April 2003 Bulletin

A primer on 2003 Medicare reimbursement

Review basic concepts

By Daniel H. Sung, JD

In order to understand how Medicare pays you for the services that you provide to Medicare patients, it’s important to understand a few basic concepts about Medicare’s physician payment system.

The Medicare physician payment system is based on a resource-based relative value scale (RBRVS). Under this system, physician services are ranked according to the relative costs of resources required to provide the service.

For example, assume Procedure A takes twice as long, is twice as difficult and requires twice as much overhead expense as Procedure B. Under an RBRVS system, Procedure A would be assigned a relative value unit (RVU) twice that of Procedure B.

For Medicare, every procedure listed in the American Medical Association’s (AMA’s) Current Procedural Terminology (CPT) is assigned a relative value unit reflecting the physician work involved in the procedure, a relative value unit reflecting the practice expense generated by the procedure and a relative value unit representing the cost of the professional liability insurance needed to provide the procedure. The sum of these three relative value units is multiplied by a dollar conversion factor. The result of this calculation is a payment rate for a particular procedure.

For example, CPT code 27130 (total hip arthroplasty) has a physician work relative value of 20.12, a practice expense relative value of 13.58 and a professional liability insurance relative value of 2.82. The 2003 conversion factor is $36.78. Thus the 2003 payment for a total hip procedure is:

(20.12 + 13.58 + 2.82) x $36.78 = $1343 for total hip arthroplasty

Medicare also makes one additional adjustment in procedure payment rates based on the geographic location of your practice. As you can see, payment levels for specific procedures are dependent on a number of factors. In 2003, two factors affected the Medicare payment rates of orthopaedic procedures–the conversion factor and changes in practice expense relative value units.

Conversion factor

The conversion factor is a dollar amount multiplier that is used to calculate payment to physicians for all medical services under Medicare. The formula for calculating the conversion factor is extremely complex and is based on a number of factors including estimates on the inflationary costs of practicing medicine, adjustments based on an expenditure target and other adjustments to maintain budget neutrality within the Medicare program. By law, the conversion factor is adjusted each year, and this adjustment affects payment of all physician services.

Initially, Medicare published a 4.4 percent decrease in the 2003 conversion factor when compared to the 2002 conversion factor. However, due to last-minute federal legislative action by Congress and the President, the 2003 conversion factor is now 1.6 percent higher than the 2002 conversion factor. The conversion factor for 2003 is $36.78.

Practice expense

In 1999, Medicare began a four-year transition to new practice expense relative value units based on studies conducted on the costs of medical practice. Medicare’s transition to this new system affects the payment for many orthopaedic procedures. The impact of these changes is not uniform across all procedures and, in fact, there is variation across different families of procedures. Generally, the new system tends to increase payment for services performed in a physician’s office and decrease payment for services performed in a hospital setting.

In some instances, decreases in the practice expense payments for a specific procedure more than offset the 1.6 percent increase in the conversion factor for 2003. This is why Medicare payment for certain orthopaedic procedures decreased in 2003. However, if Medicare had implemented the 4.4 percent decrease in the conversion factor that was originally proposed, these payment cuts would have been much more drastic.

For more information, contact AAOS department of Socioeconomic & State Society Affairs, at (847) 384-4320.


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