Medicare Physician Payment Updates and the
Sustainable Growth Rate (SGR) System
Jim Hahn
Specialist in Health Care Financing
April 7, 2011
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Medicare Physician Payment Updates and the Sustainable Growth Rate (SGR) System

Summary
Each year since 2002, the statutory method for determining the annual updates to the Medicare
physician fee schedule, known as the sustainable growth rate (SGR) system, has resulted in a
reduction in the reimbursement rates (or a “negative update”). With the exception of 2002, when
a 4.8% decrease was applied, Congress has passed a series of bills to override the reductions. The
SGR system was established because of the concern that the Medicare fee schedule itself would
not adequately constrain overall increases in spending for physicians’ services. While the fee
schedule limits the amount that Medicare will pay for each service, there are no limits on the
volume or mix of services. The SGR system was intended to serve as a restraint on aggregate
spending. If expenditures over a period are less than the cumulative spending target for the
period, the update is increased. However, if spending exceeds the cumulative spending target over
a certain period, future updates are reduced to bring spending back in line with the target.
In the first few years of the SGR system, the actual expenditures did not exceed the targets and
the updates to the physician fee schedule were close to the Medicare economic index (MEI, a
price index of inputs required to produce physician services) in the first two years (2.3% in 1998
and 1999, compared with a MEI of 2.2% in 1998 and 2.3% in 1999). For the next two years, in
2000 and 2001, the actual physician fee schedule update was more than twice the MEI for those
years (5.5% update vs. MEI of 2.4% in 2000, 5.0% update vs. MEI of 2.1% in 2001). However,
beginning in 2002, the actual expenditure exceeded allowed targets and the discrepancy has
grown with each year, resulting in a series of ever-larger cuts under the formula.
Some criticisms of the SGR system point to purported flaws in the technical details behind the
formula, while others have just expressed displeasure with the resultant outcome. Although
modifications have been proposed to replace the SGR system, no proposal has garnered sufficient
support and almost all proposals would be expensive to implement compared against the current
baseline, which necessarily assumes that significant cuts to the fee schedule will occur.
Legislative activity in the 111th Congress included several bills that addressed the SGR system.
The FY2010 Defense Appropriations Act delayed the implementation of the reductions for two
months, from January 1 through February 28, 2010. The Statutory Pay-As-You-Go Act of 2010
(P.L. 111-139) exempts the amount it would cost to freeze payments for five years from PAYGO
rules. H.R. 4691, which became law on March 2, 2010, delayed the payment cuts through March
31, 2010. On April 15, the Senate passed an amended version of H.R. 4851 that extended the
payment cut delay through May 31, 2010. The House passed the amended bill, and the President
signed P.L. 111-157 into law that day. On June 25, 2010, several weeks after the expiration of the
extension created by the Continuing Extension Act, an amended version of H.R. 3962 was signed
into law that increases fee schedule payments 2.2% retroactive to June 1 and continuing through
November 30, 2010. On November 30, 2010, the President signed the Physician Payment and
Therapy Relief Act of 2010 into law (P.L. 111-286), which extended the 2.2% increase for an
additional month through December 31, 2010. The Medicare and Medicaid Extenders Act of
2010 (P.L. 111-309) preserves the payments at this level through December 31, 2011.

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Medicare Physician Payment Updates and the Sustainable Growth Rate (SGR) System

Contents
Introduction...................................................................................................................................... 1
Background on the Medicare Fee Schedule Updates ...................................................................... 1
Updates and the Sustainable Growth Rate (SGR) System ........................................................ 1
Conversion Factor Calculation .................................................................................................. 2
Sustainable Growth Rate (SGR) ......................................................................................... 3
Update Adjustment Factor................................................................................................... 3
Historical Updates and Legislative Overrides ................................................................................. 3
Analysis and Criticisms of SGR System ......................................................................................... 6
General and Conceptual Concerns ............................................................................................ 6
Technical Concerns.................................................................................................................... 7
Per Capita Gross Domestic Product (GDP) and the Annual Update ......................................... 7
Potential Modifications and Alternatives......................................................................................... 9
Recent Legislative Activity: Not Passed........................................................................................ 11
H.R. 3162 (110th Congress) ..................................................................................................... 11
Summary ........................................................................................................................... 11
Brief Analysis.................................................................................................................... 12
H.R. 3961 (111th Congress) ..................................................................................................... 12
Summary ........................................................................................................................... 12
Brief Analysis.................................................................................................................... 13
A Senate Amendment in the form of a Substitute to H.R. 3590 (111th Congress) ................... 14
Summary ........................................................................................................................... 14
Brief Analysis.................................................................................................................... 14
Recent Legislative Activity: Enacted into Law ............................................................................. 14
Department of Defense Appropriations Act, 2010 (P.L. 111-118)........................................... 14
Summary ........................................................................................................................... 14
Brief analysis..................................................................................................................... 15
Increasing the Statutory Limit on the Public Debt (P.L. 111-139)........................................... 15
Summary ........................................................................................................................... 15
Brief Analysis.................................................................................................................... 15
Temporary Extension Act of 2010 (P.L. 111-144) ................................................................... 15
Summary ........................................................................................................................... 15
Brief Analysis.................................................................................................................... 16
Continuing Extension Act of 2010 (P.L. 111-157) .................................................................. 16
Summary ........................................................................................................................... 16
Brief Analysis.................................................................................................................... 16
Preservation of Access to Care for Medicare Beneficiaries and Pension Relief Act
(P.L. 111-192) ....................................................................................................................... 16
Summary ........................................................................................................................... 16
Brief Analysis.................................................................................................................... 17
The Physician Payment and Therapy Relief Act of 2010 (P.L. 111-286) ................................ 17
Summary ........................................................................................................................... 17
Brief Analysis.................................................................................................................... 17
Medicare and Medicaid Extenders Act of 2010 (P.L. 111-309)............................................... 18
Summary ........................................................................................................................... 18
Brief Analysis.................................................................................................................... 18

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Medicare Physician Payment Updates and the Sustainable Growth Rate (SGR) System

Figures
Figure 1. Difference Between Cumulative Allowed and Actual Expenditures for
Physician Services Under the SGR System.................................................................................. 4
Figure 2. Relative Increase in Part B Expenditures vs. per Capita GDP ......................................... 8
Figure 3. Formula Updates, Actual Updates, and the Medicare Economic Index........................... 9

Tables
Table 1. Summary of Updates and Legislative Activity .................................................................. 4


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Medicare Physician Payment Updates and the Sustainable Growth Rate (SGR) System

Introduction
Each year since 2002, the statutory method for determining the annual updates to the Medicare
physician fee schedule, known as the sustainable growth rate (SGR) system, has resulted in a
reduction in the reimbursement rates (or a “negative update”).1 With the exception of 2002, when
a 4.8% decrease was applied, Congress has passed a series of bills to override the reductions.
However, these actions have required almost yearly attention from the Congress. This report
provides a background on the Medicare fee schedule, the SGR system and the annual updates,
and discusses recent proposals to address this issue.
Background on the Medicare Fee Schedule Updates
Medicare payments for Part B services2 provided by physicians and certain non-physician
practitioners are made on the basis of a fee schedule, a list of over 7,000 tasks and services for
which physicians bill Medicare.3 From the inception of the program until 1992 and the
introduction of the resource-based relative value scale (RB-RVS) fee schedule, Medicare paid
physicians based on “usual, customary, and reasonable” charges.4
The Omnibus Budget Reconciliation Act (OBRA 89, P.L. 101-239) created the RB-RVS-based
Medicare fee schedule, which went into effect January 1, 1992. Under the RB-RVS fee schedule,
the Center for Medicare and Medicaid Services (CMS) assigns relative values that reflect
physician work (i.e., time, skill, and intensity it takes to provide the service), practice expenses,
and malpractice costs.5 The adjusted relative values are then multiplied by a conversion factor to
derive the actual payment amount in dollars. Medicare pays providers the lesser of the actual
charge for the service or the allowed amount under the fee schedule.
Updates and the Sustainable Growth Rate (SGR) System
The SGR system was established because of the concern that the Medicare fee schedule itself
would not adequately constrain overall increases in spending for physicians’ services. While the
fee schedule limits the amount that Medicare will pay for each service, there are no limits on the

1 2009 Annual Report of the Boards of Trustees of the Federal Hospital Insurance And Federal Supplementary Medical
Insurance Trust Funds, p. 22. http://www.cms.hhs.gov/ReportsTrustFunds/downloads/tr2009.pdf.
2 For detail on fee-for-service Medicare and other Medicare background information, see CRS Report R40425,
Medicare Primer.
3 Social Security Act, Sec. 1848. [42 U.S.C. 1395w–4]. In some instances, special rules apply to the calculation of
Medicare fees for some services, including anesthesia, radiology, and nuclear medicine.
4 Also called “customary, prevailing and reasonable charges,” this method based physician payments on charges
commonly used by physicians in a local community. The payment for a service was the lowest of (1) the physician’s
billed charge for the service, (2) the physician’s customary charge for the service, or (3) the prevailing charge for that
service in the community. For further discussion, see Physician Payment Review Commission, “Annual Report to
Congress, 1997.”
5 The determination of the relative value units affects all payments under the fee schedule. Refinements in existing
values and establishment of values for new services have been included in the annual fee schedule updates. This
refinement and update process is based in part on recommendations made by the American Medical Association’s
Specialty Society Relative Value Update Committee (RUC) which receives input from approximately 100 specialty
societies. The law requires a review every five years.
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volume or mix of services. The SGR system was intended to serve as a restraint on aggregate
spending. While the SGR targets are not limits on expenditures, they represent a “sustainable”
trajectory for cumulative spending on Medicare physician services from April 1996 forward. The
annual fee schedule update thus reflects the success or failure in meeting the goal. If expenditures
over a period are less than the cumulative spending target for the period, the update is increased.
However, if spending exceeds the cumulative spending target over a certain period, the update for
a future year is reduced, with the goal to bring spending back in line with the target.
Expenditure targets have been a factor in the calculation of Medicare physician payment updates
since the current fee schedule was first implemented in 1992. In the first year, one overall
conversion factor was used to calculated the update. Then, two (surgical and non-surgical
services) and eventually three conversion factors were used for different categories of services
(surgical, primary care, and other nonsurgical services). However, under the Medicare Volume
Performance Standard (MVPS) method, targets were set (and typically exceeded) each year; there
was no cumulative goal and no significant consequence to exceeding the expenditure target. The
current SGR method for calculating annual updates was created partly in response to the
shortcomings of the prior method.
The Balanced Budget Act of 1997 (BBA97, P.L. 105-33) replaced the MVPS with the SGR, with
the objective of creating a sustainable growth path for Part B expenditures. First, BBA97 added a
cumulative spending criteria that resulted in actual consequences for failing to meet expenditure
targets; beginning with April 1, 1996, as the starting point, actual program expenditures are
compared to growth targets to determine annual updates. Second, BBA 97 introduced the rate of
growth in the per capita amount of the gross domestic product (GDP) into the SGR calculation
and also provided for the use of a single conversion factor instead of three.6 By tying the
expenditure targets to the growth in GDP per capita, this system attempted to hold Medicare
physician expenditures to a level that would not consume an ever-increasing share of national
income.
Since the conversion factor applies to all services, the update to the conversion factor is the key
component for determining how reimbursements change from year to year.
Conversion Factor Calculation
The annual update to the conversion factor calculation is based on (1) the Medicare Economic
Index (MEI), which measures the weighted average annual price changes in the inputs needed to
produce physician services;7 (2) the Update Adjustment Factor (UAF), used to equate actual and
target (allowed ) expenditures; and (3) allowed expenditures, equal to the actual expenditures
updated by the SGR.

6 The Balanced Budget Refinement Act of 1999 (BBRA 99, P.L. P.L. 106-113) incorporated an adjustment for the prior
year into the UAF update calculation; it also moved from a fiscal year to a calendar year system.
7 For more information on the components used to calculate the MEI and quarterly historical data, see
http://www.cms.hhs.gov/MedicareProgramRatesStats/downloads/mktbskt-economic-index.pdf.
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Medicare Physician Payment Updates and the Sustainable Growth Rate (SGR) System

Sustainable Growth Rate (SGR)
The SGR sets both the cumulative and allowed expenditures under the UAF formula and consists
of the following components:
• the estimated percentage changes in physicians fees,
• the estimated percentage changes in the number of fee-for-service beneficiaries,
• the estimated percentage growth in real gross domestic product (GDP) per capita
(10-year moving average), and
• the estimated percentage changes resulting from changes in laws and regulations.
One important implication of the way this formula was constructed is that sustainable growth in
Medicare physician expenditures should be equivalent to the rate of growth in the economy (i.e.,
the growth in GDP per capita). In addition, the formula implies that increases in managed care
enrollment relative to fee-for-service Medicare would result in a slightly lower SGR.
Update Adjustment Factor
The update adjustment sets the conversion factor at a level so that projected spending for the year
will meet allowed spending by the end of the year. The adjustment factor is the sum of (1) the
prior year adjustment component; and (2) the cumulative adjustment component. Use of both the
prior year adjustment component and the cumulative adjustment component allows any deviation
between cumulative actual expenditures and cumulative allowed expenditures to be corrected
over several years rather than a single year. As originally established, the adjustment factor can
not be less than minus 7% or more than plus 3%. Thus, despite calculations which would have led
to larger reductions, the UAF adjustment has been minus 7% for the last several years. The caps
on the adjustment limit the annual reduction or increase. Thus, the gap between cumulative actual
spending and cumulative allowed spending grows larger each year and is exacerbated whenever
Congress overrides the reductions, since the targets are never modified under current law.
Historical Updates and Legislative Overrides
Under the update formula, if actual expenditures do not exceed target expenditures, the update
generally would be positive and payments would increase for all services under the fee schedule
subject to the single conversion factor. In the first few years of the SGR system, the actual
expenditures did not exceed the targets. (See Figure 1.) As a consequence, the updates to the
physician fee schedule were close to the MEI in the first two years (2.3% in 1998 and 1999,
compared with MEI of 2.2% in 1998 and 2.3% in 1999).8 For the next two years, in 2000 and
2001, the actual physician fee schedule update was more than twice the MEI for those years
(5.5% update vs. MEI of 2.4% in 2000, 5.0% update vs. MEI of 2.1% in 2001). However,
beginning in 2002, the actual expenditure exceeded allowed targets and the discrepancy has
grown with each year.

8 See Table 6, Actual Past Medicare Economic Index Increases and Physician Updates for 1992−2009, and Estimated
Values for 2010, in CMS publication, “Estimated Sustainable Growth Rate and Conversion Factor, for Medicare
Payments to Physicians in 2010.”
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Figure 1. Difference Between Cumulative Allowed and Actual Expenditures for
Physician Services Under the SGR System
1996-2008

Source: CRS figure from CMS data contained in “Estimated Sustainable Growth Rate and Conversion Factor,
for Medicare Payments to Physicians in 2010.” Available at http://www.cms.hhs.gov/SustainableGRatesConFact/
Downloads/sgr2010p.pdf
Notes: This graph shows the difference between cumulative al owed expenditures and actual expenditures for
physician services. The 2008 figures for both allowed and actual expenditures are CMS estimates.
As a consequence of exceeding the target, the formula dictated a reduction in the fee schedule in
2002. Although reductions have been called for every year since, Congress has passed legislation
that has overridden the cuts each year since. (See Table 1.)
Table 1. Summary of Updates and Legislative Activity
2002-2009
Year
Formula update
Actual update
Legislation
Notes
2002
−4.8%
−4.8%


2003
−4.4%
1.4% Consolidated The update was 1.7% but was
Appropriations
effective on March 1, 2003, so
Resolution of 2003
the average update for the year
(CAR)
was 1.4%.
2004
−4.5%
1.5% Medicare

Modernization Act
of 2003 (MMA, P.L.
108-173)
2005
−3.3%
1.5% MMA

2006
−4.4%
0.2% Deficit
Reduction
Although the DRA froze the
Act of 2005 (DRA,
conversion factor update,
P.L. 109-171)
refinements to the RVUs
resulted in a 0.2% update for
the year.
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Medicare Physician Payment Updates and the Sustainable Growth Rate (SGR) System

Year
Formula update
Actual update
Legislation
Notes
2007
−5.0%
0%
Tax Relief and

Health Care Act of
2006 (TRHCA, P.L.
109-432)
Jan–Jun 2008
−10.1%
0.5% Medicare,
Medicaid,
Physicians who voluntarily
and SCHIP
reported on certain quality
Extension Act of
measures during July 1, 2007-
2007 (MMSEA, P.L.
December 31, 2007, were
110-173)
eligible for a bonus payment of
1.5% in 2008 per TRHCA.
Jul–Dec 2008
−10.6% reduction
0% (0.5% from Medicare
See above.
from June 2008 level
2007 level)
Improvement for
Patients and
Providers Act of
2008 (MIPPA, P.L.
110-275)
2009

1.1%
MIPPA
Physicians who voluntarily
reported on certain quality
measures during 2008 were
eligible for a bonus payment of
1.5% in 2009 per MMSEA.
Jan 1–Feb 28,
−21.3%
0% Department
of
2010
Defense
Appropriations Act
(P.L. 111-118)
Mar 1–Mar
0%
Temporary
Signed into law on Mar 2, 2010.
31, 2010
Extension Act (P.L.
111-144)
Apr 1–May
0%
Continuing
Signed into law on Apr 15,
31, 2010
Extension Act (P.L.
2010.
111-157)
June 1–
2.2%
Preservation
of
Signed into law on June 25,
November
Access to Care for
2010. (increase was retroactive
30, 2010
Medicare
to June 1.)
Beneficiaries and
Pension Relief Act
of 2010 (P.L. 111-
192)
December 1

0% (2.2% from Jan Physician Payment

– 31, 2010.
– May, 2010 level) and Therapy Relief
Act of 2010 (P.L.
111-286P.L. 111-
286)
2011 0%
Medicare
and

Medicaid Extenders
Act (P.L. 111-309)
Source: 2010 Annual Report of the Boards of Trustees of the Federal Hospital Insurance And Federal
Supplementary Medical Insurance Trust Funds, http://www.cms.hhs.gov/ReportsTrustFunds/downloads/
tr2010.pdf, and CMS, Estimated Sustainable Growth Rate and Conversion Factor, for Medicare Payments to
Physicians in 2011, http://www.cms.hhs.gov/SustainableGRatesConFact/Downloads/sgr2011f.pdf.
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In addition to overriding the payment reductions, Congress has also included provisions in several
of the laws to increase Medicare physician payments in other ways. For example, the Congress
has altered the geographic adjustment factor for physician work, one component used in making
regional adjustments to payments under the physician fee schedule. MMA set a floor on the work
geographic adjustment index at 1.0 for 2004-2006, thereby slightly increasing the payment
amounts in some areas. TRHCA extended this provision through 2007, MMSEA extended it
through June 30, 2008, and MIPPA extends it through December 2009. In addition, beginning
January 1, 2009, MIPPA also raised the work geographic adjustment in Alaska to 1.5.
Some of the bills also modified the cap on the conversion factor, which has led to the current
situation where the consequence of not overriding the reduction would lead to cuts in excess of
the 7% cap. TRHCA specified that the override of the reduction that would have been
implemented under the statutory formula was to be treated as if it did not occur. Therefore, the
starting base for the 2008 calculation was 5% below the actual 2007 conversion factor. MMSEA
overrode the reduction for the first six months of 2008 and provided for a 0.5% increase for that
period. However, the legislation again specified that the override of the statutory formula was to
be treated as if it did not occur. MIPPA again specified that the override of the statutory formula
was to be treated as if it did not occur. As a result, CMS estimates that a reduction of 21.2% will
be necessary in 2010 unless Congress acts again to override the current situation.9
Analysis and Criticisms of SGR System
The experience in recent years has been that the volume and the intensity of physician services
provided to Medicare beneficiaries are growing at more than double the rate allowed under the
SGR system.10 Payment reductions as called for under the update formula have required almost
annual interventions by Congress and the SGR system has been criticized (and defended) amid
calls for its repeal. While some of the criticisms of the SGR system point to purported flaws in
the technical details behind the formula, others have just expressed general displeasure with the
outcome.
General and Conceptual Concerns
One commonly asserted criticism is that the SGR system treats all services and physicians equally
in the calculation of the annual payment update to the detriment of physicians who are “unduly”
penalized. The expenditure target is a nationwide aggregate and the annual updates are applied
uniformly; there is no direct link between individual behavior and the subsequent update. Thus,
actions might be individually rational (physicians provide and bill for additional services and
collect greater reimbursement) yet collectively detrimental (the annual update is reduced).11 An

9 CMS press release, “CMS Announces Payment, Policy Changes For Physicians Services To Medicare Beneficiaries
In 2010,” October 30, 2009. http://www.cms.hhs.gov/apps/media/press/release.asp?Counter=3539&intNumPerPage=
10&checkDate=&checkKey=&srchType=1&numDays=3500&srchOpt=0&srchData=&keywordType=All&
chkNewsType=1%2C+2%2C+3%2C+4%2C+5&intPage=&showAll=&pYear=&year=&desc=&cboOrder=date.
10 U.S. Government Accountability Office (GAO), Medicare Physician Payments: Trends in Utilization, Spending and
Fees Prompt Consideration of Alternative Payment Approaches, testimony of Bruce Steinwald before House Energy
and Commerce Committee, July 25, 2006.
11 Often referred to as the tragedy of the commons: while it may be individually rational for each herder to let livestock
graze on the common field (to preserve his own), the collective consequence of many such individual decisions is that
(continued...)
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individual physician who controls or reduces volume does not see a resulting increase in
payments.
Others point out that there is no ability to distinguish between appropriate volume increases (for
instance, due to changes in disease conditions that increase demand) and inappropriate volume
increases (for instance, when tests or procedures are provided that are not necessary).
Technical Concerns
The inclusion of some items and services in the expenditure targets has also been called into
question. Specifically, physicians have argued that Part B drug spending should be excluded from
the calculation because physicians have no control or influence on the price of these drugs,
although CMS is preparing to address this in its implementation of the 2010 proposed rule
changes.12
Additionally, the targets may not be not adequately modified to reflect scientific and
technological innovations or site-of-service shifts, and providers have often stated that actual
increases in practice costs exceed those allowed under the system. The impact of legislative and
regulatory changes also may not be fully reflected in the SGR calculation.
Per Capita Gross Domestic Product (GDP) and the Annual Update
The SGR is based on a number of factors, including the changes in the price of inputs required to
produce physician services (such as rent, staff and supplies), the change in the number of
Medicare fee-for-service beneficiaries, the effect of laws and regulations on part B expenditures,
and the rate of growth in the per capita gross domestic product, calculated as a 10-year moving
average.

(...continued)
the common fields are overgrazed and all herders suffer from the degradation or depletion of the common good.
12 See CMS Final Rule, Medicare Program; Payment Policies Under the Physician Fee Schedule and Other Revisions
to Part B for CY 2010, to be published in the Federal Register on November 25, 2009.
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Figure 2. Relative Increase in Part B Expenditures vs. per Capita GDP
1996-2008

Source: CMS, “Estimated Sustainable Growth Rate and Conversion Factor for Medicare Payments to Physicians
in 2010” http://www.cms.hhs.gov/SustainableGRatesConFact/Downloads/sgr2010p.pdf and U.S. Department of
Commerce, Bureau of Economic Analysis, National Income and Product Accounts, Table 7.1. “Selected Per Capita
Product and Income Series in Current and Chained Dol ars” (http://www.bea.gov/national/nipaweb/
IndexP.htm#P).
Notes: The lines are based on quarterly data that are not seasonally adjusted. The uneven pattern of Medicare
Part B expenditures reflects typical seasonal variation in health care use, which tends to increase with colder
temperatures.
The rate of growth in per capita GDP has a significant impact on the determination of the annual
update. As can be seen in Figure 2, from 1997 through 2000, per capita GDP grew faster than
part B expenditures, at more than 4% annually; part B expenditures were relatively stable from
1996 to 1998 and then started to increase in 1999 and 2000. However, economic growth slowed
at the turn of the century (as can be seen in the flatter slope in the growth of per capita GDP
during the period from 2000-2003), while part B expenditures grew at a faster rate from 2000 on.
Because the comparison of actual to target expenditures includes a significant component that is
cumulative (rather than just a comparison of the current period), the updates were positive during
the early years of the SGR system but then became negative as a result of this imbalance. (See
Figure 3.)
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Figure 3. Formula Updates, Actual Updates, and the Medicare Economic Index
2000-2009
8.0
5.5 5.5
6.0
4.8 4.8
4.0
3.0
2.9
3.1
2.8
2.4
2.6
2.1
2.1
1.8
1.6
2.0
1.5
1.5
1.4
1.1
0.5
0.2
0.0
0.0
-2.0
-3.3
% Change
-4.0
-4.4
-4.5
-4.4
-4.8 -4.8
-5.0
-6.0
-8.0
-10.0
-10.1
-10.6
-12.0
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
Formula update
Actual update
MEI

Source: 2009 Annual Report of the Boards of Trustees of the Federal Hospital Insurance And Federal
Supplementary Medical Insurance Trust Funds, p. 22. http://www.cms.hhs.gov/ReportsTrustFunds/downloads/
tr2009.pdf, and CMS, Estimated Sustainable Growth Rate and Conversion Factor, for Medicare Payments to
Physicians in 2010, http://www.cms.hhs.gov/SustainableGRatesConFact/Downloads/sgr2010p.pdf.
Notes: MMSEA included a six-month override of the SGR update (−10.1%) for the first half of 2008. MIPPA
provided for an 18-month override of the SGR update that would have taken effect on July 1, 2008 (−10.6%) that
included the second half of 2008 and al of 2009. See also Table 1.
Thus, the relative health of the economy effectively masked the increases in total part B
expenditures for the first few years under the SGR system, but as the economy slowed and
expenditures continued to increase, the updates as determined under the SGR system have turned
negative in order to bring projected actual expenditures back in line with target expenditures.
Potential Modifications and Alternatives
Although a number of modifications to the SGR system have been proposed, there is no
consensus around a long-run alternative. In addition, any permanent change would likely be quite
costly because the Congressional Budget Office (CBO) baseline must assume that a reduction in
the conversion factor will occur for the next several years as required under current law. In
addition to the impact on federal outlays, any change in the update formula will also have
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implications for beneficiaries; because Part B beneficiary premiums must cover 25% of Part B
program costs, any overall increase in spending results in a proportional increase in premiums.13
Suggested modifications have ranged from modifying the current formula to replacing the
formula and linking updates to payment adequacy and/or quality measures. While a change in the
formula would require legislation, some observers have suggested that there are things CMS
could do administratively to ease the impact of the current formula. Proponents argue that these
changes, such as removing Part B drugs from the calculation, could somewhat moderate the
negative updates that are predicted.
The Medicare Modernization Act of 2003 (MMA) required that GAO study “the appropriateness
of the sustainable growth rate formula” and “the stability and predictability of such updates and
rate and alternatives.”14 In a 2005 report, the GAO categorized options for alternatives around
two themes: (1) proposals that end the use of spending targets and separate fee updates from
explicit efforts to moderate spending growth; and (2) proposals that retain spending targets but
modify the current SGR system to address perceived shortcomings.15 The first approach
emphasizes stable fee updates, while the second automatically adjusts fee updates if spending
growth deviates from a predetermined target. GAO stated that “the choice between the two
approaches may hinge on whether primary consideration should be given to stable fee increases
or to the need for fiscal discipline within the Medicare program.” The second approach would end
targets as an explicit measure for moderating spending growth. Updates would be based on cost
increases with the possibility of specifically addressing high volume service categories such as
medical imaging.
The Deficit Reduction Act of 2005 (DRA) required MedPAC to submit a report to Congress on
mechanisms that could be used to replace the SGR system, including “such recommendations on
alternative mechanisms to replace the sustainable growth rate system as the Medicare Payment
Advisory Commission determines appropriate.”16 In its March 2007 report, MedPAC described
two possible paths: one path would eliminate the SGR and emphasize the development and
adoption of approaches for improving incentives for physicians and other providers to furnish
lower cost and higher quality care, while the second path would add a new system of expenditure
targets in addition to these approaches.17 However, MedPAC did not make any recommendations
in favor of any single alternative to the SGR, citing “significant disagreement … within the
Commission about the utility of expenditure targets” and stating that the complexity of the issues
made it difficult to recommend any option with confidence. MedPAC did stress in the report that
“a major investment should be made in Medicare’s capability to develop, implement, and refine
payment systems to reward quality and efficient use of resources while improving payment
equity.” Examples cited by MedPAC include pay-for-performance programs for quality,
improving payment accuracy, and bundling payments to reduce overutilization.

13 For details on Medicare Part B premiums see CRS Report R40082, Medicare: Part B Premiums, by Jim Hahn.
14 P.L. 108-173, Section 953(a).

15 U.S. Government Accountability Office, Medicare Physician Payments: Concerns about Spending Target System
Prompt Interest in Considering Reforms, GAO-05-85, October 8, 2004.
16 P.L. 109-171, Section 5104(c).
17 Medicare Payment Advisory Commission, Assessing Alternatives to the Sustainable Growth Rate System, March
2007.
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MedPAC has also recommended updating payments for physicians’ services based on the
estimated change in input prices for the coming year less an adjustment for savings attributable to
increased productivity. Specifically, input prices would be measured using the MEI (without
regard to the CMS adjustment for productivity increases). The recommended productivity
adjustment would be that used across all provider services.18
In March 2008, CBO issued cost estimates for a variety of approaches for dealing with the
physician payment issue.19 Proposals with modest costs assumed a freeze for the second half of
2008 (as opposed to a 10.6% reduction), with reductions in future years to hold future rates at
current law levels. More costly alternatives would freeze or increase payments over the 10-year
budget window. For example, increasing payments by the MEI each year through 2018 would
increase federal spending by $288.1 billion for the FY2008-FY2018 period. Coupling this with a
provision excluding this change from beneficiary premium calculations (“premium hold-
harmless”) would increase federal spending by $364.3 billion over the same period.
Figure 3 shows that in each year since 2002, the MEI has been greater than the update as
determined under the SGR formula and the actual update that physicians have received as a result
of congressional intervention.
Recent Legislative Activity: Not Passed
H.R. 3162 (110th Congress)
Summary
The Children’s Health and Medicare Protection Act of 2007 (CHAMP, H.R. 3162) was introduced
on July 24, 2007. Section 301 of Title III would have modified the SGR system by eliminating
the single conversion factor currently applied to all physician services and would have established
separate target growth rates and conversion factors for each of six newly created service
categories.20 The six categories of physician services would have been the following: evaluation
and management services for primary care and for preventive services; other evaluation and
management services; imaging services and diagnostic tests; major procedures; anesthesia
services; and minor procedures and other services.
The provision would have replaced the single SGR computation with separate target growth rates
for each of the service categories created above. Beginning with 2008, the target growth rate for
each service category would have been computed and applied separately using the same method
for computing the sustainable growth rate under current law except that (1) “physicians’ services”
would refer to the physicians’ services included in the appropriate service category, (2) the
estimate of the annual average percentage growth in real gross domestic product per capita for the
applicable period would have been increased by 0.03, and (3) a national coverage determination
would be treated as a change in regulation and thus incorporated into the Secretary’s estimate of

18 MedPAC, Report to the Congress, Medicare Payment Policy, March 2008.
19 http://www.cbo.gov/ftpdocs/90xx/doc9055/03-14-SGR_Options.pdf.
20 This summary and discussion includes only the proposed modifications to the Medicare physician update
methodology in the CHAMP Act relevant to the ongoing discussions regarding proposed solutions.
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the percentage change in expenditures for all physicians’ services in the fiscal year (compared
with the previous fiscal year) resulting from changes in law and regulations.
Beginning with 2008, the conversion factors would be computed and updated separately for each
service category. In 2008, the conversion factors would have been based on the single 2007
conversion factor multiplied by the appropriate update for the category. In subsequent years, the
conversion factor for each category would have been based on the conversion factor for the
service category adjusted by the appropriate update. The provision would have established a floor
for updates so that the conversion factors for each service category would be no less than 0.5%
for 2008 and 2009.
The Committee on Ways and Means amended and reported the bill on August 1, 2007, and the
House passed the bill the same day by a vote of 225-204.21 The bill was never taken up by the
Senate.
Brief Analysis
The approach to modifying the SGR as proposed in H.R. 3162 attempted to address, among other
things, the criticism that the current update calculation penalized (or rewarded) all physicians
identically regardless of the individual’s or the specialty’s contribution towards meeting or
exceeding the aggregate expenditure target. Thus, even though imaging services have grown
faster than other types of physician services (including evaluation and management services,
tests, major procedures, and other procedures) the resulting impact on the annual update factor
applies to all services across all specialties. However, others have countered that this delineation
may not be appropriate and the CHAMP approach went too far. For example, some of the
increase in imaging services may have allowed for the earlier detection of disease conditions such
as cancer, which may have produced savings for other services and specialties (e.g., nuclear
medicine and oncology services).
H.R. 3961 (111th Congress)
Summary
H.R. 3961, the Medicare Physician Payment Reform Act of 2009 was introduced on October 20,
2009. The proposals in this bill share some of the same approaches and objectives as Section 301
of the CHAMP Act, but also differ significantly in a few important ways. First, rather than
creating six different categories of physician services, the bill would create two categories of
service beginning in 2011, each with its own separate target growth rate and conversion factor
update. The two categories of service would be (1) evaluation, management, and preventive
services, and (2) all other services. Target expenditures for the E&M and preventive services
category would be allowed to grow at the rate of growth of per capita GDP plus 2%, while the
target expenditures for the all other category would be allowed to grow at the rate of growth of
per capita GDP plus 1%. Second, the year 2009 would be established as the new baseline year for
calculating expenditure targets (rather than 1996 under current law) for each of the two categories
of services. Third, only physician services would be included in the calculation of actual and

21 http://clerk.house.gov/cgi-bin/vote.asp?year=2007&rollnumber=787.
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target growth expenditures; services provided incident to the physician visit (such as laboratory
services), would not be included. Fourth, during the transition to the calculations required for the
new method of calculating targets and updates, the 2010 update would be the percentage increase
in the Medicare economic index (MEI). In its final rule for 2010 Medicare physician payments,
CMS specified that the MEI will be 1.2%.22
On November 19, 2009, the House passed H.R. 3961 by a vote of 243-183.23 However, on
February 24, 2010, the Senate amended the bill by replacing everything after the enacting clause
and renamed the bill “An Act to extend expiring provisions of the USA PATRIOT Improvement
and Reauthorization Act of 2005 and Intelligence Reform and Terrorism Prevention Act of 2004
until February 28, 2011.”24
Brief Analysis
The impact of this bill would be felt not only by physicians but also by other parts of the
Medicare program, the Department of Defense TRICARE program, and beneficiaries under
Medicare Part B. CBO estimates that enacting H.R. 3961 would increase direct spending by about
$210 billion over the 2010-2019 period.25 Not only would physician reimbursements under the
Medicare physician fee schedule increase, but expenditures under the Medicare Advantage (MA)
program would increase because per beneficiary spending for fee-for-service beneficiaries would
increase as a result of the bill, raising the “benchmarks” that Medicare uses to determine the
capitation payments for beneficiaries enrolled in Medicare Advantage plans. TRICARE
expenditures would rise because its physician reimbursements are based on Medicare’s physician
fee schedule. Furthermore, since Medicare Part B beneficiary premiums are required to cover
25% of total Part B expenditures, the increases in physician reimbursements as a result of
changing the update calculation would put pressure on future Part B premiums to rise.
The proposed modification might reduce the likelihood that future expenditures exceed the target
expenditures, since the growth rates would be more generous under this bill than under current
law, but this might lead to an increase in the total expenditures of the Medicare Part B program.
While the SGR has been heavily criticized, a fundamental assumption was that tying physician
expenditure growth to the rate of growth in GDP per capita could lead to a sustainable growth
path. By allowing the two categories to grow at GDP per capita plus 1% or 2%, this bill would
appear to allow for a situation where physician expenditures grow and consume a greater
percentage of the national income.

22 The MEI measures the weighted-average annual price change for various inputs needed to produce physicians’
services. The calculation of the 2010 MEI is given in Table 33 of the final 2010 Medicare physician payment rule
issued by CMS. http://www.federalregister.gov/OFRUpload/OFRData/2009-26502_PI.pdf.
23 http://clerk.house.gov/evs/2009/roll909.xml.
24 The Senate passed the amended bill by voice vote on February 24, 2010. The House passed the Senate-amended
version on February 25, 2010, by 315-97 and the bill became P.L. 111-141.
25 CBO Cost Estimate, “H.R. 3961—Medicare Physician Payment Reform Act of 2009,” November 4, 2009,
http://www.cbo.gov/ftpdocs/107xx/doc10704/hr3961.pdf.
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A Senate Amendment in the form of a Substitute to H.R. 3590
(111th Congress)
Summary
Section 3101 of the Senate health care reform bill, an amendment in the form of a substitute to
H.R. 3590, would have overridden the reduction in the annual update to the conversion factor
used in the determination of the Medicare fee schedule and provided an increase of 0.5% in 2010.
The conversion factor for 2011 and for subsequent years would have been computed as if the
increase in 2010 had never applied. CBO estimates that this provision would have cost $7.2
billion in 2010 and $4.1 billion in 2011, with no other budgetary impact in subsequent years.
However, the manager’s amendment contained several additions and modifications to the bill,
including Section 10310, which repealed Section 3101. On December 24, 2009, the Senate passed
the amended bill by a vote of 60-39.26
Brief Analysis
Much as other recent overrides have done, the original provision (Section 3101) would have
increased Medicare physician payments slightly in the short term while increasing the cost of
addressing this problem in the future because another year’s worth of actual expenditures that
exceed target expenditures would have contributed to the total amounts that would have to be
recouped under the current SGR system. However, the manager’s amendment struck this section,
and thus the health care reform bill as passed by the Senate does not include any provisions that
address the SGR situation.
Recent Legislative Activity: Enacted into Law
Department of Defense Appropriations Act, 2010 (P.L. 111-118)
Summary
On December 16, 2009, the House passed H.R. 3326, the FY2010 Defense Appropriations bill.
One of the provisions in Section 1011 of the bill delayed the application of the update to the
conversion factor until February 28, 2010.27 Another provision in the same section reduced the
amount of monies available in the Medicare Improvement Fund by $1.55 billion.28 The Senate
passed the bill on December 19, 2009,29 and the bill was signed into law30 that day.

26 http://www.senate.gov/legislative/LIS/roll_call_lists/roll_call_vote_cfm.cfm?congress=111&session=1&vote=
00396.
27 For roll call details, see http://clerk.house.gov/cgi-bin/vote.asp?year=2009&rollnumber=985.
28 Section 188 of MIPPA established the Medicare Improvement Fund (MIF), available to the Secretary to make
improvements under the original fee-for-service program under Parts A and B for Medicare beneficiaries.
29 For roll call details, see http://www.senate.gov/legislative/LIS/roll_call_lists/roll_call_vote_cfm.cfm?congress=111&
session=1&vote=00384.
30 P.L. 111-118.
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Brief analysis
The bill delayed the payment reductions from taking effect for two months while maintaining fee
schedule reimbursements at 2009 levels.
Increasing the Statutory Limit on the Public Debt (P.L. 111-139)
Summary
Section 7 of Title I of this bill (H.J.Res. 45, the Statutory Pay-As-You-Go Act of 2010), which
was signed into law on February 12, 2010 (P.L. 111-139), provides a limited exception to the
“pay-as-you-go (PAYGO)” rules for addressing the Medicare physician payment situation as a
result of the SGR system (as well as additional exceptions). The maximum amount of the
exception is to be the difference between estimated net outlays if 2009 Medicare fee schedule
payment rates were to be in effect for the next five years (i.e., a “freeze” through December 31,
2014) and what the payments would have been had fees reverted to levels as dictated under the
SGR system. Furthermore, any future legislation that reforms or replaces the SGR system would
be scored for PAYGO purposes only if the modification were to cost more than the cost of the
five-year freeze at 2009 levels. If legislation changing the SGR system were to be enacted that
costs less than the five-year freeze through 2014, any remaining amount in the adjustment could
be used to offset costs after 2014 as a result of the change, but the total adjustment could not
exceed the maximum adjustment amount.
Brief Analysis
The provision exempts the equivalent of a five-year freeze of Medicare reimbursement at 2009
levels from PAYGO—an amount the CBO estimates to be $88.5 billion.31 Congress would still
have to pass legislation that would override the cuts as directed by the SGR system.
Temporary Extension Act of 2010 (P.L. 111-144)
Summary
On February 25, 2010, the House passed H.R. 4691, the Temporary Extension Act of 2010, by
voice vote. This bill extended a number of expiring programs, including unemployment insurance
benefits, premium assistance for COBRA benefits, and the Medicare therapy caps, in addition to
forestalling the Medicare physician payment cuts. Section 5 modified the Defense Appropriations
Act, 2010, by delaying the payment reduction for another month, through March 31, 2010. The
CBO score for this section is $ 1.04 billion in additional outlays.32 Although a motion to pass the
bill by unanimous consent failed in the Senate that evening,33 the bill eventually passed the
Senate by a vote of 78-1934 and was signed into law (P.L. 111-144) on March 2, 2010.

31 http://www.cbo.gov/budget/factsheets/2010b/SGR-menu.pdf.
32 CBO score available at http://www.cq.com/displayfile.do?docid=3299370.
33 See the Congressional Record at http://www.congress.gov/cgi-lis/query/D?r111:2:./temp/~r111LpI3Lx.
34 http://www.senate.gov/legislative/LIS/roll_call_lists/roll_call_vote_cfm.cfm?congress=111&session=2&vote=
(continued...)
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Brief Analysis
This bill delayed the payment reductions from taking effect until April 1, 2010, while maintaining
fee schedule reimbursements at 2009 levels through March 31, 2010.
Continuing Extension Act of 2010 (P.L. 111-157)
Summary
On March 17, 2010, by voice vote, the House passed H.R. 4851, as amended (striking all after the
enacting clause and inserting new text). The bill includes extensions for several programs,
including certain unemployment insurance provisions, premium assistance for COBRA benefits,
and the Medicare therapy caps exceptions process in addition to forestalling the SGR payment
reductions for another month, until May 1, 2010. The Senate amended Section 4 of the bill by
lengthening the Medicare physician payment cut extension until May 31, 2010, and both houses
of Congress passed the bill on April 15, 2010. The President signed the bill into law (P.L. 111-
157) that day.
Brief Analysis
The bill delayed the physician payment reductions from taking effect until June 1, 2010, while
maintaining fee schedule reimbursements at 2009 levels through May 31, 2010.
Preservation of Access to Care for Medicare Beneficiaries and
Pension Relief Act (P.L. 111-192)
Summary
On June 18, 2010, more than two weeks after the May 31, 2010, expiration of the extension under
the Continuing Extension Act of 2010,35 the Senate passed an amended version of H.R. 3962 by
voice vote that would avert the SGR-determined payment reduction and increase the conversion
factor by 2.2% retroactive to June 1, 2010, and continuing through November 30, 2010. CBO
scored this provision as adding $6.3 billion to direct spending over the 5- and 10-year budget
window, with all spending occurring in fiscal years 2010 and 2011. The cost is offset (1) by
imposing a three-day prohibition on hospital provision that would bar Medicare contractors from
reopening or adjusting claims by hospitals during the three days preceding a patient’s inpatient
admission, and (2) from savings resulting from modifications that allow firms to spread out their

(...continued)
00032.
35 CMS issued two instructions to its contractors regarding claims affected by the expiration. The first, on May 27,
instructed contractors to hold claims for services dated June 1 and later and paid under the Medicare physician fee
schedule for the first 10 business days of June (i.e., through June 14, 2010). The second, on June 18, 2010, instructed
contractors to begin lifting the hold and to begin processing June 1 and later Medicare physician fee schedule claims
under the law’s negative update requirement on a first-in/first-out basis.
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pension fund obligations over a longer period, resulting in fewer tax-preferred contributions to
pension plans and creating more taxable income for the firms.
The House passed the Senate-amended bill on June 24, 2010.36 The President signed the bill into
law (P.L. 111-192) the next day.
Brief Analysis
The act increases the Medicare physician fee schedule payments by 2.2% for six months. A
substantial payment reduction (about 23%) would have been required beginning December 1,
2010, and an additional reduction (about 6%) would have been applied beginning January 1,
2011, in the absence of further congressional action.
The Physician Payment and Therapy Relief Act of 2010 (P.L. 111-
286)
Summary
On November 18, 2010, by unanimous consent, the Senate passed H.R. 5712,37 which extended
the 2.2% increase established by H.R. 3962 for an additional month through December 31, 2010.
The House passed the amended bill on November 29, 2010, by voice vote, and the President
signed the bill into law (P.L. 111-286) on November 30, 2010.
The cost of the override was to be offset by reductions to payments to providers for the second
and for additional services when multiple therapy procedures are performed on the same patient
on the same day.38
Brief Analysis
While this extension maintained provider payments at the existing level, additional legislative
action was required to forestall the reduction to payments under the Medicare fee schedule that
would have taken effect beginning January 1, 2011.

36 The vote was 417-1, with 14 members not voting. See http://clerk.house.gov/evs/2010/roll393.xml.
37 Originally introduced in the House in July, 2010 as the Veterans’, Seniors’, and Children’s Health Technical
Corrections Act of 2010, the version passed by the Senate struck and substituted everything after the enacting clause. in
addition to the physician payment modification, the bill also modified the discount applied to payments for therapy
services when multiple procedures are performed on a beneficiary on the same day.
38 See Congressional Budget Office, Estimate of the Statutory Pay-As-You-Go Effects for the Physician Payment and
Therapy Relief Act of 2010, November 18, 2010, http://cbo.gov/ftpdocs/119xx/doc11969/
PhysicianPaymentandTherapyReliefAct.pdf.
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Medicare and Medicaid Extenders Act of 2010 (P.L. 111-309)
Summary
The Medicare and Medicaid Extenders Act of 2010 (H.R. 4994) extended many Medicare
provisions that were due to expire on December 31, 2010, and made other changes to the
Medicare and Medicaid program, including a one-year override of the payment reductions
required under the SGR system. This act provided for a 0% update adjustment factor in 2011
compared to the (end-of-year) 2010 payments. These provisions were fully offset.39
Brief Analysis
Following the one-year override, the legislation states that “the conversion factor ... shall be
computed ... for 2012 and subsequent years as if [the override] had never applied.” CMS’s March
2011 estimate of the 2012 SGR40 is that a 29.5% reduction will be required beginning January 1,
2012, in the absence of further legislative action.41 In its March 2011 report, MedPAC
recommended a 1% update to the Medicare physician fee schedule for 2012.42


39 The one-year override was offset by increasing the penalties collected from individuals who improperly receive
health insurance tax credits (under health care reform), replacing the two fixed penalty amounts ($250 for individuals
and $400 for families at or below 400% of the federal poverty level) with a scaled penalty related to income. The CBO
score is available at http://cbo.gov/ftpdocs/120xx/doc12008/hr4994.pdf
40 The Secretary is required (Section 1848(d)(1)(E) of the Social Security Act) to make public an estimate of the
Sustainable Growth Rate (SGR) and the conversion factor applicable to Medicare payments for physicians’ services for
the following year by March 1 of each year.
41 See CMS, “Estimated Sustainable Growth Rate and Conversion Factor, for Medicare Payments to Physicians in
2012” available at https://www.cms.gov/SustainableGRatesConFact/Downloads/sgr2012p.pdf.
42 MedPAC, Report to the Congress: Medicare Payment Policy, MedPAC, Washington, DC, March 2011,
http://www.medpac.gov/documents/mar11_entirereport.pdf.http://www.medpac.gov/documents/mar11_entirereport.pdf
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