601 New Jersey Avenue, NW • Suite 9000 • Washington, DC 20001

(202) 220-3700 • Fax: (202) 220-3759 • www.medpac.gov
The Medicare Payment Advisory Commission (MedPAC) is an independent federal body 

established by the Balanced Budget Act of 1997 (P.L. 105–33) to advise the U.S. Congress 

on issues affecting the Medicare program. In addition to advising the Congress on payments 

to health plans participating in the Medicare Advantage program and providers in Medicare’s 

traditional fee-for-service program, MedPAC is also tasked with analyzing access to care, 

quality of care, and other issues affecting Medicare.

The Commission’s 17 members bring diverse expertise in the financing and delivery of 

health care services. Commissioners are appointed to three-year terms (subject to renewal) 

by the Comptroller General and serve part time. Appointments are staggered; the terms of 

five or six Commissioners expire each year. The Commission is supported by an executive 

director and a staff of analysts, who typically have backgrounds in economics, health policy, 

and public health.

MedPAC meets publicly to discuss policy issues and formulate its recommendations to 

the Congress. In the course of these meetings, Commissioners consider the results of staff 

research, presentations by policy experts, and comments from interested parties. (Meeting 

transcripts are available at www.medpac.gov.) Commission members and staff also seek input 

on Medicare issues through frequent meetings with individuals interested in the program, 

including staff from congressional committees and the Centers for Medicare & Medicaid 

Services (CMS), health care researchers, health care providers, and beneficiary advocates.

Two reports—issued in March and June each year—are the primary outlets for Commission 

recommendations. In addition to annual reports and occasional reports on subjects requested 

by the Congress, MedPAC advises the Congress through other avenues, including comments 

on reports and proposed regulations issued by the Secretary of the Department of Health and 

Human Services, testimony, and briefings for congressional staff. 
JUNE 2006

REPORT TO THE CONGRESS

Increasing the

Value of Medicare

601 New Jersey Avenue, NW • Suite 9000 • Washington, DC 20001

(202) 220-3700 • Fax: (202) 220-3759 • www.medpac.gov

 June 15, 2006

The Honorable Richard B. Cheney

President of the Senate

U.S. Capitol

Washington, DC 20510

Dear Mr. Vice President:

I am pleased to submit the Medicare Payment Advisory Commission’s June 2006 Report to the Congress: 

Increasing the Value of Medicare. This report fulfills MedPAC’s legislative mandate to examine issues 

affecting the Medicare program and to make specific recommendations to the Congress.

The Commission’s goal is to recommend policies that increase the value of the Medicare program for 

beneficiaries and taxpayers. In this report, we:

• examine increasing accountability and care coordination by measuring physician resource use and by 

developing models of care coordination; 

• describe ways to improve pricing accuracy in the hospice and physician payment systems; 

• consider how information can be improved by adding quality measures in home health, gathering data 

on outpatient therapy, describing the array of offerings in Medicare Advantage and the new Part D 

prescription drug program, and determining the information beneficiaries are using when evaluating 

choices in Part D; and

• explore using cost-effectiveness analysis. 

The report concludes by fulfilling our statutory obligation to analyze the Secretary of HHS’s estimate of 

the update for physician services (Appendix A of this report).

 Sincerely,

 Glenn Hackbarth, J.D.

 Chairman

Enclosure

601 New Jersey Avenue, NW • Suite 9000

Washington, DC 20001

202-220-3700 • Fax: 202-220-3759

www.medpac.gov

Glenn M. Hackbarth, J.D., Chairman

Robert D. Reischauer, Ph.D., Vice Chairman

Mark E. Miller, Ph.D., Executive Director
 June 15, 2006

The Honorable J. Dennis Hastert

Speaker of the House of Representatives

U.S. House of Representatives

H232 Capitol Building

Washington, DC 20515

Dear Mr. Speaker:

I am pleased to submit the Medicare Payment Advisory Commission’s June 2006 Report to the Congress: 

Increasing the Value of Medicare. This report fulfills MedPAC’s legislative mandate to examine issues 

affecting the Medicare program and to make specific recommendations to the Congress.

The Commission’s goal is to recommend policies that increase the value of the Medicare program for 

beneficiaries and taxpayers. In this report, we:

• examine increasing accountability and care coordination by measuring physician resource use and by 

developing models of care coordination; 

• describe ways to improve pricing accuracy in the hospice and physician payment systems; 

• consider how information can be improved by adding quality measures in home health, gathering data 

on outpatient therapy, describing the array of offerings in Medicare Advantage and the new Part D 

prescription drug program, and determining the information beneficiaries are using when evaluating 

choices in Part D; and

• explore using cost-effectiveness analysis. 

The report concludes by fulfilling our statutory obligation to analyze the Secretary of HHS’s estimate of 

the update for physician services (Appendix A of this report).

 Sincerely,

 Glenn Hackbarth, J.D.

 Chairman

Enclosure

601 New Jersey Avenue, NW • Suite 9000

Washington, DC 20001

202-220-3700 • Fax: 202-220-3759

www.medpac.gov

Glenn M. Hackbarth, J.D., Chairman

Robert D. Reischauer, Ph.D., Vice Chairman

Mark E. Miller, Ph.D., Executive Director
Report to the Congress: Increasing the Value of Medicare | June 2006 v

This report was prepared with the assistance of many 

people. Their support was key as the Commission 

considered policy issues and worked toward consensus on 

its recommendations.

Despite a heavy workload, staff members of the Centers 

for Medicare & Medicaid Services were particularly 

helpful during preparation of the report. We thank Sandra 

Bastinelli, Christian Bauer, Pamela Cheetham, William 

Clark, Kent Clemens, Rich Coyle, Alissa Deboy, Terri 

Deutsch, Aaron Eaton, Kim Elmo, Michael Fiore, Debbra 

Hattery, Jessica Herrera-Cancel, Barbara Hoffman, Anne 

Hornsby, Tim Love, Terrence Kay, Carol Kelly, Linda 

Magno, Tracey McCutcheon, Penny Mohr, Carolyn 

Mullen, Vikki Oates, Steve Phurrough, Theresa Pratt, 

Lori Robinson, Dorothy Shannon, Jennifer Shapiro, John 

Shatto, Paul Spitalnic, Cynthia Tudor, Tom Valuck, Dan 

Waldo, and Carlos Zarabozo.

The Commission also received valuable insights and 

assistance from others in government, industry, and 

the research community who generously offered their 

time and knowledge. They include Catherine Anderson, 

Stanley Aronovitch, Bruce Bagley, Melinda Beeuwkes 

Buntin, Mara Benner, Bob Berenson, Marc Berk, Martin 

Block, Richard Burke, Rhonda Byrnes, Judy Cahill, 

Stephanie Carter, Karen Cheung, Daniel Ciolek, Peter 

Clarkson, Joshua Cohen, Robb Cohen, Kathy Coltin, 

James Cosgrove, Hilary Dalin, Nancy Davenport-Ennis, 

Bob Doherty, Elizabeth Eaton, Nancy Edwards, Elliott 

Fisher, Diane Flanders, Ron Fried, Dan Gaylin, Kurt 

Gillis, Kris Haltmeyer, Elizabeth Hargrave, Dennis Hart, 

Jack Hoadley, Sarah Hughes, Katharine Iritani, Alan Jette, 

John Jones, Jon Keyserling, Harriet Komisar, Alma Kuby, 

Theresa Lee, Tammie Lindquist, Karl Lorenz, Ingrida 

Lusis, Joanne Lynn, John Mach Jr., Penny Marshall, 

David Mason, Robert Master, Stephanie Maxwell, Scott 

McCracken, Beth McGlynn, Sharon McIlrath, Katie 

Merrell, Christina Metzler, Marilyn Moon, Judy Moore, 

Janet Neigh, Peter Neumann, Nancy Nicosia, Karen Pace, 

Elaine Reardon, Dawn Robinson, Marissa Schlaifer, 

Richard Segan, Jean Slutsky, Richard Smith, Sherry 

Smith, Terry Smith, Bruce Steinwald, Mary St. Pierre, 

Laura Summer, Janet Sutton, Bill Taylor, Bill Thomas, Jim 

Verdier, Diana Verrilli, Howard Weiss, Jack Weiss, Steve 

Wickstrom, Mary Worstell, and Grace Yang.

Once again, the programmers at Social and Scientific 

Systems provided highly capable assistance to 

Commission staff. In particular, we appreciate the hard 

work of Valerie Aschenbach, Valeriy Bakushin, Daksha 

Damera, Deborah Johnson, John May, Fred Rhode, Scott 

Roberts, Mary Beth Spittel, Charles Thomson, Susan Tian, 

and Arlene Turner. 

Finally, the Commission wishes to thank Lynn Lewis and 

Oedipa Rice for their help in editing and producing this 

report. 

Acknowledgments

Report to the Congress: Increasing the Value of Medicare | June 2006 vii

Acknowledgments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . v

Tables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ix

Figures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xi

Executive summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xv

Chapters

1 Using episode groupers to assess physician resource use . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

Data and methods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

Results . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

Attributing episodes to physicians . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

Comparison of resource use and quality across MSAs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

Future work . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24

2 Care coordination in fee-for-service Medicare. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31

Why is care coordination needed? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35

Care coordination tools for patients with complex needs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37

Is there evidence that care coordination improves quality or saves costs? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41

Models of care coordination in the Medicare FFS program . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43

3 Medicare’s hospice benefit: Recent trends and consideration of payment system refinements. . . . . 59

Growth and change in Medicare’s hospice benefit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61

Consideration of payment system refinements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67

Medicare hospice payment: Directions for further investigation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71

4 Keeping physicians’ practice expense payment rates up to date . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79

Medicare needs current data on each specialty’s total practice expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83

Accuracy and reliability of the direct resource data. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87

Estimating accurate prices for clinical staff, supplies, and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89

Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95

5 Adding quality measures in home health . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .103

Strengths and weaknesses of the current measure set . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .105

Gathering best practices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .107

Translating best practices into process measures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .109

Table of contents
viii Table of contents

6 Toward better value in purchasing outpatient therapy services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .117

Growth in Medicare spending since 2000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .123

Variation in spending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .126

Alternative ways to manage therapy service use . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .128

Information needed to evaluate Medicare’s therapy purchases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .132

Next steps for CMS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .135

7 Part D plan offerings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .145

Part D’s structure and initial levels of enrollment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .149

Part D plan offerings for 2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .154

Part D formularies. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .167

Looking ahead. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .173

8 How beneficiaries learned about the drug benefit and made plan choices. . . . . . . . . . . . . . . . . . . . . . . .181

Studying how beneficiaries made choices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .183

Choosing to enroll in the drug benefit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .184

Choosing a plan. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .187

The beneficiary counselor perspective . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .190

Information and decision making . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .193

9 The Medicare Advantage program: Availability, benefits, and special needs plans . . . . . . . . . . . . . . .199

Medicare Advantage plans available for 2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .203

Special needs plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .212

10 Medicare’s use of clinical and cost-effectiveness information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .227

Do cost-effectiveness ratios vary for colorectal cancer screening and ICDs? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .232

Improving the comparability of cost-effectiveness analyses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .234

Future issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .237

Appendix

A Review of CMS’s preliminary estimate of the physician update for 2007. . . . . . . . . . . . . . . . . . . . . . . . . .249

Calculating the update. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .249

Reviewing CMS’s estimates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .250

Acronyms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 257

More about MedPAC

Commission members. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 261

Commissioners’ biographies. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 263

Commission staff. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 267
Report to the Congress: Increasing the Value of Medicare | June 2006 ix

Tables

1 Using episode groupers to assess physician resource use . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

1–1 Medicare claims classified into MEGs compared with ETGs. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

1–2 Variation in number and distribution of selected episodes, 2002. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

1–3 Average episode costs rise with disease severity and overall patient complexity, 2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

1–4 Episode costs are driven by different mixes of services, 2002. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

1–5 Most episodes can be attributed to one physician, 2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

1–6 Most beneficiaries eligible for quality indicators can be attributed to one physician . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

1–7 Relative resource use ratios for selected MSAs, 2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

1–8 Comparison of resource use in Miami and Minneapolis MSAs, 2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

1–9 Relative resource use, by type of service, Miami and Minneapolis MSAs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

1–10 Ratio of MSA to national quality scores on six conditions, 2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23

2 Care coordination in fee-for-service Medicare. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31

2–1 Beneficiaries with select chronic conditions see more physicians . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36

2–2 Current strategies to coordinate care in Medicare . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43

2–3 Components of two illustrative care coordination models. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44

2–4 Examples of quality measures: The PGP demonstration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51

3 Medicare’s hospice benefit: Recent trends and consideration of payment system refinements. . . . . 59

3–1 Medicare hospice payment categories and rates, FY 2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63

3–2 Recent trends in the number of hospices reaching the annual payment cap vary by region . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65

3–3 Use of hospice among Medicare beneficiaries increased from 2000 to 2004. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66

3–4 Total days of hospice care vary by disease category . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68

3–5 Chain and all Medicare hospice patient demographics, 2002–2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73

4 Keeping physicians’ practice expense payment rates up to date . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79

4–1 Hourly practice expenses increased for some specialties between 1995–1999 and 2001–2003. . . . . . . . . . . . . . . . . . . . . . . . . . . . 85

4–2 Alternative approaches to collect practice cost data raise many issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86

4–3 Response rates to supplemental practice expense surveys are low . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87

4–4 Direct resource data provide very specific estimates of clinical labor, medical equipment, and supplies . . . . . . . . . . . . . . . . . . . . 87

4–5 Distribution of direct costs of select MRI and CT services, 2006. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91

4–6 Illustration of how changing equipment use and interest rate assumptions affects equipment price per service. . . . . . . . . . . . . . . 94

5 Adding quality measures in home health . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .103

5–1 The current home health measure set . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .106

5–2 Fall prevention practices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .108

5–3 Pressure wound care practices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .109
x Tables

6 Toward better value in purchasing outpatient therapy services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .117

6–1 Outpatient therapy users and service intensity have increased since 2000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .125

6–2 CMS does not collect much of the information useful for predicting and comparing beneficiaries’ therapy care needs . . . . . . .132

7 Part D plan offerings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .145

7–1 Part D enrollment and other sources of drug coverage in early 2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .153

7–2 Characteristics of PDPs in 2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .155

7–3 Premiums and cost-sharing requirements among PDPs in 2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .157

7–4 PDPs offered in 2006 by organizations with at least one nationwide plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .158

7–4 PDPs offered in 2006 by organizations with at least one nationwide plan (cont.) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .159

7–5 “Near-national” organizations with 30 or more PDPs among the 34 regions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .161

7–6 Geographic distribution of PDPs in 2006. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .162

7–7 Characteristics of MA–PD drug benefits in 2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .163

7–8 Premiums and cost-sharing requirements among MA–PD drug benefits in 2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .164

7–9 Most Part D plans distinguish between preferred and nonpreferred brands and include specialty tiers . . . . . . . . . . . . . . . . . . . .169

7–10 The share of drugs listed in a therapeutic category depends on category size and regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . .172

7–11 Part D plans concentrate prior authorization in selected categories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .173

8 How beneficiaries learned about the drug benefit and made plan choices. . . . . . . . . . . . . . . . . . . . . . . .181

8–1 When you decided to sign up for the new program, how important were each of the following reasons?. . . . . . . . . . . . . . . . . . .187

8–2 Beneficiaries who use few drugs are less likely to enroll in a drug plan. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .188

8–3 How important are each of the following reasons in picking a plan? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .191

8–4 Choosing a drug plan was time consuming but the majority of beneficiaries had enough information to make a decision. . . . .192

9 The Medicare Advantage program: Availability, benefits, and special needs plans . . . . . . . . . . . . . . .199

9–1 Percent of Medicare beneficiaries with access to MA plans, 2004–2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .206

9–2 HMOs most likely to bid below benchmark and have highest rebates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .209

9–3 MA–PDs are widely available and enhanced cost-sharing protections are available in some areas. . . . . . . . . . . . . . . . . . . . . . . .210

9–4 Differences in plan availability between urban and rural areas . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .212

9–5 Categories of dual eligibles. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .214

10 Medicare’s use of clinical and cost-effectiveness information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .227

10–1 Cost-effectiveness ratios for colorectal cancer screening compared with no screening vary across studies . . . . . . . . . . . . . . . . .233

A Review of CMS’s preliminary estimate of the physician update for 2007. . . . . . . . . . . . . . . . . . . . . . . . . .249

A–1 Preliminary sustainable growth rate, 2007 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .250

A–2 Estimate of the update for physician services, 2007 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .250
Report to the Congress: Increasing the Value of Medicare | June 2006 xi

3 Medicare’s hospice benefit: Recent trends and consideration of payment system refinements. . . . . 59

3–1 Hospice use has grown for all Medicare decedents, but use remains higher among those in managed care . . . . . . . . . . . . . . . . . . 66

3–2 Long hospice stays are getting longer, but short stays persist . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67

3–3 Average length of stay in hospice by state, 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69

3–4 An increase in freestanding agencies fueled growth in the number of hospice providers, 2001–2005 . . . . . . . . . . . . . . . . . . . . . . 70

3–5 Potential case-mix adjusters explain little additional variation in visits and visit labor costs. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71

3–6 More intensive care is delivered at beginning and end of hospice stays . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71

4 Keeping physicians’ practice expense payment rates up to date . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79

4–1 MRI and CT machines used most of the time providers were open for business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 92

5 Adding quality measures in home health . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .103

5–1 Example: Translating fall prevention best practice into process measure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .110

6 Toward better value in purchasing outpatient therapy services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .117

6–1 Outpatient therapy is furnished by many different entities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .121

6–2 Medicare spending on outpatient therapy services has almost doubled since 2000. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .125

6–3 Medicare spending on therapists in private practice grew faster than that for other providers, 2000–2004. . . . . . . . . . . . . . . . . .126

6–4 Per user spending on outpatient therapy varied threefold across settings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .127

7 Part D plan offerings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .145

7–1 Distribution of PDP and MA–PD premiums for basic and enhanced plans in 2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .156

7–2 Distribution of Part D enrollees by organization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .165

7–3 Part D plans typically list about 1,000 drugs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .171

8 How beneficiaries learned about the drug benefit and made plan choices. . . . . . . . . . . . . . . . . . . . . . . .181

8–1 Have you signed up for a drug plan or are you considering signing up for a drug plan? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .187

8–2 What was the primary reason that you decided not to sign up for a drug plan? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .189

8–3 If you had help, who was the main person who helped you make a decision about signing up for a drug plan? . . . . . . . . . . . . .190

8–4 How helpful was the information provided by...? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .191

9 The Medicare Advantage program: Availability, benefits, and special needs plans . . . . . . . . . . . . . . .199

9–1 Most beneficiaries have access to 11 or more plans, 2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .207

9–2 Medicare Advantage plans used the largest share of rebate dollars to reduce cost sharing for Medicare services . . . . . . . . . . . .208

9–3 Zero-premium plans are widely available. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .209

9–4 Most beneficiaries have access to an MA–PD with a premium of $20 or less . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .211

9–5 Options for dual eligibles in 2006. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .215

9–6 Special needs plans available in 2006. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .217

9–7 Number of organizations offering special needs plans, by county, 2006. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .218

Figures
xii Figures

10 Medicare’s use of clinical and cost-effectiveness information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .227

10–1 Selecting services for cost-effectiveness analysis based on differences in their costs and quality . . . . . . . . . . . . . . . . . . . . . . . . .239

A Review of CMS’s preliminary estimate of the physician update for 2007. . . . . . . . . . . . . . . . . . . . . . . . . .249

A–1 Through 2005, actual spending for physician services exceeded target . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .251
Executive summary

Report to the Congress: Increasing the Value of Medicare | June 2006 xv

Medicare fills a critical role in our society—ensuring 

that the elderly and disabled have access to medically 

necessary care. But along with that role comes a 

responsibility for policymakers to make sure that the 

resources entrusted to the program by beneficiaries and 

taxpayers are used wisely. Medicare must increase the 

quality and value of the care it purchases and control its 

spending. 

Controlling spending is essential to assure the 

sustainability of the program. The longer action is delayed, 

the more draconian the remedies that will eventually be 

required. Since 1990, Medicare’s program outlays per 

enrollee have been growing at about 6 percent a year, 

more than 2 percentage points faster than overall growth 

per person in the U.S. economy. The new outpatient 

prescription drug program and the arrival of the baby 

boom population as Medicare beneficiaries will lead 

to greater expenditures in the near future. Medicare is 

not alone in facing rapid increases in spending. Health 

care spending per person as a whole has been growing 

more than 2 percentage points faster than gross domestic 

product (GDP) and is projected to encompass even more 

of the U.S. economy—19 percent of GDP by 2014. 

The same issues—lack of accountability and care 

coordination, rapid diffusion of technology that in some 

cases may not be cost effective, and poor incentives for 

efficiency—bedevil private payers as well as Medicare 

and other public payers. Encouraging efficiency through 

competition or price setting is difficult when markets 

have few suppliers and when purchasers focus on isolated 

services rather than on the totality of a patient’s care. 

Because time is now short, Medicare should take the lead 

in addressing these issues, yet look for opportunities to 

learn from and work with other payers when possible.

Wise stewardship of the program goes beyond controlling 

its cost. The quality and safety of the care beneficiaries 

receive are not assured. Evidence shows that beneficiaries 

do not always receive the care they need, that too often 

the care they do get is not of high quality, and that in 

some places where they receive more care there are 

also poor outcomes. This variation in care does not help 

beneficiaries and is often costly to the program. Patient 

safety also continues to present a troubling picture. 

Moreover, paying providers the same regardless of the 

quality of their care perpetuates poor care for some 

beneficiaries, misspends program resources, and is unfair 

to high-performing providers.

Within this broader picture, the Commission’s goal is 

to recommend policies that increase the value of the 

Medicare program for beneficiaries and taxpayers. In this 

report, we examine some new directions to increase the 

value of the Medicare program. We examine increasing 

accountability and care coordination by measuring 

physician resource use and by developing models of 

care coordination. We consider how information can 

be improved by describing the array of offerings in the 

new Part D prescription drug program and determining 

the information beneficiaries are using when evaluating 

them. We also discuss ways to improve pricing accuracy 

in several sectors and explore using cost-effectiveness 

analysis. Both are potential ways to increase value for the 

program. 

Many of these initiatives require more reliable and more 

current data than are now available. Making these data 

routinely available may require a significant investment, 

but the return may be substantial and an important step 

forward for policymakers, providers, and beneficiaries in 

the long run.

Improving accountability and care 

coordination

Providers must be held accountable for the quality of care 

they provide and the resources consumed in providing that 

care. But, perverse payment system incentives, lack of 

information, and fragmented delivery systems are barriers 

to full accountability. In a fee-for-service system, doing 

more pays more, regardless of the quality or efficacy 

of what is done. Most providers may wish to provide 

high-quality care to uphold professional standards and to 

satisfy patients. When payment for a service is fixed, they 

also may want to control their own costs for producing 

the service to improve their financial performance. But 

for a provider to be held accountable, the quality of 

the care a provider delivers and the cost to the system 

for that care must be measured and communicated. In 

addition, providers may refer patients to other parts of 

the delivery system dictating further resource use. To 

improve quality and efficiency, a provider’s accountability 

could be extended to all of the resources used for a 

Executive summary
xvi Executive summary

particular patient during a specific episode of care. The 

autonomy that providers value must be accompanied by 

accountability to increase value in the Medicare program. 

Fee-for-service payment systems also are barriers to care 

coordination among providers and to care management 

for beneficiaries with complex needs. Payment is directed 

to each provider separately and emphasizes treatment for 

acute conditions and face-to-face care. Overcoming those 

barriers will require a new model of care and payment.

Measuring physician resource use 

A step toward improving accountability is measuring 

physician resource use. In March 2005, the Commission 

recommended CMS provide individual physicians with 

information on their resource use relative to their peers 

in a confidential manner. In Chapter 1, we examine one 

method to achieve this—episode groupers. An episode 

grouper links all the care a beneficiary receives that is 

related to a particular spell of illness or episode and adjusts 

for patient characteristics. We describe how these tools 

might work using Medicare data and give some examples 

of results thus far.

We applied two commercially available episode groupers 

to a 5 percent sample of Medicare claims and found: 

• Although the groupers differ in their logic, for most 

conditions they generally agreed on the number of 

episodes created and the types of services in episodes, 

but the dollars allocated to episodes differ in 

some cases. 

• The vast majority of episodes and quality indicators 

could be attributed to a physician. Whether that 

physician could or should be held accountable 

for episode resource use and quality is a more 

complicated question that we will address in future 

reports. 

• Resource use and quality vary across the 13 

metropolitan statistical areas tested, and resource use 

varies more than quality. It is important to use per 

capita expenditures alongside per episode costs to get 

a complete picture of variation in resource use because 

a provider could be efficient over an episode but 

provide many episodes per beneficiary. 

We also describe how risk-adjustment techniques account 

for overall patient severity so that physicians who 

predominantly treat sicker patients are compared fairly to 

physicians who treat healthier patients. Additional analyses 

at the individual physician level will further elucidate these 

results.

Care coordination

Care coordination has the potential to improve value in the 

Medicare program. Even if individual providers deliver 

care efficiently, overall care for a beneficiary may be 

inefficient if providers do not coordinate across settings or 

assist beneficiaries in managing their conditions between 

visits. Beneficiaries with multiple chronic conditions may 

benefit the most from care coordination as they do not 

always receive necessary care and are often high cost.

In Chapter 2, we explore strategies fee-for-service 

Medicare could use to better coordinate care. (Incentives 

for care coordination already exist under Medicare 

Advantage.) To inform our discussion, Commission staff 

interviewed a wide variety of experts and organizations 

involved in care coordination, including many 

participating in CMS pilot and demonstration programs. 

Successful programs include a care manager—usually 

a nurse—and an information system. Some involve 

the beneficiary’s primary physician. We also analyzed 

Medicare claims data to understand the prevalence, cost, 

and patterns of care for beneficiaries with a subset of 

chronic conditions. 

We outline for discussion two illustrative models of 

integrating care coordination into fee-for-service Medicare 

for beneficiaries with chronic conditions. In the first, 

Medicare could contract with group practices to furnish 

care coordination services. Incentives for care coordination 

would only go to provider groups capable of integrating 

information technology and nurse care managers into 

patient clinical care. In the second, Medicare would 

contract with stand-alone care management organizations 

that have the requisite information technology and 

care manager capacities and can coordinate with the 

beneficiary’s physician. In both models, contracting 

organizations would agree initially to guarantee some level 

of cost savings as a condition of payment. 

Additionally, to encourage physicians to work with care 

coordination programs, CMS could pay a beneficiary’s 

primary physician or the group for time spent with the care 

manager. This additional payment may be less necessary 

in the group model than in the second model. However, 

if these two models coexisted, providing the fee only to 

nongroup physicians could disadvantage those working 
Report to the Congress: Increasing the Value of Medicare | June 2006 xvii

in groups. In both models, the payments would be added 

through the physician fee schedule which would entail 

some reallocation of payments among services.

In addition to these models, Medicare may consider ways 

to encourage care coordination through payments within 

the fee schedule’s evaluation and management services. 

In previous reports to the Congress, the Commission has 

also recommended pay-for-performance initiatives for 

physicians, which could complement care coordination by 

improving quality. 

Improving the accuracy of prices

The prices Medicare pays for individual products may 

not be accurate. Theoretically, a price matches the 

marginal cost of an efficient provider in furnishing a 

service. Truly competitive markets can identify such 

prices, but health care markets are imperfect because of 

asymmetric information, moral hazard, adverse selection, 

and limited supplier competition among other factors. 

Medicare generally sets the prices it will pay for services 

administratively. 

Improving payment accuracy in the hospice 

payment system

In Chapter 3, we assess whether the hospice payment 

system could be modified to improve payment accuracy. 

Medicare’s hospice benefit has grown dramatically, with 

the days of hospice care doubling between 2000 and 2004. 

As the number of users has grown, the population of 

hospice patients has become more diverse. The payment 

system was developed from a demonstration project 

that analyzed the costs of hospice care for patients with 

terminal cancer diagnoses who lived in the community. 

Today, more Medicare hospice patients have noncancer 

than cancer diagnoses and hospice patients live in nursing 

homes as well as in the community. 

The growth in spending and use, together with changes 

in the hospice population, suggest that the hospice 

payment system may need refinement to improve payment 

accuracy. To test possible payment refinements in light of 

limited Medicare data, the Commission contracted with 

RAND to test the ability of case-mix adjusters to improve 

the predictive power of the hospice payment system. We 

used data from one large chain of hospices for this analysis 

because they contained detailed utilization information 

not available from Medicare administrative records. We 

found that adding case-mix adjusters to the number of 

days in the current payment categories did not improve the 

ability to predict variation in labor costs associated with 

patient visits. We also found that payment accuracy might 

be improved by paying more for the first and last days 

of the stay than for the intervening days. However, this 

analysis is only suggestive, as it used only one chain’s data 

and because patient-level data on all costs of care (such as 

drugs) were not available from this chain. 

More detailed data from hospice agencies on the cost of 

services, the services provided, and the patients served 

are needed to assess the relationship between patient 

characteristics and hospice services. Analysis of those 

data, along with an analysis of payment adequacy such as 

the Commission undertakes for other sectors, could inform 

consideration of Medicare hospice payment policies.

Keeping physicians’ practice expense rates 

up to date 

Inaccurate payment rates can distort the market for 

physician services. Over time, if certain types of services 

become undervalued relative to others, the specialties 

that perform those services may become less financially 

attractive, potentially affecting the supply of physicians. 

At the same time, overvaluing services may stimulate 

overproduction of some services. 

Chapter 4 reviews the data sources that CMS uses 

to derive practice expense payments—an important 

determinant of pricing accuracy in the physician fee 

schedule. One source, a multispecialty survey on the costs 

of operating physicians’ practices, dates from the 1990s. 

Several specialties have submitted more recent data, but 

updating the physician fee schedule using newer data from 

some but not all specialties could introduce significant 

distortions in relative practice expense payments across 

specialties. Collecting new data would require deciding 

if Medicare or provider groups will sponsor the data 

collection, if participation would be voluntary or 

mandatory, and whether a nationally representative sample 

of providers would be sufficient. 

We recognize that collecting and updating practice cost 

data will substantially increase demands on CMS. As it 

will improve the accuracy of Medicare’s payments and 

achieve better value for Medicare spending, the Congress 

should provide CMS with the financial resources and 

administrative flexibility to undertake the effort.

In addition to estimating the type and quantity of direct 

inputs for each service, CMS also estimates prices for 

each of the inputs. To improve the accuracy of input prices, 
xviii Executive summary

CMS could revisit the assumptions it uses to estimate 

the per service cost of medical equipment, particularly 

the assumption that equipment is operated 50 percent 

of the time. If this is an underestimate, Medicare’s per 

unit payment is too high. We conducted a survey of 

imaging providers in six markets and found that magnetic 

resonance imaging (MRI) machines in those markets are 

used more than 90 percent of the time a practice is open 

and computed tomography (CT) machines are used more 

than 70 percent. CMS also assumes that providers pay an 

interest rate of 11 percent per year when borrowing money 

to buy equipment, but more recent data suggest a lower 

interest rate may be more appropriate. 

When CMS begins using direct inputs to value imaging 

services, changing the assumptions of equipment use and 

interest rates would reduce payment rates for MRI and 

CT services. Because changes to practice expense relative 

values must be budget neutral, these savings would be 

redistributed among other physician services.

Providing better information and the tools 

to use it

Medicare policymakers and administrators need better 

information both to formulate better policies and to 

create tools to give useful information to beneficiaries 

and providers. At the same time, providers need better 

information to provide quality care and to reduce or limit 

growth in resource use; beneficiaries need information 

to maintain a healthy lifestyle and to choose the highest 

quality care at lowest cost. Closing the gap between the 

information needed and the information available is a 

formidable challenge for the Medicare program, as it is for 

the health care system in general.

Process measures for home health agencies 

In Chapter 5, we discuss improving the information 

available on the quality of care in home health agencies by 

adding process measures. In March 2005, the Commission 

suggested that additional measures should be developed to 

complement existing quality measures in home health. 

As a step toward exploring new measures, we convened 

a panel of researchers, quality measurement experts, and 

home health providers to identify best practices. We asked 

the panel to focus on fall prevention and wound care. They 

gave us examples of best practices, such as determining 

whether patients’ blood pressure changes significantly 

while the patient is standing to assess the risk of falling or 

developing a standard protocol to contact a physician when 

a wound fails to heal. 

The next step is creating measures based on the practices. 

For example, a process measure for a blood pressure 

practice would include a precise description of who should 

receive this care, at what time and how often should it 

occur, a very specific definition of the practice itself, and 

rules for excluding patients who should not receive the 

care. Some additional data would have to be collected 

to support such measures. We urge CMS as part of its 

ongoing efforts to develop and test such measures and to 

add them to home health’s measure set if they are valid and 

reliable. 

Improving payment for outpatient therapy 

services 

Spending for outpatient therapy services—physical 

therapy, occupational therapy, and speech-language 

pathology services—has almost doubled since 2000, 

reaching $3.9 billion in 2004. Spending per beneficiary 

varies considerably, but there is no information on 

whether this reflects greater patient need or simply greater 

provision of services. In Chapter 6, we consider the key 

question arising for this rapid growth and large variation: 

How can Medicare allow beneficiaries to get the services 

they need without paying for services that are medically 

unnecessary? 

CMS requires better information about the therapy 

needs of beneficiaries and their outcomes to consider 

alternative payment methods that will increase the value 

of the therapy services it purchases. CMS will need to 

develop patient assessment tools that gather risk factor 

information and outcomes measures. Pilot programs 

would be a good way for CMS to test alternative ways 

to collect this information. The data gathered from the 

pilot could be used to establish benchmarks for therapy 

practice and develop risk-adjustment factors for a new 

payment method. Options for a new payment method 

include paying for a bundle of therapy services that varies 

by patient condition or developing an incentive payment 

system that encourages therapists to both provide high 

quality care and be conservative in furnishing services. For 

either option, an effective risk-adjustment system would be 

necessary. 

On January 1, 2006, the therapy caps that limit program 

spending per beneficiary were reinstated. As required by 

the Congress, CMS implemented an exceptions process so 

that beneficiaries can get approval for medically necessary 

services that exceed the limits. CMS will need to monitor 
Report to the Congress: Increasing the Value of Medicare | June 2006 xix

this process to ensure that the additional services beyond 

the caps are medically necessary. 

What benefits are available in Part D? 

The biggest change in Medicare in recent years is the 

advent of the prescription drug benefit (Part D). Chapter 7 

presents information on the organizations that have entered 

the market and the benefits they offer. This information is 

essential for policymakers to understand how the benefit is 

becoming available to beneficiaries. Beneficiaries need to 

understand what drugs are covered under what conditions 

and their resulting cost sharing to make wise decisions 

about plan enrollment.

In Part D, prescription drug plans (PDPs) deliver Medicare 

prescription benefits and assume some risk for the 

drug spending of their enrollees. For 2006, nearly 80 

organizations are offering 1,429 PDPs:

• 9 percent use the defined standard benefit, 48 percent 

have the same actuarial value as basic coverage but 

a different benefit design, and 43 percent include 

enhanced benefits (basic coverage plus some 

supplemental coverage).

• 15 percent include coverage in the defined standard 

benefit’s coverage gap, typically for generic drugs.

• 66 percent have no deductible or a reduced deductible.

• Nearly 90 percent of the 1,429 PDPs are offered by 16 

organizations and often use the same benefit structure, 

cost sharing, and formulary.

Medicare Advantage–Prescription Drug plans (MA–PDs) 

are also available, but access to specific plans varies 

depending on the county in which a beneficiary lives. 

Overall, there are 1,303 MA–PDs: 

• 7 percent use the defined standard benefit, 29 percent 

have actuarially equivalent basic benefits, and 64 

percent include enhanced benefits.

• 28 percent include coverage in the coverage gap, 

typically for generic drugs.

• 83 percent have no deductible or a reduced deductible. 

• Nearly 40 percent of MA–PDs charge no additional 

premium for Part D coverage beyond what they charge 

for Parts A and B services.

Part D plans use formularies to manage the cost and use of 

prescription drugs. Most Part D plans have tiered copays 

with different copays for preferred drugs, nonpreferred 

brands, and a specialty tier for expensive drugs, 

biologicals, and injectables. Plans usually apply at least 

some drug utilization tools—such as prior authorization, 

step therapy, and quantity limits—to selected drugs. Plans 

use these tools for drugs that are expensive, potentially 

risky, subject to abuse, or to encourage use of lower cost 

therapies. The median plan applies prior authorization to 9 

percent of the drugs on its formulary and uses step therapy 

for a very small but concentrated share of drugs. The 

median formulary covers about 1,000 drugs, but formulary 

size varies somewhat based on plan characteristics and 

the number of drugs listed does not necessarily reflect 

beneficiary access to needed medications. Off-formulary 

drugs may be covered through a plan’s nonformulary 

exceptions process, and on-formulary drugs may not be 

covered if a plan does not approve a prior authorization 

request.

How are Medicare beneficiaries learning about 

Part D?

In Chapter 8, we describe results from a study of how 

Medicare beneficiaries learned about the Medicare 

drug benefit and made choices. The study consisted of a 

beneficiary survey, focus groups with beneficiaries and 

their family members, and structured interviews with 

beneficiary counselors. 

Of those beneficiaries in our February/March survey who 

knew about the drug benefit and did not have employersponsored drug coverage, 30 percent reported that they 

had enrolled in Part D and 16 percent were considering 

doing so. Those who signed up for the benefit reported 

doing so to save money on current drug costs and protect 

themselves in case their drug costs went up in the future. 

Beneficiaries in our focus groups seemed less concerned 

about insuring themselves against future drug expenses. 

Instead they focused on whether Part D would cover their 

current drugs and save them money. When choosing a 

particular plan, beneficiaries considered drugs on the 

formulary, monthly premiums, overall savings, ability 

to use their local pharmacy, and the reputation of the 

company offering the plan.

Beneficiaries who have enrolled or are considering 

enrolling in a plan have spent considerable time studying 

their options. More than two-thirds of beneficiaries 

surveyed researched and made decisions about signing up 
xx Executive summary

for Part D by themselves. However, those who had signed 

up were twice as likely to have had help than those who 

were not considering enrolling. Many beneficiaries have 

discussed their choices with family, friends, and insurance 

agents; fewer beneficiaries have used resources like the 

Medicare toll-free help line, the Medicare plan finder, 

or counselors. Beneficiaries found the large number of 

choices available to them confusing, but a majority in 

our survey said they had enough information to make a 

decision.

About 34 percent of survey respondents without employersponsored drug coverage said they did not plan to sign up 

for the benefit. They most frequently said it was because 

they had other sources of drug coverage or they had few 

current medical expenses—about half use two or fewer 

drugs on a regular basis. Other respondents were either 

auto-enrolled into plans or had not yet decided what to do.

Beneficiary advisors reported a strong demand for their 

services and that their offices were overwhelmed by 

the high volume of calls they received. Noting that they 

only tend to see beneficiaries with problems, counselors 

reported that beneficiaries were confused by the number 

of plan choices and the variation in benefit structure. 

Counselors said that their outreach efforts led to increased 

contacts with beneficiaries dually eligible for Medicare 

and Medicaid and disabled beneficiaries. However, they 

were less successful in reaching other individuals eligible 

for the low-income subsidy. 

Changes in the Medicare Advantage program

In Chapter 9, we discuss three important changes for 

the Medicare Advantage (MA) program in 2006 and the 

resulting choices for beneficiaries. First, plans now submit 

formal bids and CMS compares the bids with benchmarks 

to determine payment. Second, the program has two new 

plan types: regional preferred provider organizations 

(PPOs) and special needs plans (SNPs). Third, the 

introduction of Medicare’s Part D prescription drug benefit 

changes the competitive environment for MA plans. 

Medicare beneficiaries have more MA plans to choose 

from in 2006. Many of those plans will have both low 

premiums and enhanced benefits. Specific findings for 

2006 include:

• 99.6 percent of beneficiaries have MA plans available 

to them.

• 88 percent have regional plans available.

• Half of all beneficiaries can choose from among 16 

or more MA plans, and 5 percent of beneficiaries can 

choose from over 40 plans.

• About 95 percent of bids were under the benchmark; 

thus almost all plans have funds to rebate to members.

• The higher the rebates, the more benefits plans can 

offer. Local HMOs and PPOs tend to have higher 

rebates. Because such plans are more common in 

urban areas, beneficiaries in those areas tend to 

have access to more benefits than beneficiaries in 

rural areas.

• Zero-premium MA plans will be available to 86 

percent of Medicare beneficiaries in 2006.

• Almost three-quarters of beneficiaries will have access 

to zero-premium plans that also include the Part D 

benefit.

Chapter 9 also discusses SNPs, which provide a common 

framework for many of the existing plans for special 

needs beneficiaries and expand beneficiaries’ access to 

and choice among MA plans. In 2004, there were just 

11 SNPs: in 2005, 125 SNPs; and in 2006, the number 

doubled to 276.

SNPs offer the potential to improve care coordination 

for dual eligibles and other special needs beneficiaries 

through unique benefit design and delivery systems. 

However, there is cause for concern that many SNPs 

are not designed to better coordinate care for special 

needs beneficiaries. SNPs, even dual-eligible SNPs, are 

not required to contract with states to provide Medicaid 

benefits. It is unclear how SNPs that do not integrate 

Medicaid can fulfill the opportunity to better coordinate 

the two programs. 

Better targeting of technology 

A pressing issue for Medicare is that technology diffuses 

rapidly without sufficient analysis or guidelines that 

target its use to the patients who will benefit the most. 

Technologies like prescription drugs, surgeries, and 

devices are usually developed to focus on a specific 

problem and the evidence supporting their use is usually 

based on specified patient populations. However, 

technologies often expand into patient populations where 

the benefits of therapies are less clear. 
Report to the Congress: Increasing the Value of Medicare | June 2006 xxi

Medicare’s use of clinical and cost-effectiveness 

information

In Chapter 10, we consider how results from costeffectiveness studies for the same service vary. We review 

methods and results from cost-effectiveness studies 

published in the medical literature for two Medicarecovered services—screening for colorectal cancer and 

implantable cardioverter defibrillators. 

The review illustrates that there are both opportunities and 

challenges in using cost-effectiveness studies in Medicare. 

For one service, despite differences in methodology, there 

is general agreement in the literature that the service 

is cost effective. By contrast, the literature for another 

service does not provide a clear indication of the service’s 

cost effectiveness because the results vary substantially 

across studies. The two main factors contributing to this 

variation are differences in the clinical characteristics of 

the patients and the differing effectiveness of the services 

as measured in major clinical trials.

The Commission plans to explore ways to develop the 

infrastructure to consider information on both the clinical 

and cost effectiveness of a service. We will look at issues 

such as whether Medicare should solely sponsor and 

fund the research or whether a public–private partnership 

is appropriate. We also intend to explore other ways 

Medicare can use this information such as by: 

• providing cost-effectiveness information to 

beneficiaries and health professionals; 

• using cost-effectiveness analysis to prioritize pay-forperformance, screening, and disease management 

initiatives; and

• using cost-effectiveness information in Medicare’s 

rate-setting process. 

Review of CMS’s preliminary estimate of 

the physician update for 2007

Appendix A fulfills the Commission’s requirement to 

review CMS’s estimate of next year’s payment update for 

physician services. CMS’s preliminary estimate is –4.6 

percent, the maximum negative update permitted under 

a formula defined in statute. This is the third consecutive 

estimate of such a large negative update, though a negative 

update has not occurred since 2002 as the Congress has 

overridden the formula. We find CMS uses estimates 

in calculating the update that are consistent with recent 

trends. CMS’s preliminary estimate is that the volume of 

physician services grew by 7.5 percent in 2005, following 

growth of 8.0 percent in 2004. Volume growth exceeding 

growth in the economy is an important factor leading 

to negative updates. The Commission is working on 

a mandated report for the Congress that will consider 

alternatives to the current update formula. The report is 

due in March 2007.

Conclusion

In this report, the Commission has started to develop 

several approaches toward increasing the value of 

the Medicare program. These approaches embody 

certain principles for evaluating policies: promoting 

accountability and care coordination, creating better 

information and tools to use it, and setting accurate prices. 

In addition, the Commission tries to further societal 

objectives and goals and assure that policies protect 

beneficiaries from the high cost of needed care. Solutions 

that add value to the program are our goal as we continue 

to address issues facing Medicare and start to address the 

problem of long-term sustainability. Using episode groupers to 

assess physician resource use

CHAPTER 1

Report to the Congress: Increasing the Value of Medicare | June 2006 3

Using episode groupers to 

assess physician resource use

1

Chapter summary

Physicians are central to the delivery of all types of health care. 

Research on variation in the use of services in Medicare implies that 

physicians and other providers may not always be directing resources 

efficiently. Some service use may not lead to higher quality care and 

could be unnecessary. As both expenditures and volume of services 

continue their steep climb, physicians are also central to efforts to use 

Medicare resources as efficiently as possible.

The Commission recommended in March 2005 that CMS use Medicare 

claims data to measure fee-for-service physicians’ resource use and to 

provide individual physicians with confidential information on their 

resource use relative to their peers. Many private health plans already 

measure and compare physicians’ resource use using episode groupers, 

which group claims into clinically distinct episodes adjusted for patient 

severity. Plans also share this information with physicians in their 

networks. The Commission is exploring the use of episode groupers 

on Medicare claims to better understand how these tools might work 

for Medicare. Because efficiency is defined both by resource use and 

In this chapter

• Data and methods

• Results

• Attributing episodes to 

physicians

• Comparison of resource use 

and quality across MSAs

• Future work

C H A P T E R 
4 Using episode groupers to assess physician resource use

quality, we are also examining quality indicators in our analyses. In this 

chapter, we describe our findings from applying two episode grouper tools to 

a nationally representative, randomly selected 5 percent sample of Medicare 

claims. In general, the analysis shows that it is possible to use these types 

of episode groupers as one tool to measure physician resource use at the 

aggregate metropolitan statistical area (MSA) level, but some technical and 

analytic issues will need to be addressed as Medicare considers using these 

groupers to understand physician resource use.

Differences between the groupers. The two groupers we used—Episode 

Treatment Groups (ETGs) and Medstat Episode Groups (MEGs)—differ in 

their logic but also have some similarities. Both groupers use diagnosis codes 

to begin episodes and to assign claims to those episodes. In addition, both 

acknowledge disease severity and complexity when creating episodes. ETGs 

use the presence of specific procedures or comorbidities to further classify 

episodes. MEGs allow a single episode type to be broken into three stages 

based on the progression of the condition. Regardless of their differences, the 

groupers agree on the number of episodes created for most conditions. The 

ETG grouper was able to assign 90 percent of claims to 24 million episodes. 

These claims accounted for 94 percent of total dollars. The MEG grouper 

was able to assign 80 percent of the same sample of claims to 30 million 

episodes. These claims accounted for 96 percent of total dollars.

Risk adjustment. We discuss how risk-adjustment techniques can be used to 

further adjust episodes for overall patient severity. Risk adjustment can be 

used to try to avoid characterizing physicians who predominantly treat sicker 

patients as high resource use physicians compared with those who treat 

healthier patients. 

Attribution. To apply relative resource use tools at the individual physician 

level, one must identify a method for attributing episodes and performance 

on quality indicators to individual physicians. This is not necessarily the 

same as identifying the physician who was actually directing care, but 
Report to the Congress: Increasing the Value of Medicare | June 2006 5

is instead a statistical analysis to identify the physician responsible for 

providing most of the services furnished to a given beneficiary. We found 

that the vast majority of episodes can be attributed to a physician using 

either evaluation and management (E&M) spending or visits. About 90 

percent of our selected episodes could be assigned to one physician who 

billed Medicare for 30 percent of E&M spending in an episode. We also 

tested multiple attribution rules. We found that only 11 percent of episodes 

had multiple physicians providing at least 35 percent of care (measured by 

spending on E&M services). 

The vast majority of quality indicators can also be attributed to one physician 

using attribution rules based on either E&M visits or dollars. About 93 

percent of our quality indicators could be assigned to one physician who 

billed Medicare for 35 percent or more of E&M visits associated with an 

indicator. We also tested multiple attribution rules. We found that only 10 

percent of quality indicators had multiple physicians providing at least 35 

percent of care, as measured by E&M visits.

Variation across MSAs. To better understand variation among different units 

of analysis, we applied the groupers and the quality indicators to 13 MSAs. 

We found that beneficiaries’ use of resources and the quality of their care 

vary across MSAs, but the variance is greater for resource use. Among our 

selected conditions, we saw MSAs where the care provided was 35 percent 

less costly than the national average and MSAs where it was 41 percent more 

costly than the national average on a per episode basis. Quality scores ranged 

from 16 percent lower than the national average to 18 percent higher than 

the national average. Interestingly, we found that certain MSAs known for 

high resource use have low per episode costs for certain types of episodes. 

However, these MSAs have higher resource use when calculated on a per 

capita basis, partly because they tend to have more episodes per patient. 

Performance on the quality indicators shows room for improvement 

nationally. The scores generally clustered around the national average or a 
6 Using episode groupers to assess physician resource use

little above in the MSAs we studied. Performance on different conditions 

also varies within MSAs. In addition, our quality analysis shows that some 

indicators may not be useful because of limited sample size or occurrence. 

Further, how indicators are weighted affects relative MSA scores and 

rankings. In summary, we find that using claims-based quality indicators is 

possible, but a broader set less related to process measures is desirable.

The second step of our analysis (using a 100 percent sample of Medicare 

claims in several geographic regions) will provide information on the 

feasibility of applying episode groupers and quality indicators at the 

individual physician level. Among the issues we will address in the 

upcoming research are the minimum number of episodes or quality 

indicators needed to evaluate a physician’s performance and the application 

of risk-adjustment techniques. Report to the Congress: Increasing the Value of Medicare | June 2006 7

Background

Physicians are central to the delivery of all types of health 

care. Medicare beneficiaries rely on them to diagnose their 

health conditions and to recommend the timing and type 

of services they need. As both expenditures and volume 

of services continue their steep climb, physicians are also 

central to efforts to use Medicare resources as efficiently 

as possible. 

Research on variation in the use of services in Medicare 

implies that physicians and other providers may not 

always be directing resources efficiently. Fisher and 

colleagues (2003) found significant regional variation in 

the amount and type of services beneficiaries receive with 

no discernible difference in quality of care. Some service 

use may not lead to higher quality care and could be 

unnecessary. 

Over the last few years, the Commission has sought a 

greater understanding of the interaction between resource 

use and quality of care, which together define efficiency. 

We have identified quality measures for various providers 

and have recommended their use to distinguish among 

providers for payment purposes (MedPAC 2005). We 

have also explored resource use and found that the private 

sector is using a variety of tools to assess resource use 

by physicians and other providers. Plans use this type of 

information to provide confidential feedback, build tiered 

networks (with lower copayments for patients who see 

more efficient physicians), and create payment incentives 

(with higher payments for more efficient physicians, and 

vice versa). At times, information on resource use is used 

along with information on quality. The goal is generally to 

decrease the costs of care, while maintaining or improving 

quality.

The Commission recommended in March 2005 that CMS 

use Medicare claims data to measure physician resource 

use and share the results with physicians confidentially to 

educate them about how they compare with their peers. 

Episodes of care emerged as a concept in the mid-1980s in 

studies that observed that health care is typically provided 

in a series of separate but related services, and that all 

of these services should be included in a comprehensive 

analysis of health care delivery. An episode of care 

comprises a series of clinically related health care claims 

over a defined time period, such as all claims related to 

a patient’s diabetes (Hornbrook et al. 1985). Episodes 

can comprise all types of health care claims: inpatient 

admissions, physician visits, other outpatient services, and 

prescription drugs. Patients can have multiple episodes 

at any given time, such as concurrent diabetes and 

pneumonia episodes. In recent years, commercial software 

packages have emerged that comb through administrative 

claims data using clinical algorithms to create episodes of 

care. 

We describe our findings from applying two of these 

grouper tools—Episode Treatment Groups (ETGs), 

developed by Symmetry Health Data Systems, and 

Medstat Episode Groups (MEGs), developed by Thomson 

Medstat—to a nationally representative, randomly 

selected 5 percent sample of Medicare claims.1

 We also 

examine a set of claims-based indicators developed by the 

Commission—the Medicare Ambulatory Care Indicators 

for the Elderly (MACIEs)—using the same 5 percent 

sample of claims (MedPAC 2006). 

We applied the ETG and MEG groupers throughout 

the analysis to a 5 percent sample of Medicare claims. 

However, for simplicity some of the findings will be 

presented for MEGs only. We also describe our findings 

from the application of the MACIEs. Our discussion 

focuses on: 

• Broad findings—The number of episodes created, 

the total and average resource use by episode, and 

variation in resource use for each of our selected 

episodes.

• Addressing episode severity and complexity—The 

grouping logic, risk-adjustment mechanisms that sort 

patients into episodes, and relative costs and types of 

services (e.g., inpatient, evaluation and management, 

and post-acute services). 

• Attribution—The ability to attribute episodes and 

quality indicators to individual physicians using 

different assumptions and the type of specialists to 

which episodes and quality indicators are attributed. 

• Resource use and quality performance by region—

The variation in resource use and quality across 

selected MSAs and the drivers of that variation.

Future research will use the lessons learned from these 

analyses to measure and evaluate resource use for 

individual physicians using a 100 percent sample of 

Medicare claims in six selected metropolitan statistical 

areas (MSAs). Using all claims for an area will allow us 

to construct physician caseloads and to determine the 
8 Using episode groupers to assess physician resource use

feasibility of developing overall physician-level indicators 

of resource use and quality of care.

Data and methods

We analyzed a 5 percent sample of Medicare claims 

data for calendar years 2001, 2002, and 2003 with both 

groupers. We used claims from the hospital inpatient, 

hospital outpatient, skilled nursing facility (SNF), home 

health, and physician/supplier (including laboratory 

claims) sectors.2

We do not have any prescription drug claims because 

this analysis is focused on a period prior to the 2006 

implementation of Medicare’s prescription drug benefit. 

Prescription drug costs are an important component 

of total costs for many episodes, and the lack of these 

data may limit our ability to see the whole picture of 

physician performance. However, recent research found 

that even without pharmacy claims, analysis can draw 

valid conclusions about performance for some conditions 

(Thomas 2006a).

Of the 204 million claims processed, the ETG grouper was 

able to assign 184 million (90 percent) of the claims to 24 

million episodes. These claims accounted for 94 percent of 

Medicare payments for the sampled claims. By contrast, 

the MEG grouper was able to assign 163 million (80 

percent) of the same claims to 30 million episodes. These 

claims accounted for 96 percent of Medicare payments for 

the sampled claims. We saw no single identifiable pattern 

among the claims that were not grouped to episodes, 

although many of them were made up of ancillary services 

from the physician and outpatient files. Home health 

records were less likely to be grouped into episodes by 

either grouper. 

We selected only clean episodes (the text box describes 

our methods in more detail) and deleted any outlier 

episodes with unusually high or low values to minimize 

any potential bias in our results. We tested a variety of 

approaches for trimming outliers. For this analysis we 

chose to delete the top and bottom percentile of each 

episode based on total payments—any episode for which 

total payments were greater than the 99th percentile or 

less than the 1st percentile. We also deleted any episode 

for which total payments were less than $30.3

 We chose 

this method because it removed extremely high and low 

outliers while not reducing sample size excessively.

Standardized payments

We standardized payments to help compare the resources 

in each episode. Standardizing excludes variation in 

resource costs due to geographic differences in input 

costs or policy considerations (e.g., teaching payments). 

Construction of episodes

Not all episodes are suitable for further analysis. 

Both of the groupers we used—Episode 

Treatment Groups and Medstat Episode 

Groups—rely on the use of a clean period to determine 

when an episode is started and finished. If an individual 

does not have a claim related to a specific episode for a 

specific period of time, then the episode is closed and 

considered to have a clean finish. These clean periods 

can vary in length from 30 days for certain acute 

episodes to 365 days for chronic conditions. 

Strictly speaking, chronic conditions by their very 

nature have no clean period, but for analytic purposes, 

both groupers close chronic episodes after 365 days. 

Complete episodes are identified by looking both 

backwards and forwards around the window of the 

claims under analysis. In this analysis, we look at 

claims six months prior and subsequent to our analysis 

window to identify complete episodes. If an episode did 

not have a clean start or a clean finish, it was deleted 

from our analysis. 

It is also important to note that episodes for a specific 

beneficiary can overlap. For example, a beneficiary 

with a 365-day chronic episode of coronary artery 

disease can also have a shorter episode of sinusitis 

within that same time frame. However, the costs from 

any given claim can only be assigned to one episode. 

Clinical algorithms decide to which episode claims 

will be assigned, particularly for patients with multiple 

chronic conditions. Report to the Congress: Increasing the Value of Medicare | June 2006 9

For example, Medicare will pay a community hospital 

in a rural area that is discharging a patient treated for a 

stroke less than a major teaching hospital in an urban area 

because of differences in the wage index, disproportionate 

share, and indirect and direct graduate medical education 

(IME/GME) payments. For this analysis, we want a 

hospital admission for stroke in all areas to have the 

same payment rate. We then can focus on the underlying 

differences in resource use due to utilization rates and 

practice patterns. 

Payment rates in some settings were easier to standardize 

than in others. For inpatient prospective payment system 

(PPS) hospitals, it was a relatively straightforward task to 

link each diagnosis related group (DRG) to the appropriate 

standardized base payment and then multiply by the 

weight for that DRG. For physician claims, we matched 

the line item on the physician claim to the physician fee 

schedule relative value file and multiplied by a conversion 

factor.

We also developed ways of addressing differences in 

payment formulas that are more difficult to standardize. 

Among these are laboratory payments and payments under 

the SNF PPS. For a more detailed description of how 

payments were standardized, see the text box on page 25.

Selected conditions 

Because each grouper classifies claims into more than 500 

discrete episodes, assessing resource use using all episodes 

from both groupers would be overwhelming. For this 

exploratory analysis, we focused on a subset of conditions 

particularly relevant to the Medicare population, 

including both acute and chronic conditions. Using 

both groupers, we chose the subset of conditions based 

on their prevalence, total and per beneficiary resource 

use, variation in resource use within episodes, and the 

availability of MACIE quality indicators. 

There is considerable agreement among ETGs and MEGs 

on the most prevalent and costly conditions among the 

Medicare population: coronary artery disease (CAD), 

hypertension, diabetes, chronic obstructive pulmonary 

disease, stroke, and congestive heart failure (CHF). Both 

groupers assign most of these conditions to the top decile 

for total resource use and prevalence. The results of the 

two groupers overlap less for conditions that occur less 

frequently. Though we have selected a mix of chronic 

and acute conditions, the labels chronic and acute can be 

misleading. Many patients with chronic conditions can 

have acute events. Patients with CAD have heart attacks 

and patients with cerebral vascular disease have strokes. 

There is also overlap among episodes. Patients with yearlong CHF episodes can have episodes for other conditions 

in the same time period.

We also determined whether the MACIEs include quality 

measures for these episode types. We often have quality 

measures for chronic conditions. The text box on p. 10 

describes our quality measures in greater detail. Some 

episodes have no corresponding quality measures, and 

other episodes need to be combined to be compared to 

quality indicators for a specific condition. For example, 

the MACIEs make no distinction between type 1 and type 

2 diabetes, yet the ETG and MEG groupers sort patients 

into different episodes on this basis. 

Results

In this section, we describe the results of applying the 

groupers to the selected conditions for several analytic 

purposes. To provide a context for the results of the 

analysis, we first describe how the groupers differ in how 

they assign claims to episodes. We then describe how the 

groupers address patient severity and complexity. For 

simplicity we describe most findings solely from MEGs, 

but we did conduct parallel analyses using ETGs. 

As we used two different groupers on the same set of 

claims, we could see whether they grouped claims in 

similar or different ways. This comparison allows us to 

begin to identify differences and similarities in grouper 

logic. Both groupers use diagnosis codes to begin episodes 

and assign claims to those episodes. Both groupers 

distinguish clinical conditions in terms of patient severity 

and complexity. ETGs use the presence of specific 

procedures or comorbidities to create distinct episodes. 

MEGs allow selected episodes to be broken into three 

stages based on the progression of the condition. In some 

cases, the types of episodes created by each grouper for 

the same disease differ. For example, MEGs have two 

diabetes episodes, one each for type 1 and type 2 diabetes. 

However, ETGs have six episodes for diabetes: types 1 and 

2 diabetes with and without comorbidities and diabetic 

retinopathy with and without comorbidities. ETGs have 

up to 15 different episodes for CAD, depending on the 

progression of the disease and the procedures performed, 

whereas MEGs have a single episode. MEGs, however, 

address severity by stage of disease, such as breaking a 
10 Using episode groupers to assess physician resource use

CAD episode into three stages depending on the severity 

of the condition.4

For certain conditions the two groupers agree fairly well 

on the number of episodes created. For example, ETGs 

create 74,045 CHF episodes and MEGs create 78,124 

CHF episodes with the sample of claims in our analysis 

(Table 1-1). Similarly, ETGs create 458,212 hypertension 

episodes compared with 415,151 created by MEGs. The 

largest difference among our selected conditions is for 

urinary tract infections in which ETGs create 137,684 

episodes, 29 percent more than the 106,900 created by 

MEGs. 

The two groupers also vary on the number of dollars they 

allocate to these episodes. In general, ETGs have higher 

(sometimes substantially higher) average total payments 

per episode. Average per episode payments for CHF in 

ETGs ($3,161) are more than twice those for MEGs 

($1,394). Similarly, average per episode payments for 

Medicare Ambulatory Care Indicators for the Elderly

For the physician resource use analysis, we used 

the Medicare Ambulatory Care Indicators 

for the Elderly (MACIEs) to measure quality. 

The MACIEs were developed to assist in analyzing 

Medicare quality and access using measures that were 

clinically meaningful and could feasibly be analyzed 

from claims data. In May 2004, the Commission 

convened an expert panel of physicians, clinicians, 

and researchers to review and update the original 

set. The experts reviewed clinical evidence from 

existing guidelines, other organizations’ efforts using 

ambulatory indicators, and the limits of claims data. 

The indicators were revised to reflect this review. 

The MACIEs are designed to reflect basic clinical 

standards of care for common medical diagnoses. 

They focus on two types of measures: the percentage 

of beneficiaries who 1) receive necessary services 

for their diagnoses and 2) have potentially avoidable 

hospitalizations directly related to their diagnoses. 

Necessary services are defined as routine care that has 

benefits that outweigh risk, that has benefits that are 

likely and substantial, and that physicians have judged 

improper not to recommend. Measures of potentially 

avoidable hospitalizations include use of emergency 

department services and inpatient hospitalizations that 

might have been averted had patients received better 

ambulatory care. 

For the MACIEs, we selected medical conditions 

that are prevalent among the elderly population, have 

effective medical treatment available, and are readily 

identifiable from diagnoses codes on Medicare claims.

Our physician resource use analysis used the MACIE 

set to measure the quality of care for beneficiaries 

with breast cancer, colon cancer, coronary artery 

disease, diabetes, congestive heart failure, depression, 

hypertension, chronic obstructive pulmonary disease, 

and stroke. 

The MACIEs reflect minimum standards of acceptable 

care for certain diagnoses. For example, they include 

lipid testing for people with coronary artery disease. 

The MACIEs are not intended to show optimal care and 

can not account for reasons why patients do not receive 

necessary care. Needed services may not be provided 

for a number of reasons, including problems accessing 

the health care system, failure of providers to perform 

or recommend services, or failure of beneficiaries to 

follow provider recommendations. 

The MACIE data analysis requires two years of claims 

data for each beneficiary cohort in order to check for 

service use within a specified amount of time (e.g., 

eye exam within a two-year period for diabetics). 

Therefore, the data set is restricted to the population 

of beneficiaries who were continuously in Medicare 

fee-for-service during the two-year study period. 

Beneficiaries were excluded from the data set if they 

died, were newly enrolled in Medicare, used hospice 

care, or were in managed care plans during the study 

period. Beneficiaries younger than age 65 were also 

excluded from the sample. For purposes of this chapter, 

we tracked these quality indicators at the national and 

the metropolitan statistical area levels. Report to the Congress: Increasing the Value of Medicare | June 2006 11

type 1 diabetes in ETGs ($1,798) are more than two times 

that for MEGs ($833).

Other conditions have more similar average per episode 

payments. For example, there is relatively little difference 

in average per episode payments for breast cancer ($2,400 

for ETGs vs. $2,341 for MEGs) and for cerebrovascular 

disease ($2,811 for ETGs vs. $2,743 for MEGs).

These differences warrant further investigation. We should 

expect some differences between the groupers as each 

uses proprietary clinical algorithms to assign claims to 

episodes. The clinical logic of the groupers often drives the 

differences. For example, the MEG grouper treats CHF not 

as a disease but as a symptom of many different diseases. 

The ETG grouper retains CHF in a distinct episode and 

does not distribute CHF services to other episodes. In the 

MEG grouper, CHF is classified as a comorbidity in 40 

other episodes; about 20 percent of all patients with CHF 

were found in these other episodes. The fact that these 

costs are distributed among a variety of episode types 

by MEGs could be one of the reasons that payments for 

MEG CHF episodes are lower on average than those for 

ETG CHF episodes. Medstat has found that average costs 

for CHF patients in non-CHF episodes are higher than 

for those in CHF episodes, and that these episodes tend 

to have higher proportions of hospital inpatient dollars 

than CHF episodes. We found a similar result when we 

examined costs by type of service within CHF episodes 

in the ETG and MEG groupers: ETG CHF episodes had 

a higher proportion of dollars attributable to hospital 

inpatient stays than MEG CHF episodes.

We will continue to examine differences between the two 

groupers in more detail for the 100 percent analysis. In 

addition, CMS is analyzing at least two of the available 

groupers to determine their characteristics when applied 

to the Medicare population. The focus of its analysis is on 

how the groupers work on this population, recognizing that 

many beneficiaries have multiple conditions that overlap 

in time. CMS will be analyzing, in detail, differences 

among the groupers in both output and clinical logic for 

selected important conditions.5

Addressing episode severity and 

overall patient complexity

An important question about episode groupers is 

whether they account for the underlying health status 

of beneficiaries. Some researchers and physicians are 

TABLE

1–1 Medicare claims classified into MEGs compared with ETGs

MEGs ETGs

Condition

Number of 

episodes

Total spending 

(in millions)

Average 

spending

Number of 

episodes

Total spending 

(in millions)

Average 

spending

Coronary artery disease 201,936 $622 $3,079 233,673 $934 $3,998 

Bacterial pneumonia 74,890 332 4,427 68,704 210 3,054 

Cerebrovascular disease 107,561 295 2,743 90,630 255 2,811 

Essential hypertension 415,151 175 423 458,212 215 469 

Congestive heart failure 78,124 109 1,394 74,045 234 3,161 

Urinary tract infections 106,900 89 830 137,684 72 521 

Diabetes:

Type 1 34,196 28 833 54,348 98 1,798 

Type 2 157,337 83 526 142,106 90 636 

Cholecystitis and cholelithiasis 16,959 77 4,549 19,970 85 4,261 

Cancer:

Prostate 47,211 67 1,410 34,484 80 2,330 

Breast 23,421 55 2,341 28,753 69 2,400 

Peptic ulcer disease 19,896 34 1,724 23,870 53 2,216 

Sinusitis 78,520 12 158 90,827 21 230 

Note: MEG (Medstat Episode Group), ETG (Episode Treatment Group).

Source: MedPAC analysis of 5 percent sample of Medicare claims using ETG and MEG episode groupers.
12 Using episode groupers to assess physician resource use

concerned that differences in health status among patients 

may influence treatment costs within episodes, and that 

the average health status of patients may differ among 

physicians (Thomas 2006b). Without adjusting for risk, 

physicians who care for less severely ill patients may look 

more efficient than those who care for more severely ill 

patients. 

The groupers we used have two separate mechanisms for 

addressing patient severity. First, they use severity in the 

logic used to group claims. Second, each has developed a 

method to risk adjust the episode information based on the 

overall health status of the beneficiary. 

Grouping logic

The logic embedded in ETGs and MEGs is designed 

to create episodes that make it possible to compare 

similar patients. ETGs create separate types of episodes 

for patients with the same underlying condition by 

distinguishing among patients with procedures or 

comorbidities that might affect the costs of their care 

TABLE

1–2 Variation in number and distribution of selected episodes, 2002

Episodes Payments

Episode group Stage Number Percent

Total 

(in millions)

Percent 

of total Average CV

Coronary artery disease 1 134,501 67% $140 22% $1,037 262

2 28,354 14 152 24 5,361 143

3 39,081 19 330 53 8,450 109

Total 201,936 100 622 100 3,079 202 

Essential hypertension 1 306,789 74 84 48 273 173

2 55,757 13 24 14 426 154

3 52,605 13 68 39 1,292 146

Total 415,151 100 176 100 423 210 

Colon cancer 0 1,764 13 1 1 648 247

1 248 2 0 0 1,441 228

2 9,714 70 47 57 4,874 155

3 2,192 16 35 41 15,750 62

Total 13,918 100 83 100 5,990 145 

Type 1 diabetes 1 20,015 59 8 27 377 275

2 11,883 35 14 48 1,140 219

3 2,298 7 7 26 3,213 127

Total 34,196 100 29 100 833 253 

Type 2 diabetes 1 101,751 65 38 46 371 156

2 48,374 31 33 40 691 150

3 7,212 5 12 14 1,612 129

Total 157,337 100 83 100 526 173 

Peptic ulcer disease 1 10,859 55 6 17 532 229

2 8,621 43 25 74 2,946 129

3 416 2 3 9 7,541 74

Total 19,896 100 34 100 1,724 182 

Note: CV (coeffi cient of variation). Outlier episodes have been removed. All episodes in the table started in 2002. Values may not sum to total due to rounding.

Source: MedPAC analysis of 5 percent sample of Medicare claims using Medstat Episode Group grouper.
Report to the Congress: Increasing the Value of Medicare | June 2006 13

for that specific episode. For example, prostate cancer 

episodes are divided into those with and without surgery 

(Symmetry 2005). MEGs generally use a single episode 

per condition but incorporate a concept known as disease 

staging that addresses the severity of that condition. The 

disease staging logic employed by the MEG grouper 

subdivides most episodes into three different disease 

severity categories.6 This allows us to examine the amount 

of resources directed toward treating a condition as it 

progresses. Not surprisingly, as a disease becomes more 

severe the treatment costs increase (except for the late 

stages of some diseases when reduced treatment options 

may result in decreased costs). This is consistent with 

other research showing that a small percentage of seriously 

ill patients account for a disproportionate percentage of 

Medicare spending (MedPAC 2004). For example, while 

stage 3 CAD episodes account for only 19 percent of all 

such episodes, they account for 53 percent of all CAD 

episode dollars (Table 1-2). Similarly, stage 3 colon cancer 

episodes account for only 16 percent of episodes, but 41 

percent of episode dollars. 

Examining the amount of variation within each stage of an 

episode can provide an indication of variation in practice 

patterns. Stage 3 episodes, while being more expensive 

on average, exhibit less variation than stage 1 and stage 

2 episodes. The coefficient of variation (CV) for stage 3 

CAD is 109 percent compared with 262 percent for stage 

1 CAD. Similarly, the CV for stage 3 peptic ulcer disease 

is less than one-third of the variation of stage 1 (74 percent 

vs. 229 percent). This could be because care for sicker 

patients, while more resource intensive, is potentially more 

clearly defined than care for individuals with less severe 

manifestations of the condition. However, the difference 

in variation among episode stages is less pronounced 

for some chronic conditions, such as type 2 diabetes and 

hypertension.

Risk adjustment 

Both the ETG grouper and the MEG grouper have 

additional capabilities that can be used to risk adjust 

episodes.7

 Risk adjustment can account for differences in 

health status that go beyond a particular disease that the 

episode grouper is trying to capture. The ETG software 

uses a companion product known as episode risk groups, 

which employs the same underlying methodology as 

ETGs. The software classifies a patient by episode and 

then looks at a person’s age, gender, and mix of episodes to 

create a clinical and demographic risk profile. Using this 

risk profile, the software computes both a retrospective 

and prospective risk score for each person.

The MEG grouper employs the diagnostic cost group 

(DCG) method, which uses the conditions and diseases 

for which a person receives treatment over a specified 

period of time (usually one year), and the person’s age and 

gender. The model estimates the level of expected cost in 

a given year as a function of medical problems treated in 

that year and creates a relative risk score (RRS) (Thomson 

Medstat 2005). Combined with the disease staging 

approach, researchers can segment episodes according to 

both episode severity and patient complexity (sample size 

permitting). 

The DCG/RRS approach can further refine comparisons 

within and across episodes. Ultimately, it also allows for 

the construction of an overall risk score for a physician’s 

caseload of patients. As described earlier, CAD episodes 

have overall average resource use of $3,079 (Table 1-2). 

However, using the DCG/RRS risk-adjustment technique, 

each CAD episode stage can be further subdivided into 

five categories of overall patient complexity, ranging 

from 1 (low complexity) to 5 (high complexity). Average 

resource use increases as patient complexity increases. 

Average resource use for stage 1 CAD episodes with a 

relative risk score of 1 is $564, while average resource use 

for stage 3 CAD episodes with a relative risk score of 5 is 

$11,509 (Table 1-3, p. 14).

Types of services

To learn more about what drives the overall resource 

use in these episodes and how resource use may vary by 

the severity of the condition, we divided all payments 

associated with an episode into types of services (Table 

1-4, p. 15).8

 For example, 64 percent of total CAD episode 

dollars are spent in an inpatient setting compared with 

only 4 percent for sinusitis episodes and 35 percent for 

CHF episodes. For those with stage 1 CAD, dollars are 

far more concentrated in imaging than they are in the two 

higher stages of severity. Table 1-4 (p. 15) also shows how 

important evaluation and management (E&M) services are 

to beneficiaries with chronic conditions such as diabetes, 

hypertension, and sinusitis. For example, E&M services 

for beneficiaries with stage 1 diabetes (types 1 and 2) 

represent 52 and 62 percent of the spending for their 

episodes, respectively.9
14 Using episode groupers to assess physician resource use

Attributing episodes to physicians

One of the main goals of grouping claims into episodes 

is to attribute episodes to physicians and to ultimately 

identify efficient physicians.10 In this analysis we do 

not have a full picture of any one physician’s patient 

panel; therefore, we can not assess any one individual 

physician’s resource use. Nonetheless, in preparation for 

future analyses that will measure individual physicians, we 

applied a variety of attribution rules to this database. We 

looked at how many episodes could be linked to physicians 

using various attribution methods. The goal is to identify 

a single physician who provides a significant portion of a 

beneficiary’s care for a given episode. 

Some plans, such as health maintenance organizations 

(HMOs), formally assign patients to a provider so 

attribution is relatively straightforward. However, in 

other private plan arrangements and the Medicare 

fee-for-service (FFS) program, patients have greater 

freedom to see any physician. This makes attribution less 

straightforward. Identifying an individual physician who 

sees the patient for a significant portion of his or her care 

has to be determined by patterns in claims data. For a 

discussion of attribution issues, see text box on page 16.

Attribution to physicians is also necessary to determine 

performance on quality indicators. We determined quality 

scores using an attribution logic independent of the logic 

used to associate episodes to physicians. It is not always 

possible to attribute quality indicators with specific 

episodes of care. Separate attribution is also consistent 

with private sector efforts to measure resource use and 

quality. Typically, resource use episodes are created and 

attributed to physicians, then physicians are compared to 

a peer group. At the same time, quality scores are created 

and attributed to physicians, then the scores are compared 

to a peer group. While we would expect overlap between 

the patients attributed to a physician for resource use and 

quality, the quality indicators are not generally tied to 

specific episodes. 

We attributed episodes to physicians using E&M codes 

to avoid giving too much weight to procedures or 

hospitalizations. Through claims, we can identify the 

number of visits beneficiaries had with a physician and 

the amount of dollars associated with those visits. We 

also looked at how our results shifted if episodes could be 

assigned to more than one physician. 

Our main focus was to evaluate how many episodes we 

could assign to physicians using different attribution 

methods and the type of specialty to which they were 

assigned. A broader question is the appropriateness of 

using the same attribution method across episodes and 

quality indicators that may differ significantly from each 

other (either clinically or in terms of resource use). A 

uniform attribution approach may not fit all episodes. 

Our analysis found that the key factor in attributing 

episodes to physicians is the threshold for attribution. 

Less important was the choice of dollars versus visits or 

whether to use all E&M services or just those furnished 

outside of a hospital. 

While this analysis is primarily focused on technical 

approaches to attribution, further discussion is needed on 

TABLE

1–3 Average episode costs rise with disease severity

 and overall patient complexity, 2002

Complexity level

Severity stage 1 2 3 4 5

Congestive heart failure 3 $1,002 $1,351 $1,611 $1,895 $2,070 

Coronary artery disease 1 564 1,312 1,833 1,944 1,944

2 3,051 7,028 8,072 8,484 8,484 

3 5,067 7,860 10,596 11,509 11,509 

Source: MedPAC analysis of 5 percent sample of Medicare claims using Medstat Episode Group grouper.
Report to the Congress: Increasing the Value of Medicare | June 2006 15

the extent to which accountability should be derived from 

these types of attribution rules. In a payment system as 

fragmented as Medicare FFS, a physician with 30 percent 

of the E&M visits in a given episode may not necessarily 

be aware of the kind of care being provided in the other 

E&M visits. For some episodes, meaningful accountability 

might rest with a single physician, while accountability 

for other episodes might rest with a team of physicians. 

In some instances, the cooperation of a hospital and its 

physicians may be important for efficiency. 

Resource use attribution

We found that more episodes can be attributed to a 

physician as the thresholds for attribution are lowered. 

We also found that as the thresholds are lowered, any 

differences between the use of E&M dollars versus E&M 

visits to determine attribution largely disappear. Seventyfive percent of the episodes we selected could be attributed 

to a physician when using a threshold of 50 percent of 

E&M visits to identify the physician versus 82 percent 

of the episodes when we use a threshold of 50 percent of 

TABLE

1–4 Episode costs are driven by different mixes of services, 2002

Percentage of episode costs, by type of service

Episode 

group Stage

Average 

payment Inpatient E&M

Post-acute

care Procedures Imaging Tests Other

Coronary artery 

disease 1 $1,037 32% 20% 5% 8% 19% 7% 9%

2 5,361 67 8 1 10 6 2 5

3 8,450 76 7 3 7 3 1 2

Total 3,079 64 10 3 8 8 3 4

Essential 

hypertension 1 273 8 68 4 2 5 13 1

2 426 12 60 3 2 10 11 2

3 1,292 60 24 4 2 4 4 3

Total 423 28 50 4 2 5 9 2

Congestive heart 

failure 3 1,394 35 31 13 3 10 5 2

Total 1,394 35 31 13 3 10 5 2

Type 1 diabetes 1 377 12 52 23 3 1 9 1

2 1,140 55 21 8 9 1 4 3

3 3,213 73 12 7 4 0 2 2

Total 833 48 27 12 6 1 5 2

Type 2 diabetes 1 371 9 62 4 2 2 20 2

2 691 21 48 3 8 1 15 5

3 1,612 53 29 3 5 1 7 3

Total 526 20 52 4 5 2 16 3

Sinusitis 1 153 4 64 0 15 9 5 3

2 402 5 34 0 34 13 5 9

3 428 15 36 0 26 15 4 4

Total 158 4 62 0 16 10 5 3

Note: E&M (evaluation and management). Outlier episodes have been removed. 

Source: MedPAC analysis of 5 percent sample of Medicare claims using Medstat Episode Group grouper.
16 Using episode groupers to assess physician resource use

E&M dollars to identify the physician. Using a threshold 

of 30 percent of E&M dollars or E&M visits allows 

90 percent of our selected episodes to be assigned to a 

provider. The share of episodes that can be attributed using 

a 30 percent threshold varies by condition—it ranges from 

a low of 71 percent for cerebrovascular disease episodes to 

a high of 96 percent for sinusitis episodes (Table 1-5).

To understand how hospitalizations affect episode 

attribution, we also restricted the analysis to dollars and 

visits associated with noninpatient settings. Using this 

approach, 86 percent of all episodes could be attributed 

to a physician who had 30 percent or more of the 

noninpatient E&M visits or noninpatient E&M dollars 

in the episode, compared to 90 percent of episodes if 

dollars and visits were not restricted to those that occurred 

in a noninpatient setting. The decrease in the number of 

attributed episodes is most pronounced in episodes that 

have a high proportion of inpatient dollars, such as peptic 

ulcer disease, depression, and choleocystitis (data not 

shown). The decrease is less pronounced for episodes that 

use a lower proportion of inpatient dollars, such as type 2 

diabetes and essential hypertension (Table 1-5).

We also explored multiple attribution, or assigning an 

episode to more than one physician. We found that for 

most episodes a single physician tends to be dominant in 

the provision of care (Table 1-5). Using single attribution 

and a 35 percent threshold of all E&M visits, 88 percent 

of our selected episodes could be attributed to a physician. 

Using the same threshold but permitting an episode to be 

assigned to any physician meeting the threshold results 

in 78 percent of selected episodes still being assigned to 

a single physician. The remaining 10 percent of episodes 

could be assigned to more than one physician using 

a multiple attribution approach.11 The proportion of 

episodes assigned to more than one physician ranged from 

a low of 7 percent for several conditions to a high of 11 

percent for CAD episodes. 

Attribution issues

Some issues involved in determining the appropriate 

approach for assigning episodes include:

• Is the attribution method conceptually valid? It must 

be defensible and accepted by payers, providers, and 

other users of the information.

• What is the appropriate unit of measurement? Using 

dollars may more accurately reflect the intensity 

of services provided, whereas the number of visits 

might better identify the physician who had the 

greatest involvement in managing a patient’s care.

• What type of dollars or visits should be counted 

in determining attribution? Should all dollars be 

counted in determining attribution? An approach 

like this might result in certain specialists and 

surgeons being assigned episodes for which they had 

relatively little control, but were attributed a majority 

of dollars due to the need for surgery or some other 

resource intensive intervention. Dollars associated 

with evaluation and management (E&M) visits 

might be a better indicator of physician involvement 

in an episode. Even if E&M dollars are used, should 

all physician E&M claims be used, including 

E&M claims that occur while a beneficiary is 

hospitalized?

• What is the appropriate threshold of dollars or visits 

to use? The higher a threshold is set the less likely 

it is to be assigned to a physician. Using a lower 

threshold might result in an episode being attributed 

to a provider who had less involvement in a 

patient’s care.

• What is the best attribution method? Multiple 

attribution recognizes that more than one physician 

may have been involved in managing the resources 

and quality of care. However, such an approach may 

work more effectively when physicians work within 

structured networks. Different attribution methods 

may be needed for different types of episodes. Report to the Congress: Increasing the Value of Medicare | June 2006 17

We examined the types of specialties to which the episodes 

were attributed. In general, episodes were attributed to 

specialties one would expect to be associated with care for 

that condition. For example, 38 percent of CAD and 20 

percent of CHF episodes are attributed to cardiologists, 

64 percent of prostate cancer episodes are attributed to 

urologists, 21 percent of peptic ulcer disease episodes 

are attributed to gastroenterologists, and 39 percent of 

breast cancer episodes are assigned to oncologists using 

a threshold of 35 percent of all E&M dollars (data not 

shown). 

Quality indicator attribution

We attribute responsibility for performance on conditionspecific quality indicators to the physician most 

likely to be managing the beneficiary’s care for that 

condition. We used a year of claims for the condition 

for which the beneficiary was eligible for the indicator 

(the denominator). For example, attributing care for 

beneficiaries with diabetes using a 35 percent threshold of 

E&M dollars means that we identified a single physician 

who billed the Medicare program for 35 percent or 

more of the E&M dollars for care of that beneficiary’s 

diabetes.12

We find a similar ability to attribute quality indicators 

using these various methods as we do for resource use 

(Table 1-6, p. 18). The care on these quality indicators for 

the vast majority of beneficiaries can be attributed to a 

single physician. The lower the threshold, the more care 

can be attributed to one physician. We also find that using 

E&M visits instead of dollars results in a small increase in 

the ability to attribute care to a single physician. 

TABLE

1–5 Most episodes can be attributed to one physician, 2002

Percentage of episodes

Attribution rule

All selected 

episodes CAD

Essential 

hypertension

Type 1 

diabetes

Type 2 

diabetes Sinusitis

Cerebrovascular 

disease

Percentage of E&M visits:

30% 90% 86% 94% 91% 95% 96% 71%

35% 88 83 93 90 93 95 68

40% 86 81 92 89 92 94 65

50% 75 69 85 81 81 88 53

Percentage of noninpatient 

E&M visits:

30% 86 81 92 85 93 95 65

Percentage of E&M dollars:

30% 90 86 94 91 96 96 71

35% 89 85 94 91 95 95 69

40% 87 82 93 90 93 95 66

50% 82 77 90 87 89 93 60

Multiple attribution based 

on visits:

35%

1 doctor 78 73 86 82 84 88 60

2 doctors 10 11 7 8 10 7 9

Total 88 84 93 90 94 95 69

Number of episodes 1,671,638 201,936 415,151 34,196 157,337 78,520 107,561

Note: E&M (evaluation and management), CAD (coronary artery disease).

Source: MedPAC analysis of 5 percent sample of Medicare claims using Medstat Episode Group grouper.
18 Using episode groupers to assess physician resource use

As with the resource use analysis, shifting the percentage 

thresholds does shift the number of beneficiaries able to 

be attributed for each indicator. For example, we find that 

with a 35 percent threshold of visits, care for 93 percent 

of beneficiaries across the conditions can be attributed to 

a single physician. This percent decreases to 74 percent 

of beneficiaries when the threshold is raised to 50 percent 

of visits. The ability to identify a single physician who 

manages beneficiary care also varies within a set of 

condition-specific indicators. For example, across all eight 

CHF indicators the average percentage of beneficiaries 

able to be attributed to a single physician using 35 percent 

of E&M dollars is 89 percent. We are able to attribute 

six of eight indicators for CHF care to a single physician 

for 90 percent to 93 percent of the beneficiaries using 35 

percent of E&M dollars (data not shown). However, we 

can only attribute 78 percent of the beneficiaries on the 

other two CHF indicators. 

We examined whether using only noninpatient E&M visits 

would affect attribution. As was the case in our resource 

use analysis, we found that slightly fewer beneficiaries 

could be attributed to a single physician using noninpatient 

E&M claims (data not shown). We also explored multiple 

attribution and again found results similar to our resource 

use analysis. When we applied a multiple attribution rule 

of 35 percent of E&M visits across all quality indicators, 

only 10 percent of beneficiaries were attributed to more 

than one physician across our selected conditions.

As was the case for resource use, we found that care for 

the quality indicators tends to be attributed to specialties 

one would associate with the specific condition. We 

also found that the same type of specialties tend to be 

responsible for both resource use and quality for the 

condition. For example, the top three types of specialties 

to which quality of care for beneficiaries with CAD is 

attributed are cardiology, internal medicine, and family 

practice. These are the same as the top three types of 

specialties to which CAD episodes in the resource use 

analysis are attributed (data not shown). 

Comparison of resource use and quality 

across MSAs 

To better understand how relative resource use and 

quality vary across different units of analysis, we applied 

the groupers and the quality indicators to our 5 percent 

sample in 13 MSAs. We chose 13 large MSAs to achieve 

the widest geographic distribution possible. We observed 

variations in both resource use and quality by MSA and 

identified technical issues that may need to be addressed 

before we apply episode grouping approaches or quality 

indicators to individual physicians.

TABLE

1–6 Most beneficiaries eligible for quality indicators

 can be attributed to one physician

Percentage of benefi ciaries with condition

Attribution rule All indicators CHF CAD Diabetes COPD Stroke

Percentage of:

E&M visits

35% 93% 92% 92% 93% 95% 90%

50% 74 74 70 74 80 64

E&M dollars

35% 89 89 88 89 92 85

50% 72 73 68 72 78 62

Note: CHF (congestive heart failure), CAD (coronary artery disease), COPD (chronic obstructive pulmonary disease), E&M (evaluation and management). The percentage 

of benefi ciaries whose care was attributed for each condition is based on an average across all condition-specifi c indicators. The all indicators column is an 

average across all indicators, including several conditions not shown in the chart.

Source: MedPAC analysis using the Medicare Ambulatory Care Indicators for the Elderly on a 5 percent sample of 2002 Medicare claims.
Report to the Congress: Increasing the Value of Medicare | June 2006 19

Variation in resource use by MSA

Research shows that the amount and type of services 

beneficiaries receive vary significantly from region to 

region (Fisher et al. 2003). Looking at resource use from 

the perspective of an episode of care, will areas that 

are high resource use on a per capita basis also be high 

resource use on a per episode basis? It is important to 

note that episode groupers have rarely, if ever, been used 

to measure relative resource use across different regions. 

Because of the fragmented nature of health insurance 

coverage for the nonelderly population, many different 

health insurance companies can insure the population of 

any given area. In using episode groupers, most plans try 

to assess the relative resource use of physicians in their 

network, not resource use relative to other physicians in 

the same market area or different markets.

We examined resource use for a subset of episodes by 

calculating average per episode costs for the providers in 

each MSA and nationally.13 We then calculated ratios of 

each MSA’s average episode cost to the national average 

(Table 1-7). Resource use across episodes varied markedly 

with relative resource ratios ranging from 0.65 (lower than 

average) to 1.41 (higher than average), depending on the 

type of episode. At first glance the results seem similar to 

previous studies that have focused on per capita spending. 

MSAs that other research has shown to use more resources 

than average (e.g., Miami, Detroit, and Houston) have 

resource use ratios of more than 1 for many episodes. 

Others that use fewer resources than average (e.g., 

Minneapolis and Denver) have resource use ratios 

of less than 1 on many episodes. 

Miami has higher-than-average resource use ratios for 

type 1 and type 2 diabetes (1.06 and 1.28, respectively), 

while Minneapolis has lower-than-average ratios (0.72 and 

0.88, respectively). Similarly, Miami’s relative resource 

use ratio for hypertension is 1.20 compared to 0.87 for 

Minneapolis.

However, for certain conditions the results are more 

surprising. Miami has a relative resource use ratio of 0.66 

for CAD, while Minneapolis has a ratio of 1.28.

We conducted several additional analyses to better 

understand what was driving such a large difference in 

per episode resource use costs for CAD between the 

TABLE

1–7 Relative resource use ratios for selected MSAs, 2002

CHF CAD

Type 1 

Diabetes

Type 2 

Diabetes

Breast 

cancer Hypertension Pneumonia

National average 

episode costs $1,394 $3,079 $833 $526 $2,341 $423 $4,427

MSA

Boston 1.00 0.86 0.99 0.95 0.86 0.96 0.96

Chicago 1.05 1.04 1.13 1.17 1.06 1.14 1.11

Denver 0.91 1.03 1.04 0.96 1.24 0.92 1.04

Detroit 0.90 0.79 1.07 1.08 0.94 1.15 0.91

Greenville 0.91 1.24 1.21 0.91 1.02 0.87 0.80

Houston 1.16 1.04 1.13 1.16 1.02 1.20 1.11

Kansas 1.31 0.98 0.96 0.99 0.79 1.13 0.96

Miami 0.99 0.66 1.06 1.28 0.82 1.20 1.16

Minneapolis 1.00 1.28 0.72 0.88 1.14 0.87 0.76

New York 0.86 0.65 1.41 1.11 1.01 1.13 1.12

Orange County 1.01 0.76 1.17 1.31 0.98 1.00 1.03

Philadelphia 1.11 0.78 1.09 1.07 0.81 1.05 1.08

Phoenix 0.81 0.91 0.95 1.05 1.08 0.94 0.78

Note: MSA (metropolitan statistical area), CHF (congestive heart failure), CAD (coronary artery disease). Relative resource use scores for individual MSAs are calculated 

by dividing the MSA’s average for a given episode by the national average for that episode. A score of more than 1.0 indicates higher-than-average episode costs 

and a score of less than 1.0 indicates lower-than-average episode costs.

Source: MedPAC analysis of 5 percent sample of Medicare claims using Medstat Episode Group grouper.
20 Using episode groupers to assess physician resource use

Minneapolis and Miami MSAs. The results of the analyses 

indicate that it may be helpful to combine per episode 

approaches to resource use with per capita approaches. 

While beneficiaries in Miami have significantly lower 

per episode costs than beneficiaries in Minneapolis 

for CAD, they are also more likely to have more total 

episodes (including non-CAD episodes) than beneficiaries 

in Minneapolis (11 vs. 8) (Table 1-8). In particular, 

beneficiaries in Miami were more likely to be diagnosed 

and coded with other cardiovascular episodes such as 

varicose veins or tibial, iliac, femoral, or popliteal artery 

disease. Some of the costs of care for these beneficiaries 

may be captured in these other episodes in Miami, 

therefore lowering the costs of their concurrent CAD 

episodes. 

Additionally, when we look at total spending across 

all episodes for beneficiaries with a CAD episode in 

each MSA, the difference between the two areas all but 

disappears. Per beneficiary Medicare spending across all 

episodes for beneficiaries with CAD is $11,700 in Miami 

compared to $11,900 in Minneapolis. This suggests that 

regional differences in coding and utilization may lead to 

situations where a beneficiary who might stay in the same 

CAD episode group in Minneapolis could be shifted to 

another heart-related episode group in Miami. Because 

of this, per episode relative resource use scores for CAD 

in Miami appear to show that physicians’ care is very 

efficient, but care may not be as efficient when we look 

across all care for beneficiaries with CAD episodes. 

Finally, when we compare the Miami and Minneapolis 

MSAs across all episodes both from a per episode and 

a per capita perspective, the results are dramatically 

different. On a per episode basis, Miami has a relative 

resource use score of 0.98 compared to 1.03 for 

Minneapolis across all episodes. However, on a per capita 

basis, Miami has a relative resource use score of 1.32 

compared to 0.88 for Minneapolis (Table 1-8).

These results suggest that beneficiaries in Miami are being 

classified into more episodes of care than beneficiaries in 

Minneapolis. These variations in resource use scores also 

highlight that episode groupers can not judge the clinical 

appropriateness of any given service, just the efficiency of 

that service relative to similar services. Put another way, it 

is possible that in some areas with low resource use scores, 

beneficiaries are more likely to go to the doctor or receive 

certain services, whereas in other areas they might not go 

to the doctor at all. In addition, when a beneficiary sees a 

physician, the physician may be more likely to order more 

tests or treatment or to identify an additional diagnosis. 

This could lead to an MSA having a lower-than-average 

resource use score for a given condition if it has a large 

number of low-cost, low-intensity episodes that other areas 

might not have. Alternatively, physician coding practices 

may differ by region. To the extent that physicians code 

claims more extensively, patients may be classified into 

additional episodes.

Variation in type of service by MSA

The types of services that are used within episodes differ 

across MSAs. It is important to note that the overall 

composition of costs in any given episode will strongly 

influence any differences in relative resource use by 

type of service. For example, inpatient stays account for 

64 percent of total CAD episode costs. Therefore any 

differences in inpatient resource use for CAD episodes 

will have a large impact on an MSA’s overall relative 

resource use ratio (Table 1-4, p. 15). There are significant 

differences in the type of services used within each CAD 

episode in Miami and Minneapolis MSAs. Beneficiaries 

in Miami are significantly less likely to have hospital 

TABLE

1–8 Comparison of resource use in 

Miami and Minneapolis MSAs, 2002

Miami Minneapolis

CAD per episode ratio 0.66 1.28

Total episodes per benefi ciary 

with a CAD episode 11 8

Total episode dollars per 

benefi ciary

with a CAD episode $11,700 $11,900 

Per episode ratio (all episodes, 

all benefi ciaries) 0.98 1.03

Per capita ratio (all episodes, 

all benefi ciaries) 1.32 0.88

Note: MSA (metropolitan statistical area), CAD (coronary artery disease). Per 

episode ratios for individual MSAs are calculated by dividing the MSA’s 

average for a given episode by the national average for that episode. 

Per episode ratios are calculated by dividing each MSA’s average per 

episode amount by the national average per episode amount. Per capita 

ratios are calculated by dividing each MSA’s average per capita amount 

by the national average per capita amount. A score of more than 1.0 

indicates higher-than-average costs and a score of less than 1.0 indicates 

lower-than-average costs.

Source: MedPAC analysis of 5 percent sample of Medicare claims using Medstat 

Episode Group grouper.
Report to the Congress: Increasing the Value of Medicare | June 2006 21

inpatient costs, with a relative hospital inpatient resource 

use ratio of 0.51 compared to 1.46 for beneficiaries 

in Minneapolis. Conversely, Miami has an imaging 

relative resource use ratio of 1.62 compared to 0.76 for 

Minneapolis (Table 1-9).

Other episodes, such as hypertension and type 1 and 

type 2 diabetes, have a stronger E&M focus. Therefore, 

Miami, which has high relative resource use ratios for 

these episodes (1.20 for hypertension, 1.06 for type 1 

diabetes, and 1.28 for type 2 diabetes) is above average for 

E&M resource use in all three episodes (1.37, 1.19, and 

1.42, respectively). 

MSA quality analysis

The Commission finds that MSA scores on quality tend 

to cluster around the national average or slightly above. 

However, the national averages are relatively low. The 

variation in the ratio of MSA quality scores to national 

quality scores across the MSAs is less than the variation 

on resource use. Further, we find that some MSAs did well 

on some indicators of necessary care but not others. No 

MSA is above average on all the conditions (Table 1-10, 

p. 23). 

We also identify several important technical issues. Small 

sample size or low incidence rates make it difficult to use 

some indicators. We created composite scores in order to 

compare MSAs. The method for weighting each individual 

indicator when creating a composite condition score 

affects the relative rankings of the MSAs. The nature of 

the indicators, which rely on claims for services delivered, 

may limit their utility when trying to determine whether 

the resources used produce high-quality care.

Methods

Our quality measures consist of indicators of necessary 

care and potentially avoidable hospitalizations for 

certain conditions—the MACIE set. The text box on 

page 10 describes these indicators. For example, one 

indicator of necessary care for diabetics is whether the 

beneficiary received a hemoglobin A1C test. An indicator 

of a potentially avoidable hospitalization is whether 

the diabetic was admitted to a hospital for long-term 

complications related to diabetes.

We deleted from the analysis any indicators with a small 

sample size either across all MSAs or for a specific 

MSA. This step eliminated all the potentially avoidable 

hospitalizations from the composite condition scores. As 

TABLE

1–9 Relative resource use, 

by type of service, 

Miami and Minneapolis MSAs

Episode group

National 

average Miami Minneapolis

CAD

E&M $307 1.05 0.93 

Imaging 234 1.62 0.76 

Inpatient 1,968 0.51 1.46 

Other 3 1.25 0.92 

Post-acute care 97 0.99 0.82 

Procedures 248 0.39 1.24 

Tests 86 1.14 0.90 

Unclassifi ed 136 0.33 1.07 

Total 3,079 0.66 1.28 

Hypertension

E&M 210 1.37 0.80 

Imaging 21 1.01 0.47 

Inpatient 120 0.99 0.88 

Other 1 2.78 0.29 

Post-acute care 17 1.14 1.56 

Procedures 7 0.91 0.73 

Tests 39 1.17 1.01 

Unclassifi ed 8 0.71 1.38 

Total 423 1.20 0.87 

Type 1 diabetes

E&M 223 1.19 0.85 

Imaging 6 0.54 2.25 

Inpatient 401 1.13 0.64 

Other 2 2.85 1.23 

Post-acute care 96 0.70 0.45 

Procedures 49 0.52 0.72 

Tests 38 0.92 0.86 

Unclassifi ed 17 1.55 1.45 

Total 833 1.06 0.72 

Type 2 diabetes

E&M 271 1.42 0.91 

Imaging 8 0.84 0.99 

Inpatient 105 1.33 0.49 

Other 3 1.69 3.36 

Post-acute care 19 1.16 1.31 

Procedures 25 0.74 0.80 

Tests 84 1.06 1.00 

Unclassifi ed 12 0.96 1.46 

Total 526 1.28 0.88 

Note: MSA (metropolitan statistical area), CAD (coronary artery disease), E&M 

(evaluation and management). Relative resource use scores for individual 

MSAs are calculated by dividing the MSA’s average for a given episode 

by the national average for that episode. A score of more than 1.0 

indicates higher-than-average episode costs and a score of less than 1.0 

indicates lower-than-average episode costs.

Source: MedPAC analysis of 5 percent sample of Medicare claims using Medstat 

Episode Group grouper.
22 Using episode groupers to assess physician resource use

a result, the composite score for each condition reflects 

the average of all the necessary care indicators for each 

condition for each MSA. To create the ratios found in 

Table 1-10, we then compared each MSA condition 

composite with the national average.

In general, the national averages show room for 

improvement across all conditions. With the exception 

of chronic obstructive pulmonary disease, 20 percent to 

40 percent of beneficiaries are not receiving necessary 

care on our selected conditions. Relative to these national 

benchmarks by condition, quality appears to vary less 

across the MSAs than resource use. Table 1-10 shows 

that no MSA is more than 16 percent lower (breast cancer 

composite in New York) than the national breast cancer 

average or more than 18 percent higher (stroke composite 

in Orange County) than the national average on stroke 

quality. In contrast, resource use ratios range from 35 

percent to 41 percent higher.

Some MSAs did well on some indicators and poorly on 

others. No MSA was above average on all the conditions. 

For example, we found that beneficiaries in Phoenix 

received necessary care for CHF at a rate 8 percent higher 

than the national average, but 5 percent lower than the 

national average for stroke patients (Table 1-10). 

Sample size and incidence

Before we grouped the indicators by condition, we 

considered whether the individual MSA scores were stable 

enough to be included in our analysis. We found two 

issues. 

First, because of their low incidence, we did not use 

potentially avoidable hospitalizations in our composite 

scores for the MSAs. Potentially avoidable hospitalizations 

specific to each condition may provide useful information 

at the national level and for population-based analyses, 

but occur too rarely to be useful with a 5 percent sample 

of claims. We will continue to analyze these indicators 

to consider ways they could be grouped to increase their 

incidence and will also revisit the issue when we are using 

a 100 percent sample. Another issue with potentially 

avoidable hospitalizations is that other factors besides 

physician management may affect whether a patient is 

hospitalized, and that multiple physicians may also be 

involved. 

Second, we found that for some indicators the number of 

beneficiaries eligible for specific quality indicators was 

too low to be used in our composite MSA scores. We 

used a threshold of 30 eligible patients in any one MSA. 

That is, if fewer than 30 beneficiaries in any one MSA 

were eligible for the necessary service, we did not use the 

indicator in calculating the MSA score. 

Composites and weighting

To use this list of quality indicators to compare MSAs, we 

grouped them into composite scores for each condition. 

Indicators of necessary ambulatory care are usually 

grouped by condition because they often apply to the 

same type of beneficiary. For some of the conditions, the 

denominators (those eligible for the service) are even the 

same. 

To create composites, it is necessary to choose a method 

for combining the various indicators for each condition 

and to determine what weight to place on each. Different 

weighting methods place importance on different 

dimensions. Relative importance can be determined by 

the number of beneficiaries affected, or how important the 

indicator might be to the beneficiary. In addition, the level 

of evidence supporting the indicator and the precision 

of the measurement of the indicators are also factors to 

be considered. The cost-effectiveness of the intervention 

could also be considered (See Chapter 10 for discussion.)

We used two weighting methods when calculating 

composites. First, we created a straight average for each 

condition by adding the scores for each indicator in 

each condition and then dividing the sum by the number 

of indicators. This method, because it weights each 

indicator the same, does not account for the fact that some 

indicators affect more beneficiaries than others. For this 

reason, we also calculated the composites by weighting the 

indicators by the number of beneficiaries each affects. This 

“opportunity” model is based on the idea of measuring the 

number of opportunities that physicians have to provide 

necessary care; it is often used for quality indicators in the 

same condition (Nolan and Berwick 2006). For example, 

for beneficiaries with diabetes, we summed the number of 

beneficiaries that should receive certain necessary services 

(the denominators for all of the diabetes indicators) and 

the number of beneficiaries who actually received the 

necessary services (the numerator for all of the diabetes 

indicators) and then divided the sum of the numerators by 

the sum of the denominators. 

When we use the opportunity approach to weighting, 

the national average scores for the conditions shift the 

most for breast cancer and stroke. This is because those 
Report to the Congress: Increasing the Value of Medicare | June 2006 23

two conditions have at least one indicator with a very 

large denominator, indicating that a large number of 

beneficiaries should receive that service. Thus, the scores 

on those indicators dominate the analysis.14 For the other 

four conditions, the numbers of eligible beneficiaries 

are similar so the national scores are less sensitive to the 

weighting method used. 

However, using different weighting strategies changes 

some of the relative rankings of the various MSAs for 

all conditions to some degree. As would be expected, the 

greatest shift was for the two that moved the most at the 

national level. However, relative rankings of the MSAs 

also shifted for the other conditions, even when little 

change occurred at the national level. 

Using a broader set of quality measures important

When looking at these MSA quality scores together with 

resource use scores, it is important to consider the types 

of quality measures used. Because both our analyses 

(resource use and quality) measure the services provided, 

it is difficult to assess quality independent of resource use. 

Further, as discussed in our March 2005 report, claimsbased process measures, especially without lab values 

or prescription drug data, represent a limited picture of 

quality (MedPAC 2005).

Because our scores clustered so closely around the 

national average, it was hard to assess whether MSAs that 

used more resources also had higher quality scores—the 

relationship we would expect if our resource use and 

quality measures moved together. The vast majority of 

quality scores were very close to the national average, 

and MSA scores on resource use and quality varied based 

on the condition measured. We found that quality scores 

could be slightly better than the national average both 

when resource use was lower than the national average and 

also when it was higher, depending on the condition. 

However, we did test another measure of quality to 

determine whether MSA scores would change if another 

type of quality measure were introduced. We found that 

MSA quality rankings by condition did vary depending 

on the measure type. The other quality measures we used 

were the potentially avoidable hospitalizations. We did 

TABLE

1–10 Ratio of MSA to national quality scores on six conditions, 2002

Breast cancer CHF CAD Diabetes COPD Stroke

National average 

quality score 57% 73% 78% 71% 93% 68%

MSA

Boston 0.97 1.04 0.97 1.01 1.02 0.93

Chicago 0.95 1.00 1.01 0.95 1.01 1.02

Denver 0.85 0.97 0.99 1.08 0.97 N/A

Detroit 1.01 1.05 1.06 0.98 1.02 1.01

Greenville 1.10 1.00 0.99 0.98 1.03 1.06

Houston 1.03 1.01 1.03 1.00 1.04 1.05

Kansas 0.93 1.07 1.01 1.02 1.02 0.99

Miami 0.93 1.07 1.10 1.05 1.05 1.00

Minneapolis 1.01 1.02 0.97 1.02 0.99 1.05

New York 0.84 1.01 1.08 1.02 1.03 1.07

Orange County 0.99 1.04 1.06 1.09 1.00 1.18

Philadelphia 0.97 1.07 1.01 1.02 1.00 0.96

Phoenix 1.14 1.08 1.05 1.06 1.01 0.95

Note: MSA (metropolitan statistical area), CHF (congestive heart failure), CAD (coronary artery disease), COPD (chronic obstructive pulmonary disease). National scores 

indicate the percentage of Medicare benefi ciaries nationwide who are receiving necessary care for their conditions. MSA ratios are calculated by dividing the 

average MSA quality score for each condition by the national average for that condition. If the MSA ratio is above 1.0, the MSA score is above the national 

average. If the MSA ratio is below 1.0, the MSA score is below the national average.

Source: MedPAC analysis using the Medicare Ambulatory Care Indicators for the Elderly on a 5 percent sample of Medicare claims.
24 Using episode groupers to assess physician resource use

not include these in our initial MSA composite scores 

because of their low incidence. However, for this analysis 

we combined all potentially avoidable hospitalization 

indicators into one score for each MSA. 

Potentially avoidable admissions are also related to the 

amount of resources used. In this case if more resources 

were used (hospitalizations), the MSA would look 

worse on quality and worse on resource use relative to 

other MSAs. We found that using a measure that could 

have a different relationship with resource use did shift 

MSA quality rankings.15 For example, Miami’s overall 

score relative to the national average on necessary care 

indicators was 1.02, or 2 percent higher than the national 

average. However, this shifted to 19 percent lower than 

the national average when quality was measured using 

potentially avoidable hospitalizations. 

To put this in context, in a region where beneficiaries 

generally use more resources, if quality is assessed solely 

on claims-based indicators of the provision of clinically 

necessary services, then an area with higher resource 

use could look better on quality. However, if measured 

on whether potentially avoidable hospitalizations were 

avoided, they would look worse. Both types of indicators 

are linked with measuring resource use, but provide 

different pictures of quality. If Medicare measures 

physician quality along with resource use, it would be 

important to have a broader set of clinical indicators less 

linked with resource use. Measures of the use of qualityenhancing tools, such as information systems to track 

patient care and outcomes, would also be important, as 

the Commission recommended in its pay-for-performance 

recommendations.

Future work

The analysis shows that it is possible to use these types 

of episode groupers as one tool to measure physician 

resource use at the aggregate MSA level. We found that 

both groupers assign a large proportion of claims and 

dollars to episodes, and that episodes can be analyzed 

for variation in resource use and the types of services 

within an episode. We also found that the vast majority of 

episodes could be attributed to a provider, and that even 

when we allowed episodes to be assigned to more than 

one provider, most episodes were still assigned to a single 

provider.

However, the analysis also raised several technical and 

analytic issues that will need to be addressed as Medicare 

considers using these groupers to understand physician 

resource use. Additional research is needed to better 

understand how the clinical logic underpinning the 

groupers affects the construction of episodes and whether 

differences in coding patterns can affect per episode 

comparisons of resource use both within and across 

regions. We also found that using claims-based quality 

indicators is possible, but that a broader set of indicators 

less related to service delivery will be important. 

The second step of our analysis (with a 100 percent 

sample in several geographic regions) will provide more 

information on the feasibility of applying these tools at 

the individual physician level. Among the issues we will 

address in the upcoming research are:

• What is the minimum number of individual episodes 

or quality indicators a physician must have in order to 

qualify for those episodes to be included in a resource 

use or quality analysis?

• What is the minimum number of total episodes 

physicians must have in order to be compared to their 

peers?

• What proportion of a physician’s practice is captured 

after removing episodes without a clean start or finish, 

outlier episodes, and episodes that do not meet the 

minimum threshold for inclusion in resource use 

comparisons?

• How large is the distribution of physician resource use 

and quality scores?

• How should risk-adjustment techniques be 

implemented? 

• Are there differences in practice patterns within more 

defined geographic areas that could lead to bias in per 

episode comparisons? Report to the Congress: Increasing the Value of Medicare | June 2006 25

Standardized payments

We used the following methods to standardize 

payments.

Hospital inpatient services—We applied the 

standardized amount for each diagnosis related group 

(DRG) for each year to all records uniformly. Cases 

involving transfers were adjusted according to the 

payment rules laid out in regulation.

Skilled nursing facility (SNF) services—We merged 

the SNF Medicare Provider Analysis and Review 

records to the DataPro SNF Stay file, which contains 

linked claims, Minimum Data Set data, and Online 

Survey, Certification, and Reporting system data for 

SNF stays nationwide. This information was combined 

with specific standardized amounts of resource 

utilization groups from CMS to create standardized 

payment amounts.

Long-term care hospital services—For discharges that 

occurred on or after October 1, 2002, we applied the 

standardized amount for each DRG. For discharges 

prior to this date, we backed out local area wage-index 

adjustments from each hospital’s payment, assuming 

local area wage indexes acted as a proxy for underlying 

costs.

Rehabilitation/psychiatric hospital services—Total 

Medicare payments and total length of stay were 

calculated for each DRG. We then created a DRG-level 

per diem amount, which was multiplied by the length of 

stay for each record.

Home health—We identified the home health case-mix 

weight on each claim and multiplied the weight by the 

base payment rate for the appropriate fiscal year. 

Physician services—We identified the relative value 

unit (RVU) for each record by matching the Healthcare 

Common Procedure Coding System (HCPCS) and 

modifier on the record to the physician fee schedule 

RVU file. We then multiplied the RVU by the units of 

volume for each record by the conversion factor for the 

appropriate year and reduced the standardized payment 

for multiple surgical procedures on the same claim 

and for services provided by physician assistants and 

assistants at surgery. 

Ambulatory surgical center (ASC) services—We used 

the HCPCS code on the ASC facility records to match 

records to ASC payment rate files. We then assigned 

the ASC payment rate to each record based on the 

HCPCS and reduced the payment rate for multiple 

surgical procedures on the same claim (the payment for 

second and subsequent procedures was reduced by 50 

percent, consistent with Medicare payment rules).

Clinical laboratory services—A record was classified 

as a clinical lab service if the HCPCS for a record on 

the carrier file matched a HCPCS on the clinical lab 

fee schedule. Each service on the lab fee schedule 

has a separate payment for each carrier, as well as the 

national limitation amount (NLA). The NLA is based 

on the median of the carrier rates and represents an 

upper payment limit for each service. In practice, most 

lab services are paid the NLA rate. The standardized 

payment rate for each lab record is the NLA for the 

service. 

Anesthesia services—We summed the base units and 

the time units for each anesthesia record, and multiplied 

the sum by the anesthesia conversion factor for the 

appropriate year. Certified registered nurse anesthetists 

were assigned an amount that was half of the full 

amount, consistent with Medicare payment rules.

Hospital outpatient services—We used the HCPCS 

code to match outpatient records to an outpatient 

prospective payment system payment rate file. We then 

assigned a standardized payment amount to each record 

based on that payment rate. 26 Using episode groupers to assess physician resource use

1 Three groupers are primarily used by the private sector—

ETGs, MEGs, and the Cave Grouper. Our choice of ETGs 

and MEGs was not based on any analysis of the utility of 

applying them to Medicare. Several large private plans use the 

Cave Grouper and it is being considered by CMS for testing, 

alongside the other two, as part of the agency’s study on 

episode groupers. 

2 Information on inpatient hospital and SNF stays was taken 

from a 5 percent sample of the Medicare Provider Analysis 

and Review file.

3 We will continue to evaluate different outlier approaches in 

our analysis of 100 percent of Medicare claims in selected 

geographic areas. We will also evaluate whether deleting 

outlier episodes versus truncating outlier episodes has a 

measurable impact on physician rankings.

4 The MEG grouper employs two different approaches 

to staging, integer staging and substages, which further 

categorize within each integer stage.

5 Additionally, the Ambulatory Quality Alliance is developing 

standard methodologies that would apply to all three major 

groupers.

6 Not all episodes have three stages, and some episodes have 

four stages. For example, all CHF episodes are assumed to 

be stage 3 episodes and prostate and colon cancers have four 

stages running from stage 0 (significant predisposing risk 

factor for the disease, but no current pathology) to stage 3.

7 We intend to use both types of risk adjusters in the second 

step of our physician resource use analysis. 

8 Using Berenson-Eggers Type of Service codes, we divided 

total episode payments into seven categories: inpatient, E&M 

services performed in both physician offices and hospital 

outpatient departments, post-acute care (including SNF, longterm care hospital, and home health services), procedures, 

imaging, tests, and other.

9 Analyzing ETG episodes by type of service produced broadly 

similar results.

10 In this context, efficiency does not necessarily mean cost of 

care only. To the extent that quality of care can be measured, 

it should be incorporated into any analysis of physician 

efficiency.

11 Using E&M dollars, 11 percent of episodes were attributed to 

more than one physician.

12 We used 35 percent instead of 30 percent, which we used for 

resource use.

13 These results have not been risk adjusted. 

14 One condition where this is well illustrated is breast cancer. 

Women who need mammographies in our sample number 

237,081. The other indicators for breast cancer have 30,000 or 

fewer beneficiaries eligible because they require that women 

have a diagnosis of breast cancer.

15 In this case, the quality would be lower if resource use were 

higher (more hospitalizations).

Endnotes
Report to the Congress: Increasing the Value of Medicare | June 2006 27

Fisher, E. S., D. E. Wennberg, T. A. Stukel, et al. 2003. The 

implications of regional variations in Medicare spending. Part 1: 

The content, quality, and accessibility of care. Annals of Internal 

Medicine 138, no. 4 (February 18): 273–287.

Hornbrook, M. C., A. V. Hurtado, and R. E. Johnson. 1985. 

Health care episodes: Definition, measurement, and use. Medical 

Care Review 42, no. 2 (Fall): 163–218.

Medicare Payment Advisory Commission. 2006. Medicare 

Ambulatory Care Indicators for the Elderly: Refinement of the 

Access to Care for the Elderly Project indicators. Contractor 

report by Magnacare Health Services Improvement, Inc. www.

medpac.gov.

Medicare Payment Advisory Commission. 2005. Report to the 

Congress: Medicare payment policy. Washington, DC: MedPAC. 

Medicare Payment Advisory Commission. 2004. Report to 

the Congress: New approaches in Medicare. Washington, DC: 

MedPAC. 

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Ann Arbor, MI: Thomson Medstat.

Nolan, T., and D. Berwick. 2006. All-or-none measurement 

raises the bar on performance. Journal of the American Medical 

Association 295, no. 10: 1168–1170.

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Treatment GroupsTM, version 5.2.

Thomas, J. W. 2006a. Economic profiling of physicians: Does 

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References

Care coordination in 

fee-for-service Medicare

CHAPTER 2

Report to the Congress: Increasing the Value of Medicare | June 2006 31

Care coordination in 

fee-for-service Medicare

C H A P T E R 2

Chapter summary

Care coordination has the potential to improve value in the Medicare 

program. Care coordination can connote a variety of activities for 

patients. But in this chapter, the Commission focuses on integrating 

the use of nurse care managers and information technology into the 

clinical care of patients with high-cost, complex needs. These services 

may improve patients’ understanding of their conditions and compliance 

with medical advice and, in turn, reduce the use of high-cost settings 

such as emergency rooms and inpatient care. Ideally, care coordination 

will also improve communication among providers, eliminating 

redundancy and improving quality. 

Fee-for-service payment mechanisms are barriers to coordination 

among providers and to care management for beneficiaries with 

complex care needs. Payment is directed to each provider separately and 

emphasizes treatment for acute conditions and face-to-face care. 

In this chapter, we explore strategies for Medicare to coordinate care 

for complex beneficiaries. Commission staff interviewed a wide variety 

In this chapter

• Why is care coordination 

needed? 

• Care coordination tools for 

patients with complex needs

• Is there evidence that care 

coordination improves 

quality or saves costs? 

• Models of care coordination 

in the Medicare FFS 

program
32 Care coordination in fee-for-service Medicare

of experts and organizations involved in care coordination (35 interviews 

in total) and analyzed Medicare claims for beneficiaries with a subset of 

chronic conditions. Interview findings include: 

• Many different tools are used to coordinate care. The two functions 

considered essential are: 1) a care manager (usually a nurse) to assist 

the patient in self-management and monitor patient progress, and 2) an 

information system to identify eligible patients, store and retrieve patient 

information, and share information with those who need it.

• Interviewees believe programs are more effective when the beneficiary’s 

primary physician is involved. 

• Care coordination programs are often required to show savings as a 

condition of payment. Therefore, to be cost effective, most programs 

focus on complex beneficiaries (e.g., those with multiple chronic 

conditions, such as congestive heart failure or diabetes, or users of many 

health care services). 

• Care coordination services appear to improve quality. Published research 

on cost savings is less clear. 

To stimulate discussion, we outline two illustrative models for complex 

patients in the fee-for-service program. Medicare could contract with 

providers in large or small groups that are capable of integrating the 

information technology (IT) and nurse care manager infrastructure into 

patient clinical care. In the other model, CMS would contract with standalone care management organizations that would work with individual 

physicians. The care management organization would have the IT and care 

manager capacity. 

In either of these models, payment for care coordination services would be 

contingent on negotiated levels of performance on cost savings and quality 

improvements. Given that Medicare faces long-term sustainability problems 

and needs to learn more about the most cost-effective interventions, the 

entities furnishing the care managers and information systems should 
Report to the Congress: Increasing the Value of Medicare | June 2006 33

initially produce some savings as a condition of payment. Demonstrating 

continued savings may not be necessary or feasible once care coordination 

strategies are broadly used. 

Additionally, to encourage individual physicians to work with care 

coordination programs, CMS could pay a monthly fee to a beneficiary’s 

primary physician or the group for time spent coordinating with the program. 

This may be less necessary if the physician is already part of a group 

practice with a care coordination program. If these two models coexisted, 

however, providing the fee only to nongroup practitioners could disadvantage 

physicians who practice in groups. As with other fee schedule services, 

these expenditures would be accommodated by re-allocating dollars among 

all services in the fee schedule. In either model, patients would volunteer to 

see a specific physician for their care related to the complex condition that 

qualifies them to receive care coordination.

These models do not represent the Commission’s view of the only way care 

coordination might work in Medicare. Other strategies, such as pay for 

performance, complement this model by focusing on improving care. Also, 

adjusting Medicare’s compensation to physicians for the longer time spent 

caring for patients with complex issues may be warranted if the current fees 

do not compensate for this extra time. Report to the Congress: Increasing the Value of Medicare | June 2006 35

Over the last two years the Commission has explored 

multiple strategies to provide incentives for high-quality, 

low-cost care, and thus improve value in the Medicare 

program.1 However, even if individual providers are 

efficient, the care for the beneficiary may still be less 

than optimal if they do not communicate well with other 

providers or monitor patient progress over time. To address 

this problem, we have been exploring ways to introduce 

care coordination by creating incentives for providers to 

share clinical information with other providers, monitor 

patient status between visits, and fully communicate with 

patients about how to take care of their disease. 

While all patients could benefit from better coordination, 

the patients who most need the services described in 

this chapter are those with multiple chronic conditions 

and other complex needs. These patients represent a 

significant proportion of Medicare spending, yet many 

do not receive necessary care. More than 75 percent 

of high-cost beneficiaries were diagnosed with one or 

more of seven major chronic conditions in 2001 (CBO 

2005). Beneficiaries with chronic conditions receive 

recommended care only 56 percent of the time and many 

experience potentially avoidable admissions (McGlynn et 

al. 2003, MedPAC 2004).

Other types of care coordination include improving 

transitions among providers, assisting all patients in 

understanding medical advice, and knowing when medical 

services are necessary. Providing these services to all types 

of patients is not directly addressed in this chapter.

The payment mechanisms in the fee-for-service (FFS) 

program are barriers to coordination among providers 

and to care management for beneficiaries with complex 

care needs. Payment goes to each provider separately and 

emphasizes treatment for acute conditions and face-to-face 

care. 

These payment incentives reflect health care’s historic 

orientation toward responding to acute illness and injury. 

In the past, the focus was on defining the problem and 

initiating short-term treatment, with the patient as a 

passive participant (Wagner et al. 2001). Because the 

episode usually resolved itself within weeks or days, 

little emphasis was placed on patient self-management 

or tracking. The Institute of Medicine’s (2001) Crossing 

the Quality Chasm report described this underlying 

system failure, noting that the poorly organized delivery 

system, including the constraints of modern information 

technology, was not capable of meeting the needs of the 

growing numbers of patients with chronic disease. 

Payment methods reinforce this historical orientation. In 

a fee-for-service system, individual providers are paid 

based on what they do in a visit or in a setting without 

regard to the quality of those services, much less on 

coordinating the patient’s care. Many of the services 

required by individuals with chronic conditions or other 

complex needs, such as ongoing monitoring and education 

for self-management, are not performed within the typical 

face-to-face office visit and often not by physicians. As 

two researchers put it, ensuring that beneficiaries receive 

these services within the context of our current payment 

and delivery system is like trying to fit a round peg into a 

square hole (Wolff and Boult 2005). 

The Congress acknowledged this problem by initiating 

a pilot program to address care coordination through the 

voluntary Chronic Care Improvement Program (now 

termed Medicare Health Support (MHS)). CMS launched 

eight pilot sites beginning in the summer of 2005 and is 

also testing other models. In June 2004, the Commission 

discussed the challenges of this new program, particularly 

applying a private sector disease management model to the 

Medicare population (MedPAC 2004). At this time, CMS 

has not yet evaluated the effectiveness of its various care 

coordination models. 

We conducted interviews with physician organizations, 

other provider-based practices, health plans, various CMS 

demonstration sites, researchers, and quality experts to 

learn more about the key attributes of care coordination 

services. Those we interviewed agreed that care managers 

and information systems are critical for effective care 

coordination and that physician involvement improves 

the effectiveness of these programs. We outline two 

illustrative models for implementing care coordination in 

the Medicare program to stimulate further discussion on 

the topic. We also discuss how changes to the fee schedule 

may be warranted to increase payment for physicians 

caring for complex patients. 

Why is care coordination needed? 

Evidence continues to mount that beneficiaries with 

chronic conditions do not receive recommended care 

and may have hospitalizations that could have been 

avoided with better primary care. Researchers attribute 
36 Care coordination in fee-for-service Medicare

this problem to poor monitoring of treatment—especially 

between visits—and the lack of good communication 

among providers. Physician offices, on their own, struggle 

to find time to provide this type of care and few practices 

have invested in the necessary tools—namely clinical 

information technology (IT) systems and nurse manager 

staff. 

In a 2003 report, researchers found that patients with 

chronic conditions received recommended care only 

56 percent of the time (McGlynn et al. 2003). MedPAC 

analysis of claims-based ambulatory measures (primarily 

for chronic conditions) found that only two-thirds of 

beneficiaries received necessary care for 20 out of 32 

indicators in 2004. Even fewer received necessary care for 

the other indicators. Our analysis of potentially avoidable 

hospitalizations found that congestive heart failure 

(CHF), chronic obstructive pulmonary disease (COPD), 

hypertension, and three forms of complications due to 

uncontrolled diabetes are among the top 12 reasons for 

hospitalization in the Medicare program. CHF is the most 

prevalent reason for a potentially avoidable admission and 

has high rates of readmissions (Rich et al. 1995). 

Partly because of these hospitalizations, beneficiaries 

with multiple chronic conditions are responsible for a 

disproportionate share of Medicare spending. A recent 

analysis found that more than 75 percent of high-cost 

beneficiaries were diagnosed with one or more of seven 

major chronic conditions in 2001 (CBO 2005). Five 

percent of Medicare beneficiaries account for nearly 

half of total FFS program spending (MedPAC 2004). 

A recent Commission analysis found that 70 percent of 

inpatient spending was for beneficiaries with three chronic 

conditions—coronary artery disease (CAD), CHF, and 

diabetes. 

All beneficiaries, not just those with chronic conditions, 

suffer from the lack of coordination across settings. A 

recent study found that 34 percent of patients, regardless 

of payer, reported medical mistakes, medication errors, or 

lab errors. That number rose to 48 percent for those with 

four or more doctors involved in their care (Schoen et al. 

2005). Thirty-three percent of survey respondents reported 

poor coordination at discharge. The respondents reported 

that they did not receive clear instructions about symptoms 

and were unclear whom to contact for questions. Many 

also said that the hospital made no arrangements for 

follow-up visits. Another study found that 19 percent of 

patients experienced an adverse event within three weeks 

of hospital discharge (Forster et al. 2003). Sixty-six 

percent of the adverse events were drug-related. 

The lack of coordination could also be due to beneficiaries 

seeing multiple physicians over the course of a year, 

which would be particularly true for patients with 

chronic conditions. Our analysis shows that an average 

Medicare beneficiary sees five physicians per year. The 

more conditions a beneficiary has, the more physicians 

TABLE

2–1 Beneficiaries with select chronic conditions see more physicians

Percent of benefi ciaries with claims billed by:

Benefi ciaries 1 physician 2–5 physicians 6–9 physicians 10+ physicians

All 16% 51% 21% 12%

Without CAD, CHF, or diabetes 20 56 18 6

With CAD, CHF, or diabetes: 7 41 27 26

Three conditions 1 14 23 61

Two conditions 3 28 29 40

One condition 8 47 27 18

Note: CAD (coronary artery disease), CHF (congestive heart failure). Rows may not sum to 100 percent due to rounding. This table relies on Unique Physician 

Identifi cation Numbers (UPINs) to identify unique physicians or practitioners. Our count of unique physicians may be affected by some physicians’ usage of more 

than one UPIN.

Source: MedPAC analysis of a 5 percent sample of 2003 inpatient, outpatient, and physician/supplier fi le claims.
Report to the Congress: Increasing the Value of Medicare | June 2006 37

he or she tends to see (Table 2-1). Sixty-one percent of 

beneficiaries with all three of the conditions we studied 

(CAD, CHF, and diabetes) saw 10 or more physicians 

in a single year. One of the reasons for this level of 

physician involvement is that multiple physicians care for 

a patient during a hospital stay. In a related analysis, we 

found that the percentage of beneficiaries seeing fewer 

than five physicians per year was 88 percent when no 

hospitalization occurred compared with 35 percent when a 

hospitalization did occur.2 

Another analysis (not shown) shows that despite the 

number of physicians involved, one physician accounts for 

much of a beneficiary’s care. Forty-seven percent of those 

with chronic conditions see one physician for 50 percent 

or more of their care, as measured by dollars. An even 

larger proportion of beneficiaries (65 percent) with none 

of the above three conditions see one physician for 50 

percent or more of their care, as measured by dollars. 

However, research suggests that physicians alone can only 

do so much to improve care coordination, especially for 

patients with chronic illness. Individual physicians may not 

have the time or be well suited to provide all the necessary 

evaluation, education, and coordination that benefit 

beneficiaries with multiple chronic conditions (Grumbach 

and Bodenheimer 2002, Rothman and Wagner 2003). One 

study found physicians would have to spend a full seven 

hours of their day just to ensure that all of their patients 

received recommended preventive services (Yarnall et al. 

2003). Another study found that older patients with select 

conditions that require time-consuming processes, such as 

history taking and counseling, are at risk for worse quality 

of care (Min et al. 2005). Further, physicians are not 

trained to educate patients about caring for their conditions 

or to set up systems for monitoring between visits. 

Physicians’ use of basic care management tools is low, 

even in group practices where building the infrastructure, 

including the use of clinical IT, for care coordination may 

be more feasible. In a study of physician groups larger 

than 20, physicians scored, on average, 5.1 out of 16 

possible points when asked if they used one or more of 

five key care management processes. The five processes 

were case management, physician feedback, disease 

registry, clinical practice guidelines, and self-management 

skills education (Casalino et al. 2003). 

Care coordination tools for patients with 

complex needs 

Experts agree care coordination is most needed and 

effective for beneficiaries with complex cases, often 

with multiple chronic conditions. Care coordination 

programs for those with complex needs use a variety 

of tools. Many are borrowed from disease management 

or case management but are applied more broadly 

across conditions or for a longer time frame.3

 The 

Commission also found that the programs discussed by 

our interviewees shared many of the six essential elements 

(noted below) outlined in the well-known chronic care 

model (CCM). We identified through our interviews two 

tools that are central to all programs: care managers and 

information technology. 

Care coordination services are described as the “glue” that 

holds the beneficiaries’ care together. Providing this glue 

may improve quality of care and reduce costs. Because 

these services are often delivered when patients move 

from one setting to another, such as from the hospital 

to home, the same services designed for patients with 

complex needs may improve transitions for all patients 

(see text box on page 38). 

In the literature on care coordination, the most cited 

model for chronic conditions is the CCM. In this model, 

programs must 1) have the support of the purchasers or 

insurers, 2) maximize other community resources to the 

extent possible, 3) support patient self-management, 4) 

support clinical decisions, 5) clarify delivery system roles 

for physicians and nonphysician team members, and 

6) rely on clinical information systems to track patient 

progress and make information available to those involved 

in patient care (Bodenheimer et al. 2002). 

To understand more about models of care coordination, 

the Commission interviewed physicians and their 

representatives, health plans that provide care coordination 

services to members, researchers, and quality experts. 

Because CMS is experimenting with a variety of care 

coordination models, we also included many of its project 

participants and staff in our interviews. (The text box on 

page 39 provides a description of the features of three 

relevant examples of CMS care coordination models.) 

Our interviewees described programs that encompassed 

many of the goals described in the CCM, but our primary 

conclusion was that two tools, in addition to physicians’ 
38 Care coordination in fee-for-service Medicare

clinical management, were essential for effectively 

managing complex cases. 

• Information systems—Care coordination programs 

use information systems to identify eligible 

beneficiaries. Care managers use the systems to track 

patients’ care and provide caregivers with information 

about the patient. 

• Care managers—A care manager, usually a nurse, 

checks on and responds to questions from patients 

and their families at home and in interactions with 

multiple providers. 

These two tools—information systems and care 

managers—were described as direct support for the 

patients. This support for the patient was most effective 

when the patient’s physician provided clinical information 

to the program and responded to the patient’s needs 

identified by the program, such as changing a medication 

order. 

How are information systems used? Our interviewees 

described a wide variety of types and functions of 

information systems.4

 Information systems enable 

care coordination programs to use predictive modeling 

programs to identify patients with the highest need for care 

coordination. Information systems are also used to track 

the patient’s condition; the care manager can pull up the 

patient’s history and risk-assessment notes to document 

the patient’s status over time. Sometimes the information 

system takes the form of an electronic health record, but 

patient information can also be stored and made accessible 

with web-based registries. 

Care managers use the information in the system 

(including some built-in decision support, such as 

protocols regarding weight fluctuation) to determine 

whether the patient’s condition is stabilizing or improving, 

and whether they may need to contact a physician. If the 

patient is improving, the care manager may call the patient 

once a month instead of once every few days. 

Improving care transitions

People with complex care needs, often older 

patients, are particularly vulnerable to 

fragmented health care (Coleman 2003). 

Potential problems include a lack of understanding 

of self-management techniques or which symptoms 

to look for, confusing medication instructions, and 

inadequate preparation (Forster 2003). These problems 

often lead to increased hospitalization and emergency 

department visits.

Often the patient and the family caregiver are the only 

connection between the sites of care. Therefore, one 

approach to improving care transitions is to focus 

directly on encouraging patients and their caregivers 

to be active advocates for themselves. Researchers at 

the University of Colorado found that patients who 

were educated about medication self-management 

and “red-flag” warning symptoms and had a patientcentered record and primary and specialist follow-up 

were less likely than patients without such care to 

have a subsequent emergency department visit or 

rehospitalization for their condition (Coleman et al. 

2005). This research also found that scores were higher 

for patients in systems with a high degree of integration 

between hospitals and physicians. 

These researchers have created a set of Care Transitions 

Measures which could be used to assess whether patient 

care involves these processes. The Patients’ Evaluation 

of Performance in California survey, designed by the 

California HealthCare Foundation for its pay-forperformance initiative, also includes several questions 

pertaining to transitions. 

Other strategies involve developing and using 

information-sharing tools among patients, families, and 

providers. One example of such a tool is the continuityof-care record. A group of physician organizations, 

along with experts in standard development, has 

defined the most relevant and timely core health 

information that should pass from one provider to 

another. Supporters say it can be created, read, and 

interpreted by various electronic health records, and 

printed in PDF or Microsoft Word documents. Another 

tool provides patients with a personal health record, 

which they use with all of their providers. Report to the Congress: Increasing the Value of Medicare | June 2006 39

Care managers are often nurses, but some programs use 

specially trained educators or physicians along with nurse 

case managers.5

 After the beneficiary enters the program, 

the care manager (either by phone or in person):

• Does an initial assessment. The care manager, often 

along with other practitioners, develops a plan for 

tracking the patient’s status. Depending on the needs 

of the patient, this could involve a once-a-week phone 

call or more intensive services, such as face-to-face 

visits or once-a-day calls.

• Helps the patient understand how to take medications, 

what symptoms to look for, and how to best manage 

his or her conditions (e.g., proper diet and exercise). 

Illustrative CMS care coordination projects

Medicare Health Support pilot 

(Chronic Care Improvement Program

in fee-for-service Medicare)

The Congress authorized this pilot in 2003 to 

test the application of disease management and 

other relevant models to the Medicare population. 

CMS has cooperative agreements with eight 

organizations to provide support for beneficiaries 

with congestive heart failure or diabetes among their 

chronic conditions. These Medicare Health Support 

organizations (MHSOs) are working with physicians 

and beneficiaries to improve the health of the targeted 

population (20,000 per site) and reduce Medicare 

expenditures. Quality and cost improvements are 

anticipated from preventing debilitating complications 

that often result in hospitalizations and emergency 

room visits.

CMS pays the MHSOs a fee up front. However, the 

MHSOs will need to pay back part or all of the fees 

if they fail to reach the target threshold of 5 percent 

net savings (Medicare claims cost and MHSO fee) 

and realize quality improvement goals as compared 

to a comparison group. As of January 2006, 110,000 

beneficiaries had agreed to participate in the program 

in 8 sites. Congress authorized the Secretary of Health 

and Human Services to expand successful programs or 

program components.

Physician group practice

The Congress mandated this demonstration in 2000 

to encourage coordination of care and investment in 

administrative structures and processes, and to reward 

physicians for improving health outcomes. In January 

2005, CMS announced it had chosen 10 physician 

multispecialty group practices (each with a minimum 

of 200 physicians) to begin the demonstration in April 

2005. It will run for three years. This demonstration 

tests whether sharing savings that result from more 

effective care lowers program expenditures or improves 

quality. CMS assigns beneficiaries to the group 

practice based on how often they use physicians in the 

practice. If actual annual Part A and B expenditures 

for the assigned population are less than the expected 

expenditures and certain quality targets are met, the 

physician group practice can share a portion of the 

Medicare savings. CMS still pays individual physicians 

in the group using fee-for-service payment. 

Care management for high-cost beneficiaries

CMS developed this demonstration to test models 

of care management in a Medicare fee-for-service 

population for beneficiaries who are both high 

cost and high risk. These beneficiaries will receive 

clinical support beyond that typically provided in 

traditional fee-for service settings to manage their 

conditions. Eligible organizations include physician 

groups, hospitals, or integrated delivery systems. 

CMS pays the organization a care management fee, 

but the fee is contingent on certain targeted levels of 

savings. CMS hopes to test such care coordination 

strategies as intensive case management, increased 

provider availability, structured chronic care programs, 

restructured physician practices, and expanded 

flexibility in care settings to address needs specific 

to this population. The organizations must assume 

financial risk for their fees if they fail to meet savings 

targets. If savings go beyond the targeted level, the 

organization may also be eligible to share in them. 40 Care coordination in fee-for-service Medicare

• Teaches the patient how to interact with the health 

system effectively (e.g., what questions to ask his or 

her physician). 

• Communicates with the patient’s providers regarding 

any problems the patient may have.

• Adjusts the care management plan, as necessary. 

The care manager checks on the patient at regular intervals 

and is also available by phone to the patient or the patient’s 

family. In some cases, care managers make appointments 

and even provide or pay for transportation.

Role of physician offices

All interviewees maintained that care coordination is 

most effective when patients’ physicians are part of the 

care coordination team. Patients with multiple chronic 

conditions, in particular, require continuous clinical 

coordination to manage comorbidities effectively. While 

physician involvement is critical for clinical management, 

nonphysician practitioners, such as nurses and social 

workers, conduct many of the care management activities. 

Those we interviewed described the following key roles 

for physician offices:

• provide referral and clinical information, including 

initial diagnoses, to the care management program;

• develop patient’s clinical care plan; 

• respond to feedback on the patient from the care 

management program (e.g., revising clinical care 

plan);

• write orders and administer necessary clinical 

services; and

• provide clinical information to the patient’s database 

on an ongoing basis.

The care management program is administered in-house in 

practices where physician offices have enough patients and 

staff to justify the cost of performing care coordination 

activities. 

However, smaller physician offices may not have enough 

patients at high complexity levels to warrant hiring care 

managers or developing patient education programs. 

Several reported that in these cases physician offices may 

provide some limited management through staff nurses, 

but the offices may need to team up with external care 

management programs to provide the full set of care 

coordination services. 

Several representatives of the CMS demonstration sites 

we interviewed stated that because physician involvement 

was critical, they intended to share a portion of their 

care management fee with physician offices. One 

interviewee stated that initially the fee would be designed 

as payment for professional services. However, over time 

the organization wanted to tie any payment to physicians 

to performance on quality and resource use measures. 

Several interviewees noted that because the goals of care 

coordination and quality improvement sometimes overlap, 

provider-level pay-for-performance incentives could 

encourage providers to initiate or collaborate with care 

management programs. 

Role of the beneficiary

Although care management programs and the patient’s 

physician are critical for care coordination programs 

to work, the central actor is still the beneficiary. 

These programs will not be effective without engaged 

beneficiaries. 

Our interviewees said that two types of engagement 

were important. First, beneficiaries needed to agree 

to participate in the care coordination program. In the 

Medicare Health Support pilot, CMS provides the 

organization a list of eligible beneficiaries, including 

contact information, and the organization must contact 

the beneficiary.6

 This information is also available to 

physician groups in the physician group practice (PGP) 

demonstration, but the practice can identify eligible 

patients as well. 

Second, and most important, once beneficiaries are in 

the care coordination program, they are responsible for 

adhering to their care plan and properly monitoring their 

condition. Beneficiaries must be willing to accept phone 

calls or visits and act on the advice of the care manager 

or physician to weigh themselves, check blood pressures, 

take their medications, and make difficult lifestyle changes 

to improve their health status. 

Most programs found beneficiaries were grateful that 

someone was paying attention and appreciated the phone 

calls. Interviewees responded positively that beneficiaries 

used the various electronic monitoring tools, and that care 

managers prompted noncompliant beneficiaries to do so. 
Report to the Congress: Increasing the Value of Medicare | June 2006 41

We do not know yet whether beneficiaries in the variety 

of programs Medicare is testing will comply with the 

advice from the care coordinators or engage in healthier 

behaviors. 

How are members with care coordination 

needs identified and who generally 

qualifies for those services? 

Care coordination programs use administrative data and 

referrals from providers to identify beneficiaries most 

able to benefit from their services. Because most of these 

programs are expected to produce cost savings, targeting 

the right services to the right group of beneficiaries is 

essential. Who is the right group? In these programs, the 

right groups are patients whose future high expenditures 

can be prevented, including beneficiaries with multiple 

comorbidities or those taking multiple medications and 

using many services. 

No two programs target exactly the same beneficiaries; 

which beneficiaries receive care depends on the type 

of organization and the type of program. If hospitals 

are involved, the program may target those at risk for 

readmissions. Without a hospital, the program may be 

more broadly targeted at patients with certain diagnoses. 

Although the complexity of beneficiaries’ conditions 

indicates a need for these services, it may be difficult to 

prevent higher costs if patients are very sick. Further, high 

users of services today may not be high users in the future. 

Commission research has found that while many high-cost 

beneficiaries in one year do have high costs in subsequent 

years, many do not (MedPAC 2004). We found that only 

38 percent of beneficiaries ranked among the top 5 percent 

by FFS program spending in the base year of 1996 were 

among the top 5 percent the next year.7

Care coordination programs target patients through claims 

analysis—including lab and prescription data—or through 

referrals from physicians, hospitals, or post-acute settings. 

As might be expected, when the organization sponsoring 

the program is provider-based, it can rely more heavily 

on referrals from physicians or hospitals than those that 

are not. The ability to analyze claims in a timely fashion 

is important for all types of programs to identify eligible 

beneficiaries and shift the level of interventions over time. 

Patients with CHF are often targeted by care coordination 

programs. CHF affects outcomes and costs and is a 

condition for which good ambulatory care, including 

better adherence to medication regimes, could prevent 

hospitalizations. One interviewee also noted that hospitals 

have difficulty covering the costs for some patients with 

CHF, thus hospitals may want to reduce readmissions for 

these types of patients. Our analysis finds that Medicare 

beneficiaries with CHF (whether it is the primary 

diagnosis of the hospitalization or not) have high rates 

of readmission: 40 percent of all types of admissions are 

readmissions for any cause within 90 days. 

Preventing readmissions for those with a variety of chronic 

conditions may be a useful way to target care coordination 

services. Our analysis also shows that rates of readmission 

within 90 days for any cause in beneficiaries with diabetes 

(34 percent), CAD (32 percent), and COPD (36 percent) 

are a relatively high proportion of all of their admissions.8 

Many programs expand their focus beyond the presence 

of chronic conditions. Interviewees noted that age, 

multiple admissions, trips to the emergency department, 

or seeing numerous physicians were often signs of a need 

for care coordination. Risk factors also help determine 

eligibility, such as hypertension, high cholesterol levels, 

and symptoms such as dementia, depression, or low levels 

of functioning. The Program of All-Inclusive Care for 

the Elderly (PACE), which provides many types of care 

coordination services, targets its services to beneficiaries 

who might otherwise be in nursing homes. 

Is there evidence that care coordination 

improves quality or saves costs? 

Evidence shows that the various types of care coordination 

programs described in the previous section improve 

quality, particularly as measured by the provision of 

necessary care. Evidence on cost savings is less clear. 

Quality improvement

Our interviewees find that care coordination services can 

improve beneficiaries’ care. They found such programs 

reduced hospitalizations, including readmissions and 

emergency department use, and improved adherence 

to evidence-based guidelines. This was particularly 

true for beneficiaries with diabetes or CHF. Published 

research on the impact of care coordination corroborates 

the experience of our interviewees. Self-management 

programs for older adults have been found to improve 

care for hypertension and diabetes (Chodosh et al. 2005). 

Other interventions have been effective for coronary artery 
42 Care coordination in fee-for-service Medicare

disease, diabetes, heart failure, and asthma (Fireman et 

al. 2004). 

In addition to improving performance on measures of 

whether patients received necessary care, several studies 

documented the impact of care coordination on outcomes, 

such as readmissions. Researchers found rates of 

readmissions fell when older patients with chronic illness 

were given a personal health record and a transition coach 

to help them manage their medications and symptoms 

(Coleman et al. 2004). Patients in the intervention group 

were approximately half as likely as those in the control 

group to return to the hospital at 30, 90, or 180 days. 

Another study found reduced readmissions for at-risk 

elders when a care manager (an advanced practice 

nurse) managed the discharge process in the hospital 

and followed the patient into the next care setting. This 

study found readmissions were reduced by 45 percent 

(37.1 percent for the control group vs. 20 percent for the 

intervention group) at six months (Naylor et al. 1999). 

Cost savings

Evidence on cost savings is less clear and savings may 

depend on how well the target population is chosen. 

When cost savings are shown, they are often limited to a 

specific type of patient, the intervention used, or the time 

frame for the intervention. Our interviewees said that 

the savings potential depended on the balance between 

targeting the right beneficiaries and finding the most 

effective interventions. Patients with CHF were seen as the 

most promising in terms of the opportunity for short-term 

cost savings and quality improvement. However, longer 

term savings could come from improved management of 

conditions such as diabetes because poor glucose control 

in diabetics can lead to worse cardiovascular health in 

the longer term. Interviewees pointed out that savings 

from better care coordination might come from both the 

diagnoses that led to patients’ enrollment and from other 

conditions these patients often have. 

In a review of the literature on disease management 

(services similar to care coordination), the Congressional 

Budget Office (CBO) concluded more evidence 

was needed to prove cost savings due to a lack of 

standardization of analysis and faulty research design 

(CBO 2004). Evaluations often did not include the cost of 

the interventions in their calculations, did not address the 

fact that many patients would have had decreased costs 

without the intervention, and were often based on one 

specific condition or intervention. 

Another review of the literature found that research 

on programs emphasizing self-care shows promise for 

cost savings, especially for patients with CHF (Goetzel 

et al. 2005). Four randomized controlled trial studies 

that calculated net savings for CHF found that, on 

average, programs saved $3.66 for every dollar spent. 

While significant, three of the studies were based on 

interventions performed when patients were at risk for 

readmissions, which could limit their generalizability. 

Further, the range of returns on investment across the 

studies was broad, from a loss of $2.77 for every dollar 

spent to a gain of $14.18 for every dollar spent. 

Goetzel and colleagues (2005) found the evidence on 

savings to be less clear when programs were directed at 

asthma, diabetes, and depression. Similar to the CBO 

report, these researchers also discuss the difficulty 

of trying to assess the cost-savings of these types of 

programs. 

A study on the use of care coordination tools at discharge 

from the hospital found that preventing readmissions 

also saved Medicare dollars. Six months after discharge, 

total Medicare payments for the intervention group of 

186 patients were $600,000 less (including the cost of 

the intervention) than those for the control group of 177 

(Naylor et al. 1999). 

The time frame used for these analyses is critical. Often 

the savings are documented in a relatively short period. 

Greater savings might be realized if measured over a 

longer time frame or vice versa. Obtaining a return 

on investment for controlling diabetes is said to take 

longer than for other conditions, perhaps five years. 

Researchers looking at the lifetime burden of chronic 

disease among the elderly concluded that beneficiaries 

with chronic conditions cost $1,000 to $2,000 more per 

year than those without them, but may cost less over their 

life time because they die sooner (Joyce et al. 2005). If 

care coordination programs work, annual spending may 

decrease, but beneficiaries may live longer with a higher 

quality of life. This would be a positive outcome for 

Medicare beneficiaries, but over the beneficiaries’ lives 

the Medicare program may not spend less than it otherwise 

would have. 

Some analysts question whether Medicare should 

require care coordination services to show savings. If 

these services are needed, effective, and improve the 

value beneficiaries receive, why should they be held to a 

different standard than other medical services? An analysis 
Report to the Congress: Increasing the Value of Medicare | June 2006 43

of one care coordination program in northern California 

concluded that a program for those with chronic illness 

“must rest on its effectiveness and value regardless of 

whether it saves money” (Fireman et al. 2004). This may 

argue for assessing programs on the basis of whether 

they provide the interventions known to be effective or 

achieve certain quality improvements rather than on their 

cost savings. Further, if care coordination services become 

widespread, over time it will become increasingly difficult 

to demonstrate savings because of a lack of a comparison 

group. 

Models of care coordination in the 

Medicare FFS program 

The strongest incentives in the Medicare program to 

coordinate care are through the Medicare Advantage 

(MA) program. Because CMS pays MA plans a capitated 

amount for all of the enrollees’ care, the plan has an 

incentive to ensure that beneficiaries with complex needs 

are well managed across settings and over time. The 

Commission does not know how effectively MA plans 

coordinate care for their complex patients, but at least the 

payment mechanisms provide the appropriate incentives. 

Care coordination is more difficult to do in the FFS 

program because it requires managing patients across 

settings and over time, neither of which is supported by 

current payment methods or organizational structures. 

Further, because patients have the freedom to go to any 

physician or other provider, it is more difficult to identify 

the practitioner most responsible for the patient’s care 

and the patient may choose to see multiple providers. The 

challenge is to find ways to create incentives in the FFS 

system to better coordinate care.

The models currently used in the private sector and those 

CMS is testing for the FFS program are reimbursed very 

differently than the typical fee-for-service transaction. 

They also require different organizational structures 

capable of operating across settings and interacting with 

the patient at home. 

Table 2-2 shows the variety of approaches currently in 

use or being contemplated for care coordination in the 

Medicare program. The continuum moves from the planlevel incentives where the plan is at risk for the costs of all 

services (medical care and care management) to pay-forperformance incentives for physician offices to provide 

appropriate care to all patients. In between these two 

approaches are the two types of models from which we 

draw for our discussion of potential new approaches. 

In the MA program, the plan is at risk for any costs of 

care that go beyond the capitated payment, but can attract 

beneficiaries with more generous benefits if it is able to 

spend less on beneficiary services than that amount. This 

payment can act as an incentive for MA plans to better 

coordinate care. MA plans, similar to health plans serving 

commercial clients, can hire care management services to 

interact directly with patients and physicians or integrate 

care management into any provider networks. CMS also 

provides incentives for care coordination through capitated 

payments to PACE program contractors and special needs 

plans. We discuss these plans in more detail in Chapter 9. 

While not yet implemented, physician-level pay for 

performance also provides an opportunity to improve care 

for those with chronic conditions. In discussing measures 

of pay-for-performance incentives, the Commission 

recommended indicators of chronic care clinical 

management, including physicians’ ability to identify 

patients with chronic conditions, monitor their progress, 

and provide self-management education. However, these 

TABLE

2–2 Current strategies to coordinate care in Medicare

MA plans PGP demonstration MHS pilot Physician P4P

Accountable entity Health plan Provider system Care management organization Physician offi ce

Payment method Capitation Shared savings At-risk care management fee Bonus payments

Note: MA (Medicare Advantage), PGP (physician group practice), MHS (Medicare Health Support), P4P (pay for performance).

Source: MedPAC analysis.
44 Care coordination in fee-for-service Medicare

pay-for-performance incentives do not ensure that a care 

manager is available to the patient, nor that patient care is 

tracked across settings.

The physician group practice demonstration and the 

Medicare Health Support pilot are currently being 

evaluated by CMS for use in FFS Medicare and are briefly 

described in the text box on page 39. We draw heavily 

from these two models in our thinking about models for 

care coordination in the FFS program. However, further 

evaluation is necessary to identify which aspects of the 

current CMS initiatives are most effective. We present 

these models not as Commission recommendations, but 

to illustrate key attributes of an effective care coordination 

program and stimulate further discussion on the topic. 

New approaches to care coordination in 

FFS Medicare: Two illustrative models

We present two models for delivering care coordination. 

In the first model, the patient’s primary physician is part 

of a group of providers with an internal care management 

program. In the second model, the patient’s primary 

physician is in a solo practice or small office with limited 

resources for care management, and the physician’s office 

works with an external organization to deliver the care 

management services between office visits (Table 2-3). 

These programs would target high complexity patients 

because these patients are the ones for whom improved 

outcomes and lower costs are most likely. Any program 

to coordinate care for patients with complex illness will 

need information systems to identify and track patients 

and provide decision support and a care manager (usually 

a nurse) to help the patients navigate the health system and 

manage their own care. These care management functions 

will need to complement and build on the care provided 

by the patient’s physician. This may be best achieved by 

integrating the care management functions of information 

technology and a care manager directly into a physician 

practice. However, not all practices have a sufficient 

number of complex patients or the resources to provide the 

necessary care management services. 

For reasons we describe below, we assume that the care 

coordination entities, whether provider groups or external 

care management organizations, would have some portion 

of their payment at risk for the outcomes they achieved, 

both in cost savings and quality improvement. Further, 

CMS may also pay a fee for individual physician time to 

interact with the care management program to encourage 

physicians to refer beneficiaries and to cooperate with the 

beneficiary’s program. 

In the following sections, we discuss the accountable 

entities, payment methods, enrollment and eligibility, and 

accountability mechanisms for the two models. 

TABLE

2–3 Components of two illustrative

 care coordination models

Model one: 

Provider group

Model two: Care 

management 

organization plus 

physician offi ce

Accountable 

entity

Group practice or 

integrated delivery 

network provides 

care coordination 

and clinical care.

External care 

management 

organization provides 

care coordination 

and physician offi ce 

provides referral and 

clinical care.

Payment 

method

Shared savings or 

at-risk fee to group. A 

potential additional 

monthly fee for 

physician interaction 

with program.

Shared savings 

or at-risk fee to 

care management 

organization. Monthly 

fees to designated 

physicians of enrolled 

benefi ciaries.

Enrollment and 

eligibility

CMS identifi es 

eligible benefi ciaries 

in region. Provider 

group targets 

services. Patients 

designate a physician 

as primary.

CMS identifi es eligible 

benefi ciaries in region. 

Care management 

organization targets 

services. Patients 

designate a physician 

as primary.

Accountability Provider group 

accountable for 

savings targets 

(expected vs. 

actual Parts A&B 

spending) and quality 

measures (process 

and outcomes). If a 

physician fee is paid, 

group accountable 

for documentation.

Care management 

organization 

accountable for savings 

targets (expected 

vs. actual Parts A&B 

spending) and quality 

measures. Physicians 

accountable for 

documentation and 

quality measures.
Report to the Congress: Increasing the Value of Medicare | June 2006 45

Accountable entity

The accountable entity in the two models is perhaps 

the largest difference between them. The financial 

incentives, accountability mechanisms, and determination 

of beneficiary eligibility are all similar. These models 

are not mutually exclusive. They could coexist and 

provide different options for care coordination that would 

recognize that beneficiaries receive services from different 

types of delivery systems. 

Provider group In the first model, the accountable 

entity would be a provider group and Medicare would 

contract with groups of providers, either group practices 

or integrated systems that also include hospitals and other 

types of providers, to furnish care coordination services. 

This would target payments for care coordination to 

organizations capable of investing in the IT and nurse care 

manager infrastructure. 

It is unclear how large a provider organization should be 

to effectively deliver care coordination services or to take 

on some risk for cost savings as a condition of payment. 

While a single physician practice may not be able to 

deliver all of the services, a small geriatric physician 

practice may have a sufficient population of complex 

Medicare beneficiaries to find it worthwhile to invest in 

the necessary information systems and hire nurse care 

managers. The PGP demonstration limits participation 

to groups of 200 or more physicians, but other CMS 

demonstrations allow much smaller provider groups to 

participate. One of the CMS demonstration sites is run by 

an independent practice association (IPA) that coordinates 

across its member physicians, so IPAs could also 

potentially qualify as a provider group under this model. 

Hospital-based systems choosing to be a part of the 

program may also vary in size. One of the PGP sites 

is centered around a single hospital with its affiliated 

physicians, while another includes multiple hospitals and 

physician groups. The program would be voluntary, so a 

physician practice or hospital-based organization would 

need to determine whether it was capable of delivering the 

necessary services. 

In the provider group model, care coordination programs 

would be integrated directly into the provider’s clinical 

care, either in a physician office practice, hospital, or 

home health practice. The nurse care manager might 

share office space with physicians. As such, beneficiaries 

may be more accepting of the program and involved 

in their own care management than if the coordination 

were performed by an external entity. If a hospital is 

in the network, these programs could be initiated at 

discharge and encourage more seamless transitions for the 

beneficiary and better coordination between the hospital 

and physicians.

The type of group a physician is in may also guide 

decisions regarding provider participation in the program. 

A study of physician practices in California found that 

the more integrated the practice, the more likely it was 

to use disease management techniques. Sixty-seven 

percent of physicians formally affiliated with Permanente 

groups reported referring patients to disease management 

programs compared to 39 percent for those contracting 

through independent practice associations, and 17 percent 

among physicians in practices with 1 to 10 independent 

physicians (Rittenhouse et al. 2004). 

Care management organization plus physician 

office Under the second model, the accountable entity 

is a care management organization working with a 

physician office. This model acknowledges that limiting 

care coordination incentives to provider groups capable of 

investing in the necessary infrastructure on an at-risk basis 

would limit the number of beneficiaries that could benefit 

from the services. This model recognizes the central 

role physicians and their staffs can play in managing the 

care of complex cases, but acknowledges that additional 

professionals and information systems are needed for 

patient education and monitoring across settings and over 

time. 

About 35 percent of office-based physicians are in solo 

or two-physician practices (Hing et al. 2005). These 

smaller practices, if grouped with others, might be able 

to participate in the first model and furnish all of the care 

coordination services themselves. However, on their own, 

these practices may not be likely to offer a broad spectrum 

of care management activities within their practice, and 

would not meet the specified criteria for participation 

outlined in our first potential model (e.g., patient panel 

size, information systems, and care managers).

The second model also recognizes that a number of care 

management organizations outside of provider settings 

have developed programs that could benefit beneficiaries 

with complex needs. For example, in the MHS pilot, CMS 

contracts with care management organizations willing to 

take responsibility for relatively large populations. These 

organizations are generally not a part of physician offices 

or integrated health systems. The patient is the primary 
46 Care coordination in fee-for-service Medicare

focus for these organizations. But, because the patient’s 

clinical care is critical, the external organization also 

has strong incentives to coordinate its activities with the 

patient’s physicians. In these situations, Medicare could 

allow stand-alone care management organizations, such 

as those contracting with the MHS pilot, to provide the 

necessary care managers and information systems. 

These external care management organizations would 

employ the nurse care managers and information systems 

to assess patient severity levels and target interventions. 

The physician office would refer complex patients to the 

care management organization and agree to collaborate 

with it to coordinate the beneficiaries’ care. 

The Advanced Medical Home model outlined by the 

American College of Physicians provides useful design 

suggestions for either model (ACP 2006). Physicians 

would need to choose which type of model best suited 

their practice. The Advanced Medical Home model 

envisions that beneficiaries would identify a physician 

who they would commit to see for care related to their 

complex needs. This feature is a part of both models. 

Further, physician practices that meet criteria outlined in 

the group model (including ongoing monitoring of patients 

with care managers and information technology) could 

become accountable entities. Other physicians might opt to 

work with stand-alone care management organizations in 

our second model. 

Payment method

Payment methods in both models would be similar. 

Payment to the care coordination entity (the group or 

the care management organization) would be tied to 

cost savings and quality goals through either shared 

savings or an at-risk care management fee. An incentive 

payment could go to physicians to encourage them to 

collaborate with these programs. In the case of a group, 

this incentive payment would go to the group. A separate 

payment may be less necessary when the group practice 

has a care coordination program. But if the two models 

coexist and the incentive payment only went to the 

individual physicians working with the care management 

organizations, physicians who practice in groups could be 

disadvantaged.

Given the challenge of the long-term sustainability of the 

Medicare program, limited evidence on cost savings, and 

the need for Medicare to move to value-based purchasing, 

putting the accountable entity at some risk gives a strong 

incentive to provide cost-effective, quality-enhancing 

interventions. Further, this type of financial risk can 

provide physicians, hospitals, and others flexibility in 

designing care coordination strategies. The alternative—

fees with no risk—requires Medicare to define the specific 

set of services, how they could be delivered, and who 

would be eligible for payment. Once care coordination 

has proven to be effective, demonstrated savings may not 

continue to be necessary and may also be more difficult 

to calculate. As more beneficiaries use these services, 

it would become increasingly difficult to achieve cost 

savings as the control group will shrink over time. 

At–risk payment for care coordination services The 

purpose of an at-risk payment is to create a strong incentive 

to provide cost-effective interventions. Here we consider 

two types of at-risk payment—shared savings and an atrisk care management fee. Both require the accountable 

entities (provider groups in model one or external care 

management organizations in model two) to take on 

“business” risk for the population they serve. The downside 

risk involved for the accountable entity delivering the care 

coordination services would be limited to the costs of those 

services. The entity would be at no risk for delivering the 

actual Medicare benefits as is the case in the MA program. 

The accountable entity may not be paid for its services or 

not paid the full cost of them unless the costs of care for 

the population it serves are less than they would have been 

absent the care coordination services. 

One type of at-risk payment is shared savings. Shared 

savings require the provider group or external care 

management organization to invest the resources necessary 

to coordinate care without any up-front payment. The 

organization receives payment only if its efforts create 

savings for the Medicare program. We found no examples, 

other than the PGP demonstration, in which this incentive 

is the only form of payment. However, the organizations 

involved in the PGP demonstration described this 

approach as a strong incentive to encourage better 

coordination, although the specific design raises concerns, 

which we discuss later.

An at-risk care management fee is used by the MHS 

program and the Medicare high-cost beneficiary 

demonstration. In these models, CMS pays the 

organization a negotiated fee for care management upfront, but part or all of the fee must be paid back if the 

program does not meet specified savings targets and 

quality goals. In the high-cost beneficiary demonstration 

the organizations can also opt to share in any savings over 

and above the care management fee.
Report to the Congress: Increasing the Value of Medicare | June 2006 47

Physicians and hospitals in both models are still paid 

under fee-for-service for Medicare-covered clinical 

services. However, if at the end of a certain time frame the 

Medicare program expenditures (Parts A and B) for the 

assigned population are lower than those of an equivalent 

population used as a control group, the organization is 

either eligible to share in the savings or allowed to keep 

part or all of the care management fee. 

Both the shared savings and at-risk care management fee 

concepts are relatively straightforward, but the calculations 

to determine whether and how much savings should or 

did occur are complex. It is necessary to identify either a 

population with which to compare costs or to calculate an 

expected cost trend and then compare it with actual costs. 

The time frame over which the savings are calculated is 

also important. Depending on whether the physician group 

or external care management organization already has an 

infrastructure in place and how quickly it is able to enroll 

beneficiaries, it could take several years before the full 

impact of the program is shown. 

If fully implemented, it might be difficult to define an 

expected cost trend independent of care coordination 

services. Over time, calculating savings would become 

more difficult as more beneficiaries became eligible for 

care coordination services. Currently, care coordination 

services are only offered to beneficiaries in regions 

where a Medicare demonstration or pilot is located. If 

implemented as a part of the Medicare program, it will 

not be possible to withhold these services from eligible 

beneficiaries who currently make up the control group. 

Further, even if the calculations were based on expected 

costs, every year the base would shift as increasing 

numbers of beneficiaries were served by these programs. 

The risk of the two forms of incentives are different, with 

shared savings requiring more up-front risk (no payment is 

provided until savings are realized) but a higher potential 

pay-out if savings above the cost of the intervention 

are realized. The at-risk care management fee allows 

organizations to receive payment up front, but if sufficient 

savings are not realized, they must pay some or all of it 

back. Medicare could also consider withholding part of 

the fee and waiting to pay the rest at a later point in time 

based on performance. It is yet to be seen if organizations 

currently contracting with CMS that do not meet their 

targets are willing or able to return this money. 

Different types of organizational structures may favor 

one financial incentive over another. Larger organizations 

may be better able to afford the initial up-front investment 

in the shared savings payment, while smaller entities 

may prefer the at-risk care management fee. Whether 

large or small, provider groups may also find the upfront investment required in shared savings aligns with 

other internal goals. For example, some of the PGP 

demonstration sites noted that the infrastructure developed 

for the demonstration, such as interoperable electronic 

health records or other mechanisms for tracking patients, 

was already a part of their overall strategic plan. A small 

physician practice may also have made some of these 

investments and appreciate the opportunity to be rewarded 

for achieving better patient outcomes. 

Provider groups with hospitals in their systems may be 

most effective in creating savings, but because savings 

targets are determined based on the costs of both Part A 

and B services, these groups will need to consider the 

loss of revenue from reduced admissions when deciding 

whether to offer a care coordination program. It may 

be easier for provider groups with hospitals to identify 

patients with complex conditions, to afford the necessary 

infrastructure, and to create teams of physicians and 

hospital personnel. Hospital and physician teams can 

prevent further hospitalizations after discharge and provide 

ongoing services to keep the patient as healthy as possible. 

Further, because the savings these programs create are 

often a result of lower admissions, provider groups with 

hospitals may have an incentive to be a part of a care 

coordination program to ensure that at least some of 

the revenue lost from decreased admissions is made 

up through either the shared savings or the care 

management fee. 

However, because much of the savings come from 

decreased hospitalization, provider groups with hospitals 

may find it hard to achieve a net gain in dollars sufficient 

to cover their investment. One PGP demonstration site 

with a hospital projected that the share of savings it could 

achieve would not be enough to cover the loss of hospital 

revenue and the intervention costs. Another factor to 

consider is whether hospitals are located in markets with 

sufficient demand to replace patients that may avoid 

hospitalizations due to improved care coordination. 

Decreasing avoidable hospitalizations is an important goal 

for individual patients and the Medicare program, and 

this type of investment may have some long-term benefits 

for the provider organization. However, organizations 

with hospitals will need to carefully balance the potential 

dollars lost with those gained. 
48 Care coordination in fee-for-service Medicare

The level and formula for calculating savings required are 

also issues. In the PGP demonstration, CMS keeps the first 

2 percent of savings for the Medicare program—regardless 

of the level achieved—because of a concern over random 

variation. Beyond that, any difference between the 

expected and actual beneficiary cost of care (including the 

care coordination services) can be shared with the provider 

group. If the savings are 5 percent, CMS keeps the first 2 

of the 5 percent—40 percent of the savings created by the 

program. 

It is unclear whether it is feasible for provider groups to 

reap any savings over and above the sum of 1) the 

Medicare 2 percent withhold, 2) the cost of the 

interventions, and 3) the loss of revenue from decreased 

admissions, at least for a provider group with a hospital. 

A more equitable approach might be for CMS to designate 

a percentage that would go to the program regardless of 

the dollars saved. For example, CMS could keep a certain 

percent of every dollar saved, regardless of the level 

of savings. 

When paying an at-risk care management fee, CMS 

negotiates the target savings level. The target in both 

the MHS and the Medicare high-cost demonstration 

is 5 percent. As the demonstrations progress, we will 

learn more about whether that level is achievable and 

at what cost. 

Fee for physician interaction with care 

management The second component of payment under 

both of our models is a fee to recognize the physicians’ 

time to interact with the care management program on 

behalf of their complex eligible patients. The goal of 

this fee is to encourage physician involvement in care 

coordination. 

Currently, CMS does not pay physicians to participate in 

any of these programs. Provider groups and the current 

care management organizations have an incentive to 

engage physicians because they are at risk for achieving 

savings. Our interviewees, particularly those not affiliated 

with a provider group, described numerous mechanisms 

they currently use to engage enrollees’ personal 

physicians, including sharing the care management fee 

CMS pays to the organization with their beneficiaries’ 

physicians. 

The Medicare program could decide that the incentives in 

current models are sufficient for encouraging physicians 

to interact with the care coordination programs and that 

direct Medicare payments are not necessary. However, 

interviewees have noted that some physicians do not view 

external programs as supportive because they demand 

time for which their offices are not compensated. While 

it may not be as necessary to provide these payments for 

physicians in provider groups, they will also need to spend 

time interacting with the care coordination program, even 

if it is internal to the practice. Further, if our illustrative 

models coexisted, the Commission would not want to 

disadvantage physicians who practice in more integrated 

systems of care. Therefore, both of our illustrative models 

include payments to physicians or groups to pay for time 

spent communicating with the care management program 

generally outside of office visits. 

How would the physician office fee work? Medicare 

could establish monthly fees to cover the interactions 

between physicians and the care management program. 

Although some face-to-face visits are necessary to discuss 

program enrollment options and referral requirements, 

Medicare’s payments would primarily be aimed at 

covering non-face-to-face activities involved in the 

patients’ care coordination. The fee would cover activities 

related to referrals, patient information transfers, care 

plan oversight, and ongoing communications between the 

physician’s office and the care management organization 

on patient status and progress. The fee would not require 

the physician to bill separately for these activities. For 

example, physicians would not bill separately for phone 

calls on behalf of the enrolled patient; rather, physicians 

would document this activity and consider it covered in 

their monthly fee from Medicare. 

This new fee would be introduced as a new code on 

the physician fee schedule. As with other fee schedule 

services, these expenditures would be accommodated by 

reallocating dollars among all services in the fee schedule. 

A certain level of documentation would be required to 

ensure that the services for this code were provided when 

billed. Although Medicare does not generally reimburse 

for non-face-to-face encounters, some precedents do exist, 

and are discussed in the text box.9

Enrollment and eligibility 

In both models, we assume that CMS would use 

administrative data to identify a population for which 

the care management organization would be evaluated 

for cost savings. We also assume that physicians would 

refer additional patients. If a physician office wished 

to be compensated for time coordinating with the care 
Report to the Congress: Increasing the Value of Medicare | June 2006 49

management program, its eligible patients would need to 

designate the physician as their primary source of care in 

order to receive the care coordination services but could 

switch designations at any time. 

In both models, the accountable entity would determine 

which beneficiaries need differing levels of care 

coordination services. However, the calculations of cost 

savings necessary for determining payment would be 

performed on the overall population identified by CMS. 

In addition to direct enrollment by the care management 

organization, physicians would be encouraged to refer 

eligible patients to the program in both models. One 

question would be whether the care management program 

would be required to accept all physician referrals, given 

it would be at risk for cost savings and physicians might 

Examples of current coverage for care coordination without face-to-face contact

For home health and hospice patients, Medicare 

covers three activities that physicians provide—

certification, recertification, and care plan 

oversight (CPO)—without requiring face-to-face 

encounters. This coverage recognizes the need for 

physicians to provide important care management 

activities without requiring the patient or the physician 

to make face-to-face contact. This exception to 

Medicare’s general face-to-face requirement shows an 

example of how Medicare can broaden its coverage of 

care coordination activities to include the interaction 

of physicians with care management organizations for 

complex patients. It also illustrates ways that Medicare 

can direct payments for care coordination activities 

through the physician fee schedule.

The physician fee schedule includes billable codes for 

certification, recertification, and CPO of home health 

and hospice patients. Billable activities include:

• communication with interdisciplinary team and 

pharmacist, including phone calls or other verbal 

communication;

• review of patient status reports;

• modification of plan of care, including the review 

and signing of modification orders; and

• review of lab results, reports, and records.

CPO must be furnished by a physician, a nurse 

practitioner, clinical nurse specialist, or physician 

assistant with a collaborative relationship with the 

physician who signed the initial hospice or home health 

agency plan of care. Beneficiaries can receive CPO 

services if they require complex treatment, are being 

cared for by multidisciplinary teams, and are enrolled 

in a Medicare-approved home health agency or hospice.

The CPO services must take at least 30 minutes in a 

calendar month to be billable. The services do not need 

to be provided on the same day, but the total services 

over the course of a month must add up to at least 30 

minutes. The physician or nonphysician practitioner 

must personally document the date, the time spent, 

and a brief description of the activities provided in the 

patient's record. The physician must have had a faceto-face service with the patient within six months of 

billing for the CPO.

A precedent also exists for monthly fees for care 

management activities for certain physicians treating 

specified patients. Medicare makes monthly payments 

to physicians who provide renal dialysis services to 

patients with end-stage renal disease. This fee includes 

many of the evaluation and management activities 

involved with dialysis patient care, including care 

coordination activities provided during the month, such 

as telephone calls and coordination with dieticians and 

social workers.

Although adjusted by the number of times the physician 

makes face-to-face contact with the patient, the fee 

includes coverage for non-face-to-face activities that 

occur between visits. Like the CPO requirements, the 

monthly service codes represent a full calendar month 

of services. Also, only one physician per patient may 

bill for the monthly fee. 50 Care coordination in fee-for-service Medicare

refer less complex patients when paid for coordinating 

their care. 

We also assume that the patients in both models would 

need to demonstrate a certain level of commitment for 

working with the physician’s office. While not locked into 

only seeing this physician, beneficiaries could identify 

the practitioner they believe oversees most aspects of their 

care and designate him or her to be the contact with the 

care management program. This practitioner, or the group 

on behalf of the practitioner in the case of a providerbased program, would receive the monthly fee when the 

beneficiary enrolls in the care management program. 

This designation of a primary physician is also a part of 

the Advanced Medical Home concept described in the 

previous section: Patients are encouraged to choose one 

physician, either a primary care physician or a specialist 

for the patients’ chief chronic medical condition, whose 

office will serve as the central resource. 

Accountability

How can Medicare ensure that the care coordination 

programs are effective and that the physician fee is 

being used for what it was intended? Care coordination 

programs should be evaluated both in terms of cost savings 

and quality improvement. Physician accountability for 

interacting with the care coordination program is also 

important.

Regarding cost savings, much of the accountability is built 

into the payment mechanism. In both our models, the care 

coordination program would be accountable for a certain 

level of cost savings. 

Related to quality, a variety of process and outcome 

measures are currently in use in the CMS pilot and 

demonstrations and we see them as a part of our two 

models. Additionally, surveys of patients’ perceptions 

of care could also provide information on patients’ 

experience with the program.

Table 2-4 shows the mix of process and outcomes 

measures used in the PGP demonstration, many of which 

are also used by CMS for evaluating MHS contractors. 

Other outcomes measures, such as reduced admissions 

(including readmissions), could also be used for both cost 

and quality accountability. 

Patient surveys could also capture patient experience in 

the program. Several of our interviewees noted that CMS 

was including this type of information in its assessments. 

The interviewees also used patient perceptions to gauge 

the performance of their own organization. One survey 

(the Care Transitions Measures) could be used to assess 

patients’ knowledge of how to manage their condition, 

including recognition of symptoms that indicate they 

should see a physician (see text box on page 38). The 

MHS pilot includes patient satisfaction as one measure of 

accountability. 

After the appropriate quality measures are defined, 

how they are used for payment is also an issue. In the 

PGP demonstration, the level of savings available to the 

organization varies based on quality scores. Over the three 

years of the demonstration, the percentage of payments 

based on quality scores increases. In the first year, quality 

scores are 30 percent of the overall score, whereas in the 

third year they rise to 50 percent of the score. Over time, 

as it becomes more difficult to calculate cost savings, 

CMS could rely more heavily on quality measures and 

could focus those measures on conditions most influenced 

by care coordination services. 

Physician offices that bill for the fee to coordinate with the 

care management program would be accountable for their 

fees in much the same way they are accountable for other 

fee schedule services they provide. Because physician fees 

would not be at risk, establishing practical mechanisms of 

physician accountability will be important. Historically, 

Medicare’s reluctance to pay for services that do not 

require the patient’s presence is based on program integrity 

concerns. However, recent exceptions to the face-to-face 

requirement include ways to establish accountability 

documentation for fees billed to Medicare without face-toface contact. Physicians may also share in accountability 

for the quality measures through a pay-for-performance 

program. 

Other mechanisms to improve chronic care 

management 

Several other mechanisms can directly and indirectly 

improve care coordination and chronic care management. 

For example, Medicare could increase payments for 

evaluation and management (E&M) services or establish 

new billing codes to enhance payments for chronic care 

patients associated with face-to-face visits. These higher 

payments could be applied generally across all E&M 

codes, or they could be limited to services provided 

to patients with multiple chronic conditions. Other 

mechanisms include pay-for-performance initiatives 

and strategies to accelerate the adoption of information 

technology.
Report to the Congress: Increasing the Value of Medicare | June 2006 51

Medicare fee-for-service already covers some care 

coordination services in its current E&M codes, as 

described in the text box on page 53. Although these 

commonly used codes technically include time for preand post-visit care coordination activities associated with 

office visits, they may not adequately account for the extra 

time and effort needed for complex patients either within 

the visit or between visits. This concern is compounded 

for physicians who have higher-than-average shares of 

patients with chronic illnesses. New medications and 

clinical protocols may warrant the introduction of new 

or higher payments for tracking and monitoring complex 

patient care. During our research, interviewees and experts 

repeatedly stated that even upper-level E&M codes have 

not kept pace with the physician resources needed for preand post-visit time necessary to treat complex patients.

Additionally, the physician fee schedule provides financial 

incentives for the physician to see more patients rather 

then spend extra time counseling a patient during a visit. 

That is, physicians may bill certain add-on codes for faceto-face visits that significantly exceed the usual service 

duration, but these codes carry lower payments than the 

physician may otherwise receive seeing a different patient 

for the same amount of time.

The American Medical Association/Specialty Society 

Relative Value Scale Update Committee (RUC) recently 

recommended an increase in payments for the majority of 

Medicare’s E&M codes (Coughlin 2006). These increases 

are not limited to complex patients but apply to all patients 

with longer visits. These recommendations apply to the 

work relative value units (RVUs) of the Medicare fee 

schedule.10 If CMS accepts the RUC’s recommendations, 

then it will designate the RVU increases for selected E&M 

codes in its proposed rule for the 2007 physician fee 

schedule.

Broader policies to increase payments for E&M services 

would recognize the importance of care management 

services that are directly linked to face-to-face E&M 

visits. Similarly, establishing new billing codes for 

comprehensive services provided to beneficiaries with 

multiple chronic conditions could help achieve these goals. 

Physicians and other Part B providers, such as nurse 

practitioners, who play larger roles in patient care 

management would be most likely to bill these codes. 

These providers may include any type of physician who 

manages the care of eligible patients, including primary 

care providers, geriatricians, and specialists, such as 

cardiologists with large caseloads of patients with multiple 

chronic conditions. Because changes in RVUs for fee 

schedule services are done in a budget neutral manner, 

revising or introducing codes for E&M RVUs would 

not theoretically incur additional Medicare spending for 

physician services. 

Pay-for-performance initiatives (in which a portion of 

providers’ payments are based on the quality of their 

care) are an additional mechanism for improving care 

TABLE

2–4 Examples of quality measures: The PGP demonstration

Diabetes CHF CAD Preventive care

HbA1c management

HbA1c control

Blood pressure management

Lipid measurement

LDL cholesterol level

Urine protein testing

Eye exam

Foot exam

Infl uenza vaccination

Pneumonia vaccination

Left ventricular function assessment

Left ventricular ejection fraction 

testing

Weight measurement

Blood pressure screening

Patient education

Beta-blocker therapy

Ace inhibitor therapy

Warfarin therapy

Infl uenza vaccination

Pneumonia vaccination

Antiplatelet therapy

LDL cholesterol lowering drugs

Beta-blocker therapy for a patient 

with prior myocardial infarction

Blood pressure

Lipid profi le

LDL cholesterol level

Ace inhibitor therapy

Blood pressure screening

Blood pressure control

Plan of care

Breast cancer screening

Colorectal cancer screening

Note: PGP (physician group practice), CHF (congestive heart failure), CAD (coronary artery disease), HbA1c (hemoglobin A1c), LDL (low-density lipoprotein).

Source: Research Triangle Institute Project Number 07964.013. Prepared for CMS. Physician Group Practice Demonstration Quality Measurement and Reporting 

Specifi cations, Version 2, July 29, 2005 
52 Care coordination in fee-for-service Medicare

coordination in FFS Medicare. In a recent report to the 

Congress, the Commission discussed design principles 

and implementation issues for establishing pay-forperformance programs in Medicare (MedPAC 2005). 

We recommended that the Congress establish a quality 

incentive payment policy for physicians in Medicare. Such 

a policy could enhance several aspects of care quality, 

including care coordination.

Indicators that measure care quality are likely to capture, 

to some degree, the level of care coordination involved in 

providing care. That is, higher care quality may well signal 

better care coordination. Thus, initiatives to make higher 

payments to providers with better performance on process 

and outcome measures may, in turn, promote better care 

coordination. 

Data management is a major component of care 

coordination programs. Initiatives to accelerate physicians’ 

adoption and use of IT may also improve the coordination 

of care for Medicare beneficiaries. Indeed, pay-forperformance measures could spur physicians to adopt 

information technology that improves care. Further, 

providers would be building the infrastructure needed for 

future quality and pay-for-performance assessments. The 

Commission has recommended that pay-for-performance 

programs include measures of functions that are supported 

by the use of IT. For example, quality measures on 

providers’ ability to track progress on all their Medicare 

patients with diabetes could encourage physicians to adopt 

IT and improve care coordination. Report to the Congress: Increasing the Value of Medicare | June 2006 53

Current fee schedule billing allowance for care coordination activities

The physician fee schedule includes a family of 

evaluation and management (E&M) codes for 

billing Medicare based on different types of 

encounters, such as office or hospital visits with either 

new or established patients. Under the fee-for-service 

payment system, physicians and certain nonphysician 

practitioners (such as nurse practitioners and physician 

assistants) bill Medicare for E&M services using the 

physician fee schedule. Other office personnel, such as 

registered nurses, may perform activities included in the 

E&M service considered “incident to” the physician’s 

service, such as taking a blood pressure or calling the 

patient with lab results.

In general, care coordination and care management 

services are considered a part of the E&M visit, and 

Medicare requires that the patient and the provider 

have a face-to-face encounter to bill for such services. 

Each E&M code includes physician time allotted for 

preparing, caring for, and following up on patients. 

These times are called pre-, intra- and post-service 

times and they are included in the physician work 

valuation of the code. Activities conducted by support 

staff (including registered nurses, licensed practical 

nurses, medical secretaries, receptionists, and 

technicians) are included in the practice cost relative 

values.

The fee schedule lists E&M codes by the level of care 

provided to allow for a continuum of relative values 

and corresponding fees for each service. Specifically, 

E&M codes are broken down by the degree to which 

three service components—history, exam, and medical 

decision making—occurred during the service. 

Therefore, physicians usually bill Medicare based on 

the content of the service they provided rather than the 

amount of face-to-face time they had with the patient 

during a visit. 

In cases where face-to-face contact was consumed 

mostly by care coordination and counseling, physicians 

may bill an E&M code based on the total time the 

physician spent with the patient rather than the extent 

to which the three service components were included 

in the visit. For example, if a face-to-face visit focuses 

mostly on a review of treatments prescribed by a 

patient’s specialists and does not include an exam or 

medical history, the physician may still bill as if these 

components were present. Thus, when care coordination 

activities consume most of an appointment, they can 

be substituted for other required components that are 

needed to support code selection.

Additionally, physicians may bill certain add-on codes 

for visits that significantly exceed the usual service 

duration. These are called prolonged service codes, 

and CMS specifies that physicians may bill them when 

face-to-face contact during an E&M visit exceeds 

specified time thresholds by at least 30 minutes. 54 Care coordination in fee-for-service Medicare

1 The Commission recommended in the March 2005 report 

to the Congress that Medicare build incentives for quality 

improvement into the payment systems for hospitals, 

physicians, home health agencies, dialysis facilities and 

physicians who treat dialysis patients, and Medicare 

Advantage plans. We also recommended that CMS 

measure the relative resource use of physicians and provide 

confidential feedback. 

2 This analysis was based on the number of evaluation and 

management claims with unique personal identification 

numbers for beneficiaries in 2003.

3 Many of the programs we describe in this report use other 

terms for their activities, such as disease management or case 

management. Disease management programs promote selfmanagement, but for the most part have not been designed 

to manage health conditions broader than a specific disease 

(Wolff and Boult 2005). Care coordination uses disease 

management tools, but applies them broadly to the whole 

patient with the understanding that Medicare beneficiaries 

who need this level of management often have multiple 

chronic conditions. Some of the attributes of care coordination 

are also similar to case management, whereby a manager 

ensures that care for very sick patients is well managed, often 

within a setting of care.

4 Other types of information gathering tools include home 

monitoring devices, such as special phones that patients use 

to call in vital signs, easy-to-use blood pressure cuffs, and 

patients’ scales that automatically send the readings to the care 

management database. 

5 One program used a salaried group of physicians, in addition 

to a nurse care manager, to do home visits for a defined client 

base. It is yet to be seen if this is a cost-effective model. 

The beneficiaries in this program are very complex, and the 

concept is to provide hospital-level care at home. If the patient 

needs urgent physician attention, the organization can send 

the physician to the home rather than referring the patient 

to the emergency department or hospital. The organization 

stated that patients who are hospitalized are often sent home 

earlier because the physicians in the hospital know that they 

are discharging the patient to a physician. The patients still 

see their primary physician, but physicians who do the home 

visits are also available and familiar with the patient’s needs. 

6 In some programs, such as the physician group practice 

demonstration sites, beneficiaries did not have to agree to 

participate. They were a part of the program (with varying 

degrees of intervention) if they were patients of the physician 

or other providers who provided care coordination services.

7 Even though some beneficiaries in the group died, a sizable 

portion of people in the top 5 percent subsequently had lower 

spending. 

8 Rates of readmission decrease significantly for these 

conditions if the analysis only includes readmissions for the 

same diagnosis. However, our analysis still shows that these 

beneficiaries are vulnerable to repeat admissions, regardless 

of the primary diagnosis. 

9 Although the Current Procedural Terminology list of billing 

codes, published by the AMA, includes some non-face-to-face 

physician services, such as a phone consultation, Medicare 

does not associate them with any RVUs and thus does not 

make payments for these codes. 

10 For a further description of the Medicare physician fee 

schedule and its use of RVUs, see MedPAC’s Payment Basics 

series at http://www.medpac.gov/publications/other_reports/

Dec05_payment_basics_physician.pdf.

Endnotes
Report to the Congress: Increasing the Value of Medicare | June 2006 55

American College of Physicians. 2006. The advanced medical 

home: A patient-centered, physician-guided model of health care.

Policy monograph. Washington, DC: ACP.

Bodenheimer, T., E. H. Wagner, and K. Grumbach. 2002. 

Improving primary care for patients with chronic illness. Journal 

of the American Medical Association 288, no. 14 (October 9): 

1775–1779.

Casalino, L., R. R. Gillies, S. M. Shortell, et al. 2003. External 

incentives, information technology, and organized processes to 

improve health care quality for patients with chronic diseases. 

Journal of the American Medical Association 289, no. 4 (January 

22/29): 434–440.

Chodosh, J., S. C. Morton, W. Mojica, et al. 2005. Meta-analysis: 

Chronic disease self-management programs for older adults. 

Annals of Internal Medicine 143, no. 6: 427–438.

Coleman, E. A., E. Mahoney, and C. Parry. 2005. Assessing the 

quality of preparation for posthospital care from the patient’s 

perspective: The Care Transitions Measure. Medical Care 43, no. 

3 (March): 246–254.

Coleman, E. A., J. D. Smith, J. C. Frank, et al. 2004. Preparing 

patients and caregivers to participate in care delivered across 

settings: The care transitions intervention. Journal of the 

American Geriatrics Society 52, no. 11 (November): 1817–1825.

Coleman, E. A. 2003. Falling through the cracks: Challenges 

and opportunities for improving transitional care for persons 

with continuous complex care needs. Journal of the American 

Geriatric Society 51, no. 5: 373–383.

Congressional Budget Office. 2005. High-cost Medicare 

beneficiaries. Washington, DC: CBO. 

Congressional Budget Office. 2004. An analysis of the literature 

on disease management programs. Washington, DC: CBO. 

Coughlin, B. 2006. You could see big increases in most E&M 

services next year. Part B News Online 20, no.13. March 27.

Fireman, B., J. Bartlett, and J. Selby. 2004. Can disease 

management reduce health care costs by improving quality? 

Health Affairs 23, no. 6 (November/December): 63–75. 

Forster, A. J., H. J. Murff, J. F. Peterson, et al. 2003. The incidence 

and severity of adverse events affecting patients after discharge 

from the hospital. Annals of Internal Medicine 138, no. 3 

(February): 161–174. 

Goetzel, R. Z., R. J. Ozminkowski, V. G. Villagra, et al. 2005. 

Return on investment in disease management: Review. Health 

Care Financing Review 26, no. 4 (Summer): 1–19.

Grumbach, K., and T. Bodenheimer. 2002. A primary care home 

for Americans. Journal of the American Medical Association 288, 

no. 7 (August 21): 889–893.

Hing, E., D. K. Cherry, D. A. Wodwell. 2005. National 

Ambulatory Medical Care Survey: 2003 summary. Advance data 

from vital and health statistics, no. 265. Hyattsville, MD: National 

Center for Health Statistics.

Institute of Medicine. 2001. Crossing the quality chasm: A new 

health system for the 21st century. Washington, DC: National 

Academy Press. 

Joyce, G. F., E. B. Keeler, B. Shang, et al. 2005. The lifetime 

burden of chronic disease among the elderly. Health Affairs Web 

Exclusives (September 26). http://www.healthaffairs.org.

Medicare Payment Advisory Commission. 2005. Report to the 

Congress: Medicare payment policy. Washington, DC: MedPAC. 

Medicare Payment Advisory Commission. 2004. Report to 

the Congress: New approaches in Medicare. Washington, DC: 

MedPAC.

McGlynn, E. A., S. M. Asch, J. Adams, et al. 2003. The quality of 

health care delivered to adults in the United States. New England 

Journal of Medicine 348, no. 26 (June 26): 2635–2645.

Min, L. C., D. B. Reuben, C. H. MacLean, et al. 2005. Predictors 

of overall quality of care provided to vulnerable older people. 

Journal of the American Geriatrics Society 53, no. 10 (October): 

1705–1711.

Naylor, M. D., D. Brooten, R. Campbell, et al. 1999. 

Comprehensive discharge planning and home follow-up of 

hospitalized elders. Journal of the American Medical Association

281, no. 7 (February 17): 613–620.

Rich, M. W., V. Beckham, C. Wittenberg, et al. 1995. A 

multidisciplinary intervention to prevent the readmission of 

elderly patients with congestive heart failure. New England 

Journal of Medicine 333, no. 18 (November 2): 1190–1195.

Rittenhouse, D. R., D. Grumbach, E. O’Neill, et al. 2004. 

Physician organization and care management in California: From 

cottage to Kaiser. Health Affairs 23, no. 6 (November/December): 

51–62. 

References
56 Care coordination in fee-for-service Medicare

Rothman, A. A., and E. H. Wagner. 2003. Chronic illness 

management: What is the role of primary care? Annals of Internal 

Medicine 138, no. 3 (February 4): 256–261.

Schoen, C., R. Osborn, P. T. Huynh, et al. 2005. Taking the 

pulse of health care systems: Experiences of patients with 

health problems in six countries. Health Affairs Web Exclusives 

(November 3). http://www.healthaffairs.org.

Wagner, E. H., B. T. Austin, C. Davis, et al. 2001. Improving 

chronic illness care: Translating evidence into action. Health 

Affairs 20, no. 6 (November/December): 64–78.

Wolff, J. L., and C. Boult. 2005. Moving beyond round pegs and 

square holes: Restructuring Medicare to improve chronic care. 

Annals of Internal Medicine 143, no. 6 (September 20): 439–445.

Yarnall, K. S., K. I. Pollak, T. Østbye, et al. 2003. Is there enough 

time for prevention in primary care? American Journal of Public 

Health 93, no. 4 (April): 635–641. 
CHAPTER 3

Medicare’s hospice 

benefit: Recent trends and 

consideration of payment 

system refinements

Report to the Congress: Increasing the Value of Medicare | June 2006 59

Medicare’s hospice 

benefit: Recent trends and 

consideration of payment 

system refinements

Chapter summary

Medicare’s hospice benefit has grown dramatically since its inception in 

1983. Between 2000 and 2004, the total number of hospice users among 

beneficiaries rose almost 50 percent, while the total number of covered 

days of hospice care doubled. The payment system was developed from 

a demonstration project that analyzed the costs of hospice care for 

patients with terminal cancer diagnoses who lived in the community. 

As the number of users has grown, the population of hospice patients 

has become more diverse. Today, more Medicare hospice patients 

have noncancer principle diagnoses than cancer diagnoses and hospice 

patients can live in the community or in nursing homes. 

Growth of the benefit and changes in the hospice population have led 

this Commission and others to suggest that the hospice payment system 

should be evaluated to assess whether it should be modified to improve 

payment accuracy. To test possible payment refinements in light of 

limited Medicare data, the Commission contracted with RAND to test 

the ability of case-mix adjusters to improve the predictive power of the 

hospice payment system. RAND used data on all Medicare patients 

In this chapter

• Growth and change in 

Medicare’s hospice benefit

• Consideration of payment 

system refinements

• Medicare hospice payment: 

Directions for further 

investigation

C H A P T E R 3
60 Medicare’s hospice benefit: Recent trends and consideration of payment system refinements

served by agencies of one large, multi-state, for-profit hospice chain for this 

analysis because its data contained detailed information not available from 

Medicare administrative records. 

RAND found that adding diagnosis and other patient characteristics did not 

improve the ability of the number of days in the current per diem payment 

categories to predict variation in labor costs associated with a hospice 

episode. Results from analysis of this single chain do not rule out that 

additional case-mix adjusters would improve the accuracy of the per diem 

payment system if tested on a more representative population of hospice 

patients and providers. Nor can we conclude that case-mix adjusters would 

not improve the explanation of the variation in costs in an analysis that 

included data on all costs of hospice care, not just visit labor costs. The 

results from this study also show that the first and last days of the stays have 

more visits and higher visit labor costs than the intervening days. Higher 

payments for the beginning and end of stays, relative to the middle days of 

the stay, may result in more accurate payments. However, these results from a 

single chain’s data are suggestive and should not be considered generalizable 

to all Medicare hospice patients without further evaluation.

Such evaluations would assess whether Medicare could improve the 

accuracy of the payment system. Paying accurately for all types of patients 

is important to ensure that the program is paying rates that cover providers’ 

costs for all types of patients. The program needs to collect more detailed 

data from Medicare-participating hospice agencies to assess the relationship 

between patient characteristics and the frequency and intensity of services 

for a representative group of hospice users. An analysis of payment 

adequacy, such as those the Commission undertakes annually for other health 

care sectors covered by the Medicare program, could provide information 

about access to hospice care for Medicare beneficiaries, providers’ access 

to capital, and the relationship of payments to costs of Medicare patients in 

hospice. These findings, along with data on the use of hospice and supply of 

providers, could inform an assessment of the adequacy of Medicare hospice 

payment policies. Report to the Congress: Increasing the Value of Medicare | June 2006 61

Growth and change in Medicare’s 

hospice benefit

The Medicare program began offering a hospice benefit 

in 1983 (HCFA 1983). From the beginning of the benefit, 

Medicare paid hospices using a prospective payment rate 

for each day of care. The payment method and Medicare 

base rates were developed using cost data from 26 

hospices providing care to Medicare patients with terminal 

cancer under a Health Care Financing Administration 

demonstration project between 1980 and 1982. The 

payment rates have been increased for inflation and other 

cost increases, but the payment method and the base rates 

for hospice care have not been updated since the initiation 

of the benefit. 

Medicare spent $6.7 billion on hospice care in 2004. The 

CMS Office of the Actuary estimates that the Medicare 

program will spend $9.8 billion on hospice care for 

beneficiaries in 2006 (OACT 2005). Hospice services’ 

spending is projected to increase at an average rate of 9 

percent per year from 2004 to 2015. This rate outpaces 

the growth in spending projected for hospital, physicians, 

skilled nursing facility, and home health services. During 

the same period the number of Medicare beneficiaries 

is expected to grow at an average annual rate of about 2 

percent per year.

Changes raise payment accuracy 

questions, but data are limited

Since the establishment of the benefit, the population of 

hospice users has become more diverse and the practice of 

caring for hospice patients has changed. For example, the 

proportion of patients with cancer as the primary hospice 

admission diagnosis steadily declined from 75 percent in 

1992 to 58 percent in 2000 (NCHS 2003). An analysis 

performed by RAND for the Commission found that in 

2002 and 2003, the share of hospice users with cancer 

diagnoses had fallen to 43 percent. Neurodegenerative 

conditions such as dementia, end-stage Alzheimer’s 

disease, and Parkinson’s disease were the most common 

noncancer primary diagnoses among Medicare hospice 

patients, followed by cardiovascular disease. These 

changes raise the question of whether the Medicare 

hospice payment system accounts for the current costs 

of caring for hospice users that have terminal diagnoses 

unlike those patients in the original demonstration.

Another change has been growth in the use of hospice 

care among patients who reside in nursing home settings 

(Miller et al. 2000).1

 Nursing home patients were not 

included in the original demonstration that was used 

to develop the payment categories and base payment 

rates (Greer et al. 1983). But precisely tracking the use 

of hospice among nursing home residents over time is 

difficult because Medicare hospice data do not readily 

allow identification of nursing home residents. One study 

using Medicare data estimated that 45 percent of hospice 

patients lived in nursing homes between 1996 and 1999 

(Campbell et al. 2004).2

Costly but beneficial treatments that may be both palliative 

and curative have been developed since the benefit began 

(Lorenz et al. 2004, Huskamp et al. 2001). But, because of 

limited data, the extent to which these treatments are being 

used is unclear. Some evidence of changes in the provision 

of hospice care come from a Government Accountability 

Office (GAO) study that found the relative costs of 

services that make up a typical day of hospice care have 

changed since the inception of the benefit (GAO 2004). 

Costs for home health aides, supplies, and outpatient 

services make up a smaller share of the cost of a day of 

routine home care—the most commonly billed category of 

Medicare hospice care—since the hospice demonstration. 

In contrast, costs of nursing, drugs, social services, and 

durable medical equipment have increased as a share of 

routine home care costs per day. For Medicare’s coverage 

rules and examples of covered services, see the text box on 

page 62. 

Evaluation of the relationship between current patients’ 

characteristics and costs could determine whether these 

changes in the use of hospice and the mix of services 

matter—that is, whether the current payment system 

allocates payments according to the variation in the costs 

of different patient types. However, Medicare does not 

collect beneficiary-level data on the number and types 

of visits and the use of drugs, equipment, and supplies. 

Hospices report aggregate data on cost reports, but these 

do not allow us to understand differences among patients. 

Claims tell only the type of day for which the hospice was 

paid, not what resources were used. Medicare data on the 

characteristics of hospice users are also limited. Unlike 

in many other prospective payment systems, the program 

does not require hospice agencies to collect or report 

patient characteristics using a standard patient assessment 

instrument. Consequently, as currently collected, Medicare 

data do not permit a detailed assessment of the relationship 

between patient-level characteristics and service use and 

cost. For example, the claim does not indicate whether 

a beneficiary lives in the community alone or with a 
62 Medicare’s hospice benefit: Recent trends and consideration of payment system refinements

caregiver or lives in a nursing home—circumstances that 

might affect service use or agencies’ costs.

Payment categories and rates

The Medicare program pays hospice providers a set rate 

for each day a beneficiary elects the hospice benefit. 

Payment for each day is not contingent on a patient 

receiving a visit on a given day and providers are not 

required to report visit data to the program. Although a 

patient may not receive a visit on a given day, the hospice 

may still incur costs of on-call services, care planning, 

Hospice coverage rules

The Medicare hospice benefit covers palliative 

and support services for beneficiaries who 

have a life expectancy of six months or less if 

the disease follows its normal course. Two physicians, 

typically the patient’s own doctor and the hospice 

physician, must certify the prognosis for a patient to 

be eligible to elect hospice. Covered services under the 

hospice benefit include:

• skilled nursing care;

• drugs and biologicals for pain control and symptom 

management;

• medical equipment and supplies;

• physical, occupation, and speech therapy;

• social work services and counseling;

• home health aide and homemaker services;

• short-term inpatient care;

• inpatient respite care; 

• grief support for the patient and family; and

• other services necessary for the palliation and 

management of the terminal illness.

Beneficiaries who elect the Medicare hospice benefit 

agree to forgo Medicare coverage for curative treatment 

for the terminal illness. Medicare continues to cover 

items and services unrelated to the terminal illness. The 

first hospice benefit period is 90 days. The patient can 

then be recertified for another 90 days. After the second 

90 days the patient can be recertified for subsequent 60-

day periods. There is no limit on the number of benefit 

periods beneficiaries may elect as long as they remain 

eligible. Beneficiaries can switch from one hospice to 

another one time during a hospice election period and 

can disenroll from hospice at any time.

The interdisciplinary team must establish, maintain, 

and follow a written plan of care for each person 

admitted to a hospice program, according to Medicare’s 

current conditions of participation for hospices.3

 The 

interdisciplinary team consists of a physician, registered 

nurse, social worker, and pastoral or other type of 

counselor. Hospices are also required to use volunteers 

to provide services equal to at least 5 percent of total 

paid patient care time. The plan of care must assess 

the patient’s needs, identify services to be provided 

(including management of discomfort and symptom 

relief), and describe the scope and frequency of services 

needed to meet the patient’s and family’s needs. 

Hospice care is carved out of Medicare’s managed care 

benefit, Medicare Advantage.4

 Medicare Advantage 

plan enrollees can elect hospice care outside their plan 

under the same eligibility rules as beneficiaries in feefor-service Medicare. Beneficiaries who elect hospice 

care do not need to disenroll from their Medicare 

Advantage plan, although they may choose to do so. 

When a Medicare Advantage enrollee elects hospice 

care and remains enrolled in a Medicare Advantage 

plan, the plan is no longer financially liable for all 

Medicare-covered services the beneficiary uses while in 

hospice care. Medicare, therefore, reduces its monthly 

capitated payment for that beneficiary. Fee-for-service 

Medicare pays for the hospice care as well as care 

unrelated to the terminal condition. The plan continues 

to be liable, however, for Part D benefits (prescription 

drugs) and non-Medicare benefits (e.g., vision or dental 

care) that it offers to its enrollees. Medicare’s reduced 

capitated payment is meant to cover this liability. Report to the Congress: Increasing the Value of Medicare | June 2006 63

drugs, or supplies for the patient. Medicare pays according 

to a fee schedule that has four base payment amounts for 

four categories of care: routine home care, continuous 

home care, inpatient respite care, and general inpatient 

care. Two caps apply to hospice agencies’ payments each 

year. See the text box on page 64 for more information 

about the hospice caps.

In 2002 and 2003, 93 percent of Medicare hospice days 

were paid at the routine home care rate, 4.1 percent were 

continuous home care days, 2.7 percent were inpatient 

respite care days, and 0.2 percent were general inpatient 

care days. The payment categories are distinguished by the 

location and intensity of the services provided. Payment 

rates vary according to expected input cost differences 

based on the hospice demonstration data. The base 

payment rates are adjusted for geographic differences in 

wages by multiplying the labor share, which varies by 

category, of each base rate by the applicable hospice wage 

index (Table 3-1).5

 A hospice is paid the routine home care 

rate for each day the patient is enrolled in hospice unless 

the hospice provides continuous home care, inpatient 

respite care, or general inpatient care. 

Beneficiary liability for hospice services is minimal. 

Hospices may charge a 5 percent coinsurance for each 

drug furnished outside the inpatient setting, but the 

coinsurance may not exceed $5 per drug. For inpatient 

respite care, beneficiaries are liable for 5 percent of 

Medicare’s respite care payment per day. Beneficiary 

coinsurance for respite care may not exceed the Part A 

inpatient deductible, which was $952 per year in 2006.

Hospice providers’ costs and payments

The Commission has never formally analyzed the 

adequacy of Medicare hospice payments because data 

on Medicare costs and payments at the agency level 

have been limited.6

 Between 1992 and 1999, hospices 

were not required to submit Medicare cost reports. 

However, the Balanced Budget Act of 1997 required 

hospice agencies to submit a cost report for each fiscal 

year, beginning in 1999. Unlike cost reports for other 

providers, such as hospitals, skilled nursing facilities, and 

home health agencies, the Medicare hospice cost report 

collects Medicare cost data, but not Medicare payment 

information. Medicare payments to each agency must 

be calculated from claims by matching claims for the 

time period overlapping the cost-reporting period. In 

addition, agencies were not required to submit electronic 

cost reports until reporting periods beginning on or after 

December 31, 2004.

Although data are limited, the available information about 

hospice margins suggests they vary by facility size and 

other characteristics. For example:

• The GAO estimated that the Medicare per diem rate 

for all hospice care in freestanding hospices was 8 

percent higher than Medicare costs in 2000 and over 

10 percent higher in 2001 (GAO 2004).7

 Smaller 

hospices had, on average, higher per diem costs than 

large or medium hospices for each of the payment 

categories.8

 Medicare costs were lower than payments 

for continuous home care, routine home care, and 

general inpatient care days, but costs were higher than 

Medicare payments for inpatient respite care days. 

TABLE

3–1 Medicare hospice payment categories and rates, FY 2006

Category Description

Base 

payment rate

Labor 

share

Share of 

days

RHC Home care provided on a typical day $126 per day 69% 93.0%

CHC Home care provided during periods of patient crisis 30.76 per hour 69 4.1

IRC Inpatient care for a short period to provide respite for primary caregiver 131 per day 54 0.2

GIC Inpatient care to treat symptoms that can not be managed in another setting 563 per day 64 2.7

Note: FY (fi scal year), RHC (routine home care), CHC (continuous home care), IRC (inpatient respite care), GIC (general inpatient care). Payment for CHC is an hourly 

rate for care delivered during periods of crisis if care is provided in the home for 8 or more hours within a 24-hour period beginning at midnight. A nurse must 

deliver half of the hours of this care to qualify for CHC-level payment. The minimum daily payment rate at the CHC level is $246 per day (8 hours at $30.75 per 

hour); maximum daily payment at the CHC level is $738 per day (24 hours at $30.75 per hour).

Source: Base payment rates and labor shares are from CMS Manual System Pub 100–04 Medicare Claims Processing, Transmittal 663, CR 3977, “Update to the Hospice 

Payment Rates, Hospice Cap, Hospice Wage Index and the Hospice Pricer for FY 2006.” Data on share of days are from RAND Corporation’s analysis of 100 

percent hospice standard analytic fi les from CMS for calendar years 2002 and 2003.
64 Medicare’s hospice benefit: Recent trends and consideration of payment system refinements

• Total margins of freestanding hospices varied by 

agency size and for-profit/nonprofit status, according 

to an analysis using 2003 freestanding hospice costreport data (McCue and Thompson 2005).10 For 

example, the median margin for large for-profit 

agencies was 18 percent, but the median for large 

nonprofits was 2 percent. However, these total 

margins are calculated using all payers’ payments 

and all patients’ costs so they may not be the same as 

Medicare margins.

• Hospice industry data also showed that total margins 

varied by agency size as measured by average daily 

census from an average of 11 percent to 19 percent in 

2004 (NHPCO 2005). However, excluding fundraising 

dollars, the National Hospice and Palliative Care 

Organization (NHPCO) reports average agency 

margins of 2 percent (NHPCO 2006). These margin 

data are from a small number of agencies voluntarily 

reporting their calculations to the NHPCO and 

therefore are not representative of all hospice 

providers.11 These, too, are total margins so they may 

not be the same as Medicare margins.

Given the age and lack of representativeness of the 

currently available information, these data are merely 

suggestive of the magnitude and variability of the current 

relationship between costs and payments across the 

industry. Additional analysis of the most recent Medicare 

cost and payment data for a representative group of 

hospices is needed to confirm the magnitude and variation 

of current Medicare margins for hospice providers, which 

could in turn inform an understanding of the adequacy of 

Medicare payment for hospice services. 

Hospice caps

When the hospice benefit was established, 

two caps were formulated to limit program 

liability for hospice spending. One cap 

limits the share of inpatient care days (either inpatient 

respite care or general inpatient care) an agency may 

provide to 20 percent of its total patient care days each 

year. This cap was also intended to prevent hospice care 

from becoming a predominantly inpatient benefit and 

to preserve the delivery of hospice care in the patient’s 

home (Gage et al. 2000). If an agency exceeds the 20 

percent inpatient cap, Medicare pays the routine home 

care rate for the days above the threshold. 

The second cap limits the average annual payment 

per patient a hospice can receive from the program.9

The average annual payment cap is calculated for the 

period November 1 through October 31 each year. For 

the year ending October 31, 2005, the cap amount was 

$19,776. If an agency’s total payments divided by its 

total number of beneficiaries exceed the cap amount, 

then the agency must repay the excess to the program. 

As with the 20 percent inpatient day cap, this cap is 

not a spending limit on each individual beneficiary, but 

is applied at the agency level. The average aggregate 

payment cap is adjusted annually by the medical 

expenditure category of the consumer price index for 

all urban consumers. Unlike the daily payment rates, 

the average aggregate payment cap is not adjusted for 

geographic differences in cost. As a result, an agency 

serving a lower wage area can provide more days of the 

same category of care per beneficiary before reaching 

the cap than an agency serving a higher wage area.

Because the cap is applied at the agency level, hospices 

can fall below the cap by having only patients whose 

lengths of stay do not cause the agency to exceed the 

average annual cap amount. Alternatively, agencies 

can have a mix of patients with long lengths of stay 

and payments in excess of the cap and patients with 

shorter lengths of stay and payments below the cap. 

The number of hospices exceeding the average annual 

payment cap has historically been low. The Government 

Accountability Office found that between 1999 and 

2002 less than 2 percent of hospices reached the cap. 

Two large, publicly traded chain providers have had 

agencies that exceeded the aggregate annual caps, 

which has drawn attention to the caps (Joseph 2005). 

To determine whether more hospices are reaching the 

average annual payment caps, we examined data from 

the four regional home health intermediaries (RHHIs), 

contractors that process and pay Medicare claims. We 

(continued on next page)
Report to the Congress: Increasing the Value of Medicare | June 2006 65

More Medicare beneficiaries used hospice 

in 2004 than in 2000

More Medicare beneficiaries are electing to use hospice 

before they die. The rate of hospice use grew from 22 

percent of decedents in 2000 to 31 percent of decedents 

in 2004. Differences in managed care and fee-for-service 

decedents’ hospice use persisted through 2004, with 

decedents in managed care plans having higher rates 

of hospice use (Figure 3-1, p. 66). Use is still highest 

among white Medicare beneficiaries, with nearly onethird of decedents using hospice. But growth in the use 

of hospice has occurred among beneficiaries in all racial 

and age groups. This increased use of Medicare’s hospice 

benefit suggests improved awareness and appreciation 

of the benefit by physicians, hospitals, patients, and their 

families (MedPAC 2004). In recent years, CMS has also 

promoted the availability of the benefit to providers and 

beneficiaries, for example through advertisements in 

physician journals.

With the increase in the share of decedents electing 

hospice before they die, the total number of hospice users 

has increased (Table 3-3, p. 66). Between 2000 and 2004, 

the number of hospice users increased almost 50 percent 

Hospice caps (cont.)

found that more agencies are reaching the aggregate 

annual cap, but that nearly all of the increase is 

accounted for by agencies in the Palmetto region (Table 

3-2). Through 2003, the share of hospices reaching the 

cap in that region was a relatively small share of total 

agencies. In 2003, the 81 agencies that reached the 

cap were just 3 percent of hospices in the region; in 

2004, the share of hospices reaching the cap jumped to 

almost 15 percent. The 20 percent inpatient cap is rarely 

reached in any of the regions according to data from the 

RHHIs.

Differences in shares of agencies reaching the cap 

across the four RHHIs raise the question of whether 

providers reaching the cap are concentrated in certain 

regions or whether all of the RHHIs are consistently 

applying the cap calculation payment method defined 

by law.12 

TABLE

3–2 Recent trends in the number of hospices reaching

 the annual payment cap vary by region

Regional home health intermediary 2000 2001 2002 2003 2004

Hospices over cap

Associated Hospital Services 0 0 0 0 0

Cahaba 0 2 4 0 N/A

Palmetto 10 21 21 81 128

United Government Services N/A N/A 3 7 10

Overpayment amount (in millions)

Associated Hospital Services $0.0 $0.0 $0.0 $0.0 $0.0

Cahaba 0.0 0.1 0.9 0.0 N/A

Palmetto 5.9 10.3 9.5 57.7 94.6

United Government Services N/A N/A 0.4 2.1 2.8

Note: N/A (not available). The four regions are each served by a different regional home health intermediary (RHHI). Associated Hospital Services is the RHHI 

for providers in CT, MA, ME, NH, RI, and VT. Cahaba is the RHHI for providers in CO, DC, DE, IA, KS, MD, MO, MT, ND, NE, PA, SD, UT, VA, WV, 

and WY. Palmetto is the RHHI for providers in AL, AR, FL, GA, IL, IN, KY, LA, MS, NC, NM, OH, OK, SC, TN, and TX. United Government Services is the 

RHHI for providers in AK, AS , AZ, CA, HI, ID, MI, MN, NJ, NY, NV, OR, WA, and WI. The annual spending cap limits the average annual payment per 

patient a hospice can receive from the program. If an agency’s total payments divided by its total number of benefi ciaries exceed the cap amount, then the 

agency must repay the excess to the program. The cap is adjusted annually by the medical expenditure category of the consumer price index for all urban 

consumers. The fi gures for 2004 are not fi nal because guidance from CMS indicates that the cap amount for this period may change.

Source: Unpublished data from regional home health intermediaries.
66 Medicare’s hospice benefit: Recent trends and consideration of payment system refinements

and the total number of covered days of hospice care 

doubled during that same period.

The increase in the number of covered hospice days 

outpaced the growth in the number of users. This trend 

is driven by increasingly longer lengths of enrollment 

over time for the share of beneficiaries at the upper end 

of the enrollment distribution. These stays drove up the 

mean length of enrollment between 2000 and 2004, but 

the median remains at about two weeks (Figure 3-2). 

From 2000 to 2004, more than 25 percent of beneficiaries 

dying in hospice were enrolled for less than a week before 

their deaths. These general trends in the distribution of 

length of enrollment in hospice are the same for hospice 

beneficiaries in fee-for-service Medicare and in Medicare 

managed care plans, so heavier rates of use do not seem to 

result in longer lengths of enrollment. 

Analysis of the diagnosis on the Medicare hospice claims 

from 2002 and 2003 shows variation in the lengths of 

stay by disease category (Table 3-4, p. 68). Across all 

disease categories, at least half of patients did not use 

any type of days of care other than routine home care. 

This is consistent with the finding that, across all disease 

Hospice use has grown for all Medicare decedents,

 but use remains higher among those in managed care

Source: MedPAC analysis of 5 percent Enrollment Database fi le, 2005 from CMS. Percent of decedents who died in hospice

40

20

30

10

0

Fee-for-service

Managed care

2000 2001 2002 2003 2004

FIGURE

3–1

TABLE

3–3 Use of hospice among Medicare

 beneficiaries increased

 from 2000 to 2004

2000 2004

Percent 

change 

2000–2004

Benefi ciaries

in hospice 534,261 797,117 49%

Payment 

(in billions) $2.9 $6.7 130

Days of care 

(in millions) 26 52 101

Share of decedents 

in hospice 22% 31% N/A

Note: N/A (not available). Data include Puerto Rico.

Source: Benefi ciaries, payments, and days of care from Medicare National 

Summary for HHA, Hospice, SNF, and Outpatient. http://www.cms.

hhs.gov/MedicareFeeforSvcPartsAB/02_MedicareUtilizationforPartA.

asp#TopOfPage. Accessed February 13, 2006. Share of decedents in 

hospice from MedPAC analysis of 5 percent Enrollment Database fi le, 

2005 from CMS.
Report to the Congress: Increasing the Value of Medicare | June 2006 67

categories, the vast majority of all hospice days—93 

percent in 2002 and 2003—are routine home care days. 

Length of stay also varied widely by state from a low of 

41 days in South Dakota to a high of 122 in Mississippi 

in 2004 (Figure 3-3, p. 69). Reasons for this variation in 

length of stay are unknown. The rate of hospice use among 

Medicare beneficiaries also varies by state. Research has 

found that the use of hospice is associated with physician, 

patient, and market characteristics but that, as with other 

types of healthcare services, “much variation in hospice 

use is unexplained” (Lorenz et al. 2004).

The supply of hospice providers increased 

between 2001 and 2005

The number of Medicare-certified hospices has increased 

in the past five years. The mix of hospice provider types 

has changed as well. Hospice agencies can be freestanding 

agencies or based in a hospital, skilled nursing facility, or 

home health agency.13 

The number of hospice agencies participating in the 

Medicare program rose 26 percent from 2001 to 2005. In 

2005 alone, 251 new Medicare hospice agencies joined the 

program while 27 agencies terminated their participation. 

This recent period of growth is attributable to the increase 

in the number of freestanding providers (Figure 3-4, p. 70).

Freestanding hospices account for the largest share of 

any hospice type—57 percent in 2005. This is a change 

from the mix of hospice provider types participating in 

the 1980–1982 demonstration, where the most common 

type of hospice provider was hospital-based (42 percent), 

followed by freestanding providers (31 percent), and home 

health agency-based (27 percent). There were no skilled 

nursing facility-based providers in the demonstration 

(GAO 2004). As of February 2006, 46 percent of hospice 

agencies were for-profit compared to 31 percent in 2001. 

Consideration of payment system 

refinements

Changes in the use and provision of hospice care suggest 

that the hospice payment system should be re-evaluated. 

Evaluation of the hospice payment system would assess 

whether the benefit structure and payment rates, developed 

25 years ago, could be changed to improve the accuracy of 

the payment rate. Paying accurately for all types of patients 

is important to ensure that the program is paying rates that 

cover providers’ costs for all types of patients. 

Determining the accuracy of the current payment system 

is difficult. Medicare administrative data offer little 

detail about hospice services that each patient uses. In 

this section, we describe the limitations of Medicare 

data in more detail. We then describe an analysis of the 

hospice payment system using data from one large chain 

provider. The results of this analysis are not necessarily 

generalizable to the entire Medicare population, but they 

permit a description of one large chain’s service provision 

and costs not available from Medicare data.

Administrative data limitations

The Medicare data available to assess the relationship 

between hospice patient characteristics and the use 

of services are limited. The type of services provided, 

the type of personnel who provided the care, and the 

frequency and duration of patient visits are not collected 

on the Medicare claims. Medicare claims provide 

information at the patient level only on the payment 

FIGURE

3–2 Long hospice stays are getting

 longer, but short stays persist

Note: Data are for Medicare benefi ciaries in fee-for-service Medicare.

Source: MedPAC analysis of 5 percent Enrollment Database fi le, 2005 from CMS. Length of enrollment (days)

180

100

60

20

140

160

120

80

40

0

10th 

percentile

2000

2004

25th 

percentile

Median 75th 

percentile

90th 

percentile
68 Medicare’s hospice benefit: Recent trends and consideration of payment system refinements

category for which the agency billed and the number 

of days of each category. Comprehensive evaluation of 

patient costs and service use by hospice patients would 

require Medicare to collect additional data. 

When the Commission last reviewed hospice payment 

policy in 2004, we concluded that an examination of 

the services hospices currently provide was needed to 

ensure that payments accurately account for efficient 

provider costs (MedPAC 2004). While not a formal 

recommendation, the Commission suggested that data 

on the types of services different patients use could be 

collected nationally by requiring hospice providers to 

report the information on claims forms or in cost reports. 

Alternatively, the data could be collected from a sample 

subset of providers. Data collection efforts should balance 

the need for information with the administrative burden 

placed on providers and CMS.

The program has not collected any additional hospice data 

since the Commission’s report. Thus, necessary data are 

not available for research on potential payment system 

refinements. In the absence of a representative Medicare 

hospice data set, we contracted with RAND to analyze 

one chain provider’s data. These data allow us to assess 

whether detailed use information suggests any potential 

modifications to Medicare’s hospice payment system to 

distribute payments according to the variations in the costs 

of different types of patients. This analysis is described in 

the following section.

Testing case-mix adjustment using data 

from a large chain provider

Given the current per diem payment structure and the 

change in the hospice population over time, RAND 

focused on three specific questions related to potential 

refinements to the hospice payment system. These 

questions had been raised in earlier literature and in the 

Commission’s June 2004 report (MedPAC 2004). 

• How well does the per diem system reflect the 

variation in hospice patient resource use?

• Should case-mix adjusters such as diagnoses be 

considered? 

• Are the beginnings and ends of hospice stays more 

intensive? 

Using one chain’s data, RAND found that the variation 

across patients in the number of visits and visit labor 

costs was well explained by the number of days in 

each of the current per diem payment categories. (For 

additional information on data and methods see the text 

box on page 73.) In addition, RAND found that patient 

characteristics alone (including diagnosis, marital status, 

and residence in a nursing home) explain much less of the 

variation in resource use across patients for the hospice 

stay. When added to the model of days and per diem 

payment categories, case-mix adjusters were not found to 

improve the explanatory power of the per diem payment 

system. RAND also found that the beginnings and ends of 

TABLE

3–4 Total days of hospice care vary by disease category

Mean total 

days of care

Mean days of:

Disease category RHC CHC IRC GIC

All conditions 46.5 43.2 1.9 1.3 0.1

Cancer conditions

Colorectal 48.3 44.0 2.4 1.4 0.1

Lung, larynx, pleura 40.1 36.6 1.8 1.2 0.1

Hematological 34.3 30.7 2.0 1.2 0.1

Noncancer conditions

Neurodegenerative 61.3 58.7 2.4 1.0 0.1

Ill-defi ned debility 54.5 52.3 1.6 0.9 0.1

Cerebrovascular 35.4 31.3 1.9 1.9 0.0

Note: RHC (routine home care), CHC (continuous home care), IRC (inpatient respite care), GIC (general inpatient care). Disease categories were created using 

International Classifi cation of Diseases, Ninth Revision, Clinical Modifi cation (ICD–9–CM) codes.

Source: RAND Corporation’s analysis of 100 percent hospice standard analytic fi les from CMS for calendar years 2002 and 2003.
Report to the Congress: Increasing the Value of Medicare | June 2006 69

hospice stays are more resource intensive for this chain. 

This is consistent with findings from earlier qualitative 

research (Huskamp et al. 2001). For a variety of reasons 

discussed in the following section, these results may not 

be generalizable to the population of Medicare hospice 

patients.

How well does the per diem system reflect 

variation in hospice resource use?

RAND estimated an ordinary least squares regression to 

examine how well the number of days in each of the per 

diem payment categories explained variation in hospice 

visits and visit labor costs across the chain’s patients. 

The adjusted R-squared is approximately 90 percent for 

both the number of visits and visit labor costs, indicating 

that variation in both the number of visits and visit labor 

costs for patients’ hospice stays are well explained by 

the number of days in each of the per diem payment 

categories. 

This result reflects several factors. Within each type of 

day of care there was little variation in visits and visit 

labor costs, so the number of visits in the hospice episode 

was largely a function of the number of days of care by 

type of day. This lack of variation in visit labor costs 

could be a function of dying patients of all diagnoses and 

characteristics measured in this model having similar 

needs for hospice visits within the per diem categories. 

Other nonlabor costs, such as drugs, equipment, or travel 

time may vary by patient characteristics but the data did 

not allow us to test this. In addition, the regression results 

may simply reflect that the chain provider responded to 

the financial incentives of the current per diem system 

and provided the level of care that the per diem covers. 

Average length of stay in hospice by state, 2004

Source: MedPAC analysis of CMS data from Medicare Hospice Utilization by State, CY 2004. http://www.cms.hhs.gov/MedicareFeeforSvcPartsAB/Downloads/

HOSPICE04.pdf. Accessed February 13, 2006.

ME

VT

MA

RI

CT

NY

PA

NJ

DE

MD

VA

NC

SC

GA

FL

AL MS

TX LA

AZ NM

OK

AR

TN

KY

OH

WV

MI

IL IN

WI

MN

IA

MO KS

NE

SD

MT ND

WY

CO

UT

NV

CA

ID

WA

OR

AK

HI

NH

41–51

52–58

59–68

70–86

106–122

Length of stay

in days:

DC

FIGURE

3–3
70 Medicare’s hospice benefit: Recent trends and consideration of payment system refinements

The lack of variation may also be a function of practice 

patterns of a single chain’s agencies, which are more 

likely to be homogenous than those of a diverse and 

representative sample of providers. It is not possible with 

available data to determine whether or to what extent the 

findings reflect each of these factors. Data from additional 

providers would allow us to compare the level of care 

across different providers who may have different practice 

patterns.

Should case-mix adjusters such as diagnoses be 

considered?

The chain provider data contain patient-level 

characteristics including primary International 

Classification of Diseases, Ninth Revision, Clinical 

Modification (ICD–9–CM) diagnosis codes, race/

ethnicity, marital status, age, receipt of care in a nursing 

home, discharge status, and location. The clinical advisors 

to the RAND team aggregated individual ICD–9–CM 

codes into nine cancer and seven noncancer diagnosis 

categories that were clinically similar and that they thought 

would have similar resource use for the purpose of the 

analyses described below. 

RAND tested whether these characteristics were useful 

predictors of resource use both on their own and in 

conjunction with the per diem category variables. Figure 

3-5 shows the results of three regressions. The first bar is 

the adjusted R-squared based on the number of days of 

care by type—routine home care, continuous home care, 

and general inpatient care. The second bar is the adjusted 

R-squared when only the patient-level demographics and 

diagnoses are included. Many of these disease categories 

are statistically significant predictors of visits and visit 

costs for the episode, but these factors alone explain no 

more than 12 percent of the variation in the number of 

visits and visit labor costs. When added to the model 

that contains days of care by type, the demographic and 

diagnoses variables add little explanatory power, as shown 

by the third bar. In a statistical sense, they do not add 

explanatory power when the number of variables added to 

the model is taken into consideration. 

An increase in freestanding agencies fueled growth

 in the number of hospice providers, 2001–2005

Note: Data for 2001–2005 are as of the end of each calendar year.

Source: MedPAC analysis of unpublished Online Survey, Certifi cation, and Reporting System data from CMS. Number of providers

1,800

1,600

1,400

1,200

1,000

800

600

400

200

0

Freestanding

Home health agency

2001 2003 2004 2005 2002

Hospital

Skilled nursing facility

FIGURE

3–4
Report to the Congress: Increasing the Value of Medicare | June 2006 71

With these data alone, we can not rule out that additional 

case-mix adjusters (e.g., functional status or availability 

of caregivers) beyond those available in these data or the 

same case-mix adjusters tested on a different population 

served by other agencies would improve the explanation 

of variance. In addition, results using case-mix adjusters 

could change using a dependent variable that more fully 

captured the total costs of care, including drugs, supplies, 

and nonvisit labor costs.14

Are the beginnings and ends of hospice stays 

more intensive?

Because the data from the chain provider record the 

admission date, discharge date, and the date of each visit, 

RAND was able to construct measures of the distribution 

of visits across each patient’s stay to assess how well a 

constant per diem rate reflects the resource use throughout 

a hospice stay. The first and last three days are more 

intensive than days falling in the middle of a hospice stay. 

The median length of stay in the sample is 13 days and 

the median number of visits received is 18; the median 

number of visits received per day is 1.5. Figure 3-6 plots 

the relative number of visits at the beginnings, middles, 

and ends of hospice stays. Given that the median length of 

stay is less than two weeks, stays were broken into three 

categories: first three, last three, and middle days of each 

stay. Stays of three days or less were allocated to the last 

three days; stays of six days or less were allocated first to 

the last three days and then to the first three days. At the 

median, patients received twice as many visits during the 

last three days as they did in the middle days. Because 

the beginnings and ends of stays are relatively more 

expensive, a constant per diem rate may create incentives 

for providers to seek patients with longer lengths of stay. 

Medicare hospice payment: Directions 

for further investigation

Growth in the benefit, changes to the hospice population, 

and changes in the delivery of care over time underscore 

the need to evaluate Medicare’s hospice prospective 

payment system—both the adequacy of the hospice 

FIGURE

3–5 Potential case-mix adjusters 

explain little additional variation 

in visits and visit labor costs

Source: RAND Corporation analysis of chain provider’s data from 2002 and 

2003.

Percent of variance explained 

(adjusted R squared)

100

60

40

20

10

80

90

70

50

30

0

Days of care

Demographics/Diagnoses

case-mix adjusters

Days of care and 

demographics/diagnoses

case-mix adjusters

Number of visits Visit labor costs

FIGURE

3–6 More intensive care is delivered at 

beginning and end of hospice stays

Note: Data for the fi rst three days include preadmission visits. Data for the last 

three days exclude patients discharged alive.

Source: RAND Corporation analysis of chain provider’s data from 2002 and 

2003.

Number of visits

2.5

1.5

1.0

0.5

2.0

0

Mean

Overall

First 3 days

Middle days

Last 3 days

Median
72 Medicare’s hospice benefit: Recent trends and consideration of payment system refinements

payment rates and the relative rates of the different 

payment categories. This is not to say that growth in the 

hospice benefit is not appropriate for or beneficial to the 

program or those who have elected the benefit. However, 

as with all payment systems, the hospice payment system 

should be evaluated to assess what the program is buying 

and whether it is paying adequately for all patients, as well 

as to ensure value for the program and taxpayer. 

The results of RAND’s analysis of the chain’s data show 

that case-mix adjusters based on patient characteristics 

did not improve the per diem system’s ability to predict 

variation in patient costs for this provider. However, 

these results do not rule out the viability of case-mix 

adjustments using alternative case-mix adjusters or 

using these adjusters on a representative population of 

hospice patients. In addition, this one chain may have 

more homogenous practice patterns and protocols 

across patients than a similarly large population selected 

randomly from the Medicare population of hospice 

providers. Replicating the patient-level analysis to yield 

results that reflect the universe of Medicare hospice 

patients and providers would require the Medicare 

program to collect additional data on all or at least a 

representative sample of patients and providers. The 

RAND study also can not evaluate the quality of the care 

received.

This Commission and the GAO have previously 

recommended evaluation of Medicare’s hospice payment 

system, recognizing that this would require additional 

data. In our May 2002 report to the Congress, we called 

for the Secretary of the Department of Health and Human 

Services to evaluate hospice payments to ensure they are 

consistent with the costs of providing appropriate care 

(MedPAC 2002). We recommended that the Secretary: 

1) analyze differences in the care and resource needs of 

hospice patients and 2) determine whether a case-mixadjusted payment system for hospice care is feasible, 

including studying ways to establish a high-cost outlier 

policy. Similarly, the GAO recommended that the 

Administrator of CMS should: 1) collect patient-specific 

data on hospice visits and services and their costs and 

2) determine whether the hospice payment method and 

payment categories need to be modified (GAO 2004). 

CMS concurred with the GAO recommendation that the 

agency should collect data but noted that funding for data 

collection was limited. 

As discussed in this chapter, descriptive research on the 

care provided to Medicare hospice patients and how that 

care has changed over time can not be conducted with 

currently collected Medicare data. Therefore, the program 

needs to collect additional data. Collecting additional 

data (e.g., the number, frequency, and duration of visits; 

personnel providing the care; and patient residence) 

would provide more detail on the costs of providing 

care to different Medicare hospice patients and how 

those costs vary by patient and provider characteristics. 

Some information on the beneficiary’s residence, such 

as whether it is an urban or rural area, is available. Other 

data, such as whether the beneficiary resides in a nursing 

facility or private residence, are not available from hospice 

claims. The relationship between the location of residence 

and costs can not be tested using currently available data. 

In the future, the Commission could assess the adequacy 

of current Medicare hospice payments, like we do for other 

sectors, by examining information about beneficiaries’ 

access to care, the supply of providers, the volume of 

services, and the quality of care, as well as providers’ 

access to capital and Medicare payments and providers’ 

costs. Analysis of these factors is undertaken annually for 

hospital inpatient, hospital outpatient, physician, skilled 

nursing facility, home health agency, and dialysis services, 

and most recently for inpatient rehabilitation facility and 

long-term care hospital services. The results of these 

analyses inform payment update recommendations that 

are intended to maintain Medicare beneficiaries’ access 

to high-quality care while getting the best value for 

taxpayers’ and beneficiaries’ resources. 

We have provided information in this chapter on some of 

these factors (supply of hospice providers and volume of 

services), but information on others (access to care and 

Medicare payments and costs) would require additional 

analysis. Quality of care would likely be difficult to assess 

for all Medicare-participating hospices because of the 

lack of data on quality of care for all agencies. Additional 

analyses could provide information about the extent 

to which access to hospice care varies among patients. 

We could also assess how Medicare costs compare to 

Medicare payments for all hospices and hospices of 

different types (e.g., those serving mostly rural and 

those serving mostly urban patients). Although payment 

adequacy analysis using this framework could provide 

a clearer picture of the overall adequacy of Medicare 

payments, determining how differences in margins or costs 

across providers relates to differences in the care delivered 

would still require the collection of detailed visit data as 

described above. Report to the Congress: Increasing the Value of Medicare | June 2006 73

Data and methods

RAND was able to address the question of how 

well the per diem system with additional casemix adjusters reflects variation in hospice 

resource use using the chain’s data because the chain’s 

data contained patient- and visit-level detail beyond 

what is available in the Medicare claims. RAND’s 

analysis sample consisted of 68,725 Medicare patients 

admitted to the chain’s agencies in 2002 and 2003. 

The chain’s patient population was about 6 percent of 

the total Medicare hospice population during the time 

period examined. The chain’s patient population differs 

from the Medicare hospice population overall: There 

are fewer lung cancer and debility patients and more 

cardiovascular, cerebrovascular, and neurodegenerative 

patients than are typical in the Medicare population. 

The chain’s patients are also somewhat older (Table 

3-5). In addition, the chain billed for more inpatient 

care than the average hospice and did not bill for respite 

care days. 

The chain data allowed RAND to construct two 

measures of patient-level resource use: the number 

of visits received and the labor costs associated with 

those visits. The number of visits per patient measure 

was constructed by counting each visit in the visit-level 

data.15 Estimated visit labor costs were constructed 

using information on the number and length of visits, 

as well as titles of the staff involved. These data were 

merged with Bureau of Labor Statistics data on average 

hourly wages of each discipline and adjusted for 

geographic location using the Medicare wage index. 

The visit labor cost measure captures the direct costs 

of time spent with patients, but can not be interpreted 

as a total cost for the visit because it does not include 

transportation time, administrative overhead, benefits, 

and nonlabor costs (e.g., drugs). RAND estimates that 

visit labor costs for this chain are about one-fifth of 

total Medicare daily costs. 

TABLE

3–5 Chain and all Medicare hospice 

patient demographics, 2002–2003

Chain

All 

Medicare

Difference 

(in percentage 

points)

Disease 

category

Cancer 34.0% 42.5% –8.5%

Noncancer 66.0 57.5 8.5

Age category

Under 65 4.1 5.1 –1.0

65 to 74 17.8 21.1 –3.3

75 to 84 37.0 37.9 –0.9

85 and over 41.1 35.9 5.2

Marital status

Divorced/separated/

widowed 58.5 N/A N/A

Married/

living together 33.5 N/A N/A

Single 8.1 N/A N/A

Race

Asian 1.0 0.6 0.4

Black 11.6 7.7 3.9

Hispanic 11.4 1.3 10.1

Other 0.6 1.0 –0.4

White 75.4 89.5 –14.1

Sex

Female 59.8 57.6 2.2

Male 40.2 42.4 –2.2

Discharge status

Died 90.7 82.8 7.9

Discharged alive 9.3 17.2 –7.9

Note: N/A (not available). Category totals may not sum to 100 percent due 

to rounding.

Source: RAND Corporation analysis of chain provider data and Medicare 

100 percent hospice standard analytic fi les for 2002 and 2003.
74 Medicare’s hospice benefit: Recent trends and consideration of payment system refinements

1 Because nursing home residence can not be determined from 

a hospice claim, this study imputed nursing home residence 

by determining whether hospice users also had a record of 

a nursing home assessment with a date that overlapped the 

hospice episode.

2 This study categorized a beneficiary as a nursing home 

resident using physician claims. It categorized a beneficiary 

as a nursing home resident if the place of service code or 

evaluation and management codes on the physician claims 

indicated that an encounter with the patient happened in a 

nursing facility or a skilled nursing facility.

3 New conditions of participation for hospices were published 

in a proposed rule on May 27, 2005. CMS has not yet issued 

a final rule. The current conditions of participation went into 

effect in 1983 and were amended 

in 1990.

4 According to CMS, hospice is not carved out of the Program 

of All-Inclusive Care for the Elderly (PACE), which is “a 

unique capitated managed care benefit for the frail elderly 

provided by a not-for-profit or public entity. The PACE 

program features a comprehensive medical and social service 

delivery system using an interdisciplinary team approach in 

an adult day health center that is supplemented by in-home 

and referral services in accordance with participants’ needs. 

Since comprehensive care is provided to PACE participants, 

those participants who need end-of-life care will receive 

the appropriate medical, pharmaceutical, and psychosocial 

services through the PACE organization. If the participant 

specifically wants to elect the hospice benefit from a certified 

hospice organization, then the participant must voluntarily 

disenroll from the PACE organization” (CMS 2006). 

5 The applicable wage index is determined by the location of 

where the services are provided not by the location of the 

hospice provider. The hospice wage index values are the 

pre-floor, pre-reclassification hospital wage index values 

subject to a budget neutrality adjustment or wage-index floor. 

Budget neutrality is defined as estimated aggregate payments 

to hospice providers that would have been made if the 1983 

wage index values remained in effect.

6 The Commission conducts an analysis of providers’ Medicare 

margins using Medicare cost reports. These margins are 

calculated by dividing the difference between Medicare 

payments and Medicare costs by Medicare payments. The 

Medicare margin is Medicare revenue as a share of Medicare 

payments. The results of these analyses can be found in our 

annual March report.

7 GAO calculated Medicare margins by comparing reported 

costs on the Medicare cost reports to the daily Medicare 

rates, unadjusted for geographic differences in wages. They 

used only freestanding hospice cost reports and excluded 

very low-volume providers from the analysis. The hospice 

industry noted that cost reports were unaudited and that 

GAO did not include volunteer or bereavement counseling 

costs. In response, GAO noted that Medicare cost reports are 

the only available source of information necessary for their 

mandated study. They also noted that only those costs that are, 

by law, reimbursable under Medicare were included in their 

calculation of hospice costs.

8 Agency size was based on the number of days of care 

provided during the year.

9 This cap was originally conceived to be an amount that 

reflected the cost to the Medicare program for patients with 

cancer in the last six months of life. However, the average 

annual payment cap was ultimately set at an amount that was 

not based on this calculation (GAO 2004).

10 Margins in this study were calculated as total net income 

divided by total patient revenue from the Medicare cost 

reports. The sample of facilities was limited to hospices with 

patient days greater than 9,696 and 3 years of financial data.

11 On the NHPCO survey, 154 hospices reported total margins 

and 153 reported margins minus fundraising data.

12 Beneficiaries are counted in a given year if they have filed an 

election to receive hospice care from the hospice during the 

period beginning on September 28 prior to the beginning of 

the cap period and ending on September 27 prior to the end of 

the cap period. If a beneficiary has received hospice care from 

more than one hospice during the year, each hospice counts 

the fraction of a beneficiary that represents the portion of a 

patient’s total hospice stay spent in that hospice. This amount 

can be obtained from the RHHI.

13 Freestanding refers to hospice agencies that are not operated 

by a hospital, home health agency, or skilled nursing facility.

14 The chain provided aggregate drug and supply costs, but not 

for individual patients.

15 Visits made by volunteers were excluded, however, and the 

chain provider does not record all contacts between patients 

receiving general inpatient care and the inpatient facility staff.

Endnotes
Report to the Congress: Increasing the Value of Medicare | June 2006 75

Campbell, D., J. Lynn, T. Louis, et al. 2004. Medicare program 

expenditures associated with hospice use. Annals of Internal 

Medicine 140, no. 4 (February 17): 269–278.

Centers for Medicare & Medicaid Services, Department of Health 

and Human Services. 2006. PACE fact sheet. http://www.cms.hhs.

gov/PACE/Downloads/PACEFactSheet.pdf.

Gage, B., C. Miller, K. Copolla, et al. 2000. Important questions 

for hospice in the next century. In Synthesis and Analysis of 

Medicare’s Hospice Benefit. Washington, DC: Department of 

Health and Human Services, Assistant Secretary for Planning 

and Evaluation, Office of Disability, Aging, and Long-Term Care 

Policy.

Government Accountability Office. 2004. Medicare hospice care: 

Modifications to payment methodology may be warranted. GAO–

05–42. Washington, DC: GAO. October.

Greer, D. S., V. Mor, S. Sherwood, et al. 1983. National hospice 

study analysis plan. Journal of Chronic Disease 36, no. 11: 

737–780. 

Health Care Financing Administration, Department of Health and 

Human Services. 1983. Medicare program; hospice care. Final 

rule. Federal Register 48, no. 243 (December 16): 56008–56036.

Hoffman, D., and A. Tarzian. 2005. Dying in America: An 

examination of policies that deter adequate end-of-life care 

in nursing homes. The Journal of Law, Medicine, and Ethics

(Summer): 294–309. 

Huskamp, H., M. Beeuwkes Buntin, V. Wang, et al. 2001. 

Providing care at the end of life: Do Medicare rules impede good 

care? Health Affairs 20, no. 3: 204–211.

Joseph, S. 2005. VistaCare rewards sales staff for short LOS 

patients. HomeHealth Line 30, no. 33 (August 26, 2005): 1–5. 

Lorenz, K., S. Asch, K. Rosenfeld, et al. 2004. Hospice admission 

practices: Where does hospice fit in the continuum of care? 

Journal of the American Geriatrics Society 52: 725–730.

McCue, M. J., and J. M. Thompson. 2005. Operational and 

financial performance of publicly traded hospice companies. 

Journal of Palliative Medicine 8, no. 6: 1196–1206.

Medicare Payment Advisory Commission. 2004. Report to 

the Congress: New approaches in Medicare. Washington, DC: 

MedPAC.

Medicare Payment Advisory Commission. 2002. Report to the 

Congress: Medicare beneficiaries’ access to hospice. Washington, 

DC: MedPAC.

Miller, S., P. Gonzalo, and V. Mor. 2000. Use of Medicare’s 

hospice benefit by nursing facility residents. In Synthesis and 

Analysis of Medicare’s Hospice Benefit. Washington, DC: 

Department of Health and Human Services, Assistant Secretary 

for Planning and Evaluation, Office of Disability, Aging, and 

Long-Term Care Policy. 

National Center for Health Statistics, Centers for Disease Control 

and Prevention, Department of Health and Human Services. 

2003. Characteristics of hospice care discharges and their length 

of service: United States, 2000. Vital and Health Statistics Series

13, no. 154. Hyattsville, MD. 

National Hospice and Palliative Care Organization. 2006. 

Comments submitted on behalf of the National Hospice and 

Palliative Care Organization (NHPCO) to the Medicare Payment 

Advisory Commission (MedPAC) focusing on the draft chapter 

on hospice issues. Unpublished e-mail to MedPAC. April 6.

National Hospice and Palliative Care Organization. 2005. 2004 

summary statistics by agency size. Alexandria, VA: NHPCO.

Office of the Actuary, Centers for Medicare & Medicaid Services, 

Department of Health and Human Services. 2005. Office of the 

Actuary mid-session review. Baltimore: CMS.

References

CHAPTER 4

Keeping physicians’ 

practice expense payment 

rates up to date

Report to the Congress: Increasing the Value of Medicare | June 2006 79

Chapter summary

The practice expense (PE) component of the physician fee schedule 

pays for the expenses incurred in operating a practice, such as office 

rents, nurses’ salaries, and equipment. PE payments account for close to 

half of the $54 billion Medicare spent under the physician fee schedule 

in 2004. 

Ensuring the accuracy of payments under the physician fee schedule is 

important for several reasons. First, inaccurate payment rates can distort 

the market for physician services. Services that are overvalued may be 

overprovided because they are more profitable than other services. At 

the same time, undervalued services may prompt providers to increase 

volume in order to maintain their overall level of payment. Conversely, 

some providers may opt not to furnish services that are undervalued, 

which can threaten beneficiaries’ access to care. Second, if certain types 

of services become undervalued relative to others, the specialties that 

perform those services may become less financially attractive, which 

can affect the supply of physicians. Finally, misvalued services mean 

In this chapter

• Medicare needs current data 

on each specialty’s total 

practice expenses

• Accuracy and reliability of 

the direct resource data

• Estimating accurate prices 

for clinical staff, supplies, 

and equipment

• Conclusion

Keeping physicians’ 

practice expense payment 

rates up to date

C H A P T E R 4
80 Keeping physicians’ practice expense payment rates up to date

that Medicare is paying too much for some services and not enough for 

others and therefore is not spending taxpayers’ and beneficiaries’ money 

wisely.

CMS uses several data sources to derive PE payments, some of which are 

out of date. We recognize that updating PE data will substantially increase 

CMS’s workload. There is a trade-off between improving the accuracy of 

PE payments and other demands on the agency’s limited administrative 

resources. Therefore, we suggest that CMS focus its efforts on areas where 

the data are most out of date and the impact on relative payment amounts 

(relative weights) is likely to be greatest: 

• obtaining current data on the total costs of operating a practice,

• revisiting the assumption that all medical equipment is operated half the 

time that a practice is open for business,

• updating the prices for the inputs (clinical labor, medical equipment, and 

supplies) used to provide services, and 

• ensuring that the estimates of the types and quantities of inputs are 

accurate. 

We discuss each of these issues in order of priority. Although some time 

lag between relative weights and actual costs is unavoidable, CMS can still 

develop a reasonable time frame and approach to periodically update the 

data sources. The Congress should provide CMS with the financial resources 

and administrative flexibility to undertake the effort as it will improve the 

accuracy of Medicare’s payments and achieve better value for Medicare 

spending.

Medicare needs more recent data on the total costs of operating a practice for 

all specialties because the current source—the Socioeconomic Monitoring 

System (SMS) survey—is dated, reflecting costs and practice patterns from 

the mid- to late-1990s. Policymakers will need to consider three key issues 

when obtaining current practice cost data: 
Report to the Congress: Increasing the Value of Medicare | June 2006 81

• Either Medicare or specialty groups could sponsor a data collection 

effort. 

• Participation by practitioners could be voluntary or mandatory. A 

voluntary effort may have a low response rate. 

• A publicly or privately sponsored effort could collect data from a 

nationally representative sample or from all practitioners. Constructing 

a sample might be more fiscally prudent given the substantial resources 

necessary to conduct an effort that includes all practitioners. 

In addition to the SMS survey, CMS uses a database that contains estimates 

of the prices, types, and quantities of the clinical labor, medical equipment, 

and supplies required to provide each service paid under the physician 

fee schedule. CMS should revisit how it estimates the per service price 

of medical equipment, in particular the assumption that all equipment is 

operated half the time that practices are open for business. If this assumption 

is an underestimate, Medicare’s per unit price is too high. We conducted a 

survey of imaging providers in six markets that indicates that providers in 

those markets use magnetic resonance imaging (MRI) machines more than 

90 percent of the time and computed tomography (CT) machines more than 

70 percent of the time. CMS also assumes that practitioners pay an interest 

rate of 11 percent per year when borrowing money to buy equipment, but 

more recent data suggest a lower interest rate may be more appropriate. Once 

CMS begins to value imaging services the same way it values most other 

physician services, increasing the equipment use assumption and lowering 

the interest rate estimate would reduce PE payments for CT and MRI 

services. Because changes to PE relative values are budget neutral, these 

savings would be redistributed among other physician services. 

Further, the agency has not established a time frame to comprehensively 

review the wage rates for clinical staff or the prices of supplies and 

equipment. Thus, CMS could set a reasonable schedule for periodically 

updating this information. The agency could also review the prices of 

expensive supply and equipment items more frequently than other items.
82 Keeping physicians’ practice expense payment rates up to date

Finally, to ensure that the types and quantities of inputs in the database are 

accurate and complete, CMS, with the assistance of the medical community, 

could check the consistency of values across similar services and obtain 

current estimates for services that have no information. It is also important 

for CMS to set a reasonable schedule for reviewing PE relative weights at 

least every five years as required and more often for services experiencing 

rapid changes. Report to the Congress: Increasing the Value of Medicare | June 2006 83

Practice expense (PE) payments cover the direct and 

indirect costs incurred in operating a practice. Direct 

expenses include costs for nonphysician clinical labor, 

medical equipment, and supplies. Indirect expenses 

include costs for administrative labor, office expenses 

(e.g., rent and utilities), and all other expenses. CMS 

bases PE payments on the relative resources needed to 

provide a service, known as relative value units (RVUs). 

These payments account for close to half of the $54 billion 

Medicare spent under the physician fee schedule in 2004.

In 2004, the Commission began to raise questions about 

whether the data sources and the methods that CMS 

uses to derive PE payments result in accurate prices 

(MedPAC 2004). More recently, we made a series of 

recommendations aimed at improving the accuracy of the 

work component of physician payments, which represents 

the time, effort, skill, stress, and risk of performing a 

service (MedPAC 2006). 

The current method to derive PE RVUs is referred to as the 

“top-down” method.1

 Under this method, CMS estimates 

each specialty’s total practice costs and then allocates costs 

to a specific service based on the resources required to 

deliver the service. These resources include nonphysician 

clinical staff time, medical supplies, and equipment. 

In 2005, CMS proposed but did not implement a new 

method to calculate direct PE RVUs. Instead of starting 

with total cost pools and then allocating practice costs to 

individual services, the proposed method sums the direct 

resources—nonphysician clinical staff time, medical 

supplies, and equipment—required to furnish each service. 

Stakeholders refer to this method as “bottom-up.” The 

agency did not propose changing the methods it uses to 

derive indirect PE RVUs.

CMS is considering this change because the current 

method is not easily understandable or transparent and 

may result in large annual fluctuations in the payment 

for some services. In addition, the PE payments for some 

services under the current method are not resource based. 

Most services that do not involve physician work still 

use pre-1998 charge-based values. CMS refers to these 

services as the nonphysician work pool.2

Under either a top-down or bottom-up approach to derive 

PE payments, CMS will need data that: 

• provide current and accurate estimates of the types, 

quantities, and cost of labor, equipment, and supplies 

that physicians and nonphysician practitioners require 

to run efficient practices;

• are representative of the physician and nonphysician 

specialties paid for under Medicare’s physician fee 

schedule; 

• reflect the factors—such as site of care and practice 

size—that affect the costs of running an efficient 

practice; and

• can be periodically updated so that PE payments 

reflect current practice patterns and costs. 

This chapter reviews the data sources that CMS uses 

to derive PE payments, some of which are out of date. 

Inaccurate data could lead to distorted payment rates. We 

recognize that updating PE data will substantially increase 

CMS’s workload. There is a trade-off between improving 

the accuracy of PE payments and other demands on the 

agency’s limited administrative resources. Therefore, we 

suggest that CMS focus its efforts on areas where the data 

are most out of date and the impact on RVUs is likely to be 

greatest. Although some time lag between relative weights 

and actual costs is unavoidable, CMS can still develop a 

reasonable time frame and approach to periodically update 

the data sources. The Congress should provide CMS 

with the financial resources and administrative flexibility 

to undertake the effort as it will improve the accuracy 

of Medicare’s payments and achieve better value for 

Medicare spending.

Medicare needs current data on each 

specialty’s total practice expenses 

The data source CMS uses to estimate total practice costs 

is dated and may not reflect current practice patterns. Upto-date and accurate data are needed for all specialties 

recognized under the physician fee schedule. Policymakers 

will need to consider many issues when updating total 

practice cost data, including who will sponsor a new effort 

and how the information will be collected and verified. 

CMS derives practice expense payments 

from outdated data that are not available 

for all specialties

CMS uses an American Medical Association (AMA) 

survey—the Socioeconomic Monitoring System (SMS)—

to estimate each specialty’s hourly total practice expenses. 
84 Keeping physicians’ practice expense payment rates up to date

The Socioeconomic Monitoring System survey is out of date and was not

designed to derive practice expense relative values

The Commission and others have raised concerns 

about the continued use of the Socioeconomic 

Monitoring System (SMS) data to derive 

practice expense (PE) payments. Most stakeholders 

agree that the survey was the best data source available 

at the time to estimate hourly practice expenses. The 

SMS survey is now dated, reflecting practice patterns 

from 1995 through 1999. Thus, the increased use and 

cost of new technologies—such as health information 

technology—may not be well measured. 

The American Medical Association (AMA) did not 

design the SMS survey with the goal of developing 

PE relative value units (RVUs) for the physician fee 

schedule. As a result, CMS has adjusted the survey data 

in order to derive PE RVUs. 

First, the SMS survey did not include all physician 

specialties paid for under the physician fee schedule, 

nor did it include nonphysician practitioners. The 

survey distinguished among 26 major physician 

specialties, while Medicare recognizes over 60 

physician and nonphysician groups. The AMA drew the 

survey sample from its Physician Masterfile, a file of 

physicians practicing in the United States, and surveyed 

physicians who spent more than 20 hours per week 

engaged in patient care activities, including officeand hospital-based physicians (but not residents). 

This file does not include nonphysician practitioners 

(e.g., physician assistants, physical therapists, and 

optometrists) who can bill separately under the 

physician fee schedule. 

Consequently, CMS crosswalked certain specialties 

to the most appropriate SMS specialty category 

because specialties recognized by Medicare either 

did not correspond to those in the SMS survey or 

were not included. For example, CMS used data 

for “all physicians” for the specialty of podiatry 

and crosswalked the specialties of oral surgery and 

maxillofacial surgery to otolaryngology.3

 Crosswalking 

data from one specialty to another would not be 

necessary if total cost data were available for all 

Medicare-recognized specialties.

Second, the survey includes the cost of services—

nonphysician practitioners, drugs, and lab services—

paid separately by Part B. CMS has removed the costs 

of some these services (e.g., drugs) from the data.4

But CMS has not removed the cost of nonphysician 

practitioners when they separately bill Medicare. If 

CMS or the AMA were to design a survey specifically 

to derive PE payments, this survey could exclude these 

services. 

Third, the SMS survey measures the practice expenses 

of individual physicians. But CMS’s method of deriving 

PE payments requires data at the practice level. To 

translate the SMS values to the practice level, CMS’s 

method assumes that physician owners share practice 

expenses equally and that all physician owners in a 

practice work the same number of hours. A new survey 

could be designed to collect data at the practice level.

The Government Accountability Office (GAO) and 

others have raised a number of additional concerns 

about the SMS survey, including:

• The response rate for the practice expense questions 

was lower than that for the overall survey, which 

reduced the sample size for some specialty groups. 

GAO raised concerns that the reported practice 

expenses may not be representative of all physicians 

in some specialties because of the limited number of 

respondents (GAO 1999). 

• The SMS survey asked physicians to report their 

number of direct patient care hours during a typical 

week. Some stakeholders are concerned about the 

accuracy of the reported data because the question 

relied on the recall of the responding physicians, and 

it did not clearly define the types of activities that 

respondent physicians should have included (Lewin 

Group 2000, CMS 2000). Report to the Congress: Increasing the Value of Medicare | June 2006 85

The issues surrounding continued use of this survey 

include:

• It is dated, reflecting practice costs and patterns from 

1995 to 1999.

• It was not designed to be used to derive PE RVUs.

• It does not include all specialty groups recognized by 

Medicare.

The text box provides more information about the 

limitations of the SMS survey.

Using data obtained from the SMS, CMS calculates hourly 

practice expenses for the specialties included in the survey. 

The agency multiplies each specialty’s hourly practice 

expenses by the number of services the specialty provided 

to Medicare beneficiaries to estimate each specialty’s 

total cost pool (MedPAC 2004). CMS then allocates each 

specialty’s total cost pool to individual services based on 

the estimated direct resources of each service.

Until recently, CMS permitted specialties to submit more 

current (supplemental) data on total practice expenses 

to try to keep the values up to date. The Balanced 

Budget Refinement Act of 1999 (BBRA) mandated that 

CMS establish a process to consider supplemental data 

submissions when updating the physician fee schedule.5

Through 2006, the agency has accepted supplemental data 

from 13 specialties, although it is not yet using all of the 

information.6

Relying on more current practice cost data submitted 

by some (but not all) specialties raises several issues. 

Supplemental submissions do not provide a recurring 

source of information for all specialties. Although the 

BBRA gave providers the option to submit more current 

information, they are not mandated to do so. Since the 

BBRA, few groups (16 out of more than 60 specialties) 

have submitted newer data. Groups informed the 

Commission that collecting PE information is costly and 

time consuming, and that they do so only when it is likely 

to increase their payment rates.

Using more current information from some but not 

all specialties could cause significant distortions in 

relative PE payments across services. When CMS uses 

supplemental submissions, a redistribution of PE RVUs 

occurs because it generally implements the changes 

in a budget neutral manner.7

 Hourly practice expenses 

increased substantially for those specialties that recently 

provided data to CMS, ranging from 43 percent for 

urology to 124 percent for cardiology (Table 4-1). Hourly 

practice expenses for other specialties remained the same. 

As a result, once CMS uses specialties’ supplemental data, 

PE payments for services primarily furnished by them 

could increase while payments for services furnished by 

other specialties could decrease. 

TABLE

4–1 Hourly practice expenses increased for some specialties

 between 1995–1999 and 2001–2003

Hourly total practice expenses

 estimated from:

Percentage of total costs that are 

indirect, estimated from:

Original SMS 

surveys

Supplemental 

surveys

Percent 

change

Original SMS 

surveys

Supplemental 

surveys

Allergy and immunology $129 $196 52% 56% 62%

Cardiology 82 184 124 66 56

Dermatology 119 179 50 66 70

Gastroenterology 62 114 84 77 70

Oncology 99 189 91 60 59

Radiation oncology 67 138 106 56 53

Radiology 68 137 101 68 61

Urology 96 137 43 55 69

Note: SMS (Socioeconomic Monitoring System). Hourly total practice expenses are reported in 1995 dollars. Column entitled “Original SMS surveys” provides the 

hourly practice expenses derived from 1995–1999 SMS surveys. Column entitled “Supplemental surveys” represents surveys conducted by the specialties between 

2001 and 2003. CMS accepted but has not used the surveys submitted by certain specialties (radiology, cardiology, radiation oncology, dermatology, allergy/

immunology, gastroenterology, and cardiology) to derive 2006 practice expense (PE) relative value units (RVUs) because the agency did not implement changes in 

the methods used to derive direct PE RVUs. 

Source: CMS 2006a, CMS 2004, CMS 2001.
86 Keeping physicians’ practice expense payment rates up to date

Updating total practice expense data

Obtaining current total practice cost data raises a number 

of issues. Who would sponsor the effort and would 

the effort be voluntary? For illustrative purposes, 

Table 4-2 compares three alternatives: a voluntary 

privately sponsored effort, a voluntary publicly sponsored 

effort, and a nonvoluntary publicly sponsored effort. 

Physician and nonphysician groups could jointly sponsor 

such an effort. CMS recently expressed interest in 

purchasing data from a privately sponsored survey (CMS 

2006c). Of concern is whether all specialties would fund 

and participate in a private effort, particularly the 13 

specialties with more recent practice expense data that 

CMS accepted. 

Public or private sponsors could design a data collection 

effort to overcome the limitations of the SMS survey, 

such as the lack of PE information for all specialty groups 

recognized by Medicare. At issue is whether such an effort 

would be voluntary or nonvoluntary. 

A voluntary effort, whether publicly or privately 

sponsored, is likely to have a low response rate if history is 

any guide. Fewer respondents answered the PE questions 

on the SMS survey than other questions (40 percent vs. 

60 percent, respectively) (GAO 1999). In addition, the 

response rate and the number of usable responses from the 

1999 SMS survey were lower than those from prior years 

(CMS 2001). The highest response rate to the specialty 

groups’ surveys that CMS accepted was 27 percent (Table 

4-3). CMS’s contractor evaluating these newer submissions 

concluded that high response rates are not achievable 

given the sensitive nature of the data being surveyed and 

the burden placed on the respondents (Lewin Group 2005). 

Sponsors of a voluntary effort will also need to address 

whether respondents fairly represent all physicians and 

nonphysician practitioners.

CMS and specialty groups will need to consider 

overarching issues in designing and implementing a 

new data effort. They could gather information from a 

nationally representative sample or from all practitioners. 

Using a sample might be more fiscally prudent given the 

substantial resources necessary to conduct an effort that 

includes all practitioners. Alternatively, CMS and specialty 

groups could use a rotating panel of practitioners. The 

sponsor could pay participants to take part in the panel and 

allow the sponsor to review the supporting PE data. 

The sponsor could stratify the sample by factors that affect 

practice costs, such as the size of the practice and site of 

care (office- vs. hospital-based). Average practice costs 

increase with size for some specialties such as cardiology 

(Lewin Group 2004). Across specialties, office-based 

practices incur higher hourly practice costs, on average, 

than hospital-based practices because the latter have lower 

direct practice costs.

CMS and specialty groups also need to consider response 

bias. Respondents might inaccurately report practice cost 

information knowing that the agency will use it to derive 

PE RVUs. Consequently, the sponsor will need to ensure 

that processes are in place to ensure the data’s accuracy. 

In determining how frequently to update the practice cost 

information, CMS will need to consider the resources 

necessary to obtain current data. Practice costs could 

increase or decrease over time with changes in medical 

equipment, supplies, and practice patterns (e.g., site of 

care and technology changes). For example, use of clinical 

information systems would increase the indirect practice 

expenses for those specialties adopting such technology. 

TABLE

4–2 Alternative approaches

 to collect practice cost 

data raise many issues

Sponsor

Participation 

of practitioners Issues

Privately 

sponsored

Voluntary • Low response rate

• Depending on sponsor, effort 

may not include all Medicarerecognized specialties

• CMS could purchase data 

from groups sponsoring 

survey; the Congress needs 

to ensure the Secretary has 

necessary resources

Publicly 

sponsored

Voluntary • Low response rate

• The Congress needs to ensure 

the Secretary has necessary 

resources

Publicly 

sponsored

Nonvoluntary • Resistance by practitioners 

and specialties

• Requires change in regulation

• The Congress needs to ensure 

the Secretary has necessary 

resources
Report to the Congress: Increasing the Value of Medicare | June 2006 87

CMS needs current data on total practice costs even if it 

decides to derive direct PE RVUs using a new, bottom-up 

approach. The agency will require total indirect costs for 

each specialty to derive indirect PE RVUs. 

Accuracy and reliability of the direct 

resource data

CMS maintains a database with detailed information about 

the types and quantities of nonphysician clinical labor, 

medical equipment, and supplies used by practitioners 

to furnish nearly all of the 7,600 services paid for under 

the physician fee schedule.8

 Table 4-4 shows an example 

of the level of detail for one service—cystourethroscopy 

(Current Procedural Terminology (CPT) code 52000). 

In addition to the types and quantities of these inputs, 

CMS also estimates a price for each clinical staff category, 

equipment item, and supply. Using these data, the agency 

estimates the direct costs incurred by practitioners to 

furnish a service. For example, CMS estimates that the 

cost to provide a cystourethroscopy in 2006 is $27.75 for 

nonphysician clinical staff, $28.45 for medical supplies, 

and $5.44 for medical equipment. 

Currently, CMS uses these data to allocate each specialty’s 

total practice expenses to individual services. Under the 

bottom-up method, CMS could sum the cost of each input 

to derive direct PE RVUs. At issue is the consistency, reliability, and accuracy of this information and the 

process for periodically updating the data to reflect current 

practice patterns. We first discuss how CMS derives the 

types and quantities of inputs and ways to improve their 

accuracy, and then describe ways to improve the prices for 

each input.

The Relative Value Scale Update 

Committee refined the original resource 

input estimates 

CMS convened 15 expert panels—the Clinical Practice 

Expert Panels (CPEPs)—in 1995 to estimate the direct 

inputs associated with providing each service to the typical 

patient. Using these data, CMS originally proposed a 

bottom-up approach to implement resource-based PE 

RVUs. However, CMS implemented the current top-down 

method in 1999 partly because of concerns about the 

accuracy of the CPEPs’ estimates. 

In 1999, the AMA/Specialty Society Relative Value Scale 

Update Committee (RUC) established a multispecialty 

committee, the Practice Expense Advisory Committee 

TABLE

4–3 Response rates to supplemental 

practice expense surveys are low

Specialty

Response 

rate

Number of 

usable responses

Allergy and immunology 27% 154

Dermatology 22 154

Urology 21 226

Radiology 21 171

Oncology 18 245

Gastroenterology 14 99

Independent laboratories 14 90

Physical therapy 14 134

Radiation oncology 13 86

Cardiology 13 389

Note: CMS approved the supplemental data submitted by these specialties 

between 2001 and 2005. 

Source: Lewin Group 2003, Lewin Group 2004, Lewin Group 2005.

TABLE

4–4 Direct resource data provide very 

specific estimates of clinical labor, 

medical equipment, and supplies

Direct resource

Types and quantities of direct 

resources for a cystourethroscopy

Clinical staff 17 minutes by a nurse or assistant 

before the procedure begins

58 minutes by a nurse or assistant 

during the procedure 

Medical equipment Power table

Mobile instrument table

Light source (xenon)

Fiberscope, fl exible, cystoscopy 

Medical supplies 1 sterile drape towel (18 inches

 by 26 inches)

1 underpad (2 feet by 3 feet)

1 package, minimum multispecialty visit

1 package urology cystoscopy

1 patient education booklet

Note: Inputs are for care provided in the nonfacility setting.

Source: CMS 2006b.
88 Keeping physicians’ practice expense payment rates up to date

(PEAC), to refine the direct inputs.9 CMS has accepted 

nearly all of the recommendations made by PEAC for 

refining about 7,600 codes. As a result of the PEAC’s 

efforts, the current direct resource inputs differ markedly 

from those originally recommended by the CPEPs. GAO 

and most other stakeholders agree that the PEAC improved 

resource estimates for individual services (GAO 2004).

The RUC now assigns the Practice Expense Review 

Committee (PERC) the task of estimating the inputs for 

new and revised codes and refining estimates for codes not 

reviewed by the PEAC. Both practice expense committees 

use a process that is similar to the one the RUC uses to 

estimate work RVUs for new and revised codes. The text 

box above provides more information about the review 

process. 

Medicare will need to ensure that the 

direct input estimates are accurate 

Do the direct inputs accurately identify the nonphysician 

clinical labor, medical equipment, and supplies used by 

efficient practitioners to provide a service? This issue is 

important because CMS recently proposed to use only the 

direct inputs to derive direct PE RVUs (CMS 2005b). 

CMS should address at least three issues to ensure 

that the direct input database is accurate and complete. 

First, the agency should check whether the resources 

of similar services are estimated using standard values 

of clinical staff time, supplies, and equipment, referred 

to as “standardized packages.” In particular, CMS and 

the PEAC may not have consistently applied these 

standardized packages to services they refined early in the 

process. Second, CMS, with the assistance of the medical 

community, should obtain estimates for services that are 

not currently valued (CMS 2005a). Last, CMS should 

ensure that the database contains no errors and anomalies. 

From time to time, stakeholders have informed the agency 

about incorrect values in the database, which CMS has 

corrected (CMS 2003).11

It is also important for CMS to periodically review the 

direct inputs because practice expenses could increase 

or decrease over time. They could rise if nonphysician 

clinical staff replaces some physician work. By contrast, 

practice expenses could decline if practitioners become 

more efficient or substitute less costly equipment and 

supplies for more expensive items.

The agency has stated that there needs to be an ongoing 

review process for the direct PE inputs to reflect changes 

in practice or new technology but has not proposed 

any specific plan for doing so (CMS 2005a). Although 

the statute requires the Secretary to review and make 

adjustments to the relative values for all physician fee 

schedule services at least every five years, CMS has not 

yet proposed a five-year review of PE RVUs. The agency 

fully implemented the resource-based PE RVUs in 2002, 

which suggests that CMS should review them by 2007. 

However, the refinements of the direct inputs continued 

through the end of 2005. 

The process for estimating practice expense inputs

The practice expense committee established by 

the American Medical Association (AMA)/

Specialty Society Relative Value Scale Update 

Committee (RUC) relies on information from specialty 

groups on the resources they require to furnish services. 

The AMA provides the specialty societies with 

background materials, such as the current resource 

estimates for a service. Each specialty society then 

gives the practice expense committee its proposed 

resource estimate for the service, describing how the 

estimate was developed and listing necessary tasks 

(GAO 2004). The composition of the practice expense 

committee is similar to the RUC with additional 

nursing representation (AMA 2005).

The RUC submits all official recommendations 

on practice expense inputs to CMS. The RUC can 

decide to adopt the practice expense committee’s 

recommendation, modify it before submitting it 

to CMS, or refer it back to the practice expense 

committee. The RUC has also recommended changes 

to the practice expense inputs when conducting its fiveyear reviews of work relative value units.10 Official 

recommendations to CMS require the approval of 

two-thirds of the RUC. Although CMS makes all final 

decisions about changes to the resource estimates, it has 

generally accepted the RUC’s recommendations. Report to the Congress: Increasing the Value of Medicare | June 2006 89

If CMS were to establish a process for reviewing PE RVUs 

that relies on specialties to identify misvalued services 

(similar to the current method for reviewing work RVUs), 

we are concerned that it could focus on undervalued codes 

rather than overvalued ones. Previous five-year reviews 

of the work RVUs led to substantially more increases in 

RVUs than decreases (MedPAC 2006). This outcome is 

not surprising given that the specialty societies and their 

members have a financial stake in the process. 

Manufacturers of medical equipment and supplies 

sometimes recommend that CMS update values in the 

direct input database. Manufacturers have incentives to 

request that CMS substitute more costly equipment and 

supplies for less costly items.

It may be appropriate to review recently introduced 

services more frequently because the practice expenses 

may change over time. As early performers of a service 

become more familiar with a procedure, they can complete 

it more quickly. The service’s clinical labor time, therefore, 

should decline. The Commission previously recommended 

scheduled reviews of the work RVUs for recently 

introduced services to ensure that Medicare’s payment 

rates reflect changes in physician work (MedPAC 2006). 

Estimating accurate prices for clinical 

staff, supplies, and equipment

In addition to maintaining accurate estimates of the type 

and quantity of direct inputs for each service, CMS also 

needs to set accurate prices for each of the inputs (clinical 

staff, equipment, and supplies). Otherwise, the relative 

weights for practice expense could become distorted over 

time. There are two primary challenges with keeping 

the prices up to date: CMS’s database contains more 

than 1,000 inputs, and there is no systematic process for 

identifying and correcting pricing errors. 

To improve the process for maintaining accurate input 

prices, CMS could: 

• set a reasonable schedule for periodically updating 

clinical staff wages;

• set a reasonable schedule for periodically updating 

all supply and equipment prices and more frequently 

reviewing the prices of expensive supplies and 

equipment (based on a dollar threshold); and 

• revisit how it estimates the per service cost of medical 

equipment, in particular the assumption that all 

equipment is operated half the time that practices are 

open for business. 

According to a Commission survey of imaging providers 

in six markets, providers in those markets use magnetic 

resonance imaging (MRI) machines more than 90 percent 

of the time and computed tomography (CT) machines 

more than 70 percent of the time. CMS also assumes 

that practitioners pay an interest rate of 11 percent per 

year when borrowing money to buy equipment. Recent 

data from the Federal Reserve Board suggest that a lower 

interest rate may be more appropriate. Once CMS begins 

using direct inputs to value imaging services, increasing 

the equipment use assumption and lowering the interest 

rate assumption would reduce payment rates for CT 

and MRI services. Because changes to practice expense 

relative values are budget neutral, these savings would be 

redistributed among other physician services. 

Updating clinical staff wages

CMS last updated nonphysician clinical staff wages for 

the 2002 fee schedule and has not indicated when wages 

will be reviewed again. Because wages for different types 

of clinical staff increase at different rates, PE RVUs could 

become less accurate over time unless wage data are kept 

up to date. Although reviewing wages is a time-consuming 

effort, CMS could set a reasonable schedule to do so 

periodically. 

The CPEP and PEAC have given CMS information on 

the types of clinical staff and amount of staff time used 

for each service. CMS then estimates a wage rate for 

each category (e.g., nurses and radiology technicians). 

CMS multiplies the wage rate for each type of staff by 

the number of minutes to determine the total cost. For 

example, cystourethroscopy (CPT code 52000) performed 

in a physician office is estimated to involve 75 minutes 

of nurse time. CMS assumes a nurse wage rate of $0.37 

per minute. Thus, the cost of a nurse for this procedure is 

$27.75. 

CMS updated staff wages for the 2002 physician fee 

schedule using primarily 1999 data from the Bureau of 

Labor Statistics (BLS) (CMS 2001).12 Because the BLS 

survey does not include all staff types represented in the 

practice expense database, CMS used supplementary 

data for 12 of the 38 staff categories.13 CMS originally 

estimated wages for the 1998 physician fee schedule.
90 Keeping physicians’ practice expense payment rates up to date

Because services vary in the types of staff used and 

wages for different jobs grow at varying rates, the 

relative values for services could become distorted if 

wage data are not kept current. For example, pathology 

services are more likely to use laboratory technicians, 

while vascular ultrasound services are more likely to use 

vascular technologists. When CMS updated wage rates 

for 2002, there was variation in the growth of rates for 

different clinical labor categories.14 At the lower end, 

estimated wages for laboratory technicians increased by 

14 percent (cumulatively) and for registered nurses by 

21 percent (CMS 2001). By contrast, wages for vascular 

technologists grew by 54 percent and for medical and 

technical assistants by 63 percent. If wage data for each 

labor category are not updated periodically, services that 

use staff whose wages increase at above-average rates will 

become undervalued. Conversely, services that use staff 

whose wages grow at below-average rates will become 

overvalued. 

Updating supply and equipment prices 

As complex services (like advanced imaging) that were 

once generally done in hospitals spread to physician 

offices, equipment and supplies become a more integral 

part of physician services. As a result, it is important that 

CMS value them accurately. Although CMS updated 

prices for all supplies and equipment in the last few years, 

the agency has not indicated when it will next perform 

a comprehensive review. Consequently, CMS should 

consider setting a reasonable schedule to reprice all 

equipment and supply items periodically. Moreover, the 

prices of new, high-cost supplies and equipment could be 

reviewed more frequently than other items to ensure that 

price changes are reflected in the data used to set relative 

values. 

CMS updated all the supply prices for the 2004 physician 

fee schedule and revised equipment prices for the 2005 

and 2006 fee schedules.15 Because there are more than 

1,000 individual supply and equipment items, this task 

was very time consuming.CMS hired a consultant who 

examined vendor catalogs and websites to determine a 

“typical” price for an item. When the consultant could 

not identify prices for a specific item, CMS asked 

specialty societies to provide information with supporting 

documentation, such as invoices. This review resulted in 

significant price changes for some items. For example, the 

estimated cost of an MRI room declined by half from 2004 

to 2006, from $3.1 million to $1.6 million (CMS 2006b).16

By contrast, the estimated price for a CT room increased 

from $1 million in 2004 to $1.3 million in 2006, reflecting 

the diffusion of new 16-slice scanners (CMS 2006b).17

In addition to CMS’s comprehensive review of all items, 

specialty groups and manufacturers can request that the 

price of an existing item be changed. These groups have 

a greater incentive to identify undervalued supplies and 

equipment than overvalued items. 

To ensure that both overvalued and undervalued items are 

identified and corrected, CMS could periodically review 

the prices of all supplies and equipment, particularly new 

and expensive items that can account for a large share 

of a service’s practice expense. Prices for new items are 

likely to drop over time as they diffuse into the market 

and as other companies begin to produce them. Some new 

disposable supplies have very high prices. For example, 

CMS estimates that a probe used in radiofrequency 

ablation of renal tumors (CPT code 50592) costs $1,995 

per service; a new probe is used each time the service is 

performed (CMS 2006b). In the final rule for the 2006 

physician fee schedule, CMS recognized the need to 

revalue high-cost, new technology supplies and said that 

it would discuss options for updating supply prices in the 

proposed rule for the 2007 fee schedule (CMS 2005a). 

In contrast to disposable supplies, the cost of equipment is 

spread over many uses and thus usually represents a small 

share of a service’s direct expense (GAO 1998). However, 

expensive equipment can still be quite costly on a per use 

basis. For example, CMS assumes that MRI equipment 

has a purchase price of $1.6 million and costs $563 per 

service for MRI of the brain, without contrast followed by 

contrast (CPT code 70553). 

Because CMS has limited administrative resources and 

there are many supply and equipment items, CMS could 

set a dollar threshold for items that it will examine more 

frequently. For example, the RUC recently encouraged 

CMS to review annually the prices of supplies that cost 

$200 or more (Rich 2005). Only 40 supply items are 

priced above $200, according to the RUC. CMS could 

update prices for a small number of expensive supplies 

and equipment using catalogs, invoices, and other 

documentation provided by specialties. Regular review of 

new equipment and supply prices is consistent with our 

recent recommendation calling for scheduled reviews of 

the work RVUs for new services (MedPAC 2006).18

Although a lower priority, it is also important to 

periodically reprice other supplies and equipment. 

Otherwise, services that use many equipment and supply 

inputs could become misvalued over time. Rather than 
Report to the Congress: Increasing the Value of Medicare | June 2006 91

reviewing all items in the same year, CMS could examine 

prices for a different subset of items each year (perhaps 

items used by a given specialty). Over time, the agency 

would eventually review prices for all supplies and 

equipment. 

Setting the per service price of medical 

equipment 

To set the per service price of a unit of equipment, CMS 

multiplies the number of minutes it is used for that 

service by the equipment’s cost per minute. The number 

of minutes the equipment is used is usually equal to the 

clinical staff time involved in performing the service.19

The cost per minute for a unit of equipment is based on 

several factors:

• the equipment’s purchase price,

• useful life, 

• annual maintenance costs,

• the cost of capital,

• the number of hours per year a physician office treats 

patients, and

• how frequently the equipment is used.20

In the previous section, we discussed how CMS estimates 

purchase prices. In this section, we address how CMS 

estimates equipment use and the cost of capital. 

Estimating how frequently equipment is used

When setting the price of medical equipment associated 

with a specific service, such as a laser used for eye 

surgery, CMS assumes the equipment is used half the 

time the practice is open for business.21 If a machine is 

actually used most of the time, its cost is spread across 

more units of service, resulting in a lower cost per service 

than if it were only operated half the time. Such equipment 

is currently overvalued by CMS. The cost of a machine 

used less than half the time is spread across fewer units 

of service, resulting in a higher cost per service than if it 

were operated half the time. Such equipment is currently 

undervalued. 

How did CMS arrive at a 50 percent assumption for 

equipment capacity? When CMS initially developed the 

resource-based practice expense RVUs, it sought—but was 

unable to obtain—valid information on how frequently 

various equipment was used across procedures and 

payers.22 In the absence of such data, CMS decided to 

assume that all equipment is used 50 percent of the time 

(CMS 1997). 

We explore whether the 50 percent utilization assumption 

is appropriate for imaging machines. It is important that 

CMS price imaging equipment accurately because the 

agency has expressed strong interest in using direct cost 

inputs—such as equipment costs—to value imaging 

services (CMS 2005b, CMS 2002). Currently, the practice 

expense payments for most imaging services are primarily 

based on pre-1998 charges. 

Providers have a financial incentive to increase the use of 

expensive equipment unless it is unprofitable. Thus, it is 

possible that MRI or CT machines are used more than half 

the time. Expensive equipment accounts for a large share 

of the direct cost of advanced imaging studies (Table 4-5). 

Equipment costs are fixed; in other words, the cost does 

not increase as volume grows. Variable costs (supplies and 

TABLE

4–5 Distribution of direct costs of select MRI and CT services, 2006

Share of total direct costs

for technical component

Service CPT code Equipment Supplies

Nonphysician 

clinical staff

MRI, lumbar spine (with contrast) 72148 90.2% 2.7% 7.0%

MRI, brain (without contrast followed by contrast) 70553 88.9 4.5 6.6

CT, pelvis (with contrast) 72193 85.2 6.5 8.3

Note: MRI (magnetic resonance imaging), CT (computed tomography), CPT (Current Procedural Terminology). The technical component includes the cost of the equipment, 

supplies, and clinical staff, but not the physician’s interpretation. Indirect costs are not shown. 

Source: Physician practice expense input fi les from CMS 2006b.
92 Keeping physicians’ practice expense payment rates up to date

clinical staff time) account for a relatively small portion of 

direct costs. Most of the indirect (or overhead) costs—such 

as office rent, utilities, and administrative staff—are 

relatively fixed. Providers have an incentive to perform 

enough services to cover the fixed cost of the equipment. 

Once the fixed cost is covered, there is a greater 

incentive to perform more services because the marginal 

profitability of additional services increases significantly; 

the profit equals the payment rate (which does not change 

as volume grows) minus the variable costs. 

Higher volume per machine could explain at least some 

of the recent rapid growth in imaging volume.23 Between 

1999 and 2003, per beneficiary use of CT scans (of parts 

of the body other than the head) grew by 16.3 percent 

per year on average (MedPAC 2006). During the same 

period, per beneficiary use of MRI studies (of parts of the 

body other than the brain) grew by 19.3 percent per year 

on average. By comparison, use of all physician services 

increased by 5.4 percent per year between 1999 and 2003. 

The Commission surveyed providers in six markets 

that performed MRI and CT services on Medicare 

beneficiaries to examine whether certain imaging 

equipment is used more than half the time. This survey 

indicates that providers in those markets used MRI and CT 

machines significantly more than 50 percent of the time 

they were open for business. We focused on MRI and CT 

equipment because of the rapid spending growth for these 

services and the high cost of these machines, as well as 

the likelihood that CMS will begin using direct cost inputs 

to value these services. We recognize that other types of 

equipment may be used more (or less) frequently than half 

the time.

Survey of imaging providers The Commission 

surveyed 133 physician practices and independent 

diagnostic testing facilities that performed MRI or CT 

studies. The providers were from six markets: Boston; 

Miami; Greenville, South Carolina; Minneapolis; Phoenix; 

and Orange County, California. These markets were 

chosen to represent a range of geographic areas and per 

capita Medicare spending. Boston and Miami are in the 

top quartile of spending, Orange County and Greenville 

are in the middle quartiles, and Phoenix and Minneapolis 

are in the bottom quartile. The survey asked about the 

following characteristics:

• number of hours per week the provider is open for 

business,

• whether the provider has a MRI or CT scanner,

• number of MRI and/or CT scanners,

• age of MRI and CT equipment, and

• hours per week that MRI and CT equipment is used. 

The survey’s response rate was 72 percent, achieved 

during a five-week field period (NORC 2006).24 The text 

box contains more information about the survey.

We calculated use rates for each provider by dividing the 

number of hours per week each machine was used by 

the number of hours per week the provider was open for 

business. The median use rate across all providers for MRI 

machines was 100 percent; in other words, the equipment 

was always in operation when the median provider was 

open for business (Figure 4-1). The mean use rate was 

91 percent (the confidence interval was 85 percent to 

FIGURE

4–1 MRI and CT machines used

 most of the time providers 

were open for business

Note: MRI (magnetic resonance imaging), CT (computed tomography). We 

calculated the percent of time providers used machines by dividing the 

number of hours per week each machine was used by the number of 

hours per week the provider was open for business. The confi dence 

interval around the mean MRI use rate is 85 percent to 97 percent. The 

confi dence interval around the mean CT use rate is 65 percent to 81 

percent. 

Source: National Opinion Research Center survey of imaging providers in six 

markets for MedPAC (NORC 2006).

Percent of time machines in use

100

60

40

20

80

0

MRI

Median

Mean

CT

CMS’s 

current 

assumption
Report to the Congress: Increasing the Value of Medicare | June 2006 93

97 percent). A few providers had use rates above 100 

percent (they used their equipment for more hours than the 

facility was normally open for business). These providers 

said that they operate beyond normal business hours to 

accommodate patients with urgent needs. The median use 

rate across all providers for CT equipment was 75 percent, 

which was very close to the mean of 73 percent 

(the confidence interval was 65 percent to 81 percent) 

(Figure 4-1). 

There are some limitations to this survey. It is not 

nationally representative because the sample is based 

on six markets. Because the sample size is small, there 

is probably substantial random variation. Thus, the 

confidence intervals around the mean use rates are 

relatively large. However, even the low ends of the 

confidence intervals are above the current 50 percent 

equipment use assumption. In addition, the results should 

be unbiased because every nonhospital imaging provider 

in the 2003 Medicare claims file (5 percent sample of 

Methodology for the survey of imaging providers

The sampling frame for the Commission’s survey 

of imaging providers was based on providers 

who performed the technical component of 

a magnetic resonance imaging (MRI) or computed 

tomography (CT) service in 2003.25 To be eligible for 

selection, a provider must: 

• have been paid under the physician fee schedule 

in 2003 (this includes physicians and independent 

diagnostic testing facilities (IDTFs));

• have performed an MRI or CT scan on a patient 

whose claims appear in the 5 percent Medicare 

carrier file, which is based on a 5 percent random 

sample of beneficiaries;

• be located in one of six markets (Boston; Miami; 

Greenville, South Carolina; Minneapolis; Phoenix; 

and Orange County, California).

The Commission and our contractors—the National 

Opinion Research Center (NORC) and Georgetown 

University—created a file of physicians and IDTFs 

that met these conditions, then aggregated individual 

physicians into group practices. We grouped physicians 

into practices to avoid double-counting physicians who 

share the same equipment (NORC 2006). We did not 

aggregate IDTFs because they did not share the same 

site. Grouping physicians into practices involved the 

following steps:

• All physicians with the same address were 

considered to be in the same imaging group.

• Each practice was included in the sample if it 

appeared to be in operation when the survey was 

conducted (February to March 2006), based on 

internet searches. 

• If an imaging group was no longer in operation but 

one or more physicians could be linked to a new 

location, that location was included in the sample. 

The contractors tracked physicians using internet 

yellow pages, Google searches, and physician 

directories.

• Groups were dropped from the sample if they were 

no longer in operation and their physicians could not 

be linked to new locations.

• Only one site was included in the survey if a group 

operated multiple sites. 

• Providers who were located at or appeared to be 

owned by a hospital were excluded. 

This process identified 189 imaging groups and 

IDTFs, which were each mailed a short questionnaire. 

The providers were able to respond by mail, fax, 

or telephone. The contractor followed up with all 

nonresponders by phone. After the initial mailing, the 

contractors determined that 56 providers were ineligible 

and 133 were eligible. The ineligible providers were 

out of business, part of a multisite group already 

represented in the sample, owned by or located at a 

hospital, or had no MRI or CT equipment. Eighty of 

the 133 eligible providers completed the survey.26 Most 

surveys were completed in less than five minutes. 94 Keeping physicians’ practice expense payment rates up to date

beneficiaries) had the same chance of being selected 

for the survey (as long as they met the conditions of 

eligibility).27

Our survey raises questions about whether CMS 

underestimates how frequently providers use MRI and 

CT equipment. It appears that MRI and CT machines 

are operated significantly more than 50 percent of the 

time, at least in these six markets. Further, the survey 

demonstrates that a short questionnaire can be used to 

collect information on how often providers use medical 

equipment and achieve a high response rate. 

Instead of basing the assumption of equipment use on 

empirical evidence, however, should it be based on an 

expectation of how frequently efficient providers operate 

equipment? To encourage more efficient use of expensive 

equipment, CMS could adopt an assumption that such 

equipment is used most of the time a provider is open for 

business. This standard, which would lower payment rates 

for services that have high equipment costs, is consistent 

with the Commission’s position that Medicare should 

pay for costs incurred by efficient providers. However, 

this policy might impair access to care in rural areas, if 

equipment is rarely used. Further, it could conflict with 

Medicare’s goal to set relative values for physician services 

that reflect typical resource use. 

Estimating the cost of capital to purchase 

medical equipment 

When estimating the cost of capital to purchase medical 

equipment, CMS assumes that providers pay an interest 

rate of 11 percent per year when borrowing money to buy 

equipment. More recent data suggest that this interest rate 

assumption is too high. The current estimate is based on 

prevailing loan rates for small businesses, which are used 

as a proxy for physician practices (CMS 1997).28 CMS 

has not updated this assumption since it was developed in 

1997. 

CMS could periodically revise the interest rate estimate as 

rates change over time. A key issue would be whether to 

use a rate from a single year or an average of rates from 

multiple years. Using an average rate from multiple years 

would reflect the range of rates paid by physicians who 

bought their equipment at different times. The number of 

years used to calculate the average rate could be based on 

the estimated useful life of equipment, such as 5 years for 

MRI and CT machines (AHA 1998). 

Although we were not able to locate data on recent small 

business loan rates, the Federal Reserve Board conducts 

an ongoing survey that CMS could use to revise its 

interest rate assumption. The Board collects quarterly 

information on commercial and industrial loans made by 

commercial banks to different types of borrowers. One 

of the advantages of using this survey is that it is updated 

regularly, which would make it easier for CMS to keep its 

assumption up to date.

Based on the Federal Reserve surveys conducted during 

the last five years (from the second quarter of 2001 to 

the first quarter of 2006), loans of more than one year 

had average annual interest rates over the last five years 

that ranged from 5.3 percent to 6.0 percent, depending 

on the risk of the loan (Federal Reserve Board 2006).29

The highest risk category (6.0 percent) includes loans 

that are considered acceptable risk. Borrowers in this 

category have fair credit ratings, no recent credit problems, 

and no access to the capital markets (Federal Reserve 

Board 2003).30 If CMS were to adopt a lower interest rate 

estimate, this would reduce payment rates for services that 

have high equipment costs.

Impact of changing equipment assumptions

Once CMS begins using direct cost inputs to value the 

technical component of imaging services, increasing 

the equipment use assumption and lowering the interest 

rate assumption would reduce PE payment rates for 

services like CT and MRI studies. Because changes to PE 

relative values are budget neutral, these savings would be 

redistributed among other physician services. 

TABLE

4–6 Illustration of how changing 

equipment use and interest rate 

assumptions affects equipment 

price per service

Percent of 

time equipment

is used

Interest 

rate

Estimated equipment 

price per service

50 11% $100

75 6 60

90 6 50

Note: CMS currently assumes that all equipment is used 50 percent of the 

time and the annual interest rate on loans to purchase equipment is 11 

percent. The alternative equipment use and interest rate assumptions 

and the $100 cost of equipment per service are illustrative. Equipment 

with different baseline prices would fall by the same proportion if the 

alternative assumptions are used. This table does not show the impact on 

overall direct practice expenses or indirect practice expenses.
Report to the Congress: Increasing the Value of Medicare | June 2006 95

Table 4-6 illustrates the impact of changing these 

assumptions on equipment price per service. If CMS 

were to use a higher assumption of equipment use and a 

lower interest rate assumption, estimated equipment price 

per service would decline significantly. For example, 

increasing the equipment use rate from 50 percent to 

75 percent and lowering the interest rate estimate from 

11 percent to 6 percent would reduce equipment price 

per service by 40 percent (based on CMS’s formula for 

calculating equipment price per service).31 Most of this 

reduction would be from changing the equipment use 

rate. Raising the equipment use rate from 50 to 90 percent 

and reducing the interest rate to 6 percent would lower 

equipment price per service by 50 percent. The percentage 

changes would be the same for all types of equipment 

and services, even when a procedure’s length of time and 

equipment purchase price varies. 

Conclusion 

This chapter suggests several ways for CMS to improve 

the data used to determine physicians’ practice expense 

payments, including: 

• options for collecting more recent data on practice 

costs for all specialties,

• methods to improve the accuracy and completeness of 

the database that estimates the types and quantities of 

direct cost inputs for each service, and

• approaches for keeping the prices of direct inputs up 

to date.

The Commission has also raised questions about whether 

the assumptions used to estimate the per service cost 

of certain imaging machines may overstate the cost of 

operating these machines.

We recognize that updating practice expense data will 

substantially increase CMS’s workload. There is a trade-off 

between improving the accuracy of PE payments and other 

demands on the agency’s limited administrative resources. 

Therefore, we suggest that CMS focus its efforts on areas 

where the data are most out of date and the impact on 

relative weights is likely to be greatest. Although some 

time lag between relative weights and actual costs is 

unavoidable, CMS can still develop a reasonable time 

frame and approach to update the data sources. The 

Congress should provide CMS with the financial resources 

and administrative flexibility to undertake the effort as it 

will improve the accuracy of Medicare’s payments and 

achieve better value for Medicare spending.

In future work, we plan to further examine alternatives 

for collecting more recent data on practice costs and the 

process by which the direct cost inputs are developed 

and refined. This research will include interviews with 

members of the AMA’s multispecialty practice expense 

committee and CMS staff. We also intend to study 

alternative methods for deriving PE relative values. 96 Keeping physicians’ practice expense payment rates up to date

1 See MedPAC 2004 for a detailed example of how CMS 

calculates the practice expense payment.

2 The major specialties composing the nonphysician work pool 

are radiology, radiation oncology, and cardiology.

3 Because the SMS survey did not capture the costs of 

uncompensated care, CMS crosswalked emergency medicine’s 

cost pools for administrative labor and other expenses to the 

practice expense per hour for all physicians (CMS 2001).

4 For example, CMS adjusted the hourly cost for medical 

materials and supplies for oncology and allergy/immunology 

because Medicare makes separate payment for the drugs 

furnished by these specialties. The agency also adjusted the 

direct patient care hours for pathologists to account for the 

fact that time spent performing autopsies and supervising 

technicians are Part A services (CMS 1998a).

5 In the August 2004 proposed rule, CMS extended until 2005 

the period for accepting supplemental data that meet the 

specific criteria set forth in the November 2000 final rule. 

After that point, CMS has not accepted supplemental practice 

expense data. The deadline for submitting supplemental data 

to be considered in calendar year 2006 was March 1, 2005.

6 CMS has accepted but is not yet using the surveys submitted 

by certain specialties because the agency withdrew its practice 

expense proposals in the final rule for the 2006 fee schedule 

in part due to a calculation error in deriving practice expense 

RVUs. These specialties include: radiology, cardiology, 

radiation oncology, freestanding radiation oncology centers, 

dermatology, allergy/immunology, gastroenterology, and 

cardiology. 

7 Section 303 of the Medicare Prescription Drug, 

Improvement, and Modernization Act of 2003 (MMA) 

required that CMS use survey data submitted by specialty 

groups that have at least 40 percent of their Part B payments 

attributable to the administration of drugs to adjust PE 

RVUs for drug administration services. The MMA provided 

an exception from budget neutrality for any additional 

expenditures resulting from the use of these data. Four 

specialty groups met this criterion (oncology, rheumatology, 

urology, and gynecology) and two have submitted surveys to 

CMS (oncology and urology). 

8 CMS only includes equipment that costs at least $500 in the 

practice expense database. The cost per use for equipment 

costing less than $500 would be negligible, because the cost is 

spread out over many uses.

9 The AMA formed the RUC in 1991 to make 

recommendations to CMS on physician work relative values 

for new and revised codes.

10 For example, if the RUC removed a physician office visit 

from a surgical procedure with a 90-day global period, the 

RUC decreased the nonphysician clinical labor, supplies, and 

equipment related to that office visit.

11 For example, the American Society of Colon and Rectal 

Surgeons noted that some of the supply inputs had not been 

changed to match the accepted new recommendations for 

CPT codes 45900, 45905, 45910, 47382, 49321, 49322, 

49422, and 49429 (CMS 2003).

12 The original clinical staff wage rates, which were initially 

used for the 1998 physician fee schedule, were developed by 

a consultant to CMS using 1994 and 1995 wage survey data 

from the BLS. 

13 For example, wages for MRI and CT technologists are based 

on a 2001 survey conducted by the American Society of 

Radiologic Technologists. 

14 CMS’s wage rates for 1998 were based on data from 1993 and 

1994, and the updated rates are primarily based on data from 

1999 (CMS 2001).

15 When CMS updated the prices, it also improved the 

uniformity of the supply and equipment databases. For 

example, the agency created 14 categories of supplies 

and standardized how supplies are described. CMS also 

developed six categories for equipment and combined items 

that were duplicative (CMS 2003). Most of the original 

supply and equipment prices were developed by a CMS 

consultant in 1997 using pricing data from supply catalogs.

16 An MRI room includes a 1.5 Tesla scanner, power injector, 

and monitoring system (CMS 2005b).

17 A CT room includes a 16-slice scanner, power injector, and 

monitoring system (CMS 2005b).

18 Because the physician work required for a new service would 

be expected to decline over time as physicians become more 

efficient in furnishing it, we recommended that new services 

likely to experience reductions in value should be reviewed 

(MedPAC 2006). 

Endnotes
Report to the Congress: Increasing the Value of Medicare | June 2006 97

19 For most types of equipment, CMS assumes that the 

equipment is in use during the entire time the procedure is 

performed. However, pathology services can involve many 

types of testing equipment, so CMS assumes that they are 

used sequentially rather than simultaneously.

20 The useful life of each equipment item is based on a 

publication by the American Hospital Association that lists 

the estimated life of equipment used by hospitals (AHA 

1998). CMS assumes that all equipment items have annual 

maintenance costs equal to 5 percent of the equipment’s 

purchase price. This assumption is based on information 

from the Medical Group Management Association (CMS 

1997).

21 Standby equipment (e.g., a crash cart) and equipment used 

for many procedures at the same time (e.g., a refrigerator) are 

considered to be indirect practice expenses and are not priced 

separately. 

22 CMS received information from some physician groups on 

equipment that is used less than 50 percent of the time (CMS 

1998b). However, CMS did not accept these estimates because 

they were not based on representative surveys of physicians. 

23 The growth of imaging services could also be related to an 

increase in the number of machines. There are no national 

data on changes in the number of MRI and CT machines used 

by nonhospital providers. 

24 The response rate is calculated by dividing the number 

of providers who completed the survey by the number of 

providers who are believed to have met the survey criteria (the 

criteria included having an MRI or CT machine, being open 

for business during the survey, and being independent of a 

hospital). There were 80 providers who completed the survey 

and 111 providers who were estimated to have been eligible 

for the survey. 

25 IDTFs are entities that furnish diagnostic services and are 

independent of a hospital or physician office. There were 78 

physician practices and 55 IDTFs in the sample. The technical 

component of an imaging service includes the cost of the 

equipment, supplies, and nonphysician staff, but not the 

physician’s interpretation.

26 The contractors could not confirm the eligibility of the 53 

providers who did not complete the survey, but estimated that 

31 of them (59 percent) were eligible for the survey based 

on the eligibility rate of the providers who were successfully 

contacted. 

27 To be eligible for the survey, providers had to still be in 

operation when the survey was conducted in 2006, operate 

MRI or CT equipment, be paid under Medicare’s physician 

fee schedule, and be independent of a hospital.

28 CMS was unable to locate data on loan rates for physician 

practices (CMS 1997). The length of the loan is based on the 

equipment’s useful life.

29 The average prime rate during this period was 5.2 percent.

30 Because many physician groups do not have access to capital 

markets, this category seems to be a reasonable proxy for 

physician practices.

31 The alternative equipment use assumptions in this section 

(75 percent and 90 percent) are based on the Commission’s 

survey of imaging providers in six markets (NORC 2006). 

The alternative interest rate estimate (6 percent) is based on 

the average annual interest rate for loans issued during the 

previous five years (Federal Reserve Board 2006). These 

alternative assumptions are meant to be illustrative. 
98 Keeping physicians’ practice expense payment rates up to date

American Medical Association. 2005. AMA/specialty society RVS 

update process. Chicago, IL: AMA.

American Hospital Association. 1998. Estimating useful lives of 

depreciable hospital assets. Chicago, IL: AHA.

Centers for Medicare & Medicaid Services, Department of Health 

and Human Services. 2006a. 2007 practice expense per hour data. 

http://www.cms.hhs.gov/PhysicianFeeSched/.

Centers for Medicare & Medicaid Services, Department of Health 

and Human Services. 2006b. CPEP files. http://www.cms.hhs.

gov/PhysicianFeeSched/. 

Centers for Medicare & Medicaid Services, Department of Health 

and Human Services. 2006c. Practice expense town hall meeting. 

Feb. 15. Baltimore, MD.

Centers for Medicare & Medicaid Services, Department of Health 

and Human Services. 2005a. Medicare program; revisions to 

payment policies under the physician fee schedule for calendar 

year 2006 and certain provisions related to the competitive 

acquisition program of outpatient drugs and biologicals under 

Part B. Final rule. Federal Register 70, no. 223 (November 21): 

70116–70150. 

Centers for Medicare & Medicaid Services, Department of Health 

and Human Services. 2005b. Medicare program; revisions to 

payment policies under the physician fee schedule for calendar 

year 2006. Proposed rule. Federal Register 70, no. 151 (August 

8): 45763–46064. 

Centers for Medicare & Medicaid Services, Department of 

Health and Human Services. 2004. Medicare program; changes to 

Medicare payment for drugs and physician fee schedule payments 

for calendar year 2004. Interim final rule. Federal Register 69, no. 

4 (January 7): 1084–1132.

Centers for Medicare & Medicaid Services, Department of Health 

and Human Services. 2003. Medicare program; revisions to 

payment policies under the physician fee schedule for calendar 

year 2004. Final rule. Federal Register 68, no. 216 (November 7): 

63196–63213.

Centers for Medicare & Medicaid Services, Department of Health 

and Human Services. 2002. Medicare program; revisions to 

payment policies under the physician fee schedule for calendar 

year 2003 and inclusion of registered nurses in the personnel 

provision of the critical access hospital emergency services 

requirement for frontier areas and remote locations. Final rule. 

Federal Register 67, no. 251 (December 31): 79966–80013. 

Centers for Medicare & Medicaid Services, Department of Health 

and Human Services. 2001. Medicare program; revisions to 

payment policies under the physician fee schedule for calendar 

year 2002. Proposed rule. Federal Register 66, no. 149 (August 

2): 40377–40378. 

Centers for Medicare & Medicaid Services, Department of Health 

and Human Services. 2000. Medicare program; revisions to 

payment policies under the physician fee schedule for calendar 

year 2001. Final rule. Federal Register 65, no. 212 (November 1): 

65375–65424. 

Centers for Medicare & Medicaid Services, Department of Health 

and Human Services. 1998a. Medicare program; revisions to 

payment policies and adjustments to the relative value units under 

the physician fee schedule for calendar year 1999. Final rule and 

notice. Federal Register 63, no. 211 (November 2): 58814–58895. 

Centers for Medicare & Medicaid Services, Department of Health 

and Human Services. 1998b. Medicare program; revisions to 

payment policies under the physician fee schedule for calendar 

year 1999. Proposed rule. Federal Register 63, no. 108 (June 5): 

30818–30824. 

Centers for Medicare & Medicaid Services, Department of Health 

and Human Services. 1997. Medicare program; revisions to 

payment policies under the physician fee schedule, other Part B 

payment policies, and establishment of the clinical psychologist 

fee schedule for calendar year 1998. Proposed rule. Federal 

Register 62, no. 117 (June 18): 33158–33164. 

Federal Reserve Board. 2006. Federal reserve statistical release: 

Survey of terms of business lending. March 21. http://www.

federalreserve.gov/releases/e2/. 

Federal Reserve Board. 2003. Survey of terms of business 

lending: Instructions. March 5. http://www.federalreserve.gov/

boarddocs/reportforms/forms/FR_2028a--s20030305_i.pdf.

Government Accountability Office. 2004. Medicare physician 

fee schedule: CMS needs a plan for updating practice expense 

component. GAO–05–60 (December). Washington, DC: GAO.

Government Accountability Office. 1999. Medicare physician 

payments: Need to refine practice expense values during 

transition and long term. GAO/HEHS–99–3 (February). 

Washington, DC: GAO.

Government Accountability Office. 1998. HCFA can improve 

methods for revising physician practice expense payments. GAO/

HEHS–98–79 (February). Washington, DC: GAO.

References
Report to the Congress: Increasing the Value of Medicare | June 2006 99

Lewin Group. 2005. Recommendations regarding supplemental 

practice expense data submitted for 2006. Falls Church, VA: The 

Lewin Group. 

Lewin Group. 2004. Recommendations regarding supplemental 

practice expense data submitted for 2005. Falls Church, VA: The 

Lewin Group. 

Lewin Group. 2003. Recommendations regarding supplemental 

practice expense data submitted for 2004. Falls Church, VA: The 

Lewin Group. 

Lewin Group. 2000. An evaluation of the Health Care Financing 

Administration’s resource based practice expense methodology. 

Contract no. 500-95-0059/TO#6. Report for the Health Care 

Financing Administration, Department of Health and Human 

Services. Falls Church, VA: The Lewin Group. 

Medicare Payment Advisory Commission. 2006. Report to the 

Congress: Medicare payment policy. Washington, DC: MedPAC. 

Medicare Payment Advisory Commission. 2004. Report to the 

Congress: Impact of resource-based practice expense payments 

for physician services. Washington, DC: MedPAC.

National Opinion Research Center. 2006. Survey of imaging 

centers and physician offices’ use of MRI and CT equipment. 

Draft submitted to MedPAC. March 31. 

Rich, William L. III. 2005. Letter to Mark B. McClellan, 

September 28. 

CHAPTER 5

Adding quality measures

 in home health

Report to the Congress: Increasing the Value of Medicare | June 2006 103

Chapter summary

In March 2005, the Commission suggested that additional measures be 

developed to complement the ones that have already been developed, 

collected, and used for quality measurement in home health. The current 

set of measures focuses on the clinical effectiveness of care given to 

patients whose physical conditions are improving. Adding measures 

could:

• broaden the patient population covered by the measure set, 

• capture safety as an aspect of quality,

• capture an aspect of care directly under providers’ control, 

• reduce variation in practice, and

• provide incentives to improve information technology.

As a step toward adding new measures to the existing set, we convened 

a panel of researchers, quality measurement experts, and home health 

providers to identify best practices. These practices can be translated 

into measures of the process of care. We asked the panel to focus on 

fall prevention and wound care because falls and wounds are prevalent 

In this chapter

• Strengths and weaknesses of 

the current measure set

• Gathering best practices

• Translating best practices 

into process measures

Adding quality measures 

in home health

C H A P T E R 5
104 Adding quality measures in home health

among home health users; the practices are part of the care for patients 

whose physical condition is not improving, as well as for patients who are 

improving; and are related to patient safety. We wanted to complement—and 

not replicate—CMS’s work on best practices in other areas. Panel members 

gave us examples of best practices, such as developing a standard protocol 

for contacting a physician when a skin wound does not respond to treatment 

and determining significant blood pressure changes while the patient is 

standing to assess the risk of falling. 

After identifying best practices, the next step is to create measures based on 

the practices. For example, a process measure for a blood pressure practice 

would include a precise description of who should receive the care, at what 

time and how often the care should occur, a very specific definition of the 

practice itself, and rules for excluding patients who should not receive the 

care. Following development, the process measures would be tested 

against the Commission’s criteria and could be added to home health’s 

measure set. Report to the Congress: Increasing the Value of Medicare | June 2006 105

Strengths and weaknesses of the current 

measure set

In 2003, the Commission recommended that Medicare 

use a portion of payments to reward providers who furnish 

high-quality care or improve the quality of care for their 

patients (MedPAC 2003). Most of Medicare’s payments 

are neutral or negative toward quality. Where there are 

good measures of the quality of care, the program should 

reward the high-quality performance of providers. There 

are three types of quality measures: 

• Outcome measures—indicate a change in health 

status such as the recovery, restoration of function, or 

survival of the patient following health care.1

• Process measures—indicate whether a specified 

practice has been applied to a patient.

• Structural measures—indicate characteristics of the 

setting in which care takes place, such as the adequacy 

of medical equipment, the qualifications of the staff, 

or the administration of the facility (Donabedian 

1966). 

The Commission developed a set of criteria for quality 

measurement to determine whether Medicare could begin 

linking payment to performance. In home health, we 

determined that the measures based on currently required 

patient assessments met those criteria: They are accepted, 

valid, reliable, and adequately risk adjusted. The data 

collection burden is minimal because the information 

needed is already part of the patient assessment tool 

that is required at the beginning and end of Medicare 

home health episodes. The measures compare patients’ 

functional score at admission to their score at discharge 

to determine, for example, the improvement of their 

ability to walk, dress, and manage their oral medications. 

The outcomes are adjusted to account for patient 

characteristics present at the initiation of care that affect 

the patients’ likelihood of improvement, such as diagnosis, 

comorbidities, overall level of functioning, and health risk 

behaviors. The measures apply to many patients and relate 

to areas where there is room for providers to improve 

their performance. In March 2005, the Commission 

recommended that the Congress implement a pay-forperformance program in home health, based on measures 

that passed the Commission’s criteria (MedPAC 2005). 

Most of the measures in the current, publicly reported set 

assess improvement in functioning. Only one measure 

assesses stabilization as an outcome; the remaining 

measures capture adverse events (Table 5-1, p. 106). The 

table illustrates that three important organizations—the 

Agency for Healthcare Research and Quality (AHRQ), 

the National Quality Forum (NQF), and CMS—have 

reviewed quality measures for home health and all three 

have endorsed a core set. The measures with a check 

mark in the AHRQ column were given a high rating by 

a group of technical experts and AHRQ uses them in 

annual reports to the nation on the quality of health care. 

The NQF used a consensus process among stakeholders 

to endorse the measures with a check mark in the NQF 

column. The third column indicates the measures used by 

CMS in public reporting on home health quality in Home 

Health Compare. The final column shows that the three 

organizations are aligned on most of the measures.2

Adding new measures to the currently available outcome 

measures could broaden the patient population we can 

assess, expand the types of quality we can measure, 

capture an aspect of care directly under providers’ control, 

reduce variation in practice, and add incentives to improve 

information technology. Measure sets should not be static; 

they should evolve to incorporate new measures and to 

remove any measures that no longer reflect best practice 

or have no more room for improvement among providers. 

Any type of measure—outcome, process, or structure—

could be added to expand the current set. We chose to 

explore new process measures because they can address 

each of the goals for evolving the set. 

Unlike measures of functional improvement, process 

measures could address the quality of ongoing efforts by 

nurses, therapists, and others to prevent the deterioration 

of health for patients who are not improving. The NQF 

(2005) concluded that developing “at least some measures 

that apply to all home health care patients” is a priority 

area. Measures of preventive processes, such as the steps 

that home health professionals take to reduce the risk of 

falling, could apply to all patients and thus broaden the 

patient population we can assess.

Outcome measures are best at indicating the clinical 

effectiveness of care. For example, the outcome measure 

“improvement in walking” indicates whether physical 

therapy and nursing care provided to patients were 

effective at increasing the patients’ mobility. However, 

clinical effectiveness is only one of the dimensions of 

quality of care. The NQF also identified patient safety as 
106 Adding quality measures in home health

an important dimension of quality—as outlined by the 

Institute of Medicine (2001) in its seminal study—and 

a priority area for quality measurement in home health. 

Measuring processes such as fall prevention or wound 

care could address agencies’ ability to maintain patients 

safely in their homes and to educate patients to sustain 

themselves safely, which are important goals of the home 

health benefit. 

Providers reasonably expect to be judged on the quality 

of aspects of care that they can influence (McGlynn 

1997). Process measures capture an aspect of care that 

is under providers’ control: whether providers take very 

specific actions in the course of caring for their patients. 

Process measures indicate whether providers adhere to 

evidence-based best practices that have been demonstrated 

to improve the outcomes of care. As such, they are not 

influenced by the unique health status of each patient, 

which is beyond the provider’s control. 

If a purchaser such as Medicare were to adopt and use 

process measures, it could speed the adoption of best 

practices and reduce some of the variation in care that 

arises from failures to adhere to best practices. Adherence 

to best practices involved in care for vulnerable, elderly 

patients ranged from 52.2 percent for screening to 58.5 

percent for follow-up care (McGlynn et al. 2003). The 

potential for standardization is real: When researchers 

randomly assigned home health nurses to an intervention 

group that used evidence-based nursing protocols and 

education and compared them to a randomized control 

group of nurses, they found a statistically significant 

reduction in the variation in the number of visits provided, 

and no increase in adverse events (Feldman et al. 2004).3

TABLE

5–1 The current home health measure set

Measures AHRQ NQF CMS All three

Improvement in:

shortness of breath ✓ ✓✓✓

bladder control ✓ ✓✓✓

upper body dressing ✓

bathing ✓ ✓✓✓

management of oral medications ✓ ✓✓✓

walking or moving around ✓ ✓✓✓

status of surgical wounds ✓

toileting ✓

getting in or out of bed ✓ ✓✓✓

pain interfering with activity ✓ ✓✓✓

confusion frequency ✓

light meal preparation ✓

Stabilization in bathing ✓

Discharge to community ✓ ✓

Any emergency care provided ✓ ✓✓✓

Emergency care related to wounds ✓

Emergency care related to medications ✓

Emergency care for hypo/hyperglycemia ✓

Increase in number of pressure ulcers ✓

Acute care hospitalization ✓ ✓✓✓

Note: AHRQ (Agency for Healthcare Research and Quality), NQF (National Quality Forum).

Source: AHRQ report on home health quality measures for CMS public reporting, March 2003. www.cms.hhs.gov/quality/hhqi/HHQIAHRQ.pdf. Center for Health 

Services Research 2002, NQF 2005. 
Report to the Congress: Increasing the Value of Medicare | June 2006 107

Financial incentives for measuring and reporting 

care processes could encourage providers to improve 

their informational capabilities to meet the new data 

requirements. The data for the current set of outcome 

measures are collected only at the first and last visits of 

a patient episode and do not include the practice of care 

in the interim. Some best practices suggest that patient 

assessment should continue during the episode and that 

certain protocols should be integrated into assessment 

activities. When nurses, therapists, and other home health 

professionals are encouraged by best practices to assess, 

record, use, and share more information about the patients’ 

health status during an episode, it will encourage wider 

use of information technology. Examples include:

• Electronic medical records. The use of electronic 

medical records to store and provide information 

on a patient’s past medical history, lab reports, and 

medications could greatly enhance the ability of health 

professionals to make informed decisions regarding 

care. In addition, electronic medical records could 

allow an organization to measure the quality of its care 

in real time rather than waiting for quarterly or annual 

measurements.

• Management tools. For example, patient registries, 

clinical reminder systems, and computerized patient 

assessments help providers manage a specific 

aspect of care.4

 If nurses used a computer program 

to help prompt and record patient assessments, it 

could reduce the burden of recording important 

clinical information, suggest appropriate tests, and 

immediately identify patients who need special 

interventions to address their needs. 

• Patient communications. Devices used in patients’ 

homes to monitor their health can make it easier for 

patients to monitor their condition, communicate 

with caregivers, and identify the need for a medical 

intervention. 

Gathering best practices

After reviewing the literature and speaking to many 

experts in the field, the Commission did not find any 

process measures for fall prevention or wound care that 

were already validated and in use. We took the first step in 

developing process measures by gathering best practices 

for fall prevention and wound care. Once best practices are 

identified, they can be translated into process measures.

We convened a panel of researchers, quality measurement 

experts, and providers to share best practices, focusing 

on fall prevention and wound care. Although the scope 

of home health is much broader than fall prevention and 

wound care, we focused our panel’s work on this portion 

of home health care practice to generate a complete 

discussion on the specifics of each practice. A failure 

to limit the scope would not have made good use of our 

resources. Also, we did not wish to duplicate a current 

effort by CMS to develop condition-specific process 

measures. In 2005, CMS modified a contract it had with 

the Center for Health Services Research at the University 

of Colorado to review existing process measures and 

to propose ways to integrate them into the home health 

quality data collection as appropriate. In addition to 

considering measures that address pain, depression, 

medication management, and other broad topics, CMS is 

looking at process measures for some specific conditions 

such as heart failure, diabetes, chronic obstructive 

pulmonary disease, and coronary artery disease. We expect 

that our work will complement CMS’s.

Fall prevention and wound care practices have several 

important strengths as potential process measures. First, 

fall prevention can be important for all patients. About 

one-third of all elderly in the community fall every year; 

1 in 10 falls leads to a fracture and 1 in 20 falls requires 

medical attention (Gillespie et al. 2003). Even falls 

that do not lead directly to injury can trigger a cascade 

of mental and physical problems. Second, wounds are 

widespread among the home health population. Improper 

care of wounds can lead to long, costly hospital stays. On 

average, hospitalizations for pressure sores last 13 days 

and cost nearly $40,000 (Russo and Elixhauser 2006). 

Third, both kinds of measures can capture the ongoing 

care of patients whose function may not be improving 

and can capture the dimension of patient safety. The panel 

discussed the strengths and weaknesses of these practices 

in terms of these criteria: 1) What is the evidence for this 

practice? and 2) What impact will this practice have on 

beneficiaries’ health status or the ability to remain safely 

at home? Generally, the panelists agreed that several 

practices had a strong evidence base and high potential 

impact. 

Fall prevention practices

Table 5-2 (p. 108) includes several of the most promising 

fall prevention practices. The panelists told us that one of 

the deficiencies of current practice is in the identification 

of patients’ fall risk. A study of fall risk assessment and 
108 Adding quality measures in home health

management practices found frequent failures in practice 

(Fortinsky et al. 2004). The panelists discussed many 

practices that related to improved assessment. They 

emphasized that assessment alone was not enough, but that 

evidence-based interventions to address risks should be 

part of the process of care. In other words, reducing falls 

requires two steps: 1) identifying patients at risk and 

2) providing care designed to reduce the factors that may 

lead to falling. Examples of both good risk assessments 

and good interventions are in Table 5-2. 

Panelists presented strong evidence for the practice of 

validated techniques to assess fall risk, rather than using 

unstandardized methods of observation. Members of 

the panel had tested these practices at their agencies and 

measured substantial success at reducing the number of 

falls among their patients. Several panel members noted 

a recent study that concluded that agencies with low 

hospitalization rates integrated prompts to make plans 

for interventions within the fall risk assessment activity 

(Briggs Corp. 2005). Linking assessment and intervention 

could be achieved in different ways. For example, a patient 

assessment program on a nurse’s handheld computer 

could be written to prevent a nurse from moving on to 

the next question on the patient assessment form if the 

nurse indicates that a risk was present. The nurse would be 

required to enter an intervention in the care plan to address 

the risk (e.g., refer patient to occupational therapist) before 

the patient assessment program could continue.

The panel’s conclusions were similar to those in a recent 

meta-analysis of clinical studies of fall prevention 

among older adults (Gillespie et al. 2003). The analysis 

included a review of 62 trials involving over 21,000 

elderly people. The analysis found strong evidence 

that a multifactor assessment tool linked with an 

intervention program, strength training, balance training, 

and withdrawal of medication that increases the risk of 

falling all significantly reduced falls among elderly in the 

community. A multifactor tool includes environmental, 

medical, functional, and psychosocial problems rather 

than focusing on one or a few of these factors. The metaanalysis also found that a home hazard assessment and 

modification program had a statistically significant effect 

on the number of falls; however, the panel said that this 

practice was already standard and consistent among 

providers of Medicare home health services.

Wound care practices

Table 5-3 includes some of the most promising practices 

for wound care. In this area of practice, too, the group said 

that best practices were not followed consistently among 

all home health agencies. Panelists agreed there was room 

for improvement and standardization in wound assessment 

and treatment. 

Several panel members said that taking a photograph or 

digital image of the wound was a substantial improvement 

in the process of measuring wounds and recording 

changes. One panelist noted that a photograph was also 

a very useful tool for communications from home health 

nurses to physicians. Her agency had a substantial increase 

in the number of physicians who were willing to change 

the plan of care when an image of the wound accompanied 

the change request. Though several panel members 

thought that the cost of photographs would be prohibitive, 

several other panel members already used the technology 

or were familiar with providers who did. Providers who 

record images of wounds say it is easy to implement this 

practice. 

The treatments and the notification protocols that were 

suggested by the panel are consistent with AHRQ’s best 

practice guidelines for the treatment of pressure ulcers 

(AHRQ 1994). The panel discussed both pressure ulcers 

and surgical wounds and agreed that some treatments and 

physician contact protocols for pressure wounds also apply 

to surgical wound care. 

Among the assessment practices discussed was use of 

specific wound measurement tools. Providers on the panel 

TABLE

5–2 Fall prevention practices

Practice Specifi cations

Use a standard, 

multifactor tool

• Include patients’ fall history

• Include medication inventory

Use validated techniques 

to measure fall risk

• Measure postural hypotension

• Measure balance defi cits by asking 

patient to stand on one foot for 

10 seconds

Link assessment tool to 

appropriate follow-up 

activities

• Contact physician to review number 

and type of medications that 

increase fall risk

• Refer patient to a physical or 

occupational therapist

• Initiate gait training, balance 

training, or strength training

Source: MedPAC analysis of expert panel discussion conducted February 2006.
Report to the Congress: Increasing the Value of Medicare | June 2006 109

said that attention to location and size of the wound, depth, 

drainage, odor, and wound margins are all key elements 

of the most effective tools. Panelists agreed that rather 

than requiring the use of a particular assessment tool, best 

practice guidelines should recommend the features of the 

tool that should be used. 

The panelists shared concern over the wide national 

variation in wound care. Several noted that practices 

known to prolong or even prevent wound healing are still 

the standard plan of care for some patients in some areas. 

As long as poor wound care practices continue to injure 

patients or prolong their recovery, the diffusion of best 

practices will remain critical to improving the health of 

Medicare beneficiaries.

In some instances, panelists from home health agencies 

felt that the physicians who give wound treatment orders 

for the plan of care prevented agencies from implementing 

better treatments. Panelists thought that some physicians 

were not familiar with the most recent studies of effective 

wound care. Establishing wound care best practices—and 

providing rewards for them—would give agencies the 

weight of Medicare’s endorsement, clinical evidence, and 

financial incentives to engage physicians to reconsider the 

wound care practices they order.

Translating best practices into process 

measures

The work of the panel could be used to expand the home 

health measure set by translating the best practices into 

process measures and validating those measures. Process 

measures include a precise description of who should 

receive the care, at what time and how often the care 

should occur, a very specific definition of the practice 

itself, and rules to exclude patients who should not receive 

the care. The process measure would then be tested against 

the Commission’s criteria for good measures: Is it reliably 

specified? Is it a valid measure of good practice? Would it 

require unduly burdensome data collection? 

Part of the assessment of these measures could include 

determining whether the practices they describe are within 

the scope of the benefit. For example, some panelists 

questioned whether some fall prevention activities are 

within the scope of services that home health agencies 

should provide according to the rules that govern the 

home health benefit. Many fall prevention techniques 

could occur during regular visits and patient contact, 

such as patient assessment and education. However, over 

the course of the days and weeks of an episode of care, 

home health personnel spend relatively little time in 

patients’ homes and have limited control over the patients’ 

environment. They can not physically prevent falls in the 

same way that an inpatient setting could.

On the other hand, the panelists may have been reacting to 

the lack of definition of the benefit, which we have noted 

in previous reports. For decades, administrators and the 

Congress have struggled with defining the home health 

benefit. In 1989, “skilled care was explicitly extended 

beyond specialized services to include judgmental 

services such as skilled observation, patient assessment 

and management, and evaluation of patients’ care plans” 

(Feder and Lambrew 1996). However, coverage is 

restricted to services that are reasonable and medically 

necessary to treat an illness or injury. For example, while it 

may be beneficial to evaluate a diabetic patient’s balance, 

this evaluation might not be necessary to treat the diabetes 

that was the primary reason he or she was admitted to 

home health care. The lack of definition of the benefit 

raises some questions about whether some good health 

practices related to safety and prevention are strictly within 

the scope of the home health benefit.

TABLE

5–3 Pressure wound care practices

Practice Specifi cations

Improve assessment • Assess skin from head to toe

• Assess wound at each visit

• Photograph wound as part of the 

record

Improve treatment • Offl oad pressure ulcers

• Maintain moist wound bed as 

appropriate

• Develop a turning schedule or 

increase mobility as appropriate

• Use infection control techniques

• Educate caregivers regarding 

infection control and following 

turning schedule

Develop physician 

contact protocols

• Contact physician at fi rst sign of 

infection

• Contact physician if wound does not 

respond to treatment within 2 weeks

Source: MedPAC analysis of expert panel discussion conducted February 2006.
110 Adding quality measures in home health

Figure 5-1 illustrates the translation from best practice to 

process measure for the example of a fall prevention best 

practice. Generally, process measures are the quantifiable 

details of what should be done, to whom, and how 

frequently, based on best practices. In the figure, we begin 

with our panel’s suggestion that best practice for fall risk 

assessments should include a gait assessment. Details 

based on that best practice are developed (the center of the 

figure). Finally, a process measure based on the details is 

assembled at the far right of the figure (Rubenstein et al. 

2001). This process measure would be accompanied by 

instructions to determine who is a “vulnerable elder” and 

what “documentation” and “gait disturbances” are. The 

instructions would be designed to ensure that each agency 

reports the same care for the same patient population. 

If the data were consistent from agency to agency, the 

measure would be considered reliable. 

Potential measures must be assessed for reliability 

and validity. A popular method for reliability testing 

is measuring two raters’ agreement in describing the 

same encounters. In the example of the practice of gait 

assessment, two different nurses or a nurse and a physical 

therapist might not agree on the kind of clinical activity 

that constitutes an “examination” of gait disturbances 

without some additional information to describe the 

clinical practice. 

The validity of process measures could be assessed in 

several ways. One way is to determine whether evidence 

links the processes to improved outcomes. Our panel 

provided clinical information and cited randomized, 

controlled trials that established these links for the 

discussed practices. Another way is to assess the measure’s 

content validity—whether the process to be measured 

captures the most important aspects of the best practice 

on which the measure is based, according to expert 

judgement. A third way is to assess construct validity—

whether all the measures within a set are related to the 

same practice (e.g., whether all of the processes in a set 

of “fall prevention” measures are related to the practice 

of fall prevention). If one or two measures within a set do 

not correlate well with the rest of set, based on statistical 

analysis, perhaps they are not valid measures of the same 

type of practice that the other measures capture. 

Once developed, process measures could enhance the 

current quality measure set in five key ways. They would 

expand the applicable patient population and expand the 

scope of quality to include safety. They would measure 

an aspect of care that the provider controls and provide an 

incentive to improve information technology use. Finally, 

they would help current best practices diffuse. These 

improvements represent a step forward in the evolution 

of quality measurement for home health, a step that the 

Example: Translating fall prevention best practice into process measure

Note: The process measure in this example is from Rubenstein et al. 2001.

Source: MedPAC analysis.

Best practice

Patients receive fall assessment 

that includes gait assessment.

Who should receive the care

all vulnerable elders

Frequency of care

at least once

Rules for exceptions

none (everyone should receive this care)

Precise definition of the care

have documentation that they were asked about or 

examined for the presence of gait disturbances

Process measure

All vulnerable elders should have 

documentation that they were 

asked about or examined for the 

presence of gait disturbances

 at least once.

FIGURE

5–1
Report to the Congress: Increasing the Value of Medicare | June 2006 111

Commission has concluded is necessary to maintain all 

measure sets. We encourage CMS to use measurement 

development experts to translate fall prevention and wound 

care best practices into process measures and to validate 

those measures. 

The home health measure set must continue to evolve. 

Ongoing research can create or validate new measures of 

all types or refresh measures currently in the set. Process 

measures should be added, altered, or dropped if new 

guidelines have stronger evidence, better outcomes, or 

provide more cost-effective alternatives. 112 Adding quality measures in home health

1 Outcomes are often divided into several subtypes, including 

mortality, adverse events (e.g., infections), and patient 

experience (e.g., whether the patient understands how to use 

medical equipment at home). 

2 AHRQ anticipates that it will use CMS’s current publicly 

reported set of measures in its next series of reports (Moy 

2006).

3 All of the patients in this research had a congestive heart 

failure diagnosis. The outcomes measured included physician 

and emergency department use, hospital admission, conditionspecific quality-of-life measures, patient satisfaction, and 

survival at 90 days. Physician use, emergency department use, 

and patient mortality remained the same in the intervention 

group. Hypothesized improvements in the other outcomes did 

not occur. 

4 These management tools are often embedded in an electronic 

medical record; however, they are also available on their own. 

Endnotes
Report to the Congress: Increasing the Value of Medicare | June 2006 113

Agency for Healthcare Research and Quality. 1994. Clinical 

practice guidelines 15: Treatment of pressure ulcers. http://www.

ncbi.nlm.nih.gov/books. 

Briggs Corporation. 2005. Briggs national quality improvement/

hospitalization reduction study. West Des Moines, IA: Briggs 

Corporation.

Center for Health Services Research, University of Colorado 

Health Services Center. 2002. OASIS and outcome-based quality 

improvement in home health care: Research and demonstration 

findings, policy implications, and considerations for future 

change, vols. 1–4. Denver, CO: Center for Health Services 

Research.

Donabedian, A. 1966. Evaluating the quality of medical care. 

The Milbank Memorial Fund Quarterly 44, no. 3: 166–203.

Feder, J., and J. Lambrew. 1996. Why Medicare matters to people 

who need long-term care. Health Care Financing Review 18, 

no. 2 (Winter): 99–112.

Feldman, P. H., T. R. Peng, C. M. Murtaugh, et al. 2004. A 

randomized intervention to improve heart failure outcomes in 

community-based home health care. Home Health Care Services

Quarterly 23, no. 1: 1–23. 

Fortinsky, R. H., M. Iannuzzi-Sucich, D. Baker, et al. 2004. Fallrisk assessment and management in clinical practice: Views from 

healthcare providers. Journal of the American Geriatrics Society

52, no. 9: 1522–1526.

Gillespie, L. D., W. J. Gillespie, M. C. Robertson, et al. 2003. 

Interventions for preventing falls in elderly people. The Cochrane 

Database of Systematic Reviews, 4.

Institute of Medicine. 2001. Crossing the quality chasm: A new 

health system for the twenty-first century. Washington, DC: 

National Academies Press.

McGlynn, E., S. Asch, J. Adams, et al. 2003. The quality of 

health care delivered to adults in the United States. New England 

Journal of Medicine 348, no. 26: 2635–2645.

McGlynn, E. 1997. Six challenges in measuring the quality of 

health care. Health Affairs 16 (May/June): 7–21.

Medicare Payment Advisory Commission. 2005. Report to the 

Congress: Medicare payment policy. Washington, DC: MedPAC. 

Medicare Payment Advisory Commission. 2003. Report to the 

Congress: Variation and innovation in Medicare. Washington, 

DC: MedPAC. 

Moy, Ernest. 2006. Telephone conversation with Sharon Bee 

Cheng, March 31.

National Quality Forum. 2005. National voluntary consensus 

standards for home health care. Washington, DC: NQF.

Rubenstein L. Z., C. M. Powers, and C. H. MacLean. 2001. 

Quality indicators for the management and prevention of falls 

and mobility problems in vulnerable elders. Annals of Internal 

Medicine 135, no. 8 (October): 686–693.

Russo, C. A., and A. Elixhauser. 2006. Hospitalizations related to 

pressure sores. Washington, DC: AHRQ.

References

Toward better value in 

purchasing outpatient 

therapy services

CHAPTER 6

Report to the Congress: Increasing the Value of Medicare | June 2006 117

Toward better value in 

purchasing outpatient 

therapy services

C H A P T E R 6

Chapter summary

Spending for outpatient therapy services—including physical therapy, 

occupational therapy, and speech-language pathology services—almost 

doubled to $3.9 billion from 2000 to 2004 yet the Commission knows 

very little about the value of this purchasing. There is little information 

about who receives services and no information about their outcomes, 

making it hard to evaluate program spending. 

The large expenditure growth was the result of more beneficiaries 

using these services and more services being furnished to each user. 

Spending per beneficiary also varied considerably. Without additional 

information, we can not know if the spending growth and variation 

reflect differences in the types of patients treated or if patients who 

received more services had better outcomes. The spending patterns also 

raise questions about how to allow beneficiaries to get the services they 

need without requiring Medicare and patients to pay for services that 

are medically unnecessary. 

In this chapter

• Growth in Medicare 

spending since 2000

• Variation in spending 

• Alternative ways to manage 

therapy service use

• Information needed to 

evaluate Medicare’s therapy 

purchases

• Next steps for CMS
118 Toward better value in purchasing outpatient therapy services

To learn about alternative strategies to ensure appropriate use of outpatient 

therapy, the Commission convened an expert panel and interviewed 

numerous researchers, medical directors at companies that process Medicare 

claims, representatives from companies that market guidelines and outcomes 

tracking systems, and private plan representatives. Of the strategies explored, 

developing guidelines and tracking resource use and patient outcomes are the 

most promising avenues for CMS to pursue. 

Like all fee-for-service methods, the payment system used for outpatient 

therapy generally encourages providers to furnish services to therapy users. 

Only patients using many services are affected by the spending limitations 

imposed on a per beneficiary basis. CMS needs better information about 

the therapy needs of beneficiaries and their outcomes to consider alternative 

payment methods. This will require the agency to develop patient assessment 

tools that gather information about beneficiaries’ risk factors and their 

outcomes. More than one tool may be required given the diverse care needs 

of patients receiving therapy and speech-language pathology services. 

Concurrent pilot studies could be used to evaluate alternative data collection 

methods and the feasibility of using the tools in a wide range of settings for 

a diverse patient population. Data gathered from the pilot studies could be 

used to establish benchmarks for therapy practice, develop risk-adjustment 

methods to predict the care needs of patients, and refine the therapy caps and 

the exceptions process. 

With more complete information about therapy and speech-language 

pathology service users and patient outcomes, CMS can consider how to 

reform the payment system so that the program gets value for its purchasing. 

One option is to pay for a bundle of services that varies by patient condition, 

with protections for unusual situations or care needs. Another is to develop 

an incentive payment system that encourages therapists and speech-language 

pathologists to provide high-quality care and also be conservative in 

furnishing services. In either payment approach, adequate risk-adjustment 

methods are essential to making providers financially neutral toward the 
Report to the Congress: Increasing the Value of Medicare | June 2006 119

types of patients they treat. Given that outpatient therapy makes up a 

relatively small share of Medicare spending, CMS will want to select costeffective interventions to make best use of its limited resources. 

On January 1, 2006, the therapy caps that limit program spending per 

beneficiary were reinstated. As required by the Congress, CMS implemented 

an exceptions process allowing beneficiaries to apply for approval of 

medically necessary services beyond the spending limits in 2006. CMS will 

need to carefully monitor this process to ensure that these additional services 

were medically necessary. Report to the Congress: Increasing the Value of Medicare | June 2006 121

Spending on outpatient therapy services has almost 

doubled since 2000, yet the Commission knows very little 

about the value of this purchasing. CMS noted that the 

growth in minor procedures, which includes outpatient 

therapy services, was a key contributor to recent increases 

in fee schedule spending in its letter to the Commission in 

March 2005 and again in April 2006 (Kuhn 2005, Kuhn 

2006). However, it is difficult to evaluate this spending 

without better information about the care needs of 

beneficiaries and their outcomes. 

Background

About 12 percent of beneficiaries use outpatient therapy. 

(The text box on page 122 provides basic information 

about the types of therapy services, Medicare coverage, 

and Medicare payments.) Therapy users, particularly 

users of occupational therapy (OT) and speech-language 

pathology (SLP) services, are disproportionately female 

and tend to be older than beneficiaries who do not use 

therapy services. 

Providers of outpatient therapy

Outpatient therapy services are furnished in many different 

settings (Figure 6-1). Therapists in private practice work 

in their own offices or as employees of physician-owned 

group practices. If a therapist works in a physician’s office, 

the therapist may bill Medicare independently or furnish 

the service as “incident to” a physician visit.1

 Incident to 

services must be supervised by a physician. 

Services furnished in therapists’ private practices and in 

nursing homes account for the largest share of Medicare 

payments for outpatient therapy.2

 Though hospital 

outpatient departments treat over a third of therapy users, 

they make up a smaller share of Medicare spending. On 

average, hospital outpatient departments treat beneficiaries 

for a shorter period of time and furnish fewer services 

per day (Ciolek and Hwang 2004a). Nursing homes treat 

about 15 percent of users but account for a larger share (23 

percent) of Medicare spending. Data are not available to 

determine if this spending variation reflects differences in 

the types of patients treated. 

Other outpatient therapy settings include physicians’ 

offices, occupational therapists in private practice, 

outpatient rehabilitation facilities (ORFs), and 

comprehensive outpatient rehabilitation facilities 

(CORFs).3 The vast majority of users (93 percent) do 

not receive services from multiple providers. Most SLP 

services are furnished in institutional settings.

Therapy caps

The Balanced Budget Act of 1997 imposed limits on 

Medicare payments for all outpatient therapy service 

providers except hospital outpatient departments.4

 Two 

therapy caps were in effect for calendar year 1999. 

One cap limited spending per beneficiary to $1,500 for 

physical therapy (PT) and SLP combined; the other capped 

spending at $1,500 per beneficiary for OT services. 

Beginning in 2000, the Congress suspended both caps 

for all but about three months in 2003 until January 1, 

FIGURE

6–1 Outpatient therapy is furnished 

by many different entities

Note: PT (physical therapist), ORF (outpatient rehabilitation facility), SNF (skilled 

nursing facility), CORF (comprehensive outpatient rehabilitation facility), 

OT (occupational therapist). Based on share of Medicare spending in 

2004. PT private practice and OT private practice include therapists 

employed by physician groups who bill independently and are not 

furnishing services incident to physician services.

Source: MedPAC analysis of the 5 percent fi le of carrier and fi scal intermediary 

claims for 2004. 

23%

Nursing home

10%

Physician

office

4%

SNF

outpatient

4%

CORF

2%

OT private

practice

14%

ORF

24%

PT private

practice

19%

Hospital

outpatient
122 Toward better value in purchasing outpatient therapy services

What are outpatient therapy services?

Outpatient therapy services include physical therapy 

(PT), occupational therapy (OT), and speech-language 

pathology services (SLP) services. 

• PT services—restore and maintain physical function 

and treat or prevent impairments, functional 

limitations, and disabilities that may result from 

disease, disorders, conditions, or injury. Examples 

include therapeutic exercise, such as aerobic 

conditioning, and therapeutic activities, such as 

agility and balance training. 

• OT services—improve and compensate for a 

patient’s ability to conduct activities of daily living, 

such as training for food preparation after the loss of 

a limb or developing strategies to optimize balance 

and coordination to help a patient with a hip fracture 

get dressed. 

• SLP services—help patients with difficulties 

communicating and swallowing as a result of 

disease, injury, or surgery. For example, stroke 

patients may receive SLP services to recover their 

ability to speak. 

Outpatient therapy does not include services furnished 

to a beneficiary during a Part A-covered hospital or 

skilled nursing facility stay or a home health care 

episode. These therapies are included in the payments 

made to those settings. 

Medicare’s spending on outpatient therapy services 

is relatively concentrated. Of the three therapies, PT 

makes up over three-quarters of Medicare spending 

and users. In 2004, two services (therapeutic exercise 

and therapeutic activities, both billed by PT and OT) 

accounted for over half of all therapy spending. The 

SLP service with the highest spending—treatment of 

swallowing dysfunction—accounted for only 3 percent 

of total therapy spending. 

Most PT and OT services are billed in 15-minute 

increments. For example, a 45-minute session is billed 

as 3 units of a therapy service. The majority of SLP 

services are not timed and, in most instances, providers 

can bill only one unit per visit. 

What are Medicare’s coverage rules? 

Medicare covers outpatient therapy services as long as 

the services are furnished by a skilled professional, are 

appropriate and effective for the patient’s condition, 

and are of reasonable frequency and duration. The 

beneficiary must be under the care of a physician, 

who must approve the plan of care every 30 days. 

The patient must have a treatable condition and be 

improving. Medicare does not cover outpatient therapy 

services that maintain a level of functioning or serve 

as a general exercise program. Therapists and speechlanguage pathologists must meet the standards and 

conditions required by regulation.5

 Qualified physical 

and occupational assistants are also covered as long as 

they are supervised. Athletic trainers, chiropractors, 

and nurses do not meet the qualification and training 

requirements for therapists.6

 

How does Medicare pay for therapy 

services?

Medicare pays for outpatient therapy services under 

Part B. Payments are established in the physician fee 

schedule for each unit of service, regardless of where 

the services are provided. As with most services 

covered under Part B, Medicare pays 80 percent of the 

payment amount and the beneficiary is responsible 

for a 20 percent coinsurance. Providers of speechlanguage pathology services can not bill Medicare 

independently—these services must be billed through 

an institution, a physician, or a therapist in private 

practice.

As with other fee-for-service payments, this method of 

payment does not encourage providers to be mindful of 

the resources used to treat most beneficiaries because 

only the highest users are affected by spending limits 

imposed by the therapy caps. Report to the Congress: Increasing the Value of Medicare | June 2006 123

2006. During the moratorium, program spending on 

therapy services was unlimited, assuming the services 

met other coverage requirements. On January 1, 2006, the 

therapy caps went back into effect. Both caps limit annual 

spending to $1,740 per beneficiary.7

The Deficit Reduction Act of 2005 required the Secretary 

of Health and Human Services to establish an exceptions 

process allowing beneficiaries to request an exemption 

from the therapy caps if the services they require are 

medically necessary (the text box on page 124 describes 

the exceptions process). This process applies to services 

furnished during calendar year 2006. The exceptions 

process counters a key criticism of the therapy caps: 

They disadvantage beneficiaries with high-care needs 

and the providers who treat them. Without an exceptions 

process, beneficiaries who needed therapy services above 

the spending limits had to pay for them out of pocket, 

go without them, or use hospital outpatient providers, 

which are exempt from the therapy caps. Now, with the 

exceptions process in place, beneficiaries who need 

services above the caps can apply to have those services 

covered without changing providers. 

The other main concern about the caps is not addressed, 

even with the exceptions process: Providers are not 

encouraged to furnish the least amount of services to 

achieve good patient outcomes under a fee-for-service 

system. Until spending reaches the therapy limits, 

providers may furnish more services than the patient 

benefits from. Providers who use resources above the 

therapy limits to achieve better outcomes are penalized 

under a cap system. 

Information available on therapy claims 

Medicare claims have limited information about the 

characteristics of users, making valid comparisons across 

patients and measuring outcomes impossible or extremely 

difficult. Claims do not include information about the 

functional status of the patient at the start or end of a 

course of treatment. Functional status measures include 

the patient’s ability to perform physical and personal 

activities, cognitive state, and living environment (e.g., 

the social support available). As a result, the Commission 

can not evaluate a patient’s functional status or whether 

it changed over time, or group patients with similar care 

needs. 

The claims information also does not include reliable 

diagnosis and impairment (e.g., leg or back pain) 

information about the patients receiving therapy and SLP 

services. Institutions are not required to submit specific 

diagnoses on their claims. The most common code used 

for PT services is not a diagnosis; it is “other physical 

therapy.” Another problem with the diagnosis coding is 

that although a single claim may include more than one 

type of service furnished during the visit, providers are 

not required to list separate diagnoses for each service 

rendered. As a result, patients may be treated for two 

conditions during the same visit but the claim may include 

only one diagnosis code. 

The claims do not consistently include information about 

a patient’s comorbidities and they do not include acuity 

measures of a patient’s symptoms, which affect a patient’s 

need for services. Over three-quarters of beneficiaries 

have one chronic condition and a majority of beneficiaries 

have two or more (MedPAC 2004). Yet, only about half of 

the outpatient claims have two or more diagnoses codes 

on them. The number and type of comorbidities (e.g., 

arthritis, osteoporosis, cardiac and pulmonary conditions, 

diabetes, and depression) affect a patient’s functional status 

(Groll et al. 2005, Stewart et al. 1989). Researchers have 

also found that patients with common chronic conditions 

have worse mental health and bodily pain compared to 

patients without them (Stewart et al. 1989). These factors 

will limit a patient’s ability to improve and increase the 

time needed to recover. 

Finally, except for therapists in private practice, individual 

therapists and speech-language pathologists typically 

do not have unique provider numbers. As a result, it is 

not possible to compare practice patterns of individual 

providers. In addition, we can not compare service use 

across different practice arrangements because therapists 

practicing as part of a physician group can not be 

distinguished from those practicing as part of a group of 

therapists.

Growth in Medicare spending since 

2000

Since the therapy caps were lifted in 2000, spending has 

almost doubled to $3.9 billion in 2004 (Figure 6-2, p. 125). 

Between 2000 and 2004, spending increases averaged 18 

percent a year. PT and OT grew slightly faster than SLP 

services. 

The large growth is a combination of more beneficiaries 

using therapy services and more services being furnished 
124 Toward better value in purchasing outpatient therapy services

to each user (Table 6-1). Since 2000, the number of users 

grew by an average of 8 percent a year, much faster than 

the 1 percent to 2 percent growth in beneficiaries each 

year. In part, the increase probably reflects the growing 

number of beneficiaries with chronic conditions. Another 

contributing factor is likely the expanded number of 

elective surgeries (both inpatient and outpatient) for which 

outpatient therapy is appropriate follow-up treatment. 

CMS exceptions process for spending above the therapy caps

CMS has designed a two-part exceptions process 

to the therapy caps retroactive to January 1, 

2006. Assuming other coverage requirements 

are met (e.g., services are medically necessary 

and restorative in nature), patients with qualifying 

conditions or complexities may use the automatic 

process for exception from the therapy caps. These 

circumstances include a patient having 1) one of a list 

of specific conditions for which the patient is being 

treated or 2) one of a list of comorbidities or clinically 

complex situations that will affect the patient’s rate 

of recovery. Manual exceptions, which must be made 

in writing with supporting documentation, will be 

considered for patients who are not eligible for the 

automatic exceptions process but whose care needs are 

believed to require services beyond the therapy limits. 

A manual request may seek approval for up to 15 visits. 

There are no visit limits on automatically granted 

requests (CMS 2006a, CMS 2006b). 

The list of conditions that qualify a patient to use 

the automatic process for exception is extensive 

and includes joint replacement, Parkinson’s disease, 

multiple sclerosis, stroke, osteoarthritis, various bone 

fractures, open wounds, and dysphasia. Complexities 

that qualify a patient to use the automatic process for 

exemption include comorbidities that otherwise do not 

qualify a patient to use the automatic exception process 

(e.g., diabetes, chronic obstructive pulmonary disease, 

congestive heart failure, and hypertension) or situations 

that are likely to prolong a patient’s recovery time. 

Clinically complex situations that qualify a patient 

to use the automatic process for exemption from the 

therapy caps include: 

• The beneficiary was discharged from a hospital or 

skilled nursing facility within 30 days.

• The beneficiary has a generalized musculoskeletal 

condition or a condition that affects multiple sites.

• The beneficiary has a cognitive disorder (e.g., 

depression or dementia) that will affect the rate of 

recovery. 

• The beneficiary requires both physical therapy and 

speech-language pathology services concurrently.

• The beneficiary had a prior episode of outpatient 

therapy during the calendar year for a different 

condition.

• The beneficiary requires the therapy to be able to 

return to a previous place of residence.

• The therapy will decrease a beneficiary’s need 

for assistance with activities of daily living or 

instrumental activities of daily living.

• The beneficiary does not have access to a hospital 

outpatient department. 

The exceptions process is purposefully broad. Previous 

analysis had indicated that in many diagnosis groups 

there were at least some patients who would have 

exceeded therapy caps had they been in place (Ciolek 

and Hwang 2004c). 

Many private payers handle exceptions to their standard 

coverage limits (typically defined by a number of 

days or visits) with manual review processes. Often, 

a therapist or nurse conducts an initial review. A 

physician then conducts a second level of review. 

CMS had to develop a process that would be mostly 

automated given the volume of claims and the lack 

of infrastructure to conduct reviews. The specificity 

of CMS’s criteria will increase consistency in how 

the companies that process Medicare claims—known 

as claims contractors—consider beneficiaries’ 

applications. Report to the Congress: Increasing the Value of Medicare | June 2006 125

For example, the number of hip and knee replacements 

grew 34 percent during this same time period. It is also 

possible that outpatient therapy now substitutes for 

services furnished on an inpatient basis more frequently. 

Discussions with therapy association representatives 

also indicated that some of the service growth reflected 

beneficiaries’ desire to remain active and independent. 

Finally, until CMS clarified the definition of a therapist in 

2004, nontherapists—such as athletic trainers—provided 

therapy services, which could have expanded the number 

of providers furnishing services.

Service intensity also drove therapy expenditures. 

Spending per user grew an average of 9 percent per year. 

Although fee raises during this period account for some of 

the increase, the number of units billed grew by an average 

of 13 percent per year. Growth in commonly furnished 

services, not new modalities, drove the increases. Due to 

the lack of data on functional status, we can not assess if 

the spending led to better patient outcomes.

Growth by provider setting

Since the therapy caps were lifted in 2000, spending 

increased annually an average of 18 percent but the growth 

rates varied considerably by setting. The largest spending 

growth occurred for therapists in private practice (Figure 

6-3, p. 126). 

Several factors help explain private practice’s rapid 

growth.8

 In 1998, the skilled nursing facility prospective 

payment system was implemented. In response, facilities 

cut back on the therapists they employed. Many therapists 

who were laid off established their own practices. In 

1999, CMS changed the conditions of participation 

so that owners of therapy practices did not have to be 

on site and do all the billing for services furnished 

by licensed therapists. Licensed employee therapists 

could independently bill the program, resulting in more 

therapists in private practice. 

Also in 1999, institutional therapy providers moved from 

cost-based reimbursement to payments established under 

the physician fee schedule. With the elimination of any 

payment differentials between settings, many therapists 

FIGURE

6–2 Medicare spending on outpatient 

therapy services has almost

doubled since 2000

Note: Therapy caps were in effect for all of 1999 and for three months in 2003.

Source: MedPAC analysis of the 5 percent fi le of carrier and fi scal intermediary 

claims for 1998–2004. 

Medicare spending (billions)

$4.5

2.0

3.0

1.0

0

1998 1999 2000 2001 2002 2003 2004

4.0

3.5

2.5

1.5

0.5

Therapy

caps

3 months

of therapy

caps

TABLE

6–1 Outpatient therapy users and service intensity have increased since 2000

1998 1999* 2000 2001 2002 2003* 2004

Average 

annual change 

2000–2004

Spending 

(billions) $2.1 $1.4 $2.0 $2.5 $3.0 $3.2 $3.9 18%

Users

(millions) 3.1 3.0 3.3 3.7 4.0 4.2 4.5 8

Spending 

per user $671 $469 $621 $693 $749 $760 $883 9

Note: *Indicates the year in which the therapy caps were operational (full year in 1999, 3 months in 2003). 

Source: MedPAC analysis of the 5 percent fi le of carrier and fi scal intermediary claims for 1998–2004. 
126 Toward better value in purchasing outpatient therapy services

changed their practice from an ORF to an independent 

practice as a way to avoid the survey and certification 

requirements of institutional settings. 

Finally, CMS clarified in March 2003 that therapists 

could be employees of physicians’ practices but still be 

considered in independent practice. This clarification 

enabled physicians to employ therapists but not be 

responsible for supervising their work. As a result of all of 

the outlined changes, the number of therapists in private 

practice who furnished services to beneficiaries more than 

doubled and accounted for over a quarter of all therapy 

spending in 2004.

Our interviews with various stakeholders identified a 

factor that may contribute to increases in therapy use, but 

we could not verify whether the practice is widespread. 

Some physicians may hire therapists as part of their 

group practice and then refer patients to them as a way 

to generate income.9

 The “in-office ancillary” exception 

states that therapy services are exempt from the Stark 

restrictions that limit physicians from referring patients to 

entities in which they have an ownership stake.10

Variation in spending 

In 2004, spending averaged $883 per user but this was 

substantially influenced by very high spending for a 

small number of users; the median was $435. Spending 

varied considerably by diagnosis, setting, and state. 

Several clinical experts with whom we spoke mentioned 

the difficulty of comparing service users due to the 

heterogeneity of the patients seen in outpatient therapy 

settings. 

Variation by diagnosis

Spending varied considerably depending on the medical 

condition being treated. In 2002, PT spending for an 

episode of care—where an episode represented a group 

Medicare spending on therapists in private practice

 grew faster than that for other providers, 2000–2004

Note: CORF (comprehensive outpatient rehabilitation facility), ORF (outpatient rehabilitation facility), PT (physical therapist), OT (occupational therapist). PT private 

practice and OT private practice include therapists employed by physician groups who bill independently and are not furnishing services incident to physician 

services.

Source: MedPAC analysis of 5 percent fi scal intermediary and carrier 2000–2004 claims fi les. Average annual percent growth

50

30

40

20

10

0

Hospital 

outpatient

CORF ORF Physician

office

Nursing

home

PT private

practice

OT private

practice

Setting where patient was treated

Mean

FIGURE

6–3
Report to the Congress: Increasing the Value of Medicare | June 2006 127

of visits associated with PT—ranged from $416 for ankle 

sprain episodes to $1,012 for spinal cord injury episodes 

(Ciolek and Hwang 2004a).11 This range will affect the 

share of patients in each diagnosis code who are likely to 

be exempt from the therapy caps. For example, in 2002, 

an estimated 13 percent of patients with lower back pain 

and 29 percent of patients with difficulty in walking would 

have exceeded the PT/SLP cap had one been in place 

(Ciolek and Hwang 2004c). This wide range in care needs 

underlines the importance of having an adequate patient 

classification system and risk-adjustment methodology for 

comparing patient outcomes and resource use. 

Variation by setting

While spending averaged $883 per user, there was 

more than a threefold difference across settings (Figure 

6-4). The least costly setting was hospital outpatient 

departments, while the most expensive was CORFs. 

Because the information about patients is limited, the 

Commission does not know if the variation across settings 

is due to differences in the types or complexity of patients 

treated or if patients who received more services had better 

outcomes. The Government Accountability Office (GAO) 

found that in Florida CORFs furnished more services to 

beneficiaries compared with other types of facility-based 

providers (GAO 2004). Differences in patients’ prior 

hospitalization diagnoses and demographic information 

did not explain this disparity. The GAO could not examine 

whether patients treated in CORFs had better outcomes. 

One study that examined the costs of episodes of care 

across settings found that care furnished for the same 

clinical condition (as reported by the diagnosis code) 

varied in duration and the services furnished per day. For 

example, PT episodes for musculoskeletal conditions of 

the knee and lower leg were 35 percent longer and had 

56 percent higher payments per day in CORFs compared 

to hospital outpatient departments. As a result, episode 

payments were more than twice as high in CORFs 

Per user spending on outpatient therapy varied threefold across settings

Note: OT (occupational therapist), PT (physical therapist), ORF (outpatient rehabilitation facility), CORF (comprehensive outpatient rehabilitation facility). PT private 

practice and OT private practice include therapists employed by physician groups who bill independently and are not furnishing services incident to physician 

services.

Source: MedPAC analysis of 5 percent fi scal intermediary and carrier 2004 claims fi les. Spending per user

$2,000

1,000

1,500

500

0

Hospital 

outpatient

Physician

office

OT private

practice

PT private

practice

ORF Nursing

home

CORF

Setting where patient was treated

Mean

FIGURE

6–4
128 Toward better value in purchasing outpatient therapy services

compared to the hospital setting (Ciolek and Hwang 

2004a). 

Because CORFs are concentrated geographically, we 

looked at where beneficiaries get therapy and SLP 

services in states with no CORFs. In these states, a high 

proportion of users received services at hospital outpatient 

departments. 

Variation by state

There are also large spending differences by state. 

Commission analyses found that in 2004, Mississippi 

and Florida had the highest average outpatient therapy 

spending per user ($1,426 and $1,126, respectively), while 

spending in North Dakota and Minnesota was less than 

half these amounts.12 In states with low per user spending 

in 2004, users were more likely to be treated in hospital 

outpatient departments (the setting with the lowest per 

beneficiary spending), compared with states with high per 

user spending. Because payment rates are the same across 

providers, differences are attributable to the volume and 

intensity of services. The different local coverage policies 

of claims contractors may also be a factor. 

Medical necessity of services 

In addition to differences across providers in patient 

complexity and outcomes achieved, another source of 

variation may be the amount of medically unnecessary 

services furnished to beneficiaries. Studies conducted by 

GAO and the Office of Inspector General (OIG) of the 

Department of Health and Human Services resulted in 

recommendations that CMS have its contractors conduct 

adequate medical reviews of outpatient therapy claims and 

increase provider education about coverage rules, local 

medical review policies, and documentation requirements 

(GAO 2004, OIG 2001, OIG 2000a, OIG 2000b). CMS 

has clarified its policies regarding therapy services and 

posted education materials regarding physical therapy 

services on the web (CMS 2005, CMS 2004). In a recent 

study of physical therapy services billed by physicians, 

OIG found that most of the claims it reviewed did not 

meet program requirements (OIG 2006). Its analysis 

of Medicare claims data from 2000 to 2004 revealed 

instances of unusually high volumes of claims, which 

suggest that the services are vulnerable to abuse.

Although Medicare claims contractors provide some 

oversight of the services furnished, their reviews are 

limited and inconsistent across contractors. Some 

contractors look for multiple billings on the same day for 

services that are not time-based (e.g., patient evaluations), 

which typically can be billed only one per day. Some 

contractors have edits on timed services that set a limit 

for the maximum number of minutes that can be billed 

on a single day, with the idea that most beneficiaries can 

not tolerate more than a set amount. Some contractors 

also look to see if the number of services billed over a 

given time period is reasonable, with the idea that most 

beneficiaries would no longer be improving. A CMS 

contractor noted that edits could also be developed for 

clinically illogical service combinations billed during a 

single day (Ciolek and Hwang 2004b).

GAO recommended that the Secretary implement 

improvements in CMS’s automated system for identifying 

claims that are likely to be improper (GAO 2005). In the 

Deficit Reduction Act of 2005, the Congress subsequently 

required that clinically appropriate edits be implemented 

by July 1, 2006. 

Although no data are likely to definitively confirm a 

patient’s need for services, patient-level information could 

be used to predict a patient’s care needs and rehabilitation 

potential based on similar patients. This information could 

be used to monitor resource use and outcomes and identify 

aberrant practices. 

Alternative ways to manage therapy 

service use

The increased number of users and services furnished 

and the large variation in spending raise questions about 

how best to allow beneficiaries to get the services they 

need while paying for only services that are medically 

necessary. The therapy caps may control spending for 

beneficiaries who use unusually high amounts of care, 

but will not address the appropriateness of care for 

beneficiaries using low and moderate amounts of care. 

Other strategies are needed to make sure that users can 

benefit from therapy services and that the amount of 

therapy provided is appropriate for the beneficiary’s 

condition. The Commission consulted a variety of 

experts—including researchers, medical directors at 

Medicare claims contractors, providers, product vendors, 

and private payers—to learn about alternative ways to 

manage therapy use. The text box describes a panel we 

convened and the experts we consulted. 
Report to the Congress: Increasing the Value of Medicare | June 2006 129

Outsource managing the benefit

Some payers contract out the management of therapy 

services (mostly PT and OT) to companies specializing 

in orthopedic specialty benefits. These companies offer 

a range of services, including utilization management, 

medical review, and establishment and management of a 

network of therapy providers. Focusing on musculoskeletal 

conditions, these companies manage service use, identify 

inappropriate care, and reduce claim appeals. Their 

clients, typically large insurers and a range of managed 

care organizations, are generally not set up to manage the 

relatively small cost items spread over a period of time that 

characterize most therapy services. 

Benefit management companies generally perform preauthorization and concurrent review services using their 

own guidelines based on clinical expertise, published 

medical association recommendations, and medical 

literature. At admission, a therapist assesses a patient’s 

functional status (e.g., range of motion, level of pain, and 

ability to perform activities of daily living). A proprietary 

model estimates the number of visits the patient will 

require to reach a certain level of improvement. The 

therapist provides services until the patient reaches the 

targeted outcomes or fails to improve. Peer therapists or 

nurses conduct medical reviews for patients who require 

additional visits to ensure that the plan of care continues to 

match the patient’s care needs. By comparing service use 

to norms, these companies manage therapy use based on 

the patient’s clinical condition and progress. 

In cases where the company manages a network of therapy 

providers, contracts delineate the terms of payment. One 

company explained that it pays providers on a per visit 

basis (not per service) as a way to decrease the number of 

modalities furnished during a visit. If the company were to 

bundle payments to span episodes of care, it might overpay 

for patients who reach their goals earlier than expected. 

Daily payments, the company said, focus providers on the 

medical necessity of every day of care. 

Contracting out the management of a therapy benefit 

generally complements other review activities that the 

payer does in-house to monitor the appropriateness of their 

subscribers’ or enrollees’ service use. For example, these 

payers and plans often conduct their own medical reviews 

of hospitalizations but have determined that managing 

an in-house review of therapy services is not cost 

effective. In contrast, the scale of the Medicare program 

makes concurrent review infeasible without spending 

considerably more on administrative expenses. 

Expert advice on ways to manage therapy service use

The Commission convened an expert panel 

of researchers, medical directors of claims 

contractors, and private plan representatives 

to consider some of the policy options available to 

the program. We asked the 15 panelists to evaluate 

the evidence for delineating therapy care needs of 

elderly patients and to consider the current activities 

undertaken by Medicare claims contractors and private 

payers to manage service use. We also asked them to 

identify the information that CMS needs to collect to 

assess patient outcomes and develop a payment system 

with adequate risk adjustment. 

We also conducted over 25 interviews with post-acute 

care researchers and representatives from companies 

that market guidelines and outcomes tracking systems, 

private plans, and users of guidelines and tracking 

systems. We asked the private plan representatives to 

describe their approach to managing therapy use and 

their assessment of whether the approach could work 

for Medicare. The representatives from outcomes 

tracking companies described the product, the 

predictive model and risk-adjustment methodology, 

the outcomes measures, and the mix of patients in 

their database. We asked the guideline company 

representatives to describe how the guidelines are 

developed and revised, outline how their clients use 

them (prospectively, concurrently, or retrospectively), 

and evaluate the evidence basis underlying the 

guidelines. 130 Toward better value in purchasing outpatient therapy services

Increase copayments 

One way to encourage appropriate use of therapy services 

would be to make the beneficiary responsible for a larger 

share of the payments. While not a common strategy, 

some private plans have adopted higher copayments for 

therapy services as a way to lower the demand for services. 

One plan told us that by shifting its definition of therapy 

services from primary to specialty care, it raised the 

copayment for each therapy visit from $15 to $25. The 

following year, service use declined by about 8 percent. 

Another plan examined the differences in therapy use 

across its Federal Employees Health Benefits plans and 

found that groups with the highest copayments had the 

lowest service use. As a result, it encouraged employers to 

raise copayments and about half have done so. However, 

the plan reported that many employers were reluctant to 

raise copayments because the approach is viewed as taking 

away benefits. 

Medicare would likely face opposition from providers 

and beneficiaries to proposals to raise the copayments 

for all therapy services above the current 20 percent. 

Another strategy might be to consider tiered copayments. 

In this model, a beneficiary’s use of services would be 

compared to some benchmark, such as the average use 

by patient condition. For service use within an acceptable 

range, copayments would remain at 20 percent. If service 

use exceeded the norm by some significant amount, 

the beneficiary would pay higher copayments for those 

services that were above some threshold. CMS would 

need to establish practice norms by patient condition—

for example, based on average service use for older users 

or, ideally, evidence-based practice guidelines. Without 

adequate risk adjustment, beneficiaries with higher care 

needs could face difficulties accessing services or being 

penalized for needing more care. 

Use practice guidelines to manage 

resource use 

Some private payers, providers, and benefit management 

companies use commercially available practice guidelines 

to review and approve the number of visits furnished to 

a patient. Although guideline products (such as those 

marketed by McKesson/InterQual, Apollo Managed Care 

Consultants, and Milliman) differ in the details of the 

patient groupings and the care they recommend, there 

are broad similarities. For any given clinical condition, 

such as osteoarthritis in the shoulder, the guidelines often 

include clinical criteria used to evaluate whether therapy 

or SLP services are indicated (e.g., limited range of 

motion), the recommended modalities of treatment (e.g., 

therapeutic exercise), and the average number or range 

of visits. The guidelines are developed in an iterative 

fashion. Staff clinicians compile and review the existing 

medical evidence, which includes peer-reviewed journals, 

other published data, guidelines developed by health 

research organizations and professional organizations, 

expert opinion, and unpublished data. Increasingly, 

guidelines include a rating of the quality of the evidence 

used to establish them.13 Draft recommendations are then 

reviewed and revised by an external group of experts. 

Most often, guidelines are used by payers and providers 

in two ways. First, they are applied concurrently to an 

ongoing treatment regimen to approve continued service 

provision. Using condition-specific guidelines and an 

associated estimated number of visits, a peer reviewer 

asks the provider to confirm a patient’s diagnosis and 

rehabilitation potential (like Medicare, most payers 

require patients to be improving) to ensure that continued 

care is medically necessary. Second, guidelines are used 

retrospectively to compare providers’ practices to those 

of other providers or to norms, such as national average 

visits. Service provision that is unusually high or low is 

flagged for follow-up review and, in some cases, provider 

education. 

The therapy associations have also been active in 

disseminating information about best practices. Based 

on expert panels it convened, the American Occupational 

Therapy Association reviewed the evidence basis for 

specific conditions and published “evidence briefs” on 

selected topics, such as stroke and Parkinson’s disease. 

The American Physical Therapy Association (APTA) 

has undertaken two guidelines-related activities to 

increase the evidence basis for practicing therapists. 

First, it wrote a guide to help physical therapists identify 

preferred tests and interventions used to treat a variety 

of conditions. Though explicitly not intended to serve 

as clinical guidelines, the guide promotes appropriate 

service provision (APTA 2003). Second, it established a 

“Hooked on Evidence” website that includes a database 

of the current research evidence on physical therapy 

interventions. 

Experts with whom we spoke had mixed opinions about 

applying guidelines to beneficiary service use. They 

differed in their assessment of the quality of evidence 

underlying the currently available guidelines. Some 
Report to the Congress: Increasing the Value of Medicare | June 2006 131

thought the guidelines lacked a strong foundation in 

randomized controlled trials, while others thought that 

the basis was strong enough to guide practice.14 Most 

agreed that guidelines could reduce the variation in service 

use but that they would need to be tailored to an elderly 

population if used by Medicare. Existing guidelines are 

generally written for a younger, healthier population and 

do not directly consider comorbidities and other factors 

that may increase a beneficiary’s care needs. Guidelines 

not tailored to the Medicare population, especially if 

used to establish payments, could encourage providers 

to select low-cost patients and to ignore treating the full 

spectrum of patients’ care needs (Boyd et al. 2005). Many 

thought that guidelines encouraged providers to furnish 

the approved number of visits rather than to consider a 

beneficiary’s continued need for therapy services. 

Assuming the guidelines created were age appropriate, 

they would be useful in several ways. First, CMS could 

compare a provider’s service use to the guidelines as a way 

to detect unusually low or high service provision. While 

many claims contractors have local coverage policies that 

identify specific service use, national guidelines would 

be a way to standardize contractors’ policies. National 

guidelines could be used to modify the payment process, 

with some method to allow exceptions for beneficiaries 

with unique care needs. In addition, guidelines could be 

used to educate providers and referring physicians about 

conditions and how much service has been shown to be 

effective for them, based on the literature. Finally, the 

guidelines might form the basis of a bundled payment 

method, such as episodes of therapy treatment. 

Using guidelines for prior authorization or concurrent 

review is costly and probably not cost effective 

for Medicare. One health system told us its prior 

authorizations cost about $30 per review and it had 

discontinued them. A carrier medical director told us 

his organization had used concurrent reviews to detect 

maintenance therapy, but had discontinued them because 

of their questionable value. Claims contractors told us 

that additional reviews, besides automated edits, created 

additional workload that could not be supported by current 

funding levels. 

Track service use and patient outcomes 

Providers increasingly monitor patient outcomes and 

service use to identify potentially inappropriate (either 

high or low) service use and to evaluate the resource 

use and patient outcomes. Some providers use vendor 

software, such as LIFEwareSM and Focus On Therapeutic 

Outcomes, Inc. (FOTO), to assess patients’ functional 

status at admission and discharge and to compare their 

outcomes and resource use with the practices of other 

providers whose data are in the vendor’s databank. APTA 

has developed an outcomes tracking and database called 

CONNECT as part of an electronic patient record system 

that will enable a physical therapy practice to compare its 

practice patterns to others. 

By tracking the number of visits furnished and patient 

outcomes, these systems allow clinicians to use the 

information to reduce the number and mix of services 

billed during a visit to achieve a desired outcome. One 

integrated health system told us it had lowered therapy 

use by 8 percent by tracking service use and outcomes in 

combination with standardizing patient evaluations and 

decision making algorithms. Another integrated health 

system uses vendor software that includes a risk-adjusted 

predictive model and an extensive database of patients to 

estimate the average number of visits likely to be needed 

to achieve a specific improvement in outcomes. Based 

on these estimates, it pre-approves a number of visits that 

varies by patient condition. The system plans to create 

incentives for providers to furnish the least amount of 

services to achieve good patient outcomes. 

Tracking resource use and patient outcomes is essential 

to establishing practice norms and to evaluating program 

spending. In addition to flagging aberrant practice, 

benchmarks could be used to vary the therapy caps by 

patient condition. Limits could be lower for beneficiaries 

with modest care needs and higher for beneficiaries 

with extensive care needs. Limits that vary by condition 

would encourage providers to be mindful of the amount 

of services furnished to all beneficiaries, not only the 

beneficiaries affected by the current therapy caps. 

Similarly, practice norms could form the basis of a new 

payment system.

Pay differently for therapy services

Many plans are not using innovative payment methods as 

a way to manage therapy provision. Often, they pay on a 

per service basis and limit the number of visits or days 

of therapy care. Some have shifted to paying per day, as 

a way to control the number of units billed during a visit. 

As already discussed, some plans use guidelines and 

tracking systems to guide the approval of and payment for 

continued service provision. 
132 Toward better value in purchasing outpatient therapy services

Many experts with whom we spoke noted that Medicare 

needs to pay for outpatient therapy and SLP services so 

that providers are not financially encouraged to furnish 

services. One clinician told us that the current method was 

a barrier to practicing cost effectively because to do so 

could lower service billings and result in “lost” revenue. 

He noted that until payers consider patient outcomes in 

their payment method, evidence-based practice is not 

encouraged. One integrated health system, Presbyterian 

Health Plan, plans to pay providers on the basis of their 

resource use (e.g., how many visits were furnished) and 

the patient outcomes (e.g., functional improvement). 

Payments to a provider will vary depending on how the 

resources used and patient outcomes compare to what is 

predicted for the patient. 

Information needed to evaluate 

Medicare’s therapy purchases 

Without better information, CMS can not evaluate the 

value of the therapy and SLP services furnished to 

beneficiaries. It does not know if higher program spending 

resulted in better outcomes. And without information 

about who uses these services and their outcomes, CMS 

can not design a payment system that encourages providers 

to be mindful of the resources used while achieving good 

outcomes for their patients. 

The agency needs two types of information. First, more 

complete information about a beneficiary’s impairment 

and risk factors would indicate their care needs and 

rehabilitation potential. Second, functional status measures 

at admission and discharge would provide information 

on functional improvement—a critical outcome. Linking 

patient characteristics, resource use, and patient outcomes 

will allow CMS to assess when service provision is 

efficient and when patients improve. CMS will need to 

consider the investments it can afford to make, given 

that demands for program improvements far outstrip its 

resources. 

Patient characteristics related to therapy 

care needs 

Many patient characteristics and risk factors are 

related to outpatient therapy care needs. These include 

a patient’s impairment and comorbidities, physical 

status at admission, and cognitive status at admission 

(including motivation and participation). In addition, the 

living environment (e.g., social support and assistance 

available to the patient) also shapes a patient’s need for 

rehabilitation services. 

Currently, CMS does not collect information on most of 

the risk factors identified by experts and stakeholders and 

does not gather any patient assessment information to 

indicate a patient’s functional status (Table 6-2). Extensive 

data matching of beneficiary information from different 

claims files would be required to use data on prior medical 

service use. 

TABLE

6–2 CMS does not collect much of the 

information useful for predicting 

and comparing beneficiaries’ 

therapy care needs

Item available 

in Medicare 

data

Data element Yes No

Age ✓

Gender ✓

Diagnoses and impairmentsa ✓

Comorbiditiesa ✓

Acuity of condition at onset ✓

Type of injury (sprain, strain, fracture, or 

post-surgical) ✓

Severity (e.g., the number of days since 

onset or surgery) ✓

Ability to perform physical activities 

at admission and discharge ✓

Ability to conduct daily activities and 

routines at admission and discharge ✓

Cognitive status at admission and discharge 

(including depression, distress, and degree of 

community integration) ✓

Motivation and self-effi cacy ✓

Social support and assistance ✓

Environmental factors, such as accessibility of 

residence ✓

Treatment settingb ✓

Previous medical use, including surgical historyc ✓

Pain ✓

Note: a The information gathered about a patient’s diagnosis and comorbidities 

is often incomplete. 

b Setting may refl ect aspects of case mix and severity that are not 

measured by other variables. 

c Data are available if various Medicare claims fi les are linked.

Source: Information gathered from the CMS stakeholders’ meeting (February 9, 

2006) and MedPAC interviews with clinical experts.
Report to the Congress: Increasing the Value of Medicare | June 2006 133

Tools for collecting functional status 

measures

Although there are over 75 functional status instruments, 

many are specific to a disease or impairment. Often, a 

tool’s accuracy or relevance declines as it tries to measure 

patients outside the range of patients it was designed to 

assess. Generic tools, such as the Short Form–36, are 

insensitive to some differences in physical disabilities and 

are unable to discriminate among patients at the upper 

and lower bounds of their accuracy.15 In addition, the 

measures gathered from the various tools differ and the 

data gathered from them can not be compared (McHorney 

and Cohen 2000). 

The Commission looked at four tools to learn about 

the possibilities for gathering outcomes data. The tools 

vary considerably in the range of patient conditions they 

typically assess and their survey method. Two tools—the 

Patient Inquiry® tool developed by FOTO, Inc. and the 

Activity Measure for Post-Acute Care (AM–PAC)—use 

computer adaptive technology and item response theory 

methodology to estimate functional status (see text box 

on page 134). Two tools use more traditional survey 

methods—the Outpatient Physical Therapy Improvement 

and Assessment Log (OPTIMAL) and the National 

Outcomes Measurement System (NOMS). Each tool has 

its relative strengths. 

The Patient Inquiry® tool

The Patient Inquiry® tool has been used primarily 

to assess orthopedic patients in over 200 outpatient 

clinics.16 FOTO’s database includes over 1.6 million 

records, including over 300,000 patients who used the 

computer adaptive technology tool. The Patient Inquiry®

tool estimates a patient’s functional status, functional 

improvement, and number of visits needed for a specific 

functional improvement. Its predictive model includes 

a risk-adjustment method that considers the patient’s 

age, impairment, acuity, severity, and surgical history to 

estimate the number of visits and the expected functional 

improvement. As FOTO extends its data collection to 

include complex medical and neurological patients, it 

will refine its risk-adjustment methodology and patient 

classifications.

FOTO’s software also links resource use to functional 

improvements, allowing providers who purchase the 

measurement system to evaluate their resource use and 

patient outcomes. Its reporting features enable users 

to compare therapists’ and site-specific measures (the 

number of visits and functional gains) to national averages. 

FOTO has a grant from CMS to explore the feasibility of 

a pay-for-performance system for PT and OT services. 

FOTO is refining its risk-adjustment methodology using 

its historical data and information collected on Medicare 

beneficiaries at two sites. It will also compare actual 

Medicare payments with an estimate of what payments 

would have been had a pay-for-performance system been 

in place at the two sites. It will also identify the types of 

patients whose care needs were poorly estimated by its 

predictive model. A final report on this project should be 

available mid-2006. 

The strengths of this tool are its large database, riskadjusted predictive model, and reporting features. 

However, the tool has not been used to assess patients 

with complex medical and neurological care needs and 

its ability to accurately assess them warrants careful 

examination. Because it relies on patients’ self-reported 

assessment information, using patient proxies for patients 

with significant cognitive and communication impairments 

would need to be explored. In addition, the tool has not 

been used across a variety of outpatient therapy settings 

and its ease of use will need to be confirmed. 

The Activity Measure for Post-Acute Care 

The AM–PAC was developed to assess patients across 

post-acute settings, in both institutional providers (skilled 

nursing facilities, inpatient rehabilitation facilities, and 

long-term care hospitals), and noninstitutional settings 

(home health care and outpatient clinics).17 The tool uses 

a broad conceptual framework to assess a patient’s ability 

to perform three types of activities: physical, personal and 

instrumental, and applied cognitive.18 Though generally a 

self-report tool, limited research found that it was reliable 

using proxy reporting (Andres et al. 2003). 

Though its database is small, the tool has been tested 

on patients with complex medical, neurological, and 

orthopedic conditions (Coster et al. 2006, Siebens et al. 

2005). As such, it can be used to assess a wide range of 

Medicare patients, including those with chronic conditions 

and comorbidities and the 15 percent of Medicare 

therapy users who are nursing home residents. However, 

its measurement accuracy for patients with significant 

cognitive and communications impairments needs to be 

established. For example, the current set of questions may 

not adequately assess patients with extensive swallowing 

difficulties. 
134 Toward better value in purchasing outpatient therapy services

As it is a relatively recent development, the tool does not 

currently tie resource use to functional improvement. 

HealthSouth and Kaiser Permanente of Northern 

California recently decided to implement the AM–PAC to 

evaluate patient outcomes across their settings, including 

outpatient rehabilitation clinics. The initial 20-site pilot 

study with HealthSouth was successful and they are 

expanding its use to another 190 clinics. Kaiser is piloting 

the tool in a clinic specializing in stroke, traumatic brain 

injury, and neurological patients. If successful, it will 

consider using it in other post-acute settings and outpatient 

clinics. 

Outpatient Physical Therapy Improvement in 

Movement Assessment Log 

The OPTIMAL self-report instrument was designed 

by APTA to document the outcomes of physical 

therapy treatments furnished primarily to patients with 

musculoskeletal conditions in outpatient settings.20 It 

assesses a patient’s ability and confidence to perform 21 

mobility actions such as standing, walking, bending, and 

climbing stairs (Guccione et al. 2005). 

This tool could provide useful outcomes information about 

beneficiaries receiving PT in outpatient settings. This 

traditional tool represents a possible alternative to the more 

complex computer adaptive technology and item response 

theory methods. However, the feasibility of extending this 

tool beyond PT services needs to be explored. Further 

work needs to be done to establish its ability to assess 

patients with a wide range of conditions, including those 

with significant impairments. As with other self-report 

tools, the use and comparability of patient proxies with 

patient responses needs to be examined. The use of the 

tool across the full spectrum of outpatient therapy settings 

would also need to be examined. 

Computer adaptive technology: An overview

Computer adaptive technology and item 

response theory are increasingly used to assess 

the health outcomes of patients because of 

their considerable advantages over traditional survey 

methods (Jette and Haley 2005). This measurement 

strategy tailors the questions asked of each patient 

based on the patient’s response to an initial question 

and answers to subsequent questions. Using an item 

bank of many questions, skip patterns adjust the length 

of the assessment until a desired level of accuracy in 

estimating a patient’s functional status is achieved. 

Relying on data gathered about other similar patients, 

an accurate estimate can be made after answering a 

small number of questions. 

Generally, patients are given the survey to complete 

themselves during the evaluation or visit. An initial 

question for every patient might be how hard it is to 

go up or down 10 stairs. Subsequent questions would 

then ask how hard it is to do other activities, with each 

question triggered by the patient’s response to the 

preceding question. If going down stairs was hard, a 

patient might be asked about how easy it is to get out 

of a car. If descending the stairs was relatively easy 

to do, the patient might be asked about performing 

more difficult tasks, such as walking around the 

block. Because every question in the item data bank is 

calibrated on the same scale, each patient can answer 

a different set of questions but the functional abilities 

across patients can still be compared. 

There are four advantages to this type of instrument. 

First, patients across a wide spectrum of settings, 

abilities, and clinical conditions can be tested without 

the survey becoming excessively long. Typically, a 

patient is assessed using about 10 questions, making 

it more efficient than other surveys.19 Second, the tool 

is accurate over a broader range of patients than many 

of the generic or disease- or impairment-specific tools. 

Third, the outcomes also can be compared because a 

single tool is used to assess a wide range of patients. 

Last, an assessment tool is relatively easy to update 

using computer adaptive technology and item response 

theory. Questions can be changed over time while 

maintaining comparability between older and newer 

versions of the survey. Report to the Congress: Increasing the Value of Medicare | June 2006 135

National Outcomes Measurement System

NOMS was developed in the late 1990s by the American 

Speech-Language Hearing Association to measure the 

functional status of patients with substantial speech, 

cognitive, or communication impairments. In reviewing 

other tools, the association found that existing tools did not 

fully capture patients’ speech and communication abilities. 

Beneficiaries receiving SLP services—such as patients 

recovering from a stroke with comprehension and speech 

difficulties or patients with apraxia of speech— typically 

have speech, communication, and cognitive impairments. 

For many of them, a self-report tool is clinically 

inappropriate or will gather information that is not reliable. 

The tool scores patients on up to 15 functional 

communication measures—such as memory, spoken 

language comprehension, spoken language expression, 

and swallowing—that are selected based on the patient’s 

disorder. The tool is currently used by over 1,400 speechlanguage pathologists who are trained and tested on 

administering the assessment. This training is likely to 

increase the tool’s reliability across assessors. The tool 

includes a reporting feature that compares a provider’s 

outcomes and resource use for individual clinical 

groups, such as stroke or Parkinson’s disease, to national 

benchmarks. 

By design, this tool assesses patients who need to use 

SLP services. In selecting this tool, CMS would need 

to consider a second tool that would be used to assess 

patients with primarily PT and OT care needs. 

Uses for the risk factor and functional 

status information 

Data gathered on a beneficiary’s risk factors and 

functional status would be helpful in several ways. First, 

the information could be used to develop a classification 

system that sorts patients into groups with similar 

resource needs. Such groupings are required to develop 

accurate risk-adjustment methodologies that allow valid 

comparisons of the care needs, service use, and outcomes 

across patients. Some of the experts with whom we spoke 

thought that the risk factors for each type of therapy 

might be different and that separate risk-adjustment 

methodologies should be explored. 

Once adequate risk-adjustment methods have been 

established, CMS could use the comparative information 

to develop benchmarks for treating older patients. While 

actual practices would represent a reasonable starting 

point for developing guidelines, they should be replaced 

with evidence-based guidelines tailored to the elderly 

if they become available. Benchmarks could be used to 

modify the payment process and identify beneficiaries 

with exceptional care needs that would be considered 

separately. Unique provider numbers for every therapist 

and speech-language pathologist could be used to hold 

individual providers accountable for their resource use 

and outcomes. Such accountability will become especially 

important if CMS links payment to outcomes. 

From the provider’s perspective, data-generated 

benchmarks could be used to predict a patient’s likely 

resource needs and outcomes based on the experiences 

of similar patients. While a patient is under a provider’s 

care, continued comparisons to benchmarks would direct 

treatment so that the best outcomes possible are achieved. 

Ideally, benchmarks and examination of outcomes would 

identify when treatments should continue and when they 

are no longer effective. 

Service use by patient grouping could also be used to 

revise the therapy caps and the exceptions process. The 

exceptions process exempts a wide range of patients, 

partly because the information about patients’ care needs 

is limited. Better data would allow this process to more 

accurately identify beneficiaries with exceptional care 

needs. In addition, data about care needs could be used to 

vary the therapy caps by patient condition.

Once risk-adjustment methods and patient groupings 

have been established, CMS can predict the care needs 

of different types of patients. Then, it could consider 

alternative payment systems that include incentives 

for providers to be efficient and achieve good patient 

outcomes. 

Next steps for CMS

Medicare needs to have a payment system for therapy 

services that encourages providers to be mindful of the 

services used while achieving good patient outcomes. 

Before CMS considers changing Medicare’s method 

of paying for therapy services, however, it needs more 

information about therapy users and their outcomes. This 

will require CMS to design patient assessment tools that 

gather risk factor information and outcomes measures. 

CMS also needs to develop accurate risk-adjustment 

methods that can help make valid patient comparisons. 
136 Toward better value in purchasing outpatient therapy services

With accurate ways to group patients with similar therapy 

needs, CMS could establish practice guidelines, profile 

providers’ practice patterns, and, in the near term, refine 

the therapy caps and exceptions process. Ultimately, this 

information would shape a new payment design. 

Selecting an outcomes measurement tool

CMS needs to select the measurement tools that are 

best suited to assess patients receiving therapy and SLP 

services. This may involve selecting more than one tool 

given the wide range in patient conditions receiving these 

services. Only the NOMS system is able to assess patients 

with severe speech and cognitive impairments, yet it is not 

appropriate for assessing most patients receiving PT and 

OT. Conversely, the tools developed to assess PT patients 

may not be able to assess all SLP patients, even with the 

use of patient proxies. While the selection of multiple tools 

may result in more accurate patient information, it will 

limit the comparability across patients. 

In evaluating each tool, CMS needs to consider the range 

of patients it can accurately assess and how this range 

compares to the diversity of patients who receive therapy 

and SLP services. If necessary, it will also have to evaluate 

whether the tool could be expanded to accurately assess a 

broader range of patients. The tool must be accessible to 

patients with limited manual dexterity and able to assess 

patients with significant cognitive and communication 

impairments. The use of patient proxies may expand 

a tool’s range, but CMS will need to examine the 

comparability of assessments gathered from self-report 

tools, clinicians, and other patient proxies. CMS will need 

to consider any systematic differences in the assessments 

gathered using various methods and, if necessary, 

what techniques are available to make the assessments 

comparable. 

An additional factor to consider is the number of 

assessments that have already been completed using each 

tool. A large database of assessments, particularly if it 

reflects a wide variation across patients, will facilitate 

CMS’s development of an accurate risk-adjustment 

methodology. The tools also vary in their current reporting 

features. For example, the AM–PAC currently does not 

link a patient’s resource use to functional improvements—

though presumably it could with time—whereas the 

Patient Inquiry® does.

Another aspect to consider is whether the tool is in the 

public domain. The use of a privately held tool may not 

be affordable or negotiable. To avoid problems with 

copyright, CMS will want to fully explore this issue. 

CMS also may want to select a tool that it can use across 

other post-acute settings. In a congressionally mandated 

demonstration of post-acute care, the Secretary is required 

to gather patient assessment information across post-acute 

settings using a standard patient assessment tool.21 A tool 

such as the AM–PAC could be used across post-acute 

care and outpatient settings, allowing CMS to compare 

the functional status of beneficiaries across the post-acute 

care continuum. This would avoid the current “silos” of 

patient assessment information, whereby the data from 

three assessment tools used in post-acute settings can not 

be compared or combined.22 Comparability is particularly 

important for patients who are hospitalized prior to 

receiving outpatient therapy, such as those recovering 

from strokes or fractures and dislocations of the hip and 

knee. For many of these patients, outpatient therapy is 

part of their post-acute care. The GAO recommended that 

the Department of Health and Human Services expedite 

development of a process for assessing patients’ care 

needs for outpatient therapy services by ensuring that 

these services were considered in its efforts to standardize 

existing patient assessment instruments (GAO 2005).

Conducting pilot studies

One way for CMS to test its selection of one or more 

patient assessment tools and gather data quickly would be 

to conduct concurrent pilot studies that compare different 

methods of gathering risk-adjustment and outcomes 

data. Each study would test the feasibility of a different 

assessment instrument using a representative mix of 

outpatient therapy settings and patients. By including a 

wide range of providers and different tools, the studies 

could test the feasibility and practical aspects of alternative 

information-gathering tools from a broad mix of 

beneficiaries and settings. Before the start of a pilot study, 

CMS may want to determine if an existing tool could be 

expanded to assess a broader range of patients than its 

current design. If so, the study could also test newly added 

assessment questions.

Each pilot study should include an evaluation of the 

limitations of the tool, including: 

• the accuracy across the range of patients who receive 

PT, OT, and SLP services; 

• the feasibility of using the tool in a variety of settings; 
Report to the Congress: Increasing the Value of Medicare | June 2006 137

• the ease of use by patients with differing impairments 

(if a self-report tool); and 

• the likelihood of success—and the costs associated—

with large-scale use.

It is likely that each tool will be appropriate for specific 

types of patients and not others. CMS should also think 

about if, and how, any of the tools could be combined and 

used in a way to minimize the burden on providers. 

At the end of the pilot studies, CMS would be able to 

evaluate which tools work for which types of patients 

and settings and consider the feasibility of computer 

adaptive technology and item response theory versus more 

a traditional data-gathering method. After selecting the 

assessment tool or tools, CMS would make any necessary 

refinements to the way the data are collected before rolling 

out the data collection method to all therapy providers.

Designing a new payment system 

When more complete information about therapy users is 

available, CMS can consider how to reform the payment 

system to get value for program purchasing. Two broad 

options include a payment based on episodes or patient 

outcomes. 

An episode-based payment would pay a provider for a 

series of therapy or SLP services associated with treating a 

patient from evaluation through the end of treatment. The 

payment amounts would vary, depending on the predicted 

resource use of patients with similar care needs. Episodes 

for simple impairments would have lower payments 

than episodes for complex cases. Payment protections 

would need to be developed for unusual circumstances 

or outlier cases. Paying on the basis of a larger bundle of 

services discourages therapists from furnishing services of 

marginal value. Outcomes measures would be needed to 

ensure that providers do not stint on care.

An incentive payment system would pay providers based 

on patient outcomes and resource use. CMS could take 

data from the pilot study to develop benchmarks for 

patient outcomes measures and resource use. These 

benchmarks could then form the basis of an incentive 

payment system. 

In both payment approaches, adequate risk-adjustment 

methods are essential to making providers neutral toward 

the types of patients they treat. If the groupings used 

to establish payments include patients with sufficiently 

different care needs, providers will be reluctant to treat 

patients with above-average care needs. Additionally, 

without adequate risk adjustment, paying for functional 

gains may compromise access for patients who are slower 

to improve or have less rehabilitation potential (Stineman 

2005). 

In addition to encouraging providers to furnish only those 

services that improve a patient’s outcomes, the payment 

system should hold providers more accountable. Whether 

the service provision is of relatively short duration or 

part of a long recovery process, the design of a payment 

system for therapy services should be consistent with the 

overarching goal of making providers accountable for the 

care delivered. And, in the longer term, it needs to look 

across all service provision, regardless of setting. 

Monitoring the exceptions process

While these data collection and other design activities are 

underway, CMS needs to make sure that its exceptions 

process is used for medically necessary care. To minimize 

the resources required to conduct these reviews, CMS 

could start with analyses to identify aberrant practice 

patterns. For example, CMS might examine the percent of 

beneficiaries treated by providers who have requested and 

received automatic and manual exceptions and compare 

the request and approval patterns across providers. 

Unusual patterns could trigger requests for additional 

information. CMS has indicated that it will examine 

billing trends for aberrant practices to ensure that providers 

use the exceptions process for only those beneficiaries 

with exceptional care needs. Such monitoring is critical to 

ensure the exceptions process is being used as intended: 

to provide only medically necessary services to those 

beneficiaries with extensive care needs. 138 Toward better value in purchasing outpatient therapy services

1 Services billed under a therapist’s provider number are 

included in the “therapists in private practice” categories. 

Services furnished incident to physician services are included 

in the “physician services” category.

2 Nursing homes furnish therapy services to long-stay residents 

and the services are paid for under Part B. Therapy services 

furnished to skilled nursing facility patients are paid for in 

the daily rates of the prospective payment system and are 

not part of outpatient therapy services. These facilities also 

provide outpatient services to beneficiaries who live in the 

community. 

3 Outpatient rehabilitation facilities offer a range of therapy 

services in a clinic-like setting. CORFs differ from 

other therapy providers in two ways: 1) they must offer 

psychological or social services and the services of a 

physician who specializes in rehabilitation medicine, and 

2) they are authorized to provide and be paid separately for 

nontherapy ancillary services (e.g., respiratory therapy and 

drugs that can not be self administered) when medically 

necessary. A very small share of outpatient therapy services 

are provided by ambulatory surgery centers and home health 

agencies.

4 A fuller description of the history and impact of the therapy 

caps can be found at http://www.medpac.gov/publications/

other_reports/Dec05_Medicare_Basics_OPT.pdf. 

5 Medicare will also cover therapy services furnished by 

physician assistants, nurse practitioners, and clinical nurse 

specialists if the state in which they practice permits them to 

furnish therapy services. When therapy services are provided 

incident to a physician, the staff member furnishing the 

service must meet the requirements for therapists (with the 

exception of licensure). 

6 In 2004, CMS clarified the qualifications for personnel 

furnishing therapy services in physicians’ and therapists’ 

offices (CMS 2004).

7 As required by the Congress, CMS has adjusted the limits 

each year for inflation using the Medicare Economic Index.

8 Interviews with representatives from CMS, the American 

Physical Therapy Association, and the American Occupational 

Therapy Association confirmed these factors.

9 Generally, physicians require the therapists to assign their 

Medicare payments to the physician practices and then the 

practices pay the therapists’ salaries. 

10 The Stark II law allows physicians to provide most 

“designated health services” (including physical therapy) in 

their own offices (called the “in-office ancillary exception”). 

Depending on their structure, such arrangements are legal. 

Some states restrict or prohibit the ownership or investment 

in physical therapy services by physicians. Proponents of the 

exception argue that it allows physicians to control the quality 

of care and enhances patient convenience. 

11 An episode lasted as long as care was provided without a 60-

day break.

12 These spending amounts were adjusted for differences in local 

prices using the geographic practice indices. 

13 For example, randomized clinical trials are rated as the best 

evidence and unpublished data are rated as the weakest.

14 The randomized clinical trials often exclude patients with 

comorbidities because treatments are likely to appear less 

effective than if only healthier and younger patients are 

included (Iezonni 2003). Some observers argue that clinical 

trials are too resource intensive to expect all practices to be 

guided by them. Instead, targeted trials could be combined 

with carefully recorded and analyzed clinical practices to 

establish best practices (Kane 1997). 

15 For example, patients with stroke and Parkinson’s disease 

were shown to not be accurately measured using the Short 

Form–36 (O’Mahoney et al. 1998, Hobson and Meara 1997). 

Generic health status measures were shown to have biases 

when used to assess patients with disabilities (Anderson and 

Meyers 2000, Kersten et al. 1999).

16 The FOTO website lists numerous journal articles published 

using its tool, including those validating it. This bibliography 

is found at http://www.fotoinc.com/research_papers.htm.

17 The three domains (physical and movement activities, 

personal and instrumental activities, and applied cognitive 

activities) of the AM–PAC have been validated (Coster et al. 

2004a, Coster et al. 2004b, Haley et al. 2006, Haley et al. 

2004a).

18 The tool is based on the domains of daily activities outlined by 

the World Health Organization’s International Classification 

of Functioning, Disability, and Health. This classification 

considers a patient’s health condition (including physical and 

cognitive functioning), activities and participation, and the 

contextual factors (including physical, social, and attitudinal 

environments) that shape a patient’s experience (Üstün et al. 

2003).

Endnotes
Report to the Congress: Increasing the Value of Medicare | June 2006 139

19 For example, the computer adaptive technology and item 

response theory were found to be 70 percent more efficient 

than the lower extremity functional scale in assessing patients 

with hip, knee, foot, or ankle impairments (Hart et al. 2005). 

A 10-question version of the AM–PAC produced accurate and 

consistent measures of functional status (Haley et al. 2004b).

20 The tool focuses on assessing the “activities and participation” 

domain of the International Classification of Functioning, 

Disability, and Health. 

21 The Deficit Reduction Act of 2005 requires the Secretary to 

implement a three-year demonstration by January 1, 2008, 

to assess the costs and patient outcomes across different 

post-acute settings. It requires that hospitalized patients be 

evaluated at discharge to determine the most appropriate postacute placement and that the patients be assessed at the end of 

their post-acute care. The same assessment tool must be used 

by acute care hospitals at a patient’s discharge and by postacute settings. 

22 CMS requires skilled nursing facilities to use the Minimum 

Data Set, home health care agencies to use the Outcomes 

and Assessment Information Set, and inpatient rehabilitation 

facilities (IRFs) to use the IRF–Patient Assessment 

Instrument. Because the time frames, definitions, and scales 

differ across the tools, information from the assessments 

can not be compared across settings (Jette and Haley 2005, 

MedPAC 2005, Iezonni and Greenberg 2003)
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American Physical Therapy Association. 2003. Guide to physical 

therapy practice, second edition. Alexandria, VA: APTA. 

Anderson, E., and A. Meyers. 2000. Health-related quality of 

life outcomes measures. Archives of Physical Medicine and 

Rehabilitation 81(supplement 2): S30–S45. 

Andres, P., S. Haley, and P. Ni. 2003. Is patient-reported function 

reliable for monitoring post-acute outcomes? Journal of Physical 

Medicine and Rehabilitation 82, no. 8: 614–621. 

Boyd, C., J. Darer, C. Boult, et al. 2005. Clinical practice 

guidelines and quality of care for older patients with multiple 

comorbid diseases. Journal of the American Medical Association

294, no. 6 (August 10): 716–724.

Centers for Medicare & Medicaid Services, Department of 

Health and Human Services. 2006a. CMS fact sheet on outpatient 

therapy caps: Exceptions process required by the DRA. http://

www.cms.hhs.gov/apps/media/press/release.asp?Counter=1782. 

Centers for Medicare & Medicaid Services, Department of Health 

and Human Services. 2006b. CMS Manual System change request 

4364, transmittal R855. http://www.cms.hhs.gov/transmittals/

downloads/R855CP.pdf.

Centers for Medicare & Medicaid Services, Department of 

Health and Human Services. 2005. CMS Manual System change 

request change 3648, transmittal 36. http://www.cms.hhs.gov/

transmittals/downloads/R36BP.pdf. 

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Feasibility analysis using existing CY 2002 claims data. 

Columbia, MD: AdvanceMed. 

Ciolek, D., and W. Hwang. 2004b. Feasibility and impact 

analysis: Application of various outpatient therapy service claim 

HCPCS edits, final report. Columbia, MD: AdvanceMed. 

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outcomes after discharge from inpatient rehabilitation settings. 

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Government Accountability Office. 2005. Little progress made 

in targeting outpatient therapy payments to beneficiaries’ needs. 

GAO–06–59. Washington, DC: GAO. 

Government Accountability Office. 2004. Comprehensive 

outpatient rehabilitation facilities: High Medicare payments 

in Florida raise program integrity concerns. GAO–04–709. 

Washington, DC: GAO. 

Groll, D., T. To, C. Bombardier, et al. 2005. The development of a 

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of Clinical Epidemiology 58, no. 6: 595–602.

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item selection in a physical functioning item bank. Journal of 

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Haley, S., W. Coster, P. Andres, et al. 2004a. Activity outcome 

measurement for post-acute care. Medical Care 42, no. 1 

(supplement): I-49–I-61. 

Haley, S., W. Coster, P. Andres, et al. 2004b. Score comparability 

of short forms and computerized adaptive testing: Simulation 

study with the activity measure for post-acute care. Archives of 

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Hart, D., J. Mioduski, and P. Stratford. 2005. Simulated 

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Hobson, J., and R. Meara. 1997. Is the SF–36 health survey 

questionnaire suitable as a self-report measure of the health status 

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6, no. 3: 213–216.

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Iezzoni, L., and M. Greenberg. 2003. Capturing and classifying 

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Part D plan offerings

CHAPTER 7

Report to the Congress: Increasing the Value of Medicare | June 2006 145

Part D plan offerings

7

Chapter summary

Part D uses a market-based approach in which private plans deliver 

Medicare prescription benefits and assume some risk for the drug 

spending of their enrollees. The law gives organizations that sponsor 

Part D plans flexibility in designing and administering drug benefits 

within certain restrictions. For 2006, nearly 80 organizations are 

offering 1,429 prescription drug plans (PDPs) on a stand-alone basis:

• 9 percent use the defined standard benefit, 48 percent have the same 

actuarial value as basic coverage but a different benefit design, and 

43 percent include enhanced benefits (basic coverage plus some 

supplemental coverage).

• 15 percent include coverage in the defined standard benefit’s 

coverage gap, typically for generic drugs.

• 66 percent have no deductible or a reduced deductible.

• Nearly 90 percent of the 1,429 PDPs are offered by 16 

organizations, which often use the same benefit structure, cost 

sharing, and formulary among their different plans.

In this chapter

• Part D’s structure and initial 

levels of enrollment

• Part D plan offerings for 

2006

• Part D formularies

• Looking ahead

C H A P T E R 
146 Part D plan offerings

Another 1,303 Medicare Advantage–Prescription Drug plans (MA–PDs) are 

available nationwide, but access to specific plans varies depending on the 

county in which a beneficiary lives: 

• 7 percent use the defined standard benefit, 29 percent have actuarially 

equivalent basic benefits, and 64 percent include enhanced benefits.

• 28 percent include coverage in the coverage gap, typically for generic 

drugs.

• 83 percent have no deductible or a reduced deductible.

• Nearly 40 percent of MA–PDs charge no additional premium for Part D 

coverage beyond what they charge for Parts A and B services.

As of mid-April 2006, CMS estimated that 27 million of the 43 million 

Medicare beneficiaries (61 percent) either signed up for Part D plans or had 

prescription drug coverage through employer-sponsored coverage under 

Medicare’s retiree drug subsidy. Another 3.5 million beneficiaries 

(8 percent) were federal or military retirees who receive drug coverage with 

at least the same value as the Part D benefit. All of the more than 7 million 

individuals who are dually eligible for Medicare and Medicaid or who 

are already enrolled in a Medicare Savings Program within their state are 

deemed eligible for Part D’s low-income subsidy (or “extra help”) that pays 

for some or all of their premiums and cost sharing. About 1.7 million other 

non-Medicaid beneficiaries with low incomes and assets qualified for Part 

D’s low-income subsidy.

Both MA–PDs and PDPs use formularies to manage the cost and use of 

prescription drugs. The most frequent tier structure distinguishes preferred 

and nonpreferred brand name drugs and includes a specialty tier for very 

expensive drugs, biologicals, and injectables. Plans that distinguish between 

preferred and nonpreferred brand name drugs charge median copays of 

$5 to $7 for generics, $22 to $29 for preferred brands, and $50 to $55 for 

nonpreferred brand name drugs. About 60 percent of all Part D plans have 

a specialty tier and charge a median of 25 percent to 30 percent coinsurance 
Report to the Congress: Increasing the Value of Medicare | June 2006 147

for them. Beneficiaries may not appeal the cost-sharing amounts for drugs 

on a specialty tier.

The median Part D plan lists about 1,000 drugs, with MA–PDs typically 

listing somewhat more drugs than PDPs. Among all plans, those that offer 

nonpreferred brand tiers generally list more drugs than plans with only brand 

and generic distinctions. Our analysis shows little difference in formulary 

size between plans that are and are not eligible for auto-enrollees. Note that 

the number of drugs on a plan’s formulary does not necessarily represent 

beneficiary access to needed medications. Unlisted drugs may be covered 

through the nonformulary exceptions process, which for some plans may be 

relatively easy, but for other plans may be more burdensome for enrollees 

and physicians. Alternatively, on-formulary drugs may not be covered in 

cases where a plan does not approve a prior authorization request. 

Most Part D plans apply drug utilization tools, such as prior authorization, to 

selected drugs. Plans use these tools for drugs that are expensive, potentially 

risky, or to encourage use of available lower cost therapies. Our analysis 

shows that Part D plans typically apply prior authorization to less than 10 

percent of the drugs on their formularies and use step therapy for a very 

small share of drugs concentrated in selected therapeutic categories. 

In the coming years, the Commission will continue to analyze aspects of 

cost, quality, and access under Part D. With further data, we would like to 

examine how plans’ benefit designs and formularies affect enrollee plan 

choice (by characteristics of beneficiaries and plans), beneficiary access 

to medications, beneficiary out-of-pocket spending, beneficiary health 

outcomes, and Medicare program spending. Additionally, the Commission 

will examine how Part D is meeting the needs of special populations, such 

as those residing in long-term care facilities, and study the consequences of 

plans’ formulary changes and utilization management tools—such as prior 

authorization—on beneficiaries, pharmacists, and physicians. Report to the Congress: Increasing the Value of Medicare | June 2006 149

Part D, Medicare’s new outpatient prescription drug 

benefit that began in January 2006, is a departure from 

traditional Medicare. Like the Medicare Advantage (MA) 

program, Part D differs from Medicare’s fee-for-service 

(FFS) program for Parts A and B services because it 

uses competing private plans that are at risk for some 

of their members’ benefit spending. The new program 

encourages both MA plans that include prescription 

drug benefits—Medicare Advantage–Prescription Drug 

plans (MA–PDs)—and new stand-alone prescription 

drug plans (PDPs) to participate. The latter are plans that 

offer drug benefits without a broader package of medical 

benefits. Organizations offering Part D plans submit bids 

to CMS to provide Part D benefits. CMS calculates the 

national average of bids for basic Part D benefits and 

then Medicare pays plans the same capitated amount per 

enrollee based on a percentage of the national average, 

adjusted for the risk of the individual enrollee. (For more 

detail about Part D payments to plans and how Medicare 

subsidizes Part D, see MedPAC 2005b, 2005c.) Plans 

may also receive additional payments from Medicare for 

members who qualify to receive Part D’s low-income 

subsidies (also called “extra help”) or who have drug 

spending high enough to trigger individual reinsurance 

subsidies.1

Rather than Medicare specifically defining Part D 

benefits, organizations that sponsor plans have flexibility 

in designing and administering drug benefits within 

certain restrictions. This approach has the advantage 

of providing a range of plan options that could 

potentially better suit each individual beneficiary’s 

needs. The approach also lets plans use different mixes 

of management tools—such as formulary designs—to 

balance enrollees’ desire for access to drug therapies 

with the need to control benefit costs. At the same time, 

allowing flexibility in Part D benefit designs means 

that CMS must monitor plans to help ensure that some 

do not try to avoid enrolling beneficiaries with higher 

prescription drug spending.2

 The agency must also strive 

to ensure that its risk adjusters capture differences in 

individuals’ benefit spending on Part D drugs.

Organizations that offer private plans negotiate prices for 

pharmaceuticals and pharmacy services, and the results of 

these negotiations affect plan bids and premiums. Since 

plans are at risk for some of their members’ drug spending, 

some policymakers believe that delivering Part D benefits 

through competing private plans will lower Medicare 

payments and Part D premiums and may help to constrain 

cost growth. Others believe that a delivery system that is 

more like traditional Medicare would provide beneficiaries 

with better access to prescription drugs, less administrative 

burden, and lower prices.

Part D’s market-based approach also means that 

beneficiaries who are most familiar with traditional 

Medicare face new challenges. They must choose among 

dozens of plans available in their local area, each with 

somewhat different benefit structures, cost-sharing 

requirements, premiums, and networks of pharmacies. 

(Plans must also include long-term care pharmacies in 

their networks. We provide background about the services 

they provide and how Part D may affect that industry 

in the text box on page 150.) Plan options differ in 

important dimensions that are often not obvious or easy 

to understand. As a result, CMS and others are challenged 

to provide even the most knowledgeable beneficiaries 

with sufficient information to help them make informed 

choices. (Chapter 8 describes some of those challenges.) 

In addition, some Medicare beneficiaries may be 

unfamiliar with the tools that private plans use to manage 

drug benefits such as formularies and tiered cost sharing, 

formulary exceptions processes, prior authorization, and 

grievance and appeals procedures. Individuals may face 

issues related to the use of these tools as they transition 

from their previous drug benefits to their new Part D 

coverage and, over time, if they switch among Part D plans 

or if their plans exit the market (MedPAC 2004). 

Part D’s structure and initial levels of 

enrollment

Policymakers sought to design Part D to promote adequate 

access to appropriate drug therapies for Medicare 

beneficiaries while encouraging efficiency, quality, and 

cost control. Before Part D began, the majority of the 

noninstitutionalized Medicare population had prescription 

drug coverage through current or former employers, 

Medicaid, MA plans, and certain medigap policies.3

 The 

relative generosity of those sources of coverage varied 

considerably, ranging from comprehensive Medicaid 

coverage with low cost sharing to medigap policies that 

typically had higher cost-sharing requirements, an overall 

limit on the dollar value of their benefits, and generally 

were not subject to formularies and management tools. 

Beneficiaries with employer-sponsored policies had 

relatively generous coverage but were also typically 

subject to pharmacy benefit management tools, including 

limited formularies. Beneficiaries with no prescription 
150 Part D plan offerings

Long-term care pharmacies

I

n order to meet the prescription drug needs of 

beneficiaries who live in long-term care (LTC) 

facilities (nursing homes and skilled nursing 

facilities), such facilities contract with long-term 

care pharmacies (LTCPs). Approximately 3.5 million 

Medicare beneficiaries (9 percent) live in an LTC 

facility (Lewin Group 2004). Many have poor overall 

health with multiple chronic conditions and require 

24-hour nursing care. Their health status also means 

that they are more likely to use a large number of 

prescription drugs, which increases the probability of 

adverse drug events. Beneficiaries residing in LTC 

facilities take an average of 8 to 10 medications per day, 

compared with 5 to 6 for Medicare beneficiaries who 

live in the community. 

LTCPs generally offer services beyond those provided 

by retail pharmacies. Among these are specialized 

compounding and packaging; alternative forms of 

drug administration (e.g., unit dosing, liquid dosing, 

chewable tablets, infusion services, or parenteral 

administration); 24-hour access to a pharmacist; 

medication delivery (including emergency deliveries); 

medication and treatment carts; and medical records 

management. Because of the relatively complex 

nature of these services, most LTC facilities tend to 

contract with a single LTCP to provide these services. 

Under the Part D program, LTCPs are subject to “any 

willing pharmacy” provisions. These provisions mean 

that plans must offer standard contracting terms and 

conditions, including performance and service criteria, 

for LTCPs specified by CMS. Plans must also provide 

members with convenient access to LTCPs—all plan 

enrollees in an LTC facility must be able to access their 

covered Part D drugs through an LTCP in the plan’s 

network. If LTCPs contract with as many plans as are 

available in a region, it is possible that even if a facility 

has residents who are enrolled in different Part D plans, 

LTC facilities will be able to continue to contract with a 

single LTCP.

Before the Part D benefit was introduced, LTCPs 

generally were reimbursed through four primary 

sources: Medicaid, Medicare Part A, private insurance, 

or self-pay. The LTCP market represents about $8 

billion in annual revenues (Leavitt 2005). Medicaid 

has been by far the largest source of revenue for 

LTCPs, accounting for 60 percent to 65 percent of 

their revenues, with the other three sources of revenue 

accounting for a little over 10 percent each. Most, if not 

all, of the revenues that previously came from Medicaid 

will now come from individual prescription drug 

plans (PDPs) and Medicare Advantage–Prescription 

Drug plans (MA–PDs) under the Part D program, 

while additional shares of both private pay and private 

insurance revenue may also be replaced by Part D. 

Therefore, most LTCPs face a sea change in the source 

of a majority of their revenues. Now, state Medicaid 

payment rates and rules are being replaced by payment 

rates, formularies, and other management tools for 

PDPs and MA–PDs. 

drug coverage generally had no supplemental coverage to 

Medicare at all or purchased medigap plans that did not 

cover prescription drugs.

Program structure

A combination of stand-alone PDPs and MA–PDs deliver 

the Part D benefit throughout the United States and in 

U.S. territories. Organizations can offer PDPs in one or 

more of 34 geographic regions; regional MA–PDs may 

operate in one or more of 26 MA regions; and local MA–

PDs may operate in various service areas (one or more 

counties) throughout the country. Plans bear some risk for 

their enrollees’ drug spending and compete for enrollees 

on the basis of premiums, benefit structures, access to 

specific drug therapies, pharmacy networks, and quality 

of services. To encourage Medicare beneficiaries to 

enroll, the government subsidizes premiums by nearly 75 

percent and provides additional premium and cost-sharing 

subsidies for beneficiaries who have low incomes and 

assets. A late-enrollment penalty similar to that for Part 

B also provided an incentive for beneficiaries to enroll 

during an initial open enrollment period, which ended on 

May 15, 2006.4

The Medicare Prescription Drug, Improvement, and 

Modernization Act of 2003 (MMA) defines a standard 

continued on next page
Report to the Congress: Increasing the Value of Medicare | June 2006 151

drug benefit under Part D, which an organization may 

offer. For 2006, the defined standard benefit includes: 

• a $250 deductible;

• coverage for 75 percent of covered drug expenses up 

to an initial coverage limit of $2,250;5 

• a coverage gap with 100 percent beneficiary cost 

sharing between the initial coverage limit and an 

out-of-pocket threshold reached when the enrollee 

has accrued $3,600 of true out-of-pocket costs (or 

$5,100 in total drug expenses for enrollees without 

supplemental drug coverage);6

 and

• beyond the out-of-pocket threshold, the greater of 

either 5 percent coinsurance or copays of $2 for 

generic or preferred brand name drugs and $5 for 

brand name drugs. 

These threshold amounts will increase each year by CMS’s 

estimate of the annual change in drug spending per person. 

For 2007, the values are as follows: a $265 deductible, 

$2,400 initial coverage limit, and a $3,850 out-of-pocket 

threshold. Above the catastrophic threshold, copayment 

amounts will increase to $2.15 for generics or preferred 

brand name drugs and $5.35 for other drugs.

The law gives organizations substantial flexibility beyond 

the defined standard benefit. Plans may, for example, 

offer a basic plan that has the same actuarial value as the 

defined standard benefit but with a different design. A 

plan could offer a tiered cost-sharing design with different 

copays by tier—such as for generic, preferred brand 

name, nonpreferred brand name drugs, and specialty 

drugs—between the deductible and the $2,250 initial 

coverage limit. However, cost-sharing requirements 

under such a tier structure would need to have the same 

Long-term care pharmacies (cont.)

The change from Medicaid to Medicare reimbursement 

is important because many of the additional services 

described above are provided by LTCPs at no extra 

charge to LTC facilities (Lewin Group 2004). LTCPs 

have not traditionally charged for such services because 

those costs were covered partly by the margin between 

Medicaid payment rates and the cost of acquiring 

drugs and supplies. In addition, LTCPs—particularly 

the four largest chains—have traditionally collected 

rebates from drug manufacturers, based on their ability 

to direct market share to specific drugs. These rebates 

have also helped to finance additional services. One 

might argue that the ability of LTCPs to provide these 

additional services at no charge may indicate that 

payment rates for drugs were too high and that the 

competitive pressures created by the Part D program 

will result in lower prices to both Part D and 

non-Part D enrollees.

In its instructions to Part D plans for contract year 

2007, CMS expressed concern about the continued 

payment of rebates to LTCPs providing drugs as 

part of a Part D plan’s network (CMS 2006). CMS 

believes that any rebates to participants in the Part D 

program ultimately should accrue to the government 

and beneficiaries through lower premiums. CMS also 

noted that rebates paid to LTCPs could be in violation 

of federal anti-kickback standards. CMS requires 

that all Part D plan sponsors include a provision in 

their pharmacy contracts in which pharmacies must 

fully disclose to the sponsor any rebates from drug 

manufacturers.

Further, the change from a single payer for a majority 

of LTC facility residents to multiple payers may 

have implications for beneficiaries, LTCPs, LTC 

facilities, and Part D plans. In particular, all of 

these stakeholders face challenges as beneficiaries 

transition among plans—initially from their Medicaid 

coverage to enrollment in Part D, as well as when 

some beneficiaries switch among Part D plans. There 

may also be administrative burden associated with 

coordinating between different plans’ formularies 

and complying with CMS requirements regarding the 

availability of nonformulary drugs. 

The Commission will monitor the experience of LTCPs 

with the Part D program and examine this issue in more 

detail in future work. 152 Part D plan offerings

actuarial value as the 25 percent coinsurance required 

under the defined standard benefit. Alternatively, a plan 

could lower or eliminate its deductible but require cost 

sharing greater than 25 percent. Plans that offer such 

actuarially equivalent benefits must meet certain tests to 

comply with the law. CMS evaluates plan benefit designs 

to help ensure that competition among plans is based on 

premiums for comparable benefits rather than selection 

among enrollees. However, tests of actuarial equivalence 

do not go so far as to require comparable formularies. 

Even two competing plans in which both plans offer the 

defined standard benefit may be somewhat different from 

one another because they can include different mixes of 

preferred and nonpreferred drugs on their formularies or 

have differences in their pharmacy networks. CMS also 

reviews plan formularies to assure that enrollees have 

access to certain medications and to ensure that plans do 

not discriminate against any particular type of beneficiary.

Organizations offering basic Part D coverage (the standard 

benefit or one that is actuarially equivalent to it) may also 

choose to offer enhanced alternative coverage. Enhanced 

coverage combines a basic benefit with supplemental 

benefits. Supplemental coverage could include either 

reductions in cost-sharing requirements that increase the 

actuarial value of the benefit package, coverage of drugs 

that are specifically excluded as Part D drugs under the 

MMA, or both. For example, a plan might include zero or 

reduced cost sharing for generic drugs in the coverage gap. 

However, the enrollee must pay for all of these additional 

benefits through a supplemental premium and any 

additional cost sharing required by the plan. Plans must 

assure CMS that their premium for supplemental coverage 

takes into account higher basic drug spending induced by 

the supplemental coverage.

Part D includes a low-income subsidy (LIS) that provides 

assistance for out-of-pocket spending by individuals 

with low incomes and assets. In 2006, individuals who 

do not receive Medicaid must have an income below 

$14,355 for a single person or $19,245 for a married 

couple to be eligible. (These values are 150 percent of 

the federal poverty level, or FPL.) Assets must be no 

greater than $10,000 for an individual or $20,000 for a 

couple, excluding the beneficiary’s primary residence 

and vehicles. Individuals who receive both full Medicaid 

and Medicare benefits (called dual eligibles) and other 

beneficiaries with incomes of up to 135 percent of the 

FPL who meet asset tests may be eligible to have Medicare 

pay their entire premiums and significantly reduce their 

copays for plans that qualify to receive such enrollees. 

These beneficiaries have copays ranging from $1 to $5 if 

they live in community settings. Full-benefit dual eligibles 

residing in long-term care facilities have no cost sharing. 

Individuals with incomes between 135 percent and 150 

percent of the FPL who meet the asset test may qualify for 

sliding-scale premium assistance and reduced cost sharing. 

Both groups are effectively exempt from Part D’s coverage 

gap—the range of drug spending between Part D’s initial 

coverage limit and its catastrophic threshold in which 

beneficiaries would normally pay 100 percent coinsurance. 

One should note, however, that unless a beneficiary 

successfully obtains a formulary exception, all Part D 

enrollees only receive benefit coverage for drugs that are 

listed on their plan’s formulary.

These subsidies are applicable only to Part D plans with 

premiums that are at or below a certain threshold level 

calculated for each region.7

 That threshold amount is 

designed to assure that beneficiaries who qualify for the 

LIS are enrolled in lower priced plans, while ensuring 

that at least one stand-alone PDP is available to them. 

Participating organizations pay attention to the LIS 

thresholds because those amounts determine whether their 

plans are eligible to be randomly assigned beneficiaries 

through CMS’s auto-enrollment process—virtually 

guaranteeing those plans some initial enrollees. Autoenrollment saves plans marketing costs, and qualifying 

organizations can count on Medicare paying for all or 

much of those enrollees’ premiums and cost sharing. 

CMS auto-enrolled about 6 million beneficiaries who are 

dually eligible for Medicare and Medicaid to begin Part D 

coverage on January 1, 2006—the date that their primary 

prescription drug coverage through Medicaid officially 

ended.8

 In a process similar to that for duals, CMS also 

helped enroll about 1 million of the 1.7 million other 

individuals who qualified for Part D’s LIS as of April 30, 

2006.

Enrollment in Part D and other sources of 

drug coverage

The program’s initial open enrollment period began on 

November 15, 2005, and ran through May 15, 2006. Early 

projections of prescription drug coverage for 2006 varied. 

The Congressional Budget Office (CBO) estimated about 

37 million (87 percent) of all Medicare beneficiaries 

would have coverage, while CMS’s Office of the Actuary 

(OACT) estimated 41 million (94 percent) (CBO 2004, 

2004 Technical review panel on the Medicare Trustees 

Report). Both sets of numbers include beneficiaries 

who enroll in Part D as well as those with primary drug 
Report to the Congress: Increasing the Value of Medicare | June 2006 153

coverage through employer-sponsored health plans, 

through which the sponsor receives Medicare’s retiree 

drug subsidy (RDS). Medicare provides a tax-free subsidy 

to employers for 28 percent of each eligible individual’s 

drug costs that fall within a specified range of spending. 

These projections exclude beneficiaries with retiree drug 

benefits through the Federal Employees Health Benefits 

(FEHB) and TRICARE programs, which cover federal 

and military retirees and their dependents, as well as other 

sources of coverage. (Although beneficiaries with FEHB 

and TRICARE coverage have drug benefits that are equal 

or greater in value to the Part D benefit (called creditable 

coverage), those programs do not participate in the RDS.) 

The Medicare trustees most recently estimated that 31 

million Medicare beneficiaries (73 percent) would have 

Part D or RDS coverage on May 15, 2006 (Boards of 

Trustees 2006).9

As of mid-April 2006, CMS estimated that 26.5 million of 

the 43 million Medicare beneficiaries (61 percent) either 

had signed up for Part D plans or had prescription drug 

coverage through employer-sponsored coverage under 

the RDS (Table 7-1). Voluntary enrollees in stand-alone 

drug plans numbered 8.1 million, or 19 percent of the 43 

million. Individuals who are dually eligible for Medicare 

and Medicaid and enrollees in MA–PDs each numbered 

5.8 million, and each group made up 13 percent of the 43 

million. Individuals whose employers receive the RDS 

in return for remaining the primary payer of prescription 

drug coverage made up 6.8 million (16 percent) of the 

43 million. Those four groups directly affect Medicare 

program spending.

Other Medicare beneficiaries have creditable drug 

coverage, but that coverage does not affect Medicare 

program spending. For example, 3.5 million beneficiaries 

(8 percent) were federal retirees who receive drug 

coverage through FEHB or TRICARE. Another 5.8 

million others (13 percent) had prescription drug coverage 

through the Department of Veterans Affairs, Indian Health 

Service, former employers that are not a part of Medicare’s 

RDS, or through current employers because the individual 

is still an active worker (data not shown).

The Commission did not receive information about 

enrollment levels in specific Part D plans in time to 

include it in this report. However, data on enrollment 

levels by plans’ parent organizations are shown on page 

165.

TABLE

7–1 Part D enrollment and other sources of drug coverage in early 2006

Millions enrolled as of

1/13/2006 2/11/2006 3/18/2006 4/18/2006

Enrollment that leads to Medicare program spending:

Voluntary enrollees in stand-alone PDPs 3.6 4.9 6.4 8.1

Enrollees in MA–PDs (including some duals) 5.1 5.3 5.7 5.8

Individuals dually eligible for Medicare and Medicaid and 

auto-enrolled in Part D plans 5.6 5.7 5.8 5.8

Individuals covered by Medicare retiree drug subsidy 6.4 6.4 6.2 6.8

Subtotal 20.6 22.3 24.0 26.5

Enrollment that does not lead to Medicare program spending:*

Estimated federal retirees in TRICARE and FEHB 3.1 3.1 3.5 3.5

Total 23.8 25.4 27.6 30.0

Note: PDP (prescription drug plan), MA–PD (Medicare Advantage prescription drug [plan]), FEHB (Federal Employees Health Benefi ts program). TRICARE is the health 

program for military retirees and their dependents. For calendar year 2006, CMS projects that an average of 43.1 million benefi ciaries will be enrolled in 

Medicare Parts A and/or B. Columns may not sum due to rounding. 

*In addition, CMS estimates that 5.8 million Medicare benefi ciaries have drug coverage of equal or greater value to Part D benefi ts through the Department of 

Veterans Affairs, Indian Health Service, former employers that do not receive Medicare’s retiree drug subsidy, or through current employers.

Source: CMS press releases dated as shown above.
154 Part D plan offerings

Enrollment in Part D’s low-income subsidy 

program

Prior to the start of Part D, projections of enrollment in 

the LIS program also varied. OACT estimated that 10.9 

million out of 14.5 million eligible Medicare beneficiaries 

would participate in the LIS program in 2006—all 7.2 

million dual eligibles, qualified Medicare beneficiaries 

(QMBs), and specified low-income Medicare beneficiaries 

(SLMBs), as well as 3.7 million other individuals who did 

not previously participate in Medicaid. By comparison, 

CBO estimated that fewer nonduals would enroll in the 

LIS program, for total enrollment (dual and nondual) 

of 8.7 million in 2006. The Medicare trustees currently 

estimate that 9 million Medicare beneficiaries will be 

eligible for Part D’s LIS program in 2006 (Boards of 

Trustees 2006).

All individuals who are dually eligible for Medicare and 

Medicaid or who are already enrolled in a Medicare 

Savings Program within their state (QMBs and SLMBs) 

are deemed eligible for Part D’s LIS. However, enrolling 

other non-Medicaid beneficiaries is proving more 

difficult. The Social Security Administration (SSA), which 

determines eligibility for the LIS program, received nearly 

5 million applications for the LIS program. A number 

of those applications were denied because beneficiaries 

had income or assets that were too high, or the SSA 

received a duplicate application. As of April 30, 2006, 

1.7 million non-Medicaid beneficiaries with low incomes 

and assets qualified for the LIS program. Some of these 

individuals did not realize that they must apply for the LIS 

program and then also enroll in a specific Part D plan. 

For this reason, CMS auto-enrolled individuals in plans 

who qualified for the LIS but had not yet chosen a plan 

themselves.

Part D plan offerings for 2006

This section describes the degree of variation that 

exists among Part D benefits and premiums for 2006. 

Throughout this chapter we exclude plans that are 

exclusive to certain groups of enrollees, such as plans 

available only to employer groups, Programs of AllInclusive Care for the Elderly, special needs plans, and 

demonstrations. We also limit the analysis to plans offered 

within the 50 states. Although much variation exists, our 

analysis reveals patterns in the structure of benefit designs 

that organizations have chosen to offer.

Plan entry, benefit designs, and premiums 

among PDPs

Although 1,429 PDPs are available across the country, 

most of those plans are offered by 16 larger actors in 

Part D—that is, organizations or groups of organizations 

offering at least one plan nationwide or a total of 30 or 

more plans in one or more of the 34 regions (the text box 

defines organizations and plans). In many cases, those 

organizations offer the same two or three benefit structures 

in the regions of the country in which they participate, and 

they typically use the same formulary. While individual 

Defining Part D organizations and plans

Throughout this chapter we define an 

organization as an entity—usually a 

combination of an insurer or medical plan with 

a pharmacy benefit management firm and a network of 

pharmacies—that offers one or more Part D plans. A 

plan is a specific combination of benefits offered to all 

Medicare beneficiaries who live within a prescription 

drug plan (PDP) region or Medicare Advantage 

prescription drug plan region. When an organization 

chooses to offer a plan nationwide, it actually offers 34 

different PDPs (one for each geographic region), even 

if those plans share the same benefit design, formulary, 

and structure of tiered copays. CMS guidance limits 

each organization to offering no more than three 

types of plans in each region. As a result, some larger 

organizations are offering as many as 102 plans (3 

plans multiplied by 34 regions) across the PDP regions, 

plus additional plans offered in the U.S. territories or 

designed for specific employer groups. For 2007, CMS 

had considered limiting each organization to two plan 

types per region, but ultimately decided to continue 

permitting organizations to offer up to three PDPs in 

each region if one of those plans includes benefits in 

the coverage gap (CMS 2006). Report to the Congress: Increasing the Value of Medicare | June 2006 155

beneficiaries still face many plan options, the degree of 

variation across the country may not be as large as 1,429 

PDPs might suggest. Although availability varies by 

county, MA–PDs are offering an additional 1,303 plans 

around the country.10 MA–PDs are more likely than PDPs 

to offer enhanced (supplemental) benefits and charge 

no deductible, often at no additional premium beyond 

the monthly premium that the enrollee pays for medical 

services.

Characteristics of PDPs offered by all 

organizations

A relatively small number of organizations (16) accounts 

for 1,225 of the 1,429 PDPs offered among the 34 

regions, and nearly 60 other organizations are offering the 

remaining 204 PDPs. In this section, we provide statistics 

for all 1,429 PDPs. Note that this analysis is not weighted 

by each plan’s enrollment. Few plans use Part D’s standard 

benefit design; instead, many offer a reduced or no 

deductible design and most use tiered cost sharing.

Among all PDPs, 57 percent provide basic benefits—

either Part D’s standard benefit design (9 percent) or 

a benefit that is actuarially equivalent to the standard 

benefit (48 percent) (Table 7-2). The remaining plans are 

enhanced (43 percent); they include basic benefits and 

supplemental coverage. 

Organizations may be testing the waters by trying several 

different benefit designs. Still, the design of a sizable 

number of PDPs reflects a widely held perception that 

beneficiaries do not want to pay deductibles. About 

58 percent of all PDPs do not charge a deductible, 34 

percent use the standard benefit’s $250 deductible, and the 

remainder use deductibles that are less than $250. 

TABLE

7–2 Characteristics of PDPs in 2006

Basic benefi ts

All types of 

benefi ts

Defi ned 

standard

Actuarially 

equivalent

Enhanced 

benefi ts

Total number of plans 1,429 132 689 608

Distribution of plans (in percent):

Plan type 100% 9% 48% 43%

Type of deductible

Zero 58 N/A 18 40

Reduced 8 N/A 5 3

$250 34 9 25 0

Cost-sharing structure before the initial coverage limit

Uses 25% coinsurance 9 9 0 0

Uses tiered cost sharing 91 N/A 48 43

Copays 21 N/A 8 13

Coinsurance 3 N/A 2 0

Both 67 N/A 38 30

Coverage in the gap

Generics 13 N/A 0 13

Generics and brands 2 N/A 0 2

None 85 N/A 48 27

Offers mail-order pharmacy services 91 8 43 40

Note: PDP (prescription drug plan), N/A (not applicable). Percentages are not weighted by plan enrollment. The PDPs described here exclude plans offered in U.S. 

territories. Benefi ts labeled actuarially equivalent to Part D’s standard benefi t include what CMS calls “actuarially equivalent standard” and “basic alternative” 

benefi ts. Plans with “gap coverage” include some benefi ts in the range of benefi ciary drug spending above the standard benefi t’s initial coverage limit and below 

its out-of-pocket threshold. Part D’s defi ned standard benefi t requires the enrollee to pay 100 percent coinsurance in this coverage gap.

Source: MedPAC based on CMS plan benefi t design and landscape data.
156 Part D plan offerings

No enhanced plans use the standard benefit’s deductible, 

and many actuarially equivalent plans charge no deductible 

either. A plan could charge no deductible yet maintain 

actuarial equivalence to the standard benefit by charging 

higher cost sharing or lowering the benefit’s initial 

coverage limit.

Most plans (91 percent) use cost-sharing tiers rather than 

Part D’s defined standard benefit with flat 25 percent 

coinsurance. This probably reflects organizations’ 

judgment that beneficiaries will prefer the relative 

predictability of fixed-dollar copays over coinsurance. 

However, 67 percent of all PDPs use a combination of 

copays (usually for lower price tiers) and coinsurance 

(typically for specialty drugs on higher price tiers). 

Some plans use copays for preferred drugs but charge 

coinsurance for nonpreferred drugs or for prescriptions 

filled at out-of-network pharmacies. Relatively few PDPs 

offer any coverage in the standard benefit’s coverage gap.

Among all basic PDPs (defined standard benefits and 

those that are actuarially equivalent) in our analysis, the 

simple average monthly premium is $33. By comparison, 

CMS officials have noted that beneficiary premiums are 

expected to average $25 a month (McClellan 2006). The 

reason for this difference is that the $25 figure is weighted 

by Part D enrollment. CMS auto-enrolled beneficiaries 

in Part D plans with lower price premiums, which partly 

explains the difference in averages. Additionally, CMS’s 

administrator also noted that the majority of beneficiaries 

who were not dually eligible for Medicare and Medicaid 

Distribution of PDP and MA–PD premiums for basic and enhanced plans in 2006

Note: PDP (prescription drug plan), MA–PD (Medicare Advantage prescription drug [plan]). Distributions are not weighted by benefi ciary enrollment. Total number of 

PDPs is 1,429, which excludes plans offered in U.S. territories. Total number of MA–PDs is 1,303, which excludes demonstration programs, 1876 cost plans, and 

plans offered in U.S. territories. MA–PD enrollees must pay any other Medicare Advantage premiums in order to obtain Part D prescription drug coverage. Benefi ts 

labeled basic include Part D’s standard benefi t design as well as benefi ts that are actuarially equivalent to standard benefi ts. Enhanced plans include supplemental 

coverage.

Source: MedPAC based on CMS plan benefi t package and landscape data.

Monthly premium (in dollars)

Basic (36% of plans)

Enhanced (64% of plans)

1.00–

19.99

0 20.00–

24.99

25.00–

29.99

30.00–

34.99

35.00–

39.99

40.00–

49.99

1.00– 50.00+

19.99

0 20.00–

24.99

25.00–

29.99

30.00–

34.99

35.00–

39.99

40.00–

49.99

50.00+

Number of plans

450

400

350

300

250

200

150

100

50

0

Basic (57% of plans)

Enhanced (43% of plans)

PDPs MA–PDs

FIGURE

7–1
Report to the Congress: Increasing the Value of Medicare | June 2006 157

selected plans with premiums below the national average 

premium (McClellan 2006). 

Turning again to the simple (unweighted) distribution 

of plans’ premiums, note that at the median, premiums 

for enhanced plans run about $10 more per month than 

premiums for basic benefits (left-hand side, Figure 

7-1). Within each category of basic and enhanced plans, 

there is quite a bit of variation among premiums. Some 

enhanced benefits cost less than $20 per month in certain 

regions, while a handful of basic plans cost more than 

$75 per month. Across all types of PDP benefits offered 

in the 34 regions—including both basic and enhanced 

packages—the plan with the lowest premium is a defined 

standard benefit at a cost of just under $2 per month, while 

the highest premium plan provides enhanced coverage for 

about $105 per month (Table 7-3).

Plans that are actuarially equivalent to the defined standard 

benefit have median and mean premium values that are 

$5 to nearly $9 higher, respectively, than those for the 

defined standard benefit.11 This occurs even though, by 

design, they have the same expected benefit value. The 

higher average premium could reflect a higher willingness 

to pay among beneficiaries for the relative predictability 

of fixed copays over coinsurance. This result may also 

reflect higher costs for providing a benefit with fixeddollar copays than one with coinsurance; a benefit design 

with copays could put a plan at greater risk for increases in 

pharmaceutical prices. 

TABLE

7–3 Premiums and cost-sharing requirements among PDPs in 2006

Basic benefi ts

Defi ned 

standard*

Actuarially 

equivalent

Enhanced 

benefi ts

Monthly premium

Minimum $2 $14 $5

Maximum 85 63 105

Median 28 32 44

Mean 26 35 43

Deductible

Minimum 250 0 0

Maximum 250 250 150

Median 250 250 0

Median cost sharing for:

Plans with generic/brand tier structure

Generic copay N/A 5 7

Brand copay N/A 28 30

Specialty tier coinsurance (where applicable) N/A 25% 25%

Plans with generic/preferred brand/nonpreferred brand tier structure

Generic copay N/A $7 $5

Preferred brand copay N/A 22 26

Nonpreferred brand copay N/A 55 50

Specialty tier coinsurance (where applicable) N/A 25% 30%

Note: PDP (prescription drug plan), N/A (not applicable). Values do not refl ect plan enrollment. The PDPs described here exclude plans offered in U.S. territories. Cost 

sharing is for median cost sharing among plans that use tiered cost sharing before the initial coverage limit. Benefi ts labeled actuarially equivalent to Part D’s 

standard benefi t include actuarially equivalent standard and basic alternative benefi ts. 

 *Part D’s defi ned standard benefi t has a $250 deductible (in 2006) and 25% coinsurance below the initial coverage limit.

Source: MedPAC based on CMS plan benefi t package and landscape data.
158 Part D plan offerings

TABLE

7–4 PDPs offered in 2006 by organizations with at least one nationwide plan

Organization and 

plan name

Regions 

in which 

plan is 

offered

Plans 

qualifying 

for autoenrollmentType of 

benefi t

Range of 

monthly 

premiums Deductible

Cost sharing 

by tier at in-network 

preferred pharmacies

Gap 

coverage

Aetna

Medicare Rx:

Essentials 34 6 Actuarially 

equivalent

$28–$39 $250 $5/$25 None

Plus 34 0 Enhanced 37–50 0 $7/$35 Generics

Premier 34 0 Enhanced 52–67 0 $2/$20/$40 Generics

Cigna

CIGNATURE Rx:

Value Plan 34 7 Actuarially 

equivalent

30–37 250 $4/$20/$40 None

Plus Plan 34 0 Enhanced 40–42 0 $5/$30/$50 None

Complete Plan 34 0 Enhanced 43–51 0 $5/$30/$50 Generics

Coventry

AdvantraRx:

Value 34 0 Enhanced 18–25 0 $10–$15/$36–$60 None

Premier 34 0 Enhanced 29–38 0 $5–$10/$20–$40/

$50–$70

None

Premier Plus 34 0 Actuarially 

equivalent

40–50 0 $5/$20–$40/$54–$70 None

Medco

YOURx Plan 34 19 Actuarially 

equivalent

27–36 250 $4/$17/75%/25% None

MemberHealth

Community Care Rx:

Basic 34 23 Actuarially 

equivalent

26–33 250 0%/25%/45% None

Choice 34 0 Actuarially 

equivalent

34–41 250 $4/$20/$40 None

Gold 34 0 Enhanced 38–45 100 $4/$25/$50 None

Pacifi Care

Pacifi Care:

Saver Plan 34 31 Actuarially 

equivalent

19–35 0 $8/$22/$47–$53/33% None

Select Plan 34 2 Actuarially 

equivalent

30–49 0 $8/$22/$56–$73/33% None

Comprehensive 

Plan

2 0 Enhanced 37–41 0 $8/$22/$53–$54/33% Generics

Complete Plan 32 0 Enhanced 34–55 0 $8/$22/$22–$54/$53/

33%/33%

Generics

Note: PDP (prescription drug plan). Benefi ts labeled actuarially equivalent to Part D’s standard benefi t include actuarially equivalent standard and basic alternative 

benefi ts. Plans that “qualify for auto-enrollment” have premiums that are at or below threshold values calculated by CMS for each PDP region. Plans with “gap 

coverage” include some benefi ts in the range of benefi ciary drug spending above the standard benefi t’s initial coverage limit and below its out-of-pocket threshold. 

Part D’s defi ned standard benefi t requires the enrollee to pay 100 percent coinsurance in this coverage gap.

Source: MedPAC based on CMS plan benefi t package and landscape data.
Report to the Congress: Increasing the Value of Medicare | June 2006 159

Plans that use tiered cost sharing tend to charge fixeddollar copayments rather than a percentage coinsurance of 

the prescription’s price. Among plans that use a generic/

brand name tier structure, median copays for generic 

drugs are $5 to $7, and those for brand name drugs are 

$28 to $30. Plans that distinguish between preferred 

and nonpreferred brand name drugs have the following 

median copay values: $7 to $5 for generics, $22 to $26 

for preferred brand name drugs, and $55 to $50 for 

nonpreferred brand name drugs. As we discuss in greater 

detail later in the chapter, many plans use a separate tier 

for higher-cost specialty drugs, such as biologics. PDPs 

that incorporate a specialty tier into their tier structure tend 

to charge 25 percent to 30 percent coinsurance. Based on 

CMS guidance, plan enrollees may not appeal payment of 

a lower tier’s cost-sharing requirement for such specialty 

drugs.

Organizations with nationwide participation

Ten organizations have at least one plan in all 34 of 

the PDP regions (Table 7-4). The offerings of these 

10 organizations account for nearly 900 of the 1,429 

PDPs available across the 34 regions. None of these 

organizations offer Part D’s standard benefit design. 

TABLE

7–4 PDPs offered in 2006 by organizations with at least one nationwide plan (cont.)

Organization and 

plan name

Regions 

in which 

plan is 

offered

Plans 

qualifying 

for autoenrollmentType of 

benefi t

Range of 

monthly 

premiums Deductible

Cost sharing 

by tier at in-network 

preferred pharmacies

Gap 

coverage

Silverscript

SilverScript 34 27 Actuarially 

equivalent

 $24–33 $250 $7–$9/25%/25% None

SilverScript Plus 34 0 Actuarially 

equivalent

 49–63 100 $7–$8/$22–$25/

$60–$62/25%

None

Unicare

Medicare Rx:

Rewards 34 34 Actuarially 

equivalent

 17–31 250 $5/$25/25%/25% None

Rewards Plus 33 0 Enhanced 26–39 0 $10/$30/25%/25% None

Rewards Premier 33 0 Enhanced 35–52 0 $10/$30/$60/30%/30% Generics

United

AARP Medicare Rx 34 33 Actuarially 

equivalent

 23–30 0 $5/$28/

$55–$56/25%

None

United Health Rx 4 4 Actuarially 

equivalent

 21–23 50 $7/$23/$54/25% None

United Medicare 

MedAdvance

34 28 Actuarially 

equivalent

 27–32 0 $10/$23/$52–$55/25% None

WellCare

WellCare:

Signature 34 33 Actuarially 

equivalent

 17–33 0 $0/$0/$62-$73/

$62–$73/30%–33%

None

Complete 34 0 Enhanced 33–51 0 $0/$0/$15/$50/30% None

Premier 34 0 Enhanced 35–54 0 $0/$0/$30/$60/30% None

Note: PDP (prescription drug plan). Benefi ts labeled actuarially equivalent to Part D’s standard benefi t include actuarially equivalent standard and basic alternative 

benefi ts. Plans that “qualify for auto-enrollment” have premiums that are at or below threshold values calculated by CMS for each PDP region. Plans with “gap 

coverage” include some benefi ts in the range of benefi ciary drug spending above the standard benefi t’s initial coverage limit and below its out-of-pocket threshold. 

Part D’s defi ned standard benefi t requires the enrollee to pay 100 percent coinsurance in this coverage gap.

Source: MedPAC based on CMS plan benefi t package and landscape data.
160 Part D plan offerings

Instead, most use tiered copays or a combination of copays 

and coinsurance and keep the standard benefit’s $2,250 

initial coverage limit. Many of the plans have equivalent 

actuarial values to the standard benefit, but charge no 

deductible or a deductible lower than the standard benefit’s 

$250. While most of these sponsoring organizations 

chose to offer one or more enhanced plans, fewer than 

half of those enhanced plans provide coverage in the 

standard benefit’s coverage gap. As discussed in Chapter 

9, beneficiaries in many regions have access to at least one 

MA–PD that includes coverage in the gap. The enhanced 

plans that do provide such coverage tend to cover generic 

drugs but not brand name drugs.

Organizations use different combinations of cost-sharing 

tiers and coverage approaches for their different benefit 

packages. For example, Aetna Medicare Rx Essentials 

lists a smaller number of drugs on its formulary than its 

Medicare Rx Premier product. The Medicare Rx Essentials 

product includes a $5 copay for a tier-one drug and $25 

for a tier-two drug, where tiers generally correspond to 

covered generic and brand name prescriptions. Aetna 

Medicare Rx Premier’s formulary charges $2 for a tierone, $20 for a tier-two, and $40 for a tier-three drug 

(covered but nonpreferred drugs). 

While they are not national plans, another six 

organizations are major participants in Part D; they offer 

30 or more PDPs across the 34 regions (Table 7-5). A few 

of these entities offer a larger total number of plans than 

do some of the 10 organizations with nationwide offerings. 

Combined, these “near-national” entities contribute 

more than 300 of the 1,429 PDPs available across the 34 

regions. Several of these organizations offer the defined 

standard benefit. Thirty-one Humana PDP Complete plans 

provide coverage in the standard benefit’s coverage gap 

and cover generic and brand name drugs. 

Characteristics of plans that qualify for autoenrollees

About 29 percent of all PDPs qualified to receive autoenrollees in 2006. Since the LIS threshold amounts 

are calculated among premiums for basic benefits (or 

the portion of enhanced benefits associated with basic 

coverage), no plans with enhanced benefits were assigned 

auto-enrollees. As a result, auto-enrolled members are 

much more likely to be assigned to a plan that uses Part 

D’s defined standard benefit than not. Plans that qualified 

for auto-enrollees in 2006 are somewhat less likely to use 

tiered cost sharing: 76 percent do so versus 91 percent 

among all PDPs. This is because more plans that qualified 

for auto-enrollees use the defined standard benefit with 25 

percent coinsurance. 

The potentially higher cost-sharing liability of coinsurance 

might be a cause for concern if those LIS enrollees were 

paying for most of their plans’ cost-sharing requirements. 

However, since the LIS covers most of the out-of-pocket 

spending for these enrollees, the more relevant issue is 

how the formularies of plans that qualify for auto-enrollees 

compare with those that did not. We discuss this issue in 

greater detail later in this chapter.

Geographic variation in plan entry and 

premiums

All regions of the country experienced strong plan entry 

among stand-alone Part D plans. Every region has at least 

27 PDPs offering Part D coverage and the median number 

of plans per region is 43. Alaska has the fewest, with 27 

plans, while the Pennsylvania-West Virginia region has 

the most, with 52 PDPs (Table 7-6, p. 162). Similarly, 

Medicare beneficiaries who qualify to receive Part D’s LIS 

also have a broad choice of PDPs available. For example, 

Arizona and Florida had the fewest PDPs qualifying for 

auto-enrollees (6), while Virginia, South Carolina, and 

Texas each had 16 PDPs qualifying. All regions but Alaska 

have at least one PDP available with a monthly premium 

of $20 or less. 

Although the average monthly premium in each region 

varies, the variation is not as large as one might have 

expected. The simple average (that is, not weighted by 

enrollment) monthly premium for basic benefits varies by 

as much as $10: Mean basic premiums range from $28 to 

$38 (Table 7-6, p. 162). Similarly, unweighted monthly 

premiums for enhanced benefits range between $37 

and $48. 

Offerings by MA–PDs

In addition to PDPs, which offer Part D drug coverage 

separately to beneficiaries in the FFS program, private 

health plans are offering 1,303 MA–PDs around 

the country. In order to enroll in an MA–PD plan, 

beneficiaries must elect to have their health care services 

(e.g., hospital and physician care) provided by the MA–

PD. As discussed in Chapter 9, MA–PDs are available to 

practically all beneficiaries nationwide, and as of midApril 2006, about 13 percent of the Medicare population 

was enrolled in MA–PD plans. The vast majority of these 

are offered at a local level; that is, availability varies 

depending on the county in which a beneficiary lives. 
Report to the Congress: Increasing the Value of Medicare | June 2006 161

TABLE

7–5 “Near-national” organizations with 30 or more PDPs among the 34 regions

Organization and 

plan name

Regions 

in which 

plan is 

offered

Plans 

qualifying 

for autoenrollmentType of 

benefi t

Range of 

monthly 

premiums Deductible

Cost sharing 

by tier at in-network 

preferred pharmacies

Gap 

coverage

American Progressive

Prescription Pathway:

Bronze 1 1 Defi ned 

standard

 $25 $250 25% None

Silver 8 0 Actuarially 

equivalent

 34–41 250 $5–$6/$27–$28/25% None

Gold 8 0 Enhanced 46–52 0 $5–$6/$27–$28/25% None

Platinum 7 0 Enhanced 64–69 0 $6/$24/$40/25% None

Marquette

Prescription Pathway:

Silver 22 0 Actuarially 

equivalent

 34–43 250 $4/$29/25% None

Gold 22 0 Enhanced 46–54 0 $4/$29/25% None

Platinum 22 0 Enhanced 62–71 0 $4/$26/$42/25% None

Pennsylvania Life

Prescription Pathway:

Bronze 31 25 Defi ned 

standard

 24–34 250 25% None

Silver 31 0 Actuarially 

equivalent

 34–43 250 $5/$28/25% None

Gold 31 0 Enhanced 46–54 0 $5/$28/25% None

Humana

Humana PDP:

Standard 31 30 Defi ned 

standard

 2–18 250 25% None

Enhanced 31 0 Enhanced 5–25 0 $7/$30/$60/25% None

Complete 31 0 Enhanced 39–73 0 $7/$30/$60/25% Generics, 

brands

Sterling

Sterling Prescription 

Drug Plan

32 0 Actuarially 

equivalent

 49–61 100 $10/$22–$28/

40%–50%/25%

None

United American

UA Medicare Part D 

Prescription 

Drug Coverage

31 2 Actuarially 

equivalent

 30–41 0 $9/$30/$60/33% None

Note: PDP (prescription drug plan). Benefi ts labeled actuarially equivalent to Part D’s standard benefi t include actuarially equivalent standard and basic alternative 

benefi ts. Plans that “qualify for auto-enrollment” have premiums that are at or below threshold values calculated by CMS for each PDP region. Plans with “gap 

coverage” include some benefi ts in the range of benefi ciary drug spending above the standard benefi t’s initial coverage limit and below its out-of-pocket threshold. 

Part D’s defi ned standard benefi t requires the enrollee to pay 100 percent coinsurance in this coverage gap.

Source: MedPAC based on CMS plan benefi t package and landscape data.
162 Part D plan offerings

However, 48 regional PPOs (4 percent of all MA–PDs) 

offer a package of Parts A, B, and D services to Medicare 

beneficiaries who live anywhere within the MA region. 

Because of certain provisions in law and regulation, 

offerings through MA–PDs differ systematically from 

PDPs. For example, the law allows MA–PDs to use 75 

percent of the difference between an MA plan’s benchmark 

TABLE

7–6 Geographic distribution of PDPs in 2006

Number of PDPs Mean premium for:

PDP 

region States in the region Total

That qualify for 

auto-enrollment

With monthly 

premium ≤$20 Basic benefi ts

Enhanced 

benefi ts

1 ME, NH 41 14 1 $35 $44

2 CT, MA, RI, VT 44 11 4 31 42

3 NY 46 15 6 32 37

4 NJ 44 14 4 32 41

5 DC, DE, MD 47 15 3 33 45

6 PA, WV 52 15 2 34 45

7 VA 41 16 2 34 44

8 NC 38 13 2 37 46

9 SC 45 16 1 35 47

10 GA 42 14 1 34 43

11 FL 43 6 4 34 47

12 AL, TN 41 9 1 35 48

13 MI 40 14 1 34 43

14 OH 43 10 3 33 42

15 IN, KY 42 13 1 36 46

16 WI 45 14 4 31 41

17 IL 42 15 1 32 43

18 MO 41 10 2 34 43

19 AR 40 13 2 35 46

20 MS 38 12 2 36 47

21 LA 39 11 1 38 48

22 TX 47 16 2 33 44

23 OK 42 12 2 36 46

24 KS 40 11 2 34 42

25 IA, MN, MT, ND, NE, SD, WY 41 14 3 32 44

26 NM 43 8 6 29 41

27 CO 43 10 3 32 41

28 AZ 43 6 4 31 40

29 NV 44 7 3 30 40

30 OR, WA 45 15 5 31 41

31 ID, UT 44 14 3 34 44

32 CA 47 10 6 28 38

33 HI 29 8 3 31 37

34 AK 27 8 0 34 41

Total 1,429 409 90 33 43

Note: PDP (prescription drug plan). Mean values are not weighted by plan enrollment. The PDPs described here exclude plans offered in U.S. territories. Benefi ts labeled 

basic include Part D’s standard benefi t design as well as benefi ts that are actuarially equivalent to standard benefi ts. Enhanced plans include supplemental 

coverage. Plans that “qualify for auto-enrollment” have premiums that are at or below threshold values calculated by CMS for each PDP region. 

Source: MedPAC based on CMS plan benefi t package and landscape data.
Report to the Congress: Increasing the Value of Medicare | June 2006 163

payment and its bid for providing Parts A and B services 

(called rebate dollars) to supplement its package of 

benefits or lower its premium. MA–PDs appear to have 

used this provision to lower the portion of their premium 

attributable to Part D or to supplement Part D’s benefit. 

A much larger proportion of MA–PD plans provide 

enhanced benefits than do PDPs—64 percent of MA–PDs 

(Table 7-7) compared with 43 percent of PDPs (Table 7-2, 

p. 155). In addition, more than 500 MA–PDs (nearly 40 

percent) charge no additional premium for Part D coverage 

beyond what they charge for Parts A and B services (righthand side of Figure 7-1, p. 156).

MA–PDs are less likely to charge a deductible than PDPs. 

For 2006, 80 percent of all MA–PDs have no deductible 

(Table 7-7), compared with 58 percent of PDPs (Table 7-2, 

p. 155). They are similar to PDPs in that they are just as 

likely to use a tiered cost-sharing structure, but MA–PDs 

are somewhat more likely to use four tiers than their standalone counterparts. They are also more likely to provide 

coverage within Part D’s coverage gap: 23 percent of 

TABLE

7–7 Characteristics of MA–PD drug benefits in 2006

Basic benefi ts

All types of 

benefi ts

Defi ned 

standard

Actuarially 

equivalent

Enhanced 

benefi ts

Total number of plans 1,303 96 376 831

Distribution of plans (in percent):

Plan type 100% 7% 29% 64%

Type of organization

 Local HMO 66 4 18 43

 Local PPO 21 1 8 12

 PFFS 10 1 2 7

 Regional PPO 4 1 1 2

Type of deductible

Zero 80 N/A 18 62

Reduced 3 N/A 2 1

$250 17 7 8 1

Cost-sharing structure before the initial coverage limit

Uses 25% coinsurance 7 7 0 0

Uses tiered cost sharing 93 N/A 29 64

Copays 34 N/A 16 17

Coinsurance 0 N/A 0 0

Both 59 N/A 13 46

Coverage in the gap

Generics 23 N/A 0 23

Generics and brands 5 N/A 0 5

None 72 N/A 29 36

Offers mail-order pharmacy services 96 7 27 62

Note: MA–PD (Medicare Advantage prescription drug [plan]), PPO (preferred provider organization), PFFS (private fee-for-service), N/A (not applicable). Local plans 

(HMOs, PPOs, and PFFS plans) select individual counties in which they operate. Regional PPOs must provide Medicare services throughout a CMS-defi ned region 

that encompasses one or more states. Percentages are not weighted by plan enrollment. The MA–PDs described here exclude demonstration programs, 1876 

cost plans, and plans offered in U.S. territories. Benefi ts labeled actuarially equivalent to Part D’s standard benefi t include what CMS calls “actuarially equivalent 

standard” and “basic alternative” benefi ts. Plans with “coverage in the gap” include some benefi ts in the range of benefi ciary drug spending above the standard 

benefi t’s initial coverage limit and below its out-of-pocket threshold. Part D’s defi ned standard benefi t requires the enrollee to pay 100 percent coinsurance in this 

coverage gap.

Source: MedPAC based on CMS plan benefi t package and landscape data.
164 Part D plan offerings

MA–PDs offer coverage of generic drugs, and another 5 

percent of MA–PDs provide coverage of both generic and 

brand name drugs. By comparison, 13 percent of PDPs 

offered generic coverage in the gap and 2 percent covered 

generic and brand name drugs (Table 7-2, p. 155). The 

higher availability of drug coverage in the gap may prove 

attractive to beneficiaries and increase the proportion of 

beneficiaries enrolled in MA plans.

Many MA organizations have applied some of their rebate 

dollars toward the premiums of enhanced plans (Table 

7-8). The median monthly premium for an enhanced MA–

PD is essentially zero. However, as discussed in Chapter 

9, not every beneficiary has access to a zero-premium 

enhanced plan; availability depends on the county in which 

they live.12 Also, in order to obtain MA–PD coverage, 

enrollees must pay the Part B premium and any other 

premium amount charged by their plan for regular medical 

services. The median combined MA–PD premiums for 

medical services and prescription drugs range from $63 to 

$29 per month (Table 7-8).

TABLE

7–8 Premiums and cost-sharing requirements among MA–PD drug benefits in 2006

Basic benefi ts

Defi ned 

standard*

Actuarially 

equivalent

Enhanced 

benefi ts

Monthly drug premium

Minimum $0 $0 $0

Maximum 77 78 120

Median 23 24 0

Mean 25 21 16

Monthly total plan premium (including medical and drug premiums)

Minimum 00 0

Maximum 202 179 260

Median 63 63 29

Mean 68 61 41

Deductible

Minimum 250 0 0

Maximum 250 250 250

Median 250 0 0

Median cost sharing for:

Plans with generic/brand tier structure

Generic copay N/A 5 7

Brand copay N/A 30 30

Specialty tier coinsurance (where applicable) N/A 25% 30%

Plans with generic/preferred brand/nonpreferred brand tier structure

Generic copay N/A $5 $5

Preferred brand copay N/A 29 28

Nonpreferred brand copay N/A 55 50

Specialty tier coinsurance (where applicable) N/A 25% 25%

Note: MA–PD (Medicare Advantage prescription drug [plan]), N/A (not applicable). Values are not weighted for plan enrollment. The MA–PDs described here exclude 

demonstration programs, 1876 cost plans, and plans offered in U.S. territories. Cost sharing is for median cost sharing among plans that use tiered cost sharing 

before the initial coverage limit. Benefi ts labeled actuarially equivalent to Part D’s standard benefi t include actuarially equivalent standard and basic alternative 

benefi ts. 

 *Part D’s defi ned standard benefi t has a $250 deductible (in 2006) and 25% coinsurance below the initial coverage limit.

Source: MedPAC based on CMS plan benefi t package and landscape data.
Report to the Congress: Increasing the Value of Medicare | June 2006 165

Unlike for PDPs, there is little difference between the 

mean and median premium values for defined standard 

benefits and plans that are actuarially equivalent (Table 

7-8). As is the case with PDPs, MA–PDs frequently use 

fixed-dollar copayments. However, it is also common to 

combine copays with coinsurance for certain tiers such as 

those for specialty drugs. Median cost-sharing amounts 

are similar to those used by PDPs. MA–PDs that use a 

generic/brand name tier structure typically charge $5 to 

$7 to fill a generic prescription and $30 for brand name 

prescriptions. Plans that distinguish between preferred 

and nonpreferred brand name drugs have the following 

median copays: $5 for generics, $29 to $28 for preferred 

brand name drugs, and $55 to $50 for nonpreferred brand 

name drugs. Plans often charge 25 percent coinsurance for 

specialty and higher priced drugs.

Enrollment by organization

As of late April 2006, Part D enrollment was concentrated 

among plans offered by a small number of parent 

organizations (Figure 7-2). Several of those organizations 

offer both stand-alone PDPs and MA–PDs. For example, 

United and PacifiCare (which merged recently) had 27 

percent of the 13.9 million enrollees in PDPs and 20 

percent of the 5.9 million enrollees in MA–PDs. Similarly, 

Humana had a considerable portion of both markets: 

18 percent of PDP enrollees and 13 percent of MA–PD 

enrollees. As information on enrollment in specific Part 

D plans becomes available, the Commission will monitor 

those data to see how enrollment patterns affect plans’ 

decision to enter or exit the market. Also, for 2007 and 

beyond, CMS will begin to weight Part D plans bids by 

enrollment when the agency calculates the nationwide 

Distribution of Part D enrollees by organization

Note: PDP (prescription drug plan), MA–PD (Medicare Advantage prescription drug [plan]). Data are as of April 27, 2006.

*Includes Blue Cross Blue Shield New England Alliance, Blue Medicare Rx, and Unicare.

Source: MedPAC based on CMS enrollment data.

PDPs

Enrollment=13.9 million

MA–PDs

Enrollment=5.9 million

31%

Other

27%

United and

PacifiCare

18%

Humana

7%

WellPoint*

7%

MemberHealth

6%

WellCare

4%

Coventry

46%

Other

20%

United and

PacifiCare

14%

Kaiser

Permanente

13%

4% Humana

Highmark

3%

Health

Net

FIGURE

7–2
166 Part D plan offerings

Guidance for plan formularies in 2006

The Medicare Prescription Drug, Improvement, 

and Modernization Act of 2003 (MMA) 

designated the U.S. Pharmacopeia (USP)—a 

nongovernmental, nonprofit organization—to develop a 

model therapeutic classification system that plans could 

use to design their formularies. Plans were not required 

to use this model, but the USP Model Guidelines were 

used as the classification structure for 74 percent of the 

Part D formularies in place at the start of the Medicare 

drug benefit (USP 2006).13 The 2006 USP guidelines 

provided the following therapeutic classification 

system:

• 41 broad therapeutic categories (e.g., cardiovascular 

agents),

• 137 pharmacologic classes (e.g., dyslipidemics), and

• 118 formulary key drug types (e.g., statins).

CMS’s guidance on the formulary drug lists includes 

the following requirements:

• Plan formularies must generally include at least two 

drugs in each approved therapeutic category and 

class, regardless of the drug classification system 

used.14

• In specified categories and classes, formularies must 

include at least one drug from USP’s category of key 

drug types.15

• Plans must list “all or substantially all” of the 

drugs listed in six drug categories: antidepressant, 

antipsychotic, anticonvulsant, anticancer, 

immunosuppressant, and HIV/AIDS drugs.16

• Plans may only have one specialty tier that may 

be designed for high-cost and unique drugs and 

biologicals, such as injectable drugs. Beneficiaries 

may not appeal the cost-sharing amount—generally 

limited to 25 percent—for drugs placed on a 

specialty tier.17

• Formularies should list drugs on a nonpreferred tier 

only when therapeutically similar drugs are available 

on a lower tier.

The text box on page 168 describes some of the 

challenges CMS faced, and will continue to face, when 

determining whether plans fulfill these requirements.

The MMA excludes certain categories of drugs from 

Part D coverage. These are the same categories of 

drugs that states have had the option to exclude from 

their Medicaid programs. Enhanced plans can cover 

these drugs, but beneficiaries must pay for this added 

coverage themselves, typically through premiums.18 

All beneficiaries have the right to request Part D 

coverage of a nonformulary drug and to appeal 

denials. To obtain coverage for a nonformulary drug, 

the prescribing physician must provide a statement 

(and supporting documentation upon request) that the 

nonformulary drug is medically necessary because all 

drugs on the formulary would not be as effective for 

the enrollee or would have adverse effects. Plans may 

manage enrollees’ drug utilization by requiring prior 

authorization or other action to obtain coverage for 

specific drugs.

During the early months of the drug benefit, CMS 

released several guidance documents on plan transition 

polices for new enrollees who were on medications 

which are nonformulary or require other action, such 

as prior authorization. CMS extended the general 

minimum transition period during which time plans had 

to temporarily cover such prescriptions and ensure that 

pharmacists did not encounter plan delays or denials for 

them. The extension increased the minimum transition 

period from 30 days to 90 days. Report to the Congress: Increasing the Value of Medicare | June 2006 167

Formulary designs

All MA–PDs and PDPs submitted their plan formularies 

to CMS for review and approval. CMS examined several 

factors to verify that the formularies met minimum 

standards. These standards were established to enhance 

beneficiary access to medications that may present 

unique therapeutic advantages in safety and efficacy, 

and to prevent plans from discouraging enrollment of 

beneficiaries with certain diseases—above and beyond the 

explicit prohibition of this practice in the MMA. The text 

box on page 166 describes these standards in more detail. 

The text box on page 168 describes some of the challenges 

CMS faced, and will continue to face, when determining 

whether plans fulfill these requirements. In particular, 

the definition of what constitutes appreciable differences 

in drug products and entities can affect how formulary 

rules and standards are applied. Such definitions are not 

formally a part of current U.S. Pharmacopeia (USP) or 

CMS guidelines. For example, should oral and topical 

forms of a drug be counted separately? Should all 

available dosages of a drug be considered on a plan’s 

formulary if at least one is listed? Decisions about whether 

or not different forms, strengths, and extended-release 

versions of a given drug are counted as one drug may 

affect the number and variety of products plans list. In 

general, CMS appears to have decided that a plan can not 

satisfy the requirement of two drugs per class by simply 

using two different forms or strengths of a given drug. 

The different versions of a drug can be treated differently, 

however, in terms of coverage and cost sharing.

For purposes of our analysis, we used a proprietary 

classification system developed by Medi-Span to translate 

the drugs that plans reported on their formularies into 

standardized drug entities. Different strengths and release 

mechanisms (e.g., regular vs. sustained release) are 

grouped into a single drug entity. Most forms of an entity 

(e.g., capsule vs. tablet) are typically counted as one drug, 

but some forms are considered separately if they are used 

for a notably different purpose. We differentiate between 

brand name and generic drugs. However, if a generic drug 

entity is available from several different manufacturers, 

all are counted as the same drug. Other researchers may 

categorize drug entities differently and thus obtain slightly 

different results. In our analysis, plan formularies are 

not weighted by beneficiary enrollment. We examined 

all drugs that plans listed and consequently did not 

select drugs by their frequency of use in the Medicare 

population.

average plan bid, federal subsidies, and beneficiary 

premiums. Thus, patterns of enrollment in 2006 could lead 

to significant changes in beneficiary premiums for 2007.

Part D formularies

The Medicare drug benefit allows plans to develop and 

use formularies to manage the cost and use of prescription 

drugs. Indeed, all PDPs and MA–PDs participating in the 

new Medicare drug benefit use formularies to designate 

the coverage and tiered cost-sharing status of outpatient 

drugs. To the extent that formularies assist plans in 

encouraging safe, effective, and cost-conscious drug 

prescribing and utilization, they are a key to the success of 

the overall Medicare drug benefit. Attention to formulary 

implementation is important to ensure that beneficiaries 

have access to a range of needed medications. In our June 

2004 report to the Congress, the Commission discussed 

formulary structure and design issues (MedPAC 2004).

In this section, we review statutory and regulatory 

standards for Part D formularies and present some 

descriptive analyses of the formularies that PDPs 

and MA–PDs submitted to CMS for the launch of 

the Medicare drug benefit. This early study provides 

some basic analysis and a beginning point for tracking 

changes in plan formularies over time. In the future, 

with enrollment and drug claims data, we will be able to 

examine how plan formularies affect enrollee plan choice 

(by beneficiary and plan characteristics), beneficiary 

access to medications, beneficiary out-of-pocket spending, 

Medicare spending, and beneficiary health outcomes.

At this point, we are able to examine the formularies 

and benefit designs that Part D plans submitted to CMS 

for use at the start of the drug benefit. For our analysis, 

researchers at the National Opinion Research Center 

(NORC) and Georgetown University examined all the 

formularies submitted to CMS beginning January 1, 

2006. Findings from this analysis indicate that most 

Part D formularies distinguish between preferred and 

nonpreferred brand name drugs and include specialty tiers. 

Plan formularies typically list about 1,000 drugs (where 

the method for counting drugs is defined in the following 

section), but the number of drugs covered varies somewhat 

based on several plan characteristics, such as a plan’s tier 

structure. Also, plans typically apply some utilization 

management tools to drugs in certain therapeutic 

categories.
168 Part D plan offerings

Tier structures

We examined plan formularies to determine if there were 

differences in their designs associated with the following 

plan characteristics:

• national or non-national,

• eligible for auto-enrolled beneficiaries,

• basic or enhanced plans, and

• tier structure.

Plans submitted formularies to CMS with a variety of tier 

structures, ranging from one to eight tiers. However, not 

all tiers reflect cost-sharing differences for enrollees; some 

plan formularies include several tiers that, in fact, have the 

same cost sharing. For our formulary analysis, therefore, 

we delineate tiers only when they mark differences in 

cost sharing. Most plans’ formularies fall into five tier 

structures, grouped into the following three categories: 

• 25 percent cost sharing for all listed drugs;

• generic and brand name tiers (some with and some 

without an additional specialty tier); and

• generic, preferred brand name, nonpreferred brand 

name tiers (some with and some without an additional 

specialty tier).

Defining a drug

How drugs are defined can have a significant 

impact on formulary rules and standards. CMS 

generally requires that plan formularies include 

at least two drugs in each of its therapeutic categories 

and classes (unless only one drug is available). Yet, 

two products may be considered the same drug by one 

measure, while they are treated as separate entities by 

another. 

The Food and Drug Administration’s national drug 

codes (NDCs) are extremely exact and give a separate 

code for every possible combination of chemical 

ingredients, strength (e.g., number of milligrams), 

form, package size (how many doses are typically 

included in one container used by the pharmacy), and 

the firm that manufactures or distributes the drug. The 

U.S. Pharmacopeia (USP) coding, on the other hand, 

is more general and lists only chemical ingredients. 

Considerations such as brand name versus generic, 

strength, and (in most cases) form are absent from the 

USP scheme. 

What drugs are counted

The absence of a clear-cut definition of which drug 

products should be considered different entities makes 

it considerably more difficult to interpret the statutory 

requirement that two drugs be covered in a given 

category or class. Some of the considerations that 

complicate this determination include the following:

• Should oral and topical forms be counted separately, 

especially if they are used to treat different 

conditions? It appears that the answer could be 

different for different drugs, as some appear in 

separate places in the USP classification and others 

do not.

• Should all versions of a drug (i.e., all NDCs) 

be covered if at least one is covered? In its June 

guidance to plans, CMS stated that it will not require 

all dosages to be included, or all manufacturers’ 

versions of a multisource product to be included. 

In addition, CMS’s guidance on displaying plan 

formularies makes it clear that plans may place 

different strengths of a drug on different costsharing tiers.

• How should extended-release versions of a drug be 

treated? It appears that CMS will neither require 

plans to cover extended-release versions of drugs, 

nor count them as an additional drug toward the 

coverage requirements. 

• Should two chemically similar, but not identical, 

drugs count as two drugs? In the case of two 

chemically similar antidepressants with rather 

different treatment indications, CMS has allowed an 

exception to the requirement that plan formularies 

include all antidepressants and allowed plans to 

exclude one of these two drugs. 

Source: NORC 2005.
Report to the Congress: Increasing the Value of Medicare | June 2006 169

Shown in Table 7-9, our analysis found that 61 percent 

of PDPs and 68 percent of MA–PDs use the generic, 

preferred, and nonpreferred brand name structure; 30 

percent of Part D plans distinguish only between brand 

name and generic drugs; and fewer than 10 percent have 

25 percent coinsurance for all covered drugs. Enhanced 

plans almost never use this latter structure. PDPs with 

25 percent coinsurance were more likely to be nonnational, basic, and qualify for auto-enrollment (vs. no 

auto-enrollees). 

As described in the text box on page 166, plans may have 

a specialty tier. For 2006, CMS did not establish specific 

criteria for placing drugs on a specialty tier but indicated 

that this tier could be used for expensive products and 

unique drugs and biologicals, such as biotechnology 

drugs. (For 2007, CMS defined the specialty tier more 

clearly and has stated that only Part D drugs with plan 

negotiated prices that exceed $500 per month may be 

placed on a specialty tier.) Beneficiaries may not appeal 

the cost-sharing amount for drugs listed on a specialty tier 

as they can for drugs on nonpreferred brand name tiers. 

Cost sharing for a specialty tier is generally limited to 

25 percent below the initial coverage limit. Our analysis 

shows that about 60 percent of the PDPs and MA–PDs 

include a specialty tier in their formularies.19 Among these 

plans, the median PDP lists 46 drugs on a specialty tier 

and the median MA–PD lists 90. 

TABLE

7–9 Most Part D plans distinguish between preferred and

 nonpreferred brands and include specialty tiers

Distribution of plans by tier structures

Generic/brand

Generic/preferred brand/

nonpreferred brand

Plan characteristics

25% 

coinsurance, 

all tiers

Without 

specialty 

tier

With 

specialty 

tier

Without 

specialty 

tier

With 

specialty 

tier Other

All Part D plans 8% 11% 15% 19% 45% 2%

All PDPs 9 8 22 23 38 1

National, near-national 5 8 21 25 40 0

Non-national 31 3 28 12 21 4

Auto-enrollment 23 2 33 9 33 1

No auto-enrollment 3 10 18 29 40 0

Basic 16 5 25 18 36 1

Enhanced 0 12 18 30 40 0

All MA–PDPs 7 16 6 15 53 3

Local HMO 6 15 5 14 58 2

Local PPO 6 21 8 24 37 5

Regional PPO 29 8 15 10 38 0

PFFS 10 11 11 0 67 0

Basic 18 21 10 16 32 2

Enhanced 1 13 5 14 65 3

Note: PDP (prescription drug plan), MA–PD (Medicare Advantage prescription drug [plan]), PPO (preferred provider organization), PFFS (private fee-for-service). The 

PDPs described here exclude plans offered in U.S. territories. The MA–PDs described here exclude demonstration programs, 1876 cost plans, and plans offered in 

U.S. territories. Auto-enrollment refers to PDPs that were eligible for automatically enrolled benefi ciaries based on low-income status. Cost-sharing structures are for 

before the initial coverage limit of Part D. A specialty tier generally includes expensive products and unique drugs and biologicals, such as biotechnology drugs, 

for which enrollees may not appeal for lower cost-sharing amounts. Numbers may not sum to 100 percent due to rounding. 

Source: National Opinion Research Center/Georgetown University analysis for MedPAC of formularies submitted to CMS for January 1, 2006.
170 Part D plan offerings

Plans that use tiered formularies can reduce their financial 

liability for expensive drugs by placing them on a specialty 

tier with higher beneficiary cost sharing than other tiers. 

If beneficiaries reach their annual out-of-pocket spending 

limits, however, plans must cover these drugs—along 

with all other medically necessary drugs—at significantly 

reduced cost-sharing levels.

Formulary sizes

The number of drugs that plans list on their formulary 

can be another starting place for analyzing Part D 

formularies. Note, however, that the number of drugs 

on a plan’s formulary does not necessarily represent 

beneficiary access to needed medications. Plans’ processes 

for nonformulary exceptions, prior authorization, and 

step therapy requirements can have a strong influence 

on access. For example, unlisted drugs may be covered 

through the nonformulary exceptions process, which 

in some plans may be relatively easy for enrollees 

and physicians, while for other plans it may be more 

burdensome. Alternatively, on-formulary drugs may not 

be covered in cases where a plan does not approve a prior 

authorization request. Also, a formulary’s size can be 

deceptively large if it includes drugs that are no longer 

used in common practice. 

As can be expected, we found that Part D formulary sizes 

vary somewhat. The median PDP lists fewer drugs than 

the median MA–PDs, but broadly speaking, they each 

typically list about a 1,000 drugs on their formularies, 

with brand name drugs making up a little more than half 

(Figure 7-3).20 Among PDPs, the total number of drugs 

listed ranges from 618 drugs to 1,743, with a median of 

957 drugs. Among MA–PDs, the total number of drugs 

listed ranges from 509 to 2,130, with a median of 1,096. 

Formularies that are very large approach open formularies, 

in which all or mostly all drugs are covered. The median 

plan appears to have many therapeutic categories that 

exclude some drugs.

When analyzing formulary size by plan type, we see some 

patterns. At the median, regional PPO and private FFS 

MA–PDs have the largest formularies, but these only 

represent 6 percent of the total number of Part D plans. 

Among PDPs, the non-national plans have the largest 

formularies. Plans that are eligible for auto-enrollment 

typically list almost the same number of total drugs and 

total brand name drugs as plans without auto-enrollment. 

It is somewhat reassuring that PDPs eligible for autoenrollees (through lower bids to CMS) have similar 

formulary sizes—and in particular include similar numbers 

of brand name drugs—as other plans. Major differences 

could have signaled concern of inequitable access to drugs 

between auto-enrollees and other beneficiaries. While 

formulary sizes appear similar, further analysis of drug 

claims and utilization management tools by therapeutic 

category will be important for measuring beneficiary 

access to needed medications because formulary size alone 

does not directly measure access.

For both MA–PDs and PDPs, enhanced plans’ formularies 

are also larger than basic plans’ formularies, but this 

difference is small (particularly for PDPs). Enhanced 

plans appear to have focused more of their added benefits 

on other areas, such as coverage in the gap. Our previous 

analysis of plan benefit designs shows that 36 percent of 

enhanced PDPs and 43 percent of enhanced MA–PDs 

offer coverage in the gap (most offering coverage only for 

generic drugs). 

We see more variation in formulary size when we compare 

by tier structure. As shown in Figure 7-3, for both PDPs 

and MA–PDs, formularies that have preferred and 

nonpreferred brand name tiers list more brand name drugs 

overall than formularies that have a single brand name tier 

(whether or not they have a specialty tier). In other words, 

adding a nonpreferred brand name tier is associated with 

including more drugs on a plan formulary and specifically, 

more brand name drugs.21 This finding is expected because 

plans generally take on less financial risk for drugs they 

place on nonpreferred and higher cost-sharing tiers. 

We found that plans with specialty tiers do not necessarily 

list more brand name drugs. In fact, for PDPs, adding a 

specialty tier to a given tier structure is associated with 

including slightly fewer brand name listings at the median. 

However, among MA–PDs, plans that list the most brand 

name drugs are often those with a nonpreferred brand 

name tier plus a specialty tier. In some cases, some of the 

drugs plans place on specialty tiers are drugs that plans 

are required to list (e.g., some expensive oral anticancer 

drugs), but in other cases, plans may have listed drugs on the 

specialty tier that they may not have otherwise listed at all.22

In addition to regulatory coverage rules for certain 

therapeutic categories, the number of drugs listed in 

a therapeutic class also reflects the size of the class of 

drugs available in the marketplace. In classes with fewer 

drugs available, plans typically cover a larger share of 

them. Conversely, when there are more drugs available in 

a given class, plans are able to negotiate better prices by 

listing only selected drugs on their formulary. In addition, 
Report to the Congress: Increasing the Value of Medicare | June 2006 171

Part D plans typically list about 1,000 drugs

Note: PDP (prescription drug plan), MA–PD (Medicare Advantage prescription drug [plan]), HMO (health maintenance organization), PPO (preferred provider 

organization), PFFS (private fee-for-service). Occasionally, plans list some generic drugs on brand tiers and vice versa. Plans with “other” tier structures are not 

displayed. The PDPs described here exclude plans offered in U.S. territories. The MA–PDs described here exclude demonstration programs, 1876 cost plans, and 

plans offered in U.S. territories. Cost-sharing structures are for before the initial coverage limit of Part D. A specialty tier generally includes expensive products and 

unique drugs and biologicals for which enrollees may not appeal for lower cost sharing.

Source: National Opinion Research Center/Georgetown University analysis for MedPAC of formularies submitted to CMS for January 1, 2006.

PDPs All PDPs (N=1,409)

National, near-national (N=1,222)

Plan type Tier structure

Non-national (N=207)

Auto-enrollment (N=409)

No auto-enrollment (N=1,020)

Basic (N=821)

Enhanced (N=608)

25% coinsurance (N=128)

Generic/brand (N=108)

Generic/brand/specialty (N=314)

Generic/preferred brand/nonpreferred brand (N=332)

Generic/preferred brand/nonpreferred brand/specialty (N=538)

Median number of drugs listed

MA–PDs All MA–PDs (N=1,302)

Local HMO (N=856)

Plan type Tier structure

Local PPO (N=275)

Regional PPO (N=48)

PFFS (N=124)

Basic (N=471)

Enhanced (N=831)

25% coinsurance (N=92)

Generic/brand (N=206)

Generic/brand/specialty (N=83)

Generic/preferred brand/nonpreferred brand (N=193)

Generic/preferred brand/nonpreferred brand/specialty (N=696)

0 500 1000 1500 2000

Generic

Brand

FIGURE

7–3
172 Part D plan offerings

there are often more overlapping products in some of 

these larger classes (e.g., antibiotics or respiratory tract 

agents), meaning that plans may not see a need to cover all 

alternatives, even if negotiation is not a factor. 

Table 7-10 shows that the share of drugs that plans 

list can decrease as class size grows. For example, in 

a therapeutic class with only a small number of drugs, 

such as cholinesterase inhibitors (within the class of 

antidementia agents), plans typically list a higher share of 

available drugs in the market. But in classes where there 

are many drugs available in the market, such as opioid 

analgesics, plans typically list a much smaller share on 

their formularies. 

Note, however, that this table does not specify tier 

placement for plans’ listed drugs. For example, further 

analysis (not shown on this table) finds that among plans 

that have nonpreferred tiers, the typical PDP plan lists 

38 percent of the available brands for dyslipidemics 

(anticholesterol agents, including statins among others) on 

the preferred brand name tier and another 50 percent on 

the nonpreferred brand name tier. 

In the six classes in which CMS requires that plans cover 

all or substantially all drugs (listed in the text box on page 

166), plans predictably list a larger share of drugs. For 

example, in the class of atypical antipsychotics (listed in 

Table 7-10), both MA–PDs and PDPs typically list all of 

the available drugs. In some of these six classes, plans do 

not list all drugs because of allowed exceptions.

As mentioned earlier, formulary size gives some insight 

into plan differences, but it does not directly measure 

access to medications. Some drugs listed on a formulary 

may require further plan approval and alternatively, 

unlisted drugs can be covered through a nonformulary 

exceptions process. We will not be able to compare actual 

differences in utilization and access until we have drug 

claims data. With claims information, we can begin to 

assess coverage rates of drugs between plans, particularly 

if we also know rates of drug claim denials.

Utilization tools

Most Part D plans apply drug utilization management 

tools to selected drugs. These tools include prior 

authorization (plans require pre-approval before coverage), 

step therapy (enrollees must try specified drugs before 

moving to other drugs), and quantity limits (plans limit 

the number of doses of a particular drug covered in a 

given time period). Plans use these tools for drugs that 

are expensive, potentially risky, subject to abuse, misuse, 

experimental use, or to encourage use of lower-cost 

therapies. Some tools are more common than others. For 

example, all PDPs and almost all MA–PDs (98 percent) 

use prior authorization for at least one drug on their 

formularies. The median plan applies prior authorization to 

9 percent of the drugs on its formulary (Table 7-11). Step 

therapy is less commonly used among Part D plans and 

those that use it do so for a smaller proportion of drugs.23

Again, use of these tools varies by drug class.

TABLE

7–10 The share of drugs listed in a therapeutic category

 depends on category size and regulation

Median percent of drugs listed by selected therapeutic categories

Cholinesterase 

inhibitors Dyslipidemics Opioid analgesics

Atypical 

antipsychotics*

Total drugs in category 4 20 61 6

Plan type:

PDPs 75% 65% 39% 100%

MA–PDs 75 75 48 100

Note: PDP (prescription drug plan), MA–PD (Medicare Advantage prescription drug [plan]). Descriptions of therapeutic categories are given in parentheses: cholinesterase 

inhibitors (antidementia agents); dyslipidemics (anticholesterol agents); opioid analgesics (narcotic pain relievers); atypical antipsychotics (nonphenothiazines). 

Occasionally, plans list some generic drugs on brand tiers and vice versa. The PDPs described here exclude plans offered in U.S. territories. The MA–PDs described 

here exclude demonstration programs, 1876 cost plans, and plans offered in U.S. territories.

*Under CMS regulation, plans are required to list all drugs in the atypical antipsychotic category.

Source: National Opinion Research Center/Georgetown University analysis for MedPAC of formularies submitted to CMS for January 1, 2006.
Report to the Congress: Increasing the Value of Medicare | June 2006 173

As found in current health plan practices, our analysis 

shows that Part D plans typically require prior 

authorization in therapeutic categories with high-cost 

drugs and drugs with elevated safety risks. For example, 

PDPs and MA–PDs that use prior authorization typically 

require this tool for most of the drugs in the immune 

suppressant category for expensive rheumatoid arthritis 

drugs. In addition, plans are likely applying prior 

authorization restrictions in this category (and several 

other categories) to assist in determining whether the 

drugs should be covered under Part B.24

Plans also use prior authorization and step therapy for 

selected drugs in classes where lower cost or over-thecounter drugs are available. For example, in the class of 

proton pump inhibitors (PPIs) (medications that reduce 

stomach acid), PDPs typically apply prior authorization to 

half of their listed PPIs, and if they use step therapy at all, 

they apply it to all of them. Similarly, MA–PDs also use 

prior authorization and step therapy at high rates in this 

therapeutic category. For atypical antipsychotic drugs—a 

category with both high- and low-cost drugs—PDPs and 

MA–PDs also appear similar in their application of prior 

authorization and step therapy. (Under CMS instructions, 

plans can only apply utilization tools in this category to 

new-start enrollees—those not already taking a drug in the 

category.) Plans use step therapy considerably less often 

than prior authorization. In some therapeutic categories, 

we found differences between MA–PDs and PDPs in step 

therapy rates, but differences do not appear systematic.

In general, one might have expected MA–PDs to apply 

more utilization management tools to their formularies 

than PDPs because MA–PDs may serve a population 

more accustomed to such tools for other health services. 

However, PDPs and MA–PDs often use the same kind of 

organizations—pharmacy benefit managers (PBMs)—to 

administer their drug benefits. Thus, similarities between 

the two are somewhat predictable. In fact, in some cases, 

PDPs and MA–PDs used the same PBM and submitted 

formularies that were identical. Nevertheless, PDPs are 

a new kind of product for a new benefit and we expect 

their formularies to evolve over time. MA–PDs have more 

experience taking on risk for a drug benefit, but formulary 

guidelines and standards for Part D are relatively new. 

Formulary changes

Throughout 2006, plans may remove a drug from their 

formularies, move a drug to a higher cost-sharing tier, or 

impose new restrictions at any point during the year, as 

long as they notify affected enrollees, pharmacists, and 

physicians at least 60 days prior to the change. However, 

starting in 2007, enrollees who are on medications must 

have continued coverage for the remainder of the year for 

their medications and, thus, are exempt from formulary 

changes during the year. (Some exceptions apply, such as 

removing formulary drugs that have been withdrawn from 

the market by either the Food and Drug Administration or 

a product manufacturer.)

Looking ahead

In 2007, CMS, health plans, pharmacists, and beneficiaries 

will have had a year of experience with Part D. In addition 

to working out operational details for this new benefit, 

CMS will adjust plan subsidies for 2007 based on 

enrollment-weighted figures from 2006. This may result 

TABLE

7–11 Part D plans concentrate prior

 authorization in selected categories

Median percent of listed drugs 

subject to prior authorization, 

among plans that use it

Therapeutic 

category PDP MA–PD

All drugs 9% 9%

Atypical antipsychotics* 33 33

Dyslipidemics 13 17

Immune suppressants* 83 71

Metabolic bone disease agents 17 17

Molecular target inhibitors* 75 75

Opioid analgesics 12 9

Oral hypoglycemics 17 11

Proton pump inhibitors 50 75

Renin-angiotensins 2 4

Reuptake inhibitors* 5 5

Note: PDP (prescription drug plan), MA–PD (Medicare Advantage prescription 

drug [plan]). Descriptions of selected therapeutic categories are given in 

parentheses: atypical antipsychotics (antipsychotics, nonphenothiazines); 

dyslipidemics (anticholesterol agents); immune suppressants (rheumatoid 

arthritis agents); opioid analgesics (narcotic pain relievers); oral 

hypoglycemics (blood sugar level agents); proton pump inhibitors (stomach 

acid reducers); renin-angiotensins (selected hypertension drugs); reuptake 

inhibitors (selected antidepressants). The PDPs described here exclude 

plans offered in U.S. territories. The MA–PDs described here exclude 

demonstration programs, 1876 cost plans, and plans offered in U.S. 

territories.

 *Plans may only apply prior authorization to new-start enrollees—those not 

already taking a drug in these categories.

Source: National Opinion Research Center/Georgetown University analysis for 

MedPAC of formularies submitted to CMS for January 1, 2006.
174 Part D plan offerings

in significant changes in premiums for the coming year. 

For example, if 2007 plan bids are similar to 2006 bids 

and enrollees cluster in lower-premium plans, the federal 

subsidy based on the enrollment-weighted average bid will 

be proportionately lower and beneficiaries’ premiums will 

rise. Some plans may exit if their enrollment is low, and 

other plans may choose to enter the market. Additionally, 

some low-income beneficiaries may need to switch 

plans if their plan no longer qualifies for the low-income 

premium subsidy, as determined through the bidding 

process.

In the coming years, the Commission will continue 

analyzing aspects of cost, quality, and access under Part 

D. We would like to examine how benefit design and plan 

formularies affect:

• enrollee plan choice (by characteristics of 

beneficiaries and plans),

• beneficiary access to medications,

• beneficiary out-of-pocket spending,

• Medicare spending, and

• beneficiary health outcomes.

These analyses will help policymakers construct 

performance measures to monitor the implementation 

of the new Medicare drug benefit, as the Commission 

has discussed previously (MedPAC 2005c). Additionally, 

the Commission will examine how Part D is meeting the 

needs of special populations, such as those residing in 

long-term care facilities. A high priority for future analysis 

will also be to examine the impact of plans’ formulary 

changes, utilization management tools (such as prior 

authorization), and nonformulary exceptions processes on 

beneficiaries and physicians. Report to the Congress: Increasing the Value of Medicare | June 2006 175

1 Medicare subsidizes 80 percent of an individual’s drug 

spending above the defined standard benefit’s out-of-pocket 

threshold; enrollees pay 5 percent cost sharing and their plan 

covers the remaining 15 percent. Individual reinsurance acts 

as a form of risk adjustment by providing greater federal 

subsidies for the highest cost enrollees. In addition, Medicare 

establishes symmetric risk corridors separately for each 

plan to limit a plan’s overall losses or profits. Under risk 

corridors, Medicare limits a plan’s potential losses (or gains) 

by financing some of the higher-than-expected costs (or 

recouping excessive profits). These corridors are scheduled 

to widen, meaning that plans should bear more insurance risk 

over time.

2 CMS reviews plans’ benefit designs and formularies with the 

goal of ensuring that plans do not substantially discourage 

enrollment by any class of enrollees.

3 In 2002, 18 percent of noninstitutionalized Medicare 

beneficiaries had no drug coverage. Thirty-four percent 

had coverage through employer-sponsored insurance, 14 

percent through Medicaid, 12 percent through Medicare 

HMOs, 12 percent through medigap policies, and 10 percent 

through other sources such as the Department of Defense or 

Department of Veterans Affairs (Kaiser Family Foundation 

2005). Although enrollment in the standardized medigap 

plans that include prescription drug coverage has been less 

than 6 percent of all standard policies, the percentage with 

prescription drug coverage through medigap plans may be 

higher because many individuals held pre-standard medigap 

policies.

4 Part D’s late enrollment penalty is 1 percent of the base 

beneficiary premium for each uncovered month. The enrollee 

would pay this penalty each month for the rest of her life 

(or as long as she was enrolled in Part D), and the penalty 

would reflect each year’s new (and presumably higher) base 

premium. An individual who postpones signing up until fall 

2006 with coverage beginning on January 1, 2007, would pay 

a penalty of about $2 to $3 per month throughout 2007.

 5 Enrollees with standard benefits will pay 100 percent 

coinsurance for drug spending greater than $2,250 but less 

than their catastrophic threshold. However, beneficiaries will 

be able to obtain their plan’s discounted price for prescription 

drugs for drug spending in this coverage gap. They will need 

to adhere to their plan’s formulary, prior authorization, and 

formulary exceptions processes to receive credit for their outof-pocket spending toward the $3,600 catastrophic limit.

6 The term “true out of pocket” refers to a feature of Part D 

in which fewer federal subsidy dollars are directed toward 

enrollees who have supplemental coverage. Specifically, 

only certain types of spending on behalf of the beneficiary 

count toward the catastrophic threshold: the beneficiary’s 

own out-of-pocket spending, that of a family member or 

official charity, supplemental drug coverage provided through 

qualifying state pharmacy assistance programs or Part D’s 

low-income subsidies, and supplemental drug coverage paid 

for with Medicare Advantage rebate dollars under CMS’s 

demonstration authority.

7 The low-income premium subsidy amount is calculated 

as the greater of the low-income benchmark premium (a 

weighted average of all PDP and MA–PD premiums for basic 

benefits in each region) or the lowest PDP premium for basic 

coverage.

8 Duals may select a different plan from the one to which they 

are auto-enrolled up to once per month.

9 Since fewer beneficiaries were enrolled at the start of 2006 

than by May 15, OACT’s average estimate of Part D and RDS 

coverage for 2006 is 29 million (Boards of Trustees 2006).

10 This number excludes demonstration programs, 1876 cost 

plans, and other plans not open to all Medicare beneficiaries 

such as employer-group plans and plans in U.S. territories.

11 The term actuarially equivalent refers to the expected value of 

each plan’s benefit, not the expected value of the combination 

of benefit spending and enrollee premiums. 

12 The relative magnitude of this difference between payments 

and bids varies geographically, based in part on how the 

Medicare+Choice program (the precursor to Medicare 

Advantage) paid particular counties. (For more on how the 

Medicare+Choice program categorized counties for payment 

purposes, see MedPAC 2005a.) Differences between payments 

and bids lead to different MA–PD premiums.

13 Plans that used the USP guidelines were granted safe 

harbor on the issue of discouraging enrollment of high-cost 

beneficiaries through their classification system.

14 Plans may list one drug in a category or class where only one 

drug is available.

15 CMS states, however, that plans may present a reasonable 

clinical justification for formularies that do not contain at 

least one drug for each of the USP formulary key drug types. 

If a USP formulary key drug type only includes drugs that are 

primarily covered under Part B, it is not CMS’s expectation 

that these key drug types be represented on formularies.

Endnotes
176 Part D plan offerings

16 Plans may apply utilization tools, such as prior authorization, 

for patients who start drug therapy in these categories (except 

for the HIV/AIDS category) during their enrollment in the 

plan.

17 For 2006, CMS did not establish specific criteria for drugs 

listed on a specialty tier, but indicated that it could be used 

for expensive products. (For 2007, CMS defined specialty tier 

more clearly and has stated that only Part D drugs with plan 

negotiated prices that exceed $500 per month may be placed 

on a specialty tier.)

18 For 2006, this list includes drugs that treat anorexia, weight 

loss, weight gain, fertility, cosmetic conditions, hair loss, 

symptomatic relief of cough and colds, most prescription 

vitamins and minerals, nonprescription drugs, barbiturates, 

and benzodiazepines. Most state Medicaid agencies covered 

benzodiazepines and continued to do so; they received the 

federal match for these expenditures. Beginning in 2007, Part 

D will not cover drugs used for the treatment of sexual or 

erectile dysfunction.

19 On the plan formulary data, CMS did not indicate which 

tiers were specialty tiers. Therefore, there may be some tiers 

that offer specialty-type drugs but do not claim this appeal 

exemption.

20 To meet the absolute minimum listing requirements for 

formularies, plans would have to list at least 425 drugs 

(NORC 2005).

21 Occasionally, plans list some brand name drugs on lower 

(generic) tiers and generic drugs on higher (brand name) tiers. 

22 For example, among plans with specialty tiers, plans listed 60 

percent of the drugs in the molecular target inhibitors class 

(part of the anticancer drugs) on their specialty tier.

23 We found that 25 percent of PDPs and 19 percent of MA–PDs 

use step therapy for at least one drug. CMS’s website reports 

that higher percentages of plans are using step therapy.

24 Medicare Part B generally covers medications that can not be 

self-administered and that are administered by or under the 

supervision of a physician in the physician’s office. Part B 

also covers oral anticancer drugs, hemophilia clotting factors, 

drugs furnished by dialysis facilities, drugs furnished as part 

of an outpatient procedure, and intravenous immune globulin 

provided in the home. Influenza, pneumonia, and hepatitis B 

vaccines are also covered under Part B.
Report to the Congress: Increasing the Value of Medicare | June 2006 177

2004 Technical review panel on the Medicare Trustees Report. 

2004. Review of the assumptions and methods of the Medicare 

trustees’ financial projections. http://aspe.hhs.gov/health/

medpanel/2004/2004_Technical_Review_Panel_on_the_

Medicare_Trustees_Report.pdf.

Boards of Trustees, Federal Hospital Insurance and Federal 

Supplementary Medical Insurance Trust Funds. 2006. 2006 

annual report of the Boards of Trustees of the Federal Hospital 

Insurance and Federal Supplementary Medical Insurance Trust 

Funds. Washington, DC: Boards of Trustees.

Centers for Medicare & Medicaid Services, Department of Health 

and Human Services. 2006. Instructions for 2007 contract year to 

Medicare prescription drug plan sponsors. Baltimore, MD: CMS. 

Congressional Budget Office. 2004. A detailed description of 

CBO’s cost estimate for the Medicare prescription drug benefit.

Washington, DC: CBO. 

Kaiser Family Foundation. 2005. Medicare chartbook, third 

edition (Summer). Washington, DC: Henry J. Kaiser Family 

Foundation.

Leavitt, M. O., Department of Health and Human Services. 2005. 

Report to Congress: Review and report on current standards of 

practice for pharmacy services provided to patients in nursing 

facilities. Washington, DC: HHS.

The Lewin Group. 2004. CMS review of current standards of 

practice for long-term care pharmacy services. Prepared for 

CMS. December 30.

McClellan, M., Centers for Medicare & Medicaid Services, 

Department of Health and Human Services. 2006. Testimony 

before the Subcommittee on Health, Committee on Ways and 

Means, U.S. House of Representatives. 109th Cong., 2nd sess. 

May 3.

Medicare Payment Advisory Commission. 2005a. MedPAC 

payment basics: Medicare Advantage program payment system. 

Washington, DC: MedPAC.

Medicare Payment Advisory Commission. 2005b. MedPAC 

payment basics: Part D payment system. Washington, DC: 

MedPAC.

Medicare Payment Advisory Commission. 2005c. Report 

to the Congress: Issues in a modernized Medicare program.

Washington, DC: MedPAC.

Medicare Payment Advisory Commission. 2004. Report to 

the Congress: New approaches in Medicare. Washington, DC: 

MedPAC.

National Opinion Research Center. 2005. Final report: Issues 

in the design and implementation of drug formularies and 

therapeutic classes. Submitted to the Office of the Assistant 

Secretary for Planning and Evaluation, Department of Health 

and Human Services. September 28. http://aspe.hhs.gov/health/

reports/05/DrugFormularies/index.htm.

U.S. Pharmacopeia. 2006. Model guidelines version 2.0: 

Preamble. Rockville, MD: USP.

References

How beneficiaries learned 

about the drug benefit and 

made plan choices

CHAPTER 8

Report to the Congress: Increasing the Value of Medicare | June 2006 181

Chapter summary

In this chapter, the Commission describes results from a study of how 

Medicare beneficiaries learned about the Medicare drug benefit and 

made choices. The study consisted of a beneficiary survey, focus groups 

with beneficiaries and their family members, and structured interviews 

with beneficiary counselors. 

Individuals had many factors to consider when deciding whether to 

enroll in Part D, but many reported similar kinds of decisions. Most 

beneficiaries who signed up for the drug benefit or considered doing 

so reported that saving money on current drug costs motivated them. 

Having another source of drug coverage was the most common reason 

beneficiaries gave for not signing up. In general, individuals who did 

not sign up for the benefit were less likely to use drugs on a regular 

basis than those who did. 

Beneficiaries who enrolled or are considering enrolling in a plan spent 

considerable time studying their options. More than two-thirds of 

beneficiaries surveyed researched and made decisions about signing 

In this chapter

• Studying how beneficiaries 

made choices

• Choosing to enroll in the 

drug benefit

• Choosing a plan

• The beneficiary counselor 

perspective

• Information and decision 

making

How beneficiaries learned 

about the drug benefit and 

made plan choices

8 C H A P T E R 
182 How beneficiaries learned about the drug benefit and made plan choices

up for Part D by themselves. However, those who had signed up were twice 

as likely to have had help (e.g., from friends and family) than those who 

were not considering signing up. Although many beneficiaries discussed 

their choices with family, friends, and insurance agents, fewer beneficiaries 

used resources like the Medicare toll-free help line, the Medicare website, 

or counselors to help them understand their options. Beneficiaries found the 

large number of choices available to them confusing, but a majority in our 

survey said they had enough information to make a decision.

Most beneficiaries reported that saving money on drug costs was important 

to them when they considered signing up for the drug benefit. When 

choosing a particular plan, they considered drugs on the formulary, monthly 

premiums, overall savings, access to their local pharmacy, and reputation 

of the company offering the plan. Beneficiaries participating in our focus 

groups also said these factors were very important. In addition, they stressed 

the importance of good customer service.

Counselors reported strong demand for their services. Counselors 

consistently said that their offices were overwhelmed by the high volume of 

calls they received, particularly in November and December 2005. Noting 

that they only tend to see beneficiaries with problems, counselors reported 

that beneficiaries were confused by the number of plan choices and the 

variation in benefit structure. Counselors said that their outreach efforts led 

to increased contacts with disabled beneficiaries and beneficiaries dually 

eligible for Medicare and Medicaid. However, they were less successful in 

reaching other individuals eligible for the low-income subsidy. Report to the Congress: Increasing the Value of Medicare | June 2006 183

Background

With the introduction of the Medicare drug benefit and 

the expansion of the Medicare Advantage (MA) program, 

beneficiaries have had to make many choices about 

their health care options in 2006. As noted in Chapter 7, 

beneficiaries in every region of the country who choose 

to participate in the drug benefit program have many plan 

choices, including stand-alone prescription drug plans 

(PDPs) and MA prescription drug plans (MA–PDs). The 

Commission examined what information beneficiaries 

used to learn about the drug benefit and their individual 

choices. Our goal was to understand how beneficiaries 

made decisions so that Medicare could learn how to best 

support their decision making in the future. 

CMS developed information and counseling resources for 

Medicare beneficiaries through the National Medicare 

Education Program (NMEP). The Balanced Budget Act 

of 1997 (BBA) included funding for NMEP to inform 

Medicare beneficiaries about the different ways that they 

could receive their Medicare benefits, including through 

coordinated care plans. The program was designed to 

inform beneficiaries about their benefits, their health plan 

choices, and their rights and protections. It consists of five 

elements:

• Medicare & You, a guide to the Medicare program, 

including comparative information on health plans 

available to beneficiaries in local areas. CMS mails 

a guide annually to each household containing a 

Medicare beneficiary;

• a toll-free help line, 1-800-Medicare, to answer 

questions on the program;

• a website, www.medicare.gov, designed to provide 

information on plan choices and program benefits;

• community-based Medicare-sponsored health fairs 

and educational events; and

• increased funding for federally subsidized individual 

counseling offered by state and local agencies through 

the State Health Insurance Assistance Program 

(SHIP).

In 2006, beneficiaries need more information and 

counseling following the addition of the Medicare 

prescription drug benefit and other plan options 

established in the Medicare Prescription Drug, 

Improvement, and Modernization Act of 2003 (MMA). 

The law also increased funding for the NMEP programs 

to inform beneficiaries about these new choices and 

help them understand their options. CMS budgeted 

$340.45 million for beneficiary education activities 

in fiscal year 2005 compared to about $150 million in 

2003 (Justice 2005). Most funds were allocated to the 

Medicare call center ($181.6 million). Communitybased outreach programs including SHIP grants, CMS 

regional office outreach activities, targeted outreach 

to minority communities, and programs to support 

grassroots coalitions totaled $48.8 million. Federal funding 

specifically for SHIPs rose from $12.5 million in 2003 

to $21 million in 2004 and $32 million in 2005 (Wright 

2006). 

In addition to NMEP programs, CMS devoted resources 

to media advertising, coalitions of beneficiary groups 

developed their own outreach activities, and individual 

plans conducted their own advertising campaigns to let 

beneficiaries know about program changes. 

Studying how beneficiaries made 

choices

The Commission worked with a team of researchers 

from the National Opinion Research Center (NORC) and 

Georgetown University to examine how beneficiaries 

learned about the Medicare drug benefit, their individual 

choices, and what factors affected their enrollment 

decisions. The studies included a beneficiary survey, six 

focus groups, and structured interviews with beneficiary 

counselors.

The beneficiary survey

NORC and Georgetown designed the beneficiary survey 

and International Communications Research (ICR) fielded 

the survey instrument as part of a larger survey. The survey 

was conducted by telephone from February 8 to March 2, 

2006. Using a random-digit dialing approach, researchers 

identified and interviewed 1,411 respondents age 65 or 

older. 

NORC and Georgetown developed a series of questions 

designed to obtain information about beneficiary decision 

making regarding the new Medicare prescription drug 

benefit. NORC interviewers extensively tested the 
184 How beneficiaries learned about the drug benefit and made plan choices

questions through cognitive interviews to ascertain 

whether or not beneficiaries understood the questions. 

ICR asked a set of demographic questions in its larger 

survey and then added additional questions from a number 

of separate sponsors. ICR weighted the data to ensure 

that the survey was nationally representative with respect 

to key demographic variables. Beneficiaries who did not 

know about the drug benefit or reported that they had 

employer-sponsored insurance (ESI), Department of 

Veterans Affairs (VA), or TRICARE drug coverage that 

they intended to keep were not asked additional questions. 

Focus groups

We conducted six focus groups in 2006: three in 

Richmond, Virginia, from February 27 to 28 and three 

in Tucson, Arizona, from March 20 to 21. Each focus 

group included 9 to 12 participants. In each location, 

one group consisted of family members who were 

helping beneficiaries make decisions and two groups of 

beneficiaries. In Richmond, we held one group with only 

beneficiaries who were enrolled in both Medicaid and 

Medicare (dual eligibles). Richmond has a low rate of 

enrollment in MA and none of the beneficiaries reported 

being enrolled in an MA plan. In contrast, each Tucson 

group included a mix of beneficiaries enrolled in MA 

plans and traditional Medicare. 

We recruited groups to include beneficiaries with a mix 

of genders, incomes, and races. Because the purpose of 

the groups was to discuss decision making regarding the 

new drug benefit, we screened out beneficiaries who had 

ESI, TRICARE, or access to drugs through the VA. For 

the family member groups, we screened based on the 

insurance coverage of the beneficiaries they were helping. 

Structured interviews

We interviewed counselors in all regions of the country 

who worked with different types of beneficiaries 

including seniors, nonelderly with disabilities, low-income 

beneficiaries, beneficiaries living in rural and urban 

areas, and beneficiaries from different racial and ethnic 

groups. We began with the 34 prescription drug plan 

(PDP) regions and grouped geographically contiguous 

states to create 15 regions, each of which included one 

or more PDPs. We did not split PDP regions among 

our geographic regions. In each of the 15 regions, we 

selected one state for interviews. In these states, we 

contacted a representative from the SHIP—either the state 

coordinator or a counselor—and someone from another 

agency that provides counseling about Medicare benefits 

to seniors and people with disabilities. We used several 

sources to create a pool of beneficiary contacts. These 

sources include lists of SHIP coordinators, individuals 

and organizations affiliated with the Access to Benefits 

Coalition, the Health Assistance Partnership, and the 

Medicare Rx group. 

From January 18 to April 4, 2006, we completed about 

30 interviews. Interviewees included 9 counselors at 

SHIPs, 7 SHIP coordinators, and 14 counselors at other 

organizations. Among these organizations were local 

advocacy organizations that work with seniors and people 

with disabilities, independent living centers, a state 

pharmacy assistance program, and one regional office of 

a national organization. SHIP counselors included those 

who work directly for the SHIP at local state offices 

and others who work with Area Agencies on Aging or 

other organizations that receive SHIP funding. Three 

interviewees counseled only people with disabilities and 

two helped only beneficiaries over 65. The remaining 

counselors served beneficiaries of all ages. Two counselors 

did outreach with specific ethnic groups in languages 

other than English.

In each study, we explored the following questions:

• Why did beneficiaries choose to enroll or not enroll in 

Part D?

• How did they decide on specific plans? 

• What information sources did they use and was the 

information helpful to them?

In the following section, we consider the factors that lead 

individuals to decide whether to enroll in a Part D plan.

Choosing to enroll in the drug benefit

Beneficiaries have to consider many factors when deciding 

whether to enroll in Part D, but many report similar kinds 

of decisions. Most individuals who sign up for the drug 

benefit or are considering doing so report that saving 

money on current drug costs motivates them. Having 

another source of drug coverage is the most common 

reason beneficiaries give for not signing up. In general, 

beneficiaries who sign up for the benefit are more likely 

to use drugs on a regular basis than those who are not 

considering enrolling. 
Report to the Congress: Increasing the Value of Medicare | June 2006 185

Beneficiaries must go through a multistep process before 

they decide to enroll in a drug plan.

• Knowing about the benefit. Beneficiaries must first 

learn about the benefit and then decide whether they 

should enroll. Many beneficiaries already have drug 

coverage from former employers, the military, MA 

plans, and other sources. These individuals must 

decide whether their existing coverage is better for 

them than enrolling in a stand-alone Part D plan. This 

is an important step because beneficiaries who enroll 

in a Part D plan while having other coverage could 

discover that they have been involuntarily disenrolled 

from their retiree health plan or MA plan. 

• Accepting auto-assignment. Beneficiaries who had 

Medicaid drug coverage in 2005 received notices autoassigning them to Part D plans. They have to decide 

whether to remain in the plan they are randomly 

assigned to or choose a different plan that better meets 

their needs. Similarly, beneficiaries enrolled in MA 

plans have to decide whether to receive drug coverage 

through their plan or choose a different option. 

• Applying for extra help. Beneficiaries with limited 

incomes have to decide whether to apply for extra help 

from Medicare. 

• Signing up for the benefit. If beneficiaries do not 

have another source of drug coverage that is at least as 

good as the Part D standard benefit, they must decide 

whether to sign up for the drug benefit and choose a 

specific plan. 

Knowing about the benefit

In both our survey and focus groups, we asked 

interviewees about their experiences at each step of this 

process. We found that most beneficiaries knew about 

the drug benefit. About 88 percent of beneficiaries 

participating in our survey reported that they were aware 

of the drug benefit.1

 While we only selected for our focus 

groups beneficiaries who knew about the benefit, their 

knowledge of specific aspects of the benefit varied. Some 

had a basic understanding of the benefit structure, while 

others knew only that a new benefit was available.

We did not explore survey respondents’ knowledge of 

the details of the benefit, but we did ask focus group 

participants about the benefit structure. Beneficiaries 

were generally aware that different plans have different 

coverage levels for different drugs. Some were aware of 

the coverage gap but many did not seem to understand 

how it worked. Most beneficiaries were aware that there 

was a penalty connected to not enrolling in a drug plan, 

but few understood how the penalty worked or why it 

was established. SHIP counselors also reported that 

beneficiaries were confused about these issues; some 

individuals believed that they would be charged a penalty 

for not enrolling at all (the text box on page 186 provides 

more detail on the late enrollment penalty).

Many family members who were helping an elderly 

relative to enroll were not noticeably better informed 

about the benefit than the Medicare beneficiaries in our 

focus groups. They reported that they were having trouble 

finding the time to make sense of the options. 

Accepting auto-assignment

Just over a quarter of beneficiaries (26 percent) without 

alternate credible drug coverage reported that they had 

received an auto-assignment letter. This group included 

dual eligibles and beneficiaries enrolled in MA plans in 

2005. Of these respondents, more than half (15 percent of 

beneficiaries) said they planned to stay with the assigned 

plan. Almost a third of those receiving the letter (8 percent 

of beneficiaries) chose a different plan. The others had 

not yet made a decision. None of the beneficiaries in our 

focus groups who were dually eligible for Medicare and 

Medicaid chose a different plan from their assigned one. 

Additionally, all of the beneficiaries in our focus groups 

who belonged to MA plans before 2006 chose to receive 

their drug benefit through their health plan.

Applying for extra help

About 10 percent of survey respondents applied for extra 

help from the low-income subsidy. At the time of the 

survey, one-third of these individuals (3 percent) were 

approved. SHIP counselors reported that they saw a 

relatively small number of beneficiaries who seemed to 

qualify for the subsidy. If they thought that a beneficiary 

might be eligible, the counselors helped them with the 

application.

Signing up for the benefit

Of those beneficiaries who knew about the benefit and 

did not have employer-sponsored coverage, 30 percent 

reported that they had signed up for a plan and 16 percent 

were considering doing so (Figure 8-1, p. 187). About 

34 percent of survey respondents said they did not plan 

to sign up for the benefit. Although beneficiaries with 

ESI were not asked this question, almost half of those 

beneficiaries who were not considering the benefit 
186 How beneficiaries learned about the drug benefit and made plan choices

reported that the primary reason was because they had 

other sources of drug coverage. As noted above, about 15 

percent of respondents chose to remain in plans to which 

they were auto-assigned. 

Most survey respondents (93 percent) who signed up 

or were considering doing so said that saving money on 

current drug costs and protecting themselves against future 

costs were important reasons to sign up for the new benefit. 

Nearly three-quarters of beneficiaries also said avoiding 

the late enrollment penalty and being able to buy drugs 

they could not afford before were important (Table 8-1).

In contrast, beneficiaries in our focus groups seemed less 

concerned about insuring themselves against the cost 

of future drugs. Instead they focused on whether Part D 

would cover their current drugs and save them money. 

Survey results also indicate that beneficiaries with few 

current drug expenses were less likely to sign up for the 

drug benefit than those with higher expenses, casting 

some doubt on the importance they attached to protecting 

themselves against future costs (Table 8-2, p. 188).

Survey respondents were asked the primary reason why 

they decided not to sign up for the drug benefit. The most 

common reason cited was that they had another source 

of drug coverage (45 percent) even though beneficiaries 

with ESI were not asked this question. Other beneficiaries 

reported that they did not have many prescriptions or that 

they did not think the benefit would save them money 

(Figure 8-2, p. 189). About 5 percent of beneficiaries 

reported that they did not sign up because they found the 

choices too confusing. Note that beneficiaries could only 

list their primary reason for not signing up for plans and 

that other factors may have been of secondary importance.

In general, beneficiaries who have not signed up for 

the benefit are less likely to use prescription drugs on a 

regular basis than those who have signed up (Table 8-2, 

p. 188). Indeed, 52 percent of beneficiaries who are not 

considering signing up for a drug plan report that they take 

two or fewer drugs on a regular basis. They also spend less 

money for their drugs, with almost 50 percent reporting 

that they spend less than $20 per month. 

Beneficiaries in our focus groups who were not 

considering signing up for Part D also generally reported 

that they had few prescriptions. Participants with few 

prescriptions who did sign up or were considering doing 

so often cited concern about the penalty they would face 

if they signed up later as the motivating factor. SHIP 

counselors also said that the main reasons beneficiaries 

The late enrollment penalty

I

n order to encourage broad initial enrollment in 

the drug benefit, Part D includes a penalty for late 

enrollment similar to that of Part B. Policymakers 

intended the penalty to ensure that healthy as well 

as sick beneficiaries would enroll in plans and 

create a broader risk pool. However, many Medicare 

beneficiaries may not be aware of or understand that 

provision. As in the case of Part B, beneficiaries who 

later sign up for the benefit are assessed a penalty for 

each month they waited to enroll. Thus, the penalty 

increases each month that the beneficiary delays 

enrollment following their initial enrollment period. 

Once beneficiaries sign up for Part D, the accumulated 

penalty is added to their monthly premiums throughout 

their lifetime. Those with drug coverage equal to or 

better than the standard Part D benefit, for example 

those with most employer-sponsored retiree coverage, 

are not charged the penalty if their coverage ends and 

they enroll in Part D at their earliest opportunity. 

Beneficiaries may find that the initial late enrollment 

penalty—between $2 and $3 per month for those 

who postpone signing up until 2007—may be low 

enough to be worth delaying enrollment until they 

know more about the program. The penalty is tied to 

the national average premium. It is meant to reflect an 

actuarial assessment of the spending of late-enrolling 

beneficiaries, who may sign up when their need for 

medications increases, relative to the spending of the 

average enrollee. Previously the Commission suggested 

that CMS move as quickly as possible to determine 

whether the penalty amount fairly reflects any higher 

costs associated with delaying enrollment (MedPAC 

2004). We also suggested that CMS inform Medicare 

beneficiaries of the penalty and how it could affect their 

premiums if individuals delay enrollment. Report to the Congress: Increasing the Value of Medicare | June 2006 187

chose not to enroll were that they did not have high drug 

costs, did not believe the benefit would save money, 

or found the program too confusing. In some regions, 

counselors reported that beneficiaries were wary of drug 

plans after their experience with the pull-out of many 

Medicare+Choice health plans in their area in the period 

from 1999 to 2001.

Choosing a plan

Most beneficiaries did research and made decisions about 

signing up for a Part D plan themselves. Consistent with 

other research, beneficiaries had difficulty deciding what 

they considered most important in a drug plan.2

 Most 

beneficiaries listed drug costs, premiums, drug coverage, 

and company reputation as critical factors in making 

their choices. We can not tell from the survey which 

of these reasons was most important to beneficiaries. 

Although many individuals took a lot of time considering 

their choices, a much smaller number used the Medicare 

website or 1-800-Medicare to help them with their 

decision. Beneficiaries were most likely to seek help from 

family, friends, and insurance agents. 

How beneficiaries made their decision

Over two-thirds of survey respondents (68 percent) said 

they researched and made the decision about whether to 

sign up without assistance from another person. However, 

those who signed up were more likely to have had help 

than those who were not considering enrollment. In fact, 

FIGURE

8–1 Have you signed up for a drug plan 

or are you considering signing up 

for a drug plan?

Note: Data are for respondents who were aware of the benefi t and did not 

have employer-sponsored insurance, TRICARE, or Department of Veterans 

Affairs coverage (N=759).

Source: MedPAC-sponsored benefi ciary survey conducted by the National 

Opinion Research Center (NORC) at the University of Chicago and 

Georgetown University, February–March 2006.

16%

Considering

34%

Not

considering

15%

Accepted

auto-assignment

5%

Do not know

30%

Have

signed up

TABLE

8–1 When you decided to sign up for the new program, 

how important were each of the following reasons?

Reason for signing up

Respondents who thought reason

 was important or very important

Have signed up

for a drug plan

Are considering 

signing up Total

Protecting yourself in case your drug costs go up in the future 91% 97% 93%

Saving money on drug costs 91 95 93

Avoiding a penalty for enrolling later in the program 68 78 72

Being able to buy drugs that you could not afford before 66 78 71

Note: Data are for respondents without employer-sponsored insurance, TRICARE, or Department of Veterans Affairs coverage who did not receive an auto-assignment 

letter (N=264).

Source: MedPAC-sponsored benefi ciary survey conducted by the National Opinion Research Center (NORC) at the University of Chicago and Georgetown University, 

February–March 2006.
188 How beneficiaries learned about the drug benefit and made plan choices

50 percent of those who said they had enrolled in a plan 

had help compared to 23 percent of those who decided not 

to enroll. Twenty-seven percent of beneficiaries who were 

considering enrollment said they have had help. 

About half of those who said they had assistance making 

their decision turned to a family member or friend (49 

percent). Insurance agents (17 percent) and health plans 

(8 percent) were the next most common sources of help. 

Relatively few beneficiaries reported they received help 

from a doctor (1 percent), pharmacist (3 percent), or 

counselor (6 percent) (Figure 8-3, p. 190).

Picking a drug plan

At least 90 percent of beneficiaries who enrolled or 

were considering enrolling in a plan cited financial 

considerations—such as how much plans charged for 

copays and premiums, whether particular drugs were 

covered, and overall savings—as important reasons 

for choosing a particular plan (Table 8-3, p. 191). The 

reputation of the company offering the drug plan was 

also considered important by 90 percent of beneficiaries. 

Beneficiaries believed that being able to use their current 

pharmacy was slightly less important (84 percent), 

followed by whether the plan had a deductible (77 percent) 

and provided extra coverage for doctor visits (63 percent).3

Beneficiaries in our focus groups also thought that cost 

and coverage of their drugs were the most important 

factors. They also stressed the reputation of the plan 

and were wary of companies with unfamiliar names. 

Additionally, they wanted to be able to use their 

neighborhood pharmacy. Some beneficiaries considered 

plan customer service a determining factor. For example, 

one participant contacted representatives of each plan and 

eliminated any plan that did not respond promptly and 

clearly to his questions.

TABLE

8–2 Beneficiaries who use few drugs are less likely to enroll in a drug plan

Question

Respondents who:

Total

Have signed up

for a drug plan

Are considering 

signing up

Are not 

considering

 signing up

How many different drugs do you take on a regular 

basis?

0 5% 15% 20% 12%

1–2 18 31 32 28

3–5 42 36 36 26

6–10 18 11 12 17

11+ 7 6 4 5

Before you signed up for a drug plan (if you signed 

up for a plan) what did you pay on a monthly basis 

for your drugs?

Took no drugs on a regular basis 5 15 20 12

Under $20 per month 10 9 28 20

Over $20 but under $50 per month 19 13 21 19

Over $50 but under $100 per month 18 18 13 16

Over $100 but under $200 per month 20 18 6 14

Over $200 but under $300 per month 10 8 2 6

Over $300 per month 11 15 3 8

Note: Data are for respondents without employer-sponsored insurance, TRICARE, or Department of Veterans Affairs coverage who did not receive an auto-assignment 

letter: Respondents who have signed up for the drug benefi t (N=229), respondents who are considering signing up (N=119), respondents who are not considering 

signing up (N=260), and total (N=608). Columns do not sum to 100 percent because they omit respondents who answered ‘Do not know’ or refused to answer 

the question.

Source: MedPAC-sponsored benefi ciary survey conducted by the National Opinion Research Center (NORC) at the University of Chicago and Georgetown University, 

February–March 2006.
Report to the Congress: Increasing the Value of Medicare | June 2006 189

tool, some counselors questioned its accuracy and tried 

to confirm information with plans before they advised 

beneficiaries about specific choices. Interviewees reported 

that CMS conference calls were very useful. Many 

counselors reported that CMS regional offices have been 

a particularly good resource when they have had to help 

beneficiaries with Part D transition problems. Counselors 

also received useful information from nongovernmental 

sources like the Health Assistance Partnership, the 

Patient Advocate Foundation, and the Access to Benefits 

Coalition. Local groups like senior centers and beneficiary 

advocate groups also received information from state 

SHIPs. 

A little more than half of survey respondents who picked a 

plan or are considering doing so tried to find out whether 

the specific drugs they were taking were covered by the 

plan. Focus group participants described calling plan 

customer service lines to ask whether their medications 

were offered by the plan. Many reported difficulty getting 

answers from this source.

Using Medicare sources

Only 19 percent of beneficiaries in our survey without 

ESI reported that they or the person who was helping 

them called 1-800-Medicare, and only 11 percent used the 

website, although we can not be sure that beneficiaries 

were fully aware of all of the sources being used by 

those who helped them.4

 Only 6 percent of beneficiaries 

reported that they had consulted a counselor (Figure 8-3, 

p. 190). None of the beneficiaries in our focus groups had 

met with a counselor.

We asked beneficiaries who had called 1-800-Medicare 

or used www.medicare.gov how helpful they found those 

resources (Figure 8-4, p. 191). About three-fifths of those 

who used them found the information helpful; two-fifths 

did not. 

Although we did not ask about use of the Medicare 

handbook—Medicare & You—in our survey, many focus 

group participants reported that they had read about the 

drug benefit in the handbook. It was an important source 

of information for many of them, although some reported 

that they found it confusing and too “legalistic.” One 

woman reported that she studied the handbook for several 

days, then used the information to contact possible plans 

and request information. Others also mentioned that they 

had used the handbook to find out what plans were offered 

in their area, then contacted the plans directly.

In general, few focus group participants said they had 

used web-based tools or counselors to help them make 

decisions. They were more likely to mention company plan 

descriptions they received in the mail, phone calls to plans, 

and conversations with plan representatives at special 

events. While some indicated that they talked to their 

doctors and pharmacists, they did not report getting much 

information from this approach. More family members 

noted that they had used the Medicare website but those 

numbers were also small.

In contrast to beneficiaries, SHIP counselors got most of 

their information from CMS. They used the website daily 

in their work. Although they agreed that it was a good 

FIGURE

8–2 What was the primary reason that 

you decided not to sign up 

for a drug plan?

Note: Numbers may not sum to 100 percent due to rounding. Data are for 

respondents who were aware of the benefi t; did not have employersponsored insurance, TRICARE, or Department of Veterans Affairs 

coverage; and were not considering signing up for a drug plan (N=260).

Source: MedPAC-sponsored benefi ciary survey conducted by the National 

Opinion Research Center (NORC) at the University of Chicago and 

Georgetown University, February–March 2006.

g p

45%

Already have

drug coverage

5%

Choices

too

confusing

20%

Do not have

many

prescriptions

9%

Other

1%

Could not find a

 plan that covers

drugs you take

4%

Monthly

premium

too high

4%

Do not know

enough

about it

12%

Do not think

it will

save money
190 How beneficiaries learned about the drug benefit and made plan choices

Although they agreed that it was beneficiaries with 

problems who contacted them, counselors had a negative 

impression of the Medicare help line. Beneficiaries 

told them that they were not able to get through or 

that they could not get their questions answered. One 

SHIP counselor reported that the call center referred all 

questions to the local SHIPs.

The beneficiary counselor perspective

SHIP and other beneficiary counselors have a unique 

perspective on how Part D was implemented. Although 

they provide individual counseling to only a small 

percentage of beneficiaries, they have the most in-depth 

view of beneficiary decision making and are most likely to 

see individuals who experience difficulty making a choice 

or using the drug benefit. In this section, the Commission 

reports on some of the issues raised by SHIP counselors. 

Although state SHIP organizations vary greatly in terms 

of resources, organizational capacity, and the demographic 

character of the populations they served, many common 

themes emerged in the interviews. 

Beneficiary use of counseling services

SHIPs are state-based organizations that receive federal 

funds to provide information and counseling about 

insurance issues to Medicare beneficiaries.5

 The MMA 

increased federal funding for the SHIP program from 

$12.5 million in 2003 to $21.1 million in 2004 and $31.7 

million in 2005. For fiscal year 2006, CMS has allocated 

$32.7 million (CMS 2006b).

In addition, many other groups have been involved in 

providing information to beneficiaries about the drug 

benefit. These groups include senior centers, retirement 

communities, and beneficiary advocacy groups. Groups 

that address the needs of individuals with specific diseases 

or disabilities also provide information on drug plans to 

their constituencies. SHIP counselors say they are pleased 

about the increased resources available to beneficiaries 

through these organizations, but some complained about 

the lack of coordination among groups.

The number of beneficiaries seeking help from SHIPs 

and other groups has increased significantly. Counselors 

consistently reported that their offices did not have the 

resources needed to meet the high volume of calls they 

received, particularly in November and December 2005. 

One office that reported an average of 800 calls each 

month received 1,500 calls in November. Another SHIP 

reported an increase in calls from 3,000 a month to more 

than 30,000 in November and December. In the past year, 

SHIP counselors have provided individual counseling on 

the drug benefit to 4.2 million beneficiaries (CMS 2006a). 

Call volume has declined since the first few weeks of 

January, but remains much higher than in previous years. 

SHIP offices reported that they lack the resources 

necessary to support the volume of requests for assistance: 

Their voice mail systems are full and they can not return 

calls immediately. In early February, one local SHIP 

coordinator said her volunteers were still returning calls 

from December. Another reported that her office needed 

to return between 500 and 800 calls. In addition, many 

counselors have focused on resolving transition problems 

FIGURE

8–3 If you had help, who was 

the main person who helped

 you make a decision about 

signing up for a drug plan?

Note: Numbers may not sum to 100 percent due to rounding. Data are for 

respondents who had help making a decision (N=179).

Source: MedPAC-sponsored benefi ciary survey conducted by the National 

Opinion Research Center (NORC) at the University of Chicago and 

Georgetown University, February–March 2006.

49%

Family member

or friend

17%

Insurance

agent

3%

Nursing 

home/

senior 

housing

2%

Employer/

union

8%

Plan

3%

Pharmacist

8%

Other

1%

Doctor

6%

Counselor
Report to the Congress: Increasing the Value of Medicare | June 2006 191

for individuals who have enrolled in plans and therefore 

had less time to continue education and outreach programs 

for beneficiaries who had not enrolled in Part D. Some 

interviewees mentioned that they expected to see another 

increase in beneficiaries looking for advice before the end 

of the first enrollment period. 

Counseling beneficiaries

SHIPs have had to extend their counseling services to 

more Medicare beneficiaries because of Part D. For 

example, they are serving more disabled beneficiaries 

under 65 than they previously served. This is particularly 

true for SHIP organizations that are part of state offices 

on aging. They are also receiving more calls from dual 

eligibles and family members of dual eligibles. These are 

not populations that traditionally seek assistance 

from SHIPs.

SHIPs and other groups offer their own meetings and 

seminars on Part D and give presentations at events 

sponsored by other local organizations. Counselors say 

that they speak with many beneficiaries who have attended 

multiple presentations before requesting assistance to 

select and enroll in a plan. There is so much information to 

present at events that beneficiaries often get overwhelmed. 

One counselor said that if several counselors are available 

at a presentation, she separates the attendees by their 

needs—for instance, people with retiree coverage, people 

TABLE

8–3 How important are each of the following reasons in picking a plan?

Reason for picking a plan

Respondents who thought reason

 was important or very important

Have signed up

for a drug plan

Are considering 

signing up Total

How much the plan charges you for each prescription 93% 98% 95%

How much the plan charges for monthly premiums 88 99 92

Whether the plan covers the drugs you currently take 92 91 92

How much money you will save on your prescriptions overall 89 90 90

The reputation of the company offering the drug plan 89 91 90

Whether you can continue going to the pharmacy you prefer 85 82 84

Whether the plan has a deductible 75 79 77

Getting extra coverage for doctor visits 55 77 63

Signing up with the same company as your spouse 39 49 42

Note: Data are for respondents who did not receive an auto-assignment letter and signed up or are considering signing up for a drug plan (N=264).

Source: MedPAC-sponsored benefi ciary survey conducted by the National Opinion Research Center (NORC) at the University of Chicago and Georgetown University, 

February–March 2006.

FIGURE

8–4 How helpful was the

 information provided by...?

Note: Data are for respondents who used 1–800–Medicare (N=115) or 

www.medicare.gov (N=65).

Source: MedPAC-sponsored benefi ciary survey conducted by the National 

Opinion Research Center (NORC) at the University of Chicago and 

Georgetown University, February–March 2006.

Percent of respondents

45

25

15

5

35

40

30

20

10

0

Very 

helpful

1–800–Medicare

www.medicare.gov

Helpful Not very

helpful

Not at all

helpful
192 How beneficiaries learned about the drug benefit and made plan choices

with Medicaid, and people without coverage—so that they 

receive only the information that applies to them.

Counselors believe that their efforts are most successful 

when they are able to provide information to beneficiaries 

in a series of encounters. Counseling sessions may take as 

long as two hours. Several counselors described a typical 

scenario. First, a counselor provides basic information 

to a group of beneficiaries at a senior center or other 

facility. Next, beneficiaries visit or phone a SHIP office 

for individual help. Using beneficiary information and the 

Medicare website, the counselor provides the beneficiaries 

with descriptions of three plans that would best suit their 

needs. After the beneficiaries have had a chance to study 

the materials, the counselor may help them enroll in a 

plan. 

If beneficiaries might be eligible for additional assistance 

due to their limited incomes, the counselors help them fill 

out the necessary forms. They also give them information 

on other programs that may be available (e.g., the 

Medicare savings programs).6

 To date, most counselors 

have reported that, except for dual eligibles, the population 

eligible for the low-income subsidy has been difficult to 

reach.

The beneficiaries who contact SHIPs are confused by 

the number of plan choices, the variation in benefit 

structure, how to apply for extra help, the coverage gap, 

and the penalty for late enrollment. Counselors note that 

TABLE

8–4 Choosing a drug plan was time consuming but the majority

 of beneficiaries had enough information to make a decision

Survey question

Respondents who:

Total

Have signed up

for a drug plan

Are considering 

signing up

Are not considering 

signing up

Was the overall information you had 

available for making your decision too much, 

too little, or about right?

Too much 32% 20% 21% 25%

Too little 12 30 15 17

About right 53 42 55 51

Do not know/Refused 4 8 10 6

Overall, how diffi cult did you fi nd it to choose 

(or not choose) a plan?

Not at all diffi cult 28 13 50 35

Not very diffi cult 28 19 19 22

Diffi cult 22 34 11 20

Very diffi cult 19 31 17 20

Do not know 2 3 3 2

About how much time have you spent making 

a decision about signing up?

Less than an hour 18 12 49 30

More than an hour, but less than 8 hours 27 40 31 31

8 hours or more 51 44 15 34

Do not know 3 4 4 4

Note: Numbers may not sum to 100 percent due to rounding. Data are for respondents without employer-sponsored insurance, TRICARE, or Department of Veterans 

Affairs coverage who did not accept an auto-assignment letter: Respondents who have signed up for the drug benefi t (N=229), respondents who are considering 

signing up (N=119), respondents who are not considering signing up (N=260), total (N=607).

Source: MedPAC-sponsored benefi ciary survey conducted by the National Opinion Research Center (NORC) at the University of Chicago and Georgetown University, 

February–March 2006.
Report to the Congress: Increasing the Value of Medicare | June 2006 193

because of the nature of their work they only tend to see 

beneficiaries with problems.

Information and decision making

Beneficiaries in our survey who had to make a decision 

about Part D generally believed that they had enough 

information to decide whether to enroll in the drug benefit. 

Those who enrolled or were considering enrolling found 

it time consuming to make a decision. Both in our focus 

groups and counselor interviews, individuals suggested 

ways that Medicare could make it easier for beneficiaries 

to understand the benefit and choose a plan. 

About half (51 percent) of beneficiaries in our survey who 

had to make a decision thought the amount of information 

available to them was about right (Table 8-4). About half 

of those who have signed up or are considering doing so, 

however, have found the decision difficult. Those who 

have signed up were more likely to say they had too much 

information than too little; those who are still considering 

were more likely to say they had too little information.

Many beneficiaries found choosing a plan to be very time 

consuming. A majority of those who have already chosen 

a plan report that it took eight or more hours to make a 

decision (51 percent). Those who are still considering 

signing up are likely to have spent eight or more hours 

(44 percent), and 40 percent have already spent between 

one and eight hours. Beneficiaries not considering signing 

up tended to spend much less time on the decision; 49 

percent reported taking less than one hour to come to a 

decision. Our findings from both the survey and focus 

groups suggest that beneficiaries spent much of their time 

comparing information they had received from individual 

plans rather than using the resources provided by CMS.

In our focus groups, beneficiaries complained about the 

lack of comparability in the information they received 

from plans. Several wanted one document that compares 

plans in an apples-to-apples way. Others suggested a 

comparison chart or a simple checklist that clearly shows 

the prices and coverage of each plan or provides answers 

to frequently asked questions. Although the Medicare 

website provides this type of information, focus group 

participants wanted a hard copy. Some suggested that 

Medicare standardize the benefit packages that plans 

offer so that beneficiaries could more easily compare their 

options. Counselors were more likely to emphasize that 

plan offerings should be limited because beneficiaries 

were confused by the large number of plan choices. As 

noted in Chapter 7, CMS will limit the number of plans 

that an organization can offer in a region in 2007. Some 

policymakers have discussed a need for standardization of 

plan offerings. 

In future work, the Commission will continue to monitor 

whether beneficiaries are able to make informed choices 

about plan offerings. Other questions of interest include:

• Does beneficiary age, gender, or income affect 

decision making?

• Are there examples of programs that have had 

particular success educating and enrolling the types of 

beneficiaries eligible for the low-income subsidy? 194 How beneficiaries learned about the drug benefit and made plan choices

1 Survey participants who did not know about the drug benefit 

were not asked any additional questions.

2 There is a large body of research analyzing differences in the 

way elderly populations make choices compared to younger 

populations. See, for example, research by Sing and Stevens 

(2005), Hibbard and colleagues (2001), and Hibbard and 

colleagues (1998).

3 This question refers to whether a beneficiary considered 

joining an MA plan and receiving coverage for other services 

along with the Part D drug benefit.

4 These numbers are not included in tables presented in this 

chapter.

5 The program was authorized in 1990 as part of the legislation 

that standardized Medicare supplemental policies. SHIP 

resources vary considerably from state to state. Some SHIP 

programs are well funded and supplement their staff through 

a large base of volunteer counselors in a wide variety of field 

locations. All provide one-on-one counseling to beneficiaries 

through outreach meetings with beneficiary groups, office 

visits, and phone calls.

6 These are programs that provide help with Medicare 

premiums and, sometimes, cost sharing to beneficiaries 

with incomes that exceed state requirements for Medicaid 

but are below a set percent of poverty and meet an asset test 

(MedPAC 2005). See Chapter 9 for additional details.

Endnotes
Report to the Congress: Increasing the Value of Medicare | June 2006 195

Centers for Medicare & Medicaid Services, Department of Health 

and Human Services. 2006. Medicare announces funding for 

health insurance counseling program for 2006. Press release, 

April 5. Washington, DC: CMS.

Centers for Medicare & Medicaid Services, Department of 

Health and Human Services. 2006b. CMS FY 2006 program 

management appropriation.

Hibbard, J., P. Slovic, E. Peters, et al. 2001. Is the informed-choice 

policy approach appropriate for Medicare beneficiaries? Health 

Affairs 20, no. 3 (May/June): 199–203.

Hibbard, J., J. Jewett, S. Engelmann, et al. 1998. Can Medicare 

beneficiaries make informed choices? Health Affairs 17, no. 6 

(November/December): 181–193.

Justice, Diane. 2005. Beneficiary information and decision 

supports for the Medicare-endorsed prescription drug discount 

card (RL3828). Washington, DC: Congressional Research 

Service.

Kelly, C., Centers for Medicare & Medicaid Services, Department 

of Health and Human Services. 2006. E-mail communication 

with author, May 4.

Medicare Payment Advisory Commission. 2005. Report to 

the Congress: Issues in a modernized Medicare program.

Washington, DC: MedPAC.

Medicare Payment Advisory Commission. 2004. Report to 

the Congress: New approaches in Medicare. Washington, DC:

MedPAC.

Sing, M., and B. Stevens. 2005. The value of experience: 

Differences in knowledge among Medicare beneficiaries. Inquiry

42, no. 3 (Fall): 266–280.

Wright, S. 2006. Early implementation of MMA: Status report 

of the State Health Insurance Assistance Programs (OEI–05–

05–00190). Washington, DC: Office of Inspector General, 

Department of Health and Human Services. 

References

The Medicare Advantage 

program: Availability, benefits, 

and special needs plans

CHAPTER 9

Report to the Congress: Increasing the Value of Medicare | June 2006 199

Chapter summary

This year brings several important changes for the Medicare Advantage 

(MA) program. First, Medicare payments to plans are determined 

differently. Plans now submit formal bids, then CMS compares the 

bids with benchmarks to determine payment. Also, the Medicare 

Prescription Drug, Improvement, and Modernization Act of 2003 

(MMA) allows new plan types, including regional preferred provider 

organizations (PPOs) that are required to serve entire regions. Another 

change is the introduction of Medicare’s Part D prescription drug 

benefit. MA plans usually include the Part D benefit and receive a 

separate payment for providing it. These changes and the introduction 

of stand-alone prescription drug plans to the marketplace affect the 

competitive environment for MA plans.

Medicare beneficiaries have more MA plans to choose from in 2006, 

and almost all beneficiaries have access to plans. In 2006, nearly 100 

percent of beneficiaries will have MA plans available to them, up from 

84 percent of beneficiaries in 2005. Overall, an average of 12 MA 

plans are offered in each county, ranging to as high as 63. Half of all 

In this chapter

• Medicare Advantage plans 

available for 2006

• Special needs plans

The Medicare Advantage 

program: Availability, benefits, 

and special needs plans

9 C H A P T E R 
200 The Medicare Advantage program: Availability, benefits, and special needs plans

beneficiaries are able to choose from among 16 or more MA plans, and 5 

percent of beneficiaries are able to choose from over 40 plans. The increase 

is due to the participation of new plans and to the expansion of service areas 

by existing plans.

Regional PPOs are available to 88 percent of beneficiaries. While expanding 

choices, their availability does not appreciably increase beneficiaries’ access 

to MA plans; 99 percent of beneficiaries have access to local MA plans. 

About 95 percent of plans bid under their benchmarks, thus almost all plans 

had funds to rebate in the form of lower Medicare cost sharing, lower Part 

B or Part D premiums, or non-Medicare supplemental benefits. As a result, 

for example, zero-premium MA plans—plans that charge no premium in 

addition to the Part B premium—are available to 84 percent of Medicare 

beneficiaries in 2006, up from about 58 percent of beneficiaries in 2005. 

Almost 70 percent of beneficiaries have access to zero-premium MA plans 

that also include the Part D benefit. Health maintenance organizations 

(HMOs) tended to bid further below the benchmarks than other types of 

plans and thus had larger rebates and greater ability to offer enhanced 

benefits.

Virtually all Medicare beneficiaries have an available MA plan, regardless 

of whether they live in urban or rural areas. However, urban beneficiaries are 

much more likely to have local HMOs and local PPOs available than those in 

rural areas while private fee-for-service (PFFS) plans are much more likely 

to be available in rural areas. Because local HMOs and local PPOs tended to 

bid further below the benchmarks and thus had more rebate dollars to return 

to beneficiaries than regional PPOs or PFFS plans, additional benefits are 

more widely available in urban areas than in rural areas.

In future work, we will examine some of the broader questions about the 

value of private plans to the Medicare program. Such questions may focus on 

quality, efficiency, and payment issues.
Report to the Congress: Increasing the Value of Medicare | June 2006 201

Special needs plans 

The Congress created special needs plans (SNPs) to provide a common 

framework for many of the existing plans for special needs beneficiaries 

and to expand beneficiaries’ access to and choice among MA plans. These 

special plans include Social Health Maintenance Organizations, Evercare, 

and various demonstration plans.

2006 marked a significant increase in the number of SNPs available to 

beneficiaries. In 2004, there were just 11 SNPs. By 2005, that number had 

grown to 125. In 2006, the total number of SNPs has more than doubled 

to 276. Organizations with experience partnering with Medicaid and 

serving special needs populations entered the SNP market, but so did MA 

organizations with little or no experience serving these populations.

The Commission has sought creative ways to deliver high-quality health 

care to special needs beneficiaries, particularly dual eligibles. The policy 

and practical issues we described in the June 2004 report on dual-eligible 

beneficiaries might be addressed through special needs plans (MedPAC 

2004b). Theoretically, SNPs may improve care coordination for dual eligibles 

and other special needs beneficiaries through unique benefit design and 

delivery systems.

However, we are concerned that many SNPs are not designed to better 

coordinate care for special needs beneficiaries. SNPs, even dual-eligible 

SNPs, are not required to contract with states to provide Medicaid benefits, 

and many appear not to do so. SNPs that do not integrate Medicare and 

Medicaid services may not coordinate the two programs. Report to the Congress: Increasing the Value of Medicare | June 2006 203

The Medicare Advantage (MA) program allows Medicare 

beneficiaries to receive their Medicare benefits from 

private plans rather than from the traditional fee-forservice (FFS) program. There are several important 

changes for the MA program in 2006. First, Medicare 

payments to plans are determined differently. CMS 

no longer determines MA plan payments based solely 

on administratively set payment rates. Plans now 

submit formal bids, then CMS compares the bids with 

benchmarks (derived from the old rates) to determine 

payment (see text box on page 204). Also, the Medicare 

Prescription Drug, Improvement, and Modernization Act 

of 2003 (MMA) allows new plan types, including regional 

preferred provider organizations (PPOs) that are required 

to serve entire regions rather than the local plan service 

areas, which can be limited to a single county.1

Another key change relates to the introduction of 

Medicare’s Part D prescription drug benefit. Organizations 

that sponsor MA plans must include the Part D benefit, 

or an actuarially equivalent or enhanced drug benefit, in 

at least one of their plan offerings. (In the Commission’s 

terminology, a “plan” is a specific set of benefits offered 

in a specific service area by a sponsoring organization. 

A sponsoring organization can offer multiple plans in 

an area.) Past studies have shown that the availability of 

prescription drug benefits in many MA plans attracted 

significant enrollment. Medicare now makes separate 

Part D payments to the MA plans that include the Part D 

benefits—Medicare Advantage–Prescription Drug plans 

(MA–PDs)—as if they were stand-alone prescription drug 

plans (PDPs). Because many MA plans already offered 

drug benefits without receiving Medicare reimbursement 

for them, the Part D payments represent a new stream of 

funding. Plans that offered drug benefits that did not reach 

the actuarial value of the Part D benefit were required 

to improve their drug coverage. Plans also had to meet 

new formulary and data requirements. Managing the full 

spectrum of care may allow some plans to operate more 

efficiently than stand-alone drug plans. 

This chapter discusses the competitive environment 

for MA plans, the range of plan types included in the 

MA program, plan bidding, and the range of MA plan 

offerings. The chapter concludes with a special focus on 

MA special needs plans (SNPs).

Medicare Advantage plans available for 

2006

Medicare beneficiaries will have more MA plans to 

choose from in 2006 than in previous years, and almost 

all beneficiaries have access to plans. Many of those 

plans will have low premiums and enhanced benefits not 

available in the Medicare FFS package. 

Features of available plan types

For this chapter, we distinguish four available plan types: 

local health maintenance organizations (HMOs), local 

PPOs, regional PPOs, and private fee-for-service (PFFS) 

plans.2

 These plans are available to most Medicare 

beneficiaries. In general:

• HMOs have comprehensive provider networks 

and members must use network providers in all 

nonemergency situations.

• PPOs have comprehensive networks, but members 

may use out-of-network providers if they pay higher 

cost sharing.

• PFFS plans are not required to have any networks and 

members may go to any willing Medicare provider.

In practice, some of the distinctions between the plan types 

may be blurred, as illustrated by a few examples. An HMO 

that has an out-of-network option may look much like a 

PPO. A local PPO could cover an entire region, making 

it resemble a regional PPO. And a PFFS plan may have 

a network that would make it hard to distinguish from a 

PPO. 

SNPs are other plan types with restrictions on beneficiary 

enrollment. They will be discussed in detail in a later 

section of this chapter and will be excluded from most 

quantitative analyses in this section because of their 

special nature. Enrollment in SNPs may be limited to 

beneficiaries with Medicaid eligibility, beneficiaries in 

long-term care institutions, or beneficiaries with certain 

chronic or disabling conditions. 

As there is a great deal of variation in plan attributes 

within each type of plan and because the lines between 

plan types are not always sharp, the statements about plan 

types should be seen as generalizations and may not apply 
204 The Medicare Advantage program: Availability, benefits, and special needs plans

to any individual plan. Some distinctions between the 

definitions of plan types are in law or regulation:

• Local HMOs with an out-of-network option may be 

very similar to local PPOs. The major difference is 

that HMOs are required to submit quality data for all 

services while PPOs must report some data only for 

services provided in-network. If a plan’s sponsoring 

organization does not have an HMO license in the 

relevant state,3

 CMS presumes the plan is a PPO and 

looser reporting requirements will apply.4

• The only difference in the definitions between 

regional PPOs and local PPOs is the service areas they 

choose to serve. 

• A PFFS plan may not be a regional plan and is not 

required to have a provider network if it pays providers 

at least Medicare FFS rates. 

What motivates plan sponsors (typically insurers) to offer, 

beneficiaries to enroll in, and providers to participate in 

different types of plans? Exploration of these dynamics 

Payments to plans based on benchmarks and bids

The benchmark is a bidding target. CMS sets 

local plan benchmarks for every county 

administratively, as directed by law. The 2006 

benchmarks are the 2005 Medicare Advantage (MA) 

county payment rates, updated by the projected national 

growth rate in per capita Medicare spending. If a local 

MA plan serves a multicounty area, the benchmark 

against which it bids is an average of the different 

benchmarks for the counties it serves, weighted by 

its projected enrollment from each county. In our 

June 2005 report to the Congress, the Commission 

recommended several changes to the benchmarks that 

would result in lowering the benchmarks to a level equal 

to Medicare’s fee-for-service costs (MedPAC 2005).

CMS determines the benchmarks for the MA regional 

preferred provider organizations (PPOs) by using a 

more complicated formula that incorporates the plan 

bids. The region’s county benchmarks are aggregated 

to produce a component of the regional benchmark. 

This component is averaged with the regional PPO bids 

to produce the final regional benchmark. The lower 

the regional PPOs bid, the lower the resulting regional 

benchmark. 

Every plan submits a separate set of bids to cover 

beneficiaries in each of its service areas. Each bid 

consists of up to three separate components:

• The bid for Medicare Part A and Part B benefits 

(except hospice). This portion of the bid must assume 

that the plan would collect the standard Medicare cost 

sharing from its enrollees. This bid is standardized to 

a nationally average beneficiary (a CMS risk factor 

of 1.0) enrolled in the plan’s service area.

• The bid for supplemental benefits (if any) that the 

plan covers. Supplemental benefits may include 

lower cost sharing on Medicare services, as well 

as benefits that fee-for-service Medicare does not 

cover.

• The bid for the Medicare Part D drug benefit (when 

offered).

CMS bases the Medicare Parts A and B payment for 

private plans on the relationship between their bids 

and the benchmarks. If a plan’s bid falls above the 

benchmark, then the plan receives the benchmark 

as its payment and the enrollees will have to pay 

an additional premium for Medicare Parts A and B 

that equals the difference between the bid and the 

benchmark. If the plan’s bid falls below the benchmark, 

the law defines the difference as the plan’s savings. The 

Medicare program retains 25 percent of the savings (if 

it is a regional plan, CMS places half of this 25 percent 

into the regional PPO stabilization fund), and the plan 

receives the other 75 percent of the savings as a rebate, 

in addition to its bid. The plan must return the rebate 

to its enrollees in the form of supplemental benefits 

or lower premiums. The plan can apply any premium 

savings to the Part B premium (in which case the 

government retains the amount for that use), to the Part 

D premium, or to the premium for the total package 

that may include supplemental benefits. Report to the Congress: Increasing the Value of Medicare | June 2006 205

may help explain plan availability and, eventually, plan 

enrollment.

Plan sponsor perceptions

When a plan sponsor decides whether to enter a market 

and what types of plans to offer, it examines the payment 

it would receive and the network construction required 

and assesses where it could offer plans that would appeal 

to beneficiaries. Plan sponsors perceive that different 

plan types have trade-offs, including Medicare payments, 

administrative costs of building and maintaining an 

appropriate provider network, and market competition. 

Plans face different requirements for network 

adequacy and quality data collection. HMOs require 

a comprehensive network. Local PPOs also require a 

comprehensive network, but members may go outside 

the network in exchange for higher cost sharing. Because 

establishing a comprehensive network across vast regions 

has presented such a difficult challenge to plans, CMS has 

chosen to make the regional PPO network requirements 

looser than the local PPO requirements. Regional PPOs 

are not required to have network providers in all locations. 

Instead, the plans must guarantee to find providers when 

members need care, pay the providers Medicare FFS rates, 

and charge members the in-network levels of cost sharing. 

This guarantee is different than the PFFS plans who only 

must guarantee that they will pay Medicare FFS rates to 

any provider that agrees to treat plan members. If a PFFS 

plan pays Medicare rates, it has no network requirements.

Generally, it is easier for plans to build networks in 

competitive urban markets. Providers in this type of 

market may sometimes be more willing to take lower rates 

in exchange for the promise of higher volume. In such 

markets, plans may be able to provide better benefits in 

plan types with tighter networks such as HMOs. In rural 

areas and other areas with low provider density, plans 

might only be able to offer looser network or non-network 

options.

The law has added financial incentives to encourage 

regional PPOs to participate in MA, including risk 

sharing for 2006 and 2007, and a regional stabilization 

fund that CMS may use to enhance the benchmarks only 

for regional PPOs bidding in regions that are having 

difficulty attracting plans. In addition, local PPO plans 

can not start in 2006 and 2007 (existing local PPOs can 

offer new products within the existing service area). This 

moratorium is intended to prompt private plans to consider 

participating as regional PPOs.5

Beneficiary perceptions

Many economists and health policy observers have 

concluded that beneficiaries see a trade-off between 

narrowing their choice of provider or submitting to more 

management in return for receiving a benefit package 

they perceive as having higher value. Plan sponsors may 

respond to these beneficiary trade-offs by marketing 

multiple products along the continuum to different subsets 

of beneficiaries. For example, studies have found that 

lower income (but not Medicare/Medicaid dual-eligible) 

beneficiaries are more likely to join MA HMOs than 

are higher income beneficiaries (Thorpe et al. 2002). 

Generally the lower out-of-pocket plans tend to appeal 

more to low-income beneficiaries and other beneficiaries 

who value lower cost sharing over expanded choice of 

providers. PPOs tend to appeal to those who want to have 

more flexibility in choice of providers. The regional PPOs 

and PFFS plans are more likely to appeal to those who 

want maximum choice of providers or those in rural or 

other low-competition areas that can not support more 

tightly managed options. Beneficiaries in those areas were 

previously likely to choose medigap. Bear in mind, these 

statements are generalizations; there is great variability in 

the benefits within each plan type and in the beneficiaries 

who choose them. For example, some of the PFFS plans 

for 2006 have generous benefits, such as low maximum 

out-of-pocket liability limits and zero-premium Part D 

benefits that could attract lower income beneficiaries.

Provider perceptions

Providers must also consider trade-offs when deciding 

whether to participate with a plan. The provider decides 

how much to give up in order to secure access to the plan’s 

members. In competitive market areas, HMOs usually pay 

less than Medicare FFS and may offer capitated rates but 

may promise volume. Participation in local PPOs may 

sometimes offer similar trade-offs. Plan sponsors may 

offer several types of plans and providers may decide to 

participate in one plan in order to be able to participate 

in another of the sponsors’ plans. In competitive areas, 

providers may feel pressure to give plans attractive terms 

or rates so that the providers can see plan members.

However, in less competitive areas, such as many rural 

areas, plans may have trouble attracting enough providers 

to guarantee an adequate network. The regional PPOs 

must have networks that cover entire states, so providers 
206 The Medicare Advantage program: Availability, benefits, and special needs plans

in less competitive areas of the state may have more 

leverage in negotiations with plans. In fact, regional PPOs 

may have been having trouble convincing providers to 

join their networks. Providers in sparsely populated areas 

could get FFS rates from regional PPOs even if they do 

not join because the plans are required to pay those rates 

where their network is incomplete. Further, regional PPO 

representatives have indicated to us that providers would 

not participate in order to discourage plan entry into their 

local areas. 

PFFS plans are not required to establish a network, as 

long as they pay providers at least FFS Medicare rates. 

Because there is no network requirement, providers do 

not need to decide whether to participate in a plan until a 

plan member requests service from the provider. As under 

FFS Medicare, in nonemergency situations the provider 

can decide whether or not to accept Medicare rates for 

that patient for that encounter. And as in FFS Medicare, 

providers can choose not to treat beneficiaries under these 

circumstances.

Implications for the Medicare program

The Commission wants to examine the value of the 

different plan types to the Medicare program. In 2006, 

beneficiaries in most plans likely cost the program more 

than they would if they were in FFS Medicare because 

the benchmarks are higher than FFS spending (MedPAC 

2005). The regional PPOs and the PFFS plans are probably 

more costly relative to Medicare FFS because they are 

likely to attract enrollees disproportionately from areas 

where the benchmarks are especially high relative to 

Medicare FFS spending. 

Different plan types may also have more or less potential 

to improve the quality of care for Medicare beneficiaries. 

HMOs are often regarded as having the most potential to 

improve care through coordination and following quality 

standards as their providers are typically accountable to 

the plan. PPOs have somewhat less potential because the 

providers are usually less accountable to the plan and in 

some cases the PPOs do not collect enough information on 

quality to judge their performance. Currently, PFFS plans 

have even less ability to influence providers because they 

rarely maintain networks. Some plan sponsors, however, 

have suggested that PFFS plans could provide coordination 

and management through disease management programs. 

Pay-for-performance systems may also work to improve 

care quality in plans with looser networks. We have no 

data on whether any PFFS plans use these management 

techniques.

Almost all Medicare beneficiaries have 

access to MA plans

In 2006, almost 100 percent of beneficiaries have MA 

plans available to them, an increase from 84 percent 

in 2005 and from 77 percent in 2004 (Table 9-1). 

Greater availability reflects growth in participation of 

coordinated care plans (CCPs)—HMOs or PPOs—and 

PFFS plans in the MA program.6

 In 2006, 80 percent of 

Medicare beneficiaries will have a local HMO or PPO 

plan operating in their counties of residence, up from 67 

percent in 2005 and from 61 percent in 2004. Previously, 

the highest availability of local CCPs (74 percent) 

occurred in 1998.

PFFS plan availability has also increased substantially in 

2006 to 80 percent of beneficiaries. In 2005, PFFS service 

areas included 45 percent of Medicare beneficiaries, up 

from 31 percent in 2004. In 2006, PFFS plans provide 

local plan access to almost all Medicare beneficiaries who 

TABLE

9–1 Percent of Medicare beneficiaries with access to MA plans, 2004–2006

Local plans

HMO or PPO PFFS Any local plan Regional PPO Any MA plan

2006 80% 80% 99% 88% 100%

2005 67 45 84 N/A 84

2004 61 31 77 N/A 77

Note: MA (Medicare Advantage), HMO (health maintenance organization), PPO (preferred provider organization), PFFS (private fee-for-service), N/A (not available).

Source: MedPAC analysis of CMS Landscape Tool, October 2005.
Report to the Congress: Increasing the Value of Medicare | June 2006 207

do not have access to a local HMO or PPO. Overall, 

99 percent of beneficiaries have a local plan available 

in 2006.

Regional plan availability

Regional PPO plans—which must cover entire state-based 

regions—are new in 2006. All plans that are not regional 

are considered “local,” meaning that they define their own 

county-based local service areas. Regional PPOs must 

have PPO-like networks, which may sometimes be looser 

than the ones required of local PPOs. 

CMS established 26 bidding regions for regional PPOs. 

No plans bid in 5 of the regions, but CMS approved bids 

for 71 plans in the other 21 regions. Beneficiaries in 

Florida have six regional PPOs from which to choose—the 

most in the country. The number of plans in a region may 

give a false impression because most regions have only 

one organization that sponsors several regional plans. Of 

the 21 regions with regional PPOs, a single organization 

offers all the plans within each of 16 regions, and two 

organizations offer all the plans within each of the 

other five regions. Overall, 42 plans are offered by one 

sponsor—Humana. (MA organizations offer multiple local 

plans as well, but we highlight the regional PPO pattern 

because the decisions made by one or two sponsors could 

change the regional plan landscape significantly.) 

Regional PPOs are available to 88 percent of beneficiaries, 

but their availability does not appreciably increase 

beneficiaries’ access to MA plans; 99 percent of 

beneficiaries have access to MA plans through the 

combination of local PPO, HMO, and PFFS plans. The 

inclusion of the regional PPOs increases beneficiaries’ 

range of choices. Also, regional PPOs help expand the 

availability of coordinated care plans; local or regional 

CCPs will be available to 98 percent of the Medicare 

population, compared with 67 percent in 2005.

Two other types of plans are eligible to participate in 

the Medicare Advantage program: plans with Medicare 

savings accounts and SNPs. Although plans with Medicare 

savings accounts are a permanent option under the MA 

program, no plans have come forward to participate 

for 2006. On the other hand, SNPs—first authorized 

in 2004—are growing rapidly, as discussed in the next 

section. They have increased from 11 plans in 2004, to 

125 plans in 2005, and to 276 plans in 2006. They are 

now available in counties where 59 percent of Medicare 

beneficiaries live.

Many beneficiaries will have numerous 

MA choices

Virtually all (99.4 percent) beneficiaries have two or more 

MA plans available.7

 Greater choice is available, not just 

because MA plans are entering new areas; more plans are 

entering already well-established MA areas potentially 

stimulating competition. Overall, 12 plans on average 

are offered per county in 2006, compared with 5 plans 

per county in late 2005. Beneficiaries in Broward county, 

Florida have the most choices available: 63 MA plans, up 

from 39 in 2005. 

As a result of all the changes, beneficiaries have many 

plans from which to choose (Figure 9-1). Almost half of 

all beneficiaries can choose from among 16 or more MA 

plans and 5 percent can choose from over 40 plans. These 

plan choices are in addition to the stand-alone prescription 

drug plan offerings.

FIGURE

9–1 Most beneficiaries have access 

to 11 or more plans, 2006

Source: MedPAC analysis of CMS Landscape Tool, October 2005.

21%

6–10

23%

11–15

13%

16–20

14%

21–25

4%

26–30

10%

31–40

5%

41–63

9%

0–5
208 The Medicare Advantage program: Availability, benefits, and special needs plans

Preliminary information from Medicare 

Advantage plan bids

The Commission has been concerned that the current 

benchmarks are higher than average per capita spending 

in FFS Medicare. We have pursued a policy of financial 

neutrality, under which the Medicare program would be 

financially neutral with regard to whether a beneficiary 

enrolled in an MA plan or remained in FFS Medicare. 

If payments to private plans are too high, it aggravates 

Medicare’s financial problems. If plan payments are 

below FFS Medicare, plans may be discouraged from 

participating in MA even if they are more efficient than 

FFS Medicare.

In our June 2005 report to the Congress, the Commission 

recommended several changes to the benchmarks that 

would have resulted in lowering the benchmarks to a 

level equal to Medicare’s FFS costs. In addition, we 

recommended that Medicare’s share of savings from bids 

below the benchmark be redistributed back to the plans 

based on quality performance measures.

Based on our preliminary analysis, plans were able to bid 

under their current benchmarks and had funds to rebate to 

their enrollees.8

 The Medicare program retains 25 percent 

of the amount by which the benchmark exceeds the bid, 

and the plan is given the other 75 percent to rebate to its 

members in one of five ways: 1) reduce Medicare Parts A 

and B cost sharing, 2) reduce the Part B premium, 

3) reduce the Part D premium, 4) enhance the Part D 

benefit, and 5) provide other additional benefits. Probably 

as a result of high benchmarks and effective management 

techniques, about 95 percent of bids were under the 

benchmark, thus almost all plans had funds to rebate to 

members. Most plans chose to spend rebates to improve 

benefits in more than one service category. Almost twothirds of rebate dollars (65 percent) were devoted to 

lowering cost sharing for Parts A and B services (Figure 

9-2). With 14 percent of the rebates, plans provided 

additional benefits—such as dental care and vision care— 

and lowered Part B or Part D premiums with another 15 

percent of total rebates.

We have also begun examining 2006 bid data by plan type. 

For this analysis, we divided plans into four groups: local 

HMOs, local PPOs, PFFS plans, and regional PPO plans. 

We found that average bids differed by plan type. The local 

HMOs were most often able to bid below the benchmark 

and had the largest average rebates. Local HMO bids came 

in below the benchmark 98 percent of the time and when 

they did, the average rebate was about $80 per month 

(Table 9-2). Local PPOs were not as likely to be below 

the benchmark, and even when they were, they received 

substantially lower rebates ($50) than HMOs. PFFS plans 

were able to bid below the benchmark in most cases (93 

percent), but their average rebates ($40) were about half of 

the HMOs’ rebates. Regional PPOs were least likely to bid 

below the benchmarks; only 69 percent of their bids came 

in below them. 

Because HMOs had larger average rebates to distribute, 

they more often could fund benefit packages that lower 

Parts A and B cost sharing, provide supplemental benefits, 

and have lower premiums. These results will generally 

translate to the greater availability of HMO plans with 

reduced cost sharing, low premiums, and enhanced drug 

benefits.

FIGURE

9–2 Medicare Advantage plans 

used the largest share of

 rebate dollars to reduce cost

 sharing for Medicare services

Note: Figure based on unweighted data. Additional benefi ts may include dental, 

vision, and hearing services.

Source: CMS 2006 unpublished bid data.

65%

Reduce Parts A and B

cost sharing

4%

Reduce

Part B

premium

11%

Reduce

Part D

premium

5%

Enhance

Part D

14%

Additional

benefits
Report to the Congress: Increasing the Value of Medicare | June 2006 209

Many plan choices have low premiums 

and include enhanced benefits

Under Medicare Advantage, plans can charge a premium 

for additional benefits. This premium is in addition to 

the Part B premium. However, many plans do not charge 

any premium for the additional benefits. These plans are 

called zero-premium plans. While a few zero-premium 

plans have used rebates to eliminate or reduce Part B 

premiums, we consider a plan to be zero-premium even 

if its members pay the full Part B premium and a Part D 

premium but no supplemental premium.

Low-premium plans are widely available

Zero-premium MA plans are available to 84 percent 

of Medicare beneficiaries in 2006, up from 58 percent 

of beneficiaries in 2005. HMOs are the most widely 

available zero-premium plans, with 54 percent of 

beneficiaries having access to one. Also, about one-third 

of beneficiaries have access to zero-premium PFFS plans 

and a similar share of beneficiaries have access to zeropremium regional PPOs in 2006 (Figure 9-3). 9

Even where there are no zero-premium plans, lowpremium plans are often available. MA plans that cost less 

than $10 per month in 2006 are available to 92 percent of 

Medicare beneficiaries. 

Plans that include both Part D and enhanced 

benefits are widely available

All MA CCP sponsors must offer at least one plan that 

includes Part D benefits (MA–PDs). Thus, 99 percent of 

beneficiaries will have access to MA–PDs. PFFS plans, 

which are not required to offer Part D coverage, have done 

so in service areas containing 70 percent of Medicare 

beneficiaries in 2006 (Table 9-3, p. 210).

As explained in detail in Chapter 7, the standard Part 

D benefit package in 2006 has a gap in coverage after 

a beneficiary has accrued drug expenses of $2,250. 

Beneficiaries in the standard plan are responsible for all 

drug expenses until they reach the catastrophic portion 

of the benefit.10 Plans with enhanced Part D benefits 

TABLE

9–2 HMOs most likely to bid below benchmark and have highest rebates

Local plans

HMO PPO PFFS Regional PPO

Percentage of plans bidding below benchmark 98% 86% 93% 69%

Average monthly rebate $80 $50 $40 $30

Note: PPO (preferred provider organization), PFFS (private fee-for-service). Data are unweighted for enrollment. Benchmarks are bidding targets with which Medicare 

Advantage plan bids are compared. When a plan bids below its benchmark, the plan receives 75 percent of the difference to rebate to its members in the form of 

additional benefi ts, lower cost sharing, or lower premiums.

Source: CMS 2006 unpublished bid data.

FIGURE

9–3 Zero-premium plans 

are widely available

Note: PPO (preferred provider organization), PFFS (private fee-for-service), MA 

(Medicare Advantage).

Source: MedPAC analysis of CMS Landscape Tool, October 2005. Percent of beneficiaries

100

60

40

20

10

80

90

70

50

30

0

HMO

Any plan

Zero premium

PPO PFFS Regional

PPO

Any

MA plan Local plans
210 The Medicare Advantage program: Availability, benefits, and special needs plans

may offer some coverage in the gap. Almost two-thirds 

of beneficiaries have MA–PDs available that offer some 

coverage in the Part D coverage gap, mostly from local 

HMOs and local PPOs. Regional PPOs offer gap coverage 

with generic drugs to 14 percent of beneficiaries, but no 

PFFS plans offer any gap coverage.11 While most of the 

coverage in the gap is for generics only, 14 percent of 

beneficiaries have access to MA–PDs that fill in coverage 

with both brand name and generic drugs.

Zero-premium MA–PD plans are also widely available. 

Almost 70 percent of beneficiaries have access to MA–PD 

plans that charge no premium for Parts A and B benefits 

and have a zero premium for the Part D benefits they offer. 

Local HMOs are the most widely available zero-premium 

MA–PDs, providing access to 48 percent of Medicare 

beneficiaries. Further, 27 percent of beneficiaries have 

access to a zero-premium plan with Part D that offers 

some coverage in the Part D coverage gap, with almost 

all of that coverage being offered by local HMOs. Finally, 

some of the zero-premium MA–PDs include brand 

and generic coverage throughout the gap; 13 percent of 

Medicare beneficiaries will have access to such a plan (all 

local HMOs).

Eighty percent of beneficiaries have access to MA–PDs 

with total premiums of $20 or less per month in 2006 

(Figure 9-4). About 11 percent of beneficiaries would have 

to pay at least $40 per month to enroll in an MA–PD, and 

some beneficiaries would have to pay as much as $116 per 

month.

Beneficiaries’ cost-sharing liability

MA enrollees face cost-sharing requirements in addition to 

any plan premiums. While in FFS Medicare, beneficiaries’ 

average cost-sharing liability (about $1,500 in 2006) is 

higher than that typical for MA enrollees (CMS 2005a). 

The Commission found in 2004 that enrollees with certain 

illnesses in some plans could also face high cost sharing 

(MedPAC 2004a). This section discusses some of the 

aspects of plans’ benefit designs that affect members’ costsharing liability.

An out-of-pocket (OOP) limit is one way to protect 

beneficiaries against high cost-sharing liability. In its 2006 

Medicare Advantage call letter, CMS encouraged plans 

to offer an OOP limit in exchange for providing greater 

latitude on individual services (CMS 2005b). Also, the 

MMA mandated that regional PPOs have an OOP limit 

TABLE

9–3 MA–PDs are widely available and enhanced cost-sharing

 protections are available in some areas

Local plans

Regional 

PPO

Any MA 

HMO PPO PFFS plan

MA–PD 72% 63% 70% 88% 99%

with some coverage in gap 46 34 0 14 62

with coverage of brand name drugs in gap 13 5 0 0 14

Zero premium MA–PD 48 11 25 15 68

with some coverage in gap 26 3 0 0 27

with coverage of brand name drugs in gap 13 0 0 0 13

Out-of-pocket limit:

$5,000 or less 53 41 75 88 98

$2,000 or less 28 16 37 4 65

Cost sharing for 6-day hospital stay, $500 or less 63 45 43 13 87

Note: MA–PD (Medicare Advantage–Prescription Drug [plan]), PPO (preferred provider organization), PFFS (private fee-for-service), MA (Medicare Advantage). Plans 

with gap coverage include some benefi ts in the range of benefi ciary drug spending above the standard benefi t’s initial coverage limit and below its out-of-pocket 

threshold. Part D’s defi ned standard benefi t requires the enrollee to pay 100 percent coinsurance in this coverage gap.

Source: CMS 2006 unpublished bid data.
Report to the Congress: Increasing the Value of Medicare | June 2006 211

on beneficiary cost-sharing liability for covered Medicare 

services provided in-network. 

Overall, 98 percent of beneficiaries have access to a plan 

that includes an annual OOP limit of $5,000 or less, and 

65 percent of beneficiaries have a plan available that 

includes an OOP limit of $2,000 or less (Table 9-3). 

PFFS plans with an OOP limit no higher than $2,000 are 

available to 37 percent of beneficiaries. Also, HMOs with 

OOP limits of $2,000 or lower are available to 28 percent 

of Medicare beneficiaries, and local PPOs with these 

limits are available to 16 percent. We note that many plans 

may charge low enough cost sharing that they do not need 

to provide an OOP limit.

While by law all regional PPOs offer OOP limits, only 4 

percent of Medicare beneficiaries live in regions where 

a regional plan with an OOP limit of $2,000 or less is 

offered. The MMA and subsequent regulations did not 

set specific dollar values for the mandated OOP limit. 

Regional PPOs decided to offer OOP limits ranging from 

$1,000 per year to $5,000 per year, with the most common 

plan design having a limit of $5,000.12

Cost sharing in plans varies across many different 

measures. An inpatient hospital stay is a relatively 

common and costly service in terms of cost sharing. In 

FFS Medicare, there is a $952 deductible for a hospital 

stay for 2006. The Commission has estimated the average 

stay is between five and six days, and the average cost 

per day is around $1,000. For this analysis, we look at the 

OOP costs for a beneficiary with a six-day stay. For those 

few plans that impose cost sharing as a percentage of cost, 

we assume a daily cost of $1,000. Most plans impose a 

flat daily copayment and often have a limit on total cost 

sharing for a hospital stay or an overall OOP limit. Across 

all plans, cost-sharing liability for a six-day hospital 

stay varies from zero to over $2,000. We focused on the 

availability of plans with cost sharing of $500 or less for 

a six-day stay, because we view that level of cost sharing 

as a significant savings from FFS Medicare for an average 

stay. 

Eighty-seven percent of Medicare beneficiaries have 

access to a plan with expected cost sharing of $500 or less 

for a six-day hospital stay. Availability of these plans is 

greater for HMOs and other local plans. Only 13 percent 

of beneficiaries have access to a regional PPO with this 

level of cost sharing.

Benefit differences between urban and 

rural areas

Additional benefits are more widely available in urban 

than in rural areas. Zero-premium plans are available to 

about 89 percent of beneficiaries living in urban areas 

and about 65 percent of rural beneficiaries. Availability 

is also wider in urban areas for zero-premium plans that 

include Part D benefits and for those that provide some 

coverage in the Part D coverage gap. Plans with annual 

limits on OOP liability for Medicare services of $5,000 

or less are available to 98 percent of both urban and rural 

beneficiaries, but plans with OOP limits of $2,000 or less 

are available to 68 percent of urban beneficiaries and 55 

percent of rural beneficiaries. Also, 92 percent of urban 

beneficiaries have access to a plan that has a $500 or lower 

OOP cost for a six-day hospital stay, while only 70 percent 

of rural beneficiaries have access to such a plan (Table 

9-4, p. 212).

The key factor in the benefit differences between urban 

and rural areas is that benefits tend to vary by plan type, 

FIGURE

9–4 Most beneficiaries have access

 to an MA–PD with a 

 premium of $20 or less

Note: MA–PD (Medicare Advantage–Prescription Drug [plan]).

Source: MedPAC analysis of CMS Landscape Tool, October 2005.

9%

$21–40

5%

$41–60

6%

$61–116

80%

$0–20
212 The Medicare Advantage program: Availability, benefits, and special needs plans

as shown earlier. Although the overall availability of plans 

is similar in urban (100 percent) and rural (99 percent) 

areas, the types of plans available tend to differ. Urban 

beneficiaries are much more likely to have local HMOs 

and local PPOs available than if they lived in rural areas. 

Local HMOs and PPOs are available to 86 percent and 

75 percent, respectively, of urban beneficiaries and are 

available to only 27 percent and 26 percent of rural 

beneficiaries. On the other hand, PFFS plans are available 

to 96 percent of rural beneficiaries and only 75 percent of 

urban beneficiaries. Regional PPOs are available to about 

the same percentages of urban and rural beneficiaries. 

Thus, the plans in rural areas are more likely to be the 

regional PPOs and PFFS plans that do not generally have 

tight networks of providers and tend to bid higher than 

local managed care plans. 

We see that the plans in urban areas, through the greater 

ability to build networks and manage care, tend to be able 

to bid lower relative to their benchmarks than plans in 

rural areas (even though benchmarks in rural areas tend 

to be higher relative to local FFS costs than benchmarks 

in urban areas). As a result, the rebates tend to be larger in 

urban areas, allowing the managed care plans there to offer 

additional benefits.

In future work, we will examine some of the broader 

questions about the value of private plans to the Medicare 

program. Such questions may focus on quality, efficiency, 

and payment issues.

Special needs plans

Almost since the beginning of the program, Medicare has 

included special plans for beneficiaries who tend to report 

lower health status, use more health care services, and 

cost the Medicare program more than other beneficiaries. 

These existing plans include the Program of All-Inclusive 

Care for the Elderly (PACE), Social Health Maintenance 

Organizations, Evercare, and various demonstration plans. 

Plans for beneficiaries who are dually eligible for 

Medicare and Medicaid have faced the additional 

challenge of integrating services from these two payers. 

In theory, these plans are designed to both improve 

care coordination for beneficiaries and reduce program 

spending. However, the inherent incentive to shift costs 

among multiple payers raises the longstanding question 

of whether these plans do result in Medicare program 

savings. 

The Commission has sought creative ways of delivering 

high-quality health care to dual-eligible Medicare 

beneficiaries. The policy and practical issues we 

described in the June 2004 report chapter on dual-eligible 

beneficiaries might be addressed through special plans 

(MedPAC 2004b). Special needs plans, a new type of 

MA plan, build on the earlier demonstrations and other 

existing plans. They also offer the potential to address 

the care needs and costliness of dual eligibles and other 

special needs beneficiaries. While our chapter is largely 

descriptive of the early days of the program, our interest 

is in three fundamental questions. First, do SNPs tailor 

benefit packages to better serve the needs of enrollees than 

fee-for-service Medicare or regular MA plans? Second, 

does risk adjustment result in an appropriate payment 

amount? Third, do dual-eligible SNPs merge Medicare 

and Medicaid benefit programs in a way that better serves 

beneficiaries, and is there cost shifting among payers? 

Creation of special needs plans

The Congress created SNPs as a new MA plan type to 

provide a common framework within the regular MA 

program for the existing plans serving special needs 

beneficiaries and to expand beneficiaries’ access to 

TABLE

9–4 Differences in plan availability

 between urban and rural areas

Urban Rural

Available plan: 100% 99%

Local HMO 86 27

Local PPO 75 26

PFFS 75 96

Regional PPO 88 89

Zero premium: 89 65

with Part D 73 47

with Part D and gap coverage 34 2

Out-of-pocket limit:

$5,000 or less 98 98

$2,000 or less 68 55

Cost sharing for 6-day hospital stay, 

$500 or less 92 70

Note: PPO (preferred provider organization), PFFS (private fee-for-service).

Source: MedPAC analysis of CMS Landscape Tool, October 2005.
Report to the Congress: Increasing the Value of Medicare | June 2006 213

and choice among MA plans. This means that many 

of the existing special plans, which were operating as 

demonstrations, could transition to become SNPs.13

In fact, existing demonstrations for special needs 

beneficiaries had to become SNPs to include the Part 

D prescription drug benefit. SNPs are not a permanent 

feature of MA. Absent congressional action, SNP 

authority will expire at the end of 2008.

SNP requirements

SNPs function essentially like any other MA plan, but 

must also provide the Part D drug benefit as well as 

additional services that go beyond regular Medicare 

services and are tailored to the special needs population. 

In exchange, they are allowed to limit their enrollment to 

their targeted population. 

Payment and risk adjustment

SNPs are paid like regular MA plans, including the same 

risk-adjustment method.14 MA plan payments have 

historically been risk adjusted based on the demographic 

characteristics of their enrollees. Recently, CMS began 

phasing in a risk-adjustment system that uses diagnosis 

data, known as the hierarchical condition categories 

(HCCs). The CMS–HCC formula generally results in 

higher payments for special needs beneficiaries than for 

the general Medicare population.15 In 2006, MA plan 

payments are 75 percent risk adjusted using CMS–HCCs. 

In 2007, payments will be fully risk adjusted in this 

manner. 

Enrollment

Special needs beneficiaries have more opportunities to 

join or switch MA plans than regular beneficiaries. Dual 

eligibles have a special election period, which begins when 

they become dually eligible and continues as long as they 

remain dually eligible. During the open enrollment period 

for institutionalized individuals, which is continuous 

beginning in 2006, beneficiaries going into, residing 

in, or leaving an institution can join any open MA plan. 

Individuals with severe or disabling chronic conditions 

have a special election period to enroll in a SNP designed 

for beneficiaries with those conditions, which begins with 

diagnosis of the condition and ends upon enrollment in 

a SNP. CMS provides a special election period for those 

who are no longer eligible for a SNP, such as those who 

lost their Medicaid eligibility, to enable them to enroll in 

a regular MA plan. With the implementation of “lock-in” 

this year, which limits beneficiaries’ ability to change 

plans, special needs beneficiaries will be the largest group 

of beneficiaries eligible to enroll in MA plans after the 

regular election period.

SNP types

The MMA authorizes Medicare to contract with SNPs for 

three types of beneficiaries: dual eligibles, institutionalized 

beneficiaries, and patients with severe chronic diseases 

or conditions. SNPs may limit their enrollment to their 

targeted special needs population exclusively, or they may 

enroll any other beneficiaries as long as their membership 

includes a disproportionate percentage of their targeted 

population. This means that the percentage of the special 

needs target population in the plan must be greater than 

the percentage that occurs nationally in the Medicare 

population. Most SNPs in 2006 have chosen to limit their 

enrollment to their targeted population exclusively. Each 

of the three types of SNPs can enroll beneficiaries who 

fall into additional targeted populations. For example, an 

institutional SNP can enroll a beneficiary who resides in 

an institution and is also dually eligible. 

Next, for each type of SNP—dual eligible, institutional, 

and chronic condition—we discuss the plan and target 

population characteristics. Because most SNPs offered this 

year are for dual eligibles, the discussion focuses primarily 

on this type.

Dual-eligible SNPs

Medicare beneficiaries can qualify for Medicaid if they 

meet certain income and resource requirements or have 

high health care bills. Each state sets its own eligibility 

standards and determines the scope of benefits provided to 

Medicaid beneficiaries within federal guidelines.

These dual-eligible beneficiaries are divided into several 

different categories based on their income and assets 

(Table 9-5, p. 214). There are more than 7 million dual 

eligibles; of these, about 6 million are “full duals”—they 

qualify to receive full Medicaid benefits. Beneficiaries 

with somewhat higher income and asset levels are eligible 

for more limited Medicaid coverage under multiple 

categories collectively known as the Medicare Savings 

Program (MSP).

Dual-eligible SNPs may choose to accept all dual 

eligibles or limit enrollment to the full benefit dual 

category. In other words, an MA organization can offer 

two dual-eligible SNPs in the same county—one for 

full-benefit duals and another for all duals. Plans can not 
214 The Medicare Advantage program: Availability, benefits, and special needs plans

limit enrollment to MSP duals alone as these tend to be 

healthier individuals than their full-dual counterparts. 

Although this policy is designed to prevent selection, there 

may still be opportunities for selection. 

Coordination of Medicare and Medicaid The law does 

not mandate any Medicaid involvement in SNPs. Although 

dual-eligible SNPs are not required to, they may choose 

to contract with states to provide Medicaid benefits.16

Institutional and chronic condition SNPs that have, or 

plan to have, dual-eligible enrollees may also incorporate 

Medicaid. It is unclear how SNPs that do not integrate 

Medicare and Medicaid services can better coordinate the 

two programs. It is also unclear how these dual-eligible 

SNPs differ from regular MA plans. 

Why integration is a good idea Having beneficiaries 

enrolled in one managed care plan for Medicare benefits 

and another for Medicaid benefits raises a variety of 

problems for care coordination. For example, a Medicaid 

managed care plan often has no incentive to manage 

beneficiaries’ care to limit unnecessary acute care use. 

Similarly, the Medicare managed care plan does not 

have an incentive to manage beneficiaries’ care to avoid 

spending on long-term care.

Case studies suggest that care coordination is challenging 

even when dual-eligible beneficiaries are enrolled in 

Medicare and Medicaid managed care plans (but not 

an integrated plan) offered by the same managed care 

organization. Beneficiaries have two separate membership 

cards and different points of contact for the Medicare 

and Medicaid benefits. Plans may not be equipped to 

coordinate across the requirements of the two programs. 

Also, most Medicaid managed care plans are not 

responsible for long-term care services (Walsh et al. 2003).

Many of these coverage and payment issues are resolved 

if the dual eligible is enrolled in the same plan for both 

Medicare- and Medicaid-covered services, and if that plan 

is committed to integrating benefits (Figure 9-5). 

States lack incentives to partner with SNPs Medicare, 

whether beneficiaries are in fee-for-service or managed 

care plans, is the primary insurer for dual eligibles and 

covers medically necessary acute care services—including 

physician, hospital, hospice, skilled nursing facility, and 

home health services—and durable medical equipment. As 

the secondary payer, Medicaid generally covers:

• Services not covered by Medicare, such as 

transportation, dental, and vision.17

• Wrap-around services, such as cost sharing for 

services covered by Medicare as well as acute care 

services that are delivered after the Medicare benefits 

are exhausted or if certain Medicare criteria are not 

met. These services include inpatient hospital, skilled 

nursing facility, and home health care.

TABLE

9–5 Categories of dual eligibles

Medicaid covers

Type of dual eligible Income limit for eligibility

Medicare Part B 

premium

Cost 

sharing

Full Medicaid 

benefi ts

Full benefi t

Meets low income standard ≤73% FPLa yes yes yes

Medically needy (spend-down) None yes yes yes

Medicare Savings Program

Qualifi ed Medicare benefi ciary ≤100% FPL yes yes someb

Specifi ed low-income Medicare benefi ciary Between 100% and 120% of FPL yes no no

Qualifying individual Between 120% and 135% of FPL yes no no

Note: FPL (federal poverty level). All types of dual eligibles except for medically needy also have asset limits; full duals are limited to $2,000 per individual or $3,000 per 

couple, and Medicare Savings Program dual eligibles are limited to $4,000 per individual or $6,000 per couple. The 2006 FPL is $9,800 for an individual and 

$13,200 for a family of two. The FPL is higher in Alaska and Hawaii.

 a States set their own Medicaid eligibility levels, usually at or below the supplemental security income eligibility level of 73 percent of the FPL. 

 b Some states have extended full Medicaid benefi ts to qualifi ed Medicare benefi ciaries.

Source: CMS. http://www.cms.hhs.gov/DualEligible/02_DualEligibleCategories.asp#TopOfPage.
Report to the Congress: Increasing the Value of Medicare | June 2006 215

• Long-term care, including custodial nursing facility 

care, home- and community-based services, and 

personal care services.

States must pay Medicare's Part B premium for all dualeligible beneficiaries and cost sharing for full duals and 

qualified Medicare beneficiaries (Table 9-5). States are 

not required to pay any MA plan premium on behalf of 

dual eligibles who enroll in MA plans.18 States’ costsharing responsibility is less clear for duals who enroll in 

MA plans, as plans generally have different cost-sharing 

structures than FFS Medicare and can offer additional 

benefits. States generally are responsible for plans’ cost 

sharing for services that are covered by FFS Medicare, but 

not for additional benefits. In addition, states may avoid 

paying cost sharing on services altogether. The Balanced 

Budget Act of 1997 allowed states to set providers’ 

reimbursement for dual eligibles equal to the Medicaid 

payment rate and generally prevented providers from 

balance billing.19 About one-third of states have set their 

rates at 80 percent or less of Medicare FFS rates, which 

virtually eliminates their cost-sharing responsibility 

(Atherly 2005). States can also choose not to pay cost 

sharing for services if they are delivered by non-Medicaidapproved providers. 

States may have little incentive to take on the 

administrative complexity of partnering with SNPs 

because now that prescription drugs are covered under 

Part D, their largest payment responsibility for duals is 

long-term care. While states may contract with SNPs to 

cover long-term care and other Medicaid services, few 

have done so.20 Furthermore, given recurring state budget 

pressures, many state Medicaid programs have reduced or 

eliminated coverage for optional services and more may 

do so in the future, leaving even fewer services to contract 

out to SNPs.

Special managed care programs for dual eligibles Several 

programs integrate the financing and delivery of care for 

the full range of health care needs of dual eligibles and 

thereby avert some of these coordination-of-benefit issues. 

By aligning incentives, this integrated payment approach 

is also intended to help plans coordinate care for dual 

eligibles. The following two types of programs combine 

Medicare and Medicaid capitated payments to integrate 

care for the dual-eligible population, and thus may be 

models for integrated SNP plans.

Options for dual eligibles in 2006

Note: FFS (fee-for-service), MA–PD (Medicare Advantage–Prescription Drug [plan]), SNP (special needs plan).

Medicare

(Parts A, B, and D)

Medicare

(Parts A, B, and D)

Medicaid

Medicaid

(FFS or managed care)

Medicaid

(FFS or managed care)

Stays in Medicare FFS

Enrolls in a regular MA–PD or a

SNP that does not integrate Medicaid

Enrolls in a SNP that integrates

Medicare and Medicaid

Medicare

(Parts A, B)

Medicare

(Part D)

FIGURE

9–5
216 The Medicare Advantage program: Availability, benefits, and special needs plans

Program of All-Inclusive Care for the Elderly PACE is 

a capitated benefit authorized by the Balanced Budget 

Act of 1997 that serves frail elderly beneficiaries, age 

55 and older, who meet states’ standards for nursing 

home placement and reside in areas served by the PACE 

organizations.21 Most enrollees are dually eligible. PACE 

plans feature a comprehensive medical and social service 

delivery system, an interdisciplinary team that provides 

services in an adult day health center setting, and in-home 

and referral services in accordance with participants’ 

needs. 

These plans receive separate capitated payments from 

Medicare and Medicaid. Until recently, the Medicare rate 

was equal to 2.3 times the Medicare county rate amount 

for MA plans, but this adjustment has been replaced 

with a frailty adjuster based on limitations in activities 

of daily living among enrollees in the plan. The PACE 

plan negotiates the Medicaid rate with the state Medicaid 

agency. Separate contracts mean that plans still have to 

deal with two payers with different policies.

State demonstration waivers Minnesota, Wisconsin, 

and Massachusetts have operated state programs that 

pool Medicaid and Medicare payments under Medicare 

demonstration authority. These plans are transitioning to 

SNPs.

In Minnesota Senior Health Options and Disability Health 

Options, Medicare and Medicaid each pay a capitated 

rate for their respective benefits, including home- and 

community-based care and nursing facility services 

(except for those provided beyond 180 days, which are 

paid on a FFS basis). Enrollment is offered to dual-eligible 

seniors and people with disabilities—both those who 

qualify for nursing home care (“nursing home certified”) 

and those who do not—as a voluntary alternative to 

Minnesota’s mandatory managed care program. 

The Wisconsin Partnership Program includes communitybased organizations that have entered into a Medicaid 

managed care contract with the Wisconsin Department 

of Health and Family Services and a Medicare contract 

with CMS. They receive monthly capitated payments for 

each participant from which they pay for all participant 

services. The Wisconsin Partnership Program serves both 

seniors over 55 and physically disabled dual eligibles. 

Qualifying beneficiaries must be nursing home certified.

Massachusetts’s MassHealth Senior Care Options includes 

organizations that contract with the state’s Division of 

Medical Assistance and CMS to offer the full range of 

Medicare and Medicaid benefits available to dual eligible 

beneficiaries. Senior Care Options organizations serve 

community-well, community-frail, and institutionalized 

people ages 65 and over.

Passive enrollment Medicaid managed care plans 

that chose to offer SNPs could apply to CMS in 2005 

to “passively enroll” their members into their new SNP. 

Approved plans passively enrolled their dual-eligible 

members into their SNP effective January 1, 2006. 

Plans had to send affected members a letter in fall 2005 

notifying them of their choices to remain in the plan, 

switch to another MA plan, or return to Medicare FFS. 

Forty-two SNPs that had operated Medicaid managed care 

plans passively enrolled their dually eligible beneficiaries 

in 13 states (McClard 2006).22

Institutional SNPs

Institutional SNPs may enroll beneficiaries who reside 

or are expected to reside for 90 days or longer in a longterm care facility, including skilled nursing facilities, 

nursing homes, skilled nursing facilities/nursing facilities, 

intermediate care facilities for the mentally retarded, 

or inpatient psychiatric facilities. They may also enroll 

beneficiaries living in the community who require an 

equivalent level of care to beneficiaries in these facilities. 

With CMS approval, they may limit their enrollment 

and marketing to select facilities within their geographic 

service area.

Importance of managing institutionalized 

beneficiaries From a state’s perspective, it is clear that 

fragmented Medicare acute care can lead to nursing 

facility placement—paid briefly under Medicare, but 

ultimately leading to long-term stays that may be paid by 

Medicaid. Integrated Medicare and Medicaid plans that 

include long-term care are designed to prevent or delay 

disability and health deterioration that would necessitate 

institutional long-term care and manage the care of 

enrollees already in institutions to prevent recurring 

hospitalizations.

Chronic condition SNPs

Chronic condition SNPs are designed for beneficiaries 

with severe chronic diseases or conditions, which CMS 

has not yet defined. CMS has stated that because chronic 

condition SNPs are a new offering, the agency did not 

want to limit their potential application by specifically 

defining a chronic condition. Instead, the agency evaluates 

proposed plans on a case-by-case basis, considering 
Report to the Congress: Increasing the Value of Medicare | June 2006 217

appropriateness of target population, clinical programs and 

expertise, and how the SNP will cover the full spectrum 

of the target population without discriminating against the 

sicker members. New chronic condition SNPs are targeted 

to beneficiaries with cardiovascular disease, congestive 

heart failure, diabetes, chronic obstructive pulmonary 

disease, asthma, hypertension, coronary artery disease, 

osteoarthritis, mental illness, end-stage renal disease, and 

HIV/AIDS.

Importance of managing chronic condition 

beneficiaries Fully 83 percent of Medicare beneficiaries 

have at least one chronic condition. However, this 

includes conditions that are less expensive to treat, such as 

arthritis. Twenty-three percent of Medicare beneficiaries 

have five or more chronic conditions and account for 

68 percent of program spending (Anderson 2005). 

Improving care coordination for these beneficiaries and 

reducing unnecessary utilization could result in significant 

Medicare savings. For more information, see Chapter 2 on 

care coordination.

SNPs have grown quickly

2006 marked a significant increase in the number of SNPs 

available to beneficiaries. In 2004, there were just 11 

SNPs. By 2005, that number had grown to 125. This year, 

the total number of SNPs has more than doubled to 276 

(CMS 2006b).

By January 1, 2006, CMS had signed 164 MA contracts 

with organizations that offer one or more SNP plans.23

These contracts represent 91 distinct corporate entities 

(CMS 2006b). Most are for profit (CMS 2006a). Many 

of these entities offer more than one SNP. All three 

types of SNPs—dual eligible, institutional, and chronic 

condition—are available in 2006; most SNPs are for dual 

eligibles (Figure 9-6).

SNPs are available in at least part of 42 states, the District 

of Columbia, and Puerto Rico (Figure 9-7, p. 218). Eight 

states, the District of Columbia, and Puerto Rico have at 

least one SNP available throughout the entire area. Several 

states have multiple types of SNPs available. 

Reasons for offering and joining a special 

needs plan

MA organizations, health care providers, beneficiaries, 

and federal and state governments have different levels of 

interest and reasons for taking part in a SNP.

Plans

Organizations entering the SNP market include those 

with experience partnering with Medicaid and serving 

special needs populations, such as the Massachusetts 

demonstration, but also include MA organizations with 

little or no similar experience that have chosen to add 

SNPs to their menu of plans. Some organizations are 

offering multiple SNP plans. In fact, some offer more 

than one dual-eligible SNP in the same geographic area. 

This allows organizations to offer a plan only to full 

duals with a benefit and cost-sharing structure designed 

to appeal to these beneficiaries and potentially attract 

state partnerships. (States have greater cost-sharing 

responsibility for full duals than for Medicare Savings 

Program duals.) At the same time, they can offer a 

plan with a different structure to all duals, including 

MSP participants. Some observers have noted that risk 

adjustment has the potential to make enrollment of special 

needs beneficiaries more profitable than it has been.

FIGURE

9–6 Special needs plans 

available in 2006

Note: Percentages do not sum to 100 due to rounding. Number of plans is given 

in parentheses.

Source: CMS special needs plan fact sheet and data summary. February 14, 

2006.

13%

Institutional

(37)

4%

Chronic condition

(13)

82%

Dual eligible

(226)
218 The Medicare Advantage program: Availability, benefits, and special needs plans

Providers

Physicians and hospitals who have served dual eligibles 

through a Medicaid managed care plan may find SNP 

payment rates more generous. The traditional MA plans 

that have added SNPs may be able to build on networks 

already in place for their regular MA plans. However, 

because special needs beneficiaries tend to have greater 

health needs than their counterparts, SNPs will probably 

have to tailor their networks by including a somewhat 

different mix of providers. This may be difficult in areas 

where Medicare physicians do not want to participate in 

managed care. We have heard reports that some Medicare 

physicians resist enrolling in SNP networks and encourage 

their dual-eligible beneficiaries who have been passively 

enrolled to switch back to FFS Medicare.

Beneficiaries

Dual eligibles’ incentive to join MA plans is not as strong 

as for other beneficiaries. They can have their choice of 

provider under FFS Medicare with cost-sharing protection 

and additional services provided by Medicaid. In fact, 

the vast majority of dual eligibles have been in FFS. 

SNPs’ advantage over FFS Medicare is that they can offer 

greater integration, including acute care, prescription 

Number of organizations offering special needs plans, by county, 2006

Source: MedPAC analysis of CMS 2006 Plan Benefi t Package data.

0

1

2

3 or more

FIGURE

9–7
Report to the Congress: Increasing the Value of Medicare | June 2006 219

drugs, and possibly long-term care. SNPs must offer 

sufficient additional benefits or reduced cost sharing to 

attract beneficiaries to join. Beneficiaries’ decisions will 

probably be largely influenced by the comparative benefits 

of their states’ Medicaid plans and available SNPs’ benefit 

packages. 

Federal and state government

Special needs beneficiaries have high health care costs. In 

2002, dual eligibles accounted for 17 percent of Medicare 

enrollment and 29 percent of Medicare spending as well 

as 14 percent of Medicaid enrollment and 42 percent of 

Medicaid spending (Elam 2006). Dual eligibles can be 

in FFS Medicare and managed care in Medicaid or vice 

versa. They can even be enrolled in two different managed 

care plans simultaneously—one sponsored by Medicare 

and one by Medicaid. Most duals have been enrolled in 

FFS in both programs. SNPs offer the potential for better 

care management and resulting efficiencies. However, 

SNP cost savings on Medicare services may be achieved 

by shifting some costs to Medicaid, especially if the SNP 

does not have a contract with the state for coverage of 

Medicaid services. This may have implications for the 

continuation of SNPs, which are scheduled to expire at 

the end of 2008. If some of the plans fail to demonstrably 

improve care for beneficiaries and deliver savings, the 

Congress may wish to modify the definition of SNPs—if 

it chooses to extend SNP authority—to better match the 

characteristics of effective plans.

Site visits

To learn more about SNPs, we visited some SNP 

organizations, state agencies, and CMS regional offices 

in Baltimore, Maryland; Boston, Massachusetts; Phoenix, 

Arizona; and Miami, Florida. Together these markets met 

the following selection criteria:

• a large number of competing SNPs;

• the presence of existing special plans that converted 

into SNPs;

• passive enrollment of Medicaid managed care 

enrollees into dual-eligible SNPs;

• the presence of organizations that offer multiple dualeligible SNPs; and

• the presence of all three types of SNPs: dual eligible, 

institutional, and chronic care (Mathematica 2006).

SNP goals and strategy

Plans’ goals and strategies for the future reflected 

differences in their experience with the target population, 

experience in local markets, relationships to Medicaid, 

and histories in Medicare and Medicaid. Some SNPs told 

us that they plan to wait before attempting to significantly 

increase their enrollment, alter their benefit packages, 

or expand their service areas. Others are considering 

expanding their service areas, adding new plans, pursuing 

partnerships with states, and increasing their marketing 

efforts. 

SNPs are generally offered by organizations that fall into 

one of two groups: 1) organizations that have experience 

providing services to special needs beneficiaries through 

a Medicare demonstration, Medicaid plan, or similar 

specialized plan and view SNPs as a natural extension of 

their mission, and 2) organizations that have experience 

operating Medicare managed care plans and view SNPs as 

an opportunity to expand their selection of products.

Relationships with states 

SNP relationships with states vary: Some have very close 

and long-established relations with states while others 

have none at all. Some dual-eligible SNPs receive payment 

from states to include some or all Medicaid benefits in 

their benefit package. Other SNPs are actively pursuing 

partnerships with states, but some SNPs have no plans to 

incorporate Medicaid. States may have little incentive to 

take on the administrative complexity of partnering with 

SNPs, especially now that prescription drugs are covered 

under Part D and about one-third of states have set their 

Medicaid rates at or below 80 percent of the Medicare 

fee schedule to limit their cost-sharing liability (Atherly 

2005). The exception is for states that have or are planning 

Medicaid managed care programs that cover long-term 

care services. SNPs may offer a promising partnership 

option for these services.

Coordination challenges 

SNPs that contracted with Medicaid noted the numerous 

conflicts between Medicare and Medicaid rules dealing 

with bidding, contracting, enrollment, marketing, 

complaints and grievances, reporting, monitoring, and 

rate setting. Plans are eager for CMS and states to work 

to reduce these administrative barriers to achieve better 

integration of the two programs.
220 The Medicare Advantage program: Availability, benefits, and special needs plans

Plans expressed frustration with CMS’s lack of support 

of their efforts to integrate Medicare and Medicaid. For 

example, several plans told us that they had to deal with 

separate Medicare and Medicaid officials at CMS and that 

these two groups rarely seemed to coordinate.

Coordinating Medicare and Medicaid payment

Some dual-eligible SNPs indicated that keeping track of 

separate funding streams was burdensome, but other SNPs 

indicated this was no problem. All SNPs indicated that the 

accounting requirements had no effect on their clinical 

care coordination efforts or on their relationships with 

providers. 

Contracting with CMS

It appears that SNP applications were reviewed and 

approved entirely by the CMS central office. CMS’s 

central office is primarily responsible for reviewing and 

approving applications for regular MA plans. Because 

SNPs, especially dual-eligible SNPs, are significantly 

affected by state and local conditions and regional offices 

are responsible for overseeing SNPs’ operation, it may be 

appropriate for regional offices to have a more active role 

in reviewing and approving their applications.

Some plans noted that CMS approved their applications 

with few changes. In contrast, other SNPs described their 

interaction with CMS as somewhat unpredictable and 

filled with last-minute changes. 

Outreach and enrollment 

Even before the creation of SNPs, outreach and enrollment 

have been an issue for special plans. If SNPs are unable to 

enroll a sufficient number of special needs beneficiaries, 

they can not act as a driver of greater integration.

SNPs have mostly opted for targeted marketing, with 

little emphasis so far on broader marketing. Few SNPs 

believe that television, newspapers, or other media will be 

effective in reaching potential members.

SNP approaches to outreach and enrollment differ 

significantly, depending on their target populations (dual 

eligibles, institutionalized, or chronic condition) and 

whether they kept many former members through passive 

enrollment. The following are broad generalizations as 

individual SNP’s marketing strategies varied. Dual-eligible 

SNPs have the broadest marketing strategies aimed at 

physicians, hospitals, community organizations, and 

beneficiary advocacy groups. Institutional SNPs market 

primarily to nursing facilities and families of residents. 

Chronic condition SNPs focus primarily on physicians, 

other chronic care providers, and related advocacy groups.

SNPs with passive enrollment focus on retaining their 

current enrollees. Organizations that offer SNPs along 

with other MA plans may focus on encouraging members 

to shift from their other plans. If they offer commercial 

products, they may also focus on marketing to members 

aging into Medicare. In most markets, the overwhelming 

majority of dual eligibles were auto-enrolled into standalone prescription drug plans. Many SNPs do not focus on 

marketing to these beneficiaries. 

The CMS web-based plan finder tool is difficult for SNPs 

to take advantage of as their specialized focus and broader 

benefits do not fit well into the current plan finder format. 

SNPs are often indistinguishable from other MA plans 

on the plan finder. At least one SNP opted to be listed as 

“information not available—contact plan” rather than list 

inaccurate information.

Quality monitoring and improvement 

To allow SNPs to continue to operate, the Congress must 

extend the SNP authorization beyond 2008. A CMS 

evaluation of SNPs is due to the Congress at the end of 

2007. However, there may be limited data available upon 

which to evaluate SNPs. 2006 data may be muddied 

by start-up issues, such as incorrect enrollment data. 

In addition, plans designed to improve care quality and 

reduce unnecessary costs may not exhibit measurable 

differences within a year. The evaluators’ task may be 

further complicated by challenges in gathering information 

from plans. For example, some plans do not maintain 

websites or use post office boxes instead of street 

addresses.

Several SNPs expressed concern that CMS’s MA quality 

monitoring and reporting system is not as applicable to 

their special target populations and benefit packages 

because these systems were designed more for acute care 

than for ongoing care of chronic or disabling conditions. 

Some SNPs have additional significant quality monitoring 

and reporting systems in place to meet Medicare 

demonstration or state Medicaid requirements. Other SNPs 

do not appear to have any special quality efforts underway 

at this point, beyond what CMS requires. SNPs recognize 

the importance of quality monitoring and performance 

reporting systems to enable SNPs to demonstrate that they 

are adding value beyond what a standard MA–PD or PDP 

might offer. 
Report to the Congress: Increasing the Value of Medicare | June 2006 221

Concluding observations

SNPs offer the opportunity to improve the coordination of 

care for special needs beneficiaries. Dual-eligible SNPs 

(or any SNP that integrates Medicare and Medicaid) 

also offer the opportunity to improve the coordination 

of Medicare and Medicaid. Although it is too early to 

determine whether SNPs result in improved quality and 

significant program savings, they may not fulfill this 

opportunity. For instance, many dual-eligible plans do 

not contract with states to include Medicaid benefits. 

As SNPs are a new offering, the Commission plans to 

continue to assist the Congress and CMS in defining what 

distinguishes them from other MA plans. To do so, we 

will further evaluate the plans that enter the market and 

examine their special characteristics. For example, the 

goal for dual-eligible SNPs is less clear now that coverage 

for prescription drugs has been moved from Medicaid to 

Medicare, leaving much less state financial responsibility 

for duals who are not in institutions. Because of the 

rapid growth of new SNPs, we also plan to look at how 

the CMS–HCC risk adjuster applies to special needs 

beneficiaries. The results of these analyses will allow us to 

advise the Congress and CMS on program elements that 

would better support SNPs’ goal to fulfill the opportunity 

for better integration and care coordination. 222 The Medicare Advantage program: Availability, benefits, and special needs plans

1 A plan may limit its service area to a partial county if it can 

explain to CMS why its network is unable to serve the entire 

county.

2 Beneficiaries may sometimes also enroll in demonstration 

project plans and in plans reimbursed based on the cost the 

plan incurs while providing Medicare services to enrollees. 

Enrollees in the cost plans retain their Medicare FFS 

eligibility for services provided outside the plan.

3 Plan sponsors of PPO products must be licensed as riskbearing entities.

4 Another difference between an HMO with a point-of-service 

option and a PPO is that the HMO may limit its level of 

financial responsibility for out-of-plan care by saying, for 

example, that out-of-network services are covered up to a 

limit of $1,000 per year. A PPO must cover all out-of-network 

care; it may impose higher cost-sharing levels for out-ofnetwork care, but it may not have a spending cap.

5 For more detail on these provisions, see MedPAC 2005.

6 A coordinated care plan is a Medicare approved plan (other 

than a PFFS plan) that delivers Medicare services to its 

members through a provider network.

7 Plan sponsors often offer more than one plan. For example, 

one plan may be a “standard” option and another may be a 

“high” option. Sponsors may also offer more than one type 

of plan. Thus, one sponsor could offer multiple HMO options 

and multiple PPO options in one service area.

8 For this analysis, we depart from past practice and show all 

plan bids weighted equally regardless of enrollment. 

9 Some zero-premium plans include a supplemental benefit 

of a rebate of some or the entire Part B premium. Enrollees 

in these plans would pay a lower net Part B premium than 

beneficiaries remaining in FFS Medicare.

10 See Chapter 7 a more detailed explanation of out-of-pocket 

spending for Part D benefits.

11 Enrollees in PFFS plans without drug coverage can enroll in a 

stand-alone PDP.

12 Some regional SNPs for dual eligibles have out-of-pocket 

limits below $1,000, but it is unclear whether enrollees would 

be responsible for the copayments anyway.

13 PACE is a separate integrated Medicare and Medicaid 

program. It is included neither in SNP nor MA authority.

14 MMA granted CMS the authority to waive regular MA 

enrollment rules, but not payment methodologies.

15 In addition, CMS is exploring the feasibility of implementing 

a frailty factor. This factor is used for PACE and 

demonstration plans that serve frail, community-dwelling 

beneficiaries and is intended to improve the accuracy of 

predicting costs by considering beneficiaries’ difficulties with 

activities of daily living for the entire MA program, but CMS 

has said that the earliest it could take effect is 2008.

16 A few SNPs are transitioning from demonstrations where their 

relationship with the state has already been worked out.

17 Until the implementation of Part D in 2006, Medicaid covered 

most outpatient prescription drugs.

18 After three consecutive months of nonpayment of premium, 

plans may disenroll a beneficiary. Plans can elect to charge a 

premium but not collect it from members who are unable to 

pay. However, they are not allowed to advertise that they 

do this.

19 In general, providers can not bill the dual eligible for any 

portion of the coinsurance unless the state charges a nominal 

Medicaid copayment for the service.

20 Long-term care is often considered to be a very expensive 

and difficult benefit to integrate. Even some Evercare plans 

targeted at institutional beneficiaries have not taken this on.

21 The model was tested through CMS (then the Health Care 

Financing Administration) demonstration projects that 

began in the mid-1980s. The Balanced Budget Act of 1997 

established the PACE model of care as a permanent entity 

within the Medicare program and enabled states to provide 

PACE services to Medicaid beneficiaries as a state option.

22 CMS approved 44 SNPs’ applications for passive enrollment, 

but only 42 plans passively enrolled their members. The 

states affected were Arizona, California, Colorado, Florida, 

Kentucky, Minnesota, New Jersey, Oregon, Pennsylvania, 

Tennessee, Texas, Utah, and Washington (McClard 2006). 

23 MA plans are offered by MA organizations, which sign 

contracts with CMS. 

Endnotes
Report to the Congress: Increasing the Value of Medicare | June 2006 223

Anderson, Gerard F. 2005. Medicare and chronic conditions. New 

England Journal of Medicine 353, no. 3 (July 21): 305–309. 

Atherly, Adam, and Bryan Dowd. 2005. The effect of Medicare 

Advantage payments on dually eligible Medicare beneficiaries. 

Health Care Financing Review 26, no. 3 (Spring) 93–103.

Centers for Medicare & Medicaid Services, Department of Health 

and Human Services. 2006a. Medicare personal plan finder. 

http://www.medicare.gov/MPPF.

Centers for Medicare & Medicaid Services, Department of Health 

and Human Services. 2006b. Special needs plans: Fact sheet 

& data summary. http://www.cms.hhs.gov/SpecialNeedsPlans/

Downloads/finalSNPfactsheetsum2-14-06.pdf. 

Centers for Medicare & Medicaid Services, Department of 

Health and Human Services. 2005a. Announcement of calendar 

year (CY) 2006 Medicare Advantage payment rates. http://

www.cms.hhs.gov/MedicareAdvtgSpecRateStats/Downloads/

Announcement2006.pdf.

Centers for Medicare & Medicaid Services, Department of 

Health and Human Services. 2005b. Medicare Advantage 2006 

call letter. Baltimore: CMS. April. http://www.cms.hhs.gov/

BenePriceBidFormPlanPackage/Downloads/2006CallLetter.zip.

Elam, Linda. 2006. Dual eligibles. Kaiser Commission on 

Medicaid and the Uninsured. http://www.kaiseredu.org/tutorials/

Duals/Duals_Elam.ppt.

Mathematica Policy Research, Inc. 2006. Medicare Advantage: 

Special needs plans site visits. www.medpac.gov. Forthcoming.

McClard, Jane. 2006. Telephone message to author, May 2.

Medicare Payment Advisory Commission. 2005. Report to 

the Congress: Issues in a modernized Medicare program.

Washington, DC: MedPAC.

Medicare Payment Advisory Commission. 2004a. Report to the 

Congress: Benefit design and cost sharing in Medicare Advantage 

plans. Washington, DC: MedPAC.

Medicare Payment Advisory Commission. 2004b. Report to 

the Congress: New approaches in Medicare. Washington, DC: 

MedPAC.

Thorpe, K. E., A. Atherly, and K. Howell. 2002. 

Medicare+Choice: Who enrolls? www.bcbshealthissues.com/

relatives/19526.pdf. 

Walsh, E. G., A. M. Greene, S. Hoover, et al. 2003. Case studies 

of managed care arrangements for dually eligible beneficiaries.

RTI International, contract no. CMS–500–95–0048, September 

26.

References

Medicare’s use of clinical and 

cost-effectiveness information

CHAPTER10

Report to the Congress: Increasing the Value of Medicare | June 2006 227

Chapter summary

Policymakers are looking for ways to use Medicare’s resources more 

efficiently and to address the long-term sustainability of the program. 

Cost-effectiveness analysis is a technique for comparing the costs and 

health outcomes of various clinical strategies. It shows the relative value 

of alternate services, including drugs, devices, diagnostic and surgical 

procedures, and medical services. Cost effectiveness has the potential to 

promote care that is more efficient and of higher quality. 

Some researchers contend that the benefits from technological 

innovations more than justify the rising costs of health care (Cutler 

and McClellan 2001). By contrast, other researchers question whether 

spending more on medical care always leads to improved outcomes 

(Fisher et al. 2003). Skinner and colleagues (2006) found that regions 

experiencing the largest spending gains were not realizing the greatest 

improvements in patient outcomes. For at least one condition (acute 

myocardial infarction), survival gains have stagnated while spending 

has continued to increase since 1996. 

In this chapter

• Do cost-effectiveness ratios 

vary for colorectal cancer 

screening and ICDs? 

• Improving the comparability 

of cost-effectiveness 

analyses 

• Future issues 

Medicare’s use of clinical and 

cost-effectiveness information

10 C H A P T E R 
228 Medicare’s use of clinical and cost-effectiveness information

CMS considers clinical effectiveness information when making national 

coverage decisions and paying for some services. By contrast, Medicare 

does not consider the cost effectiveness of a new service. The variability of 

the methods used in cost-effectiveness studies was one of several issues that 

stakeholders raised when CMS unsuccessfully tried to include a service’s 

cost effectiveness or value in the national coverage process in 1989 

and 2000.

Different methods used in cost-effectiveness studies can produce disparate 

results from evaluations of the same services and illnesses (Pignone et 

al. 2002). Published recommendations for conducting and reporting 

such evaluations do not cover every aspect of a study’s design. In the 

Commission’s June 2005 report, we concluded that before Medicare could 

routinely use cost-effectiveness analysis, policymakers would need to 

address concerns about its methods, such as how to measure outcomes and 

costs (MedPAC 2005). 

In this chapter, we consider the variability of the results across costeffectiveness studies for the same service. We provide results of a review 

of the methods and findings from cost-effectiveness studies published in 

the medical literature for two Medicare-covered services—screening for 

colorectal cancer and implantable cardioverter defibrillators (ICDs) (Cohen 

et al. 2006). 

This review shows some challenges and opportunities for the use of 

cost-effectiveness information by Medicare. Although some of the 

assumptions used across studies are consistent, differences in the models 

used, populations and comparators studied, and the clinical data and costs 

considered all contribute to the variation in the cost-effectiveness ratios for 

both services. 

Despite the variation in the cost-effectiveness ratios for colorectal cancer 

screening, the literature suggests the service’s clinical effectiveness and good 

value. By contrast, the literature for ICDs does not provide a clear indication 
Report to the Congress: Increasing the Value of Medicare | June 2006 229

of the service’s cost effectiveness because the results vary substantially 

across studies. The main reasons for this variation for this service are 

differences in the clinical characteristics of patients and the effectiveness of 

ICDs as measured by major clinical trials. 

The Commission plans to explore ways for the Secretary to develop 

the infrastructure to consider information on both the clinical and cost 

effectiveness of a service. We will look at issues such as whether Medicare 

should solely sponsor and fund the research or whether a public–private 

partnership is appropriate. We will also examine how Medicare would set 

priorities for which cost-effectiveness analyses to sponsor.

The Commission also intends to explore other ways Medicare can use this 

information. Among these are: 1) providing cost-effectiveness information 

to beneficiaries and health professionals; 2) using cost-effectiveness analysis 

to prioritize pay-for-performance, screening, and disease management 

initiatives; and 3) using cost-effectiveness information in Medicare’s 

rate-setting process. We also plan to explore the use of cost-effectiveness 

information by other payers in the United States and internationally. Report to the Congress: Increasing the Value of Medicare | June 2006 231

Considering evidence about the clinical and cost 

effectiveness of health services might increase the return 

on society’s investment in health care. Cost effectiveness 

evaluates the clinical effectiveness and resource costs of 

two or more alternate services, including drugs, medical 

devices, surgical and diagnostic procedures, and medical 

treatment strategies. 

In this chapter, we consider the variability of results across 

cost-effectiveness studies for colorectal cancer screening 

and implantable cardioverter defibrillators (ICDs). 

Although some of the assumptions used across studies 

are consistent, differences in the models used, populations 

and comparators studied, and the clinical data and costs 

considered result in variation in the findings across 

studies. The two case studies help us understand why 

such variation occurs and assists us in thinking about how 

Medicare might use cost-effectiveness information. 

The Commission plans to explore ways for the Secretary 

to develop an infrastructure to consider information on 

both the clinical and cost effectiveness of a service. We 

will look at issues such as whether Medicare should solely 

sponsor and fund the research or whether a public–private 

partnership is appropriate. 

Background

Cost-effectiveness analysis involves estimating the costs 

and health outcomes of a service and its alternatives, 

which may include no treatment. Researchers usually 

summarize their results in a series of cost-effectiveness 

ratios that show the cost of achieving one unit of health 

outcome for different kinds of patients and alternate 

services. Services include drugs, devices, diagnostic and 

surgical procedures, and medical treatment.

Researchers can use different methods to assess the cost 

effectiveness of a service, which results in variation 

in cost-effectiveness ratios across studies. The term 

“methods” includes researchers’ choice of:

• the costs and outcomes to be measured;

• the overall assessment approach (trial-based or 

modeling); 

• the patient populations to be analyzed; 

• the services and comparators to be analyzed; 

• the time horizon to measure services’ costs and 

outcomes; and

• the sources of clinical effectiveness, outcomes, and 

cost information. 

The different design methods are not the only reason costeffectiveness ratios for a specific service may vary across 

studies. The variation also stems from how analysts model 

the clinical course of an illness and from differences in 

the research questions. Finally, researchers’ discretion 

may bias the results of studies when choices favor a preexisting point of view. 

Researchers have discretion in how they measure costs. 

They can count only those costs associated with medical 

treatment or define costs more broadly by including those 

associated with nonmedical services (e.g., transportation 

costs) and the value of lost productivity. Lost productivity 

measures the costs associated with lost or impaired ability 

to work or to engage in leisure activities and lost economic 

productivity due to death. The researcher’s viewpoint 

influences the method of defining costs. A societal 

perspective includes all costs—medical, nonmedical, and 

indirect costs. By contrast, an analysis from an insurer’s 

perspective includes only those health costs that affect that 

particular insurer. 

Researchers often measure health outcomes in terms of 

life years gained or health-related quality-adjusted life 

years (QALYs). QALY is a measure of health outcome 

that assigns to each time period of a patient’s expected 

remaining years of life a weight, ranging from 0 (death) 

to 1 (perfect health), that corresponds to the quality of life 

during that period. QALYs provide a common currency 

to assess the benefits that patients gain in terms of healthrelated quality of life and survival. Some issues remain 

about the use of QALYs to inform resource allocation 

decisions (Dolan et al. 2006). For example, some analysts 

question the robustness and stability of respondents’ stated 

preferences.

There are two basic approaches to conducting a costeffectiveness analysis. In trial-based studies, researchers 

collect economic data on resource use and quality of life 

in a clinical study, such as a controlled clinical trial. In 

modeling studies, researchers combine evidence from a 

range of sources in order to answer the research question. 

Modeling studies appear more frequently in the medical 

literature partly because they are less expensive to conduct 

than trial-based studies. 
232 Medicare’s use of clinical and cost-effectiveness information

A simple modeling approach (a “statistical comparison”) 

directly compares the costs and clinical outcomes of two 

services. More complex approaches extrapolate beyond 

the period during which data are reported and extend 

results to a broader population by combining costs and 

outcomes with other assumptions. A Markov model is one 

such approach that specifies a set of health states (e.g., 

healthy, early cancer, late cancer, dead) and uses observed 

results to quantify the probability that people will move 

from one state to another during a given period of time. 

By assigning costs and outcomes to each of these states, 

Markov models can tabulate costs and outcomes for a 

population over time. 

The incremental cost-effectiveness ratio shows the tradeoffs and the value involved in choosing among services. 

For example, the cost-effectiveness ratio of a service is 

$25,000 per year of life gained if that service costs an 

additional $50,000 and extends life span by two years 

compared with its alternative. Services with low ratios are 

thought to provide greater value than services with higher 

ratios. If a service is less costly and improves outcomes 

compared with its alternative, then it “dominates” the 

alternative. Vaccinating beneficiaries for influenza 

dominates a strategy of not vaccinating (Coffield et al. 

2001).1

Other methodological issues that researchers must address 

when designing cost-effectiveness studies include:

• The patient population. Researchers can include 

all patients in an analysis or a subset of interest to a 

payer—such as Medicare beneficiaries.

• The services and comparators to be analyzed.

Researchers compare the service of interest to all or a 

subset of existing standards of care, which can include 

no treatment.

• The time horizon. Researchers must choose the period 

of time to measure a service’s costs and outcomes.

• The discounting of costs and outcomes. When the 

time horizon of the analyses extends into the future, 

researchers must convert future costs and outcomes to 

their current (present) value. In doing so, researchers 

adjust the cost-effectiveness ratio for the different 

timing of costs and outcomes. Researchers frequently 

use a discount rate of 3 percent to 5 percent. 

• The sources of clinical outcomes and costs. Sources 

for clinical outcomes include randomized clinical 

trials, comparative effectiveness studies, patients’ 

medical records, health care claims, and health care 

surveys. Sources for costs include health care claims 

submitted to a payer, charges of an individual provider, 

and health care surveys. 

• The uncertainty of key variables. Sensitivity analysis 

varies the assumptions of the clinical events, costs, 

and other key variables.

Do cost-effectiveness ratios vary for 

colorectal cancer screening and ICDs? 

On behalf of the Commission, Cohen and colleagues 

(2006) reviewed the extent to which the assumptions, 

methods, and results varied across studies assessing the 

cost effectiveness of colorectal cancer screening and ICDs. 

We selected these two services because we identified 

many studies that assessed their cost effectiveness. 

Even though there is some variation in the results for 

colorectal cancer screening, the cost-effectiveness ratios 

across all studies are relatively low, suggesting that 

screening is both clinically effective and provides good 

value compared with no screening. By contrast, the 

literature for ICDs does not provide a clear indication 

of the service’s cost effectiveness compared with 

pharmaceutical treatment because the results vary more 

widely across studies. This variation is due to differences 

in the clinical effectiveness reported in clinical trials of 

this service. The different populations and comparators 

examined across the cost-effectiveness studies also 

contributed to the variation in the results. Nonetheless, the 

literature on ICDs collectively sheds light on key areas 

of uncertainty where additional data collection might be 

helpful.

Cost-effectiveness ratios for colorectal 

cancer screening show some variation 

across studies

Cohen and colleagues (2006) reviewed 26 studies that 

evaluated the use of colorectal cancer screening. The 

majority of the studies used similar assumptions to 

1) model the discount rate for both costs and benefits 

(at 3 percent), 2) quantify benefits in terms of years of 

life gained, and 3) analyze the sensitivity of the model’s 

results. The studies used different modeling approaches to 

compare the effectiveness of colorectal cancer screening 

with no screening.2

 In addition, the studies modeled 
Report to the Congress: Increasing the Value of Medicare | June 2006 233

different screening frequencies (every 2 years, 3 years, 

5 years, and 10 years). They also compared different 

screening services (no screening to colonoscopy, virtual 

colonoscopy, double barium contrast enema, fecal 

occult blood testing, and sigmoidoscopy). Most studies 

conducted a univariate sensitivity analysis in which the 

researchers assessed the effect of varying values of key 

variables one at a time. Only one study conducted a 

multivariate sensitivity analysis.

The cost-effectiveness ratios of strategies of screening 

asymptomatic individuals for colorectal cancer compared 

with no screening show some variation across studies 

(Table 10-1). The cost-effectiveness ratios measuring the 

number of life years gained ranged from about $1,400 to 

more than $42,000 per life year gained. One study found 

that screening is both more effective and less costly than 

no screening because of lower medical spending over the 

study population’s remaining life. 

It is not surprising that the cost-effectiveness ratios vary 

across studies given that researchers assessed different 

populations and approaches to screen colorectal cancer. 

Researchers also assessed the cost effectiveness of 

screening for colorectal cancer for different time periods. 

Yet even with these different approaches, it is notable that 

the results are somewhat consistent across studies. 

The coefficient of variation (CV), which is the ratio of 

the standard deviation of cost-effectiveness ratios across 

studies divided by the mean, suggests some consistency 

among the study findings. The CVs for colonoscopy 

screening every 10 years, fecal occult blood test screening 

every year, and fecal occult blood test screening every two 

years were 0.37, 0.44, and 0.45, respectively. CVs less than 

1.0 imply that the standard deviation is less than the mean, 

which indicates the results do not vary substantially. 

Differences in the cost-effectiveness ratios also stem partly 

from the assumptions used to model the effectiveness of 

a screening strategy, including the biological behavior 

of colon cancer, the effectiveness and adverse effects 

associated with each screening strategy, and the likelihood 

that patients will actually complete the tests required for 

a given screening strategy. For example, assumptions 

about the duration of the precancerous and early cancer 

detectable phases (dwell time) affect the results. If the 

dwell time is long, strategies that involve a highly accurate 

test at a less frequent interval (e.g., screening colonoscopy 

every 10 years) will appear to perform well compared with 

a more frequent but less accurate test, such as annual fecal 

occult blood testing. 

Cost-effectiveness ratios vary substantially 

across ICD studies 

Cohen and colleagues (2006) reviewed 14 studies 

assessing the cost-effectiveness of ICDs. The majority of 

studies used similar assumptions to 1) conduct the analysis 

from the perspective of the health care payer; 2) model 

the discount rate for both costs and benefits (at 3 percent); 

3) quantify benefits in terms of life years gained; and 4) 

analyze the sensitivity of the model’s results. The studies 

varied somewhat in the modeling approaches they used to 

estimate the incremental benefits and costs of ICDs versus 

pharmaceutical treatment or no treatment.3

 Most studies 

conducted either a univariate or multivariate sensitivity 

analysis; 4 of the 14 studies did not analyze the effect of 

varying the assumptions of key variables. 

The cost-effectiveness ratios vary widely across 

studies. The cost-effectiveness ratios of ICDs versus 

pharmaceutical treatment range from $18,000 to $569,000 

per year of life gained (Cohen et al. 2006). Three studies 

found that the use of ICDs was less effective and more 

TABLE

10–1 Cost-effectiveness ratios for

 colorectal cancer screening compared

 with no screening vary across studies

Cost-effectiveness ratio

(Dollars per life year)

Screening 

strategy Frequency Low end High end

Colonoscopy Every 3 years $21,763 *

Every 5 years 17,316 $36,612

Every 10 years 10,633 26,693

Fecal occult 

blood testing

Annually

Every 2 years

 4,643

 2,942

 25,860

 10,861

Sigmoidoscopy Annually 1,391 *

Every 3 years 16,318 20,727

Every 5 years** 14,384 42,310

Every 10 years 24,226 *

Note: The cost-effectiveness ratio is given in 2004 dollars per life year gained.

*Based on the results of one study. 

**One study reported that sigmoidoscopy screening every 5 years was 

dominant (lower costs and better outcomes) compared with no screening.

Source: Cohen et al. 2006.
234 Medicare’s use of clinical and cost-effectiveness information

costly than pharmaceutical treatment. The ratios of ICDs 

versus no treatment range from $60,000 to $258,000 per 

life year gained. One study found that ICDs reduce costs 

and improve outcomes compared with no treatment. 

It is not surprising that the range of cost-effectiveness 

ratios is large because these studies analyzed patient 

populations with different clinical characteristics obtained 

from multiple clinical trials. The costs and benefits of 

ICDs vary depending on patients’ risk of mortality. Factors 

affecting risk include:

• whether the patient has experienced a life-threatening 

arrhythmia (secondary prevention patients) or not 

(primary prevention patients); 

• the extent of heart damage as measured by the 

pumping capacity of the heart’s left ventricle—the 

ejection fraction; and

• other factors, such as whether the patient was 

undergoing concomitant bypass surgery or had an 

acute myocardial infarction. 

For example, among primary prevention patients, the 

cost effectiveness of ICDs varied based on the patient’s 

ejection fraction. ICDs were more cost effective for 

patients with an ejection fraction of less than 30 percent 

than for patients with an ejection fraction greater than 40 

percent ($53,000 versus $230,000 per year of life gained 

(Hlatky et al. 2005)).4

 Another study showed that ICD 

therapy had higher costs and worse clinical outcomes 

compared with non-ICD medical therapy among primary 

prevention patients who were also undergoing concomitant 

bypass surgery or who had an acute myocardial infarction 

(Sanders et al. 2005).

The disparity in the results from multiple clinical trials 

is due to differences in their design. There are at least 10 

major trials comparing ICDs to a control group (Hlatky 

et al. 2005). Sanders and colleagues (2005) linked the 

variability in ICD clinical trial results to: 1) differing 

characteristics of the populations studied, 2) differing 

quality of the non-ICD medical therapy given to the 

control groups, and 3) differing competing risks of death 

from causes not due to ICD implantation. Clinical trials 

of ICDs in patients with a higher mortality risk will show 

a worse incremental cost-effectiveness ratio (higher costs 

and poorer outcomes) for the ICD strategy compared 

with clinical trials of ICDs in patients that have a lower 

mortality risk. 

Improving the comparability of costeffectiveness analyses 

Not all researchers follow the existing standards for 

conducting cost-effectiveness studies. Still, the methods 

that researchers employ have improved over the past 15 

years. Nevertheless, stakeholders have raised concerns 

about the variability and lack of transparency in the 

methods. 

The Panel on Cost-Effectiveness in Health and Medicine 

developed standards for conducting and reporting costeffectiveness analysis (Gold et al. 1996). The U.S. Public 

Health Service convened a panel of 13 nongovernment 

scientists and scholars in 1993. The panel recommended 

the use of a reference case (a standard set of methods and 

assumptions) to improve the comparability, reporting, and 

transparency of cost-effectiveness analyses. For example, 

they recommended that the reference case:

• discount costs and health outcomes at the same rate,

• use quality-adjusted life years to measure the 

effectiveness of the service,

• use a time horizon that is long enough to capture all 

relevant future effects of the service,

• reflect the marginal costs consumed, and 

• use a micro-costing approach to determine health care 

costs.

Despite the panel’s recommendation for a reference 

case, variation in the methods, results, and reporting 

persists across studies as evidenced by Cohen’s review 

and others (Drummond and Sculpher 2005, Jefferson 

et al. 2002). Valid comparisons of cost-effectiveness 

ratios across studies require that researchers derive 

the numerators and denominators of the ratios using 

comparable methods and assumptions and report them 

in similar terms. The reference case lays out the broad 

assumptions that researchers should use to construct these 

models. As already mentioned, researchers have discretion 

in designing the analysis. The text box provides some 

common methodological and reporting flaws of costeffectiveness analyses.

Consider the discretion researchers have in modeling the 

clinical course of an illness. The lack of consistency of the 

clinical assumptions can result in economic evaluations of 

the same disease showing different results. Eddy (2005) 
Report to the Congress: Increasing the Value of Medicare | June 2006 235

found that 5 models produced widely different estimates 

of the likelihood a diabetic would have a heart attack in 

20 years. Even though each model used the same medical 

treatment costs and quality weights, the cost-effectiveness 

ratios varied substantially (–$10,000 to nearly $40,000 

per QALY) because of the different ways each evaluation 

modeled the clinical course of diabetes.

The variation in the methods and potential bias of 

researchers is not unique to cost-effectiveness studies. 

The design of randomized clinical trials—including the 

population of patients studied, the method of randomizing 

patients, and the study time frame—can vary across 

studies for any given service. Consequently, the clinical 

effectiveness found in clinical trials can vary. Some 

researchers are also concerned that the reporting of 

randomized clinical trials in the literature is not transparent 

and needs improvement (Moher et al. 2001). For example, 

a review of 122 recently published randomized clinical 

trials found that only one paper described randomization 

adequately (Hotopf et al. 1997). Bekelman and colleagues 

(2003) showed that industry-sponsored studies were 

significantly more likely to reach conclusions that were 

favorable to the sponsor than were nonindustry-sponsored 

studies. 

While the methods of cost-effectiveness studies vary, 

the quality of some studies has improved over time. 

Neumann and colleagues (2005) noted improvement 

in the methods used in studies published between 1998 

and 2001 compared to studies published from 1976 to 

1997. Studies published in the later period presented the 

study perspective more clearly, discounted both costs and 

outcomes, and reported incremental ratios. Jefferson and 

colleagues (2002) concluded that modest improvements 

occurred in the quality and methods of studies published 

from 1990 to 2001. 

The variability of the methods and assumptions is not 

the only concern that stakeholders have raised about 

Medicare’s use of cost-effectiveness information. Some 

stakeholders are concerned that Medicare’s use of costeffectiveness information might:

• impair beneficiaries’ access to certain services,

• ration care rather than promote appropriate care, 

• slow innovation, and 

• interfere with the practice of medicine.

Common methodological and reporting flaws of cost-effectiveness analyses

Drummond and Sculpher (2005) noted 11 

methodological and reporting shortcomings 

of cost-effectiveness analyses, focusing on 

those flaws that are likely to be most important when 

deciding on payment for, or coverage of, a service:

• omitting important costs and outcomes,

• omitting one or more alternate services, 

• imprecisely comparing the clinical effectiveness of 

alternate services by using information from more 

than one clinical trial,

• not using all available clinical evidence, 

• incorrectly modeling outcomes beyond the period 

observed in clinical studies,

• relying on assumptions rather than data,

• inadequately assessing the impact of uncertainty on 

the results,

• not sufficiently reporting all of the results such as the 

costs and health effects of each service, 

• reporting average cost-effectiveness ratios (total 

costs divided by total health effects for the 

two services being compared) rather than the 

incremental ratio (the difference of the total costs 

divided by the difference of the total health effects 

between two services),

• not sufficiently reporting on the generalizability of 

the results, and

• selectively reporting results and placing undue 

emphasis on certain results. 236 Medicare’s use of clinical and cost-effectiveness information

Some researchers contend that resistance to costeffectiveness analysis may be cultural: Americans do not 

believe that resources are limited, accept limits imposed 

upon them by payers, or want to consider the tradeoffs between health costs and benefits (Ginsburg 2004, 

Neumann 2004). 

Potential strategies to improve the 

comparability of results across studies

Cost-effectiveness analysis will be most useful to 

policymakers when the results are comparable across 

studies and services. The Commission highlights four 

strategies that may improve the comparability of results 

across studies: 

• improving transparency in the reporting of studies, 

• validating clinical models against real-world 

outcomes, 

• using validated and accepted instruments for quality 

assessments, and

• increasing the availability of information about the 

effectiveness of alternate services.

Improving the transparency in the reporting of both 

publicly and privately funded studies might alleviate 

concerns about methods and potential biases. One option 

is for researchers to post their economic models and 

data on the internet (Rennie and Luft 2000). Doing so 

would permit all interested users to test the sensitivity 

of results to different assumptions and data. Posting the 

models might permit users to change multiple elements 

by inserting their own data. The Academy of Managed 

Care Pharmacy’s guideline for submission of clinical 

and economic data calls for manufacturers to submit 

an electronic version of their cost-effectiveness model 

(AMCP 2005). However, some researchers may be 

concerned about the public availability of their models 

because of proprietary reasons. Mandatory posting might 

undercut researchers’ incentive to develop new models. 

Validating clinical models used in cost-effectiveness 

analyses against real world outcomes might reduce 

some of the variability of the results across studies. 

Some of the variation in cost-effectiveness ratios stems 

from researchers using different clinical models that 

use different assumptions about the course of disease 

progression. Posting validated clinical models on the 

internet would provide access to all users and might reduce 

the variability of clinical models used in cost-effectiveness 

studies. 

Using validated and accepted instruments for measuring 

health outcomes, such as QALYs, might also reduce 

some of the variability of the results across studies for the 

same service. Differences in the methods used to estimate 

QALYs could lead to variation of the findings across costeffectiveness studies for the same illness.

Increasing the availability of evidence about the 

effectiveness of alternate services may enhance the quality 

of cost-effectiveness research. Comparative effectiveness 

reviews assess the clinical effectiveness of one treatment 

compared with its alternatives by reviewing the medical 

literature. One valuable source of this information is the 

Agency for Healthcare Research and Quality (AHRQ). 

The Medicare Prescription Drug, Improvement, and 

Modernization Act of 2003 (MMA) required that AHRQ 

conduct and support research with a focus on outcomes, 

comparative clinical effectiveness, and appropriateness 

of pharmaceuticals, devices, and health care services. 

AHRQ is currently studying 10 conditions that affect 

Medicare beneficiaries including arthritis, cancer, chronic 

obstructive pulmonary disease, asthma, diabetes, and 

dementia (e.g., Alzheimer’s disease).5

Another group conducting comparative effectiveness 

reviews is Oregon’s Center for Evidence-Based Policy. 

The Center’s Drug Effectiveness Review project is a 

collaborative effort of 15 organizations (13 of them 

are states) to obtain the best available effectiveness 

comparisons between drugs in the same class through 

reviews of the existing medical literature.

Another promising data source for effectiveness 

information is Medicare’s administrative claims database. 

Medicare’s inpatient, outpatient, and drug claims together 

offer analysts the ability to: 1) focus on the elderly and 

disabled populations, 2) compare real-world outcomes 

across different providers and settings, and 3) analyze side 

effects that may go underreported in small clinical trials 

(Hunter 2006). Analysts will need to address limitations 

and general lack of limited clinical information available 

within administrative claims data. For some analyses, 

analysts may also need to obtain additional information 

not reported on claims, such as lifestyle factors that may 

affect treatment outcomes. One concern about using 

administrative claims data is that patients who received 

a specific service may have different demographic or 

clinical characteristics than patients who received one of 
Report to the Congress: Increasing the Value of Medicare | June 2006 237

the comparators studied. Researchers can use statistical 

methods (e.g., multivariate regression) to control for 

differences in characteristics between treatment groups. 

Head-to-head clinical trials are important sources of 

effectiveness information, but they are not conducted as 

frequently as placebo-controlled trials. To gain approval 

to market a drug or device by the Food and Drug 

Administration (FDA), most manufacturers conduct trials 

of a service’s efficacy by comparing it with a placebo (an 

inactive treatment), which is not evidence of a service’s 

effectiveness relative to another service. The National 

Institutes of Health is the largest federal sponsor of headto-head trials. Other federal agencies that fund these trials 

include AHRQ and the Veterans Health Administration. 

Manufacturers of medical products also sponsor these 

trials. However, conducting head-to-head trials is not the 

primary mission of any public or private organization 

(Tunis 2003). The Commission plans to examine total 

spending and the share of each agency’s budget devoted to 

conducting head-to-head trials. 

CMS is beginning to gather information about a service’s 

effectiveness in the national coverage process. Under 

coverage with evidence development (CED), CMS 

extends national coverage to a service that, in the past, 

the agency might not have covered due to lack of data 

about its clinical appropriateness. National coverage of a 

service may be limited to providers who participate in and 

beneficiaries who enroll in a prospective data collection 

activity. The goal of CED is to ensure that patients are 

receiving care that is reasonable and necessary given 

their specific clinical condition (CMS 2005).6

 CED may 

ultimately provide patients, providers, and researchers an 

opportunity to learn about a service’s value in real-world 

settings. The agency may require CED for services:

• that are in new classes with new mechanisms;

• that may be effective for only certain types of patients;

• that have demonstrated major advances over prior 

treatments, suggesting that they could benefit patients 

with other conditions; and

• that may have substantial consequences for treating 

the wrong patients.

Services for which CMS has required CED include 

ICDs; carotid artery stenting; off-label, unlisted uses of 

drugs approved for colorectal cancer; and certain types 

of imaging services for cancer diagnosis, staging, and 

monitoring. 

Increasing the availability of comparative effectiveness 

data would overcome one potential limitation of costeffectiveness studies—using data from more than one 

randomized clinical trial to estimate the clinical effect 

of alternate services (Drummond and Sculpher 2005). 

Researchers use data from multiple clinical trials because 

comparative effectiveness information is not always 

available. Using information from more than one clinical 

trial might lead to inaccurate comparisons if 1) patients 

enrolled in the various trials are not equivalent in terms 

of baseline risk, 2) the settings for the trials are not 

comparable, and 3) the clinical endpoints are measured 

differently. Thus, an apparent superiority for one service 

versus another, derived from using data from more than 

one clinical trial, might be due to differences in the trials 

rather than differences between the therapies.

Future issues 

The Commission plans to consider the issues associated 

with Medicare sponsoring new research and developing 

the infrastructure needed to review cost-effectiveness 

information from the existing literature. Key questions 

include: 

• Who would sponsor the research?

• Who should pay for the research? 

• What services could Medicare focus on?

• What methodological issues might Medicare consider? 

• How could Medicare use cost-effectiveness 

information?

• Are there any lessons to learn from other payers and 

providers in the United States and from other countries 

that are using cost-effectiveness information?

Who would sponsor the research?

Medicare, alone or with other public payers and private 

groups, may need to sponsor additional research. This 

additional research could entail reviewing the medical 

literature and designing studies (models and head-to-head 

trials) assessing services’ cost effectiveness. 

One option is for the Department of Health and Human 

Services (HHS) to sponsor effectiveness research. 

Potential agencies include CMS and AHRQ. Both agencies 
238 Medicare’s use of clinical and cost-effectiveness information

already sponsor and conduct reviews about the clinical 

effectiveness of services. AHRQ has taken some steps in 

looking at cost effectiveness through its evidence-based 

practice centers. 

Alternatively, HHS, other public payers (e.g., the Veterans 

Health Administration and state Medicaid agencies), and 

private plans, payers, and purchasers could jointly sponsor 

clinical and cost-effectiveness studies. Private sector 

groups already sponsor comparative clinical effectiveness 

studies. For example, the Blue Cross Blue Shield 

Evaluation Center, which provides technology assessments 

to subscribing commercial health plans and provider 

groups, uses an evidence-based process for assessing the 

clinical effectiveness of services (Garber 2001). 

The increased role of the federal government in sponsoring 

clinical and cost-effectiveness research may be warranted 

because this research is a public good. Effectiveness 

research has generally not been forthcoming from private 

health plans and providers. Sponsoring this research may 

not be in any single plan’s or payer’s interest because 

it is problematic to keep the information proprietary, 

and it might be difficult to capture the full return on the 

investment (Neumann 2005). Cost-effectiveness analysis 

may have a more important role for Medicare because the 

program covers patients over a longer time period (from 

age 65 to death) than do most private payers.

A public–private partnership may more effectively address 

concerns raised by stakeholders about the use of costeffectiveness analysis than a noncollaborative process. 

Private payers may be reluctant to make extensive use of 

cost-effectiveness information out of fear that patients will 

criticize them about being more concerned about profits 

than about patients’ health. Litigation risks may also 

dissuade some private payers from using cost-effectiveness 

information (Jacobson and Kanna 2001). As discussed 

earlier, stakeholders raised a number of concerns about 

Medicare’s use of cost-effectiveness analysis, including 

that it could harm beneficiaries’ access to care and reduce 

innovation of new services. Public payers may also be 

reluctant to use cost-effectiveness information out of 

fear that beneficiaries will perceive their care as being 

second rate. A public–private partnership may also be 

advantageous because it would send a clear and effective 

signal to researchers to improve their methods and develop 

valid and transparent cost-effectiveness analyses. 

Federal agencies or independent groups could 

conduct cost-effectiveness analyses

CMS already assesses the clinical effectiveness of services 

when making national coverage decisions and paying 

for some services.7

 In some cases, CMS supplements its 

research by sponsoring outside groups, such as AHRQ, 

to conduct technology assessments and consulting with 

the Medicare Coverage Advisory Committee (MCAC). A 

technology assessment studies the medical, social, ethical, 

and economic implications of the development, diffusion, 

and use of services. The MCAC advises CMS on whether 

a specific service is reasonable and necessary under 

Medicare by reviewing and evaluating medical literature, 

reviewing technology assessments, and examining data 

and information on the effectiveness and appropriateness 

of the service under consideration (CMS 2006a).8

AHRQ has taken several steps in constructing an 

infrastructure to conduct comparative effectiveness 

reviews of health care services. AHRQ created evidencebased practice centers in 1997 to synthesize existing 

scientific literature about health care topics and to promote 

evidence-based practice and decision making. There are 

currently 13 centers, which include academic institutions 

and private research organizations.9

 The centers are 

conducting comparative effectiveness reviews of 10 health 

conditions affecting older people including dementia, 

arthritis, and diabetes. This research fulfills the MMA 

mandate that AHRQ conduct and support research with a 

focus on outcomes, comparative clinical effectiveness, and 

appropriateness of pharmaceuticals, devices, and health 

care services.

AHRQ has also developed the infrastructure to conduct 

technology assessments that CMS requests when making 

national coverage decisions. These technology assessments 

examine the clinical outcomes of one or more health 

care services. AHRQ conducts technology assessments 

in-house or collaborates with its evidence-based practice 

centers. 

The agency also assists other federal agencies with 

developing cost-effectiveness analyses. For example, CMS 

requested that AHRQ assess the cost effectiveness of drugs 

used to treat rheumatoid arthritis and multiple sclerosis 

under a MMA-mandated demonstration (CMS 2006b). 

This demonstration, which began on September 1, 2004, 

and ended on December 31, 2005, paid for selected drugs 

for cancer, multiple sclerosis, and rheumatoid arthritis that 

replaced drugs covered under Part B. (In 2006, the Part D 
Report to the Congress: Increasing the Value of Medicare | June 2006 239

program provides coverage for the drugs paid for under 

the demonstration.) As another example, in 2003 AHRQ 

completed an assessment of the cost effectiveness of fecal 

occult blood tests for CMS.

Since 1985, almost 10 percent of AHRQ’s extramural 

research grants have included a clinical economic 

component (AHRQ 2006). For example, AHRQ funded a 

study to determine the cost effectiveness of lung-volume 

reduction surgery for patients with severe emphysema. 

This study paralleled a trial sponsored by CMS and the 

National Heart, Lung, and Blood Institute comparing lungvolume reduction surgery to medical therapy for severe 

emphysema.

Alternatively, sponsoring entities could create an 

independent agency to conduct the effectiveness analyses. 

The National Institute for Health and Clinical Excellence 

(NICE) in the United Kingdom is an independent 

group that develops guidance for the National Health 

Service (NHS) in England and Wales on the clinical 

and cost effectiveness of medical services. Established 

in 1997, NICE relies on academic centers to assess 

the effectiveness of drugs, medical devices, diagnostic 

techniques, medical and surgical procedures, and the 

clinical management of specific conditions (Sculpher 

2005). 

Who should pay for the research?

One option for funding is for the Congress to appropriate 

funds to a public agency (e.g., HHS) to conduct clinical 

and cost-effectiveness analyses. Doing so would require 

policymakers to annually consider the priority of such 

research compared with other health programs. However, 

variations in the level of federal appropriations may reflect 

the budget cycle rather than the priority of the research. 

Another option is to dedicate some percentage of general 

revenues to fund effectiveness research.

Discretionary funding from private groups—such as 

private plans and payers and manufacturers of drugs, 

biologics, and medical devices—could also be vulnerable 

to budget uncertainties. Private sponsors might decide to 

withhold or withdraw funding for any number of reasons, 

such as disagreeing with the selection of a service for 

consideration. In addition, this mechanism might be open 

to conflict of interest. The influence of private groups who 

directly fund the research on a study’s design and findings 

could be a concern. 

Another alternative is a method that is not linked to 

either annual federal appropriations or discretionary 

funding from private groups. For example, one analyst 

suggested that a specified percentage of sales from 

drug manufacturers, health plans, and pharmacy benefit 

managers may be an appropriate and available mechanism 

for funding needed effectiveness research (Reinhardt 

2004). 

Which services could Medicare focus on?

Medicare could select services based on disease 

prevalence, high per unit cost, high expenditures, or 

other factors. One option is to use the same criteria that 

CMS uses in its national coverage process. CMS initiates 

such a review if the service: 1) represents a significant 

advance, and no similar service is currently covered under 

Medicare; 2) is the subject of controversy among medical 

experts as to its medical effectiveness; 3) is currently 

covered but is widely considered ineffective; and 4) may 

be either significantly underutilized or overutilized. 

Another option is to consider both the differences in cost 

and quality of alternate services (Figure 10-1). Medicare 

could begin to look at groups of services used to treat 

a specific illness that have small differences in quality 

but large differences in cost (quadrant D in Figure 10-1). 

Focusing on these services might increase the return on 

FIGURE

10–1 Selecting services for 

cost-effectiveness analysis based on 

differences in their costs and quality

Quality difference

Cost difference

Smaller Larger

Smaller

Larger

A B

C D
240 Medicare’s use of clinical and cost-effectiveness information

society’s investment in health care. By contrast, formal 

cost-effectiveness analyses may not be as needed for 

services with small differences in quality and costs. 

Medicare may find it most difficult to consider the costeffectiveness of services with large differences in cost and 

quality. It may be a matter of judgment to decide where 

given services fall in the continuum of cost and quality 

differences. 

It is worth noting that cost-effectiveness analysis may not 

save the Medicare program money. Wider use of costeffective, underutilized services might result in increased 

Medicare spending, which might not be offset with savings 

elsewhere. For example, McGlynn and colleagues (2003) 

reported on the underuse of clinically effective treatments. 

Promoting the use of such services could increase 

Medicare spending. On the other hand, over the long run, 

cost effectiveness could save the Medicare program money 

if it encourages manufacturers to develop services that 

are more cost effective than current ones or helps inform 

providers and influences their patterns of care. 

What methodological issues might 

Medicare consider? 

Medicare will need to consider the procedures for 

evaluating cost-effectiveness information and the 

methods for conducting cost-effectiveness analyses. For 

example, should studies limit the population to Medicare 

beneficiaries or patients of all ages? Should costs be 

limited to Medicare payments? Should the model include 

all costs—taking the societal perspective? Should the 

analysis measure outcomes using QALYs or another 

method such as life years gained? 

To help frame the methodological issues, Medicare—

along with other public and private groups—could 

review the guidelines developed by the Panel on CostEffectiveness in Health and Medicine. It might also be 

useful to examine current standards developed by other 

groups such as the formulary guideline developed by the 

Academy of Managed Care Pharmacy for submission 

of clinical and economic data (AMCP 2005). The goal 

of the academy’s guideline is to standardize the set of 

clinical and economic evidence that manufacturers submit 

to health plans. The guideline includes the layout for the 

submission of clinical and economic data to health plans 

and recommends that manufacturers include unpublished 

studies, data on off-label indications, related disease 

management strategies, and an economic model to provide 

evidence of the product’s value.

Bringing together users and researchers might foster 

a more collaborative relationship between all parties. 

Nonetheless, different payers may have different 

perspectives and needs, which may result in variations 

in some aspects of the design of studies across payers. 

For example, a payer may ultimately decide to limit the 

study population to the patients it covers (not all patients) 

and only include the costs of services that it pays for (not 

societal costs).

How could Medicare use cost-effectiveness 

information? 

Cost effectiveness has the potential to identify medical 

services that are more likely to improve patient outcomes 

and discourage the use of services with fewer benefits. As 

the field of cost effectiveness evolves and as Medicare and 

others address methodological issues, Medicare could use 

cost-effectiveness information in a variety of ways. 

The program could use cost-effectiveness information 

to cover a service for all Medicare beneficiaries or for 

beneficiaries with specific clinical or demographic 

characteristics. However, the coverage process may not be 

the area to begin to use this information. As we mentioned 

earlier, stakeholders raised many concerns when CMS 

tried to use the information in the national coverage 

process. Rigid use of cost-effectiveness information in the 

coverage process may not be consistent with Americans’ 

fear of limits set by public and private organizations and 

affinity for new medical technology (Neumann 2005, 

Neumann 2004). Rather, Medicare might want to begin 

to use cost effectiveness to inform providers and patients 

about the value of services and to develop payment 

policies that account for a service’s value.

Medicare could provide cost-effectiveness information to 

beneficiaries and health professionals. Both are potential 

audiences for information about the relative value of 

treatment alternatives. Currently, the traditional Medicare 

program does not encourage providers and beneficiaries 

to weigh the costs and benefits of a service when 

making health care decisions. The program does provide 

some clinical effectiveness information about certain 

providers—dialysis facilities, hospitals, home health 

agencies, and nursing homes—but not cost-effectiveness 

information. 

There is some evidence that providers and patients 

might consider cost-effectiveness information as they 

weigh treatment options. A consortium of health-related 

organizations conducted a project in which consumers 
Report to the Congress: Increasing the Value of Medicare | June 2006 241

participated in discussion groups and physicians responded 

to a survey and participated in discussion groups on the 

use of cost effectiveness. The results suggest that the 

former are interested in obtaining better information and 

that the latter consider cost effectiveness when making 

clinical decisions (Ginsburg 2004, Sacramento Healthcare 

Decisions 2001). Anecdotal reports also suggest that some 

physicians examined both the cost and outcomes of lungvolume reduction surgery when considering this procedure 

for their patients (Kolata 2006). 

Medicare might use the information to prioritize payfor-performance measures, target screening programs, 

or prioritize disease management initiatives. A pay-forperformance program could link providers’ bonuses to 

the provision of cost-effective services. Medicare might 

weight performance bonuses higher for the most costeffective services furnished by providers. Medicare could 

consider cost effectiveness when choosing measures for 

pay-for-performance programs; there are usually more 

potential measures than are practical to use.

Cost-effectiveness analysis could measure the value 

of alternative screening strategies in different patient 

populations in order to focus provider education or 

performance incentives. Cost-effectiveness analyses could 

help inform policymakers about which subpopulations 

to target for screening, such as screening diabetics for 

chronic kidney disease. Medicare already varies coverage 

of certain screening tests (e.g., colorectal cancer and 

glaucoma) according to the risk of developing the 

illness. Covered colorectal cancer screening tests for 

prevention include: 1) an annual fecal occult blood test for 

beneficiaries age 50 and older, 2) flexible sigmoidoscopy 

every 4 years for beneficiaries age 50 and older, 3) 

colonoscopy for high-risk beneficiaries every 2 years and 

for other beneficiaries every 10 years, and 4) screening 

barium enemas every 4 years for beneficiaries age 50 and 

older who are not at high risk of developing colorectal 

cancer or every two years for beneficiaries who are at 

high risk. 

Once the analyses become more rigorous, Medicare 

could use cost-effectiveness information in the payment 

and rate-setting processes. For example, Medicare 

might require manufacturers to enter into a risk-sharing 

agreement, which links actual beneficiary outcomes 

to the payment of a service based on the service’s cost 

effectiveness. Manufacturers might rebate the Medicare 

program for services that do not meet expectations for 

their effectiveness. The program is already holding some 

providers at risk for their performance. Under Medicare’s 

Chronic Care Improvement Program, contractors assume 

risk for achieving savings and quality targets. CMS is 

adjusting contractors’ fees based on whether they achieve 

targets for program savings, clinical outcomes, and 

satisfaction. 

Alternatively, Medicare could base the payment for a 

service at the level that the cost-effectiveness analysis 

suggests that the service is effective and provides value 

to the program and beneficiaries. In its comparison of the 

cost effectiveness of fecal occult blood tests conducted for 

CMS, AHRQ determined the payment level for which the 

cost effectiveness of two tests would be equal. Medicare 

could also consider a tiered cost sharing structure that 

requires higher cost sharing for those services that show 

less value to the program and includes a beneficiary 

appeal process. Many drug formulary programs tier 

copayments. Part D plans also could use the results of 

these studies in this way. 

How do other payers and providers within 

the United States and internationally use 

cost-effectiveness information?

The Commission will review in greater detail the different 

ways that other payers and providers within this country 

and elsewhere use cost-effectiveness information. The 

approaches vary from group to group, as we show in the 

three examples in the rest of this section by summarizing 

the use of cost-effectiveness information by the Veterans 

Health Administration (VHA), in England and Wales, 

and in Washington state. We are interested in looking at 

the different ways other groups select services for review 

and how they use the information (e.g., vary the level of 

payment of services). We anticipate that this review will 

inform us about the advantages and disadvantages of 

different approaches for Medicare.

Use of cost-effectiveness information 

by the VHA 

The VHA has recently emphasized the use of costeffectiveness information for newer, costly drugs for 

inclusion in its formulary (Aspinall et al. 2005). Since 

1994, the VHA has required a formal cost-effectiveness 

analysis from manufacturers of drugs that have small 

differences in quality but large differences in cost 

compared with their alternatives. The VHA routinely 

requests manufacturers to submit clinical and economic 

data using the Academy of Managed Care Pharmacy 
242 Medicare’s use of clinical and cost-effectiveness information

format and incorporates this information into the drug 

reviews used in the formulary decision making process. 

The VHA reviews a drug’s clinical and cost effectiveness 

to determine its status on the drug formulary. The VHA 

also uses effectiveness studies to develop criteria for 

patients who are most likely to benefit clinically from a 

drug. The VHA does not use a cost-effectiveness threshold 

to determine whether to include a drug in the formulary 

because of the controversy about trying to determine what 

constitutes good value.

Use of cost-effectiveness in England and Wales

NICE develops guidance for the NHS in England and 

Wales on the clinical and cost effectiveness of medical 

services. NICE’s process for developing recommendations 

takes about 14 months to complete. The Secretary of State 

for Health formally refers technologies for guidance to 

NICE. Advisory committees identify potential services 

using criteria that include 1) high clinical need, 2) potential 

for significant health gain, and 3) potential for significant 

cost impact. The NHS uses a National Horizon Scanning 

Centre to identify significant new and emerging health 

technologies. 

NICE commissions independent academic groups to 

conduct technology assessments, which are usually 

completed in six months. Technology assessments 

include 1) a systematic review of clinical and economic 

evidence, 2) a cost-effectiveness analysis, and 3) a review 

of the manufacturer’s submission. An independent 

committee—the Appraisal Committee—prepares NICE’s 

recommendations about the use of services within the 

NHS. Manufacturers, patients, and health professionals 

can comment on the scope and findings of the 

technology assessment, submit evidence to the Appraisal 

Committee, comment on the Appraisal Committee’s draft 

recommendation, and appeal the Appraisal Committee’s 

final decision. 

The Appraisal Committee does not use a threshold to 

guide its recommendations. Nevertheless, NICE’s “Guide 

to the Methods of Technology Appraisal” states that for 

services with an incremental cost-effectiveness ratio 

greater than £30,000 (about $53,000) per QALY, “the 

case for supporting the service has to be increasingly 

strong” for the Appraisal Committee to recommend its 

use. The Appraisal Committee does consider factors other 

than clinical and cost effectiveness, such as equity, in its 

recommendations.

Use of cost-effectiveness information in 

Washington state

The governor of Washington state signed into law on 

March 29, 2006, a health technology assessment program 

to consider evidence about the safety, efficacy, and cost 

effectiveness of services. The Commission intends to track 

the implementation of this program.

The administrator of the Washington State Health Care 

Authority, consulting with participating agencies and a 

health technology clinical committee, will select services 

that the health technology committee will review. The 

newly passed law gives priority to the review of services 

for which: 

• concerns exist about safety, efficacy, or cost 

effectiveness—especially relative to existing 

alternatives—or significant variations in use;

• actual or expected state expenditures are high due to 

demand, cost, or both; and 

• adequate evidence is available to conduct the review.

The health technology committee will consist of six 

practicing physicians and five other health professionals. 

The administrator of the Washington State Health Care 

Authority, consulting with participating agencies, selects 

the committee’s members. The committee will review the 

safety, efficacy, and cost effectiveness of up to six services 

the first year of the program and up to eight services 

thereafter. Evidence-based practice centers (designated 

by AHRQ or another appropriate organization) will 

conduct the technology assessments. The committee will 

determine the conditions under which the service will be 

included as a covered benefit in programs of participating 

agencies, and if covered, the criteria that the participating 

agency administering the program must use to decide 

whether the technology is medically necessary or proper 

and necessary treatment.10 Finally, the law requires that 

the administrator develop a centralized internet site that 

provides information about the technology assessment.

Other issues to consider

Policymakers will need to consider a number of 

overarching issues when setting up the infrastructure 

for Medicare to consider clinical and cost-effectiveness 

information: ensuring transparency of the study methods 
Report to the Congress: Increasing the Value of Medicare | June 2006 243

and results to stakeholders and the timing of assessing a 

service’s cost effectiveness. 

Some stakeholders mistrust cost-effectiveness analysis 

because the methods of some studies are not transparent 

and the results are not reproducible. Ensuring the 

transparency of the process will be a key issue for 

policymakers to consider if Medicare begins to use 

cost-effectiveness information. It will be important that 

Medicare offer stakeholders the opportunity for comment 

and participation in the process.

In recent years, CMS has developed a more open and 

predictable process for scrutinizing clinical evidence on 

which to base national coverage decisions. This process 

could be a model for future deliberations on the use of 

cost-effectiveness analysis. 

Another key issue is the timing of assessing a service’s 

cost effectiveness. Researchers could study a service 

when it is not widely used by providers (before or at FDA 

approval for devices and drugs) or wait until it diffuses 

into medical practice. The results of a cost-effectiveness 

analysis could change as providers adopt the service into 

their practice. On the one hand, providers may become 

more proficient in furnishing a service over time, which 

would lower its costs while still resulting in the same 

outcome. Or, researchers may become more aware of the 

side effects of a service over time, which would increase 

its costs and result in poorer outcomes. 244 Medicare’s use of clinical and cost-effectiveness information

1 If a service is more costly than its alternative but not does 

improve outcomes, then it is “dominated” by the alternative.

2 The types of models used to assess the cost effectiveness 

of colorectal screening include Markov models and static 

models. 

3 Some studies assessed the cost effectiveness of ICDs by 

statistically comparing the experience of cohorts receiving 

ICDs to the experience of control groups, while other studies 

used a Markov model or a static model.

4 A normal ejection fraction ranges from 55 percent to 70 

percent.

5 The other conditions are: depression and other mood 

disorders, ischemic heart disease, peptic ulcer disease and 

dyspepsia, pneumonia, stroke, and hypertension.

6 CMS issued draft guidance for national coverage 

determinations with evidence development in 2005. 

7 Currently, CMS considers patient’s hematocrit level when 

paying for erythropoietin and darbepoetin alfa for dialysis 

patients. In 2003, CMS set the payment rate for a new biologic 

at the same rate as an existing biologic after concluding that 

both were functionally equivalent. The Medicare Prescription 

Drug, Improvement, and Modernization Act of 2003 limits 

the use of the functional equivalence standard in the hospital 

outpatient setting.

8 The MCAC meets about six times each year. The MCAC 

functions on a committee basis by reviewing and evaluating 

medical literature, reviewing technology assessments, and 

examining data and information on the effectiveness and 

appropriateness of medical items and services that are covered 

or are eligible for coverage under Medicare. Each committee 

generally includes 13 to 15 members. 

9 The 13 evidence-based practice centers are Duke University; 

ECRI; Tufts University–New England Medical Center; the 

Blue Cross Blue Shield Technology Evaluation Center; John 

Hopkins University; McMaster University; Oregon Health & 

Science University; RTI International–University of North 

Carolina; Southern California–RAND; Stanford University–

University of California, San Francisco; University of Alberta, 

Edmonton, Alberta, Canada; University of Minnesota; and 

University of Ottawa. The first three centers (Duke, ECRI, 

and Tufts) focus on technology assessments for CMS.

10 Participating agencies include the Department of Social 

and Health Services, the state health care authority, and the 

Department of Labor and Industries. 

Endnotes
Report to the Congress: Increasing the Value of Medicare | June 2006 245

Academy of Managed Care Pharmacy. 2005. The AMCP format 

for formulary submissions. Version 2.1. http://www.fmcpnet.org/

data/resource/Format~Version_2_1~Final_Final.pdf. 

Agency for Healthcare Research and Quality. 2006. Fact sheet. 

Focus on cost-effectiveness analysis at the Agency for Healthcare 

Research and Quality. http://www.ahrq.gov/RESEARCH/costeff.

htm.

Aspinall, S. L., C. B. Good, P. A. Glassman, et al. 2005. 

The evolving use of cost-effectiveness analysis in formulary 

management within the Department of Veterans Affairs. 2005. 

Medical Care 43, no. 7 (suppl July): II-20–II-26.

Bekelman, J. E., Y. Li, and C. P. Gross. 2003. Scope and impact of 

financial conflicts of interest in biomedical research. A systematic 

review. Journal of the American Medical Association 289, no. 4 

(January 22/29): 454–465.

Centers for Medicare & Medicaid Services, Department of 

Health and Human Services. 2006a. Medicare coverage advisory 

committee. http://www.cms.hhs.gov/FACA/02_MCAC.asp.

Centers for Medicare & Medicaid Services, Department of 

Health and Human Services. 2006b. Overview of the evaluation 

of the section 641 demonstration. http://www.cms.hhs.gov/

DemoProjectsEvalRpts/downloads/MMA641_Demo_Evaluation_

p.pdf.

Centers for Medicare & Medicaid Services, Department of Health 

and Human Services. 2005. Factors CMS considers in making 

a determination of coverage with evidence development. Draft 

guidance for the public, industry, and CMS staff. April 7.

Coffield, A. B., M. V. Maciosek, J. M. McGinnis, et al. 2001. 

Priorities among recommended clinical preventive services. 

American Journal of Preventive Medicine 21, no. 1 (July): 1–9.

Cohen, J., E. Alhun, and P. J. Neumann. 2006. Review and 

analysis of cost-effectiveness analysis for two Medicare-covered 

services. Presentation at MedPAC public meeting, March 10, 

Washington, DC.

Cutler, D. M., and M. McClellan. 2001. Is technological change in 

medicine worth it? Health Affairs 20, no. 5 (September/October): 

11–29.

Dolan, P., A. Tsuchiya, C. Armitage, et al. 2006. A protocol to 

determine the relative value of a QALY according to various 

health and nonhealth characteristics. http://www.pcpoh.bham.

ac.uk/publichealth/nccrm/PDFs%20and%20documents/

Publications/PD_QALY_report_Feb03.pdf.

Drummond, M., and M. Sculpher. 2005. Common methodological 

flaws in economic evaluations. Medical Care 43, no. 7 (July): II5–II-14.

Eddy, D. 2005. The role of cost-effectiveness analysis in decision 

making for CMS. Presentation at MedPAC public meeting, March 

11, Washington, DC.

Fisher, E. S., D. E. Wennberg, and T. A. Stukel. 2003. The 

implications of regional variations in Medicare spending. Part 1: 

The content, quality, and accessibility of care. Annals of Internal 

Medicine 138, no. 4 (February 18): 273–287.

Garber, A. M. 2001. Evidence-based coverage policy. Health 

Affairs 20, no. 5 (September–October): 62–82.

Ginsburg, M. E. 2004. Cost-effectiveness: Will the public buy it 

or balk? Health Affairs (May 19): W297–W299.

Gold, M. R., J. E. Siegel, L. B. Russell, et al. 1996. Costeffectiveness in health and medicine. New York: Oxford 

University Press.

Hlatky, M. A., G. D. Sanders, and D. K. Owens. 2005. Evidencebased medicine and policy: The case of the implantable 

cardioverter defibrillator. Health Affairs 24, no. 1 (January–

February): 42–51.

Hotopf, M., G. Lewis, and C. Normand. 1997. Putting trials on 

trial—the costs and consequences of small trials in depression: A 

systematic review of methodology. Journal of Epidemiology and 

Community Health 51, no. 4 (August): 354–358.

Hunter, D. 2006. First, gather the data. New England Journal of 

Medicine 354, no. 4 (January 26): 329–331.

Jacobson P. D., and M. L. Kanna. 2001. Cost-effectiveness 

analyses in the courts: Recent trends and future prospects. Journal 

of Health Politics, Policy and Law 26, no. 2 (April): 291–395. 

Jefferson, T., V. Demicheli, and L. Vale. 2002. Quality of 

systematic reviews of economic evaluations in health care. 

Journal of the American Medical Association 287, no. 21 (June 

5): 2809–2812.

Kolata, G. 2006. Medicare says it will pay, but patients say ‘no 

thanks.’ The New York Times. March 3. 

McGlynn, E. A., S. M. Asch, J. Adams, et al. 2003. The quality of 

health care delivered to adults in the United States. New England 

Journal of Medicine 348, no. 26 (June 26): 2635–2645. 

References
246 Medicare’s use of clinical and cost-effectiveness information

Medicare Payment Advisory Commission. 2005. Report to 

the Congress: Issues in a modernized Medicare program. 

Washington, DC: MedPAC.

Moher, D., K. F. Schulz, and D. G. Altman for the 

CONSORT Group. 2001. The CONSORT statement: Revised 

recommendations for improving the quality of reports of parallelgroup randomized trials. Annals of Internal Medicine 134, no. 8 

(April 17): 657–662.

Neumann, P. J. 2005. The arrival of economic evidence in 

managed care formulary decisions. The unsolicited request 

process. Medical Care 43, no. 7 suppl (July): II-27–II-32.

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Growth and quality of the cost-utility literature, 1976–2001. Value 

Health 8, no. 1 (January–February): 3–9.

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analysis? The American Journal of Managed Care 10, no. 5 

(May): 308–312.

Pignone, M., S. Somnath, T. Hoerger, et al. 2002. Costeffectiveness analyses of colorectal cancer screening: A 

systematic review for the U.S. preventive services task force. 

Annals of Internal Medicine 137, no. 2 (July 16): 96–104.

Reinhardt, U. E. 2004. An information infrastructure for the 

pharmaceutical market. Health Affairs 23, no. 1 (January/

February): 107–112.

Rennie, D., and H. S. Luft. 2000. Pharmacoeconomic analyses. 

Making them transparent, making them credible. Journal of the 

American Medical Association 283, no. 16 (April 26): 2158–

2160.

Sacramento Healthcare Decisions. 2001. Cost-effectiveness as 

a criterion for medical and coverage decisions. http://www.

sachealthdecisions.org/vf.html. 

Sanders, G. D., M. A. Hlatky, and D. K. Owens. 2005. Costeffectiveness of implantable cardioverter-defibrillators. New 

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1480.

Sculpher, M. 2005. Technology appraisal at the National Institute 

for Health and Clinical Excellence. May 13.

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technological change in medicine always worth it? The case of 

acute myocardial infarction. Health Affairs (February 7): W34–

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A APPENDIX

Review of CMS’s preliminary 

estimate of the physician 

update for 2007

Report to the Congress: Increasing the Value of Medicare | June 2006 249

CMS’s preliminary estimate of the 2007 payment update 

for physician services is –4.6 percent, the maximum 

negative update permitted under a formula defined in 

statute (Kuhn 2006). This is the third consecutive estimate 

of such a large negative update, although a negative 

update has not occurred since 2002 as the Congress has 

overridden the formula.

In communicating the estimate to the Commission, CMS 

reminds us that an important reason the formula continues 

to call for negative updates is that the volume of physician 

services is growing rapidly. In this context, physician 

services include services paid for under Medicare’s 

physician fee schedule as well as laboratory services 

and physician-administered drugs. For 2005, CMS’s 

estimate is that the volume and intensity of physician 

services per beneficiary grew by 7.5 percent. While that 

estimate is preliminary and so may change, it is higher 

than the average for the previous five years, which was 6.1 

percent.1

 The estimate also exceeds the growth in any of 

the previous five years except 2004, when spending grew 

by 8.0 percent. CMS is working with physicians and other 

stakeholders to review and understand this growth with a 

goal of helping Medicare beneficiaries receive better and 

more efficient care.

The Commission shares CMS’s concern about volume 

growth. In March 2006, we recommended changes in 

the way services are valued in the physician fee schedule 

(MedPAC 2006). The concern is that misvaluing services 

could create financial incentives that lead to increases 

in volume. Our other work on mispricing includes 

consideration of the data and methods for determining 

payments for physicians’ practice expenses (see Chapter 4). 

We are also exploring ways to give physicians feedback on 

how their volume of services compares with that of their 

peers (see Chapter 1).

This appendix fulfills the Commission’s requirement to 

review CMS’s estimate of the update. In reviewing the 

technical details involved in estimating the update, we find 

that CMS used estimates in calculating the update that 

are consistent with recent trends. Note that our purpose in 

reviewing CMS’s estimate is not to assess the adequacy of 

the update.2

 In Congressional testimony and reports to the 

Congress, we have discussed several problems with the 

physician update formula (Hackbarth 2005a, Hackbarth 

2005b, MedPAC 2005, MedPAC 2002). We consider the 

current formula to be a flawed, inequitable mechanism 

for volume control and will consider alternatives to it in a 

report that is due in March 2007.

Calculating the update

Calculating the physician update is a two-step process. 

First, CMS estimates the sustainable growth rate (SGR). 

The SGR is the target rate of growth in spending for 

Review of CMS’s preliminary 

estimate of the physician 

update for 2007

A P P E N D I X A
250 Review of CMS’s preliminary estimate of the physician update for 2007

physician services and is a function of projected 

changes in:

• input prices for physician services;3

• real gross domestic product (GDP) per capita, an 

allowance for growth in the volume of services;4

• enrollment in traditional fee-for-service Medicare; and

• spending attributable to changes in law and regulation.

For 2007, CMS’s preliminary estimate of the SGR is 0.7 

percent (Table A-1).

Second, CMS calculates the update, which is a function of:

• the change in input prices for physician services,5

 and

• an update adjustment factor that increases or decreases 

the update as needed to align actual spending, 

cumulated over time, with target spending determined 

by the SGR.

The estimate of the change in input prices for 2007 is 2.6 

percent (Table A-2). The part of the update calculation that 

has the bigger effect, however, is the update adjustment 

factor, which CMS estimates at –7.0 percent. That is the 

maximum negative adjustment permitted under current 

law. When we combine this adjustment with the estimated 

change in input prices, the result is an update of −4.6 

percent.

The update adjustment factor is negative because actual 

spending for physician services started to exceed the target 

in 2001 (Figure A-1). Since then, volume growth has 

kept spending above the target. In addition, overrides of 

the formula (where the Congress has changed the law to 

prevent negative updates) have kept payment rates above 

the level necessary to align actual spending and the target. 

The result is that the update adjustment factor would be 

−28.0 percent, if not for the –7.0 percent limit.

Reviewing CMS’s estimates

Because an update adjustment factor of −28.0 percent 

is well beyond the statutory limit, the Commission 

anticipates no changes in CMS’s estimates that would 

be large enough to bring the factor within the limit and, 

therefore, alter the update. In the 2007 SGR, the estimate 

of the change in input prices, as measured by the Medicare 

Economic Index (MEI), is similar to changes in the MEI 

for earlier years.6

 The change in real GDP per capita of 2.3 

percent equals the 10-year moving average of real GDP 

estimates from the Bureau of Economic Analysis (BEA), 

adjusted for population growth (BEA 2006).

In the 2007 SGR, the change in spending due to law and 

regulation is noteworthy in that it is negative. Usually, this 

component of the SGR is positive to account for spending 

increases that occur when legislation expands benefits 

under Medicare Part B. For 2007, CMS expects law and 

regulation to have a negative effect on spending for two 

reasons. First, payment rates will fall in some geographic 

areas when the floor on the geographic practice cost index 

for physician work expires. The floor was established 

by the Medicare Prescription Drug, Improvement, 

and Modernization Act of 2003 (MMA) and ends on 

December 31, 2006. Second, payment rates for certain 

imaging services will go down under provisions of the 

Deficit Reduction Act of 2005 (DRA).

TABLE

A–1 Preliminary sustainable 

growth rate, 2007

Factor Percent

Change in:

input prices 2.6%

traditional Medicare enrollment –2.9

real GDP per capita 2.2

Change due to law and regulations –1.0

Sustainable growth rate 0.7

Note: GDP (gross domestic product). Percents are converted to ratios and 

multiplied, not added, to produce the sustainable growth rate.

Source: Kuhn 2006.

TABLE

A–2 Estimate of the update for 

physician services, 2007

Factor Percent

Change in:

input prices 2.6%

adjustment factor –7.0

Update –4.6

Note: Percents are converted to ratios and multiplied, not added, to produce 

the update.

Source: Kuhn 2006.
Report to the Congress: Increasing the Value of Medicare | June 2006 251

A physician specialty society, the American College of 

Radiology, has raised a question about the magnitude of 

the change in spending due to law and regulation that 

will occur in 2007. CMS’s estimate of an average change 

in payment rates of −1.0 percent is consistent with the 

Congressional Budget Office’s (CBO’s) budget scoring 

of the MMA and DRA provisions. The American College 

of Radiology believes that CBO has underestimated the 

payment reductions that will occur under the DRA by 

more than 50 percent (ACR 2006). While we can not 

assess the magnitude of these estimates, we note that CMS 

reviews and validates estimates in SGRs as data become 

available and that the agency has two years to revise an 

SGR with better data.7

 In addition, CMS will learn more 

about the effects of the DRA provisions through work 

on proposed rules for the physician fee schedule and the 

prospective payment system for outpatient hospital care to 

be published in the summer of 2006.

The remaining factor in the 2007 SGR—the change in 

fee-for-service enrollment—is the least certain. CMS 

assumes a decrease of 2.9 percent. This figure differs 

from CBO’s enrollment projection, which is an increase 

in fee-for-service enrollment of 0.3 percent for fiscal year 

2007. CMS and CBO projections of total Medicare Part 

B enrollment are similar (1.5 percent and 1.8 percent, 

respectively), so the difference in the fee-for-service 

projections is due to the size of the shift in enrollment 

from Medicare fee-for-service to Medicare Advantage 

(MA). CMS may be better able to project any such shift 

when MA plans submit bids and identify market areas in 

June 2006. CMS can then revise the enrollment projection, 

if necessary, before the update becomes final in November 

2006. Even then, CMS will have limited information on 

changes in enrollment in 2007, but the agency will have 

another two years to revise the enrollment estimate if 

better data become available, just as the agency does with 

changes in spending due to law and regulation.

The only remaining issue concerns CMS’s estimates 

of actual spending for 2005 and 2006. Data on actual 

spending are nearly complete through the first three 

quarters of 2005 but are less complete for the last quarter 

of that year. Therefore, the estimate of actual spending 

in 2005 may increase or decrease somewhat before CMS 

issues a final rule on the update in November 2006. Of 

course, the uncertainty regarding 2006 estimates is greater 

than for 2005 because CMS currently has very little 

information on actual spending for 2006.

Regardless of what happens with the various estimates that 

determine the physician update, it is very unlikely that any 

change in them will overcome an update adjustment factor 

of −28.0 percent. For this reason, we anticipate that CMS 

will revise the update calculations this fall, in preparation 

for implementing the 2007 update on January 1, and that 

the calculations will show the maximum reduction that the 

statute permits: the change in input prices reduced by an 

update adjustment of −7.0 percentage points. 

FIGURE

A–1 Through 2005, actual spending for 

physician services exceeded target

Note: The estimates shown are preliminary and so may change.

Source: Offi ce of the Actuary 2006 and Kuhn 2006.

Target

Actual

Spending (dollars in billions)

100

80

90

70

60

50

40

1997 1998 1999 2000 2001 2002 2003 2004 2005
252 Review of CMS’s preliminary estimate of the physician update for 2007

1 To illustrate the preliminary nature of CMS’s estimate, note 

that last year the initial estimate of spending growth in 2004 

was 15.2 percent. Since then, the agency has substantially 

revised the estimate downward to 11.4 percent.

2 The Commission recommended an update for 2007 equal to 

the projected change in input prices less an expectation for 

productivity growth (MedPAC 2006).

3 For the SGR, physician services include services commonly 

performed by a physician or performed in a physician’s office. 

In addition to physician fee schedule services, these services 

include diagnostic laboratory tests and most of the drugs 

covered under Medicare Part B. To estimate this factor, 

CMS uses a weighted average of the MEI, a measure of 

changes in input prices for physician services, the change 

in payment rates for laboratory services legislated by the 

Congress, and a weighted average of the change in payment 

rates for Part B-covered drugs. The MEI is the change in 

input prices for physician services less an adjustment for 

productivity growth. 

4 As required by the MMA, the real GDP per capita factor in 

the SGR is a 10-year moving average.

5 For the update, physician services include only those services 

in the physician fee schedule.

6 Historical changes in the MEI are published by the CMS 

Office of the Actuary (2006). Since 1991, they have ranged 

from 2.0 percent to 3.2 percent.

7 For further discussion of changes in spending due to law and 

regulation, see MedPAC’s Report to the Congress: Growth in 

the volume of physician services (2004).

Endnotes
Report to the Congress: Increasing the Value of Medicare | June 2006 253

American College of Radiology. 2006. ACR joins other 

medical organizations, manufacturers, and patient advocacy 

groups in letter to Capitol Hill opposing Deficit Reduction 

Act imaging cuts. March 2. http://www.acr.org/s_acr/sec.

asp?CID=3140&DID=18881.

Bureau of Economic Analysis, Department of Commerce. 2006. 

Current-dollar and real gross domestic product. Washington, DC: 

BEA. March 30. http://www.bea.gov/bea/dn/gdplev.xls.

Hackbarth, Glenn M., Medicare Payment Advisory Commission. 

2005a. Medicare payment to physicians. Oral testimony before 

the Subcommittee on Health of the Committee on Energy and 

Commerce, U.S. House of Representatives. 109th Cong., 1st sess. 

November 17.

Hackbarth, Glenn M., Medicare Payment Advisory Commission. 

2005b. Medicare payment to physicians. Oral testimony before 

the Subcommittee on Health of the Committee on Ways and 

Means, U.S. House of Representatives. 109th Cong., 1st sess. 

February 10.

Kuhn, H. B., Centers for Medicare & Medicaid Services, 

Department of Health and Human Services. 2006. Letter to Glenn 

M. Hackbarth, Medicare Payment Advisory Commission. April 7. 

http://www.cms.hhs.gov/SustainableGRatesConFact/Downloads/

MedPAC_Letter_Estimated_2007.pdf.

Medicare Payment Advisory Commission. 2006. Report to the 

Congress: Medicare payment policy. Washington, DC: MedPAC.

Medicare Payment Advisory Commission. 2005. Report to the 

Congress: Medicare payment policy. Washington, DC: MedPAC.

Medicare Payment Advisory Commission. 2004. Report to 

the Congress: Growth in the volume of physician services. 

Washington, DC: MedPAC.

Medicare Payment Advisory Commission. 2002. Report to the 

Congress: Medicare payment policy. Washington, DC: MedPAC.

Office of the Actuary, Centers for Medicare & Medicaid Services, 

Department of Health and Human Services. 2006. Estimated 

sustainable growth rate and conversion factor, for Medicare 

payments to physicians in 2007. Baltimore: CMS. http://www.

cms.hhs.gov/SustainableGRatesConFact/Downloads/sgr2007p.

pdf. 

References

Acronyms

Report to the Congress: Increasing the Value of Medicare | June 2006 257

AHRQ Agency for Healthcare Research and Quality 

AIDS acquired immunodeficiency syndrome 

AMA American Medical Association

AM–PAC Activity Measure for Post-Acute Care

APR–DRG all patient refined diagnosis related group

APTA American Physical Therapy Association

AQA Ambulatory Quality Alliance

ASC ambulatory surgical center

BBA Balanced Budget Act of 1997

BBRA Balanced Budget Refinement Act of 1999

BEA Bureau of Economic Analysis

BETOS Berenson-Eggers Type of Service

BLS Bureau of Labor Statistics

CABG coronary artery bypass graft

CAD coronary artery disease

CAT computer adaptive technology

CBO Congressional Budget Office

CCIP Chronic Care Improvement Program

CCM chronic care model

CCP coordinated care plan

CED coverage with evidence development

CHC continuous home care

CHF congestive heart failure

CMS Centers for Medicare & Medicaid Services

CMS–HCC CMS–hierarchical condition category

COPD chronic obstructive pulmonary disease

CORF comprehensive outpatient rehabilitation facility

CPEP Clinical Practice Expert Panel

CPO care plan oversight

CPT Current Procedural Terminology

CT computed tomography

CV coefficient of variation

CY calendar year

DCG diagnostic cost group

DRA Deficit Reduction Act

DRG diagnosis related group

E&M evaluation and management 

ERG episode risk group

ESI employer-sponsored insurance

ETG Episode Treatment Group

FDA Food and Drug Administration

FEHB Federal Employees Health Benefits [Program]

Acronyms

FFS fee-for-service 

FOTO Focus On Therapeutic Outcomes, Inc.

FPL federal poverty level

FY fiscal year

GAO Government Accountability Office

GDP gross domestic product 

GIC general inpatient care

GME graduate medical education

HbA1c hemoglobin A1c

HCC hierarchical condition category

HCFA Health Care Financing Administration

HCPCS Healthcare Common Procedure Coding System

HHS Department of Health and Human Services

HIV human immunodeficiency virus

HMO health maintenance organization 

ICD implantable cardioverter defibrillator

ICD–9–CM International Classification of Diseases, Ninth 

Revision, Clinical Modification

ICR International Communications Research

IDTF independent diagnostic testing facility

IME indirect medical education

IOM Institute of Medicine

IPA independent practice association 

IPPS inpatient prospective payment system

IRC inpatient respite care

IT information technology

LDL low-density lipoprotein 

LIS low-income subsidy

LOS length of stay

LTC long-term care

LTCP long-term care pharmacy

MA Medicare Advantage

MACIE Medicare Ambulatory Care Indicators for the 

Elderly

MA–PD Medicare Advantage–Prescription Drug [plan]

MCAC Medicare Coverage Advisory Committee

MDS Minimum Data Set 

MedPAC Medicare Payment Advisory Commission

MedPAR Medicare Provider Analysis and Review file

MEG Medstat Episode Group 

MEI Medicare Economic Index

MHS Medicare Health Support

MHSO Medicare Health Support organization
258 Acronyms

MMA Medicare Prescription Drug, Improvement, and 

Modernization Act of 2003

MRI magnetic resonance imaging

MSA medical savings account 

MSA metropolitan statistical area 

MSP Medicare Savings Program

N/A not applicable

N/A not available

NCHS National Center for Health Statistics

NDC national drug code

NHPCO National Hospice and Palliative Care 

Organization

NHS National Health Service (United Kingdom)

NICE National Institute for Clinical Excellence (United 

Kingdom)

NLA national limitation amount

NMEP National Medicare Education Program

NOMS National Outcomes Measurement System

NORC National Opinion Research Center

NQF National Quality Forum

OACT Office of the Actuary

OIG Office of Inspector General

OOP out-of-pocket

OPTIMAL Outpatient Physical Therapy Improvement and 

Assessment Log

ORF outpatient rehabilitation facility

OSCAR Online Survey, Certification, and Reporting 

system

OT occupational therapy

P4P pay for performance

PACE Program of All-Inclusive Care for the Elderly

PBM pharmacy benefit manager

PDP prescription drug plan

PE practice expense

PEAC Practice Expense Advisory Committee

PERC Practice Expense Review Committee

PFFS private fee-for-service

PGP physician group practice

PPI proton pump inhibitor

PPRC Physician Payment Review Commission 

PPO preferred provider organization

PPS prospective payment system

PT physical therapy

QALY quality-adjusted life year

QMB qualified Medicare beneficiary 

RDS retiree drug subsidy

RHC routine home care

RHHI regional home health intermediary

RRS relative risk score

RUC Relative Value Scale Update Committee

RUG resource utilization group

RVU relative value unit

SGR sustainable growth rate

SHIP State Health Insurance Assistance Program

SLMB specified low-income Medicare beneficiary 

SLP speech-language pathology

SMS Socioeconomic Monitoring System

SNF skilled nursing facility

SNP special needs plan

SSA Social Security Administration

UPIN Unique Physician Identification Number 

USP the U.S. Pharmacopeia 

VA Department of Veterans Affairs

VHA Veterans Health Administration
More about MedPAC

Report to the Congress: Increasing the Value of Medicare | June 2006 261

Commission members

Glenn M. Hackbarth, J.D., chairman

Bend, OR

Robert D. Reischauer, Ph.D., vice chairman

The Urban Institute

Washington, DC

Term expires April 2008

Nancy-Ann DeParle, J.D.

JPMorgan Partners

Washington, DC

David F. Durenberger, J.D.

National Institute of Health Policy

University of St. Thomas

Minneapolis, MN

Jennie Chin Hansen, R.N., 

M.S.N., F.A.A.N.

AARP

San Francisco, CA

Nancy M. Kane, D.B.A.

Harvard School of Public Health

Boston, MA

Nicholas Wolter, M.D.

Billings Clinic

Billings, MT

Term expired April 2006

Autry O. V. “Pete” DeBusk

DeRoyal

Powell, TN

Glenn M. Hackbarth, J.D.

Alan R. Nelson, M.D.

American College of Physicians

Washington, DC

Robert D. Reischauer, Ph.D.

David A. Smith, M.Ed.

Demos

New York, NY

Ray E. Stowers, D.O.

Lincoln Memorial University 

College of Osteopathic Medicine

Harrogate, TN

Term expires April 2007

John M. Bertko, F.S.A., 

M.A.A.A.

Humana Inc.

Louisville, KY

Sheila P. Burke, M.P.A.,

R.N., F.A.A.N.

Smithsonian Institution

Washington, DC

Francis J. Crosson, M.D.

The Permanente Federation, LLC

Oakland, CA

Arnold Milstein, M.D., M.P.H.

Pacific Business Group on Health

San Francisco, CA

Ralph W. Muller, M.A.

University of Pennsylvania

Health System

Philadelphia, PA

William J. Scanlon, Ph.D.

Health policy consultant

Oak Hill, VA

Report to the Congress: Increasing the Value of Medicare | June 2006 263

Commissioners’ biographies

John M. Bertko, F.S.A., M.A.A.A., is vice president and 

chief actuary for Humana Inc., where he manages the 

corporate actuarial group and directs the coordination 

of work by actuaries in Humana’s major business units, 

including public programs, commercial, individual, and 

TRICARE. Mr. Bertko has extensive experience with 

risk adjustment and has served in several public policy 

advisory roles, including prescription drug benefit design. 

He served the American Academy of Actuaries as a board 

member from 1994 to 1996 and as vice president for the 

health practice area from 1995 to 1996. He was a member 

of the Actuarial Board for Counseling and Discipline 

from 1996 to 2002. Mr. Bertko is a fellow of the Society 

of Actuaries and a member of the American Academy 

of Actuaries. He has a B.S. in mathematics from Case 

Western Reserve University.

Sheila P. Burke, M.P.A., R.N., F.A.A.N., is the 

Smithsonian Institution’s deputy secretary and chief 

operating officer. Before joining the Smithsonian, she was 

executive dean and lecturer in public policy at the John 

F. Kennedy School of Government, Harvard University, 

Cambridge. From 1986 to 1996, Ms. Burke was chief of 

staff for former Senate Majority Leader Bob Dole and was 

elected secretary of the Senate in 1995. She currently serves 

as the chair of the board of the Kaiser Family Foundation 

and is a member of the Kaiser Commission on Medicaid and 

the Uninsured, the American Board of Internal Medicine 

Foundation, WellPoint Health Networks, Chubb Insurance, 

and the University of San Francisco. She is a member of the 

National Academy of Public Administration and the Institute 

of Medicine (IOM) and chairs the IOM Committee on the 

Restructuring of the Food and Drug Administration. She is 

currently an adjunct lecturer in public policy at Harvard, a 

fellow of the Wiener Center, and an adjunct faculty member 

at Georgetown University. She has chaired the National 

Academy of Social Insurance’s project on Restructuring 

Medicare for the Long Term. Ms. Burke holds a B.S. in 

nursing from the University of San Francisco and an M.P.A. 

from Harvard University.

Francis J. Crosson, M.D., is executive director of the 

Permanente Federation of medical groups that make up 

the physician component of Kaiser Permanente. He also 

cochairs the Kaiser Permanente Partnership Group, the 

organization’s management committee. He joined Kaiser 

Permanente in 1977. In 1988, he was appointed associate 

executive director of the Permanente Medical Group and 

served in that position until his current appointment. He 

also has experience with prescription drug arrangements 

and has led efforts on comprehensive public report cards 

on clinical quality, management of a drug formulary, and 

adoption of a state-of-the-art electronic medical record. 

He currently is chair-elect of the Board of Directors of 

the American Medical Group Association. Dr. Crosson 

received his undergraduate degree in political science 

from Georgetown University and his M.D. degree from 

Georgetown’s School of Medicine.

Autry O.V. “Pete” DeBusk is chairman, chief executive 

officer, and founder of DeRoyal, a global supplier of 

medical products and services in the acute care, patient 

care, wound care, and original equipment manufacturing 

markets. Mr. DeBusk formed his first company in 1970 

with a patent he received on an orthopedic product. In 

1976, he consolidated his many product lines into one 

company, DeRoyal Industries. A member of several 

community organizations, Mr. DeBusk is also chairman 

of the Board of Trustees at Lincoln Memorial University 

in Harrogate, TN, as well as a founder of the Autry O.V. 

DeBusk facility, Boys and Girls Club, Powell, TN. As 

an innovative leader in the medical industry, he received 

a prestigious award from Duke University in 2000 

recognizing his original contributions to orthopedic 

surgery. He received his B.S. degree from Lincoln 

Memorial University and attended graduate school at the 

University of Georgia.

Nancy-Ann DeParle, J.D., is a senior adviser to 

JPMorgan Partners, LLC, and adjunct professor of health 

care systems at the Wharton School of the University 

of Pennsylvania. From 1997 to 2000, she served as 

administrator of the Health Care Financing Administration 

(HCFA), which is now the Centers for Medicare & 

Medicaid Services. Before joining HCFA, Ms. DeParle 

was associate director for health and personnel at the 

White House Office of Management and Budget. From 

1987 to 1989, she served as the Tennessee Commissioner 

of Human Services. She has also worked as a lawyer in 

private practice in Nashville, TN, and Washington, DC. 

She is a trustee of the Robert Wood Johnson Foundation 

and a board member of Cerner Corporation, DaVita, 

Guidant Corporation, Triad Hospitals, and the National 

Quality Forum. Ms. DeParle received a B.A. degree from 

the University of Tennessee; B.A. and M.A. degrees from 
264 Commissioners' biographies

Stakeholders Group, Lumetra (California’s Quality 

Improvement Organization), the Advisory Board of the 

Institute for the Future of Aging Services, the Robert 

Wood Johnson Executive Nurse Fellows Program, and the 

California HealthCare Foundation Health Care Fellows 

Program. She was a delegate to the 2005 White House 

Conference on Aging. Ms. Hansen received her B.S. from 

Boston College and her M.S.N. from the University of 

California, San Francisco.

Nancy M. Kane, D.B.A., is professor of management 

in the Department of Health Policy and Management at 

the Harvard School of Public Health. Dr. Kane directs 

the Masters in Healthcare Management Program, an 

executive leadership program for mid-career physicians 

leading health care organizations. She has taught health 

care accounting, payment systems, financial analysis, 

and competitive strategy. Her research interests include 

measuring hospital financial performance, quantifying 

community benefits and the value of tax exemption, the 

competitive structure and performance of hospital and 

insurance industries, and nonprofit hospital governance. 

Professor Kane consults with federal and state agencies 

involved in health system design, oversight, and payment. 

She is an outside director of the Urban Medical Group, 

a nonprofit physician group practice providing care to 

frail elderly in institutional and home settings. Prior to 

obtaining her business training, she practiced as a hospitalbased physical therapist. Dr. Kane earned her Masters and 

Doctor of Business Administration degrees from Harvard 

Business School. 

Arnold Milstein, M.D., M.P.H., is medical director of 

the Pacific Business Group on Health (PBGH) and U.S. 

health care thought leader at Mercer Human Resource 

Consulting. PBGH is the largest employer health care 

purchasing coalition in the United States. Dr. Milstein 

focuses on health care purchasing strategy, clinical 

performance measurement, and the psychology of clinical 

performance improvement. He cofounded both the 

Leapfrog Group and the Consumer-Purchaser Disclosure 

Project, and heads performance measurement activities 

for both initiatives. Previously a Rosenthal Lecturer at 

the Institute of Medicine, the New England Journal of 

Medicine described Dr. Milstein as a “pioneer” in efforts 

to advance quality of care. In 2004 and 2005, World-atWork, the largest global organization of human resource 

managers, awarded him its highest annual award, and 

the National Business Group on Health recognized him 

for innovation and successful implementation of health 

Oxford University, where she was a Rhodes Scholar; and a 

J.D. degree from Harvard Law School.

David F. Durenberger, J.D., is president of Policy Insight, 

LLC; senior health policy fellow at the University of 

St. Thomas in Minneapolis, MN; and chairman of the 

National Institute of Health Policy. He is also president of 

the Medical Technology Leadership Forum and a member 

of the Kaiser Foundation Commission on Medicaid and 

the Uninsured, the Board of the National Committee 

for Quality Assurance, and the National Commission 

for Quality Long-Term Care. From 1978 to 1995, he 

served as the senior U.S. Senator from Minnesota, as a 

member of the Senate Finance Committee, and chairman 

of its health subcommittee. He was a member of the 

Senate Environment Committee; the Government Affairs 

Committee; and the committee now known as the Health, 

Education, Labor, and Pensions Committee. He chaired 

the Senate Select Committee on Intelligence. Senator 

Durenberger is a graduate of St. John’s University, 

received his J.D. degree from the University of Minnesota, 

and served as an officer in the U.S. Army.

Glenn M. Hackbarth, J.D., chairman of the Commission, 

lives in Bend, OR. He has experience as a health care 

executive, government official, and policy analyst. He was 

chief executive officer and one of the founders of Harvard 

Vanguard Medical Associates, a multispecialty group 

practice in Boston that serves as a major teaching affiliate 

of Harvard Medical School. Mr. Hackbarth previously 

served as senior vice president of Harvard Community 

Health Plan. From 1981 to 1988, he held positions at the 

U.S. Department of Health and Human Services, including 

deputy administrator of the Health Care Financing 

Administration. Mr. Hackbarth received his B.A. from 

Pennsylvania State University and his M.A. and J.D. from 

Duke University.

Jennie Chin Hansen, R.N., M.S.N., F.A.A.N., of San 

Francisco, is president-elect of AARP; a senior fellow 

at the University of California, San Francisco, chairing 

the Integrated Nurse Leadership Project; and a parttime nursing faculty member at San Francisco State 

University. Ms. Hansen was executive director of On Lok 

Senior Health Services, the prototype for the Program 

of All-Inclusive Care for the Elderly (PACE). She has 

practiced nursing in both urban and rural settings and 

taught in undergraduate programs. She currently serves in 

leadership roles with the AARP Foundation, the Agency 

for Healthcare Research and Quality’s Effective Healthcare 
Report to the Congress: Increasing the Value of Medicare | June 2006 265

Robert D. Reischauer, Ph.D., is vice chairman of 

the Commission and president of the Urban Institute. 

Previously, he was a senior fellow with the Brookings 

Institution, and from 1989 to 1995 he was the director 

of the Congressional Budget Office. Dr. Reischauer 

currently serves on the boards of the Academy of Political 

Sciences, the Center on Budget and Policy Priorities, 

and the Committee for a Responsible Federal Budget. 

He also is a member of the Institute of Medicine, the 

National Academy of Public Administration, and Harvard 

Corporation. Dr. Reischauer received his A.B. degree from 

Harvard College and his M.I.A. and Ph.D. from Columbia 

University.

William J. Scanlon, Ph.D., is a senior policy advisor 

with Health Policy R&D. He is a consultant to the 

National Health Policy Forum and is a research professor 

with the Institute for Health Care Research and Policy 

at Georgetown University. Dr. Scanlon is a member of 

the National Committee on Vital and Health Statistics, 

the National Commission for Quality Long-Term Care, 

and the White House Conference on Aging Advisory 

Committee. Before his current positions, Dr. Scanlon 

was the managing director of health care issues at the 

U.S. Government Accountability Office. Previously, he 

was codirector of the Center for Health Policy Studies, an 

associate professor in the Department of Family Medicine 

at Georgetown University, and a principal research 

associate in health policy at the Urban Institute. Dr. 

Scanlon has a Ph.D. in economics from the University of 

Wisconsin–Madison.

David A. Smith, M.Ed., is a senior fellow at Demos, 

a New York-based public policy research center. He 

previously served as director of the Public Policy 

Department at the AFL–CIO. Prior to joining the 

AFL–CIO, he served as senior deputy budget director 

and as commissioner of economic development for the 

City of New York. Mr. Smith spent most of the 1980s in 

Washington as an aide to Massachusetts Senator Edward 

M. Kennedy and as a senior economist at the Joint 

Economic Committee. Mr. Smith has taught economics 

and public policy at the University of Massachusetts and 

the New School for Social Research, and he is a senior 

fellow at the Century Foundation. He is a member of the 

Board of Directors of Public Campaign and a fellow of the 

National Academy of Social Insurance. Mr. Smith attended 

Tufts University and received an M.Ed. from Harvard 

University.

care cost reductions and quality gains. He is an associate 

clinical professor at the University of California at San 

Francisco. Dr. Milstein has a B.A. in economics from 

Harvard, an M.P.H. in health services planning from the 

University of California at Berkeley, and an M.D. degree 

from Tufts University. 

Ralph W. Muller, M.A., is chief executive officer of the 

University of Pennsylvania Health System, one of the 

largest academic health systems in the country. Most 

recently he served as managing director of Stockamp & 

Associates, a hospital consulting firm, and as a visiting 

fellow at the King’s Fund in London. From 1985 to 

2001, he was president and chief executive officer of the 

University of Chicago Hospitals and Health Systems. 

Before joining the hospital, he held senior positions with 

the Commonwealth of Massachusetts, including deputy 

commissioner of the Department of Public Welfare. 

Mr. Muller is past chairman of the Association of 

American Medical Colleges and the Council of Teaching 

Hospitals and Health Systems, and past vice chairman 

of the University Health System Consortium. He is past 

chairman of the National Opinion Research Center, a 

social service research organization, and serves on the 

board of the National Committee for Quality Assurance. 

Mr. Muller received his B.A. in economics from Syracuse 

University and his M.A. in government from Harvard 

University.

Alan R. Nelson, M.D., is an internist-endocrinologist who 

was in private practice in Salt Lake City until he became 

chief executive officer of the American Society of Internal 

Medicine (ASIM) in 1992. After the merger of ASIM 

with the American College of Physicians (ACP) in 1998, 

Dr. Nelson headed the Washington office of ACP–ASIM 

until his semi-retirement in January 2000 and now 

serves as special adviser to the executive vice president 

and chief executive officer of ACP. He was president of 

the American Medical Association from 1989 to 1990. 

Dr. Nelson also serves as an advisor to the Board of 

Trustees of Intermountain HealthCare, a large integrated 

health system whose headquarters are in Salt Lake City. 

A member of the Institute of Medicine (IOM) of the 

National Academy of Sciences, he serves on the IOM 

Committee on Payment and Performance Improvement 

and was chairman of the Committee on Understanding 

and Eliminating Racial and Ethnic Disparities in Health 

Care. Dr. Nelson received his M.D. from Northwestern 

University.
266 Commissioners' biographies

Ray E. Stowers, D.O., is vice president and dean of the 

College of Osteopathic Medicine at Lincoln Memorial 

University in Harrogate, TN. Previously, he was director 

of the Oklahoma Rural Health Policy and Research Center 

as well as associate dean of rural health in the Department 

of Family Medicine at Oklahoma State University Center 

for Health Sciences. He was in private rural practice for 

25 years at Family Medicine Clinics, Inc., in Medford, 

OK, and serves on the Policy Board of the National Rural 

Health Association. Dr. Stowers is a member of the Board 

of Trustees of the American Osteopathic Association and 

has served that organization in many capacities, including 

several related to physician coding and reimbursement 

issues. He has been on the Physician Payment Review 

Commission and was a founding member of the American 

Medical Association’s Relative Value Update Committee. 

Dr. Stowers received his B.S. and B.A. degrees from 

Phillips University in Oklahoma and his D.O. degree from 

the University of Health Sciences College of Osteopathic 

Medicine in Kansas City, MO.

Nicholas Wolter, M.D., is a pulmonary and critical 

care physician who serves as chief executive officer 

for Billings Clinic in Billings, MT. Billings Clinic is 

a regional, nonprofit medical foundation consisting 

of a multispecialty group practice, a tertiary hospital, 

critical access hospital affiliates, a health maintenance 

organization, a research division, and a long-term care 

facility that serves a vast rural area in the northern 

Rockies. Dr. Wolter began his Billings Clinic practice 

in 1982 and served as medical director of the hospital’s 

intensive care unit from 1987 to 1993. He began his 

leadership role with the successful merger of the clinic and 

hospital in 1993. Dr. Wolter is a diplomate of the American 

Board of Internal Medicine and serves on the boards of 

many regional and national health care organizations. He 

has a B.A. degree from Carleton College, an M.A. degree 

from the University of Michigan, and an M.D. degree from 

the University of Michigan Medical School.
Report to the Congress: Increasing the Value of Medicare | June 2006 267

Commission staff

Mark E. Miller, Ph.D.

Executive director

Sarah Thomas, M.S.

Deputy director

Analytic staff

Jack Ashby, M.H.A.

Jill Bernstein, Ph.D.

Cristina Boccuti, M.P.P.

Niall Brennan, M.P.P.

Sharon Bee Cheng, M.S.

David V. Glass, M.S.

Timothy F. Greene, M.B.A.

Scott Harrison, Ph.D.

Kevin J. Hayes, Ph.D.

Sally Kaplan, Ph.D.

Kathryn Linehan, M.P.H.

Craig K. Lisk, M.S.

Karen Milgate, M.P.P.

Anne Mutti, M.P.A.

Jennifer Podulka, M.P.Aff.

Nancy Ray, M.S.

Rachel Schmidt, Ph.D.

Joan Sokolovsky, Ph.D.

Jeffrey Stensland, Ph.D.

Ariel Winter, M.P.P.

Daniel Zabinski, Ph.D.

Research assistants

Sarah Friedman

Sarah Kwon

Special assistant to the 

executive director

Annissa McDonald

Administrative staff

Reda H. Broadnax, B.S., 

 Executive officer

Wylene Carlyle

Diane E. Ellison

Timothy Gulley

Tina Jennings, MTESL

Plinie (Ann) Johnson

Jason McMahon

Cynthia Wilson

Staff consultants

Carol Carter, Ph.D.

Dana K. Kelley, M.P.A.

Julian Pettengill 
601 New Jersey Avenue, NW • Suite 9000 • Washington, DC 20001

(202) 220-3700 • Fax: (202) 220-3759 • www.medpac.gov