The Crazy Way that Medicare Pays Doctors—and Distorts All Medical Pricing


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The way that Medicare pays physicians is crazy. Crazy because it's bound to create weird incentives for doctors. Crazy because it's a recipe for unchecked overspending throughout the medical system. Crazy because anyone ever thought it could work.

The short version is that Medicare relies on a complicated pricing formula that attempts to ensure that doctors never have a financial incentive to do one procedure rather than another. The slightly longer version is that Medicare pays doctors based on a formula that attempts to reimburse them for their time, rather than, say, particular skills or the complexity of the procedure. The goal of a purely time-based system is to avoid creating financial incentives for doctors to perform some procedures more than others, so if Procedure A takes twice as long as Procedure B, on average, then the doctor will get paid twice as much for Procedure A. In theory, this avoids situations in which Procedures X and Y both take the same amount of time, but X pays far more, and so doctors look for ways to spend as much time as they can  doing X rather than Y.

In practice, it's just a complex system of price controls. And like all systems of price controls, it has a ton of problems. One of the most obvious is: How does Medicare know how long it takes to perform any given procedure relative to any other. The answer is that they ask doctors. The American Medical Association has a committee called the "Relative Value Update Committee," or RUC (I guess someone decided RVUC was too awkward?). The RUC surveys doctors, then determines the relative time values for any given procedure. And then, in virtually every case, Medicare accepts those values without any sort of check or further confirmation.

Basically, the biggest medical payer in the country asks doctors to determine how much they want to be paid for their work. As you might imagine, that creates some problems.

One big issue, as The Washington Post reported over the weekend, is that the relative values are hugely inflated, so that doctors end up billing for hours they couldn't possibly have worked. The Post's investigation into Medicare's records found 78 doctors from Florida (of course!) who "performed at least 24 hours worth of procedures on an average workday." Somehow I doubt that's actually happening.

The AMA doesn't even try to deny the time-inflation either. "All of the times are inflated by some factor," the chair of the AMA committee told The Post.

And that doesn't only affect Medicare. The federally run health program for seniors is the largest purchaser of medical services in the country. That means that the prices it pays serve as a de facto baseline for private insurance payments as well; the large majority of private insurers take their cues from Medicare's pricing, typically taking the federal price and then paying somewhat more. In other words, it distorts—and, arguably, actively controls—pricing throughout the entire U.S. health care system, public and private.

Meanwhile, the pricing system has failed to even accomplish its basic goal of evening out prices for different types of medical procedures. The RUC's prices end up heavily weighted toward surgery and specialty work. As The Wall Street Journal noted in a 2010 piece on the system, averaged out, primary care physicians only ended up making about $101 an hour on Medicare pricing, compared to surgeons, who averaged $161 per hour, and specialists like dermatologists, whose hourly average was $214. Which helps explain why so many doctors go into specialty fields—and why there's such a relative shortage of primary care physicians. The Post, meanwhile, points to procedures like colonoscopies, which seem to be relatively overvalued in the system, and notes that high-volume providers seem perform those procedures a lot more often.

The gist of much of the criticism of the Medicare price setting process is that it's too reliant on the doctors who are getting paid, with too few independent checks on the values they submit. But there's a more fundamental problem, here, one that more oversight of the price-setting process isn't going to fix: the whole thing is just a price control scheme that completely ignores most of the relevant market signals.

As Joseph Antos, an American Enterprise Institute scholar who helped conceive of the system before it went into place, told me back in 2011, Medicare's price-setting process totally ignores the patient-value side of the equation. "Asking committees of doctors to guess how much work is involved in something is the same thing as just setting prices," he told me. And like all price control systems, it ends up being essentially arbitrary. Adding an extra layer of oversight, or a few more bureaucratic controls, isn't likely to change that. If anything, it's likely to make the system more complex, and more inscrutable—which is what happened in the 1980s to state-based health care price control systems every time legislators sought to address imbalances and inequities in the system. The whole system of health care price controls, in other words, is crazy, and plans to fix it through bureaucratic tweaking are likely to make it crazier.