Medicare: Comments on CMS Proposed 2006 Rates for Specified	 
Covered Outpatient Drugs and Radiopharmaceuticals Used in	 
Hospitals (31-OCT-05, GAO-06-17R).				 
                                                                 
On July 25, 2005, the Centers for Medicare & Medicaid Services	 
(CMS) in the Department of Health and Human Services (HHS)	 
published its notice of proposed rulemaking (NPRM) entitled	 
"Medicare Program; Proposed Changes to the Hospital Outpatient	 
Prospective Payment System and Calendar Year 2006 Payment Rates."
As part of these changes, CMS is proposing Medicare payment rates
for certain hospital outpatient drugs classified for payment	 
purposes as specified covered outpatient drugs (SCOD). The	 
Medicare Prescription Drug, Improvement, and Modernization Act of
2003 (MMA) defined a SCOD as a drug or radiopharmaceutical used  
in hospital outpatient departments, covered by Medicare, and paid
for individually rather than as part of a payment group with	 
other services. With regard to SCODs, the MMA directed CMS to set
2006 payment rates equal to hospitals' average acquisition	 
costs--the cost to hospitals of acquiring a product, net of	 
rebates. In several related requirements, the MMA directed us to 
provide information on SCOD costs and CMS's proposed rates.	 
First, we were required to conduct a survey of hospitals to	 
obtain data on their acquisition costs of SCODs and provide	 
information based on these data to the Secretary of Health and	 
Human Services for his consideration in setting 2006 Medicare	 
payment rates. We provided information from this survey in two	 
reports--one on drugs and biologicals, and another on		 
radiopharmaceuticals. These reports presented systematic	 
information on hospitals' purchase prices of SCODs and limited	 
information on rebates. Second, we were required to evaluate	 
CMS's proposed rates for SCODs and comment on their		 
appropriateness in light of the survey of SCOD prices we	 
conducted. In response to the second requirement, this report	 
assesses the appropriateness of the Medicare payment rates that  
CMS has proposed for SCODs, taking into account the purchase	 
prices obtained from the MMA-mandated survey we conducted in 2004
and 2005. Specifically, this report focuses on the		 
appropriateness of CMS's proposed 2006 hospital outpatient rates 
for (1) drug SCODs and (2) radiopharmaceutical SCODs. To conduct 
this assessment, we examined the information CMS provided in the 
proposed rule on the data sources and methodology used to set the
2006 rates, analyzed this information in light of our survey of  
hospitals' purchase prices, and convened an expert panel to	 
review our findings. Consistent with the MMA, we did not study	 
the issue of hospitals' handling costs for SCODs and do not	 
address these costs in this report. We performed our work	 
according to generally accepted government auditing standards	 
from July through October 2005. 				 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-06-17R 					        
    ACCNO:   A40681						        
  TITLE:     Medicare: Comments on CMS Proposed 2006 Rates for	      
Specified Covered Outpatient Drugs and Radiopharmaceuticals Used 
in Hospitals							 
     DATE:   10/31/2005 
  SUBJECT:   Drugs						 
	     Health care costs					 
	     Health surveys					 
	     Hospitals						 
	     Medical services rates				 
	     Medicare						 
	     Pharmaceutical industry				 
	     Prices and pricing 				 
	     Procurement evaluation				 
	     Procurement policy 				 
	     Outpatient care					 
	     Prescription drugs 				 

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GAO-06-17R

     

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United States Government Accountability Office Washington, DC 20548

October 31, 2005

The Honorable Charles E. Grassley Chairman The Honorable Max Baucus
Ranking Minority Member Committee on Finance United States Senate

The Honorable Joe Barton Chairman The Honorable John D. Dingell Ranking
Minority Member Committee on Energy and Commerce House of Representatives

The Honorable William M. Thomas Chairman The Honorable Charles B. Rangel
Ranking Minority Member Committee on Ways and Means House of
Representatives

Subject: Medicare: Comments on CMS Proposed 2006 Rates for Specified
Covered Outpatient Drugs and Radiopharmaceuticals Used in Hospitals

On July 25, 2005, the Centers for Medicare & Medicaid Services (CMS) in
the Department of Health and Human Services (HHS) published its notice of
proposed rulemaking (NPRM) entitled "Medicare Program; Proposed Changes to
the Hospital Outpatient Prospective Payment System and Calendar Year 2006
Payment Rates." 1 As part of these changes, CMS is proposing Medicare
payment rates for certain hospital outpatient drugs-classified for payment
purposes as specified covered outpatient drugs (SCOD). The Medicare
Prescription Drug, Improvement, and Modernization Act of 2003 (MMA)
defined a SCOD as a drug or radiopharmaceutical used in hospital
outpatient departments, covered by Medicare, and paid for individually
rather than as part of a payment group with other services. 2

1

70 Fed. Reg. 42,674.

2

Pub. L. No. 108-173, sec. 621(a), S: 1833(t)(14)(B), 117 Stat. 2066,
2307-08 (to be codified at 42 U.S.C. S: 1395l(t)(14)(B)).

With regard to SCODs, the MMA directed CMS to set 2006 payment rates equal
to hospitals' average acquisition costs-the cost to hospitals of acquiring
a product, net of rebates. 3 In several related requirements, the MMA
directed us to provide information on SCOD costs and CMS's proposed rates.
4 First, we were required to conduct a survey of hospitals to obtain data
on their acquisition costs of SCODs and provide information based on these
data to the Secretary of Health and Human Services for his consideration
in setting 2006 Medicare payment rates. We provided information from this
survey in two reports5 -one on drugs and biologicals, and another on
radiopharmaceuticals. 6 These reports presented systematic information on
hospitals' purchase prices of SCODs and limited information on rebates.
Second, we were required to evaluate CMS's proposed rates for SCODs and
comment on their appropriateness in light of the survey of SCOD prices we
conducted. 7

In response to the second requirement, this report assesses the
appropriateness of the Medicare payment rates that CMS has proposed for
SCODs, taking into account the purchase prices obtained from the
MMA-mandated survey we conducted in 2004 and 2005. Specifically, this
report focuses on the appropriateness of CMS's proposed 2006 hospital
outpatient rates for (1) drug SCODs and (2) radiopharmaceutical SCODs. To
conduct this assessment, we examined the information CMS provided in the
proposed rule on the data sources and methodology used to set the 2006
rates, analyzed this information in light of our survey of hospitals'
purchase prices, and

3

Specifically, the MMA required that payment rates equal the average
acquisition costs as determined by the Secretary of Health and Human
Services, unless hospital acquisition cost data are not available. If such
data are not available, the law permitted payment rates to equal one of
several amounts, including average sales price, as calculated and adjusted
by the Secretary. MMA 117 Stat. 2307.

4MMA 117 Stat. 2308-09. The law also required the Medicare Payment
Advisory Commission (MedPAC) to report on overhead and related expenses
(such as pharmacy services and handling costs) and authorized the
Secretary of Health and Human Services to adjust the SCOD rates for these
costs. MMA 117 Stat. 2309. See ch. 6, "Payment for pharmacy handling costs
in hospital outpatient departments," in MedPAC's mandated report, Issues
in a Modernized Medicare Program (Washington, D.C.: June 2005).

5

GAO, Medicare: Drug Purchase Prices for CMS Consideration in Hospital
Outpatient Rate Setting, GAO-05-581R (Washington, D.C.: June 30, 2005),
and GAO, Medicare: Radiopharmaceutical Purchase Prices for CMS
Consideration in Hospital Outpatient Rate Setting, GAO-05-733R
(Washington, D.C.: July 14, 2005).

6

In this report, the term drugs refers to both drugs and biologicals.
Biologicals are products derived from living sources, including humans,
animals, and microorganisms. Radiopharmaceuticals are radioactive
substances used for diagnostic or therapeutic purposes.

7

The MMA also required us to report on differences in SCOD acquisition
costs by type of hospital and recommend future data collection methods,
taking into account our experience. We will address these issues in a
future report.

convened an expert panel to review our findings. 8 Consistent with the
MMA, we did not study the issue of hospitals' handling costs for SCODs and
do not address these costs in this report. We performed our work according
to generally accepted government auditing standards from July through
October 2005.

                                Results in Brief

We consider CMS's selection of a data source------average sales price
(ASP)------for use in setting Medicare's hospital outpatient rates for
drug SCODs to be practical, given available alternatives, but we consider
CMS's proposed 2006 rates for drug SCODs to be excessive.

CMS proposes to base its 2006 drug SCOD rates on manufacturers' ASP data,
setting rates at ASP+6 percent. ASP is a composite measure of the average
price of a SCOD------net of discounts, rebates, and other price
concessions------paid by all purchasers, not just hospitals. Manufacturers
report this information quarterly. In our view, ASP is a practical data
source, providing the most timely publicly available data on prices of
drug SCODs. However, we have two concerns about setting the proposed drug
SCOD rates:

     o As a composite measure, ASP is a black box, lacking the detail CMS
       needs to validate the reasonableness of the data underlying the
       reported prices. Without a breakdown of price data showing rebates and
       other components as well as average prices by purchaser type, CMS
       cannot ensure that ASPs accurately reflect average acquisition costs
       by hospital purchasers alone.
     o CMS does not provide a convincing rationale for proposing a rate 6
       percent higher than ASP. CMS's analysis indicates that ASP+6 percent
       will exceed hospitals' acquisition costs. CMS states that the prices
       reported in our survey------that is, the average prices hospitals paid
       for drug SCODs (which do not net out rebates received at a later
       time)------equal ASP+3 percent. Logically, acquisition costs, which do
       net out rebates from purchase prices, would equal an amount less than
       ASP+3 percent. Therefore, our survey data and CMS's analysis of these
       data indicate that a rate set at or above ASP+3 percent is not
       appropriate, given that it would exceed the hospitals' average
       acquisition cost.

Similarly, we are concerned that CMS's proposed 2006 rates for
radiopharmaceutical SCODs will, on average, exceed hospitals' acquisition
costs. CMS chose to use cost estimates developed from hospital charges
rather than survey data on the prices hospitals reported paying for
radiopharmaceuticals. However, as we have previously

The panelists were Joseph P. Newhouse, John D. MacArthur Professor of
Health Policy and Management, Harvard University; Robert A. Berenson,
Senior Fellow, Urban Institute; Ernst R. Berndt, Professor of Applied
Economics, Sloan School of Management, Massachusetts Institute of
Technology; Andrea G. Hershey, Clinical Coordinator and Pharmacy Residency
Program Director, Union Memorial Hospital (Baltimore, Md.); and Richard L.
Valliant, Senior Research Scientist, University of Michigan.

reported, 9 the methodology for estimating costs from charges results in
significant imprecision. CMS states that it intends to set rates for
radiopharmaceutical SCODs that are consistent with previous years' payment
rates, even though the MMA does not establish such a criterion. ASPs are
not available for radiopharmaceuticals for 2006 rate setting, but CMS
plans to get this information from manufacturers for future years' rates.

In light of our assessment that CMS's proposed rates are higher than can
be justified, we are recommending that the Secretary of Health and Human
Services reconsider the level at which HHS has proposed to set drug SCOD
rates, reconsider its reliance on charge-based cost estimates in setting
radiopharmaceutical SCOD rates, and collect more detailed information on
ASPs. In written comments on a draft of this report, CMS stated that it is
considering our recommendations as it prepares the final rule on the OPPS
for 2006.

                                   Background

The relationship of SCODs to the outpatient prospective payment system
(OPPS) and the distinctions among acquisition costs, prices, and related
terms provide a context for interpreting CMS's proposed 2006 rates for
SCODs and the agency's discussion of these rates in the NPRM.

Hospital Outpatient Payment System and SCODs

The recent history of Medicare's rate setting for hospital outpatient
department services forms a backdrop for our comments on the proposed SCOD
payment rates. Specifically, CMS uses OPPS to pay hospitals for services
that Medicare beneficiaries receive as part of their treatment in hospital
outpatient departments. Under OPPS, Medicare pays hospitals predetermined
rates for most services.

When OPPS was first developed as required by the Balanced Budget Act of
1997, 10 the OPPS rates for hospital outpatient services, drugs, and
radiopharmaceuticals were based on hospitals' 1996 median costs. However,
these rates prompted concerns that payments to hospitals would not reflect
the costs of newly introduced pharmaceutical products used to treat, for
example, cancer, rare blood disorders, and other serious conditions. In
turn, congressional concerns were raised that beneficiaries might lose
access to some of these products if hospitals avoided providing them
because of a perceived shortfall in payments. In response to these
concerns, the Medicare, Medicaid, and SCHIP Balanced Budget Refinement Act
of 1999 authorized pass-through payments, which were a way to temporarily
augment the OPPS payments for newly introduced pharmaceutical products
first used after 1996. 11 The MMA modified this payment method for some of
these pharmaceutical

9

GAO, Medicare: Information Needed to Assess Adequacy of Rate-Setting
Methodology for Payments for Hospital Outpatient Services, GAO-04-772
(Washington, D.C.: Sept. 17, 2004).

10

Pub. L. No. 105-33, S: 4523, 111 Stat. 251, 445-50.

11

Pub. L. No. 106-113, app. F, S: 201(b), 113 Stat. 1501A-321,
1501A-337-1501A-339.

products. 12 As part of the modification, the MMA defined the new SCOD
payment category, which includes many of these newly introduced
pharmaceutical products.

Acquisition Costs, Purchase Prices, Discounts, and Rebates

Hospital acquisition costs-the level at which CMS is directed to set
payment rates for SCODs-cannot be directly observed from price data alone.
Hospitals can buy pharmaceutical products directly from manufacturers or
from other vendors, namely wholesalers and distributors. 13 Hospitals may
receive discounts or rebates or both. Discounts are price concessions
given by manufacturers or wholesalers that are reflected in the purchase
price-the price hospitals pay at the time of delivery. Rebates are price
concessions given to hospitals by manufacturers subsequent to receipt of
the product. The acquisition cost to hospitals is the difference between
the purchase price paid at the time of a product's delivery and any
rebates given by the manufacturer after hospitals receive the product.
(See fig. 1.) As a result of rebates, a hospital's acquisition cost for a
product may be lower than the purchase price.

Figure 1: Relationship of Purchase Prices, Rebates, and Acquisition Costs

Note: Numbers are hypothetical.

Both discounts and rebates depend on a hospital's purchasing patterns.
Manufacturers' discounts and rebates may be based on a hospital's purchase
volume of a drug or on its market share-the percentage of a certain type
of drug bought from a single manufacturer. In some cases, rebates are
based on a purchaser's volume or market share of a set, or bundle, of
products defined by the manufacturer. This bundle may include more than
one drug or a mixture of drugs and other products, such as bandages and
surgical gloves. Hospitals can also receive "prompt pay" discounts when
they pay in advance or within a prescribed time period. 14

12MMA 117 Stat. 2307-10.

13

Wholesalers and distributors perform related functions, and the two terms
are often used interchangeably. We refer to both wholesalers and
distributors as wholesalers.

14

Conversely, vendors can charge markups when hospitals do not pay within an
agreed-upon time period.

In contrast to purchase price and acquisition cost, which are common
business and economic terms, ASP is a price measure established in law and
used by CMS. This price measure is used to set payment rates for drugs
administered in physician offices and covered under part B of Medicare.
CMS instructs pharmaceutical manufacturers to report ASP data to CMS
within 30 days after the end of each quarter. The MMA defined ASP as the
average sales price for all U.S. purchasers 15 of a drug, net of volume,
prompt pay, and cash discounts; free goods contingent on a purchase
requirement; and charge-backs and rebates. 16

CMS's Proposed Rule to Pay for SCOD Products in 2006

Under the MMA, payment for SCODs in 2006 is required to be equal to the
average acquisition cost for the drug as determined by the Secretary of
Health and Human Services, taking into account the hospital acquisition
cost survey data we collected in 2004 and 2005. 17

CMS has issued an NPRM that, along with other matters relating to the
OPPS, describes the way it proposes to implement the MMA requirements on
SCOD payment rates. CMS will receive comments from interested
organizations and individuals, consider these comments, and publish a
final rule-which may differ in some particulars from the proposed
rule-later in 2005. To establish the proposed rates, CMS made two primary
decisions for both drug SCODs and radiopharmaceutical SCODs: the data
source to use and the level at which the rates should be set.

Data for Drug SCODs

CMS considered three possible data sources-purchase prices from our
survey, Medicare charges, and ASP; it selected ASP. The NPRM noted two
problems with the purchase price data: (1) prices could have increased
since the end of the time period for which they were collected-July 2003
through June 2004-and (2) the data did not take into account rebates and
similar price concessions. The problem cited with the Medicare charge data
was that charges include both acquisition costs and handling costs.
Because of the inclusion of handling costs, CMS concluded that Medicare
charges were not an acceptable proxy for acquisition costs. The NPRM

15

MMA 117 Stat. 2240-41. Certain prices, including prices paid by federal
purchasers and prices for drugs furnished under the Medicare prescription
drug discount card program, are excluded. In the future, prices for drugs
furnished under Medicare part D, the prescription drug benefit, will also
be excluded.

16

A charge-back is a payment by a manufacturer to a wholesaler that is made
when the wholesaler's price to a hospital is lower than the price the
wholesaler initially paid the manufacturer. Charge-back arrangements occur
when hospitals have negotiated lower prices from the manufacturer, often
through a group purchasing organization. All but Medicaid rebates are
deducted in the manufacturer's calculation of ASP. Under the Medicaid
program, manufacturers are required to pay rebates to states for
prescription drugs covered by state Medicaid programs.

17MMA 117 Stat. 2307.

stated that ASP-based payment rates served as the best proxy for average
acquisition costs because the manufacturers' sales prices from the last
quarter of 2004 provided the most recent data available.

Rates for Drug SCODs

CMS considered setting the rates at three levels: ASP+3 percent, ASP+6
percent, and ASP+8 percent; it selected ASP+6 percent. 18 CMS considered
ASP+3 percent because, on average, it was equal to the purchase price
obtained from our survey. It considered ASP+8 percent because, on average,
it was equal to an estimate of cost based on charges. 19 CMS did not use
either of these options because of its concerns about using the purchase
prices from our survey and the charges from Medicare claims as data
sources. CMS arrived at a hospital drug SCOD rate of ASP+6 percent by
eliminating the other two options. The NPRM mentioned that ASP+6 percent
is also the rate that Medicare pays physicians for drugs.

Data for Radiopharmaceutical SCODs

CMS considered two data sources for radiopharmaceutical rates: survey
results on purchase prices and Medicare charges; it selected Medicare
charges. 20 ASP was not an option because ASP has not been collected for
radiopharmaceuticals. (For payment rates in 2007 and future years, CMS
plans to collect ASP for radiopharmaceuticals.) CMS elected not to use the
survey results on purchase prices because, in comparing the purchase
prices of the nine radiopharmaceuticals in the GAO data to CMS's 2005
payment rates, it found that "the GAO purchase prices were substantially
lower for several of these agents." Similarly, the Medicare charge data
yielded estimated costs lower than the 2005 payment rates. CMS selected
the Medicare charge data, noting that charges are believed to cover both
acquisition costs and handling costs, so these data could be used to set a
payment rate that covered both.

Rates for Radiopharmaceutical SCODs

Having selected the charge data, CMS had only one option: to use the
charges to estimate costs for setting radiopharmaceutical SCOD rates. For
each radiopharmaceutical SCOD, it proposed adjusting the hospital charges
to a hospital-specific estimate of costs. These estimates of cost would
include both acquisition costs and handling costs. CMS stated that it
intended to maintain consistency whenever possible between the payment
rates in 2005 and 2006, because such "rapid

18

70 Fed. Reg. 42,724-27.

19

To estimate the cost of a SCOD, CMS multiplied hospital charges for the
SCOD by a ratio of hospital costs to hospital charges.

20

70 Fed. Reg. 42,727-28.

reductions" could adversely affect beneficiary access to services
utilizing radiopharmaceuticals. 21

Adjustments to Rates for Overhead

Under the MMA, the Medicare Payment Advisory Commission (MedPAC) was
required to report on adjusting SCOD payments to take account of overhead
and related expenses, such as pharmacy services and handling costs, and
the Secretary may adjust payment rates to take into account MedPAC's
recommendations. 22 For drugs, the proposed regulation provides for
increasing the payment for drug acquisition costs by 2 percent of ASP to
cover overhead and handling, resulting in a total payment for drugs of
ASP+6 percent+2 percent. According to CMS, costs calculated from charges
equal ASP+8 percent. Since it has determined that acquisition costs are
equal to ASP+6 percent, and since pharmacy overhead costs are built into
the charges, CMS concluded that the difference between charge-based costs
(equal to ASP+8 percent) and acquisition costs (which CMS states equal
ASP+6 percent) is the overhead adjustment. Consequently, it proposed to
set the overhead adjustment at 2 percent of ASP.

For radiopharmaceuticals, CMS has chosen to use charge-based costs. Since
these costs appear to include overhead, CMS concluded that no further
adjustment for overhead is required.

See table 1 for a summary of the proposed rule for drug and
radiopharmaceutical SCODs.

      Table 1: CMS's Proposed Rule for Drug and Radiopharmaceutical SCODs

                                     Alternatives that CMS considered         
                                     (CMS decision in italics)                
Drug SCODs                        
o  Data source                    ASP                                      
                                     Purchase prices a                        
                                     Cost estimated from claims data          
o  Rates                          ASP+3 percent                            
                                     ASP+6 percent b                          
                                     ASP+8 percent                            
Radiopharmaceutical SCODs         
o  Data source                    Purchase prices a                        
                                     Cost estimated from claims data          
o  Rates                          Average purchase price                   
                                     Cost estimated from charges c            

Source: GAO analysis of CMS proposed rule.

a

Calculated by GAO from its hospital survey data.

b

CMS also proposed an additional 2 percent of ASP to cover hospitals'
overhead and handling costs for drug SCODs.

c

The rate includes hospitals' overhead and handling costs.

21

CMS gave no indication of the magnitude of any such reductions.

22

70 Fed. Reg. 42,728-29. For MedPAC's report and recommendations, see
Issues in a Modernized Medicare Program, ch. 6.

    ASP Is Reasonable as Data Source for Setting Rates, but ASP+6 Percent Is
               Excessive Relative to Hospitals' Acquisition Costs

The results from our survey of hospitals' purchases of drug SCODs suggest
that the data source on which CMS proposes to base its rate-setting is
reasonable, but the proposed rate is too high. For several practical
reasons, ASP is an acceptable data source for setting drug SCOD rates,
given the challenges of collecting drug price data. However, without more
information on the data used to construct ASP, CMS cannot determine if
this blend of average prices paid by all U.S. purchasers-not just
hospitals-measures the prices paid by hospitals alone with sufficient
accuracy. In addition, CMS's proposal to set the 2006 payment rate 6
percent above ASP is excessive and inconsistent with setting payment rates
equal to acquisition costs.

ASP Practical as Data Source, but Accuracy Could Be Affected by Certain
Information Gaps

CMS's decision to use ASP data is practical for four reasons. First, ASP
at least roughly approximates hospital acquisition costs of drug SCODs. 23
Second, the use of ASP does not entail data collection start-up costs for
CMS or manufacturers, as CMS uses an ASP-based methodology to pay for
drugs in the physician office setting. Third, ASP is the most recent
publicly available price information: it is based on data submitted by
manufacturers 30 days after the close of each quarter. In contrast, an
alternative method to ASP-conducting surveys of hospitals-would likely be
costly, present challenges to hospitals' information system capabilities,
and require a lengthy period for data collection and processing. 24
Fourth, ASP takes account of rebates, which we found were difficult for
hospitals to report, and therefore we did not deduct them from our
estimates.

Notwithstanding these advantages, information gaps remain that render ASP
a "black box" in terms of its constituent components. For example, in
reporting ASP data to CMS, manufacturers do not break out ASP price
components, such as rebates and other price concessions. 25 CMS instructs
manufacturers to deduct components such as rebates in calculating ASP, but
lacking a price breakdown-or an independent

23

Because purchase price is the largest component of acquisition costs, and
purchase cost is equal to ASP+3 percent, it follows that ASP roughly
approximates acquisition costs. Purchase price is highly correlated with
ASP for drug SCODs (r = .9978).

24

For example, our methodology, consistent with statutory requirements,
entailed considerable start-up and logistical costs as well as a
substantial period for data collection. The MMA required that we obtain
price information from hospitals, not manufacturers, and that the sample
of hospitals be "large." Our survey included over 1,000 hospitals with a
wide range of capabilities to provide needed data promptly. Fielding the
survey required a commitment of substantial resources. In addition,
hospitals had to expend considerable effort to identify, compile, and
transmit purchase price data, making the potential for frequent data
collection through hospital surveys problematic.

25

The only information regarding price that CMS requires is the product's
ASP. Nonprice information that manufacturers must report consists of the
manufacturer's name, the product's National Drug Code, and the number of
units.

source of price and rebate data-the agency cannot assess whether rebates
and other components were appropriately excluded or whether the amount of
any exclusions was plausible. In addition, information about the basis on
which manufacturers calculate rebates would be useful. Collecting price
breakdowns and related information would allow CMS to assess the
reasonableness of the data underlying the reported prices.

In addition, because ASP is an average of prices paid for a product by all
U.S. purchasers, it lacks sufficient detail for estimating acquisition
costs of hospitals in particular. ASP data are not compiled by purchaser
type-such as hospital outpatient department, physician office, retail
pharmacy, or wholesaler. Thus, ASP does not permit CMS to distinguish
between prices paid by hospitals and those paid by other end purchasers.
The net effect of averaging all sales into one price is to weaken ASP as
an accurate indicator of acquisition costs for hospitals alone.

Rationale Unconvincing for CMS's Proposed Rates, Which Would Pay Hospitals
More Than Their Acquisition Costs

CMS proposes to set payments for drug SCODs at ASP+6 percent, but the
questions that arise from setting rates at this level are not answered by
the agency's analysis. As CMS notes, the MMA requires that the agency's
determination of average acquisition costs take into account our mandated
survey of prices hospitals paid for SCOD products. According to CMS, our
survey's purchase prices on average equal ASP+3 percent, 26 and we and CMS
agree that these purchase prices do not account for any after-purchase
rebates that would lower the product's actual cost to the hospital.
Logically, then, for payment rates to equal acquisition costs, CMS would
need to set rates lower than ASP+3 percent, taking our survey data into
account. We could not determine how much lower the rates should be set, as
neither we nor CMS were able to systematically quantify the magnitude of
rebates or other price concessions as a percentage of a product's purchase
price or ASP. In effect, ASP+3 percent is the upper bound of acquisition
costs-that is, acquisition costs should be less than ASP+3 percent.
Consistent with our reasoning, CMS notes that "Inclusion of these rebates
and price concessions in the GAO data would decrease the GAO prices
relative to the ASP prices, suggesting that ASP+6 percent may be an
overestimate of hospitals' average acquisition costs."

Nevertheless, CMS did not propose to set rates at less than ASP+3 percent.
It suggests that SCOD prices may have increased from the June 30, 2004,
end point of the time period for which hospitals submitted survey data.
However, neither data from our survey of purchase prices nor CMS's
quarterly ASP data support the agency's concerns about potential drug
price increases. Specifically:

     o Between the first and last quarters for which we collected survey
       data, purchase prices for drug SCODs decreased slightly-falling by
       about 1 percent, on average.
     o CMS found that, between the fourth quarter of 2004 and the first
       quarter of 2005, ASP declined, on average, by 2 percent. CMS officials
       also told us that, between the third and fourth quarters of 2004, the
       trend in the average ASP for drug SCODs was relatively flat or
       slightly downward.

Our purchase prices do not uniformly equal ASP+3 percent. For example, for
several drug SCODs, the purchase price is approximately equal to ASP.

The lack of evidence for SCOD drug price inflation-coupled with CMS's
calculation that hospitals' acquisition costs on average are lower than
purchase prices (equivalent to ASP+3 percent)-show that a rate for SCOD
drugs of ASP+6 percent would be too high. In the NPRM, CMS notes that it
proposes to pay for drug SCODs at the payment rates used for drugs used in
physician offices and suggests that a "consistency of drug pricing between
physician offices and hospital outpatient departments" would be desirable.
However, CMS does not show evidence that acquisition costs are similar for
the two provider types.

CMS's Estimates of Hospitals' Costs for Radiopharmaceuticals Do Not
Utilize Available Data on Actual Prices Paid and May Be Excessive

CMS's proposed rates for radiopharmaceutical SCODs are cost estimates
based on charges and, although ASP data are not available for
radiopharmaceuticals, do not utilize available survey data on actual
prices paid for these products. In addition, the proposed rates may be
excessive.

Historically, CMS has not directed manufacturers to report ASPs for
radiopharmaceuticals. Lacking these data, CMS proposes to set 2006 rates
for radiopharmaceutical products equal to its estimates of the costs to
hospitals of acquiring and handling these products. To obtain these cost
estimates, CMS converts charges to costs using a ratio that applies to all
of a hospital's expenses and is not specific to radiopharmaceuticals. In
calculating this ratio, CMS will use the most recent data available on
costs, which likely will be for 2004.

CMS contends that its estimated costs are the best available proxy for the
average acquisition cost of a radiopharmaceutical and include its handling
cost. It states that hospitals' different purchasing, preparation, and
handling practices for radiopharmaceuticals are reflected in hospitals'
charges, which can be converted to costs using hospital-specific
cost-to-charge ratios. In the absence of actual transaction data, this
method would be reasonable though imperfect. At best this method is
subject to significant imprecision. The charge-setting methodologies of
hospitals and departments within hospitals vary considerably, whereas
CMS's cost-to-charge calculations assume uniformity. 27 In contrast, we
collected transaction data for our recent reports. 28 Our survey data
included purchase prices on nine key radiopharmaceutical SCODs-accounting
for over 90 percent of Medicare spending

See GAO, Medicare: Information Needed to Assess Adequacy of Rate-Setting
Methodology for Payments for Hospital Outpatient Services, GAO-04-772
(Washington, D.C.: Sept. 17, 2004).

28 GAO-05-581R and GAO-05-733R.

on all radiopharmaceutical SCODs. These purchase prices are averages of
the actual prices that hospitals paid. As a result, the average purchase
prices approximate hospitals' acquisition costs more closely than the
charge-based estimates CMS has proposed. Unlike purchase prices for drugs,
purchase prices for most radiopharmaceuticals are likely to be equivalent
to acquisition costs, as rebates are not commonly paid for
radiopharmaceuticals. Regarding the radiopharmaceutical SCODs for which
purchase price data are not available and which account for less than 10
percent of Medicare spending on radiopharmaceutical SCODs, CMS's proposed
charge-based method of estimating costs is reasonable in setting 2006
rates.

CMS does not rely on the purchase prices from our survey in setting rates
for radiopharmaceutical SCODs. It contends that the average purchase
prices developed from our survey for some radiopharmaceutical SCODs are
not suitable because these prices were substantially lower than CMS's
payment rates for these SCODs in 2005. 29 However, this relationship to
payment rates is also true for CMS's estimated costs of
radiopharmaceutical SCODs, based on charges found in hospital claims
data-the method selected in CMS's proposed rule. CMS states that it wants
to maintain consistency between 2005 and 2006 payment rates and is
concerned that "rapid reductions" in payment rates could adversely affect
access to radiopharmaceuticals. As with purchase prices, CMS also found
that for several radiopharmaceuticals its estimated costs based on charges
were lower than CMS's 2005 payment rates. However, CMS did not explain
why, despite their similar relationship to the payment rates, the
estimated costs from claims data were preferable to the actual purchase
prices for key radiopharmaceutical SCODs.

Nonetheless, maintaining consistency with 2005 rates is a questionable
goal, since the MMA directed CMS to pay SCODs an amount equal to
acquisition costs and did not mention other goals. Moreover, this
relationship suggests that some of CMS's 2005 payment rates were excessive
relative to the actual costs hospitals incurred to acquire these products,
thereby refuting CMS's contention that "rapid reductions" in 2006 payment
rates (based on average purchase price) could reduce beneficiary access to
services using radiopharmaceuticals. Furthermore, in light of the tendency
CMS noted for 2005 rates to exceed purchase prices, we are concerned that
payment rates for radiopharmaceutical SCODs for 2006 may also be too high.

                                  Conclusions

Overall, we have two concerns about CMS's proposed 2006 rates for drug
SCODs:

o  First, ASP is a black box, which does not permit CMS to ensure the
reasonableness of the data underlying the drug SCOD rates. While CMS's
selection of ASP as a data source for drug SCODs is reasonable, given the
alternatives, additional information to validate ASP is needed to assess
the accuracy of these data in approximating hospitals' acquisition costs.
A

For two of the radiopharmaceuticals in our survey, CMS payment rates were
lower than purchase prices.

breakdown of ASP by hospitals and other purchaser types would enable CMS
to determine if ASP-a blend of prices paid by wholesalers and various end
purchasers-closely approximates the prices paid by hospitals alone. A
separate breakdown of ASP by rebates and other components would enable CMS
to assess whether the magnitudes of the various components are reasonable
and to confirm that they are taken into account appropriately in
calculating ASPs.

o  Second, the proposed rates for drug SCODs are too high because their
level exceeds hospitals' acquisition costs. To approximate hospitals'
acquisition costs, average purchase prices-estimated by CMS to equal ASP+3
percent-would need to be reduced by some unknown magnitude to account for
rebates. Instead, CMS's proposed rate-ASP+6 percent-is higher than the
average purchase price, for reasons that CMS does not convincingly
explain.

For setting radiopharmaceutical SCOD rates, CMS proposes to rely on
charge-based estimates of cost, which are likely to be inaccurate measures
of acquisition costs, and dismisses available purchase price data, which
cover products accounting for more than 90 percent of Medicare's
expenditures for hospital outpatient radiopharmaceuticals. CMS's proposed
2006 rates for radiopharmaceutical SCODs are likely to exceed hospitals'
acquisition costs. CMS relies on cost estimates rather than available data
on actual purchase prices. CMS declined to use our purchase prices for the
proposed 2006 radiopharmaceutical SCOD rates because it found that our
prices were substantially lower than CMS's 2005 payment rates. However,
the fact that 2005 payment rates were higher-or lower-than the purchase
prices hospitals paid for key radiopharmaceutical SCODs only reveals
weaknesses in the payment rates.

Paying hospitals' acquisition costs and no more should be the aim that
drives CMS's rate-setting calculations for SCODs. For drug SCODs, CMS
proposes rates that are too high, while for radiopharmaceutical SCODs, the
agency has declined to set rates equal to an available measure of
acquisition costs.

                      Recommendations for Executive Action

We recommend that, to better approximate hospitals' acquisition costs of
SCODs, the Secretary of Health and Human Services take three actions:

     o Reconsider the level of proposed payment rates for drug SCODs, in
       relation to survey data on average purchase price, the role of rebates
       in determining acquisition costs, and the desirability of setting
       payment rates for SCODs at average acquisition costs.
     o Reconsider the decision to base payment rates for radiopharmaceutical
       SCODs exclusively on estimated costs, in light of the availability of
       data on actual prices paid for key radiopharmaceuticals.
     o Collect information on ASP components and ASP by purchaser type to
       validate the reasonableness of reported ASPs as a measure of hospital
       acquisition costs.

                       Agency Comments and Our Evaluation

In written comments on a draft of this report, CMS summarized our analyses
of its proposed method and payment rates for SCODs. (We reprinted CMS's
comments in enclosure I of this report.) CMS stated that it is considering
our recommendations as it prepares the final rule on the OPPS for 2006. In
particular, CMS expressed appreciation for our analysis of the data
sources it considered in the NPRM and noted our concern that because of
information gaps, CMS cannot ensure that ASPs accurately reflect
hospitals' acquisition costs. CMS affirmed its commitment to ensuring that
SCOD payment rates equal hospitals' average acquisition costs, as required
by law, and cited our finding that ASP+3 percent should be a ceiling on
payment rates. However, our finding was that ASP+3 percent is the upper
bound on acquisition costs; therefore we have revised our report to
clarify that payment rates should be less than the ceiling. With respect
to radiopharmaceutical SCODs, CMS expressed appreciation for our analysis
and noted our concern that CMS's proposed charge-based rates would overpay
hospitals for these products. CMS also noted our recommendation to collect
additional information on ASP to validate the reasonableness of reported
ASPs, saying that it would consider the feasibility of the recommendation.

Our recommendations seek to ensure that the payment rates Medicare sets
for SCODs equal hospitals' average acquisition costs and that these
average costs are measured as accurately as possible. We reiterate the
importance of taking our recommendations into account in preparing the
final rule.

We are sending copies of this report to the Secretary of Health and Human
Services and the Administrator of CMS. The report is available at no
charge on GAO's Web site at http://www.gao.gov . We will also make copies
available to others on request. If you or your staff have any questions
about this report, please contact me at (202) 512-7119 or
[email protected]. Contact points for our Offices of Congressional
Relations and Public Affairs may be found on the last page of this report.
GAO staff who made major contributions to this report are listed in
enclosure II.

Director, Health Care Enclosures - 2

                            Enclosure I Enclosure I

           Comments from the Department of Health and Human Services

                            Enclosure I Enclosure I

                            Enclosure I Enclosure I

                            Enclosure I Enclosure I

                           Enclosure II Enclosure II

                     GAO Contact and Staff Acknowledgments

GAO Contact

A. Bruce Steinwald, (202) 512-7119 or [email protected]

Acknowledgments

Jon Ratner, Assistant Director; Hannah Fein; Dae Park; Phyllis Thorburn;
Thomas Walke; and Craig Winslow contributed to this report.

(290487)

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