[House Hearing, 108 Congress]
[From the U.S. Government Publishing Office]



PHYSICIAN FEE SCHEDULE: A REVIEW OF THE CURRENT MEDICARE PAYMENT SYSTEM

=======================================================================

                                HEARING

                               before the

                         SUBCOMMITTEE ON HEALTH

                                 of the

                    COMMITTEE ON ENERGY AND COMMERCE
                        HOUSE OF REPRESENTATIVES

                      ONE HUNDRED EIGHTH CONGRESS

                             SECOND SESSION

                               __________

                              MAY 5, 2004

                               __________

                           Serial No. 108-95

                               __________

       Printed for the use of the Committee on Energy and Commerce


 Available via the World Wide Web: http://www.access.gpo.gov/congress/
                                 house

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                    ------------------------------  

                    COMMITTEE ON ENERGY AND COMMERCE

                      JOE BARTON, Texas, Chairman

W.J. ``BILLY'' TAUZIN, Louisiana     JOHN D. DINGELL, Michigan
RALPH M. HALL, Texas                   Ranking Member
MICHAEL BILIRAKIS, Florida           HENRY A. WAXMAN, California
FRED UPTON, Michigan                 EDWARD J. MARKEY, Massachusetts
CLIFF STEARNS, Florida               RICK BOUCHER, Virginia
PAUL E. GILLMOR, Ohio                EDOLPHUS TOWNS, New York
JAMES C. GREENWOOD, Pennsylvania     FRANK PALLONE, Jr., New Jersey
CHRISTOPHER COX, California          SHERROD BROWN, Ohio
NATHAN DEAL, Georgia                 BART GORDON, Tennessee
RICHARD BURR, North Carolina         PETER DEUTSCH, Florida
ED WHITFIELD, Kentucky               BOBBY L. RUSH, Illinois
CHARLIE NORWOOD, Georgia             ANNA G. ESHOO, California
BARBARA CUBIN, Wyoming               BART STUPAK, Michigan
JOHN SHIMKUS, Illinois               ELIOT L. ENGEL, New York
HEATHER WILSON, New Mexico           ALBERT R. WYNN, Maryland
JOHN B. SHADEGG, Arizona             GENE GREEN, Texas
CHARLES W. ``CHIP'' PICKERING,       KAREN McCARTHY, Missouri
Mississippi, Vice Chairman           TED STRICKLAND, Ohio
VITO FOSSELLA, New York              DIANA DeGETTE, Colorado
STEVE BUYER, Indiana                 LOIS CAPPS, California
GEORGE RADANOVICH, California        MICHAEL F. DOYLE, Pennsylvania
CHARLES F. BASS, New Hampshire       CHRISTOPHER JOHN, Louisiana
JOSEPH R. PITTS, Pennsylvania        TOM ALLEN, Maine
MARY BONO, California                JIM DAVIS, Florida
GREG WALDEN, Oregon                  JANICE D. SCHAKOWSKY, Illinois
LEE TERRY, Nebraska                  HILDA L. SOLIS, California
MIKE FERGUSON, New Jersey            CHARLES A. GONZALEZ, Texas
MIKE ROGERS, Michigan
DARRELL E. ISSA, California
C.L. ``BUTCH'' OTTER, Idaho
JOHN SULLIVAN, Oklahoma

                      Bud Albright, Staff Director

                   James D. Barnette, General Counsel

      Reid P.F. Stuntz, Minority Staff Director and Chief Counsel

                                 ______

                         Subcommittee on Health

                  MICHAEL BILIRAKIS, Florida, Chairman

RALPH M. HALL, Texas                 SHERROD BROWN, Ohio
FRED UPTON, Michigan                   Ranking Member
JAMES C. GREENWOOD, Pennsylvania     HENRY A. WAXMAN, California
NATHAN DEAL, Georgia                 EDOLPHUS TOWNS, New York
RICHARD BURR, North Carolina         FRANK PALLONE, Jr., New Jersey
ED WHITFIELD, Kentucky               BART GORDON, Tennessee
CHARLIE NORWOOD, Georgia             ANNA G. ESHOO, California
  Vice Chairman                      BART STUPAK, Michigan
BARBARA CUBIN, Wyoming               ELIOT L. ENGEL, New York
JOHN SHIMKUS, Illinois               GENE GREEN, Texas
HEATHER WILSON, New Mexico           TED STRICKLAND, Ohio
JOHN B. SHADEGG, Arizona             DIANA DeGETTE, Colorado
CHARLES W. ``CHIP'' PICKERING,       LOIS CAPPS, California
Mississippi                          CHRIS JOHN, Louisiana
STEVE BUYER, Indiana                 BOBBY L. RUSH, Illinois
JOSEPH R. PITTS, Pennsylvania        JOHN D. DINGELL, Michigan,
MIKE FERGUSON, New Jersey              (Ex Officio)
MIKE ROGERS, Michigan
JOE BARTON, Texas,
  (Ex Officio)

                                  (ii)




                            C O N T E N T S

                               __________
                                                                   Page

Testimony of:
    Hackbarth, Glenn M., Chairman, Medicare Payment Advisory 
      Commission.................................................    32
    Holtz-Eakin, Douglas, Director, Congressional Budget Office..    21
    Steinwald, A. Bruce, Director, Health Care Medicare Payment 
      Issues, U.S. General Accounting Office.....................    11
Material submitted for the record by:
    American Association for Geriatric Psychiatry, prepared 
      statement of...............................................    48
    American College of Surgeons, prepared statement of..........    50
    American Medical Association, prepared statement of..........    59
    Association of American Medical Colleges, prepared statement 
      of.........................................................    53
    Hackbarth, Glenn M., Chairman, Medicare Payment Advisory 
      Commission, response for the record........................    58
    Holtz-Eakin, Douglas, Director, Congressional Budget Office, 
      response for the record....................................    58
    Rex, Dougls K., President, American College of 
      Gastroenterology, prepared statement of....................    56
    Steinwald, A. Bruce, Director, Health Care Medicare Payment 
      Issues, U.S. General Accounting Office, response for the 
      record.....................................................    59

                                 (iii)

  

 
PHYSICIAN FEE SCHEDULE: A REVIEW OF THE CURRENT MEDICARE PAYMENT SYSTEM

                              ----------                              


                         WEDNESDAY, MAY 5, 2004

                  House of Representatives,
                  Committee on Energy and Commerce,
                                    Subcommittee on Health,
                                                    Washington, DC.
    The subcommittee met, pursuant to notice, at 10 a.m., in 
room 2123, Rayburn House Office Building, Hon. Michael 
Bilirakis (chairman) presiding.
    Members present: Representatives Bilirakis, Norwood, 
Wilson, Pitts, Ferguson, Barton (ex officio), Brown, Pallone, 
Stupak, Green, Capps, and Dingell (ex officio).
    Also present: Representatives Otter, Fossella and 
Radanovich.
    Staff present: Chuck Clapton, majority counsel; Jeremy 
Allen, health policy coordinator; Eugenia Edwards, legislative 
clerk; Bill O'Brien, projects assistant; Amy Hall, minority 
counsel; Bridgett Taylor, minority professional staff; Purvee 
Kempf, minority professional staff; and Jessica McNiece, 
minority staff assistant.
    Mr. Bilirakis. This hearing will come to order.
    I do want to start out by thanking our panelists. They are 
a most distinguished group, and I'm hoping that in addition to 
maybe helping us out on the history of the physician payment 
picture that they would also offer some suggestions on how we 
might be able to help address that problem.
    The Chair is going to do something unusual, but with 
permission of the Minority, I'm going to waive my opening 
statement for the time being and recognize Doctor Norwood for 
an opening statement, because he has a pretty serious mark-up 
in one of the other committees and would like to get over 
there.
    Charles, go ahead.
    Mr. Norwood. Thank you very much, Mr. Chairman. I don't 
have to tell you how important this hearing is to me, and, 
unfortunately, I have four of my own bills about OSHA being 
marked up and will have to leave, but I appreciate you allowing 
me to go ahead. And, I also very much appreciate you holding 
this hearing today.
    As we all know, everybody in this room knows, the physician 
payment update is a black cloud on Medicare's horizon that 
somewhere soon we have to address. Hopefully, this hearing will 
help us understand what the actual hurdles are that we are 
going to have to face.
    Mr. Chairman, to me this is a fairly simple problem. 
Congress made a mistake. We put in law a formula for paying 
physicians that was fundamentally flawed. I don't think anyone, 
anywhere, can ever make the case that Congress intended to cut 
payments to physicians year after year. And, the reason I know 
Congress didn't mean to do that is that they don't want seniors 
to not have doctors, and it's going to turn into, and is, an 
access problem.
    The problem is that our good friend from CBO assumed that 
the cost of fixing that problem is going to be pretty high. We 
don't have a lot of money lying around to fix problems like 
this. To make matters worse, when CBO realizes that they were 
very wrong about the cost of the Prescription Drug Bill that's 
going to come to be--it's going to be that much more difficult, 
Mr. Chairman, to find the money to fix the physician payment.
    Well, I've got a solution for you. The CBO makes 
assumptions about behavior every day. They make assumptions 
about the take-up rate of seniors in the Prescription Drug 
Plan, or assumptions about the economic growth that will flow 
from eliminating the estate tax. Well, I'm here to suggest to 
CBO that they make some assumptions about Congress' behavior. 
We are never going to let physicians get the cut that you are 
forecasting, it is simply not going to happen. It may be a 
last-minute fix, it may be the last day, but it is simply not 
going to happen for very practical political reasons. Members 
of Congress do not like it when senior citizens come to them 
and say I can't find a doctor in Medicare. It is not going to 
happen. These cuts will never go on.
    So, here's my suggestion to you, Doctor Holtz-Eakin, it is 
time to change the baseline. The cut you are forecasting is not 
going to happen. Once you accept that, that you need to change 
the baseline and the cuts are not going to happen, then we can 
begin, perhaps, to fix this problem. But, if you persist in 
this fantasy that Congress is actually going to cut out 
providers of healthcare so they cannot furnish healthcare, it 
makes it very much harder on us to right the wrong that 
occurred in the formula.
    Tell me at some point today what it is going to take to 
convince you. I would much rather us have a very nice 
conversation and continue all year long babbling back and forth 
about the fact that Congress is simply not going to stop paying 
physicians, even though you suggest it will happen gradually. I 
would much rather be nice and solve this problem. So, somewhere 
today tell me what it is going to take for me to convince you 
about this.
    I am going to look forward to your answer, and I am going 
to, though I may not be sitting here, I promise you I will hear 
your answer.
    And, with that, Mr. Chairman, I thank you for the time and 
I will yield back.
    Mr. Bilirakis. Thank you for being nice.
    The Chair recognizes the gentleman from Ohio, Mr. Brown.
    Mr. Brown. And, I want to mark this day, my friend, Mr. 
Norwood, for being so nice. Thank you, Charlie.
    The Medicare Physician Payment formula is flawed and needs 
to be fixed, as Mr. Norwood says, we all think that, we all 
know that. The problem came to a head in 2001, when CMS 
announced that physicians will receive a 5.4 percent cut in 
their pay in 2002. There was nothing fair about this. It was a 
function of GDP and other factors wholly outside the control of 
the healthcare system.
    The chairman and I introduced legislation to prevent the 
cut, revise the payment formula. Unfortunately, that bill did 
not become law.
    2002, Congress gave CMS the authority to correct certain 
data errors in their calculation of the physician payment 
rates, which prevented another large cut, provided a small 
increase in 2003. That was payment relief, it was, in the 
opinion of virtually all of us, it was payment fairness. 
Physician payment amounts had been miscalculated, and it was 
appropriate to correct that miscalculation.
    One of the only bright spots in the controversial Medicare 
Bill signed into law in December was the 2-year fix that gives 
physicians small payment, positive payment, updates this year 
and next, instead of the anticipated cuts. Prior to passage of 
that bill, Republican Mark Foley and I wrote a letter to 
Speaker Haskert with 160 signatures from members from both 
sides of the aisle, emphasizing the need for physician payment 
reform. That level of support is crucial, because the payment 
provisions in the Medicare Bill are a stop-gap measure.
    If Congress doesn't act again, physicians will receive a 
deep payment cut in 2006, as we know, in fact, physicians face 
cuts of 5 percent a year for the next 6 years.
    We need a permanent solution so that physicians won't 
confront potential cuts year, after year, after year, come 
lobbying Congress and have us do this each time. We need to de-
link the payment formula from GDP. We need to stop penalizing 
physicians when drug costs increase. We need to stop holding 
physicians responsible for utilization increases, over which 
they have no control. We need to smooth out the payment 
changes, so that physicians are not riding a roller coaster 
when it comes to the reimbursement.
    Fixing the physician payment formula will be expensive, 
relative to the status quo. That means this Congress needs to 
be more responsible, by going from a big budget surplus 3 years 
ago to a huge budget deficit today, when we don't have the 
money for physician payment, even though we need to do it, we 
don't have money for a lot of other things. And, somehow the 
doctors get in line, we take care of them when we often don't 
take care of the poor, we often don't take care of food safety 
rules, we often don't take care of other things we need to do 
in this Congress.
    And, as long as this Congress on the one hand says to the 
AMA and to the doctors, we want to help you, as we should, I am 
one of those, joined by my friends on the other side of the 
aisle, but we will continue to insist on tax breaks that the 
average person making a million dollars in this country gets 
$121,000 tax break, as long as we are speaking out of both 
sides of our mouths it is going to be very hard to fix this, 
and at the same time not ignore critical public health needs. 
We have no business helping physicians, which we should do, and 
not dealing with public health issues, which we are not doing, 
because, one, they don't have a good enough lobby, and second, 
because Republicans in this institution always worship at the 
altar of more tax cuts for the rich.
    But, when we under pay physicians, we are not spending 
enough. We are robbing earned income from those professionals. 
Fixing the payment formula gets us to a level playing field, 
which is where we should have been all along.
    Some of the needed changes are statutory, some can be 
accomplished administratively. The Administration needs to 
continue to include the cost of physician-administered drugs in 
the SGR, even though these drugs clearly aren't physician 
services, as defined in the law. Spending on these drugs is 
increasing far more rapidly than spending on professional 
services, which means the distortions caused by these costs is 
getting worse over time.
    I have also heard from physicians that the current spending 
calculation understates the impact of the new prescription drug 
law, and fails to account for national coverage decisions and 
other CMS policy changes.
    I look forward to hearing the views of our witnesses on 
actions the Bush Administration can and should take to improve 
the accuracy of the physician payment formula. I'm sure we'll 
benefit from your views. I hope that this Congress will become 
more responsible fiscally, generally, so that we can deal with 
this issue long term, and fix it, and fix it right.
    I yield back the balance of my time.
    Mr. Bilirakis. The Chair recognizes Chairman Joe Barton.
    Chairman Barton. Thank you, Mr. Chairman, and once again I 
want to thank you for holding this series of hearings about 
Medicare and the healthcare issues of our country.
    I want to apologize in advance. I have a hearing upstairs 
on the Alaska Natural Gas Pipeline that is going on 
simultaneously, so I'm going to be shuttling back and forth.
    I think this is an important hearing. What to do about 
physician reimbursement under Medicare is a vacuous issue. I 
have been on the committee for 18 years. I was here in 1992 
when we changed the system, from just kind of a normal fee 
increase to the various indexes that we are still having 
problems with, which is the purpose of today's hearing.
    We haven't got it right yet. Hopefully, with this hearing 
today, and the input of the three gentlemen before us, the 
interest groups in the audience, we may yet do something that 
will get it right.
    We have held, over the past 3 years in this subcommittee, 
numerous hearings, sponsored briefings, held press conferences 
on this issue, and how to do payments to physicians. This is a 
hearing today in the continuing effort to resolve the issue. 
Our three witnesses today are going to provide a unique 
perspective on the history and background of Medicare payments 
to physicians.
    I don't know that anybody on the podium is anymore 
frustrated than the people in the audience, that year after 
year we try to get a system that works, and is fair, and we 
still have the problems that we are having this year.
    We want to try to today understand and explain the creation 
of the current formula, and if you gentlemen can do that you 
will have done something. I spent about 30 minutes last night 
preparing for this meeting this morning, and I had visions of 
MEIs and all kinds of stuff dancing in my head when I woke up 
this morning. We have tried to get it right, yet we still have 
wide swings in payments to physicians. We've had 2 years in a 
row in which we've had to override the formula to give 
physicians some increase, because the last 2 years had we not 
they would have had significant reductions in their 
reimbursement.
    I have heard from many physicians in my district back in 
Texas about the impact back 2 years ago of the payment 
reductions. I have had several physicians that are very close 
to me decide to discontinue their practice because of the 
inability to be fairly reimbursed for their services.
    We simply have to come up with a way that will ensure that 
Medicare beneficiaries have access to critical healthcare 
services and are not put at risk. I know we have a budget 
problem. For example, the result of last year's override of the 
formula is expected to cost the taxpayers $54 billion over the 
next 10 years, in addition to what it would have had we not 
made that change last year.
    We all know the Federal budget is in deficit, and that the 
Medicare program is facing increasing budgetary pressure over 
the next 10 years, as baby boomers begin to retire in greater 
numbers. So, we have a challenge before us. We need to design a 
solution that allows physicians to continue to provide care to 
current beneficiaries, without bankrupting the program for 
future generations.
    I look forward to reading today's testimony and, hopefully, 
hearing as much of it as possible. I really am interested in 
the insights of the panel on how we can solve this problem. We 
hope to use the information from today's hearing to design a 
solution that will provide stable and predictable Medicare 
reimbursements for physicians.
    I want to thank you again, Chairman Bilirakis, for your 
good work on this, and I really do encourage our three 
witnesses to do more than just regurgitate facts and figures 
from the past. If we can come up with a formula that works, 
this committee will work with the other committees and 
jurisdiction, and the House leadership, on a bipartisan basis 
to try to fix this. So, this is something of a nitty-gritty 
hearing, but it has the potential to really do some good for 
the country in the years ahead.
    So, I thank you three gentlemen for being here, and I look 
forward to working together to try to find a solution. With 
that, I yield back, Chairman Bilirakis.
    Mr. Bilirakis. The Chair thanks the gentleman, and now 
recognizes the gentleman from New Jersey, Mr. Pallone, for 3 
minutes.
    Mr. Pallone. Thank you, Mr. Chairman.
    I listened to what Mr. Norwood said, and I am not just 
responding to him, I am not trying to be personal about it, but 
I do believe that when he says that, you know, there's no 
money, and that, you know, the budget deficit, and where is the 
money going to come from to pay for this, I think it all has to 
do with Republican priorities, and what they have been doing 
here in terms of, not only the larger issue, but also the 
healthcare system.
    Obviously, the main reason that there is not a lot of money 
out there for domestic priorities and for healthcare is because 
of the tax cuts that have gone mainly to the wealthy and the 
corporate interests, and also to the increased defense 
spending, and, you know, we are not here to get into the Iraq 
War, but all this has contributed to a huge deficit, and that 
made it so there is not a lot of money left for healthcare. 
Even within the healthcare system, the Republican priorities 
have been to help the HMOs, and to help the drug companies, and 
so, you know, we have a Prescription Drug Bill that primarily 
gives the money to the drug companies and not benefits to the 
people, and doesn't have any cost controls, and then we have 
money going to HMOs. There is a chart here that I would like to 
submit for the record, that says, Medicare overpays managed 
care plans by $1,080 per beneficiary in 2004. This is from 
MedPAC and CMS status. So again, where is the money left for 
the patient? Where is the money left for the physician, when, 
you know, our priorities are skewed in the wrong way? And, 
that's the problem.
    I was pleased that this Congress approved the stop-gap 
legislation that provided 2 years of relief to the physicians 
in 2003 and 2005, but I believe that a permanent fix to the 
funding formula should be put in place so physicians can rely 
on stability in Medicare reimbursement, and so physicians do 
not have to fight each year with Congress to ward off future 
cuts.
    For example, according to Medicare trustees, physicians 
face cuts of 5 percent each year, between 2006 and 2012, and 
this is outrageous. Unfortunately, the end result will be 
diminished access to care for Medicare beneficiaries, in order 
to make financial adjustments physicians and other healthcare 
providers may have to balance their patients, drop their 
Medicare payments, or leave Medicare entirely, or limit 
charitable care.
    There are several issues in particular that have to be 
addressed when updating the fee schedule. The inclusion of drug 
spending as part of the sustainable growth rate must be 
adjusted. Drug spending is increased far more rapidly than any 
spending on physician services. And, the costs of physician 
administered drugs, even though drugs are not even a 
physician's service as part of the SGR, distorts the 
calculation of actual spending that should count toward the 
amount in Medicare reimbursement.
    In addition, it is unfair for the SGR formula to be linked 
to the GDP. Physician fees adjustments should not be linked to 
the overall economy, because physician services and fees do not 
parallel the economic ups and downs.
    We have a lot of other things to discuss here, Mr. 
Chairman, but I really think that it's wrong for the 
Republicans to say the money is not there. It is their 
priorities that have created this situation. This can be fixed, 
and it should be.
    Mr. Bilirakis. The Chair thanks the gentleman, and will 
recognize Mr. Ferguson.
    Ms. Capps stepped out.
    Mr. Stupak.
    Mr. Stupak. Thank you, Mr. Chairman, and thank you calling 
the hearing today so that the committee can gain a better 
understanding of the Medicare formula that pays our physicians 
and other providers.
    To describe the formula that determines the physician fee 
schedule as complicated would be an understatement. I am glad 
we are having this hearing, so the committee can better 
understand how this formula came about, what's wrong with it, 
and what should be done to fix it.
    Thank you to our witnesses for coming today to provide 
incite.
    I think everyone is in agreement that Congress needs to 
address the formula. For the past 3 years, we have had to pass 
fixes, because the physician costs were going up, physician 
payments were to go down under the current formula. That 
doesn't make much sense to me, and it almost is impossible to 
justify to my providers back home.
    The various cost estimates for fixing the formula range 
from $90 billion to $126 billion over 10 years. That is not 
cheap, but Congress simply cannot allow the situation to 
continue. The way the formula is written now, every adjustment 
we give means larger cuts to reimbursement in the future.
    One part of the formula that I am especially interested in 
hearing about today is the sustainable growth rate component. 
The sustainable growth rate system is supposed to rein in the 
volume of healthcare being provided, therefore, reining in 
costs. But, all indications show that the system doesn't work.
    Finally, I think it's important that we not lose sight of 
the bottom line. If we don't fix this problem, physicians are 
going to leave Medicare, and that's not what anyone wants.
    I hope the committee will hear from the provider community 
in future weeks about the real impact this formula has had on 
their ability to care for patients.
    Thank you, Mr. Chairman, and I yield back the remainder of 
my time.
    Mr. Bilirakis. The Chair thanks the gentleman and 
recognizes himself for his opening statement.
    This is, as we have heard, a topic that every subcommittee 
member cares deeply about, and for that reason I am pleased 
that we have such technical expertise from members to draw on.
    I know that most everyone here is familiar with the general 
problems associated with how Medicare reimburses physicians and 
other healthcare professionals under the Physician Fee 
Schedule. Payments decreasing, while the costs of practicing 
medicine are increasing, this is, obviously, an untenable 
situation. I know doctors in Florida who are really being 
squeezed right now, as they contend with declining 
reimbursements from Medicare, at the same time they are faced 
with skyrocketing medical malpractice insurance premiums.
    That said, I want to point out that while the problem is 
easy to explain, the causes behind it and how potential 
solutions might work are complex, and that's why it's 
appropriate for us to have representatives from the three 
entities charged with advising Congress on healthcare policy, 
among other things, with us today.
    This subcommittee has taken a lead role in attempting to 
change how Medicare pays for services covered under the 
Physician Fee Schedule. I joined a number of members of this 
subcommittee in introducing the first bill designed to help 
mitigate the impact of some of the cuts physicians have faced 
over the past several years, and I also worked with my 
colleagues to avert large cuts in reimbursements in years 2003 
and 2004.
    The Medicare Modernization Act included a 2-year solution 
to the problems of declining Medicare reimbursements. Under the 
new law, the physicians will be able to count on steady 
increases in their reimbursements in 2004 and 2005. 
Unfortunately, we did not arrive at a more permanent solution 
to this very serious problem, and that's why we thought it was 
important to hold today's hearing. Our intention is that we 
focus on how we got to where we are today. More specifically, I 
hope we can focus on the history, as has already been said, of 
physician payment under Medicare, and why the SGR, the 
Sustainable Growth Rate, system was put in place, and how 
Congress has worked to address this problem over the past 
several years.
    This hearing, as so many others have already indicated, 
will serve as a starting point for future subcommittee hearings 
and, eventually, congressional action that will ensure that 
physicians will receive fair, predictable payments under 
Medicare.
    At the end of the day, I know that most of us are concerned 
that if we don't fix this problem soon Medicare patients will 
be the ones who suffer most.
    Access problems will become a real issue, and I'm afraid we 
will face a physician supply problem for years if we allow 
prolonged cuts in payments under the Fee Schedule.
    Today, the Health Subcommittee is taking the first step 
toward what we hope would be a good, reasonable, permanent 
solution.
    Again, I want to thank our witnesses for joining us, and 
now I'm pleased to recognize the gentlelady from California, 
Ms. Capps, for an opening statement.
    That's fair.
    Mr. Green.
    Mr. Green. Thank you, Mr. Chairman, and I want to thank you 
and our ranking member for holding this hearing on physician 
reimbursement from Medicare. I think this is one of the most 
pertinent topics for our subcommittee and the full committee 
and, frankly, by the whole Congress.
    It's been a decade since the Physician Fee Schedule was put 
into place in 1992, to help control increases in Medicare 
payments to physicians. Since 1997, the Fee Schedule has 
utilized the Sustainable Growth Rate system to set a spending 
target for Medicare expenditures for physician services. 
Despite the complicated formulas used to derive the SGR in the 
Physician Fee Schedule, the idea behind the formula is simple, 
if Medicare expenditures on physician services exceed the 
target in a given year CMS will decrease payment for physician 
services the next year. If expenditures fall short of the 
target, physician payments will increase. Medicare physicians 
have faced rate cuts since 2002 because of a number of factors, 
the weakened economy, data errors in previous years, and in the 
increase in the volume of services rendered, have all 
contributed to these increases.
    While Congress enacted stop-gap measures in 2002 through 
2005, it's clear that the system contains some inherent flaws 
that must be addressed to ensure the long-term viability of 
Medicare.
    For sure, my hometown of Houston contains some of the best 
medical facilities in the world. The scope of the medical care 
offered at the Texas Medical Center is unmatched. Yet, I meet 
with physicians working in every medical specialty imaginable, 
who say that this system truly threatens our Medicare 
beneficiaries' access to the specialty care that they provide. 
If this happens, Medicare will have failed its mission to 
provide equality equally in access to the healthcare for all 
American seniors.
    And that, Mr. Chairman, is why I'm particularly glad we are 
having this hearing. We have an experienced and distinguished 
panel before us today to offer us explanations behind the 
current problems, and discuss with us various options for 
remedying these problems, and putting Medicare on a secure path 
to sustainability.
    And, I know Mr. Pallone mentioned it, but I would like the 
panel particularly to see this chart that is available, where 
Medicare overpays managed care is correct. Overpayment of 
managed care by $1,080 per year for 11 percent of Medicare 
beneficiaries seemed like it was an increase under the Medicare 
Reform Bill that was passed last year, and it is in effect now. 
I'm concerned if we sift through these facts looking at this 
and other reasons this morning, I think we can all agree that 
any actions we take need to ensure that the Medicare system 
provides for our seniors equal access to quality healthcare, 
whether you are in the fee-for-service, or whether you happen 
to join a managed care and it is paid $1,000 more a year than 
fee-for-service.
    With that, Mr. Chairman, again, I'm glad the witnesses are 
here, and I yield back my time.
    [Additional statements submitted for the record follow:]

Prepared Statement of Hon. Heather Wilson, a Representative in Congress 
                      from the State of New Mexico

    Thank you, Mr. Chairman, for holding this hearing today on 
physician payment in Medicare. Medicine is no longer the desirable 
profession that it once was. Inconsistency and uncertainty in payment 
patterns by public payers including Medicare and Medicaid, combined 
with skyrocketing medical malpractice premiums, are a disincentive for 
people to enter medicine.
    One problem that affects doctors everywhere is the Sustainable 
Growth Rate (SGR) formula that ties changes in physician payment in 
Medicare to general economic growth factors instead of medical 
inflation. Flaws in this formula require physicians to come back each 
year to ask Congress for a temporary fix that will allow them to 
continue to see Medicare patients. I know, because I hear from nearly 
all 2,200 of them in my district about this every year in one way or 
another. The SGR formula is so flawed and complicated that it may be 
time to throw it out and start over from scratch. While we took steps 
in the Medicare Modernization Act last year to cancel impending cuts 
and implement a 1.5% increase in 2004 and 2005, we need a permanent 
fix.
    If we were to do this, one thing we may want to look at is 
adjusting Medicare payment rates to compensate for the patient mix in 
each state. In New Mexico, we have 21% of our population uninsured, 21% 
on Medicaid, and 13% on Medicare. This means 55% of the patients our 
physicians see pay them below the cost of providing services. These 
demographics, and our rural nature, make it hard to attract and retain 
doctors in New Mexico. If Medicare had some way to compensate doctors 
that takes into account patient mix, that would help to solve some of 
our problems.
    But another problem we have in New Mexico is the Resource-Based 
Relative Value Scale that adjusts payments for physician services based 
on a variety of factors, including geography. I find it completely 
ludicrous to assume that a doctor in New Mexico's time, skill and 
intensity are somehow worth less than that of a doctor in a major 
metropolitan area. For instance, doctors in New Mexico are paid 12% 
less for their time, skill, and intensity for services than doctors in 
Manhattan. Why should it be 12 percent more work to look in someone's 
ear in Manhattan than it is in Albuquerque? Again, while we were able 
to set the floor on the work component of the Geographic Practice Cost 
Indicator at 1.0 for 2004, 2005, and 2006 in the Medicare bill, we need 
a permanent fix that compensates doctors in rural areas like New Mexico 
fairly compared to other states.
    One by-product of the uncertainty doctors have with Medicare 
payment is a move toward employment by hospitals and health systems 
instead of private practice. In 1976 about 10% of doctors in New Mexico 
were employed, now about 60% are employed. Being employed by a hospital 
or health system provides a consistent, reliable source of income and 
also helps with malpractice insurance costs. While it is uncertain 
whether this trend is good or bad for our health care system, it is 
clear we are slowly driving the independent, private practice doctor 
out of business.
    I would like to thank all the witnesses for being here today and 
look forward to learning more about this issue.

                                 ______
                                 
Prepared Statement of Hon. Charles ``Chip'' Pickering, a Representative 
               in Congress from the State of Mississippi

    Mr. Chairman, I thank you for holding this hearing today. A 
physician access crisis is looming for Medicare patients unless the 
Centers for Medicare and Medicaid Services (CMS) and Congress work 
together to implement a physician payment formula that adequately 
reflects increases in the costs of practicing medicine. I urge CMS to 
help in this effort by taking immediate administrative action to 
improve application of the current formula.
    While a long-term change is needed, several important 
administrative alterations this year could reduce the cost of a long-
term legislative solution. I urge CMS to exercise its authority 
immediately to remove Medicare-covered drugs and biologics from the 
physician payment formula.
    Medicare payments to physicians are reduced when actual Medicare 
spending for physicians' services exceeds a pre-determined spending 
target, the sustainable growth rate (SGR). Currently, when CMS 
calculates actual spending on physicians' services, it includes the 
costs of Medicare-covered prescription drugs administered in 
physicians' offices. While administering the drug is a physician 
service which should be included in the target, the drug itself is not 
a physician service and, therefore, should not be included. Between 
1996-2002, per enrollee spending on drugs grew 244% compared to 38% for 
physician services. As a result, including drugs in the SGR greatly 
increases the odds that Medicare spending on physicians' services will 
exceed the SGR target, triggering pay cuts that penalize physicians for 
providing important new drugs to their patients. I urge you to remove 
drugs from the SGR formula before a final physician payment rule is 
published for 2005.
    I also urge CMS to ensure that government-induced increases in 
spending on physicians' services are accurately reflected in the SGR 
target. The government encourages greater use of physician services 
through legislative actions, as well as a host of other regulatory 
decisions. CMS should adequately reflect, in the SGR target, physician 
spending increases due to legislative mandates, new preventive 
screening benefits, Medicare drug discount cards and the new 
prescription drug benefit which tend to increase the use of physician 
services to save money elsewhere in the system.
    I thank the Chairman and the staff for their hard work and look 
forward to working with the Committee on this issue.

    Mr. Bilirakis. The Chair thanks the gentleman, and we'll go 
right into the panel. It consists of Mr. Bruce Steinwald, who 
is the Director for Health Care--Medicare Payments Issues, with 
the General Accounting Office. Welcome, sir. Doctor Douglas 
Holtz-Eakin, Director of CBO here in Washington, Congressional 
Budget Office, and Doctor Glenn Hackbarth, Chairman of MedPAC, 
the Medicare Payment Advisory Commission, located here in 
Washington. Thank you for being here, gentlemen.
    Your written statement, of course, as you know, is a part 
of the record, and I'll turn the clock on 5 minutes for each of 
you, but, obviously, if you are on a roll we will let you 
continue. Hopefully, you can stay as close to the 5 minutes as 
you can.
    Mr. Steinwald, why don't we start off with you.

   STATEMENTS OF A. BRUCE STEINWALD, DIRECTOR, HEALTH CARE--
 ECONOMIC AND PAYMENT ISSUES, U.S. GENERAL ACCOUNTING OFFICE; 
DOUGLAS HOLTZ-EAKIN, DIRECTOR, CONGRESSIONAL BUDGET OFFICE; AND 
    GLENN M. HACKBARTH, CHAIRMAN, MEDICARE PAYMENT ADVISORY 
                           COMMISSION

    Mr. Steinwald. Mr. Chairman and Members of the 
Subcommittee, I am pleased to be here with you today to discuss 
the system used to set and update fees paid to physicians under 
the Medicare Program.
    In my prepared testimony, I have attempted to provide a 
concise history of this system, and the related spending 
trends, with emphasis on the use of spending targets to control 
growth in physician service expenditures.
    In my remarks to you today, I want to focus on trends in 
the volume and intensity of physician services over the past 
several years, and the relationship between Medicare fees and 
physician spending per Medicare beneficiary over time.
    I believe that an examination of these trends and 
relationships is vital to both understanding and confronting 
the difficult budgetary situation that you mentioned we are 
looking ahead to in 2006.
    Please direct your attention to the first chart at the 
front of the room. It's on your left, on my right, and it is 
also Figure 3 on page eight of the written statement.
    This chart shows trends in the volume and intensity of 
physician services per Medicare beneficiary from 1975 through 
2003. Volume growth is simply the increase in the average 
number of services performed per beneficiary from year to year. 
Intensity is said to grow if over time more complex and, 
therefore, more expensive services tend to replace less 
complex, less expensive services. So, for example, more MRIs 
and fewer X-rays from 1 year to the next is an intensity 
increase. More MRIs without fewer X-rays is both an intensity 
and volume increase.
    The chart represents national averages, and, therefore, 
does not show considerable variation across physician 
specialties, across geographic areas, or across Medicare 
beneficiaries.
    I am focusing on volume and intensity because together they 
are what I would call the hidden culprit that has stymied past 
efforts to control spending on physician services, and it's a 
major source of the problem we face today.
    As the chart shows, volume and intensity growth was 
substantial during the 1980's and early 1990's, despite various 
efforts made by the Congress during those years to control 
spending growth by limiting fees. In 1992, the charge-based 
system for setting fees was replaced by a Medicare Fee 
Schedule, and with it a targeting system for controlling 
spending for physician services was installed. And, as you can 
see, for several years thereafter volume and intensity were 
moderated, and because of this Medicare spending for physician 
services was under control.
    With the new millennium, however, volume and intensity have 
begun to trend upward, and while the increases since 2000 are 
not as great as in the period before spending targets were in 
place, this is a troubling trend and has created difficulties 
for Medicare payment policy that I will explain.
    Now, please direct your attention to the second chart, 
which is also Figure 4 on page 13 of the written statement.
    This chart portrays actual and projected experience under 
the current system of targets for Medicare physician service 
expenditures, which, as you know, is the Sustainable Growth 
Rate, or SGR system. For each year, the first bar shows the 
increase in the Medicare Economic Index, or MEI, which is the 
measure used to estimate increases in the cost of running a 
medical practice. The second bar shows the Fee Schedule update 
amount, that is, the average amount fees were changed in that 
year, as a result of the SGR system. And, the third bar shows 
the increase in spending on physician services per Medicare 
beneficiary in fee-for-service plans.
    Please note that in every year spending per beneficiary 
increased more than either the MEI or the fee update, and 
sometimes substantially more, and, of course, this is due to 
increases in volume and intensity.
    In the first SGR years, 1998 and 1999, the fee update was 
sufficient to cover average increases in practice costs, with 
modest additional revenues flowing to physicians through volume 
and intensity increases.
    In 2000 and 2001, however, bad things began to happen. 
Based on inaccurate information, the fee updates for those 
years were set too high, over twice the increase in inflation, 
although this was not known at the time. In addition, volume 
and intensity trended upward, resulting in increases of about 
10 percent in each year in spending per beneficiary on 
physician services. And, under the SGR system, this 
overspending in those 2 years would have to be recouped in 
future years.
    By 2002, circumstances culminated in what might be called 
``perfect storm.'' Overspending in the two prior years, 
combined with other factors, led to massive downward pressure 
on fees. A negative update was put into effect in 2002 for the 
first time ever, and it would have been even larger if the SGR 
formula were not constrained in how much it can raise or lower 
fees in a single year. Consequently, policymakers faced the 
prospect of continued negative updates in future years.
    As you know, Congress acted to ensure a positive update for 
2003 in the Consolidated Appropriations Resolution of 2003, and 
acted again to ensure positive updates for 2004 and 2005 in the 
Medicare Modernization Act.
    Please note that the modest positive updates for these 
years are accompanied by estimates of increases in physician 
service spending per beneficiary of about 6 percent per year, 
owing to the effect of projected volume and intensity 
increases.
    Because of these increases, and the fact that the MMA 
mandated fee updates simply put off the requirements of SGR to 
balance spending with targets, rather than change the targets, 
fees are projected to decline under current law beginning in 
2006 and for several years thereafter. As you know, the MMA 
also requires GAO to examine the SGR system and report to 
Congress on potential modifications and improvements, and we 
look forward to working with this committee and others in 
Congress as you deliberate on potential legislative strategies 
concerning physician payment under Medicare.
    Mr. Chairman, this concludes my prepared remarks. I would 
be happy to answer any questions you or other committee members 
may have.
    [The prepared statement of A. Bruce Steinwald follows:]

    Prepared Statement of A. Bruce Steinwald, Director, HealthCare--
        Medicare Payments Issues, U.S. General Accounting Office

    Mr. Chairman and Members of the Subcommittee: I am pleased to be 
here today as you discuss the Sustainable Growth Rate (SGR) system that 
Medicare uses to update physician fees and moderate the growth in 
spending for physician services. As you know, the current SGR system 
evolved from the Medicare Volume Performance Standard (MVPS) system, 
which, along with a fee schedule for physician services, was 
established in 1992. MVPS, and later SGR, were designed to reduce 
physician fee updates if spending growth exceeded a specified target. 
Under both systems, spending growth slowed substantially. However, 
concerns about SGR arose when the system and other factors caused fees 
to decline by 5.4 percent in 2002. In February of that year, we 
testified before this Subcommittee and discussed the reasons for the 
fee decline and potential SGR modifications.1 Subsequent 
administrative and legislative actions modified or overrode the SGR 
system and resulted in fee increases for 2003, 2004, and 2005. Absent 
additional legislative action, fees are expected to fall by 
approximately 5 percent each year beginning in 2006 and continuing 
through 2012. These projected declines have raised concerns about the 
appropriateness of the SGR system for updating physician fees and 
physicians' continued participation in the Medicare program.
---------------------------------------------------------------------------
    \1\ U.S. General Accounting Office, Medicare Physician Payments: 
Spending Targets Encourage Fiscal Discipline, Modifications Could 
Stabilize Fees, GAO-02-441T (Washington, D.C.: Feb. 14, 2002).
---------------------------------------------------------------------------
    My comments today are intended to describe the current situation 
pertaining to physician fees and how we arrived at this juncture. 
Specifically, I will discuss (1) Medicare physician spending trends 
both before and after the implementation of spending targets and (2) 
the evolution and mechanics of the SGR system, explaining how it is 
designed to help control spending growth. My testimony is based on our 
previous work on Medicare spending trends and the SGR system--updated 
to include recent information on spending, fees, and projections--and 
was prepared during April 2004 according to generally accepted 
government auditing standards. In our February 2002 testimony, we 
discussed the need to maintain fiscal discipline to help ensure the 
long-term sustainability of the Medicare program for future 
generations. The Medicare Prescription Drug, Improvement, and 
Modernization Act of 2003 (MMA) requires us to study the 
appropriateness of the factors used in SGR and consider alternatives to 
the system.2 Our work on that study is currently underway. 
We look forward to working with the Subcommittee and others in Congress 
as policymakers seek to ensure appropriate physician payments.
---------------------------------------------------------------------------
    \2\ See Pub. L. No. 108-173,  953, 117 Stat. 2066, 2427-28.
---------------------------------------------------------------------------
    In summary, Medicare spending on physician services grew rapidly 
through the 1980s, at an average annual rate of 13.4 percent, even 
though physician fee increases were subject to some limits. The 
spending growth was driven by increases in the number of services 
provided to each beneficiary--referred to as volume--and an increase in 
the average complexity and costliness of those services--referred to as 
intensity. Recognizing that expenditure growth of this magnitude was 
not sustainable, the Congress attempted to impose fiscal discipline by 
requiring the establishment of spending targets for Medicare physician 
services along with a fee schedule beginning in 1992. Following the 
introduction of spending targets, volume and intensity growth slowed 
substantially during the 1990s. In recent years, under the SGR system, 
volume and intensity growth has increased, but not by the rates 
experienced during the 1980s before spending targets were in place.
    SGR, the current system of spending targets, evolved from the 
target system that went into effect in 1992. Under the SGR system, 
physician fee updates are adjusted up or down, depending on whether 
actual spending has fallen below or has exceeded the target. Over time, 
fees tend to increase at least as fast as the costs of providing 
physician services as long as volume and intensity growth remains below 
a specified rate--currently, a little more than 2 percent a year. If 
volume and intensity grows faster than the specified rate, SGR lowers 
fee increases or causes fees to fall. Physicians raised concerns about 
SGR when fees dropped significantly in 2002, a decline that was, in 
part, a correction for fees that had been set too high in prior years 
because of errors in forecast estimates and other data. Congressional 
action averted fee reductions, and projected fee reductions, for 2003 
through 2005. However, beginning in 2006, fees are projected to resume 
falling for several years, partly to recoup the excess spending 
accumulated from averted cuts in previous years and partly because real 
per beneficiary spending on physician services is projected to grow 
faster than allowed under SGR. The dilemma for policymakers posed by 
projected fee reductions is that while SGR's automatic responses work 
as intended from a budgetary perspective, the consequences for 
physicians and their patients are uncertain.

                               BACKGROUND

    The Omnibus Budget Reconciliation Act of 1989 (OBRA 1989) reformed 
the way Medicare pays for physician services in the traditional fee-
for-service (FFS) program.3 OBRA 1989 required the 
establishment of a physician fee schedule and a system of spending 
growth targets, known as MVPS, that became effective in 1992. In 1998, 
the SGR system of spending targets replaced MVPS. Both spending target 
systems were designed to moderate growth in the volume and intensity of 
services provided to beneficiaries.
---------------------------------------------------------------------------
    \3\ See Pub. L. No. 101-239,  6102, 103 Stat. 2106, 2169-89.
---------------------------------------------------------------------------
    Prior to the establishment of the fee schedule, Medicare payment 
rates for physician services were based on historical charges for these 
services.4 The establishment of a fee schedule was an 
attempt to break the link between physicians' charges and Medicare 
payments. The fee schedule was not designed to reduce spending levels 
overall but to redistribute payments for services based on the relative 
resources used by physicians to provide different types of care. Under 
the fee schedule, Medicare pays for more than 7,000 physician 
services.5 To arrive at Medicare's fee, the service's 
relative value is multiplied by a dollar conversion factor.
---------------------------------------------------------------------------
    \4\ 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).
    \5\ The fee for each service is determined using a resource-based 
relative value scale--that is, the resources required for that service 
relative to the resources required to provide all other physician 
services adjusted for the differences in the costs of providing 
services across geographic areas.
---------------------------------------------------------------------------
    Currently, under SGR, the Centers for Medicare & Medicaid Services 
(CMS), the agency that administers Medicare, uses the dollar conversion 
factor to calculate Medicare fees and updates the conversion factor 
each calendar year to account for the change in the cost of providing 
physician services (as measured by the Medicare Economic Index (MEI)), 
adjusted for the extent to which actual spending aligns with spending 
targets. Fee updates represent the aggregate of increases and decreases 
across all services; the fees for specific services may rise or fall 
each year.

MEDICARE SPENDING FOR PHYSICIAN SERVICES GREW RAPIDLY IN 1980S, SLOWED 
                AFTER IMPLEMENTATION OF SPENDING TARGETS

    In 1980, Medicare spending for physician services totaled $7.5 
billion.6 (See fig. 1.) By 2003, Medicare spending on these 
services totaled $47.9 billion. During much of this period, increases 
in both the volume and intensity of services physicians provided to 
each beneficiary were an important factor in spending growth.
---------------------------------------------------------------------------
    \6\ This includes spending, net of beneficiary cost-sharing, for 
aged and disabled beneficiaries in the traditional FFS program.
---------------------------------------------------------------------------
In 1980s, Spending for Physician Services Grew Rapidly
    Before the physician fee schedule was implemented, Medicare 
payments for physician services were largely based on historical 
charges. Experience in the 1980s repeated the experience of the prior 
decade: the Congress froze fees or limited fee increases, but spending 
continued to rise. From 1980 through 1991, for example, Medicare 
spending per beneficiary for physician services grew at an average 
annual rate of about 11.6 percent. (See fig. 2.)
    Total Medicare spending for physician services depends on the fee 
paid for each service, the number of beneficiaries served, the number 
of services provided to each beneficiary (volume), and the mix of those 
services--that is, the combination of more and less expensive services 
(intensity). Of these factors, physicians directly influence only the 
volume and intensity of services provided to beneficiaries.
    Much of the spending growth resulted from increases in the volume 
and intensity of services. For example, from 1986 until 1992, physician 
payment rates grew by less than 2 percent annually, while the volume 
and intensity of services rose, on average, by almost 8 percent per 
year. In 1986, the Congressional Budget Office stated that ``[b]oth the 
price and the volume of services must be controlled to constrain costs 
. . .'' 7 In 1989, citing the need for spending targets to 
limit spending growth for physician services, the Secretary of Health 
and Human Services (HHS) testified that ``Medicare physician spending 
has increased at compound annual rates of 16 percent over the past 10 
years. And in spite of our best efforts to control volume and rein in 
expenditures, Medicare physician spending is currently out of control . 
. . An expenditure target . . . sets an acceptable level of growth in 
the volume and intensity of physician services.'' 8
---------------------------------------------------------------------------
    \7\ Congressional Budget Office, Physician Reimbursement Under 
Medicare: Options for Change (Washington, D.C.: Apr. 1986).
    \8\ Testimony before the Subcommittee on Medicare and Long-term 
Care, Committee on Finance, U.S. Senate, 101st Congress, 1st Session 
(June 16, 1989).
---------------------------------------------------------------------------
In 1990s, Growth in Spending on Physician Services Slowed Under 
        Spending Target Systems
    Annual spending growth during the 1990s was far lower than in the 
preceding 10 years. Beginning in 1992, the Congress introduced spending 
targets for physician services to help constrain the rise in Medicare 
spending for physician services. Unlike prior attempts to control 
spending, spending target systems sought to limit the growth in the 
volume and intensity of services each year.
    From 1992 until 1999, the growth in the volume and intensity of 
physician services per Medicare beneficiary moderated. (See fig. 3.) 
During this time period, the average annual increase in Medicare 
spending due to changes in volume and intensity of services per 
beneficiary was about 1 percent, in contrast with the average annual 
growth of about 7 percent in the period from 1985 through 1991.
    The moderation of volume and intensity growth slowed the rate of 
increase in spending on physician services. This spending grew from 
$25.6 billion in 1992 to $36.9 billion in 2000(an average annual rate 
of 4.7 percent. In contrast, from 1985 through 1991, total spending 
increased at an average annual rate of about 10.8 percent.

In 2000s, Spending Growth for Physician Services Rose but Remained 
        Lower than Rates in the 1980s
    Beginning in 2000, the growth in volume and intensity of services 
per Medicare beneficiary began to rise, although the average annual 
rate of growth remained substantially below that experienced before 
spending targets were introduced. From 2000 to 2003, volume and 
intensity rose at an average annual rate of 5 percent. CMS actuaries 
project an average annual growth in volume and intensity of 3 percent 
from 2004 through 2013. Total spending on physician services is 
projected to grow by an average of 8 percent a year from 2000 through 
2005.

  UNDER SGR AND PRIOR SYSTEM, PHYSICIAN FEE UPDATES ARE MECHANISM TO 
          BRING ACTUAL SPENDING IN LINE WITH SPENDING TARGETS

    A target for spending on physician services serves as a budgetary 
control by automatically lowering fee updates in response to excess 
volume and intensity growth. Under Medicare's SGR spending target 
system and its MVPS predecessor, physician fees are adjusted annually 
to help bring actual spending in line with spending targets. Projected 
increases in volume and intensity, beyond what the current SGR targets 
allow, are expected to contribute to annual fee reductions for several 
years as the system tries to align spending with targets.

SGR System Evolved from Spending Target System Introduced with 
        Physician Fee Schedule in 1992
    The SGR system evolved from the MVPS system of spending targets, 
which was introduced with the physician fee schedule in 1992. The goal 
of MVPS was to provide an incentive for physicians to reduce volume and 
intensity growth and thus slow the high annual rate of increase in 
expenditures.9 Under MVPS, if a year's actual spending 
growth exceeded the target, future payment rates would be reduced, 
relative to what they would have been if actual spending had equaled 
the target, to offset the excess spending. If a year's actual spending 
growth fell short of the target, future payment rates would be 
increased.
---------------------------------------------------------------------------
    \9\ At that time, the Secretary of HHS defined ``physician 
services'' to include ``services and supplies incident to physicians' 
services,'' such as laboratory tests and Medicare-covered outpatient 
prescription drugs. This definition remains today.
---------------------------------------------------------------------------
    Concerns about the MVPS spending target prompted the Congress to 
create SGR's system of spending targets.10 In its 1996 
report to Congress, the Physician Payment Review Commission noted that, 
under MVPS, physician fees would fall over time unless there were 
continual declines in the volume and intensity of services 
provided.11 In response to the system's perceived 
shortcomings, the Congress took action in 1997 to replace it with the 
SGR system.
---------------------------------------------------------------------------
    \10\ 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.
    \11\ Physician Payment Review Commission, 1996 Annual Report to 
Congress (Washington, D.C.: Physician Payment Review Commission, 1996).
---------------------------------------------------------------------------
SGR System Differs From Prior System in Important Ways
    The SGR system was created in the Balanced Budget Act of 1997 (BBA) 
12 and revised by the Medicare, Medicaid, and SCHIP Balanced 
Budget Refinement Act of 1999 (BBRA) 13 and, most recently, 
by MMA.14 Similar to MVPS, SGR sets spending targets for 
physician services and updates fees to bring spending in line with 
those targets. Under the SGR system, if spending exceeds the target, 
future fee updates are reduced. If spending falls short of the target, 
future fee updates are increased. By adjusting fees when prior-year 
spending has deviated from the target, SGR attempts to moderate the 
growth in total Medicare outlays for physician services.
---------------------------------------------------------------------------
    \12\ See Pub. L. No. 105-33,  4503, 111 Stat. 251, 433-34.
    \13\ See Pub. L. No. 106-113, App. F,  211(b), 113 Stat. 1501A-
321, 348-49.
    \14\ See Section 601(b), 117 Stat. 2301.
---------------------------------------------------------------------------
    Specifically, the SGR formula establishes expenditure targets as 
follows: from a base year--1996 15--the targets are updated 
each year 16 to account for four factors: (1) changes in the 
number of Medicare beneficiaries in traditional fee-for-service; (2) 
growth in the costs of providing physician services, laboratory tests, 
and Medicare-covered outpatient prescription drugs; (3) growth in the 
overall economy, as measured by changes in real per capita gross 
domestic product (GDP); and (4) changes in expenditures that result 
from changes in laws or regulations. Spending and targets are estimated 
from data available in the fall, when CMS sets physician fees for the 
next calendar year. Because SGR spending targets are cumulative, the 
target set for a specific year is affected by the targets set in all 
prior years. BBRA required CMS, in calculating each year's SGR spending 
target and fee update, to revise the targets set for the two previous 
years using the most recent available data.17
---------------------------------------------------------------------------
    \15\ The base year is set equal to the 12-month period ending March 
31, 1997.
    \16\ SGR changed from a fiscal year basis to a calendar year basis 
in 2000.
    \17\ The first year of fee updates to be based on revised targets 
was 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.
---------------------------------------------------------------------------
    SGR differs from MVPS in two key ways. The first relates to volume 
and intensity growth limits. MVPS relied, in part, on historical trends 
in volume and intensity growth to set new targets each year, whereas 
SGR ties allowable volume and intensity increases to the growth in real 
GDP per capita. Under SGR, real spending per beneficiary--that is, 
spending adjusted for the underlying cost of providing physician 
services--is allowed to grow at the same rate that the national economy 
grows over time on a per-capita basis--currently projected to be about 
2 percent annually. If volume and intensity grow faster, the annual 
increase in physician fees will be less than the estimated increase in 
the cost of providing services. Conversely, if volume and intensity 
grow more slowly than 2 percent annually, the SGR system permits 
physicians to benefit from fee increases that exceed the increased cost 
of providing services. To reduce the effect of business cycles on 
physician fees, economic growth is measured as the 10-year moving 
average change in real per capita GDP. This measure is projected to 
range from 2.1 percent to 2.5 percent during the 2005 through 2014 
period.
    A second difference is that MVPS compared target and actual 
expenditures in a single year, whereas SGR compares targets and actual 
expenditures cumulatively from a base year. The cumulative nature of 
SGR's spending targets increases the potential volatility of physician 
fee updates because the system requires that excess spending in any 
year be recouped in future years. Conceptually, this means that if 
spending has exceeded the SGR targets, fee updates in future years must 
be lowered sufficiently to offset the excess spending. Conversely, the 
system also requires that if spending has fallen short of the targets, 
fees must be increased to boost future spending.
    SGR limits how much fees can be adjusted when spending has missed 
the target. SGR's performance adjustment may decrease fees by as much 
as 7 percentage points below the percentage change in MEI when spending 
has exceeded the target and may increase fees by as much as 3 
percentage points above the percentage change in MEI when spending has 
fallen short of the target. SGR adjustments to the fees are determined 
by how much the cumulative amount of spending on physician services 
since 1996 differs from the cumulative spending target since that base 
year.

Legislative Action Temporarily Avoided Fee Declines; Fees Projected to 
        Decline Beginning in 2006
    Since the introduction of the fee schedule in 1992 through 2001, 
physicians generally experienced real increases in their fees--that is, 
fees increased more than the increase in the cost of providing 
physician services, as measured by MEI. Specifically, during that 
period, fees increased by 39.7 percent, whereas MEI increased by 25.9 
percent. In 2002, however, SGR reduced fees by 4.8 
percent,18 despite an estimated 2.6 percent increase in the 
costs of providing physician services. (See fig. 4.)
---------------------------------------------------------------------------
    \18\ CMS reduced 2002 fees by an additional 0.64 percent to offset 
an increase in spending projected to occur as a result of changes in 
the calculations used to determine the amount of resources associated 
with physician services. As a result of both the SGR reduction and this 
additional offset, 2002 fees declined by 5.4 percent.
---------------------------------------------------------------------------
    SGR reduced fees in 2002 because estimated spending for physician 
services--cumulative since 1996--exceeded the target by approximately 
$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 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 percentage points 
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.
    However, 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 fee-for-service enrollment and real per capita GDP that 
actual experience had shown 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.19 Without such revisions, the cumulative spending 
targets remained lower than if errors had not been made.
---------------------------------------------------------------------------
    \19\ BBRA required CMS to use actual, after-the-fact data to revise 
the estimates used to set the spending targets, beginning with the 
estimated spending target in 2000.
---------------------------------------------------------------------------
    In late 2002, the estimate of SGR called for a negative 4.4 percent 
fee update in 2003. With the passage of the Consolidated Appropriations 
Resolution of 2003,20 CMS determined that it was authorized 
to correct the 1998 and 1999 spending targets. Because SGR targets are 
cumulative measures, these corrections resulted in an average 1.4 
percent increase in physician fees for services for 2003.21
---------------------------------------------------------------------------
    \20\ See Pub. L. No. 108-7, Div. N, Title IV,  402, 117 Stat. 11, 
548.
    \21\ 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. CBO 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.
---------------------------------------------------------------------------
    In 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 2004 and 2005.22 The MMA increases replaced SGR 
fee reductions of 4.5 percent in 2004 and an estimated 3.6 percent in 
2005. Because MMA did not make corresponding revisions to SGR's 
spending targets, SGR will reduce fees beginning in 2006, to offset the 
additional spending caused by MMA's fee increases. In addition, recent 
growth in volume and intensity, which has been larger than SGR targets 
allow, will further compound the problem of excess spending that needs 
to be recouped.
---------------------------------------------------------------------------
    \22\ See Section 601(a), 117 Stat. 2300.
---------------------------------------------------------------------------
    The 2004 Medicare Trustees Report announced that the projected 
physician update would be about negative 5 percent for 7 consecutive 
years beginning in 2006; the result is a cumulative reduction in 
physician fees of more than 31 percent from 2005 to 2012, while 
physicians' costs of providing services, as measured by MEI, are 
projected to rise by 19 percent.23
---------------------------------------------------------------------------
    \23\ Boards of Trustees, Federal Hospital Insurance and Federal 
Supplementary Medical Insurance Trust Funds, 2004 Annual Report of the 
Boards of Trustees of the Federal Hospital Insurance and Federal 
Supplementary Medical Insurance Trust Funds (Washington, D.C.: Mar. 23, 
2004).
---------------------------------------------------------------------------
                        CONCLUDING OBSERVATIONS

    To a large extent, the physician fee cuts projected by Medicare's 
Trustees are required under SGR's system of cumulative spending targets 
to make up for excess spending in earlier years. MMA added to the 
excess spending by specifying minimum fee updates for 2004 and 2005 
without resetting the spending targets for those years. As a result, 
physician fee cuts were postponed, not avoided.
    In considering the projected fee cuts, however, it is important to 
recall that Congress originally established Medicare spending targets 
for physician services in response to runaway spending in the 1980s. 
The recent increase in volume and intensity growth suggests that 
Medicare faces a fundamental physician spending growth problem even if 
the SGR slate of missed spending targets were somehow wiped clean. 
Currently, projected Medicare spending for physician services exceeds 
what policymakers have specified--through the parameters of the SGR 
system--is the appropriate amount to spend. Because of expected 
increases in the volume and intensity of services provided by 
physicians, real spending per beneficiary is projected to grow by more 
than 3 percent per year. SGR, designed to promote fiscal discipline, 
allows such spending to grow by just over 2 percent per year. If the 
growth in real spending per beneficiary is not lowered through other 
means, SGR will mechanically reduce fee updates in an attempt to impose 
fiscal discipline and moderate total spending increases. Although this 
mechanical response may be desirable from a budgetary perspective, any 
consequences for physicians and their patients are uncertain.
    Mr. Chairman, this concludes my prepared statement. I will be happy 
to answer questions you or other Subcommittee Members may have.

[GRAPHIC] [TIFF OMITTED] T3309.001

[GRAPHIC] [TIFF OMITTED] T3309.002

    Mr. Bilirakis. Thank you very much, Mr. Steinwald.
    Doctor, please proceed.

                STATEMENT OF DOUGLAS HOLTZ-EAKIN

    Mr. Holtz-Eakin. Mr. Chairman, Congressman Brown and 
Members of the Committee, thank you for the chance to be here 
today. We've submitted a prepared statement for the record. Let 
me make, simply, a few points in my opening remarks.
    Over the long term, the projected growth of Medicare, and 
its sister program Medicaid, is the central budgetary challenge 
facing Congress. Medicare will double in size--spending on 
Medicare will double--simply due to the rising number of 
beneficiaries, even if per-capita costs remain the same.
    Between now and 2030, Medicare will rise from 2.5 percent 
of GDP to over 5 percent of GDP, just due to the rise in the 
number of beneficiaries. If one includes projected increases in 
costs, the Medicare program will triple in size: spending will 
rise from 2.5 to 7.5 percent of GDP.
    Medicare payments to physicians are just one part of this 
policy issue. At present, they constitute about \1/5\ of the 
$250 billion spent on the Medicare program.
    Congress has tried several methods to constrain the cost of 
Medicare physician services. For physicians, this has produced 
a relatively volatile history of updates to Medicare fees, 
which you can see in Figure 1 on the screens. The current 
method, the SGR, has annual and cumulative targets for 
physician spending, and uses physicians' fees to meet those 
targets. Left to operate as it stands, the mechanism will bring 
spending into line with the SGR targets over the budget window. 
Note, however, that as with the history that Mr. Steinwald 
pointed out, the projection is that spending will continue to 
rise, even in the face of the SGR, at an average rate of about 
6.3 percent per year.
    At the same time, however, physicians' fees for each 
service will be subjected to the negative updates in 2006 and 
2007, and, on average, fee increases will be less than medical 
inflation through 2014.
    The underlying issue is that physicians' fees contribute 
only a portion of the growth in spending. Physician spending 
will rise because of more beneficiaries, because of the 
increased incomes that both permit beneficiaries to want more 
services and afford doctors to provide them, leading to the 
increased volume and intensity as referred to by Mr. Steinwald. 
And, it will also increase through the costs of, not just 
physicians' fees, but those other services that are furnished 
incident to physician visits. The underlying issue is that the 
SGR targets only the physicians' fees. The increasing rise in 
the spending on services furnished incident to a visit means 
that physician spending per se becomes a smaller and smaller 
part of the SGR mechanism as time goes forward, as shown in the 
last of the three slides. The decline is about 3 percentage 
points of the total.
    The recent legislative history suggests that the SGR may 
not be politically sustainable. The 2003 Omnibus and the 
Medicare Modernization Act both overrode the SGR to avoid 
negative updates.
    The MMA legislated increases of 1.5 percent in 2004 and 
2005. It also required GAO to examine the SGR system. But it 
did not change the cumulative SGR targets, so those updates 
simply represent a shift of spending from the future to the 
present.
    In contrast, the 2003 Act actually increased the targets, 
providing not only an update of 1.6 percent to physicians, but 
an overall budget cost of $54 billion over 10 years.
    Any future legislation to avoid reductions in fees will 
involve a fundamental tradeoff. Allowing fees to rise, for 
example, at the rate of medical inflation, could cost as much 
as $95 billion over a 10-year budget window. Shorter-term fixes 
might be less costly, but might simply defer the problem.
    However, allowing the SGR to operate as in the baseline 
runs the risk of reducing access to physicians by Medicare 
patients.
    I want to thank you for the chance to appear today, look 
forward to your questions, and I would ask the chairman for his 
guidance on the right time to answer questions by members in 
their opening statement.
    [The prepared statement of Douglas Holtz-Eakin follows:]

  Prepared Statement of Douglas Holtz-Eakin, Director, Congressional 
                             Budget Office

    Chairman Bilirakis, Congressman Brown, and Members of the 
Subcommittee, I am pleased to be here today to discuss Medicare's 
payments to physicians. Those payments now represent 19 percent of 
Medicare's total spending--in 2003, $47 billion of its total 
expenditures of $249 billion.1
---------------------------------------------------------------------------
    \1\ Budgetary numbers are on a fiscal year basis; years noted in 
discussions of the sustainable growth rate mechanism are calendar 
years.
---------------------------------------------------------------------------
    The aging of the baby-boom generation will have dramatic fiscal 
implications for the Medicare program's overall spending. If the nation 
spent the same fraction of gross domestic product (GDP) on each 
Medicare beneficiary in 2030 that is spent today--a proposition that 
reflects only the increased number of beneficiaries at that point--
Medicare spending in that year would claim a 5.4 percent share of GDP, 
more than double today's share of 2.5 percent, CBO projects. The fiscal 
implications of the boomers' aging are compounded by the fact that 
health care costs per beneficiary routinely grow significantly faster 
than the economy as measured on a per capita basis. Consequently, if 
current law remains unchanged, Medicare spending could climb to 7.5 
percent of GDP--or higher--by 2030.
    As you know, the sustainable growth rate (SGR) method is used to 
establish Medicare's payment rates for physicians' services. If the SGR 
mechanism had been left to operate, it would have reduced those rates 
in each of the past few years. With the exception of 2002, however, 
policymakers have acted to prevent such reductions. Most recently, the 
Medicare Prescription Drug, Improvement, and Modernization Act of 2003, 
or MMA (Public Law 108-173), specified increases of 1.5 percent in 
payment rates for physicians' services for both 2004 and 2005. The 
Congressional Budget Office (CBO) estimates that that provision of the 
MMA will increase payments to physicians by a total of about $2 billion 
during those two years.
    Under current law, however, that provision will not significantly 
affect projected spending over the next 10 years because after 2005, 
the SGR method will again be used to establish payment rates. In 
addition, the SGR mechanism will offset that $2 billion increase in 
spending in subsequent years. As a result, payment rates will be 
subject to the maximum annual reduction under the SGR method (about 5 
percent) in 2006 and 2007 and will be held below the projected rate of 
increase in physicians' costs for most, if not all, years through 2014. 
The Medicare trustees recently concluded that under their assumptions, 
physician fees would be subject to the maximum reduction for an even 
longer period--each year from 2006 through 2012.
    The Medicare Payment Advisory Commission (MedPAC) recently 
recommended that the 2005 update to payment rates for physicians' 
services be set at the change in input prices minus an adjustment for 
productivity. The Senate-passed version of the pending budget 
resolution (S. Con. Res. 95) contains a Sense of the Senate provision 
that endorses permanently adopting that approach to updating physician 
fees. Such updates would increase Medicare spending by about $95 
billion through 2014 if they were implemented in 2005, by CBO's 
estimate, and by $90 billion if they were implemented in 2006. Before 
addressing those projections, however, I will review the relationship 
between Medicare's payments to physicians and the program's spending 
and summarize the history of efforts to control Medicare spending for 
physicians' services.

        Medicare's Payments to Physicians and Its Total Spending

    Let me begin by reviewing the relationship between the fees that 
Medicare pays to physicians, the program's overall spending for 
physicians' services, and its total expenditures. Medicare pays a fee 
for each medical service. But the amount paid per service is only one 
of the components contributing to Medicare's physician spending. 
Another factor is the number of beneficiaries. According to the 
Medicare trustees' 2004 report, the number of Medicare beneficiaries 
will nearly double between now and 2030, rising from 39 million to 72 
million.
    In addition to fees and growth in the number of beneficiaries, the 
average number and type (or ``intensity'') of the services provided by 
physicians contribute to total Medicare physician spending. Taken 
together, the average number and type of physicians' services 
constitute their ``volume.'' Medicare physician spending per 
beneficiary is thus equal to fees times the volume of services. Each 
year, Medicare sets fees for physicians' services using formulas in the 
Medicare fee schedule for physicians' services and the SGR mechanism. 
However, because Medicare does not control the volume of services that 
physicians provide, physician spending per beneficiary can grow even if 
fees are reduced.
    Throughout the 1980s, Medicare's spending for physicians' services 
grew faster than its spending for all other services; in the 1990s, 
that trend reversed. From 1981 through 1990, spending for physicians' 
services grew at an average annual rate of 13.7 percent, whereas 
spending for all other services grew by 11.1 percent per year. By 1990, 
Medicare's total payments to physicians were more than three-and-a-half 
times greater than they had been 10 years earlier, and the average 
physician was receiving more than two-and-a-half times as much in 
Medicare payments. Indeed, the program's payments per physician 
increased almost twice as fast as did the nation's economy during the 
1980s. That rapid growth led policymakers to add expenditure targets to 
the formulas used to set the overall level of physician fees in order 
to control total spending for physicians' services.

           Previous Approaches to Medicare Physician Payments

    The history of payments to physicians under Medicare can be divided 
into three periods. Shortly after the program began in 1965, spending 
rose rapidly as physicians increased both their charges and the volume 
of services that they provided. Legislation subsequently limited the 
growth of fees for physicians' services to the rise in the Medicare 
economic index, or MEI, but spending continued to climb 
rapidly.2 That experience led to the second period of 
physician payments, starting in 1984, when legislation froze fees or 
limited increases in them to less than the rise in the MEI.
---------------------------------------------------------------------------
    \2\ The Medicare economic index measures changes in the costs of 
physicians' time and operating expenses; it is a weighted sum of the 
prices of inputs in those two categories. Most of the components of the 
index come from the Bureau of Labor Statistics. Changes in the costs of 
physicians' time are measured through changes in non farm labor costs. 
Changes in productivity are also factored directly into the index.
---------------------------------------------------------------------------
    Despite those actions, spending for physicians' services continued 
to grow throughout the 1980s. Limits on the growth of fees alone--
without regard to the volume of services that physicians provided--
proved ineffective in controlling expenditures. Beginning in 1992, 
further restraints were imposed on the growth of Medicare's spending 
for physicians' services, leading to the third period of physician 
payments (as discussed below).

Abandoning the Charge-Based System
    When Medicare was created in 1965, the program paid physicians fees 
that were based on their charges, the method of payment then used by 
private insurers. In addition, Medicare permitted physicians to bill 
beneficiaries for the amount of their charges that exceeded the fee 
that Medicare paid, a practice known as ``balance billing.'' The 
charge-based reimbursement system gave physicians the incentive to 
raise their charges from year to year to boost their revenues, and 
those increases led to a rate of growth in spending that averaged 13 
percent annually from 1967 through 1974.
    As concerns grew about the program's rising costs, policymakers 
focused on re straining fees. In 1972, they mandated that the annual 
update to physicians' fees be limited to the increase in the MEI, a 
provision that was implemented in 1975.
    Tying increases in fees to growth in the MEI was not sufficient to 
keep total payments from rising, however, and lawmakers took further 
steps to limit spending from 1984 through 1991. The Congress froze fees 
from 1984 through 1986; from 1987 through 1991, it raised them by 
amounts specified in legislation. The effect of those actions was that 
spending grew at an average annual rate of 15 percent from 1975 to 
1991.

Limiting Beneficiaries' Liability
    Balance billing also prompted Congressional action during the 
1980s. On average, liability for balance billing per beneficiary grew 
from $56 a year (in nominal terms) in 1980 to a high of $94 in 
1986.3 In effect, beneficiaries contributed to offsetting 
the constraints on Medicare physician fees. The Congress responded by 
imposing limits on such billing, which prevented physicians from 
raising their charges. Total charges by so-called nonparticipating 
physicians are currently restricted to 109.25 percent of Medicare's 
fees for participating physicians.4
---------------------------------------------------------------------------
    \3\ Physician Payment Review Commission, Annual Report to Congress 
(March 1998).
    \4\ Under Medicare's rules, the program pays 80 percent of the 
amount on the fee schedule, and beneficiaries or their supplemental 
insurer pays 20 percent. Balance billing occurs when beneficiaries pay 
more than 20 percent of the scheduled fee. A physician elects either to 
``participate'' (that is, to take Medicare fees as payment in full for 
all services) or to receive Medicare payments as a ``nonparticipating'' 
physician, who is allowed to bill patients for the balance of the 
charges up to the statutory limit. Fees for nonparticipating physicians 
are set at 95 percent of the amount on the fee schedule. The Medicare 
program will pay 80 percent of that amount (which is 76 percent of the 
amount on the fee schedule.) The total charge is limited to 115 percent 
of the fee for non participating physicians (115 percent of 95 percent 
is 109.25 percent of the amount on the schedule). Beneficiaries pay the 
difference--which can be as much as 33.25 percent (109.25 percent minus 
76 percent) of the fee schedule amount.
---------------------------------------------------------------------------
    The program's limits on balance billing constrain beneficiaries' 
liability for physicians' charges. But those limits also reduce the 
potential usefulness of balance billing as a signal that Medicare's 
fees are below the level necessary to attract a sufficient number of 
doctors to serve Medicare enrollees.

Redistributing Payments Among Physicians' Services
    In attempting to control Medicare's expenditures, policymakers also 
took steps to redistribute payments among physicians' services. In the 
1980s, many analysts believed that Medicare's reimbursement of such 
services was distorted by factors that led to overcompensation of so-
called procedural services (for example, surgeries) at the expense of 
what were termed cognitive services (such as office visits). Fees 
varied widely, with physicians in different specialties and in 
different geographic regions receiving different payments for 
comparable services.
    The response to those concerns was the implementation in 1992 of a 
physician fee schedule, which bases payments for individual services on 
measures of the relative resources used to provide them. The formula 
for each fee has two parts. One part is a weight--the ``relative 
value''--that indicates the resource costs of each service relative to 
all others. (For example, a CAT scan has a higher relative value than 
an intermediate-level office visit with an established patient.) The 
other part is a fixed dollar amount known as the conversion factor, 
which is multiplied by each relative weight to calculate the fee to be 
paid for each service.
    The fee schedule was intended to promote equity and to be budget 
neutral--in 1992, the conversion factors were set so that estimated 
expenditures under the schedule equaled estimates of what expenditures 
would have been under the earlier payment system. The fee schedule was 
not designed to control Medicare's spending--it merely redistributed 
that spending among physicians' services.

Controlling Volume
    In an attempt to control volume-driven growth in total spending for 
physicians' services, policymakers also enacted a mechanism that tied 
the annual update of fees for services on the physician fee schedule to 
the trend in total spending for physicians' services relative to a 
target. Under that approach, the conversion factor was to be updated 
annually (to reflect increases in physicians' costs for providing care, 
as measured by the MEI) and adjusted by another factor to counteract 
changes in the volume of services provided per beneficiary. The 
introduction of expenditure targets to the update formula initiated the 
third period in physician payments. Known as the volume performance 
standard (VPS), it provided a mechanism for adjusting fees to try to 
keep total spending for physicians' services within budgetary targets.
    The VPS led to updates that were unstable. Under that approach, the 
expenditure target was based on the historical trend in volume. Any 
excess spending relative to the target triggered a reduction in the 
update two years later. But the VPS depended heavily on the historical-
volume trend, and the decline in that trend in the mid-1990s led to 
large increases in Medicare's fees for physicians' services.
    Policymakers attempted to offset the budgetary effects of those 
increases by making successively larger reductions to the updates. 
Indeed, between 1992 and 1998 (the years that the VPS was in effect), 
the MEI varied from 2.0 percent to 3.2 percent, but the annual update 
to physician fees varied much more widely, from a low of 0.6 percent to 
a high of 7.5 percent (see Figure 1).
    Medicare's spending for services on the physician fee schedule grew 
at an average annual rate of 3.2 percent during the 1992-1998 period, 
but the changes in spending varied substantially from one year to the 
next, ranging from a reduction of 2.6 percent in 1992 to increases of 
almost 10 percent in both 1994 and 1995. That volatility led the 
Congress and the President to modify the VPS in the Balanced Budget Act 
of 1997, replacing it with the sustainable growth rate mechanism in 
place today.

                            The SGR Approach

    Like the VPS, the SGR method uses a target to adjust future payment 
rates and to control growth in Medicare's total expenditures for 
physicians' services. In contrast to the VPS, however, the target under 
the SGR mechanism is tied to growth in real (inflation-adjusted) GDP 
per capita--a measure of growth in the resources that society has 
available for each person. The update under that approach is equal to 
the MEI adjusted by a factor that reflects cumulative spending relative 
to the target. (Cumulative spending was not part of the VPS method.)
    Policymakers saw the SGR approach as objective and stable by 
comparison with the VPS. From a budgetary standpoint, the SGR method, 
like the VPS, could be effective in limiting total Medicare payments to 
physicians over time. The growth rate of GDP provides an objective 
benchmark; moreover, changes in GDP from year to year have been 
considerably less volatile (and generally smaller) than changes in the 
volume of physicians' services.

How the SGR Mechanism Works
    The SGR mechanism establishes year-by-year and cumulative 
expenditure targets for Medicare's combined spending for physicians' 
services (that is, services on the physician fee schedule) and services 
furnished ``incident to'' (in connection with) a physician visit (such 
as diagnostic laboratory services and physician-administered drugs). 
Those targets are updated each year to reflect inflation--primarily in 
physicians' costs (as measured in the MEI)--as well as changes in the 
size of the economy (as measured by real GDP per capita), growth in the 
number of Medicare enrollees in the fee-for-service sector, and any 
changes in expenditures that stem from new laws and 
regulations.5 The adjustment for changes in the economy's 
size is, in essence, an allowance for increases in the number of 
services being furnished per enrollee and shifts in the mix of services 
toward those that are more technologically advanced and (frequently) 
higher priced. Thus, the SGR mechanism establishes expenditure targets 
that, on a per-beneficiary basis, are both adjusted for inflation and 
add in an allowance for increases in real spending.
---------------------------------------------------------------------------
    \5\ The adjustment of SGR expenditure targets for inflation also 
reflects changes in the prices of ``incident-to'' services, which are 
included in the calculation of spending subject to the SGR.
---------------------------------------------------------------------------
    The SGR mechanism also has a self-correcting adjustment feature. If 
spending for services subject to the SGR method deviates from the 
expenditure targets--that is, if real growth in spending per 
beneficiary is faster or slower than the change in per capita GDP--the 
annual updates to payment rates for physicians' services will be 
adjusted so that over a period of several years, cumulative spending 
will be brought back into line with the cumulative expenditure target.
    The update to payment rates combines an adjustment for inflation 
(the MEI) with an ``update adjustment factor'' based on the 
relationship between previous spending and the expenditure targets. 
That factor takes into account both the relationship between cumulative 
spending and the cumulative expenditure target and the relationship 
between spending in the prior year and the current year's expenditure 
target. The update formula gives more weight to the latter relationship 
than to the former. Consequently, if cumulative spending exceeds the 
cumulative target (as it currently does), the SGR mechanism under 
current law will reduce payment rates each year until spending in the 
most recent year is below the expenditure target for that year. At that 
point, the updates to payment rates may become positive, but the 
increases will be set to keep annual spending below the year-by-year 
expenditure targets until cumulative spending and the cumulative target 
converge.
    In any event, the update adjustment factor is constrained by law to 
fall between a 3 percent increase and a 7 percent reduction. CBO 
projects that the MEI will aver age between about 2 percent and 2.5 
percent over the long run (through 2014). Therefore, the annual update 
to payment rates for services on the physician fee schedule will tend 
to range between increases of about 5 percent and reductions of about 5 
percent. (See the appendix for an example of the SGR method.)

Recent Legislation Affecting Application of the SGR Method
    Spending for physicians' services subject to the SGR mechanism has 
grown at an average rate of about 6 percent a year since the 1996/1997 
base year (April 1996 through March 1997). By the end of 2002, such 
spending had exceeded the cumulative target by about $17 billion, CBO 
estimates; in the next few years, expenditures in excess of the target 
would have grown by another $10 billion. As a result, physician payment 
rates for 2003 were scheduled to drop by 4.4 percent (after falling by 
5.4 percent in 2002). In the Consolidated Appropriations Resolution, 
2003 (P.L. 108-7), the Congress responded to that imminent reduction by 
allowing the Administration to boost the cumulative target, thereby 
producing a 1.6 percent increase in payment rates for physicians' 
services for 2003.
    Through 2003, that spending exceeded the higher target by about $6 
billion, CBO estimates. If it had been allowed to operate, the SGR 
method would have reduced payment rates again, this time for 2004. 
However, the Medicare Modernization Act replaced that scheduled 
reduction in rates with increases of 1.5 percent in both 2004 and 
2005--but it left the cumulative target intact, specifying that those 
increases were not to be considered changes in law or regulation for 
the purpose of adjusting the expenditure target. Thus, spending for 
physicians' services will continue to exceed the cumulative target. 
Unless it is modified again, the SGR method will reduce payment rates 
for several years beginning in 2006 and will keep updates below 
inflation through at least 2014.

     Baseline Projections of Spending Subject to the SGR Mechanism

    On a per-beneficiary basis, the SGR expenditure target has grown 
from about $1,300 in the base year (1996/1997) to $1,850 in 
2004.6 Under CBO's economic and technical assumptions, the 
target in 2014 will be about $2,900 per beneficiary. That figure 
represents a nominal increase of 120 percent in per-beneficiary 
spending over the 1996-2014 period and a real increase--above and 
beyond the rise in physicians' input costs--of 45 percent per 
beneficiary, or an average of 2.1 percent a year. That real increase 
reflects both the allowance for increases in per capita GDP and 
adjustments for changes in laws and regulations.
---------------------------------------------------------------------------
    \6\ The following discussion characterizes the expenditure targets 
and spending for services subject to the SGR mechanism in terms of 
expenditures by the Medicare program. The amounts used in rate-setting 
calculations include both the Medicare program's share and 
beneficiaries' cost-sharing obligations. Therefore, the amounts used in 
those calculations are about 25 percent larger than the Medicare 
program's share alone.
---------------------------------------------------------------------------
    Under CBO's assumptions about the number of beneficiaries in the 
fee-for-service and Medicare Advantage sectors of the Medicare program, 
year-by-year expenditure targets will grow from $62 billion in 2004 to 
$121 billion in 2014, by CBO's estimate. Medicare spending for services 
subject to the SGR mechanism over that period will rise from $66 
billion to $121 billion, an increase averaging about 6.3 percent per 
year (see Figure 2).
    As a result of the updates for 2004 and 2005 specified in the MMA, 
spending subject to the SGR mechanism will exceed the year-by-year 
expenditure targets by about $4 billion in both of those years, CBO 
estimates. Therefore, the amount of cumulative SGR-applicable spending 
that exceeds the cumulative target will grow from about $5 billion at 
the end of 2003 to $13 billion at the end of 2005. Accordingly, the SGR 
mechanism will reduce physician payment rates in 2006 and 2007 and hold 
updates below inflation through 2014. As a result, CBO estimates that 
the excess of cumulative spending over the cumulative targets will peak 
at $15 billion at the end of 2006 and then decline--to about $5 billion 
in 2014.

Incident-to Services and the ``Effective Target'' for Physicians' 
        Services
    As noted earlier, the SGR expenditure targets encompass both 
spending for services on the physician fee schedule and services 
incident to a physician visit. Including so-called incident-to services 
under the SGR mechanism was intended to make physicians accountable for 
spending for the services that they control. The mechanism, however, 
affects payment rates only for services on the physician fee schedule. 
Moreover, the SGR mechanism will adjust payment rates for physicians' 
services to offset any difference in spending that results when the 
rate of growth of spending for incident-to services deviates from the 
growth rate of the SGR expenditure targets.
    The SGR expenditure targets are adjusted for changes in both 
physicians' costs and the prices of incident-to services. CBO projects, 
however, that spending for incident-to services will grow faster, on a 
per-beneficiary basis, than the adjustments for inflation and the GDP-
based allowance for volume and technology. Therefore, spending for 
incident-to services will grow more rapidly than the SGR expenditure 
targets, and payments for those services will consume an increasing 
share of the target, rising from $12 billion in 2004 (20 percent of the 
$62 billion expenditure target) to $28 billion in 2014 (23 percent of 
the $121 billion target). In turn, the effective expenditure target for 
services on the physician fee schedule will decline from 80 percent of 
the SGR target in 2004 to 77 percent in 2014, CBO estimates. That 
decline in the share of the SGR expenditure target accounted for by 
physicians' services implies that the annual rate of growth of the 
effective target for physicians' services will be almost half a 
percentage point lower, on average, than the growth in the SGR target 
as a whole.

Spending for Physicians' Services
    To get a sense of the pressure that the SGR mechanism will put on 
updates, it is instructive to compare the cumulative amount by which 
spending exceeds the expenditure targets--all of which will ultimately 
be recovered, under current law, by holding down updates to physicians' 
fees--with the effective expenditure target for physicians' services in 
the succeeding year. The $5 billion by which cumulative spending for 
services subject to the SGR mechanism exceeded the cumulative target at 
the end of 2003 represents 10 percent of the effective target for 
physicians' services in 2004. That proportion will shoot up to 22 
percent of the effective target for such services in 2006 and--when the 
cumulative excess peaks at $15 billion at the end of 2006--will reach 
25 percent of the effective target in 2007.
    Given the extent to which projected expenditures before 2006 exceed 
the expenditure targets, CBO expects that the updates to payment rates 
for 2006 and 2007 will be subject to the maximum reduction of about 5 
percent. Although the maximum reduction could be applied for more than 
two years, CBO's projections show that in 2007, spending subject to the 
SGR mechanism will fall slightly below the expenditure target for that 
year (cumulative spending will still exceed the cumulative target by 
more than $14 billion at the end of 2007). At that point, the ``prior-
year'' component of the update adjustment factor will begin to 
partially offset the negative contribution of the factor's 
``cumulative'' component. CBO therefore expects that the maximum 
reduction will cease to be applied to payment rates for physicians' 
services within a few years after 2007--possibly as early as 2008. 
Although the update to payment rates could be positive in real terms in 
some year during the 2008-2014 period, CBO expects that, on average, 
the SGR mechanism will result in real reductions in physician payment 
rates for the 2008-2014 period as a whole.7
---------------------------------------------------------------------------
    \7\ In fact, physician payment rates will be reduced in real terms 
for the entire 2004-2014 period because the 1.5 percent increases in 
payment rates for 2004 and 2005 are below the expected increases of 3.1 
percent and 2.6 percent, respectively, in physicians' costs as measured 
by the MEI. The updates in 2006 and 2007--which CBO expects will be set 
at the maximum reduction of about 5 percent--will also be substantially 
lower than the projected rise in the MEI, which CBO estimates will be 
1.8 percent in each of those years.
---------------------------------------------------------------------------
Spending per Beneficiary for Physicians' Services
    CBO expects that the long-term trend of increases in the number of 
physicians' services provided per beneficiary and in the intensity of 
those services will continue. In turn, the annual rate of growth of 
spending per beneficiary will be higher than the update to the payment 
rate for services on the physician fee schedule.
    CBO expects that spending per beneficiary for physicians' services 
in 2014 will be higher in real terms than it was last year--despite the 
real reductions in payment rates over the next decade. Medicare spent 
about $1,400 per beneficiary in 2003 for services on the physician fee 
schedule. By 2014, CBO projects, Medicare spending for those services 
will have grown by 56 percent, to about $2,200 per beneficiary. About 
16 percentage points of that increase simply keep those payments on a 
par with inflation in physicians' costs as measured by the MEI. Over 
the 2003-2014 period, however, Medicare spending per beneficiary for 
physicians' services will grow at a pace that exceeds increases in 
physicians' costs by an average annual rate of 1.7 percent, CBO 
estimates.
    Annual changes in Medicare spending for physicians' services will 
vary substantially around that average over the coming decade. In 2006 
and 2007, CBO projects, Medicare will spend less for physicians' 
services, on a per-beneficiary basis, than it did in the previous year. 
Spending per beneficiary will increase each year, beginning in 2008, 
but it will not exceed the 2005 level until 2009 (see Figure 3).

             Budgetary Implications of Illustrative Options

    The prospect of reductions in Medicare payment rates for 
physicians' services has generated considerable interest in the costs 
associated with modifying the SGR mechanism. To date, proposals have 
generally taken one of three forms:

 Accelerate spending in the near term, and allow the SGR mechanism to 
        recoup the additional spending in subsequent years;
 Increase the SGR expenditure targets (or increase the effective 
        target for physicians' services); or
 Replace the SGR method with annual updates based on inflation.
    Recent legislation provides examples of the first two approaches. 
The increase of 1.5 percent in physician payment rates for 2004 and 
2005 that was enacted in the MMA accelerated spending into those years, 
but those increases will be recouped in subsequent years (unless the 
SGR mechanism is modified). Conversely, the Consolidated Appropriations 
Resolution, 2003, allowed the expenditure targets to be increased. 
Those contrasting approaches account for the difference between the 
negligible cost over 10 years of the MMA's provision and the $54 
billion cost of the increase in the expenditure targets.
    Several methods for increasing the SGR expenditure targets have 
been proposed. CBO has developed estimates for three such approaches as 
well as for replacing the SGR targets with annual updates based on 
inflation.
    Adjust the SGR expenditure targets to recognize the 1.5 percent 
updates in 2004 and 2005 as a change in law. By CBO's estimate, that 
change would result in increases each year in Medicare spending for 
physicians' services on a per-beneficiary basis and would increase 
overall Medicare spending by $45 billion through 2014.
    Remove spending for physician-administered prescription drugs from 
the SGR expenditure target. Although the SGR expenditure targets are 
adjusted for changes in the prices of a market basket of prescription 
drugs, shifts in the quantity and in the mix of drugs administered--
toward the use of more recently introduced and more expensive drugs--
tend to result in spending that grows faster than the inflation 
adjustment. Removing spending for physician-administered prescription 
drugs from the SGR expenditure target would leave laboratory services 
as the primary source of charges in the category of services that are 
incident to a physician visit. That approach would increase the 
proportion of the SGR expenditure target attributable to physicians' 
services as well as increase the effective target for such services. 
CBO estimates that eliminating prescription drugs from the calculation 
of the SGR expenditure target would not change spending until 2008--
because updates to physician payments would still be subject to a 1.5 
percent increase in 2005 and the maximum reduction of about 5 percent 
in 2006 and 2007. In total, this approach would increase Medicare 
outlays through 2014 by about $15 billion.
    Increase the allowance for volume and intensity to the rate of 
growth of GDP per capita plus 1 percentage point, beginning with the 
calculation of the SGR for 2005. As noted earlier, the SGR mechanism 
provides an allowance equaling the rate of growth of GDP per capita for 
changes in spending attributable to increases in volume and intensity. 
That allowance has proved to be extremely constraining. Adopting a more 
generous allowance of GDP per capita plus 1 percentage point--which was 
considered when the SGR formula was being developed--would have no 
effect on spending in 2006 and 2007 because updates in those years 
would still be subject to the maximum 5 percent reduction. However, it 
would increase physician payment rates in 2008 and subsequent years and 
increase Medicare spending by an estimated $35 billion over the 2008-
2014 period.
    Adjust payment rates for inflation. The Senate-passed version of 
the pending budget resolution for 2005 includes a Sense of the Senate 
provision that endorses permanent adoption of an inflation-based update 
for payment rates for physicians' services. Such an update, which is 
similar to one proposed by MedPAC for 2005, would be set at the change 
in input prices minus an adjustment for productivity. CBO estimated 
that use of that method for updates would raise net federal mandatory 
outlays by about $95 billion through 2014 if the update was applied to 
payments for physicians' services beginning in 2005. If the change was 
effective for services beginning in calendar year 2006--the first year 
that physicians would face a nominal decrease in payments under current 
law--net federal outlays would increase by $90 billion through fiscal 
year 2014, by CBO's estimate. The average annual increase in spending 
for services subject to the SGR mechanism would grow to 7.6 percent 
over the 2004-2014 period.

                              Conclusions

    In considering whether to change the current system for setting 
Medicare physician payments, policymakers confront the prospect of 
reductions in the fees paid per service and in the money doctors earn 
per patient for the next several years. Replacing the SGR method with 
updates based on inflation would increase Medicare spending by $90 
billion or more over the next decade. In contrast, other approaches 
might have the potential to lessen the volatility in the update without 
dismantling the mechanism for linking physician fees to total spending 
for physicians' services or to growth in the economy.
    Maintaining access to care for Medicare beneficiaries is a key 
consideration in assessing the program's fee structure. In evaluating 
the most recent systematic data about access to care (from 2002), 
MedPAC reported that it found no evidence at the national level of 
problems in beneficiaries' and physicians' views about access. But the 
lack of timely data makes it hard to know whether and to what extent 
problems exist in access to care--much less to know how to modify 
policies to maintain such access. More-recent data on that issue would 
be an important improvement over the current situation and could assist 
the Congress in its deliberations.
    Changes that increase Medicare's payments to physicians will boost 
federal spending. Incorporating higher fees for physicians' services 
into Medicare spending as currently projected would add to the already 
substantial long-run costs of the program and to the fiscal challenge 
posed by the aging of the baby boomers. Raising fees would also 
increase both beneficiaries' cost-sharing obligations and the premium 
that they must pay for Part B of Medicare (the Supplementary Medical 
Insurance program). Inevitably, over the longer term, higher spending 
by Medicare for physicians' services will require reduced spending 
elsewhere in the budget, higher taxes, or larger deficits.

      Appendix: Application of the Sustainable Growth Rate Method

    On March 4, 2004, the Centers for Medicare and Medicaid Services 
(CMS) published its Estimated Sustainable Growth Rate and Conversion 
Factor for Medicare Payments to Physicians in 2005. That notice 
estimated that the application of the sustainable growth rate (SGR) 
method would result in a reduction of 3.6 percent in the conversion 
factor for services on the physician fee schedule. However, the 
Medicare Prescription Drug, Improvement, and Modernization Act of 2003, 
or MMA (Public Law 108-173) requires that payment rates be increased by 
the larger of 1.5 percent or the update as calculated using the SGR 
method--therefore, the update will be 1.5 percent. (A final notice 
updating those calculations will be published on November 1, 2004.)
    This discussion summarizes the calculations in that notice that 
lead to the estimate that application of the SGR method will produce a 
reduction of 3.6 percent in payment rates in 2005.

The Expenditure Target for 2005
    The SGR expenditure target for 2004 is $77.3 billion. (That amount 
includes both spending by the Medicare program and cost-sharing 
obligations of beneficiaries for all physicians' services subject to 
the SGR mechanism--that is, services on the physician fee schedule and 
so-called incident-to services, as discussed in the main text.) 
8 The SGR expenditure target for 2005 is calculated on the 
basis of CMS's estimates of four factors:

    \8\ The discussion in the main text characterized the expenditure 
targets and spending for services subject to the SGR mechanism in terms 
of expenditures by the Medicare program. Therefore, the amounts used in 
those calculations are about 20 percent smaller than the combination of 
the Medicare program's share and beneficiaries' cost-sharing 
obligations.
---------------------------------------------------------------------------
 Changes in fees for services subject to the SGR mechanism, which CMS 
        estimates as a weighted average of the change in physicians' 
        costs, adjusted for changes in productivity (as measured by the 
        Medicare economic index, or MEI) and the change in prices for 
        incident-to services. That weighted average will be 2.6 percent 
        in 2005, according to CMS's estimates;
 Changes in enrollment in Medicare's fee-for-service sector, which CMS 
        estimates will be -0.2 percent;
 The estimated 10-year average annual growth in real (inflation-
        adjusted) gross domestic product per capita, which CMS 
        estimates will be 2.2 percent; and
 The effect of changes in law or regulations--CMS estimates no such 
        changes and therefore no effect.
    Those factors are multiplied (1.026 * 0.998 * 1.022 * 1.000 = 
1.046) to yield a sustainable growth rate of 4.6 percent and an 
expenditure target for 2005 that is 4.6 percent larger than the 
expenditure target for 2004--or $80.8 billion.
    CMS's estimate of the cumulative SGR expenditure target from April 
1996 through December 2004 is $531.9 billion. Actual spending for 
services subject to the SGR method will be $83.4 billion in 2004, CMS 
estimates, and $543.8 billion cumulatively from April 1996 through 
December 2004.

Update to the Conversion Factor for Services on the Physician Fee 
        Schedule
    CMS's estimate that applying the SGR method will produce a 3.6 
percent reduction in payment rates in 2005 reflects the combined 
effects of three factors:

 The MEI, which CMS estimates will be 2.8 percent;
 The update adjustment factor (discussed below), which CMS estimates 
        will be -7.0 percent; and
 A ``transitional adjustment'' factor of 0.8 percent, as specified by 
        the Balanced Budget Refinement Act of 1999. (The law specified 
        transitional adjustment factors for each year from 2001 through 
        2005.)
    Those factors are multiplied (1.028 * 0.93 * 1.008) to yield an 
update factor of -3.6 percent. The MMA specified that the update should 
be the larger of the amount calculated using the SGR method (-3.6 
percent) or an increase of 1.5 percent. There fore, payment rates for 
services on the physician fee schedule will be increased by 1.5 percent 
for 2005.
    CMS used the following formula to calculate the update adjustment 
factor (which is often referred to as the performance adjustment 
factor) for 2005:

0.75 * (Target2004 - Actual2004) / 
        Actual2004
plus
0.33 * (Targetcumulative - Actualcumulative) / 
        [Actual2004 * (1 + SGR2005)].
That is,
0.75 * ($77.3 billion - $83.4 billion) / $83.4 billion
plus
0.33 * ($531.9 billion - $543.8 billion) / [83.4 billion * (1.046)].
    Those amounts reduce to ( 0.75 * -7.3 percent) + (0.33 * -13.6 
percent) = -10.0 percent. However, because the update adjustment factor 
cannot be less than -7.0 percent (nor more than 3.0 percent), the 
update adjustment factor for 2005 will be set at -7.0 percent.

[GRAPHIC] [TIFF OMITTED] T3309.003

[GRAPHIC] [TIFF OMITTED] T3309.004

    Mr. Bilirakis. Well, thank you, Doctor. You all are giving 
us an awful lot of time to inquire when our turn comes, which 
is really great.
    Mr. Hackbarth.

                 STATEMENT OF GLENN M. HACKBARTH

    Mr. Hackbarth. Mr. Chairman, Congressman Brown, Members of 
the Committee, thank you for this opportunity. I'll try to keep 
my comments very brief.
    Let me begin by stipulating to a couple points raised by my 
colleagues, Doug and Bruce. Unconstrained growth in the 
Medicare program in general, or Part B in particular, does pose 
a very serious problem for Congress and for the Nation as a 
whole.
    In addition to that, the budget score attached to repeal of 
SGR is a very immediate and difficult problem for the Congress. 
I understand that, and the Commission as a whole understands 
that.
    MedPAC's position, while we favor repeal of SGR, is not 
that any restraint on spending is inherently bad. Indeed, I 
would remind the committee that we recommended repeal of SGR 
before it began to produce negative updates for physicians. We 
recommended repeal right on the heels of it leading to 
significant increases in the update factor for physicians.
    We think that SGR is a bad idea for three basic reasons. 
First of all, it could threaten access to quality care by 
disconnecting payments from the cost of producing the service. 
Second of all, it's inequitable. Any cuts in fees resulting 
from SGR are applied across the board to all physicians, and 
all specialities, in all areas of the country, regardless of 
whether they contributed to the problem. And, very closely 
related to that is the third flaw, which is the system does not 
provide any incentive to restrain growth in volume of care. The 
cuts operate across the board, so an individual physician 
making decisions, clinical decisions, has no incentive to alter 
those decisions. The cut happens to everybody, not to the 
individual.
    Tinkering with the SGR curve, as some proposals suggest we 
do, may address the decline in the update factors mandated 
under existing law, reduce the negative updates, but they would 
not alter the second and third problems, namely, that the 
system is inherently inequitable and does not provide an 
incentive to restrain volume.
    A better system, from our perspective, would be one that 
has not a rigid formula to determine update factors for 
physicians, but is based on the year-to-year evaluation of 
payment adequacy, and is coupled with more targeted efforts to 
reduce inappropriate volume of services and improved quality of 
care.
    Repeal of SGR is prohibitively expensive, at least from the 
perspective of budget scoring, because SGR produces 
unrealistically low conversion factors, updates for physicians. 
As has been mentioned already by some members of the committee, 
few people believe that the projected cuts will ever occur. 
Yet, that is the baseline from which CBO must assess any 
proposal.
    There are options that are much less expensive than 
outright repeal. For example, what Congress has done in the 
recent past, a one or 2-year override, or administrative 
adjustments in the underlying SGR curve. To the extent that 
these changes could forestall large repeated cuts in physician 
payment, MedPAC supports their intent.
    There should not, however, be any illusion that by 
retaining SGR we have a policy in place that would deal with 
our long-term fiscal problems and restrain growth and volume 
and intensity of service. A serious approach to volume requires 
more discriminating tools. Some services are growing rapidly, 
others are not. Some new services provide substantial benefit 
to patients, while others provide little benefit, at least 
relative to their cost. Some services are over used. Other 
services are under used. Some areas of the country are low cost 
and high quality, while others are the reverse.
    It is simply not right to say that volume growth is, per 
se, a bad thing for the Medicare program. So, what kind of 
tools might be more discriminating and helpful in controlling 
bad volume, if you will, while permitting good volume? Without 
endorsing any of these, it's fairly easy to list the tools now 
being applied in various forms by private health plans, cost 
sharing, selective contracting with certain providers, 
incentive payments for individual or small groups of 
physicians, patient and provider education about appropriate 
standards of care, use of clinical standards to review claims 
or to include in prior authorization programs.
    Obviously, some of these steps would be very controversial 
in the context of the Medicare program and difficult to 
administer.
    So, what is MedPAC doing at this point? We are studying 
rapid growth, in particular, in imaging services, and how 
private payers are attempting to restrain that growth, while 
simultaneously maintaining, if not improving, quality. By 
imaging services, we are talking about X-rays, CAT scans, MRIs, 
and the like. It's an area where there's been very rapid 
growth, rapid innovation, but often it's a discretionary 
service, and there is, in fact, very significant variation in 
how imaging is used across local markets, and that's a well-
documented fact.
    At this point, MedPAC is not prepared to make specific 
recommendations based on our analysis, but recommendations may 
well be forthcoming in next year's cycle.
    In addition, I would emphasize that MedPAC favors paying 
for quality as a long-term direction for the Medicare program. 
We've already recommended paying for quality in two areas, 
namely, private plans under Medicare Advantage, and for 
physicians in ESRD facilities in the end stage renal dialysis 
program.
    With that, I'll stop, Mr. Chairman. Thank you for the 
opportunity.
    [The prepared statement of Glenn M. Hackbarth follows:]

 Prepared Statement of Glenn M. Hackbarth, Chairman, Medicare Payment 
                          Advisory Commission

    Chairman Bilirakis, Congressman Brown, Members of the Subcommittee. 
I am Glenn Hackbarth, chairman of the Medicare Payment Advisory 
Commission (MedPAC). I am pleased to be here this morning to discuss 
payment for physician services in the Medicare program.
    Medicare expenditures for physician services are the product of the 
number of services provided, the type of service, and the price per 
unit of service. The number and type of services provided we refer to 
as service volume. The sustainable growth rate (SGR) system was meant 
to control the volume of physician services and hence total 
expenditures for physician services by setting the update (change in 
unit payment for the year) for physician services. The SGR is based on 
changes in: the number of beneficiaries in the Medicare fee-for-service 
program; input prices; law and regulation; and gross domestic product 
(GDP). The GDP, the measure of goods and services produced in the 
United States, is used as a benchmark of how much growth in volume 
society can afford. The basic SGR mechanism is to compare actual 
spending to target spending and adjust the update when there is a 
mismatch.
    The SGR approach has three basic problems.

 It disconnects payment from the cost of producing services. The 
        formula produces updates that can be unrelated to changes in 
        the cost of producing physician services and other factors that 
        should inform the update. If left alone, negative updates would 
        provide a budget control but in so doing would produce fees 
        that in the long run could threaten beneficiaries' access.
 It is a flawed volume control mechanism. Because it is a national 
        target, there is no incentive for individual physicians to 
        control volume. When fee reductions have occurred they have not 
        consistently slowed volume growth and the volume of services 
        and level of spending are still increasing rapidly.
 It is inequitable because it treats all physicians and regions of the 
        country alike regardless of their individual volume influencing 
        behavior.
    The SGR formula has produced updates that in some years have been 
too high and in others too low. As we will discuss below, MedPAC has 
consistently raised concerns about the SGR--when it has set updates 
both above and below the change in input prices. In the Medicare 
Modernization Act (MMA), the Congress intervened to prevent the 
negative payment updates for 2004 and 2005 that would have occurred 
under the formula. But every time Congress acts to override a negative 
update, the formula automatically must lower updates in the future to 
make up for it. As a result, the current projection according to the 
trustees of the Medicare trust funds, is that annual updates of 
negative five percent will occur for seven consecutive years. The 
trustees characterize this series of updates as ``unrealistically low'' 
and in terms of budget scoring, these projections make alternatives to 
the SGR appear to be unrealistically expensive.
    Instead of relying on a formula, MedPAC recommends a different 
course--one that involves explicit consideration of Medicare program 
objectives. Updates should be considered each year to ensure that 
payments for physician services are adequate to maintain Medicare 
beneficiaries' access to necessary high quality care. At the same time, 
the growth in the volume of physician services should be addressed 
directly. Volume growth differs across geographic areas and by service 
and ultimately is the result of individual physician's practice 
decisions. Is all the care being provided necessary? Dartmouth 
researchers and others have shown that often high quality care is not 
correlated with more services. We know the private sector is taking 
steps to control volume in services such as imaging with very high 
growth rates. Volume growth must be addressed by determining its root 
causes and specifying policy solutions. A formula such as the SGR that 
attempts to control volume through global payment changes treating all 
services and physicians alike is bad policy and will produce 
inequitable results.
    In this testimony we will review how the SGR came about, explain 
the problems with it, look at our alternative for constructing yearly 
updates, and provide some thoughts on addressing volume growth. We 
understand the budget dilemma the Congress is facing. MedPAC is 
sensitive to the budget context and publishes the budget implications 
of its recommendations in its reports to the Congress. We are aware 
that our proposal will, because of the way the SGR and budget scoring 
works, be expensive from a scoring perspective. But relative to what is 
likely to happen (the Congress continuing to intervene to counteract 
the SGR's negative updates) it would be less so. When the budget score 
is an artifact of a comparison with an ``unrealistically low'' current 
law baseline, it should not prevent consideration of sensible policy 
alternatives.

              HISTORICAL CONCERNS ABOUT PHYSICIAN PAYMENT

    Medicare's payments for physician services are made according to a 
fee schedule, which includes payment rates for over 7,000 discrete 
services. It is designed to account for cost differences among services 
and geographic areas.
    The Congress established the fee schedule as part of the Omnibus 
Budget Reconciliation Act of 1989 (OBRA89). As a replacement for the 
so-called customary, prevailing, and reasonable (CPR) payment method 
that existed previously, it was designed to achieve several goals. 
First, the fee schedule decoupled Medicare's payment rates and 
physicians' charges for services This was intended to end an 
inflationary bias that was believed to exist under the CPR method 
because it gave physicians an incentive to raise their charges.
    Second, the fee schedule corrected distortions in payments that had 
developed under the CPR method. Evidence of those distortions came from 
William Hsiao and his colleagues at Harvard University who found that 
payments were lower, relative to resource costs, for evaluation and 
management services but higher for invasive, imaging, and laboratory 
services. Further evidence came from analyses, conducted by one of 
MedPAC's predecessor commissions, the Physician Payment Review 
Commission, that revealed wide variation in CPR-method payment rates by 
geographic area, that could not be explained by differences in practice 
costs.
    A third element of the OBRA89 reforms is central to our testimony 
today. To allow for annual updates of the fee schedule's payment rates, 
the legislation established a formula based on achievement of an 
expenditure target. This approach to payment updates was a response to 
rapid growth in Medicare spending for physician services. From 1980 
through 1989, annual growth in spending per beneficiary, adjusted for 
inflation, ranged widely, from a low of 1.3 percent to a high of 15.2 
percent. The average annual growth rate was 8.0 percent.
    Because over half of the increase in spending in the 1980s had been 
due to increases in the volume of services, the process for setting an 
expenditure target focused on growth in the volume of services. Based 
on a volume performance standard (VPS), it linked annual updates of the 
fee schedule's conversion factor to growth in the number and type of 
services physicians provide. If volume growth in a year exceeded that 
allowed by the VPS, the update was adjusted downward two years later.
    Because of physicians' unique role in the health care system, the 
hope was that the VPS would give them a collective incentive to control 
the volume of services. Physicians order tests, imaging studies, 
surgery, drugs, and otherwise serve as gatekeepers of the health care 
system. In addition, the unit of payment in the fee schedule is quite 
small--the discrete service. By contrast, the unit of payment for most 
other sectors is larger. A large unit of payment, such as a hospital 
stay, gives providers more opportunities to respond to financial 
incentives and operate efficiently. They can economize on both the mix 
and quantity of services provided. They can also economize on the 
inputs used to produce services. A small unit of payment, such as a 
discrete service (e.g., an office visit), limits the reach of financial 
incentives to the mix and quantity of inputs.
    Experience with the VPS formula showed that it had several 
methodological flaws that prevented it from operating as intended. For 
example, each year's VPS was a function of the historical trend in the 
rate of growth in the volume of services and progressively higher 
legislated deductions from those growth rates. As the result of a 
slowdown in the growth of the volume of services during the 1990s, the 
VPSs became unrealistically stringent.
    The problems with the VPS formula prompted the Congress to replace 
it as part of the Balanced Budget Act of 1997. Under the SGR, the 
expenditure target is not a function of historical growth in the volume 
of services. Instead, the SGR target is based on growth in real GDP per 
capita and other factors--inflation in physicians' practice costs, 
changes in enrollment in fee-for-service Medicare, and changes in 
spending due to law and regulation. As noted, the real GDP factor was 
included in the SGR to link the expenditure target to growth in the 
national economy. This linkage was thought appropriate because volume 
growth for physician services is theoretically as unlimited as the 
demand for health care. This Congress decided to link to GDP as a 
benchmark of what the U.S. economy could afford.

               THE PROBLEM WITH THE CURRENT UPDATE SYSTEM

    Setting prices correctly in Medicare's payment systems is essential 
to maintain access to services for Medicare beneficiaries. The 
underlying problem with the current SGR system is that it attempts both 
to control total spending on physician services delivered to Medicare 
beneficiaries and to set prices accurately. These two goals can seldom 
be achieved simultaneously. If actual total spending for physician 
services differs from the expenditure target, to control it fees under 
the SGR system are adjusted upward or downward. When this occurs, 
payments are usually either too low, potentially jeopardizing 
beneficiaries' access to care, or too high, making spending higher than 
necessary. The SGR attempted to achieve both goals and failed, as did 
the Volume Performance Standard system before it.
    An expenditure target approach, such as the SGR, assumes that 
increasing updates if overall volume is controlled, and decreasing 
updates if overall volume is not controlled, provides physicians 
nationally a collective incentive to control the volume of services. 
However, this assumption is incorrect because physicians do not respond 
to collective incentives but individual incentives. An efficient 
physician who reduces volume does not realize a proportional increase 
in payments. If anything in the short run an individual physician has 
an incentive to increase volume under such a system and the sum of 
those individual incentives will result in an increase in volume 
overall and an eventual further reduction in fees. In fact, CMS makes 
exactly that assumption when it estimates the so-called behavioral 
response of physicians to lower payments--which is an increase in 
volume of services provided.
    Over a longer period, if payments were clearly less than 
physicians' marginal cost of providing a service, we might see 
physicians cut back their Medicare practice and concentrate on other 
patients, devote more time to other professional or leisure activities, 
or leave practice altogether. Ultimately, we could see a shift in 
residency preferences away from those specialties most heavily 
dependent on Medicare. The result eventually would be decreased access 
for Medicare beneficiaries which could be very difficult to reverse.
    Compounding the problem with the conceptual basis of the system, 
the SGR system has produced volatile updates. To control spending the 
SGR compares actual spending to an expenditure target. Experience has 
shown that the target can change abruptly, leading to volatility in the 
updates. In 2001, a reestimate of historical GDP lowered the spending 
target. The target then decreased even more when both actual and 
projected GDP went down. Updates went from increases in 2000 and 2001 
of 5.4 percent and 4.5 percent, respectively, much larger than the 
increases in practice costs, to an unexpected large reduction in 2002 
of 5.4 percent. This volatility illustrates the problem of trying to 
control spending with an update formula.
    Despite this volatility, surveys in 2002 found that most 
beneficiaries were able to obtain physician care, and most physicians 
were willing to serve Medicare beneficiaries following the payment 
reduction. The CAHPS-FFS survey, sponsored by CMS, found that 90% of 
beneficiaries report that they ``always'' or ``usually'' got a timely 
appointment for routine care in the fall of 2002. A large physician 
survey--the National Ambulatory Medical Care Survey--found that among 
office-based physicians who commonly saw Medicare patients, 93% were 
accepting any new Medicare patients throughout 2002. Additionally, we 
have found that the supply of physicians furnishing services to 
Medicare beneficiaries has more than kept pace with the growth in the 
beneficiary population, through 2002. Further, in cases where we are 
able to analyze 2003 data, we find that access to physician care was 
good in 2003.
    In the MMA, the Congress attempted to reduce the volatility 
problem. The GDP factor in the SGR is now a 10-year rolling average, 
which dampens the effects of yearly changes in GDP growth. However, 
there is another source of volatility which has not been controlled--
estimating changes in enrollment in traditional fee-for-service 
Medicare. Here, we can anticipate reestimation of enrollment growth as 
CMS gains experience with shifts in enrollment from traditional 
Medicare to Medicare Advantage. Under the SGR, this could lead to 
continued volatility in spending targets and updates.

               A DIFFERENT APPROACH TO UPDATING PAYMENTS

    To address these problems, in our March 2002 report we recommended 
that the Congress replace the SGR system for calculating an annual 
update with one based on factors influencing the unit costs of 
efficiently providing physician services. Replacing the SGR system 
could allow updates more consistent with efficiency and quality care 
and would also uncouple payment updates from spending control. If total 
spending for physician services needs to be controlled, it is necessary 
to look at more than just the payment update mechanism. For example, by 
achieving appropriate use of services through outcomes and 
effectiveness research, as we suggested in our March 2001 report to the 
Congress, and by addressing volume growth directly as discussed in the 
next section.
    A new system should update payments for physician services based on 
an analysis of payment adequacy which would include the estimated 
change in input prices for the coming year, less an adjustment for 
growth in multifactor productivity. Updates would not be automatic 
(required in statute) but be informed by changes in beneficiaries' 
access to physician services, the quality of services being provided, 
the appropriateness of cost increases, and other factors, similar to 
those MedPAC takes into account when considering updates for other 
Medicare payment systems. Furthermore, the reality is that in any given 
year Medicare might need to exercise budget restraints and MedPAC's 
analysis would serve as one input to Congress's decision making 
process.
    We stress that payment updates should take into account 
productivity improvements that enable physicians to provide care more 
efficiently. Productivity gains are certainly possible in physician 
services. For example, Pope and Burge found that doubling the size of a 
physician practice increases productivity with no increase in practice 
expense per physician. Other gains might come from new technology, 
economies of scale, managerial skill, and changes in how care is 
delivered.

               A DIFFERENT APPROACH TO CONTROLLING VOLUME

    If payment rates are adequate and updated to account for changes in 
efficient physicians' cost, the remaining issue is controlling volume, 
which is important for both beneficiaries and taxpayers. For 
beneficiaries, increases in volume lead to higher out-of-pocket costs--
copayments, the Medicare Part B premium, and any premiums they pay for 
supplemental coverage. For taxpayers, increases in volume lead to 
higher Part B expenditures supported with the general revenues of the 
Treasury.
    The concern is that volume growth has accelerated recently (Figure 
1). From 2000 to 2001 volume increased 5.4 percent and from 2001 to 
2002 it increased by 5.6 percent. To be clear, this is growth in volume 
per beneficiary and does not reflect changes in Medicare payment rates. 
Preliminary data suggest that relatively high volume growth continued 
in 2003. Regardless of the direction of the annual update, volume 
growth continued, it increased both when the update increased and when 
it decreased.
    Among the effects of this growth, is an increase in the monthly 
Part B premium. Because it is determined by average Part B spending for 
aged beneficiaries, an increase in the volume of services affects the 
premium directly. From 1999 to 2002 the premium went up by an average 
of 5.8 percent per year. By contrast, cost-of-living increases for 
Social Security benefits averaged only 2.5 percent per year during that 
period. What is more, since 2002 the Part B premium has gone up faster 
still--by 8.7 percent in 2003 and 13.5 percent in 2004. The projected 
increase of 17.3 percent for 2005 is even larger.
    Volume growth also has implications for the federal budget. The 
Committee is aware of the growth of Medicare relative to the nation's 
output of goods and services as discussed in the Medicare trustees 
report. Increases in Medicare spending per beneficiary is an important 
reason for that growth, cited by the Congressional Budget Office and 
the General Accounting Office among others.
    However, some of the root causes of volume growth may be amenable 
to policy action and some growth may be desirable. For example, growth 
arising from technology that produces meaningful gains to patients, or 
growth where there is currently underutilization of services may be 
beneficial. But one indicator that not all growth is good may be its 
variation. Among broad categories of services, growth in volume per 
beneficiary ranged from about 10 percent to over 30 percent, based on 
our analysis of data comparing 2002 with 1999 (Figure 2). Within these 
broad categories, growth rates were higher for services which 
researchers have characterized as discretionary (e.g. , imaging and 
diagnostic tests). In imaging, for example, growth rates were over 15 
percent a year for such services as magnetic resonance imaging, 
computed tomography, and nuclear medicine.
    In addition, volume varies across geographic areas. As detailed in 
our June 2003 report to the Congress, the variation is widest for 
certain services, including imaging and tests. Researchers (e.g. 
Wennberg and Fisher) have reached several conclusions about such 
findings:

 Differences in volume among geographic areas is primarily due to 
        greater use of discretionary services sensitive to the supply 
        of physicians and hospital resources.
 On measures of quality, care is often worse in areas with high volume 
        than in areas with lower volume. The high-volume areas tend to 
        have a physician workforce composed of relatively high 
        proportions of specialists and lower proportions of 
        generalists.
 Areas with high levels of volume have slightly worse access to care 
        on some measures.
    All this suggests that volume may be too high in some geographic 
areas.

                     ADDRESSING THE VOLUME PROBLEM

    Is it possible for Medicare to address problems with the volume of 
services without resorting to a formula to control spending? To seek 
answers to this question, MedPAC has begun to consider strategies used 
by private insurers to purchase services. In doing so, we have focused 
particularly on imaging services because of the wide variation in the 
volume of these services, geographically, and because of the rapid 
growth in that volume.
    What we have found is that private insurers are confronting rapid 
growth in use of the services and concerns such as the following:

 proliferation of imaging equipment;
 lack of familiarity with new imaging modalities among non-specialist 
        physicians;
 self-referral, including ordering of imaging studies by physicians 
        who furnish the studies with equipment in their offices;
 direct-to-consumer marketing of imaging services and associated 
        questions about the need for demand management;
 defensive medicine in response to physician concerns about 
        professional liability;
 repetition of imaging studies; and
 poor quality of imaging equipment in some settings.
    In adopting their purchasing strategies, private insurers are 
working to control growth in the cost and utilization of imaging 
services while ensuring access to appropriate care.
    The strategies they are adopting are multiple, depending on the 
insurer they can include profiling, pre-authorization, beneficiary 
education, privileging, coding edits, and safety standards and site 
inspections. One study, based on site inspections, showed facilities 
failing at rates approaching 50 percent, depending on the type of 
practitioner offering the services. Reasons for the failures included 
age of the equipment and use of the incorrect equipment for the types 
of imaging studies conducted. Coding edits are rules invoked during 
claims processing to decide whether and how much to pay for billed 
services. Medicare has a set of these edits, developed under what is 
known as the Correct Coding Initiative. Private insurers often use 
Medicare's edits but then augment them with other edits to, for 
example, adjust payment downward when multiple services are billed on a 
single claim.
    Whether Medicare should do more to emulate private insurers' 
strategies for purchasing imaging depends on the administrative 
feasibility of more closely aligning Medicare policy with the 
strategies of private insurers. It also depends on the effectiveness of 
those strategies for making the purchasing of imaging services more 
efficient. MedPAC plans to address these issues during the coming year.
    Our other focus is on linking Medicare payment to quality to 
improve quality in fee-for-service Medicare and in care for Medicare 
beneficiaries furnished by private plans. In our March 2004 report we 
recommended two sectors where the Congress can act now--rewarding 
quality care in outpatient dialysis and Medicare Advantage. Those two 
areas have the requisite measuring systems in place to begin to pay for 
quality. We encourage a payment-for-quality approach that is budget 
neutral, rewards both improvement and attainment, and varies quality 
measures over time.
    As discussed, higher volume does not correlate with higher quality. 
Thus, it may be possible to increase the quality of the care 
beneficiaries receive and at the same time provide incentives to 
control the volume of services. Expanding payment for quality to the 
physician sector, where payment is still by the individual services 
provided, will be a challenge. But it is a challenge that must be met 
to ensure high quality care for Medicare beneficiaries within a 
sustainable Medicare program.

[GRAPHIC] [TIFF OMITTED] T3309.005

    Mr. Bilirakis. Thank you, Mr. Hackbarth.
    I would ask Mr. Steinwald and Doctor Holtz-Eakin first, do 
you take issue with, or have any comments regarding Mr. 
Hackbarth's testimony?
    Mr. Steinwald. I think the individual initiatives they have 
underway to look at ways of targeting unnecessary utilization 
and paying for quality are certainly worth pursuing.
    MedPAC has endorsed the idea of doing away with SGR. As you 
know, we have a study underway right now looking at how SGR 
might be changed or modified, and we are not in the position 
now to comment on what changes might be made.
    Mr. Bilirakis. Doctor?
    Mr. Holtz-Eakin. I would point out that the SGR is a 
budgetary device; it's not a health policy tool. To the extent 
that Congress chooses another device to identify increases in 
cost in Medicare, the main thing is to make sure that you 
reflect on the budget the implications of any changes in health 
policy, so that the costs are correctly recognized in decisions 
that Congress makes.
    Mr. Bilirakis. Well, you know, we, obviously, are famous up 
here for many of our decisions resulting in not-intended bad 
consequences, if you will. And, certainly, we want to be 
careful here.
    Mr. Hackbarth indicate some sort of a review, some sort of 
a system on--well, I guess you were talking about procedures 
that are used by doctors, and we want to be careful, of course, 
that we, in this ivory tower, are not going to be, basically, 
telling doctors how to practice medicine.
    But, at the same time, I suppose that's something that's 
got to be done. Is that a doable thing, in such a way that it 
will not result in, in effect, doctors complaining that, yeah, 
we've had complaints about HMOs, for instance, managed care, 
basically, having to call a non-MD, if you will, to get 
permission to perform a certain procedure and that sort of 
thing, and I know that that's something that has taken place 
over the years. Is that a doable thing?
    Go ahead, Mr. Hackbarth.
    Mr. Hackbarth. I believe it's doable. Let me emphasize 
again that we've not made specific recommendations about this, 
we are still in the process of working at the issues of how you 
would do it, feasibility for the program, and the like.
    It is not possible to do it without controversy. None of 
the options we have in front of us to slow the increase in 
healthcare costs, in general or in Medicare in particular, can 
be done without controversy.
    Can we do it without harming the quality of care for 
Medicare beneficiaries? Can we do it without harming access? I 
believe that the answers to those questions are yes. Will it be 
easy? No, it won't, but there aren't any easy solutions on the 
table.
    Mr. Bilirakis. I've been in doctors' offices in one 
capacity or another, and, for instance, I've seen a family 
practitioner, general practice, maybe a half a dozen patients 
for the entire day, but maybe two dozen procedures, and then 
you would go to another family doctor and see 20 patients, or 
two dozen patients, or whatever the case might be, and 20 
procedures, or in other words, one procedure, one or two 
procedures maybe per patient at the most.
    Now, you know, who am I to say what the heck is necessary 
and what isn't, whether an echo cardiogram which is done almost 
routinely by this family practitioner is a good thing or a bad 
thing. But, those are the things that, as you indicate, you 
know, you talked about volume, Mr. Steinwald, and intensity, I 
guess that's what you were referring to, isn't it, that sort of 
thing?
    Go ahead, sir.
    Mr. Steinwald. Yes, sir. Mr. Hackbarth was correct when he 
pointed out that the application of SGR is a very blunt 
instrument, and when there is a fee update it affects every 
physician equally. But, when there are volume and intensity 
increases, it's very unequally distributed across geographic 
areas and different areas of medicine. And, I think that is 
worth noting.
    It's also worth noting, though, that those increases do 
represent real spending, and if you think back again toward the 
1980's and early 1990's, when efforts were made to control 
spending by limiting fees, those efforts, essentially, did not 
work. Spending went up precipitously, even though fees were 
controlled.
    And so, we believe it's important that you keep in mind 
that volume and intensity are as important to increases in 
physician spending, potentially more important, than the fee 
updates themselves.
    Mr. Bilirakis. Does a lot of that take place as a result of 
maybe reductions in reimbursements and, consequently, more 
procedures to try to make up for it?
    Go ahead, Doctor, first.
    Mr. Holtz-Eakin. Really three things on this. The first is 
that we do have some work underway, really trying to look at 
the behavioral response of physicians to changes in Medicare 
fees, how much do they change their volume and intensity to 
offset reductions, say, in fees.
    The second is that I heard Mr. Hackbarth talk about two 
different kinds of reviews. The first would be an annual 
assessment of the appropriate rate of growth in spending, or 
the way the update would be done, and I'd point out that at the 
moment that's de facto how the system is operating. Each year 
Congress has taken a look at the SGR and elected to override it 
and provide an update that was different than the formula would 
indicate. That has budgetary consequences that the Congress 
understood when it made those decisions. And so, what an annual 
assessment would look like compared to that, I think would 
depend on the details.
    And finally, the second kind of review was review of 
procedures and quality of care. I think any economist would 
recognize that going forward it may be the case that we will 
spend more on healthcare in the United States. We will be an 
older population, and we will be a richer population. The gold 
standard from an economist's point of view would be to make 
sure that we get the right quality per dollar and not 
overspend.
    To the extent that these sorts of reviews provide 
information that allow people to make those decisions, that 
would be a useful thing. We'd have to look at specific 
recommendations when they come out.
    Mr. Bilirakis. Well, my time has expired, but, again, I 
would say, as I will when we finish up here at the close of the 
hearing, that we would welcome suggestions from you. I know 
that we have gotten some from MedPAC, but we would welcome any 
suggestions you may have. It's not like we go right down the 
line with everything you might recommend to us, but certainly 
we will seriously consider it, because this is a problem, and 
it's something that we have got to try to fix as much as we 
can, but we wanted to try to do it with as much expertise as 
possible. That's why we depend upon you.
    I'm going to yield to Mr. Brown now.
    Mr. Brown. I thank the chairman.
    Mr. Chairman, I would like to just ask unanimous consent 
that all members could submit questions to the panel. I have 
several that I'm probably not going to get to, and would like 
to do that if we could, and any other members.
    Mr. Bilirakis. Well, and I might also add to that unanimous 
consent request that opening statements of all members of the 
subcommittee will be made a part of the record, and there is a 
statement that was given to us by the AMA which they would like 
to have placed in the record, without objection that will be 
the case.
    Please continue, sir.
    Mr. Brown. Thank you, Mr. Chairman.
    I think all of us want to see a long-term--well, not even 
long term, permanent fix to this, and that means finding a way 
to come up with the money. The money needs to come from 
somewhere. Some of us in this body neither news reports, nor 
actual evidence, would suggest that some of us actually care 
about budget deficits up here, and some of us care about long-
term fiscal stability and would like to see a more consistent 
funding stream, if not statutorily dedicated to dealing with 
this issue, at least somewhere where we knew that money would 
be available for a permanent fix.
    And, with that, I'd like to ask a series of questions to 
Mr. Hackbarth.
    MedPAC recently issue a brief report detailing the 
overpayments to Medicare HMOs. If you could tell me on average, 
how much--this is the first of a couple of questions--how much 
more than fee-for-service is Medicare paying these plans first? 
Does this include risk adjustment, the adjustment for enrolling 
healthier than average seniors, and including the fact that 
HMOs get healthier than average senior enrollees, something we 
do know to be a fact, what would the overpayments be in that 
instance?
    Mr. Hackbarth. Congressman, maybe the easiest way to do it 
is by making reference to the graph that I think you held up at 
the beginning.
    Part of the information here is based on MedPAC analysis. 
Another piece is not. The first part, and this is in the report 
that you referred to a minute ago, is that MedPAC analysis 
indicates that we pay 107 percent of the fee-for-service amount 
on behalf of beneficiaries enrolled in private health plans. 
That additional payment, that 7 percent additional payment, is 
attributable to a series of factors in the system, including 
the floors on payment that exist and are applied by geographic 
area, the minimum update provision in current law, and some 
very specific technical issues with how medical education 
payments are accounted for. Those factors comprise the bulk of 
that added 7 percent payment.
    Then the second issue, that all assumes that the riskiness 
of the patients enrolled in private plans is identical to the 
general Medicare population, I would suggest. If, in fact, they 
are healthier than average, then there could be an additional 
overpayment.
    Our source of information about whether, in fact, the 
private plan enrollees are healthier or not, is not MedPAC 
analysis, but CMS analysis that comes out of the Actuary's 
office there, and the exact number has been floating around 
recently, and so I don't want to get pinned to a particular 
number. It's really CMS' number.
    But, the most recent estimates that I've heard of are in 
the neighborhood of 8 percent, and I think that's where the 15 
percent total comes from, 7 percent from MedPAC analysis and 
another 8 percent based on the CMS analysis. The CMS is really 
the right place to go for the risk adjustment information.
    Mr. Brown. That 15 percent, according to the chart, is the 
difference between $82.75 and $71.95, so it is an overpayment 
of slightly less than $1,100.
    Mr. Hackbarth. Yes.
    Mr. Brown. $1,080 per beneficiary, and it seems to me that 
it would make sense to take some of the money going to HMOs, 
which only enroll 11 percent of beneficiaries, actually, a 
lower number than before even with the incentives that were 
given, that number, I assume, will go up with the drug bill, 
and use it to pay for part of the cost of fixing the problems. 
I would have taken approximately $17 billion in overpayments to 
HMOs and PPOs, including the $12 billion slush fund, and the 
overpayments to Medicare Advantage plans, as compared to fee-
for-service Medicare, to help pay for some of the problems in 
the Physician Payment Formula. I know that's not your place to 
advocate, except your numbers, coupled with CMS numbers that 
the overpayment is 15 percent, roughly, and it's over $1,000 
per beneficiary times a large number of beneficiaries, is a lot 
of money that could go a major way toward solving this, but I 
also recognize the political realities if the insurance 
companies, with their friends in the drug industry, pretty much 
wrote the Medicare Bill, so to get this changed to pay for this 
is going to be a difficult hurdle.
    Mr. Hackbarth. Yes.
    If I could, I'd like to be very clear about MedPAC's 
position on the role of private plans in Medicare. In fact, we 
support offering Medicare beneficiaries the option of enrolling 
in private health plans. We do that because we believe that 
private health plans have the potential to offer at least some 
Medicare beneficiaries something better than they can get 
through the traditional program.
    Having said that, we believe that there ought to be a 
neutral choice between staying in traditional Medicare or 
enrolling in a private health plan, and our concern about the 
current payment system is that the choice is not neutral, 
because we are overpaying, from our perspective, the private 
plans.
    I'd also like to be clear that, again, the number that's on 
this chart, the only number that's on this chart that is a 
MedPAC number is the 7 percent. The risk adjustment numbers we 
don't do specifically, and, frankly, I have some uncertainty 
about where that estimate stands right now. And so, I think the 
staff has tried to take the most recent number and added it to 
ours, but this is not our analysis.
    Mr. Bilirakis. So, that is not necessarily--you don't 
necessarily agree with the $1,080 figure, is that right?
    Mr. Hackbarth. We've not specifically calculated that 
number ourselves. The one number that we have calculated is the 
107 percent.
    Mr. Brown. These numbers aren't fabricated by Democrats, 
they are MedPAC, plus CMS.
    Mr. Hackbarth. Yes.
    Mr. Bilirakis. Let's see, who is first, Ms. Capps, I guess.
    Ms. Capps. Thank you, Mr. Chairman, and thank you for your 
testimony.
    Mr. Holtz-Eakin, you made a comment in your testimony that 
you are here, the three of you, and that's why we are having 
the hearing, to discuss budgetary matters, not setting policy, 
and we wear more than one hat in this place. But that, I think, 
is an issue that sort of underlies some of what we are doing, 
and a part of the Balanced Budget Act of 1997, the formula for 
expandable growth rate was set into place. And now, we are also 
mindful that the cuts in physician payments could really 
jeopardize access to care for seniors. So, your primary concern 
certainly is that of many of us, and certainly of our 
constituents. And, MedPAC, you wear those kind of dual hats 
also. So, I want to ask some questions of you, Mr. Hackbarth, 
from that role, pointing to the ways in which we can be mindful 
of access to care.
    The SGR is having some unintended consequences on 
physicians' ability to provide services throughout this 
country. Before the Medicare Modernization Act, the physicians' 
payments were set to decrease by 4.5 percent. Medicare law 
changed that and required an update for 2004 and 2005 of not 
less than positive 1.5 percent. However, we, the leadership in 
this Congress, have decided not to pay for this increase 
directly, and as a result physician payments over the next 10 
years will need to be adjusted to account for this expenditure.
    According to the Medicare Trustees Report, physicians are 
facing a 31 percent cut in fees between the years of 2006 and 
2012, on top of the fact that the Medical Economic Index, the 
amount that doctors have to pay for services, as they are in 
corporations, offices, many times are expected to increase 
these costs will be increasing about 19 percent over this time. 
So, even though physicians' costs are going up, the 
reimbursement rate will be going down significantly, and this 
will jeopardize access to care, and it is leading to an exodus 
from providing--for physicians providing both Medicare and 
Medicaid services.
    The current MedPAC report doesn't find significant problems 
with the beneficiaries' access to care, but as we're looking 
for these years out, between 2006 and 2012, this is what I'd 
like you to discuss. You certainly have to be mindful of that, 
that a 31 percent cut, that knowledge is not lost on medical 
students, or those in the practice now, and add to that an area 
like mine that is very adversely affected by gypsy rates and 
so-called ``rural reimbursement rates,'' we have seen such an 
exodus of providers for Medicare/Medicaid, we call it Medi-Cal 
in California, this is what I'd like you to respond to, sorry 
for the long prologue, to see if there's a way we can measure 
beneficiary access. What steps are you taking to evaluate 
whether this access is adequate?
    Mr. Hackbarth. We use three types of tools, beneficiary 
surveys, surveys of physicians about their willingness to 
accept Medicaid patients, and we also look at the relationship 
between Medicare payment rates and private payment rates.
    Let me just quickly summarize what we find there.
    Ms. Capps. Yes.
    Mr. Hackbarth. On the beneficiary front, we find a high 
level of satisfaction currently at a national level with access 
to care. Indeed, Medicare beneficiaries are somewhat more 
satisfied than non-Medicare people in the age 55 to 64 age 
group.
    Ms. Capps. Now, this is the Nation as a whole?
    Mr. Hackbarth. This is the Nation as a whole.
    With regard to physicians, a very high percentage of 
physicians, in excess of 90 percent, are accepting at least 
some new Medicare patients. Between 70 and 75 percent, as I 
recall, are accepting all new Medicare patients who appear at 
their door. Now again, these are national numbers, and I'll 
come back to the local dimension in just a minute.
    With regard to the relationship between Medicare payment 
rates and private payment rates, Medicare rates are, on a 
national basis, lower on average than private payment rates. 
That's, roughly, 80 percent of the private payment rates by our 
analysis.
    Now, that varies by procedure. For evaluation and 
management, sort of the basic of evaluating a patient, Medicare 
fees are quite comparable to private fees, but Medicare fees 
are lower for procedures, surgical procedures and the like.
    When we look at all of that information together, our 
conclusion on a national basis is that access is good to 
Medicare beneficiaries.
    Having said that, I share your concern about what would 
happen to access if the sort of cuts that would be mandated 
under current law were allowed to occur.
    Ms. Capps. If we're talking about 31 percent cuts, will 
this change your survey, say, 5 years from now?
    Mr. Hackbarth. Yes. My personal opinion is that that sort 
of cut would pose a significant hazard to access.
    I would note, however, that when the one cut went into 
effect in 2002, of almost 5 percent, we did not find a 
significant adverse effect on access from that.
    Ms. Capps. Although, this would be built upon that.
    Mr. Hackbarth. That's right, in that cut, the 2002 cut, it 
was on the heels of very large increases in the year 2000 and 
2001.
    Ms. Capps. Right, we are getting down to the bone.
    But, I have just less than 2 minutes left, I wanted you to 
touch on two things. One, regional differences, because 
national surveys mean very little in our own communities, and 
second, the comment that you made about radiological services 
or some specialties, and what we chilling effect this can have 
on new technology.
    Mr. Hackbarth. Yes.
    With regard to the variation in access, in fact, we've 
heard anecdotally, and seen some research by other 
organizations, indicating that there are access problems in 
particular markets. It does not necessarily follow from that, 
though, that it's due to the Medicare payment rates. Some of 
the work shows that there are also some access issues for 
private patients in these same markets, and that can be 
attributable to the fact that there's been very rapid growth 
and the supply of physicians has not kept up, or there is at 
least temporary problem in the distribution of specialists, 
specialists for the population. So, yes, there are some local 
problems, it's not necessarily true that they are all the 
result of the Medicare payment system.
    Ms. Capps. But, there is a relationship, however.
    And then finally, what can we do to contain costs without 
discouraging the use of new medical technology?
    Mr. Hackbarth. Well, you know, that's sort of the $64,000, 
or billion, or trillion dollar question for the Medicare 
program. As I said earlier in response to the chairman's 
question, it will not be an easy task to do.
    I draw comfort from the fact that as we look at the 
Medicare program across the Nation, there is abundant evidence 
from researchers, including physician researchers, that there 
are areas of the country where a much less expensive style of 
medicine is practiced, yet the results, in terms of measurable 
quality, are as good or better than those achieved in the high-
cost areas. That suggests to me that there is an opportunity, 
if we can reshape the system, and improve the appropriateness 
of the services, that we can have the gains from new 
technology, while also restraining some of the costs. But, it's 
a tricky thing.
    Ms. Capps. There's no easy answer to that.
    I think I've used my time, so thank you very much. I yield 
back.
    Mr. Bilirakis. Mr. Stupak to inquire.
    Mr. Stupak. Thank you, Mr. Chairman.
    Mr. Hackbarth, your last answer there to Ms. Capps, you 
said there's a change in some parts of the country you see 
lower costs, and you mentioned new technology, what about 
preventive healthcare, does that reduce costs in the long run, 
and does the current formula reflect the importance of 
preventive care?
    Mr. Hackbarth. Yes. I must confess that I am not the 
foremost expert on the research on the benefits of preventive 
care. I think the answer is, it's a very good thing, and it can 
help reduce costs.
    There is, of course, added expense involved, and exactly 
how those two net out I can't tell you off the top of my head. 
But, in general, it's a good thing for people.
    Mr. Stupak. Sure.
    Mr. Hackbarth. Even if it does cost us a little bit more, 
it is the right thing to do.
    Mr. Stupak. Well, should this current formula be changed to 
reflect preventive care then in the cost savings?
    Mr. Hackbarth. Well, that's the point where I can't give 
you the definitive sort of opinion that you are seeking. I 
think estimating the net impact of, for example, new provisions 
offering screening services for Medicare beneficiaries is 
really not something that MedPAC does. CBO does that, and the 
Office of the Actuary in CMS.
    Mr. Stupak. Going back to this chart I think you have in 
front of you that Mr. Brown brought up, and you said that from 
your point of view there was at least a 7 percent overpayment 
there for HMOs and the private insurance here in Medicare. And, 
some of us might say it might be as high as 15 percent, all 
sort of the average, right, I mean, you get some that are 
higher, some are probably lower, but it's an average?
    Mr. Hackbarth. Yes.
    Mr. Stupak. If we have the HMOs here in a way with 
traditional Medicare, if they are getting more money do they 
provide more services, as a general rule then?
    Mr. Hackbarth. Generally, they provide more benefits. They 
have a more comprehensive benefit package, different cost 
sharing structure.
    Mr. Stupak. Then, is that amount, 7 percent, whatever 
number you want to use, do you think it's equal to the benefits 
being received by the beneficiaries? I mean, is it a good deal? 
If it's a good deal, why don't we switch more to the HMOs then?
    Mr. Hackbarth. I don't know the answer to that if the 
additional benefits are equal to the 7 percent.
    Mr. Stupak. What are some examples of these added benefits 
that you see?
    Mr. Hackbarth. You know, vision care, dental care, some 
prescription drug coverage, even in advance of Medicare 
including prescription drugs, things like that, and a different 
cost sharing structure, lower deductibles and co-payments at 
the point of service.
    Mr. Stupak. With the new Medicare Prescription Drug Bill 
that's supposed to go into effect in 2006, do you see a shift 
then in those HMOs providing that kind of benefit, or a shift 
to others? Any idea on how the new Medicare bill may impact the 
added benefits they may receive?
    Mr. Hackbarth. Well, again, that involves questions that 
are really maybe more in Doug's area than mine. It picks up on 
Medicare beneficiaries interest and willingness to pay for 
prescription drugs. So, those are not things that we look at 
specifically.
    Mr. Stupak. Do you gentlemen want to comment on that?
    Mr. Holtz-Eakin. In terms of the particular mix of services 
that the private plans might provide, the bill provides for a 
standard benefit or its actuarial equivalent, and what will be 
an actuarial equivalent one couldn't guess in advance.
    Mr. Stupak. Well, I was just sort of wondering out loud, 
too, what with the new decision year by the EEOC going do with 
the prescription drug coverage for retirees, and that's going 
to be sort of an interesting issue there.
    I think you sort of alluded to this, Mr. Hackbarth, earlier 
in your statement, but how can the formula be changed to better 
reward efficiency? I guess that's the sort of issue we are all 
grappling with, is it, you know, more private than the HMOs, 
what can we do, do you have any suggestions?
    Mr. Hackbarth. As I said earlier in response to Congressman 
Brown, it is our belief at MedPAC that offering private plans 
to Medicare beneficiaries is an important thing to do. And, one 
of the advantages of that is that we pay a lump sum to those 
private plans and they have to work, in effect, within a fixed 
budget.
    Mr. Stupak. Sure.
    Mr. Hackbarth. And, because they have that lump sum 
payment, they have the potential to rearrange, if you will, 
services, payment rates, in a way different from Medicare, in a 
way that potentially can offer better benefits and higher 
quality for Medicare beneficiaries than the traditional 
program. They are more flexible because they are smaller, and 
not encumbered by the many rules that Medicare has.
    Mr. Stupak. The only concern I have with the HMOs is 
there's no really requirement that the overpayments go to the 
beneficiaries, and in my area, a very rural area, we don't have 
very much access to an HMO, so we can't take advantage of it, 
just because of where we live, in a rural area. So, my concern 
for the HMOs is, No. 1, there's no requirement or guarantee 
that the overpayment goes to the beneficiaries in light of 
services, second is that the rural areas it really doesn't help 
us much.
    Mr. Hackbarth. Yes, sir, and if I may, Mr. Chairman, we 
agree with that. That's why we emphasize that Medicare 
beneficiaries ought to have a choice. It's not going to be 
available for all beneficiaries. It's not the right thing for 
all beneficiaries. It ought to be a choice for everybody.
    Mr. Bilirakis. The gentleman's time has expired.
    Mr. Dingell has graced us with his presence. Did you want 
to inquire?
    Mr. Dingell. The various and gracious----
    Mr. Bilirakis. We do have a vote on the floor, too.
    Mr. Dingell. I have no questions. I do have an opening 
statement which I request be inserted in the record.
    Mr. Bilirakis. All right, without objection it will be the 
case.
    Mr. Dingell. Thank you, Mr. Chairman.
    Mr. Bilirakis. The gentlelady from New Mexico, any 
questions? No questions.
    Thank you for coming, sir.
    Mr. Bilirakis. Well, that being the case, and our timing is 
good, because we do have a vote on the floor, the hearing is 
adjourned, but again, we will have questions coming from both 
sides, and we would appreciate your prompt response to those, 
and I will reiterate, again you are in a position to be helpful 
here, so, please, let's not just talk about history and some of 
the good things, some of the bad things that have happened in 
the past, it's a case of trying to fix some of those bad 
things, if we will.
    So, we appreciate inputs from you.
    The hearing is adjourned.
    Thank you so very much for coming.
    [Whereupon, the hearing was adjourned at 11:19 a.m.]
    [Additional material submitted for the record follows:]
Prepared Statement of the American Association for Geriatric Psychiatry
    The American Association for Geriatric Psychiatry (AAGP) 
appreciates the opportunity to share our concerns with the Members of 
the Subcommittee on Health on the problems associated with the Medicare 
physician fee schedule. AAGP is a professional membership organization 
dedicated to promoting the mental health and well-being of older people 
and improving the care of those with late-life mental disorders. Our 
membership consists of 2,000 geriatric psychiatrists as well as other 
health care professionals who focus on the mental health problems faced 
by senior citizens.
    Physicians who treat Medicare beneficiaries, as Medicare providers, 
accept a fee schedule that is, at baseline, often significantly lower 
than their ``usual and customary'' fee schedule for providing services 
to their self-paying patients. As you are aware, these physicians 
continue to face the prospect of additional across-the-board reductions 
in the fees paid by the program. Unlike many other payment ``cuts'' in 
Washington, these reductions are not simply reductions in a rate of 
increase, but are absolute reductions in fee levels. In 2002, fees were 
cut by 5.4 percent below 2001 levels. Although Congress has taken 
action since that time to hold off additional reductions on a temporary 
basis and in fact has provided for a positive update of 1.5% for 2004 
and 2005, it is clear that a permanent resolution to the flawed formula 
governing physician payments must be enacted. This issue is most 
important because of the effect it will have on access to care for 
Medicare beneficiaries, especially for the vulnerable among them--those 
elderly and disabled persons who have multiple, complex medical 
conditions and limited financial resources.
    As a result of the recent and projected reductions, many physicians 
are having to reevaluate their willingness to treat Medicare patients, 
as well as their willingness to be ``participating physicians'' who 
accept Medicare payment as payment-in-full for their services. 
Consequently, many Medicare patients are already having trouble finding 
physicians to treat them. A survey by the American Medical Association 
following the 5.4 percent cut in 2002 found that 24 percent of 
physicians had either placed limits on the number of Medicare patients 
they treated or planned to institute limits. In the case of geriatric 
psychiatrists--most of whose patients are enrolled in Medicare--the 
impact of these reductions is particularly severe and is causing at 
least some in our profession to consider leaving clinical practice 
altogether to enter other fields where their experience and expertise 
are valued more appropriately.
    The impact on geriatric psychiatrists--and their patients--is 
compounded by the discriminatory reimbursement policies Medicare 
already imposes on consumers of mental health services. Under current 
law, Medicare requires beneficiaries to pay a 20 percent copayment for 
Part B services with the single exception of a requirement of a 50 
percent copayment for outpatient mental health services. The lack of 
parity for mental health treatment is unconscionable--and of great 
consequence to older adults who feel more stigmatized by psychiatric 
illness than any other group. Despite widespread need, many seniors 
decline, delay, or drop out of treatment because of the high copayment. 
In addition, current law discriminates against the non-elderly disabled 
Medicare population, many of whom have severe mental disorders.
    The result of these factors--declining reimbursement rates, 
existing discriminatory reimbursement for mental health care, and 
stigma--will undoubtedly compound the existing serious access problems 
for Medicare beneficiaries in need of mental health treatment--either 
in finding a physician to treat them or in ``balance billing'' charges 
by physicians who previously accepted assignment.1 Shifting 
costs to beneficiaries--many of whom are low income--can make essential 
mental health care unaffordable.
---------------------------------------------------------------------------
    \1\ Although ``balance billing'' may provide a short-term safety 
valve that allows some physicians to continue treating Medicare 
patients, the additional amount that Medicare permits physicians to 
collect from beneficiaries under its balance billing limits will not 
fully offset the cumulative reductions in program payments in the 
future. Moreover, some States prohibit balance billing Medicare 
beneficiaries as a condition of licensure in the State, which leaves 
those physicians without this option.
---------------------------------------------------------------------------
    The fee reductions that are forcing these choices stem from the 
mechanism for automatic annual fee ``updates'' that is currently part 
of the Medicare statute. For most types of providers, Medicare law 
incorporates a mechanism by which payment rates are automatically 
updated annually for inflation, in much the same way that Social 
Security and other Federal cash benefits are automatically increased by 
the cost of living adjustment (COLA) each year.
    However, since the inception of Medicare physician payment reform 
in the early 1990s, updating physician fees has been handled somewhat 
differently from those of other providers. The payment reform law 
established a mechanism under which the annual inflation update for 
physicians' services is automatically adjusted--above or below the rate 
of inflation--based on how actual Medicare spending for physicians' 
services compares to an annual spending target computed by the Centers 
for Medicare and Medicaid Services (CMS) based on a formula set out in 
the law.
    Until recently, this mechanism resulted in some relatively modest 
reductions below full inflation--as well as some ``bonuses'' above 
inflation. However, changes made in the ``Balanced Budget Act of 1997'' 
(BBA) tightened the annual spending targets, making it substantially 
more difficult for physicians to meet them.
    Before the BBA, the annual spending target was based on a formula 
that included a reasonable allowance for spending increases due to 
changes in technology and other related factors affecting the ``volume 
and intensity'' of services provided by physicians. The BBA replaced 
this allowance with a much less generous proxy--the estimated increase 
in the gross domestic product (GDP)--which bears no relationship to the 
factors affecting volume and intensity of services provided. The impact 
of this change can be demonstrated quite simply. Where the volume and 
intensity allowances for 1992 and 1993 were 6.8 percent and 6.0 
percent, respectively, the corresponding GDP allowances for 1999 and 
2000 were 1.3 percent and 2.7 percent.
    Furthermore, because the BBA made the new targets cumulative--so 
that a breach in one year's target would have to be fully offset by 
corresponding expenditure reductions in later years--inaccurate CMS 
estimates of several components of the formula used to compute the 
spending targets for 1998 and 1999 have been carried forward, producing 
inappropriately low targets in each subsequent year.
    For example, actual growth in the GDP for 1998 and 1999 was greater 
than the estimates on which CMS based its targets. Growth in the 
beneficiary population is another component of the target. CMS 
overestimated beneficiary migration from traditional Medicare into 
managed care plans during 1998, which had the effect of understating 
beneficiary enrollment growth in the traditional program. All of these 
forecasting errors resulted in lower targets than would have occurred 
if better data had been available.
    Unfortunately, CMS interprets the law as precluding it from 
correcting these errors. Although AAGP takes no position on this arcane 
legal issue, we do think that it is fundamentally unfair to make 
physicians--and Medicare beneficiaries--pay for estimates that everyone 
agrees in hindsight were wrong.
    Physicians want to serve all Americans. However, they simply cannot 
afford to accept an unlimited number of Medicare patients into their 
practices when they are facing continued payment reductions. These 
drastic cuts must be stopped before they devastate Medicare 
beneficiaries' access to health care.
    We commend the Congress for its action last year to avert the 
impending reductions in Medicare physician fees for 2004 and 2005. We 
note, however, that the legislation does not address the fundamental 
defects in the formula for setting annual Medicare spending targets for 
physicians' services. We urge Congress to revisit this issue in the 
near future and--at a minimum--to replace the GDP component of the 
formula with a more realistic proxy for changes technology and other 
factors affecting the volume and intensity of the services furnished to 
Medicare beneficiaries.
    Thank you again for the opportunity to share our views on this 
important issue. We look forward to working with you as you craft a 
correction to the Medicare physician payment formula.
                                 ______
                                 
         Prepared Statement of the American College of Surgeons
    We are pleased that the subcommittee is hosting this hearing on the 
Medicare physician fee schedule. Chairman Bilirakis has been a long-
time champion of this issue, and we welcome his continued support for 
resolving the instability of the Medicare physician payment system.
    The American College of Surgeons--an organization representing more 
than 66,000 surgeons dedicated to accessible, high-quality care for 
surgical patients--is grateful to the Chairman and the other 
distinguished Members of the Committee on Energy and Commerce Health 
Subcommittee who worked diligently to avert the 4.5 percent physician 
payment cut that was scheduled to take effect this year.
    Surgeons historically have had particularly high Medicare 
participation rates. The Medicare Prescription Drug, Improvement, and 
Modernization Act (MMA) 1 took an important first step in 
guaranteeing the profession's continued participation in the program by 
guaranteeing a 1.5 percent increase in physician payments in 2004 and 
2005. It is within this context that we offer the following comments.
---------------------------------------------------------------------------
    \1\ Pub. L. No. 108-173.
---------------------------------------------------------------------------
                            PAYMENT ADEQUACY

    Over the last 15 years, Medicare reimbursements for surgical 
services have declined steeply. Indeed, payments for many surgical 
procedures are less than half of what they were before the current 
physician payment system was implemented in 1992.2 Because 
the price of medical liability insurance and other practice costs 
continue to escalate, surgeons and other physicians find themselves 
struggling to keep up with the demands of an aging population.
---------------------------------------------------------------------------
    \2\ Actual dollar amounts, without any adjustments made for 
inflation.
---------------------------------------------------------------------------
    Physician practices are essentially small businesses. As is true 
for many small enterprises, there are limited options available to 
physician practices for reducing overhead costs. Unlike other business, 
however, when faced with decreasing income and soaring expenses, 
doctors cannot simply charge higher rates for their services. To keep 
the operating doors open, practices must make tough choices. Some delay 
the purchase of new equipment. Others reduce the size of their staff. 
Many increase the percentage of non-Medicare patients they see.
    While we were pleased to avoid another payment cut, it is important 
to recognize that a 1.5 percent increase does not keep pace with the 
inflationary costs of operating a practice. And, for surgical 
specialties in particular, the more recent crisis in the Medicare 
payment system comes on the heels of a series of steep reductions that 
were implemented over the past decade. For most surgical practices, 
there simply aren't too many cost cutting options left.
    The College implores Congress to work with CMS in keeping physician 
participation in Medicare at optimal levels. We suggest the following 
Congressional action with regard to the sustainable growth rate (SGR) 
system. First, Congress should urge CMS to administratively take drugs 
out of the SGR. Second, the SGR must be revised to reflect changes 
attributable to changes in law and regulation. In addition, Congress 
must examine the adequacy of Medicare reimbursement for physician 
liability insurance costs and urge CMS to make necessary revisions in 
the malpractice relative value units (RVUs).

1. Sustainable Growth Rate
    The SGR is an expenditure target. Along with the Medicare Economic 
Index (MEI) and a budget neutrality adjustment, SGR is one of three 
components used to calculate the fee schedule conversion factor, which 
determine changes in Medicare physician payments annually.
    Pursuant to this formula, payments for services are not withheld if 
the percentage increase in actual expenditures exceeds the SGR. 
Instead, the SGR is designed to adjust the update to make actual and 
target expenditures equal over time. If outlays under the fee schedule 
are higher than the target, the update is decreased. Conversely, if 
outlays are lower than the target, the update is increased.
    Specifically, the SGR is calculated each year on the basis of the 
weighted average percentage increase using four factors: reimbursements 
for physician services; Medicare fee-for-service enrollment; real per 
capita gross domestic product (GDP); and, spending due to changes in 
law and regulation.
    The ultimate solution to the update problem is for Congress to fix 
the flawed formula that is used today to calculate the annual changes 
made to the conversion factor. We are pleased that the Medicare Payment 
Advisory Commission (MedPAC) renewed its support for such legislative 
action in its March 2004 report to Congress.
    a. Physician-administered drugs--Congress should insist that CMS 
revise its calculation of the SGR because the inclusion of drug 
expenditures contravenes the statute. CMS continues to rely on an 
overbroad definition of ``physicians' services'' that does not apply to 
the update adjustment factor. As a result, Medicare payments for 
physician services--even to those physicians who do not prescribe or 
administer the covered drugs--have been reduced over the years to 
offset costs associated with the introduction of new and more expensive 
therapies. (Meanwhile, the cost for the drugs is not affected.)
    CMS has the authority to change the scope of the SGR. Pursuant to 
the Social Security Act (SSA), to calculate the update adjustment 
factor CMS compares allowed expenditures for physicians' services 
against actual expenditures.3 The primary definition of 
``physicians' services'' includes a broad number of services. However, 
CMS exempted drugs from this definition in 1991. ``Section 1848(j)(3) 
of the Act gives us the authority to specify that items and services be 
excluded from the fee schedule. Thus, we have decided to exclude the 
cost of drugs from the national fee schedule and to continue to pay for 
them under the `reasonable charge' system.'' 4 While the 
definition of ``physicians' services'' includes items and services that 
are not actually physician services, drugs are not one of those items.
---------------------------------------------------------------------------
    \3\ Social Security Act (``SSA'')  1848(d)(3)-(4), 42 U.S.C.  
1395w-4(d)(3)-(4).
    \4\ 56 Fed. Reg. 25792, 25800 (Jun. 5, 1991).
---------------------------------------------------------------------------
    It is important to note that the statute defines ``physicians' 
services'' differently depending on which section it appears. At one 
time an alternate definition of ``physicians' services'' applied to the 
calculation of the update adjustment factor, which included drugs. 
Between 1990 and 1997 CMS used this secondary definition to calculate 
the update adjustment factor.5 Through the Deficit Reduction 
Act of 1997, however, Congress deleted this reference to this broader, 
secondary definition, thus restoring the primary definition of 
``physicians' services'', which does not include drugs.6
---------------------------------------------------------------------------
    \5\ See Omnibus Budget Reconciliation Act of 1990, Pub. L. No. 101-
508 (applying the subsection (f) definition of ``physicians' services'' 
to the update adjustment factor).
    \6\ Pub. L. No. 105-33. Prior to 1990, the annual update of the 
conversion factor was based on the subsection (j) definition of 
``physicians' services''. See section 6102 of the Omnibus Budget 
Reconciliation Act of 1989, Pub. L. No. 101-239.
---------------------------------------------------------------------------
    CMS may not construe the statute to include drugs when comparing 
actual to allowed expenditures. It specifically excluded drugs and 
specified that they be paid under a special statutory methodology. 
There is no longer a statutory basis to include drugs in the 
calculation of the update adjustment factor. Congress should encourage 
CMS to conform its calculation of the SGR to statutory language.
    b. Changes attributable to changes in law and regulation--The SGR 
reflects spending that results from changes in law and regulation. 
Unfortunately, CMS only includes changes in program benefits that are 
attributable to legislation. By excluding important benefit expansions 
that are made through national coverage decisions, CMS compares actual 
expenditure data that include these services against a spending target 
that does not include them, making it more likely that the target will 
be exceeded. We urge Congress to work with CMS to correct the SGR 
formula.
    Regrettably, MMA exacerbated the problem by excluding the 1.5 
percent update in 2004 and 2005 from the SGR calculation as a change in 
law. Obviously, the College was pleased that this important legislation 
provided physicians a positive payment update. However, Congress 
undermined the methodology by preventing the SGR from reflecting 
legitimate spending increases which originated in the law.
    Due to this omission, CMS will compare actual expenditure data that 
include an increase in physician payments against a spending target 
that does not include them. Expenditures will far exceed the target and 
result in years of negative updates. Furthermore, the score of future 
legislation to correct the formula will now be artificially inflated 
because CMS disregarded the cost of the 2004 and 2005 updates at the 
direction of Congress. We strongly urge Congress to change this 
provision. Legislation is necessary to properly adjust the SGR to 
reflect this change.

2. Medical liability insurance costs
    The College strongly supports legislation to stabilize volatile 
jury awards and rising premiums. We remain fervent advocates for HR 5, 
the Help Efficient, Accessible, Low-Cost, Timely Healthcare (HEALTH) 
Act of 2003. Until that meaningful liability reform is enacted the 
liability crisis will persist. Its impact on Medicare physician 
payments must be addressed immediately.
    The growing cost of liability insurance is a primary concern for 
most surgeons, and for many other specialists, as well. In a growing 
number of states, surgeons are having difficulty obtaining medical 
liability insurance, and for those who are able to find coverage the 
cost is often prohibitively high. The large premium increases and 
declining number of liability insurance carriers are forcing many 
surgeons to make difficult decisions about limiting the scope of their 
practice, moving to other states, or retiring early. Medicare payment 
cuts only add more financial pressure to make these decisions.
    The College appreciates CMS' recognition of the growing liability 
crisis and is pleased that the agency has responded by implementing an 
increase in the Medicare Economic Index (MEI) update for professional 
liability insurance of 20.61 percent in the 2004 Physician Fee 
Schedule.7 While we support this increase, there is a 
heightened concern that specialties being hit the hardest by rising 
insurance costs are not getting the help they need.
---------------------------------------------------------------------------
    \7\ 69 Fed. Reg. 1084, 1095 (Jan. 7, 2004).
---------------------------------------------------------------------------
    MedPAC fails to adequately consider that those specialties 
experiencing the greatest liability premium hikes are coincidently the 
same groups who have been experiencing net pay decreases for a number 
of years. This results from the transition to a single conversion 
factor, followed by the phase-in to resource-based practice expenses. 
Certain surgical specialties--such as neurosurgeons, general surgeons, 
thoracic surgeons, and those in obstetrics-gynecology and 
orthopaedics--pay the highest premiums and are suffering 
disproportionately from the current escalation in premium rates. Yet, 
any MEI adjustment applies broadly and cannot direct funds to those who 
are actually experiencing these increases--even if the faulty SGR 
system did not eliminate the benefits of such an adjustment entirely.
    As CMS begins to revise the malpractice relative value units, we 
cannot overstate the importance of addressing this problem. The 
resource-based payment system must reflect the costs involved. Since 
the Medicare fee schedule is used as the basis for determining payments 
for many insurers, it is critical for the entire health care system--
not just Medicare--to account for these costs appropriately. 
Professional liability premiums are a major resource ``input,'' the 
cost of which falls outside physicians' control.
    Congress should encourage continued collaboration between CMS and 
the medical specialty societies on this issue. It is necessary to 
determine whether the current method of allocating RVUs is appropriate. 
Alternative mechanisms may better account for physicians' costs. We are 
encouraged that CMS has previously expressed interest in reviewing 
alternative methodologies during refinement of malpractice 
RVUs.8 The agency should present options and invite public 
comment on various approaches to refinement.
---------------------------------------------------------------------------
    \8\ 64 Fed. Reg. 59379, 59386 (Nov. 2, 1999).
---------------------------------------------------------------------------
                               conclusion
    One of the greatest achievements of the Medicare program is the 
access to high-quality care it has brought to our nation's senior and 
disabled patients. This level of access cannot be expected to continue 
uninterrupted in the face of continued cuts and growing liability 
premiums. We cannot emphasize enough how important it is for Congress 
to take steps to ensure that physician payment adequately reflects the 
cost of doing business.
    Thank you for your consideration of Medicare payment policies, 
including the adequacy of reimbursement for physicians. The College 
appreciates this opportunity to present its views and looks forward to 
working with you to ensure continued access to Medicare.

                                 ______
                                 
   Prepared Statement of the Association of American Medical Colleges

    The Association of American Medical Colleges (AAMC) is pleased to 
submit for the record testimony to the House Energy and Commerce 
Subcommittee on Health on the need to replace the Sustainable Growth 
Rate (SGR) methodology used to calculate the update for Medicare 
payments under the Physician Fee Schedule (``physician payment 
update''). The AAMC appreciates the Subcommittee's interest in this 
issue of great importance to both Medicare beneficiaries and the 
physicians who provide their medical care. The AAMC supports 
replacement of the SGR with a methodology that assures adequate 
payments and stable updates for physicians who participate in Medicare. 
Appropriate and stable physician payments will help ensure that 
Medicare beneficiaries have access to the complex and specialized care 
provided by academic physicians.
    The AAMC represents the country's 126 accredited medical schools 
and nearly 400 major teaching hospitals and health systems, 94 
academic/professional societies representing approximately 105,000 
faculty members, and the nation's medical students and residents.

    THE ROLE OF ACADEMIC PHYSICIAN IN SERVING PATIENTS AND MEDICARE 
                             BENEFICIARIES

    Academic physicians serve a unique, multifaceted role within the 
physician community, as well as within the larger healthcare system. As 
experts in their particular fields of medicine, academic physicians 
provide patients and referring physicians with cutting-edge clinical 
expertise. Academic physicians also educate and train the medical 
students, residents, and other health professionals who will become the 
next generation of caregivers. In addition, many academic physicians 
conduct clinical research that generates more effective, efficient, and 
compassionate healthcare for all Americans, including aging Americans. 
For example, a number of breakthroughs in research conducted by 
academic physicians, such as retinal transplants, inner ear implants, 
the development of a surgical procedure to prevent urinary incontinence 
in men with cancerous prostates, and others, now benefit many seniors, 
providing improved diagnostic and therapeutic services.
    With their clinical expertise, participation in clinical research, 
and knowledge of innovative technologies, academic physicians 
frequently partner with teaching hospitals to provide inpatient and 
outpatient care for patients with complex, multiple, or acute health 
problems that can not be managed elsewhere in the community. Among the 
AAMC teaching hospital members that partnered with academic physicians 
in 2002 (most recent data available), about five of every six hospitals 
(85 percent) provided geriatric-specific services (e.g., treatment for 
Parkinson's or Alzheimer's disease). While AAMC teaching hospital 
members represented just 6 percent of all hospitals in 2002, nearly 
one-half (42 percent) maintained arthritis treatment centers, 84 
percent performed open heart surgeries, 79 percent operated certified 
trauma centers, and 86 percent provided radiation therapy services for 
patients with cancer and related conditions.
    Nearly one-sixth of all physicians providing Medicare services are 
academic clinical physicians, rendering them vital to preserving 
healthcare access for Medicare beneficiaries.
    Academic physicians also partner with AAMC teaching hospital 
members to provide nearly one half (43.3 percent in 2001) of the 
nation's hospital-based charity care. By comprising a significant 
segment of America's healthcare safety net, academic physicians and 
their teaching hospital partners assure healthcare access for the poor 
and underserved, including Medicare beneficiaries who are dually 
eligible for Medicaid or who are unable to pay for their care. In 1999, 
faculty practices provided an average of $12 million in charity care. 
(In contrast, in 2001, one-quarter (29 percent) of all physicians did 
not provide any charity care and 27 percent of the country's 
specialists did not provide charity care services, according to the 
Center for Studying Health System Change Community Tracking Survey 
which includes a survey of physicians.)

CALCULATING ANNUAL PHYSICIAN UPDATES: THE SUSTAINABLE GROWTH RATE (SGR) 
                              METHODOLOGY

    Each year, the Centers for Medicare and Medicaid Services (CMS) 
calculates the ``Medicare Physician Update'' by determining the 
difference between actual spending on physician services and an annual 
spending target. In general, when spending exceeds the annual target, 
CMS issues a ``negative physician update.'' When spending falls below 
the annual target, CMS issues a ``positive physician update.''
    CMS calculates the annual spending target using the SGR 
methodology. Passed as part of the Balanced Budget Act of 1997 (BBA), 
the SGR methodology was intended to set annual spending targets to 
control government expenditures for Medicare physician services as well 
as account for increases in the cost of providing those services.
    The AAMC is concerned that the SGR has failed to establish an 
equitable balance between fiscal management of the Medicare program and 
the actual cost of caring for Medicare patients. For example, from 1996 
to 2004 the cost of providing physician services, as measured by the 
Medicare Economic Index (MEI), climbed an average of 2.3 percent. 
However, the physician update grew an average of 1.1 percent over that 
same period. This shortfall occurred despite intervention by Congress 
to increase the physician payment update in CYs 2003-2005.

    RECENT CONGRESSIONAL ACTION AVERTS PROJECTED MEDICARE CUTS FOR 
                               PHYSICIANS

    The AAMC appreciates Congress' efforts to avert the harmful impact 
of the flawed SGR methodology. Congress acted twice in 2003 to address 
reductions in the Medicare physician updates for CYs 2003, 2004, and 
2005.
    As part of the ``Consolidated Appropriations Resolution for FY 
2003'' passed in February 2003, Congress gave CMS the legal authority 
to revise the CY 2003 physician update from negative 4.4 percent to 
positive 1.6 percent, avoiding a sharp and significant drop in payments 
to physicians. In December, Congress similarly averted projected cuts 
in the CY 2004 and CY 2005 physician updates as part of the ``Medicare 
Prescription Drug, Improvement and Modernization Act of 2003'' (P.L. 
108-173). Because of Congress' quick action to prevent potentially 
devastating cuts, the Medicare physician payment update for CY 2004 and 
CY 2005 are set at ``not less than 1.5%.''
    When these favorable, yet short-term ``fixes'' expire in CY 2006, 
the physician update calculation reverts to the SGR methodology. Both 
the Congressional Budget Office (CBO) and Medicare Trustees anticipate 
the SGR formula will once again trigger dramatic cuts to physician 
payment updates. In fact, the Medicare Trustees project the problematic 
SGR will produce cuts of 5% per year from 2006 through 2012.
the impact of fee schedule reductions on faculty practice plans and the 

              NEED FOR STABLE, ADEQUATE MEDICARE PAYMENTS

    Stable and adequate Medicare physician payments are critical to 
ensuring that seniors have continued access to the professional 
services provided by academic physicians. In light of the fact that 
faculty practice revenues, on average, represented about 36 percent of 
medical school revenue in 2002, unstable Medicare payments could 
jeopardize beneficiary access to faculty professional services, as well 
as academic medicine's core missions of medical education, research and 
clinical services.
    Changes to the fee schedule have both direct and indirect impacts 
on faculty practices. In terms of a direct impact, a change in the 
physician update is not necessarily translated into a proportionate 
change in actual payments. Since payments under Part B are calculated 
on a service-specific basis, and a variety of factors are used to 
calculate each specific payment, the change in payment for individual 
services typically varies from the annual change in physician update.
    The variation occurs among specialties and institutions. An impact 
analysis by the University Health Consortium (UHC)/AAMC Faculty 
Practice Solutions Center found that despite the 1.6 percent increase 
in the CY 2003 update, several academic physician specialties, on 
average, saw their Medicare payments actually decrease:

------------------------------------------------------------------------
                                                               Average
                         Specialty                             Payment
                                                               Change
------------------------------------------------------------------------
Nephrology (Kidneys)......................................        -2.6%
Orthopedic Surgery........................................        -1.4%
Ophthalmology (Glaucoma)..................................        -0.2%
Colon/Rectal Surgery......................................        -0.1%
------------------------------------------------------------------------

    Another UHC/AAMC analysis provides an example of how the change in 
actual payments to academic physicians often varies from the change in 
the update. Focusing on relevant data submitted by a cohort of academic 
physician practice groups, the mean impact of the negative 5.4 percent 
update in CY 2002 across those institutions was negative 5.8 percent 
(Attachment A), with some practices reporting a decline of nearly 8 
percent. A similar analysis of the 1.6 percent physician update in 2003 
shows a mean change across the cohort practice groups of just 0.5 
percent (Attachment B).
    Academic physicians also face the indirect impact of a negative 
physician update when community-based physicians begin limiting the 
number of Medicare beneficiaries they serve. According to a 2001 Center 
for Studying Health System Change Community Tracking Survey which 
includes a survey of physicians, over one-third (35 percent) of primary 
care physicians limited the number of new Medicare patients in their 
practice, while 16 percent did not accept any new Medicare patients. 
Among specialists, 27 percent of physicians limited their number of new 
Medicare patients.
    The increased volumes of Medicare services, coupled with unstable 
and often declining reimbursement rates, place financial pressures on 
academic physician practices, endangering their fiscal viability and 
ability to maintain their societal missions, including providing care 
to Medicare beneficiaries.
    Increased financial pressures on academic physicians also creates a 
``ripple effect'' that extends to their medical schools. Declining 
revenue ultimately causes academic physicians to devote more time to 
generating additional clinical revenue, which may force them to either 
reduce the time they spend mentoring medical students and residents or 
spend less time on research, thereby slowing the pace of life-saving 
and cost-saving innovations.
    Increased clinical productivity demands and/or subsequent 
reductions in education and research time can frustrate physicians that 
enter academic medicine because they are committed to a career that 
combines two or three of these activities. Growing frustration can 
ultimately result in an academic physician's resignation, relocation, 
and/or a decision to leave academic medicine. It can also hinder 
efforts to replace retiring physicians and place an organization's 
education, research, and patient care missions at risk.
    In addition, the volatility, instability, and inadequacy of 
Medicare payments also affects payments from payers beyond Medicare. 
Many private payers and some Medicaid programs tie their reimbursement 
systems to Medicare.

               REVISING THE PHYSICIAN UPDATE METHODOLOGY

    The need for an alternative physician payment system is obvious, 
given the drastic cuts that will resume in 2006 under the SGR 
methodology. The AAMC enthusiastically welcomes the opportunity to work 
together with Congress, the Administration, and the physician community 
to develop a more workable reimbursement system. The AAMC also urges 
any SGR reform efforts to carefully consider the data sets, proxies, 
and indicators necessary to generate adequate, equitable, and fiscally 
responsible physician payments.
    For example, the past few years have demonstrated that the 
country's volatile gross domestic product (GDP) does not contribute to 
adequate and stable physician payments. Physicians have faced rising 
costs of caring for Medicare beneficiaries despite downturns in the 
national economy. Because the current payment formula failed to account 
for this phenomenon in 2002, CMS cut the physician update by 5.4 
percent, while the cost of care (MEI) rose by 2.6 percent. 
Additionally, sudden and unexpected changes in the GDP trigger 
similarly dramatic and unanticipated fluctuations in the physician 
update. The 2002 update of negative 5.4 percent represented a 
substantial and sudden drop from a positive 4.5 percent update in 2001. 
This volatility jeopardizes the ability of academic physician practices 
to make sound, long-term financial decisions and further endangers 
already fiscally strained medical schools, research programs, and 
teaching hospitals.
    Another flaw in the current SGR methodology is its failure to 
reflect changes in Medicare laws and regulations. Despite the fact that 
Medicare statute requires CMS to account fully for legislative and 
regulatory changes in the SGR, the agency appears to have 
underestimated the physician cost implications of newly mandated 
screening benefits. Similarly, coverage decisions are completely 
excluded from the SGR calculation, despite the potential that increased 
patient demand would increase expenditures for physician services.
    The AAMC is also concerned that, while Medicare law does not define 
physician-administered drugs as ``physician services,'' CMS includes 
those costs in the annual calculation of actual physician spending. 
Given the growth in life-saving outpatient drug therapies, drug costs 
help push actual spending on physician services beyond the SGR target, 
and physicians subsequently face a negative physician update. 
Eliminating physician-administered drugs from the cost of doctors' 
services would more accurately reflect actual Medicare spending on 
physicians. Some may argue that including drugs in the actual spending 
calculation is a way to discourage inappropriate drug prescribing by 
physicians. The AAMC has not seen data that indicates such patterns. If 
indeed data exists that indicates inappropriate prescribing patterns, 
the AAMC welcomes the opportunity to work with Congress and the 
Administration to address the issue in an educational manner that 
improves the quality of care for beneficiaries.
    Finally, CMS should consider that the most recently enacted 
Medicare provisions will likely increase spending on physician 
services. For example, increased beneficiary access to drugs may lead 
to more physician visits for monitoring drug efficacy or side effects. 
Expanded screening benefits provided under the law will also drive an 
increase in actual spending. These increased costs to the Medicare 
program cannot be linked inherently to physician behavior.

                               CONCLUSION

    In conclusion, Medicare beneficiaries rely on academic physicians 
and academic medical centers to provide high quality, innovative, and 
accessible healthcare. They also rely on academic physicians to develop 
the clinical advances and train the new generation of physicians that 
will assure a high quality of life for all American seniors. The AAMC 
looks forward to working with Subcommittee members in devising a long-
term solution to replace the current SGR methodology and assure 
adequate and stable Medicare physician payment updates.

                                 ______
                                 
 Prepared Statement of Dougls K. Rex, M.D., FACG, President, American 
                      College of Gastroenterology

    The American College of Gastroenterology (ACG or the College) has 
long recognized the flawed nature of the Medicare program's sustainable 
growth rate (SGR) formula and the futility in the end result. ACG urged 
the Centers for Medicare and Medicaid Services (CMS) as early as 
January 2000, of the inescapable need to remedy the formula's inherent 
and devastating inaccuracies.
    The College is pleased to see that the Committee is laying the 
foundation for the debate on how to repair the dreadful physician 
payment situation created by the SGR formula. It is encouraging to see 
that many Members of both chambers are in agreement that the current 
situation is unsustainable, especially with CMS and other agencies 
projecting a forty percent cut in physician fee payments by 2014 under 
the SGR.
    Meanwhile, the cost of practicing medicine is only increasing. The 
soaring cost of medical liability insurance is well documented, and 
this Congress has rightly taken the lead on tackling the issue head-on. 
Nevertheless, there are other factors contributing to rising costs, 
including a shortage of skilled nurses and periodic upgrades for 
computer hardware and software. In this manner--insurance, personnel 
and capital costs--practicing medicine is like any other business, but 
the similarities end there. Few if any other professions have had such 
a heavy-handed federal pricing pressure driving down practice fees for 
the last fifteen years.
    Furthermore, no other medical specialty has seen its primary volume 
procedures cut so drastically during this time period as 
gastroenterology. Relative value units (RVUs) for GI procedures have 
been slashed as a result of CMS' practice expense and site-of-service 
policies, inevitable products of the SGR spending targets. This, in 
turn, has cut the Medicare physician reimbursement level for a 
diagnostic colonoscopy by one-third since 1997. All told, the Medicare 
physician reimbursement rate for a diagnostic colonoscopy has been cut 
by 60% since 1987, down to just $205.73 in 2004.
    In fact, Medicare reimbursement for colonoscopy has been driven so 
low that now even Medicaid pays physicians more for the procedure in 
about two-thirds of the states. If Medicare is the lowest payer for 
services, access for the program's 40 million beneficiaries will 
suffer. In its Report to Congress this past March, MedPAC tried to 
address the access issue but said that ``(B)ecause most surveys do not 
compare access measures between Medicare beneficiaries and privately 
insured people, it is difficult to determine the extent to which access 
problems, such as appointment delays, are unique to the Medicare 
population.'' Evidence from in-house surveys of ACG members suggests 
that Medicare patients are waiting significantly longer for GI 
endoscopic procedures than private pay patients, with a significant 
number of gastroenterologists not accepting new Medicare patients. 
Other data suggests that falling payments are having an impact on 
access. Although Congress enacted a colorectal cancer screening benefit 
to Medicare as part of the Balanced Budget Act of 1997 (BBA), and added 
colonoscopy to the benefit as part of the Medicare, Medicaid, and SCHIP 
Benefits Improvement & Protection Act of 2000 (BIPA), the rate of 
growth for this procedure among fee-for-service Medicare beneficiaries 
fell by 25 percent from from 2001-2002 compared to 1999-2001 (percent 
change in units of service per beneficiary, March 2004 MedPAC Report to 
Congress, page 113).
    The SGR formula is fatally flawed because it is only based on 
meeting fiscal and budgetary outcomes and fails to consider its own 
impact on patient and physician outcomes and behavior. First, it 
confines physician payments within a budget baseline along with other 
non-physician health services, such as drugs and biologicals. 
Therefore, increases in non-physician payment Part B services prompt 
automatic reductions in the SGR. Tying the SGR baseline to the gross 
domestic product (GDP) can produce similar problems. Yet, even within 
the physician payment funding pool, the inherent failings of the SGR 
formula are apparent. This past year, CMS rebased and revised the 
Medicare Economic Index (MEI), including revisions to the three 
valuation components within the MEI. In the end, CMS recognized the 
growing cost of practice liability insurance (PLI), however, it came at 
the expense of the physician work RVUs and practice expense RVUs. CMS's 
actions amounted to a cosmetic reshuffling of the deck in a zero-sum 
game and did nothing to actually address the problems associated with 
skyrocketing PLI expenses.
    Numerous Members of Congress have suggested making changes to how 
the SGR is computed, such as by removing drug costs from the SGR 
baseline and untying the SGR from GDP. The College agrees with these 
proposed solutions. In the Committee's future deliberations on this 
matter, however, the College also encourages the Committee to have the 
Congressional Budget Office or the General Accounting Office develop an 
improved way to score the benefits of preventive health procedures, 
such as screening colonoscopy to prevent or detect colorectal cancer, 
to reflect the net savings by reducing Medicare expenditures in the out 
years by avoiding surgeries, hospital stays, chemotherapy and other 
related services. By enacting the colorectal cancer screening benefit 
back in 1997 and including colonoscopy in 2000, Congress recognized the 
importance of employing preventive care to stop this very deadly but 
highly preventable cancer. Now it is time that Medicare payment 
policies reflect the intent of Congressional health policies and stop 
the downward spiral in Medicare payment to physicians for performing 
this procedure. The existence of the sustainable growth rate makes this 
difficult to do outside of a targeted Congressional action.

    The American College of Gastroenterology is a physician 
organization representing gastroenterologists and other 
gastrointestinal specialists. Founded in 1932, the College currently 
numbers more than 8,000 physicians among its membership. While the 
majority of these physicians are gastroenterologists, the College's 
membership also includes surgeons, pathologists, hepatologists and 
other specialists in various aspects of the overall treatment of 
digestive diseases and conditions. The College has chosen to focus its 
activities on clinical gastroenterology--the issues confronting the 
gastrointestinal specialist in treatment of patients. The primary 
activities of the College have been, and continue to be educational
                                 ______
                                 
                       Medicare Payment Advisory Commission
                                                      June 15, 2004
Michael Bilirakis
Chairman, Subcommittee on Health
Committee on Energy and Commerce
U.S. House of Representatives
Washington, DC 20515-6115
    Dear Mr. Bilirakis: Thank you for the follow-up question on the 
subject of Physician Fee Schedule: A Review of the Current Medicare 
Payment System. The question, submitted by Congressman John B. Shadegg, 
is:
    Question: The main goal of the sustainable growth rate is to 
control physician service volume by setting an aggregate rate target, 
and penalizing physicians by reducing their payments when total volume 
growth exceeds this rate. Since each individual physician can only 
control their own volume, and consumer and payer behavior has as much 
impact on volume as physician behavior, do you believe that an 
aggregate cap such as SGR could ever serve as an effective volume 
control to be met by thousands of individual physicians?
    Response: The Commission considered these matters carefully in the 
March 2001 Report to the Congress: Medicare payment policy. In that 
report, we identified three problems with the SGR approach.

 It disconnects payment from the cost of producing services. The 
        formula produces updates that can be unrelated to changes in 
        the cost of producing physician services and other factors that 
        should inform the update. If left alone, negative updates would 
        provide a budget control but in so doing would produce fees 
        that in the long run could threaten beneficiaries' access.
 It is a flawed volume control mechanism. Because it is a national 
        target, there is no incentive for individual physicians to 
        control volume. When fee reductions have occurred they have not 
        consistently slowed volume growth and the volume of services 
        and level of spending are still increasing rapidly.
 It is inequitable because it treats all physicians and regions of the 
        country alike regardless of their individual volume influencing 
        behavior.
    In summary, the Commission believes that the SGR has not served as 
an effective volume control that can be met by the nation's physicians. 
We hope this is helpful.
    If we can be of further assistance, please do not hesitate to 
contact us.
            Sincerely,
                                   Glenn M. Hackbarth, J.D.
                                                           Chairman
                                 ______
                                 
                                Congressional Budget Office
                                                       July 6, 2004
Honorable Michael Bilirakis
Chairman, Subcommittee on Health
Committee on Energy and Commerce
U.S. House of Representatives
Washington, DC 20515
    Dear Mr. Chairman: I am pleased to respond for the record to the 
following question from Congressman Shadegg regarding my testimony on 
May 5, 2004, on Medicare's physician fee schedule:
    Question: The main goal of the Sustainable Growth Rate (SGR) is to 
control physician service volume by setting an aggregate rate target, 
and penalizing physicians by reducing their payments when total volume 
growth exceeds this rate. since each individual physician can only 
control their own volume, and consumer and payer behavior have as much 
impact on volume as MD behavior; do you believe that an aggregate cap 
such as SGR could ever serve as an effective volume control to be met 
by thousands of individual physicians?
    Response: Under current law, the Medicare program does not attempt 
to control the volume of physicians' services. Rather, the SGR method 
attempts to control growth in medicare's total expenditures for 
physicians' services. The SGR method controls growth in spending by 
establishing year-by-year and cumulative expenditure targets and by 
adjusting future payment rates to bring spending in line with those 
targets. Those expenditure targets incorporate adjustments for 
inflation and changes in the number of beneficiaries enrolled in 
Medicare's fee-for-service program; they also provide an allowance for 
increases in spending per beneficiary for physicians' services based on 
the growth in real gross domestic product per capita. The year-by-year 
expenditure targets also are adjusted to compensate for differences 
between actual spending and the expenditure targets.
    Assuming no further change in current law, CBO projects that the 
SGR method will be effective over the coming decade in bringing 
Medicare's total expenditures for physicians' services in line with 
those expenditure targets. However, it will do so by adjusting payment 
rates in response to changes in the volume of physicians' services-not 
by controlling the volume of those services.
    If you have any further questions, we would be pleased to answer 
them. The CBO staff contact is Chris Topoleski.
            Sincerely,
                                        Douglas Holtz-Eakin
                                                           Director
cc: Honorable John D. Dingell, Ranking Member
                                 ______
                                 
Response of A. Bruce Steinwald, Director, Health Care Medicare Payment 
  Issues, U.S. General Accounting Office, to Question of Hon. John B. 
                                Shadegg

    Question: The main goal of the Sustainable Growth Rate is to 
control physician service volume by setting an aggregate rate target, 
and penalizing physicians by reducing their payments when total volume 
growth exceeds this rate. Since each individual physician can only 
control their own volume, and consumer and payer behavior have as much 
impact on volume as MD behavior, do you believe that an aggregate cap 
such as SGR could ever serve as an effective volume control to be met 
by thousands of individual physicians?
    Response: Although physicians' decisions play an important role in 
determining volume and intensity growth, it is unknown how a system of 
aggregate spending targets may influence the behavior of individual 
physicians. In its 1995 report to Congress, the Physician Payment 
Review Commission (a predecessor to the current Medicare Payment 
Advisory Commission) 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.'' What is known, as I discussed 
in my testimony statement, is that we observed a dramatic decrease in 
volume and intensity growth following the implementation of a fee 
schedule and spending targets for physician services in 1992. GAO is 
currently conducting a study of Medicare's sustainable growth rate 
system and will issue its report on the subject in September.

                                 ______
                                 
         Prepared Statement of the American Medical Association

    Chairman Bilirakis, Representative Brown and Members of the 
Subcommittee, the American Medical Association (AMA) appreciates the 
opportunity to provide our views today regarding the Medicare payment 
update formula for physicians' services.
    The AMA would like to take this opportunity to commend you, Mr. 
Chairman, and each Member of the Subcommittee, for all of your hard 
work and leadership in recognizing the fundamental problems inherent in 
the Medicare physician payment update formula and enacting recent 
short-term ``fixes'' of the update formula. We deeply appreciate 
enactment of provisions in the Medicare Prescription Drug, Improvement, 
and Modernization Act of 2003 (MMA), which greatly assist in averting 
access problems for Medicare beneficiaries, including replacement of 
the 4.5% Medicare physician pay cut for 2004 and another severe cut in 
2005 with a positive 1.5% update in each of these years, as well as 
placing a floor on geographic adjustments and providing bonus payments 
for certain physician ``scarcity'' areas.
    We also applaud your commitment to developing a long-term solution 
to the current flawed physician payment formula. The flaws in this 
formula led to a 5.4% payment cut in 2002, and additional cuts in 2003 
through 2005 were averted only after Congress intervened. Further, the 
formula has produced payment updates that have failed to keep pace with 
the cost of practicing medicine. From 1991 through 2005, medical 
practice costs will have increased by 41%, yet, during the same time 
period, Medicare payments to physicians will have increased only by 
about 18% (see chart in Attachment A). Without intervention, the 
situation will worsen. The Medicare Trustees have projected that 
physicians and other health professionals face pay cuts of 5% a year 
from 2006 through 2012. The result, according to 2004 Annual Report of 
the Medicare Board of Trustees, is a cumulative reduction of more than 
31% in physician payment rates 2005 through 2012, while medical 
practice costs (MEI) during that time frame are expected to increase by 
19%.
    A physician access crisis is looming for Medicare patients unless 
action is taken to enact a long-term solution to the current physician 
payment formula. The MMA has made significant strides in improving the 
overall system for Medicare beneficiaries, including broad-scale 
improvements for care furnished to patients in rural areas as well as 
important new benefits. These critical improvements must be supported 
by an adequate payment structure for physicians' services. Physicians 
are the foundation of our nation's health care system, and continual 
cuts (or even the threat of repeated cuts) put Medicare patient access 
to physicians'' services at risk and threaten to destabilize the 
program.
    The AMA looks forward to working with Congress to achieve a 
successful solution to the problems with the current payment system. We 
are happy to have the opportunity today to address the historical 
problems with the formula.

                   THE SUSTAINABLE GROWTH RATE SYSTEM

    Medicare pays for services provided by physicians and numerous 
other health care professionals on the basis of a payment formula that 
is updated annually in accordance with a sustainable growth rate (SGR). 
Under the SGR, enacted by the Balanced Budget Act of 1997 (BBA), the 
Centers for Medicare and Medicaid Services (CMS) establishes allowed 
expenditures for physicians' services based on certain factors set 
forth in the law: (i) inflation, (ii) fee-for-service enrollment, (iii) 
real per capita gross domestic product (GDP), and (iv) laws and 
regulations. CMS then compares allowed expenditures to actual 
expenditures. If actual expenditures exceed allowed expenditures in a 
particular year, then physician payments are reduced in the subsequent 
year. Conversely, if allowed expenditures are less than actual 
expenditures, physician payments increase.

           PROBLEMS UNDER THE SUSTAINABLE GROWTH RATE SYSTEM

    The flawed SGR system has led to payment volatility and substantial 
patient access concerns requiring Congressional intervention to avoid 
erosion of beneficiary access to care.
    The vast majority of physician practices are small businesses, and, 
as such, do not have the economic and other necessary resources to 
absorb sustained losses or the steep payment fluctuations that have 
occurred under the SGR system. Further, the unpredictability of the SGR 
system makes it difficult for physician office practices, as small 
businesses, to project revenue into the future and make the necessary 
business and financial decisions needed to operate a sound business 
over time. For example, when these small medical practices experienced 
the 5.4 percent Medicare cut in 2002, physicians and non-physician 
practitioners were left with very few alternatives for maintaining a 
financially sound practice without limiting their Medicare patients' 
access in some way. It is also nearly impossible for physician 
practices to plan ahead since SGR estimates for future years (which are 
based on numerous factors that are impossible to predict), in addition 
to being quite grim, are also completely unreliable. It took strong 
efforts by Congress, in particular by this Committee, in addition to 
similar efforts by the Senate, the Administration and CMS to avoid 
another SGR-triggered pay cut in 2004 and 2005. While we greatly 
appreciate this effort, we do not believe Congress and the 
Administration (nor patients, physicians and other health care 
professionals) should have to struggle with the ill effects of such a 
system, year after year.
    The Medicare Payment Advisory Commission (MedPAC) has recommended 
that the SGR be replaced with a system where updates are based on an 
assessment of increases in practice costs, adequacy of payment rates, 
and beneficiaries' access to care, and we agree. There are several 
fundamental problems with the SGR formula:

1. Payment updates under the SGR formula are tied to the gross domestic 
        product, which bears little relationship to patients' health 
        care needs or physicians' practice costs;
2. The SGR formula is highly dependent on projections that in effect 
        require CMS to predict the unpredictable; and
3. Physicians are penalized with lower payments when utilization of 
        services exceeds the SGR spending target, yet, the factors 
        driving these increases are often beyond physicians' control 
        (as further discussed below under ``Administrative Action 
        Needed.'')

Problems with the Payment Formula Due to GDP
GDP Does Not Accurately Measure Health Care Needs
    The SGR permits utilization of physicians' services per beneficiary 
to increase by only as much as GDP. The problem with this 
``relationship'' is that GDP growth does not track the health care 
needs of Medicare beneficiaries. For example, when a slowed economy 
results in a decreased GDP, the medical needs of Medicare patients 
remain constant, or even increase, despite the economic downturn. Yet, 
physicians and numerous other health professionals, whose Medicare 
payments are tied to the physician fee schedule, are penalized with 
lower payments because of the decreased GDP.
    Further, GDP does not take into account the aging of the Medicare 
population, technological innovations or changes in the practice of 
medicine. This is a key reason that MedPAC has recommended replacing 
the SGR system.
    Use of GDP has also led to a system that relies on economic 
forecasts that nearly always need to be modified as additional data 
becomes available, and thus it is impossible to make accurate 
projections about payment update levels. For example, in March of 2001, 
CMS projected that physician payments would fall slightly by about -0.1 
percent in 2002. CMS noted that this projection was based on very early 
information and could change before a final update was announced in 
January 2002. In fact, those estimates did change, and Medicare 
payments to physicians and other health care professionals were cut by 
5.4 percent in 2002.

Technological Innovations Are Not Reflected in the Formula
    The United States' population is aging and new technologies are 
making it possible to perform more complicated procedures on patients 
who are older and more frail than in the past. The Congressional Budget 
Office has said that recent Medicare volume increases are due to 
``increased enrollment, development and diffusion of new medical 
technology'' and ``legislative and administrative'' program expansions. 
The SGR system's artificial cap on spending growth ignores such medical 
advances when it limits target utilization growth to GDP growth.
    Both Congress and the Administration have demonstrated their 
interest in fostering advances in medical technology and making these 
advances available to Medicare beneficiaries through FDA modernization, 
increases in the National Institutes of Health budget, and efforts to 
improve Medicare's coverage policy decision process
    The only way for technological innovations in medical care to 
really take root and improve standards of care is for physicians to 
invest in those technologies and incorporate them into their regular 
clinical practice. The invention of a new medical device cannot, in and 
of itself, improve health care(physicians must take the time to learn 
about the equipment, practice using it, train their staff, integrate it 
into their diagnosis and treatment plans and invest significant capital 
in it. Although the Medicare hospital payment system allows an 
adjustment for technological innovations, the physician payment system 
does not do so. The physician payment system is the only fee structure 
of Medicare that is held to GDP, and no other Medicare payment system 
faces as stringent a growth standard.
    Government efforts to foster technological innovations could be 
seriously undermined as physicians now face disincentives to invest in 
new medical technologies or to provide them to Medicare beneficiaries.

Site-of-Service Shifts Are Not Considered in the Formula
    Another concern that is not taken into account in the SGR formula 
is the effect of the shift in care from hospital inpatient settings to 
outpatient sites. As MedPAC has pointed out in the past, hospitals have 
reduced the cost of inpatient care by reducing lengths-of-stay and 
decreasing staff, as well as by moving more services to outpatient 
sites, including physician offices. This trend, which has been 
encouraged by private payers because it saves money for both the 
government and patients, has increased the number and intensity of 
services as patients with increasingly complex conditions are treated 
in physicians' offices. This increased use and intensity, however, is 
not recognized in the SGR formula.

Beneficiary Characteristics Are Not Reflected in the Formula
    A related factor that also is unrecognized in the SGR formula is 
changes over time in the characteristics of patients enrolling in the 
fee-for-service program. For example, increases in patients diagnosed 
with, or having complications due to such diseases as obesity, diabetes 
and end stage renal disease, require greater utilization of physicians' 
services. Yet, these types of changes in beneficiary characteristics 
are not reflected in the SGR.

Inability to Predict Payment Updates under the SGR
    Instead of making payments more predictable for physicians and 
budgets more predictable for policymakers, use of the SGR has had the 
opposite effect. Future updates are dependent on forecasts of (i) GDP, 
(ii) how many beneficiaries will choose Medicare Advantage versus fee-
for-service Medicare, (iii) the rate of medical practice cost inflation 
each year, (iv) the rate of utilization growth each year, and (v) 
spending changes that will occur as a result of legislative and 
regulatory changes, such as expanded coverage for preventive services.
    None of these factors can be accurately predicted before they 
occur. As a result, policymakers cannot predict the impact of Medicare 
physician services on overall Medicare spending and medical practices 
cannot predict their revenue streams for the short- or long-term. 
Estimates of payment updates initially are based on incomplete data and 
such estimates can fluctuate significantly as more data becomes 
available. Indeed, the chart in Attachment B illustrates the numerous 
changes in CMS estimates of the SGR target beginning in the Fall of 
1997 through Spring 2004.

  ADMINISTRATIVE ACTION NEEDED TO CORRECT SGR IMPLEMENTATION PROBLEMS

    Apart from the inherent problems in the physician payment formula, 
there are other problems with implementation of the SGR that seriously 
threaten patient access and inequitably affect payment updates due to 
factors that are beyond physicians' control. CMS could and should use 
its administrative authority to address these issues in the 2005 
Medicare physician payment rule:

1. Remove Medicare-covered drugs and biologics from the physician 
        payment formula
    As discussed above, Medicare payments to physicians are reduced 
when actual Medicare spending for physicians' services exceeds a pre-
determined spending target (the SGR). When CMS calculates actual 
spending on physicians' services, it includes the costs of Medicare-
covered prescription drugs administered in physicians' offices. 
Although the physician's administration of the drug is clearly a 
physician service that by statute must be included in the pool, the 
drugs themselves are not ``physicians' services'' and drugs are not 
paid under the Medicare physicians fee schedule. Thus, it is 
inconsistent to include drugs in the SGR. In fact, in an interim final 
rule issued last year, (on the application of inherent reasonableness 
to Medicare Part B services), CMS chose to exclude drugs from the 
definition of ``physicians' services.'' To include drugs as a 
``physicians' service'' for certain purposes, but not for others, is 
inconsistent and inequitable. Indeed, this policy has been questioned 
by many legislators, including Subcommittee Chairman Bilirakis and 
former Committee Chairman Tauzin, who noted in a June 2003 letter to 
former Administrator Scully that ``good public policy demands'' 
elimination of these drugs from the SGR formula.
    In the past, some CMS officials have argued that including drugs in 
the SGR was necessary to counter-balance incentives for over-
utilization in the drug reimbursement system. While the AMA does not 
accept this premise, even if such incentives existed, they were surely 
eliminated by the reductions in payment for these drugs under the MMA. 
Thus, we urge the Subcommittee to reiterate the request that CMS 
reconsider its current policy in light of the changes made in the MMA.
    Drug expenditures are continuing to grow at a very rapid pace. 
Between 1996 and 2002, per enrollee spending on drugs grew 244% 
compared to 38% for physicians services. This is partly due to a net 
increase in the number of drugs included in the SGR, from 365 in 1998 
to 435 in 2002. Further, there is no end in sight, with over 650 drugs 
and biologicals in development, as reported in a study conducted for 
MedPAC. As a result, including drugs in the SGR greatly increases the 
odds that Medicare spending on physicians' services will exceed the SGR 
target, triggering pay cuts that penalize physicians for providing 
important new drugs to their patients. Essentially, physicians are 
being asked to finance drug costs through cuts in their Medicare 
payments even though they do not have the ability to control the 
factors that are causing increases in drug utilization.
    These life-saving and quality-enhancing drugs have been developed 
with support from government policies such as expanded funding for the 
National Institutes of Health and streamlining of the drug approval 
process. In fact, it is this Administration's goal to accelerate the 
pace of drug development as evidenced in a Department of Health and 
Human Services (HHS) action plan developed last year and a recent 
Interagency Agreement between the National Cancer Institute and the 
Food and Drug Administration. In announcing the agreement last May, NCI 
and FDA officials described it as ``an important step toward NCI's goal 
to eliminate suffering and death due to cancer by 2015'' and said the 
collaboration ``holds great promise for getting better cancer drugs to 
patients sooner.''
    The AMA shares and applauds these goals, but we must also note that 
Medicare's current policy of counting drugs in the SGR threatens to 
undermine these goals. More than half of all cancers diagnosed in the 
United States today are found in those over 65. Yet CMS's policy of 
including drugs in the SGR creates the distinct possibility that 
physicians will exceed the SGR target and be penalized with pay cuts if 
Medicare beneficiaries use of covered drugs continues to grow.
    The medical profession does not condone inappropriate use of these 
drugs. Indeed, the AMA, in concert with specialties responsible for 96% 
of physician-administered drugs, has previously committed to work with 
CMS to develop and disseminate educational programs and guidance in any 
instances where the agency has evidence of misuse or abuse. We continue 
to believe that this option is better for everyone concerned than the 
current policy.

2. Ensure that government-induced increases in spending on physicians' 
        services are accurately reflected in the SGR target
    As discussed above, the government encourages greater use of 
physician services through legislative actions, as well as a host of 
other regulatory decisions. These initiatives clearly are good for 
patients and, in theory, their impact on physician spending is 
recognized in the SGR target. In practice, however, many are either 
ignored or undercounted in the target.For example, the new prescription 
drug benefit enacted under the MMA will significantly expand 
expenditures for physician services because beneficiaries who 
previously could not afford to purchase drugs will visit physicians to 
get prescriptions. Moreover, these patients will have to be monitored 
by the physician for the impact of the drugs and may need to be seen 
for other conditions discovered at the time of the visit.
    Further, the MMA contains a number of other provisions that will 
increase physician spending. The Medicare prescription drug discount 
card will become available for beneficiaries in the next several weeks 
(June 2004) and is now expected to achieve significant out-of-pocket 
cost savings on drug purchases. The RAND Health Insurance Experiment 
demonstrated that when patients' out-of-pocket costs are reduced, their 
utilization of services will increase. Thus, lower out-of-pocket drug 
costs are likely to lead seniors to fill more prescriptions and utilize 
more drugs. This would also mean that more seniors will visit 
physicians' offices more often. Of course, these physicians' office 
visits would increase total physician spending, and additional spending 
likely would occur due to the fact that increased visits may trigger an 
array of other medically necessary services, including laboratory 
tests, to monitor the impact of the drug usage and treat conditions 
that might have otherwise gone undetected and untreated. All of these 
costs should be included in the calculation of the SGR target.
    Further, the MMA establishes new Medicare benefits for (i) an 
initial preventive physical exam by a physician, which also includes 
adult immunizations, an electrocardiogram, pelvic exam, pap smear and 
mammogram, prostate and colorectal cancer screening, glaucoma, diabetes 
outpatient self-management training, and cardiovascular disease 
screening and other preventive services, (ii) cardiovascular screening 
blood tests, and (iii) diabetes screening tests. While these benefits 
will increase physician spending, additional spending will occur since 
these new services are certain to trigger ongoing care for a chronic 
condition or surgery for an acute condition.
    CMS has not provided details of how estimates are calculated 
regarding the impact on physician spending due to changes in laws and 
regulations, and certain questions remain: How does CMS estimate the 
effects of new preventive benefits? Do these estimates include the 
costs of the new screening services only, or do they also include the 
costs of diagnostic tests and treatment plans ordered as a result of 
the screening? Are impacts estimated for multiple years as more 
beneficiaries take advantage of the new benefits, or do they only 
include the first year when the benefits may be significantly 
underutilized?
    CMS should provide answers to these important questions. In 
addition, CMS should ensure that all increases in spending resulting 
from the new MMA benefits, including both the spending due to use of 
the new benefit, as well as additional services triggered by 
implementation of the new benefit, are included in the SGR target. In 
other words, all direct and indirect increases in spending resulting 
from use of these or any other new or expanded benefit should be 
included in the SGR.
    In summary, CMS should adequately reflect, in the SGR target, 
physician spending increases due to such initiatives as the following: 
(i) legislative mandates, e.g., new preventive screening benefits, 
Medicare drug discount cards and the new prescription drug benefit; 
(ii) CMS coverage expansions for new procedures and technology; (iii) 
government ``good health'' policies, such as efforts to reduce health 
care disparities, streamlining drug approvals, fighting diabetes, 
improving women's health; and (iv) federal ``quality initiatives,'' 
which tend to increase the use of physician services to save money 
elsewhere in the system.

3. Ensure that the SGR fully reflects the impact on physician spending 
        due to national coverage decisions
    When establishing the SGR spending target for physicians' services, 
the law requires that impact on spending, due to changes in laws and 
regulations, be taken into account. The AMA believes that any changes 
in national Medicare coverage policy that are adopted by CMS pursuant 
to a formal or informal rulemaking, such as a Program Memorandum or a 
national Medicare coverage policy decision, constitute a regulatory 
change as contemplated by the SGR law, and must also be taken into 
account for purposes of the spending target.
    CMS' authority to make any regulatory change is derived from law--
whether it is a law specifically authorizing Medicare coverage of a new 
service or a law that provides the Secretary of HHS with general 
rulemaking authority. Thus, any new coverage initiative is a direct 
implementation, by regulation, of a law. This is exactly what the SGR 
requires be taken into account ``increases in spending due to ``changes 
in law and regulations.''
    When the impact of regulatory changes for purposes of the SGR is 
not properly taken into account, physicians are forced to finance the 
cost of new benefits and other program changes. Not only is this 
precluded by the law, it is extremely inequitable and ultimately 
adversely impacts beneficiary access to important services.
    HHS and CMS actively promote utilization of newly-covered Medicare 
services through press releases and other public announcements. For 
example, the Secretary of HHS released a 2002 report highlighting the 
importance of medical innovations and new technology, especially new 
drugs, in helping seniors live longer and healthier lives. Further, 
another HHS release regarding Medicare coverage of sacral nerve 
treatment for urinary incontinence stated, ``[u]rinary incontinence 
affects approximately 13 million adults in the United States, with 
nearly half of nursing home residents having some degree of 
incontinence. It is twice as prevalent in women as it is in men, and 
costs more than $15 billion per year, including both direct treatment 
of the disease and nursing home costs.'' The Secretary made a similar 
announcement when Medicare expanded its coverage of lymphadema pumps, 
stating, ``[i]t's important to make effective technologies available to 
Medicare beneficiaries when it helps them the most. This coverage 
decision simplifies Medicare policy to allow older Americans who need 
these pumps to get them more quickly and easily.''
    While the AMA strongly supports Medicare beneficiary access to 
these important services, physicians and other practitioners should not 
have to finance the costs resulting from the attendant increased 
utilization.
    Accordingly, CMS should ensure that the impact on utilization and 
spending resulting from all national coverage decisions is taken into 
account for purposes of the SGR spending target.

4. Rebasing of the Medicare Economic Index
    The Medicare Economic Index (MEI) is a measure of medical 
inflation, and is a factor used by CMS to update Medicare payments to 
physicians each year. The AMA appreciates and agrees with CMS' recent 
initiative to revise weights in the Medicare Economic Index (MEI) to 
reflect more current data and changes in the cost of practicing 
medicine. This initiative, however, does not address the broader 
problem that the MEI only measures changes in the prices for specific 
physician practice inputs, but there has been no effort to look at the 
inputs themselves and ensure that the market basket for which price 
changes are being measured is still the appropriate market basket.
    Inputs to the MEI may be vastly different now than when the MEI was 
first developed in the early 1970s, and thus additional inputs may be 
needed to ensure that the current MEI adequately measures the costs of 
practicing medicine. For example, physicians must comply with an array 
of government-imposed regulatory requirements, including those relating 
to fraud and abuse, billing errors, quality monitoring and improvement, 
patient safety, and interpreter services for patients with limited 
English proficiency. To ensure compliance with these initiatives, 
physicians have had to hire additional office staff to handle these 
additional responsibilities. Indeed, The Project Hope survey for the 
Medicare Payment Advisory Commission (MedPAC) in early 2002 found that 
``half of all physicians reported that their practice had hired 
additional billing and administrative staff in the past year, and more 
than 80% indicated that the practice had increased the training given 
to staff regarding billing and insurance matters.''
    CMS should include in the MEI any additional inputs that are needed 
to ensure that the MEI adequately measures the costs of practicing 
medicine.
    We appreciate the opportunity to provide our views, and look 
forward to working with the Subcommittee, Congress and the 
Administration to ensure an adequate and reliable Medicare physician 
payment system that keeps pace with the cost of practicing medicine.

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