A resource-based, relative-value payment system ranks procedures on a common scale, according to the resources used for the procedure. The need to estimate and rank practice expenses for thousands of medical procedures, coupled with the complex structure of the Medicare program, presented HCFA with some enormous challenges. Cost data for physician practices are available in the aggregate and for individual items, including 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. For most physician practices, the total of each of these 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. Another difficulty inherent in developing a resource-based fee schedule is that significant variations in practice expenses exist among physicians and their practice settings. For example, a general practice physician in a solo practice likely has expenses different from those of a physician in a group practice. Both these problems—the difficulty in allocating expenses to procedures and the variation in expenses among physician practices—are mitigated somewhat by basing the fee schedule allowances on relative rankings of practice expenses. Even though the absolute expenses associated with a procedure cannot be precisely measured and will vary among physicians, the expense of one procedure relative to another is easier to estimate and less likely to vary across physician practices. Because of these issues, revising the practice expense component of the fee schedule has been a difficult task for HCFA, and the revisions HCFA proposed in June 1997 have been the subject of widespread controversy among physician specialty groups. This controversy is not unexpected, since the legislative requirement that fee schedule changes be budget neutral means that some physician specialty groups would benefit from the changes at the expense of other groups. Among the physician specialty groups that we met with, groups representing physicians whose Medicare payments were projected to increase generally supported HCFA’s proposal, while groups whose members’ payments were projected to decrease were far more critical of HCFA’s approach and methodology. In the spring of 1994, HCFA staff and leading researchers discussed potential approaches for developing detailed estimates of the practice expenses associated with each medical procedure. On the basis of these discussions, HCFA decided to use a variety of data gathering and mathematical methods to estimate the direct and indirect practice expenses at the procedure level. HCFA used those estimates as the basis for its June 1997 proposed revision to the physician fee schedule. The key aspects of HCFA’s approach were the use of (1) expert panels to estimate direct costs, (2) a series of HCFA’s own methods to adjust the direct cost estimates, and (3) another HCFA method to allocate indirect expenses to procedures. Since then, HCFA has continued to refine both its data and its methodologies. To estimate the direct expenses for individual procedures, HCFA convened 15 clinical practice expense panels (CPEP), organized by specialty. 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 over 60 specialties and subspecialties were represented on the panels. HCFA and contractor staff identified more than 6,000 procedure codes for which direct expense data would be developed. The contractor arranged these codes into families of clinically related codes. Within each family of codes, the contractor also selected “reference codes” that formed a basis for ranking the other codes within the family. HCFA and its consultants reviewed the contractor’s work and made the family grouping and reference code information available to medical specialty societies for their review and comment. 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. Within each panel, the members attempted to reach consensus on the type and quantity of nonphysician labor, medical equipment, and medical supplies required to perform each procedure. The CPEP members were instructed to base their estimates on the typical patient—the patient who most frequently undergoes a particular procedure—not necessarily a Medicare patient. For example, most women receiving hysterectomies are in their 40s and 50s and are not Medicare patients. Once the CPEPs completed their work, HCFA’s contractor calculated the dollar costs of the labor, medical equipment, and medical supplies that the CPEPs had estimated for each procedure. Nonphysician labor costs were calculated using about 100 occupational categories of clinical and administrative staff. For example, if a CPEP estimated that a procedure required 10 minutes of a registered nurse’s time, the associated cost was calculated from the salaries and benefits paid to registered nurses. For equipment, the contractor estimated costs using the price of the item, an applicable finance rate, and a depreciation schedule for that item based on an assumed utilization rate. For medical supplies, the contractor identified a representative cost for each item on the basis of information from catalogues, suppliers, and CPEP members. For several reasons, HCFA applied a series of adjustments to the direct expenses estimated by the CPEPs. First, HCFA reviewed the data to ensure that the costs arrived at were allowable under Medicare policy and revised the costs where necessary. Next, HCFA used a process called “linking” to convert the direct expense estimates of the different CPEPs to a common scale. HCFA also adjusted the revised estimates for labor, equipment, and supply costs to make them consistent with national practice expense data collected by the American Medical Association (AMA), a process that HCFA called “scaling.” Lastly, HCFA adjusted estimates that appeared to be unreasonable. After making all these adjustments, HCFA used a mathematical process to rank the procedures by direct expenses and convert the rankings into direct expense RVUs. Indirect expenses, such as the cost of general office supplies and utilities, cannot be associated with specific medical procedures; therefore, HCFA had to develop a method to identify and assign indirect expenses to the procedures. HCFA originally intended to survey a random sample of approximately 5,000 physician practices, obtain data on their direct and indirect practice expenses, and use those data to develop a method for allocating indirect expenses. However, HCFA abandoned this effort because few practices responded with the detailed information HCFA requested. After exploring several alternatives, HCFA decided to allocate indirect expenses to procedures on the basis of the physician work, direct practice expense, and malpractice expense RVUs associated with the procedure. Thus, procedures that ranked high in each of these categories were allocated proportionately more indirect expenses. Since publication of the proposed fee schedule revisions, HCFA has been reviewing the comments on its proposal and reexamining its data and methodologies. In October 1997, HCFA convened “validation” panels, composed primarily of physicians, to review the direct costs estimated by the original CPEPs for several hundred procedures and revise those estimates as they believed necessary. In November 1997, HCFA asked representatives of physician groups to review and comment on its methodology for estimating and assigning indirect expenses. Then, in December 1997, HCFA convened a “cross-specialty” panel comprising 38 members nominated by various medical specialty societies. HCFA asked this panel to develop standard time estimates for selected administrative tasks. HCFA officials said they may change the methods they used to convert the direct expense estimates to a common scale as well as the method they used to compute and assign indirect expenses. Ideally, estimates of the relative resources associated with each medical procedure would be based on resource data obtained from a broad, 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. Various medical specialty and physician groups, however, have criticized this methodology. They advocate using other methodologies as the basis for the fee schedule revisions—methodologies that have their own limitations. At this time, HCFA is considering what, if any, changes it will make to the CPEP data before incorporating these data into its next proposed rule. Researchers we contacted who specialize in physician reimbursement issues support HCFA’s use of CPEPs to estimate direct practice expenses. Generally, they believe that bringing together knowledgeable physicians, practice administrators, and clinical staff to identify the direct inputs used in providing a service or procedure is an acceptable, cost-effective approach. The Physician Payment Review Commission (PPRC), which advises the Congress on health care policy issues, also supports HCFA’s approach and asserts that the CPEP process is an adequate way to collect credible direct expense data for use in developing practice expense RVUs. Some of the national medical societies we met with also support the CPEP process. For example, AMA representatives told us that they believe the use of expert panels is an acceptable method for estimating the direct expenses associated with a procedure. Also, American Society of Internal Medicine representatives said that the feedback they received indicated that their members thought the CPEP meetings were an effective way to develop direct expense data for procedures. The American Academy of Family Physicians has also been supportive of HCFA’s use of practice expense panels. Some medical specialty groups have criticized HCFA’s design and implementation of the CPEP process. As discussed below, these criticisms focus on three issues.