Medicare Payment Policy:
March 1999 Recommendations of the
Medicare Payment Advisory Commission

Committee on Ways and Means,
Subcommittee on Health
U.S. House of Representatives

Gail R. Wilensky, Ph.D.
Medicare Payment Advisory Commission

March 2, 1999

Good morning Chairman Thomas, and members of the Subcommittee. I am Gail Wilensky, Chair of the Medicare Payment Advisory Commission (MedPAC). I am pleased to be here this morning to discuss MedPAC’s second annual report to the Congress on Medicare Payment Policy. This report contains the Commission’s recommendations on Medicare payment policy issues for fiscal year 2000. We will deliver another report in June that addresses other Medicare policy issues. These reports fulfill the legislative mandate we were given in the Balanced Budget Act (BBA) of 1997 to consider, develop, review, and advise the Congress on improvements to the program.

The Commission’s recommendations represent the collective judgement of MedPAC’s 15 commissioners, based on qualitative and quantitative analyses of the relevant issues, discussion of the findings and implications, and deliberations as to the appropriate policy responses. All of the recommendations were discussed at meetings open to the general public.


The Balanced Budget Act (BBA) of 1997 made widereaching changes to the Medicare program. The act established the Medicare+Choice program, which will allow new types of private health plans to offer new options for Medicare beneficiaries. It modified payment payment updates and mechanisms for Medicare+Choice plans, hospitals, and physicians, with the intent of slowing the rate of growth of Medicare spending and making payments for equitable across providers and geographic areas. The BBA also established or directed to be established new prospective payment systems for skilled nursing facilities, outpatient hospital departments, rehabilitation hospitals, and home health agencies.
Broadly speaking, the Commission’s recommendations address four topics: adequacy of payment updates, equity of payments across providers, technical and regulatory components of new payment mechanisms, and other issues related to payment concerning coverage and beneficiary cost-sharing.

For certain services whose payment updates are set in law—such as those provided by Medicare+Choice plans, inpatient hospitals under the prospective payment system, and physicians—MedPAC’s recommendations address whether the statutory updates are appropriate. In general, the Commission finds the updates to be appropriate and does not recommend changes to the law. In the case of payment for physician services, however, the Commission recommends increasing spending allowed under the Sustainable Growth Rate mechanism to accommodate changes in technology and making technical changes to the mechanism to avoid large swings in payment updates.

MedPAC addresses the issue of payment equity across providers in a number of ways. The Commission supports the introduction of a new risk adjustment system for Medicare+Choice plans. We recommend a new method of making payments to hospitals that treat a disproportionate share of low-income beneficiaries. We also recommend changing payment methods for services provided in hospital outpatient departments and by physicians to account for differences in the health status of patients that may affect the costs of treating them.

For services that the BBA directed to be paid under new prospective payment systems, MedPAC’s recommendations are addressed to the Secretary of Health and Human Services and to the Congress as appropriate given the stage of development of the new system. We recommend technical changes in regulations that would make payments more equitable within provider groups and more consistent across types of providers. For example, the Commission supports the Secretary’s efforts to develop a case-mix system that better accounts for use of services other than therapy. The Commission also supports developing a common unit of payment across providers of post-acute care.

With respect to other issues, MedPAC’s key recommendations concern services provided in outpatient hospital departments and by home health agencies. For the former, MedPAC recommends accelerating the so-called coinsurance buydown provided for in the BBA. For the latter, we recommend clarifying eligibility guidelines for receiving home health services and instituting cost-sharing.


MedPAC’s recommendations are based on the principle that Medicare’s payment policies should ensure that beneficiaries have access to medically necessary care of reasonable quality in the most appropriate setting while not spending more than is required to achieve that goal. This principle implies that payment rates must be consistent with the costs of efficiently providing the necessary level of care, offering fair payment to providers while not interfering with clinical decisions as to the amount of care or the setting in which it is provided.

The Commission’s recommendations address the following areas:

the Medicare+Choice program;

the acute care hospital inpatient prospective payment system;

payments for facilities exempted from the acute care prospective payment system;

developing new payment systems for post-acute care providers;

modifying payment for services provided in ambulatory care facilities;

continuing reform of the Medicare fee schedule for physicians; and

the composite rate for outpatient dialysis services.

The Medicare+Choice program

One of the major initiatives of the BBA was to make a wider variety of private health care coverage options available to Medicare beneficiaries by expanding the previous risk contracting program into Medicare+Choice. However, changes in the way the payment rates are determined, the establishment of new regulations in implementing the program, and concurrent trends in the health insurance environment have resulted in the availability of few new options and, in fact, a decline in the number of Medicare risk plans.

It is too soon to tell whether the recent departures from Medicare stem from systematic problems with the level or distribution of payment, but we plan to monitor this situation further in the next year. In the meantime, however, the Health Care Financing Administration (HCFA) should continue to work with the relevant parties to identify changes in specific regulations or other policies that would reduce the burden of compliance without compromising the objectives of the program. Two such changes include moving the deadline by which Medicare+Choice organizations must file their premiums and benefit packages and allowing them to vary their benefit packages by county within their service areas.

The Commission supports the Secretary’s plan to phase in, beginning in 2000, HCFA’s interim risk adjustment mechanism for Medicare+Choice payments, which is based solely on data from hospital admissions. As quickly as feasible, however, the risk adjustment mechanism should incorporate diagnosis data from all sites of care. These changes should improve the correspondence between payments to Medicare+Choice organizations and the costliness of their enrollees.

The acute care hospital inpatient prospective payment system

Although the annual updates to the operating payment rate under the Medicare hospital inpatient prospective payment system (PPS) already are set in law, MedPAC each year provides guidance to the Congress on the appropriate update for the upcoming fiscal year. Based on our ongoing analyses of the factors that determine year-to-year changes in hospital costs, we believe that the operating update for fiscal year 2000 that was enacted in the BBA—1.8 percentage points less than the increase in HCFA’s hospital operating market basket index—will provide reasonable payment rates. If the current market basket forecast holds, the update would be 0.7 percent.

The PPS capital payment rate update is set by the Secretary of Health and Human Services each year. The Commission’s recommendation on the PPS capital update for fiscal year 2000 is a range between 3.0 percentage points and 0.1 percentage points below the increase in HCFA’s hospital capital market basket index, which would be between -1.1 percent and 1.8 percent if the current forecast holds.

These recommendations are made in the context of evidence that the hospital industry has thus far successfully adapted to a more competitive market by changing its practice patterns and reducing its costs, but also out of concern that many of the major effects of the BBA are not yet fully evident. Therefore, reducing payment rates below the level prescribed in the BBA would not be prudent, at least for this year.

MedPAC also is recommending a revision in the methodology for providing extra payments to hospitals that care for a disproportionate share of low-income patients. These disproportionate share payments are made through a complex formula that determines a percentage add-on to each hospital’s PPS payments based on its location, size, certain other characteristics, and a measure of care to low-income people. The measure of care to low-income people, however, excludes uncompensated care and local indigent care programs, which represent a large share of the burden faced by many hospitals that treat low-income patients. Moreover, under the current formula, rural and small urban hospitals that treat a disproportionate share of low-income patients receive a much smaller adjustment (if any) than large urban hospitals with the same share. Our recommendations are intended to eliminate these flaws.

Payments for facilities exempted from the acute care prospective payment system

Certain types of hospitals and distinct part units of hospitals are exempt from the acute care PPS. These so-called PPS-exempt facilities are a diverse group that share a common Medicare payment method established by the Tax Equity and Fiscal Responsibility Act of 1982. They include rehabilitation, long-term, psychiatric, children’s, and cancer hospitals, and rehabilitation and psychiatric units in acute care hospitals. Each of these facilities is paid an amount based on its own costs in the payment year relative to a per-case target that depends on its costs in a base year, updated to the payment year.

MedPAC’s analysis of the factors that determine year-to-year cost increases for PPS-exempt facilities indicates that the update factor applied to the per-case targets in fiscal year 2000 should be increased by 0.4 percentage points more than in the formula prescribed in the BBA. The BBA also established a category-specific cap on the per-case targets for rehabilitation and psychiatric facilities and long-term hospitals but did not provide that these nationwide caps be adjusted for differences in input prices across areas. We recommend the correction of that technical oversight.

The BBA also required that Medicare implement a new payment system for rehabilitation facilities, and that the Secretary of Health and Human Services develop a proposal for long-term hospitals; it did not mention psychiatric facilities, however. MedPAC encourages additional research in case-mix classification for psychiatric patients, with an eye toward developing a PPS for them in the future.

Developing new payment systems for post-acute care providers

The BBA mandated substantial changes in Medicare payment policy for providers of post-acute care. In addition to the work on new payment systems for rehabilitation facilities and long-term hospitals discussed above, a PPS for skilled nursing facilities (SNFs) was implemented in July 1998 and an interim payment system for home health agencies was put in place in October 1997 until a PPS can be developed. To guide the development of consistent payment policies across post-acute care settings, MedPAC recommends that common data elements be collected to help identify and quantify the overlap of patients treated and services provided. Further, it is important to put in place quality monitoring systems in each setting to ensure that adequate care is provided in the appropriate site. We also support research and demonstrations to assess the potential of alternative classification systems for use across settings to make payments for like services more comparable.

The Commission has several recommendations intended to improve the PPS for skilled nursing facilities. More work is needed also in refining the classification system used in the PPS for skilled nursing facilities, particularly in its ability to predict the costs of nontherapy ancillary services. Alternative ways of grouping rehabilitation services provided in SNFs may also be called for, to reduce reliance on measurements of rehabilitation time. A method for updating the relative weights that determine how much facilities are paid for each type of patient is crucial as the system and the types of services that are provided change over time. In general, as better data become available with the new system, distortions in the base payment rates due to imperfections in the initial data and measures used should be detected and corrected. To avoid future problems, facilities must be accountable for accurately assessing patients’ needs and reporting the data used to determine payment for each case. Finally, the distribution of payments would be more appropriate if they were adjusted for geographic differences in labor costs using wage data from SNFs, rather than hospitals.

As systems for rehabilitation facilities and long-term hospitals are developed, a number of crucial decisions must be made. Among them is the unit of payment. MedPAC recommends that a per-discharge mechanism be adopted for rehabilitation services. A system currently exists that could serve as a basis for such an approach, perhaps with some modifications. We also recommend that, in choosing a patient classification methodology for a long-term hospital PPS, HCFA consider not only per diem but also existing and potential per-discharge approaches.

The interim payment system for home health agencies that was created in the BBA was the subject of a great deal of controversy in the year following its enactment. This controversy stemmed, in part, from the use of payment policy as a vehicle for curbing the rapidly rising cost of a benefit that was poorly defined. Although the debate appears to have subsided at least temporarily with recent changes in the system, MedPAC believes that more fundamental changes are necessary even as a new payment system is being developed. We urge the Congress, in consultation with the Secretary, to enact clearer eligibility and coverage guidelines for Medicare home health services. To understand better the content of home health visits, agencies’ bills should describe the specific services provided. Moreover, we recommend that an independent assessment of need be conducted for Medicare beneficiaries who receive extensive home health care to ensure that care is appropriately coordinated and suits the needs of the patient within the proscription of the benefit. Finally, modest beneficiary cost-sharing should be introduced for home health services; copayments should be subject to an annual limit, and low-income beneficiaries and those eligible for Medicaid should be exempt from this requirement.

Modifying payment for services provided in ambulatory care facilities

Spending for facility-based ambulatory care services has grown substantially since the early 1980s, in part because a combination of financial incentives and technological advances encouraged shifting of services that once were provided exclusively in the inpatient setting to hospital outpatient departments (OPDs), ambulatory surgical centers (ASCs), and physicians’ offices. Medicare pays for many of these services differently according to where they are provided. MedPAC offers several recommendations on making payments more equitable across settings and services.

The Commission makes several recommendations that apply to payment for ambulatory care in general. Consistent with the way that Medicare pays for physicians’ services, the unit of payment should be the individual service—that is, the primary service and the ancillary supplies and services integral to it—rather than a larger bundle of services. Accordingly, the relative costs of the individual service should determine payment, rather than groups of services taken together. In setting payment rates, the pattern of services and costs across ambulatory settings should be taken into account. Moreover, a single update mechanism, linking updates to spending growth across all ambulatory care settings, should be applied to the payment rates for each type of provider.

As required by the BBA, HCFA has proposed a new payment system for hospital outpatient services and major modifications to the payment system for ambulatory surgical centers. MedPAC recommends these changes be closely monitored to ensure that beneficiary access to appropriate care is not compromised in the face of substantial reductions in payments to hospital OPDs. In particular, payments should reflect the higher costs of treating certain types of patients. In the absence of adequate patient-level indicators, facility-level adjustments may be required for the time being. We are also concerned that loosening guidelines for determining whether a procedure is eligible for coverage in an ASC may lead to inappropriate changes in the pattern of service provision across ambulatory settings.

Although the BBA provided for a gradual reduction in the amount of beneficiary coinsurance for services provided in hospital outpatient departments, it will be years before that amount is reduced to a level comparable with that for similar Medicare-covered services. MedPAC recommends accelerating the reduction in this amount, with increased program spending being used to avoid further reductions in hospital payments.

Continuing reform of the Medicare fee schedule for physicians
The BBA mandated a number of changes in the Medicare fee schedule for physicians. Although the resource-based work component of the fee schedule has been in place for several years, HCFA recently began a phase-in of a new resource-based methodology for the practice expense component (which it intends to refine as it is used) and is developing revisions to the professional liability component. In addition, the BBA replaced the mechanism by which the payment rates for physician services are updated.

For some services, it is appropriate to pay a lower practice expense amount when physicians perform the service in facility-based settings outside the office. MedPAC recommends that a service-by-service approach be used to decide which services are subject to this site of service differential, rather than applying the same decision to entire groups of services. Services generally recognized as inappropriate to perform in a physician’s office should be paid at the lower facility practice expense level. In developing refinements to the practice expense, participants with a wide variety of relevant expertise should be included in the process.

The professional liability component of the fee schedule should reflect the risk involved in providing each service and, therefore, conform more closely to the notion of resource-based payment.

MedPAC also recommends several modifications to the sustainable growth rate (SGR) system enacted in the BBA for updating physician payment rates. These include revising the SGR to include measures of changes in the composition of Medicare fee-for-service enrollment to reflect cost increases due to desirable improvements in medical capabilities and technology and to correct for inaccuracies in the forecasts used in estimating the SGR each year. We also call for a reduction in time lags between the periods on which the various components of the SGR are based, and the earlier availability of estimated updates for each upcoming year.

The composite rate for outpatient dialysis services

MedPAC is required to recommend an appropriate update to the composite rate for outpatient dialysis services each year. The Commission’s analysis indicates that, although the dialysis industry has been profitable and firms continue to enter the market despite the lack of a significant update in the composite rate since it was established in 1983, costs have been approaching payments in recent years. We are concerned that further increases in dialysis costs relative to the payment rate may cause quality to deteriorate and, therefore, recommend that the rate be increased by between 2.4 percent and 2.9 percent. We also urge that the increasing emphasis on the quality of care received by dialysis patients continue, and efforts to collect and evaluate information on patient care and treatment patterns proceed.


In just over a decade, the first members of the so-called baby-boom generation will become eligible for Medicare. Policymakers have appropriately focused a significant amount of discussion on how to address Medicare’s future fiscal pressures and have learned that the choices will not be easy. But whatever the outcome of these discussions and any policy directions that emerge, Medicare also faces challenges in the short run as HCFA continues to implement the BBA, as new developments unfold in the market for health care, and as technologies and treatments evolve.

These short run challenges are inevitable because Medicare is an extraordinarily complex program. The program has 40 million beneficiaries, and it makes payments to hundreds of thousands of providers who deliver tens of thousands of different kinds of health care services and supplies. Whatever the outcome of the policy discussion about Medicare policy in the long run, the program’s payment policies for the foreseeable future must continue striving to ensure that the program’s aged and disabled beneficiaries have access to high quality, medically necessary acute care across the country.

To assist the Congress and HCFA in meeting this objective, MedPAC will monitor Medicare beneficiaries’ access to health care and examine what can be done to improve quality not only in Medicare+Choice, but also in the traditional fee-for-service program. The Commission will track developments as the Medicare+Choice program evolves, looking at the availability of plans, the impact of risk adjustment, and other payment policies. MedPAC will continue to analyze fee-for-service payment policies in a broad context that takes into account that health care services can increasingly be provided in different settings. This work will look not only at what constitutes a particular unit of payment, but how payments are currently updated using quite different methods. Finally, the Commission will continue to study the delivery of health care to the nonaged population to determine whether strategies that have evolved in private markets can help to inform Medicare policy.