Why Hospitals Need to Adapt to FY 2026 IPPS for Risk Adjustment, Equity, and Reimbursement

Hospitals nationwide are preparing for significant regulatory shifts driven by the Centers for Medicare & Medicaid Services (CMS).

The FY 2026 Inpatient Prospective Payment System (IPPS) Proposed Rule outlines transformative changes in how hospitals are reimbursed and evaluated, emphasizing a more profound commitment to clinical precision, socioeconomic equity, and value-based performance.

These changes affect reimbursement formulas and how hospitals must model risk, capture complexity, and realign clinical operations. At the heart of these reforms are updates to the Hierarchical Condition Category (HCC) model, the introduction of the Community Deprivation Index (CDI), and the rollout of the new Transforming Episode Accountability Model (TEAM).

One of the most substantial clinical model updates is the CMS adoption of HCC Version 28. Unlike its predecessor (Version 22), the new model does not map directly and instead redefines how chronic and complex conditions are grouped and scored. With its greater clinical specificity, Version 28 removes many broad, catch-all categories, requiring providers and analysts to take a more nuanced approach to risk adjustment and documentation.

Concurrently, CMS is transitioning from the Area Deprivation Index (ADI) to the Community Deprivation Index (CDI). While ADI was based on ZIP code-level data, CDI draws from 18 census-derived variables—housing, transportation access, education level, and employment—to provide a more accurate picture of socioeconomic disadvantage. This change enhances equity by ensuring that hospitals serving more disadvantaged populations are appropriately accounted for in pricing and performance benchmarks.

CDI will serve as a core adjuster in the new CMS TEAM model, recognizing that healthcare outcomes are influenced by more than clinical acuity alone. This is particularly significant for safety-net and urban hospitals that care for high-risk populations.

In addition to model changes, CMS proposes several payment policy updates. These include the following:

• Eliminating the Low Wage Index Hospital Policy, previously used to support hospitals in lower-wage regions.
• Reducing the labor-related share in the IPPS payment formula from 67.6 to 66.0 percent, potentially lowering base payments for affected institutions.
• Revising MS-DRG classifications to better align with current surgical complexity, using FY 2024 Medicare claims data for recalibration.

CMS is also phasing out the Health Equity Adjustment (HEA) in the Value-Based Purchasing (VBP) program by FY 2028. Moreover, pandemic-era exclusions in clinical quality measures—especially for COVID-19-related discharges—will no longer be applied, shifting hospitals back toward pre-pandemic benchmarks.

The Transforming Episode Accountability Model (TEAM), set to launch on January 1, 2026, will introduce mandatory episode-based payment in 188 selected Core-Based Statistical Areas (CBSAs) (Institute for Advancing Clinical Care, 2024). Hospitals in these regions, including major systems, will be required to participate.

TEAM integrates clinical complexity (HCC v28) and socioeconomic disadvantage (CDI) to determine risk-adjusted target prices. It also accounts for dual eligibility and disability status, ensuring a fuller representation of a hospital’s patient population’s challenges.

The model retains the ±3 percent retrospective trend factor cap but strengthens prospective pricing through predictive analytics. This forward-looking pricing design is intended to improve accuracy and reduce volatility in reconciliation payments.

In addition to broader reforms, several targeted impacts are critical for financial planning. These include the following:

• Disproportionate Share Hospital (DSH) payments will continue to calculate uncompensated care distributions based on a 3-year average of discharges.
• Graduate Medical Education (GME) policies are being clarified for institutions with reporting periods under 12 months.
• Temporary rural programs such as the Medicare Dependent Hospital (MDH) and Low-Volume Hospital (LVH) designations will expire after September 30, 2025, unless Congress extends them.

Hospitals in rural and underserved areas must factor these expenditures into future budgets and staffing models, especially if these adjustments are critical revenue sources.

As these changes take shape, hospital leaders should begin by reassessing financial models. Incorporating updated DRG logic, revised wage indices, and CDI-adjusted pricing is essential for projecting the FY 2026 revenue landscape.

Next, quality improvement teams must adapt performance strategies to include Medicare Advantage (MA) data and remove COVID-era exclusions. This shift affects readmission, mortality, and surgical complication metrics.

Finally, success will depend on cross-functional collaboration. Risk adjustment is no longer the domain of billing or coding alone—it now spans clinical documentation integrity (CDI), finance, population health, compliance, strategy, and quality. TEAM participation will require tight coordination among these teams to track outcomes and cost performance across entire episodes of care.

The FY 2026 IPPS Proposed Rule represents more than regulatory maintenance—it reflects a strategic pivot toward precision risk modeling, payment fairness, and social accountability. Hospitals that proactively align with these reforms—modernizing data systems, refining documentation workflows, and embracing social risk factors—will be best positioned to lead an increasingly value-focused healthcare economy.

The path forward is not only about compliance. It is about capacity, adaptability, and the will to serve patients better clinically and socially.

Sources:

Centers for Medicare & Medicaid Services. (2024). FY 2026 IPPS Proposed Rule Home Page. U.S. Department of Health and Human Services. https://www.cms.gov/medicare/payment/prospective-payment-systems/acute-inpatient-pps/fy-2026-ipps-proposed-rule-home-page

Centers for Medicare & Medicaid Services. (n.d.). Transforming Episode Accountability Model (TEAM). U.S. Department of Health and Human Services. https://www.cms.gov/priorities/innovation/innovation-models/team-model

Institute for Advancing Clinical Care. (2024, August 16). TEAM Model CBSA Participation List. https://www.institute4ac.org/wp-content/uploads/2024/08/IAC_TEAM-CBSA-List_8.16.24.pdf

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