4
Description of the Current Medicare Payment System and Its Historical Roots

Medicare currently pays for outpatient clinical laboratory tests according to a prospective system using a specific payment for each test or service, set separately in fee schedules for each of 56 geographic jurisdictions, and limited by a national cap. The current system has evolved over almost two decades, with many changes resulting from either legislative mandates or administrative decisions. It is an extremely complex system with no clear map to guide a newcomer. Hence the committee devoted considerable effort to collecting official documents and data and talking with experts from all aspects of the payment system.

INTRODUCTION

This chapter provides a guide to the current payment methodology and its historical roots, as well as a foundation for further analytical work in later chapters. Because payment policy for laboratory services is so deeply entwined with other policy issues such as how new tests are approved for marketing, assigned billing codes and Medicare coverage, and how claims are processed, the committee found that changes are needed in these areas to support the recommendations it makes about payment policy. To provide context for these recommendations, these issues are briefly reviewed. The final section of this chapter focuses on payment policy. It begins with a brief history of payment policy prior to the development of the current payment system, discusses how the current system evolved, and ends with a discussion of elements of the current payment system. These elements are used as a framework in Chapter 6 when payment alternatives are considered.



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Medicare Laboratory Payment Policy: Now and in the Future 4 Description of the Current Medicare Payment System and Its Historical Roots Medicare currently pays for outpatient clinical laboratory tests according to a prospective system using a specific payment for each test or service, set separately in fee schedules for each of 56 geographic jurisdictions, and limited by a national cap. The current system has evolved over almost two decades, with many changes resulting from either legislative mandates or administrative decisions. It is an extremely complex system with no clear map to guide a newcomer. Hence the committee devoted considerable effort to collecting official documents and data and talking with experts from all aspects of the payment system. INTRODUCTION This chapter provides a guide to the current payment methodology and its historical roots, as well as a foundation for further analytical work in later chapters. Because payment policy for laboratory services is so deeply entwined with other policy issues such as how new tests are approved for marketing, assigned billing codes and Medicare coverage, and how claims are processed, the committee found that changes are needed in these areas to support the recommendations it makes about payment policy. To provide context for these recommendations, these issues are briefly reviewed. The final section of this chapter focuses on payment policy. It begins with a brief history of payment policy prior to the development of the current payment system, discusses how the current system evolved, and ends with a discussion of elements of the current payment system. These elements are used as a framework in Chapter 6 when payment alternatives are considered.

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Medicare Laboratory Payment Policy: Now and in the Future Much of the research for this chapter is based on evidence provided by testimony to the committee, interviews and discussions with many individuals within the Health Care Financing Administration (HCFA), Medicare contractors, other federal regulators, and numerous members of the laboratory industry and their associations. In addition, it relies on reports and data from the committee’s consultants, the General Accounting Office (GAO), the Office of the Inspector General (OIG) of the Department of Health and Human Services (DHHS), and the Clinical Laboratory Improvement Act (CLIA) program. THE FDA APPROVAL PROCESS Before Medicare considers a new technology, the new test or technology must be reviewed by the Food and Drug Administration (FDA) to determine whether it is safe and effective. The FDA approval process does not consider costs, impact on disease treatment, or patient outcomes. In granting approval, the FDA is simply approving marketing. No representation is made to Medicare or any other insurer about whether the test is worth covering in its benefit package or how it should be used. Of the approximately 1,000 new clinical laboratory tests and technologies that come to the FDA for review annually, about 99 percent are considered substantially equivalent to existing tests (Silva, 2000). These receive an abbreviated review called a 510K Pre-Market Notification and are approved if their performance is approximately 90–95 percent the same as that of the existing, comparable test (Medical Device Act). The few new tests that are significantly different from existing tests go through a more extensive Pre-Market Approval (PMA) process. For a PMA, the manufacturer must prove, through clinical studies, that the new test or technology is safe and effective. CODING POLICY Laboratory services are billed using the HCFA Common Procedural Coding System (HCPCS). HCPCS codes include the physicians’ Current Procedural Terminology (CPT) codes, which are controlled and published by the American Medical Association (AMA), plus local and national temporary codes assigned by contractors and HCFA. Some of these codes are used for billing other payers besides Medicare. Coding Updates Each year, CPT code changes include the addition of new tests, new panels, or changes in the composition of panels including tests previously coded individually. HCFA receives the AMA’s CPT changes in July, although some are known months earlier. HCFA physicians and other staff review the code changes during the summer and begin “mapping” the changes, based on guid-

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Medicare Laboratory Payment Policy: Now and in the Future ance from the AMA. That is, they translate the location of an existing test (and its related code) in the previous coding system to its location in the updated codes, so that the previous fees can be attached to the new code. All changes have to be resolved by the end of October because the new fee schedule goes to the contractors on November 1 to allow them time to implement the changes before fees take effect at the start of the next calendar year. Panel Codes The AMA’s CPT Editorial Panel groups certain tests together for the convenience of physicians and claims processors. It has changed the composition of various panels several times since the mid-1980s, requiring corresponding changes in the payment system. For example, some time ago, the composition of multichannel test panels was changed to permit the inclusion of unrelated tests. This created problems because physicians were not aware that possibly unrelated and unnecessary tests were included in the panel and that those tests were billed separately to Medicare in addition to the standard panel of tests intentionally ordered. This opportunity for fraud and abuse was targeted by the Inspector General and the panels were redefined. The OIG also raised concerns about the medical necessity of all the tests billed in large panels and, in other cases, questioned the laboratories’ unbundling of panel tests to maximize payments by billing for each test individually. Now, panels include tests that either are all related to the analysis of a specific organ’s functions, are standard for the diagnosis of particular diseases, or are commonly ordered together for multiple diagnostic purposes. Nonetheless, the physician and the laboratory must not bill for an entire panel code unless the patient needs each test. If the full panel is not needed, the tests can be ordered individually. Codes for New Technology If a new test is similar in method or analyte (the substance being measured) to an existing test or combination of tests, it may be assigned the same code. At other times, a new test may be assigned a new code, but the payment amount for that code may be linked to an existing code or combination of codes. Tests that receive 510K approval from the FDA are more likely to be assigned an existing code. If a manufacturer believes a new test is significantly different from existing technology or has a significantly different cost than current payment rates for existing codes, the manufacturer is free to request a new code for the test from the AMA’s CPT Editorial Panel. Seeking a new code can be a time-consuming process and may slow the introduction of new technology. Alternatively, manufacturers may choose to disseminate new technology without a new CPT code, leaving laboratories to use a miscellaneous “catch-all” CPT code for billing purposes. Occasionally contractors or HCFA assign a local

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Medicare Laboratory Payment Policy: Now and in the Future or temporary HCPCS code for billing purposes. Some initially temporary codes, such as the code for venipuncture, have become permanent. Ambiguities in Code Use Although in concept there is a separate code for each service, in practice it does not always happen this way. Some codes refer to the analyte, such as a tumor antigen marker in blood, and may encompass several different measurement methods. Other codes identify a particular testing methodology, such as a generic immunoassay or generic tumor marker, rather than what is being measured. Thus, a single CPT code may identify more than one testing method for a given substance or more than one analyte measured by a single method. With more than 1,100 distinct codes, it is not always clear to a physician or laboratory how to identify a particular service, especially if it is new. In these situations, the CPT decision hierarchy indicates that (1) coding by analyte is the preferred choice, then (2) coding by methodology, and finally (3) the “99” code for “miscellaneous” is the last option. Some carriers either routinely deny claims from the miscellaneous category or set the payment rate for that code at $0.00. The ambiguities of the coding system create a challenge for any payment methodology. If there is uncertainty about exactly what is included under a particular code, it is difficult to know whether the fee or payment is appropriate. For some services, “apples and oranges” are combined under the same code, and the fee may be appropriate for the apple, but not for the orange. For example, if both available testing methods produce the same result in the same time frame, but vary substantially in cost, it is not a concern for Medicare as long as the fee reflects the less expensive version. The coding issue becomes more problematic when a new version of a test may produce a better-quality result or a faster turnaround time but costs substantially more than the payment amount linked to the code. CLAIMS PROCESSING Medicare contractors play a variety of important roles. They are the key link between the policymakers in HCFA headquarters and the laboratory providers. Their basic function is to receive and process claims and make payments. There are approximately 53 different contractors, some with multiple contracts, covering all of the 56 jurisdictions. The fiscal intermediaries (FIs), contractors for hospital-based laboratories, or the carriers, contractors for physician office laboratories (POLs) and independent laboratories, handle daily program operations. Because of their numbers and separate jurisdictions, their operations vary. This can cause problems for laboratories, primarily large independent and referral laboratories, that deal with specimens from many states. Based on industry urging, Congress included language in the 1997 Balanced Budget Act (BBA) requiring HCFA to consolidate its contractor functions for laboratories into four or five regional laboratory carriers (RLCs). One of the

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Medicare Laboratory Payment Policy: Now and in the Future RLCs is to be designated the Central Statistical Carrier (CSC) with added responsibility to provide analyses of laboratory claims and utilization issues. HCFA is now implementing this provision. The administration originally opposed the provision, in part because of the substantial additional expense to convert and operate the RLCs for the first five years. HCFA plans to have the regional laboratory carriers fully functioning within two years of resolving policy and operational issues. HCFA consolidated carriers for durable medical equipment (DME) suppliers in 1993, and they appear to be running smoothly, but there has not yet been an evaluation of the changes. HCFA reports that the DME consolidation has promoted greater consistency in program operations and led to better control of fraud and abuse. It is too soon to predict how the RLC consolidation will affect the clinical laboratory payment system. The success of this effort will depend on many policy decisions yet to be made, including the following: Will any categories of laboratory claims be excluded from the consolidation? Will hospital-based laboratories continue to bill the hospital’s fiscal intermediary? Will POLs continue to bill the physician’s carrier? Should local coverage policy remain or become consolidated at the regional level? What will the process be for creating future medical review policies? What entities should become RLCs and how will they be selected? How will regional claims data be consolidated to provide a stronger capability for detecting patterns of fraud and abuse? How will consolidation affect payment levels in different states? The way this consolidation proceeds, and how fast it occurs will have significant implications for the current payment methodology and any changes to be made to it. The committee anticipated this consolidation when it made its recommendations. Ideally, implementation of the recommendations in Chapter 7 should be planned in conjunction with plans for the RLCs. Many of the policy issues are interdependent, and the changes have to be coordinated carefully to avoid overloading the computer systems and all the stakeholders. MEDICARE COVERAGE POLICY Coverage policy is separate and distinct from payment policy, but directly affects the operation of the payment system.1 Payment for a particular service depends on Medicare recognition that the service is covered—that it is within the legislative mandate to provide medically necessary diagnostic and treatment services. Medicare specifically excludes some categories of health care, such as 1   “A Medicare coverage decision, whether made nationally or locally, is a prospective, population-based, policy that applies to a clinical subset or class of Medicare beneficiaries and describes the clinical circumstances and setting under which an item or service is available (or is not available)” (Medicare Program, 2000).

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Medicare Laboratory Payment Policy: Now and in the Future most preventive and screening services and most treatments that have not obtained FDA approval. Coverage decisions affect whether and how quickly new technologies are incorporated into the payment system. About 10 percent of new Medicare items and services receive coverage decisions at the national level; the remaining 90 percent are handled locally by HCFA’s contractors. Without coding and coverage decisions at the national level, contractors usually determine coverage policy for laboratory services. Frequently, a manufacturer markets a new test selectively in certain geographic areas. The carrier in these areas may require documentation of medical necessity and appropriateness along with the claims from the physician and the laboratory, and may also make case-by-case determinations of whether the test is covered. National Coverage Decisions As use of a new test increases and more carriers make decisions about coverage and payment, the coverage issue may rise to the national level at HCFA. A CPT code assignment by the AMA may also make the coverage issue more visible at the national level. Alternatively, the manufacturer and interested clinicians may request HCFA to make a national coverage decision, which is binding on all contractors. This is often difficult since experience with the new technology is required, and to collect that experience, laboratories have to be paid for conducting the test. New, more clear, open, and speedy national coverage procedures were announced in 1999 (Medicare Program, 1999), which should facilitate national coverage decisions at HCFA. Still, it may take from six months to several years for a new test to be approved nationally for coverage (Lewin Group, 2000). For complex, new technologies, HCFA will seek the advice of its Medicare Coverage Advisory Committee (MCAC), which has a Clinical Laboratory Subcommittee. This step could add to the processing time required. The MCAC will offer recommendations to HCFA based on literature reviews, technology assessment data, and expert advice. Criteria for evaluating new tests and procedures include consideration of scientific evidence concerning patient outcomes, although such data are rare. In the past, costs were not considered in the Medicare coverage policy decision, although this has been a controversial topic of debate. In May 2000, HCFA issued a notice of intent to publish new review criteria that include a cost consideration when the new service offers substantially the same benefit as a currently covered service (Medicare Program, 2000). The proposed criteria allow coverage if the new service results in equivalent or lower costs for the same Medicare populations than the Medicare-covered alternative. New services that provide more benefits than currently approved services will be covered, regardless of costs.

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Medicare Laboratory Payment Policy: Now and in the Future Local Medical Review Policy Carriers and FIs process claims and determine whether services being billed are medically necessary. This is an important function, since Medicare pays only for covered services that are medically necessary in each particular case. Because contractors process billions of claims annually, computers make most of the determinations, based on data submitted on the claim. To facilitate the decision process, carriers use local carrier advisory committees (CACs) to develop local medical review policies (LMRPs) for new tests and for tests that are over-used. There may be laboratory representation on the CAC, but the local laboratory industry and manufacturers generally do not have direct input into the decision process and learn about new coverage issues only after the carrier makes a decision and notifies providers. The LMRPs state which conditions and diagnoses the contractor considers appropriate (or inappropriate) for a given test. The FIs generally, but not always, follow the LMRPs of the local carrier. Because each carrier develops its LMRPs independently, there is considerable variation among the LMRPs concerning which tests need a policy at all and which of the International Classification of Diseases, Ninth Revision, (ICD-9) diagnosis and symptom codes are acceptable to justify the medical necessity of the test. Laboratories that test specimens from different geographic jurisdictions must be familiar with the carriers’ LMRPs in each jurisdiction in order to file claims properly. This is a challenge for large national and reference laboratories. LMRPs require that claims for certain tests include an ICD-9 diagnosis code. Laboratories bill Medicare directly, so they must rely on physicians to provide these diagnosis codes when they order tests. Physicians may have difficulty identifying an appropriate diagnosis code, since the test may be used to make the diagnosis. However, some ICD-9 codes indicate a range of symptoms and are used when no diagnosis is available. Physicians may be reluctant to share diagnostic information with the laboratory because of concerns about patient confidentiality. Laboratorians feel an obligation to the patient and often conduct the test even though they do not have adequate information to bill Medicare for the test. Laboratory personnel spend a considerable amount of time calling physicians to collect diagnostic information required for Medicare billing. Coverage determinations for new laboratory tests are a potpourri of statutory constraints, national coverage determinations, and local carrier decision making. Although coverage determinations, particularly at the national level, may be time consuming, the committee found no systematic evidence to suggest clinically important delays in Medicare beneficiaries’ access to new clinical laboratory technologies. Claims Denials Claims for tests are denied when they (1) are for tests not covered by Medicare; (2) do not satisfy medical necessity requirements as defined by Medicare; (3) are for persons who are not Medicare beneficiaries; (4) are from laboratories

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Medicare Laboratory Payment Policy: Now and in the Future that are not Medicare providers or not CLIA-certified to perform the particular test; (5) are insufficiently documented; or (6) are for patients who have primary coverage from another payer. Claims denials are important because they affect the cost of providing laboratory services. Even if payments cover the costs of individual tests, they will not compensate for claims denials, which increase administrative costs, reduce the aggregate Medicare revenue for laboratories, and create bad debt. Medicare’s national claims denial rates for the top 100 laboratory tests in terms of dollar volume ranged from 6 to 39 percent, according to 1998 HCFA claims data (Appendix E). Although all third-party payers deny claims on occasion, testimony from those in the laboratory industry indicates a perception that Medicare denial rates greatly exceed those of other third parties. No evidence was available to support or refute this impression. The committee’s examination of Medicare’s denial rates showed that 26 CPT codes out of 100 had denial rates of 20 percent or more. Only 25 of the top 100 tests had denial rates that were not in the double digits (Appendix E). The overall denial rate for the 100 highest-volume test codes for outpatient laboratory claims processed by carriers nationally was 15 percent in 1998. (Claims data from the FIs for hospital-based laboratories were unavailable.) These data are confounded by the fact that denied claims can be resubmitted and appealed. Although the number of claims ultimately denied is no doubt lower than the number initially denied, there is no information available regarding the size of this differential. For the top 20 laboratory tests (by dollar volume) by carrier, denial rates varied substantially by region. For example, the lipoprotein assay (CPT-83718) was denied 68 percent of the time in Montana, 48 percent in Alabama, and only 7 percent in Washington. Some potential explanations for this variation include (1) geographic patterns of fraud and abuse, (2) interpretation of Medicare rules by local carriers, and (3) low numbers of tests in a region that easily skew the proportion of denied claims. Information explaining reasons for the denials is not available.2 The committee does not know the percentage of claims denied on grounds of medical necessity, that is, claims that contain inappropriate diagnosis codes or are missing diagnostic information. However, laboratorians suggest that medical necessity is the primary reason for denials. Information was not available on how much medical necessity denial rates vary by carrier. Some potential causes of variation are unusually restrictive LMRPs in some areas and differences in interpretation of national coverage rules by local carriers. It is unclear how many of the denials result from coding errors, incomplete documentation, confusion over coverage policies, and inappropriate utilization (as defined by local or national medical review policies). 2   The committee did learn from HCFA that 2.5 percent of claims submitted by POLs were denied based on a lack of medical necessity.

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Medicare Laboratory Payment Policy: Now and in the Future When a claim is denied on grounds of medical necessity, the laboratory generally bears the financial burden. The laboratory can attempt to collect additional data from the physician to justify medical necessity and then resubmit the claim. If this fails, the laboratory can attempt to collect from the beneficiary; however, beneficiaries can be billed only if they were warned, prior to receiving the test, that it might not be covered. Alternatively, the laboratory can attempt to collect from the physician, but it appears that most laboratories are reluctant to bill physicians since they are considered the laboratory’s prime customers. Advanced Beneficiary Notice When physicians have reason to think Medicare might consider a test medically inappropriate in a particular case, they are obliged to advise the beneficiary of this possibility and have the patient sign an Advanced Beneficiary Notice (ABN) acknowledging the warning and accepting responsibility to pay for the test. In those situations, the laboratory is allowed to bill the beneficiary if Medicare denies the claim. Since the laboratory rarely has direct contact with the beneficiary, it depends on the physicians to recognize that the ordered test is subject to a medical review policy, to acknowledge that medical necessity is not obvious, and to obtain a signature on an ABN from the patient. Although this sounds straightforward, there are many nuances that can affect the use of ABNs. When a national laboratory association attempted to clarify the language and use of ABNs under particular circumstances, an extended correspondence with HCFA ensued. HCFA’s responses set important policies for the program, but they have never been communicated publicly to all contractors and providers, so substantial variations in practice continue. For example, in 1996, HCFA approved the use of ABNs for screening tests such as the Pap test that have statutorily mandated frequency limits. HCFA encouraged specifically worded ABN forms to be used, depending on particular circumstances, but it has yet to promulgate the forms and instructions for their use. In addition, since it is impossible for the physician or laboratory to know whether the patient has already received the screening test within the defined period of time, the provider has no way of knowing which version of the ABN is appropriate. Another complication is the legal ambiguity of physicians billing patients. Negotiated Rulemaking In an attempt to rationalize some of the variations in LMRPs, in 1998–1999 HCFA conducted a negotiated rulemaking, as directed by the 1997 Balanced Budget Act.3 The appointed committee developed national coverage policies for 3   In a negotiated rulemaking process, a committee of representatives of stakeholders that may be affected by the rule, including agency representatives, is formed with the aim of reaching consensus on the content and text of a proposed rule. Specific procedures are followed to ensure an impartial process.

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Medicare Laboratory Payment Policy: Now and in the Future 23 different tests, including many of the most commonly conducted tests. HCFA estimates that the 23 national coverage policies would cover 60 percent of the dollar volume of outpatient claims. These and other national coverage policies take precedence over LMRPs. The resulting proposed rule, referred to as the Neg Reg and published in March 2000, will not take full effect until one year after the final rule is published (HCFA, 2000a). The hope is that it will improve the consistency of claims processing and medical necessity determinations. Coverage policies specify the appropriate ICD-9 codes for certain tests. After implementation of the Neg Reg, if the physician fails to include a required ICD-9 code, the contractor will attempt to obtain this information (HCFA, 2000a). It currently is the responsibility of the laboratory to request the documentation from the physician. This will relieve the laboratories of an administrative burden, but will not eliminate their ultimate responsibility for the bill if the physician cannot or will not document the claim appropriately and the laboratory is reluctant to bill the physician. MEDICARE PAYMENT POLICY Early History of the Payment System The current payment system dates from changes initiated in 1984. Prior to that time, covered laboratory services ordered by a physician and performed in the physician’s office or in an independent laboratory were paid by Part B on a “reasonable charge” basis. Medicare payments to these laboratories were based on charges, not costs.4 Four primary calculations were used to determine the reasonable charge; the lowest of these four calculations was the “reasonable charge”: Actual charge: This is actual charge billed for service by a physician or an independent laboratory. Customary charge: This represents the physician’s or the laboratory’s customary charge for the service, equal to the median charge for that particular service for the past year. Prevailing charge: Within a locality, this represents the 75th percentile of all customary charges for the test, weighted by volume. Lowest charge: Some common laboratory tests were designated as tests that do not vary significantly in quality among providers. These were reimbursed at the 25th percentile of the full array of actual charges billed to the carrier within a locality during a given period. When an independent laboratory performed a test on a sample submitted by a physician, the physician would pay the laboratory for the test, often at a dis- 4   Payments to hospitals for outpatient tests were based on costs, as were other hospital services.

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Medicare Laboratory Payment Policy: Now and in the Future counted rate. The physician would then bill Medicare for the service. The “reasonable charge” of the independent laboratory was used as the basis for Medicare payment to the physician. The Omnibus Budget Reconciliation Act of 1980 (OBRA 1980) stipulated that if the physician did not identify the laboratory or the amount charged him, payment would be based on the lowest amount at which the test could have been obtained from a laboratory in the area. For tests other than those performed in the physician’s own laboratory, the physician was permitted to charge a separate fee for drawing, collecting, or handling a specimen, not to exceed $3.00 in most cases. Payment under Part B for laboratory services performed in a POL or in an independent laboratory, where the laboratory collected the sample, was made either directly to the patient or, in the case of assignment, to the independent laboratory or the physician. Assignment meant that the laboratory or physician billed Medicare directly and was paid directly on the basis of 80 percent of the reasonable charge for the service minus any outstanding deductible amount. The laboratory or physician could then charge the beneficiary no more than 20 percent of the reasonable charge (coinsurance), plus the portion of the deductible not yet paid by the beneficiary. In the case of an unassigned claim, the beneficiary filed a claim with Medicare, and Medicare paid 80 percent of the reasonable charge minus any outstanding deductible amount. The independent laboratory or POL billed the beneficiary, and the beneficiary was responsible for paying the laboratory including any charges in excess of what Medicare computed as “reasonable.” DEVELOPMENT OF THE CURRENT SYSTEM The Deficit Reduction Act of 1984 (DEFRA) introduced radical changes to the payment methodology for Medicare Part B clinical laboratory services, including (1) establishment of area-wide fee schedules, (2) direct billing by the provider that performed the test, and (3) elimination of the beneficiary copayments for services to be billed on an assigned basis (Logue, 1996). Under DEFRA, Congress established prospectively set carrier fee schedules for laboratories (Section 1833(h) of the Social Security Act). The fee schedules were based on prevailing charges, which in turn were based on 1983 customary charge data. The 75th percentile of customary charges defined the prevailing charge in a given area. There was a mechanism to update fees annually, based on the change in the Consumer Price Index (CPI). For most years, however, Congress has specified lower update factors (Table 4.1). The fee schedules varied by local carrier area. The intent was to move toward a national fee schedule. However, in 1987 OBRA 1987 postponed this requirement, and in 1989 it was completely repealed. Effective July 1, 1984, laboratories were paid based on the lower of submitted charges or the fee schedule rate. For hospital-based laboratories (outpa-

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Medicare Laboratory Payment Policy: Now and in the Future ticular service is based on how it relates to the payments for other services, rather than on a specific dollar amount. The relative relationship or relative value scale (RVS)7 can be determined in different ways—for example, by the relative relationship among charges, by negotiations, or by the resources needed to produce the various services. The current Medicare Fee Schedule for physicians reflects a resource-based relative value scale (RBRVS).8 Current laboratory payments are based on the 56 separate carrier fee schedule amounts, and the upper level of payment for each test is limited by an NLA. Level of Payment The level of payment simply refers to the actual dollar per unit of service. If the basis of payment generates dollar amounts, such as charges or a monthly capitation payment, then no separate decision is necessary to set the level of payment. In cases where the basis of payment reflects relative, rather than nominal, payment, a conversion factor is necessary to establish dollar amounts.9 A conversion factor could be used to set the payments to accommodate a specified rate of increase or decrease in spending. For example, some payers may negotiate a discounted rate that lowers actual payment levels. As the Medicare laboratory payment methodology has evolved, the level of payment and the formulas for setting it have changed; however, the level of payments today is closely related to the system’s historical roots. Prior to the establishment of the fee schedule, Medicare payments were based on the lower of the laboratory’s usual charges or the area’s prevailing charges. Little is known about the relationship between the 1983 charges and the actual costs of performing the services at the time. When Congress converted Medicare payment for laboratory services to a fee schedule in 1984, fee levels were set at 62 percent of the prevailing charge, and tests done in independent or physician office laboratories were set at 60 percent of the prevailing charge in each carrier area. In 1987, fees for outpatient services in hospital laboratories were reduced to 60 percent of the prevailing 7   An RVS is an index that assigns weights to each medical service; the weights represent the relative amount to be paid for each service. 8   In the case of the Medicare Fee Schedule for physician services, payment rates are designed to reflect relative resource use, based on separate measures of how much of a physician’s work, practice expenses, and malpractice expenses each service requires relative to other services. The RBRVS is then multiplied by a conversion factor to calculate actual dollar payment amounts (PPRC, 1997). 9   A conversion factor is used to translate the relative values for Medicare’s physician fee schedule into payment amounts. The initial conversion factor was set at a level expected to maintain aggregate Medicare physician payments at the same level physicians would have received under the prior system. In other words, the conversion factor was set to maintain budget neutrality (PPRC, 1992).

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Medicare Laboratory Payment Policy: Now and in the Future charge, except for sole community provider hospitals offering 24-hour emergency room services, which remained at 62 percent. In 1986, Congress established the National Limitation Amounts (NLAs) to serve as a ceiling on payments for each test. The NLAs are based on the median of all the carrier fees for each test. Medicare now pays the lower of the carrier’s fee, the provider’s charge, or the NLA. Currently, providers rarely, if ever, charge less than the carrier’s fee, and the carrier’s fee is usually higher that the NLA. In those cases where the NLA limits the local fee, the NLA becomes the “pricing amount”; otherwise, the pricing amount is the carrier’s fee. By the mid-1990s HCFA became aware of significant discrepancies between carrier-calculated fees and calculations made from its working files. After 1993, HCFA decided to calculate all future carrier fee schedule updates nationally along with the NLAs and to hand them back to the carriers each year. In addition, HCFA staff did a thorough reconciliation of the carriers’ fees database to ensure that all previous coding changes as well as updates were accurately reflected. HCFA worked closely with the carriers to ensure a sound database and consistency for future years. The 1994 database is maintained centrally at HCFA and serves as the base year from which HCFA calculates each subsequent year’s 56-carrier-area fee schedules and the NLAs. The NLAs have been reduced repeatedly. Congress takes up Medicare policy through the budget reconciliation process and uses that process to implement cost constraints as well as policy changes in payment methods. Through the congressional budget reconciliation process, the NLAs were initially set, in 1986, at 115 percent of the median of all carriers’ fees. Congress has gradually reduced the NLAs. They are now set at 74 percent of the median of the carrier fees. (Balanced Budget Act 1997, Section 4553(b)) (Table 4.1). Because so many of the carrier fees are constrained by the NLAs, in practical terms there is now a de facto single fee schedule. Based on the calendar year (CY) 2000 fee schedule, about 85 percent of all pricing amounts (across 56 carriers and 1,100+ different test codes) were at the NLAs. Because many of the fees that are below the NLAs are in carrier jurisdictions with relatively few beneficiaries and many of the test codes with pricing amounts below the NLAs are infrequently used tests, the NLAs actually constrain spending on much more than 85 percent of the claims and much more than 85 percent of the dollar volume. According to one model (Appendix B), it appears that as much as 98 percent of all Medicare dollars paid for outpatient laboratory services are paid at the NLAs. In other words, NLAs may be the pricing amounts for more than 98 percent of laboratory claims’ dollars; the NLAs appear to constrain more than 98 percent of Medicare’s laboratory spending.10 10   See Appendix B for an explanation of a commissioned study by Katie Merrell to assess the impact of the NLAs on carriers’ fees. To estimate the impact of the NLA based on the volume of particular services used and the dollars paid by Medicare, it was necessary to construct a model because of data constraints. The model uses data on the number

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Medicare Laboratory Payment Policy: Now and in the Future Panel Tests The payment level for panel tests is set differently from that for all other tests. In fact, there are currently two different types of panels, and each has payment levels set according to different formulas. There are 22 automated, multichannel chemistries such as cholesterol, calcium, glucose, potassium, uric acid, and phosphorus, which are now ordered individually but are priced according to the number of the tests ordered on the specimen, regardless of which specific tests are ordered and whether they are ordered as a full panel or individually. The theory is that the marginal costs of additional tests should be less than the cost of the first test since the specimen does not have to be logged in, processed, or handled after the first test, and all tests can be programmed into the machine once and results reported at one time. Because of historical anomalies related to the earlier grouping of more than one test into a single CPT code, the increase in payment does not relate in a consistent way to the number of tests included in the panel. In fact, there is no fee increase between panels of 12 tests and 15 tests (Table 4.2). Other panels consist of tests that relate to a specific disease or organ function, such as the hepatic function panel. Payments for these panels are equal to the sum of the pricing amounts for the constituent tests in each carrier jurisdiction. Because the individual test pricing amounts are already limited by the NLAs, HCFA does not follow the standard test formula and select the median of the sums from all 56 carriers and reduce it by 26 percent; therefore, there are no NLAs designated for these panels. Congressionally Set Test Payment Levels Although Congress’ main concern with the appropriateness of the level of allowed laboratory payments has been exhibited through reductions in the NLAs (changing the percentage of the median of carrier fees to be used as a cap) and constraints on inflation increases, it has also made changes in specific test fees. In 1988, Congress made a technical correction, reducing payments by 8.3 percent for certain commonly performed tests and automated chemistries. More recently, Congress addressed concerns about inadequate access to Pap smears by increasing the minimum payment. In the 1999 Balanced Budget Reconciliation Act (BBRA), Congress doubled the minimum payment for Pap tests.11 It added, “It is the sense of the Congress that (1) the Health Care Financing Administration has been slow to incorporate or provide incentives for providers to use new screening diagnostic health care technologies in the area of cervical cancer;… and that the Health Care Financing Administration should institute an appropri     of claims paid per test code for 85 of the 100 highest dollar volume tests, the number of beneficiaries in each of the carrier areas, and the fees for each laboratory code. 11   Raising the price from $7.15 to $14.60.

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Medicare Laboratory Payment Policy: Now and in the Future TABLE 4.2 Panel Tests: Automated Chemistries Number of Tests NLA (dollars) Marginal Increase (dollars) 2 7.20 N/A 3 9.18 1.98 4 9.69 0.51 5 10.81 1.12 6 10.84 0.03 7 11.29 0.45 8 11.70 0.41 9 12.00 0.30 10 12.00 0.00 11 12.21 0.21 12 12.48 0.27 13 12.48 0.00 14 12.48 0.00 15 12.48 0.00 16 14.61 2.13 17 14.61 0.00 18 14.71 0.10 19 15.28 0.57 20 15.78 0.50 21 16.27 0.49 22 16.77 0.50   SOURCE: HCFA, 2000b. ate increase in the payment rate for new cervical cancer screening technologies approved by the Food and Drug Administration” (Congressional Record, H12512, Public Law 106–113, Section 224). In addition to raising payment levels for specific tests, Congress can also reduce them. The administration’s original FY 2001 budget included a proposal to reduce, by 30 percent, the NLAs for four very high volume tests that HCFA believes are currently overpaid: (1) hemoglobin (copper sulfate method, nonautomated, glycated), CPT-83036; (2) prostate-specific antigen (PSA), CPT-84153; (3) thyroid stimulating hormone (TSH), CPT-84443; and (4) urine culture (bacterial, quantitative, colony count), CPT-87086. Fee Level for New Technology HCFA has established two different procedures to set the fees for new tests called cross-walking and gap-filling. Cross-walking is designed for new tests that are similar to existing tests, and gap-filling is designed for breakthrough

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Medicare Laboratory Payment Policy: Now and in the Future technology. The choice of which procedure to follow depends largely on how the new technology is handled by the AMA’s CPT Editorial Panel. When a new technology is assigned an existing code, the payment amount that is attached to that code will apply to the new technology. Alternatively, if HCFA determines that the new technology is similar to two existing codes, it may combine the existing payment amounts for those codes and apply it to the new test. The determination of which new tests can be cross-walked to which existing codes and related prices is made internally by HCFA, based on AMA advice, as it develops the next year’s fee schedule. There are no published criteria guiding this process, no public description of the process, and generally no participation by stakeholders or the public. There is no official process for stakeholders to challenge these decisions. When a testing product is so new that there is little upon which to base payment, the payment amount for the product is gap-filled. There is no standard data source to provide comparison prices when creating the base fee for such new tests. What private health plans pay for a new laboratory test is generally considered proprietary information and frequently is not available to the carriers because of firewalls between their private and government business. Also, some private payers may wait to see the price Medicare sets before calculating their own fee. For these new gap-fill tests, HCFA relies on the carriers to set their own fees for the first year after it has approved coverage. HCFA specifies which new CPT codes are to be gap-filled by the carrier with the issuance of each new fee schedule, but it does not tell the carriers how to calculate the payment amount. There is much flexibility in the way each carrier collects information and sets its fees. All 56 carriers go through the gap-fill exercise separately, in order to develop their area-specific fee for the test being added to the fee schedule. The carrier medical directors and their advisory committees may attempt to analyze the steps, methods, and materials that are used in the test in order to collect relevant cost data. Manufacturers of the new technology may be willing to provide an analysis of the costs involved with conducting the new test. Carrier medical directors are rarely pathologists and the quality of the gap-fill analyses may reflect the level of clinical laboratory expertise available within the carrier. Also, a number of carriers have consultants to help in this process, and some carriers survey laboratories for their pricing. Charge data are not always available on new tests so carriers attempt to collect cost data in addition to prices paid by other insurers, where available. On occasion it has been necessary for HCFA to continue the carriers’ fees for a second year in gap-fill status for a particularly problematic test, such as the HIV viral load, because extra time was required to collect data for setting the fee. There appears to be no attempt to collect cost data on a national basis for the new tests, or to share the data collected among several carriers or even within a single carrier that covers more than one area. Variations in the price-setting methodologies of carriers and in the fees calculated seem to be encouraged by

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Medicare Laboratory Payment Policy: Now and in the Future HCFA. While there are limited written instructions on gap-filling (and none specifically relate to laboratory tests), HCFA staff has informally stressed the need for independent cost analyses because it wants each area to develop its own fee, reflective of the local area’s economy. In addition, HCFA wants a spread of fees among the 56 carriers from which it selects the median for calculating the NLA. While HCFA does not discourage the sharing of technical information about the nature of the new technology among carriers, the carriers generally appear to work independently on the gap-fill process. There are two distinct problems with gap-filling that can sometimes lead to setting inappropriate payment levels. First, carriers set their fees based on historical experience, current cost data, and analysis, but unless they inflate the fees before the NLA is applied, it could create payments that are substantially below costs. This occurs because of the nature of the mandated formula, which sets the level of the NLA at 74 percent of the median of the carriers’ gap-fill fees. The second problem is that there is no mechanism for reassessing the appropriateness of the NLA and revising a gap-fill fee once the NLA has been set. Even if the cost of the new test drops significantly after it comes into common use and may become easier to conduct, or even if the gap-fill fee is so low it could limit availability, there is no routine and practical method for changing it. Hence, neither HCFA nor the carriers regularly look back at fees set earlier to see if they are still reasonable. As an indication of how frequently the gap-fill process is used, during 2000, carriers were required to gap-fill 13 codes and provide their fees to HCFA by May 2000 (HCFA, 1999). HCFA will then calculate the NLAs for the 2001 fee schedule. Because of numerous new CPT codes added in 1993 there were 98 gap-fills. Since then, there has been an average of 13 new gap-fills annually. Updating Payments Payments are rarely constant over time. Depending on the payment methodology and base, either providers or payers can raise payments. In the case of charge-based payment, providers initiate payment growth through higher charges. In other cases, when providers and payers renegotiate annual contracts, they may change the level of payment based, for example, on information about input cost increases, productivity changes, case-mix changes, quality considerations, or administrative processes. Medicare’s two more mature prospective payment systems, the hospital prospective payment system (PPS) and the physician fee schedule, both rely on administratively set update amounts that are supposed to reflect similar sets of legislatively prescribed factors.12 12   The process of developing and recommending update factors is discussed in the March annual reports of the Physician Payment Review Commission (PPRC, 1990) by the Prospective Payment Assessment Commission (1991, pp. 30–31). The process for the Medicare Fee Schedule is also described in the PPRC (1997) report to Congress.

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Medicare Laboratory Payment Policy: Now and in the Future For laboratory payments, beginning in 1984, each carrier calculated its own fee schedule using its 1983 prevailing charges at the 60 percent level plus an annual inflation factor. Originally, the inflation factor used was the urban CPI. After four years, Congress reduced the update rate—in some years to slightly less than the CPI, in other years to zero (Table 4.1). The President’s original budget proposal for FY 2001 included an annual update of Medicare’s laboratory fee schedule for fiscal years 2003 through 2005 of the CPI minus 1 percent. The administration estimated this would save the federal government $180 million. As with the setting of the NLA levels, the update provides Congress with a mechanism to help control Medicare spending. If Congress thinks laboratory payments are excessive, either because new technology is perceived to have substantially lowered the cost of producing many tests or because other payers are paying less than Medicare, it can simply reduce the update. The combination of the reductions in NLAs and limited inflation updates has contributed to a recent reduction in total Medicare outpatient clinical laboratory spending in real dollars. Adjustments It may be appropriate to adjust payments for certain circumstances associated with measurable cost differences in the provision of services that are important to the payer. Alternatively, it may be appropriate to provide an adjustment to encourage a particular behavior that is considered beneficial in terms of explicit policy objectives. Some adjustments may occur naturally in retrospective, cost-based systems since these types of payments can reflect the costs of the specific characteristics of the service provided. Charge-based systems might also implicitly reflect variations in particular factors. In a PPS, however, such adjustments have to be accounted for more explicitly. Potential factors for which adjustments may be appropriate include site of care, local input price variation, differences in patient health status or risk, access goals, or other payer goals. Adjustments can apply to both fee-for-service and capitated payments. Currently, the Medicare laboratory fee schedule has two adjustments built into the current system: (1) a geographic adjustment and (2) a sole community hospital adjustment. Geographic Adjustment There is no explicit geographic adjuster in the current laboratory payment methodology because it is inherent in the use of 56 state-based carrier fee schedules. Whatever geographic variations in charges existed in 1983 have been carried forward with various updates for inflation. The committee was unable to find evidence concerning whether charge variations from state to state were related to cost variations. Over time, the geographic disparity among the 56 fee schedules has been muted by the imposition of NLAs.

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Medicare Laboratory Payment Policy: Now and in the Future The committee examined the spread of carrier fees to determine the amount of variation from carrier to carrier. It is impossible to know whether this spread is indicative of cost differences. However, nearly 40 percent of the values in carrier fee schedules vary by more than 25 percent (either above or below) from the relevant service median value. Those that fall sufficiently below the median will be paid at rates below the NLAs, while all of those above 74 percent of the median will be paid at the NLAs, reducing the effective geographic differences in payments. Only 16 percent of service payment amounts are less than the NLAs. The amount of variation in payments is not as broad as that of the carrier fees because the NLAs cap all carrier fees that would be above them (Appendix B). Sole Community Hospital Adjustment Fees for laboratories based in qualified sole community hospitals currently receive a special adjustment.13 Each year, the new fee schedules are published at the 60 percent level with separate instructions to carriers on how to calculate the fees at 62 percent for the qualified hospitals in their area. There are two additional adjustments that can be applied when payment amounts are inappropriate, but they are used only on rare occasions. Base-Fee Adjustment If a carrier sees a major problem with a particular fee being too low (often identified by the test’s manufacturer) or, less likely, too high, it can ask the HCFA policy office for an adjustment. This happens rarely, for an obviously aberrant situation perhaps based on “data errors” or historical happenstance. Also, a representative from the laboratory or medical device industry (often with the support of members of Congress) may ask for an adjustment to the base fee of a particular test. There are only one or two such requests each year. In those cases in which HCFA decides to adjust the fee, it does so either as the whole schedule is being updated or on an interim basis by substituting the national median for the carrier’s fee. Use of the national median avoids the need to recalculate the current NLA and pricing amounts for all carriers. There are no public guidelines describing this adjustment process, but program memos were issued to carriers in the mid-1990s explaining how to apply for such an adjustment. Now, HCFA solicits comments (on the fee schedule in general) each December through a program memorandum to its contractors when it posts the new fee schedule and the accompanying explanatory program memorandum on its Web 13   A sole community hospital is located 25–35 miles from similar hospitals, serves at least 75 percent of the local residents needing such inpatient care, and meets the detailed criteria contained in 42 C.F.R. 412.92. A qualified hospital laboratory in a sole community hospital is one that provides some clinical diagnostic tests 24 hours a day, seven days a week, in order to serve the hospital’s emergency room, which is also available around the clock.

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Medicare Laboratory Payment Policy: Now and in the Future site. Since the fee schedule takes effect on January 1 of each year, comments are reviewed and necessary changes take effect in the following year’s schedule. Inherent Reasonableness The Secretary of DHHS has the authority to adjust payments for particular items and services paid under Part B that are considered to be “grossly excessive or grossly deficient,…not inherently reasonable” (COBRA). HCFA interpreted this provision as codifying both its authority and that of its carriers to establish realistic and equitable payment amounts. Complex consultative and regulatory requirements make the process cumbersome and extremely lengthy. For this reason, HCFA has attempted to adjust only one fee, not from the outpatient clinical laboratory system. Although the BBA expanded the Secretary’s authority for inherent reasonableness to include outpatient clinical laboratory fees and simplified the process, it has yet to be applied. The proposed process allows consideration of issues such as whether the payment amount reflects changing technology, increased facility with that technology, or reductions in acquisition or production costs; the Medicare amount is substantially higher or lower than the payment made for the item or service by other purchasers; the marketplace is not competitive; there are grossly inappropriate geographic variations in payment amounts; and there have been increases in payment amounts that cannot be explained by inflation or technology. Opposition from the provider community prompted a congressional request for a study by the General Accounting Office and a moratorium on inherent reasonableness adjustments until the report was released. The report supported use of the expedited system, once criteria and procedures have been clarified (GAO, 2000). It will be necessary for the Secretary to publish a final rule responding to the GAO report before the process can be implemented. An alternative approach to adjusting specific test fees, which has been used by the administration as well as the laboratory industry, is through Congress’ changing fees legislatively. Such changes to specific test fees are discussed in the preceding section on level of payment. Cost Sharing Payers typically include some form of cost sharing to reduce the chance that patients seek unnecessary or ineffective care.14 There are several different mechanisms that affect how much a patient may pay for covered health services. First, some insurance policies include a deductible, so the patient is responsible for all provider charges until the deductible is met. Second, policies include copayments, also called coinsurance, which might range from a fixed, relatively 14   See Phelps (1997, pp. 119–133) for an economic explanation of alternative cost-sharing approaches and their effect on service use.

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Medicare Laboratory Payment Policy: Now and in the Future small dollar amount within a managed care plan to a percentage of the provider’s charges in a fee-for-service plan. Third, providers may ask patients to pay any charges in excess of those covered by the payer. This balance may be quite large if the payer approves only a small percentage of the provider’s charges and there are no limits on how much the provider may charge the patient. Copayments and deductibles are commonly used in the Medicare program. For Medicare physician services, for example, beneficiaries pay 20 percent of the Medicare Fee Schedule amount and the program pays the other 80 percent. The laboratory payment system is unusual because it includes no beneficiary cost sharing. EFFECT OF LABORATORY SPENDING ON PHYSICIAN PAYMENT Aggregate Medicare spending for laboratory services influences Medicare physician fees. The volume of laboratory services is included in the measure of physician service volume that is incorporated into the sustainable growth rate (SGR) used to calculate the annual update factor for the Medicare Fee Schedule for physicians’ services (Balanced Budget Act of 1997, Public Law 105–33). Unexpected growth in the volume of laboratory services may affect Medicare’s spending for laboratory services directly, but its effect on total Medicare spending is muted because spending on physicians’ services can be controlled. If, for example, laboratory service volumes grew faster than expected, physician payment rates would be updated by less than would have occurred with lower laboratory volumes. As a result, with spending for laboratory services growing faster than expected (in this hypothetical example), physician spending would be slowed, insulating total Medicare spending from the growth in laboratory expenditures. The inclusion of laboratory services in the calculation of physician payment updates recognizes the role of physicians in determining the volume of laboratory services used by beneficiaries. The SGR applies only to physician payments and does not affect the outpatient clinical laboratory payment methodology, the calculation of laboratory payment rates, or Medicare spending on laboratory services in any way. CONCLUSION This chapter has examined the elements of the Medicare clinical laboratory payment system in some detail. Although these elements have been described individually, they do not operate in isolation: the functioning of one element affects others. Also, the laboratory payment system, as a whole, does not operate in isolation. Other regulatory and market mechanisms affect the operation of the payment methodology. Considering the various payment elements of the current system discussed in this chapter and their interrelationships with the external

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Medicare Laboratory Payment Policy: Now and in the Future forces discussed in Chapters 2 and 3 is important for assessing the current system and considering alternatives. REFERENCES Committee on Ways and Means, U.S. House of Representatives. 1998. 1998 Green Book: Overview of Entitlement Programs. Washington, DC: U.S. Government Printing Office. Government Accounting Office (GAO). 2000. Medicare Payments: Use of Revised “Inherent Reasonableness” Process Generally Appropriate. HEHS-00–79. Washington, DC: GAO. HCFA. 1999. Program Memorandum: Transmittal No. AB-99–84; Subject: Implementation of Calendar Year (CY) 2000 Clinical Diagnostic Laboratory Fee Schedule and Laboratory and Ambulance Costs Subject to Reasonable Charge Payment Methodology in 2000. Web page, accessed September 5, 2000. Available at http://www.hcfa.gov/pubforms/transmit/AB998460.htm. HCFA. 2000a. Proposed Rule: Medicare Program; Negotiated Rulemaking: Coverage and Administrative Policies for Clinical Diagnostic Laboratory Services. Federal Register 65, No. 48:13082–13167. HCFA. 2000b. FY 2000 Clinical Diagnostic Laboratory Fee Schedule. Web page, accessed January 3, 2000. Available at http://www.hcfa.gov/stats/cpt/clfdown.htm. Lewin Group, Inc. 2000. Outlook for medical technology innovation: Will patients get the care they need? Report 2: The Medicare payment process and patient access to technology, Washington, DC: The Health Industry Manufacturers Association. Logue, J. 1996. Federal reimbursement to laboratories. Clin Chem 42, No. 5:817–821. Medicare Payment Advisory Commission (MedPAC). 1998. Report to the Congress: Medicare Payment Policy 1998. Washington, DC: MedPAC. Medicare Program; Procedures for Making National Coverage Decisions. 1999. Federal Register 64, No. 80:22619–22625. Medicare Program; Criteria for Making Coverage Decisions. 2000. Federal Register 65, No. 95:31124–31129. Merrell, K. 2000. Paying for Clinical Laboratory Services under Medicare: Framework for Describing and Assessing Policy Options (unpublished). Chicago, IL. Phelps, C.E. 1997. Health Economics, Second Edition. Reading, MA: Addision-Wesley. Physician Payment Review Commission (PPRC). 1990. Annual Report to Congress 1990. Washington, D.C.: PPRC. PPRC. 1992. Annual Report to Congress 1992. Washington, D.C.: PPRC. PPRC. 1993. Annual Report to Congress 1993. Washington, D.C.: PPRC. PPRC. 1997. Basics, No. 6, September. Washington, D.C.: PPRC. Prospective Payment Assessment Commission. 1991. Report and Recommendations to the Congress. Washington, D.C.: Prospective Payment Assessment Commission. Silva, C. May 23, 2000. FDA: Moving forward with CLIA 88. Hunt Valley, MD: CLMA Annual Laboratory Seminar 2000.