Medicare Physician Payments: Information on Spending Trends and Targets
Published: 2004-05-05T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The Sustainable Growth Rate (SGR) system, implemented in 1998 and subsequently revised, is used to update Medicare's physician fees and moderate the growth in Medicare spending for physician services. SGR, and a predecessor system implemented in 1992, were designed to reduce physician fee updates if spending growth exceeded a specified target. Although spending growth slowed substantially under both systems, concerns about SGR arose when the system caused fees to decline by 5.4 percent in 2002. GAO was asked to discuss (1) Medicare physician spending trends both before and after the implementation of spending targets and (2) the evolution and mechanics of the SGR system. This statement is largely based on GAO's previous work on Medicare spending trends and the SGR system.
section_title: What GAO Found
paragraphs: Medicare spending on physician services grew rapidly through the 1980s, at an average annual rate of 13.4 percent, even though physician fee increases were subject to some limits. The spending growth was driven by increases in the number of services provided to each beneficiary--referred to as volume--and an increase in the average complexity and costliness of those services--referred to as intensity. Recognizing that expenditure growth of this magnitude was not sustainable, the Congress attempted to impose fiscal discipline by establishing a system of spending targets for Medicare physician services along with a fee schedule beginning in 1992. Following the introduction of spending targets, volume and intensity growth slowed substantially during the 1990s. In recent years, under the SGR system, volume and intensity growth has increased, but not by the rates experienced during the 1980s before spending targets were in place. SGR, the current system of spending targets, evolved from the target system that went into effect in 1992. Under the SGR system, physician fees are adjusted up or down, depending on whether actual spending has fallen below or has exceeded the target. Fees increase at least as fast as the costs of providing physician services as long as volume and intensity growth remains below a specified rate--currently, a little more than 2 percent a year. If volume and intensity grows faster than the specified rate, SGR lowers fee increases or causes fees to fall. Physicians raised concerns about SGR when fees dropped significantly in 2002, a decline that was, in part, a correction for fees that had been set too high in prior years because of errors in forecast estimates and other data. Congressional action averted fee reductions, and projected fee reductions, for 2003 through 2005. However, beginning in 2006, fees are projected to resume falling for several years, partly to recoup the excess spending accumulated from averted cuts in previous years and partly because real per beneficiary spending on physician services is projected to grow faster than allowed under SGR. A dilemma for policymakers posed by projected fee reductions is that while SGR's automatic responses work as intended from a budgetary perspective, the consequences for physicians and their patients are uncertain.

section_title: Letter
paragraphs: I am pleased to be here today as you discuss the Sustainable Growth Rate  (SGR) system that Medicare uses to update physician fees and moderate  the growth in spending for physician services. As you know, the current  SGR system evolved from the Medicare Volume Performance Standard  (MVPS) system, which, along with a fee schedule for physician services,  was established in 1992. MVPS, and later SGR, were designed to reduce  physician fee updates if spending growth exceeded a specified target.  Under both systems, spending growth slowed substantially. However,  concerns about SGR arose when the system and other factors caused fees  to decline by 5.4 percent in 2002. In February of that year, we testified  before this Subcommittee and discussed the reasons for the fee decline  and potential SGR modifications. Subsequent administrative and  legislative actions modified or overrode the SGR system and resulted in  fee increases for 2003, 2004, and 2005. Absent additional legislative action,  fees are expected to fall by approximately 5 percent each year beginning  in 2006 and continuing through 2012. These projected declines have raised  concerns about the appropriateness of the SGR system for updating  physician fees and physicians’ continued participation in the Medicare  program.
My comments today are intended to describe the current situation  pertaining to physician fees and how we arrived at this juncture.  Specifically, I will discuss (1) Medicare physician spending trends both  before and after the implementation of spending targets and (2) the  evolution and mechanics of the SGR system, explaining how it is designed  to help control spending growth. My testimony is based on our previous  work on Medicare spending trends and the SGR system—updated to  include recent information on spending, fees, and projections—and was  prepared during April 2004 according to generally accepted government  auditing standards. In our February 2002 testimony, we discussed the need  to maintain fiscal discipline to help ensure the long-term sustainability of  the Medicare program for future generations. The Medicare Prescription  Drug, Improvement, and Modernization Act of 2003 (MMA) requires us to  study the appropriateness of the factors used in SGR and consider  alternatives to the system. Our work on that study is currently underway.
We look forward to working with the Subcommittee and others in  Congress as policymakers seek to ensure appropriate physician payments.
In summary, Medicare spending on physician services grew rapidly  through the 1980s, at an average annual rate of 13.4 percent, even though  physician fee increases were subject to some limits. The spending growth  was driven by increases in the number of services provided to each  beneficiary—referred to as volume—and an increase in the average  complexity and costliness of those services—referred to as intensity.  Recognizing that expenditure growth of this magnitude was not  sustainable, the Congress attempted to impose fiscal discipline by  requiring the establishment of spending targets for Medicare physician  services along with a fee schedule beginning in 1992. Following the  introduction of spending targets, volume and intensity growth slowed  substantially during the 1990s. In recent years, under the SGR system,  volume and intensity growth has increased, but not by the rates  experienced during the 1980s before spending targets were in place.
SGR, the current system of spending targets, evolved from the target  system that went into effect in 1992. Under the SGR system, physician fee  updates are adjusted up or down, depending on whether actual spending  has fallen below or has exceeded the target. Over time, fees tend to  increase at least as fast as the costs of providing physician services as long  as volume and intensity growth remains below a specified rate—currently,  a little more than 2 percent a year. If volume and intensity grows faster  than the specified rate, SGR lowers fee increases or causes fees to fall.  Physicians raised concerns about SGR when fees dropped significantly in  2002, a decline that was, in part, a correction for fees that had been set too  high in prior years because of errors in forecast estimates and other data.  Congressional action averted fee reductions, and projected fee reductions,  for 2003 through 2005. However, beginning in 2006, fees are projected to  resume falling for several years, partly to recoup the excess spending  accumulated from averted cuts in previous years and partly because real  per beneficiary spending on physician services is projected to grow faster  than allowed under SGR. The dilemma for policymakers posed by  projected fee reductions is that while SGR’s automatic responses work as  intended from a budgetary perspective, the consequences for physicians  and their patients are uncertain.
subsections: section_title: Background
paragraphs: The Omnibus Budget Reconciliation Act of 1989 (OBRA 1989) reformed  the way Medicare pays for physician services in the traditional fee-for- service (FFS) program. OBRA 1989 required the establishment of a  physician fee schedule and a system of spending growth targets, known as  MVPS, that became effective in 1992. In 1998, the SGR system of spending  targets replaced MVPS. Both spending target systems were designed to  moderate growth in the volume and intensity of services provided to  beneficiaries.
Prior to the establishment of the fee schedule, Medicare payment rates for  physician services were based on historical charges for these services.  The establishment of a fee schedule was an attempt to break the link  between physicians’ charges and Medicare payments. The fee schedule  was not designed to reduce spending levels overall but to redistribute  payments for services based on the relative resources used by physicians  to provide different types of care. Under the fee schedule, Medicare pays  for more than 7,000 physician services.  To arrive at Medicare’s fee, the  service’s relative value is multiplied by a dollar conversion factor.
Currently, under SGR, the Centers for Medicare & Medicaid Services  (CMS), the agency that administers Medicare, uses the dollar conversion  factor to calculate Medicare fees and updates the conversion factor each  calendar year to account for the change in the cost of providing physician  services (as measured by the Medicare Economic Index (MEI)), adjusted  for the extent to which actual spending aligns with spending targets. Fee  updates represent the aggregate of increases and decreases across all  services; the fees for specific services may rise or fall each year.
section_title: Medicare Spending for Physician Services Grew Rapidly in 1980s, Slowed After Implementation of Spending Targets
paragraphs: In 1980, Medicare spending for physician services totaled $7.5 billion. (See  fig. 1.) By 2003, Medicare spending on these services totaled $47.9 billion.  During much of this period, increases in both the volume and intensity of  services physicians provided to each beneficiary were an important factor  in spending growth.
subsections: section_title: In 1980s, Spending for Physician Services Grew Rapidly
paragraphs: Before the physician fee schedule was implemented, Medicare payments  for physician services were largely based on historical charges.  Experience in the 1980s repeated the experience of the prior decade: the  Congress froze fees or limited fee increases, but spending continued to  rise. From 1980 through 1991, for example, Medicare spending per  beneficiary for physician services grew at an average annual rate of about  11.6 percent. (See fig. 2.)
Total Medicare spending for physician services depends on the fee paid for  each service, the number of beneficiaries served, the number of services  provided to each beneficiary (volume), and the mix of those services—that  is, the combination of more and less expensive services (intensity). Of  these factors, physicians directly influence only the volume and intensity  of services provided to beneficiaries.
Much of the spending growth resulted from increases in the volume and  intensity of services. For example, from 1986 until 1992, physician  payment rates grew by less than 2 percent annually, while the volume and  intensity of services rose, on average, by almost 8 percent per year. In  1986, the Congressional Budget Office stated that “oth the price and the  volume of services must be controlled to constrain costs….” In 1989,  citing the need for spending targets to limit spending growth for physician  services, the Secretary of Health and Human Services (HHS) testified that  “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 rein 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: In 1990s, Growth in Spending on Physician Services Slowed Under Spending Target Systems
paragraphs: Annual spending growth during the 1990s was far lower than in the  preceding 10 years. Beginning in 1992, the Congress introduced spending  targets for physician services to help constrain the rise in Medicare  spending for physician services. Unlike prior attempts to control spending,  spending target systems sought to limit the growth in the volume and  intensity of services each year.
From 1992 until 1999, the growth in the volume and intensity of physician  services per Medicare beneficiary moderated. (See fig. 3.) During this time  period, the average annual increase in Medicare spending due to changes  in volume and intensity of services per beneficiary was about 1 percent, in  contrast with the average annual growth of about 7 percent in the period  from 1985 through 1991.
The moderation of volume and intensity growth slowed the rate of  increase in spending on physician services. This spending grew from $25.6  billion in 1992 to $36.9 billion in 2000an average annual rate of 4.7  percent. In contrast, from 1985 through 1991, total spending increased at  an average annual rate of about 10.8 percent.
section_title: In 2000s, Spending Growth for Physician Services Rose but Remained Lower than Rates in the 1980s
paragraphs: Beginning in 2000, the growth in volume and intensity of services per  Medicare beneficiary began to rise, although the average annual rate of  growth remained substantially below that experienced before spending  targets were introduced. From 2000 to 2003, volume and intensity rose at  an average annual rate of 5 percent. CMS actuaries project an average  annual growth in volume and intensity of 3 percent from 2004 through  2013. Total spending on physician services is projected to grow by an  average of 8 percent a year from 2000 through 2005.
section_title: Under SGR and Prior System, Physician Fee Updates Are Mechanism To Bring Actual Spending in Line with Spending Targets
paragraphs: A target for spending on physician services serves as a budgetary control  by automatically lowering fee updates in response to excess volume and  intensity growth. Under Medicare’s SGR spending target system and its  MVPS predecessor, physician fees are adjusted annually to help bring  actual spending in line with spending targets. Projected increases in  volume and intensity, beyond what the current SGR targets allow, are  expected to contribute to annual fee reductions for several years as the  system tries to align spending with targets.
subsections: section_title: SGR System Evolved from Spending Target System Introduced with Physician Fee Schedule in 1992
paragraphs: The SGR system evolved from the MVPS system of spending targets, which  was introduced with the physician fee schedule in 1992. The goal of MVPS  was to provide an incentive for physicians to reduce volume and intensity  growth and thus slow the high annual rate of increase in expenditures.  Under MVPS, if a year’s actual spending growth exceeded the target,  future payment rates would be reduced, relative to what they would have  been if actual spending had equaled the target, to offset the excess  spending. If a year’s actual spending growth fell short of the target, future  payment rates would be increased.
Concerns about the MVPS spending target prompted the Congress to  create SGR’s system of spending targets. In its 1996 report to Congress,  the Physician Payment Review Commission noted that, under MVPS,  physician fees would fall over time unless there were continual declines in  the volume and intensity of services provided. In response to the system’s  perceived shortcomings, the Congress took action in 1997 to replace it  with the SGR system.
section_title: SGR System Differs From Prior System in Important Ways
paragraphs: The SGR system was created in the Balanced Budget Act of 1997 (BBA)  and revised by the Medicare, Medicaid, and SCHIP Balanced Budget  Refinement Act of 1999 (BBRA) and, most recently, by MMA. Similar to  MVPS, SGR sets spending targets for physician services and updates fees  to bring spending in line with those targets. Under the SGR system, if  spending exceeds the target, future fee updates are reduced. If spending  falls short of the target, future fee updates are increased. By adjusting fees  when prior-year spending has deviated from the target, SGR attempts to  moderate the growth in total Medicare outlays for physician services.
Specifically, the SGR formula establishes expenditure targets as follows:  from a base year—1996—the targets are updated each year to account  for four factors: (1) changes in the number of Medicare beneficiaries in  traditional fee-for-service; (2) growth in the costs of providing physician  services, laboratory tests, and Medicare-covered outpatient prescription  drugs; (3) growth in the overall economy, as measured by changes in real  per capita gross domestic product (GDP); and (4) changes in expenditures  that result from changes in laws or regulations. Spending and targets are  estimated from data available in the fall, when CMS sets physician fees for  the next calendar year. Because SGR spending targets are cumulative, the  target set for a specific year is affected by the targets set in all prior years.  BBRA required CMS, in calculating each year’s SGR spending target and  fee update, to revise the targets set for the two previous years using the  most recent available data.
SGR differs from MVPS in two key ways. The first relates to volume and  intensity growth limits. MVPS relied, in part, on historical trends in volume  and intensity growth to set new targets each year, whereas SGR ties  allowable volume and intensity increases to the growth in real GDP per  capita. Under SGR, real spending per beneficiary—that is, spending  adjusted for the underlying cost of providing physician services—is  allowed to grow at the same rate that the national economy grows over  time on a per-capita basis—currently projected to be about 2 percent  annually. If volume and intensity grow faster, the annual increase in  physician fees will be less than the estimated increase in the cost of  providing services. Conversely, if volume and intensity grow more slowly  than 2 percent annually, the SGR system permits physicians to benefit  from fee increases that exceed the increased cost of providing services. To  reduce the effect of business cycles on physician fees, economic growth is  measured as the 10-year moving average change in real per capita GDP.  This measure is projected to range from 2.1 percent to 2.5 percent during  the 2005 through 2014 period.
A second difference is that MVPS compared target and actual expenditures  in a single year, whereas SGR compares targets and actual expenditures  cumulatively from a base year. The cumulative nature of SGR’s spending  targets increases the potential volatility of physician fee updates because  the system requires that excess spending in any year be recouped in future  years. Conceptually, this means that if spending has exceeded the SGR  targets, fee updates in future years must be lowered sufficiently to offset  the excess spending. Conversely, the system also requires that if spending  has fallen short of the targets, fees must be increased to boost future  spending.
SGR limits how much fees can be adjusted when spending has missed the  target. SGR’s performance adjustment may decrease fees by as much as 7  percentage points below the percentage change in MEI when spending has  exceeded the target and may increase fees by as much as 3 percentage  points above the percentage change in MEI when spending has fallen short  of the target. SGR adjustments to the fees are determined by how much  the cumulative amount of spending on physician services since 1996  differs from the cumulative spending target since that base year.
section_title: Legislative Action Temporarily Avoided Fee Declines; Fees Projected to Decline Beginning in 2006
paragraphs: Since the introduction of the fee schedule in 1992 through 2001, physicians  generally experienced real increases in their fees—that is, fees increased  more than the increase in the cost of providing physician services, as  measured by MEI. Specifically, during that period, fees increased by 39.7  percent, whereas MEI increased by 25.9 percent. In 2002, however, SGR  reduced fees by 4.8 percent, despite an estimated 2.6 percent increase in  the costs of providing physician services. (See fig. 4.)
SGR reduced fees in 2002 because estimated spending for physician  services—cumulative since 1996—exceeded the target by approximately  $8.9 billion, or 13 percent of projected 2002 spending. In part, the fee  reduction occurred because CMS revised upward its estimates of previous  years’ actual spending. Specifically, CMS found that its previous estimates  had omitted a portion of actual spending for 1998, 1999, and 2000. In  addition, in 2002 CMS lowered the 2 previous years’ spending targets  based on revised GDP data from the Department of Commerce. Based on  the new higher spending estimates and lower targets, CMS determined  that fees had been too high in 2000 and 2001. In setting the 2002 physician  fees, the SGR system reduced fees to recoup previous excess spending.  The update would have been about negative 9 percent if the SGR system  had not limited its decrease to 7 percentage points below MEI. Because  the previous overpayments were not fully recouped in 2002, and because  of volume and intensity increases, by 2003, physicians were facing several  more years of fee reductions to bring cumulative Medicare spending on  physician services in line with cumulative targets.
However, CMS had determined that its authority to revise previous  spending targets was limited. In 2002 CMS noted that the 1998 and 1999  spending targets had been based on estimated growth rates for beneficiary  fee-for-service enrollment and real per capita GDP that actual experience  had shown to be too low. If the estimates could have been revised, the  targets for those and subsequent years would have been increased.  However, at the time that CMS acknowledged these errors, the agency  concluded that it was not allowed to revise these estimates. Without such  revisions, the cumulative spending targets remained lower than if errors  had not been made.
In late 2002, the estimate of SGR called for a negative 4.4 percent fee  update in 2003. With the passage of the Consolidated Appropriations  Resolution of 2003, CMS determined that it was authorized to correct the  1998 and 1999 spending targets. Because SGR targets are cumulative  measures, these corrections resulted in an average 1.4 percent increase in  physician fees for services for 2003.
In 2003, MMA averted additional fee reductions projected for 2004 and  2005 by specifying an update to physician fees of no less than 1.5 percent  for 2004 and 2005. The MMA increases replaced SGR fee reductions of 4.5  percent in 2004 and an estimated 3.6 percent in 2005. Because MMA did  not make corresponding revisions to SGR’s spending targets, SGR will  reduce fees beginning in 2006, to offset the additional spending caused by  MMA’s fee increases. In addition, recent growth in volume and intensity,  which has been larger than SGR targets allow, will further compound the  problem of excess spending that needs to be recouped.
The 2004 Medicare Trustees Report announced that the projected  physician update would be about negative 5 percent for 7 consecutive  years beginning in 2006; the result is a cumulative reduction in physician  fees of more than 31 percent from 2005 to 2012, while physicians’ costs of  providing services, as measured by MEI, are projected to rise by 19  percent.
section_title: Concluding Observations
paragraphs: To a large extent, the physician fee cuts projected by Medicare’s Trustees  are required under SGR’s system of cumulative spending targets to make  up for excess spending in earlier years. MMA added to the excess spending  by specifying minimum fee updates for 2004 and 2005 without resetting the  spending targets for those years. As a result, physician fee cuts were  postponed, not avoided.
In considering the projected fee cuts, however, it is important to recall that  Congress originally established Medicare spending targets for physician  services in response to runaway spending in the 1980s. The recent increase  in volume and intensity growth suggests that Medicare faces a  fundamental physician spending growth problem even if the SGR slate of  missed spending targets were somehow wiped clean. Currently, projected  Medicare spending for physician services exceeds what policymakers have  specified—through the parameters of the SGR system—is the appropriate  amount to spend. Because of expected increases in the volume and  intensity of services provided by physicians, real spending per beneficiary  is projected to grow by more than 3 percent per year. SGR, designed to  promote fiscal discipline, allows such spending to grow by just over 2  percent per year. If the growth in real spending per beneficiary is not  lowered through other means, SGR will mechanically reduce fee updates  in an attempt to impose fiscal discipline and moderate total spending  increases. Although this mechanical response may be desirable from a  budgetary perspective, any consequences for physicians and their patients  are uncertain.
Mr. Chairman, this concludes my prepared statement. I will be happy to  answer questions you or other Subcommittee Members may have.
section_title: Contact and Acknowledgments
paragraphs: For further information regarding this testimony, please contact A. Bruce  Steinwald at (202) 512-7101. James Cosgrove, Jessica Farb, Hannah Fein,  and Jennifer Podulka contributed to this statement.
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