United States General Accounting Office 

GAO Testimony 

Before the Subcommittee on Health, Committee on Energy 

and Commerce, House of Representatives 

For Release on Delivery 

Expected at 8:30 a.m. 

Thursday, February 14, 2002 

MEDICARE PHYSICIAN 

PAYMENTS 

Spending Targets 

Encourage Fiscal 

Discipline, Modifications 

Could Stabilize Fees 

Statement of William J. Scanlon 

Director, Health Care Issues 

a

GAO-02-441T

Mr. Chairman and Members of the Subcommittee: 

I am pleased to be here today as you discuss modifications to Medicare’s 

method for updating its payments to physicians, which in 2001 totaled 

about $41 billion.

1 As you know, more than a decade ago to control rapid 

increases in Medicare spending for physician services, the Congress 

implemented a physician fee schedule and a fee update formula to 

moderate spending growth relative to specified spending targets. These 

spending targets increase annually to account for growth in the costs of 

providing physician services, the growth in the overall economy, and 

changes in the number of Medicare beneficiaries, while physician fees are 

adjusted for changes in the costs of providing services and how actual 

cumulative spending compares to the cumulative targets. In November 

2001, however, the Centers for Medicare and Medicaid Services (CMS) 

announced that updating Medicare’s fees for 2002 with this formula will 

cause the fees to decline 5.4 percent from what was paid in 2001.2 The 

Congress has been concerned that fluctuations in physician payments and 

payment reductions may over the long run jeopardize beneficiary access to 

physician services. As a result, it asked the Medicare Payment Advisory 

Commission (MedPAC), which advises the Congress on Medicare payment 

issues, to study the possibility of eliminating spending targets and 

modifying the method for updating physician fees. 

As you consider refinements to Medicare’s method of updating physician 

payments, it is important to remain mindful of the need to ensure 

Medicare’s sustainability for future generations of beneficiaries. In view of 

the coming surge in the Medicare-eligible population through the aging of 

the baby boom generation, projected program spending threatens to 

absorb ever-increasing shares of the nation’s budgetary and economic 

resources. Furthermore, the slowdown in Medicare spending growth we 

saw in recent years appears to have ended. At the same time, the fiscal 

discipline imposed on provider payments continues to be challenged, and 

interest in modernizing the Medicare benefit package to include 

1

The $41 billion represents total Medicare payments to physicians, excluding beneficiary 

cost sharing. This statement refers to both calendar and fiscal years. We will use “fiscal 

year” where appropriate; other references to years, except where noted, are to calendar 

years. 

2

Until June 2001, CMS was known as the Health Care Financing Administration (HCFA). We 

will continue to refer to HCFA when referring to the organizational structure and operations 

associated with that name. 

Page 1 GAO-02-441T 
prescription drug coverage and catastrophic protection has increased. 

Together, these developments will impede efforts to achieve the fiscal 

restraint that the Comptroller General and others have warned is essential 

to the program’s sustainability. 

In the context of these broader interests, I will discuss (1) Medicare’s use of 

spending targets as a means of moderating the growth in physician service 

expenditures, (2) the factors used in computing those targets that resulted 

in the reduced fees for 2002, and (3) adjustments to determining and 

applying spending targets that could moderate swings in physician fees, 

while ensuring payments are adequate to maintain physicians’ ability to 

provide high-quality care to Medicare beneficiaries. My comments are 

based on previous and ongoing work on Medicare spending trends and 

Medicare payment methods, including the physician fee schedule. 

In brief, moderating Medicare’s spending growth on physician services 

while setting payment rates adequate to ensure beneficiary access to care 

is not a straightforward matter. Medicare spending on physician services 

grew rapidly through the 1980s, at an average annual rate of more than 12 

percent, even though physician fees were subject to some limits. The 

spending growth was driven by increases in the volume of services 

provided to each beneficiary and by increases in the intensity of services 

provided.3 Recognizing that expenditure growth of this magnitude was not 

sustainable, the Congress attempted to impose fiscal discipline through a 

physician fee schedule and a payment update mechanism that incorporates 

spending targets. Physician fees are updated to reflect the increased costs 

of providing services with the updates adjusted up or down depending on 

whether actual spending has fallen below or exceeded the targets. The 

targets themselves are adjusted annually to account for changes in the 

costs of providing services, the number of Medicare beneficiaries, and the 

gross domestic product (GDP). Since the introduction of this fee system in 

1992, annual increases in the volume and intensity of services provided per 

beneficiary have moderated significantly. In 2002 the system resulted in 

Medicare’s physician fees being reduced 5.4 percent below the fees paid in 

2001, despite an estimated 2.6 percent increase in the cost of physician 

inputs.4 This reduction is to account for historical cumulative spending 

that exceeded the target by $8.9 billion, or 13 percent of estimated 2002 

3

The intensity of services is the quantity and quality of resources used in providing them. 

4

Inputs for physicians’ services are, for example, staff salaries and overhead. 

Page 2 GAO-02-441T 
spending. Several factors contributed to the disparity between actual and 

targeted spending, including the correction of substantial errors in past 

spending estimates and the revision of targets for prior years. The current 

update mechanism could be modified to moderate fluctuations in physician 

fees and to ensure adequate payments, while retaining the fiscal discipline 

created by having a spending target. Such modifications would need to 

balance concerns about preserving fiscal discipline on physician spending 

with the need to maintain adequate payment rates to ensure that 

beneficiaries have access to physician services. Because the paramount 

consideration in setting payment rates is ensuring appropriate beneficiary 

access to services, timely and detailed data on Medicare beneficiary service 

use are essential to achieving this balance. 

Background	 Total Medicare spending for physician services depends on actual payment 

rates, the volume of services provided, and the mix of those services. 

Medicare spending goes up when the price paid to physicians for each 

service increases, when the number of services provided rises, or when 

more intensive, and therefore more expensive, services replace less 

intensive ones. 

Since 1992, Medicare has paid for physician services using a fee schedule. 

The fee for each service is a dollar conversion factor, adjusted to reflect the 

resources required for that service relative to the resources required to 

provide all other physician services, and the differences in the costs of 

providing services across geographic areas. 

Along with the fee schedule, the Congress enacted a system of spending 

targets designed to control growth in total spending for physicians’ 

services. The Sustainable Growth Rate (SGR) system was created in the 

Balanced Budget Act of 1997 and revised in the Medicare, Medicaid, and 

SCHIP Balanced Budget Refinement Act of 1999 (BBRA).

5 It replaced the 

first system of spending targets, implemented in 1992, known as the 

Volume Performance Standard. The SGR system sets spending targets for 

physician services and adjusts payment rates to bring spending in line with 

those targets. The SGR target for total spending is based on spending in an 

initial, or base, year and the estimated growth in real per capita GDP each 

5

Pub. L. No. 105-33 § 4503, 11 Stat. 251, 433 (to be codified at 42 U.S.C. § 1395w-4(f)). Pub. L. 

No. 106-113, Appendix F, § 211, 113 Stat. 1501, 1501A-345 (to be codified at 42 U.S.C. 1395W4)). 

Page 3 GAO-02-441T 
year and three other factors that affect overall spending on physician 

services—the changes in the cost of inputs used to produce physicians’ 

services (as measured by the Medicare Economic Index (MEI)), the 

number of Medicare beneficiaries in the traditional fee-for-service program, 

and expenditures that result from changes in laws or regulations. 

The spending target for physician payments is applied by incorporating it 

into the adjustment to the conversion factor that determines the payment 

amount per service. The conversion factor is determined annually by 

adjusting the previous year’s conversion factor by the change in the MEI, to 

account for the cost of inputs for physician services, and adjusting this 

product on the basis of the relationship between the cumulative SGR target 

and Medicare physician spending. The conversion factor update is greater 

than the MEI when physician spending has been below the targets and is 

less than the MEI when physician spending has been higher. 

Spending Targets 

Established to 

Moderate Rapid Rise in 

Outlays for Physician 

Services 

In response to escalating Medicare expenditures, the Congress made major 

changes in Medicare payment policies, beginning first by enacting the 

hospital inpatient prospective payment system, which was implemented in 

1983, and then the Medicare physician fee schedule, implemented in 1992. 

When enacting the fee schedule, the Congress recognized that setting fees 

alone would not sufficiently restrain physician spending growth. Despite 

some constraints on physician fees since the 1970s, spending on physician 

services had grown dramatically in the 1980s as a result of increases in the 

volume and intensity of services provided. The Congress, therefore, 

provided that annual physician fee increases would depend upon whether 

total Medicare physician spending exceeded or fell short of cumulative 

spending targets. Since the implementation of the fee schedule and 

spending targets, the rise in Medicare spending for physician services has 

slowed significantly, reflecting lower growth in the volume and intensity of 

these services. 

Spending on Physician Before the physician fee schedule was implemented, Medicare payments 

Services Grew Rapidly for physicians’ services were largely based on historical charges. Although 

Before 1992 during the 1970s the Congress introduced some controls on annual 

payment rate increases, Medicare spending for physician services 

continued to rise. This was also true in the 1980s—between 1980 and 1990, 

for example, Medicare spending per beneficiary for physician services 

Page 4 GAO-02-441T 
grew at an average annual rate of more than 12 percent, tripling from $278 

to $890 (see fig. 1). 

Figure 1: Medicare Spending for Physicians’ Services, per Beneficiary, 1975-1990 

1,000 Medicare spending in dollars 

900 

800 

700 

600 

500 

400 

300 

200 

100 

0 

$135.45 

$278.30 

$548.36 

$889.57 

1975 1980 1985 1990 

Note: Amounts represent Medicare spending, net of beneficiary cost sharing, for the year ending June 

30. 

Sources: Board of Trustees, Federal Supplementary Medical Insurance Trust Fund, 1998 Annual 

Report of the Board of Trustees of the Federal Supplementary Medical Insurance Trust Fund 

(Washington, D.C.: Apr. 28, 1998), pp. 51-2; and HCFA, A Profile of Medicare: Chartbook 1998 

(Washington, D.C.: 1998), p. 64. 

Much of the spending growth resulted from increases in the volume of 

services provided to each beneficiary and the substitution of more 

intensive and expensive services for less intensive and expensive ones. 

The Physician Payment Review Commission, which was charged with 

advising the Congress on Medicare physician payment issues, observed, 

“[b]y the late 1980s. . . volume and intensity growth had become the 

primary cause of higher program spending. In fact, from 1986 until 1992, 

while physician payment rates grew by less than 2 percent annually, the 

volume and intensity of services rose by almost 8 percent per year.”

6 

6

Physician Payment Review Commission, 1995 Annual Report to Congress (Washington, 

D.C.: Physician Payment Review Commission, 1995). 

Page 5 GAO-02-441T 
The Congressional Budget Office in 1986 stated that “[b]oth the price and 

the volume of services must be controlled to constrain costs . . ..”

7 

Spending targets were needed to limit growth in volume and intensity of 

physician services. In 1989 testimony, Health and Human Services 

Secretary Louis W. Sullivan said “Medicare physician spending has 

increased at compound annual rates of 16 percent over the past 10 years. 

And in spite of our best efforts to control volume and reign in expenditures, 

Medicare physician spending is currently out of control. . . An expenditure 

target. . . sets an acceptable level of growth in the volume and intensity of 

physician services.”

8 

Spending Targets Created 

Incentives to Moderate 

Growth in Volume and 

Intensity of Services 

The Congress introduced spending targets for physician services in 

conjunction with the physician fee schedule in 1992 to help constrain the 

rise in Medicare spending for physician services. The targets incorporated 

limited growth in the volume and intensity of services and were revised 

each year based on estimates of changes in the number of Medicare 

beneficiaries and physician input prices. If actual spending exceeded the 

targeted amounts, future payment rates would be reduced, relative to what 

they would have been if actual spending had equaled the targets, to offset 

the excess spending. If actual spending fell short of the targets, future 

payment rates would be increased. 

Since 1992, the growth in the volume and intensity of physicians’ services 

per Medicare beneficiary has moderated (see fig. 2). Between 1992 and 

2000, the average annual increase in Medicare spending due to changes in 

volume and intensity of services per beneficiary was about 2 percent. In 

contrast, between 1985 and 1991, immediately before the introduction of 

spending targets, volume and intensity of services per beneficiary 

increased at an average annual rate of about 8 percent. 

7

Congressional Budget Office, Physician Reimbursement Under Medicare: Options for 

Change (Washington, D.C.: Apr. 1986). 

8

Testimony before the Subcommittee on Medicare and Long-term Care, Committee on 

Finance, U.S. Senate, 101st Congress, 1st Session (June 16, 1989). 

Page 6 GAO-02-441T 
Figure 2: Changes in Volume and Intensity of Medicare Physician Services, per 

Beneficiary, 1975-2000 

10 Percentage change 9.7 

4.5 

8.3 

3.7 

7.6 

3.9 

6.5 

9.0 

0.2 

0.8 

4.1 

3.6 

2.8 2.5 

3.0 

-0.2 

0.6 

The application of the SGR system in 2002 resulted in a 5.4 percent 

reduction in physician payment rates, despite an estimated 2.6 percent 

increase in the costs of inputs used to provide physician services. The 

reduction occurred because estimated cumulative physician services 

spending since 1996 exceeded the target for cumulative spending by 

approximately $8.9 billion, or 13 percent of projected 2002 spending. In 

part, the payment update reflects adjustments made to the spending targets 

for previous years for revisions in GDP estimates and for more accurate 

actual spending statistics. Correcting these errors in previous years’ 

targets and spending totals to reflect more recent data resulted in larger 

physician payment increases in those years than if accurate data had been 

used, and they contributed to the size of the reduction in payments in 2002. 

The SGR system sets spending targets for physician services and adjusts 

payment rates to bring spending in line with those targets. Conceptually, if 

spending equals the targeted amount, physician payment rates are updated 

to keep pace with the percentage change in input prices as measured by the 

9.4 

9 

8 

7 

6 

5 

4 

3 

2 

1 

0 

-1 1975 1980 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 

Notes: Data are for beneficiaries in the traditional fee-for-service program only. 

From 1975 through 1995, volume and intensity of services changes are based on Medicare outlays for 

all physician services. From 1996 through 2000, volume and intensity of services changes are based 

on Medicare outlays for physician services covered by the fee schedule. 

Sources: 1998 Annual Report of the Board of Trustees of the Federal Supplementary Medical 

Insurance Trust Fund, pp. 51-2; A Profile of Medicare:Chartbook 1998, p. 64; and 2001 Annual Report 

of the Board of Trustees of the Federal Supplementary Medical Insurance Trust Fund, 

http://www.hcfa.gov/pubforms/tr/smi2001/tabiig2.htm accessed Feb. 9, 2002. 

Several Factors 

Associated With 2002 

Fee Reductions 

Page 7 GAO-02-441T 
MEI. If spending exceeds the target, the change in payment rates is smaller 

than the change in input prices. If spending falls short of the target, 

payment rates are allowed to grow faster than the rise in input prices. By 

adjusting payment rates when prior-year spending has been too high, the 

SGR system moderates the growth in Medicare outlays for physician 

services. 

The SGR adjustments to the input price update are determined by how 

much the cumulative physician spending since 1996 differs from the 

cumulative spending target since then. Spending and targets must both be 

estimated from information available each November when payment rates 

are set for the following year. Previously, those estimates were then used 

in subsequent years. Based on requirements in the BBRA, however, HCFA 

implemented a process for revising the most recent two years of spending 

and target estimates. Because the annual targets are determined by 

changes in four factors—the number of fee-for-service beneficiaries, real 

per capita GDP, input costs, and the effect of changes in laws or 

regulations—a revision to any of those factors, or to estimates of prior 

spending, can change the spending estimate. The SGR adjustments to the 

input price update can then take effect because of growth in the volume or 

intensity of services delivered, resulting in spending deviating from targets, 

or because of revised estimates for prior years’ targets and spending. 

In setting payment rates for 2002, CMS updated its estimates of past 

spending and recalculated past targets. The net effect of both revisions 

indicated that Medicare outlays were an estimated $8.9 billion too high. 

The SGR is designed to recover this excess amount by lowering payment 

rates in 2002 and future years. CMS’ original estimates of spending since 

1998 were too low, in part because the agency had not included all 

appropriate claims in making these estimates. The original spending 

targets for 2000 and 2001 were too high, largely because the Bureau of 

Economic Analysis in the Department of Commerce revised its GDP and 

GDP growth estimates for those years. 

To some extent, the reduction in payment rates this year corrects for 

inaccuracies in previous estimates that produced physician fees that were 

too high in 2000 and 2001. In both years, payment rates increased by more 

than the change in input prices because the information available at the 

time those rates were established suggested that physician spending had 

been held below the targets. In 2000, payment rates increased 5.4 percent, 

while input costs increased 2.4 percent; in 2001, payment rates increased 

4.5 percent, while input costs increased by 2.1 percent. The reason that 

Page 8 GAO-02-441T 
2002 payment rates fall 5.4 percent while input prices increase by 2.6 

percent is that the revised estimates revealed that spending exceeded the 

targets in previous years. The reduction would have been almost 4 

percentage points greater, but the SGR system limits how much fees can be 

adjusted for the differences between actual and target spending. 

Avoiding Large Several measures could moderate the fluctuations in physician payment 

rates. Although these modifications to the SGR could mitigate the possible Payment Swings in impact of rate instability or reductions in beneficiary access to needed 

System Based on services, doing so could also lessen the ability of spending targets to 

Spending Targets encourage fiscal discipline. Available data indicate that access is adequate, 

but more timely and detailed information is critical to promptly recognize 

potential deteriorations in access. 

Moderating Fluctuations in 

Physician Payment Rates 

The SGR system is designed to limit the fluctuations in payment rates, but 

its design could be modified to achieve greater rate stability. The BBRA 

specified that adjustment to realign spending with the targets cannot cause 

payments to fall by more than 7 percentage points below, or increase by 

more than 3 percentage points above, the percentage change in input 

prices. In addition, spending deviations from past targets are not corrected 

in a single year but are spread over several years. Greater rate stability 

could be achieved by narrowing the range over which rates could change 

from one year to the next. Similarly, the corrections for spending 

deviations could be spread over longer periods of time. 

Modifying how spending targets are set could also reduce year-to-year 

fluctuations in rates. Currently, the changes in GDP for a single year are 

used to establish the spending target. The difficulty in accurately 

estimating GDP has contributed to the problem of fluctuations in the 

target. In addition, linking annual changes in the targets to annual changes 

in GDP ties the target to the business cycle. GDP growth rates are higher 

during periods of prosperity and lower during downturns—a commonly 

used definition of a recession is a decline in real GDP for two successive 

quarters. But health care needs of Medicare beneficiaries are not cyclical. 

Neither significantly lowering spending targets during a downturn nor 

unduly increasing them in a period of prosperity is appropriate. Linking the 

determination of spending targets to average levels of GDP over several 

years would help eliminate much of the cyclical variation. 

Page 9 GAO-02-441T 
Any changes to the SGR must balance the desire for greater rate stability 

with the need for fiscal discipline. Spending targets create a feedback 

mechanism between physicians’ behavior and payment rate increases. 

However, spending targets do not create direct incentives for any 

individual physician, since it is the collective behavior of all physicians that 

determines the payment adjustments that result from missing the spending 

targets. The primary value of spending targets in instilling fiscal discipline 

is the signal they send that affordability of the program is an important 

concern in establishing Medicare policies. Limiting the size of the payment 

adjustment for missed spending targets or to corrections in prior years’ 

targets, and lengthening the time over which those adjustments are 

incorporated, could partially mute the signal targets send and erode some 

of the fiscal discipline they encourage. On the other hand, excessive rate 

fluctuations can be difficult for providers and may ultimately affect 

beneficiaries’ access to physician services if rate fluctuations cause too 

many providers to decline to participate in the program. 

Monitoring Beneficiary 

Access to Physicians 

Ensuring that the use of spending targets does not compromise appropriate 

access to services is a key concern. Spending targets that are updated 

principally by the growth in GDP and other factors may not reflect fully 

changes in medical care and the markets for these services. It is therefore 

important to monitor service use to assess whether appropriate access for 

beneficiaries is secured, especially if fees are reduced. Such monitoring 

needs to involve recent experience so that if spending targets need 

adjustments, those adjustments are done promptly to ameliorate any 

problems. 

Information on physicians’ willingness to see Medicare patients is dated 

but overall does not indicate access problems. Data from the 1990s show 

that virtually all physicians treated Medicare beneficiaries or if accepting 

new patients, accepted those covered by Medicare. According to data from 

the American Medical Association (AMA), 96.2 percent of all nonfederal 

physicians (excluding residents and pediatricians who do not normally 

serve Medicare patients) treated Medicare beneficiaries in 1996, an 

increase from the 94.2 percent AMA reported in 1994. A 1999 survey 

sponsored by MedPAC found that 93 percent of physicians who were 

accepting any new patients were accepting new patients covered by 

Medicare. 

Payment rate decisions should not be made in a data vacuum. As health 

needs change, technology improves, or health care markets evolve, 

Page 10 GAO-02-441T 
spending targets and resulting payment rates may need to be adjusted 

periodically, not by a formula designed for annual updates, but by 

specifying a new base year target calibrated to ensure appropriate access. 

Payment rates that are too low can impair beneficiary access to physician 

services, while payment rates that are too high add unnecessary financial 

burdens to Medicare. Informed decisions about appropriate payment rates 

and rate changes cannot be made unless policymakers have detailed and 

recent data on beneficiaries’ access to needed services. 

Concluding 

Observations 

The SGR mechanism uses information about physician spending in relation 

to cost increases, changes in the number of beneficiaries, and growth in the 

overall economy to impose fiscal discipline on Medicare outlays for these 

services. This mechanism provides a signal when spending threatens to 

grow out of control and in that sense is analogous to what the Comptroller 

General has called for in testimony on several occasions with regard to the 

entire Medicare program. The demographic changes facing the nation 

require policymakers to look ahead and assess both current and future 

Medicare spending in relation to the entire federal budget and the 

economy—first to understand the urgent need for fiscal discipline, then to 

make choices to ensure the sustainability and affordability of the program. 

A mechanism like the SGR provides a benchmark for assessing the trend in 

physician spending and can prompt actions to bring that spending in line 

with overall program goals. In assessing the options for updating physician 

payments, the program’s prospects for long-term sustainability should be 

paramount. Meeting that challenge will involve difficult decisions that will 

likely affect beneficiaries, providers, and taxpayers. 

This concludes my prepared statement. I would be happy to answer any 

questions that you or Members of the Subcommittee may have. 

GAO Contacts and For more information regarding this testimony, please contact me at (202) 

512-7114 or Laura A. Dummit at (202) 512-7119. James Cosgrove, Kathryn Staff Linehan, Lynn Nonnemaker, and Hannah Fein also made key contributions 

Acknowledgments to this statement. 

(290172) Page 11 GAO-02-441T 
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