This article is for hospital CFOs, directors of reimbursement, and reimbursement managers.
When it comes to Medicare reimbursement, the hospital Area Wage Index (AWI) may be one of the most important and often overlooked factors influencing your bottom line. This complex formula adjusts prospective payment rates based on regional labor costs and is calculated using data you submit, meaning small reporting decisions can lead to major financial impacts. Hospitals that fully understand how the AWI works and take a proactive approach to managing their data can optimize their Medicare revenue and strengthen long-term financial stability. This article breaks down how the wage index is calculated and offers practical strategies to help you avoid common pitfalls, support audit readiness, and take full advantage of this critical reimbursement mechanism.
What is the hospital AWI and how is it calculated?
Developed by the Centers for Medicare & Medicaid Services (CMS), the hospital AWI is used to adjust Medicare payments to short-term, acute care hospitals under the Prospective Payment System (PPS) to account for geographic differences in hospital labor costs. It compares the average hourly wages of PPS hospitals in a specific labor market area to the national average. Essentially, the AWI enables hospitals in higher-wage areas to receive more reimbursement to reflect their higher costs, while those in lower-wage areas receive less.
Updated annually, the AWI is calculated for each specific labor market area defined by Core-Based Statistical Areas (CBSA) as established by the US Office of Management and Budget (OMB). To calculate the AWI, CMS determines the average hourly wage from aggregated hospital data for each CBSA and compares it to the national average. For example, if a CBSA has an average hourly wage of $50 and the national average is $40, the AWI would be 1.25. This factor is applied to the labor-related portion of Medicare’s hospital payment rates to ensure more equitable reimbursement across regions with varying labor costs.
The wage index is derived from data reported by all PPS hospitals located within each CBSA, including data from annual Medicare cost reports and occupational mix surveys completed every three years. The hospital-reported data is audited, including review of payroll records, contracts, invoices for contracted labor, and other wage documentation to validate amounts reported. As such, there is a four-year delay from the reporting of wage data in cost reports to the Federal Fiscal Year (FFY) that the wage data is used to calculate the AWI. For example, the Medicare hospital AWI used to establish prospective payments for the FFY 2026 is based on hospital data from fiscal years beginning during the FFY 2022.
The following chart, which includes data from the Centers for Medicare & Medicaid Services Fiscal Year 2025 Skilled Nursing Facility (SNF) Prospective Payment System (PPS) Final Rule, illustrates the significant impact that the wage index factor has on hospital reimbursement.
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Strategic considerations for hospitals
Accuracy of submitted data
CMS scrutinizes wage index data with a high level of detail. Inaccurate or inconsistent reporting can result in reimbursement reductions or even penalties. Errors may stem from incorrect wage classifications, exclusion of eligible labor costs, or misalignment between cost report data and payroll records. Hospitals must ensure that their Medicare cost report and occupational mix survey submissions are complete, clearly documented, and compliant with CMS guidance. Regular internal reviews and cross-checks between finance and HR departments can reduce the risk of discrepancies and support a smoother audit process.
Strategy tip: Establish a wage index review team with finance, reimbursement, and HR representation to ensure consistency and defensibility across all submissions.
Occupational mix factor
The occupational mix survey is required every three years and has a multiyear impact on the wage index. It adjusts for differences in staffing models among hospitals, particularly the proportion of higher-paid professionals like RNs compared to lower-paid roles such as LNAs. Even if your total wages remain constant, a change in your occupational mix can significantly alter your wage index and, by extension, your reimbursement.
Strategy tip: If you've recently undergone staffing changes, make sure these are accurately reflected and that you’ve retained the documentation to support the reported mix.
Contract labor reporting
The rise in contract and traveler staffing has introduced new complexity to wage index reporting. CMS requires hospitals to include contract labor costs that are for direct patient care services, but only when wages and hours are clearly documented and the reported costs are only related to labor (not overhead, travel, etc.). Missing or incomplete contractor data can lead to an underreported wage index, which may reduce reimbursement. Many hospitals unintentionally leave out valid contract labor costs because of poor tracking or vendor relationships that don’t provide sufficient detail.
Strategy tip: Work with your contracted staffing vendors to ensure all contracts and invoices separate wage related rates and hours from non-wage-related cost (travel, housing, administrative fees, etc.). Develop internal controls to flag and track qualifying contract labor throughout the year, not just at cost reporting time.
Appeal and correction opportunities
Each year, CMS publishes a preliminary wage index in the Inpatient Prospective Payment System (IPPS) rulemaking process, followed by a correction and appeals window. Hospitals have a narrow opportunity to review, identify errors, and file appeals or correction requests, but many miss this window due to resource constraints or lack of awareness. These opportunities can help recover significant underpayments if discrepancies are discovered.
Strategy tip: Mark your calendar for the CMS wage index correction deadlines (typically late summer or early fall) and assign someone to monitor the release of proposed rules. Establish a process for reviewing CMS-calculated wage index factors against your internal expectations to quickly identify inconsistencies.
Geographic reclassification opportunities
If your hospital is in a lower-wage CBSA but competes in a higher-wage labor market (or is on the border of one), you may be eligible to apply for a wage index reclassification through the Medicare Geographic Classification Review Board (MGCRB). This allows hospitals to be reclassified into a nearby CBSA with higher average wages, potentially increasing your Medicare reimbursement.
The application must demonstrate that the hospital meets specific criteria related to proximity, commuting patterns, and wage comparability. While the process is data-intensive and must be initiated well in advance (typically by September 1 for the following federal fiscal year), a successful reclassification can yield substantial reimbursement gains.
Strategy tip: Evaluate your geographic and wage positioning annually. Even if you haven't qualified in the past, changes in market conditions or CMS rules may make you newly eligible. BerryDunn can assist with a feasibility analysis and guide you through the MGCRB application process.
We’re here to help
The hospital wage index is complex and reporting wage data is more than a compliance requirement; it’s a strategic lever that can influence millions in Medicare reimbursement. At BerryDunn, our reimbursement specialists can help you:
- Validate and optimize your wage index data submissions
- Prepare for audits, respond to inquiries, and assist with disputes
- Complete the occupational mix survey accurately and efficiently
- Analyze trends and opportunities in your wage index factors
- Identify opportunities for reclassification
- Monitor CMS rule changes that impact your hospital’s reimbursement
To learn more about how we can help your hospital make the most of the wage index, please contact our reimbursement consulting services team.
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