that were used to establish the

weight for DRG 480 (Liver Transplant) to those hospitals that are

Medicare-approved liver transplant centers.

Acquisition costs for kidney, heart, and liver transplants

continue to be paid on a reasonable cost basis. Unlike other excluded

costs, the acquisition costs are concentrated in specific DRGs (DRG 302

(Kidney Transplant); DRG 103 (Heart Transplant); and DRG 480 (Liver

Transplant)). Because these costs are paid separately from the

prospective payment rate, it is necessary to make an adjustment to

prevent the relative weights for these DRGs from including the effect

of the acquisition costs. Therefore, we subtracted the acquisition

charges from the total charges on each transplant bill that showed

acquisition charges before computing the average charge for the DRG and

before eliminating statistical outliers.

When we recalibrated the DRG weights for previous years, we set a

threshold of 10 cases as the minimum number of cases required to

compute a reasonable weight. We propose to use that same case threshold

in recalibrating the DRG weights for FY 1995. Using the FY 1993 MedPAR

data set, there are 35 DRGs that contain fewer than 10 cases. We

computed the weight for the 35 low-volume DRGs by adjusting the

original weights of these DRGs by the percentage change in the average

weight of the cases in the remaining DRGs.

The weights developed according to the methodology described above,

using the proposed DRG classification changes, result in an average

case weight that is different from the average case weight before

recalibration. Therefore, the new weights are normalized by an

adjustment factor, so that the average case weight after recalibration

is equal to the average case weight before recalibration. This

adjustment is intended to ensure that recalibration by itself neither

increases nor decreases total payments under the prospective payment

system.

Section 1886(d)(4)(C)(iii) of the Act requires that beginning with

FY 1991, reclassification and recalibration changes be made in a manner

that assures that the aggregate payments are neither greater than nor

less than the aggregate payments that would have been made without the

changes. Although normalization is intended to achieve this effect,

equating the average case weight after recalibration to the average

case weight before recalibration does not necessarily achieve budget

neutrality with respect to aggregate payments to hospitals because

payment to hospitals is affected by factors other than average case

weight. Therefore, as discussed in section II.A.4.b. of the Addendum to

this proposed rule, we are proposing to make a budget neutrality

adjustment to assure the requirement of section 1886(d)(4)(C)(iii) of

the Act is met.

III. Proposed Changes to the Hospital Wage Index and Possible

Refinements to Labor Market Areas

A. Background

Under the Medicare prospective payment system, different payment

rates are calculated for hospitals located in rural, urban, and large

urban areas. For purposes of the standardized payment amount, section

1886(d)(2)(D) of the Social Security Act requires that we use

Metropolitan Statistical Areas (MSAs) as defined by the Office of

Management and Budget (OMB) to determine whether hospitals are located

in rural, urban or large urban areas (areas with a population over 1

million). However, section 1886(d)(3)(A) of the Act provides for the

elimination of separate urban and rural standardized payment amounts

beginning in FY 1995. This change is discussed below in section IV.C.

of this proposed rule.

Section 1886(d)(3)(E) of the Act requires that, as part of the

methodology for determining prospective payments to hospitals, the

Secretary shall adjust the standardized amounts ``for area differences

in hospital wage levels by a factor (established by the Secretary)

reflecting the relative hospital wage level in the geographic area of

the hospital compared to the national average hospital wage level.'' In

accordance with the broad discretion conferred by this provision, we

currently define hospital labor market areas based on the definitions

of MSAs issued by OMB. Additionally, as discussed below, we adjust the

wage index to take into account the geographic reclassification of

hospitals in accordance with sections 1886(d)(8)(B) and 1886(d)(10) of

the Act.

Section 1886(d)(3)(E) of the Act also requires that the wage index

be updated annually beginning October 1, 1993. This section further

provides that the Secretary base the update on a survey of wages and

wage-related costs of short-term acute care hospitals. The survey

should measure, to the extent feasible, the earnings and paid hours of

employment by occupational category and must exclude data with respect

to the wages and wage-related costs incurred in furnishing skilled

nursing services.

For determining prospective payments to hospitals in FY 1994, the

wage index is based on the data collected from the Medicare cost

reports submitted by short-term acute care hospitals for cost reporting

periods beginning in FY 1990 (that is, cost reporting periods beginning

on or after October 1, 1989 and before October 1, 1990). The current

wage index includes wages and salaries paid by a hospital, home office

salaries, fringe benefits, and certain contract labor costs and hours.

The current computation for the wage index excludes salaries and wages

associated with non-hospital type services, such as skilled nursing

facility services, home health agency services, or other subprovider

components that are not subject to the prospective payment system.

As discussed in detail below, we are proposing to use updated wage

data to construct the wage index as required by section 1886(d)(3)(E)

of the Act. The FY 1995 wage index would be based on data for hospital

cost reporting periods beginning on or after October 1, 1990 and before

October 1, 1991 (FY 1991).

B. FY 1995 Wage Index Update

We propose to base the FY 1995 wage index, effective for hospital

discharges occurring on or after October 1, 1994 and before October 1,

1995, upon the data collected from the Medicare cost report (Worksheet

S-3, Part II) submitted by hospitals for cost reporting periods

beginning in FY 1991.

We propose to use all of the categories of data collected from

Worksheet S-3, Part II. Therefore, the proposed FY 1995 wage index

reflects the following:

Total short-term acute care hospital salaries and hours.

Home office costs and hours.

Fringe benefits associated with hospital and home office

salaries.

Direct patient care related contract labor cost and hours.

The exclusion of salaries and hours for non-hospital type

services such as skilled nursing facility services, home health

services, or other sub-provider components that are not subject to the

prospective payment system.

1. Verification of Wage Data from the Medicare Cost Report

The data for the proposed FY 1995 wage index was obtained from

Worksheet S-3, Part II, of the HCFA-2552 submitted by short-term acute

care hospitals for cost reporting periods beginning during FY 1991. The

wage data are reported electronically to HCFA through the Hospital Cost

Report Information System (HCRIS). Because of substantial deficiencies

in the initial data reported by hospitals on the cost report (including

missing data items such as excluded hours and total paid hours), we

initiated an intensive review of the wage data and made numerous edits

to ensure quality and accuracy. Medicare intermediaries were instructed

to transmit any revisions through HCRIS by early January 1994.

We subjected the revised cost report data to several edit checks.

Of the 5,294 providers in the data base, over 1,400 providers had data

elements that failed an edit; 53 of these involved mathematical errors

and have been resolved.

The other edits involved data that appeared unusual and had to be

verified by the intermediary. Only 74 providers had data elements that

were unresolved as of March 14, 1994. Most of the unresolved data

elements fall outside established edit parameters and require

verification by the intermediary. None of the unresolved data elements

failed critical edits (that is, edits indicating serious data errors

that affect the wage index computation).

The wage file used to construct the proposed wage index includes

data obtained in late January 1994 from the HCRIS database and

subsequent changes we received from intermediaries through March 14,

1994. We have instructed the intermediaries to complete their

verification of questionable data elements and to transmit any changes

to the wage data, via HCRIS, no later than June 15, 1994. We expect

that all outstanding data elements will be resolved by that date and

that we will be able to reflect the corrected data in the final rule.

In the past, the hospital wage index data file was not available to

the public until mid-May. However, to allow hospitals more time to

evaluate the wage data used to construct the proposed hospital wage

index, on March 16, 1994, we made available to the public a diskette

containing the raw hospital wage data that were used to construct the

proposed FY 1995 wage index. We advised State and national hospital

groups of the availability of the data. We also instructed all fiscal

intermediaries to inform the prospective payment hospitals they service

that we would not be sending out hospital-specific wage data as we had

for the proposed FY 1994 wage index, but that we would make the FY 1991

data available on a diskette. The fiscal intermediaries were instructed

to advise hospitals of the availability of the data either through

their representative hospital organizations or directly from HCFA using

order forms provided to them. Additional details on the cost and

ordering of this file will be found below in section VIII. B. of this

proposed rule, Requests for Data from the Public.

In addition, we note that Table 3c in the Addendum to this proposed

rule contains each hospital's inflated average hourly wage used to

construct the wage index values. By backing out the applicable

inflation factors (set forth below in section III.B.3.), a hospital can

determine its uninflated average hourly wage as reflected in the

proposed wage index. This table will also be included in the final

rule. If a hospital believes, based on its review of the data contained

in Table 3c, that its average hourly wage is inconsistent with the data

submitted on Worksheet S-3, the hospital should contact its

intermediary.

2. Requests for Wage Data Corrections

As noted above we will use cost report data from FY 1991 (that is,

cost reporting periods beginning on or after October 1, 1990 and before

October 1, 1991) for the update to the wage index. As such, we believe

hospitals have had ample time to ensure the accuracy of their FY 1991

wage data. Moreover, the ultimate responsibility for accurately

completing the cost report rests with the hospital, which must attest

to the accuracy of the data at the time the cost report is filed.

However, if a hospital believes that its FY 1991 wage data have been

incorrectly reported, the hospital must submit corrections along with

complete supporting documentation to its intermediary in time to allow

for review, verification and transmission of the data before the

development of the final wage index. To allow sufficient time to

process any changes, a hospital must submit requests for corrections to

its fiscal intermediary by May 15, 1994. The request should include all

documentation necessary to support the requested change. To be

reflected in the final wage index, any wage data corrections must be

reviewed by the intermediary and transmitted to HCFA via HCRIS on or

before June 15, 1994.

This deadline is necessary to allow sufficient time to download and

edit the data so that the final wage index calculation can be completed

for development of the final prospective payment rates to be published

by September 1, 1994. We cannot guarantee that corrections transmitted

to HCFA after June 15, 1994, will be reflected in the final wage index.

Therefore, we suggest that hospitals wishing to submit corrected data

do so as soon as possible and follow up with their intermediaries to

ensure inclusion of the corrected data in the final FY 1995 wage index.

After reviewing requested changes submitted by hospitals,

intermediaries will transmit any revised cost reports to HCRIS and will

forward to the hospitals a copy of the revised Worksheet S-3, Part II.

If requested changes are not accepted, fiscal intermediaries will

notify hospitals in writing of reasons why the changes were not

accepted. This procedure will ensure that hospitals have an opportunity

to verify the data that will be used to construct their wage index

values. We believe that fiscal intermediaries are in the best position

to make evaluations regarding the appropriateness of a particular cost

and whether it should be included in the wage index data. However, in

the event that a hospital disagrees with the intermediary's resolution

of a requested change, the hospital may contact HCFA to attempt to

resolve the dispute.

We have created the above-described process to resolve all

substantive wage data correction disputes before we finalize the raw

wage data for the FY 1995 payment rates, Accordingly, hospitals that do

not meet the procedural deadlines described above will not be afforded

a later opportunity to submit wage corrections or to dispute the

intermediary's decision with respect to requested changes. We note that

we intend to make a diskette available in mid-August that will contain

the finalized raw wage data that will be used to construct the wage

index values in the final rule. As with the diskette made available in

March 1994, HCFA will make the August diskette available to hospital

associations and the public. This August diskette, however, is being

made available only for the limited purpose of identifying any

potential errors made by HCFA or the intermediary in the entry of the

finalized wage data, not for the initiation of new wage data correction

requests. Hospitals are encouraged to review their hospital wage data

promptly after the release of the second diskette.

If after reviewing the August diskette, a hospital believes that

its wage data is incorrect due to a fiscal intermediary or HCFA error,

it should send a letter to both its fiscal intermediary and HCFA. The

letters to the intermediary and HCFA should outline why the hospital

believes an error exists. These requests must be received by HCFA no

later than September 23. Requests should be sent to: Charles R. Booth,

Director; Office of Payment Policy; 181 East High Rise; 6325 Security

Boulevard; Baltimore, Maryland 21207. The intermediary will review

requests upon receipt and, if it is determined that an intermediary or

HCFA error exists, the fiscal intermediary will notify HCFA

immediately.

As indicated above, after mid-August, we will make changes to the

hospital wage data only in those very limited situations involving an

error by the intermediary or HCFA that the hospital could not have

known about before its review of the August diskette. Specifically,

neither the intermediary nor HCFA will accept the following types of

requests in conjunction with this mid-August process: requests for wage

data correction that were submitted too late to be included in the data

transmitted to the HCRIS system on or before June 15, 1994, requests

for correction of errors made by the hospital not identified during the

hospital's review of the March 1994 data, or requests to revisit

factual determinations or policy interpretations made by the

intermediary or HCFA during the wage data correction process. Verified

corrections to the wage index made as a result of an intermediary or

HCFA error received timely (that is, by September 23, 1994) will be

effective October 1, 1994.

We continue to believe, as outlined in the final rule published

September 1, 1992 (57 FR 39765), that midyear corrections should not be

made in most cases. We believe the wage data correction process

described above provides hospitals with sufficient opportunity to bring

errors made during the preparation of Worksheet S-3 to the

intermediary's attention. Moreover, because hospitals will have access

to the raw wage data in mid-August, they will have the opportunity to

detect any ministerial data tabulation errors made by the intermediary

or HCFA before the implementation of the prospective payment rates on

October 1. We believe that if hospitals avail themselves of this

opportunity, the wage index implemented on October 1 should be free of

such errors. Nevertheless, in the unlikely event that such errors

should occur, we do not believe a hospital should be disadvantaged

because actions taken by its intermediary or HCFA in the tabulation of

its data resulted in an error of which the hospital could not have been

aware. Since the current regulations do not provide for midyear

corrections in these situations, we are proposing to revise the

regulations to specify that the Secretary retains the right to make

midyear changes to the wage index under very limited circumstances.

Again, we believe that it is appropriate to reserve the right to make

midyear changes to the wage index in those limited circumstances where

the hospital can show that an error was made, and the hospital could

not have known about, or sought to correct, the error by September 23,

1994.

Specifically, we propose to revise Sec. 412.63(s)(2) to provide

that the Secretary may make midyear corrections to the wage index only

in those limited circumstances where a hospital can show: (1) That the

intermediary or HCFA made an error in tabulating its data, and (2) that

the hospital could not have known about the error, or did not have an

opportunity to correct the error, by September 23, 1994. As indicated

earlier, since a hospital will have the opportunity to verify its data

and the intermediary will notify the hospital of any changes, we do not

foresee any specific circumstances under which midyear corrections

would be made. However, should a midyear correction be necessary, the

wage index change for the affected area will be made prospectively from

the date the correction is made. If midyear corrections are made, we

will evaluate their impact to determine if a budget neutrality

adjustment to the program payments should be made at the beginning of

the following fiscal year in accordance with Sec. 412.63(s)(4).

3. Computation of the Wage Index

As noted above, we are proposing to base the FY 1995 wage index on

wage data reported on the FY 1991 cost report. The wage index would be

based on data from 5,294 hospitals paid under the prospective payment

system and short-term acute care hospitals in waiver States. The method

used to compute the proposed wage index is as follows:

Step 1--We gathered data from each of the non-Federal short-term

acute care hospitals for which data were reported on the Worksheet S-3,

Part II of the Medicare cost report for the hospital's cost reporting

periods beginning on or after October 1, 1990, and before October 1,

1991. Each hospital was assigned to its appropriate urban or rural area

prior to any reclassifications under sections 1886(d)(8) or 1886(d)(10)

of the Act. In addition, we included data from a few hospitals that had

cost reporting periods beginning in September 1990 and had reported a

cost reporting period exceeding 52 weeks. The data were included

because no other data from these hospitals would be available for the

cost reporting period described above, and particular labor market

areas might be affected due to the omission of these hospitals.

However, we generally describe this wage data as FY 1991 data.

Step 2--For each hospital, we subtracted the excluded salaries

(that is, direct salaries attributable to skilled nursing facility

services, home health services, and other sub-provider components not

subject to the prospective payment system) from gross hospital salaries

to determine net hospital salaries. To the net hospital salaries, we

added hospital contract labor costs, hospital fringe benefits, and any

home office salaries and fringe benefits reported by the hospital to

determine total salaries plus fringe benefits.

Step 3--For each hospital, we inflated or deflated, as appropriate,

the total salaries plus fringe benefits resulting from Step 2 to a

common period to determine total adjusted salaries. To make the wage

inflation adjustment, we used the percentage change in average hourly

earnings for each 30-day increment from October 14, 1990 through

September 15, 1992, for hospital industry workers from S.I.C. 806,

Bureau of Labor Statistics Employment and Earnings Bulletin. The annual

inflation rates used were 5.6 percent for FY 1990 and FY 1991 and 4.8

percent for FY 1992. The inflation factors used to inflate the

hospital's data were based on the midpoint of the cost reporting period

as indicated below.

Midpoint of Cost Reporting Period

------------------------------------------------------------------------

Adjustment

After Before factor

------------------------------------------------------------------------

10/14/90........................................ 11/15/90 1.071953

11/14/90........................................ 12/15/90 1.067097

12/14/90........................................ 01/15/91 1.062262

01/14/91........................................ 02/15/91 1.057450

02/14/91........................................ 03/15/91 1.052659

03/14/91........................................ 04/15/91 1.047890

04/14/91........................................ 05/15/91 1.043143

05/14/91........................................ 06/15/91 1.038417

06/14/91........................................ 07/15/91 1.033713

07/14/91........................................ 08/15/91 1.029030

08/14/91........................................ 09/15/91 1.024368

09/14/91........................................ 10/15/91 1.019727

10/14/91........................................ 11/15/91 1.015751

11/14/91........................................ 12/15/91 1.011790

12/14/91........................................ 01/15/92 1.007845

01/14/92........................................ 02/15/92 1.003915

02/14/92........................................ 03/15/92 1.000000

03/14/92........................................ 04/15/92 0.996101

04/14/92........................................ 05/15/92 0.992217

05/14/92........................................ 06/15/92 0.988348

06/14/92........................................ 07/15/92 0.984494

07/14/92........................................ 08/15/92 0.980655

08/14/92........................................ 09/15/92 0.976831

------------------------------------------------------------------------

For example, the midpoint of a cost reporting period beginning January

1, 1991 and ending December 31, 1991 is June 30, 1991. An inflation

adjustment factor of 1.033713 would be applied to the wages of a

hospital with such a cost reporting period. In addition, for the data

for any cost reporting period that began in FY 1991 and covers a period

of less than 360 days or greater than 370 days, we annualized the data

to reflect a 1-year cost report. Annualization is accomplished by

dividing the data by the number of days in the cost report and then

multiplying the results by 365.

Step 4--For each hospital, we subtracted the reported excluded

hours from the gross hospital hours to determine net hospital hours. We

increased the net hours by the addition of any reported contract labor

hours and home office hours to determine total hours.

Step 5--As part of our editing process, we deleted data for 69

hospitals that are no longer participating in the Medicare program or

that are in bankruptcy status, and for which we lacked sufficient

documentation to verify data that failed edits. We retained the data

for other hospitals that are no longer participating in the Medicare

program because these hospitals contributed to the relative wage levels

in their labor market areas during their FY 1991 cost reporting period.

Step 6--Within each urban or rural labor market area we added the

total adjusted salaries plus fringe benefits obtained in Step 3 for all

hospitals in that area to determine the total adjusted salaries plus

fringe benefits for the labor market area.

Step 7--We divided the total adjusted salaries plus fringe benefits

obtained in Step 6 by the sum of the total hours (from Step 4) for all

hospitals in each labor market area to determine an average hourly wage

for the area.

Step 8--We added the total adjusted salaries plus fringe benefits

obtained in Step 3 for all hospitals in the nation and then divided the

sum by the national sum of total hours from Step 4 to arrive at a

national average hourly wage. Using the data as described above, the

national average hourly wage is $18.1808.

Step 9--For each urban or rural labor market area, we calculated

the hospital wage index value by dividing the area average hourly wage

obtained in Step 7 by the national average hourly wage computed in Step

8.

C. Changes In the Reporting of Hospital Wage Index Data

Currently, the data used to develop the wage index are submitted by

hospitals on the Worksheet S-3, Part II of the Medicare cost report. We

developed this worksheet as part of the FY 1990 cost reports, and we

used the worksheet to calculate the wage index for FY 1994. The

worksheet has been evaluated by HCFA and industry representatives to

ensure that this data collection mechanism captures relative wage costs

as accurately as possible and to determine whether any refinements are

appropriate. The Medicare Technical Advisory Group (MTAG) established a

task force to study and recommend changes to the cost reporting form

used to collect wage index data. The task force was comprised of

hospital, intermediary, and HCFA representatives. The MTAG task force

recommended, and we are proposing, three major changes to the Worksheet

S-3, Part II; the provider cost report questionnaire (HCFA 339); and

accompanying instructions as discussed below. We note that the proposed

changes outlined below are effective for cost reporting periods

beginning on or after October 1, 1994. Therefore the proposed changes

will not affect the proposed FY 1995 wage index, which is based on FY

1991 wage data.

1. The Elimination of Part A Physicians' and CRNA Salaries

Currently, a hospital that directly employs and pays the salary of

a physician can include the Part A portion of the physician's salary in

total salaries reported on Worksheet S-3, Part II. (The Part B portion

of physician salaries has always been excluded from the wage index.)

However, if a hospital contracts for physician services, it is not

permitted to include the Part A physician services as contract labor

because we consider Part A physician services to be administrative, not

direct patient-care related (to be included in the computation of the

wage index, contract labor must be directly related to patient care).

Not all hospitals directly employ physicians. There are currently

five States in which State laws specifically restrict hospitals from

directly hiring physicians. Hospitals in these States are forced to

contract out for physicians. The inability of those hospitals that

contract for physician services to include the Part A portion of the

services as contract labor has been perceived as inequitable. In States

where hospitals may directly employ physicians, the hospitals may

include some of these characteristically high wages in the wage data,

while in States where hospitals must contract for their physician

services, these contract wages cannot be included in their wage data.

We agree with the MTAG task force recommendation and are proposing

to exclude all Part A physician costs on the Worksheet S-3, Part II,

regardless of whether the physician is a hospital employee or

contractor. For purposes of this exclusion, physician's salaries are

defined as salaries applicable to positions that require a licensed

physician, such as a medical director of a department. Salaries for

physicians employed in other positions, such as hospital administrator,

that do not require a physician would not be excluded.

Since this change would apply equally to hospitals that are

permitted to employ physicians and to those that must contract for

physician services, we believe this proposal will promote payment

equity and provide more uniformity in the wage data across areas. This

action should not require any additional reporting burden since these

Part A physician salaries already are reported on the cost report

(Worksheet A-8-2).

We believe that this proposal to eliminate Part A physicians'

salaries is more appropriate than the alternative of allowing all Part

A physician costs (whether salaried or under contract) for three

reasons. First, physician costs are not driven by normal labor market

situations and, in many cases, hospitals must hire physicians from

outside of their recruiting areas. Second, many hospitals have

indicated difficulty in accurately determining the hours for the

physicians attributable to Part A services, especially for those under

contract.

Third, we have found that some hospitals that employ physicians are not

appropriately eliminating Part B physician salaries from the total

salaries reported for the wage index as required in the cost reporting

instructions. Accordingly, we are proposing that hospitals exclude all

physicians' salaries (both Part A and Part B related) from the wage

data reported on the Medicare cost report. In addition, we are

proposing that the salaries for teaching physicians also be excluded,

since payment for these services does not fall under the prospective

payment system.

Regarding Part A CRNA (certified registered nurse anesthetist)

costs, we propose to require hospitals to exclude these salaries from

the wage data reported on the cost report. These Part A services are

currently paid on a ``pass-through'' basis, outside the prospective

payment system. Therefore, we believe it is appropriate to exclude

these costs from the wage index. Moreover, this Part A pass-through

provision is applicable to a limited number of hospitals (small rural

hospitals). All other hospitals are paid for CRNA services under Part B

of the Medicare program. Therefore, in order to ensure consistency

across areas, we believe that no CRNA costs should be reflected in the

wage index computation. CRNA services are generally excluded from the

wage index as Part B services. Since the Part A portion was granted as

a pass through for certain rural hospitals, it is currently included in

wage index.

We note that these changes are effective for cost reporting periods

beginning on or after October 1, 1994 and will not affect the current

reporting of physicians and CRNA salaries.

2. Management Contracts

The second major proposed change concerns the inclusion of certain

management contracts in the hospital wage index data. Before FY 1994,

the wage index did not include any costs associated with contract

services. However, many hospitals indicated that they were

inappropriately disadvantaged because they were forced to contract out

for nurses and technicians due to shortages of these services in their

areas. To alleviate this problem, we revised the cost report to collect

the data associated with any direct patient care service contract (that

is, nursing, therapeutic, etc.). We specifically excluded any Part B

services, Part A physician services, management contracts, or any

contract for services not directly involved with patient care.

The hospital industry has expressed concern that we do not

currently recognize the cost of certain contract management services.

In particular, many rural hospitals that are either unable to recruit

or cannot afford top managers such as hospital administrators must

contract for the services of these individuals. Therefore, we believe

it is appropriate to include the costs of certain management contracts

in the wage index. We propose to expand the definition of contract

services reported on the Worksheet

S-3 to include the personnel cost associated with contracts for any

personnel hired in the top four positions within the hospital.

Allowable contract management services would be limited to the

personnel costs for those individuals who are working at the hospital

facility in the capacity of the Chief Executive Officer (CEO)/Hospital

Administrator, Chief Operating Officer (COO), Chief Financial Officer

(CFO), or Nursing Administrator. The exact titles assigned to

individuals may vary but the individuals should be performing

essentially the same duties as customarily assigned these management

positions.

The hospitals (via HCFA-339 form) would be required to provide the

fiscal intermediary with complete details on all direct patient care

related contracts and the description and aggregate totals for all

management contracts. Because of the difficulty in accurately

determining hours and isolating wage related costs for the other types

of contract services, the wage data would continue to exclude all other

non-patient care contract services except those limited management

contracts discussed above.

Since the current cost report does not provide for the collection

of management contract data, this revised definition would not be

effective until cost reporting periods beginning on or after October 1,

1994. To provide consistent reporting of data, hospitals must continue

to exclude all management contracts until the FY 1995 data is reported.

3. Reporting of Wage-Related Costs

Since we began including fringe benefits in the wage index, we have

been concerned with the inconsistent reporting of fringe benefits,

whether because of a lack of provider proficiency in identifying fringe

benefit costs or varying interpretations across fiscal intermediaries

of the definition for fringe benefits in PRM-I, Sec. 2144.1. Although

we have attempted to promote consistent reporting of fringe benefits by

providing fiscal intermediaries with general guidelines to be used in

determining allowable fringe benefit costs, the intermediaries must

necessarily make judgments as to whether certain costs qualify as a

fringe benefit, and inconsistencies persist.

Last summer, HCFA conducted a survey to determine what costs the

health care industry thought should be recognized as fringe benefit

costs. The survey consisted of a questionnaire with a yes/no response

column and a column for comments. We received 238 responses from

hospitals, fiscal intermediaries, state hospital associations, national

hospital associations, state agencies, and bureaus and offices within

HCFA. The results of those surveys were examined closely by the MTAG

task force.

Based on the recommendations of the task force, we are proposing

several changes that we believe will promote more equitable and

consistent reporting of wage-related costs for all hospitals. Where the

term ``fringe benefit'' has been used in the past, we will now refer to

these costs as ``wage- related costs'' for wage index purposes. We

believe that this change in terminology will eliminate the confusion

regarding those wage-related costs that we will allow to be

incorporated in the wage index versus the definition of fringe benefits

required by Medicare principles for cost reimbursement purposes.

Accordingly, we are proposing to revise the Worksheet S-3, Part II to

capture wage-related costs in three parts.

a. Wage-Related Costs (Core). For most hospitals, the wage-related

costs used to develop the wage index would be limited to ``core'' wage-

related costs. The list of ``core'' wage-related costs includes all

commonly recognized costs (which are similar to fringe benefits used

for cost reimbursement purposes) that contribute significantly to the

wage costs of a hospital and that are readily identifiable on the

hospital records. These costs will also be listed on the revised HCFA-

339 form, and hospitals will be required to provide the intermediary

with a detailed description of the wage-related costs in Exhibit 7.

This description will allow the intermediary to review the

appropriateness of each wage-related cost. We believe that this core

list includes virtually all significant wage-related costs, including

those costs that are required by statute.

To develop the list of core wage-related costs, the MTAG task force

established a number of specific criteria. To be considered a core

wage-related cost, one or more of the following criteria must be met:

The wage-related cost is provided at a significant

financial cost to the employer.

The wage-related cost is of a type and nature that would

generally be offered as a fringe benefit by most employers.

The perceived value of this wage-related cost is of such

importance that it would influence an individual's employment

decisions.

The wage-related cost is a mandatory requirement under

Federal or State law (for example FICA, Federal and State unemployment,

etc.).

Fees paid to external organizations that are directly

associated with the core wage-related costs may be included as part of

the wage-related cost (for example, actuarial fees, claim

administration fees, IRS form preparation fees, etc.).

The following is the proposed list of core wage-related costs:

(1) Retirement Costs:

401(k) employer contributions

Tax sheltered annuity (TSA) employer contributions

Qualified and non-qualified pension plan cost

Prior year pension service cost

(2) Plan Administration Costs (Paid to external organization):

401(k)/TSA plan administration fees

Legal/accounting/management fees--pension plan

Employee managed care program administration fees

(3) Health and Insurance Costs:

Health insurance (purchased or self-funded)

Prescription drug plan

Dental, hearing, vision plans

Life insurance (if employee is owner or beneficiary)

Accident insurance (if employee is owner or beneficiary)

Disability insurance (if employee is owner or beneficiary)

Long-term care insurance (if employee is owner or beneficiary)

Workmen's compensation insurance

Retiree health care cost (only current year, not the extraordinary

accrual required by FASB 106 (that is, the non-cumulative portion))

(4) Taxes:

FICA--employers portion only

Medicare taxes--employers portion only

Unemployment insurance

State or Federal unemployment taxes

(5) Other:

Executive deferred compensation

Day care cost and allowances

Tuition reimbursement

b. Other Wage-Related Costs. A hospital may be able to report an

additional wage-related cost that does not appear on the core list if

it meets the following criteria:

The wage-related cost is provided at a significant

financial cost to the employer. To meet this test the individual wage-

related cost must be greater than 1 percent of total salaries after the

direct excluded salaries are removed (Column 3, line 3 on Worksheet S-

3, Part II).

Any wage-related cost that would be a fringe benefit if

reported to the IRS as a fringe benefit.

The wage-related cost has not been furnished for the

convenience of the provider.

We note that those wage-related costs that are required to be

reported to the IRS as salary (for example, loan forgiveness and sick

pay accruals) would not be included as other wage-related costs, since

the costs associated with these items are considered salaries and would

already be included in the total salaries reported on line 1.01 of the

Worksheet S-3, Part II.

c. Wage-Related Costs (Excluded Area). Wage-related costs

associated with employees in areas of the hospital that are excluded

from the data used to calculate the wage index (such as a hospital-

based SNF) should be removed from the total wage-related costs. This is

not a new policy; however, to ensure that hospitals are removing these

costs, we have added a new line on the Worksheet S-3, Part II.

In addition to the above changes, we are proposing that, beginning

on or after October 1, 1994, hospitals use Generally Accepted

Accounting Principles (GAAP) in developing the wage-related costs

contained in the Worksheet S-3, Part II, for purposes of the hospital

wage index. For all other purposes, however, Medicare principles will

continue to apply in determining the allowability of fringe benefit

costs. The MTAG task force recommended application of GAAP for purposes

of developing wage-related costs used to construct the hospital wage

index. We believe it is appropriate to apply GAAP for these purposes

because the function of the wage index is to measure relative hospital

labor costs across areas. This function is distinct from that of cost

reimbursement, in which applicable Medicare principles (which may

differ from GAAP) measure the actual costs incurred by individual

hospitals. We believe the application of GAAP for purposes of compiling

data on wage-related costs used to construct the wage index will more

accurately reflect relative labor costs, because certain wage-related

costs (such as pension costs) as recorded under GAAP tend to be more

static from year to year. Application of Medicare principles, on the

other hand, could create large swings in these costs from year to year,

particularly in years when there are large over- or under-funded

pension estimates; such application might lead to a wage index that

does not accurately reflect relative labor costs. Again, we emphasize

that under this proposal, GAAP will apply only for purposes of

developing wage-related costs on Worksheet S-3 Part II. Our policy

requiring the use of applicable Medicare principles for determining

fringe benefits for all other purposes remains unchanged.

The revised cost report and the HCFA-339 forms are currently being

evaluated by the Office of Management and Budget. Once these forms are

approved, we propose to implement the form to collect wage data for any

cost report beginning on or after October 1, 1994. However, we will

issue subsequent revisions to the forms and instructions to reflect any

changes incorporated in the final rule based on public comments.

D. Revisions to the Wage Index Based on Hospital Redesignation

Under section 1886(d)(8)(B) of the Act, hospitals in certain rural

counties adjacent to one or more Metropolitan Statistical Areas (MSAs)

are considered to be located in one of the adjacent MSAs if certain

standards are met. Under section 1886(d)(10) of the Act, the Medicare

Geographic Classification Review Board (MGCRB) considers applications

by hospitals for geographic reclassification for purposes of payment

under the prospective payment system.

The methodology for determining the wage index values for

redesignated hospitals is applied jointly to the hospitals located in

those rural counties that were deemed urban under section 1886(d)(8)(B)

of the Act and those hospitals that were reclassified as a result of

the MGCRB decisions under section 1886(d)(10) of the Act. Section

1886(d)(8)(C) of the Act provides that the application of the wage

index to redesignated hospitals is dependent on the hypothetical impact

that the wage data from these hospitals would have on the wage index

value for the area to which they have been redesignated. Therefore,

pursuant to section 1886(d)(8)(c) of the Act, the wage index values

were determined by considering the following:

If including the wage data for the redesignated hospitals

reduces the MSA wage index value by 1 percentage point or less, the MSA

wage index value determined exclusive of the wage data for the

redesignated hospitals applies to the redesignated hospitals.

If including the wage data for the redesignated hospitals

reduces the wage index value for the area to which the hospitals are

redesignated by more than 1 percentage point, the hospitals that are

redesignated are subject to the wage index value of the area that

results from including the wage data of the redesignated hospitals (the

``combined'' wage index value). However, the wage index value for the

redesignated hospitals cannot be reduced below the wage index value for

the rural areas of the State in which the hospitals are located.

Rural areas whose wage index values would be reduced by

excluding the data for hospitals that have been redesignated to another

area continue to have their wage index calculated as if no

redesignation had occurred. Those rural areas whose wage index value

increases as a result of excluding the wage data for the hospitals that

have been redesignated to another area have their wage index calculated

exclusive of the redesignated hospitals.

The wage index value for an urban area is calculated

exclusive of the wage data for hospitals that have been reclassified to

another area. However, geographic reclassification may not reduce the

wage index for an urban area below the Statewide rural average,

provided the wage index prior to reclassification was greater than the

Statewide rural wage index value.

Section 13501(b) of Public Law 103-66 amended section

1886(d)(8)(C) of the Act to provide that a change in classification of

hospitals from one area to another may not result in the reduction in

the wage index for any urban area whose wage index is below the rural

wage index for the State. This provision also applies to any urban area

that encompasses an entire State.

We note that, except for those rural areas where redesignation

would reduce the rural wage index value, and in the situation described

above that was addressed by section 13501(b) of Public Law 103-66, the

wage index value for each area is computed exclusive of the data for

hospitals that have been redesignated from the area for purposes of

their wage index. As a result, several MSAs listed in Table 4a have no

hospitals remaining in the MSA. This is because all the hospitals

originally in these MSAs have been reclassified to another area by the

MGCRB. For those areas, we have listed the Statewide rural wage index

value.

The proposed revised wage index values effective for discharges

occurring on or after October 1, 1994 are shown in Tables 4a, 4b, and

4c of the addendum to this proposed rule. Hospitals that are

redesignated should use the wage index values shown in Table 4c. For

some areas, more than one wage index value will be shown in Table 4c.

This occurs when hospitals from more than one State are included in the

group of redesignated hospitals, and one State has a higher Statewide

rural wage index value than the wage index value otherwise applicable

to the redesignated hospitals. Tables 4d and 4e list the average hourly

wage for each labor market area based on the FY 1991 wage data. In

addition, we have expanded Table 3c (Hospital Case-Mix Indexes for

Discharges) to include the average hourly wage for each hospital based

on the FY 1991 data. The average hourly wage published in the final

rule will be used by the MGCRB to evaluate if a hospital meets the

reclassification criteria. Hospitals that choose to apply before

publication of the final rule can use the proposed wage data in

applying to the MGCRB for wage index reclassifications that would be

effective for FY 1996. We note that in adjudicating these wage

reclassification requests during FY 1995, the MGCRB will use the

average hourly wages for each hospital and labor market area that are

reflected in the final FY 1995 wage index.

The proposed FY 1995 wage index values incorporate all

reclassification decisions made by the MGCRB for FY 1995. At the time

this proposed wage index was constructed, the MGCRB had completed its

review. There were 429 hospitals redesignated for purposes of the wage

index (including hospitals redesignated under both sections

1886(d)(8)(B) and 1886(d)(10) of the Act). This number does not include

MGCRB decisions that are still under review by the Administrator.

Any changes to the wage index that result from withdrawals of

requests for reclassification, wage index corrections, appeals, and the

Administrator's review process will be incorporated into the wage index

values published in the final rule. The changes may affect not only the

wage index value for specific geographic areas, but also whether

redesignated hospitals receive the wage index value for the area to

which they are redesignated or a combined wage index that includes the

data for both the hospitals already in the area and the redesignated

hospitals. Further, the wage index value for the area from which the

hospitals are redesignated may be affected.

Under Sec. 412.273, hospitals that have been reclassified by the

MGCRB are permitted to withdraw their applications within 45 days of

the publication of this Federal Register document. The request for

withdrawal of an application for reclassification that would be

effective in FY 1995 must be received by the MGCRB by [OFR: Insert date

45 days after date of publication]. A hospital that requests to

withdraw its application may not request that the MGCRB decision be

reinstated after publication of the final wage index values.

E. Impact of the Revised Hospital Wage Index

Section 1886(d)(3)(E) of the Act requires that the wage index be

updated annually beginning October 1, 1993. In addition, this section

requires that updates to the hospital wage index be budget neutral. The

FY 1995 wage index will represent the second annual update to the wage

data. We will use the wage data from the FY 1991 Medicare cost report

to calculate the updated wage index. For FY 1995, the wage index will

continue to include salaries, fringe benefits, home office salaries,

and certain contract labor salaries. In the past, updates to the wage

data have resulted in significant payment shifts among hospitals. Since

the wage index is now updated annually and there are no changes to the

types of costs included in the wage index data, we expect these payment

fluctuations will be minimized. Based on the proposed wage index

calculation (after reclassifications under sections 1886(d)(8)(B) and

1886(d)(10) of the Act), there is a significant drop, compared with

previous years, in the number of labor markets that experience major

increases or decreases in wage index values. We reviewed the data for

any area that experienced a wage index change of 10 percent or more to

determine the reason for the fluctuation. When necessary, we contacted

the intermediaries to determine the validity of the data, or to obtain

an explanation for the change. Our review indicated that most of the

significant changes were attributable to improved reporting by

hospitals.

The following chart compares the shifts in wage index values (after

reclassifications) for labor markets for FY 1995 with those experienced

as a result of last year's wage index update.

------------------------------------------------------------------------

Number of labor

market areas

Percentage change in area wage index values -----------------

FY 1995 FY 1994

------------------------------------------------------------------------

Increase more than 10 percent......................... 6 13

Increase between 5 and 10 percent..................... 18 24

Decrease between 5 and 10 percent..................... 17 58

Decrease more than 10 percent......................... 11 14

------------------------------------------------------------------------

Under the proposed FY 1995 wage index, 86.4 percent of all

prospective payment hospitals (4,778 hospitals) would experience a

change in their wage index value of less than 5.0 percent.

Approximately 5.2 percent (283 hospitals) would experience a change of

between 5 and 10 percent, and 8.4 percent (469 hospitals) would

experience a change of more than 10 percent. The following chart shows

the projected impact for urban and rural hospitals. (The totals in this

chart exceed the number of hospitals in our database, as our projection

includes new hospitals and hospitals that for other reasons are not

included in our wage file.)

------------------------------------------------------------------------

Number of

hospitals

Percentage change in area wage index values -----------------

Rural Urban

------------------------------------------------------------------------

Decrease more than 10 percent......................... 188 196

Decrease between 5 and 10 percent..................... 26 94

Change between -5 and +5 percent...................... 2,099 2,679

Increase between 5 and 10 percent..................... 44 119

Increase more than 10 percent......................... 67 18

------------------------------------------------------------------------

F. Occupational Mix Adjustment

In its March 1, 1994 report, ProPAC recommended that the Secretary

develop methods to collect more timely hospital wage data by

occupational categories and to adjust the HCFA wage index for

occupational mix (Recommendation 15).

The HCFA wage index reflects variations in the cost of labor; that

is, it includes the effects of variations in the mix of occupations as

well as the price of labor. ProPAC believes that the wage index should

reflect only variations in the price of labor, which are beyond the

hospital's control and are not otherwise accounted for by adjustments

in the prospective payment system.

Previous ProPAC studies on the effect of adjusting the wage index

for occupational mix using data collected from California hospitals

found that a wage index adjusted for occupational mix would

redistribute funds from urban to rural hospitals. Within urban areas,

the occupational mix adjustment would redistribute funds from large to

small hospitals. Within rural areas, the occupational mix adjustment

would increase the wage index values of all bed-size groups. ProPAC

also reanalyzed the California data to examine the impact of an

occupational mix adjustment on wage index values based on hospital-

specific labor market areas. ProPAC currently believes that the

implementation of revised labor areas, including nearest neighbor labor

markets, would substantially improve payment equity among hospitals if

an occupational adjustment was developed.

We are not convinced that an occupational mix adjustment would

improve the accuracy of the wage index, as we have discussed most

recently in the August 30, 1991 final rule (56 FR 43222). Currently,

the wage index measures the overall costs of labor. If the wage index

were to measure the price of labor, then a set of occupational weights

would have to be developed to determine a standard occupational mix.

Hospitals would not be compensated for a mix of employees above the

standard, while hospitals with a mix of employees below the standard

would be overcompensated, relative to their cost of labor. If we were

to adopt hospital-specific labor market areas in conjunction with an

occupational mix adjustment, one concern would be the application of

occupational weights to every prospective payment hospital in the

country. Application of one set of occupational weights to every

prospective payment hospital would conflict with the intended purpose

of hospital-specific labor markets, which is to make the wage index

more responsive to local conditions. We cannot envision a single set of

occupational weights that could be applied to all prospective payment

hospitals in an equitable manner.

Last year, ProPAC suggested that we convene a working group made up

of representatives from HCFA and the hospital industry to try to

improve the timeliness and accuracy of the wage data. HCFA assembled

such a discussion work group and presented ProPAC comments concerning

the equity of adopting a method to collect data to assist in the

development of an occupational mix. The discussion workgroup's

consensus was that the data required to implement the proposal is not

currently available and the likelihood of obtaining such data would be

minimal. There seems to be little support among hospital industry

representatives for developing a system that in their opinion clearly

creates additional reporting burdens with an unproven or minimal impact

on the distribution of payments. Therefore, at this time we are not

proposing any changes to the collection of data to be used in

developing an occupational mix adjustment.

G. Research on Refinements to Labor Market Areas

1. Background

Almost from the beginning of the prospective payment system, we

have received comments from hospitals and ProPAC objecting to the use

of MSA-based labor market areas to construct the wage index. Common

concerns have been that the Statewide rural areas are too large to

distinguish differences in labor market conditions, and that the MSA-

based wage index does not reflect the fact that hospitals in the center

cities (the ``urban core'') pay higher wages than suburban hospitals.

Some commenters have argued that rural labor market areas should be

subdivided into two smaller groups based on county populations and that

MSA-based labor market areas should be divided into urban core and

suburban ring labor markets to distinguish the differences in labor

market conditions.

In light of these concerns, we have continued to examine a variety

of options for revising wage index labor market areas. In this proposed

rule, we discuss in detail issues raised by commenters concerning

ProPAC's ``nearest neighbor'' recommendation, our research and analysis

on alternative labor market areas, and the possibility of allowing all

hospitals in a State to opt out of the current labor market system.

2. Discussion of Comments Concerning ProPAC's Nearest Neighbor

Recommendation

In its March 1, 1993 report, ProPAC recommended that the Secretary

substantially revise the hospital wage index under the prospective

payment system for FY 1994. In its March 1, 1994 report, ProPAC made

the same recommendation (Recommendation 16). Specifically, ProPAC

recommends that we develop hospital-specific labor market areas based

on geographic proximity, using each hospital's ``nearest neighbors''

for purposes of a revised wage index. As in 1993, ProPAC has also

recommended that Congress repeal the current statutory provisions

relating to geographic reclassification for the wage index.

In ProPAC's 1993 report, the Commission discussed establishing each

hospital's labor market area based on its 10 nearest neighbors within a

50-mile radius. In its 1994 report, ProPAC examined defining labor

markets for each hospital by including the nearest 15 hospitals within

a 20-mile radius, and extending the radius up to 30 or 35 miles when

needed in order to include a total of at least 3 hospitals.

In our May 26, 1993 proposed rule (58 FR 30242), we stated that we

believed, and ProPAC agreed, that legislation would be required before

we could use hospital-specific labor market areas in constructing the

wage index due to the statutory requirements regarding hospital

reclassifications for wage index purposes. We also stated that in

addition to the statutory constraints, we did not believe that it would

be feasible or advisable to attempt to implement ProPAC's

recommendation in FY 1994. Although we acknowledged that ProPAC's

recommendation might have promise, we indicated that careful analysis

of the impact of such a proposal on hospitals was necessary before

proposing to adopt such a significant change. In addition, we stated

there were also a number of administrative issues that must be

carefully considered before ProPAC's proposal could be implemented,

including the possible development of an exceptions or appeals process

to resolve disputes concerning the labor market areas. We agreed with

ProPAC that if we adopted hospital-specific labor market areas using

its methodology, the MGCRB as it is currently constituted might no

longer be necessary. We also stated that we would not recommend that

Congress repeal the MGCRB provisions of the Act until we had analyzed

fully the implications of adopting hospital-specific labor market areas

or some other revisions to labor market areas. We noted that after our

analysis was complete, we would decide whether to recommend that the

mission of the MGCRB be altered to make it responsible for resolving

disputes concerning hospital-specific labor market areas.

To facilitate a thorough analysis of ProPAC's proposal, we

published in the FY 1994 proposed rule hospital-specific wage index

values using ProPAC's data on hospital locations and the new FY 1990

hospital wage data (58 FR 30457). The tables indicated what each

hospital's wage index value would be if the wage index were based on

the wage data for the hospital and its 10 nearest neighbors up to a

radius of 50 air miles. The tables also showed which hospitals were in

each hospital's labor market area based on ProPAC's data base.

Subsequently, we discovered a technical error in the wage index values

and republished a revised wage index value for each hospital in a

correction notice (June 29, 1993, 58 FR 34742).

We solicited public comments on ProPAC's proposal and suggestions

concerning the development of an exceptions or appeals process, if

appropriate, for possible implementation in FY 1995. We also solicited

comments on a number of other issues such as the feasibility of using

road miles instead of air miles, a process to verify hospital

locations, and what the process should be to establish a wage index for

new hospitals. We stated that we planned to continue our analysis of

alternatives based on the current MSA based system that have appeared

promising in the past, and that we planned to evaluate all potential

labor market revisions using the same basic criteria. Comments on these

issues were due to HCFA by August 31, 1993.

In both the proposed and final rules for FY 1994, we stated our

intention to analyze the comments we received as well as to conduct the

research we outlined. We also stated that we would continue to consult

with ProPAC and study any additional information they developed. We

stated our intention to publish a proposal for formal public comment in

the FY 1995 proposed rule if hospital-specific labor market areas based

on the nearest neighbor concept proved promising. We indicated that we

would include information describing all aspects of our proposal, and

consider all comments, before issuing a final rule for implementation.

In response to the May 26, 1993 proposed rule, we received a total

of 266 comments on the nearest neighbor wage index proposal, including

28 from national, State, and local organizations representing

hospitals. In all, 33 commenters were in favor of the nearest neighbors

proposal, 128 were opposed and 105 were in support if changes were made

to satisfy their concerns. The areas of major concern raised by the

commenters were the redistribution of Medicare payments that would

occur if hospital-specific labor market areas were adopted, how the

boundaries should be drawn around hospitals to define labor market

areas, and the nature and extent of an exceptions process. Several

commenters also had reservations about whether a hospital's nearest

neighbors were reflective of its labor market area. We discuss these

and other issues below.

Redistribution of Medicare Payments--Many commenters were

concerned about whether instituting hospital-specific labor market

areas would lead to major shifts in Medicare payments at the same time

that hospitals face an uncertain financial future because of the impact

of health care reform. One state hospital association noted that

adoption of the nearest neighbors proposal would cause a major

redistribution of payments among rural hospitals, and that many

hospitals that would be adversely affected were already in precarious

financial condition. Another state association commented that the

effects of the proposal on the hospitals in its State would vary

greatly, with substantially increased payments to some hospitals and

decreased payments to others. Many commenters suggested that if we were

to adopt the nearest neighbors proposal, some type of phase-in over

several years would be essential.

Definition of Labor Market Areas--Several commenters

stated that hospital characteristics such as size, services offered,

and case mix are a more reliable determinant of who a hospital competes

with for labor than who its nearest neighbors are. One state

association stated that its analysis of the wage index computed under

the nearest neighbors proposal demonstrates that geographic proximity

does not provide an accurate measure of the amount a hospital must pay

to compete for labor. Since there are a wide range of options for

defining hospital-specific labor market areas, many of the commenters

suggested variations depending on their perception of what new labor

market areas should achieve. Some favored changing the size of labor

market areas so as to increase payment to a particular hospital or type

of hospital, while others favored defining labor markets in a way that

would decrease the payment shifts that would occur under the options.

In order to minimize the payment changes that would result from the

wage index, some groups supported including a larger number of

hospitals in each labor market, while others supported limiting the

size of labor market areas. One state association asserted that both

nearest neighbor and fixed boundary labor market alternatives are

problematic because neither method allows a sufficient amount of

flexibility for determining labor market areas. The association

believes that it would be more accurate if the direction and distance

of worker commuting patterns were incorporated into the determination

of a hospital's nearest neighbors. Another association stated that it

may be difficult to identify a uniform approach that is equitable for

all areas of the country, and urged HCFA to consider using different

methodologies in different regions as appropriate. A national

association stated that while the nearest neighbors proposal has

conceptual appeal, whether the association would support a nearest

neighbor proposal ultimately would depend on where HCFA draws the line

around hospitals.

Exceptions Process--Most of the commenters agreed that

some type of exceptions process would be needed regardless of which

system for defining hospital labor market areas is developed. Several

commenters stressed the need for an exceptions process to address

geographic anomalies; cases in which air miles are not equivalent to

road miles; and cases in which a hospital is grouped with unlike

hospitals, such as a rural referral center (RRC) grouped with much

smaller primary care hospitals or a tertiary care hospital in a single

hospital MSA that is grouped with much smaller rural hospitals. Another

commenter supported giving a hospital the right to appeal to add or

delete hospitals from its labor market area if the target hospital can

demonstrate substantial labor market competition (or a lack of it) with

a specific hospital. Some commenters supported special exception

criteria for RRCs. One group believes that the nearest neighbors

proposal should be modified to accommodate RRCs that otherwise would

have been reclassified, that have only other rural hospitals in their

nearest neighbors group, or that would be significantly harmed by the

proposal. Another group believes that RRCs should be excluded from a

nearest neighbors wage index and that they should be allowed to use

either their own hospital-specific wage index or be allowed to

reclassify into the nearest MSA using the existing MGCRB rules.

Multi-campus hospitals--We received a wide range of

comments concerning multi-campus hospitals. Some commenters suggested

that the hospital's location should be its main address listed on the

cost report. Other commenters suggested that the facility with the

largest concentration of employees be defined as the hospital's

location, or that a hospital should be allowed to pick which campus

would be considered its location for labor market area purposes.

Hospital Location Verification--Some commenters suggested

that we publish each hospital's longitude and latitude and require them

to submit documentation to verify any requests for corrections to this

data. Others suggested that we use the Global Positioning System to

verify location. Some commenters suggested that the hospital's

emergency room entrance should be used as the hospital's location,

others suggested the main employee entrance, and still others suggested

that a hospital be allowed to designate any point on its campus as its

location.

State Boundaries--Some commenters stated that labor market

areas should not be constructed across State lines because cost of

living and labor costs can vary greatly from State to State due to

differences in State tax structures, costs of health insurance and

other employee benefit programs dependent on State law.

Blend/Floor--Some commenters suggested that a nearest

neighbors wage index should not be adopted unless a hospital's own wage

data were weighted more heavily than those of its neighbors. Other

commenters suggested that we institute a floor below which a hospital's

wage index could not fall or that we blend the current wage index with

any index based on revised labor market definitions.

3. Analysis of Alternative Labor Market Areas

We agree with commenters, and with ProPAC, that improvements to the

current labor market system should be explored. Below, we discuss the

feasibility of several alternative methodologies for establishing labor

markets, including revised versions of the current MSA-based system,

various hospital-specific methodologies, as well as an alternative that

combines the hospital-specific and MSA-based methodologies. In

evaluating each of the alternatives presented, we considered the major

issues raised by commenters, ProPAC's recommendations, as well as our

own internal research and analysis. ProPAC's data on air-mile distances

between hospitals were used to develop wage indexes based on hospital-

specific systems.

We note that in our May 26, 1993 proposed rule (58 FR 30244), we

indicated that we would hold a meeting with a working group consisting

of hospital industry representatives to review potential revisions to

labor market areas, and other issues related to the wage index. On

November 19, 1993, HCFA staff met with 17 representatives of State and

national hospital associations to discuss options for redefining

hospital labor market areas and other issues related to the current

wage index. A ProPAC representative also attended and presented

information on the status of the Commission's current research. HCFA

staff presented information on each of the options under consideration.

The group expressed no preference for any of the hospital-specific

or MSA-based options with the possible exception of a hospital-specific

wage index based in large part on the hospital's own wages. The group

was extremely concerned about the redistribution of dollars that would

occur if nearest neighbors labor market areas were adopted in the

current budgetary climate. It was also concerned about how an

exceptions process would function under any revised labor market

scheme, fearing that it would be too subjective and that it would be

impossible to predict how many hospitals would be reclassified.

a. MSA-based and Hospital-Specific Alternatives. In our labor

market research, we reviewed a large number of options: nine hospital-

specific wage indexes based on the nearest neighbor and fixed radius

approaches and seven MSA-based indexes involving ways of subdividing

MSAs or statewide rural areas. Following is a description of the

options we reviewed. We have assigned each option a name to facilitate

discussion and for use in tables that follow later in this section.

Hospital-Specific Alternatives

10 Nearest Neighbors--A wage index based on each hospital's own

wage data and that of its 10 nearest neighbors, or all hospitals within

a distance of 50 miles, if there are fewer than 10 other hospitals

within 50 miles. One hundred ninety-five hospitals had no neighbor

within 50 miles. These hospitals were assigned their own relative wage

level, which is computed by comparing its own wages to the national

average hourly wage. The same 195 hospitals also were assigned their

``own wage index'' for the 15 Nearest Neighbors and 20 Nearest

Neighbors wage indexes.

10 Nearest Neighbors/Minimum of 2--A wage index based on each

hospital's own wage data and that of its 10 nearest neighbors within 20

miles (with a minimum of at least 2 nearest neighbors within 20 miles

or all hospitals within 35 miles).

15 Nearest Neighbors--A wage index based on each hospital's own

wage data and that of its 15 nearest neighbors, or all hospitals within

a distance of 50 miles if there are fewer than 15 other hospitals

within 50 miles.

15 Nearest Neighbors/Minimum of 2--A wage index based on each

hospital's own wage data and that of its 15 nearest neighbors within 20

miles (with a minimum of at least 2 nearest neighbors within 20 miles

or all hospitals within 35 miles).

20 Nearest Neighbors--A wage index based on each hospital's own

wage data and that of its 20 nearest neighbors, or all hospitals within

50 miles if there are fewer than 20 other hospitals within 50 miles.

20-Mile Radius--A wage index based on each hospital's own wage data

and that of all its neighbors within a 20-mile radius. The 887

hospitals having no neighbor within 20 miles were assigned their own

relative wage level.

25-Mile Radius--A wage index based on each hospital's own wage data

and that of all its neighbors within a 25-mile radius. The 522

hospitals having no neighbor within 25 miles were assigned their own

relative wage level.

30-Mile Radius--A wage index based on each hospital's own wage data

and that of all its neighbors within a 30-mile radius. The 391

hospitals having no neighbor within 30 miles were assigned their own

relative wage level.

35-Mile Radius--A wage index based on each hospital's own wage data

and that of all its neighbors within a 35-mile radius. The 301

hospitals having no neighbor within 35 miles were assigned their own

relative wage level.

MSA-Based Alternatives

These alternatives represent various subdivisions (by counties) of

the current MSA/rural labor market area definitions. As such, all

counties in each subdivided category need not be contiguous.

Central-Outlying--A wage index in which each MSA is divided into 2

areas based on its central and outlying counties.

Rural-Population--A wage index in which each Statewide rural area

is divided into 2 distinct labor market areas, one including all

counties with populations greater than 25,000 and one made up of

counties with populations less than 25,000.

Rural-Density--A wage index in which each Statewide rural area is

divided into 2 areas if it contains counties with population densities

greater and less than 35 persons per square mile.

Rural-Population/Density--A wage index in which each Statewide

rural area is divided into as many as 4 areas depending on whether

populations are greater or less than 25,000 person and population

densities are greater or less than 35 persons per square mile.

Rural-Adjacent--A wage index in which each Statewide rural area is

divided into 2 areas, one including all counties adjacent to an MSA and

the other made up of counties not adjacent to an MSA.

Rural-Population/Adjacent--A wage index in which each Statewide

rural area is divided into as many as 4 areas depending on the

adjacent/non-adjacent status of its non-MSA counties and whether county

populations are greater or less than 25,000 persons.

Rural-Density/Adjacent--A wage index in which each Statewide rural

area is divided into as many as 4 areas depending on the adjacent/non-

adjacent status of its non-MSA counties and whether county population

densities are greater or less than 35 persons per square mile.

As a basis of comparison for these alternatives, we also reviewed

three variations of the current MSA-based wage index.

Current MSA-based Indexes

Geographic--The FY 1994 hospital wage index without the effects of

geographic reclassification.

Reclassification--The actual FY 1994 hospital wage index after

reclassification.

Estimated FY 1995--The FY 1994 hospital wage index revised to

include an estimate of the effects of geographic reclassification in FY

1995 (based on FY 1990 data).

We used three basic criteria to analyze each of the alternatives:

(1) Wage Conformity Within Labor Markets. This criterion assesses

the extent to which a wage index conforms to a hospital's own relative

wage level. It also evaluates the extent to which a hospital's wages

are aberrant for its labor market area (that is, are more than one

standard deviation above the labor market wage index);

(2) Wage Index Conformity Across Labor Markets (Boundary Problems).

This criterion measures the extent to which the new labor market areas

reflect uniform labor market conditions as indicated by the degree of

similarity in the hospital wage rates across labor market areas. The

boundaries should minimize inequitable treatment, that is, cases in

which hospitals facing similar labor costs are grouped into different

labor markets.

(3) Distributional Equity Improvement. This criterion examines the

impact of a labor market option to determine its effects on the

distribution of hospital payments, and the extent to which the

hospitals that would gain and lose under various proposals are already

doing well or poorly under the current system. Redistribution of

payments should fairly compensate both high-wage hospitals and low-wage

hospitals.

None of the options we initially reviewed were a significant

improvement over the current reclassified wage index in terms of wage

conformity within labor markets, wage conformity across labor markets,

or distributional equity improvement. The following tables summarize

our major results:

Wage Conformity Within Labor Markets

Table A displays the number of hospitals for which the difference

between the area wage index value for a given alternative and the

hospital's own relative wage index value (determined by dividing the

hospital's average hourly wage by the national average hourly wage) is

greater than .08 either positive or negative. A .08 difference in the

wage index was selected as it represents approximately a $200

difference in payments per case. For each wage index option, the Lose

and Gain columns show the number of hospitals for whom the difference

represents a given decrease or increase in wage index value.

Table B displays the number of hospitals whose wage index values

are more than 108 percent above their labor market wage index value

(that is, one standard deviation greater).

Table A.--Number of Hospitals Losing or Gaining More Than .08 Relative to Own Wage Level, for Selected Wage

Indexes by Type of Geographic Area

----------------------------------------------------------------------------------------------------------------

All hospitals Large urban n=1,612 Other urban n=1,307 Rural n=2,311

n=5,230 -----------------------------------------------------------------

Wage index ----------------------

Lose >.08 Gain >.08 Lose >.08 Gain >.08 Lose >.08 Gain >.08 Lose >.08 Gain >.08

----------------------------------------------------------------------------------------------------------------

Existing System:

Geographic FY 94.... 682 1,708 263 531 137 321 282 856

Estimate FY 95...... 590 1,672 289 493 141 317 160 862

Hospital-Specific:

Nearest 10.......... 627 1,674 268 452 178 302 181 920

Nearest 10/Min 2.... 597 1,204 260 421 140 259 197 524

Nearest 15/Min 2.... 592 1,224 255 439 140 261 197 524

20 Mile Radius...... 549 1,014 264 438 141 244 144 332

MSA-Based:

Central-Outlying.... 676 1,576 264 474 134 233 278 869

Rural-Adjacent...... 682 1,690 263 530 137 321 282 839

Rural-Density....... 706 1,540 262 530 137 321 307 689

----------------------------------------------------------------------------------------------------------------

Table B.--Number of Hospitals Whose Wages are More Than 108 Percent

Above Their Labor Market Area

------------------------------------------------------------------------

Number of hospitals with wages

greater than 108 percent

----------------------------------

Wage index Large Other

All urban urban Rural

hospitals n=1612 n=1307 n=2311

n=5230

------------------------------------------------------------------------

Existing System:

Geographic FY 94................. 746 235 144 367

Estimate FY 95................... 559 232 137 190

Hosp.-Specific:

Nearest 10....................... 620 217 181 222

Nearest 10/Min 2................. 650 224 135 291

Nearest 15/Min 2................. 653 228 134 291

20 Mile Radius................... 594 229 139 226

MSA-based:

Central-Outlying................. 758 243 148 367

Rural-Adjacent................... 756 235 144 377

Rural-Density.................... 798 235 144 419

------------------------------------------------------------------------

Wage Conformity Across Labor Markets

Table C presents the assessment of wage conformity across labor

markets. We determined that a ``boundary problem'' existed for a target

hospital (that is, the hospital whose wage index value is being

calculated) if--

Among nearby hospitals, one or more other hospitals' wage

index value is at least .04 greater than that of the target hospital,

corresponding to approximately a $100 difference in payments per case,

and

The hospital with the lower wage index value pays higher

wages than the hospital with the higher wage index value.

``Nearby hospitals'' were defined as the 20 nearest hospitals or if

a hospital does not have 20 other hospitals within a 35 mile radius,

all hospitals within a 35 mile radius. Table C shows the number of

hospitals with one or more boundary problems and the average size of

the wage index difference for those boundary problems. An average wage

index difference of .12 corresponds to a payment difference of about

$300 per case.

Table D shows the effects that different labor market alternatives

would have when compared to the current FY 1994 pre-reclassified wage

index.

Table C.--Number of Hospitals Subject to ``Boundary Problem'' and Average Size of ``Boundary Problem'' by Type

of Geographic Area

----------------------------------------------------------------------------------------------------------------

All hospitals n=5230 Large Urban n=1612 Other urban n=1307 Rural n=2311

-------------------------------------------------------------------------------------------

Wage index Number Average Number Average Number Average Number Average

hospitals difference hospitals difference hospitals difference hospitals difference

----------------------------------------------------------------------------------------------------------------

Existing System:

Geographic FY 94 760 0.113 49 0.099 240 0.103 471 0.125

Estimate FY 95.. 662 0.110 51 0.105 215 0.101 396 0.120

Hospital--Specific:

Nearest 10...... 1223 0.077 387 0.074 224 0.074 612 0.086

Nearest 10/Min 2 1343 0.084 405 0.079 263 0.079 675 0.091

Nearest 15/Min 2 1240 0.085 305 0.080 260 0.079 676 0.091

20 Mile Radius.. 1041 0.083 169 0.079 264 0.080 608 0.089

MSA-Based:

Central-Outlying 712 0.101 106 0.107 232 0.094 374 0.107

Rural-Adjacent.. 838 0.106 49 0.098 241 0.102 548 0.113

Rural-Density... 884 0.109 49 0.098 241 0.103 594 0.120

----------------------------------------------------------------------------------------------------------------

Table D.--Labor Market Alternatives: Percent Change from Current MSA Values

[Pre-Reclassification]

----------------------------------------------------------------------------------------------------------------

Greater Less than

All hospitals N than 10 5-10 0-5 0 -5 to 0 -10 to -5 -10

percent percent percent percent percent percent

----------------------------------------------------------------------------------------------------------------

Estimate FY 95.......... 5,230 210 64 1,114 3,556 235 48 3

Nearest 10.............. 5,230 614 665 1,629 0 1,514 490 318

Nearest 10/Min 2........ 5,230 366 480 1,692 0 1,353 590 749

Nearest 15/Min 2........ 5,230 356 452 1,761 0 1,359 553 749

20 Mile Radius.......... 5,230 356 333 1,775 0 1,381 491 894

Central-Outlying........ 5,230 10 3 1,380 3,389 150 108 190

Rural-Adjacent.......... 5,230 9 5 1,441 2,936 685 126 28

Rural-Density........... 5,230 7 163 775 3,149 506 432 198

----------------------------------------------------------------------------------------------------------------

As demonstrated by the above tables, our analyses showed that none

of the MSA-based options consistently outperformed the current

estimated FY 1995 post-reclassified wage index in terms of wage

conformity within labor market areas and wage conformity across labor

market areas.

With respect to wage conformity within labor market areas, the

results in Table A demonstrate that the 20-mile radius hospital-

specific option, with 549 losing hospitals, best reduces the number of

hospitals with wage index values more than .08 below their own wage

level. The FY 1995 post-reclassified wage index was second best, with

590 hospitals with wage index values more than .08 below their own wage

level. The 20-mile radius approach also produced the fewest number of

hospitals (1014) with wage index values more than .08 above their own

wage levels. However, as demonstrated in Table B, the estimated FY 1995

post-reclassified wage index outperformed the other labor market

options, with only 559 hospitals whose own average hourly wages were

108 percent or more of their respective labor market area's average

hourly wage. Therefore, the 20-mile radius and the estimated FY 1995

post-reclassified wage indexes demonstrated somewhat better outcomes

for wage conformity within labor market areas than any of the other

options we studied.

With respect to wage conformity across labor market areas

(``boundary problems''), as indicated in Table C, the estimated FY 1995

post-reclassified wage index generated the fewest hospitals having

boundary problems (662), with the central-outlying MSA option having

the second lowest number of such hospitals (712). All of the nearest

neighbor options, including the 20-mile radius option (with 1,041

hospitals), had the effect of significantly increasing the number of

boundary problems that would occur, although the problems were of a

smaller magnitude.

Overall, none of the MSA-based options or the nearest neighbor

options consistently outperformed the current estimated FY 1995 post-

reclassification wage index. While the 20-mile radius option performed

well in terms of wage conformity within labor market areas, it

performed significantly worse than the current system with respect to

wage conformity across labor market areas. Additionally, with respect

to the distributional effects of all the options, none demonstrated any

measurable improvement in payment equity across hospital groups.

Therefore, we are not presenting any tables concerning the

distributional effect in this discussion. We have decided not to

propose changes to labor market areas for FY 1995 because we believe

that neither revisions to the current MSA-based system or the nearest

neighbors labor market options that we studied constitute a clearly

demonstrable improvement over the current system.

b. Options for Future Wage Index Refinements Using Combined MSA/

Hospital-Specific Approach. While none of the alternative labor market

areas that we studied, whether based on current MSA definitions or the

``nearest neighbor'' approach, provided a distinct improvement over the

current reclassification wage index, we believe a classification system

that uses a combination of both approaches has considerable potential

for improving the wage index. Discussed below are some options for

further study that we believe may offer a viable alternative to the

current system by taking into consideration all of the varying factors

that affect a hospital's labor market. Each of these options is based

on a weighted average of each hospital's own average hourly wages and

the average hourly wages of a group of other hospitals. The following

concepts and assumptions underlie the wage index options that we are

now analyzing:

Empirically defining labor market areas in a highly

accurate, definitive manner is extremely difficult, if not impossible.

MSAs and statewide rural areas may be reasonably accurate in many

cases, but in other cases, these areas may be larger than a hospital's

``true'' labor market area. None of the methodologies we studied for

subdividing MSAs and/or statewide rural areas or for designing nearest

neighbor labor market areas proved to have been demonstrably more

accurate than the current system.

Both a hospital's own wage data and that of other

hospitals in its vicinity may contain relevant information about the

level of wages in the hospital's true labor market. In particular, a

hospital's own data may reflect specific circumstances of the

hospital's labor market that we have yet to discover in our analysis of

the data, but that reflect geographic variation that Medicare would

want to capture in the wage index.

No matter how we determine labor market areas, both a

hospital's own wage data and that of other hospitals assigned to its

labor market area may contain any number of spurious sources of

variation, including data errors, that should not be captured in the

wage index. The larger the number of hospitals whose data are averaged,

the more the effects of spurious factors are reduced.

To address all of these considerations, we have designed for

comment and future study an approach that uses the current MSA system

but generally gives a hospital's own wages a higher weight than under

the current system. (We have assigned each hospital's own wages a

weight sufficient to ensure that in no case would the weight of a

hospital's own wages be reduced below its current level.) We believe

that a hospital's own wages, to some degree, reflect its specific labor

market conditions. Hence, a hospital's wage index would be more

representative of these labor market conditions if a higher weight was

assigned to its own wages than typically occurs in large MSA or

statewide rural area labor markets. If this approach results in

situations in which a hospital's wage level continues to be

significantly higher than the combined average hourly wage used to

construct its wage index, we would provide

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