End-Stage Renal Disease: Bundling Medicare's Payment for Drugs	 
with Payment for All ESRD Services Would Promote Efficiency and  
Clinical Flexibility (13-NOV-06, GAO-07-77).			 
                                                                 
Medicare covers dialysis--a process that removes excess fluids	 
and toxins from the bloodstream--for most individuals with	 
end-stage renal disease (ESRD), a condition of permanent kidney  
failure. The Centers for Medicare & Medicaid Services (CMS) pays 
for certain dialysis services under a type of bundled rate,	 
called a composite rate, and, for certain dialysis-related drugs,
pays a separate rate per dose each time the drug is administered.
These drugs are referred to as "separately billable" and are paid
at 6 percent above manufacturers' average sales price (ASP).	 
Recently, the Congress required CMS to explore the creation of a 
bundled payment for all ESRD services, including separately	 
billable drugs. GAO was asked to examine (1) recent changes in	 
payments for ESRD services, (2) the ASP payment method of setting
rates for separately billable ESRD drugs, and (3) CMS efforts to 
develop a bundled payment method that includes all ESRD drugs.	 
GAO obtained information for this study from CMS, the U.S. Renal 
Data System, ESRD experts, and previously issued GAO reports.	 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-07-77						        
    ACCNO:   A63327						        
  TITLE:     End-Stage Renal Disease: Bundling Medicare's Payment for 
Drugs with Payment for All ESRD Services Would Promote Efficiency
and Clinical Flexibility					 
     DATE:   11/13/2006 
  SUBJECT:   Blood diseases					 
	     Cost analysis					 
	     Dialysis						 
	     Food and drug law					 
	     Medicare						 
	     Payments						 
	     Policy evaluation					 
	     Prescription drugs 				 
	     Prices and pricing 				 
	     Program evaluation 				 
	     Rates						 
	     Urologic diseases					 

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GAO-07-77

                 United States Government Accountability Office

GAO					 

Report to the Chairman, Committee on
Ways and Means, House of Representatives

                                 November 2006

END-STAGE RENAL DISEASE

 Bundling Medicare's Payment for Drugs with Payment for All ESRD Services Would
                  Promote Efficiency and Clinical Flexibility

GAO-07-77

END-STAGE RENAL DISEASE

Bundling Medicare's Payment for Drugs with Payment for All ESRD Services
Would Promote Efficiency and Clinical Flexibility

  What GAO Found

The effect of several legislative and regulatory changes since 2003 has
been to raise the composite rate while reducing Medicare's pre-2005
generous payments for separately billable ESRD drugs. In 2005, when the
first legislative change was implemented, Medicare expenditures for
certain separately billable drugs dropped 11.8 percent. In 2006, Medicare
regulation changed the payment for these drugs to a method based on ASP.
Since then, Medicare's payment rates have varied from quarter to quarter
but have remained relatively consistent with the lower 2005 payment rates.
Medicare's cost containment efforts have targeted the most expensive of
the separately billable drugs--Epogen(R)--for which program spending
totaled $2 billion in 2005. Epogen is used to treat anemia in ESRD
patients; most patients receive this drug at nearly every dialysis
session. Recent data indicate that Epogen use per patient continues to
rise, although more slowly than in previous years.

Several unknowns about the composition of ASP and the lack of empirical
evidence for the percentage level added to ASP make it difficult for CMS
to determine whether the ASP-based payment rates are no greater than
necessary to achieve appropriate beneficiary access. Paying for Epogen
under the ASP method is of particular concern. The ASP method relies on
market forces to moderate manufacturers' prices; but Epogen is the product
of a single manufacturer and has no competitor products in the ESRD
market. Without competition, the power of market forces to moderate price
is absent. For rarely used products, the lack of price competition may be
financially insignificant, but for Epogen, which is pervasively and
frequently used, the lack of price competition could be having a
considerable effect on Medicare spending.

In 2003, the Congress required CMS to issue a report and conduct a
demonstration of a system that would bundle payment for ESRD services,
including drugs that are currently billed separately, under a single rate.
The bundled payment approach, used to pay for most Medicare services,
encourages providers to operate efficiently, as they retain the difference
if Medicare's payment exceeds the costs they incur to provide the
services. GAO and others have found that a bundled rate for all ESRD
services would have advantages for achieving efficiency and clinical
flexibility in treating ESRD patients. CMS's demonstration testing the
feasibility of a bundled rate, mandated to start in January 2006, is
delayed, as is the completion of the agency's mandated report to the
Congress on bundling. The report was due in October 2005; as of November
2006, CMS officials could not tell us when the report would be available.

                 United States Government Accountability Office

                                    Contents

Letter             Results in Brief BackgroundNew Payment Provisions 1 5 7 
                 Reduced Subsidy from Separately Billable Drugs but Did 13 20 
                    Not Eliminate Incentives to Overuse These Drugs ASP 22 27 
                  Payment Method, While Administratively Practical, May 27 28 
                      Not Help Medicare Foster Efficient Provider Goals       
                Bundling Is Fundamental to Medicare Payment Policy, but       
                  System to Expand Composite Rate Bundle to Include All       
                  ESRD Drugs Remains in Design Phase Conclusions Matter       
                    for Congressional Consideration Agency and Industry       
                                            Comments and Our Evaluation       
Appendix I  Comments from the Centers for Medicare & Medicaid           33 
               Services                                                       
Appendix II          GAO Contact and Staff Acknowledgments              35 
Tables       Table 1: Separately Billable Injectable ESRD Drugs Used       
                         by Dialysis Facilities in 2005 Table 2: Recent       
                    Legislative and Regulatory Changes to ESRD Payments 10 14 
                      Table 3: Medicare Reimbursement Rates for Certain 15 16 
                     Separately Billable ESRD Drugs Table 4: Percentage       
                 Change in Medicare Expenditures for Certain Separately       
                                  Billable ESRD Drugs from 2004 to 2005       
Figures      Figure 1: Average Epogen Dose per Administration in the       
               First 6 Months of Each Year, 1991-2006 Figure 2: Average       
                Number of Monthly Epogen Administrations in the First 6       
                                         Months of Each Year, 1991-2006 18 19 

Abbreviations

ASP            average sales price                                         
AWP            average wholesale price                                     
CMS            Centers for Medicare & Medicaid Services                    
CHOIR          Correction of Hemoglobin and Outcomes in Renal              
                  Insufficiency Trial                                         
CREATE         Cardiovascular Risk Reduction by Early Anemia Treatment     
                  with Epoetin Beta Trial                                     
ESRD           end-stage renal disease                                     
FDA            Food and Drug Administration                                
Hct            hematocrit                                                  
HHS            Department of Health and Human Services                     
KCC            Kidney Care Council                                         
KDOQI          Kidney Disease Outcomes Quality Initiative                  
MedPAC         Medicare Payment Advisory Commission                        
MMA            The Medicare Prescription Drug, Improvement, and            
                  Modernization Act of 2003                                   
NRAA           National Renal Administrators Association                   
OIG            Office of the Inspector General                             
RPA            Renal Physicians Association                                
USRDS          United States Renal Data System                             

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

November 13, 2006

The Honorable William M. Thomas Chairman Committee on Ways and Means House
of Representatives

Dear Mr. Chairman:

Regardless of age, most individuals with end-stage renal disease (ESRD), a
condition of permanent kidney failure, are eligible for health care
coverage under Medicare.^1 Since the implementation of the ESRD benefit in
1973, hundreds of thousands of lives have been extended through
Medicarecovered dialysis treatment--a process that removes excess fluids
and toxins from the bloodstream. Patients receive additional items and
services related to their dialysis treatments, such as laboratory tests,
clinical services, and drugs to treat conditions resulting from the loss
of kidney function, such as anemia and low blood calcium. In 2005,
Medicare's ESRD population was about 390,000 and program expenditures for
dialysis and dialysis-related drugs totaled $7.9 billion.^2

The Centers for Medicare & Medicaid Services (CMS) in the Department of
Health and Human Services (HHS), which has the responsibility for
administering the Medicare program, divides ESRD items and services into
two groups for payment purposes. In the first group are dialysis and
associated routine services--such as nursing, supplies, equipment, and
certain laboratory tests. These items and services are paid for under a
composite rate--that is, one rate for a defined set of services. Paying
under a composite rate is a common form of Medicare payment also known as
bundling. In the second group are primarily injectable drugs and certain
laboratory tests that were either not routine or not available in 1983
when Medicare implemented the composite rate. These items and

1In addition to being diagnosed with ESRD, individuals generally must meet
one of the following requirements to receive Medicare coverage: obtain the
required work credits under the Social Security program, receive Social
Security benefits, or be the spouse or dependent child of a person who has
met the required work credits or is receiving Social Security benefits. 42
U.S.C. S 426-1 (2000).

2For the purposes of this report, Medicare expenditures include the 20
percent coinsurance paid by the beneficiary, unless otherwise noted.

services, which are paid for separately on a per-service basis, are
referred to as "separately billable." Over time, Medicare's composite
rate, which was not automatically adjusted for inflation, covered
progressively less of the costs to provide routine dialysis services,
while program payments for the separately billable drugs generally
exceeded providers' costs to obtain these drugs.^3 As a result, dialysis
facilities relied on Medicare's generous payments for separately billable
drugs to subsidize the composite rate payments that had remained nearly
flat for two decades.^4 In addition, the use of the separately billable
drugs by facilities became routine, and program payments for these drugs
grew substantially. In 2005, program spending for the separately billable
ESRD drugs accounted for about $2.9 billion.

Medicare's payment method for separately billable ESRD drugs has changed
several times in the last few years. Currently, each of these drugs is
paid for on a per administration basis equal to 6 percent above
manufacturers' average sales price (ASP), referred to as ASP+6; this
payment rate went into effect in 2006.^5 In 2005, Medicare spending for
one of these drugs, Epogen(R),^6 was $2 billion, accounting for more than
twothirds of Medicare payments for all separately billable ESRD drugs.
Introduced in 1989, Epogen was an expensive breakthrough drug used to

3These drugs are covered under Medicare Part B, the part of Medicare that
covers a broad range of medical services, including physician, laboratory,
hospital outpatient department services, and durable medical equipment.
Part B-covered drugs are typically administered by a physician or other
medical professional rather than by patients themselves. In contrast,
drugs covered under the new prescription drug benefit, known as Part D,
are generally self-administered by patients.

4Dialysis facilities can be hospital-based or freestanding, part of a chain
or independent, and for-profit or not-for-profit; 60 percent of dialysis
facilities in the United States are owned by two for-profit chains. Large
chains tend to receive volume discounts on ESRD drugs, whereas smaller,
independent facilities may not have the same negotiating power; thus
smaller facilities may pay higher prices for ESRD drugs.

5The Medicare Prescription Drug, Improvement, and Modernization Act of 2003
defined ASP as manufacturer's average sales price for all U.S. purchasers
of a drug, net of volume, prompt pay, and cash discounts, and charge-backs
and rebates. Certain prices, including prices paid by certain federal
purchasers, are excluded, as are prices for drugs furnished under Medicare
Part D. Pub. L. No. 108-173, sec. 302(c), S 1847(c), 117 Stat. 2066,
2240-41 (to be codified at 42 U.S.C. S 1395w-3a(c)).

6Epogen, which is a brand name for epoetin alfa, is a synthetic version of
erythropoietin--a protein made by the kidney that stimulates the
production of red blood cells. The drug was developed in the 1980s by
Amgen, a biologicals manufacturing company that markets the drug for use
in the ESRD setting.

treat anemia in patients with ESRD.^7 Over time, policymakers have raised
concerns about incentives in the Medicare payment system for dialysis
facilities to use Epogen more than necessary because Medicare payments for
the drug substantially exceeded facilities' costs of acquiring it.^8 In
principle, these incentives existed for all of the separately billable
drugs, but the attention to Epogen stems from its pervasive, frequent use:
that is, most ESRD patients receive injections of Epogen at nearly every
dialysis treatment.^9

In recent years, CMS has been exploring, as required by the Congress, the
creation of a bundled payment for all ESRD services, including the drugs
that facilities currently bill for separately. In response to a mandate
that CMS study the feasibility of creating a bundled payment,^10 the
agency issued a study in 2003 concluding that developing a bundled ESRD
payment rate was feasible and that further study of case-mix adjustment--
that is, a mechanism to account for differences in patients' use of
resources--was needed. In the Medicare Prescription Drug, Improvement, and
Modernization Act of 2003 (MMA), the Congress required that CMS report on
the design of a bundled prospective payment system for ESRD services,
including a case-mix adjustment methodology, and conduct a

7In examining Medicare's payment options in 1990 to cover this drug, the
Office of Technology Assessment noted that Epogen not only reduces
dialysis patients' need for blood transfusions but also alleviates
symptoms of anemia and improves the quality of patients' lives. See U.S.
Congress, Office of Technology Assessment, Recombinant Erythropoietin:
Payment Options for Medicare, OTA-H-451 (Washington, DC: May 1990).

8Unlike the method Medicare used to pay for other separately billable
drugs, the method Medicare used to pay for Epogen was an amount set in
statute for a single year--$10.00 per 1,000 units in 1994; CMS continued
to pay this rate at its discretion until 2005. Most patients receive
Epogen three times a week; the dose is based on the patient's body weight
among other things. A typical starting dose is 50-100 units per kilogram
or per 2.2 pounds. For example, a patient weighing 150 pounds may receive
a dose of between 3,400 units and 6,800 units three times a week. The dose
is then titrated based on the patient's response to the therapy.

9Whether Epogen has been overused has not been determined conclusively but
research currently being conducted is shedding light on this issue.
Evidence of systematic overuse is difficult to establish, as needed
amounts can vary across patients and across treatments for the same
patient. See for example, Onyekachi Ifudu, "Controversies in Renal Anemia
Management," Dialysis and Transplantation, vol. 35, no. 3 (2006) and
Dennis Cotter et al., "Translating Epoetin Research Into Practice: the
Role of Government and the Use of Scientific Evidence," Health Affairs,
vol. 25, no. 5 (2006).

10Medicare, Medicaid, and SCHIP Benefits Improvement and Protection Act of
2000, Pub L. No. 106-554, app. F, S 422(b)-(c), 114 Stat. 2763A-463,
2763A-516-2763A-517.

3-year demonstration to test the design of a bundled ESRD payment
system.^11

You asked us to report on issues related to payment for separately
billable ESRD drugs. This report examines the (1) potential for recent
payment changes to address the subsidization issue and eliminate
incentives to overuse separately billable ESRD drugs, (2) appropriateness
of the ASP payment method to set rates for separately billable ESRD drugs,
and

(3) rationale for developing, and the status of CMS's efforts to develop,
a bundled payment method that includes all ESRD drugs.

To examine the effect of recent payment changes, we reviewed legislation
and regulations relevant to the payment system for ESRD drugs and
services. We also reviewed publicly available information from CMS on
prices for drugs used in ESRD facilities. We reviewed data for the first 6
months of each year from 1991 to 2005 and preliminary data from the first
6 months of 2006 on the utilization of Epogen from the United States Renal
Data System (USRDS).^12,13 We assessed the reliability of these data by
interviewing officials responsible for producing these data, reviewing
relevant documentation, and examining the data for obvious errors. We
determined that the data were sufficiently reliable for the purposes of
our study. To determine the appropriateness of the ASP payment method, we
reviewed our previously issued products on this method and interviewed CMS
officials, dialysis facility representatives, nephrologists, drug
manufacturers, and other experts on ESRD.^14 To explore the rationale for
and efforts to design a payment bundle for ESRD services, we reviewed the
clinical literature on dialysis and injectable drugs and information

11Pub. L. No. 108-173, S 623(e)-(f), 117 Stat. 2066, 2315-17.

12We restricted the utilization data to the first half of the year to make
our comparisons consistent with preliminary 2006 data, for which we have
the first 6 months of the year.

13USRDS is a national data system that collects, analyzes, and distributes
information about ESRD in the United States and is funded by the National
Institute of Diabetes and Digestive and Kidney Diseases in conjunction
with CMS. The data for 2006 may change as more Medicare claims for ESRD
services are submitted.

^14GAO, Medicare Part B Drugs: CMS Data Source for Setting Payments Is
Practical but Concerns Remain, [1]GAO-06-971T (Washington, D.C.: July 13,
2006); Medicare Hospital Pharmaceuticals: Survey Shows Price Variation and
Highlights Data Collection Lessons and Outpatient Rate-Setting Challenges
for CMS, [2]GAO-06-372 (Washington, D.C.: Apr. 28, 2006); and Medicare:
Comments on CMS Proposed 2006 Rates for Specified Covered Outpatient Drugs
and Radiopharmaceuticals Used in Hospitals, [3]GAO-06-17R (Washington,
D.C.: Oct. 31, 2005).

from CMS on its ESRD bundling demonstration. We performed this work from
April 2006 through November 2006 in accordance with generally accepted
government auditing standards.

                                Results in Brief

Since 2003, several legislative and regulatory changes have been
implemented to adjust Medicare's composite rate and lower payment rates
for separately billable ESRD drugs. The effect of these changes has been
to raise the composite rate while reducing the subsidy from generous
Medicare payments for the separately billable drugs under pre-MMA payment
rates. In 2005, when the first MMA change to Medicare's payment method for
these drugs was implemented, Medicare expenditures for certain separately
billable ESRD drugs dropped 11.8 percent. Since 2006, when payment for
these drugs changed to a method based on ASP, Medicare's payment rates
have varied from quarter to quarter but have remained relatively
consistent with the lower 2005 payments. Medicare's cost containment
efforts have targeted Epogen, because most of the program's spending for
ESRD drugs outside the composite rate is for Epogen alone. Several months
of data suggest that, although the growth in Epogen use per patient has
slowed, the use of this drug continues to rise.

Medicare's ASP method of paying for Part B drugs--which include the ESRD
drugs outside the composite rate--may not be sufficient for achieving
Medicare's rate-setting goals. Several unknowns about the composition of
ASP and the lack of empirical evidence for the percentage level added to
ASP make it difficult for CMS to determine whether the ASP-based payment
rates are no greater than necessary to achieve appropriate beneficiary
access. Paying for Epogen under the ASP method is of particular concern.
The ASP method relies on market forces to moderate manufacturers' prices;
however, Epogen is the product of a single manufacturer and has no
competitor products in the ESRD market. In principle, ASPs are lower than
they would otherwise be when two or more manufacturers of similar products
compete on price for market share. However, when no competition exists, as
is the case for Epogen, the power of market forces to moderate price is
absent. For rarely used products, the lack of price competition may be
financially insignificant, but for Epogen, which is pervasively and
frequently used, the lack of price competition could be having a
considerable effect on Medicare spending.

Bundling services under a single payment rate is a fundamental principle
of Medicare payment policy for most types of services. The composite rate
for routine dialysis-related services was the first of Medicare's several
payment systems that, in broad terms, sets a fixed, prospective rate for a
set of clinically related services. Under Medicare's current payment
policy for ESRD services, the composite rate excludes drugs that have
become routine in treating ESRD patients. In 2003, the MMA required CMS to
design a system that would no longer pay for each injectable ESRD drug
under a separate rate but would bundle payment for these drugs together
with other ESRD items and services under a single rate. We and others have
noted that a bundled rate would have advantages for achieving efficiency
and clinical flexibility.^15 For example, a bundled rate would remove the
financial incentive for facilities to choose one treatment over another,
allowing the flexibility to choose treatments that are clinically
effective but may require less use of Epogen. Interested parties we spoke
with, including facility representatives and ESRD experts, also supported
a bundled payment for dialysis-related items and services for similar
reasons. In addition, they noted the importance of designing a sound
casemix adjuster to account for the differences across facilities in the
mix of patients using more or less resources than average and the need for
an automatic payment update to adjust the bundled rate for inflation.
CMS's report designing a model for a bundled ESRD payment system was due
in October 2005; however, as of November 2006, CMS officials could not
tell us when the report would be issued. The demonstration testing the
feasibility of a bundled rate, mandated to start in January 2006, is also
delayed.

In light of the uncertain timeline necessary for CMS to test bundling and
the potential for bundling to eliminate financial incentives to overuse
separately billable drugs, the Congress should consider establishing a
bundled payment system for all ESRD services as soon as possible.

In commenting on a draft of this report, CMS generally agreed with our
view that all ESRD services be included under a bundled payment system but
expressed the need to resolve implementation issues, primarily that the
development of a sound case-mix adjuster be finalized. Representatives
from ESRD industry groups who reviewed the report

^15See GAO Medicare Dialysis Facilities: Beneficiary Access Stable and
Problems in Payment System Being Addressed, [4]GAO-04-450 (Washington,
D.C.: June 25, 2004); Tommy

G. Thompson, Secretary of Health and Human Services, Report to Congress:
Toward a Bundled Outpatient Medicare End Stage Renal Disease Prospective
Payment System

(Washington, D.C.: May 2003); and Medicare Payment Advisory Commission
(MedPAC), Report to the Congress, Medicare Payment Policy (Washington,
D.C.: March 2006) and Report to the Congress, Medicare Payment Policy
(Washington, D.C.: March 2001). MedPAC is an independent federal body
established by law to advise the Congress on issues affecting the Medicare
program.

echoed CMS's concerns regarding the development of an adequate casemix
adjuster and expressed other concerns associated with bundled payments,
such as the need to account for the costs of technology innovation and
treatment protocols.

Background

Most individuals diagnosed with ESRD are eligible to receive Medicare
benefits under both Medicare Parts A and B.^16,17 Medicare covers over 80
percent of all individuals with the disease.

                               Treatment of ESRD

ESRD treatment options include kidney transplantation and maintenance
dialysis. The latter removes substances that would otherwise be filtered
through the kidney from the individual's blood. Kidney transplants are not
a practical option on a wide scale, as not all patients are candidates for
transplant and suitable donated organs are scarce. In contrast, dialysis
is the treatment used by most ESRD patients. Dialysis can be administered
through two methods: hemodialysis and peritoneal dialysis. During
hemodialysis, a machine pumps blood through an artificial kidney, called a
hemodialyzer, and returns the cleansed blood to the body. Hemodialysis,
the most prevalent treatment method,^18 is generally administered at

16 42 U.S.C. S 426-1(b) (2000).

17Medicare Part A covers inpatient hospital, skilled nursing facility, and
hospice care, as well as some home health care. Medicare Part B covers
physician services, hospital outpatient services, and certain other
services, such as physical therapy. Medicare coverage generally begins the
third month after the month dialysis begins. For individuals who have
employer group coverage, Medicare is the secondary payer for 30 months,
after which Medicare becomes the primary payer. 42 U.S.C. S
1395y(b)(1)(B)(iii) (2000). Generally, individuals with ESRD may not join
a Medicare Advantage Plan. 42 U.S.C. S 1395w-21(a)(3)(B) (2000).

18In 2003, about 91 percent of all dialysis patients underwent in-facility
hemodialysis, and about 8 percent of the dialysis population utilized
peritoneal dialysis.

freestanding facilities that provide dialysis services.^19 The
conventional regimen includes hemodialysis three times a week.^20

Peritoneal dialysis--which is generally done in the home--utilizes the
peritoneal membrane, which surrounds the patient's abdomen, as a natural
blood filter. Patients remove wastes and excess fluids from their abdomen
manually throughout the day, or a machine automates the process while they
sleep at night. This procedure eliminates the need for the blood to leave
the body of the patient and filter through a machine. The use of
peritoneal dialysis has declined as a treatment modality over the last
decade.^21

One of the complications of ESRD is anemia, a condition in which an
insufficient number of red blood cells is available to carry oxygen
throughout the body. In ESRD patients, this condition is treated by
maintaining at an optimal level the percentage of red blood cells relative
to all cells in whole blood (by volume). This measure is known as the
hematocrit (Hct) level. The Kidney Disease Outcomes Quality Initiative
(KDOQI), established by the National Kidney Foundation, has set the
minimum target for ESRD patients' Hct levels at 33 percent and has found
insufficient evidence to recommend routinely maintaining Hct levels at 39
percent or greater.^22 ESRD patients receive Epogen to keep their Hct
above a minimum level.^23 The Food and Drug Administration (FDA)

19In 2003, fewer than 1 percent of patients received hemodialysis at home
with the assistance of a caregiver.

20This frequency is consistent with Medicare's coverage of three
hemodialysis treatments a week. Some experts contend that daily
hemodialysis--five to seven times a week--is clinically preferable, as
this frequency more closely approximates the body's continuous cleansing
of the blood. Proponents assert that daily hemodialysis leads to fewer
hospitalizations and a reduction in the use of medications. In addition,
the National Institutes of Health is currently sponsoring a study of
nocturnal dialysis--a form of hemodialysis that can be done at home while
the patient is asleep, six nights a week.

21The percentage of patients undergoing peritoneal dialysis has steadily
decreased since its peak of 15 percent in 1990.

22See National Kidney Foundation, "KDOQI Clinical Practice Guidelines and
Clinical Practice Recommendations for Anemia in Chronic Kidney Disease,"
American Journal of Kidney Diseases, vol. 47, no. 5, supp. 3 (2006).

23According to the 18 ESRD networks that serve as the liaison between the
federal government and dialysis providers, the percent of patients with a
mean Hct greater than or equal to 33 has increased from 43 percent in 1997
to 80 percent in 2003. See The Forum of ESRD Networks Summary Report of
the ESRD Networks' Annual Reports 2004, (Baltimore, Md: December 2005).

labeled Epogen for use encompassing a somewhat lower Hct target level
ranging from 30 to 36 percent. Recent clinical studies cited by KDOQI
indicate that there may be increased patient mortality and morbidity if
Hct levels are much higher than 39 percent.^24 Epogen is typically
administered to Medicare ESRD patients intravenously. Epogen can also be
administered subcutaneously, that is, through an injection under the
skin.^25 The subcutaneous method requires less epoetin, but experts note
that, because some pain is associated with this method, patients generally
prefer intravenous delivery.^26

    Medicare Payment for ESRD Services
	 
Medicare's composite rate is designed to cover the cost of services
associated with a single dialysis treatment, including nursing and other
clinical services, social services, supplies, equipment, and certain
laboratory tests and drugs. Under the composite rate, facilities receive a
fixed payment, regardless of their actual costs to deliver these services.
In 2006, the composite base rate is about $130 for freestanding dialysis
facilities.^27

Medicare pays separately for certain drugs and laboratory tests that have
become routine treatments since 1983. These drugs include, but are not
limited to, epoetin (brand name, Epogen), injectable vitamin D, and

24See Anatole Besarab et al., "The Effects of Normal as Compared with Low
Hematocrit Values in Patients with Cardiac Disease Who Are Receiving
Hemodialysis and Epoetin," New England Journal of Medicine, vol. 339, no.
9 (1998). Two clinical trials, Cardiovascular Risk Reduction by Early
Anemia Treatment with Epoetin Beta Trial (CREATE) and Correction of
Hemoglobin and Outcomes in Renal Insufficiency Trial (CHOIR) compared the
efficacy and safety of higher Hct targets in patients with nondialysis
dependent chronic kidney disease. The target Hct level was between 39 and
45 percent in the CREATE treatment group. The CREATE trial did not achieve
its goal of reducing risk for certain cardiac events. In the CHOIR trial,
the incidence of adverse events, including mortality, was higher in the
treatment group, with a target Hct of 40.5 percent, than in the control
group, with a target of 33.9 percent. The CHOIR trial was stopped because
of safety concerns.

25At Department of Veterans Affairs facilities, subcutaneous administration
of epoetin is the predominant delivery method.

26See Denise Hynes et al., "Adherence to Guidelines for ESRD Anemia
Management," American Journal of Kidney Diseases, vol. 47, no. 3 (March
2006) and James Kaufman et al., "Subcutaneous Compared with Intravenous
Epoetin in Patients Receiving Hemodialysis," The New England Journal of
Medicine, vol. 339, no. 9 (1998).

27Additional adjustments to the rate account for, among other things,
differences in providers' costs associated with location, based on a
geographic wage index, and differences in facilities' mix of patients, who
vary in their clinical resource needs.

injectable iron. Epogen is generally administered to most patients at
every dialysis treatment, whereas the other drugs, although routinely
provided, are not administered as frequently. Table 1 highlights three
separately billable prescription drugs provided routinely to dialysis
patients.

 Table 1: Separately Billable Injectable ESRD Drugs Used by Dialysis Facilities
                                       in

Separately billable drugs used in dialysis treatments Compound

        Percentage of Medicare expenditures for Number of separately billable
                                                     manufacturers ESRD drugs

                      Injectable iron^a Iron sucrose 1 5.3

Sodium ferric gluconate complex 1 3.3

                               Iron dextran 3 0.1

                   Injectable vitamin D^b Paricalcitol 1 11.4

                             Doxercalciferol 1 2.8

                                Calcitriol 8 0.4

                         Epoetin^c Epoetin alfa 1 70.0

                             Darbepoetin alfa 1 3.7

Other separately Levocarnitine, billable drugs used in Alteplase,
Vancomycin, dialysis facilities vaccines, etc. N/A 3.0

                                  Total 100.0

Source: GAO analysis of CMS data and drug information from FDA.

aIron is used in the treatment of anemia in conjunction with epoetin.

bVitamin D is used to prevent osteomalacia by promoting bone
mineralization.

Epoetin is used in the treatment of anemia by promoting the formation of
red blood cells by the bone marrow.

As table 1 shows, three drugs--iron sucrose, paricalcitol, and epoetin
alfa--account for about 87 percent of Medicare spending on separately
billable ESRD drugs. Although each of these three drugs is a "sole-source"
product--that is, produced by a single manufacturer--two of the three have
pharmaceutical alternatives available, whereas the third, epoetin, has no
available alternatives in the ESRD market.^28

In recent years, Medicare's method of paying for separately billable ESRD
drugs has changed several times. Beginning in 1998, Medicare law required
that payment for drugs covered under Part B equal 95 percent of the drug's
average wholesale price (AWP).^29 Despite its name, however, AWP was
neither an average price nor the price wholesalers charged. It was a price
that manufacturers derived using their own criteria; there were no
requirements or conventions that AWP reflect the price of an actual sale
of drugs by a manufacturer.^30 An analysis we conducted in 2001 on Part B
drug prices found that Medicare's AWP-based payments often far exceeded
market prices that were widely available to health care providers.^31

The MMA mandated that in 2005 Medicare pay for separately billable ESRD
drugs based on their acquisition costs, as determined by the HHS Office of
the Inspector General (OIG).^32 Since acquisition costs were not defined
in the MMA, the OIG determined a drug's average acquisition cost based on
a survey of prices providers paid for the top 10 ESRD drugs,

28Although darbepoetin alfa, or Aranesp(R), is an alternative to Epogen and
is approved for use in ESRD patients, it is not generally marketed to
freestanding dialysis facilities. It is, however, marketed to hospitals,
which purchase the drug to treat anemia in patients with chronic kidney
disease, certain types of cancer, and ESRD patients receiving dialysis at
the hospital's facility.

29The Balanced Budget Act of 1997 required that payment for drugs and
biologicals furnished on or after January 1, 1998, equal 95 percent of the
drug's AWP if the drug is not otherwise paid on a cost or prospective
payment basis. Pub. L. No. 105-33 S 4556, 111 Stat. 251, 462-63. Until
2004, Medicare paid physicians 95 percent of AWP for Part B drugs. The MMA
changed this to 85 percent of AWP for 2004. MMA sec. 303(b), S
1842(o)(4)(A), 117 Stat. 2238 (to be codified at 42 U.S.C. S
1395u(o)(4)(A)).

30AWPs are published in commercial drug price compendia, based on data
obtained from manufacturers, distributors, and other suppliers; the
Medicare claims administration contractors that pay claims for Part B
drugs based providers' payments on the published AWPs.

31GAO, Medicare: Payments for Covered Outpatient Drugs Exceed Providers'
Costs, [5]GAO-01-1118 (Washington, D.C.: Sept. 21, 2001).

32MMA sec. 623(d)(1), S 1881(b)(13)(A)(ii), 117 Stat. 2314 (to be codified
at 42 U.S.C. S 1395rr(b)(13)(A)(ii)).

ranked by Medicare expenditures.^33 For 2005, Medicare paid the
OIGdetermined average acquisition cost for the top 10 ESRD drugs.^34 For
2006, the MMA gave the HHS Secretary discretion to alter the basis of
payment for separately billable ESRD drugs.^35 Under this authority, CMS
determined that Medicare would pay for the separately billable ESRD drugs
using the method required by the MMA to pay physicians for these
drugs--that is, 106 percent of the drug's ASP.^36

CMS instructs pharmaceutical manufacturers to report data to CMS on the
ASP for each Part B drug sold by the manufacturer, within 30 days after
the end of the quarter. For drugs sold at different strengths and package
sizes, manufacturers are required to report price and volume data for each
product, after accounting for price concessions. CMS then aggregates the
manufacturer-reported ASPs to calculate a national ASP for each drug
category.^37 ASP rates are calculated and posted every quarter. The rates
reflect the sales price on average from 6 months earlier.

33These prices were net of rebates and discounts providers received. See
Department of Health and Human Services Office of the Inspector General,
Medicare Reimbursement for Existing End-Stage Renal Disease Drugs,
OEI-03-04-00120 (Washington, D.C.: May 2004).

34For the drugs representing 2 percent of Medicare spending not accounted
for by the top 10 ESRD drugs, Medicare paid ASP+ 6 percent in 2005.

35MMA sec. 623(d)(1), S 1881(b)(13)(A)(iii), 117 Stat. 2314 (to be codified
at 42 U.S.C. S 1395rr(b)(13)(A)(iii)).

^3670 Fed. Reg. 70,116, 70,162 (Nov. 21, 2005).

37Manufacturers' reported price data are based on FDA's system of National
Drug Codes, while the ASP that CMS calculates for each drug is based on
the agency's Healthcare Common Procedure Coding System, which uses
categories that are broader than the FDA's coding system.

  New Payment Provisions Reduced Subsidy from Separately Billable Drugs but Did
  Not Eliminate Incentives to Overuse These Drugs

Since 2003, several legislative and regulatory changes have been
implemented affecting Medicare's composite rate for routine ESRD services
and payment rates for separately billable ESRD drugs. The changes have
increased the composite rate and reduced the subsidy facilities obtained
from generous Medicare payments for the separately billable drugs under
pre-MMA payment rates. Nevertheless, as long as facilities receive a
separate payment for each administration of each drug and the payment
exceeds the cost of acquiring the drug, an incentive remains to use more
of these drugs than necessary. For Epogen, the most frequently used drug,
several months of data indicate that the per-patient use of this drug
continues to rise, although at a slower rate than under pre-MMA payment
rates.

    New Payment Provisions Increased Composite Rate and Reduced Subsidy from
    Separately Billable Drugs

The MMA initiated new Medicare payment provisions addressing the composite
rate and payment for separately billable drugs. Prior to the MMA's payment
changes, facilities relied on payments for separately billable drugs to
subsidize the cost of providing dialysis services covered under the
composite rate. In a 2004 report, we found that, in 2001, Medicare's
payment for the composite rate was 11 percent lower on average than
facilities' average costs to provide the items and services included in
the composite rate, whereas Medicare's payment for separately billable
drugs was 16 percent higher than facilities' average costs of acquiring
these drugs.^38 We concluded that this payment disparity created an
incentive for facilities to overuse separately billable drugs, as payments
for them compensated for losses on items and services included in the
composite rate.

Together with the MMA provisions, more recent legislative and regulatory
changes have reduced the disparity between Medicare's payments and
facilities' average costs for both composite rate services and separately
billable drugs. Essentially, these changes lowered payments for separately
billable drugs from their pre-MMA amounts, and raised payments for the
composite rate. The base composite rate was increased by 1.6 percent in
2005 and 2006 and the composite rate total was further increased through a
"drug add-on" payment, which shifted some of the payments for

^38See [6]GAO-04-450 . Because composite rate payments represent a larger
share of Medicare spending than payments for separately billable drugs,
these percentage differences in costs and payments are not directly
comparable.

Page 13 GAO-07-77 End-Stage Renal Disease

separately billable drugs to the composite rate.^39 In 2005, the add-on
equaled 8.7 percent of the updated composite rate. In 2006, the 8.7
percent was replaced with a drug add-on payment of 14.5 percent of the
2006 updated composite rate.^40 (See table 2.)

      Table 2: Recent Legislative and Regulatory Changes to ESRD Payments

Changes in payment for Changes in composite rate separately billable drugs

MMA Increase in the base composite Payment rates based on

rate of 1.6 percent in 2005. average acquisition cost as

[Creation of a "drug add-on"] determined by the OIG for 2005.

adjustment to the composite rate in order to maintain budget neutrality,
starting in 2005.

Adjustment of drug add-on payment made yearly to reflect annual growth of
drug expenditures, starting in 2006.

CMS regulation Drug add-on payment equaled Payment rates based on ASP +

8.7 percent of the updated 2005 6 percent for 2006. base composite rate.

Drug add-on payment of

8.7 percent was replaced with an add-on equal to 14.5 percent of the
updated 2006 base composite rate.

Deficit Reduction Increase in the base  composite Act of 2005 rate of  1.6
percent in 2006.

Source: GAO analysis of laws and regulations.

Note: The HHS OIG developed the methodology to determine average
acquisition cost of ESRD drugs.

The most significant changes to the ESRD payment system are the changes in
payment rates for separately billable drugs. In 2005, Medicare's payment
rates based on average acquisition costs were lower than its previous
payment rates based on 95 percent of AWP. For example, from

39These add-on payments--the difference between the rates Medicare paid
under pre-MMA provisions and the rates paid each year from 2005 on--are
designed to maintain budget neutrality as a result of payment reductions
for separately billable drugs, beginning in 2005.

40The MMA required CMS to annually update the drug add-on payment to account
for changes due to increased utilization and prices. MMA sec. 623(d)(1), S
1881(b)(12)(F), 117 Stat. 2314 (to be codified at 42 U.S.C. S
1395rr(b)(12)(F)).

Page 14 GAO-07-77 End-Stage Renal Disease

2004 to 2005, the per-unit rate for iron dextran decreased from $17.91 to
$10.94 and the per-unit rate for paricalcitol decreased from $5.33 to
$4.00. (See table 3.) Since 2006, when the payment method for separately
billable drugs changed to ASP + 6 percent, Medicare's payment rates have
varied from quarter to quarter but have remained relatively consistent
with the lower 2005 payments based on average acquisition costs.

Table 3: Medicare Reimbursement Rates for Certain Separately Billable ESRD
Drugs  
                                      2005
                             2004 Average January    April   July     October 
                                          2006a      2006a   2006a      2006a 
                        95% AWP acquisition  ASP+6%  ASP+6%   ASP+6%   ASP+6% 
                                cost                                          
Iron      Iron                                                             
            dextran                                                           
           (50.0 mg)     $17.91      $10.94      n/a     n/a     n/a      n/a 
Iron                                                                       
dextranb                                                                   
(165 injection)                                                            
           (50.0 mg)             n/a     n/a  $12.25  $12.42  $11.69   $11.78 
Iron dextranb                                                              
(267 injection)                                                            
           (50.0 mg)             n/a     n/a  $10.24  $10.27  $10.34   $10.38 
Iron sucrose                                                               
         (1.0 mg)          $0.66        $0.37    $0.36 $0.36   $0.37    $0.36 
Sodium ferric                                                              
gluconate complex                                                          
                (12.5 mg)    $8.17      $4.95    $4.90 $5.06   $4.75    $4.81 
Vitamin D    Calcitriol                                                    
                (0.1 mcg)    $1.38      $0.96    $0.71 $0.46   $0.51    $0.53 
Paricalcitol                                                               
         (1.0 mcg)          $5.33       $4.00    $3.81 $3.80   $3.81    $3.81 
Doxercalciferol                                                            
              (1.0 mcg)      $5.50      $2.60    $2.69 $3.17   $3.16    $2.88 
Epoetin    Epogen                                                          
              (1,000 units) $10.00c     $9.76    $9.57 $9.33   $9.48    $9.45 

Source: GAO analysis of CMS information.

aPayments under ASP + 6 percent are based on quarterly data and rounded to
the nearest cent.

bThe different doses of iron dextran were paid separately under the ASP + 6
percent methodology.

The payment for Epogen does not represent 95 percent of AWP.

Since the implementation of these changes, Medicare spending for
individual separately billable ESRD drugs has decreased to varying
degrees. Beginning in 2005, when Medicare's payment method for these drugs
changed from AWP to average acquisition cost, Medicare expenditures for
several separately billable drugs decreased 11.8 percent from 2004. (See
table 4.) Specifically, the average payments for iron sucrose and
paricalcitol decreased by almost 35 percent and 25 percent,
respectively.^41 Similarly, payment for Epogen was lower than it had been
for the previous decade, when it was set statutorily at $10 per unit, but
the reduction--3.2 percent--was significantly less compared with the other
drugs.

Table 4: Percentage Change in Medicare Expenditures for Certain Separately
Billable ESRD Drugs from 2004 to 2005

                              Dollars in millions

2004 2005 Medicare Medicare Percentage expenditures expenditures change^a

Iron Iron dextran

(50.0 mg) 5.0 2.3 -54.4

Iron sucrose

(1.0 mg) 237.3 154.8

Sodium ferric gluconate complex

(12.5 mg) 159.6 96.2 -39.7

Vitamin D Calcitriol

(0.1 mcg) 20.9 10.9 -48.1

Paricalcitol

        (1.0
                mcg) 439.4 331.3 Doxercalciferol

(1.0
           mcg) 112.8 81.9 -27.4

Epoetin Epogen (1,000 units) 2,107.2 2,039.6

      Total 3,082.2 2,716.9

Source: GAO analysis of CMS data.

Note: Total includes Medicare expenditures from all facility types and the
20 percent coinsurance the beneficiary pays.

aTotals and percentage change were calculated prior to rounding.

Because payments to facilities for separately billable drugs are closer to
the cost of acquiring these drugs and because composite rate payments have
increased, the degree of cross-subsidization to support services

After epoetin, the next highest Medicare expenditures are for iron sucrose
and paricalcitol in the ESRD setting.

Page 16 GAO-07-77 End-Stage Renal Disease

provided under the composite rate has diminished, but the incentive to
overuse these drugs has not been eliminated. To the extent that facilities
can obtain the drugs for less than Medicare's payment rates and that the
volume of drugs billed for separately increases facilities' revenue, an
incentive remains for facilities to overuse these drugs to maximize
revenues.

    Preliminary Data Suggest that Epogen Use Continues to Grow, Though More
    Slowly than Before MMA Provisions Took Effect

Utilization of Epogen--a major spending driver for ESRD services--has been
and remains a focus of Medicare's ESRD cost containment efforts.
Preliminary data show that Epogen use--as measured by average dose per
administration--continues to increase, although at a much slower rate than
in previous years.^42 Specifically, using data for the first 6 months of
each year, we found that from 1991 through 2004, before the MMA provisions
took effect, Epogen use increased at an average annual rate of

6.7 percent, rising from about 3,000 units per administration to about
7,400 units (see fig. 1). In 2005, Epogen use remained virtually
unchanged; in 2006, the average monthly Epogen dose per administration
increased slightly from about 7,400 units to about 7,500 units, an
increase of about

1.4 percent.

42We restricted the  data to  the first  half of  the year  to increase  the
validity of our comparison  of previous years to  2006, for which we  have
only partial data.

Page 17 GAO-07-77 End-Stage Renal Disease

Figure 1: Average Epogen Dose per Administration in the First 6 Months of
Each Year, 1991-2006

      Number of units

^8,000 [7,404] 7,407 7,507

7,000

6,000

5,000

4,000

      3,000

3,005

2,000

      1,000

0

1991 1992 19931994 1995 1996 1997 19981999 2000 2001 2002 20032004 2005
2006

      Year

Source: GAO analysis of data from the USRDS.

Note: Data are per ESRD patient with at least one Epogen claim in the
first 6 months. We restricted the utilization data to the first half of
the year to make our comparisons consistent with 2006 data, which we only
have for the first 6 months of the year.

Another measure of Epogen use--the average number of Epogen
administrations per month per patient--also has not changed significantly
since the implementation of the MMA. Between the first 6 months of 1994
and the first 6 months of 2004, the average number of monthly Epogen
administrations per patient increased from about 9.4 to about 10.6 (see
fig. 2). Although the average number of monthly administrations was lower
in both 2005 and 2006--at about 10.4 and 10.5 per patient,
respectively--the average number of administrations per patient in 2006
was about 10 percent higher than in 1991, when the number was about 9.5.

Figure 2: Average Number of Monthly Epogen Administrations in the First  6
Months of Each Year, 1991-2006

Number of administrations

8
6
4
2

0 1991 1992 19931994 1995 1996 1997 19981999 2000 2001 2002 20032004 2005
2006

      Year

Source: GAO analysis of data from the USRDS.

Note: Data are per ESRD patient with at least one Epogen claim in the
first 6 months. We restricted the utilization data to the first half of
the year to make our comparisons consistent with 2006 data, which we only
have for the first 6 months of the year.

In addition to payment changes, CMS has sought over time to limit
expenditures for Epogen by issuing policies that link payment to
utilization. That is, Medicare reduces payments when a patient's Hct level
reaches a certain percentage. Since 1997, CMS has created three different
monitoring policies to encourage the efficient use of Epogen for ESRD
patients. Each of these policies has been closely aligned with the
clinical guidelines for Hct levels endorsed by the National Kidney
Foundation. In 1997, the first policy denied payment when a patient's
3-month rolling average Hct level exceeded 36.5 percent. In 1998, CMS
revised the policy so that the maximum level for the 3-month rolling
average Hct was

37.5 percent; if a patient exceeded that level, payments were not denied
as long as the Epogen dose was reduced 20 percent. In July 2004, CMS
issued a proposal for a new monitoring policy. After consultation with the
dialysis community, the final policy took effect on April 1, 2006. Under
this policy, when a patient's Hct level is above 39.0 percent, the
facility must reduce the Epogen dosage by 25 percent of the preceding
month's

administered amount.^43,44 Whether or not the facility reduces the dosage,
Medicare pays the facility as though the reduction has occurred--in
effect, not rewarding the facility for overutilization.

  ASP Payment Method, While Administratively Practical, May Not Help Medicare
  Foster Efficient Provider Goals

In broad terms, Medicare's policy is to set payment rates that are
adequate to ensure beneficiary access to services but do not exceed the
costs efficient providers incur to furnish needed care. In prior work on
Medicare payment for Part B drugs, which include separately billable ESRD
drugs, we noted that the ASP method was practical for setting payment
rates compared with Medicare's previous methods to pay for these drugs,
but we remained concerned about the appropriateness of the rates set under
ASP.^45 The practical aspects of ASP are several: it is based on actual
transactions and is a better proxy for providers' acquisition costs than
Medicare's previous methods to pay for these drugs; ASP is the most recent
publicly available price information, as it is updated quarterly, and is
therefore timely for rate-setting purposes; and price data from
manufacturers are administratively easier for CMS to collect than
obtaining such data from health care providers.

However, we also observed that CMS is not well-positioned to validate the
accuracy or appropriateness of its ASP-based payment rates. Significantly,
CMS lacks sufficient information on how manufacturers allocate rebates to
individual drugs sold in combination with other drugs or products. In
addition, CMS does not instruct manufacturers to provide a breakdown of
price and volume data by purchaser type--that is, by physicians,
hospitals, other health care providers, and wholesalers, which purchase
drugs for resale to health care providers. As a result, CMS cannot
determine how well average price data represent acquisition costs for
different purchaser types.^46 Additionally, a sufficient empirical
foundation does not exist for

43Medicare has a process under which facilities can appeal the denial of a
claim by showing that it is medically necessary. 42 U.S.C. S 1395ff
(2000).

44Effective October 2006, CMS revised the monitoring policy to, among other
things, clarify its policy for reporting dosage reductions.

^45 [7]GAO-06-971T , [8]GAO-06-372 , and [9]GAO-06-17R .

46In a report to the Congress, CMS stated that it was unable to obtain net
acquisition cost data and average sales price data by purchaser type due
to the proprietary nature of drug pricing information. See HHS, Report to
Congress--Report on Sales of Drugs and Biologicals to Large Volume
Purchasers (Washington, D.C.: 2006).

setting the payment rate for Medicare Part B drugs at 6 percent above ASP,
further complicating efforts to determine the appropriateness of the rate.

The ASP payment method is of particular concern with respect to Epogen
because it is the only product available in the ESRD market for anemia
management. The ASP method relies on market forces to achieve a favorable
payment rate for Medicare--that is, one that is sufficient to maintain
beneficiary access but not overly generous for providers and therefore
wasteful for taxpayers. In principle, under ASP, when two or more
clinically similar products exist in a market, market forces could serve
to bring prices down, as each manufacturer competes for its own product's
market share. In contrast, when a product is available through only one
manufacturer, Medicare's rate lacks the moderating influence of
competition. For this reason, Medicare's ASP method may not be appropriate
for Epogen, which is the product of a single manufacturer and has no
competitor products in the ESRD market. The lack of price competition may
be financially insignificant for noncompetitive products that are rarely
used, but for Epogen, which is pervasively and frequently used, the lack
of price competition could be having a considerable effect on Medicare
spending.

Since the introduction of Epogen in the ESRD anemia management market, it
has been difficult for competitor products to enter this market. Amgen,
Epogen's manufacturer, has held seven patents on Epogen, the first of
which was granted in 1987 and the last of which expires in 2015; Amgen has
obtained injunctions against pharmaceutical firms seeking to market their
anemia management drugs in the United States. However, competitor products
may enter the U.S. market in the near future. There are three potential
sources of future competition: a drug that currently exists, drugs that
are likely to enter the market soon, and products that are under
development. Aranesp is a drug that Amgen manufactures and markets to
hospitals and physicians to treat anemia in patients with cancer and
chronic kidney disease but generally does not market to ESRD facilities.
CERA is a drug that the manufacturer--F. Hoffmann LaRoche-- hopes to
introduce in the United States sometime in 2007.^47 Certain

Amgen has filed suit in U.S. District Court against F. Hoffmann LaRoche to
prevent it from marketing CERA in the United States on the grounds that
CERA violates Amgen's patents. Although the patent infringement case has
not been resolved, industry analysts expect that F. Hoffmann LaRoche will
launch CERA "at risk" in 2007, after getting approval from FDA. Launching
at risk here means marketing the product at the risk of incurring damages
for patent infringement.

Page 21 GAO-07-77 End-Stage Renal Disease

products currently in development, which are several years away from
entering the market, could have a distinct advantage over injectable
products, as they are expected to be long-lasting oral therapies.^48,49

  Bundling Is Fundamental to Medicare Payment Policy, but System to Expand
  Composite Rate Bundle to Include All ESRD Drugs Remains in Design Phase

The composite rate for routine dialysis-related services was the first of
Medicare's several payment systems that, in broad terms, sets a fixed,
prospective rate for a set of clinically related services. Consistent with
this payment policy, the Congress has required CMS to develop a system
that would no longer pay for each injectable ESRD drug under a separate
rate but would bundle payment for these drugs together with other ESRD
services under a single rate. A bundled rate would have advantages for
achieving efficiency and greater clinical flexibility. CMS's design of a
bundled rate is under way but behind schedule, making the implementation
of a fully bundled payment system, based on this design, at least several
years away. Any payment system changes based on CMS's report or
demonstration would require legislation.

Medicare's approach to paying for most services provided by facilities is
to pay for a group--or bundle--of services using a prospectively set rate.
For example, under prospective payment systems, Medicare makes bundled
payments for services provided by acute care hospitals, skilled nursing
facilities, home health agencies, and inpatient rehabilitation facilities.
In creating one payment bundle for a group of associated items and
services provided during an episode of care,^50 Medicare encourages
providers to operate efficiently, as providers retain the difference if
Medicare's payment exceeds the costs they incur to provide the services.
Medicare's

48For example, FibroGen recently developed FG-2216 and FG-4592, which are
currently in exploratory clinical trials in Europe.

49Oral products could be covered under Part D--Medicare's new prescription
drug benefit. In this case, payments for them would not be made to
dialysis facilities under Medicare Part B.

50For example, Medicare's bundled payment for home health services covers a
60-day episode of care.

composite rate for routine dialysis-related services was introduced in
1983 and was the program's first bundled rate.^51

In recent years, we, the Medicare Payment Advisory Commission (MedPAC),
and CMS have recommended expanding the bundled payment for ESRD services
to include not only the services paid under the composite rate but also
the drugs that facilities currently bill for separately.^52 Experts
contend that a bundled payment for dialysis-related services would have
two principal advantages. First, it would encourage facilities to provide
services efficiently; in particular, under a fixed, bundled rate for a
defined episode of care,^53 facilities would no longer have an incentive
to provide more ESRD drugs than clinically necessary. Second, bundled
payments would afford clinicians more flexibility in decision making
because incentives to prescribe a particular drug or treatment are
reduced.

For example, certain clinical alternatives are, according to some ESRD
experts, advantageous to patients and could result in the use of less
Epogen, but these alternatives are not encouraged under the current
payment system. Studies have shown that daily hemodialysis--which some
experts contend is clinically preferable--reduced the need for Epogen in
some ESRD patients with anemia.^54 However, Medicare coverage is limited
to three dialysis treatments a week. Under a bundled payment, facilities
would have the flexibility to increase the number of

51In 1978, the Secretary of HHS was required to prescribe methods and
procedures for determining the amount Medicare should pay for ESRD
services and to provide appropriate incentives to encourage more efficient
and effective delivery of services including, to the extent feasible,
prospectively set payment rates. Pub. L. No. 95-292, sec. 2, S
1881(b)(2)(B), 92 Stat. 307, 309 (codified as amended at 42 U.S.C. S
1395rr(b)(2)(B) (2000)).

^52See [10]GAO-04-450 , MedPAC (March 2006) and (March 2001), and HHS (May
2003).

53In the case of the composite rate, one dialysis session constitutes an
episode of care. Unlike the current composite rate payment method, a newly
designed payment bundle could define the episode of care more broadly. For
example, the new payment bundle could cover dialysis and related items and
services for 1 month.

54See Francesco Locatelli and Lucia Del Vecchio, "Dialysis Adequacy and
Response to Erythropoietic Agents: What is the Evidence Base?" Nephrology
Dialysis Transplantation, vol. 18, supp. 8 (2003), Ezio Movilli et al.,
"Adequacy of Dialysis Reduces the Doses of Recombinant Erythropoietin
Independently from the Use of Biocompatible Membranes in Haemodialysis
Patients," Nephrology Dialysis Transplantation, vol. 16, no.1 (2001), and
Onyekachi Ifudu et al., "The Intensity of Hemodialysis and the Response to
Erythropoietin in Patients with End-Stage Renal Disease," The New England
Journal of Medicine, vol. 334, no. 7 (1996).

weekly dialysis treatments and reduce their use of Epogen. Studies have
also shown that patients who receive subcutaneous instead of intravenous
injections of epoetin and patients undergoing peritoneal dialysis instead
of hemodialysis need less epoetin to manage their anemia.^55,56 Under the
current payment system, which pays facilities for epoetin on a per
administration basis, facilities have an incentive to select the epoetin
delivery method and the dialysis modality that maximize their Medicare
revenue. Under a bundled payment, facilities would have less incentive to
choose the costlier intravenous over subcutaneous injections of epoetin or
the costlier hemodialysis over peritoneal dialysis.

Facility representatives, ESRD experts, and other interested parties we
spoke with generally supported a bundled payment for dialysis-related
items and services while underscoring the importance of certain elements
as part of the bundled payment system. First, facility representatives
noted that bundled payments called for a case-mix adjuster--that is, a
mechanism to account for the differences in the mix of more expensive and
less expensive patients across facilities. Without accounting for these
differences, facilities that treated a disproportionate share of costly
patients would be financially disadvantaged.

Second, some facility representatives noted that an automatic payment
update would be needed to adjust the bundled rate for inflation,
consistent with Medicare's other bundled payment systems that are updated
automatically on an annual basis. They pointed out that the current ESRD

55In recent studies, researchers have determined that subcutaneous delivery
of epoetin, compared with intravenous delivery, could result in
significant cost savings to Medicare. See Denise Hynes et al., "Potential
Cost Savings of Erythropoietin Administration in End-Stage Renal Disease,"
The American Journal of Medicine, vol. 112, no. 3, (2002), Anatole Besarab
et al., "Meta-Analysis of Subcutaneous Versus Intravenous Epoetin in
Maintenance Treatment of Anemia in Hemodialysis Patients," American
Journal of Kidney Diseases, vol. 40, no. 3 (2002), and Laura Pizzi et al.,
"Economic Implications of Non-Adherence to Treatment Recommendations for
Hemodialysis Patients with Anemia," Dialyisis and Transplantation, vol.
35, no. 11 (2006).

56See Francisco Coronel et al., "Erythropoietin Requirements: A Comparative
Multicenter Study Between Peritoneal Dialysis and Hemodialysis," Journal
of Nephrology, vol 16, no. 5 (2003) and Jon Snyder et al., "Hemoglobin
Levels and Erythropoietin Doses in Hemodialysis and Peritoneal Dialysis
Patients in the United States," Journal of the American Society of
Nephrology, vol. 15, no. 1 (2004).


composite rate is Medicare's only payment bundle that does not receive an
automatic update.^57

Third, ESRD experts we spoke with noted that, under bundling, the
incentive to overuse services is blunted, but the incentive to underuse
services is present. For example, facilities could choose to provide too
little Epogen to patients with anemia because they would save money
providing less of this costly drug. These individuals commented that CMS's
monitoring policy, which currently focuses on overutilization of Epogen,
would need to refocus its attention on underutilization to ensure that
under a bundled payment system ESRD patients received appropriate levels
of Epogen and other dialysis-related drugs and services.

    Implementation of Bundled Payment System for ESRD Services Could Be Years
    Away

The MMA mandated a two-pronged approach for CMS to study the creation of a
bundled payment method. It required CMS to submit a report to the Congress
on a bundled payment system design in October 2005 and start a 3-year
bundling demonstration in January 2006.^58 The legislation linked the two
requirements by directing CMS to base the design of the bundling
demonstration on the content of the mandated report. It also required CMS
to obtain input on the demonstration's design and implementation from an
advisory panel that included industry and government experts. The report
had not been issued nor had the demonstration been launched as of November
2006. Any payment system changes based on CMS's report or demonstration
would require legislation.^59

The report and demonstration efforts, led by two different organizational
units in CMS, face similar design considerations. Both must define the
ESRD services to be included in a payment bundle, design a case-mix
adjustment model to account for differences in patients' use of resources,
and develop a payment policy for exceptional cases, known as an outlier
policy. However, despite similar goals, each unit has a different focus.

57Since the MMA provisions became effective, the drug add-on payment to the
composite rate is updated annually, but adjustments to the base rate are
not automatic; only seven adjustments have been made in the last 23 years.

58MMA S 623(e)-(f), 117 Stat. 2315-16.

59The MMA specified that drugs billed separately when it was enacted
continue to be billed separately and not bundled into the composite rate.
MMA sec. 623(d)(1), S 1881(b)(13)(B), 117 Stat. 2314-15 (to be codified at
42 U.S.C. S 1395rr(b)(13)(B)).

Essentially, the unit responsible for the report is designing a bundled
payment system that is intended to be implemented programwide and
expeditiously, following congressional approval. In contrast, the unit
responsible for the demonstration is designing a bundled payment system
that is intended to be implemented on a limited and self-selective basis--
that is, through facilities' voluntary participation in the demonstration.

The time frame for implementing a bundled payment system based on CMS's
report is uncertain. Officials could not tell us when the report would be
available. Furthermore, additional time is needed for the Congress to
review the report and possibly pass legislation based on the report. CMS
officials predict that it would take a minimum of 18 months to fully
implement the system, once legislation had been enacted.

The start of the bundled payment demonstration is similarly subject to an
uncertain chain of events. Specifically, under MMA, CMS cannot launch its
demonstration before considering the information in its mandated
report.^60 However, once demonstration staff are able to consider the
report's information, CMS can begin taking steps to solicit proposals for
participation by dialysis facilities. The selection process involves
screening applications for conformance with the demonstration's criteria
and the awarding of contracts. This process can take a minimum of several
months. Demonstration staff anticipate that the demonstration will start
in October 2007. Under this time line, they expect that the first useable
results will be available 12 months later, or October 2008. On the basis
of these results, the Congress could choose to pass legislation to change
the ESRD payment system. Because CMS typically makes mandated payment
changes effective at the beginning of calendar years, and because such
changes require a several-month period of rulemaking and public comment,
the earliest payment year that could be informed by demonstration results
is 2010.

A step toward implementing the demonstration has already been taken.
Largely as an incentive for facilities to participate, CMS is
incorporating "pay for performance" in its bundled payment design--that
is, a mechanism that would link a facility's conformance to ESRD quality
standards to Medicare's payment rate. In July 2006, CMS solicited
proposals for a contractor to develop the pay-for-performance component of
the bundling demonstration; subsequently, CMS awarded a contract.

Page 26 GAO-07-77 End-Stage Renal Disease

  Conclusions

The rationale for Medicare to continue paying for Epogen and other ESRD
drugs outside of a payment bundle has diminished over time. Composite rate
updates and add-ons, coupled with the overhaul of payment for Part B
drugs, have moved Medicare toward paying more appropriately for ESRD
services. Nevertheless, under the ASP payment method--which pays for
separately billable ESRD drugs on a per administration basis--facilities
continue to have an incentive to use these drugs more than may be
necessary. Paying for Epogen under ASP presents an additional dilemma: as
a single-source drug in a market with no competitor products, Epogen is
not subject to the moderating effects that competition can have on price.

In our view, Medicare could realize greater system efficiency if all ESRD
services, including drugs, were bundled under a single payment. A bundled
payment--suitably adjusted for differences across facilities in their mix
of patients--would encourage facilities to use drugs more prudently, as
they would have no financial incentive to use more than necessary and
could retain the difference between Medicare's payment and their costs. At
the same time, because treatment choices would be payment neutral,
clinicians would have more flexibility to try different treatment
combinations of items and services paid for in the bundle. To account for
facilities' increased or decreased costs over time, a reexamination of the
bundled rate may be necessary periodically. In the case of Epogen, for
example, if other competitor products entered the market in the future,
the costs facilities would incur to treat anemia could decline. By
adjusting the payment bundle accordingly, Medicare could realize the
benefits of such cost reductions.

CMS's time line is considerably protracted for issuing the mandated report
on a bundled ESRD payment system and conducting a demonstration that
remains under development. The time needed to complete these steps makes
the prospect of implementing such a system several years away.

  Matter for Congressional Consideration 

In light of the uncertain time frame for CMS's test of bundling and the
potential for bundling to eliminate financial incentives to overuse
separately billable drugs, the Congress should consider
establishing a bundled payment system for all ESRD services as soon as
possible.

Agency and Industry Comments and Our Evaluation

                               Comments from CMS

In written comments on a draft of this report, CMS noted its appreciation
of our interest in ensuring an appropriate payment system for all ESRD
services and stated that our findings will be useful to the agency in
fulfilling its commitment to reform the ESRD payment system. The agency
generally agreed with our view that all ESRD services should be included
under a bundled payment system but expressed the need to resolve
implementation issues, primarily that the development of a sound casemix
adjuster be finalized. It stated that such a system should also promote
efficiency and clinical flexibility for ESRD facilities and should guard
against incentives to undertreat ESRD patients in order to maximize
profits. We agree that a fully bundled system will require an adequate
casemix adjuster and a monitoring system to ensure patients receive
adequate care. At the same time, we are asking the Congress to consider
acting as soon as possible, acknowledging that the Congress would likely
want to receive and consider CMS's research findings and recommendations
before establishing a new payment system.

CMS observed that it has devoted considerable time and resources to
developing an appropriate ESRD payment system, including research on
case-mix adjusters and quality incentives. Specifically, the agency noted
that the implementation in April 2005, of the case-mix adjusted composite
rate as required by the MMA of 2003 was a significant accomplishment. CMS
has also pursued several research approaches in its efforts to create a
demonstration of a fully bundled ESRD payment system and expects to build
on these prior efforts to form the basis for ESRD payment reform. We
commend CMS for its attention to research on ESRD payment and encourage
the agency to expedite the completion of its report to the Congress. CMS
also mentioned the importance of collecting data on patient outcomes. We
appreciate the importance of collecting these data, but this issue was
beyond the scope of this report. CMS provided technical comments, which we
incorporated as appropriate. We have reprinted CMS's letter in appendix I.

    Comments from Industry Representatives

We invited representatives of drug manufacturers, large and small dialysis
facility organizations, and a nephrologist specialty association to review
and comment on the draft report. The groups represented were Amgen Inc.
(Amgen), F. Hoffmann-La Roche Ltd. (Roche), the Kidney Care Council (KCC),
the National Renal Administrators Association (NRAA), and the Renal
Physicians Association (RPA). Several of the industry groups noted that
the report was well written, thorough, and covered many of the issues
affecting dialysis providers. The bulk of the groups' comments focused on
three general issues central to the message of our report: the increase in
utilization of Epogen over time, the current ASPbased payment system for
ESRD drugs, and the implementation of a fully bundled ESRD payment system.

First, Amgen, KCC, Roche, and NRAA noted that the report did not fully
explain why utilization of Epogen has grown over time or why the growth
rate has slowed in recent years. Amgen stated that the draft report did
not sufficiently cover the goal of Epogen therapy--which is to increase
patient Hct levels--and its link to improved quality of life for dialysis
patients. KCC noted that while the average Epogen dose has increased over
time, patient outcomes--as measured by average Hct levels--have also
improved. KCC further contended that because Epogen utilization has
remained relatively flat in recent years, providers are not responding to
the incentive to overuse ESRD drugs. Roche maintained that the slow growth
in Epogen use over the past few years is attributable to more patients'
having achieved Hct levels within the target range. NRAA added that the
slower growth of Epogen use is positive because it demonstrates that
providers use less Epogen as more patients reach the target Hct range.

In our report, we discuss the utilization of Epogen rather than the
clinical outcomes associated with that utilization. In response to the
groups' comments, we have added information that describes the benefits of
Epogen therapy as well as data on patient Hct levels prior to the MMA
payment changes. Although we do not take a position on whether the drug is
overutilized at the levels we report, we stand by our contention that an
inherent incentive to maximize revenues exists when items are paid for on
a cost-plus (e.g., ASP+6 percent), fee-for-service basis. It is because of
the inherent nature of this incentive that we recommend combining payment
for ESRD drugs with all dialysis services under a single bundled rate.

Second, all of the groups commented on our discussion in the report of the
current ASP-based payment method for separately billable ESRD drugs, with
some groups expressing concerns about an abrupt movement to a fully
bundled rate. Amgen noted that the ASP method is relatively new and that
it is too early to decide whether to move to a fully bundled rate. In
addition, Amgen was concerned with our characterization of ASP payment
issues associated with Epogen and stated that the entry of a new anemia
management product may not necessarily result in reduced prices. Two of
the organizations noted that, prior to moving to a bundled rate, a
transitional system--one that encourages price competition for anemia
management drugs--may be desirable. Roche stated that continuing to use
the ASP-based payment system for Epogen could have negative downstream
effects on a fully bundled ESRD payment system, as any price increases
prior to bundling would be captured in the dollar amounts allocated for
anemia management drugs included in the bundle. Similarly, KCC stated that
an alternative payment system should be explored prior to bundling. KCC
also stated that, as long as there is no viable clinical alternative to
Epogen, bundling by itself would not provide for clinical flexibility, nor
would bundling alone ensure drug price stability. KCC suggested that a
transitional system could involve paying for drugs at ASP and transferring
the rate's current 6 percent add-on to the composite rate. In general,
both RPA and NRAA viewed the ASP-based payment method for ESRD drugs
favorably. RPA specifically referred to the recent legislative and
regulatory actions, including the move to an ASP-based rate, as
"responsible," because payments for separately billable drugs were lowered
while the composite rate was increased.

Our discussion of the ASP-based payment method focuses on payment for
separately billable drugs in general and on Epogen in particular because
of its market domination and the high Medicare expenditures associated
with it. We agree that the introduction of a competitor product may not
result in immediate price reductions, but note that, in principle,
competition tends to lower prices over time. Although we acknowledge that
there may be a better way to pay for separately billable drugs than ASP+6
percent, our focus is on the need to mitigate the incentives that can
undermine the efficient use of resources in ESRD care. Any transitional
system that allows separate billing for individual drugs perpetuates the
incentive to maximize revenues through utilization of these drugs. We
agree that bundling by itself cannot solve problems resulting from the
lack of price competition. However, as noted in our draft report, if price
competition were introduced under a bundled payment system, it could
result in lower treatment costs for providers and--after adjustments to
the bundle for these lower costs--could result in savings for Medicare.

Finally, representatives from four of the groups expressed concerns about
implementation challenges associated with a payment bundle. Consistent
with CMS's position and the position of experts cited in our draft report,
Amgen and KCC emphasized the importance of appropriate case-mix adjustment
in a bundled payment system. KCC underscored the considerable variation in
patients' need for Epogen and the role of the case-mix adjuster to ensure
adequate compensation for providers treating patients needing unusually
high levels of the drug. RPA, NRAA, and KCC were concerned that bundling
could limit innovation in the ESRD market or that physicians would be
reluctant to use any new ESRD drugs that facilities would find to costly
to cover within the payment bundle. Consistent with this concern, NRAA
noted that the payment bundle methodology should have a mechanism to
ensure the appropriate incorporation of new technologies and treatment
protocols.

We agree that an appropriate case-mix adjuster is important to a bundled
payment system and noted in the draft report that adjusting for
differences in patients' needs was a key point made by interested parties
we contacted. We acknowledge that if the payment bundle does not account
for patient differences, facilities that treat a disproportionate share of
costly patients would be financially disadvantaged. We note that CMS has
done extensive research on case-mix adjustment in a fully bundled ESRD
payment system and believe that any new system will benefit from these
efforts. We also agree that a new payment bundle should be periodically
updated to reflect the costs of current technologies and treatment
protocols. Specific details on the contents of a bundle, its
implementation, and evaluation over time were beyond the scope of this
report.

As we agreed with your office, unless you publicly announce the contents
of this report earlier, we plan no further distribution of it until 30
days from the date of this letter. At that time, we will send copies of
this report to the appropriate congressional committees and other
interested parties. We will also make copies available to others upon
request. This report will be available at no charge on GAO's Web site at
http://www.gao.gov .

If you or your staff have questions about this report, please contact me
at (202) 512-7101 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 key contributions to this report are
listed in appendix II.

Sincerely yours,

A. Bruce Steinwald
Director, Health Care

Appendix I: Comments from the Centers for Medicare & Medicaid Services

Appendix II: GAO Contact and Staff Acknowledgments

GAO Contact

A. Bruce Steinwald (202) 512-7101 or [email protected].

Acknowledgments

Phyllis Thorburn, Assistant Director;  Jessica Farb; Hannah Fein;  Zachary
Gaumer; and Shivani Sharma made key contributions to this report.

(290535)

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References

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1. http://www.gao.gov/cgi-bin/getrpt?GAO-06-971T
2. http://www.gao.gov/cgi-bin/getrpt?GAO-06-372
3. http://www.gao.gov/cgi-bin/getrpt?GAO-06-17R
4. http://www.gao.gov/cgi-bin/getrpt?GAO-04-450
5. http://www.gao.gov/cgi-bin/getrpt?GAO-01-1118
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7. http://www.gao.gov/cgi-bin/getrpt?GAO-06-971T
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  10. http://www.gao.gov/cgi-bin/getrpt?GAO-04-450
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