Short-Term Fixes to the Sustainable Growth Rate Process . 4.0 Potential Refinements of the SGR

The MEI is a fixed-weight input price index reflecting average annual changes in prices for inputs required to produce physician services, namely the physician’s own time and practice expense.  The MEI is an important ingredient in the SGR process, affecting payment updates in two ways (Figure 2).  The measure is used directly in the calculation of CFs.  The MEI is also used as a measure in the calculation of the fee component of the SGR (which, in turn, is used to calculate target spending levels). 

Under the current SGR formula, the MEI is adjusted for changes in physician productivity over time using a 10-year moving average of a measure of economy-wide multifactor productivity.  Because the MEI is not net of the price effects of improvements in human productivity, for example, the rationale for including the productivity adjustment is to offset the increase in medical care prices that reflect advances in productivity.  Critics of the productivity adjustment argue that the productivity adjustment factor is an inadequate proxy measure of physician productivity.  The measure may be deficient, because it is an economy-wide measure, reflecting input prices for many different types of markets, including non-service markets that differ from health care markets.

Elimination of the productivity adjustment increases the value the MEI.  A larger MEI has a direct effect on the size of the update because the product of the MEI factor and UAF is the main determinant of the payment update (Figure 2 above).  But as noted, a larger MEI also increases the size of the SGR.  This increase affects the payment update in two ways: an increased SGR lowers the size of the prior year penalty in the UAF (as the SGR is in the denominator of the cumulated spending term), and increases the size of spending targets in future years.  The combination of effects of changes in the MEI is positive: payment updates should increase with the MEI.  

To simulate effects of eliminating the productivity adjustment, an unchanging productivity adjustment factor of 0.9 percent from 2007 through 2014 was assumed.  This is the value of the productivity adjustment factor used to calculate the adjusted MEI in 2004 and 2005.  (The value used for 2006 was 1.0.)¹⁰  The CF for 2006 would have been $39.85, 5 percent larger that its current value of $37.90.  Compared to baseline, conversion factors under the simulation would be larger and decline at slightly slower rates through 2014 (Table 8a).  Expected spending with increases in the MEI would by about 1 percent larger than under baseline between 2006 and 2010, and 4 percent larger for 2011 through 2013 (Table 8b).

As indicated in the summary discussion of the current SGR update process, the magnitude of the UAF is a key determinant of the size of Medicare payment updates.  Without the UAF portion of the SGR process, payments would be updated using the MEI.  The UAF is the means by which the update process recovers over-spending.

The UAF used to calculate the CF for year t consists of two parts – a reward/penalty for under-/over-spending during the previous year, and the accumulation of under-/over-spending through the previous year.  The previous-year component is calculated from the amount of under-/over-spending for the previous year as a percent of total spending for the year.  Thus, for example, the previous-year component of the UAF for 2007 is over-spending during 2006 as a percent of 2006 spending.  Using data from Table 9, the previous-year term is 
(target spending - actual spending) / actual spending
= ($81.7 b – $97.4 b) / $97.4 b
= - 0.161.

Thus, over-spending is about 16 percent of actual spending for 2006. 

The portion of the UAF that measures the accumulation of over-/under-spending (hereafter, the “cumulated spending” component) is calculated as the difference between cumulated target and actual spending, as a percent of next year’s spending under “good behavior” – current year spending, increased by the value of the SGR that will be used to calculate target spending for the following year.  For 2006, the cumulated spending component of the UAF is 
(cumulated target spending - accumulated actual spending) / (actual spending * SGR factor)
= ($693.6 b – $741.0 b) / ($97.4 b * 1.007)
= - 0.483.

Thus, cumulated over-spending is about 48 percent of expected spending for 2007.  The total value of the UAF for 2006 is calculated as the sum of the previous-year and accumulation components, after weighting the former by 0.75 and the latter by 0.33, the UAF for 2006 is (-0.161 x 0.75) + (-0.483 x 0.33) = (-0.12) + (-0.16) = -0.28 (the total UAF value in Table 9).  As -0.28 is less than the floor (-0.07), the floor becomes the effective UAF for 2006, and is used to calculate the update for CY 2007.  It is clear from Table 9 that the UAF for spending during years 2007-2013 is expected to be less than the floor.  During these years, actual spending will exceed target spending, the UAF value will be its floor value, and CFs will continue to decline as UAFs more than offset the MEI.

The size of expected future reductions in CFs can be reduced with changes in the structure of the UAF.  In the remainder of this section, effects of changes in UAF floor and relative importance of the previous-year and cumulated spending terms of the UAF are explored.