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[Senate Hearing 108-223]
[From the U.S. Government Publishing Office]

                                                        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
                               __________

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_______________________________________________________________________
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                      COMMITTEE ON APPROPRIATIONS

                     TED STEVENS, Alaska, Chairman
THAD COCHRAN, Mississippi            ROBERT C. BYRD, West Virginia
ARLEN SPECTER, Pennsylvania          DANIEL K. INOUYE, Hawaii
PETE V. DOMENICI, New Mexico         ERNEST F. HOLLINGS, South Carolina
CHRISTOPHER S. BOND, Missouri        PATRICK J. LEAHY, Vermont
MITCH McCONNELL, Kentucky            TOM HARKIN, Iowa
CONRAD BURNS, Montana                BARBARA A. MIKULSKI, Maryland
RICHARD C. SHELBY, Alabama           HARRY REID, Nevada
JUDD GREGG, New Hampshire            HERB KOHL, Wisconsin
ROBERT F. BENNETT, Utah              PATTY MURRAY, Washington
BEN NIGHTHORSE CAMPBELL, Colorado    BYRON L. DORGAN, North Dakota
LARRY CRAIG, Idaho                   DIANNE FEINSTEIN, California
KAY BAILEY HUTCHISON, Texas          RICHARD J. DURBIN, Illinois
MIKE DeWINE, Ohio                    TIM JOHNSON, South Dakota
SAM BROWNBACK, Kansas                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            TOM HARKIN, Iowa
JUDD GREGG, New Hampshire            ERNEST F. HOLLINGS, South Carolina
LARRY CRAIG, Idaho                   DANIEL K. INOUYE, Hawaii
KAY BAILEY HUTCHISON, Texas          HARRY REID, Nevada
TED STEVENS, Alaska                  HERB KOHL, Wisconsin
MIKE DeWINE, Ohio                    PATTY MURRAY, Washington
RICHARD C. SHELBY, Alabama           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

                            C O N T E N T S

                              ----------                              
                                                                   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

          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 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.
    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 understand 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 something 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.
    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.

               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.
    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.
    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 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 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 long-term 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 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 
obviously, 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 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 understand, 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 intensity 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 downward 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 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 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.
    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 will work with me and my 
colleagues from the rural parts of our country to make sure 
that American seniors have access to first-class 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 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 high-quality, 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.
    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 never-ending 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 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 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.
    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, 
Wilkes-Barre 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.
    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 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. 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.
    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 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.
    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-
have-you. 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.
    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.
    [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 well-being 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.
---------------------------------------------------------------------------
    \1\ Gaynor, P., Pittsburgh Post Gazette, page E-2, January 5, 2003.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \2\ Sandy, L.G., New England Journal of Medicine, Volume 347, pp 
1971-75, December 12, 2002.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \3\ Pear R., ``Panel Citing Healthcare Crisis, Presses Bush to 
Act'', New York Times, November 21, 2002.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \4\ Sandy, ibid.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \5\ HAP Update, ``HAP survey shows continuing liability crisis'', 
page 1, November 15, 2002.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \6\ HAP Healthcare Outlook, page 1, November 2002.
    \7\ Bull, J., Pittyburgh Post Gazette, page D2, December 25, 2002.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \8\ HAP Update, page 3, December 13, 2002.
---------------------------------------------------------------------------
    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 
medical teaching programs in Pennsylvania report that their medical 
residents are choosing to continue their practices outside of 
Pennsylvania.\9\
---------------------------------------------------------------------------
    \9\ HAP Healthcare Outlook, page 1, November 2002.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \10\ Albert T., ``Pennsylvania Faces Liability Meltdown,'' AMA 
News, page 4, December 9, 2002.
---------------------------------------------------------------------------
    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.
    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 physicians surveyed in a recent AMA poll said 
they wouldn't sign Medicare participation agreements if pay cuts 
continued.\12\
---------------------------------------------------------------------------
    \11\ Maves, M., MD, MBA, ``AMA Letter to Entire U.S. Senate Urging 
Medicare Payment Update Increase of 3 percent,'' September 16, 2002.
    \12\ Albert, A., ``Delegates rally to knock out cuts in Medicare 
payments'', AMA News, page 2, January 6, 2003.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \13\ New York Tmes, page A14, December 21, 2002.
---------------------------------------------------------------------------
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, 85 
percent of medical students presently graduate with debts averaging 
about $125,000 per student. This debt compounds during their residency 
and later.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
                    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 continuing 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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    (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. 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 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:]
              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 professional 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.

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 $1\1/2\ 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, 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 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?
    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 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 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 
private-practice 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 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.
    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.
    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.
    [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.
---------------------------------------------------------------------------
    \1\ Iowa Hospital Association Profiles/Databank Program, August 
2002.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \2\ Med PAC Report to Congress, March 2002.
    \3\ Med PAC Reports to Congress, March 1999, 2000, 2001, 2002.
---------------------------------------------------------------------------
    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. 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 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.
---------------------------------------------------------------------------
    \4\ Healthcare Financial Management Association, Iowa Chapter, 
October 2002.
    \5\ Med PAC Report to Congress, March 2001.
    \6\ Audited Cost Report Data Files, CMS, 1998-2000.
    \7\ U.S. Bureau of Census.

    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.
    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 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 year-to-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.
    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.
                                 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 guidelines, 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 
Northeastern 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 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.
    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 directions, 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 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            4.6           3.2
 Bed........................................
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 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 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 well-informed 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.
    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.
    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 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 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 
so-called 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 contradicts 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 organization 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 health-care, 
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.
---------------------------------------------------------------------------
    \1\ 67 Fed. Reg. 66718, 66757-59 (Nov. 1, 2002).
---------------------------------------------------------------------------
    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 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 pass-through 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.
---------------------------------------------------------------------------
    \2\ 67 Fed. Reg. at 66757.
    \3\ Id.
    \4\ 5 U.S.C. Sec. 553.
---------------------------------------------------------------------------
    Section 1833(t)(6)(A)(iv) of the Social Security Act (``SSA'') 
establishes pass-through 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.
---------------------------------------------------------------------------
    \5\ 42 U.S.C. Sec. 1395l(t)(6)(A)(iii).
---------------------------------------------------------------------------
    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, 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.
---------------------------------------------------------------------------
    \6\ Medicare Intermediary Manual, Part 3 (CMS-Pub. 13-3), 
Transmittal No. 1717, July 1, 1997.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \7\ 67 Fed. Reg. 52092, 52119 (Aug. 9, 2002).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \8\ http://www.idecpharm.com/site/science/zevalin.htm
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \9\ 67 Fed. Reg. at 66772.
---------------------------------------------------------------------------
    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 packaged 
into the procedure or service for which the drug is integral and 
directly related, unless they were considered to be ``higher cost 
drugs.''
---------------------------------------------------------------------------
    \10\ 67 Fed. Reg. at 52124.
    \11\ Id.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \12\ Id.
    \13\ Id.
    \14\ Medicare Program Memorandum to Intermediaries, Transmittal No. 
A-02-129, January 3, 2003.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \15\ 67 Fed. Reg. at 66772.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \16\ Id.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \17\ Id.
    \18\ Id.
---------------------------------------------------------------------------
    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 payment. 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.
---------------------------------------------------------------------------
    \19\ See 21 U.S.C. Sec. 360ee.
---------------------------------------------------------------------------
    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 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.
---------------------------------------------------------------------------
    \20\ 67 Fed. Reg. at 66752.
    \21\ Id.
    \22\ Id.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \23\ 67 Fed. Reg. at 66769.
---------------------------------------------------------------------------
    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 FDA-
designated 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?
    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.
    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 
pass-through rule.
    Mr. Scully. There is a pass-through rule.
    Senator Specter. And would you define what that pass-
through rule is?
    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 
industry-listed 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.
    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.
    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.
    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.
    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 pass-through, 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 reasonable 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 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 non-elderly 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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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 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 (ACP-ASIM)--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.
                               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 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.
    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 USP-DI 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.
---------------------------------------------------------------------------
    \1\ This 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.
---------------------------------------------------------------------------
    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 supporting 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.
---------------------------------------------------------------------------
    \2\ Surveillance Data Inc. (SDI) claims consist of claims from U.S. 
physician offices.
---------------------------------------------------------------------------
  --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\
---------------------------------------------------------------------------
    \3\ Mirtching et al, Oncology 2002.
---------------------------------------------------------------------------
  --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\
---------------------------------------------------------------------------
    \4\ Blood 2002 (Supplement), abstract #3447.

------------------------------------------------------------------------
                                                             Hospital
                                             Physician      outpatient
                                              Office        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 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.]

                                   - 
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