U.S. GOVERNMENT PRINTING OFFICE

WASHINGTON : 

For sale by the Superintendent of Documents, U.S. Government Printing Office

Internet: bookstore.gpo.gov Phone: toll free (866) 512–1800; DC area (202) 512–1800

Fax: (202) 512–2250 Mail: Stop SSOP, Washington, DC 20402–0001

85–830 PDF 2004

S. HRG. 108–223

MEDICARE REIMBURSEMENT FOR

PHYSICIANS AND HOSPITALS

HEARING

BEFORE A

SUBCOMMITTEE OF THE

COMMITTEE ON APPROPRIATIONS

UNITED STATES SENATE

ONE HUNDRED EIGHTH CONGRESS

FIRST SESSION

SPECIAL HEARING

JANUARY 30, 2003—WASHINGTON, DC

Printed for the use of the Committee on Appropriations

(

Available via the World Wide Web: http://www.access.gpo.gov/congress/senate
(II)

COMMITTEE ON APPROPRIATIONS

TED STEVENS, Alaska, Chairman

THAD COCHRAN, Mississippi

ARLEN SPECTER, Pennsylvania

PETE V. DOMENICI, New Mexico

CHRISTOPHER S. BOND, Missouri

MITCH MCCONNELL, Kentucky

CONRAD BURNS, Montana

RICHARD C. SHELBY, Alabama

JUDD GREGG, New Hampshire

ROBERT F. BENNETT, Utah

BEN NIGHTHORSE CAMPBELL, Colorado

LARRY CRAIG, Idaho

KAY BAILEY HUTCHISON, Texas

MIKE DEWINE, Ohio

SAM BROWNBACK, Kansas

ROBERT C. BYRD, West Virginia

DANIEL K. INOUYE, Hawaii

ERNEST F. HOLLINGS, South Carolina

PATRICK J. LEAHY, Vermont

TOM HARKIN, Iowa

BARBARA A. MIKULSKI, Maryland

HARRY REID, Nevada

HERB KOHL, Wisconsin

PATTY MURRAY, Washington

BYRON L. DORGAN, North Dakota

DIANNE FEINSTEIN, California

RICHARD J. DURBIN, Illinois

TIM JOHNSON, South Dakota

MARY L. LANDRIEU, Louisiana

JAMES W. MORHARD, Staff Director

LISA SUTHERLAND, Deputy Staff Director

TERRENCE E. SAUVAIN, Minority Staff Director

SUBCOMMITTEE ON DEPARTMENTS OF LABOR, HEALTH AND HUMAN SERVICES, AND

EDUCATION, AND RELATED AGENCIES

ARLEN SPECTER, Pennsylvania, Chairman

THAD COCHRAN, Mississippi

JUDD GREGG, New Hampshire

LARRY CRAIG, Idaho

KAY BAILEY HUTCHISON, Texas

TED STEVENS, Alaska

MIKE DEWINE, Ohio

RICHARD C. SHELBY, Alabama

TOM HARKIN, Iowa

ERNEST F. HOLLINGS, South Carolina

DANIEL K. INOUYE, Hawaii

HARRY REID, Nevada

HERB KOHL, Wisconsin

PATTY MURRAY, Washington

MARY L. LANDRIEU, Louisiana

Professional Staff

BETTILOU TAYLOR

JIM SOURWINE

MARK LAISCH

SUDIP SHRIKANT PARIKH

CANDICE ROGERS

ELLEN MURRAY (Minority)

ERIK FATEMI (Minority)

ADRIENNE HALLETT (Minority)

Administrative Support

CAROLE GEAGLEY
(III)

CONTENTS

Page

Opening statement of Senator Arlen Specter ........................................................ 1

Opening statement of Senator Tom Harkin .......................................................... 3

Opening statement of Senator Thad Cochran ....................................................... 4

Opening statement of Senator Herbert H. Kohl ................................................... 5

Opening statement of Senator Patty Murray ........................................................ 6

Prepared statement .......................................................................................... 6

Opening statement of Senator Mary L. Landrieu ................................................. 7

Statement of Thomas A. Scully, Administrator, Centers for Medicare and

Medicaid Services, Department of Health and Human Services ..................... 8

Prepared statement .......................................................................................... 12

Opening statement of Senator Ted Stevens .......................................................... 19

Statement of Loren H. Roth, M.D., M.P.H., senior vice president, Medical

Services, UPMC Health System, associate senior vice chancellor, Schools

of the Health Sciences, University of Pittsburgh .............................................. 30

Prepared statement .......................................................................................... 33

Statement of Jitendra Desai, M.D., president-elect, Pennsylvania Medical Society ....................................................................................................................... 39

Prepared statement .......................................................................................... 41

Statement of Rich Anderson, chief executive offficer, St. Luke’s Hospital ......... 43

Prepared statement .......................................................................................... 44

Statement of Kirk Norris, president, Iowa Hospital Association ........................ 49

Prepared statement .......................................................................................... 52

Statement of Jay Kleiman, M.D., M.P.A., fellow, American College of Cardiology, clinical assistant professor of medicine, Northwestern University

Medical School ...................................................................................................... 53

Prepared statement .......................................................................................... 55

Statement of Eric W. Blomain, M.D., past president, Pennsylvania Plastic

Surgeons Society .................................................................................................. 57

Prepared statement .......................................................................................... 59

Statement of Richard E. D’Alberto, chief executive officer, J.C. Blair Memorial

Hospital ................................................................................................................. 60

Prepared statement .......................................................................................... 62

Statement of Richard F. Pops, chief executive officer, Alkermes, Inc. ................ 66

Prepared statement .......................................................................................... 69

Prepared statement of the American Association for Geriatric Psychiatry ........ 83

Prepared statement of the American College of Physicians—American Society

of Internal Medicine ............................................................................................. 85

Questions submitted by Senator Mary L. Landrieu ............................................. 89

(1)

MEDICARE REIMBURSEMENT FOR

PHYSICIANS AND HOSPITALS

THURSDAY, JANUARY 30, 2003

U.S. SENATE, SUBCOMMITTEE ON LABOR, HEALTH AND HUMAN

SERVICES, AND EDUCATION, AND RELATED AGENCIES, COMMITTEE ON APPROPRIATIONS, Washington, DC.

The subcommittee met at 9:30 a.m., in room SD–192, Dirksen

Senate Office Building, Hon. Arlen Specter (chairman) presiding.

Present: Senators Specter, Stevens, Cochran, Harkin, Kohl, Murray, and Landrieu.

OPENING STATEMENT OF SENATOR ARLEN SPECTER

Senator SPECTER. Ladies and gentlemen, the hearing of the Appropriations Subcommittee on Labor, Health and Human Services,

and Education will now proceed.

This morning’s hearing will take up the issue of doctors’ reimbursements, hospitals’ reimbursements, and the overall grave difficulties which are confronting the delivery of health services in

America today. The Balanced Budget Act of 1997 has taken a very

heavy toll in many, many directions, and the Congress has moved

in a number of ways to try to ameliorate that impact.

Another cut in physicians’ payments is scheduled for March 1 of

this year, 4.4 percent, and as I have traveled the State of Pennsylvania and elsewhere, I have heard many complaints, which are

very justifiable. Therefore, the Appropriations Committee took the

lead, and the Senate has now passed an omnibus appropriation bill

which will freeze those cuts. Now we have to go through the conference to get the agreement of the House. It is such a controversial issue that we originally scheduled this hearing early, for January 13, but we could not get the Senate reorganized at that time.

Nobody knew who the chairman of the subcommittee was, although

in the particular case of this subcommittee it does not matter

much, because Senator Harkin and I have had what we call a

seamless exchange of the gavel on these very, very important public matters. The testimony today from a number of experts will be

very important in presenting the case in the conference to try to

freeze the current physician payments and to avoid, at least for the

time being, the 4.4 percent cut.

We have taken up the issue of rural hospitals, which have been

compensated under Medicare at a lower rate than urban hospitals,

a 1.6 percent difference, and that has been altered as well. We are

raising Medicare reimbursement for rural hospitals to give them
2

some relief. As I travel the 67 counties of my State, I hear that concern and complaint over and over again.

We are also going to take up the issue of the compensation of

doctors for medical malpractice insurance, and that is one strand

of a very, very complex issue. Some States have been hit harder

than others, and as you know, the Congress is considering legislation on that subject. It is an issue which has quite a number of

parts. Reimbursement to doctors for rising malpractice rates is behind the curve. I have a very extensive letter from the Administrator, of the Centers for Medicare and Medicaid Services, Mr.

Scully. I wrote him a letter back on November 21 of last year, after

I had heard complaints around the State, and I got a very complicated letter dated yesterday, and I——

Mr. SCULLY. Sorry about that.

Senator SPECTER. Excuse me?

Mr. SCULLY. I am sorry about that.

Senator SPECTER. Oh, you have not heard the last of it.

We will come to that, Mr. Scully, when your turn comes to testify, but I started to read the letter as soon as I received it, and

I read it right along in the intervening time, but I have not finished it yet. It is that long, and it is that complicated. On a serious

note, Mr. Scully, we know how busy you are, and we appreciate

what you are doing, and we thank you for your services. It is not

the first time that we have received a letter the day before a hearing. In fact, I think it is practically a violation of executive ethics

to get it to us any sooner than that.

On the malpractice issue, there are many strands. There are

issues involving the insurance industry, which will have to be

taken up by appropriate committees. There are the issues of medical errors. We had extensive hearings on the Institute of Medicine

some time ago, and we have appropriated funds in the past to try

to deal with that, and the issue will be before the Congress as to

caps on malpractice claims. I have said publicly that I am prepared

to try to avoid the so-called lottery on caps, providing we exclude

so-called catastrophic injuries. There are ways to deal with that

issue on sanctions under Rule 11, or State rules, if there are frivolous lawsuits brought, and ways of dealing with venue, as it has

been dealt with in Pennsylvania. There are ways of dealing with

the certification by experts before suit is brought, so that there is

a basis in advance of a filing.

We will be taking up a number of these key issues today, and

I want to yield to my distinguished colleague, Senator Harkin, who

I was pleased to compliment a few moments ago in absentia.

Senator HARKIN. Oh, well, say it again.

Senator SPECTER. I said we could not figure out, Tom, on January 13, when this hearing was originally scheduled, who the chairman was.

Senator HARKIN. That is right.

Senator SPECTER. And I said it did not much matter between you

and me because we had a seamless passing of the gavel.

Senator HARKIN. That is true.

Senator SPECTER. But now we are ready to proceed.

Senator HARKIN. It has happened quite a few times. I thank you,

Mr. Chairman.
3

Senator SPECTER. Yes, it has. Senator Harkin.

OPENING STATEMENT OF SENATOR TOM HARKIN

Senator HARKIN. Thank you for your leadership, Mr. Chairman,

and for bringing us this hearing today.

There are going to be a variety of things discussed today. Two

things that I want to focus on. During his State of the Union

speech, President Bush announced a new plan to infuse the Medicare program with $400 billion over the next 10 years to modernize

the system. He admitted to a Medicare crisis that must be addressed to save the system for current and future generations.

I think first of all we have to be clear, while many providers are

struggling to meet their commitment to beneficiaries, especially in

States like Iowa, which lose money providing health care to seniors

on Medicare, the solvency of the program is not in crisis. The solvency of the program is not in crisis. In fact, the most recent Medicare actuary report indicates that the Medicare program will be

solvent for the next 28 years, the rosiest projection since 1970.

That is not to suggest there are not serious problems that need

to be addressed, two that I want to point to today, reimbursement

equity for health care providers in rural States like Iowa, and the

overwhelming need for a prescription drug benefit that is affordable and available to all in every State.

I was greatly encouraged by a couple of words that were in the

President’s State of the Union message, Mr. Scully, when the President said something about seniors, prescription drugs, and preventative health care. Most important, and I hope that we are going to

be focusing on that also.

This is not a new issue about the reimbursement rate for Medicare in rural areas, Mr. Scully. You and I have talked about it

many times in the past. Secretary Thompson and I have spoken

about it. In fact, Secretary Thompson testified before this committee last year, and he said the existing reimbursement formula

for rural areas is nonsensical and unfair, yet, as best as I can tell,

the administration has done nothing to reverse the payment gap.

I had a chart, it is on its way here, that would show, for example,

in the Medicare program benefits on the reimbursements to beneficiaries, Iowa is dead last. My State is dead last, with a per-beneficiary payment of about $3,053 per beneficiary. The top State is

Louisiana, with $7,336. Well, again, the discrepancy of two-fold—

I can understand there might be discrepancies, that there might be

some variance because of labor conditions, high rent, different

things like that that might come into play, but to say that there

is a 2-to-1 difference is ridiculous.

For example, if you look at our neighbor, Nebraska, from Iowa,

they received $4,856 per beneficiary. What could possibly be the

reason that Nebraska, next door to Iowa, should receive 63 percent

more per beneficiary than the State of Iowa? Please, someone explain that. If anything, the cost of living and providing services

might even be higher in Iowa than it is in Nebraska.

From my perspective, and from the perspective of all the Medicare providers throughout my State, this variation in payments is

unjustifiable and unacceptable. As I said, while some differences

might be arguable, depending upon where you are—I can under-
4

stand New York, high cost of living maybe, and other parts of the

country, but 2 to 1? Inexcusable.

So we have to get something done about this. Everyone agrees

that the reimbursement variance is inappropriate, but what we

have today is a result of this flawed system, and is exacerbated by

inaction. No one is doing anything. I can tell you, and you might

take it from my tone of voice, and I am reflecting what I am hearing in Iowa, it has reached the boiling point in my State. Nurses

are going across, out of Iowa, to work in Minnesota, driving, getting buses to go to Minnesota to work, going to Omaha, going

across the river. It is like they are just fleeing, like off a sinking

ship, and I am telling you, it is getting bad.

Now, people say, well, we are going to fix it. Well, there is some- thing in the omnibus bill. Yeah, a little Band-aid, $8 million. We

have got a billion-dollar problem. $8 million is laughable, to say

that somehow that is going to fix it.

There is that chart I was talking about, Tom. I am sure you have

seen it before. You know that chart. As I said, some variance might

be acceptable, but you look at the U.S. average, it is $5,490. There

are 30-some States below that national average, Mississippi, North

Carolina, South Carolina, Kentucky, and on down the list, Montana, Wyoming, Oregon, New Hampshire, New Mexico, Washington, way down there. Something has got to be done about this,

and as I said, in my State, it has reached the boiling point, and

a little Band-aid, $8 million, is not going to do it, that is in the omnibus bill.

So we have got to get this thing changed, Mr. Scully. I know you

and I have talked about it. I know I am preaching to the choir, but

we have got to get something done about it, and I look forward to

this hearing and discussing a little bit more with you on this issue.

I wanted to say a little bit more about prescription drugs, but I

have taken much of my time already. Thank you, Mr. Chairman.

Senator SPECTER. Thank you, Senator Harkin.

Senator Cochran, would you care to make an opening statement?

OPENING STATEMENT OF SENATOR THAD COCHRAN

Senator COCHRAN. Thank you very much. I came by the hearing

today to compliment Tom Scully and to thank him for taking on

this tough job. It is one of the most difficult jobs in this town, in

my opinion, but he has shown a willingness to travel around the

country. I know he has come to our State and gone to some of the

small-town hospitals, and met with officials in our State who are

responsible for the Medicaid program, and for trying to make sure

that we provide access to health care to the greatest number of

people we can in our State at affordable costs.

I am encouraged that the administration is moving forward to

modernize Medicare, to make specific recommendations for doing

that, to include a prescription drug benefit. I admire the leadership

that is being shown in that area.

There are a lot of unmet needs, and there are a lot of other problems to be solved, but I think the administration is on the right

track, and if we continue to work together, the Senate and the

House and the administration, we can solve these problems and

make a difference in the lives of a lot of Americans.
5

I am pleased, Mr. Chairman, with your leadership in getting the

changes in the omnibus appropriations bill that were included, and

I hope we can preserve those in conference with the House and can

see the effect that they will have in making things better in this

area, and I appreciate your holding the hearing, and I appreciate

the leadership that you and Senator Harkin are giving to these

issues that are under the jurisdiction of this subcommittee.

Senator SPECTER. Thank you very much, Senator Cochran.

In order of arrival, Senator Kohl, would you care to make an

opening statement?

OPENING STATEMENT OF SENATOR HERBERT H. KOHL

Senator KOHL. Briefly, Mr. Chairman. We have all heard from

doctors, hospitals, nursing homes, and home health agencies in our

States about Medicare cuts that they are facing. These cuts have

real effects on our seniors and jeopardize our access to care.

I believe we must address these cuts immediately, and I hope the

administration will come to the table as a partner in this effort, but

while many of us agree that we need to stop these cuts, the reality,

as Senator Harkin has said, is that the cuts hit providers in some

States much harder. That is because the reimbursement formulas,

as we know, that Medicare uses are flawed and outdated. They penalize efficient providers in many States, and my State of Wisconsin is a prime example, by paying them much less than other

States, and they penalize Wisconsin seniors by delivering fewer

benefits that seniors in other States enjoy.

This system, of course, is indefensible. All of our constituents pay

the same Medicare payroll taxes. They suffer from the same illnesses, they need the same treatments, they receive the same types

of health providers. Seniors in some States should not be treated

like second-class citizens when it comes to health care. They should

have the same access to treatments and benefits that seniors in

other States receive, but today, too many States lose under Medicare.

For example, Wisconsin Medicare beneficiaries receive on average $3,800 in Medicare benefits per year, the eighth-lowest, by my

calculation, in the country. That is more than 25 percent below the

national average of $5,500. Studies show this costs Wisconsin nearly a billion dollars every year in Medicare dollars lost.

Those costs do not just disappear. Businesses and employees in

the private sector pay higher costs to make the Medicare shortfall,

so there is simply no logical reason why doctors, hospitals, nursing

homes, and ultimately our seniors and the disabled should get less

in some States than in others. The formulas Medicare uses are outdated and flawed, and they must be fixed if we are to have true

Medicare reform.

I have co-sponsored legislation that would begin to address the

inequities in Medicare formulas. I hope the administration will

work with me and Senator Harkin and others that have been pushing this issue so that we can once and for all fix this system so that

it is fair for all of our seniors, no matter where they live.

Thank you, Mr. Chairman.

Senator SPECTER. Thank you, Senator Kohl.

Senator Murray.
6

OPENING STATEMENT OF SENATOR PATTY MURRAY

Senator MURRAY. Well, thank you very much, Mr. Chairman, for

having this hearing, and I really appreciate Mr. Scully being here,

and I guess I will submit my statement for the record and just simply say to Senator Harkin and Senator Kohl, me, too. My constituents are furious about the reimbursement rate and the fact that

they pay the same into Medicare, but we rank 42nd on the chart

that Senator Harkin put up there. I have introduced legislation, my

MediFair Act, to make sure that no State receives below the national average.

But this has reached a crisis point. It is no longer just the fact

that our hospitals are screaming about it. It is the fact that we are

losing access. Just as Senator Harkin said, our doctors, our nurses,

our health care providers are leaving and going to higher reimbursement States. This means that doctors and hospitals are not

taking Medicare patients in my State, and they are saying directly

as a result of this reimbursing issue they are losing doctors to

other States.

We have to deal with this issue. It is an access issue and, as Senator Kohl said, it is not fair that we are rewarding States that encourage inefficiency and high health care cost, and I do not want

to see my good friend Mary Landrieu reduce the reimbursement

rate to her State, but I think that she can understand in my State

when seniors are not getting access because we are 42nd, 42 States

behind her in reimbursement. It is not fair to people in our State,

either.

PREPARED STATEMENT

We have to deal with this issue, and I will continue to work with

my colleagues, and Mr. Scully, I am very interested in what your

agency is going to be doing to help us deal with this issue.

[The statement follows:]

PREPARED STATEMENT OF SENATOR PATTY MURRAY

Mr. Chairman, I am very grateful for the Chairman’s willingness to schedule this

hearing. I recognize that Medicare is not under the jurisdiction of this Subcommittee, however, as many of us know we often have to deal with the reimbursement problems.

Many hospitals come to us for increased funding on the discretionary side or for

earmarks to make up for the shortfalls in Medicare reimbursement.

My state faces a particularly difficult situation when it comes to Medicare reimbursement for physicians and hospitals. While all doctors experienced a 5.4 percent

reduction in their fee schedule for 2002 and may face additional reductions, doctors

in Washington state have been treated unfairly for years.

Doctors and hospitals in my state get far less per beneficiary than most states.

In fact, Washington state ranks 42nd in the nation in Medicare payments per beneficiary.

Despite these lower payments, my providers still have to compete in a highly competitive health care arena.

Hospitals in Washington state have the same technology costs as hospitals in

Florida or Louisiana, yet they receive significantly less in reimbursements.

I have been working for several years with Senator Harkin to address this inequity. I have introduced the Medifair Act, which would guarantee that no state receives less than the national average per beneficiary cost.

My legislation also includes a mechanism for the Secretary to evaluate outcomes

and work with those states that have some of the highest costs. My intent is not

to reduce payments for those higher cost states but rather to work to implement

healthy, cost-effective practices.
7

I am pleased that the Senate-passed Omnibus Appropriations bill begins to address the rural/urban inequity. However, much more needs to be done. Seniors in

Washington state simply do not have access to the same Medicare program or benefits as seniors in Florida or New York.

It’s especially frustrating for my state—because the reason we’re at the bottom

of the list is because we’ve done the right things and are highly efficient.

We have lower utilization rates and higher rates of efficiency than other states.

Washington’s seniors and health care providers have done the right things, yet

every year they are penalized.

The incentives are backwards. This has to change. We should not be rewarding

and encouraging inefficiency and costly health care decisions.

I will continue to work to eliminate the inequities that are having serious economic and health care impacts in my state.

Hospitals and physicians have little choice but to pass the shortfall in Medicare

on to private insurance—driving up the cost for employers and workers.

I can tell you that there is little flexibility remaining to shift costs to private insurance plans. This shift only increases the cost of health insurance pushing more

people into the ranks of the uninsured.

Senior citizens in Washington state deserve access to the same Medicare program

and benefits as seniors in any other state.

Senator SPECTER. Senator Landrieu.

OPENING STATEMENT OF SENATOR MARY L. LANDRIEU

Senator LANDRIEU. Thank you, Mr. Chairman. I appreciate the

opportunity just to make a few brief remarks, and Mr. Scully,

thank you for the job that you do. You have a great many challenges before you.

Unfortunately, Mr. Chairman, I am not going to be able to stay.

Senator Breaux and I are hosting a major conference of thousands

of people from our State that are up here today and tomorrow, so

I am going to have to slip out, but I came to make just one brief

comment about one of the aspects of the proposed new rule, but before I do, I want to make a comment about the issue being raised

by Senator Harkin.

I agree that probably some changes need to be made, and I most

certainly appreciate the frustration expressed by the chairman and

the other Members about the discrepancy, but there are some good

aspects to the formula, and as Louisiana is the highest beneficiary,

the current formula is based, in large part, as you know, Mr.

Scully, the rate of wages in a State, as well as the frequency of use,

both of which give rise to States like Louisiana being on top. The

fact is people in Louisiana are paid much less, are poorer, not as

healthy, and therefore access the system in greater numbers than

a healthier population, so those are some of the contributing factors

which I think are very worthy of consideration when trying to provide health care in a Nation as diverse as ours. I would hope to

work with the chairman and the ranking member on this issue so

that we can reach a solution that serves all of our States.

I wanted to, Mr. Scully, come here for the specific purpose of

stating strong objections to one change that you are recommending

that has doctors and medical professionals in my State quite concerned, and that is the change in the Medicare pass-through regulations. I have been contacted by several oncology practices in Louisiana specifically expressing a growing concern about the use of

functional equivalent standards by CMS. As you know, the standard was introduced in the context of the recently promulgated rules

for hospital outpatients, which I am sure you are familiar with.
8

It is my understanding the new concept was not raised in proposed regulations, not subject to comment from interested parties.

Had it been properly introduced, the following stringent objections

would have been raised by many practitioners in Louisiana. First,

I want to say on the record this is a subjective standard. It is a

dangerous precedent which interferes with the physician’s ability to

prescribe the best care for patients.

Second, the discretionary nature of the standard will stifle innovation, in my opinion, especially among biotechnology firms which

lack the resources to roll the dice on whether the new products will

be covered, as is the current situation, and I am afraid, Mr. Scully,

the effect of the final rule will be to delay faster treatments of

highly effective new therapies that we are all very encouraged by,

and that are administered less frequently than competing therapies. The result will be dramatically reduced reimbursement rates

that make new therapies not a viable option.

Finally, let me just say, in a rural State, which many of us represent, the options of people to have to receive treatment once a

week, or twice a week, or three times a week, can have a direct

impact on whether they are able to hold down a job or not, having

to travel great distances for health care.

So this change, I really want you to look very intently on, and

I register my strong objection to the proposed change on behalf of

many physicians in Louisiana, and say thank you for your time

and attention.

STATEMENT OF THOMAS A. SCULLY, ADMINISTRATOR, CENTERS FOR

MEDICARE AND MEDICAID SERVICES, DEPARTMENT OF HEALTH

AND HUMAN SERVICES

Senator SPECTER. Thank you, Senator Landrieu. We now turn to

our first witness, Mr. Thomas A. Scully. Since May 2001, he has

served as Administrator for the Centers for Medicare and Medicaid

Services. Prior to that appointment, he served as president and

chief executive office of the Federation of American Hospitals. He

was a partner at Patton, Boggs, and also served as Deputy Assistant to the President and Counselor and Director of the Office of

Management and Budget. He has a law degree from Catholic University and a bachelor’s degree from the University of Virginia.

Mr. Scully, we are going to ask you to observe our general rule

of a 5-minute opening statement. As I said at our initial hearing

yesterday, I attended memorial services for Ambassador Annenberg

recently, and the speeches were limited to 3 minutes. That applied

to former President Gerald Ford, and Secretary of State Colin Powell, and to me, and to the 15 other speakers, so I want you to know

that the 5-minute allocation is generous. Please proceed.

Mr. SCULLY. Mr. Chairman, I am going to talk as quickly as I

can.

Thank you, Mr. Chairman, Senator Harkin and other Senators

for inviting me today. Obviously, there are a lot of complex issues

about geographic differences, and I will try to get into those questions, because the primary focus this morning is going to be on the

physician payments.

I have worked on physician payments since the first Bush administration. I was very involved in passing the RBRVS reforms in

1989, so I have a strong personal feeling about this, and a great
9

level of disappointment about how mixed-up our physician payment

formula has become.

We paid about $44 billion for physician services in 2002, and

processed about 600 million physician claims for 7,000 different

services, but the system for Medicare physician payments has basically imploded. There are some very big flaws in the formula, and

I would say that basically, we have had the perfect storm in all

these different factors coming together to essentially cause the physician payment formula to just not work. It badly needs to be fixed,

and we appreciate the efforts that have been made in both Houses,

the House and the Senate—slightly different approaches to fixing

this—and we strongly advocate fixing it as fast as we possibly can,

and, certainly, hopefully before March 1.

There are a number of reasons that this has happened. The first

is that the law, which was rewritten in 1997, is extremely specific,

very limiting in the way we are allowed to make changes. The projections, essentially when we did the SGR calculations, the law required us to use projections for actual physician growth, spending

growth, and for economic growth in 1998 and 1999, and did not

allow us to come back and adjust it for real data later.

After 2000, we could use real numbers, but the law requires us

to use projections in 1998 and 1999. That was the first thing that

threw off the formula. We are using, by statute, incorrect numbers

for 1998 and 1999.

The second is that when the law was changed in 1997, the new

measurement for physician payments is directly reflective of the

change in GDP, so as the economy has obviously taken turns for

the worse, the reduction in GDP growth has had a drastic impact

on the physician payment formula. Again, that is set in the statute.

The third is that physician payments have grown pretty rapidly

in recent years, and that also is reflected in the downturn in the

formula, and one additional factor of that is that we have, as I

mentioned, about 7,000 different payments for physicians. In 1998,

1999, and 2000, my agency added a couple of hundred codes, which

we do in cooperation with the AMA and physician groups.

We work them all year long to figure out what new things we

should pay for, but inadvertently, believe it or not, we added 300

codes and forgot to count them, so we spent $5 billion in 1998,

1999, and 2000 that we did not know we spent until much later,

and the statute is very strict, and requires us to recapture that,

and I can explain also, if you like, the actual formula works exactly

as it was designed, but there have been a bunch of mistakes made,

inadvertent mistakes, that have basically caused it to blow up,

which is why we had a negative 5.4 percent reduction for physicians last year in the base fees, and a negative 4.4 percent coming

March 1.

We have fixed some of these within my discretion. The original

cut was supposed to happen January 1. The administration for a

variety of reasons has delayed the rule for 2 months. The original

cut would have been negative 5.1 percent. We worked with the

physicians in the physician community, and we have buffered it to

the limited amount we can under the statute from negative 5.1 to

negative 4.4. We certainly don’t expect them to be happy about

that, but I have probably spent a quarter of my time since I have
10

been in this job working with the AMA, physician groups, everybody at the highest level of the Justice Department and the White

House to try to fix this. Unfortunately the statute is so tightly

crafted that there is basically no way for us to do it administratively, or believe me, we would have tried to.

We clearly believe the physician payment formula, while extremely well-intentioned, is broken. The numbers are flawed. The

cumulative impact has clearly resulted in physician payments that

clearly were never intended, and are not appropriate for physicians.

By February 12, we have discretion to change the way contractors pay physicians. There will be a negative update—or

downdate—for doctors on March 1, and the latest that I can actually change that is February 12. I bring that up because I would

certainly hope that whatever the process brings, that Congress can

fix this before February 12, because that is the date I have to actually send the instructors to our contractors around the country to

actually fix this before this thing actually blows up.

Unfortunately, this is not just a short-term problem, it is a longterm problem. The appropriations bill fixes it for 1 year, and this

is a top legislative priority for the administration to fix it. We had

lots of discussions, which we will get into this morning, about provider give-backs, or different adjustments. There are lots of merits

for rural hospitals and other things. We don’t believe that this is

a give-back. This is a mistake and it needs to be fixed.

Negative 4.4 percent update on top of the negative 5.4 percent

update would be comparable for hospitals, for instance, to something like market basket minus 8 percent 2 years in a row. It just

is not sustainable, it is not right, and if you want the physicians

in this country to be good partners with the Government in providing services, we strongly believe it has to be fixed.

One additional factor that the chairman asked me to get into

that causes additional stress for physicians on top of this mistake

is the cost of malpractice liability insurance. Obviously, as you

know, the President has a strong program that we are pushing aggressively to reform malpractice. We hope to get that through Congress this year, but a factor for most physicians in what they get

paid is how Medicare allocates for their costs of malpractice.

Now, there are a number of different ways we measure it, three

different ways, which I will try to run through quickly, and basically, malpractice is a very small component, 3.2 percent, of what

we pay physicians in Medicare. There are three basic rates that we

pay physicians, and malpractice is about 3.2 percent of that. There

are three different factors that go into that calculation.

One is the relative value for services, which is the relative payment rates. That is updated, as the chairman pointed out, using

1996 to 1998 data. I am working on trying to find a way to adjust

that in real time.

There is an inflation update, which is the only real source of new

money into the system every year, which actually is used on 1-

year-old data, 2001 and 2002, and that calculation last year was

increased by 11 percent, but because it is such a small piece of the

Medicare calculation, you can imagine that an 11 percent increase
11

on a base of 3.2 percent does not have a real big impact for physicians and communities that are affected.

Then finally there is a geographic allocation, so we do allocate

differently for different costs. For example, Pennsylvania has had

a relative meltdown in malpractice costs this year, and we do allocate differently for different areas. The country is broken up into

89 geographic practice cost areas, and those 89 areas all do get

paid quite differently for physicians, which is similar to what I am

sure it sounds like we are going to get into on hospitals in a few

minutes.

We are working on a policy—I am working on one to try to find

a way to get more real time data into the system, but it is extremely complicated to collect, it is difficult to get right. Historically, we have collected it for two of the three categories on basically 5-year-old data, and I think the chairman raised that point

in this opening remarks.

I will just wrap up, since it looks like I am through my 5 minutes, by saying that we are working very hard to try to fix this.

We are very aware of the issues.

Senator SPECTER. Mr. Scully, we are going to hold the other people to the limits, but you are the Administrator. Take a little more

time if you need it.

Mr. SCULLY. Okay. I would just say that in respect to some of

the earlier comments about geographic distribution, as Senator

Kohl would be aware, my boss, Secretary Thompson, who is also

from Wisconsin, is equally concerned about Wisconsin. I spend a lot

of time working on rural issues. I believe that in the 2 years we

have been there, almost every time we have had the ability in the

regulation to try to adjust them—and on the margins it is not always very big—towards helping rural areas, we have done that. We

did that this year on the wage index. We have done that across the

board. Secretary Thompson is very focused on it. Our ability under

the current laws to do that is somewhat limited, but we are very,

very focused on it and very aware of that.

There are a lot of reasons, I would say, Iowa may be underpaid,

but having gone through a lot of this the last few days, I would

also say Iowa has extremely high costs, extremely efficient health

care, as does Washington State, by the way. I was out there last

year going through the same issue, and to some degree that is a

good model. You do get paid about 91 percent on the national average, for instance, in Iowa of your cost, and you get about 71 percent

per capita. Part of that is you have a much more efficient, much

better quality of care for a lower cost, which is in many ways admirable, and Washington State has the same qualities.

But we are working to make sure that the system is fair. There

is a great difference in the way we calculate, historically, physician

payments by region versus hospitals, something we can clearly look

at, and we are very focused on trying to make sure that these formulas are fair and more equitable State-by-State.

PREPARED STATEMENT

But there is no question, getting back to the primary focus of

what I was asked to testify this morning, that we have many flaws

in the Medicare program, there are many, many things that obvi-
12

ously, if I had the power, I would love to fix. We would be happy

to work with the committee to fix all of them, but as far as the

number 1 clear inequity in the program right now, that clearly is

not right or fair for seniors or their physicians, the physician payment system is broken. If there was any way we could fix it administratively, we would have done it already, and we are extremely

anxious to work with both the Senate and the House to try and get

this resolved before March 1.

Thank you, Mr. Chairman.

[The statement follows:]

PREPARED STATEMENT OF THOMAS A. SCULLY

Chairman Specter, Senator Harkin, distinguished Subcommittee members, thank

you for inviting me to discuss how Medicare pays for physicians’ services. I have

worked on Medicare physician payment issues since 1989 when I was one of the primary people in the previous Bush Administration negotiating the creation of the resource based relative value physician payment system, sometimes referred to as

RBRVS. I personally think that, over the years, this has been the most stable payment system in Medicare, and historically there has been far less controversy in

physician payments than we have witnessed with other health care providers. In

fact, the resource based relative value system has worked reasonably well and often

is used by private payers. A number of factors have combined to cause the formula,

as set in law, to produce negative updates for 2002 and 2003 as well as projected

negative updates for future years.

Over the past 15 months, I personally have devoted about a quarter of my time,

working with every group imaginable—lawyers, physicians, and the highest levels

of the Administration—to fix the fee schedule administratively. The Agency explored

every legal option possible to try to fix the negative update, but unfortunately, the

statute is too prescriptive to allow an administrative fix. We, however, were able

to modify the methodology used to calculate the Medicare Economic Index (MEI),

which measures inflation for the cost of providing physicians’ services used in the

fee schedule formula. The change we made resulted in a 0.7 percentage point increase in the 2003 MEI update, from 2.3 percent to 3.0 percent, and is expected to

increase the MEI in all future years by roughly 0.5 percentage points per year. This

change will increase Medicare spending for physicians by about $15 billion over the

next 10 years. While the 2003 update is a negative 4.4 percent, without this technical modification, the update for 2003 would have been negative 5.1 percent. This

does not resolve the fee schedule update problems, but it is a step in the right direction. We point out that Medicare expenditures for physicians’ services increased by

5 percent in 2002, and are expected to increase by 2 percent in 2003, despite the

negative update.

We believe that the physician update formula is broken and can only be corrected

by legislation. The physician update has both short-term and long-term problems.

The short-term problem is that the negative 4.4 percent update will go into effect

on March 1 without a change in law. The long-term problem is that there will be

negative updates for future years under current law. No one ever intended that the

physician formula have this result. Working with Congress to find a legislative fix

is a top legislative priority of the Administration. We believe that fixing the physician update would be a technical correction to a broken system, not a ‘‘giveback’’

that other providers have been seeking. We believe it is important that Congress

takes immediate action to prevent the 4.4 percent reduction scheduled to go into effect on March 1. Such an action is the only equitable solution that will stop physicians from experiencing payment reductions that result from this flawed formula.

HISTORY

Let me explain the origins and logistics of the physician fee schedule so that we

can all understand how the system works. In 2002, Medicare paid about $44 billion

for physician fee schedule services. Between 1997 and 2002, Medicare physician

spending increased from 17.6 percent to 19.8 percent of total Medicare fee-for-service spending. Each year, Medicare processes about 600,000,000 physician claims.

The fee schedule reflects the relative value of the resources involved in furnishing

each of 7,000 different physicians’ services. By law, we actually establish three components of relative values—physician work, practice expenses, and professional liability insurance—for each of these 7,000 services. The actual fee for a particular
13

service is determined by multiplying the relative values by a dollar-based conversion

factor. And the payment for each of the services is adjusted further for geographic

cost differences among 89 different payment areas across the nation.

Payment rates for physicians’ services are updated annually by a formula specified in law. The annual update is calculated based on inflation in physicians’ costs

to provide care (the MEI), then adjusted up or down by how ‘‘actual’’ national Medicare spending totals for physicians’ services compare to a ‘‘target’’ rate of growth.

If spending is less than the target, the physician payment update is increased, and

if spending exceeds the target, the update is reduced. The system was designed to

constrain the rate of growth in Medicare physician spending and link it to growth

in the overall economy, as well as to take into account the physician role in the volume and intensity of services. Until 2000, in large part, the formula has been working as designed.

The law that sets this formula is extremely prescriptive. It does not give the Centers for Medicare & Medicaid Services (CMS) the administrative flexibility to adjust

physicians’ payments when the formula produces unexpected payment updates, as

we witnessed in 2002 and 2003. The size of the negative update for 2002 was a surprise when it first became apparent in September 2001. As we looked at the actual

numbers going into the formula, we explored every issue and every alternative that

could have produced a different update, but we concluded that we did not have any

flexibility. We made sure that every part of the update was accurate and fully in

accord with the law.

Several factors lead to the negative updates. First, there were differences between

estimates and after-the-fact actual data for components of the fiscal year 1998 and

fiscal year 1999 Sustainable Growth Rates (SGRs). As I explain below, this means

that the cumulative target was lower than it should have been. Second, there has

been a downturn in the economy in recent years, which affected the SGR because

it is tied to the growth in the country’s Gross Domestic Product. Third, spending

for physicians’ services has grown very rapidly in recent years. The combination of

lower targets and higher expenditures accounts for negative updates. In addition,

in 2002, our measure of actual expenditures had to be adjusted to capture spending

information on services that were not previously captured in the measurement of

actual expenditures. Counting these previously uncounted actual expenses, as required by law, also increased cumulative actual expenditures—driving down the update.

While there are significant differences between the Medicare Volume Performance

Standard (or MVPS, the predecessor to the SGR) and SGR, both use the same general concept that expenditures for physicians’ services should grow by a limited percentage amount of allowed expenditures each year. One important feature of both

the MVPS and the SGRs for fiscal years 1998 and 1999 was that the percentage

increase was based on estimates of the four component factors specified in the law,

made before the beginning of the year. Under the MVPS and the SGRs for fiscal

years 1998 and 1999, the statute did not permit us to revise the estimates used to

set the annual percentage increase. Beginning with the fiscal year 2000 SGR, the

statute specifically requires us to use actual, after-the-fact data to revise the estimates used to set the SGR. For some of the component factors of both the MVPS

and the SGR, there have been differences between the estimates used to set the annual MVPS and SGR and the actual increase based on actual, after-the-fact data.

For instance, under both the MVPS and SGR, we are required to account for increases in Medicare beneficiary fee-for-service enrollment. Because it is difficult before the beginning of the year to predict beneficiary enrollment in Medicare∂Choice

(or Medicare managed care, as they were known under the MVPS) plans, there have

been differences between our estimates of the increase in fee-for-service enrollment

and the actual increase. Under the MVPS, we generally estimated higher growth

in beneficiary fee-for-service enrollment than actually occurred, although the statute

has required us to revise our estimates for subsequent years.

Because the physician fee schedule conversion factor has been affected by a comparison of the actual increase in expenditures to the level of allowed expenditures

calculated using the MVPS and the SGRs for fiscal years 1998–1999, revision of our

estimates would have resulted in different conversion factors than those we actually

determined. The 4.4 percent reduction to the physician fee schedule conversion factor is occurring, in part, because of a flawed statute that does not allow us to revise

estimates for previous years. Physicians argue that these negative payment updates

will hinder their ability to care for beneficiaries, and may result in some physicians

not accepting new Medicare patients. We take these statements seriously, and are

taking steps to monitor beneficiary access to care to ensure that our nation’s most

vulnerable citizens continue to receive the care they need. As we consider how to

improve the Medicare physician payment formula, I think it’s important to under-
14

stand, from a historical perspective, how and why the formula operates the way it

does today. It is, in fact, operating precisely as it was designed in 1997—but we recognize that this has produced some large short-term adjustments.

PHYSICIANS’ PAYMENT BEFORE 1997

As the Medicare program has grown and the practice of medicine has changed,

Congress and the Administration have worked together in an effort to ensure that

Medicare’s payments for physicians’ services reflect these changes. As a result, the

physician payment system has changed significantly in the past two decades. For

many years, Medicare paid for physicians’ services according to each doctor’s actual

or customary charge for a service, or the prevailing charge in the physician’s area,

whichever was less. From 1970 through the 1980’s, spending for physicians’ services

grew at an unaffordable and unsustainable average annual rate of more than 14

percent. And, because the system was based on historical charges, it produced wide

discrepancies in payments among different localities, medical specialties, and services. These payment differences did not necessarily reflect actual differences in the

cost of furnishing services. As a result, the system was roundly criticized in the

1980’s as overvaluing specialty services and undervaluing primary care services.

To address these criticisms, Congress directed the Physician Payment Review

Commission, an advisory body established by Congress and one of the predecessor

organizations of the Medicare Payment Advisory Commission (MedPAC), to examine

different ways of paying physicians while protecting beneficiary access to care, as

well as slowing the rate of growth in Medicare physician spending. On a bipartisan

basis, and with the support of the first Bush administration, Congress accepted

these recommendations and passed these and other reforms in the Omnibus Budget

Reconciliation Act (OBRA) of 1989, and the new fee schedule was implemented beginning January 1, 1992. The resource-based work component of the fee schedule

was phased in between 1992 and 1996.

Specifically, in its 1989 Annual Report, the Commission recommended a number

of ways to change how Medicare pays physicians. The Commission first recommended instituting a fee schedule for physicians’ payments based on the resources involved with furnishing each physician’s service, rather than on historical

charges. The Commission also recommended that the relative value of three separate components of each service—physician work, practice expense and professional

liability insurance—be calculated, as discussed above.

Under the Commission’s recommendations, once the relative values were established, they were adjusted for cost differences, such as in staff wages and supply

costs, based on the area of the country where the service was performed. Then the

actual fee for a particular service for a year was determined by multiplying the relative value units by a dollar-based conversion factor. The Relative-Value Update

Committee (RUC), a multi-specialty panel of physicians that is supported by the

American Medical Association (AMA), plays an important role in making recommendations so that the relative values we assign reflect the resources involved

with both new and existing services. We generally accept more than 90 percent of

the RUC’s recommendations, and our relationship is cooperative and extremely productive. The Physician Payment Review Commission also recommended that HHS

provide financial protection to beneficiaries by limiting the amount that a physician

could charge beneficiaries for each service.

The Commission’s third major recommendation was to establish a target rate of

growth for Medicare physician expenditures, called the Medicare Volume Performance Standard (MVPS). The MVPS target growth rate was based on physicians’ fees,

beneficiary enrollment in Medicare, legal and regulatory changes, and historical

measures of the volume and intensity of the services that physicians performed. The

MVPS was set by combining these factors and reducing that figure by 2 percentage

points, in order to control to growth rate for physicians’ services. OBRA 1993 later

changed this to minus 4 percentage points. Actual Medicare spending was compared

to the MVPS target, which led to an adjustment, up or down, to the MEI to determine the update for a future year. The law provided for a maximum reduction of

3 percentage points, which OBRA 1993 lowered to 5 percentage points.

PHYSICIANS’ PAYMENT SINCE 1997

The Balanced Budget Act of 1997 (BBA) further changed the physician payment

system based on subsequent Commission recommendations. In BBA, the SGR replaced the MVPS. Like the MVPS, the SGR is calculated based on factors including

changes in physicians’ fees, beneficiary enrollment, and legal and regulatory

changes. However, the BBA did away with using the historical volume and intensity

of physicians’ services as the factor in the target for growth in the volume and in-
15

tensity of services. Instead, the real per capita Gross Domestic Product, which measures real economic growth in the overall economy per capita, was instituted as a

replacement.

One other important difference between the old and the new growth targets is

that the old method compared target and actual expenditures in a single year while

the SGR added a cumulative comparison. Under the MVPS, if expenditures exceeded the target in the previous year, the update was adjusted for the amount of the

excess in the current year, but there was no recoupment of excess expenditures from

the previous year. Under the new SGR, the base period for the growth target was

locked in at the 12 months ending March 31, 1997. This is the base period and remains set for all future years. Annual target expenditures for each following year

equal the base period expenditures increased by a percentage amount that reflects

a formula specified in the law, and they are added to base period expenditures to

determine the cumulative target. This process continues year after year, adding a

new year of expenditures to the cumulative target. A comparison of actual cumulative expenditures is made to cumulative allowed or target expenditures. Under a

cumulative system, if expenditures in a prior year exceed the target, the current

year update is adjusted to make annual and target expenditures equal in the current year and to recoup excess expenditures from a prior year. While the BBRA

made some further technical changes to allow these adjustments to occur over multiple years, that is the general way the formula was established in law. The SGR

is working the way it was designed.

BBA also increased the amount that the update could be reduced in any year if

expenditures exceeded the target. The maximum reduction was increased by 2 percentage points, to 7 percentage points. Thus, for example, inflation updates in the

range of 2 percent, reduced by the 7 percentage point maximum reduction, would

yield a negative update in the range of 5 percent. BBA also established a limit of

3 percentage points on how much the annual inflation update could be increased

if spending was less than the target. For example, an inflation update of 2 percent

increased by the 3 percentage point maximum increase would yield an update of 5

percent.

Additionally, BBA created a single conversion factor (previously there were three

separate ones for different types of services). BBA also required that the practice

expense component of the relative value calculation, which reflects a physician’s

overhead costs, be based on the relative resources involved with performing the

service, rather than the physicians’ historical charges. This change made the practice expense component of the calculation similar to the physician work component,

and reflected actual resources. The change was phased in over four years, and was

fully implemented in 2002. BBA further required that the professional liability insurance expense component of the relative value calculation also be resource-based.

The law required that the resource-based practice expense and professional liability

relative value systems be implemented in a budget-neutral manner. The BBA provisions affecting physicians accounted for about 3 percent of total BBA 10-year Medicare savings. Because physician payment accounts for about 17.6 percent of program

payments in 1997, the physician savings in the BBA represented by these changes

were relatively modest.

The Balanced Budget Refinement Act of 1999 (BBRA) made further revisions to

the SGR in an attempt to help smooth out annual changes to physician payments

such as blending cumulative and annual comparisons of target and actual spending.

Beginning with the 2000 SGR, the law required us to revise previous SGR estimates

based on actual data that became available after the previous estimates. BBRA also

required us to make an annual estimate of the expected physician payment update

for the succeeding year available to MedPAC and the public. This estimate is due

on March 1 of each year, and is very difficult to make, because none of the claims

used to determine actual spending are available by the time we are required to

make the estimate. In 2001, we estimated that the 2002 update would be around

negative 0.1 percent. However, when we determined the actual update, which was

published 7 months later—on November 1, 2001, revised figures lowered the Gross

Domestic Product figures for 2000 and predicted a slower growing economy for 2001

than was previously estimated. Further, 2001 physician spending was higher than

our March estimate.

Additionally, in making updates to the list of codes for specific procedures that

are included in the SGR, we discovered that a number of codes for new procedures

were inadvertently not included in the measurement of actual expenditures beginning in 1998. Therefore, the previous measurements of actual expenditures for 1998,

1999, and 2000 were lower than they should have been. As a result, the physician

fee schedule updates for 2000 and 2001 (5.5 percent and 5.0 percent, respectively)

were higher than they should have been had those codes been included. The down-
16

ward adjustment to the 2002 physician fee schedule was due, in part, to recoup the

higher than intended expenditures in 2000 and 2001. The combination of these factors led to the large negative update for 2002.

As you can see, the process for calculating payments for physicians’ services is

highly complex. It is the result of years of efforts by Congress, previous Administrations, the Physician Payment Review Commission, and MedPAC to ensure that

Medicare pays physicians as appropriately as possible. Today, while the underlying

fee schedule and relative value system have been successful, we recognize that the

update calculation has produced large short-term adjustments and instability in

year-to-year updates. I know that you, Mr. Chairman, and others on this Subcommittee and elsewhere in Congress, are involved with legislative efforts to improve the formula. I want to work with you and the physician community to smooth

out the yearly adjustments to the fee schedule in a way that is budget-neutral

across all providers while ensuring that Medicare beneficiaries continue to get the

care they need.

PROFESSIONAL LIABILITY COSTS

We are very disappointed that, despite our best efforts to find an administrative

fix, physicians will face a negative 4.4 percent update this year, particularly because

we understand the financial pressures that doctors face and want to ensure that

Medicare beneficiaries continue to receive the care they need. One contributing factor is the cost of professional liability insurance. CMS’ Office of the Actuary (OACT)

considers this cost as it develops and maintains input price indexes, or market baskets for the major medical sectors (hospitals, physicians, nursing homes, home

health agencies, and the like) that are used to annually update Medicare payments.

These market baskets reflect what it would cost in a future period to purchase the

same mix of goods and services purchased in a base period. The mix of goods and

services that providers purchase include labor (wages and benefits), utilities, pharmaceuticals, food, equipment, capital, and the like. One of these inputs is professional liability insurance, which we want to appropriately reflect in our market baskets.

In fact, Medicare physician payments for malpractice are determined partly by

relative value units and partly by other elements of Medicare’s physician fee schedule. Payments for each of over 7,000 services under the fee schedule are based upon

three factors:

—Relative value units (RVUs) for each service, reflecting the relative amount of

physician work effort, practice expenses, and malpractice insurance expenses involved with furnishing each service;

—A dollar conversion factor that translates these RVUs into monetary payment

amounts, and;

—Geographic practice cost indexes (GPCIs) for physician work, practice expenses,

and malpractice insurance expenses to reflect differences in physician practice

costs among geographic areas.

All three of these factors affect the total payment amount for a service. There is

a malpractice element in each of these factors.

The first way that malpractice is reflected in the Medicare physician payment system is through a specific component of RVUs for each service for malpractice expenses. Since January 1, 2000, the statute has required that the RVUs for malpractice be based on the resources physicians actually expend to acquire professional liability insurance. We established resource-based malpractice RVUs through

notice and comment using a methodology that incorporates actual malpractice premium data and weighting by specialty and frequency of each service. The law requires that we revise the malpractice expense RVUs no less than every 5 years. If

malpractice insurance premiums rise for some specialties more than for others, the

higher expenses would be reflected in the periodic revisions we make to the malpractice expense RVUs. Subsequently, malpractice expense RVUs for services typically performed by these specialties would increase. We most recently revised these

relative values for 2001. By law, we must make these revisions to relative values

in a budget neutral manner, which means that if we increase the payment for a

service then we are required to reduce the payments for other services. Because

malpractice represents 3.2 percent of the average physician fee (physician work is

54.5 percent and practice expenses are 42.3 percent), even relatively large changes

in premiums for some specialties would have relatively modest effects on Medicare

payments.

The second way that malpractice is reflected in the physician payment system is

through the annual update to the fee schedule conversion factor. The statute specifies a formula for the update based on the MEI adjusted by performance under the
17

SGR system. The MEI is an inflation index measuring year-to-year changes in physician practice costs. One component of the MEI is specifically designed to recognize

national year-to-year changes in the costs of malpractice insurance. If malpractice

insurance premiums increase nationally, then these higher costs are incorporated

into a higher MEI, which subsequently raises all payments under the fee schedule.

These calculations are made each year by the Office of the Actuary based on data

collected from major insurers. For 2003, the malpractice expense component of the

MEI, which represents about 3.2 percent of the total index, was increased by 11.3

percent to reflect the recent liability insurance premium increases that have occurred nationwide. Thus, increases in malpractice insurance costs are reflected in

Medicare physician payments relatively quickly.

The third way that malpractice is reflected in the physician payment system is

through the geographic adjustment among areas. The statute requires a separate

geographic adjustment for the malpractice RVU component to reflect the relative

costs of malpractice expenses in different fee schedule geographic areas compared

to the national average of such costs. There are 89 physician fee schedule geographic areas. Thirty-four of these areas represent one state apiece, while the other

areas represent portions of the remaining 16 states. If malpractice insurance premiums increase more in some geographic areas than others, these higher geographic-level expenses are reflected in the periodic revisions that are made to the

geographic practice costs indexes for malpractice expenses. These revisions are

made in a budget neutral manner, no less than every three years, as required by

law. The next revision will take effect in 2004; these changes will be proposed in

the notice of proposed rulemaking for the annual update, which we plan to publish

in Spring 2003.

To make these changes, we must gather data from the Insurance Commissioners

in each State, which is an involved undertaking that requires the cooperation of 50

State offices. To make adjustments for 89 geographic areas covering the entire country requires much more detailed data than the data used to measure year-to-year

national changes in costs for the MEI calculation. I am personally following up to

ensure we have the best and most recent data possible for this revision. We have

examined whether we should make these updates more frequently in the future.

Our experience has been that the changes in the malpractice geographic practice

cost indexes from revision to revision have been relatively small, and the effects on

physician payments, given only 3.2 percent of these payments are affected by these

index values, are also small. For example, a 10 percent increase in malpractice costs

in a geographic area would result in only a 0.32 percent increase in Medicare payments in that area, and very small reductions in payments in all other areas. Collecting this data is not trivial and involves time and resources for both Federal and

State governments. On balance, given that the annual changes in the Medicare Economic Index capture overall increases in malpractice costs, we do not believe that

making revisions in the malpractice geographic practice cost index more often than

every 3 years would be a efficient use of resources.

In short, Medicare revises physician payments to reflect changes in malpractice

premiums on an annual basis. We do this through changes in the Medicare Economic Index, and thus the update to the physician fee schedule. Changes in malpractice relative value units, which reflect any changes that may have arisen across

physician specialties, have been accomplished relatively recently. The malpractice

geographic practice cost index in the next update will incorporate the latest available data. While I believe we need to address increases in malpractice premiums

forthrightly, I also believe the Medicare physician fee schedule already does a reasonable job in this respect.

HOSPITALS’ PAYMENT

I also know that this Subcommittee is concerned about how we update hospital

payments. Medicare paid approximately $100 billion in fiscal year 2003 for Medicare

inpatient hospital services. Medicare’s approximately 6,000 inpatient hospitals are

paid under a prospective payment system (PPS), which is updated annually. This

update factor is set in law and determined primarily by the projected increase in

the hospital market basket index, which measures the costs of goods and services

purchased by hospitals.

CMS has forecasted the fiscal year 2003 market basket to be 3.5 percent. However, the Medicare, Medicaid, and SCHIP Benefits Improvement and Protection Act

of 2000 (BIPA) established an update of market basket minus 0.55 percentage

points for fiscal year 2003. Therefore, the actual fiscal year 2003 hospital market

basket update is 3.5 percent minus 0.55, or 2.95 percent. Since the inception of inpatient PPS, hospitals have only once received a full market basket update (fiscal year
18

2001), and on average, the actual update has been approximately 40 percent lower

than the market basket increase.

Despite the difference between the payment update and the market basket increase, inpatient hospital margins have remained very high. In fact, since the early

1990’s, there has been a significant drop in the number of hospitals with negative

inpatient margins. For example, 61 percent of hospitals had negative inpatient margins in 1991 compared to approximately 25 percent in 1999. Moving forward, we

need to continue to ensure that hospitals are paid adequately. In the meantime, we

will continue to work hard to do what we can to help physicians and other providers

in a variety of ways.

HELPING PROVIDERS OUTSIDE OF PAYMENTS

I worked in the hospital industry for years, and I know how frustrating it can

be for physicians and providers to work with Medicare. We know that in order to

ensure beneficiaries continue to receive the highest quality care, we must streamline

Medicare’s requirements, bring openness and responsiveness into the regulatory

process, and make certain that regulatory and paperwork changes are sensible and

predictable. This effort is a priority for me personally, as well as for Secretary

Thompson and President Bush. And we have a lot of activities underway to make

Medicare a more physician- and provider-friendly program.

To promote improved responsiveness, we created eleven ‘‘Open Door Policy Forums’’ to interact directly with physicians, as well as beneficiary groups, plans, providers, and suppliers, to strengthen communication and information sharing between stakeholders and the Agency. All of these Open Door Policy Forums facilitate

information sharing and enhance communication between the Agency and its partners and beneficiaries. My goal is to make CMS an open agency—one that explains

its policies to the beneficiaries and providers who rely on us.

Furthermore, our Physicians’ Regulatory Issues Team (PRIT), chaired by an emergency room physician, Dr. Bill Rogers, integrates practicing physicians into our decision making process, allowing us to develop policies that will better serve beneficiaries and physicians. Specifically, PRIT members work within the Agency to

serve as catalysts and advisors to policy staff as changes and decisions are discussed. These outreach efforts allow us to hear from physicians and all other Americans who deal with our programs. We are listening and we are learning. I am committed to making lots of common-sense changes and ensuring that the regulations

governing our program not only make sense, but also are in plain and understandable language. This will go a long way in alleviating physicians’ fears and reducing

the amount of paperwork that, in the past, has all too often been an unnecessary

burden on physicians.

CONCLUSION

I took this job because I know how important Medicare, Medicaid, and SCHIP are

to Americans, and because I want to make a difference in improving our health care

system. I am just as frustrated as you and all of the physicians that you hear from

when it comes to how confusing and complex these programs are, and I am working

hard to improve them. I also am working hard to monitor beneficiary access to care,

and ensuring that America’s elderly and disabled can receive the high quality care

they need and deserve.

The Administration understands that the physician payment system is complex

and will continue to work with Congress to smooth out the physician update system.

I completely support legislative efforts to fix the short-term and long-term problems

with the physician update. We owe it to America’s physicians to fix the system so

that they can continue to provide Medicare beneficiaries with the vital care they

need. Thank you for the opportunity to discuss this important topic with you today.

I hope that I have helped to explain the issues, and I look forward to answering

your questions.

Senator SPECTER. Thank you very much, Mr. Scully.

We have been joined by the chairman of the full committee, Senator Stevens, and let me say publicly what I have said privately,

what an extraordinary job he did last week on the omnibus bill.

They said it could not be done, and nobody yet is quite sure how

he did it, but it was the manager’s amendment which froze the cut

in physician payments and increased rural hospitals, and he is the

manager.
19

Mr. Chairman.

OPENING STATEMENT OF SENATOR TED STEVENS

Senator STEVENS. Thank you very much. I am sorry to be late.

We had other committee meetings, and I have others to go after

this, but I did want to make a short statement, and I do thank you

for holding this hearing.

I have great concerns over the effects that continuing to ratchet

down Medicare payments to doctors, especially primary care doctors, is having on access to basic health care for our seniors. I find

I am one of them. As a matter of fact, my doctor told me to go to

see someone else.

It is affecting Alaska even more seriously, because Alaska has no

HMO’s or managed care plans. Our dispersed and relatively small

population is not suitable for those arrangements, so Alaska’s seniors must go to solo or group practices to get their medical care or

they must overburden hospital emergency rooms at a much greater

cost to the system as a whole.

I am told by Alaska family doctors that Medicare pays them only around $32 for an office visit, compared to around $75 or $80 paid

by other insurers or health plans. These doctors tell me that the

$32 payment does not cover the cost of seeing the patient, so they

lose money every time a Medicare patient walks through the door.

Most of our Alaska doctors have felt a commitment to care for

Medicare patients, but the low rate of payment means the doctors

can afford to only take a limited amount of those patients.

The latest round of cuts in Medicare payments to doctors has

been the final straw for some of our doctors, and some have announced that they will no longer see seniors at all. Clearly, this is

creating an access problem and, as I said before, seniors in Alaska

cannot turn to HMO’s as an alternative because we do not have

any.

I am also concerned at the lower payment rates to run hospitals,

rural hospitals than those located in communities over 1 million

people. Alaska does not have one community that fits that urban

requirement, so every one of our hospitals gets paid less than those

located in the larger cities throughout our country, and I do not understand that discrimination against us at all.

Mr. Chairman, it takes more to provide health care in Alaska

and rural areas than it does in the big cities. I do not understand

why the payment schedule is turned around. Congress must address this, ensuring fair payment rates to Medicare providers who

care for our seniors wherever they are located. As the chairman

said, as part of H.J. Res. 2, the omnibus appropriations legislation

for fiscal year 2003, the 4.4 percent payment cuts schedule for

March 1 will be delayed until September 30 to give the Finance

Committee and Ways and Means Committee time to fashion a

more permanent solution and suggest it to the Congress.

But Mr. Scully, we want to work with you and other colleagues,

including Senators Specter, Grassley, Gregg, and our majority leader, who have been working with us on this problem, to come up

with a creative solution to fix these problems for Alaska and other

rural areas of the country. I make that commitment to you that we

are going to work with you. I hope we have a commitment that you
20

will work with me and my colleagues from the rural parts of our

country to make sure that American seniors have access to firstclass health care no matter where they live.

My only question is, and I hope you will answer it after I leave—

I must leave, I am sorry—is how did that discrimination take

place? Why are we paying more for people who live in big cities

than we are paying for people who live in the rural areas, when

everyone knows the cost of health care delivery in rural areas costs

more? Why did Medicare decide on that type of discrimination,

based upon the number of people in the area.

I am sorry I cannot get the answer, but I will certainly read it

on the record, and I do sincerely want to know. My people in Alaska want to know.

Thank you very much, Mr. Chairman.

Senator SPECTER. Thank you, Mr. Chairman. Thank you, Senator

Stevens.

Senator Harkin has other commitments and has to leave for a

time and will return, and has asked leave to ask one question. He

has done this on a number of occasions. I have never heard it limited to one question, but he has the floor——

Senator HARKIN. Bifurcating.

Senator SPECTER [continuing]. For however many subparts this

one question has.

Senator HARKIN. Mr. Chairman, thank you very much, again, for

your indulgence. I appreciate that.

Again, Mr. Scully, I thank you again for being so available to my

staff and to me over your tenure here and even before in past administrations.

Mr. SCULLY. Sure.

Senator HARKIN. You know these issues well. You know them

better than anyone that I know of that has it all together, and you

understand them. You understand our frustration in Iowa on this

Medicare reimbursement.

There is one thing I just wanted to add to this. If you took a hospital in Des Moines, and if you assumed the following, same volume of Medicare cases, same Medicare case mix, same staff, same

services, assume all of the same, a hospital located in Cincinnati,

Ohio, would get $5.3 million more a year. In Lincoln, Nebraska,

they would get $8.8 million more a year, Denver, Colorado, $11

million more a year, Ann Arbor, Michigan, $14.6 million more a

year, and these are sort of comparable type of cities to Des Moines,

Iowa. And so you can see why our hospitals in Iowa are just at

wit’s end on this thing.

So again, I am just asking you, will the President’s proposed

$400-billion Medicare modernization package include a provision to

more fairly reimburse providers in rural States like Iowa, and can

you show us any light at the end of the tunnel on this?

Mr. SCULLY. Senator, I cannot tell you—I could quit my job and

I can tell you what is in our Medicare plan. I think it might have

to wait another week or two until the President’s ready to get into

details. We are still working on it. I will say one thing, we are not

pushing people into HMO’s, regardless of what you read in the

paper, and I will tell you that I think you are going to find that
21

some of our proposals will have a significant buffering effect on

some of the geographic disparities in the program.

Senator HARKIN. Well, I am glad to hear that, too. I did not mention that, but as you know, we do not have one in Iowa.

Mr. SCULLY. Yes.

Senator HARKIN. Why?

Mr. SCULLY. Well, we will clearly make prescription drugs available to everybody in Iowa through our plan.

Senator HARKIN. Tom, I hope it will be an equivalent. I hope that

people who go into HMO’s will get more benefit than those who

stay in fee-for-service. Do you see what I am saying?

Mr. SCULLY. At the risk of having to quit, I do not want to get

too far into this, but I will tell you that I think that we are not

pushing people into HMO’s. We are going to get prescription drug

coverage across the country, certainly in rural areas, and I think

you are going to find that some of the geographic disparities that

exist in the Medicare—Medicare is a wonderful program, but it is

very regulated, very tightly wound, very tight structure, and I

think you are going to find some of the impacts will probably help

get rid of some of the disparities, but beyond that I probably—unless I want to go back to my law firm, I probably should stop there.

Let me just answer some of the other questions about Iowa, and

again, I know the frustration with Iowa, and I know the Iowa Hospital Association, who I have talked to a lot, is testifying after this,

so if I could just go through a couple of facts with Iowa.

Iowa should be commended for being very efficient. I went

through some of these facts late last night, when I was learning a

lot more about Iowa’s reimbursement. You get about 92 percent of

the national average of cost per service, and you are about 43rd

there, and that is about, arguably—this is all about the data, and

we do pay—we have a different formula.

We have 89 regions of the country for physicians, and 250 for

hospitals, and for example, you get paid 91 percent, or 92 percent

of the national average for physicians, and about 88 for hospitals,

so clearly there is a difference that has evolved over the years, and

it is all legislative. We have very little discretion, but you get paid

differently between hospitals and docs.

But you get—even though you get about 92 percent of the costs,

on average, you only get 71 percent of the payment, which is 46th,

basically, on average, and it depends on how you calculate it. I can

explain that.

Your doctors, for instance, are 72 percent of the national average,

and they are 40th in the country, but part of it is really, the cost

per service is 92 percent, but your health care in Iowa is very highquality, and very low-utilization, and to some degree, you should be

congratulated for that.

I have looked through all the charts, and essentially when you

look at who is really doing the best job in the country, it is really

North Dakota, Iowa, Oregon, Wisconsin, Wyoming, and a large reason why you are looking at the per capita costs is that your hospitals have shorter lengths of stay, your nursing homes have shorter lengths of stay, your doctors do fewer procedures, and it is not

necessarily the payment per procedure, you are doing a lot fewer

procedures on average.
22

For example, your nursing homes spend about 68 percent of the national average on Medicare admissions, $3,000 versus a national

average of $5,000. Your actual costs per day are 96 percent of the

national average, but the average stay in a nursing home in Iowa,

for instance, is 14 days, and nationally, it is 22 days, so when you

look at the practice behaviors all through Iowa, you do have a geographic disparity, but also, Iowa should be congratulated for having

terrifically efficient health care—I mean, it is a model for the rest

of the country.

I am not sure it is going to make you feel any better, but I guess

one of my arguments, and I got in a little trouble in Washington

State for making the same argument out there last year, was, we

are certainly concerned about the geographic disparities, and we

are working on fixing them, but to some degree Washington State

and Iowa are a model for health care for other States, and I know

you are worried about the geographic discrepancies, and we are

trying to fix them, but I also think it is worthwhile to use them

as models for how health care should be practiced as well, because

there are a lot of good things that are going on in Iowa and Washington State and some other low-cost States.

So I do not mean to get myself in trouble there. We clearly have

a problem with geographic disparity, but to a large degree, a lot of

the things that are going on in Iowa and Washington State and

Wyoming, Oregon, are very good health care practices and should

be a model for other people.

Senator HARKIN. Well, Mr. Scully, commendations are nice, but

it does not put bread and butter on the table.

Mr. SCULLY. I understand.

Senator HARKIN. And it does not help the hospitals.

Now, you are getting into a chicken-and-egg argument here. You

are pointing out the efficiency of the hospitals, their shortness of

stays. Kirk Norris is here, who is the head of our hospital association, who will be testifying. You know why that is happening, because they cannot afford to keep them there any longer, because

the reimbursement rates are so low they have got to get them out,

and so now, you look at that and say, that is a wonderful thing.

It is not wonderful when you are forced to do things against the

best interest of your patients, and it is not a good thing when these

hospitals cannot afford to keep doctors and nurses on board because the reimbursement rates are so low. So you may look at that

as efficiency. We look upon it as a penalty, and it keeps getting

worse, because as we ratchet down, as we become more efficient,

you say, oh, wonderful, we can cut you even more, so it is a neverending spiral that we are on, and you know that.

Mr. SCULLY. I agree with you. It is just, unfortunately, for me it

is a statutory spiral, and I would urge you—I mean, we are happy

to work on the formulas, but they have been there for years. There

are historical reasons for—the people that wrote them 15 years ago

generally were not from rural States, and that is just the way they

work.

Now, I am just pointing out that I think that the cost per service

in Iowa, which is on average about 91 percent, does arguably reflect some of the costs, but there are reasons why it is lower. I

agree with you, and I spent a lot of time in Iowa this year, as you
23

know. I drove 2 days through most of at least the eastern half of

the State earlier this year. I went to seven different hospitals, and

I think the fact is, once you get into the spiral of wage indexes for

hospitals, if you have a lower wage index, you get reimbursed less,

your nurses get less, and it is a death spiral, but it is a statutory

death spiral——

Senator HARKIN. Exactly.

Mr. SCULLY [continuing]. And I agree with you that there are inequities in the system, and we are anxious to fix them.

Senator HARKIN. Again, you cannot—I mean, you might be able

to explain an Iowa compared to New York City. I can understand

that, or a Miami, Florida, maybe, or different high-cost areas. You

cannot explain it with regard to Lincoln, Nebraska. You just cannot

explain it. $8 million more to the same hospital, same mix of cases

and everything, for Lincoln, Nebraska compared to a hospital in

Des Moines. There is no explanation for that, other than, well, that

is the historical way we have done things.

Well, I just—okay, let us change it. We have got to change it,

and with all respect, Mr. Scully, you are a great friend of mine, I

have a great deal of respect for you professionally and personally,

we need some help from the administration to start moving and

changing these formulas and helping us out here and getting something done, and a little bit, a couple of million here, a couple of million there is not going to do it.

I know we cannot do it overnight. I do not think there is any hospital, any health provider in my State that would say, we have got

to change it tomorrow. We know we cannot do that. But for crying

out loud, to get us on a path that over, say, 4 or 5 or 6 years would

get us to a more equitable system, people could live with that if

they knew there was, as I said, that light at the end of the tunnel,

not 20 years from now but 4, 5 or 6 years we could get on that

pathway, we could do it.

Mr. SCULLY. Well, sir, to be honest, as you know, Medicare is

growing rather rapidly, and hospital reimbursement is still growing

at a rather healthy rate. Nationally, we spent $100 billion for inpatient hospital services this year, and this is a big geographic issue.

When I was in the hospital business, AHA did a very good job of

representing everybody, getting the rurals and the urbans into the

room trying to work this out over a very long period of time, but

obviously, unless you add more money in, which you know, we are

already growing at 7 or 8 percent a year, that is a redistribution

from urbans to rurals, and even in your own State that probably

causes some sensitivity, and I am sure in Pennsylvania, which is

my home State, I know it does.

So as you level these inequities out, you are taking money from

some of the higher-cost, traditionally, reimbursed urban areas and

putting them out in the rural areas. Then—I used to work in the

Washington State delegation—whether it is, you know, Seattle

too—it is very painful and difficult. But we are all for you. We will

help you.

Senator HARKIN. No one wants to take money away, but the rate

of growth, if you could just say to those really high reimbursed

States that over the next 4 or 5 years your rate of growth will be
24

less than the States who are at the bottom, you could pull those

together.

Mr. SCULLY. I think we would be happy to discuss that, but they

are legislative formulas, and I think we have said repeatedly that

we think if you are looking at a place in Medicare this year, and

we have been hesitant outside of physicians to look at other provider give-backs, we have pretty much said that we think the place

where there is the most—beyond fixing the docs—the second best

most equitable argument is probably rural hospitals.

Senator HARKIN. I would reverse them, but that is all right, the

order of priority.

Mr. SCULLY. Yes, I think the docs should get fixed first—thank

you.

Senator HARKIN. Thank you very much, Mr. Scully. I will be

back. I just have to leave. Thank you very much, Mr. Chairman,

I appreciate that.

Senator SPECTER. Thank you for your question, Senator Harkin.

Mr. Scully, when you were talking about the reimbursement on

malpractice rates, I believe you referred to some 1996 to 1998 data.

Would you amplify that, please?

Mr. SCULLY. Mr. Chairman, there is basically three different

components that we use to account for malpractice costs.

Senator SPECTER. I recall the three components. Could you focus

on 1996 to 1998?

Mr. SCULLY. Yes. When we figure in the relative values for what

we pay a doctor, let us say an internist in Philadelphia, roughly 42

percent of that is their practice expenses, about 54 percent is their

work, and——

Senator SPECTER. I noted that part. How about 1996 and 1998?

Mr. SCULLY. The data we have used for payments in 2001–2003

has been based on 1996 to 1998 data that we collect across the

country in a survey every 5 years from large malpractice insurers.

Senator SPECTER. Well, when the rates go up substantially, isn’t

data from 1996 very badly outdated?

Mr. SCULLY. It probably is.

Senator SPECTER. What do you mean, probably? Any chance that

it is not?

Mr. SCULLY. Well, the last—if we actually looked at it, the impact, even if you put, for instance, in Philadelphia the 40 percent

increase in malpractice premiums, even if you put that into the formula it would have a very small impact on the results.

Senator SPECTER. Well, you emphasized the small impact in your

letter repeatedly, but no impact is too small if you are a doctor paying the rates.

Mr. SCULLY. I totally agree with you, Senator, and I am trying

to fix this. We do—the major development that adds money——

Senator SPECTER. Why do you use 1996 statistics?

Mr. SCULLY. Senator, to be honest with you, it is difficult to collect. We use 2001 and 2002 statistics for the more variable component, which is the MEI, the inflation——

Senator SPECTER. I know you have some statistics from 2001,

and 2002, but I go back to 1996 statistics, and I am asking you if

there is any, any conceivable justification for that.
25

Mr. SCULLY. Well, to be honest I spent a large part of yesterday,

and that is because I anticipated this might come up——

Senator SPECTER. I am sorry, I cannot understand you. You have

to start off to be honest with me. We are going to assume everything you say is honest. Just tell us why you are using 1996 statistics.

Mr. SCULLY. Because it is very difficult to collect this data. It is

extremely expensive, and we basically do not have the staff resources to do it more regularly.

I believe, and I pushed my staff for the last week to essentially

factor in a more informal polling which we do in other places

through our contractors on an annual basis, to supplement the

massive data collection we do every 5 years, with the more informal polling of our 23 contractors around the country that pay doctors’ claims to see if our data that we collect every 5 years actually

reflects things like the 40 percent increases in malpractice premiums in Philadelphia, which it obviously does not, when it is 5

years old.

Senator SPECTER. Well, we are going to put a direction in our

conference report, Mr. Scully, not to use 1996 statistics, to update

the statistics.

You refer repeatedly, and I know this is a matter of statute, that

wherever you make the decisions on increases, they have to be in

a budget-neutral manner, so if you take away a little from Peter,

you deduct it from Paul. Is there some reasonable likelihood that

the administration will come up with a proposal to use some of the

$400 million that the President talked about in his State of the

Union Tuesday so that we add in some here instead of making

them all budget-neutral?

Mr. SCULLY. Well, again Mr. Chairman, at the risk of involuntarily returning to the private sector, I will not get into the details

of the plan, but I will say our plan is going to be much more reflective of what is going on in the real world, and that if you have high

malpractice costs in Philadelphia or Pittsburgh or any place in your

State they will be much more directly and much more quickly reflected in the Medicare program. So I think yes, I think the Medicare program is a wonderful program, but it is very restrictive in

the way it reacts to changes in the markets as you have right now

in malpractice in Pennsylvania.

Senator SPECTER. I take that to be a yes.

Mr. SCULLY. I think that is a yes.

Senator SPECTER. Okay. The MSA’s are very, very problemsome,

especially in some areas of Pennsylvania in the northeast, in the

Scranton area, Wilkes-Barre, where the surrounding areas have

preferential costing factors, medical personnel moves. What can be

done about that, Mr. Scully, so that we do not have that inequity

continued?

Mr. SCULLY. Mr. Chairman, I think the whole Scranton, WilkesBarre MSA, as I am sure you are aware, has a real geographic equity problem, and I have spent a lot of time working with them,

and it is a legitimate issue.

The problem they have, essentially, though, is that—I have their

wage indexes here somewhere, but roughly their wage index I believe is about .85 off the wage index.
26

Senator SPECTER. Most of the counties in Pennsylvania have the

same problem.

Mr. SCULLY. Yes.

Senator SPECTER. And there are other areas across the country

which do. What can be done about that?

Mr. SCULLY. Well, I believe that their wage index actually roughly approximates their actual cost. The problem you have in Scranton is that legislatively the northern counties in New York, west

of New York, a 2-hour drive west of New York, have been legislated

in New York City, so they actually have a wage index of like 1.2,

and Philadelphia has been legislated so far north of Philadelphia

over the years their index is 1.1, so Scranton, for instance, is stuck

in a little pocket.

Senator SPECTER. You are articulating the problem expertly.

What is the answer?

Mr. SCULLY. Well, my own personal view, Senator, would be, the

answer would be to get rid of all the previous legislative adjustments and go back and rebase the system more accurately, because

what has happened over the years is some of these counties that

had their neighbors legislatively increased are now surrounded,

where they are actually getting paid 30, 40 percent less than the

surrounding counties and they cannot recruit nurses. I think to

raise them——

Senator SPECTER. Could your Department come up with a proposal on that to submit to this subcommittee?

Mr. SCULLY. Sure. We would be absolutely happy to.

Senator SPECTER. My red light went on, so I want to observe the

time limits, since we have so many witnesses.

On Senator Stevens’ time, I think you ought to answer his question so he will not miss it in the record as to why the rural reimbursements are so much lower than the urban reimbursements.

Mr. SCULLY. In Alaska, actually, the issue in Alaska is actually

Alaska’s—for the doctors, which their reimbursement per service is

actually rather high. It is actually, their weighted average across

the country is about 1.115, the average being 1 percent, and that

actually does reflect the higher cost of practicing medicine in Alaska. I think the issue in Alaska is that again their volume of services is lower, their behavior is better, and per capita they get paid

less, but per service, I believe they are actually one of the higher

cost areas in the country, and that is reflected.

On the hospitals, it is probably not reflected as well, and again

I would argue that the hospital formula is probably more flawed in

many ways than the physician formula, and I think that is something arguably Congress should look into, is making sure that the

physician practice geographic adjustments and the hospital practice

geographic adjustments are more parallel. They have grown over

the years very independently, and completely disconnected from

each other, so I think that, I would guess that in Alaska they probably have more problems with the hospital index than the physician index.

Senator SPECTER. Senator Murray.

Senator MURRAY. Thank you, Mr. Chairman, and before I ask

you a question I just wanted to follow up on what Senator

Landrieu spoke to you about on the outpatient prospective payment
27

pass-through, and really urge you to strike the functional equivalent standard from the final rule, and I agree with what she said

and hope we hear from you on that soon.

On the whole issue that Senator Harkin has raised in terms of

the Medicare reimbursement, I know we have talked about this

many times. I just think it is grossly inadequate to say you are

really efficient, therefore, you know, we are just going to leave you

where you are, because this is affecting access in our States. It is

affecting our ability to provide health care.

It is not fair to our seniors, who pay the same as seniors in other

States, to not get the same kind of health care. Our hospitals have

the same costs, and Senator Harkin is correct, the reason we are

becoming more efficient is because we are having to put people out

on the streets before they should be, and we should not be penalizing people for that.

I would just really urge you—I know you keep saying this is a

legislative fix. That is fine, but it would be extremely helpful if you

would come to us with a proposal, and I think you would find bipartisan support to help move that through, but with your agency

just keeping a hands-off approach it is very difficult for us to move

something through Congress, so I hope we can get that commitment from you.

I did want to ask you about the changes in Medicare that you

are going to be proposing, and I know you do not want to lose your

job, but I am going to make some points anyway, because I think

we all understand that the intent is to save money and to integrate

market forces into Medicare, and that is where the administration

is coming, and we have not seen the specifics, but I just want to

share with you that I am very concerned about what I am hearing,

and that is because seniors in my home State of Washington have

seen what happens when market forces come into play. They end

up with less access to benefits and less access to doctors.

Because of the inequities in Medicare reimbursement there is no

open Medicare plus choice plan in Washington State that provides

prescription drug coverage today, and many seniors are seeing increased premiums and copayments in Medicare plus choice plans

for prescription drugs. Seniors in my State do not even have that

option.

We do have a limited number of Medicare plus choice plans that

provide additional benefits for our seniors, but most of those plans

are closed, or have seen dramatic increases in premiums, and

frankly, I am not sure that these plans are going to remain open

very much longer in my State. That is what we are hearing, so I

am concerned that the administration is planning on building on

this inequitable formula and designing a program that provides

vastly different levels of benefits to seniors depending on where

they live, and I wondered if you would comment on that.

Senator SPECTER. Senator, Murray, if I could, just a moment. I

have to go to another committee very, very briefly, so would you

continue your questioning, and when you conclude we will be in a

very, very brief recess. I shall return momentarily. Pardon the

interruption.

Mr. SCULLY. Well, Senator, my wife probably wants me to totally

answer the question so that I could quit and go get a job again.
28

I will try to answer it as thoroughly as I can. I will just say that,

as you may know, I worked in the Washington State delegation for

5 years. I am very familiar with Washington State health care.

We are clearly not building a reform package on the Medicare

plus choice program. I cannot tell you all the details, but I can tell

you that, you know, there are a lot of great things about Medicare

plus choice.

I happen to be a very big defender of it, because I think for especially low-income seniors and minority seniors who are disproportionately signed up for those managed care plans, they do it because they cannot afford Medigap premiums, which are frequently

$150 to $300 a month, and the only way for them to get drugs in

many cases, even though it is now limited is to sign up for Medicare plus——

Senator MURRAY. Very limited.

Mr. SCULLY. Well, very limited, but the fact is it is frequently the

only place to get any drugs, and to cover your extremely high

deductibles in Medicare, so most—you know, the disproportionate

number of people that sign up for Medicare∂Choice across the

country, even as the reimbursement has dropped and plans have

dropped out, it is disproportionately minorities and low-income people, and they do it because they cannot afford Medigap and it is

the best coverage that they can get.

So I am a big defender of the Medicare∂Choice program, despite

the fact that it has many flaws, and we are interested in fixing

that as well, but that is not what our proposal is built on. We have

zero desire to push people into HMO’s. That is not what the proposal is.

I think you will find when it comes out that while there is absolutely no doubt that many people will criticize it, I hope that you

will be open-minded and let me come explain it to you and at least

help your discussion with us, because I think the President, who

is very involved in this, has really committed to making the Medicare program work better, and I hope that, while I have no doubt

that you will have some concerns, I hope you will spend the time

to at least give us a chance to talk about it.

I was stunned, actually, to read the Washington Post this morning. I would say that their editorial reflects kind of where I hope

you will think we are when we come out with this plan, and not

that I always love everything the Washington Post writes, but that

was the most constructive editorial I have seen in a long time. So

I hope—I think you will find it is not based on the Medicare∂Choice program.

Senator MURRAY. Well, I look forward to having that conversation with you, because we have some real concerns about that, and

I want to make sure——

Mr. SCULLY. Just to be clear, we still have a little work to do.

Whether it is 1 week or 2 weeks, it is extremely complicated stuff

that is very sensitive, and my guess is that we are not going to be

rolling it out until we are sure everything is final.

Senator MURRAY. Well, knowing that, I hope you take my comments into consideration as you work through the final details on

this.

Mr. SCULLY. Sure. Thank you.
29

Senator MURRAY. One other question, and that has to do with

the administration not supporting increasing provider payments

beyond fixing the physician fee schedule. I think you know hospitals in my State are in really tough shape, as I assume they are

Nationwide.

There are a lot of reasons, the historically low Medicare, Medicaid reimbursements, it is the increasing cost of technology, it is

the health care professional shortage, we have bioterrorism procedures that they are asking to be limited, there are more and more

people uninsured—the financial outlook is pretty grim right now,

so I was surprised by the recent recommendations from MedPAC

that proposed no new payment increases for hospitals or other

health care providers like home health and skilled nursing care,

and wanted to find out from you today if the administration is

going to accept those recommendations from MedPAC.

Mr. SCULLY. Well, the budget, Senator, comes out Monday, so

once again I cannot tell you what is in there on hospitals. I will

tell you, I used to have a lot of friends in the hospital business,

since I ran a hospital for 6 years. I am not sure I do anymore, but

my view as a regulator is that we have to identify the trouble

spots.

The number one trouble spot for us is the financing mechanism

for doctors, which is broken. We have not supported other—we

have talked a little more favorably about rural hospitals. We think

there are some hospitals that have problems, but we have a big,

global Medicare program that pays roughly, we fix the same rate

for virtually all hospitals, or the same payments. Some are doing

better than others. In some spots we think there are problems, and

when you look at, on average, the Medicare margins on average for

hospitals are almost exactly at their historical average for 35 years.

If you looked at the average Medicare reimbursement since 1992,

it would be market basket minus 1.4. If you look back at the average of what Congress has done since 1992, it would be market basket minus 1.4. MedPAC has recommended market basket minus .4,

which would make it probably the third best reimbursement year

hospitals have had since the beginning of the program, so I understand because I used to argue as a hospital lobbyist that that is

a cut.

From the hospital’s point of view it is relatively better than they

have done in almost any other year, and I cannot tell you whether

we are going to support it or not, but I think MedPAC’s recommendation was responsible.

There are always going to be—in 1991 61 percent of the hospitals

in the country had negative margins. Right now, we are looking at

about 32 percent of the hospitals. That is about the historical average. Is it good that 32 percent of the hospitals are losing money?

I would say no.

Many of the hospitals have got mad at me for saying this, but

generally when you have 40 percent of the hospitals losing money

you have a problem, and when you have 25 percent of hospitals losing money, you have historically high averages for margins which

we had in 1996. The reason Congress whacked hospitals, and I

would argue far too hard, in 1997, was because margins were very
30

high, and even in that year we had 25 percent of hospitals losing

money.

So there are clearly trouble spots that we need to focus on. I

would say rural hospitals is probably one, but overall, my argument to my former friends and, I hope, current friends in the hospital sector is that when things are going relatively well, you

should—you know, if Congress gives too much money back, they

are going to come back and take it away in a couple of years, and

you are going to get these big roller coasters.

My personal view right now is, hospitals are about where they

should be on a national average, and there are clearly trouble

spots, and the best thing we can do in Congress is keep them on

the existing glide path without big cuts or big add-backs, and I

would say that if you look at the historical trends, the MedPAC

recommendations are extremely responsible.

That does not mean that I know or could say what is in the

budget next Monday.

Senator MURRAY. Well, we will be looking at the budget, and I

am sure hospitals will have a lot to say about that as well, but I

know my time is up, and the committee will take a short recess

until the chairman returns.

Mr. SCULLY. Thank you.

Senator SPECTER. Mr. Scully, thank you very much. We are going

to move on to panel 2. You are on panel 3. I hope you will be able

to stay and hear what our witnesses on panel 2 have to say about

this very important issue.

We will now proceed with Dr. Roth, Dr. Desai, Mr. Anderson, Mr.

Norris, Dr. Kleiman, Dr. Blomain, and Mr. D’Alberto.

I might give you just a little insight for the very brief interruption. The schedules here are very involved. I was committed to introduce a distinguished Pennsylvanian, Paul McHale, who is having a hearing before Armed Services, and I abbreviated my lengthy

introduction to 4 minutes under the 5-minute rule to make it as

brief as possible. I am due in the Judiciary Committee for the

Estrada vote briefly, but that is part of my problems, not yours.

You have your own problems, and I thank all of you for coming to

present testimony on this very important subject.

STATEMENT OF LOREN H. ROTH, M.D., M.P.H., SENIOR VICE PRESIDENT, MEDICAL SERVICES, UPMC HEALTH SYSTEM, ASSOCIATE

SENIOR VICE CHANCELLOR, SCHOOLS OF THE HEALTH

SCIENCES, UNIVERSITY OF PITTSBURGH

Senator SPECTER. Our first witness will be Dr. Loren Roth, senior vice president for medical services at the University of Pittsburgh Medical Center Health Systems, also serves as associate senior vice chancellor for health sciences and professor of medicine at

the University of Pittsburgh, a B.A. from Cornell, an M.D. from

Harvard, and a master’s in public health of the Harvard School of

Public Health.

Thank you for joining us, Dr. Roth, and the red light goes on at

zero, you have a green for 4 minutes, and a yellow to sum up at

1 minute. Thank you for joining us, and on a personal note, may

I say that I have known Loren Roth for a couple of decades, really

an outstanding physician and public servant. Dr. Roth.
31

Dr. ROTH. Thank you very much, Senator, and thank you for

having this hearing. These are critical issues. In my role as the

chief medical officer of the UPMC, I represent the medical interests

and concerns of the more than 4,500 physicians who are affiliates

or employees of our largest health care system. The UPMC today

has 20 hospitals. We employ more than 25 percent of the physicians in Allegheny County.

As you are hearing today, there is a crisis in health care delivery

in Pennsylvania and nationally. I recommend for your review and

have given you the paper from the New England Journal of Medicine, which echoes what you are hearing today.

The paper is entitled, ‘‘Homeostasis without Reserves, the Risk

of Health System Collapse.’’ Dr. Sandy notes three deep forces at

work, steady increases in real health care costs, unabated demand

for health care services, and dispirited providers, in part on the

basis of malpractice and their decreasing reimbursement.

Medical school applications have decreased 15 percent over the

last 4 years. Although, Senators, you have heard a good deal about

physicians moving from State to State, I would suggest that these

statistics may predict a future in which not only that physicians go

from State to State, but that we have less physicians, or less competent competitive physicians. This is truly a crisis.

Furthermore, I have emphasized the UPMC employs physicians.

A large number of physicians today are not in private practice, but

are employed by organizations such as hospitals and what-haveyou. The interests of physicians and hospitals today largely run together. What is economic damage to one is economic damage to the

other. Therefore, even though we are focusing mainly on physician

reimbursement, which is a real problem, as you heard from Mr.

Scully, this effect spreads throughout the entire health care system.

Given my time limits I will not review the malpractice crisis in

Pennsylvania, with which you are very aware. I will add that malpractice is only one of the several costs of business that physicians

and hospitals are coping with as our operating costs rise, as you

have heard from the various other Senators. New technology, pharmaceutical costs, workforce issues, securing payments, all the

money we spend with denials from insurance companies, managed

care companies, regulatory requirements, HIPAA, bioterrorism.

The hospitals are called upon to spend a tremendous amount of

money, et cetera, et cetera.

I have been involved with the UPMC for about 10 years, helping

to build our network. Overhead costs have risen from 45 percent

to 60 percent. These are serious matters, and we and the hospitals

are not being reimbursed for them.

You are aware, of course, of the Code Blue emergency in Pennsylvania. I will not comment in depth on that. However, I will note

from 1999 to 2003 the cost of malpractice premiums paid by our

University of Pittsburgh academic clinical physicians escalated

from more than $5 million to $23 million a year, an increase of 200

percent per faculty member. In no way is that represented, as you

have heard, in the calculation of the malpractice costs that go into

the Medicare formula.
32

However, Senators, this malpractice crisis and, I would say paradoxically, physician Medicare reimbursement cuts have the very

same effect. No one to date has noted the extent to which these

problems of decreased reimbursement and rising costs fundamentally affect the practice and pattern of how medicine is delivered.

If physicians must meet their costs in the office and they are receiving less reimbursement, how can they stay in business unless,

one, they see more patients, and I think this is actually the experience of many consumers and patients, so they attempt to see more

patients, possibly, or in the Medicare example, because they cannot

afford it, see less of those and more of others, but when you go into

a doctor’s office, you want that physician to have sufficient time to

be able to take a clinical history and not simply to order a lab test

or a very fancy test.

This is a most complex economic problem of the relationship between resource utilization and what-have-you, versus what really

should be done, and the patterns of medicine are being negatively

affected by the patterns that I am saying here.

I will not review in depth data, then. In my written testimony

there is extensive discussion of the same issues that Mr. Scully discussed about the problems in the malpractice calculations, which

simply do not keep up with the costs that the physicians and hospitals are experiencing, and so I will just refer you to my written

testimony there.

Senator SPECTER. All of the written testimony will be made a

part of the record, so we would appreciate it if you would stay within the time limits of the oral presentation.

Dr. ROTH. Okay. How much time do I have left?

Senator SPECTER. You are now almost a minute over. The timing

is right before you. The red light is on.

Dr. ROTH. Oh, I am sorry. I will summarize, then, with your indulgence, with too major points.

Senator SPECTER. Thank you.

Dr. ROTH. You have heard that the formula is inaccurate. It is

extremely frustrating to physicians to know that there is a known

inaccuracy which cannot seemingly be fixed by the legislative process, with all of the decrements coming.

My second major point, and for you, Senator, I think this is of

particular interest, you have been a wonderful supporter of the

NIH and research. We are talking here not only about physician

decrements in reimbursement. We are talking about complete impact on the academic medical center.

PREPARED STATEMENT

Every amount of money that must be paid to a greater extent for

malpractice, 90 percent of our clinical doctors survive in good part

by their clinical income. When their clinical income goes down,

there is less time for research, there is less time for education, so

what I am trying to do is give you a holistic picture that this is

a generic problem, and the tradeoffs here, as you have heard previously, when one takes from the other, is that you and we want

to preserve the academic mission, and this is directly impacting in

a negative way upon it.

Thank you for asking me to testify.
33

1Gaynor, P., Pittsburgh Post Gazette, page E–2, January 5, 2003. 2Sandy, L.G., New England Journal of Medicine, Volume 347, pp 1971–75, December 12,

2002. 3Pear R., ‘‘Panel Citing Healthcare Crisis, Presses Bush to Act’’, New York Times, November

21, 2002. 4Sandy, ibid.

[The statement follows:]

PREPARED STATEMENT OF DR. LOREN H. ROTH

Greetings to the Subcommittee. Thank you for giving me the opportunity to testify

before you today on the need to address problems with Medicare’s reimbursement

and its negative impact on physicians and academic medical centers such as ours.

I am Dr. Loren H. Roth, Senior Vice President, Medical Services and Chief Medical Officer of the University of Pittsburgh Medical Center (UPMC). I am also the

Associate Senior Vice Chancellor, Health Sciences, of the University of Pittsburgh

and Professor of Health Policy and Management at the University.

The University of Pittsburgh Medical Center and the University of Pittsburgh

School of Medicine are each nationally highly ranked institutions. They are recognized for their role in supporting and performing medical research, education of

medical students and residents, and for their delivery of innovative tertiary/quaternary and community-based care. The UPMC is committed to system wide quality

improvement efforts, patient safety, and the elimination of medical errors. We have

well-established programs in all these areas of critical importance for patient wellbeing and the practice of medicine.

In my role as Chief Medical Officer of the UPMC, I represent the medical interests and concerns of more than 4,500 physicians who are affiliates or employed physicians of one of the largest academic health care systems in the nation. The UPMC

today includes 20 hospitals, a large number of University of Pittsburgh full time

clinical faculty physicians (more than 1,300), a large number of community-based

physicians (350 employed by the System) as well as other community-based private

practice physicians who are members of UPMC hospitals’ medical staffs.

Almost one in every two people in Allegheny County and one of every four people

in the region who need hospital care obtain it in a UPMC hospital. The University

of Pittsburgh Medical Center employs more than 25 percent of the physicians in Allegheny County, Pennsylvania. The important issues that this hearing addresses affect many parties and institutions, academic and community-based physicians, our

School of Medicine, its academic mission, many hospitals, and our patients.

Western Pennsylvania has a comparative national overrepresentation of Medicare

eligible citizens, who number 19 percent of our population base. ‘‘On average, hospitals in this region receive nearly half of their patient revenue from Medicare,

while nationwide the average is about 38 percent.’’ 1 Community and teaching hospitals are particularly dependent upon Medicare reimbursement. With the exception

of South Florida, Western Pennsylvania has the highest percentage of elderly population in the country. Medicare policies, payments, and procedures greatly affect the

healthcare status of our community.

The issues we confront today are critical to the survival and well being of Southwestern Pennsylvania physicians and patients, as well to the educational/research

mission of the University of Pittsburgh and the UPMC.

Senators, I regret to inform you that there is a crisis in healthcare delivery in

Southwestern Pennsylvania and nationally. I recommend for your review a recent

New England Joumal of Medicine article by Dr. Lewis G. Sandy entitled ‘‘Homeostasis without Reserve—the Risk of Health System Collapse,’’—I have brought several copies for you.2

See also the recent statement of the National Academy of Sciences, Institute of

Medicine, ‘‘The health care delivery system is incapable of meeting the present, let

alone the future needs of the American Public—For the first time in nearly 20

years—the United States is facing a broad-based crisis in the availability and affordability of malpractice liability insurance for physicians, hospitals, and other

health care providers.’’ 3

To substantiate his case, Dr. Sandy (from the Robert Wood Johnson Foundation)

notes three ‘‘deep’’ forces at work: (1) Steady Increases in Real Healthcare Costs;

(2) Unabated Demand for Healthcare Services; and (3) Dispirited Providers. Dr.

Sandy notes that ‘‘Dissatisfaction is widespread among physicians and medical

school applications have decreased 15 percent over the past 4 years.’’ 4 These are

but some of the facts and trends that relate to this hearing.
34

5 HAP Update, ‘‘HAP survey shows continuing liability crisis’’, page 1, November 15, 2002. 6 HAP Healthcare Outlook, page 1, November 2002. 7 Bull, J., Pittyburgh Post Gazette, page D2, December 25, 2002. 8 HAP Update, page 3, December 13, 2002.

Let me turn then to the subject of ‘‘dispirited providers’’ and specifically the impact that recent trends in escalating medical malpractice costs, as well as repetitive,

severe reductions in Medicare and other reimbursements are having on both physicians and hospitals. Recall that a great number of physicians are presently employed by hospitals and healthcare systems. The subject for today is vital to the

health of the entire provider community and the patients it serves.

LIABILITY CRISIS AND CONCERNS

Senator Specter, you are well acquainted with the current malpractice crisis in

Pennsylvania and the negative impact it is having on hospitals, physicians, and patients with respect to the provision of and access to specialty and other care. The

total cost of medical professional liability insurance coverage for Pennsylvania’s hospitals increased 86 percent over the past 12 months.5 Meanwhile hospital and physician operating costs continue to rise as a result of new technology, pharmaceutical

costs, work force issues, securing payments due them from insurance and managed

care companies, regulatory requirements (such as HIPAA implementation), and

other administrative costs. In the last several years office overhead for most physicians has risen from 40/45 percent to 60/65 percent.

The cost of malpractice insurance for physicians has escalated dramatically, placing physicians in impossible dilemmas with respect to obtaining and paying for adequate malpractice coverage from either private insurers or the state.

Pennsylvania is not alone. We are one of 12 states identified by the AMA as now

in a liability (cost/availability) crisis. The similar crisis and its impact upon physicians in West Virginia have made the national news. More than two dozen surgeons

who operate at four West Virginia hospitals have recently taken leaves of absence

and pledged that they won’t return until the government and legislators address the

malpractice problem.

As noted by the Hospital Association of Pennsylvania in a recent survey of 150

Pennsylvania hospitals and health systems, ‘‘Nearly two thirds of hospitals report

that some physicians are retiring early, curtailing practices, or relocating as a result

of increasing liability costs.6 In the last three years, nine insurance companies have

stopped writing medical malpractice policies in Pennsylvania.7

Because of progressive loss of specialists in rural and urban areas, increasing

costs of coverage for high risk specialists such as neurosurgeons, orthopedists and

obstetricians, and the shutting or threatened shutting of vital services such as trauma centers, this fall the Pennsylvania Medical Society declared a ‘‘Code-Blue Emergency’’. This could have culminated in physicians electively declining to pay state

mandated surcharges to the State Catastrophic Fund (CAT Fund—now called

MCare Fund) thereby taking a vacation from their vital professional work beginning

January 1, 2003. Only last minute action by Pennsylvania Governor Elect Rendell

prevented such a negative outcome. ‘‘We have to go back to the drawing board to

keep all these physicians from leaving the state.’’ 8

The proposed Pennsylvania plan is by no means certain to occur because of opposition from private insurance companies. The plan is for these companies to ‘‘foot

the bill’’ ($220 million additional) for the necessary CAT Fund dollar infusion. This

would waive certain high-risk specialty physicians from this surcharge and provide

a 50 percent discount for other physician specialists in CY 2003. The outcome for

the physicians and their patients is still uncertain. The problem is far from solved

because this plan is a ‘‘quick fix’’ and does not resolve the underlying problems faced

by Pennsylvania physicians and hospitals.

These issues have very negatively impacted our medical center, its physicians and

the academic mission. For example, between fiscal years 1999 and 2003 the cost of

malpractice premiums paid by our University of Pittsburgh academic clinical physicians escalated from more than $5 million to more than $23 million per year, an

increase of more than 200 percent per faculty member. The increase for fiscal year

2003 alone is 23 percent. At the University of Pittsburgh Medical Center (UPMC)

our cost for ‘‘excess coverage’’ for physicians (beyond state requirements and desirable because of the proliferation of very large verdicts, especially in the eastern part

of the state) has increased 500 percent from 2000 to 2002. As a result, we are having progressive difficulty in retaining graduating residents in certain specialties to

remain in Pennsylvania. A recent HAP survey found that nearly two-thirds of med-
35

9 HAP Healthcare Outlook, page 1, November 2002. 10 Albert T., ‘‘Pennsylvania Faces Liability Meltdown,’’ AMA News, page 4, December 9, 2002.

ical teaching programs in Pennsylvania report that their medical residents are

choosing to continue their practices outside of Pennsylvania.9

The impact on other Pennsylvania physicians, some faced with individual malpractice payments in the hundreds of thousands of dollars, has been even more dramatic. For example, three obstetricians in Uniontown, Pennsylvania ‘‘stopped delivering babies this fall because the physicians, all in their thirties, couldn’t afford the

insurance, $400,000 this year compared with $150,000 last year.’’ 10

The announcement of dramatic and extremely high malpractice awards has a very

negative effect on physicians, provokes defensive medicine, poor patterns of

healthcare delivery, excess resource utilization, and escalating healthcare costs. For

example, announcement of a recent very large malpractice verdict immediately

raised the bar on malpractice settlements throughout Southwestern Pennsylvania.

This significantly drives up premiums and decreases our academic health center’s

ability to invest in new technology, quality improvement programs, recruit and

maintain physician talent, and invest in biomedical research.

Our experience parallels that summarized by U.S. Government experts. See, for

example, the Report from the U.S. Department of Health and Human Services,

‘‘Confronting the New Healthcare Crisis: Improving Healthcare Quality and Lowering Costs by Fixing our Medical Liability System’’, July 24, 2002. The report estimates that limiting unreasonable awards for non-economic damages (caps on pain

and suffering) could reduce healthcare costs by 5–9 percent without adversely affecting quality of care.

For the purposes of today’s hearing we must relate the above facts and problems

that I have thus far highlighted, to the formulas used by CMS, and mandated by

Congress, to reimburse physicians. There is a great deal of technical complexity

here. However, it is my belief supported by the following observations that the

present approach to Medicare physician reimbursement is deficient in this respect.

The formulas by no means keep up with the current costly malpractice premium

and settlement expense trends discussed above.

For example, there is an opportunity in the RBRVS system (Resource Based Relative Value Scale), which computes the number of RVU’s (Relative Value Units) to

be paid for a specific piece of physician work (CPT Codes, levels) to take malpractice

costs into account. The total number of RVU’s awarded include ‘‘Work RVU’s’’;

‘‘Practice expense RVU’s’’ and ‘‘Malpractice RVU’s’’. However, in CY 2002, and despite the trends above, ‘‘Malpractice RVU’s’’ did not change significantly in the Federal calculation of physician resources involved in a particular piece of medical

work.

Another opportunity for including malpractice expenses in determining physician

Medicare fees comes in the calculation of the Conversion Factor, which changes administratively on an annual basis as set forth by the Balanced Budget Act, BBA,

of 1997. Presently for 2003, physicians must (we hope not) once again endure an

additional reduction of 4.4 percent in the Conversion Factor, which when multiplied

times geographically corrected RVU’s for a particular piece of work results in a specific payment. The Conversion Factor is determined by factors related to the Medicare Economic Index (MEI), Medicare Sustainable Growth Rate (SGR) and by the

Statutory Adjustment Factor. As you are aware, during 2002, the reduction was 5.4

percent.

Again this is a very complex matter. In fact, this approach to physician Medicare

reimbursement has been repetitively criticized by the American Medical Association,

the Association of American Medical Colleges (AAMC)—representing academic interests, the Medical Group Management Association (MGMA), as well as by highly

regarded independent commissions such as MedPAC (Medicare Payment Advisory

Commission). The present approach needs to have an immediate overhaul. It is misleading and not structured to reflect true increases in practice costs. (See below)

For our purposes today, however, the relevant fact is that the recently released

data concerning the federal computation of the Conversion Factor for CY 2003 reflects only an 11.3 percent increase (2002 to 2003) in the Professional Liability Insurance Factor (as relates to the calculation of the MEI). This is inadequate from

any realistic account of what is actually happening to physicians and hospitals ‘‘in

the field’’ (see above). The 2002 MEI PLI factor of only 3 percent increase was also

clearly inadequate. Furthermore, the MEI/SGR systems approach to Medicare physician payments does not yield an actual 11 percent increase in payments.

The conclusion is that physicians and hospitals are not paid sufficiently by Medicare in light of these malpractice costs trends and computations. This requires immediate correction.
36

11Maves, M., MD, MBA, ‘‘AMA Letter to Entire U.S. Senate Urging Medicare Payment Update Increase of 3 percent,’’ September 16, 2002.

From our perspective in the field (both academic and community), an important

first step to halting the dramatic increases in liability premiums would be for the

the Senate to immediately consider, pass and adopt the approach of the House

HEALTH Act, H.R. 4600 (Help Efficient, Accessible, Low-Cost, Timely Health Care

Act) passed in 2002. This approach would offer a more definitive solution for physicians, hospitals, and their patients to the national liability crisis discussed above.

MEDICARE CY 2003 PHYSICIAN REIMBURSEMENT

The above discussion of escalating liability insurance costs is but one blow to physicians and hospitals. The next blow, likely to occur unless you and your fellow Senators act immediately, is the CY 2003 physician fee schedule and the 4.4 percent

reduction in the Conversion Factor. This blow cannot be sustained by American

medicine and its patients. As previously mentioned, this will be the second year of

such reductions.

This reduction is particularly aggravating to physicians and hospitals. Responsible government officials such as Mr. Thomas A. Scully, the Medicare Administrator who has just testified, has himself recently indicated that the concepts and

facts propelling this ‘‘mandated’’ reduction are not accurate. In fact, the inaccuracy

is 6 percent, to the present detriment of physicians and the hospitals that employ

them.

According to Mr. Scully, the correct Conversion Factor for CY 2003 should be a

1.6 percent increase, not a 4.4 percent decrease in physician reimbursement. As

noted by Mr. Scully and reported in The BNA Health Care Daily Report dated December 18, 2002, ‘‘If you go back to 1992 and take all of the errors up and down

and fix the fee schedule the way it should be fixed, that’s our calculation.’’ Mr.

Scully also notes in a CMS Public Affairs announcement dated December 20, 2002,

that ‘‘The reduction in physician fee schedule rates results from a formula specified

in the Medicare law and we believe that formula is flawed and must be fixed.’’

The reasons for these inaccuracies and unfairness are well known. Here I quote

from a recent public plea directed by more than 4,500 University of Pittsburgh Medical Center physicians to the Pennsylvania Congressional delegation: ‘‘The current

update formula ignores erroneous past projected targets of gross domestic product

growth and (Medicare) fee-for-service enrollment, fails to reflect the actual cost of

providing physician services, and contributes to payment volatility. If such flaws are

ignored (more cuts are coming) in just three years, Medicare physician payment

rates are expected to fall below 1991 levels, despite an estimated 40 percent increase in medical practice costs over the same period.’’ There are other reasons for

this inaccuracy, such as the growth of medical technology.

Because of Medicare cuts already made in 2002 (5.4 percent) and cuts reflecting

other pay factors in the Conversion Factor, the percent change in average payments

by Medicare Specialty Physician Fee Schedule for CY 2002 and 2003 reflects a 10

percent average decrement for all physicians.

There is also variation for CY 2002 and 2003 by specialty, from a total cut of 4

percent (OB/GYN) to higher cuts for Cardiac Surgery (16 percent), neurosurgery (14

percent), Orthopedic Surgery (13 percent), and Family Practice (8 percent).

I note with great concern the differential negative effect of the already discussed

liability insurance increases and these Medicare payment cuts upon specialties such

as neurosurgery and orthopedics. These are the very specialties needed in advanced

trauma centers, essential for producing ‘‘best patient’’ treatment outcomes in tertiary medical centers such as ours in Pittsburgh.

Can such cuts and continuing problems in the unaffordable costs of liability insurance be accomplished without negative consequences for patients? I doubt it and so

does CMS.

As noted in the CMS Public Affairs Office Announcement on December 20, 2002:

‘‘Almost 90 percent of physicians accept Medicare assignment today and as yet CMS

has not seen access problems. However, CMS expects that may change after these

rules take effect.’’ There is much to suggest that this is so. For example, the American Medical Association reported on September 16, 2002 that the American Academy of Family Physicians has released survey data showing that nearly 22 percent

of family physicians are no longer taking new Medicare patients, a significant increase from the same survey data one year earlier.11 More than 40 percent of physi-
37

12 Albert, A., ‘‘Delegates rally to knock out cuts in Medicare payments’’, AMA News, page 2,

January 6, 2003. 13 New York Tmes, page A14, December 21, 2002. 14 ‘‘Republicans Pick Frist as Senate Leader; He vows to ‘Heal Wounds of Division’’’, New York

Times, page A18, December 24, 2002. 15 Cohen, J., ‘‘AAMC Letter to Congress on Fixing the Sustainable Growth Rate’’, AAMC,

1999.

cians surveyed in a recent AMA poll said they wouldn’t sign Medicare participation

agreements if pay cuts continued.12

A similar concern has been expressed by John C. Rother, Policy Director of AARP

and a well-known advocate for senior citizens. He notes with respect to the Medicare

payment formula that ‘‘Congress should correct it as soon as possible. . . . We are

getting complaints that it is becoming difficult for Medicare beneficiaries to find a

doctor willing to accept them in some parts of the country. We don’t want that problem to spread.’’ 13

IMPACT OF MEDICARE PHYSICAN CUTS UPON THE ACADEMIC MEDICAL CENTERS AND ITS

PATIENTS/STUDENTS

What do these clearly unwarranted cuts mean for academic healthcare centers

such as the University of Pittsburgh Medical Center? Some local statistic are of interest:

Medicare physician fee cuts from fiscal year 2002, compounded with those to occur

in fiscal year 2003, have or will result in a loss of $6.4 million to our University

of Pittsburgh Medical Center academic clinical faculty physicians. Medicare cuts

have or will result in an additional loss of $2.3 million for UPMC community based

physicians over this same time period.

Medicare payments are the ‘‘standard’’ upon which other insurance payers base

their payments. A drop in Medicare payments will mean a commensurate drop in

physician reimbursement for both academic clinical faculty and community physicians, damaging their ability to provide care for both Medicare beneficiaries and

their other patients.

These cuts in physician reimbursement can ‘‘only possibly and very painfully’’ be

restored by the University of Pittsburgh Medical Center which will then have many

less dollars to spend for support of academic medicine, research and investment in

young, promising physician/scientists or otherwise we risk losing key faculty clinical

and community based physicians. This is a Hobson’s choice.

Academic success and vitality are dependent upon physician earned clinical income and the economic well being of the parent teaching hospital. For example, at

the University of Pittsburgh Medical Center, more than 90 percent of clinical faculty

salaries are paid by their clinical earnings or by the hospital. At academic

healthcare centers, clinical faculty provide innovative expert care. They teach and

perform research and clinical trials. They require financial support. If we are to retain clinical faculty and profit from their experience and longstanding ‘‘value commitments’’; then these unwarranted Medicare cuts in physician reimbursement must

stop.

The same is true for the University of Pittsburgh Medical Center physicians who

practice in the community. Patient access to their outstanding care is vital to Southwestern Pennsylvania.

Clinical faculty and University of Pittsburgh Medical Center community based

physicians also do much for which they are not paid at all or paid very poorly. Society is dependent upon them for clinical care that is otherwise not available to disadvantaged persons. There is a crisis in American medicine. This crisis includes how

best to provide care for the uninsured and disadvantaged. Presently, almost 42 million Americans have no health insurance. The AAMC’s member teaching hospitals,

which are 6 percent of all hospitals, provide nearly 50 percent of all hospital charity

care.

As recently noted by Senator Bill Frist (R-Tennessee), ‘‘We need to focus on the

uninsured and those who suffer from healthcare disparities that we so inadequately

addressed in the past, but which I saw every day working at a hospital for eight

or nine years just several blocks from here.’’ 14 Unless the formula is fixed and Medicare reimbursement can be stabilized, many problems will be coming for medical innovation, teaching, and patient care. As noted by the AAMC, ‘‘Medical schools finance up to 46 percent of their operating budgets from income generated by their

clinical faculty and relationships with teaching hospitals.’’ 15 Such clinical income

also affects medical student support and scholarships. In today’s economic climate,
38

16 ‘‘Letter on Medicare Physician Payment Relief Signed by (106) Medical School Deans, Sent

to Senate Finance Committee and Full Senate,’’ AAMC Government Affairs and Advocacy, September 19, 2002.

85 percent of medical students presently graduate with debts averaging about

$125,000 per student. This debt compounds during their residency and later.

MEDICARE HOSPITAL REIMBURSEMENTS

To fully understand the impact of Medicare physician reimbursement cuts on the

academic healthcare center, we must also keep in mind cuts that have and are occurring with Medicare hospital reimbursements.

Hospital operating margins in Western Pennsylvania are at the lowest they have

been in decades. In the last five years, Pittsburgh has experienced two major hospital system de facto bankruptcies and one of these systems, St. Francis Medical

Center, has recently closed. Given declines in investment income secondary to the

poor economy, hospital total operating income is barely positive and not positive at

all for many hospitals.

In the case of the University of Pittsburgh Medical Center, as a consequence of

the 1997 BBA, we have experienced Medicare related reductions in reimbursements

compounding the economic and academic effects noted above. Mandated market basket reductions over the last five years have totaled $52.7 million to our medical center’s bottom line.

Additionally, IME reductions (Indirect Medical Education payments) consequent

to the BBA of 1997 (Balanced Budget Act) and BIPA of 2000 (Benefits Improvement

and Protection Act) for the medical center have totaled $55.9 million over the last

five years. In fact, the last phase of the IME reductions—a 15 percent cut—were

effective on October 1, 2002.

These combined hospital and Medicare-related reductions now constitute a con- tinuing reduction to medical center income of about $30.1 million per year, with attendant negative consequences for the academic and clinical mission as discussed

above.

I urge you to work towards maintaining the IME at fiscal year 2002 levels as well

as ensuring full inflation or market basket updates to hospital inpatient and outpatient rates.

CONCLUSION

(1) The Senate should consider and pass legislation to address the current malpractice crisis. The HEALTH Act, H.R. 4600 endorsed last year (2002) by the House,

is model legislation for this purpose. That approach deserves your support.

Just 2 weeks ago, President Bush (January 16, 2003 speech at the University of

Scranton, Pennsylvania on the national malpractice crisis) appealed for medical liability reform along these lines.

(2) As documented above, multiple negative consequences to physicians, hospitals,

nursing homes, academic health care centers, medical schools, and patients will

ensue if CY 2003 Medicare physician payment reductions are implemented. Patient

access to medical care will be jeopardized and innovative medical research and education will be compromised.

The physician community, and the hospitals that help support them, cannot sustain unwarranted cuts of 18 percent of physician pay over a four year period combined with increased medical liability burdens, escalating regulatory and insurance

based administrative practice costs, and other escalating operating costs that are

impacting all U.S. businesses.

A mistake has been made. It has been clearly acknowledged by those most expert

in this field. It is time to fix the mistake. I urge this committee and the full Senate

to immediately debate and bring an end to this plan.

(3) The Senate fiscal year 2003 omnibus appropriations bill includes a temporary

freeze in the CY 2003 cut to physician payments and I support this temporary fix.

However, a long term solution to the reductions and the overall false Medicare formula must be addressed. Last year, over three-quarters of the Senate cosponsored

legislation (the ‘‘Medicare Physician Payment Fairness Act,’’ S. 1707) that would

halt the scheduled reductions and call for a more equitable alternative to the current payment methodology. Despite the indicated of strong bipartisan support, no

action has been taken.16

(4) Halt the current IME reductions and maintain IME payments at 6.5 percent

(fiscal year 2002 levels);

(5) My experience and reading convince me that the Congress should also initiate

and debate how better to pay for the future medical treatment of Medicare patients.
39

We need to devise a much better system for assessing justified physician and hospital payment that will take into account escalating health care costs from every

quarter.

Senator SPECTER. Thank you, Dr. Roth.

Gentlemen, we are going to have to observe the time limits. We

have another panel. I have to get to the Judiciary Committee, and

there is floor action coming up this afternoon, so take a look at the

timer, and please observe the time limits.

STATEMENT OF JITENDRA DESAI, M.D., PRESIDENT-ELECT, PENNSYLVANIA MEDICAL SOCIETY

ACCOMPANIED BY DENIS OLMSTEAD, ECONOMIST, PENNSYLVANIA

MEDICAL SOCIETY

Senator SPECTER. Dr. Jitendra Desai is president of the Allegheny County Medical Society, senior attending physician at Allegheny General Hospital. He is accompanied by Mr. Denis

Olmstead, senior economist and vice president of the Division of

Representation for the Pennsylvania Medical Society. Thank you

for joining us, Dr. Desai, and the floor is yours.

Dr. DESAI. Good morning, Senator, and members of the Appropriations Committee. I am Jitendra Desai. I am president-elect also

of the Pennsylvania Medical Society, a solo practitioning urologist

from Alaquippa Hospital, a low income, medically underserved

community near Pittsburgh. With me is Denis Olmstead. We are

here on behalf of Pennsylvania physicians and their patients to

comment on the current Medicare payment system and professional

liability system and their increasingly adverse effect on the availability of quality health care for our citizens.

Let me start by reinforcing what you already know, that the current formula used by Medicare physician reimbursement is dangerously flawed. This fact has been openly recognized by the administration and must be fixed legislatively by the U.S. Congress.

Pennsylvania physicians, the backbone of Pennsylvania’s health

care delivery system, cannot afford any additional payment cuts.

Without a doubt, the latest scheduled Medicare cuts could not have

come at a worse time. Pennsylvania physicians are caught in a

vise. We have a very low health insurance reimbursement, national

commercial insurance payments 40 to 50 percent higher than

Pennsylvania’s commercial insurance payment levels. We also have

extremely high physician practicing cost, driven in large part by

runaway professional liability premiums.

With such low commercial health, Medicaid and Medicare plus

choice payments, reduced Medicare fee for service payments may

be the last straw.

In addition to the reduction in Medicare conversion factors, other

important elements of the formula work against Pennsylvania physicians. As mandated by Congress, the Medicare payment formula

is resource-based. In other words, relative other units for work

costs, practice costs, and professional liability costs ought to deflect

physicians’ true expense of delivering service to the Medicare beneficiary. This is not what is happening. The payment formula does

not account for the actual cost of delivering care. For example, from

January 1997 to September 2001, the major professional liability
40

carriers in Pennsylvania increased their liability insurance rates

between 80 percent to 147 percent.

Even before the horrible terrorist attacks on September 11, rates

were already climbing at a significant rate. Since then, medical liability insurance rates have increased further. In 2002, major carriers increased rates between 40 to 50 percent, followed by similar

increases in 2003.

The Medicare payment formula, on the other hand, has not kept

up. Professional liability relative value units and its associated geographic adjuster designated to differentiate costs to practice of

medicine in a defined geographic locality are based on data collected from the period 1996 to 1998, as you mentioned.

Our present liability cost increases will not work their way into

the formula until 2007 and 2009. It is just inconceivable that in the

age of computers data reflecting the current cost of liability insurance is not being used to determine current payment rates, so you

can see not only does the current formula short-change physicians

from the professional liability perspective, but also continue to

short-change physicians for many years.

To exacerbate this situation further for many clinical physicians,

the current payment formula would have you believe that the cost

of professional liability insurance and other practice costs are less

than the national average costs incurred by physicians in other

Medicare carrier payment jurisdictions. If one is the national average geographic adjuster, most of Pennsylvania falls under the average. That is, .989 for the work relative value units, .929 for the

practice value units, and .774 for the professional liability values.

Again, this is the ultimate outcome of further reducing Medicare

payments in Pennsylvania.

In addition to the Medicare payment formula problem, Pennsylvania physicians are also faced with other specific circumstances

which act to dissuade physicians from participating in Medicare.

First, our State does not allow for balance billing of Medicare beneficiaries. We are one of the only few States that do not permit

Medicare nonparticipating physicians to balance bill the patients.

This limits the choices physicians can make regarding the billing

of Medicare beneficiaries with higher income.

Second, because of the dual eligible exclusion in Pennsylvania,

Pennsylvania Medicaid has opted not to pay for Medicare beneficiary deductibles and coinsurances. Dual eligibles are the poorest

and the sickest Medicare beneficiaries, and there are many in my

poor community where I work.

Senator SPECTER. Dr. Desai, your time has expired. Your full

statement will be in the record.

PREPARED STATEMENT

Dr. DESAI. Thank you very much. All I want to stress at this

point is that the professional liability insurance has been a problem

with us, and unless it is corrected something will happen.

Thank you very much.

[The statement follows:]
41

PREPARED STATEMENT OF DR. JITENDRA M. DESAI

Chairman Specter and members of the U.S. Senate Appropriations Committee’s

Subcommittee on Labor, Health & Human Services: Good morning and thank you

for hosting this important hearing to further address the serious physician Medicare

payment and professional liability problems facing our country and Pennsylvania.

I am Jitendra M. Desai, MD, President Elect of the Pennsylvania Medical Society

and a urologist from Pittsburgh. With me is Dennis Olmstead, chief economist for

the Pennsylvania Medical Society. We are here on behalf of Pennsylvania physicians

and their patients to comment on the current Medicare payment system and professional liability system and their increasingly adverse effect on the availability of

quality healthcare for our citizens.

Let me start by reinforcing what you already know, that the current formula used

for Medicare physician reimbursement is dangerously flawed. This fact has been

openly recognized by the Administration and must be fixed legislatively by the U.S.

Congress.

Pennsylvania physicians, the backbone of Pennsylvania’s health care delivery system cannot afford any additional payment cuts. Without a doubt, the latest scheduled Medicare reimbursement cuts couldn’t have come at a worse time.

Pennsylvania physicians are caught in a vice. We have very low health insurance

reimbursement. National commercial insurance payment norms are 40 percent to 50

percent higher than Pennsylvania’s commercial insurance payment levels. We also

have extremely high physician practice costs driven in large part by runaway professional liability premiums. With such low commercial health, Medicaid and Medicare∂Choice payments, reduced Medicare fee-for-service payments may be the last

straw.

The latest round of payment cuts will make Pennsylvania’s Medicare practice climate untenable. With 17 percent of its population eligible for Medicare one of the

highest in the nation, Pennsylvania’s physicians have already suffered a $128.6 million hit, or $4,074 per physician, as a result of the 2002 Medicare payment reduction. If not corrected, the flawed formula will cost Pennsylvania physicians another

$553 million or $17,396 per physician for the period 2003–2005. They simply cannot

afford these payment cuts.

In addition to the reduction in the Medicare conversion factor other important elements of the formula work against Pennsylvania physicians. As mandated by Congress, the Medicare payment formula is resource based. In other words relative

value units for work costs, practice costs and professional liability costs are to reflect

the physician’s true expense of delivering a service to a Medicare beneficiary. This

is not what is happening. The payment formula does not account for the actual costs

of delivering care.

For example, from January 1997 to September 2001, major professional liability

carriers in Pennsylvania increased their liability insurance rates between 80.7 percent and 147.8 percent. Even before the horrible terrorist attacks on September 11,

rates were already climbing at a significant rate. Since then, medical liability insurance rates have increased further. In 2002 major carriers increased rates between

40 and 50 percent, followed by similar increases for 2003.

The Medicare payment formula on the other hand has not kept pace. Professional

liability relative value units and its associated geographic adjuster (which is designed to differentiate costs to practice medicine in a defined geographic locality) are

based on data collected for the period 1996 through 1998. In 2004 when relative

value units and the geographic adjusters are to be updated as mandated by Congress, the data collection period will run from 1999 through 2001. Our present liability cost increases will not work their way into the formula until 2007 and 2009.

It is just inconceivable that in an age of computers, data reflecting the current cost

of liability insurance is not being used to determine current payment rates. So as

you can see not only does the current formula short change physicians from a professional liability perspective, but also will continue to short change physicians for

many years. Additionally, for the 2001–2003-payment period the weight of the geographic adjuster as a percent of the total geographic adjuster weight has been reduced from 5.6 percent to 3.2 percent. As professional liability costs continue drive

practice costs this trend should be going the other way.

To exacerbate this situation further for many Pennsylvania physicians, the current payment formula would have you believe that the costs of professional liability

insurance and other practice costs are less than the national average costs incurred

by physicians in other Medicare carrier payment jurisdictions. If one is the national

average geographic adjuster, most of Pennsylvania falls under the average i.e. .989

for work relative value units, .929 for practice relative value units, and .774 for pro-
42

fessional liability relative value units. Again, this has the ultimate outcome of further reducing Medicare payment in Pennsylvania.

In addition to the Medicare payment formula problems, Pennsylvania physicians

are also faced with other specific circumstances that act to dissuade physicians from

participating in Medicare.

First, our state does not allow for balance billing of Medicare beneficiaries. We

are one of only a few states that do not permit Medicare non-participating physicians to balance bill patients. This limits the choices physicians can make regarding

the billing of Medicare beneficiaries with higher incomes.

Second, because of a dual eligible exclusion in Pennsylvania, Pennsylvania Medicaid has opted not to pay for Medicare beneficiary deductibles and co-insurance.

Dual eligibles are the poorest and sickest Medicare beneficiaries. This creates several problems including non-payment to the physician community for the 20 percent

co-insurance and the $100 deductible as well as increasing the number of dual eligibles who seek care in the hospital emergency room rather than through a physician’s office.

And third, the rates paid by a number of commercial payers (including automobile

insurance) in Pennsylvania are tied either directly or indirectly to the payment

rates paid by Medicare. If Medicare fees are decreased these other insurers will follow suit, exacerbating even more the health care reimbursement crisis in Pennsylvania and the resulting exodus of even more physicians from the Commonwealth.

Pennsylvania already has 729 boroughs and townships designated by the federal

government as ‘‘medically underserved.’’ Exodus of additional physicians will serve

to create more medically underserved areas in the Commonwealth.

But, the Medicare cuts alone did not create such a disastrous situation that nearly shut down health care in numerous pockets of Pennsylvania. Instead, the litigious

climate in Pennsylvania has made our great Commonwealth the second worst in the

country in terms of medical liability insurance payouts. According to the National

Practitioner Databank, Pennsylvania’s total payout for medical liability claims in

2000 was more than $352 million. That’s nearly 10 percent of the national total, yet

our state’s population makes up less than five percent of the national population.

In Philadelphia alone, the median jury verdict from January 1994 through August

2001 was $972,909. Excluding Philadelphia statistics, the median jury verdict for

the rest of the state was $410,000.

Chairman Specter, while I understand that the liability insurance crisis is complex, in order to preserve the fragile doctor-patient relationship, we must evaluate

the need for reasonable tort reforms much like California adopted in the 1970s.

California’s landmark medical liability law, known as the Medical Injury Compensation Reform Act (MICRA) of 1975, proved that fair and equitable compensation

for those negligently injured, within reasonable limits, could stabilize the insurance

marketplace while maintaining access to quality health care.

After more than a quarter of a century, MICRA has proven itself as an effective

tool for limiting runaway litigation costs while maintaining access to health care for

all. It also has enabled health care professionals to focus on providing high quality

care without engaging in costly defensive medicine.

In 2001, when the Pennsylvania Medical Society commissioned a study comparing

the cost of liability insurance in California’s highest rated area compared to Pennsylvania’s highest rated area, it was clear that MICRA was working. At that time,

a Pennsylvania orthopedic surgeon could expect to pay on average $96,199, while

the same doctor in California could expect to pay $36,310. A neurosurgeon in Pennsylvania at that time would have expected to pay $111,296, while the same neurosurgeon in California would have spent $58,164 for coverage. Similar results could

be shown for other specialties.

The time has come to adopt the California MICRA model on a national level. We

must find a way to adopt a reasonable ceiling on non-economic damage awards and

a sliding scale on attorney fees to bring a degree of certainty and predictability to

the insurance market, as well as to ultimately preserve the fundamental doctor-patient relationship.

Chairman Specter, I commend you for your continued interest in addressing the

flawed Medicare formula at a time when health care can scarcely afford cuts anywhere. As you investigate this further, I would hope that you would also play a significant role in fixing the liability insurance crisis as well.

Thank you for your time. I would be happy to answer any question you might

have.
43

STATEMENT OF RICH ANDERSON, CHIEF EXECUTIVE OFFICER, ST.

LUKE’S HOSPITAL

Senator SPECTER. Thank you very much. We turn now to Mr.

Rick Anderson with St. Luke’s Hospital and Health Network. He

has been there for 17 years, has been president and CEO since

1986. He has a master of public health from the University of

Pittsburgh, and an undergraduate degree from the University of Illinois.

Mr. Anderson, thank you for joining us, and we look forward to

your testimony.

Mr. ANDERSON. Good morning, Senator. Good morning members

of the committee. I appreciate the opportunity to be here. Just a

brief background about St. Luke’s. We are a nationally recognized

organization. In the past 5 years we have received 11 national

awards. We have five hospitals, soon to be six. We are in eight

counties in Pennsylvania, one in New Jersey.

We have been recognized in U.S. News and World Report for consecutive times for our open heart surgery program. We have strategic partnerships at the University of Pennsylvania Health System, programs in trauma and medical education and cancer. We

are certainly a major teaching hospital, over 110 residents. We

have had growth in market share over the last 15 years, consecutive years, and significantly for us, our cost structure is over 95

percent, so by any measure, what I am trying to establish for you

and your committee is that we are a very successful organization.

Yet despite the success that we are having right now, we are

struggling hard to maintain margins, and we certainly need these

margins for investments and other essential services and labor

issues that we are facing.

In 2001, 40 percent of our patient revenues came from Medicare,

and that certainly is a significant number, and when you consider

the fact that in our State of Pennsylvania, populationwise we are

the second oldest State, that puts the hospitals, all the hospitals

in a very difficult position when you consider the reimbursement

issues.

In our State, it is a matter of fact, it is a matter of record that

physicians are leaving our State because of our high Medicare population to practice in other States where there is a more favorable

payer mix, and that is an issue that certainly needs to be addressed, and respectfully to Mr. Scully’s testimony about the $11⁄2

billion that was raised at the hospitals, I do not know the exact

context, probably a billion of that money that he speaks about was

lost in inappropriate outlier payments, and certainly that is an

issue that needs to be addressed.

The average margin in our State of Pennsylvania is minus 3 percent. Seven out of 10 hospitals have negative patient care margins,

so I do not know what the country’s averages are, but in our State,

we are hurting. St. Luke’s margins, despite our success, we have

about a 3.68 percent plus margin, so that puts us in a nice position.

So imagine, if we are doing what we are doing and we are doing

it very well, what are some of these other hospitals, not only in our

State but in our country, facing? What I am afraid—I mean, this

is our health care world. It is not meant to be whining, but the financial plight of our Nation’s hospitals is real, and it is serious,
44

and I am afraid in the next few years we are going to have a sign,

and this is hospital jargon, put on our doctors’ offices, our hospitals, DNR, do not resuscitate.

We need to get this fixed. I am certain this is going to occur, but

nonetheless, it needs to happen quickly. We had a certain significant issue with the Balanced Budget Act, I will not dwell on that,

and we got some relief through the Refinement Act, but it was not

enough. It was only a 25 percent relief.

If I do not communicate one other issue today to this committee,

I think it is essential that you understand that with the reimbursement the way it is, and the way it is going, despite all the ratios

and how we hide behind formulas and what the general numbers

are, and the extremely high expenses—I mean, we are in the

midst, and it was used earlier, of a perfect storm. We are out there

on the ocean. We do not see it coming, but it is happening, and it

is coming, and we need to fix it.

The extraordinary expenses that we have, for example—I have

got 1 minute—medical liability costs. I will not go into that. We all

know what it is, but we all want to be number 1 in everything we

do, and we want Pennsylvania to be number 1. Well, we are number 1. We are the worst State in the Union for the malpractice situation that we are in, and that has to be fixed.

President Bush has spoken about it. He is on target. I applaud

him. We have labor shortages, nurses. We have a gap between

what we are paid for Medicare and what we receive in terms of—

what we have to pay our nurses. We have drug costs, and we all

understand about the pharmaceutical business and the industry.

PREPARED STATEMENT

I want to summarize by saying that in the last year—I am sorry,

13 years, we have only received one full market basket increase in

13 years. That is not fair. That needs to be fixed, and it needs to

be fixed as soon as we are able to talk through the issues.

Thank you, Senator. I appreciate the opportunity to come here.

I am honored.

[The statement follows:]

PREPARED STATEMENT OF RICHARD A. ANDERSON

Mr. Chairman and Members of the Subcommittee: I am pleased and honored to

be here today to discuss various aspects of Medicare reimbursement. My name is

Richard A. Anderson and for almost 18 years I have served as President and Chief

Executive Officer of St. Luke’s Hospital & Health Network. To begin my remarks,

and to provide you with background that will help you to understand my perspective, I would like to take a few moments to describe our organization.

St. Luke’s Hospital & Health Network is a fully integrated, nationally recognized,

health care network based in Bethlehem, Pennsylvania. In the next few weeks, we

expect to sign an agreement with a neighboring hospital that will make us the largest health care network in the Greater Lehigh Valley. Our Network is presently

comprised of five, soon to be six, acute care, non-profit hospitals. The Network encompasses more than 1,400 physicians, 1,020 licensed beds, more than 6,200 employees and 40,000 annual patient admissions and is the second largest employer

in Lehigh County. Offering 72 medical specialties, the Network also includes a home

health agency, an ambulatory surgery center, numerous outpatient facilities and

various other related health organizations. St. Luke’s provides direct services in Lehigh, Northampton, Carbon, Schuylkill, upper Bucks, eastern Berks, upper Montgomery and Monroe counties in Pennsylvania and Warren County in New Jersey.

St. Luke’s Hospital—Bethlehem Campus is the Network’s tertiary hub and has been

recognized in 1997 and 2001 in the highly coveted 100 Top Hospitals: Benchmarks
45

for Success studies. These studies objectively measure, among other criteria, quality

care and efficient management.

Areas of special expertise available in the Network include: trauma, open-heart

surgery, high-risk pregnancy, oncology, interventional radiology, robotic surgery,

geriatrics and community health. Our open-heart surgery program has been recognized four consecutive times, beginning in 1999, in U.S. News & World Report’s annual America’s Best Hospitals rankings and recently four times by the 100 Top Cardiovascular Hospitals: Benchmarks for Success studies. In addition, our Intensive

Care Unit has also received national recognition for superior care.

St. Luke’s developed the first, and only, strategic partnership in the Greater Lehigh Valley with the University of Pennsylvania Health System (UPHS). St. Luke’s

and UPHS have successful cooperative agreements in trauma, cancer and medical

education. Pediatric specialists from St. Christopher’s Hospital for Children in

Philadelphia also work in cooperation with St. Luke’s specialists to provide a full

range of specialty pediatric services in Bethlehem. Both UPHS and St. Christopher’s

have also been recognized in U.S. News & World Report’s annual listings of America’s Best Hospitals.

St. Luke’s is a major teaching institution and offers 10 fully accredited residencies

in multiple specialties. St. Luke’s has both allopathic and osteopathic residencies in

family practice, emergency medicine and obstetrics and gynecology. We also have

residencies in general surgery, internal medicine and podiatry; plus a transitional

year and an osteopathic internship.

St. Luke’s is one of only 400 members of the prestigious Council of Teaching Hospitals and Health Systems. Residents who complete their training at St. Luke’s routinely achieve a 100 percent pass rate on post-residency national board examinations.

By all accounts, St. Luke’s is a very successful organization. We have experienced

growth in market share for more than 15 consecutive years and, by independent

measure, our cost structure nationally ranks well above the 95th percentile. Simply

stated, we are an efficient, cost-effective health care network that provides our patients and the citizens of the Greater Lehigh Valley with excellent medical outcomes. Yet, we are struggling to maintain a sufficient margin to enable us to make

investments required to remain a nationally recognized health care provider.

In 2001, 46 percent of St. Luke’s net patient revenue came from the Medicare program. This is not surprising, since Pennsylvania has the nation’s second oldest population. When Medicare reimbursement is inadequate physicians leave states with

high Medicare populations to practice in states with a more favorable payer mix.

Currently, we are seeing an increasing number of physicians in our region moving

to other states. The strength and security of the Medicare program is not only essential to the beneficiaries in our region, but to the hospitals and physicians providing care.

Let me now further address the issue of Medicare reimbursement. It probably has

not escaped your notice that hospitals throughout Pennsylvania are continuing to

experience severe financial pressures. According to 2001 data collected by the Pennsylvania Health Care Cost Containment Council (PHC4), the average patient care

margin in the state stands at a negative 3 percent. Seven in ten Pennsylvania hospitals—or 192 of the state’s 274 hospitals—have a negative patient care margin.

Thankfully, St. Luke’s, due to its extremely low cost structure, is more fortunate.

Our margin for the 2001 fiscal year, as published in this report, was 2.83 and averaged 3.68 for the three-year period covered in the document. While this certainly

is better than experiencing a loss, one can readily see that these margins, from a

business perspective, are razor thin. Most of us, if given the choice to invest in a

business venture with these slim margins, would politely decline the opportunity.

Nonetheless, this is the health care world in which St. Luke’s and other health care

systems must function. At a minimum, we must have even these slim margins to

buy new equipment, upgrade our facilities, bring new and advanced technology to

our community—investments that are so important if St. Luke’s and others in the

not-for-profit world are to meet its communities’ health care needs.

The financial plight of our nation’s hospitals is real. We are not crying wolf. The

wolf is no longer at the door, he is in our living room and he is eating our dinner.

Will we be his next meal?

The Balanced Budget Act of 1997 cut Medicare payments to our nation’s hospitals

by nearly $4 billion over the past five years. St. Luke’s reduction was projected at

$16.5 million through fiscal year 2000 and $33.8 million through fiscal year 2002.

Fortunately, as I previously mentioned, St. Luke’s operates well above the 95th percentile for efficiency. If one of the nation’s most efficient hospitals is so drastically

and so negatively impacted by this legislation, what then are other hospitals experiencing?
46

The subsequent Balanced Budget Refinement Act of 1999 and the Benefits Improvement and Protection Act of 2000 thankfully restored 25 percent of the cuts

across the nation. At St. Luke’s, after this legislative relief, we saw our reimbursement reduced by $13.6 million, rather than $16.5 million, through fiscal year 2000.

Through fiscal year 2002, St. Luke’s BBA-related reduction totaled $24.6 million,

down from $33.8 million. One can conclude that these are still rather substantial

reimbursement losses for St. Luke’s, which was previously noted as operating on a

razor-thin margin.

Medicare reimbursement reductions, extraordinary expense pressures and other

significant factors are converging to threaten our nation’s hospitals. I cannot over

emphasize the significance of these issues as they relate to St. Luke’s and other

health systems’ futures.

These issues include:

Medical Liability Costs

Professional medical liability costs at St. Luke’s have risen 133 percent, or more than $4 million, in just two years, bringing the total annual premium to $8 million.

As I speak, 14 of our 22 active, private practice obstetricians are telling us they

have to either leave Pennsylvania or seek financial security through hospital employment. We can not afford to employ them due to the previous factors I have been

discussing.

Anesthesiologists’ medical professional liability insurance rates are rising faster

than those of any other physician group. Not only are anesthesiologists impacted by

a 46 percent increase in malpractice premiums, their plight is further compounded

by the exodus of other physician specialists from Pennsylvania due to the drastic

reduction in Medicare reimbursement rates. Fewer physicians result in fewer procedures for anesthesiologists. In the last two years, anesthesiologists’ Medicare reimbursement rates have also been reduced by 6 percent, while their expenses continue

to escalate at a unreasonable rate.

Pennsylvania’s horrific malpractice insurance climate has effectively eliminated

the ability of hospitals and physicians to recruit new physicians. Eighty-five percent

of the graduate orthopedic surgery residents who completed training programs last

year in Pennsylvania hospitals would not even consider applying for a permanent

position in our state.

Most recently, general practitioners and pediatricians say professional medical liability insurance is getting more difficult to obtain while premium costs are increasing 25 to 50 percent per year on average. This rate of increase is also consistent

with what St. Luke’s has experienced.

The largest pediatric group in a community near St. Luke’s Quakertown Hospital

has spent more than a year trying to recruit new doctors without success. Last summer the practice stopped accepting new patients even though it is located in an area

with significant population growth. Several weeks ago, the practice informed parents it would no longer be able to schedule well-baby visits for children over the

age of 2 since the doctors needed to devote full time to caring for sick children and

administering immunizations for children under the age of 2.

Yet another financial ramification of the medical liability and Medicare reimbursement crisis, and what is generally an unspoken consequence, is that individual

hospitals are being forced to subsidize certain hospital-based specialists to the tune

of millions of dollars a year. This is also a fact of life for St. Luke’s. Radiologists,

pathologists, emergency room physicians and anesthesiologists, specialists our patients depend on, can no longer afford to practice in Pennsylvania because of the

combination of financial pressures of Medicare reimbursement and medical malpractice premiums.

The past year, three of six neurosurgeons serving our hospital left to practice in

other states. The three remaining neurosurgeons who practice at our hospital and

our trauma center came to us and requested that we either employ them or they

would be forced to leave the state. They simply could not cover their expenses in

Pennsylvania because of insufficient Medicare reimbursement and escalating malpractice coverage costs. We employed them in order to keep our trauma center open.

This last event was the most recent untoward event not anticipated in our budget

and the financial consequences of this are yet to be realized.

Lest you not fully comprehend the gravity of the exodus of neurosurgeons, there

are only seven neurosurgeons to serve our region’s 1.5 million citizens. Limited access to care is escalating for many people, and is increasing as a real threat to our

citizens’ health.

Our President’s recent speech in Scranton, Pennsylvania on January 16 was right

on target relative to the major issues I have just discussed. He pointed out that,

‘‘There are too many lawsuits in America, and there are too many lawsuits filed
47

against doctors and hospitals without merit.’’ He went on to caution the American

people that they must understand that, even though many lawsuits are, in his

words, ‘‘junk lawsuits’’ and ‘‘they have no basis,’’ they are still expensive to our

health care system.

President Bush further observed that, ‘‘The direct cost of malpractice insurance

and the indirect cost from defensive medicine raises the federal government’s health

care cost by at least $28 billion a year.’’ He also warned that, ‘‘When a physician

can not pay insurance premiums and, therefore, can not practice, somebody is going

without health care.’’ Mr. President, I could not agree with you more.

Labor Shortages

In the current Medicare reimbursement climate, escalating salary expenses are

especially onerous. Labor shortages are forcing hospitals to raise salaries to retain

existing workers and to attract new employees. For example, St. Luke’s average

hourly wage increased 9.4 percent in the last two years. During this same period,

the actual payment rate increase received from Medicare was only 5.7 percent. This

3.7 percent gap translates into a $4,300,000 annual shortfall for St. Luke’s.

In 2000, the supply of RNs in Pennsylvania was estimated at 104,000 nurses

while the demand was for nearly 110,000 nurses. This reflects a 5 percent shortage

that is anticipated to grow to 30 percent by 2020. With this shortage comes increased upward pressure on nursing salary expenses, while factors such as compressed Medicare reimbursement continue to strain our resources.

Thankfully, St. Luke’s has been able to maintain a low vacancy rate because of

our competitive salaries and because we run a cost-effective hospital. St. Luke’s 8

percent vacancy rate for registered nurses is well below the 13 percent national average reported by the American Hospital Association.

Our low vacancy rate can also be attributed to our ability to recruit nurses from

St. Luke’s School of Nursing, the nation’s oldest, hospital-based, continuously operating, fully accredited diploma program. In addition, St. Luke’s School of Nursing

at Moravian College in Bethlehem offers a baccalaureate degree in nursing. More

than 800 students have made inquiries about our nursing education programs in the

last few months.

Pharmaceutical Costs

St. Luke’s and other hospitals have experienced significant increases in pharmaceutical costs—while trying to recover from the reductions of the Balanced Budget

Act and inadequate Medicare reimbursement. The increase in pharmaceutical expenses has cost Pennsylvania hospitals nearly $400 million over the past four years.

St. Luke’s has experienced a 38 percent increase in pharmaceutical costs during this

period, increasing expenses from $9.5 million to $13 million a year.

Medical Technology

It is no secret that health care is, in large part, driven by technology. We all expect hospitals to have the latest medical technology. Patients at St. Luke’s are no

exception. In the last five years, St. Luke’s has invested more than $121 million in

capital projects across our Network. This represents 10 percent of our Network operating budget.

Bioterrorism Readiness

In the wake of September 11, every hospital in the country is assessing its ability

to care for patients in the aftermath of a bioterrorism attack. Our world has certainly changed since that ghastly September day. While it is painful and creates a

sense of frustration to even contemplate a bioterrorism attack, as responsible health

care providers we must be prepared for this eventuality. This preparation further

strains hospital budgets already at a breaking point. Please, I implore you to consider allowing hospitals to play a responsible role through the private sector in assisting our government in this endeavor. It is essential, therefore, that adequate

funding be provided for this effort.

Insufficient Medicare reimbursement and the lack of recognition of additional expenses I have just listed, force providers to shift the burden of increasing Medicare

shortfalls to non-governmental payers. Inadequate Medicare reimbursement is really nothing more than a hidden tax.

Now, let us cover the issue of how Medicare reimbursement is calculated. On October 1, 2002, at the start of the current federal fiscal year, providers saw additional

reductions in the inpatient market basket. The inpatient market basket is intended

to measure the various cost components of goods and services related to the health

care industry.

We have only received one full market basket update in the last 13 years. Further

compounding the problem is the simple fact that the market basket does not reflect
48

true increases in health care costs. It is absolutely essential, given these factors,

that Medicare provide hospitals with Medicare increases equal to the true market

basket.

Medical inflation, as measured by the Medicare market basket during the last five

years, was 16.3 percent on a compound basis. The Medicare increase during the

same five-year period was only 11 percent, resulting in a compound deficit of 5.3

percent. Had St. Luke’s received a full market basket increase during this period,

Medicare reimbursement in just the current year would have increased by

$4,000,000.

Our hospitals are in financial crisis.—We simply can not continue to survive, to

offer full access to care, to provide a full continuum of services in this oppressive

financial environment. We need to strengthen the bridge between Medicare reimbursement and hospitals’ actual expenses before it collapses and our nation’s hospitals are swept away in a raging current of financial chaos. To restate the obvious,

insufficient Medicare reimbursement results in a hidden tax.

Certainly, long-term solutions to achieve equitable Medicare reimbursement and

to address the medical liability crisis will require ongoing discussions. There is no

easy fix. Meaningful reform will take time, patience, understanding and continuing

education. In our country, consequential change takes place not by revolution, but

by evolution. However, in the interim, we must stop the hemorrhaging occurring in

our American health care system caused by the convergence of the professional liability crisis, the expense pressures that I have outlined and insufficient Medicare

reimbursement.

While I understand this subcommittee does not directly deal with medical malpractice insurance rates, it is imperative that you understand how the current premium crisis exacerbates the effects of insufficient Medicare reimbursement. Let me

further address the medical malpractice crisis, an issue that invokes great passion

for me with very good cause. Anyone who reads a newspaper is aware that Pennsylvania has the nation’s worst malpractice insurance climate. Having a malpractice

case tried in the Philadelphia court system is often akin to the lawyers and plaintiffs winning the lottery or, worse yet, an economic death sentence for hospitals and

physicians. Runaway jury verdicts and multi-million dollar awards have become the

norm. We desperately need reform to balance the rights of those who have legitimately been harmed with the rights of those who are unfairly, excessively and frivolously sued.

I speak with authority on this subject. In October 2000, a Philadelphia jury returned a verdict in the amount of $100 million against multiple defendants including St. Luke’s Hospital. Previous to this time St. Luke’s had an exemplary track

record in malpractice actions. Our hospital was a part of this suit only because of

alleged ‘‘ostensible agency.’’ A patient’s mother perceived that one of the privatepractice physicians who treated her infant was employed by the hospital.

The patient had been cared for in our Neonatal Intensive Care Unit for 90 days

and none of this care was faulted in any respect. Although we would have preferred

to challenge this award in the court system, our insurance carrier took the matter

from our hands and settled the claim for a far lesser, but substantial, amount. In

Pennsylvania, 53 cents of every malpractice settlement goes to the lawyers and to

pay administrative costs. Other than the attorney, I have no idea how the remainder of the settlement was dispersed. The child’s biological mother, who had no contact with the child, did not bring the suit and who did not receive any payment from

the settlement, is incarcerated for drug-related offenses. The adoptive parents of the

minor plaintiff were also not part of the legal action and wanted no part of the settlement.

It is no exaggeration to say that if we had been required to pay the full award,

our 130-year-old hospital would have ceased to exist. We would have been bankrupt.

This misplaced attempt at social reengineering is corrupt and utterly wrong. It allows for an excessive redistribution of resources from the medical care system to a

few individuals. If this system is allowed to continue, access to quality health care

will become very limited for thousands and thousands of our citizens.

The fallout from this travesty of justice continues to haunt our organization in

that we have been unable to secure affordable excess malpractice insurance. We

were also forced to establish our own captive insurance company in order to obtain

primary liability coverage. Prior to the jury’s $100 million award, St. Luke’s annually paid $280,000 for a $25 million excess coverage policy. At present, St. Luke’s

pays its captive insurance company $3 million for a $3 million excess policy. In the

current climate, no insurance company will provide St. Luke’s with excess coverage.

The medical liability crisis is not just a financial issue, it is also a moral and ethical issue that we must address. We must ask ourselves, it is right to take $100
49

million out of the health care system and give it to one family—after the lawyers

receive their 40 or more percent?

This social injustice and inequity in the system must be changed. This system,

if allowed to continue unchallenged, is creating all of the elements of the ‘‘perfect

storm’’ which our American health system may not survive.

In closing, I am asking Congress to reverse the inpatient market basket cuts that

went into place on October 1, 2002 and to provide adequate reimbursement to hospitals. There is the need for full market basket updates that accurately reflect the

current costs hospitals are facing. It is my understanding that The Hospital and

Health System Association of Pennsylvania has written to the Centers for Medicare

and Medicaid (CMS) asking for changes to the current market basket methodology.

I am pleased that CMS implemented the recommendation to use a re-based market

basket, updating from 1992 data to 1997 data and revising the calculation by replacing some of the proxies that are used to measure cost changes. While the new market basket is an improvement, I am still concerned that the market basket does not

reflect the true increases in costs for technology, recruitment, professional liability

and other items.

I would urge CMS to reconsider the proxy used for professional liability insurance

cost growth. As I mentioned earlier, hospitals, particularly those in Pennsylvania,

have experienced significant increases in the cost of medical malpractice insurance.

It is my understanding that CMS has contracted with the economic information

firm, DRI-WEFA to collect malpractice insurance premium data from a sample of

hospitals and plans to combine this information with their current proxy source once

the data is collected. This potentially flawed methodology could be catastrophic for

American health care. It has been recommended by The Hospital and Health System Association of Pennsylvania that DRI-WEFA collect data from Pennsylvania

hospitals including those with trauma centers. These numbers will be far higher

than those selected at random across the United States. I support this recommendation. Premium increases for hospitals in Pennsylvania with trauma centers have

skyrocketed and it is essential these numbers be reflected in the data.

It is important to note that, according to a 2001 study by the Pennsylvania Legislative Budget and Finance Committee, Pennsylvania’s acute care hospitals are the

second most cost-efficient in the nation based on Medicare inpatient costs per discharge. The fat is out of the Pennsylvania health care system. We are now experiencing cuts to muscle and bone and it hurts, it really hurts. Something has got to

give and we need your help. We are trying hard to contain costs but, many of these

expenses are out of our control.

My final comments would be to ask the members of the subcommittee to consider

enacting legislation that would result in the following outcomes:

—More timely increases in Medicare reimbursement

—especially those related to the introduction of new technology. Presently,

Medicare’s long delays in adding new technology to its reimbursement formulas ‘‘punishes’’ hospitals that are financially able to provide patients with

leading-edge technology to improve outcomes.

—Full Medicare reimbursement for true health care inflation.

—Timely increases in Medicare payments that reflect increases in the costs of

malpractice insurance

—these costs should be geographically adjusted and state specific.

I appreciate the subcommittee’s focus on issues affecting our nation’s hospitals.

In particular, I’d like to thank Senator Specter for his years of understanding and

support for the Medicare program and the beneficiaries who rely so heavily on the

Medicare program.

It is only through further cooperation in an atmosphere of mutual respect, that

our hospitals and our elected officials can work together to solve the challenges before us. Thank you.

Senator SPECTER. Thank you, Mr. Anderson. Thank you very

much.

STATEMENT OF KIRK NORRIS, PRESIDENT, IOWA HOSPITAL ASSOCIATION

Senator SPECTER. We now turn to Mr. Kirk Norris, president and

CEO of the Iowa Hospital Association. Mr. Norris served as a director of the Southeast Full Community School District, 1979 graduate of Simpson College, and a 1984 graduate of the Drake University School of Law.
50

Thank you for joining us, Mr. Norris, and we look forward to

your testimony.

Mr. NORRIS. Good morning, Mr. Chairman, and also I want to

give my thanks and appreciation for your invitation and for Senator Harkin’s invitation to speak here today on the critical subject

of Medicare payment policy.

In various professional positions for the past 16 years at the

Iowa Hospital Association it has been my privilege to represent

116——

Senator SPECTER. I am sorry, but I am going to have to interrupt

you. We will start the clock again. They are about to go to a vote

on Miguel Estrada, and I am going to have to excuse myself for a

few minutes. I will be back as soon as I can. I am sorry for the

interruption, but I just have to do that. We will stand in recess for

a few minutes.

We will resume the hearing. Again, my regrets, but in the interim Senator Harkin has joined us, so he will be in a position to

hear your testimony, Mr. Norris.

Mr. NORRIS. Thank you.

Senator SPECTER. You were in mid-sentence. Can you pick it

right up there?

Mr. NORRIS. That is why it is written down.

Thanks again for starting the clock over, and thanks for the invitation of both you and Senator Harkin to come today and speak.

In various professional positions for the past 16 years with the

Iowa Hospital Association, it has been my privilege to represent

116 private nonprofit and publicly governed community institutions

in a variety of legislative, judicial, and other public forums. It is

my pleasure to come before you this morning to address the impending health care crisis in Iowa that is being driven by payment

policy for the Medicare program.

The premise of my presentation today is that no policy difference

exists between the necessary Medicare payment corrections for

physicians and the necessary payment corrections for hospitals. In

consideration of the time limitations for presenting this morning,

I am focusing on the fact that bad payment policy is just that, bad

payment policy, regardless of the recipient of the policy.

In the circumstance at hand, the primary recipients of this bad

policy are the hospitals and physicians of Iowa. Ultimately, the impact of any payment policy decision in Medicare is borne by Iowa’s

475,000 Medicare beneficiaries. It impacts Iowa seniors every time

a hospital is unable to staff a physician at a rural clinic, when 32

out of 36 hospital school nursing graduates choose to leave the

State for better starting salaries, and every time a clinic or hospital

fails to recruit a needed physician specialist to replace a retiring

physician as medical recruits examine Medicare payments in Iowa

and determine that Iowa is not a place they want to practice when

50 percent of all revenues come from Medicare.

These issues are not new or without previous discussion in various Medicare payment policy forums, as was recognized in previous comments today. In fact, the details of these issues have all

been discussed in a series of Medicare Payment Advisory Commission reports to Congress since 1999.
51

I am also aware that Congress, and particularly the U.S. Senate,

understands these issues. Evidence of this fact is found in the fiscal

year 2003 omnibus budget bill currently headed to conference committee. Both the hospital and physician payment corrections inserted in the fiscal year 2003 omnibus bill by Senate finance chair

Grassley and supported by Senator Harkin and the rest of the U.S.

Senate are an acknowledgement that these payment policy issues

coexist and need further discussion and address in the 108th Congress. The Iowa Hospital Association supports Senator Grassley’s

and Senator Harkin’s approach to these issues.

MedPAC and the Director of CMS have evaluated the need and

called for change in the methodology for physician payment.

MedPAC has also considered the need for change in the methodology for hospital payment and recognizes its potential for positive

impact in States like Iowa.

The predominant policy issue affecting hospital payment in Iowa

and other similar states is the wage index. As you know, the wage

index is the major determinant for the amount of payment a hospital receives for its services. Policy corrections for the wage index

are apparent, and should be acted on by Congress. Medicare reform

should encompass payment policy reform to assure that high quality, efficient care is not jeopardized but, rather, is rewarded.

Iowa’s efficient health care system, which also ranks in the top

10 in quality, is in serious jeopardy of sustaining itself without correction of Medicare payment policy for both physicians and hospitals. Iowa hospitals currently subsidize the Medicare program in

excess of $80 million per year. This number is growing, and will

leap in disproportionate amounts as payment shortfalls mount for

skilled nursing services, home help, and outpatient care.

As with the payment methodology for inpatient care, Congress

has moved these other services to fixed payments, and only the

time-limited payment safety measures of the Benefit Improvement

and Protection Act are preventing the geometric accumulation of

losses for certain services in specific sizes of hospitals. For other

hospitals with these same services, significant losses are mounting.

The action of Congress in these other areas reinforces the need

to immediately address policy mistakes in mature patient methodologies like inpatient care. These payment flaws are apparent

and have long been identified, but CMS needs direction from Congress on the appropriate solutions, otherwise immediate potential

for significant curtailment of access to services for Medicare beneficiaries exists in Iowa and many other States. This potential for

seniors exists at a time when Iowa has the fifth highest percentage

of citizens over age 65, and the highest percentage of population

over 85 in the country.

PREPARED STATEMENT

The Iowa Hospital Association appreciates the additional focus

that this subcommittee brings to the topic of necessary payment

corrections in the Medicare fee for service system for the interrelated services provided by hospitals and physicians. I am pleased

to provide background information for any testimony I have given

today, and answer any questions related to the same.

Thank you for the committee’s time, Mr. Chairman.
52

1 Iowa Hospital Association Profiles/Databank Program, August 2002.

2Med PAC Report to Congress, March 2002.

3Med PAC Reports to Congress, March 1999, 2000, 2001, 2002.

4 Healthcare Financial Management Association, Iowa Chapter, October 2002.

5Med PAC Report to Congress, March 2001.

6 Audited Cost Report Data Files, CMS, 1998–2000.

[The statement follows:]

PREPARED STATEMENT OF J. KIRK NORRIS

Good Morning Mr. Chairman, Ranking member Mr. Harkin and members of the

committee and thank you for providing me an opportunity to speak on the critical

subject of Medicare payment policy.

In various professional positions for the past sixteen years at the Iowa Hospital

Association, it has been my privilege to represent 116 private non-profit and publicly governed community institutions in a variety of legislative, judicial and other

public forums. It is my pleasure to come before you this morning to address the impending healthcare crisis in Iowa that is being driven by payment policy for the

Medicare Program. The premise of my presentation today is that no policy difference

exists between the necessary Medicare payment corrections for physicians and the

necessary payment corrections for hospitals.

In consideration of the time limitations for presenting this morning, I am focusing

on the fact that bad payment policy is just that, bad payment policy, regardless of

the recipient of the policy. In the circumstance at hand, the primary recipients of

this bad policy are the hospitals and physicians of Iowa. Ultimately, the impact of

any payment policy decision in Medicare is borne by Iowa’s 475,000 Medicare beneficiaries. It impacts Iowa seniors every time a hospital is unable to staff a physician

at a rural clinic, when 32 of 36 hospital school nursing graduates choose to leave

the state for better starting salaries and every time a clinic or hospital fails to recruit a needed physician specialist to replace a retiring physician as medical recruits

examine Medicare payments in Iowa and determine that Iowa is not a place they

want to practice when 50 percent of all revenues come from Medicare.1 These issues

are not new or without previous discussion in various Medicare payment policy forums. In fact, the details of these issues have all been discussed in a series of Medicare Payment Advisory Commission Reports to Congress since 1999. I am also

aware that Congress and particularly, the United States Senate, understands these

issues.

Evidence of this fact is found in the fiscal year 2003 omnibus budget bill currently

headed to conference committee. Both the hospital and physician payment corrections inserted in the fiscal year 2003 omnibus bill by Senate Finance Chair Grassley

and supported by Senator Harkin and the rest of the U.S. Senate, are an acknowledgement that these payment policy issues co-exist and need further discussion and

address in the context of the 108th Congress. The Iowa Hospital Association supports Senator Grassley’s and Senator Harkin’s approach to these issues.

Med PAC and the Director of CMS have evaluated the need and called for change

in the methodology for physician payment. Med PAC has also considered the need

for change in the methodology for hospital payment and recognizes its potential for

positive impact in states like Iowa.2 The predominant policy issue affecting hospital

payment in Iowa and other similar states is the wage index. As you know, the wage

index is the major determinant for the amount of payment a hospital receives for

its services. Policy corrections for the wage index are apparent and should be acted

on by Congress. Medicare reform should encompass payment policy reform to assure

that high quality, efficient care is not jeopardized, but rather is rewarded.3

Iowa’s efficient healthcare system,4 which also ranks in the top ten in quality, is

in serious jeopardy of sustaining itself without correction of Medicare payment policy for both physicians and hospitals. Iowa hospitals currently subsidize the Medicare program in excess of eighty million dollars per year.5 This number is growing

and will leap in disproportionate amounts as payment shortfalls mount for skilled

nursing services, home health and outpatient care.6 As with the payment methodology for inpatient care, Congress has moved these other services to fixed payments

and only the time-limited payment safety measures of the Benefits Improvement

and Protection Act are preventing the geometric accumulation of losses for certain

services in specific sizes of hospitals. For other hospitals with the same services, significant losses are mounting. The action of Congress in these other areas reinforces

the need to immediately address policy mistakes in mature payment methodologies

like inpatient care. These payment flaws are apparent and have long been identified, but CMS needs direction from Congress on the appropriate solutions. Other-
53

7 U.S. Bureau of Census.

wise, immediate potential for significant curtailment of access to services for Medicare beneficiaries exists in Iowa and many other states. This potential for seniors

exists at a time when Iowa has the 5th highest percentage of citizens over age 65

and the highest percentage of population over 85 in the country.7 The Iowa Hospital

Association appreciates the additional focus that this subcommittee brings to the

topic of necessary payment corrections in the Medicare fee for service system for the

inter-related services provided by hospitals and physicians. I’m pleased to provide

back-up information for any of the testimony I’ve given today and answer any question related to the same. Thank you for the committee’s time Mr. Chair.

Senator SPECTER. Thank you very much, Mr. Norris, for your testimony, and for yielding back 17 seconds.

STATEMENT OF JAY KLEIMAN, M.D., M.P.A., FELLOW, AMERICAN COLLEGE OF CARDIOLOGY, CLINICAL ASSISTANT PROFESSOR OF

MEDICINE, NORTHWESTERN UNIVERSITY MEDICAL SCHOOL

Senator SPECTER. Our next witness is Dr. Jay Kleiman, M.D.,

M.P.A., clinical assistant professor of medicine at Northwestern

University Medical School, medical director for cardiovascular research and development for Pharmacia Corporation, and a Fellow

at the American College of Cardiology.

He holds a master’s degree in public administration from Harvard University’s Kennedy School of Government, received his M.D.

from the University of Michigan, did his post-graduate medical

training at the University of Chicago, National Institutes of

Health, and Georgetown University, and he has achieved this spectacular resume notwithstanding the disadvantage of being my first

cousin.

He and I are sons of sisters, and I can tell you, he is an extraordinary doctor and an extraordinary man. Dr. Kleiman, we are deducting that introduction from your time.

Thank you for coming, Jay, and the floor is yours.

Dr. KLEIMAN. Thank you, Senator Specter, Senator Harkin,

members of the subcommittee. I am Dr. Jay Kleiman, a cardiovascular specialist, research scientist, and member of the American

College of Cardiology. I am honored to testify today on behalf of the

American College of Cardiology, and on behalf of the Alliance of

Specialty Medicine, an organization representing more than

160,000 specialty care physicians.

Mr. Chairman, members of the subcommittee, we have reached

a critical juncture in the evolution of our health care system. At a

time when life-saving scientific advances are being made in every

area of medical care, basic access to quality care is in jeopardy.

This situation has been precipitated by several factors, one of the

most important of which is cuts in Medicare reimbursement to physicians.

These cuts in reimbursement threaten access to care and access

to quality for our senior citizens, but the impact goes well beyond

Medicare. Most private payers link their fee to the Medicare fee

schedule. When Medicare cuts, so do nearly all forms of reimbursement, yet the costs of running a practice continue to increase faster

than the rate of general inflation. As the Medicare population becomes a larger portion of a practice, the viability of the practice is

itself threatened.
54

As you are aware, last year physicians and other health care professionals received a 5.4 percent across-the-board cut in Medicare

reimbursement. On March 1, a second cut of 4.4 percent is scheduled. The American College of Cardiology and Alliance of Specialty

Medicine greatly appreciate the language passed by the Senate last

week as part of the fiscal year 2003 appropriations bill which will

stave off further cuts for at least 7 months. We hope the House will

act swiftly, before the additional cut takes place on March 1. This

is an important step toward the solution we seek.

You are well aware of the flaws in the Medicare schedule. I will

not reiterate them here, in the interests of time, but even if Congress stops the 4.4 percent decrease from taking effect this year,

steep cuts are in store for 2004–2005. By midway through this decade, Medicare reimbursement could be at 1991 levels and, although

today’s hearing is focused on Medicare reimbursement, it is impossible to separate this issue from the precipitous nationwide increase in medical liability insurance premiums.

Skyrocketing premiums have created a crisis that is evidenced by

reduced access to orthopaedic surgeons, neurosurgeons, and trauma

centers, by the exodus of physicians from Pennsylvania, Mississippi, West Virginia, and Iowa, by increased reliance on already

strained emergency departments.

Steep reductions in Medicare and third-party payments, coupled

with the spiraling cost of medical liability insurance, are coalescing

towards a catastrophe that threatens our health care system. The

ultimate victims of this brewing calamity will be patients.

Many practices are reaching the breaking point. According to a

recent survey of physician practices, more than half will limit the

number of Medicare patients they treat in 2003. Approximately

two-thirds postpone investments in new technology, and two-thirds

will limit practice services or expansion.

For example, in Chicago, a large cardiology practice severely limited hours at a free clinic that counsels patients on managing high

cholesterol and lipids, and at a second clinic that helps patients

manage their blood-thinning Coumadin doses.

In Kansas City, cardiology practice delayed a new program to

treat patients with heart rhythm disorders like the one that afflicted Vice President Cheney last year. Orthopaedic surgery is in

jeopardy in a growing number of States. Fifty-five percent of

orthopaedic surgeons have reduced the scope of operative procedures due to liability exposure, and 39 percent avoid performing

spinal surgery.

Pennsylvania, as you know, has been particularly hard hit. Bedford County’s only orthopaedic surgeon left the State last year, and

Huntingdon County has just one orthopaedic surgeon to take trauma calls at two hospitals. In the case of neurosurgery, an alarming

10 percent of the neurosurgeons in the United States retired in

2001.

There is impact, too, on the pipeline of physicians. Applications

for medical schools have decreased for 6 years running, threatening

the future supply of physicians.

The American College of Cardiology and Alliance of Specialty

Medicine are heartened that short-term relief from further Medicare cuts may be on the horizon, but fixing the flaws in Medicare
55

reimbursement will require an act of Congress. If CMS does not

have the authority to change the payment formula, then only Congress can solve this issue for the long term. The Congress must recognize the unacceptable costs to the health care system if it does

not do so. Above all, quality of care must be protected, and access

to care must be assured for Medicare beneficiaries and for all patients as well.

PREPARED STATEMENT

Mr. Chairman, your leadership in health care is widely recognized within the physician community. I greatly appreciate and

thank you for the opportunity to speak before this subcommittee

today.

[The statement follows:]

PREPARED STATEMENT OF DR. JAY KLEIMAN

Mr. Chairman and members of the subcommittee, I am Jay Kleiman, a cardiovascular specialist from Evanston, Illinois, and a member of the American College

of Cardiology. As a practicing cardiologist for 25 years and now a full-time clinical

research scientist, I am honored to testify today on behalf of the Alliance of Specialty Medicine, an organization of 13 national medical societies representing more

than 160,000 specialty care physicians.

We have reached a very important juncture in the evolution of the U.S. health

care system. At a time when lifesaving scientific advances are being made in nearly

every area of health care, patients are facing a situation in which basic access to

quality health care is in serious jeopardy. This situation has been brought about by

several factors, one of the most important of which we are here to discuss today:

cuts in Medicare reimbursement for physicians.

BACKGROUND

As you are aware, last year, physicians, as well as nonphysician health care professionals, received a 5.4 percent across-the-board cut in their Medicare reimbursement. On March 1, physicians are scheduled to receive an additional 4.4 percent cut.

The American College of Cardiology as well as the Alliance of Specialty Medicine

greatly appreciates the language passed by the Senate last week as part of the fiscal

year 2003 omnibus appropriations bill that would stave off another round of cuts

in physicians’ Medicare reimbursement for at least seven months. It is our hope that

the House will act swiftly and send legislation to the president’s desk before the 4.4

percent cut takes effect on March 1. This is an important step toward the solution

we seek.

The primary cause of these cuts are errors made by Medicare in calculating the

1998 and 1999 expenditure targets, including underestimates of the gross domestic

product and failure to account for the enrollment of one million beneficiaries in

Medicare fee-for-service. The formula used to determine annual physician payment

updates is inappropriately tied to the gross domestic product (GDP). Linking physician payments to the GDP causes volatile swings in payment updates from yearto-year and fails to accurately measure the costs of providing medical services to

Medicare beneficiaries. This formula penalizes physicians when there is a decline

in the nation’s economy, even as Medicare utilization and practice costs continue to

increase. The current formula also ignores the expense of new technology—from

new, cutting-edge devices to electronic medical records—which physician practices

must absorb. Finally, the cost of outpatient drugs has been inappropriately included

in the physician expenditure target.

Even if Congress stops the 4.4 percent cut from taking effect this year, physicians

still face steep cuts in 2004 and 2005. If this does in fact happen, by midway

through this decade, physicians’ Medicare reimbursement will be at 1991 levels.

These reductions in Medicare reimbursement are extremely troublesome because

they threaten access to care and quality of care for our senior citizens. The impact

of these cuts, however, goes well beyond Medicare. Most private payers—including

the large managed care plans—link their fee schedules to the Medicare fee schedule,

as does the military Tricare system. So when Medicare reimbursement is reduced,

so are nearly all other forms of reimbursement.
56

In short, physicians have been experiencing significant decreases in reimbursement from nearly all payers, while the costs of running a practice and caring for

patients continue to increase faster than the rate of general inflation. As the Medicare population becomes a larger portion of the patients a practice serves, the viability of the practice itself is threatened.

Although today’s hearing is focused on Medicare reimbursement, it is impossible

to separate this issue from the precipitous nationwide increase in physicians’ medical liability insurance premiums. Many have rightfully called the medical liability

situation a ‘‘crisis,’’ and its impact has become visible all across the country. This

crisis is evidenced:

—by reduced access to orthopaedic surgeons, neurosurgeons, and trauma centers;

—by the exodus of physicians from states like Pennsylvania, Mississippi, and

West Virginia;

—by increased reliance on already strained emergency departments; and

—in the growing practice of defensive medicine, which drives up the cost of care

and further strains an already fragile health care budget.

Yet this is just the beginning. The expected steep reductions in Medicare and

third-party payer reimbursement over the next several years and the spiraling costs

of medical liability insurance are coalescing toward a ‘‘perfect storm’’ that threatens

to dismantle our health care system.

CONSEQUENCES

This leads me to the most important point of my testimony today. The ultimate

victims of mistakes in the Medicare reimbursement system and a medical liability

system that is out of control are patients. Many practices are reaching the breaking

point. Both quality and access to care now suffer from the combined burden of Medicare miscalculations and the liability crisis.

A worst-case scenario for Medicare patients is developing. It is starting to cost

physicians more to treat Medicare patients than the physician is reimbursed. According to a survey of physician practices released by the Medical Group Management Association last week, for example, more than half of the practices surveyed

will be forced to limit the number of Medicare beneficiaries they treat in 2003.

Sixty-eight percent of respondents said they will postpone investments in new technology and 62 percent said that they would limit expansion of their practice.

Examples of these kinds of alterations in practice abound.

A large cardiology practice in Chicago has had to severely limit hours at two clinics that provided free services to Medicare patients: one clinic counsels patients on

managing lipid disorders such as elevated cholesterol, and the other assists patients

in managing their blood thinning Coumadin doses.

A small cardiology practice in Kansas City, Missouri, recently postponed the

launch of a new program to treat the growing number of patients with heart rhythm

disorders like the one that afflicted Vice President Cheney last year.

Likewise, orthopaedic care is in jeopardy in a growing number of states. A recent

survey by the American Association of Orthopaedic Surgeons found that 55 percent

of orthopaedic surgeons have reduced the range of operative procedures they perform. Thirty-nine percent avoid performing spine surgery and 48 percent limited

other surgical procedures. Pennsylvania has been particularly hard hit. Bedford

County’s only orthopaedic surgeon left the state last year, and Huntingdon County

has just one orthopaedic surgeon to take trauma calls at two hospitals.

In the case of neurosurgery, in 2001 alone, 327 neurosurgeons retired, representing an alarming 10 percent of the neurosurgical workforce in the United

States. This, coupled with the fact that it takes seven years to complete a

neurosurgical residency training program, will create a supply pool that is simply

inadequate to meet the growing aging population and its corresponding health care

needs.

Likewise, the Society of Thoracic Surgeons announced this past summer that the

number of applicants for the 7–8 year postgraduate cardiothoracic surgery residency

programs dropped to only 145 in 2002, and that 21 of the 144 available positions

went unfilled.

This climate has also had a noticeable impact on the pipeline of physicians. Applications for medical school have decreased six years in a row. The best and brightest

are beginning to eschew medical school—which requires 12 years of rigorous schooling and training. The medical trainees I teach each week tell me they will enter

practice with between $75,000 and $200,000 in educational loan debt. Simply put,

the population is aging, baby boomers are approaching Medicare eligibility, and

there are serious questions about whether the supply of physicians will be adequate

to meet the demand.
57

ACTION

The American College of Cardiology and the Alliance of Specialty Medicine are

heartened that short-term relief from further Medicare reimbursement reductions

appears to be on the horizon. But we know that the biggest challenge is yet to come.

It is clear, however, that fixing the flaws in the Medicare reimbursement formula

will require an act of Congress. The Centers for Medicare and Medicaid Services has

steadfastly maintained that it does not have the authority under current law to

make changes to the payment formula. While there is the continuing debate about

the cost of passing legislation to permanently fix the problems with this formula,

the question before Congress right now should not be whether we can afford to address this issue for the longer term, but the cost to the health care system if Congress fails to act?

The answer is clear: quality of care must be protected for all patients. Access to

care must be assured—not just for Medicare beneficiaries, but for all patients.

Mr. Chairman, your leadership in health care is widely recognized within the physician community. I greatly appreciate and thank you for the opportunity to speak

before the subcommittee today. Thank you.

STATEMENT OF ERIC W. BLOMAIN, M.D., PAST PRESIDENT, PENNSYLVANIA PLASTIC SURGEONS SOCIETY

Senator SPECTER. Your timing was perfect, Dr. Kleiman. Our

next witness is Dr. Eric Blomain, past president of the Pennsylvania Plastic Surgeons Society, chief of plastic surgery at Community Medical Center, staff member at Moses, Taylor, and Mercy

Hospitals, all located in Scranton. He received his A.B. from Cornell and his M.D. from Thomas Jefferson University.

Thank you for joining us, Dr. Blomain, and we look forward to

your testimony.

Dr. BLOMAIN. Thank you, Senator. Senator Specter, members of

the committee, and members of the audience, I would like to thank

you for the opportunity to testify before you. I am Eric Blomain,

past president of Pennsylvania Plastic Surgeons Society, and a

practicing plastic surgeon in Northeastern Pennsylvania.

It is with deep humility that I speak on behalf of the patients

and physicians of Northeastern Pennsylvania. I come to express my

opposition to the proposed Medicare cuts, since they will curtail the

care rendered to Medicare recipients. I am not speaking as a Medicare expert, but as a practicing physician observing a failing system.

Medicare is a good institution, but it must be brought into the

21st Century. Medicare reimburses physicians with rules designed

in the mid-1960s. These rules were flawed. Reimbursement differs

from region to region, and is based upon a complex formula which

is supposed to accurately represent costs and the effort in providing

care. A number of assumptions are wrong, causing the process to

be inaccurate.

For instance, it is assumed that the cost of providing medical

care in a low wage or rural area is considerably cheaper than in

an affluent area. Costs in low wage areas can equal or exceed those

in affluent areas. Malpractice costs and other expenses can be

higher in low wage areas, as is evident in my region in northeastern Pennsylvania.

Physician costs continue to escalate. Malpractice insurance, supplies, equipment, wages, rents, management fees continue to increase. Compounding the problem, the Federal Government increases costs by implementing new rules such as compliance guide-
58

lines, HIPAA guidelines, and OSHA regulations. Complying with

these needed and important regulations is expensive.

In Pennsylvania, there is a crisis in the availability of affordable

malpractice insurance. Philadelphia pays out more in malpractice

payments than the entire State of California. In the fifties, a family

physician paid $19 for malpractice insurance. In the sixties, that

same physician paid $49. Here, a typical family physician in Pennsylvania with no malpractice claims may pay in excess of $10,000.

The cost of malpractice insurance in Pennsylvania compared to

other States with documented effective tort reform are considerably

higher for all types of physicians, causing many doctors to leave

the State. The real solution is to implement the system started in

California 25 years ago, which has a proven track record.

Declining reimbursement is a reality. Cardiologists in North- eastern Pennsylvania are paid approximately $164 for cardiac catheterization. Compare this to Roto Rooter charging $150 to fix a

blocked drainage pipe. Cardiologists who do catheterizations are

then charged an additional $10,000 in malpractice.

Medicare cuts greatly affect Pennsylvania physicians, since approximately 17 percent of the population is covered by Medicare.

Additionally, other insurances such as Workman’s Comp, automobile insurance and most managed care plans are linked to the

Medicare fee schedule. Because of this fee linkage, Medicare costs

automatically lower the reimbursement for physicians, involving as

much as 60 percent of the marketplace in Northeastern Pennsylvania.

The declining reimbursement caused by previous Medicare cuts,

the flawed reimbursement formula, and the catastrophic rise in

medical malpractice premiums have created a perfect storm, where

some physicians cannot practice because their expenses exceed

their income. Recently, in Northeastern Pennsylvania more than 40

surgeons faced this dilemma, causing them to make the painful decision to close their practices. This was a devastating blow to our

region, threatening to reduce the availability of care to the community, particularly the elderly, the poor, and the disabled, who find

it difficult to travel to alternative sources of care.

Pennsylvania medical schools turn out numerous specialists.

Last year, only 14 percent of surgical specialists trained in Pennsylvania stayed in Pennsylvania because of the situation of rising

malpractice costs and declining reimbursement. These two adverse

facts create a hostile practice environment and make it impossible

to offer fair and competitive salaries to recruit new graduates,

many of whom are carrying large educational debts.

Recently, a disturbing trend has emerged where some attorneys

and accountants and practice management specialists are advising

physicians to avoid treating Medicare recipients because of low reimbursement. Thankfully, this advice is generally ignored.

PREPARED STATEMENT

In conclusion, the current Medicare reimbursement formulas are

flawed and are hurting low wage areas. The proposed cuts may

cause low wage areas to be unable to attract new physicians, get

adequate support staff, buy new equipment, and make capital improvements. This system will eventually implode, where the quality
59

and availability of care will decrease. The elderly, the poor, and the

disabled will be the first to experience this phenomenon. This phenomenon could spread to other parts of the Nation. I would humbly

ask this committee to prevent further Medicare cuts, revise the

flawed formulas, increase Medicare funding, and to resolve the

medical liability crisis.

Thank you for your concern, and for the privilege of being allowed to address you.

[The statement follows:]

PREPARED STATEMENT OF DR. ERIC W. BLOMAIN

Senator Specter, members of the Committee and members of the audience: I

would like to thank you for the opportunity to testify before you. I am Eric Blomain,

M.D., Past President of the Pennsylvania Plastic Surgical Society and a practicing

plastic surgeon in Northeastern Pennsylvania.

It is with deep humility I speak on behalf of the patients and physicians in Northeastern Pennsylvania. I come to express my opposition to the proposed Medicare

and Medicaid recipients. I am not speaking as a Medicare reimbursement expert

with detailed fact and figures, but as a practicing physician observing a failing system.

Medicare is a good institution, but it must be brought into the 21st Century.

Medicare reimburses physicians with rules designed in the mid 1960’s. These rules

were flawed then and have had severe unforeseen adverse consequences. Reimbursement differs from region to region and is based upon a complex formula which

is supposed to accurately represent the cost of overhead, the cost of malpractice, the

cost of living, the cost of rendering the care and the effort expended in providing

the care. A number of assumptions are wrong, causing the process to be inaccurate.

For instance, it is assumed that the cost of providing Medicare care in a low wage

or rural area is considerably cheaper than in an affluent area. Costs in low wage

areas can equal or exceed those in affluent areas. Malpractice costs can be higher

in low wage areas, as is evident in my region of Northeastern Pennsylvania and it

is frequently not accurately represented in the Medicare reimbursement formula.

The costs of surgical equipment and supplies purchased from national vendors can

be the same or higher because of inability of small practices to get substantial discounts.

Physician costs continue to escalate. Malpractice insurance, supplies, equipment,

wages, rents and management fees continue to increase. Compounding the problem,

the Federal Government increases costs by implementing new rules as a Compliance

Guidelines, Evaluation and Management Guidelines, HIPPA guidelines and new

OSHA regulations. Complying with these needed and important regulations is expensive. Declining reimbursement and rising expenses are beginning to threaten the

ability of many physicians to practice.

In Pennsylvania there is a crisis of availability of affordable malpractice insurance. Philadelphia pays out more in malpractice payments than the entire state of

California. In the 1950’s a family physician paid $19.00 for malpractice insurance.

In the 1960’s $49.00. This year’s typical family physician with no malpractice suits

may be in excess of $10,000. The costs of malpractice insurance in Pennsylvania

compared to other states with documented effective tort reform are considerably

higher for all types of physicians. The real solution is to implement the system

started in California 25 years ago, which has an established and proven rack record

of reducing costs and being fair to all parties.

Declining reimbursement is a reality. Cardiologists in Northeastern Pennsylvania

are paid approximately $164 for a cardiac catheterization. Compare this to Roto

Rooter charging $150 to fix a blocked drain pipe. Cardiologists who do catheterizations are charged an additional $10,000 in malpractice surcharges. The average cardiologist does 75 cardiac catheterizations a year. Forty of these catheterizations are

used to pay for this one single practice expense of malpractice insurance surcharge.

Orthopedic surgeons, neurosurgeons, general surgeons, vascular surgeons, radiologists and most medical and surgical subspecialties have experienced rising malpractice premiums and practice overhead costs with declining reimbursement. Family doctors in the past few years have seen their reimbursement fall, causing them

to see more patients and to spend less time with patients to maintain practice expenses. Some family physicians are beginning to leave the state, particularly in the

under served areas.
60

Medicare cuts greatly affect Pennsylvania physicians, since approximately 17 percent of the population is covered by Medicare. Additionally, other insurances such

as Workmen’s comp, auto insurance and most of the managed surgical care plans

are linked to Medicare fee schedules. Medicare cuts automatically lower reimbursement for physicians involving as much as 60 percent of the market in Northeastern

Pennsylvania.

The declining reimbursement caused by previous Medicare cuts, the flawed reimbursement formula and the catastrophic rise in medical malpractice premiums have

created a ‘‘perfect storm’’ where some physicians cannot practice because their expenses exceed their income. Recently in Northeastern Pennsylvania more than 40

surgeons faced this dilemma. They made the painful decision to close their practices.

This was a devastating blow to our entire region threatening to reduce the availability of care to the community, particularly the elderly, the poor and the disabled,

who found it difficult to travel to alternative sources of care. This catastrophe has

been temporarily averted, but the situation remains critical. Medicare has historically underestimated the impact of malpractice problems and practice costs in Pennsylvania, as is evidenced by testimony of other members of this panel. Because of

all of these problems, the recruitment of physicians has suffered with most surgical

subspecialties reporting problems. Pennsylvania has a number of fine medical

schools which turns out numerous specialists. Last year approximately 14 percent

of the surgical specialists trained in Pennsylvania stayed in Pennsylvania because

of the situation of rising malpractice costs and declining reimbursement. These two

adverse facts create a hostile practice environment and make it impossible to offer

fair and competitive salaries to new graduates, many of whom are carrying large

educational debts. In my home county in Pennsylvania (Lackawanna County) the

number of general surgeons, vascular surgeons and neurosurgeons has declined in

the last five years. New surgeons are not replacing those who die, retire or leave

the area.

Recently a disturbing trend has emerged where some attorneys, accountants and

practice management specialists are advising physicians to avoid treating Medicare

and Medicaid recipients because of the low reimbursement. Thankfully this advice

in general is not heeded in Pennsylvania and throughout the nation.

In conclusion, the current Medicare reimbursement formulas are flawed and are

hurting low wage areas. They must be revised. The proposed 4.4 percent additional

cuts may cause low wage areas to be unable to attract new physicians, get adequate

support staff, buy new equipment and make capital improvements. This system will

eventually implode, where the quality and availability of care will decrease. The elderly, the poor, the disabled and the under served in low wage areas will be the

first to experience this and be further deprived. This phenomenon can spread to

other areas of the nation. I would humbly ask the Committee to prevent further

Medicare cuts, revise the flowed reimbursement formulas so that they would be

more fair, to increase Medicare funding if possible and to resolve the medical liability crisis facing the nation.

Thank you for your concern and for the privilege granted to me to address you.

STATEMENT OF RICHARD E. D’ALBERTO, CHIEF EXECUTIVE OFFICER,

J.C. BLAIR MEMORIAL HOSPITAL

Senator SPECTER. Thank you very much for your testimony, Dr.

Blomain. Our final witness from this panel is Mr. Richard

D’Alberto, president and CEO of J.C. Blair Memorial Hospital in

Huntingdon, Pennsylvania, bachelor’s degree in health services administration from the Russell State College in Troy, New York.

Thank you for joining us today, Mr. D’Alberto. We look forward to

your testimony.

Mr. D’ALBERTO. Good morning, Mr. Chairman, and members of

the subcommittee. I thank you for the opportunity to come before

you today to talk about Medicare.

Let me tell you about J.C. Blair Memorial Hospital first. We are

a 104-bed full-service community hospital. We recently celebrated

our 92nd year. We are located in Huntingdon County. Huntingdon

County is an 800 square mile area with 46,000 population. We are

45 minutes to 1 hour away from any other hospital in all direc-
61

tions, sometimes over treacherous roads and over mountainous terrain.

Our county has the second highest unemployment rate in Pennsylvania, leading to a high number of underinsured and uninsured

individuals, and leads to $1.4 million worth of uncompensated care

at our hospital. In addition, 75 percent of our patients’ revenue is

from Medicare and Medicaid.

Senators, we are it in the County of Huntingdon, Pennsylvania.

I will discuss three major points for your information today.

First, I know it is a popular opinion in Washington for people to

think that hospitals are inefficient. The fact of the matter is, we

have worked over the last 5 years at our hospital to adjust our cost

structure to become one of the most efficient hospitals in Pennsylvania, and yet we continue to lose in operations over $1 million in

each of the last 3 years.

Simply put, our costs have risen significantly faster than reimbursement. Some examples of the costs are recent increases of 10

percent for salaries for RN’s. Our drug budget has doubled in 5

years, from $500,000 to $1 million a year. There are regulatory requirements, disaster planning, malpractice, and medical technology

that often contribute to the rising costs. There are no more areas

for us to cut our costs. The only thing left is to attack some of our

programs.

Second, there have been a number of well-intentioned programs

implemented to assist small and rural hospitals over the past few

years, sole community hospital, Medicare dependency, critical access are some examples. All of these programs have arbitrary cutoffs for qualification. For various reasons we have come very close

to qualifying, and yet we are not qualified.

Like most of our small hospital colleagues in Pennsylvania, we

have the same problems, but with significant more population to

serve than those hospitals that have benefitted from these programs. For us, the life preserver is only at arm’s length. We still

cannot seem to reach it.

Third, the medical malpractice issue. We were able to avoid a

four times increase in our malpractice insurance in the past year

by forming a risk retention group with 31 other hospitals, so for

the time being, the issue for us is not cost, the issue for us is access

to care.

Let me share a story with regard to our pathologists, one of the

finest group of pathologists in the State of Pennsylvania, in practice for 17 years. They were dropped by their insurance carrier at

the end of June, and at the eleventh hour, literally on a Friday

night at 11 p.m., that I heard from them that they were picked up

by the joint underwriters. Without a pathologist, you cannot run a

laboratory, you cannot run an ER. Without a pathologist, you cannot run a laboratory, you cannot do OR surgery. We were on the

verge of closing our hospital unless those pathologists got their insurance, and that occurred less than 1 hour before midnight.

In closing, financial relief for us is what was recently included

in the fiscal year 2003 omnibus appropriations, and that is an increase in the Medicare standard amount to the urban classification

for all hospitals. In addition, a full market basket update, and I
62

emphasize what was said earlier, that there has not been a full

market basket adjustment in the past 13 years.

Our biggest concern is that the Medicare reform package of 2004

will further cut hospitals’ reimbursements in order to pay for other

programs. Senators, please do not cut hospitals again and, in particular, small and rural.

PREPARED STATEMENT

We sincerely appreciate the committee’s concern about the pressures rural hospitals are facing and your willingness to learn more,

and we also thank you, Senator Specter, for your longstanding support for the Medicare program in your hospitals in Pennsylvania.

Thank you.

[The statement follows:]

PREPARED STATEMENT OF RICHARD E. D’ALBERTO

Mr. Chairman and Members of the Subcommittee: I thank you for the opportunity

to come before you today to discuss the Medicare Program. Allow me to first tell

you about my hospital. J.C. Blair Memorial Hospital is a full service community

hospital of 104 beds serving as the only hospital in a county of 46,000 population

spanning 800 square miles. Huntingdon County has the unfortunate distinction of

having the second highest unemployment rate in the state, which has resulted in

the hospital serving a significant number of underinsured and uninsured leading to

$1.4 million worth of bad debt and charity care. Our operating revenue of $28 million consists of 75 percent Medicare and Medicaid. The remainder is from Blue

Cross, HMOs, PPOs and approximately $1.4 million self pay. Since the full impact

of the Balanced Budget Act of 1997, J.C. Blair has suffered deficits of $1.4 million

in 2000, $1.5 million in 2001, $1.7 million in 2002, and we are heading for another

sizable loss in this fiscal year. Medicare reimbursement has simply not kept up with

the continuing cost of providing service to our community.

Over the last 5 years we have adjusted our cost structure and become one of the

most efficient hospitals in Pennsylvania. We are managed by Quorum Health Resources. As a result, we consistently compare our operating indicators to several like

hospitals in Pennsylvania and across the country. Let me share some of those indicators with you.

Indicator Standard J.C. Blair

Man hours per adjusted admission ........................................................................................... 90 84

Full Time Equivalents per Adjusted Occupied Bed .................................................................... 4.6 3.2

Supply Expense as a percent of Net Revenue ........................................................................... 16.5 16.1

Salaries as a percent of Net Revenue 1 ..................................................................................... 40 43

1 This number is higher because we have to pay competitive wages while our reimbursement is shrinking.

There have been a number of other cost drivers contributing to this situation:

—Shortages of nurses and other key personnel have driven up our salary costs—

10 percent for RN’s alone this past year.

—Our drug budget in 1996 was $500,000. This year it is $1,000,000

—Blood and blood products increased in price 50 percent this past year.

—Regulatory burdens such as HIPAA, EMTALA, and compliance have increased

our costs of doing business.

—Disaster planning and smallpox vaccination will cost us tens of thousands more

over the next year.

—The rising cost of malpractice insurance is crippling us in many ways. We escaped a four times increase by joining a captive.

—New medical technology, if we ever have a positive operating margin, will continue to drain our capital reserves.

Over the past several years there have been specific programs implemented to assist small and rural hospitals with their financial crisis in managing the Medicare

population. Some of them are: Sole Community Hospital status, Medicare Dependency status, and Critical Access Hospital status. All of these programs have arbitrary cut-offs for qualification. These programs have been designed to give relief to

some small and rural hospitals, but many, like ours, ‘‘fall through the cracks.’’ We
63

have tested our qualification for all of them and we fall short in every case, yet we

are a small and rural hospital like many others across the mid-west and west that

have benefited. We, like most of our small hospital colleagues in Pennsylvania, have

the same problems, but with significantly more population to serve. Pennsylvania

has the third highest rural population and second highest elderly population—this

translates into small, rural hospitals that need to be larger to effectively serve their

communities than the cut-offs that have been established for the rural relief programs, but are no less vital to their communities and no less in need of financial

relief than their smaller counterparts in other states.

Probably the most significant inequity is the Medicare Wage Index Factor, which

is .84 for J.C. Blair Memorial Hospital. In order to remain competitive regarding

wages we must pay the same or more for professional staff as the urban areas.

Equalizing our rate with other areas would bring us at least an additional $600,000

of Medicare reimbursement next year.

Just yesterday morning, I had to recommend to the hospital’s Finance Committee

that we begin serious deliberations regarding the elimination of basic and vital services. We are at the point where we have no other choice. Decreasing these vital services would result in many of our patients in most need traveling 35 or more miles

away, with mountainous terrain in all directions and treacherous roads during the

winter months, to receive care. We also have no public transportation system.

Over the years we have formed very successful relationships with other providers

in our region to keep many specialty services in our service area. Those relationships will be seriously jeopardized.

In my mind we are a ‘‘Sole Community Provider’’ and our county would be devastated if we provide any less than full service to our community. The following statistics show that we are a vital service to this community:

—380 deliveries per year 18,500 patient days per year of which 11,000 are Medicare days and 2681 are Medicaid days

—4,100 admissions per year of which 1,850 are Medicare and 750 are Medicaid

—93,000 out patient visits per year

—13,800 emergency department visits per year

We are asking Congress to reverse the cuts that went into effect on October 1,

2002, expand upon rural hospital provisions, provide more flexibility in qualifying

for special designations, equalize the Wage Index across the board, lessen the regulatory burdens, and provide full market basket updates that accurately reflect the

current cost pressures hospitals are facing.

We sincerely appreciate the Committee’s concern about the pressures rural hospitals are facing, and your willingness to learn more. We also thank you, Senator

Specter, for your longstanding support of the Medicare Program and your hospitals

in Pennsylvania. One size does not fit all. Please do what you can to keep more of

us from ‘‘falling through the cracks.’’

Senator SPECTER. Thank you very much, Mr. D’Alberto.

The testimony has been very, very impressive, and especially

since we have had a partially captive audience in Mr. Scully.

In light of the time, I am not going to ask for any oral responses,

but I would ask two questions. Mr. Anderson raised the issue of

more problems caused by the Balanced Budget Act, and I would appreciate it if you gentlemen would respond in writing to what

changes you think ought to be made in that act. We would like to

have your inputs as to what ought to be done.

The other question which I would like in writing, to save time,

relates to whether the Federal restriction on hospitals covering doctors who practice at the hospitals—Mr. Scully, will you confirm

that under existing regulations—what are the regulations with respect to hospitals including doctors who practice there in their malpractice coverage?

Well, I believe the answer to that is that hospitals are precluded

at the present time from covering doctors who practice there. I am

not sure about the employee status, or those that just have practicing rights. If a change were made in the Federal restrictions it

would lower malpractice rates for the doctors who would be in a

pool basis. It would not impose—I am not suggesting imposing an
64

obligation on the hospitals to cover the doctors, but I am suggesting

a change which would eliminate the prohibition against hospitals

covering the doctors.

In conversations I have had informally, I have had a negative response from hospitals on the ground that if the prohibition is removed there would be pressure to include the doctors, but in light

of the very severe problems on medical malpractice, I would like

your answers in writing.

I wish we had time to do a great deal more. This is already an

exceptionally long hearing for this subcommittee, and now I am

going to yield to my colleague, Senator Harkin.

Senator HARKIN. Well, again, thank you, Mr. Chairman, for holding this hearing and bringing all of these very intelligent and wellinformed witnesses before us, and I have appreciated it. I did not

hear all of the testimony. I have been sitting here reading them

and catching up, but it is vital to our deliberations, what we are

going to be doing here.

Again, I just—you will excuse me if I want to just get back to

the idea of the Medicare reimbursements to our providers, to our

hospitals. You have heard a lot of talk today about the wage index,

and how that wage index works and everything. I just ask Kirk

Norris from Iowa, who I know very well, if you would just sort of—

specifically, what is the payment flaw in the wage index, and can

you give us some idea of how you think Congress ought to correct

it?

Mr. NORRIS. Specifically, the flaw in the wage index is the portion which is attributed to labor, which are your salaries and benefits costs. For hospitals in Iowa, salaries and benefits account for

50 percent of all of their expenses.

The wage index has a proxy that says 71 percent of hospital expenses are salaries and benefits. That discriminates against States

like Iowa, where you have lower wage expenses. That does not necessarily—as I think Mr. Scully indicated, that was an issue that

was addressed, we thought wrongly, in the proposed rules last

year, and he did as well, by taking that percentage upward.

We would say it needs to go downward, but to move it downward, Congress would have to provide money so that there was not

a reallocation of dollars within that framework, because once you—

for example, if the policy was—let us say the sound policy is to attribute that percentage to what actually are the salary and benefits

expenses in that particular region, or State. That is good policy.

To do that, if you did it today in a budget-neutral context, you

are going to reallocate money between hospitals, which is a problem, at least, it is a problem politically. So what Congress would

need to do is get the policy changed so that States like Iowa were

no longer discriminated against, and that is a rule that Mr. Scully

can promulgate. The money would have to be there to fund that

differential, because there would be additional moneys that would

have to go to those low wage States.

Senator HARKIN. So the Medicare reimbursement rate based on

71 percent of these costs you say is wrong, and we have good data

in our State that can show that it is really 50 percent rather

than——

Mr. NORRIS. We have excellent data. CMS has excellent data.
65

Senator HARKIN. CMS has that data?

Mr. NORRIS. Yes. We do as well.

Senator HARKIN. I guess my question, Mr Scully, if I might just

ask you, why would not CMS then just look at each State and say,

rather than 71 percent, if it is 50 percent in Iowa, then use that

as a factor, or if it is—what is it in Pennsylvania? Does anyone

know what it is in Pennsylvania?

Mr. SCULLY. It is around 72 percent, pretty close to the national

average, almost 72 percent.

Senator HARKIN. In Pennsylvania. But Iowa seems to be much

lower than that, so why can we just not take each State separately

and say, okay, if that is what the proportion is of your costs, then

that is what we are going to reimburse on?

Mr. SCULLY. Do you want me to answer?

Senator HARKIN. Yes, please, Mr. Scully, if you could.

Mr. SCULLY. I would just say that something that we have looked

at, as Kirk mentioned. The traditional way we have measured this,

it was supposed to go up from 71 to 72 percent last year. The Secretary decided to freeze it at 71 percent, and we looked at doing

exactly what you describe. The issue is, it would cause very big redistributions, for example, out of Pennsylvania and into Iowa, out

of New York and into Kansas.

Senator HARKIN. But if it is honest, I mean, if our proportion is

only 50 percent, why are we getting penalized by having it put at

71 percent?

Mr. SCULLY. Well, we have looked at that and discussed it at

great length with the AHA and others. It has always been a national blended rate, going backwards 30 years, where we took the

national average of what wages are. In some States, wages are 80

percent of costs, in some States—Iowa I believe may be the lowest—it is in the low 50s as a percentage of the real costs, and there

are many, many variations of how to do it, county by county, MSA

by MSA, State-by-State, and we would be happy to look at all of

them, but as he accurately mentioned, it causes fairly significant

redistributions, and not always—sometimes it is actually out of

rural areas.

It is very specific to each State and each county. Actually, in

some cases, rural hospitals actually lose. As a general matter,

urbans generally lose and rurals win, but it is not always the case.

I have looked at it a lot, and it has hugely different impacts around

the country, but we are certainly happy to get into the weeds with

you if you like and go through it.

Senator HARKIN. It was Dr. Blomain, I think—I think it was,

that testified about how—maybe it was you. I have heard so much

testimony here—about how hospitals in small and rural areas actually pay higher costs. I forget who it was that was talking about

that.

Dr. BLOMAIN. Yes.

Senator HARKIN. Because they cannot buy in volume, but sometimes they have to actually pay higher wages to get someone to

come to a rural area because, let us face it, they maybe do not

want to go there, so to entice them there they have to actually pay

more than what they would pay in an urban area.

Dr. BLOMAIN. That is true, Senator.
66

Senator HARKIN. That is why this thing has got to be—we have

got to address this, because it is hurting rural areas I am sure in

Pennsylvania, as well as it is in Iowa.

Now, God bless Philadelphia and Pittsburgh, but how about the

rural areas of Pennsylvania and other States out there that are

getting hurt by this, that is my only point, is that we have got to

make some changes in this thing.

Well, my time is up. Thank you very much, Mr. Chairman.

Senator SPECTER. Thank you, Senator Harkin.

Thank you very, very much, gentlemen. I think it has been very

informative, and I predict it will have an impact. Thank you.

STATEMENT OF RICHARD F. POPS, CHIEF EXECUTIVE OFFICER,

ALKERMES, INC.

Senator SPECTER. Our final panel, finally, is Mr. Richard Pops

and Thomas Scully. Mr. Pops is the chief executive officer of

Alkermes, Inc., located in Cambridge, Massachusetts, and he is on

the board of directors of Biotechnology Industry Organization.

The issue which we are taking up here involves the newly created concept of functional equivalence. Under this standard, different drugs and biologicals could be reimbursed based on the lowest applicable rate if CMS chooses to designate them as functional

equivalents. This modifies the heretofore traditional practice of

CMS utilizing the pass-through payments.

Thank you very much for joining us, gentlemen. I hope the differences between the witnesses are not as extreme as the distances

between the chairs, and we will start with you, Mr. Pops.

Mr. POPS. Thank you very much. It is a pleasure to be here, and

thanks for allowing us to address this committee.

As you said, I am the CEO of a biotechnology company called

Alkermes. I am also the vice chairman of BIO, and BIO, as you

may know, is the largest trade organization in the world for biotechnology companies, and it represents over 1,000 biotechnology

companies.

Senator SPECTER. Pull the microphone up, Mr. Pops.

Mr. POPS. Can you hear better now?

Senator SPECTER. Yes. Go ahead.

Mr. POPS. I was saying that BIO represents about 1,000 biotechnology companies, academic institutions, and state biotechnology centers and, as such, it spans 50 States and actually

across the globe, so I am here both as the CEO of Alkermes and

as a representative of BIO.

It is interesting, our company, like most of these biotechnology

companies, is dedicated to developing important new drugs, and

this is, as some would say, an inherently optimistic strategy for a

couple of reasons; number one, how long it takes to do so, generally

measured on the order of 10 plus years to develop a new medicine,

and also the cost. In the 12 years that I have been the CEO of

Alkermes, we have raised now just on the threshold of $1 billion,

and we are not alone in this process.

Senator SPECTER. You say $1 billion for what?

Mr. POPS. $1 billion that we have raised from investors in order

to fund the expensive R&D and prior development that we do to
67

develop our first drugs, so it is a daunting economic prospect, and

some would say——

Senator SPECTER. So you are saying that it takes $1 billion to develop a new drug?

Mr. POPS. I think the data from Tufts and other places show that a new drug costs on the order of $200 to $400 million to develop,

and about 5 to 10 years.

Senator SPECTER. What was the $1 billion figure?

Mr. POPS. That is what we spent to build our company, build our

buildings, build our manufacturing plants, pay our employees, and

stay in business for the last 12 years.

Senator SPECTER. Okay.

Mr. POPS. These companies are fueled essentially by two things.

Number one is by a culture within these companies which is based

on a strong intellectual commitment to developing new drugs based

on new science, applying new science to develop drugs that the

large pharmaceutical companies either choose not to develop because they are for orphan indications, or indications they are not

particularly economically interested in, or they do not have the

technology to do, because we tend to employ the youngest, brightest, cutting edge technologies that are available in the medical

sciences.

The second thing that fuels these companies is capital, as we

were just saying, tremendous amounts of capital, and that capital

is raised from venture capitalists and also from the public equity

markets. We have done both. We have been a public company for

about 11 years now, and most of our money is raised through the

public equity markets.

So for this reason you can think of the biotech industry as essentially being almost an early warning alarm for policies or legislation that has the impact or the potential impact of restricting the

flow of new medicines into the marketplace. Faced with the prospect of reduced access to important medicines, our investors very

quickly shift funds into other sectors, and your investment dollars—without the investment dollars, the expected outcome occurs.

So today’s hearing essentially addresses, as you said in the preamble, one of these potential situations. On January 1, a new and

what we think is a flawed payment scheme went into effect for

medicines covered under Medicare’s hospital outpatient prospective

payment system, or OPPS. This covers innovative medicines used

in hospital outpatient centers such as cancer chemotherapies, kidney failure drugs, and medicines for autoimmune diseases. Often,

many of these drugs are developed by biotechnology companies.

Senator SPECTER. Mr. Pops, your voice drops off when you move

away from the microphone. Would you please speak into the microphone?

Mr. POPS. I will try to do that.

Senator SPECTER. We are missing a fair amount of what you are

saying.

Mr. POPS. All right. Can you hear now?

Senator SPECTER. Yes.

Mr. POPS. Okay. These are critical medicines for the Nation’s

senior citizens and the disabled population, who are covered under

Medicare. Unfortunately, CMS has now slashed the reimbursement
68

by an average of about 35 percent to below what the drugs cost

hospitals, and has introduced a series of precedents that we do not

think should be allowed to stand, such as arbitrarily deciding that

drugs known as radiopharmaceuticals are not drugs, choosing to

exclude only four orphan drugs from the OPPS, and creating out

of whole cloth the concept of functional equivalence.

Let me start by sharing with you just a simple data that show

the OPPS methodology.

Senator SPECTER. How do you define a functional equivalent, Mr.

Pops?

Mr. POPS. Well, I think it is essentially an arbitrary standard,

and that is the problem. Beauty is in the eye of the beholder, so

at the moment, it is currently limited to two particular drugs, but

our concern is that it may be expanded to interpretations of functional equivalence between all kinds of different classes of drugs,

and therein lies the risk, because for us to develop medicines over

a decade and several hundred million dollars and then, post hoc,

to have it determined to be functionally equivalent by some type

of a bureaucratic determination is inherently not in the best interest of the public health, and also I think it will have the unintended effect of stopping this innovation from occurring.

Senator SPECTER. How does this definition compare with the socalled pass-through payments?

Mr. POPS. Well, the pass-through payments, and I am far from

an expert on these specific issues, but generally the pass-through

payments were put in place by Congress to allow certain drugs like

chemotherapy and radiopharmaceuticals and orphan drugs to bypass this process of arbitrarily determining their price and allowing

them to flow into the community and to allow patients access to

these drugs on a more unimpeded basis.

What has happened now is that these drugs are being folded

back into this method that I can describe, and that the chart describes to some extent, showing how these relatively expensive

drugs, these innovative drugs for smaller patient populations often

get affected in the same way that a common aspirin would be affected in the way it is reimbursed.

If you want to look at the chart, it will show you that to reflect

overhead costs—and this is in your package as well—the hospital

may charge $10 for a 10-cent aspirin, an increase of 10,000 percent,

while charging $1,000 for an $800 biological, or biotech product, an

increase of only 25 percent.

In 2001, the average hospital pharmacy cost-to-charge ratio was

about .3. In the end, according to CMS, the aspirin would end up

costing $3, and the biological would end up costing $300. This is

a dramatic underreimbursement, and it provides a clear incentive,

we feel, for hospitals to stop providing higher cost, innovative drugs

and biologicals in their outpatient departments. Unless CMS recalculates OPPS rates for these products, we fear that patients will

be denied access to these types of medicines, so that is one important issue that we are worried about.

Second, we believe that the agency’s arbitrary determination that

FDA-approved radiopharmaceutical products are not drugs or

biologicals and therefore not eligible for pass-through status con-
69

tradicts the clear intention of Congress to protect Medicare patients’ access to these types of drugs.

Third, CMS decided to reimburse only four orphan drugs at actual hospital cost, leaving dozens of other products for orphan conditions inadequately reimbursed.

Fourth, in the final rule establishing hospital outpatient department rates for 2003, CMS completed this entirely new concept of

functional equivalence in order to avoid covering a new drug under

the traditional pass-through payment system, so we are troubled

by that as well.

In part, we are troubled by the disregard in our view of due process. CMS implemented this new functional equivalent standard

without any mention of it at all within the proposed rule, and interested parties like BIO and my company and others had no notice

and no opportunity to voice our opposition to that standard.

Second, we believe that the functional equivalent standard is bad

policy in a country that values medical innovation. Manufacturers

simply will not devote years of clinical development and hundreds

of millions of dollars of research toward improving current therapies or developing brand new therapies if that at the end of the day

could be seen as, quote-unquote, functionally equivalent to another

product, and I think that has real potential ramifications for patients.

Finally, we believe that this functionally equivalent standard will

harm Medicare beneficiaries’ access to advanced new therapies. Advancements such as less frequent dosing, fewer side effects, recombinant DNA production methods, or more convenient modes of administration often improve safety and in many cases increase compliance and tolerance of these medications for patients, and therefore they increase the odds that the therapy will succeed.

My company’s products, for example, are heavily oriented towards this notion. For example, we have a drug that we are developing that replaces the need for schizophrenic patients to take

their oral medication every day. It replaces that with a single injection that lasts 2 weeks, so the patient, the caregiver, the families

do not have to worry about compliance, because these medications

often are only as good as the compliance regimen that supports

them.

PREPARED STATEMENT

So because the exact benefits of our advances vary patient by patient, we really firmly believe that the physicians, not CMS, should

determine on a patient-by-patient basis whether one drug is a suitable substitute for another one.

So I will stop there. We really appreciate the opportunity to address you, and I would be happy to answer any questions.

[The statement follows:]

PREPARED STATEMENT OF RICHARD F. POPS

The Biotechnology Industry Organization (‘‘BIO’’) sincerely appreciates this opportunity to express our deep concerns about the Medicare hospital outpatient department prospective payment system (‘‘OPPS’’) and 2003 payment rates. My name is

Richard Pops, and I am the CEO of Alkermes, Inc. and Vice-Chairman of the Board

of BIO. My company is a leader in the development of products based on sophisticated drug delivery technologies and a member of BIO. BIO is the largest trade or-
70

1 67 Fed. Reg. 66718, 66757–59 (Nov. 1, 2002).

ganization to serve and represent the biotechnology industry in the United States

and around the globe. BIO represents more than 1,000 biotechnology companies,

academic institutions, state biotechnology centers, and related organizations in all

50 states. BIO members are involved in the research and development of healthcare, agricultural, industrial and environmental biotechnology products.

Representing an industry that is devoted to discovering new cures and ensuring

patient access to them, BIO consistently has expressed concerns that the OPPS

could create substantial access and quality of care issues for Medicare beneficiaries.

Our concerns fall into four categories:

1. CMS’ creation of a new ‘‘functionally equivalent’’ standard;

2. The agency’s determination that FDA-approved radiopharmaceuticals are not

drugs or biologicals and therefore are not eligible for pass-through status;

3. CMS’ decision to exclude only four orphan drugs from the OPPS, leaving dozens

of other products for orphan conditions inadequately reimbursed; and

4. CMS’ use of a fundamentally flawed rate-setting methodology for higher cost

drug and biological therapies.

CMS’ NEW ‘‘FUNCTIONALLY EQUIVALENT’’ STANDARD

CMS has for the first time in the final rule developed the concept of ‘‘functional

equivalence’’ in making payment determinations for erythropoietic products.1 The

use of the term ‘‘functionally equivalent’’ as a concept raises numerous concerns for

our industry. Had BIO been notified of the use of such a standard, we would have

presented our comments and vigorous objections. A practice that allows CMS to arbitrarily set standards such as ‘‘functionally equivalent’’ creates uncertainty in the

industry. In addition, it has substantial legal implications and, as a policy matter,

clearly discourages innovation—the foundation of the biotechnology industry. The

decision to remove pass-through payments for a new drug also is beyond the scope

of authority granted to CMS under the statute. At a minimum, it is inappropriate

for CMS to impose this dramatic departure from prior policy for the first time in

a final rule without notice and, therefore, without the opportunity for the public to

respond. BIO fears that the application of CMS’ new ‘‘functionally equivalent’’

standard will deny patients access to innovative therapies on the horizon that offer

them fewer side effects, more convenient dosing and modes of administration, and

even new hope for survival.

BIO’s first concern is CMS’ clear failure to heed the Administrative Procedure

Act’s (‘‘APA’’) requirements for rulemaking. CMS implemented its new ‘‘functionally

equivalent’’ standard without any mention whatsoever in the proposed rule. Interested parties, such as BIO, had no notice and opportunity to comment on this deeply

troubling new policy. Had it been discussed in the proposed rule, we would have

vigorously voiced our opposition. CMS’ implementation of this brand new standard

in the final rule sets a dangerous precedent and makes a mockery of the notice and

comment process.

Second, BIO fears that this new ‘‘functionally equivalent’’ standard will harm the

future development of new drugs and biologicals by creating uncertainty in the industry. Without the assurance of adequate payment rates, innovation—the foundation of the biotechnology industry—will be stifled. CMS has sent the message that

even if a company develops an improved drug and even if the improvement saves

money elsewhere in the healthcare system, the drug nonetheless may be reimbursed

based on the agency’s calculation of a comparable dose of another drug. Changing

the rules after a company has invested hundreds of millions of dollars in a new

product will make the next company think twice about making a similar investment. Manufacturers simply will not devote precious resources toward improving

current therapies or in developing new therapies that could be seen as ‘‘functionally

equivalent’’ to another product. This will have unfortunate long-term ramifications

for all patients who truly could benefit from improvements to existing therapies.

Finally, and most important, we believe that the ‘‘functionally equivalent’’ standard will harm Medicare beneficiaries’ access to advanced, new therapies. In creating

this standard, CMS ignores the incremental nature of many pharmaceutical and biological developments. Many advancements in drugs and biologicals improve existing therapies, rather than create entirely new treatments. Existing therapies have

been improved to require less frequent dosing, cause fewer side effects, offer recombinant versions, or more convenient modes of administration. Advancements such

as these often increase compliance and allow patients to tolerate the most effective

treatment available, especially when patients are elderly or live in rural areas without convenient access to hospital outpatient departments. For example, therapies
71

2 67 Fed. Reg. at 66757.

3 Id.

4 5 U.S.C. § 553.

5 42 U.S.C. § 1395l(t)(6)(A)(iii).

with fewer side effects increase the probability that patients can tolerate the full

dosage of chemotherapeutic regimens. Cures and longer remissions are more likely

as a result of this increased compliance. Likewise, the development of a recombinant

version of a drug may make it safer and enable more patients to tolerate it.

Moreover, a drug or biological that is only incrementally beneficial to one patient

could be significantly beneficial to another. This is why physicians should be the

only ones to make the decision of whether one drug is a suitable substitute for another. This point was raised in President Bush’s State of the Union Address when

he said, ‘‘Instead of bureaucrats . . ., we must put doctors and nurses and patients

back in charge of American medicine.’’ This determination should only be made on

an individual patient basis, rather than for the entire Medicare population.

Medicine is constantly evolving. When a new drug or biological is approved, it

often is difficult to predict who will benefit from it and how it should most effectively be therapeutically utilized. This is precisely why Congress created the transitional pass-through system. Through this system, CMS can collect data on new

therapies as clinical experts actually use them for a few years before establishing

payment rates. Unfortunately, darboepoetin alfa and any other new drug to which

CMS decides to apply its ‘‘functionally equivalent’’ standard will be illegally deprived of this critical data collection period.

Congress already has attempted to protect Medicare beneficiaries’ access to modern therapies. Now we ask that you ensure that CMS adheres to those statutory

protections and abolish the agency’s ‘‘functionally equivalent’’ standard immediately.

CMS’ FAILURE TO RECOGNIZE RADIOPHARMACEUTICALS AS DRUGS OR BIOLOGICALS FOR

PURPOSES OF PASS-THROUGH STATUS

In addition to the new ‘‘functionally equivalent’’ standard, CMS announced a new

policy in the final rule regarding diagnostic and therapeutic radiopharmaceuticals.

In a decision that prevents current, as well as future FDA approved radiopharmaceuticals, from qualifying for pass-through payments, CMS also has determined for

the first time in the final rule that diagnostic or therapeutic radiopharmaceuticals

are not ‘‘drugs’’ or ‘‘biologicals.’’ 2 Specifically, the agency stated that Zevalin—, that

has been approved by the FDA as a biological and is listed as such in the USPDI,

is not a drug or biological for purposes of Medicare.3 Accordingly, this therapy—as

well as other radiopharmaceuticals in the future—no longer will be eligible for passthrough payments, even though Congress clearly intended to include them in this

system. CMS’ redefinition of these longstanding terms is outrageous and clearly contradicts the statute as well as FDA policy. This substantial change in reimbursement policy for radiopharmaceuticals also was not mentioned at all in the proposed

rule. Once again, CMS has blatantly ignored the notice and comment rulemaking

requirements of the APA.4 BIO asks Congress to work with us to reverse this troubling policy and continue pass-through payments for new radiopharmaceuticals as

Congress intended, ensuring patient access to these important therapies.

Section 1833(t)(6)(A)(iv) of the Social Security Act (‘‘SSA’’) establishes passthrough payments for new medical devices, drugs, and biologicals for which payment as a outpatient hospital service was not being made as of December 31, 1996,

and for which cost is not insignificant in relation to the outpatient department fee

schedule amount. In addition to current orphan and cancer therapy drugs and

biologicals, the statute also specifies that pass-through payments would be made for

‘‘current radiopharmaceutical drugs and biological products,’’ defined as a ‘‘radiopharmaceutical drug or biological product used in diagnostic, monitoring, and therapeutic nuclear medicine procedures.’’ 5 Obviously, Congress considered radiopharmaceuticals to be ‘‘drug or biological products’’ and intended patient access to them to

be protected through the transitional pass-through system. It is inconceivable that

Congress meant to exclude these therapies from the definition of drugs and

biologicals under section 1833(t)(6)(A)(iv) of the SSA, and no theory of statutory construction would support CMS’ interpretation on this point.

The treatment of radiopharmaceuticals as ‘‘drugs or biologicals’’ also is consistent

with other provisions of the SSA as well as longstanding CMS policy. Section

1861(t)(1) of the SSA defines the terms ‘‘drugs’’ and ‘‘biologicals’’ for Medicare purposes to include only such drugs or biologicals as are included (or approved for inclusion) in the United States Pharmacopoeia, the National Formulary, or the United

States Homeopathic Pharmacopoeia, or in New Drugs or Accepted Dental Remedies,
72

6Medicare Intermediary Manual, Part 3 (CMS-Pub. 13–3), Transmittal No. 1717, July 1, 1997.

7 67 Fed. Reg. 52092, 52119 (Aug. 9, 2002).

8http://www.idecpharm.com/site/science/zevalin.htm

9 67 Fed. Reg. at 66772.

10 67 Fed. Reg. at 52124. 11 Id.

or as are approved by a hospital pharmacy and drug therapeutics committee (or

equivalent committee). Historically, CMS has considered a product approved by the

FDA as a drug or biologic and that is included or approved for inclusion in one of

the listed compendia to be a ‘‘drug’’ or ‘‘biological’’ for Medicare purposes. In July

1997, the Health Care Financing Administration issued a transmittal that instructed hospitals to use revenue code 636—drugs requiring detailed coding—for

radiopharmaceuticals.6 Clearly, the agency has characterized radiopharmaceuticals

as drugs in the past and should not be permitted to arbitrarily change that classification now.

In any event, such a dramatic departure from the plain language of the statute

as well as CMS policy should not have occurred for the first time in a final rule.

Section 553(b)(3) of the APA requires an agency proposing a new rule to include in

the notice of proposed rulemaking ‘‘either the terms or the substance of the proposed

rule or a description of the subjects and issues involved.’’ CMS gave no indication

in its proposed rule that it intended to reclassify radiopharmaceuticals. In fact, the

proposed rule indicates that CMS fully intended to continue pass-through payments

for both Y–90 Zevalin and IN111–Zevalin in calendar year 2003 by publishing anticipated pass-through payments for 2003.7 Because CMS published rates for

Zevalin . . ., it is incomprehensible that interested parties could have concluded

that CMS intended to reclassify radiopharmaceuticals and discontinue the existing

policy of providing pass-through payments for them.

Zevalin became the first radioimmunotherapy approved by the FDA in February

of 2002. It consists of monoclonal antibodies that are chemically bonded with a

radionuclide. Manufacturers increasingly are using biological agents such as

monoclonal antibodies, which are disease-fighting proteins that seek out and bind

with specific tissues or cells. Radioimmunotherapies are made by linking monoclonal

antibodies—engineered in a laboratory to recognize and attach to substances on the

surface of certain cells—to radioactive isotopes. When the drug is administered to

the patient through infusion, ‘‘radiation-carrying antibodies circulate in the body

until they locate and bind to the surface of specific cells, and then deliver their

cytotoxic radiation directly to malignant cells.’’ 8

Radioimmunotherapies provide new hope for patients battling cancer. It is essential that these radiopharmaceuticals be treated as what they are and always have

been—drugs and biologicals. Congress clearly intended for Medicare beneficiaries to

continue to have access to these important radiopharmaceuticals by including them

in the pass-through system. Congress now must ensure that therapies approved by

the FDA as ‘‘drugs’’ and ‘‘biologicals’’ and listed as such in the USPDI as drugs and

biologicals are eligible for pass-through payments. Not only is this treatment consistent with the plain language and intent of the statute, but it also protects patient

access to these critical medicines.

EXCLUSION OF ALL ORPHAN DRUGS USED FOR ORPHAN INDICATIONS

BIO applauds CMS for recognizing that certain orphan drugs are generally expensive and, by definition, rarely used, and as a result, should not be included in the

OPPS.9 Rather than carving out all drugs and biologicals designated by the FDA

as orphan and used for their orphan indications, however, CMS instead has decided

to exclude only those that the current USPDI shows have neither an approved use

for other than an orphan condition nor an off-label use for conditions other than the

orphan condition. As a result, only four orphan products are excluded. The agency’s

approach fails to do what is necessary to ensure that patients suffering from rare

diseases continue to have access to the treatments they need. Instead, BIO believes

that all drugs and biologicals designated as orphan by the FDA and used for their

orphan indications should be excluded from the OPPS.

In the August 9, 2002, proposed rule, CMS created two categories of ‘‘orphan

drugs:’’ orphan drugs used solely for orphan conditions and orphan drugs that are

used for other conditions. CMS ‘‘recognize [d] that orphan drugs that are used solely

for an orphan indication or conditions are generally expensive, and by definition, are

rarely used.’’ 10 Rather than packaging the costs of these drugs into procedure APCs,

which might not be sufficient to compensate a hospital for the costs of the drug,

CMS proposed to ‘‘establish separate APCs to pay for those orphan drugs that are

used solely for orphan conditions.’’ 11 Payment for all other orphan drugs would be
73

12 Id. 13 Id. 14Medicare Program Memorandum to Intermediaries, Transmittal No. A–02–129, January 3,

2003. 15 67 Fed. Reg. at 66772. 16 Id. 17 Id. 18 Id.

packaged into the procedure or service for which the drug is integral and directly

related, unless they were considered to be ‘‘higher cost drugs.’’

CMS proposed new criteria for identifying orphan drugs that would be paid separately under the OPPS. First, the drug must be ‘‘designated as an orphan drug by

FDA and approved by FDA for the orphan indication.’’ Second, the entry for the

drug in the USPDI must show that the drug has neither an approved use nor an

off-label use for a condition other than the orphan condition.12 Thus, separate payment would be provided only for orphan drugs that are used only by patients suffering from rare diseases. Using these criteria, CMS identified only three orphan

drugs that are eligible for separate payment under the OPPS: alglucerase injection

(J0205), alpha 1 proteinase inhibitor (J0256), and gemtuzumab ozogamicin

(J9300).13 In a recent program memorandum, CMS added injection imiglucerase

(J1785) to this carve-out.14

When CMS adopted the proposed criteria for identifying orphan drugs in the November 1, 2002, final rule, however, it also announced an entirely new payment policy for orphan products. Instead of placing orphan drugs into separate APCs, CMS

excluded them entirely from the OPPS.15 These products now will be paid on a reasonable cost basis. Thus, CMS introduced a new payment policy in the final rule

that had not been discussed in the proposed rule. The parties affected by this policy

change did not have notice that such a change would be made and therefore may

not have commented on it. In particular, some of the manufacturers of orphan drugs

that CMS failed to recognize in the proposed rule may not have identified their

products to CMS as orphan products because the payment rates for their products

would have been the same under either the orphan drug or higher cost drug criteria

in the proposed rule. These organizations may have commented about other orphan

products that met CMS’ criteria had they known about the final rule’s new payment

policy for these orphan drugs and biologicals.

In addition to failing to give notice of a change in the payment policy, CMS failed

to identify all the drugs and biologicals that met its criteria. In the final rule, CMS

recognized only the same three drugs identified in the proposed rule as meeting its

criteria for orphan status.16 As some organizations discussed in their comments to

CMS, however, these three products are not the only drugs that meet CMS’ standard. We know of several other products that meet CMS’ orphan criteria:

amphotericin B lipid complex (J0286), oprelvekin (J2355), thyrotropin alfa (J3240),

daclizumab (J7513), aldesleukin (J9015), denileukin difitox (J9160), interferon

gamma 1-b (J9216), rituximab (J9310), coagulation factor VIIa (Q0187), and

basiliximab (Q2019). At least one other product, interferon beta 1-a (J1825), meets

the spirit of CMS’ criteria, but the USPDI includes one off-label use that is extremely rarely used. In fact, in examining the 1,691 claims in Medicare database,

the company knows of no claims for the off-label indication. Similarly, other drugs

and biologicals essentially meet CMS’ new standard by having FDA-approved uses

and USPDI accepted uses that nearly all are recognized as rare diseases by the National Institutes of Health. Botulinum toxin type A (J0585) is an example of an orphan biological that fits under this ‘‘essentially meets’’ standard.

Although we appreciate CMS’ attempt to exclude certain orphan products from

the OPPS entirely, we are concerned that CMS’ eligibility criteria were too rigid and

the agency failed to recognize many true orphan drugs and biologicals as a result.

The CMS criteria attempt to distinguish rarely used orphan drugs from drugs with

an orphan indication that are frequently used for other conditions. As CMS explained in the final rule, drugs meeting its criteria can be distinguished from other

drugs ‘‘because of their low volume of patient use and their lack of other indications,

which means that they can rely on no other source of payment.’’ 17 The agency recognized that treating these products like most other drugs under the OPPS could

produce payment levels that would be ‘‘insufficient to compensate a hospital for the

typically high cost of this special type of drug.’’ 18

Simply having alternate indications in the USPDI does not mean that the drug

has other, sufficient sources of payment, however. Many orphan products are rarely

used, even though they have approved or off-label non-orphan indications. These

products have ‘‘low volume of patient use’’ and very few, if any, other sources of pay-
74

19See 21 U.S.C. § 360ee. 20 67 Fed. Reg. at 66752. 21 Id.

ment. Including them in the OPPS system is just as likely to produce insufficient

payment levels as including the drugs that meet CMS’ limited criteria. We believe

that nearly all orphan-designated drugs are low volume drugs and biologicals used

for chronic diseases and generally are provided by specialists who may be available

only in the hospital outpatient department setting. Low-volume drugs and

biologicals with payment rates below hospital costs are unlikely to be stocked by

hospitals—regardless of whether they have non-orphan uses or not. Congress needs

to ensure patient access to all low-volume orphan-designated products is protected

by excluding them from the OPPS.

Although BIO recognizes that CMS may be hesitant to use the FDA’s orphan drug

designation as the sole determinant for drugs and biologicals to be excluded from

the OPPS, we firmly believe that CMS’ standard is too narrow and does not go far

enough to protect patient access. A true orphan product, under the Orphan Drug

Act, is used to treat a small population or has no reasonable expectation of recovering the costs of research and development.19 BIO strongly believes Congress

should expand the orphan drug exclusion criteria to include all FDA-designated orphan drugs when they are used for their orphan indications. This solution will further the same policy goals as the Orphan Drug Act itself by encouraging manufacturers to engage in the research and development necessary to obtain FDA approval

for orphan indications, even when the drug or biological has other more widely-used

indications.

Ideally, CMS would be able to determine when an FDA-designated orphan drug

is used for an orphan condition and reimburse hospitals for the drug or biological

accordingly. We realize, though, that CMS’ current system is not set up to make

these distinctions and that this solution may take some time to implement. Alternatively, CMS could use the number of claims submitted for a drug to determine

whether it is a true orphan product. By looking at the number of claims filed for

a product, CMS should be able to distinguish the rarely used orphans from the products with common non-orphan indications. CMS’ current narrow criteria clearly will

deny adequate payment for many deserving orphan drugs, threatening their availability for patients without any other treatment options. Broadening CMS’ orphan

exclusion criteria to include other worthy orphan drugs and biologicals will help to

ensure that these therapies remain available for patients who suffer from rare diseases. At a minimum, Congress should ensure that the 10 additional drugs and

biologicals BIO has identified as meeting the agency’s restrictive criteria are excluded from the OPPS.

CMS’ FUNDAMENTALLY FLAWED METHODOLOGY FOR RATE-SETTING

Finally, BIO is deeply concerned that CMS is using a fundamentally flawed methodology for setting payment rates that are biased against higher cost drugs and

biologicals. Unless this methodology is revamped immediately, patient access to critical drug and biological therapies in hospital outpatient departments will be compromised substantially.

Specifically, CMS has used a single ratio to derive all pharmacy costs within a

hospital, without regard for hospitals’ actual practices in setting charges for drugs.

When hospitals set their charge levels to reflect overhead costs, they raise the

charge levels much less for higher cost drugs than they do for low-cost products. As

shown in the diagram below, an aspirin, for example, may have a cost-to-charge

ratio of .01 (charging $10 for a $0.10 pill), while a higher cost biological could have

a cost-to-charge ratio of .80 (charging $1,000 for an $800 injection). The outpatient

methodology ignores this difference and uses a single cost-to-charge ratio for all

products in a hospital’s pharmacy department. This produces substantial over-reimbursement for low-cost products and substantial under-reimbursement for higher

cost products. Using the 2001 average cost-to-charge ratio of .30 produces a $3.00

payment for the aspirin and a $300 payment for the biological—less than half of

its acquisition cost. This methodological bias results in payment rates that provide

a clear incentive for hospitals to stop providing higher cost drug and biological

therapies.

CMS attempted to defend its methodology in the final rule by saying that, in the

inpatient setting, its assumption that cost-to-charge ratios are constant across all

services has worked for almost 20 years.20 CMS asserted that, in the inpatient setting, ‘‘any deviations [between costs and charges] should largely cancel out.’’ 21 At

the same time, CMS admitted that if hospitals do not mark-up costs uniformly, the
75

22 Id. 23 67 Fed. Reg. at 66769.

payment rates resulting from CMS’ methodology ‘‘would create incentives for hospitals to avoid (or favor) particular services.’’ 22 Yet, CMS claimed that it had neither enough information nor enough time to revise the methodology for 2003.

In the final rule, CMS applied a ‘‘dampening option’’ to ‘‘lessen the impact of the

dramatic reduction in the proposed payment rates for many of the drugs and

biologicals from 2002 to 2003.’’ 23 Although well-intentioned, the dampening option

does not go far enough to address the most egregious under-reimbursements for

higher cost drugs. In fact, the dampening option actually produced lower payment

rates for all APCs because of the budget neutrality adjustments required to compensate for its cost.

Once again, we believe that CMS must correct this fundamentally flawed methodology before it produces grave consequences for patients. Unlike the inpatient PPS,

where CMS believes that over and under-reimbursements will be cancelled out, the

OPPS bundles few items and services together. Often the only service the hospital

provides to the patient is administration of the drug or biological. In these cases,

the hospital does not provide other services with over-reimbursements that can average out the under-reimbursements for higher cost therapies. In a cancer center,

for example, the $2.90 over-reimbursement in our hypothetical example for each aspirin cannot compensate for oncology drug reimbursements that fall hundreds of

dollars below their costs. Unless CMS calculates OPPS rates to acknowledge that

this charge compression occurs, its methodology and payment rates will discourage

hospitals from providing the most appropriate care for patients.

Although we understand that CMS needs time to study problems associated with

charge compression and to determine how best to respond, BIO does not believe that

patients should suffer during this time. Therefore, we believe Congress should adopt

an interim solution to ensure that hospitals are adequately reimbursed during the

period before a permanent correction can be achieved. This solution should be adopted immediately. It should encompass not only hospital acquisition costs, but also

pharmacy service and other hospital overhead and handling costs involved in delivering safe and appropriate pharmacy therapy.

CONCLUSION

BIO is deeply concerned that patient access to critical drug and biological therapies in hospital outpatient departments will be impeded substantially after January

1, 2003 as a result of the final rule. We believe that Congress must act quickly to

revamp this fundamentally flawed rate-setting methodology and to adopt an interim

solution in the meantime. We also believe that Congress should exclude all FDAdesignated orphan drugs from the OPPS when they are used for their orphan indications. Finally, we believe Congress should act now to require CMS to abandon its

new policies with respect to radiopharmaceuticals and the ‘‘functionally equivalent’’

standard. BIO appreciates this opportunity to testify and looks forward to working

with you to ensure that patients continue to have access to critical therapies in hospital outpatient departments—both now and in the future.

Senator SPECTER. Thank you very much, Mr. Pops.

Mr. Scully.

Mr. SCULLY. I was asked to respond, so I was trying to—so I am

not prepared to testify. I will just respond to the BIO testimony.

Let me digress for one second on the malpractice issue. You mentioned Pennsylvania. Just for your future interest, physicians are

allowed to be on a hospital’s malpractice plan if they are employees, and it is an antikickback rule that comes through the Inspector General, Janet Rehnquist. She did give an exemption for that,

and a temporary waiver for a while, and we are working on that,

but the bottom line is, your point about trying to save money for

physicians by folding them into the malpractice for the hospital is

a legitimate one, and we are working on it, but traditionally that

has been looked at as a kickback from the hospital to the doctor

and it violated the Stark antikickback rules.

Senator SPECTER. Where was the kickback?
76

Mr. SCULLY. Well, the argument is, if the hospital goes in and

subsidizes the doctor’s insurance premium, that that is, you

know—there is a long legislative history about inappropriate incentives for——

Senator SPECTER. If you have the doctor on your insurance policy

so he gets a group rate, that that is a kickback to the doctor?

Mr. SCULLY. There is long case law that is involved—it is Justice

Department and Inspector General, not CMS, where

theoretically——

Senator SPECTER. You say there is case law on that?

Mr. SCULLY. Oh, there are many, many, many cases in the Justice Department about if hospitals inappropriately subsidize physicians’ office rents or anything else, that that is an inappropriate incentive for them to refer doctors to their hospitals, and subsidizing

malpractice premiums have been part of——

Senator SPECTER. These are doctors who practice at the hospital?

If a doctor is an employee of the hospital, is there any problem in

being covered?

Mr. SCULLY. No. If they are an employee, they can be on the

plan.

Senator SPECTER. If a doctor practices at the hospital, you are

saying that that would be regarded as a kickback?

Mr. SCULLY. In the past, it has been by the Inspector General

under these antikickback statutes, and I believe they have given a

waiver while they try to work out some exclusions to this.

Senator SPECTER. They have given a waiver, you say?

Mr. SCULLY. I was just informed by some hospital folks that

there is a temporary waiver while they look at adjusting that rule

for this purpose, but your point—I just brought it up to say that

you are very much on point. If you are an employee, you can be

an employee doctor, which is very rare. Most doctors are not employees of hospitals. You can be in a pooled malpractice plan.

Generically, you cannot, if you are not an employee, be pooled

into the hospital’s malpractice plan because it is perceived to be an

inappropriate kickback. That has nothing to do with CMS. That is

a longstanding Inspector General rule that I believe Janet

Rehnquist has given some temporary exemptions to.

Senator SPECTER. Curious rule. I used to deal in kickbacks all

the time as a district attorney. It does not sound like a kickback

to me.

Mr. SCULLY. Well, generally those are left to Justice and the IG.

I was just—you were interested, so I thought I would pass along

the most I knew about it.

Senator SPECTER. Now, Mr. Scully, you are the administrator.

You have got to deal with what they recommend to you and make

an evaluation, and I would ask you to take a look at that. That

does not make any sense.

Mr. SCULLY. Well, I have been working with Janet Rehnquist

and the Inspector General on a lot of areas of the antikickback rule

to make it more realistic, and I think this is certainly one of them.

Senator SPECTER. Okay. On to functional equivalence.

Mr. SCULLY. I have spent hundreds of hours on this issue, and

Secretary Thompson I can tell you has spent probably many dozens.
77

Senator SPECTER. Try to summarize.

Mr. SCULLY. It is just a very complicated issue, but I would say

that we did not create a new functional equivalence rule. We have

always had the authority. I will just give you a quick summary.

We pay for outpatient drugs in two settings. We have the outpatient prospective payment rule, which brought this up, arguably

one of the more complex reimbursement tools of the Medicare program. We are capped at $19 billion a year in spending this year

on outpatient PPS. That pays for all outpatient payments, including hospital payments. We pay for drugs, outpatient drugs in that

setting and in the physician setting.

The way this issue came up is, the most expensive pair of drugs

in the Medicare program are two drugs that are similar called

Aranesp and Procrit. Procrit has been around for many years, a

great drug for cancer patients, also used very heavily for dialysis.

In the cancer area we spend a couple of million dollars—billion dollars a year, excuse me, on both.

The way this new payment mechanism came up 2 years ago,

Congress created a new outpatient payment mechanism, and for 2

years existing cancer and certain other drugs were put on there

and were paid at 95 percent of average wholesale price, which by

all accounts, including every congressional committee, is a ridiculously overpaid price. But temporarily in 2000 for certain drugs

and for new drugs that come out—for patients to have access to

them—they are paid at that price.

Senator SPECTER. That is a ridiculous overpayment that Congress has authorized?

Mr. SCULLY. I have testified before the Finance Committee, the

Ways & Means Committee, and the Commerce Committee in the

last year, and on a bipartisan basis I would say there is extremely

strong support for fixing it, and that by all accounts we are overpaying by about $1 billion a year due to an existing formula.

Senator SPECTER. So there is a strong reason, you say, for having

Congress make a modification of that?

Mr. SCULLY. Yes, but there are two pots that are going on here.

One is the 20 percent of the payments in the outpatient——

Senator SPECTER. If it is so clearcut, why hasn’t the Finance

Committee acted on it?

Mr. SCULLY. The Finance Committee has acted, as has the Commerce Committee, as has the Ways & Means Committee. They just

happen to have three different fixes, and they have not quite

worked it out, but I would say if you talk to Chairman Grassley

or Senator Baucus you would find they have very strong feelings

about fixing this, as does Chairman Tauzin and Mr. Dingell and

Chairman Thomas and Mr. Stark, and the administration has not

acted, and we said we would, largely to allow Congress to act so

that hopefully they can get——

Senator SPECTER. But at the present time there is this passthrough rule.

Mr. SCULLY. There is a pass-through rule.

Senator SPECTER. And would you define what that pass-through

rule is?
78

Mr. SCULLY. The pass-through rule says that new drugs for 2

years after they are determined to be new drugs, that we should

pay them at 95 percent of average wholesale price.

Senator SPECTER. 95 percent of average wholesale price?

Mr. SCULLY. Of average wholesale price, which is an industrylisted book, but my agency has the discretion to——

Senator SPECTER. And the average wholesale price you think is

exorbitant?

Mr. SCULLY. Is clearly exorbitant in most cases, not all. Some

companies list legitimate prices. It is an industry—by reference,

CMS has adopted an industry document called the Red book. Some

companies report accurately, some do not. We have the discretion

to use anything we like under the law.

Also, because it is capped at $19 billion, this pot, the Secretary

also has clear discretion under the law to make equitable adjustments in payment. So the standard we came up with, that functionally equivalent, is not a new standard. It was an explanation

of a longstanding legal authority that we clearly have to adjust

payments in either one of the two methods, either to say——

Senator SPECTER. When you say the average wholesale price is

absurdly high, that really touches on a much broader issue.

Mr. SCULLY. Yes.

Senator SPECTER. That is pricing of pharmaceuticals. Average

wholesale price. On its face you would think that a wholesale price

would be low.

Mr. SCULLY. Well, average wholesale price is reported by the

companies, and by virtually all accounts they report exceptionally

high ones, and by tradition, and we are looking at changing it, my

agency has paid 95 percent of whatever the price is the company

makes up. I will give you an example.

Senator SPECTER. What does wholesale mean? Wholesale means,

before you get to retail.

Mr. SCULLY. But it is not—we are required under the Medicaid

statute, for Medicaid remits to collect what is called average manufacturer price, which is the real price that people actually pay.

Senator SPECTER. What is that definition again?

Mr. SCULLY. Average manufacturer price.

Senator SPECTER. Average manufacturing price?

Mr. SCULLY. Which is substantially lower, we collect for Medicaid, but by statute we are not allowed to use that.

Senator SPECTER. How do you determine an average manufacturing price? Does that include the research costs?

Mr. SCULLY. The average manufacturer’s price for Medicaid,

which we are not allowed to use for Medicare, manufacturers actually have to report the average manufacturer’s price that they

charge all customers. It is an audited number. It is also secret, only

for use in Medicaid, believe it or not. Half of my agency can use

it, the other half cannot.

Senator SPECTER. You can use it for Medicaid, but not for Medicare? Why that distinction?

Mr. SCULLY. That is what the statute reads. We have proposed

changing it in the last two budgets, and I would suggest it may

well be in the Monday budget.
79

The average wholesale price, on the other hand, is just whatever

the manufacturer wants to report to this industry book, called the

Red book, and that is usually much, much, much higher.

I will give you an example of how this came up.

Senator SPECTER. When you define an average manufacturing

price, is that what it costs to manufacture the last pill?

Mr. SCULLY. It is an average of all the prices you charge, and we

have not advocated that is what we should pay in Medicare, but

it arguably does not create enough margin for oncologists and others to acquire the drug. It factors in sales to large hospitals, large

buyers. We would not argue that is appropriate for Medicare, but

it is clearly a much lower price than average wholesale price, which

is essentially whatever the manufacturer wants to report, and it is

obviously to their incentive to make up the highest price that they

can credibly put in the book.

But I can give you the functional way this works, which I think

will show you the problem we have, and why this has become controversial, if you would like. In the average wholesale price for the

80 percent of the market that is physicians, we currently, including

right now, pay about $1,422 every 2 weeks for Aranesp, and we pay

about $1,200 for Procrit. Procrit got paid that in the outpatient setting for 2 years.

Senator SPECTER. How much are those again?

Mr. SCULLY. For Procrit it is about $1,200, and for Aranesp, similar drug, with slightly different chemical makeup, about $1,422,

and in the outpatient setting for 2 years——

Senator SPECTER. $1,422 for one?

Mr. SCULLY. Every 2 weeks for one patient.

Senator SPECTER. And $400 for the other?

Mr. SCULLY. $1,200 for the other.

Senator SPECTER. $1,200.

Mr. SCULLY. Procrit is made by Johnson & Johnson, Aranesp is

made by Amgen, and believe me, Secretary Thompson and I spent

many hundreds of hours on this. For nearly 2 years, when this new

system was created, Procrit was the only drug on the market for

oncology. We paid them at about $1,200 every 2 weeks. At the end

of the 2 years, we basically, within this finite pot of $19 billion, we

used 90 million hospital claims, which is what some of the dispute

is about, is how we set the price, to figure out what the appropriate

price is. It is not AWP.

We determined, and I do not believe that J&J argued with this,

that the appropriate price for Procrit was about $700 every 2

weeks, so we lowered their price from about $1,200 to about $720

every 2 weeks in the 20 percent of the market that is hospital outpatient. We are still paying them $1,200 every 2 weeks on the physician side, okay.

The argument for Aranesp is, it is a new drug, and it came on

the market. Were we to pay Aranesp $1,422, we would have spent

a couple of hundred million dollars a year, which would have required me, in that finite pot of money, to cut mammographies,

colonoscopies, pro rata cut all other drugs, because it is a finite pot

of money. We only have a finite pool of money to spend on the outpatient side.
80

This 20 percent that Congress created is capped, and so if I were

to say that Aranesp and Procrit were different drugs, and that

Aranesp was, in fact, a new drug, we would have paid it double the

rate of Procrit, and we would have paid a few hundred million dollars a year in extra payments.

The Secretary has the ability to make sure he does not have to

cut other services under the current statute to make equitable adjustments. We have determined the AWP is a different price, so

when they make the argument that, under the rule, this is a new

concept, all this was is an explanation of two statutory authorities

which we have always had, which is on the outpatient side to adjust the payment. We made the decision that these drugs, and believe me, I have—this has been a very unpleasant experience.

I have people that I have worked with at both companies for a

long time. I hired—in fact, Secretary Thompson was very involved

in this—I hired the most credible, well-known doctor in this area

that I know, who has had years of experience with both drugs,

asked him to write a study, and Secretary Thompson and I followed his guidance, and he said that these drugs were functionally

the same. The impact of paying Aranesp at twice as much, on the

other drugs would be, we would have had to cut many other drugs

and devices, and we would have had to cut mammographies, emergency room visits, and everything else in this $19 billion pot to pay

more for it. We made the decision in that 20 percent pot to pay the

two drugs the same because we believe they are functionally equivalent, but we clearly had the statutory authority to do that.

Senator SPECTER. Mr. Pops, do you disagree that they are functional equivalents?

Mr. POPS. I completely disagree with the whole notion that Mr.

Scully and his consultant can make that determination.

Mr. SCULLY. Well, there is no question we have the legal authority to do that.

Mr. POPS. Oh, I am not questioning—I am not a lawyer, so I do

not know whether you had the legal standing to do it——

Mr. SCULLY. I would point out, on the other 80 percent, which is the much bigger pot of money, $4 billion, which should be their

much bigger concern, where we have not done this—because in the

$19 billion pot that exists, had we paid the one drug more and not

made this determination we would have cut emergency room visits,

colonoscopies, mammographies, and other drugs.

On the other pot, which is much bigger, the 80 percent on the

physicians side, we have not made the determination yet until we

get more information, because we are still paying the one drug at

$1,400 every 2 weeks, and Procrit at $1,200 every 2 weeks, arguably maybe the taxpayer is overpaying, but until we get more information, we made the decision not to do that.

The Secretary and many other people thought that we should

have lowered both prices, which we have the authority to do as

well, down to $700 every 2 weeks. We have not yet done that, subject to doing some studies with the National Cancer Institute and

others, but we clearly—we did not create a new standard with

functional equivalence. We basically explained why we did it under

existing legal authority, which we believe protected many, many

other patient payments in the outpatient setting.
81

Senator SPECTER. Let us give Mr. Pops an opportunity to comment here. I had asked him as to whether he thought these two

items were functional equivalents, and your response was that you

challenge their entire system, but dealing with the narrower question of functional equivalency, are they functional equivalents?

Mr. POPS. These two particular drugs?

Senator SPECTER. Yes.

Mr. POPS. I think it is very difficult to make that determination.

There are literally millions of pages of data from extensive clinical

trials and clinical use of these two drugs. I am not an expert on

both of them. I know them both generally. They are administered

under different regimens. They have different molecular compositions. They have different patents covering them. They are very different things.

Senator SPECTER. So your point is, they are different drugs. Well,

do they function differently, or can a patient take either one and

get the same result?

Mr. POPS. I think a physician should make that determination.

I do not think either I should or Mr. Scully should make that determination.

Mr. SCULLY. Well, my understanding——

Senator SPECTER. Wait just a minute. Wait just a minute, Mr.

Scully. Let me pursue this with Mr. Pops.

You think it is a matter that each individual prescribing physician should evaluate these two drugs and make that decision?

Mr. POPS. I think the answer to that is yes. Again, I want to try

to make sure that I am clear that I really do not have a particular

point of view with respect to Procrit versus Aranesp. What I am

worried about is the general principle of somebody making that determination based on a single consultant or 10 consultants in a

closed room.

Senator SPECTER. On this issue of the average wholesale price,

do you disagree with Mr. Scully’s comment that it is exorbitant?

Mr. POPS. Our drugs right now, we have one approved drug that

is sold through our partners at Genentech, so they make that determination. Our next drug will be sold through a major pharmaceutical company, so we will not make that—I do not have personal

direct experience with that.

Senator SPECTER. You are not able to comment on the average

wholesale price.

Mr. POPS. I cannot comment, but what I do sense, though, is

this——

Senator SPECTER. Are you able to comment on his statement——

Mr. POPS. No. No.

Senator SPECTER [continuing]. That the average wholesale price

is exorbitant?

Mr. POPS. No, because I have no direct experience myself on that.

We can get that data for you, though, through BIO and through

our member companies. We would be happy to respond to that.

Senator SPECTER. I would be interested to have a written response from your company.

Mr. POPS. We would be happy to do that.

Senator SPECTER. Anything you want to add, Mr. Pops?

Mr. POPS. No.
82

Senator SPECTER. Mr. Scully.

Mr. SCULLY. I would just like to add, I would clearly defer to doctors on this. I am a lawyer, not a doctor. I have a large staff of doctors. I did not have one that was particularly expert in this area.

I hired the former head of policy at HHS, who is a physician and

has long experience in this area. He was the head of it in the

Reagan administration. He had absolutely no interest in this. In

fact, he did it as a favor to me. He had no desire to get into this

quagmire.

I believe, and Secretary Thompson strongly believes after many

hours of working on this we made the right decision on a scientific

basis, and the issue, I believe, if you look—this is a very tense

issue involving billions of dollars for two very large companies. It

was on the front page of the Wall Street Journal yesterday, and it

is very difficult. It has a big impact on people, and we believe we

have done absolutely the right thing scientifically.

Mr. POPS. A final comment I would make, Senator, is that——

Senator SPECTER. Go ahead, Mr. Pops.

Mr. POPS. I would just be worried of detecting a certain inherent

bias toward drugs being expensive, and sometimes drugs nominally

are expensive, but sometimes they deliver tremendous amounts of

economic and medical value to people, and when one views the

world through the prism of cost, which is a legitimate way to view

the world, particularly when you are facing the pressures that Mr.

Scully is facing—I completely understand the logic—at the end of

the day I do not want to lose sight of the fact that we are talking

about patients’ lives and their well-being, and I think that the dollar denomination is only one of the many variables that should be

considered.

Mr. SCULLY. May I make one more comment?

Senator SPECTER. Sure.

Mr. SCULLY. Drugs cost a lot. Gleevec, a drug that was also mentioned yesterday, is a wonderful new leukemia drug that cost

$50,000 a year. It is a great drug. We pay for several drugs, and

there are other examples in their testimony. They brought up one

called Zevalin, that I was also involved in for hundreds of hours.

The Congresswoman, Democratic Congresswoman from California called me up and said, could you check on this drug’s approval, and I called over my staff and they said, yes, we are about

to give it a new code. I said, well, just out of curiosity, what does

it cost? $28,000 a dose, and the tradition on these programs was,

nobody asked any questions, and they were about to just give it a

new code.

We looked at it in great detail. It is an interesting drug, a very

good drug. It is not another issue that is—it is an add-on to an existing drug. The VA pays $12,000. $28,000 is a price they made up.

After significant involvement with the company, who is very cooperative, we worked out a price which, not through the passthrough, of $21,000. It is going to be available to patients. It is a

great drug.

But the tradition in these programs is, whatever the companies

come in and say the number is in their Red book, the Government

pays, and in the use of taxpayer dollars, we are determined to give

patients the right drugs, access to the right drugs and pay a rea-
83

sonable price, but we should not just say, well, list the price and

we will write you a check. It is crazy.

Senator SPECTER. Well, it is obviously a very complicated approach here. Where you talk about average wholesale price being

exorbitant, and you talk about an average manufacturing price, I

am going to pursue that further to see how you make that determination, and some of these prices apply for Medicare, there is a

difference in application for Medicare and Medicaid, which I am

going to pursue to see what the rationality is of that basis.

We face this on the Veterans Committee, which buys in enormous bulk, we face it on HHS, we are now facing it on Homeland

Security, and this subcommittee and the Veterans Committee are

going to be pursuing this question as to how pharmaceuticals are

priced, because it is very, very hard to figure out exactly what is

going on here.

We appreciate your testimony. Anything either of you wishes to

add?

Mr. POPS. No.

Mr. SCULLY. Thank you, Mr. Chairman.

PREPARED STATEMENTS AND ADDITIONAL COMMITTEE QUESTIONS

Senator SPECTER. We have received the statements of the American Association for Geriatric Psychiatry and the American College

of Physicians—American Society of Internal Medicine. They will be

made part of the record at this time, along with other statements

we receive. Senator Landrieu’s question for the record will also be

included at this point.

[The information follows:]

PREPARED STATEMENT OF THE AMERICAN ASSOCIATION FOR GERIATRIC PSYCHIATRY

Mr. Chairman, the American Association for Geriatric Psychiatry (AAGP) appreciates the opportunity to share our concerns, with the Members of the Subcommittee

on Labor, Health and Human Services, Education, and Related Agencies, on the

problems facing physicians who treat older Americans enrolled in Medicare. AAGP

is a professional membership organization dedicated to promoting the mental health

and well-being of older people and improving the care of those with late-life mental

disorders. Our membership consists of more than 2,000 geriatric psychiatrists as

well as other health care professionals who focus on the mental health problems

faced by senior citizens.

Physicians who treat Medicare beneficiaries, as Medicare providers, accept a fee

schedule that is, at baseline, often significantly lower than their ‘‘usual and customary’’ fee schedule for providing services to their self-paying patients. As you are

aware, these physicians now face a second consecutive year of across-the-board reductions in the fees paid by the program. Unlike many other payment ‘‘cuts’’ in

Washington, these reductions are not simply reductions in a rate of increase, but

are absolute reductions in fee levels. In 2002, fees were cut by 5.4 percent below

2001 levels. Unless the 108th Congress acts early in the new year to prevent it, fees

for 2003 are scheduled to be reduced by another 4.4 percent below 2002 levels on

March 1. Moreover, Medicare actuaries project that—without any further changes

in law—annual fee reductions of a similar magnitude are likely to continue at least

through 2005. At this rate, the conversion factor—the dollar multiplier used to compute Medicare physician fees—will fall in 2005 to a level that is close to its level

in 1993.

This issue is most important because of the effect it will have on access to care

for Medicare beneficiaries, especially for the vulnerable among them—those elderly

and disabled persons who have multiple, complex medical conditions and limited financial resources.

As a result of the recent reductions, many physicians are having to reevaluate

their willingness to treat Medicare patients, as well as their willingness to be ‘‘participating physicians’’ who accept Medicare payment as payment-in-full for their
84

1 Although ‘‘balance billing’’ may provide a short-term safety valve that allows some physicians

to continue treating Medicare patients, the additional 9.25 percent that Medicare permits physicians to collect from beneficiaries under its balance billing limits will not fully offset the cumulative reductions in program payments for 2002 and 2003. Moreover, some States prohibit balance billing Medicare beneficiaries as a condition of licensure in the State, which leaves those

physicians without this option.

services. Consequently, many Medicare patients are already having trouble finding

physicians to treat them. A recent survey by the American Medical Association

found that because of the recent cuts (5.4 percent in 2002) in Medicare payments,

24 percent of physicians have either placed limits on the number of Medicare patients they treat or plan to institute limits soon. In the case of geriatric psychiatrists—most of whose patients are enrolled in Medicare—the impact of these reductions is particularly severe and is causing at least some in our profession to consider

leaving clinical practice altogether to enter other fields where their experience and

expertise are valued more appropriately.

The impact on geriatric psychiatrists—and their patients—is compounded by the

discriminatory reimbursement policies Medicare already imposes on consumers of

mental health services. Under current law, Medicare requires beneficiaries to pay

a 20 percent copayment for Part B services with the single exception of a requirement of a 50 percent copayment for outpatient mental health services. The lack of

parity for mental health treatment is unconscionable—and of great consequence to

older adults who feel more stigmatized by psychiatric illness than any other group.

Despite widespread need, many seniors decline, delay, or drop out of treatment because of the high copayment. In addition, current law discriminates against the nonelderly disabled Medicare population, many of whom have severe mental disorders.

The result of these factors—declining reimbursement rates, existing discriminatory reimbursement for mental health care, and stigma—will undoubtedly compound the existing serious access problems for Medicare beneficiaries in need of

mental health treatment—either in finding a physician to treat them or in ‘‘balance

billing’’ charges by physicians who previously accepted assignment.1 Shifting costs

to beneficiaries—many of whom are low income—can make essential mental health

care unaffordable.

The fee reductions that are forcing these choices stem from the mechanism for

automatic annual fee ‘‘updates’’ that is currently part of the Medicare statute. For

most types of providers, Medicare law incorporates a mechanism by which payment

rates are automatically updated annually for inflation, in much the same way that

Social Security and other Federal cash benefits are automatically increased by the

cost of living adjustment (COLA) each year.

However, since the inception of Medicare physician payment reform in the early

1990s, updating physician fees has been handled somewhat differently from those

of other providers. The payment reform law established a mechanism under which

the annual inflation update for physicians’ services is automatically adjusted—above

or below the rate of inflation—based on how actual Medicare spending for physicians’ services compares to an annual spending target computed by the Centers for

Medicare and Medicaid Services (CMS) based on a formula set out in the law.

Until recently, this mechanism resulted in some relatively modest reductions

below full inflation—as well as some ‘‘bonuses’’ above inflation. However, changes

made in the ‘‘Balanced Budget Act of 1997’’ (BBA) tightened the annual spending

targets, making it substantially more difficult for physicians to meet them.

Before the BBA, the annual spending target was based on a formula that included

a reasonable allowance for spending increases due to changes in technology and

other related factors affecting the ‘‘volume and intensity’’ of services provided by

physicians. The BBA replaced this allowance with a much less generous proxy—the

estimated increase in the gross domestic product (GDP)—which bears no relationship to the factors affecting volume and intensity of services provided. The impact

of this change can be demonstrated quite simply. Where the volume and intensity

allowances for 1992 and 1993 were 6.8 percent and 6.0 percent, respectively, the corresponding GDP allowances for 1999 and 2000 were 1.3 percent and 2.7 percent.

Furthermore, because the BBA made the new targets cumulative—so that a

breach in one year’s target would have to be fully offset by corresponding expenditure reductions in later years—inaccurate CMS estimates of several components of

the formula used to compute the spending targets for 1998 and 1999 have been carried forward, producing inappropriately low targets in each subsequent year.

For example, actual growth in the GDP for 1998 and 1999 was greater than the

estimates on which CMS based its targets. Growth in the beneficiary population is

another component of the target. CMS overestimated beneficiary migration from
85

traditional Medicare into managed care plans during 1998, which had the effect of

understating beneficiary enrollment growth in the traditional program.

All of these forecasting errors resulted in lower targets than would have occurred

if better data had been available. Correction of them would eliminate the fee reductions scheduled for 2003 and significantly improve the outlook for future years as

well.

Unfortunately, CMS interprets the law as precluding it from correcting these errors. Although AAGP takes no position on this arcane legal issue, we do think that

it is fundamentally unfair to make physicians—and Medicare beneficiaries—pay for

estimates that everyone agrees in hindsight were wrong.

Physicians want to serve all Americans. However, they simply cannot afford to accept an unlimited number of Medicare patients into their practices when they are

facing continued payment reductions. These drastic cuts must be stopped before

they devastate Medicare beneficiaries’ access to health care.

We commend the Senate for its recent action on legislation to avert the impending

4.4 percent reduction in Medicare physician fees and urge it to work out its differences with the House of Representatives at the earliest possible date.

We note, however, that neither the legislation recently passed by the Senate nor

that passed by the House of Representatives in the 107th Congress on the issue addresses the fundamental defects in the formula for setting annual Medicare spending targets for physicians’ services. We urge Congress to revisit this issue in the

near future and—at a minimum—to replace the GDP component of the formula with

a more realistic proxy for changes technology and other factors affecting the volume

and intensity of the services furnished to Medicare beneficiaries.

Thank you again for the opportunity to share our views on this important issue.

We look forward to working with you as you craft a correction to the Medicare physician payment formula.

PREPARED STATEMENT OF THE AMERICAN COLLEGE OF PHYSICIANS—AMERICAN

SOCIETY OF INTERNAL MEDICINE

The American College of Physicians-American Society of Internal Medicine (ACPASIM)—representing 115,000 physicians and medical students—is the largest medical specialty society and the second largest medical organization in the United

States. Internists provide care for more Medicare patients than any other medical

specialty. We congratulate the Appropriations Subcommittee on Labor, Health and

Human Services, and Education for holding this important hearing. Of the College’s

top priorities for 2003, addressing the inadequacies of physician payment by the

Medicare program is the most critical to our members. ACP–ASIM thanks Senator

Arlen Specter, chair of the Subcommittee, and Senator Tom Harkin, ranking member of the Subcommittee, and other members, for their commitment to a strong and

stable Medicare program. We also want to extend special appreciation to Senator

Specter for his extensive efforts to improve health care for all Americans, including

his leadership on biomedical and health services research and patient safety.

In spite of efforts in both the House and Senate in the last Congress, Medicare

payments were cut by 5.4 percent on January 1, 2002. Unless Congress acts immediately, Medicare payments will be cut by another 4.4 percent on March 1, 2003

under a final rule promulgated by the Center for Medicare and Medicaid Services

(CMS) in December 2002. The effect of the cut was felt immediately in physician

offices across the country, prompting difficult decisions about the level of services

that could be provided and concerns about the future.

The Omnibus Appropriations Bill recently passed by the Senate includes language

to halt the 4.4 percent cut. A bill has been introduced in the House of Representatives (H. Con. Res. 3) that would halt implementation of the final rule, including

the 4.4 percent cut, through the authority given to Congress under the Congressional Review Act. As the conference committee begins the difficult work of resolving differences between the House and Senate versions, ACP–ASIM urges Congress

to enact legislation to halt the 4.4. percent cut as a necessary first step toward developing a long-term solution.

Whatever approach is taken, the House and Senate must agree on a bill that the

President will sign before the cut goes into effect on March 1. By freezing payments

until September 30, the Senate appropriations provisions create a reprieve that will

allow the Congress to address a long-term solution to physician reimbursement

problems. Congress will have to immediately find a way to guarantee adequate and

predictable payments that will keep pace with increases in the costs of providing

services.
86

BACKGROUND

The Centers for Medicare and Medicaid Services (CMS) has projected that Medicare payments will decline by a grand total of 17 percent from 2002–2005. This is

an absolute reduction in payments; it does not take into account the impact of inflation in the costs of providing services. Using a very conservative inflation assumption of 3 percent per year, Medicare payments per service in constant dollars will

be cut by 28.1 percent over the 2002–2005 period.

This is not a problem that was created overnight. Congress adopted the current

physician payment methodology (known as the Sustainable Growth Rate or SGR)

in the Balanced Budget Act of 1997. Even then, ACP–ASIM recognized the serious

flaws inherent in the SGR payment system and voiced our concern. Congress attempted to make corrections to the payment formula in 1999 with the Balanced

Budget Refinement Act, however, it was not sufficient to correct the intrinsic problems. The recent economic downturn the country is now facing has only exacerbated

the problem.

Recognizing the unfairness of the SGR methodology and the tremendous hardship

it has placed on physicians across the country, a super-majority of members of the

107th Congress cosponsored legislation, (the Medicare Physician Payment Fairness

Act of 2001, H.R. 3351 and S. 1707) which would have reduced the magnitude of

the 5.4 percent cut. Unfortunately, Congress failed to act prior to adjournment and

physicians suffered the effects of the across-the-board reduction in their medical

practices throughout 2002. A delay in the implementation of the Medicare Fee

Schedule Regulation has provided a window of opportunity to stop the scheduled 4.4

percent decrease from going into effect

FLAWED DATA USED IN FORMULA

The 5.4 percent across-the-board reduction in Medicare payment is primarily due

to the flawed SGR system that governs the annual payment for physician services.

The SGR system errantly ties physician payment to the Gross Domestic Product

(GDP). There is no other segment of the health care industry that uses such a methodology to update payment. What is most unfortunate is that this method of tying

physician payment to the health of the overall economy bears absolutely no relation

to the cost of providing actual physician services. In the years where the economy

is facing a downturn, such as has been the case in the recent past, a reduction in

physician payment is significant.

SGR system may even cause payments to deviate from physician costs because

it does not fully account for factors affecting the actual cost of providing services.

Specifically, while the current SGR payment system accounts for input price inflation and productivity growth, it provides no opportunity to account for other factors,

such as an increase in the regulatory burden of the Medicare program.

In addition to the flawed SGR payment system, physicians have repeatedly been

penalized for inaccurate estimates in the past. Since the SGR payment formula was

first utilized in 1998 and 1999, Medicare officials have consistently relied upon

flawed data for the annual update. Because the SGR formula is cumulative (i.e., it

relies on previous years’ estimates), these errors that were never corrected are compounded, further exacerbating the problem year after year. Due to these successive

errors, the spending target is about $15 billion lower than it actually should be.

EFFECT ON PHYSICIANS AND THEIR PATIENTS

As physician compensation falls below costs, fewer doctors are willing to see new

Medicare patients, at least in part due to Medicare payment cuts. The percentage

of physicians saying they accept all new Medicare fee-for-service patients declined

by 7.2 percent from 1999 to 2002, according to a preliminary survey by the Medicare

Payment Advisory Commission released in September, 2002. Surveys by ACP–

ASIM, the American Medical Association, the American Academy of Family Physicians, and other medical organizations show an even more pronounced deterioration

in access since the 5.4 percent payment cut went into effect on January 1, 2002.

Large numbers of physicians are reporting that it will be necessary for them to further restrict the number of Medicare patients they will see if they are subjected to

another scheduled cut of 4.4 percent on March 1, 2003.

Research by the Center for the Study of Health System Change attributes Medicare-beneficiary access problems to a number of factors, including Medicare cuts. According to the Center’s director, Paul Ginsburg, PhD, ‘‘Additional Medicare cuts of

the magnitude expected over the next few years are likely to increase beneficiaries’

access problems, especially in markets where private insurers pay significantly more

than Medicare for physician services.’’ Availability of care for Medicare patients has
87

already deteriorated over the past four years. Dr. Ginsburg reports that the percentage of Medicare patients who did not receive or delayed needed care increased from

9.27 percent in 1997 to 11.1 percent in 2001. The percentage of primary care physicians accepting all new Medicare patients declined steadily over the 1997–2001 period before the 5.4 percent cut went into effect.

Members of ACP–ASIM who responded to a recent online questionnaire received

by January 10, 2003 reported major changes in their ability to provide services to

Medicare patients as continued cuts in reimbursement take effect:

—The number of physicians who will no longer accept new Medicare patients in

2003 increased by 78 percent over the previous year.

—Less than two-thirds of participating physicians have decided to renew their

Medicare contracts for 2003.

—Of those physicians who currently accept all new Medicare patients, only one

in five will continue to do so.

—Only one-third of physicians plan to maintain their current policy towards accepting new Medicare patients.

—Of those implementing or undecided on changes, 88 percent plan to limit the

number of new Medicare patients, close their practices to new Medicare patients, or close their practice to all Medicare patients. 38 percent will completely

close their practice to new Medicare patients.

—Of those implementing or undecided on changes, only 12 percent report that

they will accept all new Medicare patients.

—Nearly 50 percent of physicians report considering early retirement or a career

change. Of those physicians, 80 percent report being concerned that their patients would be unable to find another participating Medicare provider.

—More than 70 percent of physicians have already taken cost cutting measures

to absorb previous cuts including reducing their staff, putting off the purchase

of new medical equipment and technology, or postponing raises and decreasing

staff salaries.

Reductions in Medicare reimbursement are exacerbated by increases in medical

liability insurance premiums and the expense of complying with government regulations. Rising medical liability insurance premiums are forcing many doctors to limit

services, relocate their practices, or retire early. The adverse results for patients

who are unable to find the care they need are unacceptable. In addition, physician

concerns about the billing paperwork and administration required by Medicare are

leading many to limit their acceptance of Medicare patients. According to a recent

MedPac survey of physicians, almost 75 percent were concerned about this ‘‘hassle

factor’’ and 16 percent said that they had limited their acceptance of Medicare patients because of this factor.

These financial burdens—cuts in reimbursement, increases in liability premiums

and unfunded mandates—are converging to stress the health care system to the

breaking point. The impact is being felt now but will also affect generations to come.

Without health care providers little health care can be provided. Compensation for

providers must be adequate if the system is to remain viable and open to a broad

range of patients. Inadequate compensation undermines the foundation of the current system and severely handicaps its capacity to meet future needs. Even the

most altruistic students will think twice before choosing medicine as a career.

Physicians have a strong sense of commitment to their Medicare patients. They

will do everything within reason to continue to provide their Medicare patients with

high quality, accessible health care, even in the face of rising costs and declining

reimbursement. However, there is a point where the economics of running a practice

will force physicians to institute changes to limit the damage from continued Medicare payment cuts. Like any small business, revenue must exceed the costs of providing services in order for a practice to remain financially viable. For practices that

are heavily dependent on Medicare revenue, such as a typical internal medicine

practice, the reduction of 5.4 percent in 2002 and the additional reductions that are

planned through 2005 force primary care providers to take preventive steps to cut

their losses from seeing large numbers of Medicare patients.

Physicians will have essentially only four options available to them to offset the

losses from declining Medicare payments and rising costs. They can reduce their reliance on Medicare revenue by decreasing the share of practice revenue that comes

from Medicare while increasing the share that comes from more reliable (non-Medicare) payers. This would be accomplished by putting limits on how many Medicare

patients will be seen while marketing the practice to non-Medicare populations.

They can cut costs—eliminating beneficial services and technology. They can do

both: cut beneficial services and reduce their reliance on Medicare. Or they can go

out of business, by closing their practices entirely.
88

1This indication is in addition to the indication of chronic renal failure, including patients on

dialysis and patient not on dialysis, which was the indication Aranesp® was originally approved

for in 2001.

We believe that it is very likely that physicians will be forced to limit the number

of Medicare patients in their practice; lay off staff that help Medicare patients with

appointments or medications; relocate to areas with a younger, non-Medicare eligible patients; spend less time with Medicare patients; discontinue participation in

the Medicare program; limit or discontinue investment in new technology; limit or

discontinue charitable care; or in some cases, retire or close their practices. Physicians will make such changes reluctantly, but the laws of economics will leave them

no choice but to do so.

The effects of the most recent and projected cuts in reimbursement will most likely be hardest felt in rural and other areas that are already underserved. The problems that we see today will certainly only get worse unless the severely flawed

methodology utilized by Medicare to compute physician payments is immediately

addressed.

Physicians’ efforts to reduce their reliance on an unstable and unreliable Medicare

payment system will make it even more difficult for patients to gain access to an

increasingly under-funded health care system, particularly as the number of Medicare patients increases from 34 million today, to 40 million in 2010, to 60 million

in 2030. More Medicare beneficiaries will be seeking care, yet fewer and fewer physicians will be able and willing to provide care to Medicare patients. As Medicare

is increasingly viewed as an unreliable payer whose reimbursement does not cover

the costs of providing services, young physicians will be disinclined to go into specialties that are viewed as being heavily dependent on Medicare—particularly internal medicine and geriatrics—at the time when those specialties should be most in

demand to provide care to an aging population.

CONCLUSION

ACP–ASIM urges members of the Subcommittee to help retain in the final conference report the Senate provisions in the Omnibus Appropriations bill to halt the

4.4 percent decrease in Medicare reimbursement. Our organization stands ready to

work with Congress to make constructive and lasting improvements to the Medicare

program.

AMGEN ARANESP® DATA SUBMISSIONS TO CMS

In July of 2002 the FDA granted approval to Aranesp® (darbepoetin alfa) when

used for the treatment of anemia in patients with non-myeloid malignancies where

anemia is due to the effect of concomitantly administered chemotherapy.1 The label

recognized 2.25 mcg/kg/week as the starting dose for this indication, and the clinical

studies section of the label recognized the minimum effective starting dose as 1.5

mcg/kg/week. The label also states that ‘‘Due to the longer serum half-life,

Aranesp® should be dosed less frequently than Epoetin alfa.’’ In addition, the USPDI updated the monograph for Aranesp® at this same time to indicate that the 1.5

mcg/week to 3.0 mcg/kg every other week (Q2W) is an effective dosing paradigm.

Based upon the newly approved label for Aranesp® for the treatment of chemotherapy induced anemia (CIA), and the fact that Amgen learned that CMS had

questions regarding the cost of Aranesp as compared to Epoetin alfa, Amgen initiated a series of meetings with CMS.

The information provided to CMS as part of these meetings refutes specific sections of Tom Scully’s testimony provided to Senator Specter during the Medicare

hearing on January 30. Specifically, Amgen provided data substantiating that

Aranesp® dosed at 200 meg Q2W is less expensive than Epoetin alfa and represents

a cost savings to the Medicare program.

Aranesp® Dosed at 200 mm Q2W is less expensive than Epoetin Alfa at 40,000

units weekly.—At the hearing on January 30, Tom Scully stated that CMS pays

more for Aranesp® than it does for Epoetin alfa in the physician office setting. The

quote is as follows: ‘‘We [CMS] right now pay about $1422 every two weeks for

Aranesp® and we pay about $1,200 every two weeks for Procrit®.’’ Amgen disagrees

with this statement.

From September of 2002 through and including February of 2003, Amgen has provided consistent data to CMS supporting the fact that the dose of Aranesp® most

commonly used for the treatment of CIA is 200 mcg Q2W, and that this dosing paradigm is cost effective as compared to Epoetin alfa. The wealth of evidence sup-
89

2Surveillance Data Inc. (SDI) claims consist of claims from U.S. physician offices.

3Mirtching et al, Oncology 2002.

4 Blood 2002 (Supplement), abstract #3447.

porting the fact that Aranesp® is a cost effective alternative to Epoetin alfa has increased significantly each month and has been supplied to CMS.

The data supplied to CMS includes:

—USP–DI monograph supporting 1.5 mcg/kg/week–3.0 mcg/kg Q2W.

—SDI claims data 2 demonstrating that in a review of over 6,000 claims, 89 percent of providers dose Aranesp® in CIA at 200 mcg Q2W.

—Clinical trial data for Aranesp® demonstrating that the 200 mcg Q2W dose of

Aranesp® is efficacious as compared to 40,000 units of Epoetin alfa.3

—Clinical data invited to be presented at ASH 2002 demonstrating that

Aranesp® 3.0 mcg/kg (200 mcg) administered Q2W is cost-effective compared to

Epoetin alfa administered weekly (40,000U/week). The authors conclude that

Aranesp® is 11–13 percent less expensive than Epoetin alfa while providing

similar efficacy.4

Physician Office

Hospital

outpatient

department

Aranesp®:

Reimbursement .............................................................................................................. $4.74 $2.37

Common Dose (mcg Q2W) ............................................................................................. 200 200

Weekly Reimbursement .................................................................................................. $948/2=$474 $474/2=$237

Epoetin alfa:

Reimbursement .............................................................................................................. $12.69 $9.10

Common dose (units QW) .............................................................................................. 40,000 40,000

Weekly Reimbursement .................................................................................................. $507.60 $364

Savings (percent) .................................................................................................................... 7 35

QUESTIONS SUBMITTED BY SENATOR MARY L. LANDRIEU

Question. Was the term ‘‘functional equivalence’’ introduced in the proposed rulemaking? If so, would you please highlight the appropriate reference from the notice

of proposed rulemaking?

Answer. Functional equivalence is a term CMS developed as a result of comments

received during the comment period on the notice of proposed rulemaking on the

2003 update for Medicare’s outpatient prospective payment system to describe the

relationship between Aranesp and Procrit. As we explain in the final rule, it became

apparent that darbepoetin alfa, while not structurally identical to epoetin alfa, uses

the same biological mechanism to create the same clinical effect in the body. To encapsulate this phenomenon, we used the term ‘‘functional equivalence.’’

Question. What, if any, opportunity did interested parties have to comment of the

new standard?

Answer. First, we would note that the term ‘‘functional equivalence’’ is not a

standard, but a descriptive term used to capture a relationship between two drugs.

As you may know, the comment period is a vital part of the process we use to issue

every regulation. We place high value on all comments we received from interested

parties. In fact, it was through comments received during the comment period on

the proposed rule regarding the relationship between Aranesp and Procrit that led

us to employ the term ‘‘functional equivalence.’’

Question. Do you believe the ‘‘functional equivalence’’ standard requires any consideration of ‘‘quality-of-life’’ issues such as frequency of administration?

Answer. We would remain open to the possibility that quality-of-life issues may

affect how we address payments for similar drugs in the future. However, as to

these two drugs and the circumstances in which they are administered, we believe

there is not a significant impact with regard to quality of life. As we noted in the

final rule, the relationship between darbepoetin alfa and epoetin alfa is unusual in

the strong similarity of the two drugs.

Question. What assurances can you give biotechnology firms that the ill-defined

‘‘functional equivalence’’ standard won’t be used to deny ‘‘pass-through’’ status for

their new product?

Answer. We consider the situation of darbepoetin alfa and epoetin alfa to be unusual. In the final rule we note that the situation related to darbepoetin alfa and

epoetin alfa is distinguished by the very strong similarity of the two products and

by the potential effects on the Medicare program. Thus, if a similar situation arises
90

in the future, we might consider whether to determine two drugs to be functionally

equivalent, but we do not anticipate such a situation would be at all common.

CONCLUSION OF HEARING

Senator SPECTER. Thank you all very much for being here. That

concludes our hearing.

[Whereupon, at 12:21 p.m., Thursday, January 30, the hearing

was concluded, and the subcommittee was recessed, to reconvene

subject to the call of the Chair.]

Æ