Editor’s Note: In the post below, Paul Ginsburg, the president of the Center for Studying Health System Change (HSC), begins a Health Affairs Blog series on Medicare physician compensation and the Sustainable Growth Rate mechanism. In the coming days, the series will feature posts by Robert Berenson, Jay CrossonMina Matin, Frank Opelka, Eugene Rich, and Gail Wilensky.

The Sustainable Growth Rate (SGR) system is intended to keep spending for Medicare physician services in line with growth in the national economy. The SGR sets physician payment updates on the basis of a formula that includes growth in input prices faced by physicians, growth in Medicare fee-for-service (FFS) enrollment, and growth in the volume of physician services per enrollee relative to growth in the national economy. Based on a comparison of actual spending with a target, the difference is used to add to or subtract from changes in input prices for physician services. In this manner, Congress’ goals for spending (price times volume) are executed by adjusting payment rates (price) in a fee-for-service payment system. 

For each year beginning in 2002, the SGR formula has called for a substantial reduction in Medicare physician payment rates. For 2002, payment rates were reduced by 5.4 percent. In each subsequent year, Congress has overridden the formula, specifying small increases or payment freezes instead of large cuts. But each congressional intervention has deferred rather than cancelled the reductions in payment rates. At this point, a cumulative payment rate reduction of 41 percent is scheduled through 2016 (9.9 percent on 1 July 2008 and approximately 5 percent annually thereafter), in contrast to a 21 percent increase in physician input prices projected by the Medicare Actuary.

The inherent limitation of SGR is that it does not affect the incentives of individual physicians concerning the rate of use of services. Furthermore, as Congress has found over the last few years, the formula is capable of prescribing reductions in payment rates that are so large that policymakers are reluctant to implement them. Not only would large reductions in physician payment rates harm physicians, but they also jeopardize beneficiary access.

The History Of The Sustainable Growth Mechanism

Although SGR was enacted as part of the Balanced Budget Act (BBA) of 1997, its origins go back to a similar system called Volume Performance Standards (VPS), which was enacted in 1989 along with the introduction of the Medicare physician fee schedule. Many in Congress at the time were attracted to the ability of a fee schedule to redress some of the distortion in the payment rates for different types of physician services in different geographic areas. But others in Congress and the administration were concerned about investing significant resources to address relative payments without also increasing the ability of the Medicare program to control spending increases. The Physician Payment Review Commission (PPRC) (now the Medicare Payment Advisory Commission, or MedPAC) suggested a mechanism to control spending by adjusting prices when volume trends differed from targets. 

Although the PPRC recognized that its mechanism did not change the incentives for individual physicians, it believed that some expenditure control could be accomplished through the response of specialty societies to the incentives applied to physicians as a group. If organized medicine increased support for developing practice guidelines and utilization review efforts by the Medicare program, volume trends could be slowed. Separate targets for primary care, surgery, and other services were seen as both facilitating efforts by specialty societies and limiting the degree to which physicians in a specialty were impacted by the actions of physicians outside the specialty, who they could not influence. Needless to say, there were limits to the degree to which organized medicine was willing to, or capable of, slowing the growth in volume of services. 

The change from VPS to SGR addressed some perceived shortcomings in VPS but also was motivated by Congress’s desire to reduce the budget deficit. SGR was more demanding as far as reducing trends in physician spending —- the basis for scoring a projected deficit reduction. But placing more demands on a system without much capability to deliver results led to the situation today in which the prescribed cuts in payment rates greatly exceed the magnitude of the willingness to cut fees. Indeed, any incentive that organized medicine might have had to slow volume trends has likely dissipated now that spending exceeds the target to such a large extent.

The SGR: A Discredited And Dysfunctional Tool 

At this time, the SGR system is completely discredited. MedPAC recommends that it be scrapped in favor of payment rate increases based on trends in input prices and productivity. It is maintained only because Congress has not yet come to grips with an unrealistic budget baseline that assumes very large cuts in payment rates over many years. To remove the mandate for such reductions in payment rates, Congress would have to embrace either large reductions in other spending, tax increases, or a larger budget deficit. Through annual last-minute fixes, Congress has achieved some spending cuts in other areas, but by allowing the cumulative difference between the rates specified by formula and actual rates to grow, it is de facto mostly adding to the deficit. 

The annual last-minute legislation to avoid large physician payment rate reductions has provided short-term relief each year but resulted in a long-term policy of not increasing payment rates while physician input prices have increased. I doubt whether this is a good policy decision because it is increasing the likelihood of substantive erosion in Medicare beneficiaries’ access to physicians and contributing to reductions in income for primary care physicians. Difficulties in filling primary care residencies and reports of primary care physicians retraining in dermatology or other specialties raise questions of whether primary care specialties will disappear from the scene at the same time baby boomers need more management of chronic conditions. 

Ironically, during the period in which Medicare payment rate changes have increased little, private insurers also have provided very small rate increases to physicians. They may be related, but not in the sense that private insurers simply imitated Medicare. With Medicare physician payment rates lower than private insurers’ rates in most areas, freezing Medicare rates increases physicians’ desire to limit their Medicare practices. But to do so involves increasing their numbers of privately insured patients, which for many physicians means continuing contracts with private insurers despite rates’ not keeping up with physician costs. 

Primary care physicians are most impacted by the lack of increase in Medicare (and private insurer) payment rates. Physicians in many other specialties can more readily accept declining payment rates because of productivity increases for newer procedures and the ability to increase the number of profitable procedures. With the practice expense relative values for procedural services often much too high, physicians are increasingly bringing more equipment into their offices to provide profitable services that have historically been performed mostly in hospital outpatient departments. These developments are likely contributing to rising physician spending, but the income gains are going only to physicians in certain specialties.

Reforming Medicare’s Physician Compensation Mechanism 

I believe that the key for Congress in resolving this situation is to develop a long-term strategy to more effectively control costs in the Medicare program. Attractive long-term options are unlikely to be mechanical enough so that they can be “scored” with enough savings to offset the higher spending from either ending SGR or restarting a revised version of it. Ultimately, Congress will have to accept cuts in spending elsewhere, higher taxes or a higher deficit — most likely the latter. But if a strong vision were outlined and legislation enacted, then Congress might decide to accept the fiscal heat in the short term. 

A vision for steps to slow the growth in physician spending might include the following: 

  • A more accurate relative value scale that reduces physician incentives to expand offerings of overly profitable facility services; 
  • A broader payment system that compensates physicians for care management and coordination services for patients with chronic diseases that are not reimbursed today; 
  • Developing payment rewards and penalties and patient incentives reflecting physician efficiency and quality in delivering episodes of care; 
  • Sharply increased investments in effectiveness research along with a structure that insulates choice of research topics and dissemination of results from political interference. 

Committing to such a vision will not be easy. Congress cannot guarantee that future Congresses will follow through. Indeed, an element that might be critical for making a credible commitment to long-range reform is to change governance of the Medicare program. Many have recognized the need for a governance structure that would protect the program from the extensive micromanagement that routinely comes from members of Congress representing the special interests of different stakeholders. Perhaps Congress will perceive that ceding some power is the only way to credibly put the Medicare program on the path toward slowing costs and improving the likelihood of long-term sustainability. 

My emphasis on major reform should not preclude improvements in the SGR. MedPAC has done an excellent job of outlining a range of options for Congress, and some initial steps towards improvements have generated interest in Congress. Creating separate SGRs for different categories of services, such as primary care, major procedures, minor procedures, and imaging, has the potential to use the mechanism to address some of the major shortcomings of the fee schedule’s relative values. 

Failure to resolve the SGR problem and continued dependence on yearly fixes will lead to a worsening of festering problems. It likely will mean continual reduction in inflation-adjusted payment rates for physicians. Ultimately, beneficiaries’ access to physicians will erode sufficiently that Congress will be called to account by influential constituents, who paid Medicare taxes for decades and find themselves with access that is inferior to what they had before reaching Medicare eligibility.