Ep 5. Demystifying Medicare's Annual Payment Cuts: The Budget Rules That Force December Drama

Every November, Medicare proposes physician pay cuts and every December, Congress tries to walk them back. But why? Dr Anthony Paravati and Dr Amar Rewari break down the hidden budget rules forcing specialties to fight over a fixed pie, why the much-celebrated MACRA law of 2015 did nothing to fix it, and how successful health systems are adapting their strategy. This episode is short and sweet but there's something for everyone. From basic, but often flubbed, must-know facts about the Medicare program to critical insights into payer contracting and service line decisions. Knowledge is power - especially when billions are at stake.

Introduction to Medicare Fee Cuts

Welcome to episode five of Value Health Voices podcast. Another Medicare episode. It's not just another Medicare episode. It's actually an episode about an end-of-the-year ritual here in the United States. And you can count on two things: Christmas music at the start of November and a cut to the Medicare physician fee schedule. Let's get into it.

Here we are, it's episode five. And right now, on the 9th of December, physicians are facing another proposed 2.8% cut to their payments from Medicare in the coming calendar year of 2025. This is a pattern that we see year after year. To understand why this keeps happening, we're going to talk about a couple of key historical developments and key pieces of legislation that continue to impact us today.

Historical Context: SGR, MACRA, and Legislation

The first one—and this is rewinding the clock a few years because it was repealed in 2015, but was active from 1997 until that year—was the so-called Sustainable Growth Rate formula, or SGR. The SGR regularly triggered essentially automatic cuts to physician payments. In 2015, Congress passed MACRA. The point of MACRA, among other things, was to eliminate the SGR. Back then people threw around the term "permanent doc fix." But in reality, a second law dating back all the way to 1989—actually even with MACRA—continues to force Medicare to propose cuts every year. This is a budget neutrality requirement. That's the real reason physicians, you and me Amar, face pay cuts from Medicare every year. I contend that it's a major reason why physicians in this country find themselves pissed off now and again, especially this time of year.

No, I hear you. I remember the days before MACRA with the SGR. The reason behind the SGR is there would be a target and then actuals, and they built on each other year to year. At one point right before SGR was repealed and MACRA came in, the cuts were going to be as high as 21% because it had just built year on year and they kept kicking the can down the road. When you look at the SGR cuts versus what was the Medicare Economic Index at the time, the MEI, it was completely not correlated at all. So something had to be done. I remember everyone was around this time of year in December getting very nervous about those cuts. MACRA, when it came around, people thought this is finally the answer, but it wasn't. And here we are again with another cut.

Understanding RVUs and Physician Payments

I think maybe it'd be helpful for our listeners and viewers to know a little bit about how Medicare actually sets payment for physician services to understand why it keeps getting cut. A lot of it comes down to this concept of the RVU, which is the Relative Value Unit. Physicians hear of this all the time, because that's what your procedures get valued at. Everything is valued in relation to something else, hence the "relative" part of it.

What's built into that RVU is the work you do as a physician and the practice expense. That is not only equipment and supplies, but also consists of your staffing and other clinical staff. Plus there's the indirect practice expense, which is your front desk and your overhead. Then malpractice is built into it, as well as different care costs differently across geographic regions. So there's adjustments for that. Physician work, practice expense—both direct and indirect—geographic variations, and malpractice all go together to create an RVU. Then that RVU gets multiplied by a conversion factor to get a dollar amount, and Medicare sets that conversion factor. Anthony, maybe you want to talk a little bit more about the conversion factor.

The Role of the Conversion Factor

Sure. The conversion factor is the much-watched number that comes out in the final rule released by Medicare every year in November. We'll talk a little bit about the specific yearly timeline of events. A lot of physicians, even those who pay minor attention to the comings and goings of health policy, will have some sense of this calendar as this news hits the healthcare press.

As we look forward to 2025, this dollar amount is currently set to be $32.35. So for every RVU that is done, that is converted into a dollar amount of $32.35. An interesting thing that we were talking about in preparing for this show is that this dollar amount of $32.35 is not that different than what it was way back in 1992, just to pick a year, when it was $31. If we think about the $31 in 1992 and adjusted it to today for inflation, it should be $72. Instead we are stuck at $32.35.

Incredible. To put it into an example so everyone can understand, let's say a doctor is seeing a patient for a follow-up visit that has several components. There's the physician work, which is a little less than one RVU. When you add the practice expense and the malpractice insurance in, it comes closer to about 1.5. When you make adjustments for geography, let's say there's not really much adjustment on that side. You multiply that 1.5 times the conversion factor to get the dollar amount. This year, if the conversion factor in '24 was $33, you multiply it by that and get about $54. That is how much that service costs.

The Mechanics of Budget Neutrality

So that's where that comes from. The conversion factor is multiplied by the RVU and you get your dollar amount. This is the issue. The cuts we're seeing every year is because the conversion factor is being decreased, as you said, because of budget neutrality. This is an old concept that maybe you want to explain to our viewers. Why do we have to keep having conversion factors reduced?

Yes, and we should also say that since we're talking about the conversion factor, a bit of confusion I've seen brought up again and again over the years is that sometimes people can get confused about it. There's only one. It does not matter the specialty. It's the same conversion factor for a neurosurgeon as it is for a primary care physician as it is for us in oncology. But to directly answer your question, Amar, where this all comes from: I alluded to the year 1989. Back in 1989, a bill was passed. There are these so-called omnibus bills. This is not new; this is a thing that we see again and again as to how the government is financed.

In 1989 there was the Omnibus Budget Reconciliation Act that created this situation of budget neutrality. Despite the SGR and then MACRA after that, neither of those two laws did anything to the underlying statutory requirement in the 1989 law that requires us to always be budget neutral as it relates to Medicare physician payments.

Right. By budget neutrality, I'm just going to really dumb it down even more. We're talking a fixed pot here. Medicare gives a fixed pot of money for all the docs to carve out how they see fit. Every year with technology changing, there may be new procedural codes which have new RVUs associated with them. To offset the new RVUs there, the conversion factor comes into play because it's a fixed pot. So if you're trying to all of a sudden create more, it has to come from somewhere. It's at the expense of other existing procedural codes.

Exactly. And Medicare has a threshold for this. It's 20 million bucks. So if any change would increase or even decrease overall Medicare physician spending by 20 million, then that triggers CMS having to in a compulsory way make adjustments to maintain budget neutrality. You can use some round numbers: if Medicare physician payments in your base case were 100 billion, and then a new procedure came on the scene with RVUs associated with that times the conversion factor of 40 million in new expense, this would require Medicare to respond by a 0.04% reduction in the conversion factor. It's obligatory.

What I've always said, and what I told you, Amar, in preparation for this episode, is that this idea that medical progress goes forward, new value is created, and as a result everyone else has to take a haircut—that the pie is fixed—is so irritating to physicians. It is an un-American idea that the pie is a single size and that it can't be grown. That's just not how anything else works in the US Economy.

Specialty Infighting and Allocation Challenges

No, it's very true. And it creates this infighting amongst the different specialties because you have to rob Peter to pay Paul. As you and some of the listeners may know, I'm one of the RUC advisors for our specialty. I sit at this meeting held every year where these RVUs are decided. You know that it's so critical because trying to convince the people at the table to give you any RVUs is very tough. Even maintaining existing RVUs is tough because they know that it's going to be at the expense of their specialties. It's almost like a Game of Thrones kind of environment.

Exactly. I was thinking the same thing. Everyone's trying to jockey for position to make sure that their specialty is not affected. Just like what you see happening in politics with pork barreling—if money's coming in, everyone wants to get something; if money is potentially losing, nobody wants to be the one losing the money.

Impact of Primary Care Adjustments on Proceduralists

I did want to kind of segue with some of the reasons we're seeing this recently. One of the things is new procedures. High expense procedures are going to have high valuation, so whether they're in fields that have high equipment costs or labor costs, that would cause adjustments to the conversion factor. But another thing in the last several years that's happened is there's been this push—which is a good push—to compensate primary care appropriately. The worry is that there's fewer people going to primary care, there's a lot of physician burnout, and the compensation is lacking because it's not procedural.

To bump up primary care, they adjusted the E&M codes, which are the codes for consultations and follow-up appointments, which is the bulk of what primary care does. They also adjusted staffing pricing for nurses. When all this increased in the last few years, anybody who's in a procedural specialty—surgical, oncology, radiology—saw that the way the conversion factor hit them is it caused cuts. This is the reason when I talk to my physician friends in other specialties, they're always saying, "This is Biden's fault," or "This is Trump's fault." I tell them no, this is legislation that's been around for decades. You can't even help primary care without taking it from procedural because of that budget neutrality.

Hospital Employment and Financial Pressures

It's funny you mention that, because I've had the exact same conversations with people assigning blame here or there, but they really don't have a good grounding in how the system works. An interesting thing—you and I didn't really have this as something to cover in the episode—but as you were talking, I was thinking we see physicians in greater and greater numbers employed rather than in private practice. That's a whole separate episode, but if you look at the Medicare physician fee schedule, certainly even if the number next year is $32.35, that is a massive cut in real terms compared to 1992.

If you look at the way Medicare pays for things, there's the Medicare physician fee schedule on one side. But then there's the HOPPS rules—the Hospital Outpatient Department—which are facility billing. So you have professional services on one side and facility services on the other, and facility payments are meant obviously to go to the owner of the asset. What we've seen over time is because the professional reimbursement hasn't kept up with costs, and certainly hasn't caught up with the value of physicians on a supply and demand basis, is that hospital systems are subsidizing the physician to a greater and greater extent to arrive at a competitive overall compensation package.

If you're listening to this as a hospital CFO or hospital finance leader, this is the dynamic that gives you heartburn. It's unavoidable. It is in many ways Medicare's fault. But it's just something to be aware of that this is an underlying dynamic in the US Healthcare system.

A hundred percent, Anthony. It all kind of feeds into each other. Physicians in private practice are concerned about the instability in future payments. Being able to budget appropriately and maintain their practice due to declining reimbursement is difficult, so they will choose to sell their practices to hospitals or even large corporations in private equity who then salary these people. To encourage them to sell their practices, they set very high salaries for these individuals. The hospitals, to be competitive and attract talent, have to also pay those similar salaries. But they're once again not getting paid for those services through the physician fee schedule, which is creating this whole issue now with decreasing margins in hospitals and having to shut down entire service lines in some aspects and shift costs of sites of care.

Exactly. The hospital system financial performance, in my view, is substantially impacted and substantially baked in. Your operating margins are going to be low if you're in an environment where government payers, Medicare and Medicaid, make up a huge portion of your payer mix. You're going to run up against reality. You can try to play games, but the headwind that you face is not the same headwind in some of these booming geographic areas in this country where there's so much inflow of new residents. Those people are moving there because jobs are there, which means they are commercially insured. That is a tailwind of a substantial nature that results in 3 or 4 percentage points difference in operating margin. You can find yourself as a happy, lucky CEO in a boomtown with north of 5% operating margins, or you could be the second coming of the greatest manager that ever lived and find yourself with 2% operating margins if your climate is difficult.

The Annual Legislative Timeline and the "Doc Fix"

No, this is the struggle right now in healthcare across the board. Pivoting back, let's talk a little bit about why MACRA maybe didn't fix this and why these doc fixes have to happen at the end of the year. A lot of it has to do with the cycle of how this all rolls out. CMS proposes a new physician fee schedule that comes out in the proposed rule in July. Then there's a comment period where people submit, and the final rule comes out in November. When the final rule comes out which has this new conversion factor, it's a mad rush in November and December to get this quote-unquote doc fix in any legislation to once again kick the can for these cuts down the road. MACRA, which was supposed to fix it because it just had stable set rates of 0% or 0.5% for certain years, wasn't able to adjust anything because of the budget neutrality. So you still end up with these cuts.

Yes, and that's where we are right now. As the year marches through, towards the middle of the year, CMS releases an initial proposed rule. It includes RVU changes and conversion factor changes, all taking into account the budget neutrality requirement. There's a comment period where all the different stakeholders in healthcare for about 60 days time are allowed to make comments. CMS reviews them, though often doesn't make large scale changes as a result. Then the beginning of November comes around and CMS drops the final rule.

That leads us to now, in December. Of course the final rule makes everyone unhappy. Congress realizes it's ridiculous. Congress now, in the lame duck session, tries to get its act together to pass a fix. They're talking about it as we speak: a 2.5% fix, which would leave a 0.3% haircut, by the way. No big deal, I guess that's change lost in the couch cushion.

Cost Shifting and Market Dynamics

What's interesting about it is some of the long term considerations, and how the market dynamics come into play here and cost shifting. Inflation marches forward, costs march forward—both as it relates to personnel costs and supply costs. Reimbursement through the Medicare program has not kept pace. Right now in the United States, on average, for every dollar that Medicare reimburses, a hospital's cost to get that dollar is about $1.20. That's a pretty substantial difference. Over time though, that loss has grown for hospital systems.

When the provider side—hospital systems, multi-specialty physician groups—sits down at the negotiating table with the commercial insurance company to re-up the contract, the physician side has to up the ante on what they recover in order to keep the lights on and make up the gap from the government payers. We spoke about Medicare, but Medicaid is even worse math. Over time that's resulted in increasing premiums and increasing unaffordability of health insurance for many Americans, and therefore a decrease in access to care as people decide on the margins, "Maybe I don't need coverage." It's resulted in a contraction in the commercially insured population nationwide.

No, exactly. And to flip your statistic the opposite way just to hear it: Medicare pays about $0.84 for every dollar of cost of care. Let's say if your payer mix for your patients was 40% Medicare and 60% commercial, you might need almost 100% to 150% on the commercial rates to cover for that Medicare loss. Big health systems can negotiate like this, but small health systems don't have the leverage and can't. I'm in one of those smaller health systems and it's very tough to get higher payments on the commercial side, which is why you end up struggling as a smaller community hospital.

Just like you said, Anthony, when the commercial rates are going up, they just pass it on to the consumer in terms of premiums, which then just feeds this vicious loop. It impacts whole service lines that hospitals may offer. If something is not profitable, they'll decide not to offer it because they just can't cover their costs.

That's right. Or if you have multiple locations—let's say inner-city locations and then suburban locations—you might consolidate the services in the more challenging financial environments and shift those services to environments where the payer mix shifts towards the commercial.

The Impact on Patient Care and Access

Well, is there a summary we can give our listeners and viewers from all this? We're not happy because it's not about the money. It's the lack of input, voice, and the lack of stability. Imagine any other person whose entire livelihood is based on somebody else having to suffer. It feels bad that for you to have stable payments means you have to take it away from another person who's working hard.

Yes, it's a fundamentally unsatisfactory Game of Thrones type trade-off that pits one specialty against another. To be very clear, that's not a natural way for physicians to think. Every day in patient care, I see the world in terms of all the departments, services, and units we need to bring to bear to provide a seamless, integrated experience for the patient. I personally don't see the world through an oncology lens versus a neurosurgery lens versus a thoracic surgeon lens. I see the world through a lens of "this patient has lung cancer." The pulmonologist is not more or less valuable than me as an oncologist. All of those services must be delivered or it's not a complete product.

No. And I think another thing to take away from it is for patients to get good care, they also need to have support services like social work and nutrition—things that Medicare doesn't compensate for appropriately. It's the payments that doctor practices and hospitals get from physician services that pays for all this other stuff. That's one of the first things that end up getting cut. When these reimbursements go down, it's not that they're going to just stop doing surgery. It's that all the stuff that allows for patients to have good quality personalized care gets cut.

That's really where my thoughts go quite often. It is the individuals and the families who are less well off, who are less in a position to handle the adversity that comes with being sick, who suffer the most. We spoke about it back when we went through our Medicare Advantage episode. All the badness that comes on the Medicare Advantage side ultimately hurts the senior who has difficulty paying their bills. Every once in a while, I have these patients who have things so in order in their lives and great support from their families. If we risk-stratified them, they would be stratified to the lowest risk possible. But for every patient like that, there's four or five who need substantial wraparound services to make it all happen. We finance that through physician work. There's been the emergence of some codes like oncology navigation codes, but those are helpful only against a headwind of substantial cuts in physician payments.

No, I think that's very important. The bottom line for our viewers to understand is that we are concerned as physicians about the "doc fix" and all these issues around payment stability because it does impact patients. It impacts access to care and making sure patients can get the care they need close to their home.

Closing Thoughts

That's right. And I'll close the episode in saying that one of the reasons why Amar, you and I decided to make this podcast is because we are actively engaged to try to prevent, forestall, and delay decisions that hurt patients in the manner that we've talked about in this and other episodes. That's why we do this. We decided at a certain point, why not? Why don't we jump on the bandwagon of putting content out there so we can try to take what we know outside of these small circles and make it digestible and understandable for those who might have interest in learning more. So we hope you'll stay with us as we continue this journey and we'll come back in a couple of weeks with episode six.

Sounds good. Have a Happy Holidays, everybody.

And same to you. Safe travels.