Medicare “Snowball” Continues to Grow

The latest patch on the Medicare payment system has been applied through the end of the year.  The latest measure halted a 23% reduction in physician payments, based on the Sustainable Growth Rate formula.  Unless patched again, the cut will be implemented on Jan. 1, 2011, and will be 25%.  The increase, or “snowball” occurs because as spending exceeds certain index parameters, the law adds the shortfall to the next cut.  Plenty of authors have discussed the cuts, the flaws that go into the formula, and the distorting effects on utilization that this type of scheme can cause.

Here is a highly simplified income statement for a fictitious, single physician medical practice.  It illustrates the effect of the 25% cut in revenue.  The example assumes 100% of revenues from Medicare, with 55% overhead.  All overhead (staff/rent/supplies/etc) is considered as a single item.

Fictitious Medical Practice, Income Statement

Revenues:   $250,000
Overhead:  $137,500
Pretax net to owner:  $112,500

Now, here’s the same thing after the 25% cut.

Revenues:  $187,500
Overhead:  $137,500
Pretax net to owner:  $50,000

This results in more than a 55% drop in the pretax profit.  Although the overhead is based on a revenue percentage in the first example, that same dollar amount still must be spent in the second case.   Patient volume remains the same; only the government payment rate has changed.  And when that filters down through the practice, the effect is more than double the amount of the cut.  Its a snowball on both ends.

Given the major problems that need to be solved (see the Simpson-Bowles report later this week), this recurring Medicare issue isn’t getting top billing.  There are arguments against continuing to patch a payment scheme for physicians, when there are many other serious problems still facing the U.S. economy.  But this problem cannot be ignored forever, and there is no solution in sight.


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