Why the Medicare physician fee schedule is sheer madness 

Amid the complexities of U.S. healthcare, there is probably no construct that’s more byzantine than the Medicare Physician Fee Schedule (MPFS) — the program’s elaborate system of paying physicians and other clinicians (including nurse practitioners, physician assistants and clinical psychologists) for more than 10,000 medical services.^a

In 2022, the schedule drove about $71.2 billion in payments to physicians under Part B of Medicare, and tens of billions of dollars more in clinicians’ Medicare Advantage (MA) payments, many of which are also based on the fee schedule.^b Because the schedule is widely emulated by other payers, including employer-provided plans and commercial insurers, it indirectly influences $600 billion annually in private payments as well.^c

The MPFS is emblematic of so-called administered pricing, in which prices are set by some outside authority, such as the government, rather than arrived at by markets. In the MPFS’s case, the creators of this monstrosity include Congress, federal agencies, academics and, ironically, physicians themselves. And because it is explicitly a fee-for-service (FFS) system, it manifests many of the “pathologies” of this form of payment, as the noted Harvard healthcare economist Joseph P. Newhouse, PhD, wrote in his classic analysis Pricing the priceless: A health care conundrum.^d

Rarely have the pathologies of the MPFS portended such poor outcomes for the future of U.S. healthcare as they do now.

About the MPFS and how it works 

The current MPFS dates to the late 1980s and early 1990s, when Medicare abandoned a prior pricing system and adopted a schedule based on “relative” prices for different types of services — for example, a simple office visit versus a colonoscopy versus a complex surgery. These services are classified according to about 8,000 distinct codes, which may be updated annually based on recommendations to CMS from an American Medical Association (AMA)-sponsored panel commonly known as the RVS Update Committee, or RUC.^e

Prices for these services are then calculated based on relative value units (RVUs) — weighted estimates of the amount of work that an individual service entails, along with estimates of practice expenses, such as rent and office supplies, and the premiums that clinicians pay for malpractice insurance. CMS then adjusts these multiple RVUs for price differentials across geographic markets.

A final step is multiplying these adjusted RVUs by what’s called a conversion factor, a number that translates the final RVU weights into the actual dollar amounts that will be paid for each coded service. The conversion factor is set by Congress, and now stands at $33.29 for the remainder of 2024.^f Thus, if a particular medical service is classified as worth 20 RVUs — a combination of work effort, practice costs, malpractice premiums, and the geographic adjustment — multiplying 20 by the conversion factor means that a physician will receive $665.80 from Medicare for the service in 2024.

As if this were not complicated enough, Congress makes it tough to change the fee schedule due to a budget-neutrality requirement designed to limit the overall costs of adding new services for payment. As a result, if CMS agrees to pay for a new service — such as adding a payment for primary care providers who manage chronically ill patients over time, as it did beginning this year — it must cut the fee schedule elsewhere if the cost of the new service adds more than a $20 million annually to Medicare program costs.

4 flaws in the MPFS

Along this tortured path, the MPFS’s pathologies emerge in the following four ways.

1 By promoting FFS payment. The most  obvious —and of greatest concern to  my organization, America’s Physician Groups — is that this bizarre scheme has cemented the role of FFS payment in U.S. healthcare, with its built-in incentives to do more and with limited links to quality, even with the features added under the so-called Quality Payment Program in 2017. But even we recognize, to our dismay, that FFS payment will dominate much of the system for at least a while longer. Thus, in the meantime, other failings of the MPFS must be addressed.

2 By cutting payments to physicians and not adjusting them for inflation. The next most serious flaw is that the fee schedule has effectively cut payments to physicians in real, or inflation-adjusted, terms, by an estimated 26% below inflation in practice costs from 2002 through 2023.^g Unlike other aspects of Medicare spending, such as for inpatient hospital care, there is no automatic inflationary update in the MPFS that adjusts the fee schedule to keep pace with these rising practice costs.

In fact, Medicare physician fees will fall another 1.8 % this year, in the face of a projected increase in inflation in practice costs — as measured by the so-called Medicare Economic Index (MEI) — of 3.1%.^h What’s more, current law mandates no increases in Medicare physician payment until 2026, when annual updates of 0.25% will take effect — a rate of increase almost certain to be well below practice inflation rates.

An often-voiced argument is that physician fees need to be limited this way, as physicians can simply provide more services to compensate for constrained fees. So the Medicare Payment Advisory Commission (MedPAC), which counsels Congress, now recommends that physician payment in 2025 should rise by half the projected rate of increase in the MEI, or about 1.3% — enough to provide some relief from rising practice costs, but not too much to spur an explosion of spending.

3 By requiring budget neutrality. Another aspect of the fee schedule’s pathology is the “budget neutrality” provision referenced above, which Congress created to limit increases in Medicare physician spending when new services and matching codes are added to the fee schedule. As noted, any new service and code costing more than $20 million annually must be offset by lowering payment someplace else.

But the $20 million threshold, set in 1992, is trivial in today’s world, and it’s not obvious that every service added should result in slashing another. The AMA proposes raising the threshold to $100 million, and Congress will have to wade into the politically sensitive debate about what new types of services and their attendant costs should not require an offset and should be added instead as net new increments to spending.

4 By creating uneven payment advantages among physicians according to practice differences. A final pathology is the way that RVUs are set, with the advice of the RUC, that makes relative winners out of surgeons and other proceduralists by assigning higher RVUs to their work, and losers out of those in primary care and internal medicine.

Unlike their proceduralist colleagues, the latter more cognitively oriented medical professionals are less able to generate more services to compensate for constrained fees. Medical students and others in training see the compensation handwriting on the wall and many shun these lower-paid cadres of medicine. MedPAC has warned, with considerable understatement, that “comparatively low payment rates for the services that primary care physicians tend to provide may be reducing the appeal of a career in primary care.”

No easy solution in sight 

In the face of an aging physician workforce, a broadly perceived shortage of primary care physicians, rapid consolidation among physician practices and other pressures facing the medical profession, the current fee schedule is simply bad public policy. However, for now, it is the devil that the system knows. So Congress is now holding hearings on some short-term fixes that could be enacted this year.

But altering the fee schedule, possibly redistributing Medicare payments among physicians, or even paying physicians more under Medicare will be a tough political fight — and will ultimately cost more money amid high federal budget deficits and low tolerance for higher taxes.

Those of us hoping for a better system for paying physicians should keep pushing for alternative payment models. But we probably should not hold our breath. 

Footnotes

a. CMS.gov, “Physician fee schedule,”  page last modified, March 18, 2024.
b. MedPAC, “Physician and other professional payment system,” Payment Basics, October 2023.
c. Berenson, R.A., and Emanuel, E.J., “The Medicare physician fee schedule and unethical behavior,” JAMA, June 22, 2023.
d. Newhouse, J.P., Pricing the priceless: A health care conundrum, The MIT Press, 2002.
e. AMA, “RVS Update Committee (RUC),”  April 10, 2024.
f. CMS.gov, “Physician fee schedule,”  page last modified March 18, 2024.
g. AMA, “Medicare physician payment adequacy: Budget neutrality,”  2023.
h. MedPAC, Report to the Congress: Medicare payment policy, March 2024.