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Medicare implemented a prospective payment system (PPS) for outpatient services in August 2000.1 Different service bundles are classified under about 800 ambulatory payment classification groups (APCs). Each APC contains clinically similar services with comparable resource use, and each is assigned a relative weight based on the median cost of the services included in the group. Roughly 350 APCs are for pharmaceuticals or devices. Eighty are reserved for new technologies for which Medicare does not yet have the reliable cost information needed to fold them into a regular APC.2 Distinct from the outpatient PPS, ambulatory surgical centers now provide many services—including cataract surgery, colonoscopy, and arthroscopy—that once required hospitalization.3 A conversion factor transforms the APC weights into dollar payments. The outpatient conversion factor was $63.694 in 2008. It is increased annually by the increase in the hospital market basket index unless Congress stipulates otherwise. To account for geographic differences in input prices, Medicare adjusts the labor portion of the conversion factor (60 percent) by the hospital wage index. For extremely expensive cases, outlier payments cover half of costs that exceed 1.75 times the standard payment rate and that also exceed the payment rate by $1,575. As with inpatient services, some hospitals have abused 140 Appendix B Pricing for Selected Outpatient Services Appendix B: Pricing for Selected Outpatient Services 141 this provision.4 Certain items involving new technologies—drugs, biologicals , and implantable devices—are not encompassed by the technologyrelated APCs and are paid separately.5 Clinical laboratory fees are handled differently. In theory, Medicare pays prospectively set fees for clinical lab services. In practice, however, 98 percent of lab tests are paid on the basis of national limits. Each Medicare payment region has a separate fee schedule. Each fee schedule covers over 1,100 separate tests or combinations of tests. Prices are based on 1983 laboratory charges adjusted for subsequent inflation. The national payment limits are set at 74 percent of the median amounts in the various regional fee schedules. Medicare pays rental fees or purchase costs for durable medical equipment according to fee schedules for over 2,000 product groups. Payments are increased annually by the change in the consumer price index. Because Medicare payments for some equipment came to exceed prices paid by other buyers, in 1997 Congress authorized Medicare to freeze or cut payments and to conduct demonstrations to test the feasibility and implications for access and quality of setting payment rates through competitive bidding. The demonstrations found that competitive bidding reduced costs by about 20 percent with no serious quality or access issues.6 As a result, the Medicare Modernization Act (MMA) instructed Medicare to phase in a competitive bidding system for most durable medical equipment products in large urban markets between 2008 and 2009.7 Dialysis fees are slightly higher for hospital-based facilities than for the 4,200 free-standing centers, but are the same for hemodialysis and peritoneal dialysis. A base prospective payment is adjusted crudely for differences in case mix and local input prices.8 Facilities also receive separate payments for certain new injectable drugs and vitamins and lab tests, possibly creating a strong incentive to provide these separately billed drugs.9 They now account for about 35 percent of the payments made to facilities. Several dialysis quality measures, including the share of patients who received adequate dialysis and whose anemia was under control, improved from 2000 to 2005.10 Because the number of surviving patients is growing, dialysis-related payments have increased rapidly and accounted for about 2 percent of Medicare’s expenditures in 2006. ...

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