Issue Brief: Medicare Physician Payment
Fixing the Sustainable Growth Rate (SGR) Formula

As advocates for patients and physicians, the Alliance of Specialty Medicine supports modifications to the current Medicare physician payment formula to ensure continued beneficiary access to timely, quality healthcare. The current formula has significant flaws, however, causing steep reductions in physician reimbursement and prompting an increasing number of specialty physicians to reconsider their participation in the Medicare program, limit services to Medicare beneficiaries, or restrict the number of Medicare patients they will treat. Failure to correct the flaws in this payment system will continue to put the healthcare of our Nation’s seniors at risk.

BACKGROUND

There are a number of components to the Medicare formula for reimbursing physicians. One element involves setting a monetary conversion factor, which, in part, determines reimbursement for each service paid under the Medicare Physician Fee Schedule. Each year this conversion factor is updated by the Centers for Medicare and Medicaid Services (CMS) using a complicated system – called the SGR formula -- whereby CMS takes into consideration a number of factors to set an “expenditure target” for all physician services. If actual expenditures for physician services are less than the target, physicians will receive a positive update and the conversion factor will rise. Conversely, if expenditures exceed the target, by law, CMS must impose an across-the-board reduction in physician reimbursement by lowering the conversion factor. The problems with the formula have led to an unstable payment system that can cause sudden and unpredictable drops in physician reimbursement, making it difficult for physicians to adequately meet the rising costs of medical practice.

Recent Congressional Action

While the problems with the SGR were in some respects anticipated when the law was passed in 1997, the first detrimental effects were not experienced until 2002, when physicians received a 5.4 percent reduction to the conversion factor. Since then, the flaws with the SGR formula have been so pronounced that Congress has been forced to pass two temporary measures to keep the system from falling apart completely.

In 2003, Congress included in the omnibus appropriations package language that gave CMS the authority to fix accounting mistakes that were made during 1998 and 1999. Fixing these errors infused an additional $54 billion into the Medicare physician payment system and prevented another year of reductions in reimbursement, but the legislation did nothing to fix the overall problems that plague the SGR formula. With physicians anticipating a 4.4 percent reduction in 2004, Congress again acted and included provisions in the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (MMA), mandating that CMS increase the conversion factor by at least 1.5 percent in both 2004 and 2005. However, this action did nothing to change the underlying SGR formula. In fact, while the provisions in the MMA prevented additional reductions in physician reimbursement for 2004 and 2005, no additional funds were provided to pay for this temporary fix. Therefore, the money used to fund the increase in these updates must be paid back to the Medicare program, with interest, over the next ten years.

Reimbursement Rates in 2006 and Beyond

If the SGR formula is not fixed, physicians will receive negative updates of approximately five percent each year from 2006 until 2013 and rates will not return to their 2002 level until well after 2013. (Figure 1) In other words, physicians will receive less reimbursement in 2013 than they did in 2002 for the exact same procedure, regardless of inflation and increases in practice costs. Indeed, while reimbursement will likely by cut by over 30 percent under the current formula, it is estimated that costs for providing services, as determined by the Medicare Economic Index (MEI), will rise by close to 20 percent. Such cuts will further inhibit each physician’s ability to provide services to Medicare beneficiaries as many physicians will simply be unable to afford to treat Medicare patients.

CORRECTING THE FLAWS IN THE FORMULA

Congressional action has delayed the imminent meltdown of the Medicare program and has allowed some breathing space to evaluate approaches to fixing the payment update formula. It is now time, however, to put an end to these stop-gap measures and fix the formula once and for all. Physician payments must be stabilized and further cuts must be prevented and to this end, the Alliance of Specialty Medicine believes the following issues need to be addressed:

Any Formula Used to Set the Update Should Rely on the Cost of Providing Care Rather than the Gross Domestic Product (GDP)

Reimbursement for physician services must accurately account for the increased costs of providing medical services to Medicare beneficiaries. Any reimbursement mechanism should be based on a formula that adequately accounts for the true costs of delivering healthcare services. The current Medicare Economic Index (MEI) is a fairly accurate measure of these costs, but unfortunately, the problems with the current formula override the MEI’s role in establishing physician reimbursement levels because the formula uses GDP as an additional factor for measuring inflation. Other providers, such as hospitals and skilled nursing facilities, are reimbursed based upon changes in the cost of providing services and the physician reimbursement formula should likewise more adequately take into account this factor.

Elements of the SGR Formula Must be Corrected

Currently, the most problematic areas of the SGR are as follows:

• It is cumulative, making it nearly impossible to recover from a downward spiral if one year’s actual expenditures exceed the target. The SGR formula does not compare one year’s expenditure target with that year’s actual costs. Instead, it compares the cumulative expenditure target with the cumulative actual costs. For example, when setting the 2006 update to the conversion factor, the expenditure target from April 1, 1996 through December 31, 2005 will be compared to actual spending for that time period. Under this system, if in one year the expenditure target was set too low, or if actual spending was too high, it will forever effect reimbursement. If actual costs exceed the expenditure target, the expenditure target is not adjusted in future years, but instead physician reimbursement is cut in an effort to bring spending back under the level set by the expenditure target.
• The formula requires that all excess spending be immediately recouped, up to the amount allowable by law. The formula requires that actual expenditures be brought back in line with the target expenditures each year and does not allow adjustments to be made over a period of years. Immediate recoupment makes the system volatile and does not allow for year-to-year fluctuations in volume and intensity of services. Finally, immediate recoupment combined with the cumulative nature of the formula in essence punishes physicians twice if actual expenditures are more than the expenditure target: Once in the following year when the excesses are immediately recouped and then each year thereafter when the cumulative target is compared with the cumulative actual expenditures.
• Medicare-covered outpatient drugs and other incident-to services are included in the expenditure target and are expected to grow in a disproportionate share. Physicians do not control the costs of these products and services and each year these costs represent a greater proportion of the actual costs incurred by the Medicare program. The Congressional Budget Office has predicted that spending for outpatient drugs and other incident-to services will grow faster, on a per-beneficiary basis, than allowed by the expenditure target. Each year these services will consume a greater portion of the expenditure target, rising from $12 billion (20 percent of the $62 billion expenditure target) in 2004 to $28 billion ($23 billion of the $121 billion expenditure target) in 2014. These services must be removed from the expenditure target so the expenditure target accurately reflects what it is supposed to represent – payment for physician services. While removing drugs from the pool of physician services will not have an immediate substantial impact on predicted cuts, it will shorten the number of years of negative updates and will help stabilize the system in the long run.
• Changes in law and regulation, especially the addition of preventative screening benefits and national coverage decisions that increase demand for services, are not adequately reflected by changes in the expenditure target. Each year new benefits are added to the Medicare program and these should be reflected by increases in the expenditure target. If more services are being provided, costs are naturally going to rise. However, in recent years CMS has not increased the expenditure target to correlate with new services. In addition, the MMA now mandates that CMS provide a “Welcome to Medicare” visit for all new enrollees. Other than the costs of providing the physical itself, CMS has not yet analyzed or included additional allocations to the expenditure target to reflect additional services such as lab work, imaging and diagnostic tests and other medical or surgical procedures, that may stem from this new benefit. These changes in law and regulation must be adequately accounted for in the SGR formula, or reimbursements will continue to fall.
• It is nearly impossible to set an accurate expenditure target. The expenditure target, and even the actual costs, have been changed retrospectively each year because of miscalculations, accounting errors and other problems. If physicians are to be held accountable to an expenditure target, there must be a fair and accurate way of determining the expenditure target in advance. The inability to set an expenditure target, combined with an individual physician’s inability to influence national healthcare spending, brings in to serious question the need for an expenditure target. Physicians are the only Medicare providers who are held accountable to an arbitrary spending limit and the concept of an expenditure target, originally designed as a volume-control measure, has not been effective.
• The formula does not address changes in the medical marketplace or the demographics of Medicare beneficiaries. When setting the expenditure target, CMS only considers the estimated number of enrollees in Medicare Part B fee-for-service and does not look at the age of the beneficiaries, the types of diseases from which they suffer and other factors that influence healthcare consumption. Each year Medicare beneficiaries grow older and sicker, but the expenditure target is not adjusted. In addition, the expenditure target is not adjusted to reflect changes in the medical marketplace, including changes in the site of service, increased drug therapies that require physician follow-up, greater reliance on conservative non-invasive therapies, and new technologies and treatments.

MOVING FORWARD

The Alliance of Specialty Medicine is working closely with policymakers and other stakeholders to ensure that any proposed solution for fixing the SGR system is workable and sustainable in the long-term. Some of the above identified problems can be achieved by administrative action, while others will require the Congress to pass legislation. Over the course of the next several months, we will continue to press for reform of this flawed system to ensure that Medicare beneficiaries continue to receive timely and quality healthcare.