Summary

The Medicare system adjusts fee-for-service payments to hospitals and practitioners1 according to the geographic location in which providers practice, recognizing that certain costs beyond providers’ control vary between metropolitan and nonmetropolitan areas and also differ by region. The fundamental rationale for geographic adjustment is to create a payment structure that adjusts payments for input price differences that health care and institutions face, such as the cost of employee compensation.

Medicare provides health care coverage for 47 million Americans, including 39 million individuals who are 65 years of age and older and 8 million nonelderly people with permanent disabilities or end-stage renal disease. The Congressional Budget Office estimates that Medicare payments in 2010 will reach more than $500 billion. Total per capita Medicare spending is not evenly distributed across the country, and the proportion of beneficiaries living in metropolitan and nonmetropolitan areas also varies from state to state.

Because Medicare is a national program, policy makers and researchers working to develop and implement its payment systems have long recognized the need to adjust payment amounts to reflect input price differences across geographic areas of the United States. The geographic adjustments to Medicare fee-for-service payments are the hospital wage index (HWI) and the three geographic practice cost indexes (GPCIs).2

Geographic adjustments are intended to improve the accuracy of Medicare payments to providers in various areas of the country by accounting for the differences in prices for certain expenses (such as clinical and administrative staff salaries and benefits, rent, malpractice insurance, and other defined costs) from region to region. As a result, Medicare’s Inpatient Prospective Payment System (IPPS), other institutional prospective payment systems (other PPSs), and

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1 Unless otherwise specified, the term “practitioners” is used to describe both physicians and other eligible clinical providers who are permitted to furnish and bill Medicare under the Physician Fee Schedule (PFS). These include nurse practitioners, clinical nurse specialists, psychologists, social workers, and others.

2 In broad terms, an index compares differences in price or quantity for a group of services relative to an average value for a standard or baseline geographic area or time period.



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Summary T he Medicare system adjusts fee-for-service payments to hospitals and practitioners1 according to the geographic location in which providers practice, recognizing that certain costs beyond providers’ control vary between metropolitan and nonmetropolitan areas and also differ by region. The fundamental rationale for geographic adjustment is to create a payment structure that adjusts payments for input price differences that health care professionals and institutions face, such as the cost of employee compensation. Medicare provides health care coverage for 47 million Americans, including 39 million individuals who are 65 years of age and older and 8 million nonelderly people with permanent disabilities or end-stage renal disease. The Congressional Budget Office estimates that Medicare payments in 2010 will reach more than $500 billion. Total per capita Medicare spending is not evenly distributed across the country, and the proportion of beneficiaries living in metropolitan and nonmetropolitan areas also varies from state to state. Because Medicare is a national program, policy makers and researchers working to develop and implement its payment systems have long recognized the need to adjust payment amounts to reflect input price differences across geographic areas of the United States. The geographic adjustments to Medicare fee-for-service payments are the hospital wage index (HWI) and the three geographic practice cost indexes (GPCIs).2 Geographic adjustments are intended to improve the accuracy of Medicare payments to providers in various areas of the country by accounting for the differences in prices for certain expenses (such as clinical and administrative staff salaries and benefits, rent, malpractice insur- ance, and other defined costs) from region to region. As a result, Medicare’s Inpatient Prospec- tive Payment System (IPPS), other institutional prospective payment systems (other PPSs), and 1 Unless otherwise specified, the term “practitioners” is used to describe both physicians and other eligible clinical providers who are permitted to furnish and bill Medicare under the Physician Fee Schedule (PFS). These include nurse practitioners, clinical nurse specialists, psychologists, social workers, and others. 2 In broad terms, an index compares differences in price or quantity for a group of services relative to an average value for a standard or baseline geographic area or time period. 1

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2 GEOGRAPHIC ADJUSTMENT IN MEDICARE PAYMENT the Medicare Physician Fee Schedule (PFS, or fee schedule) all employ geographic adjustment factors (GAFs). Although there is widespread agreement about the importance of providing accurate payments to providers, there is considerable and long-standing disagreement in the provider community and among policy makers about how best to adjust payments based on geographic location. In two public sessions, the committee heard testimony from critics of the existing geographic adjusters who identified a number of questions and concerns and who believe that the current adjusters are not treating them fairly. Among their stated concerns are problems and inconsistencies with the definitions of payment areas and labor markets, concerns about the relevance and accuracy of the source data for determining area wages and other input prices, questions about the occupational mix used to create the hospital wage and physician practice expense adjustments, and criticisms about the lack of transparency of index construction. These and other concerns regarding the current system for geographic adjustment are conceptually complex, widely disputed, and often contentious. With a goal of improving this system, the U.S. Department of Health and Human Services (HHS) and the U.S. Congress sought advice from the Institute of Medicine (IOM) on how to best address concerns about the accuracy of the data sources and the transparency of the methods used for making the geographic adjust- ments in payments to providers. The IOM was also asked to assess the impact of geographic adjustment on the workforce in metropolitan and nonmetropolitan areas, beneficiaries’ access to care, and the ability of providers to provide high-value, high-quality care. SCOPE OF THIS STUDY This is the first of two reports to the Secretary of HHS and the U.S. Congress. This report focuses primarily on accuracy of measuring input prices for fee-for-service Medicare Part A and Part B payments. It includes a review of the data sources used to calculate the HWI and the GPCIs and for defining the payment areas used for each index, but it does not include a review of the accuracy of payments to facilities other than short-term acute care hospitals, such as skilled nursing facilities (SNFs) or home health agencies (HHAs). In its phase 2 report, scheduled to be released in the spring of 2012, the committee will consider the role of Medicare payments in addressing matters such as the distribution of the health care workforce, population health, and the ability of providers to produce high-value, high-quality health care. To assist with the quantitative aspects of data accuracy and methodological assessments and to model the impact analysis, the IOM engaged RTI International as consultants to the committee because of its extensive previous work on the HWI and the GPCIs. RESEARCH FRAMEWORK FOR THE STUDY After evaluating its charge (see Box S-1), the committee developed a framework with a series of research questions to help guide its work and decision-making. Understanding that its recommendations must be objective, well-supported by empirical evidence, and understandable to stakeholders, the committee undertook a systematic review of current and alternative data sources and methods for making geographic adjustments. This included:

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3 SUMMARY BOX S-1 Statement of Task An ad hoc committee will conduct a comprehensive empirical study on the accuracy of the geographic adjustment factors established under Sections 1848(e) and 1886(d)(3)(E) of Title XVIII of the Social Security Act and used to ensure that Medicare payment fees and rates reflect differences in input costs across geographic areas. Specifically, the committee will • valuate the accuracy of the adjustment factors; E • valuate the methodology used to determine the adjustment factors; and E • valuate the measures used for the adjustment factors for timeliness and frequency of E revisions, for sources of data and the degree to which such data are representative of costs, and for operational costs of providers who participate in Medicare. Within the context of the U.S. health care marketplace, the committee will also evaluate and consider: • he effect of the adjustment factors on the level and distribution of the health care T workforce and resources, including recruitment and retention, taking into account m obility between urban and rural areas; ability of hospitals and other facilities to main- tain an adequate and skilled workforce; and patient access to providers and needed medical technologies; • he effect of adjustment factors on population health and quality of care; and T • he effect of the adjustment factors on the ability of providers to furnish efficient, T high-value care. A first report will address the issues surrounding the adjustment factors themselves, and then a second report that evaluates the possible effects of the adjustment factors will follow. The reports, containing findings and recommendations, will be submitted to the Secretary, U.S. Department of Health and Human Services (HHS), and the U.S. Congress. • Reviewing the existing data sources and methods used to calculate the HWI and the GPCIs, as well as considering recommendations in previous studies that have proposed changes in data sources or methods; • Examining the conceptual foundation for the geographic areas used in the HWI and GPCI adjustment process; • Considering previous recommendations about the accuracy of alternative data sources through a series of statistical comparisons of those data with the data currently being used; • Assessing the nature and extent of geographic variation in the prices for each input; • Conducting a series of simulations to determine the impact on stakeholders of using different data sources and methods for computing the indexes; • Evaluating the cost shares for both indexes; and • Choosing the most appropriate and best available data source and method for each input and each index.

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4 GEOGRAPHIC ADJUSTMENT IN MEDICARE PAYMENT PRINCIPLES AND ASSUMPTIONS Committee members made an early commitment to focus first on the committee’s charge to study the accuracy of the geographic adjustment established under Sections 1848(e) and 1886(d)(3)(E) of Title XVIII of the Social Security Act. To help guide its review and deliberations, the committee developed the following general principles. Evidence for adjustment. The continued use of geographic adjustment factors in Medicare payment is warranted to reflect geographic variations in input prices. Public testimony and written comments to this committee, along with extensive public com- ment to the Centers for Medicare and Medicaid Services on the proposed revisions to the PFS Rules in 2010, revealed clear differences of opinion about how the study should be conducted and what the committee should recommend. However, one area of agreement among stake- holders was the need to rebuild the system and to improve the accuracy of the data sources and methods used in making geographic adjustments. The committee begins its deliberations by examining the extent of geographic variation in input prices faced by hospitals and practitioners. Although the availability of sufficient representative data on practitioner compensation and practice expenses was particularly problematic and the data sources available for determining wages for the HWI had certain shortcomings, the committee agreed that the overall evidence and rationale for geographic adjustment were strong enough to warrant its continuation. To help improve the current system, the committee focused on ways to improve the data sources and methods used. 2. Accuracy. Geographic adjustment for input price differences is intended to reflect the input prices faced by providers, not the costs incurred by providers. “Accuracy” of data sources can be defined as the degree of closeness of measurements to the true value of whatever is being measured. The committee recognizes that stakeholders have different perspectives about the accuracy of data sources, and it supports moving toward a more systematic process of geographic adjustment that more accurately reflects differences in input prices across labor markets. Although the committee recognizes that every currently available data source has certain deficiencies, the committee agrees that data sources can be improved by holding the data producers to standards of accountability and accuracy in sampling, analysis, and reporting, and by making the data and data collection methods more transparent to users. The committee heard testimony from hospital administrators and clinical practitioners who believe that hospital cost reports or actual practice expense data are both more understandable and more transparent to the provider community and a more accurate reflection of their actual business costs than some of the proxy data sources currently proposed or in use. However, the committee generally concluded that independent data that reflect input prices faced by provid- ers are conceptually more appropriate than are data on costs paid by the providers, given that actual costs also reflect local business decisions or requirements that do not necessarily reflect input prices across labor markets. 3. Local labor markets. Geographic adjustment, where possible, should reflect area-wide input prices for labor faced by all employers operating in the same

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5 SUMMARY local market and should not be drawn exclusively from data on the prices paid by hospitals or health care practitioners. To improve accuracy and reflect market prices faced by providers, geographic adjustment should reflect the local labor markets in which providers operate and compete for employees. The committee recognized that such competition may exist between like entities (e.g., hos- pitals versus hospitals) and across different entities (e.g., hospitals versus ambulatory surgery centers). The committee concluded that broadening the employers whose employees would be included in calculating a wage index would be especially worthwhile in areas with few health care providers (e.g., single-hospital markets). On balance, the committee agreed that labor market data should not be drawn exclusively from hospital and provider sources, yet it also recognized that some categories of personnel are employed primarily in health care settings (e.g., nurses). In addition, the committee was concerned that certain employees in health care and other employment settings may not be identical according to their training and scope of service. In developing recommendations about data sources for the HWI and GPCIs, the committee members compared an independent source of wage data for all-industry, health care sector, and hospital-specific wages for several occupational categories and found a very high degree of correlation between health care sector wages and wages from the other data sources. As a result, the committee found a strong conceptual rationale for using health sector data rather than industry-wide data to help improve accuracy in adjustments and to respond to concerns expressed by stakeholders. 4. Consistent criteria. Consistent criteria should be used for determining the payment areas, data sources, and methods that are used in making the geographic adjustment for hospitals and practitioners. Currently, Medicare payment to hospitals is based on their location in 1 of 441 labor markets (365 metropolitan statistical areas [MSAs] and 76 non-MSAs). In contrast, physician and other practitioner payments are adjusted across 89 payment areas, with 34 statewide areas having both metropolitan and nonmetropolitan areas and the remainder being centered on large metropolitan areas. The committee understands the history leading to these geographic designations, yet it found little compelling evidence that the actual labor markets for physicians and hospitals are different. Because hospitals, physicians, and other practitioners in a given geographic area tend to function within the same local labor markets, the committee sees benefits to using the same defined payment areas for both hospitals and practitioners. In view of market and policy trends toward increasing degrees of coordination and integration between hospital and ambulatory care, this appears to be both reasonable and timely. 5. Sound rationale. Changes in the current system of geographic adjustment should be based on a clear and logical rationale. Throughout its deliberations, the committee sought to make internally consistent deci- sions that were logically valid, clearly supported by empirical evidence, and understandable to nontechnical audiences. The HWI and the GPCIs have been subject to many changes since

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6 GEOGRAPHIC ADJUSTMENT IN MEDICARE PAYMENT they were first introduced, yet they have been considered separately both in statute and in implementation. There have been many previous recommendations for improvements to both indexes over several years. The committee noted that a number of improvements could be made to both indexes through a similar strategy or data source. 6. Transparency. The geographic adjustment process should provide sufficient information to allow transparency and empirical review of the data and methods used to make the adjustments. The committee worked to develop recommendations to improve the accuracy of the current data sources and methodologies and provide a clear explanation of its reasoning for recom- mending selected data sources and methodologies to improve accuracy. Whenever possible, the committee sought to simplify the methodologies used for geographic adjustment, to use clear language to explain complex technical formulas and concepts, and to promote a reasonable and objective selection of data sources that maximize accuracy. 7. Policy adjustments. Medicare payment adjustments related to national policy goals should only be made through a separate and distinct adjustment mechanism, and not through geographic adjustment. Medicare provider payments should be adjusted on the basis of the services that they provide and the prices that they face. The committee responded to its charge for this report by focusing first on the accuracy of payments based on the market conditions and input prices that providers face in fee-for-service settings. The statement of task also asks the committee to consider the impact on stakeholders of any recommendations to change the current system of geographic adjustment. The commit- tee heard testimony from practitioners and policy makers who view geographic adjustments in fee-for-service Medicare payment as a way to help address provider shortages and achieve other policy goals. Throughout their deliberations, committee members also recognized that even the most accurate geographic adjustment factors will not resolve all problems associated with the fee-for-service payment system as they relate to issues such as access to care, provider shortages, and provider mix. The committee recognizes the importance of these issues and will examine policy adjustments and their impact on stakeholders further in its phase 2 report. ORGANIZATION OF THE REPORT Chapter 1, Introduction and Overview, includes an overview of the Medicare program, a brief history of the approaches to geographic adjustment, and a description of the committee’s approach to the study, including its principles and technical considerations. Chapter 2, Labor Markets and Payment Areas, describes the conceptual framework for the committee’s recommendations on changing the payment areas used for geographic adjustment. It provides a brief overview of labor markets, and then explains the committee’s findings on how well existing payment areas perform in differentiating providers when based on prevailing wages. Finally, the chapter lays out alternative market designations that the committee consid- ered and explains the committee’s recommendation for using MSAs and statewide non-MSAs as the basis for labor markets for both physicians and hospitals.

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7 SUMMARY Chapter 3, Hospital Wage Index, describes what the index is intended to accomplish and explains how it is calculated. The chapter also reviews the different data sources that have been used in the past, and assesses the advantages and disadvantages of using alternate data sources, including their timeliness, accuracy, and transparency to stakeholders. Finally, the chapter includes recommendations about using Bureau of Labor Statistics (BLS) health care industry wage data (instead of hospital cost survey data reported to CMS), expanding the use of BLS data collection to include benefits, and expanding the number of occupations included as inputs in the wage index, each with a fixed national weight. Chapter 4, Smoothing the Borders of Labor Markets and Payment Areas, compares differ- ent approaches to smoothing the differences in the wage indexes when neighboring hospitals competing in the same labor market have different wage indexes. The chapter recommends the use of commuting patterns of health care workers to compute the HWI and the practice expense component of the GPCI applying to employee wages. This approach would replace the current system of reclassification. Chapter 5, Geographic Practice Cost Indexes, describes the history, intent, and evolution of the GPCIs. It explains the three GPCI components: physician work; practice expense, including employee wages and rent; and professional liability, or malpractice insurance. The chapter also reviews concerns about the accuracy and appropriateness of the methods and sources of data used to calculate the GPCIs that stakeholders have expressed. After reviewing several sources of data for each GPCI component and discussing the ways in which the GPCIs are calculated, the committee made seven recommendations regarding national cost share weights; a full range of occupations in the practice expense component; geographic adjustment for certain nonclinical labor-related expenses; new data sources for office staff wages and office rent; and a new method for setting the work adjustment. Chapter 6, Transitions, is a summary of the goals of the study, themes of the committee’s deliberations, and key features of its technical approach. The chapter then makes some obser- vations about what the committee’s recommendations were intended to accomplish overall and its plans for the second phase of the study. The final section looks ahead to some broader trends in the health care industry that are already under way and could have an influence on the way in which the committee’s recommendations are implemented over the next 3 to 5 years. RECOMMENDATIONS Chapter 2: Labor Markets and Payment Areas Recommendation 2-1: The same labor market definition should be used for both the hospital wage index and the physician geographic adjustment factor. Metro- politan statistical areas and statewide nonmetropolitan statistical areas should serve as the basis for defining these labor markets. The current system of geographic adjustment for hospitals uses 441 labor markets to define payment areas. Hospitals are classified according to their location in 365 metropolitan statisti- cal areas, with the balance of nonmetropolitan counties grouped into rest-of-state areas. The geographic adjustment system for physician payment uses 89 payment areas, some of which comprise large metropolitan areas, whereas 34 are statewide with combinations of metropolitan and nonmetropolitan areas. The committee recommends using the same labor market definition

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8 GEOGRAPHIC ADJUSTMENT IN MEDICARE PAYMENT for both indexes, to reflect market integration for health care employers and workers in local markets. The committee acknowledges that moving from 89 to 441 physician payment areas could result in some areas with small sample sizes. To address this potential problem, certain areas could be combined, additional data could be collected, or data-smoothing techniques using information from adjoining areas could be used. Recommendation 2-2: The data used to construct the hospital wage index and the physician geographic adjustment factor should come from all health care employers. The current payment systems use wage data from different sources: some directly from pro- viders (e.g., hospital cost reports and physician surveys) and others that are more independent, such as census data. After comparison of hospital-only, health care sector, and industry-wide wage data, the committee concluded that the health sector data from the Bureau of Labor Statistics would be the most accurate and conceptually appropriate data source for both of the indexes. Chapter 3: Hospital Wage Index Recommendation 3-1: The U.S. Congress should revise the hospital wage index statute (Section 1886[d][3][E] of the Social Security Act) to allow the Secretary of the U.S. Department of Health and Human Services to use data from the Bureau of Labor Statistics (BLS) to compute the wage index. Currently, hospital cost survey data reported to Centers for Medicare and Medicaid Ser- vices (CMS) are used to calculate the wage index. The committee recommends that the BLS health care industry wage data be used as an independent source to improve the accuracy of the index, given that BLS data are collected at the occupational level and every occupation can be incorporated into the index. Because every occupation is measured, the average hourly wage in each area can be weighted by a fixed number of hours for each occupation. The fixed weighting allows the index to reflect the price of labor, not the reported cost of labor, which the committee views as an improvement in accuracy. If the use of BLS data were to change total payments, CMS will need to make a budget neutrality adjustment to recalibrate the wage index, as required by law. Recommendation 3-2: The Centers for Medicare and Medicaid Services (CMS) should establish an ongoing agreement with the Bureau of Labor Statistics (BLS) to use all necessary wage data from the Occupational Employment Statistics to compute the wage index. Compensation includes wages as well as benefits, and CMS will need access to the unpub- lished BLS data to accurately compute the wage index. Several options for arranging CMS access to BLS data are available, including having BLS calculate wage index values for CMS. These are implementation details for CMS to work out.

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9 SUMMARY Recommendation 3-3: The committee recommends use of all occupations as inputs in the hospital wage index, each with a fixed national weight based on the hours of each occupation employed in hospitals nationwide. Currently, a limited number of occupations are included in the computation of the wage index. The use of all occupations in the health care workforce will more accurately reflect the broad range of health care professions and skills, and it will also reflect the increasing integration of care provided in hospitals, outpatient clinics, office-based practices, and other clinical settings. Recommendation 3-4: The Centers for Medicare and Medicaid Services (CMS) should apply the proposed hospital wage index to facilities other than short-term acute care hospitals, using nationwide occupation-specific weights derived from data for each type of facility. The hospital wage index is currently applied to non–Inpatient Prospective Payment System (IPPS) facilities, such as skilled nursing facilities, home health agencies, and ambulatory surgical centers, but it does not accurately reflect the wage levels that these providers face because they have a different labor mix. To improve the accuracy of the price indexes, CMS should use the respective labor shares and occupation-specific weights from each setting. Chapter 4: Smoothing the Borders of Labor Markets and Payment Areas Recommendation 4-1: The committee recommends that wage indexes be adjusted by using formulas based on commuting patterns for health care workers who reside in a county located in one labor market but commute to work in a county located in another labor market. As described earlier, the current geographic adjustment system uses different labor market definitions and payment areas for hospitals and physicians. To streamline the system and improve accuracy, the committee has proposed using metropolitan statistical areas and non- metropolitan statistical area definitions for labor markets and payment areas in the future (see Recommendation 2-1). However, if the wage or other geographic practice cost index values are very different on either side of these defined borders, a process will be needed to smooth the boundaries in recognition of the fact that labor markets cannot classify all providers with complete accuracy. The commuting patterns of health care workers should be used as part of the smoothing adjustments because they are an indication of economic integration of labor markets across their geographically drawn boundaries. Smoothing adjustments based on commuting patterns can be implemented in several ways, but implementation will require determination of whether a minimum threshold should be applied, whether commuting patterns to lower- or higher-wage areas should be used, and whether the cost differences should be adjusted nationally or locally. The committee favored an outmigration adjustment, in which workers living in the county where a hospital is located are commuting to work in other hospitals located in areas with a higher wage index, because a precedent in using that type of adjustment already exists. However, the full range of options should be reviewed by the U.S. Department of Health and Human Services.

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10 GEOGRAPHIC ADJUSTMENT IN MEDICARE PAYMENT Recommendation 4-2: The committee’s recommendation (4-1) is intended to replace the system of geographic reclassification and exceptions that is currently in place. The committee believes that its recommendation will improve accuracy and that smooth- ing will decrease the need for reclassifications and exceptions. However, smoothing is not a replacement for index floors, which are policy adjustments rather than adjustments to improve accuracy. These and other policy adjustments will be considered as part of the phase 2 report. Chapter 5: Geographic Practice Cost Indexes Recommendation 5-1: The Geographic Practice Cost Index (GPCI) cost-share weights for adjusting fee-for-service payments to practitioners should continue to be national, including the three GPCIs (work, practice expense, and liability insur- ance) and the categories within the practice expense (office rent and personnel). Geographic adjustments should be made for the prices of inputs that are purchased and/ or produced locally and that vary from the national average. Inputs that are purchased in a national market without systematic variation in prices across geographic areas should not be adjusted geographically. In future Physician Fee Schedule (PFS) updates, the Centers for Medicare and Medicaid Services (CMS) should take steps to ensure accuracy in distinguishing between national and local market input prices. The statutory requirement to use the Medicare Economic Index (MEI) cost-share weights as the source of GPCI cost-share weights is reasonable and should be continued. Recommendation 5-2: Proxies should continue to be used to measure geographic variation in the physician work adjustment, but the Centers for Medicare and Medicaid Services (CMS) should determine whether the seven proxies currently in use should be modified. Geographic variations in the price of physician time can be measured in two ways: by directly measuring variation in physician income, or by using income data from proxy occu- pations as indicators of variations in physician income. In keeping with its principles about accuracy and independence of data sources, the committee prefers an independent source of data that reflects geographic variation in compensation levels for comparable professions rather than using physician compensation data that are affected by Medicare’s payment adjustments. Therefore, the continued use of proxy data for rate-setting to avoid the circularity of using physician income data is appropriate. However, in keeping with its principles of accuracy, con- sistency, and transparency of data sources, the committee recommends that CMS empirically reevaluate the accuracy of the seven proxies it currently employs using the most current BLS Occupational Employment Statistics (OES) data. The statistical process for this assessment is described in detail in Appendix I. The committee recognizes that this empirical approach is conceptually challenging because there is no obvious “gold standard” against which the proxy-based estimates can be judged. Although the committee does not favor basing the geographic adjuster on actual physician incomes in each area, it would be useful to assess the extent to which the proxy-based esti-

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11 SUMMARY mates are related to variation in physician compensation among geographic areas on a national basis. This process would validate their status as proxies. If the proxy data were not found to have predictive value for physician compensation, CMS might compare the predictive value of physician salary data from several different sources, such as the Medical Group Management Association (MGMA) and the American Community Survey (ACS). A proposed methodology for such a reevaluation using statistical modeling is discussed in the section on the physician work adjustment and is described in Recommendation 5-3 and Appendix I. Recommendation 5-3: The Centers for Medicare and Medicaid Services (CMS) should consider an alternative method for setting the percentage of the work adjustment based on a systematic empirical process. The committee recommends that the work adjustment should be based on a systematic empirical process that generates new evidence to predict the extent of differences in compen- sation across geographic areas. There is clearly a policy precedent for the current one-quarter adjustment, given that the GPCIs have been updated six times since the Physician Fee Schedule was implemented, and the “quarter work” adjustment has been in place by law throughout all of the updates. Many will view that precedent as adequate justification for continuing the same approach. The committee members did not think there is an adequate conceptual justification for choosing that level of adjustment. However, based on the available empirical evidence, the committee found inadequate grounds to determine a more appropriate level for the adjustment. The committee therefore advises CMS to test various statistical models using multiple regression, a versatile technique that allows testing and modeling of multiple independent or explanatory variables to predict a dependent or outcome variable (see Appendix I for more detail). Once the necessary data are assembled, CMS has reviewed the data to ensure that they are credible, and the model is estimated, CMS would determine the empirically derived percent- age for the work adjustment by using the model that provides maximum explanatory power. Several alternative data sets could be used for the modeling, each with different strengths, weaknesses, and predictive power. At a minimum, the wage index data used in the modeling would have to be adjusted to control for specialty mix, relative value units (RVUs), and residency training status to ensure that the variability in wages attributable to these non-geographical factors would not affect the geographic adjuster based on the models. While the committee strongly supports an empirical approach to determining the work adjustment, it also acknowledges that it is impossible to determine in advance how much predictive power the most appropriate statistical model may attain. If the correlations between the proxy occupation wages and the physician wages were found to be low or not statistically significant, for example, that might indicate that the factors determining physician wages are too distinctive to be adequately captured by this methodology. The committee has considered the possibility that geographical variations in the market for physician services or in amenities (including professional amenities) valued by physicians might not parallel the corresponding variations for other professionals. If that were found to be the case, CMS would need to re- evaluate the use of the current proxies, as indicated in Recommendation 5-2. For purposes of modeling (but not rate-setting), CMS might also compare the predictive power of different sources of provider-generated data, such as physician salary data from Medical Group Manage-

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12 GEOGRAPHIC ADJUSTMENT IN MEDICARE PAYMENT ment Association (MGMA) surveys and American Community Survey (ACS) data, when they become available. Recommendation 5-4: The practice expense Geographic Practice Cost Index (GPCI) should be constructed with the full range of occupations employed in physicians’ offices, each with a fixed national weight based on the hours of each occupation employed in physicians’ offices nationwide. The committee finds that independent, health-care-specific data from the Bureau of Labor Statistics (BLS) provide the most conceptually appropriate measure of differences in wages for health professional labor and clinical and administrative office staff. Although acknowledging that there are some regional differences in occupational mix of employees in the limited data available, the committee prefers a consistent set of national weights applied to wage data from the full range of health sector occupations so that hourly wage comparisons can be made. The exceptions are those health professionals who bill independently under Medicare Part B, whose compensation should be captured through the work geographic practice cost index. The expanded set of occupations will be a better reflection of the current workforce and a broader range of health professions, which will help to improve accuracy of the adjustment. In addition, the expansion will anticipate future changes in the workforce brought by changes in the labor market, including the increasing demand for expertise in the adoption and use of health information technology. Further study of the mix of occupations by specialties will be valuable to determine whether geographic differences in approaches to clinical service integra- tion and care teams should be addressed in future assessments of the geographic adjustment factors. Recommendation 5-5: The Centers for Medicare and Medicaid Services (CMS) and the Bureau of Labor Statistics (BLS) should develop a data use agreement allow- ing BLS to analyze confidential BLS data for CMS. The committee recommends that the data source for office staff wages should be all health sector employers’ wages and benefits data from the Bureau of Labor Statistics. Comparable to the analyses and recommendations about the Hospital Wage Index (HWI), the committee con- cluded that independent data that reflect market prices faced by providers are more appropriate than provider data on costs paid, because actual costs also reflect business decisions that are not necessarily an accurate reflection of input prices. Further, the committee concluded that independent data on health sector wages would be a closer proxy to physicians’ office staff wages than all-industry data from BLS. The committee recognizes that there is a need to increase coverage in areas where current data are not made available in public data files by BLS because of the need to protect confiden- tiality. Some areas have a very small number of providers; thus, increased sampling to improve accuracy may not be possible. A data use or other formal agreement between CMS and BLS would allow additional analyses to be conducted in the interest of improving transparency. Using all occupations instead of a limited number would be new, but BLS could compute an index that includes all data, including those data that are suppressed due to confidentiality.

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13 SUMMARY Recommendation 5-6: A new source of data should be developed to determine the variation in the price of commercial office rent per square foot. The committee reviewed several available sources of data to determine whether an accurate alternative is available to replace the U.S. Department of Housing and Urban Development (HUD) residential data that are currently used in the practice expense geographic practice cost index. These included rental data from the American Housing Survey (U.S. Census Bureau and HUD), the General Services Administration (GSA), The Basic Allowance for Housing (U.S. Department of Defense [DOD]), the U.S. Postal Service (USPS), the Medical Group Management Association (MGMA) Physician Cost Survey, and REIS, Inc. Each of these sources yielded a substantially different index, which indicates that they may not be representative of the market in which physicians rent space. They also collected and reported data differently (e.g., monthly rent v. price per square foot), which made comparisons difficult. Based on the limitations associated with each data source, such as low response rates, small sample sizes, and sample bias, the committee concluded that all of these sources would be imperfect or geographically incomplete proxies for variation in physician office rental costs. Because the committee also concluded that the cost of space is not adequately measured with residential data, the committee recommends the development of a new data source. Recommendation 5-7: Nonclinical labor-related expenses currently included under practice expense (PE) office expenses should be geographically adjusted as part of the wage component of the PE. The update for the physician payment rule proposed for comment in July 2011 included setting several labor-related expenses to a national index. These included occupations in the “All Other, Labor-Related” category (e.g., security guard and janitor) and the “Other Professional Expenses” category (e.g., accountants and attorneys). The Centers for Medicare and Medicaid Services (CMS) proposed to create a new category for contracted/outsourced services for these labor categories and to create a new purchased services index. Including professional and other labor expenses in labor categories would promote consistency between labor-related hospital and physician payment adjustments, and it would also take into account geographic variations in wages for the services reflected in the Bureau of Labor Statistics (BLS) data. CONCLUSION The committee recommends a shift to one set of payment areas for both indexes: using one source of wage and benefits data for both indexes, finding a new source of commercial rent data, including a more inclusive range of occupations in computing both indexes, and geographically adjusting certain additional nonclinical labor-related expenses. The committee also recommends a new method for setting the physician work adjustment based on a sys- tematic empirical process that generates new evidence to confirm differences in compensation across geographic areas. Taken together, these recommendations will mean a significant change in the way that the indexes are calculated and will require a combination of legislative, rule-making, and adminis- trative actions as well as a period of public comment. If the use of new data sources changes the total payments, CMS will need to recalibrate the payments to maintain budget neutrality.

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14 GEOGRAPHIC ADJUSTMENT IN MEDICARE PAYMENT Any such transition should be managed strategically by phasing it in over time and communi- cating clearly with stakeholders at every step along the way. However, the advantages of long-term administrative simplification, reduced administrative burden, and improved consistency within the Medicare program outweigh the short-term disadvantages of moving forward with a change.