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.