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entitled 'Medicare Physician Payments: Concerns about Spending Target 
System Prompt Interest in Considering Reforms' which was released on 
October 08, 2004.

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Report to Congressional Committees:

United States Government Accountability Office:

GAO:

October 2004:

Medicare Physician Payments:

Concerns about Spending Target System Prompt Interest in Considering 
Reforms:

GAO-05-85:

GAO Highlights:

Highlights of GAO-05-85, a report to congressional committees: 

Why GAO Did This Study:

Concerns were raised about the current system Medicare uses to 
determine annual changes to physician fees—the sustainable growth rate 
(SGR) system—when fees were reduced by 5.4 percent in 2002. Subsequent 
administrative and legislative actions modified or overrode the SGR 
system, resulting in fee increases for 2003, 2004, and 2005. However, 
projected fee reductions for 2006-2012 have raised new concerns about 
the SGR system. Policymakers are considering whether to eliminate 
spending targets or modify them.
 
The Medicare Prescription Drug, Improvement, and Modernization Act of 
2003 (MMA) required that GAO study SGR and potential alternatives to 
the system. This report examines (1) how the SGR system is designed to 
control spending for physician services, (2) what concerns have been 
raised about the SGR system and its components, (3) what affects the 
stability and predictability of physician fee updates under the SGR 
system, and (4) what alternatives to the current SGR system exist. GAO 
reviewed relevant laws and regulations and interviewed officials and 
organizations representing physicians. On the basis of this 
information, GAO identified potential alternatives to the SGR system 
and requested illustrative simulations of fee updates and spending on 
physician services from the Centers for Medicare & Medicaid Services 
(CMS).

What GAO Found:

To moderate Medicare spending for physician services, the SGR system 
sets spending targets and adjusts physician fees based on the extent 
to which actual spending aligns with specified targets. If growth in 
the number of services provided to each beneficiary—referred to as 
volume—and in the average complexity and costliness of services—
referred to as intensity—is high enough to cause spending to exceed 
the SGR target, fee updates are set lower than inflation in the cost 
of operating a medical practice. A wide enough gap between spending 
and the target results in fee reductions. 

Physician groups are dissatisfied with SGR as a system to update 
physician fees. For example, they question the fairness of including 
rapidly growing spending for physician-administered drugs in the SGR 
system’s definition of physician services expenditures. The groups also 
contend that the allowance for growth in volume and intensity is too 
low and lacks the flexibility to allow for factors outside physicians’ 
control.
 
Fee updates under the SGR system have varied widely within an allowed 
range largely because of annual fluctuations in the growth of the 
volume and intensity of services that physicians provide to 
beneficiaries. Certain system design features, such as the use of 
cumulative spending targets and the need to estimate data, also reduce 
the stability and predictability of updates. However, MMA’s revision 
of the allowance for growth in volume and intensity of services from 
an annual change to a 10-year moving average will help to make future 
updates more stable and predictable.

Possible alternatives to the SGR system cluster around the two broad 
approaches under consideration: (1) end the use of spending targets 
and separate fee updates from explicit efforts to moderate spending 
growth or (2) retain spending targets but modify the current SGR 
system to address perceived shortcomings. CMS projects that either of 
the two approaches will result in higher aggregate spending, thereby 
increasing the difficulty of addressing Medicare’s long-run financial 
challenges. The first approach emphasizes stable fee updates, while 
the second approach automatically adjusts fee updates if spending 
growth deviates from a predetermined target. While seeking to pay 
physicians appropriately, it is important to consider how modifications 
or alterations to the SGR system would affect the long-term 
sustainability and affordability of the Medicare program. In this 
context, the choice between the two approaches may hinge on whether 
primary consideration should be given to stable fee increases or to 
the need for fiscal discipline within the Medicare program.

CMS agreed with the concluding observations in the draft report. 
Groups representing physicians commented that overall, the draft 
report offered a good analysis of problems with the SGR system, but 
did not fully reflect their concerns. We modified the draft as 
appropriate.

www.gao.gov/cgi-bin/getrpt?GAO-05-85.

To view the full product, including the scope and methodology, click on 
the link above. For more information, contact A. Bruce Steinwald at 
(202) 512-7101.

[End of section]

Contents:

Letter:

Results in Brief:

Background:

SGR System Designed to Adjust Fee Updates to Bring Actual Spending for 
Physician Services in Line with Spending Targets:

Various Concerns Raised about SGR System and Its Components:

Variable Growth in Provision of Physician Services and Certain SGR 
System Design Elements Reduce Stability and Predictability of Physician 
Fee Updates:

Alternatives for Updating Physician Fees Would Eliminate Spending 
Targets or Revise Current SGR System:

Concluding Observations:

Agency and Industry Comments and Our Evaluation:

Appendix I: Calculation of the Performance Adjustment Factor:

Appendix II: Corrections to Prior Estimates Caused the SGR System's 
Cumulative Targets to Produce Negative Updates:

Appendix III: Comments from the Centers for Medicare & Medicaid 
Services:

Tables:

Table 1: CMS's Estimate of the 2005 Sustainable Growth Rate and Its 
Determinants, as of March 2004:

Table 2: Estimated 2005 Fee Update, as of March 2004:

Figures:

Figure 1: Average Annual Percentage Change in Medicare Spending for 
Physician Services per Beneficiary, 1980-2003:

Figure 2: Growth in Volume and Intensity of Medicare Physician Services 
per Beneficiary, 1980-2003:

Figure 3: Projected MEI and Fee Update under Current Law:

Figure 4: Annual Percentage Change in Real GDP Per Capita and 10-Year 
Moving Average Change in Real GDP Per Capita, 1992-2003:

Figure 5: Projected MEI and Fee Updates under Current Law and under 
Option of Eliminating Spending Targets and Tying Fee Updates to MEI:

Figure 6: Projected Aggregate Spending under Current Law and under 
Option of Eliminating Spending Targets and Tying Fee Updates to MEI:

Figure 7: Projected Real Spending for Physician Fee Schedule Services 
per FFS Beneficiary under Current Law and under Option of Eliminating 
Spending Targets and Tying Fee Updates to MEI:

Figure 8: Projected MEI and Fee Updates under Current Law and under 
Option of Not Including Any Part B Drugs in the SGR System Beginning in 
2005:

Figure 9: Projected Aggregate Spending under Current Law and under 
Option of Not Including Any Part B Drugs in the SGR System Beginning in 
2005:

Figure 10: Projected Real Spending for Physician Fee Schedule Services 
per FFS Beneficiary under Current Law and under Option of Not Including 
Any Part B Drugs in the SGR System Beginning in 2005:

Figure 11: Projected MEI and Fee Updates under Current Law and under 
Option of Resetting the Cumulative Spending Target Equal to Cumulative 
Actual Spending as of 2006:

Figure 12: Projected Aggregate Spending under Current Law and under 
Option of Resetting the Cumulative Spending Target Equal to Cumulative 
Actual Spending as of 2006:

Figure 13: Projected Real Spending for Physician Fee Schedule Services 
per FFS Beneficiary under Current Law and under Option of Resetting the 
Cumulative Spending Target Equal to Cumulative Actual Spending as of 
2006:

Figure 14: Projected MEI and Fee Updates under Current Law and under 
Option of Eliminating the Cumulative Aspect of Spending Targets:

Figure 15: Projected Aggregate Spending under Current Law and under 
Option of Eliminating the Cumulative Aspect of Spending Targets:

Figure 16: Projected Real Spending for Physician Fee Schedule Services 
per FFS Beneficiary under Current Law and under Option of Eliminating 
the Cumulative Aspect of Spending Targets:

Figure 17: Projected MEI and Fee Updates under Current Law and under 
Option of Increasing Volume and Intensity Growth Allowance to GDP Plus 
1 Percentage Point:

Figure 18: Projected Aggregate Spending under Current Law and under 
Option of Increasing Volume and Intensity Growth Allowance to GDP Plus 
1 Percentage Point:

Figure 19: Projected Real Spending for Physician Fee Schedule Services 
per FFS Beneficiary under Current Law and under Option of Increasing 
Volume and Intensity Growth Allowance to GDP Plus 1 Percentage Point:

Figure 20: Projected MEI and Fee Updates under Current Law and under 
Combination of Options of Resetting the Cumulative Spending Target 
Equal to Cumulative Actual Spending as of 2006, Not Including Any Part 
B Drugs in the SGR System Beginning in 2005, and Using GDP Plus 1 
Percentage Point:

Figure 21: Projected Aggregate Spending under Current Law and under 
Combination of Options of Resetting the Cumulative Spending Target 
Equal to Cumulative Actual Spending as of 2006, Not Including Any Part 
B Drugs in the SGR System Beginning in 2005, and Using GDP Plus 1 
Percentage Point:

Figure 22: Projected Real Spending for Physician Fee Schedule Services 
per FFS Beneficiary under Current Law and under Combination of Options 
of Resetting the Cumulative Spending Target Equal to Cumulative Actual 
Spending as of 2006, Not Including Any Part B Drugs in the SGR System 
Beginning in 2005, and Using GDP Plus 1 Percentage Point:

Figure 23: Projected MEI and Fee Updates under Current Law and under 
Combination of Options of Not Including Any Part B Drugs in the SGR 
System Beginning in 2005 and Eliminating the Cumulative Aspect of 
Spending Targets:

Figure 24: Projected Aggregate Spending under Current Law and under 
Combination of Options of Not Including Any Part B Drugs in the SGR 
System Beginning in 2005 and Eliminating the Cumulative Aspect of 
Spending Targets:

Figure 25: Projected Real Spending for Physician Fee Schedule Services 
per FFS Beneficiary under Current Law and under Combination of Options 
of Not Including Any Part B Drugs in the SGR System Beginning in 2005 
and Eliminating the Cumulative Aspect of Spending Targets:

Figure 26: Formula Used to Determine the Performance Adjustment Factor 
in 2005:

Figure 27: Percentage Change in MEI, SGR Fee Schedule Update, and 
Medicare Physician Services Spending per Beneficiary, 1998-2005:

Abbreviations:

BBA: Balanced Budget Act of 1997: 
BBRA: Medicare, Medicaid, and SCHIP Balanced Budget Refinement Act of 
1999: 
CBO: Congressional Budget Office: 
CMS: Centers for Medicare & Medicaid Services: 
CPI-U: consumer price index for urban consumers: 
ESRD: end-stage renal disease: 
FFS: fee-for-service: 
GDP: gross domestic product:
HHS: Department of Health and Human Services: 
HI: Hospital Insurance: 
MedPAC: Medicare Payment Advisory Commission: 
MEI: Medicare Economic Index: 
MMA: Medicare Prescription Drug, Improvement, and Modernization Act of 
2003: 
MVPS: Medicare volume performance standard: 
OACT: Office of the Actuary: 
PAF: performance adjustment factor: 
PPRC: Physician Payment Review Commission: 
SGR: sustainable growth rate: 
SMI: Supplementary Medical Insurance:

United States Government Accountability Office:

Washington, DC 20548:

October 8, 2004:

Congressional Committees:

Physicians and others raised concerns about the current system Medicare 
uses to determine annual changes to physician fees when those fees were 
reduced by 5.4 percent in 2002. This reduction was triggered, in part, 
because spending on physician services had exceeded predetermined 
spending targets and Medicare's system for updating fees--the 
sustainable growth rate (SGR) system--called for a reduction in fees to 
impose fiscal discipline.[Footnote 1] Subsequent administrative and 
legislative actions modified or overrode the SGR system, resulting in 
fee increases for 2003, 2004, and 2005. Absent additional action, 
however, fees are expected to fall by approximately 5 percent each year 
beginning in 2006 and continuing through 2012 as the SGR system 
attempts to offset previous excess spending and align actual spending 
with the system's spending targets. According to physician groups, such 
a decline in fees would likely discourage many physicians from treating 
Medicare beneficiaries. As a result of these concerns, policymakers are 
interested in considering the appropriateness of current spending 
targets and the SGR system as a method for determining physician fee 
updates. Essentially, they are considering whether to eliminate 
spending targets or retain them, while making modifications to the 
system.

Although the current focus of concern is largely on the potential for 
declining physician fees, the historic challenge for Medicare has been 
to find ways to moderate the rapid growth in spending for physician 
services under the Medicare Supplementary Medical Insurance (SMI)--or 
Part B--program. In the 1980s, attempts to moderate spending by 
limiting physician fees without addressing aggregate expenditures for 
physician services were unsuccessful because increases in the number of 
services physicians provided per beneficiary--known as volume--and the 
average complexity and costliness of those services--known as 
intensity--continued to drive up spending. As a result, in the Omnibus 
Budget Reconciliation Act of 1989,[Footnote 2] the Congress required 
the establishment of a national Medicare physician fee schedule and a 
system for annually updating fees that included spending targets. The 
fee schedule and spending targets first affected physician fees in 
1992. The SGR system, Medicare's current system for updating physician 
fees, was established in the Balanced Budget Act of 1997 (BBA) and was 
implemented in 1998.[Footnote 3] Both the SGR and its predecessor 
system provided for cumulative fee updates that generally exceeded 
cumulative increases in physicians' cost of providing 
services.[Footnote 4] Since the establishment of the national fee 
schedule and spending targets, the growth in spending for Medicare 
physician services has slowed substantially. Nonetheless, recent 
increases in physician expenditures due to volume and intensity growth 
are a reminder that the historic challenge of moderating spending 
growth has not disappeared.

The Medicare Prescription Drug, Improvement, and Modernization Act of 
2003 (MMA) required us to study certain adjustments to physician fees, 
including the SGR system and alternatives to the system.[Footnote 5] As 
discussed with the committees of jurisdiction, this report examines (1) 
how the SGR system is designed to control spending for physician 
services, (2) what concerns have been raised about the SGR system and 
its components, (3) what affects the stability and predictability of 
physician fee updates under the SGR system, and (4) what alternatives 
to the current SGR system exist.

In addressing these objectives, we analyzed Medicare expenditure data 
from the Medicare Trustees' 1998 and 2004 annual reports.[Footnote 6] 
We also reviewed laws and regulations pertaining to the SGR system and 
its predecessor spending target system and interviewed officials at the 
Centers for Medicare & Medicaid Services (CMS), the agency responsible 
for administering Medicare; the Congressional Budget Office (CBO); the 
Medicare Payment Advisory Commission (MedPAC);[Footnote 7] and 
organizations representing physicians, including the American Medical 
Association, the Medical Group Management Association, the Alliance for 
Specialty Medicine, and the American College of Physicians. On the 
basis of these document reviews and interviews, we identified potential 
alternatives to the SGR system. We requested illustrative simulations 
of fee updates and total spending under these alternatives from the CMS 
Office of the Actuary (OACT).[Footnote 8] Total spending includes 
expenditures from all sources--that is, government outlays and 
beneficiary spending, including monthly Part B premiums, deductibles, 
and coinsurance payments.[Footnote 9] Because the simulation estimates 
produced by CMS OACT include total spending from all sources, the 
estimated spending changes will differ from CBO's cost estimates for 
the same alternatives. CBO, which is responsible for estimating how 
legislated changes would affect federal spending, does not include 
beneficiary spending when it estimates the cost of SGR alternatives. 
CMS OACT and CBO estimates may also differ as the result of differences 
in the underlying assumptions used by the two agencies. Our analyses 
apply only to spending affected by the SGR system--that is, physician 
spending in the traditional fee-for-service (FFS) program. We assessed 
the reliability of the Medicare expenditure data and data used for the 
simulations under alternatives to the SGR system by interviewing agency 
officials knowledgeable about the data and who are responsible for 
producing the projections for the SGR system. We determined that the 
data were sufficiently reliable for the purposes of our study. We 
performed this work from January 2004 through September 2004 in 
accordance with generally accepted government auditing standards.

Results in Brief:

To help impose fiscal discipline and moderate Medicare spending for 
physician services, the SGR system sets spending targets and adjusts 
fees paid to physicians based on the extent to which actual spending 
aligns with specified targets. SGR system targets are designed to allow 
real spending per beneficiary--that is, spending per beneficiary 
adjusted for the estimated underlying cost of providing physician 
services--to grow at the same rate that the national economy (as 
measured by the rate that real gross domestic product (GDP)) grows over 
time on a per capita basis--currently estimated to be about 2.3 percent 
annually.[Footnote 10] If Medicare spending for physician services 
remains on target, the annual increase in physician fees is set equal 
to the estimated change in physicians' cost of providing 
services.[Footnote 11] However, if growth in the volume and intensity 
of services provided is high enough to cause spending to exceed the SGR 
system target, future fee updates are set below the estimated increase 
in physicians' average cost for providing services--in other words, 
physicians receive fee increases that are lower than the Medicare 
Economic Index (MEI). If the gap between spending and the target is 
wide enough, the SGR system results in fee reductions. Conversely, if 
volume and intensity growth is low enough to cause spending to fall 
below the target, the SGR system benefits physicians by producing fee 
increases that exceed the change in their cost of providing services. 
Under the SGR system's cumulative spending targets, excess spending 
that is not offset in one year accumulates in succeeding years until it 
is recouped.

Physician groups are dissatisfied with SGR as a system to update 
physician fees and have raised various concerns about its components. 
In general, they note that expenditures for physician services 
constitute Medicare's only spending that is subject to a target system. 
Physician groups report that under this system, fee updates--which are 
explicitly linked to spending controls--have caused payment rates in 
recent years to fall behind physicians' cost of providing services. 
Among specific concerns, physician groups question the fairness of 
reducing fee updates for physician services to offset rapidly growing 
expenditures for certain outpatient drugs that are covered by Medicare 
Part B and that are largely physician administered. The groups also 
contend that the SGR system's allowance for spending growth due to 
volume and intensity increases--the growth rate of real GDP per capita-
-is too low and inflexible. Physician groups contend that as a result, 
factors outside physicians' control--such as any future declines in the 
FFS population's average health status and introduction of new, 
effective medical technology--may cause spending to exceed the SGR 
system targets and thus lead to reduced fee updates. Additional 
concerns include whether CMS's method used to account for spending 
increases due to changes in laws and regulations--which can change 
payments or expand the extent and number of Medicare-covered services-
-is sufficiently complete, accurate, and transparent.

For several reasons, fee updates under the SGR system have varied--
within a specified range--and have been difficult to predict 
accurately.[Footnote 12] A principal cause of variation within this 
range has been annual fluctuations in the growth of the volume and 
intensity of services that physicians provide to beneficiaries. Since 
the SGR system was implemented in 1998, volume and intensity growth has 
ranged from 1.2 percent in 1999 to 6.1 percent in 2002. Two system 
design characteristics also reduce the stability and predictability of 
updates. First, the SGR system is designed to respond to fluctuating 
volume and intensity growth by adjusting fee updates to keep cumulative 
spending in line with the targets. Attempting to control cumulative 
spending tends to amplify the variation in annual updates. For example, 
if spending has exceeded the spending target, the SGR system must 
reduce future updates both to slow future spending growth and to recoup 
previous excess spending. Second, uncertainty in estimates of data used 
in the SGR system makes long-term estimates of fee updates less 
predictable and causes updates to vary from year to year as new data 
become available and estimates of data used in the SGR system are 
revised.

Alternatives to the SGR system we identified cluster around the two 
approaches that policymakers are considering. One approach would end 
the use of spending targets--separating fee updates from efforts to 
moderate spending growth. MedPAC is a proponent of this approach and 
since 2001 has recommended tying fee updates to estimated changes in 
physicians' cost of providing services. It has further recommended that 
Medicare seek to control spending growth by, among other things, 
identifying and addressing the utilization of rapidly growing services, 
such as diagnostic imaging. The other approach includes alternatives 
that would retain spending targets but modify the current SGR system to 
address perceived shortcomings. These modifications could include 
removing the Part B prescription drug expenditures that are currently 
counted in the SGR system; resetting the targets by not requiring the 
system to recoup previous excess spending; using annual, rather than 
cumulative, targets to dampen the fluctuation in fee updates; and 
modifying the allowance for increased spending due to volume and 
intensity growth. The advantage of eliminating spending targets would 
be greater fee update stability and predictability, whereas the 
advantage of retaining spending targets as part of the system for 
updating fees is that the system would automatically work to moderate 
spending if volume and intensity growth began to increase above 
allowable rates. However, either approach compared to current law, 
under which fees are projected to be reduced by as much as 5 percent or 
more for several years, will be very expensive--ranging from 4 percent 
to 23 percent higher cumulative spending over the 10-year period from 
2005 to 2014. Given the importance of the long-term sustainability and 
affordability of the Medicare program, examining the impact of spending 
over a longer period may be appropriate when contemplating 
modifications or alternatives to the SGR system.

CMS agreed with our concluding observations and expressed its 
commitment to pay physicians appropriately to ensure that Medicare 
beneficiaries have access to high-quality health care. Groups 
representing physicians commented that overall, a draft of our report 
offered a good analysis of problems with the SGR system, but indicated 
it did not fully reflect the extent of their concerns. Some of the 
issues the groups raised were outside the scope of our report. We 
modified the report as appropriate.

Background:

Medicare spending per beneficiary on physician services has varied 
substantially--both among geographic areas and in its growth over time. 
The geographic variation in spending--unrelated to beneficiary health 
status or outcomes--provides evidence that health needs alone do not 
determine spending. Consequently, policymakers have deemed it both 
reasonable and desirable to question the appropriateness of current and 
projected physician services spending and to explicitly consider the 
affordability of such spending when setting physician fees. The 
implementation of a national fee schedule and spending targets in 1992, 
for example, was designed, in part, to address issues of affordability 
and program sustainability by slowing spending growth. Moderating this 
growth remains part of the larger effort to ensure future Medicare 
program sustainability.

Some Spending on Physician Services May Be Unnecessary, as Suggested by 
Unwarranted Regional Variation in Use of Physician Services:

In 1989, the Physician Payment Review Commission (PPRC) reported that 
from 1979 through 1989 (the decade prior to the establishment of 
spending targets), Medicare spending on physician services per 
beneficiary more than tripled, rising much more rapidly than general 
inflation.[Footnote 13] At that time, PPRC recommended an expenditure 
target for controlling aggregate spending on physician services. The 
target was to apply initially to all physician services nationally and 
later to evolve to separate targets for regions, categories of 
physician services, or both.

Then, as now, utilization of physician services varied widely by 
geographic area, while the Medicare patient populations in these areas 
differed little from one another in their illnesses. Some studies 
report that variation in service use indicates that in some parts of 
the country compared with others, there was either overuse or underuse 
of services. Recent studies of Medicare expenditures show that regional 
variation in the use of medical services remains and that the spending 
disparities among areas are explained by physicians' discretionary 
practices rather than by differences in patient populations' health 
status.[Footnote 14]

Physician Service Expenditures Have Grown Less Rapidly after Spending 
Targets and Fee Schedule Were Established:

Three periods from 1980 to the present describe Medicare's recent 
experience in spending for physician services. Figure 1 shows growth in 
Medicare spending per beneficiary for physician services during the 
three periods. In the first period, 1980 through 1991, Medicare's 
payment rates for physician services were based on historical charges 
for these services, and limits were placed on fees and fee updates but 
not on aggregate spending. In the 1992 through 1997 period, physician 
services were paid under a national fee schedule, and the first 
spending target system--called the Medicare volume performance standard 
(MVPS)--set an allowable growth rate for aggregate spending that was 
used to adjust physician fees. From 1998 on, services continue to be 
paid under a fee schedule and the SGR system replaced the MVPS system 
and uses a different method to set an acceptable growth rate for 
aggregate spending.

Figure 1: Average Annual Percentage Change in Medicare Spending for 
Physician Services per Beneficiary, 1980-2003:

[See PDF for image]

Notes: Spending changes for 1980 through 1991 are for the years ending 
June 30 and represent average Medicare spending for beneficiaries in 
the traditional FFS program, net of beneficiary cost sharing. Spending 
for end-stage renal disease (ESRD) patients is not included. Spending 
changes for 1992 through 1997 and 1998 through 2003 are for calendar 
years and represent changes in total allowed charges--Medicare 
spending, including beneficiary cost sharing--for beneficiaries in the 
traditional FFS program.

[End of figure]

In the 1980s, Medicare paid physicians on the basis of "reasonable 
charge," defined as the lowest of the physician's actual charge, the 
customary charge (the amount the physician usually charged for the 
service), or the prevailing charge (based on comparable physicians' 
customary charges). Under this system, payment inconsistencies existed 
among physicians by services, specialties, and locations. The system 
also had an inflationary bias, as a rise in customary charges could 
increase prevailing charges over time.[Footnote 15] During this decade, 
expenditures for physician services grew rapidly: from 1980 through 
1991, Medicare spending per beneficiary for physician services grew at 
an average annual rate of 11.6 percent. Although the Congress froze 
fees or limited fee increases in the 1980s, spending continued to rise 
because there were no limits on growth in the volume and intensity of 
services physicians provided to beneficiaries.

Recognizing that the expenditure growth of the 1980s was not 
sustainable, the Congress reformed the way Medicare paid for physician 
services in the traditional FFS program by requiring the establishment 
of a national fee schedule for physician services and a system for 
controlling aggregate physician service spending, MVPS. The 
establishment of a fee schedule in 1992 was an attempt to break the 
link between physicians' charges and Medicare payments. The fee 
schedule was designed to pay for services based on the relative 
resources used by physicians to provide different types of care and to 
address the inflationary bias of the charge-based system. The adoption 
of a spending target system was an attempt to control spending growth 
attributable to increases in the volume and intensity of physician 
services.

Under MVPS, a performance standard for a given year was set, indicating 
a growth rate for expenditures that should not be exceeded. The extent 
to which actual expenditure growth fell above or below the performance 
standard helped to determine the update to physician fees 2 years 
later. For example, in 1993, CMS compared actual spending in 1992 with 
the performance standard for 1992; the difference largely determined 
the update to physician fees in 1994.[Footnote 16] The performance 
standard was based on changes in four factors: the number of FFS 
Medicare beneficiaries, practice cost inflation, the historical growth 
in volume and intensity, and laws and regulations that could affect 
spending for physician services.[Footnote 17]

From 1992 through 1997--the period that MVPS was used to set fee 
updates--annual spending growth for physician services was far lower 
than in the preceding decade. The decline in spending growth during 
this period was the result, in large part, of slower volume and 
intensity growth. For example, from 1985 through 1991, spending per 
beneficiary grew at an average annual rate of 10.8 percent; during that 
period, volume and intensity of service use per beneficiary rose an 
average 7 percent annually. From 1992 through 1997, the growth in 
spending per beneficiary fell to 4.4 percent; during that period, 
average annual growth in volume and intensity of service use per 
beneficiary fell to 1 percent. (See fig. 2.)

Figure 2: Growth in Volume and Intensity of Medicare Physician Services 
per Beneficiary, 1980-2003:

[See PDF for image]

Notes: Data are for beneficiaries in the traditional FFS program only. 
Data for ESRD patients are not included. From 1980 through 1992, volume 
and intensity of services changes are based on Medicare outlays for all 
physician services. From 1993 through 2003, volume and intensity of 
services changes are based on Medicare outlays for physician services 
covered by the fee schedule.

[End of figure]

Concerns about the MVPS spending targets arose in 1995 when physician 
fees were expected to fall over time unless there were continual 
declines in the volume and intensity of services provided.[Footnote 
18],[Footnote 19] In response to the system's perceived shortcomings, 
the Congress took action in BBA in 1997 to replace it with the SGR 
system.[Footnote 20] In 1998 and 1999, the first 2 years of the SGR 
system, volume and intensity growth remained similar to the rate under 
MVPS. However, from 2000 through 2003, volume and intensity growth rose 
at an average annual rate of about 5 percent.[Footnote 21] Over the 
1998-2003 SGR system period,[Footnote 22] the average growth in volume 
and intensity of services per Medicare beneficiary was higher than the 
average for the 1992-1997 MVPS period--but substantially below that 
experienced before spending targets were introduced. Since the 
introduction of the SGR system, total spending on physician services is 
projected to grow by an average of 8 percent a year from 2000 through 
2005.

Controlling Spending for Physician Services Part of Larger Challenge to 
Maintain Fiscal Discipline in Medicare:

In 2003, Medicare spending for physician services totaled nearly $48 
billion,[Footnote 23] which accounted for about one-sixth of program 
spending overall. We and others have argued for the need for additional 
fiscal discipline in Medicare.[Footnote 24] Within the next 10 years, 
the federal budget will experience significant increases in spending 
pressure, due primarily to known demographic trends and rising health 
care costs. Expected technological advances--involving new drugs and 
diagnostic procedures, among other things--may improve health outcomes 
but will likely increase the price tag of a Medicare program that is 
already unsustainable in its present form. In light of physician 
service expenditures' significant contribution to aggregate spending, 
containing their growth plays an important role in helping to address 
the program's long-range and fundamental financing problem.

SGR System Designed to Adjust Fee Updates to Bring Actual Spending for 
Physician Services in Line with Spending Targets:

The SGR system is designed to impose fiscal discipline and to moderate 
spending for physician services by adjusting annual fee updates to 
bring spending in line with targets. The SGR system, similar to the 
predecessor MVPS system, relies on spending targets because earlier 
attempts to achieve fiscal discipline through limits on fee increases 
did not control the spending that resulted from volume and intensity 
growth. The SGR system uses a formula specified in statute to establish 
each year an allowed spending growth rate, a spending target, and a fee 
update. Like MVPS, the SGR system includes an allowance for volume and 
intensity increases but, unlike MVPS, ties the allowance to a measure 
of the growth of the national economy.

Spending Targets for Physician Services Used to Encourage Fiscal 
Discipline:

As noted, spending targets were established--first under MVPS and later 
under the SGR system--because policymakers contended that the fee 
schedule alone would not have adequately constrained expenditure growth 
for physician services. The fee schedule limits payment for individual 
services but does not moderate spending growth resulting from volume 
and intensity increases. Although the SGR system's spending target does 
not cap expenditures for physician services, it serves as a budgetary 
control by automatically lowering fee updates in response to excess 
spending due to volume and intensity growth. In addition, reduced fee 
updates serve as a signal to physicians collectively and to the 
Congress that spending due to volume and intensity has increased more 
than allowed.

An additional reason for spending targets was advanced by PPRC in its 
1995 report to the Congress.[Footnote 25] PPRC explained that spending 
targets were intended, in part, to create a collective incentive for 
physicians. Specifically, the report stated that spending targets 
"provid[e] the medical profession with a collective incentive to reduce 
inappropriate care by, for instance, developing and disseminating 
practice guidelines that promote cost-effective practice styles."

SGR System Sets Allowable Spending Growth and Targets for Physician 
Services:

Every year, CMS must estimate the allowed rate of increase in spending 
for physician services and use that rate to construct the annual 
spending target for the following calendar year.[Footnote 26] The 
sustainable growth rate is the product of the estimated percentage 
change in (1) input prices for physicians' services; [Footnote 
27],[Footnote 28] (2) the average number of Medicare beneficiaries in 
traditional FFS; (3) national economic output, as measured by real 
(inflation-adjusted) GDP per capita; and (4) expected expenditures for 
physician services resulting from changes in laws or regulations. CMS's 
current estimate of the sustainable growth rate for 2005 is 4.6 
percent, based on the agency's estimates of the four factors. (See 
table 1.)

Table 1: CMS's Estimate of the 2005 Sustainable Growth Rate and Its 
Determinants, as of March 2004:

Sustainable growth rate determinants: Input prices for physician 
services[A]; 
Estimated percentage change: 2.6%. 

Sustainable growth rate determinants: Traditional FFS Medicare 
enrollment; 
Estimated percentage change: -0.2%. 

Sustainable growth rate determinants: Real GDP per capita; 
Estimated percentage change: 2.2%. 

Sustainable growth rate determinants: Expenditures for physician 
services resulting from changes in laws and regulations; 
Estimated percentage change: 0.0%. 

Estimated 2005 sustainable growth rate; 
Estimated percentage change: 4.6%[B]. 

Source: CMS OACT.

[A] For purposes of the sustainable growth rate, physician services 
include services paid for by the fee schedule as well as laboratory 
services and certain Medicare-covered Part B outpatient drugs.

[B] The sustainable growth rate is computed as the product of the 
percentage change in the four factors. The percentage changes are 
expressed in decimal form relative to 1.0. For example, a percentage 
change of 2.6 percent is expressed as 1.026. Therefore, the sustainable 
growth rate is computed as (1.026) x (0.998) x (1.022) x (1.0) = 1.046, 
or 4.6 percent.

[End of table]

To set each year's spending target, the SGR system increases the 
previous year's spending target by the sustainable growth rate for the 
given year.[Footnote 29] For example, target spending for 2004 was 
$77.3 billion. Target spending for 2005 is 4.6 percent higher, or $80.9 
billion. Under the SGR system, every annual target depends on the 
targets set in all previous years since the base year 1996.[Footnote 
30] BBRA required CMS, in calculating each year's SGR system spending 
target, to first revise the targets set for the 2 previous years using 
the most recent available data for all elements of the target--that is, 
revisions to figures for input prices for physician services, FFS 
beneficiary enrollment, real GDP per capita, and expenditures due to 
relevant new laws and regulations.[Footnote 31],[Footnote 32]

SGR System Adjusts Fee Updates to Align Spending with Target:

Every fall, CMS determines whether the fee update for the following 
calendar year must be adjusted to help align spending with 
targets.[Footnote 33] To do so, the agency compares actual spending, 
measured cumulatively since 1996, to the cumulative value of the annual 
targets, measured over the same period. If the two are equal, the fee 
update is set to equal the estimated increase in physicians' average 
cost of providing services--as measured by MEI. Otherwise, a 
performance adjustment factor (PAF) is used to increase or decrease the 
update relative to MEI in order to help bring spending back in line 
with the targets. (See app. I for the formula used to calculate the 
PAF.) The PAF is subject to limits and may not cause the update to be 
set at more than 3 percent above MEI or 7 percent below MEI. In part 
because of these limits, adjustments to realign actual cumulative 
spending with cumulative targets are spread out over more than 1 
year.[Footnote 34]

For example, in projecting the update for 2005, CMS estimated that 
cumulative spending from 1996 through 2004 ($543.8 billion) exceeded 
the cumulative value of the annual targets during the same period 
($531.9 billion) by approximately $11.9 billion. The estimated $11.9 
billion difference is due to two components of accumulated excess 
spending and needs to be offset: first, excessive growth in volume and 
intensity in 2003 and 2004, and second, the additional spending 
attributable to MMA. MMA replaced a fee reduction for 2004 with a 
minimum 1.5 percent increase, but it did not adjust SGR system targets 
to account for the additional spending.[Footnote 35] Because of the 
large discrepancy between spending and the target, the SGR system calls 
for the maximum PAF reduction. In conjunction with an estimated MEI of 
2.8 percent, the application of the PAF would produce a fee update of 
negative 4.4 percent.[Footnote 36] In addition to MEI and the PAF, fees 
are sometimes subject to other adjustments, including those set by law. 
For 2005, there is an additional adjustment of 0.8 percent, which 
results in an estimated SGR system fee update for 2005 of negative 3.6 
percent. (See table 2.) However, this negative update will be 
overridden by an MMA-specified minimum update of 1.5 percent for 2005. 
The resulting fee update is applied to the fee schedule's "conversion 
factor," a dollar amount that translates each service's relative value 
into an actual disbursement amount. [Footnote 37],[Footnote 38]

Table 2: Estimated 2005 Fee Update, as of March 2004:

Estimated 2005 fee update under SGR system[A]; 
Percentage change: -3.6%. 

Update based on: * Change in input prices for physician services (MEI)
[B]; 
Percentage change: 2.8%. 

Update based on: * PAF; 
Percentage change: -7.0%. 

Update based on: * BBRA required adjustment[C]; 
Percentage change: 0.8%. 

2005 fee update as specified in MMA[D]; 
Percentage change: 1.5%. 

Source: CMS OACT.

[A] Update is computed as the product of the change in input prices, 
the PAF, and the BBRA-required adjustment; all are expressed in decimal 
form. That is, 2005 fee update = [(1+0.028) x (1 - 0.07) x (1+ 0.008)] 
-1 = -0.036 or -3.6 percent.

[B] For purposes of the fee update, physician services include only 
services paid for under the fee schedule.

[C] This adjustment, required by the Medicare, Medicaid, and SCHIP 
Balanced Budget Refinement Act of 1999 (BBRA), maintains the budget 
neutrality of a technical change to the conversion factor.

[D] The actual fee update for 2005 is the greater of the calculated 
update of -3.6 percent or 1.5 percent as legislated by MMA.

[End of table]

Under SGR's system of cumulative spending targets, excess spending that 
is not offset in one year accumulates in succeeding years until it is 
recouped. For 2005, MMA increased actual spending but did not adjust 
the target for this additional spending. Now the gap between actual 
spending and the target will result in an additional deficit that under 
the SGR system will have to be recouped through negative updates in 
future years.

SGR System Ties Allowed Increases in Volume and Intensity to Growth in 
National Economy:

The parameters of the SGR system allow spending due to the volume and 
intensity of physician services to increase, but limit that growth to 
the same rate that the national economy (GDP) grows in real terms (that 
is, adjusted for inflation) over time on a per capita basis. Under the 
SGR system, if the volume and intensity of physician service use grows 
faster than the national economy, the annual increase in physician fees 
will be less than the estimated increase in the cost of providing 
services. Conversely, if volume and intensity grows more slowly, the 
SGR system permits physicians to benefit from fee increases that exceed 
the increased cost of providing services. To reduce the effect of 
yearly business cycles on physician fees, MMA required that economic 
growth be measured as the 10-year moving average change in real GDP per 
capita for each year beginning in 2003.[Footnote 39] This measure is 
projected to range from 2.1 percent to 2.5 percent during the 2005 
through 2014 period.

When the SGR system was established, GDP growth was seen as a benchmark 
that would allow for affordable increases in volume and intensity and 
also one that represented a significant improvement over the benchmark 
included in the previous MVPS system. In its 1995 annual report to the 
Congress, PPRC stated that limiting real expenditure growth to 1 or 2 
percentage points above GDP would be a "realistic and affordable 
goal."[Footnote 40] Ultimately, BBA specified the growth rate of GDP 
alone. This limit was an indicator of what the nation could afford to 
spend on volume and intensity increases. Whether this rate is a 
sufficient and appropriate allowance for volume and intensity increases 
is uncertain. Currently, volume and intensity is projected to grow by 
more than 4 percent per year, whereas the allowance for this growth 
under the SGR system is about 2.3 percent annually. Such excess volume 
and intensity growth is a key contributing factor to negative fee 
updates.

Various Concerns Raised about SGR System and Its Components:

Physician groups are dissatisfied with SGR as a system to update 
physician fees and have raised various concerns about its key 
components. Noting that physicians are uniquely subject to a system of 
fee updates that are explicitly linked to spending controls, the groups 
contend that the SGR system has caused payment rates in recent years to 
fall behind physicians' cost of providing services. The groups' 
concerns with specific SGR system components center on the following 
issues: the fairness of including Medicare-covered outpatient drugs in 
the calculation of physician service expenditures; the appropriateness 
of tying allowable volume and intensity increases to the average growth 
in real GDP per capita; and the completeness, accuracy, and 
transparency of the method used to account for spending increases due 
to changes in laws and regulations.

Physicians Dissatisfied That Medicare Spending for Physician Services 
Is Subject to Spending Targets:

Physician groups are concerned that physicians are the only Medicare 
provider type whose annual payment updates are subject to a spending 
target system. Payment rate updates for hospitals and other 
institutional providers, they note, are typically based on changes in 
the cost of providing services. However, as CBO, MedPAC, and others 
have noted, physicians are different from other providers in certain 
ways, which helps to provide a rationale for the application of targets 
solely to physician expenditures. Specifically, they note that 
physicians determine the services they deliver to their patients and 
influence the care delivered by other providers. In addition, under 
Medicare payment policies, physicians receive a separate payment for 
each service they provide. Thus, they can boost income by increasing 
the volume or intensity of services they provide. For example, a 
physician may follow up a patient's visit by scheduling another visit, 
even when such a follow-up visit is discretionary and could be 
substituted with a telephone call. In contrast, Medicare typically pays 
institutional providers a fixed amount for a bundle of services; under 
this arrangement, no inherent incentive exists to provide extra 
services, as doing so would not increase payments.

Physicians Question Fairness of Including:

Part B Outpatient Drugs in Calculation of Physician Service 
Expenditures:

One of physician groups' chief concerns is that through fee schedule 
updates, the SGR system holds physicians accountable for the escalating 
growth in Medicare expenditures for the majority of Part B-covered 
drugs.[Footnote 41] (Drugs included in the SGR system are largely 
physician administered and do not include all Part B-covered drugs.) 
The groups contend that the SGR system should not include these drugs 
in the calculation of aggregate physician service expenditures or the 
spending targets. Although the targets account for increases in the 
drugs' prices, the targets do not explicitly account for increases in 
their utilization or the substitution of more expensive drugs for less 
expensive ones. Physician groups note that the use of the outpatient 
drugs currently covered by Medicare is largely nondiscretionary and 
that physicians should not be penalized for prescribing these drugs. To 
the extent that expenditures for these Medicare-covered outpatient 
drugs grow faster than real GDP per capita--which is the SGR system's 
allowance for volume and intensity increases--other physician spending 
must grow more slowly or aggregate spending will exceed the targets and 
fee updates for physician services will be reduced.

In 2002, Medicare covered approximately 450 outpatient prescription 
drugs. The drugs that account for most of Medicare's Part B drug 
expenditures are physician administered, such as those for cancer 
chemotherapy, accounting for 80 percent of total Medicare spending for 
Part B drugs in 2001. In 2001, oncologists submitted about 42 percent 
of prescription drug claims, while urologists accounted for 17 percent.

Part B prescription drugs are not covered by the physician fee 
schedule,[Footnote 42] but the expenditures for most Part B drugs are 
included in the SGR system expenditures because, at the time spending 
targets were first introduced, the Secretary of Health and Human 
Services (HHS) included these drugs as services and supplies "incident 
to" physicians' services. Since that time, Medicare spending for all 
Part B drugs has grown substantially, from about $700 million in 1992 
to an estimated $8.5 billion in 2002. Much of the spending growth has 
resulted from increases in utilization and the substitution of newer, 
more expensive medications. Because SGR-covered Part B drug 
expenditures have grown more rapidly than other physician service 
expenditures, drug expenditures as a proportion of allowable spending 
under the targets have grown from 8.7 percent in 2002 to an estimated 
12.3 percent in 2004. Such rapid growth in drug expenditures increases 
the likelihood that actual spending will exceed SGR system targets. 
Moreover, because only payments for services included in the physician 
fee schedule are offset when physician service spending deviates from 
the spending targets, the increase in the share of total expenditures 
attributed to prescription drugs magnifies the adjustment that must be 
made to the update to bring spending in line with the targets.

Physicians Concerned That Key Spending Drivers Are Not Included in SGR 
System's Allowance for Volume and Intensity Growth:

Physician groups have expressed concern that the SGR system's allowance 
for volume and intensity growth--the 10-year moving average growth in 
real GDP per capita--is both too low and inflexible. They contend that 
tying the allowance to GDP results in targets that do not adequately 
account for appropriate increases in the demand for physician services 
and changes in medical practice, such as the following:

* A sicker beneficiary population. Physician groups reason that 
although health status drives demand for services, the GDP growth 
allowance would not account for any increases in physician spending 
that could be due to greater care demands per beneficiary.

* Technological advances. The groups note that new, expensive medical 
technologies can provide meaningful health gains for Medicare 
beneficiaries but that these technology costs are likely to grow faster 
than GDP.

* Site-of-service shifts. The groups note that patients with complex 
conditions formerly treated in hospitals are increasingly treated in 
physician offices and that treating such patients, who may require 
frequent office visits and costly procedures, is likely to contribute 
to volume and intensity growth.

The MVPS system provided an explicit opportunity to address some of 
these concerns procedurally. In addition to the allowance for volume 
and intensity growth specified in statute, the MVPS system also 
provided specific authority for the HHS Secretary to recommend revising 
the allowed increase based on factors such as changes in technology and 
concerns about access to physician services. Under the MVPS system, the 
Secretary never exercised the authority to make recommendations other 
than implementing the MVPS default formula, but it still remained an 
option.

Transparency Lacking in Process for Estimating Changes in Medicare 
Spending for Physician Services due to Laws and Regulations:

The SGR system is designed to account for changes in law and regulation 
that could affect aggregate spending for physician services. For 
example, for 2005, CMS estimates that increased spending resulting from 
MMA's coverage of a preventive physical examination for new 
beneficiaries, cardiovascular screening blood tests, and diabetes 
screening tests, among other new increases, will be almost fully offset 
by new MMA-required payment adjustments for Part B drugs, which will 
lower physician service spending. Physician groups we spoke with 
contend that the process for developing such estimates may not be 
accurate or complete.

Assessing the accuracy and completeness of these estimates is 
difficult, as CMS's process for identifying the applicable statutory 
and regulatory changes and the methods used to arrive at dollar 
estimates are not fully transparent. Either data are lacking to 
quantify the effects of changes or consensus is lacking on the 
assumptions and interpretations made about the changes and their 
effects. Currently, CMS does not use a formal mechanism for soliciting 
input from physician groups or other experts before obtaining public 
comment when future fees are announced in the Federal 
Register.[Footnote 43] Physician groups contend that at least including 
physician representatives in the process of assessing changes in laws 
and regulations would improve CMS's analysis of effects and would be 
more efficient than waiting for the public comment period.

Variable Growth in Provision of Physician Services and Certain SGR 
System Design Elements Reduce Stability and Predictability of Physician 
Fee Updates:

Fee updates under the SGR system have varied widely within an allowed 
range, principally because of annual fluctuations in the growth of the 
volume and intensity of services that physicians provide to 
beneficiaries. Two of the SGR system's design characteristics--the 
cumulative nature of spending targets and the use of estimated data 
elements in the spending target--also serve to reduce the stability and 
predictability of updates. The MMA provision that revised the allowance 
for growth in service volume and intensity from real GDP per capita 
growth rates each year to a 10-year moving average will reduce some of 
the swings in future SGR system updates.

Fluctuating Volume and Intensity Growth Is a Principal Cause of 
Instability of Fee Updates:

Annual fluctuations in the growth of the volume and intensity of 
services that physicians provide to beneficiaries have been a principal 
cause of the instability of physician fee updates. Since the SGR system 
was implemented in 1998, volume and intensity growth has ranged from 
1.2 percent in 1999 to 6.1 percent in 2002. (See fig. 2.) It is 
uncertain how much physicians' discretion in the provision of their 
services contributes to the fluctuation in volume and intensity growth.

Several studies have found that physicians respond to reduced fee 
updates by increasing the volume and intensity of services they provide 
to help maintain their total Medicare income.[Footnote 44] In 
estimating future spending and fee updates, both CMS and CBO assume 
that physicians will compensate, through volume and intensity 
increases, for a portion of any fee reductions. Consequently, both CMS 
and CBO project that for example, a 1 percent fee reduction would cause 
aggregate spending to fall by less than 1 percent. In addition, CBO 
assumes that physicians will respond to fee increases by reducing 
volume and intensity.

Physician groups contend that volume and intensity growth is a 
necessary response to increased demand caused by factors outside of 
physicians' control as noted earlier, such as the declining health 
status of Medicare beneficiaries, Medicare coverage of new benefits, 
and changing medical technology and practices that encourage 
beneficiaries to schedule more appointments with physicians. As long as 
the contributing factors are not fully understood and predictable, 
unexpected volume and intensity fluctuations will result in uncertain 
fee updates year to year.

SGR System's Cumulative Targets Increase Potential Fluctuation of 
Physician Fee Updates:

The cumulative nature of the SGR system's spending targets increases 
the potential fluctuation of physician fee updates, as the system 
requires that excess spending in any year be recouped in future years. 
Conceptually, this means that if actual spending has exceeded the SGR 
system targets, fee updates in future years must be lowered 
sufficiently to both offset the accumulated excess spending and slow 
expected spending for the coming year. Conversely, the system also 
requires that if spending were to fall short of the targets, fees would 
need to be increased so that future spending would be raised to align 
with target spending.

Estimation of the 2005 fee update illustrates how excess spending that 
is not addressed affects future fee updates. In 2004 actual 
expenditures under the SGR system are estimated to be $83.4 billion, 
whereas target expenditures for the same year will be $77.3 billion. As 
a result, 2005 fee updates need to offset a $6.1 billion deficit from 
excess spending in 2004 (plus accumulated excess spending of $5.8 
billion in past years) and to realign the year's expected spending with 
target spending.[Footnote 45] Because the SGR system is designed to 
offset accumulated excess spending over a period of years, the deficit 
for 2004 and preceding years will reduce fee updates for multiple 
years.

According to projections made by CMS OACT, maximum fee reductions will 
be in effect from 2006 through 2012. Fee updates will be positive in 
2014. (See fig. 3.)

Figure 3: Projected MEI and Fee Update under Current Law:

[See PDF for image]

Note: Projections are as of July 2004.

[End of figure]

Uncertainty in Estimates of Underlying SGR System Data Elements 
Decreases Stability and Predictability of Physician Fee Updates:

The stability of fee updates under the SGR system depends, in part, on 
CMS's ability to accurately estimate current spending and annual 
changes in the four factors that determine the sustainable growth rate: 
input prices, FFS enrollment, the 10-year moving average of real GDP 
per capita, and expenditures due to changes in laws and regulations. If 
reality proves different from these estimates, then the estimates are 
revised to incorporate more complete data, thereby contributing to the 
year to year fluctuation in fee updates. For example, in the fall of 
2004, when CMS determines the update for 2005, the agency must estimate 
cumulative expenditures through the end of 2004 based on incomplete 
data. If actual spending is underestimated, the 2005 update will be set 
higher than it would have been set without the estimation error. This 
underestimate will be corrected, because in setting a fee update, the 
SGR system requires CMS to revise the spending estimates and the 
sustainable growth rates for the 2 preceding years. Therefore, when 
more complete spending data become available, the agency will revise 
its previous cumulative spending estimates through 2004 and reduce 
future fee updates relative to what they would have been if spending 
had not been underestimated.

Uncertainty in long-term projections of FFS enrollment, in conjunction 
with the cumulative nature of the SGR system's targets, makes long-term 
estimates of fee updates less predictable. Because the SGR system 
offsets accumulated excess spending by reducing the update for the fee 
paid for each service, a decline in the number of services results in 
less spending being offset. For example, currently, CMS estimates that 
over the next 10 years, enrollment in FFS will decline as more 
beneficiaries join private plans. CMS projects that the percentage of 
Medicare beneficiaries in the FFS program will decline from about 85 
percent in 2005 to 67 percent in 2014. With fewer beneficiaries in FFS, 
fewer services would be provided. Therefore, the SGR system would call 
for more severe update reductions to offset accumulated excess spending 
relative to what would have occurred if FFS enrollment had remained 
stable. In contrast, CBO projected that FFS enrollment will increase 
over the 10-year period at about the same rate as the increase in 
overall Medicare enrollment.[Footnote 46] With more beneficiaries in 
FFS, and thus more services provided, update reductions would not need 
to be as severe to offset accumulated excess spending. Therefore, under 
CBO's FFS projection, positive fee updates would be expected to return 
sooner than under CMS's FFS projection.

Switching to the 10-Year Moving Average of Real GDP Per Capita Will 
Increase Stability and Predictability:

MMA changed the SGR system formula to use a 10-year moving average of 
real GDP per capita, which is currently 2.3 percent. As noted in our 
2002 testimony, this change will eliminate much of the cyclical 
variation in this factor that occurred in previous years under the 
formula when the SGR system target was tied to the yearly change in 
real GDP per capita.[Footnote 47] (See fig. 4.) Including a more stable 
measure of economic growth in the SGR system formula will help increase 
the stability of fee updates.

Figure 4: Annual Percentage Change in Real GDP Per Capita and 10-Year 
Moving Average Change in Real GDP Per Capita, 1992-2003:

[See PDF for image]

[End of figure]

Alternatives for Updating Physician Fees Would Eliminate Spending 
Targets or Revise Current SGR System:

The projected sustained period of declining physician fees and the 
potential for beneficiaries' access to physician services to be 
disrupted have heightened interest in alternatives for the current SGR 
system. In general, potential alternatives we identified cluster around 
two approaches. One approach would end the use of spending targets as a 
method for updating physician fees and encouraging fiscal discipline. 
The other approach would retain spending targets but modify the current 
SGR system to address perceived shortcomings. These modifications could 
include one or more of the following options: removing the Part B 
prescription drug expenditures that are currently counted in the SGR 
system; resetting the targets and not requiring the system to recoup 
previous excess spending; using annual, rather than cumulative, 
targets; raising the allowance for increased spending due to volume and 
intensity growth; and permitting some flexibility in setting the volume 
and intensity allowance.

The alternatives discussed in this section--intended to be 
illustrative--would all increase fees and thus aggregate spending--both 
government outlays and beneficiary cost sharing--for physician services 
relative to projected spending under current law.[Footnote 48] Most 
changes would require new legislation; one exception is the removal of 
Part B prescription drugs from the spending targets, which could be 
done administratively. We used CMS OACT's projections to provide a 
sense of the magnitude of the effect that potential alternatives might 
have on physician fee updates, aggregate spending for physician 
services, and real spending for physician fee schedule services per 
beneficiary (indicating a level of services beneficiaries receive 
excluding prescription drugs and other non-fee-schedule services, such 
as laboratory tests).[Footnote 49],[Footnote 50] To simplify 
comparisons among the discussed alternatives and current law, all of 
the projections use the same assumptions regarding volume and intensity 
growth for physician services and future FFS enrollment.[Footnote 51]

Eliminate Spending Targets, Base Fee Updates on Physician Cost 
Increases:

In its March 2001 report to the Congress, MedPAC recommended 
eliminating the SGR system of spending targets and replacing it with an 
approach that would base annual fee updates on changes in the cost of 
efficiently providing care.[Footnote 52] Under this approach, efforts 
to control aggregate spending would be separate from the mechanism used 
to update fees. The advantage of eliminating spending targets would be 
greater fee update stability. However, CMS OACT estimates that this 
approach, compared with the current law projection, would result in 
cumulative expenditures that are 22 percent greater over a 10-year 
period.

MedPAC reported that its recommendation could be implemented, in part, 
by basing the update on forecast changes in MEI. It suggested that 
other adjustments to the update might be necessary, for example, to 
ensure overall payment adequacy or correct for previous MEI forecast 
errors. In subsequent annual reports to the Congress, MedPAC has 
continued to recommend a physician fee update based on MEI.[Footnote 
53] In its March 2004 report, for example, MedPAC stated that current 
Medicare payments for physician services were adequate and recommended 
an update of approximately 2.6 percent for 2005 to "help maintain 
physician willingness and ability to furnish services to Medicare 
beneficiaries."[Footnote 54] MedPAC's recommendation contrasts with 
the 1.5 percent minimum update provided for by MMA and the negative 3.6 
percent update specified by the SGR system. In 2004 testimony, MedPAC 
stated that fee updates for physician services should not be automatic, 
but should be informed by changes in beneficiaries' access to services, 
the quality of services provided, the appropriateness of cost 
increases, and other factors.

Basing the update on MEI would result in positive and relatively stable 
fee updates. (See fig. 5.) According to CMS OACT simulations, such an 
approach would likely produce fee updates that ranged from 2.1 percent 
to 2.4 percent over the period from 2006 through 2014. Because 
physician fees would increase each year during the entire period, 
rather than decreasing each year until positive updates returned in 
2014 as they would under the current SGR system, Medicare spending for 
physician services would rise. For the 10-year period from 2005 through 
2014, CMS OACT estimates that this approach would result in cumulative 
expenditures that are 22 percent greater than projected under current 
law.[Footnote 55] (See fig. 6.) CMS OACT projects that under current 
law the net present value of total Medicare spending (both federal and 
beneficiary) over the next 75 years on all Part B services will be 
$16.9 trillion. If physician fee updates are based on the change in 
MEI, CMS OACT estimates that the net present value of total Medicare 
spending (both federal and beneficiary) over the next 75 years on Part 
B services would equal $19.1 trillion. Real spending per beneficiary 
would increase from $2,157 in 2005 to $2,802 in 2014, compared with 
real spending per beneficiary under current law, which would decrease 
to $1,774 in 2014. (See fig. 7.)

Figure 5: Projected MEI and Fee Updates under Current Law and under 
Option of Eliminating Spending Targets and Tying Fee Updates to MEI:

[See PDF for image]

Note: Projections are as of July 2004.

[End of figure]

Figure 6: Projected Aggregate Spending under Current Law and under 
Option of Eliminating Spending Targets and Tying Fee Updates to MEI:

[See PDF for image]

Notes: Projections are as of July 2004. Aggregate spending includes all 
expenditures for physician services--both government outlays and 
beneficiary cost sharing.

[End of figure]

Figure 7: Projected Real Spending for Physician Fee Schedule Services 
per FFS Beneficiary under Current Law and under Option of Eliminating 
Spending Targets and Tying Fee Updates to MEI:

[See PDF for image]

Notes: Projections are as of July 2004. Real spending per beneficiary 
for physician fee schedule services includes both government outlays 
and beneficiary cost sharing and is adjusted by MEI. Spending for non-
fee-schedule services--laboratory services and certain Medicare-
covered Part B outpatient drugs--is excluded.

[End of figure]

Although MedPAC's recommended update approach would limit annual 
increases in the price Medicare pays for each service, the approach 
does not contain an explicit mechanism for constraining aggregate 
spending resulting from increases in the volume and intensity of 
services physician provide. In 2001, when MedPAC first recommended 
eliminating the SGR system, it stated that volume and intensity 
increases had not been a major concern since 1992. It added, however, 
that if volume and intensity growth reemerged as a concern, Medicare 
might address the problem by trying to achieve appropriate use of 
services through outcomes and effectiveness research, disseminating 
practice guidelines and other tools for applying this research, and 
developing evidence-based measures to assess the application of the 
research findings.

Since MedPAC's 2001 report, volume and intensity growth has increased 
considerably. (See fig. 2.) Subsequent MedPAC reports and testimony 
have discussed trends in the use of physician services and have 
identified particular services--such as diagnostic imaging--that are 
growing rapidly, but the reports have not made recommendations for 
addressing volume and intensity growth. However, in 2004 testimony, 
MedPAC stated that it planned to study the efficacy of private 
insurers' strategies for controlling spending for high-growth services 
and whether Medicare might be able to emulate them.[Footnote 56]

Retain Spending Targets, Modify Current SGR System:

Another approach for addressing the perceived shortcoming of the 
current SGR system would retain spending targets but modify one or more 
elements of the system. The key distinction of this approach, in 
contrast to basing updates on MEI, is that fiscal controls designed to 
moderate spending would continue to be integral to the system used to 
update fees. The advantage of retaining spending targets as part of the 
system for updating fees is that the system would automatically work to 
moderate spending if volume and intensity growth began to increase 
above allowable rates. Although many options are possible under this 
approach, six are discussed below. All six would produce fee updates 
that are higher during the 10-year period from 2005 through 2014 than 
those projected under current law but would also result in higher 
aggregate spending ranging from 4 percent to 23 percent more, depending 
on the modification.

Remove Part B Drugs from the SGR System:

The Secretary of HHS could, under current authority, consider excluding 
Part B drugs from the definition of services furnished incident to 
physician services for purposes of the SGR system. As discussed 
earlier, expenditures for these drugs have been growing rapidly, which, 
in turn, has put downward pressure on the fees paid to Medicare 
physicians. However, according to CMS OACT simulations, removing Part B 
drugs from the SGR system beginning in 2005 would not prevent several 
years of fee declines and would not decrease the volatility in the 
updates. Fees would decline by about 5 percent per year from 2006 
through 2010. (See fig. 8.) There would be a positive update in 2011--
3 years earlier than is projected under current law. From 2012 through 
2014, fees would increase by approximately 5 percent per year. CMS OACT 
estimates that removing Part B drugs from the SGR system would result 
in cumulative spending over the 10-year period from 2005 through 2014 
that is 5 percent higher than is projected under current law.[Footnote 
57] (See fig. 9.) Real spending per beneficiary would increase from 
$2,157 in 2005 to $2,240 in 2014, compared with real spending per 
beneficiary under current law, which would decrease to $1,774 in 2014. 
(See fig. 10.)

Figure 8: Projected MEI and Fee Updates under Current Law and under 
Option of Not Including Any Part B Drugs in the SGR System Beginning in 
2005:

[See PDF for image]

Notes: Projections are as of July 2004. Projected updates under the 
option will be equal to projected updates under current law through 
2010.

[End of figure]

Figure 9: Projected Aggregate Spending under Current Law and under 
Option of Not Including Any Part B Drugs in the SGR System Beginning in 
2005:

[See PDF for image]

Notes: Projections are as of July 2004. Aggregate spending includes all 
expenditures for physician services--both government outlays and 
beneficiary cost sharing. The line depicting the projection under 
current law includes all spending included in the SGR system. Under the 
option of not including any Part B drugs in the SGR system, spending 
for Part B drugs will occur even though it is not included in the SGR 
formula. To ensure comparability between the two projections, we 
included aggregate spending for both remaining SGR-covered services and 
Part B drugs in the line depicting the projection under the option.

[End of figure]

Figure 10: Projected Real Spending for Physician Fee Schedule Services 
per FFS Beneficiary under Current Law and under Option of Not Including 
Any Part B Drugs in the SGR System Beginning in 2005:

[See PDF for image]

Notes: Projections are as of July 2004. Real spending per beneficiary 
for physician fee schedule services includes both government outlays 
and beneficiary cost sharing and is adjusted by MEI. Spending for non-
fee-schedule services--laboratory services and certain Medicare-
covered Part B outpatient drugs--is excluded.

[End of figure]

Base Future SGR System Targets on Actual Spending from a Recent Year:

In 2002, we testified that physician spending targets and fees may need 
to be adjusted periodically as health needs change, technology 
improves, or health care markets evolve.[Footnote 58] Such adjustments 
could involve specifying a new base year from which to set future 
targets. Currently, the SGR system uses spending from 1996, trended 
forward by the sustainable growth rate computed for each year, to 
determine allowable spending.

MMA avoided a fee decline in 2004, and a projected fee decline for 
2005, by stipulating a minimum update of 1.5 percent in each of those 2 
years, but the law did not similarly adjust the spending targets to 
account for the additional spending that would result from the minimum 
update. Consequently, under the SGR system the additional MMA spending 
and other accumulated excess spending will have to be recouped through 
fee reductions beginning in 2006. If policymakers believe that the 
resulting negative fee updates are inappropriately low, one solution is 
to use actual spending from a recent year as a basis for setting future 
SGR system targets. Using such an approach, policymakers could 
essentially forgive the accumulated excess spending attributable to MMA 
and other factors. The effect would be to increase future updates and, 
as with other alternatives presented here, overall spending.

According to CMS OACT simulations, forgiving the accumulated excess 
spending as of 2005--that is, resetting the cumulative spending target 
so that it equals cumulative actual spending--would raise fees in 2006. 
(See fig. 11.) However, because volume and intensity growth is 
projected to exceed the SGR system's allowance for such growth, 
negative updates would return beginning in 2008 and continue through 
2013. Resulting cumulative spending over the 10-year period from 2005 
through 2014 would be 13 percent higher than is projected under current 
law. (See fig. 12.) Real spending per beneficiary for physician 
services would grow from $2,157 in 2005 to $2,334 in 2014, compared 
with real spending per beneficiary under current law, which would 
decrease to $1,774 in 2014. (See fig. 13.)

Figure 11: Projected MEI and Fee Updates under Current Law and under 
Option of Resetting the Cumulative Spending Target Equal to Cumulative 
Actual Spending as of 2006:

[See PDF for image]

Notes: Projections are as of July 2004. Projection under option of 
eliminating accumulated excess spending assumes that the physician fee 
update would equal MEI in 2006.

[End of figure]

Figure 12: Projected Aggregate Spending under Current Law and under 
Option of Resetting the Cumulative Spending Target Equal to Cumulative 
Actual Spending as of 2006:

[See PDF for image]

Notes: Projections are as of July 2004. Aggregate spending includes all 
expenditures for physician services--both government outlays and 
beneficiary cost sharing. Projection under option of eliminating 
accumulated excess spending assumes that the physician fee update would 
equal MEI in 2006.

[End of figure]

Figure 13: Projected Real Spending for Physician Fee Schedule Services 
per FFS Beneficiary under Current Law and under Option of Resetting the 
Cumulative Spending Target Equal to Cumulative Actual Spending as of 
2006:

[See PDF for image]

Notes: Projections are as of July 2004. Projection under option of 
eliminating accumulated excess spending assumes that the physician fee 
update would equal MEI in 2006. Real spending per beneficiary for 
physician fee schedule services includes both government outlays and 
beneficiary cost sharing and is adjusted by MEI. Spending for non-fee-
schedule services--laboratory services and certain Medicare-covered 
Part B outpatient drugs--is excluded.

[End of figure]

Eliminate the Cumulative Aspect of Spending Targets:

One option for reducing the fluctuation in fee updates would be to 
eliminate the cumulative aspect of the SGR system's spending targets 
and return to a system of annual targets, as was used under MVPS. As 
previously discussed, the cumulative aspect of the SGR system's 
spending targets--although rigorous as a budgetary tool--can produce 
updates that swing from the maximum fee reduction to the maximum fee 
increase. In contrast, MVPS's annual spending target approach traded 
off some fiscal control for increased fee stability. The MVPS update 
for a year depended, in part, on whether actual spending 2 years 
earlier had exceeded or fallen short of the annual spending target for 
that year. For example, the MVPS update for 1996, which was determined 
in 1995, was affected by the relationship between actual and target 
spending in 1994. In principle, under MVPS excess spending from a 
single year, up to a limit specified by its update formula, was 
required to be recouped. Excess spending that could not be made up 
within those limits would, in essence, be forgiven.[Footnote 59]

According to CMS OACT simulations, eliminating the cumulative aspect of 
the SGR system would result in fee updates that vary less than 
projected updates under current law. For example, under an MVPS-like 
system of annual targets, from 2006 through 2014, the largest negative 
update would be negative 0.6 percent instead of negative 5.0 percent 
under current law, and the largest positive update would be 0.9 percent 
instead of 3.9 percent. (See fig. 14.) Fees would be essentially flat 
over the period, instead of swinging from large fee declines to fee 
increases as they are expected to do under the SGR system. Relative to 
spending projected under current law, under an MVPS-like system total 
spending would be greater each year from 2006 through 2014. CMS OACT 
estimates that cumulative expenditures over the 10-year period from 
2005 through 2014 would be 15 percent higher than under current law. 
(See fig. 15.) Real spending per beneficiary would increase from $2,157 
in 2005 to $2,442 in 2014, compared with real spending per beneficiary 
under current law, which would decrease to $1,774 in 2014. (See fig. 
16.)

Figure 14: Projected MEI and Fee Updates under Current Law and under 
Option of Eliminating the Cumulative Aspect of Spending Targets:

[See PDF for image]

Note: Projections are as of July 2004.

[End of figure]

Figure 15: Projected Aggregate Spending under Current Law and under 
Option of Eliminating the Cumulative Aspect of Spending Targets:

[See PDF for image]

Notes: Projections are as of July 2004. Aggregate spending includes all 
expenditures for physician services--both government outlays and 
beneficiary cost sharing.

[End of figure]

Figure 16: Projected Real Spending for Physician Fee Schedule Services 
per FFS Beneficiary under Current Law and under Option of Eliminating 
the Cumulative Aspect of Spending Targets:

[See PDF for image]

Notes: Projections are as of July 2004. Real spending per beneficiary 
for physician fee schedule services includes both government outlays 
and beneficiary cost sharing and is adjusted by MEI. Spending for non-
fee-schedule services--laboratory services and certain Medicare-
covered Part B outpatient drugs--is excluded.

[End of figure]

Modify Allowance for Volume and Intensity Growth:

If policymakers agree with physician groups that the current SGR 
system's allowance for volume and intensity growth does not adequately 
account for appropriate spending increases that result from 
technological innovation or changes in medical practice, the allowance 
could be increased by some factor above the percentage change in real 
GDP per capita. As stated earlier, the current SGR system's allowance 
for volume and intensity growth is approximately 2.3 percent per year-
-the 10-year moving average in real GDP per capita--while projected 
volume and intensity growth is higher--about 3 percent per year for 
physician services alone, and about 4 percent per year including Part B 
drugs. To offset the increased spending associated with the higher 
volume and intensity growth, the SGR system will reduce updates below 
the increase in MEI. In its 1997 report to the Congress, PPRC 
recommended adopting an allowance equal to real GDP per capita plus 1 
or 2 percentage points "to allow for advancements in medical 
capabilities."[Footnote 60]

According to CMS OACT simulations, increasing the allowance for volume 
and intensity growth to GDP plus 1 percentage point would likely 
produce positive fee updates beginning in 2012--2 years earlier than is 
projected under current law. (See fig. 17.) Because fee updates would 
be on average greater than under current law during the 10-year period 
from 2005 through 2014, Medicare spending for physician services would 
rise. CMS OACT estimates that cumulative expenditures over the 10-year 
period would increase by 4 percent more than under current 
law.[Footnote 61] (See fig. 18.) Real spending per beneficiary would 
change little from $2,157 in 2005 to $2,158 in 2014, compared with real 
spending per beneficiary under current law, which would decrease to 
$1,774 in 2014. (See fig. 19.)

Figure 17: Projected MEI and Fee Updates under Current Law and under 
Option of Increasing Volume and Intensity Growth Allowance to GDP Plus 
1 Percentage Point:

[See PDF for image]

Notes: Projections are as of July 2004. Projected updates under the 
option will be equal to projected updates under current law through 
2010.

[End of figure]

Figure 18: Projected Aggregate Spending under Current Law and under 
Option of Increasing Volume and Intensity Growth Allowance to GDP Plus 
1 Percentage Point:

[See PDF for image]

Notes: Projections are as of July 2004. Aggregate spending includes all 
expenditures for physician services--both government outlays and 
beneficiary cost sharing.

[End of figure]

Figure 19: Projected Real Spending for Physician Fee Schedule Services 
per FFS Beneficiary under Current Law and under Option of Increasing 
Volume and Intensity Growth Allowance to GDP Plus 1 Percentage Point:

[See PDF for image]

Notes: Projections are as of July 2004. Real spending per beneficiary 
for physician fee schedule services includes both government outlays 
and beneficiary cost sharing and is adjusted by MEI. Spending for non-
fee-schedule services--laboratory services and certain Medicare-
covered Part B outpatient drugs--is excluded.

[End of figure]

Congress could also modify the SGR system's allowance for volume and 
intensity growth by providing flexibility similar to that afforded by 
the MVPS system. Although that earlier system of spending targets 
specified a default volume and intensity increase, it also allowed the 
HHS Secretary to recommend a different increase if changes in medical 
technology, beneficiary access to physician services, or other factors 
warranted an allowance that was higher or lower than the default 
increase.

Combine Options:

Two alternatives illustrate the effects of combining individual 
options. For example, together the Congress and CMS could modify the 
SGR system by removing Part B drugs, resetting the base, and increasing 
allowed volume and intensity growth to GDP plus 1 percentage 
point.[Footnote 62] According to CMS OACT simulations, this combination 
of options would result in positive updates ranging from 2.2 percent to 
2.8 percent for the 2006-2014 period. (See fig. 20.) CMS OACT projects 
that the combined options would increase aggregate spending by 23 
percent over the 10-year period (see fig. 21.) and that real spending 
per beneficiary for physician services would increase from $2,157 to 
$2,866, compared with real spending per beneficiary under current law, 
which would decrease to $1,774 in 2014. (See fig. 22.)

Figure 20: Projected MEI and Fee Updates under Current Law and under 
Combination of Options of Resetting the Cumulative Spending Target 
Equal to Cumulative Actual Spending as of 2006, Not Including Any Part 
B Drugs in the SGR System Beginning in 2005, and Using GDP Plus 1 
Percentage Point:

[See PDF for image]

Notes: Projections are as of July 2004. Projection under combination of 
options of resetting the cumulative spending target equal to cumulative 
actual spending as of 2005, removing Part B drugs from the SGR system 
beginning in 2005, and using GDP plus 1 percentage point assumes that 
the physician fee update would equal MEI in 2006.

[End of figure]

Figure 21: Projected Aggregate Spending under Current Law and under 
Combination of Options of Resetting the Cumulative Spending Target 
Equal to Cumulative Actual Spending as of 2006, Not Including Any Part 
B Drugs in the SGR System Beginning in 2005, and Using GDP Plus 1 
Percentage Point:

[See PDF for image]

Notes: Projections are as of July 2004. Aggregate spending includes all 
expenditures for physician services--both government outlays and 
beneficiary cost sharing. Projection under combination of options of 
resetting the cumulative spending target equal to cumulative actual 
spending as of 2005, not including any Part B drugs in the SGR system 
beginning in 2005, and using GDP plus 1 percentage point assumes that 
the physician fee update would equal MEI in 2006. The line depicting 
the projection under current law includes all spending included in the 
SGR system. Under the option of not including any Part B drugs in the 
SGR system, spending for Part B drugs will occur even though it is not 
included in the SGR formula. To ensure comparability between the two 
projections, we included aggregate spending for both remaining SGR-
covered services and Part B drugs in the line depicting the projection 
under the option.

[End of figure]

Figure 22: Projected Real Spending for Physician Fee Schedule Services 
per FFS Beneficiary under Current Law and under Combination of Options 
of Resetting the Cumulative Spending Target Equal to Cumulative Actual 
Spending as of 2006, Not Including Any Part B Drugs in the SGR System 
Beginning in 2005, and Using GDP Plus 1 Percentage Point:

[See PDF for image]

Notes: Projections are as of July 2004. Projection under combination of 
options of resetting the cumulative spending target equal to cumulative 
actual spending as of 2005, removing Part B drugs from the SGR system 
beginning in 2005, and using GDP plus 1 percentage point assumes that 
the physician fee update would equal MEI in 2006. Real spending per 
beneficiary for physician fee schedule services includes both 
government outlays and beneficiary cost sharing and is adjusted by MEI. 
Spending for non-fee-schedule services--laboratory services and 
certain Medicare-covered Part B outpatient drugs--is excluded.

[End of figure]

Another example of combined options could involve removing Part B drugs 
and implementing an MVPS-like system of annual targets, but not 
increasing the volume and intensity allowance. CMS OACT simulations 
project that this combination would result in fee updates that range 
from 0.8 percent to 1.3 percent over the period from 2006 through 2014. 
(See fig. 23.) Over the 10-year period from 2005 through 2014, 
cumulative spending for physician services would exceed those projected 
under current law by 18 percent. (See fig. 24.) Real spending per 
beneficiary for physician services would increase from $2,157 to 
$2,615, compared with real spending per beneficiary under current law, 
which would decrease to $1,774 in 2014. (See fig. 25.)

Figure 23: Projected MEI and Fee Updates under Current Law and under 
Combination of Options of Not Including Any Part B Drugs in the SGR 
System Beginning in 2005 and Eliminating the Cumulative Aspect of 
Spending Targets:

[See PDF for image]

Note: Projections are as of July 2004.

[End of figure]

Figure 24: Projected Aggregate Spending under Current Law and under 
Combination of Options of Not Including Any Part B Drugs in the SGR 
System Beginning in 2005 and Eliminating the Cumulative Aspect of 
Spending Targets:

[See PDF for image]

Notes: Projections are as of July 2004. Aggregate spending includes all 
expenditures for physician services--both government outlays and 
beneficiary cost sharing. The line depicting the projection under 
current law includes all spending included in the SGR system. Under the 
option of not including any Part B drugs in the SGR system, spending 
for Part B drugs will occur even though it is not included in the SGR 
formula. To ensure comparability between the two projections, we 
included aggregate spending for both remaining SGR-covered services and 
Part B drugs in the line depicting the projection under the option.

[End of figure]

Figure 25: Projected Real Spending for Physician Fee Schedule Services 
per FFS Beneficiary under Current Law and under Combination of Options 
of Not Including Any Part B Drugs in the SGR System Beginning in 2005 
and Eliminating the Cumulative Aspect of Spending Targets:

[See PDF for image]

Notes: Projections are as of July 2004. Real spending per beneficiary 
for physician fee schedule services includes both government outlays 
and beneficiary cost sharing and is adjusted by MEI. Spending for non-
fee-schedule services--laboratory services and certain Medicare-
covered Part B outpatient drugs--is excluded.

[End of figure]

Concluding Observations:

Medicare faces the challenge of moderating the growth in spending for 
physician services while ensuring that physicians are paid fairly so 
that beneficiaries have appropriate access to their services. Under the 
current SGR system, fees are projected to fall by about 5 percent per 
year for the next several years. Total payments to physicians will 
continue to rise because of expected increases in volume and intensity. 
However, on a per capita basis, real spending per beneficiary will 
decline, raising concerns that a sustained period of falling fees could 
discourage some physicians from participating in the Medicare program 
and serving beneficiaries. These concerns have prompted policymakers to 
consider alternative approaches for updating physician fees.

One approach under consideration for solving the problem of declining 
fees is for Medicare to abandon the use of spending targets and 
separate the program's attempts to control spending from its method for 
adjusting physician fees each year. This is the approach that has been 
recommended by MedPAC. Although projected future fee increases would be 
positive and relatively stable, eliminating spending targets would 
increase spending. The extent to which spending growth would be 
moderated would depend upon the efficacy of separate efforts to address 
growth in volume and intensity.

Similarly, the other approach of retaining spending targets but 
modifying the SGR system to overcome its current perceived 
shortcomings, would also increase spending. These alternative 
approaches could also be augmented by separate efforts to moderate 
spending. Alternatives under this approach seek to preserve the fiscal 
discipline of spending targets while providing for reasonable fee 
updates. These alternative approaches could also be augmented by other 
efforts to moderate spending. To the extent that the growth in spending 
is moderated, physicians would benefit from an increase in fees that 
would be triggered under a spending target system.

Almost any change to the SGR system is likely to increase Medicare 
spending above the amount that is currently projected. Either of the 
two broad types of approaches discussed above--replacing the SGR system 
and revising the SGR system--could be implemented in a way that would 
likely generate positive fee updates. Therefore, the choice between the 
two approaches under consideration may hinge on whether primary 
importance should be given to stable fee increases or to the need for 
fiscal discipline within the Medicare program.

Agency and Industry Comments and Our Evaluation:

Agency Comments:

In written comments on a draft of this report, CMS agreed with our 
concluding observations that appropriately updating the physician 
payment rates requires a balance between adjusting physician fees in a 
stable and predictable manner and encouraging fiscal discipline with 
scarce Medicare resources. CMS expressed its commitment to ensuring 
that Medicare beneficiaries have access to high-quality health care and 
noted that achieving this goal requires paying physicians 
appropriately. CMS mentioned several administrative actions it has 
taken to improve Medicare's payments to physicians, including specific 
adjustments to MEI that have both made the index a more accurate 
representation of inflation in physician practice costs and resulted in 
higher payments to physicians. In addition, the agency committed to 
considering further administrative actions and discussed ongoing 
efforts to implement various provisions of MMA that may reduce adverse 
incentives in the current payment system, allow the program to pay for 
higher quality care, and uncover innovative methods to control spending 
growth in the future. We have reprinted CMS's letter in appendix III.

Industry Association Comments:

We obtained oral comments from officials representing the American 
Medical Association (AMA), the Medical Group Management Association 
(MGMA), the American College of Physicians (ACP), and the Alliance for 
Specialty Medicine (ASM). In discussing the draft report with these 
groups, their overall reaction was that the report was a good analysis 
of the problems with the SGR system; however, they raised a number of 
concerns about the draft report. The bulk of their comments focused on 
OACT's estimates of aggregate spending on physician services, the SGR 
system's use of MEI as a measure of input price inflation for physician 
services, and the draft's discussion of physicians' concerns about the 
SGR system. The rest of their comments pertained to either issues 
related to physician behavior or to topics outside the scope of our 
review. A summary of the physician groups' comments and our evaluation 
is provided below.

Representatives from all four groups commented on CMS OACT's estimates 
illustrating each option's additional aggregate spending over a 10-year 
period relative to current law spending over the same period. The 
groups were confused by the difference between CMS OACT's estimates and 
CBO's budget impact estimates, which were available for some of the 
options. CBO's budget scores--that is, cost estimates that show the 
impact of legislative changes on the federal budget--include only 
federal expenditures and exclude spending from other sources, such as 
beneficiary cost sharing. In contrast, CMS OACT's aggregate spending 
estimates include both federal outlays and beneficiary cost sharing. 
Because any changes to the SGR system that result in increased spending 
would not only affect taxpayers but also Medicare beneficiaries 
(through increased cost sharing and part B premiums), we believe it is 
appropriate to include the estimated increase in aggregate spending. 
Nevertheless, because our focus is on the relative costliness of each 
option, we revised the draft to highlight the proportional difference 
between current law spending and the spending estimated for each 
option. In addition, we now include CBO's budget scores for each 
option, where available.

All four physician groups also expressed concern that the draft report 
did not discuss the use of MEI as a measure of input price inflation 
for physician services. The groups contended that MEI does not contain 
sufficiently current data on physician practice costs, stating that it 
does not account for or keep pace with the cost of items such as 
information technology. Examining MEI and other indices included in the 
SGR system was outside the scope of our report. Moreover, in responding 
to public comments on a federal regulation, CMS stated that the various 
expense categories constituting MEI capture all practice expenses and 
are based on the most recent available data. [Footnote 63]

The physician groups commented that the projected payment reductions of 
5 percent a year from 2006 through 2014 are unrealistically severe and 
that the draft report did not sufficiently emphasize the access 
problems that beneficiaries would experience in the event of these 
cuts. They further noted that the Congress has regularly made 
adjustments to the SGR system and would probably act again. We noted in 
the draft report that policymakers, physicians, and others are 
concerned about the impact that the projected fee reductions would have 
on beneficiary access to physician services, noting that the Medicare 
Trustees and other parties believe it is unlikely that the projected 
fee reductions will take place.

Representatives from both ACP and ASM asserted that we should include a 
discussion about the effect of the spending targets on physician 
behavior and volume and intensity. They noted that evidence is lacking 
that directly correlates the introduction of both spending targets and 
the physician fee schedule in 1992 with the corresponding drop in 
volume and intensity in that year. They believe this reduction was 
likely caused by something other than the spending target, such as 
initiatives aimed at correctly coding claims for physician services. 
ACP stated that for the Congress to evaluate any alternatives, there 
must be a discussion of how the SGR system affects the volume and 
intensity of physician services. As noted in the draft report, we do 
not claim that spending targets and the fee schedule influenced 
individual behavior and reduced the volume and intensity of physician 
services in the early 1990s, we noted that PPRC claimed that a spending 
target system would provide a collective incentive for physicians to 
develop practice guidelines and control unnecessary utilization. 
Further, in the draft report we described spending targets as a method 
for automatically imposing fiscal discipline, not as a tool to modify 
the behavior of individual physicians.

Representatives from ACP further noted that while the draft report 
included a discussion of geographic variation in physician service use, 
it did not mention that the SGR system is a blunt instrument in that it 
applies nationally to all physicians. In a year in which fees are 
reduced, physicians in regions that could be characterized as low 
spending would receive the same fee reduction as physicians in higher-
spending regions. We agree that the SGR system does not distinguish 
between physicians whose discretionary practice patterns result in 
higher Medicare spending and those physicians whose practice patterns 
do not. As we stated in the draft report, at the time PPRC recommended 
expenditure targets, it initially envisioned a national target that 
would apply to all physician services and later the evolution of 
separate targets that would apply to regions, categories of physician 
services, or both.

The physician groups raised additional topics that were beyond the 
scope of our study. For example, AMA contended that Medicare's new 
preventive benefits and government-sponsored health campaigns create a 
government-induced demand among beneficiaries for services that, in 
turn, could increase volume and intensity of service use. To date, 
studies have not been conducted on whether new benefits and federal 
health campaigns have directly affected Medicare beneficiaries' use of 
physician services. Our report notes, however, that the SGR system's 
allowance for volume and intensity growth, unlike that of the MVPS 
system, is inflexible and would not take such factors into account. ACP 
noted that increased spending on physician services may be appropriate, 
as it may result in other program savings, such as reduced spending for 
hospital care. Whether such savings have been or can be achieved would 
require research outside this study's scope.

We are sending copies of this report to the Secretary of Health and 
Human Services and interested congressional committees. We will also 
provide copies to others on request. In addition, this report is 
available at no charge on the GAO Web site at http://www.gao.gov.

If you or your staff have questions about this report, please contact 
me at (202) 512-7101 or James Cosgrove at (202) 512-7029. Other 
contributors to this report include Jessica Farb, Hannah Fein, and 
Jennifer Podulka.

Signed by: 

A. Bruce Steinwald: 
Director, Health Care--Economic and Payment Issues:

List of Committees:

The Honorable Charles E. Grassley: 
Chairman: 
The Honorable Max Baucus: 
Ranking Minority Member: 
Committee on Finance: 
United States Senate:

The Honorable Joe L. Barton: 
Chairman: 
The Honorable John D. Dingell: 
Ranking Minority Member: 
Committee on Energy and Commerce: 
House of Representatives:

The Honorable William M. Thomas: 
Chairman: 
The Honorable Charles B. Rangel: 
Ranking Minority Member: 
Committee on Ways and Means: 
House of Representatives:

The Honorable Michael Bilirakis: 
Chairman: 
The Honorable Sherrod Brown: 
Ranking Minority Member: 
Subcommittee on Health: 
Committee on Energy and Commerce: 
House of Representatives:

The Honorable Nancy L. Johnson: 
Chairman: 
The Honorable Pete Stark: 
Ranking Minority Member: 
Subcommittee on Health: 
Committee on Ways and Means: 
House of Representatives: 

[End of section]

Appendix I: Calculation of the Performance Adjustment Factor:

Each year, CMS follows a statutory formula to compute a performance 
adjustment factor (PAF) and determines whether the physician fee update 
should be adjusted relative to the percentage change in the Medicare 
Economic Index (MEI) and, if so, by how much. (See fig. 26.) The PAF 
takes into account the difference between actual and target 
expenditures. If spending has equaled the targets, the PAF is equal to 
1 and the update will equal the percentage change in MEI. If spending 
has been below the targets, the PAF is greater than 1, thus increasing 
the update. If spending has been above the targets, the PAF is less 
than 1, thus reducing the update. The PAF is a blend of the relative 
difference between target and actual spending in the current year, 
accounting for 75 percent, and the relative cumulative difference in 
expenditures from April 1996 through the current year, accounting for 
33 percent. The weights were developed by the Centers for Medicare & 
Medicaid Services' (CMS) Office of the Actuary (OACT) and included in 
statute to minimize the volatility of both fee updates and the time 
required to align actual spending with the targets. Applying these 
weights causes the difference between cumulative actual expenditures 
and cumulative target expenditures to be adjusted over several years 
rather than during a single year. As a result, the fee update is less 
volatile than would be the case if the full adjustment were made in 1 
year. The PAF is subject to statutory limits and may not cause the fee 
update to be set at more than 3 percent above MEI or 7 percent below 
MEI. These limits may further increase the time necessary to align 
spending with targets.

Figure 26: Formula Used to Determine the Performance Adjustment Factor 
in 2005:

[See PDF for image]

[End of figure]

[End of section]

Appendix II: Corrections to Prior Estimates Caused the SGR System's 
Cumulative Targets to Produce Negative Updates:

Since the introduction of the fee schedule in 1992 through 2001, 
physicians generally experienced real increases in their fee updates--
that is, fee updates increased more than the increase in the cost of 
providing physician services, as measured by MEI. Specifically, during 
that period, fee updates increased by 39.7 percent, whereas MEI 
increased by 25.9 percent. In 2002, however, the sustainable growth 
rate (SGR) system reduced fees by 4.8 percent,[Footnote 64] despite an 
estimated 2.6 percent increase in the costs of providing physician 
services. (See fig. 27.)

Figure 27: Percentage Change in MEI, SGR Fee Schedule Update, and 
Medicare Physician Services Spending per Beneficiary, 1998-2005:

[See PDF for image]

Notes: Spending per beneficiary represents Medicare spending for 
beneficiaries in the traditional FFS program, net of beneficiary cost 
sharing. Spending for end-stage renal disease patients is not included. 
The physician fee schedule update figures shown do not reflect 
additional required adjustments, such as those for legislated changes 
and for budget neutrality.

[A] The 1.7 percent fee update went into effect in March 2003.

[B] The physician fee updates of 1.5 percent for 2004 and 2005 were 
specified by the Medicare Prescription Drug, Improvement, and 
Modernization Act of 2003.

[End of figure]

In 2002, corrections to prior estimation errors caused the SGR system's 
cumulative targets to begin producing negative updates. The SGR system 
reduced fees in 2002 because estimated spending for physician services-
-cumulative since 1996--exceeded the target by about $8.9 billion, or 
13 percent of projected 2002 spending. In part, the fee reduction 
occurred because CMS revised upward its estimates of previous years' 
actual spending. Specifically, CMS found that its previous estimates 
had omitted a portion of actual spending for 1998, 1999, and 2000. In 
addition, in 2002 CMS lowered the 2 previous years' spending targets 
based on revised gross domestic product (GDP) data from the Department 
of Commerce. Based on the new higher spending estimates and lower 
targets, CMS determined that fees had been too high in 2000 and 2001. 
In setting the 2002 physician fees, the SGR system reduced fees to 
recoup previous excess spending. The update would have been about 
negative 9 percent if the SGR system had not limited its decrease to 7 
percent below MEI. Because the previous overpayments were not fully 
recouped in 2002, and because of volume and intensity increases, by 
2003, physicians were facing several more years of fee reductions to 
bring cumulative Medicare spending on physician services in line with 
cumulative targets.

Despite its recognition of errors, CMS had determined that its 
authority to revise previous spending targets was limited. In 2002, CMS 
noted that the 1998 and 1999 spending targets had been based on 
estimated growth rates for beneficiary FFS enrollment and real GDP per 
capita; actual experience had shown these growth rates to be too low. 
If the estimates could have been revised, the targets for those and 
subsequent years would have been increased. However, at the time that 
CMS acknowledged these errors, the agency concluded that it was not 
allowed to revise these estimates.[Footnote 65] Without such revisions, 
the cumulative spending targets remained lower than if errors had not 
been made.

In late 2002, the estimate of the sustainable growth rate called for a 
negative 4.4 percent fee update in 2003. With the passage of the 
Consolidated Appropriations Resolution of 2003,[Footnote 66] CMS 
determined that it was authorized to correct the 1998 and 1999 spending 
targets. Because SGR system targets are cumulative measures, these 
corrections resulted in an average 1.4 percent increase in physician 
fees for services for 2003.[Footnote 67]

The Medicare Prescription Drug, Improvement, and Modernization Act of 
2003 (MMA) averted additional fee reductions projected for 2004 and 
2005 by specifying an update to physician fees of no less than 1.5 
percent for those 2 years.[Footnote 68] The MMA increases replaced SGR 
system fee reductions of 4.5 percent in 2004 and an estimated 3.6 
percent in 2005. The fee increases will result in additional aggregate 
spending. Because MMA did not make corresponding revisions to the SGR 
system's spending targets, its fee increases will require the SGR 
system to offset the additional spending by reducing fees beginning in 
2006. In addition, recent growth in spending due to volume and 
intensity, which has been larger than SGR system targets allow, will 
further compound the excess spending that needs to be recouped.

[End of section]

Appendix III: Comments from the Centers for Medicare & Medicaid 
Services:

DEPARTMENT OF HEALTH & HUMAN SERVICES: 
Centers for Medicare & Medicaid Services:

Washington, DC 20201:

DATE: SEP 27 2004:

TO: A. Bruce Steinwald:
Director, Health Care-Economic and Payment Issues: 
Government Accountability Office:

FROM: Mark B. McClellan, M.D., Ph.D. 
Administrator:

Initialed by Mark B. McClellan: 

SUBJECT: Government Accountability Office's (GAO) Draft Report: 
MEDICARE PHYSICIAN PAYMENTS: Concerns About Spending Torget System 
Prompt Interest in Considering Reforms (GAO-04-1027):

Thank you for the opportunity to review and comment on the draft 
report. We appreciate the interest of the Congressional Committees in 
the physician fee schedule (PFS) rates under the sustainable growth 
rate (SGR) system and the efforts of GAO to consider potential 
improvements to the system.

We agree with GAO that appropriately updating the physician payment 
rates requires a balance between adjusting physician fees in a stable 
and predictable manner and encouraging fiscal discipline with scarce 
Medicare resources. As a result of joint collaboration between Congress 
and the Administration, enactment of the Medicare Prescription Drug, 
Improvement and Modernization Act (MMA) guarantees that the 2004 and 
2005 physician fee schedule updates would be no less than 1.5 percent. 
The MMA improves access to high-quality care by recognizing that 
Medicare beneficiaries cannot get such care without paying physicians 
appropriately. As a result we have increased payments for doctors this 
year and will increase them again in 2005, instead of decreasing 
payment rates as would have been required by the Medicare law if the 
MMA had not been passed. As a result of the MMA, physicians will 
receive roughly 4 percent more in Medicare revenues in 2004 and 2005.

The Centers for Medicare & Medicaid Services (CMS) has taken several 
actions within its administrative authority to improve Medicare 
payments for physicians' services. For instance, CMS changed its policy 
to adjust the Medicare Economic Index (MEI) for multifactor 
productivity in place of labor productivity beginning in 2003. This 
change increased the PFS update by 0.7 percentage points for 2003. We 
estimate that the change to the MEI increased Medicare spending by 
$14.5 billion over ten years. For 2004, we increased the weight of 
malpractice costs in the MEI from 3.2 to 3.9 percent, a 21 percent 
increase. We also incorporated a 16.9 percent increase in malpractice 
premiums into the 2004 MEI. The increased weight for malpractice in 
the MEI makes the index a more accurate representation of inflation in 
physician office costs.

The GAO report notes that CMS can take certain administrative actions 
to address the physician update situation. The report correctly notes 
that these administrative proposals will have significant long-term 
cost implications but will not have an impact in 2006 and the 
subsequent few years. Therefore, without a change in law, there will 
still be a reduction in physicians' fee schedule rates for 2006 and 
subsequent years. Nevertheless, as we consider changes to the physician 
fee schedule for 2006 and future years, we are committed to looking 
thoroughly at these suggestions.

The CMS is also currently working to implement numerous provisions of 
the MMA that make vital improvements to the Medicare program, such as 
adding important preventive benefits and taking steps to reward health 
professionals for avoiding complications and reducing costs. We are 
also investigating new approaches that may reduce adverse incentives in 
the current payment system and allow Medicare to pay for better rather 
than more care. We are implementing innovative coordinated care and 
disease management pilots and demonstration programs such as the 
Chronic Care Improvement Program that may provide insight on new and 
innovative ways to control expenditure growth in the future. Further, 
we are currently assessing the impact of provisions of the MMA on 
physician spending targets.

Once again, thank you for the opportunity to review this draft report 
and CMS looks forward to working with Congress on potential changes to 
the physician payment system that will control Medicare spending and 
lead to equitable updates to physician fee schedule payment rates, as 
well as ensuring access to high quality health care. 

[End of section]

FOOTNOTES

[1] The SGR system reduced fees by 4.8 percent. Additional adjustments 
resulted in a total fee reduction of 5.4 percent. 

[2] See Pub. L. No. 101-239, §6102, 103 Stat. 2106, 2169-89.

[3] See Pub. L. No. 105-33, §4503, 111 Stat. 251, 433-34. BBA set a 
specific fee update for 1998. See BBA, §4505, 111 Stat. 435-39. 
Physician fees were first affected by the SGR system in 1999. 

[4] Specifically, from 1992 through 2001, fee updates resulting from 
the SGR and its predecessor system, increased by 39.7 percent, whereas 
input prices increased by 25.9 percent. These updates do not reflect 
other required adjustments, such as those for legislated changes and 
for budget neutrality. 

[5] See Pub. L. No. 108-173, §953, 117 Stat. 2066, 2427-28.

[6] Boards of Trustees of the Federal Hospital Insurance and Federal 
Supplementary Medical Insurance Trust Funds, 1998 Annual Report of the 
Board of Trustees of the Federal Supplementary Medical Insurance Trust 
Fund (Washington, D.C.: Apr. 28, 1998), and 2004 Annual Report of the 
Board of Trustees of the Federal Hospital Insurance and Federal 
Supplementary Medical Insurance Trust Funds (Washington, D.C.: Mar. 23, 
2004). 

[7] MedPAC is an independent federal body that advises the Congress on 
issues affecting the Medicare program.

[8] CMS OACT has the program responsibility to calculate Medicare's 
spending targets for physician services and annual physician fee 
updates. In producing these simulations, CMS OACT used the agency's 
assumptions regarding the various factors that affect the SGR system, 
such as projected fee-for-service enrollment.

[9] The Part B premium amount is adjusted each year so that expected 
premium revenues equal 25 percent of expected Part B spending. 
Beneficiaries must pay coinsurance--usually 20 percent--for most Part B 
services.

[10] This rate incorporates the 10-year moving average of real GDP per 
capita.

[11] The change in the cost of providing physician services is measured 
by the Medicare Economic Index (MEI). MEI measures input prices for 
resources needed to provide physician services. It is designed to 
estimate the increase in the total cost for the average physician to 
operate a medical practice.

[12] The SGR system permits annual physician fee updates to vary by as 
much as 7 percent below to 3 percent above the estimated change in 
physicians' cost of providing services as measured by MEI.

[13] PPRC, established by the Congress in the Consolidated Omnibus 
Budget Reconciliation Act of 1985, Pub. L. No. 99-272, §9305, 100 Stat. 
82, 190-91 (1986), was charged with advising the Congress on methods to 
reform payment to physicians under the Medicare program and with making 
recommendations annually. Subsequent legislation expanded PPRC's 
responsibilities to include, among other things, setting standards for 
expenditure growth and updating fees and monitoring beneficiary access 
and financial liability. In 1997, BBA dissolved PPRC and the 
Prospective Payment Assessment Commission and formed MedPAC. BBA, 
§4022, 111 Stat. 350-355.

[14] John E. Wennberg, Elliot S. Fisher, and Jonathan S. Skinner, 
"Geography And The Debate Over Medicare Reform," Health Affairs Web 
Exclusive, February 13, 2002; E.S. Fisher et al., "The Implications of 
Regional Variations in Medicare Spending, Part 1: The Content, Quality, 
and Accessibility of Care," Annals of Internal Medicine (2003): 273-
287; and E.S. Fisher et al.,"The Implications of Regional Variations in 
Medicare Spending, Part 2: Health Outcomes and Satisfaction with Care," 
Annals of Internal Medicine (2003): 288-298.

[15] Beginning in 1975, increases in prevailing charges were limited to 
the change in MEI.

[16] Under MVPS, the fee updates depended on both the change in MEI and 
the difference between actual spending and the performance standard. 

[17] Inflation was measured as a weighted average of input price 
increases, estimated by MEI for physician services and the consumer 
price index for urban consumers (CPI-U) for laboratory services.

[18] Physician Payment Review Commission, 1995 Annual Report to 
Congress (Washington, D.C.: 1995).

[19] The MVPS spending target was based, in part, on a 5-year 
historical trend in volume and intensity reduced by a specified number 
of percentage points. Because of this design and the fact that volume 
and intensity growth dropped dramatically after the adoption of the 
MVPS system, the target for future volume and intensity increases fell 
too.

[20] The SGR system was revised by the Medicare, Medicaid, and SCHIP 
Balanced Budget Refinement Act of 1999 (BBRA), (Pub. L. No. 106-113, 
App. F, §211(b), 113 Stat. 1501A-321, 348-49) and by MMA (see §601(b), 
117 Stat. 2301).

[21] This recent growth in volume and intensity for physician services 
is higher than the 3 percent a year that CMS OACT is projecting for 
2005 through 2014.

[22] In 2002, a year in which physicians' fees fell by 5.4 percent, 
volume and intensity grew by 6.1 percent, the largest growth in a 
single year since the fee schedule and spending targets were 
introduced.

[23] This figure does not include spending associated with Medicare's 
private plan option. 

[24] GAO, Medicare: Financial Challenges and Considerations for Reform, 
GAO-03-577T (Washington, D.C.: Apr. 10, 2003); Congressional Budget 
Office, Medicare's Long-Term Financial Condition, testimony before the 
Joint Economic Committee (Apr. 10, 2003); Office of Management and 
Budget, Analytical Perspectives, Budget of the United States 
Government, Fiscal Year 2005 (Washington, D.C.: Feb. 2, 2004); and 
Boards of Trustees of the Federal Hospital Insurance and the Federal 
Supplementary Medical Insurance Trust Funds, 2004 Report of the Boards 
of Trustees of the Federal Hospital Insurance and the Federal 
Supplementary Medical Insurance Trust Funds.

[25] Physician Payment Review Commission, 1995 Annual Report to 
Congress.

[26] This allowed rate is the sustainable growth rate from which the 
SGR system derives its name. For the purposes of this report, we use 
the abbreviation SGR when referring to the system and the full term of 
"sustainable growth rate" when referring to the allowed rate of 
increase. 

[27] CMS calculates changes in physician input prices based on the 
growth in the costs of providing physician services as measured by MEI, 
growth in the costs of providing laboratory tests as measured by CPI-U, 
and growth in the cost of Medicare Part B prescription drugs included 
in SGR spending.

[28] Under the SGR and MVPS systems, the Secretary of Health and Human 
Services defined "physician services" to include "services and supplies 
incident to physicians' services," such as laboratory tests and most 
Part B prescription drugs. 

[29] The SGR system changed from a fiscal year basis to a calendar year 
basis in 2000. 

[30] The base year is the 12-month period ending March 31, 1997.

[31] See BBRA, §211(b), 113 Stat. 1501A348-49.

[32] Revisions to targets first affected fee updates in 2001. In 
setting the target for that year, CMS revised only the 2000 SGR target. 
According to CMS, the agency was not authorized to revise the 1998 or 
1999 SGR targets.

[33] Estimates of the fee update for the following year are made in the 
spring. The final fee update is announced in November. 

[34] The formula used in the SGR system spreads the recoupment of 
excess spending over several years. Statutory limits on the PAF can 
increase the time necessary to recoup excess spending.

[35] See MMA, §601(a)(1), 117 Stat. at 2300.

[36] For 2005, the product of the change in input prices multiplied by 
the PAF is equal to 

[(1+.028) x (1 - 0.07)] -1 = -0.044, or - 4.4 percent. 

[37] The fee for each service is determined using a resource-based 
relative value scale in which the resources required for a service are 
valued in relation to the resources required to provide all other 
physician services adjusted for the differences in the costs of 
providing services across geographic areas. To arrive at a fee, the 
service's relative value is multiplied by the dollar conversion factor.

[38] The update to the dollar conversion factor represents the 
aggregate of increases and decreases across all services. Because the 
relative value of individual services can change yearly, fee changes 
for specific services may be different than the overall fee update.

[39] See MMA, §601(b), 117 Stat. at 2301.

[40] Physician Payment Review Commission, 1995 Annual Report to 
Congress.

[41] Most of the Part B drugs that Medicare covers fall into three 
categories: those typically provided in a physician office setting 
(such as chemotherapy drugs), those administered through a durable 
medical equipment item (such as a respiratory drug given in conjunction 
with a nebulizer), and those that are patient-administered and covered 
explicitly by statute (such as certain immunosuppressives).

[42] In general, payment for covered outpatient prescription drugs is 
made under Medicare Part B and is equal to either 85 percent or 95 
percent of the average wholesale price, depending on the drug. MMA 
provided for the implementation of a new payment methodology beginning 
in 2005. See MMA, §303, 117 Stat. 2233-2255. The legislation also 
establishes a new voluntary prescription drug benefit program under a 
new Part D of Title XVIII of the Social Security Act that will be 
effective January 1, 2006. 

[43] CMS is required to publish the final conversion factor update for 
the upcoming calendar year by November 1. In the period prior to 
publishing the final update--a period that usually runs from August to 
October--CMS collects public comments in response to its proposed rule. 
It is at this time that physician groups are able to submit formal 
comments on CMS's estimate of this factor. 

[44] CMS OACT has analyzed the results of these studies. See Office of 
the Actuary, Centers for Medicare & Medicaid Services, "Physician 
Volume and Intensity Response Memorandum," August 13, 1998.

[45] The 2005 fee update will be higher than allowed by the SGR system 
owing to an MMA minimum update of 1.5 percent.

[46] In its March 2004 baseline CBO projected the percentage of 
beneficiaries in FFS would remain relatively flat at about 86 percent 
to 87 percent over the 2005-2014 period.

[47] GAO, Medicare Physician Payments: Spending Targets Encourage 
Fiscal Discipline, Modifications Could Stabilize Fees, GAO-02-441T 
(Washington, D.C.: Feb. 14, 2002).

[48] The projection under current law, which is used as a comparison to 
projections under various options, assumes that the fee updates 
determined by the SGR system will not be altered by any legislative 
action. However, many parties, such as the Medicare Trustees, believe 
it is unlikely that the projected negative fee updates will be allowed 
to take effect. 

[49] The projections are included to aid comparisons among the various 
options and are not intended to serve as predictions for what would 
occur if the SGR system was replaced or modified. In addition, there is 
a degree of uncertainty surrounding any projection and that uncertainty 
tends to increase with the number of years for which the projection is 
made.

[50] For some of these options we present, CBO has developed budget 
scores, which are specific cost estimates that include only federal 
expenditures and exclude spending from other sources, such as 
beneficiary cost sharing. When available, we present CBO's cost 
estimates for the options.

[51] Volume and intensity growth for physician services alone is 
projected to be 3 percent per year. Overall volume and intensity 
growth--that is, including outpatient prescription drugs and other 
services included under the SGR system--is projected at about 4 percent 
per year. 

[52] Medicare Payment Advisory Commission, Report to the Congress: 
Medicare Payment Policy (Washington, D.C.: March 2001).

[53] Medicare Payment Advisory Commission, Report to the Congress: 
Medicare Payment Policy (Washington, D.C.: March 2002, 2003, and 2004). 


[54] Medicare Payment Advisory Commission, Report to the Congress: 
Medicare Payment Policy (Washington, D.C.: March 2004).

[55] In May 2004 testimony before the Subcommittee on Health, House 
Committee on Energy and Commerce, CBO estimated that if this option 
went into effect in 2005, it would raise net federal mandatory outlays 
by about $95 billion over the 2005-2014 period. CBO's estimates differ 
from those of CMS OACT in that CBO's estimates exclude beneficiary cost 
sharing and are based on different underlying assumptions about the 
various factors that affect the SGR system. 

[56] Medicare Payment Advisory Commission, Payment for Physician 
Services in the Medicare Program, testimony before the Subcommittee on 
Health, House Committee on Energy and Commerce (May 5, 2004).

[57] In May 2004 testimony, CBO estimated that this option would raise 
net federal mandatory outlays by about $15 billion through 2014. CBO's 
estimates differ from those of CMS OACT in that CBO's estimates exclude 
beneficiary cost sharing and are based on different underlying 
assumptions about the various factors that affect the SGR system.

[58] GAO-02-441T. 

[59] Both the SGR and MVPS systems provided for updates that could 
exceed MEI if spending fell below their respective targets.

[60] Physician Payment Review Commission, 1997 Annual Report to 
Congress (Washington, D.C.: 1997), 248.

[61] In May 2004 testimony, CBO estimated that this option would raise 
net federal mandatory outlays by about $35 billion over the 2008-2014 
period. CBO's estimates differ from those of CMS OACT in that CBO's 
estimates exclude beneficiary cost sharing and are based on different 
underlying assumptions about the various factors that affect the SGR 
system.

[62] We use GDP plus 1 percentage point as the allowance for volume and 
intensity growth for illustrative purposes only.

[63] See 68 Fed. Reg. 63196, 63239-45.

[64] Some annual fee updates are adjusted for additional factors. For 
example, a budget neutrality adjustment is used to account for changes 
in the calculations used to determine the amount of resources 
associated with physician services. In 2002, CMS reduced the update by 
an additional 0.64 percent resulting in a total fee decline of 5.4 
percent.

[65] BBRA required CMS to use the most recent data to revise the 
estimates used to set the spending targets, beginning with the 
estimated spending target in 2000. BBRA, §211(b)(5), 113 Stat. 348-49.


[66] See Pub. L. No. 108-7, Div. N. Title IV, §402, 117 Stat. 11, 548.

[67] The law allowed for a recalculation of prior years' spending 
targets, which resulted in a 1.7 increase in fees applied to spending 
on physician services provided on or after March 1, 2003. Over 12 
months, the increase averaged 1.4 percent. The Congressional Budget 
Office estimated that this provision would increase the baseline for 
Medicare spending by $800 million in 2003 and $53.4 billion over the 
2003-2013 period.

[68] See MMA, §601(a), 117 Stat. 2300.

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