Medicare Durable Medical Equipment: Class III Devices Do Not	 
Warrant a Distinct Annual Payment Update (01-MAR-06, GAO-06-62). 
                                                                 
Medicare fee schedule payments for durable medical equipment	 
(DME) that the Food and Drug Administration (FDA) regulates as	 
class III devices, those that pose the greatest potential risk,  
increased by 215 percent from 2001 through 2004. From 2004	 
through 2006, and for 2008, the Medicare Prescription Drug,	 
Improvement, and Modernization Act of 2003 (MMA) provided for a  
payment update for class III DME equal to the increase in the	 
consumer price index for all urban consumers (CPI-U). For 2007,  
MMA requires the Secretary of Health and Human Services to	 
determine the payment update. MMA also requires that other DME	 
receive a 0 percent update from 2004 through 2008. MMA directed  
GAO to report on an appropriate payment update for 2007 and 2008 
for class III DME. In this report, GAO (1) examined whether class
III devices have unique premarketing costs and (2) determined how
the fee schedule rate-setting methodology accounts for the	 
premarketing costs of such devices.				 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-06-62						        
    ACCNO:   A48017						        
  TITLE:     Medicare Durable Medical Equipment: Class III Devices Do 
Not Warrant a Distinct Annual Payment Update			 
     DATE:   03/01/2006 
  SUBJECT:   Cost analysis					 
	     Medical equipment					 
	     Medicare						 
	     Payments						 
	     Prices and pricing 				 
	     Rates						 

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GAO-06-62

     

     * Results in Brief
     * Background
     * Class III Devices Have Higher Premarketing Costs than Class
     * DME Fee Schedule Rate-Setting Methodology Accounts for Prema
     * Conclusions
     * Matter for Congressional Consideration
     * Recommendation for Executive Action
     * Agency and External Reviewer Comments and Our Evaluation
          * HHS Comments
          * Industry Comments and Our Evaluation
     * GAO Contact
     * Acknowledgments
     * GAO's Mission
     * Obtaining Copies of GAO Reports and Testimony
          * Order by Mail or Phone
     * To Report Fraud, Waste, and Abuse in Federal Programs
     * Congressional Relations
     * Public Affairs

Report to Congressional Committees

United States Government Accountability Office

GAO

March 2006

MEDICARE DURABLE MEDICAL EQUIPMENT

Class III Devices Do Not Warrant a Distinct Annual Payment Update

Medicare Payment for Durable Medical Equipment 

GAO-06-62

Contents

Letter 1

Results in Brief 3
Background 4
Class III Devices Have Higher Premarketing Costs than Class II Devices 7
DME Fee Schedule Rate-Setting Methodology Accounts for Premarketing Costs
of Class II and III Devices in a Consistent Manner 9
Conclusions 10
Matter for Congressional Consideration 11
Recommendation for Executive Action 11
Agency and External Reviewer Comments and Our Evaluation 11
Appendix I Scope and Methodology 16
Appendix II Comments from the Department of Health and Human Services 17
Appendix III GAO Contact and Staff Acknowledgments 19

Abbreviations

AdvaMed Advanced Medical Technology Association CMS Centers for Medicare &
Medicaid Services CPI-U consumer price index for all urban consumers DME
durable medical equipment FDA Food and Drug Administration HHS Department
of Health and Human Services MMA Medicare Prescription Drug, Improvement,
and Modernization Act of 2003 ODE Office of Device Evaluation PMA
premarket approval

This is a work of the U.S. government and is not subject to copyright
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separately.

United States Government Accountability Office

Washington, DC 20548

March 1, 2006

Congressional Committees

Medicare pays for durable medical equipment (DME)1 provided to
beneficiaries based on a fee schedule. Until 2004, annual updates to DME
fee schedule payment rates had been applied uniformly to all items on the
fee schedule. The Medicare Prescription Drug, Improvement, and
Modernization Act of 2003 (MMA) provided for an annual payment rate update
equal to the annual percentage increase in the consumer price index for
all urban consumers (CPI-U) from 2004 through 2006 to Medicare fee
schedule payment rates for DME regulated as class III medical devices2 by
the Food and Drug Administration (FDA).3 For these devices, in 2007, MMA
provided for an annual payment update to be determined by the Secretary of
Health and Human Services, and in 2008, for an update equal to the annual
percentage increase in the CPI-U. MMA also provided that from 2004 through
2008, all other DME will receive a 0 percent update. Although payments for
class III devices are less than 1 percent of total Medicare DME payments,
they increased from $16.9 million to $53.2 million, or by 215 percent,
from 2001 through 2004. Osteogenesis stimulators, devices used to promote
bone growth in difficult-to-heal fractures or following spinal fusion
surgery, accounted for a large proportion of class III DME payments during
this time, representing over 96 percent of the total in 2004.

1DME is equipment that primarily and customarily serves a medical purpose,
can withstand repeated use, is generally not useful to an individual in
the absence of an illness or injury, and is appropriate for use in the
home. 42 C.F.R. S: 414.202.

2Pub. L. No. 108-173, S: 302(c)(1)(A), 117 Stat. 2066, 2230-31.

3FDA regulates devices using a three-part classification system. Class III
devices are generally those that support or sustain human life, are of
substantial importance in preventing impairment of human health, or
present unreasonable risk of illness or injury. These devices typically
pose the greatest potential risk for human use and have the highest level
of FDA regulation. An example of a class III device is an automatic
external defibrillator. Class II devices generally pose less risk and
require less regulatory oversight. An example of a class II device is an
infusion pump. Class I devices generally pose the lowest risk for use by
humans and require the least regulatory oversight. An example of a class I
device is a patient examination glove.

MMA directed us to report on an appropriate payment update percentage for
2007 and 2008 to the DME fee schedule for class III devices provided to
Medicare beneficiaries.4 To report on an appropriate payment update
percentage, as agreed with the committees of jurisdiction, we (1) examined
whether there are unique premarketing costs associated with class III
devices compared to similar devices in other classes on the DME fee
schedule and (2) determined how the DME fee schedule rate-setting
methodology accounts for the premarketing costs of these devices.

To address these objectives, we interviewed officials from the Centers for
Medicare & Medicaid Services (CMS), the agency that administers Medicare;
FDA; two DME regional carriers, the contractors responsible for processing
DME claims; and the Statistical Analysis DME Regional Carrier, the
contractor that provides data analysis support to CMS. To examine the
premarketing costs of devices, we obtained the fees that FDA charges for
device review, known as user fees, which are published on the FDA Web
site. We also reviewed the FDA device approval process and data on the
length of time it takes for device review from FDA's Office of Device
Evaluation (ODE)5 2004 Annual Report. We interviewed manufacturers of
class III devices about the types of costs they incur in producing the
devices, including FDA fees for device review and the costs of research
and development, both for any clinical data the manufacturer is required
to submit and for other research and development costs, such as labor
costs. We also interviewed manufacturers of certain class II devices on
the DME fee schedule that CMS identified as similar to the class III
devices on the schedule in terms of complexity. We did not evaluate
proprietary data to determine whether a difference in other premarketing
research and development costs exists between the two types of
manufacturers. To determine how the DME fee schedule accounts for
premarketing costs, we interviewed CMS officials and reviewed CMS
documents on the DME fee schedule rate-setting methodology. We also
interviewed officials from a trade organization that represents
manufacturers of medical devices, industry organizations for orthopedic
surgeons and pain physicians, and two private health insurance companies.
Appendix I contains a more complete description of our methodology. We
conducted our work from December 2004 through February 2006 in accordance
with generally accepted government auditing standards.

4Pub. L. No. 108-173, S: 302(c)(1)(B), 117 Stat. 2231.

5ODE is a part of FDA's Center for Devices and Radiological Health. It is
responsible for the program areas under which medical devices are
evaluated or cleared for clinical trials and marketing.

                                Results in Brief

Manufacturers of class III devices, with limited exceptions, have higher
premarketing costs than do manufacturers of class II devices. Premarketing
costs consist of FDA user fees and the costs of research and development,
including the costs of submitting clinical data. Manufacturers of class
III devices pay higher FDA user fees for review of their devices, because
of the more complex FDA review required prior to marketing, than do
manufacturers of class II devices. Specifically, the user fee for class
III devices in 2005 was $239,237, while the fee for class II devices in
2005 was $3,502. In addition, according to FDA data, compared to class II
manufacturers, the FDA application and approval process takes longer for
class III manufacturers, which lengthens the time it takes before they can
market their devices and begin receiving revenue. FDA also requires that
manufacturers submit clinical data for class III devices, for which
manufacturers incur costs. FDA only occasionally requires the submission
of clinical data for class II devices. Class III manufacturers stated that
they incur higher premarketing costs for other research and development
compared to manufacturers of class II devices. However, class II
manufacturers also stated that they incur substantial premarketing costs
related to research and development. Because we did not evaluate
proprietary data on other premarketing research and development costs, we
could not determine whether a difference in premarketing research and
development costs, other than clinical data collection costs, exists
between class III and class II manufacturers.

The CMS rate-setting methodology for Medicare's DME fee schedule accounts
for all premarketing costs of class II and class III devices in a
consistent manner. Regardless of device classification, the Medicare DME
fee schedule payment rate for a device is based on either the
manufacturer's retail price or historic reasonable Medicare charges, which
CMS considers equivalent measures. Manufacturers of class III devices we
spoke with, whose devices accounted for over 96 percent of class III DME
payments in 2004, stated that when setting their retail prices, they take
into account the costs of complying with federal regulatory requirements,
including the costs of required clinical data collection and other
research and development. Manufacturers of class II devices also stated
that they take into account these costs when setting retail prices.

The Congress should consider establishing a uniform payment update to the
DME fee schedule for 2008 for class II and class III devices. Similarly,
we recommend that the Secretary of Health and Human Services establish a
uniform payment update to the DME fee schedule for 2007 for class II and
class III devices. In commenting on a draft of this report, the Department
of Health and Human Services (HHS) agreed with our recommendation to
establish a uniform payment update to the DME fee schedule for 2007 for
class II and class III devices. The agency did not comment on whether the
Congress should consider establishing a uniform payment update to the DME
fee schedule for 2008 for these devices. Industry representatives who
reviewed a draft of this report did not agree or disagree with our matter
for congressional consideration or our recommendation for executive
action. They did, however, express concern that we did not recommend a
specific update percentage for class III devices. Our report recommends a
uniform payment update to the DME fee schedule for class II and class III
devices; we believe that this recommendation satisfies the requirement in
MMA to make recommendations on the appropriate update percentage for class
III devices. Industry representatives were also concerned that we did not
examine all the costs they incur in marketing a device. Specifically, they
were concerned that we did not include some regulatory costs; labor costs
for services provided to beneficiaries and physicians; and research and
development costs to improve or find new uses for a device. Based on our
discussions with the manufacturers of class II and class III devices, we
believe labor and regulatory costs are included in our analysis. Further,
we believe the research and development costs incurred for a future device
are premarketing costs related to that new device and not costs related to
marketing the existing device.

                                   Background

FDA is responsible for regulating the marketing of medical devices6 to
provide reasonable assurance of their safety and effectiveness for human
use. As part of its regulatory responsibility, FDA reviews applications
from manufacturers that wish to market their medical devices in the United
States. Prior to marketing new devices, manufacturers must apply for FDA
marketing approval through either the premarket notification (also
referred to as 510(k)) process, or the premarket approval (PMA) process, a
more rigorous regulatory review. New devices are subject to PMA, unless
they are substantially equivalent7 to an already marketed device, in which
case they need to comply only with the premarket notification
requirements. Applications for premarket notification are generally
reviewed more quickly than applications for PMA and do not usually require
clinical data.8

6The Federal Food, Drug, and Cosmetic Act defines a medical device as an
instrument, apparatus, implement, machine, contrivance, implant, in vitro
reagent, or other similar or related article, including any component,
part, or accessory that is (a) recognized in the National Formulary or the
United States Pharmacopeia or any supplement to them, (b) intended for use
in the diagnosis of disease or other conditions, or in the cure,
mitigation, treatment, or prevention of disease in man or other animals,
or (c) intended to affect the structure or any function of the body of man
or other animals, and which does not achieve its primary intended purposes
through chemical action within or on the body of man or other animals, nor
required to be metabolized to achieve its primary intended purposes. 21
U.S.C S: 321(h).

Medical devices are regulated using a three-part classification system and
are subject to different levels of control based upon their
classifications as class I, II, or III devices. Class I devices are
generally those with the lowest risk for use by humans and require the
least regulatory oversight. These devices are subject to general controls,
which include standards for good manufacturing practices, and requirements
related to manufacturer registration, maintenance of records, and
reporting. Examples of class I devices are patient examination gloves,
canes, and crutches. Class II devices are generally of higher risk and are
also subject to general controls; however, FDA can establish special
controls for these devices, such as development and dissemination of
guidance documents, mandatory performance standards, and postmarket
surveillance. Examples of class II devices are blood glucose test systems
and infusion pumps.

Class III devices typically pose the greatest risk and thus have the
highest level of regulation. This classification includes most devices
that support or sustain human life, are of substantial importance in
preventing impairment of human health, or present a potential unreasonable
risk of illness or injury. Because general and special controls may not be
sufficient to ensure safety and effectiveness, these devices, with limited
exceptions, must obtain PMA. To obtain PMA, the manufacturer must provide
FDA with sufficient valid scientific evidence providing reasonable
assurance that the device is safe and effective for its intended use. Once
approved, changes to the device affecting safety or effectiveness require
the submission and approval of a supplement to its PMA. Examples of class
III devices include automatic external defibrillators and implantable
infusion pumps used to administer medication.

7Substantially equivalent means that a device has (1) the same intended
use and the same technological characteristics as a marketed device or (2)
the same intended use and different technological characteristics, but is
as safe and effective as the marketed device and does not raise different
questions of safety and effectiveness. 21 U.S.C. S:360c(i)(1).

8For additional information on FDA's review of medical device
applications, see GAO, Food and Drug Administration, Limited Data
Available Indicate That FDA Has Been Meeting Some Goals for Review of
Medical Device Applications, GAO-05-1042 (Washington, D.C.: Sept. 30,
2005).

Some class III devices are provided as part of a hospital visit; Medicare
pays for these devices through the hospital inpatient or outpatient
prospective payment systems. Five categories of class III devices,
however, can be provided in physicians' offices or prescribed by
physicians for use in the home; Medicare pays for these devices through
the DME fee schedule.9

In 2004, Medicare payments for class III devices under the DME fee
schedule were $53.2 million, which represented less than 1 percent of
total DME payments. The Medicare DME fee schedule payment rate for a
device is based on either the manufacturer's retail price or historic
reasonable Medicare charges,10 which CMS considers equivalent measures.
MMA provided for a 0 percent annual update for most Medicare DME fee
schedule payment rates from 2004 through 2008. However, under MMA, class
III devices were excluded from the 0 percent update and received payment
updates equal to the annual percentage increase in the CPI-U in 2004,
2005, and 2006.11 For these devices, MMA provides, in 2007 for a payment
update as determined by the Secretary of Health and Human Services, and in
2008, for a payment update equal to the annual percentage increase in the
CPI-U.

9Medicare pays for osteogenesis stimulators, infusion pumps and their
related supplies, neuromuscular stimulators, and certain ultraviolet light
therapy systems and automatic external defibrillators and related supplies
as class III devices under the DME fee schedule.

10If the actual charge for an item is less than the fee schedule payment
rate, the Medicare payment is limited to the actual charge.

11Class III devices received payment updates of 2.1 percent in 2004, 3.3
percent in 2005, and 2.5 percent in 2006.

     Class III Devices Have Higher Premarketing Costs than Class II Devices

We found that with limited exceptions, manufacturers of class III devices
have higher premarketing costs than do manufacturers of class II devices.
Manufacturers of class III devices pay higher FDA user fees for review of
their devices, because of the more complex FDA review required prior to
marketing, than do manufacturers of class II devices. According to FDA
data, compared to class II manufacturers, class III manufacturers have a
longer period before approval during the FDA application process, which
lengthens the time before they can market their devices and begin
receiving revenue. FDA requires that manufacturers submit clinical data
for class III devices, but only occasionally requires the same for class
II devices. In addition, class III manufacturers stated they incur higher
premarketing costs for other research and development than do
manufacturers of class II devices. However, class II manufacturers also
stated that they incur substantial premarketing costs related to other
research and development. Because we did not evaluate proprietary data on
other premarketing research and development costs, we could not determine
whether a difference in other premarketing research and development costs
exists between class III and class II manufacturers.

Manufacturers of class III devices pay higher FDA user fees for review of
their devices, because of the more complex FDA review required prior to
marketing, than do manufacturers of class II devices. Specifically,
manufacturers of class III devices subject to this review pay the FDA user
fee for PMA, which in 2005 was $239,237 for each PMA.12 Most PMA
supplements, which must be filed when a manufacturer makes a change to a
class III device that affects its safety or effectiveness, also require
payment of a fee, which ranged from $6,546 to $239,237. Manufacturers of
class II devices pay the FDA user fee for each premarket notification,
which in 2005 was $3,502.13 When a manufacturer makes a change to a class
II device, a new premarket notification application must be filed; there
is no supplement process for these devices.

Manufacturers of class III devices have a longer period before approval
during the FDA application process, which they stated delays the marketing
of their devices and the receipt of revenue. According to ODE's 2004
Annual Report, in 2004, the average time for PMA review was 503 days while
the average time for premarket notification review was 100 days.14 These
average times include the total time a PMA or premarket notification was
under review by FDA and the time the manufacturer used in responding to
any FDA requests for additional information.

12In 2005, for businesses with $30 million or less in annual gross sales
and revenue, PMA fees were reduced to $90,910 and the first PMA submitted
by such a business was free.

13In 2005, for businesses with $30 million or less in annual gross sales
and revenue, premarket notification fees were reduced to $2,802.

FDA requires that class III manufacturers submit clinical data, for which
manufacturers incur costs. FDA only occasionally requires the submission
of clinical data for class II devices. Specifically, FDA requires
manufacturers of class III devices to submit clinical data as part of the
PMA process to provide reasonable assurance that the devices are safe and
effective for their intended uses. During its review of a device's PMA
application, FDA may require that the manufacturer provide additional
information, which may require submission of additional clinical data.
Manufacturers of class III devices stated that to collect clinical data,
they conducted costly animal studies, human preclinical studies, and human
clinical trials. Manufacturers of class II devices must satisfy premarket
notification requirements; that is, they must submit documentation that a
device is substantially equivalent to a legally marketed device. An FDA
official stated that manufacturers of class II devices may be required to
provide clinical data. They may be required to provide these data, for
example, to demonstrate that modifications they have made to a device
would not significantly affect its safety or effectiveness, or if a device
is to be marketed for a new or different indication. According to FDA, 10
to 15 percent of premarket notification applications include clinical
data.

Manufacturers of class III devices we spoke with stated that in addition
to collecting clinical data, they incur higher premarketing costs related
to other research and development, such as labor costs and manufacturing
supplies related to designing a device, than do manufacturers of other
classes of devices. They stated that class III devices are highly
innovative, complex products that require costly premarketing research and
development to produce. One class III manufacturer we spoke with stated
that approximately 10 percent of its revenue between 2002 and 2005 was
invested in premarketing research and development. Another class III
manufacturer stated that approximately 4 percent of its operating budget
is spent on premarketing research and development.

14These average times are for reviews completed in fiscal year 2004,
regardless of when the application was received.

However, manufacturers of class II devices we spoke with also stated that
they incur substantial premarketing costs related to research and
development. Specifically, we spoke with a manufacturer of an insulin pump
and two manufacturers of continuous positive airway pressure devices,15
each of which stated it incurs substantial research and development costs.
One class II manufacturer stated that 10 to 15 percent of a device's total
cost was attributable to research and development. Another class II
manufacturer stated that approximately 7 to 10 percent of its revenue is
spent on research and development. Because we did not evaluate proprietary
data for other premarketing research and development costs, we were unable
to determine whether a difference in other premarketing research and
development costs exists between class III and class II manufacturers.

  DME Fee Schedule Rate-Setting Methodology Accounts for Premarketing Costs of
                Class II and III Devices in a Consistent Manner

The CMS rate-setting methodology for Medicare's DME fee schedule accounts
for the premarketing costs of class II and class III devices in a
consistent manner. The fee schedule payment rate for an item of DME,
regardless of device classification, is based on either historic Medicare
charges or the manufacturer's retail price, which CMS has determined are
equivalent measures. Manufacturers of both class II and class III devices
we spoke with stated that when setting their retail prices, they take into
account all premarketing costs necessary to bring the device to market.

CMS has two DME fee schedule rate-setting methodologies: one method is for
items that belong to a payment category covered by Medicare at the time
the DME fee schedule was implemented in 1989, and one method is for items
added to the DME fee schedule after 1989 that are not covered by an
existing payment category. Regardless of its classification as a class I,
II, or III device, the payment rate for an item of DME covered by Medicare
when the DME fee schedule was implemented in 1989 is based on its average
reasonable Medicare charge from July 1, 1986, through June 30, 1987, for
some items, and July 1, 1986, through December 31, 1986, for other items
(both referred to as the base year). Historically, these payment rates
have been updated by a uniform, statutorily set, percentage, which is
usually based on the annual percentage increase in the CPI-U. Generally,
for items added to the fee schedule after 1989 that are not covered by an
existing payment category, CMS does not have historic Medicare charges
upon which to base the payment rate. CMS has determined that in these
cases, the manufacturer's retail price is a sufficient substitute to
calculate the fee schedule payment amount, and CMS considers the payment
amount that results from this methodology to be equivalent to historic
reasonable Medicare charges. To determine the payment rate, CMS obtains
the manufacturer's retail price for the new item and uses a formula based
on the cumulative annual percentage increase in the CPI-U to deflate the
price to what it would have been in the base year. Using a formula based
on the statutory DME fee schedule payment updates since the base year, CMS
then inflates the base year price to the year in which the item was added
to the fee schedule. In succeeding years, the item is updated by the
applicable DME fee schedule update. The cumulative updates applied to DME
are lower than the corresponding CPI-U increases because, in certain
years, the statutory update was less than the CPI-U increase.16 Therefore,
the payment rate of a device is generally lower than its retail price.

15Continuous positive airway pressure devices are used to treat, among
other things, sleep apnea.

Manufacturers of class III devices we spoke with, whose devices accounted
for over 96 percent of class III DME payments in 2004, stated that when
setting their retail prices, they take into account the premarketing costs
of complying with federal agencies' requirements, including the costs of
collecting clinical data, and the costs of research and development.
Manufacturers of class II devices similarly stated that they take into
account the premarketing costs of complying with federal agencies'
requirements and of research and development, including any clinical data
they may be required to collect.

                                  Conclusions

From 2004 through 2006, MMA provided for a payment update to the DME fee
schedule for class III devices equal to the annual percentage increase in
the CPI-U. In addition, for these devices, for 2007, MMA provided for a
payment update to be determined by the Secretary of Health and Human
Services, and for 2008, a payment update equal to the annual percentage
increase in the CPI-U. From 2004 through 2008, for class II devices,
however, MMA provided for a 0 percent payment update.

16In 1991 and 1992, the statutory update was the annual percentage
increase in the CPI-U reduced by 1 percentage point. In 1998, 1999, 2000,
and 2002, the statutory update was 0 percent.

Manufacturers of class III devices, with limited exceptions, have higher
premarketing costs than manufacturers of class II devices, specifically,
higher costs related to FDA user fees and submission of clinical data.
However, class III and class II manufacturers we spoke with stated they
take these premarketing costs, as well as premarketing research and
development costs, into account when setting their retail prices. Because
the initial payment rates for all classes of devices on the Medicare DME
fee schedule are based on these retail prices or an equivalent measure,
they account for the costs of class III and similar class II devices in a
consistent manner. Distinct updates for two different classes of devices
are unwarranted.

                     Matter for Congressional Consideration

The Congress should consider establishing a uniform payment update to the
DME fee schedule for 2008 for class II and class III devices.

                      Recommendation for Executive Action

We recommend that the Secretary of Health and Human Services establish a
uniform payment update to the DME fee schedule for 2007 for class II and
class III devices.

            Agency and External Reviewer Comments and Our Evaluation

We received written comments on a draft of this report from HHS (see app.
II). We also received oral comments from six external reviewers
representing industry organizations. The external reviewers were the
Advanced Medical Technology Association (AdvaMed), which represents
manufacturers of medical devices, and representatives from five class III
device manufacturers-the four manufacturers of osteogenesis stimulators
and one manufacturer of both implantable infusion pumps and automatic
external defibrillators.

HHS Comments

In commenting on a draft of this report, HHS agreed with our
recommendation to establish a uniform payment update to the DME fee
schedule for 2007 for class II and class III devices. The agency did not
comment on whether the Congress should consider establishing a uniform
payment update to the DME fee schedule for 2008 for these devices. HHS
agreed with our finding that the costs of class II and class III DME have
been factored into the fee schedule amounts for these devices, noting that
CMS is committed to effectively and efficiently implementing DME payment
rules. It stated that our report did a thorough job of reviewing Medicare
payment rules associated with the costs of furnishing class III devices.

HHS also provided technical comments, which we incorporated where
appropriate.

Industry Comments and Our Evaluation

Industry representatives who reviewed a draft of this report did not agree
or disagree with our matter for congressional consideration or our
recommendation for executive action. They did, however, express concern
that we did not recommend a specific update percentage for class III
devices. Our report recommends a uniform payment update to the DME fee
schedule for class II and class III devices; we believe that this
recommendation satisfies the requirement in MMA to make recommendations on
the appropriate update percentage for class III devices.

Two manufacturers of class III devices commented on the class II device
manufacturers we interviewed. One manufacturer stated that it would have
been more appropriate to interview manufacturers of class II devices that
are not similar to class III devices in terms of complexity. The other
manufacturer expressed concern that we did not speak with more class II
manufacturers.

The four osteogenesis stimulator manufacturers expressed concern that we
did not examine costs they incur after they market a device. Specifically,
several stated that they incur labor costs for services provided to
beneficiaries and physicians, research and development costs related to
FDA-required surveillance on osteogenesis stimulators' safety, and
research and development costs to improve or find new uses for a device.
In addition, one manufacturer stated that it conducts costly research and
development for some products that never come to market.

Concerning comments about the class II manufacturers we interviewed, as
noted in the draft report, our conclusion that class III devices have
higher premarketing costs than do manufacturers of class II devices is
based on FDA requirements and FDA data that apply to class III and class
II manufacturers and not on information obtained from class III and class
II manufacturers. According to FDA data, manufacturers of class III
devices pay higher FDA user fees and have a longer period of time before
approval during the FDA application process. FDA also requires that all
class III manufacturers submit clinical data, for which manufacturers
incur costs, and only occasionally requires the submission of clinical
data for class II devices.

Regarding manufacturers' concerns that we did not examine all of their
device-related costs, we included these costs in our analysis, where
appropriate. With respect to labor costs for services provided to
beneficiaries and physicians, to the extent that suppliers do perform
these services, the costs are known prior to marketing the device and can
be taken into account when setting their retail price. Two class III
manufacturers we spoke with volunteered that they take these labor costs
into account when setting retail prices prior to the device going to
market. Regarding research and development costs for FDA-required
surveillance, both class III and class II devices may be subject to
surveillance on a case-by-case basis; prior to marketing, FDA notifies
manufacturers that a device will be subject to postmarket surveillance.
Also prior to marketing the device, manufacturers must submit, for FDA
approval, a plan to conduct the required surveillance. As noted in the
draft report, both class III and class II device manufacturers stated,
that when setting their retail prices, they take into account the
premarketing costs of complying with federal agencies' requirements. With
respect to research and development costs to improve or find new uses for
a device after it is marketed, these are costs incurred to modify an
existing device or develop a new device. Costs incurred for a future
device are premarketing costs related to that device and not costs related
to marketing the existing device. Finally, we did not examine research and
development costs for products that do not come to market because these
costs do not directly relate to items on the Medicare DME fee schedule;
therefore, it would be inappropriate to consider them when reporting on
the appropriate update percentage to items on the fee schedule.

Industry representatives raised several issues that went beyond the scope
of our report. These issues included the appropriateness of the DME
rate-setting methodology, payment incentives that may lead providers to
use one site of service over another, and incentives for manufacturers to
bring new devices to the market.

Reviewers also made technical comments, which we incorporated where
appropriate.

We are sending copies of this report to the Secretary of Health and Human
Services, the Administrators of CMS and FDA, and appropriate congressional
committees. We will also make copies available to others on request. In
addition, the report is available at no charge on GAO's Web site at
http://www.gao.gov.

If you or your staffs have any questions, 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
appendix III.

Kathleen M. King Director, Health Care

List of Committees

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

The Honorable Joe L. 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

Appendix I: Scope and Methodology Appendix I: Scope and Methodology

To address our objectives, we interviewed officials from the Centers for
Medicare & Medicaid Services (CMS); the Food and Drug Administration
(FDA); two of the four durable medical equipment (DME) regional carriers,
the contractors responsible for processing DME claims; and the Statistical
Analysis DME Regional Carrier, the contractor that provides data analysis
support to CMS. To examine the premarketing costs of devices, we obtained
the fees that FDA charges for device review, known as user fees, which are
published on the FDA Web site. We also reviewed the FDA device approval
process, and data on device review times from FDA's Office of Device
Evaluation's 2004 Annual Report. We interviewed the four manufacturers of
osteogenesis stimulators and one manufacturer of both implantable infusion
pumps and automatic external defibrillators, all class III medical
devices, about the types of costs they incur in producing the devices,
including FDA fees for device review and the costs of research and
development, both for any clinical data the manufacturer is required to
submit and for other research and development costs, such as labor costs
related to designing a device. These class III manufacturers' devices
accounted for over 96 percent of class III Medicare DME payments in 2004.
We also spoke with a manufacturer of insulin pumps and two manufacturers
of continuous positive airway pressure devices, class II devices on the
DME fee schedule that CMS identified as similar to the class III devices
on the schedule in terms of complexity. We did not evaluate proprietary
data to determine whether a difference in other premarketing research and
development costs exists between the two types of manufacturers.

To determine how the DME fee schedule accounts for premarketing costs, we
interviewed CMS officials and reviewed CMS documents on the DME fee
schedule rate-setting methodology. We interviewed representatives from the
Advanced Medical Technology Association; the American Academy of
Orthopedic Surgeons; the American Society of Interventional Pain
Physicians; and two private insurance companies.

We conducted our work from December 2004 through February 2006 in
accordance with generally accepted government auditing standards.

Appendix II: Comments from the Department of Health and Human Services
Appendix II: Comments from the Department of Health and Human Services

Appendix III: GAO Appendix III: GAO Contact and Staff Acknowledgments

                                  GAO Contact

Kathleen M. King, (202) 512-7119 or [email protected]

                                Acknowledgments

In addition to the contact named above, Nancy A. Edwards, Assistant
Director; Joanna L. Hiatt; and Andrea E. Richardson made key contributions
to this report.

(290429)

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www.gao.gov/cgi-bin/getrpt? GAO-06-62 .

To view the full product, including the scope

and methodology, click on the link above.

For more information, contact Kathleen M. King at (202) 512-7119 or
[email protected].

Highlights of GAO-06-62 , a report to congressional committees

March 2006

MEDICARE DURABLE MEDICAL EQUIPMENT

Class III Devices Do Not Warrant a Distinct Annual Payment Update

Medicare fee schedule payments for durable medical equipment (DME) that
the Food and Drug Administration (FDA) regulates as class III devices,
those that pose the greatest potential risk, increased by 215 percent from
2001 through 2004. From 2004 through 2006, and for 2008, the Medicare
Prescription Drug, Improvement, and Modernization Act of 2003 (MMA)
provided for a payment update for class III DME equal to the increase in
the consumer price index for all urban consumers (CPI-U). For 2007, MMA
requires the Secretary of Health and Human Services to determine the
payment update. MMA also requires that other DME receive a 0 percent
update from 2004 through 2008. MMA directed GAO to report on an
appropriate payment update for 2007 and 2008 for class III DME. In this
report, GAO (1) examined whether class III devices have unique
premarketing costs and

(2) determined how the fee schedule rate-setting methodology accounts for
the premarketing costs of such devices.

What GAO Recommends

The Congress should consider establishing a uniform payment update to the
DME fee schedule for 2008 for class II and III devices. GAO recommends
that the Secretary of Health and Human Services establish a uniform
payment update to the DME fee schedule for 2007 for class II and class III
devices. The agency agreed with GAO's recommendation.

GAO found that manufacturers of class III devices, with limited
exceptions, have higher premarketing costs than do manufacturers of class
II devices that are similar to class III devices. Premarketing costs
consist of FDA user fees and research and development costs, both for any
clinical data the manufacturer is required to submit and for other
research and development costs. Manufacturers of class III devices pay
higher FDA user fees, because of the more complex FDA review required
prior to marketing, than do manufacturers of class II devices.
Specifically, the user fee for class III devices subject to this review in
2005 was $239,237, while the fee for class II devices in 2005 was $3,502.
The FDA application and approval process takes longer for class III
manufacturers, which lengthens the time it takes before they can market
their devices and begin receiving revenue. FDA requires that manufacturers
submit clinical data for class III devices, but only occasionally requires
the same for class II devices. In interviews with GAO, class III
manufacturers stated that they incur higher premarketing costs for other
research and development, such as labor costs related to designing a
device, compared to manufacturers of class II devices. Class II
manufacturers also told GAO that they incur substantial costs related to
other research and development. GAO did not evaluate proprietary data to
determine whether a difference in other premarketing research and
development costs exists between the two types of manufacturers.

GAO found that the Medicare DME fee schedule rate-setting methodology
accounts for the respective premarketing costs of class II and class III
devices in a consistent manner. Regardless of device classification, the
Medicare DME fee schedule payment rate for a device is based on either the
manufacturer's retail price or historic reasonable Medicare charges, which
the Centers for Medicare & Medicaid Services considers equivalent
measures. In interviews with GAO, manufacturers of class III devices
stated that when setting their retail prices, they take into account the
premarketing costs of complying with federal regulatory requirements,
including the costs of required clinical data collection and other
research and development. These manufacturers accounted for over 96
percent of class III DME payments in 2004. Manufacturers of class II
devices also stated that they take into account these costs when setting
retail prices.
*** End of document. ***