Short-Term Fixes to the Sustainable Growth Rate Process . Executive Summary

10/30/2006

Purpose:   This report assesses effects of a variety of refinements to the current Sustainable Growth Rate (SGR) Medicare physician payment update process.  A spreadsheet model of the SGR process was developed to examine changes in conversion factors (CFs) and program spending in response to changes in the SGR process, including changes to the SGR formula and changes in the formation and composition of target spending.

Background:  Medicare allowed charges increased from a total of just under $45 billion in 1996 to almost $82 billion in 2004, a 51 percent increase.  While spending on evaluation and management (E&M) services and procedures remained at about 40 percent of total Part B spending, E&M spending as a share of SGR physician services increased from about 45 percent to 48 percent.  In 2004, expenditures for procedures accounted for about 30 percent of total SGR physician spending, and imaging spending accounted for about 17 percent. 

Examination of spending trends over time reveals that changes in intensity – defined as changes in utilization of services or procedures that are not attributable to program size or price – vary over time and by type of service.  Intensity estimates for E&M during the 2000-2004 period averaged about 3.7 percent per year, less than the intensity value for all SGR services combined, 5.5 percent.  By contrast, imaging procedure intensity averaged over 10 percent per year.  Intensity of major procedures (including major surgical procedures that require over-night hospitalization) declined slightly during 2002-2004 by about one-half of one percent per year on average.  Intensity for all other procedures (including minor procedures, endoscopies, and eye procedures) increased an average of 7.1 percent per year. 

The shift away from utilization of major procedures is also revealed from the perspective of site-of-service.  About 62 percent of charges were for services provided in office settings in 2004, whereas services provided in inpatient settings accounted for about 20 percent of Part B allowed charges by physicians.  The share of charges for services provided to inpatients declined by about a third between 1996 and 2004.  The shift of services to the office setting is not strictly due to increases in the provision of E&M services.  In 2004, for every dollar of E&M care provided in an inpatient setting, $2.60 of E&M care was provided in other settings.  But the ratio for non-E&M care was even larger.  Over four times as many allowed charges under Part B were for non-E&M services and procedures provided in non-inpatient settings than in inpatient settings.

While spending patterns vary by type of service, physician payment updates under the current SGR process are based on trends in total spending.  The SGR process consists of three formulas – formulas for the CF, Update Adjustment Factor (UAF), and SGR, the rate used to calculate the spending target from the target for the previous year.  The SGR is based on changes in Gross Domestic Product, practice costs, and the number of Medicare beneficiaries who participate in Part B fee-for-service Medicare.  The CF is calculated from the rate at which the costs of medical practice change each year and the UAF, a reward/penalty for under-/over-spending in past years.  The UAF is set based on the difference between target and actual spending during the previous year, and the difference between target and actual spending levels, cumulated over time.  Under the SGR process, a floor of -7 percent constrains the amount by which the payment update can be reduced by the UAF each year. 

A serious flaw with the SGR process is that recent payment updates have been negative, meaning that the CF used to calculate payment changes over time and associated Medicare payment rates should have declined.  Concerns that reductions in Medicare payments could negatively impact access to care under the Medicare program, however, have resulted in recent Congressional intervention and subsequent revisions to payment updates.

Methods:  A spreadsheet model was constructed for use in examining changes to the SGR payment formula.  The model was first constructed to ensure that its outputs – CFs and spending – were consistent with past experience.  The model was then extended to cover the period 2007-2014.  Data used to construct the model were from various sources compiled by the Center for Medicare and Medicaid Services (CMS), including preliminary and final rules published in the Federal Register, information published in the 2006 Medicare Trustees’ Report, and information available for downloading from the CMS website.  

The model was constructed for study of the separate contribution of certain types of services on the conversion factor and program spending, and for study of refinements to the SGR formula as currently constructed.  Thus, modeling required estimates of various components of physician spending used to calculate the payment update.  Predictions on the level and composition of spending on physician services that enter the SGR process were not available from CMS publications.  Physician/Supplier Procedure Summary Master File (PSPSMF) data (from CMS) for years 1996-2004 were used to study spending for groups of services, e.g., E&M services, imaging procedures, and the remainder of non-E&M services that affect calculation of the SGR update.  Spending shares for these groups of services were calculated from the PSPSMF data and used to estimate spending by service group for the years 2005-2013.

The spreadsheet model was used to study effects of two fundamental types of revisions to the SGR process.  First, effects of changes in various attributes of the SGR formula were studied.  Attributes of interest included: the Medicare Economic Index (MEI), effects of not adjusting the index for economy-wide changes in productivity; and the design of the UAF, effects of changing the UAF floor and the severity of penalties on over-spending in the previous year and cumulated over time. 

Second, effects of several changes in the definition of target spending were studied.  Effects of increases in the SGR were examined.  Spending projections suggest that spending will continue to exceed target spending.  An increase in the size of targets, e.g., to reflect a strengthening of preferences for more health care spending by program beneficiaries over time, should by definition reduce the size of future payment update reductions. 

Another refinement of interest is target-rebasing.  Under the current SGR process, the spending target has been updated since the late-1990s and the UAF penalizes providers for the cumulated difference between actual and target spending levels since that time.  With rebasing, target spending would be reset for the year 2006, thereby affecting calculation of updates beginning with the 2007 update.  Providers would no longer be held accountable for over-spending that has been accumulating for a number of years.  The method of rebasing studied here is to simply set target spending to actual spending for 2006; under this option, the accumulation of over-/under-spending amounts would begin in 2007. 

An attribute of target spending also addressed in this report is the composition of spending that is used by the SGR process in the setting of UAF penalties/rewards.  At present, the UAF is calculated using the total of provider spending on physician services, laboratory tests, and drugs.  Some policymakers and providers have expressed concerns that providers who are affected by updates under the Medicare Fee Schedule have less control over drug and lab prices, and therefore spending, than over prices for physician services.  In fact, baseline drug and lab spending components of SGR spending are expected to increase more rapidly than physician spending in the near future.  Perhaps physician service updates should not be based on drug and lab spending.  In this analysis, effects of deleting drug and lab spending from the update process are studied.

Findings:  An important caveat of this study is that no behavioral responses, on the part of any agents affected by the update process, including providers, Medicare beneficiaries, and Congress, have been incorporated into the structure of the update model.  Thus, no behavioral responses to changes in updates affect simulated effects on future updates and program spending.

In spite of this caveat, a model of the SGR process is a useful source of information on relative magnitudes of effects of changes in the current update process.  Effects of the payment reform options addressed in this report may be summarized from the perspective of an update continuum.  Under the current SGR process, negative payment updates (declining CFs) are expected through 2014.  The UAF formula would penalize over-spending, a consequence of expected total SGR spending levels in excess of target spending levels (bottom, Table ES-1).  At the opposite end of the update continuum is the cost approach, under which the update would be based only on the expected rate of increase in the costs of practice (as measured by the MEI).  The average CF under the cost approach would exceed the average under baseline by 20 percent between 2007 and 2010, and by 60 percent between 2011 and 2014 (top, Table ES-1).   The difference in total program spending between these two extremes is large – about $190 billion, or 27 percent of baseline spending during 2007-2013.

Table ES-1. Payment Reform Continuum
 

2007-'10

2011-'14

Model

CF (Range)

Average
Percent
Change, CF

Spending
(billions)

CF (Range)

Average
Percent
Change, CF

Spending**
(billions)

Cost

$40.13

2.2

$468.5

$43.58

2.2

$433.2

 

($38.88-41.34)

 

 

($42.17-45.06)

 

 

             
Baseline

$33.52

-5.0

$403.4

$27.23

-5.0

$308.5

 

($36.16-30.93)

 

 

($29.34-25.21)

 

 

Notes: Baseline results are based on CFs predicted for years 2007-2014.  Cost model CFs were predicted from the SGR model by basing updates only on the MEI and ‘other’ factors used by CMS; i.e., the UAF is not used in calculating the update for the cost model.  CFs and percent changes are arithmetic averages over the period of interest.  The CF range refers to the values at the beginning and end of the period.  Spending is total SGR spending during the period.  *Target spending amounts rebased to 2006 spending.  **Spending estimates are for years 2011-2013.

The update options that are the focus of this report are positioned within the update continuum bounded by the cost and baseline approaches.  Each offers smaller update reductions than the current SGR process, but at a price – higher spending than baseline, but lower spending than under the cost approach.

Refinements to the SGR Formulas.  The payment update under the current SGR process is calculated as the rate at which the cost of practicing medicine (measured by the MEI) is expected to change, adjusted for past over-/under-spending (measured by the UAF).  Under the current update process, the MEI is adjusted for changes in physician productivity over time.  Because the MEI is not net of the price effects of improvements in human productivity, 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 for productivity by physicians.  Elimination of the productivity adjustment would increase the value of the MEI.  Simulation results confirm that eliminating the productivity adjustment would increase CFs in the future relative to baseline, but these increases would not be enough to result in positive updates in the near future (Model 2, Table ES-2).  Spending for 2006-2013 associated with this refinement would increase by about 3 percent relative to baseline.

The driver of future negative payment updates is the UAF, which penalizes providers for over-spending.  Its rationale is cost-containment.  Through the UAF, CFs are adjusted to help the Medicare program recover a portion of spending in excess of targets.  Simulations indicate that the UAF during years 2007-2013 is expected to be less than the floor, meaning that the UAF itself would contribute -7 percent to the payment update.

Table ES-2. Conversion Factors and Spending Under Selected Payment Update Models
 

2007-'10

2011-'14

 

Model

CF

Average
Percent
Change, CF

Spending
(billions)

CF

Average
Percent
Change, CF

Spending*
(billions)

Spending
Ratio

               
(1) Current process         (baseline)

$33.52

-5.0

$403.4

$27.23

-5.0

$308.5

1.00

 

 

 

 

 

 

 

 

  (2) revised MEI

$34.25

-4.1

$410.5

$28.81

-4.1

$320.8

1.03

 

 

 

 

 

 

 

 

  (3) revised UAF

$34.31

-4.0

$411.2

$30.20

-2.2

$329.5

1.04

 

 

 

 

 

 

 

 

  (4) 0-update floor

$37.84

-0.1

$446.0

$37.82

0.0

$390.0

1.17

Notes: Estimates in this table are from Tables 8a, 8b, 10, 11a, and 11b.  Model (1) estimates are for the current SGR process.  Model (2) estimates are from the baseline model, but after eliminating the productivity adjustment from the MEI.  Model (3) estimates were obtained from the baseline model after revising the UAF; revisions include elimination of the cumulated over-/under-spending term from the UAF, and reduction in the penalty/reward for spending during the previous year by 50 percent.  Model (4) estimates were obtained from the baseline model, but after modifying the floor of the UAF to offset the MEI each year, such that the revised floor is 0.  CFs and percent changes are arithmetic averages over the period of interest.  Spending is total SGR spending during the period.  The Spending Ratio is the ratio of estimated total spending associated with the model to estimated total spending under baseline, Model (1).  *Spending estimates are for years 2011-2013.

Expected future reductions in CFs could be mitigated with changes in the structure of the UAF.  One policy option is to reduce the size of the UAF penalty by eliminating the penalty associated with cumulated over-spending and simultaneously cutting the penalty associated with over-spending in the previous year.  Elimination of the cumulated spending term and a reduction in the penalty/reward associated with over-/under-spending by 50 percent would also help reduce the magnitude of payment reductions, especially after 2010 when the average annual percent change in the update would be -2.2 percent (compared to -5 percent under baseline) (Model 3, Table ES-2). 

Yet another option is to alter the floor of the UAF, essentially ensuring that negative updates do not occur.  Under this 0-update floor, the floor is calculated such that the penalty associated with over-spending is only so large as to offset the MEI’s positive impact on payment changes.  At worst, this floor would result in a zero update.  Simulations indicate that CFs would be stable in the near future, as in most years the 0-update floor would be effective.  Spending for 2006-2013 under this option would increase by 17 percent relative to baseline.

Refinements to Target Spending.  A challenge posed by most of the studied changes to the SGR formula is that payment updates would generally decline (albeit not by as much as under baseline) or fail to increase in the future.  Thus, some Congressional intervention would be likely with these refinements.  Several studied refinements to target spending would yield larger payment updates in the future, but with increased spending.     

The model was used to examine effects of an increased SGR, increased by about one-third to adjust for the tendency for error in estimating past values of the SGR and to account for tastes favoring more health care.  This change, however, would have no effect on future CFs and on program spending through 2013 because increases in target spending are not large enough to offset expected spending increases.

With target rebasing (so that the 2007 update is calculated by setting the target for 2006 to the level of actual spending in 2006), CFs would decline from 2008 to 2012 but exceed baseline levels due to an initial update increase for 2007 (Model 1 in Table ES-3).  Spending would be higher than under baseline by 6 percent during 2007-2010.  The CF would begin to increase by 2013, contributing to a 12 percent increase in spending over baseline during 2011-2013.

Table ES-3. Conversion Factors and Spending Under Selected Rebased Update Models
 

2007-'10

2011-'14

 

Model

CF

Average
Percent
Change,
CF

Spending
(billions)

CF

Average
Percent
Change,
CF

Spending*
(billions)

Spending,
Ratio

Rebased Spending

  (1) basic model

$36.24

-3.0

$429.6

$32.47

-0.6

$345.4

1.09

 

 

 

 

 

 

 

 

  (2) less drug and lab spending

$36.68

-2.2

$434.0

$35.19

1.0

$366.0

1.12

 

 

 

 

 

 

 

 

  (3) with revised SGRs

$38.29

0.1

$450.2

$41.61

4.0

$413.3

1.21

 

 

 

 

 

 

 

 

  (4) with revised UAF

$38.78

0.6

$455.0

$41.60

3.2

$414.7

1.22

Notes: Estimates in this table are from Tables 13a, 13b, 14a, 14b, 15a, 15b, 16a, 16b.  Model (1) estimates are with rebased spending.  Model (2) estimates are with rebased spending, after deleting drug and lab spending from SGR spending.  Model (3) estimates were obtained with revisions to SGR values used in Model (2), and Model (4) estimates were obtained by eliminating the cumulated over-/under-spending term from the UAF in Model (3).  Rebased means that in calculating the CF for 2007, the target for 2006 is estimated spending for 2006, and initial cumulated actual and target spending amounts are set to total estimated 2006 spending; the SGR formula was then applied for years 2007-2014.  CFs and percent changes are arithmetic averages over the period of interest.  Spending is total SGR spending during the period.  The Spending Ratio is the ratio of estimated total spending associated with the model to estimated total baseline spending under the current SGR process ($711.9 billion).  *Spending estimates are for years 2011-2013.

The spreadsheet model was used to examine a variety of refinements to the rebased version of the update process, each of which helps to mitigate future update reductions.  If CFs were derived after rebasing and eliminating lab and drug spending from the CF calculations, CFs would decline between 2008 and 2010, as with simple rebasing, but CF levels would be higher without than when drug and lab spending are included (Model 2 in Table ES-3).  Total spending would increase as a consequence.  Spending would be 3 percent higher than with rebasing only, and 12 percent higher than is expected under the current SGR process. 

Effects of sequentially implementing several refinements after excluding spending for drugs and laboratory tests in the rebased SGR model were also studied.  These included increases in SGR values and eliminating the cumulated over-/under-spending portion of the UAF.  Conversion factors tend to increase with each additional refinement, albeit at varying rates.  And each refinement, successively imposed, would increase program spending.  An increase in SGRs after eliminating lab and drug spending would increase the average CF in the near future, but add 21 percent to baseline spending (Model 3 in Table ES-3).  Subsequent revision to the UAF would increase the average CF somewhat between 2007 and 2010, and increase spending relative to baseline by 22 percent (Model 4, Table ES-3).

Conclusions:  Reforms of the SGR update process that appear to hold the most promise are those involving changes in the definition of target spending, including rebasing of spending targets, changes in the definition of target spending, and changes in the rates at which targets increase after rebasing.  How best to fix the SGR process requires that policymakers agree on how to balance concerns over the benefits of avoiding future Congressional intervention and increases in program spending.

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