Medicare: Challenges Remain in Setting Payments for Medical	 
Equipment and Supplies and Covered Drugs (12-JUN-02,		 
GAO-02-833T).							 
                                                                 
Medicare has paid higher than market rates for various medical	 
equipment and supplies and often considerably higher than	 
provider acquisition costs for Medicare-covered outpatient drugs.
Congress has enacted a series of legislative changes affecting	 
payment methods and payment adjustment authority for medical	 
equipment and supplies and outpatient drugs since the late 1980s.
However, progress in setting appropriate rates has been mixed,	 
owing, in part, to various constraints faced by  the agency	 
responsible for administering Medicare--the Centers for Medicare 
and Medicaid Services (CMS). Because of the program's size,	 
scope, and role as a public payer, Medicare has limited options  
to set and adjust payments for medical equipment, supplies and	 
outpatient drugs. Medicare's method of paying for medical	 
equipment and supplies is through fee schedules that remain tied 
to suppliers' historical charges to Medicare rather than market  
prices. Medicare's payment approaches lack flexibility to keep	 
pace with market changes, and as a result, Medicare often pays	 
higher prices than other public payers. Previous efforts to lower
Medicare's overly generous payments suggest several lessons.	 
First, payment changes are most effectively implemented when the 
process used to set or adjust a rate is defensible. Second, the  
information on Medicare claims for medical equipment and supplies
is not specific enough to enable CMS to determine which products 
Medicare is actually paying for. Also, for the foreseeable	 
future, CMS will have to continue to rely on fee schedules based 
on historical charges in setting payment rates for medical	 
equipment and supply items.					 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-02-833T					        
    ACCNO:   A03575						        
  TITLE:     Medicare: Challenges Remain in Setting Payments for      
Medical Equipment and Supplies and Covered Drugs		 
     DATE:   06/12/2002 
  SUBJECT:   Drugs						 
	     Health care cost control				 
	     Health insurance cost control			 
	     Medical equipment					 
	     Medical supplies					 
	     Overpayments					 
	     Best practices					 
	     Fair market value					 
	     Prices and pricing 				 
	     HCFA Common Procedure Coding System		 
	     Medicare Program					 

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GAO-02-833T
     
Testimony Before the Subcommittee on Labor, Health and Human Services,
Education and Related Agencies, Committee on Appropriations, U. S. Senate

United States General Accounting Office

GAO For Release on Delivery Expected at 9: 30 a. m. Wednesday, June 12, 2002
MEDICARE

Challenges Remain in Setting Payments for Medical Equipment and Supplies and
Covered Drugs

Statement of Leslie G. Aronovitz Director, Health Care- Program

Administration and Integrity Issues

GAO- 02- 833T

Page 1 GAO- 02- 833T

Mr. Chairman and Members of the Subcommittee: I am pleased to be here as you
discuss Medicare payment methods related to durable medical equipment,
prosthetics, orthotics, and supplies- products referred to in this statement
as medical equipment and supplies- and covered outpatient drugs. Over the
years, we and the Department of Health and Human Services (HHS) Office of
the Inspector General (OIG) have periodically reported that Medicare has
paid higher than market rates for various medical equipment and supply items
and often considerably higher than provider acquisition costs for
Medicarecovered outpatient drugs. 1 Since the late 1980s, the Congress has
enacted a series of legislative changes affecting payment methods and
payment adjustment authority for medical equipment and supplies and
outpatient drugs. However, the progress made in setting appropriate rates
has been mixed, owing, in part, to various constraints faced by the agency
responsible for administering Medicare- the Centers for Medicare and
Medicaid Services (CMS), formerly called the Health Care Financing

Administration (HCFA). 2 In this regard, my remarks today will focus on (1)
Medicare?s experience in setting payment rates for medical equipment and
supplies and outpatient drugs; (2) certain changes designed to assist in
setting payments for medical equipment and supplies and outpatient drugs
incorporated in the Balanced Budget Act of 1997 (BBA); 3 and (3) lessons
learned from efforts to improve the appropriateness of Medicare?s payments.
My comments are based primarily on our previously issued work.

In summary, because of the program?s size, scope, and role as a public
payer, Medicare has limited options to set and adjust payments for medical
equipment and supplies and outpatient drugs. For example, in cases where
Medicare is the dominant payer for a service or product, the program?s share
of the payments can distort the market, making reliance on market prices
problematic. Medicare?s method of paying for medical equipment and supplies
is through fee schedules that remain tied to suppliers?

1 A list of related GAO products is included at the end of this statement. 2
This statement will refer to HCFA in discussing actions taken before the
agency?s name was officially changed on July 1, 2001. 3 Pub. L. No. 105- 33,
111 Stat. 251.

Page 2 GAO- 02- 833T

historical charges to Medicare rather than market prices. Similarly,
Medicare?s method of determining outpatient drug payments is based on list
prices, not prices that purchasers actually pay for the outpatient drugs.
Medicare?s payment approaches lack flexibility to keep pace with market

changes, and as a result, Medicare often pays higher prices than other
public payers for medical equipment and supplies and outpatient drugs.

Despite dramatic instances of wide disparities in market prices and
Medicare?s payment rates for medical equipment and supplies and outpatient
drugs, Medicare is not in a position to take prompt action. To lower
unreasonably high payment rates, it must follow a lengthy and complicated
regulatory process for making payment adjustments. The BBA gave HCFA
authority to use a streamlined process to adjust payment rates for most
medical equipment and supplies and outpatient drugs. 4 However, the agency?s
attempt to use this authority drew intense industry

criticism, in part because the agency acted before it responded to public
comment on how it would implement the authority. The Congress then
prohibited use of either the original or streamlined processes until public
comments are addressed and a final rule issued. 5 To date, a final rule has
not been published, effectively precluding the use of the original or
streamlined processes to adjust Medicare payment rates, where excessive.
Nevertheless, the BBA also provided HCFA the authority to test an
alternative to setting prices administratively. 6 This authority permitted
HCFA to conduct demonstrations, for a limited number of items at a few
locations, using competition to determine an appropriate payment for these
items. In this process, suppliers competed for the right to supply certain
items on the basis of quality and price. Two such demonstrations have
reported savings without any measurable problems in beneficiary access.

Past efforts to lower Medicare?s overly generous payments suggest several
lessons. First, payment changes are most effectively implemented when the
process used to set or adjust a rate is defensible. Medicare?s size and
impact on the nation?s health care economy means that its payment methods
and rate adjustments, no matter how reasonable, will face close

4 BBA at sect. 4316, 111 Stat. 390 (codified at 42 U. S. C. sect. 1395u( b)( 8) and
(9) (Supp. III 1997)). 5 Medicare, Medicaid, and SCHIP Balanced Budget
Refinement Act of 1999, Pub. L. No. 106- 113, App. F, sect. 223, 113 Stat. 1501,
1501 A- 352 (to be codified at 42 U. S. C. 1395u( b)( 8) (Supp. V 1999)).

6 BBA at sect. 4318, 111 Stat. 392 (codified at 42 U. S. C. sect. 1395w- 3 (Supp.
III 1997)).

Page 3 GAO- 02- 833T

scrutiny. As a result, the need for CMS to collect sufficient information on
market prices and potential effects on suppliers and beneficiaries before
taking action is paramount. A second lesson, related to the first, is that
the information on Medicare claims for medical equipment and supplies is not
specific enough to enable CMS to determine which products Medicare is
actually paying for. Thus, the agency has difficulty trying to use market
prices to set appropriate rates. A third lesson is that for the foreseeable
future, CMS will have to continue to rely on fee schedules based on
historical charges in setting payment rates for medical equipment and supply
items. The recent demonstrations that set payments for items through
competitive bidding were instructive, but the positive results achieved may
be neither applicable nor practical on a wider scale for many products.

CMS, an agency within HHS, is responsible for much of the federal
government?s multi- billion- dollar payments for health care, primarily
through the Medicare and Medicaid programs. Medicare- the nation?s largest
health insurance program- covers about 40 million elderly and disabled
beneficiaries. Medicaid is a state- administered health insurance program,
jointly funded by the federal and state governments, that covers eligible
low- income individuals including children and their parents, and aged,
blind, and disabled individuals. Each state administers its own program and
determines- under broad federal guidelines- eligibility for, coverage of,
and reimbursement for, specific services and items.

Most Medicare beneficiaries purchase part B insurance, which helps pay for
certain physician, outpatient hospital, laboratory, and other services;
medical supplies and durable medical equipment (such as oxygen, wheelchairs,
hospital beds, and walkers); and certain outpatient drugs. Medicare part B
pays for most medical equipment and supplies using a series of fee
schedules. Medicare pays 80 percent, and the beneficiary pays the balance,
of either the actual charge submitted by the supplier or the fee schedule
amount, whichever is less. Generally, Medicare has a separate fee schedule
for each state for most categories of items, and there are upper and lower
limits on the allowable amounts that can be paid in different states to
reduce variation in what Medicare pays for

similar items in different parts of the country. The fee schedules specify a
Medicare- allowable payment amount for each of about 1,900 groups of
products. Each product group is identified by a Healthcare Common Procedure
Coding System (HCPCS) Level II code, and all products grouped under a code
are intended to be items that are Background

Page 4 GAO- 02- 833T

alike and serve a similar health care function. For example, one code
(E1130) describes a standard wheelchair with fixed arms. Many different
brands can be billed under this code, so long as they fit the basic
description.

Medicare part B also covers roughly 450 outpatient drugs- generally those
that cannot be self- administered and are related to physicians services,
such as cancer chemotherapy, or are provided in conjunction with covered
durable medical equipment, such as inhalation drugs used with a nebulizer. 7
In addition, Medicare part B covers selected immunizations and certain
outpatient drugs that can be self- administered, such as blood clotting
factors and some oral drugs used in association with cancer treatment and
immunosuppressive therapy.

To administer Medicare part B fee- for- service claims, CMS contracts with
insurance companies, referred to as carriers, who review and pay claims that
have been submitted by physicians and other outpatient providers and

suppliers. To ensure appropriate payment, carriers conduct claims reviews
that determine, for example, whether the services claimed are covered by
Medicare, are reasonable and necessary, and have been billed with the proper
codes.

Medicare?s size and complexity make it extremely challenging to develop
payment methods that prudently reimburse providers while promoting
beneficiary access to items and services. As Medicare?s steward, CMS cannot
passively accept what providers want to charge the program. However, because
of its size, Medicare profoundly influences health care markets. Medicare is
often the dominant payer for services and products, and in such cases, it
cannot rely on market prices to determine appropriate payment amounts
because Medicare?s share of payments distorts the market. In addition,
Medicare has had difficulty relying on competition to determine prices.
Because of constraints on excluding any

qualified provider from participating in the program, Medicare traditionally
includes all such providers who want to participate. Finding ways of
encouraging competition without excluding some providers- a

normal leverage that purchasers use to make competition work- has been
problematic. As a result, Medicare has had to administratively set payment

7 A nebulizer is a device driven by a compressed air machine that allows the
patient to take medicine in the form of a mist or wet aerosol. Payment
Approaches Lack Flexibility to

Keep Pace with Market Changes

Page 5 GAO- 02- 833T

amounts for thousands of services and items, trying to do so in ways that
encourage efficient delivery, while ensuring beneficiary access to them.

Adding to the complexity of setting payment amounts is Medicare?s status as
a highly visible public program with certain obligations that may not be
consistent with efficient business practices. For example, CMS is
constrained from acting swiftly to reprice services and supplies even when
prevailing market rates suggest that payments should be modified. When
making substantive changes, Medicare?s enabling legislation generally
requires public input. This minimizes the potential for actions to have
unintended consequences. However, seeking and responding to public input
from various provider and supplier groups can be a time- consuming process
that can sometimes thwart efficient program management.

Prior to 1987, Medicare payments for medical equipment and supplies were
based on supplier charges, subject to some limitations. As part of their
responsibilities to administer Medicare claims, individual Medicare carriers
raised or lowered payments to suppliers in their local areas to align them
with market prices. When carriers sought to adjust payments on this basis,
they employed a process that involved gathering relevant pricing data from
local area markets, determining new payment levels on the basis of the price
information obtained, and notifying area suppliers of the changes. Although
HCFA monitored carriers? performance in carrying out these steps, it did not
evaluate the appropriateness of the new payment levels established.

In 1987, the Congress and HCFA began the process of moving the Medicare
program from paying on the basis of individual providers? charges for
medical equipment and supplies and covered outpatient drugs, to developing
payment methods intended to pay more prudently through use of program-
determined amounts. Specifically, the Congress introduced fee schedules for
medical equipment and supplies in 1987. 8 Statewide fees were determined on
the basis of average supplier charges on Medicare claims allowed in each
state in 1986 and 1987, and were updated for

8 Omnibus Budget Reconciliation Act of 1987, Pub. L. No. 100- 203, sect. 4062,
101 Stat. 1330, 1330- 101 (codified at 42 U. S. C. sect. 1395m (1988)). Certain
medical equipment and supply items not originally on a fee schedule were
added later- for example, surgical dressings, were added by the Omnibus
Budget Reconciliation Act of 1993 Pub. L. No. 103- 66, sect. 13544( b), 107
Stat. 312, 589 (codified at 42 U. S. C. sect. 1395m( i) (1994)).

Page 6 GAO- 02- 833T

inflation in some years. 9 However, the agency lacked mechanisms to
otherwise adjust fees to reflect marketplace changes. As a result,
disparities between fee schedule amounts and market prices developed over
time, and Medicare significantly overpaid for some medical equipment and
supplies.

In recent years, we and the HHS OIG reported on instances where Medicare
payments for certain medical equipment and supplies and outpatient drugs
were excessive compared with retail and other prices. One notable example of
excessive Medicare payments is included in our 1995 report on surgical
dressings. 10 We estimated that Medicare could have saved almost $20 million
in 1995 if it had paid the lowest wholesale prices

available in a national catalog for 44 types of surgical dressings. Although
Medicare?s fee schedule for surgical dressings was based on medians of
retail prices found in supply catalogs when the schedule was set, Medicare?s
statute did not permit HCFA to lower the fee schedule when retail prices for
dressings decreased. 11 Another instance of excessive Medicare payment was
for home oxygen

equipment and supplies provided to patients with pulmonary insufficiency.
Medicare fee schedule allowances for home oxygen were significantly higher
than the rates paid for almost identical services by the Department of
Veterans Affairs (VA), which in fiscal year 1995 paid for home oxygen
benefits for over 23,000 patients. In 1997, we estimated that Medicare

9 Prior to 1998, these fees were adjusted each year using formulas tied to
the Consumer Price Index. No update was provided from 1998 through 2000 or
in 2002, although updates were provided in 2001. 42 U. S. C. sect. 1395m( a)(
14) (Supp. IV 1998); Medicare, Medicaid and SCHIP Balanced Budget Refinement
Act of 1999, Pub. L. No. 106- 113, App. F, sect. 228, 113 Stat. 1501, 1501A-
356; and Medicare, Medicaid, and SCHIP Benefits Improvement and

Protection Act of 2000, Pub. L. No. 106- 554, App. F, sect. 425, 114 Stat. 2763,
2763A- 519 (to be codified at 42 U. S. C. sect. 1395m( a)( 14)).

10 U. S. General Accounting Office, Medicare: Excessive Payments for Medical
Supplies Continue Despite Improvements, GAO/ HEHS- 95- 171 (Washington, D.
C.: Aug. 8, 1995). 11 Authority to adjust payment rates that were excessive
did not extend to surgical dressings and certain other medical supplies at
that time. The BBA extended the authority to adjust rates for any payments
under part B that are excessive. BBA at sect. 4316, sec. 1842( b)( 8)( A)( i)(
I), 111 Stat. 390 (changing ?application of this subsection? to ?application
of this part).? Clarifying this broadened scope, ?application of this part?
was later changed to ?application of this title to payment under this part.?
Medicare, Medicaid, and SCHIP Balanced Budget Refinement Act of 1999, Pub.
L. No. 106- 113, App. F, sect. 223( c), 113 Stat. 1501, 1501A- 353.

Page 7 GAO- 02- 833T

could have saved over $500 million in fiscal year 1996 if it had paid rates
for home oxygen comparable to those paid by VA. 12 Medicare?s payments for
outpatient drugs have been similarly excessive,

although the methodology used to determine payment amounts is somewhat
different and attempts to tie Medicare?s payments to market prices. In 1989,
the Congress required that physician services be paid based on fee schedules
beginning in 1992. 13 The fee schedules developed by HCFA to comply with
this requirement provided for all outpatient drugs furnished to Medicare
beneficiaries not paid on a cost or prospective payment basis to be paid
based on the lower of the estimated acquisition cost or the national average
wholesale price (AWP). 14 Manufacturers report AWPs to organizations that
publish them in drug price compendia, which are typically updated annually,
and Medicare carriers base providers? payments on these published AWPs.

In concept, such a payment method has the potential to be market- based and
self- adjusting. The reality is, however, that AWP is neither an average nor
a price that wholesalers charge. Because the term AWP is not defined in law
or regulation, there are no requirements or conventions that AWP reflect the
price of any actual sale of drugs by a manufacturer. Given the latitude
manufacturers have in setting AWPs, Medicare?s payments are often not
related to market prices that physicians and suppliers actually pay for the
products.

A June 1997 House Budget Committee report accompanying the bill that became
the BBA, in explaining the reason for specifying a 5- percent reduction from
AWP, cited a report by the HHS OIG regarding Medicare payments for
outpatient drugs. 15 Among the OIG findings were that

Medicare payments ranged from 20 percent to nearly 1,000 percent of certain
oncology drugs? commercially available prices.

12 The savings estimate includes adding a 30- percent adjustment to VA
payment rates to account for differences between the Medicare and VA
programs. See U. S. General Accounting Office, Medicare: Comparative
Information on Medicare and VA Patients, Services, and Payment Rates for
Home Oxygen, GAO/ HEHS- 97- 151R (Washington, D. C.: June 6, 1997).

13 Omnibus Budget Reconciliation Act of 1989, Pub. L. No. 101- 239, sect. 6102,
103 Stat. 2106, 2169 (codified at 42 U. S. C. sect. 1395w- 4 (Supp. I 1989)). 14
56 Fed. Reg. 59, 502, 59, 507 (Nov. 25, 1991).

15 H. R. Rep. No. 105- 149, at 1354 (1997).

Page 8 GAO- 02- 833T

Our recent work found that Medicare payments in 2001 for part B- covered
outpatient drugs remained significantly higher than prices widely available
to physicians and pharmacy suppliers. 16 For example, most
physicianadministered drugs had widely available discounts ranging from 13
to 34 percent below AWP. Two other physician- administered drugs had
discounts of 65 and 86 percent. Pharmacy suppliers- the predominant billers
for 10 of the high- expenditure and high- volume drugs we analyzed- also
purchased drugs at prices considerably lower than Medicare payments. For
example, two inhalation drugs accounting for most of Medicare payments to
pharmacy suppliers had widely available discounts averaging 78 percent and
85 percent from AWP.

Despite such dramatic illustrations of disparities between Medicare payments
and prices widely available to others acquiring medical equipment and
supplies and covered outpatient drugs, Medicare has not had the tools to
respond quickly in such instances. Carriers used to adjust payment amounts
as part of their responsibility to appropriately pay Medicare claims, but in
1987, the Congress effectively prohibited use of this process to lower
Medicare payment rates until 1991. 17 In 1988, the Congress required use of
a more formal ?inherent reasonableness? process

that could be accomplished only by HCFA, not by the carriers. 18 In other
reports, we have described this process as slow and cumbersome and have
noted that it is not available for some items, such as surgical supplies. 19
Since 1991, when HCFA was first permitted to use the inherent

reasonableness process to adjust payments for medical equipment and
supplies, it successfully did so only once- for blood glucose monitors-

16 U. S. General Accounting Office, Medicare: Payments for Covered
Outpatient Drugs Exceed Providers? Cost, GAO- 01- 1118 (Washington, D. C.:
Sept. 21, 2001). 17 Omnibus Budget Reconciliation Act of 1987, Pub. L. No.
100- 203, sect. 4062( b), 101 Stat. 1330, 1330- 100. 18 Medicare Catastrophic
Coverage Act of 1988, Pub. L. No. 100- 360, sect. 411( g)( 1)( B)( xiii), 102
Stat. 683, 782. These procedures were previously applicable only to any
inherent

reasonableness review with respect to physician services. 42 U. S. C. 1395m(
a)( 10)( B) (1988).

19 Changing an unreasonable payment level required, among other things, a
formal noticeand- comment rulemaking process that involved the HCFA
Administrator, the Secretary of Health and Human Services, and the Director
of the Office of Management and Budget (OMB). U. S. General Accounting
Office, Medicare Payments: Use of Revised ?Inherent

Reasonableness? Process Generally Appropriate, GAO/ HEHS- 00- 79
(Washington, D. C.: July 5, 2000) and GAO/ HEHS- 95- 171. BBA Reforms Sought

to Improve Medicare?s Ability to Set Appropriate Rates

Page 9 GAO- 02- 833T

and in that instance took almost 3 years to adjust the maximum allowable
Medicare payment from $185. 79 to $58.71.

In 1997, in response to concerns about HCFA?s difficulties in adjusting
payment rates determined to be excessive, the Congress included a provision
in the BBA that gave HCFA authority to use a streamlined inherent
reasonableness process to adjust payments for medical equipment and supplies
and covered outpatient drugs by up to 15 percent a year. 20 Subsequent
legislation required that a final regulation taking into

account public comments be published before the agency could use any
inherent reasonableness authority. Because the agency has not issued the
final regulation, it cannot adjust Medicare?s fee schedules to respond to
market price information. The BBA also provided HCFA with opportunities to
test an alternative to setting rates administratively that

could be more responsive to market prices. 21 This alternative is
competitive bidding- a process allowing suppliers to compete for the right
to supply their products on the basis of established criteria, such as
quality and price. 22 The BBA gave HCFA authority to use a streamlined
inherent

reasonableness process for part B services (excluding physician?s services).
Under this authority, HCFA can adjust payments by up to 15 percent per year
using a streamlined process, or can use its original process with formal
notice and comment to make larger adjustments. In January 1998, the agency
published an ?interim final rule with comment period? for the streamlined
inherent reasonableness process that became effective 60 days after it was
published. 23 This was a departure from the usual practice of first
responding to public comments before issuing a final regulation.

20 BBA at sect. 4316, 111 Stat. 251, 390. 21 BBA at sect. 4319, 111 Stat. 251, 392.
(Codified at 42 U. S. C. sect. 1395w- 4 (Supp. III 1997). 22 In the competitive
bidding demonstration projects authorized under BBA, Medicare part B items
and services (other than physician services) were furnished under
competitively awarded contracts. For each demonstration product or service,
the prices bid by winning suppliers were used to determine the competitively
bid fee schedule price.

23 63 Fed. Reg. 687 (Jan. 7, 1998). In this interim final rule, HCFA
committed to having a notice and comment period for any payment adjustments,
even through the streamlined process. Streamlined Process to Adjust Fees
Needs Further

Regulatory Action to Be Implemented

Page 10 GAO- 02- 833T

Under the interim final rule, HCFA delegated authority to use the
streamlined process to the Medicare carriers that process claims for medical
equipment and supplies, with final action on payment adjustments to be
approved by the agency. The carriers attempted to lower maximum payment
rates for eight groups of products, gathering information on retail prices
through surveys conducted in at least 16 states. In September 1998, the
carriers notified suppliers of proposed adjustments for eight groups of
products and solicited comments. Industry groups representing various

medical equipment and supply manufacturers and suppliers expressed serious
concerns about how the inherent reasonableness process was implemented and
whether the surveys were conducted properly. The Congress requested that we
review the appropriateness of implementing the streamlined inherent
reasonableness authority through an interim final rule and the soundness of
the carriers? surveys. Pending the results of our review, HCFA suspended the
carrier- proposed payment reductions in March 1999. In November 1999, the
Congress passed legislation prohibiting HCFA or

the carriers from using any inherent reasonableness authority until we
issued our report and the agency issued a final rule taking into account our
findings and public comment. 24 In our July 2000 report, we concluded that,
while the carriers could have conducted their surveys more rigorously, the
surveys and other evidence sufficiently justified the carriers? proposed
payment reductions for five of eight product groups. 25 In our report, we
recommended that HCFA clarify criteria for using its inherent reasonableness
authority, strengthen agency or carrier survey

methodology in the future, collect additional data on prices for the other
three product groups before adjusting their payment amounts, and monitor
beneficiary access after any payment changes. Although our report is almost
2 years old, CMS has not issued a final regulation that would allow it to
use either its streamlined or original inherent reasonableness processes to
adjust Medicare payment amounts for part B supplier- billed services. Thus,
the agency lacks a tool to adjust its fee schedules, short of statutory
changes.

24 Medicare, Medicaid, and SCHIP Balanced Budget Refinement Act of 1999,
Pub. L. No. 106- 113, App. F, sect. 223, 113 Stat. 1501, 1501A- 352 (signed into
law January 29, 1999). 25 GAO/ HEHS- 00- 79.

Page 11 GAO- 02- 833T

In order to experiment with other ways of setting Medicare?s payments for
medical equipment and supplies and outpatient drugs, the BBA provided
authority for HCFA to conduct demonstration projects using competitive
bidding and to include home oxygen in at least one of the demonstrations. 26
Evidence from two competitive bidding projects suggests that, for most of
the items selected, competition might provide a tool that facilitates
setting more appropriate payment rates and result in program savings.

In its first competitive bidding demonstration, conducted in Polk County,
Florida, HCFA set rates for oxygen, hospital beds, surgical dressings,
enteral nutrition and supplies, and urological supplies through competitive
bidding. HCFA reported that the new rates set by this competitive process in
the Florida demonstration saved Medicare an average of 17 percent on the
cost of these medical equipment and supply items without compromising
beneficiary access to these items. 27 In a second demonstration in San
Antonio, Texas, the agency included

oxygen; hospital beds; manual wheelchairs; noncustomized orthotic devices,
including ?off- the- shelf? items such as braces and splints; and albuterol
sulfate and other nebulizer drugs. Preliminary CMS information on the San
Antonio competitive bidding demonstration identified an average savings of
20 percent, without any negative effects on beneficiary access.

Whether attempting to adjust payments administratively or through
competitive bidding, CMS can only be effective if it has a defensible
process for doing so and accurate information upon which to base action. Any
change to Medicare?s payments, particularly a reduction in fees for

medical equipment and supplies or covered outpatient drugs, should be
accompanied by an ongoing assessment of whether the new payments adequately
support Medicare beneficiaries? access to such items and services and
properly reimburse providers and suppliers. Such monitoring

26 BBA at sect. 4219, 111 Stat. 392. The BBA at 4552( a), 111 Stat. 459, also
reduced home oxygen payment amounts by 25 percent effective January 1, 1998,
and an additional 5 percent effective January 1, 1999.

27 Medicare program savings did not occur in all product categories; there
were higher prices for surgical dressings, one of five product categories in
the demonstration. BBA Provisions Authorized Competitive

Bidding Demonstration Projects

Past Efforts to Correct Inappropriate Payments Suggest Lessons for The
Future

Page 12 GAO- 02- 833T

needs to examine current experience so that prompt fee adjustments can be
made if access problems are found.

Efforts to lower excessive payment rates through the inherent reasonableness
process illustrate the difficulties CMS has in making even minor
adjustments, as the agency?s actions can have wide ramifications for

providers, suppliers, and beneficiaries. When HCFA tried to use its
streamlined inherent reasonableness authority in 1998 to reduce payment
rates for various medical equipment and supply items and outpatient drugs,
it attempted to take action before responding to public comment, thereby
leaving the effort open to criticism. In addition, we concluded that the
carriers? survey methodology was not rigorous enough to provide a basis to
adjust fees nationally for all of the products under review.

What the agency lacked was sufficient information on market prices. Such
information, along with current local, as well as national, data on
beneficiaries? use of services and program expenditures, is key to setting
rates administratively. Because HCFA did not have reliable acquisition

cost information, its carriers engaged in a very labor- intensive
information- gathering effort.

One major problem CMS has when going to the marketplace to collect
information is that it cannot determine the specific products Medicare is
paying for when carriers process claims for medical equipment and supplies.
Carriers pay claims on the basis of billing codes indicating that the
supplied items belong to a particular product group. These groups can cover
a broad range of product types, quality, and market prices. As a

result, products that differ widely in properties, use, performance, and
price are billed under the same code and the program pays the same amount.
For example, we reported in 1998 that catheters belonging to a single
product category varied in type and price, from about $1 to $18, with
Medicare?s maximum fee payments ranging across states from $9.95 to $11.70.
28 However, HCFA had no information on which catheters were being provided
to beneficiaries.

To address the problem of insufficient specificity, we recommended in the
1998 report that suppliers be required to include universal product numbers
(UPN) as well as current billing codes on claims. UPNs and

28 U. S. General Accounting Office, Medicare: Need to Overhaul Costly
Payment System for Medical Equipment and Supplies, GAO/ HEHS- 98- 102
(Washington, D. C.: May 12, 1998).

Page 13 GAO- 02- 833T

associated bar codes are increasingly used to identify specific medical
equipment and supplies, similar to the way universal product codes are used
in supermarkets. Manufacturers can use bar codes for each product to
identify characteristics such as the manufacturer, product type, model,
size, and unit of packaging. Using UPNs- or some other mechanism-
incorporated into claim forms to bring more specificity to what is provided
to beneficiaries could help CMS better determine appropriate payments.

Under provisions in the Health Insurance Portability and Accountability Act
of 1996 (HIPAA), HHS has adopted standards for coding medical services,
procedures, and equipment and supplies. 29 These provisions were aimed at
simplifying data reporting and claims processing requirements across all
public and private payers. Under the standards, HCPCS Level II was
designated as the code set for medical equipment and supplies. Its

limitation in specificity argues for evaluating whether the current code set
can be adjusted to better distinguish between various products currently
grouped within a single HCPCS Level II code.

Lack of specificity has been a similar problem for the codes used to define
inpatient hospital procedures. The HIPAA standard code set for reporting
hospital inpatient procedures is the International Classification of
Disease, 9th Edition, Clinical Modification, Volume 3 (ICD- 9 CM Vol. 3).
The inadequacy of this code set is widely recognized, as it lacks both the
specificity to accurately identify many key aspects of medical procedures as
well as the capacity to expand in order to appropriately incorporate

codes in response to new technology. In fact, HHS recognized that in
adopting the ICD- 9- CM Vol. 3 as a HIPAA standard, the agency would need to
replace it, given the code set?s limitations. As a consequence, CMS plans to
implement a new code set, the International Classification of Disease, 10th
Edition, Procedural Coding System (10 PCS), which would provide much greater
specificity. Our work on payments for covered outpatient drugs, which
identified

strategies used by other payers to obtain prices closer to acquisition
costs, underscores the value of accurate information for determining
appropriate payments. For example, the VA uses the leverage of federal
purchasers to secure verifiable information on actual market transactions by
private purchasers- specifically, the prices that drug manufacturers charge
their ?most- favored? private customers. To enable the VA to determine the

29 Pub. L. No. 104- 191, sect. 262( a), sect. 1173( c), 110 Stat. 1936, 2025.

Page 14 GAO- 02- 833T

most- favored- customer price, by statute, manufacturers who wish to sell
their products to the federal agencies involved are required to provide
information on price discounts and rebates offered to domestic customers and
the terms and conditions involved, such as length of contract periods and
ordering and delivery practices. 30 The manufacturers provide this
information and agree to offer the VA and other government purchasers drugs
at these prices, subject to VA audit of their records, 31 in order to have
state Medicaid programs cover their drugs.

This type of information could be helpful in setting payment amounts for
certain Medicare drugs. It is already available to CMS, but for use only in
the Medicaid- not the Medicare- program. 32 With congressional approval, CMS
could use the information provided to Medicaid to determine appropriate
prices for Medicare that would be based on actual prices being paid in the
market. One key step would be to determine the formula to use to calculate
payments based on the price data. Most likely, Medicare would not set
payments to match the prices paid by most favored

customers but would need to pay closer to average market prices to ensure
access for all beneficiaries and adequate payments to providers.

Results from the competitive bidding demonstrations suggest that competition
can also serve as a tool to obtain more appropriate prices for medical
equipment and supplies and outpatient drugs. By competing a small number of
products and limiting the geographic area of competition, CMS took steps to
manage the process, which included monitoring of beneficiary access and
product quality. In its fiscal year 2003 budget, the Administration proposed
expanding competitive bidding for medical

30 38 U. S. C. sect. 8126 (1994). 31 The VA negotiates prices for and purchases
medical equipment, supplies, and drugs through the Federal Supply Schedule.
Federal Supply Schedule prices are available to any federal agency that
directly procures pharmaceuticals or medical equipment and supplies,

including VA medical centers, the Department of Defense, the Bureau of
Prisons, the Public Health Service, and other designated entities such as
the District of Columbia, U. S. territorial governments, the Indian Health
Service, and some state veterans homes. 32 Under a provision of the Omnibus
Budget Reconciliation Act of 1990 (OBRA), state Medicaid programs receive
rebates from manufacturers based on either the manufacturer?s ?best price?
to a private purchaser or the average price (including cash discounts and
other price reductions) paid to drug manufacturers by U. S. wholesalers for
certain drugs. In order to have their drugs covered by Medicaid,
manufacturers must be willing to provide the rebate and price information to
calculate it. sect. 1927 of the Social Security Act, added by OBRA 1990, Pub. L.
No. 101- 508, sect. 4401, 104 Stat. 1388, 1388- 143 (1990) (classified to 42 U.
S. C. Sec. 1396r- 8).

Page 15 GAO- 02- 833T

equipment and supplies nationally, which it estimates could save $240
million in fiscal year 2003 and $5 billion over 10 years.

The Administration?s expansion proposal to translate these limited
demonstrations into a competition involving a larger number of products
nationally would be a substantial undertaking and may not be practical or
appropriate for all products. CMS would require new authority to begin to
use competitive bidding outside of a demonstration. A key element to the

new authority would be the extent to which and the basis whereby providers
could be excluded from Medicare. While Medicare normally allows any
qualified provider to participate in the program, competitive bidding may be
most effective only by limiting the number of providers or suppliers who
could provide items or services. For example, in the Polk County
demonstration, only 16 out of the 30 bidders were selected to participate.
Limiting the number of participating suppliers obviously has an effect on
both beneficiaries and suppliers. While provider participation is not an
entitlement, the effects of exclusion- in terms of numbers of providers and
the volume of services affected- need to be identified and assessed.
Similarly, for some products, who the provider is may be of little

consequence for the beneficiary, but for others, maintaining greater
beneficiary choice and direct access to the provider could be important.

Whether payment rates are set or adjusted through competitive bidding or
administrative fee- setting, monitoring to ensure that beneficiaries
continue to have access to the items or services is a critical component of
such efforts. For example, when the Congress reduced Medicare home oxygen
payment rates by 25 percent effective January 1, 1998, and an additional 5
percent effective January 1, 1999, it wanted assurance that beneficiaries

could continue to receive satisfactory service. 33 To evaluate the impact of
the home oxygen payment reduction on access and quality, the BBA

33 For beneficiaries who receive oxygen at home, Medicare part B pays
suppliers a fixed monthly fee per beneficiary that covers a stationary,
home- based oxygen unit and all related services and supplies, such as tank
refills. There is a separate fixed monthly fee for a portable unit, if one
is prescribed. Medicare?s oxygen payment method is called ?modality neutral?
because the payment rate is the same regardless of the type of oxygen
delivery system prescribed, i. e. compressed gas, liquid oxygen, or oxygen
concentrator.

Page 16 GAO- 02- 833T

required studies conducted by us and HHS. 34 Neither study found any
significant access problems with the payment reduction. In addition, home
oxygen was included in both competitive bidding demonstrations, and through
those demonstrations, prices were reduced further. HCFA estimated that
Medicare?s home oxygen payments were reduced by 16 percent in the Polk
County demonstration, without beneficiary access problems. Such monitoring
is important, not just when required by statute but as part of an ongoing
effort to ensure the Medicare program is effectively serving its
beneficiaries.

Unfortunately, such studies to review the effects of payment reductions on
access are the exception. As we have reported before, CMS has not been able
to generate data that are timely, accurate, and useful on payment and
service trends essential to effective program monitoring. 35 One of the
principal lessons to be drawn from the many BBA payment reforms is that
newly implemented policies need a thorough assessment of their effects.
Policy changes, particularly those that constrain payment, almost inevitably
spark calls for revisions. Considerations of such revisions need to be based
on sufficient information so that, at one extreme, policies are not unduly
affected by external pressures and premature conclusions as to their impact,
and at the other extreme, policies do not remain static when change is
clearly warranted. 36 CMS has not been well- positioned to collect and
analyze data regarding beneficiaries? use of services- information that is
essential to managing the program effectively. 37 This year?s 5. 4 percent
reduction of physicians? fees from what was paid in 2001 raised concerns
about beneficiaries? access. While prior information available on
physicians? willingness to see Medicare beneficiaries did not indicate

34 U. S. General Accounting Office, Medicare: Access to Home Oxygen Largely
Unchanged; Closer HCFA Monitoring Needed, GAO/ HEHS- 99- 56 (Washington, D.
C.: Apr. 5, 1999) and Rebecca Olson, Carolyn Harper, Stephanie Lui, and
others. Report on Peer Review Evaluation of Home Oxygen Equipment.
California Medical Review, Inc. (San Francisco, Calif.: Sept. 30, 2000).
This HHS study analyzed 1996 and 1998 claims data to calculate the number of
Medicare oxygen prescriptions, and also conducted 1999 surveys of
physicians,

suppliers, and beneficiaries. 35 U. S. General Accounting Office, Major
Management Challenges and Program Risks: Department of Health and Human
Services, GAO- 01- 247 (Washington, D. C.: Jan. 2001). 36 U. S. General
Accounting Office, Balanced Budget Act: Any Proposed Fee- for- Service
Payment Modifications Need Thorough Evaluation, GAO/ T- HEHS- 99- 139
(Washington, D. C.: June 10, 1999).

37 U. S. General Accounting Office, Medicare: HCFA Faces Challenges to
Control Improper Payments, GAO/ T- HEHS- 00- 74, (Washington, D. C.: Mar. 9,
2000).

Page 17 GAO- 02- 833T

access problems, this information is somewhat dated. 38 Informed decisions
about appropriate payment rates and rate changes cannot be made unless
policymakers have detailed and recent data on beneficiaries? access to
needed services.

Mr. Chairman, this concludes my prepared remarks. I will be happy to answer
any questions you or the Subcommittee Members may have.

For further information regarding this testimony, please contact me at (312)
220- 7600. Sheila Avruch, Hannah Fein, Sandra Gove, Joy Kraybill, and Craig
Winslow made contributions to this statement.

38 U. S. General Accounting Office, Medicare Physician Payments: Spending
Targets Encourage Fiscal Discipline, Modifications Could Stabilize Fees,
GAO- 02- 441T, (Washington, D. C.: Feb. 14, 2002). Contact and

Acknowledgments

Page 18 GAO- 02- 833T

Medicare Outpatient Drugs: Program Payments Should Better Reflect Market
Prices. GAO- 02- 531T. Washington, D. C.: March 14, 2002.

Medicare Physician Payments: Spending Targets Encourage Fiscal Discipline,
Modifications Could Stabilize Fees. GAO- 02- 441T. Washington, D. C.:
February 14, 2002. Medicare: Payments for Covered Outpatient Drugs Exceed
Providers?

Cost. GAO- 01- 1118. Washington, D. C.: September 21, 2001.

Medicare Part B Drugs: Program Payments Should Reflect Market Prices. GAO-
01- 1142T. Washington, D. C.: September 21, 2001.

Medicare Management: CMS Faces Challenges to Sustain Progress and Address
Weaknesses. GAO- 01- 817. Washington, D. C.: July 31, 2001.

DOD and VA Pharmacy: Progress and Remaining Challenges in Jointly Buying and
Mailing Out Drugs. GAO- 01- 588. Washington, D. C.: May 25, 2001.

Medicare Payments: Use of Revised ?Inherent Reasonableness? Process
Generally Appropriate. GAO/ HEHS- 00- 79. Washington, D. C.: July 5, 2000.
Balanced Budget Act: Any Proposed Fee- for- Service Payment

Modifications Need Thorough Evaluation. GAO/ T- HEHS- 99- 139. Washington,
D. C.: June 10, 1999.

Medicare: Need to Overhaul Costly Payment System for Medical Equipment and
Supplies. GAO/ HEHS- 98- 102. Washington, D. C.: May 12, 1998.

Medicare: Access to Home Oxygen Largely Unchanged; Closer HCFA Monitoring
Needed. GAO/ HEHS- 99- 56. Washington, D. C.: April 5, 1999.

Medicare: Comparative Information on Medicare and VA Patients, Services, and
Payment Rates for Home Oxygen. GAO/ HEHS- 97- 151R. Washington, D. C.: June
6, 1997.

Medicare: Excessive Payments for Medical Supplies Continue Despite
Improvements. GAO/ HEHS- 95- 171. Washington, D. C.: August 8, 1995.

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