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entitled 'Medicare Durable Medical Equipment: Class III Devices Do Not 
Warrant a Distinct Annual Payment Update' which was released on March 
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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: 

GAO-06-62: 

GAO Highlights: 

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

Why GAO Did This Study: 

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 Found: 

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 manufacturers 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. 

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 GAOs recommendation. 

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 kingk@gao.gov. 

[End of section] 

Contents: 

Letter: 

Results in Brief: 

Background: 

Class III Devices Have Higher Premarketing Costs than Class II Devices: 

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

Conclusions: 

Matter for Congressional Consideration: 

Recommendation for Executive Action: 

Agency and External Reviewer Comments and Our Evaluation: 

Appendix I: Scope and Methodology: 

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

Appendix III: GAO Contact and Staff Acknowledgments: 

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: 

United States Government Accountability Office: 

Washington, DC 20548: 

March 1, 2006: 

Congressional Committees: 

Medicare pays for durable medical equipment (DME)[Footnote 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 devices[Footnote 2] by the Food and Drug Administration 
(FDA).[Footnote 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. 

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.[Footnote 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)[Footnote 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. 

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 
devices[Footnote 6] 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 
equivalent[Footnote 7] 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.[Footnote 8] 

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. 

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.[Footnote 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,[Footnote 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.[Footnote 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. 

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.[Footnote 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.[Footnote 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.[Footnote 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. 

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. 

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,[Footnote 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.[Footnote 16] Therefore, the payment rate of a device is 
generally lower than its retail price. 

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. 

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 kingk@gao.gov. 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. 

Signed by: 

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: 

[End of section] 

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. 

[End of section] 

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

DEPARTMENT OF HEALTH & HUMAN SERVICES: 
Office of Inspector General: 

FEB 7 2006: 

Ms. Kathleen M. King: 
Director, Health Care: 
U.S. Government Accountability Office: 
Washington, DC 20548: 

Dear Ms. King: 

Enclosed are the Department's comments on the U.S. Government 
Accountability Office's (GAO's) draft report entitled, "MEDICARE 
DURABLE MEDICAL EQUIPMENT: Class III Devices Do Not Warrant a Distinct 
Annual Payment Update" (GAO-06-62). These comments represent the 
tentative position of the Department and are subject to reevaluation 
when the final version of this report is received. 

The Department provided technical comments directly to your staff. 

The Department appreciates the opportunity to comment on this draft 
report before its publication. 

Sincerely, 

Signed by: 

Daniel R. Levinson: 
Inspector General: 

Enclosure: 

The Office of Inspector General (OIG) is transmitting the Department's 
response to this draft report in our capacity as the Department's 
designated focal point and coordinator for U.S. Government 
Accountability Office reports. OIG has not conducted an independent 
assessment of these comments and therefore expresses no opinion on 
them. 

COMMENTS OF THE DEPARTMENT OF HEALTH AND HUMAN SERVICES ON THE U.S. 
GOVERNMENT ACCOUNTABILITY OFFICE'S DRAFT REPORT ENTITLED, -MEDICARE 
DURABLE MEDICAL EQUIPMENT: CLASS III DEVICES DO NOT WARRANT A DISTINCT 
ANNUAL PAYMENT UPDATE" (GAO-06-62): 

The Department of Health and Human Services (HHS) appreciates the 
opportunity to review the Government Accountability Office's (GAO) 
draft report. 

HHS's Centers for Medicare & Medicaid Services (CMS) is committed to 
effectively and efficiently implementing the payment rules set forth in 
the Social Security Act for durable medical equipment (DME) and other 
items and services. The Medicare Prescription Drug, Improvement, and 
Modernization Act of 2003 (MMA) mandates competitive acquisition 
programs for DME, excluding devices determined by the Food and Drug 
Administration to be class III devices under the Federal Food, Drug, 
and Cosmetic Act, such as bone growth stimulators, implanted infusion 
pumps, and stair climbing wheelchairs. As part of the transition to 
competitive acquisition, Congress mandated that the fee schedule 
amounts for DME, other than class III devices, be frozen at 2003 levels 
through 2008. 

The MMA mandates that for class III DME, an annual update factor based 
on the percentage change in the consumer price index for urban 
consumers (CPI-U) is applied to the fee schedule amounts for 2004 
through 2006. For 2007, the 2006 fee schedule amounts for class III DME 
are to be updated by a factor determined to be appropriate by the 
Secretary of HHS after taking into account recommendations by the GAO 
study regarding the appropriate update percentage for class III devices 
for both 2007 and 2008. Also mandated by the MMA, for 2008, the 2007 
fee schedule amounts for class III DME are to be increased by an annual 
update factor based on the percentage change in the CPI-U. 

GAO has done a thorough job in reviewing Medicare payment rules and 
methods and issues associated with the costs of furnishing class III 
devices. We agree with the finding in the report that the costs of 
furnishing class II and class III DME devices have been factored into 
the fee schedule amounts calculated for these devices. We also agree 
with the recommendation to establish a uniform fee schedule update for 
2007 for class II and class III devices. We will take GAO's 
recommendation into consideration when establishing an update for class 
III devices as mandated by section 302 (c)(1)(B) of the MMA; GAO's 
recommendation is necessary for CMS to determine an appropriate fee 
schedule update factor for 2007 for class III DME. 

We thank GAO for their efforts in this report in establishing the 
covered item update for class III DME for 2007. We look forward to 
working with GAO on any follow-up issues associated with Medicare 
payments for class III DME. 

[End of section] 

Appendix III: GAO Contact and Staff Acknowledgments: 

GAO Contact: 

Kathleen M. King, (202) 512-7119 or kingk@gao.gov: 

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. 

FOOTNOTES 

[1] DME 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.  414.202. 

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

[3] FDA 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. 

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

[5] ODE 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. 

[6] The 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  321(h). 

[7] Substantially 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. 360c(i)(1). 

[8] For 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). 

[9] Medicare 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. 

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

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

[12] In 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. 

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

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

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

[16] In 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. 

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