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entitled 'Medicare: Comments on CMS Proposed 2006 Rates for Specified 
Covered Outpatient Drugs and Radiopharmaceuticals Used in Hospitals' 
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October 31, 2005: 

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

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

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

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

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

With regard to SCODs, the MMA directed CMS to set 2006 payment rates 
equal to hospitals' average acquisition costs--the cost to hospitals of 
acquiring a product, net of rebates.[Footnote 3] In several related 
requirements, the MMA directed us to provide information on SCOD costs 
and CMS's proposed rates.[Footnote 4] First, we were required to 
conduct a survey of hospitals to obtain data on their acquisition costs 
of SCODs and provide information based on these data to the Secretary 
of Health and Human Services for his consideration in setting 2006 
Medicare payment rates. We provided information from this survey in two 
reports[Footnote 5]--one on drugs and biologicals, and another on 
radiopharmaceuticals.[Footnote 6] These reports presented systematic 
information on hospitals' purchase prices of SCODs and limited 
information on rebates. Second, we were required to evaluate CMS's 
proposed rates for SCODs and comment on their appropriateness in light 
of the survey of SCOD prices we conducted.[Footnote 7] 

In response to the second requirement, this report assesses the 
appropriateness of the Medicare payment rates that CMS has proposed for 
SCODs, taking into account the purchase prices obtained from the MMA- 
mandated survey we conducted in 2004 and 2005. Specifically, this 
report focuses on the appropriateness of CMS's proposed 2006 hospital 
outpatient rates for (1) drug SCODs and (2) radiopharmaceutical SCODs. 
To conduct this assessment, we examined the information CMS provided in 
the proposed rule on the data sources and methodology used to set the 
2006 rates, analyzed this information in light of our survey of 
hospitals' purchase prices, and convened an expert panel to review our 
findings.[Footnote 8] Consistent with the MMA, we did not study the 
issue of hospitals' handling costs for SCODs and do not address these 
costs in this report. We performed our work according to generally 
accepted government auditing standards from July through October 2005. 

Results in Brief: 

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

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

* As a composite measure, ASP is a black box, lacking the detail CMS 
needs to validate the reasonableness of the data underlying the 
reported prices. Without a breakdown of price data showing rebates and 
other components as well as average prices by purchaser type, CMS 
cannot ensure that ASPs accurately reflect average acquisition costs by 
hospital purchasers alone. 

* CMS does not provide a convincing rationale for proposing a rate 6 
percent higher than ASP. CMS's analysis indicates that ASP+6 percent 
will exceed hospitals' acquisition costs. CMS states that the prices 
reported in our survey--that is, the average prices hospitals paid for 
drug SCODs (which do not net out rebates received at a later time)-- 
equal ASP+3 percent. Logically, acquisition costs, which do net out 
rebates from purchase prices, would equal an amount less than ASP+3 
percent. Therefore, our survey data and CMS's analysis of these data 
indicate that a rate set at or above ASP+3 percent is not appropriate, 
given that it would exceed the hospitals' average acquisition cost. 

Similarly, we are concerned that CMS's proposed 2006 rates for 
radiopharmaceutical SCODs will, on average, exceed hospitals' 
acquisition costs. CMS chose to use cost estimates developed from 
hospital charges rather than survey data on the prices hospitals 
reported paying for radiopharmaceuticals. However, as we have 
previously reported,[Footnote 9] the methodology for estimating costs 
from charges results in significant imprecision. CMS states that it 
intends to set rates for radiopharmaceutical SCODs that are consistent 
with previous years' payment rates, even though the MMA does not 
establish such a criterion. ASPs are not available for 
radiopharmaceuticals for 2006 rate setting, but CMS plans to get this 
information from manufacturers for future years' rates. 

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

Background: 

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

Hospital Outpatient Payment System and SCODs: 

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

When OPPS was first developed as required by the Balanced Budget Act of 
1997,[Footnote 10] the OPPS rates for hospital outpatient services, 
drugs, and radiopharmaceuticals were based on hospitals' 1996 median 
costs. However, these rates prompted concerns that payments to 
hospitals would not reflect the costs of newly introduced 
pharmaceutical products used to treat, for example, cancer, rare blood 
disorders, and other serious conditions. In turn, congressional 
concerns were raised that beneficiaries might lose access to some of 
these products if hospitals avoided providing them because of a 
perceived shortfall in payments. In response to these concerns, the 
Medicare, Medicaid, and SCHIP Balanced Budget Refinement Act of 1999 
authorized pass-through payments, which were a way to temporarily 
augment the OPPS payments for newly introduced pharmaceutical products 
first used after 1996.[Footnote 11] The MMA modified this payment 
method for some of these pharmaceutical products.[Footnote 12] As part 
of the modification, the MMA defined the new SCOD payment category, 
which includes many of these newly introduced pharmaceutical products. 

Acquisition Costs, Purchase Prices, Discounts, and Rebates: 

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

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

[See PDF for image] 

Note: Numbers are hypothetical. 

[End of figure] 

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

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

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

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

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

Data for Drug SCODs: 

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

Rates for Drug SCODs: 

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

Data for Radiopharmaceutical SCODs: 

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

Rates for Radiopharmaceutical SCODs: 

Having selected the charge data, CMS had only one option: to use the 
charges to estimate costs for setting radiopharmaceutical SCOD rates. 
For each radiopharmaceutical SCOD, it proposed adjusting the hospital 
charges to a hospital-specific estimate of costs. These estimates of 
cost would include both acquisition costs and handling costs. CMS 
stated that it intended to maintain consistency whenever possible 
between the payment rates in 2005 and 2006, because such "rapid 
reductions" could adversely affect beneficiary access to services 
utilizing radiopharmaceuticals.[Footnote 21] 

Adjustments to Rates for Overhead: 

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

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

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

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

Drug SCODs: Data source; 
Alternatives that CMS considered (CMS decision in italics): 
* ASP; 
* Purchase prices[A]; 
* Cost estimated from claims data. 

Drug SCODs: Rates; 
Alternatives that CMS considered (CMS decision in italics): 
* ASP+3 percent; 
* ASP+6 percent [B]; 
* ASP+8 percent. 

Radiopharmaceutical SCODs: Data source; 
Alternatives that CMS considered (CMS decision in italics): 
* Purchase prices[A], Cost estimated from claims data. 

Radiopharmaceutical SCODs: Rates; 
* Alternatives that CMS considered (CMS decision in italics): 
* Average purchase price; Cost estimated from charges[C]. 

Source: GAO analysis of CMS proposed rule. 

[A] Calculated by GAO from its hospital survey data. 

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

[C] The rate includes hospitals' overhead and handling costs. 

[End of table] 

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

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

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

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

Notwithstanding these advantages, information gaps remain that render 
ASP a "black box" in terms of its constituent components. For example, 
in reporting ASP data to CMS, manufacturers do not break out ASP price 
components, such as rebates and other price concessions.[Footnote 25] 
CMS instructs manufacturers to deduct components such as rebates in 
calculating ASP, but lacking a price breakdown--or an independent 
source of price and rebate data--the agency cannot assess whether 
rebates and other components were appropriately excluded or whether the 
amount of any exclusions was plausible. In addition, information about 
the basis on which manufacturers calculate rebates would be useful. 
Collecting price breakdowns and related information would allow CMS to 
assess the reasonableness of the data underlying the reported prices. 

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

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

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

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

* Between the first and last quarters for which we collected survey 
data, purchase prices for drug SCODs decreased slightly--falling by 
about 1 percent, on average. 

* CMS found that, between the fourth quarter of 2004 and the first 
quarter of 2005, ASP declined, on average, by 2 percent. CMS officials 
also told us that, between the third and fourth quarters of 2004, the 
trend in the average ASP for drug SCODs was relatively flat or slightly 
downward. 

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

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

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

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

CMS contends that its estimated costs are the best available proxy for 
the average acquisition cost of a radiopharmaceutical and include its 
handling cost. It states that hospitals' different purchasing, 
preparation, and handling practices for radiopharmaceuticals are 
reflected in hospitals' charges, which can be converted to costs using 
hospital-specific cost-to-charge ratios. In the absence of actual 
transaction data, this method would be reasonable though imperfect. At 
best this method is subject to significant imprecision. The charge- 
setting methodologies of hospitals and departments within hospitals 
vary considerably, whereas CMS's cost-to-charge calculations assume 
uniformity.[Footnote 27] In contrast, we collected transaction data for 
our recent reports.[Footnote 28] Our survey data included purchase 
prices on nine key radiopharmaceutical SCODs--accounting for over 90 
percent of Medicare spending on all radiopharmaceutical SCODs. These 
purchase prices are averages of the actual prices that hospitals paid. 
As a result, the average purchase prices approximate hospitals' 
acquisition costs more closely than the charge-based estimates CMS has 
proposed. Unlike purchase prices for drugs, purchase prices for most 
radiopharmaceuticals are likely to be equivalent to acquisition costs, 
as rebates are not commonly paid for radiopharmaceuticals. Regarding 
the radiopharmaceutical SCODs for which purchase price data are not 
available and which account for less than 10 percent of Medicare 
spending on radiopharmaceutical SCODs, CMS's proposed charge-based 
method of estimating costs is reasonable in setting 2006 rates. 

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

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

Conclusions: 

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

* First, ASP is a black box, which does not permit CMS to ensure the 
reasonableness of the data underlying the drug SCOD rates. While CMS's 
selection of ASP as a data source for drug SCODs is reasonable, given 
the alternatives, additional information to validate ASP is needed to 
assess the accuracy of these data in approximating hospitals' 
acquisition costs. A breakdown of ASP by hospitals and other purchaser 
types would enable CMS to determine if ASP--a blend of prices paid by 
wholesalers and various end purchasers--closely approximates the prices 
paid by hospitals alone. A separate breakdown of ASP by rebates and 
other components would enable CMS to assess whether the magnitudes of 
the various components are reasonable and to confirm that they are 
taken into account appropriately in calculating ASPs. 

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

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

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

Recommendations for Executive Action: 

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

* Reconsider the level of proposed payment rates for drug SCODs, in 
relation to survey data on average purchase price, the role of rebates 
in determining acquisition costs, and the desirability of setting 
payment rates for SCODs at average acquisition costs. 

* Reconsider the decision to base payment rates for radiopharmaceutical 
SCODs exclusively on estimated costs, in light of the availability of 
data on actual prices paid for key radiopharmaceuticals. 

* Collect information on ASP components and ASP by purchaser type to 
validate the reasonableness of reported ASPs as a measure of hospital 
acquisition costs. 

Agency Comments and Our Evaluation: 

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

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

We are sending copies of this report to the Secretary of Health and 
Human Services and the Administrator of CMS. The report is available at 
no charge on GAO's Web site at http://www.gao.gov. We will also make 
copies available to others on request. If you or your staff have any 
questions about this report, please contact me at (202) 512-7119 or 
steinwalda@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 enclosure II. 

Signed by: 

A. Bruce Steinwald: 
Director, Health Care: 

Enclosures - 2: 

Comments from the Department of Health and Human Services: 

DEPARTMENT OF HEALTH 8t HUMAN SERVICES: 
Office of Inspector General: 
Washington, D.C. 20201: 

OCT 21 2005: 

Mr. A. Bruce Steinwald: 
Director, Health Care: 
U.S. Government Accountability Office: 
Washington, DC 20548: 

Dear Mr. Steinwald: 

Enclosed are the Department's continents on the U.S. Government 
Accountability Office's: 

(GAO's) draft correspondence entitled, "MEDICARE: Comments on CMS 
Proposed 2006 Rates for Specified Covered Outpatient Drugs and 
Radiopharmaceuticals Used in Hospitals" (GAO-06-17R). 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 appreciates the opportunity to comment on this draft 
report before its publication. 

Sincerely, 

Signed for: 

Daniel R. Levinson: 
Inspector General: 

Enclosure: 

The Office of Inspector General (OIG) is transmitting the Department's 
response to this draft correspondence 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. 

HHS COMMENTS ON THE U.S. GOVERNMENT ACCOUNTABILITY OFFICE'S DRAFT 
CORRESPONDENCE ENTITLED, "MEDICARE: COMMENTS ON CMS PROPOSED 2006 RATES 
FOR SPECIFIED COVERED OUTPATIENT DRUGS AND RADIOPHARMACEUTICALS USED IN 
HOSPITALS" (GAO-06-17R): 

The Department of Health and Human Services (HHS) appreciates the 
opportunity to comment on the U.S. Government Accountability Office's 
(GAO) draft correspondence. 

General Comments: 

The draft correspondence summarizes GAO's position regarding the 
proposed payment rates for Specified Covered Outpatient Drugs (SCODs) 
and radiopharmaceuticals included in the calendar year (CY) 2006 
Outpatient Prospective Payment System (OPPS) Proposed Rule. 

The Medicare Prescription Drug, Improvement, and Modernization Act of 
2003 (MMA) instructed the Centers for Medicare & Medicaid Services 
(CMS) to pay hospitals for outpatient drugs based on average 
acquisition cost beginning in 2006. Also in the MMA was a provision 
requiring GAO to conduct a survey in 2004 and 2005 on hospital 
acquisition cost of drugs in the outpatient department and to share the 
results with CMS. 

In the OPPS proposed rule, CMS proposed basing average acquisition cost 
on average sales price (ASP) data already collected by CMS. CMS 
included GAO's findings on hospital acquisition costs in our analysis 
of the three proposed payment rate options: ASP + 3 percent, ASP + 6 
percent, and ASP + 8 percent. As radiopharmaceuticals were not required 
to report ASP data in 2005, CMS proposed to base payment on hospital 
charges adjusted to cost using hospital-specific, department-specific 
cost-to-charge (CCR) ratios. 

In general, GAO supports CMS's proposal to pay acquisition costs based 
upon ASP methodology and includes further analysis of the three 
proposed payment rates for SCODs discussed in the OPPS rule. In 
addition, GAO analyzes the proposed payment rate for 
radiopharmaceuticals and offers alternative suggestions for CMS to 
consider for all drugs and radiopharmaceuticals. 

The GAO analysis notes several reservations to CMS's proposal to set 
SCOD payment rates at ASP + 6 percent and the payment of 
radiopharmaceutical agents at hospital charges adjusted to costs. 

CMS is committed to ensuring that in 2006 hospitals are paid for SCODs 
and radiopharmaceuticals at average hospital acquisition cost as 
required by the MMA. We appreciate the effort that went into this 
report and are considering GAO's recommendations as we prepare our 
final rule on the OPPS for CY 2006. We look forward to working with GAO 
on this and other pertinent issues addressed in this report. 

GAO Recommendation #1: 

Reconsider the level of proposed payment rates for drug SCODs in 
relation to survey data on average purchase price, the role of rebates 
in determining acquisition costs, and the desirability of setting 
payment rates for SCODs at average acquisition costs. 

HHS Response: 

CMS is committed to ensuring that in 2006 hospitals are paid for SCODs 
at average hospital acquisition cost as required by the MMA. 

In this draft correspondence, GAO generally supports CMS's proposal to 
base SCOD payments on the ASP methodology because of its ability to 
quickly reflect market trends and its ability to account for hospital 
rebates, but cautions that information gaps may decrease the accuracy 
of ASP rates. GAO suggests ASP + 3 percent as a payment ceiling instead 
of CMS's proposed ASP + 6 percent payment rate for SCODs. 

We appreciate GAO's analysis of the data sources that we considered 
when developing our proposed rule. We are considering GAO's 
recommendations as we prepare our final rule on the OPPS for calendar 
year 2006. 

GAO Recommendation #2: 

Reconsider the decision to base payment rates for radiopharmaceutical 
SCODs exclusively on estimated costs, in light of the availability of 
data on actual prices paid for key radiopharmaceuticals. 

HHS Response: 

Unlike SCODs, radiopharmaceuticals were not subject to ASP reporting 
requirements in 2005, and therefore payments must be based on an 
alternative methodology that accounts for the cost of the materials and 
their preparation. 

GAO presents an analysis regarding radiopharmaceutical costs and 
outlines the alternative payment method that they suggest CMS adopt for 
these products in 2006. GAO offers analysis that indicates that CMS's 
proposed payment rate of hospital charges reduced to cost would overpay 
hospitals for these agents. 

Again, CMS appreciates GAO's analysis, and the recommendation will be 
considered as we prepare our upcoming OPPS final rule. 

GAO Recommendation #3: 

Collect information on ASP components and ASP by purchaser type to 
validate the reasonableness of reported ASPS as a measure of hospital 
acquisition costs. 

HHS Response: 

We note the GAO's recommendations for better understanding the 
relationship between ASP and hospital acquisition costs and will 
consider the feasibility of the recommendation. 

[End of section] 

Enclosure II: 

GAO Contact and Staff Acknowledgments: 

GAO Contact: 

A. Bruce Steinwald, (202) 512-7119 or steinwalda@gao.gov: 

Acknowledgments: 

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

(290487): 

FOOTNOTES 

[1] 70 Fed. Reg. 42,674. 

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

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

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

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

[6] In this report, the term drugs refers to both drugs and 
biologicals. Biologicals are products derived 

from living sources, including humans, animals, and microorganisms. 
Radiopharmaceuticals are radioactive substances used for diagnostic or 
therapeutic purposes. 

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

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

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

[10] Pub. L. No. 105-33,  4523, 111 Stat. 251, 445--50. 

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

[12] MMA 117 Stat. 2307--10. 

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

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

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

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

[17] MMA 117 Stat. 2307. 

[18] 70 Fed. Reg. 42,724--27. 

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

[20] 70 Fed. Reg. 42,727--28. 

[21] CMS gave no indication of the magnitude of any such reductions. 

[22] 70 Fed. Reg. 42,728-29. For MedPAC's report and recommendations, 
see Issues in a Modernized Medicare Program, ch. 6. 

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

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

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

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

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

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

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