Medicare Inpatient Methodology

Below outlines the Payerset methodology for calculating Medicare Inpatient rates.

Medicare Inpatient Prospective Payment System (IPPS) Fee Schedule Methodology

Document Information

• Version: 1.0

• Fiscal Year: FY 2026 (Discharges October 1, 2025 – September 30, 2026)

• Last Updated: November 2025

• Regulatory Authority: 42 CFR Part 412; CMS-1833-F (August 4, 2025)

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Executive Summary

This document describes the methodology used to calculate estimated Medicare IPPS fee schedule amounts for acute care hospital inpatient stays. The calculations are based on the Centers for Medicare & Medicaid Services (CMS) FY 2026 IPPS Final Rule and associated data files. These estimates represent the expected base Medicare payment for a given hospital and MS-DRG combination, excluding outlier payments, new technology add-on payments, and certain other case-specific adjustments.

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Regulatory Framework

Legal Authority

Medicare payments to acute care hospitals for inpatient stays are governed by Section 1886(d) of the Social Security Act, which establishes the Inpatient Prospective Payment System (IPPS). Under IPPS, hospitals receive a predetermined payment for each discharge based on the patient's diagnosis-related group (MS-DRG), adjusted for geographic and hospital-specific factors.

Primary Data Sources

Source	Description	Publication Date
CMS-1833-F	FY 2026 IPPS/LTCH PPS Final Rule	August 4, 2025
Table 1A-1E	National Standardized Amounts	August 2025
Table 2	Case-Mix Index and Wage Index by CCN	August 2025
Table 5	MS-DRG Relative Weights	August 2025
Impact File	Provider-Specific Payment Factors	August 2025

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Payment Components

IPPS payments consist of two separate components, each calculated independently:

1. Operating Payment: Covers the operating costs of providing inpatient care (labor, supplies, overhead)

2. Capital Payment: Covers capital-related costs (building depreciation, interest, rent, property taxes)

Total Estimated Payment

Total IPPS Payment = Operating Payment + Capital Payment

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Operating Payment Calculation

Formula Structure

Operating Payment = Adjusted Base Rate × DRG Weight × Quality Adjustments × (1 + DSH + IME)

Step 1: Determine Adjusted Base Rate

The base rate varies depending on whether the hospital's wage index exceeds 1.0:

If Wage Index > 1.0 (Table 1A rates apply):

Adjusted Base Rate = (Labor Share × Wage Index) + (Nonlabor Share × COLA)
                   = ($4,456.72 × Wage Index) + ($2,295.89 × COLA)

If Wage Index ≤ 1.0 (Table 1B rates apply):

Adjusted Base Rate = (Labor Share × Wage Index) + (Nonlabor Share × COLA)
                   = ($4,186.62 × Wage Index) + ($2,565.99 × COLA)

Labor-Related Share

• 66% for hospitals with wage index > 1.0 (Table 1A)

• 62% for hospitals with wage index ≤ 1.0 (Table 1B)

This reflects CMS's rebasing of the IPPS market basket to a 2023 base year, as finalized in the FY 2026 IPPS Final Rule.

Cost of Living Adjustment (COLA)

• Applies only to the nonlabor portion

• Applicable only to hospitals in Alaska and Hawaii

• Default value: 1.0 (no adjustment)

Step 2: Apply MS-DRG Weight

DRG-Adjusted Payment = Adjusted Base Rate × MS-DRG Relative Weight

MS-DRG weights are published in Table 5 of the IPPS Final Rule and reflect the average resources required to treat patients in each diagnostic category relative to the average Medicare patient.

Note: Weights incorporate a 10% cap on year-over-year decreases, as mandated by regulation.

Step 3: Apply Quality Adjustments

Quality-Adjusted Payment = DRG-Adjusted Payment × VBP Factor × HRRP Factor

Adjustment	Description	Application
VBP	Hospital Value-Based Purchasing Program	Ranges typically 0.98–1.02
HRRP	Hospital Readmissions Reduction Program	Maximum reduction of 3%

These adjustments apply to the base operating DRG payment before DSH and IME add-ons.

Step 4: Apply DSH and IME Add-Ons

Final Operating Payment = Quality-Adjusted Payment × (1 + DSH% + IME%)

Disproportionate Share Hospital (DSH) Adjustment

The DSH adjustment compensates hospitals that serve a disproportionate share of low-income patients. Post-ACA (FY 2014+), hospitals receive:

• 25% of their pre-ACA DSH payment as an empirically justified operating add-on (case-mix adjusted)

• 75% as uncompensated care payments (not included in this per-discharge calculation)

Source: DSHPCT field from CMS Impact File

Indirect Medical Education (IME) Adjustment

Teaching hospitals receive additional payments to account for the higher indirect costs associated with residency training programs.

Formula:

IME Adjustment = 1.35 × [(1 + r)^0.405 - 1]

Where:

• r = Resident-to-Bed Ratio (from Impact File)

• 1.35 = Congressional multiplier (represents 5.5% increase per 10% increase in teaching intensity)

• 0.405 = Empirically estimated teaching cost coefficient

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Capital Payment Calculation

Formula Structure

Capital Payment = Federal Rate × DRG Weight × GAF × COLA × (1 + DSH + Capital IME)

Components

Component	FY 2026 Value	Source
Capital Federal Rate	$524.15	Table 1D
DRG Weight	Same as operating	Table 5
GAF	Hospital-specific	Impact File
Capital COLA	Alaska/Hawaii only	Impact File

Geographic Adjustment Factor (GAF)

The GAF adjusts capital payments for geographic variation in capital costs. Unlike the operating wage index adjustment, the GAF is a single multiplicative factor published in the Impact File.

Capital IME Adjustment

The capital IME formula differs from the operating IME formula:

Capital IME = e^(0.2822 × RADC) - 1

Where:

• e = Euler's number (≈2.71828)

• 0.2822 = Empirically estimated capital teaching coefficient

• RADC = Resident-to-Average Daily Census Ratio

RADC Calculation:

RADC = (Resident-to-Bed Ratio × Beds) ÷ Average Daily Census

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Key Assumptions and Limitations

Assumptions

1. Standard Discharge: Calculations assume a standard discharge without transfer, early discharge, or post-acute care transfer adjustments.

2. No Outlier Payments: Extremely high-cost cases may qualify for additional outlier payments not reflected in these estimates.

3. No New Technology Add-Ons: Cases involving qualifying new technologies may receive additional payments (NTAP) not included here.

4. Quality Program Participation: Calculations assume hospitals participate in quality reporting programs and are meaningful EHR users (receiving the full 2.6% update).

5. No Special Payment Provisions: Calculations exclude:

   • Sole Community Hospital (SCH) provisions

   • Medicare-Dependent Hospital (MDH) provisions (expired September 30, 2025)

   • Low-Volume Hospital adjustments

   • Rural Emergency Hospital provisions

6. DSH Methodology: The DSH percentage used (DSHPCT) represents the empirically justified DSH operating adjustment. Uncompensated care payments (75% of DSH) are paid as a separate flat amount per discharge and are not included in these per-DRG estimates.

Limitations

1. Estimation vs. Actual Payment: These are estimated fee schedule amounts. Actual Medicare payments may vary due to:

   • Outlier payments for high-cost cases

   • Transfer payment adjustments

   • New technology add-on payments

   • Cost report settlements

   • Sequestration adjustments (currently 2%)

2. Provider-Specific Factors: Some hospital-specific payment adjustments may not be fully captured in public data files.

3. Timing: Wage index values and other factors may be updated by CMS during the fiscal year through correction notices.

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Data Quality Notes

Validation Approach

Calculated fee schedule amounts should be validated against:

1. CMS IPPS Web Pricer (https://webpricer.cms.gov/)

2. Actual Medicare payment data from claims

3. Hospital cost reports

Expected Variance

When comparing estimated fee schedule amounts to actual Medicare payments:

• ±5% variance is typical and expected

• ±10% variance may indicate outlier cases, transfers, or special circumstances

• >10% variance warrants investigation

Data Refresh Frequency

This methodology should be updated annually upon publication of the IPPS Final Rule (typically August).

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Glossary

Term	Definition
ADC	Average Daily Census
CCN	CMS Certification Number (6-digit provider identifier)
COLA	Cost of Living Adjustment
DRG	Diagnosis-Related Group
DSH	Disproportionate Share Hospital
GAF	Geographic Adjustment Factor
HRRP	Hospital Readmissions Reduction Program
IME	Indirect Medical Education
IPPS	Inpatient Prospective Payment System
MS-DRG	Medicare Severity Diagnosis-Related Group
NTAP	New Technology Add-On Payment
VBP	Value-Based Purchasing

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Regulatory References

1. 42 CFR Part 412 – Prospective Payment Systems for Inpatient Hospital Services

2. Social Security Act §1886(d) – Payments to Hospitals for Inpatient Hospital Services

3. CMS-1833-F – FY 2026 IPPS/LTCH PPS Final Rule (89 FR 36536, August 4, 2025)

4. 42 CFR §412.64 – Federal Rates for Inpatient Operating Costs

5. 42 CFR §412.105 – Indirect Medical Education Adjustment

6. 42 CFR §412.106 – Disproportionate Share Adjustment

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Contact and Support

For questions regarding CMS payment policy:

• CMS IPPS website: https://www.cms.gov/medicare/payment/prospective-payment-systems/acute-inpatient-pps

• CMS Web Pricer: https://webpricer.cms.gov/

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This documentation is provided for informational purposes. Users should verify calculations against official CMS sources and consult with qualified healthcare reimbursement professionals for specific payment determinations.