The medicare conversion factor.

To understand the Medicare compensation system for physician services, it is necessary to understand how the relative values of medical services are translated into fee schedule payment amounts. Basically, the relative value of a procedure multiplied by the number of dollars per Relative Value Unit (RVU) is the fee paid by Medicare for the procedure (RVUW physician work, RVUPE practice expense, RVUMP malpractice). The Conversion Factor (CF) is the number of dollars assigned to an RVU. It is calculated by use of a complex formula (Fig 1) that takes into account the overall state of the economy of the United States, the number of Medicare beneficiaries, the amount of money spent in prior years, and changes in the regulations governing covered services. Medicare fees are set according to a relative value scale rather than a free market, payments are made by third parties rather than consumers, and the labor market for physicians is illiquid, so the pricing mechanisms that regulate markets in other parts of the economy are not effective in rationalizing prices. The factors that influence the CF calculation are similar to those that are used in calculating global health care budgets; therefore the principles are durable, even if the precise formula might be altered in the future. Annually, the CF is based on the previous year’s CF and adjusted for the Medical Economic Index, the Update Adjustment Factor, Legislative Change, and Budget Neutrality. The Medical Economic Index is a calculation of the inflation rate for medical services, which is generally higher than inflation in consumer prices overall. The Update Adjustment Factor encompasses the Sustainable Growth Rate (SGR) that takes into account growth or decline in the Gross Domestic Product, changes in the number of beneficiaries, and certain regulatory adjustments that may affect the demand for and costs of providing Medicare services. This is the mechanism through which the relative proportion of Part B Medicare spending is maintained at an acceptable level with respect to overall government spending and the size of the economy as a whole. The process of setting the CF each year balances increases in demand for medical services and the finite productive capacity of the economy. The calculation is then subject to Budget Neutrality, requiring any increase in the relative expenditures in one area of the Medicare program to be offset by cuts in other areas. The calculation must result in a budget for Medicare that is within $20 million of the target.