United States Government Accountability Office

GAO Report to Congressional Committees

MEDICARE 

DURABLE MEDICAL 

EQUIPMENT 

Class III Devices Do 

Not Warrant a Distinct 

Annual Payment 

Update 

March 2006 

 

GAO-06-62 
What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

Accountability Integrity Reliability

March 2006

MEDICARE DURABLE MEDICAL 

EQUIPMENT 

Class III Devices Do Not Warrant a 

Distinct Annual Payment Update 

Highlights of GAO-06-62, a report to 

congressional committees 

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. 

Medicare fee schedule payments 

for durable medical equipment 

(DME) that the Food and Drug 

Administration (FDA) regulates as 

class III devices, those that pose

the greatest potential risk,

increased by 215 percent from 2001

through 2004. From 2004 through 

2006, and for 2008, the Medicare 

Prescription Drug, Improvement,

and Modernization Act of 2003 

(MMA) provided for a payment 

update for class III DME equal to 

the increase in the consumer price

index for all urban consumers 

(CPI-U). For 2007, MMA requires 

the Secretary of Health and Human

Services to determine the payment 

update. MMA also requires that 

other DME receive a 0 percent 

update from 2004 through 2008. 

MMA directed GAO to report on an

appropriate payment update for 

2007 and 2008 for class III DME. In

this report, GAO (1) examined

whether class III devices have 

unique premarketing costs and

(2) determined how the fee 

schedule rate-setting methodology 

accounts for the premarketing 

costs of such devices. 

What GAO Recommends

The Congress should consider

establishing a uniform payment 

update to the DME fee schedule for

2008 for class II and III devices. 

GAO recommends that the

Secretary of Health and Human 

Services establish a uniform

payment update to the DME fee 

schedule for 2007 for class II and 

class III devices. The agency

agreed with GAO’s 

recommendation. 

GAO found that manufacturers of class III devices, with limited exceptions, 

have higher premarketing costs than do manufacturers of class II devices

that are similar to class III devices. Premarketing costs consist of FDA user 

fees and research and development costs, both for any clinical data the 

manufacturer is required to submit and for other research and development 

costs. Manufacturers of class III devices pay higher FDA user fees, because 

of the more complex FDA review required prior to marketing, than do 

manufacturers of class II devices. Specifically, the user fee for class III 

devices subject to this review in 2005 was $239,237, while the fee for class II 

devices in 2005 was $3,502. The FDA application and approval process takes 

longer for class III manufacturers, which lengthens the time it takes before 

they can market their devices and begin receiving revenue. FDA requires

that manufacturers submit clinical data for class III devices, but only 

occasionally requires the same for class II devices. In interviews with GAO, 

class III manufacturers stated that they incur higher premarketing costs for 

other research and development, such as labor costs related to designing a 

device, compared to manufacturers of class II devices. Class II 

manufacturers also told GAO that they incur substantial costs related to 

other research and development. GAO did not evaluate proprietary data to 

determine whether a difference in other premarketing research and 

development costs exists between the two types of manufacturers. 

GAO found that the Medicare DME fee schedule rate-setting methodology 

accounts for the respective premarketing costs of class II and class III 

devices in a consistent manner. Regardless of device classification, the 

Medicare DME fee schedule payment rate for a device is based on either the 

manufacturer’s retail price or historic reasonable Medicare charges, which 

the Centers for Medicare & Medicaid Services considers equivalent 

measures. In interviews with GAO, manufacturers of class III devices stated 

that when setting their retail prices, they take into account the premarketing

costs of complying with federal regulatory requirements, including the costs 

of required clinical data collection and other research and development. 

These manufacturers accounted for over 96 percent of class III DME 

payments in 2004. Manufacturers of class II devices also stated that they 

take into account these costs when setting retail prices. 
Contents 

Letter 1

Results in Brief 3 

Background 4

Class III Devices Have Higher Premarketing Costs than Class II 

Devices 7

DME Fee Schedule Rate-Setting Methodology Accounts for 

Premarketing Costs of Class II and III Devices in a Consistent 

Manner 9

Conclusions 10

Matter for Congressional Consideration 11 

Recommendation for Executive Action 11 

Agency and External Reviewer Comments and Our Evaluation 11 

Appendix I Scope and Methodology 16 

Appendix II Comments from the Department of Health and 

Human Services 17 

Appendix III GAO Contact and Staff Acknowledgments 19 

Page i GAO-06-62 Medicare Payment for Durable Medical Equipment
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 

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Page ii GAO-06-62 Medicare Payment for Durable Medical Equipment
United States Government Accountability Office

Washington, DC 20548 

March 1, 2006

Congressional Committees 

Medicare pays for durable medical equipment (DME)1

 provided to 

beneficiaries based on a fee schedule. Until 2004, annual updates to DME 

fee schedule payment rates had been applied uniformly to all items on the 

fee schedule. The Medicare Prescription Drug, Improvement, and 

Modernization Act of 2003 (MMA) provided for an annual payment rate 

update equal to the annual percentage increase in the consumer price 

index for all urban consumers (CPI-U) from 2004 through 2006 to 

Medicare fee schedule payment rates for DME regulated as class III 

medical devices2

 by the Food and Drug Administration (FDA).3 For these 

devices, in 2007, MMA provided for an annual payment update to be 

determined by the Secretary of Health and Human Services, and in 2008, 

for an update equal to the annual percentage increase in the CPI-U. MMA 

also provided that from 2004 through 2008, all other DME will receive a 

0 percent update. Although payments for class III devices are less than 

1 percent of total Medicare DME payments, they increased from 

$16.9 million to $53.2 million, or by 215 percent, from 2001 through 2004. 

Osteogenesis stimulators, devices used to promote bone growth in 

difficult-to-heal fractures or following spinal fusion surgery, accounted for 

a large proportion of class III DME payments during this time, 

representing over 96 percent of the total in 2004.

 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. 

Page 1 GAO-06-62 Medicare Payment for Durable Medical Equipment
MMA directed us to report on an appropriate payment update percentage 

for 2007 and 2008 to the DME fee schedule for class III devices provided to

Medicare beneficiaries.4

 To report on an appropriate payment update 

percentage, as agreed with the committees of jurisdiction, we 

(1) examined whether there are unique premarketing costs associated 

with class III devices compared to similar devices in other classes on the 

DME fee schedule and (2) determined how the DME fee schedule ratesetting methodology accounts for the premarketing costs of these devices. 

To address these objectives, we interviewed officials from the Centers for 

Medicare & Medicaid Services (CMS), the agency that administers 

Medicare; FDA; two DME regional carriers, the contractors responsible for 

processing DME claims; and the Statistical Analysis DME Regional Carrier, 

the contractor that provides data analysis support to CMS. To examine the 

premarketing costs of devices, we obtained the fees that FDA charges for 

device review, known as user fees, which are published on the FDA Web 

site. We also reviewed the FDA device approval process and data on the

length of time it takes for device review from FDA’s Office of Device 

Evaluation (ODE)5 2004 Annual Report. We interviewed manufacturers of 

class III devices about the types of costs they incur in producing the 

devices, including FDA fees for device review and the costs of research 

and development, both for any clinical data the manufacturer is required 

to submit and for other research and development costs, such as labor 

costs. We also interviewed manufacturers of certain class II devices on the 

DME fee schedule that CMS identified as similar to the class III devices on 

the schedule in terms of complexity. We did not evaluate proprietary data 

to determine whether a difference in other premarketing research and

development costs exists between the two types of manufacturers. To 

determine how the DME fee schedule accounts for premarketing costs, we 

interviewed CMS officials and reviewed CMS documents on the DME fee 

schedule rate-setting methodology. We also interviewed officials from a 

trade organization that represents manufacturers of medical devices, 

industry organizations for orthopedic surgeons and pain physicians, and 

two private health insurance companies. Appendix I contains a more 

complete description of our methodology. We conducted our work from

 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. 

Page 2 GAO-06-62 Medicare Payment for Durable Medical Equipment
December 2004 through February 2006 in accordance with generally 

accepted government auditing standards. 

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. 

Results in Brief 

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. 

Page 3 GAO-06-62 Medicare Payment for Durable Medical Equipment
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. 

FDA is responsible for regulating the marketing of medical devices6

 to 

provide reasonable assurance of their safety and effectiveness for human Background 

 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). 

Page 4 GAO-06-62 Medicare Payment for Durable Medical Equipment
use. As part of its regulatory responsibility, FDA reviews applications from 

manufacturers that wish to market their medical devices in the United 

States. Prior to marketing new devices, manufacturers must apply for FDA 

marketing approval through either the premarket notification (also 

referred to as 510(k)) process, or the premarket approval (PMA) process, 

a more rigorous regulatory review. New devices are subject to PMA, 

unless they are substantially equivalent7

 to an already marketed device, in

which case they need to comply only with the premarket notification 

requirements. Applications for premarket notification are generally 

reviewed more quickly than applications for PMA and do not usually 

require clinical data.

8

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 

 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). 

Page 5 GAO-06-62 Medicare Payment for Durable Medical Equipment
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.9

In 2004, Medicare payments for class III devices under the DME fee 

schedule were $53.2 million, which represented less than 1 percent of total 

DME payments. The Medicare DME fee schedule payment rate for a device

is based on either the manufacturer’s retail price or historic reasonable 

Medicare charges,10 which CMS considers equivalent measures. MMA 

provided for a 0 percent annual update for most Medicare DME fee 

schedule payment rates from 2004 through 2008. However, under MMA, 

class III devices were excluded from the 0 percent update and received 

payment updates equal to the annual percentage increase in the CPI-U in 

2004, 2005, and 2006.11 For these devices, MMA provides, in 2007 for a 

payment update as determined by the Secretary of Health and Human 

Services, and in 2008, for a payment update equal to the annual percentage 

increase in the CPI-U. 

 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. 

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

payment is limited to the actual charge. 

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

2.5 percent in 2006. 

Page 6 GAO-06-62 Medicare Payment for Durable Medical Equipment
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. 

Class III Devices Have 

Higher Premarketing 

Costs than 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. Specifically, 

manufacturers of class III devices subject to this review pay the FDA user 

fee for PMA, which in 2005 was $239,237 for each PMA.12 Most PMA 

supplements, which must be filed when a manufacturer makes a change to

a class III device that affects its safety or effectiveness, also require 

payment of a fee, which ranged from $6,546 to $239,237. Manufacturers of 

class II devices pay the FDA user fee for each premarket notification, 

which in 2005 was $3,502.

13 When a manufacturer makes a change to a

class II device, a new premarket notification application must be filed; 

there is no supplement process for these devices.

Manufacturers of class III devices have a longer period before approval

during the FDA application process, which they stated delays the 

marketing of their devices and the receipt of revenue. According to ODE’s 

2004 Annual Report, in 2004, the average time for PMA review was 

 12In 2005, for businesses with $30 million or less in annual gross sales and revenue, PMA 

fees were reduced to $90,910 and the first PMA submitted by such a business was free. 

13In 2005, for businesses with $30 million or less in annual gross sales and revenue, 

premarket notification fees were reduced to $2,802. 

Page 7 GAO-06-62 Medicare Payment for Durable Medical Equipment
503 days while the average time for premarket notification review was 

100 days.14 These average times include the total time a PMA or premarket 

notification was under review by FDA and the time the manufacturer used 

in responding to any FDA requests for additional information. 

FDA requires that class III manufacturers submit clinical data, for which 

manufacturers incur costs. FDA only occasionally requires the submission 

of clinical data for class II devices. Specifically, FDA requires 

manufacturers of class III devices to submit clinical data as part of the 

PMA process to provide reasonable assurance that the devices are safe 

and effective for their intended uses. During its review of a device’s PMA 

application, FDA may require that the manufacturer provide additional 

information, which may require submission of additional clinical data. 

Manufacturers of class III devices stated that to collect clinical data, they 

conducted costly animal studies, human preclinical studies, and human 

clinical trials. Manufacturers of class II devices must satisfy premarket 

notification requirements; that is, they must submit documentation that a 

device is substantially equivalent to a legally marketed device. An FDA 

official stated that manufacturers of class II devices may be required to 

provide clinical data. They may be required to provide these data, for 

example, to demonstrate that modifications they have made to a device 

would not significantly affect its safety or effectiveness, or if a device is to 

be marketed for a new or different indication. According to FDA, 10 to 

15 percent of premarket notification applications include clinical data. 

Manufacturers of class III devices we spoke with stated that in addition to 

collecting clinical data, they incur higher premarketing costs related to 

other research and development, such as labor costs and manufacturing 

supplies related to designing a device, than do manufacturers of other 

classes of devices. They stated that class III devices are highly innovative, 

complex products that require costly premarketing research and 

development to produce. One class III manufacturer we spoke with stated 

that approximately 10 percent of its revenue between 2002 and 2005 was 

invested in premarketing research and development. Another class III 

manufacturer stated that approximately 4 percent of its operating budget

is spent on premarketing research and development. 

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

application was received. 

Page 8 GAO-06-62 Medicare Payment for Durable Medical Equipment
However, manufacturers of class II devices we spoke with also stated that

they incur substantial premarketing costs related to research and 

development. Specifically, we spoke with a manufacturer of an insulin 

pump and two manufacturers of continuous positive airway pressure 

devices,15 each of which stated it incurs substantial research and 

development costs. One class II manufacturer stated that 10 to 15 percent

of a device’s total cost was attributable to research and development. 

Another class II manufacturer stated that approximately 7 to 10 percent of 

its revenue is spent on research and development. Because we did not 

evaluate proprietary data for other premarketing research and 

development costs, we were unable to determine whether a difference in

other premarketing research and development costs exists between class

III and class II manufacturers. 

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 

DME Fee Schedule 

Rate-Setting 

Methodology 

Accounts for 

Premarketing Costs of 

Class II and III 

Devices in a 

Consistent Manner 

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

apnea. 

Page 9 GAO-06-62 Medicare Payment for Durable Medical Equipment
upon which to base the payment rate. CMS has determined that in these 

cases, the manufacturer’s retail price is a sufficient substitute to calculate 

the fee schedule payment amount, and CMS considers the payment 

amount that results from this methodology to be equivalent to historic 

reasonable Medicare charges. To determine the payment rate, CMS 

obtains the manufacturer’s retail price for the new item and uses a formula 

based on the cumulative annual percentage increase in the CPI-U to 

deflate the price to what it would have been in the base year. Using a 

formula based on the statutory DME fee schedule payment updates since 

the base year, CMS then inflates the base year price to the year in which 

the item was added to the fee schedule. In succeeding years, the item is 

updated by the applicable DME fee schedule update. The cumulative 

updates applied to DME are lower than the corresponding CPI-U increases 

because, in certain years, the statutory update was less than the CPI-U 

increase.16 Therefore, the payment rate of a device is generally lower than 

its retail price. 

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. 

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. 

Conclusions 

 16In 1991 and 1992, the statutory update was the annual percentage increase in the CPI-U 

reduced by 1 percentage point. In 1998, 1999, 2000, and 2002, the statutory update was 0

percent. 

Page 10 GAO-06-62 Medicare Payment for Durable Medical Equipment
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. 

The Congress should consider establishing a uniform payment update to 

the DME fee schedule for 2008 for class II and class III devices. 

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. 

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. 

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 

Matter for 

Congressional 

Consideration 

Recommendation for 

Executive Action 

Agency and External 

Reviewer Comments 

and Our Evaluation 

HHS Comments 

Page 11 GAO-06-62 Medicare Payment for Durable Medical Equipment
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, 

Page 12 GAO-06-62 Medicare Payment for Durable Medical Equipment
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 caseby-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 ratesetting 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.

Page 13 GAO-06-62 Medicare Payment for Durable Medical Equipment
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. 

Kathleen M. King 

Director, Health Care 

Page 14 GAO-06-62 Medicare Payment for Durable Medical Equipment
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 

Page 15 GAO-06-62 Medicare Payment for Durable Medical Equipment
Appendix I: Scope and Methodology Appendix I: Scope and Methodology 

To address our objectives, we interviewed officials from the Centers for 

Medicare & Medicaid Services (CMS); the Food and Drug Administration

(FDA); two of the four durable medical equipment (DME) regional 

carriers, the contractors responsible for processing DME claims; and the 

Statistical Analysis DME Regional Carrier, the contractor that provides 

data analysis support to CMS. To examine the premarketing costs of 

devices, we obtained the fees that FDA charges for device review, known 

as user fees, which are published on the FDA Web site. We also reviewed 

the FDA device approval process, and data on device review times from 

FDA’s Office of Device Evaluation’s 2004 Annual Report. We interviewed 

the four manufacturers of osteogenesis stimulators and one manufacturer 

of both implantable infusion pumps and automatic external defibrillators, 

all class III medical devices, about the types of costs they incur in 

producing the devices, including FDA fees for device review and the costs 

of research and development, both for any clinical data the manufacturer 

is required to submit and for other research and development costs, such 

as labor costs related to designing a device. These class III manufacturers’ 

devices accounted for over 96 percent of class III Medicare DME payments 

in 2004. We also spoke with a manufacturer of insulin pumps and two 

manufacturers of continuous positive airway pressure devices, class II 

devices on the DME fee schedule that CMS identified as similar to the 

class III devices on the schedule in terms of complexity. We did not 

evaluate proprietary data to determine whether a difference in other 

premarketing research and development costs exists between the two 

types of manufacturers. 

To determine how the DME fee schedule accounts for premarketing costs, 

we interviewed CMS officials and reviewed CMS documents on the DME 

fee schedule rate-setting methodology. We interviewed representatives 

from the Advanced Medical Technology Association; the American 

Academy of Orthopedic Surgeons; the American Society of Interventional 

Pain Physicians; and two private insurance companies. 

We conducted our work from December 2004 through February 2006 in 

accordance with generally accepted government auditing standards. 

Page 16 GAO-06-62 Medicare Payment for Durable Medical Equipment
Appendix II: Comments from the Department of Health and Appendix II: Comments from the Department Human Services

of Health and Human Services 

Page 17 GAO-06-62 Medicare Payment for Durable Medical Equipment
Appendix II: Comments from the Department of Health and

Human Services

Page 18 GAO-06-62 Medicare Payment for Durable Medical Equipment
Appendix III: GAO Contact and Staff Acknowledgments 

Page 19 GAO-06-62

Appendix III: GAO Contact and Staff 

Acknowledgments 

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

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. 

 Medicare Payment for Durable Medical Equipment

Acknowledgments 

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