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Research Questions

  1. Are there alternative sources of physician practice cost data that could improve the indirect cost allocation?
  2. Are indirect costs appropriately valued for physicians that mostly provide services in an office setting versus physicians who practice mostly in a facility setting?
  3. What options might be considered for incorporating hospital outpatient cost data in the PE valuation process, and how might they affect the distribution of payments across specialties?

This report addresses concerns that aspects of the practice expense (PE) valuation methodology used to determine the Medicare Physician Fee Schedule (MPFS) contribute to misvalued payment rates. The fee for each service is denominated in relative value units (RVUs). The report proposes potential improvements in the current methodology used to allocate indirect practice costs in determining PE RVUs for a service and assesses alternative data sources that could be used to regularly update indirect practice cost estimates. A number of potential policy changes are recommended for improving the rate setting of PE. The most sweeping change would be to adopt relative values for total PE based on the Outpatient Prospective Payment System (OPPS), which is used to value outpatient hospital visits. Potentially, OPPS-based costs could be used to inform or replace the MPFS PE valuations. This change would reduce site of service payment differentials, simplify Medicare payment policy, and improve returns from rate-setting resources since cost information would be shared between the two Medicare payment systems. There are a number of methodological issues that would need to be resolved before this change could be implemented, but the potential benefits are great enough to justify investments to further develop this option. Alternatively, new data could be collected to update PE valuations using the current framework. The report proposes survey processes that could minimize survey burden in order to facilitate on-going data collection. Improving payment accuracy would support improved payment policies in many other areas of the country's health care system.

Key Findings

Practice Expense Measures Were Collected Ten Years Ago, and Much Has Changed in the U.S. Health Care System Since Then

  • There has been an overall shift away from physician ownership of practices, which emphasizes the importance of putting in place a system that can update PE valuation models to accommodate ongoing changes to the health care system.

Current Methodology May Not Accurately Capture Some Components of PE

  • Services with extremely low levels of direct expenses may be allocated less PE than other types of services, relative to the resources typically required to furnish the service.
  • Many physicians work almost entirely in a facility setting, and many services are typically performed by physicians who are facility-based. Physicians who work in non-facility settings incur certain practice expenses that facility-based physicians typically do not; the current system does not fully account for these differences.
  • There is no established mechanism for regularly updating the direct and indirect cost estimates for each service.

Payment Differentials Across Ambulatory Settings Create Payment Incentives That Are Inconsistent with Furnishing Medical Care in the Medically Appropriate Setting

  • It is feasible to use hospital outpatient costs to inform or replace the PE valuation process. Moving toward a system that uses the same underlying data to establish relative values across site of service could reduce payment differentials or allow for any explicit payment differentials to be transparent to policymakers, providers, and patients.


  • Adopt relative values for total PE based on the Outpatient Prospective Payment System (OPPS). This wholesale change would reduce financial incentives to perform services in a setting that may not align with medical considerations, simplify Medicare payment policy, and make more efficient use of rate-setting resources. Apply budget neutrality constraints by types of service to aid in transitioning from the current rate-setting methodology to this alternative approach.
  • If it is not possible to adopt a wholesale change to the PE valuation system, take steps to improve rate setting within the current system. Physicians who work in non-facility settings incur certain practice expenses that facility-based physicians typically do not; the current system does not fully account for these differences. Additionally, group specialties into a smaller number of categories, which would reduce survey burden yet still produce inputs that are based on sufficiently large sample sizes to reliably allocate PE.
  • For future PE surveys, record practice expense by work RVU (wRVU) rather than practice expense per hour (PE/HR). Physician time is harder to measure and produces less reliable measurements that come at a larger burden for data collection. Many practices could report direct and indirect PE/wRVU with little effort beyond what is currently done for their routine accounting systems.
  • OPPS information could be used within the current PE system to identify misvalued services.

This study was funded by the Centers for Medicare & Medicaid Services (CMS) and conducted by RAND Health.

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