Physician reaction to price changes: an episode-of-care analysis - Medicare Payment Systems: Moving Toward the Future

Health Care Financing Review, Winter, 1994 by A. James Lee, Janet B. Mitchell

INTRODUCTION

For nearly 25 years, Medicare has reimbursed physicians by using the customary, prevailing, and reasonable (CPR) methodology, which calculates payment rates from current and historical charge patterns in local geographic areas. As part of OBRA 1989, however, Congress fundamentally altered the method of physician payment under Medicare. A fee schedule is replacing the CPR methodology with a fixed fee per service, regardless of historical charges. The fees themselves, furthermore, are based on the resource-based relative value scale (RBRVS) developed by Hsiao and colleagues (1988) and refined by the Physician Payment Review Commission (PPRC) (1989) and HCFA

The Medicare fee schedule (MFS) redresses a major perceived inequity in the current Medicare payment system--namely, that the CPR methodology "overpays" technical procedures like surgery and "underpays" other services such as office visits. By basing payments on relative work effort, the MFS increases most fees for visits and lowers fees for many surgeries and diagnostic tests. The implications of this change for physicians' Medicare revenues are substantial. Simulations performed by HCFA have shown substantial declines for surgeons and radiologists, with corresponding increases for general and family practitioners (Federal Register, 1991). Little is known, however, about how physicians will respond to the new fee schedule. Of particular concern is how surgeons will respond to the payment reductions, which can be as high as 35 percent for some procedures. Will surgeons see fewer Medicare patients, or stop treating them altogether? Or will surgeons provide even more procedures in order to maintain target incomes? Or will beneficiaries themselves demand more procedures in response to the price cuts? The answers to these questions have important implications for both beneficiary access and program outlays.

Previous research suggests that fee freezes or outright fee reductions may lead to increased program costs. Gabel and Rice (1985) summarized the evidence from natural experiments involving such fee changes and concluded that physicians responded by increasing the quantity provided (including more surgery). In a recent reanalysis of data from one of the studies reviewed (Rice and McCall, 1982), the U.S. Congressional Budget Office (1989) concluded that physicians faced with fee reductions would "make up" at least one-half of the revenue loss through volume increases.

These natural experiments are limited in their ability to disentangle patient-induced demand from physician-induced demand as alternative responses to fee reductions. Nevertheless, the availability of supplemental coverage for most Medicare beneficiaries would seem to attenuate (if not eliminate) patient demand as an important factor. Econometric studies, furthermore, have found clear evidence of inducement in the case of surgery (Cromwell and Mitchell, 1986; Fuchs, 1978). Evidence for inducement in the case of office visits (McCarthy, 1985; Wilensky and Rossiter, 1981) is less clear.

In addition, previous research has generally examined physician responses either to fee freezes or to relatively small payment reductions. Under the MFS, reductions for many high-volume Medicare operations will be on the order of 20-30 percent. Knowing how physicians respond to cuts of this magnitude will help policymakers estimate future program outlays. The MFS itself will not be fully implemented for some time. Phase-in began in January 1992, but implementation will not be completed until January 1996. However, payment reductions for "overpriced" procedures that took effect in 1987 and 1988 provide a convenient opportunity to study physician reactions to fee reductions.

As part of OBRA 1986, prevailing charges for cataract surgery were reduced 10 percent, subject to a 75-percent floor (i.e., no charge could be reduced to less than 75 percent of the national average prevailing charge). This "overvalued" procedure fee reduction went into effect on January 1, 1987. In OBRA 1987, Congress introduced a more sophisticated approach--reducing prevailing charges disproportionately more in high-fee areas--and applied it to a much larger group of procedures. Those procedures included total hip replacement, total knee replacement, knee arthroscopy, bronchoscopy, pacemaker insertion, CABG surgery, upper GI endoscopy, transurethral and suprapubic prostatectomy, dilation and curettage of uterus, carpal tunnel release, and (again) cataract surgery. Prevailing charges for these procedures did not receive the 1988 Medicare Economic Index update; instead, 1987 prevailing charges were reduced by 2 percent. A sliding scale formula was then applied that further reduced each charge, based on its relationship with the national average. The higher the area prevailing charge relative to the national prevailing charge, the greater the reduction made to the area prevailing charge (with a maximum possible reduction of 15 percent). In no case was an area prevailing charge allowed to fall below a floor that was set at 85 percent of the national average. These reductions went into effect on April 1, 1988.