must not increase or decrease total Medicare payments. Physicians could, however, experience increases or decreases in their payments from Medicare, depending on the services and procedures they provide. HCFA published a notice of proposed rulemaking in the June 18, 1997, Federal Register describing its proposed revisions to physician practice expense payments. HCFA estimated that its revisions, had they been in effect in fiscal year 1997, would have reallocated $2 billion of the $18 billion of the practice expense component of the Medicare fee schedule that year. The revisions would generally increase Medicare payments to physician specialties that provide more office-based services while decreasing payments to physician specialties that provide primarily hospital-based services. The revisions could also affect physicians’ non-Medicare income, since many other health insurers use the Medicare fee schedule as the basis for their payments. Some physician groups argued that HCFA based its proposed revisions on invalid data and that the reallocations of Medicare payments would be too severe. Subsequently, the Balanced Budget Act of 1997 delayed implementation of the resource-based practice expense revisions until 1999 and required HCFA to publish a revised proposal by May 1, 1998. The act also required us to evaluate the June 1997 proposed revisions, including their potential impact on beneficiary access to care. HCFA faced significant challenges in revising the practice expense component of the fee schedule—perhaps more challenging than the task of estimating the physician work associated with each procedure. Practice expenses involve multiple items, such as the wages and salaries of receptionists, nurses, and technicians employed by the physician; the cost of office equipment such as examining tables, instruments, and diagnostic equipment; the cost of supplies such as face masks and wound dressings; and the cost of billing services and office space. Practice expenses are also expected to vary significantly. For example, a general practice physician in a solo practice may have different expenses than a physician in a group practice. For most physician practices, the total of supply, equipment, and nonphysician labor expenses is probably readily available. However, Medicare pays physicians by procedure, such as a skin biopsy; therefore, HCFA had to develop a way to estimate the portion of practice expenses associated with each procedure—information that is not readily available. representative sample of physician practices. However, the feasibility of completing such an enormous data collection task within reasonable time and cost constraints is doubtful, as evidenced by HCFA’s unsuccessful attempt to survey 5,000 practices. After considering this option and the limitations of survey data already gathered by other organizations, HCFA decided to use expert panels to estimate the relative resources associated with medical procedures and convened 15 specialty-specific clinical practice expense panels (CPEP). Each panel included 12 to 15 members; about half the members of each panel were physicians, and the remaining members were practice administrators and nonphysician clinicians such as nurses. HCFA provided national medical specialty societies an opportunity to nominate the panelists, and panel members represented over 60 specialties and subspecialties. Each panel was asked to estimate the practice expenses associated with selected procedure codes. Some codes, called “redundant codes,” were assigned to two or more CPEPs so that HCFA and its contractor could analyze differences in the estimates developed by the various panels. For example, HCFA included the repair of a disk in the lower back among the procedures reviewed by both the orthopedic and neurosurgery panels. We believe that HCFA’s use of expert panels is a reasonable method for estimating the direct labor and other direct practice expenses associated with medical services and procedures. We explored alternative primary data-gathering approaches, such as mailing out surveys, using existing survey data, and gathering data on-site, and we concluded that each of those approaches has practical limitations that preclude their use as reasonable alternatives to HCFA’s use of expert panels. Gathering data directly from a limited number of physician practices would, however, be a useful external validity check on HCFA’s proposed practice expense revisions and would also help HCFA identify refinements needed during phase-in of the fee schedule revisions. HCFA staff believed that each of the CPEPs developed reasonable relative rankings of their assigned procedure codes. However, they also believed that the CPEP estimates needed to be adjusted to convert them to a common scale, eliminate certain inappropriate expenses, and align the panels’ estimates with data on aggregate practice expenses. While we agree with the intent of these adjustments, we identified methodological weaknesses with some and a lack of supporting data with others. HCFA staff found that labor estimates varied across CPEPs for the same procedures and therefore used an adjustment process referred to as “linking” to convert the different labor estimates to a common scale. HCFA’s linking process used a statistical model to reconcile significant differences between various panels’ estimates for the same procedure (for example, hernia repair). HCFA used linking factors derived from its model to adjust CPEP’s estimates. HCFA’s linking model works best when the estimates from different CPEPs follow certain patterns; however, we found that, in some cases, the CPEP data deviated considerably from these patterns and that there are technical weaknesses in the model that raise questions about the linking factors HCFA used. HCFA applied two sets of edits to the direct expense data in order to eliminate inappropriate or unreasonable expenses: one based on policy considerations, the other to correct for certain estimates HCFA considered to be unreasonable. The most controversial policy edit concerned HCFA’s elimination of nearly all expenses related to physicians’ staff, primarily nurses, for work they do in hospitals. HCFA excluded these physician practice expenses from the panels’ estimates because, under current Medicare policy, those expenses are covered by payments to hospitals rather than to physicians. We believe that HCFA acted appropriately according to Medicare policy by excluding these expenses. However, shifts in medical practices affecting Medicare’s payments may have resulted in physicians absorbing these expenses. In a notice published in the October 1997 Federal Register, HCFA asked for specific data from physicians, hospitals, and others on this issue. After we completed our field work, HCFA received some limited information, which we have not reviewed. HCFA officials said that they will review that information to determine whether a change in their position is warranted. If additional data indicate that this practice occurs frequently, it would be appropriate for HCFA to determine whether Medicare reimbursements to hospitals and physicians warrant adjustment. HCFA also limited some administrative and clinical labor estimates that it believes are too high. Specifically, HCFA believes that (1) the administrative labor time estimates developed by the CPEPs for many diagnostic tests and minor procedures seemed excessive compared with the administrative labor time estimates for a midlevel office visit; and (2) the clinical labor time estimates for many procedures appeared to be excessive compared with the time physicians spend in performing the procedures. Therefore, HCFA capped the administrative labor time for several categories of services at the level of a midlevel office visit. Furthermore, with certain exceptions, HCFA capped nonphysician clinical labor at 1-1/2 times the number of minutes it takes a physician to perform a procedure. HCFA has not, however, conducted tests or studies that validate the appropriateness of these caps and thus cannot be assured that they are necessary or reasonable. Various physician groups have suggested that HCFA reclassify certain administrative labor activities as indirect expenses. Such a move could eliminate the need for limiting some of the expert panels’ administrative labor estimates, which some observers believe are less reliable than the other estimates they developed. HCFA officials said that they are considering this possibility. Finally, HCFA adjusted the CPEP data so that it was consistent in the aggregate with national practice expense data developed from the American Medical Association’s (AMA) Socioeconomic Monitoring System (SMS) survey—a process that it called “scaling.” HCFA found that the aggregate CPEP estimates for labor, supplies, and equipment each accounted for a different portion of total direct expenses than the SMS data did. For example, labor accounted for 73 percent of total direct expenses in the SMS survey data but only 60 percent of the total direct expenses in the CPEP data. To make the CPEP percentages mirror the SMS survey percentages, HCFA inflated the CPEPs’ labor expenses for each code by 21 percent and the medical supply expenses by 6 percent and deflated the CPEPs’ medical equipment expenses by 61 percent. that supports all or nearly all services provided by a practice, such as an examination table, HCFA assumed a utilization rate of 100 percent. Scaling provided HCFA with a cap on the total amount of practice expenses devoted to equipment that was not dependent upon the equipment rate assumptions HCFA used. While HCFA officials acknowledge that their equipment utilization rate assumptions are not based on actual data, they claim that the assumptions are not significant for most procedures since equipment typically represents only a small fraction of a procedure’s direct expenses. The AMA and other physician groups that we contacted have said, however, that HCFA’s estimates greatly overstate the utilization of most equipment, which results in underestimating equipment expenses used in developing new practice expense fees. HCFA agrees that the equipment utilization rates will affect each medical specialty differently, especially those with high equipment expenses, but HCFA staff have not tested the effects of different utilization rates on the various specialties. In a notice in the October 1997 Federal Register, HCFA asked for copies of any studies or other data showing actual utilization rates of equipment, by procedure code. This is consistent with the Balanced Budget Act of 1997 requirement that HCFA use actual data in setting equipment utilization rates. It is not clear whether beneficiary access to care will be adversely affected by Medicare’s new fee schedule payments for physician practice expenses. This will depend upon such factors as the magnitude of the Medicare payment reductions experienced by different medical specialties, other health insurers’ use of the fee schedule, and fees paid by other purchasers of physician services.