Medicare Physician Payments: Information on Spending Trends and  
Targets (05-MAY-04, GAO-04-751T).				 
                                                                 
The Sustainable Growth Rate (SGR) system, implemented in 1998 and
subsequently revised, is used to update Medicare's physician fees
and moderate the growth in Medicare spending for physician	 
services. SGR, and a predecessor system implemented in 1992, were
designed to reduce physician fee updates if spending growth	 
exceeded a specified target. Although spending growth slowed	 
substantially under both systems, concerns about SGR arose when  
the system caused fees to decline by 5.4 percent in 2002. GAO was
asked to 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. This statement is 
largely based on GAO's previous work on Medicare spending trends 
and the SGR system.						 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-04-751T					        
    ACCNO:   A09957						        
  TITLE:     Medicare Physician Payments: Information on Spending     
Trends and Targets						 
     DATE:   05/05/2004 
  SUBJECT:   Financial analysis 				 
	     Fiscal policies					 
	     Medical economic analysis				 
	     Medical fees					 
	     Medical services rates				 
	     Physicians 					 
	     Medicare Sustainable Growth Rate System		 
	     Medicare Program					 
	     Medicare Economic Index				 
	     Medicare Volume Performance Standard		 
	     System						 
                                                                 

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GAO-04-751T

United States General Accounting Office

GAO Testimony

Before the Subcommittee on Health, Committee on Energy and Commerce, House
of Representatives

For Release on Delivery

Expected at 10:00 a.m. EDT MEDICARE PHYSICIAN

Wednesday, May 5, 2004

PAYMENTS

                   Information on Spending Trends and Targets

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

GAO-04-751T

Highlights of GAO-04-751T, a testimony before the Subcommittee on Health,
Committee on Energy and Commerce, House of Representatives

The Sustainable Growth Rate (SGR) system, implemented in 1998 and
subsequently revised, is used to update Medicare's physician fees and
moderate the growth in Medicare spending for physician services. SGR, and
a predecessor system implemented in 1992, were designed to reduce
physician fee updates if spending growth exceeded a specified target.
Although spending growth slowed substantially under both systems, concerns
about SGR arose when the system caused fees to decline by 5.4 percent in
2002.

GAO was asked to 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. This statement is largely based
on GAO's previous work on Medicare spending trends and the SGR system.

May 5, 2004

MEDICARE PHYSICIAN PAYMENTS

Information on Spending Trends and Targets

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 establishing a system 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 fees
are adjusted up or down, depending on whether actual spending has fallen
below or has exceeded the target. Fees 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. A 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.

www.gao.gov/cgi-bin/getrpt?GAO-04-751T.

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

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.

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.

1U. 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).

2See Pub. L. No. 108-173, S:953, 117 Stat. 2066, 2427-28.

We look forward to working with the Subcommittee and others in Congress as
policymakers seek to ensure appropriate physician payments.

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-forservice (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.

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.

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.

3See Pub. L. No. 101-239, S:6102, 103 Stat. 2106, 2169-89.

4Medicare 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).

5The 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.

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.

Figure 1: Medicare Spending for Physician Services, 1975-2005

Dollars in billions 60

54.2

50

40

30

20

10

0 1975 1980 1985 1990 1995 2000 2005 est.

Sources: GAO analysis of data from CMS and the Boards of Trustees of the
Federal Hospital Insurance (HI) and Supplementary Medical Insurance (SMI)
Trust Funds.

Notes: Amounts represent Medicare spending for aged and disabled
beneficiaries in the traditional FFS program, net of beneficiary cost
sharing. Spending for end stage renal disease (ESRD) patients is not
included. Amounts for 1975-1990 are for the years ending June 30 and
amounts for 1995-2005 represent calendar years. The estimate for 2005 is
based on Trustees' projections under intermediate assumptions.

6This includes spending, net of beneficiary cost-sharing, for aged and
disabled beneficiaries in the traditional FFS program.

In 1980s, Spending for Before the physician fee schedule was implemented,
Medicare payments Physician Services Grew for physician services were
largely based on historical charges. Rapidly 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.)

Figure 2: Average Annual Change in Medicare Spending for Physician
Services per

Beneficiary, 1980-2003

Percentage 14

12 11.6

10

8

6

4

2

0 1980-1991 1992-1997 1998-2003

Sources: GAO analysis of data from CMS and the Boards of Trustees of the
Federal HI and SMI Trust Funds.

Notes: Amounts for 1980-1991 are for the years ending June 30 and
represent weighted average Medicare spending for aged and disabled
beneficiaries in the traditional FFS program, net of beneficiary cost
sharing. Spending for ESRD patients is not included. Amounts for 1992-1997
and 1998-2003 are for calendar years and represent total allowed
charges-Medicare spending, including beneficiary cost sharing-for aged and
disabled beneficiaries in the traditional FFS program.

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

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.

7Congressional Budget Office, Physician Reimbursement Under Medicare:
Options for Change (Washington, D.C.: Apr. 1986).

8Testimony before the Subcommittee on Medicare and Long-term Care,
Committee on Finance, U.S. Senate, 101st Congress, 1st Session (June 16,
1989).

  Figure 3: Growth in Volume and Intensity of Medicare Physician Services per
                             Beneficiary, 1975-2003

Percentage

9.7

1975 1980 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
                            1999 2000 2001 2002 2003

Sources: GAO analysis of data from CMS and the Boards of Trustees of the Federal
                            HI and SMI Trust Funds.

Notes: Data are for aged and disabled beneficiaries in the traditional FFS
program only. Data for ESRD patients are not included. From 1975 through
1992, volume and intensity of services changes are based on Medicare
outlays for all physician services. From 1993 through 2003, volume and
intensity of services changes are based on Medicare outlays for physician
services covered by the fee schedule.

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.

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.

9At 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.

10The 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.

11Physician Payment Review Commission, 1996 Annual Report to Congress
(Washington, D.C.: Physician Payment Review Commission, 1996).

SGR System Differs From The SGR system was created in the Balanced Budget
Act of 1997 (BBA)12 Prior System in Important and revised by the Medicare,
Medicaid, and SCHIP Balanced Budget Ways 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.

Specifically, the SGR formula establishes expenditure targets as follows:
from a base year-199615-the targets are updated each year16 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

                                       17

most recent available data.

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

12See Pub. L. No. 105-33, S:4503, 111 Stat. 251, 433-34.

13See Pub. L. No. 106-113, App. F, S:211(b), 113 Stat. 1501A-321, 348-49.

14See Section 601(b), 117 Stat. 2301.

15The base year is set equal to the 12-month period ending March 31, 1997.

16SGR changed from a fiscal year basis to a calendar year basis in 2000.

17The 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.

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.)

18CMS 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.

Figure 4. Percentage Change in MEI, Fee Schedule Update, and Medicare
Physician Services Spending Per Beneficiary, 19982005

Percentage

12

                                      10.1

10

8

6

4

2

0

-2

-4

                                      -4.8

-6

                    1998 1999 2000 2001 2002 2003 2004 2005

MEI

Physician fee update

Spending per beneficiary

Source: GAO analysis of data from the Boards of Trustees of the Federal HI
and SMI Trust Funds.

Note: Spending per beneficiary represents Medicare spending for aged and
disabled beneficiaries in the traditional FFS program, net of beneficiary
cost sharing. Spending for end stage renal disease (ESRD) patients is not
included.

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.

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

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

19BBRA 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.

20See Pub. L. No. 108-7, Div. N, Title IV, S:402, 117 Stat. 11, 548.

21The 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.

22See Section 601(a), 117 Stat. 2300.

Concluding Observations

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.

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

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

23Boards 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).

budgetary perspective, any consequences for physicians and their patients
are uncertain.

Contact and Acknowledgments

(290381)

Mr. Chairman, this concludes my prepared statement. I will be happy to
answer questions you or other Subcommittee Members may have.

For further information regarding this testimony, please contact A. Bruce
Steinwald at (202) 512-7101. James Cosgrove, Jessica Farb, Hannah Fein,
and Jennifer Podulka contributed to this statement.

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