Geographic classification of hospitals: alternative labor market areas

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

Because the current wage index is based on the average hourly wage in the labor market area, some hospitals receive a relatively greater adjustment than their own wages would otherwise warrant, and other hospitals receive a lower adjustment. The average hospital pays wages almost 6 percent below the area average. The bottom 25 percent of hospitals are more than 13 percent below the area average, and the top 25 percent of hospitals are more than 3 percent above the area average. Because the wage index is hour-weighted rather than hospital-weighted, large hospitals (which are more likely to pay higher wages and have more staff hours) have a greater influence on the average area wage than do small hospitals (which are more likely to pay lower wages and have less staff hours).

Evaluation criteria

Each labor market area was measured against four criteria designed to determine which, if any, of the alternatives were superior to the current labor market areas.

Criterion 1: Is the explanation of wage variation improved? - compared with the current labor market areas, alternative labor market areas should significantly increase the amount of wage variation explained. The methodology used to evaluate explanation of wage variation was analysis of variance; the alternative labor market areas were independent variables and hospital average hourly wage was the dependent variable. The increase in explanatory power (measured by the [R.sup.2] statistic) of each alternative labor market area was then compared with the current labor market area.

Criterion 2: Are the new labor market areas reasonable based on hospital wages? - Labor market areas can be defined using a number of different criteria. However sensible these criteria may be in terms of subdividing MSAs or States, they must also be reasonable based on hospital wages. That is, the new labor market areas should seek to improve upon the uniformity of the labor markets from which hospitals draw their workers. The boundaries should minimize the perception of inequitable treatment, whereupon hospitals facing different labor costs are grouped in the same labor market area or hospitals facing similar labor costs are grouped into different labor market areas.

Direct evaluation of boundary problems was beyond the scope of this article. As a proxy, the wage index was computed for the hypothesized high- and low-wage labor market areas and compared across each of the alternatives.

Criterion 3: Are the new labor market areas of reasonable size across the country? - new labor market areas should be constructed using variables that reasonably subdivide the current labor market areas across the country. Because of differences in population density and distribution, county size, and other factors, a system that works well in one area may not be appropriate in other areas.

To evaluate the size of labor market areas, a minimum of five hospitals was selected to identify labor market areas with a reasonable cell size; those with fewer than five hospitals were considered to have a small cell size. The number of labor market areas with small cell size was evaluated for their geographic distribution.