Medicare Physician Payments: Considerations for Reforming the Sustainable Growth Rate System
Published: 2005-02-10T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Concerns were raised about the system Medicare uses to determine annual changes to physician fees--the sustainable growth rate (SGR) system--when it reduced physician fees by almost 5 percent in 2002. Subsequent administrative and legislative actions modified or overrode the SGR system to avert fee declines in 2003, 2004, and 2005. However, projected fee reductions for 2006 to 2012 have raised new concerns about the SGR system. Policymakers question the appropriateness of the SGR system for updating physician fees and its effect on physicians' continued participation in the Medicare program if fees are permitted to decline. At the same time, there are concerns about the impact of increased spending on the long-term fiscal sustainability of Medicare. GAO was asked to discuss the SGR system. Specifically, this statement addresses the following: (1) how the SGR system is designed to moderate the growth in spending for physician services, (2) why physician fees are projected to decline under the SGR system, and (3) options for revising or replacing the SGR system and their implications for physician fee updates and Medicare spending. This statement is based on GAO's most recent report on the SGR system, Medicare Physician Payments: Concerns about Spending Target System Prompt Interest in Considering Reforms (GAO-05-85).
section_title: What GAO Found
paragraphs: To moderate Medicare spending for physician services, the SGR system sets spending targets and adjusts physician fees based on the extent to which actual spending aligns with specified targets. If growth in the number of services provided to each beneficiary--referred to as volume--and in the average complexity and costliness of services--referred to as intensity--is high enough, spending will exceed the SGR target. While the SGR system allows for some volume and intensity spending growth, this allowance is limited. If such growth exceeds the average growth in the national economy, as measured by the gross domestic product per capita, fee updates are set lower than inflation in the cost of operating a medical practice. A large gap between spending and the target may result in fee reductions. There are two principal reasons why physician fees are projected to decline under the SGR system beginning in 2006. One problem is that projected volume and intensity spending growth exceeds the SGR allowance for such growth. Second, the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (MMA) increased the update for 2004 and 2005--thus increasing spending--but did not raise the spending targets for those years. The SGR system, which is designed to keep spending in line with its targets, must reduce fees beginning in 2006 to offset excess spending attributable to both volume and intensity growth and the MMA provision. In general, proposals to reform Medicare's method for updating physician fees would either (1) eliminate spending targets and establish new considerations for the annual fee updates or (2) retain spending targets, but modify certain aspects of the current system. The first approach emphasizes stable and positive fee updates, while the second approach automatically applies financial brakes whenever spending for physician services exceeds predefined spending targets. Either approach could be complemented by focused efforts to moderate volume and intensity growth directly. As policymakers consider options for updating physician fees, it is important to be mindful of the serious financial challenges facing Medicare and the need to design policies that help ensure the long-term sustainability and affordability of the program.

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. A brief look at the updates  resulting from the SGR system since it was enacted by Congress puts  current concerns in context. From 1999—the first year that the SGR  system was used to update Medicare’s physician fees—through 2001,  annual fee increases ranged from 2.3 percent to 5.5 percent. However, in  2002 the SGR system reduced physician fees by nearly 5 percent. Fee  declines in subsequent years were averted only by new legislation that  modified or temporarily overrode the SGR system. For example, the  Medicare Prescription Drug, Improvement, and Modernization Act of 2003  (MMA) specified a minimum update of 1.5 percent for both 2004 and 2005.  Absent additional administrative or legislative action, however, the SGR  system is projected to reduce fees by about 5 percent per year for several  years beginning in 2006. These projected declines have raised  policymakers’ concerns about the appropriateness of the SGR system for  updating physician fees and about physicians’ continued participation in  the Medicare program. At the same time, there are concerns about  Medicare spending growth and the long-term fiscal sustainability of the  program.
My comments today are intended to describe the issues that Medicare  faces in annually updating physician fees and potential approaches for  addressing those issues. Specifically, I will discuss (1) how the SGR  system is designed to moderate the growth in spending for physician  services, (2) why physician fees are projected to decline under the SGR  system, and (3) options for revising or replacing the SGR system and their  implications for physician fee updates and Medicare spending. My  testimony today is based on the findings contained in our October 2004  report on this subject. This work was performed between January 2004  through September 2004 according to generally accepted government  auditing standards.
In summary, the SGR system is designed to apply financial brakes  whenever spending for physician services exceeds predefined spending  targets. It does this by reducing physician fees or limiting their annual  increase. Historically, efforts that limited fees but did not set spending  targets failed to moderate spending growth. Increases in the number of  services delivered to each beneficiary—known as volume—and the  complexity or costliness of those services—known as intensity—caused  continued increases in spending. The SGR system allows for some volume  and intensity spending growth, but if such growth exceeds the average  growth in the national economy, as measured by the gross domestic  product (GDP) per capita, fee updates are reduced. There are two  principal reasons why physician fees are projected to decline under the  SGR system beginning in 2006. One reason is that projected spending  growth attributable to volume and intensity increases exceeds the SGR  allowance for such growth. The MMA is also partly responsible because it  increased the update for 2004 and 2005—thus increasing spending—but  did not raise the spending targets for those years. The SGR system, which  is designed to keep spending in line with its targets, must reduce fees  beginning in 2006 to offset the excess spending attributable to both  volume and intensity increases and this MMA provision. In general,  proposals to reform Medicare’s method for updating physician fees would  either (1) eliminate spending targets and establish new considerations for  the annual fee updates or (2) retain spending targets, but modify certain  aspects of the current system. Either approach could be complemented by  focused efforts to moderate volume and intensity growth directly.
subsections: section_title: Background
paragraphs: Although the current focus of concern is largely on the potential for  several years of declining physician fees, the historic challenge for  Medicare has been to find ways to moderate the rapid growth in spending  for physician services. Before 1992, the fees that Medicare paid for those  services were largely based on physicians’ historical charges. Spending  for physician services grew rapidly in the 1980s, at a rate that the Secretary  of Health and Human Services (HHS) characterized as out of control.  Although Congress froze fees or limited fee increases, spending continued  to rise because of increases in the volume and intensity of physician  services. From 1980 through 1991, for example, Medicare spending per  beneficiary for physician services grew at an average annual rate of 11.6  percent.
The ineffectiveness of fee controls alone led Congress to reform the way  that Medicare set physician fees. The Omnibus Budget Reconciliation Act  of 1989 (OBRA 1989) established both a national fee schedule and a  system of spending targets, which first affected physician fees in 1992.  From 1992 through 1997, annual spending growth for physician services  was far lower than the previous decade. The decline in spending growth  was the result in large part of slower volume and intensity growth. (See  fig. 1.) Over time, Medicare’s spending target system has been revised and  renamed. The SGR system, Medicare’s current system for updating  physician fees, was established in the Balanced Budget Act of 1997 (BBA)  and was first used to adjust fees in 1999.
Following the implementation of the fee schedule and spending targets in  1992, through 1999, average annual growth in volume and intensity of  service use per beneficiary fell to 1.1 percent. More recently volume and  intensity growth has trended upward, rising at an average annual rate of  about 5 percent from 2000 through 2003. Although this average annual rate  of growth remains substantially below that experienced before spending  targets were introduced, the recent increases in volume and intensity  growth are a reminder that inflationary pressures continue to challenge  efforts to moderate growth in physician expenditures.
section_title: SGR System Designed to Limit or Reduce Physician Fee Updates in Response to Excess Growth in Volume and Intensity
paragraphs: The SGR system establishes spending targets to moderate physician  services spending increases caused by excess growth in volume and  intensity. SGR’s spending targets do not cap expenditures for physician  services. Instead, spending in excess of the target triggers a reduced fee  update or a fee cut. In this way, the SGR system applies financial brakes to  physician services spending and thus serves as an automatic budgetary  control device. In addition, reduced fee updates signal physicians  collectively and Congress that spending due to volume and intensity has  increased more than allowed.
To apply the SGR system, every year the Centers for Medicare & Medicaid  Services (CMS) follows a statutory formula to estimate the allowed rate of  increase in spending for physician services and uses that rate to construct  the spending target for the following calendar year. The sustainable  growth rate is the product of the estimated percentage change in (1) input  prices for physician services;9, 10 (2) the average number of Medicare  beneficiaries in the traditional fee-for-service (FFS) program; (3) national  economic output, as measured by real (inflation-adjusted) GDP per capita;  and (4) expected expenditures for physician services resulting from  changes in laws or regulations. SGR spending targets are cumulative. That  is, the sum of all physician services spending since 1996 is compared to the  sum of all annual targets since the same year to determine whether  spending has fallen short of, equaled, or exceeded the SGR targets. The  use of cumulative targets means, for example, that if actual spending has  exceeded the SGR system targets, fee updates in future years must be  lowered sufficiently both to offset the accumulated excess spending and to  slow expected spending for the coming year.
CMS calculates changes in physician input prices based on the growth in the costs of  providing physician services as measured by the Medicare Economic Index, growth in the  costs of providing laboratory tests as measured by the consumer price index for urban  consumers, and growth in the cost of Medicare Part B prescription drugs included in SGR  spending.
Under the SGR and MVPS systems, the Secretary of Health and Human Services defined  physician services to include “services and supplies incident to physicians’ services,” such  as laboratory tests and most Part B prescription drugs.
Under SGR, spending per beneficiary adjusted for the estimated  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 slightly more than 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, MMA modified the SGR system to  require that economic growth be 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.
When the SGR system was established, GDP growth was seen as a  benchmark that would allow for affordable increases in volume and  intensity. In its 1995 annual report to Congress, the Physician Payment  Review Commission stated that limiting real expenditure growth to 1 or 2  percentage points above GDP would be a “realistic and affordable goal.”  Ultimately, BBA specified the growth rate of GDP alone. This limit was an  indicator of what the 105th Congress thought the nation could afford to  spend on volume and intensity increases.
If cumulative spending on physician services is in line with SGR’s target,  the physician fee schedule update for the next calendar year is set equal to  the estimated increase in the average cost of providing physician services  as measured by the Medicare Economic Index (MEI). If cumulative  spending exceeds the target, the fee update will be less than the change in  MEI or may even be negative. If cumulative spending falls short of the  target, the update will exceed the change in MEI. The SGR system places  bounds on the extent to which fee updates can deviate from MEI. In  general, with an MEI of about 2 percent, the largest allowable fee decrease  would be about 5 percent and the largest fee increase would be about 5  percent.
section_title: Continued Volume and Intensity Growth and Legislated Fee Updates Contribute to Projected Decline in Physician Fees
paragraphs: The 2004 Medicare Trustees Report announced that the projected  physician fee 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. According to projections made by CMS Office of the Actuary  (OACT) in July 2004, maximum fee reductions will be in effect from 2006  through 2012, while fee updates will be positive in 2014. (See fig. 2.) There  are two principal reasons for the projected fee declines: increases in  volume and intensity that exceed the SGR’s allowance—partly as a result  of spending for Part B prescription drugs—and the minimum fee updates  for 2004 and 2005 specified by MMA.
subsections: section_title: Volume and Intensity Growing Rapidly, Partly as a Result of Included Spending for Outpatient Drugs
paragraphs: Recent growth in spending due to volume and intensity increases has been  larger than SGR targets allow, resulting in excess spending that must be  recouped through reduced fee updates. In general, the SGR system allows  physician fee updates to equal or exceed the MEI as long as spending  growth due to volume and intensity increases is no higher than the average  growth in real GDP per capita—about 2.3 percent annually. However, in  July 2004, CMS OACT projected that the volume and intensity of physician  services paid for under the physician fee schedule would grow by   3 percent per year. To offset the resulting excess spending, the SGR  system will have to reduce future physician fee updates.
Additional downward pressure on physician fees arises from the growth in  spending for other Medicare services that are included in the SGR system,  but that are not paid for under the physician fee schedule. Such services  include laboratory tests and many Part B outpatient prescription drugs  that physicians provide to patients. Because physicians influence the  volume of services they provide directly—that is, fee schedule services— as well as these other services, defined by the Secretary of HHS as  “incident to” physician services, expenditures for both types of services  were included when spending targets were introduced. In July 2004, CMS  OACT projected that SGR-covered Part B drug expenditures would grow  more rapidly than other physician service expenditures, thus increasing  the likelihood that future spending would exceed SGR system targets. To  the extent that spending for SGR Part B drugs and other “incident to”  services grows larger as a share of overall SGR spending, additional  pressure is put on fee adjustments to offset excess spending and bring  overall SGR spending in line with the system’s targets. This occurs  because the SGR system attempts to moderate spending only through the  fee schedule, even when the excess spending is caused by expenditures  for “incident to” services, such as Part B drugs, which are not paid for  under the fee schedule.
section_title: MMA’s Minimum Updates for 2004 and 2005 Contribute to Future Physician Fee Cuts
paragraphs: The MMA averted fee reductions projected for 2004 and 2005 by specifying  an update to physician fees of no less than 1.5 percent for those 2 years.  The MMA increases replaced SGR system fee reductions of 4.5 percent in  2004 and 3.3 percent in 2005 and thus will result in additional aggregate  spending. Because MMA did not make corresponding revisions to the SGR  system’s spending targets, the SGR system must offset the additional  spending by reducing fees beginning in 2006.
An examination of the SGR fee update that would have gone into effect in  2005, absent the MMA minimum updates, illustrates the impact of the  system’s cumulative spending targets. To begin with, actual expenditures  under the SGR system in 2004 are estimated to be $84.9 billion, whereas  target expenditures for 2004 were $77.1 billion. As a result, SGR’s 2005 fee  updates would have needed to offset the $7.8 billion deficit from excess  spending in 2004 plus the accumulated excess spending of $5.9 billion  from previous years to realign expected spending with target spending.  Because the SGR system is designed to offset accumulated excess  spending over a period of years, the deficit for 2004 and preceding years  reduces fee updates for multiple years.
section_title: Alternatives for Updating Physician Fees Would Eliminate Spending Targets or Revise Current SGR System
paragraphs: The projected sustained period of declining physician fees and the  potential for beneficiaries’ access to physician services to be disrupted  have heightened interest in alternatives for the current SGR system. In  general, potential alternatives cluster around two approaches. One  approach would end the use of spending targets as a method for updating  physician fees and encouraging fiscal discipline. The other approach  would retain spending targets but modify the current SGR system to  address perceived shortcomings. These modifications include such  options as removing the prescription drug expenditures that are currently  counted in the SGR system; resetting the targets and not requiring the  system to recoup previous excess spending; and raising the allowance for  increased spending due to volume and intensity growth.
The Part B premium amount is adjusted each year so that expected premium revenues  equal 25 percent of expected Part B spending. Beneficiaries must pay coinsurance—usually  20 percent—for most Part B services. physicians appropriately, it is important to consider how modifications or  alterations to the SGR system would affect the long-term sustainability and  affordability of the Medicare program.
subsections: section_title: Eliminate Spending Targets, Base Fee Updates on Physician Cost Increases
paragraphs: See GAO-05-85 for more information about these alternatives.
See Medicare Payment Advisory Commission, Report to the Congress: Medicare Payment  Policy (Washington, D.C.: March 2001, 2002, 2003, and 2004).
MedPAC suggested that other adjustments to the update might be necessary, for example,  to ensure overall payment adequacy, correct for previous MEI forecast errors, and to  address other factors. likely produce fee updates that ranged from 2.1 percent to 2.4 percent over  the period from 2006 through 2014. (See table 1.) However, Medicare  spending for physician services would rise, resulting in cumulative  expenditures that are 22 percent greater over a 10-year period than under  current law, based on CMS OACT estimates. Although MedPAC’s  recommended update approach would limit annual increases in the price  Medicare pays for each service, the approach does not contain an explicit  mechanism for constraining aggregate spending resulting from increases  in the volume and intensity of services physicians provide. In 2004  testimony, MedPAC stated that fee updates for physician services should  not be automatic, but should be informed by changes in beneficiaries’  access to services, the quality of services provided, the appropriateness of  cost increases, and other factors, similar to those that MedPAC takes into  consideration when considering updates for other providers.
section_title: Retain Spending Targets, Modify Current SGR System
paragraphs: Another approach for addressing the perceived shortcoming of the current  SGR system would retain spending targets but modify one or more  elements of the system. The key distinction of this approach, in contrast to  basing updates on MEI, is that fiscal controls designed to moderate  spending would continue to be integral to the system used to update fees.  Although spending for physician services would likely also rise under this  approach, the advantage of retaining spending targets is that the fee  update system would automatically work to moderate spending if volume  and intensity growth began to increase above allowable rates. The SGR  system could be modified in a number of ways: for example, by raising the  allowance for increased spending due to volume and intensity growth;  resetting the base for the spending targets and not requiring the system to  recoup previous excess spending; or removing the prescription drug  expenditures that are currently counted in the SGR system.
subsections: section_title: Increase Allowance for Volume and Intensity Growth
paragraphs: The current SGR system’s allowance for volume and intensity growth  could be increased, through congressional action, by some factor above  the percentage change in real GDP per capita. As stated earlier, the current  SGR system’s allowance for volume and intensity growth is approximately  2.3 percent per year—the 10-year moving average in real GDP per capita— while CMS OACT projected that volume and intensity growth would be  more than 3 percent per year. To offset the increased spending associated  with the higher volume and intensity growth, the SGR system will reduce  updates below the increase in MEI. According to CMS OACT simulations,  increasing the allowance for volume and intensity growth to GDP plus 1  percentage point would likely produce positive fee updates beginning in  2012—2 years earlier than is projected under current law. Because fee  updates would be on average greater than under current law during the 10- year period from 2005 through 2014, Medicare spending for physician  services would rise. CMS OACT estimated that cumulative expenditures  over the 10-year period would increase by 4 percent more than under  current law. (See table 1.)
section_title: Reset Spending Base for Future SGR System Targets
paragraphs: In 2002, we testified that physician spending targets and fees may need to  be adjusted periodically as health needs change, technology improves, or  health care markets evolve. Such adjustments could involve specifying a  new base year from which to set future targets. Currently, the SGR system  uses spending from 1996, trended forward by the sustainable growth rate  computed for each year, to determine allowable spending.
MMA avoided fee declines in 2004 and in 2005 by stipulating a minimum  update of 1.5 percent in each of those 2 years, but the law did not similarly  adjust the spending targets to account for the additional spending that  would result from the minimum update. Consequently, under the SGR  system the additional MMA spending and other accumulated excess  spending will have to be recouped through fee reductions beginning in  2006. If the resulting negative fee updates are considered inappropriately  low, one solution would be, through congressional action, to use actual  spending from a recent year as a basis for setting future SGR system  targets and forgiving the accumulated excess spending attributable to  MMA and other factors. The effect of this action would be to increase  future updates and, as with other alternatives presented here, overall  spending.
According to CMS OACT simulations, forgiving the accumulated excess  spending as of 2005—that is, resetting the cumulative spending target so  that it equals cumulative actual spending—would raise fees in 2006.  However, because volume and intensity growth is projected to exceed the  SGR system’s allowance for such growth, negative updates would return  beginning in 2008 and continue through 2013. Resulting cumulative  spending over the 10-year period from 2005 through 2014 would be 13  percent higher than is projected under current law. (See table 1.)
section_title: Remove Prescription Drugs from the SGR System
paragraphs: The Secretary of HHS could, under current authority, consider excluding  Part B drugs from the definition of services furnished incident to physician  services for purposes of the SGR system. Expenditures for these drugs  have been growing rapidly, which, in turn, has put downward pressure on  the fees paid to Medicare physicians. However, according to CMS OACT  simulations, removing Part B drugs from the SGR system beginning in 2005  would not prevent several years of fee declines and would not decrease  the volatility in the updates. Fees would decline by about 5 percent per  year from 2006 through 2010. There would be positive updates beginning  in 2011—3 years earlier than is projected under current law. (See table 1.)  CMS OACT estimated that removing Part B drugs from the SGR system  would result in cumulative spending over the 10-year period from 2005  through 2014 that is 5 percent higher than is projected under current law.
section_title: Combine Multiple Spending Target Modifications
paragraphs: Together Congress and CMS could implement several modifications to the  SGR system, for example, by increasing the allowance for volume and  intensity growth to GDP plus 1 percentage point, resetting the spending  base for future SGR targets, and removing prescription drugs. According  to CMS OACT simulations, this combination of options would result in  positive updates ranging from 2.2 percent to 2.8 percent for the 2006–2014  period. CMS OACT projected that the combined options would increase  aggregate spending by 23 percent over the 10-year period. (See table 1.)
section_title: Concluding Observations
paragraphs: Medicare faces the challenge of moderating the growth in spending for  physician services while ensuring that physicians are paid fairly so that  beneficiaries have appropriate access to their services. Concerns have  been raised that access to physician services could eventually be  compromised if the SGR system is left unchanged and the projected fee  cuts become a reality. These concerns have prompted policymakers to  consider two broad approaches for updating physician fees. The first  approach—eliminating targets—emphasizes fee stability while the second  approach—retaining and modifying targets—includes an automatic fiscal  brake. Either of the two approaches could be implemented in a way that  would likely generate positive fee updates and each could be accompanied  by separate, focused efforts to moderate volume and intensity growth.  Because multiple years of projected 5 percent fee cuts are incorporated in  Medicare’s budgeting baseline, almost any change to the SGR system is  likely to increase program spending above the baseline. As policymakers  consider options for updating physician fees, it is important to be mindful  of the serious financial challenges facing Medicare and the need to design  policies that help ensure the long-term sustainability and affordability of  the program. We look forward to working with the Subcommittee and  others in Congress as policymakers seek to moderate program spending  growth while ensuring appropriate physician payments.
Madam Chairman, this concludes my prepared statement. I will be happy  to answer questions you or the 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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