Practice expenses in the MFS: the service-class approach

Health Care Financing Review, Spring, 1995 by Eric A. Latimer, Nancy M. Kane

INTRODUCTION

The Medicare Physician Payment Reform Program (MPPRP) of 1989 established the MFS, based on Harvard University's resource based relative value scale (RBRVS), as the new basis of fee-for-service (FFS) payment for physician services under Medicare. The MFS maintains the coding of services according to the Current Procedural Terminology, Fourth Edition (CPT-4), but intends to make payment for those services resource-based. In other words, it intends to compensate physicians for their services in proportion to the resources that they expend in providing them. This is supposed to provide physicians with a "level playing field," giving them neutral economic incentives in their treatment decisions (Hsiao et al., 1988). In its current form, the MFS falls well short of that goal: Almost one-half of payments made are still based on historical Medicare charges.

The MFS is made up of three components. The largest, which accounts for about 54 percent of the fee, on average, is intended to compensate physicians for their work in providing a service (as defined by CPT-4). It is based on the RBRVS (Hsiao et al., 1992). A second component, accounting for only 5 percent of the fee, on average, compensates physicians for their malpractice insurance premium expenses. The third and final component, accounting for about 41 percent of the fee, on average, compensates physicians for other practice expenses. The malpractice and practice expense components are largely based on historical (i.e., pre-MFS) Medicare charges for services. They do not necessarily reflect expenses incurred in providing services (Physician Payment Review Commission, 1992). When the MPPRP was passed in 1989, neither the methods nor the data yet existed to produce resource-based malpractice and practice expense components. Recent legislation, however, requires that HCFA revise the practice expense component by January 1, 1998. The specific methodology that will be used to accomplish this has not yet been determined as of this writing.

The stakes are considerable: The evidence to date indicates that making the practice expense component resource-based could produce changes of 15 percent or more in Medicare fees for two-thirds of services, as well as changes of 10 percent or more in several specialties' Medicare incomes (Physician Payment Review Commission, 1992). In addition, many non-Medicare payers, especially State Medicaid programs and Blue Cross/Blue Shield plans, are replacing their usual, customary, and reasonable charge systems with fee schedules patterned after the MFS (Physician Payment Review Commission, 1993). Whatever revision Medicare adopts is likely to affect non-Medicare payers as well. Depending on what legislation (if any) emerges from Congress, the revision could have a more substantial impact still: Most proposals for an all-payer fee schedule are based on the MFS. Even capitation-based payment systems (payment made on a per capita rather than per service basis) are expected to incorporate explicit assumptions regarding resource-based values of services provided per enrollee.

Various proposals for redefining the practice expense component have been made, most notably by the Physician Payment Review Commission (1992). The service-class approach, which we propose here, significantly extends the methodological foundations that PPRC has laid. As background, we explain the construction of the current practice expense component in the MFS.

CURRENT CHARGE-BASED PRACTICE

EXPENSE COMPONENT

The MPPRP specifies that the practice expense relative value units (RVUs) for a service be computed by applying a service-specific practice cost percentage to the estimated 1991 national average Medicare-allowed charge for each service.

The practice cost percentage is computed by following several steps. First, the average percentages of physicians' gross revenues that go toward practice expenses are determined from national survey data for each specialty. The MFS uses American Medical Association (AMA) survey data, which indicate, for example, that 31.8 percent of general surgeons' gross incomes go toward practice costs, and 7.4 percent toward professional liability insurance. Second, using Medicare Part B data, the numbers of each type of service performed in 1989 are determined, and the proportions that each specialty accounts for are calculated. Such calculations could indicate, for example, that general surgeons perform 83 percent of service A, while obstetrician-gynecologists perform 17 percent. Third, using 0.83 and 0.17 as weights, a practice cost percentage is computed for each service. The practice cost share for general surgeons being 31.4 percent and that for obstetrician-gynecologists 38.0 percent, the practice expense percentage for service A ([PEP.sub. A]) is:

[PEP.sub. A] = (0.31 x 0.83) + (0.38 x 0.17) [PEP.sub. A] = 0.32.

The practice expense percentage for a service is then multiplied by the 1991 national average Medicare-allowed charge for the service to determine the practice share in dollars. If the national average Medicare-allowed charge for service A is $500, the practice expense share for that service is 0.32 x $500 = $160. The relative dollar amounts obtained determine the practice expense RVUs for each service.