Medicare Physician Payments: Considerations for Reforming the	 
Sustainable Growth Rate System (10-FEB-05, GAO-05-326T).	 
                                                                 
Concerns were raised about the system Medicare uses to determine 
annual changes to physician fees--the sustainable growth rate	 
(SGR) system--when it reduced physician fees by almost 5 percent 
in 2002. Subsequent administrative and legislative actions	 
modified or overrode the SGR system to avert fee declines in	 
2003, 2004, and 2005. However, projected fee reductions for 2006 
to 2012 have raised new concerns about the SGR system.		 
Policymakers question the appropriateness of the SGR system for  
updating physician fees and its effect on physicians' continued  
participation in the Medicare program if fees are permitted to	 
decline. At the same time, there are concerns about the impact of
increased spending on the long-term fiscal sustainability of	 
Medicare. GAO was asked to discuss the SGR system. Specifically, 
this statement addresses the following: (1) how the SGR system is
designed to moderate the growth in spending for physician	 
services, (2) why physician fees are projected to decline under  
the SGR system, and (3) options for revising or replacing the SGR
system and their implications for physician fee updates and	 
Medicare spending. This statement is based on GAO's most recent  
report on the SGR system, Medicare Physician Payments: Concerns  
about Spending Target System Prompt Interest in Considering	 
Reforms (GAO-05-85).						 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-05-326T					        
    ACCNO:   A17377						        
  TITLE:     Medicare Physician Payments: Considerations for Reforming
the Sustainable Growth Rate System				 
     DATE:   02/10/2005 
  SUBJECT:   Cost analysis					 
	     Future budget projections				 
	     Health care programs				 
	     Medical fees					 
	     Medical services rates				 
	     Physicians 					 
	     Program evaluation 				 
	     Systems analysis					 
	     Systems design					 
	     Medicare Economic Index				 
	     Medicare Program					 
	     Medicare Sustainable Growth Rate System		 

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GAO-05-326T

United States Government Accountability Office

GAO Testimony

Before the Subcommittee on Health, Committee on Ways and Means, House of
Representatives

For Release on Delivery Expected at 10:00 a.m. EST Thursday, February 10,
2005

MEDICARE PHYSICIAN PAYMENTS

        Considerations for Reforming the Sustainable Growth Rate System

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

GAO-05-326T

February 10, 2005

MEDICARE PHYSICIAN PAYMENTS

Considerations for Reforming the Sustainable Growth Rate System

What GAO Found

To moderate Medicare spending for physician services, the SGR system sets
spending targets and adjusts physician fees based on the extent to which
actual spending aligns with specified targets. If growth in the number of
services provided to each beneficiary-referred to as volume-and in the
average complexity and costliness of services-referred to as intensity-is
high enough, spending will exceed the SGR target. While the SGR system
allows for some volume and intensity spending growth, this allowance is
limited. If such growth exceeds the average growth in the national
economy, as measured by the gross domestic product per capita, fee updates
are set lower than inflation in the cost of operating a medical practice.
A large gap between spending and the target may result in fee reductions.

There are two principal reasons why physician fees are projected to
decline under the SGR system beginning in 2006. One problem is that
projected volume and intensity spending growth exceeds the SGR allowance
for such growth. Second, the Medicare Prescription Drug, Improvement, and
Modernization Act of 2003 (MMA) increased the update for 2004 and 2005-
thus increasing spending-but did not raise the spending targets for those
years. The SGR system, which is designed to keep spending in line with its
targets, must reduce fees beginning in 2006 to offset excess spending
attributable to both volume and intensity growth and the MMA provision.

In general, proposals to reform Medicare's method for updating physician
fees would either (1) eliminate spending targets and establish new
considerations for the annual fee updates or (2) retain spending targets,
but modify certain aspects of the current system. The first approach
emphasizes stable and positive fee updates, while the second approach
automatically applies financial brakes whenever spending for physician
services exceeds predefined spending targets. Either approach could be
complemented by focused efforts to moderate volume and intensity growth
directly. As policymakers consider options for updating physician fees, it
is important to be mindful of the serious financial challenges facing
Medicare and the need to design policies that help ensure the long-term
sustainability and affordability of the program.

                 United States Government Accountability Office

Madam 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. A brief look at the updates
resulting from the SGR system since it was enacted by Congress puts
current concerns in context. From 1999-the first year that the SGR system
was used to update Medicare's physician fees-through 2001, annual fee
increases ranged from 2.3 percent to 5.5 percent. However, in 2002 the SGR
system reduced physician fees by nearly 5 percent. Fee declines in
subsequent years were averted only by new legislation that modified or
temporarily overrode the SGR system. For example, the Medicare
Prescription Drug, Improvement, and Modernization Act of 2003 (MMA)
specified a minimum update of 1.5 percent for both 2004 and 2005.1 Absent
additional administrative or legislative action, however, the SGR system
is projected to reduce fees by about 5 percent per year for several years
beginning in 2006. These projected declines have raised policymakers'
concerns about the appropriateness of the SGR system for updating
physician fees and about physicians' continued participation in the
Medicare program. At the same time, there are concerns about Medicare
spending growth and the long-term fiscal sustainability of the program.

My comments today are intended to describe the issues that Medicare faces
in annually updating physician fees and potential approaches for
addressing those issues. Specifically, I will discuss (1) how the SGR
system is designed to moderate the growth in spending for physician
services, (2) why physician fees are projected to decline under the SGR
system, and (3) options for revising or replacing the SGR system and their
implications for physician fee updates and Medicare spending. My testimony
today is based on the findings contained in our October 2004 report on
this subject.2 This work was performed between January 2004 through
September 2004 according to generally accepted government auditing
standards.

In summary, the SGR system is designed to apply financial brakes whenever
spending for physician services exceeds predefined spending

1Pub. L. No. 108-173, S:601 (a)(1), 117 Stat. 2067, 2300.

2GAO, Medicare Physician Payments: Concerns about Spending Target System
Prompt Interest in Considering Reforms, GAO-05-85 (Washington, D.C.: Oct.
8, 2004).

targets. It does this by reducing physician fees or limiting their annual
increase. Historically, efforts that limited fees but did not set spending
targets failed to moderate spending growth. Increases in the number of
services delivered to each beneficiary-known as volume-and the complexity
or costliness of those services-known as intensity-caused continued
increases in spending. The SGR system allows for some volume and intensity
spending growth, but if such growth exceeds the average growth in the
national economy, as measured by the gross domestic product (GDP) per
capita, fee updates are reduced. There are two principal reasons why
physician fees are projected to decline under the SGR system beginning in
2006. One reason is that projected spending growth attributable to volume
and intensity increases exceeds the SGR allowance for such growth. The MMA
is also partly responsible because it increased the update for 2004 and
2005-thus increasing spending-but did not raise the spending targets for
those years. The SGR system, which is designed to keep spending in line
with its targets, must reduce fees beginning in 2006 to offset the excess
spending attributable to both volume and intensity increases and this MMA
provision. In general, proposals to reform Medicare's method for updating
physician fees would either (1) eliminate spending targets and establish
new considerations for the annual fee updates or (2) retain spending
targets, but modify certain aspects of the current system. Either approach
could be complemented by focused efforts to moderate volume and intensity
growth directly.

                                   Background

Although the current focus of concern is largely on the potential for
several years of declining physician fees, the historic challenge for
Medicare has been to find ways to moderate the rapid growth in spending
for physician services. Before 1992, the fees that Medicare paid for those
services were largely based on physicians' historical charges.3 Spending
for physician services grew rapidly in the 1980s, at a rate that the
Secretary of Health and Human Services (HHS) characterized as out of
control. Although Congress froze fees or limited fee increases, spending
continued to rise because of increases in the volume and intensity of
physician services. From 1980 through 1991, for example, Medicare spending
per beneficiary for physician services grew at an average annual rate of
11.6 percent.

3Medicare 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).

The ineffectiveness of fee controls alone led Congress to reform the way
that Medicare set physician fees. The Omnibus Budget Reconciliation Act of
1989 (OBRA 1989)4 established both a national fee schedule and a system of
spending targets,5 which first affected physician fees in 1992.6 From 1992
through 1997, annual spending growth for physician services was far lower
than the previous decade. The decline in spending growth was the result in
large part of slower volume and intensity growth. (See fig. 1.) Over time,
Medicare's spending target system has been revised and renamed. The SGR
system, Medicare's current system for updating physician fees, was
established in the Balanced Budget Act of 1997 (BBA) and was first used to
adjust fees in 1999.7

4See Pub. L. No. 101-239, S:6102, 103 Stat. 2106, 2169-89.

5Medicare sets fees for more than 7,000 physician services based on the
resources required to provide each service, adjusted for differences in
the costs of providing services across geographic areas.

6The first system of spending growth targets, known as the Medicare Volume
Performance Standard (MVPS), was in effect from 1992 through 1997. In
1998, the SGR system of spending targets replaced MVPS.

7See Pub. L. No. 105-33, S:4503, 111 Stat. 251, 433-34. BBA set a specific
fee update for 1998. See BBA, S:4505, 111 Stat. 435-39.

Figure 1: Growth in Volume and Intensity of Medicare Physician Services
per Beneficiary, 1980-2003

Percentage 10 9 8 7 6 5 4 3 2 1 0 -1

9.7

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

                              Charge-based system

                       Fee schedule and spending targets

Source: GAO analysis of data from the Centers for Medicare and Medicaid
Services (CMS) and the Boards of Trustees of the Federal Hospital
Insurance and Supplementary Medical Insurance Trust Funds.

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

Following the implementation of the fee schedule and spending targets in
1992, through 1999, average annual growth in volume and intensity of
service use per beneficiary fell to 1.1 percent. More recently volume and
intensity growth has trended upward, rising at an average annual rate of
about 5 percent from 2000 through 2003. Although this average annual rate
of growth remains substantially below that experienced before spending
targets were introduced, the recent increases in volume and intensity
growth are a reminder that inflationary pressures continue to challenge
efforts to moderate growth in physician expenditures.

SGR System Designed to Limit or Reduce Physician Fee Updates in Response
to Excess Growth in Volume and Intensity

The SGR system establishes spending targets to moderate physician services
spending increases caused by excess growth in volume and intensity. SGR's
spending targets do not cap expenditures for physician services. Instead,
spending in excess of the target triggers a reduced fee update or a fee
cut. In this way, the SGR system applies financial brakes to physician
services spending and thus serves as an automatic budgetary control
device. In addition, reduced fee updates signal physicians collectively
and Congress that spending due to volume and intensity has increased more
than allowed.

To apply the SGR system, every year the Centers for Medicare & Medicaid
Services (CMS) follows a statutory formula to estimate the allowed rate of
increase in spending for physician services and uses that rate to
construct the spending target for the following calendar year.8 The
sustainable growth rate is the product of the estimated percentage change
in (1) input prices for physician services;9, 10 (2) the average number of
Medicare beneficiaries in the traditional fee-for-service (FFS) program;
(3) national economic output, as measured by real (inflation-adjusted) GDP
per capita; and (4) expected expenditures for physician services resulting
from changes in laws or regulations. SGR spending targets are cumulative.
That is, the sum of all physician services spending since 1996 is compared
to the sum of all annual targets since the same year to determine whether
spending has fallen short of, equaled, or exceeded the SGR targets. The
use of cumulative targets means, for example, that if actual spending has
exceeded the SGR system targets, fee updates in future years must be
lowered sufficiently both to offset the accumulated excess spending and to
slow expected spending for the coming year.

8This allowed rate is the sustainable growth rate from which the SGR
system derives its name. We use the abbreviation SGR when referring to the
system and the full term of "sustainable growth rate" when referring to
the allowed rate of increase.

9CMS calculates changes in physician input prices based on the growth in
the costs of providing physician services as measured by the Medicare
Economic Index, growth in the costs of providing laboratory tests as
measured by the consumer price index for urban consumers, and growth in
the cost of Medicare Part B prescription drugs included in SGR spending.

10Under the SGR and MVPS systems, the Secretary of Health and Human
Services defined physician services to include "services and supplies
incident to physicians' services," such as laboratory tests and most Part
B prescription drugs.

Under SGR, spending per beneficiary adjusted for the estimated 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 slightly more than 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, MMA modified the SGR system to require that
economic growth be 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.

When the SGR system was established, GDP growth was seen as a benchmark
that would allow for affordable increases in volume and intensity. In its
1995 annual report to Congress, the Physician Payment Review Commission
stated that limiting real expenditure growth to 1 or 2 percentage points
above GDP would be a "realistic and affordable goal."11 Ultimately, BBA
specified the growth rate of GDP alone. This limit was an indicator of
what the 105th Congress thought the nation could afford to spend on volume
and intensity increases.

If cumulative spending on physician services is in line with SGR's target,
the physician fee schedule update for the next calendar year is set equal
to the estimated increase in the average cost of providing physician
services as measured by the Medicare Economic Index (MEI). If cumulative
spending exceeds the target, the fee update will be less than the change
in MEI or may even be negative. If cumulative spending falls short of the
target, the update will exceed the change in MEI. The SGR system places
bounds on the extent to which fee updates can deviate from MEI. In
general, with an MEI of about 2 percent, the largest allowable fee
decrease would be about 5 percent and the largest fee increase would be
about 5 percent.

11Physician Payment Review Commission, 1995 Annual Report to Congress
(Washington, D.C.: 1995).

Continued Volume and Intensity Growth and Legislated Fee Updates
Contribute to Projected Decline in Physician Fees

The 2004 Medicare Trustees Report announced that the projected physician
fee 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.12 According to projections made by CMS Office of the Actuary
(OACT) in July 2004, maximum fee reductions will be in effect from 2006
through 2012, while fee updates will be positive in 2014. (See fig. 2.)
There are two principal reasons for the projected fee declines: increases
in volume and intensity that exceed the SGR's allowance-partly as a result
of spending for Part B prescription drugs-and the minimum fee updates for
2004 and 2005 specified by MMA.

12Boards 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).

Figure 2: Projected MEI and Fee Update under Current Law

Percentage 6

4

2

0

-2

-4

-6 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Projected MEI Projected fee update under current law Source: CMS OACT.

                     Note: Projections are as of July 2004.

Volume and Intensity Growing Rapidly, Partly as a Result of Included
Spending for Outpatient Drugs

Recent growth in spending due to volume and intensity increases has been
larger than SGR targets allow, resulting in excess spending that must be
recouped through reduced fee updates. In general, the SGR system allows
physician fee updates to equal or exceed the MEI as long as spending
growth due to volume and intensity increases is no higher than the average
growth in real GDP per capita-about 2.3 percent annually. However, in July
2004, CMS OACT projected that the volume and intensity of physician
services paid for under the physician fee schedule would grow by 3 percent
per year. To offset the resulting excess spending, the SGR system will
have to reduce future physician fee updates.

Additional downward pressure on physician fees arises from the growth in
spending for other Medicare services that are included in the SGR system,
but that are not paid for under the physician fee schedule. Such services
include laboratory tests and many Part B outpatient prescription drugs
that physicians provide to patients.13 Because physicians influence the
volume of services they provide directly-that is, fee schedule services-
as well as these other services, defined by the Secretary of HHS as
"incident to" physician services, expenditures for both types of services
were included when spending targets were introduced. In July 2004, CMS
OACT projected that SGR-covered Part B drug expenditures would grow more
rapidly than other physician service expenditures, thus increasing the
likelihood that future spending would exceed SGR system targets. To the
extent that spending for SGR Part B drugs and other "incident to" services
grows larger as a share of overall SGR spending, additional pressure is
put on fee adjustments to offset excess spending and bring overall SGR
spending in line with the system's targets. This occurs because the SGR
system attempts to moderate spending only through the fee schedule, even
when the excess spending is caused by expenditures for "incident to"
services, such as Part B drugs, which are not paid for under the fee
schedule.

13Most of the Part B drugs that Medicare covers fall into three
categories: those typically provided in a physician office setting (such
as chemotherapy drugs), those administered through a durable medical
equipment item (such as a respiratory drug given in conjunction with a
nebulizer), and those that are patient-administered and covered explicitly
by statute (such as certain immunosuppressives).

MMA's Minimum Updates for 2004 and 2005 Contribute to Future Physician Fee
Cuts

The MMA averted fee reductions projected for 2004 and 2005 by specifying
an update to physician fees of no less than 1.5 percent for those 2 years.
The MMA increases replaced SGR system fee reductions of 4.5 percent in
2004 and 3.3 percent in 2005 and thus will result in additional aggregate
spending. Because MMA did not make corresponding revisions to the SGR
system's spending targets, the SGR system must offset the additional
spending by reducing fees beginning in 2006.

An examination of the SGR fee update that would have gone into effect in
2005, absent the MMA minimum updates, illustrates the impact of the
system's cumulative spending targets. To begin with, actual expenditures
under the SGR system in 2004 are estimated to be $84.9 billion, whereas
target expenditures for 2004 were $77.1 billion. As a result, SGR's 2005
fee updates would have needed to offset the $7.8 billion deficit from
excess spending in 2004 plus the accumulated excess spending of $5.9
billion from previous years to realign expected spending with target
spending. Because the SGR system is designed to offset accumulated excess
spending over a period of years, the deficit for 2004 and preceding years
reduces fee updates for multiple years.

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

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

Alternatives to the SGR system would increase fees and thus aggregate
spending-both government outlays and beneficiary cost sharing, including
Part B premiums, for physician services relative to projected spending
under current law.14, 15 (See table 1.) While seeking to pay

14The Part B premium amount is adjusted each year so that expected premium
revenues equal 25 percent of expected Part B spending. Beneficiaries must
pay coinsurance-usually 20 percent-for most Part B services.

physicians appropriately, it is important to consider how modifications or
alterations to the SGR system would affect the long-term sustainability
and affordability of the Medicare program.

Table 1: Projected Effect on Fee Updates and Physician Services Spending
under Current Law and Selected Potential Options for the SGR System, 2006
to 2014

                                                                   Cumulative 
                                                                 expenditures 
                                    Years with                       increase 
                      Minimum fee negative fee   Maximum fee      relative to 
            Options        update         update        update    current law 

                          Current law -5.0% 8 +3.9% -

Eliminate spending
targets +2.1% 0 +2.4% 22%

                            Modify spending targets

                   Set allowable                                    
                       growth to                                    
                   GDP+1 percent    -5.0%        6        +5.3%            4% 
                  Reset spending                                    
                    base for SGR                                    
                         targets    -2.3%        6        +2.2%           13% 
                   Remove Part B                                    
                           drugs    -5.0%        5        +5.3%            5% 
                     Combine all                                    
                           three                                    
                   modifications    +2.2%        0        +2.8%           23% 

                               Source: CMS OACT.

Eliminate Spending Targets, Base Fee Updates on Physician Cost Increases

In several reports to Congress, the Medicare Payment Advisory Commission
(MedPAC) has recommended eliminating the SGR system of spending targets
and replacing it with an approach that would base annual fee updates on
changes in the cost of efficiently providing care as measured by MEI.16,
17 Under this approach, efforts to control aggregate spending would be
separate from the mechanism used to update fees. The advantage of
eliminating spending targets would be greater fee update stability.
According to CMS OACT simulations, such an approach would

15See GAO-05-85 for more information about these alternatives.

16See Medicare Payment Advisory Commission, Report to the Congress:
Medicare Payment Policy (Washington, D.C.: March 2001, 2002, 2003, and
2004).

17MedPAC suggested that other adjustments to the update might be
necessary, for example, to ensure overall payment adequacy, correct for
previous MEI forecast errors, and to address other factors.

likely produce fee updates that ranged from 2.1 percent to 2.4 percent
over the period from 2006 through 2014. (See table 1.) However, Medicare
spending for physician services would rise, resulting in cumulative
expenditures that are 22 percent greater over a 10-year period than under
current law, based on CMS OACT estimates. Although MedPAC's recommended
update approach would limit annual increases in the price Medicare pays
for each service, the approach does not contain an explicit mechanism for
constraining aggregate spending resulting from increases in the volume and
intensity of services physicians provide. In 2004 testimony, MedPAC stated
that fee updates for physician services should not be automatic, but
should be informed by changes in beneficiaries' access to services, the
quality of services provided, the appropriateness of cost increases, and
other factors, similar to those that MedPAC takes into consideration when
considering updates for other providers.18

Retain Spending Targets, Modify Current SGR System

Increase Allowance for Volume and Intensity Growth

Another approach for addressing the perceived shortcoming of the current
SGR system would retain spending targets but modify one or more elements
of the system. The key distinction of this approach, in contrast to basing
updates on MEI, is that fiscal controls designed to moderate spending
would continue to be integral to the system used to update fees. Although
spending for physician services would likely also rise under this
approach, the advantage of retaining spending targets is that the fee
update system would automatically work to moderate spending if volume and
intensity growth began to increase above allowable rates. The SGR system
could be modified in a number of ways: for example, by raising the
allowance for increased spending due to volume and intensity growth;
resetting the base for the spending targets and not requiring the system
to recoup previous excess spending; or removing the prescription drug
expenditures that are currently counted in the SGR system.

The current SGR system's allowance for volume and intensity growth could
be increased, through congressional action, by some factor above the
percentage change in real GDP per capita. As stated earlier, the current
SGR system's allowance for volume and intensity growth is approximately
2.3 percent per year-the 10-year moving average in real GDP per capita-
while CMS OACT projected that volume and intensity growth would be

18Medicare Payment Advisory Commission, Payment for Physician Services in
the Medicare Program, testimony before the Subcommittee on Health, House
Committee on Energy and Commerce (May 5, 2004).

Reset Spending Base for Future SGR System Targets

more than 3 percent per year. To offset the increased spending associated
with the higher volume and intensity growth, the SGR system will reduce
updates below the increase in MEI. According to CMS OACT simulations,
increasing the allowance for volume and intensity growth to GDP plus 1
percentage point would likely produce positive fee updates beginning in
2012-2 years earlier than is projected under current law.19 Because fee
updates would be on average greater than under current law during the
10year period from 2005 through 2014, Medicare spending for physician
services would rise. CMS OACT estimated that cumulative expenditures over
the 10-year period would increase by 4 percent more than under current
law.20 (See table 1.)

In 2002, we testified that physician spending targets and fees may need to
be adjusted periodically as health needs change, technology improves, or
health care markets evolve.21 Such adjustments could involve specifying a
new base year from which to set future targets. Currently, the SGR system
uses spending from 1996, trended forward by the sustainable growth rate
computed for each year, to determine allowable spending.

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

19We use GDP plus 1 percentage point as the allowance for volume and
intensity growth for illustrative purposes only.

20In May 2004 testimony, CBO estimated that this option would raise net
federal mandatory outlays by about $35 billion over the 2008-2014 period.
Congressional Budget Office, Medicare's Physician Fee Schedule, testimony
before the Subcommittee on Health, House Committee on Energy and Commerce
(May 5, 2004).

21GAO, Medicare Physician Payments: Spending Targets Encourage Fiscal
Discipline, Modifications Could Stabilize Fees, GAO-02-441T (Washington,
D.C.: Feb. 14, 2002).

Remove Prescription Drugs from the SGR System

Combine Multiple Spending Target Modifications

Concluding Observations

According to CMS OACT simulations, forgiving the accumulated excess
spending as of 2005-that is, resetting the cumulative spending target so
that it equals cumulative actual spending-would raise fees in 2006.
However, because volume and intensity growth is projected to exceed the
SGR system's allowance for such growth, negative updates would return
beginning in 2008 and continue through 2013. Resulting cumulative spending
over the 10-year period from 2005 through 2014 would be 13 percent higher
than is projected under current law. (See table 1.)

The Secretary of HHS could, under current authority, consider excluding
Part B drugs from the definition of services furnished incident to
physician services for purposes of the SGR system. Expenditures for these
drugs have been growing rapidly, which, in turn, has put downward pressure
on the fees paid to Medicare physicians. However, according to CMS OACT
simulations, removing Part B drugs from the SGR system beginning in 2005
would not prevent several years of fee declines and would not decrease the
volatility in the updates. Fees would decline by about 5 percent per year
from 2006 through 2010. There would be positive updates beginning in
2011-3 years earlier than is projected under current law. (See table 1.)
CMS OACT estimated that removing Part B drugs from the SGR system would
result in cumulative spending over the 10-year period from 2005 through
2014 that is 5 percent higher than is projected under current law.22

Together Congress and CMS could implement several modifications to the SGR
system, for example, by increasing the allowance for volume and intensity
growth to GDP plus 1 percentage point, resetting the spending base for
future SGR targets, and removing prescription drugs. According to CMS OACT
simulations, this combination of options would result in positive updates
ranging from 2.2 percent to 2.8 percent for the 2006-2014 period. CMS OACT
projected that the combined options would increase aggregate spending by
23 percent over the 10-year period. (See table 1.)

Medicare faces the challenge of moderating the growth in spending for
physician services while ensuring that physicians are paid fairly so that
beneficiaries have appropriate access to their services. Concerns have
been raised that access to physician services could eventually be

22In May 2004 testimony, CBO estimated that this option would raise net
federal mandatory outlays by about $15 billion through 2014. Congressional
Budget Office, Medicare's Physician Fee Schedule, testimony before the
Subcommittee on Health, House Committee on Energy and Commerce (May 5,
2004).

compromised if the SGR system is left unchanged and the projected fee cuts
become a reality. These concerns have prompted policymakers to consider
two broad approaches for updating physician fees. The first
approach-eliminating targets-emphasizes fee stability while the second
approach-retaining and modifying targets-includes an automatic fiscal
brake. Either of the two approaches could be implemented in a way that
would likely generate positive fee updates and each could be accompanied
by separate, focused efforts to moderate volume and intensity growth.
Because multiple years of projected 5 percent fee cuts are incorporated in
Medicare's budgeting baseline, almost any change to the SGR system is
likely to increase program spending above the baseline. As policymakers
consider options for updating physician fees, it is important to be
mindful of the serious financial challenges facing Medicare and the need
to design policies that help ensure the long-term sustainability and
affordability of the program. We look forward to working with the
Subcommittee and others in Congress as policymakers seek to moderate
program spending growth while ensuring appropriate physician payments.

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

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

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