Physician Payment and Physician Behavior: A Complex Interaction

December 2010

This month, Congress was in familiar territory with an approaching deadline to cut or delay cuts in Medicare payments to physicians. There have been multiple short-term patches in the past year.1 A couple of weeks before a December 1 deadline, Congress voted to delay for one month a 23 percent reduction in Medicare payments to physicians.2 Last week, Senate leaders came to an agreement to implement another reprieve on scheduled fee cuts. The one-year delay will be financed through changes to the subsidy provisions associated with the insurance exchanges.3 Yet the overriding issue, how they will ultimately craft a new payment system—one that properly aligns incentives, improves the quality of care and begins to curtail cost growth—remains unresolved.

Historically, Medicare employed the “usual, customary and reasonable” payment criteria used by private payers. In order to create greater uniformity and equity, Medicare adopted the physician fee schedule in 1992. Prices for physician services are based on (1) the physician’s time and effort, (2) practice resources, and (3) professional liability insurance. A "relative value" assigned to each service is adjusted according to variations across markets and then multiplied by a “conversion factor” to express the value in dollar amounts.4 

As part of the Balanced Budget Act of 1997 (BBA), Congress adopted the Sustainable Growth Rate (SGR), a tool designed to calculate annual payment updates and control Medicare spending. Early analyses in 2001 suggested that while the effects of future payment changes remained uncertain, the BBA reform was working as intended and Medicare beneficiary access to physicians was not declining.5 

The SGR has targeted payments cuts each year since 2002. Beginning in 2003 Congress set those cuts aside. If Congress were not to continue to pass periodic legislation delaying implementation of the SGR, the cumulative cuts, which are now very large, would go into effect.6  

Redesigning the Payment System—Short and Long Term Options
The current Medicare payment system suffers from instability—physicians are unable to count on stable payment levels. Moreover, the fee-for-service model rewards sheer volume rather than value. A recently released Health Affairs/RWJF policy brief outlines a series of short and long-term options for resolving weaknesses of the current model.7 At one end of the spectrum, Congress could “do nothing” and allow the scheduled reductions to take effect. However, the substantial drop in reimbursement rates could lead to physicians’ refusing to accept Medicare patients. Congress could, alternatively, elect to abandon the current system and develop a payment system that creates incentives to promote the delivery of primary care and other “undervalued” services, while discouraging the delivery of “overvalued” services. In recent years, Medicare has developed pay-for-performance (P4P) efforts to provide bonus payments to physicians through the Physician Quality Reporting Initiative (PQRI).8 In addition, the Patient Protection and Affordable Care Act (ACA) promotes a realignment of physician through provisions to test value based purchasing, bundled payments, and accountable care organizations (ACOs).9,10

In its report, “The Moment of Truth,” the National Commission on Fiscal Responsibility and Reform cautioned that “federal health care spending represents our single largest fiscal challenge over the long-run.”11 The Commission’s recommendations to achieve health care savings include reforming the SGR. In the short term, the Commission recommended replacing the current SGR formula with a freeze on physician payment levels through 2013, followed by a one percent cut in 2014.  Longer term, the Commission recommended that CMS establish a new payment formula “that encourages care coordination across multiple providers and settings and pays doctors based on quality instead of quantity of services.”12 While votes for the report fell short of the total needed to send it to Congress, the findings are likely to inform Medicare payment reform discussions.

While policymakers are only now beginning to grapple with how best to restructure the current payment system, researchers have been exploring tools and innovations to realign incentives for some time. Most notably among these have been quality reporting and pay-for-performance experiments. These efforts to motivate changes in physician behavior are not without challenges, including developing appropriate measures of performance and patient outcomes. In a HCFO-funded study evaluating the impact of a quality-based scorecard and financial incentives developed by Premera Blue Cross in Washington State, Doug Conrad and colleagues determined that another challenge is the level of the financial incentive, which must be sufficient enough to cover the cost of quality improvements.13 An attendant challenge is whether consumers consider quality information in making choices about physicians, as examined in another HCFO study on the impact of performance reporting on consumer and physician behavior, conducted by Meredith Rosenthal.14   

The Payment/Behavior Interaction
Underlying the potential success of these proposed reforms is the relationship between payment structures and physician decisions about the services they supply. The extensive literature examining physician behavioral responses to price changes underscores the complexity of the issue, including the economic, psychological and organizational factors that influence such responses.15 While some studies show that physicians increase their supply of services when prices decline,16 the news media has identified physicians who say that payment cuts have led or will lead them to stop supplying services to Medicare patients.17

In a HCFO-funded study on this issue, Jim Reschovsky, Jack Hadley and colleagues examined the relationship between Medicare fees and the supply of physician services. The researchers noted that the empirical evidence is mixed regarding whether physicians are likely to increase the supply of services in response to fee cuts.18 They explained that while policymakers may assume that physicians engage in “volume-offset behavior,” multiple factors may influence a physician’s supply of service and that supply varies due to differences such as cost functions and clinical practice standards. The researchers further noted that if the demand by privately-insured patients is low, the supply of physician services for Medicare patients is greater.19 

In yet another recent HCFO-funded study, Mireille Jacobson and Joseph Newhouse found that a fee change increased the likelihood that lung cancer patients received chemotherapy and the type of type of drug administered. The researchers noted that their findings were consistent with economic literature that finds that “when fees that affect a large share of physicians’ income decline, utilization increases…when fees that affect a small share of physicians’ income decline, utilization falls.”20 The researchers pointed out that they could not infer the appropriateness of treatment or health outcomes from their analyses. They did, however, note that their study “urges caution for health care payment reform. Any redesign requires an understanding of both the value of services and the impact of changing reimbursements on the use of those services.”21 

Researchers and policymakers alike believe that payment to physicians should ultimately reflect the value of the services they provide.22 Being able to accomplish this goal, however, will require a more robust body of evidence than currently exists on the comparative effectiveness of medical therapies.  In addition, a better understanding of how physicians’ provision of services overall and with respect to specific services is affected by differences in Medicare payment rates will be critical to the development of successful payment reforms.  While the challenges to reforming Medicare payment policy are significant, current projections of health care spending generally, and Medicare spending in particular, underscore the importance of continuing to develop our understanding of physician behavior and payment alternatives. 




2 The accumulated effect of postponed cuts totaled 23 percent this year, with an additional two percent scheduled to trigger on January 1.
3 “Senate Leaders Agree on Doc-Fix,” POLITICO, December 7, 2010,
4 MedPAC, “Physician Services Payment System,” October 2010,
5 Schoenman, et al., “Medicare Physician Payment Changes: Impact on Physicians and Beneficiaries,” Health Affairs, Vol. 20, No. 2, March/April 2001.
6 Health Policy Brief, Health Affairs/RWJF, December 2, 2010,
7 Ibid.
9 Ibid.
10 See Ginsburg, P., “Rapidly Evolving Physician-Payment Policy – More than Just SGR,” NEJM, December 8, 2010,
11 “The Moment of Truth,” The National Commission on Fiscal Responsibility, December 2010
12 Ibid at 36-37.
15 Town, R., et al., “Assessing the Influence of Incentives on Physicians and Medical Groups,” Medical Care Research and Review, Vol. 61, No. 3, Suppl., pp. 80S-118S, 2004. 
16 See e.g. Rice, T.H., “The Impact of Changing Medicare Reimbursement Rates on Physician-Induced Demand,” Medical Care, Vol. 21, No. 8, August 1983.
17 “Physicians Refuse Medicare Patients,” New York Times, April 12, 1992; but see, “Docs Not Dropping Medicare Payments Just Yet,” Shots – NPR Health Blog, December 3, 2010 (noting that in a recent survey by MedPAC, Medicare beneficiaries reported having fewer problems finding doctors and getting coverage than those with private coverage). and
18 Hadley, J. et al., “Medicare Fees and the Volume of Physician Services,” Inquiry, Vol. 46, No. 4, pp. 372-87.
19 Ibid.
20 Jacobson, M., et al., “How Medicare Payment Cuts For Cancer Chemotherapy Drugs Changed Patterns of Treatment.” Health Affairs, Vol. 29, No. 7, pp. 1394-1402.
21 Ibid.
22 See “Making the Value Proposition in Benefit Design,” HCFO Hot Topic, June 2010