Payment for Physician Services: Strategies

for Medicare

February 1986

NTIS order #PB86-182011
Recommended Citation:

U.S. Congress, Office of Technology Assessment, Payment for Physician Services: Strategies

for Medicare, OTA-H-294 (Washington, DC: U.S. Government Printing Office, February

1986).

Library of Congress Catalog Card Number 85-600641

For sale by the Superintendent of Documents

U.S. Government Printing Office, Washington, DC 20402
Foreword

Medicare coverage of physician services for elderly and disabled beneficiaries improves

their financial access to medical care. But Medicare’s payment methods have also fueled increases in expenditures for physician services, which are now one of the most rapidly growing parts of the Federal budget. The method of customary, prevailing, and reasonable charge

payment is inherently inflationary and contains incentives for providers to use additional

and more expensive services.

To curtail continuing increases in expenditures for physician services, the Deficit Reduction

Act of 1984 (Public Law 98-369) froze physician charges to Medicare beneficiaries for 15

months beginning July 1, 1984. That act also mandated OTA to examine alternative methods

of paying for physician services in order to guide payment reform. The House Energy and

Commerce Committee, the House Ways and Means Committee, and the Senate Finance Committee have jurisdiction over physician services under Medicare and that section of the act.

The Senate Special Committee on Aging also requested OTA to study the effect of physician

payment methods on the use of medical technology.

In preparing this report, OTA staff drew on the expertise of members of the advisory

panel, members of the OTA Health Program Advisory Committee, and experts in medicine,

economics, insurance, industry, and health policy. Drafts of the final report were reviewed

by the advisory panel, chaired by Dr. Sidney S. Lee; OTA’s Health Program Advisory Committee, also chaired by Dr. Lee; and numerous individuals and organizations with expertise

and interest in the area. We are grateful for their assistance. Key OTA staff involved in the

analysis were Jane E. Sisk, Charles L. Betley, Pony M. Ehrenhaft, Peter McMenamin, Elaine

J. Power, Gloria Ruby, Ellen S. Smith, and Kerry Britten Kemp.
List of Related OTA Reports

●

●

●

●

●

●

●

●

●

Medicare’s Prospective Payment System: Strategies for Evaluating Cost, Quality,

and Medical Technology.

OTA-H-262, October 1985, GPO stock #052-003-01010-l.

Technology and Aging in America.

OTA-BA-264, June 1985, GPO stock #052-O03-O0970-6.

Federal Policies and the Medical Devices Industry.

OTA-H-229, October 1984, GPO stock #052-O03-O0965-0.

Medical Technology and Costs of the Medicare Program.

OTA-H-227, July 1984, GPO stock #052-O03-O0957-9.

Medical Technology Under Proposals To Increase Competition in Health Care.

OTA-H-190, October 1982, NTIS order #PB 83-164046.

The Implications of Cost-Effectiveness Analysis of Medical Technology.

OTA-H-126, August 1980, NTIS order #PB 80-216864.

Assessing the Efficacy and Safety of Medical Technologies.

OTA-H-75, September 1978, NTIS order #PB 286929.

Technical Memoranda:

—Update of Federal Activities Regarding the Use of Pneumococcal Vaccine.

OTA-TM-H-23, May 1984. GPO stock #052-O03-O0955-2.

—Diagnosis Related Groups (DRGs) and the Medicare Program: Implications for Medical Technology.

OTA-TM-H-17, July 1983, GPO stock #052-003-00919-6.

Case Studies:

—Nurse Practitioners, Physician Assistants, and Certified Nurse Midwives: Quality, Access, Cost,

and Payment Issues.

(forthcoming)

—Nuclear Magnetic Resonance Imaging Technology: A Clinical, Industrial, and Policy Analysis.

OTA-HCS-27, September 1984, GPO stock #052-003-00964-l.

—Cost Effectiveness of Automated Multichannel Chemistry Analyzers.

OTA-BP-H(9)-4, April 1981, NTIS order #PB 81-209793.

NOTE: Reports are available through the U.S. Government Printing Office, Superintendent of Documents, Washington, DC 20402,

(202) 783-3238; and the National Technical Information Service, 5285 Port Royal Rd., Springfield, VA 22161, (703) 487-4650,

iv
Strategies for Medicare

OTA Project Staff—Payment for Physician Services:

Roger C. Herdman, Assistant Director, OTA

Health and Life Sciences Division

Clyde J. Behney, Health Program Manager

Jane E. Sisk, Project Director

Charles L. Betley, Research Assistant

Pony M. Ehrenhaft, Senior Analyst

Peter McMenamin, Senior Analyst

Elaine J. Power, Research Analyst

Gloria Ruby, Senior Analyst

Ellen S. Smith, Analyst

Kerry Britten Kemp, Health and Life Sciences Division Editor

Other Contributing Staff

Becky Berka, Research Assistant

Cynthia P. King, Analyst

Virginia Cwalina, Administrative Assistant

Beckie Erickson, P.C. Specialist/Word Processorl

Carol Ann Guntow, Secretary/Word Processor Specialist

Diann G. Hohenthaner, P.C. Specialist/Word ProcessorContractors

Morris L. Barer, Robert G. Evans, and Roberta Labelle, University of British Columbia

Alexander M. Capron, University of Southern California

Morris F. Cohen, Northern California Kaiser-Permanente Medical Care Program

Louis P. Garrison, The Project HOPE Health Sciences Education Center

Glenn T. Hammons, Robert H. Brook, and Joseph P. Newhouse, The Rand Corp.

Lisa I. Iezzoni, Oren Grad, and Mark A. Moskowitz, Boston University

David A. Juba, The Urban Institute

Lois P. Myers, John M. Eisenberg, and Mark V. Pauly, University of Pennsylvania

Michael A. Riddiough, Riddiough & Associates

Jonathan A. Showstack, Eliseo J. Perez-Stable, Eric Sawitz, University of California, San Francisco

James Vertrees, Dennis Tolley, and Kenneth Manton, La Jolla Management Corp.

‘Until August 1985.

v
. .

Advisory Panel— Payment for Physician Services:

Strategies for Medicare

Sidney S. Lee, Chair

President, Milbank Memorial Fund, New York, NY

John R. Ball

Associate Executive Vice President

American College of Physicians

Washington, DC

Thomas L. Beauchamp

Professor of Philosophy and Senior Research

Scholar

Kennedy Institute of Ethics

Georgetown University

Washington, DC

Karen Davis

Chair

Department of Health Policy and

Management

School of Hygiene and Public Health

Johns Hopkins University

Baltimore, MD

Richard C. Dever

Fellow and Governor at Large for Florida

American College of Surgeons

Jacksonville, FL

Joseph Eichenholz

Assistant Vice President

Affiliated Businesses Group

CIGNA Corp.

Hartford, CT

Peter D. Fox

Vice President

Lewin & Associates

Washington, DC

Jack Hadley

Director

Center for Health Policy Studies

Georgetown University

Washington, DC

Ronald E. Henderson

Physician, private practice

Birmingham, AL

Jack A. Meyer

Director

Health Policy Studies

American Enterprise Institute

Washington, DC

Janet B. Mitchell

Vice President

Health Economics Research

Chestnut Hill, MA

Vita R. Ostrander

President

American Association of Retired Persons

Washington, DC

Thomas O. Pyle

President and Chief Executive Officer

Harvard Community Health Plan

Boston, MA

Uwe E. Reinhardt

Professor

Department of Economics

Princeton University

Princeton, NJ

C. Burns Roehrig

President

American Society for Internal Medicine

Boston, MA

Jerald R. Schenken

Vice Chairman

Council on Legislation

American Medical Association

Omaha, NE

Steven A. Schroeder

Chief of Division of General Internal Medicine

Department of Medicine

University of California

San Francisco, CA

vi
Jack K. Shelton

Manager

Employees’ Insurance Department

Ford Motor Co.

Dearborne, MI

Robert H. Taylor

Executive Committee, Board of Directors

American Academy of Family Physicians

Spartanburg, SC

B. Elizabeth Tunney

Director, Legislation

Retail, Wholesale, and Department Store

Union, International

New York, NY

Sankey V. Williams

Associate Professor

Section of General Medicine

Hospital of the University of Pennsylvania

Philadelphia, PA
Contents

Chapter Page

I. Summary and Policy Options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

2. Physician Payment Under the Medicare Program: Problems and

Changing Context . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39

3. Overview of Alternative Physician Payment Methods Under Medicare:

A Framework for Evaluation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81

4. Modifications to Customary, Prevailing, and Reasonable Charge Payment. . 97

5. Payment Basedon Fee Schedules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .......121

6. Payment for Packages of Services. . . . . . . . . . . . . . . . . . . . . . . . . . . . ..........155

7. Cavitation Payment.....<. . . . . . . . . . . . . . . . . . . . . . ......................179

Appendix Page

A. Method of the Study . . . . . . . . . . . . . . . . . . . . . . . . . ........................211

B. Acknowledgments and Health Program Advisory Committee . .............213

C. Medicare and Medicaid Payment for Physicians’ Services . ................219

D. Private Sector Approaches to Physician Payment . .......................236

References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ..251
Glossary of Acronyms and Terms

Glossary of Acronyms

AAFP

AAPCC

AARP

ACIP

ACP

ACR

ACS

AHCCCS

AMA

ASC

ASIM

BC/BS

CBO

CFR

–American Association of Family Physicians

—average adjusted per capita cost

—American Association of Retired Persons

—Immunization Practices Advisory Committee (CDC)

—American College of Physicians

—adjusted community rate

—American College of Surgeons

—Arizona Health Care Cost Containment

System

—American Medical Association

—ambulatory surgical center

—American Society of Internal Medicine

—Blue Cross and Blue Shield Association

–Congressional Budget Office (U.S.

Congress)

—Code of Federal Regulations

CHAMPUS—Civilian Health and Medical Program of

the Uniformed Services (Department of

Defense)

CMP —competitive medical plan

CPI —Consumer Price Index

CPR —customary, prevailing, and reasonable

CPT-4 —Current Procedural Terminology, 4th

Edition

CT –X-ray computed tomography

DHHS —U.S. Department of Health and Human

Services

DRG —diagnosis-related group

ESRD —end-stage renal disease

ESWL —extracorporeal shock wave lithotripsy

FDA –Food and Drug Administration (DHHS)

FR —Federal Register

FTC —U.S. Federal Trade Commission

GAO –General Accounting Office (U.S.

Congress)

GMENAC —Graduate Medical Education National

Advisory Committee

GNP —Gross National Product

HCFA —Health Care Financing Administration

(DHHS)

HCPCS —HCFA’s Common Procedure Coding

System

HMO —health maintenance organization

HRSA —Health Resources and Services Administration (Public Health Service, DHHS)

ICD-9-CM —International Classification of Diseases,

9th Revision, Clinical Modification

ICU —intensive care unit

IOL —intraocular lens

IMC

IPA

MEI

MRI

OTA

P r o

PRO

ProPAC

PSRO

RVS

TEFRA

UCR

—International Medical Centers, Inc.

—individual practice association

—Medicare Economic Index

—magnetic resonance imaging

–Office of Technology Assessment (U.S.

Congress)

—preferred provider organization

–(utilization and quality control) peer review organization

– Prospective Payment Assessment Commission

—professional standards review organization

—relative value scale

—Tax Equity and Fiscal Responsibility

Act of 1982 (Public Law 97-248)

—usual, customary, and reasonable

Glossary of Terms

Access: Potential and actual entry into the health care

system.

Actual charge (Medicare): The charge billed by a physician or other supplier of Medicare Part B medical

services. Along with the provider’s customary

charge and the prevailing charge in the locality, the

actual charge is used to determine approved charges.

Allowed charge (Medicare): See approved charge,

Ambulatory services: Medical services provided to patients who are not hospitalized.

Ancillary services or technology: Medical technology

or services used directly to support basic clinical

services, including diagnostic radiology, radiation

therapy, clinical laboratory, and other special

services.

Approved charge (Medicare): An individual charge determination made by a Medicare carrier on a covered Part B medical service or supply. In the absence of unusual medical circumstances, it is the

lowest of: 1) the physician’s or supplier’s customary charge for that service, 2) the prevailing charge

for similar services in the locality, 3) the actual

charge made by the physician or supplier, and 4)

the carrier’s private business charge for a comparable service. Also called allowed charge or reasonable charge,

Assignment (Medicare): An agreement by a provider

(physician or supplier) to accept a Medicare beneficiary’s rights to benefits under Supplementary

Medical Insurance (Part B), to bill the Medicare carix
rier rather than the patient, and to accept Medicare’s

approved charge paid by the carrier as payment in

full (excluding the beneficiary’s 20-percent coinsurance and the deductible). The provider may then

bill the beneficiary only for the coinsurance and any

applicable deductible.

Average adjusted per capita cost (AAPCC): As defined

under the Tax Equity and Fiscal Responsibility Act

of 1982 (Public Law 97-248), the AAPCC is the estimated average per capita amount that Medicare

would pay if covered services for Medicare competitive medical plan (CMP) members were furnished in local fee-for-service practices. The AAPCC

formula consists of the product of three major components: 1) the U.S. per capita Medicare cost as projected to the current year; 2) an adjustment based

on the historical relationship between national

Medicare costs and Medicare per capita reimbursements in the local area that a CMP serves; and 3)

an adjustment for the differences between persons

who choose to enroll in a CMP and the Medicare

population at large from which CMP enrollees are

drawn,

Billed charge (Medicare): See actual charge.

Cavitation payment: A method of paying for medical

care by a prospective per capita payment that is independent of the number of services received.

Carrier (Medicare): Organizations, typically Blue

Shield plans or commercial insurance firms, under

contract to the Health Care Financing Administration for administering Part B of the Medicare program. Their tasks include computing reasonable

charges for physician services, making actual payments, determining whether claims are for covered

services, denying claims for noncovered services,

and denying claims for unnecessary use of services.

Case mix: A measure of the mix of cases being treated

by a particular health care provider that is intended

to reflect the patients’ different needs for resources,

Case mix is generally established by estimating the

relative frequency of various types of patients seen

by the provider in question during a given time

period and may be measured by factors such as

diagnosis, severity of illness, utilization of services,

and provider characteristics.

Coinsurance: That percentage of covered hospital and

medical expenses, after subtraction of any deductible, for which an insured person is responsible. Under Medicare Part B, after the annual deductible has

been met, Medicare will generally pay 80 percent

of approved charges for covered services and supplies; the remaining 20 percent is the coinsurance,

which the beneficiary pays.

Competitive medical plan (CMP): A health plan option available to Medicare beneficiaries that provides

physicians’ services, laboratory, X-ray, emergency,

and preventive services, and inpatient hospital services, assumes risk for the provision of the required

x

services and out of area coverage, and meets certain requirements to assure financial solvency. Such

a plan is eligible to enter into a Medicare risk contract in return for a cavitation payment under the

Tax Equity and Fiscal Responsibility Act of 1982

(Public Law 98-248).

Cost-sharing: That portion of the payment to a provider

of health care services that is the initial liability of

the patient and that may include deductibles, copayments, coinsurance, and under Medicare Part B, unassigned liability. Also, the general set of financial

arrangements under which health care insurance is

contingent on a purchaser’s acceptance of the obligation to pay some portion of the reimbursements

for those services.

Current Procedural Terminology, 4th Edition (CPT4) Coding: A taxonomy of procedures performed

by physicians that is used for recording and billing

for services rendered. This taxonomy has been incorporated in the HCFA Common Procedure Coding system, which all Medicare carriers are now required to use.

Customary charge (Medicare): In the absence of unusual medical circumstances, the maximum amount

the a Medicare carrier will approve for payment for

a particular service provided by a particular physician practice. The customary charge is computed

by the carrier based on actual charge data for a specific service performed by one physician (practice

or supplier) to his or her patients in general.

Customary, prevailing, and reasonable (CPR) method

(Medicare): The method used by Medicare carriers

to determine the approved charge for a particular

Part B service from a particular physician or supplier. Under this method, the approved charge is

limited to the lowest of the physician’s actual charge

for the service, the physician’s customary charge for

the service, and charges by peer physicians or suppliers in the same locality. If necessary, prevailing

charges are adjusted by the Medicare Economic

Index.

Deductible: An initial expense of a specified amount

of approved charges for covered services within a

given time period (e.g., $75 per year) payable by

an insured before the insurer assumes liability for

any additional costs of covered services. The Part

B deductible is the portion of approved charges (for

covered services each calendar year) for which a

beneficiary is responsible before Medicare assumes

liability.

Diagnosis-related groups (DRGs): Entries in a taxonomy

of types of hospitalizations based on groupings of

diagnostic categories drawn from the International

Classification of Diseases and modified by the presence of a surgical procedure, patient age, presence

or absence of significant morbidities or complications, and other relevant criteria. DRGs have been

mandated for use in establishing payment amounts
for individual admissions under Medicare’s prospective hospital payment system as required by the Social Security Amendments of 1983 (Public Law

98-21).

Extracorporeal shock wave lithotripsy (ESWL): A technique for the disintegrating of upper urinary tract

stones that uses shock waves generated outside a

patient’s body and does not require a surgical incision.

Fee-for-service payment: A method of paying for medical care in which each service performed by an individual provider can bear a related charge.

Fee schedule: An exhaustive list of physician services

in which each entry is associated with one specific

monetary amount representing the approved payment for a given insurance plan.

Fee screen: A limit used to determine an insurer’s approved charge for a particular physician service,

such as under Medicare the physician’s customary

charge or the locality prevailing charge for the service in question.

Fee screen year: The calendar period during which a

particular year’s CPR limits are in effect. As of September 30, 1984, fee screen years run from October

1 through September 30 of the following calendar

year, with fee screen year 1985, for example, beginning on October 1, 1984 and ending on September 30, 1985. Prior to the Deficit Reduction Act of

1984 (Public Law 98-369), fee screen years began

on July 1 of a calendar year and continued through

June 30 of the next year.

Fiscal intermediary: An organization that acts as an

agent and purchaser of health care insurance or

health care services for insureds.

Health maintenance organization (HMO): A health

care organization that acts as both insurer and provider of comprehensive but specified medical services. A defined set of physicians provides services

to a voluntarily enrolled population for a prospective per capita amount (i.e., by cavitation). Prepaid

group practices and individual practice associations

are types of HMOs.

Individual practice association (IPA): A type of HMO

whose physicians usually practice in private offices

and are paid by the HMO on a fee-for-service basis. Members, however, pay the HMO for coverage through cavitation payments.

Inpatient services: Services provided to patients who

are hospitalized.

Intermediaries (Medicare): Organizations, typically

Blue Cross plans or commercial insurance firms, under contract to the Health Care Financing Administration for administering Part A of the Medicare

program. Their tasks include determining reasonable costs for covered items and services, making

payments, and guarding against unnecessary use of

covered services for Medicare Part A payments. Intermediaries also make payments for home health

and outpatient hospital services covered under Part

B.

Locality (Medicare): For the purpose of making Medicare approved charge determinations, a locality is

identified as a geographic area for which a carrier

derives the prevailing charges for services. Usually,

a locality is a political or economic subdivision of

a State include a cross-section of the population

with respect to economic and other characteristics.

Magnetic resonance imaging (MRI): An imaging technique based on the physical response of atomic

nuclei to imposition of a forceful external magnetic

field, and hence not requiring the ionizing radiation associated with X-ray technologies.

Managerial technology: Technology used to facilitate

and support the provision of health care services

but not directly associated with patient care, including administration, transportation, and communication, both within and among health care facilities.

Mandatory assignment: An alternative to the present

system of Medicare assignment. Under a system of

mandatory assignment, only those services for

which a physician had agreed to accept the Medicare determination of approved charges as payment

in full would be reimbursable. A beneficiary who

received a service from a physician who did not

agree to accept the Medicare approved charge as

payment in full would not be able to be reimbursed

for that service under a policy of mandatory assignment.

Medical technology: The drugs, devices, and medical

and surgical procedures used in medical care, and

the organizational and support systems within

which such care is provided.

Medicare Economic Index (MEI): The index that the

Medicare program uses to set limits on physicians’

prevailing charges. The MEI is based on estimates

of the costs of producing physician office services

and a measure of increases in earning levels in the

general economy, as specified by the Social Security Amendments of 1972 (Public Law 92-603).

Medigap insurance: Private supplementary medical insurance covering out-of-pocket expenditures of Medicare beneficiaries such as deductibles and coinsurance, but typically not covering unassigned liability

for physician services provided under Part B.

Nonassigned liability: See unassigned liability.

Nonparticipating physician (Medicare): A physician

practice that has not elected to become a Medicare

participating physician, i.e., one that has retained

the right to accept assignment on a case-by-base basis. Compare participating physician.

Nonprocedural service: A service, such as an office

visit, that may involve but does not depend in a

major way on a medical device.

Opportunity cost: In economics, defined as the return

xi
available from the best alternative use of a particular resource, for example, the value of the other

products that might otherwise have been produced

by the resources used in the production of a particular good or service. Any single opportunity

taken will have a cost in terms of an opportunity

forgone.

Packages of services: Groups of related physician services or functions that have either uniform content

or expected therapeutic effect, or that involve sets

of alternative, commonly performed but not required services complementary to a particular major physician service.

Part A (Medicare): Medicare’s Hospital Insurance program, which provides insurance benefits against the

costs of hospital and related posthospital services

for elderly and disabled beneficiaries. Part A, which

is an entitlement program for those who are eligible, is available without payment of a premium, although the beneficiary is responsible for an initial

deductible or copayment for some services. Those

not automatically eligible for Part A may enroll in

the program by paying a monthly premium.

Part B (Medicare): Medicare’s Supplementary Medical Insurance program, which provides insurance

benefits for medically necessary physician services,

hospital outpatient services, ambulatory physical

therapy and speech pathology services, comprehensive rehabilitation facility services, and various

other limited ambulatory services and supplies, such

as prosthetic devices and durable medical equipment. Part B also covers home health services for

those Medicare beneficiaries who have Part B coverage only. Enrollment in Part B is optional and requires payment of a monthly premium. The beneficiary is also responsible for a deductible and a

coinsurance payment for most covered services.

Participating physician (Medicare): A physician practice that has elected to provide all Medicare Part

B services on an assigned basis for a year. In return

for forgoing the right to bill for Part B services on

a unassigned basis, the participating physician is

listed in a directory of participating physicians

available to beneficiary organizations and may

receive greater increases in Medicare approved

charges than nonparticipating physicians.

Preferred provider organization (PPO): A form of

health care delivery system in which an agreement

is made between providers and purchasers that patients who seek medical care from the “preferred

providers” will obtain benefits such as reduced cost

sharing. In return for the potential increase in volume of patients, the preferred providers may agree

to discount their charges or to submit to enhanced

utilization review.

Prepaid group practice: A type of HMO consisting of

group practice that provides or arranges comprehensive covered services for enrollees, who pay by

cavitation.

Prevailing charge (Medicare): In the absence of unusual medical circumstances, the maximum amount

a Medicare carrier will approve for payment for a

particular service provided by any physician practice within a particular peer group and locality.

Generally, this amount is equal to the lowest charge

in an array of customary charges that is high enough

to include 75 percent of all the relevant customary

charges.

Procedural service: A service, such as endoscopy, that

is dependent in a substantial way on the use of a

medical device.

Prospective payment: Payment for medical care on the

basis of rates established in advance of the time

period in which they apply. The unit of payment

may vary from individual medical services to

broader categories, such as hospital case, episode

of illness, or person (cavitation).

Prospective Payment Assessment Commission (ProPAC):

A commission established by the same law that created the DRG-based prospective payment system

for Medicare (Public Law 98-21) to make recommendations to the Secretary of Health and Human

Services on the annual update factor and on adjustments of DRG classifications and weights.

Quality of care: The degree to which actions taken or

not taken maximize the probability of beneficial

health outcomes and minimize risk and other untoward outcomes, given the existing state of medical science and art.

Quality assurance: Integrated programs that attempt

to protect or raise quality of care by conducting

assessments, taking action to correct problems

found, and following up with corrective interventions.

Reasonable charge (Medicare): See approved charge.

Relative value scale (RVS): A list of all physician services containing a cardinal ranking of those services

with respect to some conception of value, such that

the difference between the numerical rankings for

any two services is a measure of the difference in

value between those services.

Third-party payment: Payment by a private insurer

or government program to a medical provider for

care given to a patient.

Unassigned liability: The difference, if any, between

a physician’s actual charge for a service on an unassigned claim and the Medicare approved charge

for that service.

Usual, customary, and reasonable charges (UCR): In

private health insurance, the bases for reasonable

xii
charge reimbursement of physicians. This approach ary, ” in this context, refers to a percentile of the

was developed in the early 1960s somewhat before pattern of charges made by physicians in a given

the introduction of Medicare, and was adapted by locality (comparable to Medicare’s “prevailing”

Medicare as the model for CPR. “Usual” refers to charges). “Reasonable” is the lesser of the usual or

the individual physician’s fee profile, equivalent to customary screens.

Medicare’s “customary” charge screen. “Custom-
Chapter 1

Summary and Policy Options

There’s always an easy solution to every problem—neat, plausible, and wrong.

—H.L. Mencken
Contents

Introduction . . . . . . . . . . . .

Scope of the Study . . . . . .

Physician Payment Under

Policy Options. . . . . . . . . .

General Options . . . . . .

Continuation of Present

Payment Based on Fee

Payment for Packages

Cavitation Payment . .

Conclusion . . . . . . . . . . . .

List of Figures

Figure No.

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Medicare: Problems

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. . . . . . . . . . . . . . . . . .

.., .

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and

.., .

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Payment Arrangements

Schedules. . . . . . . . . . . . . .

of Services . . . . . . . . . . . . .

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Changing Content

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Physician

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1-1. Congressional Options for Medicare Payment of

and Other Services , . . . . . . . . . . . . . . , , . . . . . . . . .

1-2. Alternative Methods of Medicare Payment for Services Provided to a

Hypothetical Patient Presenting the Symptom of Extreme Flank Pain . . . . .

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Chapter 1

Summary and Policy Options

INTRODUCTION

In an era of concern about Federal budget deficits, the growth and size of Medicare expenditures on physician services have made this sector

an obvious target for constraining outlays. During the 1980s, Medicare expenditures for physician services have risen at an average rate of 16

percent per year and in fiscal year 1985 reached

an estimated $19 billion. For 1985, Medicare’s

Supplementary Medicare Insurance (Part B) program, which includes physician expenditures,l

was estimated to be the fourth largest domestic

program in the Federal budget, following Social

Security, Medicare’s Hospital Insurance (Part A)

program, and Medicaid2 (401,553).

Important policy concerns apart from rising

Medicare expenditures are at issue. There are indications that medical care is not being provided

efficiently—that more or fewer resources than

appropriate are being used to manage medical

conditions and that the benefits gained from additional services may not be worth their costs.

Wide variations exist in the use of physician and

hospital services that cannot be explained by

differences among populations (568). Observers

have concluded that some technologies, such as

vaccines, have been underused (397). On the other

hand, populations with lower use of hospitalization and associated physician services have

suffered no apparent ill effects over time (65,

279,285).

To some extent, the present situation stems

from the fact that medicine is not an exact science.

Alternatives exist for the management of many

medical conditions, and physicians use their ex1Medicare’s Part B program covers physician, home health, and

ambulatory services. Eligibility for Social Security benefits determines entitlement for coverage of Part A, which pays for hospital

and related post-hospital services. People eligible for Part A and

U.S. residents over age 65 may enroll in Part B. Enrollees pay a

monthly premium, a deductible, and 20 percent of the charges allowed by Medicare (493). In fiscal year 1984, physicians’ services

accounted for 85 percent of Part B expenditures (553).

‘Expenditures for national defense and net interest also exceeded

those for Part B in 1985 (470).

pertise and judgment to determine the medical

care for particular patients. Given the discretion

that physicians exercise and the lack of definitive

information available to clinicians concerning the

efficacy and cost-effectiveness of medical technologies, it is perhaps not suprising that there are substantial variations in practice patterns.

But past policies regarding health insurance

coverage and payment methods have also played

a major role in rising medical expenditures. In general, health insurance dulls the sensitivity of consumers, physicians, and other providers to the financial implications of using medical care (137).

With existing levels of cost-sharing, elderly Medicare beneficiaries in general are likely to be sensitive to the cost of using medical care. But coverage and beneficiary cost-sharing vary across

settings and technologies. Both elderly Medicare

beneficiaries and their physicians are likely to be

less sensitive to the cost of technologies that have

more nearly complete Medicare coverage. Routine checkups are statutorily excluded from coverage, for example, while physician services for

certain surgery performed in designated ambulaPhoto credit: Merck, Sharp, & Dohme

Pneumococcal vaccination, shown here, is the only

preventive service covered by Medicare for

all beneficiaries,

3
4 . Payment for Physician Services: Strategies for Medicare

tory surgical centers or hospital outpatient settings

is reimbursed at the rate of 100 percent of approved charges. Although Medicare’s payment

policies for ambulatory surgery are intended to

encourage physicians and beneficiaries to use less

costly settings, in some cases, program expenditures for ambulatory surgery have exceeded the

amount that Medicare would have paid for an inpatient case (161).3

Overall, Medicare pays 45 percent of the medical expenses of its elderly beneficiaries; this includes 74 percent of their hospital expenses and

55 percent of their physician expenses, but a much

smaller percentage of their other medical expenses

(551). About 65 percent of elderly people outside

of institutions have private insurance to supplement their Medicare coverage. Despite Medicare

and other coverage, elderly people still bear substantial medical expenses; in 1984, elderly people spent an estimated 15 percent of their average income on out-of-pocket costs for health care,

the same percentage as in 1966 before Medicare

was fully implemented (495).

Medicare’s traditional payment methods for

physician services, like those of other payers, have

provided incentives for physicians to provide additional services, regardless of the additional benefit to be gained by beneficiaries. Medicare pays

physicians and other Part B providers a fee for

each service performed. This fee-for-service payment method places the financial risk for the care

provided on the Medicare program and the beneficiary, not on the physician. With fee-for-service

payment, physicians have an incentive to perform

additional services, provided that the additional

revenue they receive exceeds their costs.4 Because

much uncertainty exists in medicine and physicians must exercise discretion in their clinical decisions, there is much room for them to recom-

$ October 1, 1983, Medicare began phasing in a prospective payment system for beneficiaries’ inpatient care. Under this system of

payment according to diagnosis-related groups (DRGs), Medicare

pays a fixed amount based on diagnosis for the operating costs of

beneficiaries’ inpatient admissions.

“’Cost” here refers to the physician’s expenses of resources used

in the course of providing a service. The physician’s cost includes

his or her “opportunity cost, ” that is, the payment that the physician could obtain for other activities, such as performing another

service for another patient. In contrast to cost, price or approved

charge refers to the revenue that a physician receives for a service.

mend additional followup visits or procedures

within the bounds of accepted medical practice.

Medicare’s payment rates are based on what

physicians have charged in the past, a system that

is inherently inflationary (262). Under Medicare’s

customary, prevailing, and reasonable (CPR) payment method, the Medicare approved charges is

limited to the lowest of a physician’s billed charge,

the customary charge for that service based on

that physician’s prior billings, and the prevailing

charge for that service based on comparable physicians’ prior billings for the same service. An additional limit on the prevailing charge for a service is set by the Medicare Economic Index, which

measures changes in practice expenses and general earnings.

Depending on whether the physician “accepts

assignment, ” either the Medicare administrative

carrier6 or the beneficiary pays the physician. The

beneficiary, after having met the annual deductible, is entitled to have Medicare pay 80 percent

of the approved charge for a Part B service. If the

physician accepts assignment, she or he accepts

Medicare’s approved charge as payment in full

and may collect only the beneficiary’s 20-percent

coinsurance and any remaining deductible from

the beneficiary. If the physician does not accept

assignment, the beneficiary is liable for any difference between the physician’s actual charge and

Medicare’s approved charge (the beneficiary’s unassigned liability), plus the coinsurance and any

deductible.

Since October 1, 1984, physicians have been

able to become Medicare “participating physicians” by agreeing to accept assignment for all

Medicare claims for the next 12 months. From July

1, 1984 to October 1, 1985, the customary and

prevailing charges of all physicians and the billed

charges of “nonparticipating” physicians were frozen. In the absence of passage of Medicare’s authorization for fiscal year 1986, Congress in De5

The terms approved charge, reasonable charge, and allowed

charge are used interchangeably to connote the amount that Medicare pays for a specific physician service. After the beneficiary has

paid an annual deductible, Medicare pays 80 percent of the approved

charge, and the beneficiary is responsible for 20 percent.

6

T0 administer Part B, Medicare contracts with private organizations termed carriers, which are primarily insurance companies

that also have private lines of business.
Ch. l—Summary and Policy Options ● 5

cember 1985 temporarily extended the freeze to

March 15, 1986.

Like the use of the service as the unit of payment, the structure of relative fees under the CPR

payment method has not contained incentives for

the efficient provision of medical care. Medicare,

as well as most private third-party payers, has historically paid higher rates for urban, specialist,

and inpatient services than for rural, generalist,

and ambulatory services. Medicare has also rewarded services dependent on equipment more

highly than historytaking and counseling (227,424).

The Deficit Reduction Act of 1984 (Public Law

98-369), which established the participating physician program and froze physician charges to

Medicare beneficiaries, also mandated OTA to exSCOPE OF THE STUDY

This report uses the term “physician services”

for services that are commonly provided by physicians but are sometimes provided by other

professionals or organizations.7 Clinical laboratory tests, for example, may be performed in a

physician’s office, an independent clinical laboratory, or a hospital laboratory. Similarly, refraction and fitting of corrective lenses may be provided by physicians, such as ophthalmologists,

or by other professionals, such as optometrists.

Furthermore, some of the alternative payment

methods that are considered in this report entail

payments for the institutional as well as the physician portion of inpatient care.

This report uses OTA’s definition of medical

technology: the drugs, devices, medical, and surgical procedures used in medical care, and the organizational and supportive systems within which

such care is provided.

7The Social Security Act defines “physicians’ services” as professional services performed by doctors of medicine, osteopathy, dentistry, podiatry, and optometry; and chiropractors (Section 1861

(r)). In addition, health maintenance organizations and competitive

medical plans may furnish the services of certain other health professionals without the direct supervision of a physician: physician assistants, nurse practitioners, and clinical psychologists (50 FR 1351,

42 CFR 417.416).

amine different ways of paying for physician services under Medicare. The act specified that OTA

was to pay particular attention to the following

topics: any inequities in relative payments by type

of service, locality, and specialty or in relative

payments between procedural and nonprocedural

services; incentives for providers to accept assignment; the effects of alternative payment methods

and levels on the use of services; and possible

methods to develop fee schedules. The House Energy and Commerce Committee, the House Ways

and Means Committee, and the Senate Finance

Committee have jurisdiction over Medicare Part

B and this section of the law. In addition, the Senate Special Committee on Aging requested OTA

to study the effect of physician payment methods on the use of medical technology.

The problems with Medicare’s current system

of paying for physician services are examined in

chapter 2, and chapter 3 presents a framework

for evaluating alternative methods of payment to

deal with these problems. Subsequent chapters focus on the analysis of specific payment alternatives: modifications to Medicare’s customary, prevailing, and reasonable (CPR) charge payment

(ch. 4); payment based on fee schedules (ch. 5);

payment for packages of services (ch. 6); and capitation payment (ch. 7).

The remainder of this chapter summarizes these

topics and presents policy options for Congress

to address the problems identified and to pursue

strategies culminating in different payment reforms. Appendix A describes the method of conducting the study; appendix B acknowledges the

valuable assistance of several individuals; and appendixes C and D present background information on topics related to but broader than Medicare, Medicaid, and private sector approaches to

paying for physician services. In addition to the

main report, a case study on extracorporeal shock

wave lithotripsy (ESWL) is being published in connection with this assessment.
6 . payment for Physician Services: Strategies for Medicare

PHYSICIAN PAYMENT UNDER MEDICARE:

PROBLEMS AND CHANGING CONTEXT

The Medicare program is intended to help

elderly and disabled people meet their medical expenses. Expressed as the missions of the program,

this goal entails promoting the delivery of quality health care services to beneficiaries, making

those services accessible to them, and doing so

in a manner that is consistent with the costeffective delivery of services within both Medicare and the general U.S. health care system

(491,508).

Over the life of the program, per capita Medicare expenditures for physician services have risen

at roughly the same rate as increases for the

United States; however, since 1978 and especially

since 1982, per capita Medicare expenditures for

physician services have risen more rapidly than

expenditures for the Nation as a whole. Although

growth slackened in 1984, total expenditures for

Medicare’s Part B program are expected to continue to rise by almost 14 percent per year through

fiscal year 1990 (401). Increases in the beneficiary population have accounted for only a minor

part of this growth. From 1976 to 1982, Medicare

expenditures for physician services for elderly people increased 18 percent per year—2 percent from

enrollment increases, 10 percent from price increases, and 6 percent from increases in the number of services per enrollee (133). Claims per beneficiary have risen continuously throughout the

history of Medicare, from 1.1 in 1967 to 7.9 in

1984 (527).

There is substantial variation in aspects of

Medicare payment, including assignment rates,

annual expenditures per beneficiary, and relative

rates paid for certain services. This variation, discussed further below, may be indicative of problems regarding quality, access, and efficiency. But

substantial variation is to be expected within a

national program serving over 30 million beneficiaries in thousands of local markets, and little

or no consensus exists regarding whether specific

variations signify problems.

Across the United States, assignment rates vary

from 17 percent for elderly people in South

Dakota to 87 percent in Rhode Island (296).

Differences in assignment rates affect beneficiaries’

out-of-pocket costs. For the claims of elderly beneficiaries, assignment rates increase with the age

of the beneficiary, but for disabled people, assignment rates have been highest for the youngest age

group. Assignment rates also rise substantially for

higher bills. In general, the data are consistent

with the hypothesis that physicians accept assignment more readily when there is a greater risk of

incurring a bad debt.

Although Medicare’s Part B program is a national program funded through general revenues

and beneficiary premiums and deductibles are uniform across the country, Medicare’s payments on

behalf of beneficiaries vary considerably. Across

the United States, there is more than a twofold

variation by carrier jurisdiction in Medicare expenditures per beneficiary for physician and other

medical services (525). This variation depends on

the proportion of beneficiaries who exceed the

Medicare deductible and are thus eligible for reimbursement; that proportion, in turn, depends on

variations in health, service volume, physicians’

charges, and the stringency with which Medicare

carriers determine approved charges.

Compared to beneficiaries in States with high

approved charges, beneficiaries in States with low

approved charges have to receive more services

to meet the deductible and qualify for program

payments. On the other hand, for a given volume of services, beneficiaries in States with lower

approved charges may have lower out-of-pocket

expenses. Even within a national program, provision of a uniform real level of benefits requires

that Medicare pay different prices across jurisdictions to reflect different practice costs,

Within States, variations generally reflect disparities in payment levels between urban and rural areas. Under the Social Security Act, Medicare carriers are given discretion in identifying

localities for payment purposes. Because of this

carrier discretion, the entire State is the locality

‘In fiscal year 1984, the 58 jurisdictions across the United States

were administered by 40 carriers (535).
Ch. l—Summary and Policy Options • 7

for 18 States, while Michigan has 2, Pennsylvania

has 4, and Texas has 32 localities. Across localities, the range in charges for specific services is

often great. In 1980, the highest prevailing charge

exceeded the lowest by 159 percent for cataract

removal and by 536 percent for chest X-rays (494).

Even after adjustment for cost-of-living differences, great variations continue to exist (50), but

the costs of operating practices of equivalent size

and style are not available. To the extent that

differences in approved charges exceed differences

across local market areas, reducing the number

of localities for charge determination is a reasonable goal.

Carriers also differ across the United States in

their use of physician specialty to determine approved charges for services. Four carriers make

no distinction among physician specialties (473),

while the carrier for Pennsylvania has had 58

different groups. For many services, prevailing

charges are specialty specific regardless of carrier

policy, because one specialty typically performs

a certain procedure. Few cataract removals, for

example, are performed by physicians who are

not ophthalmologists. Specialty-specific determinations may have the most effect on approved

charges for physician visits, which are performed

by many different specialties and account for

about half of all physician services provided to

beneficiaries. The justification for recognizing

higher approved charges for specialists compared

to generalists is that specialists provide either

higher quality or different services. Some evidence

suggests that higher quality care is provided by

physicians practicing in the area of medical care

for which they were trained (so called “modal

specialists”) (370). The difficulty arises in determining in specific cases when services, mainly

visits, performed by specialists and generalists

constitute similar services and when a specialist

or generalist is the modal specialist and deserves

higher payment. There is no empirical literature

to guide determinations for specific cases.

Medicare payment for physician visits also

varies by the site of service, with a hospital visit

paid more than a nursing home visit, and a nursing home visit paid more than an office visit (494).

In 1982, average prevailing charges were 11 to 32

percent higher for inpatient visits than for office

visits. Since physicians do not pay hospitals for

the use of their facilities, these differences suggest

an incentive for physicians to favor the hospital

as the site of care. However, the nomenclature

of physician services may be misleading in this

instance. A limited inpatient visit may differ from

a limited office visit because inpatients are usually sicker and may require more physician time

and skill.

Large differences appear to exist in relative approved charges for procedural services such as endoscopy, which depend in a major way on the

use of medical devices, and nonprocedural services such as office visits, which use medical devices only incidentally. g One study reported that

after adjustment for such factors as training, resource cost, and service complexity, physicians

were paid as much as four to five times more per

hour for inpatient surgery than for office visits

(227). Within the office, the lack of additional

payment for such primary-care services as historytaking or nutritional counseling contrasts sharply with the additional income that can be generated from, for example, providing laboratory

tests, interpreting an electrocardiogram, or performing an endoscopy. In office practice, payment

‘Although procedural services are often referred to as cognitive

services, both procedural and nonprocedural services use cognitive

skills.

Photo credit: American College of Physicians, HEALTHSCOPE film series

The lack of additional payment for primary-care services

such as counseling and historytaking contrasts sharply

with the additional payment for services, such as

interpreting electrocardiograms, that depend greatly

on medical devices.
. —

8 ● Payment for Physician Services: Strategies for Medicare

rates are such that physicians might realize greater

net incomes from performing an additional diagnostic test than from seeing an additional patient

(424).

The establishment and maintenance of high

payment rates for equipment-embodied and surgical technologies may have contributed to payment differentials between procedural and nonprocedural services. Many technologies are priced

high when new because they are complex and requre special skills to perform. Even if over the

years the required physician time and other resources decline and the necessary skills become

more commonplace, the initial price is maintained.

Differentials in Medicare payment rates for certain services raise the concern that they may be

affecting the quality of care received by beneficiaries and the cost of care paid by Medicare and

beneficiaries. Differences in net revenue to providers would be most likely to influence medical

decisions for which the medically and ethically

correct choice is unclear (194). The comparison

involves both the net revenues from services that

are substitutes for a particular patient and the physician’s opportunity costs of providing services to

another patient. In the case of a beneficiary who

has private supplementary insurance to cover

cost-sharing, the additional cost to the patient of

a diagnostic procedure, such as endoscopy, may

be negligible. Since the test may provide useful

information and requires little time, the increase

in revenue to the physician of several hundred dollars may be a strong incentive to perform the test.

Currently, beneficiaries may find it harder to

obtain nonprocedural than procedural services.

There is evidence that carriers have paid a lower

percentage of billed charges for visits than for surgeries (247,294), that assignment rates have been

lower for primary-care specialties than for surgical ones, and that beneficiary out-of-pocket payments have been a larger part of revenue associated with the Medicare program for primary-care

physicians than for surgeons and radiologists

(247). There is no indication, however, that beneficiaries’ health has suffered from lack of access

to primary-care services.

Variations in payment rates also result from the

application of the Medicare Economic Index. The

effect of the index varies greatly, depending on

the services and specialty. In 1980 in California,

the index affected almost no payments for eye

exams from ophthalmologists but affected almost

all payments for basic anesthesiology services

from anesthesiologists (187). On the other hand,

by capping prevailing charges in urban areas, the

index in effect prevented urban-rural differentials

from increasing (359).

The changing context of medical practice adds

other considerations to an analysis of Medicare’s

payment policies. In recent years, physicians have

felt under greater competitive pressure. In part,

this sense may have come from the increases in

physician supply, which has grown rapidly over

the past decade and is expected to outstrip requirements for additional physician services for the rest

of the century (544). The sense of greater competition may also have come from activities of employers to contain increases in health insurance

premiums and of Federal and State governments

to moderate increases in their health care expenditures.

Perhaps in response to these changing circumstances, innovative practice arrangements are burgeoning, and physicians are increasingly entering

organizational and payment systems, such as prepaid group practices, individual practice associations, and preferred provider organizations (PPOs),

that differ from traditional fee-for-service solo

practice in utilization controls, payment methods,

and benefit design. Although these organizations

usually exert more control over the availability

and use of resources than physicians would experience in solo practices, physicians in these organizations gain greater predictability in patient

load, income, and practice hours. As a result of

prospective hospital payment systems that Medicare and several States have adopted in recent

years, hospitals have new incentives to reduce inpatient operating costs. Cutbacks in lengths of

stay appear to be affecting the inpatient services

that physicians perform, but payment for services in the ambulatory settings including physi-
Ch. l—Summary and Policy Options . 9

cians’ offices has remained relatively unconstrained.

Greater Medicare expenditures can be expected

as the increasing supply of physicians enables the

growing demand from more numerous and more

elderly beneficiaries to be realized. Because of the

increasing supply of physicians, however, these

providers may be more willing to accept lower

prices for their services and lower increases in their

incomes. To the extent that competition would

lead physicians to moderate their billed charges,

Medicare’s present CPR system would permit the

program and its beneficiaries to benefit from lower

costs. But under CPR, Medicare could also experience increases in use and expenditures if physicians chose to maintain their incomes in the face

of greater competition by increasing the discretionary use of services or if beneficiaries

demanded more services in response to lower

charges.

Recent changes in legislation and regulation

have made participation in Medicare more attractive to risk-sharing health maintenance organizations (HMOs) and other competitive medical

plans (CMPs), and beneficiary enrollment in

HMOs mushroomed during 1985. Nevertheless,

it appears that Medicare has not fully taken

advantage of opportunities in the marketplace.

Despite the fact that beneficiaries account for a

large share of certain physician services, Medicare uses a standard formula to determine approved charges and has not attempted to negotiPOLICY OPTIONS

To address the problems identified with Medicare’s current system of paying for physician services, Congress could undertake four different

strategies, depending on the payment method that

Congress ultimately wished to adopt for Medicare (see figure l-l). The first strategy would retain CPR as the mainstream payment method, but

continue other payment methods in specific circumstances, such as cavitation payment for beneficiaries who elected to enroll in HMOs. A second strategy would replace the CPR payment

approach with payment based on fee schedules.

The third strategy could be adopted if Congress

wished to explore the strategy of moving to payate discounts. Although the determination of

approved charges might be considered a form of

quantity discounting, one might expect greater reductions for services provided primarily to beneficiaries, such as cataract surgery. Medicare also

lacks arrangements with PPOs, organizations

which contract with physicians and sometimes

hospitals to provide services at lower than usual

rates on the expectation that patient load will be

greater.

Review of Medicare’s payment of physician

services raises questions regarding the quality, accessibility, and efficiency of beneficiaries’ medical care. It is clear that Medicare expenditures for

physician services are currently unpredictable and

lie largely outside the control of the program and

its beneficiaries. Using fee-for-service as the

method of payment and CPR as the basis for determining approved charges has been associated

with continual increases in claims per beneficiary

and in recent years with more rapid expenditure

increases for Medicare than for the Nation as a

whole. Nor does the pattern of variations in approved charges among services appear consistent

with incentives for providers to deliver good quality care in an efficient manner. There is also no

question that variations in payment levels have

led to confusion among providers about the approved charges that they may expect for a service and among beneficiaries about their out-ofpocket expenses.

ment for packages of services on a wide scale. Under the fourth strategy, Medicare would pay for

all beneficiaries’ medical care by cavitation payment. In addition to the four strategies, a set of

general options addresses problems that are likely

to continue under all of the payment alternatives

that continue payment for individual or packages

of services, that is, for all of the alternatives except cavitation payment (see figure 1-1).

The four sets of payment alternatives vary with

respect to the unit on which medical care is based.

Two of the alternatives, modifications to CPR

payment and payment based on fee schedules,
10 ● payment for Physician Services: Strategies for Medicare
Ch. l—Summary and Policy Options • 11

would continue the individual service as the unit

of payment. Payment for packages of services

would involve grouping related services, such as

all services associated with an ambulatory visit

or a special procedure, and paying for them as

an aggregate unit; thus payment under the packaging approach is also based on the services provided. Cavitation (per capita) payment would

base payment on the number of beneficiaries enrolled in a plan. The payment alternatives take

the perspective of the Medicare program and concern how Medicare could pay for physician services rather than how physicians receive payment

for their work. Thus, for example, Medicare

might pay an HMO a cavitation payment for providing physician services to beneficiaries, but the

HMO organization in turn could pay physicians

on a different basis, including salary, fee-forservice, or some combination.

In addition to varying by the unit of payment,

payment for physician services varies by the level

of payment and the relative rate structure. All of

these aspects may affect physicians’ and beneficiaries’ decisions about the use of specific services

and total expenditures for medical care. Regardless of the unit of payment, the recipient increases

revenue by increasing those units, whether they

be individual services, packages of services, or

beneficiaries as enrollees. It is in the financial interest of the recipient to increase the number of

units only if an additional unit adds more to revenue than to costs, including the opportunity cost

of using resources in other uses. And that situation depends on the level of payment and the relative rates paid for other units.

The payment alternatives in this report have

been evaluated for their implications for quality

of care; access to care, both financial and geographic; costs and efficiency; technological

change; and administrative feasibility. The effects

of alternative methods of paying for physician

services are difficult to predict because of uncertainty regarding physicians’ behavior, especially

in the context of the present medical marketplace.

Faced with a decrease in the fee for a service, physicians might respond like most suppliers and reduce the volume of services that they were willing to provide. Because of that effect, reductions

in approved charges could lead to reductions in

Medicare expenditures. But the possibility has

been raised that physicians can induce demand

for their services. In that case, total Medicare and

beneficiary expenditures could rise even with a

decrease in price, and utilization control would

be needed to control expenditures under fee-forservice payment. Although studies have found

that public health insurance programs that froze

or reduced physician fees did not control expenditures (158), the empirical work is not definitive

because of concomitant changes in relative charges

paid by other third-payers or because of the possibility that beneficiaries may have increased their

demand for services in response to lower prices.

In the dynamic situation of increasing physician supply, physicians’ behavior is even more difficult to predict. Physicians are increasingly entering innovative practice arrangements that

control their use of services and incomes and may

be more willing to accept lower prices for their

services and lower increases in their incomes. On

the other hand, physicians in the United States

and Canada have maintained their income levels

even in the face of substantial increases in physician supply (28). It is possible that physicians

would respond to general restrictions on payment

rates by increasing the use of certain services, such

as laboratory tests, and billing for more highly

priced visit categories. In fact, such behavior may

already be occurring. From 1977 to 1982, physician billing for hospital and office visits shifted

markedly from lower priced categories, such as

followup and generalist visits, to higher priced categories, such as initial and specialist visits (133),

Another thorny issue concerns assignment

rates. The relationship between assignment rates

and access of beneficiaries to medical care is not

clear cut; access is not synonymous with assignment. Although assignment is intended to improve beneficiaries’ financial access to care, it is

possible that a beneficiary could have lower outof-pocket expenses for services from a physician

who refused assignment than from a physician

who took assignment but had higher approved

charges. In addition, some physicians who refuse

assignment may not pursue the beneficiary for his

or her unassigned liability. There are no documented problems with beneficiaries’ access to care

at present assignment rates. In fiscal year 1985,
12 ● Payment for Physician Services: Strategies for Medicare

30 percent of physicians who bill Medicare elected

to become participating physicians (to take assignment for all claims) (518). Assignment on a caseby-case basis has been rising since the low point

in 1976, when it was 50.5 percent of claims and

47.6 percent of charges (494). In fiscal year 1985,

including participating physicians, the assignment

rate reached 67.7 percent of claims and 67.4 percent of charges (534a). Despite the uncertainty

about the desirable level of assignment rates, it

is reasonable to conclude that an increase in assignment rates will improve access and a decrease

will reduce access for some beneficiaries.

A related issue is physicians’ willingness to accept assignment. The higher Medicare’s approved

charge in relation to a physician’s billed charge,

the more likely that physician is to accept assignment (184,317,357,402), the more services are

likely to be provided to Medicare patients per capita, and the greater is the number of Medicare patients likely to be treated by that physician (188).

Early information on physicians who choose to

become participating physicians for fiscal year

1985 indicates that previous assignment rates and

the percentage of the usual fee paid by Medicare

were the most important economic variables associated with the decision to participate (94). If, as

is likely, changes in Medicare payment of physician services affected the approved charges of

physicians, assignment and participating physician rates would be expected to decrease in instances where approved charges had decreased

and to increase in instances where approved

charges had increased. The effects on beneficiaries’

out-of-pocket expenses would be conflicting. A

beneficiary whose physician’s approved charges

declined would have lower coinsurance liability.

But since that physician would be less likely to

take assignment or become a participating physician, the beneficiary would be likely to face

higher unassigned liability. One would expect that

the change in unassigned liability would be greater

than the change in coinsurance.

General Options

Reducing differentials in payment among certain services, reducing the number of codes for

payment purposes, adopting other controls over

volume of services, and mandating assignment are

four general options that would be consistent with

payment alternatives that continue to base payment on individual services or packages of services provided. Issues concerning volume of services and mandatory assignment would become

more pressing if Medicare placed greater constraints on the prices paid for physician services

by reducing the level of approved charges under

CPR or adopting payment based on fee schedules

or packages of services. Although the other four

general options would be diversions on a path to

cavitation payment, a fifth general option, establishing a commission to advise on physician payment reform, could be consistent with either capitation or the other payment alternatives.

Option 1: Mandate the Medicare program to reduce or eliminate differentials in payment in

one or more of the following categories:

● approved charges within States,

● similar services provided by generalists

and specialists,

. comparable services performed in different sites of care, and

● nonprocedural services (primarily visits)

vs. procedural services.

To address perceived imbalances in Medicare

payment, the approved charges for the higher

priced services (urban, specialist, inpatient, or

procedural) could be reduced with or without raising the approved charges for the lower priced

services (rural, generalist, ambulatory, or nonprocedural). In the course of reducing the variation in approved charges between procedural and

nonprocedural services, Medicare could adjust approved charges for technologies whose costs have

decreased over time. Medicare could also periodically review and adjust approved charges for such

technologies.

Reducing the approved charges for the higher

priced services would decrease assignment rates

for and beneficiaries’ financial access to these

services. Services such as magnetic resonance

imaging (MRI), which are provided by only a few

physicians who have non-Medicare as well as

Medicare patients, would be less accessible to beneficiaries if Medicare’s payment level was much

below that of private insurers (234). Access to

lower priced services would be likely to increase

if their approved charges were raised.
Ch. l—Summary and Policy Options ● 1 3

Photo credit: University of Virginia Medical Center

Medicare payment rates for expensive new technologies, such as extracorporeal shock wave Iithotripsy (ESWL) being

performed here, have tended to remain at their initial levels or rise, even if the costs of resources have declined.

Assignment rates are likely to fall least for physicians, such as radiologists, general surgeons,

ophthalmologists, and orthopedic surgeons, whose

approved charges are currently the least constrained by prevailing charge limits (247).

Specialists for whom approved charges have been

most constrained by prevailing charge limits,

namely general practitioners, family physicians,

and internists, could benefit from increases in relative payment rates for nonprocedural services.

However, lowering payment rates for procedural

services would affect internists whose practice involves the substantial performance of procedures

such as gastroendoscopy.

There is some overlap between past levels of

assignment and the extent to which prevailing

charges constrained a specialty’s approved changes.

Radiologists have had higher assignment rates and

less constraint from prevailing limits, but psychiatrists, pathologists, and pediatricians have

also had high assignment rates (69). General practitioners and family physicians, with approved

charges most limited by prevailing charges, have

had some of the lowest assignment rates. Other

specialists that have had low assignment rates are

allergists, surgical specialists, and anesthesiologists (69). Medicare might exert greater leverage

over physicians with a larger proportion of their

practice revenue from Medicare payments. In that

case, thoracic surgeons, internists, radiologists,

and general surgeons would be most affected by

changes in approved charges and gynecologists,

psychiatrists, plastic surgeons, family physicians,

orthopedic surgeons, and general practitioners the

least affected (353).
—

74 . Payment for Physician Services: Strategies for Medicare

Overall, lower approved charges would be

likely to affect least the assignment rates of pathologists, radiologists, and some of the surgical

specialists. Whether an internist’s approved charges

and hence assignment rate would rise or fall would

depend on a particular physician’s location and

pattern of practice. Internists have been dependent on Medicare revenue, but have also had their

approved charges more constrained by prevailing charge limits. Although the approved charges

of general practitioners and family physicians

have been highly constrained by prevailing charge

limits, these specialties are also less dependent on

Medicare revenue.

How this option would affect quality of care

is unclear. Besides effects on quality through

changes in access, changes in quality would depend on the appropriate level of specific services,

which is often not known (568). If the use of procedural services, such as electrocardiograms, is

being unduly stimulated by present payment

rates, lowering approved charge levels would improve quality. The quality implications of reducing differentials for similar generalist and specialist

services are further confounded by the unresolved

issue of whether specialists provide higher quality care than generalists. Specialists appear to provide higher quality care when practicing within

the domain of their advanced training (369,392,

398). But the evidence that physician performance

per se is related to specialization is weaker (194)

and contradictory (416).

The effect of this option on Medicare expenditures would depend on the changes in volume of

services in response to the changes in prices, a subject that is still a matter of debate. If the volume

of services provided to Medicare beneficiaries did

not increase, lowering approved charges for relatively high-priced services without increasing

those for relatively low-priced services would decrease total Medicare expenditures. However, if

the response of physicians or beneficiaries raised

the volume of services used, Medicare expenditures could rise. The effect on total Medicare expenditures of increasing approved charges for

lower priced services while lowering approved

charges for higher priced services is indeterminate.

With lower approved charges and no volume

changes, beneficiaries’ out-of-pocket expenses in

the absence of mandatory assignment would increase because of lower assignment rates and

greater unassigned liability, but their costs would

decrease because of lower coinsurance. Since the

increase in unassigned liability is likely to be

greater than the decrease in coinsurance, beneficiaries’ total expenses would increase. In cases

where approved charges for lower priced services

were raised, the decrease in unassigned liability

would most likely exceed the increase in coinsurance, with the result that beneficiaries’ total outof-pocket costs for that service would decrease.

Physicians whose approved charges were lowered

would be unlikely to raise their charges to nonMedicare patients. But these physicians would be

likely to shift their time and provision of services to other patients for whom physician time was

more highly paid. If approved charges were reduced to levels significantly below those of the

non-Medicare market, physicians might choose

not to participate in the Medicare program.

Option 2: Mandate the Medicare program to reduce the number of procedure codes used to

pay for physician services.

The multitude of procedure codes for payment

purposes (7,040) includes different codes for services that have only minimal distinctions. For example, office visits have 11 codes (new patient:

brief, limited, intermediate, extended, comprehensive; established patient: minimal, brief, limited,

intermediate, extended, and comprehensive), and

some particular procedures, such as chest X-ray,

have many categories based on very fine differences in actual technology. This situation enables

physicians to upgrade their billing codes. Physicians may also bill separately for services such as

laboratory tests instead of including them within

the office visit charge (319).

Medicare could reduce the number of categories for visits and procedures such as colonoscopy

by combining codes that differ in only minor

ways. New payment rates could be constructed

from a weighted average of the historical charges
Ch. l—Summary and Policy Options ● 1 5

for all related codes (319) or on the fee for the

code used most frequently (569). Once new categories were established, codes could be collapsed

at either the carrier level (allowing physicians to

continue to bill with present codes) or the physician level (requiring physicians to bill using new

codes). A variation, which is used in Quebec,

would include payment for simple laboratory tests

in the rate for office visits (28).

The experience in Quebec since the mid-197@

suggests that reductions in the number of codes

would be likely to moderate the rate of growth

in Medicare expenditures for physician services

(28). With fewer codes for similar services, physician would be less able to upgrade their billing

to more expensive codes. Providers would be

likely to find this option acceptable, because they

could continue to bill for specific services, perhaps even with the same codes. Since the reduced

number of codes would still reflect differences

among visits or other services, physicians would

be unlikely to change their use of services in such

a way that total expenditures increased.

Collapsing codes would entail raising payment

for some codes and some physicians and lowering payment for others. Similarly, some beneficiaries would have higher or lower cost-sharing

than in the past. If the 13 present colonoscopy

codes were collapsed into 2, for example, the approved charge and beneficiaries’ cost-sharing

would be greater for colonoscopies of a short distance into the colon.

Option 3: Mandate the Medicare program to develop and adopt controls over the volume of

physician services billed under CPR, fee schedules, or packaging.

About half the increase in Medicare physician

expenditures has been related to changes in the

intensity or quantity of physician services. Although approved charges for some services are

capped under CPR through the use of the Medicare Economic Index, service volumes in the aggregate are virtually unconstrained.

Utilization controls under Part A of Medicare

have a long history. Utilization review was a condition of participation for hospitals in the original Medicare regulations. In 1972, professional

standards review organizations (PSROs) were

mandated to review hospital utilization. PSROs

have now been supplanted by the utilization and

quality control peer review organizations (PROS)

mandated under the Part A prospective payment

system. For Part B, carriers are required to establish prepayment screens to detect potentially implausible combinations of claims for a single physician’s services to a particular patient, such as

multiple consultations during a hospitalization or

followup office visits within 2 to 4 weeks of a major surgery. But there are no uniform, nonexperimental means to assess the appropriateness of aggregate service volumes.

Some observers believe that additional or more

formal utilization controls are warranted with respect to physician services provided to Medicare

beneficiaries. The substantial variations in the use

of specific services have been cited as an indication that excessive amounts of some services are

being provided in the high use areas. Fee-forservice payment contains incentives to provide additional services even if they provide minimal benefit to patients. Especially in the face of lower approved charges, some physicians might increase

the volume or intensity of services billed to Medicare. Monitoring or controlling specific services

would respond to the concern about variations

in use, but a more encompassing utilization review program would respond to the concern

about more pervasive use increases.

Monitoring might take the form of more elaborate physician profiles that would focus on utilization patterns by specific physicians in addition to the current profiles that focus primarily

on charges. These profiles might be refined to examine patterns of practice including all physician

services provided or ordered in the treatment of

particular diagnoses. One might want to reexamine the results from the evaluation of the Experimental Medical Care Review Organizations or the

utilization review programs of certain individual

practice associations to assess the relevance of

such approaches for the Medicare program. As

discussed in option 2, collapsing codes could control volume of services billed by inhibiting billing of more highly paid categories or by inhibiting performing additional ancillaries if they were

included in visits.
16 . Payment for Physician Services: Strategies for Medicare

If excessive use of services were verified, strengthened controls could be mandated. These might

include mandatory prepayment screens to be implemented by Medicare carriers for specific physician services using national parameters to detect potential overuse. If certain relatively costly

services were found to be overused, a pretreatment authorization requirement could be introduced. PROS might be given the option to review

physician services provided to hospitalized Medicare beneficiaries, which account for 61.9 percent

of all Medicare approved charges for physician

services (69). But given the existing PRO review

of the associated hospital services and the hospitals’ own incentives to reduce the provision of

marginally useful ancillary services, additional efforts to review physician services provided in hospitals might not be warranted.

Physician services provided on an ambulatory

basis would provide a more fruitful realm for review by PROS or others, especially if service

volumes increased in response to relative reductions in approved charges. A report on volume

and case-mix changes under the Medicare fee

freeze was mandated for 1985. An examination

of this report might highlight the potential use of

carriers for monitoring utilization changes under

fee schedules. Alternatively, the Health Care

Financing Administration (HCFA) might reinstitute research and demonstrations on new approaches to ambulatory medical care review.

Under CPR payment, controlling use without

additional controls on price might fail to control

total Medicare expenditures if providers were able

to increase their billed and hence approved charges

over time. With payment based on fee schedules

or packages of services, Medicare would have

more control over payment rates.

HCFA might explore the use of an expenditure

cap as a means of controlling utilization and total expenditures. This approach has been used in

both the Federal Republic of Germany and in

Quebec, with revenue limits placed on individual physicians or on groups of specialists (263).

More research on this approach would be needed,

however, because there is no consensus on whether

this type of approach has reduced utilization or

the rate of growth of expenditures. Furthermore,

in contrast to the situation in Germany and Quebec, Medicare is one of several sources of physician revenue. The administrative feasibility and

other implications of an expenditure cap under

Medicare would have to be evaluated in this different context.

Option 4: Mandate the Medicare program to require physicians to accept assignment in order

to receive payments from the program.

Although no available data indicate that beneficiaries’ financial access to care is limited by current assignment policies, there is justifiable concern that lowering approved charges under CPR

or under a fee schedule would reduce assignment

rates and reduce beneficiaries’ financial access to

care by raising their out-of-pocket expenses.

Continuing case-by-case assignment would be

inconsistent with payment for packages of services, which are intended to put coordinating physicians or other recipients of payment at financial risk for the cost of resource use. If providers

could take assignment on a case-by-case basis,

they would do so only for cases whose costs were

likely to fall below the packaged rate paid by

Medicare. For cases whose costs were likely to exceed the packaged rate, physicians would refuse

assignment and bill higher charges to the beneficiary, thus transferring the financial risk back to

the beneficiary.

Medicare could mandate assignment for all

services, either as individual services or as packages of services, paying neither the physicians who

did not take assignment nor the beneficiaries who

used their services. Or Medicare could limit mandatory assignment to selected services or packages over which it has market power, such as for

inpatient services or cataract surgery, Another

alternative would be to adopt all-or-nothing participation, which differs from mandatory assignment in that beneficiaries would still be paid at

the level of Medicare’s approved charges if they

used physicians who did not take assignment.

As discussed in option 1, the extent to which

prevailing charges have limited a specialty’s approved charges, the proportion of practice revenue derived from Medicare patients, and the level
Ch. l—Summary and Policy Options • 17

of past assignment rates might predict whether

particular specialists would accept Medicare patients under mandatory assignment or would accept assignment under all-or-nothing participation. On these grounds, general practitioners and

family physicians would be the least likely to accept assignment under the new policies, and radiologists, pathologists, and general surgeons would

be the most likely to accept assignment. That

internists’ approved charges have been highly constrained by prevailing charge limits would predict that they would be less likely to accept assignment under the new policies, but Medicare

also accounts for a substantial portion of their

practice revenue.

Although the effect of mandatory assignment

on Medicare expenditures would depend on the

approved charges and volume response of physicians who continued to take beneficiaries as

patients, it is likely that within a specialty physicians with lower approved charges would continue to participate and that Medicare expenditures would rise less rapidly in the short term.

Mandatory assignment could reduce beneficiary

out-of-pocket expenses and increase beneficiary

financial access if physicians with lower approved

charges remained in the program. But beneficiary access would be reduced to the extent that

physicians refused to participate in Medicare. Under all-or-nothing participation, Medicare expenditures would remain the same, but beneficiaries’

out-of-pocket expenses would depend on the approved charges of physicians who accepted assignment and on the extent to which physicians who

refused assignment billed beneficiaries above the

level of approved charges. The effect on other

payers would depend on the extent to which physicians whose revenues from Medicare beneficiaries were lowered shifted their practice time and

provision of services to other patients.

With regard to mandatory assignment for packages of services, neither the Medicare program nor

the Medicaid program has had experience with

assignment related to paying a coordinating physician. Such a role would be new for physicians

other than those who have functioned as case

managers. Acting in this capacity would require

physicians to develop different professional relationships and would entail additional paperwork

and coordination by the primary physician. Although coordinating physicians would have a

limit on payment received, other physicians providing services to patients might wish to “bill” the

attending at higher rates than the package could

bear. Unless the risk was shared among physicians

or with Medicare, many physicians might refuse

to participate in the program. Paying a group of

physicians or the medical staff of a hospital would

be less of a novelty for physicians who had participated in group practices or individual practice

associations.

Option S: Establish a physician payment commission to review potential changes in payment

methods and to monitor changes implemented.

A consensus is developing that supports reforms

in Medicare’s methods of paying for physician

services. But even if a method was adopted that

could be implemented quickly, such as construction of fee schedules from historical charge data,

critical technical and clinical issues would remain

to be decided, including relative fees for types and

sites of services and a process for updating scheduled fees and reweighing selected fees. Movement

over a longer period to other payment systems,

such as per-case payment for inpatient physician

services or mandatory cavitation payment, would

require similar technical expertise.

This option would establish a physician payment commission to advise HCFA about such

physician payment changes. The Medicare Reconciliation Act, H.R. 3128, which was approved by

House-Senate conferees of the 99th Congress, contained such a provision. Like the Prospective Payment Assessment Commission created in connection with Medicare’s prospective payment system

for inpatient services, a physician payment commission could consist of people from disciplines

and perspectives that have an interest in the issues (such as beneficiaries, physicians from different areas of medicine, and other health providers

and organizations likely to be affected) and that

have technical expertise that is important to incorporate in policy decisions (such as economists

and insurers).

A physician payment commission could provide technical and clinical advice that HCFA
18 • payment for Physician Services: Strategies for Medicare

would need to make informed decisions. The commission could also serve as a conduit for the views

of parties, such as physician associations, insurers,

and HMOs, that would be affected by physician

payment reform.

Even if such a commission was not established,

HCFA could obtain technical and clinical advice

from relevant individuals and organizations. Furthermore, policymakers would still have to evaluate the recommendations made by the advisory

group. It could also be argued that the advice of

a physician payment commission would be more

valuable after the course of payment reform was

set, when such a commission could make recommendations about implementation, refinements,

and updates.

Continuation of Present Payment

Arrangements

The options presented below could be adopted

in the short term under a strategy to continue CPR

as the mainstream payment method but to refine

other existing or related payment methods. Within

this set of options, Congress could emphasize

measures related to fee schedules or cavitation

payment if it were interested in moving Medicare

payment in that direction.

Option 6: Mandate the Medicare program to reduce approved charges under CPR by one of

the following methods:

●

●

●

lowering the percentile at which prevailing charges are calculated,

reducing the frequency of updating charges

by freezing charges, and

giving beneficiaries the option of receiving care from preferred provider organizations (PPOs).

This option is intended to reduce the rate of increase in Medicare expenditures by reducing

Medicare’s approved charges. But any program

savings produced by lowering the percentile at

which prevailing charges are calculated would be

diluted over time because physicians could raise

their approved charges by raising their billed

charges. Furthermore, the effects of the first two

approaches on Medicare expenditures are difficult

to predict because of uncertainty surrounding the

change in volume of services that would be associated with reductions in approved charges.

Beneficiaries’ unassigned liability would increase as physicians’ assignment rates fell in reaction to lower approved charges and would most

likely exceed decreases in coinsurance. As in the

case of other measures to reduce approved charges,

the effect on other payers would depend on the

extent to which physicians shifted their provision

of services to non-Medicare patients.

Giving beneficiaries the option of receiving care

through PPOs would enable Medicare to take

advantage of the increasingly competitive marketplace. Medicare could contract either directly

with providers or indirectly with PPO organizations or insurers for payment below the level of

approved charges. Medicare could encourage beneficiaries to use PPO physicians by reducing costsharing or premiums. Consistent with the concept

of induced demand, physicians joining a PPO

might expect to counteract lower Medicare payment rates with greater volume of services. To

address this concern, utilization control could be

undertaken by either the PPO or Medicare.

In the absence of greater use of services, beneficiaries who used PPO providers would have

lower out-of-pocket expenses. Reductions in the

deductible or coinsurance rate for using PPO physicians might entice beneficiaries to exercise the

PPO option. Many beneficiaries have private supplementary insurance that covers Medicare costsharing amounts, but some might welcome the

chance not to pay premiums for private insurance.

Although reducing Medicare premiums would be

an attractive financial incentive to beneficiaries,

beneficiaries would then be required to receive

care only from PPO providers.

Option 7: Mandate the Medicare program to pay

for specific services according to fee schedules.

A mixed option might involve the use of fee

schedules only for services with certain characteristics. In particular, services that are believed

to be widely and consistently available at relatively homogeneous prices or, alternatively, “referred” services provided to hospitalized beneficiaries might be paid through the use of a fee

schedule. In the case of anesthesia services, for
Ch. l—Summary and Policy Options . 1 9

example, most beneficiaries have little or no role

in selecting an anesthesiologist, and little opportunity to search for one that might be available

at a relatively low price. For this reason, a single

approved charge could be established for the professional components of radiology, anesthesiology, and pathology—and any others—involved

in providing services to hospitalized beneficiaries.

This approach has the virtue that it could be

quickly implemented, particularly with respect to

those services deemed widely and consistently

available. Waiting for the completion of analyses covering all 7,040 procedures would not be

necessary. The difficulty would be in the reaction

of those physicians who are affected by this policy and receive lower approved charges. Referral physicians would be less able to increase volume of services in response to lower payment rates

because they are dependent on other physicians’

referring patients. Affected physicians might refuse assignment for such services, in effect, placing the burden of the reductions on the beneficiaries. If this problem occurred, this option might

be amended to mandate assignment for all services provided under the fee schedule. As discussed

in option 4, radiologists and pathologists are

among specialists most likely to participate under mandatory assignment.

Option 8: Mandate the Medicare program to increase its funding of research and demonstrations on the construction and use of rates for

cavitation payment.

Increased beneficiary enrollment in plans paid

by cavitation has the potential to help control

Medicare expenditures. A major impediment to

the realization of this potential is the lack of welldeveloped methods for adjusting cavitation rates

to the likelihood that a beneficiary’s care will be

expensive or inexpensive. Without an appropriate adjustment for risk, cavitation payment could

give plans a financial incentive to enroll low-risk

beneficiaries and to shun high-risk ones. In those

circumstances, expenditures of the Medicare program might even rise if high-cost beneficiaries remained in traditional arrangements and Medicare

paid greater amounts than otherwise for low-risk

beneficiaries.

This option would mandate HCFA to increase

research on risk-adjusted cavitation rates and to

test different approaches in demonstration projects. Further research and demonstrations would

permit HCFA to ascertain whether additional adjustments to the adjusted average per capita cost

(AAPCC) for health status, such as the presence

of certain conditions that are expensive to treat,

or other approaches, such as competitive bidding

or risk-sharing arrangements with Medicare,

would be feasible and advisable. Diagnosis-related

group (DRG) categories were based on diagnostic information that hospitals had been recording

for decades. Risk adjustors for cavitation payment

must relate to beneficiaries’ use of a much broader

range of medical care, and there is no accepted

classification system for this task.

HCFA is currently sponsoring some extramural

and intramural research on refining the AAPCC

used for payment to risk-sharing plans (539). Increasing that research would draw funds from the

budget for HCFA’s Office of Research and Demonstrations, a budget that has been reduced in recent years. If this option was not adopted and

such research was maintained at existing levels,

policymakers could make decisions on the basis

of research and demonstrations that are now underway and could respond empirically to any problems as they arose with new techniques.

Option 9: Mandate the Medicare program to fund

demonstrations of alternative techniques for

quality assurance under cavitation payment.

Although studies of non-Medicare enrollees in

HMOs have concluded that HMOs have provided

care equal to or better than that provided by comparison groups, the financial incentives inherent

in cavitation payment cause concern about underprovision of services and adverse effects on patient management and health. In addition, these

studies have not examined the care of elderly people. The regulations implementing the Tax Equity

and Fiscal Responsibility Act of 1982 (Public Law

97-248) (TEFRA) call for PROS to review the care

provided by HMOs and CMPs. However, there

is little experience in quality review and assurance

regarding underprovision of services.

56-119 0 - 86 - 2 : QL 3
20 ● Payment for Physician Services: Strategies for Medicare

Under this option, HCFA would be required to

fund demonstration projects that would evaluate

alternative methods of assuring quality in risksharing plans. Medicare could test the potential

applicability of quality assurance and case management techniques now being developed and

used in the private sector. These activities could

also draw on the knowledge of likely quality problems that is being gained in the current evaluation of Medicare demonstrations of cavitation

payment. Methods could then be identified to

monitor and correct such problems. The insight

gained during the demonstration projects could

be applied to quality assurance in risk-sharing

plans or under geographic cavitation, if Medicare

chose to adopt that approach.

A drawback of this option is that PROS, or their

designated representatives, might acquire similar

knowledge at less expense in the course of reviewing the care provided by HMOs and other CMPs.

It might then be simpler and cheaper to rely on

existing organizations and stipulate that the knowledge gained be evaluated and disseminated among

PROS and other interested organizations.

Payment Based on Fee Schedules

Basing payment for services on fee schedules

would address several of the problems currently

perceived within CPR: variations in approved

charges, unpredictability of payment amounts,

confusion on the part of beneficiaries and providers, and limited Government control over rising price levels for physician services.

Because under a fee schedule a single fee is paid

for a specific service to any physician within a

particular peer group in a particular jurisdiction,

variations in approved charges are eliminated

within that peer group and jurisdiction. In extreme

form, a national fee schedule that did not include

specialty distinctions would provide a single payment rate for a specific service for all physicians

in all parts of the country. More likely forms of

fee schedules would involve some geographic distinctions (e.g., state- or carrier-wide fee jurisdictions), and specialty distinctions could also be retained under a fee schedule.

Because Medicare’s payment rate could be

known in advance for both beneficiaries and physicians, there would be much less uncertainty

about beneficiary coinsurance liability and physicians’ expected Medicare receipts. Physicians’

billings could proceed on a more expeditious basis because Medicare payment amounts could be

better known in advance. A fee schedule could

also enable Medicare beneficiaries to become better buyers because the amount of any unassigned

liability would be easier to establish in advance

and some beneficiaries could be expected to search

for physicians who provided a specific service “at

the Medicare fee” or to request their usual physician to provide the service at that price.

Given a fee schedule system of payment, a single parameter could be used to revise the level of

payments to take account of changes in the costs

of producing physician services and perceived

changes in the value of those services. Even under a relative value system with multiple conversion factors for the various types of physician

services, a fee schedule would give Medicare potentially greater control than CPR of the level of

and increases in approved charges. In fact, in the

absence of changes in the mix of services, a fee

schedule updated with the Medicare Economic Index could be expected to exhibit lower increases

in average approved charges than the CPR system with the Medicare Economic Index because

under CPR only some of the maximum approved

charges are constrained; average approved

charges under CPR can increase at a faster rate.

Because the circumstances that underlie correct

relative approved charges are dynamic, one would

want the fee schedule system to have a mechanism for responding to changes. Geographical and

specialty differentials and the approved charges

of new procedures could be reviewed over time

to determine whether changes in payment rates

were appropriate.

Adoption of payment based on fee schedules

does not imply a particular change in the level

of Medicare average payments per service, although there would be more interest in a conversion expected to reduce expenditures than in one

that was budget neutral. A change that reduced
Ch. I—Summary and Policy Options ● 21

the rate of growth in average approved charges

might also have the effect of stimulating efficiency

in the production of individual physician services.

However, given the incentives of fee-for-service

payment, inefficiencies would be likely to remain

in the combination of services used for a medical

condition.

Concerns about increases in the volume of services billed would arise under fee schedules or any

other fee-for-service reform if Medicare payment

levels were more constrained. In addition, a conversion to fee schedules would increase payment

rates to some physicians and lower them to others,

compared to CPR. Physicians who experienced

a decrease might attempt to recoup perceived lost

revenues by providing or billing for additional

services or substituting services with higher approved charges, with no countervailing decreases

in service volume by physicians who experienced

increases in approved charges (158). If this occurred, payment by fee schedule might lead to

higher Medicare expenditures. For this reason, additional efforts to monitor use and to control unwarranted utilization increases might be necessary. In addition, collapsing procedure codes

within a fee schedule might prevent increases in

billing for additional services or upgrading of services billed. The experience in Quebec, which collapsed visit codes and incorporated payments for

common laboratory tests in the office visit fee,

suggests that these changes can check increases

in use and total expenditures under a fee schedule (28).

A fee schedule could be used to determine reimbursement in several ways that are not mutually

exclusive. Any or all of these alternatives might

also be combined with an expenditure cap, which

could be implemented by either disallowing claims

above the cap or by discounting claims until there

was a reasonable expectation that the cap would

not be exceeded. A fee schedule implemented as

a schedule of maximum allowances would set upper bounds on approved charges for specific services. The approved charge for any service would

be established as the lower of the physician’s billed

charge or the fee schedule amount. Under another

alternative, mandatory assignment, the approved

charge would be deemed payment in full and physicians would be prohibited from billing above the

Medicare allowance. A third alternative would

involve payment of only the fee schedule amount

regardless of the physician’s actual billed charges.

Because the beneficiaries would be responsible for

paying for the difference between the physician’s

bill and the Medicare allowance, beneficiaries

would have a substantial incentive to seek physicians with low charges.

Option 10: Mandate the Medicare program to

construct fee schedules for physician services.

Three major variations have been identified to

construct fee schedules, either because of ease of

their implementation or current professional interest in their development: using historical charge

data, developing a relative value scale (RVS) by

estimating the resource costs associated with each

specific physician service, and developing an RVS

or a fee schedule with physician involvement. A

blend of these and other options would be possible, for example, using historical charge data to

develop fee schedules, but addressing payment

differentials among certain services or payment

rates for new procedures through an an analysis

of resource costs and physician advice.

Option 10A: Mandate the Medicare program to

construct fee schedules for physician services

based on historical charge data maintained by

Medicare carriers.

Creating fee schedules from carrier data on physician charges for specific procedures would be

a viable short-term option. Average approved

charges for each service could be computed from

each carrier’s beneficiary history data files. The

average approved charge would establish the Medicare fee schedule amount for that service within

a carrier jurisdiction. Carrier-specific fee schedules would probably be fairly consistent across

the country in terms of relative fee levels within

jurisdictions if not in absolute levels. Nationally,

there is substantial correspondence in relative

values among carriers and little difference among

relative value scales based on prevailing charges,

median billed or approved charges, or average

billed or approved charges.

In all likelihood, the initial fee schedules created under this option would have to be State or
22 . Payment for Physician Services: Strategies for Medicare

locality specific, because merging the data across

carrier jurisdictions would be difficult in many instances because of differences in data recording

techniques and billing conventions. However, this

problem might actually ease the transition from

CPR to a fee schedule, because for most physicians, the resulting approved charges for any procedure would not be significantly different from

previous payments for that procedure (389).

The advantage of this method of establishing

fee schedules is its speed of implementation. A potential disadvantage is that the creation of fee

schedules derived from charge data would ignore

any imbalances in the current structure of charges.

If there are discrepancies in relative payment levels

between procedural and nonprocedural services,

they could become further embedded in any fee

schedule based on charges.

A market-oriented variation to this approach

that established fee levels below the current averages might be based on physicians’ existing patterns of participation in the Medicare. In effect

this method would explicitly test whether sufficient quantities of some services might be procured at levels much below that of the prevailing

charge. Under this variation, Medicare would instruct its carriers to identify for each service the

lowest approved charge necessary to supply a

significant fraction of the total volume provided

to Medicare beneficiaries. Alternatively, a more

stringent approach would be to identify the lowest

approved charge that would be greater than or

equal to the approved charges of a significant fraction of all physicians providing that service to

Medicare. Either of these approaches might be

modified to identify the lowest charge needed to

acquire a sufficient number of assigned services.

Determining the approved charge level would be

difficult, and beneficiary access would be jeopardized if too low a payment level was established. Studies have confirmed that physicians are

responsive to the level of Medicare approved

charges but there is no previous research on the

issue of beneficiary access to physician services

under this type of pricing. A demonstration project

could be undertaken to evaluate this approach.

Option 10B: Mandate the Medicare program to

construct fee schedules for physician services

based on estimates of the resource costs associated with each procedure.

The considerable attention given to estimations

of resource costs as the source of an RVS is to

be expected, given the common perception that

price ought to be related to cost. In addition, the

controversy over the relative differences in payments for procedural and nonprocedural services

originates in a comparison of the relative efforts

in physician time between office visits and some

of the more technical services. It is argued that

if relative payment levels were based on costs, the

disparities would disappear, removing potentially

inappropriate incentives that may influence physicians’ clinical decisionmaking.

Under most suggested approaches, resource cost

estimates would be derived from time and motion studies or other data on actual resources used

by actual physicians. These data would also be

adjusted to reflect differences among physicians

in the length of required training and in overhead

expenses and differences among services in complexity or urgency. The resulting resource-costbased relative values would then be converted to

a fee schedule by determining the level of a monetary conversion factor.

The difficulties and costs associated with such

an approach should not be underestimated. There

are 7,040 different physician services identified in

the HCFA Common Procedure Coding System.

In theory, all would require resource cost estimates. As an alternative, resource cost estimates

for selected services could be used to “anchor” existing alternative relative values for related services, such as those implicit in charge data, until

a complete set of resource costs became available.

Even estimating the resource costs of only a few

services would require considerable time and

effort.

In addition, many believe that the search for

an objective set of resource costs is chimerical.

Two physicians may produce the same service at

two different costs without either one of them be-
Ch. l—Summary and Policy Options Ž 23

ing inefficient. Two physicians may produce two

different services at identical cost, yet if one is

produced efficiently and the other not, a resourcecost-based approach might reward the inefficient

producer. Further, the costs of producing a particular service can be expected to drift to the level

of the payment for that service whether that level

is higher or lower than that of cost. If payment

is below cost for some physicians, they will discontinue providing the service, and hence costs

will appear to fall, If payment exceeds costs, costs

can be expected to rise as a result of either competition among physicians in quality enhancements or a lack of price-sensitive purchasing by

physicians for the resources used to perform those

services.

Option 10C: Mandate the Medicare program to

elicit physician professional input to construct

fee schedules based on:

● a consensus among physician groups with

respect to the relative values of individual procedures, or

● negotiations between the Medicare program

and provider groups for the specific purpose

of establishing Medicare fee schedules.

Consensus development methods could be used

to formulate relative values. This approach might

focus more directly on differences between services in terms of the physician efforts and other

professional resources that they require. The nonphysician costs of operating physicians’ practices

have been estimated at 40 percent of gross professional revenues with no extraordinary differences

across specialties (37), implying that direct physician costs are 60 percent of the costs of producing physician services. Consensus relative values

might approximate resource costs, obviating the

requirement for detailed data collection.

Development of consensus relative values by

physicians would take advantage of physicians’

familiarity with the range and frequency of possible situations in which certain services may be

performed. In addition, physician input might facilitate cross-specialty comparisons that might be

difficult for the nonphysician or that might not

be readily apparent in any subsection of an RVS

prepared by a particular specialty. Other participants, such as nonphysician providers, representatives of other third-party payers, and Medicare

beneficiaries, could also be included in the process of establishing relative values. The process of

explicitly eliciting physician and other professional

input into the RVS construction process would

enhance the acceptance of the final fee schedule(s)

derived from this RVS.

The time required for a complete examination

of physician services’ relative values could be considerable. Further, based on previous reviews, a

new set of consensus relative values would be unlikely to differ much from existing sets of relative values or those relative values that are implicit in current charge-based payments (191,

225,226).

Fee schedules for government health insurance

programs in other countries have been developed

through explicit negotiations with physician associations (388). In Canada, for example, where separate negotiations are conducted in each of 10

provinces, real per capita expenditures on physician services increased 17.8 percent between 1971

and 1982 compared to 46.1 percent in the United

States. In Quebec, reputed to be the most stringent with respect to fee negotiations, the increase

was 15 percent below the Canadian national average (28).

In such countries, the focus of negotiations is

price per relative value unit from an existing RVS.

In the United States, there is no single, consensus

RVS, although various editions of the California

Relative Value Studies and their progeny remain

in circulation. Some effort would have to be made

to identify a definitive RVS for conducting negotiations. An RVS based on current Medicare average approved charges could be constructed, but

there would be some controversy over its use as

a starting point for negotiations given the perception of imbalances in existing fees.

Another hurdle in proceeding to negotiations

would be the identification of negotiating groups

to represent physicians. HCFA could select a panel

of physicians for this process, perhaps by choosing from among physicians nominated by national

associations of physicians, but those physicians’

authority as negotiators would be uncertain as

would any claim as to their representativeness.

There is no history in this country of such nego-
24 ● Payment for Physician Services: Strategies for Medicare

tiations, nationally or locally, that might guide

the drafting of legislation to foster the development of such groups.

Payment for Packages of Services

Payment for packages of services would put

providers at financial risk for the use and cost of

services by giving them a fixed payment for a set

of related services. Packages of services for payment purposes could range in scope from a visit

or procedure to all physician, ancillary, and

possibly facility services associated with a particular episode of care. ’” An ambulatory-visit package adjusted for diagnosis would include all physician and ancillary services related to one visit.

Building on the global fee now paid to surgeons

for certain procedures, a special-procedure package would include ancillaries and the services of

all physicians associated with a single diagnostic

or therapeutic procedure, such as a magnetic resonance imaging (MRI) scan, extracorporeal shock

wave lithotripsy (ESWL), or cataract surgery. A

package for an ambulatory episode of care would

include all physician and ancillary services associated with an ambulatory episode, whereas a

package for an inpatient episode of care would

include the services of all the physicians associated with a hospitalized patient (see figure 1-2).

A package for a total episode of care would encompass all ambulatory and inpatient physician

services and ambulatory ancillaries associated

with the overall episode.

Although payment for packages of related services is similar to the global fee paid to surgeons

for all of their services connected with cataract

surgery or other procedures, there is no experience with payment for packages that include the

services of more than one physician. Because of

the lack of experience and, in some cases, usable

payment categories, the options within this strategy call for research to develop categories or demonstrations to evaluate the effects of packaged

payment.

IOA~ ~ precursor t. payment for packages of services, codes for

certain services could be collapsed and common laboratory tests

included in the visit rate (see option 2).

Providers receiving a fixed amount for a package of services would have a financial incentive

to refrain from using resources whenever possible and to use the least expensive ancillary services, referral physicians, and, when applicable,

facilities. Mandatory assignment would be necessary with packaging to prevent providers from

passing that financial risk back to Medicare or on

to the beneficiary by billing for amounts in addition to the packaged rate. In contrast to the

present situation, the concern about quality of

care within packages would be that services would

be underused or of inferior quality. Access could

also be problematic if the variation in the costs

of treating expensive patients was not adequately

reflected in the case-mix adjustment. In that case,

physicians might refuse to treat beneficiaries with

complicated and possibly expensive conditions.

The cost to Medicare and to society would depend on the extent to which providers shifted care

outside the package and shifted more expensive

beneficiaries to other payers. Beneficiaries’ costs

could increase, decrease, or remain the same. If

the packaged rate was set at the mean, the coinsurance of beneficiaries with less costly care would

rise, while that of beneficiaries with more costly

care would fall. Beneficiaries’ cost-sharing liability might rise if physicians shifted care outside of

the package.

Payment for packages of services would encourage efficient use of resources within packages,

but not across packages. Expensive technologies,

such as MRI and ESWL, would be more likely to

be regionalized if their services were included in

a package. Because MRI is so expensive, its use

within a package would be more likely than at

present to be limited to conditions for which its

efficacy had been demonstrated. To the extent

that ESWL obviated more expensive procedures

(such as open surgery on the kidney) that were

included within the same package, ESWL would

be more likely than at present to be used within

that package. Clinical laboratory procedures

might be used more efficiently, but not if their

use could be spun off into out-of-package care.

In general, payment for packages would encourage the development of technologies that saved

physicians’ time, such as new surgical or diagnostic procedures.
Figure 1-2.—Alternative Methods of Medicare Payment for Services Provided to a Hypothetical Patient

Presenting the Symptom of Extreme Flank Paina

Pre-hospital ambulatory services Inpatient services Post-hospital ambulatory services

First office First office Urinalysis Intravenous Radiologist Radiologist Anesthesiologist Urologist Physician ESWL Hospital Urine KUB Blood Post- IVP Radiologist Second One office

visit: visit pyelogram service service service for services consultant procedure stay 9

culture X-ray tests hospital service post- visit every

primary urologist (lVP)b

for IVP for KUB extracorporeal ESWL servicesf

oft ice KUB for IVP or hospital 6

physician X-rayc

shock wave and visit: X-ray KUB X-ray visit: months:

Iithotripsy (ESWL) hospital urologist urologst h

urologist

Capitation payment

Payment by CPR or fee schedulesi

Packaged paymentj

a

The actual treatment would depend on the particular patient. Sorne patients might be seen initially in an emergency room or require a procedure other than ESWL, such as surgery.

bAn intravenous X-ray of the kidneys and ureters.

cx.ray of the kidneys, ureters, and bladder.

dThe number of hospital visits would vary with the PStient’S length of stay.

~he urologist peforrning ESWL might charge a fee for the ESWL procedure separate from fees for related hospital visits, or instead might charge a global fee covering both the procedure and the visit.

fsome cornp~icated patients rnigflt need to be seen by specialists such aS cardiologists.

gThe current av~age length of stay for EsWL IS 4 days (40).

hMost patients ~mld ne~ only one post. hospitai visit. A patient with gout or multiple stone recurrence might need two post-hospital visits and additional viSitS SVery 6 months.

ilt is assumed that DRG payment wouid COntinUe fOr inpatient faCility SWViCeS.

jpackaged payment can include setices related to an ambulatory or inpatient episode of care or an ambulatory visit. A total episode-of-care package, though not shown here, would combine services in

ambulatov- and inpatient-episode-of-are packages. A special-procedure package, also not shown here, wculd include services associated with a special procedure such as ESWL.

kcapitation payment here includes ambulatory and in~tient services, including physician, ancillary, and h~pital services. Cavitation payment could alternatively exclude hospital inpatient SefViCeS.

SOURCE: Office of Technology Assessment, 1965. Based on data from A. Jenkins, University of Virginia Medical School, Charlottesville, VA, personal communication, Nov. 26, 1965.
26 ● Payment for physician Services: Strategies for Medicare

One of the major uncertainties regarding packaging is how physicians would handle the distribution of the packaged payment rate among several physicians who participated in a case. The

primary physician would in a sense act as a general contractor for the services of other physicians

and health professionals, such as anesthesiologists

or nurse anesthetists and assistant surgeons. The

recipient of the packaged payment rate would

have to negotiate with other providers concerning the availability and price of their services. The

primary physician would also bear financial risk

for these services. Even with mandatory assignment, unless case-mix adjustment was adequate,

physicians might avoid seeing more complicated

and expensive patients or might request out-ofpackage payment for them.

Option 11: Mandate the Medicare program to investigate paying a packaged rate for selected

special procedures.

A special procedure package would incorporate

physicians’ services and ancillaries related to a single diagnostic or therapeutic service. Physicians

would then have an incentive to consider cost in

deciding about the use of ancillaries, assistant surgeons, or particular anesthesiologists. A package

for MRI or ESWL, for example, would incorporate

physicians’ charges, the MRI or ESWL procedure,

and any visits. A cataract surgery package would

pay the attending physician for the procedure and

followup care, anesthesiologist services, and ancillary services. The facility cost could also be included in the package amount, an addition that

would encourage use of the least costly setting,

whether in an inpatient or ambulatory facility.

To the extent that physicians found packaged

payment for special procedures similar to present

arrangements, the change in payment method

would be more acceptable to them. Costs and utilization would be controlled within special-procedure packages, because physicians would receive a fixed payment and would not receive

additional revenue for providing extra services.

If policymakers decided that packaging is a reasonable payment alternative, packaging small segments of the system would be easier to implement

initially.

However, more complicated patients whose

care was likely to be more expensive than the

packaged rate might receive poor quality care.

Payment for a package contains incentives discouraging the use of ancillary and referral services. Unless case-mix adjustment was adequate,

the coordinating physician would have a financial incentive against obtaining consultations for

diabetic patients having cataract surgery, for example. In addition, as would be the case with payment for other packages, new professional relationships would have to be created. Since only

small portions of the system would be controlled,

utilization and expenditures could rise for other

procedures and out-of-package care. And excluding the facility cost would provide physicians with

no incentive to choose the most cost-effective site.

Option 12: Mandate the Medicare program to

conduct further research to define episodes of

care, both ambulatory and total episodes, and

to develop case-mix measures appropriate for

physician payment purposes.

Currently, no defined episode categories exist

for payment purposes. Defining episodes of care

would give Medicare the option of moving away

from a fee for each service toward fees for groups

of services. Examining episodes of care would also

aid evaluation for utilization review or quality assurance of the components of the care process,

including outcomes and efficiency of diagnostic

treatment (223).

Different categories would have to be defined

for episodes of preventive care, chronic care, and

acute care because of the variability of resource

use among the types of care. In addition, classification systems would have to take into account

that principal diagnosis is more definite in the

inpatient setting than in the ambulatory setting

(222). For total episodes of care, case-mix classification systems that encompass the totality of

patient care would have to be developed because

there is no coordinated system for both ambulatory and inpatient services.

Option 13: Mandate Medicare demonstration

projects to pay for physicians’ inpatient services by diagnosis-related groups (DRGs).
Ch. l—Summary and Policy Options Ž 27

Medicare’s prospective DRG-based payment

system gives hospitals a financial incentive to

control the use and cost of services provided to

inpatients. As a result of this payment system,

physicians may feel pressured by hospital administrators to constrain orders for ancillary services

and to limit patients’ lengths of stay. But physicians have no direct financial incentive to consider price and cost when ordering the consultative

services of other physicians and health professionals. In order to provide such incentives, Medicare could use DRGs to pay for inpatient physician services. Payment by DRGs could be applied

to only hospital-based physicians (radiologists,

anesthesiologists, and pathologists) or to attending and consultative physicians as well.

Option 13A: Mandate a Medicare demonstration

project to pay for hospital-base physician services as part of hospital DRGs.

Under current payment arrangements, attending physicians and hospital administrators have

little incentive to consider the costs of hospitalbased physicians who provide anesthesiology,

pathology, or radiology services to individual patients. If payment for the services of hospitalbased physicians were incorporated into current

DRG payments made to hospitals, hospital administrators would have more of an incentive to

encourage attending physicians use the services

of these hospital-based physicians more efficiently

or to substitute, where possible, the services of

other less expensive health professionals.

Physician services that relate to a hospital or

patient population as a whole, such as managing

a clinical laboratory, are already paid as part of

the hospital’s DRG payment (Social Security

Amendments of 1983, Public Law 98-21). In addition, tests that do not require the direct services

of a pathologist are paid under Part A. If policymakers deem payment by DRGs for all inpatient

services a reasonable alternative, this option

would be a step in that direction.

Under this option, hospitals would wish to negotiate contractual arrangements with hospitalbased physicians, namely, radiologists, anesthesiologists, and pathologists, to provide services

at lower cost. In fact, precedent exists for such

contractual arrangements (326). And until TEFRA,

hospitals could bill Medicare for the services of

pathologists and radiologists. Relative to other

specialties, the hospital-based specialties have high

incomes, and the gap appears to have widened

in recent years (123,391).

Incorporating payment for physicians’ services

provided by the three hospital-based specialties

into the hospital DRG would encourage these

physicians to provide care in other sites and perhaps to non-Medicare patients. The extent to

which these physicians could afford to change

their involvement with Medicare would depend

on the extent of practice revenue gained from

these patients. In 1981, when all physicians on

average collected 17 percent of gross practice income from Medicare, radiologists collected 28 percent, anesthesiologists 22 percent, and pathologists 21 percent (353). Thus, a substantial portion

of revenue for the three specialties would be affected if Medicare patients were not seen. Furthermore, radiologists and pathologists have had

higher assignment rates than any other specialists.

Although anesthesiologists have had lower rates

than general surgeons, the assignment rates of

anesthesiologists have been as high as surgical

specialists overall (494).

In the absence of research examining the effect

of incorporating payment for the services of hospital-based physicians into hospital DRGs, there

are few data on which to base a change. If a demonstration project were funded, however, few

physicians might volunteer for it. Although radiologists, anesthesiologists, and pathologists have

been singled out for changes in payment under

previous legislation, such as TEFRA, questions of

equity might be raised. Thus, it might be necessary to incorporate payment for hospital-based

physicians’ services in hospital DRGs without a

demonstration or to offer certain benefits for participation in the project.

Option 13B: Mandate a Medicare demonstration

project to pay for all inpatient physicians’ services by physician DRGs.

Medicare could fund a demonstration project

to pay for inpatient physician services by physician DRGs. Physician DRGs could be applied to
28 . payment for Physician Services: Strategies for Medicare

all inpatient care or only to surgical inpatient care.

The demonstration could experiment with different recipients of payment, such as the attending

physician, the medical staff, the hospital, or a

combined hospital-medical staff entity. Mandatory assignment would be necessary for these

demonstrations so that physicians would face a

fixed budget constraint and so that they would

be unable to accept assignment only for the less

costly cases.

The recipient of payment would have an incentive to carefully evaluate and to reduce the use

of physician services within these inpatient-episode-of-care packages. Since this package would

apply only to the inpatient portion of the system,

ambulatory use and expenditures might rise. This

option might encourage underuse of inpatient consultative services to the detriment of patients. If

case-mix measures or payment policies did not

adequately reflect severity, physicians might

choose to see only uncomplicated and less expensive patients. This payment approach could also

create confusion and administrative complexity

if the physician DRG categories differed from the

hospital DRG categories or if another system replaced payment by hospital DRGs.

Medicare could fund a demonstration project

to pay only for inpatient surgery by physician

DRGs, while using CPR or a fee schedule for medical services (320,321). Some researchers consider

physician-related charges in surgical DRGs to be

relatively homogeneous (313,320,321). But others

report that although relative to average charges,

charges within surgical DRGs appear to be less

variable than those within medical DRGs, the

standard deviations (absolute variability) are

greater for surgery (571).

Since this inpatient-episode-of-care package

would apply only to surgical services in the inpatient portion of the health care system, the use

of and expenditures on ambulatory and other inpatient services might rise. On the other hand,

payment for surgical DRGs could affect about 22

percent of Medicare’s expenditures for physician

services ll (69).

I IIn 1981, 25 percent of Medicare physician expenditures was for

surgical care, and over 90 percent of Medicare’s payments for surgery was for inpatient services (69).

Cavitation Payment

Although most Medicare beneficiaries have

Medicare pay for their care by fee for service, beneficiaries do currently have the option of having

Medicare pay for their medical care by cavitation.

Regulations to implement TEFRA, effective February 1, 1985, established in effect a voluntary

voucher system whereby Medicare may pay a

predetermined amount to enroll beneficiaries in

plans of their choice (148).

The options below would expand this voluntary system to a mandatory voucher system for

all Medicare beneficiaries. Medicare could make

cavitation payments to two different kinds of fiscal intermediaries: risk-sharing plans, such as

HMOS or other CMPS that would provide or arrange for the care of their enrollees; or geographic

intermediaries, such as carriers, that would assume the financial risk for the care of beneficiaries in a certain area. In either case, Congress

could require that fiscal intermediaries accept

Medicare’s cavitation payment to cover a minimum benefit package. The cavitation payment

could cover both Part A and Part B services, or

it could cover only Part B services, with hospital

DRGs retained for Part A services. It is assumed

that one of the beneficiaries’ options would be to

continue to select individual physicians to provide care on a fee-for-service basis. For example,

a private insurance company might offer such an

arrangement and accept the cavitation payment

as the premium.

In an era of concern about containing medical

expenditures, cavitation payment has the advantage of having shown that it can reduce expenditures for care, apparently without compromising

quality (279,285). Medicare program expenditures

would be much more predictable and controllable under cavitation payment than under any of

the other payment alternatives. Under a mandatory voucher system of cavitation payment, beneficiaries’ costs would be likely to fall if plans, as

now, were required to share savings with beneficiaries in the form of increased benefits or reduced

premiums. On average, beneficiaries’ costs would

not rise unless Congress decided to increase their

financial liability under the Medicare program.
Ch. l—Summary and Policy Options Ž 29

However, there is little experience with prospective cavitation payment for elderly people in general or for Medicare beneficiaries in particular.

How elderly people would fare under risk-sharing

plans—whether they would have difficulty choosing and enrolling in plans, gaining access to physicians in large organizations, or receiving appropriate care—is not known. Furthermore, studies

of cavitation have pertained almost entirely to the

experience of large established prepaid group practices, which may differ substantially from the experience of newer plans, which tend to be smaller

and differently organized. Medicare demonstration of cavitation payment, which have enrolled

substantial numbers of beneficiaries since they

were funded in 1982, will provide information to

address these issues. HCFA has funded an evaluation of these plans (539). Results are being compiled and will become available over the next 2

years.

The amount of a cavitation payment is fixed

in advance and is independent of the services actually used (see figure 1-2). Under cavitation payment, the recipient of payment instead of the

Medicare program or beneficiary bears the financial risk for covered services. Since enrollees of

cavitation plans have little or no cost-sharing

when services are used, they face little financial

deterrent to seeking care and have been more

likely than other insured people to have at least

one physician visit during a year (279). On the

other hand, a plan that receives little or no extra

revenue from additional services has no financial

incentive to provide them. Like those paid feefor-service, recipients of cavitation payment have

an incentive to perform individual services efficiently. But unlike fee-for-service payment, capitation payment gives recipients an incentive to use

the most efficient number and mix of services to

manage a patient’s condition. To the extent that

services add more to cost than to revenue, providers on a fixed budget also have a financial incentive against providing additional services. The

countervailing incentive is that plans may lose enrollees who become dissatisfied.

If the cavitation payment did not cover Part

A services, payment recipients would have increased incentives compared to the present to hospitalize patients. Diagnostic and therapeutic procedures could thereby be performed while the plan

incurred the cost only of physician services. These

incentives would be compatible with those of hospitals paid by DRGs, because hospitals desire additional admissions and profit from low-cost cases

in a given DRG. If cavitation payment covered

only Part B services, possibly unnecessary admissions would warrant particular attention by the

PRO.

Cavitation payment to organizations acting as

fiscal intermediaries rather than to individual physicians buffers the incentive to underuse services.

The bases on which the fiscal intermediary distributes revenue to individual physicians and

other providers determine where the financial incentives of cavitation payment fall. Providers who

are paid by cavitation or who share in a risk pool

for referrals of ancillary or specialist services have

a financial incentive to use judiciously and even

underuse the services for which they are at financial risk. Providers paid fees for services have an

incentive to provide additional services if the extra revenue exceeds the extra cost. Salaried payment promotes neither overuse nor underuse, but,

unlike fee-for-service payment, does not by itself

contain incentives for providers to use their time

productively (264). In practice, the majority of

physician groups paid mainly by cavitation have

had explicit productivity guidelines, perhaps to

compensate for the financial incentives of salaried payment to physicians (205).

Option 14: Amend the Social Security Act to pay

for the medical care of all Medicare beneficiaries by cavitation payment.

Although voluntary beneficiary enrollment in

risk-sharing plans has been increasing dramatically in recent months and by December 1985 encompassed about half a million people or 4.2 percent of all beneficiaries (533), this route to national

cavitation payment is likely to be gradual and

slow. In the meantime, the Medicare program

would not be able to take advantage of the predictability of total annual expenditures and of possible cost savings from widespread cavitation

payment.

This option would establish a mandatory

voucher system for Medicare beneficiaries. Medi-
30 . payment for physician Services: Strategies for Medicare

care would pay to the plan chosen by a beneficiary a cavitation payment to cover care provided

during a certain time period. The choice of plans

could be expanded beyond present HMOs and

other CMPs to include PPOs and traditional insurers that were willing to provide the minimum

benefit coverage for the cavitation payment.

HCFA or another part of the Department of

Health and Human Services could certify a plan’s

financial viability. This option would be consistent with Enthoven’s Consumer Choice proposal

regarding plans that would provide comprehensive care (129) and with the Administration’s

proposals that beneficiaries be given vouchers and

select plans (104).

Prepaid group practices have lowered total per

capita costs 10 to 40 percent compared to comparison plans, primarily because of lower hospitalization rates (279). HMOs have had about the

same rates of increase as fee-for-service practices

(279,343), suggesting that cavitation plans have

been able to maintain a lower level of costs over

time, despite the introduction of new technologies.

A study of enrollees randomly assigned to a prepaid group and given comparable benefits found

expenditures 25 percent lower than fee-for-service

enrollees with free care, but no significant differences compared to enrollees with 95 percent coinsurance (285). The results suggest that prepaid

group practice and high cost-sharing had similar

effects on expenditures and hospital use, but that

prepaid group enrollees were not so deterred from

seeking care (343).

Because the technology of setting cavitation

rates for different categories of beneficiaries is not

well developed, the structure of cavitation rates

could unintentionally contain incentives for plans

to select beneficiaries likely to have lower than

average expenditures and to shun higher cost beneficiaries. Because of variations in annual expenditures among beneficiaries, a risk-sharing plan has

the potential to suffer great losses or to reap sizable gains. Studies from the mid to late 1970s

found that prior expenditures for beneficiaries

who enrolled in prepaid groups were significantly

lower than for other beneficiaries (32,120,121,

278). These results may not be generalizable to

other plans or to the situation under widespread

cavitation payment. But depending on risk-sharing arrangements and cavitation rates, biased

selection, either from beneficiaries’ choices or

plans’ marketing practices, could result in Medicare’s paying much more than the actual cost for

a low-cost beneficiary and much less than the actual cost for a high-cost beneficiary in a risksharing plan. As discussed in option 8, research

is underway to refine the AAPCC, which is now

used as the basis of cavitation payment. A model

that incorporates information on prior hospital

use has proved superior to others and is being

tested in a current demonstration project (278).

Studies have consistently found that practices

paid by cavitation delivered care of at least as

good and usually better quality than comparison

groups (97,107,194,279,404,579). Although no

study examined specifically the quality of care to

Medicare beneficiaries, the National Medicare

Competition Evaluation funded by HCFA is evaluating quality (411, 541). Problems related to

timely enrollment and disenrollment have been

identified in certain Florida plans (476), which are

part of the evaluation. Quality is of particular

concern for Medicare beneficiaries because their

medical and social needs may differ from those

of employed populations and Medicaid enrollees

(194) and may affect their ability to cope with unfamiliar administrative arrangements. However,

once a beneficiary becomes familiar with plan procedures, cavitation payment would entail less

paperwork than fee-for-service payment.

Some observers have theorized that plans paid

by cavitation would not skimp on treatment of

severe illness for which definitive treatment is

available, and that they might excel in reassuring worried-well patients (223). But people who

are subtly sick may experience delays in the diagnosis of potentially serious disease if plan physicians face bureaucratic complexities in ordering

diagnostic workups or in obtaining tests from outside the plan. In fact, delays in diagnosing colorectal cancer were found for enrollees of a prepaid

group compared to fee-for-service patients (150).

Given the incentives of cavitation payment, delays might also occur in resorting to a more expensive treatment for a condition for which there

were less costly alternative therapies, such as initially using ESWL instead of surgery for renal
Ch. l—Summary and Policy Options . 31

stones or delaying the removal of cataracts. Delaying surgery might constitute poorer quality care

if the person’s ability to function was impeded, but

delays can have health benefits if the surgery is

ultimately avoided or if the diagnosis is refined.

Greater delay would be expected in adopting an

expensive technology such as MRI while its demonstrated advantages over alternative modalities

were fairly limited (234). As long as use inside the

plan was low, the plan would be likely to contract for such services outside the plan.

Risk-sharing plans know in advance the size of

the population for which they are responsible and

have financial incentives to take advantage of

economies of scale in locating and using expensive equipment. These incentives would promote

greater regionalization of expensive equipment.

There would be incentives to send more tests to

centralized clinical laboratories and to perform

fewer tests in physician offices. Such a shift has

the potential to improve the quality of test results

since State standards may be more likely to apply to central laboratories, and appropriately

trained technicians may be more likely to perform

the tests.

Compared to other insured people, HMO enrollees have had no consistent pattern of vaccinations, preventive technologies considered costeffective (483,576). It is unlikely that pneumococcal vaccination, for example, would be higher under cavitation because of barriers to use that precede payment.

Option 15: Mandate the Medicare program to

fund demonstrations of cavitation payment to

geographic fiscal intermediaries.

All of Medicare’s experience with cavitation

payment has been with individual plans. This option would require Medicare to try an alternative

approach. In the context of demonstration projects, Medicare could pay fiscal intermediaries (for

example, carriers or PROS) who were willing to

assume the financial risk for beneficiaries’ care in

a geographic area (70,564). The intermediary-atrisk could negotiate arrangements with area providers and offer beneficiaries choices. Continuation of present Medicare coverage and cost-sharing

provisions would remain an option. Cavitation

payment would give a geographic fiscal intermediary financial incentives to control expenditures

for beneficiaries’ care by persuading beneficiaries

to choose lower cost alternatives, such as HMO

enrollment or PPO providers, by negotiating discounts with providers in a PPO or HMO, or by

pursuing more stringent review of fee-for-service

claims (70).

From the perspective of the Medicare program,

the problem of establishing equitable rates for

different categories of beneficiaries would be mitigated under this option because the intermediary would be at risk for all the beneficiaries in

an area. However, random variations in beneficiary expenditures from year to year could entail

substantial amounts. It would be possible for

Medicare to share the risk with the carrier by paying the carrier a “risk premium, ” by permitting

the carrier to establish a risk stabilization fund

to buffer annual gains and losses, or by specifying that Medicare would share a certain percentage of the annual gains and losses. Different arrangements could be tested in the demonstrations.

Even if there were some retrospective adjustments based on actual expenditures, the Medicare

program could benefit from being better able to

predict total annual expenditures. Beneficiaries

might also gain to the extent that plans and providers sought their patronage by reducing costsharing liabilities or by increasing benefits.

Demonstrations of cavitation payment to geographic fiscal intermediaries would permit Medicare to evaluate the implications of this payment

alternative for beneficiaries’ access to and quality of care. Both the carriers and providers who

were at risk would have financial incentives to

control use, perhaps at the expense of quality and

access. The experience that Medicare gained from

the demonstrations would permit the program to

identify problem areas and to design methods of

monitoring and assuring quality and access.

Demonstrations would also enable the Medicare program to identify and seek solutions to

matters concerning enrollment of beneficiaries,

establishing and updating cavitation rates, and assignment for fee-for-service providers. Either

Medicare or the intermediary could conduct an

open enrollment period. One possibility to inject
32 ● Payment for Physician Services: Strategies for Medicare

Photo credit: General Electric Medical Systems

Expensive technologies with substantial fixed costs, such as magnetic resonance imaging (MRI), would be more likely

to be regionalized if their services were included in payment for packages of services or in cavitation payment, or if

payment rates were lowered under fee-for-service payment.

greater competition would be for the geographic

fiscal intermediary to contract with HMOS and

other CMPS that it did not sponsor and offer them

as options to beneficiaries.

Establishing a geographic intermediary-at-risk

would vest substantial market power in one entity. Once established, the intermediary would

have a strong negotiating position with Medicare

because of the difficulty for Medicare if the intermediary opted out after a few years. The intermediary’s control over sizable funds would give

it great leverage in negotiating with plans and

providers. An undesirable consequence would be

that the carrier might use its market power to

drive out competitors.

Monitoring and assuring quality and access

during the demonstration would be important to

protect the welfare of beneficiaries. These activities would also be difficult. Past quality assurance

programs have concentrated on overprovision of

services because of the financial incentives of feefor-service payment. By contrast, quality assurance under cavitation payment would have to be

directed toward underprovision of services, a field

in which little experience exists (see option 9).
Ch. 1—Summary and Policy Options ● 33

CONCLUSION

Each of the four strategies to change Medicare

payment for physician services has advantages,

disadvantages, and uncertain implications. Capitation payment under a mandatory voucher system is most likely to be able to control Medicare

expenditures without increasing beneficiaries’ expenditures. But since the technology of setting

cavitation rates for different categories of beneficiaries is not well developed, the rate structure

could unintentionally contain incentives for payment recipients to seek some beneficiaries as enrollees and to avoid others. The cavitation payment recipient would be at financial risk for the

use and cost of covered services.

Payment based on fee schedules would give

Medicare greater control over price, but changes

in total expenditures would depend on changes

in the volume and types of services as prices were

constrained. Continuing CPR payment and lowering Medicare’s approved charges might initially

reduce the growth in Medicare expenditures, but

this effect would be unlikely to be sustained. Payment for packages of services could theoretically

enable Medicare to limit expenditures for packaged services, but total expenditures would depend on the effects of case-mix adjustment and

on the extent to which related services were used

outside the packages. Moreover, little or no experience exists with payment for packages that include the services of different physicians.

The effects of different payment alternatives on

quality of care would depend on the level and unit

of payment and on how appropriately services are

now being used. Some services, especially procedural ones, such as certain clinical laboratory

services and some surgeries, now tend to be overused. If reductions in the levels of payment and

more global units of payment led to lower use of

such services, quality could be enhanced. On the

other hand, quality would fall if lower payment

levels or revenue constraints led to reductions in

services and delays in diagnosis and treatment that

hurt beneficiaries’ health.

Quality assurance is a concern for all the payment alternatives, but the direction of concern

differs for specific alternatives—from overuse of

services with fee-for-service payment to underuse

with payment for packages of services and capitation payment. As the unit of payment and scope

of services become more comprehensive, financial incentives for efficiency apply across a greater

range of services, and incentives for underuse and

concern about adverse effects on quality of care

also increase. Under both cavitation payment and

payment for packages of services, providers that

underserve beneficiaries run the risk of losing patients to other practices. Although cavitation

plans have apparently provided medical care at

lower cost while maintaining quality at levels

equal to or better than comparison practices, it

is uncertain whether new plans, which differ in

size, sponsorship, organization, and risk-sharing

arrangements, will achieve similar results.

Since assignment rates decline with lower payment rates, lowering approved charges under CPR

would decrease beneficiaries’ financial access to

the physicians or services affected. Payment for

packages of services would require mandatory assignment, whose effect on access is uncertain.

Cavitation payment has reduced enrollees’ direct

financial barriers to securing care, but new plans

might differ in coverage of services and cost-sharing provisions. The ongoing evaluation of capitation plans with Medicare enrollees will indicate

whether beneficiaries have had difficulty dealing

with plan bureaucracy.

There are no documented problems with present access to care for specific beneficiary groups.

But an important factor in future access under all

of the payment alternatives discussed in this report would be the level of Medicare payment.

There is the possibility that if payment rates were

pushed too low, providers would increasingly refuse to accept Medicare’s payment as payment in

full. Some beneficiaries would be able to bear

higher out-of-pocket expenses. But poorer beneficiaries would have restricted access to medical

care and perhaps untoward effects on their health.

Payment reform that lowers the level of payment or limits the revenue to a provider would

encourage the development and use of cost-saving

technologies and of less expensive sites of care.
34 ● Payment for Physician Services: Strategies for Medicare

Such reforms would also stimulate regionalization of expensive technologies, perhaps with a

concomitant decrease in beneficiaries’ geographic

access. Expensive new technologies, such as MRI,

might be adopted more slowly than at present.

Within packages and under cavitation payment,

new cost-increasing technologies would be more

likely to be used in cases where their efficacy had

been documented. The use of preventive technologies such as pneumococcal vaccination might

increase with higher levels of payment or with

payment for a designated package of preventive

services. To the extent that physicians’ and beneficiaries’ attitudes toward prevention account for

low levels of use of even cost-effective preventive

services, however, physician payment reform

would not change the use of such services.

The policy options that involve the least change

from present CPR payment or that call for research and demonstrations could be undertaken

fairly quickly, within 1 or 2 years. This applies

to four of the five general options: reducing the

number of payment codes, adopting volume controls, mandating assignment, and establishing a

physician payment commission. All of the options

under the strategy of continuing present payment

arrangements could also be implemented in a

short time: reducing approved charges and giving beneficiaries the option of PPOs, adopting fee

schedules for specific services, increasing funding

for research and demonstrations on cavitation

rates, and funding demonstrations of quality assurance under cavitation payment. Fee schedules

for the strategy of payment based on fee schedules could also be constructed quickly if they were

based on carriers’ historical charge data. All of

the options in the strategy of payment for packages of services could be undertaken in a short

time, because they all relate to developing further

information on packaging: investigating payment

for special-procedure packages, conducting research on episodes of care and case-mix measures,

and instituting demonstration projects to pay for

inpatient physician services by DRGs. Within the

strategy of cavitation payment, a demonstration

of cavitation payment to geographic fiscal intermediaries could begin in the near future. HCFA

is currently funding or examining most of the research and demonstration projects discussed in the

options. What Congress would gain by mandating certain avenues of research or demonstration

is an emphasis on a certain payment strategy.

Options that depend on further analysis, especially regarding resource costs and relative value

scales, would require a longer period of time to

carry out. The general option to reduce payment

differentials among certain services and the construction of fee schedules based on estimates of

resource costs or physician involvement fall into

this category. Cavitation payment for all beneficiaries either could be implemented quickly using

present payment rates based on the AAPCC or

delayed until payment rates were more refined

and recent demonstration projects had been evaluated. For the most part, payment for packages of

services, as opposed to research or demonstrations

on packaging, is not ready to be implemented because payment categories have not been developed or tested.

Although it would be most reasonable for Congress to consider policy options related to the payment strategy that it wished to adopt, it would

be possible to adopt other options or strategies

while awaiting further information from research

and demonstration projects that would guide the

ultimate decision. The general options would be

consistent with the three payment alternatives that

would continue to base payment on individual

services or packages of services. Although capitation payment would render moot most of the

issues addressed by the general options, it would

still be feasible to move from any of the general

options to general cavitation payment. The options to continue CPR as the mainstream payment

method could be undertaken in the same spirit.

Within this set of options, Congress could emphasize measures related to an alternative payment

method if it was interested in moving in that

direction.

The strategy of payment based on fee schedules instead of CPR would also be consistent with

ultimately adopting payment for packages of services or general cavitation payment. The effort and

expense to implement payment changes associated

with fee schedules would then have to be repeated

for the new payment alternative. But payment

based on fee schedules could be a bridge for de-
termining rates for broader packages of services.

And under general cavitation payment, payment

based on fee schedules instead of CPR could be

the fee-for-service alternative guaranteed to beneficiaries who wished to continue with that approach.

It would be technically feasible but more difficult to move from some of the packaging options

to strategies to adopt other payment alternatives

(574). Paying for some or all inpatient physician

services by DRGs would prompt organizational

and financial changes within the physician comCh. 1—Summary and Policy Options • 35

munity and within hospitals that would have to

be disrupted if payment based on fee schedules

or general cavitation payment were subsequently

adopted. Similarly, it would be possible with additional effort and expense to move from general

cavitation payment to payment based on fee

schedules or payment for packages of services. But

general cavitation payment would most likely

stimulate both beneficiaries and providers to align

with plans, and the substitution of a different payment alternative would be disruptive to those relationships and to the individuals involved,
Chapter 2

Physician Payment Under the

Medicare Program: Problems and

Changing Context

You would be surprised at the number of years it took me to see

clearly what some of the problems were which had to be solved

Looking back, I think it was more difficult to see what the problems were than to solve them.

—Charles Darwin

Contents

Page

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . 39

Expenditures for Physician Services . . . . . . 40

Medicare Expenditures for Physician

Services. . . . . . . . . . . . . . . . . . . . . . . . . . 40

U.S. Expenditures for Physician

Services. . . . . . . . . . . . . . . . . . . . . . . . . . 44

Physician Payment Changes and

Practice Choices. ... , . . . . . . . . . . . . . . . . 49

Physicians as Entrepreneurs:

Accepting Assignment . . . . . . . . . . . . . 49

The Effect of Relative Prices on

Technology Choices . . . . . . . . . . . . . . . 51

Page

Is There Too Much Service With Fee

for Service? . . . . . . . . . . . . . . . . . . . . . . 52

Volume Responses and Induced

Demand . . . . . . . . . . . . . . . . . . . . . . . . . 53

Cost-Shifting . . . . . . . . . . . . . . . . . . . . . . . . 53

Issues With Respect to Medicare’s

Physician Payment System . . . . . . . . . . . 54

Beneficiary and Provider Confusion . . . 55

Inefficiencies in the Delivery of

Medical Care . . . . . . . . . . . . . . . . . . . . . 56

Variations in Annual Expenditures

per Beneficiary . . . . . . . . . . . . . . . . . . . 56
Page

Variations Related to Assignment . . . . . 57

Perceived Payment Imbalances . . . . . . . . 59

Summary of Variations . . . . . . . . . . . . . . 71

The Changing Context of

Physician Payment . . . . . . . . . . . . . . . . . . 72

Changes in Policies of Hospital

Payment . . . . . . . . . . . . . . . . . . . . . . . . . 73

Changes in the Elderly Population . . . . . 73

Changes in Medical Providers . . . . . . . . . 74

Implications for Medicare

Expenditures . . . . . . . . . . . . . . . . . . . . . . 76

Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . 77

.

List of Tables

Table No. Page

2-1.

2-2.

2-3.

2-4.

2-5.

2-6.

2-7.

2-8.

Medicare Part B Enrollment,

—

Reimbursement Amounts, and

Claims Volume, Fiscal Years

1967-84 . . . . . . . . . . . . . . . . . . . . . . . . . 41

Percent Distribution of Medicare

Approved Charges for Physicians’

Services, by Combinations of Place

and Type of Service, 1983 . . . . . . . . . 43

Components of Increases in Total

Medicare Approved Charges for

Physician Services per Aged

Enrollee, 1967-83 . . . . . . . . . . . . . . . . . 44

Annual Percentage Increases in

Medicare Payments for Physicians’

Services for Aged Beneficiaries,

1975-82 . . . . . . . . . . . . . . . . . . . . . . . . . 45

U.S. Physician Expenditures and

Factors Accounting for Growth,

1965-83 . . . . . . . . . . . . . . . . . . . . . . . . . 46

Trends in the Gross Income,

Expenses, Net Income, and Real Net

Income of Physicians, 1970-84 . . . . . 47

Mean Physician Net Income After

Expenses Before Taxes, Selected

Years, 1973-83 . . . . . . . . . . . . . . . . . . . 47

Gross Physician Earnings From

Medicare, 1981. . . . . . . . . . . . . . . . . . . 48

Table No. Page

2-9.

2-10.

2-11,

2-12.

2-13.

2-14.

2-15.

2-16.

2-17.

Percent of Self-Employed Physicians

Reporting Specific-Percentile-Ranges

of Patients With Medicare

Coverage, 1984 . . . . . . . . . . . . . . . . . .

Medicare Reasonable Charge

Reductions per Claim, JanuaryMarch, 1985 . . . . . . . . . . . . . . . . . . . . .

High and Low Prevailing Charges

in Localities for Five Selected

Procedures, Fee Screen Year 1980 . .

Elderly Population’s Share of

Market for Selected Inpatient

Surgical and Diagnostic and

Therapeutic Procedures, 1983 . . . . . .

Distribution of Medicare Approved

Charges Across CPR Limits, and

Specialty and Type of Service . . . . .

Elderly Population in the United

States, Actual and Projected, by

Age Cohort, 1970-2050 . . . . . . . . . . .

Life Expectancy at Birth and Age

65, by Sex and Calendar Year . . . .

Medicare Enrollees Served and

Their Reimbursement,

by Age, 1982 . . . . . . . . . . . . . . . . . . . .

Active Physicians in the United

49

58

60

70

72

74

74

74

States and Estimated Requirements,

1970-2000 . . . . . . . . . . . . . . . . . . . . . . 75

List of Figures

Figure No. Page

2-1.

2-2.

2-3.

Percent Distribution of Medicare “

Approved Charges for Physician

Services by Type of Service, 1983... 4 2

Percent Distribution of Medicare

Approved Charges for Physician

Services by Place of Service, 1983... 4 2

Percent Growth in U.S. and

Medicare per Capita Physician

Expenditures, 1968-83 . . . . . . . . . . . . . . 44
Chapter 2

Physician Payment Under the Medicare

Program: Problems and Changing Context

INTRODUCTION

The law establishing the Medicare program was

enacted in 1965 as a means to enhance access of

elderly people to hospital and physician services

by providing insurance that would reduce the outof-pocket costs of such care. In this regard, the

program has largely succeeded. This success, however, has come at an increasing cost to the Medicare program. Furthermore, elderly people have

not been immune to increases over time in outof-pocket costs for Medicare premiums, deductibles, 1 coinsurance, and “nonassigned” liability for

covered services—not to mention the total costs

for those health care services that are not covered

by Medicare. Finally, there is some concern that

the program does not provide equal financial protection to all beneficiaries. In particular, there are

perceived imbalances by region, location within

region, type of service, and other factors not related to eligibility.

The Medicare program represents a major part

of U.S. health insurance coverage, which has increased greatly over the past generation. Although

health insurance has improved people’s access to

medical care, it has also fueled the use and cost

of medical technology (129,137). The nature of

insurance coverage and the specific payment

methods that have been used by Medicare and

other third-party payers have dulled the sensitivity of consumers, physicians, and other providers

to cost considerations. The result has often been

inappropriate technology use and higher expenditures than warranted for the health benefits received (483).

Until recently, increases in hospital expenditures

under Part A of Medicare have attracted the most

attention and concern because hospital expenditures have accounted for the largest share of total

‘In constant dollar terms, there has been a decline in premiums

and the deductible over time, but totaI reaI out-of-pocket costs for

beneficiaries have increased.

Medicare expenditures and have been growing at

a high rate. However, the increase in Medicare

hospital expenditures has slowed since fiscal year

1983; and in October 1983, Medicare began paying for inpatient operating costs by diagnosisrelated groups (DRGs). For fiscal year 1984, expenditures grew faster for physician and other

services under Part B than under Part A or indeed for any other component of the Federal

budget (401).

As attention has turned to expenditures for Part

B services, Medicare’s method of paying for physician services according to customary, prevailing, and reasonable (CPR) charges has come under particular criticism. In fact, the inherent

inflationary bias in the CPR approach has been

demonstrated both theoretically (151) and empirically (189), This situation contrasts with the “financial” goals posed for the Medicare payment

system of achieving at least predictable and preferably contained levels of beneficiary and program

expenditures.

Other developments in the medical care sector

also affect Medicare’s payment of physician services. Changes taking place in the supply of physicians and the organization of their practices may

result in a more competitive market for physician

services and a new environment for Medicare program payment policies.

This chapter reviews the increases in Medicare

expenditures for physician services along with

other current issues in physician reimbursement

in the Medicare program. It also identifies current developments outside of Medicare that may

affect physician payment. The discussion in this

chapter reviews the context for addressing both

Medicare’s physician reimbursement issues and

the other general objectives of the Medicare program: promoting access of Medicare beneficiaries

to health care services of an acceptably high quality delivered in a cost-effective manner.

39
40 ● Payment for Physician Services: Strategies for Medicare

EXPENDITURES FOR PHYSICIAN SERVICES

In 1984, the Nation spent $75.4 billion on physician services (507). This was an increase of 9.3

percent over the previous year, exceeding the rate

of growth in expenditures on all health care services and supplies in general and the growth in hospital expenditures in particular, Medicare expenditures on physician services in 1984 were $14.6

billion, or 19.3 percent of the total. All Federal

expenditures for physicians services in 1984 were

$16.9 billion, compared to an estimated $200 million in 1965. As a proportion of all expenditures

for physician services since that time, Federal expenditures have increased from 1.8 to 22.4 percent (165,507),

Medicare Expenditures for

Physician Services

Method of Physician Payment

Under Medicare

The predominant method of physician payment

under the Medicare program is fee for service. Although some Medicare funds for physician services are paid to hospitals and other institutions

(e.g., health maintenance organizations (HMOs))

that may employ salaried physicians or retain

physicians on other than a fee-for-service basis,

such arrangements represent a very small fraction

of the Medicare business. Of Part B incurred allowed charges for physician services in the year

ending June 30, 1983, 96 percent originated with

individual patient bills submitted on the standard physician claims forms for fee-for-service

practice (553)0

2

Reasonable or approved charges for those

claims are determined through the CPR charge determination process, which is described in appendix C. Medicare’s “approved charges” for any

service are limited to the lowest of the physician’s

billed charge, the customary charge for the service based on that physician’s prior billings to the

Medicare carrier, or the prevailing charge for that

service based on comparable physicians’ prior bill-

‘Comparable statistics are not available with respect to the volume of Part A funds used for physician reimbursement, Although

much of this Part A funding will be used to pay salaried physicians,

hospitals may bill carriers for services performed by salaried physicians.

ings to the carrier for the same service as adjusted,

if necessary, by the Medicare Economic Index

(MEI). As a result, Medicare carriers (as most

large private physician insurance programs) typically do not approve the full amount of a physician’s charges for a service provided to a Medicare patient. In the first quarter of 1985, the

average reduction due to the CPR process was

26.2 percent (535). For a bill with submitted

charges of $100, therefore, approved charges

would average $73.80. (The carrier would pay the

physician 80 percent of the approved charges, or

$59.04, less any unpaid patient deductibles, ) Contrary to the conventional wisdom, not all physician claims are submitted at amounts that exceed

the CPR limits. Through the end of calendar year

1984, 18.3 percent of all claims were submitted

at or below the CPR limits (535).

Physicians are paid for their services to Medicare beneficiaries either directly by the beneficiary or by a Medicare carrier, depending on

whether the physician “accepts assignment. ” By

statute, it is only the Medicare beneficiary who

is entitled to be paid a reimbursement benefit.

That benefit is equal to 80 percent of the approved

charge for the service once the beneficiary has approved bills that exceed the annual deductible. Instead of being reimbursed directly, the beneficiary may elect to assign the benefit to the physician

who provided the service. If the physician accepts

assignment, he or she must accept the approved

charge as payment in full (and may bill the beneficiary for the 20-percent coinsurance and any remaining deductible). If assignment is not accepted,

the physician’s expected full payment is not bound

by the approved charge, and the beneficiary is liable for any difference between the physician’s actual charge and the allowed charge, in addition

to the coinsurance and deductible. Medicare’s approved charge, however, is determined without

regard to assignment.

Prior to October 1, 1984, each physician was

free to make assignment decisions on a case-bycase basis.3 Passage of the Deficit Reduction Act

31n cases where a physician treated a patient who was eligible for

both Medicare and Medicaid, accepting assignment was mandatory.

And, in the case where a physician provided more than one service

to a beneficiary on the same day, assignment would have to be ac-
Ch. 2—Physician Payment Under the Medicare Program: Problems and Changing Context ● 41

of 1984 (Public Law 98-369), however, introduced

the concept of Medicare “participating physicians”

along with a 15-month freeze on customary and

prevailing charges for all physicians and a freeze

on submitted charges by “non-par” physicians

(i.e., physicians who did not elect to become participating physicians). A physician who elected

to become a participating physician agreed to accept assignment for all Medicare claims for the

next 12 months. In return, that physician would

be listed in a directory of participating physicians

available to beneficiaries, and would be allowed

to increase billed charges. According to the provisions of the Deficit Reduction Act, participating physicians would receive higher approved

charges in fee screen year4 1986, while the approved charges of the non-pars in fee screen year

1986 would not increase appreciably beyond the

fee screen year 1984 levels. ’ Although non-par

physicians are not required to accept assignment

on 100 percent of their claims, they may continue

to accept assignment on a case-by-case basis.

Participating physicians represent 29.8 percent

of all physicians who receive payment under the

Medicare program (518). In the first quarter of

1985, participating physicians submitted 36.1 percent of all physician claims to Medicare and 56.5

percent of all assigned claims. Participating physicians accounted for 34.9 percent of covered

charges for physician services (537).

Composition of and Growth in Medicare

Expenditures for Physician Services

In fiscal year 1984, Medicare carriers processed

229 million Part B claims (527), approximately 7

——

cepted on all of those services or none of the services. The physician in that case could not accept assignment for only some of the

services. Beginning in fiscal year 1985, however, assignment could

be accepted for laboratory services only without the requirement

that assignment be accepted on all services if it was accepted on any

service.

4A fee screen year is the calendar period during which a particular year’s CPR limits are in effect. Prior to the Deficit Reduction

Act of 1984 (Public Law 98-369), fee screen years began on July 1

of a calendar year and continued through June 30 of the next year.

As of Sept. 30, 1984, fee screen years run from Oct. 1 through Sept.

30 of the following year, with fee screen year 1985, for example,

beginning on Oct. 1, 1984.

‘Because the freeze limits were based on the charges from the last

3 months of fee screen year 1984, it is conceivable that non-pars

who had increased their fees between July 1, 1983, and Mar. 30,

1984, would receive increases in their customary charges in spite

of the freeze.

claims per enrollee. The average claim included

charges for covered services of $128.74; average

approved charges per claim were $97.61. Total

claims volume has grown at an average annual

rate of 12.6 percent since 1968, while annual

growth in claims per enrollee has averaged 9.4

percent (see table 2-1).

Eighty-five percent of Part B expenditures are

for physician services, with the bulk of the remainder going to outpatient departments (553).

As shown in figure 2-1, the expenditures are concentrated in the areas of medical care and surgery,

at 37.3 and 33.7 percent, respectively, of total approved charges in 1983 (69). Diagnostic radiology and diagnostic laboratory services represented

8.4 and 8.0 percent, respectively, of total approved charges, with all other physician services

combining to total 12.6 percent,

Most of the expenditures for physician services

are for services provided in the hospital. In 1983,

the most recent year for which estimates are available, 61.9 percent of all approved charges were

Table 2.1 .—Medicare Part B Enrollment,

Reimbursement Amounts, and Claims Volume,

Fiscal Years 1967-84 (in millions)

Number of Total Number Claims per

Fiscal year beneficiaries dollars of claims beneficiary

1967 . . . . . . 17.8a

1968 . . . . . . 18.0

1969 . . . . . . 18.8

1970 . . . . . . 19.3

1971 . . . . . . 19.7

1972 . . . . . . 20.0

1973 . . . . . . 20.4

1974 . . . . . . 22.6

1975 . . . . . . 23.3

1976 . . . . . . 24.1

TQb . . . . . . .

1977 . . . . . . 24.8

1978 . . . . . . 25.6

1979 . . . . . . 26.3

1980 . . . . . . 26.9

1981 . . . . . . 27.5

1982 . . . . . . 28.0

1983 . . . . . . 28.5

1984 . . . . . . 29.0

$ 664

1,390

1,645

1,979

2,035

2,255

2,391

2,874

3,765

4,672

1,269

5,867

6,852

8,259

10,144

12,345

14,806

17,487

19,473

19.7

34.2

39.3

43.8

49.1

54.5

58.5

68.0

81.4

93.5

110.0

122.1

136.2

154.5

171.7

188.3

208.4

229.0

1.1

1.9

2.1

2.3

2.5

2.7

2.9

3.0

3.5

3.9

4.4

4.8

5.2

5.7

6.2

6.7

7.3

7.9

aAfter 1977 enrollment is as of June 30, not the end of the fiscal year, Sept 30.

b

Transition quarter

SOURCES: Enrollment, years ending June 30 and Incurred reimbursement

amounts: U S Federal Supplementary Medical Insurance Fund, Board

of Trustees, “1985 Annual Report of the Board of Trustees of the Fed.

eral Supplementary Medical Insurance Trust Fund,” Washington, DC,

Mar. 28.1985, Claims volume: U.S. Department of Health and Human

Services, Health Care Financing Administration, Bureau of Data

Management and Strategy, D!vision of Reports and Analysis, Compllect Carrier Workload Reports, 1985.
42 ● Payment for Physician Services: Strategies for Medicare

Figure 2-1 .—Percent Distribution of Medicare

Approved Charges for Physician Services by Type

of Service, 1983

Anesthesi a

Diagnostic (4.80/’,)

SOURCE: 1. Burney and G. Schieber, “Medicare Physicians’ Services: The Composition of Spending and Assignment Rates, ” Health Care Firrarrcing

Review, forthcoming,

provided in an inpatient setting. Physicians’ offices

and outpatient departments were the second and

third ranked sites, with 29.2 and 5.9 percent, respectively, of approved charges (see figure 2-2).

In terms of the most significant place of service/type of service combinations, 27.5 percent of

total approved charges were for surgical services

in a hospital, 18.8 percent were for medical services in a hospital, and 15.5 percent were for medical services in a physician’s office (see table 2-2).

Internal medicine was the specialty that received the highest proportion of Medicare physician expenditures, accounting for 20.4 percent of

total approved charges in 1981 (69). The medical

specialties as a whole accounted for 28.5 percent

of 1981 approved charges, and general and family practice combined accounted for an additional

11.5 percent. Surgical specialties accounted for

34.8 percent of total approved charges, with the

services of general surgeons representing 9.6 percent of the total and those of ophthalmologists

representing 8.2 percent. The distribution of

specialists’ charges by type of service is unremarkable, with general and family practice and most

Figure 2-2.— Percent Distribution of Medicare

Approved Charges for Physician Services by Place

of Service, 1983

Other

Hospita l

(2.80/o)

outpatient

(5.9%)

SOURCE: 1. Burney and G. Schieber, “Medicare Physicians’ Services: The Composition of Spending and Assignment Rates, ” Health Care Financing

Review, forthcoming.

medical specialties billing most of their charges

for medical care and most surgical specialties billing most for surgery. With few exceptions, most

specialties have higher total billings for services

provided in the hospital than in an office (69).

Two specialties, however, received more than 50

percent of 1981 approved charges for services provided in their offices: otolaryngology (50.3 percent) and dermatology (91.1 percent).

In spite of the CPR limits or, as some would

have it, because of them, approved charges for

physician services per aged Medicare enrollee increased by 591 percent between fiscal year 1968

and fiscal year 1983. Medicare Part B benefit payments totaled $1.4 billion during fiscal year 1968;

16 years later, benefit payments had increased to

more than $19. s billion, an increase of 1,400 percent (553).

These increases were due to a variety of factors

in addition to the changes in approved charges,

including changes in enrollment, changes in physicians’ billed prices, and changes in utilization.

In order to explore these increases, one can ex-
Ch. 2—Physician Payment Under the Medicare Program: Problems and Changing Context ● 43

Table 2-2.—Percent Distribution of Medicare Approved Charges for Physicians’ Services,

by Combinations of Place and Type of Service, 1983

Place of service

Type of service All Office Inpatient Home OPDa

Lab SNF

b Other

All types . . . . . . . . . . . . .

Medical care . . . . . . . . . .

Surgery . . . . . . . . . . . . . .

Consultation . . . . . . . . .

Diagnostic radiology . . .

Diagnostic laboratory . .

Radiation therapy. . . . .

Anesthesia . . . . . . . . . . .

Assistant-at-surgery. . .

Other medical . . . . . . . . .

100.0

37.3

33.7

3.8

8.4

8.0

1.2

4.8

1.8

0.9

29.2

15.5

3.8

0.7

3.4

5.1

0.4

●

●

0.4

61.9

18.8

27.5

2.9

3.7

2.2

0.2

4.7

1,8

0.1

0.6

0.5

●

●

*

●

●

☛

☛

0.1

5.9

1.1

2.4

0.1

1.3

0.4

0.5

0.1

0.1

0.1

0.3

●

●

●

●

0.3

●

●

●

●

1.3

1.1

●

0.1

0.1

●

●

*

●

●

0.6

0.3

●

●

●

●

●

●

☛

0.3

aOPD = (Outpatlent department

bSNF = Skilled nursing facility

● = Less than O 05%

SOURCE I Burney and G Schieber, “Medicare Physicians’ Services: The Composition of Spending and Assignment Rates,” Health Care financing Review, forthcoming

amine the changes in Medicare expenditures by

partitioning expenditures as follows:

Total Medicare = number of x per capita x average

expenditures beneficiaries use physician

enrolled prices

From this it also follows that:

Change in = change in + change in + change in

total enrollment utilization physician

expenditures prices6

Since the beginning of the Medicare program,

enrollment has grown at an average annualized

rate of 2.4 percent for the aged population and

3.0 percent in aggregate (553), (The relatively

small disabled Medicare population grew at an

annualized rate of 7 percent per year from 1974

through calendar year 1981, after which enrollment declined. ) The annual increase in the enrollment of the aged population has been so nearly

constant—just in excess of 2 percent—that yearto-year fluctuations in reimbursements are almost

entirely derived from changes in utilization or

physician prices.

‘Although conceptually accurate, in practice it is difficult to completely distinguish changes in utilization from changes in price. For

example, the most common measure of physician fee inflation is

the Professional Services Index of the Medical Care Component of

the Consumer Price Index. This index is computed by pricing a fixed

market basket of physician procedures from a fixed cohort of roughly

700 physician practices. As a result, the index reflects neither changes

in the mix of physician services available in the market nor changes

in the mix of physician practices active in the market. Therefore,

simply “deflating” physician expenditures with the index may not

yield an entirely accurate estimate of changes in utilization.

From June 30, 1967, to June 30, 1983, approved

charges per aged enrollee increased 591 percent,

or 11.5 percent per year. The increase in approved

charges per disabled enrollee from June 30, 1974,

to June 30, 1983 was 390 percent, or 18.3 percent

per year. Further, as shown in table 2-3, through

fiscal year 1983, the aggregate increases in allowed

charges per enrollee had been accelerating. With

only two exceptions, the year-to-year total increase in recognized charges per aged enrollee increased in every year between 1970 and 1983

(553). Through June 30, 1970, the increase was

4.0 percent; by 1974, it was 8.9 percent; in 1978,

13.3 percent; in 1980, 16.0 percent; and in 1983,

charges per enrollee increased 20.6 percent.7 From

1978 onward, Medicare’s approved charges per

enrollee have consistently increased faster than

total per capita expenditures for physician services in the United States (see figure 2-3).

Of the 1968 to 1983 annualized increase of 11.5

percent per year, 6.9 percent was due to price increases and 4.6 percent was due to residual factors that include changes in utilization. Although

there are no consistent trends in either price

changes or the residual factors analogous to the

accelerating change in approved charges per enrollee, the rate of price increase rose substantially

‘Comparable fiscal year 1984 estimates will not be available until the preparation of the Federal Supplementary Medical Insurance

Trustees report for 1986. In fiscal year 1984, the aggregate reimbursements for aged Medicare beneficiaries increased 12 percent over

the previous fiscal year, compared to increases in excess of 19 percent in each of the 5 preceding fiscal years (533).
44 ● Payment for physician Services: Strategies for Medicare

Table 2-3.—Components of Increases in Total Medicare Approved Charges for

Physician Services per Aged Enrollee, 1967-83 (in percent)

Price change factors

Year CPR fee screens Residual factors Total

(ending June 30) CPl a Cumulative Annual Net Gross Denials Net increase

1967 . . . . . . . . . . . . . . 7.6 –2.6

1968 . . . . . . . . . . . . . . 5.9 –3.6 –0.6 5.3 10.8 – 1.4 9.4 14.7

1969 . . . . . . . . . . . . . . 6.2 –5.0 – 1.5 4.7 2.9 –0.4 2.5 7.2

1970 . . . . . . . . . . . . . . 6.7 –7.5 –2.8 3.9 3.2 –3.1 0.1 4.0

1971 . . . . . . . . . . . . . . 7.5 – 10.1 –3.0 4.5 3.6 –3.2 0.4 4.9

1972 . . . . . . . . . . . . . . 5.2 – 11.2 – 1.2 4.0 2.3 0.4 2.7 6.7

1973 . . . . . . . . . . . . . . 2.6 – 11.7 –0.5 2.1 5.7 –0.6 5.1 7.2

1974 . . . . . . . . . . . . . . 5.0 – 13.2 – 1.6 3.4 6.1 –0.6 5.5 8.9

1975 . . . . . . . . . . . . . . 12.8 – 16.2 –3.6 9.2 3.8 –0.3 3.5 12.7

1976 . . . . . . . . . . . . . . 11.4 – 18.6 –2.9 8.5 2.9 0.1 3.0 11.5

1977 . . . . . . . . . . . . . . 10.2 – 19.5 – 1.0 9.2 3.3 0.1 3.4 12.6

1978 . . . . . . . . . . . . . . 8.9 –19.4 0.5 9.4 3.8 0.1 3.9 13.3

1979 . . . . . . . . . . . . . . 8.6 –20.0 –0.5 8.1 3.9 –0.3 3.6 11.7

1980 . . . . . . . . . . . . . . 11.5 –22.1 –2.4 9.1 6.8 0.1 6.9 16.0

1981 . . . . . . . . . . . . . . 11.1 –24.5 –2.8 8.3 0.7 7.8 16.1

1982 . . . . . . . . . . . . . . 9.9 –23.9 1.5 11.4 5.9 0.5 6.4 17.8

1983 . . . . . . . . . . . . . . 8.2 –23.4 1.6 9.8 10.9 –0.1 10.8 20.6

aCPl=Medical Care Component of the Consumer Price Index.

SOURCE: US. Federal Supplementary Medical Insurance Trust Fund. Board of Trustees. ’’l985 Annual Report of the Board of Trustees of the Federal supplementarv

Medical lnsurance Trust F~nd:’Washington, DC, Mar28, 1985.

Figure 2-3.— Percent Growth in U.S. and Medicare

per Capita Physician Expenditures, 1968-83

Ci 1988 1971 1974 1977 1980 1983

Years

————U.S. total

Medicare aged only

SOURCE: M. Freeland, Bureau of Data Management and Strategy, Health Care

Financing Administration, U.S. Department of Health and Human Services, Baltimore, MD, personal communication, Apr. 4, 1985; and U.S.

Federal Supplementary Medical insurance Trust Fund, Board of

Trustees, “1985 Annual Report of the Board of Trustees of the Federal Supplementary Medical Insurance Trust Fund, ” Washington, DC,

Mar. 28, 1985.

after 1974, and the rate of increase in the residual factors also rose substantially after 1979.

Increases in expenditures have not been uniform

across physician specialties or the types of services that they provide. Data have been analyzed

from thes percent Bill Summary Record sample

to disaggregate changes by specialty and type of

service over the period 1975 to 1982 (133). Some

of these data are reproduced in table 2-4. (Over

this time period, total physician expenditures for

the aged increased by 18 percent: 2 percent from

enrollment increases, 10 percent from increases

in reimbursements per service, and 6 percent from

increases in services per enrollee. ) Specialists in

cardiovascular disease saw their Medicare reimbursements rise by 26 percent in total, half from

increases in service volume, half from increases

in reimbumements per service. Ophthalmologists

and general surgeons also enjoyed comparable

increases—of 13 percent—in reimbursement per

service, while many other specialties saw increases

in reimbursements per service of 9 or 10 percent.

Increases in the provision of services appeared

to be much more variable across specialties. Pathologists’ services increased by 21 percent over that

time period, while general and family practitioners’ services increased only 2 percent and those

of general surgeons increased but 1 percent (133).

U.S. Expenditures for

Physician Services

As indicated earlier, Medicare is only one

player in the market for physician services, and
Ch. 2—Physician Payment Under the Medicare Program: Problems and Changing Context . 45

Table 2-4.—Annual Percentage Increases in Medicare Payments for

Physicians’ Services for Aged Beneficiaries, 1975-82

—

Total Reimbursements/

Specialty reimbursements Services service

Cardiology . . . . . . . . . . . . . . . . . . . . . . . . . + 26% + 13% + 1 3%

Pathology . . . . . . . . . . . . . . . . . . . . . . . . . . 25 21 4

Ophthalmology . . . . . . . . . . . . . . . . . . . . . 22 9 13

Radiology . . . . . . . . . . . . . . . . . . . . . . . . . 22 13 9

Podiatry . . . . . . . . . . . . . . . . . . . . . . . . . . 20 11 9

Dermatology . . . . . . . . . . . . . . . . . . . . . . . 20 10 10

Otology/laryngology /rhinology . . . . . . . . 17 7 10

Orthopedic surgery . . . . . . . . . . . . . . . . . . 17 7 10

Internal medicine . . . . . . . . . . . . . . . . . . . 17 7 10

Urology . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 5 9

General surgery. . . . . . . . . . . . . . . . . . . . . 14 1 13

General practice/family practice . . . . . . 12 2 10

SOURCE L Etheridge and D Juba, “ Medicare Payments for Physicians’ Services, ” Health Atfairs 3(4) 132-137 Winter 1984

Part B physician service payments in 1984 were

19.3 percent of all expenditures for physician services (507). As a result, trends in that larger physicians’ market must be observed to understand

both the source of some of Medicare’s problems

and the prospects for their resolution.

Much like Medicare expenditures for physician

services, expenditures for physician services in

general are a function of the size of the population, per capita use of physician services, and price

per service. Hence the change in physician expenditures is a function of changes in prices, changes

in per capita use, and changes in the population.

The Health Care Financing Administration (HCFA)

has developed internal estimates to further partition price changes into those due to price changes

in the general economy and price changes in physician services that differ from those in the general economy. These estimates are reported in

table 2-5.

In 1965, an estimated total of $8.5 billion was

spent on physician services in the United States

(165). By 1984, that expense had expanded more

than eightfold to $75.4 billion, a rate of growth

of 11.5 percent per year. The years of the largest

growth in physician expenditures occurred in 1969

to 1971, prior to the imposition of the Economic

Stabilization Program; in 1976 to 1977, arguably

as a result of the malpractice crisis of 1976; and

during the inflationary period of 1979 to 1981.

In fact, just over half of the growth in physician expenditures since 1965 can be ascribed to

inflation in the general economy as measured by

the Gross National Product (GNP) deflator. Physician fee inflation has exceeded inflation in the

general economy with the exception of the 1972

to 1974 period of the Economic Stabilization Program. Since 1965, the total excess has been 39 percent, averaging just less than 2 percent each year

(152). The difference between the GNP deflator

and the professional services index of the medical care component of the Consumer Price Index

(CPI) reached a high of 6 percentage points between 1975 and 1976. Since 1980, this excess inflation has been accelerating as medical inflation

has continued while general inflation has declined,

Between 1982 and 1983, medical inflation was

twice the rate of inflation in the general economy.

Physician fee inflation in excess of general inflation contributed 15 percent of the total growth

in physician expenditures since the beginning of

the Medicare program (152).

The rate of growth in the general population

has been fairly constant since 1965, at approximately 1 percent annually. Per capita use of physician services has increased only slightly since

1965 and exhibited actual declines from 1980

through 1983. Together, growth in the use of physician services has represented just under 10 percent of the total growth in expenditures for physician services since 1965 (152).

Finally, one-quarter of the growth of physician

expenditures can be ascribed only to the residual

category. In the framework of the National Health

Accounts (165), this residual can be interpreted

as either an increase in the intensity or complex-
46 ● Payment for Physician Services: Strategies for Medicare

Table 2-5.–U.S. Physician Expenditures and Factors Accounting for Growth, 1965-83

Year

1985 . . . . . .

1966 . . . . . .

1987 . . . . . .

1968 . . . . . .

1969 . . . . . .

1970 . . . . . .

1971 . . . . . .

1972 . . . . . .

1973 . . . . . .

1974 . . . . . .

1975 . . . . . .

1976 . . . . . .

1977 . . . . . .

1978 . . . . . .

1979 . . . . . .

1980 . . . . . .

1981 . . . . . .

1982 . . . . . .

1983 . . . . . .

Total Percent change from previous year

dollars Total Physician fee Use of physician Change in Other

(in billions) dollars GNPdeflator a

inflation services per person population factors

8.5 NAC NA NA NA NA NA

9.2 8.2 3.2 2.5 –3.8 1.2 5.1

10.1 9.8 2.9 3.8 0.0 0.9 2.1

11.1 9.9 4.7 1.2 –1.8 1.1 4.7

12.6 13.5 5.3 1.7 1.6 1.0 3.9

14.3 13.5 5.5 2.1 7.9 1.1 –3.1

15.9 11.2 5.2 1.9 4.9 1.3 –2.1

17.2 8.2 4.4 –1.0 0.8 2.9

19.1 11.0 5.8 –2.4 0.7 0.9 6.0

21.2 11.0 8.7 0.3 –0.7 0.8 1.9

24.9 17.5 9.8 3.0 1.7 1.0 1.9

27.6 10.8 5.5 6.0 –1.4 1.0 –0.2

31.9 15.6 6.1 3.4 –2.4 1.0 7.5

35.8 12.2 7.5 0.9 –1.1 1.0 4.0

40.2 12.3 8.8 0.5 –0.2 1.1 2.1

46.8 16.4 9.7 1.3 1.2 3.5

54.8 17.1 10.1 1.3 -2. 4 1.0 7.1

61.8 12.8 6.2 3.3 –1.9 1.0 4.1

69.0 11.7 3.9 3.9 –0.6 1.0 3.5

1965-83

Total change . . . . . . . . . . . . . . . 711.8 199.0 39.1 1.5 20.5 70.6

Average annual change . . . . . . 12.2 6.3 1.9 0.1 1.0 3.0

The GNP deflator is a measure of the inflation in the general economy.

b

physician fee inflation is measured here by the physicians’ Services Component of the Consumer Price index minus the GNP deflator

cNA=Not available.

SOURCE: U.S. Department of Health and Human Services, Health Care Financing Administration, Bureau of Data Management and Strategy, Office of Financial and

Actuarial Analysis. Division of National Cost Estimates, unpublished data, 1985: and R.M. Gibson, K.R. Levit, H. Lazenby, et al,, “National Health Expenditures, 1963, ” Hea/th Care Financing Review 6(2):1-30, Winter 1964.

ity of the average physician service-possibly due

to technological change-or an increase in the fee

for the average service that is not accounted for

in the physicians’ services price index (that estimates changes in prices with respect to a fixed

market basket of services).

In fact, over the period from 1968 to 1983, the

increases in per capita expenditures for physician

services for the Medicare program have risen at

about the same rate as per capita increases in the

country as a whole (see figure 2-3). Over that time

period, the United States as a whole has averaged

increases of 11.6 percent. The comparable statistic for the Medicare program is 11.5 percent.

Through 1977, the Medicare increase was less than

that of the United States as a whole in 8 out of

10 years. Only since 1978 has the Medicare increase consistently exceeded the aggregate increase.

Physician Incomes

Payments for physicians’ services can also be

considered as income to physicians. Those incomes have also been increasing. For example,

average gross professional revenues more than

doubled from $81,800 in 1973 to $192,200 in 1983

(391). Physicians’ average net income also rose

over that decade, but in constant dollar terms,

it was nearly constant. Average real net physician income in 1984 was 4 percent lower than in

1970 (see table 2-6). However, this pattern of stable or declining real income was common to many

occupations during the period of the 1970s with

its high inflation rates. During the same period,

earnings in constant dollars of workers in private

nonagricultural industries fell 9 percent (500).

Income data indicate that there have been substantial differences among physicians by specialty

in both the level of income and the growth of income level. Hospital-based specialists in anesthesiology and radiology have had both the highest

and the most rapidly increasing net incomes. General practitioners have had the lowest net incomes,

on average. Net incomes for general practitioners

actually declined between 1981 and 1983 by 2.6

percent a year (see table 2-7).
Ch. 2—Physician Payment Under the Medicare Program: Problems and Changing Context ● 47

Table 2-6.—Trends in the Gross Income, Expenses, Net Income, and Real Net Income of Physicians, 1970-84

Average Average Average Median Real

Year gross income expenses net income net income net incomea

1970 ...., . . . . . . . . . . . . . . $ 66,100 $24,300 $41,800 - N A

b

$41,800

1971 ..., . . . . . . . . . . . . . . . 74,200 28,900 45,300 NA 43,400

1972 ......, . . . . . . . . . . . . . . . . 78,500 31,300 47,200 NA 43,900

1973 . . . . . . . . . . . . . . . . . . . . . . . 80,800 32,200 48,600 NA 42,700

1974 . . . . . . . . . . . . . . . . . . . . . . . 86,000 34,000 52,000 41,200

1975 ......, . . . . . . . . . . 94,900 38,500 56,400 $54,000 40,800

1977. ........, ..., . . . . . . . 106,700 45,500 61,200 56,300 39,200

1978. . . . . . . . . . . . . . . . . . . . . . . 111,900 48,400 65,500 60,000 39,000

1979. . . . . . . . . . . . . . . . . . . . . . 131,300 52,900 78,400 73,200 41,600

1981 . . . . . . . . . . . . . . . . . . . . . . . 167,000 74,000 93,000 78,000 39,400

1982. . . . . . . . . . . . . . . . . . . . . . . 177,900 78,400 99,500 85,000 40,100

1983. . . . . . . . . . . . . . . . . . . . . . . 192,200 85,900 106,300 90,000 41,600

1984 . . . . . . . . . . . . . . . . . . . . . . . 201,000 92,600 108,400 92,000 40,200

aAverage net Income In 1970 dollars

bNA- Not available

SOURCE American Medical Association, Profi/eof Med/ca/ Pracf/ce 1981 (Chicago, IL AMA, 1982) G L Glandon andJ L Werner “PhyslclansPractice Experience

During the Decade of the 1970s’ JAMA 244(22) 2514-2518, Dec 5, 1980; “AverageNet Income and ExpensesofPhyslclans.1981 ‘SMSf3eport 15 June

1982 and RA Reynolds and RL Ohsfeldt(edsk Socioeconori?/c,4spects of Med/ca/Pracfice 1984 (Ch(cago IL American Medical Assoclatton 1984)

Table 2-7.— Mean Physician Net Income After Expenses Before Taxes, Selected Years, 1973-83 (in $OOO)a

. —

1973 1974 1975 1977 1978 1979 1981b

1982b~ 1983b

All physicians . . . . . . . . . . . . . $48.6 $52.0 $56.4 $61.2 $65.5 $78.4 $ 93.0 $ 99.5

Specialty:

General/family practice . . . . . 41.9

Internal medicine ., . . . . . . . . 47.8

Surgery . . . . . . . . . . . . . . . . . . . 57.4

Pediatrics. . . . . . . . . . . . . . . 41.1

Obstetrics/gynecology . . . . . . 55.4

Radiology. . . . . . . . . . . . . 59.5

Psychiatry . . . . . . . . . . . . . . 38.4

Anesthesiology . . . . . . . . . . . 48.1

Census division:

New England ..., . . . . . . . 44.2

Middle Atlantic . . . . . . . . . . . 43.8

East North Central . . . . . . . . . 50.5

West North Central . . . . . . . . 51.5

South Atlantic . . . . . . . . . . . . . 50.3

East South Central . . . . . . . . . 53.3

West South Central . . . . . . . . 52.8

Mountain . . . . . . . . . . . . . 47.4

Pacific . . . . . . . . . . . . . . . . . . . 48.1

Type of practice:

solo . . . . . . . . . . . . . . . . . . . . . . 45.3

Non-solo. . . . . . . . . . . . . . . . . . 52.8

Location:

Nonmetropolitan . . . . . . . . . . . 46.9

Metropolitan

Less than 1,000,000 . . . . . . 50.3

1,000,000 and over . . . . . . . 47.5

44.7

51.4

60.5

42.1

61.7

63,8

41.3

54.4

46.3

47.7

54.2

53.6

54.4

58.4

57.7

49.5

50.9

48.5

55.6

48.5

53.7

51.5

40.6

57.1

58.9

49.3

34.0

45.4

57.0

68.2

44.3

63.3

75.2

44.8

57.1

47.2

53.2

59.9

56.6

58.2

65.5

61.4

54.7

54.8

51.6

61.1

50.2

58.8

55.6

43.7

62.9

62.3

54.1

35.0

51.1

61.5

74.0

48.2

69.9

76.7

48.2

65.5

53.1

55.9

62.7

61.1

61.8

68.2

67.9

57.5

63.6

56.3

68.3

56.7

63.2

60.6

49.6

69.9

67.7

58.7

36.8

54.6

63.8

82.6

51.2

70.3

81.5

50.2

74.2

54.9

59.1

69.9

70.2

64.9

79.7

70.9

61.8

64.9

61.3

69.9

64.8

67.4

63.9

49.0

70.1

76.2

65.3

44.4

62.0

76.2

96.0

60.4

91.8

98.0

62.6

91.4

66.6

73.2

81.2

79.4

79.8

87.0

85.8

73.5

78.6

75,8

80.7

74.1

78.8

78.8

64.3

87.5

87.1

75.9

54.9

72.2

85.1

118.6

65.1

110.8

116.9

70.6

118.6

85.0

85.6

100.9

87.4

92.6

97.5

101.6

92.6

91.7

88.4

96.6

87.1

99.6

90.2

62.5

98.1

110.8

95.6

68.3

71.9

86.8

130.5

70.3

115.8

136.8

76.5

131.4

82.2

91.1

106.2

106.5

97.9

106.8

118,7

95.8

92.9

93.4

104.0

86.9

103.9

98.4

73,3

108.2

116.5

99.5

64.3

Physician age:

Less than 36 years . . . . . . . . . 32.8

36-45 years . . . . . . . . . . . . . . . . 51.9

46-55 years . . . . . . . . . . . . . . . 55.0

56-65 years . . . . . . . . . . . . . . . . 48.3

66 or more years . . . . . . . . . . . 31.9

aData other than In the specialty breakdown, are based on responses from physicians in all specialties

bcau~on~hould be~bse~edlrlcornparing results for1981.~ with results forprevlous years becauseof changes ln methodology made lnthetransltlon from fheperlodlc

surveys of physicians to the socioeconomic monitoring system Results for 1981 and 1982 In the Iocatlon breakdown reflect correct lonsof previously reported results

SOURCE R A Reynolds and R L Ohsfeldt (eds ), Socloeconornic Aspects of kfedica/ Pract~ce 1984 (Ch!cago, IL American Medical Assoclatlon, 1984)

$106.3

68.5

93.3

145.5

70.7

119.9

148.0

80.0

144.7

84,5

98.6

114.3

110.5

106,7

114.9

124.4

91.4

103.1

100.0

111.3

87.2

111.0

106.3

77.0

110.2

133.6

103.1

71,9
48 • Payment for Physician Services: Strategies for Medicare

The variations in income parallel the variation

in return on training among specialties. Dresh

assessed the net capital value of returns to physician training for various specialties compared to

general practice using a measure of lifetime physician earnings (113). He found that, except for

pediatricians, psychiatrists and allergists/dermatologists, the adjusted lifetime earnings of medical and surgical specialists were much higher than

those of general practitioners (113).

There is also a marked difference in annual

earnings among specialties. Several studies confirm this finding and indicate that physician earnings for some specialties are higher than those for

other specialties even when allowances are made

for the opportunity costs of education and capital spent on education and offices (46).

Medicare’s contribution to physicians’ income

also varies by specialty (353) (see table 2-8). A

report of a recent survey of physicians indicated

that only 8.4 percent of self-employed physicians

had no Medicare patients in 1984 (406a). Those

physicians who reported providing care to some

Medicare beneficiaries indicated that 31.3 percent

of their patients had Medicare as the primary

source of insurance coverage (see table 2-9). What

is not known is whether, and if so, to what extent, specialty differentials contribute to the differences in Medicare payment among specialty

groups. Numerous other variables, such as volume of Medicare services provided, relative payments for procedural services vs. nonprocedural

services, and the different mix of services provided

by different medical disciplines are also contributory factors.

Physician Control Over Expenditures

for Physician Services

Although physician expenditures represent 22

percent of all health expenditures (165), physicians

have considerable influence on the use of a wide

variety of nonphysician services. Blumberg estimated the fraction of all health care services under physician control and the relative cost of those

services (46). By taking the product of those two

factors for each type of service and summing over

all services, he estimated physician control for

1976 as 69.8 percent of total costs. With respect

Table 2.8.—Gross Physician Earnings

From Medicare, 1981

Medicare Percent of total

Specialty income gross income

Anesthesiology . . . . . . . . . . . . . $32,790 22

Family practice . . . . . . . . . . . . . 21,220 15

General practice . . . . . . . . . . . . 21,170 18

General surgery. . . . . . . . . . . . . 43,750 25

Internal medicine . . . . . . . . . . . 39,630 29

Neurology . . . . . . . . . . . . . . . . . 37,390 24

Neurosurgery. . . . . . . . . . . . . . . 37,310 . 18

Obstetrics/gynecology . . . . . . . 8,530 5

Ophthalmology . . . . . . . . . . . . . 49,010 24

Orthopedic surgery. . . . . . . . . . 43,220 17

Pathology . . . . . . . . . . . . . . . . . . 28,000 21

Pediatrics . . . . . . . . . . . . . . . . . . 1,170 1

Plastic surgery . . . . . . . . . . . . . 18,780 12

Psychiatry . . . . . . . . . . . . . . . . . 6,370 6

Radiology . . . . . . . . . . . . . . . . . . 49,730 28

Thoracic surgery . . . . . . . . . . . . 72,420 35

All surgical specialties . . . . . . 38,910 20

All nonsurgical specialties . . . 24,660 17

All MDs . . . . . . . . . . . . . . . . . . . 27,490 17

SOURCE A. Owens, “How Much of Your Money Comes From Third Parties?”

Medical Economics 60:254-263, Apr. 4, 1983.

to individual services, physician control ranged

from 91 percent of the cost of hospital expenditures to 20 percent of the cost of “other professional services. ” Physician control was assessed

by estimating the proportion of services that patients received on the direction of their physicians.

In aggregate, physician control over ambulatory

care was estimated as 61.5 percent, ranging from

45 percent in pediatrics to 81 percent in psychiatry. Physician control over all physician services in all sites was estimated to be 76 percent.

Another perspective on this question comes

from recent work on the potential use of DRGs

for physician reimbursement purposes (571). If

physician charges represent 20 percent of all health

care bills but physicians are responsible for 70 percent of all charges, one would infer that physicians order services of roughly 2.5 times the value

of their own services. Based on all the physician

approved charge data within 2 months on either

side of a hospital stay for Medicare beneficiaries

in Florida in 1981, West et al. estimated that physicians as a whole ordered hospital services 1.73

times the value of their own services (571). With

respect to only those physician services provided

during the hospital stay, the Florida statistic would

be 2.2. In South Carolina for the same year, physician charges during a stay and within 2 months
Ch. 2—Physician Payment Under the Medicare Program: Problems and Changing Context • 49

Table 2-9.—Percent of Self= Employed Physicians

Reporting Specific Percentile Ranges of Patients

With Medicare Coverage, 1984

Percent of self-employed physicians

Percent of Physicians with

patients with All some Medicare

Medicare coverage physicians patients

o . . . . . . . . . . . . . . 8.40/o o

< 10% . . . . . . . . . . . . . 30.0 23.50/o

<20 . . . . . . . . . . . . . . 44.2 39.0

<30 . . . . . . . . . . . . . . . 60.8 57.2

<40 . . . . . . . . . . . . . . . 75.8 73.5

<50. . . . . . . . . . . . . . . 86.1 84.7

<60 . . . . . . . . . . . . . . . 92.0 91.1

<70 . . . . . . . . . . . . . . . 95.3 94.8

<80 . . . . . . . . . . . . . . . 98.6 98.4

a

synthesis of reported percentage of physicians without Medicare Patients and

estimated number of physicians with specific Medicare percentages. These percentages were not directly combined in the source report.

SOURCE M L Rosenbach, S Hurdle, and J. Cromwell, An Analysis of Medicare’s

Physic/in Participafion Agreement Program (Chestnut Hill, MA: Health

Economics Research Center, Oct 29, 1985).

of either side of a Medicare hospitalization were

accompanied by 2.7 times that amount in hospital services. Hospital charges were 3.3 times the

value of Medicare physician allowed charges for

strictly inhospital physician services. When the

physician charges were further disaggregated to

identify the physician practice that alone was responsible for the largest fraction of physician

charges, each “lead” practice was responsible for

3.8 times the value of own charges in Florida

and 4.8 times the value of own charges in South

Carolina.

Whether physicians control 70 percent or more

of additional health care services, the potential

spillover effect of physician payment reform on

those additional health care dollars heightens the

importance of any reform.

PHYSICIAN PAYMENT CHANGES AND PRACTICE CHOICES

With any change in the method of physician

payment adopted by Medicare, one can expect responses by physicians in practice. The variety of

choices available to physicians in response to payment changes includes both entrepreneurial and

clinical decisions. Net payment to the physician,

however, is only one factor in the physician’s decisionmaking process. A patient’s health status, presenting complaints, income, health insurance coverage, and health insurer’s utilization controls, in

addition to the physician’s experience, practice

style, repertoire of skills, and available equipment

may be equally if not more important in influencing both the clinical and business decisions of

the physician. These decisions include choices

among particular physician services, choices with

respect to the volume of services provided to

Medicare beneficiaries, and choices with respect

to physician participation in the Medicare program on an assigned basis.

Physicians as Entrepreneurs:

Accepting Assignment

Two basic entrepreneurial decisions that physicians must make with respect to the Medicare

program are: 1) whether to accept Medicare beneficiaries as patients and bill the program for services provided to those patients, and 2) whether

to accept assignment.8 The factors that influence

these decisions have been studied, and some significant factors identified, in studies using an economic model of the physician as entrepreneur

based on the assumption that the physician is a

discriminating monopolist’ (184,188,317,357,402).

There is little question about the effects of

changes in approved charges on physician participation in the Medicare program. The higher

the ratio of approved charges to billed charges,

the more likely a physician is to accept assignment for Medicare patients. The higher that ratio, the more services will be provided to Medicare patients per capita and the greater will be the

number of individual Medicare patients treated

‘Since the passage of the Deficit Reduction Act of 1984, all physicians who provide services to Medicare beneficiaries have been

asked to make an annual election either: 1 ) to become a Medicare

participating physician and accept assignment for all Medicare

claims, or 2) to retain the option of accepting or rejecting assignment on a case-by-case basis.

‘Strictly defined, a monopolist is the only seller of a particular

good or service in a particular market. A seller who can influence

(raise) the final market price due to control over a substantial portion of the total volume of a particular commodity or service has

a substantial degree of monopoly power. A monopolist who can

maintain different prices for different consumers is a discriminating monopolist.
50 • Payment for Physician Services: Strategies for Medicare

by that physician. The estimated relationships

have been consistent and positive. The estimates

of physician responsiveness to Medicare’s relative

allowances have clustered around the value of 0.7

(293), implying that for a 10-percent increase in

the ratio of approved to billed charges, there

would be an increase of 7 percent in assignment.

With respect to the influence of approved charges

on the decision to become a Medicare participating physician, one would expect participating

physicians to be comparable to physicians who

exhibited high assignment rates prior to the participating physician program (317). Early evidence

suggests that those physicians who did elect to

“participate” had relatively high assignment rates

prior to the initiation of that program (15). An

initial study of participating physicians showed,

in fact, that previous assignment rates and the percentage of the usual fee reimbursed by Medicare

were the most important economic variables associated with the decision to participate (94).

In all likelihood, modification of CPR or conversion of Medicare physician payments from

CPR to some other system would result in increases in approved charges for some physicians

for some services and might result in decreases

for others. Therefore, one would expect a decrease

in the probability of assignment being accepted

in those instances where approved charges were

reduced and an increase where approved charges

were raised. (Similarly, one would expect an increase in the probability that a physician would

become a “participating physician” if his or her

allowed charges had been increased. ) The individual effects on specific physicians would depend

on their approved charges in aggregate under CPR

relative to those of their peers.

The financial effects of changes in physicians’

allowed charges on individual beneficiaries would

depend on the constellation of physicians providing services and the individual services provided

in treatment. Given both increases and decreases

in approved charges, one would expect both decreases and increases, respectively, in nonassigned

liabilities and increases and decreases, respectively, in beneficiary cost-sharing liabilities. For

example, a beneficiary whose physician experiences an increase in approved charges would be

more likely than otherwise to have that physician

accept assignment, thereby reducing the expected

nonassigned liability. At the same time, however,

that beneficiary would face an increase in coinsurance liability equal to 20 percent of the increase

in the allowed charge. The net financial effect on

any one beneficiary would depend on his or her

physicians’ combined assignment/participation

behaviors and changes in allowed charges.

Changes in the quality of care received by beneficiaries can also be expected to accompany the

financial changes occasioned by physician decisions on assignment. In response to any net increases in out-of-pocket liabilities, Medicare beneficiaries may choose to forgo the use of some

physician services. For some beneficiaries, such

a change might actually result in an increase in

quality through the reduction in the probability

of receipt of some physician services that are inappropriate to the patient’s condition. On the

other hand, the provision of otherwise appropriate services might also be reduced, and the probability of receipt of appropriate services that are

not currently being provided might also decline.

For poor patients, a reduction in care would be

likely to have an adverse effect on their health

(194).

Quality of care might also be affected if patient

choice among physicians were to be restricted because of physician decisions about assignment. If

it were the case that those physicians who provided relatively high quality experienced the greatest reductions in allowed charges, the beneficiaries’

out-of-pocket costs for securing access to those

physicians would be expected to exhibit greater

than average increases. If those physicians’ patients switched to other sources of care, quality

might decline. However, there is no evidence associating physician quality and the level of allowed

charges. Further, there is some evidence that patients will not switch providers in response to

changes in out-of-pocket costs (288).

A Medicare physician payment reform that is

designed to reduce Medicare program expenditures probably will result in increased beneficiary liabilities as long as the case-by-case assignment choice remains an option for physicians and

as long as there exists a private market for physi-
.

Ch. 2—Physician Payment Under the Medicare Program: Problems and Changing Context . 51

cians’ services. A net decrease in average allowed

charges can be expected to lead to reductions in

assignment by nonparticipating physicians and reductions in the numbers of physicians who elect

to become participating physicians.

The participating physician concept has modified physicians’ options with respect to assignment. One can infer, however, that the participating physician decision is analogous to the

case-by-case assignment decision (15), an inference that appears to be confirmed in a study using

American Medical Association survey data (94).

Data from the Medicare carriers indicate that assignment rates for all claims have increased under the participating physician program (537). A

study based on physician survey data from five

specialties suggested that net assignment rates for

physician visits would decline with respect to a

possible “all or none”10 assignment system (317).

The Effect of Relative Prices

on Technology Choices

If one assumes that a physician has made the

decision to accept Medicare patients on either an

assigned or unassigned basis, in effect, an array

of relative expected payments available for specific services is established in advance. That is,

the physician can know that he or she may expect to receive $16 from Medicare and $4 from

the patient for an assigned office visit, for example, or $48 from Medicare and $52 from the patient for an unassigned sigmoidoscopy. At that

point, one might begin to ask about the impact

of such price differences.

In theory, in addition to factors specific to the

patient, the patient’s health insurance, the patient’s

physician, and the physician’s practice, relative

prices can influence physicians’ clinical decisions.

Specifically, one can identify two types of clinical choices where relative prices may make a difference: 1) choices between two services that are

substitutes for one another, and 2) choices among

services that may be complements.

10Under an “all or none” system, a physician would have to choose

between accepting assignment on all Medicare claims versus not being able to accept assignment on any Medicare claims. The current

system might be described as “all or some. ”

The choice between substitutes is usually illustrated by the classic distinction between medical

and surgical treatments for a particular disease.

In fact, there may actually be more than two treatments that can be substitutes as in the case of (surgical) Open nephrolithotorny, (catheter-based) percutaneous nephrolithotomy, and extracorporeal

shock wave lithotripsy (ESWL) for the treatment

of kidney stones. An alternative type of substitution may occur if the physician has the option

of delegating the performance of a particular diagnostic test, for example, to an assistant. Similarly,

the physician may substitute time spent in performing specialized diagnostic tests, such as endoscopies, for his or her own direct patient contact time. The distinction between substitutes and

complements may become blurred at this point,

and discerning actual choices from billing records

becomes especially difficult. Although it may involve a complementary service, when physicians

choose to perform endoscopies or other diagnostic tests by themselves, they are substituting time

with one patient for time that might have been

spent with another patient.

When would relative price make a difference?

Where there are clear medical indications of the

advantage of one technology over another or clear

contraindications against one choice, price may

not matter much to the physician. Differences in

net revenues to the physician would be more likely

to influence medical decisions for which the medically and ethically correct decision is unclear

(194). The relevant comparison with respect to

net revenues involves not only the net revenues

anticipated from the particular services that may

be substitutes for the patient in question, but the

opportunity costs of providing services to another

patient. For example, although a physician might

receive a greater net revenue from Medicare for

providing a limited11 office visit rather than a brief

11The manuel of Current Procedural Terminology, 4th ed. (CP’T-4)

defines a limited service as follows, ”a limited level of service is one

pertaining to the evaluation of a circumscribed acute illness or to

the periodic re-evaluation of a problem including an interval history and examination, the review of effectiveness of past medical

management, the ordering and evaluation of appropriate diagnostic tests, the adjustment of therapeutic management as indicated,

and the discussion of findings and/or medical management” (85).

Brief involves “a level of service pertaining to the evaluation and

treatment of a condition requiring only an abbreviated history and

examination .“

56-119 0 - 86 - 3 : QL 3
52 • Payment for Physician Services: Strategies for Medicare

office visit to a Medicare beneficiary, that physician might choose to provide the brief visit if still

greater net revenues were available for providing services to patients with insurance that provide higher payments than Medicare.

The effects of relative prices on treatment

choices, however, have not been studied empirically. This situation is partly a result of data limitations, but it also derives from the difficulty in

empirically framing the question for analysis.

Finding specific examples where a sufficient number of individual physicians face a particular

choice among substitute services involving comparable patients but with differing relative payment levels is not easy.

Several authors have speculated on the potential effects of relative revenue differences involving services that may be viewed as complements

to office visits (4,424). Schroeder and Showstack

note that the per physician net incomes of a group

practice that performed eight specific diagnostic

tests in the practice would be nearly three times

greater than that of a physician in a solo practice

in which virtually no diagnostic testing was performed by the physician in the office even though

each physician in the group practice might see

fewer patients than the solo physician (424). In

the case of a Medicare beneficiary whose coinsurance and deductible were covered by a private

supplemental insurance policy, the additional cost

to the patient of an endoscopic exam might be

negligible, but the increase in revenue to the physician who complements the patient’s treatment

with that exam may be several hundred dollars.

Because the information provided by the test may

be useful and the time required to perform the test

is relatively short (423), the incentive to perform

the test may be nearly irresistible.

Is There Too Much Service

With Fee for Service?

One issue that should be addressed at this point

involves the incentives faced by physicians under a fee-for-service payment system. In one sense,

fee-for-service incentives are volume increasing

because the physician can receive an extra payment for each extra service performed and billed.

The gross price per service alone, however, will

not establish a positive incentive. Any incentive

will depend on the available revenue per service

net of cost. If, for example, a physician can spend

the same amount of time to administer an injection of pneumococcal vaccine or prescribe a drug,

and if the additional cost to the physician for the

vaccine is $5 with no appreciable additional cost

for a prescription pad, a positive incentive exists

to prescribe rather than to inject even if the payment for the injection is $10 and that of the visit

with a prescription is $6.

One might argue, however, that physicians behave as if virtually all their costs were fixed; ’z

hence gross payment levels do indicate incentives.

Physician obligations for employee salaries, space

and equipment, insurance, and transportation

may be considered by physicians to be fixed annually, and those obligations may represent 70

to 90 percent of all office expenses (355,391). Further, since total physician office costs are approximately 40 percent of gross professional revenues,

most services may appear to yield profits and

hence embody an incentive to provide more. This

argument assumes, however, that physician time

is of no value in and of itself. When the alternative revenues that a physician might generate with

his or her time, the opportunity costs, are included

in the calculation of costs, incentives for greater

amounts of service exist only when net payments

exceed those opportunity costs. From this perspective, any incentives would be a function of the

level of payment in addition to the method through

which that payment level is derived.

In one sense, Medicare payments may be too

high for some services. They may be too high in

general. For example, nearly one claim in five is

paid at or below the level of the physicians’ customary charges (535). Because a physician will be

paid the lower of the billed charge or the customary (or prevailing) charge, one would expect billed

charges to exceed customary charges if approved

charges were consistently too low. Lower approved charges within the context of a fee-for12Fixed costs are those costs that do not vary as output varies.

Most overhead costs can be considered fixed costs. Although a policy

for professional liability insurance may subsequently be canceled,

a physician’s expenditures for such insurance are fixed at rates established annually. Some office overhead expenditures, e.g., heat or

electricity, however, are not fixed, since they will cease to be incurred if the physician does not have his or her office in operation.
Ch. 2—Physician Payment Under the Medicare Program: Problems and Changing Context Ž 53

service, therefore, might retain beneficiary access

to physician services in addition to reducing some

inappropriate incentives to provide too much

service.

Volume Responses and

Induced Demand

The additional possibilities of providing physician services that in some sense are complements

to treatment lead to the issue of changes in the

aggregate volume of physician services in response

to changes in allowed charges. In a market economy, most suppliers would respond to a decrease

in prices paid for their goods and services by reducing the quantity they were willing to sell. One

might believe, therefore, that reductions in approved charges for physicians services would lead

to reductions in Medicare expenditures for those

services, even if there were no reduction in the

volume of services provided. In fact, one might

believe that a reduction in approved charges by

Medicare would lead to a reduction in the number of services provided by physicians to beneficiaries, reducing expenditures by an even greater

amount. However, in response to changes in approved charges, beneficiaries and physicians may

appear to change their behaviors in ways that increase service volumes. For example, in response

to a decrease in approved charges some patients

might want to increase their purchases of physician services. If, in addition, physicians can control service volumes, an alternative approach to

payment “reform based solely on reductions in allowed charges may be needed to control increases

in expenditures,

The question of whether physicians in particular can influence the use of their services and hence

frustrate cost control efforts based solely on controls on fees is one of a number of issues included

under the topic of iatrogenic- or supplier-induced

demand. The possibility that physicians might induce demand for their services has been the subject of empirical studies since as early as the late

1960s (389). In particular, studies of cases where

public health insurance programs have reduced

or frozen physician fees have suggested that such

efforts have not controlled costs (158).

Unfortunately, none of the studies unequivocally proves or disproves the magnitude or even

the existence of induced demand. For example,

a study of California physicians’ billings to Medicare during the period of the Economic Stabilization Program, found that in spite of the fee

freeze overall costs rose substantially because

there was an increase in the volume of services

provided to Medicare beneficiaries (215). This result is often cited as evidence that even if price

controls do control price, they do not control expenditures. However, an alternative explanation

for the increase in Medicare volume during the

Economic Stabilization Program can be found in

the well-established positive relation between

Medicare participation and allowed charges. The

Economic Stabilization Program was instituted in

August 1971, 1 month after Medicare approved

charges had been increased for fee screen year

1972 and 5 months prior to the (January) period

typically exhibiting the largest increases in physicians charges. As a result, Medicare approved

charges relative to private market payments were

frozen at a level typically higher than that of any

other time of the year. Given that physician participation in the Medicare program has been found

to be positively related to the ratio of approved

charges to billed charges, one would have expected physicians to increase the volume of services provided to Medicare patients.

If not resolved, the current debate on this issue only simmers. There appears to be some physician volume response to reductions in physician

prices. Quebec’s experience indicates that fee controls can be effective in reducing the rate of growth

in physician expenditures, in spite of some volume increases (28). If the volume response is perceived as potentially vitiating the desired effect

of physician payment reform, an initial step might

be to monitor volume changes to ascertain the

need, if any, for additional controls.

Cost-Shifting

One other potential physician response to reductions in Medicare approved charges is that

physicians might raise their non-Medicare charges,

a form of “cost-shifting. ” However, if non-Medi-
54 ● Payment for Physician Services: Strategies for Medicare

care patients are responsive to price, i.e., if their

willingness to purchase physician services is reduced when prices increase, rational physicians

would reduce their charges to non-Medicare patients rather than increase them in response to reductions in approved charges (188,357). It may

well be the case that physicians may choose not

to participate in the Medicare program if payments are reduced to levels significantly below

those of the non-Medicare market, but there is

no theoretical or empirical evidence for physicians’ cost shifting.

It is possible that some physicians might appear

to provide greater quantities of service to their

non-Medicare patients as an additional response

to reductions in Medicare approved charges. This

might also be perceived as “cost-shifting. ” However, other things being equal, if non-Medicare

patients are responsive to price, there should be

no net increase in physician service volumes to

those patients unless there is a decrease in average fees char@ to those patients. Alternatively,

if some physicians elect to serve fewer Medicare

patients in response to a decrease in Medicare approved charges, there might be a reduction in appointment delays or office waiting times, This decrease in the “time price” might then be followed

by an increase in demand for services by those

physicians’ non-Medicare patients.

ISSUES WITH RESPECT TO MEDICARE’S

PHYSICIAN PAYMENT SYSTEM

Then HCFA Administrator Leonard Schaefer

enunciated the basic missions of HCFA in 1979

(508):

● to promote the timely, cost-effective delivery of appropriate, quality health care services to its beneficiaries;

• to make beneficiaries aware of the services

for which they are eligible, and to make those

services accessible to them in the most effective manner; and

. to ensure that its policies and actions promote

efficiency and quality within the total health

delivery system which serves all Americans.

This mission statement can provide the basic

starting point in examining whether Medicare’s

physician payment systems foster or hinder the

achievement of those objectives. As might be expected, however, it is easier to raise the issues than

to resolve them. As reviewed above, Medicare expenditures for physician services have continued

to increase, but until 1982, Medicare increases

were roughly in concert with those observed in

all U.S. expenditures for physician services. There

are perceived excessive variations in such aspects

of Medicare physician services as payment levels,

assignment rates (and hence effective financial

coverage), and utilization of services. Such variations are consistent with problems in quality, access, cost and/or efficiency, but one would also

expect to observe even some substantial variations

in a national program serving more than 30 million beneficiaries in thousands of local markets.

Although many observers conclude that the variations are too great not to reflect a particular

problem of interest, there is little or no consensus about whether the variations signify actual

problems.

Although the many perceived variations in the

Part B program may not unequivocally indicate

the presence of problems, there seems to be no

question that such variations have led to confusion on the part of both the beneficiaries and the

providers. In addition, health insurance coverage,

which insulates patients and providers from health

care costs, and the design of the Medicare benefit package itself do not provide incentives for efficiency. Confusion and inefficiency are the first issues reviewed below. Following that discussion,

the magnitudes of the potential problem variations

are addressed. Potential problems include:

●

●

●

variations in annual expenditures per beneficiary;

variations related to assignment; and

payment level variations with respect to geographic areas, physician specialties, and

place, type, and vintage of service.
Ch. 2—Physician Payment Under the Medicare Program: Problems and Changing Context • 55

Some variations that might be expected, such

as those due to quantity discounts, for Medicare

as a large payer, are not evident, and some variations are either exacerbated or moderated by the

MEI. These potential problem areas are reviewed

in light of what is known about plausible levels

of variations in payments and expenditures that

might be expected in the Medicare program.

Beneficiary and Provider Confusion

The CPR method of determining approved

charges, the possibility of case-by-case assignment

choice by physicians, and even the existence of

the Part B deductible itself all contribute to confusion about payments among both beneficiaries

and providers. An Administrator of HCFA once

noted, “We get something like 9 million letters a

year on reimbursement, most simply wanting to

know how the payment was arrived at” (98). Even

with the Medicare participating physician program initiated under the Deficit Reduction Act of

1984 (Public Law 98-369), it is rarely straightforward for a Medicare beneficiary to establish in

advance his or her out-of-pocket liability for covered Part B services.

Because CPR in effect establishes a separate fee

schedule for each physician practice, the approved

charge for a specific procedure may vary widely

within a given locality. Hence, there will be variations in beneficiary coinsurance liability for a

specific service regardless of assignment. Further,

some physicians may not be able to recall their

Medicare approved charges when they recommend to the patient that a specific service be rendered, and when they refer a patient to another

physician for a specialized service, they may not

know all of the services that that physician may

render, much less the charges for those services.

In that case those physicians may not be able to

tell patients what their expected out-of-pocket cost

will be. Finally, for some infrequently performed

procedures rendered near the beginning of a fee

screen year, an approved charge for the procedure may not have been calculated for the physician practice. Neither the beneficiary nor the physician would then know the level of the approved

charge until after a bill for the service had been

submitted.

Under Medicare’s participating physician program, a significant proportion of practices have

agreed to accept assignment on all claims. There

are also directories available at the offices of the

carriers that identify those practices. Unfortunately, because some physicians may have more

than one practice and may not have elected to

“participate” in each practice, the directories are

not a perfect guide to 100-percent” assigned practices (231).

With respect to the providers, there are many

situations in which a physician will not know how

much he or she will be paid for treating a Medicare beneficiary. Prior to the implementation of

the freeze, at the beginning of a fee screen year

a physician would be likely to learn of that year’s

allowed charges only as reimbursements were received for services rendered in the new fee screen

year. A physician could request information on

those new approved charges from the carrier, but

there was no organized information dissemination of approved charges to physicians from the

carriers. However, even where the approved

charges are known, those charges are not reimbursed by the carriers for patients who have not

yet satisfied the Medicare deductible. Further, the

deductible is assessed as of date of payment, not

date of service. If a Medicare beneficiary received

$75 of physician services on a nonassigned basis

in January but did not file those claims until after receiving $75 of assigned physician services in

March, the assigned services would be applied to

the deductible and hence would not result in a

payment from the carrier. Even though the patient may have indicated that he or she had already met the deductible, the physician who accepted assignment in this example would have to

collect those charges from the beneficiary.

Finally, provisions regarding elderly beneficiaries who are employed may also lead to uncertainty for providers. Medicare is not the primary

payer for aged beneficiaries below age 70 who are

covered by employer-offered health insurance

plans. As a result, a physician who treats such

a Medicare patient may find that the charge approved by the patient’s insurer is not the same as

the Medicare allowed charge. In addition, if the

physician had accepted assignment and submitted

a bill to the Medicare carrier, Medicare might
56 ● Payment for Physician Services: Strategies for Medicare

deny payment of the bill unless it had been first

presented to the third-party carrier of the patient’s

employer.

Inefficiencies in the Delivery

of Medical Care

In addition to improving people’s ability to obtain medical care, health insurance affects people’s decisions about using services and providers’

decisions about purchasing and using technologies

(343). Compared to those who pay for care out

of pocket, cost is less of a deterrent to insured persons’ decisions to seek care and to choose costly

providers and technologies. Similarly, consideration of insured patients’ finances is less of a concern to physicians and other providers who buy

and use medical technologies. Thus, one would

expect to observe Medicare beneficiaries demanding greater volumes of covered physician services

at any price level than would be strictly cost effective. Further, this is more likely to be the case

for those beneficiaries who: 1) receive services under cavitation without copayment, or 2) have obtained supplemental insurance that pays for the

Medicare deductible and coinsurance. Under feefor-service payment, in those cases where net revenues are increased by the increased provision of

care, providers’ financial incentives reinforce the

beneficiaries’ enhanced demand for services. Under cavitation, net revenues are diminished by the

increased provision of care; hence, the incentives

regarding use for beneficiaries conflict with the

incentives for those who receive the cavitation

payments.

The Medicare benefit package may also contribute to inefficiency in the provision of physician services. Although providers render much

preventive care to Medicare beneficiaries in the

course of visits, many preventive services, such

as physical examinations and influenza vaccinations, and some rehabilitative services, such as

hearing aids, are not officially included under

Medicare coverage. Exceptions are pneumococcal vaccination, which is covered for all beneficiaries, and hepatitis B vaccine, which is covered

for end-stage renal disease patients and other categories of beneficiaries at high or intermediate risk

of contracting hepatitis B (89). Beneficiaries are

liable for the total charges of services not covered

by Medicare, and might be expected to use less

of such services than might be recommended on

strictly medical or cost-effective grounds. On the

other hand, legislation (the Omnibus Reconciliation Act of 1980, Public Law 96-499) has eliminated beneficiary cost-sharing in certain cases to

encourage the use of less costly alternatives. For

example, beneficiaries are liable for no deductibles or coinsurance for certain surgery performed

in ambulatory surgical centers.

The result from these design decisions would

be expected to be inefficiency (higher cost for a

given level of quality) in the provision of particular technologies and in the combination of technologies used for a given medical condition. For

example, duplicative laboratory tests may be performed, diagnostic and therapeutic equipment and

facilities may be used far below capacity, and the

more expensive and hazardous hospital setting

may be used when ambulatory care would be Just

as effective (483).

Variations in Annual

per Beneficiary

Expenditures

There is more than a twofold variation in reimbursements per Medicare enrollee across the 50

States. In 1982, for example, Medicare reimbursements for physician and other Part B medical services on behalf of aged beneficiaries in the United

States averaged $517.93 per enrollee. In Nevada,

however, the average was $842.29, while in West

Virginia, the average was $305.15 per enrollee.

The western census region as a whole averaged

$654.40, nearly 40 percent greater than the southern census region at $468 (525).

Although not necessarily indicative of problems, there are also variations by age, gender, and

race. As might be expected, Medicare reimbursements per enrollee increase as the age of the enrollee cohort increases. In 1978, average reimbursements per enrollee for physician services for

aged Medicare eligibles averaged $197. For the age

65 to 69 cohort, the average was $152; for those

aged 85 and over, the average was $259. During

that same year, reimbursements on behalf of male

beneficiaries were $214 compared to $186 for fe-
Ch. 2—Physician Payment Under the Medicare Program: Problems and Changing Context • 57

males. This disparity widened over the 1975 to

1978 period. Average reimbursements for white

beneficiaries were $201 in 1978, compared to an

average of $153 for nonwhite beneficiaries. (There

was no obvious trend in this relation over the 1975

to 1978 time period (297). )

Part of the regional variation in Medicare expenditures per beneficiary is due to the variation

in the proportion of beneficiaries who exceed the

Medicare deductible—and who are thus eligible

for reimbursements. ’3 In 1982, 65.6 percent of

both the aged and the disabled populations exceeded the deductible. In Rhode Island, however,

78 percent of the aged beneficiaries exceeded the

deductible, while only 54.7 percent of Kentucky’s

aged beneficiaries exceeded the deductible. (There

are no marked disparities in any State between

aged and disabled Medicare populations in terms

of the percentages exceeding the deductible. )

One other factor that contributes to the variation in expenditures per beneficiary involves differences in the apparent relative stringency of the

reasonable charge process. In the first quarter of

1985, 17.4 percent of physician claims were submitted with charges at or below the effective approved charge limits. Of the remaining 82.6 percent of claims, the average reduction per claim

was $32.84. As a result, Medicare’s approved

charges in aggregate were 74.5 percent of the total submitted charges. The differences in these statistics among carriers are striking. For example,

Maryland Blue Shield reduced only 48.7 percent

of claims, while 91.6 percent of Hawaii’s claims

were subject to reductions by its carrier, Aetna.

The average reduction per claim for that time

period was $19.98 in Vermont, but $44.49 in Nevada. Finally, allowed charges were 80.8 percent

of total covered charges in Kentucky, but only

66.2 percent of total covered charges in Rhode Island (535). Thus, a Kentucky beneficiary with a

nonassigned claim for $100 might expect to have

to pay $33.36 out-of-pocket charges, while a

Rhode Island beneficiary with a comparable claim

might have to pay $47.04, 41 percent more.

13This in turn is due to variations in patient health and in both

the level of allowed charges and service volume. Patients who do

not initiate visits to physicians or patients with either very inexpensive doctors and/or medically very conservative doctors may

not exceed the deductible.

Variations Related to Assignment

There is substantial variation in assignment

rates across the United States. Assignment rates

nationally declined from 1969 through 1977, but

they have increased since that time reaching 59

percent of claims and 59.6 percent of charges in

1984. ’4 In 1982, when assignment was accepted

on 51.8 percent of charges for the aged, assignment rates for elderly people increased as the age

of the cohort increased, ranging from 47.3 percent for the age 65 to 69 cohort to 61.1 percent

for those aged 85 or above. Assignment rates

among female beneficiaries exceeded those of

males, 52.6 percent compared to 50.6, and nonwhite beneficiaries exhibited higher assignment

rates than whites, 79.9 percent compared to 49.3.

Assignment rates for disabled beneficiaries exceeded those for aged beneficiaries. Within the disabled population, rates for females were greater

than for males, and rates for nonwhites were

greater than those of whites. Assignment rates for

the youngest cohorts of disabled beneficiaries were

the greatest at 88.7 percent for those younger than

age 25 compared to 66.6 percent for those aged

45 to 64. Across the States in 1982, the rates for

the aged ranged from 87 percent in Rhode Island

to a low of 17 percent in South Dakota. Assignment rates for most major physician specialties

ranged from 40 for otolaryngologists to 54.7 percent for cardiologists with most specialties at less

than 50 percent (296).

In fiscal year 1985, the first year of the participating physician program, 29.8 percent of the

physician practices that provided services to Medicare beneficiaries elected to participate. Across the

States, the percentage of participating physician

practices ranged from a high of 53.9 percent in

Alabama to a low of 5.6 percent of the practices

in South Dakota. With respect to physician specialties with substantial Medicare volumes, 21.1

percent of anesthesiology practices elected to participate compared to 50.8 percent of the nephrologists. Of 17 distinct physician specialties reported

by HCFA, 11 exhibited participation rates between 25 and 35 percent (518). (Early tabulations

14Unless otherwise noted, these and subsquent statistics on assignment include the mandatorily assigned c aims of beneficiaries 7

who are entitled to both Medicare and Medicaid coverage.
58 ● Payment for Physician Services: Strategies for Medicare

from the second year of the program indicate that

15.3 percent of the participating practices of physicians, osteopaths, and limited license practitioners from fiscal year 1985 did not continue their

participation into fiscal year 1986, although 13,718

new agreements were submitted. As a result, the

aggregate participation rate for physicians, osteopaths, and limited license practitioners dropped

from 30.4 to 28.4 percent (521). )

Because of the assignment option, differences

in the proportion of total charges that are approved yield differences in beneficiaries’ out-ofpocket liabilities for covered services. In the first

quarter of 1985, 81,6 percent of assigned claims

were subject to reductions averaging $32.48 per

claim, as a result of which 73.5 percent of total

covered charges were allowed. Of nonassigned

claims, 84.7 percent were subject to reductions,

which averaged $32.84 per claim, yielding approved charges equal on average to 74.5 percent

of total covered charges (535). Therefore, for

claims that were subject to CPR reductions, expected beneficiary out-of-pocket cost was $18.02

for the average assigned claim. Adding an average coinsurance of $19.19 to the nonassigned liability of $32.84, the expected beneficiary out-ofpocket on an unassigned claim was $52.03 (see

table 2-10).

Historically the differences in the statistics between assigned and nonassigned claims have been

small. Although a slightly higher percentage of

nonassigned claims have been subject to reductions, the reductions on assigned claims have been

somewhat greater both in absolute and percentage terms, Within the class of nonassigned claims,

however, differences in the effective stringency

of the reasonable charge process across carriers

directly lead to differences in beneficiary liability. In dollar terms, the average reduction on

nonassigned claims is exactly equal to beneficiary average nonassigned liability per nonassigned

claim. Although the average for the country was

$32.84 per claim in the first quarter of 1985, in

Maine, the average nonassigned liability per claim

was $17.37, while in the Minneapolis, Minnesota,

region served by Travelers, this liability was

$56.38 per claim (535).

One might expect that beneficiaries would appear to react to these variations in nonassigned

liability with more searching for doctors who accept assignment in those areas where average

nonassigned claims were relatively expensive in

terms of beneficiary out-of-pocket costs. This does

not appear to be the case, however. There is little obvious positive correlation between assignment rates and average nonassigned liability per

claim. In fact, in the carrier data reported to

HCFA one can observe a slight negative correlation. 15

Some evidence consistent with searching for assignment can be seen in the variations in assign15In the first quarter of 1982, the correlation between average nonassigned liability per claim and the assignment rate by carrier was

–0.26. Possibly due to the increase in assignment rates concomitant with the participating physician program, the negative correlation between average nonassigned liability per claim and the assignment rate by carrier has been reduced. In the first quarter of

1985, this correlation was –0.12.

Table 2.10.—Medicare Reasonable Charge Reductions per Claim,

January-March, 1985

Type of claim

Assigned Unassigned

Average billed charge . . . . . . . $122.35 $128.93

Percent of claims reduced . . . 81.60/0 84.70/o

Percentage reduction . . . . . . . . 26.50/o 25.50/o

Average CPR reduction . . . . . . (26.5°/0 x $122.35) $32.48 (25.50/o X $128.93) $32.84

Average approved charge . . . . ($122.35 – 32.48) $89.87 ($128.93 - $32.84) $96.09

Medicare payment . . . . . . . . . . (80°/0 x $89.97) $71.90 (800/0 X $96.09) $76.87

Beneficiary coinsurance . . . . . (20°/0 x $89.97) $ 17.97 (200/0 X $96.09) $ 19.22

Nonassigned liability . . . . . . . . $ 0.0 0 $32.84

Total beneficiary cost . . . . . . . $ 17.97 ($19.22 + $32.84) $52.06

SOURCE: U S, Department of Health and Human Services, Health Care Financing Administration, Bureau of Quality Control,

Carrier Reasonable Charge and Denial Activity Report January-March 1985 (Washington, DC: U S Government Prtnting Office 1985)
Ch. 2—Physician Payment Under the Medicare Program: Problems and Changing Context Ž 59

ment rates by annual charges per user. In 1978,

assignment was accepted on 44.6 percent of total

physician charges. For those aged patients with

charges less than $100, the assignment rate was

30.3 percent. For those with charges between $100

and $149, the rate was 27.9 percent. For those

with annual charges in excess of $149, however,

as annual charges increased, assignment rates increased. The maximum average assignment rates

were 52 percent for those beneficiaries with annual charges in excess of $2,500. This general pattern is consistent by specialty and holds for both

the aged and disabled populations (297). These

data are also consistent with the “big bill” hypothesis that physicians accept assignment more readily for services with high charges, accepting the

Medicare approved charge with certainty rather

than risk the possibility of incurring a relatively

large bad debt. In 1981, with respect to those “big

bills” with submitted charges in excess of $200,

assigned charges were 52.9 percent of total submitted charges. For bills of $200 or less, assigned

charges were 47.6 percent of the total (69).

The assignment option probably exists in Medicare because Blue Shield Plans in the mid-1960s

had participating physician options under which,

for some patients, a physician would agree to accept as payment in full a fee that was below his

or her usual charge for a particular service. A beneficiary who receives an assigned service from a

particular physician has therefore received a discount from that physician’s otherwise standard

fee. From this perspective there is no correct or

best level of assignment. A beneficiary who received all physician services on assignment is not

necessarily better off than another beneficiary

who received the same services from another physician with no services provided on assignment.

The out-of-pocket costs of the first beneficiary

could be higher than those of the second. Other

things being equal, assignment can mean reduced

out-of-pocket liabilities and hence reduced financial barriers to care. Assignment rates may thus

be interpreted as imperfect indicators of beneficiary access to care, with higher assignment rates

presumed to reflect better access. There is no evidence, however, that there are particular groups

of Medicare beneficiaries who could not obtain

access to needed physician services included in the

Medicare benefit package.

Perceived Payment Imbalances

In addition to aggregate and per capita variations in expenditures and out-of-pocket liabilities,

there are also significant variations in approved

charges for specific services, i.e., individual fees.

There are variations across States, across geographic areas within States, and across the physician specialties regardless of State. Variations

have also been observed by site of service, by the

type of service, by the vintage of the service, and

by the apparent relative effective stringency of the

MEI.

By design, the legislation establishing the Medicare program did not mandate a national fee

schedule for physician services, and the CPR system was at least partly adopted to allow recognition of local differences in charge levels. The observed ranges in approved charges, however,

suggest to some that there is excessive variation

in charges. Further, the variation in charges is not

random. As a result, the incentive effects of Medicare’s physician reimbursements may not be in

concert with other public policy objectives.

Geographic Variations

For Medicare Part B payment purposes, the

country is currently divided into 240 localities.

In 18 States, the entire State is a locality; in the

remaining States, there are two or more localities. Texas has the greatest number of localities

with 32, California has 28, and Illinois has 16

(515). Although multiple localities may be identified and used to partition physician claims for

the purposes of establishing prevailing charges and

determining approved charges, it should be noted

that not every procedure will have a prevailing

charge established on a locality-specific basis.

Relatively low-volume procedures may have a

state- or carrier-wide prevailing charge even in

some States with more than one locality.

Medicare carriers were given the responsibility to identify localities in the original Medicare

legislation, The Social Security Act, however, was

permissive in that it did not require that a carrier

identify two or more localities. The original guidelines indicated that localities were to embody substantial, relatively homogeneous, but not necessarily contiguous geographic areas. Homogeneous
60 ● Payment for physician Services: Strategies for Medicare

but relatively small jurisdictions, such as particular neighborhoods, were not to be identified as

distinct localities for payment purposes. Subsequent instructions to the carriers required HCFA

permission to change the number of localities

within any carrier jurisdiction. In recent years,

many carriers have consolidated two or more localities.

Interarea Variations. —The range across localities in charges for specific services is substantial.

Data from HCFA for fee screen year 1980 reveal

that the highest prevailing charge for a brief followup hospital visit exceeded the lowest by 373

percent. For extraction of lens the “excess” was

159 percent. For electrosection of the prostate,

hysterectomy, and single view chest X-rays, respectively, comparable differences were estimated

as 197, 143, and 536 percent (see table 2-11).

Four-, five-, and six-fold differences in prevailing charges in 1980 were not aberrations. Data

from fee screen years 1976 through 1980 show

those differences as datively constant over time.

A study of Medicare prevailing charge data from

1975 for a selection of surgeries also showed the

same range of results (50). In addition, that review examined whether those variations could be

explained by differences in cost of living, malpractice premiums, quality of care, or relative physician shortages. The findings of the study were that

cost-of-living adjusted fees still showed three-fold

variation; that neither quality differences nor malpractice expense differences could explain the variation; and that relative physician shortage areas

exhibited lower rather than higher fees as might

have been anticipated.

Intrastate Variations. —Within those States

where carriers had established more than one locality, variations in prevailing charges between

the highest charge and lowest charge localities

have been commonly observed to exceed so percent (494). In general this reflects urban/rural payment level disparities. A 1976 study showed that

Medicare payment levels in urban areas exceeded

those in rural areas by 23 percent (421). After adjustment for cost-of-living differences, Medicare

prevailing charges in the largest standard metropolitan statistical areas in 1975 averaged 17 percent above the national average, while those in

the counties with the lowest populations averaged

8 percent below (494). If payment level differences

exceed differences in physicians’ costs of practice,

these urban/rural disparities under Medicare will

tend to discourage physicians from locating in rural areas. To the extent that the Federal Government has a policy of trying to enhance access of

residents of rural areas to physician services,

Medicare’s physician reimbursement policy in this

regard is at variance with national policy.

How Much Geographic Variation Is Enough?—

There are arguments on both sides of the question of whether to have identical or varying fees

for the same service in different jurisdictions. Two

arguments for identical payment levels across

jurisdictions, such as might be produced through

the use of fee schedules, involve: 1) the potential

inappropriateness of different effective benefit

Table 2-11 .—High and Low Prevailing Charges in Localities for

Five Selected Procedures, Fee Screen Year 1980

Locality prevailing charges

Procedure High Low Range Ratio

1. Brief followup hospital visit by an

internist . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 33.10 $ 7.00 $26.10 4.73:1

2. Extraction of lens by an

ophthalmologist . . . . . . . . . . . . . . . . . . . . 1,390.70 536.50 854.20 2.59:1

3. Electrosection of prostate by a

urologist . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,410.40 475.25 935.15 2.97:1

4. Hysterectomy by an obstetrician/

gynecologist . . . . . . . . . . . . . . . . . . . . . . . 1,305.20 536.50 768.70 2.43:1

5. Chest X-ray single view by a

radiologist . . . . . . . . . . . . . . . . . . . . . . . . . 35.00 5.50 29.50 6.36:1

SOURCES: U.S. Department of Health and Human Services, Health Care Financing Administration, “Medicare Part B Charges,

Overview and Trends, Fee Screen Years, 1976-1960,” Washington, DC, Feb. 3, 1982; and U.S. Congress, Senate Committee on Finance and House Committee on Ways and Means, Background Data on Physician Reimbursement Urtder Medicare, S Pd. 98-153 (Washington, DC: U S. Government Printing Office, October 1983).
Ch. 2—Physician Payment Under the Medicare Program: Problems and Changing Context ● 61

levels for a program supported by national taxes

and beneficiary premiums that do not vary by

jurisdiction, and 2) the implicit incentives in varying payment levels that make the Medicare program nonneutral with respect to physician location choice. (In particular, it is alleged that

Medicare payments encourage new physicians to

locate in urban areas while the explicit policy of

the Department of Health and Human Services

has been to encourage physicians to locate in “undeserved,” predominantly rural areas. ) On the

other hand, two arguments for varying payment

levels involve: 1) variations in the costs of physician practices across jurisdictions, and 2) variations in what may be market-determined prices

for physician services across those areas.

National Equity, —The Medicare Part B program is a national program. It is funded primarily (about 75 percent) through general revenues

collected largely on the basis of ability to pay—

not State of residence. Beneficiary premiums for

enrolling in Part B do not vary across the country, nor is there variation in the deductible that

must be met prior to receiving reimbursements for

approved charges. Part B enrollees are eligible for

benefits regardless of their State of residence or

the State in which they may receive physician

services.

Medicare payments on behalf of beneficiaries,

however, do vary considerably. Variations in

payment levels across States and within some

States contribute to the variations in benefit payments both directly and indirectly. In particular,

compared to beneficiaries who receive physician

services in States with relatively high approved

charges, those in States with low approved charges

have to receive more physician services in order

to meet the deductible and hence qualify for reimbursement. In effect, beneficiaries who are in some

sense in equally poor health may not have equal

financial access to care through the Medicare program. Of course, beneficiaries in lower cost areas

are likely to have lower cost-sharing for a given

set of physician services.

Location Incentives. —In general, Medicare allowed charges for physician services are highest

in urban or suburban areas and lowest in rural

parts of the country (471). However, it is exactly

in those rural areas that beneficiaries may experience the most difficulty finding a source of medical care because physicians have not elected to

establish practices in those locations. Recent evidence has suggested that increasingly fewer rural

areas are without a specialist physician (344), but

there is still enough of a perceived problem of unequal access to care that Federal policy remains

committed to rectifying shortages in “underserved”

areas. Therefore, the incentive effects of Medicare

physician payment policies are in conflict with

other Federal policies with respect to the encouragement of rural practice locations.

The importance of this conflict, however, is far

from clear. Based on 1981 revenue estimates, Medicare payments to physicians represent only 17

percent of all their gross professional revenues,

ranging from a low of 1 percent for pediatricians

to a high of 35 percent for thoracic surgeons (353).

In this regard, one might want to design a system

that was “location neutral” only to certain specialties, not necessarily including those specializing in tertiary care. However, to the extent that

current levels of Medicare approved charges approximate those of the private market in individual localities for any specialty, spectacular increases in Medicare allowances would be required

to reduce any aggregate location incentives due

to differences in physician prices. Further, the empirical evidence shows that, other things being

equal, the link between market-specific physician

payment levels and location choice is weak (438).

Thus, even if Medicare prices were adjusted to

become location neutral, there would be little, if

any, effect on local physician shortages.

Differences in Practice Costs.—Although the

possibility of varying cost levels provides a plausible argument for varying payment levels, the

data on the degree of cost variation are equivocal. Average physician expenditures for practice

inputs consistently have been the highest in the

West South Central census division and lowest

in the Middle Atlantic census division (390). In

addition, average reported professional expenses

have been highest in nonmetropolitan areas, and

lowest in the largest of the metropolitan areas

(390). Unfortunately, these gross differences in expenditures may mask both differences in practice

volumes and differences in physicians’ purchasing decisions as a result of their rational entre-
62 ● Payment for Physician Services: Strategies for Medicare

preneurial responses to differences in price. For

example, other things being equal, physicians who

practice in an areas with relatively low commercial rent levels may choose to have larger offices

or more patient examining rooms. As a result,

those physicians’ expenses for office space might

be greater than, equal to, or less than those of their

counterparts in the higher rent districts. There are

no available data on the variations in the costs

of operating physician practices of equivalent size,

amenity levels, or style.

The available evidence does suggest that current Medicare variations in payment levels exceed

plausible differences in the costs of living, if not

costs of an “equivalent” practice. As a result, some

consideration might be given during implementation of any Medicare physician payment reform

to assessing the extent of some of the existing variations to verify whether any remaining variation

can be justified.

Physician Opportunity Costs. —Although practice cost differences are important, differences in

physicians’ opportunity costs need to be considered in establishing a Medicare payment policy

that must also foster the goal of assuring beneficiary access to care. Various authors have found

that physicians’ decisions with respect to Medicare program participation—either generally or

specifically on an assigned basis—are influenced

by the level of Medicare approved charges relative to the physicians’ billed charges (190,317,357).

If physicians’ private pay patients (and their insurers) are willing to pay relatively high fees regardless of—or even in excess of—differences in

practice costs, constraining variations in Medicare allowances to the levels of practice cost differences may result—in high fee areas-in fewer physicians’ either accepting Medicare patients or

accepting assignment when they do see Medicare

patients.

In fact, data from the Medicare carriers suggest that there is less variation in the degree to

which approved charges match private pay prices

than in the absolute approved charges themselves.

Physician submitted charges to Medicare have

been found to be a good estimator of private market prices even if most insurers rarely pay 100 percent of submitted charges. As a result, the ratio

of allowed charges to submitted charges, by carrier has been accepted as a measure of the degree

to which Medicare payment levels match private

market levels (215). In the first quarter of 1985,

the range in this ratio across carriers went from

a low of 66.2 percent in Rhode Island to a high

of 81.8 percent in Kentucky, For all but six carriers, the ratio of approved charges to billed

charges was between 70 and 80 percent. The national average was 73.8 percent (535). Reducing

the interstate variations in Medicare absolute approved charge levels by paying the national average would tend to increase the variation in Medicare’s “comparability” to private market physician

prices. In particular, it would reduce Medicare’s

comparability in such States as New York, Pennsylvania, Florida, Michigan, and Texas, all of

which are currently below average in terms of the

ratio of approved charges to billed. The initial impact of such a policy might well be to reduce beneficiary access to care in States with above-average ratios. One might argue, however, that if

Medicare reduced its payment levels in States with

relatively high physician prices, the private market would follow, thus bringing Medicare’s charges

back into line and ameliorating any adverse impact on physician participation in Medicare.

Are Geographic Differentials Necessary?—

Having examined the pros and cons with respect

to uniform payment levels, what can one conclude? First, a national fee determination process cannot be dismissed as a possibility for improvement. Providing uniform national benefits

to Medicare enrollees is not an unreasonable goal.

Further, the evidence on the correlation between

payment levels and the percentage of beneficiaries

meeting the deductible is consistent with effectively nonuniform insurance coverage under Medicare Part ‘!. (A Medicare beneficiary in California need not be so sick as one in Oklahoma in

order to meet the deductible and hence qualify

to receive additional reimbursements.) Eliminating geographic differentials would certainly reduce

some of the administrative complexities of the

program, and fee schedules by jurisdiction could

eliminate any confusion among beneficiaries or

physicians about what amounts Medicare will

pay. (Fee schedules by jurisdiction could eliminate all variation in approved charges within a
—

Ch. 2—Physician Payment Under the Medicare Program: Problems and Changing Context ● 63

jurisdiction. ) To a certain extent, a national fee

schedule might also make resistance to physician

price increases easier for private market payers

in relatively high cost States. Further, if there is

significant competition between private insurers

in the affected jurisdictions, the imposition of a

national fee schedule would not necessarily contribute to market-wide price increases for physician services in the relatively low cost States even

though the physicians in those States might increase submitted charges in response to the increase in Medicare payments.

On the other hand, neither a national fee schedule nor even a set of 53 statewide fee schedules

is a requirement. 16 Although it is a national program, Medicare must operate in local markets

across which the costs of operating a physician

practice—including the opportunity costs of the

physicians’ own time—are not uniform. In fact,

given that the market prices of specific physician

services differ across the country, the provision

(through those markets) of a uniform real level

of benefits to Part B enrollees would require that

different prices be paid in different jurisdictions,

(In fact, a substantial factor in the origin of the

“usual, customary, and prevailing” within Blue

Shield Plans was the demand from national purchasers, such as the automobile manufacturers,

for consistent paid-in-full benefits for members

in all parts of the country (122,312 ).) Paying the

same price for a particular service in all parts of

the country would certainly imply large interregional transfers of funds within the Medicare

program, and one would expect significant changes

in beneficiaries’ access to assigned services.

What would be useful, if not required, would

be an explicit effort to monitor the continued

justification both for maintaining the level of

differences in approved charges among jurisdictions and even for maintaining separate locality

jurisdictions. Because program administration is

eased and provider and beneficiary understanding can be improved when there are fewer rather

than more localities in any State, reducing the

number of Localities to only those with reasonable justification is a plausible goal. There may

be some negative spillover effects on assignment

16Fifty states plUS the District of Columbia, Guam, and Puerto

Rico,

rates concomitant with locality consolidation that

should be weighed in advance against anticipated

benefits .17

Specialty Variations

One other source of variation in approved

charges per unit of service is the use of specialtyspecific groupings of physician practices in implementing the CPR fee determination process. In the

1984 fee screen year, Medicare carriers established

prevailing charge limits by specialty in all areas

of the country except Florida, the area of Kansas

served by Blue Shield of Kansas, North Dakota,

South Dakota, and the area of New York served

by Blue Shield of Western New York (471). All

of the other carriers have established that there

may be some services for which approved charges

may be influenced by the specialty of the physician who performed the service.

This approach may take the form of two prevailing charge screens, one for “generalists” and

the other for “specialists.” Alternatively, separate

prevailing charge screens may be established for

each of several sets of specialties. South Carolina,

for example, has 33 prevailing charge screens, and

Pennsylvania has 58 different groups. Although

each physician’s customary charge for a particular procedure is established solely with respect to

his or her own submitted charges for that procedure, in jurisdictions that recognize more than two

specialty distinctions, two or more specialty-specific prevailing charges might be established for

the procedure. As a result, two physicians of different specialties with identical customary charges

might have different approved charges for the

same procedure.

In fact, because of physician specialization,

most of the roughly 7,000 physician procedures

will have specialty-specific prevailing charges

whether or not the carrier in question recognizes

specialty distinctions. For example, relatively few

cataract operations are performed by physicians

who are not ophthalmologists. As a result, the

“Colorado consolidated its localites into a single locality in 1976.

Assignment rates declined in each area of the State following the

consolidation, consistent with the declining trend in assignment rates

observed at that time in all parts of the country. Assignment rates

declined the most, however, in those areas where prevailing charges

were reduced as a result of the consolidation (394).
64 . Payment for Physician Services: Strategies for Medicare

distribution of ophthalmologists’ customary charges

will determine the prevailing charge for this type

of procedure even where all physicians’ charges

for the procedure are combined to determine a

single prevailing charge.

Specialty-specific prevailing charge screens that

may make a difference involve those services that

are performed by physicians of many different

specialties. The most prominent of such services

are visits (which account for 57 percent of all physician services provided to Medicare beneficiaries

and 33 percent of total approved charges (247)).

Among the prevailing charges in fee screen year

1982 for a selection of 16 specific types of office

or hospital visits, differences between general

practitioners and internists were observed of up

to 53 percent (494). Further, the prevailing charge

for the general practitioners was lower than that

of the internists in 15 of the 16 cases.

Effects of Maintaining Separate Specialty Charge

Screens.—Under the CPR system, however, the

prevailing charges set only a maximum on the approved charge for a particular set of physicians;

each physician’s customary charge also establishes

a unique limit that maybe the effective constraint

on the approved charge. Because the approved

charge for a service from a particular physician

will never exceed his or her customary charge for

that service, the major effects of establishing separate charge screens by specialty involve primarily

those physicians in each specialty whose customary charges are high relative to their peers. The

actual effects of any specialty consolidation or

partition would depend on the relative volumes

of service for the specialties in question and the

degree of overlap in the distribution of customary charges among those specialties.

For example, if one ignores for the moment the

effects of the MEI, the results of creating two specialty screens where formerly there was one might

be as follows: If the service volumes of the two

specialties were comparable but the customary

charges of one specialty were no higher than the

50th percentile of the other, the partition would

raise the approved charges of only those physicians in the higher charge specialty whose customary charges were above the 50th percentile. It

would lower the approved charges of only those

physicians in the low charge specialty that were

above the 75th percentile in that specialty because

all other physicians in that specialty had been unaffected by the initial prevailing charge and would

remain unaffected by the new one. If the service

volume of the lower charge specialty were insignificant compared to the other, the partition

would have little effect on the higher volume,

higher charge specialty, while reducing the approved charges of only those physicians in the low

volume, low charge specialty which were above

the 75th percentile in that specialty. Finally, if the

service volume of the higher charge specialty were

insignificant compared to the other, the partition

might have a slightly negative effect on the approved charges of the higher volume, lower

charge specialty above the 75th percentile in that

group, while raising the approved charges of most

of the physicians in the low volume, high charge

specialty.

For the most part, maintaining separate prevailing screens for different specialties permits higher

approved charges for the highest priced of the

higher priced specialties and reduces the approved

charges of the highest priced of the lower priced

specialties. The effects on the beneficiaries of

maintaining separate specialty distinctions are not

unequivocal. The out-of-pocket costs of a beneficiary who receives service from one of the relatively low priced physicians in either of two specialties would be virtually unaffected by creating

separate prevailing charges. The patient who receives service from a high priced doctor in the

lower priced specialty will face reduced coinsurance but possibly a higher amount of nonassigned

liability. Similarly, the patient who receives service from a high priced doctor in the higher priced

specialty will face increased coinsurance but a

somewhat lower level of unassigned liability.

Considerable attention has been given to comparisons of the prevailing charges of general practitioners and “specialists” due to the availability

of the Medicare prevailing charge directories

(513). Although there is Some concern that such

differentials may encourage specialization, there

is no evidence that fee differentials in and of themselves have much influence on specialty choice

(438), and no one has seriously suggested that the
Ch. 2—Physician Payment Under the Medicare Program: Problems and Changing Context • 65

relatively low fees paid by Medicare are solely responsible for the declining numbers of general

practitioners. There is some question about the

appropriateness of allowing individual physicians

to declare themselves specialists and take advantage of higher prevailing charges (475).

Recent analyses of the distributions of approved

charges for individual procedures have found that,

compared to surgeries, a much greater proportion

of physician visits have approved charges equal

to the prevailing charge (247,294). Where the MEI

(or market competition) has compressed the distribution of approved charges within specialties,

changes in specialty distinctions can have more

dramatic effects. Juba estimated that if a fee schedule had been adopted based on average approved

charges in South Carolina in 1983 that did not

recognize specialty differentials, Medicare revenues for office visits for general practitioners

would have increased 19.6 percent. Family practitioners would have observed an increase of 16.6

percent, and internists would have observed a decrease of 16.5 percent (247).

These findings suggest a difference between fee

schedules and CPR. Because of the presumption

that fee schedule amounts will provide a limit for

all physician payments—not just payments for the

physicians with the highest fees relative to their

peers, specialty distinctions may have more significant financial implications under a fee schedule than under CPR.

Different Fees for Different Physicians. -There

are no data with respect to the number of distinct

specialties that have billed Medicare carriers for

specific physician procedures. Office visits and

hospital visits—which account for 33 percent of

Medicare approved charges (247), however, are

provided and billed by most of the medical specialties and subspecialties. It is commonly accepted that most surgeries are primarily specialty

specific, but here, too, there may be instances

where some fraction of particular surgeries may

be performed by physicians outside of the specialty considered most likely or most appropriate to perform that procedure (“modal” specialists). How does one determine the “right price”

in these instances, and should that price be the

same as is paid to the modal specialists?

The common justifications for recognizing

higher approved charges for specialists compared

to general practitioners involved either higher

quality or qualitatively different services provided

by specialists even though the procedures (such

as visits) may have the same label. Office visits

of internists, for example, have been found to be

46 percent longer than visits to general and family practitioners (548). Although physician time

is important, time alone may not fully describe

the differences in professional effort that may be

involved or the resources of knowledge and skill

that may be brought to bear by the physicians

in question.

In order to account for such differences between

physician services, various observers have introduced the concept of skill, complexity, urgency,

intensity, stress, and severity. Although the concepts differ from one another, they are all interrelated with respect to the utilization of physicians’

personal resources. Basic skills involve the clinical judgment needed to diagnose and choose appropriate therapeutic procedures. Complexity reflects the technical skills needed to perform the

procedure. A patient’s severity and the urgency

of his or her medical situation will influence both

the intensity of the physical or mental effort required of the physician and the stress due to the

potential risk of the procedure in question.

Previous studies have found a fair degree of

consensus among physicians with respect to these

types of complexity rankings across individual

physician services (225,226,227,422). There is no

empirical literature on whether such differences

are evident with respect to a set of specific procedures performed by physicians of different specialties.

Physician Opportunity Costs.—One might argue that physicians in different specialties elect to

invest different amounts of time in specialty training, and that payment differentials should merely

reflect such differences. Various authors have used

a “returns to training” adjustment to account for

differences in physicians’ incomes and, notably,

differences between the costs of various physician

services (227). 18

ISIf ~nYthing, these studies Of income differences have tended to

suggest that payment levels to specialists more than compensate those

physicians for their additional investments in training (72,113).
66 . Payment for Physician Services: Strategies for Medicare

When applied to specific physician services,

however, this argument involves a potential double adjustment for differences across specialties

in physician opportunity costs. The problem is

as follows: Although physicians do make an investment of time and money in obtaining specialty

training beyond the “intern” level, part of the return on that investment is the “specific training”

(31) skills that allow the performance of relatively

complex—and more highly paid—services. In theory, services that involve primarily the “general

training” skills that all physicians acquire will not

warrant additional payment. If, for example, a

gastroenterologist perceives the opportunity costs

of the professional time devoted to an office visit

in terms of the payments available for performing an endoscopy, it maybe rational for that physician to bill accordingly. However, unless it can

be shown that beneficiaries’ access to comparable specialists’ services suffers or that the Medicare program can make operational a valid option

demand” for that physician’s more specialized

skills, it may not be rational for Medicare to pay

higher approved charges for that visit.

Practice Status. —Because the arguments for the

use of board certification as a basis for payment

differentials are essentially a refinement of the general specialty differential arguments, these arguments will not be repeated in this section. The

arguments with respect to higher payment levels

for teaching physicians do involve a different perspective. In particular, teaching physicians may

provide an adjunct service-teaching of new physicians—at the same time that they provide strictly

medical services to Medicare beneficiaries. In

addition, some may argue that because the opportunity costs of a teaching practice are high,

higher payments than otherwise available for

comparable services will be necessary to retain

highly qualified physicians in the role of teachers.

With respect to the first argument, Medicare

has recognized a share in hospitals’ direct and indirect education and training expenses of health

professionals even under the prospective payment

system. This situation might tend to legitimize the

argument for higher payments for such physi19An option demand Would involve a payment for a service that

although it may not be used by the purchaser is valued for its existence as an option.

cians. Alternatively, one can argue that Medicare

or other governmental contributions for such expenses should be made explicitly. Payments embodied in allowed charge differentials for teaching physicians could contribute to inequitable

variations in beneficiary liability just as much as

any locality or specialty differential. With respect

to the question of the opportunity costs of teaching, one might want to examine evidence that the

quality of the teaching staffs in the country have

suffered due to relatively low payments available

under Medicare before proceeding to raise payments in that regard.

Variations by Site of Service

Comparable though not necessarily identical

services may be observed to have both differing

customary charges and prevailing charges for a

single physician practice depending on the site of

service. In the HCFA Common Procedure Coding System (HCPCS) and most other physician

service taxonomies, different procedure codes are

assigned to physician encounters—visits—according to where they occur. Thus, one can have a

limited20 (subsequent) visit in the physician’s office (CPT-4 code 90050); in the patient’s home

(90150); in the hospital (90250); in a skilled nursing facility, intermediate care facility, or other

long-term care facility (90350); in a nursing home,

boarding home, domiciliary, or other custodial

care facility (90450); in an emergency department

(90550); or in a critical care unit (99172). (A

limited visit may also be provided as a consultation (90641) or for the purpose of issuing a second opinion (90650) without regard to site (85). )

Average prevailing charges across the country

(for fee screen year 1982) exhibited the pattern that

for a given category of visit (such as limited or

intermediate) a hospital visit commanded a higher

allowed charge than a nursing home visit, which

in turn was higher than an office visit (494). Average prevailing charges in that year ranged from

11 to 32 percent higher for the inpatient visits

compared to office visits. If one assumed that the

medical content of the visits was comparable, this

pattern implies an incentive to favor the hospital

20T’he defjnjtjon of a “]imit~” service is provided in fOOtnOte 11

to this chapter.
Ch. 2—Physician Payment Under the Medicare program: Problems and Changing Context . 67

as a site of service where additional physician

practice costs, if any, for hospital visits were less

than 11 percent higher than comparable office

costs. (One might also note that the regulations

promulgated with respect to physician services

performed in an ambulatory surgical center provide for physicians to be paid 100 percent of approved charges on those services whether provided in an ambulatory surgery center or hospital

outpatient department, if they accept assignment.

Although accepting assignment in this case may

lead to a reduction in a physician’s bad debts, that

physician’s total expected revenues may still be

greater when assignment is not accepted for those

services. Further, whether the physician is paid

more for ambulatory surgical services than for the

same services provided to inpatients depends on

the relevant array of customary and prevailing

charges. A physician’s total expected revenue may

remain higher for hospitalized patients. )

The arguments with respect to site differentials

revolve around two questions, The first involves

the issue of whether existing differentials inappropriately influence the site of care, particularly

when in-hospital payments exceed those for services that might otherwise be provided in a physician’s office. Second, for services provided outside a physician’s office, there is the perception

that some of the practice costs are not paid by

that physician, and hence payment to the physician should be lower.

For the most part, the first issue arises for

separately billed physician visits, not for surgeries or interpretations. Prevailing charges for office visits have been shown to be lower than those

for hospital visits of ostensibly the same variety

(494). With respect to the second issue, it is argued that since physician’s overhead costs account

for roughly 40 percent of gross professional revenues, payments for services provided in outpatient departments, for example, should be limited

to 60 percent of payments allowed for comparable services provided in the physician’s office.

The first issue regarding payments for inpatient

visits may be a case where the nomenclature of

physician services may be misleading. A limited

hospital visit may be very different from a limited

office visit even though both are described as

limited visits. On the whole, patients seen in hospitals are sicker than those who are ambulatory.

And on average their verified medical complaints

may require more physician attention than the reported symptoms of their ambulatory counterparts. If there are some circumstances for which

physician hospital visits are warranted to be cursory, that situation may argue for a single, per

admission hospital care payment rather than daily

visit payments, not necessarily for reducing daily

payment rates to the level of office visit payments.

With respect to both issues, differentials in payment may be compared to differentials in costs,

including both variable costs with respect to the

site of treatment and fixed costs of the physician’s

office or primary place of practice. Although physicians do have the use of highly qualified technical personnel in outpatient departments or emergency rooms, those persons, for the most part,

are not substituting for similarly trained individuals in the physician’s office. Physicians’ costs for

providing such services outside of the office may

be lower than they would be otherwise, but most

physicians bill only for a professional component

for such care; they do not bill for the cost of services provided by the institution. Most physician’s

office employees are bookkeepers, receptionists,

or secretaries. In effect, their compensation is a

fixed cost to the physician that is unaffected by

the amount of professional time spent on practice outside the office. Variable costs with respect

to site maybe limited to drugs and supplies, which

represent 4 percent of physicians’ gross revenues

(117).

Differences Among Procedural and

Nonprocedural Services

In addition to the obvious issue about the justification for establishing different approved

charges for what appear to be identical services,

there have also been questions raised about the

appropriateness of apparently large differences in

relative approved charges for different services.

In particular, there is some concern that “procedural” services are overvalued compared to “nonprocedural” services. One HCFA study found that

even after adjusting for differences in complexity

, physicians were reimbursed as much as four
68 . Payment for Physician Services: Strategies for Medicare

to five times more per hour for inpatient surgery

than for office visits (227). Even within the office

setting, the lack of additional reimbursement for

such primary care services as history taking or

nutritional counseling provided during a visit is

in sharp contrast to the additional fees that can

be generated by ordering and/or interpreting an

electrocardiogram (EKG), performing an endoscopy, or providing laboratory tests. To the extent that physicians respond to relatively lower

reimbursements for nonprocedural services, fewer

of these services will be provided to Medicare beneficiaries with a possible increase in the subsequent

demand for more expensive curative or ameliorative services. To the extent that net revenues from

procedural services exceed those of the nonprocedural services, there may be a financial incentive to provide more of such services than would

be appropriate on strictly clinical grounds.

There has been a great deal of recent interest

in identifying whether the extent of the differences

observed between payments for procedural services and those for less technical nonprocedural

services are warranted (16,17,103,136,195). There

are a variety of reasons why the actual payment

rates for specific services might differ from one

another on either an absolute basis or as expressed

in payments per unit of time. Such differences in

payment may be due to differences in patient characteristics including health status differences,

differences in the physical and mental demands

on the physician occasioned by the service and/or

circumstances in question, and differences in the

length of training invested by individual physicians. The question remains whether the present

physician payment systems—in which Medicare

is only a subsystem—overcompensate for some

of those differences. In particular, since the “beneficiaries of the perceived overcompensation are

also physicians in specialties that have relatively

high estimated net incomes, namely, surgery,

there is an issue of whether these perceived imbalances should be redressed concomitant with

the initial implementation of any physician payment reform .21

Were overcompensation to be verified, the time

of conversion to a new payment system might be

Z~A ~P~CifiC Propowd rem~y is the development of a resource

cost-based relative value scale, which is reviewed in ch. 5.

an opportune one. Any major modification of

Medicare’s physician payment system is likely to

embody some years of conversion, much as the

recent implementation of the prospective payment

system for hospital payments. If there is a problem that needs correcting, delay until after the

conversion might simply make a subsequent correction that much harder to implement. The question remains, however, how to identify whether

there is a problem.

The arguments and evidence on procedural/

nonprocedural imbalances are as follows: physician payments for nonprocedural services, i.e.,

visits, are low compared to surgeries in terms of

payment per unit of time spent with patients (227);

specialties in which the bulk of practice involves

procedural services receive higher net incomes

than those specialties more heavily concentrated

in nonprocedural services (35422); estimated rates

of return to training are higher in medicine than

in other learned professions and within medicine,

higher in those specialties in which the procedural

services are concentrated (72,113); patients’ health

would be improved if they received more primary/preventive/nonprocedural services, which

in turn would be more available if those services

were paid higher fees (336).

Although the price and income differences may

be evidence of imbalances, it is not clear that those

differences alone are evidence of a problem, much

less a problem to be redressed by Medicare. In

a market economy, one would expect periodic imbalances between supply and demand and reductions over time in those imbalances as physicians,

in this case, responded to just those market signals that are being produced. In a simple world,

one would expect that more physicians in training would enter the surgical specialties and that

more students in general would enter the profession of medicine because the returns to medicine

exceed those of other learned professions. Longrun trends in medicine are consistent with such

“corrections.” There are more physicians per capita, but fewer physicians not pursuing a specialty.

‘

zThe author reports an increase in internists’ net incomes relative to changes in the Consumer Price Index, and states, ‘This suggests that [internists] have begun to succeed in their long-standing

battle to reduce the third-party reimbursement gap between cognitive and procedural services. ”
Ch. 2—Physician Payment Under the Medicare Program: Problems and Changing Context ● 69

Many observers would be unwilling to wait for

the long run to arrive. They would assert that although some differences in payment are expected,

the observed differences represent actual discrepancies in payment policy that are either not right

in and of themselves or not right in that these payment differences lead to incentives that may inappropriately influence medical decisionmaking.

With respect to the “correctness” of fee (or income) differences, there is no consensus. For example, in fee screen year 1984, the average prevailing charge for a cataract extraction was

$981.77, nearly 50 times higher than the average

prevailing charge for a limited office visit (532).

During that same year, the median income of

ophthalmologists was estimated to be $150,000,

compared to a median income of $89,660 for internists (354). The face validity (or lack of validity) of such payment/income differences, however, rests primarily in the eye of the beholder.

Whether ophthalmologists or internists or both

are paid too much or too little is an open question.

There is potential consensus with respect to

whether such payment differences either inappropriately influence medical decisionmaking or

threaten beneficiaries’ access to care. If the relative approved charges of procedural services were

so high as to lead to the provision of services of

zero or negative benefits to patients, many physicians would agree that those prices were too

high. 23 On the other hand, if the relative approved

charges of nonprocedural services were so low

that physicians providing such services refused to

see Medicare patients and if, as a result, those patients’ health deteriorated, many would agree that

those prices were too low.

Verifying either of these states of the world in

the current state, however, has proved elusive.

There is a host of literature on variations in the

use of hospital services and individual surgical

services (272). None of these studies has identified a correlation between levels of use and levels

of fees. Various observers have claimed to identify specific surgeries that may have been provided

Z~Economists would argue that the price of a particular procedure

was too high if services were provided at a price that exceeded the

value of the change in health status expected to result from a particular procedure.

in excess, but there is no indication that this surgical excess has been associated with excessive

reimbursement rates. At the same time, there are

no studies indicating that any particular groups

of Medicare patients have not had access to

needed health care services due to low reimbursement rates. Further, recent empirical evidence on

the lack of dramatic effects for those who have

forgone primary/preventive care (343,348) suggests that the health improvement argument for

raising nonprocedural fees may be overstated.

Where additional arguments might be made

and where sufficient evidence may yet be developed involves differences in beneficiary access to

specific types of health care services in terms of

differential out-of-pocket liabilities with respect

to different types of physician services. There is

some evidence that reasonable charge reductions

by carriers are relatively higher for visits than for

surgeries (247,294), that assignment rates prior to

1984 were somewhat lower for primary care specialties than for surgical ones (247), and that beneficiary out-of-pocket expenses, if collected, were

a larger part of total Medicare billings by the primary care doctors than for surgeons and radiologists (247). This situation may suggest that it is

harder for beneficiaries to secure nonprocedural

services.

New vs. Old

Finally, one other pattern observed among approved charges is that services of newer vintage

or those that are provided by physicians of newer

vintage have higher approved charges than those

of older vintages. Specifically, new physician

practices appear to have higher customary charges

than more established ones, and newly introduced

physician procedures have higher customary and

prevailing charges than those procedures that have

been commonly accepted for a longer time. With

respect to a carrier’s assessing claims from new

physicians, there is no claims experience from

which to compute a customary charge. Carrier

rules have therefore been established to assign a

customary charge in such cases by default. This

default customary charge is equal to the 50th percentile of the distribution of comparable customary charges for the procedure in the relevent

locality. As a result, new physicians can have ap-
70 . Payment for physician Services: Strategies for Medicare

proved charges that, by definition, may exceed

those of half of their more established colleagues.

Prior to the freeze on submitted charges imposed

by the Deficit Reduction Act of 1984 those more

established colleagues were not prohibited from

raising their own charges to retain a relative allowed charge position more in keeping with their

experience .24

The question of the appropriateness of relatively higher approved charges for “new” procedures is more subtle. Very often a new procedure

will require the acquisition of new skills or new

equipment. The extra care required to execute the

new procedure may require more time or place

more stress on the physician performing the procedure for the first time. The relative value of the

physician services involved in performing the procedure may be relatively high, and initial approved charges will reflect this, Although over

time one would expect this relative value to decline as performance of the procedure becomes

more routine, both the perceived relative value

and the submitted charges of the procedure tend

to become embedded in the structure of relative

charges within a particular specialty. Since there

is no periodic “zero-based” reevaluation of charges

for specific procedures, the structure of approved

charges simply drifts upward over time. (This is

consistent with and may exacerbate the perceived

imbalances in approved charges between procedural and nonprocedural services. )

For example, coronary artery bypass surgery

has been cited as a procedure that when first introduced required extraordinary expertise and

enormous amounts of time. Initially, 3 or 4 procedures per week were a heavy workload, but toda , some surgeons perform 3 to 4 procedures in

1 day. Furthermore, many of the surgeons’ earlier

tasks are carried out by other professionals

who bill independently from the surgeon. Surgeons’ fees have not dropped but have increased

more than the rate of inflation (403). Both cata24A common misperception among physicians, however, was that

Medicare “locked” them into a set of fee screens, over which successively newer cohorts of physicians would leapfrog, leaving established physicians financially behind. Patients’ expectations, if not

their potential responsiveness to price changes may have inhibited

physicians from raising charges as much as desired, but this outcome was not a function of Medicare regulations,

ract surgery and blood chemistry tests, in particular, have also been cited as examples of this phenomenon (46).

Lack of Variations Due to Quantity Discounts

Although Medicare reimbursements may account for only 17 percent of physicians’ gross

professional revenues, there may be some services for which Medicare revenues represent the

bulk of all purchases. One might expect Medicare

to get a better bargain in purchases of those services compared to physician services that are little

used by Medicare beneficiaries. Table 2-12 indicates the proportion of specific inpatient services

that are provided to elderly persons—who can be

presumed to be Medicare patients. Although the

reasonable charge reductions inherent in the curTable 2-12.—Elderly Population’s Share of Market

for Selected Inpatient Surgical and Diagnostic

and Therapeutic Procedures, 1983

Market share

represented by

population 65 and

Procedure over (percent)

Inpatient surgical procedures:

Insertion of prosthetic lens. . . . . . . . . . . . . . . 82.80/o

Extraction of lens . . . . . . . . . . . . . . . . . . . . . . . 79.5

Pacemaker a 

. . . . . . . . . . . . . . . . . . . . . . . . . . . . 79.4

Prostatectomy ., . . . . . . . . . . . . . . . . . . . . . . . . 76.8

Arthroplasty and replacement of hip . . . . . . . 74.2

Partial gastrectomy/resection of intestine . . 59.7

Dilation of urethra. . . . . . . . . . . . . . . . . . . . . . . 42,9

Mastectomy . . . . . . . . . . . . . . . . . . . . ... , . . . . 37.9

Direct heart revascularization . . . . . . . . . . . . . 35.1

Open heart surgery . . . . . . . . . . . . . . . . . . . . . . 32.0

Open reduction of fracture . . . . . . . . . . . . . . . 31.4

Arthroplasty and replacement of knee . . . . . 27.9

Repair of inguinal hernia . . . . . . . . . . . . . . . . . 27.5

Skin graft (except mouth or lip) ... , . . . . . . . 26.0

Inpatient diagnostic and therapeutic procedures:

Endoscopy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51.40/o

Radioisotope scan . . . . . . . . . . . . . . . . . . . . . . 47.0

Bronchoscopy . . . . . . . . . . . . . . . . . . . . . . . . . . 44.5

Computerized axial tomography (CAT) . . . . . 42.8

Esophagoscopy and gastroscopy. . . . . . . . . . 38.6

Arteriography and angiocardiography , . . . . . 38.3

Diagnostic ultrasound . . . . . . . . . . . . . . . . . . . 35.8

Pyelogram b. ... , ., . . . . . . . . . . . . . . . . . . . . . . 33.8

Cardiac catheterization . . . . . . . . . . . . . . . . . . 27.2

alncludes irlsertion, replacernerl!, removal, and rePair of Pacemakers.

b An X.ray highlighting the kidney and urinary tract

Data source. Table 7, Advance Data, Sept. 28, 1984, No, 101, Vital and Health

Statmtlcs National Center for Health Statistics, Department of

Health and Human Services, Public Health Ser[vce.

SOURCE: 1. Burney and G. Schieber, “Medicare Physicians’ Services: The Composition of Spending and Assignment Rates, ” Health Care Financing

Review, forthcoming,
Ch. 2—Physician Payment Under the Medicare Program: Problems and Changing Context ● 71

rent CPR system may be considered to be a form

of quantity discounting in and of themselves, one

might expect that greater reductions would be observed for those services primarily provided to

Medicare beneficiaries. In fact, this does not appear to be the case. In 1983 in South Carolina,

for example, Medicare approved charges were

roughly 75 percent of billed charges for all services, but for cataract extractions—the most common Medicare surgery in that State—approved

charges were 90 percent of billed charges (294).

Uneven Effects of the Medicare

Economic Index (MEI)

In 1972, in response to concerns that increases

in physician fees under Part B were the cause of

rather than the result of medical inflation, Congress mandated that an additional fee limit—an

economic index—be included in the reasonable

charge determination process. This index was to

reflect changes in physicians’ operating expenses

and changes in general earnings levels and was

to be used as a cap on prevailing charges. 25 Prior

to the imposition of the index, the maximum reasonable charge allowed by the carriers was equal

to the “prevailing charge. ” The prevailing charge

for any service was computed by the Part B carriers as the lowest customary charge that was no

less than 75 percent of all customary charges when

weighted by the volume of services billed. With

the advent of the MEI, the value of the maximum

reasonable charge was established as the “adjusted” prevailing charge, which was the lesser of:

1) the unadjusted prevailing, i.e., the 75th percentile; or 2) the product of the prevailing charge

from fee screen year 1973 multiplied by the value

of the MEI (117).

Although some observers contend that the effect of the MEI has been to create de facto fee

schedules, the actual effects are much less certain.

The MEI has been constraining, and in the early

1980s, it appeared to be becoming more constrain251nput~ t. the MEI are of two types, one reflecting increases in

physician practice costs and the other reflecting increases in general earning levels. Of the first type, there are six practice costs measures: wages and salaries, office space, drugs and supplies, automobile expenses, professional liability insurance premiums, and all other

practice expenses. General earnings levels measures included in the

MEI are average weekly earnings of nonagricultural production and

nonsupervisory workers and changes in productivity (117).

ing over time. In fact, however, in the Medicare

Directory of Prevailing Charges the number of entries that indicate those prevailing charges that

were due to the MEI declined each year from 1981

to 1984 (532). In addition, a study of fee screen

year 1980 data from California for a selection of

physician procedures found that the percentage

of customary charges that might be directly affected by the MEI ranged from 24.5 percent of

eye exams from ophthalmologists to 99.7 percent

of basic anesthesiology services from anesthesiologists (187). Basically, this range goes from no

effect to total effect. Further, an analysis of calendar year 1983 carrier data from the State of South

Carolina showed that 43.2 percent of approved

charges were established at the level of the adjusted prevailing charge (see table 2-13). Because

the adjusted prevailing is the lower of the MEI

cap or the actual 75th percentile, 43.2 percent

must be considered an upper bound estimate of

the impact of the MEI in that State (247). Finally,

although some have alleged that the MEI has unfairly prevented reimbursements from rising in rural areas (415), California data show instances

where in capping prevailing charges in urban

areas, the MEI, in effect, prevented urban/rural

disparities from increasing (359).

Until recently, in performing the reasonable

charge reduction process, carriers did not commonly record the specific limit—actual charge,

customary, adjusted prevailing, or unadjusted

prevailing—used to determine the approved charge

for a specific claim. Because of this lack of data

on the specific reasons for reasonable charge reductions and amounts of reductions by type of

limit, there has been no definitive analysis of the

impacts of the MEI. Its inclusion in the reasonable charge process does make the process somewhat more cumbersome and potentially more

confusing to providers, if not to the beneficiaries.

Further, because by constraining some reimbursements but not others the MEI can lead to either

increased or decreased payment differentials, the

MEI also contributes to variations in payment

levels across specialties and geographic areas.

Summary of Variations

The review of issues with respect to Medicare’s

physician payment system began with an indica-
72 • Payment for Physician Services: Strategies for Medicare

Table 2-13.—Distribution of Medicare Approved Charges Across CPR Limits

by Specialty and Type of Service (South Carolina, 1983)

CPR limit

Billed Customary Prevailing a

charge charge charge Other b

Specialty:

All . . . . . . . . . . . . . . . . . . . . . . . . 15.7 38.7 43.2 2.3

General practice . . . . . . . . . . . . 20.7 20.5 56.8 2.0

Family practice . . . . . . . . . . . . . 15.2 22.9 59.0 2.9

Internal medicine . . . . . . . . . . . 17.4 28.5 51.2 2.9

General surgery. . . . . . . . . . . . . 20.8 49.7 28.4 1.1

Orthopedic surgery. . . . . . . . . . 13.1 38.1 48.1 0.7

Ophthalmology . . . . . . . . . . . . . 12.8 72.3 14.6 0.3

Radiology . . . . . . . . . . . . . . . . . . 12.9 40.4 39.7 7.0

Type of service:

Office visits . . . . . . . . . . . . . . . . 12.4 19.7 65.2 2.8

Hospital visits . . . . . . . . . . . . . . 11.4 22.4 64.6 1.7

Other medicine . . . . . . . . . . . . . 27.0 34.7 37.0 1.2

Surgery . . . . . . . . . . . . . . . . . . . . 15.4 53.4 30.3 0.9

Radiology . . . . . . . . . . . . . . . . . . 13.0 41.2 38.9 6.9

‘Adjusted prevailing charge

bAny ‘mounts not equal 10 either the billed, customary, or Prevailing limits.

SOURCE: D. Juba, “Analysis of Issues Relating to Implementing a Medicare Physician Fee Schedule, ” prepared for the Office

of Technology Assessment, U.S. Congress, Washington, DC, November 1985,

tion of beneficiary and provider confusion. In the

sections that followed some of the other sources

of beneficiary and provider confusion were themselves illustrated as issues. In the Medicare program, one can observe variations in annual expenditures, variations in the proportions of beneficiaries who meet the deductible, and variations

in assignment rates. In addition, approved charges

for a particular service will vary by geographic

area, specialty of the physician, place of service,

type of service, and “cohort” of either the service or of the physician performing the service.

There are also variations in use of physician services across the country, and these variations have

not been found to correlate with variations in apE

roved charges. Finally, there do not appear to

e variations in approved charges by quantity of

service provided to Medicare beneficiaries, but

there are unpredictable and uncertain variations

in approved charges due to the MEI.

Medicare is a national program with roughly

30 million beneficiaries receiving physician services in thousands of communities in the United

States and abroad. Some of the variability in the

program should be expected and much of the

variability is desirable.

What has not been included in the Medicare

program is an organized and timely review of

Medicare’s experiences to identify potential disparities across the many dimensions of the program and to verify or refute the existence of such

problems. Time and again one finds, “There are

no data.” Although this may be taken to imply

that there are no problems, in fact, it is more likely

to betoken the lack of solutions for the problems

that do become evident.

THE CHANGING CONTEXT OF PHYSICIAN PAYMENT

Changes in Medicare payment policies are be- outside of Medicare are likely to affect program

ing discussed in a context that is itself in flux. From expenditures independently of changes in payment

both the beneficiary and the provider sides of policies. The remainder of this chapter examines

health care delivery, developments taking place the implications for future Medicare expenditures
Ch. 2—Physician Payment Under the Medicare Program: Problems and Changing Context Ž 73

of changes in payment policies regarding hospitals; results from certain trends in the demographics of the elderly population, who makeup

97 percent of Medicare beneficiaries (563); and developments with respect to the number and practice arrangements of physicians.

Changes in Policies of

Hospital Payment

In October 1983, Medicare began paying for

the operating costs of beneficiaries’ inpatient care

on the basis of DRGs. Until that time, Medicare

reimbursed hospitals on the basis of the estimated

costs that they incurred for Medicare patients.

This payment method encouraged the adoption

and use of expensive technology rather than the

efficient diagnosis and treatment of medical conditions.

Beginning with the hospital payment reforms

introduced in the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) (Public Law 97-248),

the link between costs and Medicare payment

levels was reduced. Under the new prospective

payment system, Medicare pays a fixed amount

based on diagnosis for the operating costs associated with inpatient admissions. Within each

diagnostic category, the hospital has an incentive

to use resources judiciously, including staff and

equipment, and to reduce the length of stay. Incentives remain, however, to increase the number of admissions.

During the first year of Medicare’s DRG-based

hospital payment system, lengths of stay for elderly people fell much more than the secular trend

even though the prospective payment system was

applied to a relatively small fraction of the hospitals in that year (489). Whereas the length of

stay for people over age 65 had been falling by

1.9 percent per year, the length of stay during fiscal year 1984 fell 10.2 percent. Contrary to expectations, Medicare hospital admissions also declined during fiscal year 1984.

The rate of increase in Part B expenditures fell

substantially during the first year of the prospective payment system. During fiscal year 1984, Part

B Medicare payments rose only 12 percent, in contrast to increases exceeding 19 percent in each of

the 5 preceding fiscal years. This reduction is consistent with the likelihood that expenditures for

physician hospital visits and consultations would

be lower for patients with shorter lengths of stay.

It is unlikely, however, that shorter lengths of stay

accounted for all or even most of this reduction

in Part B increases. Since hospital visits and consultations account for about 20 percent of Part

B expenditures (68) and lengths of stay fell 10.2

percent, one might expect the growth in total Part

B expenditures to have fallen about 2 percent because of DRG payment. Other factors, such as

declines in price increases, may help to explain

the overall decline.

Changes in the Elderly Population

The aging of the U.S. population is a long-term

trend that is projected to continue into the next

century. From 1970 to 1980, the cohort of people 65 years or older grew from 9.8 to 11.3 percent of the population. This cohort will account

for 13.1 percent of the population in the year 2000

and 21.7 percent by 2050 (see table 2-14). Within

the elderly population, the age structure is also

changing. Those age 75 and older comprised 4.4

percent of the population in 1980, but will reach

6.5 percent by the year 2000.

The growth of the elderly population stems

mainly from previous changes in birth rates. Current increases in the 65 to 74 age group reflect

higher birth rates after World War I. The size of

this age group is projected to fall slightly by the

year 2000 because of lower birth rates during the

Depression and then to rise sharply as the baby

boom of World War II reaches age 65 (498).

Increases in life expectancy, although less important in explaining changes in the elderly population, have been substantial. A woman of age

65 could expect about 17 more years of life in

1970, but will be likely to live almost 21 additional

years in the year 2000 (see table 2-15). The ageadjusted death rate for people age 65 and older

fell 22 percent from 1970 to 1982, with a much

faster decline for women than for men (550,563).

A pattern of higher use and expenditures can

also be observed among the older age groups

within the elderly population. As previously noted
74 ● Payment for Physician Services: Strategies for Medicare

Table 2-14.—Elderly Population in the United States, Actual and Projected, by Age Cohort,

1970 -2050a (numbers in thousands)

Total population 65 to 74 years 75 to 84 years >= 85 years >= 65 years

Year all ages Number Percent Number Percent Number Percent Number Percent

1970 . . . . . . 203,302 12,447 6.1 6,124 3.0 1,409 0.7 19,980 9.8

1980 . . . . . . 226,505 15,578 6.9 7,727 3.4 2,240 1.0 25,544 11.3

1990 . . . . . . 249,731 18,054 7.2 10,284 4.1 3,461 1.4 31,799 12.7

2000 . . . . . . 267,990 17,693 6.6 12,207 4.6 5,136 1.9 35,036 13.1

2010 . . # . . . 283,141 20,279 7.2 12,172 4.3 6,818 2.4 39,269 13.9

2020 . . . . . . 296,339 29,769 10.0 14,280 4.8 7,337 2.5 51,386 17.3

2030 . . . . . . 304,339 34,416 11.3 21,128 6.9 8,801 2.9 64,345 21.1

2040 . . . . . . 307,952 29,168 9.5 24,529 8.0 12,946 4.2 66,643 21.6

2050 . . . . . . 308,856 30,022 9.7 20,976 6.8 16,063 5.2 67,061 21.7

aProjections are middle Series.

SOURCE: U.S. Department of Commerce, Bureau of the Census, Decennial Censuses of Population 7900-1980 and Projection of the Population of the United States:

1982 to 2050 (Advance Report), Current Population Reports, Series P-25, No. 922, October 1982; as cited in U.S. Congress, Senate Special Committee on Aging,

and the American Association of Retired Persons, Aging America” Trends and Projections, (Washington, DC: U.S. Government Printing Office, Second Printing, 1984),

Table 2-15.—Life Expectancy at Birth and Age 65,

by Sex and Calendar Year

Male Female

Year At birth At age 65 At birth At age 65

1970 . . . . . . 67.05 13.14 74.80 17.12

1980 . . . . . . 69.85 14.02 77.53 18.35

1990 . . . . . . 72.29 15.11 79.85 19.92

2000 . . . . . . 73.42 15.71 81.05 20.81

2010 . . . . . . 73.93 16.08 81.62 21.27

2020 . . . . . . 74.42 16.45 82.18 21.73

SOURCE: U.S. Department of Health and Human Services, Social Security Ad.

ministration, Office of the Actuary, September 1982, as cited In US

Congress, Senate Special Committee on Aging and the American Association of Retired Persons, Aging America: Trends and Projections

(Washington, DC U S Government Printing Office, Second Prlntlng.

1984).

those aged 75 and older are more likely to have

Medicare reimbursements and to have higher reimbursements per person served (see table 2-16).

Older people have higher expenditures at least

partly because they have higher death rates; people during the last year of life have had Medicare

reimbursements six times the level for survivors

(277,487a).

Health care expenditures for women, who will

constitute an ever-growing percentage of Medicare beneficiaries because of their lower mortality rates, have also exceeded the average (213,487a).

Among elderly people, the difference is especially

pronounced for nursing homes. Women age 65

and older are twice as likely to use nursing homes

as men (550).

All of these demographic trends portend increasing health care expenditures for the Medicare program. Greater numbers of people will

Table 2-16.—Medicare Enrollees Served and

Their Reimbursement, by Age, 1982

Persons served Reimbursement

Age per 1,000 enrolled per person served

Total >=65 . . . . . . . 641 $2,439

65-74 . . . . . . . . . . . 600 2,172

75-84 . . . . . . . . . . . 691 2,705

>= 85 . . . . . . . . . . . . 733 2,960

SOURCE: D.R Waldo and H C Lazenby “Demographic Characteristics and

Health Care Use and Expenditures by the Aged in the United States:

1977 -84,” Health Care Financing Review 6(1)1-29, Fall 1984

reach age 65 and be eligible for the Medicare program. Furthermore, Medicare beneficiaries as a

group will be older and consist of more women,

both subgroups that have higher per capita medical expenditures.

Changes in Medical Providers

Increasing Supply of Physicians

From 1970 to 1980, the number of active physicians in the United States grew from 156 to 197

per 100,000 population (see table 2-17). This increase occurred primarily as a result of Federal

support to expand medical school enrollment dating from the late 1960s (168). Since 1982, the Federal Government has moved away from funding

medical schools and subsidizing loans for medical students, and both medical school enrollment

and medical school applications have begun to decline (96). About one-fifth of the growth in the

number of physicians resulted from sizable increases in foreign medical graduates, who in 1982

accounted for 38 percent of hospitals’ full-time
Ch. 2—Physician Payment Under the Medicare Program: problems and Changing Context • 75

Table 2-17.—Active Physicians (M.D.s and D.O.S) in

the United States and Estimated Requirements,

1970-2000

Actual

physicians

Number of per 100,000 Estimated

Year physicians population requirements

1970 . . . . . . 326,500 156

1980 . . . . . . 457,500 197

1990 . . . . . . 594,600 243 559,300

2000 . . . . . . 706,500 271 654,700

SOURCES U.S Department of Health, Education, and Welfare, Public Health

Service, Bureau of Health Manpower, Report to the President and

Congress on the Sfafus of Health Profess/ons Personnel, , DHEW Pub

No (HRA) 79-93 (Washington DC DHEW, August 1978 and March

1979), U S Department of Health and Human Services, Publlc Health

Service, Health Resources and Services Administration, Report to the

Presidenf and Congress on fhe Status of Hea/fh Personne/ In fhe

Urr/fed States, 1984, DHHS Pub No HRS-P-OD 84.4 (5/84) (Washing.

ton, DC HRSA, May 1984), and U S Department of Health and Human Serwces, Publtc Health Serwce, Nattonal Center for Health

Statlstlcs, Hea/fh, Un/ted Slates, 1983, DHHS Pub No (PHS) 84.1232

(12/83) (Washington, DC U S Government Pr!nting Office, December

1983)

staff. The number of foreign medical graduates

is expected to grow at a slower rate in the future

because of changes in the required examination

and competition for the decreasing number of

residency positions (524,547). At the same time,

U.S. physician graduates are increasing in number, and the orientation of medical practice is

shifting away from hospitals.

Even with these expected changes, current estimates project that active physicians will number

243 per 100,000 population in 1990 and 271 per

100,000 by the year 2000 (550).2

’ As implied by

these ratios, physician increases are expected to

continue to outpace population growth. Moreover, physician supply is projected to exceed the

estimated requirements for physician services,

based on projected changes in the age and sex distribution of the population and adjustments for

expected per capita use (547).

26The Graduate Medical Education National Advisory Commission methods were developed to set national goals for physician specialty distribution. The “adjusted needs based” approach produced

physician requirements as a function of expected national morbidity, which was initially modified by expert opinion. Experts identified morbidity that would require medical intervention and then

modified requirements by the estimated constraints of the existing

health care system. The Bureau of Health Professions based its estimates of requirements on projected demand for medical services

using the “adjusted utilization approach. ” This approach modified

recent existing patterns of medical use with projected population

changes, such as age and sex adjustments, and trends in per capita

use. The estimates were updated for the 1984 Report to the President by refinements in health personnel staffing.

The increasing supply of physicians has had implications for availability of and access to physician services. Increasing physician supply has been

associated with a change in the distribution of

physicians between urban and rural areas and presumably greater availability of specialists in more

sparsely settled areas (344). Although physicians

have continued to be concentrated in the most

populated States, from 1977 to 1981 the number

of counties without an active physician fell from

139 to 131 (124). Primary care physicians (general practice, family practice, internal medicine,

and pediatrics) increased at about the same rate

as total physicians and grew from 56 per 100,000

population in 1970 to 70 per 100,000 population

in 1981 (546).

Changes in Physician Practice Arrangements

In addition to the growth in physician supply,

a major development in the provision of medical

care has been the increasing number of innovative practice arrangements through which physicians provide services to their patients. Indeed,

physicians may have sought such arrangements

because they felt greater competition from their

colleagues for patients and for income. No longer

is the typical physician a solo practitioner paid

on a fee-for-service basis. From the early 1980s,

the majority of physicians have been in practices

of two or more physicians (82).

Health Maintenance Organizations. -HMOs

have been growing rapidly in recent years. HMO

enrollment increased 24.9 percent in the year ending June 1985, and total HMO enrollment estimated at more than 18.9 million in June 1985 may

rise as high as 50 million by 1990 (5,464). In 1984

over 16,7 million persons (over 7 percent of the

insured population) belonged to 337 HMOs operating in 43 States, the District of Columbia, and

Guam (240).

By the end of 1985, 635,000 Medicare beneficiaries were enrolled in HMOs for the equivalent

of Part A and Part B services. This number included those enrolled in Medicare demonstration

HMOs. Previous Medicare HMO enrollment was

116,000 as of March 1982. An additional 637,000

Medicare enrollees receive Part B benefits from

prepaid group practices under the provisions of

Section 1833 of the Social Security Act—up from
76 ● Payment for physician Services: Strategies for Medicare

515,000 in March 1982 (533). Under these provisions HMOs or prepaid practice plans can contract with HCFA and provide Part B services on

a usual, customary, and reasonable basis. The

Medicare population enrolled in HMOs is expected to increase as new regulations under the

TEFRA legislation are implemented.

There have been other changes in organizational structure among HMOs that are likely to affect physicians. Health care services organizations

are forming multistate chains, and corporations

are increasing their for-profit involvement in

HMOs. HMOs are also joining forces for joint

purchasing decisions and other cost-saving

ventures.

Preferred Provider Organizations .-Preferred

provider organizations (PPOs) contract with insurers or employers to give care at a reduced price.

Since these contracts are individualized, it is difficult to generalize about PPOs. patients have the

option of seeing the preferred provider and receiving full reimbursement or visiting another provider and receiving less than full reimbursement.

Although designed to reduce expenditure, as yet

no evidence exists that PPOs deliver care at lower

cost .

Although unknown as an organizational form

in 1977, PPOs have grown in number to 334 (229

in operation) by June 1985. Fifty-six of the operating PPOs were sponsored by doctors, 59 were

jointly sponsored by hospitals and doctors, 60 by

hospitals, 12 were sponsored by third-party administrators, 54 by insurers, and 11 by individual practice associations (237). A number of States

are passing legislation that would either encourage

or allow PPO development. California passed

such a law, and by the end of 1983, 74 percent

of physicians had been offered contracts by PPOs

and 36 percent had signed them (77). PPOs are

also diversifying to include other than physician

services, such as dental and mental health services (383).

Freestanding Ambulatory Care Centers.—Hospitals have offered ambulatory surgery for some

time, but the first freestanding ambulatory surgery center was opened in Phoenix, Arizona, in

February 1970. By 1984, freestanding surgery

centers numbered slightly over 300 (238 open and

65 under development (130)).

Medicare began paying for freestanding ambulatory surgery centers in 1982 under Part B. In

an attempt to encourage utilization where appropriate, Medicare reimburses the centers based on

complexity of procedure with no copayment or

deductible required from patients. In addition,

physicians who accept assignment are paid 100

percent of reasonable charges for covered services.

Another new type of practice setting is the

freestanding emergency center offering expanded

office hours or other increased conveniences to

patients often at lower cost than traditional medical care facilities. However, only 9 percent of

physicians in 1983 provided some

tings, and they averaged only 13

practicing in such facilities (82),

Implications for Medicare

Expenditures

care in such sethours per week

Changes that are occurring in the provision of

medical care have less clear-cut implications than

those concerning beneficiaries’ demographics.

Greater numbers of physicians will increase the

availability and most likely the accessibility of

services to beneficiaries. Independent of physicians’ changes in patterns of use or pricing, higher

Medicare expenditures can be expected as greater

physician accessibility enables the increased demand from more numerous and more elderly beneficiaries to be realized. However, the level and

rate of increase of Medicare expenditures may be

affected by changes in physician practice arrangements. Such changes are unpredictable. Even the

few results to date with respect to alternative practice arrangements may not be generalizable to

Medicare beneficiaries, to other physicians, or to

other organizations.

Recent policy changes have been intended to

moderate the growth in medical expenditures by

rewarding hospitals for more efficient resource use

and by channeling beneficiaries to less costly sites

of care and delivery systems. Although these

changes have initially been associated with reductions in the hospital sector and lower increases
Ch. 2—Physician Payment Under the Medicare Program: Problems and Changing Context • 77

in Part B expenditures, policy changes only partly physicians, other providers, and plans respond

explain these declines. Moreover, expenditure to policy changes as they enroll beneficiaries, use

changes over a longer period will depend on how technologies, and price services.

CONCLUSION

Medicare physician expenditures represent 17

percent of gross professional revenues for physicians and 23.1 percent of total Medicare expenses

(507). Both the program and the profession of

medicine have a substantial relation to one another.

This chapter has reviewed some of the aspects of

this relation that have been called into question

by observers of trends in health care financing.

. With the exception of the most recent fiscal

year, Medicare physician expenditures have been

increasing at rates in excess of 19 percent per year,

increases which have exceeded those of most Federal programs. In addition, in examining the distribution of Medicare physician expenditures,

there remain substantial variations across many

dimensions. These variations suggest to some observers that there exist either potential economies

in the program or ways to make the distribution

of benefits more equitable. There is little if any

consensus, however, on the exact magnitude of

specific problems, much less on the value of specific remedies. In the chapters that follow, general approaches to the perceived problems will be

outlined and explored with respect to their applicability for reforming Medicare’s physician

payment program.
Chapter 3

Overview of Alternative

Physician Payment Methods

Under Medicare: A Framework

for Evaluation

If you don’t know where you are going, you will probably end u p

somewhere else.

—Lawrence J. Peter, The Peter Principle
Page

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . + . . . . . . . . . . . . . . . . . . . . 81

Alternatives for Payment of Physician Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81

Modifications in Payment Based uncustomary, Prevailing,

and Reasonable Charges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82

Payment Based on Fee Schedules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82

Payment for Packages of Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82

Cavitation payment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83

Dimensions for Evaluating Payment Alternatives . . . . . . . . . . . . . . . . . . . . . . . . . . 83

Quality of Care. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84

Access to Care. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84

Costs and Efficiency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85

Technological Change . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86

Administrative Feasibility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86

Specific Medical Technologies for Subsequent Analysis . . . . . . . . . . . . . . . . . . . . . 86

Pneumococcal Vaccination . .

Clinical Laboratory Testing .

Cataract Surgery. . . . . . . . . . .

Magnetic Resonance Imaging

Extracorporeal Shock WaveL

Table

Table No.

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91

thotripsy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93

Page

3-1. Medicare Payment and Beneficiary Liability for Cataract Surgery

With Intraocular Lens Implantation in Four Sites of Care . . . . . . . . . . . . . . . 90
Chapter 3

Overview of Alternative Physician Payment

Methods Under Medicare:

A Framework for Evaluation

INTRODUCTION

Because of shortcomings in the present system,

Congress and other policymakers are considering alternative arrangements to pay for physician

services under the Medicare program. This report

analyzes four sets of alternatives:

●

●

●

●

modifications to the present system of payment according to customary, prevailing,

and reasonable (CPR) charges;

payment based on a fee schedule, with predetermined payment rates that would be the

same for similar services;

global payment for packages of related services; and

cavitation payment, under which a predetermined amount would be paid for a beneficiary’s care during a time period.

ALTERNATIVES FOR PAYMENT OF

The sets of payment alternatives considered in

this report vary according to the unit by which

medical care is paid. Modifications in the CPR

system and payment based on a fee schedule

would continue the service as the unit of payment;

the packaging approach would base payment on

units that could range from ambulatory visits

through therapeutic procedures to medical conditions; and cavitation (per capita) payment

would pay according to the number of beneficiaries. The alternatives also vary according to the

scope of medical services, the recipient of payment, and the methods of setting the payment

level.

The core interest of this report is physician services, although some alternatives include payments

for ancillary services and inpatient care. “PhysiThis chapter briefly outlines the sets of payment

alternatives and variations among them. The second section of the chapter discusses the dimensions across which the alternatives are examined

in chapters 4 (modifications to CPR), 5 (fee schedules), 6 (packaging), and 7 (cavitation); and introduces certain issues common to several payment alternatives. The chapter concludes with

brief descriptions of five medical technologies:

pneumococcal vaccination, clinical laboratory

testing, cataract surgery, magnetic resonance imaging, and extracorporeal shock wave lithotripsy.

These technologies are used in subsequent chapters to illustrate the effect of the various physician payment alternatives on specific technologies.

PHYSICIAN SERVICES

cian services” refers to services that are commonly

provided by physicians but are sometimes provided by other professionals or organizations. An

example is clinical laboratory tests, which may

be performed in a physician’s office, an independent clinical laboratory, or a hospital laboratory.

Similarly, optometrists provide some services,

such as refraction and fitting of corrective lenses,

that may be provided by ophthalmologists.

The alternatives discussed in this report concern how the Medicare program could pay for

physician services rather than how physicians receive payment for their work. For example, Medicare might pay a health maintenance organization (HMO) or hospital a per capita amount for

providing physician services to beneficiaries, but

the organization in turn could pay physicians on

81
82 . payment for physician Services: Strategies for Medicare

a different basis, such as salary, fee-for-service,

or some combination.

Modifications in Payment Based on

Customary, Prevailing, and

Reasonable (CPR) Charges

Under this set of alternatives, Medicare would

continue to base its payment for physician services on reasonable charges calculated from the customary and prevailing charges billed by physicians and other providers (see app. C). The scope

of services included in the payment and the recipients of payment would not change.

What would change is the method of calculating reasonable rates. One set of changes would

limit the rates paid for physician services, with

the intention of reducing the increase in Medicare

expenditures. Some of the options would apply

to all physician services, such as lowering the percentile of prevailing charges used to determine allowable charges. Medicare could also contract

with preferred provider organizations to care for

beneficiaries at discounted rates.

Other options would apply more selectively to

services with perceived payment imbalances relative to others. Rates for procedural services could

be lowered relative to nonprocedural services,

specialists and generalists could be paid the same

rates for similar services, or geographic differences

in rates could be reduced. Changing relative payment levels for certain services would also be possible under payment based on fee schedule.

Payment Based on Fee Schedules

Like the previous set of alternatives, payment

by fee schedules would retain the scope of services and recipients of payment of the present system, but it would alter the method of calculating

rates paid by the Medicare program. The schedule of fees would be set in advance of the time

period in which they were to apply, with similar

rates set for services considered to be similar. Fees

could be set on the basis of average charges billed

in previous years, the cost of providing the services, or rates negotiated with providers. Fee schedules could also incorporate any changes desired

in the relative prices paid for different services depending on their location or content.

Once developed, a fee schedule could be used

in different ways. Medicare could treat the scheduled fee as the maximum allowable charge, but

pay physicians a lower amount if they billed less.

Or, Medicare could pay all physicians the applicable scheduled fee regardless of what was billed.

In addition, Medicare could either require providers to accept the scheduled fee as full payment,

or could pay beneficiaries the scheduled fee and

permit providers to bill beneficiaries for additional

amounts.

Payment for Packages of Services

This set of alternatives would package related

services and pay for them as a unit. In comparison with the present system, changes could occur in the scope of services, recipient of payment,

and method of calculating rates. Calculation of

rates for most of the packages would require consideration of variation in resource use among patients and potential financial risk to the physician

or other recipient of payment.

The scope of services included in a package

could range from a visit under an ambulatory visit

package to all physician, ancillary, and possibly

facility services under a total episode of care for

a particular illness. Collapsing procedure codes

would reduce the number of billing codes for services that have little distinction, such as “brief” and

“limited” office visits. The codes would be redefined as a single more comprehensive one (in this

example, a short visit).

A more diverse package is the ambulatory-visit

package, in which an ambulatory visit to a physician and all ancillary services associated with

that visit would be paid at a single rate. The rate

could vary depending on the patient’s diagnosis

or reason for the visit. A third alternative, the

special-procedure package, would pay a single

rate for all physician services (including anesthesiologists and consultants) associated with a single procedure, such as cataract surgery. A variation of this alternative could include ancillaries

and facility expenses for ambulatory procedures

as well.

Other possible variations of packages are packages for an ambulatory episode of care, an inpatient episode of care, or a total episode of care,

which would include both ambulatory and in-
Ch. 3—Overview of Alternative Physician Payment Methods Under Medicare: A Framework for Evaluation ● 83

patient services. Payment for inpatient physician

services for the inpatient-episode-of-care package,

for example, could be made according to diagnosis-related groups (DRGs) or other case-mix

classifications. Such payments, which would include the services of attending physicians, anesthesiologists, and consultants, could be made to

the attending physician, the medical staff, or the

hospital.

The goal of this set of alternatives is to contain Medicare expenditures by giving providers

financial incentives for the more judicious use of

resources, whether they be ancillary services, consultants, or facilities. The intention of payment

for a package such as cataract surgery is that the

attending physician consider cost more heavily

that at present when ordering ancillaries, seeking

consultations, or choosing the site for the surgery.

Cavitation Payment

Under this set of alternatives, Medicare would

pay a fixed amount set in advance and independent of the actual use of services for care to be provided beneficiaries during a certain time period.

Although Medicare beneficiaries currently have

the option of enrolling in HMOs paid on a capitation basis, cavitation payment for all beneficiaries would entail changes in the recipient of payment, scope of services, and method of calculating

rates.

The recipient of cavitation payment could be

a risk-sharing plan, such as a traditional HMO.

Alternatively, the payment could be made to geographic fiscal intermediaries, which would receive

payments for all beneficiaries in that region. In

both cases, beneficiaries would continue to have

as one option continuation of present coverage,

cost-sharing, and receipt of care from providers

paid fees for services. This report considers two

variations in the scope of services: 1) all acute and

chronic care that lies outside of Medicare’s payment system for hospitals facility expenses, and

2) all ambulatory and inpatient services. Calculation of cavitation rates would require attention

to differences in medical expenditures among beneficiaries and the potential financial risk to the recipients of payment.

Payment of a fixed amount per beneficiary is

intended to curb expenditures by giving providers

a financial incentive to use the most cost-effective

level and mix of medical professionals, sites of

care, and other resources in managing patient

care. Payment by cavitation does not necessarily

imply that individual physicians receive payment

on a per capita basis, however. If the carrier received the cavitation payment, for example, it

could still pay physicians by fee for service or

some other method.

DIMENSIONS FOR EVALUATING PAYMENT ALTERNATIVES

The payment alternatives discussed in this report are evaluated across five dimensions:

● quality of care,

● access to care,

● cost,

• technological change, and

● administrative feasibility.

These dimensions emanate from the goals of the

Medicare program and concerns about its present

shortcomings. The Medicare program was intended to help elderly and disabled people who

needed assistance in meeting medical expenses

(491). Concern with access to good quality care

was evident from the start of the program in requirements that providers had to meet in order

to participate (487). Later amendments to the Social Security Act added utilization review and

quality assurance, first by professional standards

review organizations (Public Law 92-603) and

later by utilization and quality control peer review organizations (Public Law 98-21). Cost is

now a primary issue because current interest in

reform of Medicare physician payment has been

aroused by ever-rising program expenditures.

These three dimensions—quality, access, and cost

—are ones by which the medical care system in

general and programs in particular are typically

evaluated.

56-119 0 - 86 - 4 s QL 3
84 Ž Payment for Physician Services: Strategies for Medicare

Technological change merits attention as a separate dimension because of the great influence that

the Medicare program has on this activity as part

of Medicare’s impact on the financing and delivery of medical care throughout the United States.

In addition, administrative feasibility is examined

separately from cost and quality, to which it relates, because it pertains to the ease with which

changes in physician payment could be implemented.

Quality of Care

Quality of care, given the existing state of medical science and art, is the degree to which actions

taken or not taken maximize the probability of

beneficial health outcomes (health improvements)

and minimize risk and other untoward outcomes.

Health improvements include changes in the level

of physical, psychological, and social functioning (108).

Quality is a multidimensional concept that depends on both technical and interpersonal aspects

of medical care. Technical care entails the application of science and technology and encompasses

the preventive, diagnostic, and therapeutic procedures performed for a person’s medical condition. Interpersonal aspects or the art of care concerns the reamer of the provider in delivering care

and communicating with the patient, (63,108).

Unlike recent definitions (108,194), this conception of quality does not include clinical efficiency,

that is, “the ability of the physician to arrive at

a favorable solution to the patient’s problem while

consuming the minimum amount of resources necessary” (61). Consideration of what care is appropriate for a person’s medical condition certainly

entails weighing the implications for the use of

resources and their costs against the net health

benefits that are expected. However, this report

considers net health benefits, costs, and efficiency

as different concepts. The approach in this report

permits examination of the multiple effects of a

payment alternative and identification of the

tradeoffs that may be needed among cost containment and added health benefits.

This approach is also consistent with the present

situation, in which deficiencies exist on clinical

as well as efficiency grounds (483). Numerous

reports and commissions have concluded that

much medical technology has been used with insufficient evidence of its efficacy. In addition,

some technologies, such as diagnostic tests or hysterectomy, have been used when they provide little or no additional health benefit and may even

harm the patient, while other technologies, such

as vaccinations and hypertension monitoring,

could greatly improve health if used more extensively (481,482).

Studies to evaluate quality of care have often

had difficulty measuring and evaluating outcome,

especially the effect on the patient, because information was not available or because a person’s

health status depended on factors other than medical care. Patient outcome is also difficult to evaluate because it may change over time; whether a

patient’s health status is judged to be improved

may depend on when it is measured. Therefore,

many studies have used the process of care, what

a provider does for a patient, and the structure

of care, the characteristics of facilities or providers, as proxies to evaluate the quality of care.

However, specific process measures, such as the

use of a certain test, and structure measures, such

as board certification of a specialist, are valid

proxies only if they are associated with better

quality care.

Access to Care

Access is the ease with which a beneficiary can

obtain medical care. Access depends in part on

the ability of people to overcome financial, spatial, psychological, or social obstacles to obtain

care. It also depends on the accessibility of the

medical care system to people, which in turn depends on the characteristics of the organizations

and individuals that provide care.

Access is related to both quality and cost. The

ease with which people are able to obtain medical care affects the kinds of services that they receive and hence affects quality. The extent of patient cost-sharing when services are performed is

part of financial access and directly affects the implications of a particular payment alternative for

beneficiaries’ cost.

Despite its close relationship to these other

dimensions, access is considered separately here
Ch. 3—Overview of Alternative Physician Payment Methods Under Medicare: A Framework for Evacuation Ž 85

because of its importance to equity. Not only do

physician payment alternatives vary in the financial and bureaucratic barriers to obtaining care

that they present, but these barriers may well impede access for some groups, such as poor and

frail people, more than others. Separate consideration of access will highlight any such problems

for equitable treatment of beneficiaries.

The extent to which physicians accept assignment for Medicare claims is closely related to patients’ access to care, If a physician does not accept assignment for a service, he or she can bill

that patient for an amount greater than the Medicare-determined allowed charge for the service.

This additional amount could impede access to

care for patients to whom it presents a financial

barrier. However, as discussed in chapter 2, access and assignment are not synonymous, The

relationship between the level of assignment and

degree of access is not clear because it is not

known whether the current rate of assignment represents a real barrier to many patients’ ease in obtaining physician services. Nevertheless, it is reasonable to assume that an increase in assignment

rates will improve access for at least some patients, and a decrease in assignment rates will reduce access. Thus, changes in assignment rates

may be interpreted as changes in the accessibility of the medical care system, even though the

current degree of accessibility y has not been quantified.

Costs and Efficiency

In subsequent chapters, the implications of physician payment alternatives for medical care expenditures are considered from several perspectives. One is that of the Medicare program. As

documented in chapter 2, expenditures on physician services have been rising by as much as 20

percent per year, a particularly disturbing trend

in times of growing budget deficits and a particularly noticeable one in light of recent declines in

the growth of hospital expenditures.

Another perspective is that of Medicare beneficiaries. The financial implications of a physician

payment alternative for beneficiaries may well differ in magnitude and direction from the implications for the Medicare program. Beneficiaries’

costs now consist of premium payments for Part

B coverage, a deductible amount, coinsurance for

certain assigned services (see app. C), and, if the

physician’s charge exceeds the Medicare approved

charge, any balance that the physician bills the

patient for unassigned services. Under the current

system, in which fees are paid for services performed and physicians have the option of taking

assignment, a beneficiary’s out-of-pocket costs depend on the volume of services used, the prices

charged, and physicians’ decisions about accepting assignment and billing beneficiaries above the

approved charges.

Costs may also be considered from the perspective of society as a whole. It is possible that Medicare’s payment policies or physicians’ billing and

practice patterns may shift costs from Medicare

or beneficiaries to (or from) other payers, such

as employers who buy health insurance or State

and local governments that are responsible for the

medical care of indigent people. Of course, expenditures for medical care constitute income

from the perspective of physicians and other medical providers. The payment alternative chosen

affects whether these groups gain or lose income

compared to the present situation.

The level of costs matters to policymakers who

are concerned about Medicare’s budget and to

beneficiaries who are living on fixed incomes. An

issue in addition to the level of costs, however,

is the efficiency with which resources are used to

deliver medical care. There are two types of efficiency. Productive efficiency describes the performance of a service or delivery of medical care

of a given quality with the least expenditure of

resources. Allocative efficiency concerns not only

whether care is provided as cheaply as possible

given its quality and quantity, but also whether

the costs expended for the additional care are

worth the expected benefits to be gained. Efficiency rather than the level of costs addresses

whether resources are being used appropriately

in medical care or whether more benefit could be

gained from applying them to different uses in

medicine or elsewhere in society.

A major shortcoming of present physician payment has been the lack of cost consciousness and

financial incentives for efficiency among providers,

patients, and payers (129,367). As a result, indi-
86 . payment for Physician Services: Strategies for Medicare

vidual services have often been performed inefficiently, such as using unnecessary consultants and

assistants for surgical cases and ordering duplicative laboratory tests to diagnose myocardial infarctions. Inefficiency also exists in the treatment

of medical conditions with an inefficient mix of

services, such as performing surgery for a cardiac

condition that could be treated medically with a

better or equal outcome or treating a case of influenza that could have been prevented with prior

immunization.

Technological

Since Medicare

of physicians as a

Change

pays 17 percent of the income

group and as much as 35 percent for some specialties, such as thoracic surgery

(353), that care primarily for elderly people, how

Medicare pays for physician services and associated medical care can exert substantial leverage

over prices and uses of medical technologies

throughout society. The adoption of Medicare’s

payment methods by other payers reinforces these

direct effects. Through its influence on the market for medical care, Medicare in turn shapes the

market for medical devices and other technologies

and affects the direction and extent of medical innovation (487).

Until recent changes in Federal and State payment for inpatients, payment policies encouraged

manufacturers to develop and market sophisticated products that increased quality of care and

that were directed to acute hospital care. Technological development has slighted cost-saving

devices, since potential purchasers had little incentive to adopt them, and preventive and rehabilitative devices, which have been much less

likely to be covered by Medicare and other insurance.

With the greater payment limitations on inpatient care and clinical laboratories, market incentives are now fostering the development of

devices for ambulatory settings, especially for

physicians’ offices. State certificate-of-need laws,

which regulate the purchase of expensive equipment and construction of facilities, contain similar incentives since they have applied to hospitals and certain other facilities, such as dialysis

centers, but rarely to physicians’ offices. As of

April 1985, only 13 States and the District of Columbia had certificate-of-need laws that applied

to some or all major equipment acquired by nonhospital ambulatory care facilities and one State

(Maryland) required that costly technologies in

all settings be licensed (ll).l

Administrative Feasibility

Although all of the physician payment alternatives considered in this report are feasible to

administer, they all require some changes in administration, especially for the Medicare contractor or carrier (see app. D). These changes range

from different methods of determining Medicare’s

approved charges and different coding procedures

to negotiating with providers and assuming financial risk for utilization. Consideration of these

differences will highlight changes necessary to implement the alternatives.

‘The 13 States are Colorado, Connecticut, Iowa, Missouri, Montana, New Hampshire, North Dakota, Rhode Island, Utah, Virginia,

West Virginia, Wisconsin, and Wyoming (11).

SPECIFIC MEDICAL TECHNOLOGIES FOR SUBSEQUENT ANALYSIS

In order to provide some concrete examples of ● cataract surgery,

the way in which different physician payment ● magnetic resonance imaging (MRI), and

methods might affect medical technologies, sub- . extracorporeal shock wave lithotripsy (ESWL).

sequent chapters on specific payment alternatives These five examples can illustrate potential pay- will consider the implications of payment reform

on five technologies: ment effects on a diverse set of technologies. Pneumococcal vaccination is a preventive technology

● pneumococcal vaccination, that is low in cost and underused by the Medi-

• clinical laboratory testing, care population (485). Clinical laboratory testing
Ch. 3—Overview of Alternative Physician Payment Methods Under Medicare: A Framework for Evaluation . 87

is a diagnostic technology, consisting of many

high volume, relatively low-cost procedures. Cataract surgery is a well-established therapeutic

technology also performed at high volume o n

Medicare patients. Finally, MRI and ESWL are

diagnostic and therapeutic technologies, respectively, that are new, expensive to purchase, and

undergoing rapid technological change. All five

technologies can be provided in more than one

setting: hospital outpatient departments, inpatient

settings, freestanding ambulatory facilities, or

physicians’ offices. Thus, these examples can illustrate the ways in which alternative physician

payment methods might affect the site of care .

Pneumococcal Vaccination

The vaccine to protect against pneumococcal

pneumomia, which represents about 14 percent

of all pneumonias, is the only preventive technology that is part of Medicare’s benefits for all beneficiaries. Covered by Medicare since July 1, 1981

(Public Law 96-611), the vaccine is indicated for

use among persons with certain chronic illnesses,

who are at a higher than average risk of contracting pneumococcal infection. The Centers for Disease Control’s Immunization Practices Advisory

Committee also recommends that all older persons, particularly those over age 65, receive the

vaccine even if they are otherwise healthy (386).

Nevertheless, estimates based on vaccine sales and

physician surveys suggest that only 10 to 25 percent of elderly people have been vaccinated (397,

485).

Pneumococcal vaccination is a relatively stable technology. Since its approval by the Food

and Drug Administration (FDA) in 1977, the vaccine has undergone one major change: In 1983,

FDA approved a vaccine with capsular polysaccharides of 23 of the 83 pneumococcal types, an

increase from the previous vaccine with 14 types

(545). The 23-valent vaccine provides coverage

against types that cause 90 percent of pneumococcal bacteremia and is marketed by two manufacturers (485). A single injection probably provides effective coverage for at least 3 to 8 years

in elderly adults (485).

The vaccine is an inexpensive technology as

well, though the average Medicare allowed charge

is probably lower than the average physician’s

charge for administering a dose. The average

charge per dose was estimated at $11.37 in 1978,

$4.90 for the vaccine and $6.47 for the physician’s

fee to administer it (485). In 1983, the average

price for the vaccine had actually decreased to

$4.43. If physicians’ charges had increased at the

same rate as the Consumer Price Index over those

5 years (57.9 percent), the average physician’s injection fee would have increased to $10.22. Total average charge for the vaccine in 1983 was

therefore approximately $14.65 per person. Medicare approved charges vary by carrier and geographic region; in 1985, the approved charges of

four carriers ranged from $7.00 to $11.10 (397),

which assumes a low approved charge for injection. One Florida Medicare carrier, for example,

reimbursed for pneumococcal vaccination at a

rate of $5.50 for the vaccine itself plus $2. 00 for

the injection fee (105).

It has been estimated that pneumococcal vaccination for a person age 65 or older could provide on average an additional 0.5 day of healthy

life for about $8.00, or a rate of about $6,000 to

gain a year of healthy life (485). The cost to the

Medicare program was higher, estimated at about

$8,000 per year of healthy life gained because

Medicare does not pay for the total medical expenditures of program beneficiaries and therefore

reaps only part of the savings in treatment costs

due to a reduction in pneumococcal pneumonia.

Medicare pays 100 percent of the allowed

charge for pneumococcal vaccination; beneficiaries are liable for neither deductible nor coinsurance. They are, however, liable for any charges

in excess of the allowed charge if the physician

does not accept assignment. Since pneumococcal

vaccination is a Part B service, hospitals can bill

Medicare for the vaccine separately from inpatient

facility services, which are paid according to

DRGs (485).

The use of preventive technologies for adults,

such as pneumococcal vaccination, has characteristically been low, even among the patients of

physicians who support their use (363). Neither

adults nor the clinicians who care for them have

been attuned to prevention in the way that parents and pediatricians have been for children. Although the extent to which financial incentives can

affect physicians’ decisions to use preventive technologies including vaccines is unknown, pneumo-
88 ● Payment for Physician Services: Strategies for Medicare

coccal vaccination has faced special barriers. Uncertainty surrounded efficacy when the vaccine

was first marketed in 1978. Although the Immunization Practices Advisory Committee strengthened its recommendations in 1984, the initial

situation may have discouraged clinicians from

recommending its use. In addition, people are unlikely to feel threatened by pneumococcal pneumonia because public awareness of the disease is

low. Nor is it clear that clinicians perceive that

elderly people are at higher risk from the disease

(485).

In September 1985, the Health Care Financing

Administration awarded two demonstration projects to organizations that will offer packages of

preventive services to Medicare beneficiaries and

assess the cost-effectiveness of these services over

a 6-year period. Payment for the package is limited to $100 per year. The package to be offered

by the University of North Carolina includes both

pneumococcal and influenza vaccinations (441).

Clinical Laboratory Testing

Clinical laboratory testing is of interest because

it is an example of a technology that has low perunit but high aggregate costs (145) and may at

times be overused or inappropriately used. In

addition, it is a technology that is undergoing

rapid and significant change.

Laboratory tests are ordered by physicians for

a wide variety of reasons. Test results maybe used

to assist in diagnosis, as with fecal tests to detect

colon cancer; to establish clinical baseline values,

as with tests of blood components; to monitor

therapy, as with tests for drug levels in the blood

that can indicate whether a patient is adhering to

a prescribed drug regimen; or simply to reassure

patients that a disease is absent or under control.

An increase in “defensive medicine” may also play

a role in physicians’ decisions to order tests (284).

Total revenues for clinical testing services in the

United States have been estimated at $20 billion,

making it a highly important component of the

health care market (159).

Most clinical laboratories today are highly

automated, and current technological trends are

to make them more so. The increasing automation combined with smaller equipment and a variety of diagnostic test kits has made the performance of most routine tests practical for group

practices and even for individual physicians’

offices. Advances in biotechnology have supported rapid change in testing methods through

the use of monoclinal antibodies and other technologies to enable rapid, simple, and accurate in

vitro diagnostic testing (484), and more dramatic

changes are imminent.

Historically, most testing has been done in hospitals, and about half of it still is (159). Independent and reference laboratories perform about a

quarter of clinical tests. The most significant

change in site of testing, however, is the return

toward testing in physicians’ offices, which accounts for the remaining 25 percent of clinical laboratory tests. Approximately 50 to 60 percent of

all office-based physicians conduct some clinical

laboratory tests in their offices, drawing approximately $5 billion in clinical testing revenues (159).

Many of these physicians are in group practices,

a target market for new technologies such as a

recently developed blood analyzer (114). Some

tests, such as those that indicate the possible presence of colon cancer or diabetes, have even been

developed for home use by patients.

Payment for clinical laboratory testing has been

as dynamic an area as changes in the technology.

Before July 1984, physicians could bill Medicare

for the laboratory services they ordered, regardless of whether the tests were actually performed

in the physician’s office or in an outside laboratory (332). If a physician’s claim indicated that

the test was performed in the physician’s office,

Medicare paid physicians 80 percent of the reasonable charge (less any beneficiary deductible)

(487). If the test was performed outside the physician’s office, Medicare would pay the physician

laboratory’s approved charge plus a $3 handling

fee. The physician would then pay the laboratory.

If the physician did not accept assignment, the

beneficiary in either case would be liable for all

physician charges above the Medicare reasonable

charge. Thus, the total payment to the physician

for the test could be considerably higher than the

laboratory’s charge. Under this system, the physician might reap a financial reward for ordering

the test even though it was actually performed

elsewhere.
Ch. 3—Overview of Alternative Physician Payment Methods Under Medicare: A Framework for Evaluation ● 89

Photo credit: American College of Physicians, HEAL THSCOPE film series

Some devices for clinical laboratory testing, such as

this blood glucose monitor for diabetic patients, have

been developed for home use.

More recent changes in the law have eliminated

this financial reward to physicians who act as intermediaries, increasing the incentives for physicians to perform tests themselves (487). The Deficit Reduction Act of 1984 (Public Law 98-369)

prohibited physicians from billing for laboratory

services unless they are performed in a physician’s

office. It also established Medicare maximum payment levels for laboratory services, for a 3-year

period beginning in 1984, at a fixed percent of the

prevailing fee levels for each service (60 percent

for physicians’ offices, independent laboratories,

and hospital laboratories serving nonhospital patients; 62 percent for hospital laboratory services

to hospital outpatients). These fee levels are adjusted annually according to the Consumer Price

Index; the maximum increase in payments for laboratory services provided from July 1985 through

June 1986 has been set at 4.1 percent (351). In

1987, a national fee schedule, presumably based

on a method other than prevailing charge levels,

will be developed for tests performed in physicians’ offices and independent laboratories (487).

Hospital laboratories, however, will revert to

cost-based payment (as before 1984) unless an

alternative payment mechanism is devised.

The Deficit Reduction Act also changed arrangements regarding assignment for tests in physician’s

offices and independent laboratories. Independent laboratories and hospital laboratories serving

outpatients must accept assignment, but Medicare

will pay 100 percent of the fee schedule, thereby

waiving coinsurance and deductible requirements

for tests in these settings. Physicians who conduct

their own tests may choose to accept or decline

assignment, but if they accept, Medicare will again

pay 100 percent of the fee schedule, waiving coinsurance and deductible. If they decline assignment, of course, the beneficiary is liable for both

the deductible and a coinsurance equal to 20 percent of the Medicare-approved rate for the tests,

plus any excess about the fee schedule amount.

If the physician does not actually perform the test,

Medicare payment to the physician is limited to

a maximum payment of $3 for specimen collection, handling, and test interpretation.

Hospital laboratory services to nonhospital

patients are considered to be identical to independent laboratory services, and assignment is

mandatory. For services to the hospital’s own outpatients, the hospital is constrained by its Medicare provider agreement to accept Medicare payment as payment in full, effectively mandating

“assignment” in these cases as well. In both cases,

Medicare pays 100 percent of the fee schedule rate,

so no beneficiary deductible or coinsurance is necessary (88).

Cataract Surgery

As one of the most frequent surgical procedures

performed on the elderly (69,468), the removal

of cataracts—a clouding of the lens of the eye—

receives considerable attention from the Medicare

program. The practice of cataract surgery has undergone major changes in the past few years. Once

a major hospital procedure that involved a long
90 Ž Payment for Physician Services: Strategies for Medicare

stay and post-surgical vision correction with

heavy spectacles, cataract removal is now a delicate but streamlined procedure that is commonly

performed on ambulatory patients (161). In about

85 percent of cases, it now also includes the implantation of a prosthetic intraocular lens (IOL)

to replace the natural one extracted from the eye

(385). By comparison, in 1980 fewer than half of

cataract extractions included an implantable lens

(385).

Medicare is the foremost payer of cataract surgery; persons over 65, most of whom are covered

by Medicare, account for nearly 83 percent of inpatient cataract extractions (69). Concern has been

expressed that in a few cases, this procedure is

performed unnecessarily in patients whose cata- “

racts did not yet impede their everyday activities

(479).

Cataract surgery is a particularly interesting

procedure because of the wide variety of settings

in which it can be performed under Medicare.

These include hospital inpatient settings, hospital outpatient departments,2 ambulatory surgical

centers (ASCs), and other ambulatory settings not

certified by Medicare as ASCs. (These settings are

often referred to for Medicare purposes as “physicians’ offices, ” although they may look nothing

like the traditional office of a physician in solo

‘Hospital outpatient departments can choose if they wish to be

certified and treated for payment purposes as ambulatory surgical

centers (ASCS). However, once this choice is made the outpatient

department is subject to all of the constraints and payment methods imposed on ASCS (47 FR 34082).

practice. ) Table 3-1 summarizes Medicare reimbursement for cataract surgery in various settings.

Reimbursement for costs associated with cataract surgery fall into three categories. First are the

facility costs, which include surgical equipment,

routine medical supplies, and nonphysician staff.

Second are the professional costs for ophthalmic

surgeons and surgical assistants. Third is the cost

of the IOL, which is reimbursed as a prosthetic

device. In certified ambulatory settings, these

three components are reimbursed separately under Part B. For hospital inpatients, the facility and

IOL costs are reimbursed under the Part A DRG

rate; only professional fees are reimbursed under

Part B. In noncertified ambulatory settings, Medicare Part B pays the approved portion of the physicians’ professional charge and the charge for the

IOL. Medicare will not make any additional payment for the technical (facility and equipment)

charges of physicians performing cataract surgery

in this setting.3

Medicare hospital payment incentives and utilization controls have encouraged the trend toward ambulatory rather than inpatient cataract

surgery. Hospitals are now paid a fixed rate for

all services associated with the procedure when

it is performed on inpatients, giving hospitals an

incentive in many cases to provide it to ambulatory patients instead, for whom costs in most

3Medicare will pay a technical fee to the physician only for certain services, such as radiolo~, that are “incident to” treatment and

have high equipment costs (202).

Table 3-1 .—Medicare Payment and Beneficiary Liability for Cataract Surgery With

Intraocular Lens (IOL) Implantation in Four Sites of Care

Site of care

Ambulatory

Medicare payment Hospital inpatient Hospital outpatient surgical center Other ambulatory

Facility payment . .....1000/. DRG rate 80% reasonable COSt 100%

b class 4 rate o

Physician payment c . . . . 80%. approved charge 100°/0 approved charge 100% approved charge 80°/0 approved charge

Intraocular lens (IOL)

payment . . . . . . . . . . . . Included in DRG rate 800/o approved charge 80°/0 approved charge O

Beneficiary Iiabilityc . . .20°/0 physician’s 20% facility cost + 200/. IOL charge 20°/0 physician’s charge

charge 20% IOL charge + 200/. IOL charge

aEXCePt for those hospital outpatient departments that have chosen to be certified as ambulatory surgical centerS.

blsoof. if intraocular lens implanted.

Clf ph~sician accepts assignment, If not, beneficiary is liable for all charges over Medicare’s wvxoved charge.

SOURCE: 47 FR 34082; 47 FR 34099.
Ch. 3—Overview of Alternative Physician Payment Methods Under Medicare: A Framework for Evaluation ● 91

cases are still reimbursed as incurred. Inpatient

cataract surgery is also being monitored by many

utilization and quality control peer review organizations, the prospective payment system’s utilization control mechanism, which is intended to

prevent hospital admissions of low-risk cataract

patients that would otherwise be profitable for the

hospital.

Unlike hospital outpatient departments, which

are paid according to their costs, ASCs are paid

according to a fixed rate schedule (47 FR 34082).

The facility cost portion of the cataract surgery

procedure in an ASC is reimbursed at a single percase (class 4)4 rate under Medicare Part B. Beneficiaries receiving cataract surgery services in this

setting are subject to neither deductibles nor

copayments.

At present, Medicare physician payment incentives for cataract surgery also tend to reinforce

the trend toward ambulatory surgery. Since beneficiaries who undergo cataract surgery in hospital outpatient or freestanding ambulatory surgical settings are not liable for any copayment (47

FR 34082), physicians who accept Medicare assignment have a more assured reimbursement if

they perform the procedure in these settings.

Beneficiaries probably pay the least when they

undergo cataract surgery performed in certified

ASCs by physicians accepting assignment; in this

setting beneficiaries are liable only for a portion

of the charge for the IOL. In all other settings,

beneficiaries are responsible for the Medicare Part

B deductible and at least a 20-percent coinsurance

of the physician’s charge (in hospital inpatient and

noncertified ambulatory settings) or the facility

and IOL costs (in non-ASC hospital outpatient

sites).

Magnetic Resonance Imaging (MRI)

MRI has gained attention as a potentially powerful new tool to complement the current diagnostic imaging armamentarium. Two characteristics

make it particularly attractive. First, it uses electromagnetic fields instead of ionizing radiation to

4Class 4 has the highest payment level of the four ASC rate categories. If the cataract extraction includes implantation of an IOL,

the ASC received 1.50 percent of the class 4 rate.

Photo credit: Georgetown Medical Bulletin

Medicare payment incentives reinforce the trend for

cataract surgery, shown here, to be performed

in ambulatory settings.

produce images, so it lacks the ionizing radiation

dangers of traditional X-ray and X-ray computed

tomography (CT) scanning. Second, MR images

are not distorted by signals from bone, a problem with conventional X-rays. But the powerful

magnets that make MRI a novel and promising

technology come at great expense. The cost of

MRI, the logistical problems involved in providing it, and the uncertainty about the scope of its

future applications have acted to slow its diffusion (234,449).

Although MRI holds tremendous potential to

advance diagnostic science and to replace other

riskier modalities, it is largely unclear what the

clinical role of MR imaging will or ought to be

(234). At present, there are special indications for

MRI only for anatomic areas that have never been

adequately imaged by conventional modalities.

For example, MRI is the modality of choice for

scans of the posterior fossa region of the skull and

the cervical spine and is a promising modality for

imaging the pelvis, where the absence of ionizing radiation is particularly important (234). In

the near future, most clinicians are likely to view

MRI as a complement rather than as a substitute

for X-ray CT or other diagnostic technologies.

It is possible for the use of MRI to skyrocket

as its uses become better defined. The central

nervous system, as the most heavily explored area

to date, offers the greatest potential for extensive
—

92 ● Payment for Physician Services: Strategies for Medicare

MRI use. Some researchers already consider MRI

the modality of choice for initial screening of suspected brain disease. MRI’s well-documented ability to delineate the plaques of multiple sclerosis

may lead to its use for nonspecific complaints,

mostly for patients younger than most Medicare

beneficiaries. If MR technology improves as expected in cardiac and tumor imaging, the potential for widespread applicability in a Medicare

population would also grow. At present, however, much of the clinical experiences is anecdotal,

not from controlled trials (234).

MRI at this point in its development is a classic case of diagnostic methods’ outstripping therapeutic options. Obtaining a definitive diagnosis

may be a desirable outcome in itself, but therapeutic limitations may make it unlikely that diagnosis will change the course of a patient’s illness.

For cerebella and brainstem infarctions, for example, which by virtue of their location in the

posterior fossa offer indications for MRI, little can

currently be done to alter the prognosis for most

patients (234). MRI has the potential to be useful

in certain diseases such as some tumors for which

treatments have been more successful, and greater

knowledge about disease processes may ultimately

lead to therapeutic advances. However, because

the value of MRI in altering therapy or improving

quality of care has not been adequately studied,

it is difficult to ascribe an appropriate position

for MRI in the provision of good quality medical

care (234).

Another major source of uncertainty to MRI

purchasers concerns technical developments (449).

Prospective buyers must choose among MRI systems with different types of magnets (resistive,

permanent, and superconducting) and different

magnet strengths, and considerable debate surrounds the relative efficacy and cost effectiveness

of the different systems. The costs of equipment

and site preparation range from about $1.7 million to $2.4 million, depending on the type and

field strength of the magnet (447). An additional

complicating factor is that magnetic resonance is

also used to perform MR spectroscopy, which indicates relative concentrations of different compounds in tissues or organs. MR spectroscopy requires high field strengths and, although it has

great promise, it is still in a research phase and

its clinical importance is unclear (449). Providers

do not want to purchase an unnecessarily expensive imager, but neither do they want to purchase

a (still costly) less expensive device that will be

outmoded in a few years. Nonetheless, a variety

of physicians, including radiologists, neurosurgeons, neurologists, and cardiologists, envisage

MRI as an important future component of their

practice and are learning to perform it (234).

Governmental policies have most likely slowed

the diffusion of MRI and affected its distribution.

By the end of 1984, 4 years after MRI’s introduction into the United States, 108 MRI units were

installed in the United States, 39 percent in ambulatory settings (449). MRI diffusion has been

occurring during a period when payment for inpatient services has been undergoing great change.

Medicare’s payment of operating expenses by

DRGs has constrained its payments to hospitals

and given hospitals a financial disincentive to use

technologies such as MRI that are likely to increase the cost of caring for patients. Although

capital expenses connected with the purchase and

installation of equipment have continued to be

paid on a cost-reimbursement basis, approaches

are being developed to include capital in the prospective payment system. In addition, as mentioned above, State certificate-of-need laws for the

most part apply to hospitals but not to ambulatory sites, such as physicians’ offices or ambulatory diagnostic imaging centers. Since both payment and planning policies constrain hospitals

much more than ambulatory settings, the predictable result is an increased tendency to install expensive new technologies such as MRI outside of

hospitals. It is noteworthy that after a comparable period of diffusion in the United States, 18 percent of X-ray CT scanners v. 39 percent of MRI

units were in nonhospital settings (449).

Total charges for MRI scans, consisting of a

technical (facility) fee and a professional (physician) fee, have ranged from $450 to $1,000 (234).

There is virtually no Medicare experience in paying for MRI. HCFA has approved paying for the

use of MRI for certain purposes only since November 22, 1985 (20), although a few Medicare

carriers apparently chose to accept MRI claims

before this date (234). At present, the use of MRI

does not increase payment to ASCs or to hospi-
Ch. 3—Overview of Alternative physician payment Methods Under Medicare: A Framework for Evaluation • 93

tals using it to diagnose inpatients. s HCFA is developing guidelines for carriers regarding paying

physicians a technical as well as a professional fee

for MRI performed in nonhospital settings (55).

Eighty percent of the top 30 commercial insurance companies were paying for MRI services on

a routine or case-by-case basis in January 1985

(234), but only 20 percent of the 70 Blue CrossBlue Shield plans were paying for MRI in July

1985 (210).

Extracorporeal Shock Wave

Lithotripsy (ESWL)

Like MRI, ESWL is a new and expensive procedure that has excited considerable interest. Unlike MRI, its costs and applications are relatively

simple to define. It has only recently been approved as a reimbursable procedure by Medicare

(301), and most carriers do not yet have any experience paying for it. Its cost-saving potential,

however, has made most payers—including Medicare —eager to include it as a covered service.

ESWL uses shock waves produced outside the

body to disintegrate kidney and other upper urinary stones, eliminating the need for traditional

open surgery in most cases (18). The current

model of the device used for ESWL is large and

expensive to purchase and requires its own facility. Nevertheless, if used by enough patients (over

1,000 per year), it results in a per-patient treatment cost considerably lower than that for open

surgery, primarily because it requires a very short

hospital stay (18). Some centers even offer ESWL

to ambulatory patients.

Because of anticipated lower costs per treatment, ESWL promises to be a profitable technology for those hospitals that provide it, particularly if these cases are reimbursed at the same rate

as open surgery. However, the high fixed costs

of the extracorporeal lithotripter (about $2 million for purchase and installation of the current

model) make it less expensive than the alterna-

‘At present, the use of MR1 itself does not increase Medicare payment to a hospital, even though use of MRI for a patient may increase that hospital’s costs. A possible alternative form of payment

for MRI, which has been recommended in principle by the Prospective Payment Assessment Commission, is a budget-neutral DRG addon for cases in which MRI is used.

tives only at high volumes of use. Because the

number of kidney stone patients is limited, it is

probable that more devices will become available

than are justified strictly by the number of patients who would have undergone stone surgery

otherwise. If this is the case, the eligibility criteria

for ESWL might be expanded to include many patients with less serious stones in addition to those

otherwise eligible for surgery, leading to an increase in demand for the service (431). In the future, the technology itself may be applied to patients with lower urinary stones and gallstones,

but the present device is not approved by the Food

and Drug Administration for these purposes (379).

Medicare reimbursement for ESWL is similar

in structure to that for surgery. Medicare’s share

of the capital costs of its purchase and installation are reimbursed at cost through Medicare Part

A, though it is possible that these costs will be

incorporated in the DRG rate in the future. The

hospital’s costs of operating the device and of caring for lithotripsy patients are reimbursed (also

under Part A) at the rate of the applicable DRG

(#323 or #324 if no adjunct surgical procedures

are performed). Physicians’ charges for performing the procedure, of course, are reimbursed under Part B.

ESWL technology is undergoing rapid change.

Although only one manufacturer, Donnier Systems, currently has approval from the Food and

Drug Administration to market the device, a number of other companies are developing competetive devices. Medicare’s per-case hospital payment

system, which presently pays for ESWL at a DRG

rate that is much lower than the rate for open surgery for kidney stones, makes these alternatives

highly promising and has probably helped stimulate their development. Only a few hospitals can

provide extracorporeal lithotripsy; fewer than 60

devices will be in place in the United States by

the end of 1985 (378). A few nonhospital ambulatory centers are providing ESWL, but it is not

an approved procedure in ASCS, and Medicare

will not pay for its facility-related costs in this

setting.

Other alternatives to open surgery besides

ESWL are also expanding rapidly. Endoscopic

procedures that can withdraw kidney stones

through a narrow tract, rather than a large inci-
94 ● Payment for Physician Services: Strategies for Medicare

sion, are proliferating simultaneously with ESWL.

Like traditional surgery, these procedures require

a surgical suite and require specialized endoscopic

instruments costing up to $50,000 as well (3).

A major issue at present is what and how physicians should be paid for ESWL. More specifically, payers are questioning whether physicians

should be paid the same for performing ESWL as

for the open surgery it replaces, since ESWL requires additional training on the part of practicing physicians but appears to take less time to perform (18,431). The few carriers thus far with any

ESWL reimbursement experience are reimbursing

the procedure at rates ranging from approximately

$1,200 to $2,000, at or slightly lower than the surgical rate, In most cases, the rates were based on

consultations with outside urology experts and negotiations with the respective lithotripsy centers

(431). HCFA is developing guidelines to help carriers establish an approved charge for the service

(431).

For the most part, kidney stone surgery, like

most other surgical services, is reimbursed as a

package that includes some preoperative and postoperative care by the urologist. Under the present

system, an effort to reimburse for lithotripsy at

a lower rate might stimulate some “unbundling,”

or redefinition of the service that results in physicians’ billing for the procedure separately from

some of the preoperative or postoperative visits

now included in a single bill. Conversely, if ESWL

is reimbursed at the same rate as major surgery,

the physicians who perform it will reap a considerable profit. The existence of ESWL in a few regional centers, if it continues, could result in some

form of price level negotiations between carriers

and urologists performing ESWL, regardless of the

structure of physician payment (431).
Chapter 4

Modifications to Customary,

Prevailing, and Reasonable

Charge Payment

What’s past is prologue.

—William Shakespeare, The Tempest
Page

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97

Implications of Alternative Methods of Modifying CPR. . . . . . . . . . . . . . . . . . . . . 98

Controlling Approved Charges for All Services . . . . . . . . . . . . . . . . . . . . . . . . . . 100

Controlling Approved Charges for Selected Services . . . . . . . . . . . . . . . . . . . . . . 103

Negotiated or Discounted Fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 112

Technological Change . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114

Administrative Feasibility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115

Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 117

List of Tables

Table No. Page

4-1. Methods for Modifying CPR Payment Intended To Control Medicare

Expenditures or To Reduce Variations in Reimbursement for Services . . . . 9$

4-2. Medicare Approved Charges and Assignment Rates for

Physicians’ Services, by Type and Place of Service, 1981 . . . . . . . . . . . . . . . 104

4-3. Medicare Approved Charges, Percent Distribution of

Approved Charges, and Assignment Rates for Physicians’ Services,

by Combinations of Place and Type of Service, 1981 . . . . . . . . . . . . . . . . . . . 105

4-4. Medicare Weighted Mean Prevailing Charges for the Five Most

Common Services, Specialists/Nonspecialist, Calendar Year 1982 . . . . . . . . 108
Chapter 4

Modification to Customary, Prevailing,

and Reasonable Charge Payment

INTRODUCTION

This chapter examines possible changes to Medicare’s customary, prevailing, and reasonable

(CPR) charge method’ of paying physicians that

would continue the historical pattern under CPR

of computing distinct charges for individual physicians. Most of the modifications are intended

to constrain the rate of growth of expenditures

for physician services. 2 Some of the changes identified could also reduce the substantial variation

in Medicare payment rates for selected services.

As noted in chapter 2, the variations in Medicare

payment rates for some services suggest possible

inequities in the distribution of benefits and inefficiencies in the program.

From the start, Medicare’s CPR payment system has included several features intended to limit

program expenditures for physician services. One

such feature is a restriction on the amount that

Medicare pays for physician services. Medicare’s

approved charge3 for a physician’s service is the

lowest of the physician’s billed (or actual) charge,

the physician’s customary charge, or the prevailing charge in a locality. Indeed, in fiscal year 1984,

Medicare-determined approved charges were, on

average, 24 percent lower than physicians’ billed

charges (69). A second feature of Medicare’s original payment system intended to limit program expenditures is the requirement that beneficiaries

assume responsibility for a portion of physicians’

approved charges, namely, by paying a deductible and coinsurance. A third feature of Medicare’s

original payment system that has cost-containment attributes is assignment. Medicare expend-

‘The CPR method, the principal method that Medicare uses to

pay physicians, is described in app. C along with other facets of

Medicare’s physician payment process.

‘The chapter considers controlling Medicare’s expenditures for

physician services by controlling Medicare’s payment to physicians

and does not consider other means, such as revising beneficiary

payments.

3Under Medicare, reasonable charges, approved charges, and allowed charges are synonymous terms. Approved charges will be

the term used in this chapter.

itures are not directly affected by assignment, but

by accepting assignment, physicians are in fact

accepting a reduction in the payment for any service for which their billed charge exceeds Medicare’s approved charge.

Medicare has made further attempts to constrain program expenditures by amending CPR

in various ways. Past approaches have included

temporarily freezing all fees, as mandated by the

Deficit Reduction Act of 1984 (Public Law 98-

369); lowering the percentile at which all prevailing charges are set; and applying the Medicare

Economic Index (MEI) to limit annual increases

in all prevailing charges. Although Part B expenditures have risen despite these measures, they

might have increased more if controls had not

been imposed.

Medicare has not in the past attempted to moderate the growth in program expenditures or to

redress perceived imbalances in relative payments

by reducing differentials in payment rates for

selected services. As noted in chapter 2, Medicare

payment rates tend to be higher for procedural

and inpatient services than for nonprocedural and

ambulatory services, reflecting the program’s benefit package that emphasizes high-cost acute and

inpatient care. The rates also tend to be higher

for specialist and urban services than for generalist and rural services in order to reflect local

differences in physicians’ fees.

Another untried approach in reducing the rate

of growth in program expenditures is for Medicare to give beneficiaries the option of receiving

care from preferred provider organizations (PPOs).

Medicare could take advantage of the increasingly

competitive market and contract, either directly

or through carriers or other entities, with only

those physicians or groups of physicians who

would agree to accept Medicare payments below

the level of approved charges as payment in full.

97
98 • Payment for Physician Services: Strategies for Medicare

This chapter explores, in the context of today’s expenditures and modifying perceived imbalances

conditions, variations of the CPR method previ- in Medicare payment rates for services that vary

ously or currently used by Medicare to restrain by type, site, specialty, and geographic location.

program expenditures for physician services. It Negotiated or discounted fees are also considered

also analyzes the potential for controlling program as a cost-containment approach.

IMPLICATIONS OF ALTERNATIVE METHODS OF MODIFYING CPR

Under CPR, the rate of growth in Medicare ex- Under both methods, assignment (physicians’ acpenditures for physician services could theoreti- ceptance of Medicare’s approved charges as paycally be restrained by controlling approved charges ment in full) could be voluntary or mandatory,

for all or selected services (see table 4-1). Approved and mandatory assignment could apply to some

charges could be controlled by changing the man- or all services. b

ner of updating prevailing or customary charges,

for example, by freezing them.4 Approved charges

could also be controlled by lowering the percentile for calculating prevailing charges, which is

now at the 75th percentile of customary charges.5

.— -.——

‘A freeze on physician charges is but one way of changing the

manner of updating charges. Other ways include changing the frequency of updating customary or prevailing charges and capping

prevailing charges.

‘Another method of controlling the rate of growth in Medicare

expenditures would be to reform Medicare’s coding system, which

encourages physicians to bill separately for each activity undertaken

in the care of the patient and may stimulate coding for more complex services. Coding problems are found in all fee-for-service methThe implications of controlling Medicare approved charges for all services and for selected

services are evaluated below with respect to dimensions indicative of the performance of the

health care system: cost and efficiency, quality

of care, access, technological change, and administrative feasibility.

——.——

ods, and the issue is discussed in ch. 6. In addition, the possibility

of imposing an aggregate expenditure cap is discussed in connection with fee schedules in ch. 5.

bThe analysis that follows assumes the retention of voluntary assignment unless otherwise mentioned.

Table 4-1 .—Methods for Modifying CPR Payment Intended To Control Medicare Expenditures or

To Reduce Variations in Reimbursement for Services

Change manner of updating

prevailing and/or customary charges Change percentile for calculating

Scope of change (e.g., by freezing) prevailing charges

All servicesa 

. . . . . . . . . . . . . 1. Freeze prevailing and/or customary 1. Lower percentile for calculating prevailing

charges for all sevices charges for all services

Selected services . . . . . . . . 2. Freeze prevailing and/or customary 2. Lower percentile for calculating prevailing

charges for selected services such as: charges for selected services, such as:

● procedural, ● procedural,

● inpatient, ● inpatient,

● specialist, and ● specialist, and

● urban ● urban

3. Freeze prevailing and/or customary 3. Lower percentile for calculating prevailing

charges for selected services such as: charges for selected services, such as:

● procedural, ● procedural,

. inpatient, ● inpatient,

● specialist, and ● specialist, and

● urban ● urban

and increaseb prevailing and/or and raise the percentile for calculating the

customary charges for other services, prevailing charge for other services,

such as: such as:

● nonprocedural, ● nonprocedural,

● ambulatory, ● ambulatory,

● generalist, and ● generalist, and

● rural ● rural

aModifications that affect all charges for services will not reduce variations in charges between services.

bs uch ~elective increases can be accomplished by an add-on to frozen charge screens.

SOURCE: Office of Technology Assessment, 1985.
Ch. 4—Modifications to Customary, Prevailing, and Reasonable Charge Payment ● 99

The implications of controlling approved charges

for selected services are also examined with respect to redressing perceived payment imbalances

by type of service, by site of treatment, by physician specialty, and by geographic location (see

table 4-l). Controlling Medicare payments for

selected services by reducing the variation in approved charges among them could also pertain

to constructing a fee schedule (see ch. 5). Indeed,

conversion to a fee schedule would afford an opportunity to make any corrections in relative approved charges.

None of the modifications to CPR payment discussed in this chapter would change the financial

incentives that CPR gives physicians to provide

additional services to generate income. In deciding whether or not to provide a service, physicians would be likely to respond to changes in

payment level or in relative payment rates. Moreover, any decrease in the growth of Medicare expenditures would be of short duration. CPR payment per se and the modifications discussed in this

chapter encourage physicians who respond to financial incentives to raise their billed charges to

beneficiaries, since such increases are later reflected in Medicare’s approved charges.

A confounding factor in examining the effects

of controlling approved charges on costs and

other dimensions is the uncertainty surrounding

the relationship between lower payment rates and

changes in the volume of services beneficiaries receive (see ch. 2). How physicians and beneficiaries would respond to lowered approved charges

is uncertain. As suppliers of services, physicians

would be expected to react to lower payment rates

by providing fewer services. But physicians also

exert control over services used and might seek

to maintain their incomes by providing or billing for additional or more highly priced services.

Lowering approved charges would lower beneficiary coinsurance payments, and if out-of-pocket expenses fell as a result, beneficiaries would be

expected to seek more care. But if assignment continued to be voluntary, increases in beneficiaries’

out-of-pocket expenses for unassigned liability

would most likely exceed reductions in coinsurance. The decrease in beneficiary coinsurance

would apply to only 20 percent of the reduction

in approved charges. Thus, if Medicare reduced

the approved charge for a service from $100 to

$80, coinsurance would be reduced from $20 to

$16 (i.e., 20 percent of the $20 reduction). If a

physician refused to take assignment with the

lower approved charge, he or she might continue

to bill the beneficiary $100. Beneficiary unassigned

liability would then be $20. Despite the $4 decrease in coinsurance, total out-of-pocket costs

for the beneficiary would increase to $36. Only

if the physician billed between $81 and $85 would

the decrease in cost-sharing be more than the increase in unassigned liability. Thus, beneficiary

out-of-pocket expenses might well increase with

lower approved charges.

There is no theoretical or empirical evidence to

indicate that physicians would increase their

charges to non-Medicare patients if Medicare lowered approved charges for Medicare patients.

Indeed, non-Medicare patients might not be willing to purchase physician services if fees to them

were raised (188,357), particular in an era of increasing physician supply. But physicians might

shift their time and provision of services to nonMedicare patients, thus increasing non-Medicare

aggregate expenditures.

Lowering approved charges would lower beneficiaries’ financial access to care. Reducing the

ratio of approved to billed charges has reduced

assignment rates (158,184,315,357,394). The additional costs associated with seeing physicians

who do not take assignment would diminish access to care. Access could also decline if, as a result of lower Medicare approved charges, physicians chose not to treat Medicare patients for

certain services.

A decrease in the assignment rate could also indirectly affect quality by curtailing access. If

access to appropriately used services, e.g., extracoporeal shock wave lithotripsy (ESWL) for certain renal stones, was reduced, quality could be

lowered. On the other hand, if access to inappropriately used services, e.g., routine skull X-rays

for minor injuries, was reduced, quality could be

improved. In addition, lower approved charges

could directly affect quality by influencing the actions of some physicians who take assignment.

Physicians might include financial considerations
100 • payment for physician Services: Strategies for Medicare

in choosing and providing services where the medical and ethical decision is unclear (194). For example, some physicians might spend less time with

Medicare beneficiaries and more time with patients for whom their time is more highly paid.

Controlling Approved Charges for All

Services

A freeze on fees for physician services could be

designed and implemented in a variety of ways.

Variables include charges to be updated (e.g., the

prevailing or the customary and the prevailing),

the frequency of updating, and the method of updating. For example, customary and prevailing

charges could be frozen for 2 years, and the updates could allow increases only in billed charges

for the first year. There would also be discretion

about the concept of participating physicians (see

ch. 2). Although the specifics of a particular freezing method would influence its effects, the discussion below for the most part is confined to the

general implications of a fee freeze.

Lowering the percentile for calculating prevailing charges could also be accomplished in a number of ways. One strategy would be to lower the

current prevailing percentile and retain the current MEI. Another strategy, to lower the current

prevailing percentile and eliminate the current

MEI, would decrease provider and beneficiary

confusion and moderate the uneven effects of the

index on approved charges (see ch. 2).

Costs and Efficiency

As noted above, short-term savings to the Medicare program could theoretically be achieved by

freezing charges for all services. But the empirical research on the U.S. and Quebec health care

systems suggests that this approach has been ineffective in constraining the rate of growth in expenditures for physicians’ services (158). These

research findings are not conclusive, since an increase in the number and complexity of services

billed may have masked the effects of constraining payment rates on expenditures. The mechanism driving these changes in service quantity and

intensity is a matter of uncertainty and debate.

Explanations put forward include physician-induced demand; patient-initiated demand; a shift

from non-Medicare to Medicare patients; changes

in physician opportunity costs; and changes in

billing practices, such as billing for a more complex procedure than actually provided or billing

separately for items customarily included under

one procedure (see ch. 2) (28,158,259).

Simulations have examined the effect of the

MEI on controlling approved charges and program costs (see Paringer in box 4-A). The data

have to be extrapolated with caution, since the

MEI “caps” payment and is only partially analogous to a freeze. The MEI, a looser form of control than a freeze, allows for inflation in the general economy and in physician practice costs. The

index has had a decided effect on lowering the annual increase in the prevailing charge for some

procedures. Nonetheless, a large percentage of the

increase in Medicare program costs—47 percent

from 1980 to 1983—was due to higher prices for

individual services (70).

The effect of the physician fee freeze enacted

under the Deficit Reduction Act of 1984 on Medicare costs and other dimensions of beneficiaries’

health care has yet to be measured and reported.

Preliminary evidence shows a reduction in the rate

of growth in expenditures per beneficiary for physician services for fiscal year 1984 (84). These data

might reflect changes in the health field, such as

changes in Medicare’s payment methods for hospital services or an increasing competitive environment. Whether changes in market incentives

resulting from an increased physician supply and

from alternative organizational and delivery systems would favor decreases in approved charges

and would be strong enough to overcome traditionall Patterns of physician practice is conjectural.

Lowering the percentile at which prevailing

charges are calculated could produce short-term

reductions in the growth of Medicare expenditures. If the prevailing percentile is lowered from

the 75th to, for example, the 50th, Medicare expenditures for physician services would be reduced to the extent that approved charges are currently higher than the 50th percentile, assuming

that the volume and complexity of services are

not increased. The magnitude of the decrease in

the rate of growth cannot be determined. To the

extent, if any, that the volume of services in-
Ch 4—Modifications to Customary, Prevailing, and Reasonable v’~=’sf= ‘ =1’~-.. ‘-”
102 ● Payment for Physician Services: Strategies for Medicare

creased, the decrease in the growth of Medicare

expenditures would be lessened.

In some cases, the magnitude of Medicare savings would be influenced by the MEI. For those

procedures with indexed prevailing charges (the

prevailing charge adjusted by the MEI) now at or

above the 50th percentile, the MEI would have

no effect on the amount of short-term savings.

For procedures with indexed prevailing that are

lower than the 50th percentile, maintaining the

MEI after reducing the prevailing percentile to the

50th would protect short-term savings. There

would be no additional savings for services for

which the indexed prevailing is now below the

50th percentile. If the MEI was eliminated, however, short-term program savings would be less

because of an increase in payments for procedures

that had been capped below the 50th percentile

by the MEI.

Even in the short term, establishing the prevailing at the 50th percentile would not decrease the

prevailing charge for those procedures that have

a very small spread of customary charges between

the 50th and 75th percentile. In effect, the 50th

and 75th percentiles of customary charges are the

same for such services. Anecdotal evidence indicates that a small spread is typical of procedures

that are controlled by a physician specialty, e.g.,

cardiac nuclear procedures (347), and of specific

localities (521a).

Long-term savings produced by lowering the

prevailing percentile to the 50th percentile are unlikely. Over time, an increase in billed charges

would lead to increased prevailing charges, which

in time could be as high as the indexed prevailing would have been.

Access and Quality

A decrease in assignment rates in response to

lowered Medicare payment rates for all physician

services would decrease beneficiary financial access to care. Access would also be negatively affected if physicians choose to provide a service

only to non-Medicare patients. For example, the

use of magnetic resonance imaging (MRI) and

ESWL for Medicare beneficiaries would depend

on the level of Medicare’s approved charge. If

physicians perceived the lower approved charge

as providing insufficient net revenues, they could

either refuse assignment or orient use to patients

with private, higher paying insurance (234,431).

An exception might be made in providing MRI

for certain elderly patients with specific conditions

that are the target of research protocols, but in

that case, access would be sporadic. Decreasing

access to ESWL could have cost implications for

the Medicare program, because ESWL might be

less costly than surgery for certain renal stone care

(431).

There are effects on access and quality unique

to the specifics of the freezing method. Physicians’

reaction to a comprehensive freeze would depend

both on the effect of the freeze on their real incomes and on the medical economic environment.

The longer the freeze lasted, the greater the number of physicians who would be hurt financially

and the greater the number of physicians who

would be likely to refuse assignment.

A freeze on approved charges could also affect

access and quality through the method of updating charges, the relationship of assignment to updating, and the extent of assignment. If physicians

were required to accept assignment for all services during a freeze, fewer physicians would accept assignment during a freeze period than if

assignment could also be accepted on a claim-byclaim basis.

If there was a participating physician component comparable to that of the freeze imposed by

the Deficit Reduction Act of 1984 (see ch. 2), only

nonparticipating physicians could refuse assignment during the freeze. However, future access

could be decreased to the extent that participating physicians refused to renew their participation agreements. In a strongly competitive area,

physicians might be more willing to accept assignment and renew participation agreements. The

care provided by participating physicians might

not change, because their charges will be updated

at the end of the freeze. Unless the net revenues

for discretionary services were generous at the onset of the freeze, the clinical decisions of nonparticipating physicians for such services taken

on assignment might be affected.
Ch. 4—Modifications to Customary, Prevailing, and Reasonable Charge Payment ● 103

Controlling Approved Charges for

Selected Services

The variation in approved charges for selected

services could be reduced by lowering approved

charges for procedural, inpatient, specialist, and

urban services (higher priced services) either with

or without raising the approved charges of nonprocedural, ambulatory, generalist, and rural

services (lower priced services). Both approaches

could modify perceived imbalances in approved

charges among such services.

Reducing the Variation in Approved Charges

by Type and Site of Service

The concept of reducing the perceived disparity in approved charges between procedural and

nonprocedural services is initially attractive in

considering Medicare expenditures. Some evidence indicates disproportionate differences in the

cost and the price of certain procedural services

(46,227). When new technologies, in particular

equipment-intensive and surgical procedures, are

introduced, they are often priced at a high level

(403,424,588). Initially, a high fee maybe appropriate because the new procedure may require special skills and much professional time. Although

experience and technological improvements over

time often lower the level of expertise and amount

of time needed to perform the procedure, initial

payment levels are not reevaluated. In this regard,

it would be informative to trace the evolution in

prices over time for MRI and ESWL, which were

both approved for Medicare coverage in 1985.

The establishment and maintainence of high prices

for services whose costs have declined over time

is thought to have contributed to the wide differences in approved charges for procedural and nonprocedural services.

Medicare has also continued to provide more

generous payment for inpatient services than for

services in other sites. This policy has not kept

pace with recent Medicare initiatives, e.g., increased coverage for home health services, that

encourage out-of-hospital care. The comparability of inpatient and ambulatory services, particularly visits, is still undecided. A rationale for paying more for visits in a hospital than in an office

is that the visits differ. Patients in hospitals tend

to be sicker than ambulatory patients and require

more physician attention. On the other hand,

physicians do not pay overhead costs for treating patients in hospitals, although their time and

transportation costs may be higher than when caring for patients in their offices.

Lowering approved charges for procedural

services or inpatient services over which Medicare has market power could be an interim step

in reducing the growth of Medicare expenditures

or could be an independent modification of CPR.

Medicare in 1983 had 74 percent or more of the

market share for seven high-priced surgical procedures, including cataract surgery, and 40 percent or more of the market share for four highvolume diagnostic procedures (see table 2-12 in

ch. 2) (69). Furthermore, the elderly accounted

for anywhere between 26 and 37 percent of the

performance of nine other surgical procedures and

five other diagnostic and therapeutic procedures.

Costs and Efficiency .—The fact that approved

charges for procedural services and inpatient services constitute a major part of Medicare’s expenditures for physician services suggests that reducing such charges has the potential for restraining

the overall rate of increase of Medicare expenditures. National data for 1981 indicate that considerably more than half of Medicare’s approved

charges for physician services nationwide are for

procedural services and that almost 64 percent of

these charges are for services provided in inpatient

settings (see table 4-2). 7 If approved charges for

inpatient medical care (primarily visits), which

represent 20.6 percent of Medicare’s approved

charges for physician services (see table 4-3), and

payment for all procedural services, which represent 48.2 percent of these charges (see table 4-

2) were constrained, 68.8 percent of Medicare’s

approved charges would be affected.

How reducing approved charges for procedural

and inpatient services would affect Medicare costs

is not clear, in part because the effect of price on

use of services is still a matter of debate.8 If the

‘South Carolina 1983 Part B claims data suggest that an even

higher percentage (66 percent) of approved charges are for procedural services (247).

8However, the relation of use to expenditures is clear from Medicare Part B data from 1975-1983. Figures on the contribution of increased volume per enrollee to the growth in approved charges for

surgical, clinical laboratory, diagnostic, and X-ray services ranged

from 39 to 44 percent; the increase in volume of services per enrollee for medical care (primarily office visits) was 22 percent (248).
104 . Payment for Physician Services: Strategies for Medicare

Table 4-2.—Medicare Approved Charges and Assignment Rates for Physicians’ Services,

by Type and Place of Service, 1981

Approved charges Percent of Assignment

(in $000s) approved charges rate

Type Of Service

Nonprocedural services:

Medical care. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Consultations a 

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Subtotal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Procedural services:

Surgery . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Diagnostic radiology. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Diagnostic iaboratory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Radiation therapy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Anesthesia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Assistant-at-surgery . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Subtotal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Other:

Other medical services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total for all services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Place of service:

Office . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

lnpatient hospital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Outpatient hospital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Home. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

independent laboratory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Skilled nursing facilityc 

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total for all services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$4,517 40.2%40

381 3.4

4,898 43.6

$3,635

865

834

151

535

196

6,216

$ 127

32.3%

7.7

7,4

1.3

4.8

1.7

48.2

1.2%

$11,241 100.0%

$3,203 28.5%

7,144 63.6

532 4.8

71 0.6

39 0.4

150

102 0.9

$11,241 100.O%

51.4%

59.7

47.6%

57.5

48.1

62.3

44.7

48.1

61.9%

50.5%

37.1%

53.7

68.7

57.0

40.1

83.2

79.3

50.570

consultations involve nonprocedural services primarily.

bother m~ical~ewice$in~lude the rental of durabiemedi~al equipment, the purchase of durable medical equlprnerlt,tfleuse of ambulance services, and the rental

and saleof Internal and external prostheses and supplles. CThlSCategO~ also includes physicians’services rendered in nonskilled nursin9 homes.

NOTE: Columns may not add tolOO.O percent duetoroundlng.

SOURCE: l. Burneyand G. Schiebe~”Medicare Physicians’ Services: The Composition of Spending and Assignment Rates/’ He+WrCare Firrartcing Review, forthcoming. The original table listed service by type of service without categorization as nonprocedural and procedural

volume of services increased, lowering approved

charges for procedural and inpatient services—

with or without raising approved charges for nonprocedural and ambulatory services-could increase Medicare costs. If the volume of services

did not increase, lowering approved charges for

procedural and inpatient services could decrease

the rate of growth in total Medicare expenditures.

If approved charges for nonprocedural and ambulatory services were raised simultaneously, the

growth in Medicare expenditures would increase

or decrease depending”on the magnitude of the

change in approved charges and in the use of each

type of service. However, the proportion of procedural to nonprocedural and inpatient to ambulatory services among physician services is

unknown and might change with a change in approved charges.

In addition, the practice of medicine is not always precise. There is general agreement about

the need for some services for specific conditions

(e.g,in vitro cultures for suspected urinary tract

infections) and the need for providing services in

certain sites (e.g., treatment for hip fractures in

the hospital). Changes in approved charges would

be unlikely to affect the provision of such services. For many presenting conditions, however,

physicians must use their judgment in choosing

among possible diagnostic and therapeutic services and sites. The finding that the cystoscopic rate

for urologic conditions in one medical market area

in Maine is more than double the rate for the State

as a whole, while the cystoscopic rate in another

medical market area is only about half the average, for example, indicates the discretionary nature of cystoscopy (568). A procedure that can

be performed successfully either as an ambulatory
Table 4-3.—Medicare Approved Charges, Percent Distribution of Approved Charges, and Assignment Rates for Physicians’ Services,

by Combinations of Place and Type of Service, 1981

Inpatient Outpatient Skilled nursing

All places Office hospital Home hospital Independent facility Other places

Approved charges (in $000s)

All types of services . . . . . . . . $11,239.8 $3,202.8 $7,143.9 $71.0 $532.2 $39.0 $150.1 $100.8

Medical care . . . . . . . . . . . . . 4,516.7 1,780.9 2,319.3 60.2 181.5 —a 127.4 47.4

Surgery . . . . . . . . . . . . . . . . . . 3,643.4 365.1 3,125.8 2.0 137.9 —a 3.2 0.4

Consultation . . . . . . . . . . . . . 381.0 63.8 304.0 0.6 7.1 —a 5.3 0.2

Diagnostic radiology . . . . . . 864.9 358.4 385.4 1.0 110.5 1.0 8.1 0.5

Diagnostic laboratory. . . . . . 834.1 536.9 222.6 2.4 27.2 38.0 2.9 4.1

Radiation therapy . . . . . . . . . 150.9 47.2 53.9 —a 47.0 —a —a

Anesthesia. . . . . . . . . . . . . . . 535.0 2.1 529.6 0.1 3.1 —a —a —a

Assistant-at-surgery . . . . . . . 195.8 2.0 192.2 0.1 1.5 —a —a —a

Other medical services . . . . 127.0 46.4 11.1 319.3 16.4 —a 3.2 45.3

Percent distribution of approved charges

All types of services . . . . . . . . 1OO.OO

/O

Medical care . . . . . . . . . . . . . 40.1

Surgery . . . . . . . . . . . . . . . . . . 32.3

Consultation . . . . . . . . . . . . . 3.4

Diagnostic radiology . . . . . . 7.7

Diagnostic laboratory. . . . . . 7.4

Radiation therapy . . . . . . . . . 1.3

Anesthesia. . . . . . . . . . . . . . . 4.8

Assistant-at-surgery . . . . . . . 1.7

Other medical services . . . . 1.1

28.50/o

15.8

3.2

0.6

3.2

4.8

_ b

—b

0.4

63.6%

20.6

27.8

2.7

3.4

2.0

0.5

4.7

1.7

0.1

0.6%

0.5

— b

— b

— b

— b

— b

— b

— b

— b

4.7%

1.6

1.2

0.1

1.0

0.2

0.4

—b

0.1

Assignment rates (percent)

All types of services . . . . . . . . 510!0 37% 54% 570/0 69% 40% 830/o 79%

Medical care . . . . . . . . . . . . . 51 34 59 81 —b

Surgery . . . . . . . . . . . . . . . . . . 4a 42 48 _ b 54 —b 8 1 8 5

Consultation . . . . . . . . . . . . . 60 41 63 —b 57 —b —b —b

Diagnostic radiology . . . . . . 57 38 71 —b 67 —b —b

Diagnostic laboratory. . . . . . 48 40 64 —b 66 —b —b

Radiation therapy . . . . . . . . . 62 72 —b _ b —b —b

Anesthesia. . . . . . . . . . . . . . . 45 _ b 45 —b - b —b —b —b

Assistant-at-surgery . . . . . . . 48 —b 48 —b —b —b —b —b

Other medical services . . . . 62 44 39 —b 93 —b —b 77

a~e~~ than W.1 ~illion.

bLe~9 than 0.05 Prom.

NOTE: Columns and rows may not add to 100 percent due to rounding.

SOURCE: 1. Burney and G. Schieber, “Medicare Physicians’ Services: The Composition of Spending and Assignment Rates,” /+ea/th Care Firrar)c/ng Review, forthcoming.
I&j . Payment for Physician Services: Strategies for Medicare

or as an inpatient service is cataract surgery (161).

Increasing the approved charge for nonprocedural

and ambulatory services might affect the choice

of services and sites in cases where the choice is

discretionary. The effect on total volume of services and expenditures cannot be estimated, because among other factors, the number of such

discretionary services is unknown.

If approved charges for procedural and inpatient services were lowered, beneficiary costs

would increase whether or not there was an increase in use, because beneficiaries’ increase in

nonassigned liability would almost always be

greater than their decrease in coinsurance. If approved charges for procedural and inpatient services were lowered as approved charges for nonprocedural and ambulatory services were raised,

the net effect on beneficiary costs would be uncertain. The change in beneficiary unassigned liability and coinsurance would depend on the extent to which assignment for procedural and

inpatient services decreased and assignment for

nonprocedural services increased and on the absolute changes in approved charges and the magnitude of any changes in use.

Access.—If approved charges for procedural

and inpatient services were reduced, the ratio of

approved to billed charges would decrease, assignment rates would fall, and access could decrease.

On the other hand, competition among providers

of many procedural services is likely, given the

current and projected supply of most surgical specialties and some internal medicine specialties.

Most national studies project a continued growth

in the supply of these physicians and an oversupply by 1990 (176). Competition among physicians

in the form of taking assignment could be financially rewarding, if beneficiaries considered the

differences in their liability between assigned and

unassigned claims when choosing physicians.

Furthermore, one study found that surgical assignment rates were not significantly related to payment levels for surgical services (393).9 Also, since

———-—

‘The relationship of assignment and reimbursement rates for 1aboratory and X-rays services is unclear. The main finding of the Rice

study is that there is a significant positive relationship between

changes in reimbursement rates for medical services and changes

in assignment rates (393). Although changes in the assignment rates

for laboratory and radiological services appear to be significantly

correlated with changes in the reimbursement rate for medical serva reduction of 10 to 20 percent in payment rates

for many procedures and inpatient hospital visits

would still give physicians high Medicare net revenues, assignment rates might not decline substantially if approved charges for such services were

lowered (166).

The relationship between Medicare approved

charges and the price paid by other insurers also

affects access to procedural services. If Medicare’s

lower approved charge for a service was much

below the price allowed by other insurers, some

physicians might choose not to provide the service to Medicare beneficiaries. For this situation to

occur, however, there would have to be an adequate non-Medicare market for the service, such

as there is in the case of MRI (234) and ESWL

(431).

Access to hospital-based, procedure-oriented

physicians —radiologists, pathologists, and anesthesiologists —might not be affected by controlling approved charges for their services. Pathologists and radiologists currently have very high

assignment rates (68). Although anesthesiologists

accept assignment less frequently than thoracic

surgeons, anesthesiologists accept it as often as

surgical specialists such as urologists and orthopedic surgeons (68). Competition might be a minor factor in assignment decisions for some radiologists and pathologists. The Graduate Medical

Education National Advisory Committee projected

that specialists in anesthesiology, pathology, and

therapeutic radiology would be in near balance

with supply in 1990; diagnostic radiology was

Projected to be a specialty in oversupply (57).

Anesthesiologists were originally projected to be

in undersupply, but during the last few years

residency programs have grown to such an extent that anesthesiology may be in oversupply in

the near future (350).

Raising approved charges for nonprocedural or

ambulatory services would increase assignment

rates and hence access to these services. The use

ices, the finding may be an aberration of the claims system. The

Medicare program prohibits physicians from assigning only a portion of services that are delivered to a beneficiary at the same place

and time. Thus, if laboratory and radiological services were provided at the same time and place as a medical service, which is likely,

they would most likely be listed on the same claim, and accepting

assignment for these services would be directly connected to accepting assignment for the medical service.
Ch. 4—Modifications to Customary, Prevailing, and Reasonable Charge Payment . 107

of pneumococcal vaccination might increase, although its low use seems related more to the lack

of physician and beneficiary knowledge of its effectiveness than to a low payment level.

Quality .—Effects of reducing the variation in

approved charges by type and site on quality of

care would depend, in part, on the extent to which

assignment rates were affected, and, in part, on

the appropriateness of services.10 Reviews of the

literature have concluded that there is excessive

use of hospitals, some surgical services, and inpatient laboratory services in teaching hospitals

and to a lesser extent in nonteaching hospitals

(108,109,110,581). However, there is a problem

in determining the appropriate use of specific procedural and inpatient services, as illustrated by

the great variation in the practice of medicine and

the lack of scientific norms of medical care (568).

For example, in Iowa, the chances that a male resident 85 years old will have had a prostatectomy

range from 15 percent to 60 percent in different

medical service markets (568). This large variation suggests that for some patients a prostatectomy may have been inappropriate treatment and

may have constituted poor quality of care. Surgery and hospitalization are not without risk: the

mortality rate attributable to a prostatectomy, for

example, ranges from 1.2 percent to 4 percent

(568).

If lowering approved charges reduced the inappropriate use of procedures and inpatient care,

quality could be improved (184). However, there

is the danger that cutting the payment level for

all procedural and inpatient services might reduce

the provision of necessary as well as unnecessary

services (108,109,110,581). Patients with severe

illnesses that require much specialized, procedural

care might be harmed by such a change (194).

Quality related to the use of nonprocedural and

ambulatory services could also be influenced by

raising approved charges for nonprocedural and

ambulatory services and increasing access to such

services. Because the need for an increase in use

has not been identified, the effect on quality of

increasing access to such services is not clear.

Ioln mmt of the studi~, inappropriate services are defined as sewices that “provide no significant benefit or . . . could be rendered

in a less costly lower level institution or outpatient setting” (163).

Reducing the Variation in Approved Charges

by Specialty and Location”

In the 1970s, a major concern of Congress was

rationalizing the distribution of physicians by specialty and by location (492) by reducing the variation in approved charges for similar services provided by generalists and specialists and provided

in different geographic localities, particularly

within States. Recently, policy interest has been

focused on reducing such variations as a cost-containment mechanism.12

For the most part, differences in approved

charges are relevant for services that are provided

by physicians of many disciplines: the greatest

overlap in services provided by generalists and

specialties lies in the visit category, which nationwide accounts for 41 percent of Medicare approved charges (69). In 1982, the prevailing charges

nationwide for different types of visits, the five

most common procedures, averaged 24 to 73 percent higher for specialists than for generalists (see

table 4-4).13

Almost all the empirical evidence indicates that

physicians practicing in urban and suburban areas

usually receive higher Medicare approved charges

for similar services than physicians practicing in

— —

ll~e f~us of this di~ssion is on reducing the variation in prices

within States, since this geographic division best reflects urban/rural price disparities, which are a policy issue of interest.

IZEquity t. providers could be a reason for attempting to modify

the wide differentials in payment levels between generalists and

specialists and among geographic localities. Opinions on Medicare’s

responsibility in this regard differ. The opinions are based on both

a philosophical stance and practical considerations of access and

costs. If equity among providers were one of the Medicare program’s

concerns, the program’s ability to act as a prudent buyer, i.e., to

provide its beneficiaries with the most appropriate services available at the low=t possible cost to the program, could be constrained

by the need to assure equitable revenues to providers. On the other

hand, Medicare would be concerned if disparate charges among

providers and among areas decreased beneficiaries’ access to appropriate health services.

IJThere are many problems in analyzing national Medicare data

based on carrier data, because of the variety of ways in which carriers classify specialists. A specific problem is that the specialty standing of family physicians varies among carriers. In calculating prevailing charges, Medicare carriers usually categorize general

practitioners as generalists and internists as specialists, but nationwide information on carrier practices about the categorization of

family physicians on the carrier level for reimbursement purposes

is not available. Conversations with staff of the Inspector General’s

Office of the Department of Health and Human Services suggest

that carriers could categorize family physicians as a specialty, but

not all carriers do so (542).
108 . Payment for Physician Services: Strategies for Medicare

Table 4-4.—Medicare Weighted Mean Prevailing Charges for the Five Most Common

Services, Specialist/Nonspecialist, Calendar Year 1982

Percentage

specialist

Service Nonspecialist Specialist differential

Brief F/Ua hospital visit . . . . . . . . . . . $16.63 $23.90 43.7%0

Limited F/U hospital visit. . . . . . . . . . 19.63 25.88 31.8

Limited F/U office visit. . . . . . . . . . . . 16.99 21.05 23.9

Brief F/U office visit . . . . . . . . . . . . . . 13.58 17.67 30.1

Minimal F/U office visit . . . . . . . . . . . 16.11 27.92 73,3

aF/U = FOIIOWUP.

SOURCES: U.S. Department of Health and Human Services, Health Care Financing Administration, Bureau of Program Operating, unpublished computer tabulations from the D/rectory of Meal/care Prevailing Charges, W. Merashoff, personal

communication, June 19, 1985

rural and inner city areas (71). As an example,

in 1975 Medicare approved charges for specialists

averaged 23 percent higher in metropolitan than

in nonmetropolitan areas. When adjusted for costof-living differences, the payment level difference

was reduced to 8 percent (71). More recent data

found that fees for first office visits were 52 percent higher in urban areas than in rural areas and

median fees for revisits were 7 percent higher in

urban areas than in rural areas (354). A study by

Pennsylvania Blue Shield on physician pricing

patterns under Medicare in Pennsylvania had less

definitive findings. Interarea price variations by

specialty varied with the procedure, and, although

prices tended to be highest in the Philadelphia urban area, prices in rural areas were not always

the lowest (372).

Costs and Efficiency. —If there was an increase

in volume, lowering approved charges for specialist and urban services with or without raising approved charges for generalist and rural services

could increase Medicare costs. But, available data

suggest that if there were no increase in volume,

lowering charges for specialist and urban services

could constrain the rate in growth of Medicare

expenditures for physician services. If approved

charges for generalist and rural services were

raised at the same time, the effect on Medicare

expenditures would be uncertain. Medicare expenditures could increase if the costs saved by the

program due to a decrease in approved charges

for specialist and urban services were less than

the costs added to the program by the increase

in approved charges for generalist and rural services. On the other hand, Medicare expenditures

could decrease if the costs saved by the program

due to a decrease in approved charges for specialist and urban services were more than the costs

added to the program by the increase in approved

charges for generalist and rural services.

One approach to lower approved charges for

specialist services and to raise approved charges

for generalist services would be to calculate a single prevailing charge for all physicians in a locality. If a single prevailing charge were calculated

for generalist and specialist services in a locality,

the effect on Medicare expenditures would depend

on the proportion of generalist and specialist services in the locality and the distribution of customary charges for generalists and specialists. If the

distribution of customary charges for generalist

and specialist services was narrow calculating a

single 75th percentile for both generalists and

specialists would be about the same as calculating a separate 75th percentile for each and averaging them. In this case, calculating a single 75th

percentile for specialists and generalists would not

affect Medicare expenditures.

Or a single prevailing charge could be calculated for all physicians in a State as a way of

lowering approved charges for specialist services

and raising approved charges for generalist services. This approach would also lower approved

charges for urban services and raise approval for

rural services.

Research on the cost effects of reducing variations by specialty is sparse and has not considered the effect of changes in prevailing charges

on volume of services. One study found no significant differences in Medicare costs when prevailing charges were computed separately for each
Ch. 4—Modifications to Customary, Prevailing, and Reasonable Charge Payment Ž 109

specialty as compared with computing them for

physicians grouped into three broad categories

(331). Program outlays were reduced about 2 percent in a simulation that eliminated specialty differentials by computing a prevailing charge for

all physicians in a county (330). If assignment continued on a claim-by-claim basis, approximately

half of the beneficiaries would have had an increase (averaging 17 percent) in out-of-pocket expenses (330).

Evidence on the effect of reducing variations

in prevailing charges by locality is equally scanty.

Unfortunately, the results of the few available

studies are mixed and inconclusive, leaving unanswered the question of how reducing variations

within a State would affect Medicare program

costs and beneficiary liability. The major issue of

volume response also remains unresolved.

When prevailing charges were calculated on a

statewide basis rather than by localities within a

State, prevailing charges for physicians in the major urban areas decreased and the prevailing

charges for physicians in small urban and nonurban areas of the State increased as expected (394).

However, total Medicare expenditures were not

reduced: physicians billed for a greater number

of services and more complex services.

A nationwide study performed for the Civilian Health and Medical Program of the Uniformed

Services (CHAMPUS) examined the cost effects

of reducing variations in prevailing charges by

specialty and by location (504). Although the findings cannot be generalized to the Medicare program for reasons such as wide differences in patient population and program administration

between the two programs, the findings are of interest. An increase in CHAMPUS program expenditures was estimated if separate prevailing

charge screens for specialists, and, where applicable, separate charge localities in a State were

eliminated and statewide prevailing charge screens

for all physicians were established. The new

method of calculating prevailing charges was

adopted in 1980. The increase has been, as projected, approximately 5 percent annually over any

increase in CHAMPUS expenditures in the absence of the policy change (241). A corresponding increase in beneficiary cost-sharing occurred.

Although increased physician participation had

been anticipated when charges were increased,

there has been no increase in assignment rates

(241).

Access.—A major policy issue has been improving access to primary care services provided

by physicians of appropriate training. ” Reducing variations in approved charges by specialty

and within States would affect access to general

practitioners, family physicians, and internists

differently, because carriers classify general practitioners as generalists and internists as specialists.

Carriers can classify family physicians as specialists, but not all carriers do so.

If there were no increase in volume, assignment

rates and access to primary care provided by general practitioners could increase if approved

charges for the primary care services of general

practitioners were increased at the same time as

approved charges for such services provided by

specialists were lowered. In localities where family physicians are classified as generalists, increasing approved charges for the primary care services of generalists could increase the assignment

rates of family physicians and access to their primary care services.

If specialists’ approved charges were lowered,

for example, by calculating a single prevailing

charge for generalists and specialists, and there

was no increase in volume, there is a strong possibility that assignment and beneficiary access to

primary care provided by family physicians (if

they were in the specialist prevailing charge screen)

and internists could decrease.

The effect of reducing specialty differentials on

physicians’ decisions to train in the primary care

specialties is problematic.15 If approved charges

14Although the term “appropriate” training is difficult to define,

Federal policy, mainly through the channel of training grants for

primary care residencies, has explicitly accepted that primary care

services are to be provided by physicians trained in primary care

and has defined primary care physicians as general and family physicians, general internists, and general pediatricians. The first three

medical disciplines are of import for the elderly Medicare population.

15The number of primary Care physicians (general practice, family practice, general internal medicine, and general pediatrics) increased at about the same rate as total physicians and grew from

56 physicians per 100,000 population in 1970 to 70 physicians per

100,000 population in 1981 (544). The Graduate Medical Education

National Advisory Committee has stressed training primary care

physicans to improve the balance of physicians across specialties.
110 Ž Payment for Physician Services: Strategies for Medicare

for specialist services were decreased and there

were no increase in the volume, there would be

a decrease in Medicare expenditures for services

provided by internists and family physicians, in

those areas where family physicians are classified

as specialists. If approved charges for generalist

services were increased as well, there would be

an increase in Medicare expenditures for services

provided by general practitioners.16 If there were

an increase in the volume of services, the effect

on Medicare revenues for each specialty would

be uncertain. Furthermore, the effect of financial

incentives on specialty choice in today’s economic

environment has not been investigated. The early

literature indicates that financial incentives played

only a minor role in specialty choice (334). However, those studies were performed when debts

for medical education and malpractice insurance

rates were much lower.

Access to primary care services provided by primary care physicians is also affected by the geographic distribution of these medical disciplines.

However, the ability of or need for statewide prevailing charges to attract more primary care physicians into poorly served areas is not clear. Numerous factors affect location decisions. Although

a series of studies in the 1960s and 1970s suggested

that economic factors were a minor factor (334),

later analyses of Canadian physicians reported a

positive, although small, relationship between income level and location choice (36,184). Berry

found that if gross earnings increased 1 percent

in medical service areas in Quebec, net immigration increased by 3.4 percent (36). Comparable

results were found by Hadley in Canadian provinces; a 1 percent increase in net income could expect to attract 3.3 percent more new physicians

(184).

More recent research showed that more physicians in the United States have located in nonmetropolitan areas (427). Some researchers have

concluded that the economic forces of an increase

in the total supply of physicians and the overall

growth rate of each specialty determines the geographic dispersion of the specialty (344).

- .— “The increase in approved charges for general practitioner services is a moot point in the long term, since few if any general practitioners are now being trained.

Although between 1970 and 1979, the number

of general practitioners and family physicians in

the smaller towns declined, in 1979 nearly every

town with a population of 5,000 had a general

practitioner or family physician, and 85 percent

of towns with a population of 2,500 to 5,000 had

a general practitioner or family physician present

(344). In 1982, there were still 131 counties housing 3.5 million people (approximately 2 percent

of the population) without an active physician

(124). The Newhouse study showed that very few

rural residents lived far from a physician and predicted an increase in the diffusion of family physicians into the smallest towns as their numbers

grew (344). The Bureau of Health Professions has

predicted that the diffusion of primary care physicians is expected to reduce overall shortage area

needs in the coming years, although needs will

persist in many currently designated shortage

areas (546).

As noted earlier, the evidence suggests that approved charges in rural areas, for the most part,

are lower than in urban areas. Higher practice

costs in urban areas could explain the differences,

however, the data on the costs of operating physicians’ practices in different locations are conflicting (50,334,355,512). Indeed, the latest data indicate that practice costs are higher in rural than

in urban areas (355). To the extent that urban/rural differences in approved charges exceed differences in urban/rural practice costs, physicians

might be discouraged from practicing in rural

areas.

If one believes that more family physicians are

required in sparsely populated areas, reducing the

variation in approved charges within States and

thereby increasing payment rates in rural areas

might be sufficiently effective on the margin to

increase the interest of family physicians in settling in such localities. The number of family physicians increased 22 percent from 1977 to 1985

(344), and graduates of family practice residency

programs are more likely to settle in smaller and

nonmetropolitan areas than are other specialties.

Since established physicians are not likely to

move, the location choices of young physicians

are most apt to be influenced by financial considerations.
Ch. 4—Modifications to Customary, Prevailing, and Reasonable Charge Payment Ž 111

A much lower percentage of communities with

2,500 to 5,000 people had a practicing internist

than had a general practitioners or a family physician in 1979, although the percentage of communities with an internist had increased 35 percent from 1970 to 1979. If one considered it

necessary to further increase the expected rate of

movement of internists into rural areas, narrowing the difference in internists’ prevailing charges

between metropolitan and nonmetropolitan areas

might influence the location decisions of new internists. Medicare is an important source of revenue for internists. Other than thoracic surgeons,

internists derive the largest percentage of gross income (29 percent) from Medicare of any specialty

(see table 2-8).

Based on precedent, internists in urban areas

might further decrease their assignment rate if

modifying geographic differentials meant a decrease in approved charges in urban areas. Therefore, at the same time that reducing geographic

differentials might interest new internists to locate

in less populous areas, such a change might decrease internists’ assignment rates and beneficiary access in urban areas.

It should be noted that reducing the variation

in approved charges by specialty might also affect access to primary-care services provided by

nonprimary-care specialists (1). Most nonprimary-care physicians have higher assignment rates

than primary care physicians. If these data indicate that nonprimary-care physicians are more

satisfied with Medicare payment under assignment than primary care physicians, access to primary care services provided by nonprimary-care

physicians may not be unduly affected by a decrease in payment. If, on the other hand, these

data are more reflective of the nonprimary-care

services of nonprimary-care physicians, the assignment rate for, and access to, nonprocedural

services provided by nonprimary-care specialists

might decrease if approved charges for such services were decreased.

Quality .–Anticipating the effects on quality

of reducing the variations in prices for services

by specialty is confounded by the unresolved issue of whether generalists and specialists deliver

“similar services, ” or whether specialists provide

higher quality care than generalists. If specialists

provide the same services as generalists, both

groups of physicians should be paid at the same

level. However, the degree of similarity between

services cannot easily be distinguished from the

coding system, the basis of payment under any

fee-for-service system. Even though the code for

a service provided by both general practitioners

and specialists is the same, the service provided

under the code may be different. For example,

almost all visit codes do not differentiate by diagnosis or the content of the service provided.

One school of thought is that services provided

by generalists and specialists are similar for payment purposes (336,420). Medicare’s coverage

policy is consistent with this view, since Medicare does not limit coverage for most services

according to specific training, but usually permits

all physicians to provide all services (414). Another

view is held by those Medicare’s carriers that use

different fee screens for specialists and general

practitioners on the grounds that services delivered by specialists are different, more intensive,

or of higher quality than those provided by generalists and that the more extensive training of the

specialist warrants a higher level of payment.

The issue of “similar services” for payment purposes has not been resolved by court action. The

Michigan Academy of Family Physicians successfully sued for the elimination of specialty screens

by their Medicare carrier. The District Court

found that if and when services are found to be

similar, prevailing charge payment should be the

same regardless of who provides the service, thus

implicitly rejecting the argument that differences

in charging patterns among specialties are indicative of different services’ being performed under

the same procedure code (309). Although the U.S.

Court of Appeals, Sixth Circuit, partially affirmed

the District Court’s ruling, the decision is currently

being submitted to the Supreme Court for the second time for reconsideration (534).17

17Another pertinent court action took place in Florida where the

Medicare carrier does not employ any specialty reimbursement

differentials. The Dade County Society of Internal Medicine sued

to force the carrier to use specialty screens for internists, and by

implication, for other medical disciplines. The plaintiffs argued that

Medicare beneficiaries in Florida receive lower allowances than in

other areas of the country when beneficiaries use the services of
112 . Payment for Physician Services: Strategies for Medicare

Studies of care given by different specialists provide some but inconclusive support for the position that specialty training is associated with better

quality of both ambulatory care and hospital care

when specialized physicians are practicing within

the domain of their training (369,370,392,398).

The evidence that physician performance is improved by specialization per se is weaker (194)

and contradictory (416). An analysis of visits

found that nearly all specialists have significantly

longer visits than general practitioners and family physicians (322). However, there is no evidence

to support that differences in time result in differences in quality. Indeed, time, per se may not be

an important measure of quality.

In addition to the lack of definitive evidence

on whether specialists provide better care than

generalists, there are other unknown and confounding factors that stand in the way of determining how reducing the variation between generalists’ and specialists’ approved charges would

affect quality. These factors include the extent to

which specialists provide care for conditions outside of their own specialty, the inability to determine specialists’ care because of the variation in

the number of prevailing charge screens among

carriers, and the relationship between quality and

financial incentives. Quality may depend not only

on the kind of physician, but also on the interaction among the kind of physician, the kind of patient, and the kind of service.

The quality issue is further complicated by the

lack of a standard definition of a specialist by

Medicare for payment purposes. A General Accounting Office survey of three carriers found that

roughly 50 percent of physicians who classify

themselves as specialists are not board certified

in their declared specialty. About one-fourth of

the physicians that classified themselves in one

subspecialty of internal medicine were not board

certified in either internal medicine or the board

specialty (475). However, there are no data on

the relationship of quality to board certification

as compared with quality and board eligibility or

quality and self-declared specialization.

specialists, and, therefore, beneficiaries allegedly suffer both direct

economic loss and possible injury when they are discouraged from

consulting a specialist. After 5 years of litigation, the Dade County

Society of Internal Medicine withdrew the case in the spring of 1985

(534).

Negotiated or Discounted Fees

Some private sector payers and Medi-Cal (California’s Medicaid program) have recently adopted

selective contracting with providers, primarily as

a cost-containment measure. Under selective contracting, payers contract with selected providers,

usually hospitals, who agree to accept either a negotiated fee or a flat discount from their charges

as payment in full. The experiences of private sector organizations and Medi-Cal with selective contracting may provide insight into the potential of

using this method as an option in the Medicare

program, while CPR continues as Medicare’s major way of paying physicians. The discussion that

follows considers two questions. Does the evidence

show that the method is worthy of consideration

for Medicare? Furthermore, does Medicare have

the authority and capability to implement a discounting system?

Preferred Provider Organizations

Negotiated or discounted fees in the private sector have been utilized as a financial component

of PPOs and not as a payment method used by

traditional indemnity plans. A PPO “may be an

organization, a delivery system, or an arrangement between providers and third-party payers”

(156). PPOs are characterized more by their diversity than by their similarity (see app. D).

The third party pays the PPO plan, which in

turn makes arrangements to pay the providers.

One of the ways in which PPOs vary is how they

pay providers. Payment mechanisms for hospitals range from negotiated per diem reimbursement (244) to cavitation (52) and discounted

charges (156). Currently, most PPOs reimburse

physicians either by negotiating a discount from

an established fee schedule or by discounting from

usual, customary, and reasonable charges18 (53,

156), with discounts ranging from 5 to 30 percent

(156). Two payment methods that are gaining in

use are relative value scales constructed specifically for a PPO and cavitation (144). Indeed, some

experts consider discounting a transitory payment

laThe usual, Customav and reasonable charge method is basically the same as Medicare’s CPR method of paying physicians, but

uses different nomenclature (see app. C). For clarity of discussion,

this chapter substitutes Medicare terms for those used by the private sector
Ch. 4—Modifications to Customary, Prevailing, and Reasonable Charge Payment ● 113

methodology and expect that many PPOS will

evolve into health maintenance organizations

(HMOs), as risk is increasingly shared with providers (53).

Relation of PPO Payment Methods

to the CPR Method

PPOs that discount from fees that are determined by usual, customary, and reasonable methods use payment methods that are very similar

to those used by Medicare to constrain prices. If

there is no available claims history, the PPO may

reduce physician charges based on their billed

charges. This method is used by a few PPOs that

have been established by organizations other than

insurers, but its use appears to be declining for

a number of reasons, including potential antitrust

considerations (177). The method is similar to taking assignment under Medicare—both methods

reduce payment from an individual physician’s

actual charges for a service when the actual charge

is greater than the approved charge—and to Medicare’s method of paying physicians who choose

to become participating physicians under the arrangements mandated by the Deficit Reduction

Act of 1984. Like Medicare, PPOs that discount

from fees reduce charges for all services provided

by participating physicians when their actual

charges are greater than the program’s approved

charges. Furthermore, Medicare’s participating

physicians have signed an agreement for a year’s

participation, an acceptance of assignment on all

claims, which is similar to physicians’ contracting with a PPO.

PPOs that have a claims history of physician

payment usually evaluate physician charges in an

area and declare some reduction on an areawide

basis. Again, the methods used are similar to those

used or those that could be used by Medicare.

Some PPOs lower the percentile at which the prevailing charge is calculated (462a); some offer a

percentage of an area’s prevailing charge (29); and

some establish payment at the mean of the prevailing charge (7). A very few have lowered the

percentile at which the prevailing charge is calculated for medical services less than they lower

the percentile at which the prevailing charge is calculated for surgical services (244).

Both PPOs and Medicare use utilization review

to control the volume of inpatient services, and

many PPOs go beyond Medicare controls to include prior authorization before hospitalization.

In a survey of members of the American Association of Preferred Providers, almost half of the

143 operational members reported that they had

a utilization program in place for cost-containment purposes (7). Relatively few PPOs have developed “adequate protocols to review clinical

efficiency or appropriateness of care” (51). It is

unlikely that PPOs utilization review programs

have been extended to cover office-based physicians’ services. Although under Medicare utilization review for office-based physicians is required,

the implementation of the review varies considerably among carriers and is often ineffective in containing costs (475). 19

The major way that PPOs differ from Medicare in physician payment is not in pricing method, but in the negotiation of contracts with selected providers. Under Medicare, almost any

physician who chooses can participate in the

program, but in a PPO arrangement, the PPO

chooses the providers with whom it wishes to contract. The methods for selecting participating physicians vary. Some, but far from all, PPOs limit

physician enrollment on the basis of performance

standards (53). Future PPOs may attempt to restrict members to practitioners with cost-effective

practice patterns (51). Very few PPOs have the

standards or the technology capable of systematically evaluating the cost-effectiveness of physicians.

Dimensions of Evaluation

Evidence of the effect of discounting by PPOs

in the private sector on quality, access, and costs

is primarily limited to information supplied by

sponsors of PPOs and other interested parties.

The number of PPOs and their rate of growth are

indicators of private sector interest in PPOs, and

— — .

lgsections 75w.7535 of the Medicare Carriers Manual, Part C,

Claims Process provides instructions for utilization review by carriers. The General Accounting Office concluded that the Health Care

Financing Administration’s policies and practices have tended to provide disincentives to carriers for performing effective utilization review (475).
114 ● Payment for Physician Services: Strategies for Medicare

since the emphasis in the private sector is on controlling costs through price competition, an oblique

expression of the private sector’s evaluation of the

cost-containment potential of PPOs. Despite wide

variations in estimates (see app. D), it is evident

that PPOs have increased considerably since the

acronym was first established in 1981 (7) and will

increase in the future.

To the extent that PPOs employ discounting

as a payment methodology, physicians’ acceptance of PPO discounting is indicated by their

enrollment in PPOs. One study estimates that

overall 5 percent of the Nation’s doctors had a

contractual arrangement with a PPO in 1983

(156). A much higher percentage of physicians

was involved in California, which is the State

where the largest number of PPOs are located.20

The level of physician participation would appear

to be linked with the degree of competition in an

area.

Information on patient acceptance of PPOs is

just developing, and available numbers are too

small to be statistically significant. In 1983, only

14.6 percent of the physicians in California who

had signed contracts with PPOs had seen PPOlinked patients (374). Of all physicians, obstetrician/gynecologists and orthopedists were most

likely to have seen a PPO patient. The likelihood

of patient participation was also higher among the

larger metropolitan areas than in the semi-urban

and rural areas, and varied among metropolitan

areas (374).

Objective analysis of the cost-effectiveness of

PPOs is sparse. A study of Stouffer Corporation’s

PPOs found significant cost savings the first year.

In addition to discounting, the PPOs had a rigorous monitoring system of utilization review in

participating facilities, which had lower charges

than the community norm before the PPOs were

functioning (53).

Selective contracting by Medi-Cal with hospitals on a negotiated rate basis yielded substantial

savings to the State from reduced payments, with

— . — Zoone.fourth of physicians contacted in California to join PPOS

have signed a contract with one or more organizations. If physicians not yet contacted signed up at the same rate as those that were

contacted, 35.5 percent of physicians in California would have signed

PPO contracts (374).

little evidence of reduction of quality of care (245).

The Medi-Cal program does not contract with

physicians, although there is legislation authorizing it to do so. Although private payers have

signed contracts with physicians, by early 1985

the practice was still not sufficiently widespread

to have affected office practice patterns. Assessment of the effects of private sector contracting

on access to physicians and quality of care remains to be done.

Selective contracting with negotiated or discounted fees would allow Medicare to use its

leverage in the market place to bargain with physicians about the price of services and assignment

(242). Furthermore, Medicare could technically

implement a discounting method based on selective contracting (see following section on administrative feasibility). One problem, however, is

that although PPOs in the private sector are often

designed to reward patients for using member

physicians, Medicare might have problems in implementing a reward system. Reducing deductibles and coinsurance of those beneficiaries who

use less costly physicians might not be effective

because of the extensive use by Medicare beneficiaries of Medigap insurance that covers their costsharing liability. On the other hand, Medicare

beneficiaries might choose not to purchase Medigap insurance if they were able to obtain the coverage they want from Medicare. Reducing premiums for some beneficiaries and not others might

be politically troublesome.

Technological Change

An important condition affecting the development of technologies is the potential market,

which is determined in large part by third-party

reimbursement (487). CPR reimbursement provides physicians with financial incentives to provide technology, particularly equipment-intensive

and surgical technology, to the extent that their

net revenues are higher with greater use. Although

the CPR payment method has been instrumental

in the development of cost-increasing technology,

it has provided little incentive for physicians to

choose cost-saving technology.

By reducing Medicare’s approved charges, the

modifications to CPR described in this chapter
Ch. 4—Modifications to Customary, Prevailing, and Reasonable Charge Payment ● 115

could change physicians’ financial incentives to

adopt and use medical technology and, in turn,

affect the market for medical technology .21 The

effect on the market for medical technology cannot be ascertained, however, because the effect

of lowering approved charges on the volume of

services provided is uncertain.

If the volume of services provided to Medicare

beneficiaries in response to lowered approved

charges were to increase, the effect on the market would depend on the extent to which increased

Medicare revenues to physicians from the increased volume compensated for the decrease in

Medicare revenues to physicians from decreased

approved charges.

If the volume of services did not increase, constraining approved charges would decrease physicians’ demand for services that they use in their

practice. Generally, to the extent that physicians’

Medicare net revenue for a technology decreased,

physicians’ financial incentives to refer patients

for services to other facilities would increase. Beneficiaries receiving highly sophisticated, expensive

and new technology, such as MRI, would probably be referred to a regional facility. Beneficiaries receiving more established technologies that

physicians might have in their offices but need

replacement, such as mammographic, electrocardiographic, and X-ray equipment, could be referred locally, for example, to an office that only

performs mammography located in the same

building as their physician. Manufacturers could

respond by developing cost-saving office-based

equipment as well as continuing to develop technology for larger ambulatory facililites. Officebased laboratory testing equipment, for example,

is already being developed in response to financial incentives, such as Medicare’s prospective

payment for inpatient services, to move care to

less financially constrained ambulatory sites (332).

A number of factors could work against a

shrinking market if Medicare’s approved charges

—-———

ZIThe financial constraints on the use of technology imposed by

Medicare’s prospective payment system for hospitals has had an effect on the market for technology, and has played a role in shifting

some technology into ambulatory sites (489). Changes in physicians’

Medicare revenues would also be expected to affect the market, since

physicians influence the use of technology both in inpatient and ambulatory sites.

were lowered. First, the modifications to CPR

might restrain approved charges for only a relatively short period, and, hence, might not affect

physicians’ adoption and use of technology. Second, the competitive nature of today’s health care

system and the fear of malpractice claims would

undoubtedly affect physician behavior and might

soften the decrease in physicians’ demand for technology. Lastly, the non-Medicare market might

be sufficiently large to override any changes in

the diffusion of the technology.

Moreover, the effects that lowering Medicare’s

approved charges would have on technologies for

which Medicare has market power and that provide a large part of physicians’ incomes might be

somewhat different from the effects for other technology. For example, about 80 percent of the cataract surgeries performed in the United States are

covered by the Medicare program, and decreasing prices for such surgery would have a dramatic

effect on the incomes, as well as the Medicare revenues, of ophthalmologists who perform the surgery (161). For cataract surgery, unlike MRI and

ESWL, there does not appear to be another large

population who could be provided with the procedure if physicians perceived a lower level of

remuneration as unsatisfactory. Although some

ophthalmologists might reduce the amount of cataract surgery in response to lower approved

charges, others might increase the number of such

procedures. In any case, the growing supply of

ophthalmologists would propbably increase the

aggregate supply of ophthalmologic surgery, so

that reducing Medicare prices is unlikely by itself to decrease the use of the procedure and the

use of implantable lenses (161). Because of the potential for volume increase, the financial incentives for the development of lower priced lens implants are not clear.

Administrative Feasibility

The administration of the Medicare program’s

physician payment system is complex, cumbersome, and characterized by extreme variation

among carriers along a series of parameters and

by confusion among beneficiaries and physicians

(see app. C and ch. 2). Although any of the above

modifications of the current CPR method are administratively feasible with current computer tech56-119 0 - 86 - 5 : QL 3
116 ● Payment for Physician Services: Strategies for Medicare

nology, changes with the greatest promise of simplifying administration are those that would

reduce the number of factors for discriminating

among physicians in determining their level of

payment. The disapproval rate for physician

claims is much higher under Medicare than in the

private sector partly because private sector payers

make fewer distinctions among physicians, making payment more consistent, uniform, and understandable (488). Competitive pressures among

insurers to pay subscribers’ bills is also instrumental in the lower disapproval rate. Perhaps of

greater import is the fact that Medicare’s prevailing charges are calculated at the 75th percentile

of customary charges, whereas the corresponding private sector prevailing charges are calculated

at the 80th to 90th percentile.

Both freezing customary or prevailing charges

and lowering the percentile at which prevailing

charges are calculated could be easily and inexpensively implemented, because they require no

new data or basic changes in Medicare’s physician payment system or in claims processing.

Nonetheless, these methods retain all the features

that make the system so difficult to administer.

Furthermore, if such modifications resulted in prevailing charges that were appreciably lower than

now, carriers could have increased administrative

expenses due to an increase in telephone calls, letters, and appeals from physicians.

Reducing the variation in approved charges for

services by type and site of service might make

the CPR payment method even more complex

than at present. Lowering approved charges for

some services but not others, or lowering approved charges for some services and raising approved charges for others would require the identification of specific services and would generally

increase the number of factors used to determine

physicians’ charges. The Health Care Financing

Administration (HCFA), with expert advice,

could identify those services whose appproved

charges would be lowered and those services

whose approved charges would not be changed

or would be raised. The carriers would then have

to implement HCFA’s decisions. Although not

outwardly obvious, lowering approved charges

for inpatient services would also complicate the

administration of CPR, because in practice carriers construct one prevailing charge for surgical

services irrespective of where performed (347).

Thus, additional prevailing charges would have

to be developed for surgical services performed

on an ambulatory basis. Again, physicians who

were adversely affected by the modifications

might require carriers to spend time and effort in

answering their complaints.

Reducing the variation in approved charges by

specialty and within States could simplify administration. Either change would increase the uniformity of payment among physicians, although

changes in payment level might initially cause a

negative reaction from physicians whose approved charges were lowered.

The concept of selective contracting by negotiating fees or discounting from charges is very

new to Medicare. Medicare might have some of

the technical capability to implement a discounting method for physicians’ services based on selective contracting. Claims administration for PPOs

in the private sector has proven to be more complex and costly than many insurers had anticipated (246). Although Medicare might have the

ability to identify lower cost physicians from historical data, the possibility of establishing a utilization review system for ambulatory services,

a system necessary for cost saving, is less certain

in the short run.

Although HCFA appears to have the jurisdiction to negotiate directly with physicians (174),

such direct negotiations run counter to precedent.

Since carriers have traditionally been HCFA’s contact with physicians, the most likely approach is

for carriers to undertake selective contracting with

providers or provider groups who would lower

their allowed charges (preferred providers). Establishing a category of preferred providers would

require supplying physicians with copies of their

customary and prevailing profiles. It would also

require establishing two pricing systems for claims

processing—one for physicians who would be

paid by the traditional method and another for

physicians who would be paid on a contract basis (347).
Ch. 4—Modifications to Customary, Prevailing, and Reasonable Charge Payment ● 117

CONCLUSION

The effects on Medicare expenditures of lowering approved charges for all or selected services—

whether by freezing customary and/or prevailing charges or by lowering the percentile at which

prevailing charges are calculated—are uncertain.

The relation of payment rates to volume of services has not been established in the theoretical or

the empirical literature. If the volume of services

does not increase in response to a reduction in approved charges, lowering approved charges would

decrease the rate of growth in Medicare expenditures. If the volume of services does increase when

approved charges are lowered, however, the effect on Medicare expenditures would depend on

the magnitude of the costs saved by the program

due to an decrease in approved charges compared

with the magnitude of program costs incurred due

to an increase in the use.

Lowering approved charges for all or selected

services by freezing charges or lowering prevailing percentiles would have only a temporary effect at best in terms of reducing Medicare expenditures. Under CPR, increases in physicians’ billed

charges are later reflected in Medicare’s approved

charges, thereby encouraging physicians to raise

their billed charges to beneficiaries. None of the

identified modifications would change this feature

of CPR.

Freezing charges or lowering prevailing percentiles would be likely to increase beneficiary costs

regardless of whether the volume of services provided to beneficiaries changed. Since lowering

Medicare payment decreases assignment rates,

beneficiary unassigned liability would be likely

to increase. Although beneficiary coinsurance

would decrease with lower approved charges, the

increase in beneficiary unassigned liability would

most likely exceed the decrease in coinsurance.

An increase in beneficiaries’ out-of-pocket expenses would decrease their financial access to

services. Quality of care would be decreased to

the extent that access to an appropriate level of

services fell. If the volume of services provided

to Medicare beneficiaries did not increase in response to lowered charges, physicians might increase their time spent and volume of services provided to non-Medicare patients to maintain total

revenues.

Reducing the variation in approved charges for

selected services would address the problem of

perceived inequities in payment rates between certain services. Lowering approved charges for services over which Medicare has market power could

be undertaken as an interim step or as an independent modification.

The effects on cost, access to care, and quality

of reducing the variation in payment rates among

services by lowering the approved charges for procedural services, inpatient services, specialist, and

urban services would be similar to the effects of

lowering approved charges for all services. Access to nonprocedural services, ambulatory services, generalist, and rural services, however, might

not be affected.

If the variation in approved charges among

services was reduced by lowering approved charges

for procedural services, inpatient services, specialist, and urban services and raising the approved

charges of nonprocedural services, ambulatory

services, generalist, and rural services, the cost

and access effects would be different. The effect

on Medicare program expenditures would be unpredictable and would depend on whether the cost

saved by the program due to a decrease in approved charges was equal to, greater than, or less

than the costs added to the program by the increase in approved charges.

Beneficiary liability would increase for services

with lower approved charges and would decrease

for services with higher approved charges. The

effect on net beneficiary liability is uncertain and

would depend on whether the increase in beneficiary liability as a result of lowering approved

charges for some services was equal to, greater

than, or less than the decrease in beneficiary liability as a result of raising approved charges for

other services.

During the process of reducing the variation in

approved charges between procedural and nonprocedural services, Medicare could adjust approved charges for technologies whose initial pay-
118 ● Payment for Physician Services: Strategies for Medicare

ment level has been maintained although the

physician time, skills, and resources required to

perform the procedure have declined. Medicare

could also periodically review and adjust approved charges for such technologies whether or

not variations in approved charges between procedural and nonprocedural services were reduced.

Reducing the variation in approved charges by

specialty and location has aspects that differ from

reducing the variation in approved charges by

type of service and site of service. One way of

reducing the variation by specialty would be to

calculate a single prevailing charge for all physicians in a locality. This approach would simultaneously lower the approved charges for specialist services and raise the approved charges for

generalist services. The change in total Medicare

expenditures would depend on the relative numbers of generalist and specialist services in the locality and the distribution of customary charges

for generalists and specialists in the locality. Similarly, the change in Medicare expenditures from

reducing locality differentials by calculating a

statewide prevailing charge for all physicians

would depend on the relative number of services

in the different localities and the distribution of

customary charges by locality.

Reducing the variation by specialty does not

appear to be an effective way to stimulate physicians to train as primary care physicians; however, the effect of payment rates on specialty

choice in today’s economic environment has not

been investigated. Reducing the variation within

States might marginally influence family physicians and internists to locate in small towns.

Determining the quality effects of reducing the

variation in approved charges by specialty is confounded by the unresolved issue of whether specialists provide better quality care than generalists.

Controlling the approved charges of all services by providing beneficiaries with the option of

receiving care from preferred providers appears

to have the potential for constraining expenditures. The effects on quality of, and access to care,

however, are unassessed as yet. Medicare could

adopt this new method as an optional payment

method for Medicare beneficiaries.
Chapter 5

Payment Based on Fee Schedules

Things are only worth what one makes them worth.

—Moliere, Les Precieuses Ridicules
Contents

Page

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 121

The Concept ofFee Schedules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 121

Uses of Fee Schedules for Reimbursement Purposes . . . . . . . . . . . . . . . . . . . . . . . 122

Initial Implementation Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 124

Updating, Maintenance, and Appropriateness Checks. . . . . . . . . . . . . . . . . . . . . 129

Approaches to the Initial Construction of Fee Schedules . . . . . . . . . . . . . . . . . . . . 132

Relative Value Scales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 132

“Competitively’’Developed Fee Schedules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 140

Implications of Payment Based on Fee Schedules. . . . . . . . . . . . . . . . . . . . . . . . . . . 143

Quality and Access. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 144

Access and Assignment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 145

Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 146

Technological Change . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 150

Administrative Feasibility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 151

Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 151

List of Tables

Table No. Page

5-1. Mean Approved Charges and Standard Deviations for Selected Medicare

Services, South Carolina, 1983 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 129

5-2. Simulated Percent Changes in Medicare Program Payments Following

Conversion to a Fee Schedule From CPR Payment,

South Carolina, 1983 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 134

s-3. Simulated Percent Changes in Physicians’ Medicare Revenues Following

Conversion to a Fee Schedule From CPR Payment,

South Carolina, 1983 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 135

5-4. Resource Cost Relative Values and Relative Reimbursements per Hour

Implied by Medicare Prevailing Charges, Massachusetts, 1978 . . . . . . . . . . . 157

S-S. Simulated Alternative Percent Changes in Beneficiary Liabilities by

Provider Specialty Following Conversion to a Fee Schedule

From CPR Payment, South Carolina, 1983 . . . . . . . . . . . . . . . . . . . . . . . . . . . . 149
Chapter 5

Payment Based on Fee Schedules

INTRODUCTION

In one sense, Medicare’s customary, prevailing,

and reasonable (CPR) charge determination system can be thought of as being neutral with respect to prices in the physicians’ services market;

Medicare approved charges are simply established

by identifying particular prices from the existing

distribution of fees charged by the physicians themselves. As a result of this approach, however, even

within a single locality and within a single specialty, any two physicians who perform a particular procedure may have different maximum

approved charges. In fact, it is possible—although

highly improbable—that every physician performing a particular procedure would have his or

her own unique Medicare approved charge.

Because one year of a physician’s billed charges

are used to set the next year’s Medicare approved

rates, the CPR system has obviously not been neutral with respect to physicians’ billed charges in

the succeeding years of its implementation. An

alternative to a neutral payment system might be

designed to take advantage of Medicare’s substantial potential market power with respect to phyTHE CONCEPT OF FEE SCHEDULES

sicians services. Further, such a system might be

much simpler to understand for both the physicians and the beneficiaries.

In the sections that follow, the notions of fee

schedules are reviewed. The chapter begins with

an explanation of the concepts of fee schedules,

relative value scales (RVSs), and procedural coding and terminology systems. Also discussed are

the potential uses of a fee schedule for reimbursement purposes. The initial issues arising prior to

the implementation of any fee schedule are enumerated, as are issues revolving around the problems of maintenance of a fee schedule via updating or occasional appropriateness checks for

possible recalibration. Two somewhat arbitrary

categories for methods of constructing particular

fee schedules are then discussed: 1) relative-valuebased methods, and 2) “competitive” methods.

The concluding sections of the chapter address the

potential impacts of all of the various fee schedule options and review the prospects for fee schedules as a whole.

A fee schedule can be viewed as an exhaustive

list of physician services in which each entry is

associated with one specific monetary amount.

(Two basic variations on the fee schedule theme

involve possible multiple monetary amounts for

each service depending on the geographic location or specialty of the involved physicians. ) A

concept closely related to a fee schedule is that

of an RVS. An RVS is an exhaustive list of physician services in which each entry is associated

with one specific numerical value that expresses

the value of the service in question relative to an

arbitrary numeraire. An RVS can be converted

to a fee schedule by multiplying the relative value

of each service by a monetary conversion factor.

An ordering sequence for the list of services is

generally provided by a procedural coding and

terminology system, a taxonomy of physician

services. The most commonly used procedural

coding and terminology systems are: 1) the various versions of the California Relative Value

Studies; 2) (510) the system primarily used for

diagnostic coding but which also includes the procedural coding scheme used in Medicare’s prospective hospital payment system; and 3) the Current

Procedural Terminology, 4th Edition (CPT-4) (85)

the coding system developed under the auspices

of the American Medical Association and currently incorporated in the HCFA Common Procedure Coding System (HCPCS).1

I By HCFA policy, by July 1984, all carriers were to have converted to the use of HCPCS for all Medicare Part B data to be submitted to HCFA central office in Baltimore.

121
122 ● Payment for Physician Services: Strategies for Medicare

Fee schedules offer a method of fee determination within the context of fee-for-service reimbursement that can address many of the problems

currently perceived within CPR. These include

such issues as variations in approved charges, unpredictability of payment amounts, confusion on

the part of beneficiaries and providers, and limited

Government control over rising price levels for

physician services.

Because under a fee schedule a single fee is paid

for a particular service to any physician (within

a particular peer group in a particular jurisdiction), variations in approved charges are eliminated within that peer group and jurisdiction. In

an extreme form, a national fee schedule that did

not recognize specialty distinctions for payment

purposes could provide a single payment rate for

a specific service for all physicians in all parts of

the country. There would be no variations in payment. More likely forms of fee schedules would

involve some geographic distinctions for payment

purposes, such as fee schedules applicable on a

statewide or carrier-wide basis. Under some circumstances, specialty distinctions for payment

purposes could be a feature of fee schedules.

The establishment of a set of fee schedules could

also highlight differences in payment levels for

various services, such as those observed between

procedural and nonprocedural services. Because

the relative approved charges for any two specific services would be identical across physicians

given a fee schedule, it would be easier to identify potential discrepancies in fees in the schedule compared to discrepancies under CPR. In implementing or updating a fee schedule, one could

resolve such discrepancies. Discrepancies in payment for a particular physician service by site

might also be easier to resolve under the administration of a fee schedule.

Because the payment amount provided as a

Medicare benefit for a particular physician service could be known in advance for both beneficiaries and physicians, there would be much less

uncertainty about beneficiary coinsurance liability and physicians’ expected receipts from Medicare carriers. As a result, one would expect much

less confusion on the part of beneficiaries with respect to their financial obligations. Knowing their

unassigned liability in advance would also enable

beneficiaries to become better buyers. Under such

a system, physicians’ billings could proceed on a

more expeditious basis under fee schedules because payment amounts could be better known

in advance.

Given a fee schedule system of payment, a single parameter could be used to revise the level of

payments to take account of changes in the costs

of producing physician services and perceived

changes in the value of those services. This is in

sharp contrast to the fee revisions under CPR,

which result from the interactions of individual

physicians’ billing decisions, changes in medical

practice and medical practice costs, and departures, if any, from relative values observed in

Medicare localities in calendar year 1971. Even

under a relative value system with multiple conversion factors for the various types of physician

services, there would be potentially greater control of increases in the prices paid by Medicare

for physician services.

Uses of Fee Schedules for

Reimbursement Purposes

Three alternative approaches to the use of fee

schedules for the purpose of determining reimbursements can be identified:

● a schedule of maximum allowances,

● a schedule of absolute reimbursements with

no permitted additional patient liabilities,

and

● a schedule of Medicare reimbursements without regard to potential patient liabilities.

These alternatives are not mutually exclusive. Furthermore, any or all of these alternatives might

also be combined with an expenditure cap, which

might be implemented by either disallowing claims

above the cap or by discounting claims until there

was a reasonable expectation that the cap would

not be exceeded.

In effect, Medicare’s current reasonable charge

process operates as a schedule of maximum allowances, with individual maximum allowances

available for each procedure provided by any

physician (or physician practice). For physicians
Ch. 5—Payment Based on Fee Schedules ● 123

whose customary charge for a particular procedure exceeds the adjusted prevailing charge, the

value of the maximum allowance is equal to that

of the adjusted prevailing charge. For a physician

whose customary charge is at or below the adjusted prevailing charge, the value of the maximum is equal to that of the customary charge.

For all physicians, however, for any claim submitted with a charge below the lesser of the customary or prevailing charge, the approved charge

is the submitted charge. In calendar year 1984,

18.3 percent of all Part B claims were submitted

at or below the CPR limits (535).

Alternative Reimbursement Approaches

A fee schedule implemented as a schedule of

maximum allowances would set upper bounds on

approved charges for specific services. For example, were the fee schedule amount for cataract

excisions with intraocular lens insertions to be

established at $1,500, the approved charge for a

physician who billed for that procedure would be

set at the lower of the submitted charge or $1,500.

As under the current system of coinsurance, beneficiaries would have an incentive to secure needed

physician services from a provider who would bill

for an amount lower than the approved charge.

This incentive would be diminished for those beneficiaries with Medigap coverage that “filled in”

coinsurance amounts.

A fee schedule implemented as a schedule of

absolute reimbursements with no additional patient liabilities permitted would involve a significant departure from the present Medicare system

of physician reimbursement. This option would

involve a form of mandatory assignment—in effect, a prohibition of physician billing above the

Medicare allowance. Under such a system a physician would receive only that portion of the fee

schedule amount above the coinsurance (and any

deductible) regardless of the submitted charge.

The submitted charge, if any, might be disregarded;

only the procedure code for the service would be

used in determining the appropriate reimbursemerit. z Other things being equal, physician price

‘Under a comparable system used for pharmaceutical reimbursement under the Medicaid program in California, providers billed

for specific services often without specifying a charge, since that

charge was irrelevant with respect to reimbursement.

under such a system would have no effect on beneficiaries’ decisions with respect to individual physicians since there would be no difference in beneficiary liability for specific services.

The third alternative with respect to establishing reimbursement amounts from a fee schedule

would involve an even more radical departure

from the present Medicare system of determining approved charges for physician payment. A

fee schedule implemented as a schedule of Medicare reimbursements without regard to potential

patient liabilities would in effect be universal

nonassignment. This new arrangement would involve payment of only the fee schedule amount

(above the deductible and any coinsurance) regardless of the physician’s submitted charges. (Although physicians might still bill carriers directly,

there would be no implication that the approved

charge in such cases would necessarily be payment

in full. ) Because the beneficiaries would be responsible for paying for the difference between the

physician’s bill and the Medicare allowance under this kind of system, beneficiaries would have

a substantial incentive to seek physicians with low

submitted charges for needed services. Such a system might also be implemented to allow a beneficiary to keep any difference between the fee allowed by the schedule and any lower fee charged

by and paid to the physician.

Expenditure Cap

Any or all of the three methods of using a fee

schedule for Medicare reimbursement might be

modified to implement an aggregate expenditure

cap for physician services. One form of such a

system has been employed under the health insurance program in the Canadian province of

Quebec (388). Under an expenditure cap system,

reimbursements might be made at some fraction

of the relevant amount as long as there was a

possibility that the expenditure cap might be exceeded. Most likely (and comparable to the compensation schemes used by some individual practice associations (IPAs)) would be a discounting

program involving payments at, say, 85 to 95 percent of expected amounts with rebates to physicians (based on billing volume) if the expenditure

cap exceeded total interim payments. A somewhat

unlikely version of an expenditure cap might in-
124 ● Payment for Physician Services: Strategies for Medicare

volve payments at 100 percent of the expected

level until the cap had been reached, after which

no claims would be paid. (It is alleged that some

Medicaid programs, in effect, employed such a

system by deferring until their next fiscal year payment on all current year claims starting from the

time that their expected budget limit had been

reached. ) Another alternative might involve payments at 100 percent during the initial quarter of

the year with quarterly downward adjustments,

if needed, based on projections of anticipated

claims in succeeding quarters. Unfortunately, this

might have the effect of producing “gaming” behavior by physicians with patients who presented

afflictions during the last quarter of the year. In

this regard, in Quebec it is reported that some

physicians at or near their billing limits join “billing-pools” to take advantage of unused billing

quotas of other colleagues at the end of a billing

period (388).

One other issue that might arise in the implementation of an expenditure cap implemented

through discounting would involve beneficiary

coinsurance and nonassigned liability. If beneficiary coinsurance were calculated on the basis of

the discounted approved charge, there would be

a net decrease in expected beneficiary liability and,

possibly, an increase in beneficiary utilization in

response to the change in price. Other things being equal, a budget neutral proposal would retain beneficiary coinsurance liability with respect

to the undiscounted charge. A more serious problem might be anticipated with respect to nonassigned liability under a discounting system. If physicians collected from the beneficiaries the full

difference between their submitted charge and the

discounted approved charge, the later rebates, if

any, would involve double payments to physicians since the rebate amount would already have

been collected from the beneficiaries. Further,

even if beneficiaries were “indemnified” in this

process by being reimbursed for the entire undiscounted approved charge on unassigned claims,

under this system physicians would have an increased incentive to not accept assignment. Having the certain beneficiary payment in lieu of the

potential rebate would minimize the “loss” to the

physician that might occur if the expenditure cap

were exceeded.

Initial Implementation Issues

In addition to issues with respect to the ability

to administer a fee schedule on a continuing basis (to be addressed later in this chapter), there

are a variety of issues that relate to problems attendant solely to the initial implementation of a

fee schedule. Such issues include the following:

●

●

●

The

who might participate in the development of

a fee schedule (specifically involving antitrust

related prohibitions with respect to physician

organizations);

whether the method of fee schedule construction needs to be the method of fee schedule

maintenance over time; and

how to handle the transition from CPR to

a fee schedule.3 The last issue prompts the

question of exactly how close to a fee schedule is the current distribution of approved

charges?

Antitrust Issue

As a purely mechanical exercise, any Medicare

carrier could be instructed to estimate average approved charges for each service that it has reimbursed. A listing of the resulting charges by service

could be used as a fee schedule. However, because

of technological change in medical practice this

fee schedule would soon become inadequate. Continuing input from physicians would be necessary

to update the fee schedule, both with respect to

new procedures and to changes among the established ones.

Physician input in the development of a fee

schedule clearly is useful and probably is essential. The method through which that input is obtained, however, may be suspect because of possible violations of one or more of the antitrust

3Basically, there would be few administrative difficulties in converting from CPR to a fee schedule. The major complication would

be what policies, if any, would be used in the case of physicians

whose approved charges would be reduced following the conversion. Previous physician payment reform proposals have suggested

the use of “hold-harmless” measures that, in effect, would freeze

individual physician’s approved charges rather than reducing them

until the time when increases in other charges brought the frozen

charges into proper alignment. Another alternative would involve

blending the new rates with the established ones as has been used

in the conversion of hospital payment policies under the prospective payment system.
Ch. 5—Payment Based on Fee Schedules • 125

statutes. It is hard to imagine physicians’ establishing a fee schedule as something other than

pricefixing. In fact, the Federal Trade Commission (FTC) has sued several medical associations

with respect to their actions involving the publication of relative value studies or participation

in fee review efforts. FTC has also issued a number of advisory opinions that have had the effect

of circumscribing concerted physician action with

respect to the development of fee schedules. The

effect of these opinions is not to prohibit physician input into the development of fee reforms.

Individual physicians and medical societies may

not negotiate fees but may discuss reimbursement

issues —including relative values—with thirdparty payers without running afoul of antitrust

prohibitions (93).

FTC has modified its consent orders with several physician associations to note specifically that

a physician association is not prohibited from

“providing information or views, on its own behalf or on behalf of its members, to third party

payers concerning any issue, including reimbursement” (554). What has been proscribed by FTC

orders are agreements between physician associations and third-party payers, “whether extracted

by negotiation or coercion, and any conduct in

furtherance of such a result” (554).

At the outset, it should be noted that the Medicare program (and any State Medicaid program)

cannot be held to be in violation of antitrust prohibitions. If the Health Care Financing Administration (HCFA) unilaterally issued a fee schedule

without physician input or if it adopted without

modification the 1974 California Relative Value

Study, there would be no violation. There is a

“deemed repeal” of the antitrust acts for organizations established through the direct actions of

the U.S. Congress. State actions (such as those

that might involve Medicaid) are also exempt

(377).

Procuring physician aid even in a legal fee

schedule development process, however, might

be somewhat convoluted. The antitrust laws were

instituted to prohibit “unreasonable” restraints on

trade and competition (377). The drafters of those

acts can be presumed to have believed that vigorous competition among many sellers would be

the preferred state in any market because a system of competition would foster efficiencies unless restricted by private agreements or actions.

However, that competition in the (physician) market might not produce good results is, in and of

itself, not an acceptable antitrust defense. That

the alternative, for example, to a fee schedule

“competitively” derived from bilateral monopoly

negotiations between a private market insurer and

a medical society might not involve perfect competition is also not relevant. Therefore, that physicians might perceive an agreement to cooperate in the development of a relative value scale

—much less a fee schedule-to be an antitrust violation might inhibit needed physician cooperation

even though many types of physician contributions to such an effort would not be perceived by

FTC itself to be potential antitrust violations,

Three ingredients are needed to prove an antitrust violation: 1) there must be an agreement

between two or more otherwise independent parties (usually in the same line of business); 2) the

agreement must restrain trade or competition; and

3) the agreement must be “unreasonable” in terms

of its effects on competition (267). An illegal

agreement would be one that suppresses or destroys competition, not merely an agreement that

regulated the behavior of the parties concerned

while promoting competition,

FTC has promulgated its judgment that RVSs

for physician services may have anticompetitive

consequences including the following (554):

●

●

●

●

establishment of price relationships without

regard to quality, efficiency, or demand

differences;

fragmentation of billing categories, with separate charges for individual services resulting in higher prices;

concerted or interdependent adherence to

relative value scales by physicians; and

establishment of a “starting point” from

which collusion may occur,

In addition, FTC also noted in its advisory

opinion to the American Society of Internal Medicine (ASIM) that an agreement by ASIM’s members to adhere to its proposed “relative value

guide” would do the following (556):

● tamper with market pricing structures;

● pose a danger of higher prices with respect

to some medical services;
126 ● Payment for Physician Services: Strategies for Medicare

● stabilize prices artificially; or

● restrict output of certain services, viz., procedural services, and possibly restrict the output of nonprocedural services as well.

The major objections involve the possible effects on the price structure in the markets for physician services.4 In fact, any relative value scale

adopted by Medicare would likely find use in the

private market by both physicians and other

health care insurers. Physicians, insurers, and

health care financing researchers continue to use

the California Relative Value Study even though

its publication has been enjoined by FTC since

1979.

Should HCFA initiate fee negotiations or request or be granted congressional authorization

to conduct fee schedule negotiations with one or

more medical societies, the implied repeal of antitrust violations would be effective. However,

were HCFA to issue a solicitation in the form of

a Request for Proposals for an RVS, some medical societies that considered responding would be

unlikely to respond because they might consider

themselves to be in danger of being sued by FTC

or a competing physician association for violating antitrust prohibitions.

Implementation v. Maintenance

Clearly, any particular method of creating a fee

schedule could be replicated any number of times

as needed to adjust for changes over time. Because

of this, it might be possible to establish a fee schedule system for which the method of updating fees

was identical with the method of original implementation. An easy example might be the use of

one year’s average submitted charges to estimate

a next year’s fee schedule. Some methods, however, do not lend themselves to easy or at least

inexpensive replication, viz., empirical estimates

of resource costs associated with specific proce-

— 4The fragmentation issue arises in the evolution of procedural coding and terminology systems; it is not a function of RVSS. The output restrictions referred to in the FTC’s advisory opinion to ASIM

involve procedural services most likely performed by physicians who

are not internists. One infers from the FTC opinion that surgeons,

for example, would rationally reduce the supply of their services

if their payment rates declined. If ASIM members or other physicians, however, were successful in raising the prices of their own

services attendant to publication of their relative value guide, buyers

might reduce their purchases of those services (555).

dures. In such cases, replication as a means of updating might imply a very expensive system—perhaps, therefore, an infeasible system.

Replication, however, is not the only means of

updating. The Medicare Economic Index (MEI),

for example, which is used in the process of updating Medicare prevailing charges, could be used

to update a fee schedule regardless of the process

used to derive that schedule. Other price or cost

indexes might also serve this function. Use of an

index might allow for the establishment, for example, of an RVS through a one-time physician

consensus development process for each procedure or set of procedures. This process would not

have to be repeated every year. Replication of the

original process for the reconsideration of relative values (or relative fees) might be necessary

only to establish levels for newly introduced procedures or for other practice changes that were

believed to warrant such reconsideration.

A varied mix of methods might be used to improve the rationality of any particular fee schedule over time. For example, one might initially

change to a Medicare fee schedule by having carriers estimate average approved charges for each

procedure to establish a baseline RVS. For payment purposes, this RVS might be converted to

a fee schedule that might be updated each year

using the MEI. New procedures might be given

interim payment rates following a consensus development process. Final payment rates could be

established following estimations of resource

costs, perhaps 18 to 36 months after the interim

rates had gone into effect. Finally, the members

of an independent physician payment review commission might review and recommend changes to

correct any interjurisdictional or interspecialty

differences brought to their attention.

Transition From CPR to a Fee Schedule

If a particular fee schedule were identified and

deemed to be desirable, an initial problem would

involve the transition from the current system to

that schedule of fees. The expectation under the

current system is that for approximately no less

than 25 percent of the Medicare volume for any

procedure, the approved charge is equal in value

to that of the adjusted prevailing charge, with the
Ch. 5—Payment Based on Fee Schedules ● 127

rest of the distribution of charges at a variety of

lower levels. For some time, however, there has

been speculation that Medicare payment levels

were moving in the direction of de facto fee schedules because of the implementation of the MEI.

To the extent that this phenomenon has occurred,

a transition to a de jure fee schedule might be less

of a problem.

By the early 1970s, it was clear that the use of

one year’s submitted charges to establish the next

year’s customary and prevailing charges provided

an incentive to accelerate fee increases. As a result, there was a concern expressed that Medicare

fees were fostering inflation in medical care prices,

rather than merely following changes in the costs

of providing physician services. To attempt to ensure that increases in Medicare approved charges

followed rather than led inflation in physician

fees, legislation was passed to institute a procedure to cap prevailing charges. The level of the

cap would be changed each year through the use

of an “economic index, ” which explicitly estimated

both increases in the costs of providing physician

services5 and increases in general earnings levels.

The MEI was mandated in section 223 of the Social Security Act Amendments of 1972 (Public

Law 92-603). Because of the imposition of the Economic Stabilization Program in 1972, the provisions of the MEI were not implemented until July

1, 1975.

Prevailing charges in effect at the passage of the

legislation provided the initial caps on approved

charges. Thus, the base year for the MEI was July

1, 1972 through June 30, 1973, fee screen year

1973.6 In any subsequent fee screen year, the “adjusted” prevailing charge for any service would

be the lower of the 75th percentile of the distribution of volume weighted customary charges—

now known as the “unadjusted” prevailing—or

a value equal to the product of the prevailing

charge from fee screen year 1973 multiplied by

the current value of the MEI. For example, for

a procedure that had a fee screen year 1973 pre-

‘The components of physician practice expenses that are included

in the MEI are staff salaries, rental costs, automobile expenses, supplies, professional liability insurance, and “all other” costs.

‘Approved charges for that time period had been established

through statistical manipulations of physician charges submitted during calendar year 1971.

vailing charge of $100 and for which the fee screen

year 1982 “unadjusted” prevailing charge was

$185, the “adjusted” prevailing charge would have

been $179—the value of the MEI times the base

year prevailing charge (116).

From the MEI base year through June 1983,

physician prices as measured by the Consumer

Price Index (CPI) increased 258 percent while the

MEI increased 206 percent. Because of this disparity, it has been assumed that the MEI might

ultimately transform the CPR system into a fee

schedule based on the fee screen year 1973 prevailing. However, because the particular limit (submitted, customary, prevailing, or other charge)

used to establish the approved charge for any physician bill to Medicare has not generally been

recorded by carriers during the payment process

until recently, there has never been a complete

national source of statistics on the constraints imposed by the MEI. Thus, it has been impossible

to distinguish whether an MEI induced fee schedule will be achieved or merely approached asymptotically.

The available evidence is equivocal with respect

to how close the current system is to a fee schedule. For some years, the Medicare Directory of

Prevailing Charges (532) has included an indicator to identify for 110 common physician services those prevailing charges that have been established through the use of the .MEI. In fee screen

year 1984, 55 percent of all prevailing charges

listed in the Directory for general practitioners and

62 percent of the procedures for specialists were

established by the MEI (532). These numbers,

however, have been relatively stable if not declining since at least 1981, a pattern that is not indicative of the imminent coming of fee schedules

for all services.

Using the MEI indicators and other data collected for the fee screen year 1984 Directory, the

Congressional Budget Office (CBO) estimated that

60 percent of approved charges in the Medicare

program are priced at levels determined through

the MEI. They estimate that by 1990, this will increase to 70 percent. Those estimates, however,

are probably somewhat upward biased because

of peculiarities in the data definitions in the in-
128 • Payment for Physician Services: Strategies for Medicare

structions to Medicare carriers for collecting these

data. 7

An alternative source is an analysis of calendar year 1983 carrier data from the State of South

Carolina (247). This analysis of data on physician services excluding anesthesiology showed

that 43.2 percent of approved charges were established at the level of the adjusted prevailing. Because the adjusted prevailing is the lower of the

MEI cap or the actual 75th percentile of the distribution of volume weighted customary charges,

43.2 percent must be considered an upper bound

estimate of the impact of the MEI in that State.

In addition to this aggregate estimate, Juba estimated comparable percentages for a variety of

types of services. These ranged from 65.2 percent

and 64.6 percent for office and hospital visits, respectively, to 38.9 percent and 30.3 percent for

radiology (professional component only) services

and surgery, respectively. These statistics suggest

that the MEI may be closer to producing a fee

schedule for physician visits and other nonprocedural services than for surgeries and some of

the more technical services. It does not suggest

that a fee schedule is at hand as a result of the

MEI.

If this interpretation is correct, however, transition to a fee schedule may become both easier

...— —

‘Data for the Directory submitted by the carriers for each of 110

services include: the adjusted prevailing charge, the 50th and 75th

percentiles of the distributions of volume weighted customary

charges, and the total number of services whose prices were used

to establish the prevailing charge. By assuming that the distribution of customary charges is statistically normal or near normal,

one can estimate the actual percentile of the prevailing. The total

units of service can then be used to aggregate expenditures over the

entire set of procedures. This is basically the CBO procedure.

Because the 50th and 75th percentile estimates are established by

identifying the lowest customary charge that is no less than (i.e.,

equal to or greater than) the desired percentile, the resulting CBO

percentile estimates will be biased upward by varying degrees. Further, to the extent that procedures introduced since 1971 have been

less affected by the MEI, the 110 procedures included in the Directory will be less representative of the distribution of all physician

services provided to Medicare beneficiaries, again contributing an

upward bias to the estimates. Finally, of the 110 procedures included

in the Directory, inpatient surgical procedures tend to be underrepresented, because the surgeries included in the Directory are a

much smaller proportion of approved charges for all surgeries than

the comparable proportion represented by the specific types of physician visits included in the Directory. Because recent evidence

(247,294) suggests that visits are relatively more constrained by the

MEI than surgeries, the underrepresentativeness of surgeries in the

Directory will impart an additional upward bias to the resulting estimates of MEI impact.

and somewhat more complicated. The ease in

transition would be found in the problem of establishing fees for the office visits and hospital visits,

services responsible for significant fractions of

Medicare expenditures. To the extent that there

is relatively little variation in approved charges

with respect to individual visit types, intraspecialty disputes over appropriate prices maybe lessened. Standard deviations with respect to average approved charges for the four most common

office and hospital visits (in South Carolina) were

found to be between $2.35 and $3.40 (247) (see

table 5-1). If the distribution of approved charges

is roughly normal, approximately two-thirds of

the approved charges for any of those visits are

within $3.40 or less of the average. In fact, 85 percent of the limited followup office visits exhibited

approved charges within 25 percent of the State

mean approved charge across all specialties, and

94 percent were within 10 percent of the relevant

specialty mean. Thus, establishing a fee schedule

amount at the average approved charge would not

imply substantial changes in unit payments.

On the other hand, standard deviations for

some of the surgical procedures, for example, are

10 to 100 times greater than those of the most

common visits. This relationship implies that for

a particular patient or—for some physicians—

all patients, a single fee schedule amount, even

if based upon the average, might involve a nontrivial loss of unit revenue. Such a prospect might

cause a physician to change his or her clinical decisions about the patient’s therapy or his or her

entrepreneurial decisions about assignment or participation in the Medicare program.

To the extent that this problem exists, it may

be advisable to phase-in a change to a fee schedule. In the past, proposed Medicare physician payment changes have been designed to be phasedin through the use of “hold-harmless” provisions.

Under this approach, the payment for a particular procedure to a physician whose approved

charge would otherwise exceed the fee schedule

amount is frozen at the previous approved charge

level until such time as approved charge increases

for other physicians bring the fee schedule amount

to that level. This approach has the effect of temporarily rewarding physicians whose fees are

above average. If the expenditures for those
Ch. 5—Payment Based on Fee Schedules • 129

Table 5-1.—Mean Approved Charges and Standard Deviations for

Selected Medicare Services,a

South Carolina, 1983

Percent of total Mean

approved charges approved Standard

in State charge deviation

Office visits:

90080 Comprehensive: established patient . . . . . . . . . . . . . . 1 .03% $ 42.48 $ 15.47

90020 Comprehensive: initial patient . . . . . . . . . . . . . . . . . . . 0.81 38.11 17.53

90060 Intermediate: established patient . . . . . . . . . . . . . . . . 1,37 18.23 3.68

90050 Limited: established patient . . . . . . . . . . . . . . . . . . . . . 9.57 12.83 2,35

90040 Brief: established patient . . . . . . . . . . . . . . . . . . . . . . . 0.72 11.54 2.74

Hospital visits:

90220 Comprehensive examination . . . . . . . . . . . . . . . . . . . . 4.56 54.63 13.76

90250 Limited: followup . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11.86 16.26 3.40

90240 Brief: followup . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.53 13.99 2.59

Other medical procedures:

93547 Selective angiography . . . . . . . . . . . . . . . . . . . . . . . . . . 0.67 563.27 46.64

90620 Consultation: initial comprehensive . . . . . . . . . . . . . . 1.85 63.01 10.91

90630 Consultation: initial complex . . . . . . . . . . . . . . . . . . . . 0.53 63.01 9.43

99174 Critical care: extended . . . . . . . . . . . . . . . . . . . . . . . . . 0.65 39.69 10.53

99173 Critical care: intermediate. . . . . . . . . . . . . . . . . . . . . . . 0.73 36.56 7.97

93000EKG . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.56 23.27 3.20

Surgery:

33513 Quadruple bypass . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.65 3,691.17 175.67

33512Triple bypass. ......, . . . . . . . . . . . . . . . . . . . . . . . . . . 0.92 3,617.33 344.82

27130 Athroplasty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.66 2,009.57 257.69

66980 Lens prosthesis: cataracts . . . . . . . . . . . . . . . . . . . . . . 7.15 1,335.70 139.51

27244 Femoral fracture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.89 1,003.70 93.50

44140 Colectomy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.67 984.54 123.80

27236 Femoral fracture: proximal end . . . . . . . . . . . . . . . . . . 0.52 835.26 55.86

66920 Cataract removal extraction lens . . . . . . . . . . . . . . . . 0.61 794.57 40.62

52601 Transurethral resection of prostate. . . . . . . . . . . . . . . 2.44 792.16 35.72

47605 Cholecystectomy with cholangiography . . . . . . . . . . . 0.69 702.04 72.98

43239 Upper G.I. endoscopy with biopsy . . . . . . . . . . . . . . . 0.52 229.48 34.54

43235 Upper G.I. endoscopy . . . . . . . . . . . . . . . .’, . . . . . . . . . 0.72 208.59 35.79

Radiology:

74240Upper G.I. tract and exam . . . . . . . . . . . . . . . . . . . . . . . 0.51 31.12 3.22

77405 Therapeutic: intermediate . . . . . . . . . . . . . . . . . . . . . . . 0.51 24.10 3.05

71020 Two-view chest X-ray . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.34 13.76 1.44

71010 Single-view chest X-ray . . . . . . . . . . . . . . . . . . . . . . . . . 1.01 9.71 .77

Pathology:

82947 Glucose test . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.53 5.59 1.04

81000 Urinalysis. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.70 3.79 .48

aProcedures that account for at least 0.5 percent of approved charges in the State.

SOURCE: D.Juba, “Analyslsoflssuea Relating tolmplementing aMedicare Physician FwSchedule;’ prepared for the US. Congress, Office of Technology Assessmerit, Washington, DC, November 19S5.

“above average” fees are used, in effect, to reduce

the increases allowed for other physicians, the

hold-harmless approach penalizes those physicians whose fees were below average. An alternative would involve blending fee schedule payments with CPR payments during a transition

period. This approach allows for a faster transition to single payment rates than would “hold

harmless’’ provisions, while reducing the magnitude of any windfall losses or gains that might

attend an “overnight” implementation of a fee

schedule.

Updating, Maintenance, and

Appropriateness Checks

As indicated earlier, the method of fee schedule origination need not be the method of updating. For this reason, relatively costly methods of

creating fee schedules or RVSs could be consid-
130 ● Payment for Physician Services: Strategies for Medicare

ered to take advantage of any of their potential

design features. (Replication could remain a method of updating either on an annual basis or for

less frequent or partial recalibration.) In the absence of replication, there are two general problems that can be anticipated in updating a fee

schedule: 1) identifying appropriate aggregate

changes in the level of fees, and 2) identifying

appropriate changes in relative fees within the

schedule. (One might note that these are the two

primary functions given to the Prospective Payment Assessment Commission (ProPAC) under

Public Law 98-21, which established the prospective payment system for Medicare Part A.)

If the market for physicians’ services were perfectly competitive and if CPR did not contain incentives to raise billed charges in one year to increase approved charges in the next, CPR would

have a theoretical advantage with respect to maintenance of payment levels. Other things being

equal, if the costs of practice of all physicians rose,

billed charges would also rise appropriately to reflect input cost increases, and approved charges

would follow. If the costs of producing a particular physician service rose more than other services, one should observe a greater increase in

approved charges for that service under CPR.

However, it has been noted that CPR’s incentives

can influence billed charge levels. Further, although competitive, the market for physicians

services is not perfectly so. Given a conversion

to a fee schedule by Medicare, some other alternative to sole reliance on the prior year’s billings

would have to be adopted for fee schedule updating.

Aggregate Changes Over Time

The model of a perfectly competitive market

can be used to examine how prices should change

over time in an efficient economy. Such an examination can provide guidance in the development

of policy for updating a fee schedule. Specifically,

in a perfectly competitive market, suppliers would

behave as if they were minimizing the costs of producing their services for any level of total output. Increases in input prices would be reflected

in changes in suppliers’ cost functions,8 from

‘A cost function denotes the mathematical relation between input prices and the minimum cost of production of a particular level

of output for a particular production process.

which one could infer the price increase that

would be anticipated in a competitive market with

a fixed level of output. The mathematical results

of this exercise are the following: the expected

proportional change in cost for a cost minimizer

given changes in input prices is equal to the

weighted sum of proportional changes in input

prices, where the weights are the shares of total

cost of the various inputs. Hence, one could develop an index to estimate the most “efficient” increase in fees that would be appropriate given observed increases in physicians’ costs of practice.

There are two available indices that relate to

physicians’ costs and prices. They are the Professional Services Index of the Medical Care Component of the CPI and the MEI. The former is

somewhat better known to the general public and

has been computed on a monthly basis longer

than the Medicare program has been in existence.

It is based on 79 somewhat general physician services,9 the billed charge for which is requested on

a monthly or bimonthly basis from a fixed cohort of roughly 650 physicians located in urban

areas across the United States. For historical reasons, the services of ophthalmologists are included

in a separate vision care index, and the services

of anesthesiologists and pathologists are included

in the Hospital Price Index subcomponent of the

CPI.

For the purpose of updating a fee schedule, the

CPI professional service subcomponent does have

the advantage of being an index of fees that physicians charge their patients. Because it is based

on a fixed basket of services, for a fixed cohort

of physicians who are asked prices charged to

private-pay patients, it may even be biased downward as an index of physician fees in general. In

any case, it does not directly reflect changes in

the costs of physicians’ practices,

The MEI was mandated by the Social Security

Act Amendments of 1972 (Public Law 92-603) in

response to concerns that increases in Medicare

approved charges led rather than followed inflation in physician fees. To break this pattern, the

Senate Finance Committee had proposed to limit

increases in Medicare prevailing charges by com-

‘The exact number of specific services included is much larger,

since each physician practice in the sample provides his or her billed

charge for a specific service within one or more of the somewhat

general categories.
Ch. 5—Payment Based on Fee Schedules • 131

paring the prevailing to an index based on increases in the costs of producing physician services and increases in general earnings levels. The

Finance Committee did not specify the exact form

of the index, but it did suggest that the weighted

sum of the price changes for various practice inputs might be an acceptable approach. The notion is common sensical: if the prices of 40 percent of one’s inputs are increasing by 10 percent

and the remainder are increasing by 15 percent,

then on average input costs are increasing by 13

percent (13,251).

Although neither the Senate staff nor the Social Security Administration staff who developed

the MEI (118) began with a cost function analysis, the index that was developed is a closer analog than the CPI to a predictor of the price increases expected from efficient physicians who

faced increasing input prices. There are a number of refinements that might be introduced in the

MEI, particularly with respect to the question of

productivity changes, but the existing MEI might

be an appropriate index for use in updating the

general level of fees in a Medicare fee schedule.

In an RVS-based fee schedule, one would simply

multiply the change in the MEI by the existing

conversion factor to obtain the appropriate increase in the conversion factor.

Recalibration

The index approach to fee schedule updating

is administratively easy, but it embodies the implicit presumption that relative fees within the

schedule are correct and remain correct. At this

point, one could reprise the justifications for locality and specialty differentials, restate the arguments for using the payment system to encourage

the provision of some services and to discourage

others, and review the appropriate way to establish and monitor approved charges for new procedures that enter the repertoires of a significant

number of physicians. Because the circumstances

that underlie these issues are dynamic, one would

want the fee schedule system itself to have a mechanism for responding to such dynamics.

For example, if the Medicare approved charge

for a particular service were $25 in Manhattan and

$20 in northern New Jersey, there could be a periodic review of the need to continue such a differential. Similarly, specialty differentials for specific services could be reviewed. The approved

charges of new procedures not only could be reviewed over time to verify efficiencies that could

be expected to evolve, but the approved charges

of any procedures that are replaced by new ones

could be examined to determine any continued

justification for paying different prices for services with equal results.

Keeping Fee Schedule Levels and Cavitation

Levels Commensurate

Within the framework of the fee schedule as a

method of payment for physician services, aggregate price levels and relative price levels remain

the two basic issues. However, even if fee-forservice continues as the predominant method of

payment, whether by fee schedules or not, there

are a substantial number of Medicare beneficiaries

whose physician services will be provided under

cavitation arrangements, such as competitive

medical plans (CMPs) or health maintenance

organizations (HMOs). Comparisons of the expenditures for physicians’ services under the two

systems may provide another means of assessing

the appropriateness of fee levels under fee-forservice. If there were HMOs that maintained disaggregate data on their costs of treating specific

ailments on an ambulatory basis, such costs might

be used to examine approved charges for the physician services used in those treatments.

The comparisons might also be used to examine the appropriateness of payments made under

prepayment arrangements. For example, in California it was recently observed that the State pays

more per Medi-Cal (Medicaid) recipient enrolled

in HMOs than it does for recipients who receive

services in the fee-for-service sector (74).10 Nonetheless, because the level of costs of CMPs may

rise to the level of prepayment amounts, one

might justifiably use fee schedule payment level

changes to assess proposed changes in prepayment

levels.’ ]

IOThis appeared to be a resldt of State stringency in raiSing fee

levels for fee-for-service providers rather than as a result of HMO

inefficiencies.

“Under a worst case scenario, average adjusted per capita cost

(AAPCC) levels for competitive medical plans (CMPS) would be

overestimates because of beneficiary selection favorable to the CMPS.

CMP costs, however, could rise even further as they compete for

healthy patients by offering additional benefits or amenities. AAPCC

levels based on non-CMP enrollees would also rise due to exacerbated adverse selection. As a result, neither CMP costs nor aggregate

expenditure levels for the nonenrolled beneficiaries would be an

appropriate guide to future CMP prepayment levels.
132 Ž Payment for Physician Services: Strategies for Medicare

APPROACHES TO THE INITIAL CONSTRUCTION

OF FEE SCHEDULES

For the purpose of discussion, methods to construct fee schedules will be partitioned into two

categories. The first includes all approaches based

on the concept of an RVS—whether a chargebased, resource-cost-based, or consensus RVS.

The second labeled “competitively” developed fee

schedules, includes four methods that for the most

part are based on either implicit or explicit use

of market mechanisms to develop a set of fees.

The first two involve unilateral buying policies

that might be adopted by the Medicare program

in developing a fee schedule. The third involves

soliciting for competitive bids from physicians or

other suppliers of physician services from which

a fee schedule would be constructed. The fourth

alternative involves direct negotiations between

the Medicare program and physician groups to

explicitly develop a fee schedule.

Relative Value Scales

An RVS, in and of itself, is not a fee schedule.

Given a procedural coding and terminology system listing all physician services, an RVS is a

cardinal ranking of each of those services with respect to some conception of value.12 For example, a total hip replacement might have a ranking of 40.0 compared to the ranking of an inguinal

herniorraphy of 9.0 (76). Each service’s ranking

allows an ordering of that service relative to all

others. The difference between any two services’

rankings in some sense is a measure of a difference in value (192).

Conversion of an RVS to a fee schedule is relatively straightforward. Assigning a monetary conversion factor to a relative value unit allows the

computation of a fee for any service: the fee is

simply the product of the service’s relative value

in units multiplied by the conversion factor. Alternately, there might be different conversion factors associated with different types of service.

12The units of re]ative value for any RVS are arbitrary. ~tho@

one might choose a numeraire semice (228), the choice of a numeraire service would itself be arbitrary and none of the issues of the

California RVS, for example, was based on such a numeraire. The

number of RVS units for any service has no meaning except in relation to the number of units of some other service.

Thus, two services might have the same relative

value, but be assigned different fees. The health

insurance programs in France use this type of system (115).

RVSs for physician services area relatively recent phenomenon. The Casualty Actuarial Society developed RVSs for commercial insurers in

the 1940s (430). The best known of the RVSs are

those that were published by the California Medical Association. Separate editions were published

in 1956, 1957, 1960, 1964, 1969, and 1974. (As

noted above, the California Medical Association

was enjoined from publishing any further editions

in 1979. ) Other professional societies, such as the

American Society of Anesthesiologists and the

American College of Obstetrics and Gynecology,

have also developed RVSs.

The Value in Relative Value

The concept of value embodied in any RVS is

important. Differences in the concept to be used

may lead to quite different sets of relative values.

One might argue that the values in an RVS should

reflect differences in the costs of producing the

services. This approach would tend to establish

RVS based fees to physicians that did not distort

their clinical decisionmaking. On average the resulting approved charges would be a constant

multiple of estimated costs and there would be

no expectation that any one set of services would

be particularly encouraged by the payment system. However, even if this type of RVS were to

be based on the costs of the most efficient ways

of producing the services, there might be an objection that some services of little or no medical

benefit to patients should not be valued at cost.

Alternately, therefore, one might argue that

values in an RVS should reflect differences in the

statistically expected value of a change in health

status (compared to not receiving the service) of

a patient who receives a particular service. Physicians might be able to acheive some concensus

on this issue, although patients’ perceptions of the

value of physicians services might well be varied,

and might differ from those of the physicians, as
Ch. 5—Payment Based on Fee Schedules ● 133

well as from the values that might be discerned

by the Medicare program. In addition, from the

latter perspective, the value of a particular service might be placed in the context of all of the

other nonphysician services that might be provided in conjunction with the services in question.

A service provided in an ambulatory care setting,

for example, might be preferred to an apparently

equivalent service provided in a hospital because

the total cost to the program would be lower.

Relative values, therefore, could reflect not only

the costs of efficient production, including the

costs of physicians’ time, but also the preferences

and costs of patients, the Medicare program, and

probably those of society as a whole. It is unlikely

that any set of RVSs would meet each of these

requirements. (One might argue that, if nothing

else, because historical charges represent the resultant of: 1) physician costs; 2) Medicare, insured,

and private-pay patients’ preferences; and 3)

Medicare rules and regulations, the relative values

implicit in charge histories are an appropriate

source for an RVS. )

As a practical matter, however, there area variety of ways of constructing an RVS. These methods can be assessed in terms of the derivation of

their relative values and possible impacts of their

use for establishing a fee schedule. At the outset,

it should be noted that attempts to date to compare relative value scales from various sources

have found few aggregate differences among alternative RVSs (191,227). Some of those differences,

however, may be significant for the choice of RVS

or modification of an RVS that might be employed in establishing a fee schedule. Similarity

among alternative RVSs strengthens the case for

using a relatively inexpensive method of constructing an RVS.

Charge-Based Relative Value Scales

One first option for fee schedules would involve

the use of carriers’ patient history data to establish an RVS. Estimation of a central tendency

measure (mean, median, specified percentile) for

each physician service would establish that service’s relative value. Based on the total approved

charges for all procedures, a single conversion factor would be established that would make the resulting fee schedule budget neutral compared to

CPR.

Hadley and colleagues found that the choice of

the central tendency measure does not appreciably affect RVS scores (191). This would argue for

the use of average charge values, which are mathematically easier to compute than percentiles. If

the incidence and magnitude of outliers were

found not to be similar across procedures, use

of the median charge might replace the use of

averages.

Hadley and colleagues examined submitted

charges, prevailing charges, and reimbursements

for specific procedures and found that the choice

of charge measure also had little effect on the resulting RVS scores that might be computed from

history data (191). Data used for that analysis included fee screen year 1982 national data from

the Medicare Directory of Prevailing Charges and

1978 Medicare claims data from the State of California. In light of the recent findings that allowed

charges for visits appear to be a smaller fraction

of billed charges than for the more technical services (247,294), one might expect that an RVS

based on submitted charges would differ from one

based on allowed charges, especially with respect

to visits. To the extent that submitted charges reflect current private market values that source

would be preferred as a source of relative values .13

This option is the only one for which there exists empirical data on any of the effects of a change

from the current CPR system. Claims data from

the State of South Carolina14 from calendar year

IJRegardless of the choice, approved charges would be used to

determine the conversion factor to preserve a budget neutral change

to this type of RVS-based fee schedule.

liA1thou@ the State of South Carolina is relatively small and approved charges per claim in that jurisdiction are 14 percent lower

than the national average, its implementation of the CPR system

for determining approved charges is not believed to be unrepresentative of all carriers. In March of 1983, for example, the net claims

assignment rate in South Carolina was 56.7 percent compared to

53,2 for the United States as a whole (530). In the first quarter of

fiscal year 1983, the approved charges as a percentage of billed

charges in South Carolina were 78.1 percent and 76.2 percent, respectively, on assigned and unassigned claims. The comparable U.S.

statistics were 76.1 percent and 76.6 percent, respectively. Where

South Carolina’s claims processing system is different from the nation’s as a whole is in its early introduction of the use of CPT-4

as the procedural coding and terminology system for physician services, a system that is now required of all carriers. For that reason,

data analysis of potential chan~es in South Carolina maybe representative of national effects that may be forthcoming.
134 ● Payment for Physician Services: Strategies for Medicare

1983 to assess the effects of a change to a fee

schedule based on average approved charges without specialty differentials (247). By design, the system was budget neutral, so there was no change

in estimated Medicare expenditures. The major

effect of the simulated change to a fee schedule

was to increase payments to general and family

practitioners and to reduce program payments to

internists. Payments to surgeons and radiologists

were largely unaffected, i.e., total payments for

the services of those specialists remained within

1 percent of actual payments under CPR (see table 5-2). With no changes in physicians’ assignment decisions following the change to a fee

schedule, anticipated total Medicare revenues of

physicians would change by smaller amounts than

the change in Medicare payments. The reason is

that beneficiary costs on unassigned claims would

increase for some of the patients of physicians

whose approved charges had been reduced.

Juba’s examination of aggregate estimated

changes in physicians’ Medicare revenues showed

that for individual physician practices roughly

two thirds of all physicians would have observed

either no change in Medicare revenues or a change

of less than 5 percent (see table s-3). A total of

6.4 percent of all physicians would observe losses

of more than 10 percent percent, including 14.3

percent of all internists. Nearly 10 percent of all

physicians would observe increases in excess of

10 percent, including 19 percent of all general

practitioners and 11.3 percent of family practitioners, but only 3.8 percent of radiologists and

1.5 percent of all internists (see table s-3).

Similar results were found by Sulvetta in simulating a fee schedule based on average approved

charges using California data from 1980 (455). Total anticipated Medicare revenues for four out of

five specialties’s studied were changed by less than

1 percent; internists’ Medicare revenues were reduced by 1.64 percent. Of greater interest is the

range of gains and losses within each specialty:

86.2 percent of physicians were found to experience revenues under the fee schedule within 5 percent of their previous experience (with 29 percent

of physicians experiencing no change). However,

6 percent of physicians were found to experience

gains of more than 5 percent, and 7.7 percent to

experience losses greater than 5 percent. The latter group included 12 percent of the internists and

10 percent of the orthopedic surgeons.

Resource-Cost-Based Relative Value Scales

It has long been recognized that sound reimbursement principles require that (physician) payment levels not be greater than needed to procure

sufficient, high quality physician services, but also

not be less than needed to reflect the costs of efficiently producing those services, including a return on physicians’ investments in training. Hence

there has been interest in the development of a

resource-cost-based RVS.

On the face of it, the steps involved in estimating resource costs should be straightforward. One

begins with the enumeration of the constituent re15The five specialties were general practice, general surgery, internal medicine, orthopedic surgery, and ophthalmology.

Table 5-2.—Simulated Percent Changes in Medicare Program Payments Following Conversion to a

Fee Schedule” From CPR Payment, South Carolina, 1983

All General Family Internal General Orthopedic

specialties practice practice medicine surgery surgery Ophthalmology Radiology

Office visits. . . . . . . . . 0.0 19.60/o 16.60/0 – 16.50/o 1.2% –6.00/0 —

Hospital visits. ... , . . 0.0

—

17.4 11.5 –8.8 6.6 —

Surgery . . . . . . . . . . . . 0.0 –

— —

— 8.4 0.1 –0.9 0.0 —

Radiology. . . . . . . . . . . 0.0 — — — — — –0.1

Pathology. . . . . . . . . . . 0.0

—

1.3 – 1.8 1.8 0.1 –4.5

All types of

— —

services bc . . . . . . . . 0.0 16.5 11.9 –7.5 1.0 –0.6 0.1 –0.2

—Procedures in the cell account for less than 5 percent of total approved charges for that specialty.

aFee schedule bag@ on statewide average approved charges without regard to physician specialty.

b

lncludes physicians in listed specialties and others.

c

lncludes other medical services; excludes anesthesia.

SOURCE: D. Juba, “Analysis of Issues Relating to Implementing a Medicare Physician Fee Schedule,” prepared for the US. Congress, Office of Technology Assessment, Washington, DC, November 1985.
Ch. 5–Payment Based on Fee Schedules • 135

Table 5-3.—Simulated Percent Changes in Physicians’ Medicare Revenues Following Conversion to a

Fee Schedulea From CPR Payment, South Carolina, 1983

Reductions Increases

greater –11% –6% –1%to N o + 1 % to +6% to +11 to greater

than 25°/0 –250/o –10!40 – 5 % change + 5% + 10% + 15% than 25%

All specialties. . . . . . . . 0.5% 5.9% 6.50/o 21 .9 ”/0 23.1 % 22.30/o 10.1 % 7.3% 2.5°10

General practice. . . . . . . 0.0 0.4 1.0 1.0 26.0 33.8 18.7 13.7 5.3

Family practice . . . . . . . 0.0 1.4 0.0 2.8 20.9 39.4 24.1 9.2 2.1

Internal medicine . . . . . . 1.0 13.3 13.0 43.5 16.4 8.3 3.1 0.9 0.6

General surgery . . . . . . . 0.0 0.9 7.9 29.0 16.4 29.4 6.1 8.4 1.9

Orthopedic surgery . . . . 0.0 0.0 1.9 33.7 34.6 15.4 4.8 7.7 1.9

Ophthalmology. . . . . . . . 0.0 1.0 4.9 22.6 41.2 12.8 7.8 7.8 2.0

Radiology . . . . . . . . . . . . 0.0 0.0 7.6 50.6 14.2 15.2 7.6 3.8 0.0

aF6e schedule based On Statewide average approved charges without regard to physician sPecialtY.

blncludes physicians in listed specialties and others.

SOURCE: D. Juba, “Analysis of Issues Relating to Implementing a Medicare Physician Fee Schedule, ” prepared for the U S. Congress, Office of Technology Assess- -.

ment, Washington, DC, November 1985, ‘

sources that comprise the costs to be measured.

These variables can be readily identified. At a very

basic level, two categories have been identified:

1) all overhead costs such as salaries, rents, utilities, supplies, professional liability insurance, and

other services; and 2) physicians’ own time resources. There is a general consensus on the relative total costs of physician and overhead resources within individual physician practices. Net

physician revenues have consistently been found

to be approximately 60 percent of gross professional revenues. This result has remained virtually constant since the American Medical Association has published data on physician practice

costs. HCFA survey data have also been consistent with this results. Comparable data are reported in the journal Mecial Economics based on

survey data. The most recent findings published

in that journal indicate that the median practice

expense proportion was 38.2 percent (355). There

is not much variation in this ratio among specialties, nor is this ratio much affected by legal form

of organization.

The current empirical literature, however, is

sparce specifically with respect to resource costs

for particular procedures. There has been little or

no attempt to assess resource costs for actual practices. Wagner describes the difficulties involved

in identifying and collecting data for assessing

resource costs (561). She describes it as a “bottomup” approach since it involves measuring the

quantity of each type of input involved in producing each kind of product. Unit prices are also

needed for each type of input. The vector product of all of the units of input and the unit prices

of those inputs yields an estimate of the costs of

the final product.

Crucial assumptions involved are: 1) that the

observed level of utilization of capacity (of both

equipment and personnel) be optimal, 2) that the

organization and technology of the observed settings be optimal, 3) that the proficiency of the performers in the observed settings be optimal, and

4) that the observed quality of services provided

be optimal. Any deviation from these assumptions

at a minimum would introduce statistical noise

into estimates derived from several different practice locations. In fact, violations of one or more

of the assumptions would involve comparing different products or different inputs. For example,

if measured by the gross professional revenue per

patient contact minute, the apparent cost of physician time for a fully occupied physician may appear to be much less than a second physician with

an identical income but with some free time for

seeing additional patients. In fact, the contrary

is the correct view. The opportunity costs16 for

the first physician can be seen as the greater because slack time generates no additional revenue

or output of patient services.

Differing quality levels in the estimates obviously involve different products, but even differing technologies used to produce seemingly iden-

———-—

“’’opportunity cost” is a concept used in economics generally defined as the return available from the best alternative use of a particular resource, One is told that “there is no such thing as a free

lunch, ” because there are remunerative or at least satisfying alternatives to being treated to an otherwise “free” meal.
136 ● Payment for Physician Services: Strategies for Medicare

tical products may also imply different products.

Similarly, practitioners of different competencies

may also produce “identical” services that are far

from identical. In theory this might invalidate any

micro-costing study as a guide to more general

application, specifically its use in a relative value

study. In fact, however, some theoretical compromises are necessary once it is recognized that

there is some statistical variation about any measures of average performance that may become

available.

Wagner examined micro-costing studies of radiology procedures in two large teaching hospitals, clinical laboratory tests in a British hospital, and six hospital-based obstetrics/gynecology

procedures in a large U.S. teaching hospital (561).

She did not find a great deal of correspondence

between the relative values produced by these

studies and the relative values published in the

1974 California RVS. Unfortunately, there was

no way to examine the variations in relative

values that might have been found through these

studies since they were based on such small samples and each of the studies was focused on a

different set of procedures.

The most relevant attempt to date to estimate

resource costs for physician procedures was the

study by Hsiao and Stason for HCFA (227). In

this study, data from the Study of Surgical Services in the United States were assembled to estimate average physician patient contact time for

a selection of so surgical services. The authors estimated total resource cost relative values as the

product of estimated average physician time, relative complexity, imputed physician opportunity

costs (to correct for differences in the length of

specialty training), and relative overhead by specialty: 17

resource

cost-relative = MD time, x complexity~ X opportunity costj

valueij

where i and j refer to the ith procedure

jth physician specialty, respectively.

x overhead]

and the

l7Average patient contact time in the operating room was derived

directly from Study of Surgical Services in the U.S. statistics. Estimated pre- and post-operative patient time was developed by a consensus measure of visit time for any operation. Procedure complexity

measures were developed using a Delphi method with a panel of

25 physicians from the Boston area. Training length estimates came

from American Medical Association data, and overhead estimates

came from Medical Economics survey data.

This formulation assumes that the average patient contact time estimate is a fairly reliable estimate for all physicians within a specialty; that all

sources of variation in required physician skill

levels can be accounted for in a single complexity measure; that a physician’s opportunity costs

are solely related to length of training; and that

overhead by specialty is uniformly related to all

services within that specialty.

The simplifying assumptions were necessary for

any estimates to be produced. Within that context, the exercise was useful in identifying the issues involved in estimating resource costs and in

demonstrating that a plausible set of estimates

could result (see table s-4). In general, there has

been no controversy with respect to the specific

estimates produced by Hsiao and Stason in 1979.

Any current objections to the results involve the

timeliness of the data used and data refinements

that might increase the potential realism of the

assumptions. The data for the physician time estimates used for each service were collected in the

early 1970s and may no longer reflect current physician practices. The simplifying assumptions from

the original study might now be relaxed or refined

given better data on individual physician practices and their finances. There are some other perspectives, however, on the general problems of

estimation of resource costs for payment purposes

that are presented in the following sections.

Should It Cost What It Costs? —Another range

of issues involves the contrast of concerns between

providers and Medicare as a payer. “Resource

costs” is fundamentally a supply side concept;

reimbursement is more often the subject of demand side considerations. In particular, one must

exercise a general caution in applying any resource

cost estimation methodology for the purpose of

establishing relative payment levels, particularly

with the purpose of identifying a “just price” (187).

Empirical studies in health care and other industries have verified the economists’ theoretical

prediction that the costs of production will rise

(and occasionally fall) to the level of the purchase

price. The most common example cited is the cost

of producing airline services prior to deregulation.

When the Civil Aeronautics Board established

price levels for certain airline trips, the commercial carriers’ competition for passengers drove up

the provision of in-flight amenities, and hence the
Ch. 5—Payment Based on Fee Schedules ● 137

Table 5-4.—Resource Cost Relative Values and Relative Reimbursements per Hour

Implied by Medicare Prevailing Charges, Massachusetts, 1978

Relative Medicare Payment

Physician service (and specialty) value prevailing charge per hour

Hemorrhoidectomy . . . . . . . . . . . . . . . . . . . . 0.9 $271 $193

Inguinal hernia repair. . . . . . . . . . . . . . . . . . . 1 .0a

339 218

Appendectomy . . . . . . . . . . . . . . . . . . . . . . . . 1.0 339 272

Cholecystectomy . . . . . . . . . . . . . . . . . . . . . . 1,6 570 275

Hysterectomy . . . . . . . . . . . . . . . . . . . . . . . . . 1.9 640 279

Lens extraction. . . . . . . . . . . . . . . . . . . . . . . . 1.7 678 679

Suprapubic prostatectomy . . . . . . . . . . . . . . 1.8 720 399

Transurethral prostatic resection . . . . . . . . 678 475

Initial office visit (general practitioner) . . . 0.19 20 40

Routine brief office visit (general

practitioner). . . . . . . . . . . . . . . . . . . . . . . . . 0.08 10 40

Initial office visit (internist) . . . . . . . . . . . . . 0.21 34 68

Routine brief office visit (internist) . . . . . . . 0.09 15 60

aB~ d~~i~”, inQUinal hernia repair was selected as the nur-neraire service thereby establishing its relative value as 1.0

SOURCE: W.C. Hsiao and WE. Stason, “Toward Developing a Relative Value Scale for Medical and Surgical Services,” Hea/th

Care Financing Review 1(2):23-3S, fall 1979.

cost of producing those trips. Similar results have

been found with respect to the costs of in-center

maintenance dialysis given the HCFA’s fixed limit

on dialysis payments (56).

This result does not even require explicit and

direct competition between sellers. To paraphrase

one of the earliest neoclassical economic theorists,

Alfred Lord Marshall, if the price that the final

purchaser is willing to pay is relatively high and

relatively flexible, the sellers’ purchases of product inputs will also tend to be relatively high and

relatively flexible (289). Thus, if Medicare’s reasonable charge levels for endoscopic examinations, for example, were initially in excess of resource costs, physicians who purchase endoscopes

would be less likely to try to bid down the price

of that type of equipment. Other things being

equal, over time the “costs” of producing endoscopic exams would rise to the level of the purchase price, the reasonable charge.

Other Resource Cost Issues.—There are several

issues that have been identified with respect to the

problem of resource cost estimation:

● demand side adjustments to resource cost

estimates that might be introduced in a relative value scale such as

—identification of physician services generally believed to be ineffective,

—identification of services whose provision

should be encouraged,

—identification of sets of “equally effective”

physician services;

Ž task delegation and physician time estimates;

● variations in practice input unit costs;

. variations in physician incomes with respect

to specialty and experience;

. variations in physician practice styles; and

● variations in estimates of resource costs for

specific physician services.

Potential Demand Side Adjustments. —As noted

above, there might be a need for an adjustment

factor in a resource-cost-based RVS to reflect differences in the general effectiveness of specific

services. Although some generally effective services may not prove to be effective with respect

to a particular patient, there are some services that

are generally believed to be ineffective and some,

for example, gastric freezing, that have been

shown to be ineffective. The costs of ineffective

services-however inexpensive—need not warrant equal treatment with the costs of services of

proven efficacy. On the other hand, one might

also want to examine a multiplier adjustment for

such services as effective preventive care such as

pneumococcal vaccination, if it were believed that

payment levels above costs would lead to the additional provision of such services. Finally, a possibility exists that within the set of generally effective physician services, there will be sets of

equally effective services that are substitutes for

one another. In this case, a pure demand side ap-
138 ● Payment for Physician Services: Strategies for Medicare

preach would require that payment for the two

services be equal and set at the level of the lower

priced service.

Physician Time Estimates and Task Delegation.

—It is expected that the most significant observable resource involved in the production of physician services would be individual physician time.

The varieties of styles of medical practice, however, suggest that physicians have a great deal of

choice with respect to whether they individually

perform certain tasks or delegate those tasks to

appropriately trained staff. For example, many

medical practices routinely delegate blood pressure testing to nurses or physician assistants. If

not properly accounted for, the substitution of

staff time for physician time could confound any

resource cost estimates, or at least introduce additional variation in the estimates of the averages.

A common approach has been to measure only

direct physician time and to allocate all costs for

support personnel to physician overhead without

regard to the specific services in which those personnel may participate. This relatively simple approximating strategy has some merit. The single

most common category of employee in physicians’

offices is “secretary, receptionist, bookkeeper”

(499). These employees are unlikely to be directly

involved in the production of medical services.

However, there are a significant number of physician assistants employed in medical practices,

and appropriate weighting strategies for including those costs would have to be explored (490).

Variations in Practice Input Unit Costs. —Surveys of physician practice costs and incomes by

HCFA, the American Medical Association and

Medical Economics have been successful in eliciting information from physicians on their total annual expenditures for practice inputs. The survey

approach has been somewhat less successful in

estimating unit costs because of data definition

problems and difficulties in determining the appropriate measures of units. Annual expenditure

statistics are clearly less burdensome to collect

than would be unit costs: there would also be less

required detail. As a result, however, the impact

of differences in unit costs on practice decisions

is unknown.

The notion of the estimation of average resource costs of specific physician services from a

sample of practicing physicians would rely on the

assumption that there is some degree of uniformity in the production of those services. Although

there exist certain (recipe driven) production processes in which there are no choices with respect

to amounts of inputs, physicians can and do make

choices with respect to the organization of their

practices.

Although for the most part physicians’ business

decisions rather than their clinical decisions are

involved, these choices affect the costs of providing clinical services and may affect the estimates

of the costs of those services. A simple example

can be seen in decisions with respect to office

space. In an area of relatively low rentals, a physician practice may acquire office space with relatively large rooms. The net impact on actual rental

overhead or absolute rent expenditures is uncertain. Costs could be higher, lower, or identical

with the corresponding expenses of practices in

areas with higher rental rates. However, in the

absence of good data on the unit costs of each

practice, use of average rental rates for estimation will make it appear that this practice carried

either a relatively larger overhead for office rental

expense or absolutely larger rental expenses for

each physician service performed in the office.

Variations in Physician Incomes With Respect

to Specialty and Experience, —The remaining unit

cost of interest is the physician cost. Except for

the case of salaried physicians, for the most part

this statistic is not directly available. Relevant estimates that are currently available relate to physician net incomes after practice expenses—that

often include deferred income. As might be expected, net incomes are computed as residuals.

The unit cost measure that results is net professional revenues per year or per hour.

Actual net income is only one of several available means of valuing physician time. The most

simple method of valuing the physician resources

employed in the provision of a specific service

would be to multiply the average net income per

hour and the time, in hours, used to produce the

service. Actual incomes embody the results of so
Ch. 5—Payment Based on Fee Schedules ● 139

many individual choices, however, that computation based on any small sample of practices

might not lead to accurate results. The alternate

method of establishing a relative value of phyician time used in the literature is to base those

values on relative complexity and opportunity

costs (227,271).

Variations in Physician Practice Styles. —One

of the implicit assumptions involved in the development of any resource cost method for potential use in payment reform would be that there

are not too many clinical options with respect to

performing specific physician services. The underlying distribution of tasks and time would exhibit

only some limited variation. If, however, there

is a continuum of clinical options, then the averages generated from the observations in an estimation study might not represent any one style

of practice. Payment rates derived from such estimates might be too high for some styles of practice and too low for others. For example, in estimating the total approved physician charges

associated with Medicare beneficiaries hospitalized in particular diagnosis-related groups,

Mitchell, et al. found that the costs attributed to

any observation were significantly affected by the

presence of an assistant at surgery (320). payments

based on the average would be too high for cases

without an assistant, too low otherwise. Given

variation in practice styles across physicians performing the same service, one might expect a comparable result.

Variations in Estimates of Resource Costs for

Specific Services. —Finally, for all of the reasons

discussed above plus any other natural occurrences of variation, one would expect that there

would be variation about any average resource

cost estimate that can be produced for an individual physician service. The relative size of the

variations among a set of services whose resource

costs have been estimated is crucial. Even with

the most accurate estimation method, resource

costs estimates that are not found to be significantly different from one another due to inordinate variation will not prove to be a compelling guide to reimbursement reform.

Relative Value Scales Achieved Through

Negotiations/Consensus Development

Both the charge-based and resource-cost-based

RVSs would be derived primarily from empirical analysis of quantitative data. The former

would involve a somewhat mechanical determination of central tendency values from distributions of charges; the latter would involve a somewhat more thoughtful examination of physician

practice cost data, perhaps supplemented with information on the relative complexity of various

procedures. An alternative that would place

greater reliance on physicians’ professional judgments might involve explicit negotiations or consensus development processes to achieve an RVS.

The developers of previous RVSs have employed professional judgments in modifying the

results obtained from statistical manipulations.

For example, in the preface to the 1960 version

of the California Relative Value Studies, it is noted

that although basic relative values were established by statistical analysis of data from 6,800

physicians with respect to roughly 600 procedures

(75):

[I]n a few instances it was apparent from analysis of the data and from consideration of subsidiary data that strict adherence to the survey

values would produce unrealistic results. In such

instances, values were set by consultative means.

Thus, the use of professional judgments in the

establishment or revision of an RVS through negotiations or consensus development procedures

is not unprecedented. In fact, considerable physician consensus with respect to relative values has

been shown to exist. In the 1950s, Horton demonstrated this fact through analysis of surveys of

physicians in Connecticut and Montana (225,226).

Hsiao and Stason found such consensus within

a set of surgical services although not between surgical services as a class and office visits as a class

(227). Recently, Egdahl and Manuel have used a

consensus development process to rank surgeries with respect to complexity and severity (119).

Types of Decisions. —One should make distinctions between the various types of decisions that
140 ● Payment for Physician Services: Strategies for Medicare

might be the subject of an RVS negotiation or consensus development process. (For the purpose of

discussion they will be described as changes in

relative values. The same types of decisions would

also have to be made in the initial development

of an RVS. ) Negotiations with respect to the value

of a conversion factor or factors used to transform an RVS into a fee schedule are one example, but will be discussed in a later section. Other

examples are as follows:

●

●

●

changes in relative values with respect to a

numeraire service whose price is to remain

fixed,

changes in relative values for a class of services while the price of all other services remains fixed, and

changes in relative values subject to the constraint that projected total relative values be

fixed given anticipated volumes for each

service.

The relation or lack of relation between the

RVS and one or more prices in a fee schedule

changes the nature of the negotiations; hence the

distinctions made above. The first example might

involve specific services perceived to be either undervalued or overvalued with respect to actual

payment levels; hence the need for revisions in

a relative value scale without a general change in

conversion factors. The second example is itself

best exemplified in the current discussions with

respect to the relative values of nonprocedural

services. One might expect discussions on the

merits of raising the relative values of those services while holding the conversion factors for all

other services constant, the expectation expressed

by FTC (554). Alternatively, one might discuss

the merits of reducing the relative values of all

other services, holding the conversion factor for

nonprocedural services constant. The final example would involve “pure” changes in relative

values, but this would imply much less certainty

about results, since all prices in any fee schedule

derived from the RVS in question would be subject to change.18

18 The process might be as follows: Given a revised set of relative

values, one could sum the anticipated total of relative value units,

assuming that the volume of services from a prior time period would

remain unchanged. Given that volume, one would compute the conversion factor implied by a specific budget target. Since any set of

relative values would imply its own conversion factor, all prices

in the resulting fee schedules would be changed.

Possible Outcomes.—Berenson has discussed

various options that might be employed in establishing a relative value scale through group-decisionmaking processes (33). He suggested that although costly, a commission representing the

community at large might be better able to develop an RVS that reflected a broad view of what

should constitute the values of a range of medical services than a commission constituted of “experts” representing each of the various specialties.

He also noted that there are no models available

that could be used to predict the impact on the

relative value of any service that might result from

such complex decisionmaking processes.

Experience to date with negotiating systems

used in other countries gives little additional guidance on outcomes. The West German sickness

funds have tried without much success to reduce

the relative fees paid for laboratory services and

to raise fees for basic medical services so as to increase the relative incomes of general practitioners

(162). However, most governments that have been

involved in such negotiations have been perceived

to be more interested in adjusting fees to control

expenditures in the aggregate rather than in finetuning with respect to individual services (33).

“Competitively” Developed

Fee Schedules

The CPR system, to a certain extent, is neutral

with respect to price competition in the markets

for physician services. Physician fees evolve, for

whatever reasons, and the CPR process educes a

set of approved charges from the middle to upper ranges of the fee distribution. At best, this is

a passively competitive posture: Medicare as a

price taker without searching for the lowest price.

However, more competitive postures for the program are available. These would include pricing

policies that would be more directly analogous

to perfect competition, bilateral monopoly, or the

use of the purchasing power of a monopsonist. 19

19perfect competition describes an idealized market for a

homogeneous good in that there area substantial number of both

(cost minimizing) buyers and (profit maximizing) sellers, no one of

which has a direct effect on the price of the good in question. (Hence,

the phrase “price taker.”) Bilateral monopoly describes a market

in which there is a single seller and a single buyer. Monopsony describes a market in which there are many sellers but only a single

buyer. Perfect competition and monopoly (or monopsony) are not

opposite ends of a spectrum with respect to competition. The op-
Ch. 5—Payment Based on Fee Schedules . 147

HCFA has used various analogs of such reimbursement policies for the purchases of pharmaceuticals, durable medical equipment, and laboratory tests (292).

Four approaches to “competitive” physician

payment policies are discussed below. The first

two involve unilateral buying policies that might

be adopted by the Medicare program in developing a fee schedule. The third involves soliciting

for competitive bids from physicians or other suppliers of physician services from which a fee

schedule would be constructed. The fourth alternative involves direct negotiations between the

Medicare program and physician groups to explicitly develop a fee schedule.

Lower the Price

In theory, a virtue of the CPR system is that

it allows beneficiaries in any locality the expectation that a significant fraction of the charges for

a physician service will be covered by Medicare

almost without regard to the beneficiary’s choice

of a physician. Only those beneficiaries who receive services from the most expensive doctors

should expect to have substantial additional liabilities, and those liabilities would apply only on

nonassigned claims. This flexibility was one of the

reasons that prompted the National Association

of Blue Shield Plans to adopt the UCR20 concept

in the mid-1960s. Perhaps equally important,

UCR offered the Blue Shield Plans the opportunity to sell a product that would nearly always

give subscribers paid-in-full benefits without the

additional cost of setting (national) fee schedule

payments at a level high enough to guarantee physician participation in all parts of the country

(312). Obviously, the same would be true for

Medicare under CPR even if the jurisdictions in

question were each of the States as an alternative

to the Nation as a whole.

— . —

posite of competition—whether perfect or monopolistic—involves

a lack of (low) price searching by buyers and a lack of purposive

behavior by sellers to either maximize profit, surplus, or market

share.

20UCR stands for “usual, customary, and reasonable charges, ”

the pricing concept used primarily by Blue Shield plans. It was developed prior to the introduction of Medicare, and was the model

adopted for CPR. Blue Shield’s “usual” charge became Medicare’s

“customary” charge, Blue Shield’s “customary” charge became Medicare’s “prevailing” charge.

Although the degree of physician participation

was and is an important marketing consideration

for Blue Shield Plans, it is not clear that the Medicare analog—physician acceptance of assignment

—is as important for the Medicare program given

that: 1) carriers do not act as insurers that underwrite the Medicare program, and 2) there is recent evidence from the Medicare participating

physician program that a significant number of

physicians will agree to accept assignment on 100

percent of claims (521). Assignment is important

to both Medicare beneficiaries and to the Medicare program. However, a fee schedule alternative to CPR need not involve a relatively high

price uniform in all jurisdictions to guarantee high

assignment statistics. A relatively low price may

suffice in some localities. Specifically, if an approved charge of $2,000 is necessary to elicit an

assignment rate of 50 percent for cataract extraction operations in New York City, that does not

imply that $2, 000 should be the approved charge

for that operation for all of New York State, much

less all of the country. Lower prices might elicit

equal or higher assignment rates for that operation in jurisdictions outside of New York City.

One might establish fee schedule payment levels

below current prevailing charge levels. In fact, a

relatively low percentile level might be selected,

such as the 50th percentile of approved charges

or lower. (Under Medicare’s “lowest charge limitations” applied to certain laboratory tests and

items of durable medical equipment in the late

1970s, payment levels were restricted to the 25th

percentile. ) With few exceptions, use of the 50th

percentile would produce a fee schedule comparable to that that would be produced by using average approved charges to develop a relative value

scale. If the distributions of approved charges for

individual physician services are skewed to the

left, selection of the 50th percentile as the fee

schedule standard might have a slight downward

effect on total Medicare expenditures for physician services. Such a decline, however, would be

moderated if there were volume increases observed with respect to physicians’ experiencing reductions in approved charges.

Find the Lowest Sufficient Price

A potential difficulty with the use of the 50th

percentile as the fee schedule amount is that in
142 Ž Payment for Physician Services: Strategies for Medicare

some jurisdictions that amount will be too high

and in others too low to secure sufficient access

for beneficiaries to needed health care services.

Were the level too high, one might observe an

increase in the number of physicians becoming

Medicare “participating practices” and an increase

in the percentage of claims for which assignment

was accepted. In contrast, were the level too low,

one would expect to observe a decrease in physician participation or acceptance of assignment.

Rather than merely reacting to these changes

in beneficiary access, a policy might be initiated

to explicitly identify the lowest fee schedule

amounts subject to the constraint of achieving

comparable expected levels of beneficiary access

in each jurisdiction. For example, carriers might

be instructed to identify the lowest approved

charge for a particular physician service that

would include 25 percent of the physicians who

had provided such services to Medicare beneficiaries. (Once the fee schedule amount had been

established, however, any and all physicians could

provide the service at that price. ) Alternatively,

the carriers might be instructed to identify the

lowest approved charge (for each service) that

would encompass a particular fraction of assigned

services in each locality.

By design, these types of procedures for establishing fee schedules would draw maximum fees

from the lower end of the distributions of approved charges rather than the upper end as in

the current CPR system. The pricing philosophy

in this case is analogous to that used in the Maximum Allowable Cost program that HCFA has implemented for purchases of pharmaceuticals—

primarily in the Medicaid programs (261).

To remain competitive within the Medicare system, physicians would have to restrain their fees

or possibly subject their Medicare patients to substantial amounts of nonassigned liability. Alternatively, the physicians whose fees were at or below fee schedule amounts might find additional

Medicare patients requesting their services in lieu

of continuing to obtain services from the relatively

higher priced physicians in a particular locality.

In contrast, under the current CPR system (as supplemented by Medigap insurance), there is little

or no advantage to a physician in having relatively low fees.

Solicit Bids

If there were some uncertainty that physicians

would supply sufficient services to Medicare beneficiaries under either of the two empirical methods of establishing fee schedules from existing distributions of approved charges, an alternative

approach to competitively procuring such services would be to solicit bids. This approach might

take the form of exclusive or semi-exclusive bidding. Under the former, a single physician group

or consortium of groups willing to supply up to

a specific quantity of a particular service for a

fixed unit price would bid for the exclusive right

to provide those services to the Medicare population in a specific geographic area. Obviously this

would imply restricting beneficiary freedom of

choice in that area. Partly for this reason, it might

be particularly applicable to such services as extracorporeal shock wave lithotripsy (ESWL),

where a relatively small number of providers can

be expected in each market. This approach, however, would seem to be inappropriate for a service such as the provision of pneumococcal vaccine that is easily and generally available from

many providers.

Alternatively, a semi-exclusive approach might

be tried. Under that approach bids for particular

physician services would be solicited from all

practices in a particular locality. These bids would

be in the form of both a price and an expected

quantity of service to be supplied at that price.

All physician bids would be examined to identify

the lowest bid price sufficiently high to provide

the expected utilization of the service in question.

Again, any and all physicians in that locality

might be allowed to provide the specific service

at that price. In fact, much as in the U.S. Treasury’s auctions for its bills, physicians might bid

“the auction price” for their expected provision

of the service in question, explicitly accepting the

price to be determined by the bidding. This approach would work well for pneumococcal vaccinations. However, it might vitiate any potential Medicare market advantage in procuring

lithotripsy or magnetic resonance imaging services if all bidders knew they might participate at

the winning price.

A problem with either of these potential bidding schemes is the multiplicity of both services
Ch. 5—Payment Based on Fee Schedules . 743

and localities. Conduct of the bidding even on just

a one-time basis could be extremely complicated.

Further, under a simpleminded version of the exclusive bidding option, one might expect absurd

results, such as one practice in the northern part

of a city with exclusive rights to limited office

visits, while the rights to limited hospital visits

might be won by a competing practice on the

other side of town. There is also the potential

problem of the creation of a local monopoly for

a single winning bidder. If market entry required

substantial resources, a single winning bidder

without competition might successfully resist subsequent Medicare cost containment initiatives.

For these reasons, semi-exclusive bidding might

be conducted with respect to relative value unit

conversion factors for a complete set of physician

services. Alternatively, exclusive bidding for a

relatively compact set of related services might

be conducted with any additional services not in

the bidding set to be priced based on the RVS conversion factor implied by the bid. Finally, exclusive bidding might be used only for relatively

homogeneous services with high expected volume

or expenditure levels, such as cataract excisions

(with intraocular lens insertions) or laboratory

tests. All other services might be priced using one

of the other alternative approaches to developing a fee schedule.

Negotiate

The final “competitive” option would involve

explicit negotiations between the Medicare program and physicians providing services to Medicare beneficiaries. In theory, this could take the

form of service-by-service discussions to arrive

at a fee schedule, although more likely would be

negotiations with respect to conversion factors to

be used with an existing RVS. The latter has been

the more commonly observed pattern among government programs in other countries (33). In Canada, for example, the Ontario Health Services Insurance Plan has adopted every version of the

RVS promulgated by the Ontario Medical Association, negotiating primarily with respect to the

conversion factor (578).

Due to FTC interpretations, this is an option

that exists only for Medicare or other governmentsponsored programs, such as Medicaid. Blue

Shield negotiations with physician groups, for example, would be prohibited although physician

input in the form of discussions about fees would

not be prohibited. The problems facing the Medicare program in implementing negotiations, however, would start with identifying a group with

whom to negotiate. The American Medical Association is the largest single association of physicians in this country, but its membership includes

just more than half of all U.S. physicians. A new

physician group might have to be constituted to

sit on the other side of the negotiating table.

Other countries with experience in negotiating

fees have tended to recognize existing physician

associations. In Canada, the Medical Care Act of

1966 established that a uniform schedule of fees

would be negotiated periodically between the

medical association of each province and the

provincial agency responsible for their payment

(28). In West Germany, the Cost Containment

Act of 1977 mandated the establishment of a National Health Conference including all major interest groups active in the health care sector, specifically including the associations of sickness

funds’ physicians. A national relative value scale

is periodically negotiated between the association

of sickness funds and the associations of sickness

funds’ physicians (387).

IMPLICATIONS OF PAYMENT BASED ON FEE SCHEDULES

The dimensions by which to assess the conver- be speculative, because of the lack of data availsion of Medicare physician payments from CPR able to examine even the initial changes in fees

to a fee schedule are: quality of care, access to that might be wrought by a conversion to fee

care, cost, technological change, and administra- schedules, much less to project behavioral changes

tive feasibility. Much of the following analysis will that might be induced thereafter. In addition, al-
144 ● Payment for Physician Services: Strategies for Medicare

though the conversion to a fee schedule for the

most part would be a quantitative rather than a

qualitative change in payment policy, in the aggregate the expected effects of this type of change

would be small. The CPR system is basically a

fee schedule system with physician-specific fees

for many services of most physicians and localityspecific and/or specialty-specific fees for the remaining services/physicians.

In that both CPR and any of the alternative fee

schedules involve fee-for-service payments, the

impacts of a switch to the latter may rest solely

on any difference in the level of payment rather

than in the method of fee determination. Given

that a physician’s clinical choices with respect to

specific services are also influenced by considering patient preferences, available practice resources, and medical indications with respect to

modalities within the physician’s repertoire, other

things being equal, the effects on clinical choices

of changes in that physician’s approved charges

for specific services should be small. More likely

are changes in physicians’ entrepreneurial decisions with respect to agreeing to provide services

to Medicare patients in the first place and/or accepting assignment on those services.

Paradoxically, conversion of Medicare physician payments from CPR to a fee schedule system would both make more rigid the structure of

relative values for physician services and allow

more Government flexibility in changing those

relative values. The use of a fee schedule for payment purposes would imply that the ratio of the

approved charge for any service to the approved

charge for any other would be a constant. If a fee

schedule were based on a single national relative

value scale, such ratios would be fixed for all services in all jurisdictions. Because of this, changes

in a single fee in the schedule could dramatically

change relative values. In theory, correcting any

perceived imbalances in approved charges, such

as those involving procedural/nonprocedural differences, would be simpler in a fee schedule world

than in a world of CPR. But because the effects

of such changes would be more pervasive under

fee schedules, there might be more resistance to

such change. For this reason, advocates of such

changes might prefer that procedural /nonprocedural imbalances be corrected in the initial implementation of the fee schedule.

Quality and Access

There are no data with respect to the relationship, if any, between quality of care and method

of payment. And even any such relationship between quality and level of payment as exists

would be unlikely to be discerned if a fee schedule conversion led to relatively small differences

in payment levels. In terms of the technical quality of performance of specific services-once the

choice has been made to provide those services—

price can be expected to be of little importance

in the short run.21 In the long run, however, lower

Medicare payments might lead physicians to obtain lower quality supplies, facilities or personnel.

The quality impact of price—in this case, the

level of the Medicare approved charge under a

fee schedule—is likely to be indirect through its

effects on access to particular physicians and the

facilities in which they practice. That impact will

depend on the opportunity cost to the individual

physician of the use of his or her time to attend

to an alternative, non-Medicare patient. To the

extent that private insurance pays a physician

higher amounts than Medicare and to the extent

that patients with such insurance demand the physician’s services, that physician’s Medicare patients

may not receive as much time or attention as

otherwise. And to the extent that those private

patients recognize quality and demand the services of physicians perceived to provide relatively

high quality services, the opportunity costs for

those physicians of attending to Medicare patients

will be higher. If it were the case that physicians

who provided relatively high quality care indeed

perceived higher opportunity costs in the private

market (regardless of the level of their Medicare

approved charges relative to peer physicians) and

responded by not participating in the Medicare

program, quality of care for Medicare patients

might decline.

21The “short run” denotes a period of time during which physicians’ capital and other resources cannot be changed. By construction, therefore, the costs of discriminating between patient payer

classes with respect to quality could be substantial.
Ch. 5—Payment Based on Fee Schedules . 145

How the resulting level of quality would compare to that under CPR is uncertain. The major

theoretical difference between a fee schedule and

CPR is that CPR would allow a higher payment

to a physician who, because of superior quality,

had a higher customary charge. Of course CPR

allows higher payments to any physician with

higher customary charges, regardless of origin.

Hence, it is unclear that only the physicians of

highest quality are disadvantaged by Medicare

payment levels.

Within the category of fee schedules, any options that eliminated specialty differentials or locality differentials might also affect quality in this

regard. In general, quality could be enhanced to

the extent that physicians who provide relatively

high quality services respond to increases in their

approved charges by increasing their participation in the Medicare program. Other physicians,

however, might also respond comparably. Further, quality could be reduced in response to an

aggregate increase in approved charges to the extent that those increases lead to a increase in the

probability of beneficiaries’ receipt of services of

inappropriately high risk or of little effectiveness.

These gross effects can be anticipated with any

physician payments regardless of whether there

are increases or decreases in average approved

charges. Which effects will predominate cannot

be predicted, a priori.

If the initial estimates from the resource cost

based RVS approaches are correct (227), one

might expect that the approved charges for office

visits would increase relative to surgical services

under a fee schedule derived from such a study.

If the approved charges were realigned by raising average approved charges for office visits relative to current levels without changing the average approved charges for other services, one

might expect an increase in the provision of the

nonprocedural services. This increase would improve quality of care only to the extent that the

expected value of changes in health status attendant to such visits exceeds current approved

charges. (There is no evidence, however, of current “underuse” of such services given current

levels of approved charges. ) If average approved

charges were lowered for the surgeries leaving office visit average approved charges unchanged,

one would not expect an improvement in quality

resulting from an increase in the provision of primary care. However, to the extent that surgical

services that are not risk-free are provided in response to current approved charges that exceed

either costs to the physicians or benefits to the

Medicare patients, a decline in surgeries might

lead to an improvement in quality for Medicare

beneficiaries.

Access and Assignment

As indicated in chapter 2, a positive correlation between the level of Medicare approved

charges and assignment has been well established.

Conversion of Medicare physician payments from

CPR to a fee schedule based on average or median (or some other central tendency measure of)

approved charges would result in increases in approved charges for some physicians for some services and decreases for others. Therefore, one

would expect a decrease in the probability of assignment, being accepted in those instances where

approved charges were reduced and an increase

where approved charges were raised. (Similarly,

one would expect an increase in the probability

that a physician would become a “participating

physician” if his or her approved charges had been

increased. ) Unfortunately, use of the available

models of assignment to make projections can

only provide aggregate expected effects; in particular, a budget neutral fee schedule of any variety would be estimated to have an expected zero

net impact on assignment. Within such models individual beneficiaries would be projected to experience increases or decreases in assignment with

the accompanying changes in liabilities for physician services. More refined models than those

currently available would have to be developed

and validated to estimate specific supply responses

and allow a more realistic estimation of aggregate

changes in response to conversion to a fee schedule embodying a specific level of aggregate fees.

If Medicare converted to fee schedules and imposed mandatory assignment, some physicians

could be expected to no longer provide services

to Medicare beneficiaries. Those physicians who
146 ● Payment for Physician Services: Strategies for Medicare

dropped out of the Medicare program would be

likely to be those with relatively high billed

charges compared to their peers in individual localities. This could reduce beneficiaries’ access to

certain types of physicians. If, on the other hand,

the fee schedule amount was established only as

the Medicare allowance and not necessarily implying payment in full, beneficiaries’ access to

physician services would become primarily a

question of their personal finances. Beneficiary

financial barriers to access to the services of physicians with relatively high billed charges could

be increased. With respect to any single physician

so affected, this would hurt his or her poorer

Medicare patients more than the more affluent

ones.

costs

Medicare Program Costs

With respect to Medicare expenditures for physician services at any point in time, the cost impacts of a change to fee schedules would depend

more on the level of payment than the method

of fee determination. Assuming that a budget neutral conversion to fee schedules were imposed, one

might expect little initial impact on total Medicare Part B expenditures. On the other hand, one

might speculate that physicians whose approved

charges were constrained would respond by increasing the intensity or quantities of services

billed, such as billing for longer, and more expensive, visits or providing additional ancillary services; hence there might be some increase in costs.

(Those physicians who experienced an increase

in approved charges might not raise their charges

so much as otherwise in future years, but they

would not be expected to bill for fewer or less expensive services on average in the year of the conversion. ) As indicated in chapter 2, the evidence

with respect to physicians’ volume responses to

changes in approved charges is equivocal. Unless

there was a substantial volume response, under

a fee schedule conversion conducted to coincide

with the advent of a new fee screen year (that

would be accompanied by higher aggregate approved charges regardless of the conversion), any

initial cost impacts might be undiscernible.

If a fee schedule conversion embodied a selective reduction in average approved charges—e.g.,

a reduction in approved charges for services for

which costs were believed to have declined substantially since their introducton—savings might

accrue to Medicare. If there were no change in

the volumes of such services, the savings would

be proportional to the reduction in approved

charges. If physicians reduced the provision of

such services, the savings to Medicare would be

greater. Further, to the extent that the financial

incentives in the current high payments cause inappropriately high utilization levels for such services where there is also patient risk, a reduction

in use might imply an improvement in quality for

Medicare beneficiaries. If physicians responded

to reduced approved charges by increasing volumes the cost reductions and potential quality enhancements would be smaller than otherwise.

In order to examine and estimate changes that

might occur under a budget-neutral conversion

to fee schedules that simultaneously reduced some

procedural/nonprocedural imbalances, a simulation analysis was conducted (247). Assuming there

were no charges in volume, if approved charges

were unchanged on average, but the fee schedule

introduced was designed to “adjust” approved

charges to increase payments for office visits—

chosen to illustrate the effects of raising the relative approved charges of nonprocedural services

to levels commensurate with the estimates from

earlier studies (227), total Medicare costs, by assumption, would be unchanged, but payments for

office visits would nearly double (247). Revenues

for general practitioners and family practitioners

would increase 50.8 and 37.3 percent, respectively. Internists’ revenues from Medicare would

be nearly constant, but radiologists and surgeons

would experience declines.

If the fee schedule were initially based on average approved charges, but—for illustration—approved charges for office visits were increased as

above, holding all other fees in the schedule constant, total Medicare physician payments might

increase by 3.9 percent, including a 36.7 percent

increase in payments made for office visits assuming that carriers paid the lower of the billed charge

or the fee schedule amount (247). Paying the fee
Ch. 5—Payment Based on Fee Schedules ● 147

schedule amount in all cases would require additional increases in expenditures.

Changes in Medicare costs over time might be

influenced by a change to fee schedules for two

reasons. The first involves the fee screen updating process. Under CPR this is a mechanical, if

not mindless process. Increases in approved charges

are somewhat limited by MEI, but there are still

a considerable number of services not constrained

by the Index. Further, average approved charges

can increase by more than the increase in MEI

even for those services where the prevailing charge

is established by MEI.22 A potential virtue of a

fee schedule is that the entire price structure can

be controlled during the fee schedule updating

process. In fact, a study of physician payments

in Medicaid programs found that expenditure increases were lower in those States that used fee

schedules compared to those that used CPR approaches to fee setting (215).

A second, and much less likely, reason why

Medicare expenditure increases might be reduced

under a fee schedule regimen involves the relative approved charges for preventive care. This

argument suggests that if, for example, under a

resource-cost-based RVS, approved charges for

office visits were increased, a greater number of

preventive care services would be provided. As

a result, there would be a reduced need for acute

curative services in later time periods. Although

there might be an initial increase in expenditures

given the increase in approved charges for the

nonprocedural services, the rate of increase in total expenditures—if not the level of expenditures

—would decline. The cogency of this argument

is reduced, however, by recent evidence that has

not verified that those persons who forgo preventive care in one time period experience greater

costs in future time periods (343,348). Furthermore, if greater use of preventive services increased life expectancy, the total Medicare expenditures would probably increase as survivors

incurred medical expenses in their additional years

of life (437,485,576).

2ZThe MEI wij] constrain the increase in the maximum approvecf

charge for a given service. Until 100 percent of the volume of a particular service is limited by the MEI, the average approved charge

for that service can increase faster than the maximum.

The additional effects on the Medicare program’s

costs of any changes in assignment policy that accompanied a conversion to fee schedule should

be neglible compared with a fee schedule conversion without assignment changes given that Medicare only pays that portion of the bill equal to

the approved charge. To the extent, however, that

a mandatory assignment policy reduced the participation of physicians with relatively high charges,

declines in expenditures that might otherwise have

been made for the services of such physicians

might exceed the increase in payment levels for

physicians whose prior approved charges had

been relatively low. Beneficiaries who formerly

received services from physicians with above

average approved charges who elected to no

longer accept Medicare patients would be expected to either switch to less expensive physicians

or forgo the use of services that might otherwise

have been provided. Both effects would tend to

reduce aggregate Medicare obligations. A net increase in Medicare expenditures would be expected only if the above average charge physicians

who remained in the program increased volumes

by more than enough to offset the reductions effected by beneficiaries’ receiving services at or below the previous average approved charge. Under a fee schedule implemented as the Medicare

allowance only, beneficiaries might reduce their

utilization of services in the aggregate. This might

lower Medicare expenditures, but primarily by

shifting Medicare costs back to the beneficiaries.

Whether an expenditure cap would, in fact, cap

expenditures is an open question. For example,

the evidence from the Canadian province of Quebec has been interpreted to both support and refute the effectiveness of an expenditure cap in the

form of individual physician revenue limits—a

system with direct rather than indirect physician

incentives under a payment system with a single

payer rather than many payers as in the United

States. It is alleged to have produced gaming behavior on the part of the physicians (388), but

other Canadian observers conclude that the limits

were set so high that they may not have had any

aggregate effect (135). An expenditure cap system

with less direct incentives for individual physicians

would be unlikely to be more effective in constraining expenditure increases.

56-119 0 - 86 - 6 : QL 3
148 . Payment for Physician Services: Strategies for Medicare

Beneficiary Costs

As would Medicare program expenditures (and

assuming a continuation of the present participation/assignment policies), beneficiary costs would

depend more on the level of payment than on the

method of approved charge determination within

a fee-for-service system. Further, under a budget

neutral conversion to fee schedules, unless there

were substantial changes in service volumes that

were not counterbalancing, the net impact on beneficiary costs should be zero. In fact, given the

increases and decreases in approved charges, one

would expect both decreases and increases, respectively, in nonassigned liabilities and increases and

decreases, respectively, in beneficiary cost-sharing

liabilities. For example, a beneficiary whose physician experiences an increase in approved charges

will be more likely than otherwise to have that

physician accept assignment, thereby reducing the

expected nonassigned liability. At the same time,

however, that beneficiary will face an increase in

coinsurance liability equal to 20 percent of the increase in the approved charges. With respect to

any single physician, the expected change in nonassigned liability will exceed the expected change

in coinsurance. The total net effect on any one

beneficiary will depend on his or her physicians’

combined assignment/participation behaviors and

changes in approved charges.

A fee schedule implementation that is designed

to reduce Medicare program expenditures probably will result in increased beneficiary liabilities

as long as the case-by-case assignment choice remains an option for physicians and as long as

there exists a private market for physicians’ services. A net decrease in average approved charges

can be expected to lead to reductions in assignment by nonparticipating physicians and reductions in the numbers of physicians who elect to

become participating physicians. These results will

be somewhat ameliorated only if some physicians

in competitive markets find it necessary either to

participate or accept assignment in a high percentage of cases in order to retain desired patient

loads. In this regard, where beneficiaries faced

with increased liabilities can identify physicians

who continue to accept assignment, they maybe

able to avoid the increase in out-of-pocket expense

by switching physicians.

In simulating a conversion to a fee schedule

based on average approved charges, Juba estimated several outcomes based on possible values

for the relation between approved charges and assignment (247). The more responsive physicians

were to changes in approved charges, the greater

was the potential increase in beneficiary costs

since reductions in approved charges for physicians would be more likely to be countered by

decreases in assignment by the physicians so affected. If physicians did not change their service

volumes or assignment decisions following a conversion to a fee schedule based on average approved charges, changes in beneficiary liability

would be minimal .23 The more responsive physicians are assumed to be to changes in approved

charges, the greater the estimated increase in beneficiary costs (see table 5-5). For this reason,

provider revenues would be less affected by a conversion to a fee schedule based on average approved charges than would Medicare program

costs.

In the very short run, beneficiary financial costs

would be reduced by a policy of mandatory assignment. In the first quarter of 1985, the beneficiary nonassigned liability was nearly $33 on an

average unassigned claim (535). Nonfinancial

costs, however, such as waiting times and delays

in scheduling appointments, might increase if

fewer physicians participated in the Medicare program because of a mandatory assignment policy.

Under a schedule of Medicare allowances, potential extra billings by physicians would be unlimited, but beneficiaries’ choices with respect to

their total out-of-pocket costs for specific physicians would determine whether their aggregate expenses increased or decreased. Given the added

financial incentives to identify relatively inexpensive physicians,

decline.

Societal Costs

The initial cost

total beneficiary costs could

effects of a Medicare fee schedule conversion with respect to nonfederally insured or private pay patients should be small.

23There might be an aggregate increase in beneficiary liability if

approved charges were based on the fee schedule amount even in

those cases where the physician’s billed charge was less than that

amount.
Ch. 5–Payment Based on Fee Schedules ● 149

Table 5=5.—Simulated Alternative Percent Changes in Beneficiary Liabilities by Provider Specialty Following

Conversion to a Fee Schedulea From CPR Payment, South Carolina, 1983

All General Family Internal General Orthopedic

Elasticity b

specialties practice practice medicine surgery surgery Ophthalmology Radiology

0.00 0.8 –11.5 – 10.0 8.9 0.8 1.7 2.7 –0.2

0.50 2.8 –11.1 –9.9 11.5 4.2 3.1 3.2 1.8

1.00 4.6 –1 1.1 – 10.0 13.9 7.3 4.4 3.6 3.7

aFee Schedule bagecf on statewide average approved charges.

bAssumed values for Ph@~ians responses to changes in approved charges with respect to assignment without respect to physician specialty, For example, an dt3StiCity of 0.00 implies there would be no change in physicians’ assignment decisions; an elasticity of 1.00 implies that for any given percentage change in approved charges,

there would be an equal and opposite change In assignment rates.

clncludes physicians in listed .SpeClaltieS and others.

SOURCE: D. Juba, “Analysis of Issues Relating to Implementing a Medicare Physician Fee Schedule,” prepared for the U.S. Congress, Office of Technology Assessment, Washington, DC, November 1985.

Medicare represents 17 percent of the market for

physicians services (353). Most Blue Shield plans

and most of the rest of the physician insurance

market establish prices through usual, customary,

and reasonable fee determination systems much

like CPR. If a substantial number of physicians

did not experience great changes in approved

charges under a conversion to a fee schedule by

Medicare, little else would be expected to change

solely because Medicare adopted a fee schedule

approach to physician payment. The increasing

number of physicians in the United States might

lead to a decline in the rate of increase in physician prices, but such a deceleration would also

be relatively unaffected by a change in Medicare

payment policy. Other things being equal, only

if patients in the non-Medicare market (and their

insurers) were unresponsive to physician prices

would there be a possibility for an aggregate increase in expenditures for physician services in the

absence of a relative reduction in fees charged to

those patients.

If Medicare did switch to a fee schedule, there

might be increased interest by the private insurers

in establishing their own fee schedules, particularly if the Medicare program published a comprehensive relative value scale. Given the competitive nature of the market for health insurance,

however, no insurer would want to be in a position where it could not offer at least one line of

paid-in-full benefits on a price competitive basis.

Locally adjusted fee schedules might be attractive

to employer groups given their implicit cost-saving incentives and the relative predictability of

benefit expenses. On the other hand, programs

for national accounts with fee schedules that could

not guarantee nearly uniform insurance coverage

for members in different parts of the country

would be resisted by labor and management alike.

It was this set of interests that led to the adoption of UCR programs in the first place (312).

Conversion of Medicare payments to a fee

schedule that lowered approved charges on average would prompt concern about cost-shifting.

The apprehension of many nongovernmental

third-party payers would be that the effects of

such a fee schedule would be to lower Medicare

payments without reducing physicians’ costs, thus

increasing the charges to all other payers. To the

extent that there is a competitive market for medical insurance, this issue may be irrelevant. The

various insurers offering health insurance coverage for physician services cannot afford to let benefit costs rise unreasonably without having to raise

premiums, hence jeopardizing market share. Although it has long been recognized that there are

circumstances when it will be advantageous to

sellers to have different prices paid by different

purchasers, given a decrease in prices paid by

Medicare under such circumstances, a rational

(physician) seller would decrease rather than increase charges to other payers in order to maximize revenues (at a new, lower expected charge

level given the change in relative fees available

for treating patients from the various payer

groups.)

A reduction in Medicare approved charges for

physicians that have substantial Medicare patient

loads or aggregate reductions in charges by all

payers might serve to increase incentives for efficiency in the production of physician services for

physicians so affected. There would be no expected change, however, in efficiency in the pro-
150 ● Payment for Physician Services: Strategies for Medicare

duction of health care services requiring inputs

in addition to physician services except to the extent that those inputs are complements to physician services. Nor would greater efficiency be expected in the combination of services used to treat

a medical condition or in the weighing of the costs

and benefits of services.

Technological Change

Technological change may be one area in which

method of fee determination can have an effect

in addition to level of payment. In this regard,

as long as payment rates are determined prospectively without regard to costs, it will always be

the case that the higher the level of potential payment, the greater the potential return to innovation, particularly cost-saving innovation. Interest in cost-saving innovation, however, may be

greater the less is the difference between payments

and current costs. Quality-enhancing innovations

that involve increases in cost would probably be

advanced more under current CPR than any other

alternative physician payment system because

payments are based on charges that can be increased to reflect increases in costs. Such innovation would thrive more under most fee schedules than under packaging or cavitation. A new

fee for a new service would probably be introduced within a fee schedule system. But under

packaging and cavitation, adoption of cost-increasing technologies would add to cost but not

to revenue, and payment recipients would have

little financial incentive to adopt such technologies

except to prevent losing patients.

Where the physician payment includes both

professional and technical components, payment

levels can provide (or fail to provide) incentives

for technological change, particularly with respect

to cost-saving innovations. However, where total payments for a service are split between physicians’ professional components and facility or

equipment expenses, the effects of physician payments on technological change are uncertain. Further, the specific effects of Medicare physician

payment policies may be negligible with respect

to any technologies where Medicare beneficiaries

are only a small fraction of the relevant patient

population and hence where innovation and diffusion may be driven by the policies of private insurers.

Even where Medicare policies may make a difference, as long as Medicare institutional payments to hospitals, outpatient departments, and

ambulatory surgical centers are large compared

to payments to physicians for particular services

dependent on acquisition of resources paid by

Medicare intermediaries under either Part A or

Part B, innovation in such physician services may

depend more on institutional payment policies

than physician payment policies. If those facility

or equipment expenses are not recognized as covered services or if institutional payment levels are

too low, many physicians may be unable to secure access to such equipment for their Medicare

patients regardless of how remunerative the Medicare approved charge for the professional service may appear to physicians. (Although hospitals may continue to compete for physicians and

patients by attempting to acquire “prestigious”

and costly new equipment, there have been neither studies nor anecdotes to suggest that such acquisitions have been associated with the payment

levels for physician services associated with the

use of such equipment. ) Only where the physician payment levels were too low might physicians not adopt certain technologies for their

Medicare patients even where the institutional

payment policies did not inhibit acquisition of the

resources required for the technology in question.

Within the fee schedule options, treatment of

new services will almost always be an incidental

matter. Obviously, vendors of new services can

be expected to recommend high approved charges

rather than low ones. Therefore, advocates of any

new potentially cost-saving service, such as extracorporeal shock wave lithotripsy, will want to

argue on relative value grounds for establishing

an approved charge based on an existing substitute service. Advocates of potentially cost-increasing innovations such as MRI for many conditions

would prefer resource-cost-based approaches.

Were exclusive competitive bidding to become a

generally accepted means of establishing fees, the

potential advantages to providers of cost-saving

innovations would increase, spurring additional

innovation along those lines. However, to the ex-
Ch. 5—Payment Based on Fee Schedules • 151

tent that competitive procurements were periodically reopened for bids, the potential physician

returns to innovation can be expected to be bid

to zero. The diffusion of technologies whose

approved charges are lowered is likely to be retarded.

Administrative Feasibility

Compared to CPR and packaging, fee schedule administration would be easier. CPR, in particular, requires the equivalent of maintenance of

individual fee schedules for each physician practice. Under all of the fee schedule approaches considered, the need to retain physician-specific fee

data would be eliminated although aggregate fee

data might be retained for updating purposes. In

addition, beneficiary and provider inquiries should

be reduced because the payment levels for any

service can be established and disseminated in

advance.

With respect to updating, relative ease of administration would depend on whether replication was selected as the means to update the fee

schedule over time. Some of the fee schedule options would require fairly elaborate construction

efforts for an initial implementation. Replication

in those cases would be costly. None of the fee

schedule approaches would necessarily require

replication for updating. In fact, updating through

the use of an index such as the current MEI or

a more refined index could be performed as a

purely ministerial exercise for any fee schedule

option.

Periodic examination of fee schedules for recalibration within the schedule or for proper evaluation of new services would be a useful adjunct

to any of the options. Here again, replication is

an option for such periodic examinations, but not

CONCLUSION

The primary potential advantages of fee schedules are rationality, predictability, and simplicity, and therefore ease of understanding for both

beneficiaries and providers. In addition, a fee

schedule system would not involve the maintenance of what amount to individual price scheda requirement. Combinations of fee schedule development methods for this purpose would not

be illogical. As indicated in an earlier illustration,

one might initially change to a Medicare fee schedule by having carriers estimate average approved

charges for each procedure to establish a baseline

RVS. (For payment purposes, this RVS might be

converted to a fee schedule that might be updated

each year using the MEI. ) New procedures might

be given interim payment rates following a consensus development process. Final payment rates

could be established following estimations of resource costs, perhaps 18 to 36 months after the

interim rates had gone into effect. Finally, the

members of an independent physician payment

review commission might review or recommend

changes to correct any interjurisdictional or interspecialty differences brought to their attention.

There are major differences among the fee

schedule options in terms of the efforts required

for implementation. Use of historical charge data

by the carriers clearly would be the easiest method. Estimation of the lowest prices needed to procure certain levels of (assigned) utilization would

be straightforward, but would require greater effort. Development of resource-cost-based relative

values for even a significant fraction of the over

7,000 available procedures in HCPCS would be

a substantial undertaking. Unfortunately, the efforts required for consensus development, competitive bidding, and fee schedule negotiations

cannot be estimated at this time. There is little

or no experience in the use of these methods specifically for the purpose of pricing physician services in the United States. They are likely to require more effort than the purely data driven

approaches. Whether they would require more or

less resources than resource-cost-based estimates

is uncertain.

ules for each physician as is required under the

current CPR system. Further, fee schedule updating could be accomplished using methods that

would allow greater control over annual increases

in average price levels than are currently possible under CPR even with the use of the MEI.
152 . Payment for Physician Services: Strategies for Medicare

The various options that have been reviewed

each have their advantages and disadvantages. Fee

schedules based on historical data on average approved charges would be fast and simple to construct. There would not be much initial change

in approved charges for most physicians, and presumably there would be little initial disruption in

the Part B program. Such fee schedules, however,

would preserve—if not embed—any existing disparities in payment observed between procedural

and nonprocedural services as well as geographic

and specialty differentials. Although such disparities and differentials might be addressed and resolved over time, a direct approach to these problems would be preferred by many observers.

In fact, many of those same observers would

prefer to develop fee schedules based on analyses of the relative resource costs of individual services. In theory, such a system would have an

advantage over current effective payments in that

resource cost based rates would be neutral with

respect to clinical decisionmaking. In addition, it

is argued that such a system would reduce, if not

eliminate, the alleged disparities between procedural and nonprocedural services. There is little

experience with fee schedules based on this kind

of estimate so the effects are uncertain. In any

event, construction of a complete fee schedule

based on this approach would be likely to be very

expensive. Further, it is not clear that the results

of such an effort would be as reliable a guide to

appropriate Medicare pricing as its advocates contend. Although some concept of resource costs

should be included in the consideration of Medicare payment levels, there are so many arguments

for including other considerations that even if statistically reliable resource cost estimates could be

obtained, they would not provide a definitive

guide to relative values.

Consensus development efforts involving physicians and other groups might prove to be a faster

method to educe acceptable and meaningful relative values. The acceptability of the results of such

an approach, however, is uncertain. What would

be expected to be the primary problem would be

establishing the relative values of specific procedural and nonprocedural services. The composition of the consensus groups could be crucial, especially given an exercise conducted to produce

a budget neutral fee schedule conversion.

The competitive approaches are relatively untried. It would be relatively straightforward to instruct carriers to determine relatively low levels

of approved charges representing some specific

fraction of current Medicare utilization levels for

particular services or even all services. There is

no precedent, however, for predicting the aggregate effects on Medicare expenditures, or beneficiary costs in particular and access in general.

There are no data, much less studies, that would

allow predictions as to whether geographic or specialty or procedural/nonprocedural differences

would be reduced or increased under that kind

of approach.

Similarly, competitive bidding for physician

services or what would be, in effect, bilateral competition between the Government and the medical profession with respect to price are untried in

this country. Both might achieve a fee schedule

with the general advantages attendant to a fee

schedule. That either of such fee schedules might

specifically reduce the perceived unwarranted variations in payments in the Medicare program is

unlikely although not impossible. Competitive

bidding in itself could involve such administrative complexities that trying to tie a series of services to specific relative charge levels would prove

daunting. The foreign experience in negotiations

between health insurance officials and physician

representatives suggests that shifts in relative

prices would not be soon forthcoming (162,578).

No one system is entirely superior to all others

for the development and evolution of fee schedules. A judicious mix of the various methods

might enable the achievement of a variety of

goals, including directly addressing the perceived

inequities in the administration of benefits under

the Part B program. However, pending the acquisition of additional data and the development

of more sophisticated models to resolve the question of the changes, if any, in the use of services

in response to fee schedule changes, what remains

uncertain are the specific effects on Medicare expenditures and beneficiary expenditures, access

to services, and quality of care. There is no evidence that such effects would be substantial, but

there is also no consensus on whether their net

effects would be beneficial or detrimental to either beneficiaries or the Medicare program as a

whole.
Chapter 6

Payment for Packages of Services

Words differently arranged have a different meaning, and meanings differently arranged have a different effect.

—Pascal
Contents

Page

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 155

The Concept of Packaging . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 156

Implications of Alternative Methods of Payment for Packages of Services. . . . . 160

Collapsed Procedure Codes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 161

Ambulatory-Visit Package . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 164

Special-Procedure Package . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 165

Ambulatory-Episode-of-Care Package . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 167

Inpatient-Episode-of-Care Package . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 169

Total-Episode-of-Care Package . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 173

Administrative Feasibility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 174

Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 175

Table

Table No. Page

6-1. Variations in Packages of Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 158

6-2. Procedure Codes for Office Medical Services (Visits) and Chest X-Rays... 162

6-3. Collapsed Procedure Code Package: Diagnostic Colonoscopy. . . . . . . . . . . . 164

6-4. Ambulatory Episodes of Care: Package Prices for Essential Benign

Hypertension . ............+.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 168

Figure

Figure No. Page

6-1. Alternative Methods of Medicare Payment for Packages of Services

Provided to a Hypothetical Patient Presenting the Symptom of

Extreme Flank Pain.... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 157
Chapter 6

Payment for Packages of Services

INTRODUCTION

Packaging is an approach to physician payment

that involves redefining the payment unit from

the individual service to a broader “bundle” of

services (313). I This approach could control both

costs and utilization by reducing the number of

service units billed and encouraging the judicious

use of services within packages. Under packaging, the financial risk would be borne by the individual physician or other recipient of payment

(547). This chapter examines variations in packages of services and discusses potential effects of

packaging alternatives on quality of care, access

to care, costs and efficiency, technological change,

and administrative feasibility. Also considered in

this chapter are the potential effects of paying for

physician services via collapsed procedure codes.2

One objective of paying physicians a specified

rate for a group of services would be to give the

Medicare program more control over program

costs. Unless the rates for packages were set at

the same level as or below the mean of current

charges, however, payment for packages of services would not necessarily result in a reduction

of Medicare expenditures. In most cases, rates for

packages would be prospectively determined and

would include ancillary services (e.g., clinical laboratory tests, X-rays, injections) so physicians

might think carefully about ordering a marginal

test or requesting a consultation.

The major difficulties of paying a rate for a

package of services stem from the potential for

underuse of needed expensive services or denial

of care to very ill and potentially resource-intensive patients. The use of appropriate case-mix

‘This chapter uses the term “packaging” synonymously with the

term “bundling.”

‘Collapsed procedure codes would not produce a “true” package

(319), because the unit of payment under collapsed codes would remain the individual service. Although collapsing procedure codes

is compatible with Medicare’s customary, prevailing, and reasonable (CPR) payment method (ch. 4) or fee schedules (ch. 5), the concept is discussed here as a means of introducing the concept of

packaging.

measures—measures of the relative frequency

with which physicians treat patients with different types of medical conditions—should result in

higher payments to physicians who treat more

complex patients and should obviate some of the

negative effects. Relative to the present customary, prevailing, and reasonable (CPR) Medicare

fee screen method, packaging would create situations where physicians might gain or lose income, due to the “averaging effect. ”3 So that physicians faced a fixed amount of revenue for each

package of services, mandatory assignment would

be necessary. Otherwise, physicians would be able

to shift the financial risk to Medicare beneficiaries

by billing them more than the allowed packaged

rate.

Some physicians, for example, surgeons, already provide much care that is paid on the basis of a global or package rate. However, there

has been little empirical research testing the applicability of packaging to broader areas of physician payment. To address the lack of research

on packaging physicians’ services for inpatients,

the Social Security Amendments of 1983 (Public

Law 98-21) mandated a study by the Department

of Health and Human Services (DHHS) to examine the feasibility of using a diagnosis-related

group (DRG)4 type of classification to pay for inpatient services provided by physicians to Medicare beneficiaries. In addition, the Office of Research and Demonstrations in the Health Care

3Relative to the present, paying an average rate for a package of

services would reduce payment for some physicians and increase

payment for other physicians.

‘Diagnosis-related groups (DRGs) are groupings of diagnostic categories drawn from the International Classification of Diseases and

modified by the presence or absence of a surgical procedure, patient age, presence or absence of significant comorbidities or complications, and other relevant criteria. DRGs are the case-mix measure mandated for Medicare’s prospective hospital payment system

by the Social Security Amendments of 1983 (Public Law 98-21)

(141,489). A later section of this chapter discusses the applicability

of DRGs to physician payment.

155
 156 ● Payment for Physician Services: Strategies for Medicare

Financing Administration (HCFA) of DHHS is

plannning demonstrations to study packaging

physician services to nonhospital as well as hospital settings (540). Planned demonstrations include incorporating payment for physicians’ servTHE CONCEPT OF PACKAGING

What is a package? As suggested above, a package is a group of related medical services (319).

During a patient’s visit to a physician, for instance, a comprehensive physical examination

may include a record of the patient’s blood pressure, some laboratory tests, and a medical history. The visit is clearly a package of functions

whether or not it is billed as such (319). As illustrated in figure 6-1, packaging expands the concept of fee-for-service payment by including multiple services in the bundle.

The six variations reviewed in this chapter

range from least comprehensive (collapsed procedure codes) to most comprehensive (total episode of care):

● Collapsed procedure codes. —The coding system used to pay for physicians’ services under Medicare’s Part B, the Physicians’ Current Procedure Terminology, 4th edition

(CPT-4), 6 includes codes for 7,040 procedures. 7 Combining codes for procedures that

have only fine distinctions would reduce the

number of allowable billing units.

● Ambulatory-visit package. —An ambulatory-visit package would incorporate all physicians’ services and ancillary services (e.g.,

clinical laboratory tests, X-rays, and injections) related to one visit.

● Special-procedure package. —A special-procedure package would include all or some

physicians’ services and ancillaries associated

with a single therapeutic or diagnostic procedure, such as cataract surgery, extracor-

‘The CPT-4 coding system, developed by the American Medical

Association, lists descriptive terms and identifying codes for reporting

medical services performed by physicians. (85).

7HCFA’s Common Procedure Coding System (HCPCS) also includes codes for nonphysician services, such as durable medical

equipment, ambulance services, eyeglasses, rehabilitation services,

and injectable drugs.

ices into hospital DRGs;5 and paying prospectively

for all Medicare Part B services (540).

5HCFA’S Office of Research and Demonstrations has budgeted

$1 million for a study demonstrating and evaluating combined physician/hospital payment for fiscal year 1986 (540).

●

●

●

poreal shock wave lithotripsy (ESWL), colonoscopy, or magnetic resonance imaging

(MRI). If selected diagnostic and therapeutic procedures were paid based on a rate for

a package of services, other parts of the system might still be paid by CPR or by a fee

schedule.

Ambulatory-episode-of-care package. —A

package for an ambulatory episode would include all physicians’ services and ancillaries

associated with an illness treated in ambulatory settings.8

Inpatient-episode-of-care package.—This

package would incorporate all physicians’

services associated with a hospitalized

patient.

Total-episode-of-care package. —A package

for a total episode of care would incorporate

all ambulatory and inpatient physician services and ancillaries related to an episode of

medical care.

As shown in table 6-1, packages can be defined

by a number of different variables, including: 1)

the unit of payment, 2) case-mix adjustor (if any),

3) recipient of payment, 4) scope of services, 5)

approach to payment, and 6) time period. Mitch-

‘Medicare now pays the primary physician treating end-stage renal disease (ESRD) patients a fixed monthly payment that is similar to an ambulatory-episode package. The rate is based on a

weighted average of dialysis sessions per month, prevailing charges

for a medical specialists’ brief followup visit for an established

patient, and prevailing charges for intermediate followup visits,

weighted by national averages of the percentages of patients dialyzed in facilities and at home (48 FR 21254) (see app. C). If patients are admitted to the hospital, physicians are paid on a fee-forservice basis instead of their monthly payment (if a patient is in the

hospital 1 day and the physician converts to fee-for-service, the

monthly payment is reduced by 1/30), and hospitals are paid under Medicare’s prospective payment system for inpatient services.

Physicians may elect to remain on the monthly payment during the

hospital stay, but the vast majority choose to bill fee-for-service

(426). Out-of-package care–any care not related to dialysis–is also

paid on a fee-for-service basis, generally to other physicians.
Ch. 6—Payment for Packages of Services . 157

Figure 6-1.—Alternative Methods of Medicare Payment for Packages of Services Provided to a

Ambulatory

visit

Hypothetical Patient Presenting the Symptom of Extreme Flank Paina b

Ambulatory

visit

Ambulatory episode of care Inpatient episode of care

Total episode of care

Ambulatory episode of care

~his is a hypothetical example of how a patient with flank pain might be treated during a total episode of care.

%his axample excludes a special-procedure package, which would include the services of an anesthesiologist and urologlst and the ESWL procedure.

cKidney, ureter, md bladder X-raY,

dThe factlity cost for extracorporeal shock wave l{thot~psy tEsWL) Would be lnCllK@d in the hospital DRG, A urine culture might also be administered in the hospital,

but would be covered by the hospital DRG.

SOURCE: A. Jenkins, University of Virginia Medical Center, Charlottesville, VA, personal communication, Nov. 26, 1985,

ell and colleagues have described these and other

variables for defining packages (319).

The unit of payment for packages maybe a procedure, a visit, or a case. In a sense, packaging

would still be a type of fee-for-service payment,

but the unit of payment would be expanded, in

general, to include more than one service (see fig.

6-l). In the case of collapsed procedure codes, the

unit of payment would remain the service. In the

case of an ambulatory-visit package, the unit of

payment would be the visit. In the case of a

special-procedure package, the unit would be either a procedure or a case. Per-case payment, i.e.,

paying the physician a specific amount for each

case regardless of the number of services provided

or additional physicians involved, is also applicable to ambulatory-, inpatient-, and total-episode-of-care packages. Per-case payment would

usually be adjusted by case-mix measures, such

as DRGs.

The purpose of a case-mix adjustment is to recognize differing patient needs or resource use. In

general, the more comprehensive the package, the

more likely that a case-mix measure would be

needed. Case-mix approaches can distinguish units

of payment by visit or procedure type, diagnosis, or demographics. Age or sex would be an example of another case-mix adjustment. Investigators have also examined reason for visit or

admission as a case-mix adjustment (319).

As indicated in table 6-1, with collapsed procedure codes, no case-mix measurement would be

necessary. The case-mix for an ambulatory visit

could be adjusted by diagnosis, reason for visit,

visit type (e.g., new or established patient), or ambulatory visit group. Case-mix for an ambulatory

episode of care could be adjusted by ambulatory

visit groups, diagnosis, or reasons for visit.

The proper unit for billing ambulatory care is

more difficult to define than those for inpatient

care (270). For instance, patients visiting physicians’ offices for routine hypertension treatment

require physician resources different from those

required by a patient with uncontrolled hypertension. In addition, principal diagnosis may not be

so clear in the office setting as it would be for inpatient care or for ambulatory surgery.

Different types of case-mix measures may be

needed for emergency room ambulatory care,
Table 6-1 .-Variations in Packages of Services

Collapsed Ambulatory episode Inpatient episode Total episode —

Variable procedure codes Ambulat visit Special procedure of care of care of care

Unit of payment Procedure Visit

Case-mix None AVGs, a reasons for

adjustor visit, or visit types

Recipient of Physician or Primary physician or

payment physician physician group

group

Scope of Procedure Visit and ancillaries

services

Approach to Prospective or Prospective

payment retrospective

Procedure

Diagnoses, DRGs, PMCs,b

or severity-of-illness

indexc

Primary physician or

physician group

Physician services and

ancillaries included for

ambulatory patients but

excluded for inpatients

Prospective

Ambulatory episode of care Inpatient episode of care

AVGs, diagnoses, or DRGs, staging,d APACHE, e

reasons for initial visit PMCS, severity of-illness

index, or MEDISGRPSf

Primary physician or Physician, physician group,

physician group medical staff, hospital,

combined medicalhospital staff

Physician services and Inpatient physician

ancillaries entire episode servicesh

of ambulatory care

Prospective Prospective

Total episode of care —

AVGs, DRGs, or ICD-9-CM

codesg May need new

classification system

Primary physician or

physician group

Inpatient and ambulatory

physician services and

ancillaries

Prospective

Time period Immediatei

Immediate Fixed interval Episodic or fixed interval Episodic Episodic or fixed interval

aA~bulat~ry “i~it ~roup~ (AVG~J, a ~lag~ifi~ati~n system similar to DRGs, define similar visit types in relation to the amount of time a physician spends with a patient (140).

bpatient management categories (Pf4@.) are based on patients’ clinical characteristics and severity of HhIeSS (588).

cThe severity of.illness index reflects the patients’ overall severity of illness, not just the severity of each diagnosis (219,220

dstaging was developed t. me=ure the biological progression of an iliness within diagnostic categories (173,489).

‘%he Acute Physiology and Chronic Health Evaluation, Modified Version (APACHE) consists of 12 commonly used physiologic measures weighted to produce a total score for an intensive care unit patient.

fThe M@ical Illness Severity Grouping system (MEDlsGflps) groups patients by sever(ty on the basis of data acquired after admission (59).

gThe International Classification of Disease, Clinical Modification, 9th edition (lCD-Q-CM), developed in the late 1970s, is a diagnostic lexicon of 10,241 five-digit codes, that encompass the realm of diseases

known at that time.

hHospital ancillaries we assumed to be incorporated in the hospital DRG

ilmm~iate time period refers to the services related to a single patient-provider encounter.

jThe services associated with the intew~ surrounding the procedure.

SOURCE: Adapted from J.B. Mitchell, K.A. Calore, J. Cromwell, et al., “Alternative Methods for Describing Physician Services Performed and Billed,” prepared for the Health Care Financing Administration,

U.S. Departnmnt of Health and Human Services, Baltimore, MD, November 1983.
Ch. 6—Payment for Packages of Services ● 159

physician office visit ambulatory care, and specialized ambulatory care including chemotherapy

or ambulatory surgery (270). A study is currently

being conducted in California to develop emergency department groups for both hospital and

physician costs of emergency room treatment (78).

Investigators have examined the effects of three

different case-mix measures on the creation of

ambulatory-visit packages. Mitchell and colleagues

found that reason for the visit, diagnosis combined with the visit type, and ambulatory patient

groups (the name was later changed to ambulatory visit groups, were not superior to diagnosis

alone in explaining the variation in services associated with an office visit (319). The number of

categories created by the different methods varied significantly. Using diagnosis/visit type produced hundreds of packages; ambulatory patient

groups produced 154; and reason for visit produced 14 (319). Substantial variation in services

remained even after adjustment for case-mix (319).

The simplest special-procedure packages would

be based on collapsed procedure codes and combined services; therefore, case-mix might not need

to be adjusted (319). For instance, a package might

include the surgeons’ services, the anesthesiologists’ services, and assistant surgeons’ services as

well as X-rays. If case-mix were adjusted, DRGs

or patient management categories might be used

for inpatients, and other categories could be chosen for ambulatory patients. An inpatient episode

of care might be classified by DRGs or patient

management categories. New classification systems would need to be developed for a total episode of care.

Packaged payment may introduce new administrative and competitive arrangements for physicians depending on who is paid. The recipient

of payment for a packaged fee, if assignment were

‘These investigators used the 1979 and 1980 National Ambulatory Care Survey as a means of examining the services associated

with different types of office visit packages (319). The National Ambulatory Care Survey asks a nationally representative sample of

office-based physicians to provide information on all services ordered, even if the physicians do not provide them. There area number of limitations to the data: volume of service cannot be determined; no physician fee data are collected; there are no data on

patient office followup; no ambulatory department (hospital) information is collected; and all possible ancillary services are not

covered.

made mandatory, could be the individual physician, a single specialty physician group, a multispecialty physician group, a facility, or a combined facility-physician corporate entity .’” Although Medicare can determine how it will pay

for physicians’ services, the Medicare program

cannot control how physicians are paid within a

group setting. For instance, although a group of

physicians may bill on a fee-for-service basis, the

group may pay its members a salary or offer a

salary plus a percentage of income earned above

a base figure. How an individual physician is paid

bears particular importance for packaging, because the intended positive incentives of packaging, such as those for the judicious use of services, may be diluted if physicians are far removed

from the direct payment (364). On the other hand,

removing physicians from the negative incentives

of a particular payment mechanism, such as for

the underuse of services, may be beneficial.

Paying an individual coordinating physician for

some of the more complex packages would involve substantial financial risk to that physician.

For instance, if a patient’s episode of care for myocardial infarction was complicated by another

chronic illness, such as diabetes, the coordinating physician would be financially liable for additional visits and payment for other physicians’

consultative services. Empirical research has

shown that many physicians have small inpatient

caseloads and may experience large losses because

of random variation in case-mix severity (313).

Although a large group of physicians might be

better able to handle these variations in payment,

an individual physician may have difficulty doing so (320). Payment to a larger entity, such as

the medical staff, produces greater opportunity

for risk pooling and averaging (314). Medical

staffs could form an individual practice association, an organizational form that has become

more common in recent years.

The scope of services covered by a package may

either be narrow or broad (see table 6-l). An example of a package with a narrow scope is an

ambulatory-visit package, which is limited to the

services associated with one visit to a physician.

10If assignment remained optional, the beneficiary could also receive the payment.
160 ● payment for Physician Services: Strategies for Medicare

A special-procedure package has a somewhat

broader scope, covering most of the services associated with a single procedure, such as ESWL. An

ambulatory-, inpatient-, or total-episode-of-care

package would cover an even broader scope of

services (including more days and services). A

typical inpatient-episode-of-care package could include office visits for a week on either side of the

hospitalization (320). ”

The more comprehensive a package, the less

likely it would be that care related to a specific

medical condition would be provided outside of

the package, and the stronger the incentive for

the provider to skimp on services within packages because physicians would be paid a fixed rate

no matter how many services they performed.

With payment based on a visit or a hospital episode, physicians might provide care in a different site or outside of the package in order to maintain or increase revenue. For instance, a physician

might provide laboratory tests to a patient in the

office prior to hospitalization. Alternatively, a patient might be discharged earlier than usual from

a hospital but be seen more frequently in the physician’s office for separate followup visits. The

physician’s ability to provide care outside of the

package would depend on a patient’s willingness

to return for extra visits or to attend preadmission testing despite the increase in cost-sharing for

the patient.

The approach to payment for most packages

would be prospective, i.e., payment rates for a

particular procedure or package of services would

be set in advance. As discussed in appendix C,

Medicare’s current CPR payment system has retrospectively determined rates. With collapsed procedure codes, payment could either be prospective or retrospective.

Under collapsed procedure codes, physicians

could continue to be paid by the current fee screen

method or by a fee schedule. Determining payment for comprehensive packages, such as ambulatory-, inpatient-, or total-episode-of-care packages, would be more complex, requiring, first, the

selection of an appropriate classification system

for patients, diseases, procedures, cases, or episodes, and second, the determination of relative

weights for various categories within the classification system.

12 T. create a payment schedule,

these weights would have to be converted to prices

by standardized rates (conversion factors). Adjustments might be made for differences in costs

of living among areas, or the payment schedule

could consist of a set of national rates.

The time period covered by a package could

be either immediate, fixed interval, or episodic,

depending on the package. An immediate time

period would incorporate all services associated

with one patient encounter with a physician (e.g.,

an ambulatory visit for essential benign hypertension). A fixed-interval time period might include all services for a defined period of time (e.g.,

a l-month ambulatory-episode-of-care package

for hypertension). A variable episodic situation

would depend on the length of the time needed

to “cure” an illness, such as a strep throat, or

to recover from a operation, such as cataract

surgery.

~lThe anci]]aw services for an inpatient episode of care are assumed to be included in the hospital’s DRG payment.

IZone method of determining relative weights would be to base

them on historically approved physician charges (242).

IMPLICATIONS OF ALTERNATIVE METHODS OF

PAYMENT FOR PACKAGES OF SERVICES

Certain implications are common to payment might adversely affect quality of care. In the case

for all of the packages of services. Prime among of services that appear to have been overused in

these is underuse of services within packages. Be- the past, such as certain laboratory tests, the tendcause of this potential for underuse, packaging ency for underuse might actually improve qual-
Ch. 6–Payment for Packages of Services ● 161

ity of care. But if the incentive for underuse affects services that have not been overused in the

past, quality of care problems might occur.

Mandatory assignment would reduce participation in the Medicare program by physicians

whose approved charges had been above the

packaged rate. The access to care of beneficiaries

who used those physicians could be reduced accordingly. In the absence of mandatory assignment, some physicians would refuse assignment

for cases likely to be complex and more costly

than the packaged rate, such as cataract surgery

for diabetic beneficiaries.

Efficiency would be encouraged within packages but not across packages. The cost to Medicare and to society under packaging would depend on the extent to which physicians shifted

care outside the package and the extent to which

care for more complicated patients was shifted to

other non-Medicare payers in either the private

or public sector, The costs to Medicare beneficiaries under packaging would depend on the nature of their illness and on whether assignment

was mandatory. If assignment was mandatory,

beneficiaries would know their costs in advance

and would be charged the same amount no matter how many services were used within a package. If payment rates were set at the mean, beneficiaries with less complex and expensive illnesses

would pay more and those with more complex

and expensive illnesses would pay less than they

would have in the past.

Payment rates could be set at percentiles lower

than those currently used to calculate approved

charges in an attempt to reduce Medicare expenditures. Lowered payment would exacerbate potential problems such as underuse of services

within packages or access difficulties for complex,

expensive patients.

Different incentives for utilization of care would

exist for beneficiaries and physicians. Because beneficiaries would face fixed and predictable costsharing for specific packages, they might request

additional services. Physicians would have an incentive to provide the least expensive care to their

patients consistent with good quality. This incentive would lead physicians to consider more carefully and probably to reduce the use and expenses

of ancillary and consultative services, such as additional laboratory tests and assistants at surgery.

Packaging is likely to encourage the development

of cost-saving procedural technologies that would

save physician time.

Over time, either collapsed procedure codes or

packaging would be easier to administer than

Medicare’s current payment system because fewer

billing categories would exist. In the short run,

administrative difficulties might arise for carriers,

physicians, and beneficiaries as the changes were

implemented. Since the coordinating physician or

other recipient of payment would bear the financial risk for the packages of services provided,

these physicians would have major new administrative responsibilities, such as negotiating payment rates with other physicians and monitoring

utilization within packages.

Collapsed Procedure Codes

Why collapse procedure codes? CPT-4, which

is the coding system used for the physicians’ services portion of HCFA’s Common Procedure Coding System (HCPCS), has been criticized as being overly detailed, and allowing physicians too

much latitude in billing (319). In fact, this latitude may allow physicians to bill Medicare or private insurers for an upgraded service without

really altering the content of the service (because

two codes may have minimal distinctions) and to

bill separately for each test (319).

The number of CPT codes increased 238 percent between 1966 (2,084 codes) and 1985 (7,040

codes) (85,319,328). To some degree, coding increases were influenced by the rapid increases in

medical knowledge and technological developments. As new procedures, such as fiberoptic or

ESWL, are developed, terminology is updated to

provide a means for reporting on and reimbursing for them. Substantial increases came from

fragmenting procedures into a number of detailed

codes in place of a single descriptor (569). When
162 Ž Payment for Physician Services: Strategies for Medicare

California converted from the 1964 California

relative value scale to the expanded 1969 version

for Medicare billing purposes, billed or approved

charges attributable to terminology changes increased 5 percent for office visits and 7 to 8 percent for hospital visits (442).

If procedure codes were collapsed, the 11 existing codes for visits or the 9 for chest X-ray might

be reduced to fewer categories for payment (see

table 6-2). A group of experts could be convened

to determine which codes to collapse on the basis of current codes used. For example, payment

could be based on the most frequently billed code

for a particular category (569). In other cases, a

group of codes being considered for collapsing

might have an equal or near equal distribution,

and calculations of the payment rates could be

based on a weighted average (319). Physicians

could either continue to bill with the multitude

of codes as they do now (and codes could be collapsed at the carrier level)13 or they could be given

new code books.

The potential effects of collapsed procedure

codes on quality of care, access to care, costs and

efficiency, technological change, and administrative feasibility are discussed below.

Quality of Care

Since payment for physician services under collapsed procedure codes would be similar to the

current payment system, the payment level would

be more likely to affect quality of care than the

collapsing per se. If only 3 visit codes instead of

the current 11 were allowed and payment rates

*

3

1n the past, carriers collapsed codes by default. From the inception of the Medicare program until HCPCS was required in 1984,

carriers used different coding systems: 1) one of two early versions

of the California relative value scale, 2) a national Blue Shield Association coding system, 3) CPT, or 4) carrier adaptations of coding

systems, such as the 1964 California relative value scale. Those carriers using systems other than CPT might have been billed by physicians with CPT codes. In order to pay physicians, carriers would

have needed to collapse the CPT codes to fit into the California Relative Value Studies scale (569). Some carriers may have collapsed

codes on a predetermined basis, and others may have done so on

an ad hoc basis (55).

For the first year of HCPCS, carriers are also, in effect, collapsing payment. Carriers who in the past used coding systems with

fewer visit codes than CPT-4, would have only historical charges

for those codes. Therefore, the carriers would have to assign a visit

code to one of the categories for payment purposes (58). By the second year, charges would then exist for the 11 CPT-4 visit categories.

Table 6.2.—Procedure Codes for Office Medical

Services (Visits) and Chest X-Rays

Codes for office medical services (visits):

New patient:

90000 Brief service

90010 Limited service

90015 Intermediate service

90017 Extended service

Established patient:

90030 Minimal service

90040 Brief service

90050 Limited service

90060 Intermediate service

90070 Extended service

90080 Comprehensive service

Codes for chest X-rays:

71010

71015

71020

71021

71022

71023

71030

71034

71035

Radiologic examination, chest; single view, frontal

stereo, frontal

Radiologic examination, chest, two views, frontal

and lateral;

with apical Iordotic procedure

with oblique projections

with fluoroscope

Radiologic examination, chest, complete,

minimum of four views;

with fluoroscope

Radiologic examination, chest, special views (e.g.,

lateral decubitus, Bucky studies)

SOURCE: S.B. Clauser, C.M. Fanta, A,J. Finkel, et al. (eds.), Physicians’ Current

Procedurs/ Terminology, 4fh Edifion, CPT4 (Chicago, IL: American Medical Association, 1985).

were set at the mean, 14 physicians who earned less

per visit than they had in the past might either

provide unneeded laboratory tests or bill separately for previously included laboratory tests

(332). In addition, some physicians might reduce

the time spent in face-to-face contact with their

patients in order to see more patients per day.

These incentives would not apply to those physicians who earned more per visit.

Access to Care

If payment rates with collapsed procedure codes

appeared reasonable to physicians and if specialists were still allowed to bill different rates from

generalists, access to care might remain stable

(319). Specialty-specific billing in certain ways

serves as a partial proxy for case-mix adjustment

(319). Without specialty-specific rates, 80 to 90

percent of the specialists in one study would have

lost money under collapsed procedure codes relative to the present system (319). If payment rates

14 payment rates for all packages were set at the median, some

of the skewing that an average produces might be avoided (569).
Ch. 6—Payment for Packages of Services . 163

did not appear reasonable to physicians and specialty-specific billing was not maintained, patient

access to care might suffer.

Analysis of South Carolina Part B data from

1981 showed that overall assignment rates for collapsed office visit codes would fall only slightly

if specialty-specific billing were maintained (319).

The Medicare market share in an area and in a

physician’s practice might determine whether access is a problem or not (319). In South Carolina,

one-fifth of the physicians, for instance, provided

one-half of all visits to Medicare beneficiaries

(319). Medicare would be able to exert considerable leverage over these physicians.

Costs and Efficiency

Although collapsed procedure codes could control the rate of increase of Medicare expenditures,

they would not necessarily reduce Medicare expenditures. The effect of collapsed procedure

codes on Medicare expenditures would depend on

the nature of the collapsed codes, utilization patterns, and the patient’s severity of illness. With

payment rates set at the mean, the effects would

be similar to those described above.

Mitchell and colleagues collapsed 12 codes for

colonoscopy 15 (a type of colon examination) in

two different ways (319):

Ž into a single collapsed procedure code (with

a weighted average of charges for all 12 procedures), and

. into two different codes based on the extent

to which the fiberoptoscope was inserted during colonoscopy.

With a single code for all 12 procedures, the

price for a colonoscopy was $247. With two codes

based on distance into the colon, the price was

$165 for the less complicated procedure and $293

for the more complicated procedure (see table 6-

3). If all 12 colonoscopy codes were collapsed into

one, physicians who lost money relative to the

current system would be paid $21 to $102 less than

at present; physicians who gained money relative

to the present system would earn between $14 and

$106 more. Medicare might save the amounts

lsThe newest edition of CPT-4 lists 13 codes for Kdonoscopy.

listed for physicians who lost income relative to

the present on colonoscopies that go higher into

the large intestine. Conversely, Medicare would

have some losses for lower level colonoscopies.

Should present assignment rules continue, a beneficiary would be likely to have higher costsharing liability if a simple colonoscopy was performed but a lower liability for a colonoscopy

higher into the large intestine. The same would

apply to Medicare program costs. If assignment

was not mandatory, physicians who stood to lose

money on particular cases might refuse assignment in order to be able to bill patients for additional amounts.

Mitchell and colleagues also collapsed 11 visit

codes in two different ways (319). In the first situation, 11 visit codes were collapsed into 2 types

of visits according to the type of patient seen (new

or established). In the second situation, the 11 visit

codes were collapsed into 5 codes (2 for new patients and 3 for established patients). Rates were

set using a weighted average of charges in the various visit categories. When specialty was taken into

account and 5 codes were used, the amounts paid

to physicians would have been comparable to the

present. Results similar to those for colonoscopy

occurred when visit codes were all collapsed into

one code. Patients’ cost-sharing liability would rise

if their visits were classified in a category with

a higher average charge, and cost-sharing liability would fall for patients in a category with a

lower average charge than in the past.

Technological Change

The incentives for technological change under

collapsed procedure codes would be similar to

those under the present system. If the collapsing

of visit codes was coupled with the inclusion of

certain laboratory tests in the visit rate (as was

done in Quebec (28)), physicians would have an

incentive to use fewer and less expensive laboratory tests.16

Ib]n Quebec, Canadar between 1971 and 1976, the average number of base services, such as visits to physicians, provided to patients remained stable even with fee constraints and rising physician expenditures. But the number of associated diagnostic and

therapeutic services accompanying base services rose 53 percent (28).

And the average fee per examination rose 20 percent more than aver-

(continued on next page)
164 ● Payment for Physician Services: Strategies for Medicare

Table 6-3.-Collapsed Procedure Code Package: Diagnostic Colonoscopy

Relative Medicare Beneficiary 20-percent

CPT-4 frequency Usual approved copayment if

code Procedure (n =358) charge charge deductible is met

45360 Colonoscopy, fiberoptic, beyond 25 cm to

splenic flexure: diagnostic procedure . . . . . . . . . . 0.28 $188 $141 $28.20

45365 with biopsy and/or collection of specimen for

cytology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.05 251 222 44.00

45367 with removal of foreign body . . . . . . . . . . . . . . . 0.00

45368 with control of hemorrhage. . . . . . . . . . . . . . . . . —a 300 200 40.00

45370 with removal of polypoid lesion(s) . . . . . . . . . . . 0.03 388 306 61.20

45371 with retrograde Iavage (e.g., water pik) . . . . . . . 0.00 — —

Collapsed procedure (CPT-4 codes 45360-45371)

package price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.36 $211 $165 $33.00

Coefficient of variation . . . . . . . . . . . . . . . . . . . . . . 46.70/o 46.60/o

45378 Colonoscopy, fiberoptic, beyond splenic flexure:

diagnostic procedure . . . . . . . . . . . . . . . . . . . . . . . . 0.33 $315 $267 $53.40

45379 with removal of foreign body . . . . . . . . . . . . . . . 0.01 267 233 46.60

45380 with biopsy and/or collection of specimen for

cytology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.12 350 283 56.60

45382 for control of hemorrhage . . . . . . . . . . . . . . . . . . —a 400 275 55.00

45385 with removal of polypoid lesion(s) ., . . . . . . . . . 0.18 452 349 69.80

45386 with retrograde Iavage (e.g., water pik) . . . . . . . 0.00 — —

Collapsed procedure (CPT-4 codes 45378-45366)

package price. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.64 $359 $293 $58.60

Coefficient of variation . . . . . . . . . . . . . . . . . . . . . . 29.1 % 20.6%

Total collapsed procedure (CPT-4 codes

45360-45371, 45378-45386) package price . . . . . 1.00 $306 $247 $49.40

Coefficient of variation . . . . . . . . . . . . . . . . . . . . . . 48.70/o 45.6%

aFrequency less than 1 Percent.

SOURCE: J.B. Mitchell, K.A. Calore, J. Cromwell, et al., “Alternative Methods for Describing Physician Services Performed and Billed, ” prepared for the Health Care

Financing Administration, U.S. Department of Health and Human Services, Baltimore, MD, November 1983.

Ambulatory-Visit Package

As has been mentioned previously, principal

diagnosis is not so easily defined in the ambulatory setting as in the inpatient setting (270). The

implications of paying for ambulatory visits in

package form are discussed below.

Quality of Care

Because of the potential for underuse of ancillary services within packages, payment by ambulatory-visit packages might adversely affect quality of care. Incentives for underuse of needed

services, however, would be tempered by the current malpractice climate, by physician’s ethics

(continued from previous page)

age fee schedule increases as physicians began billing for an increasing

number of higher priced complete examinations as opposed to the

lower priced simpler examinations (28). TO address some of these

issues, in 1976 a new fee schedule was negotiated with higher rates,

but with collapsed visit codes and some ancillaries, such as certain

clinical laboratory tests, included in the exam fee. (28).

(79), and by the fact that physicians see in-office

provision of laboratory tests as a patient convenience (80).

In order to maintain consistent levels of payment or to increase payment levels, physicians

might request that patients return for more ambulatory visits than in the past. Since these return visits would increase beneficiary cost-sharing

and time costs, beneficiaries might resist return

visits. Physicians might avoid the more costly patients. Alternatively, physicians might see patients

for a shorter time per visit in order to see more

patients per day.

Including multiple physician charges in an ambulatory-visit package might discourage the primary physician from requesting specialist services (94). If these additional specialist visits had

been needed in the past, concerns about the quality of care would be raised. On the other hand,

if consultant services had been overused, then little effect on quality of care would be noted.
Ch. 6—Payment for Packages of Services • 165

If payment for physician services provided to

inpatients was perceived to be less restrictive than

payment for ambulatory care, physicians might

hospitalize some patients for tests that could

otherwise be performed on an ambulatory basis,

Physicians’ ability to hospitalize patients unnecessarily would be limited by Medicare’s prospective payment system for hospitals and the monitoring responsibilities of utilization and quality

control peer review organizations (PROS) .17

Access to Care

Access concerns outlined at

this section would apply to

packages.

Costs and Efficiency

the beginning of

ambulatory-visit

Within ambulatory-visit packages, but not

across packages, program expenditures would be

controlled. The control of total Medicare expenditures with ambulatory-visit packages would depend on the degree to which physicians encouraged revisits or billed for a higher level of service.

Some increase in beneficiary cost-sharing could

occur if revisit rates increased. To prevent an increase in their liability, however, beneficiaries

might avoid revisits. In addition, beneficiaries

who were “below average” for the number of ancillaries received for a visit in the past might have

a higher cost-sharing liability. The “above average” ancillary users might have a lower costsharing liability than they did in the past.

Technological Change

In order to conserve on the costs of ancillary

services included in an ambulatory-visit package,

physicians might be motivated to adopt new lowcost laboratory devices (332). Physicians might

also be motivated to reduce the amount of laboratory testing within a visit package (332).

17PROS must identify and meet objectives in five areas: 1 ) reducing unnecessary readmission due to previously substandard care;

2) assuring provision of medical services, which if not given, would

have significant potential for causing serious patient complications;

3) reducing the risk of mortality associated with selected procedures

or conditions requiring hospitalization; 4) lowering unnecessary surgery; and 5) reducing avoidable postoperative complications (489).

Use of new, expensive technologies such as MRI

would be greatly discouraged within an ambulatory visit (234). Physicians wishing to control

costs within ambulatory visits would be likely to

suggest another visit and to avoid using expensive technologies.

Special-Procedure Package

For some physicians, special-procedure packages would represent only a slight change from

the current payment system. Surgeons, for instance, have performed surgery as part of what

amounts to a package for years, since their preand post-hospitalization visits and the actual procedure are included in their fees. Some special procedure packages could address the problem of

multiple physicians’ (e.g., a surgeon and an anesthesiologist) billing for one procedure. Other

special-procedure packages could address the

problem of physicians’ billing for both a visit and

a procedure (e.g., when an MRI scan is administered to a patient, the patient is charged for the

scan itself as well as the visit).

The attending or primary physician might resist the special-procedure package alternative because the primary physician would have to negotiate fees with other physicians and would bear

the financial risk of services included in the package, such as payments to other physicians (319).

Certain procedures can be performed either in a

hospital setting or an ambulatory surgery center.

Payment for special-procedure packages might encourage fee bargaining among physicians and

might result in less hospital use. For instance, if

a surgical procedure package were created, the

surgeon might negotiate with an anesthesiologist

or a nurse anesthetist to obtain a favorable fee.

In addition, should the facility fee be included in

the package, physicians might seek the least costly

facility to perform a procedure. Because specialprocedure packages would change the way in

which hospital-based physicians are reimbursed,

such physicians might resist this approach.

The potential effects of special-procedure packages on quality of care, access to care, costs and

efficiency, technological change, and administrative feasibility are discussed below.
166 . Payment for Physician Services: Strategies for Medicare

Quality of Care

In order to keep costs down within specialprocedure packages, physicians might seek to use

the least costly services. Surgeons, for instance,

might choose the least costly anesthesiologist.

There is no evidence of a relationship between

quality of care and high-charging physicians;

therefore, if the coordinating physician sought

lower cost providers, there might be minimal effects on quality. Use of assistant surgeons might

also be reduced as a means of controlling the costs

of resources used within the package. In some

cases, the use of assistant surgeons might be unnecessary, and, no quality problems would ensue.

As has been mentioned with other packages,

to the extent that laboratory tests have been overused, a reduction in the number of tests would

improve quality of care (332). The exact volume

of services and choice of testing location would

depend on the relative marginal costs and benefits of various tests (332).

Should cataract surgery, for example, be paid

as a special-procedure package, low-cost interocular lenses would be most acceptable to physicians.

On the other hand, new, better quality, high-cost

interocular lenses might not be adopted by physicians even if their costs would fall over time,

because the initial costs of lenses would be high

and would take funds from the package price

(161).

Access to Care

Special-procedure packages might encourage

physicians to refuse care for patients with multiple medical problems out of concern that the financial risk would be too great. Appropriate casemix measures to adjust for severity of illness

would be needed to protect access to care for the

more complicated patients. Access problems

might also be avoided by a well-defined policy

for unusually resource-intensive patients (an outlier policy).18 If codes were collapsed to create

special-procedure packages, it might be advisable

to maintain specialty differential payment in or18An Outlier would be a case with unusually high or lOW resource

use. An outlier policy could adjust a physician’s payment for patients with very high or very low resource use.

der to protect access, because specialty-specific

billing has served as a proxy for case-mix adjustment, in some circumstances paying physicians

for more complex cases at a higher rate (319).

If only some procedures were packaged, physicians or facilities might specialize either in wellpaid packages or in procedures that were not

packaged. Specialization might lead to regionalization of facilities, which might reduce geographical access. MRI, for instance, might be regionalized because of high initial costs.

Costs and Efficiency

The effects of averaging prices noted with other

packages would also be apparent with specialprocedure packages. Mitchell and colleagues analyzed South Carolina 1981 Medicare Part B claims

data and found that the average package price for

upper gastrointestinal endoscopy by surgeons

would be $226.30 versus $190.75 when performed

by internists. An average price for all physicians

would be $203.94, $13 more than the average for

internists and $23 less than the average for surgeons. A diagnostic cystourethroscopy package

done in a hospital was priced at $154 and in an

office at $81. An average package price for either

inpatient or ambulatory care would be $131, thus

giving the physician an incentive to do the procedure in the office if it was less costly (319).

If Medicare were to price special-procedure

packages low, there might be a tendency for physicians to shift costs to other payers. For instance,

ESWL involves high initial capital costs. If individuals or facilities knew that a large market existed among other payers, then they might be willing to take a loss on Medicare patients, because

costs would be borne by other patients or thirdparty payers.

Technological Change

Special-procedure packages would give physicians an incentive to adopt new cost-saving and

potentially beneficial technologies such as ESWL.

A package for ESWL might encourage the development of less expensive machines or the use of

the least expensive alternative to hold costs down

within a package. If packages included the average cost for an operative procedure, there would
Ch. 6—Payment for Packages of Services Ž 167

be an incentive to use ESWL in place of surgery

and still receive a higher fee (431).

For an emerging, expensive technology such as

MRI, physicians might compete to be the “package” physician. To keep the entire fee, neurologists might choose to do the MRI scan on their

own instead of requesting the additional help of

a radiologist (234). Physicians would also have

an incentive to use more cost-effective clinical laboratory services within packages.

Ambulatory- Episode-of-Care Package

Packaged payment for ambulatory episodes of

care would give physicians an incentive to control use of and expenditures for services that may

have minimal benefit, including ancillaries and

consultant physicians. The effects of ambulatoryepisode-of-care packages on quality of care, access to care, costs, technological change, and

administrative feasibility are discussed below.

Quality of Care

The effects of ambulatory-episode-of-care packages on the use of ancillary services would be comparable to the effects with other packages. Incentives might also exist for physicians to cut back

on the use of consultant services (if these services were included within the package), and to perform procedures or to evaluate test results without the assistance of consultants when they might

normally be used (194). In many cases, physicians

do evaluate their own test results.

Within an ambulatory episode of care, some

incentive would exist for physicians to reduce the

average number of visits. In addition, physicians

might choose to reduce the time spent with individual patients and to see more patients in a day.

Access to Care

If assignment were required and payment rates

for ambulatory-episode packages seemed equitable to physicians, access might be similar to that

under the current system. One investigator classified assignment patterns of physicians treating

hypertension patients into three categories: always

takes assignment, sometimes takes assignment,

and never takes assignment (319). Packages for

ambulatory episodes were created by using claims

and survey data. Physicians who had always

taken assignment had average package prices 62

percent higher than physicians who never had

taken assignment ($152 vs. $94) because of greater

use of ancillary tests (319).

Physicians who had sometimes taken assignment within the same package averaged package

prices 50 percent higher than physicians who had

always taken assignment ($229 vs. $152) and 1.5

times higher than physicians who had never taken

assignment ($229 vs. $94) (319). Physicians who

never took assignment accounted for 63 percent

of total charges, and 24 percent of total charges

were taken on assignment by other physicians,

leaving only 13 percent of other physicians’

charges unassigned (319). If assignment were mandatory, close to half of the physicians in Michigan would have to reevaluate their decisions to

never accept assignment (319).

If a physician were responsible for a significant

amount of chronic care, accessibility might be reduced for the more complicated patients. The physician might also wish to avoid a significant loss

on patients with multiple conditions. Some access

problems might be avoided if case-mix adjustment

was adequate and a well-articulated outlier policy was created.

Costs and Efficiency

The effects that ambulatory-episode-of-care

packages would have on costs to beneficiaries, the

Medicare program, and society are similar to

those with other packages.

Studies by Mitchell and colleagues and by Walden found substantial variation in resource use

and costs in potential episode packages, particularly for chronic diseases (319,562), and Mitchell, et al., recommended that packages be defined

by a fixed-interval of time (319). The packages

that these investigators created for hypertension

(including ancillaries but excluding hospital services) were similar in price, although the data they

used were from different years (see table 6-4).

Using Michigan 1981 claims data, Mitchell, et al.,

created packages for two chronic conditions commonly found in the Medicare population: essential benign hypertension and diabetes mellitus.
168 ● Payment for Physician Services: Strategies for Medicare

Table 6=4.—Ambulatory Episodes of Care: Package

Prices for Essentiail Benign Hypertension

Package

Source Package price

Mitchell, et ala . .Total ambulatory-episode

package b

. . . . . . . . . . . . . . . . . $133.67

Walden c 

. . . . . . . .Total ambulatory packaged . . . $ 74.39

Total ambulatory-episode

package e . . . . . . . . . . . . . . . . . $124.83

aBased on Michigan 1981 Medicare Part B data.

Total package price is a weighted average of all physician charges for the

3-month period.

CBased on household data from the National Medical Care Expenditure SUrveY,

1977.

dThis ambulato~ package includes visits to the package physician, other

physicians, and nonphysicians. It differs from Mitchell and colleagues’

ambulatory-visit pack~es and ambulatory-episode packages.

eThis ~bulato~+pigode package includes visits to the package physician, other

physicians, nonphysicians; and prescribed medicines and sundries.

SOURCES: J.B. Mitchell, K.A. Calore, J. Cromwell, et al., “Alternative Methods

for Describing Physician Services Performed and Billed,” final report

prepared for the Health Care Financing Administration, U.S.

Department of Health and Human Services, Baltimore, MD, Novemhr

19S3; md D.C. Walden, “Paying Several Physicians for Treating an

Episode of Illness,” presented at the Annual Meeting of the American

Public Health Association, Anaheim, CA, Nov. 13, 1984.

Physicians’ services and ancillaries were included

in the package. The time interval of the diseasespecific episode was 3 months. Visits to the primary physician accounted for 27 percent of total

costs, and ancillary services (mostly laboratory

tests) accounted for the remainder. Almost twothirds of the care provided during the 3-month

period for both the hypertension and diabetes

packages was for care unrelated to diabetes or

hypertension. Therefore, the potential for package fragmentation exists. Although the average

physician charges over a 3-month period for diabetes and hypertension were $134 to $140 respectively, the charges ranged from a low of $7 to a

high of $3,400.

With an ambulatory-episode package, physicians assigned to packages by the researchers were

likely to be underpaid or overpaid significantly,

and specialty did not necessarily explain the variation. Because significant out-of-package care existed, either a method for handling out-of-package

care could be developed or a time-interval ambulatory-care package would need to be established

(319).

Using 1977 National Medical Care Expenditure

Survey data,19 Walden described similar results

19This data set has many advantages because it includes patients

of all ages, represents care in all so States and the District of Columbia, and allows construction of episode-of-illness files. The disadvantages include the fact that questionnaire respondents defined

the content of packages. In addition, the data did not permit determination of the primary physician responsible for the patient’s care.

(562). He examined four different packages for diabetes, the common cold, pneumonia, and hypertension. Most cases involved one physician. In the

case of chronic disease, visits for care unrelated

to the chronic disease were fairly common. In

many cases, the primary physician handled much

of the care unrelated to the specific condition.

Much of the variation associated with a patient’s

care related to the number of visits to the package physician and to nonphysician providers and

to the use of laboratory tests and X-rays. Volume

of service was found to be the most important

variable associated with expenditure variation.

Whether a patient had more than one condition

was also found to be a significant factor in services used for a chronic disease, such as hypertension.

With the package price set at the mean, only

5 to 7 percent of the packages would be paid at

current fee-for-service prices: 70 percent would

be set higher than the average and about 25 percent would be set lower. On the whole, physicians with a large proportion of chronic disease

patients would have to absorb costs of care above

the mean payment. Physicians treating a disproportionate share of elderly patients with chronic

conditions might question the equity of their payment, because they would more likely have to absorb losses. Access to care would then become an

issue, as physicians might refuse to treat elderly

chronically ill patients (562).

Technological Change

Ambulatory-episode-of-care packages might

provide an incentive for development of costeffective laboratory devices for the office. In order to conserve on the number of visits within episodes, physicians might choose to provide laboratory tests within the office if the machines could

be purchased at lower prices. This might encourage the development of lower cost analyzers for

in-office use (332).

Physicians might be financially neutral about

adoption and use of preventive technologies, such

as pneumococcal vaccination, traditionally provided in ambulatory settings. The payoff—better

health for beneficiaries—might not occur in any

one particular ambulatory episode of care.

Adoption of new, potentially efficacious technologies such as MRI might be slowed if such a
Ch. 6—Payment for Packages of Services . 169

diagnostic procedure were to be included in the

ambulatory-episode package (234). Although

MRI’s usefulness for patient care and diagnosis

has not been entirely determined (234), if the procedure were more expensive than alternatives, and

if it were included in the package rate, incentives

to avoid its use would exist. To the extent that

MRI would have helped in patient care, quality

of care would suffer (234).

lnpatient-Episod-of-Care Package

Global payment for all physicians’ services

associated with a single episode of inpatient care

is sometimes termed payment by “inpatient physician DRGs. ”20 DRGs were originally created as

a means of monitoring hospital utilization and are

the basis of payment under Medicare’s prospective payment system for inpatient hospital services (141,489).

Payment for packages of physicians’ services

for inpatient episodes of care could take various

forms:

● Payment for all physicians’ inpatient services

based on physician DRGs.

● Payment for surgical inpatient services based

on physician DRGs. —All physicians’ services for surgical care would be paid by physician DRG. Medical services would be paid

by fee schedule or CPR.

 ŽPayment for the services of hospital-based

physicians (e.g., anesthesiologists, radiologists, and pathologists) as part of a hospital

DRG.—Hospital DRG rates would be recalibrated to reflect the services provided by

hospital-based physicians.

Two studies have created inpatient physician

DRGs using claims data. In one study, Mitchell,

et al., expressly examined the feasibility of using

physician DRGs as a means of paying for inpatient

physician care (321). Hospital episodes were constructed with 1982 data from four States (Michigan, New Jersey, North Carolina, and WashingZopatient Classification systems other than DRGs may be more

appropriate for describing a patient’s severity of illness, but they

have not yet been analyzed for the purposes of physician payment.

Possible alternatives include patient managment categories, staging, seventy of illness, medical illness seventy grouping system, and

the acute physiology and chronic health evaluation instrument.

ton). The episodes included all physician services

provided during a hospital stay and physician

services provided the week before and the week

after the hospitalization (313,321). In a second

study, West, et al., explored methods that might

be employed in merging Part A and Part B data

(571).

Some investigators have suggested that physicians could be paid by DRG for inpatient surgical care and by either the current CPR system or

by a fee schedule for medical services. Mitchell,

et al., for example, suggest that because physician charges in surgical DRGs are relatively homogeneous, physician surgical DRGs could be

adopted (320). But West, et al., suggest caution

in adopting any DRG type of payment because

payments within DRGs are not sufficiently homogeneous (571). West, et al. ’s, findings indicated

that “although payments within physician surgical DRGs may appear to be slightly less variable

than medical DRGs with respect to their arithmetic averages, their absolute variability (standard deviation) in dollars is greater” (571). Among

67 high-volume medical DRGs in South Carolina

during 1981, the highest average charge for a DRG

was 2.2 times the lowest. On the other hand, for

surgical DRGs, the highest average charge was 23

times than the lowest (571).

The option of paying for the services of hospital-based physicians as part of the hospital DRG

payment has not been studied. Including the services of hospital-based physicians in the hospital

DRG payments has certain advantages. Hospitalbased physicians generally see patients or examine specimens at the request of other physicians.

Because patients rely on referrals to these physicians, mechanisms intended to encourage greater

competitive price-shopping by patients would not

be effective. Since many hospital-based physicians

earn some portion of their income from salary or

contracts with hospitals, the change to more direct control from hospitals would not be drastic.

Hospitals would then have greater incentives to

negotiate lower rates with these physicians (469).

The history of payment arrangements for hospital-based physicians is different from that for

other physicians, and payment arrangements have

differed for radiologists, pathologists, and anesthesiologists. In 1982, the Medicare program in-
170 ● Payment for Physician Services: Strategies for Medicare

troduced new complexities into hospital-based

physicians’ relationships with hospitals by eliminating combined billing and requiring that all

medical professional services be billed and paid

for under Part B of Medicare .21 In reaction to the

original Medicare legislation and subsequent

amendments, hospital-based physicians began a

gradual transition to fee-for-service compensation.

The American College of Radiology explicitly encouraged its members to move in that direction

(268). Since the implementation in October 1983

of the Tax Equity and Fiscal Responsibility Act

of 1982 (TEFRA) (Public Law 97-248) and Medicare’s prospective payment system for inpatient

hospital services, the trend to fee-for-service

among radiologists has accelerated (123).

Among pathologists, there have been increases

in both fee-for-service and salaried compensation

but not in arrangements by which they receive

a percent of their billings. Reimbursement per unit

of service tends to be smaller in pathology than

in radiology, so the per unit expenses of billing

for fee-for-service practices are relatively higher

for pathologists than for radiologists. Therefore,

pathologists might be more logically inclined to

salaried practice (450). TEFRA’s most severe limitations are on the billing practices of pathologists,

by defining almost all clinical laboratory tests as

Part A services not reimbursable on a charge basis. Under TEFRA’s regulations, clinical laboratory services meeting very specific criteria can be

considered reimbursable under Part B; all other

clinical laboratory services are reimbursed under

Part A. All anatomical pathology services are considered professional services and must be paid for

on a reasonable charge basis under Part B (see ch.

3).

Anesthesiologists are predominantly fee-forservice practitioners who provide services directly

to patients. In this respect, they are more similar

ZIA]though the congressional intent to separate physician administrative charges (Part A) and physician clinical charges (Part B) was

in the initial Medicare legislation, carriers differed in their interpretations of how certain charges were handled. The Tax Equity and

Fiscal Responsibility Act (TEFRA) (Public Law 97-248) (Section 112)

mandated the separation. In addition, TEFRA eliminated a requirement that Medicare pay 100 percent of the reasonable charges for

pathology and radiology services delivered to hospital inpatients.

TEFRA also eliminated combined billing (48 FR 39740), which allowed hospitals to bill for the services of pathologists and radiologists.

to office-based physicians than other hospitalbased physicians. A study in 1979 indicated that

77 percent of anesthesiologists were paid on the

basis of fee-for-service, 19 percent were salaried,

and 4 percent used the percentage of departmental

revenue as their method of compensation (451).

In former years, the American Society of Anesthesiologists required as a condition of membership that billing be on a fee-for-service basis unless the physician was a government employee.

Following the intervention of the Federal Trade

Commission, the Society amended its rule in 1980,

but continues to advocate fee-for-service as the

method of compensation (428).

Quality of Care

Packaged payment for an inpatient episode of

care contains incentives for underuse of consultants. As has been noted previously, to the extent

that specialists’ consultations have been overused

in the past, a reduction in the use of consultants

would not adversely affect quality of care. Evidence is equivocal as to whether consultations improve quality of care, but a positive relationship

seems to exist (275). Methodolo`gical problems of

studies prevent clear-cut interpretation of many

of the studies on consultation (275). Some States

(e.g., New Jersey) use all physician resources for

inpatients, including consultants, at a higher rate.

Whether increased resource use at that level adds

to quality of care is unclear (320,321).

Photo credit: American College of Physicians, HEALTHSCOPE film series

Payment for an inpatient-episode-of-care package

would contain incentives to reduce the use of referral

services, such as those of consultant physicians.
Ch. 6—Payment for Packages of Services . 171

If under packaged payment surgical cases were

more highly paid than medical cases (as they are

under Medicare’s prospective payment system),

some patients might have surgery earlier than in

the past (before certain medical procedures are

tried). This change might affect the quality of patient care if a medical treatment would have been

successful.

If physician inpatient care were paid by DRG,

a physician’s decision to examine all avenues before deciding on a diagnosis might be influenced

by the relative payment rates for different DRGs

(233). In the case of a pneumonia patient, if the

exact cause of a disease were found, the patient

might then be assigned to a more lucrative DRG.

The physician’s marginal gain from an additional

diagnostic test might therefore exceed the marginal

cost (233). On the other hand, an anemic patient

might be treated initially with iron supplements,

because determining the exact cause of the anemia would not change the patient’s assignment to

a particular DRG. Only if that treatment failed

would an exact etiology of the disease or another

treatment be tried (233).

Patients might be discharged from the hospital, if their conditions allowed, and then readmitted at a later date for additional procedures. PROS

currently review readmission to the same hospital for the same diagnosis within 7 days of patient discharge. But patients who entered another

hospital, were admitted to the same hospital for

related but not the same causes, or were readmitted after 7 days would not be detected.

If payment were more restrictive for inpatient

services than for ambulatory services, physicians

might change the setting of care to ambulatory,

and patients who needed inpatient care would suffer. On the other hand, patients whose hospitalization was questionable could benefit.

Access to Care

If assignment was mandatory under payment

for an inpatient episode of care, the decision to

participate in the Medicare program might be

made by physician groups, including medical

staffs. Since the financial risk of paying an individual physician for an inpatient episode of care

is great, investigators have suggested that a larger

entity, such as a single-specialty group or a multispecialty medical staff (perhaps in the form of an

IPA), could be the recipient of payment (320). The

larger the size of the physician group, the greater

the potential for loss of income if mandatory assignment was refused. If mandatory assignment

was accepted, access might be improved. But in

areas with few hospitals, if a medical staff chose

not to accept assignment, significant access problems might occur.

Hospital-based physicians who could realign

their market might choose to do so, if payment

in those sites were not so constrained. Radiologists might engage in ambulatory work, and anesthesiologists might choose to work in ambulatory

surgery centers. In addition to affecting quality

of care, the change in sites might reduce access

to these physicians for hospitalized patients.

Physicians might try to transfer patients to

other hospitals, especially if the physician and

hospital were paid one rate. This would be especially evident if the patient had multiple, expensive conditions. Paying for all inpatient care by

DRGs or other methods places the hospital and

physician in a situation with the same incentive

plan for underuse of services.

Costs and Efficiency

Research based on claims data suggests that,

given the wide range of physician payments for

medical and surgical DRGs, the vast majority (82

percent) of Medicare beneficiaries would experience a change (increase or decrease) in their total

cost-sharing of $75 or less (321), assuming mandatory assignment. For 1.6 percent of beneficiaries, there would be an average increase in costsharing liability of more than $150. Under a physician DRG system, patients might exercise less

constraint in their requests for additional services

as cost-sharing would be known in advance (469).

The cost-sharing liability would be higher than

at present for less complicated cases and lower

for more complicated ones. In a sense, less costly

cases would be subsidizing the more costly ones.

If surgical cases were more highly paid (as they

are under Medicare’s prospective payment system), some patients might have surgery earlier

than in the past before certain medical procedures
172 • Payment for Physician Services: Strategies for Medicare

are tried. This change might negatively affect the

quality of patient care if a medical treatment might

have been successful.

A Pennsylvania study of per case payment for

physicians’ inpatient services found that total hospital outlays were reduced in many hospitals. But

total physicians’ payments increased because physicians were reimbursed 100 percent of a negotiated schedule of fees instead of the 90th percentile of usual, customary, and reasonable charges

(286). Physician participation in the program was

voluntary, and not all physicians who originally

volunteered for the program completed it. By reducing hospital lengths of stay, a number of the

participating hospitals reduced combined total

expenditures despite the increase in physician expenditures. The Pennsylvania study had a number of methodological problems that prevent generalizing the results. Since physicians volunteered

to be in the program, there may have been selection bias. In addition, the sample was small as

very few analyses from the control and experimental groups were usable.

As has been mentioned with other packages,

there is no guarantee that payment for inpatient

episodes of care would save money for the Medicare program, although expenditures per case

might be more predictable. To the extent that physicians chose to readmit patients, program expenditures might rise. Physicians might also shift

services to another setting. Shifting services from

one setting to another would depend on the ability to substitute ambulatory or nursing home care

for inpatient care. Research indicates that such

substitution is possible (101,206). The effect of

shifting services on program expenditures would

depend on the cost of care in other settings and

the extent of care used.

Efficiency of resource use would be encouraged

within a package but not necessarily across packages. Multiple admissions might increase if physicians sought to maintain or increase income.

Physicians might attempt to provide more packages of care or to see only less costly patients.

For a particular case, a physician might either

profit or lose financially relative to the present

system.22 Because a physician would be likely to

treat small numbers of cases within each DRG (2

to 2.5 patients on average), there is little opportunity for gains and losses to cancel each other

out at the DRG level (320). Even at the medical

staff level, payments to physicians under DRGs

would be lower where the medical staff is highly

specialized (320,321). Because medical subspecialists and generalists charge less on average than

surgical specialists, their relative loss of funds

would be greater than that of the surgical specialists. In fact, the DRG payment could be a lottery

with large losses for some physicians and windfall gains for others (313).

In the four States that Mitchell, et al., studied,

the standards of care varied (320,321). For example, for lens procedures, New Jersey’s care was

far more service-intensive than in the other three

States. Physicians in New Jersey used an assistant

surgeon in three-quarters of the operations, while

those in Michigan and Washington did so only

28 and 36 percent of the time, respectively, and

North Carolina physicians never used an assistant surgeon who billed Medicare. Physicians in

New Jersey also kept their patients in the hospital far longer than physicians in the other three

States. Because of interstate variations, creating

payment rates acceptable to all physicians would

be difficult. Specialty differences in terms of

charges were not great within New Jersey, but

were significantly different within North Carolina and Washington. Specialty, however, accounted for little of the variation in treatment

costs (320,321). Similar variations in treatment

patterns, including hospitalization, have been

noted by other researchers (125,568).

ZZGinsburg and Newhouse have su~ested that a blended fee-forservice/DRG payment might be appropriate to alleviate some of

the problems associated with the potential for certain physicians

to gain or lose a great deal. The process would begin by examining

each DRG to determine how homogeneous physician charges are

within the DRG. Physicians would bill their regular charge, which

would be screened by the CPR method and the DRG rate. The payment would be a weighted average of the CPR approved rate and

the DRG rate. Since each bill would need to be screened the system

would be more expensive than a DRG-only rate. With this blended

method, incentives for cost containment would not be so great as

with a simple DRG payment system, but incentives for underutilization would also be reduced (167),
Ch. 6—Payment for Packages of Services ● 173

In one instance, the prospective ratesetting system for hospitals in New York State, pressures

to contain hospital costs under a prospective payment system contributed to reduced payment for

hospital-based physicians. Including hospitalbased physicians in the hospital DRG payment

would provide similar incentives for hospitals to

pay these physicians less (429). In fact, a 1983 survey by the American College of Radiology found

that 80 percent of radiologists were on fee-forservice, compared with a previous finding of 63

percent in 1979 (9)

Technological Change

DRGs would encourage the development of

cost-saving procedural technologies to save physician time. For example, physicians would have

an incentive to develop surgical techniques that

reduced operative time, such as an improved

method of performing a coronary artery bypass

graft or a hip replacement.

Whether an inpatient-episode package would

encourage or discourage the use of ESWL would

depend on whether ESWL was classified in a medical (generally, it is now treated as a medical procedure) or surgical DRG or in another classification. If ESWL were incorporated in the same

package with a surgical treatment, use of the procedure that used less costly physician resources

would be encouraged.

Total-Episode-of-Care Package

A total episode of care may be defined as beginning either when the patient formally requests

an appointment for medical care (224) or when

the patient has a face-to-face contact with a physician (224,250). Since making an appointment

does not guarantee that a patient will actually follow through on medical care, the first face-to-face

contact may serve as a better marker. For payment purposes, an episode would end when the

last care for a particular illness was given.

Payment for a total episode of care has the potential for generating more consistent and appropriate incentives for efficiency than the current

payment system (399). With the total episode approach, the provider would be given a fixed payment for an episode or a health problem. The recipient of payment could be held accountable for

only those aspects of care that were physicianadministered, or the facility cost could also be included.

Classification systems for total episodes of care

have yet to be defined. Some investigators have

defined fixed-interval episodes for purposes other

than payment, such as tracking utilization (179),

and other investigators have combined inpatient

and ambulatory claims to form an episode of illness (249). Episodes of acute disease may be easier to define than episodes of chronic care, because

acute episodes have more definite beginnings and

endings. Therefore, as mentioned in the discussion of ambulatory episode of care, payment for

chronic care might have to be defined according

to a period of time. Payment for a total episode

of care would encourage efficient use of resources

across the entire array of diagnoses and treatments

for that episode. Criteria would have to be established to define minimal times between contacts

for the same problem in order to divide separate

episodes (222).

It has been estimated that an episode classification system could be developed, tested, and refined so as to be usable for payment purposes in

5 years (222). Defining total episodes would be

complicated by the fact that principal diagnosis

is much more exact in the hospital setting than

in ambulatory care.

The effects of a total-episode-of-care package

on quality of care, access to care, costs and efficiency, technological change, and administrative

feasibility are summarized below.

Quality of Care

As has been discussed with other packages, incentives to underuse consultants and ancillaries

would exist under payment for a total episode.

To the extent that these services add to the quality of care, problems might arise.

Access to Care

Access to care might or might not be of concern. As long as comorbid conditions were included in separate episodes, it is unlikely that there
174 . Payment for Physician Services: Strategies for Medicare

would be access problems. Still, the oldest beneficiaries might be at risk for underprovision or

denial of care because they are most likely to have

multiple chronic diseases and to require expensive treatment. Classification systems that adjusted well for case-mix and severity would make

physicians neutral about treating different patients. Otherwise, physicians might avoid more

expensive patients.

Beneficiaries would have incentives to increase

visits because their cost-sharing liability would not

change. As with other packages, physicians would

have an incentive to reduce visits as they would

be paid no more for additional visits.

Costs and Efficiency

Costs to the beneficiary might be more controlled within an episode than under the current

CPR system. Both the beneficiary and the program would know their costs per episode in

advance.

As long as all care was packaged in some form,

Medicare program costs might be controlled.

Whether program costs would fall would depend

on the extent of out-of-episode care allowed.

Payment to physicians for a total episode of

care would encourage efficient use of resources

across the entire array of diagnoses and treatments

for that episode. Some inefficiency might occur

across episodes. Physicians would have an incentive to increase the number of episodes by billing

for different episodes of care, and Medicare would

have an incentive to define episodes broadly so

that more was included within episodes.

Technological Change

With payment for total episodes of care, innovation and research and development would be

more likely to be directed toward cost-saving technologies in both the inpatient and ambulatory settings. This situation might produce a problem for

expensive new technologies that increased quality or that might be cost saving in the long run.

Because incentives would exist to control costs

within packages, adoption of new, untried technologies with unproven efficacy would be retarded.

In situations where MRI could be substituted for

X-ray computed tomography (CT) scanning, for

instance, physicians might choose not to use MRI.

The adoption of new lenses for cataract surgery

would be encouraged if they were inexpensive,

but discouraged if they were expensive even if

costs would drop over time.

Administrative Feasibility

Overall, packaging might be simpler to administer than the current CPR system. Beneficiaries,

the Medicare program, carriers, and physicians

would probably have fewer forms to complete because of the reduced number of bills submitted.

However, if procedure codes were collapsed at the

carrier level and physicians could continue to bill

as they do now, the number of forms submitted

would be identical to the present system. Because

claims volume might be smaller with packaged

payment, there would be some potential saving

for the Medicare program (319). Initially, some

of the savings would be cancelled out by the expense of creating packages. Over time, expense

would also be involved in updating packages and

creating new ones. If only a portion of care were

paid on a packaged basis, carriers might need to

implement additional monitoring procedures to

screen for services included in a package.

Implementation of most packages would involve major changes for the recipients of payments. First, the recipient (the coordinating physician, physician group, or medical staff) would

have to negotiate with the physicians involved to

determine how to allocate payment for physician

services within the package. This negotiation

might be done each time a service is performed

or for a time interval. In many cases, negotiating

with others would be a new and potentially bothersome responsibility. In addition, administrative

responsibilities would increase for the recipient

of payment. Once allocation decisions were made,

the recipient of payment would need to monitor

the provision of care and to determine which services were and were not included in the package.

Although establishing codes for visits or episodes might be difficult, once the codes were

established, claims processing would be simplified as certain ancillaries would be included in the
Ch. 6—Payment for Packages of Services ● 175

bills. Physicians would still be likely to document

within their own records actual tests performed

for liability and clinical reasons.

Carriers would be faced with additional burdens in administering an episode-of-care approach. Theoretically, physicians would be able

to streamline their administrative procedures in

order to submit one bill including all services associated with one episode of inpatient or ambulatory care. In practice, it might be that the episode

determination would be made at the carrier level,

which might delay the actual payment to the physician. This would be especially true with the more

complex forms of paying physicians, such as a total episode of care. In particular, carriers would

need to screen bills to make sure that services

within one episode were paid as part of that

episode.

Should assignment be optional, some administrative confusion would result for beneficiaries

CONCLUSION

There has been little or no experience with payment for the majority of packages of services.

Payment under collapsed procedure codes could

be based on CPT-4 codes, but for most packages,

the categories for payment have not yet been defined. In some cases, such as total-episode-of-care

packages, rudimentary research would need to

be conducted to develop payment categories. In

other cases, such as ambulatory-visit packages,

research to develop categories is currently being

conducted. Some packages, such as those for inpatient episodes of care, might require demonstrations to evaluate the effects on Medicare program

and beneficiaries’ costs and on quality of care and

access. Collapsed procedures codes could be implemented fairly quickly after decisions were made

about which codes to collapse. Special-procedure

packages could be implemented within a shorter

time than other packages if the current coding system was used to create packages, but it would be

necessary to define the package content and to

delineate the tasks that the coordinating physician would have to perform.

who would not know who was being paid in what

manner for what services and what cost-sharing

they would bear. Packaging incentives might then

not apply. Effective methods of communicating

with beneficiaries would need to be developed.

Monitoring for underuse of services within

packages and overuse of services outside of packages would be necessary. Inpatient utilization review systems currently in place are more developed and easier to administer than ambulatory

systems. Although Medicare requires utilization

review for office-based physicians’ services, the

implementation of reviews varies among carriers

(474). Given the lack of experience in evaluating

utilization in ambulatory settings, systems might

need to be refined or new ones developed. Once

developed, the systems might be expensive to

administer.

cipient, whether it was a coordinating physician,

a physician group, or the medical staff of a facility. The recipient of payment would have to negotiate prices and availability for referral physicians, clinical laboratories, regionalized facilities,

and other referred services. An effective means

of addressing the financial risk, such as an outlier policy or a reinsurance scheme, could assist

with some of the financial risks that the recipient

of payment would bear.

Mandatory assignment would be necessary in

order for the recipient of payment to bear the financial risk of packaging’s fixed payment. In the

absence of mandatory assignment, the Medicare

program and the beneficiaries would continue to

bear the financial risk. Furthermore, without mandatory assignment, selection bias would occur.

Physicians would be likely to accept assignment

only for less complex and less expensive cases and

to bill beneficiaries with more expensive care for

amounts in excess of Medicare’s payment.

Payment for most packages would entail major changes in financial risk for the payment re-
Chapter 7

Cavitation Payment

. the point remains that rationing is inevitable for all resources

in all societies. The issue is simply that of how: through what

institutional framework?

Robert G. Evans, Journal of Health, Politics, and Law
Page

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 179

The Concept of Cavitation Payment and Possible Variations . . . . . . . . . . . . . . . . 179

Medicare Experience With Cavitation Payment . . . . . . . . . . . . . . . . . . . . . . . . . . . . 182

Establishing the Cavitation Rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 189

Alternative Methods of Refining the Average Adjusted Per Capita Cost . . . . 190

Other Methods of Determining Cavitation Payment . . . . . . . . . . . . . . . . . . . . . . 191

Implications of Medicare Cavitation Alternatives.. . . . . . . . . . . . . . . . . . . . . . . . . . 192

Cavitation Payment to Health Plans.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 194

Cavitation Payment to Geographic Fiscal Intermediaries . . . . . . . . . . . . . . . . . . 204

Administrative Feasibility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 207

Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 207

List of Tables

Table No. Page

7-1. Alternatives for Cavitation Payment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 179

7-2. Participation of Prepayment Plans in the Medicare Program, 1984-85 . . . . 182

7-3. Cavitation Payment for Medicare Beneficiaries in Demonstration Projects,

as of Mar. 31, 1985 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 186

7-4. Medicare Demonstrations of Cavitation Payment, December 1985 . . . . . . . 191

7-5. Major Sponsors of Health Maintenance Organizations and Preferred

Provider Organizations, 1985 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 197

7-6. Cavitation Payment for Medicaid Beneficiaries in Demonstration Projects,

December 1985 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 198

List of Figures

Figure No. Page

7-1. Medicare Cavitation Payment to Different Fiscal Intermediaries. . . . . . . . . . 181
Chapter 7

Cavitation Payment

INTRODUCTION

Policymakers’ interest in cavitation payment

has grown continually over the past decade as

pressures to control health expenditures have

mounted and as experience with health maintenance organizations (HMOs), which are paid by

cavitation, has become more widespread. In prepaid group practices, a kind of HMO, total expenditures 10 to 40 percent lower than in solo feefor-service practices have been documented, primarily because of lower hospitalization rates

(279,285). Furthermore, studies have found quality of care in these HMOs equal to or better than

that provided by other practices (97,279). Since

relatively few Medicare beneficiaries (4.2 percent

in December 1985 (533)) or Medicaid eligibles

have historically been enrolled in HMOs the

question arises of whether the Medicare program

could constrain its expenditures by adopting capitation payment for all beneficiaries.

Beneficiaries now have the option of having

Medicare pay for their medical care by cavitation.

Provisions of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) (Public Law 97-248)

enable Medicare to pay risk-sharing plans on a

cavitation basis without subsequent adjustment.

The act in effect set up a voluntary voucher system whereby Medicare may pay a predetermined

amount to enroll beneficiaries in plans of their

choice (148).

This chapter considers the expansion of capitation payment to a mandatory voucher system

for all Medicare beneficiaries. The chapter first

describes the concept of cavitation payment and

variations possible within the Medicare program.

A brief historical review then documents Medicare’s experience with cavitation payment, including present payment for HMO contracts and demonstration projects. Because of the importance of

the cavitation rate, which is the price that Medicare would pay plans for beneficiaries’ care, research on cavitation rates is discussed in a separate section. Medicare could make cavitation

payments to risk-sharing plans or to fiscal intermediaries responsible for a geographic area. An

analysis follows of the likely implications of different forms of cavitation payment across the dimensions and medical technologies introduced in

chapter 3. The chapter concludes with findings

regarding the dimensions and variations of capitation payment.

THE CONCEPT OF CAVITATION PAYMENT AND

POSSIBLE VARIATIONS

Cavitation payment is a yearly or monthly

amount per person that is fixed in advance and

independent of the medical services used. Capitation arrangements may vary according to the

recipient of the cavitation payment and scope of

services covered in the payment (table 7-1). How

the rate is set may also vary, a matter discussed

in a subsequent section of this chapter.

This chapter examines cavitation payment for

all beneficiaries to two different kinds of fiscal intermediaries: risk-sharing health plans, such as

HMOs, which would assume the financial risk of

arranging for or providing care to their enrollees;

and geographic intermediaries, which would assume the financial risk for the care of all the beneficiaries in a geographic area. Although there are

historical examples of cavitation payments directly to individual physicians, recent experience

under Medicare and Medicaid and in the private

sector has centered on payments to fiscal intermediaries, and Medicare cavitation payment to

individual physicians is not considered here.

For payment to both kinds of fiscal intermediaries, Medicare would pay for beneficiaries’ care

179

56-119 0 - 86 - 7 : QL 3
—

180 ● Payment for Physician Services: Strategies for Medicare

Table 7-1.-Alternatives for Cavitation Payment

Scope of services

Ambulatory services

Ambulatory services Ambulatory services and physician and

(physician and and physician facility inpatient

Recipient of payment ancillary) inpatient services services

Physician . . . . . . . . . . . . . . .

Health plan. . . . . . . . . . . . . . x x

Geographic fiscal

intermediary . . . . . . . . . . . . . x x

X= Alternative considered in this report.

SOURCE: Office of Technology Assessment, 1985

by cavitation, but the fiscal intermediary could

pay physicians and other providers by other methods, including fee-for-service, salary, or capitation. Both recipients of cavitation would receive

payments from the Medicare program and arrange for medical care to beneficiaries. But geographic cavitation could add another level between Medicare and providers (see figure 7-1)

(70,564). The intermediary-at-risk would negotiate arrangements with area providers and might

sponsor its own HMO or preferred provider organization (PPO). The Health Care Financing Administration (HCFA) could continue to contract

directly with HMOs and competitive medical

plans (CMPs) not sponsored by the geographic

intermediary.

Through vouchers or some other mechanism,

beneficiaries could choose among alternative arrangements under both kinds of Medicare capitation payment. In both cases, continuation of

present Medicare coverage and cost-sharing provisions and of care through physicians paid feefor-service would remain an option for beneficiaries.

This chapter examines two variations in the

scope of services included in the cavitation payment: ambulatory services (physician and ancillary) and inpatient physician services; and ambulatory services, plus physician and facility

inpatient services. The first variation approximates coverage of Medicare Part B services and

has been used in some Medicare plans (health care

prepayment plans) for beneficiaries who have coverage for Part B but not Part A. The second variation, which is similar to coverage for Parts A

and B, is the scope of services that has been included in most Medicare contracts and demonstration projects and by most prepaid group practices and other HMOs. The chapter does not

examine two other variations in the scope of services. Some Medicaid programs, such as New Jersey’s, are making cavitation payments for ambulatory services alone, including ambulatory

physician and ancillary services but excluding inpatient physician and hospital services (197,558a).

The chapter also does not consider the variation

in scope of services that adds social services and

long-term care to routine acute- and chronic-care

coverage and that is being used in Medicare demonstrations of social HMOs. Since long-term care

lies outside the scope of this report, social HMOs

will not be considered further.

This chapter thus considers the four variations

in cavitation payment indicated in table 7-1: payment to risk-sharing health plans for all physician

and ambulatory services, payment to risk-sharing

health plans for all ambulatory and inpatient services, payment to geographic intermediaries for all

physician and ambulatory services, and payment

to geographic intermediaries for all ambulatory

and inpatient services.

The concept of cavitation payment has three

important elements. First, the enrollee, or Medicare beneficiary, is the unit of payment. The way

a recipient of cavitation payment gains more revenue is by enrolling additional people into the

plan. In addition, the entity knows at the start

of the coverage period the number of people for

whom it is responsible and can plan the facilities

and personnel needed to provide care. Unlike

providers who are paid fees after they provide

services or insurers who pay claims for services

used, an entity paid by cavitation is obligated to

provide or arrange for covered care during the

applicable time period.
Ch. 7—Cavitation Payment ● 181

.—Medicare Cavitation Payment to Different Fiscal Intermediaries

?

!

,

*

I I I I

a Medicare could continue to contract directly with HMOs and other CMPs not sponsored by geographic intermediaries.

b Risk-sharindplans could include HMOs, other CMPS, or plans sponsored by insurers that offered present coverage, cost-sharing, and fee-for-service payment to providers

c Physicians and other providers could be paid by different methods, such as fee for service, capitatlon, or salary.

d This arrangement would allow beneficiaries to contlnue present coverage, cost. sharing, and fee-for.service payment to providers

SOURCE: Office of Technology Assessment, 1985

Second, the amount paid does not depend on

the services used. Although some HMO patients

may have to pay minimal amounts when they use

services, such as $5 for an office visit, these charges

enable plans to have lower premiums and do not

generate substantial revenue. Since cost-sharing

when services are used is so low, enrollees face

little financial deterrent to seeking care. In actual

experience, people who have faced lower costsharing at the time of use have been more likely

to have a physician visit (343), and members of

prepaid groups have been more likely than other

insured people to have at least one physician visit

during the year (279).

On the other hand, a provider that receives a

fixed cavitation payment set in advance and receives little extra revenue from additional services has no financial incentive to provide them.

Within the scope of services covered by capitation, the provider has a financial incentive to use

the number and mix of medical services to care

for a patient’s condition most efficiently and to

produce each service with the greatest technical

efficiency. In fact, to the extent that the provision of services adds to cost and not to revenue,

that is, to the extent that the provider is at financial risk, the provider on a fixed budget also has

a financial incentive against providing additional

services. A countervailing incentive is that the failure of the plan to give enrolled beneficiaries

desired services may lead to loss of enrollees and

gross revenue.

The third important element is that the payment

rate is set in advance of the time period during

which it is to apply. As noted above, this prospective aspect implies that the entity paid by capitation has a defined population for which it is responsible for providing care and a fixed budget
182 ● Payment for Physician Services: Strategies for Medicare

within which to provide that care. Within the

period of time that the rate applies, the provider

cannot influence the revenue received for a person’s care.

Although this chapter takes the perspective of

Medicare, which would pay a cavitation payment

to a fiscal intermediary, the intermediary may distribute that revenue to individual physicians on

bases other than cavitation. How the intermediary pays physicians and other medical professionals determines where the financial incentives

of cavitation payment fall. Individual physicians

who are paid by cavitation or share in a risk pool

for referrals of ancillary or specialist services have

a financial incentive to use judiciously and even

underuse the services for which they are at financial risk. Physicians paid fees for services have

an incentive to provide additional services providing the extra revenue exceeds the extra cost.

Salaried payment to physicians promotes neither

underuse nor overuse of services, but by itself does

not provide incentives for physicians to use their

time productively. In 1978, groups paid mainly

by cavitation distributed 67 percent of their incomes to physician owners by salary. Perhaps to

compensate for the financial incentives of salaried payment, 53 percent of prepaid groups, compared with only 16 percent of fee-for-service

groups, had explicit productivity guidelines (205).

MEDICARE EXPERIENCE WITH CAVITATION PAYMENT

Although the Medicare program in December

1985 had contracts with close to 200 prepayment

plans that had enrolled almost 1.3 million beneficiaries, its experience with prospective capitation payments has been much more limited (see

table 7-2). Until the January 1985 regulations implementing TEFRA, almost all of Medicare’s contracts reimbursed prepayment plans on the basis

of their costs, under arrangements similar to costbased reimbursement of hospitals (see app. C).

In June 1984, before changes in plans’ status as

a result of TEFRA, 44 “health care prepayment

plans” had cost contracts for Part B services and

62 plans had “cost contracts” for services in Parts

A and B (50 FR 1341). These two types of costbased contracts covered 77 percent of the beneficiaries then in prepayment plans. TEFRA stipulated that after January 1, 1986, payment to costbased plans would be limited to the average adjusted per capita cost (AAPCC) of different categories of Medicare enrollees (42 CFR 417.532), as

defined below.

Table 7-2.—Participation of Prepayment Plans in the Medicare Program, 1984-85°

Number Medicare enrollment

of plans (thousands)

Type of contract 1984 1985 1984 1985

Cost contracts: . . . . . . . . . . . . . . . . . . . . . 108 87 675 774

Health care prepayment plans and

group practice prepayment plansb . . . 44 35 575 637

Cost contractc . . . . . . . . . . . . . . . . . . . . . . 62 52 100 137

Risk-sharing contracts: . . . . . . . . . . . . . . 27 104 200 498d

Pre-TEFRA risk-sharing contract . . . . . . 1 4 30 43

Demonstration. . . . . . . . . . . . . . . . . . . . . . 26 10 170 14

TEFRA risk contracts . . . . . . . . . . . . . . . . NA 90 NA 441

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . 133 191 875 1,272e

NA=Not applicable.

aJune I, 1984 and Dec. 13, 19S5.

bHealth care prepayment plans and group practice prepayment plans cover part B se~lces.

Cpian~ in this @egoV cover ~e~ces in parts A ad B, Total for December 1*includes W,971 enrollees in TEFRA COSt pkUMi.

dThig figure represented 2.0 percent of all Medicare beneficiaries.

eThis total represented 4.2 percent o! all Medicare beneficiaries.

SOURCES: U.S. Department of Health and Human Services, Health Care Financing Administration, Division of Group Health

Plan Operations, Baltimore, MD, personal communication, Dec. 13, 1985; 50 FR 1314-1418.
Ch. 7—Capitation Payment ● 183

By June 1984 only one plan, Group Health Cooperative of Puget Sound, had elected the risksharing option made available to plans by the Social Security Amendments of 1972 (Public Law

92-603 ).’ In light of the disadvantages of this option for HMOs and other prepayment plans, it

is not surprising that interest was low. Although

a risk-sharing HMO received a cavitation payment for beneficiaries, Medicare’s actual payment

was still determined retrospectively, based on a

comparison of the plan’s costs for its Medicare

enrollees and Medicare expenditures for comparable beneficiaries in the service area. Moreover, a

plan was limited in the surplus that it could retain, but had to absorb all losses (see app. C).

TEFRA and the regulations effective February

1, 1985 (50 FR 1341), broadened the definition of

plans that are eligible for Medicare contracts and

enabled Medicare to pay plans on a cavitation basis without retrospective adjustment.2 In addition

to plans that are considered qualified HMOs under the Public Health Service Act, Medicare may

now contract with CMPs. Although the requirements for enrollment in their private lines of business are more restrictive for qualified HMOs than

for CMPs, both CMPs and HMOs face the same

requirements for Medicare enrollees. Both kinds

of plans must provide Medicare covered services3

to enrollees for a fixed prospective payment that

does not depend on the frequency, extent, or kind

of service actually provided. In both cases beneficiaries’ premiums and cost-sharing are limited

to the actuarial equivalent amounts that enrollees

would have paid for Medicare-covered services

if they had not enrolled in the plan. CMPs and

HMOs also face the same requirements for their

Medicare business regarding such matters as open

IInternational Medical Centers, Inc., in Miami, FL, had a risk contract with Medicare prior to entering a demonstration project in 1982

(539). By Aug. 1, 1985, three additional plans had pre-TEFRA risksharing contracts: Community Health Care Center Plan in New Haven, Connecticut; Total Health Care in Missouri; and Prime Health

in Missouri (533). An advantage in converting to a risk contract

before TEFRA regulations were promulgated was that the regulations specify that a plan with a risk contract must enroll two new

Medicare beneficiaries for every one for whom payment is converted

from a reasonable cost to a risk basis (42 CFR 417.432).

2TEFRA eliminated the previous risk-sharing option but retained

the reasonable cost option.

3

The plan must provide Parts A and B or only Part B services,

depending on an enrollee’s Medicare coverage.

enrollment, enrollment literature, and grievance

and hearing procedures.4

Under TEFRA provisions for risk contracts,

Medicare pays for each Medicare enrollee in a

plan a monthly payment that is based on the estimated average per capita cost of providing care

to beneficiaries in that geographic area who are

not in prepayment plans. The actual cavitation

payment is to be 95 percent of the AAPCC, that

is, the average per capita cost adjusted for age,

sex, disability, and, if available and appropriate,

welfare and institutional status and other relevant

factors (42 CFR 417.588, 50 FR 1369). Before the

contract period, the CMP or qualified HMO must

compute its adjusted community rate (ACR), the

rate equal to the premium that the plan would

have charged non-Medicare enrollees for Medicare covered services adjusted for utilization characteristics of the plan’s Medicare enrollees and reduced by the value of Medicare coinsurance and

deductibles (42 CFR 417.594, 50 FR 1369). If the

plan’s ACR is less than the average of the Medicare cavitation payments to be made to the plan

(which it usually is (533)), the plan is required to

provide Medicare enrollees additional benefits, to

reduce premiums or other charges to Medicare

enrollees, to contribute to a benefit stabilization

fund,5 or to request a reduction in its monthly

cavitation payment from Medicare (42 CFR 417.

442, 50 FR 1354). HCFA pays each plan based on

the rates for the rate cells each enrollees occupies

and adjusts the plan’s cavitation payment if actual Medicare enrollment differs from the estimates (42 CFR 417.598).

—.———

4A major difference between CMPS and federally qualified HMOS

is that such HMOS must charge community rates, that is, their rates

must be equivalent for similar individuals or families (42 CFR

110.105). In addition, employers with 25 or more employees must

offer a federally qualified HMO, but not a CMP, as a health benefit option. CMPS, on the other hand, may experience rate, that is,

they may base the premiums for an enrollment group on the experience of that group. Unlike qualified HMOs, CMPS for their commercial enrolks have no restrictions on the copayments and deductibles that they may charge; have no requirement to cover mental

health care, substance abuse, or home health care; and have no requirement to offer enrollment to a population broadly representative of people in the service area. CMPS need not be a separate legal entity; they may be a line of business (533).

‘The plan may request that HCFA withhold part of its monthly

per capita payment in a benefit stabilization fund to prevent excessive fluctuation in the cost of additional benefits in subsequent contract periods. Contributions to the fund may not exceed 1S percent

of the differenm between the ACR and the payment rate.
184 . Payment for Physician Services: Strategies for Medicare

TEFRA’s risk-sharing provisions are considered

more favorable to prepayment plans than previous risk arrangements. Although cavitation payments to TEFRA plans are based on 95 percent

instead of 100 percent of the AAPCC, the rate

is set prospectively and does not depend on the

costs incurred by the plan’s enrollees. A plan can

count on that revenue, subject to variations in enrollment, and set its budget accordingly. TEFRA

plans may realize the same profit rate on its Medicare enrollees as on its commercial enrollees, without limits on the profit that the plan may earn.

Given the restrictions noted above on the relationship between the ACR and 95 percent of the

AAPCC, TEFRA permits risk-sharing plans to retain any surpluses, rather than having to share

them with the Medicare program. Although

TEFRA plans, like previous plans at risk, must

absorb all losses, TEFRA plans may obtain reinsurance or share risk with providers (42 CFR

417.407).

At the same time, financial benefits may flow

to the Medicare program and to beneficiaries because of the TEFRA provisions that link capitation payments and enrollee benefits to conditions

in the local marketplace. A plan’s ACR, which

depends on premiums charged for the plans’s commercial business and hence must be competitive

with other health insurance, acts as a ceiling for

Medicare payments that may be retained for the

plan’s own use and as a threshhold for increasing benefits to Medicare enrollees or reducing payments from Medicare. Although the law gives

HMOs and CMPs several options for dealing with

the difference, they generally return the difference

to the beneficiary by reducing premiums or adding benefits (533).

From June 1984 to December 1985, Medicare

enrollment in risk-sharing plans more than doubled from 200,000 to 498,000 beneficiaries (see table 7-2). In addition to 32 plans that converted

from demonstrations, by December 198558 other

plans had negotiated TEFRA risk contracts and

78 applications were pending (533). In addition,

4 plans have pre-TEFRA risk-sharing contracts

(533).

Despite the rapid and continuing increase in

TEFRA risk contracts, it is apparent that Medicare’s experience with prospective cavitation payment has been limited mainly to 32 demonstration projects and 1 pre-TEFRA risk contract (see

box 7-A). In 1980, eight HMOs in five market

areas began enrolling Medicare beneficiaries in

“cavitation” demonstrations that involved prospective cavitation payments (411). The seven

plans that continued on a cavitation basis had

51,327 Medicare enrollees as of January 1985. Under subsequent “competition” demonstrations, 21

plans (including 1 in the cavitation demonstrations) in 12 market areas were awarded contracts

and were operational by mid-1984 (411). By the

end of March 1985, 13 plans remained in the demonstration projects (see table 7-3). The enrollment

of almost half a million Medicare beneficiaries in

risk-sharing plans by December 1985 indicates

that such plans are capable of marketing to and

enrolling this group.

HCFA has contracted with Mathematical Policy Research to evaluate the competition demonstrations (59). The project is examining determinants of beneficiaries’ choice of plan; effects of

enrollment on the use, quality, and cost of care;

competition among providers in a market area;

and the effects on the fee-for-service sector of prospective cavitation payments by Medicare to risksharing plans (539). Although the evaluation is

not scheduled for completion until the end of

1987, preliminary results will be available in the

interim.

Previous studies have examined the experience

of Medicare beneficiaries in seven prepaid group

practices paid on a cost-reimbursement basis and

in four plans paid under risk-sharing arrangements. These studies suggest that prepaid groups

can deliver care to Medicare enrollees at lower

cost than the care provided to other beneficiaries

in an area, but the studies of risk-sharing plans

raise questions about the extent to which plan beneficiaries have been representative of other area

beneficiaries in the same payment categories.

In the first set of studies of prepaid groups,

Medicare payments to “group practice prepayment plans” (later health care prepayment plans,

as described above) were based on their costs and

covered only Part B services within the plan. Medicare paid separately for enrollees’ use of Part B
Ch. 7—Cavitation Payment • 185

Box 7-A. -International Medical Centers, Inc. (IMC), Miami, FL

IMC is a for-profit HMO that provides health quire pre-authorized from a physician panel,

services to enrollees through a combination of sal- which is staffed 24 hours a day. A nurse-staffed utiaried physicians who practice in its own clinics and lization review team provides concurrent review,

affiliated medical groups operating as a network. reigning an anticipated length of stay to each inIts service area covers the Miami and Palm Beach patient and monitoring the patient’s progress. The

area on the East coast of Florida and a three-county team also reviews the daily reports of an automated

area around Tampa Bay. managment information system on the use of servThe physicians on& staff of INK-owned clinics ices all hospital patients, sorted by patient, by

are salaried employees Of IMC whose financial in- and by individual primary -

W Affiliated provider groups are re- centives are not formally tied to their utilization of ible for their own utilization review proce- services. Their individual productivity and utilization rates are monitored, however, and affect their . outside of the hospital, and the IMC staff phycontinued employment by IMC. Outside specialists

to whom patients are referred by the staff physicians in the clinics are paid by IMC according to

a standard fee schedule.

All the affiliated provider groups in the network

receive cavitation payment for their professional

services. IMC withholds 15 percent of the capitation payment for administration and marketing

expenses. For Medicare enrollees, the payment arrangements are somewhat different. IMC immediately transfers the entire payment for Part B services to the affiliated groups, but retains the Part A

payment in a hospitalization risk pool for the group

and splits any excess or surplus equally with the

group. The affiliated provider groups distribute the

cavitation payments to their constituent physicians

at their own discretion, using a wide variety of arrangements including fee-for-service, salary, and

cavitation, with and without utilization incentives.

The affiliated providers are responsible for making

their own payment arrangements, subject to IMC

approval, for all specialist services that they themselves cannot provide. But since the payment that

the affiliated provider groups receive from IMC is

intended to cover all professional services, these

groups must bear the risk for the use and cost of

those services.

Under a variety of contractual arrangements

ranging from negotiated charges to per diem payments, hospital costs are paid by the plan to several area hospitals. However, most admissions are

directed to a hospital that is a subsidiary of the hold

ing company that owns but is administratively separate from IMC. In addition, IMC self-insures for

all adverse utilization experiences, i.e., it bears all

risk for catastrophic costs, without stop-loss or reinsurance.

sicians are subject to monitoring for productivity,

use of laboratory services, drugs, and referrals.

A quality assurance committee meets monthly to

evaluate a sample of medical records, to evaluate

services and programs, and to prepare a report to

the administrator . A separate physician peer review

committee reviews individual physicians by examining a random sample of their patient records and

by conducting complete reviews of any providers

who may be suspected of substandard care. An additional quality assurance team consisting of a nurse

practitioner, a physician, and a health administrator Was begun in response to the rapid growth of

the plan. The team visits each medical center and

affilated provider every 3 or 4 months to conduct

an audit..

IMC is heavily dependent on Medicare for its enrollment, with some 40,000 out of a total of 75,000

members being Medicare enrollees as of early 1984.

Before entering the Medicare competition demonstration in August 1982, IMC had 12,000 Medicare

enrollees under a Section 1876 (of the Social Security Act) Medicare risk contract. Its rapid expansion has been met by expanded utilization review

and quaility assurance programs, as well as the management information systems mentioned previously. However, allegations of deficiencies in the

services provided to Medicare beneficiaries led to

an investigation by the General Accounting Office

of he other HMOs in the south Florida

demonstration project. Most of the problems seemed

to) have been caused by Medicare beneficiaries not

requirement of HMO enrollment

that they seek care only from plan doctors and by

difficulties in maintaining records on enrollment

and disenrollment of Medicare beneficiaries in

HMOs (476).

Utilization control begins with the assignment of

a personal physician to each member as a primarycare case-manager who must approve all services

and specialist referrals. All hospital admissions re- . .

SOURCE: Drawn horn A. Brewster, K. Langwek E’. McMenamin, et

al., Evaluation of the MstA”care Competition Demonstrations: Preliminary Implementation Case Studies of Four South FJonda AHPS (Washimzton. DC: Mathematical Policv Research, inc., APr

i

l 19S4).
l86 . payment for physician Services: Strategies for Medicare

=

n

E

. -

-0

- 0

. -

.-

— .

c

1

I
Table 7-3.—Capitation Payment for Medicare Beneficiaries in Demonstration Projects, as of Mar. 31, 1985a–Continued

Unit of payment Unit of payment Government-plan

Plan to physicians to hospitals nsk-sharing

●

Health Options of South Florida

Miami, FL . HMO pays IPA, which pays case Per diem Plan shares in AMCRA

managers capitation, minus withhold risk poolf

to fund hospitalization and referrals;

referred specialists paid FFS

Central Massachusetts Health Care, Inc.

Worcester, MA . . . IPA pays members UCR, minus 20% Unspecified Plan shares in AMCRA

from ambulatory services and 25% risk poolf

from hospital services to fund risk

pool

Plan-provider Beneficiary

risk-sharing cost-sharing

Case managers at risk Premium and nominal

for withhold in referral copayment

and hospital fund,

pooling risk among

case managers

20% of ambulato

%
—. — ——

188 ● Payment for Physician Services: Strategies for Medicare

services outside the plan and for Part A services.

Thus, the experience with these plans does not relate to the incentives of prospective cavitation

payment. Nevertheless, for five of the seven plans,

Medicare expenditures including in- and out-ofplan care were lower for plan enrollees than for

control groups (91,566). Unlike the two other

plans, these five owned or controlled their own

hospitals and operated outside of New York City.

In all instances, Medicare expenditures per enrollee were higher for physician and related services but lower for inpatient services and, with one

exception, for hospital outpatient services (91).

Conflicting hypotheses have been advanced to

predict utilization and medical expenditures for

people who enroll in HMOs (279). According to

one theory, people who feel at higher risk of expensive care are more likely to join HMOs for the

comprehensive coverage and financial protection

offered. The greater coverage of HMOs may also

attract people who favor preventive care and are

likely to seek care when illness occurs. Other explanations would predict that HMO enrollees may

be predisposed to use less expensive care than

average either because they prefer not to use medical care or because enrollees are less likely to have

ties to an existing provider, an indication that they

were in good health. Studies of non-Medicare enrollees have indicated the importance of an existing physician relationship, but have found conflicting results concerning indicators of prior

health status.

The second set of Medicare studies examined

the prior use and cost of beneficiaries who joined

four risk-sharing plans during the mid to late

1970s (120,121). Enrollees in a plan with a preTEFRA risk-sharing contract had inpatient use

and expenditures about 50 percent lower than a

comparison group (120). Two out of three plans

studied from the Medicare cavitation demonstrations also had indications of nonrandom selection,

since their enrollees had previously had 20 percent lower Medicare reimbursements than comparison groups (121). A greater degree of biased

selection by low-risk people into HMOs was found

in four Medicare demonstration projects in which

HMOs were permitted to screen the health of applicants before offering high- or low-option coverage (278).

The results of these studies and of others indicating biased selection by low-risk non-Medicare

enrollees into HMOs may not be generalizable

(32,278). First, all cases of lower risk enrollment

concerned prepaid group practices. Higher risk

people may be attracted to the individual practice association type of HMO since they can maintain previous relationships with physicians. Second, with one exception, only one fee-for-service

alternative was offered. A study of Federal employees’ enrollment in health plans found lower

users gravitated not to HMOs but to low-premium, high-cost-sharing, fee-for-service plans

(433). Third, with one exception, the studies reported on cases where an HMO option was being offered for the first time. Furthermore, countervailing information for people under age 65

suggests, for example, that although enrollees of

prepaid group practices in the West were younger than those in competing plans, prepaid group

practice enrollees in most age-sex and diagnostic

categories had greater need for hospital care (47).

Enrollment in HMOs of beneficiaries likely to

have medical expenses much below average could

occur because of the preferences of enrollees or

the marketing techniques of the plan. Holding an

open enrollment period, during which beneficiaries choose among options and plans must accept people on a first-come first-enrolled basis,

has been suggested as a partial means of avoiding biased selection (1.29). In some of the instances

cited above, however, apparently nonrandom selection resulted from an open enrollment process.

It should be noted that Enthoven also called for

community rather than experience rating, limitations on switching plans, and minimum benefit coverage.

As part of the Medicare cavitation demonstrations, beneficiaries in the Minneapolis-St. Paul

area had the choice of enrolling in one of four

HMOs or of retaining traditional fee-for-service

arrangements. In 1982, a comparison of HMO enrollees and nonenrollees found that beneficiaries

who had joined an HMO during the early part

of the demonstration tended to have had less private health insurance than nonenrollees and were

more dissatisfied with their usual source of care,

especially in the areas of cost and paperwork

(155). The beneficiaries who chose HMOs char-

.
Ch. 7—Cavitation Payment Ž 189

acterized themselves as healthier than those who

remained with fee-for-service arrangements. HMO

enrollees were more socially active and less likely

than nonenrollees to report having a serious medical condition associated with a greater likelihood

of high medical cost. This finding may have been

related to the fact that until 1984, HCFA permitted

the four HMOs to screen beneficiaries’ health before enrollment in a high-option plan.

is a selection bias will affect whether Medicare

gains or loses from greater enrollment in risksharing plans. Medicare will gain if it pays plans

95 percent of the AAPCC for enrollees who would

have incurred greater expenses outside of the plan,

but Medicare will lose if it pays plans 95 percent

of the AAPCC for beneficiaries whose expenses

would have been far below that amount outside

of the plan.

The issue of biased enrollment is of great importance to the Medicare program. Whether there

ESTABLISHING THE CAVITATION RATE

It is in the interest of the Medicare program,

its beneficiaries, and society as a whole to pay

for medical care in such a way that plans have

financial incentives to work with providers to deliver care efficiently. If great differences exist in

the profit that can be made from enrolling lowrisk vs. high-risk beneficiaries, plans will find it

in their interest to stress marketing strategies

rather than efficient delivery of care. Competing

through marketing techniques to enroll low-risk

people and to avoid high risks would be consistent with the expertise of health insurance companies, which may sponsor risk-sharing plans.

Because of the substantial variation in medical

expenses among Medicare beneficiaries, risksharing plans could face great losses. In 1977,

Medicare paid $4,000 or more per patient for only

about 5 percent of its beneficiaries, but the expenses of these beneficiaries accounted for 52 percent of Medicare’s total expenditures (182). Medicare paid more than $20,000 per patient for only

0.09 percent of all beneficiaries, and these payments totaled 2.8 percent of program expenditures. A risk-sharing plan with a random group

of beneficiaries could thus be hurt financially if

even a small number of these expensive cases enrolled in excess of the predicted average. The risk

would be greater for smaller plans because they

would be subject to relatively more random fluctuation. An HMO with 1,000 enrollees could experience a 5 percent or greater cost increase from

the enrollment of three beneficiaries instead of the

expected one in the category over $20,000. Such

a plan would probably bear an even greater risk

because HMOs, unlike Medicare, typically provide catastrophic coverage.

At the same time, a risk-sharing plan has the

potential to reap sizable gains. In 1977, Medicare

incurred no expenses for about 36 percent of its

beneficiaries (182).’ In addition to people who

used no services during the year, these beneficiaries included people who did not reach the deductible and people who did not bother to submit claims. However, most of the variance in

Medicare expenditures (about 92 percent) was

associated with differences among people who incurred costs, especially with whether or not people had hospital costs (about 38 percent of the total variance),

A risk-sharing plan uncertain whether or not

Medicare’s payment will cover the expenses of enrollees may attempt to enroll lower risk beneficiaries. A greater degree of favorable selection will

be required to cushion a plan against such uncertainty the smaller the plan’s enrollment, the less

uncertainty the plan’s management is willing to

bear, the lower the savings that the plan expects

from more efficient delivery of care, and the less

the difference between the AAPCC and Medicare’s payment (182). On the other hand, by reducing hospitalization rates, HMOs may realize

greater net revenues (revenue from AAPCC payments minus expenses of care) from high-risk enb

In 1982, Medicare incurred no expenses for 31 percent of elderly

beneficiaries and 45 percent of disabled beneficiaries (525).
190 ● payment for physician services: Strategies for Medicare

rollees who are especially likely to use hospital

care under fee-for-service arrangements. It should

also be noted that the regulations implementing

TEFRA prohibit plans from using health screening or discriminatory marketing practices.

Private health insurance has not developed

means to adjust rates for different risk groups that

are applicable to Medicare (461). Only about 15

percent of all individual applications for medical

insurance are rejected because of adverse medical histories, are offered policies that exclude certain medical conditions, or are insured for an excess premium that reflects such high-risk factors

as health status and occupational hazards. Because

companies have rejected the worst risks or have

restricted their coverage, the experience of the private sector provides little basis for calculating

rates according to risk category.

On the other hand, the insurance industry’s experience with coverage for affinity groups may

be transferable to the Medicare population. Insurers have provided coverage for employers who

wished to furnish health insurance to their elderly

workers. More importantly, insurance companies

have sold policies to beneficiaries to supplement

their Medicare coverage. A related development

is coverage of long-term care as an insurance

product.

A desirable approach to establish Medicare

cavitation rates would contain incentives for plans

to deliver cost-effective care and attract plans to

participate, while allowing Medicare to reap some

of the savings from more efficient delivery of care.

The approach would also discourage manipulation by plans, including selection of low risks, and

would require minimal additional data and expense to implement and administer.

Alternative Methods of Refining the

Average Adjusted Per Capita Cost

(AAPCC)

In 1983, an actuarial firm advising HCFA concluded that the AAPCC method was the best then

available for determining Medicare payment to

risk-sharing plans (311). However, the AAPCC

explains very little of the variation in Medicare

expenditures for its elderly beneficiaries (32). Applied to 1979 expenditures per beneficiary, for example, age, sex, and welfare status explained only

0.6 percent of the variation.7 Research is underway to refine the AAPCC to incorporate factors

that would identify low- and high-risk beneficiaries, namely prior use of medical care (19,32),

functional limitations and disability from chronic

illness (181,456), or demographic and socioeconomic characteristics (48).

One model used as prior use variables the hospital days used in the previous 2 years, whether

or not the enrollee was hospitalized in the previous year, and whether or not the Medicare Part

B deductible was met in the previous 2 years (32).

Although this model was superior to the current

AAPCC and to whether or not a person was hospitalized in the previous year, the hospital daysPart B model explained only 4.3 percent of the

variance in Medicare expenditures per beneficiary.

The prediction for groups of enrollees is the important result because Medicare would pay risksharing plans for groups of beneficiaries. As one

would expect, the predictions for groups were

more accurate.8 The hospital days-Part B model

was again superior to the others. For groups of

beneficiaries biased by prior use, age, or welfare

status, the ratio of the predicted reimbursement

for the biased group to the actual reimbursement

for the population from which the biased group

was selected differed no more than5 percent. This

model is being used in a demonstration project

in Minneapolis, in which an HMO is trying to attract frail elderly beneficiaries (see table 7-4) (278).

The main shortcoming of this refinement is that

it does not distinguish high users who had selflimiting acute conditions from those with chronic

conditions that will continue over time (183,278).

If an HMO would enroll fewer (more) chronically

ill people among its high users, Medicare would

be likely to have greater losses (gains).

Another refinement of the AAPCC related to

prior use would add information about diagno7The proxy for welfare status was whether or not States had purchased Medicare Part B coverage for beneficiaries who were also

eligible for Medicaid. Institutional status, although used in the

AAPCC formula, was excluded because it is available only from

special surveys.

‘The random errors of predictions for individuals tend to cancel

out for large groups (278).
Ch. 7—Cavitation Payment ● 191

Table 7-4.—Medicare Demonstrations of Cavitation Payment, December 1985

Prior Use Modification of AAPCC. Medicare Payment at 85 Percent of AAPCC.

Senior Health Plan, Minneapolis, MN Finlay Health Plan, Miami, FL

Genera/ Description: For all Medicare enrollees who have

been in the program at least 2 years, i.e., those 67 or older,

data from the Health Insurance Master File on prior hospital days used and whether they met the Medicare deductible, rather than institutional category, are used along with

age, sex, and Medicaid status to produce an individually

adjusted Average Adjusted Per Capita Cost (AAPCC). Medicare’s cavitation payment to the plan is 95 percent of the

adjusted AAPCC. Medicare pays for enrollees without 2

years of utilization experience in the Master File at 95 percent of the standard AAPCC, adjusted for age, sex, Medicaid, and institutional status.

Scope of Services: Medicare Parts A and B, with no limit on

days of use for inpatient and nursing facility services. Plan

makes arrangements for some community-based social

services, but not to the same extent as a Social/Health

Maintenance Organization.

Payment to Physicians: Network model. Plan pays a capitation payment for both physician and hospital services to

6 riskpools made up of both physicians and hospitals. Each

pool uses different arrangements to share risks and pay

providers.

Payment to Hospitals.’ In all cases the plan puts both the hospital and primary care physicians acting as gatekeepers at

risk for some portion of their services. The level of risk

borne and the payment rate are negotiated between the

plan and representatives of the risk pool. Physician referrals are paid according to arrangements made by each risk

pool. However, the plan withholds a negotiated portion of

the pool’s cavitation payment to fund referals.

Risk-Sharing With HCFA: None. Plan may arrange independently for stop-loss insurance.

Beneficiary Cost-Sharing: Premium is $21.75, in addition to

standard Part B premium. Beneficiary is not liable for copayments or deductible.

General Description: Medicare pays plan a cavitation payment of 85 percent of the AAPCC, instead of 95 percent

as mandated by regulations implementing the provisions

of Tax Equity arid Fiscal Responsibility Act of 1982 (TEFRA)

(Public Law 97-248). In return, the plan can keep any surplus revenues from the cavitation payment, rather than having to report an Adjusted Community Rate and make adjustments required by TEFRA regulations.

Scope of Services: Medicare Parts A and B, with no day limits

on hospital care and additional coverage for routine medical care, prescription drugs, routine dental care, eyeglasses.

Payment to Physicians: Network model. Cavitation payments

are made to plan-owned clinics with staff physicians and

also to contracting affiliated providers (including both

group practices and solo practitioners). For Medicare enrollees, the plan makes one cavitation payment to cover

ambulatory service, and a separate payment to cover inpatient, home health, skilled nursing facility, and hospitalbased outpatient care. For the latter payment, risk is shared

between the plan and the providers, with 75 percent of any

surpluses or deficits accruing to the plan and the remainder

to the contracting unit.

Payment to Hospitals: Negotiated per diem contracts.

Beneficiary Cost-Sharing: None. No additional premium in

addition to Part B premium and no deductible or copayment liability.

Risk-Sharing With HCFA: None. Plan may arrange independently for stop-loss insurance.

SOURCES: R. Deacon, Office of Demonstrations and Evaluation, Health Care Financing Administration, U.S. Department of Health and Human Services, Baltimore,

MD, personal communication, Dec. 4, 1985; J. Laly, Senior Health Plan, Minneapolis, MN, personal communication, Dec. 5, 1985; J Robinson, Finlay Health

Plan, Miami, FL, personal communication, Dec. 4, 1985; and R. Sirmon, Office of Demonstrations and Evaluation, Health Care Financing Administration,

U.S. Department of Health and Human Services, Baltimore, MD, personal communication, Dec. 2, 1985.

ses associated with hospitalization and indicative

of chronic conditions likely to result in substantial future medical costs (183,278). Including diagnosis has raised the explanatory power of the

model to 9 percent of the variance (183). The

University Health Policy Consortium based at

Brandeis University further classified hospitalizations and found that repeated hospitalizations for

cardiac conditions, cancer, or musculoskeletal

conditions were associated with subsequent expenditures about 3.5 times the average (278). Research is proceeding to predict expenses after enrollment in an HMO and to focus on conditions

with large unavoidable expenditures that are not

discretionary and hence manipulable by the risksharing plan. It is also important that the approach used does not penalize risk-sharing plans

for keeping use and costs of care low.

Other Methods of Determining

Cavitation Payment

Besides refining the cavitation rate, the AAPCC,

to deal with the risk to be borne by plans and

possible biased selection by enrollees, Medicare

could change its risk-sharing arrangements with

plans. Such approaches would incorporate some

retrospective adjustments to the prospective payment depending on actual cost of treating beneficiaries (183).
192 ● Payment for Physician Services: Strategies for Medicare

These approaches would have Medicare share

in the risk of high-cost enrollees and would

thereby reduce the risk of losses for the HMO

from severely ill enrollees. In exchange for Medicare’s sharing the risk, the HMO would receive

a lower percentage of the AAPCC. In effect,

Medicare would be providing reinsurance to the

HMO, and Medicare and the HMO would share

the profits from greater efficiency. HMOs would

be more willing to enroll all beneficiaries. For example, Medicare could pay an HMO well below

the AAPCC and in addition pay 80 percent of an

individual’s care over $5,000 (individual stop-loss

reinsurance). Or Medicare could pay a plan 85

percent of the AAPCC and absorb any losses over

3 percent of their total cavitation revenue (aggregate stop-loss reinsurance). Both approaches

would reduce but not eliminate the financial incentives for the plans to be efficient (183).

Alternatively, risk-sharing plans could rely on

private reinsurance, which is permitted under the

regulations implementing TEFRA, to protect them

against losses. Under this approach, Medicare

would transfer all the risk to the plan, which

would then pay an insurer to help bear the risk.

Any savings that Medicare might then share in

the form of lower cavitation payments would stem

from any efficiencies in delivering medical care

that were achieved by the plans.

Cavitation rates could also be determined by

competitive bidding. This approach would be

more compatible with cavitation payment to a fiscal intermediary than to numerous risk-sharing

plans. Competitive bidding to select an intermediary would entail disadvantages similar to those

enumerated in chapter 5, such as the possibility

of unintentionally setting up an organization that

would develop monopoly power.

IMPLICATIONS OF MEDICARE CAVITATION ALTERNATIVES

A substantial body of literature stretching over

25 years pertains to experience with providers paid

by prospective cavitation payments. Most of the

studies concern large, established, nonprofit prepaid group practices, and some of the groups,

such as Group Health Cooperative of Puget

Sound and many of the Kaiser-Permanente Medical Care Programs (see box 7-B), owned their

own hospitals.

It is difficult to extrapolate the results of these

studies to other plans, both present and future.

Although group practices in June 1984 still accounted for 59 percent of all HMOs and 81 percent of total enrollment, their number had stayed

almost constant over the previous year, while individual practice associations (IPAs) had grown

27 percent in number of plans and 56 percent in

total enrollment (240). More than half of all enrollees were in plans with 100,000 or more members, but by far the greatest growth in enrollment

was occurring among plans of 50,000 to 99,999

members (240). Newer plans are also more likely

than older ones to be investor owned (for profit)

(121) and to have arrangements that place physicians at financial risk (see box 7-C). Even before

the TEFRA regulations, Medicare enrollment in

HMOs was increasing more rapidly than general

enrollment (212). From June 1983 to June 1984 Medicare enrollment in HMOs increased 36 percent.

In addition to HMOs that have expanded their

operations to different States, insurers and hospital management companies have entered the

HMO market in substantial numbers (see table

7-5). Not only is the relative number of IPAs increasing, but, according to anecdotal information,

their sponsorship is as well. Early IPAs were preexisting foundations for medical care or were

established by medical societies. By contrast,

newer IPAs may be outgrowths of fee-for-service

group practices or HMOs that wish to grow rapidly. Individual physicians feeling competitive

pressure may join an IPA to increase their patient

load, and the group practice or HMO may find

“direct contract IPAs” a desirable way to expand

without great capital investment in facilities.

All of these plans will be operating in a market environment much different from the past. As
Ch. 7—Cavitation Payment ● 193

BOX 7-B-Paymemt to Physicians the Northern California KaiserPermanente Medical Care Program*

The Kaiser Permanente Medical Care Program, the‘ ~ “

Northern CaliforniaRegion, is a prepaid group annualincenti%iecompen -

practicqtype of HMO. It is matk up of thma%co-,

C)peratin$ independent ur@nWMms m ~-~ive ~=W~- ‘rhe K&$@& . , .,:, ., ,.~

‘ t ~ong the Health Plan, Hosand #Wlp sukrh’S to @ro*’ CCmpz’ehemm? ‘ &l Ckoupwas initiated in the late

with some modifications .

in turn Ccmtrm!t% WI* * Kai$e!r Foundation HtWpitalsto Provide hospitdl timsartdwith theX- “ -

‘ com@lasation amngemats,

in both kvorable and advers e manente Medical Group to provkk #t_ @-

ices for enrolkes. As of DQ@mdxW 1984, tWMedical ‘ IIWWdkdYiIWOhd in the

GIW %ogra In *HwJ* had 1.9 million ~ , ~ ~ * ~ ~r

about 112,000 w-~

year, a targeted “ ‘ ● , f~~ ~ ~fi$~~t ~~enti~e

At the beghing of the program in the Aly contractual WP@ ~m

1!?40s, aIl physicians were empkqwesof % sole pm MediCal Group was an additiona l

prietorship (what wouId today be calkd a df ~~ & advm that became an admodel HMo) and wem paid a monthly @WY in ditiortid 1-1 of earnings for Medical Group partaccordance with a schedule accounting for levei of ners to be distributed equdy among them. It was

administrative reqmnsMlhy, Mmr@( @* ~ mnthqpt because even though a mutually agreed

skills, andtheXmarketrute fornewph@ckms. q-fkJW was included in the financiaI foreThe program found early that in order ta retain Capk tk qc$d amount was dependent on the overphysicians, total annual income had to satisfy in- & riasultq # operations for the year, and thus was

dividual physician’ expectations and meet the pre- rwt paeciW& predictable. The incentive payment

va~ market price. By providhg income parity was tit to M 43 %ur@zs” or an “excess”

with physicians outside the pro~am, the pkut !MW of*, but a pkmned feature of the Medical

kept tednatmn‘ rates hqnrtmm?orshareholders) Group’s ~h$mkiad compensation program.

for other than normail wtirefnent or long-term dis- In the 19?0s, to minimize fluctuations in income, ability at tibout 1 percent per year. Only once (in

1970) when mtld ifiCOIMS dl’0# klOQv tit of

the competition did the &rmination rate reach 3.7

percent.

In 1948, thePermanente Me@@ Group Wqs spun

off born the Kaiser Foundation Health Plans and

Kaiser Foundation Hospitals M an ipk~dwt

group practice ptnerdu“$$. Each year t@3h@i@an

Partnership negotiatwl with tkHeaIthPlq ii prQspectivecapitation payment p&42nrolie&f&&d@!-

livery jh&. %

addition, the Health Plan &ndkmd ‘th@r@*pf6r

fixed expenws,

Under thepartnerdiip ~angement, after &“&

of salaried employment by thi! Aedical *,qR$J

physicians became eligible to become partn@rs. k ~ Rp@mmdqr

order to raise workgc3#@ta.1, *- made ~~•

a modest financial contributi~ to .

which was returned to the*yai* ifii4 aralwkd

‘vflwnlld.-T-w kltht%llwltw Mdkd mup,w_titiOE&afT AO@mim?, Us.

Congress, Wad@@n, DC, August 19S5. basic fixed monthly income of senior physicians;
194 • payment for Physician Services: Strategies for Medicare

before, HMOs will be competing for enrollees and

physicians with fee-for-service arrangements, but

the entire medical care sector is under much

greater pressure to reduce the costs of performing services and to constrain total expenditures

(see ch. 2). How plan managers, private thirdparty payers, physicians, and lay people will respond is, of course, unpredictable. But the rapid

and substantial changes in market context and

configuration of plans dictate caution in formulating policy on the basis of past results.

This section analyzes the implications of different Medicare cavitation arrangements for the

dimensions outlined in chapter 3: quality of care,

access to care, cost and efficiency, technological

change, and administrative feasibility. In the

course of the discussion, the implications are

noted for five medical technologies: pneumococcal vaccination, clinical laboratory services, magnetic resonance imaging (MRI), extracorporeal

shock wave lithotripsy (ESWL), and cataract surgery. The section is divided into two parts according to the recipient of Medicare payment: the first

concerns cavitation payment to plans, such as

HMOs, that in turn would arrange for physicians

and perhaps other providers to deliver medical

care to enrollees; and the other examines capitation to fiscal intermediaries, such as Medicare carriers, that would arrange for plans and providers

to deliver care. In either case the scope of services covered by the cavitation payment could vary

from physician and ambulatory services to those

services plus inpatient care. The discussion

throughout highlights potential problems that

would warrant attention as Medicare policy is designed and implemented.

Cavitation Payment to Health Plans

Under this approach, Medicare would pay to

the plan chosen by a beneficiary a cavitation payment for care to be provided during a given time

period. Although it is beyond the scope of this

project to examine the mechanics of beneficiary

choice, this alternative is consistent with Enthoven’s Consumer Choice proposal regarding plans

that would provide comprehensive care (129) and

with the Reagan Administration’s proposals that

beneficiaries be given vouchers and select plans

(104). Indemnity insurers as well as HMOs and

CMPs could receive cavitation payments. HCFA

might require that all plans meet a minimum benefit requirement and certify their financial viability. It is assumed that one of the beneficiaries’ options would be to continue present coverage and

present arrangements with physicians. For example, a private insurance company might offer such

coverage and accept the cavitation payment as the

premium.
Ch. 7—Cavitation Payment ● 195

Box 7-C.--MD-WA Health Plan, Rockville, MD

MD-IPA is a for-profit, federally qualified individual practice association HMO. The plan pays

primary care physicians a monthly capitation payment. The plan is divided into two independent corporations: an association of physicians (Physicians'

Health Plan of Maryland) providing the professional services of physicians and noninstitutional

ancillaries, such as laboratory and X-ray services,

and the administrative arm (MD-IPA), which provides administrative and marketing services, such

as enrollment, premium collection, and financial

‘planning, and contracting for institutional, pharmacy, and dental services. This dual structuref

which was originally a requirment for Federal qualification as an HMO, has been retained by the plan

even though this provision of the Health Maintenance Organization Act (Public Law 93-222) has

since been amended. MD-IPA operates in the Washington, DC, metropolitan area, covering the District of Columbia and portions of Maryland and

northern Virginia.

The administrative arm contracts with the physicians’ association to provide physicians’ and other

services to members of the health plan in return for

a cavitation payment. The physicians’ association

then distributes a monthIy capitation payment to

each primary care physician (defined as a family

practitioner, internist, pediatrician, or obstetrician/

gynecologist). The primary care physician acts as

a case manager for her or his panel of patients. The

monthly cavitation payment covers the costs of professional services rendered by that physician to each

enrollee on that physician’s pad, whether those

services are delivered in a hospital or in an ambulatory setting, and the costs of all office ancillary

services. The payment is adjusted for the age and

sex of each patient in the panel, and 20 percent of

each payment is withheld by the physicians’ association for a risk-sharing/incentive fund.

The cavitation rate for primary care physicians

was originally determined through an actuarial

study of “reasonable gross incomes” by specialty,

divided by productivity measures, such as visits per

physician. Actual fees were not used in this initial

calculation. The cavitation rate has been adjusted

over the operational years of the plan by comparing this actuarial rate with the actual fees that the

physician wouId have charged for the services rendered. The annual adjustment of the cavitation rate

has resulted in the primary care physicians’ getting

paid about what they would have&m paid if they

had billed charges (333).

A second age- and sex-adjusted cavitation payment for referral and ancillary services is made by

the physicians’ association into a credit account ad-

. . ministeredbythepdrnary care physician. Charges for

referrals to specialist and ancillary services are debited against the individual accounts of the primary

care physician who ordered them. The specialists

in the p ysicians’ association are paid from the ac- h

count on a fee-for-service basis according to a pre-

,’

determined maximum fee schedule. So that the specialists”also share in the financial risk, 15 percent

of the scheduled rate is withheld from their fees and

placed in the risk-sharing/incentive fund.

If expenditures for the referrals of a primary care

physician exceed the amount in the referral and

ancillary services account, there is no penalty for

that physician. The cost of the excess is paid out

of the risk-sharing/incentive fund, which is financed

from the 20 percent withheld from the primary care

cavitation payment and the 15 percent withheld

from specialist fees. However, if at the end of a 6-

month period there are surpluses m the primary care

physician’s referral and ancillary services account,

the excess is given to that physician, up to certain

limits. Thus, the incentive is a positive one against

excess expenditures; there is no negative sanction

if a deficit does occur. At the end of the calendar

year, after all expenses are paid, the Board of Directors of the Physicians’ Health Plan distributes

any funds remaining in the risk-sharing/incentive

fund to the physician members of the IPA, both primary care and specialist, in proportion to the

amount each physician paid in.

‘The risk to the individual primary care physician

is limited further according to the size of his or her

panel of patients by a graduated series of stop-loss

provisions. A physician with only a few IPA enrollees among his or her patients maybe liable for

a maximumm ● of $500 per patient from the ancillary

and referral account. Per patient expenditures for

referral and ancillary services above that amount

are automatically paid from the risk sharing/incentive fund. Those with a larger number of IPA patients may be liable to pay up to $10,000 per patient per 6-month period from their ancillary and

referral account, according to the principle that a

physician can spread the risk of extraordinary expenses more evenly across a lamer pool of Patients. * - . .
Quality of Care

From the early studies of prepaid group practices in the 1960s through the reviews of IPAs and

other HMOs of the 1980s, evaluations of practices paid by cavitation have found the quality

of care provided to their enrollees at least as good

and usually better than that of comparison groups

(97,107,194,223,279,404,483,579,581). These evaluations have incorporated measures of structure,

process, and outcome. The cavitation practices

have had higher percentages of board-certified

physicians, for example; have followed standards

for process of care as well as or better than feefor-service practices; and have had comparable

or better mortality and morbidity rates. Although

people in capitated plans have been as satisfied

with the technical aspects of care, they have been

less satisfied with interpersonal aspects than those

in fee-for-service practices. More recently, a 1984

survey found HMO members more likely than

eligible nonmembers to be satisfied with their

health care. The greatest differences concerned

out-of-pocket expenses, availability of services,

and waiting time for an appointment (274).

But certain incentives of cavitation payment,

the results of specific studies, the public sector’s

experience with prepaid plans, and particular

problems of Medicare beneficiaries prevent automatically generalizing the above results to Medicare beneficiaries. No study has examined the

quality of care provided to Medicare beneficiaries.

Until recently, few Medicare beneficiaries have

been enrolled in HMOs, which have marketed

their plans mainly to employed populations. The

National Medicare Competition Evaluation funded

by HCFA includes an evaluation of the quality

of care provided by risk-sharing plans (411). Although that part of the evaluation was expanded

in June 1985, results are not expected until 1987

(541). In addition, an HCFA-sponsored evaluation of Medicaid demonstration projects may also

provide relevant information (see table 7-6) (197).

Cavitation payment provides financial incentives to care for enrollees at low cost. Since per

capita revenue is fixed for the time period, the

plan’s net revenue or profit depends on the costs

incurred in providing care. These incentives have

many positive implications for quality. There is

an incentive to avoid hospitalization and to treat

people elsewhere, an approach that reduces exposure to nosocomial infections and to unnecessary procedures. In fact, lower hospitalization

rates have been observed in prepaid groups for

both medical and surgical care (279). In prepaid

groups, admissions were lower for diagnosis and

tests and for surgical procedures, including ones

that have been associated with unnecessary care

(hemorrhoidectomy, surgery for varicose veins,

and hysterectomy) (279).

However, financial incentives, at least at the

plan level, are to reduce cost, and that may be

done at the expense of quality. The check on such
Ch. 7—Cavitation Payment ● 197

Table 7-5.–Major Sponsors of Health Maintenance Organizations (HMOs)

and Preferred Provider Organizations (PPOs), 1985a

HMOs b

PPOs

Sponsor Total Group Staff IPA Network Total Operational Preoperational

Insurers:

Aetna. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 0 0 3 0 7 NA

Blue Cross/Blue Shield Affiliated Plans . . . . . . . 73C 1 4 8 23 28 34d34 NA

CIGNA Health Plans . . . . . . . . . . . . . . . . . . . . . . . . 15 2 8 5 0

CIGNA Insurance Co. . . . . . . . . . . . . . . . . . . . . . . . 17 17 NA

Equitable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0 0 0 0 0 4 2 2

Hancock/Dikewood . . . . . . . . . . . . . . . . . . . . . . . . . 4 0 0 3 1

John Hancock Insurance . . . . . . . . . . . . . . . . . . . . 9 5 4

Metropolitan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 0 0 0 2 20 14 6

Provident Life Insurance (Health Point Corp.) . . 0 0 0 0 0 7 5 2

PruCare . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 14 0 3 0

Prudential (PruNet) . . . . . . . . . . . . . . . . . . . . . . . . . 30 2 28

Wausaulnsurance Co. . . . . . . . . . . . . . . . . . . . . . . 5 0 0 5 0 1 1 NA

Hospital Management Companies:

American Medical International . . . . . . . . . . . . . . 2 0 1 0 3 3 NA

Hospital Corp. of America . . . . . . . . . . . . . . . . . . . 4 1 : 2 1 1 0 1

Humana, inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 0 0 2 8 21e

21 NA

National Medical Enterprises . . . . . . . . . . . . . . . . 3 0 0 3 0 5 5 NA

Nationwide HMO Networks:

HealthAmerica . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 8 9 13 6 0 0 0

Kaiser Permanence . . . . . . . . . . . . . . . . . . . . . . . . . 11 11 0 0 0 0

Maxicare . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 0 0 : 13 o 0 0

U. S. Health Care Systems . . . . . . . . . . . . . . . . . . . 3 0 0 3 0 0 0 0

United Health Care Corp. . . . . . . . . . . . . . . . . . . . . 33 0 27 6 1 1 NA

SANUS Corp. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 0 : 4 o 1 NA

Whitaker Health Services . . . . . . . . . . . . . . . . . . . . 10 0 — — —0 10 0 0 0 o

Totals 248 50 26 156 65 161 118 43

aData ~b~ained frm telephone ~uwey, November lg85, *x~ePt as noted. This list should not be considered exhaustive of sponsoring organizations.

bNumber of HMOS owned and operated as lines of business by cited institutions, Does not include HMOS operated under management contracts.

cData from Blue Cross and Blue Shield Association, June 5, 1985, and SePt. 1, 1985.

d Data from Blue Cross and Blue Shield Association, OCt. 1, 1965.

estates where Humana Care plus programs are operational, “Humana are pIus” plans we operated as Hfvfos or Pp@ in different markets, with varying degrees of

selective contracting and free choice of providers.

SOURCES: Aetna data: J. Harper, Aetna Insurance Co., Hartford, CT, personal communication, Nov. 12, 1965. Amertcan Medical International data: H. Leavit, American

Medic@ International, Beverly Hills, CA, personal communication, Nov. 15, 1965. Blue Croea data: Blue Cross and Blue Shield Association, “Blue Cross

and Blue Shield Plan Activities in H MOS, December 31, 1964,” June 5, 1965; Blue Cross and Blue Shield Association, “Blue Cross and Blue Shield Plan

HMOS Operational After December 31, 1964,” Sept. 1, 1965; ad Blue Cross and Blue Shield Association, “Blue Cross and Blue Shield Plans Marketing

Preferred Provider Products, ” Oct. 1, 1985 CIGNA data: R. Maag, CIGNA Corp., Hartford, CT, personal communication, Nov. 14, 1985, and S. Shulman, ClGNA Health Plans, Dailas, TX, personal communication, Nov. 7, 1985. Equitable data: J. Neely, Equitable Life Assurance, New York, NY, personal communication, Nov. 20, 1985; and R. Unman, Equitabie Insurance Society, New York, NY, personal communication, Nov. 19, 1985. John Hancock data: R. Morse,

Hancock/Dikewood Health Plans, Boston, MA, personal communication, Nov. 8, 1985; and C. Somers, John Hancock Insurance, Boston, MA, personal communication, Nov 11, 1965. Hoapital Corp. of Amertca data: J. Horn, HCA Health Plans, Nashville, TN, personal communication, Nov. 15, 1985. Health Point

data: R. Padenl Health Point Corp., Chattanooga, TN, personal communication, Nov. 21, 1985. HealthAmerfca data: G. Nielson, HealthAmerica, Inc., Nashville, TN, personal communication, Nov. 14, 1965. Humans data: M. Hoover, Humana Care Plus, Louisville, KY, personal communication, Nov. 21, 1965. Kaiser

data: Interstudy, Inc., National HMO Census (Excelsior, MN: Interstudy, Inc., March 1965); and M. Tatge, “HMO Enrollment Up 26.70/0 to 1.68 Million,” Modern

F/ealthcare, l~4):13&141, June 7, 1965. Maxlcara data: K. Wichser, Maxicare Health Plans, Hawthorne, CA, personal communication, Nov. 19, 1965. Metropolitan

data: L. Hyman, Metropolitan Life Insurance Co., New York, NY, personal communication, Nov. 7, 1965; and T. Nimnicht, Metropolitan Life Insurance, St

Louis, MO, personal communication, Nov., 19, 1965 National Medical Enterprise data: S. Tyler, National Medical Enterprises, Beverly Hills, CA, personal

communication, Nov. 25, 1965. Prudential data: T. Burke, Prudential Insurance Co., Newark, NJ, personal communication, Nov. 7, 1985. SANUS data: M.

Rosen, Sanus Corp., New York, NY, personal communication, Nov. 15, 1965. United Health Cara data: A. Billingstad, United Health Care Corp., Minnetonka,

MN, personal communication, Nov. 21, 1965’ and S. Conway, United Health Care Corp., Minnetonka, MN, personal communication, Nov. 19, 1985, U.S. Health

Care data: D. Richman, “US Health Care Aims at Growth With Push Into New York, Dallas,” Modern Hea/thcare 15(20):50-53, Sept. 27, 1965. Whitaker data:

Whitaker Health Services, Marketing Department, Los Angeles, CA, personal communication, Nov. 18, 1985.

behavior is that plans would lose enrollment if ter able to judge technical care for conditions or

members perceived that quality was below an technologies that they or their friends use freacceptable level. Such enrollee dissatisfaction de- quently, but are dependent on physicians’ guidpends to some extent on lay knowledge of what ance for infrequently used or new procedures

constitutes appropriate care. People would be bet- (366).
Table 7-6. -Cavitation Payment for Medicaid Beneficiaries in Demonstration Projects, December 1985a

Recipient of

government Unit of payment

cavitation to physician Unit of payment Government-plan Plan-provider

Plan payment providers to hospitals risk-sharing risk-sharing

New Jersey Medicaid Personal

Physician Plan . . . . . . . . . . . . . . . Physician Cavitation fund for case DRGs

managers’ services,

referrals, and ancillaries, up

to a maximum. Separate

fund for hospital services

Monroe County Medicap

Monroe County, NY . . . . . . . . . . . . . Medicap acts as HMO discretion

intermediary; seeks bids

from 4 competing HMOs

for rights to serve Medicaid

beneficiaries

Santa Barbara County Health

Initiative

Santa Barbara County, CA . . . . . . .County Health Authority

(intermediary)

Arizona Health Care Cost

Containment System . . . . . . . . . . Prepaid plans bid on rates

to serve Medicaid clients

and medically indigent

Missouri Managed Care

Jackson, County, MO . . . . . . . . . . . Plans contract for services

at State-set rates

Minnesota Prepaid Medicaid

Competition Demonstration . . . . Plans contract for services

at State-set rates

HMO discretion

(county is exempt

from State ratesetting)

Cavitation account to case Per diem

manager covers all patient

services with 20% withheld

for risk sharing

Plan discretion Plan discretion

Plan discretion Plan discretion

Plan discretion Plan discretion

NA

HMO bids include level of

risk borne; intermediary

sponsors stop loss pool,

which HMO can opt out of

for higher cavitation

payment

Authority at risk b

State stop-loss per

beneficiary

Contracting plan bears allb

For Supplemental Security

Income beneficiaries,

government pays between

9 50/0 and 100°/0 of AAPCCb

At risk for referrals,

professional services, and

ancillaries up to defined

maximum per provider; not

at risk for hospital

facilities, receives 50°/0 of

savings, bonus for

outpatient management of

inpatient procedures

HMO discretion

200/o withhold maximum

risk to case managers,

excesses in cavitation

account shared with county

Plan discretion

Plan discretion

Plan discretion

NA=Not applicable.

aplans may have arrangements for beneficiary cost-sharing.

bReinsurance may limit catastrophic losses

SOURCE: R. Deacon, Office of Demonstrations and Evaluation, Health Care Financing Administration, U.S. Department of Health and Human Services, Baltimore, MD, personal communication, Dec 20, 1985;

P.L. Haynes, Evacuating State Medicaid Reforms (Washington, DC: American Enterprise Institute, 19S5); J. Meyer, American Enterprise Institute, Washington, DC, personal communication, Oct. 10,

1985; S. Treiger, Office of Demonstration and Evaluation, Health Care Financing Administration, U.S. Department of Health and Human Services, Baltimore, MD, personal communication, Nov. 25,

1965; and J. Vertrees, La Jolla Management Corp., Rockville, MD, personal communication, Jan. 3, 1986.
Ch. 7–Cavitation Payment . 199

As discussed above, the incentives of individual physicians depend on how they are paid by

the plan. If physicians continue to be paid fees

for their services, financial incentives continue to

reward the provision of additional services. Physicians in prepaid groups usually derive part of

their income from profit-sharing or “productivity”

measures, that is, their use of services and number of patients. The percentage of such income

may be quite small; at Kaiser-Permanente in

northern California, for example, the incentive

compensation payment, which depends on the results of overall operations for the year, has not

exceeded 5 percent of the average physicianpartner’s income (87). However, in spite of the

specific arrangements for compensating physicians, physicians have a personal financial stake

in the continued solvency of the organization.

Management practices may also be relevant to

physician behavior in this regard. Kaiser-Permanente physicians retain the same responsibility for seeing a full load of ambulatory clinic patients regardless of the number of their patients

who are hospitalized (223). All other things being equal, a physician in this circumstance would

be more likely to prescribe return visits in the office than to hospitalize the patient and increase

demands on the physician’s time.

Hornbrook and Berki have theorized that HMOs

would not be expected to skimp on treatment of

severe illness, such as colorectal cancer, for which

definitive treatment is available (223). HMO physicians are subject to the same community standards of practice as fee-for-service physicians and

may face greater malpractice liability exposure

since corporations are more likely than individual physicians to be sued. HMOs may also excel

in reassuring worried-well patients that their

symptoms are self limiting or part of the aging

process. But people who are subtly sick, that is,

whose conditions cannot readily be identified,

may experience delays in the diagnosis of potentially serious disease if HMO physicians face

bureaucratic complexities in ordering diagnostic

workups or in obtaining tests from outside the

HMO. Of course, to the extent that enrollees are

dissatisfied and believe that they would receive

more prompt care under different arrangements,

they can leave that plan and join another.

Results of a study in Washington State of patients with colorectal cancer are consistent with

the hypothesis concerning delay in diagnosis, but

not conclusive (150). After 4 years, no differences

in outcome were found between prepaid group

and fee-for-service patients, and treatment was

comparable once the diagnosis was made. However, a significantly longer period elapsed in the

prepaid group between initial contact with a physician and start of treatment, 47 days in the HMO

and 14 days in fee-for-service practice.

It is possible, under the financial incentives of

cavitation payment, that delays would occur in

resorting to more expensive treatment for a condition for which there were alternative therapies.

For treatment of renal stones, which depending

on the stone may be treated surgically or medically, there might be a preference for the initial use of a potentially cost-saving technology,

such as ESWL, perhaps on an ambulatory basis.

Whether or not such a delay would compromise

the patient’s outcome and quality would depend

on the specific situation, Similarly, cavitation

plans would have an incentive to delay surgery

such as cataract removal and to have it performed

by physicians who specialize in that procedure.

The likely effect on quality is not clear. Delaying

surgery might constitute poorer quality care if the

person was unable to function effectively in her

or his daily activities. On the other hand, delays

in surgery can have health benefits if the surgery,

such as appendectomy, is avoided or if the diagnosis is refined.

Under cavitation payment, plans would have

financial incentives to take advantage of economies of scale in locating and using expensive

equipment. There would be incentives to send

more tests to centralized clinical laboratories, perhaps ones owned by the plan, and to perform far

fewer tests in separate physicians’ offices. Such

a shift has the potential to improve the quality

of test results. State standards maybe more likely

to apply to testing in central laboratories than in

physician offices, and appropriately trained technicians may be more likely to perform the test.

Although cavitation plans have financial incentives to underuse diagnostic tests, like other services, no difference in use has been detected (279).
200 . Payment for Physician Services: Strategies for Medicare

Although greater use of preventive services has

been reported for enrollees of cavitation plans,

for the most part these services consisted of annual physical examinations, which have questionable efficacy (483). This greater use is consistent

with lower financial barriers to initial use because

patient cost-sharing has typically been lower in

cavitation plans (279). There are no recent studies

assessing whether HMOs are providing more of

other preventive services, such as health education, nutritional guidance, and counseling. HMOs

may cover preventive services and feature that

coverage in advertisements as a marketing tool.

Vaccinations are often cited as an example

of a cost-effective preventive technology (576).

Studies that have examined rates of vaccination,

including influenza vaccination, among HMO enrollees have found no consistent pattern of use:

the enrollees of some plans had lower rates and

the enrollees of other plans had higher rates than

comparison groups (483). Pneumococcal vaccine

is the only preventive service that Medicare covers for all beneficiaries. Cavitation plans have financial incentives to provide pneumococcal vaccine to elderly and high-risk people to the extent

that they are likely to remain in the plan long

enough for the plan to reap any savings from disease prevention. But pneumococcal vaccine is unlikely to save costs, and initial uncertainty about

its efficacy probably deterred physicians from recommending its use (485). The low use of pneumococcal vaccine, regardless of payment arrangement, is consistent with barriers that precede

payment, as discussed in chapter 3.

The financial incentives for risk-sharing plans

to reduce the costs of care and perhaps to provide too few services apply only to the services

covered by the payment. If the cavitation payment did not cover inpatient care, the plan and

perhaps its physicians, depending on their income

arrangements, would have increased incentives

compared to the present situation to hospitalize

patients for care. Hospitalization would enable

physicians to perform tests and therapeutic procedures while incurring the cost only of physician

services for the plan. Even overhead expenses

would be borne by the hospital. These incentives

would be compatible with those of hospitals paid

according to diagnosis-related groups (DRGs), because hospitals desire additional admissions and

profit from low-cost cases in a given DRG. If capitation payment covered only non-inpatient services, attention to admissions from risk-sharing

plans would warrant the particular attention of

the quality assurance and utilization review body.

Although Medicaid programs have increasingly

been adopting cavitation payment, historically

few Medicaid eligibles have been enrolled in

HMOs. Some HMOs have served poor people effectively (194). At least at Kaiser-Permanente in

Oregon the program entailed adding substantial

outreach activities to the regular HMO (178).

During the early 1970s, substantial quality

problems occurred in prepaid health plans setup

for people eligible for California’s Medicaid program (483). These problems were addressed by

subsequent Federal and State legislation. Amendments to the Health Maintenance Organization

Act in 1976 (Public Law 94-460) required that all

plans receiving Medicaid funds be federally qualified HMOs, and California implemented more

stringent regulations for certification and prohibited certain marketing and management practices.

More recently, concerns have been about the

quality of care received by Medicare beneficiaries

in certain demonstration projects in Florida (477).

The problems identified in hearings by the House

and in a report by the General Accounting Office related primarily to timely enrollment and disenrollment (476). The General Accounting Office

is continuing to examine the situation, and Mathematica’s evaluation of Medicare competition demonstrations will also cover the plans involved.

The Office of Health Maintenance Organizations in the Public Health Service determines

whether plans meet the conditions of an HMO

or CMP and are eligible to contract with HCFA

(584). These arrangements have been continued

under the regulations implementing TEFRA and

apply to HMOs and CMPs (both cost and risk

plans) (533). The Public Health Service reviews

among other things that the plans have in effect

quality assurance programs and are financially

viable organizations.

The regulations implementing TEFRA also give

utilization and quality control peer review organizations (PROS) the responsibility of reviewing
Ch. 7—Cavitation Payment Ž 201

the care provided by HMOs and CMPs (5o FR

1341). Although the specifics are still under discussion, the intention is to tailor review to the

different financial incentives and to stress review

for underprovision rather than overprovision of

services (302). PROS would be able to delegate

quality review to committees made up of HMO

physicians.

The contract that HCFA requires for eligible

plans stipulates that as part of its quality assurance program the organization agrees to comply

with requirements in the regulations for PRO review of services to Medicare enrollees and to furnish the PRO pertinent data (Article IV General

Conditions) (533). The organization also agrees

to disclose required financial information and to

comply with other reporting requirements designed to monitor continued compliance with the

regulations. Prior to TEFRA, HMOs also had to

have quality assurance programs and to agree to

review by professional standards review organizations (PSROs) (533). In fact, review for HMOs

like other practices pertained only to inpatient

hospital cases (325).

The final set of concerns about quality stem

from the characteristics of Medicare beneficiaries.

Elderly poor people and elderly people generally

have medical and social needs that differ from

those of employed populations or even of Medicaid beneficiaries (194). Elderly people are more

likely to have chronic illnesses and conditions such

as impaired heart or lung function that complicate management of acute illness. Medicare beneficiaries are also more likely than the general population to have motor or sensory impairments that

may affect their ability to cope with unfamiliar

administrative arrangements, especially those of

a large bureaucracy. On the other hand, once a

beneficiary becomes familiar with HMO procedures, administrative matters may be more simple than under fee-for-service arrangements because the patient has less paperwork.

The evaluation of Medicare competition demonstrations will provide information on whether

or not these concerns are well founded, In the

meantime, they suggest the need for monitoring

the experience of Medicare beneficiaries in capitation plans, especially if Medicare enrollment was

expanded into new and rapidly growing plans

(194). Factors to monitor would include an increase in preventable deaths, reduction in functional status because of failure to provide services such as physical therapy, and deterioration

in quality of life from failure to perform expensive therapies such as coronary artery bypass surgery or artificial hip replacement. If concern lay

mainly with plan rather than physician incentives

to provide too few services, emphasis could be

directed to the availability of resources that hinge

on management decisions, such as the number of

certain specialists per enrolled population or the

availability of certain expensive technologies.

Access and Selection Bias

If risk-sharing plans continued the low levels

of cost-sharing that have typified prepaid groups

and erected no additional bureaucratic barriers

to access, it is likely that Medicare beneficiaries

would have improved financial access to care

compared to present Medicare coverage. Enrollees

of prepaid groups have been more likely than people in comparison practices to have at least one

physician visit during the year (279), a result consistent with the findings of the Rand Health Insurance Study that the likelihood rises with lower

cost-sharing (343). The experience has been mixed

with enrollees of IPAs (279). Medicaid eligibles

in prepaid groups were also found more likely

than controls to initiate visits (279). No such pattern has been evident for followup visits (279),

a finding consistent with physicians’ rather than

patients’ being more likely to initiate such care.

Medicare beneficiaries’ geographic access to

care might be reduced, especially for specialized

services. Plans paid by cavitation have an incentive and the ability to match equipment, facilities,

and staff to the enrolled population. An example

is regionalizing facilities to take advantage of

economies of scale in producing technical services. Where regionalization of services was evident in the San Francisco area of Kaiser-Permanente, some larger hospitals were fully equipped,

and some smaller ones were equipped for emergency and chronic care (280). Kaiser enrollees may

have had longer travel times in some cases. Reduced geographic access could pose problems for
202 ● Payment for Physician Services: Strategies for Medicare

beneficiaries who have vision or mobility impairments. On the other hand, access could be improved to the extent that more facilities are available in one place.

A major concern about access stems from the

possibility that plans might attempt to enroll lowrisk or low-cost beneficiaries. If such preferred

selection took place, beneficiaries with conditions

that put them at high risk of using expensive services might have difficulty finding plans to accept

them. A standard benefit package and an open

enrollment period during which plans were required to enroll people in the order they applied

could alleviate this problem (129). TEFRA already

mandates an annual 30-day open enrollment

period during which plans must accept enrollees

on a first-come, first-enrolled basis. But biased

selection, whether by plans or beneficiaries, may

have occurred during previous open enrollment

periods (278). Constructing cavitation rates that

would adequately reward plans for caring for beneficiaries in high-cost categories would reduce

plans’ preference for low-cost enrollees and might

result in plans’ preferring to enroll high-cost beneficiaries.

Cost and Efficiency

Prepaid group practices have achieved savings

in total per capita costs (premiums plus out-ofpocket expenses) of 10.to 40 percent versus comparison plans (279). Earlier studies could not

distinguish the role of differences in benefit coverage, characteristics of enrollees, payment methods, and scope of services (extent of vertical integration). However, Rand’s National Health

Insurance Study assigned people randomly and

covered comparable benefits (285). In that study,

the expenditure rate for enrollees of Group Health

Cooperative, the prepaid group practice, was 25

percent lower than that for nongroup fee-for-service enrollees who received free care. There were

no significant differences, however, between expenditures for the HMO enrollees and for people

subject to 95 percent coinsurance for fee-for-service care. People with high cost-sharing had lower

visit rates than prepaid group enrollees, but not

significantly different hospitalization rates. These

results suggest that prepaid group practice and

high cost-sharing had similar effects on expenditures and hospital use, but that prepaid group enrollees were not so deterred from seeking care

(343). As described earlier, studies have found

that, compared to control groups, Medicare payments were lower for beneficiaries in five of seven

prepaid groups that had cost contracts (91).

Lower costs can be achieved by producing technical services at lower cost or by using a lower

cost mix of services to provide the same quality

care. In general, HMOs were not found to produce services more efficiently (279), although a

recent study reported that within a hospital-based

clinic, HMO patients had significantly fewer visits

and lower laboratory charges for hysterectomies

and appendectomies and lower total charges for

appendectomies, but not for cholecystectomy and

hernia (23).

For the general population and for Medicare

beneficiaries, savings have been attributed to

lower hospital admission rates for both medical

and surgical diagnoses. This phenomenon is consistent with providing a lower cost mix of services. Cavitation payment contains an incentive

to deliver care in the most efficient setting with

the most efficient mix of technologies. Cataract

removal, for example, would be likely to be performed almost exclusively in an outpatient setting, except for patients with complicating comorbid conditions. Expensive technologies with high

fixed costs, such as MRI or ESWL, might be

regionalized by entrepreneurs or plans in freestanding diagnostic or therapeutic centers.

As noted above, an implication of having a defined population to serve is that an organization

can match facilities and staff to that population.

Prepaid groups have historically had lower numbers of surgeons and hospital beds per population (483). This result, of course, may indicate not

the efficient use of resources, but the enrollment

of a population with lower use of those services.

Out-of-plan use has not accounted for the differences in costs between prepaid groups and

other practices, and neither ambulatory physician

visits nor ancillary use has been markedly lower

(279). Nor have HMOs held their rate increases

below those of fee-for-service practices, suggest-
Ch. 7—Cavitation Payment ● 203

ing that any reductions are one-time savings

(279,343) and that cavitation plans have been able

to maintain a lower level of costs over time.

Other organizational arrangements besides prepaid group practice have had low hospitalization

rates (436). Two fee-for-service practices that

owned their own hospitals, an ambulatory feefor-service group, and physicians in solo practice

acting as case managers have achieved low hospitalization rates comparable to those of prepaid

groups. These findings suggest the importance of

organization as a factor separate from payment

method. Lower surgical rates but not savings in

expenditures have been found for IPA enrollees

compared to people insured with Blue Shield or

indemnity plans (279,483). The hospitalization

rates of IPAs have been much lower than those

of the genera] population, a mean of 448 days per

1,000 enrollees compared with about 737 per

1,000 U.S. population under age 65 for 1983 to

19849 (240,549). These figures were not age-sex

adjusted and, like other comparisons involving

HMOs, it is not known whether enrollees were

representative of the population. It is also not

clear whether consistent definitions of hospital

days were used regarding newborns, Medicare

beneficiaries, and benefits coordinated with other

insurers. Among types of HMOs, network models,

in which an HMO contracts with two or more

group practices to provide medical services, and

group models have had the lowest hospitalization

rates, followed by staff models and IPAs (239,240).

Since organizational formats besides prepaid

group practice appear capable of achieving efficiencies, it is not clear which type of arrangement

would predominate in a situation where the incentives of cavitation payment pushed plans and

providers to operate more efficiently. How plans

paid by cavitation react would depend greatly on

the structure of cavitation rates, which, as described in an earlier section, could reward creative marketing strategies to enroll low-cost beneficiaries or could reward efficient delivery of care.

Medicare program expenditures over time

would depend on which occurred. In any case,

9The information on IPAs covers July 1, 1983, to June 30, 1984.

Data for the U.S. population are an average of rates for calendar

years 1983 and 1984.

program expenditures would be more predictable and controllable than under the current CPR

system.

Beneficiaries’ costs would be likely to fall if risksharing plans, as now, were required to share savings with beneficiaries in the form of increased

benefits or reduced premiums. Beneficiaries’ costs

would not rise in the absence of a Federal policy

decision to increase their financial liability under

the program.

If Medicare’s cavitation rates were comparable

to payments by other payers, cavitation payment

for beneficiaries would in itself be unlikely to affect the expenditures of other payers. If Medicare’s

rates were much below the market rate, plans and

providers would find non-Medicare enrollees

more attractive and would be expected to shift

their marketing and provision of services to them.

In either case, the ultimate effect on the costs of

other payers would depend on the cost-saving activities undertaken by them (see app. D) and by

the competitive pressure on providers engendered

by such independent changes as increases in physician supply (see ch. 2).

Technological Change

Cavitation payment would expand the changes

in market conditions created by Medicare’s prospective payment system for inpatients, so that

the development of cost-saving technologies

would be rewarded beyond the inpatient setting.

In recent decades, the prevalence of insurance coverage increasingly provided a secure and growing market for medical technologies (487). In the

context of open-ended third-party reimbursment,

new technologies, especially those for acute inpatient care, were valued if they provided additional benefits, such as improved diagnosis or

treatment. Potential purchasers and users of technology paid little attention to cost because their

charges or costs were usually reimbursed.

The constraints of cavitation payment would

make providers more cost conscious about the

capital and operating costs of technology. Such

a change already appears to be taking place regarding inpatient care as a result of Medicare’s

payment by DRGs (489). Depending on Medicare’s leverage from its market share, Medicare’s
204 ● Payment for Physician Services: Strategies for Medicare

paying for ambulatory care on a prospective basis would extend these incentives to physicians’

offices, freestanding centers, and hospital outpatient departments. Since DRG payment applies

to inpatient operating expenses and some method

of including capital costs seems likely, market incentives would change even if the cavitation payment applied only to ambulatory care and physician services.

Physicians’ offices have become a more attractive target for technology development and marketing sinew Medicare DRG payment. Under capitation payment manufacturers would attempt to

incorporate cost-saving features in the technologies for the ambulatory market as well as the

hospital market. For example, physicians who

continued to perform clinical laboratory tests in

their offices would have greater interest in equipment to perform simple tests that was inexpensive to purchase and did not require expensive

technicians to operate.

Most technology would continue to be developed for hospitals, because the most severe, complex, and expensive cases would be treated there

and because hospitals would continue to account

for a large portion of the medical market. The

medical community would continue to value technologies that clearly improved diagnosis or therapy, even if they increased costs, especially since

physician researchers are typically involved in

technology development, evaluation, and initial

adoption. It is also possible that hospitals would

continue to compete for physicians and patients

by acquiring new technologies. This phenomenon

seems to be occurring even under DRG payment

in northern Virginia, where the largest hospital

wished to purchase an ESWL unit that the hospital hoped would serve the Washington, DC, metropolitan area (413).

Nevertheless, even within that context, the

more cost-conscious environment would discourage the development and adoption of some technologies, especially expensive ones that added to

the cost of care. No evidence has been found that

HMOs have been less likely to use expensive technologies for their patients (582). But in the early

phase of an expensive new technology, when appropriate use was unclear and use rates were low,

at least the larger prepaid groups have sent their

patients to facilities outside the plan. KaiserPermanente in Northern California used this strategy for X-ray computed tomography (CT) scanning and for open-heart surgery (129,480). If

higher rates of use or lower technology cost later

made it cheaper for the plan to provide the service inside the plan, the facilities were added to the

plan. Otherwise, the plan continued to contract

outside the plan for those specialized services.

Under more generalized Medicare cavitation

payment, one would thus expect more delay in

adoption of an expensive technology such as MRI,

especially while its demonstrated advantages over

alternative modalities are fairly limited (234). As

long as use inside the plan was low and the technology remained expensive, a plan would be likely

to contract for MRI services outside the plan.

Cavitation payment could greatly boost the development of managerial technologies (483). Although prepaid group practices have been able to

deliver medical care at lower cost than comparison practices, the capability of other organizational arrangements has not been subjected to a

market test. As noted above, there are indications

that other formats, such as multispecialty fee-forservice group practice, can also achieve lower

costs. And IPAs appear to be evolving in the direction of cavitation payment to physicians and

greater utilization controls. Greater cost constraints from cavitation payment would probably

stimulate the development of other arrangements

and the spread of those that were successful.

Cavitation Payment to Geographic

Fiscal Intermediaries

Instead of paying individual plans a cavitation

payment, Medicare could pay fiscal intermediaries

that were willing to assume financial risk for services to beneficiaries in a geographic area (70,242,

564). The cavitation payment could cover only

physician services and ambulatory care or could

also encompass inpatient services. The intermediary or carrier in turn would negotiate arrangements with providers in the area and offer beneficiaries a choice among plans.
Ch. 7—Cavitation Payment ● 205

—

No such arrangement has existed under Medicare. But in response to an HCFA solicitation, at

least one organization has submitted a proposal

to undertake geographic cavitation as a 5-year

demonstration project (290). Under the proposal,

Medicare would pay Blue Cross-Blue Shield of

Maryland to insure beneficiaries rather than only

to administer the program in Maryland (434). 10

Medicare would pay the plan a monthly amount

based on the number of Medicare beneficiaries

(434). Half of any profits would go to the Federal Government and the other half would be

divided between Blue Cross-Blue Shield and beneficiaries, who would receive a rebate (434). Beneficiaries could choose from several options:

traditional Medicare coverage, traditional health

insurance, Blue Cross-backed HMOs, and a Blue

Cross-sponsored PPO, whose physicians would

charge lower fees. Other HMOs and CMPs would

continue to relate directly with the Federal Government to be qualified and to enroll Medicare

beneficiaries. HCFA is reviewing the proposal,

and officials estimate that a decision will require

several months (434).

Putting the fiscal intermediary at risk for medical expenditures would greatly change present incentives for carriers, who now receive a fixed

amount per claim to administer the program, but

who have no responsibility for the level of program expenditures. To control expenditures, a

capitated carrier could encourage beneficiaries to

opt for lower cost alternatives, such as HMO

membership or physicians in a PPO; negotiate discounts with physicians and other providers in the

context of a PPO or HMO; or pursue more stringent review of fee-for-service claims (70). HCFA’S

guidelines for those who are considering the submission of demonstration proposals state that the

present system of payment for physician services

based on customary, prevailing, and reasonable

charges should be continued as an option for beneficiaries and providers. Although a fiscal intermediary could enlist providers or plans to agree

to utilization control or expenditure caps, the intermediary could not impose such constraints

(465).

10Blue CroSs/ Blue Shield of Maryland now acts as Medicare’s intermediary for Part A services and as Medicare’s carrier for Part

B services.

It is not clear how several administrative matters would be handled under carrier cavitation,

such as enrollment of beneficiaries, establishment

and updating of cavitation payments, policy concerning case-by-case vs. mandatory assignment,

and sharing of risk between Medicare and the

carrier.

Quality of Care

A capitated carrier would have financial incentives to control the use of providers who continued to be paid on a fee-for-service basis. The

effects on quality would depend on which services were constrained or reduced (194). Quality

could improve if use decreased for services that

provide little or no additional benefit, entail unreasonable risk for the potential benefit, or are

employed in inappropriate settings. On the other

hand, quality would be impaired if decreased use

occurred for services that are now used appropriately or that are underused. An important element would thus be identifying services to target

for utilization review. The carrier, perhaps with

assistance from HCFA, might review the literature and work with panels of expert physicians

to select inappropriately used services that would

be amenable to utilization review.

If the cavitation payment did not cover inpatient care, providers and carriers would have

financial incentives to contain their own expenses

by admitting patients to hospitals, a move that

would be welcomed by hospitals paid more for

additional admissions. The entity charged with

quality assurance could pay particular attention

to institutionalized patients. In addition, the risksharing arrangements between Medicare and the

carrier or between the carrier and providers could

share any savings from reduced hospitalization.

Medicare would have continuing responsibility to monitor the quality of care and to ensure

that appropriate covered services were not being

denied to beneficiaries (70). This function would

have great importance in a situation that would

be novel and perhaps initially confusing to beneficiaries. HCFA could draw on the experience of

two Medicaid programs that operate through carriers, one in Texas and the other in California

(564).
206 . Payment for Physician Services: Strategies for Medicare

Access to Care

Beneficiaries could experience problems of geographic access to physicians and other providers

if the intermediary contracted with a limited number of providers in an area. Medicare could alleviate this problem by requiring that the intermediary enlist the participation of a minimum

percentage of physicians of different specialties

and perhaps make arrangements to pay for outof-plan use, or by requiring that present arrangements remain an option for beneficiaries and providers. By contrast beneficiaries’ access could be

expanded if they were able to choose providers

in PPOs and HMOs that were previously unavailable through traditional Medicare arrangements.

Depending on the number of physicians and their

practice preferences, beneficiaries in rural areas

might not have access to an HMO or other practice forms (459).

The enrollment process could affect access to

certain facilities, providers, and services. Whether

Medicare or the intermediary conducted the enrollment process, it would be critical for marketing of options and enrollment of beneficiaries to

be conducted fairly, without favoring or slighting any of the intermediary or nonintermediarysponsored plans. Intermediaries would have a financial interest in encouraging enrollment in certain plans, such as the PPO, and in discouraging

continuation of traditional Medicare arrangements. One possibility would be for the geographic intermediary to contract with HMOs that

it did not sponsor and offer them as options to

beneficiaries. That situation could inject some

competition into arrangements with the intermediary and reduce the likelihood that low-cost

beneficiaries would tend to be enrolled in plans

sponsored by intermediary. Regardless of who

conducted the process, Medicare could review the

marketing material and stipulate certain procedures to be followed. In any case, it would be

desirable to limit Medicare requirements to measures needed to protect beneficiaries and not to discourage plans and providers from participating.

The enrollment of large numbers of beneficiaries in HMOs in Florida identified administrative problems regarding enrollment and disenrollment (477). Delay in updating beneficiary

enrollment records led to initially incorrect payment decisions in some cases. Prior to signing

TEFRA risk contracts in April 1985, HCFA initiated procedures designed to ensure that HCFA

and carrier records are updated in a timely fashion (533).

Cost and Efficiency

Depending on risk-sharing arrangements and

the results of utilization control, the Medicare program could achieve greater predictability over

program expenditures and greater control over annual increases. Geographic cavitation has been

likened to a carrier-wide IPA or CMP that covered both enrolled and unenrolled beneficiaries

(70). IPAs have varied tremendously in their success, and specifically in their ability to control use

and to reduce total expenditures below that of

comparison practices. The achievements of an

intermediary-at-risk would, like those of IPAs,

depend on its ability to negotiate with providers

and to control their use of services.

Under the Texas Medicaid program, the Texas

Purchased Health Program, there has been a substantial increase in total expenditures and an increase in hospital outpatient visits relative to physician office visits (564). The State sets the fees

to be paid for services, and the carrier attempts

to control volume of services. The cavitation payment to the carrier covers hospital and physician

services and ancillaries.

The Redwood Health Foundation is the carrier

for all public assistance beneficiaries in three counties of California (564). Medi-Cal (California Medicaid) costs per enrollee in this area have been

below the State average and the average in comparable counties, but slightly above costs per enrollee in prepaid health plans. Medi-Cal authorizes rates of fee-for-service payment. The carrier

contracts risk-sharing arrangements with providers

and conducts utilization and quality control.

Like cavitation payment to health plans, geographic cavitation should not entail additional

costs for beneficiaries and might result in savings

in additional benefits or reduced cost-sharing. The

cost implications for other payers would depend

on the desire and ability of plans and providers

to increase their private rates and use.
Ch. 7—Cavitation Payment . 207

Technological Change

Any change in technology would depend on

changes in the market for medical services and

in the incentives to use different types of care.

Such implications are very tenuous, for the reasons outlined above. If geographic cavitation

resulted in cost constraints and greater cost consciousness among providers, the effects on technology would be similar to those described for

cavitation payment to health plans. On the other

hand, geographic cavitation might produce few

changes in the delivery of medical care, and

present incentives for technological change could

continue.

Administrative Feasibility

Use of the AAPCC to determine cavitation rates

would be less problematic for Medicare under geographic cavitation than under cavitation to risksharing plans. A geographic intermediary would

receive payments for large numbers of beneficiaries across which the risk would be spread. Payment to risk-sharing plans would require further

refinement in the cavitation rate to reduce the possibility of biased selection by beneficiaries or

plans.

Quality assurance activities would differ from

those historically undertaken, since the incentive

CONCLUSION

Cavitation payment contains incentives for the

recipients to control medical expenditures. Beneficiaries’ welfare will be furthered if these incentives are expressed by providing care through a

more efficient mix of services, reducing inappropriate care, or treating conditions before they become costly. Past experience of non-Medicare enrollees with HMOs, particularly with prepaid

groups, has shown that cavitation plans do care

for enrollees at lower costs, while maintaining

quality at levels equal to or better than comparison practices.

However, there is the danger that future plans

or intermediaries may constrain expenditures at

the expense of quality of care, by reducing or deof cavitation payment is toward underprovision

rather than overprovision of services. It is likely

that some experience will be gained with these issues as PROS or their designates in the plans undertake the reviews required by the TEFRA regulations.

Both rate-setting and quality assurance would

most likely require new data, for example, on

health status, severity, or outcome measures

(459). It would be most reasonable for HCFA to

determine from research and demonstrations what

kind of data was needed. HCFA might also wish

to survey beneficiaries about enrollment to indicate their characteristics and motivations in selecting and changing plans. It would be important for HCFA to be judicious in its requirements

for information so that intermediaries were not

unduly burdened.

Both cavitation payment to health plans and

to geographic intermediaries would require that

procedures be established regarding enrollment.

As discussed above, geographic intermediaries

may have conflicts of interest with respect to beneficiary enrollment in nonintermediary-sponsored

plans. Under either cavitation payment arrangement, however, it would be vital for HCFA and

its intermediaries to coordinate their activities and

to have timely, orderly, and accurate procedures

for enrollment and disenrollment.

laying appropriate services, or at the expense of

access to care, by giving preference to low-cost

over high-cost enrollees. Similar trade-offs apply

to sharing financial risk with providers. Placing

greater financial risk on physicians gives them a

stronger incentive to contain costs, but also increases the likelihood that appropriate care will

be reduced.

The major disadvantage of geographic capitation is the substantial market power given to the

intermediary, not only with regards to plans competing for beneficiaries to enroll, but also in relation to the Medicare program. A geographic

intermediary would be in a strong position in negotiating cavitation rates with Medicare because
208 • Payment for Physician Services: Strategies for Medicare

of the difficulty that Medicare would face if the

intermediary opted out of the arrangement after

a few years. From the intermediary’s perspective,

an important factor would be the reliability of

Medicare in continuing this payment approach

and in paying rates considered reasonable by the

intermediary.

The extent to which plans and providers are

pushed to be efficient depends on the level of payment as well as the method of payment. At lower

levels of cavitation payment, there would be a

greater likelihood that lower use and cost would

be achieved at the expense of quality. Moreover,

if relative payment rates diverged from the cost

of resources required to care for high-cost and

low-cost beneficiaries, plans would be more likely

to concentrate on marketing strategies to seek lowcost enrollees and less likely to urge providers to

deliver cost-effective care.

It is difficult to predict the implications of widespread Medicare cavitation payment on the basis of financial incentives and past experience.

Medicare enrollment in risk-sharing plans has only

recently reached substantial numbers, mostly in

demonstration projects that remain to be evaluated. And one cannot assume that new plans,

which differ in size, sponsorship, organization,

and risk-sharing arrangements from the older,

well-studied ones, will achieve similar results in

cost, quality, and access. Geographic cavitation

for Medicare beneficiaries is completely untried

as yet, and little experience exists at the State level

under Medicaid.

Cavitation payment, especially to risk-sharing

plans, has the potential to moderate the growth

in Medicare expenditures while providing beneficiaries with good quality care. The challenge is

to develop a method for setting cavitation rates

that provides incentives for intermediaries and

providers to deliver cost-effective care and to provide access to all beneficiaries.
Appendixes
—

Appendix A

Method of the Study

The Deficit Reduction Act of 1984, Public Law 98-

369 (Sec. 2309), mandated OTA to conduct a study

of physician payment under Medicare. In addition, the

Senate Special Committee on Aging requested OTA

to analyze the effects of physician payment on medical technology, with particular attention to payment

of physician services under Part B of Medicare. On

June 21, 1984, the OTA Technology Assessment Board

approved the proposal for this project.

During the early part of the project, OTA staff consulted with professional associations for suggestions

of candidates for the study’s advisory panel. The advisory panels for OTA studies guide OTA staff in selecting material and issues to consider and review the

written work of the staff, but the panels are not responsible for the content of the final reports. The advisory panel for this study consisted of members from

various interested parties: medical specialties; corporate health benefits; health insurers; carriers; consumer advocacy groups; and scholars in medical

ethics, economics, and health policy analysis. Sidney

Lee, president of the Milbank Memorial Fund and

chair of the standing OTA Health Program Advisory

Committee, chaired the advisory panel for this study.

The first meeting of the advisory panel was held on

September 10, 1984. Before the meeting, the staff began preliminary research into the issues involved in

Medicare physician payment and prepared a draft outline for the study. During the meeting, the panel was

asked to define and narrow the scope of the task of

studying Medicare physician payment. Staff from the

Health Care Financing Administration, the Institute

of Medicine of the National Academy of Sciences, and

the Congressional Budget Office reported on the

progress and emphasis of their complementary studies

on physician payment to help define the focus of

OTA’s assessment.

After the meeting, the project staff refined the

project outline and identified for analysis four alternative approaches to medicare payment for physician

services: 1) modifications in Medicare’s traditional customary, prevailing, and reasonable method of payment; 2) payment based on fee schedules; 3) payment

for packages of services; and 4) cavitation payment.

The staff also selected five medical technologies for indepth examination of the effects of payment alternatives. Contracts were let for background papers that

would each examine one of the five technologies: pneumococcal vaccination, clinical laboratory services,

magnetic resonance imaging, extracorporeal shock

wave lithotripsy, and cataract surgery.

On January 29, 1985, a workshop was held to discuss empirical research on the effects of particular payment mechanisms. The workshop, under the chair of

Uwe Reinhardt, professor of economics at Princeton

University and advisory panel member, included members of the advisory panel and others experienced in

the use of databases available from Medicare carriers.

In light of the information gained from this workshop,

the OTA staff let two contracts for empirical studies

on the issues related to fee schedules and cavitation

payment.

The project was discussed further at the February

11, 1985 meeting of the Health Program Advisory

Committee, an independent body of experts that advises the OTA Health Program. Discussion centered

around the availability of data on physician incentives

under various forms of payment and the relative uncertainty about the effects of particular changes.

Another set of background papers was commissioned to elicit comparative perspectives on potential

methods of paying for physician services. One contractor was chosen to write a background paper on

the experience of the Canadian Government in financing a national system of payment for physician services on the basis of fee schedules. Another contractor

wrote of the experience of the Kaiser-Permanente Medical Care Program in paying its physicians on a capitation basis.

In addition, contractors were chosen to write background papers on the implications of the alternative

payment methods for quality of care and ethical issues, matters that are common to all of the alternatives.

The second meeting of the advisory panel was held

on March 7, 1985, to bring the panel members up to

date on the progress of the report. The panel reviewed

draft background information intended for the final

report. The panel also gave advice on issues for the

chapters on the specific payment alternatives.

During the spring and summer of 1985, the project

staff reviewed the available literature relating to the

various payment methods. Draft background papers

were also received throughout this time, and the drafts

were critiqued by the project staff, by advisory panel

members, and by outside reviewers with expertise in

the relevant fields. The staff also organized a workshop, held on June 13, 1985, on the administrative issues relating to possible changes in Medicare payment

of physician services. The workshop participants, under the chair of Sidney Lee of the advisory panel, included representatives from the Health Care Financ211

56-119 0 - 86 - 8 : QL 3
212 . Payment for Physician Services: Strategies for Medicare

ing Administration, current Medicare carriers, other

insurers, and members of the advisory panel.

The staff prepared a draft report, which was discussed at the final meeting of the advisory panel on

October 10, 1985, and at the meeting of the Health

Program Advisory Committee on October 18, 1985.

The draft was also sent to other experts and interested

parties for review. During October and November

1985, the project staff revised the report in response

to reviewers’ comments and sent selected chapters for

additional review to members of the advisory panel.

After subsequent revision, the staff prepared a final

draft, which was submitted in mid-December to the

Technology Assessment Board for approval.

Other documents in addition to the main report

were prepared in connection with this assessment. A

case study, Effects of Federal Policies on Extracorporeal Shock Wave Lithotripsy, was prepared by the

project staff and will be available through the U.S.

Government Printing Office. In addition, the following papers were prepared on contract to OTA to provide background information for the main report and

are

●

●

●

available through OTA in limited quantities:

“The Frozen North: Controlling Physician Costs

Through Controlling Fees,” by Morris L. Barer,

Robert G. Evans, and Roberta Labelle, University of British Columbia;

“Evaluation of Ethical Implications of Selected

Alternatives for Paying Physicians Under the

Medicare Program, ” by Alexander M, Capron,

University of Southern California;

“Payments to Physicians in the Permanence Medical Group,” by Morris F. Cohen, Northern California Kaiser-Perrnanente Medical Care Program;

●

●

●

●

●

●

●

●

“Background Paper on Cataract Surgery and Physician Payment Under the Medicare Program, ” by

Louis P. Garrison, Jr., and Sandra M. Yamashiro,

Project HOPE Center for Health Affairs;

“Evaluation of Effects on the Quality of Care of

Selected Alternatives for Paying Physicians Under the Medicare Program,” by Glenn T. Hammons, Robert H. Brook, and Joseph P. Newhouse, The Rand Corp.;

“Reform of Medicare Physician Payment Policies:

Impact on Magnetic Resonance Imaging Technology,” by Lisa I. Iezzoni, Oren Grad, and Mark A.

Moskowitz, Boston University Medical Center;

“Analysis of Issues Relating to Implementing a

Medicare Physician Fee Schedule,” by David A.

Juba, The Urban Institute;

“The Effects on Clinical Laboratory Services of

Selected Alternatives for Paying Physicians Under the Medicare Program, ” by Lois P. Myers,

John M. Eisenberg, and Mark V. Pauly, University of Pennsylvania;

“Implications of Alternative Medicare Payment

Methods for Pneumococcal Vaccination, ” by

Michael A. Riddiough, Riddiough & Associates;

“Extracorporeal Shock Wave Lithotripsy: Clinical Applications and Physician Payment, ” by

Jonathan A. Showstack, Eliseo J, Perez-Stable,

and Eric Sawitz, University of California, San

Francisco; and

“Issues in Cavitation: Risks of Financial Ruin for

Providers and Ways To Control This Risk,” by

James Vertrees, Dennis Tolley, and Kenneth Manton, La Jolla Management Corp.
Appendix B

Acknowledgments and

Health Program Advisory Committee

This project has benefited from the advice and review of several other people in addition to the advisory

panel. The staff would like to express its appreciation to the following people for their valuable guidance.

James Aquavella Robert Butler

American Academy of Ophthalmology Bureau of Data Management and Strategy

Rochester, NY Health Care Financing Administration

Mary Ann Baily Baltimore, MD

Department of Economics Thomas W. Byrne

George Washington University Blue Cross/Blue Shield of Massachusetts

Washington, DC Bostonf MA

Robert Ball James Cantwell

Center for the Study of Social Policy U.S. General Accounting Office

Washington, DC Washington, DC

James Barnett

Bureau of Program Operations

Health Care Financing Administration

Baltimore, MD

Marshall Becker

Department of Health Behavior

School of Public Health

University of Michigan

Ann Arbor, MI

Ellis Benson

Department of Laboratory Medicine and

Pathology

University of Minnesota Medical School

Minneapolis, MN

Mark S. Blumberg

Kaiser Foundation Health Plan, Inc.

Oakland, CA

Charles Booth

Sandra Christensen

Congressional Budget Office

Washington, DC

John Clark

Bureau of Health Care Delivery and Assistance

Health Resources and Services Administration

U.S. Department of Health and Human Services

Rockville, MD

Catherine Grealy Cohen

American Society of Clinical Pathologists

Washington, DC

Eunice Cole

American Nurses Association

Kansas City, MO

Andre'-Pierre Contandriopoulos

Department de I’Administration de la Sante'

Universite' de Montre'al

Montre'al, Canada

Office of Reimbursement Policy

Health Care Financing Administration Robert Crane

Baltimore, MD Kaiser Foundation Health Plan, Inc.

Oakland, CA

Dan Brock Patricia M. Danzon

Department of Philosophy Center for Health Policy Studies

Brown University Duke University

Providence, RI Durham, NC

Ira Burney Ronald Deacon

Office of Legislation and Policy Office of Demonstrations and Evaluation

Health Care Financing Administration Health Care Financing Administration

Washington, DC Baltimore, MD

213
214 . Payment for Physician Services: Strategies for Medicare

Linda Demlo

Office of Demonstrations and Evaluation

Health Care Financing Administration

Baltimore, MD

Richard DiMonda

Division of Technology Management and Policy

Office of Hospital Management Programs

American Hospital Association

Chicago, IL

Allen Dobson

Office of Reimbursement

Health Care Financing Administration

Baltimore, MD

Thomas Dowdal

U.S. General Accounting Office

Washington, DC

Steven P. Dretler

Department of Urology

Massachusetts General Hospital

Boston, MA

Charles F. Duvall

Private practice

Washington, DC

Richard Egdahl

Health Care Research Unit

Boston University Medical Center

Boston, MA

David Ehrenfried

Blue Cross and Blue Shield Association

Chicago, IL

Alfred Ercolano

College of American Pathologists

Washington, DC

Al Esposito

Office of Demonstrations and Evaluation

Health Care Financing Administration

Baltimore, MD

David S. Fedson

Department of Internal Medicine

School of Medicine, University of Virginia

Charlottesville, VA

Jon Gabel

National Center for Health Services

Research and Health Care Technology

Assessment

U.S Department of Health and Human Services

Rockville, MD

Paul Ginsburg

The Rand Corp.

Washington, DC

Merwyn Greerlick

Health Services Research Center

Kaiser-Permanente Medical Care Program

Portland, OR

Leonard Gruenberg

Health Policy Center

Heller Graduate School

Brandeis University

Waltham, MA

Paul Gurney

Office of Demonstrations and Evaluation

Health Care Financing Administration

Baltimore, MD

James Hadley

Office of Demonstrations and Evaluation

Health Care Financing Administration

Baltimore, MD

John D. Haytaian

FONAR Corp.

Melville, NY

Harold Heatherington

Office of Reimbursement Policy

Health Care Financing Administration

Baltimore, MD

Alan Hinman

Centers for Disease Control

Atlanta, GA

Mark Hornbrook

Health Services Research Center

Kaiser-Permanente Medical Care Program

Portland, OR

Fredrick Hunt

Society of Professional Benefit Administrators

Washington, DC

Steven Jencks

Office of Research

Health Care Financing Administration

Baltimore, MD

Lucy Johns

Health Care Planning and Policy

San Francisco, CA
.—. —

App. B—Acknowledgments and Health Program Advisory Committee • 215

Frank Jolesz

Department of Radiology

Brigham and Women’s Hospital

Boston, MA

Terry Kay

Office of Research

Health Care Financing Administration

Baltimore, MD

Carol Kelly

Office of Legislation and Policy

Health Care Financing Administration

Washington, DC

Janet Kline

Education and Public Welfare Division

Congressional Research Service

Library of Congress

Washington, DC

Mary Nell Lehnard

Blue Cross and Blue

Washington, DC

Dieter A. Lehnortt

American College of

Dallas, TX

Joanna Lion

Shield Association

Emergency Physicians

Health Policy Center

Heller Graduate School

Brandeis University

Waltham, MA

A. Russell Localio

Risk Management Foundation of the Harvard

Medical Institutions

Cambridge, MA

James Lubitz

Office of Research

Health Care Financing Administration

Baltimore, MD

Harold Luft

Institute for Health Policy Studies

School of Medicine

University of California, San Francisco

San Francisco, CA

Penn Lupovich

Group Health Association

Washington, DC

Leo Marcus

MANDEX, Inc.

Vienna, VA

Cindy Mason

Office of Demonstrations and Evaluation

Health Care Financing Administration

Baltimore, MD

John McConnell

National Committee on Clinical Laboratory

Standards

Villanova, PA

David Mechanic

Health and Health Services Research Coordinating

Council

Rutgers University

New Brunswick, NJ

Stephanie Mensch

American Academy of Ophthalmology

Washington, DC

William H. Moncrief, Jr.

California Medical Review, Inc.

San Francisco, CA

Laura Murphy

National Electrical Manufacturers Association

Washington, DC

Robert Mussachio

Center for Health Policy Research

American Medical Association

Chicago, IL

Helen Oglesby

Blue Shield of California

San Francisco, CA

Heather Palmer

Department of Health Policy and Management

Harvard School of Public Health

Boston, MA

David Plotnick

Group Health Association of America

Washington, DC

Martin Resnick

School of Medicine, Division of Urology

Case Western Reserve University

Cleveland, OH

Roger Reynolds

American Medical Association

Chicago, IL
216 Ž Payment for Physician Services: Strategies for Medicare

Thomas Rice

Department of Health Policy and Planning

School of Public Health

University of North Carolina

Chapel Hill, NC

Paul Riesel

Bureau of Eligibility, Reimbursement, and

Coverage

Health Care Financing Administration

Baltimore, MD

Gerald Riley

Office of Research

Health Care Financing Administration

Baltimore, MD

Jack Rodgers

Congressional Budget Office

Washington, DC

Louis Rossiter

Medical College of Virginia

Virginia Commonwealth University

Richmond, VA

Earl Schwartz

Bureau of Data Management and Strategy

Health Care Financing Administration

Baltimore, MD

Anne Scitovsky

Health Economics Department

Palo Alto Medical Foundation

Palo Alto, CA

Marc Segal

Department of Health Care Resources

American Medical Association

Chicago, IL

Ralph Shaffarzick

Blue Shield of California

San Francisco, CA

Philip A. Shelton

Eye Physician Associates

Hartford, CT

George Silver

Health Research Group

Washington, DC

Malcolm Sneen

Bureau of Data Management and Strategy

Health Care Financing Administration

Baltimore, MD

William Sobaski

Office of Research

Health Care Financing Administration

Baltimore, MD

George F. Stevenson

American Society of Clinical Pathologists

Chicago, IL

Eugene Stickler

Bureau of Data Management and Strategy

Health Care Financing Administration

Baltimore, MD

Rosemary Sweeney

The American Academy of Family Physicians

Washington, DC

Sherry A. Terrell

Office of Research

Health Care Financing Administration

Baltimore, MD

Edward R. Thorns

Pennsylvania Blue Shield

Camp Hill, PA

Joan B. Trauner

Institute for Health Policy Studies

School of Medicine

University of California, San Francisco

San Francisco, CA

Sidney Treiger

Office of Demonstrations and Evaluation

Health Care Financing Administration

Baltimore, MD

Leroy Walters

Center for Bioethics

Kennedy Institute of Ethics

Georgetown University

Washington, DC

Peter Welch

Office of Management and Budget

Washington, DC

Norman Welford

Bureau of Medical Devices

Food and Drug Administration

Silver Spring, MD

Howard West

MANDEX, Inc.

Vienna, VA
App. B—Acknowledgments and Health Program Advisory Committee ● 217

Richard E. Wild

Office of Reimbursement Policy

Health Care Financing Administration

Baltimore, MD

Irwin Wolkstein

Health Policy Alternatives

Washington, DC

David Worthen

Veterans Administration

Washington, DC

Bernice Young

Bureau of Health Maintenance Organizations and

Resources Development

Health Resources and Services Administration

U.S. Department of Health and Human Services

Rockville, MD

Donald Young

William Pepper Lab

Hospital of the University of Pennsylvania

Philadelphia, PA

Barbara Wynn

Bureau of Eligibility, Reimbursement, and

Coverage

Health Care Financing Administration

Baltimore, MD

Workshop on Administrative Feasibility of Alternative Methods

of Paying for Physician Services, June 13, 1985

Charles R. Booth

Office of Reimbursement Policy

Health Care Financing Administration

Baltimore, MD

Merwyn Greenlick

Health Services Research Center

Kaiser-Permanente Medical Care Program

Portland, OR

Jean Harris

Office of Program Operations and Procedures

Health Care Financing Administration

Baltimore, MD

Lisa Iezzoni

Health Care Research Unit

Boston University Medical Center

Boston, MA

Stephen Isaacson

Policy Division

Office of the Civilian Health and Medical Program

of the Uniformed Services

Aurora, CO

Ronald M. Klar

Health Services Analysis, Inc.

Washington, DC

Sidney Lee, Workshop Chair

Milbank Memorial Fund

New York, NY

Arthur Lifson

Equitable Life Assurance Society of America

New York, NY

Chris McEntee

American Association of Retired Persons

Washington, DC

Helen Oglesby

Blue Shield of California

San Francisco, CA

C. Burns Roehrig

American Society of Internal Medicine

Boston, MA

Christie Somers

Health Services Alternative Delivery System

Development

John Hancock Insurance Co.

Boston, MA

Robert Taylor

American Academy of Family Physicians

Spartanburg, SC

Howard West

MANDEX, Inc.

Vienna, VA
218 • Payment for Physician Services: Strategies for Medicare

Health Program Advisory Committee

Sidney S. Lee, Chair

President, Milbank Memorial Fund

H. David Banta

Project Director

STG Project on Future Health Technology

The Netherlands

Rashi Fein

Professor

Department of Social Medicine and Health Policy

Harvard Medical School

Harvey Fineberg

Dean

School of Public Health

Harvard University

Patricia King

Professor

Georgetown Law Center

Joyce C. Lashof

Dean

School of Public Health

University of California, Berkeley

Alexander Leaf

Professor of Medicine

Harvard Medical School

Massachusetts General Hospital

Frederick Mosteller

Professor and Chair

Department of Health Policy and Management

School of Public Health

Harvard University

Norton Nelson

Professor

Department of Environmental Medicine

New York University Medical School

Robert Oseasohn

Associate Dean

School of Public Health

University of Texas

Nora Piore

Senior Fellow and Advisor to the President

United Hospital Fund of New York

Dorothy Rice

Regents Lecturer

Department of Social and Behavioral Sciences

School of Nursing

University of California, San Francisco

Richard Riegelman

Associate Professor

George Washington University

School of Medicine

Walter Robb

Vice President & General Manager

Medical Systems Operations

General Electric

Milwaukee, WI

Frederick C. Robbins

University Professor

Department of Epidemiology and Biostatistics

School of Medicine

Case Western Reserve University

Cleveland, OH

Frank E. Samuel, Jr.

President

Health Industry Manufacturers’ Association

Rosemary Stevens

Professor

Department of History

and Sociology of Science

University of Pennsylvania
Appendix c

Medicare and Medicaid Payment

for Physicians’ Services

Introduction

Third-party payment practices for physicians’ services are complex and diverse, Third-party payers i n

the United States have traditionally paid a fee for each

service* provided by physicians. Nonetheless, there are

a variety of approaches in actual payment practices

under fee-for-service among third-party payers, including public programs. Diversity is expected because feefor-service is a generic term that includes multiple elements (e. g., payment basis, level determination, and

payment updating schedule) that can be combined in

numerous ways. Furthermore, public programs have

broad policy discretion within Federal legislation, regulation, and guidelines in designing payments for physicians.

This appendix describes third-party payment for

physicians’ services in the public sector, focusing on

the Medicare program. A general description of the

Medicare program is followed by a summary of the

origins of the fee-for-service method adopted by the

program and a description of the current payment

methods for physician services under Medicare. Although fee-for service by far is the most common

method, the Medicare program has adapted it in numerous ways for special circumstances and has sometimes used other payment methods. This appendix also

includes a section on physician payment under Medicaid, highlighting similarities to and differences from

the Medicare program.

Medicare Payment for

Physicians’ Services

The 1965 legislation that established Medicare under Title XVIII (Health Insurance for the Aged and Disabled) of the Social Security Act mandated eligibility

for insurance benefits for most Americans 65 years and

over.2 On July 1, 1973, the Social Security Amendments of 1972 (Public Law 92-603) extended eligibility to persons under 65 who have been entitled for a

period of 24 months to Social Security or Railroad Retirement benefits because they are disabled, and to

I Throughout this appendix, the terms service and technology are used as

synonyms.

‘Although eligibility for Part A is tied to eligibility for Social Security, at

the onset of the program, individuals who were age 65 and not ellgible for

Social Security were given 3 years to establlsh eligibility (445)

most workers and their dependents with end-stage renal disease (ESRD).

Medicare covers hospital insurance benefits (Part A)

and supplementary medical insurance benefits (Part

B). Table C-l displays Medicare’s current benefits and

the financial responsibilities of the program and its

beneficiaries under Parts A and B. Part A’s primary

purpose is to provide insurance against the costs of

inpatient hospital care. Other benefits include payment

for inpatient psychiatric services, skilled nursing facility services, home health services, hospice services,

and comprehensive ambulatory rehabilitation facility

services. Payment for most physician services is under Part B, which also includes payment for outpatient

hospital services, ambulatory laboratory and X-ray

services, ambulatory physical therapy and speech

pathology services, and various other limited ambulatory services and supplies, such as prosthetic devices

and durable medical equipment (see table C-l). part

B also covers home health services for those Medicare

beneficiaries who have Part B coverage only. The law

excludes most preventive services and certain other

services, such as dental and custodial care.

In order to pay for a new technology (service) that

is not mandated or prohibited by law, a decision to

cover the specific service, or technology, is required.

(Coverage is distinguished from payment in that coverage refers to benefits available to eligible beneficiaries, and payment refers to the amount and methods

of payment for covered services (585). ) Impressive advances in the numbers and types of technologies available to the health care system in recent years has led

to an increasing need for coverage decisions. Medicare

decides whether or not to cover a service on the basis

of Section 1862 of the Social Security Act, which prohibits payment for items and services that are “not reasonable and necessary for the diagnosis or treatment

of illness and injury or to improve the functioning of

a malformed body member. ” The criteria Medicare

uses to determine if a technology meets the broad statutory language of “reasonable and necessary” are: 1)

general acceptance as safe and necessary, 2) not experimental, 3) medically necessary, and 4) provided

according to standards of medical practice in an appropriate setting.3

3

The OTA report Medical Technology and Costs of the Medicare l’rogr~rn

(486) includes a comprehensive discussion of Medicare’s coverage process

219
220 Ž Payment for Physician Services: Strategies for Medicare

Table C-1.–Medicare Benefits and Limitations, as of January 1986

Kind of care Medicare pays Beneficial pays Comments

Part A:

Hospitalization 1-60 days

61-90 days

91-150 days (60 day lifetime reserve)

After 150 days—no coverage

Initial deductible ($492) Deductible and copayments are adjusted

Daily copayment ($123) annually

Daily copayment ($246) Lifetime reserve can be used only once

Psychiatric Same as hospitalization Same as hospitalization Lifetime limitation of 190 days of

coverage

Skilled nursing

facility

1-20 days

21-100 days

After 100 days—no coverage

Nothing

Daily copayment ($61.50)

Home health

services

Hospice care

Unlimited visits

Reasonable costs

Nothing Beneficiary must be eligible for Part A

Prospective payment rates, per day to

maximum of $6,500 average “cap” per

beneficiary to each facility

Routine home care: $53.17

Inpatient respitea care: $55.33

General inpatient care: $271.00

Total continuous home care: $358.67

50/0 of cost to program for:

—Drugs and biological (not

to exceed $5 per

prescription)

—Inpatient respite a care

(per day) (total not to

exceed inpatient

Beneficiary may elect hospice care in

lieu of other medical care services

(with its attendant deductibles and

copayments), for two periods of 90

days and one of 30 days, to be taken

that order, upon determination of a

terminal illness.

in

deductible) Benefit provision expires Sept. 30, 1986.

Part B: SMI basic premium—

$15.50/mo.

Home health Unlimited visits Nothing Beneficiary eligible for Part B only

services Reasonable costs

Physician and other 80% of approved charges after deductible Initial deductible ($75)

medical services 20% of approved charms is met

1000/. of approved charges for services

provided in approved ambulatory surgical

center or hospital outpatient department

if the physician accepts assignment

Pneumococcal vaccine

Hepatitis B vaccine (for ESRD patients and

others at high risk of hepatitis)

Excess of physician charges

above approved charges if

physician does not accept

assignment of benefits

Nothing for covered

vaccines, deductible does

not apply

All costs for all other

vaccines

All other charges

Immunizations

Chiropractors’

services

Most routine foot

care

Dentists’ services

Manual spinal manipulation

Nothing All charges

Jaw surgery, setting of facial fractures, All other charges

treatment of oral infections

May cover other dental services when

incident to the provision of covered

medical services

Dentures

Routine hearing

and eye exams

Nothing All costs

Nothing All costs Examinations may be covered as incident

to other diagnostic and therapeutic

procedures, e.g., prior to surgery to

correct hearing and vision disorders

Eyeglasses and

hearing aids

Routine physical

examinations

Prosthetic devices

Nothing All costs

Nothing All costs Examinations covered as incident to

diagnosis and treatment

Those needed to substitute for an internal All costs

body organ, or for artificial limbs and

eyes, and arm, leg, back, and neck

braces

If rented, approved charges 200/0 coinsurance

If purchased, monthly payments until

Medicare’s share is paid or equipment is

no longer necessary

For long-term use, payment may be made

in a lump sum

Dressings, splints, and casts

Equipment furnished by provider is paid

by Part A intermediary on a reasonable

cost basis

Durable medical

equipment

Medical supplies All other costs (e.g., common Physicians may bill for supplies provided

first aid supplies at cost to them

purchased by patient)
App. C—Medicare and Medicaid Payment for Physicians’ Services ● 221

Table C-1 .—Medicare Benefits and Limitations, as of January 1986—Continued

Kind of care Medicare pays Beneficiary pays Comments

Blood For all but first 3 pints First three pints or replace

Outpatient mental 62.5°/0 of reasonable charges up to $500 37.5°/0 of reasonable charges

illness (i.e., $312.50) up to $500, and 100°/0 of

charges above $500

Outpatient physical In doctor’s office, 800/0 of approved $75 deductible and 20°/0

therapy charges after deductible is met coinsurance

From physical therapist, $400/yr. maximum All costs above $400/yr.

From clinic, home health agency, or other $75 deductible and 200/0

agencies, 800/0 of approved charges after coinsurance

deductible

End-stage renal 80% of prospectively determined, per $75 deductible and 200/. Coverage ends 12 months after the

disease treatment regionally adjusted rates coinsurance month maintenance dialysis stops or

treatments Physicians’ services incident to 36 months after month of kidney

maintenance dialysis, 800/0 of monthly transplant

cavitation rates

Comprehensive Lesser of 800/0 of reasonable cost or the $75 deductible and 20°/0 of In order for the beneficiary to receive

outpatient reasonable cost minus 20°/0 of customary charges reimbursement for CORF services, a

rehabilitation reasonable charges physician must submit a plan of

facilities (CORF) treatment which must be reviewed

every 60 days, Coverage ends when no

further progress is being made with

respect to the goals specified in the

plan

Rural health 800/0 of prospectively determined all- $75 deductible and 20°/0

services inclusive per visit rate coinsurance

aRespite care is defined as short-term (limited to 5 days) inpatient care provided to the individual only when necessary to relieve the familY members or other Persons

caring for the Individual during period of hospice election.

SOURCE” Commerce Clearing House, Inc., Medicare and Medicaid Guide (Chicago, IL: Commerce Clearing House, Inc , 1985),

Part A is an entitlement program and is available

without payment of a premium to those eligible.4 Individuals who are not automatically entitled may voluntarily obtain insurance by paying the full actuarial

cost of such coverage ($174 per month in 1985) (471).

Individuals eligible for Part A are automatically enrolled in Part B unless they indicate they do not wish

to be enrolled. Any citizen or legal alien for 5 years

who is age 65 and older, even individuals who are not

eligible for Part A, may enroll in Part B, a distinct program under Medicare. Participation in Part B is voluntary and requires payment of a monthly premiums

The Part B, premium is deducted automatically from

monthly Social Security checks, except in cases where

States pay the premium or when work or some other

event precludes payment of the monthly benefit check.

Participation in Part B is high. In 1982, 99 percent of

the eligible elderly and 92 percent of eligible disabled

people in Part A were also enrolled in Part B (467).

Medicare is administered through private contractors

(intermediaries for Part A and carriers for Part B), all

of whom maintain a private business as well as the

Government contract business. In fiscal year 1984,

Medicare had 60 carrier jurisdictions that were serviced by 39 carriers: 28 Blue Cross/Blue Shield Plans

and 11 others (514).

‘Thirty percent, or 4 mllllon, of State and local employees are the ma]or

group of ind]wduals currently not el]gible for Part A (27)

‘The I’art B premium was $15.50 month as of Jan 1, 1985.

Fee-for-Service Payment

Background.—By the early 1950s, the movement for

a national health insurance program for the entire population that began in the 1930s had become a proposal

to assist Social Security beneficiaries with the costs of

hospitalization. However, despite the limited nature

of proposed health insurance legislation, successive attempts at passage failed until 1965, when President

Johnson’s active interest in a health insurance program

during and after his successful bid for reelection and

striking changes in the political composition of Congress overcame the resistance of opponents (27). The

knowledge that some form of Medicare would pass

caused some opponents to facilitate enactment of Government health insurance for the elderly and other opponents to sponsor health insurance bills for the elderly

for the first time (287)

In early 1965, revised versions of bills sponsored

by the Administration (H.R. 1 introduced by Rep.

Cecil R. King and S. 1 introduced by Sen. Clinton Anderson) were reintroduced, and Rep. James Burns, a

former opponent, sponsored H.R. 4351—a Government health insurance bill. The King-Anderson bill

called for compulsory contributions and was closely

associated with the Social Security system. It limited

benefits to hospital care, nursing home care, and home

health care. The Burns bill included physician and

other medical services as well as inpatient services. It
222 ● Payment for Physician Services: Strategies for Medicare

provided for voluntary participation and a Government subsidy, and was separated from the Social Security system (445). The Burns bill was modeled on a

high-option Aetna policy available to members of the

Federal Employees Health Benefits Program (27,580).

In a strategic move, Rep. Wilbur Mills, chairman

of the House Ways and Means Committee, proposed

incorporating elements of both the King-Anderson bill

and the Burns bill into Title XVIII of the Social Security Act. b Title XVIII retains the basic philosophy of

both bills. Although insurance for hospital services,

Part A of Title XVIII, is financed by compulsory contributions of employers and employees through the Social Security system, insurance for physician services,

Part B of Title XVIII, is voluntary and is financed from

premiums paid by the insured and general revenues.

The nonregulatory approach of H.R. 4351 was incorporated into the following statutory language (580):

. . . where payment . . . is on a charge basis, such

charge will be reasonable and not higher than the

charge applicable for a comparable service and under

comparable circumstances to the policy holders and

subscribers of the carrier . . . In determining the reasonable charge . . . there shall be taken into consideration the customary charges for similar services as

well as the prevailing charges in the locality for similar services.

Although longstanding advocates of Medicare legislation had recognized that basing physician payment

on physician charges was potentially inflationary,7

they also knew that it was impractical to contest the

method. If Medicare was to be passed, Rep. Mills’ support was necessary, and tampering with his package

in this major way would jeopardize his approval (27).

Furthermore, the logical alternative, i.e., paying physicians on the basis of prospectively determined fees,

exercised more control over physicians than a chargebased method and might have adversely affected physicians’ cooperation with the program (287).

Fee schedules were a traditional payment method

for physician services in the United States that had the

advantages of uniformity and ease of understanding

by both patients and physicians. On the other hand,

the charge-based method that Congress adopted was

relatively new—it had first been used by a Blue Shield

plan in Wisconsin in 1954. Blue Shield had also initiated a “prevailing fee program” for national accounts,

which was designed to permit physicians to establish

charges for their services without being limited by fee

schedules or income levels (312). Furthermore, the

bThe “Eldercare” bills, H.R. 3727 and H. R. 3728, became Title XIX of the

Social Security Act.

7

1n the 1965 Senate debate, the leading Senate proponent of Medicare, Sen.

Clinton Anderson noted that paying physicians their “usual and customary

fees (the Burns suggestion) would significantly and unnecessarily inflate the

cost of the program to the taxpayer and the aged” (287).

method afforded physicians considerable latitude in

establishing payment levels and was considered less

intrusive than fee schedules in a physician’s financial

decisions.

Specific definition of the terminology used in the legislation was lacking, but “ . . . fears of a physicians’

boycott and the absence of an obviously attractive alternative, persuaded Senate reformers not to raise further questions about the sensitive issue of what constituted reasonable charges” (287). The congressional

intent to make health care for aged citizens available

without regard to income level was evident in the report of the Committee on Ways and Means to accompany H.R. 6675. The report states, “where payment

is on the basis of assignment, the reasonable charge

would have to be accepted as the full payment” (478).

In the late 1960s and 1970s, the original statutory language was clarified by a series of regulations and administrative guidelines. In attempts to strengthen Government control over physician payment and to restrain the rising costs of the Part B program, tighter

controls on the operations of the carriers were developed by increasing the frequency of updating physician charges and by freezing charge limits for various

periods of time (27,565).

The payment method and its administration described below have perpetuated a loosely administered, decentralized system with differences in payment

levels among physicians. The implications of the Medicare payment system for current Part B costs and other

effects of the payment system are discussed in chapter 2 of this report. Significant refinements to the current system are considered in chapters 4, 5, 6, and 7.

Current Status.—As noted earlier, Title XVIII of the

Social Security Act specifies that payment for physician services under Part B of Medicare are to be made

on the basis of reasonable charges that are computed

from usual, customary, and prevailing (CPR) charges.8

The Part B program generally pays 80 percent of reasonable charges in excess of the beneficiaries’ annual

Part B deductible, $75 in 1985.

Medicare carriers, private contractors that receive,

process, and pay claims for Part B services, have the

primary responsibility for determining the reasonable

charge for each service provided. Their determinations

are to be consistent with the law, regulations, and general principles and guidelines issued by the Health Care

Financing Administration (HCFA) (509). Although the

basic formula is applied uniformly nationwide, carriers exhibit great variation in executing the method-

‘Both usual, customary, and reasonable and CPR refer to a general system of computing a payment level based on historical and comparative profiles of physicians’ charges. Since CPR is Medicare terminology, it will be

used in this report. The terms reasonable, allowed, and approved are used

as synonyms in this appendix.
App. C—Medicare and Medicaid Payment for Physicians’ Services ● 223

ology in such areas as locality designation and specialty recognition because of the autonomy offered by

the law and implementing instructions.

Based on claims information, Medicare carriers

maintain records of the services provided and the

charges billed by physicians in their charge area. The

carriers then develop individual statistical profiles and

areawide statistical profiles of physician charges,

which are updated annually and are in effect for a “fee

screen” year.’ The standards per fee screen year have

been based on charges submitted during the calendar

year preceding the fee screen year, creating a lag period

in updating (509). For example, the charge limits for

the fee screen year July 1, 1982 to June 30, 1983, were

based on charges received during the preceding calendar year January 1, 1981 to December 31, 1981 (509).

The reasonable charge is the lowest of a physician’s

actual charge, a physician’s customary charge (Level

1 fee screen), or the area’s prevailing charge (Level 2

fee screen). There are special circumstances when the

reasonable charge may not be the lowest of the above

three charges. If there are unusual circumstances or

medical complications causing essentially different

services to be provided, the actual charge for the service may be specified as the reasonable charge even

though the actual charge is higher than the customary charge and prevailing charge. The Social Security

Act requires that the reasonable charge for a service

may not be higher than the charge for a comparable

service provided under comparable circumstances to

a carrier’s non-Medicare subscribers.

The actual charge is the charge the physician has

billed for the service provided. The customary charge

is the physician’s median submitted charge during the

data collection period preceding the fee screen year. 10

The customary charge is fluid. If a physician revises

his or her fees, the carrier will recognize the change

when processing claims with the new charges.

Until 1976, the prevailing charge for a service was

the lowest charge for the service that was greater than

or equal to a percentile of the distribution of physicians’ customary charges weighted by the number of

times each physician billed for the service in a locality (designated as a “charge area”) the previous calen-

‘As a result of provisions of the Deflclt Reduction Act of 1984 discussed

later, the fee screen year as of October 1, 1984, was changed from July 1-

June 30th to October l-September 30th and charge Ilmits for the tee screen

year will be based on charges submitted from April I-March 30th ot the prewous year.

l~The customary charge for a service provided by physicians bewmw a

new pract]ce IS based on the 50th percentile of the customary charges ]n a

charge area weighted by how often physicians b]lled for the serv]ce ~50Q)

In calculating the customary charge, the earner not only corwders charges

made by physicians to Medicare benef]c~aries, but also cons]ders charges made

by the physicians to their pat]ents ]n general The amount of non-Medicare

data included m the computatmn varies among carriers according to the wze

of their non-Medicare business (509).

dar year. The prevailing charge limits were originally

paid by some individual carriers at the 90th percentile. Medicare later set prevailing change limits at the

83rd percentile in 1969, and they have remained at the

75th percentile since 1971 (496).

The Social Security Amendments of 1972 (Public

Law 92-603) placed further limits on the yearly increases in prevailing charge levels—because of subsequent congressional action to prevent a rollback in approved charges, these limits were not fully implemented

until 1976. The amendments established a Medicare

Economic Index (MEI) that relates the rate of increase

in physicians’ fees to increases in general earning levels

and increases in physician practice costs. The index,

which is updated annually for a 12-month period beginning July 1, sets an annual capon prevailing. Prevailing charges are now either the lesser of the prevailing charge (“unadjusted” prevailing) or the product of

the 1973 fee screen year prevailing charge multiplied

by the value of the current MEI (“adjusted “ prevailing) (116). The MEI for 1983 was 2.063. If a prevailing charge for a certain service was $10.00 in 1973,

and if the “unadjusted” prevailing was no less than

$20.63, the prevailing charge for fiscal year 1983 would

be $20,63 (the “adjusted” prevailing). However, if a

prevailing charge for a certain service was $10.00 in

1973, and if the “unadjusted” prevailing in 1983 was

less than $20.63, the prevailing would be set at the

charge that is less than the $20.63 (the “unadjusted”

prevailing).

In implementing the CPR approach, each carrier is

allowed considerable latitude in delineating a charge

area. Carriers are expected to delineate localities based

on their knowledge of local charging practices, service patterns, and differences in population density, economic levels, and other factors that affect charges for

services. Charge areas are usually a subdivision of a

State that includes a cross-section of the population

(509). Thus, there is no uniform geographic configuration for a charge area. Four types of locality configurations are: 1) statewide localities, 2) regional localities (contiguous counties) without specific regard to

urban/rural distinctions, 3) urban and rural localities

comprised of noncontiguous areas, and 4) separate

localities for major metropolitan areas with nonmetropolitan areas consolidated into one or more localities. Currently there are 240 geographic charge localities (514).

Charge areas may also differ according to types and

levels of services. For example, a carrier may decide

in determining a prevailing fee screen that a State has

seven localities for general practitioners, but only one

locality (the entire State) for members of a particular

specialty.
224 . Payment for Physician Services: Strategies for Medicare

Furthermore, carrier practice concerning specialty

recognition for the purpose of determining prevailing

charges is also extremely variable as it is meant to reflect the existing patterns of charges within a locality.

The variation in carrier practice ranges from carriers

that use a single prevailing charge screen for services

of all physicians11 to those carriers that calculate separate prevailing charge screens for individual specialties. Blue Shield of Pennsylvania, for example, has

individual charge screens for more than 50 distinct

specialties (458). Some carriers calculate a prevailing

charge screen for general practitioners and a prevailing charge screen for all other physicians. Other carriers group specialties into other categories, so that

there may be one prevailing charge for all surgical specialties and another prevailing charge for medical specialties. Massachusetts constructs prevailing charge

screens by type of service and recognizes 25 specialties in constructing prevailing screens for visits and

consultative procedures, but only two groups (general

and family practitioners, and other physicians) for

other procedures (475).12

The recognition of specialties is a complex issue,

confounded by the lack of a clear definition of a specialist within the medical community .13 Eighty-two

specific physician specialties and subspecialties are reported by physicians and included in the Masterfile

of the American Medical Association (124). At this

time, some carriers define a specialist as one who is

board-eligible in a particular specialty, and others limit

the designation only to board-certified physicians. Still

other carriers define specialists as physicians who classify themselves as such and who limit their practice

to a particular specialty (30).

11Carriers for the States of Florida, North Dakota, and South Dakota, the

State of Kansas excluding Kansas City, western New York, and the combined

territories of the Puerto Rico and the Virgin Islands use a prevailing charge

screen for the services of all physicians. The American Society of Internal

Medicine has brought suit against Florida Blue Cross Blue Shield to force recognition of specialists. The court suit also concerns differentiating between

physicians and nonphysicians who use the same codes for a service, and discriminating between specialists and levels of expertise. The suit was withdrawn in 198s.

l~~e variation in carrier practice can be explained by the lack of the specificity of the regulations concerning specialty practice and the wide latitude

allowed carriers in implementing instructions. The regulations stipulate that:

1) carriers should be responsive to differentials in levels of charges among

different kinds of services in establishing prevailing charge levels; 2) where

general practitioners and specialists in a locality have established different

levels of fees for their services, the carriers should recognize such differences

in establishing prevailing charge screens; and 3) when the physicians have

not themselves established fee differentials based on specialty practice, the

carrier should not establish artificial ones (42 CFR 405.504).

13An important step on the part of the medical community in defining a

medical specialist was taken on Mar. 20, 1984, when the Ad Hoc Committee

on Designation of a Specialist of the Council of Medical Specialty Societies

released guidelines for the designation of a physician as a specialist. The guidelines do not accept self-designation alone, but list four objective criteria to

be used in verifying specialty designation.

Medicare carriers frequently rely on relative value

studies if there are insufficient charge data about a particular physician’s use of a specific service to determine

a customary charge screen or if there are insufficient

data about the use of a service in a charge area to determine a prevailing charge.14 Physicians also rely on

such studies when determining a fee for a new service.

Relative value studies express the relationship between services in unit values and not dollar amounts. 15

In determining a physician’s customary charge for a

service, the carrier multiplies the relative value of the

service and a monetary conversion factor that is derived from a physician’s known customary charges for

similar services in the same category of service (e. g.,

medicine, surgery, and radiology), In determining the

prevailing charge for a service, the carrier multiplies

the relative value of the service and a monetary conversion factor derived from the fully adjusted prevailing charges for other services in the same category

(509). Thus, an important factor in price determination is the monetary conversion factor which, when

used as a multiplier, establishes the price (or payment

level) for a service, The conversion factor can be

changed to decrease or increase the price of services,

and different conversion factors can be used to develop

different prices for the same service depending on locality, medical specialty, or other factors.

Relative value studies are also procedural terminology documents that health professionals use in describing (coding) services when claiming insurance payment

and for other purposes. The number of terms in the

various studies has increased dramatically over the

years. For example, the number of terms in the Current Procedural Terminology of the American Medical Association increased from 2,084 in 1966 to 6,132

by 1977 and to 7,040 by 1985. The increase in coding

terms is intended to provide physicians with more accurate descriptors of the services provided. It also provides physicians with flexibility in describing services.

]A]n order for a carrier to have a sufficient statistical base on which to calculate a physician’s customary charge for a specific service, the physician must

submit three claims for that service. And, a minimum of four customary

charges for a particular service are required for calculating the prevailing

charge for the service in a locality (88).

15 The antitrust implications of relative value studies have been under examination by the Federal Trade Commission (FTC) and the Justice Department in the past. Continued publication and revision of a number of relative

value studies, including the California Relative Value Study, were halted after the settlement of a series of lawsuits in the mid and late 1970s. The antitrust implications of relative value studies depend on the extent to which the

members of the groups and output involved in their construction attempt

or wish to influence prices and output; thus, the use of relative value studies

by the medical professions can be questioned if the intent of the physicians

is to fix fees. However, their use by health insurers when determining payment levels for physician services appears to “serve a valid function” (266).

Recently, a few medical societies have approached the FTC for advisory opinions concerning the development or updating of new relative value guides

and a reexamination of the previous orders. The current standing of the issue is discussed in ch. 5.
App. C—Medicare and Medicaid Payment for Physicians’ Services ● 225

Recently the Deficit Reduction Act of 1984 (Public

Law 98-369) mandated a fee freeze, which started on

July 1, 1984, of Medicare customary and prevailing

charges for physicians’ services. Although the freeze

is scheduled to continue only until September 30, 1985,

the administration has recommended extending the

freeze for another year (552). The conditions of the

freeze are dependent on assignment arrangements and

are discussed in a section below.

Special Provisions. —There are special provisions for

hospital-based physicians, teaching physicians, and

physician services in intermediate care facilities.

Hospital-Based Physicians, —Hospital-based physicians are defined as physicians who provide ancillary

medical services in a hospital setting. The three “traditional” hospital-based specialties are radiology, pathology, and anesthesiology, although a number of other

types of practices, including emergency medicine, rehabilitation medicine, and cardiology, sometimes meet

this definition.

Since the beginning of the Medicare program, the

Federal Government has made special provisions for

paying hospital-based providers, because the program

requires the separation of charges for professional and

hospital services and because the services hospitalbased physicians provide are so closely allied with hospital services. A physician’s professional service—a

service that contributes to the diagnosis or treatment

of the patient—is paid on a charge basis under Part

B. Other services performed by physicians, such as administrative or quality control activities, are considered hospital services and are reimbursed under Part

A.

In order to simplify reimbursement and claims processing, the 1967 Amendments to the Social Security

Act (Public Law 90-248) allowed “combined billing”

to be used by hospitals for radiology and pathology

services furnished to inpatients, and all physicians’

services furnished in hospital outpatient departments.

Under combined billing, the hospital uses a single billing form for both the professional and hospital components of inpatient radiology and pathology services.

The professional component was identified as a fixed

proportion of the total bill for services. Combined billing could be used only if all the physicians in the radiology or pathology departments had a salary or percentage arrangement with the hospital. 16

lbHo~plta].based physicians are compensated for their services Prlmarll]r

by salary, percentage of departmental revenue, or fee-for serv]ce, with teefor-service becoming the predominant important method Many variations

and combinations of methods have been developed to meet spec]f]c needs

of physicians and hospitals.

The 1967 amendments also specified that radiology

and pathology professional services rendered to hospital inpatients were to be reimbursed at 100 percent

of reasonable charges. Beneficiaries bore no liability

for copayment of those services. Because the charges

that radiologists and pathologists billed to their carriers continued to be reimbursed at the 80 percent level,

this provision was justified as eliminating coinsurance

payments by beneficiaries to physicians whose services were not the choice of the beneficiary. It was also

intended to reduce hospital-based physicians’ incentives for separate billing and thereby reduce processing costs to providers and to the Social Security Administration, even though it made more Federal dollars

available for financing hospital-based services (451).

The intermediaries paid the combined billing charges,

and adjustments were made on an actuarial basis between the two Medicare revenue sources to account

for Part B charges being paid by Part A intermediaries.

The hospital was paid on the basis of cost, using the

charges to compute the cost. The allocation between

the Part A and Part B trust fund was based on the physician’s allocative agreement.

The Tax Equity and Fiscal Responsibility Act of 1982

(TEFRA) (Public Law 97-248) modified the way Medicare pays hospital-based physicians. Section 112 eliminated the provision that Medicare pay 100 percent of

the reasonable charges for pathology and radiology

services delivered to hospital inpatients. These professional services became subject to the same deductible

and coinsurance requirements as other Part B services,

Moreover, HCFA determined that the special processing routines required for combined billing were not justified since the option was never widely used, and in

implementing regulations eliminated combined billing

as of October 1, 1983 (48 FR 39740).

More importantly, TEFRA mandated a clearer distinction between Part A hospital services and Part B

physician services, regardless of the doctor-hospital

relationship. The regulations implementing Section 108

of the legislation restated and clarified the criteria that

must be met for a physician’s service to be paid on a

reasonable charge basis under Part B. In addition to

the existing requirements that the service be personally

furnished by the physician and contribute to the diagnosis or treatment of an individual patient, a requirement was added that the service ordinarily require performance by a physician (48 FR 8902). If the physician

is salaried by the hospital or is on a percentage arrangement, the carrier is required to develop customary

charges based on the compensation that the physician

receives for the services.

TEFRA also mandated that all physician services

that do not meet the conditions for charge payment,

but benefit a hospital or the patient population as a
226 ● Payment for Physician Services: Strategies for Medicare

whole, are considered hospital services and are to be

reimbursed under Part A. Physicians who receive any

compensation from the hospital must have formal

agreements that specify time and reimbursement for

any Part A services or that provide the basis of allocation of payment between Part A and Part B services. The regulations implementing TEFRA provided

that the reasonable cost reimbursement for physicians’

services paid under Part A could not exceed “reasonable compensation equivalent” limits that HCFA developed based on physicians’ average net income adjusted for specialty, location, and hours worked. The

reasonble compensation equivalent limits never became an important factor except for hospital outpatient services, since the implementation of TEFRA and

the Social Security Amendments of 1983, which replaced cost-based reimbursement for inpatient services with a prospective payment system based on rates

determined by diagnosis; both started October 1, 1983.

Part A inpatient physician services are covered by prospective payment just like any other Part A inpatient

service.

TEFRA also mandated specific provisions governing reimbursement for radiologists, pathologists, and

anesthesiologists. The hospital-based radiologist became subject to a limit of 40 percent of the prevailing

fee services generally available in radiologists’ offices

in the community. TEFRA regulations permit payment

on a reasonable charge basis to anesthesiologists for

up to four concurrent procedures if the anesthesiologist also meets specific guidelines defining appropriate patient care. If an assisting nurse anesthetist is employed by the anesthesiologist, the physician can bill

his or her full customary charge as an anesthesiologist. If a nurse anesthetist is employed by the hospital

or is self-employed, computation of the anesthesiologist’s customary charge is based on one-half time units.

(Anesthesiologists bill using a “relative value guide”

that combines time units with the relative difficulty

and skill involved in procedures, )

The greatest changes in TEFRA regarding physicians

apply to pathologists. The legislation defined almost

all clinical laboratory tests as Part A services, and thus,

not reimbursable on a charge basis. Under TEFRA’s

regulations, only clinical laboratory services meeting

very specific criteria can be considered consultative

services and reimbursable under Part B; all other clinical laboratory services are reimbursed by Part A. On

the other hand, all anatomical pathology services are

considered professional services and must be paid on

a reasonable charge basis under Part B, Anatomical

pathology generally requires examination of body tissue, fluid, or cells by the pathologist. Because anatomical pathology services and some clinical laboratory

services, which had previously been combined billed

to Part A, are now required to be billed to Part B, carriers have had to quickly establish customary charges

using charges for similar services.

Teaching Physicians. —Like hospital-based physicians, teaching physicians provide services for the hospital itself (educational and supervisory services) in

addition to supplying professional medical services to

individual patients. Teaching physicians also tend to

be salaried for at least part of their total compensation.

Since 1969, with the issuance of Intermediary Letter (IL) #372, Medicare has targeted teaching physicians for special treatment. IL #372 established criteria

for identifying the personal, identifiable services that

a teaching physician must perform for an individual

patient to qualify for fee-for-service payment (6). In

1972, Section 227 of Public Law 92-603 mandated a

legislative solution to paying teaching physicians, but

was never implemented by regulation. Section 948 of

the Omnibus Reconciliation Act of 1980 (Public Law

96-499) repealed Section 227 and essentially codified

the requirements in IL #372 that define when a teaching physician may bill for professional services.

Section 948 also set forth the manner in which feefor-service payments should be determined for physicians practicing primarily in teaching hospitals. It required that Medicare use the greater of the mean or

modal charge collected from non-Medicare patients to

determine payment for an individual service. In order to ensure a reasonable minimum for Medicare fees,

the Deficit Reduction Act of 1984 amended the 1980

Onmibus Reconciliation Act and set the floor for Medicare fees in a teaching setting at 85 percent of the Medicare prevailing fee in the area.

HCFA has not yet published regulations to implement Section 948 of the Omnibus Reconciliation Act

of 1980, although they are expected some time in 1985

(252). The Medicare program’s only policy that is in

effect is its administrative directive, IL #372, which

stipulates the conditions for charge payment. There

are no promulgated regulations on the level of payment for teaching physicians, and as a result, teaching physicians are today reimbursed by Medicare just

like any other physicians.

Physician Services in Intermediate Care Facilities, —

Under fee-for-service, Medicare limits physician payment for visits to beneficiaries in intermediate care facilities (nursing homes) with respect to multiple visits.

This restriction was initiated in response to reported

abuses early in the program (99). Except when more

intensive care can be substantiated, Medicare pays

only for one physician visit a month to the same patient in a nursing home, and there is a difference in

payment level if more than one patient is visited. If

the visit is a routine followup visit, it is paid at the

level of a routine followup house call. If the physician
App. C—Medicare and Medicaid Payment for Physicians’ Services Ž 227

visits more than one patient (“multiple visits”) for routine followup visits, the payment level is lowered to

that for a routine followup office visit. If the visit is

brief, the Medicare payment may not exceed the payment for brief house calls for single patients and brief

office visits for multiple patients (514). Multiple visit

rates are 25 percent lower on average than single patient visits (318). Attempts by the Office of the Inspector General in the Department of Health and Human

Services to extend the multiple visit limitation to physician visits in skilled nursing facilities17 and hospitals

(254) have been unsuccessful to date (99).

In addition to limiting payment, Medicare and Medicaid rules also require that patients in skilled nursing

facilities be visited at least once every 30 days for the

first 90 days following admission, after which the requirement is lowered to once every 60 days (42 CFR

405 l123(b)). Patients in intermediate care facilities

must be visited every 60 days (42 CFR 442.346 (b)).

Other Payment Methods

Although fee-for-service is by far the method used

to pay for the great majority of physicians’ professional

services under Medicare, the program has veered from

traditional fee-for-service payment and used alternative payment methods for physicians’ professional

services to accommodate to special conditions. In certain circumstances, the program has paid an institution, either on a cost or cavitation basis, and the institution subsequently has paid the physician a salary

or negotiated a fee with the physician for the service

or paid the physician per capita. The Medicare program has also paid the physician directly on a nonfee-for-service basis for some services and uses a statewide fee schedule to pay for certain physician provided

clinical laboratory services.

Physician Services for Kidney Dialysis Patients.—

Medicare uses alternative methods of fee-for-service

in paying for some physician services provided to beneficiaries in the Medicare’s ESRD program. Until August 1, 1983, physicians could choose from two methods of payment for maintenance dialysis, the principal

service provided in the ESRD program. Under the “initial method, ” payment for physician services to patients undergoing maintenance dialysis was to the facility, and physicians negotiated a fee with the facility

for their supervision or for routine services provided

during a dialysis session (nonroutine services were paid

I-A skilled nursing facility IS a specially qualified facility which has the

staff and equipment to provided skilled nursing care or rehabilitation services and other related health services Medicare pays for care in skilled nursjng facdltles and for physician services provided In such facihtles Medicare,

however, does not pay for care provided in nursing homes that are not specially qualifled,

according to reasonable charge criteria). Or, under the

“alternative method, ” Medicare could pay a comprehensive monthly fee per patient. For patients dialyzed

in facilities, the physician’s fee was based on a calculation of the customary or prevailing charges for a followup visit, multiplied by 20, For supervision of home

patients, the weighting factor was set at 14, to reflect

the presumed lower requirements of home patients for

physician supervision (405). The payment would be

made by the carrier to the physician, if the physician

accepted assignment, or to the patient, if the physician did not accept assignment (see discussion of assignment below).

In order to provide incentives to the use of home

dialysis, the Omnibus Reconciliation Act of 1981 (Public Law 97-35) and subsequent regulations (48 FR 21254)

eliminated the “initial method” and require that on and

after August 1, 1983, physician services furnished to

ambulatory maintenance dialysis patients in a freestanding facility or hospital-based facility or to patients

undergoing dialysis at home be paid only under the

alternative method. The calculation of the physicians’

monthly payments is based on the number of typical

dialysis sessions per month, prevailing charges for a

medical specialist’s brief followup visit for an established patient, and prevailing charges for an intermediate followup visit, weighted by the national averages

of patients dialyzed in facilities and at home. 18 Upper

and lower limits on the physicians’ monthly capitation payments were established after adjustments for

extreme ranges in prevailing charges. The minimum

is set at $144 per month and the maximum at $220 per

month for both physician services in the home and in

facilities. HCFA’s intention is not to automatically

change the payment levels according to changes in prevailing charges but to review program data and change

payment levels if warranted (48 FR 21254).

Physician Services for Clinical Laboratory Services.

—Prior to July 1984, Medicare payments for clinical

laboratory services furnished by a physician or an independent laboratory were made on a reasonable

charge basis subject to the Part B deductible and coinsurance. 19 The method varied somewhat from Medicare’s traditional CPR method of computing reasonable charges. The reasonable charge for ambulatory

laboratory services was the lowest of the actual charge,

the customary charge, the prevailing charge in the locality, and the lowest charge at which the test is widely

and consistently available (which was established for

12 common laboratory tests).

“specifics of the calculation are ~n 48 FR 21269.

19A later~tiondiscusse5 Medicare’s deductible and coinsurance under part

B.
228 ● Payment for Physician Services: Strategies for Medicare

Assignment was permitted on a case-by-case basis,

and physicians could bill for laboratory services

whether or not they performed or supervised the test .20

When the physician’s claim indicated that the test was

performed in the office, Medicare would pay the physician as indicated above; when the physician’s claim

indicated that the test was performed by an outside

laboratory, Medicare would pay the physician the laboratory’s reasonable charge plus a $3 handling fee.

Before July 1984, Medicare payment for laboratory

services ordered during hospital outpatient visits was

on the basis of reasonable cost. Hospitals providing

these services to their outpatients were required to accept assignment; hospitals providing these services to

nonhospital patients receiving laboratory services from

a hospital serving as an independent laboratory were

not required to accept assignment and were paid on

a reasonable charge basis.

The Deficit Reduction Act of 1984 established a different payment method–a carrier-based fee schedule—for clinical laboratory services conducted in physicians’ offices, in independent laboratories, and in

hospital laboratories acting as independent laboratories, i.e., furnishing tests to nonhospital patients. The

fee schedule was established at 60 percent of the prevailing charge levels for the fee screen year beginning

July 1,1984. After 3 years, a national fee schedule will

be formulated with methodology as yet undefined, to

serve as the basis of payment.

The 1984 law also established a fee schedule for clinical laboratory services conducted by hospital laboratories serving hospital outpatients—the payment level

to be set at 62 percent of prevailing charges. After 3

years payment will be on the basis of cost reimbursement unless Congress decides otherwise.

Other relevant provisions in the Deficit Reduction

Act of 1984 include an annual adjustment of fee schedules to reflect changes in the consumer price index for

all urban consumers (U.S. city average) and permission for the Secretary of Health and Human Services

to adjust the fee schedules to reflect technological

change, emergency services, and other special services.

Furthermore, the act also modifies current billing

and assignment options. Physicians may bill for services only if the physician personally performs or supervises the test. Anyone who furnishes laboratory

services may bill a nominal amount, currently $3 for

the collection of the patient specimen; however, only

one collection fee per patient encounter will be permitted, Physicians may continue to accept assignment

on a bill-by-bill basis, but independent and hospital

laboratories must accept assignment. For assigned

2 0A detailed description of assignment under Medicare is in a subsequent

section of this appendix.

claims, Medicare will reimburse at 100 percent of the

fee schedule and waive coinsurance and the deductible for all assigned tests. Physicians can accept assignment on the laboratory portion of a claim only and

not accept assignment for other services.

Physician Services and Health Maintenance Organizations (HMOs).—Medicare does not pay physicians

directly for their services provided in HMO settings,

but contracts with HMOs for physician and other services. The original Medicare legislation authorized payment on the basis of the costs to the organization for

providing the specific services to beneficiaries. The Social Security Amendments of 1972 added the option

of paying HMOs on a risk-sharing basis for services

covered under both Part A and Part B to the existing

method of reimbursement on a reasonable cost basis.

Under the risk-sharing method, a per capita reimbursement rate that reflects the estimated costs to an HMO

for its enrolled Medicare population is compared at

the end of the year to the actuarial measure of the costs

that would have been incurred by Medicare to serve

comparable beneficiaries within the HMO’s service

area on a fee-for-service basis (the average adjusted

per capita cost or AAPCC). If the HMO’s costs are

less than the AAPCC, the HMO is reimbursed for costs

and receives one-half of the excess of the AAPCC over

its costs, up to a maximum of 10 percent of the AAPCC.

If the HMO’s costs are greater than the AAPCC, the

HMO has to absorb the entire loss.

Both the risk and reasonable cost reimbursement

methods required retrospective determination of costs,

which is an awkward arrangement for HMOs, which

are designed to operate under prospective budgets

without extensive reporting requirements to thirdparty payers. Furthermore under the risk-sharing

method, although the HMO might have to absorb all

losses, it can share in only half of any surpluses. This

lack of a strong incentive resulted in only one HMO’s

entering into a risk-sharing contract with Medicare.

As of June 1984, 62 HMOs were reimbursed on a cost

basis and an additional 26 were reimbursed on a risk

basis under various HCFA demonstration projects.

Forty-four other health care prepayment plans had

contracts with HCFA on a cost basis for Part B services only (50 FR 1341).

In 1982, the Tax Equity and Fiscal Responsibility Act

or TEFRA changed the way organizations are reimbursed on a risk basis to permit prepaid cavitation payment without retroactive adjustments. The regulations,

which became effective February 1, 1985, provide for

monthly per capita payments equal to 95 percent of

the AAPCC, as adjusted for geographic area and variations within the enrolled Medicare population—age,

sex, disability status, welfare status, institutional status, and other relevant factors (50 FR 1369). The orga-
App. C—Medicare and Medicaid Payment for Physicians’ Services • 229

nization is also required to compute an “adjusted community rate”—a rate equal to the premium the organization would charge its non-Medicare enrollees for

the Medicare covered services adjusted to reflect the

utilization characteristics of the organization’s Medicare enrollees. If the organization’s adjusted community rate is less than the cavitation payment rate, the

HMO may keep the entire surplus, but must use it either for providing beneficiaries with additional benefits beyond those required by Parts A and B of Medicare or for reducing premium rates. The HMO may

also put some of the surplus into a benefit stabilization fund or return it to HCFA (see ch. 7). If the adjusted community rate exceeds 95 percent of the AAPCC,

the organization may elect to be reimbursed on a reasonable cost basis as in the past,

TEFRA also expands the definition of organizations

eligible to contract with HCFA for Medicare payment

to other medical delivery systems, termed competitive

medical plans, that do not meet the restrictive definition of federally qualified HMOs in the Public Health

Service Act. Like HMOs, competitive medical plans

are required to enroll members on a prepaid capitation basis and assume full financial risk for the full

scope of Part A and Part B Medicare benefits. HMOs

that have federally qualified must meet other structural regulations and are required to community rate,

rather than experience rate, their premiums for their

private lines of business (see ch. 7).

Physicians’ Acceptance of Medicare Payment

Physicians receive Medicare payment for each claim

for their services on an assigned or nonassigned basis. When a physician accepts assignment, the physician agrees to accept Medicare’s reasonable charge determination as full payment. The physician bills the

program directly and, after the deductible is satisfied,

is paid an amount equal to Medicare’s reasonable

charge less the 20-percent coinsurance, which is the

patient’s share of the bill. If the patient has not had

bills sufficient to meet the annual deductible, the patient is also obligated to pay the physician the deductible amount not met.21

When a physician does not accept assignment, the

physician bills the beneficiary and the beneficiary requests reimbursement from Medicare. If Medicare’s

reasonable charge is lower than the physician’s actual

charge, the beneficiary is responsible for paying the

difference between the two charges in addition to the

amount of the coinsurance after the beneficiary has

satisfied the deductible. The physician’s actual charge

21The (oIIOwing section on beneficiary financial liability discusses deductibles and coinsurance in detail.

is included in the calculation of the customary charge

and the prevailing charge for the next fee screen period

irrespective of his or her assignment status.

The nationwide net assignment rate of claims declined from a high of 61.5 percent in 1969 to a low

of 50.5 percent in 1976 and 1977, and rose to 59 percent of claims and 59.6 percent of charges in 1984

(518). Voluntary assignment is lower than the above

rates indicate, since joint Medicare-Medicaid claims

are factored into the calculations and assignment is

mandatory for Medicaid beneficiaries. The number of

the noninstitutionalized dually entitled people, i.e.,

those eligible for both Medicare and for Medicaid, is

estimated at over 3 million or about 15 percent of persons over age 65 (295). However, the exact number

of Medicaid beneficiaries who are enrolled in Part B

of Medicare is unknown due to insufficient data about

the institutionalized elderly and “buy -ins,” i.e., beneficiaries for whom States pay the Part B premium.

Based on estimates of the dually entitled, voluntary

assignment rates appear to average about 11 percent

less than indicated by the aggregate statistics (496).

Specific estimates of the voluntary assignment rate

ranged from 35 (1) to 40 percent in 1982 (486) to 42

to 43 percent in 1982 (174a).

The assignment rate varies according to a number

of factors, including the following:

1.

2.

3.

Physician.—Selected physician reimbursement

data from Medicare and Medicaid programs in

the 1970s indicate that 28 to 30 percent of physicians never accept assignment, 18 to 19 percent always accept assignment, and 52 to 53 percent make their decisions on a case-by-case basis

(71,315). Later data from the American Medical Association show that in 198483.9 percent

of all non-Federal patient care physicians who

treated some Medicare patients sometimes accepted assignment. Slightly over 16 percent did

not accept assignment for any patient and 32.1

percent accepted assignment for all of their patients (15).

Beneficiary. —Physicians are more likely to accept assignment for disabled Medicare beneficiaries than for elderly beneficiaries and for the

older Medicare population than for the younger elderly (494).

Geography,—The region and, even more so, the

State are factors in accepting assignment. In calendar year 1982 assignment rates ranged from

82.9 percent in Rhode Island to 19.4 percent in

Wyoming (494). i-he geographical variation has

been ascribed to historical precedent, physician

preference, and administrative practices of individual carriers (496).
230 Ž Payment for Physician Services: Strategies for Medicare

4.

5.

6.

Medical specialty .—The highest assignment

rates (about 60 percent) are in the hospital-based

specialties of pathology and radiology (297).

Among office-based physicians, general surgeons

had the highest and otolaryngologists and ophthalmologists had the lowest assignment rates

(138).

Size of bill.—Physicians tend to accept assignment more often on bills of $100 to $200 than

on bills lower than $100 or higher than $200

(297,494).

Payment level.—Assignment rates increase with

an increase in Medicare reimbursement rates,

and decrease with a decrease in reimbursement

rates (188,315,357,394).

A recent, fundamental addition to the assignment

process is the establishment of a participating physician program on July 18, 1984, as mandated by the

Deficit Reduction Act of 1984. The acceptance of assignment on a bill-by-bill basis still pertains for those

physicians who decide not to become participating

physicians. However, those physicians who have become participating physicians have voluntarily entered

into an agreement to accept assignment for all services provided to Medicare patients for 12-month periods beginning on October 1st of each year (516).

There are a number of incentives in the legislation

to encourage participation; the major incentive is that

participating physicians are exempt from a limitation

on future physician charge increases. The statute, as

noted earlier, freezes Medicare customary and prevailing charge levels for the services of physicians from

July 1, 1984, through September 30, 1985. The law

prohibits nonparticipating physicians from raising

their actual charges to Medicare patients during the

15-month freeze period and stipulates that Medicare

will not recognize any increases in charges during the

fee freeze period in calculating customary charges on

October 1, 1985, and October 1, 1986. In addition,

if nonparticipating physicians increase their actual

charges billed to Medicare beneficiaries, they can be

excluded from the Medicare program for up to 5 years

or be subject to civil monetary penalties.

Participating physicians are exempt from some of

these limitations. Although no increases in Medicare

payment are permitted from July 1, 1984, to September 30, 1985, participating physicians who increase

billed charges during the 15-month freeze were to have

the increase recognized in the customary charge updates on October 1, 1985, and October 1, 1986.22

Other incentives for participating physicians include

22A~ noted earlier, the Administration’s budget proposal for 1986 includes

extending the phyician fee freeze for an additional 12 months and delay updating of participating physicians payments by 1 year,

listings in directories made available to beneficiaries,

toll-free carrier telephone services, and electronic transmission of claims.

January 1985 data show that almost one-third (29.8

percent) of all physicians billing Medicare have chosen to become participating physicians (516). The level

of participation varies by specialty and State. As can

be seen in table C-2, “other” surgical specialists, anesthesiologists and otolaryngologists have the lowest percentage of participation; and nephrologists, radiologists, and pathologists have the highest percentage of

participation. Among the States, physicians and suppliers who practice in South Dakota, Alaska, and

North Dakota have the lowest percentage of participation; and physicians who practice in Alabama, Kansas, and the District of Columbia have the highest percentage of participation (516).

More recent data indicates that 30.4 percent of all

physicians billing Medicare were participating physicians in fiscal year 1985 and 28.4 percent are expected

to participate in fiscal year 1986.

The assignment rate for all physicians, participating and nonparticipating, in January 1985 had increased to 66.5 percent, a considerable increase over

the fiscal year 1984 rate of 56.4 percent (352). The 66.5

percent assignment rate includes mandatory assigned

claims by clinical laboratories, as indicated earlier, as

well as physicians who have accepted assignment on

a claim-by-claim basis, and physicians who have accepted assignment for all services to Medicare beneficiaries. The assignment rate for fiscal year 1985 for

all physicians has increased to 67.7 percent (521a).

Beneficiary Payment Liability

Eligible individuals must pay monthly premiums for

coverage of physician and other services under Part

B and are subject to a deductible and coinsurance for

covered services used. If a physician does not accept

assignment, the Medicare patient is also liable for the

difference between the amount the physician bills and

the amount Medicare allows for the service. Services

that are not covered for payment by Medicare are the

complete financial responsibility of the beneficiary.

Beneficiaries’ participation in Part B of the Medicare program begins with a fixed monthly premium,

which has been rising gradually from $9.60 in fiscal

year 1980 to $15.50 on January 1, 1985, a 60-percent

increase (see table C-3) (523). The annual out-of-pocket

premium payment by the elderly for Part B coverage

increased 138 percent from 1977 ($78) to 1985 ($186).

At the outset of the program, premiums contributed

half of Part B revenues, while general revenues subsidized the other half. Subsequent amendments limited

Part B premium increases to no more than the percent-
App. C—Medicare and Medicaid Payment for Physicians’ Services ● 231

Table C-2.—Medicare Participating Physicians and Suppliers

—.

Percentage of Percentage of

Number of all physicians/ Number of all physicians/

Specialty participants suppliers Specialty participants suppliers

Physicians (M.D.s and D. O. S):

General practice . . . . . . . . . .

General surgery ., . . . . . . . . . . .

Otology, Iaryngology, rhinology ., .

Anesthesiology ., ., . . . . . . . . . .

Cardiovascular disease . . . . . . .

Dermatology . ., . . . . . . . .

Family practice . . . . . ., ., . . . . . . .

Internal medicine . . . . . . . . . . .

Neurology ... ... . . . . . . . .

Obstetrics-gynecology . . . . . . . . . .

Ophthalmology . . . . . . . . . . . . . . .

Orthopedic surgery ., . . . . . . .

Pathology. . . . . . . . . . . . . . . . . . .

Psychiatry . . . . . . . . . . . . . . .

Radiology . . . . . . . . . . . . . . . . . . .

Urology. ....... . . . . . . . . . . . . .

Nephrology . . . . . . . . . . . . . . . . .

Clinic or other group practice—

not GPPP. ., . . . . . . . . .

Other medical specialties . . . . . . .

Other surgical specialties . . . . . . .

13,743

9,491

1,741

3,269

3,820

2,089

8,820

21,067

2,543

4,220

4,220

4,096

2,263

6,871

6,658

2,381

944

6,795

6,515

4,398

27.30/a

33.9

24.6

21,1

35.6

34.0

25.5

32.5

34.8

27.3

27.3

29.0

39.6

30.0

41,3

27.8

50,8

33.8

32.4

18.2

Limited license practitioners:

Chiropractor . . . . . . . . . . . . . . . . .

Podiatry-surgical chiropody . . . . .

Optometrist . . . . . . . . . . . . . . . . . . . .

Other limited license practitioners

(audiologists, psychologists,

physical therapists) . . . . . . . . .

Independent laboratory . . . . . . . . .

Durable medical equipment

suppliers . . . . . . . . . . . . . . . . . . . .

Ambulance service suppliers . . . . .

Miscellaneous suppliers

(orthotists, prosthetists,

portable X-ray suppliers) . . . . . .

Grand total . . . . . . . . . . . . . . . . .

Total physicians . . . . . . . . . . . . . . . .

Total limited license

practitioners . . . . . . . . . . . . . . . . .

Total suppliers . . . . . . . . . . . . . . . . .

6,217

4,541

4,541

2,845

1,698

5,018

2,551

8,555

156.001

118.428

19,751

17,822

25.40/a

38,2

38.2

36.8

28.4

22.7

28.6

22.5

29.4 %

29.8

34.0

23.8

SOURCE: US Department of Health and Human Services, Health Care Financing Administration, HCFA Fact Sheet January 1985

Table C-3.—Monthly Beneficiary Premium for Medicare Part B Coverage

Inflation adjusted Annual increase

premium above inflation

Period Premium (1980=100) a

(percent change)

Fiscal year 1980 . . . . . . . . . . . . $ 9.60 $ 9.60 NA

Fiscal year 1981 . . . . . . . . . . . . 11.00 9.98 3.96

Fiscal year 1982 . . . . . . . . . . . . 12.20 10.44 4.61

Fiscal year 1983 . . . . . . . . . . . . 13.50 11.22 7.47

Calendar year 1984 . . . . . . . . . . 14.60 11.72 4.46

Calendar year 1985.... . . . . . . 15.50 — —

aPremlum deflated by Consumer Price Index forUrban Wage Earners and Clerical Workers forthecalendar year, aspubllshed

in US Department of Labor, Bureau of Labor Statlstlcs, Monthly Labor Review, September 1985

SOURCES US Department of Health and Human Services, Health Care Financing Administration, Medfcare Program Stat/stics 7981 (Washington, DC US Government Printing Office, 19&3); and 49 FR 38511

age increase in Social Security cash benefits. As a result by 1978, the percentage contribution of premiums

to Part B costs had dropped below 25 percent (164).

The Tax Equity and Fiscal Responsibility Act of 1982

and the Social Security Amendments of 1983 (Public

Law 98-21) temporarily suspended the limitation and

increased Part B basic premiums as of calendar year

1984 to a level that results in premium revenues equal

to 25 percent of program costs. The Deficit Reduction

Act of 1984 extended the requirement that the Part B

premium produce income equal to 25 percent of program costs through 1987, with the constraint that the

increase in the Part B premium may not exceed the dollar amount of the Social Security cost-of-living adjustment (49 FR 38510).

Almost 80 percent of Medicare enrollees 65 years

of age and over used physician services in 1982 and

60 percent of Medicare enrollees met the initial deductible (495), In any year, the beneficiary has to incur an

initial expense—a deductible—before Medicare will

pay for Part B services. In 1982, the deductible was

raised from the first $60 to the first $75 of approved

charges in a calendar year. Coinsurance is applied each

time physician and other Part B services are used and

is 20 percent of the remainder of approved charges after the deductible is satisfied. The deductible and coinsurance per enrollee for 1984 was estimated to average at $236, which is an increase of 143 percent from

1977, when they were $97 (see table C-4).

Beneficiaries also incur costs when physicians do not

accept assignment, since the beneficiary is liable for

any difference between the physician’s billed charge

and Medicare’s payment for the service (reasonable

charge reduction on unassigned claims). HCFA esti-
. .

Table C-4.—Medicare Supplementary Insurance: Estimated Total and Per Enrollee Cost-Sharing for the Aged, 1977-84a

Total in millions

Potential

liability from

Total unassigned Total costYear Deductible Coinsurance copayments claims c

sharing

1977, . . . . . . . . . . $ 969 $1,244 $2,213 $ 804 $3,017

1978 . . . . . . . . . . . 1,011 1,454 2,465 912 3,377

1979 . . . . . . . . . . . 1,055 1,736 2,791 1,158 3,949

1980 . . . . . . . . . . . 1,103 2,112 3,215 1,538 4,753

1981 . . . . . . . . . . . 1,148 2,576 3,724 1,873 5,597

1982 . . . . . . . . . . . 1,525 3,235 4,760 2,281 7,041

1983 . . . . . . . . . . . 1,571 3,967 5,538 NA NA

1984d . . . . . . . . . . 1,616 4,678 6,294 NA NA

NA = Data not available.

Per enrolleeb

Potential

liability from

Total Annual SMI Total cost- unassigned

Deductible Coinsurance copayments premium sharing claims c

$42 $ 5 4 $ 9 7 $89.40 $186.40 $32

43 62 105 95.40 200.40 35

44 72 116 96.65 212.65 43

45 86 131 101.40 232.40 56

46 103 148 123.60 271.60 67

126 186 139.20 325.20 80

60 152 212 146.40 358.40 NA

61 175 236 175.20 411.20 NA

aJanua~ Ig&I current law estimates of copayment amounts based on incurred charges. Data are subject to revision.

b Average annual enrollment is used to calculate these items.

Clncludes both aged and disabled beneficiaries, +(potential liability,, refers to the fact that physicians who do not accept assignment are free to pursue payment Of their billed charges in exceSS Of the Medicare

approved charges from the beneficiary, but it is not known how many actually do SO.

‘Projected.

SOURCE: D.R. Waldo, and H.C. Lazenby, “Demographic Characteristics and Health Care Use and Expenditures by the Aged in the United States: 1977-64,” Hea/th Care Fkrancing Review 6(1):1-29, Fall 1964.

U.S. Department of Health and Human Services, Social Security Administration, Social Security Bulletin, Annual Statistical Supplement, 1962, Table 145 (Washington, DC: 1964).
App. C—Medicare and Medicaid Payment for Physicians’ Services ● 233

mates that the reasonable charge reduction on unassigned claims has increased from $31 per enrollee in

1977 to $85 per enrollee in 1983 (a 214-percent increase) (563).

Of the per capita expenditures on physician services by the aged projected for 1984, the Medicare program is expected to spend 58 percent. The beneficiary

out-of-pocket component, when defined as the deductible, coinsurance, and reasonable charge reduction,

was estimated to be 26.1 percent of the per capita expenditure in 1984 (563). When the Medicare premium

and the payments to the deductible made by Medicare

beneficiaries who do not meet the deductible are included, Medicare beneficiaries are estimated as paying 60 percent of the cost of physician services under

Part B (8).

Most of the elderly participants in Part B have some

form of supplemental “Medigap” private insurance .23

By 1977, approximately 66 percent of the elderly population had some type of private health insurance to

supplement their Medicare benefits (558). Private insurers annually paid $117 in 1984 ($48 in 1977) for

physician services for elderly Medicare beneficiaries

(563). Most policies are supplementary to Medicare

coverage and limited to paying for deductibles and coinsurance (“Medigap”), although there are other forms

of “Medigap” insurance that are more comprehensive.

To the extent that beneficiary unassigned liability is

actually collected, the payment of deductibles and coinsurance by Medigap tends to dilute control of beneficiary use of Part B services through cost-sharing,

Medicaid Payment for

Physicians’ Services

The Medicaid program was authorized in 1966 under Title XIX of the Social Security Act as a social welfare program to provide medical assistance to certain

categories of low-income people, including the elderly,

the blind, the disabled, and members of families with

dependent children (the categorically needy). Medicaid

is a joint Federal-State program that is administered

by individual States under general Federal guidelines

that include minimum benefits that must be available

to eligible recipients and optional benefits that individual States may elect for their recipients.

Both the individual States and the Federal Government provide program funds; the Federal Government

contributes “matching funds” for the categorically

needy, and, if the State chooses, for the medically inZjFor ~ ~omprehen5ive di~u55ion of supplementary medical insurance, See

app. F of the October 1982 OTA report kfedical Technology Under Proposals

To increase Competition in Health Care (483).

digent.24 The Federal Government’s current contribution to Medicaid payment is estimated at an average

of 53 percent with a range from 50 to 78 percent among

the States (236,563).

State Medicaid programs have considerable discretion in the method to determine payment levels and

can use adaptations of either the maximum fee screen

method (CPR) or fee schedules. In early 1982, 25 Medicaid programs used various adaptations of the CPR

method, 12 of which reimbursed at below Medicare’s

75th percentile of prevailing charges (255). The States

vary in how often they update prevailing charges, the

data sources they use to establish physician profiles,

and the percentile at which they set the prevailing

charge (214). For example, Medi-Cal (the California

Medicaid program) at one time defined the prevailing

charge as the 60th percentile in contrast with the 75th

percentile then used in the Medicare program (430).

State Medicaid programs are required to use the MEI

as a screen to limit the rate of increase in prevailing

charges (214).

In 1982, 24 States reported using a fee schedule

(255). Some States derive their fee schedule from Medicare or private insurance payment levels and adjust

the schedule over time. Others base the fee schedule

on a relative value scale and a conversion factor of

their choosing (214). Two States reported using this

methodology in 1982 (255).

Although in 1979, almost an equal number of States

based payment levels on fee schedules as those that

used the CPR methodology, 7 of the Nation’s 10 largest

Medicaid programs used fee schedules, and States with

fee schedules accounted for 68 percent of all Medicaid

expenditures. States that employed fee schedules increased their fees much less frequently than States that

used the CPR methodology to establish payment levels

(214).

The fee levels in the Medicaid program average only

72 percent of Medicare levels and areas low as 49 percent in some States (204). The State Medicaid programs vary widely in payment levels. When an adjusted weighted average fee for each State adjusted for

the cost of living is used, statewide fee indices that aggregated fees across 41 procedures varied from $108.04

for Nevada to $21.68 for Pennsylvania (214). T h e

Medicaid programs also vary according to medical

specialty and geographic area (214). For example, payment for an appendectomy performed by a general

practitioner ranged from a low of $100 in Pennsylvania

to $512.89 in Nevada (255).

— —24 —

The medically indigent are individuals who meet categorical requirements

for Aid to Families with Dependent Children and Aid to the Aged, Blind,

and Disabled, but have incomes that a State considers too high to be eligible

for cash assistance, but not sufficiently high to pay medical bills
234 . Payment for Physician Services: Strategies for Medicare

Physicians who provide medical care to Medicaid

recipients cannot bill recipients, but must accept Medicaid payment as payment in full (236). Medicaid recipients in States with low Medicaid payment levels

and low rates of physician participation are more likely

to receive care in hospital outpatient departments and

clinics, which are usually more expensive than physician’s offices (170).

Physician fee freezes are utilized by many State

Medicaid programs to control program costs. As of

July 1984, 17 States had frozen physician fees for 1985

at the allowable rates established for 1984 or an earlier

year (214). Some State programs have frozen fees for

many years. For example, except for certain procedures, Florida has not increased physician fees since

1983, Michigan since 1977, and Ohio since 1972. Louisiana has frozen fees for 2 years and intends to initiate a flat fee system. Although New York State has

frozen physician fees, there is legislation pending to

increase physician fees for primary care services (214).

In addition to fee-for-service physician payment,

State Medicaid programs also have the authority to

contract with federally qualified HMOs and with comprehensive medical plans. However, the influence of

HMOs has been small; as of September 30, 1984, there

were only 65 HMO Medicaid contracts in 21 States

(229). Until recently, payment to the HMOs was on

a cavitation basis only25 and no more than 50 percent

of the enrollees in a contracting HMO could be Medicaid or Medicare beneficiaries. 26 The Omnibus Reconciliation Act of 1981 increased the maximum proportion of Medicare and Medicaid beneficiaries to 75

percent, with provisions for a waiver in special circumstances. Furthermore, regulatory reform efforts

have relaxed regulations governing Medicaid reimbursement to HMOs and established procedures for

States to contract with HMOs for services provided

to Medicaid beneficiaries on a cost27 as well as on a

cavitation basis.

Until October 1, 1982, when the Arizona Health

Care Cost Containment System (AHCCCS) became

operational, Arizona was the only State without a

Medicaid program. The purpose of AHCCCS is to develop and test an alternative payment and delivery system that is based on cavitation, competition among

providers, and a network concept of primary care.

AHCCCS contracts with both the public sector (county government) and with the private sector (including

individual practice associations (IPAs) and other HMOs)

jsA]thou@ the Smial Security Act did not expressly forbid reimbursement

arrangements from being on a cost basis, regulations governing Medicaid payment to HMOS (42 CFR 431.524) required that all such contracts be on a

risk basis.

z~socia] Securjty Act, Section 1903(m).

2748 FR 54013, fina] ru]e establishing new Section 42 CFR 434.

to provide basic health services to individuals in the

Aid to Families with Dependent Children program, individuals on Supplementary Security Income, and single individuals with less than $3,200 annual income

(238). The program appears to be encountering problems with respect to costs, the providers’ financial performance, and quality of care, and HCFA is imposing tighter controls on its operation (198).

The Arizona experiment illustrates some of the

changes taking place in the payment and delivery philosophy of the Medicaid program. As described above,

the Medicaid program historically has paid physicians

on a fee-for-service basis with care delivered by the

private delivery system. Beneficiaries have had little

or no cost-sharing requirements and were allowed free

choice of providers. In the last few years, States, with

support from the Federal Government, have turned to

systems of case management combined with payment

on a cavitation basis, restrictions on physician choice,

and beneficiary cost-sharing in attempts to contain

costs (235).

The Omnibus Reconciliation Act of 1981 wrought

a major change in State Medicaid programs by modifying Medicaid’s long-standing provisions that gave

recipients the freedom to obtain services from any provider. As of June 1984, 24 States had restricted recipients’ access to all providers by limiting freedom of

choice, by requiring recipients to obtain services from

a primary care provider or “gatekeeper,” or by requiring recipients to receive care only from providers with

whom the State had contracts (214). Six of the State

programs are in the demonstration or pilot stage. Of

the 14 States that will reimburse only those providers

with whom the State has a contract, 3 States have limited the provision to selected services, and 1 State has

applied the provision only to 6,000 Medicaid recipients enrolled in HMOs (214).

Other changes from traditional Medicaid payment

procedures include cavitation programs and recipient

cost-sharing.

28 Twelve States now have provisions for

paying physicians on a cavitation basis rather than

traditional fee-for-service; four of the States have demonstration cavitation programs. And, as of July 1984,

25 States collected a copayment or deductible from

Medicaid recipients for selected services that vary from

State to State. States have also provided medical care

for some recipients by enrolling them in HMOs; 23

28ZeThe Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) altered

Medicaid cost-sharing requirements so that States now have the option to

require copayment, coinsurance, or deductibles for almost all services to both

the categorically needy and the medically needy with certain exceptions, such

as categorically needy who are enrolled in an HMO. The regulations also

state that no provider participating in the Medicaid program may deny care

or services to individuals because of their inability to pay the cost-sharing

charges.
App. C—Medicare and Medicaid Payment for Physicians’ Services . 235

States had exercised this option for some of their recipients as of July 1984 (214).

Conclusion

Medicare’s payment method for physician services

can be characterized as a predominantly fee-for-service

system, which, in comparison with Medicaid and private health insurance, has remained relatively unaltered in the past 20 years. Until July of 1984, when

a temporary freeze on physician fees went into effect,

Medicare’s major efforts to control physician payment

were to reduce the level of prevailing, to delay the

updating of physician fees, and to apply the MEI

(which became effective in 1976).

The prescribed method for computing physician

payment based on reasonable charges as determined

by the CPR method is extremely variable among Medicare carriers because of the decentralized mechanism

established in law and regulations. The variation extends to the delineation of charge areas and the specification of prevailing charges depending on medical

specialty.

The Medicare program has been flexible in its payment method on a national level. The program has

adapted CPR for special conditions, e.g., paying hospital-based physicians. Morever, Medicare has veered

from the traditional fee-for-service method, and for

some special services (maintenance kidney dialysis and

ambulatory laboratory services) has paid physicians

on other bases. Medicare has also contracted with

HMOs on a cost or cavitation basis for physician and

other services.

Physician financial involvement in Medicare is influenced by payment practices. The data on physician

participation indicate that the number of physicians

accepting assignment on a claim-by-claim basis is rising slowly, with extreme variation among medical specialists and among States. Similar variation exists

among physicians who have become “participating

physicians” in Medicare, i.e., they have agreed to accept assignment for all services provided to Medicare

beneficiaries.

Over the years beneficiaries’ financial liability for

physician charges has increased. As a result many

elderly Medicare beneficiaries have purchased supplemental medical insurance (Medigap).

The other major Federal third-party payment system, Medicaid, differs from Medicare with respect to

physician payment historically in having used two

ways of setting payment levels, CPR and fee schedules. Almost an equal number of States use each method. Typically, Medicaid pays physicians at a lower

rate than Medicare. Another difference is that in the

past few years, States, with support from the Federal

Government, have used innovative ways of paying

physicians and organizing the delivery of medical care.

Many States are using systems of case management

and restrictions on physician choice as cost-control

methods.
Appendix D

Private Sector Approaches

to Physician Payment

Introduction

Much attention has been drawn to the problems of

the Medicare program in maintaining the viability of

a medical insurance system for elderly and disabled

beneficiaries in the face of rising medical costs. It is

important to recognize, however, that rising costs of

medical care do not affect Medicare alone. In 1983,

private payers for health care services in the United

States spent $206.6 billion, or 58.1 percent of the national total of $355.4 billion. Private expenditures grew

at an average annual rate of 13.6 percent from 1979

to 1983. Private expenditures for physician services totaled $49.7 billion in 1983, and were projected to increase to $60.4 billion in 1985 and to $88.0 billion in

1990 (21).

Many of those private payments are made by thirdparty payers in the form of health insurance benefits

provided to employee groups. In 1979, 73.3 percent

of the population had some form of private insurance

coverage, and 60.6 percent of the population was covered under employer group contracts (83). In 1983, an

average of $2,100 to $2,400 was spent by medium and

large employers on each employee’s health care (448).

The sources for health insurance coverage in the United

States have been commercial insurance companies,

hospital and medical service plans (e.g., Blue Cross

and Blue Shield), prepayment group medical plans,

such as health maintenance organizations (HMOs),

and others, such as employers or labor unions (201).

In addition to employee groups, an important part

of the market for some insurers is “Medigap” insurance.l Corporate payers of health care benefits have

a stake in controlling the costs of care for the Medicare population, since 58.4 percent of medium and

large employers in 1980 maintained health benefit

plans for retired employees over age 65 (83).

Although Medicare was designed around the model

of private health insurance (287), from its inception,

Medicare has differed from private third-party payers

in the specifics of its benefits, coverage, payment, and

other policies. Furthermore, although Medicare policies are determined by laws and regulations, practices

of private health insurers have been developed in response to market demand from purchaser groups, by

Federal laws such as the Employee Retirement Income

“’Medigap” is described in app. C.

236

Security Act of 1974 (Public Law 9346), and by State

laws and regulations (329). In addition, corporate payers of health benefits plans have increasingly turned

to self-insurance, or self-funding of benefits, in order

to have greater control over the outlays for their employees’ benefits. Thus, differences between private insurers’ methods of physician payment provide another

base of experience for Medicare to examine in considering alternatives for physician payment. The first part

of this appendix discusses the range of alternatives in

private health insurance.

In addition, the recent outcry from corporate payers

of health care benefits for controls on health care costs

have caused the private sector health insurance industry to respond with many innovations in the provision of benefits and health care services. Although

many of these innovations are too recent to have been

evaluated for their effectiveness in controlling costs,

the private sector may be gaining experience in identifying cost-effective practices and developing methods for rationalizing the provision of health services

that may be worthwhile for Medicare to examine. The

second part of this appendix discusses these innovations in the private sector.

The Private Insurance Market

Framework

Like Medicare, private health insurance groups the

benefits for which it will pay into broad categories.

As is illustrated in figure D-1, in addition to the extent of benefit coverage in an insurance plan and the

method of determining payment level, the insurance

organization’s theoretical approach to health insurance

is a dimension of payment. Private insurers also make

decisions on a claim-by-claim basis for those services,

usually new technologies, not explicitly covered or excluded under the terms of the insurance policy.

Approaches to Insurance.—Indemnity insurance

and service plans represent the two theoretical traditional approaches to health benefit coverage. Indemnity insurance guarantees the enrollee a fixed amount

for a specific service (95,445), The enrollee pays the

physician the physician’s billed amount for the service, which may be more than the insurer’s guaranteed

amount (430), and collects payment from the insurer

(439). In contrast, service plans assure their members
App. D—Private Sector Approaches to Physician Payment . 237

Figure D-1.— Dimensions of Payment for Physicians’

Services in Private Health Insurance (Fee for Service)

Basic medical

Indemnity

SOURCE: Office of Technology Assessment, 1985.

specific units of service, for example a day of hospital

care, for a regular premium in prepayment of those

services (95,445). A physician, if a participating provider, contracts with the plan to accept the plan’s allowance as full compensation for his or her services

(430), and collects payment from the plan (439). However, the theoretical approaches have become entwined; many service plans incorporate some indemnity features, and some indemnity plans have some

service plan features (22).

Methods of Determining Payment Levels.—Both the

indemnity approach and service approach use fee

schedules and variable fee screens (usual, customary,

and reasonable or UCR) in determining payment levels

(95,122). In practice, fee schedules are most common

in indemnity policies (325), while the UCR method is

most often used to determine payment levels in service plans.

Types of Insurance.—In contrast to Medicare, benefits of private health insurance are covered for payment under two principal types of insurance: 1) basic

medical expense insurance, and 2) major medical expense insurance. Basic medical expense insurance is

further divided into hospital expense insurance, surgical expense insurance, and medical expense insurance. Hospital expense insurance usually includes coverage for hospital room and board and nearly all

services provided by a hospital, other than personal

convenience items and most physician fees. Surgical

expense insurance typically covers the expenses of surgeons and related professional services. Regular medical expense insurance covers physician’s nonsurgical

services in a hospital, at home, or in the office, and

sometimes covers diagnostic services (587).

Major medical expense insurance applies broadly to

almost all kinds of medical care. Major medical expense insurance is sold either as a distinct policy to

supplement existing basic coverage, or it provides coverage for all medical expenses (subject to deductibles

and coinsurance) in a single unit. This type of insurance, called comprehensive coverage, provides extensive benefits, including coverage for most health care

services prescribed by a physician in or out of a hospital (587).

Benefits and Coverage. —The specific benefits, the

exclusions, and the extent of financial coverage vary

from one insurer to another and from policy to policy within each of the organizations. Nonetheless, in

general there are some benefits that differ markedly

from those offered under Medicare. Dental care, vision and hearing care, outpatient prescription drugs

and, more rarely, physical examinations are covered

under some private health insurance policies purchased

through employer groups (201,203,575). Some major

medical policies also offer a relatively high level of protection against catastrophic expenses. Furthermore, although less extensive than other services, coverage for

inpatient and ambulatory psychiatric services is considerably greater than that offered under Medicare

(414). As can be seen in table D-1, the percent of coverage differed for each category of benefit.

A constraint on the benefits offered by private insurance plans is State and Federal laws and regulations

which mandate particular types of coverage. Until recently, it had been believed that the Employee Retirement Income Security Act of 1974 and the National

Labor Relations Act preempted State laws regulating

the content of insurance policies for employees. On

June 3, 1985, however, the U.S. Supreme Court upheld a Massachusetts statute mandating certain types

of mental health benefits in employee health benefit

plans, thus opening the way for States to regulate the

content of employee health plans. This ruling is causing concern to nationwide corporations, who believe

that the costs of their plans will rise if they are required

to meet differing benefits requirements in all of the

jurisdictions in which they operate (35,329).

Physician Payment in Private Insurance Plans

Private health insurance varies from Medicare in

relying on both benefit schedules (fee schedules) and

variable fee screens in determining payment levels for
238 ● Payment for Physician Services: Strategies for Medicare

Table D-1 .—Group Coverage of Selected Categories

of Health Care

Percent with benefit

Category of Wilensky, Hedger and

health care et ala Schmitt b HIAA C

Ambulatory prescription

drugs . . . . . . . . . . . . . . 88.0%0 97.5% 75.0%

Dental care . . . . . . . . . . . 28.3 74.6 46.0

Vision or hearing care. . 11.7

Vision care . . . . . . . . . . . 28.0 16.0

Ambulatory psychiatric

care. . . . . . . . . . . . . . . . 77.0 93.0

Mental health care. . . . . 98.7

Physical exam . . . . . . . . 6.3 5.2

apercentage of civilian noninstitutionalized individuals with group coverage

(N= 13,916); Data from National Medical Care Expenditure Survey (1977). b

percentage of 116 health insurance plans that covered 5 million employees in

1979. Survey performed in 1981.

c

percentage of 36 employee health insurance plans with 21.8 million employees.

Survey performed in 1961 by the Health Insurance Association of America (HIAA).

SOURCE: G.R. Wilensky, P.J. Farley, and A.K. Taylor, “Variations in Health

Insurance Coverage: Benefits vs. Premiums,” Milbank Mem. Fund Q.

62(1):53-81, Winter 1964; D. Hedger and D. Schmitt, “Trends in Major

Medical Coverage During a Period of Rising Costs, ” Monthly Labor

Review 106(7):1 1-16, July 1983; and Health Insurance Association of

America, A Profile of Group Medical Insurance in the United States

(Washington, DC: HIAA, no date),

their fee-for-service business. Furthermore, as is described below, the variable fee screen method is similar, but not identical, to the method used by Medicare.

Fee Screens.—For major medical policies most private insurance companies and health benefit plans use

variable fee screens in determining physician payment

levels. The amount allowed by a plan or company for

a given service is known as the reasonable charge and

depends on a fee screen determination of the physician’s usual charge and the local customary charge

(UCR). In private insurance terminology, the Level 1

fee screen, the physician’s usual charge, is comparable to Medicare’s customary charge (583). The socalled customary charge, comparable to Medicare’s

prevailing charge, is the Level 2 fee screen.

The Level 2 (customary) fee screen in private health

insurance is generally set at the 80th to 90th percentile, that is, the charge level at or below which 80 to

90 percent of the billed charges occur. Medicare, by

contrast, is legally limited to the 75th percentile for

its Level 2 (prevailing) fee screen (Section 1842(b)(3),

Soc. Sec. Act). The reasonable charge is generally the

lowest of the usual charge (Level 1 screen) or the customary charge (Level 2 screen), both of which are generally calculated from the physician’s charge pattern

over the previous year (430). In special circumstances,

such as an unusually complex treatment, the reasonable fee may be the physician’s actual charge, even

though it exceeds the fee screens (324).

Fee Schedules. -Most private health insurance companies and health benefit plans use benefit schedules

(i.e., fee schedules) for determining physician payment

for their basic medical expense policies (430). The insurer generally pays the lesser of the listed amount for

a service or the actual charge by the physician, irrespective of medical specialty or geographic location

(430). If the physician’s actual charge is higher than

the listed amount, the patient is responsible for the additional payment for the service. Maximum benefit

schedules can be set by negotiation or according to

actuarial calculations.

Blue Cross and Blue Shield Plans.—Individual Blue

Cross and Blue Shield plans are members of the Blue

Cross and Blue Shield Association, which was formed

in 1982 when the Blue Shield Association and the Blue

Cross Association merged. All plans are not-for-profit

organizations organized under State insurance laws or

under special enabling legislation. Blue Cross plans

originally covered primarily hospital expenses, but enlarged their scope of coverage to include ambulatory

care, other institutional services, and home health care.

The Blue Shield plans were founded to cover physician services, but many have expanded their coverage to include other benefits, such as dental services,

vision services, and ambulatory services.

As of September 1985, there were 67 Blue Shield

Plans and 68 Blue Cross Plans, of which 40 are joint

plans, making a total of 89 corporations (122). Each

of the Blue Cross and Blue Shield Plans is an autonomous organization with its own staff, organizational

hierarchies, and decisionmaking processes (22). Although there are specific standards to which a plan

must adhere to be designated as a Blue Shield Plan and

a member of the national Blue Cross and Blue Shield

organization, 3

the plans vary considerably.

Participation of Physicians. —The concept of participating physicians is a cornerstone of the Blue

Cross/Blue Shield plans’ philosophy, but there are variations among the plans in applying the concept. Generally, the plan and the physician decide on the payment, without direct patient involvement. In return

for agreeing to accept the plan’s allowance as payment

in full, participating physicians are then paid by the

plan rather than by the patient (430). In addition to

direct payment by the plan, the non-price incentives

for participating in the plans include simplified billing, prompt payment, avoidance of bad debts on covered services, a predictable cash flow, and services of

a field staff to handle problem claims (324).

‘In the 1930s and 1940s, insurers sometimes negotiated fee schedules with medical societies. The current interpretation of antitrust

law requires that schedules be set unilaterally by the carrier (324).

3

For example, “A member must be endorsed by the State or county

medical societies of the area in which it operates, be nonprofit, maintain free choice of doctor, return at least 75 percent of earned subscription income to members in benefits, maintain professional relations and utilization review programs and meet certain financial

and reporting requirements” (372).
App. D—Private Sector Approaches to Physician Payment Ž 239

Physicians agree to participate in a Blue Shield service benefit program either independently or because

of a decision made by the physicians’ medical society4

(although individual physicians may then opt out of

their society’s participation agreement). About three

times as many individual agreements are entered into

as are medical society endorsements (439). The findings of a 1978 study indicate that interest in being a

participating physician in Blue Shield plans is quite

high. When individual physicians were given the option of participation, only 28 percent of office-based

physicians declined to do so (440). However, the rate

of participation is extremely variable among plans. For

example, in 1984 only 16 percent of solo physicians

participated in Blue Cross/Blue Shield of Florida (45),

although the overall participation rate is 70 percent

(122).

Although under Medicare a physician may accept

or refuse assignment of benefits on a claim-by-claim

basis, Blue Shield plans usually require participation

on an “all-or-nothing” basis, i.e., the physician’s participation agreement requires that she or he accept the

plan’s determination of reasonable charges as full payment in all cases.

As under Medicare, most Blue Shield plans will also

pay for services performed by a nonparticipating physician. However, Blue Shield of Massachusetts cannot,

by law, pay nonparticipating physicians, or reimburse

subscribers who use them (587). The billing and payment relationship between Blue Shield plans, the subscribers, and the nonparticipating physicians varies.

Under some plan arrangements, the nonparticipating

physician bills the patient directly, with the plan paying the patient. Under other plans, the participating

and nonparticipating physicians are paid on the same

basis. Other plans will pay nonparticipating physicians

directly if the physician obtains an assignment of benefits from the subscriber (587), but the physician then

cannot “balance-bill, ” i.e., bill the patient for any excess above the plan’s allowed charge (122).

Beneficiary Cost-Sharing, —Blue Shield plans traditionally have been associated with the service approach to insurance, that is, the plans guarantee to

provide services in full, with subscriber cost-sharing

limited to levels based on fee schedule allowances or

reasonable charges (122). Recently, however, market

demands for cost containment have led to an increased

emphasis on plans with copayments and deductibles.

Florida Blue Cross/Blue Shield, for example, has found

that comprehensive insurance combining the medical

service coverage of both basic and major medical service plans with subscriber cost-sharing in the form of

4This agreement, in order to meet antitrust regulations, must not

have anything to do with price setting (122).

deductibles and copayments is more marketable to employers than separate basic and major medical plans.

Some plans also offer pure indemnity type plans

(22,458).

Methods of Determining Levels of Payment. —Plans

vary in the ways they construct a fee schedule. Blue

Cross/Blue Shield of Florida, for example, constructs

separate fee schedules for each of its charge areas. Relative values are determined from the 90th percentile of

Level 2 charges and then multiplied by a separate conversion factor for each charge area to establish a fee

(45).

The methodology for determining UCR charge levels

also varies. Some plans, e.g., Blue Shield of Pennsylvania and Blue Cross/Blue Shield of Florida merge their

Medicare claims and private claims in creating Level

1 and Level 2 fee screens. The construction of specialtyspecific fee screens is another area of variation. Some

Blue Shield plans, e.g., Blue Cross/Blue Shield of

Florida, calculate a Level 2 fee screen (customary

charges) for all physicians regardless of specialty.

Other plans calculate separate Level 2 fee screens for

paricular specialties; Pennsylvania Blue Shield, for

example, calculates discrete level 2 fee screens for 56

specialties.

The plans also vary from Medicare in how often

they update fee screens. Typically the Level 1 (usual)

and the Level 2 (customary) fee screens are revised

every 6 or 12 months. Indeed, the UCR method of payment is analogous to a floating fee schedule; the maximum amount the insurer pays is updated at specified

intervals, and the shorter the interval between updates,

the higher the reasonable fee (22).

Medicare’s Medical Economic Index has a parallel

in the Blue Cross and Blue Shield Association’s membership standard that suggests controlling the Level 2

(customary) fee screen. Some plans employ the rate

of increase in the Consumer Price Index as a cap on

the Level 2 fee screen, a few plans use other indices

(324), and other plans do not use any control on customary charges (45).

Commercial Insurance Companies.—At the end of

1981, more than 1,000 private insurance companies,

mostly for-profit proprietary companies or subscriberowned mutual companies, were estimated to be offering individual or group health insurance covering over

108 million persons (201). Unlike the majority of Blue

Cross and Blue Shield plans, which provide only health

benefits coverage and other health-related services,

most commercial firms sell other types of insurance

as well. In fact, life insurance is the main line of business of the major companies in the commercial health

insurance field (587).

Moreover, commercial insurers do not have a system of participating physicians. The large number of
240 ● Payment for Physician Services: Strategies for Medicare

commercial insurers and the lack of standardization

in claim forms and benefit programs among insurers

make it difficult for physicians to deal with individual companies. Rather, the physicians bill the patients,

who must then obtain reimbursement from the insurance company (587).

Like Blue Shield, commercial insurers use both fee

schedules and the UCR methodology in determining

physician payment levels. However, most commercial

insurers do not differentiate payment levels by specialty. The physician payment methodology is often

part of the specifications of group policies. When selling group policies, the insurer either bids on a series

of benefits and specifications designed by the prospective buyer or plans a group’s health and welfare program based on the needs and resources of the buyer.

Large insurance companies, such as the Metropolitan Life Insurance Co. and the Prudential Insurance

Co. generate their own data base on which to base

levels of physician payment. Smaller companies usually do not have sufficient claims on which to base a

credible 5 payment level and often depend on other

sources for guidance. One such source is provided by

the Health Insurance Association of America Prevailing Healthcare Charges System, which collects, compiles, and publishes data on charges for surgical procedures by physicians (200). Some of the larger

insurance companies, e.g., Metropolitan Life Insurance

Co., use the surgical charge program as a “back-up”

source in responding to physician questions about payment level, or if the number of claims on which to

establish a credible prevailing charge is insufficient

(303).

Both Blue Cross/Blue Shield and commercial insurers are providing new types of insurance coverage

through the development of preferred provider organizations (PPOs) (see table 7-s in ch. 7). Payment of

physician’s services under PPOs through negotiated

discounts from the physician’s charges or through negotiated fee schedules has added a new source of variation in the methods of payment available under private health insurance plans. In addition, these plans

usually provide incentives to the enrollee to obtain care

from preferred providers by reducing levels of costsharing for care from those providers. However, since

many groups other than insurers are also currently involved in the development of PPOs, they will be discussed in greater detail later in this appendix.

5The credibility of a payment level has legal implications. When

the insurer claims reimbursement will cover reasonable fees, or when

the insurer claims reimbursement will not create excess physician

billing of the patient for charges in excess of the insurer’s approved

charges, an insurer has to be able to defend the payment methodology as well as the amount of payment if a provider questions an

insurers’ payment.

Self Insurance. —An increasing number of employee

benefit plans and other organizations are self-insuring,

i.e., they underwrite their own benefits coverage with

a budget funded by the organization. Plans can either

self-administer or hire an outside firm to process claims

and to perform other administrative services. In either

case, the plan prospectively determines its medical expenditures for the year. If costs are lower than projected, the plan retains the savings, and if costs are

higher than estimated, the plan absorbs the loss. In

order to protect against high or unexpected costs, most

self-funded plans re-insure their plan, i.e., purchase

“stop-loss” insurance that takes effect when a claim

for a specific individual exceeds a predetermined

amount and when the overall costs of the plan are

higher than a prespecified amount.

The growth of self-insurance in the past few years

has been dramatic, although estimates of market share

vary. The Society of Professional Benefit Administrators, the national association of independent thirdparty contract benefit administration firms, estimates

that for mid-1984 commercial insurance company fully

insured policies have 20 percent of the market for

health benefits coverage, Blue Cross and Blue Shield

Plans have 35 percent of the market, and self-funded

plans have 45 percent of the market. The self-funded

statistic includes plans administered by third-party administrators, self-administered plans, and administrative services only arrangements administered by insurance companies (230).

Both the commercial companies and Blue Cross and

Blue Shield Plans are responding to this potential loss

of market share by contracting to administer selfinsured plans for self-funded organizations (149). The

Health Insurance Association of America, measuring

a subset of self-funded plans, in the form of administrative services only arrangements and minimum premium plans provided by commercial group insurers,

has estimated that prior to 1979 only 5 percent of total insurance company group coverage was self-funded

insurance. By 1980, these types of arrangements represented approximately 25 percent of total insurance

company group coverage; by 1981, they represented

30 percent of such coverage (201).

Innovative Private Sector Approaches

to the Provision of Health Services

Historically, the function of insurance has been to

protect individuals from the risk of financial ruin from

actuarially predictable untoward events by providing

either cash or service benefits to enrolled beneficiaries.

Private insurers sought business from large purchasers

of group insurance, such as employers, by designing
App. D—Private Sector Approaches to Physician Payment Ž 241

insurance packages, including payment methods, to

fit the specific requirements of the purchaser in protecting the beneficiaries from such risks. In fields of

insurance other than health, competitive pressures to

provide the greatest amount of protection at the lowest

price force insurers to initiate actions that will reduce

the number and cost of catastrophic events (e.g., risk

management techniques used by liability insurers)

(171). Yet, until recently, most purchasers of health

care have not been interested in demanding alternatives to traditional forms of insurance which would

reduce their costs for care (417,454). In the absence

of demand, private insurers rarely made initiatives to

control costs on their own.

One reason suggested for the previous lack of interest in cost containment among insurers and purchasers of insurance is that the potential variability

among services and in patient need make it difficult

for third-party health insurers to identify discrete episodes with predictably finite costs whose risks and

costs they can then work to reduce (157). To ensure

that the care delivered during a hospital stay, for example, is as efficient as possible or to ensure that the

care delivered during that stay is rendered in the most

efficient site (which may not be in a hospital at all)

requires that the third-party payer move beyond the

financial function of insurance to develop a system for

monitoring and controlling the provision of care itself.

Rapid growth in the cost of insurance premiums to

employers has focused their attention on finding alternative, less costly ways of providing care to their beneficiaries. The increase in the number of self-funded

plans, for example, is one example of the response of

corporate purchasers of health care to rapidly increasing premiums. The private sector is also adopting innovations in the provision of health benefits for employees that may be viewed as stages in the evolution

of various managerial technologies for the provision

of health care. The remainder of this appendix will describe each of these approaches in turn:

Ž approaches directed at the beneficiary’s choice of

medical provider and site of treatment, e.g.,

changing benefit packages to increase beneficiary

cost-sharing or to cover particular services in

preference to others;

• approaches directed at medical care providers,

such as systems of utilization review to monitor

the cost, choice, and use of hospital and ambulatory services;

● development of alternative provider arrangements, such as HMOs and PPOs; and

● development of coalitions of health care purchasers to coordinate activities on a local or regional level.

In addition, private sector payers have established

other approaches to containing health care costs, such

as health promotion and awareness programs, e.g.,

corporate “wellness” programs that encourage healthenhancing behavioral changes in employees in hopes

of lowering the groups’ utilization of services. Although these efforts may have an effect on health care

costs by lowering the demand for medical services

(with as yet unknowable effects on the unit price of

such services), they are not germane to our discussion

of alternatives for the payment of services when the

demand for them actually occurs.

To date, research to establish the effectiveness of

these changes in private sector policy in controlling

aggregate health care costs has been scant, and the evidence available is mostly anecdotal. Companies have

noted individual savings in their insurance premiums

(or, in the case of self-funded companies, their benefit payouts). In a 1984 survey of corporate benefits

officers and senior executives of corporations with

more than 500 employees, executives of companies

who reported changes in their benefit plans to control

costs estimated that the changes in health care plans

their organizations had instituted had saved between

16 and 18 percent over the last 3 years over what their

costs would have been (273). Independent confirmation of these estimates is not available, however.

Nevertheless, the changes in corporate health benefit plans are worth examining as a type of natural experiment in alternative payment for health care and

physician services. The very success or failure of those

attempts may affect the overall market for physician

services in which Medicare must participate. The response of the system to these innovations may be instructive in designing changes in Medicare payment.

Changes in Medicare reimbursement may complement

these changes in the private sector, having a synergistic effect on controlling health costs. It should be

noted, however, that these lessons from the private

sector in changing benefits apply to a working population. Whether those results may then be applied to

an aged Medicare population is a question for further

research to answer.

Managing the Provision of Benefits

To Change Beneficiary Incentives

The redesign of health insurance benefit packages

to modify beneficiary incentives to seek less costly

forms of medical care has two facets. One is to increase

employee awareness of the costs of treatment choices

by increasing the level of costs the employee must pay

out-of-pocket for that care. The other is to encourage

or mandate particular providers of care or modes of

treatment that are believed to reduce costs.
242 ● Payment for Physician Services: Strategies for Medicare

Increasing Beneficiary Awareness of Costs. —Increasing beneficiary cost awareness is not per se an alternative method for reimbursing physicians. Yet, the

level of coverage a beneficiary receives under his or

her insurance plan is an influential factor in the decision to seek the medical care. Health services researchers have noted that the existence of insurance, while

perhaps sparing the individual the risk of financial ruin

in the event of illness, also serves to insulate the individual and the physician from considering the direct

financial consequences of their joint or separate treatment decisions (342,365).

Increasing Cost-Sharing. —Unlike Medicare, patient

cost-sharing in the form of a deductible amount and

coinsurance generally has been characteristic of only

part of the insurance coverage offered by private insurance, i.e., major medical insurance. The deductible amount usually takes the form of an absolute

amount, or very rarely a fixed percentage of income,

and may be applied on an illness, a person, or a family basis (587). Recently, there has been a trend for

large businesses to incorporate some form of costsharing in all the insurance that they offer their employees (149).

There are a number of reasons why corporate benefits plans may wish to increase the portion of the cost

of health care borne by beneficiaries. Increasing costsharing is believed to be relatively easy to implement

and administer (209). All other things being equal,

sharing more of the costs of care with the employee

immediately lowers the costs of care being borne

by the company and therefore its health insurance

premiums.

A second aspect of increased cost-sharing is that it

will cause the beneficiary to consider more carefully

whether or not to initiate an episode of care. Thus,

increased cost-sharing reduces not only the expenditures of the third party, but also aggregate health care

expenditures. Insurers who were asked to estimate the

savings resulting from various cost-sharing requirements said that increasing the deductible from $0 to

$500 would save an estimated average of 20.8 percent

in claims, and a coinsurance rate of 30 percent would

save an estimated 27.5 percent in claims compared to

a zero percent coinsurance rate (209). Empirical data

from the Rand Health Insurance study seem to confirm this; adult beneficiaries with first-dollar coverage

of health care were found to use significantly more

health care services than those who paid some coinsurance or deductibles (343).

Because of these cost advantages, corporate benefit

plans have increased the level of cost-sharing borne

by individual employees. One recent survey found that

50 percent of a sample of corporations employing 500

or more employees increased deductibles in the past

3 years, and that 22 percent of those corporations instituted copayment on medical bills (273). Another survey found 71 percent of 150 companies surveyed raised

the amount of deductibles, 53 percent increased the

level of coinsurance, and 44 percent increased the employee’s share of the premiums paid (147). A 1983 survey of companies found that 48 percent were introducing or increasing cost-sharing for their employees

(25). Public sector employers were relatively less strict

in increasing employee cost-sharing than private sector employers. According to survey data, 30 percent

of public sector employers have increased their deductibles, although they are still relatively low. Plans with

deductibles of $150 or less covered 65 percent of salaried public employees and 55 percent of hourly public workers, compared with 43 percent of all workers

in the public sector (577). Employers were found to

be four times more likely to use deductibles over $100

in 1984 than in 1982, and that plans which covered

all costs after meeting the deductible declined from 67

percent in 1982 to 42 percent in 1984 (307).

The Medicare Part B program already imposes 20-

percent coinsurance on the beneficiary, while many

private benefit plans are only beginning to approach

that level. In 1982, 25 percent of employer group

health insurance plans had a 20-percent beneficiary coinsurance rate for inpatient care, while in 1984, the

proportion increased to 43 percent (307). Although the

effect of Medicare coinsurance may be mitigated by

Medigap coverage, lower income elderly persons may

not carry Medigap coverage if they feel they cannot

afford the additional premium. Further, there is substantial evidence that the imposition of cost-sharing

has disproportionatly negative effects on utilization of

health services by persons of lower income (483). In

addition, since the elderly are greater users of medical care, it is believed that substantial increases in beneficiary cost-sharing would thus likely come at the cost

of reduced access for Medicare beneficiaries (486).

Positive Incentives To Reduce Utilization. —An alternative to directly increasing the costs of care borne

by the beneficiary is to create positive financial incentives for the beneficiary to constrain utilization. An

example of a direct positive incentive would be a bonus that is paid to a beneficiary if he or she does not

submit any claims. Such incentives may be perceived

by employees as less harsh because the person deciding to initiate care may be in dire need of that care

and perhaps should not be forced to expose his or her

own resources to risk. Alternatively, indirect incentives, such as flexible benefits plans, in which the employee can choose his or her level of health coverage

and take some or all of the employer’s contribution
App. D—Private Sector Approaches to Physician Payment Ž 243

as cash compensation, are also being tried in hopes

of lowering the employer’s expenditure on health care

coverage.

The use of positive financial incentives for employee

beneficiaries to reduce their use of health services is

not nearly so common as increasing the level of financial risk borne by the employee. Neither is it known

how effective such positive incentives would be in reducing utilization.

Positive incentives usually come in the form of a

cash bonus given to employees for not using any services during the course of the year. Alternatively, the

employer establishes a fund in the employee’s name

to which the employer makes contributions, which can

be used to cover medical cost-sharing or which can

be carried over from year to year and used when

needed, while any balance can be withdrawn on retirement (153). However, the Internal Revenue Service has

recently challenged the tax-free status of such benefit

accounts, declaring that the funds in the account must

be spent within a calendar or fiscal year (448). A.S.

Hansen, Inc., found that only 10 percent of its surveyed companies had instituted such incentive plans

(25).

A related system of positive incentives to reduce utilization is found in so-called “flexible benefits plans,”

also known as cafeteria benefits plans, in which employees choose between types of insurance coverage

available. One type of flexible benefits plan establishes

a “flexible spending account” to which employees contribute pre-tax income as a type of voucher with which

they can purchase benefits from a range of options

offered by a company. Many employees participating in these accounts have exhibited a preference for

greater disposable income rather than for health insurance plans with reduced cost-sharing. The Employee Benefit Research Institute found that health insurance deductibles in these plans averaged $207,

versus a nationwide average for all firms of $100 (127).

Directing Beneficiaries’ Choice of Treatment and

Providers.—Health insurance benefits plans are becoming more innovative in the management of their

employees’ benefits outside the scope of traditional insurance coverage. As was discussed earlier, to direct

and manage the provision of health care is a step beyond the insurers’ function of providing protection

against financial ruin. Several approaches used include

the following:

●

●

●

encouraging or requiring second opinions for

nonemergency surgery;

encouraging or requiring the provision of certain

types of surgery and routine laboratory tests on

an ambulatory basis; and

educating employees about and channeling them

to efficient providers—i.e., case management.

Second Opinions for Surgery .—There are three

types of second surgical opinion programs, varying in

the level of coercion involved: the passive reimbursement of second opinions obtained at the initiative of

the beneficiary, the active promotion by the company

of second surgical opinions, and the requirement that

the beneficiary obtain a second opinion for all elective surgery (149). Second surgical opinion programs

of any type are among the most common of the private sector cost containment activities directed at beneficiaries. A survey of Fortune 500 companies revealed

that 71 percent had some sort of second opinion program, 64 percent have a penalty associated with failure to obtain a second opinion, and so percent mandate that employees use the program before surgery

(160), Another survey found that 54 percent of a sample of employers began a mandatory second opinion

program in the past 3 years (273). Public sector employers were found to be less likely to use strict second opinion programs with 27 percent having mandatory programs, and 32 percent having only voluntary programs (577).

There is still some controversy over the cost-effectiveness of second surgical opinion programs. It is believed that obtaining the concurring opinion of a second, disinterested physician in the necessity for a

surgical operation can help to screen out cases for

which indications are weak and that may be amenable to less drastic alternative treatments (62). One

study found that the mandatory second surgical opinion programs studied exhibited a cost-benefit ratio of

2.63:1 (i.e., $2.63 was saved for every $1 spent to

administer the program), while voluntary programs

were less effective in reducing costs (146). Some recent studies have determined that 14 to 16 percent of

proposed surgeries submitted to second opinions were

not confirmed (62). However, one cannot conclude

that those nonconfirmations are indicative of unnecessary surgery. Such nonconcurring opinions may often advise delaying surgery, or pursuing medical rather

than surgical treatment, and may eventually be followed by the surgery originally proposed (373). At the

same time, it is not known whether delay may result

in more complicated surgery later (62). The Congressional Budget Office estimated the benefits of a mandatory second surgical opinion program to Medicare

at about $80 million (418). The American College of

Surgeons said that “it seems only prudent to consider

the alleged advantages of the second-opinion concept

as unproved and to postpone widespread implementation of programs” (10).

Ambulatory Surgery and Testing. —The provision

of medical services on an ambulatory rather than on

an inpatient basis is also being encouraged by employee health benefits plans. Of the companies re56-119 0 - 86 - 9 : QL 3
244 • Payment for Physician Services: Strategies for Medicare

spending to the Louis Harris survey, 47 percent had

initiated financial incentives of the provision of surgery and testing on an ambulatory basis (273). Gardner, et al., found that 82 percent of Fortune 500 companies were encouraging ambulatory surgery where

possible, and 79 percent were encouraging ambulatory

testing (160).

It is difficult to distinguish on the basis of these surveys what is meant when it is said that an employer

will encourage ambulatory care. Encouragement can

be either active or passive; there has been no systematic collection of data on the extent to which private

third-party payers simply reimburse for or actively encourage ambulatory surgery testing. Although some

insurance carriers maintain lists of procedures that will

be reimbursed only on an ambulatory basis, others

simply provide information about the availability of

the coverage without taking an active role in encouraging it. Some carriers have tried to increase the incentive for physicians to perform ambulatory surgery by

increasing the level of reimbursement to physicians for

performing surgery on an ambulatory rather than on

an inpatient basis (149).

Case Management. —In case management programs,

an agent is assigned to the beneficiary to direct and

coordinate the provision of medical care for that beneficiary. Although a case manager maybe a physician

or other provider of care whose services are engaged

by the beneficiary directly, in this context case management refers to an agent employed by the corporate

benefit plan who arranges and directs the provision

of care for the beneficiaries of that plan.

The expertise of a case manager is intended to help

employees make choices among less costly providers

and services and to reduce the cost of care. At the same

time, the use of a case manager involves a considerable amount of overhead for the sponsoring plan. Although a few corporations maintain case management

teams in-house, most of those using case management

programs contract with outside consultants for services. Costs of case management programs are said to

run about 1.2 percent of the level of claims. It is not

a commonly used method for managing beneficiary

incentives. One survey found that only 1.3 percent of

surveyed companies used case management techniques

in 1983, although the case manager approach was seen

to be growing rapidly (207).

Management of Provider Behavior:

Utilization Review

By monitoring the process of care-giving according

to some defined standard, utilization review attempts

to manage provider behavior in the provision of care

to assure the appropriate use of the plan’s resources

for the protection of the plan’s beneficiaries and of the

financial well-being of the plan.

Utilization Review: Types. -The focus of most review programs conducted by private insurers, thirdparty administrators, and self-funded employee health

benefit plans is on services rendered in a hospital, since

those services are the most expensive and the payoff

to monitoring services in that site is greater. However,

utilization review could be performed in an ambulatory care setting, although it would be likely to be

more costly because the site base is so diffuse. Utilization review, as currently used, can be divided into particular types based on when they apply to the patient:

preadmission review (requiring approval before an

elective admission to a hospital), concurrent review

(during the hospital stay), and retrospective review (after discharge from the hospital).

Utilization Review: Sources. —Numerous types of

private sector organizations provide utilization review

for health benefits plans, either under contract to a

number of different plans or as a part of the business

of providing health insurance benefits (149). Foundations for medical care and peer review organizations

are organizations providing utilization review services

that are usually sponsored by physicians and are

geographically restricted. They have the advantage of

having closer relationships with local providers and

may thus have a greater ability to elicit cooperation

with the goals of utilization review. Corporations also

contract with independent commercial utilization review organizations and with third-party administrators for utilization review services (437). Insurance

companies are also developing utilization review programs to meet the competitive challenge of the other

organizations (172). The latter three need not be restricted to a particular locality, but may provide services nationwide. Lastly, some employers will organize

utilization review programs in-house rather than contracting with outside organizations.

Cost-Effectiveness and Prevalence of Utilization Review.—Empirical assessments of the cost-effectiveness

of review programs conflict. Studies performed have

usually had methodological flaws that have made it

impossible to draw conclusions about the effectiveness

of particular programs (142,149). Nor has evidence as

to effectiveness of utilization review with regard to

Medicare beneficiaries been made available (111).

However, anecdotal data available from some companies’ benefit plans report savings in expenditures of

7 to 22 percent resulting from utilization review programs, at a cost of about $1 to $2 per employee per

month (142,361). Others have found that the total

costs of care have increased in spite of utilization review mechanisms that constrain utilization. One large

company found that its utilization review program re-
App. D—Private Sector Approaches to Physician Payment • 245

Table D-2.—Surveys of Use of Utilization Review Mechanisms Among Employee Benefit Plans

Percent of employers using method

Gardner, A.S. Hansen, Louis Harris Hewitt Merceret ala Inc.b & Associatesc Associates d Meidinger e

Mechanism (1984) (1983) (1984) (1982) (1984) (1985)

Preadmission certification . . . . . . . . . 32% 100% 280/o 20/0 26% 260/o

Concurrent review . . . . . . . . . . . . . . . . 14 NRf

8 34 30

Retrospective review. . . . . . . . . . . . . . t & 17 NR 18 40

General utilization review

programs; type unspecified . . . . . . 68 48 27

aunjverse of Fortune 500 Cwnpanles, sample and respondents Unspecified.

bsa~Ple and reSpOnden@ unspecified.

cprograrns begun in last s yews; sample of 1,250 companies With 500 or mOre emPloYees.

dsample of 1,I85 companies.

esample of 258 public employers surveyed in May 1985.

‘NR = Not reported.

SOURCES: S.F. Gardner, J.B. Kyzr-Sheeley, and F, Sabatine, “Big Business Embraces Alternate Dellvery,” Hospitals 59(4):81-84, Mar. 18, 1985; A.S. Hansen, Inc., IW?3

Benefits Survey (Lake Bluff, IL: A.S. Hansen, Inc., 1984); Louis Harris& Associates, Corporate /rtMat&es arrd Employee Attitudes orI Cost containment (New

York: The Equitable Life Assurance Society of the United States, February/March 1985); Hewitt Associates, “Company Practices in Health Care Cost Management —1984, ” quoted in J. Goldsmith, “Death of a Paradigm: The Challenge of Competition, ” Health Affairs 3(3):5-19, Fall 1984; and William M. MercerMeidinger, inc., Hea/thcare Cost Containment in the Pub//c Sector (New York: William M. Mercer-Meidinger, Inc., 1985).

duced corporate wide inpatient utilization by 46 percent over a 5-year period; yet its hospitalization costs

per person covered increased 60 percent in that same

period (52). (One cannot be certain that costs would

not have risen even further in the absence of the company’s utilization review program, however. ) In spite

of equivocal evidence, the use of utilization review in

the private sector has been expanding among larger

employee benefit plans. Table D-2 summarizes some

recent survey data on the prevalence of various utilization review methods.

One reason cited by companies for the use of utilization review programs is that, rather than being considered a cost-saving practice in itself, it is seen as a

method for collecting provider-specific utilization data

that can later be used as a bargaining tool for negotiation of preferred provider arrangements and other

alternative health care systems (149) (see discussion below). Still, it is believed that utilization review programs possess a great deal of potential for reducing

the costs of care, simply because the known degree of

nationwide variation in use of services suggests that

reductions in utilization are possible without a loss in

quality of care (208). A utilization review program can

call attention to patterns of care that fall out of line

with established norms, and may educate providers

in how their practice patterns diverge from those of

others. Another reason for the use of these programs

may be a belief in the so-called “sentinel effect, ” which

holds that the process of review need not necessarily

call particular episodes of care into question. Rather,

the fact that the review process exists at all will cause

providers to behave more cautiously in prescribing

care.

There is a further difficulty in instituting and coordinating utilization review programs, particularly for

corporations doing business nationwide. Medical service data are not collected in any systematic fashion

throughout the country, making it difficult to calculate and compare plan use with nationwide norms for

care. Providers have been unwilling to cooperate with

utilization review programs in the past, although that

reluctance is lessening as providers come to believe that

it is in their own best interests to cooperate (149).

Development of Alternative

Provider Arrangements

Alternative provider arrangements place the choice

of treatment in the context of a system for the provision of care. Although individual treatment choices

may still be left to the discretion of the patient and

the provider, the presence of a superseding organizational structure may force the provider to account for

the economic trade-offs between different treatment

choices. if the success of the organization is predicated

on the ability to deliver health care in a more costconscious manner.

Types of Alternative Provider Arrangements.—

Although alternative provider arrangements derive

from numerous sources, including hospital/physician

joint ventures, insurance companies, and consumer

groups, corporate benefits plans have recently become

leading figures in the establishment of alternative provider arrangements. The major types of alternative

provider arrangements considered in this appendix are

PPOs and HMOs. Although health maintenance organizations have been in existence for nearly 50 years

and have been extensively studied (see ch. 7), PPOs

are a newer form of alternative provider arrangement

that has not been extensively studied. Nevertheless,

PPOs have attracted attention because of their poten-
246 Ž Payment for Physician Services: Strategies for Medicare

tial for creating financial incentives for beneficiaries

to choose cost-effective providers.

Preferred Provider Organizations (PPOs), –PPOs

include a diverse array of arrangements between a

third-party payer and providers of health care, including physicians, hospitals, or both. Estimates of the

number of PPOs differ. In January 1985, the American Association of Preferred Provider Organizations

identified 143 operational PPOs in 28 States and the

District of Columbia (7). According to the Institute for

International Health Initiatives, as of June 1985, 229

PPOs were operational, 67 were defined as preoperational, and 38 were of undefined status, in a total of

35 States (237). A conservative estimate of the number of persons enrolled in PPOs in June 1985 was about

5.8 million, a fourfold increase from a December 1984

enrollment estimate of 1.3 million (382). PPOs vary

in a sponsorship, membership, and payment methodology. As of June 1985, most PPOs had been sponsored by providers, with 52.3 percent having been

sponsored by physicians, hospitals, or physician/hospital joint ventures. Insurance companies and Blue

Cross/Blue Shield plans supported 16 percent of the

total (237).

Physicians providing services under the auspices of

a PPO generally agree to fee-for-service reimbursement

at some discount from their customary, prevailing, and

reasonable charges, although arrangements have included reimbursement according to a fee schedule or

on a cavitation basis. Of those PPOs responding to

the survey, 29 used a relative value scale, 23 used a

fee schedule, 18 used individual provider discounts,

18 used “modified fee for service, ” 3 used gatekeeper

reimbursement, and 3 used cavitation (7).

Among the characteristics that may be involved in

a PPO, those features that distinguish it from other

types of payment plans are: 1) that the providers agree

to accept payment for medical services at some discounted rate, and 2) that providers are willing to accept the scrutiny of utilization review programs in the

provision of care. PPOs are believed to be making increasing use of utilization review programs, although

most of the efforts at utilization review so far have concentrated on inpatient rather than ambulatory care

(382). A 1984 survey showed that of the operating

PPOs responding to the poll, 83.1 percent used precertification of admissions, 63.4 percent used discharge

planning, 57.7 percent used concurrent review, 54.9

percent used retrospective review, and 35.2 percent

used second surgical opinions (425). The Institute for

International Health Initiatives found that 73 percent

of its respondents had preadmission certification, 74

percent had concurrent review, 66 percent had retrospective review, and 43 percent had mandatory second surgical opinion programs (237). These results suggest that PPOs use utilization review programs more

frequently than traditional employee benefit plans (see

table D-2).

One example of a PPO developed by a private insurer is one sponsored by Blue Cross/Blue Shield of

Florida (45). Its strategy involves agreements with selected hospitals that have a reasonably low payment

level based on the hospital prospective payment system of diagnosis-related groups (DRGs). If a hospital

agrees to participate, Blue Cross/Blue Shield of Florida

will then negotiate a DRG contract with it and request

the hospital’s assistance in signing its medical staff for

the PPO.

For the PPO program, the plan has divided the State

into four regions. A fee schedule based on 90 percent

of the average billed charges for 1983 is being developed for each of three regions. If a physician agrees

to become a preferred provider, he or she will accept

the lower of his or her billed charges or the scheduled

fee. The physician also agrees to a system of preadmission certification, certain locally determined surgical procedures requiring to be performed on an ambulatory basis and a medical necessity retrospective

review of claims. In return, Blue Shield promises to

review, but not necessarily update, the fee schedule

annually.

A different method had been designed for determining the level of physician payment for physicians in

the southern region of Florida, which differs markedly

from the other regions in numbers and types of physicians and beneficiaries. For the southern region, a

UCR fee schedule is being developed that is based

on the 75th percentile of the physicians’ 1983 billed

charges. Since the 90th percentile is used for determining the reasonable charge for the plan’s traditional

business, basing the payment on the 75th percentile

assures a discount. The payment is tailored to each

physician’s charges as contrasted with the regionwide

fee schedule described above, since each physician will

be paid the lowest of the usual, billed, customary, or

reasonable charge.

Health Maintenance Organizations (HMOs).—

HMOs are organizational entities that accept payment

for the provision of medical services on a per-enrollee

cavitation basis. The HMO makes arrangements with

a panel of physician and hospital providers to provide

services to those enrollees, and bears risk for the costs

of services in excess of the cavitation payment. Except

in an emergency or with prior authorization, the enrollee is required to obtain health care services only

from those providers with whom the HMO has contracted to obtain care. HMOs increased from 39 to 337

between 1972 and 1984, and the number of subscribers
App. D—Private Sector Approaches to Physician Payment . 247

increased from 3.5 million to 16.7 million (240). In

1983, roughly 40 percent of HMO members were in

one of the Kaiser plans (239).

Commercial insurance companies are actively involved in a growing segment of the HMO industry,

“national HMO firms, ” which are firms that own or

manage separate HMO firms in two or more States

(239). Commercial insurance companies sponsored

about 10 percent of HMO plans in 1983, which enrolled 11 percent of HMO clients (239).

Potential for Cost Savings.—PPOs can be seen as

a competitive response by insurers and health care

providers jointly to market their services as a unique

“product” that may be superior to others’ services because it is less expensive on a per unit basis, or, more

importantly, less expensive in aggregate because of the

efficiency of the providers. Beneficiaries enrolled in the

PPO are encouraged to use PPO services by benefiting from reductions in cost-sharing. However, their

choice of caregiver is not restricted to these preferred

providers; they may choose any other provider outside of the arrangement as long as they pay the applicable deductible and coinsurance.

Preferred providers who simply offer to discount the

price of their services while recouping their losses

through expanding their volume of services do not offer the same cost savings as preferred providers who

both discount their services and maintain strict efficiencies in the provision of their services. Few existing PPOs maintain the necessary sophistication of data

collection, however, and the record of PPOs in constraining costs has not been evaluated (52). Nevertheless, many believe that the development of more sophisticated information systems and utilization review

mechanisms will allow PPOs to distinguish truly efficient providers and offer their services to the marketplace as a distinct medical product.

Development of Health Care Coalitions:

Cooperative Ventures in Health Care Cost

Containment

Coalitions have evolved on a regional basis to address some of the unique variations in health care utilization. Although the name “coalition” connotes the

ideal of a merger of a broad range of interests in the

health care field, up to this time coalitions have been

organized largely by employers (308). Estimates of the

number of coalitions differ. The U.S. Chamber of

Commerce reported that in 1984 there were 135 coalitions with 6,500 members, an increase of 14 percent

from the year before (380). The American Hospital

Association found 151 coalitions operating in 1984,

with an additional 14 in the development stage (12,

381). This was an increase of 13 percent from the year

before.

Coalitions, though perceived by some as underrepresenting some of the responsible parties in health care

cost containment (308), do provide a mechanism for

participating corporations to cooperate in the pursuit

of specific goals defined by the membership of that particular coalition. To the extent that the coalitions have

unique goals specific to the conditions of the health

care market in their regions, the members establish

their own criteria for success and predicate the continued existence of the coalition on those criteria (149).

Among these goals is the development of providerspecific utilization data systems, which are crucial to

the identification of efficient providers. Having identified these providers, one can construct an alternative, cost-conscious provider system. According to

U.S. Chamber of Commerce figures, 80 percent of the

coalitions are involved in such activities (380). The

American Hospital Association found that 71 percent

of the respondents to its survey of coalitions were involved in the development of data systems (12). Coalitions have served as foci for political action in attempts to change local and State regulations in order

to foster a more competitive market for health services, and have been instrumental in establishing State

all-payer rate-setting regulations in Massachusetts and

Connecticut (73,208). Other coalitions have served as

a mechanism for employers to establish alternative

provider arrangements. According to the U.S. Chamber of Commerce, 70-percent of existing coalitions are

active in developing such arrangements (380). According to the American Hospital Association, 44 percent

of coalitions responding to its survey were active in

developing alternative provider arrangements (12).

Conclusion

The pace of change in the private health insurance

market has become very rapid, as the industry has responded to the demands of its customers to provide

new approaches to financing and providing health

care. Many of these changes in the financing and provision of care are too recent to evaluate for their effectiveness in reducing costs while retaining quality of

care. Corporate benefits managers are taking on the

role of being the informed buyer for their employees/beneficiaries amid the plethora of new alternatives

in insurance coverage and alternative provider arrangements. Nevertheless, individual insurance beneficiaries will require greater access to information in

order to make rational choices about the purchase of

health care (483).
248 ● Payment for Physician Services: Strategies for Medicare

The lessons learned from the private insurance industry in the provision of health care relate to changes

in payment to physicians under the Medicare program,

but results from that experience should be applied with

caution. The effectiveness of many private sector initiatives in controlling costs and preserving quality is

unknown. In addition, there are distinct differences between the populations covered by Medicare and those

covered by private insurers. Further research will be

required on such issues as:

● Does increased cost-sharing cause beneficiaries to

forgo necessary health care and result in greater

expenditures later?

● How effective are various forms of utilization controls in assuring cost-effectiveness and quality of

care?

● How effective are PPOs in restraining costs?

● To what extent can the experience of private sector insurers in providing care for their beneficiaries be duplicated for public sector beneficiaries?

(368).
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