FY 2026 Medicare Hospital Inpatient Proposed Regulation Signals Several Changes Lie Ahead for the Hospital Industry and Beneficiaries

This week, our In Focus section reviews the policy changes that the Centers for Medicare & Medicaid Services (CMS) proposes to make in the Fiscal Year (FY) 2026 Medicare Hospital Inpatient Prospective Payment System (IPPS) and Long-Term Acute Care Hospital (LTCH) Proposed Rule (CMS-1833-P). The IPPS proposed rule, released April 11, 2025, includes several important policy changes that will alter hospital margins and change administrative procedures, beginning as soon as October 1, 2025.

Key Provisions of the FY 2026 Hospital IPPS and LTCH Proposed Rule

For FY 2026, CMS proposes to modify several hospital inpatient payment policies. We highlight and interpret six of these proposed policies that may be among the most impactful for Medicare beneficiaries, hospitals and health systems, payers, and manufacturers, as follows:

1. Annual inpatient market basket update
2. Labor share reduction
3. Medicare Advantage (MA) data integration in measuring hospital readmissions
4. New Technology Add-on Payment (NTAP) program growth
5. Transforming Episode Accountability Model (TEAM) modifications
6. Uncompensated care payment increase for disproportionate share hospitals (DSHs)

Annual Inpatient Market Basket Update

Proposed Rule: CMS’s FY 2026 Medicare IPPS Proposed Rule will increase payments to acute care hospitals overall by 2.4 percent from FY 2025, amounting to an estimated $4 billion increase in reimbursement. This update is based on a hospital market basket increase of 3.2 percent and a 0.8 percent reduction for total factor productivity.

HMA Analysis: CMS’s 2.4 percent increase results from the estimated rate of increase in the cost of a standard basket of hospital goods—the hospital market basket. For beneficiaries, this payment increase will lead to a slightly higher standard Medicare inpatient deductible and an increase in out-of-pocket costs. For hospitals and health systems, payers, and manufacturers, the proposed payment increase (2.4 percent) is consistent with economy-wide inflation over the past year (2.4 percent) and below the amount that MA plans will receive for 2026 (5 percent).^[1], [2] Although the published payment update for FY 2026 is 2.4 percent, other policy changes result in the average change in inpatient payments totaling slightly more than 3 percent. We anticipate the proposed 2.4 percent increase will increase somewhat by the time CMS finalizes these rates later in the year.

Labor Share Reduction

Proposed Rule: CMS proposes to modify the hospital labor share used to reimburse hospitals for inpatient services. Using 2023 hospital cost report data CMS proposed a national labor‑related share of 66.0 percent, a decrease from the labor share of 67.6 percent.

HMA Analysis: Every five years, CMS recalculates the hospital market basket and the hospital labor share using updated cost data from the hospital cost reports. For FY 2026, CMS conducted its routine rebasing calculation using 2023 cost report data, replacing the 2018 cost data currently used. As a result, CMS calculated that the cost of labor accounts for a slightly smaller share of total hospital costs in 2023 than in 2018. The labor share is used within the IPPS to identify the proportion of payments that are affected by the hospital wage index in an effort to adjust payments for geographic variation in labor costs. The consequence of a lower hospital labor share is that a slightly smaller share of hospital inpatient payments will be adjusted by the hospital wage index. The subtle impact of this change is that hospitals with higher wage index values may experience reductions in payment. Further, this downward revision of the labor share signals that hospital wages, salaries, and employee benefits account for a smaller share of total costs in the post-pandemic environment. This change may come to a surprise to some, as hospital labor costs have been a subject of concern since the COVID-19 public health emergency.

Medicare Advantage Data Integration in Measuring Hospital Readmissions

Proposed Rule: CMS proposed to make several modifications to the Hospital Readmissions Reduction Program (HRRP), including:

• Refining all six readmission measures to add MA patient data
• Removing the COVID-19 patient denominator exclusion from measures
• Reducing the applicable period from three years to two
• Modifying the DRG payment ratios in the payment adjustment formula to include MA beneficiaries
• Clarifying that CMS has the discretion to grant an extension to hospitals under the extraordinary circumstances exception (ECE)

CMS also proposed to include MA data in other measures included in the Hospital Value-Based Purchasing (VBP) program and the Inpatient Quality Reporting (IQR) program.

HMA Analysis: The inclusion of MA data in the HRRP may have significant payment implications for many hospitals because it will alter their readmission rates in unanticipated ways, particularly if hospitals’ MA patients differ substantially from traditional Medicare beneficiaries. Importantly, the inclusion of MA data in the HRRP measures, and also within the VBP program and the IQR program, signals that CMS is moving toward broader integration of MA data into Medicare fee-for-service reimbursement systems.

New Technology Add-on Payment Program Growth

Proposed Rule: CMS proposed to continue NTAP status for 26 products because they continue to meet the newness criteria required under this program. In addition, within the proposed rule CMS discusses new NTAP applications for 43 additional products. Among these applications, 29 were submitted under the alternative pathways for breakthrough devices and qualified infectious disease products (QIDP).

HMA Analysis: The overall number of products with NTAPs is on par with other recent years, but the number of NTAP applications has blossomed in FY 2026 as the result of the alternative breakthrough application pathway. This alternative pathway allows breakthrough devices and certain antibiotic and antimicrobial drugs to apply for NTAP using an abbreviated application process.

Transforming Episode Accountability Model Modifications

Proposed Rule: CMS proposed several modifications to the forthcoming CMS Innovation Center TEAM framework. Among the various methodological modifications proposed to this mandatory payment model beginning January 1, 2026, CMS proposed to take the following actions:

• Limit the deferment period for certain hospitals
• Replace the Area Deprivation Index (ADI) with the Community Deprivation Index (CDI)
• Use a 180-day lookback period and Hierarchical Condition Categories (HCC) for risk adjustment
• Remove health equity and health-related social needs data reporting
• Expand use of the Skilled Nursing Facility (SNF) three-day rule waiver

HMA Analysis: The critical aspect of CMS’s TEAM provision is that the agency proposes to follow through with this Innovation Center model while cancelling other Innovation Center payment models in recent months. It also is noteworthy that the agency has proposed to remove the health equity data reporting requirements for TEAM in line with actions taken with many other CMS programs. Another proposal of note is the plan to expand the use of the waiver to circumvent the SNF three-day inpatient stay rule, which will allow hospitals to discharge patients more quickly to SNFs.

Uncompensated Care Payment Increase for Disproportionate Share Hospitals

Proposed Rule: CMS proposes to increase uncompensated care payments to DSHs by $1.5 billion in FY 2026.

HMA Analysis: CMS’s proposal will increase uncompensated care payments to hospitals by 26 percent. This increase is driven by CMS’s assumption that the rate of uninsured people will increase to 8.7 percent of the population in 2026 from 7.7 percent in 2025.

Stakeholder comments on the IPPS proposed rule are due no later than June 10, 2025.

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The Health Management Associates, Inc. (HMA), Medicare Practice Group monitors federal regulatory and legislative developments in the inpatient setting and assesses the impact on hospitals, life science companies, and other stakeholders. Our experts interpret and model hospital payment policies and assist clients in developing CMS comment letters and long-term strategic plans. Our team replicates CMS payment methodologies and model alternative policies using the most current Medicare fee-for-service and Medicare Advantage (100%) claims data. We also support clients with DRG reassignment requests, NTAP applications, and analyses of Innovation Center alternative payment models.

For more information about the proposed policies, please contact our expert below.

[1] U.S. Bureau of Labor Statistics. Table 1. Consumer Price Index for All Urban Consumers (CPI-U): U.S. City Average, by Expenditure Category. Modified April 10, 2025. Available at:  https://www.bls.gov/news.release/cpi.t01.htm.

[2] Centers for Medicare & Medicaid Services. 2026 Medicare Advantage and Part D Rate Announcement. April 7, 2025. Available at: https://www.cms.gov/newsroom/fact-sheets/2026-medicare-advantage-and-part-d-rate-announcement.