Allocating practice expense under the Medicare fee schedule

Health Care Financing Review, Spring, 1993 by Gregory C. Pope, Russel T. Burge

In the short run, practice expense percentages are necessarily based on historical practice cost, income, and revenue data that will be altered by the implementation or the MFS. The MFS's revaluation of work will also revalue practice expenses, which was one of PPRC's criticisms of the multiplicative allocation of practice expense. To overcome this limitation, each specialty's historical practice expense percentage could be adjusted for the average percentage revaluation of physician work by the MFS. We have not done so in the simulations reported in this article. Eventually, the PEPS can be updated with new, post-MFS physician survey data. In the long run, the PEPS should reflect the realigned relationship between physician work (income) and practice expenses as the MFS and other resource-based fee schedules are adopted.

Within specialty, the proposed method allocates practice expenses in proportion to physician work. An alternative is to allocate in proportion to physician time. Time has the advantages of being more objective and less subject to physician manipulation (Latimer and Becker, 1992). We believe!, however, that practice expenses are likely to be higher for those services characterized by greater work relative to time. The higher work services are generally procedural, and tend to require more supplies, equipment, and aides. In any case, work and time are highly correlated, so the choice between the two should not have a major influence on simulated fees.

An important addition to the method proposed here is an office or non-office site-of-service differential, which is discussed in a later section.

Relationship to Hsaio and PPRC Methods

If the PEP is redefined from a service-specific to a specialty basis, the method proposed here is equivalent to the practice expense allocation originally proposed by Hsaio. To see this, note that PEP = PE/GR where PE = practice expense, and GR = gross revenue. Then, 1/(1-PEP) = GRINI, where NI = physician net income. But GRINI = Hsaio's practice cost factor, PCF (as previously discussed), so the two formulas are equivalent.

As noted in an earlier section, the PPRC criticized Hsaio's original multiplicative approach to allocating practice expenses, preferring the additive formula that is now used in the MFS. However, one of PPRC's criticisms, that payments would vary by specialty, does not apply to the method simulated in this article. We use the service-specific practice expense percentages developed for the MFS to determine fees, rather than the specialty-specific percentages proposed by Hsaio.

Another of PPRC's criticisms of the Hsaio method, that practice expenses are determined only on a specialty basis and not on a service-specific basis, applies to the method used in this article as well. However, the much greater data requirements and expense of PPRC's service-specific methodology must be weighed against its potentially greater accuracy in measuring practice costs. It is an empirical question whether specialty PEPS can provide an adequate approximation to service-specific costs. PPRC considers about two-thirds of practice expense to be indirect costs. PPRC allocates indirect costs in proportion to the sum of physician work and direct costs, not unlike what is proposed here. This suggests that the specialty-based multiplicative method and PPRC's method may yield similar results for many services.