Medicare payment -- past, present, future: Prelude to a crisis

In 1992 physicians lost the ability to set their own Medicare prices. The new payment system seemed to work at first, but problems quickly ensued. Part 1 of a 3-part series.

By — Posted Sept. 25, 2006

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Family physician J. Edward Hill, MD, remembers a time when physicians who saw Medicare patients were able to do something that is unheard of today. After the visit, they would tell the federal government what they thought was a fair price for their care, and Medicare would pay.

"The reimbursement system was unbelievable," said Dr. Hill, American Medical Association immediate past president. "You were actually paid what you charged."

When Dr. Hill started practicing in 1968, near the beginning of Medicare's life, he charged $3 for a basic office or home visit. No government-set physician fee schedule based on rigid mathematical formulas determined this figure for him.

For nearly 30 years from Medicare's birth in 1965, the program operated under some form of the "usual, customary and reasonable" physician fee system. As long as a doctor quoted his or her usual charge for a procedure and as long as that figure was within a certain range of fees that physicians in the same area were charging for the same service, Medicare would pay its full share.

The claims process was simple enough that most doctors did not need the support staff that they do today to help figure it out, Dr. Hill said. "My wife was filling out Medicare claims longhand at the kitchen table at night and then mailing them the next day."

Physicians were subject to certain limits in what they charged, but they would hit these caps only if they raised fees past the top end of the range. At that point, Medicare would pay them at the upper limit for that area. If more and more physicians in the region increased their fees at the same time, the maximum charge would rise accordingly.

Doctors soon found that they could discover Medicare's limits by charging increasingly higher rates until the government checks started coming back short.

Therein lay the major failing of the system, said Stuart H. Altman, PhD, a health policy professor at Brandeis University in Waltham, Mass. Because federal limits increased when large numbers of physicians raised their fees, the amounts that Medicare and many beneficiaries were paying soon went out of control.

Medicare had adopted this payment structure because it was demanded by a physician community that was opposed to the creation of the program in the first place. But much of this opposition turned to approval once doctors realized it could be profitable to see Medicare patients and to increase the volume of services that they were offering them, said Dr. Altman, who from 1984 to 1996 chaired a panel that advised Congress on Medicare hospital payment.

"It wasn't all justified, but there was a lot of criticism that Medicare essentially became a money-making machine for physicians," he said.

Calls for a more rational system

Most physicians did not have any intention of gouging the system, but the economic incentive to bill higher rates and to increase their volume of services influenced even the most conscientious doctors, Dr. Hill said.

Lawmakers and Medicare administrators soon realized that they had a funding commitment that was too open-ended, and within years of Medicare's launch they started imposing more limits on how much physicians actually could charge. A series of revisions to the program's statute implemented more stringent controls on fee increases, created incentives for doctors to accept discounted rates and reduced reimbursements for procedures that were deemed to be overvalued.

But by the 1980s, even many physicians had come to realize a complete system overhaul would be necessary to make it more rational and equitable, Dr. Altman said. Though all doctors could set their own prices to a certain extent, many primary care physicians and doctors in rural areas were complaining about what they saw as exorbitant fees being paid to specialists and urban doctors.

In an effort to correct some of these perceived inequities, the government in 1985 called in a team of Harvard University economists led by William C. Hsiao, PhD, to craft a completely new system.

Predictions at Medicare's onset that allowing physicians to determine their own fees would lead to a truly competitive playing field had not come true because health care had proven to be its own animal, Dr. Hsiao said. Life-threatening situations meant many patients did not have the luxury of shopping around for the lowest prices, and some were so fearful for their well-being that they were willing to pay virtually any price for their care, he said.

"It takes a rational buyer to make a competitive market, and patients aren't rational," Dr. Hsiao said. "So some specialties could charge huge amounts, while others, like family physicians or pediatricians who don't really deal with emergency conditions, could not charge these huge fees."

Using input from a range of specialties, the team helped bring about what some experts called the biggest change to the Medicare payment system in the program's history. The Resource-Based Relative Value Scale, or RBRVS, eventually won the approval of Congress and went live in January 1992.

Rather than base reimbursements on what area physicians charged for services, the new system established a set fee schedule by assigning each service a certain number of relative value units based on the amount of time and resources that a physician was expected to spend on providing the procedure. Newer and more complex services, for example, generally would receive a higher relative value than procedures that physicians could perform quickly and easily. Medicare then employed a special conversion factor to turn the relative value into a dollar figure that the government would pay to all the physicians in a given area.

What went wrong

Both the economists who developed the fee schedule and the physicians who assisted in the process said the new payment system did not work nearly as well as intended.

For one thing, Congress adopted the system as a replacement for usual, customary and reasonable charges before Dr. Hsiao and his colleagues had time to finish their work, Dr. Hill said. Although a committee led by the AMA helped revise the relative values several times after that, some primary care physicians still complained that the services that they provided remained undervalued compared with the ones specialists offered.

In addition, the RBRVS was accompanied by restrictions that eventually would become the basis for several of the biggest complaints that physicians came to have with the Medicare reimbursement structure.

The practice of balance billing, in which doctors charged some patients the difference between Medicare's allowed rate and the physician's fee, had been prohibited for Medicare-participating physicians ever since the concept of accepting Medicare assignment came into being in the mid-1980s. Now it also became strictly limited for physicians who were nonparticipating and who accepted Medicare patients only on a case-by-case basis.

Moreover, when physician groups, such as the AMA, backed the legislation that activated the relative value scale, they also got the accompanying Medicare Volume Performance Standard. This was a mechanism aimed at controlling spikes in the volume and intensity of services that doctors provided.

In 1998, Congress replaced this control with the sustainable growth rate, part of a formula that aligned physician pay updates with the performance of the nation's economy and reduced rates for all doctors if yearly spending totals exceeded federal limits.

Gail Wilensky, PhD, Medicare's administrator from 1990 to 1992, said Congress dropped the program's long-time payment system primarily because lawmakers at the time were so keen on these long-term physician spending controls that they were willing to get them by accepting an overhaul that was based entirely on a work in progress. Although the early years of the Medicare Volume Performance Standard and the sustainable growth rate actually worked in many doctors' favor when it came to reimbursement updates, the austere side of volume control eventually surfaced to place physicians in a very tight financial spot.

"For the first couple of years, the increase in total physician spending had been less than projected, so physicians were able to receive updates that were greater than anticipated," Dr. Wilensky said. "So the other side was sitting out there, and some of us were saying, 'This is going to reach up and bite you,' but we had less of an audience than we might have thought."

It wasn't long before physicians who had lived through Medicare's old way of doing business, including Dr. Hill, quickly saw the promise of a more rational system melt away.

Next week: A "rational" system unraveled.

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How Medicare cuts happen

[download pdf]

The physician update adjustment factor (UAF), which helps determine whether physician fees will go up or down in a given year, is based on a formula set in Medicare statute. Federal actuaries compare last year's target physician expenditures, in billions of dollars, with actual expenditures to see if doctors exceeded the limit. These figures are modified by the sustainable growth rate (SGR), which is a measure of the economy's growth, changes in program fees and enrollment, and legislative changes.

Source: Centers for Medicare & Medicaid Services

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The payment formula

Step 1: Medicare calculates relative value units for each physician service based on how much a physician is expected to spend on the procedure in terms of work and practice expenses, including medical liability coverage.

Step 2: The relative value units are adjusted based on the cost of practicing medicine in the doctor's geographic area.

Step 3: Medicare calculates the update adjustment factor, of which the sustainable growth rate is a part. The factor is used to control physician spending in Medicare.

Step 4: The update adjustment factor is multiplied by the Medicare Economic Index, which is a measure of change in the cost of practicing medicine. The resulting update is a percentage.

Step 5: The update is applied to Medicare's conversion factor. This step raises or lowers physician payment because the conversion factor is then used to turn the relative value unit totals into dollar amounts. The result is a new payment rate for each physician service.

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Hypothetical visit from Medicare past

The scenario: A 68-year-old man whom the physician has never seen before comes into the office because he now has outpatient coverage through a new program called Medicare. Demand for primary care physicians for seniors has skyrocketed since Medicare's 1965 inception, and even doctors who opposed the program's creation are finding that it has given them a steady stream of patients.

The encounter: The patient has not seen a doctor in several years, so the physician conducts a complete examination and orders a full range of diagnostic tests. It's a good thing that this patient came in, because the lack of preventive care has contributed to cardiac and respiratory conditions that require close monitoring and possible hospitalization if they worsen.

The payment: The physician mails in a relatively simple paper claims form on which he has named what he views as a fair price for all of the covered services. Medicare sends back a check for the full government share. Since this patient is relatively well-off, the physician bills him for the remainder of the full fee. Although the doctor tries to attract more of the burgeoning Medicare market by keeping his charges lower than many nearby colleagues, he is able to maintain a solid income even after covering all practice costs.

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