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: 2.0

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

• Last Updated: January 2026

• 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

The operating payment combines quality-adjusted base payments with DSH, IME, and Uncompensated Care add-ons:

Operating Payment = (Base DRG Payment × VBP × HRRP)
                  + (Base DRG Payment × DSH Operating Factor)
                  + Uncompensated Care Per Claim
                  + (Base DRG Payment × IME Factor)

Important: VBP and HRRP adjustments apply only to the base DRG payment. DSH and IME amounts are calculated on the unadjusted base and added separately. Uncompensated Care is a flat per-discharge amount.

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)

FY 2026 Standardized Amounts

Component	Wage Index > 1.0	Wage Index ≤ 1.0
Labor Share	66% ($4,456.72)	62% ($4,186.62)
Nonlabor Share	34% ($2,295.89)	38% ($2,565.99)
Total	$6,752.61	$6,752.61

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)

• Source: Cost of Living Adjustment field in Impact File

Step 2: Apply MS-DRG Weight

Base DRG 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: Use the Weights - 10% Cap Applied column, which incorporates the regulatory cap on year-over-year weight decreases.

Step 3: Apply Quality Adjustments to Base

Quality adjustments apply to the base DRG payment before DSH/IME/UCP add-ons:

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

Adjustment	Description	Typical Range	Source Field
VBP	Hospital Value-Based Purchasing Program	0.98–1.02	Proxy Value Based Purchasing Adjustment Factor
HRRP	Hospital Readmissions Reduction Program	0.97–1.00	Proxy Readmission Adjustment Factor

Step 4: Calculate DSH Add-On

DSH Amount = Base DRG Payment × DSH Operating Factor

Disproportionate Share Hospital (DSH) Adjustment

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

• Empirically Justified DSH (25%): A case-mix adjusted operating add-on, reflected in the DSHOPP field

• Uncompensated Care (75%): Paid as a separate per-discharge amount (see Step 6)

Source: DSHOPP field from CMS Impact File (this is the operating DSH factor, already computed)

Step 5: Calculate IME Add-On

IME Amount = Base DRG Payment × IME Factor

Indirect Medical Education (IME) Adjustment

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

Source: TCHOP field from CMS Impact File (this is the operating IME factor, already computed using the formula below)

IME Formula Reference (for understanding; use pre-computed TCHOP value):

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

Where:

• r = Resident-to-Bed Ratio

• 1.35 = Congressional multiplier

• 0.405 = Empirically estimated teaching cost coefficient

Step 6: Add Uncompensated Care Payment

Uncompensated Care = UCP Per Claim Amount

This is a flat dollar amount per discharge that varies by hospital, representing that hospital's share of the 75% uncompensated care pool. This amount is added directly to the payment (not multiplied).

Source: UCP Per Claim Amount field from CMS Impact File

Step 7: Calculate Total Operating Payment

Operating Payment = (Base DRG Payment × VBP × HRRP)
                  + (Base DRG Payment × DSHOPP)
                  + UCP Per Claim Amount
                  + (Base DRG Payment × TCHOP)

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Capital Payment Calculation

Formula Structure

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

Components

Component	FY 2026 Value	Source Field
Capital Federal Rate	$524.15	Table 1D (fixed)
DRG Weight	Same as operating	Table 5 Weights - 10% Cap Applied
GAF	Hospital-specific	Impact File GAF
Capital COLA	Alaska/Hawaii only	Impact File Capital Cost of Living Adjustment
Capital DSH	Hospital-specific	Impact File DSHCPP
Capital IME	Hospital-specific	Impact File TCHCP

Geographic Adjustment Factor (GAF)

The GAF adjusts capital payments for geographic variation in capital costs. Unlike the operating wage index adjustment (which splits labor/nonlabor), the GAF is a single multiplicative factor.

Capital DSH and IME

Capital DSH and IME use different formulas than their operating counterparts:

Capital DSH Formula (reference; use pre-computed DSHCPP):

Capital DSH = e^(0.2025 × DSH Patient Percentage) - 1

Capital IME Formula (reference; use pre-computed TCHCP):

Capital IME = e^(0.2822 × RADC) - 1

Where RADC = Resident-to-Average Daily Census Ratio (capped at 1.5)

Key Difference from Operating IME: Capital IME uses Average Daily Census in the denominator, while Operating IME uses Beds.

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Summary: Data Fields Used

Calculation Component	Impact File Field	Notes
Wage Index	Table 2: 3,6 FY 2026 Wage Index With Cap	Determines labor/nonlabor split
DRG Weight	Table 5: Weights - 10% Cap Applied	Use capped weights
Operating COLA	Cost of Living Adjustment	Default 1.0
Operating DSH	DSHOPP	Pre-computed factor
Operating IME	TCHOP	Pre-computed factor
Uncompensated Care	UCP Per Claim Amount	Flat dollar amount
VBP Adjustment	Proxy Value Based Purchasing Adjustment Factor	Default 1.0
HRRP Adjustment	Proxy Readmission Adjustment Factor	Default 1.0
Capital GAF	GAF	Geographic adjustment
Capital COLA	Capital Cost of Living Adjustment	Default 1.0
Capital DSH	DSHCPP	Pre-computed factor
Capital IME	TCHCP	Pre-computed factor

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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.

5. No Special Payment Provisions: Calculations exclude:

   • Sole Community Hospital (SCH) provisions

   • Medicare-Dependent Hospital (MDH) provisions

   • Low-Volume Hospital adjustments

   • Rural Emergency Hospital provisions

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 have been validated against the CMS IPPS Web Pricer (https://webpricer.cms.gov/) and produce exact matches for operating and capital components when using consistent input parameters.

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
UCP	Uncompensated Care 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 (90 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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Change Log

Version	Date	Changes
1.0	November 2025	Initial release
2.0	January 2026	Added Uncompensated Care Payment (UCP Per Claim Amount); Corrected VBP/HRRP application to base only; Clarified DSH field usage (DSHOPP vs DSHPCT); Added Impact File field reference table; Validated against CMS Web Pricer

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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.