Medicare Physician Payments: Spending Targets Encourage Fiscal Discipline, Modifications Could Stabilize Fees
Published: 2002-02-14T00:00:00

Fast Facts:

Highlights:
section_title: What GAO Found
paragraphs: Congress implemented a physician fee schedule and a fee update formula to moderate spending growth relative to specified Medicare spending targets. These spending targets increase annually to reflect higher costs for physician services, the growth in the overall economy, and changes in the number of Medicare beneficiaries. Physician fees are adjusted for changes in the costs of providing services and on actual cumulative spending compared to the cumulative targets. Physician fees are updated to reflect higher costs to provide services. These updates are adjusted up or down on actual spending either falling below or exceeding the targets. In November 2001, the Centers for Medicare and Medicaid announced that updating Medicare's fees will decline 5.4 percent from what was paid in 2001, despite an estimated 2.6 percent increase in the cost of physician inputs. This reduction accounts for historical cumulative spending that exceeded the target by $8.9 billion, or 13 percent of estimated 2002 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.

section_title: Letter
paragraphs: 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. 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.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  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. 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. This reduction is to account for historical cumulative spending  that exceeded the target by $8.9 billion, or 13 percent of estimated 2002  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.
subsections: section_title: Background
paragraphs: 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). 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  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.
section_title: Spending Targets Established to Moderate Rapid Rise in Outlays for Physician Services
paragraphs: 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.
subsections: section_title: Spending on Physician Services Grew Rapidly Before 1992
paragraphs: Before the physician fee schedule was implemented, Medicare payments  for physicians’ services were largely based on historical charges.  Although  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  grew at an average annual rate of more than 12 percent, tripling from $278  to $890 (see fig. 1).
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,  “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.”
The Congressional Budget Office in 1986 stated that “oth the price and  the volume of services must be controlled to constrain costs . . ..”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.”
section_title: Spending Targets Created Incentives to Moderate Growth in Volume and Intensity of Services
paragraphs: 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.
section_title: Several Factors Associated With 2002 Fee Reductions
paragraphs: 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  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  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.
section_title: Avoiding Large Payment Swings in System Based on Spending Targets
paragraphs: Several measures could moderate the fluctuations in physician payment  rates.  Although these modifications to the SGR could mitigate the possible impact of rate instability or reductions in beneficiary access to needed  services, doing so could also lessen the ability of spending targets to  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.
subsections: section_title: Moderating Fluctuations in Physician Payment Rates
paragraphs: 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.
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.
section_title: Monitoring Beneficiary Access to Physicians
paragraphs: 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,  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.
section_title: Concluding Observations
paragraphs: 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.
section_title: GAO Contacts and Staff Acknowledgments
paragraphs: For more information regarding this testimony, please contact me at (202)  512-7114 or Laura A. Dummit at (202) 512-7119.  James Cosgrove, Kathryn Linehan, Lynn Nonnemaker, and Hannah Fein also made key contributions  to this statement.