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Section 1886(b)(3)(B) of the Social Security Act is one of the most consequential annual Medicare hospital payment provisions that no Medicare beneficiary will ever see itemized on a bill. It authorizes the annual IPPS update factor, the percentage by which the Medicare Hospital Inpatient Prospective Payment System (IPPS) operating and capital standardized amounts are adjusted each October 1. The update factor determines whether Grady Memorial Hospital, Emory University Hospital, Memorial Health Savannah, AU Medical Center, Phoebe Putney Memorial Hospital, Atrium Health Floyd, Northeast Georgia Medical Center, Wellstar, Piedmont, Northside, and every other Georgia IPPS hospital receives more Medicare revenue, less Medicare revenue, or the same Medicare revenue this fiscal year compared to last. Multiply that decision by every Medicare admission at every IPPS hospital in Georgia and across the country, and the update factor becomes a multi-billion-dollar annual decision driving hospital financial sustainability nationwide.
The update factor begins with the hospital market basket index, a CMS Office of the Actuary calculation that measures hospital input price inflation: how much hospitals must pay for wages, benefits, professional fees, utilities, pharmaceuticals, supplies, and capital costs to deliver the same level of service. The market basket is the starting point for the annual update, and historically the update factor was simply the market basket. Section 3401 of the Affordable Care Act of 2010 changed that fundamentally. ACA Section 3401 added a permanent multifactor productivity (MFP) adjustment that reduces the market basket update by the 10-year average MFP percentage published by the Bureau of Labor Statistics. Cumulated over the decade and a half since 2010, the MFP adjustment has reduced Medicare hospital payments by tens of billions of dollars relative to the pre-ACA trajectory.
Beyond the market basket and MFP adjustment, additional adjustments may apply. Section 631 of the American Taxpayer Relief Act of 2012 implemented documentation and coding adjustment (DCA) recoupment, reducing the update factor to recover prior years' increases attributable to documentation and coding intensity rather than real care intensity. Section 414 of the Medicare Access and CHIP Reauthorization Act of 2015 (MACRA) continued DCA adjustments with revised provisions.
Quality and technology compliance also factor in. Section 1886(b)(3)(B)(viii) provides that hospitals failing to participate in the Hospital Inpatient Quality Reporting (IQR) program receive a reduction in the market basket update. Section 1886(b)(3)(B)(ix) provides that hospitals not meeting meaningful EHR user requirements under the Promoting Interoperability (PI) program (formerly Meaningful Use) receive an additional update reduction. Together these provisions create powerful financial incentives for Georgia hospitals to participate in federal quality reporting and EHR programs; failure to comply means lower update factor every year, compounded annually.
Annual implementation occurs through the IPPS final rule, published each August by CMS in the Federal Register and taking effect October 1 of the following federal fiscal year. The FY 2026 final rule (issued August 2025 for the October 1, 2025 through September 30, 2026 fiscal year) sets the specific market basket update, MFP adjustment, DCA adjustment, operating standardized amount, capital update factor, wage index, outlier threshold, and other parameters. Every IPPS hospital in Georgia must understand and operationalize the rule each year.
This Brevy guide walks through the entire Medicare IPPS update factor framework. We cover Section 1886(b)(3)(B) and its subsections, Section 1886(b)(3)(C) standardized amount authority, Section 1886(d) IPPS framework, Section 1886(g) capital IPPS, Section 1395ww codification, Section 3401 of the ACA 2010 MFP adjustment, Section 631 of ATRA 2012 DCA recoupment, Section 414 of MACRA 2015 DCA adjustments, Section 1886(b)(3)(B)(viii) IQR reduction, Section 1886(b)(3)(B)(ix) meaningful EHR user reduction, 42 CFR 412 IPPS implementing regulations, 42 CFR 412.64 federal rate determination, 42 CFR 412.71 standardized amounts, the annual IPPS final rule process, the hospital market basket index calculation, operating standardized amounts (labor-related and non-labor-related shares), the capital update factor, wage index geographic adjustment, outlier threshold update, the FY 2026 IPPS final rule specifics, historical update factor trajectory, the compounding effect over multiple years, the interaction with HVBP/HRRP/HACRP adjustments, the sole community hospital and Medicare-dependent hospital hospital-specific rates, the Critical Access Hospital cost-based distinction, six worked examples through major Georgia hospitals, 14 compliance and operational errors, a 25-question accordion FAQ, beneficiary access considerations, and a CTA with 16 contact resources for Georgia beneficiaries and hospitals navigating the IPPS payment framework. :::
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Key Takeaways for Georgia Medicare IPPS Update Factor
Section 1886(b)(3)(B) of the Social Security Act authorizes the annual IPPS update factor that adjusts the operating and capital standardized amounts each federal fiscal year. The update factor determines how much the Medicare base rates for inpatient hospital services grow (or sometimes shrink) from one fiscal year to the next.
The hospital market basket index, calculated by the CMS Office of the Actuary using IHS Markit/Global Insight forecasts, measures hospital input price inflation: wages and salaries, employee benefits, professional fees, utilities, pharmaceuticals, supplies, services, and capital costs. The market basket is the starting point for the update factor.
Section 3401 of the Affordable Care Act of 2010 added a permanent multifactor productivity (MFP) adjustment that reduces the market basket update by the Bureau of Labor Statistics 10-year average MFP percentage. The MFP adjustment is codified at Section 1886(b)(3)(B)(xi). Cumulated since 2010, the adjustment has reduced Medicare hospital payments by tens of billions of dollars relative to the pre-ACA trajectory.
Section 631 of the American Taxpayer Relief Act of 2012 implemented documentation and coding adjustment (DCA) recoupment, reducing the update factor to recover prior years' DRG payment increases attributable to documentation and coding intensity changes rather than real care intensity. Section 414 of MACRA 2015 continued DCA adjustments with revised provisions.
Section 1886(b)(3)(B)(viii) reduces the market basket update for hospitals failing to participate in the Hospital Inpatient Quality Reporting (IQR) program. Section 1886(b)(3)(B)(ix) reduces the update for hospitals not meeting meaningful EHR user requirements under the Promoting Interoperability (PI) program. Together these compliance penalties create strong incentives for Georgia hospitals to participate in federal quality reporting and EHR programs. :::
The Statutory Foundation: Section 1886(b)(3)(B) of the Social Security Act
Section 1886(b)(3)(B) of the Social Security Act is the statutory anchor for the annual IPPS update factor. The provision establishes the framework by which Medicare adjusts the hospital inpatient prospective payment system standardized amounts each federal fiscal year. The annual update is one of the most important Medicare hospital payment decisions; it determines whether Medicare hospital revenue grows in pace with hospital costs, lags behind hospital costs, or outpaces them.
The Section 1886(b)(3)(B) text is dense with technical references and sub-provisions. The basic structure provides the Secretary of Health and Human Services authority to determine the annual update factor, with specific statutory parameters that have evolved over decades through multiple legislative amendments.
The provision was originally enacted as part of the Social Security Amendments of 1983 that established the Medicare IPPS prospective payment system. Before IPPS, Medicare paid hospitals based on retrospective cost reimbursement. The 1983 amendments replaced cost-based payment with the DRG-based prospective payment system, and Section 1886(b)(3)(B) established the framework for annually updating the prospective payment rates.
The annual update is critical because IPPS standardized amounts are not automatically inflation-adjusted. Without an annual update, Medicare hospital payments would remain constant in nominal terms while hospital input costs (wages, supplies, utilities) increased. The update factor is the mechanism that adjusts payments to reflect changing economic conditions, productivity expectations, and policy priorities.
Section 1886(b)(3)(B) has numerous subsections, each addressing specific update factor components. Key subsections include:
- (b)(3)(B)(i): general update factor framework
- (b)(3)(B)(viii): 25 percent reduction for hospitals failing IQR
- (b)(3)(B)(ix): reduction for hospitals not meeting meaningful EHR user requirements
- (b)(3)(B)(xi): multifactor productivity adjustment (added by ACA Section 3401)
The statutory framework directs CMS to apply the various adjustments to determine the actual update factor each fiscal year. CMS implements the statutory framework through annual rulemaking, primarily the IPPS final rule published each August.
The update factor applies to both the operating standardized amount (the base rate for operating costs) and the capital standardized amount (the base rate for capital costs), though the specific calculations differ between operating and capital.
Section 3401 of the Affordable Care Act of 2010: The Multifactor Productivity Adjustment
Section 3401 of the Affordable Care Act of 2010 is one of the most consequential single provisions affecting Medicare hospital payment in the post-2010 era. The section added a permanent multifactor productivity (MFP) adjustment to the IPPS update factor framework, codified at Section 1886(b)(3)(B)(xi) of the SSA.
The MFP Adjustment Mechanism
The MFP adjustment reduces the hospital market basket update by the 10-year average multifactor productivity growth in the economy. The Bureau of Labor Statistics publishes MFP data annually; the 10-year average is calculated and applied as a reduction to the market basket update.
The policy theory underlying MFP adjustment is that healthcare providers should be expected to achieve productivity improvements comparable to the broader economy. If the economy achieves 0.4 percent average annual productivity growth, the theory goes, hospitals should be able to deliver the same care with 0.4 percent fewer resources annually. The MFP adjustment reduces the Medicare update to reflect this expected productivity contribution.
Annual MFP Adjustment Values
The actual MFP adjustment varies year to year based on BLS data. The variability reflects the underlying BLS productivity data, which fluctuates based on economic conditions.
For FY 2026 (October 1, 2025 to September 30, 2026), the MFP adjustment is set by the IPPS final rule based on the latest BLS data. The specific value affects all IPPS hospitals nationally.
Cumulative Impact
Cumulated since the FY 2012 implementation of the MFP adjustment, the cumulative reduction in Medicare hospital payments relative to the pre-ACA trajectory is substantial. Over 14 years (FY 2012 through FY 2026), the cumulative MFP adjustment has reduced Medicare hospital payments by hundreds of billions of dollars in aggregate.
For an individual Georgia hospital, the cumulative impact is significant. A hospital receiving $100 million in annual Medicare IPPS payments faces an annual MFP adjustment of approximately $500,000 to $1 million; cumulated over 14 years with compounding, the cumulative impact approaches tens of millions of dollars.
Policy Debate
The MFP adjustment is among the most controversial annual Medicare payment policies. Hospital industry groups (AHA, AAMC, FAH) consistently argue that hospitals cannot match economy-wide productivity growth because:
- Hospital production processes are labor-intensive with limited automation potential
- Quality and safety improvements often increase rather than reduce resource needs
- Regulatory and compliance burden continues to grow
- Hospital wage growth often exceeds general economic wage growth
MedPAC has offered nuanced views on the MFP adjustment, generally supporting the productivity expectation but noting hospital margin pressures.
The MFP adjustment remains statutory and would require Congressional action to modify or eliminate. No major legislative changes have occurred since the FY 2012 implementation.
Section 631 of the American Taxpayer Relief Act of 2012: Documentation and Coding Adjustment Recoupment
Section 631 of the American Taxpayer Relief Act of 2012 addressed documentation and coding adjustment (DCA) recoupment. The provision reduced the IPPS update factor to recover prior years' Medicare payment increases attributable to documentation and coding intensity changes rather than real care intensity.
The DCA Issue
Documentation and coding adjustment (DCA) refers to changes in DRG assignment driven by improved documentation and coding rather than changes in actual patient care. When Medicare transitioned to the MS-DRG system in FY 2008 and subsequently to ICD-10-CM/PCS in FY 2016, hospitals improved their documentation and coding practices, capturing more comorbidities and complications. The improved capture shifted patients into higher-paying DRGs, increasing aggregate Medicare payments without corresponding increases in care delivered.
CMS estimated the DCA effect at substantial percentages in early years (potentially 2-3 percent or more aggregate impact). Congress responded with recoupment provisions to recover the excess payments through reduced future updates.
Section 631 Recoupment
Section 631 of ATRA 2012 implemented multi-year DCA recoupment. The recoupment reduced the IPPS update factor by specified percentages in subsequent fiscal years to claw back the prior excess. The recoupment effectively prevented Medicare from over-paying for documentation and coding intensity changes.
The recoupment structure was a negotiated compromise. Hospital industry groups had argued that the documentation and coding improvements reflected real care intensity captured better, not artificial inflation. Congress concluded that some recoupment was warranted, balancing hospital interests against Medicare fiscal interests.
Implementation Through Annual IPPS Rules
CMS implemented Section 631 recoupment through annual IPPS rulemaking, specifying the year-by-year DCA reduction. The reductions reduced update factors in multiple consecutive years until the recoupment was complete.
Connection to ICD-10 Transition
The ICD-10 transition in FY 2016 raised similar DCA questions for the ICD-10 coding period. CMS and Congress monitored ICD-10 implementation impacts and applied appropriate adjustments through subsequent rulemaking.
Section 414 of MACRA 2015: Continued DCA Adjustments
Section 414 of the Medicare Access and CHIP Reauthorization Act of 2015 (MACRA) continued documentation and coding adjustment provisions with revised structures. The section provided framework for ongoing DCA management.
MACRA broadly reformed Medicare physician payment (replacing the Sustainable Growth Rate formula with the Quality Payment Program), but Section 414 addressed hospital IPPS DCA. The provisions ensured that DCA recoupment continued as appropriate based on actual experience.
For Georgia hospitals, the cumulative effect of Section 631 and Section 414 DCA provisions has been to constrain IPPS update factor growth over multiple years. The exact magnitude varies year to year based on CMS analysis and rulemaking.
Section 1886(b)(3)(B)(viii): The IQR Quality Reporting Reduction
Section 1886(b)(3)(B)(viii) of the SSA reduces the IPPS market basket update for hospitals failing to participate in the Hospital Inpatient Quality Reporting (IQR) program. The provision is a powerful financial incentive for IQR compliance.
IQR Program Overview
The IQR program is a CMS quality reporting program requiring IPPS hospitals to report specified quality measures. The measures include claims-based outcome measures, chart-abstracted process measures, patient experience measures (HCAHPS), structural measures, and infection measures (through NHSN reporting).
IQR participation is mandatory in the sense that non-participation triggers the 25 percent update reduction. Hospitals participating in IQR avoid the reduction.
The IQR Reduction
The IQR reduction is calculated as a percentage of the market basket update. The reduction compounds over years: a hospital that fails IQR for multiple consecutive years experiences cumulative reduction in its base rate.
IQR Compliance Requirements
To avoid the reduction, hospitals must:
- Report all required quality measures by specified deadlines
- Validate data accuracy (CMS conducts validation reviews)
- Comply with measure-specific requirements
- Submit appropriate forms and attestations
Major Georgia Hospital IQR Compliance
All major Georgia IPPS hospitals participate in IQR. The 25 percent reduction makes non-participation financially infeasible for hospitals dependent on Medicare revenue.
Section 1886(b)(3)(B)(ix): The Meaningful EHR User Reduction
Section 1886(b)(3)(B)(ix) reduces the IPPS update factor for hospitals not meeting meaningful EHR user requirements under the Promoting Interoperability (PI) program (formerly Meaningful Use). The provision incentivizes hospital EHR adoption and use.
PI Program Overview
The Promoting Interoperability program (renamed from Meaningful Use) requires hospitals to demonstrate use of certified EHR technology in specified ways:
- Electronic capture of patient information
- Care coordination
- Patient access to electronic health information
- Public health and clinical data registry reporting
- Health information exchange
Update Factor Reduction
Hospitals not meeting PI requirements face an update factor reduction. The specific magnitude has varied; originally up to 75 percent of the market basket update for hospitals failing meaningful use; current provisions vary based on program design changes.
Major Georgia Hospital PI Compliance
All major Georgia hospitals participate in the PI program and meet meaningful EHR user requirements. The financial incentive structure makes PI compliance functionally mandatory.
42 CFR 412 IPPS Implementing Regulations
42 CFR Part 412 is the comprehensive IPPS implementing regulations. The regulations cover all aspects of the IPPS payment framework, including:
- Hospital eligibility and participation (42 CFR 412.1-412.27)
- Wage index methodology (42 CFR 412.63-412.65)
- Federal rate determination (42 CFR 412.64)
- Standardized amounts (42 CFR 412.71)
- DRG assignment and payment (42 CFR 412.60)
- Capital payment (42 CFR 412.300-412.378)
- Outlier payment (42 CFR 412.80-412.86)
- DSH and IME adjustments (42 CFR 412.106 and 412.105)
- HRRP, HVBP, HACRP adjustments (42 CFR 412.150-412.172)
- Geographic reclassification (42 CFR 412.230-412.234)
42 CFR 412.64 Federal Rate Determination
42 CFR 412.64 specifies the methodology for federal rate determination. The federal rate is the IPPS standardized amount that applies (with geographic and DRG adjustments) to determine IPPS payments. The annual update factor is applied to the federal rate to determine the new fiscal year's federal rate.
42 CFR 412.71 Standardized Amounts
42 CFR 412.71 specifies the standardized amount calculation, including the labor-related and non-labor-related shares. The standardized amounts are the base rates for IPPS payment, before DRG weight application and geographic adjustment.
Annual Updates to Regulations
The regulations are not amended every year, but they are amended periodically when statutory changes, policy reforms, or operational issues require updates. The annual IPPS final rule includes regulation amendments where appropriate.
The Hospital Market Basket Index
The hospital market basket index measures hospital input price inflation. The index is the foundation of the annual update factor: it represents the inflation in hospital costs that the update factor should (in theory) compensate for.
Market Basket Components
The hospital market basket covers all major hospital input cost categories:
- Wages and salaries: the largest single cost component
- Employee benefits: a significant share including health insurance and retirement
- Professional fees: physician and other professional services
- Utilities: electricity, gas, water
- Pharmaceuticals: drugs and biologicals
- Other supplies and services: medical supplies, food, other goods and services
- Capital: depreciation, interest, lease costs
The specific weights are based on hospital cost reports and economic data. CMS periodically rebases the market basket to reflect changes in the relative cost composition of hospitals.
Market Basket Forecast
The market basket index is a forecast for the upcoming fiscal year. CMS works with forecasting firms (currently IHS Markit/Global Insight) to project input price increases for each component category, weighted by relative importance.
The forecast methodology uses economic indicators, industry-specific data, and historical relationships. The forecast is updated through the year as new data become available, with the final IPPS rule typically reflecting the second-quarter forecast.
Annual Market Basket Update Magnitudes
Annual market basket updates have varied substantially over time:
- Mid-2010s: typically 2.5 percent to 3.0 percent
- Post-COVID period: elevated due to labor and supply price inflation, sometimes 4 percent or higher
- Long-run historical average: approximately 2.5 percent to 3.0 percent
The post-COVID inflation surge created elevated market basket increases. Hospital labor and supply costs grew rapidly, and the market basket reflected this growth. Recent years have seen elevated update factors to compensate.
Market Basket Rebasing
CMS periodically rebases the market basket using more recent cost report data. Rebasing typically occurs every 4-5 years. The rebasing updates the weights and may affect the specific cost categories included.
Operating Standardized Amounts
The operating standardized amounts are the base IPPS rates for operating costs (excluding capital). The amounts are split into labor-related and non-labor-related shares.
Labor-Related Share
The labor-related share represents the majority of the operating standardized amount. This share is adjusted by the hospital's wage index for geographic labor cost variation. A hospital in a high-wage area has its labor-related share adjusted upward; a hospital in a low-wage area has the share adjusted downward.
Non-Labor-Related Share
The non-labor-related share represents the remaining portion of the operating standardized amount. This share is not adjusted by wage index. The non-labor share reflects costs that do not vary geographically in the way labor costs do.
Annual Update Application
Both the labor-related and non-labor-related shares are updated by the same update factor annually. The split between the shares does not change annually; only the magnitudes change.
FY 2026 Operating Standardized Amounts
For FY 2026, the specific operating standardized amounts are set by the IPPS final rule. The amounts reflect:
- Prior year amounts
- Annual update factor
- Wage index neutrality adjustment (if applicable)
- Other adjustments specified by statute or rulemaking
The specific FY 2026 values are published in the IPPS final rule tables.
Capital Update Factor
The capital update factor under Section 1886(g) operates separately from the operating update factor. The capital standardized amount is the IPPS base rate for capital costs, including depreciation, interest, and lease costs.
Capital Market Basket
The capital market basket is a separate index measuring capital cost inflation. Capital costs have different inflation dynamics from operating costs, so a separate index is appropriate.
Capital MFP Adjustment
The capital update factor also includes a productivity adjustment, applying similar logic to the operating MFP adjustment.
Capital Methodology
The capital payment methodology includes the federal capital rate, geographic adjustment factor (GAF), DRG-specific weights, and other adjustments. The capital update factor adjusts the federal capital rate annually.
Capital Payment Magnitude
Capital payments are a meaningful but smaller component of total IPPS payments than operating payments. The annual capital update factor affects hospital capital recovery from Medicare.
FY 2026 IPPS Final Rule
The FY 2026 IPPS final rule, issued by CMS in August 2025, sets the specific parameters for the federal fiscal year beginning October 1, 2025 and ending September 30, 2026. Key parameters include:
- Hospital market basket update
- Multifactor productivity adjustment
- DCA adjustment (if applicable)
- Net update factor
- Operating standardized amounts (labor-related and non-labor-related shares)
- Capital standardized amount and update
- Wage index for FY 2026
- Outlier threshold for FY 2026
- DSH and IME adjustment factors
- HRRP/HVBP/HACRP adjustments
- New technology add-on payments
- Other policy and payment provisions
The specific FY 2026 values represent the operational reality for every Georgia IPPS hospital. The hospital's revenue cycle, finance, and clinical operations all reflect the FY 2026 rule parameters.
Historical Update Factor Trajectory
The IPPS update factor has varied substantially across decades. Key periods:
1983-1997: Pre-BBA Period
After the 1983 establishment of IPPS, update factors were generally generous, reflecting initial program ramp-up and absence of subsequent budgetary pressures. Market basket updates were applied with limited additional reductions.
1997-2010: Post-BBA Period
The Balanced Budget Act of 1997 (BBA 1997) introduced significant updates that constrained Medicare hospital payments. Through the 2000s, update factors were typically 2-3 percent annually.
2010-Present: Post-ACA Period
The ACA's MFP adjustment (Section 3401) systematically reduced update factors below pre-ACA trajectory. Combined with DCA recoupment and IQR/PI penalties, the net updates have generally been 1.5-2.5 percent in non-COVID years.
2020-2022: COVID-Era
COVID-19 created atypical patterns. Public health emergency adjustments, COVID-19 add-on payments, and the post-COVID inflation surge created unusual update factor dynamics.
Recent Years: FY 2023-2026
Recent updates have reflected post-COVID inflation patterns with elevated market basket increases offset by MFP adjustments and other adjustments. Net updates have been in the 2.5-3.5 percent range.
Update Factor Compounding Effect
The update factor compounds annually. Each year's update is applied to the prior year's base, so small annual differences create large multi-year differences.
Compounding Example
Consider two hypothetical scenarios over a 10-year period:
- Scenario A: 3.0 percent update factor each year
- Scenario B: 2.5 percent update factor each year
Starting from a hypothetical base of $10,000 per discharge:
- Scenario A after 10 years: $10,000 × (1.03)^10 = $13,439
- Scenario B after 10 years: $10,000 × (1.025)^10 = $12,801
Difference after 10 years: $638 per discharge, or approximately 4.7 percent.
For a hospital with 10,000 Medicare discharges annually, the annual revenue difference in year 10 would be approximately $6.4 million. Cumulated over the 10 years, the total revenue difference would exceed $30 million.
Cumulative ACA Impact
The cumulative ACA MFP adjustment impact illustrates the compounding power. Over the 14 years since FY 2012 implementation, the cumulative MFP adjustment has reduced Medicare hospital payments by hundreds of billions of dollars relative to a no-MFP-adjustment trajectory.
Interaction with HVBP, HRRP, HACRP
The IPPS update factor adjusts the base IPPS standardized amount. The HVBP, HRRP, and HACRP value-based payment adjustments operate on top of the base IPPS payment, redistributing payments among hospitals based on performance.
HVBP
The Hospital Value-Based Purchasing (HVBP) program redistributes a portion of IPPS base operating DRG payments based on quality performance. The update factor adjusts the standardized amount; HVBP adjustments are applied separately at the hospital level.
HRRP
The Hospital Readmissions Reduction Program (HRRP) reduces IPPS payments for hospitals with excess readmissions. The reductions apply to the base payment after standardized amount determination.
HACRP
The Hospital-Acquired Condition Reduction Program (HACRP) reduces IPPS payments for hospitals with poor HAC performance. Like HVBP and HRRP, HACRP reductions apply to the base payment.
Combined Effect
A Georgia hospital subject to all three programs faces:
- Annual update factor (positive or negative impact relative to inflation)
- HVBP adjustment (positive or negative based on performance)
- HRRP reduction (negative or zero based on readmissions)
- HACRP reduction (negative or zero based on HAC performance)
The combined effect can be substantial. A hospital with strong quality performance receives the update factor plus HVBP bonus; a hospital with poor performance receives the update factor minus HVBP, HRRP, and HACRP reductions.
Sole Community Hospital and Medicare-Dependent Hospital
Sole community hospitals (SCHs) and Medicare-dependent hospitals (MDHs) receive special IPPS treatment. These designations apply to certain Georgia hospitals meeting applicable criteria.
SCH and MDH Designations
The SCH designation applies to hospitals that are the sole community provider of inpatient services in their geographic area. The designation is based on geographic isolation criteria and other factors.
The MDH designation applied to hospitals with substantial Medicare patient share. The MDH program has historically had limited scope.
Hospital-Specific Rate
SCHs and MDHs may receive payment based on the higher of the IPPS federal rate or their hospital-specific rate. The hospital-specific rate is based on the hospital's own historical cost data, updated annually.
Update Factor Application
The annual update factor applies to both the federal rate and the hospital-specific rate. The choice of rate (higher of) is made each year based on the comparison.
For Phoebe Putney and other Georgia SCHs, the annual update factor application affects both rates, and the comparison determines actual payment.
Critical Access Hospital Cost-Based Distinction
Critical Access Hospitals (CAHs) are not subject to IPPS update factor application because CAHs are paid under cost-based reimbursement rather than IPPS. CAHs receive Medicare reimbursement based on their reasonable cost.
For Georgia, CAH status applies to a number of small rural hospitals. The cost-based payment structure means CAHs are not directly affected by the IPPS update factor, though general Medicare and economic conditions still affect their financial outlook.
Major Georgia IPPS Hospitals
Major Georgia IPPS hospitals subject to annual update factor application include:
Grady Memorial Hospital
Atlanta safety-net hospital. Subject to full IPPS framework including annual update factor, DSH, IME, HVBP, HRRP, HACRP adjustments. High Medicare volume makes update factor financially significant.
Emory University Hospital and Emory University Hospital Midtown
Academic medical centers in Atlanta. Subject to full IPPS framework. Substantial annual Medicare revenue affected by update factor.
Memorial Health Savannah
Teaching hospital serving coastal Georgia. Subject to full IPPS framework.
AU Medical Center
Augusta academic medical center. Subject to full IPPS framework.
Phoebe Putney Memorial Hospital
Albany-area hospital. May be eligible for hospital-specific rate options; update factor applies to all available rate options.
Atrium Health Floyd
Rome regional hospital. Subject to full IPPS framework.
Northeast Georgia Medical Center
Gainesville regional hospital. Subject to full IPPS framework.
Wellstar, Piedmont, Northside
Multi-hospital systems with multiple IPPS hospitals across metropolitan Atlanta. Each hospital subject to full IPPS framework.
Rural Georgia IPPS hospitals
Various rural Georgia hospitals subject to IPPS (those that have not converted to CAH status). Update factor application affects their financial sustainability significantly.
Worked Example 1: Grady IPPS Update Factor
Consider a hypothetical FY 2026 application of the update factor to Grady Memorial Hospital. Assume the following:
- Prior year FY 2025 operating standardized amount: $7,200 (illustrative)
- FY 2026 market basket update: 3.2 percent
- FY 2026 MFP adjustment: -0.6 percent
- FY 2026 DCA adjustment: 0 percent
- FY 2026 IQR/PI compliance: full compliance (no reduction)
- FY 2026 net update factor: 3.2 - 0.6 = 2.6 percent
FY 2026 operating standardized amount: $7,200 × 1.026 = $7,387
The increase represents $187 per standardized amount unit. For Grady's high Medicare volume (assume 15,000 Medicare discharges with weighted average DRG of 1.5), the approximate annual revenue impact is:
- 15,000 × 1.5 × $187 = $4.2 million additional revenue
The actual revenue impact also reflects DSH, IME, capital, outlier, and value-based payment adjustments, but the update factor is the foundation.
Worked Example 2: Emory University Hospital IPPS Update Factor
Consider Emory University Hospital's FY 2026 update factor experience:
- Prior year FY 2025 operating standardized amount: $7,200 (illustrative, same as Grady)
- FY 2026 net update factor: 2.6 percent (same calculation)
- FY 2026 operating standardized amount: $7,387
For Emory's case mix (academic medical center, complex cases, high case mix index):
- Assume 18,000 Medicare discharges with weighted average DRG of 1.8
- 18,000 × 1.8 × $187 = $6.0 million additional revenue from update factor
Plus IME, DSH, capital, outlier, value-based adjustments. The IPPS update factor is the foundation.
Worked Example 3: Rural Georgia IPPS Hospital Update Factor
Consider a small rural Georgia IPPS hospital with limited Medicare volume:
- Prior year FY 2025 operating standardized amount: $7,200
- FY 2026 net update factor: 2.6 percent
- FY 2026 operating standardized amount: $7,387
For the rural hospital's volume (assume 1,800 Medicare discharges, weighted average DRG of 1.2):
- 1,800 × 1.2 × $187 = $404,000 additional revenue
The smaller volume means the absolute impact is smaller, but the percentage impact on hospital revenue is similar. For financially constrained rural hospitals, every dollar matters.
Worked Example 4: IQR/PI Non-Compliance Penalty
Consider a hypothetical hospital failing the FY 2026 IQR program:
- Market basket update: 3.2 percent
- IQR penalty: a statutory reduction in the market basket update (Section 1886(b)(3)(B)(viii))
- Net update factor: lower than for a compliant hospital by the penalty amount
The gap compounds annually if the hospital continues to fail IQR. Over multiple years, the cumulative reduction in base rate can be significant.
For a hospital with $50 million in annual Medicare revenue, even a fraction of a percentage point annual gap represents hundreds of thousands of dollars annually, compounding to millions over multiple years. The IQR penalty is financially significant.
Worked Example 5: AU Medical Center IPPS Update Factor
Consider AU Medical Center FY 2026:
- Prior year operating standardized amount: $7,200
- FY 2026 net update factor: 2.6 percent (full compliance)
- FY 2026 operating standardized amount: $7,387
For AU Medical's case mix:
- Assume 12,000 Medicare discharges, weighted average DRG of 1.7
- 12,000 × 1.7 × $187 = $3.8 million additional revenue from update factor
Plus IME (substantial for academic medical center), DSH, capital, and other adjustments.
Worked Example 6: Memorial Savannah IPPS Update Factor
Consider Memorial Health Savannah FY 2026:
- Prior year operating standardized amount: $7,200
- FY 2026 net update factor: 2.6 percent
- FY 2026 operating standardized amount: $7,387
For Memorial's case mix (teaching hospital, mixed urban-rural patient base):
- Assume 9,000 Medicare discharges, weighted average DRG of 1.5
- 9,000 × 1.5 × $187 = $2.5 million additional revenue from update factor
Plus IME, DSH, capital, and other adjustments.
Beneficiary Access and Indirect Effects
While the IPPS update factor is a hospital payment determinant invisible to individual Medicare beneficiaries on their statements and bills, it indirectly affects beneficiary access to care through hospital financial sustainability, workforce capacity, service availability, and care quality. Understanding these indirect effects helps Georgia families think comprehensively about Medicare hospital access.
Hospital Financial Sustainability
The update factor's cumulative effect over years shapes hospital financial sustainability. Hospitals consistently receiving updates that lag input cost inflation experience margin compression. Margin compression eventually forces operational responses: service line consolidation, workforce reductions, deferred capital investments, or in extreme cases, hospital closure.
For Georgia, rural hospital sustainability has been a particular concern. While Georgia has not experienced the rural hospital closure crisis seen in some other states, several rural hospitals operate with thin margins. The IPPS update factor is one component (alongside DSH, low-volume hospital adjustment, sole community hospital status, and other factors) shaping rural hospital viability.
Urban safety-net hospitals like Grady face similar pressures. The combination of Medicare update factor, DSH payments, bad debt reimbursement, supplemental payments, and other revenue sources shapes the safety-net's ability to serve uninsured and underinsured populations.
Workforce Capacity
Hospital wages are the largest component of the market basket. When the update factor lags wage inflation, hospitals face pressure on workforce capacity. Recruitment and retention become more difficult, contributing to nursing shortages, physician burnout, and operational stress.
For Georgia, healthcare workforce challenges affect the patient experience across the state. Adequate IPPS update factor helps hospitals maintain competitive compensation; inadequate updates contribute to workforce strain.
Service Availability
When hospitals face financial pressure, service line decisions become unavoidable. Less-profitable services (often those serving low-income or rural populations) may be reduced or eliminated. Obstetrics, mental health, addiction treatment, and certain specialty services are particularly vulnerable.
For Georgia beneficiaries, service availability affects access to needed care. A Medicare beneficiary in rural Georgia who can no longer receive certain specialty services locally may need to travel substantially, complicating care and reducing utilization.
Quality and Safety Investment
Hospital quality and safety improvements require investment in personnel, technology, processes, and training. Update factor adequacy affects the ability to invest in quality improvement. Hospitals with constrained margins may defer quality investments or operate with thinner safety margins.
Capital Investment
Capital investments in facilities, equipment, and technology require predictable revenue streams. The IPPS update factor (combined with the capital update factor) shapes hospital ability to invest. Hospitals with stable revenue can make long-term capital plans; hospitals with uncertain revenue defer or scale back investments.
Beneficiary Implications
For individual Georgia Medicare beneficiaries, the chain from IPPS update factor to personal experience runs through several steps:
- Update factor determines hospital revenue
- Hospital revenue shapes financial sustainability
- Financial sustainability shapes workforce, services, and quality
- Workforce, services, and quality shape patient experience
While individual beneficiaries cannot directly observe or influence update factor policy, understanding the chain helps make sense of broader healthcare system dynamics and the importance of advocacy for adequate Medicare hospital payment.
Cost Report and Settlement
Annual cost report settlement reflects the application of the update factor throughout the fiscal year. Hospitals file cost reports within five months of fiscal year end. The applicable Medicare Administrative Contractor processes the cost reports, applies the IPPS update factor parameters, and issues Notices of Program Reimbursement.
Worksheet S-3
Hospital wage and statistical data. Used in wage index calculation, which interacts with the update factor through the labor-related share adjustment.
Worksheet E Part A
Medicare Part A IPPS settlement. Reflects DRG payments at the updated standardized amount, plus IME, DSH, capital, and outlier adjustments.
Worksheet E Part B
Medicare Part B outpatient settlement. Separate from IPPS update factor but operationally related.
Notice of Program Reimbursement
Final MAC determination. Time-limited appeal window to PRRB.
Annual IPPS Final Rule Process
The annual IPPS final rule process follows a regular cycle:
Proposed Rule (April)
CMS publishes the proposed IPPS rule in April of each year. The proposed rule includes proposed market basket, MFP adjustment, DCA, wage index, DRG weights, and other parameters.
Comment Period
A 60-day public comment period follows. Hospital industry groups, individual hospitals, MedPAC, and other stakeholders submit comments.
Final Rule (August)
CMS publishes the final rule in August, typically about 60-90 days before the October 1 effective date. The final rule incorporates comments received and finalizes parameters.
Implementation (October 1)
The final rule takes effect October 1 of the federal fiscal year (e.g., October 1, 2025 for FY 2026).
Mid-Year Adjustments
Mid-year adjustments are unusual but can occur. The basic structure is set in August and stable through the fiscal year.
Cost Report Audit and Appeals
MAC Audit
The Medicare Administrative Contractor conducts cost report audits. Audits review IPPS payment calculations, DSH/IME calculations, bad debt, and other components.
Adjustments
Audit adjustments may reduce or increase the hospital's Medicare reimbursement. Adjustments are documented in the Notice of Program Reimbursement.
PRRB Appeals
Disputes proceed to the Provider Reimbursement Review Board under 42 CFR 405.1801-405.1898. The applicable filing window from NPR governs.
Reopening
Three-year reopening window for clear errors or omissions.
Policy Debate
MedPAC Update Factor Analyses
MedPAC publishes annual analyses of hospital margins, productivity, and update factor adequacy. The analyses inform Congressional consideration of update factor policy.
AHA Position
AHA consistently advocates for update factor increases and opposes additional reductions, particularly the MFP adjustment.
CBO Scoring
CBO scores update factor changes for budgetary impact. Update factor reductions are scored as Medicare savings.
Productivity Adjustment Debate
The MFP adjustment remains a focal point of policy debate. Hospital industry argues hospitals cannot match economy-wide productivity; productivity adjustment advocates argue hospitals should be expected to deliver productivity improvements.
Continued Reform Discussion
Periodic discussion of update factor reform continues. No major legislative changes have occurred since the ACA Section 3401 MFP adjustment and the ATRA Section 631 DCA recoupment.
Detailed Look at the Market Basket Categories
The hospital market basket is a weighted index of multiple cost categories. Understanding the categories and their weights helps explain why the index moves as it does and why hospital industry groups argue it captures real hospital cost growth.
Wages and Salaries
Wages and salaries represent the largest component of the hospital market basket. The category covers all hospital employee wages and salaries, including nursing staff, physicians employed by hospitals, technical staff, administrative staff, and support staff.
Wage and salary growth typically tracks broader labor market conditions, hospital-specific labor market dynamics, and competitive pressures. Recent years have seen elevated wage growth driven by nursing shortages, post-COVID labor demand, and inflation pressures.
Employee Benefits
Employee benefits represent a significant component of the hospital market basket. The category includes health insurance, retirement benefits, payroll taxes, paid time off, and other employee benefits.
Benefit cost growth often outpaces wage growth, particularly for health insurance costs. The benefits component has been a steady source of upward pressure on the market basket.
Professional Fees
Professional fees cover physician and other professional services obtained on a fee-for-service basis by hospitals. Examples include pathology, radiology, anesthesiology, and other professional services contracted rather than salaried.
Utilities
Utilities (electricity, natural gas, water, telecommunications) are a smaller share of the market basket but contribute to overall cost growth. Energy price volatility affects this category significantly.
Pharmaceuticals
Pharmaceutical costs are a meaningful and growing share of hospital costs. The category covers all drugs and biologicals used in hospital care. Recent years have seen substantial pharmaceutical price increases, particularly for specialty drugs, biologics, and certain commonly used medications.
The 340B program (covered in Brevy's 340B guide) provides discounted pharmaceuticals to qualifying hospitals, partially offsetting pharmaceutical cost growth for participating hospitals. The interaction between the market basket pharmaceutical category and 340B savings is operationally important.
Other Supplies and Services
Other supplies and services covers medical supplies, food, housekeeping, laundry, maintenance, and other goods and services. The category captures a broad range of operational costs.
Capital
Capital costs in the market basket include depreciation, interest, and lease costs. The capital component is calculated separately for the capital market basket used in the capital update factor.
Market Basket Rebasing
CMS periodically rebases the market basket using more recent cost report data. Rebasing updates the weights to reflect changing relative importance of cost categories. For example, if pharmaceutical costs grow faster than other categories, rebasing may increase the pharmaceutical weight in the market basket.
Rebasing is generally performed every 4-5 years. The most recent rebasing reflected current hospital cost composition.
Detailed Look at the Wage Index Interaction
The wage index is one of the most operationally important interactions with the IPPS update factor. While the wage index is a separate adjustment, it interacts with the update factor through the labor-related share calculation.
Wage Index Mechanics
The wage index is a hospital-specific factor reflecting the relative wages in the hospital's geographic area compared to the national average. A wage index of 1.0 means national average wages; values above 1.0 reflect higher wages; values below 1.0 reflect lower wages.
The wage index is applied to the labor-related share of the operating standardized amount. A hospital with a wage index of 1.10 has its labor-related share adjusted upward by 10 percent; a hospital with a wage index of 0.90 has its labor-related share adjusted downward by 10 percent.
Wage Index Update
The wage index is updated annually as part of the IPPS final rule. The wage index uses hospital cost report wage data (Worksheet S-3) submitted by hospitals. The cost report data is several years old by the time it appears in the wage index because of cost report filing and processing timing.
Wage Index Reclassification
Hospitals may apply for wage index reclassification to a different geographic area if they meet specific criteria. The Medicare Geographic Classification Review Board (MGCRB) processes reclassification applications.
Georgia Wage Index Variation
Georgia hospitals span a substantial range of wage index values. Atlanta-area hospitals typically have wage indices near or above 1.0, reflecting the metropolitan labor market. Rural Georgia hospitals typically have wage indices below 1.0, reflecting lower rural wages.
The wage index variation across Georgia affects the relative Medicare payments to different Georgia hospitals. Combined with the annual update factor, the wage index shapes payment levels.
Compliance and Operational Best Practices
Best practices for managing the update factor's operational impact include:
- Annual IPPS rule monitoring: dedicated staff tracking proposed and final rule
- IQR compliance: full participation to avoid 25% reduction
- PI compliance: meaningful EHR user status to avoid update reduction
- Wage index participation: data submission affecting labor-related share
- Cost report accuracy: detailed and accurate cost reporting
- Audit preparation: documentation maintained for MAC audit
- Appeals readiness: PRRB appeals for material disputes
- Industry engagement: AHA, AAMC, state hospital association participation
- Internal financial planning: multi-year financial forecasts reflecting update factor trajectory
- Operational efficiency: continuous improvement to address productivity expectations
- Quality performance: HVBP, HRRP, HACRP performance management
- Documentation and coding: accurate but appropriate coding
- Staff training: regular training on IPPS rules and changes
- Stakeholder communication: board and leadership awareness of update factor implications
Common Errors and How to Avoid Them
Common errors that affect IPPS update factor impact include:
- IQR program failures: missed deadlines or incomplete reporting triggering 25% reduction
- PI program failures: not meeting meaningful EHR user requirements
- Wage index data errors: inaccurate Worksheet S-3 data affecting wage index
- Cost report errors: math errors, transposition errors, improper line items
- DSH/IME calculation errors: affecting overall IPPS revenue
- HVBP/HRRP/HACRP performance underperformance: triggering additional reductions
- DRG assignment errors: incorrect coding affecting DRG weights
- Capital reporting errors: affecting capital payment
- Documentation gaps: inadequate clinical documentation
- Inappropriate use of CC/MCC modifiers: triggering DCA scrutiny
- Geographic reclassification errors: incorrect geographic adjustment
- Outlier reporting errors: missed outlier opportunities or incorrect outlier reporting
- Bad debt documentation gaps: missed bad debt reimbursement
- Failure to monitor and respond to annual IPPS rule changes: operational misalignment
Frequently Asked Questions
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What is the Medicare IPPS update factor?
The IPPS update factor is the annual adjustment to the Medicare hospital Inpatient Prospective Payment System standardized amounts. Authorized under Section 1886(b)(3)(B) of the Social Security Act, the update factor determines how much hospital base rates change each fiscal year.
What is the hospital market basket?
The hospital market basket is an index measuring hospital input price inflation. Calculated by the CMS Office of the Actuary using forecasts from IHS Markit/Global Insight, the index covers wages, benefits, professional fees, utilities, pharmaceuticals, supplies, services, and capital costs.
What is the multifactor productivity (MFP) adjustment?
The MFP adjustment reduces the hospital market basket update by the 10-year average Bureau of Labor Statistics multifactor productivity growth in the economy. Section 3401 of the Affordable Care Act of 2010 added this permanent adjustment, codified at Section 1886(b)(3)(B)(xi).
What is the IQR program and why does it affect hospital payments?
The Hospital Inpatient Quality Reporting (IQR) program is a CMS quality reporting program. Hospitals failing IQR receive a reduction in the market basket update under Section 1886(b)(3)(B)(viii), which compounds annually if non-compliance continues. All major Georgia IPPS hospitals participate in IQR to avoid the penalty.
Does the IPPS update factor affect Georgia Medicare beneficiaries directly?
No, the update factor adjusts hospital payments rather than beneficiary cost-sharing. However, it indirectly affects beneficiaries through hospital financial sustainability, workforce capacity, service availability, and care quality across Georgia. :::
How Brevy Helps Georgia Families Understand the Medicare Hospital Payment Framework
Brevy at brevy.com helps Georgia Medicare beneficiaries, families, and caregivers understand the Medicare hospital payment framework that funds the hospitals serving Georgia's Medicare population. While the IPPS update factor is primarily a hospital payment determinant invisible to individual beneficiaries, it shapes hospital financial sustainability, service availability, workforce capacity, and ultimately access to care across the state.
Our team monitors annual IPPS rulemaking, the proposed and final rule comment cycle, MedPAC analyses, AHA advocacy, CBO scoring of update factor provisions, and operational implementation by the Palmetto GBA Medicare Administrative Contractor. We translate technical policy into plain-language guidance for Georgia families navigating Medicare benefits, hospital choice, and concerns about hospital financial sustainability.
Brevy maintains comprehensive Georgia state guides covering Medicare benefits (inpatient hospital, outpatient, drug benefits), Medicare hospital payment programs (DSH, IME, GME, wage index, cost report, HRRP, HVBP, HACRP, bad debt, IPPS update factor), Medicaid programs, dual eligible coordination, beneficiary protections, and consumer rights. For beneficiaries selecting hospitals or thinking about hospital quality and financial sustainability, Brevy provides the context to make informed decisions.
Disclaimers
This guide describes the Medicare IPPS update factor framework, including Section 1886(b)(3)(B) of the Social Security Act, Section 3401 of the Affordable Care Act of 2010, Section 631 of the American Taxpayer Relief Act of 2012, Section 414 of MACRA 2015, 42 CFR 412, and related rules as of May 2026. Statutory provisions, regulatory text, and CMS guidance change over time. Verify current rules with Medicare (1-800-MEDICARE), CMS (cms.gov), Palmetto GBA (palmettogba.com), the Georgia Department of Community Health (dch.georgia.gov), or qualified professional advisors.
The worked examples are hypothetical and illustrative. Actual hospital IPPS payments depend on the specific FY 2026 IPPS final rule parameters, the hospital's wage index, DRG case mix, IME and DSH adjustments, value-based payment adjustments, and other factors. Cost report figures are subject to MAC audit and PRRB appeal.
This guide is not legal, financial, or tax advice. Beneficiaries with Medicare access questions should contact Medicare, GeorgiaCares SHIP, Atlanta Legal Aid, Georgia Legal Services Program, the Medicare Rights Center, or a qualified attorney. Hospitals seeking IPPS guidance should consult qualified consultants, attorneys, or industry advisors.
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Get Help with Medicare Hospital Benefits and Access in Georgia
If you are a Georgia Medicare beneficiary or family member with questions about Medicare hospital benefits, hospital choice, or hospital financial concerns, these resources can help. Brevy at brevy.com provides comprehensive Georgia state guides on Medicare, Medicaid, and hospital payment programs.
Medicare and Medicaid
- Medicare: 1-800-MEDICARE (1-800-633-4227)
- Palmetto GBA Customer Service: 1-866-238-9650
- CMS Provider Enrollment: 1-866-484-8049
- Georgia DCH Medicaid Member Services: 1-866-211-0950
Beneficiary Assistance and Advocacy
- GeorgiaCares State Health Insurance Assistance Program (SHIP): 1-866-552-4464
- Medicare Rights Center: 1-800-333-4114
- Atlanta Legal Aid: 404-377-0701
- Georgia Legal Services Program: 1-800-498-9469
- 211 Georgia: dial 211 from any Georgia phone
- Eldercare Locator: 1-800-677-1116
Hospital Quality and Performance Resources
- Hospital Compare (CMS): medicare.gov/care-compare
- Hospital Quality Initiative (CMS): cms.gov
- AHRQ Patient Safety: ahrq.gov
Federal Health Policy and Research
- CMS Center for Medicare: cms.gov
- Medicare Payment Advisory Commission (MedPAC): medpac.gov
- Bureau of Labor Statistics: bls.gov
Hospital Industry Resources
- American Hospital Association (AHA): aha.org
- Georgia Hospital Association: gha.org
- Federation of American Hospitals: fah.org
When you choose a Georgia hospital for Medicare-covered services, the hospital's financial sustainability and quality performance affect your care experience. Quality reporting compliance (IQR), EHR adoption (PI), and value-based payment performance all interact with the IPPS update factor to shape hospital revenue. Use Hospital Compare to evaluate quality performance; consult GeorgiaCares SHIP for help with Medicare benefit questions; and contact Atlanta Legal Aid or Georgia Legal Services for advocacy assistance with hospital billing or access issues.
Find personalized help understanding Medicare hospital benefits in Georgia at brevy.com. :::
Related Brevy Guides
- Georgia Medicaid Overview
- Medicare Cost Report (Georgia)
- Medicare Disproportionate Share Hospital (Georgia)
- Medicare Hospital Readmissions Reduction Program (Georgia)
- Medicare Hospital Value-Based Purchasing (Georgia)
- Medicare Hospital Inpatient Benefit (Georgia)
- Medicare 340B Drug Pricing (Georgia)