Linking efficiency to physician payment policy has been a subject of interest among policymakers and health policy analysts. For example, the Institute of Medicine has recently recommended that Medicare payment policies should be reformed to include a system for paying health care providers differentially based on how well they meet performance standards for quality or efficiency or both. In April 2005, CMS initiated a demonstration mandated by the Medicare, Medicaid, and SCHIP Benefits Improvement and Protection Act of 2000 (BIPA) to test this approach. Under the Physician Group Practice demonstration, 10 large physician group practices, each comprising at least 200 physicians, are eligible for bonus payments if they meet quality targets and succeed in keeping the total expenditures of their Medicare population below annual targets. Several studies have found that Medicare and other purchasers could realize substantial savings if a portion of patients switched from less efficient to more efficient physicians. The estimates vary according to assumptions about the proportion of beneficiaries changing physicians. In 2003, the Consumer-Purchaser Disclosure Project, a partnership of consumer, labor, and purchaser organizations, asked actuaries and health researchers to estimate the potential savings to Medicare if a small proportion of beneficiaries started using more efficient physicians. The Project reported that Medicare could save between 2 and 4 percent of total costs if 1 out of 10 beneficiaries moved to more efficient physicians. This conclusion is based on information received from one actuarial firm and two academic researchers. One researcher concluded, based on his simulations, that if 5 to 10 percent of Medicare enrollees switched to the most efficient physicians, savings would be 1 to 3 percent of program costs—which would amount to about $5 billion to $14 billion in 2007. The Congress has also recently expressed interest in approaches to constrain the growth of physician spending. The Deficit Reduction Act of 2005 required the Medicare Payment Advisory Commission (MedPAC) to study options for controlling the volume of physicians’ services under Medicare. One approach for applying volume controls that the Congress directed MedPAC to consider is a payment system that takes into account physician outliers. In our report on which this statement is based, we sought information about other purchasers’ profiling efforts designed to encourage physicians to practice efficiently. We selected 10 health care purchasers that profiled physicians in their networks—that is, compared physicians’ performance to an efficiency standard to identify those who practiced inefficiently. To measure efficiency, the purchasers we spoke with generally compared actual spending for physicians’ patients to the expected spending for those same patients, given their clinical and demographic characteristics. Most purchasers said they also evaluated physicians on quality. The purchasers linked their efficiency profiling results and other measures to a range of physician-focused strategies to encourage the efficient provision of care. Some of the purchasers said their profiling efforts produced savings. Having considered the efforts of other health care purchasers in profiling physicians for efficiency, we conducted our own profiling analysis of physician practices in Medicare and found individual physicians who were likely to practice medicine inefficiently in each of 12 metropolitan areas studied. We selected areas that were diverse geographically and in terms of Medicare spending per beneficiary. We focused our analysis on generalists—physicians who described their specialty as general practice, internal medicine, or family practice. Although we did not include specialists in our analysis, our method does not preclude profiling specialists, as long as enough data are available to make meaningful comparisons across physicians. Under our methodology, we computed the percentage of overly expensive patients in each physician’s Medicare practice. To identify overly expensive patients, we grouped the Medicare beneficiaries in the 12 areas according to their health status, using diagnostic and demographic information. We classified beneficiaries as overly expensive if their total Medicare expenditures—for services provided by all health providers, not just physicians—ranked in the top fifth of their health status cohort for 2003 claims. Within each health status cohort, we observed large differences in total Medicare spending across beneficiaries. For example, in one cohort of beneficiaries whose health status was about average, overly expensive beneficiaries—the top fifth ranked by expenditures—had average total expenditures of $24,574, as compared with the cohort’s bottom fifth, averaging $1,155. (See fig. 1.) This variation may reflect differences in the number and type of services provided and ordered by these patients’ physicians as well as factors not under the physicians’ direct control, such as a patient’s response to and compliance with treatment protocols. Holding health status constant, overly expensive beneficiaries accounted for nearly one-half of total Medicare expenditures even though they represented only 20 percent of beneficiaries in our sample. Once these patients were identified and linked to the physicians who treated them, we were able to determine which physicians treated a disproportionate share of these patients compared with their generalist peers in the same location. We classified these physicians as outliers—that is, physicians whose proportions of overly expensive patients would occur by chance less than 1 time in 100. Notably, all physicians had some overly expensive patients in their Medicare practice, but outlier physicians had a much higher percentage of such patients. We concluded that these outlier physicians were likely to be practicing medicine inefficiently. Based on 2003 Medicare claims data, our analysis found outlier generalist physicians in all 12 metropolitan areas we studied. The Miami area had the highest percentage—almost 21 percent—of outlier generalists, followed by the Baton Rouge area at about 11 percent. (See table 1.) Across the other areas, the percentage of outliers ranged from 2 percent to about 6 percent. In 2003, outlier generalists’ Medicare practices were similar to those of other generalists, but the beneficiaries they treated tended to experience higher utilization of certain services. Outlier generalists and other generalists saw similar average numbers of Medicare patients (219 compared with 235) and their patients averaged the same number of office visits (3.7 compared with 3.5). However, after taking into account beneficiary health status and geographic location, we found that beneficiaries who saw an outlier generalist, compared with those who saw other generalists, were 15 percent more likely to have been hospitalized, 57 percent more likely to have been hospitalized multiple times, and 51 percent more likely to have used home health services. By contrast, they were 10 percent less likely to have been admitted to a skilled nursing facility. Medicare’s data-rich environment is conducive to identifying physicians who are likely to practice medicine inefficiently. Fundamental to this effort is the ability to make statistical comparisons that enable health care purchasers to identify physicians practicing outside of established standards. CMS has the tools to make statistically valid comparisons, including comprehensive medical claims information, sufficient numbers of physicians in most areas to construct adequate sample sizes, and methods to adjust for differences in patient health status. Among the resources available to CMS are the following: Comprehensive source of medical claims information. CMS maintains a centralized repository, or database, of all Medicare claims that provides a comprehensive source of information on patients’ Medicare-covered medical encounters. Using claims from the central database, each of which includes the beneficiary’s unique identification number, CMS can identify and link patients to the various types of services they received and to the physicians who treated them. Data samples large enough to ensure meaningful comparisons across physicians. The feasibility of using efficiency measures to compare physicians’ performance depends, in part, on two factors: the availability of enough data on each physician to compute an efficiency measure and numbers of physicians large enough to provide meaningful comparisons. In 2005, Medicare’s 33.6 million FFS enrollees were served by about 618,800 physicians. These figures suggest that CMS has enough clinical and expenditure data to compute efficiency measures for most physicians billing Medicare. Methods to account for differences in patient health status. Because sicker patients are expected to use more health care resources than healthier patients, the health status of patients must be taken into account to make meaningful comparisons among physicians. Medicare has significant experience with risk adjustment, a methodological tool that assigns individuals a health status score based on their diagnoses and demographic characteristics. For example, CMS has used increasingly sophisticated risk adjustment methodologies over the past decade to set payment rates for beneficiaries enrolled in managed care plans. On the related topic of measuring resource use, CMS noted in comments on a draft of our report that emerging “episode grouper” technology was a promising approach to measuring resource use associated with a given episode of care. We agree, but we also consider our measurement of resource use on a per capita basis, capturing total health care expenditures for a given period of time, equally promising. To conduct profiling analyses, CMS would likely make methodological decisions similar to those made by the health care purchasers we interviewed. For example, the health care purchasers we spoke with made choices about whether to profile individual physicians or group practices; which risk adjustment tool was best suited for a purchaser’s physician and enrollee population; whether to measure costs associated with episodes of care or the costs, within a specific time period, associated with the patients in a physician’s practice; and what criteria to use to define inefficient practice patterns. As for ways CMS could use profiling results, actions taken by other health care purchasers we interviewed may be instructive in suggesting future directions for Medicare. For example, all purchasers in our study used physician education as part of their strategy to change behavior. Educational outreach to physicians has been a long-standing and widespread activity in Medicare as a means to change physician behavior based on profiling efforts to identify improper billing practices and potential fraud. Outreach includes letters sent to physicians alerting them to billing practices that are inappropriate. In some cases, physicians are given comparative information on how the physician varies from other physicians in the same specialty or locality with respect to use of a certain service. A physician education effort based on efficiency profiling would therefore not be a foreign concept in Medicare. For example, CMS could provide physicians a report that compares their practice’s efficiency with that of their peers. This would enable physicians to see whether their practice style is outside the norm.