The one-year anniversary of the One Big Beautiful Bill Act (OBBBA) has renewed attention to the financial stability of rural hospitals. The sweeping legislation made significant changes to Medicaid funding and eligibility, effects of which are still coming into focus for rural facilities. But the OBBBA is only the latest chapter in a longer story. The structural forces most responsible for rural hospitals’ financial precarity predate the law by decades.
More than 180 rural hospitals have closed since 2010, further narrowing rural patients’ access to critical healthcare providers, including OB/GYNs and primary care doctors compared with their urban counterparts. Heavy consolidation of hospital and insurance markets, meanwhile, combines with low patient volumes and inadequate federal reimbursement structures to erode already thin operating margins and push facilities to cut services or to close altogether. Indeed, more than one-third of those currently operating are at risk of closing.
Addressing these funding issues is crucial to maintain services and expand healthcare access for rural patients.
The impact of the federal Medicare Wage Index
A good place to start is with the federal government’s reimbursement policies, which have contributed to rural hospitals’ longstanding and ongoing financial instability. At the core is the Medicare Wage Index (MWI).
The MWI is an adjustment to Medicare reimbursement rates that standardizes Medicare payments to hospitals. Based on local and geographic differences in wages, the index plays a key role in determining the reimbursement rates that can make or break a hospital’s ability to hire staff, stay open and serve its community. The principle is that because urban hospitals often pay higher wages, they should receive higher Medicare reimbursements. Yet it’s one more factor driving the cycle of low wages, tight margins, and limited ability to recruit and retain providers, forcing even lower MWIs — and driving the cycle faster.
How the MWI works
The MWI system adjusts Medicare Inpatient Prospective Payment System (IPPS) rates to hospitals to account for local and geographic differences in hospital labor costs. It uses Core-Based Statistical Areas (CBSAs), a geographic demarcation indicating a service area as either metropolitan, micropolitan, or rural. The federal Centers for Medicare & Medicaid Services calculates the wage index value by comparing the average hourly wage of each CBSA with the national average; CBSAs above the national average receive higher reimbursement rates; those below receive lower rates.
This wage index structure makes sense given its purpose to account for geographic labor differences — at least at first glance. However, given rural hospitals’ financial challenges, further losses in reimbursements can be the tipping point for a hospital’s closure. Looked at in this way, the MWI has been a significant contributor to the gap in margin between large urban facilities and their small rural counterparts.
How reimbursement rates drive treatment decisions
Because the MWI shapes a hospital’s reimbursement, it also influences the procedures a hospital can afford to offer patients. A 2022 study by the American Journal of Managed Care found that regional variation in the application of the wage index was correlated with a hospital’s use of device-intensive procedures. It found that regions whose wage index was half the national mean recorded 35 percent fewer device-intensive procedures, while regions whose wage index was 50 percent higher than the national mean recorded 52 percent more device-intensive procedures. The implication was that lower MWIs reduce patients’ access to more innovative, albeit more expensive, procedures — and once again worsening the shortage in specialist care in rural communities.
Underscoring the point, research done by the American College of Cardiology indicated that 83 percent of rural counties had no cardiologist. The Journal of Rural Health found similar trends for anesthesiology and general surgery: 55.1 percent of rural counties lacked a surgeon and 81.2 percent lacked an anesthesiologist.
It’s also true that the MWI allows exceptions for hospitals, whether metropolitan, micropolitan, or rural, to receive a higher MWI rate their local data would otherwise produce. These include mechanisms that set floors for rural or frontier (low population density) locations or adjustments to account for health professional outmigration to higher‑wage areas. In 2022, for example, over 66 percent of hospitals used at least one MWI exception, making them the norm rather than the exception. Since the MWI is budget-neutral, however, every upward adjustment for hospitals that can secure an exception is offset by lower payments to other hospitals, often in nearby areas. And because these exceptions are not grounded in a consistent empirical measure of local labor costs, they essentially shift money around arbitrarily rather than direct support to where it’s most needed, which are often vulnerable facilities.
Flawed incentives and regional disparities
The downward dynamic of low reimbursement rates, financial precarity, low patient population, and constraints in recruiting and retaining healthcare professionals is particularly evident in the South and Southeast. It stems from structural flaws in how the MWI is designed and administered.
First, MWI’s use of regional boundaries — the Core-Based Statistical Areas discussed earlier — to define economic markets masks variation in relative wages within a region. As a result, hospitals that may offer different relative wages receive the same MWI if they are in the same statistical area. This can create problems for both hospitals and physicians: facilities lose potential revenue that could have offset local wage costs, while physicians earn substantially different payments depending on their employer. In the same way, variable MWI allocations between neighboring statistical areas can create wage cliffs — that is, severe drops in funding allocations from one region to the next — leading to provider outflow from to higher-paying employers, which tend to be the nonrural employers.
The plethora of MWI exceptions exacerbates inequities among healthcare facilities by allowing hospitals to gain non MWI-related benefits. For example, using what’s known as the reclassification exception, more than 425 urban hospitals have recategorized themselves as rural CBSAs between 2017-2023. The rural designation enables them to receive benefits such as rural hospital designation status and snagging Medicare-funded residency slots allocated for rural areas. Once having secured the benefits, these hospitals often restore their original high-wage/high-reimbursement CBSA designation and the higher MWI value and emoluments that go with it. This reclassification-declassification cycle is particularly damaging to hospitals that cannot participate in it, as illustrated by the case of Alabama.
Alabama faces one of the lowest MWI values in the country, reflecting the state’s low wages relative to the national average, with 42 percent of the state’s population living in rural areas. Alabama hospitals cannot exploit the reclassification maneuver to escape this disadvantage: the 35-mile rule requires a qualifying higher-wage labor market nearby, and Alabama’s sparse rural geography means few such markets exist within reach. Furthermore, when higher-wage urban hospitals reclassify into Alabama’s rural CBSAs to capture rural designations and then revert, they temporarily distort the wage calculations those rural hospitals are measured against, leaving Alabama’s genuinely rural hospitals with a lower relative MWI and diminished capacity to recruit staff.
These misguided incentives encourage providers in low-rate areas to commute to different, higher-paying states. Along the coast that Florida and Alabama share, the Infirmary Health System on the Alabama side loses providers to hospitals in Pensacola, where they can earn $5 more per hour due to Florida’s higher MWI.
What’s next: Reforming the MWI
Senators Marsha Blackburn (R-TN) and Mark Warner (D-VA) recently introduced legislation to partially address this dynamic by codifying a wage index floor for the lowest-paid hospitals, boosting reimbursements for facilities below the 25th percentile. The bill, the Save Struggling Hospitals Act, would reduce some of the damage caused by MWI’s low rates for rural hospitals, but not the structural reforms needed for durable long-term solutions. Policymakers have a few options to address MWI’s structural flaws, all recommended by the nonpartisan Medicare Payment Advisory Commission:
- Shift the underlying data source: Because Inpatient Prospective Payment System data captures wages only within the hospital sector, it encodes existing labor market disparities into the formula itself. Rather than relying on these cost reports, the MWI could draw data from the Bureau of Labor Statistics or U.S. Census Bureau to account for all employers in a region to produce a more accurate picture of true local labor costs.
- Adopt a smoothed wage index: An alternative wage index that gradually blends MWI values across neighboring regions and caps wage index cliffs at 10 percent would reduce the sharp reimbursement disparities at geographic boundaries that currently drive provider outmigration and destabilize rural hospital finances.
- Replace MWI exceptions with a better base formula: The proliferation of carve-outs has distorted the index far beyond its original intent to account for geographic differences in labor by rewarding hospitals skilled at navigating regulatory loopholes rather than those most in need of support. Streamlining the MWI to function as originally designed would reduce gaming and restore the index’s core purpose.
The MWI aims to adjust hospital reimbursement to overcome regional and geographic differences in wage rates. However, MWI’s quirks, flaws, and susceptibilities to manipulation hurt those who most depend on it: rural healthcare facilities, providers, and patients. They form a vicious cycle in which every rotation deepens their disadvantage and widens the gap between the healthcare haves and havenots. The irony is that it compounds the problems it was created to address. Congress has the opportunity, and the policy options, to correct a formula that has long disadvantaged the hospitals and communities that need support the most.
