Geographic classification of hospitals: alternative labor market areas

Health Care Financing Review, Winter, 1992 by Nancy De Lew

Introduction

The Medicare prospective payment system (PPS) provides hospitals with an average payment for each discharge adjusted for factors considered beyond the control of an individual hospital, including the patient's diagnosis, geographic location, wages, teaching, and service to low-income patients. The goal of the wage adjustment, which reflects the relative level of hospital wages across geographic areas, is to reflect differences in labor costs. Hospitals are grouped into geographically distinct labor market areas to minimize the likelihood that an individual hospital could raise its wages, relative to other hospitals, and hence its payments. By reflecting the average hospital wage in a given geographic area, PPS provides hospitals with an incentive to control their labor costs.

The wage index has been criticized for inadequately measuring wages (by excluding contract labor), for overcompensating richly staffed hospitals (by not controlling for occupational mix), and for drawing labor market area boundaries in a seemingly arbitrary fashion (by using metropolitan statistical area [MSA] definitions to define market areas) (Williams, Pettengill, and Lisk, 1990; Prospective Payment Assessment Commission, 1990; 1991). This article evaluates potential refinements to labor market areas. The goal of the analysis is to increase the explanatory power of the wage index as well as improve payment equity in a single-rate system.

The cost-containment goal of grouping hospitals into labor market areas is clear; however, there is no concomitant clarity about what constitutes an appropriately drawn hospital labor market. Originally, MSAs were used to define urban labor market areas. Counties not included in an MSA were grouped into statewide rural labor market areas. MSAs have been criticized as hospital labor market areas because hospitals that appear otherwise similar, but are located on either side of a county boundary, may receive significantly different payments under PPS (Prospective Payment Assessment Commission, 1989). Occasionally there are wide variations in the wage-index values between two adjacent labor market areas. For example, the adjacent MSAs of Allentown-Bethlehem-Easton, Pennsylvania, and Philadelphia, Pennsylvania, have a 17-percent difference in their fiscal year (FY) 1992 wage index values.

Rural and urban hospitals that border areas with a higher wage index complained of unfair treatment. Subsequently, Congress established several provisions whereby hospitals may change their location for payment purposes. The most notable example is the Medicare Geographic Classification Review Board established by the Omnibus Budget Reconciliation Act of 1989 (Public Law 101-239), which reclassified nearly 1,000 hospitals in FY 1992 and FY 1993 from one labor market area to another, thereby providing new impetus for the refinement of labor market areas. (The effects of the Board's decisions are not reflected in the data analysis discussed in this article.) However, finding other tools to define labor market areas that better reflect hospital wage variation, minimize payment cliffs, and improve payment equity has proved difficult (Wright and Marlor, 1990). Several alternative labor market areas have been examined by researchers hoping to improve upon the original labor market areas. These alternative labor market area definitions largely relied on existing geographic units such as cities and counties.

Rural labor market areas

Hospitals in rural counties adjacent to MSAs claimed that they paid higher wages than did hospitals in non-adjacent rural counties. Hendricks found that adjacent hospitals paid slightly higher wages (4 percent) than did hospitals in non-adjacent counties, but that the difference was not statistically significant (Hendricks, 1989a; U.S. Department of Health and Human Services, 1987). Hendricks found that occupational mix, case mix, teaching activity, and location in a high-rent county were more important than adjacent status in explaining wage variation.

The Prospective Payment Assessment Commission (ProPAC) examined several alternative rural labor market areas including adjacent and non-adjacent counties, urbanized (with a city of 25,000 or more) and non-urbanized counties, and rural portions of Bureau of Economic Analysis areas. ProPAC found that urbanized counties were best at differentiating high-and low-wage hospitals and recommended that rural labor market areas be disaggregated based on urbanized and non-urbanized counties (Prospective Payment Assessment Commission, 1987; Schmitz and Merrell, 1987).

Urban labor market areas

Studies of urban wages have found evidence that many types of wages are higher in the center of the metropolitan area than in the surrounding suburban ring (Madden, 1985; Eberts, 1981). Advocates for central city, also called "core," hospitals argued that they paid higher wages than their suburban counterparts, also called "ring," and should receive additional payments through a core city wage index (Ashby, 1984; Ashby and Parmer, 1985). Several studies subsequently examined wage variation in MSAs, using several different measures of core and ring to test the hypothesis that central city hospitals pay significantly higher wages than their suburban counterparts (U.S. Department of Health and Human Services, 1987; Prospective Payment Assessment Commission, 1987; Hendricks and Keller, 1987).