Short-Term Fixes to the Sustainable Growth Rate Process . 2.2 Physician Payment Policy

Over time, a variety of policy measures designed to help contain costs has been incorporated into the Medicare program.  But policymakers have also demonstrated concerns with maintaining efficiencies and not introducing policies with incentives that distort the health care system and lead to undesirable distributional outcomes.  Prospective payment systems have been implemented to help contain costs and eliminate inefficiencies of previous payment systems based not on relative costs, but on historical charge patterns.  These systems revolutionized how Medicare payments for hospital care and physician services are determined, and more recently how payments for home health care, nursing home care, and hospital outpatient services are determined.   

Under the Medicare Fee Schedule (MFS), each service is assigned its relative value unit (RVU), a measure of resources used to produce the service.  A conversion factor (CF) was used to convert RVUs to dollar payment amounts.  Payments were updated over time by updating the CF.  When the MFS was first implemented, payment updates were determined by the Volume Performance Standard (VPS) process.  VPS was designed so that if the volume of services grew beyond a target amount (with adjustments for factors such as the effect of changes in laws and regulations), the annual update to the physician fee schedule would be less than the rate of inflation, and vice versa if volume grew more slowly than the target.  Under the VPS system, the Secretary of Health and Human Services established a target rate of growth in the volume of physician services.  The conceptual design of the VPS system was that physician payments would be reduced if service volume rose too rapidly to adequately control program cost, giving the physician community as a whole an incentive to avoid increasing services to compensate for any payment changes.  The performance measure setting process took several factors into account, including growth and productivity of the economy at large, and changes in laws and regulations affecting the Medicare program.  Initially, a single performance standard and update were employed.  For several years in the mid-1990’s, separate targets were used to produce separate updates for medical and surgical services, and then for E&M services.

The VPS system contained costs reasonably well for the first several years, but over time it exhibited a degree of instability that was projected to lead to wide swings in updates from one year to the next.  In addition, some criticized the VPS system for failing to set strong incentives for individual physicians to modify their own behavior.  An individual physician’s impact on program spending is minimal, and it was difficult, therefore, to convince physicians to take actions that would have collective consequences on the annual update.  Furthermore, the use of multiple updates over time distorted relative values, defeating the purpose of the resource-based MFS.  This happened because resource content across services is measured by differences in the service’s relative values.  Payment for a service is calculated by multiplying the service’s relative value by the conversion factor.  If there is more than one conversion factor, payment will vary by both resource content and the conversion factor used to calculate the payment.

The VPS was replaced with the SGR process, following passage of the Balanced Budget Act of 1997.  As was VPS, the SGR process was designed to allow for increases in Medicare payments while ensuring that growth in aggregate spending would be contained.⁴  Unlike the VPS when it was replaced, the SGR system produces a single update.

Figure 2.  Calculating the SGR for the CY 2006 Physician Payment Update

For CY 2006:

2005 Conversion Factor: $37.8972
MEI Factor: 1.0290
Update Adjustment Factor (UAF) By formula: 0.9300
Other Adjustments (Laws and Regulations): 0.9985
Total Update Factor (= MEI x UAF x Other): 0.9555
2006 Conversion Factor: $ 36.2121
2006 Conversion Factor after Congressional intervention: $37.8972

CMS, Office of the Actuary, “Estimated Sustainable Growth Rate and Conversion Factor, for Medicare Payments to Physicians in 2002,” http://www.hcfa.gov/pubforms/actuary/sgr, March 19, 2001.

The payment update calculation updates the MFS CF annually.  The update reflects changes in the cost of providing care, the update adjustment factor (UAF), and other adjustments (Figure 2).  The cost of providing care is measured by the MEI.  The UAF adjusts for previous over-/under-spending relative to targets set in previous years.  Other adjustments include adjustments to payments deemed necessary or required by CMS, e.g., to implement fixes in the resource-based relative value scale in a budget-neutral fashion.   

Conceptually, the SGR⁵ may be viewed as the rate at which physician expenditures under Medicare should increase, ‘should’ referring to CMS’s interpretation of the intent of Congress, which in turn represents—in some sense—society’s statement of how many additional real dollars are to be targeted to cover per capita medical expenses of the elderly.  In actuality, and in the context of program cost containment, the SGR process intends to allow for increases in Medicare payments, but at rates that ensure that growth in aggregate Medicare spending will be contained.  The numerical value of the SGR is determined by how the economy at large is growing, as measured by changes in per capita Gross Domestic Product (GDP), the total number of Part B fee-for-service beneficiaries, the cost of producing services covered by the Medicare Fee Schedule, and laws and regulations governing the Medicare program (bottom frame, Figure 2). 

A key part of the SGR process is the UAF.  The UAF, defined by formula, penalizes/rewards providers for over-/under-spending.  This is the portion of the SGR process that has given rise to recent declines in the payment update.  There are two parts to the formula, which can be written as follows:

UAFt = { 0.75 * [ (targett-1 – actualt-1) / actualt-1 ] }
+ { 0.33 * [ (targetc – actualc) / (actualt-1 *  SGRt) ] }

where

targett-1 is target spending for year t-1;
actualt-1 is actual spending;
targetc is the sum of previous years’ targets (back through part of 1996); and
actualc is the sum of previous years’ actual spending.

The first part of the formula accounts for over-/under-spending in the prior year (year t-1).  Over-/under-spending is expressed as a fraction of spending for the year.  The second part of the formula accounts for cumulated over-/under-spending.  The denominator of the cumulated spending term is spending during the previous year, updated by the current year’s SGR – a measure of next year’s target spending.  Thus, the second term expresses cumulated spending as a fraction of what spending is expected next year if the target is met.  Because the SGR enters the UAF formula, the UAF indirectly depends on those factors that influence the value of the SGR (Figure 2).  The UAF formula’s ‘ingredients’ include the weights attached to the previous and cumulated spending terms (currently, set at 0.75 and 0.33, respectively).  Currently, the UAF has floor and ceiling values that limit its effects: the floor is -0.07 and ceiling is 0.03, a maximum penalty of 7 percent and a maximum reward of 3 percent.

Using calculation of the CF for 2006 as an example of how the SGR process works, the cost of practice factor (measured by MEI as fraction plus 1) was 1.029, indicating that the cost of providing services increased by 2.9 percent over the previous year.  The UAF, 0.9300, means that over-spending in the previous and prior years contributed to a reduction of 7 percent in the CF relative to CY 2005.  In 2005, spending exceeded the target by about $13 billion (target and actual spending were $80.4 and $93.3 billion, respectively), about 14 percent of 2005 spending.  Cumulated spending exceeded the cumulated target by $30.7 billion (cumulated spending and target amounts were $611.8 and $642.5 billion, respectively), and cumulated overspending was about 32 percent of 2005 spending updated by the SGR.  The value of the UAF, after applying the formula weights, was -0.21, considerably below the floor of -0.07.  Thus, the UAF is 1-0.07, or 0.9300.  The impacts of other adjustments reduced the CF (relative to CY 2005) by another 0.15 percent, so the corresponding factor is 0.9985 (1-0.15).  The CF for CY 2006 was to be the product of the CF for CY 2005, multiplied by the set of factors in Figure 1:

CF2006 = $37.8972 * 1.029 * 0.9300 * 0.9985
        = $37.8972 x 0.9555
        = $36.2121

In other words, the update would be a 4.5 percent reduction in payment, from $37.90 to $36.21 per relative value unit of service.  Congress intervened, however, defining the update to be 0, so CF2006 remained as in CY 2005.

Advocates for SGR reform cite significant flaws with the current process.  First, recent updates have been large and negative, a consequence of over-spending.  A string of negative updates has pressured Congress to intervene legislatively, as large and widespread changes in provider behavior are necessary to overcome the negative impacts on payment updates from the terms of the UAF.  The SGR process as legislated is not sustainable.  As demonstrated below, the update calculated by the original formula has been consistently negative during the last several years and is expected to remain so into the future.  Congressional intervention may be needed annually until the process is changed.

A second flaw is that the target-setting mechanism may not accurately measure desired growth.  Some providers argue that the process does not allow for enough growth to accommodate changes in technology.  For example, some argue that GDP, as the measure of allowance for spending growth, is too low and thus not representative of society’s value of health care relative to other goods and services in the economy.  Some policymakers argue that certain types of services should be exempt from inclusion in the target setting process.  For example, expenditures on certain types of drugs are included, even though physicians have little control over drug pricing.  Others argue that the target should be applied only to services that are responsible for the fastest spending growth, e.g., due to overuse or incentives based on MFS relative values that are not correct measures of resource composition.   

Another set of criticisms has been directed at the presuppositions that target mechanisms implemented at the national level (such as the formula currently in use) generate incentives that will successfully alter behavior of individual providers, and that providers will overlook incentives on individual behavior and practice in a manner that benefits all physicians.  The update process’ lack of transparency makes it difficult for providers and policymakers to understand how behavior might be affected to help contain costs.